The Competitive Advantage of Russia

CASE: IB-73 DATE: 06/30/08

THE COMPETITIVE ADVANTAGE OF RUSSIA
It is foolish for people in the West to deny that Russia is a great power and that, in some ways, its influence has increased. ⎯ “Putin’s People,” The Economist, August 23, 2007

INTRODUCTION The Russian Federation (Russia) was the largest of the 15 geopolitical entities that emerged in 1991 from the Soviet Union. Despite a series of reforms initiated in 1992 to help the country transition from its centrally planned economy, Russia plunged into a deep recession that was exacerbated by a financial crisis in 1998. Tens of millions of people were thrust into poverty and a severe fall in the standard of living triggered an outbreak of corruption and organized crime. By 1998, Russia’s GDP had fallen nearly 40 percent from its 1991 level.1 It was not until 1999, following eight years of turmoil, macroeconomic stabilization and economic restructuring, that the economy slowly began to grow again. When Vladimir Vladimirovich Putin became president on December 31, 1999, Russia was the world’s tenthlargest economy and its foreign reserves stood at $8.5 billion. By 2007, the country’s economy had become the world’s eighth-biggest, with reserves of $407.5 billion.2 Russia’s GDP reached $1,290 billion in 2007, and grew at approximately 8.1 percent.3 With its improved economic performance, vast natural resources, a highly educated population of approximately 142 million people, and a position of increasing political influence in the world, Russia’s potential was great. Yet, supporters and critics alike remained cautious regarding the country’s burgeoning economic power. For one thing, Russia’s economy was heavily dependent on high prices for oil, gas, and other commodities that might not last. It was relatively weak in manufacturing, services, and high-technology industries. And both foreign and domestic investments were low, particularly compared with nations such as China. Furthermore, there were growing concerns regarding the government’s perceived reversal in attitude toward private investment in the country, increased media censorship, a general roll-back of political freedoms, and the progressively divisive role that Russia was playing in its relations with the United States and the European Union.

Katya Reuk, Victoria Chang, and Lyn Denend prepared this case under the supervision of Professor Bruce McKern as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Some material was drawn from an earlier work by Sweta Sarnot. Copyright © 2008 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: [email protected] or write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University, Stanford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means –– electronic, mechanical, photocopying, recording, or otherwise –– without the permission of the Stanford Graduate School of Business.

The Competitive Advantage of Russia IB-73

p. 2

In May 2008, when Russia’s new president, Dmitry Medvedev, was inaugurated and Putin assumed the role of prime minister, western companies with interests in Russia faced great uncertainty. Would Putin’s hand-picked successor, under Putin’s powerful and watchful eye, continue to enact policies and take actions that would make the business environment increasingly unfavorable to foreign investment? Or, would the new regime chart a more liberal and democratic course for Russia that would enable the country to improve its global competitiveness and allow outside investors to participate in its prosperity? Russia had made great strides to improve its position in the world since the dissolution of the Soviet Union. Nevertheless, it remained to be seen whether the country, particularly under its current circumstances, could create and sustain lasting international competitive advantage, which many western critics believed would require a more democratic political regime. COUNTRY OVERVIEW Russia’s Post-Soviet History After the December 1991 dissolution of the Soviet Union, the Russian Federation became its largest successor state, inheriting its permanent seat on the United Nations Security Council, as well as the bulk of its nuclear weapons, foreign assets, and debt. Boris Yeltsin was elected president of Russia by popular vote in June 1991. However, by the fall of 1993, politics in Russia had reached a stalemate between Yeltsin and the parliament. In a dramatic speech in September of that year, Yeltsin dissolved the Russian parliament and called for new national elections and a new constitution. The standoff turned violent in October, with President Yeltsin ordering the army to respond with force to capture the parliament building. In December, voters elected a new parliament and approved a new constitution, which had been drafted by the Yeltsin government. The December 1995 parliamentary election produced an opposition-dominated State Duma (the lower house of the legislature), but six months later, Yeltsin—with financial help and media support from the country’s business elite (the oligarchs4)—won re-election in a second-round run-off against the leader of the communist party, Gennady Zyuganov. Widely criticized for presiding over a seemingly unstoppable increase in corruption and poverty, Yeltsin’s economic reform policies nevertheless laid some of the foundations for the increased prosperity Russia would enjoy in the 2000s. However, when a financial crisis in August 1998 undermined Yeltsin’s credibility, he resigned on December 31, 1999. In doing so, he designated Vladimir Putin, his prime minister at the time, as the acting president. This appointment was perceived as controversial by some, since Putin was a former KGB officer, head of the FSB (the KGB’s postSoviet secret police/intelligence agency), and relatively unknown before becoming prime minister.5 Putin achieved widespread popularity by stabilizing the government, in marked contrast to what many Russians saw as the chaos of the latter Yeltsin years. At the same time, the consolidation of state authority following Putin’s election as president prompted concerns as to whether Russia’s nascent democracy was being undermined. However, Putin’s strong-man tactics in the bitter Chechnya insurrection were electorally popular and, in March 2000, he won election in his own right as Russia’s second president (with 53 percent of the vote).6 Under his leadership the economy grew both because of rising oil prices and because Putin followed a reformist path,

The Competitive Advantage of Russia IB-73

p. 3

further liberalizing the economy, stopping a spiral of hyperinflation, and cracking down on corruption and crime (including the power of the oligarchs). He also maintained Russia’s democratic institutions and moved closer to the West, particularly following the attacks of September 11, 2001 in the U.S., which allowed him to portray Russia’s war in Chechnya as part of a wider struggle against Islamist terrorism. In 2004, Putin was re-elected with nearly three-fourths of the vote.7 In September of that year, early in Putin’s second presidential term, a group of terrorists attacked a school in Beslan, a small town in the Caucasus region of Russia. More than 330 hostages, including scores of school children, were killed. Putin then proposed sweeping changes for consolidating presidential authority to fight terrorism, which raised a blitzkrieg of condemnatory reactions from the West. Some critics blamed the Russian military’s tactics for the heavy loss of life. Many of Putin’s subsequent actions reinforced western worries, such as the government’s closure of a prominent independent TV station, placement of extensive restrictions on the activities of non-governmental organizations, the abolition of elections for regional governorships, and the allegedly politically motivated arrest and trial of a former oligarch, which led to the destruction of the country’s largest private oil company. As one 2008 article stated in describing the raids and takeovers carried out by the Russian government against private firms, “The practice is so widespread, it’s impossible to list all the cases.”8 Critics further asserted that Putin was undermining Russia’s evolution as a liberal state and reversing the progress made on private ownership and media freedom under his predecessor and mentor, Boris Yeltsin.9 In parallel with these changing domestic policies, Russia began playing a more controversial role abroad, taking an increasingly confrontational position toward the U.S. and a more divisive approach to its relations with the EU. As one 2008 article described: Putin’s foreign policy—and, by extension, [new president] Medvedev’s—rests on two key assumptions and one strategic calculation. It assumes the United States is facing a collapse that is not much different from the collapse of Soviet power. It also assumes that the EU—despite being, in Russia’s view, a temporary phenomenon—is a threat to the Russian regime by its very existence as a postmodern empire. The calculation is that the next decade presents a strategic window of opportunity for Russia to position itself as a great power in the emerging multipolar world, while also securing the legitimacy of the regime, even if that means following a more assertive and confrontational foreign policy.10 While many were hopeful that Medvedev would take the country in a more liberal, democratic, and diplomatic direction, others feared that his regime, particularly with Putin exercising unprecedented levels of influence in the role of prime minister, would offer more of the same. While Russia’s promise (and its vulnerability) were widely recognized in the international community, the country was again, for the first time since the Soviet era, perceived as a growing threat: The paradox is that, faced with new Russian revisionism, the West is becoming nostalgic for the old Soviet Union…. In the words of one senior French diplomat, ‘The Soviet Union was easier to deal with than Russia is today. Sometimes the

The Competitive Advantage of Russia IB-73

p. 4

Soviets were difficult, but you knew they were being obstructive in order to achieve an objective. Now, Russia seeks to block the West systematically on every subject, apparently without purpose.’ In other words, Russia is not simply a revisionist power—it is something potentially more dangerous: a spoiler at large. The Kremlin’s recent actions easily fit this threatening image.11 Political System In the political system established by the 1993 constitution, Russia was a democratic, federal republic. The government was structured into three branches: the executive, legislature, and judiciary.12 Russia was a federation, but the precise distribution of powers between the central government and the regional and local authorities was still evolving. The Russian Federation consisted of 89 components, including regions, autonomous republics, territories, and the two federal cities, Moscow and St. Petersburg. The constitution explicitly defined the federal government’s exclusive powers, but it also described most key regional issues as the joint responsibility of the federal government and the components of the Federation. The federal government, in the course of the 1990s, signed power-sharing agreements with many of these entities. However, Yeltsin’s encouragement of greater regional autonomy in the early to mid-1990s resulted in many regional leaders exercising disproportionate levels of power. As a result, Putin made reforming Russian federalism a priority. In 2000, he grouped the regions into seven federal districts, with presidential appointees established in Moscow and six provincial capitals. At his initiative, the Federal Assembly passed legislation making regional leaders subject to removal from office for failing to comply with federal law or the constitution. In March 2004, the constitution was amended to permit the merger of some regional administrative units. Another law, enacted in December 2004, took these policies further by eliminating the direct election of the country’s regional leaders.13 Instead, senators were nominated by the president and subject to confirmation by the regional legislatures. These and other initiatives were designed to strengthen the power of the center and to rein in regional leaders, some of whom had come to exercise almost unlimited authority in their own realms. Executive Branch Under the Russian constitution, the president and prime minister (chairman of the government) represented the executive branch.14 The president wielded considerable executive power and there was no vice president. The president nominated the highest state officials, including the prime minister, subject to the approval of the Duma (part of the much weaker legislative branch). The president could pass decrees without the assent of the Duma and was also head of the armed forces and the National Security Council. The president was elected for a four-year term and could serve a maximum of two terms. Legislative Branch The legislative branch, or Federal Assembly, was a bicameral body consisting of the Federation Council and the State Duma. The State Duma, the lower house, consisted of 450 deputies. Until 2005, half of these deputies were elected from single-mandate geographic districts and half on the basis of party lists. In the election of 2003, 100 of these seats had been won by independents or minor party candidates.15 However, these single-member constituencies were abolished in

The Competitive Advantage of Russia IB-73

p. 5

early 2005 as a result of a presidential measure adopted by the Duma. Supporters argued that the new approach would simplify the Duma system, strengthen local representation, and direct public attention and political resources outside of Moscow, Russia’s capital city. Critics, on the other hand, maintained that the policy shift toward a pure majoritarian system would exaggerate representation of larger political parties, undermine the representation of political and social minorities, and reduce incentives for development of new political parties.16 In terms of their responsibilities, representatives of the Duma confirmed candidates for prime minister, passed federal laws, adopted the federal budget, and ratified treaties. Deputies were elected to four-year terms (the next election was scheduled for December 2, 2007), although the constitution allowed the president to dismiss the Duma and call early elections in rare circumstances. Historically, Russia’s upper house, the Federation Council, was composed of senators elected by components of the Federation. In 2007, there were 176 senators.17 As noted, a new law adopted in 2004, authorized the president to pick these representatives, subject to the confirmation of the regional legislatures.18 Unlike the State Duma, with its multiple political parties, the Federation Council had a specific rule that political factions were not to exist in the upper house. As a result, the Council relied on consensus politics to perform its work (cooperating with the State Duma to complete and vote on draft laws, budgets, customs regulations, credit monitoring, and the ratification of international treaties). Senators were able to retain membership of their respective parties; however, they were instructed not to directly represent these views on the floor of the upper house. Since the reforms of the early 2000s, which did away with party politics, the Council had enjoyed a relatively close relationship with the Kremlin and was criticized at times for easily passing laws according to the president’s wishes, under the guidance of the chairman and the various committee and commission chairs.19 Judicial Branch The 1993 constitution empowered the Constitutional Court to arbitrate disputes between the executive and legislative branches, and between Moscow and the regional and local governments. The court was also authorized to rule on violations of constitutional rights, to examine appeals from various bodies, and to participate in impeachment proceedings against the president. The new Constitutional Court Act of July 1994 prohibited the Constitutional Court from examining cases on its own initiative and limited the scope of issues it could hear.20 By the late 1990s, the Russian government had begun to reform the criminal justice system and judicial institutions, including the reintroduction of jury trials in certain criminal cases. President Putin had made judicial and other legal reforms one of his top priorities and had secured the passage of several key judicial reform bills, including a new Code of Criminal Procedure, which came into force on July 1, 2002. Despite these reforms, Russia’s judiciary and justice system were relatively weak. Numerous matters, which in other European countries were dealt with by administrative authority, remained subject to political influence in Russia,21 and judges were only beginning to assert their

