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. Last Updated: 07/27/2016

Mayor Yury Luzhkov and the Very Big Business Of Running Moscow

Mayor Yury Luzhkov runs a Moscow city business empire that controls oil and gas enterprises, banks, media outlets, real estate and telecommunications. Mark Whitehouse reports on the mayor's hybrid of command economy, state capitalism and city favoritism.Doug Steele, a veteran expatriate and founder of three popular Moscow drinking establishments, knows the ropes of business in the Russian capital. But even for him, the tree police were something new.


In honor of Moscow's upcoming 850th anniversary, city officials ordered the Chesterfield Cafe, Steele's latest venture, to buy two potted trees and place them on either side of its street-level entrance.


"We had no choice," he said. "People came around ... just to make sure that we actually had the trees."


The trees, which have appeared at the entrances to bars and restaurants throughout central Moscow, are more than just a city beautification effort. They are an expression of populist mayor Yury Luzhkov's economic vision, a hybrid of the Soviet command system and the free market in which the city, in one way or another, controls just about every business on its territory.


Aside from getting involved in the minutiae of private ventures, Luzhkov's government has built a vast public conglomerate with interests that include real estate, oil and telecommunications, in many cases competing side by side with the same entrepreneurs it regulates. Buy an Ostankinsky sausage, watch Channel 3, have lunch at the new Marriott Hotel or shop in the soon-to-be-opened mall on Manezh Square and you are doing business with the city.


"The ideology of [Luzhkov's] activity is to know everything about everything and have control of everything in the city," said Konstantin Chernishyov, senior analyst at the Rinaco-Plus brokerage house.


On the surface, Moscow's command capitalism looks like a success. Over the past five years, the city has been transformed from a dreary population center into a vibrant, cosmopolitan world capital packed with upscale restaurants, shops and office buildings. It is by far the most important subject of the Russian Federation, accounting for 13.1 percent of gross domestic product and 26 percent of budget revenues.


But at what cost? Beneath the veneer of prosperity, economists see problems much like the ones that brought down the Soviet model. Government control all too often leads to wasted resources, ineffective management and a tendency among bureaucrats to treat the state's and other people's property as their own. The city's dual role as regulator and entrepreneur creates excellent conditions for Luzhkov's pet projects but can discourage competition, contributing to the inflation that has made Moscow one of the world's most expensive cities.


"My sense," said one Western economist, "is that Moscow has been successful despite Luzhkov rather than because of him."


THE EMPIRE


From the very beginning of economic reforms in Russia, Luzhkov has followed his own authoritarian path, preserving the paternalistic aspects of Soviet power and even the old regime.


"To apply here, in Russia, a method of economic shock thought up somewhere in the West ... could only occur to theoreticians far removed from everyday life," Luzhkov wrote in his recent autobiography. "The Russian being has always counted on the government. ... In his relationship with authority there was something filial, kindred.


"To break that tradition would mean to force people to survive not reform, but a betrayal."


When the government of former acting prime minister Yegor Gaidar freed prices and privatized small enterprises in the early 1990s, Moscow kept a tight grip, setting maximum profit margins for retailers and dictating the range of products that many stores could sell.


Anybody who wanted to get a piece of Moscow's awakening market had to share with the city. Real estate developers gave up as much as half of the apartments and office space they built. McDonald's and Pizza Hut gave the city controlling interests in their local ventures, though they have since bought the stakes back.


Luzhkov came into direct conflict with Russia's liberal reformers in 1994, when he refused to go along with the voucher privatization program championed by Anatoly Chubais. Faced with a small political window in which to undertake an unprecedented sell-off of state assets, Chubais wanted to put companies into private hands as quickly as possible, but Luzhkov insisted on greater control and more income for the city budget. President Boris Yeltsin ultimately sided with Luzhkov, allowing him to do what he pleased in the capital.


The mayor not only slowed down privatization, but built from scratch a far-reaching government business empire. According to the Moscow Property Committee, over the past four years the city has taken stakes in 188 new ventures, most of which it controls, though the full extent of the city's holdings are difficult to estimate. Moscow properties include first-class hotels such as the National and Metropol, office complexes, restaurants, food processing factories and even the Moscow Stock Exchange.


More recently, the mayor has been following in the footsteps of politically powerful bankers-cum-industrialists such as Vladimir Potanin and Mikhail Khodorkovsky, creating a Moscow city financial-industrial group with interests in banking, oil, media and telecoms:


?The Bank of Moscow, founded just three years ago, has come out of nowhere to become one of Russia's largest financial institutions, with a reported $2.2 billion in assets. The bank took over the city's lucrative budget accounts from private institutions such as MOST-Bank and Montazhspetsbank, services $500 million in Moscow Eurobonds and recently bought a 20 percent stake in leading Russian investment bank Troika Dialog.


