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. Last Updated: 07/27/2016

Russia's First Foreign Investment Pioneers

I worked," Nikita Khrushchev once commented to a group of foreigners in the evening of his life, "at a factory owned by Germans, at pits owned by Frenchmen, and at a chemical plant owned by Belgians."

In the Ukraine of his youth, Khrushchev toiled at a squalid mining town called Yuzhova, where the pits were not only controlled by foreigners, but the very name of the town came from a foreigner, a Welshman called Hughes, who built the iron works there in 1869. Yuzhova was the heart of the Donbas industrial region, which was then almost wholly in the hands of overseas concessionaires.

Khrushchev's hard adolescence left him embittered about his foreign masters. His biographer Edward Crankshaw continues the quote: "There I discovered something about capitalists. They are all alike, whatever their nationality. All they wanted from me was the most work for the least money that kept me alive. So I became a Communist."

Such foreign "exploitation" gave the young Nikita, like other Communist leaders, a burning desire to establish a Soviet industrial power which was a match for its Western progenitor. Yuzhova was later to be symbolically renamed Stalino after the greatest Communist industrializer of them all.

Competition does not wait

How did this state of affairs come about? In the late 19th century, when the locomotive of Russian industrialization began to get going, it was largely under foreign control and funding. There were few qualms about capitalists, or about low wages -- how could there be in a country which only emancipated its serfs in the 1860s? There were, however, worries about foreign domination of industry.

"International competition does not wait. If we do not take energetic and decisive measures so that in the course of the next decades our industry will be able to satisfy Russia and the Asiatic countries which are -- or should be -- under our influence, then the rapidly growing foreign industries will break through our tariff barriers and establish themselves in our fatherland and in the Asiatic countries ... and drive their roots into the depths of our economy."

No, not a comment from communist members of the State Duma in 1996. So wrote Sergei Witte, the expansionist finance minister in the last decade of the 19th century, to Tsar Nicholas II in 1900.

In fact, late tsarist Russia encouraged foreign industrial involvement. Then as now, the choice was between economic progress or keeping Russia Russian. Then as now, the country was perennially short of cash. All through its history, Russia, with its agriculturally based economy, hampered by a short growing season and long transport distances, has been poor and has needed to attract foreign capital. All through its history it has needed to import Western know-how to move forward.

It is one of Russia's permanent quandaries: Growth does not come without foreign influence.

Even when the Communists proclaimed mass industrialization in their five-year plans, foreign expertise was often called upon behind the scenes. Such propaganda projects as the huge Magnitogorsk steel works behind the Urals, part of the crash heavy-industry program of the 1930s, was supervised by foreign "experts" in its early stages.

A good case can be made that one of the major themes of Russian history, for centuries before communism, has been the state contriving to limit Russian proclivities for trade and commerce, on which foreign visitors so often remarked. The absolutism of tsarist power prevented the rise of an urban middle class, with constitutional rights, which was so important in the development of bourgeois society in Europe. Instead, the merchant class was held back. In the 15th and 16th centuries, the tsars consistently imposed state monopolies on any form of trade which proved advantageous. They normally appointed foreign specialists to run these state monopolies, cutting out Russian entrepreneurs completely.

As a result, up to the 17th century, Russia had no indigenous industries of note. "Because of the difficult conditions, Russian merchants tended to have operations small in volume, oriented toward profit, and conducted almost exclusively on a barter basis," wrote Harvard historian Richard Pipes.

Pipes points out that the pervading trading influence was from the East, not from the West, which unfortunately led to a stamp of business dishonesty. Another restricting factor was that there was never very much money in circulation in Russia: The country was far from international routes of trade, and until the 18th century no precious metals had been found here.

From the middle of the 17th century the state's attitude changed, and henceforth it never failed to try to promote private industry -- but it favored the land-owning classes at the expense of an urban middle class. There was no urbanization in 18th-century Russia for this reason. Many of the largest industrial operations either belonged to the aristocracy -- for instance on the estates of Sheremetyevo, the largest serf owner in Russia -- or to serf entrepreneurs, some of whom, for a large price, were able to buy their freedom.

As a result, Pipes wrote, "The second phase of Russian industrialization [in the 1880s] involving steel, coal, petrol, chemical and electrical industries, found Russia's middle class unprepared and unwilling."

Russia then was rather like the country at the end of the 1980s: basically unschooled in capitalist business and poorly equipped to compete with countries that were. The country had been in comparative economic decline during the first half of the century, as the other major powers began to industrialize very fast. When Russia decided to catch up, it inevitably meant that it had to employ foreign expertise.

Foreign investment in the 1890s

Thus the rejuvenation of the Russian economy went hand in hand with the opening of the country to foreign influence.

