Why Free Enterprise is

Regulated Enterprise:
Legal Systems and The Failure of Free Market
Transformation in
Post-Communist Russia
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Law & Development of Emerging Economies

University of Venice
Istituto Veneto di Scienze Lettere ed Arti
Venice, Italy
Author:
Teri Abel
2005
Copyright  2005. All rights reserved. No other uses without express author permission.
 PROLOGUE

A libertarian adage states:

“Government is for fighting the wars and toting the mail. And we’re not so sure
about the mail.”

Thus is invoked the sentiment of some westerners who advocate for market

allocations of virtually all means of productivity and resources. This presentation

examines the generic role of government in market economies, and examines

government’s particular role in transformation to a market economy in the examples of

former republics of the Soviet Union, most notably, Russia.

1
 EXCERPT

If communist Russia with its finally faltering centrally planned economy was
America’s most polar ideological and economic opposite, and the exemplary justification
for bulwarks against command economies and state ownership, then post communism,
Russia should be the best example of what privatization could make right. It is not.
Post-communist Russia has featured: a metastasized organized crime and the
attendant un-taxable underworld economy; a government that has defaulted on both ruble
and dollar-denominated debt; a backlogged court system with unpaid judges; financial
preclusion from dismantling dangerous stockpiles of biological weapons; a bankrupt
banking industry; potential unregulated over-the-counter sales of nuclear weapons
intelligence to arbitrary states, possibly posing a greater threat to the West than the
deterrent-based cold war; and poor provision of basic public goods like a nontoxic
environment, elementary school books, x-ray film in public hospitals, veterans' benefits, a
national road system, and potable water 1. Add to that a reduced life expectancy and an
HIV and TB contagious disease epidemic; a real potential for more Chernobyl-style
meltdowns; no generic social security; and a whopping new underclass reaching heights
2
of 37% of the Russian citizenry, a portion of which reverted to subsistence agriculture.
Even now, only 31% of Russian children are regarded as healthy.3 In this post communist
climate of weak command institutions and no compelling culture of fair play, tax
collectors who attempted tax collection sometimes turned up rich, or dead. For bribery
became business, and the murder of Russian tax agents became as frequent as 1 every
other week.4
Western reformers’ advisement and predictions for Russia’s future and new
economy coming out of communism were quite the contrary. Via voucher programs
placing institutional equity into the hands of Russian managers and employees, Russia’s
largest firms were quickly denationalized. Indeed, privatization was such good medicine,

1
Stephen Holmes, “What Russia Teaches Us Now”, The American Prospect vol. 8 no. 33 July 1 - August 1
1997.
2
Holmes, “Russia,” pg. 5
3
Smolchenko, Anna. “Oil Wealth Trickling Down to the Poorest” Moscow Times October 13, 2005
4
Holmes, “Russia,” pg. 5

2
advanced the West, that you couldn’t choke and you couldn’t overdose: the more
privatization, the better; the sooner it arrived, the better. The order of the day was “shock
5
therapy” and Russia proceeded with “rapid mass privatization” of its most substantial
enterprises. Such swiftness of transition was aimed to quickly establish privatization’s
credibility and momentum.
Comparatively less vigor went to mounting a regulatory apparatus in any way
suggestive of that where privatization has agreeably been successful. Consequently,
equity that systematically landed in the hands of kleptocrats and the agreeably unsavory,
was nevertheless equity out of the hands of government, and as such, was characterized
as progress prima facie. Moreover, self-dealers’ accumulating market power was
reinforced by their financial ability to make key acquisitions of the press, which they
used not only to promote their preferred politicians, but also to construct their own
ownership images for public consumption.
For staunch market enthusiasts who today advocate for more privatization and
less regulation in the U.S. economy, the Russian economy should be expected to have
significant value creation and represent an attractive and competitive equity market even
by adjusted American standards. This does not accurately describe the case; and when the
percentage of Russian GDP collected in taxes was as low as 10% 6 vs. more than 30% in
the U.S., no droves of libertarians moved either their pensions or their permanent
addresses to Moscow.
The American free market has restraints. The cast of regulatory characters that
weigh in on our economy does not a short list make. Included are: the Securities and
Exchange Commission; the Department of Justice; Antitrust law; the Food and Drug
Administration; the Federal Trade Commission; the Delaware corporate code; the
Internal Revenue Service; the MBCA; the Environmental Protection Agency; the U.S.
Department of Labor; the Federal Energy Regulatory Commission; the Federal Reserve
Board and still more. Additionally shaping public equity valuations, firm management
and free market dynamics are: FASB and Generally Accepted Accounting Principles;
exchange listing requirements; a free press; Deloitte & Touche; the newest governmental

