#12 - JRL 7205
Carnegie Endowment for International Peace
www.ceip.org
The Future of Russian Business in Global Markets
Vladimir Potanin, president and chairman of the board of Interros
May 15, 2003

The event was Potanin's first public appearance in Washington. Jessica Mathews, president of the Carnegie Endowment, introduced Mr. Potanin, noting that during his three-year tenure, Interros has increased its valuation over three times to $4 billion. Enterprises owned and managed by Interros account for 2.5 percent of Russia's GDP and employ over 190,000 people. In 2002 the prestigious Russian Union of Industrialists and Entrepreneurs awarded Interros the "Company of the Year" prize.

From 1996 to 1997, Potanin served as First Deputy Prime Minister of the Russian Federation for Economic issues. He is the only oligarch to have held a major government position, giving him a unique perspective on the capacity of the Russian government to develop, implement, and enforce legislation enhancing Russia's business climate.

Recent Accomplishments: Potanin spoke about the ways in which Russia has changed under President Vladimir Putin. Most significantly, he said, "power has been restored." The turmoil of the 1990s has given way to calm, stability, and increased popular confidence in the government. Real income has grown; the gap between the rich and the poor, while still too wide, has narrowed. Despite these positive developments, the Russian economy remains overly dependent on external factors. The recent period of economic growth and stability should serve as incentives for the government to implement much-needed economic reforms.

Potanin hailed the improved working relationship between the government and parliament as another positive influence on Russia's economic growth. When the government proposes laws, they get through the parliament. Taxes have become more orderly and predictable, and most important, the government has managed the budget with strict discipline. Because of poor budget finance during the 1990s, the government failed to pay schools and hospitals, schools did not pay for electricity, electric stations did not pay for gas, and Gazprom did not pay its taxes-thus the government could not pay wages. While the government was once the leading non-payer, it is now a reliable partner.

"Finally, the last thing I will say about recent accomplishments-so that I don't seem too much like a 1970s propaganda artist-the government has improved the standing of the Russian Federation in the world," Potanin said. Russia's international relations have grown more stable, the standards for Russia's behavior have grown more clear to the rest of the world, and the government has attempted to build Russian business interests abroad.

The Challenges of Reform: Potanin then shifted the discussion to unresolved problems in Russian development, namely economic growth and stabilization, and Russia's continued integration into world economic space. "I have some ideas for some, but not for all," he said.

First on the list was the nature of governmental reform, particularly the strengthening of the "vertical" of power. "The process is reminiscent of when a sick man takes pills to make himself better at the hospital, but the tablets are so strong that have strong side effects," Potanin said. The government is trying to make the power vertical stronger, but the attempts taken above are interpreted by the bureaucrats below as signals or mandates to amass ever greater power and more numerous functions. As a consequence, bureaucrats are less effective in each job they do and have greater opportunities for corruption. "Most important," Potanin said, "the bureaucracy creates a huge administrative impass for small and medium sized businesses." While large companies have learned how to defend themselves with huge legal departments and transparent finance methods, the smaller companies do not have the money or expertise to spend on such protection, and instead they find themselves in the hold of bureaucrat powers. Thus, despite the economic growth and climate improvement over the past three years, these small and medium sized enterprises (SMEs) have an even harder time getting started.

In addition to legal and finance departments, Potanin added, big Russian companies supply themselves with everything else they need, maintaining "in house" lawyers, security staff, even cooks. "There is no such thing as outsourcing in Russia," Potanin said, and SMEs simply cannot maintain all of these functions themselves. The resulting negative effect on economic growth worries most big businessmen, who have suggested reforms limiting the functions absorbed by the government to those that it can perform well and that are most important.

Potanin also recommended reforming the system by which government employees are recruited and paid. Because of complicated government procedures and the widespread belief that the government will not hire businessmen, skilled people look for work first in the private sector. There is a barrier between those who work in business and government, and it is considered not correct to invite businessmen to work in government. Even so, Potanin said, the government needs qualified people as much as business, perhaps even more. The barrier between the two fields, that is "not written in any law," Potanin clarified, "but as we said in the Soviet era, 'there is an opinion…,' and then it is understood."

Potanin noted that reform must be undertaken with care, but suggested that in certain sectors, insufficient speed might slow the growth potential of the Russian economy. Both the banks and the pension systems need to be overhauled, Potanin said, and both could become monopolies if not carefully reformed. "It is no secret that a big source of money for investment is pension funds and insurance companies," Potanin said. "Over a year ago, the president agreed that private companies should gain access to those sectors, but the inertia of the government and the reform process has slowed us down." The reform date now has been pushed back to 2005. Excessive caution has also slowed the liberalization of currency laws. The Russian Union of Industrialists and Entrepreneurs, of which Potanin is a member, has repeatedly appealed to the president and the government for more radical reform. The present laws prevent Russian enterprises from growing and doing business outside of Russia. As Potanin explained, for a Russian company to buy a factory in Ukraine or stocks in a French or American company, it must apply to the Russian Central Bank for the currency it needs to complete the transaction, as the purchase is considered a capital export. Even if the bank moves quickly, it is impossible to get the necessary money and approval in less than eight weeks time.

