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Capitalism is built on trust
A society where capital does not circulated
Conclusion
Kensaku KUMABE,
Japan Bank for International Cooperation Representative in Moscow,
Chief Representative
Hiromi YUSA,
Japan Bank for International Cooperation Representative in Moscow,
Research Officer

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Capitalism is built on trust

"It's nonsense! You come to a country which claims to be one of G8 and find menus in restaurants priced in US dollars, shops abundant with illegally imported goods and people keeping 50 billion dollars under their mattresses because they do not trust banks", - says a Japanese producer of medical equipment. By the way, official international reserves of the same country, as of August 2000, amount to little more than $23 billion.

For eight years since "new Russia" emerged in January 1992 international organizations and western governments have been extending rigorous effort to help Russian president Yeltsin build capitalism in his country. It has been widely believed that after the end of historic confrontation "communism vs. capitalism" price liberalization and privatization will automatically bring about capitalism in Russia. Indeed, just like anywhere in the world goods now flow in Russia to where the money is. Total price regulation by government is gone, as well as the old Soviet system when money could not buy goods unless supported by privilege. Now every kind of imported goods is available in Moscow, money can buy you here a really comfortable and easy living. So, you may think, capitalism has made his way to Russia. But few will ask themselves: who owns all these goods, how much profit they bring and who benefits from it? Can one be sure that 20 different kinds of catsup that one can find on a shelf of a clean and spacious Moscow supermarket (by the way, few shops in Tokyo can boast that much) are produced in a legal way? Capitalism implies that flows of goods and money form an open and transparent system. The Russian case is different.

Dictionary gives the following definition of capitalism: "the kind of society where profit-seeking privately owned capital and labor interrelate through market transactions at prices determined by supply and demand". But to be able to live by this rule a society needs people's trust in regard to the state and society: it needs a system that would make possible smooth and safe interrelation between people who are complete strangers to each other. Certainly it is not easy to trust someone you see for the first time, but trusting the system as a whole does make it possible. Capitalist society is covered by a dense net of professional knowledge and activities, like financial accounting, auditing of business enterprises, managing stocks etc. There is also an underlying assumption that there exist sanctions against who infringe upon laws, and these sanctions are in effect duly exercised. The kind of society which finds those features and institutions absent or void turns into specific "crony capitalism". If relevant laws and institutions do not function, how can one trust a stranger? How can one trust his hard-earned money to an institution which calls itself a bank, if there is no guarantee that this "bank" will give the money back when it is due? And how many banks will choose to loan money to enterprises which have no idea of their debts or even the notion of a collateral?

For the said reason, capital in Russia moves within the boundaries of certain sectors of its economy never crossing those boundaries. Let us evaluate the situation in the four main sectors of Russian economy which are; households, banking sector and government.

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A society where capital does not circulated

Households

People do not trust banks, government or their national currency. Ruble incomes are immediately go for consumption, and cashed and, with the exception of certain amount of cash turn into US dollars. On pay-days both state employees and those in private sector line to withdraw their salary from ATMs. Driven by bitter experiences of inflation and ruble crashes, many restaurants and shops fix their prices in dollars.

Consumption is booming. Moscow streets abound with shops and boutiques of the same brands one may see in Tokyo. Audio and video brand products sell like hot dogs in a country where official average monthly wages amount to less than 100 dollars. Easy to turn into cash or barter for other goods, these products proved to be a better asset to hold value than rubles prone to devaluation. Besides, there seems to be no tradition to save, which may be accounted for by low level of medical and educational expenses as well as by the relics of Soviet mentality. Coupled with the policy of a "strong ruble" which had made hitherto not affordable imported materials look relatively inexpensive to many consumers, it initiated consumption boom in Russian urban cities. After the 1998 financial crisis a larger share has been taken by domestically produced goods, but the overall feeling of Moscow's prosperity often bewilders those foreigners who had an image of Russia as a poor and suffering country.

