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July 1989

Perspectives on U.S. - Soviet joint ventures. (includes related article)

by Morgan, H. Randall

    Abstract- An overview of US-Soviet Union joint venture (JV) activity reveals that an exhibition of Soviet goods in New York during Dec 1988 resulted in the development of $300 million in contracts with the Soviet Union. While JV trade activity has increased between the US and the USSR, there are still a variety of obstacles that must be confronted when establishing JVs including restrictions on technology transfers from the US, and determining how to repatriate profits from the USSR. There are also certain legal issues that US firms need to be aware of when considering Soviet JVs. Issues include: understanding that JVs operate independently of Soviet economic planning; understanding that as of April 1989, foreign firms can own a majority share of a Soviet JV; and understanding that JVs are to be operated using primarily Soviet labor. Another key to successful US-Soviet JVs is a positive negotiating strategy.

HEADNOTE: Economic forces are at work in the world to foster more East- West trade and open up relatively untapped markets to Western entrepreneurs. The authors describe efforts under way to develop joint ventures in a wide range of industries. The legal aspects of joint ventures, as well as some of the typical problems confronted by Western partners are also discussed. General Secretary Mikhail Gorbachev's plan of perestroika is designed to eliminate the principal shortcomings of the Soviet economy--a decreasing growth rate in national income, the economy's inability to satisfy consumer demand, and its shortfall in foreign trade (hard currency) earnings. Foreign trade deficits and the desire to import Western technological, scientific, and managerial innovation, which are necessary for accelerated economic development, have paced the Soviet need for Western investment.

Traditionally, the Soviets have relied on the export of raw materials, mainly natural gas, ferrous metals, lumber, oil, and petroleum products, to obtain hard currency. However, the uncertainty of continued purchases from abroad makes the export of raw materials an unreliable source for hard currency earnings. Sharp drops in world market oil prices in the last few years have exacerbated the Soviets' foreign trade deficit problems by cutting short their principal source of hard currency. Energy resources alone account for 60% of Soviet exports, and in 1986 the USSR suffered one of the greatest losses ever--$7 billion in oil export revenues--roughly 33% of its foreign currency income.

Economic Reform

Gorbachev is attempting to broaden the Soviet export palette with finished goods of increased technological sophistication. This requires an economic reform that will motivate plants and engineers to think foremost in terms of meeting international standards. Towards the end of 1985, Gorbachev began to promote joint ventures (JVs) as a vehicle for his program of economic reform. In January 1987, the decree on the Establishment of Joint Ventures was promulgated. The decree has since undergone several revisions; the most recent, dealt with in this article, was in December 1988.

Joint Ventures: Raison d'etre

JVs satisfy two objectives of Soviet economic reform: 1) the generation of hard currency; and 2) perhaps more important, an effective means of incorporating Western technical, managerial, and marketing know-how into Soviet industry. In the past, the Soviet Union has acquired Western technology through direct purchases of industrial, medical, and scientific instrumentation, turn-key plants, and, of course, there have been incidents of procurement by stealth. These efforts, however, have not always been effectual. A primary drawback of turn-key plants, for example, has been that by the time the plants are assimilated into the mainstream of the Soviet industrial cycle, the equipment is often already obsolete. There have been numerous cases where Western technology has lain fallow because Soviet technicians were not appropriately trained to operate or repair the equipment. Moreover, U.S. trade laws closely regulate the export of many technologies, including the technical expertise needed to service equipment.

This is not the first time the Soviet Union has used the JV as a means of acquiring foreign technology and hard currency. The USSR first created JVs with the West in the 1920s, but they lasted only a decade. In contrast, many socialist countries have since been able to develop successful co-production arrangements with Western firms. Of all the East bloc countries, Hungary has gained the most experience in JV operations. The first Hungarian JVs with Western companies were formed in 1972. By 1986, more than 280 JVs had been established. These JVs maintain special accounts in convertible currency which are exempt from domestic enterprise legislation on wages and prices, and in 1982, these enterprises were also freed from Hungarian customs duties.

