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. Last Updated: 07/27/2016

Small Business Now a Big Deal

In less than a month, the State Council will convene in the Kremlin to hammer out a federal plan to develop the country's neglected small-business sector. Thousands of people, from union leaders to ordinary proprietors, are eagerly awaiting the results and hoping that, after seven years of rhetorical support, the government will put its money where its mouth is.

The State Council, an assembly of regional leaders that convenes four times a year to discuss pressing issues, is a forum where politicians from across the country can make their voices heard. On Dec. 5, the council is scheduled to debate topics ranging from integrating the work of small and large businesses to perfecting the small-business tax system. And their conclusions will be incorporated into a 2003-05 federal plan for the development of small business, according to Sergei Baskakov, head of the Anti-Monopoly Ministry department for developing small and medium enterprises, or SME.

The reason for the need to act is obvious -- a strong small-business sector is considered vital to the creation of a healthy economy. But Russia's SME sector, which one observer says is now a "fashionable topic" in government circles, is woefully weak, accounting for just 10 percent of gross domestic product, according to the Small and Medium Enterprise Resource Center, a nonprofit organization in Moscow that provides information to small businesses. In former Soviet satellite Poland, for example, the figure is 50 percent, on par with the United States, while in the European Union, SMEs represent 63 percent to 67 percent of .

"[SMEs] are the root of dynamism in the economy," said Bryan Nielsen, program coordinator for the European Bank for Reconstruction and Development's Russia Small Business Fund. "If they are given the potential to grow, they can provide greater stability in the country through diversification of national income and also increase employment."

The sector's importance is especially apparent now, when the government is scratching its head for ways to balance the federal budget in a time of foundering oil prices. A strong small-business sector could help stabilize the economy and lessen its dependency on natural resources.

"The small-business sector is very mobile and is where new technologies are created. Within it lies a great potential for higher employment in the country," Nielsen said.

Small businesses employ only 10.2 percent of the country's workforce. In the United States, 51 percent of private-sector jobs are in small businesses, which make up 99 percent of all employers, according to U.S. government figures.

Statistics concerning SMEs, however, can be misleading. While the most common benchmark for calling a business small is 100 employees, definitions vary from country to country. For example, the State Statistics Committee did not include individual entrepreneurs or so-called micro-businessmen in last year's report on the sector. The committee estimated that there are 4 million such entrepreneurs in Russia, compared with an estimated 1 million small businesses.

The small business sector in Russia has deep-rooted problems that are not easily solved with reform legislation. The 1998 financial crisis devastated the sector, which was heavily involved in import and retail. The fall of the ruble cut people's buying power and dried up demand for the foreign products most small businesses were selling. The EBRD's Nielsen said small businesses had jumped into retail because "it's the easiest to get into."

An increase in the variety and volume of domestic products has since helped stabilize the internal market, but "the small-business sector needs to diversify," said Yevsey Gorvich, research manager of the Economic Expert Group, a think tank sponsored by the Finance Ministry.

Yet Russian SMEs are showing up in other industries as well. Fourteen percent of small firms account for 28 percent of production in construction and manufacturing. But only 1.5 percent of small businesses are involved in agriculture, largely due to the Soviet-era legacy of communal farming.

SMEs' social importance can be seen in the number of jobs the sector creates. In the United States, they create 75 percent of new jobs. In Russia, that figure is unknown, but with only 6 million people in a population of 146 million working in small business, it can't be very high.

Banking Headache

In the United States, around 55 percent of small firms obtained some form of credit in 1998, according to the U.S. Small Business Administration.

Not so in Russia, where 75 percent of capital invested in small businesses in 2000 belonged to private individuals, according to the State Statistics Committee.

Government officials say this simply shows that small businesses are stable.

"When someone is investing his own money, then he acts responsibly with it," said Andrei Tsyganov, deputy anti-monopoly minister, at a news conference last month. "It makes no sense to steal from yourself."

But many observers say that the absence of a functioning banking system makes it impossible for the small-business sector to flourish and handicaps the economy as a whole.

