Global Finance, Local Control

Corruption and Wealth in Contemporary Russia

Igor O. Logvinenko

• Publisher: Cornell University Press
• Year: 2021
• Print ISBN:
  9781501759604
• eBook ISBN:
  9781501759611
• Topic: Politique et relations internationales
• Subtopic: Histoire de la Russie

Exploring Russia's reentry into global capital markets at the dawn of the twenty-first century, Global Finance, Local Control shows how economic integration became deeply entangled with a bare-knuckled struggle for control over the vestiges of the Soviet empire. Igor Logvinenko reveals how the post-communist Russian economy became a full-fledged participant in the international financial sector without significantly improving the local rule of law.

By the end of Vladimir Putin's second presidential term, Russia was more integrated into the global financial system than at any point in the past. However, the country's longstanding deficiencies—including widespread corruption, administration of justice, and an increasingly overbearing state—continued unabated. Scrutinizing stock-market restrictions on foreign ownership during the first fifteen years of Russia's economic transition, Logvinenko concludes that financial internationalization allowed local elites to raise capital from foreign investors while maintaining control over local assets. They legitimized their wealth using Western institutions, but they did so on their terms.

Global Finance, Local Control delivers a somber lesson about the integration of emerging markets: without strong domestic rule-of-law protections, financial internationalization entrenches oligarchic capitalism and strengthens authoritarian regimes.

1

LOCAL CONTROL AND GLOBAL ACCESS

The famous declaration that “behind every great fortune lies a crime” can be traced to Honoré de Balzac. His original point was subtler: “The secret of a great fortune made without apparent cause is soon forgotten, if the crime is committed in a respectable way.”¹ In other words, a skillful fraudster need only apply a veneer of respectability and good manners for the source of his fortune to be forgotten. The Russian tycoons founded their fortunes in the grand crimes of privatization, reprivatization, and subsequent nationalization. They also kept those fortunes by continuously engaging in a litany of semi-legal activities. They gave bribes, traded favors, and made backroom deals, both with each other and with the Kremlin, in their quest to hold onto their mines, factories, and oil wells. Over time, the post-Soviet tycoons also managed to imbue their conduct with an aura of respectability and decorum by taking advantage of the rise of financial globalization. In Russia, local conditions have always required unscrupulous business tactics, but Russia’s integration into the global financial system has allowed these ruthless businessmen to defend their great fortunes through so-called respectable means. The oligarchs may have become wealthy without apparent cause, but their ability to hold on to their assets has identifiable causes. This book explores one of them: financial internationalization.

Scholars and policymakers rarely see financial internationalization as a scaffolding that supports the uneasy relationship between the state and big business in countries not bound by the rule of law. Since the early 1990s, financial integration—particularly the relaxation of foreign access to local capital markets—came to play precisely this unique but enormously critical role in Russia. The local controlling owners used financial openness tactically. While they controlled their assets by relying on local clout, they also utilized increased global financial accessibility of these assets on international markets to gain liquidity and bolster the legitimacy of their ownership claims on these assets. Ultimately, financial integration allowed Russian owners to have their cake and eat it too, to reap the benefits of both local and global connections. This two-pronged approach of combing Local Control and Global Access (LCGA) proved to be a successful and enduring strategy of wealth defense that remains in place to this day.

In this chapter, I unpack the conceptual and theoretical underpinnings of the LCGA framework and situate it within existing scholarship on globalization and development to establish a link between the Russian political economy’s global and local realities. To maintain control of a major asset in Russia for an extended period, its owner must simultaneously exist in two separate worlds. First, there is the political world where the rule of law (and the formal, predictable order that it imposes) does not exist. Instead, control over the most valuable economic assets is managed via the informal and unpredictable rule of clout decided by personal connections, making property rights permanently politically contingent and contestable. The second world is that of international financial markets, foreign courtrooms, spotless conference rooms of international law firms, automated stock exchanges, and investment roadshows. This world is governed by the rule of law, formalism, and highly impersonal technical procedures reliably administered by third-party arbiters in foreign jurisdictions. These two worlds are radically different, so the ability to seamlessly navigate between them is the distinguishing quality of those who have managed to remain in the ranks of Russia’s superrich during the last three decades.

