[JPRT 107-50]
[From the U.S. Government Publishing Office]
107th Congress
1st Session JOINT COMMITTEE PRINT S. Prt.
107-50
_______________________________________________________________________
RUSSIA'S UNCERTAIN ECONOMIC
FUTURE
__________
COMPENDIUM OF PAPERS
SUBMITTED TO THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13
DECEMBER 2001
Printed for the use of the Joint Economic Committee
U.S. GOVERNMENT PRINTING OFFICE
76-171 WASHINGTON : 2002
FOREWORD
By Senator Robert F. Bennett
----------
Russia's economy has rebounded significantly since the
crisis of 1998. Economic growth has resumed, unemployment has
fallen, and production, consumption, and investment have all
expanded. At the same time, Russia has initiated a series of
promising economic reforms, including strengthening its banking
system and enacting fundamental tax reform.
These improvements illustrate Russia's potential for a
strong economic future. At the same time, memories of past
economic difficulties demonstrate the risks that Russia faces
if its reforms do not succeed.
Russia's economic future is of great importance to the
United States. To assist American citizens and policymakers in
thinking about that future, I asked the Congressional Research
Service to commission a collection of expert reports on the
Russian economy. The resulting reports review the recent
history of the Russian economy, analyze current policy issues,
and consider possible futures.
The reports were prepared by experts--in academia, the
private sector, and government--who represent a wide diversity
of professional perspectives on the Russian economy. The
reports thus reflect a broad range of opinions on the
challenges and opportunities before Russia. The views and
conclusions in these reports are those of their authors, not
those of the Joint Economic Committee or any of its individual
members.
I hope that these reports will contribute to our ongoing
efforts to understand the Russian economy. I thank the
Congressional Research Service for its efforts and the authors
for sharing their expertise.
C O N T E N T S
----------
Page
Foreword, by Senator Robert F. Bennett........................... iii
Historical Note.................................................. vii
Highlights, by John Hardt........................................ ix
Overview, by John Hardt.......................................... xi
Past Economic Performance and Insights for Future Prospects
Russia's Economic Performance: Entering the 21st Century, by
William H. Cooper.............................................. 3
Russia's Economic Challenges
Removing Barriers and Providing an Incentive System.............. 25
The Russian Economy: How Far from Sustainable Growth?, by Ben
Slay........................................................... 25
Unlocking Economic Growth in Russia, by Vincent Palmeda and Bill
Lewis.......................................................... 47
Administration and Reform of the Russian Economy, by Paul Gregory
and Wolfram Schrettl........................................... 81
Russian Crime and Corruption in an Era of Globalization:
Implications for the United States, by Jonathan M. Winer and
Phil Williams.................................................. 97
Financial Reform: Taxes, Budgets and Banks....................... 125
Tax Reform in Russia, by Z. Blake Marshall....................... 125
Putin's Dilemma: Austere Budgeting in a Poor State, by James A.
Duran, Jr...................................................... 141
Russian Defense Spending, by Christopher J. Hill................. 161
Russian Financial Transition: The Development of Institutions and
Markets for Growth, by David M. Kemme.......................... 183
Breakup of Monopolies: Energy, Transportation and Agriculture.... 213
The Russian Energy Sector: Current Conditions and Long-Term
Outlook, by Matthew J. Sagers.................................. 213
Agricultural Reform: Major Commodity Restructuring but Little
Institutional Change, by William Liefert....................... 253
Human Capital and the Social Contract............................ 283
Russia's Demographic and Health Meltdown, by Murray Feshbach..... 283
Social Welfare: A Social Contract, by Judyth L. Twigg............ 307
Long-term Prospects for Russia's Economic Governance
Long-run Prospects for the Russian Economy, James R. Millar...... 329
Russia's Evolution as a Predatory State, by Peter J. Stavrakis... 347
Russia's Economic Future and U.S. Interests
U.S. Bilateral Assistance to Russia, 1992-2001, by Curt Tarnoff.. 369
Arms Exports and Russia's Defense Industries: Issues for the U.S.
Congress, by Kevin P. O'Prey................................... 385
U.S.-Russian Trade and Investment: Policy and Performance, by
Inga Litvinsky, Matt London, and Tanya Shuster................. 411
Russia and the International Financial Institutions: From Special
Case to a Normal Country, by Jonathan E. Sanford............... 425
HISTORICAL NOTE
----------
This study belongs to the series of committee prints for
the Joint Economic Committee by the Congressional Research
Service and its predecessor, the Legislative Reference Service,
dating back to the 1950s, on the economies of the Soviet Union
and successor states, the People's Republic of China, and
Central Eastern Europe. In November 1959, the Joint Economic
Committee held a week of hearings that highlighted the
publication entitled Comparisons of the United States and
Soviet Economies. These hearings were a continuation of the
committee's past interest in this subject that had resulted in
the publication of two studies prepared for the committee by
the Legislative Reference Service of the Library of Congress--
one, in 1955, entitled Trends in Economic Growth: A Comparison
of the Western Powers and the Soviet Bloc, and the other, in
1957, entitled Soviet Economic Growth: A Comparison with the
United States.
The first study on the People's Republic of China, An
Economic Profile of Mainland China, was released in 1966, after
the initiation of the Cultural Revolution. The first volume on
Central Eastern Europe, Economic Development in Countries of
Eastern Europe, was released in 1970, following the Soviet
invasion of Czechoslovakia. Other studies followed at regular
intervals.
The most recent study in this long series was China's
Economic Future: Challenges to the U.S. Policy, released in
1996. The most recent study on Eastern Europe was East-Central
European Economies in Transition, released in 1994, which was
preceded by a two-volume study, The Former Soviet Economies in
Transition, released in 1993.
HIGHLIGHTS
By John Hardt \1\
----------
The authors in this volume analyze the present state of the
Russian economy and its future possibilities. Vladimir Putin
has committed himself to economic reform in his 2 years as
Russia's president. The opportunity for a transition to a
democratic market economy is more likely now than at any
previous time in Russian history. This volume explores the
opportunities offered by this transition and the obstacles it
faces, with particular reference to Putin's reform agenda. The
main findings of the volume are as follows:
---------------------------------------------------------------------------
\1\ John P. Hardt, Senior Specialist in Post-Soviet Economics at
the Congressional Research Service, is author of the Highlights, the
Overview and coordinator of the volume.
Sustained economic growth will be crucial to all
reform efforts. Russia's recent performance since its
financial crisis in 1998 has been positive in terms of
both its annual growth of gross domestic product (GDP)
and its balance of payments. Whether this recent
performance represents a new trend line of sustained
growth or is a part of a cyclical pattern of prosperity
and crisis remains unknown.
Putin's unfinished reform agenda features changes
critical to the development of a pluralistic market
system under the rule of law, such as the establishment
of market-friendly administrative and judicial systems
and the introduction of an effective banking system.
Bureaucratic inertia and lingering corruption continue
to hinder these reform efforts.
Putin's reform policies will be decisive only if
they result in redistribution of political power that
controls economic decision-making along with revision
of budgetary priorities. Restructuring the power of
Russian financial and governmental elites and reducing
populist subsidies will prove difficult, however,
because that may erode Putin's power and popularity.
Russia's economic competitiveness and growth
potential would be greatly enhanced by the breakup of
monopolies in three key sectors: energy, transportation
and agriculture. Such reforms are underway, but they
have not been completed.
Russia's human capital has become a depreciating
asset. Without appropriate legislation and budgets,
Russia is facing a ``demographic and health meltdown.''
Russia is not yet living up to Putin's commitments to
the Russian people; welfare entitlements, pension funds
and education needs are all underfunded.
The path of Russia's economic development will make a
significant difference to the United States. U.S. policy, in
turn, will play an important role in Russia's future economic
development.
Russia may become a major trading and investment
partner with the United States in spite of its modest
bilateral trade and investment in the past.
The United States may benefit from reduced Russian
sale of arms to countries who may be a threat to U.S.
security interests.
U.S. support could facilitate Russia's integration
into the global economy and its eventual accession to
the World Trade Organization in spite of the
noncompetitive nature of most Russian enterprises and
strong protectionist sentiments.
The United States may take an effective lead in
helping Russia manage its external debt burden, even
though the majority of its external debt is held by
other countries.
OVERVIEW
By John Hardt \1\
----------
Russia's uncertain economic future is of special concern to
U.S. as well as Russian policymakers. This was highlighted by
the Bush/Putin Summit in Washington, DC, and Crawford, Texas,
November 13-15, 2001, as Putin moved to align Russia more
closely with the western market economies.\2\ The range of
possible economic developments in Russia is greater now than in
the past.
---------------------------------------------------------------------------
\1\ John P. Hardt is a Senior Specialist in Post-Soviet Economics
at the Congressional Research Service. References to authors from the
volume are made in the text of the Overview. References to authors not
in the volume are made in footnotes.
\2\ Communiques of Washington/Crawford Summit, Washington File,
State Department.
---------------------------------------------------------------------------
This volume includes articles that present four approaches
to the overarching question: Where is the Russian economy
going?
A discussion of Russia's past performance and
insights for future growth. Is extrapolation of Russian
past economic performance useful for projecting
Russia's economic future? Will current opportunities
for improved growth lead instead, as in the past, to
economic crises?
A discussion of the reform policy issues that
challenge the leadership of President Vladimir Putin to
make choices that may determine economic governance in
Russia. What policy decisions would best advance the
reform agenda and the necessary redistribution of power
and financial resources? Will Putin prove to be an
effective democratic reformer or yet another promoter
of strong state power?
A discussion of the range of possible outcomes for
long-term development of Russia's political and
economic system. Is Russia likely to abandon its
historical pattern of autocratic governance in favor of
the western model of democracy and market economy? Is
either of these antithetical outcomes inevitable or
subject to change?
An assessment of U.S.-Russian economic issues that
materially affect U.S. interests. Does it make a
significant difference to the United States how Russia
develops economically? Can and should the United States
influence or effectively manage the outcome?
This volume is divided into four sections: past
performance and insights for future prospects; Russia's
economic challenges; long-term prospects for Russia's economic
governance; and Russia's economic future and U.S. interests.
What follows is a summary of the authors' responses to the
above questions, supplemented by commentary provided by the
volume's coordinator. The contributors to this volume offer
contrasting perspectives on these questions. They consider that
Putin turning out to be an effective reformer rather than an
authoritarian leader to be crucial to the development of
Russia's economic future. While these contributions do not
represent the views of the Congressional Research Service
(which does not take positions on public issues), nor
necessarily of the Joint Economic Committee of the U.S.
Congress, they do reflect schools of thought in the
professional community in the United States and abroad.
Past Economic Performance and Insights for Future Prospects
Past performance in quantitative terms is useful but not
definitive in understanding the past and in forecasting its
future. While progress in reform made in the early 1990s
provided some expectation of improved growth, Russia suffered a
severe recession from 1992 through 1998. By 1998 gross domestic
product (GDP) was 70 percent that of 1992. After the financial
crisis in 1998, Russia experienced unprecedented short-term
economic growth, with real GDP growth expected to reach 5
percent in 2001.
William Cooper, in his performance assessment, finds that
making accurate projections of Russia's economic future is
difficult: ``The current economic growth could be short lived
but it has generated political support and thus presents
President Putin and his team with a `window of opportunity' to
promote economic reform. The current upswing in economic growth
is favorable but not sufficient to assure sustained growth.''
Russia's Economic Challenges
Ben Slay reports: ``Huge current account surpluses and
unprecedented growth and reserves are welcome developments in
the last 3 years. However, capital flight has not abated and
foreign direct investment that would help modernize and
recapitalize Russian industry is conspicuously absent in
Russia.'' Ben Slay adds that large capital flight and minuscule
foreign direct investment mirror each other as symptoms of
failure of institutional reform in Russia.\3\ In this context
it may be just as difficult to substantiate that Russia has
``turned the corner'' toward sustained economic growth and is
now a market economy as it was earlier to document that Russia
was a failing transitional economy.
---------------------------------------------------------------------------
\3\ European Bank for Reconstruction and Development (EBRD),
``Cross-Border Capital Flows,'' Transition Report Update, April 2001;
John P. Hardt, Russia's Economic Policy Dilemma and U.S. Interests, CRS
Report RL30266, January 23, 1999; Alexander Boulatov and Mark Silveira,
``Capital Flight and Foreign Direct Investment,'' Working Paper,
Washington, DC, August 2001.
---------------------------------------------------------------------------
Past performance shortfalls provide a road map for the
difficult reform path ahead. Future reform requires development
of an incentive system, a working financial system, competitive
enterprises, and adequate attention to the quality of life.
Russia's current economic challenges are summarized in
Putin's ``unfinished agenda.'' Slay argues, along with many
other specialists, that only the radical reforms in the Putin
agenda will be sufficient to create a market-friendly system.
While a turning point toward development of a market system may
be more likely than at any time in Russian history,
implementation of reform policies on the Putin agenda can be
decisive only if they result in redistribution of the political
power that controls economic decisionmaking, along with a
revision of budgetary priorities.
Central to reform implementation, in the view of this
report's contributors, will be the character of President Putin
as a reformer. President Putin has used his vision of Russia's
economic future as the theoretical basis for his reform agenda.
Putin's vision is for ``rapid and comprehensive'' institutional
reform, to ensure that Russia will not fall further behind the
developed countries in economic performance. Putin, as an
advocate of reform, has prescribed the reform medicine favored
by western economic specialists, but it remains to be seen
whether Putin, as President, administers this medicine. By
restructuring the power of Russian financial and government
elites and reducing populist subsidies, Putin may erode his own
popularity and power. While many reforms may have an immediate
impact, the full benefits from successful reform may accrue to
Putin's successors. If Putin is unable or unwilling to be
proactive on his reform agenda, then, in the view of Jonathan
Winer and Phil Williams, political elites will continue to
dominate the political and economic future of Russia.
Putin's difficulty in supporting reform may be
characterized as a twofold dilemma arising from the necessity
to bring about a redistribution of power and a change in
budgetary priorities. On the redistribution of power that is a
prerequisite for reform, Putin has the classic Machiavellian
constraint that he must utilize the full force of his
leadership against the wishes of strong, entrenched opponents
because the proponents of change are weaker and less ardent.
Budgetary priorities need to promote the market system
rather than cater to the state and political elites. Winer and
Williams consider the political elites satisfied that the
fruits of reform and their preferential share can be retained
through the use of state power.
Putin, as a reformer, may have to effectively use his
leadership role to maintain both the elite and popular support
needed for implementing reform. For example, in restructuring
Gazprom, the energy conglomerate, Putin may have to convince
its administrators and stockholders that being a global
enterprise, and conforming to the requirements of the world
marketplace, would protect their wealth and assure their future
income, more than would retaining their privileged domestic
position under an autocratic model of governance. Were Gazprom
to become a model of corporate governance, the likely increase
in wealth and profit for its shareholders might influence other
oligarchs to support infrastructure monopoly reforms.
There are some recent indications that other enterprises
may be seeking profits instead of rents. Ben Slay notes that
the consolidation trend in industry has recently led many cash-
rich enterprises to raise the level of corporate governance in
lossmaking enterprises they have acquired. Responsiveness to
market forces may thus be seen as beneficial to some Russian
industrial elites by assuring protection of their wealth and
prospects for profitability. Profit seeking beneficial to the
Russian economy as a whole may prove more favorable
economically to some industrial elites than rent seeking that
only feathers their own nests.
In reducing subsidies to housing and utilities, Putin may
need to design a support program that does not sink Russian
urban dwellers further into poverty and generate opposition to
reform but that, instead, offers prospects for future
improvement in the quality of citizens' lives. By developing a
new social contract supporting education and a meaningful
social safety net, as suggested by Judyth Twigg, Putin might
generate more reform support from the developing middle class
and the populace. Some need-based income maintenance programs
may be both economically and politically more successful than
traditional subsidies.
Without a proactive policy, the benefits of market
transition toward sustained economic growth are unlikely to be
forthcoming. There is uncertainty about implementation of
reform in Russia because Putin must face difficult decisions
that will involve political risks and economic costs. Reform
would reduce the direct political and economic power of the
financial and governmental elites, including the Putin
presidency. The marketplace, foreign investors and government
regulators would take over important economic decisionmaking
functions and change the basis for wealth accumulation from
political to economic criteria.
Even with more revenue in a growing economy, relative
shares of the budget would need to shift away from national
security, politically popular or populist subsidies, and debt
servicing. A market-friendly budget would need to fund
necessary reforms: a new civil service, a working financial
system, infrastructure improvement, and social welfare. These
are both very costly and inimical to the interests of the
entrenched elites. Budget priorities that favor the interests
of the middle class and the populace as a whole may gain broad
support for reform over time, but reduction of populist
subsidies and uncertainty of future growth may lead to short-
term popular sentiments against reform.
removing barriers and providing an incentive system
The authors in this section stress the importance of
removing barriers inherited from the previous Soviet system in
order to assure development of a market-based incentive system.
In the in-depth studies of Russian economic performance in the
1990s, Vincent Palmeda and Bill Lewis conclude that the
productivity potential of key sectors and the economy as a
whole have been constrained by the lack of an incentive
system.\4\ Palmeda and Lewis, in updating their assessment to
2001, conclude that with market-oriented changes in economic
institutions, Russia's economy might expect to sustain a GDP
growth rate of 8 percent per annum.
---------------------------------------------------------------------------
\4\ McKinsey Global Institute, Unlocking Economic Growth in Russia,
October 1999.
---------------------------------------------------------------------------
In their essay, Paul Gregory and Wolfram Schrettl note that
the Russian economy denies itself the benefits of its full
productive potential by the lack of a market-friendly
administrative system that incorporates rule-of-law concepts,
establishes property rights, and enforces laws through a
competent judicial system. Such an administrative reform would
require a professional civil service. Gregory and Schrettl
opine that economic rationality should lead Putin to give
priority to administrative restructuring and adequately
rewarding a new civil service in Russia as a condition for
effective reform. However, they are not optimistic that Putin
will overcome the political barriers to implementing these
administrative reforms. Winer and Williams are even more
doubtful that the current administrative system based on
cronyism, crime and corruption will change. The necessary
reforms, they argue, ``require Russia to undertake steps that
threaten those whose power depends on discouraging rule-of-law,
including criminals, exploitative business persons and corrupt
bureaucrats.''
financial reform: taxes, budgets and banks
An efficient monetized economy is essential for operation
of a market economy. To promote these objectives, a variety of
financial reforms are required:
Generation of sufficient tax revenue that may be
used to fund reform programs;
A shift of budget priorities sufficient to promote
market reform initiatives; and
Creation of banks that are attractive to savers and
banks that efficiently convert savings to investment.
According to Z. Blake Marshall, tax reform currently under
way will remove the onerous taxes of the past authoritarian
command economy and replace them with taxes that do not place
undue burdens on domestic and foreign enterprises. The new tax
code, if fully implemented, will go far toward encouraging a
market-friendly system.
Budgets have recently become important instruments of
Putin's policymaking, according to James Duran. The current
priority budgetary outlays, however, do not support effective
reform. Three appropriations are scheduled to absorb the major
share of the 2002 budget: external debt servicing, subsidies
for holding down apartment rents and utility fees, and defense
spending. Duran says reform may not be implemented effectively
without a radical change in these budget priorities. Even if
adequate expenditures for reform are mandated, there may
continue to be unfunded mandates because of the likely over-
commitment of future budgets and the continuing pressures
toward funding traditional claimants.
On the issue of debt servicing, Putin accepted in 2001 the
foreign creditors' requirement that debt be fully serviced.
External debt servicing will peak in 2003 and continue at a
high level thereafter unless Russia receives major debt relief.
Closing down popular subsidies for holding down rents and
utility fees is proving to be politically difficult, as
indicated by current parliamentary debates. Putin's civilian
budget policy may be doomed to a robbing Peter to pay Paul
policy of partially funding reform-related programs.
In the area of defense spending, Russia continues to
allocate a higher percentage of GDP than any NATO countries,
and spends more in absolute terms than all NATO countries
except the United States, according to Christopher Hill. Under
current defense plans, maintaining and developing some new
weapon systems and downscaling military manpower will require
additional spending. Hill states that in order to re-emerge as
a modern and powerful presence on the world scene by 2010,
total defense spending needs to increase by about 3.5 percent
per annum in terms of real increase in GDP. Other Russian
defense economic specialists say that fulfilling Putin's
defense policy requirements for the decade will require defense
spending increases that exceed the rate of GDP growth.\5\ Still
other analysts do not see that increasing defense spending
necessarily reduces civilian allocations to meet reform needs.
They believe that Russia can establish market conditions in its
civilian economy that would attract foreign investment and
generate increased growth that could permit increased defense
spending and also generate funds for necessary reform.\6\
---------------------------------------------------------------------------
\5\ Christopher Davis, ``Defense Sector in the Economy of a
Declining Superpower: Soviet Union and Russia, 1965-2001,'' Defense and
Peace Economics, Overseas Publishers Association, 2001.
\6\ Steven Rosefielde, ``Back To The Future: Prospects for Russia's
Military Industrial Revival,'' Conference on Eurasia's Future Landpower
Environment, Washington, DC, July 10-11, 2001.
---------------------------------------------------------------------------
On the issue of financial reform, David Kemme considers
development of a functioning banking system the key to Putin's
plan to generate increased investment in order to promote
sustained growth. ``While the number of financial institutions
has increased dramatically, the state structure still dominates
the financial sector,'' reports Kemme. Because of a lack of
legal and regulatory development in banks, savers do not trust
banks, banks do not convert savings to investment, and
conflicts of interest are rampant throughout the banking
system. At this stage of Russian development, banks are far
more critical than stock and bond markets for assuring economic
growth, according to Kemme. The best indicator for success in
banking reform, according to Slay, would be purchase and
control of some major Russian banks by large western banks,
such as Deutsche Bank or Citibank. Only multinational banks
possess the resources and the size needed to resist political
pressures to lend, Slay asserts.
breakup of monopolies: energy, transportation and agriculture
There are three major monopolistic sectors Putin's reform
policies seek to break up: energy, transportation and
agriculture. Enhanced competitiveness in these sectors would
facilitate increased economic growth.
Opening the energy industry by restructuring Gazprom and
the Unified Energy System (UES) would provide the benefits of
globalization, larger markets, more foreign direct investment
and better corporate governance. The energy sector accounted
for about 16 percent of GDP, 48 percent of federal budget
revenue and 54 percent of foreign exchange earnings in 2000,
according to Matthew Sagers. Energy, especially gas and oil,
may be the primary engine of future Russian growth. Long-term
investment necessary for growth in the energy sector is largely
dependent on comprehensive reform, according to Sagers. A major
increase in foreign direct investment (FDI) may be channeled
early on to the oil and gas sectors if current reforms lead to
one or more foreign investment success stories, e.g., joint oil
and gas developments in Sakhalin, expansion of the Caspian
pipeline consortia, or increased foreign investment in a
reformed Gazprom and UES.
Overall, the saying ``As Gazprom goes, so goes the economic
reform of Russia'' has some merit. If domestic and foreign
shareholders have a larger say in decisionmaking and corporate
governance improves, Gazprom may become a global enterprise and
a major spur to overall reform. Gazprom, as a competitive
global enterprise, might be the largest industry or sector
contributor to future Russian GDP, revenue, and export
earnings.\7\ Increased revenue from gas and oil sales might
then serve to loosen budget constraints that limit funding for
reform programs.
---------------------------------------------------------------------------
\7\ Boris Fyodorov, Interviews and Correspondence.
---------------------------------------------------------------------------
Putin wants the railroad system to follow the same reform
pattern projected for Gazprom and UES. The current partially
privatized rail transport system is inefficient and a burden on
the Russian economy as a whole.
Although not directly bracketed in Putin's reform agenda
with energy and transportation monopolies, Russian agriculture
is another key monopolistic system from farm to market.
Agriculture is ticketed for restructuring and clarification of
property rights through a new Land Code for agricultural land.
Only 5 percent of agriculture is privatized. While the Russian
Parliament has passed a Land Code providing for property rights
for urban centers, legislation has not yet extended the Land
Code to include agricultural land. Providing for secure land
ownership for Russian farmers would permit equity financing in
the agriculture sector. Some vertical consolidation, ``joint
stock companies,'' may hold promise for more efficient farm-to-
market agriculture, according to William Liefert.
Overall, demonopolization in the Russian economy may serve
to shift the structure of the Russian economy toward value-
added manufacturing and processing enterprises, according to
Palmeda and Lewis. Oil, gas and other commodity output might
substantially increase in absolute terms. Sectors such as
general merchandising, food processing and distribution would
then likely increase their relative share of GDP, moving Russia
over time toward a developed economy structure and away from
the commodity-based pattern of a developing economy.
human capital and the social contract
Russia's large, literate and skilled labor force has
traditionally been considered a strong asset for improving
productivity. As Murray Feshbach and Judyth Twigg graphically
demonstrated, Russia's human capital has become a seriously
depreciating asset. Population decreases caused by the ``burden
of decades of destructive practices that have had a direct,
harmful impact on public health'' make addressing demographic
and health concerns a national priority, according to Feshbach.
With a projected escalation of HIV/AIDS and tuberculosis,
infectious diseases may reach calamitous proportions in Russia.
However, there has been no appropriate legislation addressing
what Feshbach calls the ``demographic and health meltdown.''
The quality of human capital, such as skilled workers and
scientists, also has been sharply deteriorating due to lack of
social security measures. In the Soviet era, workers had some
degree of stability through a social safety net that provided
minimal but predictable benefits. This represented an implicit
social contract between the state and the citizenry. In post-
Soviet Russia, this minimal commitment of the state to the
citizens has not been fulfilled. Twigg notes the deleterious
effect this has had on the development of human capital:
``Sudden withdrawal of meager but comprehensive programs
covering health care, pensions, employment, housing and other
services has resulted in widespread poverty and disillusion.''
Putin has introduced ambitious and, if funded, expensive
programs for social welfare entitlements, pension funds, and
education to meet human capital needs. Duran notes that Putin
also supports expensive legal reform that would stimulate
enterprise efficiency and protect workers' rights. Unless there
is more revenue and a change in budgetary priorities, these
mandates will be underfunded.
Long-term Prospects for Russia's Economic Governance
Many Russian specialists subscribe to one of two differing
schools of thought on Russia's future beyond 2010. One
envisions a market economy, the other foresees rule by a
predatory elite. James Millar sees an ``inexorable trend''
toward a complete market economy and away from the past
autocratic economic governance model, especially the Soviet
development pattern. This judgment is based on Russia's
commitment to attain sustained economic growth that can only
come from transition to a market system. Peter Stavrakis, on
the other hand, projects a predatory model for Russia that
rejects liberal democracy and postulates retention of only a
patina of a democratic market system. ``Free markets and civil
society,'' Stavrakis claims, ``are thus hostage to political
elites who are free to intervene whenever and wherever this
appears financially profitable and politically useful.'' In his
view, Russian state leadership would continue to support the
powerful predatory elites.
Russia's predatory elites favor a continued state role in
governing the economy. The ``directive economy'' plan supported
by Viktor Ishayev, governor of Khabarovsk, calls for continued
state control of economic decisionmaking in investment and
allocation of resources.\8\ Through state control of economic
decisions on investment and production, Ishayev's group
promises results comparable to those projected for Putin's
unfinished reform agenda without reducing the direct economic
power of the state and the political elites. The Ishayev
program also promises to increase the size and influence of the
middle class. Some members of Putin's state apparatus appear to
be inclined toward supporting the Ishayev plan. There is
concern that adoption of the Ishayev plan would support the
views of Stavrakis that Russia's future governance will be
based on a predatory, political elite system.
---------------------------------------------------------------------------
\8\ Strategy for the Development of the State to the Year 2010,
Moscow, 2000. Cf. John Hardt, CRS Report RL30266, op. cit.
---------------------------------------------------------------------------
The authors in this volume consider it necessary that Putin
take a strong leadership role in reform and make the necessary
decisions reducing the role of the state in economic
decisionmaking. Whether Putin is able to fulfil this strategic
role is still to be demonstrated.
Proponents of these contrasting views expect Russia's
future to be determined by long-term historical processes
without major policy changes in the short run up to 2010. Both
Millar and Stavrakis consider that the choices of Russia's
future economic governance are at this point largely pre-
ordained. Millar cites ``reform fatigue'' as a reason for not
expecting effective reform soon. Moreover, a functioning market
system would require across-the-board comprehensive reform that
would not come quickly even if Russia adhered to the accession
process of the European Union (EU). Effective compliance with
the transition requirements of the EU would be a lengthy
process for Russia.
Stavrakis finds the autocratic trend resistant to reform.
He sees the entrenched ``financial oligarchy now competing with
the state elites using standard Russia-style methods:
corruption and cronyism dominate and society has withdrawn from
the political and economic arena.'' Moreover, he argues that
the autocratic model is more consonant with Russia's imperial
legacy. Stavrakis sees a pattern of historical crises, ``times
of trouble,'' characterized by recurring resistance of Russia
to western democratic market models accompanied by increasingly
authoritarian, inward-directed governance.
Russia's Economic Future and U.S. Interests
In considering Russia's economic future, U.S. policymakers
may recognize not only the diverse possible outcomes for
Russia, but also the varying effects those outcomes may have on
U.S. interests. Russian success and U.S. interests may not
converge, but they are not necessarily opposed. Curt Tarnoff
notes that ``three overarching interests are involved:
security, stability and humanitarian concerns.'' Successful
reforms may provide considerable reduction in the threats to
U.S. security if reform leads to decreased defense spending,
reduced weapons inventories, non-proliferation of weapons of
mass destruction, and reduced arm sales. However, a stronger
economy may also permit re-establishment of military forces in
Russia that might be considered a threat to U.S. security.
Market reform may lead to a stable and profitable commercial
relationship with Russia. However, a reformed Russia may be a
stronger competitor in the world market and an increased threat
to U.S. national security interests. The rule of law needed for
effective market reform may contribute to development of a more
civil, humane Russian society. However, the absence of
effective reform may have negative effects on the human rights
interests of the United States.
security issues
The United States has tried to discourage Russia from
making foreign arms sales, especially to states that are
perceived to be threats to U.S. security. The current expansion
of Russian arms sales appears troublesome to the United States,
as Kevin O'Prey notes, because ``more sophisticated weapon
systems have been supplied to countries that may be a threat to
U.S. interests.''
U.S. policymakers may also be concerned that the income
from arms sales might be used to revive and expand Russia's
military industrial base. While 1,600 defense enterprises
continue to operate at minimum production levels, only 6 to 10
of these enterprises benefit from cash sale of arms. Moreover,
even with more arms sales and increased defense spending,
O'Prey doubts that Moscow could resume the cold war arms race
with the United States. Russia's military complex does not have
the capability to compete in high-technology weapons,
especially because of backwardness in electronics. Even in the
worst-case scenario, Russia could return only to manufacturing
large quantities of older generation weapons, according to
O'Prey. Others consider it possible for Russia to fund reform
and increase defense spending, thereby having the resources to
rebuild its war mobilization base sufficient to compete with
the United States.\9\
---------------------------------------------------------------------------
\9\ Steven Rosefielde, op. cit.; and Vitaly Shlykov in Voennyi
Vestnik (Military Herald) #8, Moscow, April 2001.
---------------------------------------------------------------------------
Promotion of nuclear and chemical non-proliferation has
also been a centerpiece of U.S. security relations with Russia.
If the United States felt assured that Russian budget
priorities would shift to funding reform, some mutually
beneficial debt swaps might be in order.\10\ Security and
stability interests of the United States and Russia may be
linked by debt for non-proliferation swaps that might dampen
the proliferation threat and reduce the heavy debt service
burden from Soviet-era debt. U.S. leadership in debt management
negotiations might influence other creditors to follow
suit.\11\ Germany has been considering debt for assets swaps in
negotiating some inherited Russian Paris Club debt since the
Schroeder-Putin summit in April 2000. The European Bank for
Reconstruction and Development (EBRD) has offered to support
debt swaps that might encourage nuclear power plant safety and
discourage weapons proliferation in the former states of the
Soviet Union.\12\
---------------------------------------------------------------------------
\10\ John P. Hardt, Russia's Paris Club Debt and U.S. Interests,
CRS Report RL30617, updated June 6, 2001; John P. Hardt, Putin's
Economic Strategy and U.S. Interests, CRS Report RL31023, June 19,
2001.
\11\ The Biden-Lugar-Helms S-1803, Russian Federation Debt
Reduction for Nonproliferation Act of 2001. James Fuller, Debt-for-
Nonproliferation, Pacific Northwest Center for Gloval Security and
Defense Nonproliferation Programs. Paper delivered in Moscow, Russia,
December 10, 2001.
\12\ EBRD, Transition Report Update, April 2001.
---------------------------------------------------------------------------
stability issues
Programs favoring development of a democratic market system
may support domestic stability in Russia and its integration
into the global marketplace and international institutions. In
the Department of Commerce paper in this volume, Inga Litvinsky
and Matt London note, ``The U.S. administration would like to
see business become the bedrock of U.S.-Russian relations . . .
Thus, U.S. and Russian interests are in alignment to commence a
new bilateral commercial era.'' Bilateral trade and investment
ties in the past have been small and concentrated in a limited
number of sectors, according to Tanya Shuster. Were Russia to
reform and enter the process of accession to the World Trade
Organization (WTO), U.S. commercial relations with Russia might
substantially expand in volume and scope. The Economic
Dialogue, with its private sector initiative, undertaken after
the Bush/Putin June 2001 Summit may encourage favorable trade
and investment developments. Successful energy investments
might top the bilateral commercial agenda. Litvinsky and London
further note, ``As Russia moves closer to WTO membership, the
United States will need to re-examine our domestic trade
laws.'' Permanent normal trade relations (PNTR), more access of
Russian steel and other commodities to the U.S. market, and
greater Export/Import Bank financing might then be placed on
the U.S. legislative agenda.
Favorable developments in the bilateral commercial
environment are contingent on Russia completing Putin's
unfinished agenda. Thus, reform may have to be the horse
leading the bilateral commercial cart.
humanitarian issues
Human and civil rights in Russia have been of continuing
concern to the United States. The conduct of the war in
Chechnya violates many of the humanitarian principles of the
United States. Threats to freedom of religion in Russia have
drawn continuous U.S. monitoring and concern. Freedom of
speech, imperiled by state intervention and control over
television, radio and print media, has troubled U.S.
policymakers. Human and civil rights and stability interests
have been adversely affected by persistent crime and corruption
in Russia.
Russian crime, corruption and money laundering have all
plagued U.S.-Russian relations and deterred market reform.
Capital flight and money laundering have had a disruptive
effect on the U.S. banking system and encouraged international
crime and terrorism, in the view of Winer and Williams. A
peaceful, prosperous, market-oriented Russia might become more
democratic and more sensitive to civil and human rights, but
the record to date is mixed.
Thus, in summary, policymakers in Russia and the United
States face prospective benefits and costs as well as the
uncertainty inherent in Russian policy options. The current
policy of renewed dialogue and engagement adopted by both sides
at the Bush-Putin Summits of 2001 may generate a forum within
which prospective Russian economic reform measures may be
influenced by the interaction of Russian and U.S. policymakers.
The analyses in this volume do not provide definitive answers
to the questions posed at the outset of this overview or to the
overarching question, where is the Russian economy going, but
they may offer a carefully reasoned range of U.S. policy
choices.
The United States, in concert with other western countries,
may influence the direction that Putin pursues in economic
reform. Policies needed for the reform process pose difficult
decisions for the Russian leadership, some of which could lead
to a different distribution of power and resources in Russia,
contrary to the vested interests of powerful elites. These
decisions may be influenced by U.S. policymakers and western
allies of the United States. The United States and Germany may
encourage or discourage Russian reform measures by use of
leverage from debt management policy. By engaging in debt
restructuring the United States may be able to use its leverage
to push Russia toward more effective non-proliferation
measures. Germany, as Russia's leading western trading partner
and creditor, may play a leading role in economic policy with
Russia, if it chooses to take the initiative. An economic
dialog between the Bush and Putin Administrations could be an
important stimulus for broader agreements that would enhance
our mutual national interests. Similarly, WTO accession
discussions might benefit both countries. However, caution may
be required to assure that the Russian economic reform process
leads to concrete developments rather than promises that remain
unfulfilled.
The IMF, World Bank, EBRD and other international
institutions may play a continuing but less critical role in
Russian economic development. If debt rescheduling is put on
the policy agenda, the IMF would need to be involved. Jonathan
Sanford notes that after a decade of programs from
international financial institutions (IFIs) treating Russia as
a special case for aid and advice, the IFIs now plan to treat
Russia as a normal country.
=======================================================================
PAST ECONOMIC PERFORMANCE AND INSIGHTS FOR FUTURE PROSPECTS
=======================================================================
RUSSIA'S ECONOMIC PERFORMANCE: ENTERING THE 21ST CENTURY
By William H. Cooper \1\
----------
contents
Page
Summary.......................................................... 3
Introduction..................................................... 4
Macro-economic Performance....................................... 5
Output....................................................... 5
Inflation.................................................... 7
Structural Economic Performance.................................. 7
Dominance of large unrestructured enterprises................ 7
Structural problems in the banking sector.................... 8
Living Conditions................................................ 9
Real income.................................................. 9
Unemployment rate............................................ 10
Poverty...................................................... 11
Life expectancy.............................................. 12
Income disparity............................................. 12
External Economic Performance.................................... 13
Foreign trade................................................ 13
Foreign investments.......................................... 14
Foreign debt................................................. 16
Analyzing Russia's Economic Performance.......................... 17
Policy Implications for Russia................................... 19
Implications for the United States............................... 20
Appendix A: Notes on the Data.................................... 21
Appendix B: The 1998 Financial Crisis............................ 21
Symptoms..................................................... 21
Causes....................................................... 22
Summary
Russia enters the 21st century potentially in better shape
economically than it was during the last decade of the 20th
century. It has not only survived several financial crises,
including its most severe crisis in 1998, but has also enjoyed
3 straight years of economic growth and rising income for the
average Russian citizen. But the improvement comes after more
than 7 years of severe economic contraction that left many
Russians worse off than they had been during the Soviet era, at
least in economic terms. The economy and its people have been
the victims of the lingering Soviet legacy of central planning
and of misdirected and incomplete economic reforms of post-
Soviet Russian leaders.
---------------------------------------------------------------------------
\1\ William H. Cooper is a Specialist in International Trade and
Finance from the Foreign Affairs, National Defense, and Trade Division
of the Congressional Research Service (CRS).
---------------------------------------------------------------------------
Some analysts have suggested that recent economic growth
indicates that the Russian economy is on the road to sustained
economic growth. However, the recent growth may be fragile and
short term. An examination of Russia's recent economic
performance suggests that one might be cautious about
predicting Russia's long-term economic prospects based on the
past 3 years. The factors that have generated growth--high
world commodity prices and ruble devaluation--are by nature
ephemeral and subject to the vagaries of world markets.
Furthermore, the economic growth has run neither deep nor wide.
Some regions have benefited much more than others, and the
disparity in income distribution within the Russian population
has widened over the years.
Whether short term or more sustainable, Russia's economic
growth presents President Putin and his policy team a ``window
of opportunity'' to address the structural problems of the
Russian economy by completing the reform process to help ensure
long-term growth. In addition, Putin and his team must preserve
the ``accomplishments'' attained during the past 10 years. For
example, maintaining macro-economic stability, a crucial
condition for gaining investor confidence and attaining
sustainable economic growth, remains a challenge for Russia.
The recent 20 percent inflation rates, while moderate by post-
Soviet standards, are still high by conventional standards.
Introduction
By the end of the 1980s, the Soviet Union was declining
economically, rapidly falling behind the industrialized West
and even slipping behind some of the advanced developing
countries of East Asia. The Communist system of central
planning, under which the Soviet Union undertook rapid
industrialization during and after World War II generated high
economic growth rates through the 1960s. Eventually, however,
the system led the Soviet Union into a period of economic
stagnation in the 1970s and decline in the 1980s with few
prospects of improvement. This dismal outlook was a factor in
Mikhail Gorbachev's decision to undertake perestroika to try to
save the Soviet system through reform. The system proved beyond
reform, and Gorbachev's perestroika led to the collapse of the
Soviet Union by the end of 1991. For the next 10 years, Russian
leaders, Presidents Boris Yeltsin and Vladimir Putin, and their
respective governments, have had to lead Russia through the
transition from a central planned economy to what many hope and
expect to be a market economy. The transition remains a work in
progress and not always linear.
The 10 year economic performance of post-Soviet Russia has
been mixed at best. For most of the decade, the Russian economy
shrank and, with it, the standard of living of the average
Russian citizen. The economy has been burdened by the legacies
of central planning and by misdirected and incomplete
government reform efforts of its leadership. But Russia enters
the 21st century potentially in better shape economically than
it had been during the last 7 years of the 20th century. It has
not only survived several financial crises, including its most
severe crisis in 1998, but also has enjoyed 3 straight years of
economic growth and rising income for the average Russia
citizen. However, the Russian economic recovery may not be long
term under present conditions.
Russia's record of economic performance suggests that
Russian leaders face a formidable challenge in turning Russia
into a modern industrialized economy. The performance has
critical implications for the Russian leadership and for U.S.
policymakers as well.
Macro-economic Performance
Russia's economic performance during the past decade has
largely been disappointing at best and destabilizing at worst.
This is evident in examining the output of the Russian economy
measured by real gross domestic product (GDP) and Russian
inflation rates. It has also been uneven with some regions of
the country hit harder than others. Yet, the performance during
the last 3 years has shown tentative signs of recovery.
output
GDP is one of the most comprehensive measures of a nation's
economic activity and health. An economy must grow in order to
improve, or at least maintain, the living standards of the
population. A contracting economy, especially over an extended
period of time, can threaten a nation's political as well as
its economic foundation.
The Russian economy, measured in real (adjusted for
inflation) GDP, has contracted since the collapse of the Soviet
Union (1992-2000). The level of real GDP in 2000 was less than
80 percent of what it was in 1992 (see Figure 1). The sharpest
decline occurred early in the transition, between 1992 and
1996, when the economy shrank 27 percent, before the economy
grew modestly (1 percent) in 1997.
The economic contraction affected sectors across the
economy, some much harder than others. On the production side,
industrial production declined 28 percent between 1992 and 2000
and agricultural production declined 29 percent. On the
expenditure side, fixed investment, a crucial factor for future
growth, declined 49 percent between 1992 and 2000.\2\
---------------------------------------------------------------------------
\2\ These calculations are based on CRS-constructed production
indices of Goskomstat data.
---------------------------------------------------------------------------
The economic slide, especially in the early years of the
transition, was not entirely unexpected. An economy, like
Russia's, that is going through a wrenching transition will
certainly contract. Much of Russian economic output during the
Soviet period was of little economic value. It was directed
toward heavy industry to supply the military and military-
related industries. Soviet production in the consumer sector,
for example, clothing, prepared foods, and passenger cars, was
of poor quality as Soviet producers faced no competition. Once
the Russian economy opened its borders to trade, domestic
producers were unable to meet the foreign competition, and
production collapsed. Therefore, the decline was inevitable as
market forces began to take hold and rationalize investment and
production. But if the decline was inevitable, it was longer
than in other economies going through post-Communist
transitions in East and Central Europe.
In 1997 real GDP increased 1 percent. However, the positive
news proved not only modest but ephemeral. In 1998, a financial
crisis hit. (See note in appendix B for background on the
crisis). As a result of the crisis, GDP plunged 4.9 percent.
The downturn hit all sectors of the economy, setting back
economic progress. Many analysts speculated that 1998 would be
just the beginning of a new phase of Russian economic decline
because Russia would be cut off from capital markets and the
weaker ruble would discourage consumption. Instead, Russia
experienced growth in 1999 (3.2 percent) and in 2000 (7.7
percent). The Russian economy continued to grow in 2001 in
terms of real GDP at an estimated rate of 5.1. percent.\3\
---------------------------------------------------------------------------
\3\ As of June 2001. Russian Economic Trends. October 2001. p. 14.
FIGURE 1._INDEX OF REAL RUSSIAN GDP, 1992-2000
[1992 = 100]
[GRAPHIC] [TIFF OMITTED] T6171.023
Index constructed by CRS based on Goskomstat data.
Despite the recent growth, the 10 year record of economic
performance suggests that the Russian economy still has much
room to grow. In 2000, Russian real GDP was less than 80
percent of its level in 1992, just after the collapse of the
Soviet Union. Its level of fixed investment was only 51 percent
of the 1992 level. Similar gaps are prevalent throughout the
economy.\4\
---------------------------------------------------------------------------
\4\ Ibid.
---------------------------------------------------------------------------
Russian economic growth has been unevenly distributed among
the regions of the country. In 1999, the per capita nominal GDP
for the entire Russian Federation was 15.81 thousand rubles. In
the oil-rich Tyumen region, per capita GDP was 64.49 thousand
rubles and was 37.49 in the Moscow region. In contrast, the per
capital GDP for North Ossetia in the Caucasus was only 5.66
thousand rubles.\5\
---------------------------------------------------------------------------
\5\ Goskomstat.
---------------------------------------------------------------------------
inflation
Compounding the problem of declining growth were very high
inflation rates. In 1992 alone, Russian consumer prices rose
2,509 percent and 840 percent in 1993. Inflation robs
individuals of their savings and lowers their standard of
living. Hyperinflation, accompanied by declines in output, can
create political and social unrest. Fortunately, except for an
increase in workers' strikes, Russia avoided massive social
upheaval. But the Russian people began to lose faith in their
transition to the market economy. By 1997, inflation rates
declined to 11 percent, but rose to 84 percent in 1998 as a
symptom of the financial crisis. By 2000 they had declined to
20 percent, a manageable, but still unstable rate. As Russia
enters the 21st century, inflation remains a persistent problem
for the economy, although much less so than at the beginning of
the economic transition.
TABLE 1.--RUSSIAN INFLATION RATES, 1992-2001
[Annual percentage change in consumer prices]
----------------------------------------------------------------------------------------------------------------
Inflation
Year rate Year Inflation rate
----------------------------------------------------------------------------------------------------------------
1992........................................... 2,508.8 1997............................. 11.0
1993........................................... 839.9 1998............................. 84.4
1994........................................... 215.1 1999............................. 36.5
1995........................................... 175.0 2000............................. 20.2
1996........................................... 21.8 2001 \1\........................ 20.0
----------------------------------------------------------------------------------------------------------------
\1\ As of September 2001.
Source: Goskomstat data in Russian Economic Trends.
Structural Economic Performance
Underlying the weak macro-economic performance in Russia
during the 10 years of the transition have been structural
economic problems. Many of the problems affect the efficiency
of the economy, that is, the productivity of its labor and
capital. These inefficiencies make it difficult, if not
impossible, for the economy to achieve long-term growth. They
also affect the distribution of income among regions and within
the population. Two critical areas of the economy that suffer
from structural problems are the business sector and the
banking sector. The problems in these sectors are symptomatic
of structural problems throughout the economy.
dominance of large unrestructured enterprises
The Russian Government privatized most of the state
enterprises in several phases. Nevertheless, the current
profile of Russian business suggests that while Russia has made
some progress in restructuring, it remains incomplete. Large
enterprises that are legacies of the Soviet period continue to
dominate the Russian economy. The top 20 Russian companies
accounted for 30 to 35 percent of Russian GDP and for 70
percent of Russian exports in 1999. These companies are largely
in the natural resources and infrastructure sectors (energy,
transportation, etc.).\6\ Small- and medium-sized enterprises
accounted for only 30 percent of the total number of
enterprises and 10 percent of the workforce. In contrast,
small- and medium-sized companies accounted for 50 percent of
the employment in the transition economies in Central and
Eastern Europe and for 65 percent of the employment in the
European Union. Furthermore, the number of small- and medium-
sized Russian firms has remained constant since 1995 indicating
little progress in business restructuring and development.\7\
The stalled restructuring impedes productivity as it signifies
barriers to the exit of inefficient firms and the entry of new
firms to the market. These barriers prevent the efficient use
of resources and diminish productivity.
---------------------------------------------------------------------------
\6\ European Bank for Reconstruction and Development (EBRD).
