Committee for Russian Economic Freedom

Serfs

Russian natural resource minister Yuri Trutnev annoucned that TNK-BP’s licence to develop the Kovykta gas field will be handed over to the state, where Gazprom has a natural gas monopoly. Although TNK-BP was in discussions to sell Kovykta to Gazprom for $1 billion, the transaction was never comnpleted and it appears TNK-BP will walk away from Kovykta with nothing.

Details of TNK-BP’s travails are covered in a previous post, but it’s worth rementioning that in 2007 the Kremlin passed a law restricting all gas exports to public entities, yes, Gazprom. Although the recent Reuters article touches upon weakening demand for natural gas, it neglected to mention that Kovykta is located in the eastern Russia and TNK-BP was developing those fields for natural gas export to energy hungry China. According to China’s official news agency Xinhua, China’s natural gas consumption is forecasted to more than double over the next ten years.

President Medvedev’s visit to California’s Silicon Valley last week focused on Russia’s ambition to make Skolkovo into Innovation City. But as a Moscow Times op-ed mentions, the President and the government must restore trust in government procedures and laws of the land. Only through the re-establishment of trust can Russia foster the kind of environment entrepreneurs, engineers and venture capitalists need to create and execute new ideas and projects. As an indication of his commitment, Medvedev signed along with other G20 leaders their commitment to combatting corruption and protecting whistle blowers by creating a committee that will eventually draft rules for all G20 members.

While the Skolkovo project renews debate over the successful path of Russia as a state capitalist country versus democratic capitalist nations, financial commentators have renewed interest in Friedrich Hayek, Nobel Prize winning economist. Counter to John Maynard Keyes who wrote about the importance of governmental intervention, Hayek warned against government intervention as it would lead to serfdom. Having experienced serfdom for centuries prior to 1861, Russia is at a political and economic crossroad. Will Medvedev’s commitment to innovation, rule of law and transparency extend to the coming presidential election in 2012, or will a perceived tainted election redirect Russia’s political and economic path towards greater government control and, serfdom?

San Jose Mercury News
By Jamison Firestone
Special to the Mercury News
Posted: 06/23/2010 08:00:00 PM PDT

Russian President Dmitry Medvedev visited Silicon Valley this week in hopes of wooing executives to invest in Russia. But as high-tech leaders think through the pitch, they might want to consider what could happen when their Russian investments are up and running.

I am a member of the New York Bar who’s served on the board of directors of the American Chamber of Commerce in Russia for the past six years and managed a law firm in Moscow for 17 years. My firm represented the largest foreign investor in Russia, Hermitage Fund, which once had more than $4 billion invested there.

In 2007, officials from the Moscow Interior Ministry raided my offices and my client’s offices and took all of Hermitage Fund’s statutory documents and seals. Even the Russian government now concedes in Moscow court filings that those documents and seals were then used to fraudulently re-register the companies into the name of a convicted killer. A criminal group subsequently applied for a refund of the $230 million of taxes that the Hermitage Fund paid in 2006. The payment was granted in one day, no questions asked. It was the largest tax refund in the history of Russia, a country where even the smallest refunds take months, if not years.

Hermitage hired five law firms to report the thefts and recover the stolen companies. In the two years that followed, I personally witnessed Russian officials implicated in the crimes attempting to arrest every lawyer who was involved in the investigation or reporting of the thefts. In a classic case of Kafkaesque absurdity, two of Russia’s most famous and respected lawyers were criminally prosecuted for reporting the theft. They fled the country.

third respected corporate lawyer, my partner Sergei Magnitsky, refused to flee Russia because he thought the law would protect him. He testified against the corrupt officials. One month after his testimony, he was arrested by the very officials he testified against. The next day, they tried to arrest three more lawyers, all of whom fled Russia.

Magnitsky was kept in pre-trial detention for 12 months and was tortured to get him to withdraw his testimony, but he refused. On Nov. 16, 2009, Magnitsky died as a result of torture at the age of 37, leaving a wife and two young boys.

Since then, it became public that the same group of officers and criminals had been accused of similar crimes in the past. It was also discovered that immediately after the thefts were reported, the officers’ families acquired millions of dollars in assets.

Like many people, I find Medvedev confusing. He speaks about fighting corruption, building rule of law and fostering investment, but Russia’s level of corruption continues to increase. Silicon Valley may see him as the first Russian leader to surf the Web and use e-mail, but television news still is under state control, and independent journalists, human rights activists, businessmen and now their lawyers are arrested and killed with impunity.

