BA - my 2cents worth in the round of pieces on this topic. BA
>From no growth at all in the 1990s economists now worry that Russia's
biggest companies are growing too much. Eight industrial groups dominate
private enterprise and between them account for 85% of all wealth created by
the country's nascent free market.
A study by Peter Boone and Denis Rodionov of Brunswick Warburg, a Moscow-based investment bank, found that Russia's companies had total sales of $109bn in 2000. The leading state-owned companies generated $47bn in sales - mostly from the two natural monopolies of Gazprom and United Energy Systems - while privately owned companies generating $62bn or a quarter of GDP. Of these private companies a mere eight account for 85% of these sales.
The concentration of wealth creation is so small that some economists are starting to talk about the "Chaebolisation" of the Russian economy, similar to South Korea's experience.
South Korea's chaebol system produced rapid growth between the early 1960s and the late 1990s by mobilising investment and importing management skills. According to the IMF the 30 largest Chaebols owned two thirds of 100 biggest manufacturers in the mid-90s and accounted for 16% of GDP
This is the second time that modern Russia has created large industrial groups. The first were formed in the now infamous loans-for-shares deals of 1995-6 where the Russian government sold off its industrial jewels for pennies on the dollar and created a business elite - the so-called oligarchs.
In 1996 business tycoon Boris Berezovsky famously claimed that he and the other six oligarchs controlled half the economy. Berezovsky was exaggerating for political reasons, but at their height the seven leading financial-industrial groups controlled about 11% of Russia's GDP.
A few of these groups survived the 1998 financial crisis - notably Mikhail Khodorkovsky's Yukos, Vladimir Potanin's Interros and Mikhail Fridman's Alfa Group -- and more have been set up in the last few years. The metal, oil and automotive sectors are all largely under the control of Russia's biggest industrial groups and they continue to add the best companies in other sectors. More recently the new and old oligarchs have been expanding into agriculture, timber and coal businesses.
And they have been growing fast. Without a working banking system the big industrial groups are the only entities with the resources to invest in themselves and can take their pick of Russia's undervalued assets. The Brunswick report shows that new eight industrial groups have doubled their share of economy and now account for 21% of GDP.
"These groups are at their height," says Peter Boone. "If these assets were under state-ownership it would be a disaster. We are not going to see dispersed ownership in Russia for some time."
The big eight's share of the economy is boosted by the fact that small- and medium-sized enterprises are still struggling. While oligarchs have the money and political clout to cut through the endless red tape, smaller entrepreneurs don't. If president Vladimir Putin successfully pushes through planned structural reforms and gets the strong growth he is hoping for, the industrial groups' share will be diluted again.
"At the moment exporting raw materials is profitable because the ruble is cheap," says Boone. "But as the ruble continues to appreciate against the dollar exporting metal and oil will become less profitable and the pendulum will swing towards the manufacturers of consumer goods. The current oligarchs will never dominate these businesses."
In the short term successful groups are not necessarily a bad thing as they are mobilising the capital and investing in a wide range of industries. For the meantime the Kremlin is unconcerned with the economic power these companies are collecting. But in the long run too few companies controlling too much of the production can cause problems. Big groups tend to make poor investment decisions. After a period of fast growth typically these mistakes end in crises before the cycle repeats itself.
Mature economies are already flexible enough to smooth out the worst of boom-bust cycle. Over the last forty years the American economy has reached an equilibrium where the average growth of 3% has fluctuated between -2% and 6% and the average investment as a proportion of output has been 19%, fluctuating in a relatively narrow band of 16% to 21%. These numbers draw a tight cycle of relative stability. (see diag)
Russia's experience has been much more volatile and draws a wide circle of good times - bad times. According to Evgeny Gavrilenko, chief economist at Troika Dialog, Russia is once again at the start of a 40-year cycle (see diag).
Comparing Russia to the American experience and the picture is very different. In the last two decades of the Soviet Union's life investments doubled as a share of GDP while growth faltered. Gorbachev's political reforms were designed to stave off the collapse of a crumbling system, but didn't go far enough to prevent the eventual fall.
Partial liberalisation at the end of 1980s saw some of the worst decisions undone, but growth continued to slow and the economy went into complete meltdown following the coup attempt in 1991 and Gorbachev's ouster.
The 1998 financial crisis brought Russia's economy back to the start of the forty-year cycle and growth and investment rates are now similar to those of 1961.
If Russia follows same pattern as Asian - which display the same volatility - then although Russia is about enjoy as much as a decade of strong growth it will end in another collapse unless the domination of the big companies can be diluted through creation of other business. Boone argues that it doesn't matter if one or more of the big groups go belly up.
"So what if a big group borrows too much and then collapses? This is what the free market is all about," says Boone. "What is driving growth now is the big groups all want to grow and integrate with the world economy. What is missing is the grass roots pressure from below; small- and medium-sized enterprises putting pressure on regional government to make market-friendly reforms. It will happen as there has never been a better time to invest."
Finland has already been through the reforms that Russia now faces. Like Russia, Finland invested heavily in the 1980s to develop capital-intensive industries focused on exports to the Soviet Union. The collapse of the Soviet Union plunged the Finnish economy into crisis and lead to the devaluation of the Finnish markka. From the crisis emerged a strong financial system and led to Finland putting in some of the highest growth rates in Europe. New sectors, like telecoms, have replaced the old capital-intensive ones and the economy has seems to have started a new tighter cyclical pattern similar to that of America's.
Gavrilenko believes that the government needs to play a more active role in promoting new business to dilute the big eight industrial groups' role in the economy and should not be content to let the big eight drive growth.
"Russia is at a fork in the road," says Gavrilenko. "If it can put a strong banking sector in place that can allocate resources efficiently, lower the barriers to new business and stimulate competition then the country can look forward to high rates of growth. If not then another economic crisis is inevitable."
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