The Way Out

Western governments were deeply involved in helping to design economic policies for Boris Yeltsin's Kremlin. Now, as the house Yeltsin and USAID built collapses, reassessments are in order. Katy Daigle and Matt Bivens chart what happened to Russia -- and lay out some alternative economic visions.


Over the weekend, the foreign ministers for the 15 European Union countries met in Salzburg to take the first tentative Western steps to divorce their nations from the fiasco that is Russia.


Russia should have paid more attention to its ordinary people, the ministers proclaimed in a joint statement. Future economic reforms must have more "social cohesion." It is time now to establish "a social market economy." The prescriptions of the International Monetary Fund, the World Bank and other radical free marketeers must be reviewed.


"We don't want more Harvard boys with their laptop computers," said Wolfgang Schussel, the Austrian foreign minister who presided over the meeting.


That was a veiled reference to Anatoly Chubais, the architect of Russian privatization, and to the Harvard Institute for International Development, a group funded by the U.S. Agency for International Development and tasked with helping Chubais draft economic policies.


Across the Atlantic, meanwhile, the Republican Party was already crowing over Russia's collapse and jockeying to use it against the Democrats and U.S. President Bill Clinton.


"It is time for a Congressional investigation that might well be titled: Who Lost Russia?" wrote right-wing commentator Pat Buchanan, a leading voice in forming Republican foreign policy. "Its focus should be on who got -- and who stole -- the billions of dollars in Western loans sunk into Russia since 1991, because it surely was not the people of Russia."


In October 1991, President Boris Yeltsin, in a landmark address to the nation, explicitly asked the International Monetary Fund, the World Bank and Western governments for economic advice and help. Calling for emergency powers to run the country by decree for a year, Yeltsin promised to pursue bold reforms designed by young, English-speaking pro-Western economists like Chubais and Yegor Gaidar. It was a historic moment: No Russian leader had ever reached out so openly to the West.


Together the Western advisers and the so-called "young economic reformers" began to draft a radical economic program, using as a blueprint the immodestly-named "Washington consensus."


The Washington consensus is a package of policies prescribed by the IMF, the World Bank and the U.S. government for sick countries around the world. The consensus emphasizes free international trade and a freely exchanged currency; deep cuts in government spending, particularly for domestic social programs; and rapid privatization.


Another key element of the program is the creation of capital markets, which let capital freely seek its best uses. The hope was that newly privatized industries could borrow cheaply at capital markets and rebuild.


But this never took root. Billions of dollars were raised rapidly on the capital markets -- only to be whisked just as rapidly back out of the economy, either by fickle foreign investors or by corruption.


And suddenly, seven years later, Russia is in some ways back where it started in 1991. Now, as then, there are practically no working banks and no functioning capital markets. Now, as then, savings are evaporating as the ruble slips into a dangerously inflationary period. Now, as then, the country is unsure where it is headed, and frightened by the specter of food shortages and political extremism.


Now Russia is again headed into uncharted economic territory. Economists are being forced to rethink their theories and models, in search of new ways to lift Russia out of its crisis. What happened? And what is to be done now?


There is no unanimity.


But then, there never has been. One of the leading myths of the Yeltsin era was that there was some sort of consensus that radical free-market policies associated with Ronald Reagan and Margaret Thatcher were Russia's best and only hope.


Tokyo, for one, has been skeptical from the outset. The same month of Yeltsin's landmark speech, October 1991, the Japanese government for the first time offered a public dissent to the Washington consensus.


At the World Bank's annual meeting, Japan argued that the market will never develop the industries a country needs to sustain its economy in the 21st century without government protection or subsidies. Japan also argued that political stability and economic health both also depend on equitable wealth sharing among citizens. A country where a few hundred thousand in the capital are rich, while tens of millions of others are poor, makes for a lousy market.


Despite Japan's serious economic troubles today, its recipe did work. Tokyo somehow transformed its small war-wrecked Pacific island with no natural resources into the world's second-largest economy -- and the World Bank's second-largest donor -- in a matter of about 40 years.


Now the EU -- or at least its foreign ministers, who tend to take a softer line on such matters than other European leaders and institutions -- sounds suspiciously close to holding sympathy for Tokyo's arguments.


The EU foreign ministers' statement argued that income must be shared more equitably. It also reflected a change in thinking in the West, where policy-makers are beginning to recognize that the state has a strong stabilizing role to play in a country's economy.