The Competitive Advantage of Russia IB-73

p. 6

constitutionally mandated independence from other branches of government. There were rising concerns that prosecutors selectively targeted individuals for political reasons, as in the prosecution of Mikhail Khodorkovsky, the CEO of Yukos Oil, who had been a vocal critic of the Kremlin. In spite of the general tendency to increase judicial independence (for example, by raising the salaries of judges), many judges still saw their role not as impartial and independent arbiters, but as government officials protecting state interests. Political Environment 2008 was an important year for Russia politically due to the country’s presidential election. Putin, who had served for two four-year terms, was banned from running for re-election under the constitution (although he would be eligible again in 2012). In December 2007, he announced that Dmitry Medvedev would become his successor, while also promising to become the country’s prime minister.22 When Russian voters cast their ballots on March 2, 2008, it was described as a “mere ritual.”23 According to one article: ‘There was no election,’ said a young, middle-class Muscovite. ‘I voted for Medvedev, because there was no choice.’ Opposition candidates who might have proven more of a challenge to the Kremlin, such as Mikhail Kasyanov [Russia’s prime minister from 2000 to 2004 and a vocal opponent of Putin] were banned from running. Those candidates allowed to compete by the Kremlin included the Communist Gennady Zyuganov, the clownish nationalist Vladimir Zhirinovsky, and a Kremlin clone, Andrei Bogdanov.24 Critics further asserted that the Kremlin fixed the election in favor of its candidate by turning some voters away from the polls and massaging both the results of the vote and the turnout figures,25 another sign that Russia’s democracy was seriously weakened. However, while some feared that Medvedev would be little more than Putin’s puppet, others perceived him as more of a liberal. On the one hand, “Moscow has been rife with speculation about who will really be in charge ever since Mr. Putin chose his long-time protégé and lawyer as his successor. For now, the answer appears to be either that nobody knows, or that it will still be Mr. Putin.”26 On the other hand, “Mr. Medvedev is the first Russian leader since the tsars to have come from neither the security services nor the old Communist Party. And judging by what he says, including in his inaugural speech, he has some liberal instincts and an understanding of why the rule of law matters.”27 During Putin’s time in office, the role of the president increased in strength. As a result, the relationship between the president and the Duma was strained and often fractious, as each one carefully guarded its own powers and privileges. The political system was also characterized by a plethora of parties, often with policy programs that were defined more by loyalty to key political players than by ideology.28 In 2008, though, the situation looked somewhat different. In preparation for his move to the position of prime minister, Putin, while still president, “gave himself extra powers, including oversight of regional governors; and transferred more mundane tasks to some ministries, giving himself time to concentrate on strategic tasks.”29 He also

The Competitive Advantage of Russia IB-73

p. 7

accepted the position of leader for the largest political party in Russia⎯the United Russia Party, which held 70 percent of the seats in the Duma in 2008. As one article put it: Becoming the chairman of United Russia will significantly enhance Putin’s political power beyond the authorities of the prime minister’s office. While being prime minister will accord Putin authority over the government's administrative apparatus … he will now also have effective control of the country’s legislative branch. This includes key constitutional prerogatives such as veto powers over new legislation and certain presidential appointments such as the central bank chairman. Even more crucial is that with a two-thirds vote of the Duma, which Putin will easily be able to command, he will be able to initiate impeachment proceedings against the president and amend the constitution. Moreover, as United Russia controls most of the country’s regional legislatures, Putin will continue to exert influence over matters of sub-national policy. From a policy perspective, this underlines our core view that the transition to a new president will not signal a major shift in Russian government ideology.30 Moreover, Putin remained at the peak of his popularity, with an approval rating above 70 percent.31 According to at least one poll, “as many Russians want the two men to share power as say they would like Mr. Medvedev to lead alone.”32 This signalled that many citizens welcomed the continuation of Putin’s policies. Yet, it remained to be seen how this new political scenario would play out following Medvedev’s inauguration in May 2008: Maybe Mr. Putin will slowly fade out, building up Mr. Medvedev as a strong successor. More likely, either Mr. Medvedev will be a figurehead atop a strong Putin government, perhaps an interim leader before Mr. Putin returns as president; or he (and those around him) will set about using the president's immense powers to try to sap Mr. Putin's strength. Either way, a double-headed government promises to be a source of extra instability. At a time when the challenges for the next president are harder than ever, that is the last thing Russia needs.33 Political Outlook at the End of 2008 As noted, a measurable cooling in Russia’s relations with the West was among the political challenges Russia’s leadership faced. These strained relations reflected deep differences in the Putin era on issues such as national security and nuclear armaments. Relations between Russia and the U.S. were particularly contentious, although Russia’s relations with the EU were also poor. Importantly, however, many EU countries (unlike the U.S.) were closely tied to Russia due to their close trade and energy links with the country: the EU satisfied approximately onefifth of its energy needs from the Russian Federation. Russia’s temporary suspension of gas supplies through Ukraine in 2006 and oil supplies through Belarus in 2007 exacerbated European doubts about Russia’s reliability as a source of energy. The EU asked Russia to agree to international rules on investment and trade in energy as part of an attempt to enter into a strategic partnership with the country, yet Russia seemed reluctant to relax state control over the sector. Furthermore, the increasing role in EU energy markets of Gazprom, the largest Russian company and biggest extractor of natural gas in the world, continued to be a source of contention.34 One article summarized Russia’s foreign policy this way:

The Competitive Advantage of Russia IB-73

p. 8

In recent years, for example, Moscow has orchestrated a noisy and confrontational return to the international scene. It decided not to cooperate with the West in taming Iran’s nuclear ambitions or in settling the final status of Kosovo. Last year, the Kremlin unilaterally suspended the Treaty on Conventional Armed Forces in Europe. It blocked the work of the Organization for Security and Cooperation in Europe. Gazprom, Russia’s gas monopoly, aggressively tries to control the energy supply throughout the region. The country’s military budget has increased sixfold since 2000. Russian planes are patrolling the Atlantic. Moscow’s intelligence network is creeping into all corners of Europe. Not since the hottest days of the Cold War have so many wondered just what was going on behind the Kremlin’s closed doors.35 Russia also had to deal with its post-Soviet relationship with former republics. For example, in mid-2005, relations between Russia and Estonia took a negative turn. The Estonian parliament introduced a reference to Soviet occupation into its border treaty with Russia before parliamentary ratification. Russia responded by withdrawing from the agreement. In 2007, serious tensions remained with Ukraine and Belarus over the pricing and terms of payment for natural gas. Meanwhile, Chechnya continued to be a major concern at the core of Putin’s fight against terrorism. The death of the central figure within the Chechen resistance in July 2006, however, was seen as a coup for the government. In parallel, government pressure continued to weaken freedom of expression and the independence of some media, particularly major national television networks and regional media outlets. For example, a government decision resulted in the elimination of the last major nonstate television network in 2003.36 The national press was increasingly under government control, narrowing the range of expressed opinions and provoking self-censorship. Unsolved murders of journalists, including the killing of respected investigative reporter Anna Politkovskaya in October 2006, caused mounting international concern and pressure on journalists to avoid subjects considered sensitive. While Russia’s highest court ruled in favor of a media-training group in May 2008 in a case that was seen as an example of the Kremlin’s pressure on civil society and freedom of the press,37 critics remained concerned about the direction of the Russian government in this arena. To observers, Medvedev appeared “well aware of Russia’s colossal corruption, lawlessness and inefficiency … but he also believes that the system needs only upgrading, not replacing.38 Economic Environment As described, following the collapse of the Soviet Union in 1991, Russia launched reforms with the goal of transforming the centrally planned economy into a free-market system. Difficulties in implementing fiscal reforms aimed at raising government revenues, combined with a dependence on short-term borrowing to finance budget deficits led to a serious financial crisis in 1998. Lower prices for Russia’s major exports⎯oil, natural gas, metals, and timber accounted for more than 80 percent of Russian exports at the time39⎯as well as the non-payment of taxes by the energy and manufacturing industries, and a loss of investor confidence due to the Asian financial crisis (which began in 1997) all exacerbated the country’s financial problems. The

The Competitive Advantage of Russia IB-73

p. 9

result was a rapid and steep decline in the value of the ruble by more than 80 percent,40 the flight of foreign investment, delayed payments on sovereign and private debt, a breakdown of commercial transactions through the banking system, and the threat of runaway inflation. While life for Russia’s people was economically difficult during this period, the economy as a whole rebounded remarkably quickly from the crisis. By 1999, the country began to experience a financial turnaround, driven in part by rising world oil prices, which created a large trade surplus in 1999 and 2000. Some of the country’s domestic industries, such as food processing, also benefited from the currency devaluation, which caused a steep increase in the prices of imported goods. Additionally, the economy was helped by an infusion of cash (from financial assistance packages provided by the International Monetary Fund and World Bank). As companies were able to pay off their debts and other obligations, they were encouraged to hire and expand, causing unemployment to drop and consumer demand to rise.41 Signs of Russia’s recovery included an average annual gain of 10 percent in real fixed capital investments between 2003 and 2007, while real personal incomes increased in excess of 12 percent within the same period. The country also reduced its foreign debt from 90 percent of GDP to approximately 28 percent by 2006.42 By nearly all accounts, Russia’s turnaround under Putin was remarkable, although it was not clear how sustainable: Even Mr. Putin’s critics are impressed by Russia's transformation in the past few years. A country that almost went bust ten years ago now boasts a $1.3 trillion economy, foreign-currency reserves of nearly $480 billion and a $144 billion stabilization fund [created from the taxation of] oil and gas revenue. Annual growth of real incomes has been in double digits. GDP per head has risen from less than $2,000 in 1998 to $9,000 today at current rates of exchange. Yet the truth is that Russia's economy began its rebound 18 months before he became president. Behind it lie three factors: a revival of private initiative, oil prices that have risen fourfold during his presidency and macroeconomic stability. Only the third can be credited to Mr. Putin. The economy is now more dependent on oil than ever. And the outlook is bleaker: a slowing world economy means that oil prices may not rise further, and could even fall.43 The need to diversify the economy and reduce the overarching dependence on high prices in the energy and raw material sectors was explicitly recognized by the government and was reflected in a number of subsequent measures, including changes in tax rules coupled with tax breaks to promote innovation-related activities, as well as the creation of special economic zones (SEZs) and technology parks to boost the manufacturing and IT sectors. To bolster exports, a move that was necessary because Russia “had largely failed to convert the oil stimulus into domestic production,”44 the government also proposed subsidized credits for exporters. It further sought to accelerate the implementation of the numerous recently enacted economic reforms, attract and retain additional foreign investment, and stimulate the development of small and medium-sized enterprises. Despite these moves, economists feared the Russian economy was overheating. Unable to digest the money generated by the oil-and-gas boom and the resultant sizable capital

The Competitive Advantage of Russia IB-73

p. 10

inflows, Russia experienced double-digit inflation in late 200745 despite appreciation of the ruble. Russia’s economic stability was considered all the more fragile when one viewed it in the context of the country’s current political environment. According to an interview with Andrei Illarionov, a former economic advisor to Putin during the early years of his presidency, Russia’s reforms went off course in mid-2003 when the government initiated its attacks on oil company Yukos. The article further asserted: The significance of the Yukos affair went beyond the destruction of Russia’s largest [private] oil company and the imprisonment of its boss, Mikhail Khodorkovsky. It dictated the country’s entire economic and political course. The attack on Mr. Khodorkovsky was presented as a crackdown on the oligarchs. Yet it created a new, more powerful and less visible caste that began to play a dominant role in the economy. The share of crude-oil production controlled by state and semi-state companies doubled. Growth in oil output, which before the Yukos affair had been running at about 9 percent a year, slowed to just 1 percent by the end of 2007. Worse, the destruction of Yukos negated any efforts to strengthen the rule of law. ‘The problem is not that the Russian legal system is weak,’ says Vitaly Naishul, who watches Russian institutions. ‘The problem is that it does not exist. The Russian justice system has as much to do with justice as the Soviet system of trade with trade.’ That problem is as old as Russia, but under Mr. Yeltsin the courts, however corrupt, were at least independent of the Kremlin. Under Mr. Putin, judges have again turned into bureaucrats who rubberstamp dubious administrative decisions. The destruction of Yukos and the redistribution of its assets to Rosneft, a quasi-state oil company chaired by Mr. Putin’s deputy chief of staff, showed that property rights count for little. ‘After Yukos nobody can feel safe,’ says the owner of a factory making kitchen shelves in Kaluga. Instead of cultivating the rule of law, as Mr. Putin promised, Russia was subjected to the rule of thugs, says Mr. Illarionov.46 Economic Reforms The process of economic reform in Russia accelerated significantly in late 2000 through early 2002, with the enactment of a range of sweeping legislation. As the focus began to shift toward implementation, progress slowed. Despite this slowdown, however, there had been significant policy changes in the areas of fiscal policy, trade, foreign investment, banking, taxation, tariff and non-tariff barriers, and currency policies. Fiscal Policy The economic upturn due to improved competitiveness and higher oil prices had led to more buoyant fiscal revenues, particularly from the energy sector. However, an unprecedented increase in the current account surplus exacerbated inflationary and exchange rate pressures. In response, the Central Bank introduced more flexibility in the exchange rate policy, allowing the ruble to appreciate in nominal terms (in the first 10 months of 2006, the ruble appreciated 7.6

The Competitive Advantage of Russia IB-73

p. 11

percent against the US dollar). worrisome.