Strategy for the Russian Federation. Paris. October 2000. p. 15.
\7\ Ibid. p. 47.
---------------------------------------------------------------------------
structural problems in the banking sector
A viable banking sector is critical to an economy. Its
primary function is to operate as an intermediary funneling
capital between savers (households) and borrowers (businesses,
consumers, etc.) thereby facilitating the efficient use of
financial resources. Without banks, businesses and others would
be hard pressed to raise funds to finance investment to replace
outdated equipment and technology or to expand production
capacity. Banks also allow individuals to take out mortgages to
invest in housing and to purchase big-ticket consumer goods. A
weak banking sector can impede economic growth. An important
principle for a banking sector to be credible is to maintain an
``arm's-length'' relationship with borrowers so that loans are
extended at market-determined rates and that borrowers are
deemed acceptable risks.
A number of private Russian banks emerged just prior to the
collapse of the Soviet Union in response to the Gorbachev
reforms. The number accelerated during the Yeltsin period.
However, the ownership of the vast majority of these banks was
closely tied to emerging private enterprises and functioned as
conduits of soft credits from the government to those
enterprises. Some of the larger banks belong to the financial
conglomerates controlled by the so-called oligarchs. Such a
conglomerate may consist not only of a bank, but a major
enterprise, usually a raw material producer (nickel, diamonds,
oil), or a news media outlet (television, newspaper). Most of
the banks survived because of subsidies from the government or
because they were part of an oligarch's conglomerate. In
addition, some of the oligarch-owned banks made money by
holding deposits for the Russian Government and investing the
funds. They were not operating as financial intermediaries.
In the mid-1990s, many banks, including the larger ones,
sought returns by heavily investing in Russian Government
treasury bills (GKOs) that were paying high interest rates;
they were not making money lending funds.\8\ Households have
placed most of their savings deposits in the state-owned and -
operated Sberbank, which is the only institution whose deposits
are insured by the state.\9\ The weakness of the banking sector
was exposed when the government was forced to default on the
GKOs in August 1998 forcing most of the banks into virtual
bankruptcy. As a result, the Russian Government under Vladimir
Putin has ostensibly made restructuring the banking industry a
major priority. The government established the Agency for
Restructuring Credit Organizations (ARCO). Its job was to
ensure that those banks that had no hope of surviving would
disappear while recapitalizing potentially viable banks under
conditions that would make them profitable.
---------------------------------------------------------------------------
\8\ One report estimates that 80 percent of household deposits are
held by Sberbank. Talskaya, Marina. Russia Misled Western Creditors.
Vremya. September 13, 2000.
\9\ EBRD. Strategy for the Russian Federation. Paris. October 2000.
p. 16.
---------------------------------------------------------------------------
However, few banks have closed. At the end of the third
quarter of 1998, the height of the financial crisis, there were
2,473 commercial banks in Russia. By the end of the second
quarter 2001, only 398 banks had been closed.\10\ Most of the
remaining banks are not viable, and the sector remains under-
capitalized.\11\ Unless the banking sector is restructured and
banks are in a position to lend, the expansion of the business
sector, and consequently of the economy as a whole, is stymied.
Russian enterprises have relied on retained earnings as a
source of investment, rather than banks, thereby severely
limiting industrial expansion.
---------------------------------------------------------------------------
\10\ Central Bank of the Russian Federation (Central Bank of Russia
or CBR). Bulletin of Banking Statistics. No. 7. 2001. p. 64.
\11\ Economist Intelligence Unit. September 2000. p. 31.
---------------------------------------------------------------------------
Living Conditions
The macro-economic performance and the structural economic
problems in Russia have had a direct impact on living
conditions for the average Russian. These conditions have
deteriorated during the past 10 years. The conventional
measures of living standards--real disposable income,
unemployment, poverty, and life expectancy--indicate that the
transition has adversely affected the average Russian, although
here, too, experts differ on the significance and accuracy of
the data.
real income
Russian real disposable income, a basic measure of economic
welfare or purchasing power, has fluctuated during the 10 year
period, but has declined appreciably overall. According to
official government data, from 1992 through 1994, the level of
real income increased. Between 1994 and 1996, real income
declined substantially (16 percent) before recovering modestly
in 1997, mirroring the upturn that year in real GDP. However,
the data in Figure 2 indicate that the 1998 financial crisis
had a major impact on the buying power of the average Russian.
Between the end of 1997 and the end of 1999, the level of real
disposable income declined 27 percent and rose only modestly (9
percent) in 2000. The data suggest that despite the recovery in
the last 2 years, Russian real disposable income was still 21
percent below its level in 1997, before the financial crisis,
and remained slightly below its level when the transition began
in 1992. Preliminary figures show that during the first 6
months of 2001, real disposable income rose 4.4 percent.\12\
---------------------------------------------------------------------------
\12\ Jamestown Foundation Monitor. August 6, 2001.
FIGURE 2._INDEX OF REAL RUSSIAN DISPOSABLE INCOME, 1992-2000
[1992 = 100]
[GRAPHIC] [TIFF OMITTED] T6171.022
Index constructed by CRS based on Goskomstat data.
unemployment rate
Russia has had to confront the phenomenon of unemployment
in the post-Soviet period. Under the Soviet system, everyone
had a job, although much of that labor was redundant. Economic
changes in the last 10 years have forced Russian firms to
rationalize their business practices, in order to compete. They
have had to layoff workers or, in some cases, firms have had to
close down thereby eliminating jobs. The unemployment rate has
risen, accordingly, although some specialists argue that
standard indicators do not accurately measure the magnitude of
Russian unemployment. In some cases, the unemployment rate may
not take into account redundant labor as some firms are forced
to retain workers because the firms remain the primary
distributor of housing, food, and other necessities, even
though the employees may not be actually working. In other
cases, the unemployment rate may not take into account laborers
who work in ``the shadow economy,'' in jobs not captured by
official statistics.
The data in Table 2 show that the economic transition has
taken a toll on workers. The rate of unemployment had risen
since the beginning of the economic transition period in 1992,
peaking at 12.6 percent in 1999. As a result of the recent
economic expansion, the unemployment rate has declined since
1999 but is still above the rates of the early 1990s and is
almost double the rate in 1992. The increase in unemployment
may prove beneficial to the Russian economy, if the economy is
shedding unproductive labor. While painful to the individual
worker in the short run, the process can improve overall labor
productivity in the economy. The economy then can create more
employment through growth, which seems to be the case in the
recent drop in the unemployment rate. But the process also
draws on government resources to provide unemployment insurance
and other safety net benefits to assist unemployed workers
through the transition.
TABLE 2.--RUSSIAN UNEMPLOYMENT RATE, 1992-2001
[Percentage of workforce, International Labor Organization definition]
----------------------------------------------------------------------------------------------------------------
Year Rate Year Rate
----------------------------------------------------------------------------------------------------------------
1992........................................... 4.7 1997............................. 10.8
1993........................................... 5.5 1998............................. 11.9
1994........................................... 7.4 1999............................. 12.6
1995........................................... 8.5 2000............................. 10.4
1996........................................... 9.6 2001 \1\........................ 8.2
----------------------------------------------------------------------------------------------------------------
\1\ As of August 2001.
Source: For the 1992-1994 data--Goskomstat. For 1995-2001--Russian Economic Trends, October 2001.
poverty
The Russian statistical committee measures poverty as the
percentage of the population that lives below an officially
established subsistence level. The government calculates the
subsistence as the cost of purchasing a set basket of goods and
adjusts that level annually.\13\ The Russian Government has
also revised its methodologies for calculating the poverty
rate, at times making the construction of a consistent data
series somewhat difficult.\14\ The Russian Government changed
the methodology in 1994 and 2000, partially accounting for some
of the abrupt downward shifts in the poverty rates in those
years.
---------------------------------------------------------------------------
\13\ At the end of 2000, the official subsistence level was around
1,285 rubles, or about $44, per month.
\14\ For example, the methodology was changed in 1994 which biased
the rate downward. The change accounts for some of the step drop in the
poverty rate that year. One study estimates that the poverty rate would
have risen to around 34 percent if the methodology had not been
changed. Similarly, the government changed it again that added an
upward bias. Ovtcharova, Lilia. What Kind of Poverty Alleviation Policy
Does Russia Need. Russian-European Center for Economic Policy. Research
Paper. May 2001. pp. 4-5.
---------------------------------------------------------------------------
The data indicate, however, that the poverty rate declined
somewhat between 1994 and 1997, but that the financial crisis
in 1998 eliminated these gains as the poverty rate increased
markedly by 1999. This trend is in line with the dramatic
decrease in real disposable income and the rise in the
unemployment rates in those years as noted in Figure 2 and
Table 2. The growth of poverty is another sign of deteriorating
living conditions in Russia. The Russian people are well known
for managing to survive with little income through subsistence
farming on private plots and through barter. Nevertheless, the
low officially-determined level of subsistence means that a
significant number of individuals may be living well below what
would be considered subsistence in many other countries. Other
data indicate among those that are considered living in poverty
are a number of people who live substantially below the
official poverty level.
TABLE 3.--RUSSIAN ANNUAL RATE OF POVERTY, 1992-2000
[Percentage of population]
----------------------------------------------------------------------------------------------------------------
Year Rate Year Rate
----------------------------------------------------------------------------------------------------------------
1992........................................... 33.5 1997............................. 21.2
1993........................................... 31.5 1998............................. 24.6
1994........................................... 22.4 1999............................. 39.1
1995........................................... 26.2 2000............................. 33.7
1996........................................... 21.4 2001 \1\........................ 31.3
----------------------------------------------------------------------------------------------------------------
\1\ As of June 2001.
Source: Goskomstat, Russian Economic Trends.
life expectancy
A significant indicator of the deterioration of living
conditions in Russia has been the decline in the life
expectancy of the average Russian, especially the Russian male.
In 1991, life expectancy for males was 64 years and 74 years
for females. By 1999, it had declined to 59 years for males and
72 years for females placing Russia among developing countries
in that category. Increases in alcoholism and other diseases,
some of which like tuberculosis have been nearly eradicated in
developed countries, have contributed to the decline. It is
also explained by the poor and deteriorating health system
which has been slow to adjust to the transition from central
planning. A World Health Organization (WHO) report ranks the
Russian health care system 130th in the world, below that of
even many developing countries.\15\
---------------------------------------------------------------------------
\15\ WHO. World Health Report 2000. http://www.who.org.
---------------------------------------------------------------------------
income disparity
The distribution of income within Russia has become
increasingly unequal during the post-Soviet period. A standard
measure of income distribution is the Gini coefficient (or
index) which is on a 0.00 to 1.00 scale. The lower the number
the more equal the income distribution. Thus, 0.00 is perfectly
equal income distribution, while 1.00 is totally unequal.
According to Table 4, the Gini coefficient for the Russian
population has increased. This conclusion is underscored by a
second measure of income distribution, which shows how income
has been distributed at various income levels of Russian
society. These data show that in 1991, before the collapse of
the Soviet Union, the richest 20 percent of Russian the Russian
population accounted for 30.7 percent of Russian income while
the poorest 20 percent accounted for 11.90 percent. By early
2000, the richest 20 percent held 48.6 percent of the income
while the poorest 20 percent's share had declined to 5.9
percent. The middle 60 percent of the population's share had
declined from 57.4 percent in 1992 to 45.4 percent by early
2000.\16\ The two sets of income distribution indicators mean
that some segments of the Russian population have suffered more
than others as living conditions in Russia have deteriorated
during the past decade.
---------------------------------------------------------------------------
\16\ Goskomstat.
TABLE 4.--RUSSIAN INCOME DISTRIBUTION
[Gini coefficient]
----------------------------------------------------------------------------------------------------------------
Year Rate Year Rate
----------------------------------------------------------------------------------------------------------------
1992........................................... 0.289 1997............................. 0.375
1993........................................... 0.398 1998............................. 0.379
1994........................................... 0.409 1999............................. 0.394
1995........................................... 0.381 2000............................. \1\ 0.401
1996........................................... 0.375
----------------------------------------------------------------------------------------------------------------
\1\ Estimate.
Source: Goskomstat.
External Economic Performance
Russia's foreign economic has driven recent economic
growth. However, Russia has also proved vulnerable to the
vagaries of foreign markets, which could eventually undermine
the growth.
foreign trade
The role of foreign trade in the Russian economy has
increased since Russia embarked on its transition. According to
some rough estimates in 1994 (the earliest data available)
exports were equivalent to 24 percent of Russian GDP. By 2000,
the percentage had grown to 42 percent. Russian imports were
equivalent to 18 percent of Russian GDP in 1994 and in
2000.\17\ Furthermore, Russian trade is largely conducted
outside of the former Soviet Union. By 2000, only 14 percent of
Russian exports and 30 percent of Russian imports were with
former Soviet republics. In 2000, Russian exports were split
50-50 between the industrialized countries (Canada, the United
States, Europe, Japan, Australia, and New Zealand) and
developing countries. Developing countries accounted for
approximately two-thirds of Russian imports and industrialized
countries account for the remaining one-third.\18\ These
figures indicate that the Russian economy has changed from one
that operated under the closed system during the Soviet period
where most trade was conducted within the Soviet bloc,
including Central and Eastern Europe, to one where trade has
become geographically diverse.
---------------------------------------------------------------------------
\17\ Calculations based on International Monetary Fund (IMF) data
in International Financial Statistics. July 2001. pp. 702, 704, 706.
Trade data are expressed in dollars, while GDP data are in rubles. The
ruble figures were converted into dollars using an exchange rate of
2.19 rubles per dollar for 1994 and 28.1 rubles per dollar for 2000.
\18\ IMF. Direction of Trade Statistics. June 2001. p. 214.
---------------------------------------------------------------------------
However, Russian trade particularly Russian exports, is
highly concentrated in a narrow group of commodities. In 2000,
50 percent of Russian exports were in oil and oil products and
natural gas. The share of commodities increases to over 65
percent, when exports of other raw materials, such as metals,
are included.\19\ These figures suggest that Russian trade is
highly vulnerable to the often volatile world market prices for
energy and raw materials. They also indicate that after 10
years of transition, the manufacturing sector of the Russian
economy remains uncompetitive.
---------------------------------------------------------------------------
\19\ Russian Economic Trends. June 2001. p. 22.
---------------------------------------------------------------------------
In 2000, the Russian current account (trade in goods and
services, plus investment income, and unilateral transfers) had
a surplus of $46.3 billion, soaring from $24.6 billion in 1999
and from $0.7 billion in 1998. The surplus has allowed the
Central Bank of the Russian Federation (Central Bank of Russia
or CBR) to build up foreign reserves to $24 billion by the end
of 2000 (not including gold reserves).\20\
---------------------------------------------------------------------------
\20\ IMF. International Financial Statistics. July 2001. pp. 704,
706.
---------------------------------------------------------------------------
foreign investments
With outdated infrastructure and other modernization
requirements the Russian economy needs financial capital. Other
economies in transition, such as Hungary and Poland, have
proved ripe targets of foreign investors. Yet, Russia has run
up large capital account deficits indicating minimal confidence
of foreign investors in the long-term prospects of the Russian
economy.
Both the Yeltsin and Putin governments have promoted
foreign direct investment (FDI). Loosely defined, FDI is long-
term investment in plants and real estate. Through FDI, foreign
investors establish a presence in the economy that often
includes transfers of technology, management skills, and other
intangible assets. The Russian economy so far has failed to
attract much foreign investment during the post-Soviet
transition.
From 1992 to 1999, total FDI flows into Russia were $19.8
billion (see Table 5), one-third of which occurred in one year,
1997. In comparison, total FDI flows into Poland were $31.0
billion. The Russian FDI level was more comparable to that of
Hungary ($17.8 billion), an economy that is much smaller than
Russia. Moreover, the trends are not improving despite economic
growth. In 2000, $2.7 billion in FDI flowed into Russia, down
from $3.2 billion in 1999. In fact, FDI outflows from Russia in
2000 exceeded inflows by about $500 million. During the first
half of 2001, $1.2 billion in FDI flowed into Russia, while
$1.5 billion flowed out of Russia.\21\ (These recent numbers
are preliminary and subject to revision.)
---------------------------------------------------------------------------
\21\ Central Bank of Russia. Balance of Payments Data. http://
www.cbr.ru.
---------------------------------------------------------------------------
The regional distribution of FDI into Russia has been
highly uneven. According to Goskomstat data reproduced by the
Organization for Economic Cooperation and Development, as of
January 1, 2000, Moscow and its environs accounted for 48.9
percent of the stock of FDI in Russia. Sakhalin region was next
with 5.1 percent.\22\
---------------------------------------------------------------------------
\22\ OECD. The Investment Environment of the Russian Federation-
Laws, Policies, and Institutions. p. 194. Paris. 2001.
---------------------------------------------------------------------------
Portfolio investments are all other foreign investments
besides direct investments--government bonds, corporate stocks
and bonds, treasury bills, etc. By their nature portfolio
investments do not represent as firm a commitment and are an
indicator of short-term investors' outlook for an economy.
Russia has not done well in attracting portfolio investments,
either, especially since the 1998 crisis. Table 6 shows that
portfolio investments surged, in 1997 to $46 billion. In 1998,
the year of the crisis, $8.9 billion still flowed to Russia.
But in 1999 and 2000, Russia incurred a disinvestment of
foreign portfolio assets, $1.3 billion and $9.9 billion,
respectively. During the first half of 2001, portfolio
investments into Russia were only slightly negative.
TABLE 5.--FOREIGN DIRECT INVESTMENT (FDI) IN RUSSIA, 1992-2000
[In billions of dollars]
----------------------------------------------------------------------------------------------------------------
Year Rate Year Rate
----------------------------------------------------------------------------------------------------------------
1992........................................... $0.7 1997............................. $6.6
1993........................................... 1.2 1998............................. 2.8
1994........................................... 0.6 1999............................. 3.3
1995........................................... 2.0 2000............................. 2.7
1996........................................... 2.5 1992-2000........................ 19.8
----------------------------------------------------------------------------------------------------------------
Source: Central Bank of the Russian Federation (Central Bank of Russia or CBR).
TABLE 6.--PORTFOLIO INVESTMENT FLOWS INTO RUSSIA, 1994-2000
[In billions of dollars]
----------------------------------------------------------------------------------------------------------------
Year Rate Year Rate
----------------------------------------------------------------------------------------------------------------
1994........................................... -$0.1 1998............................. $8.9
1995........................................... -0.7 1999............................. -1.3
1996........................................... 4.6 2000............................. -9.9
1997........................................... 46.0
----------------------------------------------------------------------------------------------------------------
Source: Central Bank of Russia.
The trends in foreign direct and portfolio investments in
Russia indicate that investor confidence in the Russian economy
weakened rather than strengthened. This conclusion is
reinforced by the problem that Russia has had with ``capital
flight.'' Capital flight is an abnormal flow of funds whose
holders seek safe havens from financial uncertainty and
taxation or to launder proceeds from illegal activities.
Russian capital flight is a longstanding problem with very
negative consequences for the Russian economy. It deprives the
Russian economy of critical investment and tax revenues that
might be used for restructuring the pension system and other
social security programs. More importantly, capital flight
indicates a lack of confidence by Russian and foreign investors
in the Russian ruble, in the Russian financial system, and more
generally, in the Russian economy. Capital flight signifies
that Russia's transition to a market economy continues to be
incomplete and far from sustainable.
Estimates of the amount of Russian capital flight vary
according to definition and context. Most estimates suggest
that between 1992 and 1999, $150 billion of capital left Russia
as capital flight. Furthermore, the problem of capital flight
has remained the same or may have worsened. According to one
estimate, Russian capital flight was $28 to $29 billion in
2000, an increase from $24 billion in 1999.\23\
---------------------------------------------------------------------------
\23\ This estimate is from the Ministry of Finance's Economic
Experts Group and is cited in the Economist Intelligence Unit. Country
Report: Russia. March 2001. p. 39.
---------------------------------------------------------------------------
foreign debt
The Russian Government carries a rather heavy burden of
foreign debt. Much of this debt was inherited from the Soviet
Union. As part of an arrangement with the other former Soviet
states, Russia agreed to accept the obligations of servicing
the Soviet debt in exchange for control over Soviet official
assets abroad, such as embassy facilities. As Table 7 below
shows, much of the Soviet debt was in the form of credits
extended or guaranteed by foreign governments to finance Soviet
Government purchases of equipment for major projects. Since the
Soviet Union's collapse, Russia has incurred its own foreign
debt obligations particularly in the form of loans from the
International Monetary Fund (IMF), the World Bank, and the
European Bank for Reconstruction and Development (EBRD).
TABLE 7.--RUSSIAN FOREIGN DEBT, 2000
[In billions of dollars]
------------------------------------------------------------------------
------------------------------------------------------------------------
Post-Soviet Russian debt................................... $44.5
Debt inherited from the Soviet Union....................... 97.7
------------
Total federal government............................... $142.2
============
Russian regional authorities............................... 2.0
Central Bank of Russia..................................... 3.4
Russian private sector debt................................ 27.9
------------
Total.............................................. 175.6
------------------------------------------------------------------------
Source: Central Bank of Russia, Economist Intelligence Unit.
Various measures are used to determine the burden of
foreign debt on a nation's economy. It is not the absolute size
of the debt that is critical but its term structure,
composition, and size relative to the economy's ability to meet
the servicing obligations.
IMF data (see Table 8) show the level of Russia's long-term
debt-service payments and the ratio of these payments to the
level of Russia's exports for the years 1997 to 2005.\24\ Data
for the years 2000 through 2005 are projections. Although debt
service payments are projected to remain roughly stable between
2001 and 2002, they are projected to rise in 2003 to $23.3
billion, equal to 20.6 percent of goods and service exports,
the highest percentage share since 1999, when they stood at
23.9 percent.
---------------------------------------------------------------------------
\24\ This analysis of the Russian debt burden is drawn from work by
Patricia Wertman, Specialist in International Trade and Finance, CRS,
and various IMF reports.
TABLE 8.--RUSSIA'S FOREIGN DEBT SERVICE BURDEN, 1997-2005
------------------------------------------------------------------------
Debt-service
payments (in Debt service/
Year billions of exports (in
dollars) percent)
------------------------------------------------------------------------
1997.................................... $15.4 24.9
1998.................................... 17.5 20.0
1999.................................... 20.3 23.9
2000.................................... 15.7 13.8
2001.................................... 18.2 15.8
2002.................................... 18.2 16.1
2003.................................... 23.3 20.6
2004.................................... 17.4 14.9
2005.................................... 19.2 15.7
------------------------------------------------------------------------
Data for 2001 through 2005 are projections.
Source: IMF, Russian Federation: Post-Program Monitoring Discussions--
Staff Report and Public Information on the Executive Board Discussion.
IMF Country Report no. 01/02. July 2001.
Russia is projected to face a debt servicing burden
ballooning in 2003. Nevertheless the IMF projects that Russia
should be able to service the burden from its own resources.
The IMF forecast assumes that declining oil prices will be
offset by an improved domestic economic climate that will
encourage foreign investment and the return of capital. In
addition, the structural reforms, the IMF assumes, will allow
Russia to boost non-energy exports cutting its dependence on
oil and natural gas exports. Any dramatic negative shifts in
these assumptions would affect Russia's debt forecast, and
therefore the projections are subject to revision.\25\ The
trends in foreign investment and capital flight for 2000 and
2001 noted above would indicate that Russia's international
financial situation may be deteriorating rather than improving.
---------------------------------------------------------------------------
\25\ IMF Country Report: Russian Federation. No. 01/102. July 2001.
pp. 17, 25, 26.
---------------------------------------------------------------------------
Analyzing Russia's Economic Performance
The decade of economic transition has taken a large toll on
the Russian economy and its people. Individual Russian data
series may not accurately measure the economic performance.
However, by examining the economic performance from a variety
of perspectives, it is accurate to conclude that the Russian
standard of living has declined considerably over the last 10
years. In some respects, the average Russian citizen is worse
off now than he or she was prior to the end of the Soviet
Union, and the depth of economic decline will require Russia to
generate high growth rates over a significant period of time in
order to regain what its people have lost. The data on Russian
poverty levels, life expectancy, shrinking population, and
health-related conditions point to an economic decline that has
left deep roots and long-term problems.
Furthermore, the burden of the economic contraction has
fallen disproportionately on some segments of Russian society
and on some regions of the Russian Federation. The income gap
between the richest and poorest segments of the Russian
population has widened significantly in the last 10 years. In
addition, the available wealth in the Russian economy has been
concentrated in the larger, more politically influential
regions of Moscow and St. Petersburg and in those regions
naturally endowed with oil and other commodities. Other
regions, such as those in the Caucasus, are much poorer and
have been hit much harder by the effects of the transition.
Russia has shown signs of economic recovery since 1999, and
that recovery appears to be generated in most sectors on the
demand and supply sides of the GDP equation. Of particular
importance has been the surge in investment in equipment and
machinery. Russia's infrastructure in both the public and
private sectors is sorely outdated, so new investment is a
welcomed and necessary trend. Russian living standards have
also shown signs of improving in the last 3 years with modest
increases in real income and consumption.
Furthermore, Russian terms of trade have improved
significantly boosting current account surpluses and Russian
foreign currency reserves. This trend has allowed Russia's to
meet its immediate foreign debt service obligations without
incurring more debt. However, the large and increasing outflows
of capital, especially in the form capital flight, strongly
suggest that investors, both foreign and Russian, are skeptical
about the depth of Russia's economic recovery.
What lies behind Russia's economic performance? In general,
as many observers have pointed out, Russia's transition away
from central planning was bound to be more difficult and longer
than that of the Central and East European states. The
Communist system was much more entrenched in the Soviet Union
than it was in the rest of the Soviet bloc. Furthermore, Russia
does not have a legacy of market economy to draw on as is the
case with some of the Central and East European states. Russia
has had to deal with the legacy of a Soviet economy that was
administered to meet the needs of the military while civilian
production and investment were given low priority.
However, the Soviet legacy aside, Russia's economic
problems were also grounded in policy failures during the
transition. These failures included loose monetary and fiscal
policies early in the transition period. They have also
included structural problems such as poorly developed and
executed privatization programs that have left many potentially
productive assets in the control of enterprise mangers from the
Soviet period or in the hands of a few politically-connected
individuals (oligarchs) who extracted the value from many of
these assets rather than making them commercially viable for
the long run. In addition, an inefficient banking system, the
lack of private land ownership protection, the absence of a
adequate system of commercial laws, and an inefficient and
corrupt government bureaucracy inhibited economic growth and
development.
Despite the setbacks and the challenges for Russian
policymakers, it is important to keep in mind what Russia has
accomplished in terms of economic reforms during the last
decade:
The government has eliminated price controls on most
goods and services. This reform has been important
because it allows the market forces of supply and
demand to guide producers and consumers on purchasing,
production and investment making the economy more
efficient. Controls have remained on some important
items, such as energy, housing, and transportation, but
these, too, are scheduled for removal.
Russia has opened its economy to foreign trade and
investment.
The structure of Russian production more closely
resembles that of an open economy than of a militarized
economy. For example, the service sector accounts for a
much larger share of national output than does the
goods sector.
The ruble is convertible, and Russian residents may
hold hard currency assets which can be a hedge against
inflation and help protect Russian savings.
The private sector accounts for roughly three-
fourths of national output.
The economic growth that Russia has experienced since 1999
has been largely driven by favorable trends in the Russian
balance of payments. The sharp depreciation of the ruble in
1998 cut demand for imports and encouraged domestic production
of goods. A rapid increase in world oil prices boosted revenues
from Russian exports. Those factors are by nature ephemeral,
subject to sudden changes. Indeed, the ruble has recently been
appreciating in real terms causing imports to increase and
reducing the price competitiveness of Russian goods.
Nevertheless, the Russian economy in terms of real GDP
continues to grow in 2001 at an estimated 5.5 percent rate
suggesting that domestic demand may be driving some of the
growth. It is difficult to estimate how long this trend will
continue.
Policy Implications for Russia
Sustainable economic growth is critical to Russia. Among
other things, it is necessary in order to improve the standard
of living of the average Russian, and, as the above analysis
has indicated, the standard of living needs improvement. In
addition, sustainable economic growth is necessary in order to
generate tax revenues to meet growing pressures on the
government sector.
The question of whether Russia's current economic growth is
sustainable over the long term or just short term has
significant policy implications for Russia. If the answer is
the former, then Putin and his team could give the economy
lower policy priority and delay undertaking politically
challenging structural reforms.
Some specialists have suggested that Russia's period of
economic growth indicates that the Russian economy has turned
the corner and is on the road to sustained economic growth.\26\
However, the above analysis suggests that one must be cautious
in extrapolating long-term trends from the record of the past 3
years. The analysis, instead, indicates that the economic
growth is fragile and that without continued economic reforms
it may not be sustainable. Many of these reforms would be aimed
at increasing investor confidence in the Russian economy. They
would include, banking reform, tax reform, land policy reform
and the protection of property rights, government regulatory
reform, and legal reform.\27\ The Putin government and the
Russian Duma have proceeded with introducing and passing some
of these reforms which are part of the Putin team's economic
strategy for the next decade. Some of these reforms are
difficult because they will entail fundamental changes in the
way of life for Russians. At the same time, the Putin
leadership will have to preserve the ``accomplishments'' of
past years. For example, macro-economic stability, that is low
inflation and a stable exchange rate, is critical to gaining
investor confidence and ensuring an environment conducive to
sustainable economic growth.
---------------------------------------------------------------------------
\26\ See, for example, Aslund, Anders. The Bear Turns Bullish.
World Link. July-August 2000. pp. 49, 51, 53-54. (Available on the
Carnegie Endowment for International Peace Web site: http://
www.ceip.org/files/Publications/aslund/). Another expert who subscribes
to this point of view is Yegor Gaidar, the former Russian Prime
Minister. The Political and Economic Situation in Russia. Remarks to
the Carnegie Endowment for International Peace. January 29, 2001.
http://www.ceip.org/files/events/.
\27\ OECD. The Investment Environment in the Russian Federation:
Laws, Policies, and Institutions. Paris. 2001. pp. 36-37.
---------------------------------------------------------------------------
Economic reforms will require political support. The
current period of economic growth is a ``window of
opportunity'' for the Putin leadership to undertake these
reforms because it has provided Russians with some relief from
the adverse impact of the transition and has generated popular
support for Putin.
Implications for the United States
Russia's economic performance has significant implications
for U.S. interests. How Members of Congress and other
policymakers view Russia's economic performance in relation to
U.S. national interests is a function of their views of the
fundamental nature of the U.S.-Russian relationship.
In some respects, an economically weakened Russia has
benefited the United States by greatly reducing it as a
military threat. Some might argue, therefore, that a weak
Russian economy will help to prevent the threat from
reemerging. The military sector will have to compete with other
domestic needs for limited resources helping to keep military
spending down. In addition, Western creditors could maintain
some financial leverage over Russia which might help to manage
any threat to U.S. interests. This view is held by many of
those who still see Russia as primarily a security threat,
albeit a weakened one.
On the other hand, others believe an economically strong
Russia better would serve U.S. interests. Many in the business
and financial communities and those who analyze the U.S.-
Russian relationship within an economic framework hold this
view. It can be argued, for example, that an economically
efficient and expanding Russia enhances U.S. and global
economic welfare. Russia is viewed by many as a trade partner
and target for U.S. investments, and these opportunities will
grow as Russia becomes healthier economically. Furthermore, an
economically strong Russia would be less likely to have to
export arms to states whose policies are adverse to U.S.
national interests. Some also hold that an economically stable
Russia would mean a politically stable Russia which would
benefit the United States, its allies, and the countries
surrounding Russia.
Appendix A: Notes on the Data
This survey of Russia's economic performance relies on
official Russian Government data published by the Russian
Government State Committee on Statistics (Goskomstat), the
Russian Ministry of Finance, the Central Bank of Russia, and
the Russian Economic and Trade Ministry. These data are derived
directly from these agencies through their online sites or
through secondary sources, such as Russian Economic Trends.
Russian economic data, as with the Russian economy, has been
going through a major transition since the collapse of the
Soviet Union. Soviet data and early versions of Russian
official data were notoriously unreliable.
Russian Government data-collection methodologies have
improved over time and with them so has the quality of data.
Russia's participation in international organizations, such as
the IMF and the World Bank, and its bid to join the World Trade
Organization (WTO), have required Russian data collectors to
conform to international standards. As many analysts continue
to point out, the current versions of economic data still
suffer shortcomings, for example, under-reporting of some
activity in the ``grey economy.'' Nevertheless, the data do
allow analysts to measure trends and changes in magnitude and
thus to construct an informative survey Russia's economic
performance over the last decade. Possible shortcomings in the
official data will be noted in the survey.
Appendix B: The 1998 Financial Crisis
The 1998 financial crisis proved to be a pivotal event in
Russia's transition to a market economy. It exposed many of the
weaknesses of Russian economic policies and the need for
economic reform.\28\
---------------------------------------------------------------------------
\28\ This is a brief discussion. For more analysis of the financial
crisis see CRS Report 98-578, The Russian Financial Crisis: An Analysis
of Trends, Causes, and Implications, by William H. Cooper.
---------------------------------------------------------------------------
symptoms
The crisis culminated in August 1998, when the government
of then-Prime Minister Sergei Kiriyenko abandoned its defense
of a strong ruble. It also defaulted on official domestic debt
forcing its restructuring and imposed a 90 day moratorium on
commercial external debt payments. The crisis led to the demise
of many Russian banks, owned by oligarchs, which had held
government debt. The crisis also led to Kiriyenko's firing by
Russian President Yeltsin who replaced him with Prime Minister
Primakov.
Symptoms of the crisis developed months before August.
Interest rates soared.--Yields on GKOs rose sharply
in a matter of months--to 135.3 percent by the end of
August 1998. The CBR refinancing rate skyrocketed from
30 percent at the end of April to 150 percent by the
end of May. The CBR's overnight interbank lending rate
increased from an average of 45.3 percent in August to
135.3 percent in September 1998.\29\
---------------------------------------------------------------------------
\29\ Central Bank of Russia data published in Russian Economic
Trends. September 15, 2000. p. 29.
---------------------------------------------------------------------------
Stock market values plummeted.--The Moscow Times
(MT) index of stock prices declined 79 percent from the
end of April to the end of August 1998.\30\
---------------------------------------------------------------------------
\30\ Ibid. p. 30.
---------------------------------------------------------------------------
The value of the Russian ruble sank.--Between the
end of July 1998 and the end of September 1998, the
ruble lost 60 percent of its (nominal) value in terms
of the dollar.\31\
---------------------------------------------------------------------------
\31\ Furthermore, the ruble continued to decline losing 71 percent
of its value from April to the end of 1998. Measured on a real
effective exchange rate basis (adjusted for inflation), the ruble
depreciated 41 percent between April and December 1998. CRS
calculations based on data in Ibid.
---------------------------------------------------------------------------
Foreign reserves declined sharply.--Between the end
of July 1998 and August 1998, the reserves, including
gold, dropped from $18.4 billion to $12.5 billion.\32\
---------------------------------------------------------------------------
\32\ Ibid.
---------------------------------------------------------------------------
Real GDP dropped 4.9 percent in 1998 after a modest
increase in 1997 and inflation soared to 84.4 percent
from 11.0 percent the year before.\33\
---------------------------------------------------------------------------
\33\ Ibid. p. 22.
---------------------------------------------------------------------------
causes
The immediate cause of the crisis was the accumulation of
Russian Government short-term debt in the form of GKOs and
bonds (OFZs), to finance burgeoning budget deficits. As long as
the Russian Government could service the debt, it managed to
maintain large budget deficits without incurring inflation and
was able to keep the ruble stable.
But beginning in 1997 and into 1998, a number of forces
came into play that placed Russia in a financially vulnerable
position:
World prices for oil and other commodities, on which
Russian depends for much of its foreign currency
earnings, plummeted, putting downward pressure on
foreign currency reserves and making it more difficult
to service the debt and defend the ruble.
The Asian financial crisis made investors much more
wary of holding risky short-term securities such as
GKOs.
The decline in demand for Russian debt and declining
world commodity prices put downward pressure on the
Russian ruble, making foreign debt servicing much more
expensive.
Foreign economic shocks that hit a financially vulnerable
Russia largely explain the suddenness of the 1998 financial
crisis. The effects of the crisis are still being felt. But
analysts explain how Russia got to this point of vulnerability
by citing more fundamental problems with Russian economic
policy and economic structure. These included the failure to
institute tax reform, property rights, and bankruptcy laws and
procedures.
=======================================================================
RUSSIA'S ECONOMIC CHALLENGES
=======================================================================
Removing Barriers and Providing an Incentive System
THE RUSSIAN ECONOMY: HOW FAR FROM SUSTAINABLE GROWTH?
By Ben Slay \1\
----------
contents
Page
Summary.......................................................... 25
Introduction..................................................... 25
Russian Macro-economic and Political Economy Trends, 1991-2001... 27
Russia's External Trends......................................... 33
Russia's Unfinished Reform Agenda................................ 37
Reform of infrastructure sectors............................. 38
Financial system............................................. 39
Leading Indicators for the Future of Russia's Transition......... 44
Business formation........................................... 44
Labor force participation rates.............................. 45
Commodity composition of exports............................. 45
FDI levels and composition................................... 45
The ``Putin factor''......................................... 45
Summary
The consolidation of capitalism in Russia during the 1990s
was difficult, but reform initiatives ultimately succeeded in
stabilizing prices and restoring economic growth. Most markets
have undergone significant liberalization, and the bulk of the
enterprise sector is in private hands. But the consolidation of
these changes is likely to require important structural reforms
that comprise Russia's ``unfinished reform agenda.'' In the
short run by 2010, institutional reform, particularly in the
infrastructure and financial sectors, would be necessary to
establish a well-functioning market economy with sustained
growth. If reform is not completed by 2010, Russian leadership
could still finish the unfinished agenda.
---------------------------------------------------------------------------
\1\ Ben Slay is Director, Regional Support Centre, United Nations
Development Programme's Regional Bureau for Europe and the CIS,
Bratislava. The views in this paper do not necessarily reflect those of
the United Nations. Much of this paper was written while the author
worked as senior economist at PlanEcon, Inc., the Washington-based
economics consultancy. The author acknowledges his gratitude for the
PlanEcon data and analyses that underpin this paper.
---------------------------------------------------------------------------
Introduction
Russia has had a capitalist economy since the mid-1990s.
\2\ Market forces set most prices, and the bulk of Russian
enterprises are privately owned. International economic
integration has proceeded apace: exports of energy, metals, and
raw materials play a key role in determining Russia's external
creditworthiness and growth prospects. The imperative of fiscal
balance has played a key role in federal budget policy since
1999, while monetary and exchange rate policies reflect the
tradeoffs between price stability and exchange rate
competitiveness faced by central banks everywhere. Although
elite commitment to democracy remains an open question, the
inevitability of capitalism is widely accepted across Russia's
political spectrum. And after years of sharp reported declines
in output and incomes, the Russian economy has recorded growth
in 4 of the past 5 years. The 14 percent cumulative expansion
in gross domestic product (GDP) reported in 1999-2000 was
Russia's best growth performance since the 1970s.\3\
---------------------------------------------------------------------------
\2\ Aaslund, A., How Russia Became a Market Economy, Washington,
DC, 1995, The Brookings Institution.
\3\ All data are taken from the official monthly and annual
publications for the Russian State Statistical Office and the Central
Bank of the Russian Federation (Central Bank of Russia or CBR) (or from
their Web sites) unless otherwise indicated. Indicators on poverty and
inequality trends are taken from Human Development Report 2000: Russian
Federation, UNDP, Moscow, 2001.
---------------------------------------------------------------------------
But if Russian capitalism is here to stay, it is far from
well-functioning. The creation of efficient markets supervised
by regulatory institutions applying best international
practices remains years (if not decades) away in many sectors.
Most enterprises have passed out of full state ownership, but
problems of corporate governance, the judicial system, and land
ownership continue to distort property rights. Market forces
determine prices, but administrative decisions keep key tariffs
for energy, transport, and communal services well below market
levels. Although the federal government reported an impressive
fiscal adjustment during 1999-2001, sub-national fiscal policy
leaves much to be desired. Unaddressed consequences of the
August 1998 financial collapse continue to plague Russia's
banking system, and foreign capital inflows remain minuscule.
While Russia is fully servicing its sovereign external debt in
2001, this is only the second year (after 1997) since the
Soviet collapse in which Moscow has not stiffed its creditors.
The strong economic growth reported during 1999-2000 was due in
part to such transitory factors as high world prices for key
energy exports, and the temporary effects of the ruble's sharp
devaluation after August 1998. The signs of a slowdown were
apparent in the first half of 2001, when industrial and GDP
growth slowed to around 5 percent. And despite the strong
growth recorded during 1999-2000, much of the country still
lives in poverty.
Like most transition economies, the Russian economy has
markets, private enterprise, and is growing. But in contrast to
the leading Central European and Baltic transition economies,
Russia's development prospects remain constrained by sharp
institutional divergences from best international practices. As
the Russian Government itself has admitted,\4\ the economy is
unlikely to find a sustainable development path unless these
divergences are narrowed significantly. Russia also faces some
worrisome demographic, public health, and infrastructure trends
that raise troubling longer-term questions.\5\ While the
economic development program for 2000-2020 promulgated by
Economics Minister German Gref and approved by President
Vladimir Putin acknowledges these problems, prospects for their
effective resolution are far from certain.
---------------------------------------------------------------------------
\4\ Osnovnye napravleniya sotsial'no-ekonomicheskogo razvitiya
Rossii na dolgosrochnuyu perspektivu (Gref program), Ministry of
Economy and Trade, Moscow, 2000 (http://www.economy.gov.ru/program/
soderzanie.html).
\5\ See Russia's Physical and Social Infrastructure: Implications
for Future Development, National Intelligence Council, Washington, DC,
December 2000.
---------------------------------------------------------------------------
This paper addresses these issues in the following manner.
First is a brief narrative of key macro-economic and political
economy trends since the Soviet collapse. Special emphasis is
placed on the causes and implications of the August 1998
financial crisis, and the drivers of the economic expansion
that followed. Next is an investigation of external trends,
paying particular attention to developments in the commodity
composition of Russian trade, the balance of payments, foreign
investment, capital flight, and relations with the country's
creditors. Following that is an examination of key issues in
the unfinished reform agenda, with particular emphasis on the
infrastructure monopolies and the financial system. Last are
some concluding remarks and some leading indicators on
prospects for sustainable growth in Russia.
Russian Macro-economic and Political Economy Trends, 1991-2001
The official data in Table 1 show that Russian macro-
economic trends during the 1990s closely resembled patterns
apparent in other transition economies. An initial period
(1991-1994) of systemic collapse and deep structural changes
was accompanied by triple- and quadruple-digit inflation and
sharp declines in reported output and employment.\6\ This was
the period in which many prices and commercial activities were
liberalized (although not with Central European decisiveness),
and ownership of thousands of state enterprises passed into
private hands.\7\ It was also the period of deep political
transformation (if not necessarily democratization), in which
President Boris Yeltsin forcibly suppressed an insurrection in
October 1993 orchestrated by the Communist and Nationalist
opposition. A constitution was approved (in highly inauspicious
circumstances) by plebiscite shortly thereafter, codifying the
basic outlines of electoral democracy and a federal system.
---------------------------------------------------------------------------
\6\ For a provocative investigation of the differences between
actual and reported declines in output in Russia and other transition
economies during this time, see Aaslund, A., ``The Myth of Output
Collapse After Communism,'' Carnegie Endowment Working Paper 18, 2001,
Washington, DC, Carnegie Endowment. (http://www.ceip.org/files/
Publications/wp18.asp?from=pubauthor) 2001
\7\ Blasi, J.R., M. Kroumova, and D. Kruse, Kremlin Capitalism:
Privatizing the Russian Economy, Cornell University Press, 1997, Ithaca
and London.
---------------------------------------------------------------------------
The introduction of a quasi-fixed exchange rate mechanism
(the currency corridor) in July 1995 marked the end of the
chronic macro-economic instability that characterized the first
period of the Russian transition. The exchange rate's nominal
peg and growing financial assistance from the International
Monetary Fund (IMF) and World Bank helped inflation rates to
fall sharply after mid-1995. Reduced financial instability
helped attenuate the reported contraction in economic activity:
annual declines in GDP fell to 3 to 4 percent during 1995-1996,
and stopped in 1997. Slowing inflation, the appearance of
economic growth, better relations with its creditors, Yeltsin's
re-election in 1996, and propitious conditions on international
capital markets caused the Russian stock market to boom.
TABLE 1.--MACRO-ECONOMIC TRENDS, 1991-2000
--------------------------------------------------------------------------------------------------------------------------------------------------------
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Dollar GDP (at purchasing power parity exchange rates,\1\ in $1,063 $909 $830 $726 $696 $672 $678 $645 $680 $736
billions)..................................................
Per-capita dollar GDP \2\................................... 7,200 6,100 5,600 4,900 4,700 4,500 4,600 4,400 4,700 5,100
Real GDP growth (in percent)................................ -5.0 -14.5 -8.7 -12.7 -4.1 -3.4 0.9 -4.9 5.4 8.3
Growth in personal consumption (in percent)................. -5 -3 0 -3 -7 -5 5 -3 -4 9
Growth in gross fixed investment (in percent)............... -16 -40 -12 -24 -10 -18 -5 -10 5 16
Federal budget balance (percent of GDP)..................... NA -3 -1 -5 -3 -4 -5 -3 -1 3
Consolidated budget balance (percent of GDP)................ NA -4 -5 -10 -3 -4 -7 -4 -1 3
Consumer price inflation (annual average, in percent)....... 96 1533 881 322 196 48 15 27 93 21
Unemployment rate (by ILO standards, in percent)............ NA 4.9 5.5 7.5 8.2 10.1 12.2 13.3 12.2 9.6
Gini coefficient (income inequality)........................ 0.26 0.29 0.40 0.41 0.38 0.38 0.38 0.40 0.40 0.39
Population with below-subsistence incomes (in percent)...... NA 34 32 22 25 22 21 24 39 34
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ PlanEcon estimates.
\2\ Ibid.
NA--Not available.
Some $50 billion in foreign direct and portfolio investment
poured into the country in 1997, as emerging market investors
increasingly saw Russia as a transition economy on the verge of
``turning the corner.'' After years of deterioration, social
indicators of poverty and inequality also began to improve in
the mid-1990s. After rising from 0.26 in 1991 to 0.41 in 1994,
Russia's Gini coefficient of income inequality dropped to
around 0.38 during 1995-1997. And the share of the population
with incomes classified as below the poverty line dropped from
around 33 percent during 1992-1993 to about 20 percent in 1997.
The calumnious events that led to the currency, debt, and
banking crisis of August 1998 brought an end to the second
phase of the Russian transition, and revealed the optimism
engendered by developments in 1996-1997 to have been premature.
The federal government in that month defaulted on its domestic
debt and began accumulating arrears on its rescheduled external
debt obligations inherited from the Soviet period. The
government and the Central Bank of the Russian Federation
(Central Bank of Russia or CBR) halted their defense of the
quasi-fixed exchange rate, permitting the nominal exchange rate
to collapse from 6.2 rubles per dollar to 21.1 rubles per
dollar by the end of the year. The ruble's collapse led to
renewed price pressures: year-on-year consumer price inflation
rates had returned to triple-digit levels by mid-1999. Almost
all of Russia's private banks collapsed after the devaluation,
leaving the state savings bank, Sberbank, the only domestic
financial institution of any consequence. The ``reformist''
Western-oriented governments that had ruled Russia since 1992
were replaced in September 1998 by a cabinet that drew its
support from the Communist Party of the Russian Federation, the
largest party in the parliament.\8\
---------------------------------------------------------------------------
\8\ For more on August 1998, see Komulainen, T., and I. Korhonen,
eds., Russian Crisis and Its Effects, Helsinki, 2000, Kikimora
Publishers.
