LECTURE#26

Where is Russia heading to?

RUSSIA FACING THE CHALLENGES OF THE 21st CENTURY
Oleg Bogomolov

Contents:

1. Some lessons of international experience in market reform

2. The economic disaster

3. A fresh start on reforms

Notes

The final decade of the 20th century became a critical period in the fortunes of Russia. It is marked by dramatic events: the painful parting with past history and the beginnings of a future that still hazy. In what condition will Russia enter the new age? Will it be enfeebled by the current conflicts and economic hardships, or will it be resurgent and strengthened? That is the question historians, political scientists and economists have been trying to answer. Much will depend on those who stand at the helm of politics and take decisions.

In its urge to alter the existing social structure, Russia has launched upon an unexplored path. One might think that nothing could be simpler than to start living like other civilised nations and to return to one''s own historical roots. But the practice of reform in Russia has turned out to be a new social experiment, creating yet more victims and sacrifices. The democratic and market transformations in Russia could have been substantially eased and made less dramatic had the reformers chosen to draw more heavily on Russian social science, had they better evaluated the specifics of the Russian case, and had they seriously considered the experience of other nations, notably that of the countries of China and of Eastern and Central Europe, where nations have moved to the market much more successfully than has Russia.

1. Some lessons of international experience in market reform
The international experience in market reform gained over the past decade points to a number of important conclusions in terms of both theory and the practical guidelines for economic policy. In this period, striking changes have occurred in many countries. But was it worth paying for these changes the price that was exacted in the societies undergoing reform? Many of those who have had to bear the burdens of change are asking this question, and particularly it is on the lips of millions of Russians. Erudite scholars will, of course, say that invaluable historical experience in reforms has now been gained, and that we can now see more clearly the paths of progress for the peoples that have gone astray in their quest for a better life. Liberal-minded admirers of Milton Friedman will once again sing hosannas to free enterprise and the market. Clearly, communist authoritarian and totalitarian systems with a centralised planned economy failed to stand the tests of history, and the multinational states unified by these systems have fallen apart. But what kind of economic and political order should triumph on their ruins? Is it to be the semi-criminal order marked with the stamp of degradation that has taken shape in Russia and some other post-socialist countries? The populations of these countries certainly do not want such a future.

As the new authorities parted with the past and got down to dismantling the command economic system in Russia, they usually had a rather murky notion of the ultimate goals and how they were to be attained. Democracy and a market economy were, of course, the general objectives, but these objectives had to be spelled out and turned into clear-cut programmes of transition.
The intention of realising these objectives in the Gorbachov perestroika and the Yeltsin reforms was met in the West with support and generous offers of knowledge and experience. Following the aborted coap d’etat of August 1991, Western activity along these lines was markedly stepped up. A steady stream of adviser delegations came to Russia from abroad, and young reformers from the Gaidar team avidly assimilated the advice given by foreigners grown wise with experience. Chicago school neoliberalism was in vogue and won over Russian admirers hastening to disown the communist faith, and now and again these proselytes became even more orthodox than their new ideological idols. According to an apt remark by Gregor Kolodka, one of the architects of the Polish reforms, Russia professed "the world''s worst post-communist neoliberalism". In hindsight, we can observe that Western ideological expansion has done much harm, which is why this phenomenon deserves to be analysed.

The 1980s and 1990s have been marked by an upsurge of neoliberal ideology, which has gripped the minds of most economists and political leaders in the West. Nevertheless, this has not always been so. In the trying years faced by capitalism during the Great Depression of the 1930s, and then at the time of post-war dislocation after 1945, popularity was enjoyed by very different ideas, such as those formulated by John Maynard Keynes, who cast doubt on automatic market self-regulation and on many postulates of monetarism. Keynes regarded effective demand as a factor conducive to an increase in production, and he argued that governments could cure depression and unemployment through the mechanisms of government expenditures and taxes. Keynes came out as a critic of the dominant orthodoxy, which had no remedies against the Great Depression other than accessible credit and wage cuts. Keynes countered by proposing the use of the budget deficit to finance public works. Let us recall that Franklin D. Roosevelt relied on Keynesian ideas to lead the US economy out of financial collapse and the deepest slump in its history.

After the end of the Second World War, West European governments also made extensive use of state control and intervention in economic life in order to restore production and growth. At that time, the hour of neoliberalism had not yet arrived and Keynesianism was still to be overthrown. But once modern capitalism had recovered from the aftermath of war, once it had strengthened its economy and put it on the road of dynamic and crisis-free development, it acquired sufficient confidence to reduce state guidance to a minimum. Its theorists were ever more insistent in urging the need to denationalise state-owned enterprises and "deregulate" economic life, that is, to release it from intervention by the state. Major transnational companies and banks, they said, were able to ensure scientific and technical progress and equilibrium in the economy and in international economic relations, doing it on their own on the basis of competition. There were certainly some grounds for such an assumption, because the state machine, suffering from sluggishness, bureaucratic practices and corruption, often became a brake in the way of greater efficiency and competitiveness of enterprises that were owned or regulated under its control. And while there were many examples of the successful operation of state-owned enterprises and of fully justified government interventionism, the odds were clearly in favour of a liberal policy, which had ever more influential supporters. That may explain the general enthusiasm among politicians and publicists, especially of the conservative persuasion, for the neoliberal views of the Chicago school. It is not surprising, therefore, that the recipes that the West was able to propose for transition from an administrative system to a market system were couched in the spirit of the ideology predominant in that part of the world.

At a meeting of the Group of Seven in Houston in July 1990, participants requested the International Monetary Fund, the World Bank, the Organisation for Economic Co-operation and Development, and the European Bank for Reconstruction and Development to carry out, in close co-operation with the European Communities Commission, a detailed study of the Soviet economy. They were to work out recommendations with respect to its reforms and to establish criteria for the granting of Western economic aid in support of those reforms. Soviet economic and financial agencies and leading Soviet research institutes also worked on that assignment. By the beginning of 1991, a circumstantial report was completed and was put before the heads of state of the G7 and the Soviet Union.

The idea of closely tying in large-scale Western aid with progress in market reform in the USSR had, of course, emerged even earlier. It was spelled out in a joint report by Grigory Yavlinsky and Professor Graham Allison of Harvard University entitled «The Grand Bargain», which was widely advertised in Russia and in the United States. The international report contained highly detailed recommendations as to how to reform the Soviet economy, but in contrast to the Yavlinsky-Allison proposals it did not promise any concrete material assistance, being confined to general considerations.

What the team of Gaidar reformers began to do with the Russian economy a year later was, in effect, mapped out in general outline in this report. Its proposed radical-liberal conception of market reform, rejected under Gorbachov as unacceptable for Russian conditions, was adopted as a guide.

The quintessence of the recommended reform was to consist of three main elements, which came to be known as the Washington Consensus and whose pursuit conditioned the granting of Western aid. There was the so-called "macroeconomic stabilisation," which involved budget deficit reduction and strict limitations on credits and money emission; an abolition of price controls, which required the transition to world relative price proportions and liberalisation of domestic and foreign trade; and finally privatisation of state-owned property. According to the conception of the Washington Consensus, as soon as these tasks were fulfilled and the state "got out of the way", the market would make an effective allocation of resources and ensure economic growth. This policy appeared to be simple enough in terms of its several economic indicators: inflation, money supply, interest rates, budget and trade deficit, and the exchange rate, which served as the basis for a set of political recommendations. And the policy did produce positive results in a number of countries, such as those in Latin America, but in other cases it turned out to be counter-productive. Yeltsin and his associates decided that the shock-therapy line recommended by the West was the only possible one, that there was simply no alternative to it, so that they failed to heed warnings concerning its dangerous consequences.

The architects of reforms in Russia, in the countries of Central and Eastern Europe and in the Commonwealth of Independent States (CIS) did not initially give much thought to the fact that a great many varieties of democracy and the market economy exist in the world and that not all of these create conditions for genuine socio-economic progress. They did not, as a rule, ask themselves which type of democratic system and market economy would best agree with the specific features of the country in question, its historical traditions and the mentality of its population. Many regarded the American model as the ideal. According to the International Monetary Fund and the World Bank, it was the guiding star to follow, and Russia, Poland, Czechoslovakia and a number of other countries ultimately began to emulate that model. Today, in the light of the sad experience gained by some of these countries in transition, and also by a number of states in South East Asia, a conception of economic stabilisation different from that of the Washington Consensus has been taking shape.

It cannot be said that among serious American and European social scientists there were no critics of the market experiment in Russia. Such critics were present at the congress of the International Economic Association in Moscow in August 1992 and published critical articles in newspapers and magazines from time to time, proposing alternative paths for the market transition, but their voices were drowned out in the din of official and unofficial expressions of sympathy for the resolute policy of the Russian reformers. Even after years of mounting economic difficulties, when the failures of the reforms became evident the official West refused to face the real state of affairs and continued to stand up for the transition course that it had recommended.

