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?

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The 21 Working Groups have presented an Interim Report (apparently about 400 pages) to that part of the government headed by Putin. It has not been published on the official Strategy2020 internet site, but media reports of its content suggest that it contains few surprises to anyone who has been following the work of the individual groups. A Final Report is due to be completed by December. I expect that further work by the 21 Working Groups published on the Strategy2020 website will essentially be refinements of that which has already been published. Thus, commentary on this site (ie the one you are now reading) will move more to what is actually happening now in the economic reform process in the areas being worked on by most of these groups. I will aim to post a new commentary every Monday.

Last week saw many reports and much commentary in the Russian media related to the necessity of promoting “modernization” and “innovation”.

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Some psychological articles  — which are relevant to economic reform — from www.jeffschubert.com for reading over the Summer holiday month of August.

(1)   Vladimir Putin’s likely policies, written in March 2000:

The post-USSR chaos in Russia was bound to throw up a leader whose instinct was more authoritarian and nationalistic than Boris Yeltsin. This leader has now arrived. In 1989 Unity was a dirty word, but now both society and Putin want it. In this sense, the desires of Putin and society complement each other in much the same way as did Yeltsin and society a decade earlier. Putin will be seeking to reconstruct some of what Yeltsin sought to destroy. Whereas Yeltsin sought, in his own way, to promote diversity within society and to free the Russian regional governments from the centre, Putin will be aiming for consolidation.

http://www.jeffschubert.com/index.php?id=20

(2)   Putin & Medvedev – Ataturk and Ismet Inonu — written in March 2008:

Psychologically, Medvedev will remain Putin’s servant (as with Inonu, “puppet” is too strong a word) for some time. As Medvedev exercises power he will begin to like it and become less the servant — and, initially at least, Putin is likely to take some pride in Medvedev as a capable (and I think he will be) president. Over time, however, Putin will need to accept various indications of his decline in formal and informal power — and will, at times, have to swallow his pride. However, Putin is not as focused on “self” as Ataturk and will accept this for a time. Nevertheless, tensions will grow.

http://www.jeffschubert.com/index.php?id=56

(3)   Medvedev and Putin and the effect of “power” — written in November 2008:

Albert Speer, Adolf Hitler’s architect and Armaments Minister, nicely summed it up the effect of prolonged power:

“There is a special trap for every holder of power, whether the director of a company, the head of a state, or the ruler of a dictatorship. His favour is so desirable to his subordinates that they will sue for it by every means possible. Servility becomes endemic among his entourage, who compete among themselves in their show of devotion. This in turn exercises a sway upon the ruler, who becomes corrupted in his turn.”

http://www.jeffschubert.com/index.php?id=61

(4)   Putin “personality cult” — written in December 2009:

Dimitry Medvedev believes that he is the best person to be president after the 2012 presidential elections. But power is as much about the psychological need for power – and, not surprisingly, Putin’s need has grown with time in power – as it is about intellectual analysis. Medvedev’s visual image is very lackluster, and unless he can do something about it in early 2010 – and boost his self-confidence (a la Mao) – he will be “psyched-out” both privately and publicly by Putin.

http://www.jeffschubert.com/index.php?id=73

(5)   Medvedev and Obama — written in March 2010:

While Obama’s team will be continually reminding him of 9/11, Medvedev’s team will be continually reminding him of the disastrous Yeltsin years. Medvedev’s team – which includes Putin – is afraid of loosening the government’s role as society policeman. Medvedev says he wants to strengthen the rule of law, but he appears to be having some issues in his own mind about how to do this without reducing ultimate state power over citizens. He is thus forced into a philosophy of modernization from above (ie “city of the future” project) rather than – more sensibly – providing the conditions to let it emerge from below.

http://www.jeffschubert.com/index.php?id=80

(6)   Putin’s “flaw in the weave” and no “new faces” approach — written in July 2010:

Neither Putin nor Medvedev seem generally inclined to use the “termination” option as a management tool. After the disastrous Yeltsin years, both Putin and Medvedev crave stability in the Russian governmental system. But there is also a difference. Medvedev is probably disinclined to use “termination” because of his intellectual nature which seems to generally focus on the good in people. Putin, however, is clearly more manipulative and inclined to use force. Putin’s reluctance to use the “termination” option can be explained, at least in part, by considering how some historical strong-men have approached this issue.

http://www.jeffschubert.com/index.php?id=88

It is now some months since President Medvedev directed that some way be found to lower the 34% “insurance contribution” on wages up to the threshold – in 2011 – of 463,000 rubles per year.