I would like to believe that Medvedev is sincere. But he has done nothing to bring Sergei’s killers to justice, to find the stolen government money, to help my client recover its companies or to stop the attacks on lawyers.

What happened to my client can happen to anyone doing business in Russia, and no law firm in the world can defend you in a land without law. Large companies that were sure they would have government support, like Shell, BP, Carrefour, Telenor and Ikea, were left to the wolves. In each case, the Kremlin either attacked or allowed corrupt officials to attack foreign investors that bought into the same pitch you just heard.

Caveat emptor.

JAMISON FIRESTONE is managing partner of Firestone Duncan, Moscow. He wrote this article for this newspaper.

Russian President Dmitry Medvedev looks through 3D glasses at an exhibition at the economic forum in St. Petersburg, Russia, Saturday, June 19, 2010. (AP Photo/Dmitry Lovetsky)

Just a few weeks ago Putin was front and center with his visits to Istanbul and Paris, negotiating foreign policy disputes over UN sanctions against Iran. He even made comments about his tandem leadership with Medvedev that Kremlinologist have interpreted to mean that Putin as no choice but take over the reins in 2012, lest Medvedev actually execute his modernization plans by reducing 160,000 bureaucrats and nearly 300,000 policemen. Of course not all of these government employees have profited from Putin’s rein at the helm but they benefit from the existing “old” system (“budget inefficiency and a resource-based economy” as Arkady Dvorkovich, Medvedev’s top economic advisor put it.)

What a difference a few weeks make.

This week President Medvedev is visiting Silicon Valley to drum up support for a Russian Silicon Valley in Skolkovo outside Moscow. Despite a more promising outlook for Russia’s growth this year, in order for Medvedev’s modernization to be realized, laws must be enacted and enforced.

Another hinderance to Medvedev’s efforts is widespread corruption in the country, equivalent to a third of the country’s GDP annually. The death of Sergey Magnitsky while in pre-trial detention hangs like a cloud. Today, Magnitsky’s business partner Jamison Firestone released a video documenting what the government officials who are responsible for Magnitsky’s death are doing with their ill-gotten fortunes.

Beyond the Magnitsky tragedy the Khodorkovsky trial is a symbol of the lack of property rights in Russia and is costing Russian companies a risk premium as foreign investors demand greater compensation for this political risk.

Leon Aron, director of Russian studies at the American Enterprise Institute wrote in the Los Angeles Times that:

The road to a Russian Silicon Valley starts not in California, Mr. President. It begins with unlocking the door to Mikhail Khodorkovsky’s jail cell.

This is a critical time for Russia’s development as an emerging market. It remains to be seen if Medvedev’s modernization initiatives will be allowed to proceed and allow Russia to develop in an ever crowded global economic playing field or will the presidential election of 2012 reaffirm the Kremlinologists prediction that Putin will rein in liberalizing efforts and lead Russia down the path of increased centralization in government and government oversight of business and trade.

Los Angeles Times
The government is building a Russian version of Silicon Valley. But the Kremlin’s Big Brother approach, along with lawlessness and corruption, leaves entrepreneurs wary of taking risks.
Leon Aron
June 23, 2010

Having survived — barely — an 8% contraction in its gross domestic product (the worst among the G-20 countries), Russia’s prospects for the next few years are iffy at best. Unless oil shoots back up to more than $100 a barrel, the country’s economy may grow only slightly — or stagnate for the next few years.

In response to its economic woes, the Kremlin has decided that what Russia needs is the equivalent of a Silicon Valley. And so the government is building “Innovation City” in Skolkovo, just outside Moscow. The project is envisioned as a kind of free entrepreneurial zone, aimed at attracting the best and the brightest from Russia and abroad. The Kremlin has appropriated $3.5 billion to build the “technopolis” — a gated community surrounded by guards

This is hardly a new strategy. Importing ideas and technology from the West has been a key element in Russia’s “modernizations” since at least Peter the Great in the early 18th century. For two centuries, Russian leaders followed in the czar’s footsteps, including when Stalin implemented his five-year plans. But Russia has tightly controlled what it imported. Machines and engineers, yes. A spirit of free inquiry, a commitment to innovation free from bureaucratic “guidance” and, most importantly, encouragement of brave, even brash, entrepreneurs who can be confident they will own the results of their work — most certainly no.

