Exclusive Coverage of Dr. Tucker Hart Adams President and CEO, The Adams Group

The following is excerpted from a presentation delivered in Denver on March 18, 1998 by Dr. Tucker Hart Adams. Dr. Adams is a nationally known Colorado economist and businesswoman. She is founder, President and CEO of American Russian Collaborative Enterprises (ARCHES), LLC and The Adams Group, Inc., based in Denver, Colorado, and a founder and director or ARCHES-Moscow. She has worked with numerous U.S.-Russian joint ventures and business projects. Dr. Adams serves on numerous corporate boards, foundations and advisory committees. She is a popular writer and public speaker, known for her frank assessments and down-to-earth analysis. Dr. Adams is a member of the Russian-American Chamber of Commerce®.

"A few months ago I gave a presentation at the University of Colorado Business School. The only Russian in the room sat across from me, his face expressionless. I pay attention to my audience as I speak, watching their faces to be sure they understand what I am saying. As I spoke about the Russian culture and the way Americans must behave to be successful there, there was no reaction from the Russian, indeed he looked almost hostile. "I have it all wrong," I worried. "I don't understand Russia at all." After my presentation was over, the Russian waited until everyone else had left to speak to me. "Oh no, here it comes," I thought. But he said, "That was great! I have never seen an American with a better understanding of the way Russians think." I breathed a sign of relief and realized, once again, how difficult it is for an American to read the reactions of his/her Russian customer.

I have worked very hard to understand the Russian mind and how Russian business is done. The biggest challenge to Americans trying to do business over there isn't the mafia or the language. It is trying to understand and think the way your Russian client does.

Russia in Review

In the past year I have become very aware of how badly the Russian people have been demoralized by the changes of in the last 10-15 years. Initially, there was boundless optimism: "Everything is going to be wonderful, soon we'll live like rich Americans."

But, reality has set in. Even the people that I consider strong democrats in terms of supporting the reforms, people who are doing well financially, are discouraged. It is so easy to focus on how far Russia has to go that sometimes they forget to look back and remember how far they have come. For Americans, this is even harder.

If you look back 15 years ago, the communists were firmly in charge. It was a centrally planned economy. And, it was an economy that was collapsing, imploding. There were long lines. There were shortages of goods. It was a grim situation.

In April of 1985, Gorbachev came into power. He had no plan to decentralize decision making, no plan to change the political regime. But he did recognize that something had to be done about the economy. What he set out to do was to implement a system of socialism, of communism, but with a much higher standard of living. The Russian people had been told that they had the highest standard of living in the world. But, even back then there was enough travel back and forth that they realized this was a lie.

In 1986, Gorbachev proclaimed perestroika and glasnost. Things were going to be open. Things were going to change, to improve. It was a time of hope, of anticipation of the future.

In 1987, Gorbachev realized he was going to have to decentralize economic decision making. A law was passed permitting cooperatives. One of my Russian business partners organized the fifth cooperative in Russia, selling honey. It is still in existence. At the same time, Yeltsin began his rise to power and popularity. Yeltsin was critical of how slowly things were happening, urging Gorbachev to make things happen more rapidly.

In 1988, Gorbachev recognized that political reform was necessary. He realized he would not be able to accomplish what must be done by working only on the economic side. Power was transformed from the Party to the Soviets. Legally, perhaps, it had always been that way, but in fact power was vested in the Party.

1989 was Gorbachev's finest year. It was the time of my first trip to Russia. Gorbachev was extremely popular. He convened the Congress of People's Deputies, with representatives from all over Russia. Human rights activists spoke up publicly with little fear of retaliation. But, by the end of the year it was apparent that reform had broken free, that Gorbachev had lost control.

Gorbachev was elected president of the Soviet Union in 1990. He gave up his post as leader of the Party, a very important symbolic action. And, of course, 1991 was the last year of the Soviet Union and the year of the first coup. Boris Yeltsin was elected president of Russia, one of the 15 Soviet Republics. By the end of December, the Soviet Union had been dissolved, Gorbachev was out and Yeltsin, as president of the Russian Federation, held much of the power that was once Gorbachev's.

From my point of view as an economist and businessperson, 1992 was really the most critical and interesting time. Prices were freed in January of 1992; they tripled over night. Gaidar became Prime Minister and, with the help of American advisers, implemented shock therapy. The idea was to make the changes all at once, accept the fact that things would get worse for a little while and get it over.