---------------------------------------------------------------------------
The shock waves generated by the ``Russian crisis'' were
felt throughout the world. Investment bankers hawking the
``Russian boom'' gave way to pundits claiming that Russia's
economic and political transitions had failed, or that Russia
was a failed state. In Washington, opponents of the policies
pursued by the Clinton administration and the IMF and World
Bank vis-a-vis Russia explained the Russian crisis as the
inevitable result of ideological orthodoxy and/or political
opportunism.\9\ Coming on the heals of the East Asian crisis
that began in mid-1997, Russia's financial crisis contributed
to the global emerging market rout that led the Federal Reserve
to sharply cut interest rates in order to avoid a global
liquidity squeeze in late 1998. It also added new urgency to
the search for a ``new international financial infrastructure''
to deal with such problems as financial contagion and money
laundering.
---------------------------------------------------------------------------
\9\ Stiglitz, J., ``Whither Reform? Ten Years of Transition,''
Washington, DC, The World Bank, 1999.
---------------------------------------------------------------------------
Rather than marking the inevitable failure of the Russian
transition, the August 1998 financial crisis reflected a
confluence of unfortunate domestic and external factors. Some
of these were avoidable, others of which not. Moreover, the
storm clouds generated by August 1998 also weakened or removed
many of the causes of the crisis, which helped pave the way for
the strong GDP growth that took hold in 1999-2000. The recovery
of 1999-2001 marks the third phase of Russia's economic
transition, which is marked by the challenge of transforming
the growth that took hold since August 1998 into sustainable
economic and social development.
Two domestic causes of August 1998 were paramount. First,
Russia's macro-economic policy framework was plagued by
inconsistencies between the quasi-fixed exchange rate regime
and large fiscal deficits that were financed by foreign
borrowing. Russia's consolidated government budget (i.e., the
balance on the federal, regional, and municipal government
budgets) reported deficits of 5 to 7 percent of GDP during
1996-1997, and through mid-1998. The borrowing required to
finance these deficits created increasingly unstable foreign-
and domestic-debt dynamics that by mid-1998 undermined the
credibility of the monetary and exchange rate policies.
Second, the implementation pace of Russia's market reform
agenda slowed noticeably after 1995. Virtually no major
improvements in economic policy or institutions were introduced
during 1995-1998. This resulted in part from a lack of
leadership at the top, due first to the 1996 presidential
election campaign and then to President Yeltsin's growing
infirmity that culminated in his surprise December 1999
resignation. But the stagnating market reform agenda also
reflected the political economy of transition, which has
produced what the World Bank's Joel Hellman has termed ``low-
level, partial reform equilibria'' in many transition
economies. As Hellman points out, the successes of the initial
stages of the economic transition--the partial liberalization
of prices and commerce, the first waves of rapid privatization,
and the devolution of power from the central to regional
authorities--create new interest groups who are opposed to
further market reforms.\10\ In Russia, the ``oligarchs'' who
benefited from the rent-seeking opportunities created by the
incomplete liberalization of prices and trade, and then from
quick and dirty privatizations of key state companies, were
instrumental in securing Yeltsin's re-election in 1996.
Yeltsin's reliance on Russia's regional leaders in his battles
against the Communist opposition allowed the regions to pursue
policies that balkanized Russia's large domestic market and
weakened Russia's fiscal coherence. Measures to strengthen the
financial system, improve regulation of infrastructure
monopolies, or provide a level playing field across Russia's
economic space, generally went nowhere after 1995.
---------------------------------------------------------------------------
\10\ Hellman, J., ``Winners Take All: The Politics of Partial
Reform in Postcommunist Transitions,'' World Politics, 50 (January
1998), pp. 203-234.
---------------------------------------------------------------------------
The Russian economy in 1998 was also hit by three highly
unfavorable developments over which it had no control: a bad
harvest, an oil price shock, and financial contagion from East
Asia. Bad weather in various parts of the country caused a 19
percent reduction in value added contributed by the
agricultural sector in 1998. The dollar prices of Russian
exports dropped 15 percent in that year, as oil exports were
selling for only $7 per barrel in December 1998 (according to
official data). Export prices dropped another 4 percent in 1999
as well. This terms-of-trade shock pushed overall exports down
from $88 billion during 1996-1997 to $74 to $76 billion in
1998-1999. Russia's current account balance, which registered
surpluses of 2 to 3 percent of GDP during 1995-1997, had fallen
into deficit by mid-1998. At the same time, foreign investors
who were burned by the East Asian financial crises in 1997
became increasingly unwilling to risk investing in Russian
securities in 1998. This ``repricing of Russian risk'' combined
with the collapse of Russia's current account surplus would
have posed daunting policy challenges even for a country with a
robustly pro-reform political elite.
The August 1998 crisis did significant damage to Russia's
financial system, to the country's external creditworthiness,
and to living standards. Financial intermediation by private
banks essentially stopped in August 1998, and has not been
renewed since. With only a handful of exceptions, private- and
public-sector borrowers in Russia effectively lost access to
international capital markets and have not regained it since.
After years of small improvements, Russian indicators of
poverty, inequality, and social hardship deteriorated anew
during 1999-2000.
But August 1998 also made possible the rapid GDP growth
that was reported in 1999-2000. The ruble's sharp devaluation
set the stage for an import-substituting industrial recovery
led by privatized firms in the metallurgical, light industrial,
and machine building sectors. The banking collapse and the low
oil prices of 1998-1999 weakened the oligarchs, while the
collapse of the domestic debt market deprived the federal and
regional governments of sources of borrowing. Russia therefore
got fiscal religion: regional governments were forced to start
running budget surpluses in 1999, and the federal budget has
been in surplus since early 2000. While these surpluses were
due in part to reductions in debt servicing, they also
reflected improvements in tax collection. The share of GDP
collected as consolidated government tax revenues, which had
dropped below 20 percent in 1998, rose to 21 percent in 1999
and 24 percent in 2000. And in contrast to 1998, when as much
as a third of federal and half of regional tax revenues were
collected in non-monetary forms, all federal tax revenues since
early 2000 have been collected in cash. The crisis of arrears,
barter, and monetary surrogates that seemed to be choking the
Russian economy in 1998 has largely melted away.
Other factors besides the bounce from August 1998
facilitated Russia's recovery during 1999-2000. High oil prices
were obviously one of these: thanks to 65 percent growth in the
prices of export crude and refined oil products, Russia's
dollar export prices rose by 26 percent in 2000. But high world
prices for energy and other exports do not explain the strength
of Russia's recovery during 1999-2000. For one thing, 5.4
percent GDP growth was reported in 1999, even though Russia's
export prices fell 4 percent overall in that year. Sharply
lower relative prices for energy and transport services also
played an important role in promoting the Russian recovery.
Thanks to regulatory decisions that held energy and transport
prices in check in the aftermath of the August 1998 financial
crisis, the relative prices of gas, transport, and electricity
dropped by 20, 23, and 39 percent respectively (calculated vis-
a-vis the industrial producer price index on an end-year basis)
during 1998-2000. Energy-intensive companies in chemicals,
ferrous metallurgy, and other manufacturing branches were able
to re-export this cheap energy in the form of highly price-
competitive exports. The economy also benefited from Boris
Yeltsin's relatively painless departure from the Russian
presidency in December 1999, and from the rapid consolidation
of power by his successor Vladimir Putin.\11\
---------------------------------------------------------------------------
\11\ See Rutland, P., ``Putin's Path to Power,'' Post-Soviet
Affairs, Vol. 16, No. 4 (December 2000), pp. 313-354.
---------------------------------------------------------------------------
Russia's growth in 1999 was driven largely by foreign
demand. Whereas exports in volume terms rose by some 7 percent
in that year, import volumes dropped by nearly a third. This
sharp growth in net exports compensated for a decline in
domestic demand, as personal consumption dropped 4 percent. In
sector-of-origin terms, growth in 1999 was powered by the
industrial sector (an 11 percent increase was reported in
industrial value added) and agriculture (which, recovering from
the poor harvest of 1998, reported a 17 percent increase in
value added in 1999). By contrast, the declines in imports and
personal consumption kept growth in the service sector flat, as
value added generated by the trade sector dropped 3 percent in
1999. In 2000, on the other hand, domestic demand became the
driver of the 8.3 percent GDP growth reported for that year.
Personal consumption was reported up 9 percent, while fixed
investment rose 16 percent. Russia's recovery in 2000 was also
more balanced sectorally: the 12 percent growth in value added
reported for the industrial sector was complemented by 11
percent growth in construction and 10 percent growth in the
trade sector. While export volumes reported healthy 11 percent
growth in 2000, import volume grew by some 20 percent. Average
inflation rates also dropped sharply in 2000, while the
unemployment rate at the end of the year had fallen to 9.6
percent, down from 13.3 percent at the end of 1998.
With a few exceptions, these trends continued into 2001.
While growth in production volumes in the industrial and
construction sectors slowed to 6 percent during the first half
of the year, retail trade turnover continued to surge, with 10
percent growth was reported during the first half. Consumer
price inflation stopped falling, however, and averaged nearly
25 percent in year-on-year terms during the first half of the
year. This inflation was due primarily to very loose monetary
policies. Inflows of foreign exchange produced by the
continuing large current account surpluses, combined with
unsterilized CBR intervention, kept growth in the monetary base
and M2 in the 50 to 60 percent ever since the second half of
1999. While the demand for rubles grew strongly during 1999-
2000 thanks to Russia's strong output growth and sharp
reductions in the use of monetary surrogates, the supply of
rubles in 2001 had clearly begun to outpace demand. Inflation
in the 25 percent range combined with an essentially stable
nominal exchange rate to further boost the value of the ruble
in real effective terms; and the firmer ruble in turn helped
boost imports and slow growth in the manufacturing sector. A
long-delayed correction in the relative prices for energy and
transport services also took hold in 2001, further slowing
industrial growth.
Despite these problems, 4.9 percent GDP growth was reported
for the first quarter of 2001, and gross output trends
suggested a similar or slightly higher rate of growth for the
second quarter as well. These are hopeful signs for Russia's
economic prospects. But Russia's development during the 1990s
suggested that a return to growth was at some point inevitable.
Output trends in virtually all Eurasian transition economies--
ranging from success stories like Poland and Estonia to
laggards like Belarus and Tajikistan--show that a third,
``recovery'' phase eventually follows an initial period of
macro-economic disorganization and contraction, and then a
second period of stabilization and austerity. Russia's great
misfortune was that the first two phases lasted nearly 10
years, whereas Poland managed to get through the first two
phases of its economic transition in only 2 to 3 years.\12\ The
challenge now facing policymakers in Russia--as in many other
Commonwealth of Independent States (CIS) economies--is to
transform the recovery of 1999-2000 into sustainable economic
and human development.
---------------------------------------------------------------------------
\12\ Slay, B., ``The Polish Economic Transition: Outcome and
Lessons,'' Communist and Post-Communist Studies 33 (2000), pp. 49-70.
---------------------------------------------------------------------------
Russia's External Trends
The dramatic improvement of Russia's external position
during 1999-2000 is among the most hopeful post-August 1998
changes. The current account deficit reported at mid-1998 gave
way to a surplus of nearly $46 billion--nearly 19 percent of
GDP--in 2000. Official reserves tripled from $11 billion in
March 1999 to $35 billion as of mid-2001--more than double
their previous high recorded in late 1997. Russia in 2001
returned to fully covering its external sovereign debt after
rescheduling a portion of its Soviet-era obligations to the
London Club of commercial creditors in 2000. In contrast to the
1990s, Moscow is not dependent on credits from multi-lateral or
private lenders, and in contrast to 1997-1998 there is very
little ``hot money'' in the country. If prior to August 1998
Russia was on IMF life support, Moscow was able to reduce its
obligations to the Fund from $19 billion in 1998 to around $10
billion as of mid-2001.
To be sure, these improvements came at a high cost. The
sharp reductions in household incomes and personal consumption
recorded during 1998-1999, coupled with sharply higher
unemployment, were the price Russian households paid for the
restoration of external balance. Serendipity has also helped
strengthen Russia's external position, in the form of sharply
higher export prices in 2000 (when Russian received an
estimated 33 percent terms of trade windfall). The extent of
this improvement could face a sharp test in 2003, when Russia's
sovereign foreign debt obligations are slated to rise from $9
billion in 2000 to some $19 billion.
Still, the unprecedented growth in reserves, the huge
current account surplus, and the shift in Moscow's fiscal
priorities in 2001 to allow for full coverage of external debt
obligations, suggest that Russia's external position can weaken
but still remain quite strong compared to pre-1998 levels. The
risks associated with the debt spike in 2003 are being
addressed by a host of policy measures, and others can be
employed in the future. Moscow in late 2000 and the first half
of 2001 used undisclosed amounts of surplus budget revenues to
repurchase its heavily discounted sovereign debt. These pre-
payments reduce Russia's debt burden and make full coverage of
future obligations less burdensome. Despite the sharp increase
in debt-service payments in 2001, the CBR's foreign exchange
reserves rose from $28 billion at the end of 2000 to $34
billion as of mid-2001. A joint government/CBR declaration on
economic policy through 2004 released in May 2001 calls for
reserves to grow to $37 billion by the end of this year. This
target seems eminently feasible--especially since reserves in
mid-July had climbed close to $36 billion. The CBR's target of
$45 billion in official reserves by the end of 2002 therefore
seems quite attainable.
Russia's sovereign domestic debt at the end of 2000 stood
at only $20 billion, less than 10 percent of GDP. Strong ruble
liquidity in the Russian financial system should allow Moscow
to borrow domestically to repay foreign debt during 2001-2002.
The Finance Ministry in June 2001 auctioned off 5 billion
rubles' ($175 million) worth of 3 year domestic debt
instruments. This issue, which was snapped up by cash-rich
Russian banks, marked the largest such sale of government debt
since the August 1998 financial crisis. Should Russia's
external position deteriorate due to a terms-of-trade shock,
the Paris Club of sovereign creditors has declared its
willingness to consider restructuring Russia's obligations. The
IMF ostensibly stands ready to provide financing during 2002-
2003 through a precautionary framework, should this prove
necessary--and if Moscow can meet its conditions. Additional
revenues for foreign debt repayment can be raised from sales of
precious metals, from issuing new eurobonds, or by arranging
non-securitized loans.
But protection against a balance-of-payments crisis is not
the same as sustainable growth. The commodity composition of
Russian exports, Russia's problematic record with foreign
investment, and continued large capital outflows are
particularly worrisome in this respect. As Table 2 shows, fuels
made up half of Russia's export basket in 2000--a higher share
than in 1993. By contrast, machinery and equipment comprised
only 11 percent of total exports in 2000, down from 14 percent
in 1993. Attempts to parley Russia's comparative advantages in
metallurgy, armaments, aerospace, and IT into a more
competitive engineering sector have not achieved spectacular
results. This contrasts sharply with the export-driven
industrial restructuring that occurred in the leading Central
European transition economies during the late 1990s.
The foreign direct investment (FDI) that has driven Central
Europe's industrial modernization is conspicuously absent in
Russia. Russia through 2000 had attracted $23.5 billion in
cumulative inward FDI, or $160 on a per-capita basis. By way of
comparison, per-capita inward FDI in Hungary--the leader among
transition economies--was nearly $2,500. The Czech Republic
reported $2,000 in per-capita FDI, Estonia registered $1,500,
and Poland had $780. Among CIS countries, Russia's per-capita
FDI compares quite unfavorably with Azerbaijan's $620 and
Kazakhstan's $580. Even Armenia--a country with virtually no
energy reserves, and which has faced an economic blockade for
more than 10 years--reported higher per-capita cumulative FDI
($170) through 2000 than Russia.\13\
---------------------------------------------------------------------------
\13\ These data come from national bank publications or Web sites
for the countries in question.
TABLE 2.--EXTERNAL TRENDS, 1993-2000
----------------------------------------------------------------------------------------------------------------
1993 1994 1995 1996 1997 1998 1999 2000
----------------------------------------------------------------------------------------------------------------
Exports (in billions of dollars)........................... $59 $68 $81 $89 $88 $74 $76 $106
Percent share of fuel exports in total................... 40 42 38 43 44 38 41 50
Imports (in billions of dollars)........................... 44 51 61 69 73 59 40 45
Trade balance (in billions of dollars)..................... 15 17 20 20 15 15 36 61
Percent share of GDP..................................... 8 6 6 5 4 6 19 24
Current account balance (in billions of dollars)........... 13 8 7 12 2 1 25 46
Percent share of GDP..................................... 7 3 2 3 1 0 13 19
Percent change in terms of trade........................... 3 7 3 7 -3 -14 -4 33
Inward FDI (in billions of dollars)........................ 1 1 2 3 5 3 3 3
Net portfolio investment (in billions of dollars).......... 0 0 2 4 46 9 -1 -1
``Capital flight'' (in billions of dollars) \1\............ 10 9 13 24 30 17 11 15
Percent share of GDP..................................... 5 3 4 6 7 6 6 6
Gross foreign debt (in billions of dollars)................ 121 132 143 152 167 191 181 172
Percent share of GDP..................................... 65 48 42 36 39 70 95 68
Official reserves, end year (in billions of dollars)....... 8 7 14 15 18 12 12 28
Import coverage (months)................................. 2 2 3 3 3 3 4 8
Percent change in real effective exchange rate \2\......... 169 79 40 39 8 -32 -29 22
----------------------------------------------------------------------------------------------------------------
\1\ Calculated as the sum of: (1) Russian purchases of foreign exchange; (2) export contracts that have been
concluded but for which revenues have not been received; (3) import contracts that have been concluded but for
which payment has not been made; and (4) net errors and omissions.
\2\ Unweighted average of annual changes in real effective exchange rates vis-a-vis domestic, euroland, and
dollar consumer and industrial producer price trends.
Russia's energy and non-ferrous metallurgical bounty
suggests that industry, and energy and metals in particular,
should have attracted the bulk of the country's inward FDI.
This has not been the case. Only $3.6 billion--one-sixth of
Russia's inward FDI--went into the energy sector during 1993-
2000. Virtually all of this went into crude oil extraction.
Ferrous and non-ferrous metallurgy combined accounted for less
than 2 percent of total FDI during this time, while virtually
no FDI went into natural gas or electric power. The industrial
sector as a whole attracted 47 percent of total FDI, with
manufacturing accounting for 31 percent. The food processing
branch was manufacturing's leading recipient, with 18 percent
($4 billion) of total FDI. Since food processing accounts for
at most 3 percent of Russian GDP, the sector's strong FDI
performance is somewhat surprising. The explanation is largely
political: foreign investment in food processing generally
remains ``below the radar screen.'' By contrast, Russian elites
are generally unwilling to permit significant amounts of
foreign capital into ``strategic'' sectors such as oil, gas,
electric power, diamonds, nickel, and aluminum.
Rather than attracting foreign investment, Russia is
instead becoming an important source of FDI for other CIS
countries. The CBR registered some $3.1 in outward FDI in 2000,
which exceeded the $2.7 billion in inward FDI reported. Cash-
rich Russian oil companies took control of three of Ukraine's
six major oil refineries during 1999-2000, while the Russian
Aluminum conglomerate acquired Ukraine's Mykolayivsky
Hlynozemny Zavod, Europe's largest alumina maker. Russian
acquisitions were not limited to the CIS, however: Lukoil in
late 2000 spent $70 million to acquire Getty Oil's retail
outlets in the United States. After recording large inflows
during 1997-1998, net outflows were reported on Russia's
portfolio investment balance during 1999-2000 as well.
Russia's strong economic recovery during 1999-2000 was
paradoxically accompanied by a steep acceleration in capital
outflows. After posting positive balances during 1995, 1997 and
1998, Russia's financial account swing heavily into deficit,
posting net outflows of $17 billion in 1999 and $48 billion in
2000. But in many respects, trends on Russia's financial
account offer a misleading guide to capital flows. For one
thing, substantial negative sums are reported every year on
``net errors and omissions.'' During 1995-2000, this balance
was fairly stable, averaging--$7 billion annually. These large
negative balances are commonly viewed as indicators of illicit
capital flight and as such they should be considered part of
Russia's net outflows. But not all transactions reported as net
outflows on the financial account reflect transfers of assets
from Russia to other countries. Some reflect portfolio
management choices by Russian households and companies.
Decisions to increase dollar cash holdings (for savings or
working capital) in the informal sector, at the expense of
ruble assets in official bank accounts, boost net outflows
reported on the financial account even though these funds do
not leave Russia. Likewise, export receipts that are left in
off-shore accounts in order to finance imports may appear on
the balance of payments as a capital outflow, even though they
function as working capital.
Russia's external accounts do not distinguish ``capital
flight'' that reflects illicit, speculative, or hedging
purposes from ``normal,'' transactions-based capital outflows
reflecting the liquidation of Russian assets held by non-
residents. A commonly used measure of capital flight in the
Russian case is the sum of: (1) Russian purchases of foreign
exchange; (2) export contracts that have been concluded but for
which revenues have not been received; (3) import contracts
that have been concluded but for which payment has not been
made; and (4) net errors and omissions. This measure shows
Russian capital flight falling from $30 billion in 1997 to $11
billion during 1999, before rising to $15 billion in 2000. As a
share of dollar GDP, this measure of capital flight has
remained at 6 to 7 percent ever since 1996.
An alternative perspective on Russian capital flight comes
from comparing gross capital inflows (changes in the gross
liabilities recorded on the capital and financial accounts) and
outflows (changes in the gross assets in Russia's capital and
financial accounts, plus net errors and omissions). Gross
outflows as a share of GDP rose from 9 percent during 1996-1997
to 13 percent in 1999, before dropping back to 12 percent in
2000. By contrast, gross capital inflows essentially dried up
after August 1998, falling from 9 percent of GDP in 1997 to
below 1 percent in 1999-2000. This suggests that the sharp
acceleration in net outflows on the financial account during
1999-2000 were not due primarily to capital outflows per se,
but rather to foreign investors' post-1998 aversion to Russia.
Russia's poor track record on attracting FDI may not last.
Foreign investment in transition economies typically lags a few
years behind recoveries in GDP and domestic investment. Still,
a comparative assessment of Russia's FDI performance to date
can not help but cast a shadow over future prospects for
sustainable growth. Making Russia more attractive to
investors--foreign and domestic alike--requires significant
reforms in the financial and legal systems.
Russia's Unfinished Reform Agenda
Arguments about links between growth and market reform in
transition economies--particularly in Russia--often reflect two
implicit propositions: (1) the far-reaching institutional
reforms needed to create a well-functioning market economy are
necessary and sufficient conditions for growth; and (2)
transition economies' short-term growth prospects are closely
tied to progress in market reform. The record of the 1990s
shows that both assertions are at the very least exaggerations.
Instead, the liberalization of prices and commerce, the
creation of stable monetary, fiscal, and exchange rate
environments, and some measure of privatization, are generally
sufficient to create the ``critical mass'' of institutional and
policy changes needed to end the transition recession.\14\
Albania, for example, recorded annual GDP growth during 1993-
1996 and 1998-2000 of 8 percent or above, despite a large
unfinished reform agenda. Azerbaijan's growth performance
during the second half of the 1990s was far superior to the
Czech Republic's, despite the fact that market reforms were
much farther advanced in the latter country than in the former.
Many factors besides the extent and pace of market reforms--
including location, size, resource endowment, political
stability, economic policies, and state capacity--have an
important impact on growth in economies--transition or
otherwise.
---------------------------------------------------------------------------
\14\ Balcerowicz, L., ``The Interplay Between Economic and
Political Transition,'' in Zecchini, S., ed., Lessons From Economic
Transition: Central and Eastern Europe in the 1990s, 1995, pp. 153-167.
---------------------------------------------------------------------------
Still, there can be little doubt that progress in market
reform--understood as measures to remove barriers or threats to
growth that were inherited from the Soviet-type system, or
which appeared during the course of transition--has a key
influence on prospects for sustainable growth and development
in transition economies. If banks do not become effective
financial intermediaries, capital will continue to be poorly
mobilized and allocated. If infrastructure monopolies do not
face competition or charge prices that cover their costs, the
provision of basic public services can come under threat. If
investors can not rely on courts to protect and clarify
property rights, some investments will not be made. If
bureaucratic connections are more important for entrepreneurs
than competitive advantage, companies will continue to invest
in ``relational capital'' rather than in fixed assets. All of
these problems stand in the way of sustainable growth, and--as
the Gref program acknowledges--Russia suffers from all of them.
During Boris Yeltsin's second term, initiatives to address
these problems made little headway. Upon becoming president,
Vladimir Putin promised rapid and decisive steps in these
areas. Some progress was made in Putin's first year, and as of
mid-2001 the government had succeeded in pushing a raft of
market reform initiatives through parliament. Still, much
remained to be done, and many of the salient results
anticipated from these changes will take decades to
materialize.
reform of infrastructure sectors
Thousands of urban dwellers in Siberia and the Far East
spent much of winter 2000-2001 without adequate supplies of
heat and electricity. In many places Russia's infrastructure
for heat, power, and communal services simply buckled. The
sharp declines in human welfare stemming from these problems
prevented many Russians from experiencing the benefits of the
strong economic growth recorded in 2000. While a number of
factors--including a particularly cold winter and ineptitude on
the part of the local authorities--contributed to the deep
freeze, years of below-cost pricing and mismanagement by the
Unified Energy Systems (UES) national electricity company and
its subsidiaries played a critical role in this debacle.
Although Russia's gas infrastructure remains relatively free of
such problems, production at Gazprom--Russia's gas monopoly--
dropped some 5 percent during 1999-2000, and the company had to
import significant quantities of gas from Turkmenistan in order
to meet its supply commitments. UES and Gazprom management
argue that tens of billions of dollars must be invested in
these sectors in order to maintain and expand output levels in
the future. This seems to particularly be the case for UES,
since fixed investment in the electricity sector dropped by
some 30 percent during 1997-2000. Similar claims are made by
municipal administrations, who point out that household charges
for rent, sewer, and water cover less than half of the costs of
providing these services. And Railroad Ministry officials argue
that billions more must be invested in Russia's rail
infrastructure, in order to prevent the further
decapitalization of Russia's largest and most important
transport network.
According to the Gref program, the government intends to
deal with these problems by further marketizing these sectors,
by: (1) reducing administrative barriers, so as to promote
increased competition and entry by new suppliers; (2)
increasing relative prices in these sectors, in order to bring
tariffs closer to full cost-recovery levels; (3) selling off
state monopoly assets to private (and potentially foreign)
investors; (4) introducing compensating payments for those
households (and other users) whose welfare is most threatened
by step (2); and (5) introducing tighter controls over those
monopolistic activities remaining under state control, via: (a)
better regulation of monopoly pricing; and (b) more active
control by federal bodies--acting in their capacity as owners--
over management in these sectors.
As of mid-2001, measures embodying these themes had been
approved for implementation in the electricity, gas, rail,
housing, and communal service sectors. To the surprise of many
observers, Rem Vyakhirev was replaced as Gazprom CEO by Putin
loyalist Aleksei Miller in May. Miller promised to halt the
large-scale asset stripping at Gazprom that allegedly occurred
during Vyakhirev's tenure. He also promised to afford
independent gas producers access to Gazprom's domestic pipeline
network, thereby increasing other companies' abilities to bring
gas to market. After nearly a year of haggling, UES CEO Anatoly
Chubais in July 2001 struck a deal with minority shareholders
that cleared away some obstacles to the sale of UES assets as
part of the company's competitive restructuring. Economics
Minister Gref and Railroad Minister Nikolai Aksyonenko by mid-
year seemed to have agreed on a compromise rail restructuring
program that would divest the Railroad Ministry of most of its
commercial assets (i.e., rolling stock) and liberalize the
determination of rail tariffs and route structures. And the
government in August approved legislation to create an omnibus
regulatory agency, in which the regulation of monopoly price
setting would be centralized and (presumably) depoliticized.
These developments, combined with concurrent parliamentary
approval of other measures--including passage of legislation on
pension reform, the liberalization of the sale of non-
agricultural land, reductions in the number of burdensome
licenses needed for entrepreneurial activity, and banking
reform--amounted to Russia's most impressive flurry of market
reform activity in nearly a decade. If implemented as planned,
these measures could significantly improve prospects for
sustainable economic growth. But political and economic factors
are likely to constrain the government's ability to implement
these measures as planned. For one thing, the sharp increases
needed to quickly bring tariffs up to cost-recovery levels are
seen as too painful socially, particularly in light of Russia's
still-high (20 percent and above) inflation rates and the
parliamentary and presidential elections scheduled for 2003 and
2004, respectively. The bulk of these tariff hikes are
therefore slated to be postponed until after 2004. But new
suppliers are unlikely to enter these markets in significant
numbers as long as (relatively) low prices are maintained.
Sales of assets in firms whose prices are set below costs can
be rightly seen as a asset stripping--as UES minority
shareholders frequently pointed out when explaining their
opposition to CEO Chubais' competitive restructuring program.
In the meanwhile, the continued absence of competition from new
suppliers is likely to result in higher costs and tariff hikes
than would otherwise be the case. Finally, the difficulties
Russia's ponderous social welfare bureaucracies would face in
identifying and subsidizing those households most at risk from
the tariff hikes are unlikely to be anything short of immense.
financial system
Russia's financial system has recovered from the crash of
August 1998--after a fashion. Economic growth, tighter fiscal
policies, and improved enterprise liquidity have reduced
arrears and the use of monetary surrogates. More retained
earnings helped finance investment growth. A consolidation wave
based in the oil and metallurgical sectors that began in 1999
suggests that some of Russia's largest companies are becoming
more interested in corporate governance. On the other hand, the
government and CBR have done little to restructure commercial
banks or improve the foreign investment environment. Financial
sector privatization faces stiff opposition from political and
business elites. And the restructuring driven by oil and
metallurgical companies may do little more than create a new
class of oligarchs that do not differ fundamentally from their
predecessors.
The best news in the financial sector lies in the shrinkage
of Russia's ``virtual economy.'' \15\ After soaring in 1998,
total arrears (measured as the sum of wage and general
government tax arrears plus overdue enterprise payables to
banks and other enterprises) dropped by 55 percent during 1999-
2000. In real terms, arrears fell by three quarters during this
time. The ratio of total arrears to nominal GDP, which averaged
0.33 during 1998, fell to 0.07 in 2000. Most of this progress
came from sharp reductions in wage arrears, which constitute
more than 90 percent of the total. Wage arrears shrank 77
percent in real terms during 1999-2000, as public-sector wage
arrears (which are now less than a fifth of total wage arrears)
fell 80 percent. While overdue enterprise payables to other
companies rose in nominal terms during 1999-2000, their real
value dropped some 38 percent. Similar trends are apparent in
the use of monetary surrogates--barter, promissory notes, and
mutual offsets of liabilities--accepted as ``payment'' by
companies. Only 31 percent of total payments collected by
Russia's largest companies were settled via these surrogates in
2000, down from 51 percent in 1999 and 63 percent in 1998. The
8 percent increase in the real value of the stock of tax
arrears to the general government in 2000 was the only
significant exception to this trend.
---------------------------------------------------------------------------
\15\ For more on the ``virtual economy,'' see Gaddy, C. and B.W.
Ickes, ``An Accounting Model of the Virtual Economy in Russia,'' Post-
Soviet Geography and Economics, Vol. 40, No. 2, 1999, pp. 79-97; and
Slay, B., ``A Comment on the Virtual Economy,'' Post-Soviet Geography
and Economics, Vol. 40, No. 2, 1999, pp. 110-113.
---------------------------------------------------------------------------
Positive developments occurred in terms of corporate
governance as well. Minority shareholders, led by former
Finance Minister Boris Fyodorov who represents minority
shareholders on the UES, Gazprom, and Sberbank boards of
directors, are increasingly well-organized, and their demands
for corporate transparency and accountability are increasingly
difficult to dismiss. Minority shareholders in UES ultimately
forced management to adopt a more investor-friendly version of
the company's original competitive restructuring program.
Fyodorov's campaign against Gazprom management helped
precipitate Vyakhirev's removal, and tipped the balance toward
removing some of the controls over foreign purchases of Gazprom
shares. Although the legal framework (especially Russia's
under-capitalized court system) continues to prevent effective
capital market regulation, the Federal Securities Commission
(FSC) intervened on behalf of minority shareholders against the
managements of UES, Gazprom, and Norilsk Nickel. The FSC also
promoted discussion and (in some cases) the adoption of
corporate governance codes in some of Russia's largest
companies.
More important corporate governance changes could be
occurring as a result of consolidation trends within Russian
industry. Cash-rich oil, metallurgical, and other companies are
increasingly investing big money in productive assets, and are
increasingly worried about getting their money's worth from
their investments. Lukoil's 1999 $300 million acquisition of
Komitek, and the Tyumen Oil Company's (TNK's) $1 billion
purchase of Onako in September 2000, are the most visible
results of this trend. In food processing, Wimm Bill Dann is
using cash generated from dairy products to diversify into
breweries. Severstal, Russia's largest and one of its best-run
ferrous metallurgical companies, has acquired stakes in a
number of automotive producers. Open-market purchases last year
by Siberian Aluminium (Sibal) of equity in Nizhny Novgorod's
Gorkovsky Avtomobilny Zavod (GAZ)--Russia's second largest
automobile company--set off a bidding war for GAZ stock and
ended with Sibal's acquisition of a controlling stake in the
company.
These acquisitions have an international dimension as well.
By the end of last year, Russian companies had taken control of
three of Ukraine's six major oil refineries: Lukoil owned the
Odessa refinery; Tatneft was running the UkrTatnafta joint
venture at Kremenchug; while TNK owned the Lisichansk refinery.
Thanks to these investments, Russian companies supplied half of
Ukraine's refined oil products last year. The Ukrainian
subsidiary of the Russian Aluminum conglomerate (Rusal--which
is itself the product of consolidation trends within the
industry) spent at least $130 million during 2000 to acquire a
controlling stake in Ukraine's Mykolayivsky Hlynozemny Zavod,
Europe's largest alumina maker. Russian acquisitions were not
limited to the CIS, however: Lukoil in late 2000 spent $70
million to acquire Getty Oil's retail outlets in the United
States.
This corporate shopping spree has many desirable
properties. First, acquirers like Severstal and Rusal now have
an interest in better corporate governance, in order to protect
the value of their purchases. Second, in contrast to the
consolidation that followed Russia's first privatization wave
in the early 1990s, the role of state agencies and Russian
banks in these acquisitions is very small. These purchases are
the result of hardheaded business calculations, and do not
represent the misappropriation of other people's money. Third,
poorly managed companies and assets are generally being
acquired by better-managed companies. This should ultimately
boost efficiency. On the other hand, much of this consolidation
violates the spirit (if not the letter) of Russian competition
and securities law. Political considerations may be less
important than in previous consolidation waves, but well-
connected oligarchs like Roman Abramovich (oil, aluminum),
Anatoly Chubais (electricity), and Oleg Deripasko (aluminum)
continue to use their influence in the government, the courts,
and the media to advance their corporate and personal
interests. Russia's commercial playing field may be
globalizing, but it is not necessarily becoming more level.
The August 1998 financial crash left most of Russia's
large, privately owned banks insolvent. Their owners took
advantage of Russia's unclear regulatory framework and
transferred assets to other ``bridge'' banks, in the process
defrauding creditors, depositors, and minority shareholders.
Rather than seeking their prosecution, the CBR was more likely
to refinance the oligarchs' new bridge banks. Since then, the
CBR, the courts, and parliament have generally been
uninterested in closing the regulatory loopholes that
facilitated these scams. Russian households and companies
therefore use the banks as a payments system, but continue to
save and hold working capital elsewhere.
The banking system has in some respects recovered from
August 1998. Bank exposure to foreign-exchange risk continues
to fall: the ratio of commercial bank foreign-currency assets
to liabilities rose from 0.8 during 1997-1998 to 2.0 in 2000.
Total commercial banking assets rose from a low of $49.1
billion in December 1998 to $83.3 billion as of December 2000.
``Overdue'' bank credits at the end of 2000 represented only 4
percent of total bank credits, down from 11 percent in early
1999. Banks are now lending to companies: credits to
enterprises grew by some 11 percent in real terms in 2000, and
this growth has continued into 2001. The authorities in mid-
2001 also succeeded in passing bank reform legislation that had
been long sought by the IMF, directed at tightening banking
supervision and cracking down on money laundering.
But there is little else to cheer about in the Russian
banking sector. Despite the growth in total banking assets, the
0.34 ratio of banking assets to nominal GDP at the end of 2000
was actually below 1998's end-year ratio of 0.38. The absence
of significant improvement in commercial bank transparency and
supervision makes reported improvements in the quality of loan
portfolios difficult to interpret. Key perpetrators of the
August 1998 developments continue to play important roles in
the Russian banking system. The Sberbank state savings bank
seems to be the sole institution to enjoy minimal confidence on
the part of the population. Thanks to the fact that its savings
accounts are guaranteed by the federal government, Sberbank at
the end of 2000 held some 40 million household savings accounts
(87 percent of the total deposit base).
These circumstances make it difficult to be optimistic
about the consequences of the rapid growth in bank lending to
enterprises that took hold during 2000-2001. This growth was
extremely rapid after mid-2000, averaging 72 percent in nominal
terms and 25 percent in real terms. Much of this lending is now
being done by Sberbank--its share of total bank credits to
enterprises rose to 37 percent in 2000--and is occurring at
negative real interest rates. When adjusted for changes in the
industrial producer price index, the interest rate on 12 month
commercial credits averaged--24 percent in 2000, and--19
percent in 1999.
Since 60 percent of Sberbank's equity is held by the CBR,
and since neither institution is a paragon of transparency, it
is difficult to assess the consequences of Sberbank's lending
offensive. (The CBR's latest target date for completing the
commercial banks' transition to international accounting
standards is 2006.) Its monopsonistic position on the household
savings market (which affords Sberbank a healthy spread on its
commercial loans) and the reported declines in non-performing
loans suggest that Sberbank's cash flow and profitability
should be strong and improving. The bank's preliminary 2000
financial statement, which was computed under Russian
accounting standards and released in February 2001, seems to
confirm this: profits were reported up 63 percent from a year
earlier. But Sberbank's management also announced in February
that the bank's capital-adequacy ratio had dropped below the
legally mandated 10 percent, necessitating a new share issue.
While its political and economic moxie make Sberbank's
bankruptcy highly unlikely, pressures on bank managers to
``lend to the real sector'' combined with its opaque regulatory
and ownership framework make Sberbank a strong candidate for a
future financial crisis. Since its 40 million savings deposits
are de facto liabilities of the Russian Government, a run on
Sberbank could be tantamount to a run on the federal budget.
Experience in other transition economies shows that poorly
regulated state-owned banking systems are prodigious generators
of financial crises. While the timing and magnitude of Russia's
next banking crisis can not be predicted, the probability of
its occurrence is high.
The experience of other transition economies shows that the
sale of leading commercial banks to strategic investors is the
only viable solution to the problems. Only multinational banks
possess the resources needed to straighten out messes like
Russia's and the size needed to resist political pressures to
lend. The banking reform programs announced by the government
and CBR during 2000-2001 generally ignore these lessons,
however, and instead emphasize continued state ownership over
Sberbank and Russia's other large commercial banks (the
Vneshekonom and Vneshtorg foreign trade banks, and the
Industrial, Agricultural, and Regional Development Banks).
Federal government control over these institutions is to be
attained through the acquisition of 75 percent equity stakes,
large enough to prevent minority owners from assembling
blocking (25 percent plus one) stakes. Funds to purchase these
stakes are to be raised by selling off the state's minority
shareholdings in up to 500 smaller banks.
In contrast to the dramatic post-1998 changes apparent in
fiscal policy and foreign debt management, or the (perhaps
excessively) ambitious market reform agenda apparent in the
infrastructure sectors, Russian policies toward the financial
sector are characterized by benign neglect. The lending
campaign conducted by state banks, the continued sorry state of
bank supervision, the official disinterest in improving
corporate disclosure and transparency--all this has two
strongly negative implications for Russia's growth prospects.
First, it ensures that fixed investment must continue to be
financed primarily by retained earnings. In part for this
reason, investment growth had already begun to slow in 2001, as
enterprise profits (reported under Russian accounting
standards) actually fell in real terms during the first half of
2001. After soaring 18 percent in 2000, year-on-year growth in
gross fixed investment had dropped to around 5 percent by mid-
2001. Second, the surging growth in lending to companies by
state-owned banks during 2000-2001 suggests that Russia's next
banking crisis--if and when it occurs--will have a significant
fiscal dimension. In light of Russia's heavy debt-service
burden during 2003 and beyond, the implications of such a
crisis can not be easily dismissed. The contingent fiscal
liabilities implied by such a banking crisis could undo much of
the post-1998 progress made in achieving fiscal balance, and
could lead to heightened capital outflows as well. And the
unwillingness to open up the financial sector (and other
sectors) to foreign investment and competition constitutes a
major obstacle to Russia's timely accession to the World Trade
Organization.
Russia's unfinished reform agenda extends well beyond the
financial sector and the infrastructure monopolies. The
creation of an appropriate legal framework for the long-delayed
restructuring of the agricultural sector (including passage of
legislation to protect and standardize agricultural land
ownership, and to govern the bankruptcy of Soviet-era state and
collective farms), the modernization of Russia's judicial
system, the rationalization of Russia's quasi-dysfunctional
fiscal federalism--these are all multi-year undertakings
fraught with grave political, economic, and social risks. To
its credit, the government has pledged to address these
barriers to growth. But should these attempts fail--or should
the implementation of its reform programs stretch out
indefinitely--its divergences from best international practices
will continue to burden Russia's economic prospects.
Leading Indicators for the Future of Russia's Transition
Russian ``exceptionalists'' often reject the utility of
comparisons with other countries, claiming that Russia is
``different.'' While such claims can of course be made for all
countries, Russia as a transition economy does stand out in a
number of respects. Its immense size and ethno-regional
diversity, its scientific potential, its energy/natural
resource base, the legacy of the large Soviet-era military-
industrial complex, Russia's uncertain Eurasian geopolitical
status, its federal nature, and (since 1998) its relative
insulation from the international capital markets--the
combination of these features does give Russia a somewhat
unique profile among transition economies.
This combination suggests that not every lesson from the
more successful Central European and Baltic transition
economies is relevant for Russia. For example, membership in
the European Union--the prospects for which have been a driving
force behind the leading transition economies' success in
introducing best international economic practices--is most
unlikely to be an option for Russia in the foreseeable future.
As such, the justification for introducing these changes must
be sought elsewhere. Its characteristics as a transition
economy--particularly the commodity composition of its
exports--also suggest that Russia's short-term economic
performance is likely to be less directly correlated with
economic policies and reforms than other countries. Movements
in world energy, metals, and raw materials prices in particular
are likely to have a much greater short-term effect on economic
performance in Russia than in most other transition economies--
despite Russia's larger size and nominally smaller
``openness.''
Trends in a number of key indicators (besides movement in
real output and incomes) are likely to be particularly
revealing in demonstrating whether Russia is making progress
toward sustainable growth. These include the following:
business formation
The number of registered Russian companies per thousand
inhabitants rose to 23 in 2000, compared to 1995's 15 per
thousand figure. While this remains well below Central European
levels, it also shows the extent to which Russian businesses
and households continue to operate below the authorities' radar
screens. Moreover, while the numbers of large and medium-sized
firms continued to grow in 2000, the creation of small
enterprises seemed to come to a standstill. Continuing this
growth--which requires reducing the administrative and tax
burden on enterprises and households--will be an important
indicator (and source) of sustainable growth. Continuing
stagnation in small business formation by contrast would be a
very bad sign.
labor force participation rates
During 1998-2000 Russia was able to offset accelerating
population declines by boosting crude labor force participation
rates (the labor force divided by the population) from 49.4
percent to above 50 percent. Along with the sharp declines in
unemployment recorded during this time (from a high of 14.1
percent in February 1999 to around 9.5 percent during the first
half of 2001), rising participation rates made possible the
employment growth needed to fuel Russia's expansion. Since
Russia's population is expected to shrink significantly during
the next 15 years, prolonging the economic expansion will
require continued increases in participation rates. This need
not prove impossible: the crude labor force participation rate
was close to 51 percent in 1993, and was much higher during the
Soviet period. But boosting labor force participation will
require further reductions in the tax and regulatory burden on
enterprises and households, in order to strengthen incentives
to move out of the grey sector.
commodity composition of exports
The dominant role of energy, metals, and raw materials in
Russia's export basket makes Russia's short-term economic
prospects hostage to world price trends. The leading transition
economies have succeeded in reducing this vulnerability by
significantly increasing the share of engineering products--
particularly machinery and equipment--in total exports.
Sustainable growth in Russia is unlikely to occur if the share
of primary products in total exports does not shrink. A ``petro
state'' afflicted with Dutch disease and a dual economy would
instead be the more likely outcome.
fdi levels and composition
Industrial restructuring in the leading transition
economies has been driven by FDI into their manufacturing
sectors. Long-term improvements in Russia's industrial and
export competitiveness are unlikely if FDI continues to remain
at its anemic levels, and remains concentrated in oil
extraction and food processing.
the ``putin factor''
President Vladimir Putin's robust support for market reform
initiatives is one of the most pleasant surprises of the past 2
years. But this support--coupled as it is with his initiatives
to strengthen the role of the Kremlin and security apparatus in
Russian politics--is a double-edged sword. The successful
economic transitions in Central Europe and the Baltics
correlate unambiguously with democratization, demilitarization,
the flowering of non-governmental organizations (NGOs), and
through this progress in establishing the rule of law. The
creation of the rule of law in Russia that Putin's Kremlin
claims to seek is inconsistent with the authorities'
hostility--if not outright persecution--of NGOs, and with their
profound suspicion of independent media and environmental
activism. The perilous state of Russia's environmental and
demographic balance, as well as attempts at reducing excessive
administrative discretion and increasing public accountability,
are poorly served by such hostility. The same can be said for
Putin's bloody military solution to Russia's ``Chechen
problem''--a problem that ultimately does not have a military
solution, short of a genocide directed against a people (the
Chechens) that also happen to be citizens of the Russian
Federation.
Putin's rule represents an attempt at strengthening order
and markets at the expense of freedom. This combination is
troubling, and not only because it contains strongly
conflicting elements. Despite his support for market reform to
date, Putin is not an economist, and as such he does not seem
to value market reforms per se. Putin instead sees them as a
means to achieving certain ends: namely, the rebuilding of
Russia's position on the world stage, and sustained
improvements in Russians' living standards. Should Putin become
convinced that other economic policies are more conducive to
meeting these ends, he could attempt to supplement or replace
them with policies that deepen, rather than narrow, the gaps
between Russian and best international economic practices. In
this sense, Vladimir Putin's continuing evolution is itself a
key indicator of Russia's progress toward sustainable growth.
UNLOCKING ECONOMIC GROWTH IN RUSSIA
By Vincent Palmeda and Bill Lewis \1\
----------
contents
Page
Summary.......................................................... 47
Introduction..................................................... 49
The productivity problem..................................... 50
How Does Low Productivity Lead to Low Standards of Living........ 50
Low Productivity Performance in All Parts of the Russian Economy. 51
Main Operational Reasons for Persistent Low Productivity......... 54
The Direct Cause: Unequal Competitive Conditions................. 56
Immediate Impact of Unequal Competitive Conditions............... 56
Steel and cement............................................. 57
Oil.......................................................... 58
Confectionery................................................ 59
Residential construction..................................... 59
Food and general merchandise retailing....................... 60
Software..................................................... 60
Indirect Impact of Unequal Competitive Conditions................ 61
Dairy........................................................ 61
Software..................................................... 62
Secondary Causes................................................. 63
Russia's Growth Potential with Key Economic Reforms.............. 64
Sectors with the Highest Growth Potential........................ 64
Large Amounts of Potentially Viable Spare Industrial Capacity.... 65
Benefits from Foreign Direct Investments (FDIs).................. 65
Fundamental Barriers to Economic Reforms......................... 66
Social Concerns.................................................. 68
Corruption....................................................... 68
Lack of Information.............................................. 69
Appendix: Summaries of Sector Case Studies....................... 70
Summary
Russia is in a dire economic situation. Unlike some other
reformed ex-Communist economies--Poland or Hungary--where
economic performance sagged in the early years of the reform,
but surged as reforms took hold, Russia experienced only
decline to 1999. Gross domestic product (GDP) per capita has
fallen by as much as 40 percent since 1992 and is now at only
15 percent of the U.S. level. Unemployment topped 12 percent,
and many more people are now engaged in subsistence forms of
employment.
