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Becoming partners with the Russians.

Mikhail Gorbachev has seen fit to invite, indeed to court, capitalist ownership in the USSR. The reason for this shift in position is not that the old fears of capitalism have entirely evaporated. Rather, the potential benefits of socialist-capitalist cooperation are now generally seen as outweighing the risks. The urgency of the situation was underlined in October 1988 when Konstantin F. Katushev, Soviet Minister of Foreign Economic Relations, revealed that the Government would let foreign firms hold a controlling interest in future joint ventures.

The key factor in this new cost-benefit assessment has been the marked deterioration of Soviet economic performance. The problem goes deeper than the decline in productivity, the slow rate of growth of the gross national product, and the big budget deficits recently acknowledged by the Soviet finance minister. Those trends might be explained by seemingly transient factors such as corruption, bad work habits, and poor judgment in formulating central plans, or by external factors such as the precipitous drop in oil prices-explanations given by Gorbachev's predecessors. The new leadership, however, has openly admitted that these are merely symptoms of a deeper problem: the economy's vulnerability to setbacks from global economic changes.

The basic deficiency in the Soviet economic system is that it has failed to take advantage of the scientific-technological revolution. The Soviets are strong in theoretical science and research but often have been unable to generate practical applications from this work.

The Gorbachev leadership has identified a number of reasons for this failure. One is the damper placed on creativity by the centralized system of planning and managing the economy. Another is the failure to take full advantage of international specialization and divisions of labor within the socialist bloc. The USSR, through the Council for Mutual Economic Assistance (CMEA) of the socialist countries, is attempting to remedy this deficiency by closer cooperation between governments and increased direct ties between enterprises. But progress has been extremely slow due to deep economic problems in each socialist state. Even without the internal opposition to perestroika, fundamental reform of the Soviet economy would take years, if not decades, to implement.

It is not yet clear whether the Soviets' professed interest in increased cooperation with the West will be matched by a willingness over the long term to increase trade. Soviet concerns about Western imports are based on an aversion founded as much on political as economic grounds-to amassing too great a debt to the West. For that reason, the joint-venture approach, with its emphasis on Western investment and export for hard currency, may appear all the more attractive to the Soviets.

In looking to the capitalist countries for help in introducing new techniques and equipment, the Soviet leadership wants to move beyond the old mechanisms of one-time sales of licenses or products. They want the capitalist participant to have a vested interest in seeing that the new product or service is efficiently integrated into the Soviet economy, meets world standards of quality, and is constantly upgraded to keep pace with new technologies. The Soviets also want the kind of close and long-term association with the capitalist participant that is necessary to insure that management know-how will be transferred to Soviet managers.

The Soviet preference is to attract foreign partners that can help modernize the USSR's industrial base, particularly machine building, computers, robotics, and control systems. The training of Soviet managers and workers is an important related interest. Also important are joint ventures that provide increased variety and quality of consumer goods and services-vital to motivating the workforce and containing discontent. The Soviets want help in areas as diverse as medical services (diagnostic equipment, drugs, treatment facilities) and agricultural production, processing, storage, and distribution. The fundamental problem, however, is the nonconvertibility of the ruble. In order to meet its hard-currency expenses and distribute its profits, the foreign partner must be able either to convert rubles or earn hard currency, usually outside the USSR.

A complex negotiation involving seven U.S. firms and a group of Soviet entities turns on the ability of one of the prospective partners, Chevron, to earn hard currency through selling energy products abroad. Under this arrangement, a portion of the hard currency would go into a pool to be allocated to consortium partners for expenses and profits. It is not at all clear, however, whether this pattern could be generalized to other ventures. Nor is it certain that the U.S. companies would agree to export products from the USSR to markets where they would compete with their own products-for example, cereals sold by RJR-Nabisco in Europe. (A number of ways to get around the currency limitation are described in the box on page 20.)

The Soviet joint-venture law, introduced in 1987 and amended in 1988, remains very new and, in some respects, very general. Whole areas have yet to be clarified-for example, how differing Western and Soviet labor laws and policies will mesh. Substantial reorganization of Soviet agencies responsible for foreign economic relations, in 1986 and again in 1988, has compounded the uncertainties.