The expectations, both for Americans and Russians, were extremely naive: The economy would contract for 18 months, prices would triple. But then, the worst would be over and foreign investment would pour into Russia.

So we thought. The reality, of course, was that in 1992 prices went up 2700%, while output declined 15%. Despite this, the market worked in some ways. Consumer goods became more readily available, for example. When I returned to Russia in the fall of 1992, I could not believe my eyes. First in Sheremetevo Airport and then when I went onto the streets, I saw western automobiles and kiosks brimming with things to buy. It was an interesting combination of goods - Marlboro cigarettes, Mars bars, Pepsi and cheap electronics and polyester jackets imported from China. For the first time in my travels to Russia, you could buy a pop and a candy bar if you were hungry. That was seldom possible in 1989 and 1991.

In 1993, disenchantment set in. Prices went up another 900%. Output declined another 15%. Gaidar was fired. The second coup in October was extremely violent. Yeltsin's popularity has never recovered from the fact that he was forced to shell the White House, shooting his own people. There was a referendum. To a lot of people's surprise, the Russians rallied and voted to support the new Constitution and the president. But, Yeltsin's popularity was on the decline.

In 1994 came the second near fatal blow to Yeltsin's popularity: the war in Chechnya. Prices went up another 200%. Output went down another 15%. However, if you looked closely at inflation, as bad as it was, a positive pattern was emerging -down from 2700% to 900% to 200%.

In 1995, there were new parliamentary elections and the communists did very well. Prices only went up 100%. GDP declined only 3%, a rate that is comparable to a serious recession in the U.S. Perhaps the most important thing to occur was the government's decision to stop printing money. Inflation had been fueled by a central bank that was turning out rubles literally as fast as the printing presses could produce them.

In 1996, presidential elections were held. Inflation dropped to 22%. Output fell 5%. The worst, for the economy at least, was over.

1997 Developments

This brings us to 1997. Last year, improvement became obvious, at least in Western Russia: renovation and new construction were underway on every corner, new automobiles jammed the streets. Inflation slowed to 12%, about what it was in the United States 20 years ago. Output actually increased by 0.4%. This is very important, because what dominates the official statistics is the old industrial sector, the former state factories. This is the weakest sector of the economy. What is doing well is distribution and services, dominated by the new entrepreneurial firms. Much of this activity is conducted off the books, it doesn't show up in measured output. Plus, you have to remember that in the old system the incentive was to overstate growth, since you were measured on meeting your quotas. Now with taxes running well above 100% of profits, the incentive is to understate.

Other good things occurred. The average real income in Russia rose 2.5%, a statistic that is seldom mentioned. Not everyone's income increased - some people did very well, while others became even more impoverished. But, a significant middle class appeared, families with discretionary income that allowed them to purchase cars, refrigerators, to travel abroad. In 1997, about a third of all Russians owned automobiles. In 1989, traffic was light in Moscow, and there were few cars in other parts of the country. Now, you take your life in your hands every time you step off of the curb.

While it is important to be aware of the positive things that have occurred, we must also remember the enormous trauma that people have been through, what has happened to the routine of daily life, the value system and the social infrastructure. The unanswered question is whether the good things that have occurred - economic growth, growing stability, moderate inflation (probably at the single digit level in 1998), a stable ruble - are worth the price.

A Multi-Part Economy

To answer this question, we must understand what has resulted from the trauma of the recent past. First, a multi-part economy has developed. There is the old state sector and the new entrepreneurial sector. Within the old state sector, now privatized except for a few strategic industries, there is a three-tiered economy. The first tier, primarily oil and gas production, is growing solidly at about 3-5% a year. Even in the early years when it was contracting, it only shrank about 5-10%. Fortunes have been made in this sector.

The second tier includes electric utilities, telecommunications, some of the ferrous metals, chemicals and the weapons industry. These industries are growing slowly, after a decline of approximately 20-30%.

Then there is the third tier, the rest of the old state economy. It is comprised of the textiles industry, apparel, agriculture and the rest of manufacturing. These sectors have already declined by 80-90% and are still contracting. If you go out to a city like Ivanovo, an old textile center, it is very depressed. Near Moscow you can visit a former aircraft plant that now makes plastic stoppers for bathtubs, desperate for any contract that brings in a little business. Depending on the economic base of the city in which you are doing business, you get very different reports on how things are going in Russia. Each is an accurate, realistic assessment of the current situation. It is impossible to speak on average about the Russian economy.

