INFORMALIZATION OF RULES IN THE RUSSIAN
ECONOMY1
Vadim Radaev
Abstract
Development of markets in post-communist Russia is analyzed through the
prism of informalization of rules. The latter is defined as a continuous transformation
of institutional arrangements when formal rules are largely substituted by the informal
agreements and are built into informal relationships. Informalization of rules is
considered with regard to claims on resources and revenues, governance structures,
and rules of exchange, which include business to government and business to business
relationships.
The study is based on data of two 1997-1998 surveys. A standardized survey
including 227 questionnaires of entrepreneurs from 21 regions of Russia and a set of
96 in-depth interviews with the entrepreneurs have been conducted by the author and
research team of the Center for Political Technologies (Moscow). The regional
evidence is also attracted from the 1997-1999 study conducted by the author in Tomsk
oblast of Russia.
Introductory remarks
At least for the last decade it was a part of conventional wisdom that postcommunist Russia had a weak state and suffered from the lack of formal rules in the
economy. Establishing of the rule of law and increasing formalization of rules were
seen as the core element of market building. According to this view, the main progress
is to be achieved by filling the gaps in the legislative and regulatory basis. Recently,
this view was challenged by new expert claims that transitional period has been
completed in Russia given nearly all necessary formal institutional arrangements have
already emerged, and the main task is to put the new laws to work.
In our opinion, both views overemphasize significance of the generalized legal
norms. We would argue that neither ‘institutional vacuum’ nor abundance of formal
rules is the main problem today but rather the structure of these rules and the way they
are introduced into the economy. Thus, principal links between formal and informal
rules are to be at the core of our analysis2. To characterize these links we introduce the
notion of informalization of rules.
1
Revisited version of the paper presented at the Annual Conference of International Society
for the New Institutional Economics (Tubingen, Germany, 22-24 September 2000)
2
Importance of informal rules is underlined in a famous statement of D.North: "In the
Informalization of rules is defined as a continuous transformation of
institutions when formal rules are largely substituted by the informal ones and built
into informal relationships. It describes a situation in which existing formal rules are
known by the actors but avoided on a day-to-day basis3. It does not mean that these
rules are entirely rejected. Rather they are built into more sophisticated system of
informal boundaries and widely used as an umbrella for flexible informal strategies.
Theoretical model. We need a theoretical model to define the structure of
institutions that enable actors to organize themselves in the markets, and at the same
time, constrain their actions. Using elements of N.Fligstein’s model [Fligstein 1996,
Fligstein, Mara-Drita 1996], the following institutional arrangements are
distinguished:
 Property rights
 Governance structures
 Rules of exchange
Property rights are social relations that determine legitimate claims on limited
resources and revenues of the firms. We would distinguish between two sorts of
claims in this paper. The first one deals with the market entry and acquisition of
property rights. The second one deals with protection of property rights and outcomes
of economic activity.
Governance structures refer to the institutional forms in which the firms can
stabilize and control the markets. They include vertical integration and various
managerial schemes by which the firms separate themselves from the market.
Rules of exchange define the conditions under which transactions are carried
out among independent firms and businesses. They specify how business partners are
selected, what sort of contracting relationships are established, and how these
contracts are enforced.
Taking the case of Russian business, this paper deals with the following
questions:
 How are claims on resources and revenues arranged in conditions of the
informalization of rules?
 What kinds of governance structures are built up for implementing
strategies of informalization?
modern Western world, we think of life and the economy as being ordered by
formal laws and property rights. Yet formal rules, in even the most developed
economy, make up a small (although very important) part of the sum of constraints
that shape choices... In our daily interaction... the governing structure is
overwhelmingly defined by codes of conduct, norms of behavior, and conventions"
[North 1992, p. 36].
3
Widespread avoidance of formal rules does not lead to a total criminalisation of the
post-communist economy as it is widely presented in mass media. Widespread
shadow activities of legal economic agents should be distinguished here from
criminal activities in a strict sense.
1
 In which ways do the actors enforce their business contracts given the lack
of legal ordering?
Data sources. Our empirical analysis is based on data collected in the course
of two main 1997-1998 surveys of the non-state enterprise managers and
entrepreneurs. These include:
 Standardized survey
 Set of in-depth interviews
The surveys have been conducted by the author and research team of the
Center for Political Technologies (Moscow) (head - I.Bunin). The U.S. Center for
International Private Enterprise (CIPE) funded the research. Quantitative data and
brief quotations from the in-depth interviews will be used below [for detailed
description of research outcomes see: Radaev 1998b].
Standardized survey was conducted in November 1997 - January 1998. 227
filled questionnaires have been collected from the heads of non-state enterprises in 21
regions (mainly in the Central European parts of Russia). All the main areas of
economic activity have been represented. You will find selected basic parameters of
enterprises and entrepreneurs below:
Privatized state enterprises
- 18 %
Non-state enterprises from the start
- 82 %
Small firms
- 79 %
Large and medium-sized firms
- 21 %
Male entrepreneurs
- 75 %
Female entrepreneurs
- 25 %
Have a university diploma
- 83 %
(One of the) owners of the enterprise
- 79 %
Members of business associations
- 28 %
Moscow entrepreneurs
- 19 %
In-depth interviews were conducted from May 1997 to April 1998. 96
interviews have been recorded in total. The sample includes 27 interviews, which
were conducted with respondents questioned for the second time after the Center for
Political Technologies survey in 1993. The main focus was made upon the emerging
areas of non-state businesses. The sample also includes several leaders of the firms
providing various market services.
We also attract the outcomes of two studies conducted by the author in Tomsk
oblast (one of the Siberian regions) in 1997 and 1999. They were initiated by the
Organization for Economic Co-Operation and Development. The data was collected
from the interviews with the officials of regional and municipal administrations, heads
of development agencies supporting small business, and entrepreneurs. Regional
2
legislative documents, official statistics, survey data, and analytical papers have been
also used. The outcomes of the first study is presented elsewhere [Radaev 1998a].
Acquisition of property rights and administrative barriers
Considering acquisition of the property rights we deal with the issues of
registration of the firm, licensing of the activity, and getting access to premises. From
the standpoint of formal legislation, the rules of market entry have been basically
liberalized since the beginning of Russian reforms in the late 1980s. Acquisition of
private property rights on production resources is allowed, and formal administrative
fees for the market entry are relatively low. However, the market entry is not reduced
to mere formal procedures. State authorities still maintain their control by imposing
numerous administrative barriers, which present a painful problem for Russian
entrepreneurs.
It is essential that formal rules are introduced and established by the authorities
in a specific way, which always leaves room for uncertainty or even creates
uncertainty4. The latter encourages negotiation on the concrete meaning of these rules.
It also means that formal rules can not be followed strictly at least to a full extent. And
the firms respond to it by managing the strategies of institutional compromises. These
strategies may include:

Giving bribes to the corrupt officials

Using services of market intermediaries for avoiding barriers

Bargaining with the authorities for privileged conditions on which formal
rules are implemented
Registration and licensing of activity. To start up the entrepreneur has to
register the firm. Many areas of economic activity are also subject to licensing and
certification. Formally, one is supposed to visit a district Registration Chamber and
State Licensing Chamber to fill the forms and pay a small fee. However, real life
brings much more trouble. The entrepreneur is still supposed to spend a great deal of
time and energy on visiting many state agencies and submit a lot of documents5. The
total number of state agencies entitled with supervisory functions is estimated above
fifty in Russia. Among them we should mention Fire Surveillance, Sanitary
Surveillance, Standardization Committee, State Committee on Statistics, Architectural
Department, Communal Service, and many specialized branches responsible for
certain areas of economic activity.
The Russian Federal Law of 1998 defined the range of activities, which are
subject to licensing. That list was very long and contained more than 200 items. Later
it was extended continuously by two bureaucratic methods. The first method is to
divide one area of activity into several “products” and force the agent to get a separate
4
«Corrupt officials, seeing the financial benefits of accepting bribes, frequently have
the discretion to redesign their activities. They create scarcity, delay, and red tape
to encourage bribery» [Rose-Ackerman 1999, p. 26].
5
For example, to obtain a license for cargo transportation the individual entrepreneur
has to submit more than 20 different documents.
3
license for each single product. The second method is the following. Regional and
municipal authorities introduce the procedures of accreditation, which is compulsory
for some areas of activity. Actually, it becomes a slightly camouflaged form of
additional licensing, which is beyond existing legislative documents [Tsyganov 1997].
Important part of the problem is that federal ministries and state committees
still have their branches in all regions of Russia. These branches are supposed to keep
state control in their fields and have prerogatives of licensing and certification of
activities. Federal authorities often do not have enough funds to maintain their
regional departments. However, they are reluctant to close them down. As a result,
their numerous regional departments have built up a lot of administrative barriers and
started to collect their rent both as formal payments and informal bribes.
Now we will have a look at the quantitative data. According to our 1997-1998
survey outcomes, one fourth of entrepreneurs pointed to registration and licensing as
one of the most serious issues faced by them during the start-up. More complaints
come from those who started in 1989-1991 at the stage of spontaneous privatization
and those who entered the markets most recently and have fresh memories of the entry
procedures. Privatized enterprises had fewer difficulties in this respect if compared to
the newly established non-state firms (Table 1). As for the areas of activity, the firms
dealing with retailing, catering, consumer services faced serious problems more often
(35 %). Firms in science, health care and culture (31 %) followed them. It was easier
for those working in construction, transportation and communications. Only 16% of
the last group pointed to serious problems of this sort.
Confronting administrative barriers, the entrepreneurs apply strategies of
informalization in respect to binding formal regulations. The first strategy is closely
linked to corruption. Almost two thirds of our respondents claim that apart from
official fees it was necessary to pay extra unofficial payments for starting a new
enterprise. It is more often in case of new non-state businesses; especially those that
were established most recently (Table 1). The claims for bribes were more spread in
wholesale trade (70 %) and less spread in industrial production (56.5 %), science,
health care and culture (50 %).
Table 1. Bureaucratic problems by the type of enterprise (column percent)
Type of enterprise
Privatized
Non-state
Have serious problems with
registration and licensing
11
27
Pay extra unofficial fees to public
officials
56
64
The entrepreneur surely can try to follow all formal rules without giving
bribes. But it would take much more time and effort. Here is the view of a
professional in the field of registration:
4
«Just a common man... would never register his/her enterprise because it is
impossible for the human being. It is possible only in case if he/she will treat
registration as an ultimate goal of the whole life» (head of the firm assisting in
registration of enterprises).
The second strategy is at hand to speed up the process. There are a large
number of market intermediaries, which would register one's firm within a couple of
weeks or sell an already registered firm with a legal address and bank account within a
couple of days. Market intermediaries operate legally and are quite open in advertising
their activity. They resolve all necessary issues: check the name of the firm for
avoiding duplications; get a legal address; write a Statute of the enterprise; open a
bank account; and arrange all official payments. They also take a job of bribing the
officials.
These middlemen firms charge from several hundred dollars for registration to
several thousand dollars in case of sophisticated licensing. Many entrepreneurs use the
services of these market intermediaries today. Everyone is happy in the end:
entrepreneur gets a registered firm; intermediary firm gets a commission; civil
servants keep their jobs and enjoy fees for bureaucratic services.
The third strategy for removing administrative barriers is connected with the
mobilization of political ties. If the entrepreneur has good connections with civil
servants, or with the higher public officials, he/she could get a license without wasting
time in the lines and paying bribes for accelerating the formal procedures.
Access to premises. Similar situation is observed in getting access to
production and office facilities. The municipalities own a major part of premises.
Formally, these premises can be subject to sales. However, officials are reluctant to
sell them and prefer leasing relationships. One of the reasons is that it helps to
maintain resource dependency of the entrepreneur.
According to our 1998 survey data, 34 % of entrepreneurs had troubles with
getting premises when starting their businesses. 42 % of heads of the firms created in
the years of spontaneous privatization in 1989-1991, report on difficulties they had at
the start-up period. As the time goes the problem loses some of its importance.
Among the new enterprises established in 1996-1997 it was mentioned only by 28 %
entrepreneurs (Table 2). The firms in industrial production (52 %), science, health
care and culture (46 %), finance and market services (44 %) complained for the lack
of access to premises and material resources more often.
We asked the entrepreneurs if they are supposed to give bribes to the officials
for getting facilities. 22.5 % of them gave a positive answer. It is noteworthy that one
group of entrepreneurs point at the serious problems with leasing of the office space
