Western Capitalists Riding in on White Horses-Maybe
Dr. Jennifer I Considine and Professor William A Kerr, in the Russian Oil Economy
The following excerpt from the Russian Oil Economy describes early Soviet attempts to attract Western Capital and Joint Ventures. Part of our working history series, the message to industry participants hoping to attract working capital are invaluable…
Rumour had it that there were more people waiting to get in to the Pushkin Square McDonald's on opening day [January 31, 1990] than there were in Red Square, waiting to see Lenin's Tomb (Cohon, 1997, p. 216).
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While the 'Perestroika' of intra-CMEA relations may have progressed at a snail's pace, all of the CMEA member nations, and particularly the USSR, had been taking decisive measures to attract capital flows from the West.
As early as August 1986, Western enterprises were encouraged to submit proposals for joint ventures with Soviet enterprises (Aslund, 1991). On 13 January 1987, the Soviet Union adopted two decrees outlining the conditions and procedures governing the creation of joint ventures with production associations on Soviet territory. In the USSR, the terms offered to foreign partners were hopelessly complex and, in the perspective of Western investors, poorly conceived (Aslund, 1991). A brief summary of the main conditions, and concessions, included:
1. a Soviet share in the joint venture of at least 51 per cent;
2. the requirement that the chairman of the board, and enterprise director of the joint venture were citizens of the Soviet Union; 3. joint ventures were to be 'subject to' all Soviet decrees, and restrictions 'implying an obligation to obey thousands of unpublished acts, which the foreign partner had no right to see' (Aslund, 1991, p. 144);
4. all joint venture purchases from, and sales to, Soviet enterprises were to be conducted through the appropriate Foreign Trade Organization (FTO) at 'agreed prices which took world market conditions into account' (Smith, 1993, p. 129);
5. the joint ventures were not to be subject to the strict provisions of central planning and production quotas, a double-edged sword because of the difficulties associated with obtaining inputs and disposing of output through the still planned supply chains;
6. a 20 per cent tax on the transfer of profits abroad;
7. a profit tax of 30 per cent;
8. full confidentiality of all joint venture information (Riva, 1994);
9. the free transfer of shares to an approved third party; and finally
10. the terms and conditions that had not yet been 'specified' (regulated) were to be determined by mutual negotiation. The latter included but were by no means limited to labour relations, currency restrictions,
taxes, and capitalization.
Perhaps the most important condition for a joint venture in the oil industry was the absolute prerequisite that a licence for the right to exploit mineral resources (oil and gas) be 'transferred' to any joint venture that had been properly registered under the Joint Venture Law of 1987. In the Soviet Union, mineral resources, and indeed all natural resources, were regarded as the natural heritage of the people living in the territory or republic where the resources [were] located. At the same time, the authority over these resources had been 'willingly' delegated to the state, so that the government had exclusive jurisdiction over the rights of exploitation. Licences for the right to exploit natural resources were distributed (granted) to the production associations by the appropriate state mining supervisory body.
As a general rule, the Ministry of Oil and Gas (Minneftegaz)4 and Gazprom were given the first right of refusal on development prospects. Deposits that were rejected, for whatever reason, would subsequently be presented to Mingeo. The production association would not receive title to the oil and gas until it was produced. While foreign partners were not permitted to obtain an equity interest in a licence, 'exploitation rights' would be transferred to the joint venture after the successful completion of a complex approval process. The arduous 'approval' procedure may be briefly summarized as follows:
1. the foreign partner and Soviet production association were requested to draw up a draft joint venture proposal with an unspecified level of mandatory assistance from the appropriate Ministry – Minneftegas and/or Mingeo;
2. the proposal was to be submitted to the council of ministers of the appropriate Soviet republic;
3. the proposal was to be submitted to the appropriate state mining supervisory body, and the Council of Ministers USSR;
4. a government decree was to be written to sanction the proposed joint venture;
5. the joint venture was to be registered by the appropriate republican Ministry of Finance;
6. the joint venture was required to make all necessary provisions to obtain state approval for exports, and gain access to centralized transmission facilities, that is, pipelines.
The complex maze of negotiations, bureaucratic procedures and state agencies, was complicated by frequent turnovers (firings) of agency personnel, and fundamental differences in the perspectives, and unstated requirements of Soviet and Western participants (Stem, 1992). Prominent among these was the absence of a comprehensive and reliable legislative and fiscal system. For centuries, the Soviet Union (and before it, Russia) had been governed by autocrats (dictators), and administrative fiat (rule by decree). This system had no need of rules that facilitated transactions and provided security for investment.