Outside of the three tiers that comprise the former state economy is a new entrepreneurial sector that is flourishing. Here people are making an incredible amount of money. The new entrepreneurial sector is now spreading into telecommunications and a limited segment of manufacturing.

Rising Nationalism

The second thing that is happening as a result of the trauma that people have been through is a rise in nationalism. There's clearly disenchantment with the West. The idea that if it is American, it's better, has changed substantially in the past two years. No longer are American films the best. Now people are saying Russian films are better. It's not American chicken that's preferred. People are saying Russian chicken is much tastier. This is a significant change.

Nationalism is not bad per se. It is important to have pride in things Russian. But rampant nationalism can quickly slide into fascism, the kind of thing that happened in Germany in the 1930s. We are very fortunate that Zhironovsky, the militant nationalist who did so well in the first Duma elections, has been completely discredited. Despite the fact that he is charismatic and knows how to play to a television audience, he's no more than a clown. The Russian people, initially enchanted with him, have been put off by his bizarre behavior and he has little influence. I shudder to think what could have happened if he had been a much more sensible person who maintained people's admiration.

Another factor related to nationalism that cannot be ignored is the Slavic idea that Russia has a special place in the world. It manifests itself in a number of ways, but one of the most common is the belief that Russia has a unique, almost God given role, to stand between the East and the West, as a bridge between the two cultures. There is a lot of conflict within the government, and within business, between people who think they need to adopt the Western way and others who think that Russia should fulfill its mystical destiny, remaining apart from the West. One of the factors contributing to the near-hatred of Chubais is that he looks to the west, disregarding the Slavic ideal. He does not embrace this idea of Russia's special role standing apart from the West.

Business Issues

There are a number of issues you need to be aware of when doing business in Russia today. I discuss them in no particular order, but you can't do business there without confronting them.

First, there is the tax system and the resulting nonpayment of taxes. Current tax policy is based on the expectation that people will not pay taxes. If you add up all of the different types of taxes that a business must pay and consider all of the normal (in the western sense) business expenses that cannot be deducted from revenues, tax rates run anywhere from 93% to 135% or more of profits. As a result, tax avoidance is an art form. Less than 50% of the taxes that are levied are collected. The typical way things work in Russia is that the tax inspector shows up, takes over a desk in your office, sets up shop and stays there a few weeks investigating the company. Eventually you work out a deal with him. He gets to keep something. You get to keep something. The government gets to keep something. And he goes away happy. Yeltsin was elected, I believe, because he had an unspoken agreement with large businesses and banks in Russia that he wouldn't insist that they pay taxes. In return, they put large amounts of money into his campaign. It should be no surprise that large businesses are not being forced to step up and pay the all of the taxes they owe.

Now, if the government is not collecting taxes, but its expenses continue, there are only three options. First, the Central Bank can print the money, but this quickly fuels triple digit inflation, or worse. The Central Bank has resisted doing this.

The second option is not to pay the bills. There has been a lot of this. The Russian government is not refusing to pay salaries and pensions because the leaders are mean, cruel or uncaring. They just don't have the money to meet all of their obligations. So, they pay pensions this month, the coal miners next month, the army the next month. How to pay the people still in the state sector is a major problem. For example, professors at a university make about $60-70 a month, well below the average wage and far less than they need to get by. This used to be a well paid, highly respected sector. You find a lot of bitterness among people like this who have become economically disenfranchised. People still in government jobs - teachers, artists, entertainers, sports figures - who were previously well paid and enjoyed prestige and respect, are very angry and bitter about all the upstart entrepreneurs who drive Mercedes and are doing very well.

The third thing government can do is issue debt, borrowing the money like we do in the U.S. But there is a limit to this. There is only a certain amount of debt that financial markets will absorb. In addition, government borrowing crowds out money for private investment. Government debt is almost always safer than private investment and the government, unfettered by a profit constraint, will pay whatever interest rate it needs to get the amount of money it wants.

Another issue, and certainly the one that gets the most attention in this country, is corruption and crime. This is clearly a problem. However, I see very little evidence, either personally or in the Russia media, of street crime, the random drive-by shootings, rapes and muggings that people generally worry about in America.