At the same time not many Russians duly pay their taxes. There is perhaps not more than a handful of such people among the Russia's "new rich", some of whom earn as much as $10,000 a month. The reasoning they give for their refusal to comply with tax laws goes like following: "If required to pay my taxes in full, I must give away some 40% of my income as payments to social funds and 35% as income tax, which makes a total of $7,500 out of $10,000, while old-age pensions do not size even $50 a month. You should be crazy to pay $7,500 a month to earn the right to a $50 pension." On the other hand, Russians working for a monthly salary of some $100 have their own reasoning: "If the rich with all the luxuries they enjoy are allowed to have a free ride, why should we pay for them?" As a result the government finds it extremely difficult to collect taxes. The share of "shadow economy" is believed to be somewhere between 25 and 60 percent, while official Goskomstat (State Statistical Committee) figures suggest that approximately a quarter of all economic activities in the country goes unreported and has to be recalculated by statistical authorities to figure Russia's total GDP.

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Financial sector

Russian banks have failed to attract and get hold of savings of the household sector. Cash savings in home of the latter are estimated at $50 billion, and capital flight - at $2.5 billion a month (estimate of the Central Bank). Capital circulates between households, shadow economy and foreign banks with very little of it finding its way to Russian banks. Several years before the crisis of autumn 1998 saw Russia's newly-born middle class and pensioners gradually getting to keep their money in commercial banks, tempted with high interest the latter offered. However the devastating financial crisis destroyed the last shreds of trust in the banking system. Even Sberbank (the Savings Bank) which was the only Russian bank covered by the system of government guarantees, had to temporarily stop paying out salaries and pensions. Russians learned the lesson: "a stranger is never to be trusted".

But when it comes to your own circle, it's quite another matter. The so-called "oligarchs" whose fortunes may be envied by most Americans or Japanese came out of the crisis without suffering a loss. Having had access to insider information they managed to sell state bonds before the government defaulted on them and move their money from unstable commercial banks to safer places. There on August 17, 1998 Russian government and Central Bank announced withdrawal of their support for the ruble, suspension of trade in short-term government bonds and a 90-day ban (moratorium) on repayment of foreign loans by commercial banks. The reasoning behind imposing such a ban at the moment was inconceivable both for specialists and foreign creditors. Comments by then vice-chairman of the Central Bank Sergey Alexashenko, offered to representatives of foreign investors on August 24, didn't make the issue any more clear. In fact, some banks used the time granted to them by this moratorium to transfer good assets off the bank's balance sheet. Amendments to the Law on Bankruptcy of Credit Organizations, designed to streamline bankruptcy procedure and protect the rights of creditors, were approved by both houses of Russian parliament but vetoed by then-president Yeltsin on October 30, 1998. As a result, for example, the said Menatep Bank crashed into bankrupt and broke down with its creditors' money, while a new bank called Menatep - Saint-Petersburg was established at the very same time. Offices of the new bank often were located in the same rooms previously used by Menatep, they used the same staff and the same computers, but the new institution was not legally liable for any debts made by its predecessor.

Big Russian banks used to earn their profits by playing government and corporate securities markets, assisting in money-laundering schemes, holding government accounts and providing short-time finance to businesses. Long-term financing was also possible if the clientele had powerful organized groups or top government officials behind its back. As Russian commercial banks were often established by large businesses as their "pocket banks", many of them retained strong links with selected designated enterprises. Deficiencies preventing effective use of collateral in loan transactions explain the low volume of finance available to ordinary business clients. Indeed, in spite of the large help extended by international financial institutions and western governments to bring about a modern banking system in Russia, mere establishing banks would not make money circulate in the society unless the country has a sound financial system able to pump money from the household sector to industries. If banks find it hard and unrewarding to finance real sector industries, they will continue experiencing great difficulties in managing the funds they may have drawn, with little alternative left but to engage themselves in "money games" again.

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Businesses

Tax burden on businesses in the last 8 years was unrealistically heavy. It may sound like a bad joke, but punctual payment of all taxes levied on a business would leave it with zero profit-or minus. Besides tax rates being high, the reason also lies with the inadequate interpretation of "cost" notion. Many essential expenses (like advertising etc.) are treated as part of the profit subject to taxation. To start a business one needs getting more than a hundred of different licenses and registrations which involve additional "tax" burden in the form of various fees and outright bribes. To survive businesses are forced to resort to double or even triple system of financial accounting, thus concealing their true position. In fact, the motive of mere surviving makes enterprises guard against giving out any information about their finances.

