Mafia Capitalism or Red Legacy in Russia?

March 4, 2000 • Commentary

Russians will go to the polls on March 26 and are almost certain to make the temporary presidency of Vladimir Putin official. A key factor driving Mr. Putin’s rosy electoral prospects is the fact that the Russian economy has improved measurably over the past 18 months. Thanks in large part to the devaluation of the ruble and rising oil prices, Russia’s economy is on more stable footing. Gross domestic product grew by 1.6 percent in 1999; inflation was restrained and revenues were higher than expected.

Russia’s long‐​term economic prospects, however, remain grim because the country is experiencing a crime epidemic. Its Interior Ministry says there are now more than 9,000 criminal organizations operating inside the country, employing nearly 100,000 people — about the same number as the U.S. Internal Revenue Service. The Analytical Center for Social and Economic Policies, a government‐​sponsored think tank that reports directly to acting President Putin, estimates that four out of five Russian businesses pay protection money. They also report that more than 8,000 Russians have mysteriously vanished from their homes, which have become lucrative pieces of real estate since the collapse of communism.

News accounts in this country of Russia’s crime epidemic, however, continue to erroneously suggest that organized criminal activity there is an “extreme form of capitalism.” Journalist Adrian Kreye, for example, says Russia is experiencing a “mafia capitalism” which is based on “the dollar and the law of the fist,” and Reuters reports that “threats and murders have become commonplace in the wild atmosphere of post‐​Soviet capitalism.” More subtly, The Washington Post blurs the distinction between legitimate business and organized crime with talk of criminal “conglomerates” and “mergers.”

Others hold that organized crime in Russia is simply an “early stage” of capitalism. “Today’s corruption,” writes Cornell University professor Michael Scammell, seems “characteristic of a period of profound change and upheaval, when Russian society is in the stage of the primitive accumulation of capital.” And Stephen Handelman, author of Comrade Criminal: The Theft of the Second Russian Revolution, reports that many Russians believe “that a period of lawlessness is part of the price every society pays” for capitalist development.

But Russian organized crime is neither a “form” nor “stage” of capitalism. History shows that Russian organized crime is a direct legacy of years of all‐​pervasive bureaucratic control and an economy that was forced underground.

A History of Government Control

It was the presence of government control everywhere in Soviet life that provided the original opportunity for the institutionalization of widespread bribery and extortion. Indeed, Soviet bureaucrats could, and did, demand payment or favors for everything from drivers’ licenses and consumer goods to medical care and higher education.

Such bureaucratic corruption and favor trading meant that there was no standing rule of law to live by under the Soviet state. Instead, Russians encountered rules and requirements that varied with each bureaucrat and government ministry they dealt with. The result was that the Soviet Union did not establish the rule of law, but the arbitrary rule of bureaucrats.

Today, Russia is paying for its inability to establish the rule of law. Faced with rampant crime, many Russian businesses are taking matters into their own hands and hiring private security agents and bodyguards. One security service provider says Russian businesses have little choice but to recruit their own security forces. “They do not trust the state. If they relied on the state, then you wouldn’t see them riding around Moscow in a convoy. I laugh when I see five businessmen; they usually have 25 bodyguards.” Officially, there are now 10,000 private guard services registered in Russia, but experts say there may be as many as three times that number.

A lack of faith in the Russian government’s ability to enforce the law is not limited to the business world. In 1996 a jailed Russian mobster testified before a U.S. Senate subcommittee that Russian hockey players in the National Hockey League, including Alexei Zhitnick, were extortion targets of the Russian mob. The witness claimed that when Zhitnick was confronted with the extortion demand he did not go to the Russian authorities. Instead, said the witness, he “went to a more powerful criminal group to take care of the problem.” According to Zhitnick: “The cops can’t do anything. No rules. No laws.” Most Russians share his view.

Underground Markets

The underground markets that emerged under communism are another source of Russia’s organized crime problem. Shortages of consumer and producer goods in the Soviet era provided the opportunity for additional income at all stages of commerce. Goods arriving at retail stores were often set aside for preferred customers who paid extra. Those who controlled the distribution of goods, housing, etc. were often in a position to extract additional payments from consumers. “Illegal private economic activities,” reports Berkeley economist Gregory Grossman, were “a major and extremely widespread phenomenon,” and for a large part of the Russian population, “a regular, almost daily, experience.”

It is no accident, then, that many members of today’s criminal class are current or former Soviet officials. The 1960s saw forged in Russia crime networks based on the ability of the criminal underground to provide Soviet officials with consumer goods and services unavailable under the Communist regime. As Gorbachev liberalized in the early 1990s, Russian organized crime retained its links to government officials, and many former police and intelligence agents joined the Russian mafia after the collapse of communism. Several recent books published inside Russia support this view. Mafia: Unannounced Visit by Interior Ministry official Vladimir Ovchinsky describes the intertwining of the corrupt state bureaucracy and the criminal underworld, especially during the last years of communist rule. In Thieves In Law, Georgy Podlesskikh and Andrei Tereshonok expose how organized crime and the Russian government are tied to each other. Based on internal KGB documents, they show that Soviet officials influenced and sometimes supervised organized criminal activities.

Today, no level of government is immune from criminal inflitration. Take the case of Gregori Miroshnik. Imprisoned four times, he was widely considered to be a dangerous criminal. But in 1991, he somehow became the economic advisor to the vice president. When asked where he found his advisors, the vice president said that he was too busy and couldn’t check everyone’s resume.