On the initiative of some progressively minded US economists, a Russian-American Economic Transition Group was set up in 1994, bringing together prominent scientists from both countries in their desire to offer an alternative to what can be termed the "radical-liberal" reforms being pursued in Russia. The joint Mission Statement signed by some of the most authoritative social scientists of Russia and the United States, including several Nobel Prize winners, set forth the credo and the programme of joint work. It said that there was an alternative to the shock-therapy method of transition to the market and financial stability then underway in Russia. The American and Russian economists proposed less risky and much more effective policies for the transition than those being followed in Russia. Unfortunately, the sway of the "radical-liberal" ideology prevented these from being taken into account.

An idea persistently foisted on Russian society was that it had only one choice(the liberalisation of prices and of domestic and foreign trade(and that this choice was supported by the entire Western world, which was why the burdens of the reforms had to be borne in the hope of their inevitable success. Conceptions of more gradual and phased reforms, which would not have allowed excessive social hardships for the majority of the population, were either ignored or branded as unrealistic or anti-reformist. However, joint research made it possible to verify, in the light of concrete Russian and international experiences, whether the course chosen by our leadership was in fact justifiable and whether it ignored alternative solutions.

Co-operation within the framework of the Russian-American research group yielded a joint address to the future President on the eve of the 1996 elections, entitled "A New Economic Policy for Russia" and published in Nezavisimaya gazeta. From the same sources also came a book on The Reforms as Seen by Russian and American Scientists, published in 1996. Sadly but understandably in the political context of the time, there was no response to the address, as the new presidential administration and the Russian government simply dismissed the proposals of five Nobel Prize-winning economists and leading Russian academicians. Meanwhile, even several years later, the text of the address remained meaningful and urgent, outlining the badly needed policy adjustment.

Signs of a reassessment of the standard recipes for economic reform also began to appear in the later 1990s within international financial organisations. While some of this rethinking naturally centred on Russia, the critical attitudes were intensified after the ineffectiveness of the moves by these organisations to avert and overcome the grave financial crisis in South East Asia. In this respect, a sensation was caused by a lecture of Professor Joseph Stiglitz, Senior Vice President and Chief Economist of the World Bank, given at the annual session of the World Institute of Development and Economic Research (WIDER) in Helsinki in January 1998. He was the first official of the World Bank to cast doubt publicly on the conception of the Washington Consensus and to formulate alternatives to it in accord with the new realities.

Stiglitz said, "the set of policies which underlay the Washington Consensus are neither necessary nor sufficient, either for macro-stability or longer-term development." He declared that these policies are "sometimes misguided", that they "neglect ... fundamental issues", are "sometimes even misleading", and do "not even address ... vital questions." In order to keep the markets operating, he said, "something more is required than low inflation alone; this requires effective financial regulation, a policy in support of competition, measures to stimulate the transfer of technologies and to enhance market transparency. Those are only some of the fundamental propositions omitted by the Washington Consensus." The focus on inflation, he noted, may not only distort economic policy, preventing the country from fully realising its potential for growth and industrial production. It may also "promote institutional changes reducing economic flexibility without yielding any major benefits conducive to economic growth." He added that the oversimplified advice for economic stabilisation through a tightening of monetary policy in the spirit of the Washington Consensus, had it been followed in the United States, would have produced undesirable results. Had this advice been followed in the United States, «the remarkable expansion of the US economy», coupled with a low level of unemployment «would have been thwarted. China had ignored this kind of advice and scored successes, while Russia had followed it and suffered an unprecedented failure.

Joseph E. Stiglitz has elaborated his criticism against IMF policy toward Russia in his paper prepared for the Annual Bank Conference on Development Economics in April 28-30, 1999. His point is that the failures of the reforms in Russia go «to misunderstanding of the very foundations of a market economy, as well as a failure to grasp the fundamentals of reform processes. Textbook economics may be fine for teaching students, but not for advising governments trying to establish from anew a market economy - especially since the typical American style textbook relies so heavily ... on the neoclassical model, leaving out other traditions...»

A comparative analysis of the results of the reforms in the post-socialist countries makes it possible to draw yet another important conclusion on the issue of maintaining some continuity with the socialist past, of determining that not everything has to be radically altered. In fact, the Soviet model created on the principles of domination of state ownership, centralised planning and the leading role of the communist party was viable in some ways, since it did ensure development (and in some periods highly dynamic development) of the economy and a rise in living standards. Its evident flaws, primarily its inability to provide competitiveness and efficiency as compared with the Western countries, made it necessary to abandon the model, but this does not mean that the turned-over pages of history have no value at all and need to be entirely rewritten. In fact, countries in which this perspective was duly taken into account have managed to avoid grave mistakes in the course of major transformations.

But what kind of economic model will Russia achieve in the century ahead? It will hardly be the wild and piratical capitalism of the Manchesterian type that characterised Russia in the middle 1990s, or even the glossy appearance of United States capitalism today. Instead, it may rather be a convergent capitalism or, to put it more accurately, a convergent socialism, a mixed society in which the market economy has a pronounced social orientation. In such a model, a democratically formed state guarantees social justice and represents the broad strata of the population instead of merely catering to the interests of a narrow group of industrial and financial magnates.

In contrast to this perspective, there is a widespread view, accepted by many almost as an axiom, that a move of the former socialist countries to the road of democratic and market civilisation inevitably involves, if not sanguinary clashes, at least considerable material sacrifices and privations. The experience of Central and Eastern Europe and of the states that arose from the former USSR appears to confirm that view. The only disparity is presented by China''s market reforms, which almost from the outset led to an improvement in the economy and in the life of the people, and which still help to maintain high rates of growth. Can China be regarded as an exception and its experience as purely specific and unique? It is hard to ascribe twenty years of sustained advance to some kind of especially favourable concurrence of circumstances that characterise China alone. This is rather the result of a correct political choice, a reasonable line of reforms which contains much that is instructive for others. Unfortunately, the Russian architects of reforms have so far ignored the Chinese experience, having failed to appreciate anything useful in it.

In order to get down to market reforms, a nation requires political impetus, which can only come from authorities free of ideological dogmas. At the initial stage of reform, politics has to take the upper hand. But that does not exhaust the interconnection between politics and economics, since their interconnections are diverse and not always evident. Politics is precisely where, I think, one should look for the key to the success or failure of economic transformations. What is more, the political climate in a country(the stability or crises of a society in transition(also depends largely on the interactions between politics and economics, between market laws and legal mechanisms, and between business practices and morality.

On the strength of international experience, it is easier to bring out the necessary political prerequisites for healthy market relations and, on the other hand, to understand how the latter help to establish democracy. One of the lessons is that a strong and authoritative state capable of regulating and directing the transition process along the right lines is the most important instrument in creating a healthy market economy. That is why, regardless of the Washington Consensus, which holds that the state must withdraw from the economy and cease meddling in it, and the sooner the better, market reform in Russia required particular attention to creating an effective and competent state administrative apparatus free from corruption and bureaucratic practices. Alas, recommendations from the other side of the ocean were more sacrosanct for us than the considerations of common sense.

In my view, everything said above is directly relevant to the challenge faced by Russia in the 21st century: the kind of adjustments required by Russia''s policy and the way to continue the market reforms if we are to escape from the abyss. The painful financial setback in the autumn of 1998 contributed a lot to the understanding of inevitable changes in the reform course. It manifested itself as a collapse of the exchange rate of the rouble, the paralysis of the banking system, the refusal by the state and some of the major banks to pay up on their domestic and foreign debts, the spurt of inflation, and yet another robbery of citizens by the state and the banks ( liberalizeing prices in 1992 the state already deprived people of their savings). All of that helped to open the eyes of millions of ordinary people to the adventurist substance of the economic policy pursued. Its results turned out to be truly lamentable. The moment of truth had come, a moment for painful reappraisal of the earlier reformist experiments, a time for working out new approaches in putting through market reform and reanimating the economy. The era of Yeltsin the reformer came to an end with a failure of his reforms. But its agony lasted painfully.

2. The economic disaster

In order to appreciate what must be done after Yeltsin, we need first to consider in more detail what has gone wrong in the past.

During the 20th century, no major country in the world suffered in peacetime such an economic disaster as did Russia in the 1990s. In the years of radical reform, Russia lost its erstwhile economic might, falling in terms of Gross Domestic Product (GDP) even behind such countries as Mexico, Brazil and Indonesia, with a five-fold lag behind China and a ten-fold lag behind the United States. The recession continued, year after year, despite government declarations to the contrary. As compared with the pre-reform level, the productivity of the Russian economy on the threshold of the new century was more than cut in half, industrial output fell to 40 per cent of what it had been, and in the light industry and the food industry it dropped by two-thirds.

In terms of socio-economic parameters and indicators, Russia has joined the "league" of underdeveloped countries. This is especially notable in the structure of exports that stress fuel and energy, in a dependence of the population on imports for about half of its food and other goods, and in falling life expectancy, mass poverty, the spread of epidemic diseases, and the incidence of mental diseases and suicides. The population has also had to confront another unknown calamity: mass unemployment. Compulsory leaves of employees, a covert form of unemployment, have become widespread.

