In an interview with Russia Direct, Edward Verona, president and CEO of the US-Russia Business Council, discusses what foreign companies should know about doing business in Russia.
Photo source: press-photo
Edward Verona steps down this summer as president and CEO of the United States-Russia Business Council. Before taking the helm of the Washington, DC-based organization in 2008, he spent many years in Moscow working for several of the world’s leading energy giants. Verona spoke with Artem Zagorodnov of Russia Direct about the role of oil and gas in the Russian economy, how the WTO affected Russia’s development and what’s holding back investors.
R.D.: You have been working on and off in Moscow since the mid-1990s. During this time, how have the dynamics in the business relationship with the United States changed?
E.V.: In the last five to 10 years, consumer goods have become a major driver of growth in trade between the United States and Russia. That’s a big difference from 20 years ago, when the primary focus was on commodities, especially oil and gas. The critical factor, according to a recent Ernst&Young study, is that nowadays the disposable income of the average Muscovite exceeds that of the average Houstonian, thanks to a decade of buoyant economic growth, a low, flat income tax rate (13 percent), social benefits provided by the Russian government and, perhaps most importantly, the fact that the average Russian owns his or her home and doesn’t have a mortgage.
Russians have a lot more money to spend on consumer goods and they are eager to catch up after seven decades under communism and a difficult transition to a market economy. American brands enjoy a strong reputation in Russia and have found a receptive market in the country’s 142 million consumers (over 170 million including Belarus and Kazakhstan, Russia’s partners in the Customs Union). This accounts for the strong growth that U.S. companies have experienced in Russia.
In the oil and gas industry, which I know quite well, there have been some notable policy shifts during the last five years. Just before the crisis struck in 2008, when oil prices hit a peak of $147 a barrel, Russia passed two very important pieces of legislation governing the sector. The idea behind these legislative changes was that Russia could go it alone in many respects: it could buy services and equipment abroad, but domestic companies could develop the resources on their own.
It didn’t quite work out that way. Investment by Russian companies in “greenfields” exploration was disappointing; meanwhile, production costs in the industry had grown and the country’s leadership realized that this nationalistic model hadn’t produced the desired results. This change in thinking is reflected in the fact that both [laws] were amended in 2010 to expand the access of foreign companies in the sector, bringing us – legislatively – closer to where we were in the 1990s and early 2000s.
R.D.: How has WTO membership affected the business environment? What challenges/opportunities does WTO membership offer foreign investors in Russia?
E.V.: Entry into the WTO was a watershed event in Russia’s economic history; it created the conditions for a major expansion of trade and investment between Russia and all of its economic partners. According to a study by the Washington-based Petersen Institute, Russia's membership in the WTO could lead to a tripling of U.S.-Russian trade within a decade. Another international study indicated that over the current decade, Russia’s GDP growth could be as much as three percentage points higher as a result of WTO membership.
The direct trade benefits are evident, but the psychological component of membership shouldn’t be overlooked. The message it sends to investors is: “Russia is prepared to live by a set of rules established by an international organization and, potentially, submit to decisions made by its independent arbitration panels.”
R.D.: Many commentators have said that business and politics are very closely linked in Russia – more so than in other markets. Is this true? To what extent have geopolitical relations between the United States and Russia affected business ties?
E.V.: Business and politics are linked in Russia just as they are in all advanced industrialized democracies; it’s a matter of degree. I would say that the links are relatively close in Russia, but maybe not so if compared to China.
In Russia, it’s partly a legacy of the privatization process, when large segments of the economy were acquired by private owners through a not-so-transparent process. It also reflects the fact that the government still retains control of about 45 percent of the national economy.
We’ve gone through a few particularly rough periods in U.S.-Russian relations during the past decade, but I personally have not heard a single business person say that he or she wasn’t investing in Russia because the bilateral political relationship was bad.
R.D.: Is the business climate improving?
E.V.: One major change I’ve seen is the emergence of a new generation of Russian business elite. These are people who came of age in the post-Soviet period. Some of them have been educated abroad; almost all of them have traveled abroad. They speak English and understand what’s expected of them by their foreign business partners.
