Perestroyka and Western Direct Investment: The Task of Integrating A Western Company into the Changing Soviet Economy

PERESTROYKA AND WESTERN DIRECT INVESTMENT: THE TASK OF INTEGRATING A WESTERN COMPANY INTO THE CHANGING SOVIET ECONOMY TIMOTHY L. FELKER, JR., ESQ.* 1. INTRODUCTION Under President Mikhail Gorbachev's policy of perestroyka, or restructuring, the Soviet government has decided to allow foreign investment in the Soviet economy. Western investors may now establish investments under the 1987 Joint Venture Decree' or the 1990 Regulation on Joint-Stock Companies and Limited Liability Companies.2 For most companies organized under these laws, success or failure will depend upon the ability of economic reforms to transform the Soviet economy into a market economy and integrate it into the world economy.3 Westerners seeking to invest in the Soviet Union must accept that they are gambling on the eventual success of market reforms which will span a generation. 4 The performance of Western investment in the Soviet Union has thus far been something short of spectacular. The Soviet government estimates that up to seventy percent of joint ventures between Western * Honors Program, Chief Counsel, U.S. Army Corps of Engineers; J.D. 1990, University of Virginia; B.A. 1987 University of Notre Dame. The author is grateful to Paul Stephan for his guidance and comments on this paper and thanks Paul Harter and Adam Decry for their advice on an earlier draft. The author retains responsibility for any errors. I On the Establishment in the Territory of the USSR and Operation of Joint Ventures with the Participation of Soviet Organizations and Firms from Capitalist and Developing Countries, 1987 Sobranie Postanovlenii i Pravitelstva SSSR [SP SSSR] No. 9, item 40 (Decree of the USSR Council of Ministers of Jan. 13, 1987), translated in K. HOBER, JOINT VENTURES IN THE SOVIET UNION app. 3 (1989) [hereinafter Joint Venture Decree]. I Regulation on Joint-Stock Companies and Limited Liability Companies, 1990 SP SSSR No. 15, item 82 (Decree of the USSR Council of Ministers of June 15, 1990), translated in USSR LEGAL MATERIALS (V. Pechota & P. Pettibone eds. 1990) [hereinafter Regulation on Joint-Stock Companies]. I Russian Roulette with Six Bullets, ECONOMIST, Jan. 12, 1991, at 64-65 [hereinafter Russian Roulette]. See generally Osakwe, The Death of Ideology in Soviet Foreign Investment Policy: A Clinical Examination of the Soviet Joint Venture Law of 1987, 22 VAND. J. TRANSNAT'L L. 1 (1989). " Hertzfeld, Joint Ventures: Saving the Soviets from Perestroika, HARV. Bus. REv. Jan.-Feb. 1991, at 80, 81. (219) Published by Penn Law: Legal Scholarship Repository, 2014 U. Pa. J. Int'l Bus. L. [Vol. 12:2 companies and Soviet firms will fail.5 Official statistics that list 2,800 joint ventures registered with Soviet authorities are somewhat misleading.' In reality, fewer than 1,000 of these joint ventures actually have bank accounts7 and only a small number of these are operating, profitable ventures. 8 The majority of joint ventures are either fronts for Soviet cooperatives that seek the tax benefits conferred on the joint venture form9 or thinly capitalized brokerages for Western exporters that do not manufacture anything in the Soviet Union. 0 Many other joint ventures exist on paper only. 1 The few hundred joint ventures that have successfully established manufacturing operations are grinding to a halt. 2 Soviet customers that promised to pay joint ventures in hard currency have not been able to pay their bills.1 " Moreover, these domestic hard currency transactions are the exception; in order to earn hard currency, most joint ventures must still conduct export transactions' 4 'under a strictly controlled export regime.' The Soviet political situation is unclear,'" and it is likely that the 17 environment for investment will remain uncertain for some time. Nevertheless, many Western business leaders have decided that the problems of doing business in the Soviet Union are more than offset by the opportunities presented there. 8 Some Western businesspersons agree that sound reasons exist for investing now, rather than waiting ' Failure Rate for Western Joint Ventures in Soviet Union Seen Hitting 70 Percent, 6 Int'l Trade Rep. (BNA) 1603 (Dec. 6, 1989) [hereinafter Failure Rate]. I Russian Roulette, supra note 3, at 65. 7 Id. 8 See U.S. Firms Operating in Soviet Union Face 'Enormous' Problems, Expert Says, 6 Int'l Trade Rep. (BNA) 1484 (Nov. 15, 1989). 1 Russian Roulette, supra note 3, at 65. 10 Id. The capital structure for this type of brokerage or intermediary was outlawed in December 1988. However, a "grandfather clause" permits joint ventures registered before March 1989 to import goods manufactured outside the Soviet Union. See infra notes 122-34 and accompanying text. 11 Russian Roulette, supra note 3, at 65. 12 Id. Is Id. 14 Id. 's See infra notes 113-34 and accompanying text. 16 Schmemann, A Gain for Yeltsin: Marchers Face Kremlin's Huge Show of Force without Violence, N.Y. Times, Mar. 29, 1991, at Al, col.6. 17 Hertzfeld, supra note 4, at 84. 1C Commerce's Willkie Discusses Administration Efforts to Assist Reform in Eastern Europe, 7 Int'l Trade Rep. (BNA) 1308, 1309 (Aug. 22, 1990). See Hertzfeld, supra note 4, at 80. The Soviet Union offers Western investors the chance to reach a potential market of over 280 million consumers. HOBER, supra note 1, at IX.G(1). The potential for profit is enormous, especially in Russia, the Ukraine, and the Baltic Republics, where there are tens of millions of cultured, educated, and motivated Europeans who need virtually everything. Hertzfeld, supra note 4, at 84. https://scholarship.law.upenn.edu/jil/vol12/iss2/2 1991] PERESTROYKA for more economic stability in the future.1 Although conditions may be more predictable in several years, individuals investing sooner will have established an advantageous infrastructure with Soviet consumers and Soviet partners. ° The decision to invest now with the proper strategy could create a significant competitive advantage. 21 For now, and for at least the next several years, Western enterprises investing in the Soviet Union must attempt to create their own markets within an economy that remains largely subject to central planning, with virtual or complete government monopolies on currency, foreign exchange, and foreign trade. In order to survive in this environment, Western investors must tailor their businesses to operate within the constraints of this economic system and prepare for the economic turmoil that anticipated reforms are likely to produce. During the next ten years, successful investment in the Soviet Union will require a high degree of operational self-sufficiency within the Soviet economy. 22 This article discusses the Soviet system of central economic planning and analyzes the ways in which it complicates the task of integrating Western concerns into the Soviet economy. Economic reforms over the past two years have allowed for a significant amount of decentralization. However, with these re (...truncated)