Despite this move, inflation was becoming increasingly

Large balance of payments surpluses complicated monetary policy for Russia. The Central Bank followed a policy of “managed” appreciation in an attempt to ease the impact on domestic producers, while the government attempted to offset the impact of the capital inflows by running large budget surpluses. However, the Central Bank had to buy dollars generated by the export surplus, pumping additional ruble liquidity into the system. The rising demand for money due to the growth of the economy softened the inflationary impact, but these policy choices complicated the government’s efforts to lower inflation to the single digits. Consumer price inflation was 9.2 percent in 2007, having steadily decreased from more than 20 percent in 2000. Despite these measures, inflation was forecast to climb to 13.5 percent in 2008.47 The extent of real effective appreciation in recent years was considerable and had by 2007 nullified the gains in competitiveness arising from the 1998 devaluation. Further strengthening of the ruble appeared inevitable, owing to continued foreign-exchange inflows and the dearth of sterilization instruments at the Central Bank’s disposal.48 Concerns over inflation were expected to lead the Central Bank to accept more ruble appreciation. Russia’s federal budget policy was aimed at ensuring balanced government finance, increased spending efficiency, risk reduction, refinement of inter-budgetary mechanisms, and modernization of the budget sphere. Starting in 2006, the budget was developed on the basis of a prospective three-year financial plan. In 2006, the Ministry of Finance pursued a policy of separating existing and new government obligations (in particular, this concerned the decisions to increase the salaries of government employees, as well as pensions and benefits) in order to improve stability, predictability, and transparency in government spending. This project was expected to create a more flexible and efficient incentive system for government employees and to raise the appeal of government service on the employment market.49 The Russian federal budget had run growing surpluses since 2001, as the government had taxed and saved much of the rapidly increasing oil revenues. The 2007 budget surplus was more than 5 percent of GDP.50 Although there were strong pressures to relax spending ahead of elections, the government loosened its spending gradually, as the economy was running at near capacity and there were dangers of continued inflation and rapid exchange rate appreciation. Spending increases were mostly for increased salaries of government employees and pensions.51 Trade Exports represented $355 billion in 2007, with imports at $223 billion, resulting in a trade surplus of $132 billion, which boosted domestic demand. Primary exports included petroleum and petroleum products, natural gas, wood and wood products, metals, and chemicals. Russian GDP growth and the surplus in the federal budget were closely linked to world oil prices, since commodities comprised such a high percentage of Russian exports.52 Since the collapse of communism, Russia’s trade with the West had grown significantly, while its trade links with the former Eastern Bloc countries and other parts of the former Soviet Union had become relatively less significant. The EU emerged as Russia’s largest trading partner,

The Competitive Advantage of Russia IB-73

p. 12

accounting for more than 50 percent of the country’s total trade, followed by the countries of the Commonwealth of Independent States (CIS), which contributed another 14 percent. On the export side, the Netherlands was the biggest destination, accounting for 10.3 percent of total Russian exports. Germany and Italy accounted for another 8.3 percent and 7.9 percent respectively. Among the CIS countries, Ukraine was the biggest export destination, receiving around 5.2 percent of total Russian exports. China (5.5 percent), Turkey (4.5 percent), and Switzerland (4.4 percent) were also key markets. On the import side, Germany was Russia’s largest supplier, accounting for 13.6 percent of total imports. In the CIS, Ukraine (8 percent) and Belarus (4.7 percent) were the most important suppliers. China (7.4 percent), Japan (6 percent), the U.S. (4.7 percent), and South Korea (4.1 percent) were other important sources.53 Primary imports to Russia from the U.S. included machinery, meat (mostly poultry), electrical equipment, and high-technology products.54 Foreign Investment Despite Russia’s size and economic potential, foreign direct investment (FDI) inflows were meager throughout the 1990s. In the 2000s, FDI inflows increased, as foreign investors sought opportunities in line with those in China, India, and Brazil. However, Russia’s cumulative FDI per capita still lagged far behind such countries as Hungary, Poland, and the Czech Republic. Russia’s poor business climate, lack of transparency, and widespread corruption partly negated the country’s solid macroeconomic fundamentals and its consumer and retail booms, which were providing double-digit returns to investors and attracting some new inflows. Another significant drawback to investors was the Russian banking sector, which lacked the resources, capability, and credibility needed to attract substantial savings and direct these toward productive investments.55 Russia attracted nearly $29 billion in FDI in 2006, up from almost $13 billion in 2005.56 In 2007, FDI again increased significantly and was estimated to have reached $52 billion.57 Russian domestic funds were also flowing back into the country, as much of the foreign investment coming into Russia from locations such as Cyprus and Gibraltar was actually repatriated Russian capital.58 Russia’s approach to FDI was relatively subdued, compared with some other developing economies. However, the energy sector was an exception, with some large oil and gas projects distorting the overall investment picture. While efforts were made to reform tax law and administration, foreign firms sometimes struggled to interpret rules. Direct investment could be particularly tricky in the country’s regions, as corruption remained a serious issue, and the treatment of foreign investors in Russia’s privatization program was far from consistent. During Putin’s tenure as president, the government focused strongly on attracting FDI, particularly through structural reforms. However, while many regions also developed laws and programs to attract FDI, the tax reforms instituted in 2001 effectively limited the amount of incentives that regions could offer. In general, foreign investors had limited access to the privatization process, which had already disposed of the country’s most attractive assets. For instance, the 1995-1996 “loans-for-shares” privatization policy banned foreign investors from investing in the oil, natural gas, and precious metals sectors. (Subsequently, some foreign investors bought shares of privatized enterprises in

The Competitive Advantage of Russia IB-73

p. 13

secondary transactions, including oil and gas). Foreign investors participating in Russian privatization sales often were confined to limited positions and faced problems with minority shareholder rights and corporate governance. Until 2002, FDI in Russia was also limited to specific sectors, causing some critics to question the government’s commitment to foreign investment. For example, until that time, tight controls in its energy sector restrained foreign companies from anything more than minority stakes (and often only 20-25 percent) in larger projects.59 Investment in other key sectors, such as aerospace, natural gas, insurance, electric power, defense, natural resources, and large-scale construction projects, remained subject to official or de facto restrictions. In sectors where licensing was needed, such as banking, mining, and telecommunications, lengthy and nontransparent procedures created another deterrent to FDI. Despite some opening up of government policies toward foreign investment, prior approval was still required in the following sectors: (1) new enterprises using assets of existing Russian enterprises; (2) defense industries; and (3) the exploitation of natural resources. Approval was also required for all investment ventures in which the foreign share exceeded 50 percent, or which took over incomplete housing and construction projects. British oil giant BP was one company which had realized the importance of close relationships with state-controlled enterprises in order to do business in Russia. In 2003, it formed a joint venture with a Russian company TNK, investing some $6.8 billion for a 50 percent stake.60 According to the SEC, TKN-BP had estimated proven petroleum reserves of 4.1 billion barrels (of which 3.2 billion barrels were developed), making it the third-largest oil company in Russia by some accounts. After Russia’s largest private oil company, Yukos, was thrust into bankruptcy by the Russian government’s claims that the company owed as much as $32 billion in back taxes,61 TNK-BP decided to bid for Yukos’ 9.4 percent stake in state oil producer Rosneft. Many considered this an attempt by TNK-BP to build strategic ties with the state-run company. However, at auction in March 2007, BP quickly conceded defeat to Rosneft, the only other bidder. As a result, Rosneft reclaimed ownership of its assets for $7.6 billion, a 10 percent discount to market value.62 Two months later, in May 2007, Rosneft purchased additional Yukos assets in Siberia, enabling the company to overtake the privately owned Lukoil in terms of oil production capacity and become Russia's largest oil company. This move also continued efforts by the Russian government to strengthen its control of the country’s oil and gas sectors, which had been diminished during the privatization process of the early 1990s.63 In 2006, TNK-BP invested a large amount of money and prestige in a plan to develop a giant natural gas deposit in Siberia, with an eye on the Chinese gas market. However, in 2007 the Russian government threatened to revoke its license on the grounds that the firm was not producing gas quickly enough from the Siberian development. In response, TNK-BP asserted that it was unable to develop the field because the authorities had refused to grant the jointventure access to important gas pipelines. The move highlighted growing state control of upstream assets, a trend that had earlier prompted Russia’s largest privately owned company, Lukoil, to form a joint venture with GazpromNeft, the oil division of state-controlled Gazprom in

The Competitive Advantage of Russia IB-73

p. 14

order to counter Rosneft’s rising dominance.64 In June 2007, the TNK-BP joint venture agreed to sell Gazprom its majority interest in the Siberian field for some $900 million, in exchange for an agreement to join with Gazprom in unspecified foreign ventures. Analysts considered the agreed-upon price to be considerably less than what TNK-BP’s stake was worth, and saw it as another example of the Kremlin forcing out Western energy firms.65 BP’s problems, together with the earlier forced withdrawal of Royal Dutch Shell from a major energy project in 2006 in Sakhalin, were evidence of mounting concerns regarding the Russian government’s diminishing commitment to market norms in the energy sector.66 As one article described: Last year [in 2007] the authorities began investigating TNK-BP, a joint venture between Britain’s BP and private Russian investors, for failing to meet its production quotas from Kovykta, a huge gas field. Before that, Royal Dutch Shell and its partners fell foul of environmental inspectors. In both cases, the firms agreed to sell controlling stakes in the relevant projects to Gazprom, Russia’s state-owned gas giant, and their problems magically disappeared.67 In July 2007, the Duma introduced a new bill restricting foreign investment in 39 industry segments linked with state monopolies, Although the bill further restricted foreign access to the Russian economy, it reportedly provided more transparent and permanent “rules of the game” for foreign investors68⎯a change that was sorely needed, according to many established and potential investors. In 2008, however, ventures such as TNK-BP’s still faced pressure in Russia, although it was unclear in this case whether the government or its Russian partners were the source of the difficulty. Concurrently under investigation for tax-evasion at a subsidiary, “industrial espionage” activities by one of its employees, and other labor-related issues that resulted in the company and its CEO, Robert Dudley, being fined, BP professed to see no connection between these events.69 Yet some suspected the Kremlin of seeking more assets for state-owned Gazprom and Rosneft. Another theory was that BP’s partners in the venture, a group of Russian billionaires, were maneuvering for more control and a stronger financial position.70 This conflict became public in mid-2008 when the Russian owners demanded Dudley’s resignation and announced that they were planning legal action to defend their interests.71 As one article described: As it fights to preserve its TNK-BP Ltd. Russian joint venture, BP PLC is struggling with two big unknowns: What does the Kremlin want and what are BP’s Russian-billionaire partners really after? Lacking clear answers to those questions, BP has been fighting trench warfare to keep its partners from gaining control inside TNK-BP even as it continues high-level talks with them. BP has also marshaled support from London, Washington, and Brussels to quietly convey the message to Russian officials that Western capitals are watching the fight as a key test of newly elected President Dmitry Medvedev.72 BP offered to exchange the Russian shareholders’ stock in TNK-BP for shares in BP, if the Kremlin would approve the transaction and agree to let BP, in turn, sell 50 percent or more of the venture to a company such as Gazprom or Rosneft. Publicly, the Russian

The Competitive Advantage of Russia IB-73

p. 15

shareholders indicated that they would not consider such an exchange for at least 12 to 18 months. Insiders speculated that this could have been because they believed TNK-BP’s estimated market capitalization—of approximately $40 billion—to be substantially undervalued at the time the offer was made.73 Banking As noted, Russia’s banking sector was a source of concern for foreign investors as well as those with domestic and government interests. It had been adversely affected by the currency fluctuations and the economic conditions following the 1998 financial crisis. Further, the lack of well-developed bankruptcy laws, the absence of formalized procedures for the registration and enforcement of collateral, and other legal and fiscal impediments contributed to the challenging environment for banks. The Central Bank regulated all activities of the banking industry and state-owned banks dominated the industry. A large number of foreign banks had established a presence in the market, but their activities were largely restricted to Moscow and St. Petersburg. Domestic capital markets were still in a developmental stage, with a low level of liquidity in the public and private debt and equity markets. The structure of the banking sector suffered from the dual difficulties of excessive concentration at one end and inadequate concentration at the other. At one extreme was the leading bank, Sberbank (in which the Central Bank had a controlling stake), which accounted for approximately one-fourth of the country’s total banking assets. Sberbank also accounted for more than one-half of total bank deposits, and more than three-fourths of total household deposits in the banking sector. At the other end of the spectrum were almost 1,400 active commercial banks. Within this group, the smallest 800 banks each had an average asset level of around $1 million, and low levels of capitalization and profitability meant that many were at risk. Although consolidation might have produced scale efficiencies and improved the health of the financial sector, this possibility was hampered by a lack of transparency over ownership structures and balance sheets. Areas for further reform included improved on-site supervision of financial institutions, more consolidated supervision of large banking groups, and more stringent licensing requirements, including proper requirements for both managers and shareholders. Some organizations in the sector had begun to provide the foundation for capital markets. Russian investment banks emerged, such as the highly regarded Troika Dialog Bank. Meanwhile, a number of large Russian companies, constrained by the fledgling domestic capital market, successfully turned to international capital markets, primarily for debt, while some others listed on foreign stock exchanges. Taxation In 2001, the tax system in Russia underwent a comprehensive reform, designed primarily to ease the tax burden on individuals and companies. As a result, tax legislation more closely matched the needs of a growing market economy and eliminated many of the distortions of previous legislation, which had kept many businesses in the shadow economy. Highlights of the new program included a reduction in personal income tax to a flat rate of 13 percent, and simplification of corporate taxes, which were reduced from 35 percent to 24 percent. Most turnover taxes were abolished, sales tax was eliminated, and taxation of the oil sector was simplified. With oil production declining at alarming rates, the government provided $4.5 billion

The Competitive Advantage of Russia IB-73

p. 16

in tax breaks to the industry in 2007. However, according to the oil companies, this was barely enough to keep production stable. In his inaugural speech to the Duma as prime minister in May 2008, Putin proclaimed that taxes on the industry would have to be further reduced.74 The recent buoyancy in tax revenues suggested that the overall program to reform taxation was positive (although surging oil revenues deserved at least part of the credit). Yet, the use of punitive taxes as an instrument in settling disputes continued, and though rules governing tax inspections had been revised, the new rules left the tax authorities with much the same arbitrary power as before.75 Tariffs and Non-Tariff Barriers Russia continued to maintain a number of barriers with respect to imports, including tariffs and tariff-rate quotas, discriminatory and prohibitive charges and fees, and discriminatory licensing, registration, and certification regimes. Discussions were under way to eliminate these measures or modify them to be consistent with internationally accepted trade policy practices. However, tariff and non-tariff barriers were frequently used to restrict foreign access to Russian markets.76 Currency Policies Under the Foreign Investment Law, after exchange regulations were satisfied and taxes paid, profit generated in foreign currency could, in principle, be repatriated. Central Bank amendments in 2001 extended this to dividends on equities, as well as corporate and sovereign bond repatriations. Transactions involving currencies were liberalized under the December 2003 law “On Currency Regulation and Currency Control.” Notably, the new law limited the authority of the Central Bank to restrict currency operations in Russia, and divided responsibility for managing currency regulation functions between the CBR and the government. The CBR was given responsibility for currency operations related to loans and financing, transactions with securities, and banking operations. The government was chartered to regulate currency operations relating to foreign trade, such as export and import of goods, works and services, intellectual property, and the participation of residents in the charter capital of foreign companies other than joint-stock companies. Together, the two entities were to manage residents’ investments into foreign companies, partnerships, and other property.77 The new law also aimed to replace the permission-based system with a free-hand regime, meaning that any currency transaction not specifically prohibited under the law was permissable. Under the old system, only a limited number of currency operations could be performed without a Central Bank license (which sometimes took more than six months to obtain).78 The new law also prohibited the Central Bank and Russian government from introducing new requirements to the currency regime, except as provided by the law itself. Three primary forms of restrictions on currency operations that remained were mandatory reserving (to help manage currency reserves and protect against ruble exchange-rate fluctuations and capital flight), preliminary registration (to allow for monitoring), and the establishment of special accounts (for settlements associated with certain operations).79 However, some of these restrictions were earmarked for further relaxation in 2007.

