Committee for Russian Economic Freedom

It’s been a month since President Medvedev’s visit to Silicon Valley and burger lunch with President Obama. And almost a year since Medvedev’s “Forward Russia!” speech introducing his modernization efforts at diversifying the economy and promoting home grown technology.

Despite Medvedev’s words and perhaps good intentions, his plans to reduce the police force have stalled and his executive order ending pre-trial detention for economic charges ignored by the courts. All of this points to his “non-leadership” as Pavel Baev points out in the Eurasia Daily Monitor.

There is a strong demand for “for-of-the-same” in the welfare-oriented society and in the predatory bureaucracy, so Putin’s message is conveyed easily–and his authority unshakeable. Medvedev’s discourse of “modernization” remains foreign, and his attempts to encourage innovations are treated with the same ironic indifference as Nikita Khrushchev’s orders to introduce corn after his “historic” visit to the US in 1959. Medvedev is often reduced to complaining about the sabotage of his orders, which only signals to bureaucrats opposed to modernization that real executive power remains out of his grasp.

Civil liberties of different kinds depend on each other and Medvedev’s initiatives have had little effect on shifting Russian into a more open society.

The Russian Interior Ministry today reported that bribes have doubled since last year to $1,320 per occurence on average. And overall, the Russian economy leaks $300 billion as the result of bribes. With only 10%  going to rank-and-file policemen, that leaves a large chunk of change for provincial and Kremlin authorities.

And what could Russia do with an extra $300 billion in its coffers? Repair infrastructure, for sure, invest in alternative fuels or new techonologies, reducing its dependence on foreign investment to diversify the economy or perhaps postpone the largest state asset sale since the early 1990s.

Corruption remains pervasive and the current power structure is unwilling to kill the golden goose. Sergey Magnitsky died in pre-trial detention for refusing to renounce corruption activities of senior Kremlin officials. With much fanfare, Medvedev launched an investigation into his untimely death, but the investigation has stalled. According to Valery Borshchev, head of the government oversight panel responsible for the investigation into Mr. Magnitsky’s death,

They’re dragging their feet because some very important figures are implicated

Aleksei Dymovsky, the YouTube policeman, whose video galvanized a country inured to corruption spoke about his new quest to raise a grassroots campaign against corruption. He knows it won’t be easy as someone who participated in the pyramid corruption scheme that required police officers to hand off that day’s bribes to a “cashier,” a senior member of the police force. Those who didn’t comply were reprimanded.

The dubious charges against Russia’s mobile phone king, Yevgeny Chichvarkin show how hard it is for companies to do business in Russia, even domestic ones. The problems started for Chichvarkin in 2006 when he refused to pay bribes in order to prepare his accounting books for an initial public offering in London. His refusal resulted in the confiscation of $20 million of Motorola phones and the current charges against him. Motorola was his largest corporate partner and suffered huge losses when Department K, the interior ministry’s economic crimes division, released false warnings about the safety of their mobile phones. Motorola’s market share has dropped from 20% in 2006 to less than 1% where it is today.

Cisco has pledged a $1 billion investment in Skolkovo but John Chambers should have scratched Russia’s surface a little deeper.

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.

Alexander Zemlianichenko Jr./Bloomberg

Despite President Medvedev’s modernization initatives creating a Russian Silicon Valley, establishing of an international financial center as well as a new Russian identity, fundamental elements in the Russian economy and society remain broken. 

The recent spasms caused by the Eurozone’s response to Greece’s potential default have roiled global markets, erased gains for the year and pushed markets back levels from last fall. Russia’s stock market have followed suit and is now below its 200-day moving average. These global economic winds are difficult to manage as Russian IPOs continue to be delayed such as the $300 million RusAgro and the $200 million Strikeforce Mining & Resources (SMR).

However other IPO postponements can’t be simply chalked up to poor credit markets: Uralchem’s $600 million IPO was pulled after failing to meet ecological standards and Rusal, the first Russian company to IPO on the Hong Kong Stock Exchange, has fallen 31% from its IPO price, which is sowing doubts in foreign investors’ minds about the long-term profitability of debt-ladden Russian companies. It also doesn’t build investor confidence when Rusal’s CEO Oleg Deripaska gives himself a $70 million IPO bonus three months after Rusal’s IPO even as the stock continued its slide.

Russia’s infrastructure problems are well-known internally and externally, given Moscow’s predilection for putting politics ahead of economic concerns. In the latest World Competitiveness Yearbook 2010 from Swiss business school IMD in Lausanne, Russia’s ranking continues to decline in comparison to other BRIC countries despite its natural resource and higher GDP advantages. The Yearbook notes:

Russia is richer than it is competitive. Per capita GDP ranks 38th in the world, but its IMD ranking has slipped eight positions since 2007 to 51st—the lowest among the so-called BRIC countries. Among the main reasons: poor productivity and efficiency, weak management practices, unfavorable prices, and low marks for health/environment. Russia does a lot better in scientific infrastructure, fiscal policy, and international investment.