?Eyeing the growing number of gas-thirsty cars clogging Moscow's streets, Luzhkov in January combined city stakes in the Moscow Refinery and a wholesale gasoline distributor to form the Central Fuel Company. With Yury Shafranik, Russia's influential former fuel and energy minister, at its helm, analysts say Central Fuel is in a good position to dominate the local market.


?The city's television channel, TV Center, hit the airwaves in June and plans to compete nationwide. The station has bought the rights to show Formula-1 racing and has been spending abundantly on top Western films.


?Mostelekom, the acquisitive mayor's latest brainchild, will unite the city's 33 percent stake in the Moscow City Telephone Network with other investments such as a 50 percent stake in Comstar, a major provider of phone services to well-heeled businesses and individuals. Mostelekom has the potential to control some 4.4 million access lines, which would make it about one-fifth the size of Svyazinvest, Russia's giant national telecoms holding.


Luzhkov's ambition extends well beyond the city's limits. Hoping to add a source of crude to the Central Fuel Company, the mayor has announced that Moscow should be given its own piece of the oil-rich Caspian Sea, and earlier this year he unsuccessfully lobbied Prime Minister Viktor Chernomyrdin to hand over the government's stake in the Tyumen Oil company. Moscow has also begun investing in agricultural and building materials enterprises as far afield as Nizhny Tagil, Bashkortostan and Karelia.


The mayor's fervent empire-building has put him well on his way to forming the financial and media base he needs to launch a presidential bid in 2000, although Luzhkov has tirelessly denied having his sights on the presidency.


"There is no other way to explain everything that he is doing," said Nikolai Petrov, a political analyst at the Carnegie Moscow Center. "He's the only candidate who is absolutely self-sufficient. Luzhkov has combined everything that is necessary: money, mass media, image."


SOCIAL CONSCIOUSNESS


As the city prepares for its 850th anniversary celebration, the benefits of the mayor's heavy-handed management style have never been more visible. He has been able to mobilize public and private resources not only to put potted trees on sidewalks, but to restore pre-Revolutionary facades, scrub the cobblestones around the Kremlin and rebuild the highway that circles the city.


Vladimir Vinogradov, a Moscow Property Committee official who oversees the city's business interests, said Luzhkov's command capitalism has spread the wealth created by reforms to all Muscovites and guaranteed that the dark days of shortages and long lines will never return.


"The goal is more social than commercial," he said. "There were times when bread disappeared, when other food products disappeared. ... In order to avoid such failures, the city gets involved in every aspect of its citizens' lives."


Most of the city's business ventures, he said, are the type of capital-intensive, low-return infrastructure projects that private investors won't touch.


"The Moscow government itself took a niche that nobody really wanted to take over the past several years," agreed Pavel Teplukhin, chief economist at Troika Dialog. "The niche was to invest in Moscow city infrastructure and companies."


Politically, the investments have paid off: Moscow's build-out has vastly contributed to the populist mayor's approval ratings. In the 1996 mayoral elections, Luzhkov won 90 percent of the vote.


But the city's return on its business empire has been dismal. Over three and a half years, Moscow has invested 800 billion rubles in its enterprises and received only 40.4 billion rubles in profits for the budget, Vinogradov said.


"The city goes into these enterprises not only for profits," he said. "Job creation is also a very important factor."


The city's enterprises have not always brought positive results even for its citizens. Luzhkov's attempts to control gasoline prices and supplies, for example, have on several occasions led to shortages and huge lines throughout the city. The city has also built thousands of apartments that Muscovites either cannot or do not want to buy, leaving it with huge bank debts and a lot of empty housing on its hands.


THE MOSCOW ROOF


Still, working within the Moscow fold is a deal that most entrepreneurs can't refuse. According to Vinogradov, the city creates the best conditions possible for those companies in which it invests.


First of all, he said, "there is Moscow's krysha," or roof, a slang term for protection from racketeers and organized crime. Much like other kryshas, the city can provide easy financing and help untangle red tape.


"This kind of cooperation is very advantageous, and has a very big effect" on a business's success, said Vinogradov.


When, for example, Luzhkov took control of ZiL, a nearly bankrupt Moscow truck producer that he calls a victim of Russia's privatization program, he issued an order allowing the company's 3.5-ton "Little Bull" trucks to enter the city center at any time of day. No other trucks bigger than GAZ's 1.5 ton Gazelle had the privilege.


