Russia's Big Conglomerates and the Country's Modernization

On Wednesday, April 17 Professor Alexander A. Dynkin spoke about "Russia's Big Conglomerates and the Country's Modernization." Professor Dynkin is First Deputy Director of the Institute of the World Economy and International Relations (IMEMO) and corresponding member of the Russian Academy of Sciences. He has worked as an economic advisor to former Prime Minister Yevgeny Primakov and former Deputy Prime Minister Boris Fedorov.

Russia is a country dominated by 15-20 big conglomerates. Professor Dynkin recently completed a study of these conglomerates and their effect on the Russian economy. Professor Dynkin examined 738 enterprises belonging to 8 different Integrated Business Groups (IBG). Each IBG was selected for the study on the basis of five formal statistical criteria - output volume, reported profits, number of staff, market value and volume of exports - and various informal criteria such as cross ownership of property and friendly relations between top managers. Russia's large state-owned natural monopolies like Gazprom and RAO UES were purposely excluded from the study. The 8 IBGs that were selected were LUKoil, Yukos, Interros, Surgutneftegaz, Alfa Group-Renova, Sibirski Aluminy-Sibneft, Severstal and Sistema. Together these 8 businesses account for 15% of Russia's total output of goods and services and over 32% of Russia's industrial output.

Each of these IBGs share common structural elements. Within each IBG there exists a core group of manufacturing and banking enterprises surrounded by a wide web of financial institutions, building companies, transport companies, mass media outlets and even health and recreation centers. According to Dynkin, this vast hodgepodge of enterprises that reside within one IBG is a natural reaction to the system of centralized economic planning out of which these conglomerates emerged. In form, these Russian IBGs are similar to other large chaebol like companies that have taken root in countries as diverse as India, Brazil and Chile. In the early 20th century, the United States itself had similar types of business. The Ford Motor Company of 1927 really was not all that different from the Russian IBGs of today.

Recently, various trends in the development of Russia's IBGs have begun to emerge. Most notably, these companies have begun to shift the focus of their activities from simple resource extraction to higher value-added sectors of the economy. Both Interros and Sistema have moved aggressively into communications and electronics, while Sibirski Aluminy-Sibneft and Severstal have started to develop enterprises in the engineering industry. All 8 of the IBGs studied by Professor Dynkin appear to have weathered the 1998 financial storm intact and have steadily increased their share of tax revenues, to over 25% of state revenues for 2000, their share of exports, to over 25% of Russia's total volume of exports for 2000, and the level of their long-term investments in the Russian economy. Concomitantly, Russia's IBGs have expanded their activities in Russia's regions, opening numerous regional branches and acquiring local enterprises. Most IBG activity is focused in Russia's central federal district, but large gains have been made in the Privolzhski, Siberian, Ural and NorthWestern districts as well. Thus, these IBGs are well poised to continue in their roles as major investors in the Russian economy for the next 5-7 years.

Overall, the growth of IBGs has had many positive benefits for the Russian economy. IBGs have been instrumental in adapting Russian big industry to the market economy. They have cut transaction expenses and helped mediate between individual companies and imperfect markets. They have effectively concentrated highly qualified human capital where it has been most in demand and have taken technological and financial risks, helping to bring innovative new products to the market. Moreover, IBGs have been crucial in mediating between the interests of their own enterprises and those of foreign partners and the authorities.
In light of these positive developments, Professor Dynkin proposes more active state support for IBGs. A number of measures including state subsidization of interest rates on merger & acquisition financing, transferring state-owned stock to trust managements and converting enterprises' tax debt into stock for sale to strategic owners would help these companies. Overall, the development of Russia's IBGs should be guided by joint decision making between state and business representatives. Consultations with industry associations should be encouraged through the Ministry of Economy, while a place should also be made for consulting firms and PR-agencies to voice their opinions to ensure that numerous actors can provide input in government to business relations.

In the future, Professor Dynkin believes that there are three possible ways for Russia's big conglomerates to develop. The first and most likely scenario would be the corporatization of these IBGs with their transformation into public highly-diversified industrial corporations, supplying a wide range of products and services. In the second scenario, these IBGs would consolidate their positions through leveraged buy-outs, selling part of their non-core assets while forming a core business group. The third possible scenario would be the complete disintegration of Russian IBGs resulting from a 'managers' revolution', whereby enterprise managers would seize the stock of profitable companies and force the owners to hand over the controlling stock.

Whatever the future may hold for Russia's IBGs, they remain, in Professor Dynkin's eyes, the key to ensuring investment in the Russian economy. It may be true that big conglomerates hamper the growth of small business, have a dubious impact on the strength of democracy and do not always ensure a proper allocation of resources, but given historical circumstances Russia simply has no other choice in its development strategy. Russia's banking sector is far too small and the capitalization of its stock market is too low to adequately meet the investment needs of the country. As long as foreign investors remain wary of Russia's notorious pitfalls, IBGs will remain the only resource available for financing Russia's continued growth.

Summary by Karlis Kirsis, Junior Fellow, Russian & Eurasian Program.