Barriers to new entrants

Structural dominance

At the national level, the degree of concentration of industrial output in Russia does not indicate that the lack of competition is a structural problem. The four-firm concentration ratio—that is, the sum of the market shares of the top four producers—in many industries averages about 60 percent, which is similar to that in the United States, and the largest Russian manufacturing enterprises (measured by number of employees) are not unusually large, compared with U.S. firms. However, this aggregate-level analysis of structural dominance masks three underlying attributes of Russia's industrial landscape.

First, large Russian enterprises tend to be configured as single, integrated, multiplant establishments often located in or near the same city, whereas enterprises in industrial countries usually have multiple establishments at several different locations domestically and, often, abroad as well. Thus, the establishments of the largest Russian enterprises are, on average, significantly larger (in terms of number of employees) than their counterparts in other countries, including the United States. Because of the limits of conventional measures of national market share and concentration, the true extent of horizontal dominance in many Russian markets is probably understated. Data on a variety of Russian sectors suggest that, at the oblast (regional) level, the average market share for a typical firm is about 45 percent and the average four-firm concentration ratio is greater than 95 percent. Although the existing level of horizontal integration in Russian manufacturing is largely a legacy of Soviet central planning, such integration appears to be increasing. The increase is due not to new corporate expansion, however, but to mergers and acquisitions.

Second, many of the dominant enterprises in Russia are also highly vertically integrated (or have exclusive buyer-seller relationships). Forty-six percent of the firms participating in a recent survey indicated that their customers purchased supplies from only one or two suppliers and that 23 percent of the suppliers controlled more than 65 percent of the relevant input market. To be sure, putting successive stages of production under one corporate roof can result in economies of scale and reduce transaction costs, as in the case of continuous steel-casting: it would be economically inefficient—if not technologically impossible—to have three separate firms heating iron ore, rolling it into ingots, and then producing the finished steel products. But in most industries, such vertical efficiencies exist only up to a point. Indeed, in many product markets throughout the world, it is increasingly cheaper for a firm to buy inputs (or sell outputs) on the open market or through arm's-length contracts than to produce them internally. In Russia, because the enforceability of contracts still cannot be taken for granted, there are strong incentives for vertical integration. The uncertainties and chronic shortages of the old Soviet supply system encouraged a high degree of vertical integration, which has persisted, in part, because of inertia. Moreover, vertical integration, like horizontal dominance, is increasing—again, usually through mergers and acquisitions rather than expansion. Importantly, excessive vertical integration superimposed on horizontally concentrated product markets can foreclose the entry of rival firms.

Third, significant political and economic power is wielded by regional authorities in Russia, a feature of other large transition economies, such as China. This is evident in the tight control of important economic activities within a region. Such control, in combination with vertical integration, helps freeze the high degree of structural autarky engendered under the Soviet system, when producing consumer goods was a local responsibility and enterprises served only local markets. Worse, it strengthens administrative—as opposed to economic—geographic market boundaries and fosters the regional segmentation of the Russian economy, hampering the establishment of a unified economic space, vigorous interregional competition, and natural economies of scale. Local authorities engage in a variety of practices to limit the interregional movement of goods and services, including charging duties on the "import" or "export" of certain alcoholic beverages; maintaining regional price controls on some agricultural products; imposing registration fees on workers from other oblasts; granting tax or credit preferences to support the building of local "business champions"; and supporting arbitrarily exclusive licensing. In this regard, it is telling that in recent years some of the most frequent violations dealt with by the Ministry of Antimonopoly Policy and Support for Entrepreneurship have been anticompetitive actions by local governments.

Barriers to new entrants

According to official estimates, in 2000 more than 70 percent of Russia's GDP came from the private sector, up from less than 10 percent just eight years earlier, at the start of reform. This is a remarkable achievement. But the expansion of Russia's private sector is due mainly to privatization of state-owned enterprises, not creation of new enterprises.