In 1986, the Soviet Ministry of Foreign Trade lost its dominant position and was superseded by a new agency-the State Foreign Economic Commission. Foreign Trade Organizations (FTOs), many of which had operated under the direction of the Ministry of Foreign Trade, lost their monopoly over import and export. As of January 1987, 91 Soviet ministries, departments, economic associations, and enterprises were authorized to deal directly with foreign firms. In January 1988, the Ministry of Foreign Trade, as well as the State Committee for Foreign Economic Relations (which had. provided assistance to developing countries), were disbanded. A new Ministry of Foreign Economic Relations replaced them.

At least in the initial stages, these measures have created uncertainty for both foreigners and Soviets. Now trade and investment can be handled directly by the enterprise managers, who naturally have the best understanding of their needs and the largest stake in success. However, Soviet managers generally lack the FTOS' knowledge of foreign trade and may be unfamiliar with how to take advantage of resources. The first task of negotiators is to produce a letter of intent. This document does not legally obligate either party to reach a joint-venture agreement, nor does it specify in detail the rights and responsibilities of the parties. The letter of intent is, however, a significant step in that it outlines the basic concept of the venture. As the negotiations proceed, it is good practice to draft protocols to this letter to create a mutual and agreed record of what has transpired.

In many cases, the principal negotiations will be with the branch ministry or agency that is the immediate superior of the enterprise. But that ministry or agency will ordinarily not be empowered to resolve all the questions that arise. A variety of other ministries and agencies may have to pass on such questions as the share of hard currency that a Soviet enterprise will provide to a venture, the credit line available to the joint venture, the technological resources that the Soviet side may invest, and the opportunities for export and import. The foreign firm may face a multilateral negotiation that includes the Ministry of Finance, the Ministry of Foreign Economic Relations, the Ministry of Justice, the Bank for Foreign Economic Affairs, the various domestic state banks, the central state planning agency, anc the State Committee on Science and Technology.

In addition, a U.S. company weighing a joint venture will want to begin early discussions with U.S. government authorities responsible for administering export controls. The company should seek assurances that if the venture goes forward the necessary licenses will be issued. The agencies are set up to rule on completed applications, however, not to issue preliminary advisory rulings. This is a particularly acute problem for joint ventures, since export licenses are not issued for indefinite periods. Under current law and regulations, the joint venture could obtain initial export licenses but be forced to apply in the future for renewal.

The U.S. partner will also begin discussions with banks and agencies involved in financing, insurance, and other aspects of international business. Western investors are asking Soviet authorities to accelerate the pace of perestroika to permit a full range of banking and insurance services-product-liability insurance, for example-to be offered in the USSR. At present, the Western firm considering a joint venture will often have to depend upon Western sources for services that would normally be available in the host country.


After the letter of intent has been signed, the next milestone in the joint-venture negotiation is preparation of a feasibility study. The prospective partners will wish to exchange business data, undertake market research, and develop a business plan spanning several years. In addition, the Western partner should insure that its concepts of accounting are understood by the Soviet enterprise and that it, in turn, understands Soviet methods, agreeing finally to mutually satisfactory accounting procedures.

The basic agreement-called the foundation documents or the statute of the joint venture may contain any provisions agreed to by the parties so long as they are not contrary to Soviet law. The statute must specify the nature and objectives of the venture; the amount of capital it will have and procedures for raising it; the structure, composition, and competence of the venture's management bodies; the decision making structure, including the range of issues to be settled unanimously; and the liquidation procedure. It is common for some important issues to be covered in separate agreements, which also constitute part of the foundation documents. These agreements might cover living arrangements for foreign employees, marketing, and protection of intellectual property.

Under the 1987 joint-venture decree, the Soviet partner must contribute not less than 51 percent of the "authorized" or "charter" fund, and profits are distributed according to the partners' shares of this fund. The joint-venture law also requires that resources be allocated to a number of funds-described only as those "necessary for [the venture's] operation and for the social needs of its personnel"-besides the charter fund. The proportion of each partner's contribution to these other funds is not spelled out in the law and should be carefully specified in the foundation documents.

The law says that the joint venture may, "if necessary," obtain credit in hard currency from the Bank for Foreign Economic Affairs or, with that bank's approval, from foreign banks and firms. Credit in rubles may be obtained from the Bank for Foreign Economic Affairs or Gosbank. Both banks must insure that adequate security is provided. The foreign partner may nonetheless wish to obtain guarantees that credit will be available from Soviet banks, without regard to a determination of necessity, for whatever purpose the management of the venture chooses, subject only to adequate security.

