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Toni Schönfelder
A lifetime of innovation

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Toni Schönfelder
A lifetime of innovation

Russia has reverted to the Wild East. But these days the crooks are the government.  
By Frank Brown  
Newsweek May 16 issue -  
The May 9 celebrations are over. Global luminaries have gone home. Now comes Act II: the endgame in the takedown of Mikhail Khodorkovsky, the founding CEO of Yukos Oil and once Russias richest man.  
A Moscow court will deliver its verdict on May 16. The betting isnt guilty or not. Its how many years in prison—10, or something less? The case is only the most visible in a depressing pattern. Russias rulers keep saying that the bad old days of the Wild East are gone. Yet how to explain the regular grudge killings of businessmen? The persecution of entrepreneurs, small and large, by tax authorities and rogue bureaucrats eager to line their own pockets? The epidemic corruption that is the hallmark of doing business in Russia?  
Vladimir Putin is only too familiar with the problem. "Everyone who opens a new firm or business and registers it should be given a medal for courage," he said in March, vowing that his government would change things—quickly. But it hasnt. Does that suggest the Russian president doesnt mean what he says? Or, far worse, that he cant do much—that he has lost control of the very bureaucracy he unleashed on Yukos?  
Consider some stats for Moscow, Russias booming showcase city: 177 businesses were illegally seized in 2004 through force or the manipulation of the courts, according to city halls Economic Security unit. Thats a whopping number, given that private entrepreneurship is in its infancy in Russia. Think what it implies for Putins vision of an economically modern Russia, buoyed by a rising business middle class. Hint: forget it.  
Many businessmen trace the resurgent problem to the mother of all Putin-era hos—tile takeovers: the ongoing legal dismemberment of Yukos, hammered into pending oblivion with a $28 billion tax bill and jail for its leading executives. "Yukos showed that there are no more rules, that Russia has a new reality," says economist Mikhail Delyagin at Moscows Institute for Globalization Issues. Willy-nilly, the case introduced a new-style thug to the Russian business scene: state officials in the Kremlin and security services who use their connections with courts, tax authorities and prosecutors to steal chunks of companies for themselves. "The big bureaucrats understand that they can now control the big companies," says Delyagin, "and the smaller bureaucrats get the smaller companies."  
Whatever ultimately happens to Yukos, the cost to Russia has proved immense. Its once vibrant stock market has tanked. Capital has fled the country—by some accounts the total has tripled since the Yukos affair began nearly two years ago. Growth in foreign investment has slowed. Meanwhile, other emerging markets like China, India and Brazil are looking a lot more attractive, says Christof Ruehl, the World Banks former chief economist in Russia. "You face administrative barriers everywhere—bureaucracy, corruption and the like. But expropriation, as in Russia, has an entirely different quality."  
Thats exactly what happened to an American entrepreneur, Frank Neuman. Over the course of a decade, he built up a profitable chain of six high-end furniture stores in Moscow. He gave money to Russian charities and cultivated contacts among pro-business government officials at the highest levels. One morning earlier this year, armed men came in and took over on behalf of "new owners." Neuman went to the police and prepared to fight, though not before retaining six bodyguards. "I always thought that if I were honest, I wouldnt need a bodyguard," he said in mid-January. Neuman hoped to appeal to the courts, then to his political contacts. But a month later, it became clear his opponents had vastly better connections. When Neuman flew into Moscow on Valentines Day, he was told at passport control that his name was on a blacklist, his visa was invalid and he had to leave Russia. Bizarre as the episode may sound, its anything but rare. To the contrary, says Grigory Yavlinsky, head of the liberal Yabloko party, "this happens all the time."  
Entrepreneurs like Neuman, whether foreign or homegrown, are vital to Russias economic development. Currently, just 13 percent of the countrys GDP is generated by small- and medium-size businesses. (In Western economies, that figure is around 50 percent, accounting for up to 90 percent of employment.) Soaring energy prices have kept GDP growing and helped Russia dodge the problems of its lopsided economy where oil and gas represents 20 percent of GDP and 1 percent of employment. Still, economists agree that there are strict limits to how far Russia can advance without diversifying. "The fact is," says a pro-business lawmaker, Gennady Gudkov, "if there isnt develop-ment of small and medium businesses right now, then we are doomed to a huge crisis."  
On paper, Russia should be a hothouse of growth. Individuals pay a flat 13 percent income tax, one of the lowest in Europe. Corporations are subject to a 24 percent levy. The problem, business owners say, is that avaricious bureaucrats extract crippling bribes in a capricious way that makes planning impossible. One restaurant executive with properties across Russia says that up to 20 percent of his operating costs go to bribes, a situation that has worsened under Putin to the point where his chains profitability is in jeopardy. The cost of opening a new gas station in Moscow can approach $1 million, with $150,000 of that going to satisfy the local officials who must sign off on hundreds of permits, says a part-owner of several stations. Often given a choice between dodging taxes and avoiding bribes, entrepreneurs choose the easier route: taxes, says Dina Krylova, an analyst at OPORA, a small business lobby. "Businessmen want to be transparent," she says, "but theres no law that lets you claim bribes to bureaucrats as an expense."  
Businesses are starting to fight back. Some have banded together to form legal-defense organizations like the Civic Initiative Foundation, started by high-tech entrepreneur Yury Korolyov. His Moscow firm, ICS, was raided last April by 200 club-wielding men led by a minority shareholder, brandishing doctored ownership documents and claiming the premises. They occupied Korolyovs factory through August, leaving only when the local police threatened to step in. Korolyovs use of one branch of the government, the police, to trump another, a court, is a perfect example of how Putin has failed to deliver his much-touted stability. "The bureaucracy is not monolithic," says Ruehl. "This is a scattered bureaucracy of a thousand hydras, a thousand mouths to feed."  
In recent speeches, Putin has pledged to stop bureaucrats from "terrorizing" businessmen. Yet no one expects a change for the better any time soon. Reason: the Kremlin is already girding for the 2008 presidential election, when it will rely on loyal bureaucrats, no matter how venal, to get out the vote. All in all, its a grim time. In New York recently, one of Russias biggest boosters, William Browder, head of Hermitage Capital Management, tried to talk up his client-countrys prospects. Challenged to rank Russia as a place to invest, he paused, then bowed to reality. "Between bad and horrible," he said. Now, thats damning with faint praise.  
With Nadya Titova in Moscow  
© 2005 Newsweek, Inc.  

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