Peter and his successors sought to produce fruit without cultivating the roots. During the 17th and 18th centuries, this approach could be seen in the Nemetskaya sloboda (German district), where foreign craftsmen lived but Russians were not allowed lest they be tainted by foreign influences.

When national economies were defined by the amount of pig iron, steel and coal they produced, a serf or a worker with no rights would do. They could cast Peter’s cannons and pour concrete for the plants of Stalin’s industrialization. But only a man or woman free from fear and overseers can build a Silicon Valley.

And such men and women are harder and harder to come by in Russia today. Disgusted and scared by the lawlessness and rampant corruption, they tend to shy away from ambitious plans and avoid taking risks.

To be fair, President Dmitry Medvedev, who will visit California’s Silicon Valley this week, is aware of the problems and says all the right things about the need for liberty, private property and a spirit of unfettered innovation. He speaks of the importance of the rule of law. But after two years in power, he is losing credibility, and his words are wearing thin. “How are things, really?” I recently asked a top Russian entrepreneur, having made sure that no one could hear us. “Poka ne trogayut,” he answered. “They are not after me yet.” Hardly an environment for an innovation-driven business model.

Paralyzed with fear and uncertainty, Russian entrepreneurs are investing very little in their country beyond their immediate production needs. Up to 80% of investment in Russia today comes from the government. Capital flight is rampant. Worse yet, according to recent research, some of the most successful Russian entrepreneurs, not satisfied with merely sending their children to live and study in the West, increasingly think of selling their businesses and leaving themselves. At the very least, almost all are building their lives and business around the “two-home” model: one in Russia, one in the West.

Today’s atmosphere is a far cry from the end of the 1990s and first few years of this century. Then, with the worst of the rough-and-tumble, raw and crude capitalism behind it, Russia seemed as if it would soon be capable of forging its silicon valleys. State power seemed to be finally detaching itself from property, and top Russian entrepreneurs, newly confident of their property rights, began to invest billions of dollars to create companies every bit as modern, efficient and open as the leading Western conglomerates. With their profits, they donated millions to charity, promoted computer literacy and Internet availability and invested in a “knowledge-based” economy.

One company and its entrepreneurial leader stood as symbols of the new business environment: the oil company Yukos and its chief executive and principal owner Mikhail Khodorkovsky. Today, the company is no more. It was taken over by the state for alleged nonpayment of taxes, broken up and sold at rigged actions to the state-owned Rosneft. Convicted by a kangaroo court on charges of fraud and sentenced to eight years in prison after his 2005 trial, Khodorkovsky today is in the middle of another farce of a trial, accused of stealing 350 million tons of oil from Yukos’ subsidiaries.

The road to a Russian Silicon Valley starts not in California, Mr. President. It begins with unlocking the door to Mikhail Khodorkovsky’s jail cell.

Leon Aron is director of Russian studies at the American Enterprise Institute.

(Russian) CREF Chairman’s Letter to St. Petersburg Economic Forum Attendees

The CREF letter sent to forum attendees has also made it into media.  Reuters and the Moscow Times recently posted the article below. The entire letter is in the previous post.

Ex-YUKOS lawyer warns Russia forum guests

* Previous YUKOS lawyer says Russia dangerous for business
* Sent e-mail to 1,000 Russian forum participants

By Jessica Bachman

MOSCOW, June 11 (Reuters) – A week before Russia rolls out its largest annual economic forum, an ex-lawyer for YUKOS who currently heads a nonprofit organization promoting transparency in business warned almost 1,000 foreign participants against going into the event with rose-colored glasses.

In a mass e-mail sent late on Thursday, Pavel Ivlev, who fled Russia in 2005 and now leads the Committee for Russian Economic Freedom, reminded participants including Citigroup (C.N) Chief Executive Officer Vikram Pandit and ConocoPhillips (COP.N) head James Mulva that Russia is an “extremely dangerous” place to do business.

“As you listen to Russian officials and businessmen discuss potential gold mines in investing in Russia, be mindful that there are numerous land mines as well,” reads the final line of his e-mail.

Several European leaders, including French President Nicolas Sarkozy, are expected to attend the international economic forum, which opens in Russia’s second city of Saint Petersburg on June 17.

