Publication: Prism Volume: 2 Issue: 7

Will Middle Class Owners in Russia Become a Support for Economic Reform?

By Lidia Lukyanova

In 1995, there were nearly 10 million people in Russia employed in 900,000 small enterprises. These enterprises, however, accounted for only 12 to 13 percent of the national GDP. Among them, 53 percent specialized in industry, construction, and transport; 36 percent, in trade, and 11 percent, in agriculture and financial services.

Given Russia’s size and the social mission of small business, experts from the Institute of Market Problems of the Russian Academy of Sciences consider the share of small business in the Russian economy today to be no more than a drop in the ocean. When one bears in mind that Ministry of Internal Affairs data shows that 30 percent of officially registered small enterprises have, for some unknown reason, not yet begun operations, it is clear that small business is just beginning to take its first, unsteady steps in Russia. Obviously the process has been delayed since the onset of economic reform in the country.

What is responsible for the delay? Above all, the attitude of the state structures towards small enterprises. The necessity to support small business has not yet become axiomatic; such support is to a large extent hampered by dominant views on the state’s role in the economy and the choice among strategic priorities for reviving the national economy. To date, the measures that have been adopted to support small businesses have been contradictory and inconsistent. The granting of reduced tax privileges, for example, was immediately followed by the imposition of stricter conditions in other spheres of activity which blocked the development of small businesses. More often than not, legal acts adopted to support small enterprises usually lack implementation mechanisms. In spite of the many loud statements made in support of small business, the 1996 federal budget allocates only 0.16 percent of total expenditures for their support.

Official neglect affects the political attitudes of businessmen. Commenting on government policy towards small business, Director of the Institute of Market Problems of the Russian Academy of Sciences Nikolai Petrakov remarked: "At the upper echelons of power, two opposing views on the role of small businessmen in society are giving rise to equally contradictory legal acts and government resolutions designed to regulate small business. A step forward is always followed by a step backward. As a result, we are marching in place…"

Many Russian business leaders believe that today, in the sixth year of reform, private business is beginning to be squeezed out of the economy in Russia. Without a doubt, it is easier to strangle the one who is smaller. In Orlov’s opinion, the state apparatus is building state capitalism — Viktor Chernomyrdin’s assurances about government support for private business simply pass it right by. Mr. Orlov cites several arguments to prove his point. State bureaucrats won a victory over the legislature and the latter adopted a system of taxation which, as any sensible person can see, makes it impossible to develop any kind of honest business in the country. The state takes away up to 96 kopecks out of every ruble in taxes, duties, and other mandatory payments. As the system continues to operate, someone must benefit from it. Nongovernmental pension funds (with respect to the number of people employed, such funds are considered small enterprises) had barely been created when they were strangled to death by taxes. The population’s demand for such funds spurred their rapid growth (more than 600 were established), but unbearable taxes made it impossible for them to operate honestly. As a result, popular trust in the funds was undermined and they passed out of existence.

The law "On a Simplified Taxation and Accounting System for Small Enterprises," which has came into effect, applies only to individual entrepreneurs and enterprises that employ less than 15 people, regardless of the kind of activity in which these enterprises engage. Thus the law does not apply to the majority of small enterprises that specialize in production because it sets an unrealistic limit on the number of employees. According to Chairman of the State Committee for the Support and Development of Small Business Vyacheslav Prokhorov, the benefits of this law accrue primarily to enterprises specializing in sales. Was it for their sake that the law was adopted? Independent experts from the State Duma Subcommittee on Small Business maintain that the law’s sole purpose is to increase revenue for the federal budget. Thus, in reality, no tax relief has been granted to small business.

At the first nationwide congress of small business in Moscow, businessmen expressed the hope that if the government truly wanted to support small business, the current tax legislation would be reconsidered. But, as chairman of the Russian Association for Developing Small Business Aleksandr Ioffe argues, laws which have been adopted strengthen the inequality between the private business and the state sector in the economy. In spite of the fact that the Russian constitution calls for the equality of all forms of ownership, state bureaucrats do not allow private entrepreneurs to enjoy equal rights with the state sector in, for example, precision machine building, metallurgy, or even — oddly enough — agriculture.

No one in Russia today believes that small business could survive, let alone develop, without state support. This is why a special federal law "On the Support and Development of Small Business" was adopted and a relevant state committee formed. After a sustained struggle with the federal government, this state committee finally managed to have the State Duma adopt certain tax exemptions for small businesses.