But investors are still wary. There are a lot of questions concerning the independence of the judicial system as a whole and instances of selective application of the law. Then there’s corruption: even top Russian officials admit it’s a huge problem, but it doesn’t seem to be getting better according to Transparency International. A lot of laws have been passed in this regard, now it’s a question of how effectively they’re being implemented.
A particular concern is that, according to polls, many young Russians say they want to work for the government as opposed to the private sector. This was not the case 10 years ago, when many wanted to work for a private company or start their own companies; it’s a sign that the business environment is unattractive to young talent.
R.D.: What is the most important message you would like to share with the average person in America about doing business in Russia? What do you feel is the greatest misconception he or she is likely to hold?
E.V.: The biggest stereotype is a holdover from the 1990s. When I tell someone that my work involves Russia, people ask: “Isn’t it dangerous? Aren’t there mafia types everywhere? Do you feel safe?” I’ve never felt unsafe in Moscow, even in the “wild east” environment of the 1990s.
The biggest point I try to drive home is the one I made earlier: the 142 to 170 million consumers of this market with purchasing power and a liking for American-branded goods.
Virtually every member company of the USRBC tells me its operations in Russia are extremely profitable. It may be prudent not to advertise this fact, but Russia has very high margins for companies that are well established and provide those iconic products that were once beyond the means of ordinary people. Russians are now making up for lost time. Even if U.S. policies are not high in likeability polls, American goods are very popular.
At the same time, doing business in Russia is not easy. Companies that are doing well today came here in the 1990s and made a long-term commitment. The market is more crowded now and you have to commit more resources and senior management time than perhaps in any other emerging market of comparable size.
If you’re a small business looking at Russia, you’d better know the market very well, have a product that will be well received and be willing to sit out the long periods necessary for permitting and licensing. Big companies have deep pockets and wide bottoms – they can sit for a long time and wait for approvals. As a small business, you don’t want to find yourself in a position where you either lose your business or have to make an illegal payment. American companies know just how vulnerable they are to prosecution if they do that.
R.D.: Russia in 2020: What surprises can we expect? Do you expect Americans to start seeing more products labeled “Made in Russia” on their store shelves? Will oil, gas and other raw materials remain the country’s primary exports?
E.V.: One of the things I’ve become convinced of during my time in Russia is the country’s capacity to surprise – so I don’t rule out anything.
I don’t think there’s anything wrong with oil and gas being the backbone of the Russian economy; raw materials offer the country a huge comparative advantage. The key is using those revenues to the advantage of the Russian people, avoiding crowding out other business activities, and not allowing the ruble to appreciate to the point that it makes other industries less competitive.
At the same time, if Russia doesn’t modernize its economy, I don’t predict a very rosy outlook. So far its dependence on oil and gas is increasing, and I don’t yet see the structural changes occurring that would facilitate the sustained growth of innovative industries and small and medium-sized enterprises.
But I’d also say that Americans tend to overlook some important Russian products that aren’t necessarily linked to world-famous brand names, but are no less important. Incidentally, about one-fourth of the U.S. steel industry is owned by Russian companies: TNK, Evraz and Severstal. Their products are used in everything from automobiles to home appliances. What they make is not a commodity – it is specialized steel, high-strength and lightweight – and the technology is Russian.
R.D.: The United States is lagging way behind countries like Germany in the volume of investments into Russia (and vice-versa). When will bilateral investment intensify?
E.V.: I recall that Ludwig Erhard, the economics minister associated with Germany’s “economic miracle,” was once asked what would help Germany rebuild its economy after the war. He said “about 50 kilometers of shared border with the United States.” Geography is a major driver – it facilitates trade. It makes it possible to build shared physical infrastructure, such as pipelines. That is the basis for the large trade between Germany and Russia in oil and gas, and this generates trade and investment in both directions. But that doesn’t prevent us from being very successful in a host of sectors where our companies have an advantage and where geography is not destiny.