The Competitive Advantage of Russia IB-73

p. 17

WTO Accession Prospects Russia had been engaged in negotiations to join the World Trade Organization (WTO) for more than 15 years. In mid-2002, an important milestone was reached when both the U.S. and the EU granted Russia the status of a market economy. The signing of a trade pact between Russia and the U.S. in November 2006 lifted perhaps one of the biggest obstacles to the country’s inclusion (along with the endorsement of the EU, which was secured prior to the U.S. agreement). However, because any single member was empowered to block another country from joining the group, Russia continued to face challenges (and delays) in gaining membership. Its latest difficulties had been raised by the Ukraine, which became a member of the WTO in May 2008. This country sought to engage in bilateral talks to resolve long-standing trade disputes with Russia before endorsing the country’s accession to the WTO. Georgia had also become increasingly vocal about blocking the country’s membership. This former-Soviet country joined the WTO in June 2000, after just four years of negotiations. Tensions between Georgia and Russia had intensified over Russia’s wooing of two separatist regions to cede from Georgia, and its efforts to block Georgia’s membership in NATO. Until Russia could bring these issues under control, it would not achieve its goal of becoming a WTO member. Business Environment In 2008, one of the most crucial policy issues facing the country was the extent of state intervention in business and the economy. The future of capitalism in Russia depended on whether its economic policies maintained a supportive environment, or continued to impede the creativity, growth and profitability of private companies.80 Small business, the economic engine of most developed economies, employed only 20 percent of Russia’s economically active population, versus more than 50 percent in Europe and 80 percent in Japan.81 Economists argued that supportive policies would encourage entrepreneurship by reducing the bureaucratic requirements for starting businesses, and also reduce opportunities for bribery and corruption. Russia was one of the most industrialized of the former Soviet republics. However, despite the prevalence of a large manufacturing sector, much of the industry was antiquated, highly inefficient, and unproductive according to global standards. The replacement or modernization of equipment and production processes was deemed essential if this sector was to contribute to economic growth. Russia also inherited most of the defense industry of the former Soviet Union. Efforts throughout the late 1990s and early 2000s to convert defense industries to civilian use had met with varying levels of success. One positive consequence of this conversion was the availability of highly skilled scientists, engineers, and technicians in the business environment. Labor Force Driven by these changes, the Russian labor force was undergoing a transformation. Although well educated and highly skilled, the country’s workers were largely mismatched to the rapidly changing needs of the Russian economy. As a result, much of Russia's existing large pool of scientific and engineering talent remained under-utilized. Foreign investors were beginning to harness these inexpensive skills by opening enterprises such as engineering design bureaus and offshore software development shops in Russia. Projects of this type were proving to be

The Competitive Advantage of Russia IB-73

p. 18

particularly successful, and were embraced by Russian authorities who were worried by a brain drain overseas of Russia's best talent. Corruption One of the most significant problems in Russia’s business environment was the continued impact of corruption in both the public and private sectors. The complex central planning system of the communists left a legacy of patronage, kickbacks, and cronyism among government officials, bank employees, and productive sector managers. This culture had survived, and in many cases flourished, since the transition to capitalism, permeating and distorting many market mechanisms. For instance, one estimate suggested that annual bribes paid to police officers approached $400 million, with even higher levels of kickbacks and unofficial payments made to health and education sector officials. Low salaries and morale within the public sector were major contributors to the problem. In the financial sector, for example, crony capitalism manifested itself in direct lending on favorable terms to large, politically influential firms and the withholding of financing from more dynamic small and medium-sized enterprises. According to a 2008 article: Andrei Sharonov, a liberal reformer who left the economics ministry last year, says he underestimated the impact of arbitrary bureaucratic decisions. ‘We have turned our back on healthy competition. The system rewards those who are closer to the centre of power, not those who work better. It is easier to get a competitor into a jail than to compete with him.’ Businessmen complain that corruption, already rampant in the 1990s, is now more entrenched, and the sums involved are getting larger…. Corruption is of two kinds. One sort is driven by private firms and individuals who bribe officials to turn a blind eye to the rules. This allows businesses to get around a net of conflicting and outdated laws. ‘If everyone followed every rule and instruction in Russia, the country would grind to a halt,’ says Mr. [Vitaly] Naishul [who watches Russian institutions]. The other kind of corruption emanates directly from the Kremlin and benefits state officials and their friends who double up as businessmen. Both damage the country, but the second is more insidious.82 Russia’s Oligarchy and Siloviki Capitalism “Oligarchic capitalism” in Russia referred to the economic activities of a small number of very large and powerful financial-industrial groups operating in highly concentrated industries in the private sector, predominantly in natural resources. These firms operated globally, with limited domestic competition, and benefited from the buoyant climate for natural resources prevailing in the early years of the century. Oligarchic capitalism dominated the Russian economy in the second half of the 1990s and early 2000s, and remained an important but less dominant component of the economy in 2007. Most of these financial-industrial empires were owned by a small number of extremely wealthy and powerful individuals, the oligarchs⎯many of whom were included on Fortune’s annual list of billionaires.83 The growing government involvement with oligarchy in business led to a condition that economist Marshall Goldman termed “siloviki” capitalism. The term siloviki referred to

The Competitive Advantage of Russia IB-73

p. 19

politicians or bureaucrats, often with ties to the old regime, who exercised power with government support. This form of capitalism characterized the various ways in which the government exerted influence over the economy to favor national interests, and the major corporations in which it had a majority stake (or significant ownership). A growing number of representatives from the siloviki had been appointed to key positions in major corporations with majority government ownership, and some to essentially private companies. Putin’s siloviki appointments included administration deputy head Igor Sechin, as chairman of the board of stateowned Rosneft, as well as top Putin aides Alexei Miller and former KGB officer Viktor Ivanov, as chairmen of the boards of Gazprom and Aeroflot respectively. Economic minister German Gref announced in February 2006 that the government intended to gain majority control of Alrosa, the Russian diamond monopoly, whose chairman was Finance Minister Alexei Kudrin. Some analysts considered these activities a vivid example of how members of Putin's inner circle, many of them with links to the former KGB or its successor,84 were using their network to take over private companies and amass personal wealth in the process.85 Oligarchs who did not cooperate could find their holdings threatened with tax assessments, or confiscated by emerging firms in state-declared strategic industries (as in the Yukos case). Their power was demonstrated by the sales of valuable natural resource assets by several oligarchs to state-owned companies, often under duress. In 2008, however, as one of his first acts as prime minister, Putin initiated somewhat of a shakeup within the siloviki, demoting or sidelining many of the men he previously had put into power (including Ivanov and others like him). One explanation for this behavior was that “they had become too powerful for Mr. Putin’s liking.”86 According to Olga Kryshtanovskaya, a sociologist who studies the Russian elite, Putin was cleansing the siloviki clan and getting rid of those who were equal or even senior to him in the KGB. “A tsar does not have colleagues, he has subjects,” she said.87 Additionally, the state used many other methods to exert its influence on the economy. These included regulating and restricting entry of firms, controlling the use of land and real estate that private businesses occupied, taxing businesses to suit its own ends, inspecting firms and sometimes closing them at will, and exercising control over international trade and foreign exchange transactions.88 In early 2006, for instance, government policies remained in place to prevent investors and business people from owning land in Moscow, even though federal law had legalized private land ownership in 2001.89 Obstacles to Foreign Investment Despite Russia’s continued growth, as well as its vast potential, structural economic problems and well-publicized problems in the business environment made many individuals and groups wary of making major investments in the country. Highest on the list of concerns raised by foreign business people in periodic surveys were issues such as the pervasive influence of government bureaucracy in every area of business operations, unofficial barriers imposed by regional authorities, weak enforcement of the rule of law, and lack of respect for property rights. Taxation and business regulations were still not wholly predictable, and legal enforcement of private business agreements (especially outside Moscow and St. Petersburg) was weak. According to World Bank data, it took 29 separate procedures and an average of 330 days to

The Competitive Advantage of Russia IB-73

p. 20

enforce a contract (compared to 19 procedures and 229 days in high-income, developed nations).90 Investors were further dissuaded by the high costs of complying with the Russian tax code, inconsistent government regulation, limited ability to obtain redress through the legal system, organized crime, and corruption. On Transparency International’s Corruption Perceptions Index in 2005, Russia was ranked 126th (out of 159), and its score of 2.4 was lower than the average score of 3.25 for emerging countries in Europe (the average score for developed countries in Western Europe was 8.2).91 The most common forms of corruption were bribe demands from officials with responsibility for licensing and other investment-related activity; extortion of foreign firms by central and local tax authorities; and courts influenced by vested domestic business interests, particularly regional senators. In September 2006, Andrei Kozlov, the first deputy chairman of the Russian Central Bank, was shot to death. Prosecutors surmised that Kozlov may have been killed because of his leadership in the decision to revoke the licenses of several banks believed to be guilty of money laundering. His decision had likely been intended to deter corruption in a country seeking to build better transparency. The killing of Kozlov sent a warning that such efforts were likely to be resisted with deadly force.92 These systemic problems were compounded by lack of available financing, and concerns about long-term economic and political stability. Many large U.S. companies remained cautious about acquisitions in Russia because of fears of unknown liabilities associated with past operations (especially environmental cleanup obligations), hidden financial liabilities, inadequate bankruptcy procedures, and weak protection of minority shareholder rights. The absence of a functioning framework for production-sharing agreements, along with weak corporate governance practices in Russia’s oil majors, deterred FDI in the lucrative natural resources sector. Though investment levels had improved recently, without significant institutional reform Russia was unlikely to improve on its past record in attracting inward investment.93 Before the end of his second term, President Putin admitted that the government was too large and intrusive, and that past attempts to reduce its influence had failed. Planned measures to reduce the size and role of the state in the economy included reducing the number of activities that required a state license from 500 to 90, and the outright abolition of some ministries. One additional problem that served as a barrier to foreign investment in Russia was the quality of the country’s physical infrastructure. Due to lack of infrastructure investment through the 1980s and 1990s, Russia was sorely behind other developed and developing nations. As of mid-2000, the majority of Russia's ports, airports, railways, and power stations were about 40 years old, and the quality of fixed assets in factories was generally poor. Outside the major cities, the energy infrastructure was in need of renewal. Huge investment in the electricity industry was vital in order to eliminate the gap between energy production and consumption. Fuel shortages, nonpayment, and outdated equipment resulted in frequent blackouts, while the telecommunications infrastructure was also substandard, in terms of both its quality and geographical coverage. The Russian Mindset94 When doing business in Russia, foreign companies often discover that the older and younger generations have quite different mindsets. Older generations were conditioned to secrecy,

The Competitive Advantage of Russia IB-73

p. 21

distrust, and fear during the Communist era, and their sense of personal responsibility, selfworth, motivation, and personal security were affected. The younger generation, in contrast, was generally more open and relaxed. Core Russian values across generations included the family, security and stability, loyalty, honor and pride, endurance, patience, and mutual support. Russians took duality to greater extremes than other nationalities. They could be emotional and irresponsible and yet haunted by conscience; reckless yet cautious; independent yet needing a sense of belonging to a family group or team. There was conformity within a loose hierarchical structure and a tendency to follow a leader rather than the rules. As a result, working with Russians could be both frustrating and rewarding. Getting an appointment could be difficult. Meetings could go on for hours and stray far from their original agenda. Negotiations could be protracted and contracts easily broken. Schedules could change constantly, making planning almost impossible. Hours might be spent discussing a problem with no real plan to develop a solution. A common attitude was that one should work to live and not vice versa. Apart from the new business-oriented class, Russians could take a laid-back attitude to getting things done. When time could be saved at the expense of money, a Russian would often opt for lower cost (despite the expenditure of more time). Money was a much more precious commodity than time, and this philosophy was reflected in their business behavior. (See Exhibits 1 through 5 for additional background materials and economic data, as well as Exhibit 6 for additional information about the characteristics of Russian society.) RUSSIA’S INTERNATIONAL COMPETITIVENESS The Competitiveness of Nations Although there is a role for government in creating a macroeconomic and microeconomic environment in which business can flourish, the increasing role of government in the business environment of Russia was unfavorable for the development of a broad range of internationally competitive companies. As Michael Porter of Harvard University, an authority on the subject of national competitiveness, recently noted, a top-down approach by government must be complemented by a bottom-up (or microeconomic) approach that stimulates individual firm performance.95 This paper now shifts its focus to explore Russia’s current international competitive position in the light of its resources and government policies. Porter’s Competitive Advantage of Nations Framework In early 1990, Porter published the results of a major research project in his book, The Competitive Advantage of Nations.96 In this book, Porter defined international competitiveness in terms not of static trade performance but of the raising of incomes over time through trade and the attraction of foreign investment. He asserted that competitiveness was determined by the productivity that a nation achieves in using its human, capital, and natural resources.97 According to Porter: • Productivity defines the standard of living (wages, return on capital, return on natural resources) for a country and, in turn, drives national prosperity.