U.S.-Soviet Trade: Key Developments

Since the original JV decree was adopted in January 1988, several U.S. initiatives have expedited the process of establishing the JVs. For example, in April 1988, former U.S. Secretary of Commerce C.W. Verity escorted roughly 500 U.S. business executives to Moscow for the Eleventh Annual Meeting of the U.S.-USSR Joint Commercial Commission (JCC). At the meeting, a protocol was signed to encourage the further development of U.S.-Soviet trade. In addition, high level U.S.-Soviet working groups were organized to facilitate trade in the construction and supply, automotive, chemical, consumer goods and services (including insurance), energy, food and agribusiness, medical and health care sectors. Recently, in March 1989, the U.S.-USSR Medical Working Group convened in Washington, D.C., at the U.S. Department of Commerce. Representatives from the leading Soviet institutes in medical technology and health care spoke on their specific needs for medical equipment. The U.S. and Soviet directors of COMED, the first U.S.-USSR JV for medical equipment and computer systems, also attended.

The creation of the American Trade Consortium (ATC) and its counterpart, the Soviet Foreign Economic Consortium (SFEC) is another initiative spurred on by the U.S.-USSR Trade and Economic Council. The ATC is comprised of seven companies: 1) Archer Daniels Midland; 2) Chevron Corp.; 3) Eastman Kodak Co.; 4) Ford Motor Co.; 5) Johnson & Johnson; 6) the Mercator Co.; and 7) RJR-Nabisco. These companies, in the course of establishing their own JVs, have compelled the Soviet government to augment the original JV legislation, eliminating some of the bureaucratic roadblocks which deter other businesses from pursuing JVs. In effect, the ATC is setting a precedent for future U.S.-Soviet JVs.

Perhaps the greatest display of U.S. commercial interests in Soviet industry was witnessed at the Soviet Export Goods Exhibition held in New York December 8-21, 1988. Around 11,000 U.S. business representatives attended the exhibit to see roughly 4,500 Soviet products. Approximately $300 million (U.S.) of contracts resulted from the convention.

Despite the flourish of trade activity between the U.S. and USSR, many obstacles remain. The Department of Commerce, although currently liberalizing its export control policies, continues to closely monitor technology transfer. Moreover, Western partners are still confronting the problem of how to repatriate profits from the Soviet Union. The venture partners must be creative in structuring their JV agreement so that both partners can profit from the arrangement. The inconvertibility and the poor value of the ruble continue to make conventional repatriation methods impossible. Even countertrade is difficult since Soviet goods available for barter are limited.

Legal Notes on Soviet Joint Ventures(1)

* JVs may be established at the initiative of either a Soviet or a foreign company.

* Applications to undertake a JV are subject to a detailed feasibility study, although many of the details of the new venture are worked out a priori in a protocol or letter of intent.

* Once the feasibility study is completed, a proposal for the JV must be submitted to the appropriate supervisory bodies, in particular, the Council of Ministers of the republic where the JV is to be established, the Krai (district) Executive Committee, the Oblast' (regional) Executive Committee, the Moscow City Executive Committee or the Leningrad City Executive Committee, depending on where the new entity is located, and the appropriate industrial ministry.

* Final approval of the JV is granted on a case-by-case basis by the State Economic Planning Committee (Gosplan), the Ministry of Finance (Minfin), and the appropriate industrial ministries.

* Once registered with Minfin, a JV acquires the rights and responsibilities of a legal entity in the USSR. As of January 1, 1989, 188 JVs had been registered.

* JVs operate independently of Soviet centralized economic planning. Orders placed by JVs often mean above-plan work for suppliers and other Soviet industrial organizations. Because local supply organizations are constrained by state plans, there is no guarantee of availability of resources for JVs.

* As of April 1, 1989, foreign companies are permitted to own a majority share of a JV. Previously, a foreign partner could own no more than 49%.

* Ownership shares are to be determined between the partners in the charter of the JV.

* As of April 1, 1989, the chairman of the board of directors, as well as the general director of the JV may be foreign citizens.

* In principle, an equal number of Soviet and foreign citizens will participate on the board of directors. Each side is to have veto power in policy decisions.

* JVs are to be operated primarily by Soviet labor and are subject to Soviet labor laws. However, as of April 1, 1989, questions of hiring and firing and forms and sizes of payment to employees as well as incentives in Soviet rubles, are decided by the JV's board.

* Pay by foreign employees of joint ventures for housing and other services is made in rubles, except in those circumstances provided for by the USSR Council of Ministers.

* The Soviet contribution usually includes production facilities, equipment, labor, materials, and energy resources. The foreign partner is expected to provide modern equipment unavailable in the USSR, licenses, technological and managerial know-how, personnel, and financial credits.