As one frustrated former Moscow prosecutor has summarized Russia’s current organized crime problem: “The main way the mafia penetrates into the economy is via the bureaucrats. They are our main enemy. The mafiosi are only the second enemy.”

Laissez‐​Faire or Kremlin Capitalism?

Far from being a “form” or “stage” of capitalism, organized crime in Russia is a direct threat to capitalist reforms. Rampant theft, fraud and extortion have rendered property rights meaningless to many Russians, and without credible property rights, ownership does not facilitate investment and economic efficiency. This is a point that Adam Smith made more than 200 years ago. Owners, he said, have strong incentives to eliminate waste and maximize the value of their property, naturally seeking “the most advantageous application of every inch of ground upon [their] estate.” Insecure property rights not only remove the incentives to improve one’s property, but also discourage the purchase of new property. Indeed, as political scientist David Weimer clearly explains in his new book, The Political Economy of Property Rights, “the greater the perceived risk of losing existing property rights, the less likely the holders of those rights will be to forgo current consumption to accumulate property.”

Widespread violence and crime in Russia are even beginning to generate nostalgia for authoritarian rule. Flagrant lawlessness has resulted in a resurgence of politicians who promise to re‐​establish order and fairness using brute force. Increased criminal activities fueled the backlash that contributed to ultranationalist Vladimir Zhirinovsky’s electoral success in 1993. Zhirinovsky’s platform included on‐​the‐​spot executions of criminal gang leaders by firing squads and the wholesale seizure of assets thought to belong to criminals.

But in reality, it is Russia’s reluctance to loosen remaining state economic controls that is the biggest catalyst for crime. Businesses seek to evade what are perceived as unacceptably high taxes or overly restrictive regulations; mafia groups thrive by providing a means for them to do so. Thus, the scope of power of organized crime is largely dependent upon the continued existence of government monopolies and restrictions on private activity. The privatization of state‐​owned enterprises, tax reform, and a reduction of the regulatory burden are the most important steps to bringing criminal activity under control.

The type of crime being committed illustrates the need for continued economic liberalization. Most serious organized crime in Russia is not based on “traditional” forms of illegal activity, such as prostitution or stolen‐​car rings, but is instead intertwined with government ownership of business and resources. “It’s [a] serious economic operation,” writes Igor Baranovski, a reporter for Moscow News, “Playing games on the exchange rate. Half‐​legal operations selling oil.” Large‐​scale crime in Russia often means selling government resources that nobody really owns. Billions of dollars of government controlled resources — everything from aluminum to gold to fishing rights — has been sold for private gain.

Government ownership is not the only factor that leads to corruption: excessive regulations and fees turn otherwise legitimate businessmen into criminals. Both at the federal and local level, government levies a daunting array of transaction costs on normal business activities. Rather than pay fees for countless licensing and permit requirements, firms choose to avoid official red tape by paying less costly bribes. According to the director of a large Moscow bank, government officials who issue licenses and permits “practically have a price list hanging on the office wall.” A recent study of the Ukraine found that small businesses in Kiev spent an average of $2,000 a year on such under‐​the‐​table payments, whereas official fees amounted to about $12,000. The mafia often plays the role of middleman in these situations, facilitating transactions between businessmen and corrupt government officials.

Burdensome customs procedures have also made Russia into a nation of smugglers. A paper by the RAND Corporation reported that a quarter to a third of Russia’s foreign trade is now carried out by small‐​time importers who travel by every means imaginable. These “shuttle traders” must routinely engage in extensive illegal activities. Quasi‐​legitimate shipping companies charge a fee for handling paperwork, customs negotiations, a despensing bribes. Attempts by the federal government to stiffen customs requirements has only resulted in a greater demand for illegal facilitation services.

Indeed, we recently observed this activity first‐​hand while traveling from Turkey to Russia on a mafia‐​owned passenger bus. Except for our party, the only “passengers” on the bus were color televisions, car batteries, and friendly gun‐​toting mobsters. The actual border crossing consisted of a quick payoff to a uniformed official followed by a bumpy ride through a dry creek bed. Without high tariffs and labryntine customs procedures, such covert border crossings would not be necessary.

What Should Be Done?

As Russia has shown, excessive government economic control coupled with ambiguous laws and weak enforcement lead to rampant corruption and crime. Russia is not suffering from “excess capitalism,” meaning that it has too little government, but from “Kremlin capitalism,” meaning that government does too much of the wrong things. The role of the state vital, but it must be limited in scope. Continued privatization and liberalization will render most criminal activity unprofitable, but such reform must be accompanied by changes in the police and legal system. Russia’s private businesses are plagued by the inability to legally enforce business contracts, laws are often conflicting, and police departments cannot be relied upon to provide protection from physical threats. Russian lawmakers must clarify contract laws and develop new legislation that governs private business activity. Additionally, police salaries should be increased to limit incentives for corruption.

In short, what Russia needs is not “more government” or “less capitalism,” but a greater commitment to fulfilling the core tasks of liberal governance: the prevention of harm and the protection of property rights. Just as importantly, privatization of state owned enterprises needs to be completed, unnecessary regulations lifted, and barriers to trade reduced. Unless Mr. Putin is able to make real progress in these areas, the long‐​term viability of Russia’s capitalist reforms will remain in doubt.

About the Authors