The Competitive Advantage of Russia IB-73

p. 22

• • • •

Productivity depends on the value of products and services a nation provides (e.g., uniqueness, quality) as well as the efficiency with which they are delivered. It is not in what industries a nation competes that determines prosperity, but how firms compete in those industries. Productivity in a nation is a reflection of what both domestic and foreign firms choose to do in that location. The location of ownership is secondary for national prosperity. The productivity of “local” industries is of fundamental importance to competitiveness, not only that of industries in the traded sector.98

Porter believed the capacity of a nation to innovate was the cornerstone of productivity.99 However, his definition of innovation went far beyond the traditional concept of scientific discovery. In an economic development context, innovation referred to a country’s ability to upgrade its business environment continually to support and encourage more sophisticated ways of competing.100 Economic upgrading occurred through the interaction of four key variables referred to as the “Diamond of National Advantage”⎯Factor Conditions, Demand Conditions, Related and Supporting Industries, and the Context for Firm Strategy, Structure, and Rivalry. Porter’s framework maintained that a nation could build and sustain increasing levels of competitiveness by managing these four determinants. The Global Competitiveness Report Each year, the World Economic Forum produced an annual Global Competitiveness Report (GCR) with the objective of evaluating the economic competitiveness of countries.101 In its 2007-2008 version, the GCR presented two complementary approaches for assessing national competitiveness. The first was the Growth Competitiveness Index (GCI), developed by Professor Xavier Sala-i-Martin of Columbia University. Through the GCI, the report assessed a nation’s ability to sustain economic growth over a medium to long-term period by evaluating twelve ‘pillars’ of competitiveness: (1) Institutions; (2) Infrastructure; (3) Macroeconomic stability; (4) Health and primary education; (5) Higher education and training; (6) Goods market efficiency; (7) Labor market efficiency; (8) Financial market sophistication; (9) Technological readiness; (10) Market size; (11) Business sophistication; and (12) Innovation. In this edition, the GCI examined 131 countries and rated them by providing a weighted average of the many different components that made up the 12 pillars of competitiveness. The second approach used to evaluate national competitiveness in the Global Competitiveness Report was called the Business Competitiveness Index (BCI), developed by Michael Porter. The BCI took a microeconomic approach toward assessing a nation’s competitiveness. According to a previous report: The productivity of a country is ultimately set by the productivity of its companies. An economy cannot be competitive unless companies operating there are competitive, whether they are domestic firms or subsidiaries of foreign companies. However, the sophistication and productivity of companies are inextricably intertwined with the quality of the national business environment. More productive company strategies require more highly skilled people, better information, more efficient government processes, improved infrastructure, better

The Competitive Advantage of Russia IB-73

p. 23

supplies, more advanced research institutions, and more intense competitive pressure, among other things. This is what the BCI tries to capture.102 For the BCI, Porter calculated two primary subindices focused on (1) company operations and strategy, and (2) the national business environment. Based on a country’s score in these two areas, an overall ranking was then determined. In the 2007–2008 Global Competitiveness Report, the BCI included 127 countries. To calculate the GCI and the BCI, the GCR drew on publicly available statistical data, as well as qualitative information collected via an Executive Opinion Survey conducted annually by the World Economic Forum. While the Global Competitiveness Report, in its entirety, extended beyond the microeconomic boundaries of Porter’s Competitive Advantage of Nations framework, they were considered complementary. Accordingly, this paper references data and rankings from the GCR as it evaluates Russia’s competitive position in the worldwide economy. Russia’s Competitive Position Russia’s overall ranking on the Global Competitiveness Index fell from 53 in 2005-2006 to 62 in 2006-2007 and then climbed to 58 in 2007-2008. The report pointed to a number of problems related to the country’s business environment, all of which affected its overall ranking (see Exhibits 7 and 8): Despite the country’s large market size and improving macroeconomic management, Russia places below the other large European countries, mainly attributable to weaknesses in its institutional environment and business standards. Of major concern is a perceived lack of government efficiency (118th), the lack of independence of the judiciary (106th), and more general concerns about government favoritism in its dealings with the private sector. Further, the environment for the protection of property rights is extremely poor and worsening (122nd this year). Private institutions also get poor marks, with corporate ethics in the country placing Russia 120th overall on this indicator.103 On the Business Competitive Index (BCI), Russia improved its overall ranking by six points, climbing to 71 in 2007-2008. To assess Russia’s challenges for improvement, this paper turns to a more detailed evaluation of Russia’s performance in the four key areas of the Porter “diamond”—Factor Conditions, Demand Conditions, Related and Supporting Industries, and the Context for Firm Strategy, Structure, and Rivalry. Factor Conditions Within the microeconomic environment, factor conditions refer to the efficiency, quality, and specialization of the underlying inputs that companies draw on when competing.104 Important factors include human resources, capital resources, the country’s physical, information, scientific, and technological infrastructure, and its natural resources.105

The Competitive Advantage of Russia IB-73

p. 24

Human Resources Relative to many other countries, the Russian workforce was relatively highly educated. The average Russian citizen (25 and older), spent 10.5 years of his/her life in school. This statistic placed Russia ahead of Brazil, India, China, South Africa, Germany, Japan, and the United Kingdom in terms of education. In the 2007-2008 GCR, Russia ranked 47th in secondary education enrollment, but in tertiary (university) enrollment, it ranked much higher at 14th. Russia also ranked among the highest in terms of the proportion of its population with a tertiary education (more than 50 percent). However, the Moscow Times reported that only two Russian colleges, Moscow State and St. Petersburg State, were listed among the world’s top 500 universities. Moreover, Russia spent far less of its GDP on higher education than Europe or America.106 In recent years, the quality of higher education in Russia had attracted the attention of the government, including Putin himself. The system was beset by familiar problems, such as meager salaries, corruption, outdated materials, and a lack of proper oversight.107 Quality was just barely above average in terms of ranking in the 2007-2008 GCR, where Russia ranked 46th in terms of quality of the educational system and 38th in terms of math and science education quality. The quality of the workforce was also declining, according to Raj M. Desai of the Wolfensohn Center for Development and Itzhak Goldberg of the World Bank: The Russian workforce lacks the requisite skills for firms to compete on the global market. More than a third of all managers reported deterioration in the quality of their workforce between 1996 and 2005. Almost half of the firms hired workers with lower quality skills, while only 10 percent of firms improved workforce quality by hiring more skilled workers.108 In addition to deterioration in workforce skills, according to an article in the Moscow Times in 2004, an internal government report indicated that “the country’s workforce is shrinking at twice the rate of the general population due to a decrepit healthcare system and dangerous working conditions that have remained unchanged for the past century.”109 Other studies by the Federal Statistics Agency echoed these concerns, stating that the population was shrinking by 1 million per year. 110 Such workforce reductions were caused by workplace-related illnesses, injuries, and deaths, usually in the manufacturing industry. Health-related issues such as the rapid spread of tuberculosis and HIV/AIDS also caused workforce-related problems and general health issues. The World Bank warned that HIV/AIDS could decrease Russia’s annual growth by half a percentage point starting in 2010.111 Russia was rated 39th in terms of the medium-term impact of HIV/AIDS on business, and the country’s life expectancy was on the low end in the 96th position. In terms of the productivity of Russia’s labor force, Desai and Goldberg asserted that productivity in sectors such as manufacturing was substandard. They argued that: Although productivity in the manufacturing sector has been rising, it has not kept pace with rising real wages in recent years, limiting the international competitiveness of the Russian manufacturing sector. Real wages in

The Competitive Advantage of Russia IB-73

p. 25

manufacturing in Russia (deflated by the producer price index) have increased 72 percent since 1999. The monthly manufacturing wage in 2005 was approximately $300, an increase of 65 percent in just two years, and a 369 percent increase over the 1999 level of $64 per month. Under these conditions, international competition with countries whose labor costs are cheaper may be increasingly difficult for Russian manufacturers. Russian manufacturing productivity is now about 40 percent of Brazil’s and only one-third of South Africa’s. Productivity in Poland is twice as high as in Russia. Although labor productivity in Russia is slightly higher than that of India and China, Chinese wages in manufacturing are 30 percent lower than in Russia. And low labor costs in these two countries give Russia a competitive disadvantage: for each dollar of wages, a Russian worker produces about half the output of an Indian or Chinese worker.112 Compounding these challenges was the fact that employer-employee relations had traditionally been heavily regulated by the Russian Labor Code, which included provisions to protect employees against wrongful dismissal, a harmful working environment, and excessive working periods. However, new labor legislation, which came into effect in 2002, had begun to address these barriers. Policies to make it easier for employers to hire and fire employees, standardized hiring procedures, and longer probationary periods (six months) for more categories of employees were all helping make the labor environment in Russia more business-friendly. Capital Resources According to the 2006-2007 GCR, Russia ranked 60th in terms of venture capital availability, 108th in terms of the soundness of its banks, and 81st in terms of financing through the local equity market. Russia’s financial markets also ranked poorly on the financial market sophistication scale (88th). In 2005, the Russian government developed a state-backed venture capital program, spearheaded by then President Putin (and announced in early 2006). Putin’s goal was to jumpstart the hightech industry and move beyond oil-related growth. The government earmarked $800 million in funds and the first of these, the Moscow Venture Fund, began accepting applications in 2006. Putin also created the Russian Venture Company (RVC), an organization that used oil money to finance various venture capital funds. The idea was to create approximately 10 funds with $50 million of government money in each. The government’s money constituted 49 percent of ownership, with 51 percent being raised by private investors. Importantly, because the government would be in a minority position, it would play no role in the investment decisionmaking process. In contrast, the government’s telecommunications fund, which received $300 million to invest directly in the telecom sector, was not a “fund of funds” structure like the RVC. Thus, it received criticism related to potential bureaucracy and corruption issues. As a Western banker stated, “The point of the RVC’s fund of funds structure is to remove bureaucrats from the investment decision process. Not only are they, by definition, the worst people to make this sort of decision, you also lay yourself open to the problems of vested interests and corruption. The structure of the telecom fund is fundamentally flawed.”113

The Competitive Advantage of Russia IB-73

p. 26

Prior to these efforts, a venture capital industry did exist in Russia. However, it was small (estimated at $200 million in assets in 2006). Most venture capital money in Russia did not typically come from venture capital funds, but rather from big domestic companies investing in new technologies in their respective industries. Similarly, private equity firms were not very developed, with most of their money coming from business people who decided to back certain projects. The government’s focus on venture capital has led some to estimate that the industry could reach $3 billion before 2010.114 By comparison, in 2006 U.S. investors raised $30.8 billion in venture capital.115 Physical and Information Infrastructure In the 2007-2008 GCR, the overall quality of Russia’s infrastructure ranked towards the bottom of the list (81st). The railway system ranked highest at 29th while all other measures ranked lower—the quality of the port infrastructure was 72nd, air transport infrastructure was 79th, electricity supply was 76th, and roads were lowest at 106th. Russia’s railway system was the most important mode of transport, with 80 percent of the country’s freight traffic traveling by rail compared to only 20 percent in the West. Under Putin’s rule it had received significant funding for modernization.116 When the government decided to initiate these upgrades, it estimated that 58 percent of railway equipment was worn out and that it would cost $20 billion to upgrade the system. To raise the money, the government transferred the country’s rail assets in 2004 to a new government-controlled company called Russian Railways Co. with the idea of wresting control of the system from the Railways Ministry, which traditionally owned and operated the country’s railways. Although the infrastructure remained government-controlled, 60 percent of the rolling stock (railroad vehicles) would eventually be under private control.117 According to Business Monitor International, Russia needed to double the length of its roads in order to meet its economic and social needs.118 The government announced the “Modernization of Transportation Infrastructure in Russia” program in May 2004, which included the improvement and development of highways, railways, airports, seaports, and urban transportation systems. The program was funded with $170 billion from federal and local budgets, as well as the private sector. The country’s airport infrastructure was inherited from the former Soviet Union. Although the government was aware of necessary modernization, financial aspects hindered airport development projects. The Russian government planned to retain 60 of the 350 airports under federal supervision and the remaining airports would go under the control of regional authorities.119 Physical infrastructure for information and communications technology remained a challenge in Russia, as demonstrated by the country’s Internet users, personal computer users, and mobile telephone subscribers, which ranked in the middle of the 2007-2008 GCR at 56th, 47th, and 36th respectively. With Internet penetration rates at only 19.5 percent in 2007,120 Internet usage in Russia remained on the low side. The broadband Internet market was nearly nonexistent with just under 2 percent of the population subscribing to services121 (although the country rated 60th on this measure). Because of Russia’s size, Wi-Fi connections served as potential cost-effective