5
Black, Bernard S., Kraakman, Reinier H. and Tarassova, Anna, "Russian Privatization and Corporate
Governance: What Went Wrong?” Stanford Law Review, Vol. 52, pp. 1731-1808, 2000
6
Holmes, “Russia,” pg. 8

3
body that audits Deloitte & Touche; talent rich corporate boards; astute and diverse
shareholders; investment banks; and a legal system and market culture steeped in the
concept of fiduciary duty that supplies and nurtures the world’s most competitive
executive labor pool.
Yet amidst this constellation of solvent, coercive regulation and world class
scrutiny, an Enron can still emerge; as can a WorldCom, Tyco, HealthSouth, Global
Crossing and plethora of dot-com combustions. Policing is no cakewalk for the earnest,
the prepared or the brilliant:

Enron’s esteemed Board included a Professor of accounting emeritus and former
dean of the first-ranked Stanford Graduate School of Business, both the President
(emeritus) and President of the University of Texas, and a former senior vice
president from General Electric. The workforce was among the best trained and
competitively educated;

Before its collapse, Arthur Andersen was hardly a novice accounting firm with no
eye for long term brand value;

According to Weiss Ratings, Inc., the single ratings firm not funded by corporate
dollars, Salomon Smith Barney maintained "hold" ratings on eight companies up
to the date the companies filed for bankruptcy. Holding “buy” ratings nearly as
long were Bear Stearns, Lehman Brothers, Goldman Sachs, Bank of America
Securities, Prudential Securities, CIBC World Markets, and Dresdner Kleinwort
Wasserstein;

GAAP is ever a work in progress, adapting to the craftiness of business
accounting practices that mislead the investing public;

A conservative administration had no difficulty extending government’s
regulatory reach to include its newest character, Sarbanes-Oxley.

At least two features of the western market economy appear trivialized in some
reformers’ visions: the utility of a coercive and solvent market regulatory infrastructure
for chaperoning a transitioning economy, and a functional intellectual and training
infrastructure to source managerial talent. For example, when Russia did get some hint
of an SEC, its staff of forty frequently turned over. Even with all of our western liberty

4
and rights, it is hard to imagine our IRS being more afraid of the taxpayers, than we are
of them. When there is impropriety in the market place, we have inquiring regulatory
bodies, skilled prosecutors and trial lawyers unafraid to sue and American judges, paid on
time, and unafraid to rule. In addition, Russia, unlike the U.S., has no option to draw
from a dense pool of executive leadership—no Welches, Buffetts, Eisners, Goizuetas, or
Iaccocas; no superior management training places or talent pipelines—no Stanford,
Harvard or Wharton and no slew of Fortune 500 corporate finance departments; and no
justice system comfortable with the concept of fiduciary duty.
Perhaps at the heart of reformers’ vision was a romanticized qualification of the
behavior “innate” to the harborer of property rights or the behavior induced by markets.
One lesson of post communist Russia is that ownership in an enterprise need not induce
stewardship of that enterprise, particularly by one whose core competency is theft.
However, we hardly needed Russia for this lesson: in the U.S. where a wealth of
executive talent resides to successfully reorganize, expand or break up any business and
value create for any firm, significant ownership in Enron, for example, did not always
induce exemplary or unquestionable stewardship by the significant owners—including its
founder who actually harbored managerial talent. There appears to have been no real
basis in the American example for the grade of enthusiasm held by western reformers
about any swift transformation to competitive markets of the Russian economy post
communism. Indeed what faint claims of any market success Russia might attempt,
conveniently align with the accident, thanks be only to nature, of Russian oil deposits.