"The necessary elements for the development of any business in this country are missing," said Tanya Monaghan of the International Chamber of Commerce. She put a healthy banking infrastructure at the top of her list.

A stable, working banking system is essential because it allows for a great amount of capital, which is largely stagnant or kept within a group of related organizations, to enter the economy through small businesses and other potential debtors who want to buy an apartment or a car.

Most of the country's capital is concentrated in central Russia generally and Moscow specifically. So it is hardly surprising that 43 percent of all small businesses are in central Russia -- 29 percent in Moscow -- and the rest more or less equally distributed throughout the country, with the second-highest concentration, 5 percent, in St. Petersburg.

Experts put the national banking system's failure to address the small-business sector down to inexperience.

"[Russian banks] don't think it is profitable to lend to small businesses," said the EBRD's Nielsen. "They don't know how to deal with small clients."

The system lacks the infrastructure needed to assess an organization's cash flow and its financial standing. Nielsen said banks have neither the ability to analyze demand for a small business' product nor the desire to do so.

"I won't name names, but many banks here were created to service specific institutions or groups of institutions that are related to each other, and they are comfortable with that because they know how to work with those partners," he said.

But as more capital flows into Russia, bankers are starting to look into other options. "What we're seeing on the market is that there is a fixed number of organizations to lend to," Nielsen said. When that segment is saturated, banks might start to tap virgin areas of the credit market, he said.

Currently, the $300 million EBRD small-business fund is one of the only credit resources for small businesses in the country. It gives loans to small firms through a number of banks across Russia, including Sberbank and its own Russian Small Business Bank. The fund has dispersed 65,000 loans since its founding in 1995.

There are other sources of financing, such as USAID and TACIS, but Nielsen believes it is necessary for small businesses to be funded through banks in order for a normal, sustainable banking culture to develop.

Another source of financing untouched by the government and big business is federal contracts, which represent a large portion of business done by small firms in the West.

In the United States, for example, 33.3 percent of the value of federal contracts to private firms goes to small businesses, either directly or through subcontracts.

In Russia, "subcontracting is not even a known word," said Igor Mikhalik, director of the SME Resource Center. "The attitude of big business and the government has to change before those kinds of market relations will appear."

Legal Jungle

Yet at first glance, the government's attitude toward small and medium businesses is as supportive as any. As early as 1996, President Boris Yeltsin told a congregation of small and medium business proprietors that he considered "the support of small business to be a prerequisite for the further development of the economy and the appearance of a middle class."

To achieve these goals, he created the now-defunct State Committee for the Promotion of Small Business, which has been replaced by the state department of small-business support within the Anti-Monopoly Ministry. It advocates the same goals, yet not much has changed over the years. Bureaucratic barriers are rife. Registration is still a tedious process that involves juggling packs of documents through a long list of government departments.

The process is so unnerving, in fact, that a whole class of small businesses has developed just to cater to those wishing to start their own small business.

"I avoided registering my company like the plague," said Moteius Chepaitis, who is starting a small publishing business.

In order to get his business off the ground, Chepaitis bought the rights to a company name with a false general director from an agency that sells registered companies for $500 apiece. "I guess they have contacts in the government, so they can register as many companies as they want to the same address," said Chepaitis.

"I just came in, took a look at a list of names they had already registered and chose one," he added.

Possibly more frustrating, though, is closing a company. "Even if an organization has no debt, the liquidation process is so complicated that not everybody has the kind of nerves it takes to go through with it. Almost nobody does," said the SME Resource Center's Mikhalik.

Anton Solovyov, deputy director of Strekh-1, a mid-sized textile firm and a member of the small business working group of the Russian Union of Industrialists and Entrepreneurs, or RSPP, agreed. "The liquidation process is too complicated, so firms opt to expire de facto, rather than de jure," he said.

Although it is apparent that the government is not doing enough to sweep away bureaucratic barriers impeding development, Mikhalik said the laws that are characterized by Solovyov as simply declarative, such as the federal law on the support of small business, also have a real purpose.