The Competitive Advantage of Russia IB-73

p. 27

alternatives to fixed networks, and companies such as Cisco Systems were betting on future growth. In April 2007, Cisco announced a venture capital initiative in which the company would invest in technology-related startups and in local venture capital firms that invested in technology. Its first investment was in a leading Russian e-commerce site similar to Amazon, called Ozon. In terms of landline phone service, Russia ranked 44th. Rostelecom had a strong monopoly in the long distance and international phone service markets, and its service could be inefficient and unreliable. Local phone companies were only partially privatized under the government’s holding company Svyazinvest.122 Scientific and Technological Infrastructure Russia’s science and technology infrastructure was still in the process of being developed, despite the high quality of Russian science. The country ranked 61st on research collaboration between its industries and universities, and 50th on company spending on research and development in the 2007-2008 GCR. The country ranked 46th in terms of the availability of scientists and engineers and 37th in the quality of scientific research institutions, the latter being a legacy of the country’s Soviet past. In fact, the country had up to 40 percent more scientists per capita than Germany, France, and the U.K., and 20 percent more than India.123 Natural Resources As noted, Russia was one of the world’s richest countries in terms of raw materials. The country accounted for 20 percent of the world’s production of oil and natural gas and Russia had large reserves of both, making the country self-sufficient in energy, as well as an exporter of the fuels. Other non-fuel minerals such as iron ore, manganese, chromium, nickel, platinum, titanium, copper, lead, diamonds, and gold were abundant, too. The few natural minerals imported into Russia were tin, tungsten, bauxite, and mercury. Russia also had one-fifth of the world’s timber within the forests of Siberia.124 The emphasis on growth throughout Russia’s Stalinist history led to significant environmental degradation and, in general, the country’s environmental record has been dismal. Uncontrolled growth along with limited environmental protection resulted in pollution problems in many of its largest cities. In 84 of Russia’s largest cities, the air pollution was 10 times the accepted safety levels. Russia was a major contributor to global ozone depletion. It had been the world’s largest producer and consumer of Ozone Depleting Substances until several Russian enterprises ceased production of chlorofluorocarbons (CFCs) and halons. In the past, the Russian government did not respond as quickly to incidents such as bursting of oil pipelines, due to the country’s abundant resources and the belief that the land could absorb pollution. However, in the 1990s, the government identified 40 percent of Russia’s territory as under high or moderately high ecological stress. Both pollution and environmental incidents have led to health problems such as respiratory and endocrine diseases.125 Although the government was gradually beginning to respond to environmental issues, the damage would take decades and trillions of dollars to remedy.126

The Competitive Advantage of Russia IB-73

p. 28

Demand Conditions According to Porter’s framework, demand conditions refer to the sophistication of domestic consumption and the pressure that local consumers exert on a country’s firms to create and improve products and services, which are then able to compete in world markets.127 According to the 2007-2008 GCR, Russian buyer sophistication ranked 58th, slightly above the median, meaning that its consumers tended to be reasonably knowledgeable and demanding and looked for superior performance attributes rather than the lowest price. Part of what was driving increasing consumer sophistication was the improved economy, following a seven-year decline in the early 1990s. Since that period, Russia had experienced eight straight years of economic growth and consumers had benefited measurably. “Russia has one of the fastest-growing income and consumption [growth] rates in the world,” said Mikhail Terentiev, a consumer analyst at Moscow’s Troika Dialog investment bank. “People who could never afford to buy quality goods now can.”128 All the data pointed to an emerging middle class, particularly in major cities such as Moscow and St. Petersburg. Estimates of the middle class segment usually ranged from 20 percent to 40 percent of the population. Real disposable incomes grew by 8.8 percent in 2005, spurring considerable growth in private consumption.129 The proportion of the population living below the poverty line (defined as a subsistence wage of $94 per month) also fell to less than 8 percent, in contrast to 38 percent in 1998.130 However, despite improved conditions and increasing consumer optimism, millions of Russians still lived in poverty, particularly in more rural areas. The Russian culture of spending rather than saving helped the consumer sector, especially as average disposable incomes were on the rise. Household consumption was buoyant; it played a stronger role than investment in the 11.6 percent increase in domestic demand recorded year-onyear in the first quarter of 2007. With real disposable incomes up by 13 percent, private consumption rose by 12.7 percent year-over-year in January through March 2007, according to the economic development ministry's estimates. This helped to fuel a 13.6 percent rise in retail sales and a 7.9 percent increase in the sales of services to the population.131 The consumer sector fundamentally operated in a market-oriented, competitive fashion, with many growing Russian companies and an increasing number of foreign competitors, such as Coca-Cola, Gillette, Danone, Caterpillar, Indesit and General Motors. Russian automotive companies, in particular, faced increasingly severe competition from imported and foreign vehicles assembled in Russia. Improving access to consumer credit also helped to fuel demand. Domestic credit rose by 46.4 percent year-over-year in 2006, and continued to expand in the first quarter of 2007. The Central Bank reported a 53.7 percent rise in the value of ruble credit in 2006, with foreign-currency loans up by a more modest 29.3 percent. Loans to individuals recorded unprecedented growth, increasing 75 percent in 2006 (more than twice the 38.6 percent increase in corporate credit within the same timeframe).132 The rapid rise in lending to individuals came from a low base, and was expected to continue, particularly as the government’s emphasis on housing pushed up the traditionally low demand for mortgages.

The Competitive Advantage of Russia IB-73

p. 29

Related and Supporting Industries Within Porter’s framework, the concept of related and supporting industries refers to the presence of interconnected companies and institutions in a particular field. These clusters bring together the environment, resources, and partnerships needed for innovation to occur more rapidly and easily.133 In Russia, the quality of local suppliers and the sophistication of production processes were both low, ranking 86th and 79th respectively. The intensity of local competition was also low, ranking 92nd. In the twenty-first century, the Russian government began making technology a higher national priority. In 2005, Putin announced the plan to create a network of “technoparks.” This initiative aimed to raise the volume of Russia’s IT market to $40 billion, bringing high tech’s share of GDP to 5 percent. The initial plan was to establish seven technology parks in seven regions across the country which would be open to technology companies, including nanotechnology and biotechnology companies. A federal budget of $75 million was set aside by the government and it expected the parks to employ 19,000 people by 2008 and 75,000 by 2011. The Russian IT Minister predicted that the output of the technoparks would be $749 million by 2008 and $4.4 billion by 2011. Boeing, Cisco, IBM, and Intel expressed interest in becoming a part of these technoparks, although several of them already had projects in Russia. The government also established special economic zones which provided companies with longterm favorable tax breaks and adherence to private-property laws. The seven zones were in St. Petersburg, Dubna, Zelenograd, Elabuga, Lipetsk, Tomsk, and Kaliningrad. Context for Firm Strategy, Structure, and Rivalry Despite Russia’s successes in the late 1990s and the early twenty-first century, Russia’s business environment still posed significant challenges. As noted, corruption remained a significant part of the culture, with companies that held monopoly positions or political connections receiving tax breaks, investment credits, subsidies, and guaranteed loans. According to the 2007-2008 GCR, Russia ranked 107th on the scale of favoritism in the decisions of government officials, meaning that government officials tended to favor well-connected firms and individuals; and 118th in terms of burden of government regulation. It was also 118th on the transparency of government policymaking. On organized crime it ranked 103rd, indicating that crime imposed significant costs on businesses. According to Desai and Goldberg: While there has been some improvement over the past few years, more firms complain of bribe payments to acquire business licenses, to inspectors, to tax collectors, and in dealings with courts in 2005 than in 2002. During the same period, this problem has become less acute in the Commonwealth of Independent States (CIS) and in Central Europe and the Baltic region. There are, additionally, problems with real estate transactions and land privatization, as they are neither transparent nor fair. Over one-third of the firms trying to purchase premises had to spend over half a year on that procedure; about 90 percent of the firms trying to purchase land failed to finish the procedure in half a year.134

The Competitive Advantage of Russia IB-73

p. 30

According to the 2007-2008 GCR, Russia ranked 122nd in terms of property rights, implying that relative to other countries its rights were poorly defined and not protected by law. Russia ranked 115th in intellectual property protection, which was weak or nonexistent. Desai and Goldberg commented on the challenging intellectual property rights environment: With regard to innovation, the intellectual property rights (IPRs) regime remains one of the primary weaknesses. First, the assignment of IPRs remains unclear, specifically if they should belong to the inventor, the inventor’s employer, or to the state that may have paid R&D costs. These uncertainties complicate collaboration between private firms and public institutes, inhibit technology transfer, and impair the development of spin-off companies into independent and growing businesses. Second, registered IPRs are weakly protected due to inability of public authorities to police producers or importers of pirated goods.135 Another important issue affecting Russia’s competitiveness was its companies’ lack of breadth in the global value chain. With a rank of 120th on this measure, Russia’s companies were disproportionately involved in resource extraction and production instead of higher value functions which would serve as a long-term source of competitive advantage, such as product design, sales, marketing, logistics, and after-sales services. CONCLUSION As Medvedev took office in 2008, Russians looked to the future with a mixture of optimism and concern. The country’s vast petroleum wealth had freed Russia from foreign debt and enabled it to put aside funds for investment, while at the same time allowing the government to reassert Russia’s importance and power as a force to be reckoned with on the world stage. Yet, while many Russians were benefiting from the country’s increased prosperity, others had not yet seen great improvements to their living standards and were impatient for change. Despite Russia’s undoubted strength in the sciences and the high standard of its education system, great challenges remained to bring the country's infrastructure and services up to acceptable standards. The great experiment in democracy which began with Gorbachev was compromised by the growing concentration of political power, and the intrusion of the state into the economy was inhibiting the spontaneous development of entrepreneurial business. The opportunities for foreign investors in Russia were undeniably attractive and extensive, but would international corporations be able to find the right balance between opportunity and risk, to contribute towards meeting the growing needs of this great country? As one article concluded:136 …. there’s so much we can’t know about the direction Russia is heading. It is, at once, a regime that offers its citizens consumer rights but not political freedoms, state sovereignty but not individual autonomy, a market economy but not genuine democracy. It is both a rising global power and a weak state with corrupt and inefficient institutions. The Kremlin’s regime seems both rock solid and

The Competitive Advantage of Russia IB-73

p. 31

extremely vulnerable, simultaneously authoritarian and wildly popular. Although Russia’s economy has performed well in the past 10 years, it is more dependent on the production and export of natural resources today than it was during Soviet times. Its foreign policy is no less puzzling. Russia may be more democratic today, but it is less predictable and reliable as a world player than was the Soviet Union. The more capitalist and westernized Russia becomes, the more antiwestern its policies seem. The more successful Russia’s foreign policy looks, the more unclear its goals appear.

The Competitive Advantage of Russia IB-73

p. 32

Exhibit 1 Russia: Country Profile Geography • Area: 17,075,200 sq. km., approx. 1.8 times the size of the U.S. • Cities: Capital – Moscow (population 10.4 million). Other cities – St. Petersburg (4.6 million), Novosibirsk (1.4 million), Nizhny Novgorod (1.3 million), Yekaterinburg (1.3 million). • Terrain: Broad plain with low hills west of Urals; vast coniferous forest and tundra in Siberia; uplands and mountains along southern border regions. • Climate: Ranges from steppes in the south through humid continental in much of European Russia; subarctic in Siberia to tundra climate in the polar north; winters vary from cool along Black Sea coast to frigid in Siberia; summers vary from warm in the steppes to cool along Arctic coast.

People • Nationality: Russian • Population: 141 million (July 2007 est.) • Annual population growth rate: -0.5% (2007 est.) • Ethnic groups: Russian 79.8%, Tatar 3.8%, Ukrainian 2%, Bashkir 1.2%, Chuvash 1.1%, other or unspecified 15.9% (2002 census) • Religions: Russian Orthodox 15-20%, Muslim 10-15%, other Christian 2% (2006 est.) • Languages: Russian and local languages • Literacy: Age 15 and over who could read and write: total population 99.4%; male 99.7%; female 99.2% (2002 est.) • Workforce: Total of 73.9 million workers: agriculture 10.8%, industry 29.1%, services 60.1% (2006 est.) Government • Type: Federation • Independence: August 24, 1991 (from Soviet Union) • Constitution: Adopted December 12, 1993

The Competitive Advantage of Russia IB-73

p. 33

•

• •

Branches: Executive – President (chief of state), Premier (head of government), Cabinet Legislative – bicameral Federal Assembly Judicial – Constitutional Court; Supreme Court; Superior Court of Arbitration Administrative divisions: 48 oblasts, 21 republics, 7 autonomous okrugs, 7 krays, 2 federal cities, and 1 autonomous oblast Suffrage: Universal from 18 years of age

Economy • GDP (Official Exchange Rate): 2005 – $740 billion, 2006 – $734 billion; Real GDP Growth 6.7% (2006 est.) • Currency: Russian ruble (post-January 1998 ruble is equal to 1,000 of the pre-January 1, 1998 rubles) • Unemployment: 7.1 percent (2006 est.), plus considerable underemployment • Natural resources: Wide natural resource base including major deposits of oil, natural gas, coal, and many strategic minerals, timber (note: formidable obstacles of climate, terrain, and distance hinder exploitation of natural resources) • Trade: Exports ($317.6 billion) – petroleum and petroleum products, natural gas, wood and wood products, and metals account for approx. 80% of exports (2006 est.) Major markets: Netherlands 10.3%, Germany 8.3%, Italy 7.9%, China 5.5%, Ukraine 5.2%, Turkey 4.5%, Switzerland 4.4%. Imports ($171.5 billion) – machinery and equipment, consumer goods, medicines, meat, grain, sugar, semi-finished metal products. Major suppliers: Germany 13.6%, Ukraine 8%, China 7.4%, Japan 6%, Belarus 4.7%, U.S. 4.7%, Italy 4.6%, South Korea 4.1%

Source: Compiled from the CIA’s “The World Factbook” (2007) and The Economist Intelligence Unit’s “Country Profile: Russia” (2007).

