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Russian Government and Business:
From Conspiracy to Moral Truce

by Alexander Zaichenko

By present international standards Russia continues to be a significant source of money-laundering. Last year, Russia was labeled as a country with "non-cooperative jurisdiction" and was put on a list, which initially included 15 countries. That list was later revised to three, but Russia is still on it.

Paradoxically, Russia was one of the world pioneers in fighting for transparency of all income sources. In the 60-s and 70-s communist leaders issued a number of harsh laws trying to impose “socialist justice in distribution of income and consumption.” The method of inspection was predictable: checking personal incomes against personal consumption expenditures. Severe (up to capital) punishments were introduced to secure a rigid balance between what the average Soviet man was allowed to earn and his real consumption patterns.

But the artificial, ideological character of such a policy was evident even to its initiators. For instance, party nomenclature were excluded from surveillance because communist bosses were officially regarded as “untouchable.”

Money-laundering processes and models in Russia are rather complicated, reflecting the multicultural nature of the society and the transitional character of its present economy. In order to reach more clearance in discussion of this phenomenon we offer a special model entitiled: “Societal patterns of money-laundering in Russia.”

1. Participants

Among the main participants in the money-laundering process (or in the struggle against it) there are two separate groups: a) “regulators” and b) “initiators”.

“Regulators” are represented by all branches of state power, national culture, society and international community. In spite of all the initiatives taken by the communists in recent decades, the government of Russia launched active steps against money-laundering only several months ago. Prior to that active roles in this area were exclusively domain of the “initiators”: private businesses, national and international banks, and criminal organizations.

1.1 “Regulators”

The principle tasks of “regulators” in area of business transparency are as follows:

• to fix legal boundaries in currency transfare and in business activity in general
  
  
• to outline general conditions of these processes inside and outside the country
  
  
• to influence these processes indirectly through general economic policy
  
  
• to react on the specific actions of “initiators”

Here we’ll not discuss in depth the regulatory roles of a society (public ethical standards) and national culture. Suffice it to say that even between the main “regulators”, that is state centers of power, on one side, and public opinion (public moral standards) and national culture, on the other side, there has been no truce. And the reason for this was not so much in modernity and pro-reform stance of the government (versus society and culture) but in the longstanding and very deep mistrust between the state (its primary elite) and the rest of the population, including business circles.

Another feature which greatly influences the positioning of the majority of society to problems of money-screening and -laundering is the persistent and still ongoing refusal of the government, and ruling elites in general, to respect non-ruling sections of the population and recognize the personal dignity of individuals. This feature is rather distinctive for Russian national culture and still is very strong. Take for instance the traditional economic and social overexploitation of Russian business and the workforce by its own government. The share of wages and salaries in gross product (on a national level or in industries) for more than a century is among the lowest in the world. In other words, in terms of productivity, Russia ranks among moderately developed countries like Poland, Hungary, etc, but in the terms of reimbursement and living standards – among the underdeveloped. In the past, the margin was expropriated by the state. Now, Russian businesses have managed to transfer this overexploitation to its workers and to grab even more. This fact is especially striking for a country with such hard climatic conditions, where considerable part of personal income must be spent for heating of all types of dwellings, its insulation and compensation of unpredicted damages, caused to people and the economy by the weather. We regard this overexploitaton as one of the primary factor of the negative population growth in the vast Central, Northern and North-Eastern regions of Russia, which has continued now for 40 years in succession. As a result, unauthorized “privatization” of incomes or final products by employees, as a means for mere survival, became widely accepted on the level of actual behavior and on moral grounds. To screen such behavior and save for your living against greedy and merciless rulers is a matter of honor and justifiable revenge in eversasting war with state power. And it happened not only in the communist past, but also in the democratic present.