Moreover, increasingly unequal income distribution and falling GDP have had a depressing effect on the people, increasing social discontent. The living standards of a sizeable part of the population have been almost halved; the gap between the incomes of the poor and the rich has become far wider than in the developed countries; and there has been continuing degradation of the systems of social insurance, public health care, education and science, with crime raging in its most repugnant forms. In terms of the inequality in the distribution of incomes, Russia is now among the world''s leaders. According to the data of international organisations, the sum of incomes received by the richest 10 per cent of the population is 30 times greater than those received by the poorest 10 per cent. The corresponding decile coefficients in Western European countries are between 2.6 and 5.7, in the United States 5.3, in the countries of Central and Eastern Europe is between 5.1 and 5.6, and in China 14.

For years, Russia has suffered from an acute budget crisis and from large numbers of defaults by companies on their obligations. In 1998, company arrears on accounts payable reached almost 1 trillion roubles. Russians regularly suffered delays in the payment of wages for months on end, both in the sphere of budget financing and in industry, as well as reductions (sequestrations) of budget allocations for capital investments, for the maintenance of the armed forces and the agencies of law and order, and for medicine, science and culture.

Another aspect of this crisis was the avalanche-like increase in the domestic and foreign government debt. According to the Chairman of the Accounting Chamber of the Russian Federation, Russia''s domestic government debt, as of January 1, 1995, came to Rbs 88.4 billion, or 14% of GDP, and by the end of 1998 it was expected to go up to Rbs 750 billion ($115-120 billion), or one-quarter of GDP. The overwhelming part of this debt (Rbs 436 billion, as of July 1, 1998) consisted of short-term, high-yield treasury bills traded on the securities exchange, so that there was a threat of their massive dumping in unfavourable circumstances. These treasury bills were issued to plug a hole in the budget. Their maturity (ranging from several weeks to several months) and their fantastic yield (from 30 per cent to 100 per cent) made these obligations different from the treasury bonds of Western states, which are usually issued for a long period and at normal interest rates. The Russian Central Bank naturally set correspondingly high rates of refinance, so that this financial pyramid eventually collapsed. But its existence over a period of years siphoned off accumulations of funds from the real economy into financial speculative, thus further curtailing economic growth. When we also take into account the state indebtedness to Sberbank depositors, who were to be compensated for the savings lost as a result of price liberalisation, and also state responsibility for wage and pension arrears, the state''s aggregate domestic debt by mid-1998 was up to 50 per cent of GDP.

To this should be added the external debt amounting, as of the end of 1998, to over $140 billion, or almost 30 per cent of GDP. Worse still, apart from the central authorities, in the 1990s Russian regions and private banks also attracted large foreign credits, for which they were naturally indebted. In a ruined Russia, total indebtedness and liabilities came to exceed the critical threshold. Debt repayment and servicing in accordance with concluded agreements became highly onerous, and repayment was no longer possible without difficult negotiations with creditors on debt restructuring.

An economy with immense potential was thus confined to injections of domestic and foreign borrowings in order to prolong the life of the bankrupt political regime. In fact, the decline in household consumption did not proceed as rapidly as the decline in GDP, and this created the illusion of an absence of serious threats. According to the Institute for Economic Forecasting of the Russian Academy of Sciences, between 1991 and 1996 household consumption shrank by 18 per cent and GDP by 42 per cent. The country lived on, gradually moving into the noose of debt, eating through its natural resources and wealth accumulated in the past. Investments in fixed capital of production facilities in 1998 were down to almost one-fifth of the pre-reform level. Equipment deteriorated and went out of service without replacement, and technical progress came to a standstill, with new industrial construction being an exception. The appalling flight of capital from Russia made the situation even more hopeless. From the start of radical reforms up until 1999, the outflow of capital was estimated at $150 billion US dollars and possibly even more. Even a relatively strong economy can not sustain this kind of bloodletting, and for the impoverished Russians this capital outflow could have disastrous consequences.

3. A fresh start on reforms
Instead of saving the economy Yeltsin was exclusively concerned to save his power dismissing the prime-ministers one after another and reshuffling the government. There was a hope that Primakov’s government will get down to saving the economy. In the autumn 1998 Yeltsin was forced tacitly to accept the abandonment of the radical-liberal policy based on monetarist recipes and an underestimation of the regulating role of the state, a policy stubbornly pursued with his support. That made it possible to start an adjustment of the old course and to commence government support of the real sector of the Russian economy.

Let us recall, for instance, that the liberals held measures to stimulate fixed capital formation, to lower taxes and expand investment and consumer demand to be meaningless so long as inflation had not been brought down to an acceptable minimum of roughly 10-12% per annum. Accordingly, they pressed inflation down with the use of patently cunning methods: wages were not paid for months, money was attracted to the budget at monstrously high interest rates on the financial-pyramid scheme. As a result, inflation was artificially beaten down to almost the aforesaid level, and the reforms were accordingly declared to be a success. But the triumph did not last long: the country had to pay as a result of the financial collapse of 1998 a high price for that hazardous policy.

The activity of Primakov’s cabinet has been complicated by the acute shortage of time, by a crisis of confidence in the institutions of power, and an unwillingness on the part of many to recognise the earlier policy as a fiasco and admit the need for serious adjustments. Moreover, most of the mass media both in Russia and in the West, especially in the United States, began to accuse Primakov and his cabinet of being incapable of action, of the lack of a well-considered programme, and of attempts to resurrect administrative practices, and to predict the inevitable failure of the new course. While being under fire from various sides and bearing the burden of a grave heritage, the government nevertheless began gradually to shovel away what appeared to be impassable obstructions.

Once it would be coped with that in the main, and there was a hope it would, if nothing unpredictable happens, it will be faced with matters of strategy. A great deal here was yet to be thought out and specified. However, the main guidelines in adjusting the strategic course of the reforms appeared to be mapped out. The task was put forward to create conditions enabling the real economy to operate without hitch and to grow in order to ensure the people''s welfare and normal living conditions. Market transformation is meaningful when it doesn’t improve the condition of the economy and the material well-being of the people. And it is just such a social orientation that the state needs to impart to the market, doing so as a representative and exponent of the interests of the society as a whole. That was roughly how Primakov formulated his credo.

In spite of visible improvements in economic situation Primakov’s government was dismissed after seven month of its activities. There were no persuasive motives for Yeltzin’s decision to fire the government except his fear to loose the power if the new policy will succeed and prove the bankruptcy of the previous economic course.

It is very likely that after Primakov the Russian economic policy would experience a set-back. The implementation of the badly needed correction in the reform strategy seems to be postponed till the next political earthquake. But sooner or later Russia will adopt a new strategy.

One could expect that elaboration of a strategy for Russia''s development in the 21st century will proceed along the following main lines.

1. As never before in the past, key importance attaches to a restoration of confidence in state power and an enhancement of its regulatory role in forming market relations. This does not imply any bureaucratic meddling, which is often motivated by the self-seeking interests of officialdom and which draws well-justified censure, but means that power should be used for laying down and observing the rules of civilised marketplace behaviour, giving the reforms a social orientation, stimulating and protecting the domestic producer, and pursuing a sensible structural policy. In addition, the state has the duty to manage its property effectively, seeking to increase returns.

Attainment of all these goals requires not only time and a development of democracy, but also systematic efforts to strengthen and improve state administrative structures, to pick officials and help them raise their professional standards, to resolutely root out corruption, and to reduce the swollen administrative apparatus down to reasonable proportions. Laws should be adopted to tighten up responsibility of various-level administrators for honest and bona fide performance of their duties and expenditure of taxpayers'' money. Those who maintain the state administrative apparatus must have the right and the possibility of verifying how their money is spent. The budgets of all levels must be honest and transparent, and their adoption and control of their execution must be effected by democratically elected institutions in the light of publicity. These rules should also cover various off-budget and special funds through which public money are often plundered. The task of ensuring compliance with stringent accounting rules in the budgetary and all other spheres is one of the vital tasks of market reform. In this context, a growing role belongs to such an independent agency as the RF Accounting Chamber, whose conclusions it is inadmissible to hush up or leave without consequences, for that amounts to a direct challenge to the democratic rights of citizens.

2. Ahead lies the task of continuing the tax reform, lowering taxation step by step down to a level which makes it possible to produce goods and services with normal profitability and to realise them on the market without resorting to diverse tricks and dodges for the purpose of tax evasion. At the same time, it is important to tighten up administrative and criminal liability for non-payment of taxes. For a long time, the risk of avoiding payments into various kinds of budgets and funds was justified on the plea that otherwise the commodity producer was unable to survive. In the presence of suppressed effective demand, enterprises were often forced, in order to market their products and obtain hard cash for paying off wage arrears, to give up their products at prices not ensuring any profits and even failing to cover the depreciation of production assets. That is why non-payment of taxes was seen as being in the order of things. The time has come to convert taxes from a purely fiscal instrument used to replenish the state treasury into an instrument for stimulating production and investment activity. The budget''s temporary losses from tax cuts will subsequently be made up by an increase in the total amount of tax receipts as a result of growing output and higher returns. Evidence of this is provided by international experience.

3. The Central Bank''s refinance rate and especially the yield on government securities cannot remain on a level considerably in excess of the normal profitability of industrial enterprises and productive investments, for that leads to investment of funds accumulated by enterprises and of household savings not into production, but into the speculative financial sphere. Resources for productive investments are thereby limited to the utmost, and such investments, which have no appeal as it is because of inflation risks, are altogether deprived of any attractiveness.