while a different group complains for a necessity to bribe the officials (Table 2). A
possible explanation is the following: if you do not bribe the officials, you have space
rental problems. Managers of the firms working in retailing, catering, and consumer
services had to «stimulate» public officials more often (32 %). Those followed them
in science, health care and culture (27 %). The problem was much less demanding for
the firms in construction, transportation and communications (6 %).
Table 2. Access to material resources and premises by years of start-up (column
percent).
5
Period of start-up
Face a severe deficit of
material resources and
premises when starting up
Point to a necessity of
bribes for getting premises
Before 1991
1992-1993
1994-1995
1996-1997
42
37
33
28
13
25
24
25
After getting initial agreement, space rental relationships remain largely
informal. It is a regular practice when minimal payment rates are declared in formal
contracts while 50 % of payments and even more are delivered in black cash. It is
especially characteristic of sub-lease agreements.
And again, it is much easier to get space rental or even get it owned if having
good connections with the municipalities.
Claims on revenues and protection of property rights
Next set of problems for the operating firm arises with the claims laid by
different corporate and individual actors on the firm’s revenues. On the formal side,
the firm is supposed to pay taxes, fees, interests, and commissions. However, the
formal rules in Russian business are arranged in such a way that formal payments are
largely substituted by the informal fees, bribes, and paybacks kept away from
accounting books.
Russian taxation system gives a most prominent example here. It presents the
main issue for complains according to many surveys of Russian entrepreneurs. Tax
burden is high. Taxation rates are subject to permanent change. Besides, the whole
system is complicated and non-transparent. All in all, there is a well-established view
that it is absolutely impossible to pay all the taxes without ruining the enterprise.
“If paying all the taxes, any enterprise would be ruined in a couple of months”
(manager of the financial auditing firm).
“Different laws contradict each other… First accounting officer would point
to one mode of accounting. Second one would come and say it must be
different. Third accountant would point to a third way. And everyone would be
right. It is pretty convenient for tax inspectors. They are always able to impose
fines on any enterprise” (owner of the chain of stores).
General logic of informalization is as follows. Existence of contradictory and
non-effectively monitored formal rules encourages the entrepreneurs to develop semilegal schemes of activity. Use of such schemes makes the firms vulnerable in front of
selective administrative control. Regular controlling surveys of the enterprises lead to
extortion by the officials. The firms have to compromise by paying them off or
looking for political protection and patronage. Shadow activity also raises the risk of
violent pressures. Facing the lack of protection provided as a public good, the firms
use private services of various protection agencies. The latter naturally expect to get a
part of the revenues.
6
Administrative surveys. When every economic agent is a potential subject for
the formal sanctions, it creates a favorable ground for selective control. Officials use
to conduct numerous controlling surveys. To evaluate the scale of this control we
asked the entrepreneurs how often the administrative inspections of their firms are
carried out. It made two check-ups a month in average though variation across the
groups of enterprises was considerable6. What is important, nearly half of controlling
surveys are conducted by the authorities on a spontaneous basis beyond any
predetermined schedule. Given that inspections can bring serious distortions to the
enterprise operations, this element of regulatory environment is considered as nonfavorable for business development in Russia.
We put an open-ended question revealing which regulatory bodies are the most
frequent visitors to the enterprise? They are the following:
State Tax Inspection
- 70 %
Sanitary Surveillance
- 23 %
Fire Inspection
- 21 %
Off-budget social funds
- 8%
Intensity of control varies across the markets. Tax Inspectors are most
interested in checking up the firms in finance (74 %) and market services (70 %).
Sanitary Surveillance is most active in the areas of retailing, catering and consumer
services (32 %), health care, science and culture (28 %) while Fire guards use to keep
their eye more closely on retailing, catering and consumer services (26 %),
construction and transport (23.5 %).
Bureaucratic extortion. Repetitive visits to the enterprise do not lead to a
significant improvement in tax collection. Instead they provoke practices of extortion
by the officials. We put several perception questions to our standardized survey
revealing the spread of this extortion. A vast majority of entrepreneurs (87 %) claim
that bureaucratic pressures exist in Russian business. As for their personal experience,
two thirds (65 %) of respondents report that they use to confront some attempts of
extortion by the civil servants in the activity of their own firms. 20 % of entrepreneurs
face it on a frequent basis while 45 % of them experience it from time to time [Radaev
2000a].
We have statistical evidence that bureaucratic extortion is successful in a way
that it benefits the officials and raises transaction costs of the enterprise. The number
of controlling surveys correlates with the significance of costs spent on ‘informal
business services’. The share of firms having significant expenditures of this sort
increases from 7 to 31 % along with the increase of inspection numbers. At the same
time the share of enterprises not having such expenditures declines from 43 to 23 %
with the increase of the number of check-ups (Table 3).
6
Let us mention that a comparative survey of small shops conducted by T.Frye and
A.Shleifer in Moscow and Warsaw demonstrated that the number of inspections in
Russia is two times higher than in Poland, i.e. 18.5 vs. 9 check-ups per year
respectively [Frye, Shleifer 1997, p. 357].
7
A major part of entrepreneurs tends to think that the level of bureaucratic
extortion has not at all changed over the last 2-3 years. Comparing it with the data
from our previous surveys, we can confirm that corruption at least has not declined
[Radaev 1996]. As for the principal possibility to avoid bribing, only 20 % of
respondents believe that it is possible to run a successful business without it.
Elimination of corruption seems unrealistic today to a majority of Russian
businessmen.
Table 3. Enterprise expenditures on informal business services and the number of
administrative inspections (column percent)
Enterprise expenditures
on informal business
services
Share
of firms
(%)
Number of inspections (per month)
<1
1
1.5-2
2.5-5
>5
Average
number of
inspections
Significant
15
7
17
13
21
31
2,4
Insignificant
46
50
41,5
49
43
46
1,9
Absent
39
43
41,5
38
36
23
2,2
100
100
100
100
100
100
2,1
Total
According to the in-depth interview data, non-precedent openness of voluntary
and compulsory services at the bureaucratic «market» is striking today in comparison
with the Soviet period. The scale of bribing has obviously increased within the last
decade though civil servants become more selective in accepting payments. The
