Russia's Crony Capitalism
Page 20
If the United States wishes to alter the behavior of Russian and other kleptocrats, its first measure should be to investigate the assets of those Russian individuals and enterprises already sanctioned and supposed to be subject to asset freezes. Second, it should carry out legislative changes to force all beneficial owners of property in the country to reveal themselves, as is standard in most European countries. Third, all currency transfers into the United States should be subject to elementary bank regulation, which is the case in most European nations. Fourth, large cash payments should never be allowed. Fifth, FinCEN should be greatly reinforced, having its staff multiplied.
In May 2018, the Berliner Zeitung revealed that a dozen companies belonging to Arkady Rotenberg, who is also sanctioned in the EU, owned major public and office buildings in Berlin, Frankfurt, Hamburg, and Munich worth about Ä1 billion ($1.2 billion) through complex layers of shell companies. This shows that the problem with hidden ownership also exists in other countries.28
Since 1989, Russia has seen steady and large capital outflows, although the Russian government made the ruble fully convertible and liberalized capital flows only in July 2006.
Russia has thus experienced large and persistent capital outflows. For the period 1994–2010, the International Monetary Fund estimates that the average capital outflows were $30 billion a year. In a fine analysis, Global Financial Integrity assesses that the total legal and illegal outflows averaged $43 billion a year from 1994 to 2011. The big peak occurred during the global crisis of 2008, when capital outflows surged to $203 billion (table 6.1).
The authors of the Global Financial Integrity report note that their estimates are close to the IMF numbers for the period 2000–2005, while the difference is greater for the period 2006–2011 because of increased misinvoicing, which is not included in the IMF estimates. Factoring in the size of the enterprises of the Putin cronies, whose businesses took off around 2006, can explain the increased misinvoicing. If we multiply the alternative annual assessments with twenty-six post-Soviet years, 1992–2017, the total capital outflows from Russia would be $780 billion, according to the IMF, or $1,118 billion, according to Global Financial Integrity.29
Table 6.2 offers the IMF numbers for capital and financial account, a broader measure also including public financial flows. Comparable numbers in current US dollars are available from 2001 to 2016. The annual average is $35.8 billion a year, a bit more than in table 6.1, but the contrasts between different years are more striking. From 2001 to 2006, Russia seems to have stabilized, while 2007 appears to have been a wild boom. The boom was followed by a sharp capital outflow in 2008 of $131 billion. The capital outflows stayed high, with a minor peak in 2011 and a massive peak of $173 billion in 2014. Looking at the numbers, it appears as if investors lost their confidence in Russia in 2008, and they never recovered it. That was the year when Russia went from boom to stagnation.
Table 6.1: Estimated capital outfl ows from Russia, 1994–2011 (billion current US$)
Year Global
Financial Integrity: Licit and illicit
IMF: Capital flight
1994
20
16.7
1995
0
4
1996
20.3
25
1997
0.9
22.3
1998
57.2
26.8
1999
21.4
22
2000
15.6
21.9
2001
37.7
18.3
2002
12.5
21.6
2003
38.2
24.4
2004
51.5
30.1
2005
66.4
42.3
2006
4.6
20.7
2007
48.6
57.7
2008
203.3
118.5
2009
14.9
17.5
2010
69.8
24.5
2011
99.5
n/a
Total
782.4
514.3
Source: Kar and Freitas 2013, 13, 16
Professor James S. Henry of Columbia University has assessed for the Tax Justice Network that by the end of 2014 no less than $1.3 trillion of assets from Russia were sitting offshore. He formulated this figure on the basis of data from global international institutions, approximately as Global Financial Integrity has done. This number appears too high as an assessment of Russian funds abroad, because it includes outflows that returned to Russia. His aim and the goal of Global Financial Integrity is to assess tax evasion through total misinvoicing in both capital outflows and inflows, whereas the focus in this book is total net private assets held by Russians abroad.30
Table 6.2: Capital and financial account, 2001–2016
Year
Billion US$
2001
−13.9
2002
−10.9
2003
−0.9
2004
−6.4
2005
−11.7
2006
6.9
2007
85.7
2008
−131
2009
45.1
2010
−26.9
2011
−86.2
2012
−30.9
2013
−45.4
2014
−173.1
2015
−70.3
2016
−13.9
Total
−483.8
Source: IMF Article IV Reviews, various years
These assessments refer only to capital outflows from Russia. Filip Novokmet, Thomas Piketty, and Gabriel Zucman have analyzed Russian offshore wealth to analyze inequality, offering a different perspective on the same facts. They argue that Russia is the country in the world where offshore wealth is most significant. They estimate “offshore wealth at about $800 billion or 75 percent of national income in 2015, with 100 percent as a maximum and 55 percent as a minimum.” This assessment of $800 billion of net private Russian offshore wealth contrasts with the Forbes assessment of the total wealth of the Russian billionaires of $400 billion.31
These authors assume low returns for Russian assets abroad, but high returns for foreign investments in Russia. Considering all the efforts Russians make to hide their offshore wealth, their return is likely to be small or negative, since the investors opt for secrecy, security, and stability rather than maximum return. Money laundering is usually a misnomer, because the money is rarely completely cleansed. Some regulator or other can usually ask about the money’s origin. This is one reason why much of the dirty money is hidden in anonymous real estate that does not move fast. Stocks and banks are quite transparent. Many of the holders of this capital, moreover, are not professional investors but corrupt state officials.
