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

Introduction

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

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

• Criminal underworld formation began in 1917 as a political rejection of the Bolshevik victory.
  • Counter-revolutionary banditry was carried out by former capitalists, aristocrats, White sympathizers, and disillusioned revolutionaries operating outside formal hierarchies (FH).
  • Activities included attacks on public enterprises and individuals, as defined in the 1928 formal system of rules.
• In the 1930s, an informal set of rules appeared among thieves, who totally rejected the Soviet socioeconomic system.
  • Before World War II, they posed no threat to the status quo and the FH had no reason to eliminate or compromise with them.
• During WWII, Stalin offered thieves freedom in exchange for fighting at the front.
  • After the war, Stalin sent cooperative thieves back to prisons, hoping for their elimination in the "War of the Bitches" between those who violated the thieves' informal rules and the faithful.
• Postwar criminals emerged due to the devastated economy, turning to crime for economic opportunity and material gain, abandoning the anti-state ideology of their predecessors.
  • Their activities included theft, burglary, drug trafficking, bank fraud, and prostitution.
  • The relationship between the FH and OCGs was limited to bribes offered to low-ranking officials, similar to the situation in the United States.
  • The FH had the power to eliminate OCGs if they posed a threat to the status quo.
• The emergence of an informal system of management, whereby managers turned entrepreneurs, was another development in Stalin's era.
  • To meet strict quotas, managers established informal networks to ensure the provision of supplies, involving reciprocal payoffs.
• Incentives for the FH to cooperate with OCGs were at the core of the distribution system.
  • Administrative rationing of non-tradable commodities and administratively set prices for tradable ones led to an underground economy.
  • Commodities were diverted to informal or foreign markets where they could be sold at higher prices.
  • Underground circulation required corruption in related sectors like transportation, lodging, and food services.
  • Managers reserved services for OCGs, who paid premium fees that were embezzled.
• During the Brezhnev era (1964-82), the informal underground economy became more important.
  • Underground factories and OCGs supplied what the formal economy failed to supply, with the cooperation of the highest levels of the FH.
  • Informal entrepreneurs (IE) amassed wealth through clandestine operations.
  • OCGs extended their activities to extortion of IE, requiring monopoly rights over victims.
  • OCGs reached informal agreements to divide shares of victims, integrating their interests with the success of IE.
  • OCGs transitioned from extortion to infiltration into the management of IE's factories.
  • OCGs were in full control of the underground world.
• The economic failure of central planning led to the FH's informal approval of two kinds of entrepreneurs in the informal sphere.
• Absolute political power corrupted the FH, inducing them to solicit services from OCGs through informal channels, offering a third of profits as gifts and cash payoffs for protection.
• These developments compromised formal rules and means, excluding outsiders who refused to compromise or lacked power.
• By 1986, the Soviet economy was dominated by the FH, IE, postwar OCGs, and old, traditional OCGs.
• The government's 1985 anti-alcohol policy dramatically increased the wealth of IE and OCGs, leading to self-sustained growth.
• OCGs cooperating with the FH demonstrated a hierarchical division of labor.
  • Elite groups were isolated from working units, with support groups transmitting commands and security groups ensuring safety.
  • OCGs had no political power independent of the FH.

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

• Gorbachev initiated political and economic reforms to address the economic and social crisis of the centrally planned system.
• The FH, fearing the loss of privileges, sought legislation to allow legal private access to state enterprises by cooperating with IE and OCGs.
• IE and OCGs responded positively, allowing infiltration of the formal economy through legalization of assets and joint ventures with state enterprises.
• The 1987 Law of State Enterprises gave independence to state enterprises and allowed joint ventures with IE and OCGs, creating legal connections between the FH and OCGs.
• The 1988 Law of Cooperatives lifted restrictions on activities, profit, size, and pricing, allowing joint ventures with foreign firms and access to Western banks for laundering money.
• These laws, combined with access to foreign capital and OCG infiltration, led to the formation of elite mob entrepreneurs.
• These elites operated major enterprises and prepared for ownership allowed by the privatization scheme overseen by KGB personnel after the Communist party ended its monopoly over power on February 5, 1990.
• Party assets were transferred to elite members of the FH.
  • FH purchased Communist party property at symbolic prices, transferred party funds to Western banks, or provided capital to establish private banks.
• On the eve of the failed August 1991 coup, the FH, IE, and OCGs were dependent on each other within a network of connections that made up the USSR's economic infrastructure.
• The FH still dominated the political scene.

