The Price Tag of Russia's Organized Crime

by Louise I. Shelley

Organized crime has a devastating impact on Russia's economy. It discourages foreign investment, deprives the country of its tax base, dominates the banking sector and financial markets, and exacerbates the already widespread problem of corruption. But probably the most damaging aspect of Russian organized crime activity is its contribution to large-scale capital flight.

Why Is Russia's Organized Crime Special?

Colombian drug traffickers repatriate most of their profits. Italian authorities were able to freeze $3 billion of mafia assets in the mid-1990s because much of the profits of Italian organized crime were invested domestically. In contrast, Russian organized crime groups repatriate little of their profits, instead depositing their proceeds in foreign countries, establishing banks in offshore havens. A specialist on capital flight reported at a recent Ministry of Interior conference in Moscow that $150 billion had been exported from Russia since 1991. This figure may be high but conservative estimates are still more than $50 billion. A minimum of 40 percent of the estimated $2 billion in monthly capital flight is attributable to organized crime groups. The problem of capital flight dwarfs the lamented absence of foreign investment (a figure estimated at approximately $6 billion since 1991).

Russian organized crime groups do more damage to their country's tax base than do their compatriots in other countries. Apart from not paying taxes, organized crime groups, by usurping the state's tax collection role, often deprive the state of needed resources. Recent research on the Russian customs service revealed that duties are paid on only 35 of every 1,000 cars imported into the country. Regional crime bosses control customs warehouses in many parts of the country. Many customs officials, who are on the payroll of crime groups, collude to divert customs duties to the crime organizations.

Russian organized crime has also infiltrated the domestic banking sector and financial markets more deeply than have their counterparts in other countries. Millions of citizens have lost their limited savings in pyramid schemes and in banking institutions that have collapsed. Hundreds of banks are owned or controlled by organized crime groups that are laundering money (abroad by Russian organized crime groups and within Russia by foreign organized crime groups). Bankers who refuse to launder money cannot compete with banks that provide such services. This criminalization of the banking sector and financial institutions has boosted capital flight.

Russian organized crime groups secured a massive transfer of state property because the privatization occurred rapidly, on a huge scale, without legal safeguards, and without transparency. These groups used force, if necessary, but relied mainly on their large financial assets and their close ties to the former Communist Party elite, the military, and the banking sector. (Colombian, Italian, and Mexican organized crime groups have also benefited from the privatization of state resources, but on a much more modest scale.) Amassing privatized property even before the collapse of the Soviet state, the Russian mafia now controls more than 40 percent of the total economy. In some sectors, such as consumer markets, real estate, and banking, their role is even greater. In other countries crime organizations also diversify from the illicit sector to the legitimate economy. But in Russia, organized crime groups are dominating both legitimate and illegitimate economic sectors simultaneously. The new owners, often uninterested in making their enterprises function, drain the resources and transfer the proceeds abroad, exacerbating the problems of both capital flight and nonpayment of wages.

Fighting on the Ground

The cancer of organized crime cannot be addressed solely of the national level or through officials in Moscow. There are significant geographic variations. For example, organized crime is based in the shipping industry in the Far East, in the appropriation and export of natural resources in the Urals, and in banking and real estate in Moscow. The weakness of the central Russian state and the rise of regional power means that assistance programs must involve a variety of individuals and groups apart from state institutions. A multipronged strategy is called for:

• Economic and legal assistance programs must be targeted to the most criminalized sectors of individual regions.
• Programs must seek to build civil society and help secure citizens' property rights. International programs to fight organized crime must work with groups like the Association of Russian Bankers, workers groups addressing issues of illegal privatization, and consumers groups educating citizens on the risks of investing in the largely unregulated banking sector, commodity markets, and stock exchanges.
• An integrated strategy of economic, social, civil, and criminal legal assistance is needed. Reform of the banking sector, assistance in privatization, and maintenance of a free press must be implemented along with legal assistance to fight organized crime. Also required is coordinated legal reform in the criminal and civil areas, including enforcement measures; banking, tax, and regulatory reform; protection and education of journalists; and the empowerment of citizens to fight organized crime.
• Individual countries and international organizations assisting in the privatization process, such as the World Bank and the EU, must pay more attention to corruption. They must work to ensure that citizens have more access to the property now being privatized and to legal assistance in this area.
• More attention must be paid to ensuring the openness of the privatization process. Citizens must have better access to information about the integrity and viability of the institutions in which they may invest.
• Building integrity in the banking sector and in financial markets must be a key objective of any assistance program to combat Russian organized crime. Civil and criminal legal assistance must proceed in tandem to ensure that new economic institutions can be defended against further criminalization.

To sum up, efforts to decriminalize the Russian economy must define the problem more broadly than simply as money laundering. Donor nations and institutions must better coordinate their help in establishing the regulation and enforcement mechanisms for effective governing of financial institutions and markets. Assistance programs must identify areas of the economy that have managed to avoid massive criminalization.

The author is professor at the American University, Department of Justice, Law, and Society, Washington D.C. This article is based on her forthcoming book" Stealing the Russian State."