4. The next in turn is a review of anti-inflationary policy, which in the years of the radical-liberal reforms was confined to tight restrictions in the sphere of money and credit emission and budget expenditures. The economy was very soon faced with a shortage of own payment resources. The working capital of enterprises turned out to be below all conceivable norms. The money-supply shortage was made up by means of barter deals (up to 70% of all transactions in 1998), foreign exchange, mutual offsets, promissory notes, etc. That was evidence not only of a dangerous dislocation of the monetary system, but also of a loss by the state treasury of large sums of incomes. According to various estimates, from $30 billion to $50 billion in the form of banknotes were in circulation in the country in 1998; recalculated into roubles, that amount exceeded the amount of roubles in circulation. That meant not only profits foregone, because the budget was deprived of the corresponding income from money emission {seigniorage}, but also interest-free and long-term crediting of the United States and other Western countries, something that is impermissible for a country in trouble. Russia exported its goods and services, sold a part of its property, and received in exchange, instead of the goods and services it needed, debt obligations in the form of dollar banknotes settled in the hands of the public and of individual firms. In other words, these became an instrument of keeping savings secure. Of course, this is primarily a manifestation of the most profound crisis of confidence in the Russian state, its currency and its banking system. But it is also a consequence of a primitive monetary policy dictated not so much by real experience as by monetarist dogmas, by the fear of any money and credit emission.

It is no easy thing to turn one''s back on deeply ingrained prejudices, but otherwise it will be hardly possible to bring about a radical improvement of the monetary system. Controlled expansion of money supply through an increase in money and credit emission is not only permissible, but is in fact necessary.

It is true that in doing so the state should seek to direct the additional effective demand in such a way as to have it operate towards a loading up of production capacities and new investments instead of crashing down in its entirety on the consumer and currency markets. For instance, target credits for replenishing the working capital of promising enterprises could serve to enliven production. At the same time, it is necessary to improve the structure of the money supply, reducing the proportion of cash in circulation, extending the use of non-cash, including electronic settlements, squeezing out inferior-quality money surrogates and, finally, putting in order the turnover of cheques and promissory notes.

5. One of the central strategic goals of the market reform is to restore confidence in the national currency and to ensure its stability. The lack of confidence in the rouble and in the authorities, which have over the past eight years robbed the people on three occasions by devaluating money and deposits, is fraught with outbursts of panic buying and inflation, so preventing the formation of healthy market relations. The attempts to strengthen the rouble and minimise inflation by means of the purely monetarist methods of reducing the money supply and imposing credit and fiscal restrictions created an artificial shortage of money, forcing the economy to resort to diverse money surrogates. Cosmetic measures in the form of deleting a few zeros on banknotes did nothing to improve the health of the monetary system, because they failed to solve either the problem of confidence or the problem of stability. It is not surprising that the country began to make wide use of someone else''s hard currency, the US dollar, which serves as a unit of account, a store of value and very often as a medium of exchange. That amounts to a vast deduction from its already limited resources.

The struggle by means of administrative methods against the dollarisation of the economy has no prospects before it. Economic solutions need to be sought. That is why the question of a monetary reform which could expel foreign currency and inferior-quality money surrogates from domestic settlements tends to acquire especial importance.

The introduction of the dollar into the Russian economy as a parallel currency suggests the idea that it is better, on the strength of the experience of NEP Russia in the 1920s, to have one''s own hard and freely convertible currency parallel with the present rouble: a new chervonets. It would be important to back it properly with liquid assets and to create an especially favourable regime in the use of such a currency for accumulation of reserves and for settlements (both internal and external. It could initially service cashless banking operations and then, in the event of positive results, also enter into circulation as cash. In order to ensure the necessary confidence in such a currency, the Central Bank''s authority and government guarantees will clearly be inadequate in the years ahead. For participants in economic life and individual citizens to be able to put their trust in the durability of the new currency and its unhindered convertibility into foreign currencies, a solid international guarantor will have to be involved.

The introduction of the chervonets would substantially alter the investment climate in the country, enabling us to have reliable assessments of fixed assets, to make a correct estimate of depreciation deductions and accumulate these without loss, and to calculate the returns on and recoupment of investments with greater confidence.

6. The new strategy of reforms must undoubtedly also include changes in the distribution of money incomes, with an increase in the incomes of the main mass of the population. The much too low relative level of remuneration of wage labour in Russia, as compared with the much too high level of income from business is reflected, for instance, by such an indicator as the share of wages in the national income. Its magnitude in Russia comes to 40%, whereas in the United States it has gone up from 60% in 1929 to almost 75% by the end of the 1990s.

In mid-1998, per capita money incomes in Russia, if we are to believe official statistics, came to roughly $150 a month, in 1999 it decreased to less than $100, whereas in market economies close to Russia in level of development they are two or three times higher. At the same time, domestic prices in Russia came very close to world prices, and in some cases even surpassed these when recalculated at the dollar exchange rate. Following the more than three-fold devaluation of the rouble, money incomes in dollar terms shrank almost to the same extent. There was also a corresponding contraction of effective demand, which, in addition, was met to some 50-60% with imported goods. That makes it clear how narrow the domestic market is for loading Russian enterprises, even those capable of competing on this market.

In order to give production an impetus to growth, the authorities must show concern for expanding the domestic market for national producers, doing this with due consideration and caution, and channelling additional demand along the required course with the smallest risk of provoking an increase in inflation. It goes without saying that any changes in the money incomes of the population call for a very cautious and well-considered policy. One cannot take away from people--without pain or with impunity--something which they by rights had in their possession. To do so is, at the very least, fraught with an explosion of social discontent and a governmental crisis. But the badly needed increase in incomes expanding demand for goods and services is also latent with the dangers of provoking inflation and with discontent of another kind connected with an increase in the cost of housing, medical services and education.

A reform of the labour remuneration system requires a complex approach, that is, changes in wages, taxes, the provision of pensions, and the system of social insurance must be put into effect in connection and in agreement with each other, without undue haste, stage by stage. It is important to carry these out in such a way as to raise the level of real incomes, so increasing the demand for goods and services and, consequently, stimulating production. At the same time, higher pay must be tied in with higher results, providing material and moral incentives to conscientious labour and observance of labour discipline.

An increase in wages cannot, of course, but have an effect on a rise in the costs in production and, consequently, in prices as well, unless there is a reduction in the mandatory charges on wages going into the budget, and also in taxes on business, and unless labour productivity goes up. There will probably also be a need for other measures to counteract the inflationary threat, including some control of prices. Changes in income and property taxation must, among other things, pursue the task of reducing the gap between the living standards of the rich and the poor down to reasonable and socially acceptable proportions, and of moderating unwarranted differences in remuneration between the various branches of the national economy, for instance, between those operating for export and for the domestic market.

In order to direct the additional effective demand of the population towards the purchase of Russian goods and services, and not only of imported goods or hard currency, various instruments of government regulation cannot be avoided. Restoration of savings on bank accounts in Sberbank lost by the population as a result of price liberalisation could, for instance, be turned to use in developing production, provided a reasonable and phased procedure is worked out for their use in the acquisition of housing, Russian-made durable goods, and so on.

In such a sphere as pension security and social insurance, which is so supersensitive for the public consciousness, reform is designed to improve the human condition, with a growing sense of social justice. Evidently, there is a need for a reasonable combination of guaranteed state benefits protecting from poverty in old age and in case of disability or unemployment with opportunities for improving one''s condition over and above the guaranteed level through individual insurance or voluntary contributions to the respective funds.

The main purpose of a reform of money incomes and wages is to revive the economy, improve social relations, and restore respect for honest labour. In contrast to the schemes of the radical liberals, with their projects for eliminating state subsidies for housing and other social services, an incomes policy cannot be subordinated to the purely fiscal objectives of plugging the holes in the state budget.

7. Despite all the postulates of liberalism, Russia can never overcome the disastrous state of its economy without resorting to price control in the highly monopolised industries, which include natural monopolies, in the first place, or to an adjustment of relative prices (proportions between the prices of various goods) according to the concrete conditions and structure of the Russian economy. The present disparity in the prices of agricultural products and of machines and fertilisers purchased by farmers can hardly be tolerated any longer. Railway tariffs are disproportionately high in comparison with other goods, and the prices of some other products are just as exorbitant, often exceeding world prices. The spontaneous transfer of the level and proportions of world prices to Russian soil is destructive for the economy, which, because of its scale, can and must be oriented mainly towards the domestic market.

8. A fresh start on the reforms implies initiative and intervention on the part of the state in order to create a competitive environment in the country, because it is the pith and core of the market economy. As a result of the ill-considered liberalisation, state monopolies have been replaced by private and criminal monopolies craving for easy money. Former Argentine minister Domingo Cavallo, who visited Moscow, called in his interview to American magazine «Forbs» Russian capitalists and bankers "predators, and not helpers of the economy". The state will have to ensure effective control of the monopolies, to prevent them from exploiting their dominant positions on the market, to eliminate the mafia groups which provide a "roof" for many banks, for the bulk of wholesale and retail trade, and for many of the most profitable branches and enterprises in industry.