In fact, Russia has for years been toying with the Asian model -- particularly the Tokyo-style emphasis on a government that protects and supports industries it judges to be strategic. A Kremlin that was favorable to a few select industries would have obvious attractions for the financiers known as the oligarchy, who, thanks to a corrupt privatization process, now hold most of the choice industries in Russia.


Leading oligarchs like Bank Menatep's Mikhail Khodorokovsky have called for the establishment of an Industrial Policy Board along the lines of Japan's MITI, the Ministry for International Trade and Industry. The Kremlin has obliged by meeting regularly with the oligarchs, and also by establishing the industry and trade ministry and installing a former Gosplan chief and a top Communist Party member, Yury Maslyukov.


Acting Prime Minister Viktor Chernomyrdin has also obliged, promising to install an "economic dictatorship" in January, under which industries could renationalize


All of this suggests Russia is in the process of making "a significant swing away from free markets to a statist economy," according to Martin Malia, professor emeritus of Russian history at the University of California at Berkley. Writing in The New York Times, Malia added, "This new course will last a long time, perhaps a matter of years."


But would Russia's understanding of the so-called Asian model simply mean elevating the oligarchy to official status? That is the nightmare scenario for those who believe Russia's real problem is not economic policy but simple criminalization.


Russia has long wrestled with corruption -- and liberals like Gaidar and Chubais clearly did not put enough emphasis on stamping out graft and theft and insisting on the rule of law.


Privatization, for example, was seen as an economic good whether it was carried out justly or not. And so the state was able in 1995, under Chubais's guidance, to hand over the oil companies, metals companies and other export giants to a handful of financiers -- the future oligarchs.


These barons were the beneficiaries of Chubais-led reforms -- as planned. They were supposed to be aggressive businessmen who would lead the nation's economic restructuring and growth. But instead of


investing in their newly acquired industries, they either took their cash to foreign bank accounts, or used it to buy more state influence, or put it into the highly lucrative equity and debt markets.


Instead of becoming markets where industries went to raise capital, the Russian capital markets became gambling houses for domestic and international investors. Fortunes were made, and the stock market itself became a Russian success story. But soaring stock prices were divorced from the reality of Russia's sagging industrial sector.


"People think economic success is a healthy capital market. That is not the case," said Paul Reynolds, director of the international division of the Adam Smith Institute. "There is a real world out there that's gone wrong, and that's what the government should be focusing on."


The oligarchs have also been able to dictate government policy. Their most infamous representative, financier Boris Berezovsky, by some reports even pays Yeltsin and his family in cash each month. Former Prime Minister Sergei Kiriyenko and his deputy, Boris Nemtsov, have both argued that their firing last month was brought about by Berezovsky and other oligarchs, as punishment for advocating bankrupting some banks.


If that is true, it raises fundamental questions about Russia's commitment to a free market system.


"The West should stop talking about market reform and admit it never happened," said Alexander Kennaway, an economist at the Conflict Studies Research Center in Great Britain. "None of the key elements leading to social and economic stability and progress exist in Russia today, nor is there any sign that they will appear in the foreseeable future."


Kennaway argues that Russia should reappropriate privatized assets from the oligarchs. "It is essential. Drive the fat cats out to Bermuda. Until they stop this top level corruption, [the government is] not going to get anywhere," he said.


But in the financial rubble that is Russia, there is something for every economist and every economic theory. Some point to the collapse and advocate even quicker Washington consensus reforms -- more privatization, deeper budget cuts, more free trade. "Russia went wrong because it was stubborn in making some necessary reforms to further facilitate a free trade economy," argues Brigitte Granville, an economist with the Moscow-based International


College of Economics and Finance. "Confiscating and controlling [privatized] assets will just give another guy the excuse to steal even more."


As to trying to find money for industry and for ordinary people, that might well involve printing money -- which would feed already blazing inflation. Moreover, Russia has tried this before. When in 1994 the government couldn't balance its books, Chernomyrdin's solution was to print more money. The result was a free-fall in the ruble rate, inflation and immediate widespread loss of personal savings. Westerners cringed, and recommended that the government instead temporarily plug budget holes by borrowing cash by issuing treasury bills.


The debt just grew, as the government refused to make difficult decisions about budget balancing. The IMF helped out by approving billions of dollars in loans -- most recently a $17.1 emergency bailout package. But the debt grew ever more, right up until an Aug. 17 freeze on the T-bill market.