The Piketty group arrives at several important conclusions. They assess that Russia’s total national wealth was 400 percent of national income in 1990 (which is a European average for the last century) and still only 450 percent of national income in 2015. This reflects that savings of about one-tenth of GDP are taken out of Russia each year and not invested in the Russian economy, depressing growth. They calculate further that aggregate national wealth surged from about 300 percent of GDP in 1999 to 550 percent of GDP in 2008. This occurred during the oil boom, when private enterprise still dominated, but they do not even mention the renationalization and new Putin oligarchy.32
The Piketty group also notes that the offshore wealth, which is private, grossly changes the proportions of private and public shares of Russian wealth. They assess the private share of R
ussia’s national wealth at almost 80 percent, which includes the real estate sector, and is predominantly private. The offshore wealth also raises the concentration of wealth. They assess the share of Russian wealth owned by the top 1 percent at 43 percent in 2015, even slightly more than in the United States. The top 1 percent earned 20 percent of all incomes, approximately the same as in the United States.33
In May 2001, Putin seized management control of Gazprom, but until 2004, the remaining independent members of the Russian government, such as Prime Minister Mikhail Kasyanov and Presidential Chief of Staff Alexander Voloshin, raised many barriers, hindering the Putin group from acquiring absolute control over Gazprom’s cash flow.
Thanks to the Yukos affair, which erupted in the winter of 2003–2004, Putin could consolidate his political power, sweeping away the remaining barriers. No big Russian businessmen dared to stand up against Putin after Khodorkovsky’s arrest. In December 2003, Putin gained full control over the State Duma. Voloshin and Kasyanov, who had checked Putin’s power and opposed the Yukos confiscation, were forced out, leaving Putin in charge of the state, its powers, and its assets. It was only during Putin’s second term, starting in 2004, that Putin and his friends became truly wealthy. The main source of their wealth was Gazprom. It is difficult to comprehend what floodgates of wealth they opened for themselves.34
In principle, Russian law requires open competition for public contracts, but as the journalist Joshua Yaffa notes, “Although Russian law requires that state procurement contracts be awarded through open bidding, it also allows them to get granted in a closed, no-bid process if the projects are deemed strategically important.” A 2015 report prepared for the Russian government showed that 95 percent of state purchases were noncompetitive and 40 percent went to one supplier. The letter of the law was observed even as the spirit was violated.35
Sergei Kolesnikov has testified that the rents in the medical equipment procurement were 35 percent, but that was early on, and rents have clearly risen as the share of competitive purchases has declined. The Gazprom pipelines seem to cost three times too much. Some is waste, but a net rent of 50 percent appears likely. From what we know from Kolesnikov, we may assume that half of these rents goes to Putin and half to his chief partners—Timchenko, the Rotenbergs, Kovalchuk, and Shamalov—with tiny shares of a few percent for junior partners.36
Russian Forbes has published regular assessments of the wealth of top Russian businessmen since the early 2000s and comparable assessments in current US dollars from 2011 to 2017. These numbers are compiled in table 6.3. Presumably they include only assets in Russia, not financial assets in offshore havens, which are impossible to assess. Although their wealth is considerable, some developments are peculiar.
Table 6.3: Russian Forbes assessment of the wealth of the cronies, 2011–2017 (billion current US$)
2011
2012
2013
2014
2015
2016
2017
Gennady Timchenko
5.5
9.1
14.1
15.3
10.7
11.4
16
Arkady Rotenberg
1.1
1
3.3
4
1.4
1
2.6
Igor Rotenberg
—
—
—
—
0.5
0.4
0.7
Boris Rotenberg
0.55
0.5
1.4
1.7
0.95
1
1
Rotenberg family
1.65
1.5
4.7
5.7
2.85
2.4
4.3
Yuri Kovalchuk
1.5
1.2
1.1
1.4
0.65
0.5
1
Total crony wealth
8.65
11.8
19.9
22.4
14.2
14.3
21.3
Source: Russian Forbes 2017
Gennady Timchenko’s wealth rose sharply from $5.5 billion in 2011 to $15 billion in 2014, when he was hit by Western sanctions and low oil prices in 2015–2016. In 2017, Timchenko apparently figured out how to solve his problems, and his fortune surged again. His wealth has developed as one would expect from a successful businessman.
