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124 PART two  The Environment of International Business

Active Learning Case

How risky is foreign investment in Russia?


Making investments in any foreign country is a risky
business. Each and every foreign country has a different
set of legal, political, social, and economic institutions.

Source: Quentin Bargate/Alamy Stock Photo


Despite allegations that the world is flat, what we know
is that there remains a large degree of variation in both
country and regional institutional arrangements. So, no
investor can afford to assume that doing business abroad
is risk free. This logic applies to the current situation in
Russia.
A number of problems continue to plague Russia.
Natural resources account for 80 percent of the country’s
exports, including oil and natural gas, making the econ-
omy susceptible to world price fluctuations. The banking
system is weak and, after a series of crises dating back
to 1998, generally distrusted. In 2004, for instance,
smaller banks faced a liquidity crisis as depositors, not an accurate assessment of the political and economic
afraid for their savings, withdrew large sums of money. In situation in Russia. The nationalization of key resource-
addition, widespread corruption and government inter- based companies and the perceived inappropriate treat-
ference in the judiciary process stymies both domestic ment of some foreign investors undoubtedly reflect an
and ­foreign investment. The country ranks as 136th out of increase in Russian economic nationalism. But it is an
175 countries in Transparency International’s “Corruption easier place to do business than many would suspect. It
Perceptions Index” 2014 and among the worst in their ranked 51st out of 189 countries in the World Bank “Ease
“Bribe Payers Index.” of Doing Business” list in 2015 and 5th in the world in
A case in point is that of Yukos, one of Russia’s largest terms of “Enforcing Contracts,” one of the key criteria
oil companies, whose privatization was one of many cor- (although this does fit the stereotype that many have of
rupt undertakings in the transition to a market economy. the country).
The government sought to collect back taxes that are The reason that Russian authorities will not engage in
threatening to bankrupt the company. Yukos is charged massive nationalization of foreign assets is that the Russian
with tax evasion, but critics claim the move was politi- economy remains dependent on foreign investment. Russia
cally motivated and that the tools used to evade taxes has large supplies of energy resources, but it needs to sell
were perfectly legal under Russian law when they were these to foreign consumers. Russia’s resources will lose
undertaken. value if they are restricted to Russian consumers. There is as
By 2010, the former Russian oil tycoon Mikhail yet no economic evidence that Russia is seeking to be a self-
Khodorkovsky of Yukos was already serving an eight-year contained, protected, and isolated economy. Instead, it relies
jail term for fraud and tax evasion. In the verdict of the upon trade and foreign investment. However, at a time of
second trial on December 27, 2010, he and his business increased concern over energy security, Moscow has more
partner Platon Lebedev were found guilty of stealing bil- than once reminded the rest of the world of the power it
lions of dollars from their own oil firm, Yukos, and laun- yields as a major energy supplier. In the past it cut gas to
dering the proceeds between 1998 and 2003. They would Ukraine after a row between the countries—a move that also
have to stay in jail until 2017. Many critics believe the affected the supply of gas to western Europe. This then led to
government wants the former tycoon kept behind bars for armed conflict in the region.
as long as possible because he challenged the president Today Russia is one of the largest economies in the
Vladimir Putin. As a result of this internal uncertainty, world. It is attracting large amounts of foreign direct
foreign investors continue to reassess their opportunities investment from members of the European Union, espe-
in Russia. cially Germany and the UK. But the Russian government is
It is often argued that such political events in Russia thought to have an “extensive shopping list of information”
make it far too dangerous a place to do business. This is that it is trying to acquire through covert means—on the
CHAPTER 4  International Politics 125

aerospace industry, defense, and information technology, specific investment projects can escape risk. Russia is still at
as well as in politics and diplomacy, and significant cross- an early stage of economic development. It is not very long
border political tensions continue. A long-running dispute since the Berlin Wall crumbled and the former Soviet Union
that began with the apparent murder of Alexander was opened to market forces. Russia has found it difficult to
Litvinenko in London in November 2006 led to diplomats develop the appropriate market-based institutions to match
being expelled from both countries. It continued over ten its acceptance of worldwide capitalism.
years and in January 2016 the findings of a public enquiry Instead, Russia remains an autocratic regime, and foreign
strongly suggested that President Vladimir Putin approved investors need to be careful in making commitments where
the murder. the normal level and contractual arrangements available in
Despite this reversion to Cold War diplomacy, it is not the EU and North America do not yet fully exist. However,
anticipated that British investment in Russia will decrease. Russia is making progress in improving its institutional
Nor is it expected that London will stop being a second home framework. Investors need to adopt a long-term view and
for many wealthy Russian businessmen. In short, the British/ should not be thrown off by short-term political develop-
Russian political difficulties appear to make less of an impact ments in Russia. Foreign investors should seek to build last-
on the economic relationship between the two countries than ing personal relationships with Russia’s leaders in business
one would expect. and economics.
In contrast to the British case, US political relations with Websites: www.ford.com; www.imf.org; www.worldbank.org; www.
Russia have been more benign. There have been a number of tetrapak.de; www.pepsico.com; www.mcdonalds.com; www.yukos.com;
bilateral trade and investment agreements between the two www.telia.se; www.sonera.fi; www.telecominvest.com; http://www.
transparency.org/cpi2014; http://www.doingbusiness.org/rankings
countries. The United States also helped Russia with its
application to join the World Trade Organization. In general, Source: Adapted from Alan Rugman, “Is it safe for Americans to invest in
Russia?,” Kansas City, Sunday Star, October 7, 2007; “Cinderella’s witching hour,”
US officials encourage US investment in Russia, and also
The Economist, July 8, 2004; “Court ‘freezes’ key Yukos assets,” BBC News, April
welcome Russian investment in the United States. It is 19, 2005; Russia Country Profile, news.bbc.co.uk; “Prove my aid is Russian spy,
unlikely that the US government will take any action to offset says MP Mike Hancock,” BBC News, December 5, 2010; “Russia postpones verdict
on oil tycoon Khodorkovsky,” BBC News, December 15, 2010; “Russian ex-tycoon
its ongoing concerns about human rights violations in Russia Khodorkovsky appeals against jail term,” BBC News, December 31, 2010;
or an increase in Russian economic nationalism. Transparency International, 2014 Corruption Perceptions Index, http://www.
This long-run analysis of why Russia will remain an inte- transparency.org/cpi2014; World Bank, Ease of Doing Business survey, 2015,
http://www.doingbusiness.org/rankings
gral part of the world economic system does not mean that

1 What type of economic system now exists in Russia: market-driven, centrally determined, or mixed?
2 Would Russia benefit by gaining admission to one of the major economic unions such as the EU? Why?
3 Is Russia a good potential investment for Western business? Explain.

Introduction
Over the past two decades, many countries have seen a dramatic change in their political
systems. In general this has been characterized by a return to democracy for many develop-
ing and emerging economies and the development of more mature free market systems.
Two significant examples are China and the Russian Federation. Each has a very different
central government and governance system, but both have embraced free market econom-
ics and reforms are progressing across many fronts.
The movement toward market-driven economies of countries that were once controlled
by the former Soviet Union is the result of historical political reforms. For example,
Poland, Hungary, the Czech Republic, Latvia, Lithuania, and Estonia, to name but six,
have all created market-driven economies. Years ago the former Soviet Union would not
have permitted these satellite nations to abandon the command economy advocated by
communist ideology and replace it with a free market system. Under Mikhail Gorbachev,

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