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Monday, February 28, 2011

Time for stronger disincentives for those on the take

The RF State Duma is considering President Medvedev’s bill making a bribe-taker/giver liable to fines of 100 times higher than the bribe itself. A great move in corruption-plagued Russia, on the face of it, but is it going to make a difference?

Whether or not Russia will be able to vanquish the high level of corruption it faces is an extremely important issue. A lot of people today wonder how to reduce graft in this country and what mechanisms can be used to eliminate these types of practices and make Russia more attractive for foreign investors.

My opinion is that before we answer the question how we need to understand why Russia has suffered from so much corruption historically. What are the root causes of this? It’s very important for Russia to understand those and only through that to then create new laws which will reduce graft.

To my mind, one of the main root causes of corruption is that Russia has been a classic, top-down, centralized commodity economy for nearly its entire existence. In this type of economy, a certain legal structure has been developed, which historically protects those owning resources of the economy and enshrines the latter’s position above the law, making the rest of the population live below the law.

Therefore, one has to address the entire concept of law. I’d like to draw a parallel with protection of intellectual property.

The innovation-driven economies have extremely high penalties regarding IP fraud. For example, in the United States you can see very tiny small companies or individual entrepreneurs suing large global companies and literally winning billions of dollars in the IP lawsuits. If you look at other strong innovation clusters such as Israel, Finland or Singapore, they have very tough laws protecting IP, too. The penalties they have could bankrupt the largest companies in the planet.

But with China or other emerging markets, one of the basic problems they have is that the penalties are very low, and for someone to break the law and have a very small fine is not enough of a disincentive. According to some articles I’ve read, the largest fine ever paid for breaking IP laws in Russia is 125,000 euros.

I would 100% agree with new laws coming out that will increase the fines that people involved in corruption will have to pay. The very concept of what bribe givers and takers deserve has to be dramatically reviewed. In this light, the new proposal by President Medvedev is in line with what disincentives for people who act in such a way should be.

Societies behave according to the laws that are passed. If laws are weak, people will take advantage of those laws and act on their own behalf. If laws are strong, then society can be guided by those laws and this, in effect, increases the trust between individual parties. Likewise, if the institutions that guide a free-market economy and a democracy are weak, a system cannon work as efficiently as systems with stronger incentives for positive actions and disincentives against negative actions.

The law is the instrument that society agrees to use to regulate itself. This is the bottom line. If society as a whole wants to create a market economy with strong democratic institutions, then the people responsible for setting laws must develop and write those laws correctly, implementing them on the ground, on a daily basis, at the local and national levels.

This is a critical aspect Russia is going through now. In the U.S., for example, the legal system has been evolving over the past 200 years; Russia has only had 20 years for that. It’s very small amount of time, and it’s understandable that people writing laws in Russia very often have no business experience. So, how can they understand the implication of a law?

The first thing is to start putting in the basic structure of commercial law. The next step is to start building the body of case studies of how that law works, with example of where it works properly and where it fails. Lawyers, prosecutors and judges will begin to build the body of experience so that if a law is written badly, it will show itself with many negative examples which society rejects.

And in the end, laws that don’t work will not properly motivate people. If people are not properly motivated, they will not follow the actions that the government wants people to do, like investing in innovation. If laws are correct, innovation and investment will follow.

So, will Russia always suffer from high levels of corruption? No. I believe that by choosing the path of increasing the strength of laws, the disincentives to cheat and the incentives to do things properly, and by shifting the economy away from trading and more toward investing in technology and innovation, a critical mass of an effort to change Russia as a system will be created. This will support the ability for people to negotiate in a fair way, and when they suffer from some inequities they have a way to address those.

When people trust the law, they will enter into legal contracts and they will do business. If they don’t trust the law, then everything has to be done secretly and in a corrupt way. So, by strengthening laws against bribery you strengthen the system. Each law is like a brick laying a foundation for a new system.

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