Asset Control under the Rule of Clout

The foundation of a functioning rule-of-law system is the impartial exercise of state power in a transparent fashion through formal institutions, ensuring equality before the law for both the rulers and the ruled. The rule of law is crucial to developing the free market, which is an enormously complicated system of voluntary exchange and allocation of property rights across time and space. The success of the market as an economic institution depends on efficient enforcement of contracts and disinterested third-party arbitration by the state. In the absence of these mechanisms and institutions, property rights become contestable, informal relationships undermine formal rules, and the incentives for economic activity and market-based information exchange become distorted. In the absence of the rule of law, the realms of politics and economics become inextricably and pathologically intertwined, corrupting both.²

Scholars of postcommunism have long fixated on how the weak rule of law and deficient property rights institutions impacted political-economic outcomes in Russia.³ Even casual observers of the early transition from Soviet state socialism foresaw that Western-style rule-of-law institutions, particularly those guaranteeing property rights protections, would have to be integral to the reforms for them to succeed.⁴ But in Russia, where the state had owned all significant assets for many decades and even centuries, there could not be such a thing as an impartial exercise of state power. The stifling legacy of state socialism and the grim macroeconomic circumstances surrounding the Soviet collapse politicized the reform process. Despite some early attempts to assure an equitable division of assets, much of formerly state-owned property was ultimately distributed and redistributed according to the logic of the rule of clout.⁵ To this day, the Russian economy is in the grips of clout politics.

In a rule-of-clout system, the economic actors with the greatest informal political influence direct the application of administrative, coercive, and juridical authority to advance their economic goals. To have clout is to be able to influence the selective application of the law by the state. Formal legal rules play a role, but (as Balzac noted) they are used as a facade that allows the economic actors with the most political clout to advance their interests covertly. The main consequence of the rule of clout is the never-ending contestability of property rights that has been the central background condition of Russia’s transition period.⁶

For the wealthy, the rule of clout has both upsides and downsides because the same weak institutions that open channels for wealth acquisition also make it difficult to reliably protect that wealth once it is acquired. Corrupt institutions allow oligarchs to gain and maintain control over assets and rents, as those with clout can shut new competitors out of the market and thus keep monopolistic rents. In rule-of-clout systems, entrenched business interests, therefore, have few incentives to support more vital public property rights institutions: these institutions would make it more difficult to control the market.⁷ However, these same weak property rights protections make the oligarchs’ hold on their wealth fundamentally tenuous and contingent. As Jeffrey Winters, the leading expert on oligarchic systems, has put it, “The claim ‘all of this is mine’ will constantly be confronted with the response ‘says who?’ ”⁸ Thus, the Russian nouveau riche continually look for ways to maintain control over their assets and bolster the legitimacy of their claims to ownership. In the past, oligarchs have used “primitive” wealth defense strategies such as hiring private armies.⁹ But as the business environment became more civilized, many oligarchs turned to formal governance strategies.

Consider majority blockholding—a nearly universal form of corporate organization in Russia. Students of capitalism have long observed that as corporations grow in size, they require a separation of management (control) and risk bearing (ownership). Separation of ownership and control creates a principal-agent problem, a situation in which managers (agents who have effective decision-making control over the firms) have incentives to act in their interest rather than the owners’ interests (principals, who own the firm). To overcome this problem, key corporate stakeholders, courts, legislatures, and other actors devised formal frameworks of corporate governance, including laws and norms concerning contract enforcement, torts, public disclosures, and bankruptcy.¹⁰ Over the years, Russian policymakers have made genuine efforts to introduce these modern corporate governance practices, but the prevalence of the rule-of-clout norms mostly neutered most of these reforms.¹¹

