Jump into Social Media Before Other Investors

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Published April 30, 2013

| FOXBusiness

Today, Yuri Milner, the billionaire investor in social media, stopped in for a chat with Liz and Dave about how to find the bargains in social media before all the other investors jump in (Yuri owned 10% of Facebook long before its IPO). Yuri credits a large part of his acumen to the influence of his father, a famous Russian economist named Boris Milner. Turns out that Yuri’s father was a prime source for an article that David wrote 20 years ago, when he was with the Wall Street Journal. Dave’s article follows:

Cleansing the New Russia of Old Privileges

MOSCOW -- In the hallway outside the Moscow law office of Baker and McKenzie, a doorman frowns at the TV as he watches President Boris Yeltsin's address before the U.S. Congress. I don't speak Russian and the doorman doesn't speak English, but Mr. Yeltsin's comments are followed by an English translation, so it's possible to figure out that it's Mr. Yeltsin's platitudes about economic change in Russia that are the most poorly received. After Mr. Yeltsin is given a standing ovation for one of his comments, the doorman groans and moves to turn off the TV.

The doorman's reaction was typical of the skepticism I encountered from a wide range of Russians last month in Moscow and St. Petersburg. In particular, many doubted that Western aid projects to Russia -- such as those under consideration this week at the Munich summit -- would do anything more than feed Russia's avaricious bureaucracy. Citizens are particularly irritated that economic and social reform have not kept pace with political reform; many of the communist apparatchiks remain in positions of political and economic control.

The nomenklatura hangs on because the Russian Parliament and Mr. Yeltsin have been slow to end its privileges and subsidies for the state-owned enterprises it controls. Perhaps more fundamental is the failure to lift fiscal and regulatory barriers that prevent Russian entrepreneurs from growing at a rate that would make the nomenklatura irrelevant.

Spotting the privileges still enjoyed by the Russian elite is not difficult. On a country road about 10 miles outside of St. Petersburg, a motorcade approaches from the opposite direction. Flanked by four police cars with sirens blaring and lights flashing, a black limousine speeds toward the old czarist capital. My taxi driver explains that many of the old party leaders maintain their dachas, or country homes, in this area. He shakes his head and says, "Our new democrat apparatchik."

The system of special favors so pervades the country that even this reporter got tangled in it. I had plans to interview economists at the Institute for Social and Economic Sciences in St. Petersburg. The economists found me a hotel. I insisted on paying for my own accommodation. This turned out to be difficult. The Institute and the hotel are both still part of the state apparatus, and the Institute pays a ruble-denominated fee which is just a fraction of the normal $182 nightly rate for foreigners. But the institute refused any money from me. I finally managed to get my hosts to accept about $70 worth of Scotch as remuneration. I was told this was probably much more than the hotel room cost them.

"It's going to take three generations to work this concept of special privileges out of the system," says Johann Isaak, director of the Academic Center of Marketing Research, which is affiliated with the St. Petersburg Institute. "After 75 years of dictatorship by men, we need a dictatorship of laws." Shortly after telling me this, Mr. Isaak took me to the Hermitage museum and butted in front of a long line of people waiting for tickets to get me one.

The economic core of the privileged elite remains embedded in Russia's 132,000 state industries. "The industrial backbone of the nomenklatura has not yet been broken," says Leon Aron of the American Enterprise Institute. "Most of the industries and almost all the agricultural production are still in the hands of the nomenklatura, and they still receive enormous subsidies." On June 21, the government pledged an increase in subsidies for state industries, despite their 2.5 trillion ruble debt load.

As for privatizations of state industries, some fear a quick, shotgun approach will play into the hands of the nomenklatura. "Currently there is a strong push by Prime Minister Yegor Gaidar and those around him to privatize everything as quickly as possible," says Boris Milner, an economist at the Russian Academy of Sciences in Moscow. "But we must be very careful not to privatize before we have created a deregulated environment in which the new private companies will compete openly with other companies. . . . Privatization must be done in the context of a competitive market in which contract laws have been established."

Perhaps the most important economic contract needed to establish trust in the legal market is a strong and stable currency. "Every ruble note is a contract between the people and the government," says Institute for Social and Economic Studies director Anatoli Kogut. "This contract must not be broken again."

But even if Russian officials honor the currency contract, other economic rules being established make incorporation of small enterprises exceedingly difficult. "When you add all the taxes you are now forced to pay, sometimes it's better to quit," says Vladimir Svirski, a Russian entrepreneur who has helped incorporate hundreds of small firms. "Then you have the different regulations made by both Moscow and Russian authorities -- some of which directly contradict each other. A market doesn't seem to be enough for many of the rule-makers. They want a supermarket which they can control."

Tax and regulatory requirements are astounding. A 28% value-added tax can, because of different rules adopted by central and local governments, be applied at several stages of the production and distribution line and add up to almost 90%. Employers must pay a minimum 28% "social security" tax for each employee, which quickly rises to 37% with higher wages. This often discourages bosses from increasing wages. Finally, a 60% top rate on personal income kicks in at $6,000 a year, hardly a fortune even by Russian standards.

While the Russian Parliament wants to lower tax rates, Prime Minister Gaidar is warning that any tax rate cuts would imperil loans from the IMF. "Our creditors will immediately stop talks because such a decision would break a mutual understanding on responsible monetary policies," Mr. Gaidar told Parliament last Thursday. Mr. Gaidar said the government would lose a third of its revenues if the legislature approved a proposal to cut the VAT in half and bring the top income tax rate down to 30%.

Others complain that if tax rates remain high, government revenues will continue to fall, and thus the deficit will increase. "The government was mistaken in believing that higher tax rates would bring in more revenue," says Mr. Kogut. "That didn't happen. We must lower taxes. Otherwise we will get no real growth, and the people will lose all faith."

Still, with all the tax and regulatory barriers, many of Russia's new entrepreneurs have not lost faith. In fact, merely the process of beginning new ventures has a way of cleansing the system of bad habits.

Elena George is the author of a screenplay that will be among the first films financed by Russian entrepreneurs. Her husband, who is an American lawyer working in Moscow, helped her prepare contracts with the workers and investors. "The old socialist contracts were very loose and based on a system that was completely arbitrary. But in preparing this free-market contract, we are tightening up the way in which the industry works and making it much more efficient. Five years ago, I would have been pessimistic. But these changes have built an enormous momentum that can't be stopped."

Back in Moscow, economist Boris Milner weighs in with the optimists: "I've got to be optimistic. I've worked all my life to see Russia change like this. We can't go back. If we do . . ." He stops and points his index finger to his temple.

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