The Competitive Advantage of Russia IB-73

p. 34

Exhibit 2 Russian Federation Macroeconomic Data
Annual Indicators GDP at Market Prices (Rb bn) GDP (US$ bn) Nominal GDP at Purchasing Power Parity (US$ bn)* Real GDP Growth (%) GDP per Head (US$) GDP per Head at Purchasing Power Parity (US$) Population (m) Consumer Price Inflation (%) Unemployment (%)* Lending Interest Rate (%) Working capital loans of 1 yr maturity* Exchange Rate (average Rb:US$) Exports of Goods fob (US$ bn) Imports of Goods fob (US$ bn) Trade Balance (US$ bn)* Current Account Balance (US$ bn) Budget Balance (% of GDP)* Foreign Exchange Reserves (US$ bn) - Excluding gold

2000 9,638 260 1,115 10.0 1,772 7,609 146.6 20.8 10.6

2005 13,182 765 1,698 6.4 5,342 11,861 143.1 12.7 7.6

2006 14,131 989 1,881 7.4 6,934 13,190 142.6 9.7 7.2

2007 15,233 1,290 2,087 8.1 9,059(f) 14,661 142.3 9.2 6.2

2008 16,328(f) 1,691(f) 2,301(f) 7.2(f) 11,920(f) 16,220(f) 141.8(f) 13.5(f) 6.7(f)

2009 17,366(f) 1,966(f) 2,504(f) 6.4(f) 13,900(f) 17,700(f) 141.4(f) 10.9(f) 6.6(f)

24.4

10.7

10.5

10.0

11.0(f)

9.5(f)

28.1 105 -45 60 47 2.4 24

28.3 244 -125 118 83 7.5 176

27.2 304 -165 139 94 7.4 296

25.6 355 -223 132(f) 78 5.4 464

24.0(f) 446(f) -300(f) 146(f) 89(f) 3.5(f) 556(f)

24.5(f) 469(f) -353(f) 115(f) 58(f) 2.9(f) 665(f)

The Competitive Advantage of Russia IB-73

p. 35

Annual Indicators Total Foreign Debt (US$ bn)

2000 160

2005 229

2006 251

2007 341(e)

2008 378(f)

2009 406(f)

Notes: f=forecast; e=estimate

Source: Data marked with an asterisk is from EIU Data Services, “China: Selected Series,” http://countrydata.bvdep.com (April 8, 2004). All other information is from Economist Intelligence Unit, Country Data, June 11, 2008.

The Competitive Advantage of Russia IB-73

p. 36

Exhibit 3 Foreign Direct Investment (FDI) in Russian Federation (2001-2006) 2001 Russian Federation --Inward --Outward Comparative Data Developing Economies --Inward --Outward World --Inward --Outward
In Million US$

2002 2,421 3,284 2002

2002 2,421 3,284 2002

2003 7,958 9,727 2003

2004 15,444 13,782 2004

2005 12,766 12,763 2005

2006 28,732 17,979

2,469 2,533 2001

209,431 47,382 823,825 711,445

162,145 43,095 651,188 647,363

162,145 43,095 651,188 647,363

175,138 35,566 557,869 561,104

283,030 117,336 742,143 877,301

314,316 115,860 945,795 837,194

379,070 174,398 1,305,852 1,215,789

Source: Data from 2001 through 2003 compiled from UNCTAD’s “World Investment Report 2004.” Data from 2004 through 2006 compiled from UNCTAD’s “World Investment Report 2007.”

The Competitive Advantage of Russia IB-73

p. 37

Exhibit 4 Ruble-Dollar Historical Exchange Rate (2000-2009)

2000 Nominal exchange rate (Rb/US$)* Close Real effective exchange rate index – CPI based**

2001

2002

2003

2004

2005

2006

2007

2008

2009

28.12

29.16

31.34

30.69

28.81

28.28

27.19

25.58

24.00(f)

24.50(f)

66.1

77.8

79.7

81.9

88.2

97.0

107.1

114.0

122.9 (f) 131.2(f)

Notes: * Expressed in re-denominated rubles **Trade-weighted basket of currencies converted to an index (1997=100) and adjusted for relative price movements. f=forecast

Source: Nominal real effective exchange rate data compiled from Global Financial Data, June 2008. Real effective exchange rate data compiled from EIU Country Data, September 2007.

The Competitive Advantage of Russia IB-73

p. 38

Exhibit 5 Comparative Economic Indicators (2007) Russian Federation and Other Countries Russia 1,290 2,087 14,661 142.3 9.2 78 6.1 36 (e) 8.1 (e) Kazakhstan 104 167 (e) 10,760 (e) 15.6 10.8 -7 -6.9 22 (e) 39.0(e) Ukraine Poland 141 422 323 (e) 621 (e) 6,990(e) 46.2 12.8 -6 -4.2 16 (e) 24.6 (e) 16,291 (e) 38.1 2.5 -16 -3.7 40(e) 21.4 (e) Germany 3,319 2,807 33,990 (e) 82.6 (e) 2.3 183 5.5 n.a. n.a.

GDP (US$ bn) GDP (US$ bn at PPP) GDP per head (US$ at PPP) Population (m) Consumer price inflation (av %) Current-account balance (US$ bn) % of GDP External debt (US$ bn) Debt-service ratio, paid (%)
Note: e=estimate.

Source: Economist Intelligence Unit, Country Data, June 2008.

The Competitive Advantage of Russia IB-73

p. 39

Exhibit 6 Doing Business in Russia and Characteristics of Russian Society In 2007, Russia was still going through a tortuous struggle to exchange the values of communism for those of a free-market economy and democracy. Some observers likened present-day Russia to the American Wild West of the 1870s⎯fortunes were being made and sometimes lost in the scramble. There had always been inequality and struggles for power, such as those between free-market economists and nationalists. Ethnic tensions within Russia were also coming to a head and threatening to disrupt social stability. Harshness and casual indifference were stark features of everyday Russian society. Distance as a means of survival (often manifested as selfreliance, stony resolve, and strong will) was a characteristic of the Russian people (who had been isolated from the rest of the world for centuries). Russian culture was characterized by two main groupings: the intelligentsia and the working class. An emergent middle class had begun to establish itself in major cities such as Moscow and St. Petersburg. Diversity and Lifestyle Diversity was not a big concern of most Russian companies. Women had reasonable access to key professional positions⎯virtually all doctors, for example, were female. However, ethnic minorities had a harder time. Laws existed to protect against racist-related violence but were rarely invoked. Lifestyles varied enormously between the rich and poor, as well as rural and urban dwellers. Levels of income and quality of life in Moscow and St. Petersburg greatly surpassed those in the other regions. Attitudes Toward Money In Russia, relations between people were almost entirely oriented around money. One of the biggest changes since the break-up of the USSR has been the rapid rise to wealth of some individuals, and their extravagant spending habits. Yet the vast majority of working Russians got by on the equivalent of between $50 and $300 a month, which led to a debilitating braindrain after 1991, as highly qualified scientists and doctors pursued better-paying work abroad. Only a handful of people earned more than $400 a month and they were in Moscow, where the cost of living was high compared to the regions. Many Russians, located primarily in the big cities, were big spenders, label-conscious, and gadget-loving. Outside the cities, Russians tended to be uneasy about financial success, often assuming that wealth was amassed dishonestly, or at least at someone else’s expense. Many Russians held their savings in US dollars or Euros, as most did not trust the ruble, and many were still reluctant to deposit cash in a bank following the high-profile collapse of some banks and investment schemes in the late 1990s. Teamwork Russian society had a pronounced collective emphasis. Young children were taught how to behave and relate to others from an early age. Respect and deference for authority figures was the norm in every classroom. Russians worked very well together in teams. There could be a high level of human contact between colleagues, and teams often developed a family atmosphere. Groups might even become almost closed to outsiders, but in times of crisis, team members would support one another. Russian workers typically wanted a place where they would be understood. They wanted work to feel like home, needed time on the job to chat, and time off for special occasions. Russians wanted and needed to feel a part of a greater good.

The Competitive Advantage of Russia IB-73

p. 40

Change at short notice could unnerve a team, but Russians often operated without back-up or contingency plans, so change had to be implemented with care and sensitivity. Russian leaders were almost always male, and mostly middle-aged, so typically would have grown up in the Communist era. Status was valued and respect for age and position was expected to be observed. Russian managers were expected to be authoritarian, assertive, and inspirational⎯but also to understand and work at a grassroots level. An enterprise was considered a democratic institution. Everyone was entitled to have his or her voice heard, and even the humblest of employees felt free to speak to the boss. If the manager stood up for workers’ interests, then s/he could count on their loyalty. Older-style Russian managers were, however, fairly dictatorial, whereas the more educated managers would let objective facts dictate the truth. Management skills, as accepted in Western Europe and the U.S., were often lacking, although Russians were enthusiastic to learn. Registration Business registration in Russia was regulated by the following basic laws and government resolutions: • • • • The 1999 Federal Law “On Foreign Investment in the Russian Federation.” The 1999 Civil Code. The August 8, 2001 Federal Law "On State Registration of Legal Entities" (entrepreneurs). The Russian Government Resolution No. 319 "On Authorized Federal Entity of the Executive Power, Providing State Registration of Legal Entities" of May 17, 2002.

Conducting business without registration was illegal. Russian law offered several commonly used modes to conduct business, including: • • • • Several different forms of corporations such as the limited liability company (OOO). The privately held, closed joint stock company (ZAO) and the publicly held, opened joint stock company (OAO). The representative or branch office of a foreign company. Registration as an individual private entrepreneur.

Representative offices and branches were not legal entities under Russian legislation, but were considered subdivisions of their head office, which was liable for their activity in Russia. Russian regulations represented the biggest liability to any successful joint venture. Since these regulations were in constant flux, a good legal expert was essential for anybody setting up in Russia. Majority ownership of a company was different in Russia from the West; 51 percent was not a controlling interest, as most companies required unanimity among the partners for major decisions.137
Source: Compiled from TMA’s Country Navigator: Russia, “The Russian Mindset” (2007) and BISNIS, U.S. Department of Commerce, International Trade Administration, September 2002, http://www.bisnis.doc.gov/bisnis/country/Rsfactsheet_2002.htm (December 26, 2002).

The Competitive Advantage of Russia IB-73

p. 41

Exhibit 7 Sample of Data on Russia from the 2007–2008 Global Competitiveness Report Competitiveness Rankings Global Competitiveness Index (GCI) Overall Institutions Infrastructure Macroeconomic stability Health and primary education Higher education and training Goods market efficiency Labor market efficiency Financial market sophistication Technological readiness Business sophistication Innovation Business Competitiveness Index (BCI): 2006-2007 Overall Ranking Sophistication of company operations and strategy Quality of the national business environment Most Problematic Factors for Doing Business Corruption Tax regulations Tax rates Crime and theft Inefficient government bureaucracy Access to financing Inflation Percent of responses 18.8 15.0 10.0 8.4 8.3 8.2 7.0 Out of 127 countries 71 77 70 Rank Out of 131 countries 58 116 65 37 60 45 84 33 109 72 88 57

To compile the data in the table above, respondents to the World Economic Forum’s 2007 Executive Opinion Survey were asked to select and rank the five most problematic factors for doing business in Russia (from a list of 14 factors). The percent of response figures listed above are weighted to reflect the assigned rankings.
Source: World Economic Forum, The Global Competitiveness Report 2006-2007 (New York: Oxford University Press, 2007).

The Competitive Advantage of Russia IB-73

p. 42

Exhibit 8 Excerpts from Porter’s Research on Russian Competitiveness

Source: Presentations on National Competitiveness, Institute for Strategy and Competitiveness, Harvard Business School. Copyright © 2007. All rights reserved. Reprinted by permission of Michael E. Porter.

The Competitive Advantage of Russia IB-73

p. 43

Source: Presentations on National Competitiveness, Institute for Strategy and Competitiveness, Harvard Business School. Copyright © 2007. All rights reserved. Reprinted by permission of Michael E. Porter.

The Competitive Advantage of Russia IB-73

p. 44

Source: Presentations on National Competitiveness, Institute for Strategy and Competitiveness, Harvard Business School. Copyright © 2007. All rights reserved. Reprinted by permission of Michael E. Porter.