Attention was drawn to Russia’s lack of rule of law and corruption this week through the hunger strike of Mikhail Khodorkovsky and New York Times report on unsolved attacks on journalists who report on local corruption.

Khodorkovsky’s hunger strike sought to raise awareness that the legal reforms signed by President Dmitry Medvedev on April 7, 2010 are being sabotaged. The law, which resulted from President Medvedev’s efforts to halt abuses by officials of the criminal justice system from attacking legitimate businesses, and to make criminal law more humane after the death of Sergei Magnitsky, ordering that the courts can no longer use arrest as a pre-trial measure of restraint in cases involving allegations of certain economic crimes, including the alleged crimes in Khodorkovsky’s ongoing case. Through an intermediary, President Medvedev acknowledged Khodorkovsky’s plea and so ended the hunger strike.

According to the Committee to Protect Journalists, 32 reporters have been killed since the end of the Soviet Union and the beginning of perestroika and glasnost. As these unsolved persecutions show, corruption in Russia seeps down from above and spreads from below unchecked by any semblance of law or justice.

Khodorkovsky’s second trial continues to display the kind of “legal nihilism” Medvedev claims to end. Yuri Schmidt in today’s Wall Street Journal writes that François Zimeray, the French Ambassador for Human Rights visited the court last month, observed that :

“Mikhail Khodorkovsky’s resistance to being broken by the system has made him an icon for defenders of human rights.” He concluded that not just one man, but rather Russia’s future, is on trial.

For President Medvedev’s modernization to take place, much more needs to be done than creating fantasy technology and financial centers and redefining the national character.

Reuters recently released an article outlining three key risks in Russia: the variable price of oil, political shake up in the Kremlin and further insurgency attacks. Though the world’s largest energy producer, Russia’s manufacturing, construction and retail industries continues to contract as domestic consumption and foreign investment continues to lag, increasing the economy’s dependence on oil prices for growth.

Prime Minister Vladimir Putin remains popular and the driver behind the co-governance team with President Dmitry Medvedev. Despite highlighting their differences and indicating Medvedev’s intentions of political and judicial reform, Reuters notes that Russian markets would rebound only if Putin remained in place. The maintenance of the status quo despite Russia’s world renown for government corruption and weak rule of law seems curious. With foreign investors, such as IKEA, Hermitage Capital, and now HBK investments scaling back or pulling out of Russia due to corruption and extortion, why would the markets value Russian companies more if the status quo remained?

And how does the continued expropriation of private business by government officials add to Russia’s economic capital?

The extraction of Russia’s economic and natural resources by the politically connected few leads to only self-enrichment. Perhaps this self-enrichment would be tolerable if the proceeds were reinvested in Russia and the Russian people, but this is rarely the case. What Russia needs is investment to update oil and pipeline infrastructure, capital to encourage innovation and a stronger rule of law to benefit all Russian people.

Russia’s most famous political prisoner, Mikhail Khodorkovsky began his spirited defense yesterday against his Kafka-esque second trial. The government charged Khodorkovsky and his business partner Platon Lebedev with stealing 2.5 billion barrels of YUKOS’s crude oil or a third of the United States’ entire annual consumption of oil.

The trial is also viewed domestically and abroad as a test of Medvedev’s commitment to ending “legal nihilism” and his power and control within the Kremlin. Medvedev even started a national anti-corruption drive this March. According the Associated Press,

The trial is considered a test of whether President Dmitry Medvedev, himself a lawyer, is serious about reforming Russia’s judicial system. In other cases, judges have come forward to complain they face political pressure.

Only time will tell if Medvedev makes good on his words.

At World Economic Forum this year, Russian officials headed by Finance Minister Alexei Kudrin were no where to be seen. Ian Bremmer, head of the foreign policy think tank Eurasia Group blogged that

Russia as a topic generally comes across as a negative in global circles–revisionist geopolitics, resource nationalism, and strongly authoritarian (albeit charismatic, in a fashion) domestic leadership.

Those negative sentiments were backed up by 75% of Russian businessmen attending Davos and predicting another year of stagnation or further economic decline.  This mood was backed up by dismal economic numbers in 2009. The Russian economy shrank 7.9%, the most in 15 years and analysts forecast the economy to shrink by 8.5% in 2010.

