Several weeks ago a tribunal of Arbitration Court judges passed a case regarding “thin capitalization” up to the Supreme Arbitration Court for definitive determination. The Federal Taxation Service was claiming that interest payments to a foreign company were really dividends and that they should be taxed as such, and that the interest payments on the loan should not be an allowable expense for the calculation of taxable profit. At issue was an apparent conflict between the requirements of the Russian tax code and one of Russia’s international agreements on the avoidance of double taxation.  

The above paragraph in itself says something about Russia: there is a taxation authority which is pursuing a company through the courts because its inspections suggest that financial flows have been misrepresented in the accounts for taxation purposes. It might sound simple, but each of the steps in this process is quite sophisticated. Exactly the same scenario could occur in Australia, the UK or most other “modern” economies.

Last week the Federal Anti-Monopoly Service announced that it was taking legal action against Russian Railways and two subsidiary companies involved in supplying wagons for goods transportation. It seems that Russian Railways cannot or is refusing to supply wagons at regulated tariff rates and that its subsidiaries are instead offering the wagons at higher unregulated tariffs. From one point of view, this could be seen as sensible commercial behavior by Russian Railways group of companies, but from another point of view it might be seen as activity to boost prices with anti-competitive monopoly behavior.

Whether the Anti-Monopoly Service has a good case will depend on the details, but my main point here is that – following complaints from organizations wanting to move cargo – the Anti-Monopoly Service is on the job and basing its case on the law. Working Group 4 has done work on anti-competition laws and enforcement (see right-hand listing of Groups) and, while things are by no means perfect in his area, they do function in a similar way to a “modern” economy.

I could labor the point with other examples, such as the Central Bank, but my point is that from an institutional framework point of view Russian is already a “modern” economy.

Yet, at the same time the efficient functioning of the taxation system, the court system and the banking system is greatly hampered by very significant corruption and sometime staggering incompetence. And the examples abound: from the issue of VAT refunds (highlighted by the Magnitsky case) to the Bank of Moscow case.

So, what has this got to do with the choice between Vladimir Putin and Dimitri Medvedev?

I have little doubt that a return of Putin to the presidency would mean continued attempts to improve the institutional functioning of the economy – in such areas as taxation, competition law, central banking and banking supervision etc. Putin is not the ogre that many in the West like to imagine. He works hard, is pragmatic, and has an intellectual understanding of most of the requirements for an efficient market economy.

The drawn out case of the rate changes to the payroll based “insurance contribution” which seems to have finally been resolved after around 6 months of to-and-fro between the Ministry of Finance and the Ministry of Economic Development (basically backed by the Kremlin) is some evidence of Putin’s pragmatism and patience. In my view, there is been a sensible compromise with the acceptance of a lowering of the headline rate from 34% to 30% and the introduction of the requirement (with some concessions) to pay the contribution at a lower rate on wages about the indexed threshold (one of my earlier posts, on 31 July, covered this issue in considerable detail). 

Despite the above comments, the problem is that Putin’s basic psychological instinct will always be for direct “hands-on” intervention to solve problems, and a return to the presidency will do nothing to reduce this. Indeed, it may have the reverse effect. He came to power after the disastrous Yeltsin years and rightly saw that a greater sense of order was needed. He now cannot let go.

A characteristic of many hands-on managers is that they are a little afraid of “new faces” as subordinates, and prefer to keep working with even somewhat incompetent and corrupt people because they understand “the flaw in the weave”. Thus, it is no surprise that there has not been a lot of change in Russia’s top level officials over the last decade. (For a fuller explanation of this psychological phenomenon read: http://www.jeffschubert.com/index.php?id=88)

An interesting case in this regard could be that of Vladimir Yakunin, head of Russian Railways. A long investigative report in “Vedomosti” on Monday, 12 September looked at the relationships between some of the leadership of Russian Railways and the management/ownership of affiliated companies and suppliers. There was enough in this piece to suggest considerable corruption in this organization.

Yakunin should probably be sacked, and I suspect Medvedev would not be unhappy if he was. But Yakunin apparently has a strong personal relationship with Putin who would mostly know about the “flaws in the weave” and, while not particularly happy about them would accept them has been the price of avoiding “new faces”.

Perhaps the prime example of all this is Yuri Luzhkov, the former mayor of Moscow. It was Medvedev who finally got tired of Luzkov and forced him out of office. Putin seems to have accepted Luzhkov in spite of his corruption because he knew of the “flaws in the weave”. He probably also could not figure out who the “new face” would be.

But the ouster of Luzhkov has been a very good thing, with Sergei Sobyanin clearly taking a more professional approach to the job. It was this sacking that brought the Bank of Moscow issue to light.

What the Russian economy needs is more such sackings of senior officials – and this is something that a more confident Medvedev, if returned to the presidency, is more likely to do than Putin. This is one reason why I think that Medvedev’s “principles” based approach would better serve the economy than Putin’s “hands-on” approach.