---------------------------------------------------------------------------
\1\ Vincent Palmeda is the principal author of the McKinsey Global
Institute study on Russia. Vincent Palmeda holds an engineering degree
from Ecole Nationale des Ponts et Chaussees and an MBA from
Northwestern University (Kellogg) in Chicago. Dr. Bill Lewis is the
Director of the McKinsey Global Institute. His doctorate is in
theoretical physics from Oxford.
---------------------------------------------------------------------------
In an attempt to understand why economic reform has failed
in Russia, we looked at the performance of ten representative
sectors--software, steel, general merchandise and food
retailing, hotels, oil, housing construction, cement,
confectionery, and dairy-- and related their performance to
that of the overall Russian economy. We also gauged the
productivity of those industries against best practices around
the world, determined why Russian companies lagged best
practice, and identified what the government should do in
priority to provide them with the means and incentives to
improve their operational performance and expand. We believe
that this micro-economic analysis is the only way to build a
firm foundation for future economic policies and economic
growth.
Our primary findings are:
Overall labor productivity is indeed very low. Our ten
industries averaged only 19 percent of U.S. productivity
levels, with software leading the group at 38 percent and
cement at only 7 percent.
Soviet legacy assets--which were roughly 30 percent as
productive as U.S. assets in 1992--have had their productivity
halved. This precipitous drop results from the fact that
industries have not restructured despite sharp drops in demand
from Russian consumers who now have access to products from
around the world. Roughly 25 percent of Russia industrial
capacity is currently in sub-scale or obsolete assets, which
are still operating and fully staffed, but should be shut down.
Assets added since 1992 are surprisingly unproductive.
Almost no new capacity is being added in the oil and consumer
goods industries, the sectors of the economy with the greatest
potential for fast performance improvement. New assets are
either well below efficient scale--as in housing construction
and software, or undercapitalized--as in open-air markets.
Despite high competitive intensity, the competition is
unequal and it causes low productivity. Price decontrol and
privatization did successfully stimulate competition.
Paradoxically, however, in Russia the more productive companies
are often the least profitable. Thus, more productive companies
are not gaining market share and not pushing less productive
firms out.
In nine out of the ten sectors, the direct cause of low
economic performance is market distortions that prevent equal
competition. The distortions come from attempts to address
social concerns, corrupt practices, and lack of information.
In the manufacturing sectors, regional governments channel
implicit federal subsidies to unproductive companies. Such
subsidies take the form of lower tax and energy payments, and
are allegedly intended to prevent companies from shutting down
and laying off employees. This puts potentially productive
companies at a cost disadvantage, blocking investments and
growth on their part.
In the service sectors, where employment should grow,
investments by efficient companies are discouraged by the
presence of well connected unproductive incumbents who benefit
from favorable regulations, weak law enforcement, and
privileged access to land or government procurements.
Furthermore, these sector level market distortions are key
contributors to macro-economic instability, because they reduce
government revenues and increase its expenditures. Macro-
economic instability itself is another important deterrent to
investments.
We found the other often mentioned reasons for Russia's
economic problems to play a much smaller role (e.g., poor
corporate governance and lack of a transport infrastructure).
There are no natural or economic obstacles to high economic
growth in Russia, and the current situation need not be
tolerated. Russia can rely on a skilled and inexpensive labor
force, large and economically attractive energy reserves, and
surprisingly, much spare capacity in potentially productive
industrial assets. Explicit and targeted social policies
combined with balanced and enforceable regulations (mostly at
the sector level, involving taxes, energy, land and red tape)
would remove the most important market distortions. The payoff
would be strong economic growth in Russia.
The findings and conclusions of this report have been
largely published by the Russian and international media, as
well as extensively discussed with the current Russian
Government.
Although economic reforms have accelerated in the last year
in Russia and economic performance has been markedly better
since the publication of our report in October 1999, we believe
that its main findings and conclusions still hold true.\2\
---------------------------------------------------------------------------
\2\ Bill Lewis, Director of the McKinsey Global Institute, reviewed
the earlier detailed report and concluded that in June 2001 the main
findings and conclusions still remain.
---------------------------------------------------------------------------
First, Russia's strong economic performance in 2000 can be
largely attributed to a rebound following the 1998 financial
crisis and subsequent devaluation of the ruble. Good economic
performance was further helped by the rapid rise in oil and gas
prices. Furthermore, productivity growth (once adjusted for the
cyclical increase in capacity utilization) and business
investments, notably from foreign companies, are still at
levels way below Russia's potential.
Second, despite a sound economic plan, most of the key
necessary economic reforms outlined in our report have yet to
be drafted, passed through the Duma and/or enforced.
Nevertheless, there have been some promising starts with the
tax and land codes as well as with the reform plans of some
crucial sectors such as telecom, railways and electricity.
The U.S. Congress has a crucial role to play in helping
Russia to quickly join the ranks of the advanced democracies,
and we hope that it will find our report to be a useful
contribution to that aim.
These findings are discussed in greater detail in the
following sections.
Introduction
This paper is the executive summary of a year-long project
by the McKinsey Global Institute, working closely with members
of the McKinsey's Moscow office, on the economic performance of
Russia.\3\ This report was first published In October 1999, but
we believe that its main findings and conclusions still apply
to the Russian economy of the year 2001.
---------------------------------------------------------------------------
\3\ The full report (more than 400 pages) can be accessed on the
Internet (www.mckinsey.com) or obtained by faxing request to the
Institute in Washington, DC (1-202-662-3218).
---------------------------------------------------------------------------
McKinsey undertook this project as an important step in
developing our understanding of how the global economy is
working. The failure of the reforms undertaken in Russia in the
early 1990s to generate good economic performance is one of the
highest priority problems in the global economy. We wanted to
find out whether the reforms were causing change at the micro-
level that would eventually yield good economic performance. If
not, we wanted to find out why reforms had failed and how to
improve the situation. We have undertaken this work as an
investment by McKinsey in knowledge building, we would
emphasize that the work is independent and has not been
commissioned or sponsored in any way by any business,
governmental or other institution.
This project builds upon the previous work of the McKinsey
Global Institute in assessing economic performance among the
leading economies of the world. Our earlier reports addressed
separately labor and capital productivity and employment, the
fundamental components of economic performance. Later, we
combined these components to address the overall performance of
Sweden, Australia, France, Germany, The Netherlands, Brazil,
Korea, the United Kingdom, Poland, Japan and India.
As before the core of our work is conducting sector case
studies to measure differences in productivity, output and
employment performance across countries and to determine the
reasons for the differences. We studied in detail ten
representative economic sectors. Specifically, we examined why
Russian companies are not restructuring and expanding faster,
and why foreign companies are not investing more in Russia.
This comprehensive micro-economic approach reveals the relative
importance of the various problems, which plague the Russian
economy and thus helps set priorities among the long list of
economic policy changes recommended from all directions.
In conducting the project, we have drawn on the counsel of
an external Advisory Committee. Chaired by Professor Robert
Solow of the Massachusetts Institute of Technology, it included
Professor Olivier Blanchard, also from the Massachusetts
Institute of Technology, Professor Richard Cooper of Harvard
University and Ted Hall, Chairman of the McKinsey Global
Institute Advisory Board.
the productivity problem
Market reforms so far have failed to improve Russia's
economic performance. Although the efficiency (productivity)
with which companies produced goods and services in the Soviet
era was already low compared to the best practice in the world,
it has gotten worse since the reforms started. By understanding
the underlying operational sources of the productivity gaps
between Russian companies and global best practice, we are able
to better understand which factors in the external (regulatory)
environment are causing managers and investors not to make
progress toward closing the gaps.
The size and nature of the productivity gaps are discussed
below in this section, the main external factors stopping
productivity growth, and consequently economic growth, are
discussed in the next section.
How Does Low Productivity Lead to Low Standards of Living
The material standard of living in a country is determined
by the amount of goods and services produced by the economy,
referred to as GDP. Russia's GDP per capita is only at 15
percent of the U.S. level. It is also falling behind many of
the ex-Communist countries, notably Poland, which, unlike
Russia, has been rebounding economically since 1992 (Figure 1).
The GDP (output) level is determined by the combination of
two factors: the amount of hours worked by the people (labor
inputs) multiplied by the amount of goods and services produced
by an average hour of work (labor productivity). Because people
in all countries work to make ends meet, labor inputs tend to
be at similar levels. In Russia, for example, despite high
unemployment, labor inputs per capita are still at more than 80
percent of the U.S. level. Thus, labor productivity ultimately
becomes the determinant of economic performance. Russia's labor
productivity is very low at only 19 percent of the U.S. level
in 1997, down from around 30 percent in 1991 (Figure 2).
FIGURE 1._GDP PER CAPITA AT PURCHASING POWER PARITY
[United States = 100 in 1995]
[GRAPHIC] [TIFF OMITTED] T6171.019
Source: Goskomstat, Polish Central Statistical Office;
Organization for Economic Cooperation and Development (OECD),
Economist Intelligence Unit (EIU).
Low Productivity Performance in All Parts of the Russian Economy
In this study, we have examined in detail ten economic
sectors which cut across manufacturing and services and
together represent over 15 percent of total employment in
Russia: steel, cement, oil, dairy, confectionery, residential
construction, food retailing, general merchandising, hotels,
and software. Agriculture and government sectors, like defense,
were not included in the scope of the project. Our cases cover
both heavy and light manufacturing, the large core domestic
sectors of construction and retailing, and software, the
largest of the new, high technology service sectors.
FIGURE 2._RUSSIA'S GDP PER CAPITA
[United States = 100 in 1995]
[GRAPHIC] [TIFF OMITTED] T6171.018
* Based on hours worked per capita.
** Fifteen percent in 1998.
Source: Goskomstat; EIU; Bureau of Economic Analysis;
McKinsey analysis.
In each of these selected sectors we have compared the
performance of companies operating in Russia (both Russian and
foreign) with those in the United States, selected as the
benchmark country.
Our study reveals huge productivity gaps in all sectors of
the Russian economy, whose productivity ranges from 7 percent
of the U.S. level in cement to 38 percent in the new software
sector (Figure 3). Moreover, in the sectors we studied, a long
tail of unproductive enterprises co-existed with a few
relatively productive ones, dragging down the overall
productivity (Figure 4).
Over the last 8 years, labor productivity in the old assets
(put in place before 1992) fell from 30 percent to 17 percent
of the U.S. level. This decline was not compensated for by a
rapid growth of a new and productive economy. New assets (put
in place since 1992) employ less than 10 percent of the Russian
workforce and, surprisingly, achieve only 30 percent of the
U.S. productivity level on average (Figure 5).
FIGURE 3._AVERAGE LABOR PRODUCTIVITY BY SECTOR, RUSSIA 1997
[United States = 100 in 1995]
[GRAPHIC] [TIFF OMITTED] T6171.016
* Russia's actual labor productivity is 25, but only 15 if
measured on a geology-comparable basis.
** Weighted by employment share.
Source: McKinsey analysis.
FIGURE 4._EMPLOYMENT AND LABOR PRODUCTIVITY IN FOOD RETAILING IN MOSCOW
[GRAPHIC] [TIFF OMITTED] T6171.017
Source: Case studies.
FIGURE 5._THE OLD AND NEW ECONOMY *
[United States = 100 in 1995]
[GRAPHIC] [TIFF OMITTED] T6171.014
* Estimates based on sector case studies.
Source: Goskomstat; EIU; McKinsey analysis.
Main Operational Reasons for Persistent Low Productivity
We found three main operational reasons for persistent low
productivity in Russia:
Excess workers maintained in the old assets.--
Customers turned away from low quality products and
services offered by the old companies once they had to
pay the full cash price for them. The resulting 50
percent fall in the output of these companies was not
matched by a similar reduction in employment, which
fell by ``only'' 20 percent. We estimate that 10
percent of workers on average are redundant, while
another 20 percent are currently stranded in non-viable
operations.
Inefficient organization still prevailing in the old
assets.--Although most of the former Soviet companies
have been privatized. They remain plagued by antiquated
modes of organization: absence of marketing and sales
skills, poor quality control, lack of basic profit
incentives and teamwork. Below are three examples from
the studied sectors:
In steel, breakdowns or defects often go
unreported because workers fear being blamed for
them.
Sales and marketing departments at many
confectionery plants have extended their product
portfolios well beyond an efficient scope.
In hotels, a team of receptionists could absorb
the functions currently performed by the
dezhurnayas on each floor (e.g., key handling and
surveillance).
Potentially profitable investments not made.--We
discovered that managers and investors forego
investment opportunities in covered upgrading existing
assets and in developing new ones. In markets covered
with equal conditions of competition, such investments
would bring financial return in excess of 30 percent.
Our sector studies show that almost three-fourths
of the old assets are still economically viable and
could achieve up to 65 percent of the U.S.
productivity with limited upgrade investments
combined with modern forms of organization (Figure
6). The investments are primarily required to
improve the quality of output and/or energy
efficiency. Examples include upgrading the wet/gas
technology in cement, more hydrofracturing in oil,
more flexible production lines in panel housing and
conversion of gastronoms into mini-markets.
FIGURE 6._LABOR PRODUCTIVITY POTENTIAL OF VIABLE OLD OPERATING ASSETS
[United States = 100 in 1995]
[GRAPHIC] [TIFF OMITTED] T6171.015
* Impact from favorable geology included.
Source: McKinsey analysis.
Potentially high return and substantial
investments in). The developing new productive
assets are also not made. For example, new oil
fields should be developed in the economically
attractive proven reserves of Western Siberia. And,
unlike in Poland, very little new capacity has been
developed in the consumer goods industries. In
these sectors, the demand for quality goods is
still being met largely through imports. In food
retail, there is strong evidence of unmet demand
for high service (relative to open-air wholesale
markets) formats like supermarkets. These modern
high productivity formats are still almost entirely
absent from Russia with less than 1 percent market
share, against already 18 percent in Poland
(growing fast) and 36 percent in Brazil.
We will now explain why managers and investors are not
scrambling to seize these operational improvement
opportunities, which should, in a market economy with equal
competition, lead to higher profits.
The Direct Cause: Unequal Competitive Conditions
Unequal conditions of competition at the sector level,
caused by the existing economic policies, are the most
important reason for the lack of restructuring and productive
investment in Russia. These inequalities tend to favor low
productivity incumbents, protecting them from takeovers and
productive new entrants. These policies are often put in place
to achieve social objectives, namely protecting existing jobs,
but in many cases, the suspicion is that they also serve the
personal financial interests of government officials in
collusion with businessmen.
We show below how these distortions have both direct and
indirect negative impacts on the economy.
Immediate Impact of Unequal Competitive Conditions
In open markets with equal conditions of competition, the
most efficient (productive) company should be the most
profitable. Being more productive means that the company either
uses less inputs for the same output (i.e., it has lower costs)
or produces better output with the same inputs (i.e., it makes
superior products that command higher prices). Higher
profitability should enable productive companies to invest and
grow at the expense of less productive ones, which should be
eventually forced to either improve their operations or shut
down.
Studying the sectors of the Russian economy, we found that
while competitive intensity is usually high, the rules of the
game are different for different competitors. The rules are
seriously distorted in favor of less productive companies.
Often the regulatory environment in which companies operate
makes it difficult for the productive companies to crowd out or
take over their unproductive competitors. As a result of
unfavorable differential treatment, more productive companies
often struggle financially, while their less efficient
competitors thrive.
These distortions tend to be sector-specific; they can take
many different forms such as:
Different effective tax rates paid by the companies
within one sector
Preferential access to land and government
procurements
Different effective energy prices paid by different
players in the same industry
Variable degrees of red tape imposed on companies at
the discretion of authorities
Differential law enforcement, e.g., in the area of
intellectual property rights or import tariffs
Differential access to government-controlled export
infrastructure.
Below are examples of the impact these market distortions
have on the development of the sectors covered by our study.
steel and cement
Obsolete (sub-scale and/or inefficient in their use of
energy) steel and cement plants are avoiding shutdowns by
paying for only a fraction of their energy bills--their largest
cost component. Because these companies are often the major
employers in a town, municipal and regional officials go to
great lengths to keep them operating (Figure 7). Regional
governments channel implicit federal energy subsidies to these
companies by letting arrears to federal suppliers (Gazprom and
Unified Energy Systems (UES)) accumulate at the local gas and
electricity distribution companies. These energy distribution
companies are often under effective control of the regional
governments; laws make their bankruptcy practically impossible.
These subsidies slow down recovery in many manufacturing
sectors by preventing upgrading investments and industry
consolidation in and around the viable industrial assets.
FIGURE 7._COMPANY STEEL TOWNS
[Steel plant workforce as a percentage of town employment]
[GRAPHIC] [TIFF OMITTED] T6171.013
= Major social issue.
Source: Goskomstat.
Serving as a means of reallocation of resources to
unproductive enterprises, these subsidies may also be viewed as
fines imposed on healthy firms. As a result of the subsidies,
financially sound companies end up paying taxes and energy
bills ``for themselves and the other guy.''
oil
Russia has large and economically attractive proven
reserves which can become a source of additional export and tax
revenues. Unpredictable economic policies impede investments
into the development of new oil fields. Oil companies are
reluctant to commit to large long-term investments without
stable and workable tax policies (the recently passed law on
the production sharing agreement is far from being operational)
and without fully liberalized domestic oil prices. But here
again, the social objectives are pursued inefficiently. Policy
makers deliberately limit oil exports to secure supply of cheap
oil to ``strategic'' customers like the agriculture and defense
sectors. Combined with the current rate of depletion in the
existing oil fields, the export-limiting regulations may make
Russia a net importer of oil by 2009. Providing the necessary
assurances to investors, notably well financed foreigners,
could enable oil production to double in 10 years (Figure 8).
Such an increase would be sufficient to meet the demand of a
fast growing economy and to increase oil exports by at least 50
percent. In addition, it would provide additional tax revenues,
which would be more than enough to compensate strategic
customers for higher oil prices.
FIGURE 8._POSSIBLE SCENARIOS FOR FUTURE OIL PRODUCTION
[Millions of barrels per day]
[GRAPHIC] [TIFF OMITTED] T6171.012
Source: Mckinsey analysis.
confectionery
Investments into existing confectionery plants are also
discouraged. Regional and municipal governments may effectively
ban the best practice companies from laying off excess workers
and reaping the productivity benefits of their investments.
Local authorities have the means to discipline disobedient
managers by, for example, subjecting them to troublesome fire,
safety, health and other inspections, the number of which can
reach 400 in a year for a single company.
Regional governments, as in the steel and cement
industries, can support unproductive confectionery plants by
effectively waiving their local tax obligations and helping
them to pay less federal taxes. As a result, the few law
abiding best practice foreign companies are less profitable
(after taxes) than their inefficient domestic competitors
(Figure 9).
FIGURE 9._CONFECTIONERY INDUSTRY DYNAMICS
[GRAPHIC] [TIFF OMITTED] T6171.011
* Excludes brownfield plants operated by multinationals (13
percent market share).
Source: Goskomstat; Institute for confectionery industry.
residential construction
More than half of residential construction in Russia is
still financed by the government. Although government contracts
are officially submitted to open tenders, they almost
invariably end up going to the same ex-Soviet companies closely
affiliated with the local authorities. As a result, these
companies have no incentives to increase their very low
productivity (which they could quadruple with almost no
investments). On the contrary, one of their implicit deals with
the local government is to get the contracts in exchange for no
layoffs.
food and general merchandise retailing
Productivity in the retail sector in Russia is low mainly
due to a very low penetration of modern formats: supermarkets,
hypermarkets, malls and convenience store chains.
Supermarkets--the most productive format in food retailing--
have less than a 1 percent market share in Russia.
The share of supermarkets is low because productive modern
formats are treated unfavorably and, as a result, have a
significant cost disadvantage vis-a-vis the much less
productive sub-scale formats like open-air wholesale market
stands and kiosks. The latter benefit from much lower tax
liabilities, less control on the origin of their goods (which
are often illegal imports or counterfeits), and cheaper access
to prime locations (Figure 10). Here again the official
rationale for such distortions is social: many jobs are at
stake in small format operations, and open-air wholesale
markets are the way to get cheap food to the poor.
FIGURE 10._ESTIMATED EFFECTS OF UNEQUAL TAX AND LAW ENFORCEMENT ACROSS
RETAIL FORMATS
[Indexed to price in gastronoms = 100]
[GRAPHIC] [TIFF OMITTED] T6171.010
Source: McKinsey price survey; McKinsey productivity survey;
Gubernia, expert interviews.
software
Because the products of Russian packaged software companies
are systematically pirated, they lack the resources to invest
into the development of innovative products. This consequently
limits their productivity and growth potential (Figure 11).
The other sub-sector in the software industry, project
services, proves by reaching 72 percent of the U.S.
productivity level that, with equal conditions of competition,
a whole economic sector can reach high productivity. There are
no market distortions in this sector for two reasons; first, it
is completely new, with no incumbents to be protected, and
second, its customized nature makes it immune to piracy.
FIGURE 11._EFFECTS OF SOFTWARE PIRACY ON PRODUCTIVITY
[GRAPHIC] [TIFF OMITTED] T6171.009
* Indicates total worth of software.
** Russia, 1998; other countries, 1996.
Source: Bureau of Statistical Analysis; International
Development Corporation; ``Russian Shield'' Association;
financial reporting; McKinsey analysis.
Indirect Impact of Unequal Competitive Conditions
Negative effects of market distortions are not limited to
the sectors where they appear. Barriers to higher economic
performance in key sectors of the economy block the growth of
productivity, and consequently output, in related industries
via negative spillover effects, and fundamentally lead to
macro-economic instability.
Negative spillover effects from problems in related sectors
are important in explaining the lack of productivity and
investment growth in four out of the ten studied sectors. Below
are two examples:
dairy
Negative spillover effects plague the all-important food
chain. The absence of large modern retail formats leads to the
dominance of monopolistic wholesalers who squeeze retailers and
dairy plants. The cash-poor milk processors can neither invest
in new equipment, nor pay the ailing dairy farmers. In
response, farmers set up their own dramatically sub-scale dairy
plants and then distribute the milk (including a large
proportion of raw milk) directly to retailers and consumers.
Recent development in Poland shows that the modern best
practice supermarkets are interested in helping the local food
industry to improve efficiency and grow. They establish direct
purchasing agreements to leverage their scale and bypass
monopolistic wholesalers. In turn, increasingly sophisticated
Polish food processors have, due to supermarkets, the financial
resources to help develop efficient farmers through contract
growing agreements.
software
The growth of software companies in Russia depends on the
growth of their local business customers. In markets with equal
and intense competition, the largest software consumers (like
banks, supermarkets and telecommunication companies) constantly
require productivity enhancing software tools to help them beat
their competitors. Naturally, when productivity improvement is
not the primary way to financial success, as is the case in
Russia, software services are in low demand. Russian companies
spend only 0.1 percent of their output on purchasing software,
against more than 1 percent in the United States (Figure 12).
The much smaller size of output of Russian companies confounds
the situation.
FIGURE 12._ESTIMATED CONSUMPTION OF SOFTWARE BY SOME SECTORS OF THE
ECONOMY *
[Software spending as percent of output of the sector]
[GRAPHIC] [TIFF OMITTED] T6171.008
* Russia, 1997; other countries, 1996.
Source: International Development Corporation; OECD; EIU;
interviews.
Barter transactions, which are prevalent in half of
Russia's economy, are fundamentally a result of these market
distortions. Tax evasion, energy subsidies and directed
government procurements are most often carried out through
complex barter deals. The government and government-related
companies conceal these subsidies under unfavorable (if real
market prices are applied) barter deals, which also provide
ample personal enrichment opportunities because they are put in
place through short-lived and hugely profitable trading
companies.
Macro-economic instability in Russia has been directly
caused by the fiscal deficit, which results from the fact that
the government spends more than the taxes it manages to
collect. This deficit has to be financed by either printing
money or by paying high real interest rates to attract private
investors. Both ways of financing the deficit introduce macro-
economic instability: inflation becomes a hidden tax on all
holders of Russian currency, and high real interest rates paid
on government debt lures private investment away from the rest
of the economy. The negative effects of macro-economic
instability could be seen in all the studied sectors, and most
notably in oil and hotels, where a long time is needed to
recuperate large initial investments.
Unequal rules of competition are a fundamental cause of the
chronic budget deficit. Government expenditures are increased
by large implicit federal subsidies to inefficient enterprises
in the traditional declining sectors (e.g., heavy manufacturing
and construction), while tax collection from the unproductive
but well-connected firms in the new growing sectors (e.g.,
retail) is very poor.
The recent progress made toward balancing the budget should
be little cause for comfort. Around 40 percent of budget
revenues still depend on extremely volatile oil and gas prices,
which have fortunately soared in 1999. Key government
expenditures, like the wages of law enforcement officials, are
still grossly inadequate. Capital flight, rational when
economic policies discourage investment within Russia,
continues. Finally, the rise in industrial production, which
followed the August 1998 devaluation, should be seen as a one-
time adjustment due to a sudden increase in prices of imports,
rather than the start of a prolonged economic recovery.
Overall, the facts show that inequalities in the rules of
competition at the sector level are the main roadblocks on the
path of economic growth in Russia. Notwithstanding corrupt
practices or plain disbelief in the market economy, many of
these distortions have been put in place by the government to
meet social objectives. Unfortunately, they keep Russia at a
very low level of economic performance and thus damage the
social provisions they were intended to improve.
We discuss in the last section which policies and dynamics
could unlock the current system of intertwined social,
political and financial interests.
Secondary Causes
We found the other most often cited reasons for lack of
growth in Russia to be much less important than the sector
level market distortions described above.
Problems in the area of corporate governance, resulting
from a combination of privatization to insiders and the lack of
shareholders' rights, are often mentioned as key to Russia's
economic under-performance. The existing governance environment
gives the current managers more incentives to divert the
company cash flows to their own trading firms, than to
restructure or invest. Such cash diversions have been commonly
mentioned in the steel, cement and oil sectors. However, in
these industries, battles for corporate control are now coming
to an end in most of the viable assets, allowing management to
focus on increasing long-term value of the company.
Restrictions on labor mobility may lead to social tensions
in company towns, but do not limit the abilities of growing
companies to recruit workers. For example in Moscow, where the
labor market is allegedly tight, a large share of workers
engaged in government-financed housing construction could be
easily made available for re-employment. Facilitating labor
mobility, notably in the non-viable company towns, would
nevertheless help release the current pressure on regional and
municipal governments to oppose restructuring of enterprises.
Lack of legal infrastructure to enforce commercial
agreements.--While the lack of a strong and independent
judiciary does make it difficult for productive companies to
appeal against the inequalities of competition, private parties
are now finding ways to work out secured transaction
arrangements (e.g., cash on delivery and employment of private
third party negotiators).
Lack of an effective banking system.--Lack of trust in both
the ruble and the banks (especially following the August 1998
debacle) leads people not to make their savings available for
subsequent lending by the banks (savings are mostly kept at
home in dollar notes, or outside of the country). Although this
is certainly bad news for Russia, it should be noted that the
virtual absence of bank lending in Poland did not prevent it
from achieving a strong economic growth due to foreign direct
investment (FDI) and retained earnings, the main source of
business investments in the West.
Poor transport and communications infrastructure, even with
the great Russian distances, did not emerge as an important
barrier. Most of the population and production facilities are
located west of the Urals, where distances are not as huge as
in the Eastern part of the country, and most of the European
part of Russia can be reached fairly quickly and inexpensively
by truck or train.
Russia's Growth Potential with Key Economic Reforms
As described in the previous section, our investigation of
sectors of the Russian economy helped us identify the relative
importance of the reforms now being discussed. We concluded
that the main barriers to economic growth, unequal conditions
of competition, tend to be industry-specific. Thus, they have
to be removed on a sector-by-sector basis. Given the political
difficulty of reform, this process probably should start with
the high growth potential sectors identified below.
Removing the market distortions, especially in the sectors
with high growth potential, could enable Russia to achieve and
sustain rapid economic growth. Eight percent per annum would be
within reach, allowing standards of living to double in less
than 10 years. This performance could be achieved due to a
significant share of potentially viable spare capacity, a
sizeable pool of skilled and inexpensive labor, and crucially,
a large inflow of FDI into Russia, which can be expected once
the inequalities are eliminated from the conditions of
competition.
Sectors with the Highest Growth Potential
We have estimated the relative potential of output growth
in Russia's economic sectors based on the experience of other
countries, Russia's starting point and sources of comparative
advantage (Figure 13). This analysis shows that in addition to
oil, where exports could sharply increase, output in light
manufacturing (food processing, consumer goods and automotive
industries) should grow to replace the current high share of
imports. Demand for new services, like supermarkets, should
also continue to increase. These are the sectors where the
market distortions should be removed first.
FIGURE 13._RELATIVE OUTPUT GROWTH POTENTIAL OF RUSSIA'S SECTORS
[Percentage points of U.S. GDP in 1995 per capita]
[GRAPHIC] [TIFF OMITTED] T6171.006
* Oil expected to grow faster than gas and mining.
** Commercial and infrastructure construction to grow faster
than housing construction.
Source: OECD; McKinsey analysis.
Large Amounts of Potentially Viable Spare Industrial Capacity
Our sector analyses have shown that about 75 percent of
Russia's inherited assets (put in place before 1992) would
still be viable if upgraded and managed according to modern
principles. Generalizing from the sectors we studied and
assuming equal market conditions, this upgrade would allow
production in these assets to increase by 40 percent on average
for a relatively small investment, only around 5 percent of GDP
per annum, for 5 years (Figure 14).
Benefits from Foreign Direct Investments (FDIs)
FDI could be attracted en masse into the high growth
sectors and potentially viable assets, provided that the market
distortions are removed. Foreign companies would bring not only
the dollars necessary to finance imports of machinery, but also
the best practice managerial skills indispensable to achieving
high productivity.
FIGURE 14._SIZE OF UPGRADING INVESTMENTS
[GRAPHIC] [TIFF OMITTED] T6171.007
Source: Interviews.
In oil alone, foreign investment could amount to $80
billion over the next 10 years, the equivalent of 3 percent of
Russia's GDP every year. Foreign oil companies would also bring
the expertise and technologies, that would double drilling
efficiency in new fields.
In Poland, which has no oil, direct foreign investment
already amounts to 7 percent of GDP, against less than 1
percent today in Russia. FDI in Poland is concentrated in light
manufacturing and services, and in light manufacturing accounts
for 60 percent of total investment (Figure 15). Large inflows
of FDI have been the secret of Poland's ``economic miracle.''
The Polish experience also shows that if exposed to intense
competition on an equal basis, foreign companies do not
``milk'' the country, but rather keep reinvesting profits and
develop a pool of local management talent.
The Novgorod region of Russia is a rare positive example of
what can be done in today's Russia by regional governments. It
managed to attract more FDI than almost any other Russian
region, including nearby St. Petersburg, by removing red tape,
facilitating access to land and offering tax holidays to
investors. As a result, the region has enjoyed economic growth
since 1995, and over half of industrial output is now coming
from productive foreign companies (Figure 16).
Fundamental Barriers to Economic Reforms
The drive toward establishing a market economy based on
equal opportunities for all competitors has essentially stopped
in Russia since 1995. Why has this happened? There are three
fundamental explanations for this: social concerns, corruption
and lack of information. We discuss below how these factors
interplay to lock Russia at the current low level of economic
performance and what could be the ways to unlock it.
FIGURE 15._POTENTIAL INCREASE IN BUSINESS INVESTMENT
[Percent of GDP]
[GRAPHIC] [TIFF OMITTED] T6171.005
* Includes automotive.
** Transport, communication, business and personal services.
Source: Goskomstat; Polish Analysis of Industrial Enterprises
(PAIZ); McKinsey analysis.
FIGURE 16._SUCCESS OF MARKET REFORMS IN NOVGOROD REGION
[GRAPHIC] [TIFF OMITTED] T6171.004
* Median of cumulative 1995-1997 FDI per capita of all
regions.
** First quarter 1998.
Source: Goskomstat; interviews; Bureau of Economic Analysis;
Institute of East-West Studies (IEWS); press reports.
Social Concerns
Many of the market distortions are kept in place in the
name of preserving existing employment. When justified, these
social concerns would be better addressed with a system of
explicit direct subsidies to the workers, rather than through
the current mechanism of implicit subsidies to companies, which
also serves to enrich government officials and company
managers.
Ill-founded social concerns.--Based on the
experience of other countries further ahead in their
economic development, notably Poland, and our
understanding of labor productivity gaps in Russia, we
have estimated how employment would evolve by sector if
the barriers to economic growth were removed. We found
that employment should continue to grow in services and
remain roughly stable in light manufacturing and
construction. Thus, workers who would loose their jobs
as a result of strong productivity growth or shutdowns
in these sectors should be able to find new jobs of
similar profile, especially if they are around large
urban areas. As a result there are no social reasons to
keep in place the following barriers which have been
identified in the cases:
Red tape limiting the restructuring of potentially
viable dairy and confectionery plants
Directed housing contracts to preserve employment
levels in the traditional (panel type) housing
construction companies
Tax and other advantages given to open-air
wholesale markets, kiosks and pavilions
Government ownership of hotels.
Alternative for addressing well founded social
concerns. In the heavy manufacturing sectors,
productivity would grow faster than output, leading to
substantial employment losses. This prospect does raise
serious social issues, especially in doomed company
towns, because workers' mobility is restricted by the
registration (propiska) system. In such cases, direct
subsidies, given to the workers to help them relocate
would be much more efficient than the current barter-
based corrupt system of implicit federal subsidies to
unproductive companies. Doing this would allow the
removal of the following distortions:
Unequal energy and tax payments slowing down
modernization of viable industrial assets
Limits on oil exports to force cheap oil to be
supplied to agriculture and defense, discouraging
investment into new oil production.
Corruption
Our interviews with companies confirmed the common view
that pursuit of personal financial gains within the government
and government-related agencies or companies is pervasive in
Russia. Like in many other developing countries, the
combination of arcane laws, government control over key assets,
low salaries of state employees and weak enforcement and
control mechanisms provides the means and incentives for
corrupt practices. In Russia, virtually every business is in
violation of laws (primarily tax laws) and hence the potential
target of public or private shakedowns (primarily at the local
level). We believe that in many cases corruption, together with
social concerns, is the main reason for the rules of
competition to be kept unequal.
The conventional wisdom on how to fix corruption
suggests that the highest level of government,
remaining untarnished, should initiate the crackdown:
``the fish rots from the head.'' The salary level of
key officials needs to be increased, laws against
conflict of interest passed and strong independent
controls need to be put in place together with credible
punishment.
Based on our case studies, we believe that a
potentially more effective way to reduce corruption in
Russia would be to remove the numerous means by which
the federal and local governments can interfere with
the markets to extract economic rent. This would entail
lower and simpler taxes, streamlined red tape, reduced
scope for government procurements (e.g., social
housing) and privatization of remaining government
assets (e.g., land and hotels).
This suggests that corruption is not only a cause of
Russia's current economic problems but also a consequence of
incomplete market reforms.
Lack of Information
Such vicious dynamics have been broken in other countries
through the democratic process on the basis of fact-based
policy debates. Facts about the Russian economy are difficult
to obtain. We hope to contribute a useful fact base to policy
debates, as we show with micro-economic analysis:
The extent of the performance gaps for both the old
and new economy
The absence of fundamental natural or economic
obstacles to high economic growth in Russia
The economic sectors with the highest growth
potential
The often underestimated importance of services in
stimulating overall economic growth (e.g., supermarkets
triggering positive spillover effects down the whole
food chain)
The key role that could be played by FDIs,
especially in a ``strategic'' sector like oil
The most important economic reforms, to be pursued
with priority in the high growth potential sectors
How these economic reforms can be made compatible
with the pursuit of social objectives
How these economic reforms would help reduce the
scope for corrupt practices
The key role and responsibility of regional
governments in fostering economic growth.
The changes described above require painstaking efforts in
the political process to overcome conflicts of interest and
reach compromises. Today's advanced democracies have taken
decades to achieve good economic policy, both at the macro-
economic and sector levels. However, the result has been that
they have achieved the highest levels of economic performance
in the world. Russia can benefit from the hard lessons learned
by others, but for historical reasons, the obstacles in Russia
are more difficult. How to lead a democratic political process
to overcome these obstacles is beyond the scope of this project
and beyond McKinsey's experience and expertise. However, we
have found no structural constraints on the economic side that
would prevent Russia from quickly joining the ranks of the
advanced economies.
Appendix: Summaries of Sector Case Studies
Below we present summaries of each of the ten sector case
studies. Each summary covers five topics: industry overview,
productivity performance, reasons for productivity gap at the
operational level, external barriers to productivity and output
growth, and to conclude, policy implications and future
outlook.
steel
Industry overview
In 1990 the Soviet Union was the largest steel producer in
the world. Following a 60 percent drop in domestic steel
consumption, not compensated for by an increase in exports,
steel production fell by 40 percent in Russia since the 1990
production peak. The more than 100 Russian steel plants can be
divided between the ``Big Three'' integrated steel plants
(mainly flat products), the ``Medium Six'' (long products) and
``Small Others.'' Each group employs around one third of the
almost 400,000 steelworkers.
Productivity performance
With no shutdowns or layoffs, productivity fell by 40
percent to 28 percent of the U.S. level between 1990 and 1997.
The Big Three achieve around 45 percent of the U.S.
productivity level, the Medium Six 25 percent and the Small
Others only 10 percent of the U.S. level.
The main reasons for the productivity gap at the
operational level for the Big Three and Medium Six are low
capacity utilization, excess workers in logistics and overhead
functions, and low yields on energy and raw materials. These
plants could achieve more than 80 percent of the U.S.
productivity level with very little upgrading investments. Most
of the Small Others, however, are not viable because they use
the outdated open hearth furnace and ingot casting process,
wasting energy and representing major environmental hazards.
The most important external barrier to productivity and
output growth is the implicit federal energy subsidy given, in
the form of arrears or advantageous barter deals, to many non-
viable Small Others, allowing them to remain in operation.
There have been virtually no layoffs in the viable steel plants
because wages are free to adjust downward, as the prevailing
registration (propiska) system curbs the ability of workers to
travel in search of better jobs. Poor corporate governance was
a key barrier to growth soon after the privatization (1993-
1996) as managers concentrated their efforts on gaining
control. Today, with the end of most shareholder battles at the
large productive plants, it is of secondary importance.
Policy implications and future outlook
With adequate technology in most of its production
capacity, and relatively low labor and energy costs, Russia has
a clear competitive advantage in steel. To allow the industry
to realize its full potential, local governments should stop
channeling implicit subsidies to doomed plants in exchange for
appropriate mobility provisions and social safety nets to be
provided by the federal government. At the same time, a good
way for the West to help Russia would be to remove the current
restrictions on Russian steel imports.
cement
Industry overview
There are 50 cement plants in Russia employing around
40,000 workers. Cement production collapsed by more than 60
percent since the 1990 peak; it is now at half the Polish level
on a per capita basis. The industry has remained extremely
fragmented since privatization, and the three foreign global
players present in Russia have yet to commit to significant
investment.
Productivity performance
Despite the production collapse, there have been virtually
no plant shut downs or layoffs. Productivity has thus dropped
from 20 percent of the U.S. level in 1990 to 7 percent in 1997.
The best Russian plant achieves 30 percent of the U.S.
productivity level, while many plants stand at 1 percent.
The main reasons for the productivity gap at the
operational level are very low capacity utilization, lack of
multi-tasking, less automation in packaging and delivery and
inferior wet/gas technology leading to much higher energy
consumption and lower cement quality. More than half of the
cement plants could achieve 50 percent of the U.S. productivity
level at full utilization, with best practice modes of
organization and a few targeted investments like converting to
semi-wet/gas technology.
The most important external barrier to productivity and
output growth is the flow of implicit federal subsidies in the
form of cheap energy, tax arrears and/or directed government
procurements channeled to the weakest players by local
governments anxious to prevent shut-downs. These subsidies and
political constraints are also preventing best practice
companies from buying up excess capacity to shut it down in
order to increase capacity utilization and make the necessary
upgrading investments that are worthwhile in the viable
capacity. These subsidies do not only serve a social cause,
since allegedly, part of the subsidy flow is being diverted,
via complex barter deals, to short lived and well-connected
trading companies.
Policy implications and future outlook
A strong federal government could force the rapid
restructuring of the sector by cutting the flow of energy and
tax subsidies and replacing them with direct help to the
workers wherever deemed necessary. This would make more higher
quality and cheaper cement available to major downstream
industries, such as construction and oil.
Oil
Industry overview
While its employees accounted for only 1 percent of the
Russian workforce, the oil sector \3\ sales represented 6
percent of GDP, 16 percent of exports and 22 percent of budget
revenues in 1998 (despite relatively low oil prices). Oil
production has halved since the peak of 1988, with the fall in
domestic demand and exports to countries of the ex-Communist
block. The industry has been privatized to insiders with very
little foreign involvement.
---------------------------------------------------------------------------
\3\ Including refining and transportation of crude and petroleum
products.
---------------------------------------------------------------------------
Productivity performance
The actual total factor productivity (the combined measure
of labor and capital productivity) of the Russian oil industry
is 55 percent of that of Texas on-shore. Once adjusted for
favorable geology and younger oil fields in Russia, the
productivity level falls to about 30 percent.
The main reasons for the productivity gap at the
operational level are lower oil recovery due mostly to less
hydrofracturing and poor reservoir management techniques, and
inefficient drilling because of low quality drill bits,
cleaning muds and cement being used. There are also more than
35 percent excess workers and a large amount of idle drilling
equipment resulting from the stoppage of new field developments
since 1991, despite attractive proven reserves in Western
Siberia. The total production cost in these new fields would be
as low as $6 a barrel (against $20 a barrel for current world
oil prices) with best practice operations.
The most important external barriers to productivity and
output growth are the lack of workable tax laws (the recently
passed production sharing agreement is not yet operational) and
distorted domestic oil markets with limits on oil exports.
These limitations, which discourage any significant
investments, force the supply of cheap oil to ``strategic
sectors'' such as defense and agriculture. Other, less
important, factors include unresolved shareholder battles with
weak minority shareholder rights protection, and widespread
barriers to layoffs put in place by local governments in oil
company towns.
Policy implications and future outlook
If the main barriers to investment are not removed, Russia
could, with the current rate of depletion in the existing
fields, end up being a net importer of oil in 10 years. The
social objectives and national interest would be better served
if further assurances were given to investors, notably deep
pocket foreigners who could pour in 80 billion dollars' worth
of investment over the next 10 years. Such assurances should
include workable taxes as well as a fully liberalized domestic
oil market with open access to an enlarged export
infrastructure. As a result production could double in 10
years, thus meeting demand of a (hopefully) fast growing
economy and increasing exports by more than 50 percent (keeping
Russia's market share of world oil exports constant given
current expectations of increasing future demand). Also, the
additional tax revenues would suffice to keep subsidizing (if
deemed necessary) the oil purchases for agriculture and defense
customers and help relocate stranded oil workers.
dairy
Industry overview
The industry consists of four functions: raw milk
receiving, fluid and non-fluid milk processing, and packaging.
Dairy farming and distribution are excluded from our study. The
major processed dairy products are fluid milk (the largest
category), cream, butter, cheese and milk powder. In 1997,
199,000 people were employed in the Russian dairy industry
across 1,753 plants.
Productivity performance
Labor productivity in dairy is at 8 percent of the U.S.
level. Russian dairy plants produce one-fifth of U.S. output
per capita using more than twice as many people. Since 1990,
labor productivity has almost halved. Productivity differs by
size of plant, since large economies of scale are present in
this industry: 72 large plants (capacity of 55,000 tons a year
or more) employ about 20 percent of the industry workforce and
have 12 percent of the U.S. level of productivity; 1,681 small
plants employ the rest, and operate at 7 percent of U.S.
productivity level.
The main reasons for the productivity gap at the
operational level differ between small and large plants. Large
plants (43 percent of industry capacity) could raise their
productivity from 12 percent to more than 60 percent of the
U.S. level without major investments, since the present gap is
mainly due to low capacity utilization and inefficient
organization of functions and tasks. The remainder of the gap
comes from lack of automation and inefficient relations with
suppliers. These large plants, if utilized at 80 percent, could
produce all current output of the industry by themselves. Small
processors need major investments to reach minimum efficient
scale--an investment that will not be economical.
The most important external barriers to productivity and
output growth are problems in up- and down-stream industries,
macro-economic instability and local government interventions.
Problems in up- and down-stream industries hinge on
monopolistic wholesalers, who force arrears onto dairy plants
and set off a chain of events leading to inefficient dairy
farming and the emergence of sub-scale mini-plants which do
their own distribution. Macro-economic instability manifests
itself via a high cost of capital (discouraging investments
into larger scale plants, and into shelf-life enhancing
technologies that could give dairy plants more bargaining power
over wholesalers) and a low level of demand (leading to reduced
consumption of processed milk and lower capacity utilization of
dairy plants). Local governments shield wholesalers from
competition from supermarkets by taxing the latter ones out,
and directly hamper restructuring of the dairy sector by
deterring layoffs and bankruptcies of inefficient plants, thus
creating unequal conditions of competition in the industry.
Policy implications and future outlook
For Russia to increase its productivity in the dairy
sector, large plants should expand, while small ones should
exit. For this to happen, barriers to growth of supermarkets
need to be lifted (see the summary of the Food Retailing
industry), regulatory interventions against layoffs must be
stopped, and bankruptcies of small plants should not be
artificially prevented. With these policies, the sector would
be able to achieve more than 60 percent of the U.S.
productivity level with limited investments.
confectionery
Industry overview
The confectionery industry consists of four functions: raw
material receiving: mixing; processing; and packaging. Farming
and distribution are excluded from this study. Following the
official Russian industry definition, biscuits and crackers are
included in addition to regular confectionery. In 1997, 120,000
people were employed in the industry across 925 plants. This
sector has been relatively successful in attracting best
practice foreign companies, although these investments are
still too small to make any significant difference to the
overall sector's performance.
Productivity performance
Labor productivity in the Russian confectionery industry is
at 10 percent of the U.S. level, down from 13 percent in 1990.
Productivity differs between large (capacity of 35,000 tons per
year or more) and small plants: 11 large plants achieve
productivity of 22 percent, using 20 percent of total
employment in the sector. The productivity of 914 small plants
is 7 percent, using 80 percent of total employment.
The main reasons for the productivity gap at the
operational level are low scale and capital intensity. Even the
large plants that have minimum efficient scale have to rebuild
their multi-storied structures in order to use new equipment.
Large confectionery plants already have a high capacity
utilization and thus the potential for improvements is smaller
than in the large dairy plants. The productivity potential for
large plants and small plants without major investment-fixing
capacity utilization, organization of functions and tasks and
product proliferation/value added within category--is around 50
percent of the U.S. level for the large plants and less than 30
percent for the small plants.
The most important external barriers to productivity and
output growth are low labor cost, an unfavorable tax structure,
unequal tax enforcement, and an inefficient wholesaling
industry. The low labor cost renders automation uneconomical
even for multinationals with a low cost of capital.
Deductibility of advertising expenses for tax purposes is very
limited, and advertising expenses can be taxed in some regions.
This discourages expansion of best practice firms through brand
building. The playing field is further distorted when local
governments deter layoffs by best-practice firms by subjecting
them to numerous inspections, and condone tax arrears from
unproductive companies, which end up being more profitable than
their global best practice competitors. Rights of brand
ownership are not enforced, further hampering investment into
branding and expansion, and the procedure for approving shelf-
life claims can be very slow and subject to undue influence.
Due to the large number of wholesalers in the confectionery
distribution chain, wholesale margins in Russia are twice the
U.S. level, which protects local players by making cross-
regional expansion more difficult for productive players.
Policy implications and future outlook
In order for the industry to increase its overall
productivity restrictions on layoffs must be removed, taxes
from all firms collected equally, tax disincentives to
advertising removed, brand property rights enforced, and shelf-
life approval process streamlined. Under such conditions, the
industry overall would be able to reach 30 percent of the U.S.
productivity level (without major investments) and compete more
successfully against imports.
food retailing
Industry overview
The food retailing industry employs 4 percent of the
Russian workforce and is one of the largest sectors in the
economy. Since food constitutes 45 percent of Russian household
spending and food retailing accounts for 20 percent of that
cost, the sector affects 9 percent of total household spending.