9. In contrast to the Western practice of privatisation, which started with loss-making enterprises, in Russia it was the most profitable enterprises that were first of all given up into private hands and sold off for a song. As a result of such a suicidal policy, the state treasury has been emptied and the state itself is close to bankruptcy. What is more, the state has actually given up the management of state-owned property and the revenues it yields. This has given Primakov cause to declare that "the country requires another kind of privatisation which would develop the real economy and improve the life of the people". One should evidently expect to see a tightening up of control by the state over its share of the property in joint-stock companies and active use by the state of its controlling interest to exert an influence on enterprise activity. Besides, a more rational division of property rights between the Federal, regional and municipal levels is required. Sooner or later, the results of privatisation carried out in breach of the laws and having a semi-criminal nature will be reviewed in judicial proceedings. And that will evidently become a part of the general strategy of struggle against the criminalisation of the economy and the corruption of administrative structures.

10. The exchange-rate policy is in need of a substantive adjustment. In order to stem the massive flight of capital from Russia, the state has to tighten up of currency control and currency restrictions and to make more efficient the respective state mechanisms. Regulation of the exchange rate of the rouble must be effected with proper consideration and with due account of all the consequences for the economy as a whole. The important thing is to prevent any damage to the interests either of exporter-producers or of importer-consumers.

11. And here is yet another vital task. Government measures will have to be taken to work out and implement a conception of restructuring the economy and preventing its conversion into a fuel and raw-material appendage of the developed world. This involves priority capital investments into high-technology lines of production, an effort to preserve and increase the scientific and technological advantages in some of the machine-building and other lines of production, support of science, a revival of the light and food industry on a modern technological foundation, and in-depth modernisation of the transport and communications systems. A revival of agriculture ruined by the irresponsible policy of the radical reformers has a place apart. The dependence on food imports has acquired inadmissible proportions both from the standpoint of national security and of the crying dissipation of the natural and human potential.

Implementation of a structural (including industrial) policy is inconceivable without a favourable regime of taxation and crediting, and also without attraction of direct foreign investments, promotion of integration between enterprises with the object of bringing together all the technological stages in a single complex, and reasonable protection, in accordance with the rules of the World Trade Organisation, of Russian producers against foreign competition and export expansion.

The list of proposals being discussed in Russian scientific and political circles for setting Russia on the road of sustainable economic growth in the 21st century is naturally not confined to what has been said above. Only the very key points have been listed. Whether these will be taken into account and translated into life depends on how well they stand the test of practice and, most important of all, on how favourably the political situation takes shape in the country.

Notes :
1. Izvestiya, December 9, 1998.
2. The Washington Consensus was a set of political recommendations worked out by the economic elite of the United States, the International Monetary Fund and the World Bank for overcoming the crisis faced by many countries of Latin America in the 1980s. It determined the formula whose application was to create a dynamically developing private sector and to stimulate economic growth.
3. This was to be what the report called "the earliest and most comprehensive abolition of price controls." See USSR Economy: Conclusions and Recommendations. Report by a Group of International Experts. Voprosy ekonomiki, No. 3, 1991, p. 35.
4. According to the report, the Russians should "go on, as soon as possible, to an open and decentralized system of control and exchange rates." See ibid., p. 24.
5. The report declared that "the ultimate goal of the property reform consists in privatisation of virtually all enterprises." See ibid., p. 37.
5. Problemy prognozirovaniya, No.4, 1994, pp.60-63.
6. A New Economic Policy for Russia. Nezavisimaya gazeta, July 1, 1996.
7. The Reforms as Seen by American and Russian Scientists. Edited by Academician O.T. Bogomolov. Moscow, 1996, 265pp.
8. Stiglitz J. More Instruments and Broader Goals: Moving toward the Post-Washington Consensus. WIDER Annual Lectures 2. Helsinki, UNU/WIDER, 1998.
9. Ibid., pp. 4-5.
10. Ibid., p. 11.
11. Ibid, p. 12
12.Whither Reform? Ten Years of the Transition. Keynote Address, World Bank Annual Bank Conference on Development Economics, 1999
13. World Bank. Report on World Development, 1997, pp. 258-259.
14. See Khachim Kramokov. A Country of Debtors. Vek, No. 16, 1998.
15. Institute for Economic Forecasting of the Russian Academy of Sciences. Economic Monitoring of Russia. Bulletin No. 8, Moscow, January 1997, p. 21.
16. Russia''s Economy in 1998. Academy of the National Economy of the Russian Government. Higher School of International Business. August 1998, p. 11.
17. M. Primakov. "The Government''s Principal Tasks." Speech in the Federation Council on October 14, 1998.

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From Yeltsin to Putin: Milestones on an Unfinished Journey

April & May 2000, No. 100
Published by the Heritage Foundation

By Ariel Cohen

Boris Yeltsin’s passing from the world scene demonstrates once again how one man can change history. If not for Yeltsin, Russia today might still be ruled by the Soviet Communist Party, either in reformist or Stalinist incarnation. But Yeltsin only started the long and still unfinished business of reforming Russia. He has left much of the job to his hand-picked successor, Vladimir Putin, the steely-eyed former intelligence officer and ex-head of the Russian secret police who only a year ago was a complete unknown. It is now up to Putin to tackle the future of Russia and its centuries-old problem of integration into the West.

As the Soviet Union collapsed, the Russian reform-oriented elites led by Yeltsin attempted a political modernization that included the wholesale import of Western-style political machinery. The trappings of democracy installed in Russia included participatory elections, the creation of an office of the president, and the adoption of a constitution influenced by pre-revolutionary Russian political practice, the French Fifth Republic, and the United States. But as has been true since the time of Peter the Great, when Western practices are planted in Russian soil, they acquire uniquely Russian characteristics. Putin’s presidency will inevitably be evaluated in the light of the successes (or failures) of the political and economic reforms started under Yeltsin and Gorbachev.

Putin’s March 26, 2000 presidential bid wasn’t quite a formally uncontested election of the kind that was a hallmark of the Soviet era, but it still presents a peculiarly Russian phenomenon — the election of a monarch. The wildly popular political novice Putin ran without a strong opponent, and at this writing looked to face no serious obstacles on his way to the presidency. After a "dirty tricks" campaign aimed against them, former Prime Minister Yevgeny Primakov and Moscow’s Mayor Yurii Luzhkov, both of whom appeared formidable only a year ago, opted not to enter the contest. The consensus in Moscow is that the young, ambitious, and focused Putin will be very much a hands-on leader, inheriting the legacy of the impetuous and autocratic Yeltsin.

Sorting out Yeltsin’s past role and Putin’s future rule is an important challenge for Western policy experts and politicians. It is also important to understand how Russia is really ruled, and not to be misled by those familiar Western terms: elections, parliament, president. We must see Russia for what it is — a huge country that has been stuck in what the Russians call "catch-up modernization" for the past 300 years, but does not really consider itself to be entirely a part of the West. As in the past, Russia today is ruled by elites who are willing to acquire Western goods and concepts, but do not fully identify with the West and often are envious of it. The world’s ability to live with and next to Russia now hangs in the hands of Putin.

Yeltsin’s ambiguous place in history

Like many russian rulers before him, Yeltsin started out a reformer and wound up a retrograde. While he earlier defied the communist putschists, liberated prices, and launched a massive privatization, he later ended up presiding over the economic crash of August 1998 and the destruction of Chechnya. His resignation on the eve of New Year’s 2000 concluded an era in Russian politics that began with Mikhail Gorbachev’s ascent to power in 1985.

This was the era of dismantling communism, the centrally planned economy, and the Soviet multinational empire. By the time Yeltsin assumed office, Gorbachev had pulled most Soviet forces out of the external empire and had refrained from interfering when democrats toppled the communist governments in Eastern and Central Europe. In fact, Gorbachev reportedly encouraged the removal of the hard-line leadership of East Germany, led by Erich Honecker, and he had no kind words for the Romanian dictator Nicolae Ceauçescu upon his demise.

In the Soviet Union itself, the Communist Party was utterly discredited. Graves containing the remains of hundreds of thousands of Stalin’s victims were exhumed across 11 time zones, from Belarus to Eastern Siberia. Russians were disoriented and demoralized as the old order fell, but at the same time full of hope for a better future.

The Soviet Union itself was about to be transformed into a confederation when the August 1991 coup struck. The fiction of the "Soviet people — a new historic entity," as it was called under Brezhnev, had fallen apart. Ethnic conflicts raged between Armenia and Azerbaijan in the Southern Caucasus. To save the internal Soviet empire, Gorbachev authorized the use of force against independence-minded leaders of the Baltic states and anti-communist nationalists in Georgia and Azerbaijan, but to no avail. War was about to erupt between the communist-leaning Slavs and Romanian-speaking nationalists in the Trans-Dniester part of Moldova.