There are least three more aftereffects of this persistent mistrust between rulers and bulk of the Russian population. The first is the permanent built-in readiness of the Russian citizens to defy the law as a symbol of the oppression from the state. The second is the huge potential of corrupt behavior of governmental employees. This phenomenum is known as “privatization of state power by bureaucrats”. Just imagine: on one side, there is the aberage government emplaoyee with monthly salary of 150 – 200 US$, whose decisions can be valued by the market from thousands to tens and hundreds of millions US dollars. On the other side – there are powerful, greedy business and aggressive organized crime. The third aftereffect is that business and organized crime managed very soon after their emergence in the new democratic Russia to convert their wealth and violence into even more economic wealth and poltical influence. Today, as a new center of power, business enjoys 10% of all national stock of political power; organized crime – 13%. Compare these figures with: President – 24%; federal government – 11%; regional leaders (governors) – 18%, federal parliament – 5%, army - 3%, state security service – 6%, law-enforcement bodies – 5%, courts – only 2%; political parties and movements – 1%, Orthodox church – 1%, trade unions –1%. But in spite of the enormous scale of stealing and corruption, the Russian culture still treats bribes and extortion as sins, unlike some Muslim subcultures inside the country.

During the last 3 years a new “regulator” has stepped forward into international and national money-laundering arenas with its ever-growing impact on all other stakeholders, including Russian governmental bodies, businesses, banks, organized crime, international and foreign financial and credit institutions. This new powerful player is a block of developed countries united by their determination to fight against any form of intermational economic crime. In the beginning of the 90-s this union, headed by the United States and Great Britain, launched a total war against international money-laundering with its special body, the Financial Action Task Force, and other national and international organizations. Russia should be very grateful to this new “regulator’, because the final result of this struggle will do much to help Russia. It is this very stakeholder who is managing to help us to turn back the long standing tradition of theft, screening, and laundering, not only on the international but also the national level.

The major part of money-laundering is being exercised within the country. Casinos, lotteries, gambling, big deals with real estate, etc., which are still beyond efficient government control are widely used for this purpose. In recent years we have witnessed how impudently and openly criminal capital corrupted power in order to steal, hide, and remove resources from the country. The moral passivity and ethical relativism of majority of the Russian population, to a significant extent, are explained by the fact that Russian authorities have done nothing to oppose criminals effectively in business and politics.

Only recently the “initiators” of money-laundering started to accept much more active and superior position than “regulators”.

According to the most general definition, money laundering is the use of illegal money with the intent to conceal its source. It is engaged in for a variety of reasons. One is to prevent law enforcement from detecting that money, and thereby investigating crime. Another is to conceal the money from government to prevent its taxation. And a third is to allow a criminal to enjoy and use his money in a fashion that will prevent its being viewed as the proceeds of his criminal activity. Thus “initiators” are represented by large business companies, banks (national and international) and organized crime (also national and international). Usually money-laundering operations become a legal problem when national fiscal legislation adopts a principle of free declaration of income. In the West this principle was launched 60-80 years ago, in Russia – 5 years ago. But a law directly prohibiting money-laundering in Russia has adopted only a year ago.

The present situation with the flight of capital from Russia is rather simple. Capital flees because, on the one hand, the Russian state does not enjoy investors' trust and therefore people want to hide their money where it will be safe. This is one half of the truth. The other half is in the psychology of the investor himself, who gets the larger share of the capital he transfers via the shadow economy at best, while at worst has to launder the money because it represents the proceeds of criminal operations.

1.2 “Initiators”

The basic motivation of “initiators” is to optimize their longstanding cumulative business gains from a specific set of conditions determined by the current economic situation and the actions of “regulators”. A new class of businesspeople, which almost instantly became one of the outstanding centers of power in Russia, realized that the past and the present of Russian people as an object of overexploitation may soon become their own future. Actual steps by all Yeltsin’s liberal cabinets proved those apprehensions: 22% - value added tax, plus 35% income tax, plus 35% payroll tax, plus 5-10% local taxes, plus other taxes, plus extortion from bureaucrats and criminals. The cultural motivation of this fiscal madness is based on presumption that those taxes will never be paid. From the very beginning both sides knew that they would not be paid in full, but such laws gave the authorities the opportunity to keep business on corrupted hooks. Naturally, the idea of screening and laundering of business earnings was also silently presented in these latent tax “contracts”. But why not set up more realistic fiscal obligations for business and budget rights for the government? The reason was not only to be found in the area of intangible cultural peculiarities of Russia. In a transitional society, in an atmosphere of permanent crisis, in a poorly managed and measured economy, under conditions of unpredictable financial and capital markets and risky agriculture, such strict fiscal boundaries were difficult to keep. At the same time the latent loopholes in these tax “contracts” gave the authorities the arbitrary advantage to preserve their chance for future initiatives in this everlasting war for supremacy in society over any newly emerged center of power.