Relics of the Soviet Era in Economic Life: "Maybe the bureaucrats don't know that the Cold War is over, or they haven't been watching television since 9/11," Potanin said, because they continue to preserve "classified documents and regime secrecy," and also the Soviet capacity to mobilize for war-Soviet style. If the owner of a factory that produces parts for airplanes is approached by an American company and asked to make different parts, and the American company offers a great deal of money for the deal, the Russian government will first demand a 51% interest in the endeavor, and next will ask how the factory, if it is making American parts, will be able to observe laws concerning Russia's war capability. In case of war, Russia must be prepared to produce a certain number of parts to match a particular plan that was drafted in the late Seventies and would be useless in the present day. Despite assurances from the factory owner that the American contract will not hinder the factory's obligations, the government makes such demands.

Potanin emphasized throughout his presentation that administrative reform should be the top priority of the Russian government. Overregulation and old Soviet standards also make it next to impossible to start a small business. "To produce Swiss watches, a small business would need to get a license certifying that the Swiss watches meet Russian standards," Potanin said. "Why are you laughing?" he chuckled. "The Swiss watches don't meet Russian standards. For that reason, you can't certify them." The government continues to struggle to provide adequate copyright protection and intellectual property rights. Piracy remains a problem in the entertainment industry, funnelling hundreds of millions of dollars annually in potential profits into the hands of pirates instead of company profits that would be reinvested in the industry. Additional problems in rights occur in the sports industry and in defending company brands.

Five years ago, the problem of defending minority shareholder rights, was strong and real. Today the acuity of the problem remains in small and medium sized businesses, Potanin said, while large companies that have listed on the stock market have resolved their problems with minority shareholders. A wide swath of Russian companies now understand shareholder rights as they are understood in Europe and the U.S., meaning that more investors in Russia "can feel normal, as if their rights are normally recognized."

Corporate governance in Russia has also improved, Potanin explained. A "fairly large" number of companies have accepted rules of corporate governance, and some have adopted a unified corporate governance code. The Russian Union of Industrialists and Entrepreneurs has created a Commission for Ethics with a peer court that publicly condemns businessmen who have violated its corporate governance code. The commission also maintains a list of unreliable business partners. Reputation problems are vastly more important to russian businessmen than they were several years ago, rendering this kind of social pressure both stronger and more influential. The court and threats of public humiliation genuinely intimidate businesses, and for that reason accusations are generally settled prior to the passage of such sanctions. While many Russian businessmen would have laughed at such a threat several years ago, now, Potanin said, "none of my colleagues would want this."

Corporate power and the government cooperate better with one another. Government bosses better understand what the economy needs, if not creating incentives for business, then at least leaving businesses alone. Even so, Russia's government does not know its own objective well enough with regard to business. As an example, Potanin cited Russia's ongoing negotiations to gain membership in the WTO. Noting first the debate surrounding the question itself-should Russia join the WTO or not-Potanin said that a consensus exists that membership is necessary, but the timing of accession remains unresolved. "Should we join slow or fast? How much should we protect? Is the goal of membership to gain access to international markets?" Potanin asked. "If so, then we must protect our industries, and the valor of the negotiator should be judged according to his ability to obtain access without giving access to outsiders." Most of those in the government concerned with WTO accession have agreed that gaining access without giving access is Russia's objective in WTO negotiations. Potanin argued, however, that WTO membership should be a tool, not an objective in and of itself. "The end goal should be for Russian companies to collide with their competitors," Potanin said, learning how to compete or dropping out of the market. Companies that fail to earn profits from their activity, paying low salaries and low taxes, do not increase consumers' buying power or contribute to the national economy.

The only legitimate objection to WTO entry, Potanin continued, is from the agriculture sector and others who will suffer from accession because they cannot compete. The government already heavily subsidizes these sectors and the cities that have only one factory or one industry to support them. The government should subsidize non-competitive industries to avoid major social problems. But the sooner Russian businesses clash with international industry, the better for the health of the economy. To speed accession, Potanin said, "Russia should add a clause to our negotiations with the WTO that, with our own money, we will protect non-competitive industries." The current negotiation tactic, as Potanin explained it, is ineffective. "Russian negotiators demand $50 million in subsidies, and the WTO asks, 'Why $50 million? How large is your current subsidy?' The Russian negotiators reply, 'Well, now we give $2 million.' So the WTO asks, 'And how large was the subsidy in Soviet times?' and we reply, 'Then it was $16 million.' So the WTO asks 'why do you want $50 million in subsidies,' and the answer is zapasam, meaning, 'in case of emergency,' [the traditional Soviet answer]." While the numbers in this scenario are not real, Potanin added, the technique is.

