SOVEREIGN VENTURES, INC.
HOUSE COMMITTTE ON INTERNATIONAL RELATIONS
TESTIMONY BY
MATTHEW H. MURRAY
PRESIDENT, SOVEREIGN VENTURES, INC.
OCTOBER 7, 1999

“SMALL BUSINESS: A RESPONSE TO CORRUPTION IN RUSSIA”

HOLD FOR RELEASE: October 7, 1999 10:00 a.m.
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I have been professionally involved in Russian affairs for 20 years, as a legislative assistant in the Senate, a researcher at the Carnegie Endowment and Library of Congress, an attorney representing western corporations and an investor. Between 1992-1998, I lived in St. Petersburg and managed a number of business start-ups on behalf of the U.S. firm, Sovereign Ventures.

My dedication to earn profit for Sovereign Ventures on a legal basis has instilled a deep appreciation for the cultural barriers to small business in Russia. Other countries making the transition from a command economy, such as Poland and the Czech Republic, have succeeded in removing barriers. During Russia’s transition, by contrast, small business has been severely regulated. The most mundane activities are subject to licensing and reporting requirements. Taxes are imposed not simply on profits, but also on revenues, the mere movement of capital and goods. A small business that challenges government authority risks sanctions and state interference.

The main element in Russian culture stifling entrepreneurs is the unrestrained role of government -- not only in regulating the economy, but also in profiting from the economy. Many officials in Russia have an expectation of financial reward for serving in public office. Many government positions are for sale and votes on legislation have an established market price.

During Russia’s transition to capitalism, this expectation of reward has led to what economists call “rent-seeking”. Rent-seeking is conducted by political elites in transitional economies who use their access to power to privatize state property spontaneously at nominal prices. As power-brokers, they convert their access to assets into cash by renting them to business. At times, rent-seeking takes the form of a demand for a bribe or extortion. Often, however, rent-seeking is quasi-legal, making it harder to detect.

The use of public position for private gain did not start with Perestroika or privatization. Nor can it be explained simply by Russia’s low government salaries. To comprehend the phenomenon, your must first examine Russian history. Due to the absence of a strong idea of the state, government officials have traditionally been inclined and permitted to take care of their personal interests first. The Tsar’s provincial representatives were expected to "feed themselves from official business". Under Soviet central planning, state resources were exploited by those with access to power, the members of the communist party, whose positions were bought and sold like commodities.

This government behavior takes place against a backdrop of public tolerance and weak institutions. Traditionally, Russian people have shown extreme dependency on the government and been reluctant to hold officials accountable. Currently, the Russian constitution provides Duma members immunity from prosecution. Russia lacks an independent judiciary capable of prosecuting government officials and an independent press capable of protecting their investigative journalists.

While Russia engages in privatization and other market reforms, official corruption adds a layer of rent on economic activity, increasing transaction costs for small business and the price of goods and services for consumers. By imposing an enormous number of different taxes and collecting them arbitrarily, the Russian government also extracts rent from small business.

Even tax reform designed to help small business yields new costs. For example, in 1995, Russia simplified the tax code for small business by eliminating all taxes in favor of a straight 10% tax on revenue, but left it to local legislators to decide how to implement the new reform. In St. Petersburg, they defeated the purpose by imposing a fee of up to $8,500.00 per year on those businesses who wanted to use the simple tax. Foreign small businesses are effectively prohibited from using the simple tax, which is only available to companies with less than 25% foreign ownership.

I am pleased, therefore, to have the opportunity to appear before the House Committee on International Relations. At this time in debate over aid to Russia, there is consensus that the introduction of capitalism needs to be accompanied by the rule of law. But it would appear difficult to accept that the motivation for legal reform will not come from the Russian government. Historically, Russia's public officials have not relinquished their unilateral powers of interpretation and enforcement of the law. Currently, due to lack of resources and political will, the government is unable to enforce existing laws or adopt new legislation to protect small business and private property.

Instead, small business itself is the most effective agent for the type of social, legal and political reform sought in Russia. To date, Russia’s market reforms have failed to produce a middle class. Small business can fill the “missing middle” by producing independent entrepreneurs with a vested interested in a stable and transparent legal system and the determination to hold government officials accountable.

To reduce official corruption, and otherwise sustain market reform, Russians must be empowered to remove all barriers to small business. Russia does not need western financial capital as much as it needs “social capital” – that is, the trust and shared values among individuals, businesses and government officials which are the very foundation of a successful market economy. Social capital accrues at the grassroots through the creation of voluntary organizations, such as business, trade and professional associations, rotary clubs, church groups, charities and non-governmental organizations. As small businesses must work together to break-down market barriers, they are a natural catalyst for the formation of such voluntary organizations.

Due to the special value Americans attach to small business and the rule of law, the United States has been acting to create social capital in Russia, by helping to build voluntary organizations, to reinforce traditional Russian ethics and to shape government institutions which are accountable. For example, in September 1998, the Eurasia Foundation, a non-governmental organization funded by the U.S. Agency for International Development, provided Sovereign Ventures an $88,000.00 grant to begin a private sector initiative to promote business ethics. The Grant helped St. Petersburg small businesses create the Declaration of Integrity in Business Conduct, a voluntary statement of commitment to international business principles and practices. Between June and September 1999, over 100 businesses voluntarily signed the Declaration of Integrity in Business Conduct. The Association of St. Petersburg Contractors, the St. Petersburg Chamber of Commerce and Industry, the St. Petersburg International Business Association, the American Chamber of Commerce and the St. Petersburg Rotary Club, which together have a combined membership of over 1,200 companies, have supported the Declaration and presented it to their memberships for signature. By adopting the Declaration, each company undertakes a no-bribery pledge and must implement a code of business ethics.

The Declaration is a small but critical step towards creating social capital among Russian businesses, business associations and non-governmental organizations in St. Petersburg. By empowering them to make a unified commitment to repudiate bribery, the Declaration potentially provides leverage to require the St. Petersburg government to take reciprocal actions to reduce opportunities for demanding bribes. The Governor of St. Petersburg's Council on Investment, an institution represented by both local government and private sector leaders, has already endorsed the Declaration. (The Declaration of Integrity in Business Conduct and a list of the signatories to the Declaration are attached for your reference.)

After a decade of rent-seeking capitalism, Russians must accept the fact that government corruption is endemic, an historical burden on economic and political modernization. Russians must find their own path to root out corruption, using the multitude of positive values and ethical traditions found in Russian culture. The St. Petersburg Declaration of Integrity is but one example of a process whereby Russians are beginning to integrate their strong moral traditions with international standards of business ethics.

Faced with the evidence of government corruption in Russia, many in the United States are shouting: “call the game”. As though punishing this powerful nation will enable it to throw off a complex history. As though many other nations were not similarly infected by crony capitalism.

Instead, we should recognize that the process of rooting out corruption is long term and that Russians must find their own path towards this objective. Under these circumstances, it would be a mistake to isolate further the Russian people. On the contrary, the United States should seize upon the evidence of endemic corruption in government to increase aid directly to small business and micro-enterprises and the non-governmental organizations and business associations which are needed to lobby their interests. In the process, the U.S. can help Russian citizens prosper and form the social capital needed to protect individual private property from rent-seeking capitalists.