The three-day event is Russia’s answer to Davos in Switzerland, where foreign corporate and political leaders come to clinch billions of dollars worth of contracts and hobnob with the creme de la creme of Russia’s political and business elite.

Ivlev, a former lawyer for oil firm YUKOS, told Reuters on Friday his e-mail was a “call to action.”

“I am not suggesting a boycott of the forum; rather I am calling on the business community to stop being quiet and start speaking out about the lack of transparency and rule in law in Russia,” he said by telephone from the United States.

Ivlev worked for an independent law firm in Moscow that represented YUKOS, the former oil giant dissolved by the Kremlin and bankrupted in 2007.

Charges were brought against Ivlev in 2005 for theft, money laundering and helping YUKOS in tax evasion schemes, two years after his client, the company’s former CEO Mikhail Khodorkovsky, was arrested and jailed.

Khodorkovsky, in prison in eastern Siberia, is now facing a second round of trials, also on charges of theft and money laundering. (Reporting by Jessica Bachman)

The 2010 St. Petersburg International Economic Forum will start next week on June 17. This is a key capital markets event for investors, business people and policymakers and supported by the Russian Federation. Talk about the economy and banking is everywhere. This neatly dovetails into Russia’s own focus on economics as the main engagement point with other countries, especially those in the G20. Below is a letter from CREF’s Chairman Pavel Ivlev to forum attendees.

CREF Chairman’s Letter to St. Petersburg Economic Forum Attendees

Zuma Press - Gazprom company worker places a Russian flag on the Nord Stream pipeline last month. The pipeline will run from Russia to Europe.

With the arrival of Ian Bremmer’s new book, “The End of the Free Market: Who Wins the War Between States and Corporations?” the future of the global economy has been set up as an epic battle between state capitalists like China and Russia and free-market capitalists like the US, EU, Japan and Canada.

State capitalists are defined by their domination of strategic assets and creation of wealth that is used to maintain and enrich the political leadership. State capitalists also tilt the marketplace in favor of state-owned companies and put multi-national corporations at a disadvantage through laws and regulations. An example of this from Ian Bremmer in the Wall Street Journal:

In December 2006, the Russian government informed Shell, Mitsubishi and Mitsui that it had revoked their environmental permits as project managers for the $22 billion Sakhalin 2 project, forcing them to halve their respective holdings and give Gazprom, Russia’s natural gas monopoly, a majority stake. This instantly wiped out 2.5% of Shell’s global reserves.

Russia is a model state capitalist as the Kremlin consolidates control over the country’s vast oil and gas reserves and increasingly pressure multi-nationals to sell their companies to state-owned entities. This recently happened with one of BP’s investments in Russia, RUSIA Petroleum.

BP purchased the Kovykta natural gas field back in the early 1990s because of its proximity to China and its enormous reserves. It created a joint venture with local businessmen to create TNK-BP. Before they could make any money, TNK-BP invested hundreds of millions of dollars to develop the infrastructure and pipelines needed to get the Kovykta gas to China.

As the project developed more Russian officials took notice and in 2007 TNK-BP was pressured to sell RUSIA Petroleum to Gazprom, Russia’s state-owned oil and gas company. That same year, the Kremlin passed a law prohibiting private gas exports from Russia, institutionalizing Gazprom’s monopolistic position.

With Gazprom the only buyer of RUSIA Petroleum and government officials dictating not only the pipeline start date but also insisting on a northern, circuitous route, RUSIA Petroleum could not get natural gas to consumers and fell behind on its loan repayments. TNK-BP, which was a creditholder to RUSIA Petroleum, is trying to recoup some of its losses by filing for bankruptcy. It will be seen whether the officials of Russia’s state government give some of TNK-BP’s money back.

Situations such as these make President Dmitry Medvedev’s goal of transforming Moscow into a global financial center and the next Silicon Valley even less likely. Matt Marshall, the only US reporter on a recent venture capitalist tour, was invited to visit Russia as part of the Kremlin’s plan to encourage more foreign direct investment. His critical assessment of Russia’s investment potential is probably not the press the Kremlin was hoping for:

Russia is the sixth-largest economy in the world, but it’s also a country relatively untouched by foreign investors, especially investors in technology. Could Russia potentially be the home of the next massive tech boom?

The short answer is: No way. At least not anytime soon. That’s the conclusion I’ve come to after a week in Moscow, a week in which I took part in the first ever delegation of US venture capital investors to visit Russia.

