Mafianomics: How Did Mob Entrepreneurs Infiltrate and Dominate the Russian Economy?

Introduction

• Mark Tomass's paper examines how organized crime infiltrated and dominated the Russian economy after the collapse of the Soviet Union.
• The paper defines Organized Crime Groups (OCGs) as hierarchically structured resource-sharing groups that enforce informal rules and use informal means to achieve their informal ends without the voluntary consent of outsiders.
• It explores the conditions that led to the emergence of organized crime activities (OCAs) in post-Soviet states, the structures of OCGs, the incentives that drove them, and the constraints they faced.

Formal Failure and the Emergence of Organized Crime (1917-1986)

• Criminal underworld formation in the Soviet era began in 1917 as a political rejection of Bolshevik victory.
• Early criminal activity involved counter-revolutionary banditry by former capitalists, aristocrats, White sympathizers, and disillusioned revolutionaries, operating outside formal hierarchies (FH).
• The formal system of rules in 1928 described these activities as attacks on public enterprises and individuals.
• In the 1930s, an informal set of rules appeared among thieves, rejecting the formal Soviet socioeconomic system.
• Before World War II, these thieves did not threaten the status quo or benefit the FH, so the FH had no incentive to eliminate or compromise with them.
• During the Nazi invasion, some thieves accepted Stalin's offer to fight in exchange for freedom, but they were later sent back to prison after the war in the "War of the Bitches."
• Postwar criminals emerged due to the devastated economy, seeking economic opportunity rather than ideological opposition to the state.
• This shift opened new avenues for cooperation with the FH, involving activities like theft, burglary, drug trafficking, and bank fraud.
• The FH's power was independent of OCGs and could have eliminated it had it threatened the status quo.

Informal System of Management

• An informal system of management emerged where managers turned entrepreneurs to meet central planning quotas, using reciprocal payoffs.
• Members of the FH developed entrepreneurial skills and established informal networks to ensure the provision of supplies from other state-owned enterprises [Berliner 1952].
• Incentives for the FH to cooperate with OCGs were rooted in the distribution system, where administrative rationing and set prices led to an underground economy.
• Commodities were diverted to informal or foreign markets, requiring corruption in transportation, lodging, and food services.
• Managers reserved facilities for OCGs in exchange for premium fees, exacerbating existing shortages for ordinary citizens.

Brezhnev Era (1964-1982)

• The underground economy gained importance during the Brezhnev era, with underground factories and OCGs supplying what the formal economy could not, with the cooperation of the highest levels of the FH.
• These informal activities cultivated a class of informal entrepreneurs (IE) who amassed wealth through clandestine operations.
• OCGs extended their activities to extorting IEs, requiring monopoly rights over victims.
• OCGs reached informal agreements to divide their shares of victims, integrating their interests with the success of IEs.

Control and Corruption

• OCGs infiltrated the management of IE factories and were in full control of the underground world.
• The FH informally approved the existence of entrepreneurs in the informal sphere due to the economic failure of central planning.
• Absolute political power corrupted the FH, leading it to solicit services from OCGs in return for protection from prosecution; OCGs supplied the FH with a third of its profits as gifts and cash payoffs.
• These developments compromised the formal rules and means designed for production and distribution.
• By 1986, the main players in the Soviet economy were the FH, the IE, the postwar OCGs, and the old, traditional OCGs.
• The government’s 1985 anti-alcohol policy dramatically increased the wealth of IE and OCGs.

Structure of OCGs

• OCGs cooperating with the FH demonstrated a division of labor, isolating elite groups from working units.
• Support groups transmitted commands from bosses to working units, while security groups insured the safety of bosses and support groups.
• Despite the Soviet economy's dependence on underground networks, OCGs had no independent political power from the FH.

Organized Crime's Infiltration of the Formal Economy (1986-1991)

• Gorbachev's reforms threatened the one-party system and the power of the FH.
• Fearing the loss of their privileges, the FH called for legislation allowing them legal private access to state enterprises by cooperating with IE and OCGs.
• The 1987 Law of State Enterprises gave independence to state enterprises and allowed joint ventures with IE and OCGs.
• The 1988 Law of Cooperatives lifted restrictions on types of activities of companies, profit, size, and pricing, allowing joint ventures with foreign firms facilitating money laundering.
• The combination of new laws, access to foreign capital, and infiltration of OCGs into the formal economy gave rise to elite mob entrepreneurs.
• These elite operated major enterprises and prepared for ownership during the privatization scheme overseen by KGB personnel.
• Party assets were transferred to elite members of the FH through various means, such as purchasing Communist party property at symbolic prices and transferring party funds to Western banks.
• The FH, IE, and OCGs were presiding over the bulk of Soviet industrial wealth on the eve of the failed August 1991 coup.

The Proliferation of New Organized Crime Groups (1991-Present)

• The failed coup of August 1991 led to the handover of state enterprises to enterprise managers through worker buyouts financed by IE and OCGs.
• By 1996, the majority of the FH controlled privatized enterprises, while the banking industry was almost exclusively in the hands of former IE and OCGs.
• OCGs infiltrated the banking industry through extortion and contract killings of bank managers who refused to compromise.
• The mob-controlled banking system rendered attempts to regulate its operations ineffectual.
• The FH handed over municipal properties to OCGs at fractions of their expected values.
• Competition among OCGs to acquire state enterprises and properties led to gang wars in 1991-1992, which ended after territorial and functional boundaries were defined through informal agreements.
• The active role played by OCGs in drawing functional boundaries led to higher prices for consumers through industry-wide cartels.
• Law enforcement weakened due to hyperinflation and declining state budgets, leading to widespread bribery and ineffectiveness.
• Many law enforcement officers became private security officers or ventured into business for themselves.
• The power vacuum was filled by established OCGs as well as new ones, particularly from the Caucasus.
• The emerging business elite of former FH, IE, and OCGs evaded taxes and appropriated state subsidies by forming business lobbies.
• The rest of the population was subject to a predatory taxing system.
• Emerging small entrepreneurs evaded taxes by keeping their businesses in the shadow economy due to the ill-defined formal system of property rights.
• Parties with conflicts invited OCGs to defend their interests, offering protection and dispute settlement in return for fees.
• OCGs extended their activities into the extortion of newly emerging private businesses.

Current Power Structure

• The current power structure of Russian business consists of a business elite (former FH, IE, and OCG bosses) who own and manage major enterprises, banks, and media outlets.
• Beneath them are emerging OCGs or those who did not receive a slice of Soviet wealth during privatization.
• Conflicts between the two levels of OCGs are a major source of social and economic instability.
• Impoverished and demoralized youths continue to view OC as a means to facilitate their upward social mobility, leading to the emergence of new OCGs.

Conclusion

• The author argues that the infiltration of OCGs into the formal economy was not due to miscalculations or a lack of foresight by the FH but rather the short-sightedness of Gorbachev's reforms.
• It was naive to think that democratic elections could transfer power and wealth "to the people" in a setting where no mechanisms functioned according to formal rules.
• Reforms intended to change the status quo will clash with the interests of those who want to maintain it.
• In the case of Russia, the outcome of the reforms decreased the living standards of the majority of Russians.
• Democratic forces demanding radical economic reforms in countries where their formal hierarchies acquired power through informal mechanisms may want to reconsider the consequences of such demands.
• Institutions are cultural artifacts that emerge and take hold over long periods of time; their subjection to radical transformation may divert them from the very aims for which the reforms are intended.