FDI-Russia

Limits to Foreign Direct Investment in Russia
The Russian Economy emerged from the upheaval of the 1990s as a market where power was inadequately dispersed among the oligarchs, formal regulating institutions were scarcely in force and the state assumed too much of a role in an economy that was to run on free market principles. A decade later, there have been minimal reforms despite the widespread political rhetoric about Russia being integrated into the world economy. How has the absence of a fully developed free market and dominance of Oligarchs proven to be an impediment to the Economic growth? How has the relationship between them and the Russian government changed over time? What are some of the malpractices of the domestic economy? These are some questions that help us determine how the world views the economy in Russia and how it limits foreign investment.
Informal practices exploited by the Oligarchs confound the world
Since the privatization of Russian firms, the domestic market in Russia was run by a ‘grabbing hand model’ – “government at all levels were likely to prey on more successful firms to redistribute rents to less successful firms and to political allies”(Frye,Yakovlev,and Yasin,p.32). The oligarchs captured immense power during the mayhem of economic liberalization and created enormous wealth, thereby they “managed to capture the state, enrich themselves, and undermine economic development” (Frye,Yakovlev,and Yasin,p.33). This hardly fostered efficiency in the market since the motive was “wealth Extraction not wealth generation” (Rise and Fall of Oligarchs,p.3). They viewed the state as an ‘irrelevant player’ and resorted to “fraudulent accounting to hiring a private army to wrest control of an asset away from its rightful owner” (Rise and Fall Of Oligarchs, p.3 ). With a lack of hindsight, immediate economic gains were the main concern of the oligarchs.
In 1996, a group of American economists tried persuaded the state to adopt “property rights, a viable currency, a legal system with enforcement , regulations to deal with monopoly and the theft of newly privatized enterprises , and a simplified and enforced tax code”(Shleifer and Treisman,p.18). Such establishments are viewed by the world market as the benchmark for the functioning of free market. The persistent lack of them creates skepticism in the minds of foreign investors, turning investment in Russia an undesired venture. No investor wants to tap a resource that has uncalculated risks despite the calculated rewards.
The business strategies and fraudulent techniques in Russia are dismal and continue to scare away investors. The private security industry is associated with “debt recovery and other routine business tasks, all of which need to be accomplished in an environment of pervasive corruption and high risks”(Ledeneva,p.178). In the absence of formal regulations, informal means such as “arranging for an opponent’s shares or assets to be frozen, refusing to renew the terms of a loan and demanding immediate repayment, threatening a firm with insolvency proceedings, and increasing the level of bribes”(Ledeneva, p.174) emerge to seal transactions.
How has the scene changed?
The reckless resource extraction and short term profiting had been the way Oligarchs functioned. However, in the current economic downturn, the oligarchs have been forced to work towards efficiency to earn economic rents. They have come to realize that their personal coffers can no longer be supplemented by malpractice. Desperate to break even, they have now turned towards the government only to meet the rising ambition of Putin. The vertical integration of the political and economic sphere under Putin poses as much of a challenge to the free market as the presence of earlier practices. From an investor’s perspective, whether it is battling the informal practices or Putin’s ambitions, there are limited incentives to be a stake holder in an economy with corrupt corporate governance. The state might emerge as the bigger oligarch of them all and how that impacts the next round of economic development is going to be new story.
With the economic crisis of 1998, the oligarchs were forced to rethink their strategies and “standard reinvestment and asset-maintenance practices were introduced”(Rise and fall Of Oligarchs, p.4 ). In 2000, Putin addressed the oligarchs in a round table conference and established the new relation between the businesses and the state. To limit the power of the oligarchs, Putin established the dichotomy and asked them to pay their taxes and stay out of politics. The extradition of Mikhail Khodorkovsky ,who owned Yukos, was deemed to be strategic by some in order for the state to control “ Russia’s most important political economic and social lever”(Rise and Fall Of Oligarchs, p.5). This weakens the rule of law in the absence of an independent judicial system. The handover of Yukos to state owned Rosneft decreased the oil output from 9% to about 1% by 2007. 1In this corporate climate , “the legal murkiness and sordid corporate histories of most Russian firms –state and private-frightened away investors and Russian IPOs were at best tepid affairs” (Rise and Fall Of Oligarchs, p.5).
Now, the shift in balance of power is apparent in Putin’s final consolidation of power. The financial crisis of 2008 has left the Oligarchs in a credit crunch and turning to the kremlin for support which may imply a change in ownership of these firms.
The world view of the market
Research on the Foreign Direct Investment (FDI) in Russia has shown that the present market distortions and dominance of oligarchs have kept it at bay, thereby obstructing the path to “improve productivity, develop international trade, and experience economic growth” (Michalet in Fabry and Zeghni, p.290). In order to foster growth through FDI, the host country should have “positive local and regional markets, stabilize the macro and political environment, develop institutions and legal stability, and promote qualitative upgrading of labor…”(Fabry and Zeghni,p.293). As I have argued before, these were fundamentally lacking in the Russian domestic market. The Oligarchs accumulated their wealth through practices that undermined protection of property rights – a crucial factor for FDI. The investors in Russia have to resort to informal means of investing “privately in protection from revenue appropriation” (Fabry and Zeghni , p.295). These practices raise the monetary transaction costs which in the presence of formal institutions might have been a smaller opportunity cost in relation to the economic rent. Since the risk involved is so high, Russia has been attracting mostly speculators that deem it worth the risk to enter the market .