Government enterprises which are either refused subsidies or have them paid much behind the schedule, suffer from poor liquidity and are often forced to engage in barter deals. The data released by the Central Bank estimates the share of barter deals to be as much as 50 to 60 percent of all transactions between industrial enterprises, while in the regions it may amount to 70-80 percent. It could thus be said that Russian economy after the collapse of the Soviet Union have acquired more "materialistic" (i.e. with all payments made in kind ) rather than "capitalistic" form.

Complex schemes of barter deals have been developed. For example, a pharmaceutical firm may get cardboard boxes in exchange for the drugs it supplied to a bookstore, and use them to pay a car factory which may need those boxes, for instance, to pack spare parts. Sometimes wages and salaries are also paid in kind. As prices assigned to goods and services for barter agreements and other kinds of "non-capital" settlements do not necessarily coincide with market prices, their use makes financial position of participating enterprises still less transparent and more convenient for practicing various tax evasion schemes. In fact there is a strong opinion that it's exactly tax evasion motive rather than shortage of cash which is the main factor behind the proliferation of barter deals.

Many issues are also to be raised in connection with the privatization of state assets and enterprises. For eight years international financial organizations have been pressing Russian government to subject inefficient state enterprises to bankruptcy and subsequent sell-out. At the same time many of them were sold over to the so-called "oligarchs" either very cheap or bypassing the law. As such pattern of privatization, which was encouraged by the World bank and the IMF, met no public criticism on their part, many Russians now blame the West for "people's property being sold out to crooks and criminals". Nowadays international financial organizations call the Russian government to continue its privatization campaign. But wouldn't it rather be necessary for them to stipulate that financial assistance would be rendered on a strict condition of fairness and total transparency of privatization procedure?

The international financial organizations also insist that privatized enterprises playing monopoly in the public utilities sector, that is "Gazprom" (formerly Ministry of Gas Industry) and "UES of Russia" (the exclusive successor to former Ministry of Electric Power Industry), should stop deliveries to customers who fail to pay their gas and electricity bills. But it is the government and institutions affiliated to it, including the military and military industry, which have the largest gas and electricity arrears. Is it really a proper solution to cut electricity supplies to military nuclear facilities? When the Russian government, acting in spirit of the recommendations of international financial organizations, endorsed "no pay - no electricity" policy and let "UES of Russia" cut supplies to a military base, the military responded by occupying local power station (NTV news, 28.06.2000). On July 24 electricity stoppage in Vladivostok resulted in the death of a new-born baby in a local hospital(July 24, 2000, ORT TVnews). An attempt made by "UES of Russia" on August 13 to cut supplies to the Ministry of Railways which is one of the largest debtors to the former, provoked disorder in railway transportation. Destabilizing systems vital to life and security of the nation can hardly be considered a proper policy for the government. Far better it would be to have the government properly pay its own bills instead.

Government

It is not only the banks who would like to know the true financial standing of Russian enterprises. In fact, the government surely has to know it to collect taxes. Being unable to collect taxes in cash the government in its turn defaults on payments to "Gazprom" and "UES of Russia" for gas and electricity. In the past the government preferred to rely on force to make companies pay taxes: it sent masked tax police officers with Kalashnikov rifles to raid offices and Minister of Tax worked on a bill that would compel citizens to put their money into banks (the bill was proposed in January 1999 but later scrapped). Being well aware of a limited effect of such measures, president Putin's think-tank - the Center for Strategic Research - proposed a plan of real tax cuts. In July 2000 Russian parliament adopted the government proposal to set income tax rate at 13% - the lowest level by western standards. By changing the existing system of progressive taxation with 30% rate for the highest bracket to a flat 13% rate, the government hopes to collect more taxes through reducing tax dodging.

It remains to be seen whether these hopes are justified, but one thing is certain: the least transparent finances in the country are those of the government, Central Bank and presidential administration. Capital flight in this sector could not be compared to that in the corporate or household sector. Foreign currency receipts from sale of precious metals stay in foreign banks and often are not counted as part of official international reserves. Considering the fact that the Central Bank of Russia (CBR) has subsidiaries and affiliates both in and outside the country and continues its non-transparent special financing to some legal entities, the true size and extent of its funds are not really known.