The sector has experienced a dramatic transformation in recent
years. Open-air wholesale market stands, kiosks, pavilions and
agricultural markets have taken shares away from Soviet-era
formats (whose shares have declined from 90 percent in 1990 to
41 percent in 1997).
Productivity performance
The Russian labor productivity is at 23 percent of the
U.S. level. Street vendors are at 9 percent, traditional
Soviet-era formats (the smaller gastronoms) at 24 percent,
open-air wholesale markets at 24 percent, kiosks and pavilions
at 26 percent, and supermarkets at 78 percent of the average
U.S. productivity.
The main reasons for the productivity gap at the
operational level can be grouped into two. First, Russia lacks
modern productive formats such as supermarkets and
hypermarkets. The market share of modern formats is less than 1
percent in Russia compared to over 70 percent in the United
States. Second, format-to-format, Russian stores suffer from
over-manning, low scale of chains and stores, and low capital
intensity compared to their U.S. counterparts.
The most important external barriers to productivity and
output growth are those that prevent the penetration of modern
formats. Modern formats cannot gain share against the less
productive open-air wholesale market stands, kiosks and
pavilions because the latter benefit from lower tax
liabilities, less control on the origin of their goods (which
are often illegal imports or counterfeits), and cheaper access
to prime locations. Inefficient Russian food processors also
impede the entry of modern formats since best practice firms
will not invest in a country unless they can source quality
products domestically.
Policy implications and future outlook
If the main barriers are removed, modern formats should
gain substantial market share. For example, in the city of
Obninsk in Central Russia, supermarkets gained 15 to 20 percent
market share (compared to less than 1 percent for all of
Russia) after the local government provided equal opportunities
(for supermarkets and open-air wholesale market stands) in
terms of land allocation and tax/tariff/counterfeit
enforcement. As another example, Polish supermarkets and
hypermarkets gained 18 percent market share in less than 5
years--having started from a similar format mix as Russia--
after the government put into place equal tax legislation and
clear land allocation procedures.
general merchandise retailing
Industry overview
The general merchandising industry employs 2 percent of
the workforce and generates 2.5 percent of GDP in Russia.
Between 1990 and 1997, general merchandising turnover dropped
by 40 percent and the share of imports rose from 15 percent to
80 percent. The share of Soviet-era formats declined from 100
percent to 20 percent, they were replaced by new more
convenient or cheaper formats, especially open-air wholesale
markets, which captured 65 percent market share.
Productivity performance
The Russian labor productivity is at 26 percent of the
U.S. level. Soviet-era multi-product stores are at 10 percent,
Soviet-era single-product stores at 24 percent, open-air
wholesale markets at 27 percent, kiosks and pavilions at 28
percent, and the few modern chains (mostly in electronics) at
less than 80 percent of the productivity level of their U.S.
equivalent.
The main reasons for the productivity gap on the
operational level can be grouped into two. First, Russia lacks
modern chains that are more productive than non-chains. The
market share of modern chains is at 8 percent in Russia
compared to 70 percent in the United States. Nearly all the
modern chains are consumer electronics chains. Second, open-air
wholesale markets stands have low productivity because they are
both sub-scale and under-capitalized. Finally, and much less
importantly, Russian (consumer electronics) chains have lower
productivity than their U.S. counterparts because they do not
use part-time workers to match demand fluctuations, and enjoy
less economies of scale.
The most important external barriers to productivity and
output growth are those that prevent the penetration of modern
chains. Modern chains cannot gain share against the less
productive open-air wholesale market stands, kiosks and
pavilions because the latter benefit from lower tax
liabilities, less control on the origin of their goods (which
are often illegal imports or counterfeits), and cheaper access
to prime locations. In addition, the high cost of capital
deters domestic investors from financing capital-intensive
hypermarkets or malls.
Policy implications and future outlook
If the main barriers are removed, modern chains should
gain substantial market share. Foreign multinationals can
overcome financing limitations and are thus attractive
candidates for investment. Such multinationals invested only
$0.1 billion in Russian retailing (both food and general
merchandise) compared to $2.1 billion in Poland (with another
$2.7 billion in the pipeline), where the playing field is much
more level with serious law enforcement. As a result, Poland
enjoys a 22 percent market share for chains, while bazaars (the
equivalent of Russian wholesale markets) are in marked decline,
with only 10 percent market share in 1999.
hotels
Industry overview
Approximately 100,000 people are employed in about 5,000
hotels located in Russia. Unlike most Russian sectors that have
been privatized, over 80 percent of hotels remain in the hands
of municipal, regional or federal government. Recently four-
and five-star hotel foreign chain operators have entered the
high-end segment of the market; they currently account for 15
percent of turnover.
Productivity performance
Russian labor productivity in the hotel sector (for
lodging only, excluding food and beverage) is at 18 percent of
the U.S. level. Russian chains (exclusively the four- and five-
star hotels) are at 60 percent of the productivity of U.S.
chains while Russian non-chains are at 19 percent of the
productivity of U.S. non-chains.
The main reasons for the productivity gap at the
operational level can be separated into three groups. First,
comparing Russian non-chains to U.S. non-chains, Russian hotels
are less utilized, do not implement multi-tasking of personnel,
have lower value-added rooms, and are more sub-scale. Second,
comparing Russian chains (managed by Western operators) to U.S.
chains, Russian hotels are penalized by the need to train their
personnel (e.g., cleaning ladies). Third, Russia lacks chains,
which are more productive than non-chains (e.g., central
booking leading to higher utilization); chains account for only
15 percent of turnover in Russia compared to 40 percent in
Poland and 70 percent in the United States.
The most important external barriers to productivity and
output growth are also separated into three groups. For non-
chains, government ownership stifles managerial incentives for
improving efficiencies. Also, the collapse in demand has
reduced capacity utilization, while low income has limited the
demand for higher value added rooms. For chains, lack of multi-
tasking should be resolved over time as a skilled labor pool is
developed. Last, for chain penetration, collapse in demand,
high cost of capital and country risk, under-developed tourist
attractions, high construction costs, and red tape/corruption
involved in land allocation have been the main barriers.
Policy implications and future outlook
If the main barriers are removed, the Russian hotel
industry could achieve productivity of up to 60 to 65 percent
of U.S. levels. International experience shows that demand for
hotels increases rapidly as income per capita grows. Removing
the barriers is likely to increase investment in new hotels,
especially in chains. Besides the improvements in the format
mix, this higher chain penetration will also foster
productivity in non-chains by increasing the industry's
competitive intensity.
residential construction
Industry overview
Residential construction is one of the largest economic
sectors in Russia accounting for about 5 percent of total
employment and 3 percent of GDP. Output in the sector has
declined by 25 percent since 1990. Growth in the construction
of privately financed brick houses and apartments has not
compensated for the 50 percent decline in the construction of
government-financed traditional pre-fabricated apartment
buildings.
Productivity performance
The overall productivity of the sector is estimated at
around 10 percent of the U.S. level. Productivity fell to 10
percent of the U.S. level in the traditional segment, as many
companies did not adjust their staffing levels to the fall in
output. New entrants only achieve 20 percent of the U.S.
productivity level, and furthermore, around one-fourth of all
construction is now being carried out ``brick by brick'' by
individuals (5 percent productivity level) as financing becomes
available.
The main reasons for the productivity gap at the
operational level for the traditional companies are very low
capacity utilization at both the panel factories and
construction sites, and complete lack of incentives for workers
to improve efficiency or quality levels. The new companies are
mostly affected by both the lack of special trade companies and
the small scale of privately financed housing programs.
The most important external barrier to productivity and
output growth is the fact that local governments systematically
allocate housing programs to the same (ex-Soviet) companies in
exchange for no layoffs. New private companies are also
penalized by the fact that large single family housing programs
(the most productive form of housing construction) are
virtually impossible in the absence of an operational land code
and mortgage financing.
Policy implications and future outlook
Government-financed housing programs should be limited to
the most urgent social needs (e.g., relocation of stranded
industrial workers) and carried out through open and equal
tenders. The following would also help stimulate the demand for
private housing, appropriate legislation in the areas of land
property and usage rights, tenant rights, a mortgage system
(with macro-economic stability as a prerequisite), removal of
administrative barriers to labor mobility (propiska system),
and accelerated phasing out of the utility and maintenance
subsidies in the existing housing stock.
software
Industry overview
We address two distinct sub-sectors in our software case:
packaged software and project services, in total employing
about 8,000 people in Russia (compared to more than 600,000 in
the United States).
Productivity performance
The overall labor productivity in the sector is 38 percent
of the U.S. level, an average of 13 percent for packaged
software and 72 percent for project services (consulting,
implementation and training in the information technology
area). This latter sub-sector is the most productive of all the
industries we have studied in Russia.
The main reasons for the productivity gap at the
operational level for packaged software, a high fixed
(development) cost business, are low scale (on average, Russian
packaged software companies are 100 times smaller than their
U.S. counterparts), and a low value-added product mix. This
latter factor is also responsible for the (small) productivity
gap in project services.
The most important external barriers to productivity and
output growth differ between sub-sectors. In packaged software,
the causes are the prevalence of software piracy and lack of
leading-edge demand from business customers. The piracy rate is
90 percent in Russia--one of the world's highest, so Russian
software firms lose most of their resources to pirates and can
not invest in research and development of better products.
Software-consuming sectors, whose demand drives development of
software firms, are both very small in Russia and less
interested in productivity-enhancing software tools than their
Western counterparts. For example, banks, important software
consumers elsewhere, in Russia depend on relationships with
authorities, rather than cost control or good service. Kiosks,
unlike supermarkets, do not consume software.
The customized nature of project services makes this sub-
sector immune to piracy. The low value-added service mix of
Russian project services firms, the main culprit of the (small)
productivity gap, comes from the low level of customer demand.
The low level of domestic demand can be partially overcome by
serving overseas customers via offshore programming. The
Russian business of offshore programming is growing at 50 to 60
percent per year, although from a very small base. With time,
this industry should be able to obtain the requisite track
record and international certification, and become a force in
the world offshore programming market along with India.
Policy implications and future outlook
The following four policy measures should improve the
economic prospects for the software sector in Russia: removal
of barriers to productivity and output growth in the other
(software-consuming) sectors (see all other sector case
studies), stepping up enforcement of anti-piracy laws (which
are already in place), support to ISO- and SEI-certification
initiatives (e.g., through setting up a number of specialized
certification centers to ease the process for Russian
companies), and removal of red tape in software export
procedures. The future of the domestically oriented packaged
software and project services sub-sectors will depend on growth
of the whole economy. Offshore programming can be expected to
continue growing output and employment at the current rate of
50 to 60 percent per year.
ADMINISTRATION AND REFORM OF THE RUSSIAN ECONOMY
By Paul Gregory and Wolfram Schrettl \1\
----------
contents
Page
Objectives of Russian Administrative Reform...................... 81
Soviet Administration............................................ 82
The Administration of the Russian Federation..................... 84
Federalism....................................................... 89
Liberalization, De-Bureaucratization, and Corruption............. 90
Civil Service Reform............................................. 93
Are Putin's Reforms Too Good To Be True?......................... 94
The goal of Russian administrative reform is to create a
``rule of law'' that encourages domestic entrepreneurship,
foreign investment, and economic growth. Old planning
institutions must be replaced by new state institutions that a
market economy requires. After more than 10 years of
transformation, the major administrative changes have been the
replacement of the executive, legislative, and judicial
Communist Party monopoly with a strong presidency and a to-date
weak legislature. Destatized large enterprises have replaced
the industrial ministries, and they represent a new source of
independent power. New agencies have been created but they have
not taken firm hold in the new administrative system. President
Putin has presented a comprehensive program of administrative
reform. His regional reform has passed the legislature and
decides the federalism issue by centralizing power. His de-
bureaucratization reforms seek to improve Russia's business and
investment climate by reducing bureaucratic interference and
arbitrary official behavior. Significant reforms remain to be
implemented; namely, judicial reform and civil service reform.
A key question is whether these reforms are successfully
resisted, as have been earlier reforms, by those parts of the
bureaucracy that stand to lose income and power.
---------------------------------------------------------------------------
\1\ Paul Gregory is Professor of Economics, University of Houston.
Wolfram Schrettl is Head, Department of International Economics, German
Institute for Economic Research, DIW Berlin. The authors wish to thank
Henning Schroeder for comments and suggestions on an earlier draft of
this paper and Carina Schulz for able research assistance. Wolfram
Schrettl is grateful to the KfW-managed TRANSFORM program of the German
Government for financial support to GLOROS (``Global Economy and
Russia. A Russian-German Dialogue''), a project of DIW Berlin (German
Institute for Economic Research) and HSE Moscow (State University
Higher School of Economics).
---------------------------------------------------------------------------
Objectives of Russian Administrative Reform
A significant part of the transformation process is the
creation of a structure for the administration of a market
economy to replace the administrative structure of the planned
economy. Such a transformation requires the government's
credible commitment to firm legal ``rules of the game,'' a non-
corrupt bureaucracy that enforces and interprets these rules
impartially, and a judiciary that independently interprets
these rules and punishes violations. The term administrative
reform means different things to different people in
contemporary Russia. Changes in center-periphery relations,
anti-bureaucratic legislation, and civil service reform all
fall under the category of administrative reform. In this
paper, we interpret progressive administrative reform as any
reform that creates new legal rules of the game that will
administered fairly and efficiently by the bureaucracy. We
describe the current Russian administrative system in terms of
this general goal, and we use the Soviet legacy, which has left
a strong imprint on the current system, as our starting point.
Soviet Administration
Figure 1 provides a schematic sketch of the Soviet-type
administrative structure from which that of the Russian
Federation evolved. It shows that the legislative rules of the
game were set by the top leadership of the Communist Party in
the Central Committee and Politburo. Formal decrees and orders
were issued by the state administration (called the Soviet
order), but the top administration of both state and party
comprised an interlocking directorate of key political figures
that blurred distinctions between the party and state at the
highest level. This was a decree-based system in which national
laws and instructions were issued by the Council of Ministers,
with the most important decrees issued jointly by the state and
party. Decrees and orders were typically quite specific,
instructing some subordinate agency to fulfill a designated
task.
The Soviet Government was the Council of Ministers in which
the most important ministries and state committees were
represented. Ministries consisted of two types: Industrial
ministries which supervised productive enterprises and
functional ministries that carried out the normal state
functions, such as education, defense, internal security,
justice, and public finance. State committees typically
attended to functions specific to a planned economy and usually
not found in market economies. Gosplan drew up national plans,
Gossnab prepared supply plans, Goskomtsen set prices,
Goskomtekhnika supervised research and development, and
Gosstroi planned construction. A monopoly state bank assumed
all functions of banking, and carried out, in particular,
central banking and allocations of credit. Its monetary and
credit policies were subordinated to the plans prepared by
other state committees, and its main job was the distribution
of credits according to plan.
This central administrative structure was replicated in the
15 republics, of which the Russian Republic was one, with
Republican governments answering to the Council of Ministers
and Communist Party. These Republican Party and state
organizations supervised local industries, they did not play
independent roles, and their influence on national policy was
felt primarily through the Republican leader's influence within
the party apparatus.
FIGURE 1._SOVIET ADMINISTRATION
[Schematic version]
[GRAPHIC] [TIFF OMITTED] T6171.021
The plan was ``the law.'' Given that there were a large
number of plans, many conflicting, the administration engaged
in considerable negotiating, coercion, and compromising in the
absence of overall rules of the game. The party was the
``leading institution'' which gave it the primary role of
negotiator, compromisor, and facilitator. Administrators with
authority to make resource allocation decisions (party,
planners, ministers, etc.) were the distributors of the
economic rents associated with the monopolistic structure of
Soviet industry. Contemporary writers even argue that the
party's main role was to distribute economic rents among
society's players. \2\ Those with power to distribute and use
resources were called fundholders. They actively traded
resources among themselves by barter, plan instructions, and
outright sales in a manner that is still poorly understood.
---------------------------------------------------------------------------
\2\ Boettke, Peter. Calculation and Coordination (London:
Routledge, 2001).
---------------------------------------------------------------------------
The Soviet system used a nomenklatura system for
administrative appointments, promotions and firings, which was
managed at the top by the party personnel department. The
nomenklatura system had rather clearly stated rules concerning
which agency (state or party) was authorized to make personnel
decisions. We do not know to what extent the nomenklatura
system was merit based. Some appointments were made on merit;
others through connections or family relations. The operations
of the nomenklatura system were opaque and unlike the Western-
style ideal of a transparent civil service. The notion of free
access to administrative careers in the state or party through
a well-defined set of rules was totally foreign. In a society
that lived drably, membership in the nomenklatura meant access
to goods, perks, and services beyond the reach of ordinary
citizens. These perks and benefits could not be purchased; they
were linked to specific positions in the nomenklatura.
The Administration of the Russian Federation
The Soviet administrative system collapsed along with the
Communist Party monopoly in late 1991, which had been its
foundation. The administrative-command economy collapsed with
Gorbachev's withdrawal of administrative power from the branch
ministries in the late 1980s. Once Yeltsin and his reform team
determined to abandon the Soviet command system, administration
had to change to meet the new circumstances of an economy that
was no longer centrally planned, in which there was
considerable market allocation, and significant privatization
(or destatization) of property. Conceptually, such an economy
required creation of a rule of law based upon a legislative
framework to which the state was ``credibly committed'' as
opposed to ad hoc decrees, which could change with the whims of
leaders. Also required was a well-defined distribution of power
among the executive, legislative, and judicial branches with
the legislature making law, the executive executing that law,
and the judiciary interpreting law and resolving conflicts. The
distribution of power, tax revenues and government
expenditures, and property between the central government and
regional and municipal governments had to be agreed upon with
non-contradictory and non-overlapping rules and regulations.
Without such ``federalism'' agreements, state property could
not be managed and disposed of and businesses could not operate
in a uniform market with a level playingfield.
A series of new or improved government institutions was
also required, including ``normal'' institutions for monetary
and fiscal policy, such as a two-tiered banking system (with a
quasi-independent Central Bank of the Russian Federation
(Central Bank of Russia or CBR)) to replace the monopoly state
bank and a system for orderly fiscal budgeting. Also new
agencies required by a market economy had to be created and
agencies associated with planning and administrative price
setting had to be eliminated. Agencies had to be appointed that
would effectively manage property, either fully or partially
owned by the state, in the public interest.
In place of the party-directed nomenklatura, which was
designed to issue orders and distribute resources in an opaque
fashion, a Western-style civil service had to be installed.
This civil service should be appointed according to merit, be
inculcated with a notion of service to the public, and
administer rules and regulations impartially.
Figure 2 provides a schematic sketch of the current Russian
administrative structure. When compared with Figure 1, it shows
the substantive changes that have taken place over the past
decade but underscores the reforms that have yet to be made.
The lack of full resolution of the general objectives of
administrative reform listed above after more than 10 years is
not at all surprising. A complete restructuring of a society's
administrative structures and power relations requires
considerable time, especially in the face of substantial and
mostly concealed opposition.
FIGURE 2._ADMINISTRATION OF RUSSIAN GOVERNMENT
[Schematic version]
[GRAPHIC] [TIFF OMITTED] T6171.020
The most significant changes are the disappearance of the
Communist Party as the leading institution and the conversion
of former industrial ministries into semi-independent
corporations. Although the Communist Party remains the largest
single faction in the legislature, it lacks the power to
``order.'' Earlier it had the power to block, a power
apparently lost under Putin. In the Soviet era, the party was
the ultimate source of legislative power and was the ultimate
enforcer of executive power, although most legislative decrees
were formally issued by state power; namely, by the Soviet
Council of Ministers. Given that all responsible positions were
held by party officials through the nomenklatura, the party
also had the power to punish and thus acted as well as a
judiciary.
Figure 2 shows that the ``legislative-executive-judicial''
party has been replaced by a President, who serves as the
ultimate source of executive power, but also can serve as a
source of legislative power through the use of presidential
decrees--a device used frequently during the Yeltsin
presidency. The President has the power to nominate the Prime
Minister and hence oversees the top appointments to the
executive branch, subject to approval of the legislature, the
Duma, which can be forced to dissolve itself if the President's
nominee is not accepted. These procedures were put in place in
the 1993 Yeltsin Constitution, which affords the President
considerable power in naming the government (pravitelstvo).
Given the strong presidency, a massive presidential
administration of officials, advisors, and bureaucrats is
associated with the office of the President.
The appointment, confirmation, staffing, and
responsibilities of the government are defined in the
constitutional law approved in December 1997.\3\ The government
is headed by a Prime Minister and a number of Deputy Prime
Ministers with specific obligations, who preside over the
various governmental agencies and ministries. The government,
like its former Soviet variant the Council of Ministers,
continues to have a massive administrative apparat, which
competes in influence and size with the presidential
administration.
---------------------------------------------------------------------------
\3\ Federalny konstitutsionny zakon o pravitelstve Rossiiskoi
Federatsii. 31.12.97 N 3-FKZ.
---------------------------------------------------------------------------
Figure 2 shows that there have been major changes in the
makeup of the Russian Government which consists of slightly
less than 50 ministries, agencies, and committees.\4\
Previously powerful planning committees have been converted
primarily into regulatory agencies and agencies for devising
economic policies and strategies. Gosplan has become the
Ministry of Economic Development and Trade, which drafts
industrial policy and regulations rather than issuing
directives. Some former industrial ministries have become
regulatory and licensing agencies such as the fuel and energy
ministry and the geology ministry. Most significantly, most
``production'' ministries have been converted into non-state
(at least partially privatized) enterprises in which the state
continues to own significant shares, such as Gazprom, Lukoil,
and Unified Energy System (UES). The conversion of industrial
ministries from direct controllers of branch enterprises into
``destatized'' companies has been a significant change in
Russian administration. The state's dealings with these
companies remains in flux. It is unclear in whose interests
these enterprises are being run and whether the state is able
or willing to properly exercise its role as the largest single
shareholder.\5\ Other agencies of the Russian Government are
ministries common to all countries--education, defense, trade,
labor, ecology, justice, and internal security, although the
power of the Federal Security Service (FSB) may now be
exceptional under Putin, insofar as Putin himself was trained
in the FSB's predecessor organization, the State Security
Committee (KGB).
---------------------------------------------------------------------------
\4\ Spravochnik: Federal'naia vlast' v Rossii.
\5\ Putin's replacement of Gazprom Chairman Vyakhirev with his own
man, Miller, in June 2001, represents perhaps a watershed in the
state's relation with large destatized corporations.
---------------------------------------------------------------------------
Figure 2 also shows that new agencies required by a market
economy have been created. Of the 49 ministries, committees,
and agencies of the Russian Government, 6 are ``new'' agencies
required by a market economy.\6\ Skeptics note that these new
agencies were not part of the traditional power structure of
the Soviet Union, and they have not become credible centers of
authority. Another feature of the new Russian structure is the
substantial overlap among agencies, with several agencies
responsible for taxes, security, construction, and
technology.\7\ This overlap and duplication will presumably be
a prime issue of contention in future administrative reforms.
---------------------------------------------------------------------------
\6\ Pravitelstvo Rossiiskoi Federatsii, Struktura federalnykh
organov ispolnitelnoi vlasti (www.pravitelstvo.gov.ru). They are the
anti-monopoly ministry, the property ministry, the tariff committee,
the securities commission, the bankruptcy commission, and the land
registry committee.
\7\ Parison, Neil. ``Russia: Public Administration Reform: Issues
and Options,'' mimeo; a Russian version appeared in E.G. Yasin (ed.),
Investitsionny klimat i perspektivy ekonomicheskogo rosta v Rossii
(Moscow: Vyshaia shkola ekonomiki, 2001), pp. 202-213.
---------------------------------------------------------------------------
The Russian legislature consists of two houses, the state
Duma and the Federation Council. The lower-house Duma is
comprised of elected deputies, while the upper house, the
Federation Council, is comprised of regional leaders or, more
recently, of their representatives.\8\ Of the two, the Duma is
the dominant legislative body. Unlike the Soviet system where
power clearly derived from the Communist Party, Figure 2 shows
the basic power conflict in the new Russian administration--the
potential of stalemate between legislative and executive power.
The legislative branch has been dominated by the Communist
Party, which has shared virtually no common goals with either
Russian President. Legislation was passed slowly in the
Communist dominated Duma, if at all, and Yeltsin sought to
legislate by presidential decree--a poor substitute for
legislation approved by the legislature. With the recent
decline in Communist Party power and Putin's relatively easy
election and personal popularity, it appears that the
legislative logjam is breaking and movement toward a
legislative rule of law is gathering steam.\9\
---------------------------------------------------------------------------
\8\ Putin's regional reforms, discussed below, phase out membership
of governors in the Federation Council. But selected regional leaders
will be members of the resurrected State Council under the Putin plan.
\9\ During its Spring 2001 session, for example, the Duma adopted 4
federal constitutional laws, 155 federal laws, ratified 27
international treaties, and considered 58 of 83 priority draft laws
scheduled for discussion. See RFE/RL Newsline, 16 July, 2001.
---------------------------------------------------------------------------
A second point of conflict is between the powerful
administration of the President and the official bureaucracy of
the country; namely, the apparat of the government. Such
conflicts are not uncommon in democracies, where officials
close to the chief executive often wield more power in specific
areas than does the responsible minister.
A third source of potential conflict is between the Russian
Government (as represented by the legislature or the President)
and the quasi-independent large corporations, headed by former
branch ministry officials (Gazprom, Lukoil) and the financial
industrial groups headed by oligarchs who were not prominent
members of the old elite (Berezovsky, Abramovich, Gusinsky).
These large industrial, raw material, and financial companies
represent a new source of power, whose relations with the state
remain to be decided. Their predecessors, the industrial
ministries, were indeed powerful, but they were reined in by
Gosplan, the Council of Ministers, and the Communist Party
leadership. As major employers, often the most substantial tax
payers, and sources of liquidity, these destatized corporations
hold considerable unofficial power. They can make campaign
contributions, bribe regulatory officials, acquire vast media
empires, or ``buy'' their own members of the legislature. The
balance of power between these large corporations and the
official holders of power (the legislature, the President and
the bureaucracy) is in flux and remains to be defined. The
issue of unofficial state power has become so acute in some
transition economies, including Russia, that experts question
to what extent the state has been ``captured'' by these
unofficial interests.\10\
---------------------------------------------------------------------------
\10\ The European Bank for Reconstruction and Development (EBRD)
even compiles ``state capture'' indexes for the transition economies in
their various transition reports.
---------------------------------------------------------------------------
In many cases, the state continues to own substantial
shares in the destatized corporations, not only of the
prominent companies such as Gazprom and Lukoil but also of
regional and local destatized companies. The ``state''
therefore has a natural means of controlling such companies by
exercising its rights as the largest single shareholder.
Putin's recent replacement of Gazprom's general director with a
trusted subordinate provides a model. In less prominent cases,
such as smaller regional destatized companies, management
appears to have ``captured'' state officials who are supposed
to represent the state's interests, and they escape effective
state control. For example, at about the same time that Putin
was replacing the management of Gazprom, the GOK Combinat was
being ``auctioned'' to insiders for $20 million instead of its
``expected'' price of $100 million. Accordingly, the state
budget seems to have lost $80 million through this insider
transaction.\11\
---------------------------------------------------------------------------
\11\ ``Ochen' spetsialny auktsion,'' Moskovskie novosti, 12-18
June, 2001.
---------------------------------------------------------------------------
Some agencies have grown in power and others have lost
power compared to the Soviet period. Previously dominant
agencies, such as Gosplan, have been converted into a less-
powerful Ministry of Economic Development and Trade.\12\ The
Soviet Ministry of Oil and Gas Industry, which ran the
U.S.S.R.'s vast energy complex, has become a regulator and
issuer of licenses as the Russian Ministry of Fuel and Energy.
The various tax collection agencies have grown in importance
now that taxes are collected from more independent units rather
than semi-automatically by the state banking system from state
enterprises. The property committee has been a powerful agency,
particularly during periods of active privatization. It had no
predecessor in the Soviet period. The ``new'' ministries and
agencies required for a market economy (such as the Federal
Securities Agency, the Federal Service for Financial
Rehabilitation and Bankruptcy) were grafted into the structure
of government without gaining much influence in government
circles. They have been unable to attract sufficient funding or
secure cooperation from other ministries. Moreover, cuts in
government agencies have been carried out uniformly, meaning
that the new agencies, which tend to be understaffed, become
more understaffed, while traditional ministries, which are
overstaffed become less overstaffed.\13\
---------------------------------------------------------------------------
\12\ The power of a particular agency depends upon proximity and
trust of the President. For example, the Ministry of Economic
Development and Trade has been very influential in the first 2 years of
the Putin presidency and has spearheaded the reform process.
\13\ Parisons, Neil. op. cit., pp. 202-213.
---------------------------------------------------------------------------
Figure 2 lists one state agency, the State Bank, which by
legislation of 1995, has become a quasi-independent agency. The
Soviet structure also lacked independent agencies. The most
obvious candidate for future independence, the judiciary
branch, may become an independent branch of government if
Putin's declared reform program is realized. Putin has made the
creation of an independent judiciary a priority of his state
program announced in 2001.\14\ Putin argues that the investment
climate of Russia cannot improve without confidence in an
impartial judiciary; hence an independent judiciary is being
proposed for quite pragmatic reasons.
---------------------------------------------------------------------------
\14\ BBC Monitoring Service, Russian President's Annual Address to
Federal Assembly, April 3, 2001; translation of Vystuplenie presidenta
RF V.V. Putina s poslaniem federalnomu sobraniiu RF, 3 April 2001
(http://president.kremlin.ru/events/191.html).
---------------------------------------------------------------------------
Federalism
In the Soviet period, there was no debate about
federalism--who owned state property, how tax revenues were
distributed, who regulated enterprises located in the region,
etc.? Republics, provinces, regions, and cities were clearly
subservient to the national government. The Soviet budget was a
unified budget prepared by the Soviet finance ministry; taxes
were collected and credits allocated by the state banking
system; spending was allocated through the unified state
budget. Nevertheless, the de facto owners of state property
were known. The national ministries were the de facto owners of
the most important industrial assets; Republican ministries and
state agencies were the de facto owners of assets of lesser
importance. Local governments were the de facto owners of
enterprises that worked for local markets, such as gravel and
local building materials. Regional, metropolitan, and local
governments' claims to resources were largely dictated by the
political position of the regional leader (whether or not the
regional leader was in the Politburo or Central Committee).
Appointments to republican, regional, and local positions were
made from Moscow through the nomenklatura list. The best and
most promising people were transferred to Moscow.
The federalism issue--how are power and resources to be
divided between the center and the periphery--has been one of
the most difficult tasks of Russian administrative reform. The
lack of resolution of this issue should come as no surprise.
Even highly stable countries, like the United States, still
argue bitterly over issues like states' rights more than 250
years after their founding.
Federalism asks whether power is to be decentralized to the
regions or centralized in Moscow? Different countries have
arrived at different solutions that work well in practice. On a
theoretical level, a decentralized system encourages diversity,
offers citizens different choices, and allows for
experimentation. On a practical level, a well-defined rule of
law requires sufficiently uniform and consistent laws and
regulations. Excessive divergences of regional laws from
national laws, or even contradictions of one by the other,
cause the national political space to subdivide into different
markets, operating according to substantially different rules
of the game. Founding constitutions usually address rights of
regions vis-a-vis the center, but the 1993 Russian Constitution
left many of these issues to be resolved in practice.
Upon achieving independence, the Russian periphery
consisted of 89 regions, each headed by a governor or
equivalent. The governor was elected, often with rigged
elections, and could not be dismissed by the President.
President Yeltsin's attempts to remove a regional governor
failed. Each region passed its own laws and regulations and
made claims to assets, such as oil fields or industrial assets
that were located on its territories. Taxes were collected
mostly at the local level, and the distribution of tax proceeds
was a constant source of conflict. Many regional laws and
regulations were passed chaotically without reference to the
Constitution of the Russian Federation, and a number of regions
made claims to complete independence (including Chechnya, which
led to a war between the center and this periphery).
Putin's legislation creating seven federal districts was
passed by the Duma and even by a compliant Federation Council
(which the measure emasculated) in spring 2000. Putin's
regional reform goes a long way toward resolving Russia's
federalism issue in favor of the centralized variant. Putin has
called the passage of this measure ``one of the most important
decisions taken in 2000.'' \15\ This legislation inserted seven
federal regions, headed by a plenipotentiary regional
representative appointed by the President, between the federal
government and the regional governors. This reform enables the
Russian President to appoint all representatives of federal
power within the district, control regional legislation,
monitor the carrying out of federal decrees, and increase
control over regional governors (even allowing the President to
dismiss governors under certain conditions).
---------------------------------------------------------------------------
\15\ BBC, op. cit., April 3, 2001.
---------------------------------------------------------------------------
Putin's regional reform also redistributes tax revenue from
55 percent for the center to 70 percent for the center and
makes the region's primary source of revenue the uncertain
profits tax on enterprises on the theory that regional
authorities can better gauge enterprise profits than some
national tax authority.\16\ A key feature of the reform is the
harmonization of regional laws and regulations with national
laws and the Russian Constitution. According to Putin, more
than 3,500 laws of the regions conflicted either with the
constitution or with federal laws.\17\ In the year 2000,
prosecutors and Presidential envoys brought 90 percent of the
regional laws into compliance with federal laws,\18\ but the
harmonization work continues, especially on joint jurisdiction
issues. The negotiation of 42 power-sharing agreements is still
required, on which more than 250 existing agreements are
based.\19\
---------------------------------------------------------------------------
\16\ Petrov, Nikolai. ``Decentralization and Recentralization in
Russia,'' Carnegie Endowment for International Peace, Russian and
Eurasian Program, Vol. 2, October 25, 2000.
\17\ BBC, op. cit.
\18\ Kommersant, June 27, 2001.
\19\ RFE/RL Russian Federation Report, Vol. 3, no. 20, July 2001.
---------------------------------------------------------------------------
Putin's success in resolving, at least for the time being,
the federalism issue relates to his first-round election in
early 2000, his popularity associated with a rising economy,
and his popular tough stand on Chechnya leading up to the
Presidential election.
Liberalization, De-Bureaucratization, and Corruption
Russia receives low rankings from international
organizations and agencies, such as European Bank for
Reconstruction and Development (EBRD), Transparency
International, and Heritage Foundation, concerning its high
corruption and limited economic liberalization and economic
freedom among the transition countries. Foreign investment is
limited by the lack of a clear ``rule of law'' as is domestic
entrepreneurship.\20\ Excessive bureaucracy also encourages
businesses to operate in the shadow economy by making it too
expensive to operate legally. Unclear or conflicting laws
encourage bureaucratic intervention. Tax complexity allows more
discretion by tax officials and hence encourages bribes to
officials. A vague criminal justice system encourages the
negotiation of sentences for fees.\21\
---------------------------------------------------------------------------
\20\ See e.g., the two volume study by E.G. Yasin (ed.), op. cit.
\21\ A new administrative code passed the Duma in October 2000. It
constitutes a 500 page document that updates the 16 year old Soviet
administrative code. This code requires, among a large number of
regulations, Russian citizens to carry their passports, regulates fines
for traffic violations and sets the rights of police to impound
vehicles, and levies fines on officials for giving false information to
citizens. It is unclear whether the new administrative code is an
improvement in guaranteeing the civil rights of citizens. One of the
fiercest debates in the Duma was a provision (subsequently dropped)
that would have allowed the traffic police to impound vehicles. On
this, see ``State Duma Lays Down the Law of the Land,'' Moscow Times,
October 6, 2000.
---------------------------------------------------------------------------
Russian writers depict endless inspections, certifications,
and unnecessary restrictions on property rights. In many cases,
the same licenses are required by different agencies, making
the cost of licensing excessively high. Examples of excessive
bureaucracy and corruption abound: The budget gets, for
example, only 5 to 7 percent of the sum charged for licences.
Regional administrations issue unlawful licences for 600 types
of entrepreneurial activities. Licences serve as market
barriers on the principle ``pay to enter the market and then do
what you want.'' \22\ Expert calculations suggest that
administrative barriers cost Russian families $18 a month in
the form of higher retail prices.\23\ Because of confusing and
contradictory laws, practically every businessman is obliged to
break the rules and to pay bribes to get the exemptions
required to operate the business.\24\
---------------------------------------------------------------------------
\22\ Press Briefing By Minister for Economic Development and Trade
German Gref, March 2, 2001 (www.fednews.ru/).
\23\ ``Getting rid of bureaucrats will save $5.8 bln,'' March 2,
2001 (www.strana.ru).
\24\ Press Briefing By Minister for Economic Development and Trade
German Gref, March 2, 2001, op. cit.
---------------------------------------------------------------------------
Economic analysts, both within and outside of Russia, argue
that the regulatory burden on Russian enterprises must be
reduced significantly if the economy is to continue to grow and
to attract foreign investment.\25\
---------------------------------------------------------------------------
\25\ Yu. A. Tikhomirov, ``Rol gosudarstva i prava v formirovanii
blagopriiatnogo investitsionnogo klimata,'' in E.G. Yasin (ed.), pp.
213-218.
---------------------------------------------------------------------------
The Putin government, as represented by the reform-minded
Minister of Economic Development and Trade, German Gref, issued
an ``anti-bureaucracy'' decree in June 2001 forming the
``Commission of the Government of the Russian Federation for
the Curtailment of Administrative Restrictions on
Entrepreneurship and the Optimization of Expenditures of the
Federal Budget on State administration.'' \26\ This commission
is charged with reducing the amount of bureaucratic
intervention in business affairs, ensuring that laws are
applied to business consistently, and combating corruption of
officials. The government's long-term development program
assigns the anti-bureaucracy commission the following tasks,
among others: \27\ The Commission must lower barriers to entry
into markets, remove technical barriers to the process of
production and trade, eliminate redundant administrative
regulation of entrepreneurial activity, assure agreement
between national and regional organs of authority, and
eliminate redundant and ineffective regulation in the sphere of
arbitration. There should be one system of licensing for the
entire Russian Federation with a unified system of forms and
documentation based on a ``one window'' registration procedure.
Moreover, there should be a register of information on
juridical persons that is available to all, and a sharp
reduction in the number of licensed activities. The licensing
of investment projects (such as major energy infrastructure
projects) are also to have a ``one window'' licensing procedure
and cannot be required to obtain licenses from multiple
authorities. The Commission is also charged with reducing the
number of certifications, the number of agencies that are
allowed to make inspections; and the elimination of duplication
of inspections. Moreover, it is recommended that more use be
made of professional self-regulating organizations, rather than
government agencies.\28\
---------------------------------------------------------------------------
\26\ Postanovlenie pravitelstva rossiiskoi federatsii No. 452, June
8, 2001.
\27\ Kuzminov, Yaroslav. ``Rol gosudarstva i prava v formirovanii
blagopriiatnogo investitsionnogo klimata v Rossii,'' in E.G. Yasin
(ed.), pp. 213-218.
\28\ Osnovnye napravleniia sotsial'no-ekonomicheskogo razvitiia
rossiiskoi federatsii na dolgosrochnuiu perspektivu, Moscow, 2001,
Section 1.2.3.
---------------------------------------------------------------------------
These anti-bureaucracy measures have considerable popular
appeal and the support of both domestic and foreign
entrepreneurs, but they also face considerable opposition. The
economic theory of corruption states that an economy that is
``over-regulated'' with rules, licensing requirements and
bureaucratic interventions encourages corruption.\29\ A highly
regulated economy creates opportunities for government
officials to ``sell'' monopoly rents, or even to charge
businesspersons for carrying out their ``normal'' bureaucratic
duties, like issuing a routine license. The more liberalized
the economy, the fewer the opportunities for officials to earn
income by selling valuable rights or by charging customers for
carrying out their normal duties. If the regulated domestic
price of oil is one half the foreign price, an oil export
license provides the owner of the license an opportunity to
double his money. In a liberalized economy, the two prices
would be the same and the export license would not be valuable.
If there were specific sentencing guidelines in the criminal
code, prosecutors could not sell lenient sentences to
criminals.\30\ If it did not take 6 months to obtain a business
license, the situation would not exist where the license may
officially cost 15,000 rubles but people actually pay
$400,000.\31\
---------------------------------------------------------------------------
\29\ Shleifer, A. and R. Vishny. ``Pervasive Shortages Under
Socialism,'' Rand Journal of Economics, Vol. 23, 1992, pp. 237-246.
\30\ Yasin, E.G. ``Modernization of the Russian Economy: Problems
on the Agenda, Modernization of the Economy of Russia,'' Higher School
of Economics, Moscow, April 30, 2001.
\31\ Press Briefing By Minister for Economic Development and Trade
German Gref, March 2, 2001, op. cit.
---------------------------------------------------------------------------
The regional reform's harmonization of regional and
national laws is intimately related to the anti-bureaucratic
reform in that much of the redundancy and duplication in
matters of licensing and certifications are related to
conflicts between federal and regional statutes and
regulations.
Putin's anti-bureaucracy reforms, if implemented, attack
the heart of official corruption. A lower bureaucratic and
regulatory burden on businesses reduces the demand for official
corruption. The more liberalized the economy's prices,
international trade, banking institutions, licensing
procedures, and the like, the less opportunity officials have
to sell monopolies to rent seekers.
Despite its popular appeal, these anti-bureaucracy measures
face considerable open and hidden opposition for the very
reason that they threaten the incomes of officials, who, more
than likely, receive low nominal salaries for their official
work. Any Russian official with the power to regulate, starting
with a lowly traffic policeman to the distributor of oil export
licenses, stands to lose considerable ``bribe'' income if the
anti-bureaucracy commission is successful. As in Soviet times,
economic reform stumbled over bureaucratic opposition; it
remains to be seen whether Russia's bureaucrats can
successfully block the current reform effort.
Civil Service Reform
Russia's civil service administration is governed by the
Civil Service Law of 1995. Moreover, the Federal Constitutional
Law on the Government of the Russian Federation spells out
rules of conduct for government officials, such as the conflict
of interest rules in article 11. Putin included a basic outline
of proposals for civil service reform in his 2001 agenda, but
apparently no draft of the civil service reform has been
released. Its basic objectives, however, were spelled out in
Putin's state of the union address of April 2001.\32\ According
to Putin, ``the efficiency of a state is determined not so much
by the amount of property it has under its control but rather
by the efficiency of the political and administrative
mechanisms the state has to protect the public interest.'' \33\
In his address, Putin stated the following principles: The
Russian administration is currently too large and needs to be
trimmed. The federal administration employed 882,000 in 1993
but employed more than one million in 2001. The number of
bureaucrats at all levels has grown since Soviet days from 1.15
million in 1980 to 2.6 million. In 2000 alone, the number of
official chauffeur driven cars grew by 23,500 to 605,290.\34\
---------------------------------------------------------------------------
\32\ BBC, op. cit.
\33\ Ibid.
\34\ Reuters, March 6, 2001.
---------------------------------------------------------------------------
In line with the anti-bureaucracy measures, governmental
agencies should be subjected to review to identify their
functions and presumably reduce the amount of overlap. All
relations between the state and business should be transparent,
eliminating the possibility of arbitrary intervention and
excessive regulation.
In its essence, Putin's civil service reform outline aims
to change the Russian bureaucracy from its petitioning and
strong control structure of the Soviet past to a service
culture.\35\ Position papers prepared in anticipation of an
eventual civil service reform state the goal of creating a
professional civil service based upon merit selection, civil
service rules, and competitive salaries that reduce bribe
taking and corruption. Low pay of civil servants discourages
public service and limits the entry of young persons into
public service (the average age of employees in the ministry of
economics is over 50). The assumption is that Russian civil
servants if properly compensated will reduce their intervention
in the affairs of private businesses because they will no
longer need bribes and other payoffs to make ends meet.
---------------------------------------------------------------------------
\35\ Parison, op. cit., p. 362.
---------------------------------------------------------------------------
Although not stated specifically, the need for higher
salaries appears to be a reason why administrative reform is
not scheduled for the immediate future. If an average salary
of, say, $1,000 per month were agreed upon as one that would
drastically limit graft and corruption, this figure alone would
account for about one-third of all federal government spending
or 20 percent of spending from the consolidated budget.
Clearly, if salaries are to be raised to such levels, the size
of the state bureaucracy has to be markedly reduced, which is a
time consuming activity that goes against strong vested
interests.
In order for a public administration reform to be
successful the remnants of the old nomenklatura mentality must
be removed. The nomenklatura mentality was that public
positions are to be obtained not through merit but through
influence, connections, and perhaps even outright purchase.\36\
The nomenclature or bureaucratic mentality also assumed that
membership in the nomenklatura brought with it perks and
privileges not accessible to others. When perks and privileges
associated with public service declined, graft and bribe taking
took their place.
---------------------------------------------------------------------------
\36\ In modern day Russia there are rumors and other evidence that
high-level government positions an purchased. See Parison, op. cit., p.
363.
---------------------------------------------------------------------------
Are Putin's Reforms Too Good To Be True?
The administrative reforms outlined in this paper are
breathtaking in their rhetoric and scope. They surpass the 1992
reform language of the Gaidar reform government. These measures
appear to move the country in the right direction, although one
can disagree with Putin's consolidation of power in the center.
It could be argued that a rule of law can be imposed on a
country in chaos only from the center and that regional
experimentation and autonomy may have to be sacrificed in the
process. Two significant issues remain: Will Putin remain
steadfast in his support of liberalizing reforms or will he,
like his predecessor, Yeltsin, vacillate between liberalizing
and de-liberalizing reforms with the passage of time and
fluctuations in his popularity. If Putin, as a relatively young
man, intends to be President for the next decade, he would
likely take a long-run view and realize that the Russian
economy cannot prosper without a rule of law, without domestic
and foreign private investment, and a reduction of corruption.
Thus, Putin's interests and the interests of economic
rationality would coincide. We, of course, cannot guess what
Putin's personal objectives are, but we cannot rule out that
they prominently include the long-term economic growth and
development of the Russian economy. The second question is
whether Putin, like decades of Russian and Soviet leaders
before him, will be sabotaged in his reform efforts at the
grassroots level. In attacking bureaucratic excesses,
corruption, and barriers to entry, Putin is taking on powerful
and largely unseen forces that have objectives inconsistent
with the development of an efficient economic system. It should
be noted that the current Russian nomenklatura is basically the
old Soviet elite. During the first half of the reform decade,
the survival rate among the regional administrative elite was
82 percent and 65 to 75 percent of the former nomenklatura
continued to occupy positions within the Russian post-Communist
elite. Some have moved across institutional boundaries, but
most have continued to occupy their old positions or similar
positions.\37\ We cannot tell whether such vested interests
still succeed in defeating these and subsequent administrative
reforms. The thousands of administrative decisions that must be
made monthly or quarterly, such as auctions of government
shares in less visible companies or the implementation of de-
bureaucratization rules at the local level, will determine
whether Russia operates by a rule of law or not. These
decisions cannot be taken by the President. They must be taken
by thousands of faceless officials, who must somehow be
motivated to decide in the larger interests of the state. This
is a daunting goal that only a few ``civilized'' countries have
achieved. In this light, Russia faces an uphill battle in its
struggle for rational administrative reform.
---------------------------------------------------------------------------
\37\ These figures are from Stephen White and Olga Kryshtanovskaya,
``Russia: Elite Continuity and Change,'' in Mattei Dogan and John
Higley (eds.), Elite, Crises, and the Origins of Regimes (Lanham:
Rowman and Littlefield, 1998).