Yeltsin accelerated Gorbachev’s reforms, bringing about the dissolution of the Soviet Union and administering the coup de grâce to the iron rule of the Communist Party. He should also be credited for ushering in a working democratic political process, albeit in a rather inelegant fashion. After a few years, a new elite crystallized. It combined more advanced members of the communist-era nomenklatura and security apparatus with some representatives of the emerging entrepreneurial class. This elite effectively privatized most of Russian industry: the lucrative oil and gas sector, the largest aluminum, nickel, platinum, and palladium plants in the world, and that giant but creaky Soviet flagship airline, Aeroflot. A stock market appeared, then soared to become the best-performing financial market in the world (1996-97) before crashing in 1998.

The new business oligarchy attempted to create a rough-and-tumble universe of the new Russian commercial banking (which collapsed in August 1998, leaving billions of dollars of debt behind). Fortunes were made, but many lives were lost (or destroyed) in the process. At one point in the mid-1990s, Moscow had more Mercedes 600 cars than the rest of Europe combined.

Prostitution and drug use, both very hush-hush in the Soviet era, became open and rampant. Russian society may have lost some of the warped values of the communist era, but it failed to gain any others instead. The Orthodox Church, heavily penetrated by the Soviet secret police, hardly provided a substitute for the spiritual vacuum of the late communist and post-communist era. Instead, it was busy begging for tariff breaks for its vast alcohol and tobacco importing operations. A spiritual leader of the liberal reformers of the Church, Father Alexander Men, was brutally murdered. Other reformers and dissidents in the Church, such as Father Gleb Yakunin and Father Georgi Edelstein, were defrocked or exiled to far-away parishes.

The new oligarchy seized control of the Soviet TV channels while building new media outlets. As the corpses of bank presidents multiplied, so did the horror stories in the Western media connecting the oligarchs with corruption at the highest level in the Kremlin.

Yeltsin, like many a revolutionary before him, came from the ruling class of the previous regime, from the apex of the communist nomenklatura. He was a nonvoting member of Mikhail Gorbachev’s Politburo and first secretary of the Moscow city party organization before he officially broke with the communists and launched his own bid for power. Yeltsin’s star turn on the global stage came as leader of the opposition to the hard-line communist coup in August 1991. Russia’s history ¾ and that of the world ¾ would have been very different if the gray apparatchik conspirators, who included Gorbachev’s own vice president, the Soviet defense minister, the interior minister, and the head of the kgb, had succeeded in restoring a Brezhnevite Soviet Union and eliminating Gorbachev and Yeltsin.

Yeltsin’s personal style was authoritarian. In October 1993, he sent troops to shell the White House, then the seat of a rebellious Russian Supreme Soviet dominated by communists and other hard-liners. He did not allow other politicians to build their own power bases, changing his prime ministers as often as Nicholas II. However, unlike the last czar, his political instincts were somewhat more democratic. He refused to rule as an autocrat after defeating the Supreme Soviet. He did not dispute the decision of the pro-communist courts to pardon the 1991 coup plotters or the 1993 Duma pardon of the hard-line opposition. Yeltsin permitted parliamentary elections and accepted their bitter results both in 1993 (which gave a victory to the clownish nationalist Vladimir Zhirinovsky) and in 1995 (a communist last hurrah). While he had the authority to dissolve the Duma and call for new elections, he never made use of it. Once he had pushed through a constitution, he adhered to it, refusing his confidante and chief bodyguard Alexander Korzhakov’s advice to cancel the 1996 presidential elections.

Yeltsin’s weaknesses and drawbacks were as significant as his achievements. While he operated well during crises, he quickly lost interest in the daily affairs of state. Perhaps due to his lack of understanding of economics and the law, he allowed the privatization of the vast and obsolete Russian industrial base to be abused and corrupted by insiders. He never understood the necessity of building a functioning legal system, including a framework for the enforcement of contracts, or of maintaining an adequate law enforcement apparatus. Disintegration of the legal system became so advanced that in some towns judges were placed on retainer by larger law offices. In other cities, lawyers paid for judges’ office supplies.

Having surrounded himself with corrupt cronies and financiers, Yeltsin paid only lip service to fighting crime and corruption. He presided over an unprecedented deterioration in Russia’s internal security and law enforcement. The population became disgruntled as bandits ruled the streets and businesses, while businesspeople, foreign and domestic, balked at investing. Taken together, the failures of the post-communist transformation and the inability to construct even a minimal social safety net lowered the already meager standard of living of tens of millions of Russians and helped make Boris Yeltsin as unpopular at the end of his term as Mikhail Gorbachev was at the end of his.

Chechnya is another black spot on Yeltsin’s legacy. He launched an unsuccessful military campaign in 1994, hoping to boost his flagging popularity. The Russian generals, still smarting from the defeat in Afghanistan, learned that while the Soviet Army, with its mass of ill-trained conscripts, might have been prepared to fight on the Northern European plain, it was not ready to fight in mountains populated by Muslim guerillas. The Kremlin planners and generals did not anticipate fierce resistance by the Chechen nationalists led by the late Soviet Air Force Gen. Djohar Dudaev. Yeltsin’s democratic instincts failed him when it came to non-Russian, dark-skinned mountain dwellers: He refused to meet with Dudaev or to make any concessions to his successor, the ex-Soviet Army Col. Aslan Maskhadov.

The first war, unconstitutional and ill-conceived, brought great humiliation to the Russian military and allowed Chechnya to effect a de facto secession. One of the reasons Russian forces performed so abysmally in 1994-96 was that Yeltsin failed either to reform the Russian military and security services or to keep them outside the grip of the pervasive corruption that marred his presidency. The war served as a cover for the generals to make millions of dollars profiteering: The generals sold artillery shells, cannon and light weapons by the trainload, claiming that all the hardware had been lost in battle. Moreover, they sold some of the weapons to the Chechen militants they were supposed to be fighting. No wonder Yeltsin had to sue for peace before the 1996 presidential election, following debacle after debacle in the battlefield.

That did not close the subject, however. Yeltsin authorized preparations for a new invasion of Chechnya in spring 1999. In August that year, Chechen militants Shamil Basaev and Khattab (the nom de guerre of a Jordanian-born Chechen) invaded Dagestan with several hundred militant Islamic fighters. The two claimed that they had embarked on a jihad against Russia and intended to establish an Islamic state in the Northern Caucasus from the Black Sea to the Caspian Sea. Russian oil interests in the Caspian were endangered, and the territorial integrity of the Russian Federation was put in question. The "field commanders" were repelled in August, but four mysterious explosions blasted through apartment buildings in Moscow and the south of Russia.

These heinous acts were immediately pinned on the Chechens, and in September 1999, Yeltsin authorized a full-scale invasion of Chechnya to erase the defeat of the 1994-96 war and to assist the election of his chosen successor, Putin. The second Chechen war resulted in over 10,000 killed and 250,000 refugees. The city of Grozny was effectively erased from the face of the earth, the worst urban destruction in Europe since World War II.

Finally, there was the ignominy of the presidential pardon Putin granted Yeltsin. The ex-ruler of Russia and his family were connected in published accounts to a massive bribery scandal originating with the Mabetex company based in Lugano, Switzerland. There were also charges in Moscow that Yeltsin’s family members received villas as presents from influential Russian business tycoons. When Russia’s left-leaning former prosecutor general, Yuri Skuratov, attempted to investigate these allegations, a tape surfaced showing him cavorting with two prostitutes whose services were reportedly paid for by a banker he was also investigating. Yeltsin fired Skuratov in the wake of the rather conveniently timed scandal.
On his first day in office, acting Russian President Putin pardoned Yeltsin for any possible misdeeds and granted him total immunity from prosecution (or even from being searched and questioned) for any and all actions committed while in office. Yeltsin also received a life pension and a state dacha. An orderly transition of power? Perhaps. A demonstration that you can get away with a lot while in public office? Certainly.

Putin’s debut

Vladimir Putin is a tough (some say ruthless), competent, non-ideological ruler. Moscow pundits agree that he is more focused than his predecessor. Igor Malashenko, a well-known Russian commentator, recently stated that Yeltsin presided over a "disorganized autocracy," while he anticipates that Putin’s will be an orderly one. A prominent Russian businessman termed the whole of Putin’s generation "ruthless and unprincipled." Secretary of State Madeleine Albright, in a view shared by at least one Russian reformist politician, thinks that Putin is a moderate nationalist. There is little doubt that Putin is a statist who surrounds himself with "securocrats" — long-tested collaborators primarily from the intelligence services.
Putin’s speeches and interviews demonstrate beyond doubt that he is acutely aware of Russia’s weaknesses and deficiencies. He understands that Russia’s over-dependence on energy exports, with their market volatility, bodes ill for a country of 150 million people. Putin became aware of Russia’s industrial decline during the 1980s, while he was stationed in Dresden, East Germany, as a kgb intelligence officer. During his stint in the GDR, he was reportedly involved in some "technological acquisitions" (industrial espionage) for Moscow and was a kgb liaison to the East German secret police, the Stasi. Putin is said to have realized that the Soviet Union did not possess the manufacturing base necessary for the early post-industrial age. It could not even manufacture adequate personal computers and mainframes. Given his position at the time, he must have been aware of the inadequacies of the Soviet Union’s late start in the information age. The highly centralized, incompetently run economy was losing to the West.