But the mafia clearly exists. At its best, it performs functions that should be the responsibility of the government. It serves as a private police force, ensuring order. It enforces contracts, although it does not recognize the concept of limited liability.

At its worst, there are the forced payoffs and Chicago gangland-style contract killings. No question that this is there. Particularly if you are a large visible business, this will be a part of your reality. You must have a Russian partner to help you weave your way through this maze, because it would be a serious error to deal with this type of organized crime.

But, you must recognize that "mafia" means many things in Russia and there are an estimated 4,000 separate mafia groups. I taught a commercial bank lending course two years ago and, when my students wrote their business plans, almost everyone included an item to payoff the local mafia.

Another problem, perhaps the one that makes people the angriest, is what I call the negation of the social contract. There was an unspoken agreement in the Soviet Union that people would work for the government until they retired, at 55 for females, and 60 for males. They wouldn't be paid very much, but they would get a lot of free or cheap goods and services. Then, when they retired, they would receive an adequate pension, a pension that would not only take care of them in their old age, but would give them money so they could help their children. The sad thing is that today's retirees kept their half of the bargain. They did what they were supposed to do. But now the government doesn't have the money to pay adequate pensions. Even when they are paid, they provide at best half of what is required for a modest standard of living. So people feel they have been double-crossed. Even the young people, the ones who are doing well, are angry when they see what has been done to their grandparents. It's not fair. This whole burden of social infrastructure, which in the past fell totally on the government, has nothing to take its place.

As a result of all of these things, there has been a loss of faith in the reformers and the process of privatization. There is no question that a lot of corruption exists. People who were factory managers under the old system suddenly acquired large chunks of shares under the new system. People who were in the government running the privatization process ended up very wealthy. There is no question that, when there is a tender offer, certain banks always seem to have the highest bid. I don't think the process is as corrupt as the average Russian believes it is, but I do believe it is a corrupt process. People are disillusioned with what they call crony capitalism.

If you really want to do business in Russia, you need to be part of a financial industrial group, which is a combination of business and banking. It's how you become an insider and there are some special tax laws, particularly relative to VAT, that are attractive for these financial industrial groups. But, it's another manifestation of crony capitalism.

Consequences

Many people have lost faith that the situation will change anytime soon. When the government tells them it's going to get better, they laugh. Communism was 70 years of lies about how things would soon improve. Don't try to explain to a Russian colleague about delayed gratification if you want to be taken seriously.

Another huge concern is what I call the loss of moral grounding. Under communism a type of morality was imposed by force. That's gone and there is nothing to take its place. Within a small group composed of immediate family and close friends, total trust and total honesty exist. But once you are outside of this group, anything goes. I wonder if a true market economy can develop without a moral standard that allows people who don't know each other to do business expecting the other party to live up to its word. One of the great strengths of the United States is that most people, most of the time, will do what they tell you they are going to do. Americans are generally pretty honest. We can't judge Russia by our standards, because they don't have the same moral standard that we do. The question is whether our standard is fundamental to a market economy.

Some people say that the church will replace the state and provide the new standard in Russia. I don't think so. The return to religion that I see is superficial. Religion is a trendy thing. It's cool to be baptized, wear a cross and go light an occasional candle. But it goes no deeper than that. The church is probably as corrupt as any of the large economic units there.

Perceptions

So, you decide, despite the obstacles, to do business in Russia. What are you going to face?

First of all, you will deal with a culture that is more Eastern than Western. It is a culture that is based on friendships, favors, who you know and the fact that someone's relative's relative works in the agency where you need to get something approved. Much of the world does business this way, but America doesn't. Much that is accepted practice in Russia is illegal here. To be successful in Russia you must play by their rules, not ours.

Second, something that concerns me enormously as an economist, is the total misunderstanding about the direction of causality between the collapse of the economy and perestroika. In other words, which one caused which? Russians, almost to the person, will tell you Gorbachev came into power, instituted perestroika and caused the economy to collapse. In fact, it is crystal clear that it was the collapse of the economy that forced Gorbachev to do what he did. If it hadn't been Gorbachev, it would have been someone else, although he was a man uniquely suited for his role in history. I think this critical misunderstanding misleads people into believing that if they could just go back to the way things were before, then everything would be okay. The other thing I find is that when people think back, they don't think back to how it was in 1989 and 1990, they think back to how it was under Brezhnev, when they were still living off of the seed corn, so to speak. And we always look at the past through rose-colored glasses, remembering the good and forgetting the bad. I say to my friends, "Don't you remember when you couldn't get milk for your kids? Don't you remember the lines and the shortages?" There is a real misunderstanding of what caused what.