Former prosecutor-general Yuri Skuratov provoked a scandal by stating in his address to the parliament on February 1,1999 that "in the period from 1993 through 1998 the CBR transferred 50 billion dollars to its subsidiary company FIMACO, which had been registered in a British offshore with the capital of $1,000". On the next day however he was relieved of his duties by then-president Yeltsin "for the reason of health". Later a videotape was broadcasted on a state TV showing him in company with prostitutes. Soon legal action was taken against him on corruption charges to be followed by official displacement from office. Shortly after that Central Bank chairman Victor Geraschenko announced that FIMACO had been used by the CBR "to protect the country's official international reserves", thus justifying secret transfer of official foreign currency funds to destinations abroad and concealing the true size of the country's international reserves from international financial organizations. In the circumstance when exact information on the latter was a condition attached to IMF loans, the said statement amounted to confirming the fact of misinforming the IMF. In the wake of the scandal the IMF demanded that international auditing of the CBR be made. In the end "Price Waterhouse Coopers" which did the auditing found no guilt with CBR managers, but the results of the auditing are still held in doubt.

Assets held by the presidential administration are not transparent either. The property committee in the lower house of the Russian parliament on April 26, 2000 released its estimates of foreign assets of the government which ran between 3 and 400 billion US dollars. However the published data on these assets is limited to real estate worth 11 million dollars. Russian Ministry of Finance did make an attempt in 1995 to compile a registrar of the government's foreign assets but failed for "the lack of funding". In 1998 the same job was undertaken from the presidential administration by a western company "Kroll Associates", but the results of its study were not made public. The Russian parliament experiences great difficulties in getting the information on the subject because of very limited possibilities to obtain it, so the true picture is nowhere to be seen. The draft bill on disclosing the data on public property was submitted to then-president Yeltsin three times, and each time it was rejected. Vice-chairman of the parliamentary property committee Igor Lisinenko, who represented "Fatherland - All Russia" opposition faction, criticized the government for "illegally transferring control over its foreign assets to presidential administration and its business manager Pavel Borodin." According to Lisinenko, "no proper inventory of these assets have ever been drawn up". On the other hand, Borodin himself in his interview to NTV TV reporter boasted that the presidential administration owns "715 items of property in 78 countries worth 650 billion US dollars in a total".

At the same time we are witness to payments not being made and schools being cut off electricity supply because of unpaid accounts. The situation can hardly be seen as good and fair use of public property and funds. Certainly it is important to make taxation system more realistic. But to make people trust the government and start paying taxes still another task is vital. What is needed is to assure people that money collected as taxes are used properly and efficiently, and do not "disappear" without a trace. If the present government demands that those who had privatized public property to their own benefit should surrender it back to the nation (just like Indonesian president Wahid demanded the return of 45 billion dollars that had been pocketed by his predecessor Suharto), it would help restore the trust of the people as well as to secure new funds for the government. However the first decree signed by Putin after he assumed the powers of an acting president granted his predecessor Yeltsin and his family material benefits and total security, including immunity to possible legal actions. Given that, few people in Russia expect president Putin to initiate redistribution of income, including nationalization of property held by members of previous governments. But if he officially proclaims his intention to secure "equality of all citizens before the law", to fight corruption and opt for "transparency", the first thing he should probably do is to disclose information on the property of the government and of his own administration.

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Towards a modern capitalism

Since 1999 Russian economy has been on the rise. However the growth has been caused by mainly external factors, like the rise in the price of oil, which is one of Russia's main export items, and import substitution effect of the ruble's depreciation. The government itself recognizes that the fundamentals of the Russian economy are still fragile. It still faces the task of building up relationship of trust between main sectors of Russian economy - households, banking sector, non-financial business enterprises and government-and let capital circulate between them..

Up to this time, the main elements of "economic reforms", as formulated by the IMF and other international organizations, have been limited to price liberalization, privatization and establishment of financial markets. Indeed, financial and technical help has been rendered to help achieve these goals, but little of it could be traced after the change of government in Russia. On the other hand, assisting in training personnel and technical cooperation which focuses on building up trust would be a universal value, irrespective of changes in the government etc. Regarding this task we would like to stress the importance of the following four points.