* Contributions to JV funds are calculated at the official ruble exchange rate, according to world market prices. Official exchange rates between the ruble and hard currencies have exaggerated the ruble's value. Soviet officials are overrating "tangibles," such as real estate, which is often valued at Tokyo and London prices. Western investors are advised to overvalue "intangibles," such as know-how, in order to balance out the scale.

* Unless the JV earns hard currency, such currency cannot be repatriated to the Western partner.

* The ventures will operate on the basis of cost-accounting and self- financing (khozraschet) principles.

* Each JV will be exempt from taxes for its first two years of profit, after which it will be subject to a two-tier tax system. The JV will pay 30% on its profits, and the foreign partner will pay 20% on any profits it repatriates.

* As of April 1, 1989, JVs based in the Far Eastern region of the USSR are free from payment of taxes for the first three years of profit, after which the JV will be subject to a 10% tax on profits.

* Minfin has the right to not tax, or to lower taxes, levied on any JV in the Far Eastern region of the USSR or on any JV which produces consumer goods, medical technology or medications, or high-technology goods.

* To obtain foreign currency to import products, the JV may borrow foreign currency credits directly from the Soviet Bank for Foreign Economic Relations or, with that bank's permission, from a foreign bank.

* There is a catch-all provision in the JV law which indicates that anything not specifically prohibited in the law is allowed or at least negotiable.

* It has been reported that a separate commercial entity may be able to "piggy-back" on an existing JV for the purpose of selling its own product.

* The Soviet Council of Ministers maintains the right to liquidate a JV if it determines that the JV does not "conform to the objectives for which it was established."

* Soviet law lacks a formal concept of organizational liability. In the Soviet Union, an enterprise cannot be held liable for mishaps. Instead, the enterprise's management is held responsible. Western participants are scrabbing to negotiate for a policy that will protect their personnel.

Developing a Negotiation Strategy

The key to a good negotiation strategy is preparation--do your research before you go to Moscow. Otherwise, the time and money you spend on negotiations in the USSR could easily wipe out your anticipated profits--before you get the deal. It is important to understand the industrial context in which you intend to set up shop: identify the appropriate partners and assess their capabilities and constraints. Once you find a partner you like and trust, you can begin to negotiate the deal. Although the Soviets are demonstrating surprising flexibility in their negotiations, it is advisable to clearly define all details of the JV arrangement in the contract, including accounting procedures, supplies, shipments, arbitration, insurance, the valuation of each partner's contributions and duties, and even liquidation. Moreover, it is worth the extra time it takes to personally ensure that all parties expected to play a role in your venture agree to the terms specified in the contract. Most JVs involve local supply and shipping agencies, the Soviet auditing bureau Inaudit, Vneshekonombank Minfin, Soviet customs officials, and others. These organizations should be contacted before the contract is signed.

Finally, if you are in a hurry, conducting trade with the Soviets is not for you. For most, the Soviet Union is not the place to make a "fast buck" but offers opportunity for long-term investments and high returns.


Tables 1 and 2 indicate: 1) the geographic distribution of foreign partners in JVs approved by the end of 1988; and 2) a classification by activity.

The foreign partners represent 32 different countries, including five from the COMECON community. Of the 188 JVs registered by Minfin, eight involve partners from more than one foreign country.

A variety of activities are covered by the new JVs. It is interesting to note that 31 of the 188 JVs are involved in the design, assembly, distribution or service of computers and automation systems; 12 operate in the tourism, hotel, and restaurant sector; and only four are involved in medicine and medical equipment production. As mentioned previously, the first U.S.-Soviet JV for the production of medical equipment was not established until February 1989. Other U.S. companies have entered into ventures for the following pursuits:

* Preparation of computer software;

* Assembly of personal computers;

* Control systems for the fertilizer industry;

* Construction and restoration of buildings;

* Research and design of information services;

* Marketing, advertising, and export of a wide variety of products and services;

* Book publishing and printing. Tabular Data 1 to 2 Omitted

(1)The following comments on Soviet JV legislation reflect the revisions stipulated in the decree on "The Further Development of Foreign Trade Activities," adopted in December 1988, effective April 1, 1989.

Erika D. Nobel has authored and edited numerous monographs on Soviet science, technology, and economics. Ms. Nobel is also the President of American-Soviet Exchange & Trade Consultants Inc., a firm specializing in U.S.-Soviet trade, located in McLean, VA. H. Randall Morgan is Editor of USSR Technology Update, a bi-weekly newsletter on Soviet trade, science, and technology published by Delphic Associates, Inc., Falls Church, VA and is CEO for ASET Consultants, Inc.

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