Another issue that must be addressed in the foundation documents, and is likely to recur during operation of the venture, is how to value the partners' contributions. The Western partner's contribution is likely to be in the form of licenses, know-how, equipment, and hard currency. The Soviet partner's contribution is likely to be in the form of such things as buildings, equipment, rights to land and water, and rubles. These contributions are valued in rubles according to an agreement between the partners reached "with due regard for world-market prices."

From the Western firm's perspective, there are several potential problems with this arrangement. One involves the fair valuation of Soviet contributions. The value of real estate or Soviet equipment and know-how may be difficult to gauge in relation to world-market prices. A related problem is the official Soviet exchange rate. Direct contributions of hard currency by the Western partner must be made at the official rate. And, as one Western businessman put it diplomatically, the ruble includes a "measure of social value" that considerably overestimates its worth in relation to convertible currencies.

Confronted with Western concerns on this point, one high-level Soviet official suggested that potential inequities caused by the exchange rate could be compensated for in negotiations. That is, the negotiators would take the exchange-rate distortions into account when arriving at "agreed prices." If the Western firm's contribution in currency was only part of its total contribution, the Soviet partner might agree to overstate the value of the noncurrency contributions. However, there is no guarantee when further contributions must be made to the venture later that the Western partner will have the bargaining leverage needed to correct for the exchange-rate distortions.

The lifetime of the joint venture is usually established in the foundation documents or in a separate agreement, but the term may be left indefinite. The partners also specify in the foundation documents the terms and conditions for liquidation of the venture. The Western partner should seek an explicit right to terminate the venture if its interests are jeopardized. The Western firm can justifiably argue that uncertainties inherent in the enterprise-the weak legal framework for conducting business activities, lack of precedent for ventures with capitalist firms, rapidly changing economic environment under perestroika-entitle it to withdraw under certain conditions.

The Western partner should also seek to define and limit the circumstances under which the Soviet partner can withdraw. This is particularly important because the USSR Council of Ministers is empowered to terminate the venture unilaterally if its activities are found to be inconsistent with the objectives established in the foundation documents. A principal issue will be whether and how, in the event of termination, the Western partner will be guaranteed the right to take the value of its contributions home in hard currency or another acceptable medium of exchange. Here again the artificially inflated value of the ruble with respect to hard currencies may present problems.


Up to now the Soviets have insisted on a controlling share in joint ventures, though American firms have been able to negotiate ways to insure that they will not be overridden on certain operational decisions. Konstantin Katushev, the foreign-trade minister, has said in an interview that new laws will be introduced next year to eliminate the 49 percent lid on foreign ownership. The Soviets may allow Western firms to own as much as 80 percent-or more of future ventures. This would permit the participation of foreign firms that, as a matter of policy, will not invest as minority partners or that limit transfer of technology or intellectual property to joint ventures in which they are minority partners.

The venture is governed by a board, appointed by the partners, with a Soviet citizen as chairman. The director-general, who manages the venture, must also be a Soviet. The law allows the partners to establish their own extensive list of issues to be decided by consensus, and Western firms that have experience in ventures say the Soviets have liberally interpreted this provision. Even the most sensitive and important issues may be included in the list, such as how quality control will be assured, how much of the venture's product will be exported, or how hiring and firing decisions will be made.

Management discretion is constrained, however, by the provision in the law declaring that personnel matters (such as pay and working conditions), social needs (such as housing, recreation, and medical services), and pensions are governed by applicable Soviet law. The management must also conclude collective agreements with trade unions set up at the joint venture's facilities.

The joint-venture decree, in characteristically vague language, provides that "the personnel of joint ventures shall consist mainly of Soviet citizens." So far, Soviet statistics indicate that this injunction is being observed. To what extent the management will have a free hand in setting pay levels and offering incentives, such as bonuses in hard currency, remains unclear. Soviet legislation and labor codes strictly regulate the ability of managers here to dismiss, lay off, or transfer employees. The law also spells out rehiring priorities that must be observed after employees are dismissed as a result of reorganizations.

