When asked whether his company was profitable last year, Kakha Bendukidze, the president of Uralmash, once one of the world's largest machine tool and armaments producers, replied, "By Russian accounting standards we had a $40 million profit; however, by Western accounting standards we had a $50 million loss."
Bendukidze's accounting quandary dramatically illustrates how distorted the Russian economy has become in the wake of what were supposed to be liberalizing economic reforms. Much of the problem stems from faulty privatization procedures that have resulted in the brazen theft of state property. Less attention has been devoted to another factor: barter, which has displaced the ruble in anywhere from 70 to 80 percent of the country's business transactions.
Barter is an extremely inefficient way to run a country. Moreover, with barter, the buyers and sellers are never sure precisely what their actual costs and sales prices are–which explains why Uralmash's president reported a profit using Russian accounting procedures and a loss using more precise Western standards.
As unsettling as these arbitrary practices might be to an American businessperson, in today's business climate many Russians prefer barter to cash transactions. Barter in Russia among businesses has a long history with origins in the prerevolutionary period. It was also used widely during the communist era of central planning. In fact, the way economic activity is conducted in Russia today and the way Soviet managers traded with one another for goods not provided in their planning allocation are striking.
Because it is so inconvenient and cumbersome, as societies grow economically they dispense with barter and rely increasingly on money transactions. As elementary economics textbooks point out, it is much more efficient to attach prices to goods and services and pay for those goods in a common currency than to swap one good directly for another. By using currency and prices there is no need to determine relative values and locate two or more parties with goods that equal each other in value. Barter makes it more difficult to establish precise values; as a consequence, not only must more resources be devoted to conducting a swap operation than would be the case if all purchases and sales were conducted in cash, but usually the goods obtained in exchange bring less value to the transaction than if cash and prices were used. Economists call this extra time and expense a "transaction cost." Normally, therefore, it is only when an economy is dysfunctional that barter increases as a share of GDP. What makes modern-day Russia so intriguing is that even when the economy seemed to be showing signs of improvement, barter continued to play an important role.
Why is barter, which is avoided by Western businesspeople, so attractive to their Russian counterparts? The answers provide important insights into Russia's culture and its economic mores.
By the time Stalin instituted centralized economic planning in 1928, the economy had reconstituted itself but with a prohibition against the private ownership of the means of production in industry, agriculture, and services. This should have reduced the role of barter since, in theory, if central planning is fully effective, there is no need for barter; all enterprise and personal needs will be anticipated and supplied and the enterprises will conduct their transactions by clearing ruble debts and credits in state-owned banks. But in real life it is nearly impossible to be so omniscient. Even in market capitalism there are periodic shortages (beanie babies) and gluts (Redux pills). In time, barter came to account for an increasingly large number of transactions in the Soviet Union, not only among individuals but also among state enterprises.
Contrary to expectations, planning in the Soviet Union seemed designed to create anything but equilibrium conditions. Many planners acknowledged that they intentionally attempted to generate taut economic conditions. Their rationale was that this was the best way to stimulate higher output. Sometimes tautness achieved just that, but as often as not the ubiquitous disequilibria provided bountiful windfall opportunities, an environment made to order for underground activity and barter.
Stalin was determined to curb such behavior, severely penalizing those who circumvented the plan by operating private production facilities. Police surveillance and controls did deter many from risking jail or even execution. As a result, there were even greater profit opportunities for those daring enough to flout the law.
While private profit-making activities were clearly illegal, there were other gray area practices adopted by most state enterprises to cope with the rigidities of the planning process. Because the plans were set so far in advance, factory directors almost always found themselves in need of one input or another not anticipated by the plan. Failure to satisfy such needs, however, would often jeopardize plan fulfillment.