"Despite these deficiencies," Potanin said, "I would like to conclude on a positive note: the changes are obvious and for the better." While some like the pace and some do not, and it might be better to move faster, greater instability might result. "It is better to undertake reforms over the course of several years than to do them quickly and have to do everything over again." If asked to characterize Russian business in one word, Potanin said, he would choose the word, "responsibility." Some Russian companies now propagandize their social responsibility and their attempts to increase jobs. Industrialists have started to think about ecological problems, and many invest in this area despite its complexity. Norilsk Nickel, one of Interros's largest companies, is a huge polluter, as Potanin's Soviet predecessors built the plant without purification capability. Like many other Russian companies, Norilsk Nickel must now overhaul its technology.

A new culture of quality and corporate governance, shareholder rights and the basics of management, has just started and must be supported. "The goal of my trip here," Potanin said, "is to tell our contacts and partners, that investing in a national economy is always risky, and you have to do a risk-benefit analysis….Today, the terms are clearly favorable. The ratio now favors investors. The risks are high, but there is a steady trend now that it is more lucrative than risky to invest in Russia."

Discussion: Mr. Potanin was asked whether the Russian Union of Industrialists and Entrepreneurs has relations with its American counterparts, to which he replied that the organization exchanges information with unions in America and other nations. The most important function of the Union is to open communication lines, resolve problems blocking relations, and improving the image of Russia and Russian business abroad.

In response to a question concerning the status of Interros's acquisition of the American company Still Watermining, Potanin explained that sometime ago, Interros, through its largest holding Norilsk Nickel, approached the American company to acquire a controlling stake, the first time that a Russian company has bought a publicly listed American company. The deal has been approved by the board of general directors of Still Watermining, and waits for approval by its shareholders and the U.S. Federal Trade Commission.

One participant, noting the two schools of thought on Russian energy development-one holding that it fuels economic growth, the other that like a narcotic, it quashes economic diversity-asked how revenues from energy sales will be channelled into building the resources Russia needs. Potanin replied that he did not know which school was right, but agreed that energy money should be used for building Russia's infrastructure, most effectively by reforming the banking system, which is capable of sending money into different sectors. Right now, banks perform only a computational function, and not a distributive function. Banks could serve as a clearinghouse of capital in the Russian economy. In addition, a base for long term investment must be developed through insurance sector and pension reform, so that money would be invested more quickly. Finally, Potanin said, "we must improve conditions for foreign investment in Russia. Right now the climate is acceptable but still not attractive." High taxes and huge bureaucratic barriers make the growth of SMEs impossible, in addition to scaring off investors.

Replying to a question about the role of business in the reform of Russian higher education, Potanin commented that if something good came out of the Soviet period, it was the quality of the Soviet education system. "Russia has the money to keep its education system going, but you can't just stand in place. There is truly not enough [money] to make it grow." The Vladimir Potanin Charitable Fund awards talented youth with scholarships to the leading public institutions in the country. Fifteen hundred students currently hold the scholarship, in whose selection process 20,000 people have participated in total. Perhaps the most important benefit of the scholarships, Potanin said, is that young people learn "someone cares about them, and needs them."

Another participant asked about the status of a corporate code for the stakeholders in the Steel Watermining project, and wondered whether whether the working conditions for Steel Watermining's workers in Montana will change upon acquisition by Norilsk Nickel. Potanin replied that Norilsk Nickel has offered Steel Watermining five candidates for the board, all of whom will answer to modern American legal standards for the independence of directors. As for the workers in Montana, Potanin said, "the answer might be, I hope to God that they live and work in the conditions Norilsk workers do, because the highest salaries in Russia are found in Norilsk. The average salary in russia is two hundred dollars a month. At Norilsk the average salary is around one thousand dollars a month."

In response to a question concerning the "reality and the myth" of energy reform in Russia, Potanin replied that the electricity industry will be broken into its functions-generation will be separate from transmission. Transmission will remain a state monopoly, while generation facilities will be broken down into large regional companies. Legislation has been accepted that will make this reform likely in two to three years time, at the end of which one market will exist with independent companies, governed by market laws. Potanin did not expect the reform of Gazprom to be achieved soon.

Summary prepared by Anne O'Donnell, Junior Fellow with the Russian and Eurasian Program at the Carnegie Endowment.