"Declarations are important for the regional governments; they're used as a yardstick by which they measure their behavior," he said. "The government has only spoken in a very general way about supporting small business. But I think we have to wait for the State Council to convene before we can say in which direction the country is headed."

However, Vladlen Maximov of the Liga Svobody inter-regional union, which includes more than 1,000 small businesses in Moscow and the surrounding region, said the federal government has set a bad example that regional governments are likely to follow in making statements of support for small business but declining to do anything concrete.

Solovyov said the 1995 federal law on the support of small business needs revision: "The criteria for what to classify as a small business need to be more specific; the law totally omits the concepts of a medium-sized business and a micro business. Such classifications would allow for a differentiated approach to taxation."

Tax laws, a thorny subject for legislators and entrepreneurs alike, are far from complete. The unified tax, for example, which is applied to all small businesses, works on the basis of inferred profit.

In other words, a prediction of how much profit a company will make in a tax period is made based on the area a company occupies, or other irrelevant factors, after which the company must pay a set amount of tax, regardless of how high or low revenues for the period actually were.

"This approach is too arbitrary, and the methods by which taxes are levied differ greatly from region to region. Frequently, it does not reflect reality," Solovyov said.

Nevertheless, the State Duma changed the licensing law in September to make the process a one-stop job and to shorten the list of professions that require licensing. The same should to be done for the processes for registering or liquidating a company.

A more simple tax system is necessary, but Mikhalik said reforms should not be drastic. "The worst thing for business is a drastic change in legislation," he said.

As an example, he said the terms of contracts frequently list unforeseeable changes in legislation as conditions under which agreements cannot be fulfilled, alongside earthquakes and other unpredictable situations.

The World Outside

After the September attacks in the United States, Russia has found itself in the unique and unprecedented position of cultivating warm relations with the West. With its newfound footing on the world stage, Russia is reviewing its role in the global marketplace.

The government is committed to joining the World Trade Organization, and last month, President Vladimir Putin told a group of small and medium-sized businesses that he was confident that membership would be good for the economy. However, he cautioned that "many of our goods are not competitive, and we must carefully analyze the consequences."

Opinions on what those consequences could be vary, as experts warn that the population has too little information on the topic for the government to make a balanced judgement.

"If Russia were to join today, the consequences would be disastrous," said the ICC's Monaghan.

She said if Russia were to join the WTO, "Russian small businesses would not be able to sustain the competition from foreign firms." She distributed a 132-page report outlining the dangers of WTO membership to various government agencies this summer.

"Small businesses don't need globalization," she said. "What good is free trade when Russian small business has nothing worthy of export?"

The Russian marketplace is simply not ready yet, according to Monaghan.

"Although competition is the key to success, all the other conditions of a free market, like a healthy infrastructure, the protection of entrepreneurs' rights and mechanisms for the implementation of laws, have to be in place before Russian and foreign firms are on equal ground," Monaghan said. "It's no secret that ordinary citizens' and companies' rights are poorly protected and that the level of corruption is very high," she said.

The Economic Development and Trade Ministry has said a working group will informally discuss the possibility of Russia joining the WTO at bilateral trade talks scheduled for December in Geneva.

The ministry maintains that it is continuing its dialogue with business leaders and will take their opinions into account in ongoing WTO membership talks.

Monaghan said the government is talking about joining in 2003, but the country needs another five to seven years before it is fully ready to reap the rewards -- and avoid the pitfalls -- of membership in the global trade body.

But Gorvich, of the Economic Expert Group, took a more moderate stance on the WTO. "In most countries, small businesses are local, and international companies don't usually occupy their niche; membership in the WTO won't have a drastic effect on [Russian small businesses] one way or the other," he said.

But the adverse or positive effects that may hold sway on the Russian economy largely depend on Russia's adhesion to the rules the WTO prescribes.

"Even if there are signs of risk to Russian businesses after Russia joins, the government will impose protectionist restrictions, one way or another," Mikhalik said. "There's nothing wrong with that."