To avoid the criticism and penalties that invariably followed planning shortfalls, most Soviet enterprises used the services of what were called tolkatchi (pushers or expediters). Their function was to supply the plant director with whatever was needed but not included or delivered by the plan. This usually meant falling back on unauthorized sources of supply. Payment for these goods was made sometimes in rubles but just as often in barter or swaps. Technically such activities were illegal. Periodically state authorities would arrest a circle of tolkatchi who might have been particularly blatant or excessive in their dealings.
For the most part the tolkatchi were tolerated as a necessary evil because it was widely acknowledged that without the flexibility they provided, the planning system would have been even more rigid and unresponsive than it was. Many Russians came to assume, even if only subconsciously, that the tolkatchi were essential to the smooth functioning of the Soviet economy. As a consequence, over the years large numbers of men and women were trained to deal in these often arcane practices. Just as Americans have placed a premium on developing a large core of specialists skilled in finding new ways of raising capital on Wall Street (practices of absolutely no use in a centrally planned system), so large numbers of Russians developed bartering skills that would have been of little or no use in a healthy market system.
As Presidents Mikhail Gorbachev and Boris Yeltsin began to allow and ultimately encourage market practices, it looked for a time as though there would be less and possibly no need for underground or barter activities. After 1987 it was no longer illegal to operate a private business, and with the disappearance of the five year plans, there were no longer constraints on what directors of enterprises could buy or sell. Those who had been operating in a clandestine fashion could now operate in the open.
On a visit to Sakhalin in 1992, I saw firsthand such a transformation. I was introduced to a hunter who had just opened a retail store that sold fur skins and coats. However, he also took me to a secluded basement workshop that he had operated clandestinely for many years in the Soviet era. Once it became legal to open a private business, he literally moved out of the underground basement and established a street-level presence.
Not all Russian businesses moved so quickly to establish a legal presence. Given the many policy changes of the past, some feared there might again be a similar reversal penalizing those who too quickly embraced the market and capitalist exploitation. But there were other concerns, some because of the fear of crime, some because of the initial opposition to private initiatives, and some that arose because of the flawed nature of the economic reforms themselves.
This ambiguity made it possible for many to legitimize activities that previously, as with the fur dealer on Sakhalin, would have been classified as economic crimes. But there were many others who became involved in more than buying and selling. Given the enormous profits available to those who could supply the pent-up hunger for consumer goods off-limits in the Soviet era, many Russians suddenly became very wealthy. They in turn quickly became targets of mafia groups, some of which had always existed secretly and others that materialized to take advantage of the new opportunities. Prospective entrepreneurs came to appreciate that the more public their operation, the more vulnerable to crime and extortion they would become.
Gradually this also discouraged businesspeople from holding large sums of money in private banks. Various mafia groups decided early on to penetrate or even control almost one-half of the Russian banks–not for the assets, but for the records of deposits. With these lists they were able to persuade those with money that they had a need for protection. To avoid such confrontations, businesspeople rapidly learned to accept payment in barter and thus operate under the radar screens of criminal groups.
Before long it was not just criminal groups that businesses sought to hide from but the Russian government. Such "stealth" procedures became all but essential as the government sought to increase the taxes it collected. In the Soviet era tax collection was not a concern. Since virtually everyone worked for the state, personal income taxes were quietly deducted from workers' pay envelopes; most workers never even knew that there were income taxes in the Soviet Union. Similarly, all businesses were owned by the state and in the same way taxes on profits were deducted from state enterprises and turned over directly to the government.
With the privatization of state enterprises and the legalization of new private businesses, it became more difficult to require compulsory wage deductions. In addition, those who are self-employed as well as those who have a second job are now supposed to file their own tax returns. But without a tradition of voluntary tax collection, fewer than 4 million Russians out of the 65 million in the workforce filed returns in 1997. (Some say the figure was less than 2 percent of the workforce.) Moreover, when a self-acknowledged billionaire like Boris Berezovsky reports that his income in 1997 was less than $40,000, there is reason to worry about the accuracy of those returns that are filed.