RUSSIAN CRIME AND CORRUPTION IN AN ERA OF GLOBALIZATION: IMPLICATIONS
---------------------------------------------------------------------------
FOR THE UNITED STATES
By Jonathan M. Winer and Phil Williams \1\
----------
contents
Page
Summary.......................................................... 97
Russian Organized Crime: Economic Impact and Characteristics..... 99
Historical and cultural elements............................. 101
The element of violence in Russian organized crime and Mafiya
businesses................................................. 106
Typologies of Russian organized crime........................ 109
Differences from Organized Crime Elsewhere....................... 110
The Scope and Impact of Russian Organized Crime Activities
Outside Russia................................................. 111
Where is Russian organized crime?............................ 111
What kinds of presence and how developed?.................... 112
The Impact of Russian Organized Crime on Russia's Evolution...... 113
Money Laundering and Financial Crime............................. 116
The gray economy, Russia's tax system and capital flight..... 117
Poor accounting, auditing, and documentation requirements.... 118
Prominence and connection of organized crime to officials and
official structures........................................ 118
Rent-seeking activity by government officials................ 118
Ease of moving funds offshore................................ 119
Inadequate knowledge base, training, government capacity..... 119
Options for Reform in Russia..................................... 119
Anti-corruption measures..................................... 120
Increased press freedom...................................... 120
Improving tax system......................................... 120
Financial sector regulatory reforms.......................... 120
Legal reforms................................................ 120
Money laundering legislation................................. 121
Policy Options for the United States............................. 121
Summary
While globalization and privatization have clearly fueled
Russian organized crime, organized crime has a lengthy history
in Russia. Among the most important elements of today's
organized crime are liaisons between the nomenklatura, ethnic
traders, and Russian criminals. Important elements of these
groups colluded during Russia's transition to convert the
resources of the Soviet Union's command economy to their
personal ownership and control. The mechanisms by which they
accomplished this included ruble to dollar credit manipulation,
theft of natural resources owned by the government through
false documentation, the exploitation of the state to secure
exemption from taxation and from oversight, bribery, extortion,
contract killings, and money laundering. Triangular
relationships between criminals, business persons, and
officials exploit the lack of clear distinctions in Russia
between what is legal and what is illegal; what is public and
what is private; and what is permissible and what is
prohibited. Closely linked to Russia's organized crime is
Russian money laundering, whose infrastructure serves not only
criminals but facilitates large-scale capital flight, depriving
Russia of fiscal resources, and fueling Russia's shadow
economy.
---------------------------------------------------------------------------
\1\ Jonathan M. Winer, formerly U.S. Deputy Assistant Secretary of
State for International Enforcement, is currently counsel at Alston &
Bird, L.L.P. Dr. Phil Williams is a Professor in the Graduate School of
Public and International Affairs at the University of Pittsburgh and
formerly Director of the University's Ridgway Center for International
Security Studies. Certain elements of this paper were originally
prepared for the National Intelligence Council in spring 2001 in
separate presentations by each of the authors.
---------------------------------------------------------------------------
The transformation of Russia to a country where free
markets and democracy are realities requires Russia to
undertake steps that threaten those whose power depends on
discouraging rule of law, including criminals, exploitative
business persons and corrupt bureaucrats. Russian organized
crime will likely continue to oppose Russian efforts to collect
taxes in a fair manner, pay its civil service a living wage,
maintain high caliber professionals in government, build
effective self-regulatory organizations, and sanction those who
engage in unfair trade and business practices. Reforms that
would begin to provide an environment better suited for Russia
to combat its organized crime problem would include effective
anti-corruption measures, increased freedom of the press, a
fairer and more effective tax system, financial sector
regulatory reforms, legal reforms, and effective implementation
of the recently passed money laundering legislation.
The investment that Russia has attracted over the
past few years is minuscule, compared to that which has
flowed to other transition economies, and to that which
the country should attract, given its rich natural
endowment and its talent and educated workforce. If you
deduct negative investment, i.e., capital flight, the
picture is a bit more discouraging. Capital flight is
estimated at about $2 billion per month. That amount
attracted is meanwhile worse than minuscule. As
President Putin said in his April Address to the
Federal Assembly, up to now the only investors who have
come here are those who have to be here, whether
because they focused on Russia's natural resources or
are supplying Russia's still fledgling consumer
industry . . . The reasons for this situation are the
very issues that the Russian government is now moving
to confront. They include corporate governance abuses,
the country's weak judicial system, and inadequate
defense of property rights, excessive bureaucracy and
lack of transparency, and corruption. All of this
further adds up to a profound issue of the lack of
trust in economic institutions that continues to hinder
normal economic relationships and structures from
developing. (Farewell speech, U.S. Ambassador to
Moscow, Ambassador James Collins, American Chamber of
Commerce, June 15, 2001)
The excitement over reform in Russia--the passage of
a budget, tax changes, a growing economy and political
stability--is increasing among the international
business community. In fact, it seems that Russia will
soon become the darling of foreign investors, with
political risk now practically nil and state coffers
overflowing with petrodollars. But within this
favorable situation, some critical factors remain
largely ignored. The real environment in which Russian
business operates, at least those firms that are
profitable, lies within the shadow of criminal
organizations with strong links to both the government
and bureaucracy . . . Since Russian crime syndicates do
not have the documented origins and family structure of
the Cosa Nostra--and are often loosely tied through
backroom dealings--statistics on how many Russian
businesses are actually under the control of the
``Mafia'' are virtually impossible to come up with. But
the fact that almost all of the thousand-odd contract
killings of business people here over the past seven
years remain unsolved speaks for itself. (Editorial,
``A Culture of Crime,'' Russia Journal, July 23, 2001)
Average Russians continue to suffer abuse daily at
the hands of the militia, the traffic police, and
corrupt bureaucrats. The state may try them more than
once for a crime. They may be detained without charges
for seventy-two hours or held in a tuberculosis-ridden
pre-trial detention center for years. Opening a
business involves as much paperwork and bribery as
ever. The mafiya still extracts dan from entrepreneurs.
The countrywide decay that began during the Yeltsin
years continues, with television towers catching fire,
nuclear submarines sinking, military aircraft crashing
to earth, apartment buildings exploding from leaks in
decrepit gas pipes, and entire regions of the country
going without heat and electricity in winter months.
Thirty-six percent of the population, or 52 million
people, live below the subsistence level, set at a
dollar a day. (Article, ``Russia is Finished,''
Atlantic Monthly, May, 2001, Jeffrey Tailer)
Russian Organized Crime: Economic Impact and Characteristics \2\
There is widespread consensus that the weakness of the
Russian state, the existence of a pre-existing black market,
and the corruption that pervaded the privatization process
inhibited the development of formal legal standards and norms
that would have exercised effective control over Russia's rapid
transition from a command to a market economy. There is less
consensus about the role played by organized crime in these
problems. Some commentators seek to differentiate the economic
impact of capital flight involving corruption and theft of
resources from traditional forms of organized crime, such as
drug trafficking, trafficking in women, motor vehicle theft,
and extortion.\3\ However, standard characterizations of
organized crime tend to define the activity in ways that render
such differentiation meaningless: organized crime encompasses
economically motivated illicit activity undertaken by any
group, association or other body consisting of two or more
individuals, whether formally or informally organized, where
the negative impact of said activity could be considered
significant from an economic, social, violence generation,
health and safety and/or environmental perspective.\4\
Furthermore, even if one limits the definition of organized
crime to that activity involving illicit force or the threat of
force by non-state actors, such as contract killings or
extortion, it remains clear that Russian organized crime
pervaded the Russian transition, affecting such important
economic sectors as oil and gas, minerals and other extractive
industries, financial services sector institutions; and
substantial portions of Russia's cross-border trade.\5\
---------------------------------------------------------------------------
\2\ For the sake of length and clarity, this paper looks at Russian
organized crime in terms of criminal activity arising in and out of
Russia itself, regardless of which Russian-speaking ethnic group
carries out the activity. In general, the observations within this
essay would apply with equal force to most other components of the
former Soviet Union, including in particular Ukraine and Kazakhstan,
and to some extent Belarus, Georgia, Armenia, and the Baltics. The
tribal history and future of most of the other ``stans,'' which include
the withdrawal of substantial components of the former Soviet presence,
represent a distinct set of problems, including Islamicism and poppy
cultivation, which require separate analysis.
\3\ See e.g., L. Grigoryev, A. Kosarev, ``Capital Flight: Scale and
Nature,'' February 24, 2000, available from the International Monetary
Fund (IMF), Bureau of Economy Analysis, arguing that most of the money
laundered out of Russia represents avoidance of currency exchange and
tax laws, rather than income obtained through drug trafficking,
financial manipulations or racketeering. The authors argue that whereas
in the west, the transferred funds would represent theft of a company's
resources from owners or shareholders, in a Russian context, ``owners
and managers oftentimes do not draw much of a distinction between cash
belonging to the enterprise and their own cash.'' As argued below, the
lack of such distinctions is one of the major problems confronting
Russia.
\4\ This definition is taken from the 1998 ``Organized Crime Impact
Study,'' of the Solicitor General of Canada. Other definitions include
INTERPOL's 1988 definition of organized crime as ``Any enterprise or
group of persons engaged in a continuing illegal activity which has as
its primary purpose generation of profits, irrespective of national
boundaries,'' from INTERPOL's First National Symposium on Organized
Crime at St. Cloud, France, May 1988; the German national police or
Bundeskriminalamt (BKA) definition of organized crime as ``Any group of
people who have consciously and deliberately decided to cooperate in
illegal activities over a certain period of time, apportioning tasks
among themselves, and often using modern infrastructure systems, with
the principal aim of amassing substantial profits as quickly as
possible,'' and the current INTERPOL definition, ``Any group having a
corporate structure whose primary objective is to obtain money through
illegal activities, often surviving on fear and corruption.'' The
United Nation's Convention Against Transnational Organized Crime,
signed in Palermo, Italy in December 2000, defines organized crime as
actions undertaken by a group of three or more persons in violation of
national law for economic or financial benefit. Each of these
definitions captures the activities in Russia that are the subject of
this article.
\5\ A report in St. Petersburg Times, June 25, 1999, suggested that
contract ``hits'' were most common in the oil and gas, metals and
banking sectors.
---------------------------------------------------------------------------
Recent figures suggest that the influence of organized
crime in Russia's economy remains a significant element of
Russia's economy, as well as its political life. On February 7,
2001, Alexander Kulikov, the Chairman of the state Duma
security committee announced that the shadow economy had become
a matter of national concern, as the level of criminal business
was seriously undermining the economic security of the state.
Citing statistics from Russia's Interior Ministry, Kulikov
stated that some 40 percent of Russia's economy was engaged in
the shadow sector through parallel commercial structures
involving ``filial companies'' and ``dummy firms,'' in such
sectors as alcohol, gambling and show business.'' \6\ According
to Kulikov, between 50 and 85 percent of all banks operating
throughout Russia are under the control of organized crime,
while revenues from the shadow economy making up 40 percent of
Russia's gross domestic product (GDP), with nearly 9 million
citizens involved in such activities. Kulikov also claimed that
``over the last five years, the number of organized crime
groups increased 17 times, while the number of groups with
corrupt links rose 170 times.'' \7\
---------------------------------------------------------------------------
\6\ "Criminal Business Undermining Economic Security of Russia,''
February 7, 2001, RIA Novsti.
\7\ Id.
---------------------------------------------------------------------------
Notably, Russia's economy ministries take a different view.
Recently, Russia's Economic Development and Trade Minister,
German Gref, contends that conditions for investment in Russia
by foreigners are ``better than ever'' and that a ``silent
revolution'' has taken place in Russia's economy, making the
picture for the future positive.\8\ While the recovery has
closely paralleled the worldwide increase in prices for natural
resources, in particular, oil and gas, some analysts also
contend not only that the impact of Russian crime on Russia's
economy in the past has been overstated but also that it is
likely to diminish even further in the future.\9\ For the most
part, however, there is a consensus that capital flight,
infrastructure decay, tax collection, loss of foreign
investment, remain current, not historical problems, and each
problem has been exacerbated by Russian corruption and
organized crime.\10\
---------------------------------------------------------------------------
\8\ Interview, Russia TV channel, Moscow, BBC Monitor, June 24,
2001,
\9\ See e.g., ``Think Again,'' Anders Aslund, Foreign Policy, July/
August 2001, arguing that the 44 percent loss of GDP in Russian from
1989 to 1998 is ``grossly exaggerated'' due to statistical quirks; that
the virtual barter economy is ``marginal,'' and that because
privatization ``permanently deprives public servants of public property
. . . they can no longer charge money for the privilege of using it.''
Aslund states that the Russian investment climate remains poor because
of ``excessive bureaucracy and corrupt law enforcement,''
distinguishing these elements from what he views to be essentially
honest ``privatization.''
\10\ See e.g., CRS: RL30394: Russian Capital Flight, Economic
Reforms, and U.S. Interests: An Analysis, William H. Cooper, Specialist
in International Trade and Finance, Foreign Affairs, Defense, and Trade
Division, John P. Hardt, Senior Specialist in Post-Soviet Economics,
Foreign Affairs, Defense, and Trade Division, March 10, 2000, ``Capital
flight is a symptom of poor economic conditions in Russia. But it also
re-enforces poor economic conditions as it deprives the economy of the
critical investment and budgetary resources to build sustainable
economic growth and finance social welfare programs.'' See also
testimony of U.S. Secretary of the Treasurer Larry Summers before House
Committee on Banking, September 21, 1999, stating that ``money
laundering requires neither official corruption nor capital flight.
However, the three often come together where the rule of law is weak
and confidence in the economy is low.''
---------------------------------------------------------------------------
historical and cultural elements
While globalization and privatization have clearly fueled
Russian organized crime, its presence in Russian society goes
back to Czarist times, and endured throughout the Soviet
period.\11\ Salient factors pertaining to the relationship
between the Russian Government and Russian organized crime that
have endured throughout the 20th century include:
---------------------------------------------------------------------------
\11\ See e.g., ``A State of Lawlessness, Corruption, Coercion Reign
in Russia,'' David Hoffman, Washington Post, September 10, 1999, noting
``throughout its history, from the czars to the Soviet Communist Party,
Russia has no tradition of the rule of law. The legacy of previous
generations runs deep and includes a chasm between state and society
and a heritage of arbitrary and unreachable authorities. Power was
exercised ruthlessly and without recourse for its victims. Today's
Russia, despite the changes of recent years, still bears the deep
imprint of this history.''
Disconnection between the authority and legitimacy
of the head of state (whether the Czar, Stalin, or
Yeltsin) and the actions of the often arbitrary or
ineffective government operating beneath the head of
state, with the result that the head of state has often
acted to undermine the authority of key ministries and
agencies.\12\
---------------------------------------------------------------------------
\12\ While this assessment may not be true of the Putin government,
the current structural elements of Russian organized crime are a
continuing consequence of the conditions of their formation and
operation during the Yeltsin period.
---------------------------------------------------------------------------
Rulemaking and regulation which in practice and
effect are experienced as arbitrary and capricious by
the governed, making their rationality, as well as
legitimacy, questionable.
A lack of a developed and vigorous civil society.
Social structures and institutions apart from the
government are not only weak but are accompanied by
governmental structures that function incompetently.
Corruption as a way of life for officials, whether
motivated by a desire simply to make ends meet or by
greed.
Corruption as a way of life for the private sector,
however large or small that has been, to get its
business done.
Little transparency in governmental operations,
leading to inadequate oversight and lack of popular
participation in governmental decisionmaking.
Collusion and even merger of key governmental
officials and structures with counterpart criminals and
criminal organizations on the outside.\13\
---------------------------------------------------------------------------
\13\ A comprehensive journalistic description of this phenomenon in
the Yeltsin era is set forth in ``Comrade Criminal--Russia's New
Mafia,'' Stephen Handelman, Yale University Press, 1995.
---------------------------------------------------------------------------
A tradition of governance that emphasizes the rule
of people or party and not the rule of law. Both the
Czars and the Communists, in effect, were both above
and beyond the law.
These conditions, which have undermined the Russian
Government and strengthened Russian organized crime, are the
heritage of both Czarist Russia and the Soviet state. Lenin and
Stalin built power upon the delegitimatization of the Czarist
state. The new Soviet Union was not an expression of a
government in a traditional sense, but of a system of
governance that aimed to further the ends of a political party,
the Bolsheviks, whose means, if not their explicit goals,
differed in scale but not in substance from those used by
organized crime the world over. Core values of criminals
everywhere are disdain for rule of law and for democracy.
Criminals have no reason to adhere to either principle, except
to the extent that they are threatened by sanctions being
enforced by those who do adhere to those principles. The
Russian Communist Party had similar reasons to oppose both the
principles of rule of law and of democracy. Any increase in
either of those two trends created a concomitant and relatively
proportional increase in the risks that sanctions would be
applied to the Communists and their relative power in society
would decrease.
During the Brezhnev stagnation, the ideological and
patriotic fervor sustained by the victory over the Germans in
World War II and the grab for empire in Central Europe in the
post-war period waned. Significant elements of the Communist
Party, the Soviet Government, and the Soviet economy developed
into a system of ``mafiyas'' that had a close resemblance to
governance in Sicily. Favorites obtained territories that they
were permitted to exploit. In that corruption, lay what a
number of commentators have described as the seeds of the
criminalization of the modern Russia, through the development
of criminal practices, by three identifiable classes of
persons:
Nomenklatura, whose access to resources and licenses
provided a means of trading access and permission for
material goods and special privileges. The nomenklatura
consisted of both state managers and members of the
institutions of social control such as the KGB, the
Ministry of Interior and even the Soviet military.
Ethnic traders, whose non-Russian status gave them
greater access to the West, western institutions, and
capitalist activities at a time when direct
participation in commerce would have been ideologically
risky for members of the nomenklatura themselves. The
traders, who included Jews, Armenians, and Georgians,
among others, formed the bow wave of this group, acting
as importers and exporters under the Soviet regime,
often in complex relationships with governmental
enterprises, elements of the nomenklatura, elements of
Soviet intelligence, and elements of the Soviet
military;
Thieves in law and other Russian criminals who honed
bureaucratic survival skills in the gulag; later these
groups formed close ties with those involved in Russian
wrestling, hockey, and other sports where physical
strength provided a basis for prestige and power on the
one hand, and for demonstrating the ability to provide
physical protection (or physical intimidation) on the
other.
During the 30 year period of the cold war (roughly, from
the death of Stalin through the death of Chernyenko), Geneva,
Paris, Vienna, and Tel Aviv became important entry points for
covert financial activities by the Soviet Union. Riga,
Kalingrad, and Crimea developed port capabilities suitable for
smuggling. Third world outposts in the Middle East, Africa,
South East Asia, and during the 1980s, Central America, became
opportunities for refining techniques of transporting
prohibited goods through corrupt or weakened governmental
mechanisms. False invoicing, fraudulent documentation, the use
of shell companies and cut-outs, all essential elements of the
tradecraft of Soviet espionage, became techniques widely known
through the relatively small community of people who handled
the Soviet's economic contacts with the West. These techniques,
together with a culture of non-transparency and corruption,
would translate easily into post-Communist Russia, and
eventually play a substantial role in swallowing up reform.
Indeed, they inflicted profound systemic harm to Russia's
initial efforts, from 1990 through 2000, to modernize its
political and economic system in a manner that would strengthen
rule of law and democracy.
In this context, the Gorbachev reforms weakened the
position of the Communist Party in society and of the state
itself. Glasnost created the intended consequence of greater
democratization and strengthened those elements of society,
such as the academic and professional elites, the core of the
then Russian upper middle class, whose political and economic
opportunity would increase with greater democratization and
strengthened rule of law. However, the reform process had the
paradoxical result of also strengthening those elements of
government that saw the weaker state as presenting a once-in-a-
lifetime opportunity to seize control of important resources,
and those elements of society that saw the weaker state as an
unprecedented opportunity to engage in predatory or criminal
behavior with little fear of retribution.
The Communist Party and the Soviet State had historically
functioned as mechanisms to divide up the wealth of whatever
they controlled as the arbiters of the command economy. With
the breakup of the Communist Party and the Soviet State as the
entities which by right or might controlled all the wealth of
the Soviet Union, who had the right to the resources was an
extraordinarily open question. Not surprisingly, therefore, the
three groups who provided the basic components of a novel and
distinctive form of organized crime--the nomenklatura
(including important elements of the military, law enforcement,
and Soviet intelligence), the ethnic traders, and the criminals
and athletes--found enormous and lucrative opportunities to
collude with one another to convert the resources of the Soviet
Union's command economy to their personal ownership and
control. The mechanisms by which they accomplished this were as
myriad as the opportunities provided by the transition from the
Soviet economy to the so-called market economy. Some of the
more significant included:
The issuance of large quantities of ruble loans by
Soviet financial institutions to well-placed persons
who later became known as oligarchs. These ruble loans,
issued at interest rates that were intentionally well
below market, were immediately converted into dollars.
The mass conversion of these rubles into dollars in
turn facilitated the depreciation of the ruble against
the dollar, providing instant wealth the holders of the
dollars, who were able to repay their debts at a few
kopecks to a ruble. This activity had a massive impact
in reducing the value of the ruble against other
currencies and its buying power within Russia. It
simultaneously provided a mechanism by which those with
the ability to borrow rubles (i.e., ruble debtors) had
a lever to convert a substantial portion of the
inherited capital of the Soviet Union into personal
fortunes. The concomitant corollary of this activity
was the devaluation and the commonplace reduction to
beggary of the millions of souls who had the misfortune
of actually holding rubles. These soon became worthless
and were exchanged at a ratio of 100 to 1 for new
rubles.\14\ Thus the wealth of a nation, such as it
was, was efficiently converted into the capital of the
few. Prominent examples of this class of oligarch/
criminal include Boris Berezovsky, Vladimir Gusinsky,
Alexander Smolensky, and Mikhail Khodorkovsky.\15\
---------------------------------------------------------------------------
\14\ The initial devaluation of the Russian ruble in the early
1990s was far more profound in its consequences than the more recent
devaluation of 1999, which merely reduced the ruble's value by 75
percent, with the other three-fourths of the ruble's value mostly going
to the lucky holders of Russian bonds who had been able to book the
interest rates without holding as their own the worthless notes once
the IMF recognized the folly of being the guarantor of the integrity of
Russia's banking system. The systemic misleading of the IMF by Russia's
Central Bank (Central Bank of the Russian Federation), including its
long-term chief Central Banker, as evidenced in the Financial
Management Company (FIMACO) affair in spring 1999, prior to the ruble's
collapse, provided evidence that Russian financial services regulation
did yet to meet global standards.
\15\ Khodorkovsky declared his flagship bank, Menatep, bankrupt at
the time of the Russian ruble crisis, moving its assets to a second
Menatep in St. Petersburg, and re-opening the Moscow offices of Menatep
in the form of an oil company that he had purchased through
manipulating Menatep's assets. In the United States, this activity
would constitute racketeering. In Russia, Khodorkovsky continues to be
a successful businessman and financier.
---------------------------------------------------------------------------
Chubais' voucher-for-shares plan, which enabled the
oligarchs who had previously enriched themselves
through dollar-ruble manipulations to further secure
the ownership of the vast preponderance of Russia's
wealth-generating industries, especially those in oil
and gas, metals, timber, and other extractive
industries.
The sale of natural resources owned by the
government to private persons through various
mechanisms, including many involving false invoicing,
false financing, false titling, and false ownership,
enabling those who were able to control the export of
any particular quantity of natural resources to steal
most if not all of its value without having to pay
market prices for the goods, taxes on the goods, funds
to invest in the productive infrastructure to continue
the goods, or any other costs besides those associated
with bribing or killing anyone who might prevent them
from so exporting the goods.
The exploitation of the state to secure unique
benefits, such as exemption from taxation and from
oversight, as was exemplified by Viktor Chernomyrdin's
effective stewardship over Gazprom during the period he
was Prime Minister of Russia.
Thus, collusion between those controlling Russia's
resources, traders and brokers, and armed enforcers built the
new system of Russian governance and economics. Under Brezhnev
and his successors, the Russian command economy had required
coercion, extortion, theft, repression, and systemic corruption
in order to function. In the Yeltsin period, this devolved into
a new public-private system for government that preserved most
of these mechanisms (i.e., coercion, extortion, theft,
repression and systemic corruption) but substantially
privatized them, and made them even harder to control: in
short, Yeltsin's reforms, taking place in the context of a
corrupted Soviet state, resulted in empowering a criminal class
to take over an economy, and in important areas, its
government.
As a consequence of these structural and cultural features
of Russian life, Russian organized crime has not been simply
about the provision of illegal goods and services; it is also
about the control of legal goods and services. In Russia there
is not simply a criminal-political nexus but a political-
criminal-business troika, consisting partly of dense network
connections among key people in the three sectors ands partly
of some figures straddling the three sectors, and engaging in
politics, licit commerce and illegal business. These networks
are ubiquitous. They have several dimensions: direct person to
person relations; shared ownership of, or interest in, specific
companies; and linkages through pivotal figures who are clearly
network connectors.
Russian organized crime is thus characterized by at least
three seamless webs--the seamless web between extortionists and
security companies, the seamless web between licit and illicit
business, and the seamless web between criminals on the one
side and political and bureaucratic elites on the other. Out of
these seamless webs has emerged a triangle of crime, business,
and politics. There are two major reasons why this triangular
relationship is extremely strong and resilient. First, each of
the participants brings a different but complementary dimension
to the table, thereby ensuring that the exchange relationships
are beneficial to all. The political figures have access to the
resources of government; the business figures bring both access
to wealth and connections in the worlds of commerce and
finance; and the criminal organizations provide coercive power
and plausible deniability for the other two groups.\16\ The
triangular relationship is an alliance of convenience rather
than of natural affinity, but the benefits are so deep that, in
effect, the relationship has become institutionalized. Second,
the triangle is based on the lack of clear distinctions in
Russia between what is legal and what is illegal; what is
public and what is private; and what is permissible and what is
prohibited. Furthermore, so long as there is no clarity in the
borders among these areas, the stability and durability of the
triangle are likely to continue unhindered.
---------------------------------------------------------------------------
\16\ The authors would like to thank Gregory Baudin-O'Hayon, a
Graduate Research Associate at the Ridgway Center, University of
Pittsburgh and William Cook, formerly a Graduate Research Associate at
the Ridgway Center, University of Pittsburgh for the ideas, research,
and network diagrams that have informed this part of the analysis.
---------------------------------------------------------------------------
the element of violence in russian organized crime and mafiya
businesses
It is often observed that in Russia those would limit
themselves to legitimate business activity in other countries
must engage in criminal activities such as tax evasion and
money laundering in Russia, in order to carry out legitimate
business. While this observation may be true in the case of
particular individuals, the magnitude of clearly criminal
violence involving extortion has been an impressive feature of
Russia's economic transition. During this transition, cities as
diverse as Yekaterinburg and St. Petersburg have been
characterized by clashes among rival groups that surpass
anything that occurred in Chicago during Prohibition. One
result of this has been the success of a new generation of
Russian criminals who do not accept the old rules of the vor-v-
zakone and see the rapid accumulation of wealth as their raison
d'etre. The criminals, however, have gone well beyond killing
one another. While rivalry in the criminal world is certainly
not unique to Russia, what has been far more surprising is the
diversity of the targets of Russian contract killings. The
victims have included bankers and businessmen, journalists and
reformist politicians, local bureaucrats, hotel managers, and
anyone who poses a threat or presents an obstacle to criminal
activities. In one prominent case, American businessman, Paul
Tatum was killed amidst reports that he had been feuding with
his Russian business partners in the Radisson Hotel joint
venture. Another prominent victim was Galina Staravoitova, a
leading Duma deputy active in combating organized crime and
corruption.\17\ Other victims in recent years have included:
Ilya Waisman, economic and finance director of the Baltica Beer
Company, who, in January 2000, was shot and killed at his home
in St. Petersburg; Uralmash General Director Oleg Belonenko who
was killed in July 2000; and Alexander Volkovsky, President of
the Russo-Balt Petroleum Company, who was shot in the entrance
to his apartment building in January 2001. Not all hits are
successful of course. Among those who survived an attempted
contract killing was Deputy Mayor of the Moscow city
government, Iosif Ordzhonikidze, a figure with considerable
reputation as a facilitator for business.
---------------------------------------------------------------------------
\17\ See William A. Cook and Gregory Baudin-O'Hayon, ``A Chronology
of Russian Killings'' Transnational Organized Crime, Vol. 4 No. 2
Summer 1998 pp. 117-201.
---------------------------------------------------------------------------
Official statistics suggest some improvement in the
situation, with only 386 contract killings in Russia in 2000, a
major decline from the 500 to 600 that occurred each year
through most of the 1990s.\18\ Obtaining accurate figures,
however, remains difficult, not least because different
officials often release contradictory statistics. In June 1999,
for example, senior Ministry of Interior official, Akhmed
Khairov, deputy head of the Interior Ministry's major crimes
section told journalists that 567 people were murdered in
contract killings in Russia during the first 5 months of 1999--
more than double the 232 killed during the same period in 1998.
Khairov attributed the increase to the financial collapse of
August 17, 1998 and the increase in unpaid debts.\19\ Yet in
March 2001, Alexander Kirushev, deputy chief of the Ministry of
Interior's Criminal Investigation Main Administration noted
that the number of contract killings in 2000, was only 386--
down from the 591 committed in 1999. Unless the fall-off rate
in the second half of 1999 was unprecedented (only 24 contract
killings in 7 months), this seems to be a considerable under-
estimate for that year. Even allowing for the discrepancy
however, the overall trend does seem to have been a marked
reduction in the number of contract killings (accompanied by an
increased success rate in solving these murders). However, the
apparent trend should treated with some caution. An examination
of the incidence of contract killings reveals a clear tendency
to cluster in particular industries or economic sectors for
several months (or in some cases 1 or 2 years) and then to
disappear. This can be explained in several ways. Perhaps the
most plausible explanation is that contract killings cease when
organized crime has achieved its objectives and successfully
infiltrated a particular sector such as banking or a particular
industry such as aluminum. By eliminating those who resist
them, organized crime can have a highly coercive impact on
those who are left--without further killing. Similarly, the
reduction in contract killings of vory-v-zakone or criminal
authorities suggests that internecine warfare in the criminal
world has given way to an established pecking order in which
territories and markets have been divided up in ways that are
more or less acceptable. In short, the decline in contract
killings suggests not a decline in the power and influence of
organized crime but its consolidation.
---------------------------------------------------------------------------
\18\ Aleksandr Strogin ``Contract Killings Being Cleared Up After
All. One Has Already Been 60-Percent Cleared Up'' Moscow Kommersant, 21
Mar 2001 p. 3.
\19\ See St. Petersburg Times, June 25, 1999, ``Russia's economic
woes have put the cut-throat back into competition, with the first 5
months of 1999 seeing the incidence of contract killings double,
Interior Ministry officials said Thursday. Between January and May this
year, 567 businessmen were slain on the orders of their competitors,
compared to 232 such killings over the same period last year and 599
contract killings for the whole of 1998, according to police figures.
The figures also show contract ``hits'' are most common in the oil and
gas, metals and banking sectors, said Akhmed Khairov, deputy head of
the Interior Ministry's major crimes section.''
---------------------------------------------------------------------------
Indeed, as the comments by Kulikov quoted above indicate,
organized crime has had considerable success in infiltrating
and controlling legitimate businesses and economic sectors. The
methods by which Russian organized crime has achieved this
include contract killings but only as part of a complex mixture
of guile and intimidation, political influence and acts of
violent criminal intimidation. On the basis of an analysis of
the Russian aluminum industry as well as the energy sectors in
St. Petersburg, it is possible to identify forms of behavior
that tend to be present in all such cases (and that provide
ample warning indicators):
Murder and other violent attacks on personnel in a
particular company or industry sector who might be an
obstacle to the takeover.
Equity or share purchases designed to obtain a
controlling interest in a particular company. In some
cases, shares are obtained through coercion and
violence; in other cases where it is necessary to avoid
Russian anti-monopoly legislation they are done through
front companies that obscure the real ownership and
interest.
Insertion of personnel into management positions or
on to boards of directors. Packing the board is also a
means of ensuring that once the takeover has succeeded
control is maintained
Obtaining support from corrupt links with
politicians who are visibly in favor of the takeover
effort and lend their power and prestige to at least
those parts of it that are legal and transparent.
These apparently disparate tactics typically blend into a
coherent and effective strategy that facilitates at least
short-term domination of an industry that in some cases is
transformed into a longer-term pattern.
There is one view of mafia business, presented most fully
by Diego Gambetta that suggests that the mafia is really about
the business of private protection.\20\ Federico Varese has
applied this argument to Russia, and suggested that although in
many cases the relationship between criminal organizations and
businesses are purely parasitical, in other instances there
really is protection for businesses as the criminals developed
a vested interest in their success.\21\ In some cases the
protection is requested; in others it is imposed. Whatever form
it takes, extortion appears to be the single most important
staple of organized crime activities at the local level,
particularly as rivalries have given way to more stable spheres
of influence among criminal organizations.
---------------------------------------------------------------------------
\20\ Diego Gambetta, The Sicilian Mafia: The Business of Private
Protection, Cambridge, MA: Harvard University Press, 1993.
\21\ See e.g., Federico Varese, ``What is the Russian Mafia?'' Low
Intensity Conflict and Law Enforcement, Vol 5 No. 2, pp. 129-138. See
also Varese's forthcoming book on the Russian Mafia published by Oxford
University Press.
---------------------------------------------------------------------------
As well as ubiquitous protection rackets, Russian criminals
traffic in a wide variety of products--stolen, regulated and
illegal. Trafficking in women, nuclear material, arms,
endangered species, drugs, icons, stolen cars, give the Russian
organized crime scene a comprehensiveness that at least matches
and perhaps surpasses that in Italy, China or Japan. In some
cases Russian criminal organizations traffic commodities out of
Russia; in other cases Russia itself provides the market--as
for drugs and stolen cars. The wide portfolio is perhaps
exemplified best by the Solntsevo group that reportedly
controls the University, and Cosmos hotels; several casinos;
the Solntsevo car exchange; all non-food markets in the
Southwest District of Moscow; and commercial transportation to
and from Vnukovo airport. In addition, about 300 commercial
firms and banks are believed to be under Solntsevo's ownership
or control. These extend beyond Moscow to Samara and Crimea and
even to Hungary, Britain, and Israel.\22\
---------------------------------------------------------------------------
\22\ For a useful discussion see Jeffrey Robinson, The Merger,
London: Simon and Schuster UK, 1999.
---------------------------------------------------------------------------
typologies of russian organized crime
Organized crime historically has been first and foremost
about muscle. In the case of Russian organized crime this
element is certainly not lacking. Yet there is also a high
degree of sophistication. A great deal of Russian organized
crime is financial crime or what has traditionally been
categorized as white-collar crime rather than the more mundane
forms of organized crime. Sophisticated fraud and embezzlement
schemes, proximity to the banking sector, the widespread use of
front and shell companies to move money and illegal products
across borders, and the extension of networks of power and
influence into the licit economy are all characteristics of
Russian organized crime that stand out. Even if the financial
dimensions of Russian organized crime are not completely
unprecedented, they are a much more important part of Russian
organized crime than the provision of illegal goods and
services.
The Russian criminal scene is characterized by considerable
diversity, and it is possible to identify at least six
different kinds of criminal groups in Russia:
Businesses that are ostensibly (and in some
instances perhaps even predominantly) licit but with
their origin in criminal activities and a residual
tendency to use violence and corruption to protect and
promote their activities and to deal with competitors.
Criminal organizations that have close links with
officials and that are a key part of the competing
administrative financial criminal oligarchies that are
one of the dominant forces in Russia today and that
operate at local and regional levels as well as
nationally.
Ethnic criminal organizations that include Slavic,
Azeri, Georgian, and Chechen groups and that often
specialize in one of more criminal activities. Although
weakened somewhat by the ``wars'' with the Slavic
criminals, these groups remain a significant part of
the organized crime scene in Russia.
What might be termed umbrella criminal associations
that encompass a wide range of smaller groups and
engage in a wide variety of criminal activities.
Perhaps the exemplar of this kind of association is the
Solntsevo group. One of Moscow's premier criminal
organizations, Solntsevo has several layers of strong
leadership, a well-established structure, a high level
of professionalism, some 300 individual crime groups in
its fold, and extensive transnational connections.
Predatory criminal organizations that essentially
engage in small-scale criminal activities such as
localized extortion, car theft and the like, and that
do not have links with corrupt officials. These
organizations are more like street gangs than organized
crime, although the more successful ones evolve into
organized crime groups and develop links with the
business, political, and administrative elites.
Specialized organizations including groups of
contract killers that are the equivalent of the old
``murder incorporated'' in the U.S. mafia.
This diversity--although sometimes a source of conflict
among the different kinds of organization--makes the Russian
criminal world particularly difficult to contain. Tactics that
work well against some groups are less effective against others
with different characteristics.
Differences from Organized Crime Elsewhere
Russian organized crime has some features in common with
organized crime elsewhere, including the interpenetration of
organized crime with government corruption, its reliance on
extortion and bribery, and its provision of black-market goods
and services in prohibited economic sectors. However, for
reasons of history and culture, it also has distinct
characteristics, even where it resembles other recent models
for widespread organized crime.
For example, in post-World War II Italy, organized crime
flourished through a menage a trois between Italy's political
parties, especially the Christian Democrats, the Mafia, and
Italy's labor unions, whereby the three groups traded jobs,
business, and money among one another to sustain the power of
each for some 45 years until the culture demanded a more law-
based system.\23\ However, even Italy's heavily criminalized
political class remained only a strand, albeit a thick strand,
in a broader set of political, social, and economic
institutions. While the Italian mob may have held enormous
influence with Italy's political parties and its governmental
personnel practices, especially at the local level, it never
dominated Italian business life or controlled a preponderance
of Italian resources. Legitimate businesses in the north were
not mobbed up. They controlled their own capital, and that
capital was invested in legitimate enterprise.
---------------------------------------------------------------------------
\23\ See ``Excellent Cadavers,'' Alexander Stille, Pantheon, 1995.
---------------------------------------------------------------------------
Similarly, other powerful criminal cultures in larger
countries in the world have tended to be limited to inhabiting
portions of society, rather than a country's heart. For
example, Nigerian crime features tribal predation. Criminal
cells or families prey on innocents elsewhere in Nigeria, or
outside Nigeria, but seldom their own people. In China and
Japan, particular criminal subcultures maintain limited and
unreliable ties to elements of the government (Chinese triads,
Japanese yakuza), but do not control vast components of their
country's respective national resources. In drug trafficking
countries, such as Colombia, criminal enterprises can exercise
enormous political and economic influence, and infiltrate
governmental institutions and businesses, but the traffickers
are viewed by everyone as external elements to the institutions
they are corrupting, rather than as components of them as in
Russia. In most other countries, such as the United States,
Canada, Western Europe, and the Middle East, criminal groups
exist almost entirely as subcultures, often based on
disaffected components of society, segregated by and with
resentments arising from economic class or ethnicity.
In short, Russian organized crime has differed from
organized crime in other regions in being less of a subculture,
and more central to what has always been a centralized state
with relatively few other political institutions to act as
counterweights.
The Scope and Impact of Russian Organized Crime Activities Outside
Russia
Globalization has meant that the infrastructure of the
western democracies, for finance, information,
telecommunications, governance, has rapidly spread throughout
the world to constitute an ever-thickening web of connectivity.
Post-Communist Russian organized crime arose just as this
infrastructure was becoming rapidly more democratized through
the proliferation of telecommunications technologies and
electronic networks of various kinds. With the technical
borders down, and the legal barriers against Russian contact
with the west eradicated almost as rapidly as the Berlin Wall
was bulldozed into history, Russian organized crime found an
infrastructure outside Russia well-designed to facilitate every
form of criminal activity, and ill-designed to investigate or
prosecute it.
In considering the scope and impact of Russian organized
crime outside Russia, there are several questions that need to
be considered. These include:
Where is Russian organized crime going? What is it
doing there and what is it seeking to achieve?
How is the presence developed? What kind of criminal
activities come with the presence?
where is russian organized crime?
There are four main answers to this question:
Given the extreme cold of Russian winter, Russian
organized crime has often followed the sun.\24\ Among
the locations that Russian organized crime has become
prominent are various Caribbean islands, Israel, the
Costa del Sol, the French Riviera, South Florida, and
Thailand. The playgrounds of the rich are very
attractive for organizations and individuals whose
primary activity is the accumulation of wealth through
illegal means.
---------------------------------------------------------------------------
\24\ The authors are grateful to Gregory Baudin-O'Hayon for this
observation.
---------------------------------------------------------------------------
Some Russian organized crime moved out of Russia but
stayed close to it. Budapest, Berlin, and Vienna, for
example, all witnessed a significant increase in the
Russian criminal presence. In some respects these
cities were natural haunts for Russian organized crime
as they were familiar from the cold war era, and in the
case of Berlin and Vienna provided convenient windows
on the west while having the advantage of proximity.
Russian organized crime looks for opportunities that
come with an acceptable level of risk, engaging in what
can be described as jurisdictional arbitrage. One of
Israel's attractions, for example, until summer 2000,
was the lack of any anti-money laundering legislation.
When this permissive environment was combined with the
law of return and the lack of questions about the
personal wealth that immigrants brought with them it is
clear that Israel was an attractive, low-risk
destination for Russian criminal organizations. The
United States carries a higher level of risk but also
provides enormous opportunities for criminals,
particularly in areas such as Medicare, car insurance,
and gasoline taxation where fraud schemes are very
lucrative. The capacity to meld into the ethnic Russian
communities also makes the United States attractive to
Russian organized crime.\25\ Conversely, where ethnic
communities of this kind are not well established,
Russian organized crime is less likely to have a
significant presence. Neither Britain nor Sweden, for
example, has experienced the influx of Russian
organized crime that was expected.
---------------------------------------------------------------------------
\25\ Analysts affiliated with the National Institute of Justice
estimate that approximately 15 criminal groups arising out of the
former Soviet Union are currently operating in the United States, and
that 8 or 9 of them maintain links to Russia. The analysts estimate
membership of those groups to be 5,000 to 6,000 members. Finckenauer,
James O. and Elin J. Waring, Russian Mafia in America, Boston:
Northeastern University Press, 1998.
---------------------------------------------------------------------------
Russian organized crime follows the Russian
Diaspora. It is sometimes argued that organized crime
is extremely difficult to transplant to other
countries, particularly when it is based on protection
activities. Where and when organized crime can be
embedded in migrant ethnic communities, however, then a
successful transplant is feasible. Most migrant
organized crime, initially, at least, preys on its own
community, before subsequently expanding into the
broader society and economy of the host nation.
what kinds of presence and how developed?
To date, Russian organization crime penetration of other
countries has developed into variations of six models:
Direct criminal presence in another country
accompanied by a full panoply of criminal activities,
as demonstrated by Russian organized crime in the
United States, Israel, much of Western Europe, and most
formerly Eastern bloc countries in Central Europe.
More limited criminal presence for the purpose of
using the country's services on a regular basis, to
make it a reliable part of the criminal organization's
infrastructure, as in the use of Austria, Cyprus and
Switzerland for financial and business dealings; and
the use of the Baltic countries, especially Latvia, for
smuggling.
Criminal presence in a neutral (not a targeted or
host) country that offers opportunities for contacts
and negotiations with other criminal organizations
rather than criminal activities per se. Some Caribbean
islands have been used in this way as a meeting ground
for Russian criminals and Colombian drug traffickers.
Modest (or largely indirect) presence through
connections with indigenous criminal organizations. In
effect, the presence of Russian criminals is designed
merely to facilitate cooperative relationships with the
indigenous criminal organizations. Any Russian criminal
presence in Colombia, for example, would likely be at
the invitation of Colombian drug traffickers interested
in exploiting the burgeoning Russian drug market or in
obtaining arms.
A purely ``pass through'' financial presence. The
proceeds of Russian crime often go through or are
secreted in jurisdictions in which there is little or
no Russian physical presence. This is certainly the
case with some of the offshore financial centers such
as the Caymans, Nauru, Vanuatu, and Liechtenstein that
have been used by Russian criminal organizations to
move, launder, and hide their proceeds.
Rest, relaxation, and consumerism. Russian criminals
have congregated in resort communities in Southeast
Asia and Western Europe, buying real estate and
expensive goods, with little impact on the overall
environment of such communities, which tend to accept
money as money regardless of its provenance, with
little change to the underlying culture of hedonism.
The extent of the Russian organized crime threat in a
country depends largely on the viability and effectiveness of
the institutions of governance. Where there is a viable, highly
legitimate, well-functioning democracy based on the rule of
law, then the threat is predominantly a law and order one, with
some residual concerns over what might be termed the corrosion
of institutions. Where these conditions are absent then the
threat is more serious. In host states--as well as its home
state--Russian organized crime uses corruption as an instrument
to neutralize law enforcement and the criminal justice system,
to co-opt support and buy impunity. Such tactics have an
insidious impact and when a state already has serious
governance problems these will be exacerbated.
The Impact of Russian Organized Crime on Russia's Evolution
Russian organized crime has been a major impediment to
progress toward democracy, the rule of law and free markets in
Russia. It will continue to be so. There are two closely
interwoven myths about Russian organized crime that have been
perpetrated largely by economists in the United States and
Western Europe and that continue to have some currency. They
need to be dispelled. The first is that Russian organized crime
is similar to the robber baron phase in American history. In
fact, the robber barons built infrastructure and created
wealth; Russian organized crime in contrast has looted the
country, imposed parasitical relationships on licit business,
driven out much legal entrepreneurship, and become an
impediment to foreign investment. The second myth is that
Russian organized crime is a passing phenomenon that will
diminish significantly as the process of free market reform
continues, that it is a temporary feature of transition rather
than an enduring feature of post-Communist Russia, simply a
short term nuisance unlikely to have long term impact. This
ignores several characteristics of organized crime: it is a
political as well as economic force, it consolidates its power
in ways that enable it to outlast the market conditions that
initially facilitated its expansion, it creates symbiotic
linkages with politics and business that are difficult to undo,
and it is not simply dependent on rents from imperfect
competition in the Russian economy. Indeed, Russian organized
crime represents a concentration of illegal power that is not
going to go away and will continue to hinder efforts to
establish a strong legitimate Russian state, to eradicate
corruption and to develop a system that is clearly based on the
rule of law. Born in part out of state weakness Russian
organized crime aims to perpetuate this weakness.
Some argue that Russia is going beyond the neutralization
of the state and is exhibiting symptoms of state capture. A
recent paper of the World Bank Institute suggests that in
Russia oligarchs have ``captured the state,'' shaping the
policy and legal environment to their advantage at the expense
of the rest of the country.\26\ The notion of state capture has
the following components: (1) corrupt individuals have access
to the resources of the state and are able to exploit these
resources for their own purposes; (2) the state can only act
effectively, at least domestically, when its actions do not
seriously impinge on the power and well-being of the corrupt
individuals; (3) state institutions can be used as fronts for
corruption and extortion; (4) it is not clear where the state
ends and the corrupt private-sector organization begins--or
vice versa; and (5) the corrupt organization usurps some of the
functions of the state.
---------------------------------------------------------------------------
\26\ ``Seize the State, Seize the Day--State Capture, Corruption
and Influence in Transition,'' Joel S. Hellman, Geraint Jones and
Daniel Kaufmann, World Bank Institute, September 2000, Policy Research
Working Paper 2444.
---------------------------------------------------------------------------
The process of usurping state powers is nowhere more
obvious than in the areas of business protection and taxation.
Because the state has not provided legal protection and
arbitration for licit business, organized crime has filled the
breach, in effect exploiting lack of state capacity and filling
the resulting functional holes. Organized crime provides
contract enforcement and debt collection. In the area of
taxation, the problem in Russia is that the system is not only
burdensome and ineffective, but also provides perverse
incentives for tax evasion and criminal behavior. Businesses
typically evade taxes; criminal organizations discover this
(often obtaining information through the banking system) and
then extort businesses that find it cheaper to pay ``taxes''
imposed by criminal organizations than those imposed by the
Russian state. Consequently, Russia has failed to develop a tax
base adequate to fund government services in a variety of
sectors including law enforcement. This then becomes one of
several interlocking vicious circles: lack of resources makes
it difficult for the Russian state to combat organized crime;
in turn organized crime becomes more powerful and acquires more
resources that would normally accrue to the state. According to
World Bank Institute analysis, countries with these features,
such as Russia exhibit increasing concentration of wealth among
the most corrupt firms, reduction in the ability of the state
to provide necessary public goods, and weakened economic
growth.\27\
---------------------------------------------------------------------------
\27\ Id.