Although President Dmitry Medvedev keeps up the positive drumbeat on foreign investment in Russia, business leaders are more circumspect, expressing concerns over instiutional corruption stifling economic development and entrepreneurial spirit. German Gref, CEO of Russia’s largest bank Sberbank talked about

…the mood of fear gripping the private sector since the state take over oil major YUKOS several years ago.

Former YUKOS CEO Mikhail Khodorkovsky wrote in last week’s New York Times op-ed piece that Russia only exports gas and corruption and its refusal to see the limits of a state-controlled petro-economy is taking Russia down the path to becoming

a classic third-world style, raw materials-based economy, where corruption is the norm rather than the exception and there is no working system of democratic and social institutions.

At an international conference in Moscow, Deputy Prime Minister Igor Shuvalov, who also happens to be the head of Russia’s anti-crisis program, mentioned two impediments to Russia’s economic development: lack of private property rights and an over dependence on oil and other raw materials to drive economic growth.

US Ambassador to Russia John Beyrle included these challenges in his speech at University of Michigan’s Ford School of Public Policy last week. Ambassador Beyrle cited corruption and the lack of rule of law in Russia as impediments to both foreign investment and the development of a democratic society.

On corruption, Ambassador Beyrle said,

Russia is still a very tough place to do business. The combination of bureaucratic and administrative obstacles intertwined with pervasive corruption in Russia still constitutes a pretty significant risk premium for American investors and American businessmen who want to enter the Russian market or grow their businesses.

And on the rule of law in Russia, he said,

Corruption in the Russian government and especially in the judicial system…is still rampant in Russia. The road ahead for Russia is not completely clear.

What both Deputy Prime Minister Shuvalov and Ambassador Beyrle recognize is reflected in the Heritage Foundation’s Index of Economic Freedom out this week. Russia’s overall rating in this measurement of economic openness, regulatory efficiency, the rule of law and competitiveness, dropped 10.5 points to 50.3 this year. Ten different components make up the overall score and Russia’s three lowest scores are in the Investment Freedom, Property Rights and Freedom from Corruption categories.

‘The problems of systemic corruption, abuse of property rights and legal nihilism are well known and recently publicly discussed by top US and Russian officials. The question is what, if anything, are they going to do with these impediments to Russia’s economic growth? Besides talking about “reset” or “modernization,” do they have the political will to find solutions to these issues?

After dragging its feet for four years, the Russian parliament ratified the European Court of Human Rights’ (ECHR) Protocol 14 earlier today. Russia had been the only country out of 47 participating states to refuse to ratify Protocol 14, which improves the efficiency of the Court. The current process has created a backlog of complaints, a third of which are filed against Russia.

Dmitri F. Vyatkin, Russian Parliamentary member mentioned that the impasse was overcome because the ECHR had addressed Russia’s concerns by providing written commitments that Russian judges would be included in reviews of potential cases against Russia, the Court would not begin investigating complaints before cases were formally accepted and the Court would not have new powers to enforce rulings.

Taken together this sounds like Russia wants to transform the ECHR into a Russian court: by hearing complaints against Russia that the Russian government approves of, not delving too much in to the details of complaints filed and if the complaint is accepted for the Court to have no ability to enforce its ruling.

However, Thomas Hammarberg, the human rights commissioner of the Leaders of the Council of Europe, presents a different view of Russia’s approval of Protocol 14, that Russia’s concerns where heard but ultimately Russia will be held to the same rules that apply to other members and that no changes to the protocol were made.

Leaving for now, what Russia’s ratification of Protocol 14 actually means for the ECHR, a central question remains, “What propelled Russia to ratify the protocol after all these years?”

“Smoothing over differences” appears to be the official reason media outlets are reporting, however there may be other reasons political and financial reasons why Russia is offering this carrot to the West.  

Earlier this week, the $100 billion lawsuit YUKOS v. Russia was postponed for the third time because two Russian representatives were unavailable. Perhaps the Russian authorities feel that ratification of Protocal 14 could pave the way for this case to be dismissed.

Additionally, the Financial Times reported earlier this week that Russian companies would be seeking $90 billion over the next two years to finance debt restructuring and capital improvements and perhaps to rebuild the coffers for politically connected Russian business owners who saw their fortunes collapse during the 2008 financial crisis. As demonstrated with the Rusal IPO, concerns over the management of Russian companies remain and ratifying Protocol 14 may be a signal to the investment community that Russia wants to play nice.

Russia may see ratifying Protocol 14 satifying many goals: to reduce the effectiveness complaints against Russia in the ECHR while reassuring investors that Russia abides by the rule of law. But as the trial against former YUKOS chief Mikhail Khodorkovsky and a Russian policeman’s open letter to end authorized corruption demonstrate, Russia remains a feudal state, where

in absence of functional legal or law enforcement systems, people’s only real protection lies in a network of personal and professional relationships with powerful individuals.