Another critical issue is that of pride versus lack of experience. Russians are well educated, savvy people. They are proud people. But they are simply being forced to deal in a world where the rules have totally changed and no one gave them the manual. They don't want to feel stupid. Several things happen as a result of this. One thing is that sometimes you get no response to an idea or proposal. What I have learned over time is that this is frequently because they don't know the answer, not because they aren't interested in your project. They stonewall you, rather than admitting that they don't know. If you understand this, then you can very gently help them understand, without making them feel dumb. If you are successful, the barriers will suddenly disappear. The ugly American is not an unrealistic caricature. We go over there, knowing everything, sure that we have all the answers. There's nothing more arrogant than a young MBA, fresh out of a top business school. We have to whip them into shape in the U.S. But, in Russia they are often turned loose without experienced managers to season them. This is not the way to do business in Russia. If you can step in and help the Russians be smart, serving as a bridge between the two ways of doing things, you will be enormously successful.

Russians distrust foreign promises. We have been going over there since 1991 making promises, "We'll do this, we'll do that, we'll be back with money." But not much has happened. Very little American investment has gone into Russia. Most of our foreign aid went to American accounting firms and huge consulting groups, not to Russian businesses. Russia desperately needs foreign capital. People pay too much attention to what the newspapers say about what is going on in Russia. Because of this, they are afraid to invest there.

There is also a lot of talk about capital flowing out of Russia, that Russians don't invest in their own country. This isn't true. Russian capital is being invested in Russia, but it arrives there through a circuitous route. Because of the tax system, one can't make money in Russia, then reinvest there without attracting unwelcome attention from the tax authorities. So, Russian profits go through an offshore bank before being reinvested in Russia. The investment then shows up as an inflow of foreign capital, even though it is Russian money. This lays to rest the question of why one would want to invest in Russia if the people who work there and know it best won't invest in their own country. They do, the money is just coming in through the back door.

Western Attitudes and Misperceptions

I am concerned about the attitude and the misunderstanding of the West towards Russia, especially the misunderstanding exhibited by our politicians. Secretary of State Madeline Albright, a college classmate and friend at Wellesley, shows little understanding of the situation in her dealings with Russia.

The expansion of NATO is a case in point. What was NATO created for? To stop the Soviet threat in Western Europe. It should come as no surprise that the Russians are upset about the planned expansion of NATO. It baffles me why NATO is not simply dissolved, after declaring victory. It could then be reconstituted under a new name, with the same membership, around the broader purpose of peace in Europe. It would be a collaborative new effort with the former Soviet Union and Eastern Bloc, not an expansion of something that was created to contain the Soviet Union.

Or, take our handling of the D-Day celebration. We didn't bother to invite Russia. The United States lost about 500,000 troops in World War II. Russia's losses, including civilians and soldiers, were over 40 million. Russia contained 70% of the German forces on the Eastern front, so we only had to fight 30% of the forces on the Western front. They were insulted and hurt by the fact we didn't include them. This wasn't merely insensitive, it was stupid. The entire attitude of Congress and the President, with their misunderstanding of Russia, is creating problems in present and future U.S.-Russian relations.

Conclusions

To summarize, you'll find that exploitation is the name of the game in Russia. You just have to work with within the system. My granddaughter says, "Nana, just deal with it!" That's the only way to approach business in Russia.

Be prepared to deal with the lack of effective Russian managers. The concepts of management, efficiency and motivation were not a part of the Communist system. Your Russian employees and colleagues will have to be trained in these skills.

My advice to people is to go in with your eyes open. Find an honest, reliable Russian partner. Get outside of Moscow and St. Petersburg. There are a lot of people trying to do business there, but there are many opportunities in the other oblasts. Do your homework before you go. You have to be able to work with the local administration. It is usually much easier to work with the regional governments than with the federal authorities.

If you have a strong stomach and a long time horizon, Russia is the place to be. Just deal with it!"

russia@rmi.net

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