---------------------------------------------------------------------------
To combat organized crime, most countries adopt a
conventional, predominantly law enforcement approach, in which
investigations lead to arrests, arrests to prosecutions,
prosecutions to trials, and trials to convictions of
individuals and the eventual dismantling of criminal
organizations. In the case of organized crime in Russia this is
patently inadequate. It is necessary to adopt a much broader
approach aimed at creating a far less congenial environment
within which organized crime has to operate. In Russia it is
crucial to establish clear lines of demarcation between public
and private, legal and illegal, permissible, and impermissible
activities. In addition, it is necessary to correct a tax
system that provides perverse incentives for criminality.
Consideration might also be given to a strategy of
legitimization that would provide incentives for the inflow of
flight capital--whether clean or dirty--and for the
transformation of businesses founded on criminal activity into
legitimate businesses that would abandon old habits and
patterns of behavior. In effect, organized crime will be
impossible to reduce unless major changes are made in both the
environment and in the payoff structures.
Putin inherited a Russia with limited institutional
locations of integrity from which one could theoretically
construct a decriminalized government. Regional governors, like
the Duma, heavily intersect with some of Russia's most
prominent criminals. Institutions like the Procuracy routinely
lie to western counterparts about the information they have on
Russian criminals, when the criminals are sufficiently
prominent.\28\ The Ministry of Internal Affairs (MVD)
undertakes effective prosecutions of lower-level criminals who
lack a sufficient krysha or roof to avoid sanctions, and is
equally effective at investigating the bad acts of oligarchs
who have been insufficiently adroit with the rulers of the
day.\29\ However, substantial areas of criminal activity and
corruption are simply off limits, even to MVD officials who
would like to enforce the law.\30\
---------------------------------------------------------------------------
\28\ This phenomenon was most clearly demonstrated in the case of
Sergei Mikhailov, head of the Solntsevo organization. When the Swiss
Government asked the procuracy in 1998 for information on Mikhailov's
criminal activities, which had previously been detailed to the Swiss by
an MVD general, the Procuracy stated it had no such information.
Mikhailov was acquitted, and the MVD general was forced to seek asylum
in Switzerland.
\29\ The current legal problems in Russia of formerly successful
oligarch Vladimir Gusinsky provide a vivid recent example.
\30\ One of the authors had numerous conversations in Moscow in
1997, 1998, and 1999 with relatively senior Russian officials from
Russia's foreign ministry, the MVD, the Procuracy, the VEK, the
Customs, and the Tax Police concerning this issue in the course of his
work for the State Department. In summary, officials from each of these
agencies stated that Russia was not yet a normal country, and that
anyone who put himself at risk as a result of investigating a well-
placed official or oligarch would have far more at risk than merely the
loss of their job.
---------------------------------------------------------------------------
One factor in the prevalence of organized crime's
involvement in Russia's economy is the structural similarity
between a command economy, operating by force, and criminal
activity, which similarly relies upon force. Another factor is
the merger between groups: in Russia it remains often difficult
to tell who is merely a businessman, and who is a criminal. It
is not just a matter of appropriate epithets: a careful link
analysis of the business activities of most of the oligarchs
show social, economic, and personnel connections with various
members of the more prominent purely criminal groups, such as
Solntsevo, Mogilevich, and Ismailov. The difficulty of
distinguishing between the monopolists, the oligarchs and the
criminals in Russia was aptly illustrated in the Bank and New
York/Benex money laundering/capital flight case. The operation
laundered funds for prominent politicians, oligarchs, and
criminals alike. The countries of Nauru and Vanuatu performed
similar functions, laundering the proceeds of narcotics
trafficking, organized crime, tax avoidance, and theft with the
same legal and accounting mechanisms.
Within Russia, resources that once were available to anyone
with the will and location to secure them have now been
converted to a more stable form of ownership that remains,
however, potentially subject to further direction from the
Russian state, as recent media takeovers have demonstrated.
These assets were and remain the wealth of a command economy,
not the wealth of a market economy. Those who converted these
resources have primarily not been persons operating through the
mechanisms of a market economy, but rather those operating
through the decaying infrastructure of the old command economy.
The persons who secured the wealth have not been faced in
Russia with a system of rule of law or democracy that would
confine their activities looking forward. For the reasons set
forth in the World Bank Institute study, having obtained wealth
and power, Russian criminals and oligarchs are unlikely now to
abandon the unfair business techniques upon which they have
built their empires. Generally, criminals and oligarchs limit
themselves to legitimate and legal activities to the extent
that there is no competitive threat to them when they do so. If
other unfair competitors remain to intrude on their turf, they
unfairly compete themselves. In Russia, individuals with
extremely unsavory reputations, such as the Chernoy brothers,
one of whom became a key figure in the aluminum industry amidst
a spate of unsolved business killings, wind up having business
dealings with a wide range of the most powerful and prominent
people.\31\
---------------------------------------------------------------------------
\31\ For example, Chernoy was in business with, and sold assets to,
oligarchs Boris Berezovsky and Roman Abramovitch. The Moscow Tribune,
February 16, 2000, ``Russian Aluminum--When Politics Melts Metal,'' by
John Helmer.
---------------------------------------------------------------------------
Money Laundering and Financial Crime
Russia's placement on the list of 15 non-cooperative
countries by the G-7 in summer 2000 reflected the enormity of
its money laundering and financial integrity problems. The
combined lack of transparency and lack of integrity in Russia's
financial system have made it a sieve for most forms of
financial abuses, with catastrophic consequences for the safety
and soundness of Russia's financial system, for Russian tax
collection, and for sustained foreign investment commensurate
with Russia's potential economy. These twin problems have
facilitated not only money laundering and capital flight, but
unfair competition, abusive business practices, the theft of
Russian natural resources, the depreciation of the Russian
ruble against hard currencies, and the creation of a business
climate that is estimated by foreigners as among the worst in
the world. Russian elites, including important members of the
former Communist Party nomenklatura, pro-Western ``reformers,''
bankers, brokers, and traders, and heads of criminal
organizations, have collectively exploited the interface
between Russian banking after the fall of Communism with the
global financial services infrastructure of the West to steal
Russia's wealth and commit massive frauds that have repeatedly
shaken Russia's financial stability.
Moreover, the laundering over the past decade of the
proceeds of stolen Russian resources, profits made through the
manipulation of and devaluation of the ruble, the proceeds of
drug trafficking, arms trafficking, prostitution, alien
smuggling, theft, and extortion, combined with the proceeds of
capital flight, have made Russia's money laundering problem a
global one, affecting countries literally all over the world.
Russian money is laundered in former Communist countries like
Latvia, Hungary, Slovenia, Poland and Ukraine; in the Middle
East through Lebanon, the United Arab Emirates and Dubai;
throughout Western Europe, including substantial amounts of
activity in Austria, Cyprus and Switzerland; through the
Russian community based in Israel; through off-shore havens
such as the British Virgin Islands, Cayman Islands, Isle of Man
and the Bahamas; through brass-plate institutions in the
Caribbean (Antigua, Belize, Dominica) and the South Pacific
(Nauru, Niue, Tonga, Vanuatu); and through and into the world's
major financial markets in the United States and the United
Kingdom. Russian money has been also laundered in the
Seychelles, which has some 600 offshore companies for Russian
persons and entities, and South Africa, where Russian money
laundering and illicit finance has become a factor in the
diamond business. Russian criminal groups involved in money
laundering have been active in Central America (Costa Rica and
Panama), engaged in money laundering and criminal activities in
collaboration with Colombian and Bolivian criminals in the
cocaine business, and moved into purchasing illicit businesses
in the Pacific in places such as Thailand and Macao. In short,
there is evidence of illicit Russian money streaming throughout
the money-laundering infrastructure of the world, and the
Russian money has already had some impact in weakening
regulatory and enforcement structures in many locations,
especially those involving poorer and smaller governments.
The persistence of large-scale capital flight, the legacy
of an intrusive state bureaucracy, underdeveloped market
institutions and lack of fiscal resources further complicate
the fight against money laundering in Russia. Thus, Russia's
money laundering problem is a subset of and simultaneously a
contributing factor to Russia's governance problem, inexorably
intermingled with it.
In Russia, no financial institution has ever been
sanctioned for laundering money. There remains no system for
financial services record keeping that is demonstrably enforced
by bank regulators and no obligations to report the true
beneficial owner of bank accounts. Elaborate mechanisms have
been established by Russian financial elites in collusion with
Russian financial institutions and in some cases with Russian
officials that have successfully moved billions of dollars a
year in funds offshore where they cannot be traced. Russia's
areas of vulnerability and deficiency extend to every aspect of
its financial services sector, and there may be no other nation
in which the lack of transparency regarding transfers of funds
plays a greater role in debilitating its economy. Significant
areas of special vulnerability include:
the gray economy, russia's tax system and capital flight
Russian regulatory and law enforcement officials have
estimated that the gray economy accounts for some 40 percent of
the total Russian economy, although other estimates put the
number as high as 60 percent. Gray economic activity consists
both of legal activities that are not reported to the tax
authorities, leaving the income untaxed and unreported, and
illegal activities, which are also not reported to the state
and therefore not taxed. The gray economy includes and rewards
barter, avoids documentation, and facilitates money laundering.
It in turn has been created in part by Russia's complex tax
system that has led to an environment in which many businesses
view total compliance with all assessed taxes and penalties to
be incompatible with staying competitive. The introduction of a
flat rate social tax promises to simplify--and thereby
improve--the tax situation in Russia. One difficulty, however,
is that the Tax Police has only 7,000 of the 13,000 personnel
it believes necessary to implement collection and to ensure
that the funds enter the government budget. The Russian
business sector's well-developed mechanisms for hiding funds
from tax authorities will continue to pose a challenge even to
the best funded enforcement agency.
poor accounting, auditing, and documentation requirements
With no properly functioning regulatory mechanisms, such as
effective banking regulators or an equivalent of the U.S.
Securities and Exchange Commission, and with poor civil
enforcement remedies, Russia has lacked mechanisms to develop
and to demand high standards for accounting, auditing and
documentation, even as Russia's tax system has driven
businesses to develop methods for false bookkeeping. The lack
of authentic documentation, and the ease of developing false
documents make it easy for Russians to launder money through
the formal financial services sector, as part of routine
import-export activity.
prominence and connection of organized crime to officials and official
structures
As noted above, the chaotic business environment of post-
Communist Russia has facilitated the development of criminal
organizations, such as the Solntsevo, Ismailov, and Mogilevich
groups, with close ties to government officials and official
structures, that provide them protection from enforcement
activity, through a mechanism sometimes described as a krysha,
or roof. Significant criminal proceeds are generated in Russia,
including funds from narcotics trafficking, smuggling, tax
evasion and tax fraud, arms trafficking, extortion, theft of
government property, and corruption. The interpenetration of
government and criminal structures to engage in financial crime
and corrupt activities provides a favorable condition for money
laundering.
rent-seeking activity by government officials
Low civil service salaries, corruption, the Communist
heritage, and cultural experience, have provided a foundation
for widespread payoffs of government officials in exchange for
economic privileges such as business permits, government
contracts, exemptions from taxes and customs duties, and
protection from investigations. Each of these activities plays
a significant role in Russia's money laundering problem.
ease of moving funds offshore
Collusion between those involved in capital flight, those
involved in organized crime, those involved in money
laundering, and Russian's major financial institutions has made
it easy for criminals to move funds offshore. Russian
regulatory and law enforcement officials have estimated that
since independence in December 1991, more than $100 billion in
illegal proceeds have been generated from criminal activity and
subsequently laundered. As noted above, criminal funds leaving
Russia have been transferred to financial institutions in the
former Soviet Union, especially Latvia, Western Europe, the
United Arab Emirates, Cyprus, the United States, and throughout
the world's offshore sector, including some of the havens in
the South Pacific. The use of correspondent bank accounts in
foreign banks, in particular in the Baltics, Cyprus and
offshore zones, has been a significant problem, due to the
ability of the money launderers to commingle funds from many
sources through this mechanism.
inadequate knowledge base, training, government capacity
Russian law enforcement agencies have very limited
experience in investigating and prosecuting significant
financial crime cases, confront problems of integrity,
training, capacity, and resources, and have to contend with
uncertain laws, duplicitous sources of potential evidence, and
major gaps in the overall regime for combating money
laundering, such as the failure to require currency reporting
or mandatory suspicious activities report (SAR) reporting.
In this environment, passage by Russia of comprehensive
money laundering legislation, as was in process in July 2001,
constitutes a first step to money laundering reform in what
would under any circumstances be a lengthy journey.
Options for Reform in Russia
The so-called new Russians who today control the most
important elements of Russian wealth inherited from the Soviet
Union, its industries, its raw materials, its lands and its
infrastructure have demonstrated their ability to seize the
resources of the former Soviet state. These people have not,
however, by and large demonstrated a capacity to build, to put
people to work, to invent, to improve, or to invest and
maintain that which they have effectively exploited. Rather,
they are people who were able to exploit politics to obtain
wealth and power without regard for market integrity,
transparency, democracy, or rule of law. Strengthened civil
institutions, greater transparency, and greater market
integrity all would create opportunities for others with less
existing power and wealth to become potential competitors with
the criminals who now control the vast preponderance of
Russia's wealth. Accordingly, Russia's organized criminals have
continued to slow the development of such institutions.
The transformation of Russia from a criminalized country to
one where free markets and democracy are realities requires
precisely those steps that most threaten those whose power
depends on discouraging rule of law: bad businessmen and
incompetent, corrupt bureaucrats. For Russia to evolve in a
positive fashion, its government must collect taxes in a fair
manner, pay its civil service a living wage, maintain an
adequate number of high caliber professionals in government,
supplement that government with self-regulatory organizations
made up of businesses whose owners recognize that a level
playing field is an essential element for keeping the game
going, and sanction those who engage in unfair trade and
business practices. These are formidable challenges for any
country in transition. In a Russian context, their viability
remains threatened by most of the more powerful interests with
power in the country, including the oligarchs and the
nomenklatura.
Accordingly, a package of reforms that would begin to
provide an environment better suited for Russia to combat its
organized crime problem would include:
anti-corruption measures
Reducing the number of persons in government, increasing
the salaries of those remaining in government, and creating
strong disincentives to taking bribes.
increased press freedom
The essential oversight function of an open press remains a
prerequisite for effective reforms; the recent consolidations
of Russian broadcasting under the control of the Kremlin has
the potential for sufficiently impairing oversight by the press
as to render other anti-corruption measures of little utility.
improving tax system
Strengthening the fiscal position of the federal
government, through enforcing and collecting federal taxes at a
sustainable rate. Recent changes to the Russian tax code,
including a 13 percent flat rate on federal income tax,
strongly endorsed by the International Monetary Fund, represent
a potentially positive development.
financial sector regulatory reforms
Creating a modern capital market, strengthening the banking
system and banking supervision. Russian financial institutions
continue to operate on a quasi-barter basis, with little long-
term lending to independent borrowers. The Central Bank of the
Russian Federation (Central Bank of Russia) has had a poor
track record of safety and soundness regulation and
supervision. Securities regulation, investor protection, and
basic elements of corporate governance are further necessities
for the recovery of the financial sector.
legal reforms
In May 2001, Putin announced his intentions for a sweeping
reform of the judicial system, which would curb the powers of
prosecutors and police, introduce jury trials, and increase
funding for the courts. Creating transparent mechanisms with
adequate and fair process to resolve both criminal and civil
cases are essential elements of changing the environment to one
less likely to facilitate organized crime, by creating the
possibility of alternatives to private dispute resolution
systems involving extortion and protection.
money laundering legislation
Russia needs to complete passage of the comprehensive
preventive law passed by the Duma in July 2001, to create clear
legal obligations for customer identification and record
keeping, and a mandatory suspicious transaction reporting
regime without any monetary threshold. Related reforms would
include clear legal provisions protecting financial
institutions from criminal or civil liability in respect of
disclosures made in good faith; much stricter controls on the
licensing of banks and exchange houses; a clear timetable for
the conversion of any existing anonymous accounts into normal
accounts subject to the usual customer identification
requirements; regulations issued by the Central Bank of Russia
to ensure steps are taken to verify beneficial owners when an
account is opened or a transaction is conducted; and provisions
to insure that beneficial owners are identified and not hidden
through intermediaries.
Policy Options for the United States
In the post-World War II period, the United States has had
a series of well-defined policies toward the Soviet Union,
which roughly can be divided into the periods of containment,
during the Stalin through Khruschev period of the cold war;
competition and co-existence, during the period of Brezhnev
through Chernyenko; and growing cooperation during the
Gorbachev era of perestroika and glasnost. Following the
collapse of the Soviet Union and the ascendancy of Boris
Yeltsin, U.S. policy could be defined in brief as one of
constructive engagement, in which the United States
aggressively and assiduously worked to secure Russian
integration with the world economy, Russian political, economic
and legal reform, and democratization.
Current policy toward Russia in the context of organized
crime could be seen as containing elements of each of these
models. Existing U.S. policy in the area of international
financial regulation, and limitations on the issuance of visas
to suspected Russian criminals, could be seen as a form of
containment strategy. Limited new assistance programs and new
investment by the United States could be viewed as a kind of
co-existence strategy, one that lives side-by-side with
individual cases of cooperation in a law enforcement context,
and constructive engagement through some forms of continuing
assistance.
These strategic choices play out in practice through a
series of policy options for the United States, many of which
may be seen in the first instance as not relating directly to
organized crime, but which could have substantial impact on the
Russian governance issues that most directly would impact
organized crime. These could include:
The level and nature of assistance to be offered
Russia by the United States, and the kinds of
conditions imposed on such assistance. Such assistance
could focus on rule of law, democratization, judicial
training and reform, civil society and democracy
programs, support for an independent press, and
corporate governance, among those programs that could
potentially have an impact on organized crime. Such
programs could potentially be structured with
conditionality, so that failures of cooperation or
follow-through could result in diminished assistance.
U.S. policy toward balance of payments support from
the International Monetary Fund, and the issue of
conditionality. The United States could take the
position that further assistance to Russia from the IMF
depends on not only the enactment but also the
implementation of comprehensive financial services
regulatory reforms, with higher standards for auditing
and accounting of businesses that include some
mechanism for public scrutiny.
Promoting or limiting direct Russian access to the
U.S. financial system. Currently, the Federal Reserve
has not authorized Russian entities to carry out
banking services in the United States, due to
inadequate supervision within Russia. The United States
could set down an assessment mechanism and schedule for
further consideration of granting Russia greater access
to the United States as a result of Russia undertaking
further reforms. Alternatively, the United States could
consider further limits on access by Russian financial
institutions to correspondent banking services by U.S.
financial institutions; further enhanced scrutiny under
Treasury regulations; or multilateral sanctions, as
could be imposed by the Financial Action Task Force as
a result of Russian failure to enact and enforce anti-
money laundering laws.
Other options for U.S. action that would focus more
directly on Russian organized crime could include:
Allocating further resources to the creation of law
enforcement and intelligence data bases focused on
Russian organized crime;
Establishing better mechanisms for interagency
cooperation within the United States targeting those
identified as major Russian organized crime threats;
Identifying priority cases involving Russian
organized crime for investigation and possible
prosecution domestically, with resources appropriately
configured to ensure appropriate treatment of priority
cases.
Identifying priority cases involving Russian
organized crime for bilateral or multilateral or
bilateral action involving relevant U.S. law
enforcement partners. These could include more focused
attention by the United States to take advantage of the
capabilities of existing foreign law enforcement
institutions, including the European Union's Europol;
data bases pertaining to Russian organized crime at
INTERPOL; possible further harmonized efforts by the
national Customs authorities through the World Customs
Organization; or a more case-oriented use of U.S.
funded International Law Enforcement Academies, such as
the Academy at Budapest. Such efforts could include
initiatives aimed at disrupting criminal organizations
in situations where prosecution was not feasible.
Upgrading existing efforts to establish names
databases for immigration purposes, to prevent Russian
criminals from securing entry into the United States.
Strengthening programs aimed at responding to the
problem of trafficking in women to create a strategy
that targets the criminal organizations engaged in the
trafficking on an ``end-to-end'' basis, similar to the
``kingpin'' strategy used to combat Colombian cocaine
drug traffickers.
Enacting legislation in the United States to add
foreign corruption as a predicate offense to U.S. anti-
money laundering laws.
Seizing the assets of Russian criminals through
aggressive use of forfeiture laws.
Publicizing information pertaining to incidents of
Russian corruption, theft of resources, or criminal
activity, adopting a ``name and shame'' approach that
could make it more difficult for Russian criminals to
do business in the United States and other countries.
Imposing higher standards of due diligence for
investments involving U.S. guarantee programs or other
assistance to insure that U.S. programs do not
inadvertently support corrupt individuals or entities.
Using U.S. law enforcement, diplomatic reporting, or
intelligence reporting, to create a black list of
persons and entities not eligible for benefits under
U.S. guarantee programs, such as those financed by the
U.S. Export-Import Bank (Exim Bank) and the Overseas
Private Investment Corporation (OPIC).
Even if these measures are instituted and the United States
does develop and implement a well-coordinated strategy to
combat organized crime and corruption in Russia, along with
dealing with the transnational dimensions of the problem,
success will be measured incrementally. The problem of Russian
organized crime and corruption is a Russian problem which the
United States can try to contain, influence, or combat but
cannot hope to eradicate.
Some analysts continue to have a hopeful view regarding
Russia's ability to combat organized crime. They cite the
recent passage of a series of economic and political reforms by
the Duma prior to its summer recess as evidence that under
Putin, substantial further progress is not only possible, but
likely. For example, in August 2001, the World Bank's chief
economist for Russia, Christof Ruehl, told Reuters he was
``cautiously optimistic, with the accent on optimistic,''
regarding Russia's medium-term economic future, due to the
``good start made on the reform agenda'' by President
Putin.\32\
---------------------------------------------------------------------------
\32\ ``World Bank Optimistic on Russian Reforms,'' Reuters, August
10, 2001; See also ``Russian economy seen more robust, not out of
woods, Reuters, August 9, 2001, describing the optimistic views of
various Western businessmen and economists regarding Russian reforms.
---------------------------------------------------------------------------
If this perspective were to be adopted, it would argue for
the kind of policy recently articulated by U.S. Secretary of
the Treasury Paul O'Neill, who has focused on banking reforms,
trade liberalization, and strengthening of accounting controls
as mechanisms to strengthen Russia's economy and to bring it
into line with world standards. Under this approach, the United
States would work with Russia on a bilateral basis, and with
the international lending institutions multilaterally, to
promote good practice in business and in government in Russia's
regions, as well as in Moscow and St. Petersburg. Secretary
O'Neill has emphasized the importance of reforms reaching the
local level in addition to the federal level. Other elements of
the agenda would include advancing work on WTO accession,
consulting on market economy status for Russia, cooperating on
an anti-money laundering law, and exploring new Export-Import
Bank financing.\33\
---------------------------------------------------------------------------
\33\ ``How Russia Can Fulfill Its Potential,'' Secretary of the
Treasury Paul O'Neill, Wall Street Journal, August 9, 2001.
---------------------------------------------------------------------------
Other analysts, describing Russia as ``Zaire with
permafrost,'' believe that organized crime has become so
central to the identity of the post-Soviet Russian state that
it is unrealistic to expect any Russian Government, whatever
its rhetoric, to combat organized crime with a sustained and
systematic strategy. They argue that ``within a few decades
Russia will concern the rest of the world no more than any
Third World country with abundant resources, an impoverished
people, and a corrupt government. In short, as a Great Power,
Russia is finished.'' \34\ From this perspective, the U.S.
Government must recognize the limits of the possible. The first
decade of the Russian transition has underlined the limits of
western-oriented reforms in a Russian context. Rather than an
easy transition in Russia to a free market and liberal
democracy, the Russian transition has featured a state that has
been both criminalized and corrupt. For such analysts, there
remain basic questions as to the degree to which Russia may be
capable of fundamental reform. They point out that organized
crime and corruption in Russia survived the Czars and outlasted
the Communist Party, and will be a likely feature of the
Russian social, political, and economic environment for the
foreseeable future, regardless of any steps undertaken by the
United States and other countries.
---------------------------------------------------------------------------
\34\ See e.g., Jeffrey Tayler, ``Russia is Finished,'' Atlantic
Monthly, May, 2001.
---------------------------------------------------------------------------
If this perspective were to be adopted, it might imply a
possible strategic bifurcation for U.S. treatment of Russia:
continued engagement with Russia within a national security
context as a nuclear power and a mixture within the economic
context of a policy of containment of Russia to protect against
contagion from inadequate regulatory and law enforcement
systems, mixed with continued efforts, to be sustained over
many years, to build a better climate for reform.
Financial Reform: Taxes, Budgets and Banks
TAX REFORM IN RUSSIA
By Z. Blake Marshall \1\
----------
contents
Page
Summary.......................................................... 125
Policy Progress to Date.......................................... 128
Tax Code: part I............................................. 128
Tax Code: part II............................................ 129
Personal Income Tax.............................................. 129
Unified Social Fund Tax.......................................... 130
Value Added Tax (VAT)............................................ 130
Turnover Taxes................................................... 130
The Road Ahead: Next Steps for Policymakers...................... 131
Profits tax.................................................. 131
Customs duties............................................... 133
Value added tax (VAT)........................................ 135
Administrative procedures.................................... 136
Production sharing agreements (PSAs)......................... 137
Conclusion....................................................... 138
Summary
Of all the commercial policy issues brought to the fore
during Russia's decade-long market transition, one has
consistently topped the list of investor concerns: the dire
need for reform of Russia's complex, unpredictable and
inefficient tax system.
---------------------------------------------------------------------------
\1\ Dr. Marshall is the Executive Vice President of the U.S.-Russia
Business Council.
---------------------------------------------------------------------------
Russia's tax system remains a major obstacle to foreign
investment and to business activity more generally, cited time
and again by companies as a primary obstacle impeding their
business plans, deterring new market participants and
constraining Russia's considerable economic potential. The
number of taxes with which a firm must comply, coupled with a
perpetually changing compliance regime, leaves companies
operating in an atmosphere of uncertainty that compromises
business planning. Dating from the excess-wage tax controversy
of the mid-1990s (which was ultimately abolished under pressure
from business groups), corporate attitudes have reflected
continual attempts to combat the imposition of a (often
redundant) new tax, an arbitrary interpretation of an existing
obligation, or capriciousness and harassment in the audits and
penalties realm.
As Organization for Economic Cooperation and Development
(OECD) analysts point out, the difficulties experienced by
businesses have not primarily been a function of the rates
prescribed by law: ``Statutory tax rates were in fact not very
high by world standards--other than in the case of wage taxes--
even before the recent tax reform. It has been more a question
of the multitude of different taxes levied and, primarily, the
methods of determination of the actual tax base.'' \2\
---------------------------------------------------------------------------
\2\ OECD, The Investment Environment in the Russian Federation:
Laws, Policies and Institutions, 2001, p. 121.
---------------------------------------------------------------------------
Efforts to rationalize and streamline the tax system are
inextricably linked to the country's fiscal health, as
collection difficulties have plagued Russia's attempt to
balance its social commitments and foreign debt burden, topics
that are addressed elsewhere in this volume. Thus policy and
rate revisions have an impact on compliance--a widening of the
tax base that complements reforms aimed at improving tax
administration and enforcement.
Given this dual importance, the business community has been
encouraged by the significant steps forward that Russia has
made in the past 2 years. For the better part of a decade, the
average company operating in Russia has been responsible for
deciphering and complying with a combination of roughly 50
taxes and social fund payments levied at the federal, regional
and local levels. As a result of tax reforms put into effect
for 2001, that number has been cut in half.\3\
---------------------------------------------------------------------------
\3\ Ibid., p. 23.
---------------------------------------------------------------------------
This progress has not gone unnoticed in the business
community. A recent Economist Intelligence Unit survey of 100
multinational companies operating in Russia found that two-
thirds of the firms polled believe Russia's tax environment to
be improving, with a mere 5 percent of the opinion that it is
getting worse. It is not difficult to imagine that statistic's
relationship to another telling data point: More than 80
percent of the respondents reported making a profit last year
(and greater than half of them expect their 2001 sales to grow
between 10 and 25 percent).\4\
---------------------------------------------------------------------------
\4\ Reuters, April 11, 2001.
---------------------------------------------------------------------------
Regarding the budgetary impact of recent reforms on a gray
economy pegged at 30 percent, Deputy Minister of Economic
Development and Trade Arkady Dvorkovich recently commented that
``half of these companies might come out from the shadows
purely thanks to tax reform.'' \5\ The early evidence this year
supports this and similarly optimistic projections, as the
government's collection rate rose to 90 percent in the first
quarter of 2001, compared to only 60 percent in the first
quarter of last year.\6\
---------------------------------------------------------------------------
\5\ St. Petersburg Times, June 13, 2001.
\6\ Associated Press, April 5, 2001.
---------------------------------------------------------------------------
The amounts collected have soared in tandem, as receipts
for the first quarter of 2001 grew 36 percent year on year.\7\
In addition to the increased receipts, ``the federal government
has managed the difficult task of collecting all taxes in cash
since the second quarter of 1999. This contrasts with a strong
reliance on various money surrogates in the past.'' \8\ Figure
1 portrays the steady climb in tax revenue as a percentage of
gross domestic product (GDP), an important indicator of the
Russian Government's fiscal health.
---------------------------------------------------------------------------
\7\ Agence France Presse, April 22, 2001.
\8\ OECD Policy Brief, Economic Survey of the Russian Federation,
March 2000, p. 5.
---------------------------------------------------------------------------
Furthermore, there are clear indications that, contrary to
the policy stagnation and stalled reforms that characterized
much of the late 1990s, the Putin Administration is taking this
issue seriously and is committed to building on recent
successes. Minister of Economic Development and Trade German
Gref is clear on the priority affixed to tax reform initiatives
for 2001: ``Our plans for this year can best be described as
Napoleonic--we would like, above all else, to complete the next
phase of tax reform.'' \9\ With further reforms pursued in
2001-2002, this next phase will determine whether the Putin
team meets its goal of lowering the nominal tax burden from 43
percent to 35 percent of GDP by the end of 2003.\10\
---------------------------------------------------------------------------
\9\ Gref, German O. Speech to the U.S.-Russia Business Council,
April 3, 2001.
\10\ Bush, Keith. The Russian Economy in June 2001, p. 21.
---------------------------------------------------------------------------
FIGURE 1._RUSSIAN GOVERNMENT TAX REVENUE AS A PERCENTAGE OF GDP
[GRAPHIC] [TIFF OMITTED] T6171.026
* Preliminary data for the first quarter of 2001.
Source: Ministry of Finance of the Russian Federation.
This paper will discuss the nature of Russia's tax system
from the perspective of business interests. In doing so, it
will document the progress Russian officials have made in
adopting constituent pieces of the Tax Code, as well as the
remaining tax policy and tax administration challenges that are
key to Russia's realization of its economic potential.
The progress to date covers both the enactment of part I of
the Tax Code and the adoption and implementation of significant
pieces of part II, including what could be fairly characterized
as a radical liberalization of the income tax, social funds and
turnover tax regimes. The adoption of four key chapters of part
II last year has set the stage for further legislative progress
on the profits tax--which, as discussed below, passed its
second reading in the state Duma just prior to the summer
recess--and other significant areas of importance to Western
business.
Beyond the realm of rates and policies, the system of
interpreting and implementing legislation must also be
addressed. A key determinant of the system's evolving fairness
and transparency is the extent to which Russia's 180,000 tax
inspectors across the country adhere to uniform standards
applied on a consistent basis. The same consistency should be
fairly expected at the federal level from the Ministry of Taxes
and Levies. For several years now, the system of auditing
taxpayers has relied upon targeting law-abiding foreign
companies when revenue shortfalls have to be remedied. Clearly,
Russia must strive to bring pure tax evaders into the system,
rather than repeatedly targeting firms that are willing to
comply with a stable, predictable system.\11\
---------------------------------------------------------------------------
\11\ U.S.-Russia Business Council and American Chamber of Commerce
in Russia, Commercial Engagement with Russia: Policy Recommendations
for the Bush Administration, March 2001.
---------------------------------------------------------------------------
Policy Progress to Date
tax code: part i
Part I of the Tax Code, the ``tax constitution'' of Russia,
consists of 142 articles that outline basic principles, key
definitions, and rights and responsibilities.\12\ In codifying
the relationships between taxpayers and the tax authorities,
part I has had a far-reaching effect on the way the tax system
is perceived, favorably impacting the business environment and
inspiring increased company confidence. For the first time in
its post-Soviet transition, Russia has arrived at a legislative
framework with a fairer balance between the tax authorities and
taxpayers. By clearly setting forth taxpayer rights and
official responsibilities, it rid the system of unclear appeals
procedures as well as a variety of punitive sanctions levied
without recourse.
---------------------------------------------------------------------------
\12\ OECD, The Investment Environment in the Russian Federation:
Laws, Policies and Institutions, op. cit., p. 115.
---------------------------------------------------------------------------
The changes brought about by implementation of part I,
which came into force in January 1999, included several
important provisions concerning both tax relief and
enforcement. For example, part I took the bold step of
reversing, in effect, the burden of proof in tax dispute
between the tax authorities and the taxpayer--the latter is now
presumed innocent until proven otherwise. The rights of the
taxpayer include protection against arbitrary penalties not
justified by the tax authorities in a court of law, placing the
burden squarely on the Russian Government to prove taxpayer
liability. The 19 penalties prescribed in part I are much less
severe than their predecessors, and they also attempt to
differentiate between ``negligent'' or ``intentional'' behavior
and violations due to other mitigating circumstances.\13\
---------------------------------------------------------------------------
\13\ Ibid., p. 140.
---------------------------------------------------------------------------
Part I of the Code also included a provision allowing
companies to transfer certain assets to newly established
subsidiaries as they undergo restructuring. Previously, these
asset transfers were taxable because they were considered
trading transactions. That is no longer the case, except in
circumstances where there are sufficient grounds to prove that
the restructuring process was designed purely as an instrument
for tax evasion.\14\
---------------------------------------------------------------------------
\14\ American Chamber of Commerce in Russia Tax Committee, informal
memoranda, March 1999.
---------------------------------------------------------------------------
Also important to companies operating in Russia was the
elimination of tax restrictions on sales below cost. Originally
intended to curb tax evasion, these measures instead had a
debilitating effect on manufacturers. Their removal allows law-
abiding firms to pursue flexible marketing strategies that
include selling at a loss.
As a result of the part I implementation, tax collection
has become the liability of the so-called agent who controls
the source of the taxable payments (such as an employer, in the
case of income tax). Prior to 1999, companies could simply
refer the tax authorities to an entity that received a payment,
thereby making tax collection difficult, if not impossible, if
the receiving company happened to be located outside of Russia.
The revamped policy establishes that an agent that fails to
transfer the requisite duties can be fined 20 percent of the
amount due.\15\
---------------------------------------------------------------------------
\15\ Ibid.
---------------------------------------------------------------------------
Finally, part I also revised the definitions that apply to
terms such as the ``arm's length principle,'' ``related
parties,'' and ``market price.'' These concepts were either
undefined or received minimal treatment in the preexisting
Russian legislation. Thus part I of the Tax Code sought to
limit the tax-reduction tactics available to Russian companies
via transfer-pricing schemes that allowed subsidiaries to
minimize taxable profits and offshore parent firms to pay rates
lower than their Russian equivalent.\16\ The stricter
definitions contained in part I allow officials to examine
contracts to ensure that related companies (defined as having
more than 20 percent cross-ownership) are acting in accordance
with market conditions (acceptable percentage variations
established for prices charged) and not engaging in tax
evasion. During the state Duma's fall session, the Ministry of
Finance plans to introduce further amendments to part I
pertaining to transfer pricing.\17\
---------------------------------------------------------------------------
\16\ Ibid.
\17\ Interfax, May 29, 2001.
---------------------------------------------------------------------------
tax code: part ii
Several important chapters of part II of the Tax Code were
adopted last summer by the Federal Assembly and signed by
President Putin on August 6, 2000. When they came into force on
January 1 of this year along with a law on implementing
instructions for part II, these chapters signified a huge
stride forward in Russia's efforts to rationalize it tax system
and make it more closely conform to international practice.
To put the magnitude of these accomplishments into
perspective, the four chapters adopted covering the flat income
tax, social taxes, excise taxes, and the value added tax (VAT)
represent 60 percent of the revenue side of Russia's ledger,
and revenues from these four line items increased by 60 percent
through the first 5 months of 2001 on a year-on-year basis.\18\
As Figure 2 indicates, when the profits tax is added in, these
taxes account for roughly three-fourths of Russia's tax
revenue. In addition, companies welcomed a long-awaited
reduction in turnover taxes. Several of these sweeping changes
are described below.
---------------------------------------------------------------------------
\18\ Ministry of Economic Development and Trade; and Interfax, June
13, 2001.
---------------------------------------------------------------------------
Personal Income Tax
Perhaps the most attention has been given to the Russian
Government's introduction of a 13 percent flat income tax in
place of progressive rates ranging from 12 to 30 percent. The
new flat tax generated an immediate impact as soon as it took
effect, as income tax revenues increased by 70 percent in the
first quarter of 2001 compared to the fourth quarter of last
year.\19\ According to Minister of Finance Aleksei Kudrin,
through the first 5 months of 2001, collections of the income
tax were up 52 percent over the comparable period in 2000.\20\
---------------------------------------------------------------------------
\19\ Gref, op. cit.
\20\ RIA Novosti, June 19, 2001.
---------------------------------------------------------------------------
FIGURE 2._TAX REVENUES AS A PERCENTAGE OF THE 2000 BUDGET
[GRAPHIC] [TIFF OMITTED] T6171.025
Source: Audit Chamber of the Russian Federation.
Unified Social Fund Tax
The adoption of the unified social fund tax integrated four
previously separate budgetary line items into one, a move that,
according to Minister Gref, ``had wonderful anti-corruption
consequences, making the revenue and expenditure sides of these
funds more transparent.'' \21\ In place of the previous 39.5
percent flat rate, the new rates follow a regressive scale from
35 percent down to 5 percent.
---------------------------------------------------------------------------
\21\ Gref, op. cit.
---------------------------------------------------------------------------
Value Added Tax (VAT)
Several improvements to the VAT--the stable source of one-
third of Russia's tax revenue (see Figure 2 above)--were
introduced with the adoption of chapter 21 of part II last
year. Among the most important is the new exemption on capital
construction that took effect on January 1. This provision
eliminated the previously unrecoverable 20 percent charge on
capital investment in Russia, and its adoption was influenced
by several years of sustained engagement on the part of both
the U.S. Government and Western business groups.
Turnover Taxes
Turnover taxes such as the housing fund tax and the road
users tax have for many years been the primary example of
Russia's penchant for taxes based on gross revenues rather than
profits. These charges have long acted as a major disincentive
to investment, as they disproportionately impact new businesses
and those running operating losses. The conceptual underpinning
of turnover taxes encourages businesses to understate or
suppress their actual revenues, thereby gravitating into the
infamous shadow economy. This of course distorts competition by
shifting the relative tax burden onto those companies that
comply in a straightforward manner.
Last year, the Putin team sought the complete elimination
of turnover taxes but was forced into a compromise to
orchestrate legislative approval of its tax package. Their
overall reduction from 4 percent to 1 percent represented the
outright elimination of the housing tax (1.5 percent) and a
decrease in the road tax from 2.5 percent to 1 percent until
its planned abolition in 2003.\22\ In his annual address to the
Federal Assembly in April, President Putin stressed that ``our
strategic priority today is the consistent lowering of taxation
on non-rental income and the final elimination of the turnover
tax.'' \23\
---------------------------------------------------------------------------
\22\ OECD, The Investment Environment in the Russian Federation:
Laws, Policies and Institutions, op. cit., p. 123.
\23\ Putin, Vladimir V. State of the Nation Address to the Federal
Assembly, April 3, 2001.
---------------------------------------------------------------------------
The Road Ahead: Next Steps for Policymakers
This section elaborates on additional strands of Russian
tax reform, picking up where last year's accomplishments left
off. What are the next steps as perceived by the business
community, and what are the relative priorities identified by
the Putin Administration? In terms of the work remaining to be
done by the Russian Government to build on last year's
momentum, this section will focus on five key areas: profits
tax, customs duties, VAT, tax administration concerns, and tax
provisions associated with production sharing agreements (PSAs)
in the energy sector.
profits tax
Companies active in the Russian market have for several
years urged the Russian Government to move away from a variety
of revenue-based methods of taxation. One of the primary focal
points in this campaign has been an effort to make net profit,
as defined by international norms, the basis on which firms
calculate the profits tax. The level of taxation is not the
root of the problem, as Russia's current 35 percent rate (43
percent for financial services firms) is on par with, or even
less than, the corporate rates in other industrialized
countries.\24\
---------------------------------------------------------------------------
\24\ OECD, The Investment Environment in the Russian Federation:
Laws, Policies and Institutions, op. cit., p. 125.
---------------------------------------------------------------------------
Despite a multi-year lobbying effort to allow widely
accepted business deductions, the profits tax is still not
payable on net profit. Advertising costs, training expenses,
business travel, loan financing, and depreciation allowances
are only deductible within very restricted norms. For example,
deductible domestic travel expenses are capped at $11.40 per
day, and depreciation schedules far exceed the economic life of
certain assets (e.g., buildings spread over 250 years).\25\ As
a result, as a recent OECD study points out, ``the tax base for
the Russian profits tax has been and still is larger than the
comparable corporate tax base in other industrialized
countries, often resulting in a higher . . . effective profits
tax rate than the nominal statutory rate.'' \26\
---------------------------------------------------------------------------
\25\ Ibid., pp. 126-127.
\26\ Ibid., p. 23.
---------------------------------------------------------------------------
Fortunately, relief is on the way. The Putin Administration
has sought to build on last year's successes by overhauling the
profits tax to stimulate business activity and recapture firms
from the shadow economy, making this initiative the top tax-
related priority for 2001.
In what Deputy Finance Minister Sergei Shatalov referred to
as an ``essential measure that can bring about revolutionary
changes in Russia,'' the state Duma voted just prior to the
summer recess to approve, by a vote of 339 to 6, chapter 25 of
part II of the Tax Code, ``On the Tax of Profit of
Organizations.'' \27\ The passage of this second reading, the
most critical of the three readings, means the bill is expected
to sail through third reading ratification early in the fall
session and should be signed into law to take effect on January
1, 2002.
---------------------------------------------------------------------------
\27\ Agence France Presse, June 22, 2001.
---------------------------------------------------------------------------
In addition to business-friendly provisions pertaining to
thin capitalization rules and depreciation of fixed assets, the
bill has produced two major accomplishments that will have a
far-reaching impact on bottom-line performance when enacted
next year: a considerable rate reduction and full deductibility
of legitimate business expenses. In allowing deductions for all
``necessary, reasonable and documented'' expenses, the new law,
according to Ernst & Young's Peter Arnett, ``is moving away
from the prescriptive Soviet approach, moving expense
deductibility from an exclusive list to an inclusive list.''
\28\
---------------------------------------------------------------------------
\28\ St. Petersburg Times, op. cit.
---------------------------------------------------------------------------
Furthermore, companies have been urging the Russian
Government to promote both purchased and leased capital
investments. To do so, financing and depreciation norms have to
be revised, so that businesses are allowed to expense the full
cost of fixed or leased assets over a period that reflects the
economics of the transaction.\29\
---------------------------------------------------------------------------
\29\ U.S.-Russia Business Council and American Chamber of Commerce
in Russia, op. cit.
---------------------------------------------------------------------------
The final product, which lowered the tax rate from 35
percent to 24 percent, was yet another example of executive-
legislative compromise. The Putin Administration, mindful that
each percentage point reduction equates to 25 billion rubles
(approximately $850 million) in foregone revenue, had sought to
lower the rate to 25 percent.\30\ The government proposal
called for 8 percent to be allocated to the federal budget and
the remaining 17 percent shared among regional and local
budgets, while regions would be allowed to reduce the rate by
up to 3 percent.\31\ The formula currently in effect allocates
11 percent to the federal budget, with 19 percent going to
regions and 5 percent to localities. However, some regions
waive all but a fraction of a percentage point as an investment
and company registration incentive.\32\
---------------------------------------------------------------------------
\30\ Interfax, June 20, 2001.
\31\ Financial Times, June 20, 2001.
\32\ Ibid.
---------------------------------------------------------------------------
Many in the state Duma, including a majority of the Budget
Committee, had favored setting the rate at 23 percent, while
retaining tax privileges and investment incentives opposed by
the Ministry of Finance. Ultimately, the government agreed to
split the difference, settling on the 24 percent rate in
exchange for the removal of the investment deduction and other
exemptions. Of that amount, 7.5 percent will go to the federal
government and 14.5 percent to the regions, with the remaining
2 percent allocated to local budgets.\33\ An incentive
provision allowing regions to reduce the tax by as much as 4
percentage points was also part of the compromise version that
passed.\34\
---------------------------------------------------------------------------
\33\ Oganes Sarkisov, Taxation of Businesses in Russia: An Update,
July 6, 2001.
\34\ Troika Dialog, Duma Spring Term Report, July 2001.
---------------------------------------------------------------------------
Businesses will feel the immediate impact of this changed
environment in 2002, as the Finance Ministry estimates the
enactment of the profits tax chapter will reduce the overall
tax burden by some 100 billion rubles, or 1.1 percent of
GDP.\35\ As Steve Henderson, a tax partner at Deloitte & Touche
puts it, ``there seems to be a race on to see how much the
economy will move when the profits tax rate is lowered.
Globally, there is a tendency toward more consumer-based tax
regimes. Companies will have more of their money available to
invest and optimize operations.'' \36\ The direct correlation
to investment growth is striking--according to Alfa Bank, over
half (54 percent) of capital investment in Russia is funded by
company profits, while bank financing accounts for only 3
percent.\37\
---------------------------------------------------------------------------
\35\ Interfax, April 5, 2001.
\36\ St. Petersburg Times, June 19, 2001.
\37\ St. Petersburg Times, June 13, 2001.
---------------------------------------------------------------------------
And, as Minister Gref points out, the Russian Government
will reap the rewards as well: ``we have taken a long time
discussing this law with our businesses and with the State
Duma, and if this law is passed, it will provide a great
stimulus to our economy. We expect to increase revenue by 1.75
percent of GDP.'' \38\ The importance of the profits tax to the
Russian federal budget is depicted in Figure 3.
---------------------------------------------------------------------------
\38\ Gref, op. cit.
---------------------------------------------------------------------------
customs duties
Russia's customs regime is an area where tremendous
progress has been made but significant challenges remain. The
issues described below continue to hamper business activity and
compromise the system's potential for revenue collection.
Customs duties evasion is a major policy dilemma for the
Russian Government as well as for competition in the
marketplace. Tax evasion on goods coming in across the border
costs the Russian Government billions of rubles in lost in
revenue. In addition, gray-market imports that avoid paying
customs duties are clearly less expensive than their
domestically produced counterparts and legitimate foreign
imports. This illustrates yet another example of instances in
which companies that comply are competitively disadvantaged, as
the prices of their products obviously reflect higher
importation costs.
As Russia seeks to become increasingly integrated into the
global marketplace, it will have to ameliorate the conditions
encountered in cross-border trading activity: overly complex
and contradictory clearance procedures, ambiguous legislation
pertaining to goods classification, and--most troubling in some
respects--the threat of retroactive reassessment of goods
imported many years ago. These issues introduce additional
risks and costs that often alter the commercial terms of the
original trade transaction.\39\
---------------------------------------------------------------------------
\39\ U.S.-Russia Business Council and American Chamber of Commerce
in Russia, op. cit.
---------------------------------------------------------------------------
FIGURE 3._PROFITS TAX REVENUE AS A PERCENTAGE OF FEDERAL BUDGET
[GRAPHIC] [TIFF OMITTED] T6171.024
Source: Ministry of Finance of the Russian Federation.
