Capturing the State in the Russian Regions
By Irina Slinko, Yevgeny Yakovlev, and Ekaterina Zhuravskaya

Small business growth is hampered in "high-capture" environments, in other words, where state institutions succumb to vested private interests. While the captor firms enjoy benefits, their activity has a negative effect on the respective regions’ fiscal expenditures.

Observers have attributed strikingly different economic performance between transition countries, and even between regions of larger economies, to variations in the transformation process and the initial conditions of the institutional environment. A wide range of institutions is regarded as an important prerequisite for a smooth transition, including federalism and, more generally, structure of government; the presence of outside anchors, social norms, and trust; as well as the political regime.

The monopolization of certain areas of the economy can thwart reform efforts, for example, capital market monopolization may lead to credit rationing and monopolization of the resource sector may lead to distortions in factor markets, including labor, capital, and land markets. State capture, that is, a situation where the institutional environment (legislature, regulatory agencies, and judiciary) is shaped by a business elite, is arguably the most serious effect of monopolization on economic reforms.

The first decade of Russia’s transition was notorious for major interventions by the oligarchs aimed at influencing the direction and speed of institutional reforms and, more generally, all aspects of federal economic policy. The regional picture largely mirrors the situation at the federal level, thus it came as no surprise when Russia was ranked fourth on the 1999 business environment and enterprise performance survey, which ranked 20 transition economies based on the extent of state capture. The survey was developed jointly by the World Bank and the European Bank for Reconstruction and Development.

The extent of capture widely varies among transition countries, and the speed and success of reforms is partly explained by the interplay of capture and democratization in these economies. Firm-level analysis of business environment and enterprise performance survey data showed that in high-capture countries, captor firms showed superior performance in the short run, but could not expect the same long-term productivity growth as similar noncaptor firms.

To assess the effect of capture on regional economies and on the performance of captor firms we analyzed preferential treatment in regional legislation for up to 20 of the largest firms in each of Russia’s 89 regions between 1992 and 2002. By preferential treatment we mean tax breaks, investment credits, subsidies, subsidized loans or loans with a regional budget guarantee, official delays in tax payments, subsidized licensing, access to state property for free, or creation of a special open economic zone on the territory of one particular enterprise. We measured the degree of capture by looking at the persistence of preferential treatment, that is, the extent to which it is repeated from year to year for any particular enterprise, and the concentration of preferential treatment, that is, the extent to which persistent preferential treatments are dispersed among several enterprises or concentrated in the hands of one firm. A region is considered more captured if preferential treatments are concentrated among a few large regional firms.

The case of the Briansk regional legislature is a typical example of preferential treatment. In 1997 the legislature adopted a law on regulating the liquor market that ruled that only licensed firms were entitled to sell spirits. According to the law, if a firm satisfied certain criteria, such as having several years of market presence and possessing storage facilities of a certain size, it is entitled to apply for a license from the regional administration. The problem was that only one company could meet all the criteria listed in the law. As a result the other companies had to give up their spirits sales or face confiscation of their stock.

By evaluating how state capture effects macroeconomic conditions at the regional level and the performance of captor firms, we found that in high-capture environments the regional authorities create obstacles to small business growth. Captor firms benefit from institutional advantages, and this could result in short-term growth of the aggregate gross regional product. This growth is, however, not sustained in the long run, because of the lack of incentives among captor firms as well as the adverse effects of capture on the rest of the economy. Capture-induced, short-term gross regional product growth does not provide higher budget revenues either, because tax collection falls and arrears increase. The subversion of fiscal expenditures means that in high-capture regions spending on housing, education, and health care is slashed.

As for the microeconomic level, we found that capturing the state brings firms significant short-term advantages: captors grow faster in terms of sales, market share, employment, investment, and productivity. In addition, enhanced bargaining power gives captors the ability to maintain higher arrears to suppliers and employees, and local officials protect captors from legal enforcement of these payments. State capture also brings benefits to captor firms in the long run: captors maintain higher average employment, investment, and market share growth and higher average wage arrears; however, labor productivity at these firms tends to be below that in noncaptor firms.

Irina Slinko is a researcher at CEFIR and a PhD student at the Stockholm School of Economics, Yevgeny Yakovlev is a researcher at CEFIR, and Ekaterina Zhuravskaya is academic director and senior researcher at CEFIR.