The Rotenbergs have acted as a family, and Arkady Rotenberg has transferred considerable wealth to his son Igor, so Arkady, Boris, Igor, and Roman Rotenberg are best understood as one holding company. Until 2013, the Rotenbergs were not very wealthy by Russian standards, but they struck gold with the Sochi Olympics. Like Timchenko, they were hit by sanctions in 2015–2016, but in 2017 they came back because of the construction of the bridge over the Kerch Straits to Crimea and some other compensatory business contracts. Theirs looks like a thoroughly crony, not very efficient, business. Yet, considering that Rotenbergs have been the kings of state contracts for a decade, the Forbes assessment of their fortunes looks far too low.37
Kovalchuk’s wealth numbers make no sense. Although he is the spider in the Putin financial web, his fortune plummeted from $1.9 billion in 2008 to $500 million in 2016. Admittedly, television advertising and banking revenues plunged with the price of oil and depreciation of the ruble, as well as with Western sanctions, though few enjoy more privileges than Kovalchuk. But his aim was probably not profit maximization. He is more of a political operator, as the chief distributor of political funds and the top media overseer.38
The Forbes assessed fortunes of the cronies of $21 billion in 2017 are great by any standard except contemporary Russian norms. The most plausible explanation is that most of the crony wealth is being transferred to anonymous shell companies in offshore havens. Clearly, Forbes did not know that Arkady Rotenberg owned real estate in Germany worth $1.2 billion. The Forbes wealth assessments seem strangely unrelated to the amounts transferred from state enterprises to the cronies’ companies. Nemtsov and Milov set the looting of Gazprom through public procurement, asset stripping, and stock manipulation from 2004 to 2007 at a total of $60 billion, or $15 billion a year. Their assessment might be a bit high, and not all was transferred out of the country. Yet Vladimir Milov thinks that the amount can only have increased, given that the cronies have expanded their ownership so much. The rents from Gazprom and other state procurement would suggest a transfer to this group of at least $10–15 billion annually from 2006 to the present. These funds have in all probability been transferred to offshore havens.39
The cronies enjoyed many other flows, as the Panama Papers show. Asset stripping is not a one-way street. State companies tend to sell and buy the same companies, such as Gazprombank and Sogaz, over and over again, making it hard to keep up with current ownership. Stock manipulation is another permanent game. Extortion of private businesses should be added.
Without probing deeper into the numbers, it would be reasonable to assume that Putin and his cronies made slightly less than twice as much each year as they made on Gazprom alone, that is, $15–25 billion a year since 2006. The newly minted Putin aristocracy has seized control over the Russian state and the state corporations, letting their fortunes slip into their crony companies. Both the state companies and the crony companies enjoy monopoly rents. The crucial last fourth circle of the Putin system is the offshore havens. At home, Putin has facilitated capital outflows through minimal taxation and loose currency regulations. The old Soviet Cyprus-Russia double-taxation agreement allows him and his cronies to transfer any funds through Cyprus without any hassle.
In June 2013, the retiring long-time chairman of the Central Bank Sergei Ignatiev made a remarkable statement to the State Duma. He declared that the Central Bank had revealed a network of fly-by-
night firms that had illegally transferred at least $25 billion out of Russia in violation of currency and tax laws in 2010–2012. Ignatiev stated: “I have the impression that this whole net of one-day firms is controlled by one group of people.”40
The same day the Central Bank posted a memorandum on its website claiming that about $15 billion had been transferred illegally through Belarus and $10 billion through Kazakhstan through fictitious import invoices in 2012. This is $25 billion in one year. Neither piece of information had been publicized before. Russian insiders interpreted Ignatiev’s dramatic statement in the Duma as a daring exposure of Putin’s crony group. No other group possessed such amounts of cash, but nothing more was heard about this. It appears that Ignatiev meant to say that the Putin group illegally transferred $25 billion in 2012 and that this was their pattern.41
How large is Putin’s personal fortune? We know that Putin lives a life of extraordinary luxury and that he appreciates every comfort, not least multiple watches worth tens of thousands of dollars. Anybody who is under the illusion that Putin is an honest citizen should read Boris Nemtsov and Leonid Martynyuk’s booklet The Life of a Galley Slave. They conclude that Putin has at his disposal twenty palaces, four yachts, fifty-eight aircraft, and a collection of watches worth $600,000.42