The Competitive Advantage of Russia IB-73

p. 45

Endnotes
Igor Nikolayev, “The Russian Economy in 2006,” The Washington Post.com, http://www.washingtonpost.com/wp-adv/specialsale/spotlight2006/articles_v6/economy.html (September 4, 2007). 2 “Putin’s People,” The Economist, August 23, 2007, pp. 25-28. 3 Economist Intelligence Unit, Country Data, June 11, 2008. 4 Powerful businessmen, commonly referred to as ‘the oligarchs,’ exerted considerable influence on Russian political life during the 1990s. During Yeltsin’s presidency, the Russian government engineered the infamous loansfor-share scheme in 1995, wherein a number of Russian companies were ‘privatized’ at bargain rates in exchange for loans used in part to fund Yeltsin’s 1996 re-election campaign. Some of these oligarchs served as ministers while others were awarded prestigious official positions. Apart from the continuing influence of the ‘old’ oligarchs, by 2007, Russia had a younger generation of powerful businessmen favored by the Putin administration and an influential group of former members of the security services. 5 “Russia Country Profile,” Datamonitor, December 2006. 6 “Background Note: Russia,” U.S. State Department, Bureau of European and Eurasian Affairs, February 2007. 7 “Russia Country Profile,” op. cit. 8 “Smoke and Mirrors,” The Economist, February 28, 2008, http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=349002&story_id=10765120 (June 5, 2008). 9 Padma Desai, Conversations on Russia: Reform from Yeltsin to Putin (Cary, NC: Oxford University Press, Inc., 2006). 10 Ivan Krastev, “What Russia Wants,” Foreign Policy, May/June 2008, pp. 48-51. 11 Ibid. 12 “Russia: A Country Study,” Library of Congress, July 1996, http://lcweb2.loc.gov/frd/cs/rutoc.html (December 19, 2002). 13 “Background Note: Russia,” op. cit. 14 Ibid. 15 “Russian Legislative Election—2007,” www.wikipedia.org, http://en.wikipedia.org/wiki/Russian_legislative_election,_2007 (September 4, 2007). 16 Robert Alan Dahl, “Alternative Voting Systems for Electing Deputies to the State Duma of the Russian Federation,” March 1998, http://www.democracy.ru/english/library/comments/eng_1998-5.html (September 4, 2007). 17 “Federation Council of Russia,” www.wikipedia.org, http://en.wikipedia.org/wiki/Federation_Council_of_Russia (September 4, 2007). 18 Desai, op. cit. 19 “Federation Council of Russia,” op. cit. 20 “Constitutional Court of the Russian Federation,” www.wikipedia.org, http://en.wikipedia.org/wiki/Constitutional_Court_of_the_Russian_Federation (September 4, 2007). 21 “Background Note: Russia,” op. cit. 22 “A Putin-Shaped Throne,” The Economist, March 6, 2008, http://www.economist.com/world/europe/displaystory.cfm?story_id=10808981 (June 5, 2008). 23 Ibid. 24 “An Ugly Victory,” The Economist, March 2, 2008, http://www.economist.com/world/europe/displaystory.cfm?story_id=10792183 (June 5, 2008). 25 “An Ugly Victory,” The Economist, March 2, 2008, http://www.economist.com/world/europe/displaystory.cfm?story_id=10792183 (June 5, 2008). 26 “Enter, Pursued by a Bear,” The Economist, May 8, 2008, http://www.economist.com/opinion/displaystory.cfm?story_id=11332356 (June 5, 2008). 27 Ibid. 28 “Russia Country Profile,” op. cit. 29 A Strange Kremlin Wedding,” The Economist, May 8, 2008, http://www.economist.com/world/europe/displaystory.cfm?story_id=11332639 (June 5, 2008). 29 “New Jobs, Old Faces,” The Economist, May 15, 2008, 30 “Russia – Political Risk,” BMI, June 5, 2008. 31 Ibid.
1

The Competitive Advantage of Russia IB-73

p. 46

Alan Cullinson and Marc Champion, “Putin, Now Premier, Still Plays a Presidential Role Overseas,” The Wall Street Journal, June 4, 2008, p. A9. 33 A Strange Kremlin Wedding,” The Economist, May 8, 2008, http://www.economist.com/world/europe/displaystory.cfm?story_id=11332639 (June 5, 2008). 33 “New Jobs, Old Faces,” The Economist, May 15, 2008, 34 “Country Outlook,” Economist Intelligence Unit, August 2007. 35 Krastev, op. cit. 36 “Background Note: Russia,” op. cit. 37 Gregory L. White and Daria Solovieva, “Small Victory for Speech in Russia,” The Wall Street Journal, May 28, 2008, p. A10. 38 “New Jobs, Old Faces,” The Economist, May 15, 2008, http://www.economist.com/world/europe/displaystory.cfm?story_id=11376699 (June 5, 2008). 39 “Russian Financial Crisis,” www.wikipedia.org, http://en.wikipedia.org/wiki/Russian_financial_crisis (September 5, 2007). 40 “Russia’s Crisis: Will Russia Survive its Economic and Political Crisis?” PBS, September 17, 1998, http://www.pbs.org/newshour/forum/september98/russia.html (September 5, 2007). 41 “Russian Financial Crisis,” op. cit. 42 “Flight Pack: Russia,” Country Navigator, TMA 2007. 43 “Smoke and Mirrors,” The Economist, February 28, 2008, http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=349002&story_id=10765120 (June 5, 2008). 44 “Smoke and Mirrors,” op. cit. 45 Ibid. 46 Ibid. 47 Economist Intelligence Unit, Country Data, June 11, 2008. 48 “Country Outlook,” op. cit. 49 “The Economy and Investment Climate in Russia,” American Chamber of Commerce in Russia, 2007. 50 “Zubkov Forecasts $40 Bln Budget Surplus in 2008,” Moscow News, January 31, 2008, http://www.mnweekly.ru/busbrief/20080131/55306488.html (June 12, 2008). 51 “Background Note: Russia,” op. cit. 52 Ibid. 53 “Russia Country Profile,” op. cit. 54 “Background Note: Russia,” op. cit. 55 Ibid. 56 UNCTAD’s “World Investment Report,” 2007. 57 Vladimir Kvint, “Russia’s Surging Economy,” Forbes, January 8, 2008, http://www.forbes.com/2008/01/08/russia-economy-projections-oped-cx_vkv_0108russia.html (June 12, 2008). 58 Ibid. 59 “Doing Business in Russia: A Country Commercial Guide for U.S. Companies,” U.S. & Foreign Commercial Service and U.S. Department of State, 2005. 60 “TKN-BP Overview,” BP, October 2003, http://www.bp.com/liveassets/bp_internet/globalbp/STAGING/global_assets/downloads/T/TNK-BP_Overview.pdf (September 28, 2007). 61 “Bankruptcy Court Opens Yukos Case, BBC News, March 28, 2006, http://news.bbc.co.uk/1/hi/business/4854530.stm (September 28, 2007). 62 “Rosneft Buys Asset Cheaply After BP Drops Out of Early Bidding,” The Times Online, http://business.timesonline.co.uk/tol/business/industry_sectors/natural_resources/article1577240.ece (September 28, 2007). 63 Sergei Blagov, “Rosneft Wins Key Yukos Assets in Eastern Siberia,” Eurasia Daily Monitor, May 8, 2007, http://www.jamestown.org/edm/article.php?article_id=2372149 (September 28, 2007). 64 “Russia Risk Profile,” Emerging Europe Monitor, July 2007. 65 “BP Sells Siberia Stake to Gazprom,” BBC News, June 22, 2007, http://news.bbc.co.uk/1/hi/business/6230556.stm (September 28, 2007). 66 “BP Playing Russian Roulette,” American Metal Market, March 23, 2007.

32

The Competitive Advantage of Russia IB-73

p. 47

“Another Inspector Calls,” The Economist, March 27, 2008, http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=349002&story_id=10925679 (June 5, 2008). 68 Vedomosti, Tuda Nelzya, July 9, 2007. 69 “Another Inspector Calls,” op. cit. 70 Ibid. 71 Gregory L. White and Guy Chazan, “Boardroom Brawl Roils BP’s Russia Venture,” Wall Street Journal, June 12, 2008, p. A1. 72 Gregory L. White and Guy Chazan, “BP is in the Dark in Battle to Save Russian Venture,” Wall Street Journal, June 30, 2008, p. A1. 73 Ibid. 74 “Trouble in the Pipeline,” The Economist, May 8, 2008, http://www.economist.com/opinion/displaystory.cfm?story_id=11332313 (June 5, 2008). 75 “Russia Income Taxes and Tax Laws,” www.worldwide-tax.com, August 2006, http://www.worldwidetax.com/russia/russia_tax.asp (September 5, 2007). 76 “Background Note: Russia,” op. cit. 77 “New Currency Control Law,” CommerceCan, http://commercecan.ic.gc.ca/scdt/bizmap/interface2.nsf/vDownload/IMI_0502/$file/X_3717013.DOC (September 5, 2007). 78 “Alla Russia Con Amore,” Trade and Forfaiting Review, http://www.tfreview.com/xq/asp/txtSearch.Legal+Issues/exactphrase.1/sid.0/articleid.7B40443F-1398-475A-B3E581468606D1AB/qx/display.htm (September 5, 2007). 79 “New Currency Control Law,” op. cit. 80 Sheila Puffer, “Can Russia’s State-Managed Network Capitalism Be Competitive?” Northeastern University, December 11, 2006. 81 Ibid. 82 “Smoke and Mirrors,” op. cit. 83 Puffer, op. cit. 84 “Putin’s People,” op. cit. 85 G. Chazan, “Kremlin Capitalism,” Wall Street Journal 19, 2006. 86 “New Jobs, Old Faces,” The Economist, May 15, 2008, http://www.economist.com/world/europe/displaystory.cfm?story_id=11376699 (June 5, 2008). 87 Ibid. 88 A. Shleifer, A Normal Country: Russia After Communism (Cambridge: Harvard University Press, 2005). 89 Puffer, op. cit. 90 “Business Environment: Russia,” Business Monitor International, Q3 2006. 91 Ibid. 92 “2007 Country Review: Russia,” CountryWatch, Inc., 2007. 93 “Russia Country Profile,” op. cit. 94 This section was drawn heavily from TMA’s Country Navigator: Russia, “The Russian Mindset,” 2007, as was Exhibit 3. 95 B. Snowdon and G. Stonehouse, “Competitiveness in a Globalized World: Michael Porter on the Microeconomic Foundations of the Competitiveness of Nations, Regions, and Firms,” Journal of International Business Studies, 2006. 96 Michael E. Porter, The Competitive Advantage of Nations (New York: Free Press, 1990). 97 Michael E. Porter, “Chinese Competitiveness: Where Does the Nation Stand?” Institute for Strategy and Competitiveness (Harvard Business School), June 18, 2004, http://www.isc.hbs.edu/pdf/CAON_China_2004.06.18.pdf (August 19, 2004). 98 Ibid. 99 Ibid. 100 Ibid. 101 World Economic Forum, The Global Competitiveness Report 2006-2007 (New York: Oxford University Press, 2007). 102 Ibid., p. 192.

67

The Competitive Advantage of Russia IB-73

p. 48

World Economic Forum, The Global Competitiveness Report 2007-2008 (New York: Palgrave MacMillan, 2007) p. 22. 104 World Economic Forum, The Global Competitiveness Report 2006-2007, op. cit., p. 95. 105 Porter, “Chinese Competitiveness: Where Does the Nation Stand?” op. cit. 106 Thomas Friedman, “Will Russia Bet on its People?” The International Herald Tribune, February 17, 2007. 107 Byron MacWilliams, “Russia Looks to Reform its Higher-Education System,” The Chronicle of Higher Education, November 11, 2005. 108 Raj M. Desai and Itzhak Goldberg, “Russia’s Innovation Gap,” October 2006, http://www.brookings.edu/views/op-ed/20061024desai.htm. 109 Simon Ostrovsky, “Report Warns of Crisis in Workforce,” Moscow Times, August 24, 2004. 110 Ibid. 111 Ibid. 112 Raj M. Desai and Itzhak Goldberg, “Russia’s Innovation Gap,” October 2006, http://www.brookings.edu/views/op-ed/20061024desai.htm. 113 Ben Aris, “Russia-Kremlin Nurtures Venture Capital—Moscow Hopes Venture Capital Will Boost Investment and Kick-Start a High-Tech Industry That Is Sadly Lacking Funding,” The Banker, November 1, 2006. 114 Ibid. 115 Thomson Financial and National Venture Capital Association, New York, July 16, 2007. 116 Jason Bush, “Putin Has Been Working on the Railroads,” BusinessWeek, April 28, 2003. 117 Ibid. 118 “Russia Infrastructure Forecast Q2 2007,” Business Monitor International, June 14, 2007. 119 Ibid. 120 “Internet World Stats,” http://www.internetworldstats.com/europa2.htm (June 6, 2008). 121 “Telecommunications Forecast Q2 2007,” Business Monitor International, June 14, 2007. 122 “IT in the Russian Federation,” www.American.edu, http://www.american.edu/initeb/sw5840a/infrastructure.htm (September 6, 2007). 123 “Russia Infrastructure Forecast Q2 2007,” op. cit. 124 Glenn E. Curtis, “Russia: A Country Study,” Washington: GPO for the Library of Congress, 1996, http://countrystudies.us/russia/59.htm (September 6, 2007). 125 Ibid., http://countrystudies.us/russia/25.htm (September 6, 2007). 126 “Russia,” www.RussiansAbroad.com, http://www.russiansabroad.com/russian_history_89.html (September 6, 2007). 127 World Economic Forum, op. cit., p. 95. 128 Michael Mainville, “Russians Relish Their Freedom to Shop,” The Toronto Star, p. A16. 129 “Background Note: Russia,” op. cit. 130 Ibid. 131 “Country Data: Russia,” Economist Intelligence Unit, August 9, 2007. 132 Ibid. 133 World Economic Forum, op. cit., p. 95. 134 Raj M. Desai and Itzhak Goldberg, “Russia’s Innovation Gap,” October 2006, http://www.brookings.edu/views/op-ed/20061024desai.htm. 135 Ibid. 136 Ivan Krastev, “What Russia Wants,” Foreign Policy, May/June 2008, pp. 48-51. 137 “Flight Pack: Russia,” op. cit.

103