Russian Economic Reform

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Russia’s new privatization scam?

Published on March 31 2012
Posted by: jeff

As noted in the previous blog on this site, the final “Strategy2020” Report has six parts with the first being entitled a “new model of economic growth”. Also as noted, this part is divided into three sections with the second entitled “strategy for improving the business climate and increasing investment attractiveness with the aim of moving to more stable growth”.

Although this section makes some important points, it is not wildly exciting reading and I was tempted to pass-over it and try to go onto something else. However, I then noticed an article on the “Russia Profile” internet site about SMEs soon being able to more easily purchase the premises which they presently rent from various levels of government. See: http://russiaprofile.org/business/56557.html

These are extracts from the article:

“Starting next year, small business owners who lease office space directly from federal and municipal authorities will be able to take advantage of a preferential right of privatization to own them. The measure could touch up to 19 million square meters of federal and municipal premises, which are currently leased out to owners of small businesses and individual entrepreneurs across the nation at highly reduced rates. The right to privatize rented office space, which was contained in a government-sponsored draft bill, is expected to benefit small business owners who have been leasing office space from regional and municipal authorities for more than two years. A clause in the draft bill forbids state bodies from turning down requests for privatization of such premises and also allows those previously refused permission to re-apply. Another business friendly provision in the bill allows entrepreneurs to acquire leased premises without the customary 30 percent down payment. The measures were first approved at a March 2 meeting of the Government Commission of Small and Medium Business Development headed by First Deputy Prime Minister Igor Shuvalov.” “Rental costs remain one of the largest and most critical expenditures facing small business owners in Russia, and analysts say business tenants always see municipal leases as bargains. During a meeting with representatives of major Russian banks in January, President Dmitry Medvedev listed the lack of office space as one of the three main problems hindering the development of SMEs in Russia. The other two, the president said, are administrative barriers and the absence of competition. Leasing space in unused parts of municipal buildings is often the only choice for many small businesses and startups in the regions where the cost of commercial real estate is prohibitive. Municipal authorities in the country’s centers of commerce like Moscow, St. Petersburg and Yekaterinburg already rent space to private businesses, including restaurants, banks, hair salons, newsstands, even local movie theaters and farmers’ markets.”

Two things particularly struck me about this article.

One thing is that this system of insider sales seems ripe for abuse (albeit on a much smaller scale than of many other privatizations) and, in my view, an open auction system of sales would be preferable. This is particularly the case given that — according to the article — there “will be no restrictions whatsoever on the size of the area that can be privatized” and “entrepreneurs will have at least three years to pay up while they will also have the right to determine the order in which payments are made.” Municipal budgets are already under enormous pressure and an open auction system would almost certainly yield greater revenue for local government than this insider trading approach.

The second thing was a reported comment by “Moskovsky Komsomolets” (newspaper) that the Kremlin “has decided that the other two issues listed by the president (administrative barriers and the absence of competition) can’t be solved; hence the focus on rental costs.” I suspect there is a lot of truth is this comment, and perhaps more generally it reflects a government tendency to see things in terms of amounts of money when other aspects of the institution environment may be more important.

And, indeed, it is these other factors that are addressed in part 1, chapter two of the “Strategy2020” Report. The most important message in this section is that “macroeconomic efforts will be insufficient unless accompanied by the creation of favorable conditions at the micro level”. It then identifies the “main negative factors in this area as: excessive inequality of rights of market agents; barriers to entry for new companies; distorting effect of state and monopoly sectors; excessive and inefficient regulation; slow pace of restructuring of the old companies receiving government support; and corruption.

The Report lists a whole range of measures to reduce barriers to entry and increase competition. Most would be of little particular interest to readers of this site, but they include business registration procedures, costs and legal forms; reducing the difficulties and costs (including informal payments) for access of companies to natural monopoly networks; national standards development and decisions;  clarification and separation of functions and powers of the various law enforcement agencies in the control of economic and business activity and suppression of crime in this area; creation of an open database of court decisions, the introduction of the annual public report on the judicial practice, prepared on the basis of parity representation of business associations, the judiciary, bar associations and prosecutors; the creation of incentives to improve the business environment at regional and local authorities; and reforms of various aspects of the criminal code.