Putin’s eventual involvement in reformist politics and his current preoccupation with economic growth rates as well as Russia’s technology base do not contradict his security background. His treatise on Russia’s place in the twenty-first century (published on the Russian government’s website) claims that by growing 8 percent to 10 percent a year, Russia can catch up with Western Europe’s current levels of production within 15 to 20 years. Unfortunately, Russia grew only 2 percent during the very favorable economic climate of 1999.

Thus far, Putin’s political and public relations instincts have been astute. He was filmed giving out hunting knives to Russian officers and troops in the trenches of Chechnya the morning of New Year’s Day, when most Russians were sound asleep after having spent the night toasting the new millennium. He sent Yeltsin’s daughter, Tatyana Diachenko, packing on his first day on the job. The notorious Diachenko not only was her father’s Kremlin advisor, but is also alleged to have spearheaded many of the corrupt financial dealings attributed to the Yeltsin family. He fired Yeltsin’s presidential property manager, Pavel Pavlovich Borodin, who is now being sought by police in Switzerland. He demoted Nikolai Aksenenko, first deputy prime minister in charge of the economic portfolio, to preside over the railways, while elevating a tough debt negotiator, former Finance Minister Mikhail Kasyanov, to the No. 1 economic position. Watching their dynamic new acting president, many Russians quoted their proverb, "a new broom, which sweeps clean."

The first political crisis of the "new broom" occurred when the newly elected Duma met. The much-anticipated "coalition for reform," including the Union of Right Forces, the liberal-left Yabloko, the Fatherland-All Russia Party led by Primakov and Luzhkov, and Putin’s party, the Unity Party (a.k.a. the Bear) failed to materialize. Instead, Putin struck a compromise with the communists. Gennady Seleznev, a fellow Peterbourgeois and a rather docile former Duma speaker, was reelected. The Duma communist faction received the largest number of committee chairmanships, nine, while the opposition coalition got only three committees.

While the liberal factions cried foul, the coalition with the communists made sense for Putin from a number of angles. To begin with, it denied Primakov the important perch of chairmanship of the Duma, from which he could have challenged the acting president. Second, it made the communists appear not to be in implacable opposition to the Kremlin prior to the presidential elections. In addition, the move provided Putin with a manageable chairman within the legislature. And finally, it struck a blow to the cocky Union of Right Forces and its de facto leader, Anatoly Chubais, who had boasted that Putin was in his pocket.

But Putin’s "pact with the devil" dealt a blow to hopes for a reformist agenda. While the communists may well give Putin parliamentary votes, the Union of Right Forces could have provided him not only loyal Duma members but also a relatively competent (by Russian standards) pool of yuppie policy analysts and managers. These experts would have been independent of Boris Berezovsky and his group. In addition, the coalition with the communists served to discredit Putin among the Russian elites and anti-communist voters and did nothing to boost his image in the West. While the deal might be sensible tactically, in the long run it undermines the same reforms that Putin claims he is so anxious to promote. The communist faction in the Duma will not support the private ownership of land, a new bankruptcy law, and tax reform, all of which are at the top of the reformist legislative agenda. Putin will need the voices of the democrats, namely Yabloko, and some of the Fatherland deputies, in order to legislate Russia forward.

Even more worrisome is Putin’s reliance on the St. Petersburg "mafia" of ex-kgb officers to staff his administration. These advisors make the Russian intellectuals nervous. They cite potentially repressive steps, from Internet controls to outright censorship and a crackdown on Russia’s relatively free media. Two cases in point of the tendency toward greater intervention in the media came to light recently. In January 2000, Vladimir Babitsky, Radio Liberty’s correspondent in Chechnya, was arrested by the Russian military and then disappeared. When he finally resurfaced, he was immediately rearrested. The Russian prosecutor’s office is threatening to charge him with treason. In another incident, also in January, Alexander Khinshtein, a Muscovite investigative reporter, was threatened with incarceration in a psychiatric prison for digging into the background and business practices of the controversial tycoon Berezovsky and Interior Minister Vladimir Rushailo. This was the first time since the Soviet era that authorities attempted to use psychiatric prisons for intimidation.

Yeltsin and Putin: Is the jury still out?

Yeltsin took over when russia was in a declining trajectory. He and his advisors borrowed such concepts from the West as price liberalization and privatization, as well as political architecture, in an attempt to bring the country’s political and economic systems into compliance with contemporary Western models. Expectations were high. The Russian leaders led the public to believe that this "borrowing" would effect a palpable improvement in the standard of living almost immediately. They were naive. It is clear that with all the political and economic innovation of the 1980s and 1990s, Russia failed to bring about the kind of free market and democratic reforms that would facilitate the country’s inclusion into the Western family of nations. Russia has not even achieved the level of integration and growth reached by such Central European countries as Poland, the Czech Republic, Hungary, and the three Baltic states.

The historic experience of Russian reforms since the time of Peter the Great demonstrates that when elements of Western technology and social mechanisms are introduced from the top, this is usually an attempt by the ruling elite to close technological and military gaps between Russia and its perceived adversaries. By introducing glasnost and perestroika, Gorbachev hoped to revitalize socialism to allow for easier absorption of Western technological innovation. Usually, the democratization of political life, greater participation in governance, and economic liberalization have either been granted from above (Alexander II, 1860-81) or have been forced by the elites (Nicholas II, 1905-17; Gorbachev, 1989-90; Yeltsin, 1992-99). Under the most aggressive reformers, Peter I and Stalin, the price for reforms has been paid by the populace, who were taxed without pity and sent to work like serfs.

What about the incomplete reforms of the post-Soviet period? What benchmarks can we establish according to which we will be able to judge Russia’s progress this time around?

Nurturing civil society and participatory democracy on Russian soil, including the support of free media. Under communism, all volunteer and professional organizations, as well as commercial and business activities, were run by the state. Since Gorbachev, thousands of private businesses and nonprofit organizations have sprung up, unleashing a pent-up energy for civic and business activity. When Vladimir Putin talks about strengthening the role of the state and improving government efficiency, many Russian commentators and democratic activists are worried. Is Putin talking about a paternalistic state, such as Germany or Sweden, or something more sinister? Putin brought many of his KGB buddies into positions of power in the Kremlin. And his business allies’ control over most important outlets of the mass media, especially the two national TV channels, ORT and RTR, as well as attempts to regulate the Internet, may seriously endanger the future of free media in Russia.

Maintaining the federal nature of the Russian state, preventing both its disintegration and the reemergence of a centralized unitary state or an empire. Under Yeltsin, the election of regional governors was introduced for the first time in Russian history. Power partially shifted from the center in Moscow to the 89 regional capitals of Russia (roughly equivalent in size and population to U.S. states, and in many cases much vaster). Ethnically based constituent republics of the Russian Federation were particularly vociferous in asserting their unique "state rights," often contradicting federal legislation by promulgating their own rules. Putin has floated some trial balloons about abolition of gubernatorial elections and wants to revert to the czarist and Soviet practice of regional governors nominated from the center. Such a radical move, which cannot be accomplished without a fundamental constitutional change, would be a move toward authoritarianism.

Resolving ethnic and religious conflicts through peaceful means and preventing a surge of xenophobia and racism. Russia is a multi-ethnic state that still grapples with the question of who is a Russian, with the rights of "Russian-speakers" in the neighboring countries, and with the status of its own Muslim citizens (Chechens, Ingush, Dagestani, and others). Registration of ethnicity in internal passports and governmental documents is mandatory (though a person has a right to refuse to answer such a question). In the early 1990s, Yeltsin challenged regional leaders to take all the sovereignty they could. He was exaggerating: Moscow insists on ruling the regions from the center, having a say in the distribution of wealth and major economic decisions of the provinces.

In the large non-Russian republics, such as Tatarstan and Bashkortostan, the "titular" national elite, which often consists of the Soviet-era nomenklatura, is anxious to preserve its hold on power. Often, the fight over the control of the vast natural resources is depicted as ethnically motivated: Tatars or Yakuts against Russians. In reality, it is also a fight over the control of wealth. For example, Tatarstan and Bashkortostan are rich in oil, while the Komi republic (Hanty-Mansi and Yamal-Nenets districts) is virtually one giant natural gas field. The Republic of Yakutia-Sakha in Eastern Siberia is one of the largest diamond producing areas in the world. How the pie is going to be divided among Moscow and the regions is a serious challenge for the next Russian president.

Since the war in Chechnya, attacks on dark-skinned citizens of Russia and the former Soviet Union are on the rise. So are the number and relative strength of ultranationalist and xenophobic organizations, such as the neo-Nazi Russian National Unity (RNU), led by Vladimir Barkashov. This movement attacks Christianity as a "Jewish ruse"; its supporters wear black uniforms and use a Nazi salute; and it utilizes a modified swastika as its symbol. Members of RNU were charged in a number of murders believed to be initiation tests for would-be members of the movement. While RNU claims 100,000 members and supporters, including some in the armed services and the police, the real number is lower, possibly around 10,000. They were disqualified from running in the 1999 Duma and 2000 presidential elections. Other organizations, such as Pamiat, attempt to break up political meetings of democratic organizations; they have also attacked synagogues. The Communist Party of the Russian Federation is another bulwark of racism. Extremist nationalists do not seem too dangerous at the ballot box, but may influence the youth and some in the security services, police, and the military. The test is whether they will continue to be marginalized or permitted to bid for mainstream acceptance.