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

• The failed coup of August 1991 was an attempt by anti-reform factions of the FH to reverse privatization and economic liberalization.
• Control and ownership of state enterprises were handed over to enterprise managers through worker buyouts with funds from IE and OCG allies.
• By 1996, the majority of the FH were in charge of privatized enterprises, and the banking industry was almost exclusively in the hands of former IE and OCGs.
• OCGs infiltrated the banking industry through extortion enforced by contract killing 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.
• The wars ended with triumphant OCG bosses defining territorial and functional boundaries through informal agreements that guaranteed monopoly rights for each group.
• The active role played by OCGs in drawing functional boundaries resulted in higher prices passed on to consumers through industry-wide cartels.
• Law enforcement weakened due to hyperinflation and declining state budgets, making them susceptible to bribery and ineffective in providing security or enforcing legal contracts.
• Many law enforcement officers became private security officers or ventured into business themselves.
• The power vacuum was filled by established and new OCGs, with the strongest emerging from the Caucasus.
• The emerging business elite of former FH, IE, and OCGs evaded taxes and appropriated state subsidies by forming business lobbies that influenced political decisions.
• Massive redistribution of state funds led to a predatory taxing system for the rest of the population.
• Due to this and an ill-defined formal system of property rights, emerging small entrepreneurs evaded taxes and kept businesses in the shadow economy.
• Parties with conflicts invited OCGs to defend their interests, who offered protection and an informal system of dispute settlement in return for fees.
• OCGs extended activities into the extortion of newly emerging private businesses not owned or protected by established rival OCGs.
• The current power structure of Russian business shows a pattern where the business elite (former FH, IE, and OCG bosses) own/manage enterprises, banks, and media outlets and support politicians to guarantee government subsidies.
• Beneath them are new rival OCG bosses who attempt to establish connections with the business elite and infiltrate their firms.
• Conflicts between the two levels of OCGs present a major source of social and economic instability.
• Impoverished youths continue to see OC as a means to upward social mobility, leading to the emergence of new OCGs.
• Informal rules and means by which OCGs settle disputes prevail, reinforcing a cultural climate of informal deals that exclude outsiders.

Conclusion

• Commentators often blame the Soviet transformation's outcome on the lack of a legal code to prosecute corruption, define property rights, regulate banks, prevent money laundering, etc.
• The author suggests that Russia's FH intended not to seek the establishment and enforcement of a legal code that could have eradicated OCG before it completed its infiltration of the formal economy.
• OCGs' infiltration was not a result of miscalculations but the shortsightedness of Gorbachev's reforms, whose initiative for "openness" threatened privileges acquired through decades of informal rules.
• It was naive to think that democratic elections could transfer power and wealth "to the people" in a political setting where no mechanisms functioned according to formal rules.
• Deficiencies in formal rules lead people to circumvent them through informal mechanisms that exclude those outside the networks.
• Reforms clash with the interests of those who favor maintaining the status quo, who adapt to new conditions through the same informal mechanisms.
• In Russia, the reforms decreased the living standards of the majority who were not insiders in these networks.
• Democratic forces demanding radical economic reforms in countries where FH acquired power through informal mechanisms may want to reconsider the consequences.
• Institutions are cultural artifacts that emerge over long periods; radical transformation may divert them from their intended aims.