1. The need for international accounting standards

Russia needs the system that would ensure transparency of corporate finance and thus enable the government and banks to pump money to efficient businesses. Several seminars on this subject have already been held with western assistance, but very limited amount of people would be ready to spend their precious time and money to attend such seminars, unless international accounting standards are made obligatory for Russian companies. Indeed, the only use of these standards now is to help get foreign funding. To dodge taxes or engage in barter deals, non-transparent finances are a better option for the owners of businesses. In fact, transparent finances will hardly be ever achieved unless the use of international accounting standards is made obligatory. The IMF has already made it a condition for extending its loans in the case of financial institutions, but that is obviously not enough. Without transparent finances in other industries circulation of capital to the benefit of society will remain unattainable.

2. Strengthening ability of banks to investigate and analyze

Banks should increase their ability to study and access their client companies. In the Soviet Union the rationale behind sorting out and supporting selected enterprises was of rather political than economic nature. This kind of reasoning have partly survived up to nowadays. On the other hand, while banks became too keen to profit from trading in foreign currency and bonds, they have failed so far to develop know-how necessary to investigate and analyze industrial companies. They do need specialized knowledge and technique to pick up best projects considering not only financial standing of enterprises but also market sales prospects, state of competition etc.

3. Continuity in government and institutions

Russia still has the situation when certain projects are launched at the government's will and often stumble as top officials change. Business is also often affected by sweeping changes in related laws and institutions. People can be changed but promise should be kept to successors. To give one example, a company that had been designated by the Russian government to participate in a project to be financed by the former Export-Import Bank of Japan was suddenly put on the bankruptcy list by the successive administration. A Russian company wanted to import Japanese machine equipments backed by Governmental guarantee, but during it constructed a factory for the equipment, suddenly the equipment was taxed for importing. Therefore, the company could not pay tax and those equipments were kept In bonded house. On the other hand, Russian government started to pay back money to our bank. It is such a wasteful way of using money for both government and company. Reasonable continuity Is now lacked in Russia. No promises made by the new government of president Putin to improve business climate, when viewed against the background of such incidents, could substantially lower the risks associated with making business with Russian firms.

4.Transparency of government finances

IIt is very important to give a full information on government finances, as to why, where and how public funds are used. As for the situation nowadays, the country has no system of punishing the use of public funds in disrespect of the budget law adopted by the parliament; and the finance ministry still has a free hand in deciding matters related to it. Given the situation when breach of the budget law goes unpunished, efficient use of public funds could hardly be ever secured. Strengthening powers and independence of the Audit Chamber also remains an important task.

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Conclusion

In the first post-war years, as well as during the Meiji period in the second half of the 19th century, Japan had "oligarchs" similar to Russian ones, who were manipulating the nation's government and economy to their own benefit. To build a system that ensures equality before the law is a long task that requires time. Besides, unlike Japan or Germany who had lost a war, Russia did not. Consequently, psychologically it is far more difficult for the Russians to completely reject the old system and build a new one anew. Offensive things that come along with reforms invite protest and resistance from a large part of the population. Auditing and compiling financial reports for Russian companies are delegated mostly to western companies, western consultants receive big sums of money disbursed for assisting Russia. Certainly there grows among Russians a feeling of them being "used", which gives ground to anti-West mood, especially in the wake of Kosovo conflict and heated discussions on the US NMD strategy. In contrast to the first years after the collapse of the Soviet Union, when everything related to the West was seen with hope and admiration, now the pendulum moves the opposite way. On the other hand, president Putin has taken a pragmatic stand of developing relations with every foreign partner, including the West; welcomes foreign investments in Russia. For some time in his internal policy he may ignore or even use to a certain extent to his own ends the anti-west ern mood in the country. However the distorted system which prevents capital from recycling to the benefit of society, has already taken roots. To reform structures and institutions benefiting from this system is far from easy. Nevertheless Russia with its abundant resources like oil, gas, precious metals etc., is a potentially rich country. If it succeeds in building a genuine capitalism which makes possible for capital to make its cycles benefiting the society, Russia has every chance to regain its role as a superpower.

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