Building the accountable, functioning, and transparent institutions of a market economy. Russian reformists in the economic policy area naively posited that deregulation of prices and privatization of industrial enterprises would quickly allow for a market economy to build itself spontaneously. They were too optimistic. Modern markets are extremely complex systems, dependent upon the proper function of numerous highly sophisticated elements, from commercial banks to futures markets to banking supervisory structures. Such market institutions require a competent legislature and a clean bureaucracy. While privatization and price deregulation have been largely achieved (with the exception of land, oil and gas pipelines, and railroad privatization), the banking system, the capital markets, and the entire system of government regulation of the economy, including the Central Bank of Russia and Ministry of Finance, leave much to be desired by Western standards. Since the August 1998 financial collapse, economic reforms have all but stopped. Monopolists’ vested interests, centralizing approaches of the Soviet era, a dearth of qualified personnel, as well as the pervasive corruption are slowing down the reform process.

Achieving sustainable economic growth; making Russia attractive for foreign investment and hospitable to domestic entrepreneurship. Russia has become a net exporter of capital on an unprecedented scale: From 1987 on, between $20 billion and $24 billion in capital has departed Russia on a yearly basis. The overall amount of exported Russian capital is a staggering $300 billion. This is much more than the combined Western portfolio and direct investment, as well as bilateral (country to country) and multilateral assistance (from such organizations as the International Monetary Fund and the World Bank). The reasons for capital flight include inhospitable tax and macroeconomic environments, pervasive corruption, and bureaucratic red tape.

The examples of several Latin American countries, such as Brazil and Argentina, have demonstrated that once significant economic reforms are implemented, expatriated capital returns. However, the Putin administration may attempt to tackle the problem by police regulation, not via macroeconomic adjustment and liberalization.

Legislating the most necessary elements of the much-anticipated economic package (including private property on land, revamped bankruptcy laws, and tax reform). Russia is a naturally endowed cornucopia of tremendous wealth. In order to turn it into a rapidly developing economy, the government needs to create economic conditions that would make Russia a level playing field for domestic and foreign investors. This includes the introduction of private property on land, including for mining, agricultural activities, and construction; a significant decrease of tax rates, which currently may take away over 100 percent of a business entity’s profit; simplification of the tax code; and optimization of asset distribution through transparent and equitable bankruptcy procedures. Instead of embracing these reforms, Putin’s first deputy prime minister (de facto prime minister) and chief economic advisor Mikhail Kasyanov voiced resistance to free market principles of economic management, criticizing calls for tax reduction and private land holdings. Putin did not support the Union of Right Forces’ idea of conducting a national referendum to push through land privatization. Without it, ordinary Russians may continue languishing in poverty while a thin layer of the super-rich oligarchs and ex-communist nomenklatura capitalize on their political connections.

Improving the legal system, including the enforcement of court rulings, and enacting effective mechanisms for dispute resolution. Russian courts and contract enforcement are probably the most crucial missing link in the puzzle of economic reform. While some vital areas, such as private real property, have gone unlegislated, other laws are not adequately implemented. Contracts are more often enforced by the mob than by courts and police. Judges often take bribes and tweak their rulings accordingly. The failure is aggravated by scarcity of contract enforcement personnel (court bailiffs were introduced only a couple of years ago). Lawyers are few, and those who are available were often trained in the socialist, politicized, and criminal law-based system of the Soviet era, or the second-rate post-Soviet colleges that pass for law schools.

Building a small and efficient state, instead of the current bloated and ineffective one. Today, Russia boasts twice as many bureaucrats as there were in the Soviet Union in 1989. The government pays its workers little but gives them vast powers to regulate business and economic activity. Thus, the big eyes and hungry mouths of the bureaucracy cause companies to spend up to 8 percent of gross income on bribes, in one estimate. In some cities, organized crime, which often exists symbiotically with the government and law enforcement, takes bribes amounting to as much as 25 percent to 30 percent of company’s gross income.

A comprehensive government reform is in order, one that will cut by at least half the state apparatus, including the large military forces (currently belonging to the Ministry of Defense, Ministry of Interior, the Border Guards, the railroad troops, Emergency Ministry troops, etc.). Economic regulators, who are notorious for taking bribes, have to be under strict orders not to interfere with business activity, especially by vulnerable small and medium-sized businesses. The biggest challenge will be curbing unnecessary regulation while keeping the much-abused environment intact and observing at least minimal health standards.

Cracking down on organized crime and corruption. Today, the police and security services are part of the problem, not part of the solution. The police collect protection money from businesses while granting cover (krysha in Russian, or "roof") to shady businessmen, drug dealers, prostitutes, and smugglers. The highest "authorities" in organized crime have bought seats on the Duma lists of several political parties and are often seen as guests of honor at social events in Moscow. If Putin is serious about his much-hailed platform of law and order, this has to change. Not only do well-known criminal leaders need to go to jail, but high ranking government officials and oligarchs who broke the law should also be prosecuted. Only then will Russians have reason to believe that democracy and the machinery of the state serve them.

Reforming the military and security apparatus, including democratization of these services and effective civilian, budgetary, and legislative control. The Russian military is on the verge of escaping civilian control. Its indiscriminate use of force in Chechnya against Russian civilians is a prime example. The generals who commanded the field operations threatened the Yeltsin government with "resignations, or worse" if the Kremlin entered into negotiations with the Chechen leadership. In addition, the military still has not accounted for billions of dollars of equipment and ammunition that disappeared as the Soviet Army withdrew from Eastern Europe and fought the wars in Chechnya, Moldova, Tajikistan, and elsewhere.

At the same time, the military loudly demands and gets increased budgets, including a 50 percent hike in overall appropriations for fiscal 2000, a 57 percent increase in new system acquisitions, and an 80 percent increase in research and development funds. Russia officially is spending just over 3 percent of its GDP on the military; unofficial figures are as high as 10 percent (when the Interior Ministry and other quasi-militarized budgets are taken into account). With an official per capita annual GDP of $1,500 to $2,000 (the figure could be as high $4,000 per capita once all informal economic activities are taken into account), the Russians cannot afford to feed and equip so many uniformed "protectors of the Motherland." The heirs of Tchaikovsky and Tolstoy deserve a better lot.

The temptations of history

Vladimir Putin will be strongly tempted to revert to the traditional paths of autocracy and statism. As a former intelligence officer and head of the secret police, he has the right profile to emerge as a centralizing, strong leader in the tradition of Peter the Great, or even worse, Nicholas I, the preeminent monarch-policeman of the first part of the nineteenth century. Putin’s entry into the political scene is inescapably connected to the war in Chechnya, which, the critics say, was engineered to launch the "Putin for President" campaign. He may see both the fate of Russia and his rule through the traditional prism of military prowess and conquest.

Like many Russian rulers before him, Putin may be interested in maintaining a dialogue and exchange with the West in order to attract the technology and investment needed to build military power. The Chinese leadership starting with Deng Xiaoping has pursued this strategy quite successfully. Or Putin may realize that Russia, despite the preachings of the Slavophiles and Eurasianists (those who see Russia’s greatness as lying between East and West), does not really have a "third way" that can permanently and viably separate it from the West; and so instead it must continue to absorb Western values and economic and government mechanisms. In the decentralized, entrepreneurial, and globalizing environment of the twenty-first century, the traditional preoccupation of Russia’s elites with a strong, paternalistic, and sometimes aggressive state could prove too taxing, and in the end, self-defeating. Such a form of government, based on bureaucratic regulation, may further breed the corruption that is already choking Western investment and causing unprecedented capital flight from Russia.

If indeed Russia becomes more bureaucratic and authoritarian, will it also become more dangerous for the West? Not necessarily: It will still be a slow-growing economy with a GDP of about $250 billion to $300 billion a year and a military budget a fraction of that of the United States. It may become more dangerous for its immediate neighbors, especially those against whom influential circles in Moscow bear a grudge — Georgian President Eduard Shevardnadze, for example, or oil-rich Azerbaijan, or countries with large Russian-speaking minorities, such as Latvia, Estonia, Ukraine, or Kazakhstan. The challenge for the West would then be how to respond to a Russian threat against these countries, if and when it materializes.

Russia, as many times before, has approached a fork in its road to modernization. For the first time in the past 10 years, it will be making a decision on its direction without Boris Yeltsin. Whether he will be remembered for bringing down communism and the Soviet Union and presiding over the transition to a market economy — or for institutionalizing corruption, failing to reform the security apparatus and the military, and embroiling Russia in a prolonged war in the Caucasus — will largely depend on where Russia goes from here. Thus Yeltsin’s place in history is to a large degree in the hands of his chosen successor, Vladimir Putin. The Yeltsin chapter in the Russian quest for identity and its place in the world is over. The Putin chapter has begun.

Ariel Cohen is research fellow in Russian and Eurasian studies at The Heritage Foundation.
From: http://www.policyreview.org/apr00/cohen.html