following statement of our respondent illustrates it:
«Unfortunately, in the last years many [officials] do not take [bribes] but if
they do they use to take very much» (head of multi-profile firm).
Dealing with corrupt officials, entrepreneurs develop two sorts of informal
strategies. The first strategy is to negotiate with the inspectors and reach compromises.
For example, accountants let the tax inspectors disclose some minor gaps in the their
books and impose small fines. In turn, they let him/her go away with more serious
violations provided all accounting forms are filled properly. As a result of this tacit
agreement formal duties are fulfilled but in a “flexible manner”.
The second strategy is to establish relationships of the informal state
patronage. The latter means that a regulatory state body or an influential civil servant
takes informal responsibilities of business protection, including protection from the
controlling bodies.
«If everyone knows that some firm belongs, or indirectly, is connected with the
interests of a high-level official... naturally there will be no check-ups, no
police, no sanitary control» (head of the firm dealing with fuel supply).
8
Protection from violence. Formally, the state is supposed to provide a
protection of property rights for all businesses. However, the level of protection
provided as a public good is not sufficient to secure assets and revenues from the
informal claims. Risk of violence is still high for the Russian entrepreneur. A major
part of our respondents (79 %) acknowledge that threats and force are used in Russian
business today. Personal experience of this sort is relatively modest. 42 % of
respondents use to confront such coercive pressures themselves (3 % experience it
often; 39 % - occasionally). All in all, violent pressures are a widespread
phenomenon, especially in businesses, in which informal practices are developed.
There is a slight optimism in estimating recent trends here. 30 per cent of
entrepreneurs believe that the attempts to use force have been becoming less frequent
during the last 2-3 years. At the same time the majority (56 per cent) think that the
situation with violence in business has not changed (changed for worse - 14 per cent).
As for the possibility of avoiding violence in business relations, relative optimism is
more evident. 58 per cent of entrepreneurs declare that it is quite possible (difficult to
avoid - 34 per cent, impossible to avoid - 8 per cent).
Use of violence increases the costs of business protection. According to our
survey data, more than a half (53 per cent) of our respondents declare that they do
have expenditures on business protection. Two-thirds of them consider these costs as
not very significant for their enterprise; and for one-third of them these costs are
significant. Not surprisingly, the amount of these expenditures correlates with the
frequency of violent pressures in business relations.
In the course of 1990s violence was transformed into a ‘normal’ element of
economic relations. The firms have to build up strategic alliances with legal or/and
illegal protection agencies and cover the costs of their services. Selection of these
agencies is based upon their reputation, which, in turn, depends not on the formal
records but on sustainability of the positions in the market of protection services.
State protection structures are deeply involved in this business along with the
private structures. Strategic alliances with the state agencies are acknowledged as
providing more security. Besides, their services are usually cheaper. They have more
legal opportunities and run lower risks than their non-state and criminal counterparts.
It is remarkable that state guards provide protection services as a private good, i.e. on
unofficial or semi-official grounds. To get these services one has to establish good
personal ties or/and to pay for these services.
Within the last decade more sustainable and more ‘civilized’ forms of control
over enterprises replaced much of spontaneous racketeering by organized force
agencies. Protection agencies do not merely extort a part of profits. They position
themselves as provider of services, which are informal substitutes for the scarce
public goods of protection [Frye, Zhuravskaya 1999]. Package of complex protection
services may include collection of information, links with the officials, and resolution
of tax evasion issues. Use of their services does not mean necessarily the use of
violence. Protection agencies play a role of influential third parties to whom
entrepreneurs delegate functions of control over big transactions (soprovozhdeniye
sdelok). This sort of force control has become a necessary element of business life
[Volkov 1999]. Private protection agencies (both legal and criminal) are also hired for
special deals, for example, to recover debts of the unreliable and dishonest partners.
9
What is a conception of control established in specific market of protection
services? The local order is provided here by means of specification and identification
of agencies, which have their legitimate right to carry out violence in certain market
segments and exclude all other ‘intruders’. Relationships between entrepreneurs and
protection groups are built upon a specific ethics based upon a respect to force. Thus,
formal law is replaced by a sort of customary law, which is, in turn, backed by means
of violence.
Governance structures and business circuits
The firms need specific governance structures to cope with uncertainty raised
due to administrative barriers and lack of property rights protection. These governance
structures are institutional arrangements by which the firms stabilize and control their
market segments. They include vertical integration and managerial schemes
Vertical integration defines modes of organization by which economic agents
establish their own institutional boundaries and limits for the activity. We would
delineate two forms of vertical integration: the firm and the business.
The ‘firm’ is a set of transactions carried out within the economic unit having
legal status of the single enterprise. It has more or less distinct owner-manager
structure and centralized cash flows.
Formally, the individual firm is still considered as the main unit of economic
analysis and main subject to economic policies. However, many analysts and policy
makers overlook an important shift from the firm to a different prevailing mode of
integration. We would call it the ‘business’. It presents more flexible and informal
organizational structure. It includes several firms, which are formally independent but
governed from the single managerial division, which consolidates the flow of
resources in one business circuit. A special firm or a bank can monopolize managerial
functions. But these functions are often dispersed among affiliated firms and fulfilled
by the managerial team built upon informal personal ties rather than formal
institutional arrangements. These forms of integration called “holdings” or “integrated
business groups” (Granovetter 1994; Pappe 2000). They originate from the practices
of spin-offs and mergers, which leave the firms their formal independence.
Developed business circuits are used for implementation of managerial
schemes aimed to control market transactions and manipulate resources. Managerial
scheme consists of the following elements:

Structure of affiliated units

Connections between affiliated units

Order of resource allocation
Structure of affiliated units defines a profile of the business circuit, which may
include production units, investment units, accounting units, infrastructure units,
market intermediaries, and protection agencies. These units may be of different legal
status, which is also important here.
Connections between affiliated units are determined by the relationships of
cross-ownership, interlocking directorships, and personal ties of managers.
10
Order of resource allocation presents a system of transfers among the units of
the business circuit. Modes of payment and eventual redistribution of income are
important elements of this order.
Managerial schemes are worked out to achieve organized diversity (D.Stark),
which produces ambiguity of assets and numerous modes of evaluation of resources.
In Russian economy business circuits are normally non-transparent for the outsiders
(controlling bodies, competitors, and potential investors). They become a device
stimulating capital flight, assets tripping, and certainly, tax evasion. Sophisticated
business circuits are used for these purposes. Apart from ‘trivial’ corruption, they
allow to apply the instruments, which we would call institutional fictions and games
of exchange.
Most prominent example of the institutional fiction is the pseudo-firm or ‘oneday’ firm (firma-odnodnevka), which is established specially for shadow dealings for
the period within three months. Then it is left over without reporting to the tax
authorities.
«They establish a new firm which is to disappear in three months without tax
reporting... Big law firms being aware of all the details of our inconsistent
legislation are working on that... The regular chain is the following: Russian
firm - western firm. Money is transferred to the West. And everything is
absolutely in accordance with the laws. They charge from 2 to 5 % for their
services» (head of multiprofile firm).
Such one-day firms are used for getting bank loans and advance payments,
which are never paid back. They accumulate tax payments and then disappear. No
bribes are required here. Only the minimal costs of registration and operation of such
firms are taken.
Games of exchange, in turn, provide effective ways of concealing revenues by
balancing on the edge between legal and illegal transactions. Most frequent methods
are the following:

Fictitious transactions

Non-equivalent exchanges

Intended sanctions
We call it fictitious transactions when accounting books fix non-existing
transactions between the firm and market intermediary or institutional fiction. It may
involve advance payments for the goods no one is going to deliver, or payments for
marketing research, which has never been done. False export transfers are arranged to
recover VAT payments. Insurance premiums are paid for casualties, which never
happen, or on the contrary, happen on everyday basis.
Non-equivalent exchange emerges when contracts are signed to the benefit of
the “outside” affiliated firm and the value of transferred goods and services is
underestimated or overestimated. Barter exchanges and mutual set-offs are convenient
for buying and selling goods above and below their market value. They also use
differences in internal transfer prices, and gaps between nominal and real value of
veschels. The stocks of different liquidity are exchanged. Loans are provided at the
11
higher interest rates. All in all, it helps to conceal the difference in value and
contribute to asset tripping.
Finally, intended sanctions are applied. Unrealistic contract obligations are
taken, which lead to serious fines in favor of affiliated firms. Transfer of mortgage to
the affiliated business structures is practiced as a result of intended infringement of
contract requirements.
By and large, economic actors respond to the discrepancies in taxation system
in a rational way. They invent dozens of ways how to avoid tax payments both legally
and illegally. Tax evasion is undoubtedly the most widespread target of shadow
economy dealings at present. It was mentioned by 84 % of entrepreneurs when
answering an open-ended question. 10 % of respondents mentioned also «other
financial violations», which may be closely connected with the tax issues as well
[Radaev 1998b].
As a result, the share of tax payments, which are non-collected to the state
budget, makes from 25 to 40 % including direct concealment of revenues making 20
% (according to the Ministry of Finance estimates). Expert estimations are more
pessimistic. Nearly all firms are involved in tax evasion and use to conceal at least
part of their revenues [Glinkina 1997, p. 50]. What is important, the actors are in fact
allowed not to pay. It becomes a part of broader institutional compromises with the
authorities when the firms and businesses do not pay all the taxes. Instead they pay
part which they decide to pay.
“Who pay taxes today? Only people who want to pay and who decide to
contribute a little bit to the state” (manager of financial auditing firm).
“Folks do not pay real taxes. They pay some part of it, which they are able to
pay… It makes sense to pay some reasonable rate of taxes” (manager of
trading firm).
However, this situation does not confine to the argument that in the «weak
state» civil servants are not able to collect taxes. More important reason is that part of
tax payments are substituted by informal fees and bribes [Shleifer, Vishny 1993, p.
602, 611-612].
Rules of exchange and opportunistic behavior
Business circuits link affiliated firms as if they are independent units. In
contrast, rules of exchange define conditions under which transactions are carried out
between independent firms and businesses. They specify how business partners are
selected, what sort of contracting relationships are established, how these contracts are
enforced, and finally how different businesses are integrated.
Contract infringement and trust. There is one more room for risk and
uncertainty in Russian business, namely the high probability of contract infringement.
As many as 92 % of entrepreneurs admit that the infringements of contractual
obligations do exist in Russian business today. Negative personal experience is also
widespread in this case. 82 % of entrepreneurs report that they become victims of such
violations in their own economic activity. 32 % of them have this bad experience
frequently. So nearly everyone is familiar with this phenomenon. As for dynamics, a
half of our respondents thinks that the situation has not changed at all in this respect
12
during the last 2-3 years. 23 % of them express the view that contract violations have
become more frequent.
Taking a sectoral dimension, 100 % of respondents in finance point to the
contract infringement experience. It makes 94 % in construction and transportation, 89
% in industrial production, and 88 % in wholesale trade. The problem seems to be less
challenging in the areas of retailing, catering, and consumer services (74 %). A
possible explanation is the following. If the clients have to pay in cash, like in
retailing, etc., one is able to impose immediate control over payments. As for those
who deal with the bank transfers they become victims of numerous payment delays
and financial tricks more frequently.
There has been a continuous debate among Russian experts whether the
chronic inter-enterprise payment arrears result from general macroeconomic
instability and restrictive monetarist policies of the Russian Government, or they
largely come as a part of conscious strategies of the enterprise managers prone to
opportunism and cheating7. Anyway, the degree of uncertainty faced by the economic
agents is very high.
Opportunism and cheating in business relationships and infringement of
contracts lead to additional transaction costs of three sorts:
 Costs of collection of data on the reliability of business partners
 Costs of having sanctions against the opportunists and dishonest partners
 Opportunity costs connected with the lost potential profit and non-efficient
allocation of resources.
Opportunism and cheating also have more serious institutional impact for it
breaks trust among business partners. Under conditions of low trust one can not avoid
suspicions even in case of long-term partnership. The dominant feeling is expressed in