In the 1890s, direct foreign investment really began to get going. It was instrumental in the development of the heavy industries which powered the worldwide growth of the late 19th century: the iron industry of the Krivoi Rog area and the coal industry in the Donets basin were both built up by foreigners.

The iron and steel industry was the most extreme example of a domestic industry that proved unable to compete. Russia had long had an iron and steel industry in the Urals. In a time of rapid technological change, it did not modernize quickly enough and was left totally behind. Foreign-owned plants came to account for as much as two-thirds of production.

In the southern pig-iron and steel industry, of which Khrushchev's boyhood town Yuzhova was a part, foreign ownership went as high as 85 percent.

Overseas interference in the Russian coal market was so extensive that a syndicate for coal marketing, Produgol, in effect a cartel, was engineered from Paris.

Foreign entrepreneurs featured strongly among the often-motley crew of entrepreneurs in the late 19th-century railway boom. The railways were mainly financed by foreign Jews and Germans -- such as Von Meck and Von Derviz.

Another of Russia's endowments in natural resources made it a magnet for late 19th-century entrepreneurs. Oil, first in demand for lighting, then for internal-combustion engines, became big business. The Baku oil fields were originally a state monopoly. When the government threw open the business in the 1870s, wrote Daniel Yergin in "The Prize," a chronicle of the oil industry, it started an explosion of entrepreneurship. It was a Swede, Ludwig Nobel -- also famous for an armaments company he built up which was patronized by the Russian government -- who was to become "the oil king of Baku." And it was French finance, in the form of the Paris branch of the Rothschild family, which helped him build the railway from Baku to Batumi on the Black Sea, from which Russia supplied at the peak close to one-third of world oil exports.

Russian foreign trade, particularly imports, had always been in the hands of foreigners, according to historian Olga Crisp, writing in "Studies in the Russian Economy Before 1914." In 1847, foreign merchants controlled 90 percent of Russian imports and no less than 97 percent of exports. Some 90 percent of the ships in Russian ports were foreign-registered, wrote historian Theodore von Laue. Businessmen from Poland and Ukraine were to be found trading all across Russia. The port of Odessa in Ukraine was known for its Greek and Italian influence.

St. Petersburg, the imperial capital and the country's main port, was to become particularly international, as befits Russia's "window on the West." From the beginning of the 19th century, the city's economy was dominated by foreigners, notably by the Germans and the British. In the 1860s, 70 percent of workers in machine-producing factories were employed by English and Scottish companies such as Baird and Wilson. One half of all enterprises in the city were foreign-owned.

Firms from America, later in its industrial revolution than the powers of northern Europe, were not so numerous. They included, in St. Petersburg, Bell Telephone, Singer and International Harvester, as well as insurance interests.

Russian industrialization would not have come about without a modern banking system. Here, too, the role of foreigners was central. This was not a story of a domestic industry crumbling under foreign competition. There simply was not a domestic commercial banking sector there to compete. Until the 1860s Russia only had two banks, both of which were controlled by the state. The first joint-stock bank was formed in 1864, involving German and Austrian capital.

According to Crisp, among the top half-dozen banks in 1914 were the Russo-Asiatic Bank, founded by Soci?t? G?n?rale of France in 1910 via a bank merger; St. Petersburg International, with strong German connections; the Russian Bank for Foreign Trade, known for its British links; and Moscow United Bank, formed from three small banks by Union Parisienne.

At the outset of the World War I, half of Russian state bonds were in foreign hands. In 1916, foreign inputs amounted to 45 percent of the total capital in joint-stock banks. Of this, just over one-half was French, 37 percent German, and 9 percent British. French banks were particularly active in starting syndicates with Russian joint stock banks, and in placing shares on the French market. They played an important role in building up the extremely high French investment in Russia, an exposure which was to hurt French investors dear after the Bolshevik Revolution, when many industrial assets were expropriated without compensation and foreign debt was simply cancelled.

As today, banking was one of the most profitable sectors of the economy. Joint-stock banks often made enormous profits on company promotion and reorganization, wrote Peter Gatrell in his book "The Tsarist Economy 1850-1917."

France was the most extensive foreign influence in industry as a whole, often along with Belgian companies. By 1900 a quarter of French financial investment was in Russia. One firm, Soci?t? G?n?rale pour l'industrie en Russie, founded in Paris in 1896, which was not permitted to conduct business in Russia, nevertheless managed to control the fate of 47 of the biggest Russian companies, wrote von Laue.

In general, the preferred investments of French investors were the railways, the arms industry and shipbuilding. The French were particularly active in the railway industry, which was shunned by many other investors, including Russian ones. French money went both into new railway lines, and into the large railway companies which had survived nationalization in the 1890s. The Paris Rothschilds had an important role, but the most significant single bank was Credit Lyonnais.