So, in its attempt to survive and to remain in the market, Russian business is ready to undertake any steps to avoid over-taxation, thus becoming a main stakeholder and initiator of money-laundering. A long standing tradition not to trust the government works in full scale. The Director of the Federal Tax Police, Michael Fradkov, proves that from 3.5 million registered businesses more than 1.5 million (about 43%) don’t submit any report to authorities and consequently don’t pay any taxes.(“Nezavisimoya Gazeta”, May 31, 2001, p.4). Under present Russian conditions, it is not the rate of profit, but rather the safety of capital that remains a principle factor of money outflow. According to National Investment Council Chairman Alexander Lebedev, each year Russian companies illegally hide and transfer abroad between 10 and 15% of their hard currency earnings. (“Nezavisimoya Gazeta”, April 17, 2001, p.9).

Another participant is the Russian banking sector. As part of the business community, it must be viewed as a separate stakeholder. It is still in the center of money-laundering. Eventually banks serve as a conductor, as an executor of the will and intentions of the big players, rather than independent “initiator”. Among their customers are tycoons of state and private companies. But when the national government began more actively pursuing its counter-laundering campaign, many banks in Russia suddenly were no longer happy with the demands of these powerful customers to screen and launder money they underreported, stole or grabbed. But the impoverished economic status of the overwhelming portion of the population, underdevelopment, the negligible position of small business, and the professional and managerial immaturity of the banking system often left banks no option on the clients’ market.

In recent years, the collapse of the old communist political infrastructure and numerous weaknesses of the new democratic regime gave a chance for organized criminal groups to appear in the economic and political life of Russia and to declare themselves as one more significant center of power.

Organized crime, until recently known as the "krysha" or business roof, has now evolved into a pillar of the Russian economy. The gangsters who operated before the privatization years have converted themselves and their outfits into respectable businesses. They control, directly or indirectly, large enterprises and their trading and export operations - thus keeping money laundering and capital flight operations largely in their own hands. But the state and its organs have shown neither the ability nor the will to tackle this critical problem. And it seems logical that even if the political will existed at the top, the ridiculously low salaries and appalling living conditions of security ministry officials makes it highly unlikely that they could effectively tackle the issue. In fact, many government organs are the muscles that settle the turf wars - bringing handsome rewards to bureaucrats and functionaries.

Relatively recently some new outside stakeholders have appeared among the “initiators” as energetic actors in the Russian money-laundering game. Though their sources of income and final goals were different, they often use the same channels and techniques of money-laundering. Russian organized crime very quickly perceived the underground skills and experience of their senior comrades and soon opened vast opportunities beyond Russian borders. Then came the turn of big international banks. Gradually many of them were lured by their new Russian customers into what might be called “gray and dark-gray operations”. The laundering is best at Swiss banks, and in offshore zones on Cyprus, for example, where everything is established. No country will oppose an inflow of capital unless forced by the world community. It will close its eyes to the fact that the money is likely too dirty. Naturally, the so-called tax paradise phenomenon is also at work. Money is money; it is brought there and there it works.

A. Lebedev considers that the flight of Russian capital is strongly assisted by major Western banks. The principal part of the money that has been transferred to Western bank accounts is owned by 50 leading Russian banks and exporting corporations. He proves that each year, anywhere between $15 and $30 billion of this money is granted to Russia in short-term credits, on which it pays considerable interest to the West. As a rule, this money goes through big Western banks. He argues that these Western banks developed and supplied Russian clients with the most advanced technologies of money-laundering. The role and place of Western banks in the flight of capital are so great that it is possible to come up with suits for the defense of the Russian Federation's interests. It is quite possible to have a considerable sum of this money brought back to the Russian Federation.

