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Magnets for Growth

“False facts are highly injurious to the progress of science, for they often long endure; but false views, if supported by some evidence, do little harm, as every one takes a salutary pleasure in proving their falseness; and when this is done, one path towards error is closed and the road to truth is often at the same time opened.”

Charles Darwin, The Descent of Man (1871)

Crony capitalism is the subject of considerable and often misguided debate. It is an economic system where those who are inappropriately close to government officials are given unfair advantages, commonly in the form of financial incentives. As a person with a regulated European fund and yet on the receiving end of baseless allegations of crony capitalism, this is a topic I follow closely.

I am a frequent reader of The Economist, a publication which prides itself on its quality of research, but  I was very surprised by an article that I recently read which featured an updated ‘crony capitalism index’. The index claims to rank countries where wealth generation is most affected by such unfair advantages. Russia featured highly on the list (the first edition of which was published in 2014).

In a world such as the one painted by The Economist, big businesses profit significantly more from ‘rent seeking’ via preferential relations with government than by means of pioneering new technologies, processes etc in a free, competitive market. This, the Economist reasoned, is bad for capitalism as a whole since capitalism’s fundamental principle is the creation of new wealth.

This portrayal of Russia is in keeping with many Western perceptions of the country: they imagine an economy dominated by established business leaders who maintain close ties to powerful politicians. According to this view, success in business is wholly reliant on state connections at the top.  This index not only paints an unfair picture of Russia but also of most of the emerging economies.

If The Economist was right we should expect to find that the fastest growing businesses are similarly dependent on financial benefits or other undue government incentives or support to fuel their growth. In fact, the current situation reveals the contrary: many of the fastest growing companies in Russia do not rely upon any relations with government officials in order to create wealth, which is the essence of capitalism (as highlighted by RBC). Even the Economist noted that crony capitalism is actually in decline and has less effect on the markets than it did previously, further endorsing the argument that privately run businesses do not need cosy government relations to succeed.

A prominent example of an innovative business which proves that private and independently run firms can be successful is Magnit, Russia’s leading supermarket chain with over 12,000 stores, which features 18th on the RBC list. The company is chaired by self-made billionaire Sergey Galitsky, who is admired by many for his ambition to expand Magnit despite difficult market conditions (FT). Notably, he raised $143 million in a share sale last year (Moscow Times).

Galitsky is also known for his independence and refusal to engage in politics and yet, despite this, he has shown that he can compete with the country’s top businessmen (Bloomberg). His strategy has paid off: Forbes reported that Galitsky is now one of Russia’s wealthiest men, and he achieved this through his own graft.

Of course, Galitsky is just one person who exemplifies the ability of many Russians to create successful businesses. Russian people are recognised as innovators; the country scored favourably on the Global Innovation Index rankings in 2015, well ahead of BRICS countries such as Brazil, India and South Africa.

The creation of new wealth by companies from different sectors supports the idea that Russians businesses can succeed, regardless of background or connections. Russia’s fastest growing companies are drawn from a range of sectors including meat and poultry production (Akashevskaya), online clothes retail (Wildberries.ru), residential development (Setl Group), clothing manufacture (BTK Group), farming produce (Rif Trading House), and alcohol retail (SPS Holding). These companies can also compete in Russia and in global markets, as Kaspersky has demonstrated in relation to anti-virus software. The success of these companies is an important step towards diversifying the Russian economy away from a heavy reliance on oil and gas, and therefore is good for the country as a whole.

Of course, this is not to say that the creation of wealth in the Russian private sector is always economically efficient. As with any country, Russia has its share of ‘too big to fail’ firms which may be periodically – and controversially – bailed out using taxpayers’ money. Between 2008 and 2009, the UK government acquired a £45 billion stake in RBS (BBC) and the US government had to bailout General Motors for an estimated $50 billion (Reuters). Likewise, the Russian government stepped in to back Rosneft in 2014 (Reuters) and the list goes on and on all over the world.

As we have seen, the ‘crony capitalism index’ is a narrow way of looking at a country’s economy. Russia sees significant growth potential in companies and sectors which are perceived to be prone to ‘crony capitalism’, as well as – more importantly – in the innovative companies which have shown no requirement for friends in high places in order to grow and succeed.

As PwC‘s 2014-15 survey of Russian private and family run businesses showed, company owners are confident that the growth of these businesses, which lie at the very heart of capitalism, will remain ‘intensive and dynamic’. Given the subsequent data from RBC and others, their confidence looks to be well-placed. It is by further harnessing this growth that Russian firms will continue to strive to banish some of the ‘false views’ on crony capitalism, which fail to tell the whole story about the growth of financial capital in Russia.

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