French pre-eminence had much to do with politics. Russia's natural trading partner was Germany, which was in the process of rapid industrialization. However, as the Russians became increasingly wary of German influence, the French took the Germans' place.

Russian banks abroad

The Russian banks which grew up in the commercial boom were themselves partly to blame for the overwhelming foreign influence in the domestic banking system. Then, as now, a lot of Russian financial activity took place outside the country's borders. Russian banks tended to introduce shares on foreign markets, even though they could have sold them domestically, and even though such shares were subsequently purchased by Russians.

Russian investors also had less faith in their industry than foreigners: Russians tended to put their money into bank deposits rather than securities. Placing shares in Russia was therefore difficult. Instead, the French market was popular. This could be a lucrative business for the French banks, which both provided cash in Russia and placed shares back in Paris. A large number of shares in Russian companies, though quoted on the St. Petersburg stock exchange, were effectively only traded on foreign exchanges, notably in Paris and Brussels.

The St. Petersburg banks were the most Western. They favored mining and metallurgy, and increasingly became involved in investment banking activities. They were often prepared to take risks, and made more loans on securities which were not guaranteed.

Banking in Moscow was more insular, wrote Crisp, with an emphasis on established connections. Here the banks focused heavily on two industries, textiles and sugar refining. These were two of the few industries which stayed mainly in Russian hands.

But even Russian entrepreneurs tended to prefer to hire foreign specialists to run their businesses. One-third of the board members and directors of Russian companies were foreigners.

Not that Western companies were models of efficiency. Russia was fertile territory for the 1890s equivalents of modern Russia's swarms of aid budget-funded consultants: French companies in particular had a bad reputation for too many directors, commissaires, controleurs and agents commerciaux.

One of the undoubted drawbacks of Russian exposure to foreign investment was the degree this made the internal economic situation of the country dependent on the world economic climate, even at the end of the 19th century, when the international economy was far less a matter of global trends than it is today. In 1899, the French withdrew short-term credits and limited further loans. Overall, direct foreign investment fell to a trickle in that year and almost ceased until 1908.

Who gained most from the industrialization is a contentious point. Western companies operating in Russia were not particularly profitable. Low productivity cancelled out lower wages. There were some very profitable investments such as the South Russian Dnepr Metallurgical Company, which paid dividends averaging 40 percent between 1895 and 1900. But in 1890-93 the average return on foreign capital was only between 6.1 and 7.4 percent, and in 1894-1900 between 4.8 and 8.9 percent, quoted von Laue. Only those companies with government contracts tended to prosper, wrote Gatrell. Setting up factories was expensive, as import tariffs were very high.

If the oppression waged on entrepreneurs and the middle class explains why the early growth of a bourgeoisie was stunted, it still remains puzzling when opportunities opened up why so few Russian industrial dynasties survived. Crisp said that on the whole, fortunes in Russia were very transitory and fragile. Inheritance laws that led to the parceling out of wealth did not help.

Observers of New Russian behavior may have a more simple answer, that the new rich of a century ago simply spent their money.

In the first half of the 19th century most fortunes derived from tax collecting or textile manufacture. According to Crisp, only where fortunes involved landed property, forests or mineral resources did they survive over several centuries: In other words, they became a part of the Russian landed aristocracy. All the big merchant families in the age of Peter the Great, if they had not dropped out of prominence, had been ennobled by the end of the 19th century.

This was bad news for industry. As Crisp wrote: "The nobles transferred to industrial enterprises the same wasteful, extravagant and inefficient practices that characterized the exploitation of their landed estates." Adds Gatrell: "The Russian gentry did not make use of the money market for the purpose of productive investment. Instead, they obtained credit to finance the debts that they had incurred over several generations of conspicuous consumption."

The merchant class was generally indifferent to education, and inward-looking. Merchants tended to distrust joint stock companies, and accounting methods made no distinction between personal and business expenses.

The end of the 19th century saw the development of some highly sophisticated business families. But they tended to put their money and their interest into the arts, not into politics.

The business class was a group largely apart. Many merchants were Old Believers, who hung tenaciously to the old ceremony of the Orthodox Church and believed Peter the Great was a heretic, in part for his Westernization of the country. The tsars were suspicious of Old Believer merchants, which might have helped the merchants' feeling of solidarity, but not their business opportunities. In Moscow the Old Believers kept a close community, based in Kitai Gorod.

In Moscow, the merchants tended to be more go-ahead than elsewhere, and more prepared to invest in activities outside their specialty, another reason why Moscow business was more dominated by Russians than in St. Petersburg.

With the Bolshevik Revolution, Russians were soon to be in charge almost everywhere.