Irina Razumnova, a senior researcher at the Institute of the USA and Canada of the Russian Academy of Sciences who studies the problems of small business, considers the law to have specifically confirmed the right of state ministries to control small business, rather than to support and develop it. The law, she insists, did not go so far as to specify the rights of private entrepreneurs, but concentrated on establishing funds to support small businesses. Such funds have already begun to be created in the regions and a federal fund has now been established under the auspices of the State Committee for the Support and Development of Small Business. The law specifies that these funds are to be used for direct financial support, loans, and loan guarantees, but fails to formulate a procedure by which small businesses can qualify for loans — the most acute problem of small business in Russia. The law grants privileges not to businesses, but to the funds, which are exempt from taxation. Academician Nikolai Petrakov maintains that the state granted this colossal privilege to the funds without any means of control — the law does not even determine who these funds are supposed to support or how they are to be supported. The ultimate result, he concludes, may simply be an inefficient waste of money. In reality, a state official at the center or in the provinces will play the role of racketeer just as he does when granting business licenses for various undertakings: "Give him a bribe and you get the loan. If you have nothing to grease his palms with, however, take a walk."

Clearly, the current legislative base for small businesses suffers from a host of flaws and fails to resolve their fundamental problems, including the number one problem of obtaining credit. This adverse situation persists in spite of the federal program for the support of small business, which has established program centers, together with their own regional funds, in seventy of the subjects of the Russian Federation. According to the state committee, these assistance programs are being implemented in more than 30 regions of the Russian Federation. Certain Federation subjects, such as Moscow, have even adopted local legal acts designed to correct the flaws in the relevant federal laws on small business, but the problem of receiving a loan on the basis of a business plan remains pressing. The negative experience of the principal bank specializing in small business services, Mezhekonomsberbank — currently on the verge of bankruptcy — goes a long way toward explaining most banks’ general distrust of the financial reliability of small businesses. Other banks do not want to share the fate of Mezhekonomsberbank, which makes it extremely difficult for a small enterprise to find a guarantor, no matter how attractive the project for which he solicits a loan.

The Federal Fund for the Support of Small Business is trying to correct the situation by means of a special "Guarantee" program that will act as a reserve fund to provide loan guarantees to small enterprises. At the moment, however, the process of accumulating funds for this reserve is still underway. The credit problem is further aggravated by the fact that the money market is still in an embryonic state in Russia. The financial and investment instruments used in the country are limited, unstable, and distorted by inflation and oscillations in the foreign exchange rate. Even such investment goods as land and other real estate are not oriented towards the needs of small business because the real estate sector is significantly corrupt in Russia.

Badly in need of cash, small enterprises are unable to buy modern equipment or technologies (leasing companies have only just begun to appear in Russia). Due to technological backwardness, the products of the majority of domestic small businesses are uncompetitive in both price and quality and, hence, not in demand. This factor also hampers the development of small business in Russia. In spite of the abundance of public and corporate organizations established in order to support small enterprise, private entrepreneurs do not maintain close contacts with each other, especially in the provinces, and thus work with acute shortages of information. At the same time, the heads of the organizations established to support small businesses are in no hurry to create a common information system because they are driven by personal ambition, not any general interest in small business.

Many enterprising and self-motivated people in Russia would like to launch a business, but are unable to do so because they have no start-up capital and no possibility of obtaining credit. It was not mere coincidence that the rate of growth of small enterprises in Russia sharply decreased in 1995.

The real curse of small enterprise in Russia is the absence of legal basis for regulating property relations. According to current law, a private entrepreneur cannot buy a plot of land or a building in a country, he has to rent them. Although the same law specifies that the rental period can be as long as forty years, local authorities seek to sign rental agreements for five to six years. These five to six years are often not enough for a small enterprise to mature and become highly profitable. Local authorities, moreover, can cancel rental agreements at any moment, either by breaking the law outright or using some kind of pretext. This practice is flourishing everywhere: as soon as someone offers better terms to the proper official, the official tries to cancel the existing rental agreement. A private entrepreneur is virtually helpless before the powers that be in such a situation — suing the mighty in Russia would cost him even more dearly.

Thus the typical Russian entrepreneur is in no hurry to invest in his business, which stands on ground that he does not own and occupies premises that he rents on a temporary basis. He makes both ends meet, earns enough for a living, and stops at that. Let’s wait and see, he says. Such a distorted mentality is yet another result of the small businessman’s insurmountable problems. For this reason, experts of the Russian Federation Chamber of Commerce believe that the huge potential of small businesses in Russia remains unrealized. Aleksandr Ioffe published an article in which he expressed concern that the current, short-sighted policy of collecting excessive taxes from small businesses and the insurmountable bureaucratic barriers placed in their way have forced them into the "shadow" economy in a number of regions. According to an anonymous sociological poll, the average Russian small business does not record as much as 30-40 percent of its activities on the books. The state treasury is losing more than it is receiving by imposing excessive taxes.

Translated by Aleksandr Kondorsky

Lidia Lukyanova writes on economic topics for Kuranty and other publications