Now, of course, I’d be delighted if I could report that this Russia is the next India, China or Israel — all places that have seen massive foreign investment in recent years. Russia has among the highest per capita number of students in the world, boasts high levels of mathematics and science education, and being in desperate need of modernization, you’d think Russia would be a gold mine for investors. President Medvedev greeted the delegation, and made clear that technology is needed to diversify from Russian oil, gas and metals — which make up 80 percent of Russia’s total exports. That legacy industry is highly influenced by a group of about 22 so-called oligarchs — many of them exerting their power behind the scenes through corruption. Technology entrepreneurship, if it is fostered, will lead to positive change — there is no question. Everyone agrees.

But investing in Russia can be “insanity.”

The more time I spent in Russia, the more complex the story became (and I’m not the first to say that about Russia). The more I learned — about corruption, the abuses of the courts, the terribly archaic educational system, the choked up traffic, the lack of investment in infrastructure, the cultural penchant for Hobbesian brute leaders, the lack of a truly independent media, and the assassination of journalists when they do show independence — the harder it is for me see a positive short-term future for U.S.-style tech investment for this country.

EDITORIALS
Wednesday, June 9, 2010

RUSSIA’S GOVERNMENT has calculated that it needs better relations with the West to attract more foreign investment and modern technology, according to a paper by its foreign ministry that leaked to the press last month. Prime Minister Vladimir Putin has recently made conciliatory gestures to Poland, while President Dmitry Medvedev sealed a nuclear arms treaty with President Obama. At the United Nations, Russia has agreed to join Western powers in supporting new sanctions against Iran.

Moscow’s new friendliness, however, hasn’t led to any change in its repressive domestic policies. The foreign ministry paper says Russia needs to show itself as a democracy with a market economy to gain Western favor. But Mr. Putin and Mr. Medvedev have yet to take steps in that direction. There have been no arrests in the more than a dozen outstanding cases of murdered journalists and human rights advocates; a former KGB operative accused by Scotland Yard of assassinating a dissident in London still sits in the Russian parliament.

Perhaps most significantly, the Russian leadership is allowing the trial of Mikhail Khodorkovsky, a former oil executive who has become the country’s best-known political prisoner, to go forward even though it has become a showcase for the regime’s cynicism, corruption and disregard for the rule of law. Mr. Khodorkovsky, who angered Mr. Putin by funding opposition political parties, was arrested in 2003 and convicted on charges of tax evasion. His Yukos oil company, then Russia’s largest, was broken up and handed over to state-controlled firms.

A second trial of Mr. Khodorkovsky is nearing its completion in Moscow, nearly a year after it began. Its purpose is transparent: to prevent the prisoner’s release when his first sentence expires next year. The new charges are, as Mr. Putin’s own former prime minister testified last week, absurd: Mr. Khodorkovsky and an associate, Platon Lebedev, are now accused of embezzling Yukos’s oil production, a crime that, had it occurred, would have made their previously alleged crime of tax evasion impossible.

Mr. Khodorkovsky, who acquired his oil empire in the rough and tumble of Russia’s transition from communism, is no saint, but neither is he his country’s Al Capone, as Mr. Putin has claimed. In fact, he is looking more and more like the prisoners of conscience who have haunted previous Kremlin regimes. In the past several years he has written numerous articles critiquing Russia’s corruption and lack of democracy, including one on our op-ed page last month.

Mr. Obama raised the case of Mr. Khodorkovsky last year, and the State Department’s most recent human rights report said the trial “raised concerns about due process and the rule of law.” But the administration has not let this obvious instance of persecution, or Mr. Putin’s overall failure to ease domestic repression, get in the way of its “reset” of relations with Moscow. If the United States and leading European governments would make clear that improvements in human rights are necessary for Moscow to win trade and other economic concessions, there is a chance Mr. Putin would respond. If he does not, Western governments at least would have a clearer understanding of where better relations stand on the list of his true priorities.

Today’s NYTimes article reinforces Yuri Schmidt’s op-ed in the Wall Street Journal on the show trial of Mikhail Khodorkovsky and lends support to Khodorkovsky’s assertions in his Washington Post op-ed that Russia’s great export is corruption.

Although most obvious impact is on the political prisoners, Russia’s attractiveness as an investment takes a hit as well. Recent declarations by President Medvedev and various ministers about the shift in foreign policy to focus on investment and technology should not put blinders on investors.