The rule-of-clout logic and the associated need for majority control almost unfailingly governed the bitterly acrimonious journey from Gorbachev’s state socialism to Putin’s state capitalism that entailed a series of transfers of asset-control rights among powerful groups of connected interests. The initial phase of privatization in the early 1990s was a partial and brief exception, for it produced multiple stakeholders in major firms, with few enterprises having a single majority owner.¹² Predictably, in the absence of functioning corporate governance infrastructure and minority shareholder protections, this initial (and short-lived) multiple-stakeholder model enabled widespread asset-stripping by insider-managers, who held the most political clout because they de facto controlled the enterprises and their workforces. After this disastrous experiment with privatization, the largest and most profitable Russian companies were gathered into ownership arrangements led by a single entity that controlled the most shares in the asset. In the absence of the rule of law, the principal-agent problem at the core of the management-ownership nexus was overcome by combining ownership and control through majority blockholding.¹³ Majority blockholding allowed owners to both overrule management and prevent any combination of minority shareholders from challenging their authority.¹⁴ When the state again became a significant owner of assets under Putin, it retained this majority-blockholding model. Even today, large firms with widely dispersed ownership are mostly anomalous in Russia.¹⁵

Global Accessibility: Liquidity and Legitimacy

Struggles for asset control and the associated prevalence of majority blockholding in Russian corporate governance are well known to even casual observers of Russian business. Nearly universal adoption of majority blockholding has been a natural consequence of the rule-of-clout dynamics. Yet, there has been very little scholarly attention paid to the relationship between the contingent nature of Russian property rights and the efforts to internationalize Russian capital markets. The peculiarly assertive (and strategically timed) embrace of financial globalization has been a potentially more important consequence of corruption and weakness of property rights protections. In episode after episode, once new owners established full control over assets, they consistently and enthusiastically invited outside investors to become minority partners and lenders. Broadly conceived, any property rights system is a collection of rules and norms regulating access to and control over assets.¹⁶ Russian experience suggests that in rule-of-clout settings, the ability to continuously control the asset turns on the ability to regulate access to the asset.¹⁷ To understand why this was the case, first, I will introduce some historical context and settle on a few key concepts.

Political philosophers have long noted the momentous political importance of changes in asset mobility. Commenting on this phenomenon in the middle of the eighteenth century, Charles de Montesquieu observed that the invention of the bill of exchange made it possible for the Jewish traders of Northern Italy to escape violence, “for the richest trader had only invisible wealth which could be sent everywhere without leaving any trace … [compelling rulers] to govern with greater wisdom than they have intended.”¹⁸ Montesquieu may well have been observing a minor bout of financial internationalization when the transborder markets for promissory notes became one of the critical innovations of early modern European capitalism that in turn had well-known consequences for political changes in European monarchies. Over the centuries, many other broad social developments, such as urbanization, technological progress, and legal-institutional advances, all profoundly altered the capacity of wealth to traverse political jurisdictions. In the long course of economic development, societies generally transition from dependence on predominantly location-specific asset bases (e.g., agriculture, mining) to mostly mobile assets (e.g., finance, technology), unsettling previous political orders in the process.¹⁹ More immediate changes, like the adoption of automated stock markets that allow shares in joint-stock companies to be easily tradable across borders, can also make otherwise immobile wealth (like mineral deposits) partially portable.

Historically these changes endowed the economic elites with a new source of leverage against the political establishment. Modernization of financial systems and the emergence of genuinely global money in the second half of the 1800s and again late in the twentieth century empowered financial capital, which produced a myriad of complicated consequences in governance and economic development in the West. But something else often gets left out of the story: financial globalization made it possible for interconnected markets, operated by armies of skilled accountants, lawyers, and bankers, to extend European and American rule-of-law protections and business conduct norms to emerging business elites across the globe. This significantly reduced the risks of doing business where local institutions are weak and obviated the need for governance reforms in those countries.

In the argot of economics, organizational structures and governance solutions—such as stock markets, impartial arbitrage agents, and auditing services—lower the transaction costs of economic exchange, facilitating the market’s expansion. Thus, internationalization of domestic financial markets reduces the transaction cos...

Table of contents

• Preface
• Acknowledgments
• Abbreviations and Acronyms
• Note on Transliteration
• Introduction
• 1. Local Control and Global Access
• 2. Episode 1
• 3. Episode 2
• 4. Episode 3
• 5. Coda
• Conclusion
• Appendix
• Notes
• Bibliography
• Index