the following way: «I do not trust entirely anyone in business» (head of real-estate
firm). Relationships with personal friends and acquaintances are not an exception.
«... It does not matter if you have very close relations with somebody and that
somebody loves you tenderly. Payment arrears are quite normal» (head of the
firm selling medical equipment).
According to our interview data, cheating in business relations has been
becoming less frequent in the course of 1990s. It does not mean that honesty has
started to pay overall. Rather, running a risk of cheating, the entrepreneurs become
more and more cautious when dealing with their business partners. How are the rules
of exchange established when legal institutions are not efficient and the trust is low?
Formal enforcement of contracts. Contract enforcement is associated with
the surveillance over contract implementation and use of sanctions in case of
infringement. It is divided into formal enforcement and informal private ordering.
Formal enforcement assumes that official third parties are attracted for the dispute
settlement, including Arbitration Courts, legal protection agencies.
7
We distinguish between opportunism as self-interested behavior and cheating as
dishonest behavior.
13
Theoretically, the core of rules of exchange must be formed by the formal
contracting relationships based upon existing laws. Implementation of contracts is to
be enforced by the Court and Arbitration systems. However, legislation system is
underdeveloped in Russia. Courts are not independent from the authorities and
businesses. And adopted laws are not efficiently enforced. Though the formal appeals
of entrepreneurs to Arbitration Court tend to increase within the last years in Russia
[Sapsai 1997]. However, this mode of action is preferred only by one fourth of
entrepreneurs. Arbitration procedures are long run and costly. It may cost from 1.5 to
5 % of the disputed sum. Besides, there is no guarantee that justice will be established.
There are many areas, which are not covered by the existing legislation. And even if
the entrepreneur wins in the court it does not necessarily mean that his/her losses will
be covered. According to the opinion of our respondent, «it is worth to appeal to the
Arbitration Court if you are dealing with the reputable business organization only»
(head of trading firm).
Apart from inefficiency of arbitration procedures and high expenses
(especially for the small enterprises) there are informal constraints of customary law,
which pursue the entrepreneurs to solve delicate issues among themselves. Formal
appeals to the state are judged frequently on moral grounds as the attempts to break
somebody down. And this logic of negative solidarity confronting «us» (businessmen)
and «them» (authorities) is still influential.
We asked about most probable reaction of the entrepreneur to the attempts to
cheat him/her or to break business obligations? Answers are distributed in the
following way:
 Negotiate and persuade the partners - 55 %
 Address the Arbitration court
- 24 %
 Try to use force
- 11 %
 Try to win back later
- 3%
 Do nothing
- 4%
We see that formal ordering does not prevail. If formal ways of enforcement
are not efficient or not applicable for some reasons, private ordering is applied.
Private ordering. Private enforcement of rules and dispute settlement
presumes direct business to business relationships or involvement of a third party on
unofficial basis. If litigation is not efficient in dispute settlements and appealing to
Court is not a ‘popular measure’, entrepreneurs must keep control over the behavior of
business partners at their own risk. According to data, a major part of enterprise
representatives (55 %) tends to negotiate and persuade their partners to follow
obligations in informal ways. As for the informal ways of dispute settlement, we
would like to draw attention to 11 % of entrepreneurs who tend to use force. They
could probably deal with criminal and semi-criminal groupings.
It is interesting that our findings partially coincide with the outcomes of a
different 1997 study of 328 Russian enterprises [Hendley et al 1999]. According to
this study, 56 % of enterprise heads prefer to hold meetings with their partners to
prevent/resolve problems while 25 % of them would appeal to the Arbitrage. It is
almost exactly what we have in our data. Different conclusion was drawn by
14
K.Hendley and co-authors when asking another set of questions regarding the
effectiveness of legal procedures. They claim that legal methods of enforcement are
preferred to private methods. This difference can be explained by the prevalence of
privatized enterprises (77 %) in their sample, which tend to deal with the court more
often indeed. For example, in our case the managers of older age and heads of
privatized establishments do appeal to the Arbitration courts more frequently.
The choice of negotiation rather than litigation is not unique preference for
Russian businessmen only. For example, studies of business relations in the USA
show that the entrepreneurs tend to settle disputes without appealing to court. The
lawsuits for breach the contracts are rare for suing a partner is considered as a poor
strategy [Macaulay 1992, p. 273-274, 279]. Still we would like to point to a
substantial difference. In the developed Western countries negotiations are based on
latent references to existing legal codes. Even if actual sanctions are not taken these
references make a good ground for effective informal agreements. In case of Russian
business references to legal sanctions are not so efficient if compared, for example, to
references to means of violence.
The lack of efficient means of formal control through the authorities makes the
entrepreneurs to develop their own rules of exchange on the micro-level. In which
forms is private ordering carried out? Among the widespread modes of private
ordering we would recall the following:

Additional tacit agreements on conditions, which are not fixed in formal
contracts (for example, use of “black cash” in transactions)

Flexible amendments to contracting relationships, including changes in
favor of business partners (for instance, additional discount offers)

Informal negotiation and references to the codes of business ethics aimed
to pursue business partners to follow contract obligations

Organization of intended check-ups of the other firm (zakaznye proverki)
by the authorities (Tax Police, etc.)

Providing pressures on the economic agents by threads of disclosing
information of discrediting character (compromat)

Use of threats and force in relations with business partners
Special organizational measures are taken to prevent opportunism and
cheating. They start with the formal contracts discriminating against the partners,
which are not trustworthy enough. The requirement of advance payments may serve
the most prominent example here. In case of transactions with the new partners prepayments are demanded on a compulsory basis.
However, normally formal contracting is not sufficient to secure positive
outcomes. Any formal document is not a panacea from failures. First, the culture of
formal business contracting is not highly developed in Russia. Second, formal
agreement can not cover all necessary issues and anticipate all possible factors. Third,
having signed a contract the entrepreneur still is not secured from violations.
15
«No doubt it is necessary to sign contracts in any case. But all the same
implementation of this contract depends on the person» (head of real estate
firm).
Thus, the entrepreneurs start to check up their potential partners thoroughly.
«We use to check up every new partner thoroughly and for the long time. And
if we start working with him/her we ensure the conditions which provide
sufficient guarantees for us» (head of the group of companies).
To check up business partners entrepreneurs start collecting information. The
possibilities to obtain information on the financial sustainability and business
reputation of economic agents have been extended during the last decade. One can
address the business registers and commercial databases. Personal recommendations
play an important role in establishing contacts. As a result, contract relationships are
turned into continuous relational contracting in which the identity of the parties
matters [Williamson 1986, p. 185].
Business networks. Relational contracting, in turn, is maintained through
personal business networks. Business network can be defined as a stable and relatively
closed set of interpersonal links among long-term business partners. It is based on a
combination of formal control and informal exchange of services. Business networks
fulfil several inter-connected functions, namely:
 Channeling confidential information
 Ranking of businesses and forming reputations
 Establishing trust and decreasing uncertainty
 Saving transaction costs
 Providing mutual assistance
Inclusion into the business networks presents an important part of social
capital bringing both economic resources to the enterprise and professional prestige to
the entrepreneur [Radaev 2000b]. We have evidence that Russian businessmen have
become more selective in dealing with the other agents over the last years. There is a
certain intention to stay within «your own» business circles excluding all newcomers.
One of our respondents postulates it very clearly:
«We are dealing with smaller and smaller number of people. Some time ago
one could disseminate a hundred personal cards among some people. Now we
do not use cards because we do not meet new people. And even if you are
introduced to somebody new it is done via those with the high reputation. The
circle has not closed down completely but it is extending very slowly» (head of
several firms).
What criteria are applied for ranking of the partners in terms of their
reliability? It is remarkable that the main criterion of division of firms into
‘respectable’ ones («they will not let you down») and unknown ones («you should be
cautious with them») is the time during which the firm has been staying in the market.
16
Business networks are maintained through the mutual informal services. It
adds flexibility to formal contracting by providing selective incentives (privileges) to
the long-term business partners on the individual basis. Among these privileges we
have to mention:
Cut the price down
- 55 %
Do not require pre-payments
- 44 %
Tolerate delays with payments
- 39 %
Provide additional free services
- 30 %
Provide goods and services of better - 14 %
quality
Others
-3%
Are the entrepreneurs ready to provide more substantial support to their
partners? We have asked whether they would give a considerable sum of money to a
firm of their regular partner who confronts financial difficulties. Only one out of five
entrepreneurs responded in a negative way. More than half of them feels like giving a
support though the conditions differ, namely:
Give free of interest
- 27 %
Give on low interest
- 25 %
Give on market interest
- 3%
Do not give
- 20 %
Hard to say
-25 %
Thus, informal support going beyond contracting relationships does play a
significant role in business networks. It is remarkable that only a small part of agents
would act on pure market conditions here. The support is normally provided on nonmarket basis or not provided at all.
What are the main channels of this business networks recruitment at present?
On initial stages the new Russian entrepreneurs preferred to attract their friends and
relatives into the start-up teams [Radaev 1997]. However, a serious shift is witnessed
here in the course of the last five-seven years. Many old business teams have been
often dismantled and replaced by more authoritarian rule. It does not mean that the
entrepreneur takes part in the «war of all against all». Flexible inter-firm coalitions
replace more rigid teams within the firms. These coalitions are not built upon longterm personal relationships with the kin members and friends but increasingly on the
professional abilities and business reputations.
It is important that business networks are often not institutionalized in any
formal way. Formal business associations and unions are rather numerous but not very
influential today. Businessmen prefer to lobby their interest individually or join
informal clubs. According to our survey data, a variable of membership in formal
associations does not correlate with main characteristics of economic activity.
Continuous substitution of legal ordering by informal ordering means that trust
among business partners in Russia at present is not so much enforced by formal
institutions. It develops rather through the implicit contracts and business networks.
17
The entrepreneurs try to cope with the uncertainty and to persuade their partners by a
variety of means including selective material incentives and bribes, informal linkages
and exchange of services.
Conclusions
1. Neither ‘institutional vacuum’ nor abundance of formal rules is the main problem
today but rather the links between formal and informal rules. To characterize these
links we introduce the notion of informalization of rules. It is defined as a
continuous transformation of institutional arrangements when formal rules are
largely substituted by the informal ones and built into informal relationships. It
points to the situation in which formal rules are not explicitly rejected but rather
avoided on day-to-day basis. Informalization largely defines how legitimate claims
on resources and profits are arranged, which governance structures are developed
by economic actors, and how the business contracts are enforced on the microlevel.
2. Informalization of rules does not result merely from the opportunism of economic
agents. It is essential that formal rules are introduced and established by the
authorities in a specific way, which leaves room for uncertainty or even creates
uncertainty. Entrepreneurs respond to it by developing such informal strategies as
giving bribes to the corrupt officials; using services of market intermediaries, and
political bargaining with the authorities.
3. Impossibility to follow strictly all contradictory formal rules encourages the
entrepreneurs to escape to the shadow economy and develop semi-legal schemes
of activity. Facing principal uncertainty the firms build up specific governance
structures, by which they stabilize and control the markets. They include
managerial schemes, which are used for capital flight, assets tripping, and tax
evasion. Apart from bribing he officials, they apply the instruments of institutional
fictions and games of exchange.
4. Use of these schemes makes the firms vulnerable in front of selective
administrative control. Regular controlling surveys lead to extortion by the
officials. The firms have to compromise by paying them off or looking for
political protection and patronage. Involvement into informal dealings also makes
the firms vulnerable to violent pressures. Facing a lack of protection delivered
provided as a public good, the firms look for private services of various protection
agencies.
5. Continuous substitution of legal dispute settlement by the private ordering reflects
a situation when trust among business partners in Russia at present is not so much
enforced by formal institutions. It develops rather through the implicit contracts
and business networks. The entrepreneurs try to establish reciprocal trust by a
variety of means including selective material incentives and bribes, informal
linkages and exchange of services.
6. The economic interests of both public officials and entrepreneurs cement the
whole system of informalization of rules. It gets institutionalized in norms and
customs of economic behavior and reproduced as an inherent element of flexible
and short-term business strategies.
18
Acknowledgements
We would like to express our gratitude to Neil Fligstein for his valuable
comments on the draft of this paper. Special thanks are to I.Bunin, R.Kapelyushnikov,
and A.Zudin for their important contribution to this project. We also highly appreciate
efforts put by V.Gubernatorov (Russian Federation Chamber of Commerce and
Industry) and N. Nazarova in the organization of surveys.
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