2. Clash of interests

Under Yeltsin’s regime illegal incomes nominally were condemned and prosecuted. But actually the government was not committed to struggle against these crimes, it widely used such struggle in its political maneuvering, in a manner similar to negative feudal privilege. In other words, authorities could use the potential threat of applying official law against those businessmen, public leaders and politicians, who might “forget” the rules of the political game, led by Kremlin. As a result of the chronic weakness of his power, Yeltsin never fully realized this threat in practice, but he widely used it to consolidate support for his regime among oligarchs. Putin broke this tradition. His power as a president is based not on the political weaknesses of the former president’s adversaries: big business, parliament, parties, etc., but on real support from such influential centers of power as the army, security, parliament, public opinion (image). Recently very strong supporters have joined the camp of his allies: parliament, regional leaders and big political parties. Presumably, Putin views himself not only as a strong leader consolidating all and everything in this country, but, (and it is probably more important) as the first successful pro-democratic reformer in history of Russia. In the beginning of his presidency, Putin declared a war on crime, including crime in big business. Later he evidently decided to postpone it in favor of winning sympathies from regional barons, parliament, and political parties, rather than at the same time adding the headache of opening hostilities with big business, organized crime and mass media. But unexpectedly, a new and powerful stakeholder entered the scene. It was the joint international program to defeat money laundering in its most extreme forms throughout the world. The pressure was considerable: such affairs as IMF loans, Bank of New York, Borodin and some other minors. But Putin, as a strategist, responded positively to these signs no sooner than he coped successfully with important tasks in his internal struggle for consolidating his power and defeating resistance of his opponents. Strengthening the position of the central government, adopting new, more efficient laws, and increasing cooperation with the international community on one side, and continuous isolation of business from organized crime on the other side, led to radical positive changes in the struggle against money-laundering. Unfortunately, Putin up to now, has done very little to build trust between the State and Society. People, social, economic and political dignity of his own people are still the means not the final goals of his consolidation. So we think that such a traditional factor of Russian culture as “mistrust” will continue to have a negative impact on combatting income-screening and money-laundering.

From conspiracy to truce

In order to turn the tide in fighting economic crimes and specifically money-laundering the state power must improve the economic climate in Russia, but this is still a very complex and difficult problem. Lying on the surface is poor regulation plus imperfect regimes of investment and taxation. A more deep-rooted factor is the rampant mistrust of the state by domestic investors. An even deeper layer concerns the obtaining of all basic incomes by less than legal methods. The main stumbling block here is the absence of effective proprietors, one result of the privatization process. For many years people who received the juiciest chunks of property simply plundered them without bothering to develop their enterprises or modernize them. Like vampires, they suck the blood from these enterprises and create personal fortunes, yet the money does not stay in Russia because it is necessary to cover up the plunder.

But recently Russia has witnessed the encouraging signs in the battle for business transparency. All branches of state power have shown an unusual unity in solving the most chronic problems. Now Putin is ready to declare war against crooks in big business and organized crime. His decisiveness to launch a war against organized crime is based not only on his recent successes in consolidating his power but also on very sound economic reasons. According to a professor of the All-Russian Academy of International Trade, Alexander Belychook, today this country is suffering from capital flight in two directions: the first is annual payments 8 – 17 billion US$ in foreign debt, the second – 20-30 billion US$ in illegal outflow. The government has confirmed its obligations to pay off debts, but Russia can not sustain a loss of 30 – 40 billion US$ every year. (“Nezavisimoya Gazeta”, April 3, 2001, p.11).