Compliance in the business community is probably not much better. According to a study conducted by the prosecutor general's office, out of the 2.7 million companies that should pay taxes, 33 percent neither paid taxes nor filed tax declarations. Of those that did pay taxes, one-third used barter as a form of mutual settlements. Another survey found that only one-fifth of Russian businesses even filed a tax form. This means that not only does the state have difficulty collecting business taxes, but it also has difficulty collecting those deductions made from the salaries of businesses' employees.
All of this has a direct impact on the growth of barter in the Russian economy. Because the state has had so much trouble collecting the taxes it levies, it has sought whenever feasible–and even in some cases when it was not–to increase the number and range of taxes. What the state could not collect with a few taxes it hoped to capture with a wider variety. Thus, starting with about 4 profit-based taxes in 1991, by 1998 oil companies faced 42 different taxes, almost all of which were based not on profits but on revenues. Other businesses reported that in 1998, if local and regional taxes were included, they had to pay 200 different taxes.
There are few businesses, Russian or foreign, that can honestly pay all their tax obligations, especially those levied on revenue, and not operate at a loss. Many Russians quickly realized that they could reduce their tax burden by drawing on their extensive experience in escaping state controls, a practice that antedates the Soviet era.
Avoiding taxes has become an art. Businesses underrepresent income and adopt financial procedures that avoid accumulating bank deposits. The reason is that according to the pre-July 1998 tax code, tax liability was determined not only by a business's sales for cash, but also by an imputed value assigned to its barter transactions. But barter may lead to a higher tax bill than a cash sale would, since the list price or advertised value of the product is usually higher than the barter value that both parties accept. Even if the barter price is far below the list price, both the seller and the purchaser in the barter deal must report the higher list price on their tax forms. This means that the taxes owed could total more than the cash value of the bartered goods actually received.
This creates a terrible dilemma for most businesses. Since the tax police have the right to seize business bank accounts to collect unpaid taxes, and since unpaid taxes frequently exceed actual cash or bartered revenues, businesses have every incentive to avoid cash transactions or bank deposits and insist on barter instead, even though at first glance it may seem that this could result in a higher tax bill. In fact, most businesses have learned how to use barter to reduce or even avoid taxes. Here is how it works. They must pay their wages, and for that reason the tax code gives priority to wage payments over tax collection. Whatever is left over the government can claim. Because wages on average constitute 15 percent of business expenses, businesses are perfectly happy to hold the cash share of their revenue to about 15 percent–indeed they prefer it. If there are no bank deposits other than money set aside for wages there is nothing to be seized. Thus Russia is one of the few countries in the world where sellers even more than buyers insist on being paid not in cash but in goods. (This of course refers to large businesses that have little or no contact with retail customers; retailers do prefer to be paid in cash.) As much as anything, the determination to avoid tax payments explains why about 70 to 80 percent of all business transactions are in barter, not cash.
The policy was designed to reduce business activity, and once demand pressures had been cut it was expected that prices would fall. But factory directors and a growing number of newly privatized enterprises almost immediately discovered a way around these government restraints. They began to issue each other credits, that is, they just agreed not to pay each other's bills. Thus interfirm debt grew from 37 billion rubles in January 1992 to 3.2 trillion rubles in August 1992 and 25 trillion rubles in 1994. This increase of course was exaggerated by the 26-fold rise in prices, but it also reflected a substantial real increase in interfirm debt. In the months that followed there were periodic reductions in this debt, but by January 1998 the net interfirm debt amounted to 800 trillion rubles (800 billion new rubles), or $130 billion. This included not only interfirm obligations but unpaid taxes and wages.
Barter deals can sometimes be quite complicated. A typical example is reported in the April 13, 1998, issue of Business Week. Governor Yuri Vneyneyolov of the Yamal Nenets region wanted to acquire a jet plane. He set aside some of the natural gas paid the region as a royalty in lieu of rubles. The gas was then bartered to the airplane manufacturer. But since the aircraft plant lacked the cash to buy the aircraft components it needed, it used the gas to obtain cars, tractors, and buses that it then swapped to obtain the engine for the aircraft. Along the way electricity and tires were also exchanged for necessary electrical equipment. The airplane was finally delivered six months later.