The trick now is to stabilize the ruble, and government officials are again flirting with the same sort of harsh austerity that bailed them out following Black Tuesday in 1994 -- tougher tax collection and a clamp-down on the number of rubles in circulation.


There is a problem with this approach as well, however. One is that it could be politically untenable. The political demise of Kiriyenko and Nemtsov shows what happens when the oligarchs are threatened by tougher tax collection and a refusal to bail out their banks by printing rubles. And we still don't know how much longer workers who were owed $10 billion in back wages will show patience.


The other, more subtle, problem is that the simple monetarist blueprint for fighting inflation -- shrink the amount of rubles chasing goods -- does not correspond to reality. In August, as the Central Bank sold dollars for rubles, it ended up shrinking the ruble money supply by 0.8 percent -- yet inflation continues to soar. This suggests that inflation is a far more complex phenomenon than is recognized by Russian monetarism. Perhaps some far more innovative economic thinking is in order.


One of the most striking things about the Russian economy is the extent to which barter rules. Last year, 50 percent of all Russian business was conducted in barter, and 40 percent of federal taxes were paid in barter. U.S. economists Barry Ickes and Clifford Gaddy have a model to explain this. They say Russia has created a completely new economic system, what they call the "virtual economy."


They say that a barter system allows the creation of goods worth less than the cost of making them, the result of which is a catastrophic loss of value in the country that no one will admit exists. But society and government continue to tax, spend and price goods as if they were worth more -- while the West, with both its financial support and advice, is propping up this strange system and allowing it to flourish.


The virtual economy offers rewards for all participants, says Ickes: When no one pays anyone, no one has to admit there is no money. That means no bankruptcies, so workers stay inside their factories instead of storming the Kremlin walls. It also means the government can pretend it has lots of money -- instead of lots of IOUs -- to support a million-man army, a Mir space station and other superpower trappings.


"Russia has to swallow its pride and admit it is poor. Admit that the


factories are not kept open because they are valuable, but because they are socially beneficial in keeping people employed," said Gaddy.


Correct or not, the virtual economy model has generated much Western media coverage -- and has touched a nerve in Russian circles. Konstantin Voitsekhovich, Kiriyenko's press secretary, said in an interview that Kiriyenko had gotten upset upon reading an account of the virtual economy theory published in late July in the New York Times.


"[Kiriyenko] said, 'This is a very good example of how people see us, of what we look like,'" Voitsekhovich said. "Although he did not agree with the analysis in the [virtual economy] model, he said that it drove home a very central point [about the lack of bankruptcies in Russia]."


Voitsekhovich said Kiriyenko had copies of the New York Times article made and shown to underlings, and began talking animatedly about the need for more bankruptcies. "I don't know if it was by coincidence or not, but [the government soon after] submitted to the Duma a draft law on simplifying bankruptcy procedures."


And there are even more radical proposals afloat these days. Boris Fyodorov, the deputy prime minister, has kicked off discussion of unusual theories by suggesting Russia simply accept the U.S. dollar as the legal tender here. (There's no word yet what the U.S. Treasury thinks of that.)


An opinion piece in The (London) Independent put forward another novel idea: Russia could sell Siberia and the Far East to the United States, and subcontract out the administration of its government and its economy to Western managers. The (London) Times, not to be outdone, ran an opinion piece suggesting that it was time to consider whether Russia should even be a democracy; perhaps a dictatorship would have better luck turning the nation around.


Meanwhile, as the economists dither, the economy is more decisive. It is collapsing. There is still no government. Once one is finally chosen, it will face the near-impossible task of paying Russia's enormous foreign debt. Andrei Illarionov, director of the Institute of Economic Analysis in Moscow, told Interfax that he calculates Russia owes the world about $6 billion before the end of the year, while its total budgeted revenue is $4.5 billion. Cranking up the ruble printing presses will be no help -- the debt is dollar-denominated. Moreover, come 1999, the country will be obliged to start paying interest on the debt it froze in August.


There is always some hope of receiving another multi-billion-dollar Western grant. But that hope is dwindling, too, as both European and American politicians backpedal furiously from Yeltsin's disaster.


So what economic vision will be next pursued in Russia -- the world's largest nuclear arsenal, with a credit rating equal to that of the war-torn Republic of Congo? And who will decide? That remains anybody's guess.