How to achieve this has turned into a protracted dispute between ministers and officials from the ministries of “Health and Social Development”, “Economic Development” and “Finance”. The latter has finally gained the support of Deputy Premier Igor Shuvalov and Vladimir Putin for its variant, and a report has been prepared for Medvedev.

The Ministry of Finance, under Alexi Kudrin, suggested a new scale with the general rate being lowered from 34% to 30%, and with the introduction of a new 10% rate for wage payments about the threshold limit (which will rise to 512,000 in 2012 because of indexation for inflation associated wages growth). “Small business” will get a “discount”, in the form of a general scale of 20%, and a 7% rate above the threshold.

The Ministry of Economic Development had opposed the addition contribution and wanted this amount to be compensated from the Federal Budget. The Ministry of Health and Social Development had opposed the additional contribution by small business, but not for medium and large business.

The president’s assistant for economic issues, Arkady Dvorkovich, has reportedly “promised to fight to the bitter end” against the Ministry of Finance idea of the additional contributions of 10% and 7%. (He earlier had accepted, it was reported, the idea of an additional 5% contribution as part of a variant that included compensating the Pension Fund from, among other ways, privatization receipts.)

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Expert Group 15 has prepared a very good interim report on “Managing government property and privatization” which will be included in a interim consolidated report by all the Groups to be discussed by the Government in August. 

The Group 15 interim report only appeared on the “2020Strategy.ru” internet site on 26 July, but parts of it were reported in “Vedomosti” on 25 July. On 26 July “Vedemosti” reported that First Deputy Premier Igor Shuvalov had already sent a report to President Medvedev with suggestions for widening the privatization program in the period to 2017. Medvedev has been pressuring the government (headed by Putin) to quicken the privatization process (and had set a deadline of 1 August for new proposals).

It could be that the advisory work of Group 15 has struggled to keep up with the government decision making process and that the early appearance of its interim report in the media was an effort to compensate for this. However, the 27 page report of this Group is generally in sync with what has been reported about the Shuvalov report (which is, in any case, probably much shorter), and with its considerable detail can be seen as a “how-to-do” as well as “what-to-do” document.

Shuvalov’s report seems to contain few surprises.

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President Medvedev has expressed his indignation about the hidden ownership structure of Domodedova Airport which handled 2.3 million passengers in 2010, and which is supposedly valued at around $5 bn. Even after the January terrorist attack which killed 37 people, the “management” of the airport have refused to divulge the ultimate owners.

What should the Russian authorities do about this?

Aside from doing nothing, one option is to resume state ownership (ie nationalization). But, there are probably some more appropriate steps between these two extremes that could be taken.

Some issues to consider are:

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Expert Group 2, which is concerned with “Budgetary and monetary policy and macro-economic parameters for developing the Russian economy”, has been one of the least active of the 21 Groups. Budgetary and monetary policy can be quite technical issues and it is essential to get these right, but Group 2 might also consider helping the Ministry of Finance understand the PR side of macro-economic policy – after all, isn’t the idea of managing “inflationary expectations” really based on a PR stunt?

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President Medvedev is trying to give further privatization a hurry-up, but perhaps he should ease up a little.  

In 1992, after my second visit to Russia as Chief Economist of HSBC (Australia) I wrote about the reform plans then contemplated: “The pace of privatization is unachievable because of the lack of an existing market and institutional framework to support it. … The other danger with rapid privatization of larger enterprises is that its lack of control may deliver many state assets into the hands of only a few groups who will then exercise monopoly powers and control over the economy.” (See left hand-side of page for full article.)

The institutional framework is obviously now much better, but possible impediments to competition enhancing transactions which give the state a decent price remain. Moreover, some of the suggested sales in the “natural monopoly” area are possibly counter-productive.

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Group 19 says that the “most capital-intensive and socially-conflicted issues of Russian federal transport policy are in the areas of railways and roads”. It makes a number of suggestions including: very significant increases in taxes related to road transport and the possibility of a Dutch-style GPS based road tax system; better management of road building contracts; and possible introduction to Russian Railways of a freer “wholesale market” system.

Jeff says that ….

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The basic idea of the work of Group 21 is that the Customs Union of Russia, Belarus and Kazakhstan should gradually become some sort of “Eurasian economic area” – and over the “longer term” become part of an eventual Eurasian economic and free trade area stretching from the Atlantic to Pacific Ocean. That is, it would eventually include the EU. There are several shorter-term goals, including some sort grouping mainly involving “CIS” countries which allows for macro-economic (including monetary policy) coordination, and regional reserve currency status for the Russian ruble. A series of steps are set out to achieve both shorter term and longer term goals.

Jeff says that ….

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