In order to attract FDI and boost domestic economic growth, the government has to ensure the institutional, contractual and political stability, combat corruption and “reinforce legal and regulation framework” (Fabry and Zeghni,p.300) along with “secure market access to protect intellectual rights”(Fabry and Zeghni,p.300).
Russia launches reforms
Increasingly President Medvedev and Prime Minister Putin have underscored the importance of opening the economy to investors to boost growth. Dmitry Medvedev called for Russia to “modernize more quickly, but stressed that it should happen through the development of democratic institutions and a market economy.”2 In his recent public appearance about developing new goals in a series called Go Russia! , He highlighted the importance of eliminating “inefficient state giants...and establishing accountability and transparency.”3 Putin in a TV interview addressed the investors to “bring certain technologies and culture of production”4. To assist this he acknowledged the need and offered plans to “introduce the principle of notification [rather than obtaining permission] for a number of activities and to hand over part of regulatory functions to the level of self-regulating organizations”5 It is apparent that especially in the recent crisis capital is “more scarce…there 's a recognition that Russia does have to play the game.”6
Despite the rhetoric of the leaders in making the market work independently, the increasing control of the state in businesses “ run against the logic of separation of the state from business…that is essential for creating a market democracy”(Ledeneva,p.188). It is widely understood in Russia that the prospects for making the rules transparent “means to lose manageability and centralization”(Ledeneva,p.188).
The problem of corruption and abuse of the law creates a cycle of issues that cannot be eliminated as one bureaucracy is replaced by another. Selective interpretation of the law has been a dominant problem. Authorities find ways to disrupt functioning of businesses and demand bribes to ensure smooth functioning. To foster trust in the law, the government needs to set standards that comply horizontally across the nation and create a mechanism of auditing and monitoring by international organizations. To ensure these new institutions are not crippled by the problems faced by their predecessors, the officials should be paid well and given contracts on the basis of regional competition in providing the best suited business climate. Although it is an uphill task to rebuild norms that have been in practice for a long time, the first steps have to be taken. Rhetorical promises can only offer cautious optimism to an economy that needs to see concrete laws and their subsequent enforcement in order to lure foreign investors.

Bibliography – outside sources
"Future Privatization in Russia to Occur without Discounts, Says Putin." BBC Monitoring Former Soviet Union - Political Supplied by BBC Worldwide Monitoring October 6 2009.
Kramer, Andrew E. "Private Enterprise Back in Favor in Russia ; with Renewed Warmth, Putin Urges Nonstate Investors to Lead Revival." The International Herald Tribune September 30 2009, sec. FINANCE: 17. Print.
Moscow. "Medvedev Calls for Reform." The Age (Melbourne, Australia) November 13 2009, sec. NEWS; International News: 10.
"Russia 's Putin Invites Foreign Investment, Promises to Cut Red Tape." BBC Monitoring Former Soviet Union - Political Supplied by BBC Worldwide Monitoring November 9 2009.

Bibliography: – outside sources "Future Privatization in Russia to Occur without Discounts, Says Putin." BBC Monitoring Former Soviet Union - Political Supplied by BBC Worldwide Monitoring October 6 2009. Kramer, Andrew E. "Private Enterprise Back in Favor in Russia ; with Renewed Warmth, Putin Urges Nonstate Investors to Lead Revival." The International Herald Tribune September 30 2009, sec. FINANCE: 17. Print. Moscow. "Medvedev Calls for Reform." The Age (Melbourne, Australia) November 13 2009, sec. NEWS; International News: 10. "Russia 's Putin Invites Foreign Investment, Promises to Cut Red Tape." BBC Monitoring Former Soviet Union - Political Supplied by BBC Worldwide Monitoring November 9 2009.