As the number of foreign workers in joint ventures grows, conflicts may arise between Western and Soviet labor law. In general, the joint venture and its employees are subject to the same laws as Soviet enterprises and citizens, as well as foreigners in the USSR. Soviet negotiators have hinted to their Western counterparts that laws that appear ill-suited to joint ventures, or that pose special problems for joint-venture employees (for example, laws relating to secrecy), will be rewritten or simply not enforced. Clearly, the prospective Western partner will wish to have more specific assurances written into the

joint venture agreements.

Under the law on state enterprises that governs perestroika, most Soviet enterprises will be required to adopt a new system of "full cost accounting, self-support, and self-financing." joint ventures in the USSR are similarly required to be self-sufficient; of course, the Western partner would not expect otherwise. But it will be years before the pricing system in the USSR is brought into line with these principles of self sufficiency. In the meantime, negotiations on prices will be severely constrained by the need to take centrally fixed prices into account. To ameliorate this problem, the law provides that prices contracted between the venture and its suppliers and customers will be set "with due regard to world-market prices." The situation thus remains uncertain.

The venture may also be constrained in its choice of suppliers and limited in its access to potential customers. Under the system of central control, merely agreeing on terms with a supplier or customer is not enough to complete the deal. It must be authorized by the appropriate ministry. In tandem with the turn toward wholesale-price negotiation, perestroika is introducing a wholesale-market system, which will allow buyers and sellers to conclude agreements without central approval.

The joint-venture laws strongly encourage development of exports able to compete on the world market. The Western partner will nevertheless have reason to be concerned about quality. joint ventures that rely on Soviet sources for supplies and services will likely encounter problems, at least until perestroika improves the performance of those enterprises.

The January 1987 decree exempts joint ventures from paying taxes on their profits during the first two years of operation. It was initially unclear whether this period began with the registration of the venture or at some later date, but an amendment in 1987 states that, "It is possible to excuse [ventures] from payment of profit tax during the first two years from the time that a declared profit is made." The nominal tax on profit is 30 percent, calculated after deductions have been made for transfers to various reserve funds and other funds "intended for the development of production, science, and technology." In addition to the 30 percent tax on profit, there is a 20 percent tax on the portion of the foreign partner's profit that is transferred abroad.


Some fundamental aspects of how socialist capitalist joint ventures relate to the general body of Soviet law apparently remain open to debate. An eminent Soviet legal expert, Professor Mark Boguslavsky of the Institute of State and Law, is drafting new economic legislation and asserted last April that it was still not certain to what extent the basic law of perestroika is applicable to joint ventures. On the one hand, prospective foreign partners may find the lack of a firm legal structure for domestic and international commerce to be disconcerting. On the other, Western pioneers in joint ventures may view the unsettled condition of commercial law in the USSR as an advantage. With few statutes and regulations and even fewer precedents-to guide decisionmaking, a surprisingly broad area is open to negotiation.

The business climate, just like the legal climate, is an important factor in assessing the merits of proceeding with a joint venture in the USSR. There is a definite need to make sure that the two sides are speaking the same business language even such basic concepts as profit and the role of price may be viewed quite differently by the partners. The differences may not surface at the outset unless a concerted effort is made to uncover and address them.

There are a variety of other factors that could be lumped under the rubric of "business climate." For example, Western managers who depend on efficient and reliable means of communication will be frustrated by Soviet reality. Telephone service is of low quality. Computer facilities are relatively scarce, as are facsimile machines and telex equipment. Overnight mail within the USSR is not even on the horizon. Business travel is daunting by Western standards, and hotel accommodations are generally scarce and of poor quality. More important, the lack of office space and housing for Western personnel may be a major problem.

These deficiencies must, however, be placed in context. Despite its status as a military superpower, with great influence in world affairs and the second-largest GNP in the world, the Soviet Union has been accurately described as a developing country. In comparison to most developing countries, however, it presents a relatively hospitable business climate. As perestroika progresses, the Soviet Union could offer unparalleled opportunities for foreign investors. N
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Title Annotation:includes related article; Soviet-American Joint Ventures
Author:Sherr, Alan B.
Publication:Business Perspectives
Date:Sep 22, 1989
Previous Article:Breaking down barriers to U.S.-Soviet trade with Soviet market access for small and medium size U.S. companies.
Next Article:Business' silent partner.

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