As this example shows, barter trade is time consuming. It can also be dangerous. On a visit to a tire mold factory in Yaroslavl, I was told that the factory was paid for the molds that it sold to the adjacent tire factory with, naturally enough, tires. The mold factory then began to sell the tires on the open market but at a price that undercut the efforts of its customer, the tire factory. Upset by this, the tire factory director demanded that the director of the mold factory raise his prices. He refused and was found dead shortly thereafter. This is a uniquely Russian way to eliminate the competition.
The tight money policy along with the way that the privatization process was implemented created perfect conditions for the reintroduction of that Soviet institution, the tolkatch. This time, however, the tolkatch has taken the guise of the trading company. Trading companies are not new. Some of the largest businesses in Japan are trading companies. Unlike present-day Japanese trading companies, however, this post-Soviet Russian version operates primarily through barter, not cash, and is usually a front for providing kickbacks to the enterprise directors it serves.
Because it is so hard to find perfect matches in a barter deal, it makes sense to use the services of a specialist (the tolkatch) who has experience with the complex trades that may be necessary as well as possible sources of supply. The extra trouble and transaction costs involved are thus only warranted when–because of the tight money policy–the cheaper and faster cash transactions are not an option. Sometimes tolkatchi are also brought in because the parties to such an arrangement see this as the best way to line their own pockets.
Verhkne Volzhck Shina (VVSh), a tire trading company in the city of Yaroslavl, is a typical trading firm. It was established in 1994 in the wake of the privatization of the Yaroslavl tire factory, which had been one of the largest state enterprises in the city. As a state factory, there was no need to worry about the acquisition of raw material supplies or the disposal of the tires produced. That was the responsibility of Gosplan, the state planning organization, and Gossnab, the state supply organization. But after privatization these acquisition and sale functions fell back on the shoulders of the tire company executives. Given their lack of experience with such basic commercial market activities as buying and selling, mastering these new procedures overnight was not easy. Nor did it help that there were no well-established markets to provide guidance as to what proper prices should be. And, because of the tight money policy, almost no one had cash to pay for large tire orders.
Recognizing how difficult operating the now private tire factory would be, the commercial director of the factory suggested to some of his friends that they set up the VVSh trading company. Since neither the tire factory customers nor its suppliers had cash, the trading company had to arrange whatever barter transactions were needed. For his part, the commercial director of the factory would ensure that the trading company had first call on the tires produced by the factory. It was understood that this would entitle the director to a kickback.
While today 50 percent of the newly privatized enterprises in Russia are running at a loss, most of the trading companies are doing quite well. Although initially dependent on the Yaroslavl tire factory, the VVSh trading company soon began to branch out, so that by the time of my visit it had gone into real estate, textiles, and the conversion of a nuclear submarine shipyard.
Although not always visible to outsiders, these trading companies have become a key element in the operation of the Russian economy. Their influence is not always benign. In many instances they have become the tail that wags the dog, and they are at least partly responsible for the poor performance of so many businesses. A recent article in the Moscow newspaper Noviie Izvestia examined the Magnitogorsk steel mill and explained how the trading companies it deals with have brought the plant to the verge of bankruptcy. Since sales executives in the plant working with the trading company are not the majority owners of the plant, they are not particularly concerned if the steel mill's assets are siphoned off by the trading company.
It also helps if the trading company, like the one in Yaroslavl, can find ways to reward those with whom it works. Thus Profit, the trading company that supplies Magnitogorsk the scrap steel it uses as a raw material input, purchases the scrap at a low price but sells it to Magnitogorsk at six times the prevailing market price. Since the brother of Magnitogorsk's general director runs Profit, there is relatively little concern about the high prices. Magnitogorsk also overpays for its coal swaps in much the same way. Similarly, it swaps the steel that it produces at a low price for a small quantity of natural gas. In the second half of 1997, it provided 280 billion rubles' worth of steel for 75 billion rubles' worth of natural gas.