The total volume of illegal capital, formely transfered abroad, is directly related to 5 thousand men, 60% of whom are in still CEOs of existing or bankrupted companies and banks in Russia. The remaining 40% - are acting or resigned employees of central and regional governmental bodies. Till recently no steps were undertaken to make them bring the money back. But now there are signs that both parliament and the president have a will to cope with this problem. Recently, under the Ministry of the Interior, a Center for Counteractions Against Money-Laundering was established and so far this body has managed to bring back more than 300 mln. US$, stolen from Russia. A significant part of these assets, belonging to several Russian banks, were recently brought back from abroad. (Alexander Lebedev, “Nezavisimoya Gazeta”, April 17, 2001, p.9).

The major part of capital driven illegally from Russia is money extracted from international trade operations. Usually this is accomplished by screening part of the income from exports through lowering export prices versus world prices. Oil and gas exporting companies are responsible for 70% of all illegal outflow of money. (“Nezavisimoya Gazeta”, April 3, 2001, p.11). Very often final products are being exported under the title of raw materials. According to Alexander Lebedev, since the middle of the 90s, through these tricks, not less than 45 bln. US$ fled the country. Another 40 bln. US$ was taken abroad in the form of assets of more than 5 thousand companies and banks which were opened and closed in the second part of the 90s. This was achieved through false bankruptcies, fictitious liabilities, or outright plunders. (“Nezavisimoya Gazeta”, April 17, 2001, p.9). At the end of May the government deposed Rem Vyahirev as head of powerful “Gazprom”. At the same time Putin has promised to liberalize currency legislation in order to attract business to keep money in the Russian market.

Russian Federal Parliament has also joined executive branches in the fight for transparency in the economy.

• The Duma is now considering new measures for combatting the illegal export of money, trying to find a way to bring it back. Consensus probably will give no amnesty for direct criminal actions preceding the outflow of money, but exceptions will be made for capital which fled by reason of tax-avoidance (before January 1-st, 2001).
  
  
• In April 2001 the Duma passed the European Convention on Money Laundering, a treaty Russia signed in 1999. The lack of a money-laundering law may leave the FATF unconvinced about removing Russia from its list.
  
  
• In a move to take the country off an international money-laundering black list, the State Duma gave tentative approval in May this year to a bill to create an agency to monitor financial transactions.
  
  
• In 2001 - 2002 parliament has passed the money-laundering bill. As a result in 2002 FATF session excluded Russia from a list of countries that could face sanctions for failing to tackle the issue.

The revised version calls for the creation of a government agency to monitor suspicious deals such as cash transactions and the purchase of real estate abroad. All cash transactions worth more than 500,000 rubles ($16,200) and real estate deals of more than 2.5 million rubles would be subject to scrutiny. The agency would have 200 employees and an annual budget of 66 million rubles ($2.1 million). Even after the ratification it will not be so easy to head off the flight of capital. The problem of cooperation with law enforcement bodies of foreign states in this area is still rather difficult.

National governments and various world organizations have accumulated tremendous experience in the fight against money-laundering. These efforts were successful or unsuccessful depending upon the extent to which specific policy corresponded to local conditions, the presence of will and strength from executive power, and the proper sequence of actions. For instance, strict currency control in China and India in 1997 helped these countries to weaken the negative impact of the World Financial crisis in South-East Asia. Russia must rely on the support and experience of developed countries and international organizations, but must use them appropriately. We think real success might be achieved only when ruling elites change their attitude toward the population and start to respect the political, economic and social rights of all stakeholders in Russian society. Meanwhile Putin’s administration has initiated dialogue with powerful “initiators”. And big business and big banks have already responded to this signal. Leaders of big business such as Chodorkovskiy (oil industry), Benukidze (machine-building companies), Aven (Alfa-bank) and others openly addressed their Russian partners and colleagues to stop income screening and money-laundering. There is a hope that this dialogue will reach and touch all sections of Russian society.

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Now in the area of business transparency we can observe a strategic turn in the relationships between the main stakeholders. There are signs, still very tentative, but anyway quite definite, that the longstanding mistrust between “regulators” and “initiators” from one side and internal rivalry within each group from other side, are coming to an end. All stakeholders are gradually moving to a truce, based

on the mutual comprehension that Russia is driven inevitably into the open community of civilized nations, where common laws, high public moral standards and mutual trust are the passes into the future.