Beneath the city's giant krysha, there is plenty of room for Luzhkov's friends to build their own empires. Take, for example, the Moscow Committee for Science and Technology, actually a joint-stock company in which the city holds an 80 percent stake.


Aside from managing key city investments such as a 33 percent stake in the Moscow City Telephone Network, committee chairman Vladimir Yevtushenkov, a close Luzhkov ally, heads a low-profile private holding called Sistema.


Over the past several years, Sistema has amassed stakes in more than 100 companies throughout Russia with more than 30,000 employees. The holding's president, Yevgeny Novitsky, recently told Profil magazine that some of the stakes were won at the same voucher auctions that Luzhkov so vehemently opposed.


In contrast to the city, Sistema does not sweat the low-return infrastructure projects. According to Novitsky, Sistema's properties include the Moscow Bank for Reconstruction and Development, cellular phone companies Mobile TeleSystems and Rosiko, six computer enterprises in Zelenograd, real estate developer Sistema-Galz, Intourist, Detsky Mir department store, and oil fields in the Komi Republic with 35 million tons of proven reserves. In all, said spokesman Gennady Talalayev, the holding controls more than $1 billion in assets.


Sistema has recently been looking for foreign money to further expand its empire. In July, Yevtushenkov signed an agreement with investment bank ING Barings, under which ING will help find foreign financing in return for consulting services in Russia.


While Sistema officials are coy about the level of support received from Luzhkov, the holding has proved capable of some amazing bureaucratic feats. The Communications Ministry, for example, broke with its policy of granting only one license for each type of cellular phone technology used in Moscow, awarding a licence to Rosiko for the DCS technology used by market leader Vimpelcom.


Novitsky told Profil that the city has a stake in many of Sistema's companies. Vinogradov of the Moscow Property Committee, however, denied any knowledge of Sistema.


Sistema exemplifies the gray area between public and personal interests that arises when the government gets deeply involved in commercial enterprise. Given the choice between their own and the city's benefit, officials are tempted to choose the former.


"In Moscow, bureaucratic corruption is at a very high level," said World Bank economist Alexander Morozov. "Formally there is a high level of control, but factually [the city] can't execute control. The bureaucrats who are supposed to represent the city's interests in enterprises ... represent totally different interests, for example, their own interests."


City officials deny charges of corruption, but the Moscow government has recognized the problem. According to Vinogradov, the city is setting up two new departments to keep better track of its representatives in commercial enterprises and review their performance.


THE BIG PICTURE


No matter how far Luzhkov extends his control, the government is not likely to be an effective entrepreneur in the long term. The mayor, a talented manager, has built a vertically integrated bureaucracy that functions smoothly with him at the helm, but that would face a crisis if he left.


"The system functions well while he is at the top of the pyramid," said Petrov. "It seems that it is designed to work well with him and poorly without him."


Throughout Russia, regional governors have built similar authoritarian systems with often disastrous results. In the Primorsky region of the Far East, for example, governor Yevgeny Nazdratenko's attempts at total control have brought little more than crippling corruption and economic stagnation.


Despite Luzhkov's achievements, Moscow could already be doing a lot better considering its privileged position as Russia's financial and political center, said Morozov.


"Moscow controls 80 percent of the country's financial resources: Even with ineffective use of those resources it's possible to achieve results," he said. "In the short term, Luzhkov's policies can bring some positive results, but in the long term if the government doesn't do away with those policies, then Moscow will lose."


By creating special conditions for favored enterprises, the city makes it relatively more difficult for businesses outside its krysha to succeed. This, said Morozov, has stifled competition and allowed prices for many goods and services to get out of hand.


"Moscow has become the third city in the world by cost of living," he said. "That means that there are adequately big obstacles to the market in Moscow, that normal competition does not exist."


Teplukhin agreed that the path forward lies in less government intervention and more in privatization. But he said Moscow can afford to take a different approach than Russia as a whole, since the capital is smaller, wealthier and more manageable.


"The discussion on the role of the government in the ideal economy is still going on -- it's not over yet even in the developed economies," he said. "So far real life hasn't proven anything. Probably our grandchildren will know."


Meanwhile, back at the Chesterfield, the unforeseen costs of doing business in Moscow keep piling up. As if the trees weren't enough, the city ordered the restaurant to buy outdoor 850th anniversary posters and special commemorative badges for all its personnel. The posters alone, said executive director Alexander Tatarinov, cost $1,000.


"For me it's not bureaucratic," he said. "I see it as part of the order of things."