To illustrate how the government uses the veksel, assume that it is obligated to pay a manufacturer of tanks 1 million rubles. Since it has no rubles available, it will instead issue a certificate (the veksel) to the tank manufacturer, declaring that in 9 months' time the certificate will be accepted by the government as a 1 million ruble tax payment.
But the tank manufacturer wants rubles now to pay its employees. Even though the veksel will be honored in only 9 months, there are businesses with rubles that are willing to buy the certificate today and hold it if they can pay considerably less than the 1 million rubles of the face value. Therefore the tank manufacturer takes his veksel to a bank or trader who will resell it at a discount. The buyer is usually an exporter such as Gazprom, the natural gas enterprise, or one of the oil companies, which can use the veksel to pay its tax bills at a fraction of what it would otherwise owe. According to one estimate, the veksels issued by both the government and private business now amount to 23 percent of the country's cash transactions. Economists criticize the use of veksels because, like barter, they increase transaction costs, allow some businesses to pay less in taxes than they should, and restrict what the government can do with the tax revenue it does collect.
The shortage of cash as well as the desire to avoid or at least reduce taxes also reflects the way workers are compensated. The simplest way for most businesses to deal with the cash shortage and their unprofitable business is to do what they do with their bills for taxes and supplies: to delay payment. Wage arrears were on average 3 to 4 months behind for most workers and exceeded $10 billion in mid-1998. When wages are paid they are often paid in kind or in barter; there is a swap of labor power for what the factory makes or what it can obtain through other swaps.
A drive around most provincial cities provides graphic evidence of wages paid in kind. For example, the highway to Yaroslavl runs through the textile district around Ivanovo. Along the road are stalls staffed by workers from these factories trying to sell the towels, sheets, shirts, and other cotton goods they have been paid in lieu of wages. In other cities workers have been paid in toilet paper, tires, shoes, trucks, manure, condoms, brassieres, tombstones, and coffins.
Even when cash is paid it may not come in the form of wages but in a more byzantine fashion. For example, since interest earned on savings accounts was tax-free until July 1998, many employers set up savings accounts in their workers' names so the workers could collect tax-free interest rather than the equivalent amount in taxable wages.
In another common stratagem to avoid paying taxes, many Russian employers buy insurance annuities in their employees' names. Until July 1998, income from the annuities was also nontaxable. Moreover, if they choose to, employees can always cash in their policies and collect the face value, which is why the government has decided to try to tax insurance proceeds.
Many of the practices have become so pervasive because of the flawed nature of the reforms, particularly the application of tight money policies and the overenthusiastic attempt at privatization. But given how deeply rooted some of these practices are in Russia's past, even if there had been a more effective reform strategy, the odds are that those in power would still have reinvented some of these procedures.
In an effort to correct the abuses of the past, the government is attempting to end the use of veksels and abolish tax exemptions on insurance annuities and interest income. However, the most effective action would be to insist on the determined application of bankruptcy procedures. This would induce a substantial number of factory directors to settle their bills and pay in cash. Many businesses, including a large number that are officially operating at a loss, would find the means to pay their bills if there were an effective threat to close down the business, return it to the state, and throw out the existing management. But there is a political obstacle: throwing not only the managers but the workers out into the streets could spark civil upheaval. This is what makes the prospect of meaningful and fundamental reform so doubtful.
MARSHALL I. GOLDMAN is the Kathryn Davis Professor of Russian Economics at Wellesley College and associate director of the Davis Center for Russian Studies, Harvard University. He is a contributing editor to the magazine and the author of Lost Opportunity: Why Economic Reforms in Russia Have Not Worked (New York: Norton, 1996).
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