Most new entrants in Russia are owner-manager firms—mainly small and medium-sized enterprises. There are about one million registered small and medium-sized enterprises (generally defined as business establishments with fewer than 250 employees); they employ about 13 percent of the Russian labor force and produce about 12 percent of GDP. These figures, however, are likely to be inaccurate, because much small business activity is still in the informal economy and thus goes largely unreported. Nonetheless, in comparison with other transition countries, the growth of small and medium-sized enterprises in Russia has been exceptionally slow: the percentage of national employment accounted for by small and medium-sized enterprises is 37 percent in the Czech Republic, 58 percent in Georgia, and 37 percent in the former Yugoslav Republic of Macedonia. Importantly, the geographic distribution of small and medium-sized enterprises in Russia is highly skewed. Whereas Moscow and St. Petersburg account for 22 percent and 10 percent, respectively, of all small and medium-sized enterprises, 28 other regions account for only about 0.5 percent of the total each.

Evidence suggests that in many sectors, the principal constraints on entry by new private firms in Russia are the anticompetitive market structure and the anticompetitive conduct of existing dominant firms, which is often sanctioned or supported by local governments. In effect, incumbents do not leave enough structural economic space for new entrants to make a go of it.

Moreover, impediments to entry include the lack of competition in and poor quality of (state-owned or controlled) infrastructure services, as well as blocked access to warehousing and distribution channels; weak mechanisms for resolving commercial disputes; the lack of access to seed capital and competitively priced credit; the difficulty of obtaining suitable business premises and real estate; the absence of rules-based procedures for, and the complexity of, business licensing, registration, and inspections; and corruption and organized crime.

In the key infrastructure services—electricity, heating, natural gas supply and transmission, and rail transport—state-dominated monopolies still play a major role. In purchasing infrastructure inputs—if service hookups can even be arranged—manufacturing firms (particularly new, smaller ones) have little choice: there is usually only one supplier; pricing is not cost-based; and the quality of service is often poor. On the output side, manufacturing firms must deal with underdeveloped distribution or warehousing facilities outside the major Russian cities. The lack of refrigeration facilities is a particularly serious problem, making shipment of perishable products across regions extremely expensive. Many intercity roads are in poor condition, making long-haul trucking hazardous.

In Russia (as in most other transition economies), contracts are hard to verify and enforce. Private property rights are not secure and lack credibility. The lack of efficient methods for resolving commercial disputes substantially increases the cost of entry. Most businesspeople in Russia attempt to resolve differences among themselves rather than take cases to the overburdened courts. And if a company does go to court, enforcement of compensation for successful plaintiffs collecting debts is notoriously weak.

Persuading financial institutions to back start-up businesses can be challenging even in industrial countries; in transition economies, where capital market imperfections are pronounced and institutions that intermediate savings into investment capital are typically not yet fully developed, the problem is particularly acute. In Russia, bank loans for new businesses—if they are available at all—are short term (typically six months) and expensive. As a result, most start-ups of small and medium-sized enterprises are funded out of personal savings. According to the State Committee on Small Businesses, only 15 percent of small businesses in Russia have received bank credits in recent years.

Access to commercial real estate in Russia is often limited because of municipal administrations' monopoly ownership and control of urban land. In theory, enterprises have the right to privatize associated land plots; in practice, property rights and procedures are unclear. Less than 10 percent of the land under privatized enterprises has been privatized.

The average new business applicant in Russia must deal with a multitude of agencies at both the federal and the local levels and obtain approval of myriad registration and licensing forms. But new firms rarely consider these administrative barriers, however time consuming, to be the most problematic aspects of registering and licensing, conventional wisdom to the contrary. Indeed, firms that specialize in helping new businesses navigate the process have become a new growth industry. Far more onerous—although it has received much less attention—is the lack of uniformity in procedures and fees across regions, and the scope for discretionary conduct by licensing, registration, and inspection officials. In business surveys, it is typical to find that about one-third of questioned firms indicate they are forced to obtain a license that, in their opinion, was not legally required, and more than 10 percent indicate that they pay licensing and registration fees over the legal limit. It is therefore not surprising that the licensing and registration process is fertile ground for corruption. A not atypical anecdote has an entrepreneur paying the equivalent of $7,000 for a license, of which only $800 goes to the government.

Corruption as a barrier to business entry in Russia—as in many other transition economies—is pervasive: virtually all firms pay bribes to tax inspectors, customs officers, and a host of local bureaucrats who visit firms several times a year. The result is that, often, firms must increase staffing simply to deal with inspectors—a nonproductive activity. In addition, most enterprises have to pay organized criminal groups to survive; these groups' levies commonly start at 5 percent of profits but are often higher and are usually collected as flat monthly fees.