In the late 1980s, the Gorbachev economic reform programme was still in its infancy, and Russia was barely beginning the complex process of establishing the foundations for the comprehensive legal and fiscal regulatory system that would govern the activities of foreign participation in the oil industry (Stem, 1992). The 'subject' of domestic legal reform, and the creation of a law-based state, had yet to be addressed seriously by the Soviet government (Coleman, 1997).
Westem investors, on the other hand, regarded the existence, stability, and predictability of taxes, commercial laws, and legal mechanisms, as an essential pre-requisite to profitable investment (Hobbs et al, 1997). According to Stem ( 1992, p. 41 ): 'A common position of potential investors is that nothing can be achieved until a stable legal and fiscal framework has been established, and has been working for a period of time.' Despite genuine interest by foreign participants, the list of terms, procedures and differences was overwhelming. Applications were deterred by the complexity of the procedures, and the extreme level of political and economic risk. In September 1987 the complex bureaucratic procedure was modified slightly, permitting all-union and republican ministers to grant joint venture approval and joint ventures were permitted to purchase domestic supplies through Gossnab (not simply the FTOs). By year-end 1987, only 23 joint ventures (Ns), representing an aggregate capital investment of approximately 159 million roubles, had been established in the USSR. In December 1988, the Soviet Union adopted a decree offering a number of incentives to hesitant and bewildered foreign investors. These were:
1. foreigners were permitted to serve as chairman of the board and enterprise director;
2. the requirement that the Soviet share ofa N 'must' exceed 51 per cent was abolished;
3. the JV was given greater powers to hire, and fire, workers;
4. limited tax breaks were offered to foreign partners; and
5. the foreign employees of JVs were given permission to pay for housing and services in Soviet roubles (Smith, 1993).
The limited concessions, the first in what would turn out to be an exhaustive repertoire of N-related decrees, revisions, tax breaks and corrections, were not sufficient to attract substantial quantities of foreign capital. By June 1990, an aggregate total of only 1754 Ns had been registered in the Soviet Union (Smith, 1993). The combined N effort, including production and services, amounted to less than 0.5 per cent of GNP in 1990. While there were some glaring success stories – MacDonalds had its first grand opening in Pushkin Square on 31 January 1990 – the victory was too often overshadowed by the arduous negotiation procedure.
MacDonalds, for example, was no stranger to the idiosyncrasies of the USSR, and had in fact been negotiating with the Soviet Union (Brezhnev) since 1976 (Cohon, 1997). The difficulties in the oil industry, which included the obtuse and complex licensing procedures, and the centralized domestic pricing system, were frustrated by the low government priority assigned to Ns in the energy sector as well as unscrupulous entrepreneurs protected by corrupt bureaucrats. According to Stem (1992, p. 29): At the end of 1989, out of more than 1,000 registered Ns, only two involved the energy sector .... Recalling that the dramatic decline in oil production only began in 1989, we can see clearly that the Soviet authorities did not at that time believe that energy was a priority sector for JV activity. If opening up the oil industry to foreign investment was to provide the means to stave off the impending economic collapse, its timidity meant it was a complete failure. It also put in place complex systems that would be hard to dismantle once the planning system was gone. Complex regulations are a mainstay of corruption (Kerr and MacKay, 1997).
References
Åslund, Anders. Gorbachev’s Struggle for Economic Reform. Cornell University Press, 1991.
Cohon, George. To Russia with Fries. McClelland & Stewart, 2012.
“Petroleum Exploration Opportunities in the Former Soviet Union: Riva, Joseph P.: 9780878144143: Amazon.Com: Books.” Accessed June 14, 2024. https://www.amazon.com/Petroleum-Exploration-Opportunities-Former-Soviet/dp/0878144145.
Kerr, W. A., and E. MacKay. 1997. Is mainland China evolving into a market economy? Issues and Studies 33(9): 31-45.
Smith, Brenda J. The Collapse of the Soviet Union. San Diego: Lucent Books, 1994.
“The Collapse of the Soviet Union (Lucent Overview): Smith, Brenda J.: 9781560061427: Amazon.Com: Books.” Accessed June 14, 2024. https://www.amazon.com/Collapse-Soviet-Union-Lucent-Overview/dp/1560061421.