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. Last Updated: 07/27/2016

'Big Eight' Out-Earn the Government

Privatization has produced a handful of billionaires and multibillion-dollar holdings, but not one group has the fiscal power the government does.

Eight do.

According to a study released this week by Brunswick UBS Warburg, eight major shareholder groups -- Menatep, Interros, Millhouse/Russian Aluminum, Sistema, LUKoil, Alfa, Surgutneftegaz and AvtoVAZ -- had revenues of $62 billion in 2000, 50 percent more than that year's federal budget. By comparison, the largest state-controlled companies, Gazprom, Unified Energy Systems, Sberbank and Svyazinvest, had revenues of just $47 billion.

The authors of the 30-page report, Peter Boone and Denis Rodionov, concluded that the "big eight" control 85 percent of the top 64 privatized companies. And the top 12 collectively have annual sales equal to the amount of money collected by the federal government every year, making them equal to the state in terms of "fiscal power."

Many economists have raised concerns over the concentration of such a huge amount of capital in so few hands, arguing that it lays the foundation for a crisis similar to the one that leveled the economy in 1998.

Boone and Rodionov, however, say the "chaebolization" of the economy is actually a blessing, provided the new oligarchs continue to lobby for the rule of law and a better investment climate.

In their report, titled "Rent Seeking in Russia and the CIS," the economists concluded that the lawlessness that reigned in the aftermath of the Soviet Union's demise was encouraged by businessmen and politicians in order to redistribute resources, which in Russia led to the emergence of the eight financial-industrial giants. Now that most of those resources have been divvied up, often by criminal means, "the new propertied class, with large concentrated wealth, is a key factor in explaining the end of rent seeking."

Rent seeking, loosely defined as groups or individuals seeking special favors from the government at the expense of everyone else, was the driving force of the economic decline in Russia in the early 1990s, the report argues.

"The combination of rent seeking and weak property rights is probably the single most important factor in explaining large-scale capital flight from Russia throughout the last decade," the authors wrote.

Top 10 Private Companies

Russian Aluminum
Tyumen Oil Co.
Norilsk Nickel
Nizhny Tagil
Source: UBS Warburg
The International Monetary Fund estimates total gross private capital outflows from Russia averaged more than $20 billion per year after 1994, likely adding up to more than $200 billion, or 64 percent of annual gross domestic product, during the decade.

The macroeconomic landscape continued to deteriorate until enough groups of propertied elite had amassed highly concentrated interests in companies, giving them a greater incentive for legislation and economic reforms, Boone and Rodionov concluded.

Now that the "big eight" have amassed their holdings, the next step is to nurture them -- and ensure that they keep them.

"Once industrial-financial groups staked their claims over property and accumulated around 70 percent to 100 percent of the shares in these enterprises, we are seeing major turnarounds," Boone said in an interview Thursday.

President Vladimir Putin came to power in part because he had the backing of most of the country's most powerful businessmen. In exchange, one of the first commitments Putin made was that the existing distribution of property would remain. He is reported to have told Russia's top business leaders at a closed meeting that they could keep their property, but only as long as they stayed out of politics and invested their wealth in their companies, rather than vying for political power or shipping cash out of the country.

According to the report, of the 10 largest traded privately owned companies -- LUKoil, Surgutneftegaz, Yukos, Sibneft, MTS, Severstal, Norilsk Nickel, United Heavy Machineries, Russian Aluminum and TNK -- all either plan to or already have listed their shares on international stock exchanges; seven plan to sell a sizeable stake to a foreign strategic partner; eight have clear, five-year strategic growth plans; and five aim to be major international players.

With all these powerful companies planning for the future, it would stand to reason that they have an interest in stabilizing the country and encouraging investment, both domestic and foreign.

"With highly valuable tradable property and a group of core shareholders that is sufficiently small to collude, it is no longer in their interest to violate the law and engage in rent seeking that destabilizes the economy," Boone said.

This can be seen with the re-emergence after Putin's election of the so-called "union of oligarchs," the Russian Union of Industrialists and Entrepreneurs, or RSPP, whose members have been assigned to working groups on key reform areas -- banking, pensions, power generation and distribution, tax and currency control, courts; customs, WTO entry, labor legislation and small businesses.

Analysts say these businessmen are influential enough to see their plans implemented.

"The significance of big business in reforms is doubtless," said Natalia Orlova, chief economist at Alfa Bank.

"In terms of the close connection of the government and the business groups the situation hasn't changed much," she said. "Before, we had separate individuals dealing with the head of state, now it is the RSPP that has direct access to Putin."

This propertied elite has become and will be a key lobby for strengthening property rights and implementing policies that improve Russia's investment climate and reduces its sovereign risk, Boone said.

"Indeed, most of the growth rates in Russia between 1999 and 2002 were delivered by these enterprises," said Yevgeny Gavrilenkov, chief economist at Troika Dialog.

Mattias Westman, a fund manager from Prosperity Capital, agreed: "Their businesses cannot develop if the environment does not develop."

The next stage, at least for the exporters, is diversification, as many have turned their attention to snapping up major enterprises in the motor vehicles, timber, manufacturing and agriculture industries. These companies will also be in the lead as the private sector eventually gains ownership of the biggest remaining state companies like Gazprom, UES, Svyazinvest and Sberbank.

"This is better than the economic disorder Russia had before. This system may deliver rapid success, but is also gives rise to illusions among policy makers," Gavrilenkov said.

One of the major concerns of the chaebolization of the economy is that it breeds closer ties between the government and business, Gavrilenkov said.

"This kind of system does not need a developed banking sector or financial markets, since the reallocation of financial resources can generally be arranged within conglomerates, or chaebols," Gavrilenkov said. "If Russia can put a strong banking system in place to allocate investment resources efficiently, and lower the barriers to new business to stimulate maximum competition, it may yet achieve high and sustainable economic growth," he said. "However, if Russia continues to evolve after the Asian model, after a period of growth a new crisis will be inevitable."

Boone dismisses that argument and says the emergence of the big eight -- regardless of how they got there -- is a positive development.

"There has never been a better environment in Russia for investment and for returns on investment," he said. "If you look at the individual companies, they are restructuring and becoming much more productive and much better managed and that's going to continue."