Indeed these issues, and a variety of tariff barriers that
are out of sync with international norms, implicate Russia's
accession to the World Trade Organization (WTO). Their WTO
relevance has provided an impetus to the Putin Administration's
pursuit of customs reform. In January, the Russian Government
reduced duties on one-fourth of all goods coming into the
country, a measure that yielded a 25 percent revenue surge in
the first quarter of 2001 compared to the fourth quarter of
last year.\40\
---------------------------------------------------------------------------
\40\ Gref, op. cit.
---------------------------------------------------------------------------
Importantly, the Russian Government has also taken steps to
unify and recategorize import duties, a move that has greatly
simplified the quest to comply with customs procedures and may
help reduce both customs corruption and gray-market activity.
Minister Gref has labeled the 30 percent reduction in
classification line items (from 13,500 to 9,500) ``an absolute
revolution in customs tariffs'' that will yield substantial
benefits in the battle against corruption.\41\
---------------------------------------------------------------------------
\41\ Ibid.
---------------------------------------------------------------------------
Despite these recent accomplishments, much work remains for
Russia to fashion a customs regime that will facilitate--not
hinder--its aspirations to become a full participant in the
global economy. The concrete objectives for the remainder of
this year and into 2002 include codification of chapter 26 of
part II of the Tax Code and the adoption of a new Customs Code.
President Putin himself has emphasized the importance of
continued customs reform: ``measures have already been taken to
simplify and lower the level of import tariffs, but this is
insufficient. A radical change in the system of customs
administration is necessary. The main task of the year in this
sphere is the approval of a new Customs Code, moreover as a law
that has direct force. Naturally, the code must correspond to
the norms of the World Trade Organization (WTO), accession to
which remains our priority.'' \42\
---------------------------------------------------------------------------
\42\ Putin, op. cit.
---------------------------------------------------------------------------
value added tax (vat)
The VAT is intended to be a levy charged to the final
consumers of goods and services, not to firms producing these
goods and services. Like the profits tax, its 20 percent rate
and other statutory features make the Russian VAT not terribly
unlike European variants, at least in theory: ``Despite its
superficial similarity to other countries' VAT laws, however,
the Russian VAT does not function in a manner consistent with a
traditional VAT.'' \43\
---------------------------------------------------------------------------
\43\ OECD, The Investment Environment in the Russian Federation:
Laws, Policies and Institutions, op. cit., p. 129.
---------------------------------------------------------------------------
In order to fulfill its intended purpose, businesses should
collect and pay VAT to the Russian budget at each stage of
production, and it should not be a cost to businesses
themselves. Unfortunately, despite last year's amendments to
the VAT Law, this is still not the case in Russia. Companies
continue to grapple with a limited ability to fully credit VAT
on purchases, making the Russian variant, in effect, a tax on
production: ``The result is that the effective VAT rate is
usually greater than the statutory VAT rate and becomes a cost
to business.'' \44\
---------------------------------------------------------------------------
\44\ Ibid., p. 24.
---------------------------------------------------------------------------
For several years, companies in Russia have been required
to charge VAT on all exports to other Commonwealth of
Independent States (CIS) countries. Charging VAT at the point
of origin on intra-CIS trade, unlike the practice in other CIS
countries, hinders the export operations of Russia-based
manufacturers and limits investment in Russia, as it decreases
Russia's attractiveness as a manufacturing base for exports to
CIS markets. Russia's past reluctance to move away from the
point-of-origin principle in favor of the destination principle
(having refused to ratify a CIS protocol) has in part reflected
serious concern over revenues derived from oil, gas and
electricity sales Russia's CIS neighbors.\45\
---------------------------------------------------------------------------
\45\ U.S.-Russia Business Council and American Chamber of Commerce
in Russia, Commercial Issue Briefs, June 2000.
---------------------------------------------------------------------------
Fortunately, as a result of lobbying efforts by both the
Russian private sector and foreign investors, Russia has
recently acted to remedy this problem. Moving to the
destination principle for intra-CIS trade, effective July 1 of
this year, affords Russia the opportunity to encourage
manufacturers to build and expand facilities in Russia to
supply CIS markets, thereby deriving the direct economic
benefits of job creation and budgetary revenues.
Resolving several remaining issues would make the VAT
system more transparent and therefore better understood by
investors. As a result, businesses would be discouraged from
avoiding VAT payments, which would be collected more easily
from the end consumer (who has fewer means of tax evasion).
Following are several examples of the difficulties encountered
by businesses.
While last year's changes contained in part II
provide that VAT is creditable when paid on certain
nondeductible business expenses, such is not the case
in practice.\46\ VAT should be recoverable on all
genuine business expenses (e.g., advertising)
irrespective of their treatment for other accounting
purposes (e.g., profits tax calculation).\47\
---------------------------------------------------------------------------
\46\ OECD, The Investment Environment in the Russian Federation:
Laws, Policies and Institutions, op. cit., p. 131.
\47\ U.S.-Russia Business Council and American Chamber of Commerce
in Russia, Commercial Issue Briefs, op. cit.
---------------------------------------------------------------------------
There continues to be a considerable difference
between the provision of VAT refunds in theory and in
practice. Business experience has shown that a legal
entitlement to a VAT refund is not correlated to the
timely issuance of that refund, if it is processed at
all. Certain companies such as PSA investors, start-ups
and export-oriented firms encounter great difficulties
in collecting their refunds notwithstanding the
unambiguous provisions in both part I of the Tax Code
and the VAT Law. Prior to last year's adoption of
chapter 21 of part II, interest did not accrue on the
refund amounts due, and firms were not permitted to
offset these refunds owed against other current tax
liabilities. Provisions were introduced beginning in
January of this year to address these deficiencies, but
they have not yet been widely tested in practice.\48\
---------------------------------------------------------------------------
\48\ OECD, The Investment Environment in the Russian Federation:
Laws, Policies and Institutions, op. cit., p. 132.
---------------------------------------------------------------------------
Interpretation of VAT-related legislation still
lacks clarity and consistency (e.g., rules pertaining
to when cross-border services are subject to VAT).\49\
---------------------------------------------------------------------------
\49\ U.S.-Russia Business Council and American Chamber of Commerce
in Russia, Commercial Issue Briefs, op. cit.
---------------------------------------------------------------------------
Finally, because the requirement of moving from a
cash basis to an accruals basis for VAT poses
substantial costs to businesses on a cash-flow basis,
consideration should be given to easing the practical
burden of this transition.\50\
---------------------------------------------------------------------------
\50\ Ibid.
---------------------------------------------------------------------------
administrative procedures
While the Russian Government's commitment to tax reform is
evidenced by numerous recent improvements in legislation, the
application of Russian tax law remains inconsistent and
arbitrary. The OECD highlights three factors that contribute to
this situation: a lack of modernization such as computers to
track accounts, inadequate training of tax inspectors, and
limited knowledge of market-oriented tax policy on the part of
Russian judges.\51\ Clearly, practical measures in these areas
could yield substantial dividends.
---------------------------------------------------------------------------
\51\ OECD, The Investment Environment in the Russian Federation:
Laws, Policies and Institutions, op. cit., p. 24.
---------------------------------------------------------------------------
In terms of the appeals process, the recourse available to
companies is twofold. Firms can pursue an administrative appeal
through channels of higher local, regional and federal
authorities, or seek redress through a court action.\52\
Because there are no tax courts per se in Russia, tax disputes
involving businesses are currently addressed in arbitration
courts, where companies have been enjoying ever greater
success: ``Although precise statistics are not available, it is
estimated that taxpayers win over 50 percent of cases involving
disputes with the tax authorities.'' \53\
---------------------------------------------------------------------------
\52\ Ibid., p. 141.
\53\ Ibid., p. 141.
---------------------------------------------------------------------------
The Russian Government could demonstrate progress in the
area of tax administration by focusing on three key issues:
The federal government should promote greater
consistency by exercising central control over regional
tax bodies that adopt inconsistent interpretations and
apply inappropriate pressure on firms in their quests
for additional revenue.
While this year's modifications to the VAT regime
ameliorated many previous inadequacies, it has not
solved the problems concerning repayment of excess VAT
persist--the tax authorities must take steps to ensure
that refunds are available with minimum delay.
Finally, an effective mechanism for tax appeals
outside of the court process is sorely needed. A
central ombudsman or a dispute resolution center would
dispense with relatively uncomplicated tax disputes
more efficiently and consistently than current
administrative practice.
production sharing agreements (psas)
Russia's tax-related progress in support of a viable PSA
regime has lagged behind its counterparts in the tax reform
process. Exploiting the current window of opportunity offered
by high oil prices means ensuring that the new Tax Code will
work fairly and efficiently with respect to investors in the
energy sector. Specifically, Russian policymakers should follow
through on the enactment of the PSA law with specific Tax Code
provisions that support the PSA tax rules.
The Russian Government pledged to introduce the relevant
chapter of part II of the Tax Code by June 20. The draft given
a first reading in the state Duma prior to the summer recess,
however, was the Duma's version, not the draft under
development by the Ministry of Economic Development and Trade.
It met with strong objections by some deputies and executive
branch colleagues striving to make the PSA regime operational.
It remains unclear whether this Duma draft will be heavily
amended or another draft might be substituted and introduced in
the fall session.
It is equally critical that other new chapters of the Tax
Code reaffirm, rather than contradict, the tax regime currently
contained in the PSA law. Another possible test looming for the
fall session involves the draft of chapter 27 concerning
taxation of natural resource production, which is designed to
supercede the mineral replacement tax and certain royalty
payments to the Russian Government.
Conclusion
Russian tax reform has a beleaguered history over the past
decade, with conflicts within the Duma and between the
legislative and executive branches slowing progress to a near
halt for certain intervals in the 1990s. For the most part, the
failure to move more expeditiously in establishing a fair,
stable and transparent tax system has not been caused by a
knowledge deficit concerning the problems and their solutions:
``Russian policymakers and experts drafted a new Tax Code based
on such principles as early as 1993, but this and subsequent
reform initiatives have for many years been mired in political
controversy, both at the federal and regional level, often
becoming hostage to other political bargains.'' \54\
---------------------------------------------------------------------------
\54\ Ibid., p. 122.
---------------------------------------------------------------------------
Thankfully, the commercial policy area that has caused
businesses the greatest frustration during Russia's market
transition is now also exhibiting some of the most successful
policy initiatives and concrete accomplishments. The Finance
Ministry's Chief of Tax Policy, Alexander Ivaneyev, projects
that the Russian Government will push through the final phase
of tax reform in 2002, with the adoption of measures covering
property taxes, the use of natural resources and a single
agricultural tax to act as a companion to the profits tax.\55\
---------------------------------------------------------------------------
\55\ Interfax, May 29, 2001.
---------------------------------------------------------------------------
To be sure, remaining tax, corporate governance and other
structural reforms lend a cautionary note to the optimism
unfolding in the business community. But the recent track
record on tax reform may help Russia finally close the chapter
on its post-crisis recovery--debates over lingering devaluation
dividends and exogenous factors such as commodity prices
notwithstanding--and begin a new chapter featuring truly
sustainable, diversified economic growth.
According to Peter Westin, chief analyst at ATON Investment
Bank in Moscow, when the income tax set at 13 percent combines
with a profits tax of 24 percent beginning next year, Russia
will suddenly have one of the lowest marginal tax rates in the
world.\56\ And the revenue benefit from increased compliance
and overall economic activity could be precisely the boon the
Russian Government needs to help manage its roughly $30 billion
debt burden in 2002-2003. Though the reduction in Russia's
profits tax is not as dramatic, the Irish rate-cutting example
of a decade ago helps to illustrate the potential. When Ireland
lowered its profits tax to 10 percent for the manufacturing and
certain other sectors, its revenues increased from $655 million
in 1991 to $3.7 billion in 2000, with the profits tax share of
total revenue nearly doubling from 8 percent to 15 percent in
that time.\57\
---------------------------------------------------------------------------
\56\ Interfax, June 20, 2001.
\57\ St. Petersburg Times, June 19, 2001.
---------------------------------------------------------------------------
The continuing development of the Tax Code will provide
tremendous economic benefits to Russia if it results in a tax
system conducive to capital formation rather than one marked by
investment disincentives. The Russian Government would do well
to capitalize on the momentum of the past 18 months and ensure
that the guiding principle for subsequent draft laws is that
they are enacted in a form that promotes business and
investment.
Success will be defined by the extent to which the Tax Code
gives legal force to an equitable system of taxation that
treats all businesses fairly. The creation of a level
playingfield requires unambiguous laws that achieve their
intended tax objectives and are consistently administered.
PUTIN'S DILEMMA: AUSTERE BUDGETING IN A POOR STATE
By James A. Duran, Jr.\1\
----------
contents
Page
Summary.......................................................... 141
An Impoverished State with Limited Fiscal Resources.............. 144
Bargaining Over the Budget....................................... 145
Building Budget Institutions..................................... 147
Reducing Public Expenditures on Housing and Municipal Services... 150
Targeting Social Welfare Entitlements............................ 153
Pension Fund Reform Scheduled To Be Enacted in 2001.............. 154
Executing Legal Reform........................................... 155
Raising Educational Standards.................................... 157
Conclusion....................................................... 159
Summary
President Vladimir Putin and the Council of Ministers are
pushing an ambitious program to restructure five non-defense
institutions inherited from the Soviet era. They are obstacles
to Russia's transition to a liberal market economy. A change in
the basic institutional environment to which the population had
become accustomed threatens the welfare of a poor population.
Under the centrally planned economy (CPE), a form of social
contract emerged. The ``nanny'' state managed by a small elite
created a broad network of social and economic benefits that
provided a high degree of certainty to the great majority of
the citizenry. Employees' wages were low, but they received
proportionately very high subsidies for food, housing and
municipal services, utilities, sports and cultural facilities,
education, health care, social welfare entitlements, pensions,
etc. Since 1991 the challenge to the reformers has been to
restructure the social contract to one based on high wages
giving individual households the right to select the goods and
services they prefer in the market economy. Unfortunately,
wages for most households have remained low while prices for
food, consumer goods, and many services have risen sharply. A
majority of households remain heavily dependent on subsidized
institutions from the old order. Russian leaders have hesitated
to restructure these obligations in fear of provoking social
disorder.
---------------------------------------------------------------------------
\1\ James A. Duran, Jr. is Professor Emeritus of History, Canisius
College; Councillor of The Atlantic Council of the U.S.; an author of
the Atlantic Council's Bulletin originally entitled Perestroika Update:
The U.S.S.R. in Transition, later retitled as The Russian Federation:
Political and Economic Update, from 1992 through 1998.
---------------------------------------------------------------------------
Putin's dilemma is rooted in the lack of sufficient fiscal
resources to finance major reforms. The combined federal,
regional, and local budgets fall far short of paying current
obligations. Though currently enjoying the second consecutive
year of growth, the Russian Federation ranks only at about the
level of Mexico in gross domestic product (GDP), i.e.,
fourteenth in the world. Since 1989 the real GDP has fallen by
an estimated 50 percent. With all levels of government taking
about 40 percent of GDP in revenues, raising taxes to finance
further reforms would discourage entrepreneurs from investing
in the nascent economy. Seventy-eight percent of GDP growth in
2000 resulted from increased earnings in energy and primary
commodities exports. Budget revenues would drop sharply if
world market prices were to plummet. Aware of this reality, the
central government has pursued an austere balanced budget
policy. In 2000 and 2001 the federal budget amounted to about
$42.4 billion. Adjusting for purchasing power parity at the
official rate of exchange, that total would at most be around
$170 billion. About one-half goes to servicing debt, foreign
and internal, and financing the security forces. That
allocation leaves little money for funding the regular internal
responsibilities of the federal government. In 2000 funds set
aside for regional and local budgets were about 15 percent of
GDP, the same percentage as the central government. As this
paper will explain, most regional and local governments had
insufficient resources to finance fully all their functions and
in particular federal mandates inherited from the old CPE
system. Ministers, academics, and analysts warn of a possible
fiscal-budgetary crisis in 2003. Foreign debt servicing in that
year is scheduled to rise to $18.2 billion, an increase of more
than $5 billion over each of the prior 2 years. If world market
conditions deteriorate, the Russian federal budget will need
assistance from the International Monetary Fund (IMF) to
sustain even current levels of spending adjusted for
inflation.\2\
---------------------------------------------------------------------------
\2\ Nina Pautola, ``Russia's External Debt, Solvency and Options
for Alternative Capital Inflow,'' Russian Economic Trends, v. 9, no. 1,
2000, pp. 30-38; Rossiyskaya Gazeta, 12 May 2001, FBIS-SOV-2001-0514;
Russian Economic Developments, no. 96, March 2001, pp. 6-7; John P.
Hardt, Russia's Paris Club Debt and U.S. Interests, CRS Report for
Congress RL30617, updated June 6, 2001; John P. Hardt, Putin's Economic
Strategy and U.S. Interests, CRS Report for Congress RL31023, June 19,
2001; Vremya MN, June 15, 2001, FBIS-SOV-2001-0615; Andrei Nesterenko,
``The Modernization Challenge Facing President Putin,'' Finance and
Development, A Quarterly Magazine of the IMF, vol. 37, no. 3,
September, 2000, pp. 1-7; ``IMF Concludes Post-Program Monitoring
Discussion on the Russian Federation,'' IMF Public Information Notice
(PIN) no. 01/68, July 18, 2001.
---------------------------------------------------------------------------
The first two sections of this paper describes the fiscal
conditions of the Russian state and the institutional changes
that have taken place in the procedures for formulating and
administering the state budget. During the Soviet CPE era the
budget was secondary to the annual plan, the parameters of
which were decided by a powerful Communist Party elite. Today
the Russian Federation budget determines the cash flows
necessary for implementing desired policies. Intense political
bargaining by vested interest groups is comparable to the
debates that occur in most liberal democratic states. With the
help of bilateral and international agencies, the Russian
bureaucracy at the central federal level has been trained to
formulate, execute and audit the revenues and expenditures in a
radically different way than was done previously. Focus has now
shifted to improving the competence of regional and local
officials in the administration of their fiscal affairs.
The succeeding sections of the paper analyze major policy
debates on proposals to execute major reforms in five different
sectors that affect the livelihood of every Russian citizen.
(1) A major problem concerns the shift from financing basic
expenditures such as housing maintenance, municipal services,
and utilities out of the budgets of local governments to
individual households. During the CPE period only 2 to 3
percent was paid by the tenants with the rest being provided
through state agencies or enterprises. Much of that burden,
amounting to 4 percent of GDP, was transferred during
privatization of enterprises to fiscally strapped regional and
local governments. While tenants now cover up to 40 percent of
charges, the government with lower budgets and individuals with
modest incomes lack resources to do much more than deal with
emergencies. Sixty percent of urban infrastructure has
deteriorated so badly that billions of rubles need to be
expended on renovation and new installations.
(2) Another 4 percent of GDP is spent on a broad range of
more than 160 social welfare entitlements for which 47
categories of citizens are eligible regardless of need. Full
payment would require an estimated 22 percent of GDP. The
federal government has made the regional and local governments
responsible for funding these mandates without transferring
adequate fiscal means to do so. The question remains how to
reduce the number of these commitments and focus distribution
of funds to the truly needy. An estimated two-thirds of
payments now goes to those above subsistence level.
(3) During this fall's session of the Federal Assembly,
legislation to reform the old-age pension system funded by the
extra-budgetary Pension Fund will probably be enacted. Inspired
by the Chilean model, a portion of each worker's contributions
will be transferred into a savings account to be invested in
bond or stock funds. With a poorly developed financial services
sector, finding suitable investments represents a major
challenge. The combination of very low birthrates and a large
relative increase of retirees constitutes a serious problem.
Reform is essential if an already austere state budget is to
avoid an additional rapidly growing fiscal burden beginning in
7 to 8 years.
(4) The fourth reform is designed to increase the
confidence of the public in the judicial system. President
Putin and his government are making the reform of the judiciary
and of the Criminal Procedure Code a high priority and have
proposed a large increase in appropriations in the federal
budget for 2002. Funds are sought to increase dramatically the
number of judges by 2003. In addition, the new lower level of
justices of the peace to handle relatively minor cases is to be
rapidly expanded. Such procedures as requiring that judges give
prior approval to arrest warrants and the introduction of plea
bargaining have the potential for significantly reducing the
widespread abuse of prisoners held for long periods in pre-
trial detention centers.
(5) The final reform to be analyzed is the comprehensive
restructuring of the educational system from bottom to top.
Recent studies have shown that the Russian work force is
significantly less skilled even than that of the People's
Republic of China. Even with the 50 percent raise proposed in
the 2002 budget, teachers' salaries on average will still be
below the official subsistence level. One goal is to expand the
opportunity for graduates from regular secondary schools to
gain entry into higher education institutions through the use
of vouchers.
Prospects for approving most of the Putin Administration's
programs appear promising. The present state Duma is more
supportive of the executive branch's proposals than were the
preceding legislatures during Boris Yeltsin's two terms as
President. There is broad support for the restructuring of
fiscal federalism. Too often a balanced budget at the center
has resulted in passing federal mandates down to the regional
and local levels which lack the means to pay. Federal
authorities who control sources of revenue have been changing
the rules virtually every year. Local officials bear the brunt
of criticism from citizens deprived of what they regard as
their just due. Responding to considerable pressure, the
central government published a proposal on August 21, 2001, to
set out in statute a clear division of responsibilities and
revenues until 2005. More needs to be done to improve budget
practices on the lower levels of government. Sound
administrative practices are vital when reforms change the
institutional framework within which citizens must live and are
being implemented when resources are scarce.
An Impoverished State with Limited Fiscal Resources
Russian leaders face a dilemma in that they must operate
within austere fiscal limits. Although Russia encompasses a
huge territory and is richly endowed with natural resources and
a relatively literate population of 147 million, the nominal
GDP in 2000 was only about $276 billion calculated at the
official exchange rate. Of that total, state authorities
consumed about 42 percent in revenues. Taxes collected to fund
federal budget outlays amounted to 16.2 percent of GDP,
regional and local budgets--15.1 percent, and the four major
social insurance funds (The Pension Fund, Social Insurance
Fund, State Employment Fund, and Medical Insurance Fund)--10.8
percent. The federal 2000 budget of $42.4 billion in nominal
terms approximately equals that of Finland. Since many prices
fall below their counterparts in advanced market economies,
estimates of purchasing power parity range from 3\1/2\ to 4
times more than the nominal rate of the ruble on international
exchange markets. The result is a federal budget about $170
billion.\3\
---------------------------------------------------------------------------
\3\ Russian Economic Developments, No. 96, March 2001, pp. 6-7;
Nesterenko. op. cit., p. 2, Padma Desai, ``Putin's bluff,'' Financial
Times, June 21, 2001, p. 16.
---------------------------------------------------------------------------
President Putin and the Council of Ministers understand
that businesses are too heavily taxed. Present exorbitant rates
slow economic growth and stimulate off-the-books transactions
and capital flight. The reduction of the personal income tax to
a 13 percent flat rate effective January 1, 2001, has
contributed to a 70 percent increase in this source of revenue
during the first 5 months of 2001, although the double-digit
inflation of 16 to 18 percent reduced real gain. On second
reading the Duma has approved a reduction of the tax rate on
corporate profits from 35 percent to 24 percent effective on
January 1, 2002. Another measure under consideration is
slashing the 29.6 percent combined social insurance payroll tax
by a point or two since revenues allotted to the Pension Fund
are running a surplus. Obviously, there is risk in supporting
this supply-side policy, but incentives are essential in the
effort to stimulate economic growth.\4\
---------------------------------------------------------------------------
\4\ Ian Cochrane, Vladimir Gidirim, Tim Carty and Zhanna
Dobritskays, ``The Russian Tax System: Achievements in 2000 and the
Possible Agenda for 2001,'' Russian Economic Trends , v. 9, no. 3,
2000, pp. 17-21; ITAR-TASS, April 25, 2001, FBIS-SOV-2001-425; ITAR-
TASS, April 23, 2001, FBIS-SOV-2001-0423; Kommersant, April 21, 2001,
p. 1; Moscow Mayak Radio, June 19, 2001, FBIS-SOV-2001-0628;
Rossiyskaya Gazeta, June 26, 2001, p. 1, FBIS-SOV-2001-0626; Obshchaya
Gazeta, June 14, 2001, FBIS-SOV-2001-0613.
---------------------------------------------------------------------------
A reason for Putin's continued popularity has been his
insistence that pensions and federally budgeted salaries be
paid on time. After years of uncertainty, some stability in
household cash flow represents a significant improvement for
the recipients. For years the state did not collect enough in
rubles to cover these outlays. In 1996 nearly half the receipts
for the ``consolidated'' budget, i.e., those of the central,
regional and local governments, were in the form of ``mutual
offsets,'' i.e., barter in the form of goods and services, and
monetary surrogates such as promissory notes, bills of
exchange, local vouchers, etc. In addition, tax evasion was
widespread. Cash was scarce. Salaries, wages, and allowances of
budget-funded civil servants and the military fell into
arrears. Delays in paying pensions were partly due to the
failure of the government itself to pay the payroll taxes it
owed to the Pension Fund. Simultaneously, legislators pressed
hard to increase pensions and salaries to match inflation, but
the recipients by no means received full indexing. Such
privatization schemes as the scandalous ``loans for shares''
occurred in part because desperate leaders wanted cash to
disburse to employees and pensioners, particularly as elections
were approaching. As of July 2001, some arrears to civil
servants and the military have yet to be paid.\5\
---------------------------------------------------------------------------
\5\ David Woodruff, Money Unmade, Barter and the Fate of Russian
Capitalism (Ithaca, New York: Cornell University Press, 1999), pp. 79-
176; ITAR-TASS, May 22, 2001, FBIS-SOV-2001-0522; Elena Romanova,
``Pension Arrears in Russia: The Story Behind the Figures,'' Russian
Economic Trends, v. 8, no. 4, 1999, pp. 14-24; Sergei Guriev and Barry
Ickes, ``Barter in Russian Enterprises: Myths vs. Empirical Evidence,''
Russian Economic Trends, v. 8, no. 2, 1999, pp. 6-13; Padma Desai and
Todd Idson, Work Without Wages, Russia's Nonpayment Crisis (Cambridge,
Mass.: The MIT Press), pp. 2-23.
---------------------------------------------------------------------------
Bargaining Over the Budget
The contentious but democratic haggling over budget
assumptions and spending priorities among representatives of
the executive branch, the state Duma deputies, and the
Federation Council senators who represent the regions is in
itself evidence of transition to a new political system.
Without the approval of the legislature, the budget cannot
become law. Bargaining is prolonged since there has been no
disciplined, pro-government majority in the Duma. Nominated by
the President and confirmed by the Duma, the Premier is
primarily the President's man. Putin's Council of Ministers is
charged with managing economic and routine internal affairs.
The ministers are chosen not because they are prominent figures
with strong political support in the legislature, but mainly
for their technocratic skills. The Presidential Administration,
comparable to the Executive Office of the U.S. President, is
divided into departments which oversee all state activities.
The Security Council and its staff responsible for security
affairs, internal and external, are directly responsible to the
President, who chairs its meetings. The ``power'' ministers
running military, police, and intelligence affairs are also
directly subordinate to him. Unlike in the Soviet era, sharp
public disputes occur among ministers and members of the
Presidential Administration even as bargaining on the budget is
underway with the legislators.\6\
---------------------------------------------------------------------------
\6\ Andrei Kunov and Alexei Sitnikov. ``The `Constitutional
Economy' of Russia: Political Roots of Economic Problems,'' Russian
Economic Trends, v. 8, no. 4, 1999, pp. 6-14; Eugene Huskey,
Presidential Power in Russia (Armonk, New York, M.E. Sharpe, 1999), pp.
43-182; Steven S. Smith and Thomas F. Remington, The Politics of
Institutional Choice, The Formation of the Russian State Duma
(Princeton, NJ, Princeton University Press, 2001), pp. 27-92, 116-160;
Thomas F. Remington, Politics in Russia (New York, Longman, 1999), pp.
40-57, 124-173.
---------------------------------------------------------------------------
Leaders of the executive and legislative branches in the
past decade have established procedures in the Budget Code for
enacting the annual state budget that basically conform to the
standards of the G-7. They understand that managing cash flows
is central to the implementation of desired policies. The
Ministry of Finance is the principal agency that enters into
negotiations with the government departments and agencies as
well as with governors of the 89 regions (oblasts, territories,
and ethnic republics) composing the Federation. The President
lays out his priorities in the Annual Budget address to the
parliament in June or July. By mid-August, the Cabinet presents
its detailed proposal in the hope that the the budget will be
enacted into law before the beginning of the fiscal year
starting on January 1. The Duma Budget Committee and other
committees on matters that fall under their jurisdictions
review the document and make their recommendations. The budget
bill must submit to four readings, one more than usual. The
second and third are the most important. Upon passage, the bill
is sent to the Federation Council for its review and approval
by the Senators.\7\
---------------------------------------------------------------------------
\7\ Andrei Kunov and Alexis Sitnikov, ``Economic Legislation of the
Duma: The Role of Organizational Structure,'' Russian Economic Trends,
v. 8, no. 2, 1999, pp. 14-21; Interfax, May 3, 2001, FBIS-SOV-2001-
0503; Rossiyskaya Gazeta, May 4, 2001, FBIS-SOV-2001-0508; Remington,
Politics in Russia, pp. 124-173; The World Bank, Fiscal Management in
Russia (Washington, DC, The World Bank, 1996), pp. 41-65, hereafter
referred to as Fiscal Management in Russia, 1996; Russian Economic
Trends, v. 6, no. 1, 1997, pp. 9-11.
---------------------------------------------------------------------------
Diverse coalitions representing various vested interest
groups form and dissolve in the quest for budget commitments.
Ministers engage in tough bargaining to gain support for their
policies and sometimes are forced to make distasteful
compromises which often cause an increase in budget obligations
to ensure enactment. Disagreements between the two houses are
resolved through a conciliation procedure involving Duma
deputies, Senators, representatives of the Council of Ministers
and the Presidential Administration. Finally, the President
signs the budget into law. At a recent meeting of the collegium
of the Ministry of Finance, Putin complained that 3 months of
the fiscal year had passed before the bureaucracy completed all
the paperwork authorizing the disbursement of funds in 2001.\8\
---------------------------------------------------------------------------
\8\ Kommersant, September 15, 1999, p. 2; Kommersant, September 24,
1999, p. 2; Kommersant, September 25, 1999, p. 2; Izvestiya, October
27, 1999, p. 1; Izvestiya, December 4, 1999, p. 5, Kommersant, December
4, 1999, p. 4; Rossiyskaya Gazeta, April 17, 2001, p. 3 in FBIS-SOV-
2001-0417; Moskovskiye Novosti, July 17, 2001, FBIS-SOV-2001-717;
Remington, Politics in Russia (New York, NY: 1999), pp. 124-173.
---------------------------------------------------------------------------
This democratic process, although prolonged, for adopting
the budget sharply contrasts sharply with the document produced
by the highly centralized Soviet system. At that time the
state-owned, comprehensive CPE was directed by a tiny elite,
the Communist Party Politburo with its Central Committee
secretariat and key ministers. Priorities were decided in
camera. The budget was merely an instrument for implementing
the annual economic plan. It also was a unitary system since
the budgets of the lower echelons of government were
incorporated into the final product. A brief annual budget bill
was passed by the U.S.S.R. Supreme Soviet after a pro forma,
carefully scripted debate. By mid-1988, Gorbachev's reforms
freed some sectors of the economy which caused severe fiscal
problems and rising inflation. In October the U.S.S.R. Minister
of Finance revealed a major state secret: namely, the Soviet
Union had been running a deficit budget since 1976 and the
country had plunged into a severe fiscal crisis. Records
indicate that the deputies in the Supreme Soviet did not seem
to understand the profound implications of this revelation.
Before the U.S.S.R. dissolved in December, 1991, this old CPE
fiscal system had already collapsed.\9\
---------------------------------------------------------------------------
\9\ Fiscal Management in Russia, 1996, 7-11; James A. Duran, Jr.,
``Russian Fiscal and Monetary Policy: A Tough Road Ahead,'' The Former
Soviet Union in Transition, U.S. Congress, Joint Economic Committee.
103d Congress, 1st Session, S. Print 103-1, February 1993, v. 1, pp.
196-217; Vremya MN, June 22, 2001, FBIS-SOV-2001-0622.
---------------------------------------------------------------------------
Building Budget Institutions
In 1991 leaders of the new Russian state faced the awesome
task of building an essentially new set of institutions to
manage fiscal affairs. With IMF assistance particularly since
1995, needed reforms have been put in place in the center which
remains in a dominant position. The Ministry of Finance has
been reconstituted and its staff retrained and expanded to play
the central role in state finances. Only in 1995 did Russia
adopt the basic line-item classification system developed as
the standard for members of the IMF. The Ministry of Economics,
currently the Ministry of Economic Development and Trade,
prepares medium- and long-term forecasts, draws up detailed
plans and estimates costs of proposed reforms. Its current
head, German Gref, is influential with President Putin. Under
the old CPE system corporate managers and individual households
did not have to worry about paying taxes to the government as
is customary in market economies. CPE accounting systems were
rudimentary and centralized in the Central Bank of the Russian
Federation (Central Bank of Russia or CBR) or the few
specialized state banks. In moving to a market economy, Russian
managers and accountants have become obligated to meet the
rigorous reporting standards required by tax authorities.
International accounting standards are scheduled to be fully in
effect by January 1, 2003. An essentially new state Tax Service
had to be established to extract revenue from a population with
no taxpaying tradition. Inspectors have often been harassed or
even physically attacked. Though their salaries are paid by
Moscow, they remain vulnerable to local pressure. Like most
federal civil servants in Russia, they are dependent on
regional and local authorities for housing and municipal
services. The state Tax Police were established in part to
protect these collectors. The present Duma has made major
market-oriented improvements in the Tax Code, but debate still
continues on revising additional chapters. Many Russian
entrepreneurs as well as foreigners conducting business in the
country will be pleased when comprehensive and relatively
stable regulations governing taxes and taxpayers' rights have
been instituted. As in any market economy, debate will continue
as various interest groups seek to alter the laws to their
advantage.\10\
---------------------------------------------------------------------------
\10\ Fiscal Management in Russia, 1996, xxv-xxvi, 83-88; Russian
Federation, OECD Economic Surveys, March 2000 (Paris, France: OECD,
2000), pp. 118-120, hereafter referred to as OECD, 2000; Milka
Casanegra de Jantscher, Carlos Silvani, and Charles L, Vehorn,
``Modernizing Tax Administration,'' Fiscal Policies in Economies in
Transition edited by Vito Tanzi (Washington DC: International Monetary
Fund, 1992), pp. 120-141, hereafter referred to as Fiscal Policies in
Economies in Transition; RFE/RL Newsline, June 22, 2001; Frank Gregory
& Gerald Brooke, ``Policing Economic Transition and Increasing Revenue:
A Case Study of the Federal Tax Police of the Russian Federation 1992-
1998,'' in Europe-Asia Studies, v. 52, no. 3, May, 2000, pp. 433-455.
---------------------------------------------------------------------------
Recognizing the urgent need for reform, the government as
instructed by President Putin published its ``Program for the
Development of Budget Federalism for the Period Until 2005'' on
August 21, 2001. A national commission is to prepare
legislation for legislative enactment in 2002. The goal is to
establish by statute the specific revenues assigned to regions
and the specific programs which they are obligated to support.
While Russia is constitutionally designated as a Federation,
the center controls revenue and has placed mandates on the
regions that cannot fully paid from their funds. Unlike in
Western federal systems, the 89 regions comprising the
Federation at present have no separate taxing authority. Nor do
local governments whose revenues are included within the
regional unit. The rates of virtually all revenues are set by
laws passed by the central legislature in Moscow. These include
the value added tax (VAT), corporate profits tax, turnover tax,
personal income tax, sales tax, excises, export and import
duties, levies on natural resources, social insurance
contributions, land taxes, licensing fees, etc. Budget debates
in Moscow focus not only on the rates, but also on the
proportions to be allocated to the central budget and to the 89
regions. Through 2000 the division between the center and the
regions was about 50-50. Recently President Putin and the
Council of Ministers pushed through a 56-44 formula for 2001.
On the expenditure side, more than 80 percent of regional
expenditures are mandated by the center. Only by drastically
underfunding most social welfare entitlements do lower-level
administrators gain some limited resources to meet emergencies.
About 1.7 percent of GDP is transferred through the Fund for
Financial Support of Subjects of the Federation to poor regions
that register claims. Unfortunately, the criteria can be
manipulated by lobbying and do not take into adequate account
the economic capacity of the region. Conscientious fiscal
administrators are apt to receive the least amount. Thus, the
present system of fiscal federalism puts lower officials in a
very difficult position. Federal regulations and the outright
fiscal unfeasibility of executing them lead officials to resort
to informal practices to enhance their resources. Given the
very low salaries paid to civil servants, a degree of
corruption is inevitable. For these reasons, major legislation
to restructure the federal fiscal system will probably be
enacted in 2002.\11\
---------------------------------------------------------------------------
\11\ Rossiyskaya Gazeta, July 18, 2001, p. 2, and August 21, 2001,
p. 4; OECD 2000, pp. 116-149; Alexei M. Lavrov, Alexei G. Makushkin, et
al., translated by James E. Walker, The Fiscal Structure of the Russian
Federation, Financial Flows Between the Center and the Regions (Armonk,
NY: M.E. Sharpe, 2001), pp. 1-8, 39-43, hereafter referred to as The
Fiscal Structure of the Russian Federation; Jorge Martinez-Vasquez and
Jameson Boex, Russia's Transition to a New Federalism (Washington, DC:
The World Bank, 2001), pp. 1-54, 89-96, hereafter referred to as
Russia's Transition to a New Federalism..
---------------------------------------------------------------------------
Managing revenues and disbursements efficiently presents a
difficult challenge to any government. During the Soviet
period, this task was handled largely through accounts for all
state agencies and enterprises held in the CBR or specialized
state-owned banks. With the role of the CBR being steadily
reduced to functions normal in Western market economies, a new
institution, the state Treasury, was initiated in 1993. All
revenues were to be deposited into its accounts and legally
budgeted expenditures disbursed to agencies as authorized by
decrees of the Ministry of Finance. By March, 1995, only 47 of
the 74 regional offices were fully operational. Even then, a
common electronic system had not been completed. The last
regional office was established in Tatarstan only in March,
2001. During the interim while the Treasury system was being
built, certain private, politically well-connected private
banks were authorized to administer official accounts. Many
earned a bad reputation by using these funds to speculate for
private gain. During 2001 the seven regions possessing the
largest budget deficits were placed under special Treasury
monitoring. Initial results indicate a dramatic improvement in
their fiscal affairs.\12\
---------------------------------------------------------------------------
\12\ Rossiyskaya Gazeta, May 23, 2001, pp. 1, 3. FBIS-SOV-2001-
0523; The Fiscal Structure of the Russian Federation, pp. 4-6, 59-61;
Fiscal Management in Russia (The World Bank, Washington, DC, 1996), pp.
77-78, 159-163, hereafter referred to as Fiscal Management in Russia;
Russia's Transition to a New Federalism, pp. 51-52.
---------------------------------------------------------------------------
Implementation of a standard system of accounting in all
ministries and government agencies has proven to be a time-
consuming task. Cash management, debt management, and
procurement, relatively unimportant under central planning, are
indispensable to function in a market economy. By October 1,
2001, the books of the Ministry of Defense, reportedly the last
ministry remaining outside the system, are supposed to be
brought into compliance with Treasury requirements. The
dismissal of the Ministry's Colonel General of Finance, General
Auditor, and General Accountant for incompetence resulted from
the installation of the new accounting procedures. These
officials could not account for the disappearance in London of
$450 million in hard currency.\13\
---------------------------------------------------------------------------
\13\ Fiscal Management in Russia, pp. 83-88; Moscow News, No. 1-2,
January 10-16, 2001, p. 2; A. Premchand and L. Garamfalvi, ``Government
Budget and Accounting Systems,'' in Fiscal Policies in Economies in
Transition, pp. 268-290.
---------------------------------------------------------------------------
Provision was made in the 1993 Constitution for an
Accounting Chamber headed by an Auditor General for a period of
5 years and similar in function to the U.S. General Accounting
Office. The newly created office is responsible to the Federal
Assembly. Its duties are to conduct budget evaluations and
audits. The first Auditor General was a professional, but, as a
moderate Communist, found himself at odds with the market
reformers. He and his staff conducted hundreds of audits
involving privatizations but their efforts failed to reverse
any privatizations resulting from breach of contract. Many of
the new private owners had violated their contractual
obligations to invest and to preserve jobs. Instead, they had
stripped assets for personal gain rather than honoring their
contractual obligations to invest and to preserve jobs. Only
one prosecution was initiated. In 2000 former premier Sergei
Stepashin, a prominent political figure during the Yeltsin
years, became Auditor-General. He was emphatic that suspect
regional administrations were to be strictly audited to ensure
that government funds were spent for authorized purposes. His
first target was Kalmykia, one of the most independent acting
republics in the Federation. Stepashin has also advocated
increasing the powers of the Auditor-General to include the
right to initiate prosecutions for malfeasance rather than to
depend on the independent Procurator-General (Attorney-
General). So far, this suggestion has not been approved. A
proposal by Putin to place the Auditing Chamber directly under
the President has not been met with enthusiasm by many
parliamentarians.\14\
---------------------------------------------------------------------------
\14\ RFE/RL Newsline, June 26, 2001; June 27, 2001; July 3, 2001;
and July 10, 2001; Rossiyskaya Gazeta, November, 15, 2000, p. 2;
Kommersant, November 15, 2000, p. 3; Sevodnya, Nov. 9, 2000, p. 5 in
The Current Digest of the Post-Soviet Press (hereafter referred to as
CDPSP), v. 52, no. 45, December 6, 2000, p. 14; Noviye Izvestiya,
September 29, 2001, p. 2 in CDPSP, v. 52, no. 39, October 25, 2000, p.
12.
---------------------------------------------------------------------------
Arguably, the first Russian federal budget that was
fiscally sound was enacted after the financial collapse of
August 1998 and implemented in 1999. The emerging fiscal crisis
had precipitated a rapid turnover of cabinet ministers between
1997 and 1998. Russia was confronted with the pressing need to
reduce expenditures in order to match the revenues available to
the government. Resort to excessive internal short-term, high-
rate borrowing complicated the problem since the rapidly
increasing expenditures outlays to service the debt crippled
normal government fiscal operations. The left-dominated state
Duma would not agree to sharp cuts in expenditures and other
reform measures. After Asian stock markets crashed and oil
export revenues dropped sharply, foreigners lost confidence in
investing in the financial markets of developing countries
including Russia. Consequently, the Federation defaulted on its
internal debt obligations and the ruble's value fell by 80
percent. Without the crash of 1998 deputies in the Duma,
particularly the leftists, would not have been motivated to
support the reduction of budget outlays and changes in tax
laws. The crash of 1998 served as a harsh lesson to deputies in
the Duma. The austere budget for 1999 proposed by the outgoing
Kireyenko government was enacted into law with their approval.
For the first time the government was able to fund most
commitments made in the budget fully without resort to major
sequestration or excessive borrowing. The budgets for 2000 and
2001 are in the same category.\15\
---------------------------------------------------------------------------
\15\ ITAR-TASS, July 3, 2001, in FBIS-SOV-2001-0703; Interfax, June
5, 2001, FBIS-SOV-2001-0605; Vremya MN, June 15, 2001, FBIS-SOV-2001-
0615.
---------------------------------------------------------------------------
Reducing Public Expenditures on Housing and Municipal Services
Despite progress toward fiscal accountability, entrenched
institutions inherited from the Soviet period continue to drain
precious funds at an exorbitant rate. President Putin and his
ministers are wrestling with the difficult job of designing a
strategy that would shift part of the costs for financing
housing and municipal services to private consumers. At
present, an estimated 4 percent of GDP from the consolidated
federal and regional-local budgets is allocated to cover the
expenses for housing maintenance, heating and water systems,
waste disposal, utilities, and public transportation.
Currently, local governments allocate 24 to 34 percent of their
budgets for maintaining this sector. In many localities the
remaining money is barely sufficient to pay the salaries of
their employees. Investment in renovation and installation of
new infrastructure has remained at a near standstill for a
decade because of lack of funds. An estimated 60 percent of
water and district heating systems are worn out and need
replacement. Experts predict that breakdowns such as occurred
during winter 2000-2001 in the North and Far East are likely to
multiply in future winters unless vital funds are made
available. If a reform in this sector could reduce the budget
burden by 1 percent of GDP, the solvency of regional and local
budgets would be dramatically improved.\16\
---------------------------------------------------------------------------
\16\ Rossiyskaya Gazeta, February 3, 2001, pp. 2, 6, in CDPSP, v.
53, no. 5, February 28, 2001, p. 9; Trud, February 16, 2001, p. 1, in
CDPSP, v. 53, no. 7, March 14, 2001, p. 13; ITAR-TASS, August 21, 2001,
FBIS-SOV-2001-0821; Interfax, August 14, 2001, FBIS-SOV-2001-0815.
---------------------------------------------------------------------------
This situation is an example of how reform is obstructed by
the unbalanced social contract inherited from the Soviet
period. Employees were paid very low wages in cash, but through
employers received proportionately high benefits, i.e., housing
and municipal services, utilities, kindergartens, clinics,
restaurants, sports and cultural facilities, etc., for which
they paid only 2 to 3 percent of costs. That percentage was
less than the average household spent on vodka and cigarettes.
The enterprise, ministry, academic or research institute, or
other state organization took care of the expenses incurred by
their employees, who essentially lived within ``company
towns.'' Capital costs were funded through the annual plan, not
bonds which had to be paid off by real estate taxes. As major
enterprises were privatized and entered into the market
economy, the responsibility for funding many of these
facilities and services were shifted mainly to the jurisdiction
of local governments. The latter in 1994 only received one-
fourth of the federal compensation theoretically authorized by
privatization laws to cover the additional budgetary
obligations. Many citizens took advantage of the opportunity to
privatize their apartments. Unlike in western condominiums,
owners of these apartments have not assumed responsibility for
paying basic maintenance and capital expenses associated with
their buildings. In most cases local governments continue to
bear the responsibility for the most of the costs incurred.
Only slowly have payments made by tenants and owners risen to
cover an estimated 40 percent of the charges.\17\
---------------------------------------------------------------------------
\17\ Kommersant, March 20, 2001, p. 8 in CDPSP, v. 51, no. 12,
April 18, 2001, p. 8; Vremya MN, June 1, 2001, FBIS-SOV-2001-0601;
Rossiyskaya Gazeta, June 26, 2001, FBIS-SOV-2001-0626; The Changing
Social Benefits in Russian Enterprises (Paris, OECD, 1996); Andrea
Stevenson Sanjan, ``State-Society Relations and the Evolution of Social
Policy in Russia,'' in State-Building in Russia, The Yeltsin Legacy and
the Challenge of the Future edited by Gordon B. Smith (Armonk, N.Y.:
M.E. Sharpe, 1999), pp. 177-199; Linda J. Cook, ``The Russian Welfare
State: Obstacles to Restructuring,'' in Post-Soviet Affairs, v. 16, no.
4, October-December, 2000, pp. 355-378; Nigel M. Healey, Vladimir
Leksin, and Alexandr Svetsov, ``The Municipalization of Enterprise-
Owned `Social Assets' in Russia,'' Post-Soviet Affairs, vol. 15, no. 3,
July-September, 1999, pp. 262-280.
---------------------------------------------------------------------------
The majority of households cannot afford a change in the
system that would raise their monthly bill for housing,
municipal services and utilities by 150 percent. The average
monthly wage in 2000 was only 2,268 rubles ($78), which is less
than the official subsistence for an adult and child.
Increasing salaries would resolve the problem by enabling the
workers to pay for these basic living costs. Several deputies
successfully introduced an amendment to the proposed Labor Code
mandating that the legal minimum wage equal the subsistence
level. Aleksandr Pochinok, the capable Minister of Labor and
Social Development, cautioned that the government could not
implement this measure in the near future. The additional cost
of increasing pay for government-funded employees would be 800
billion rubles from the federal budget and almost 2.5 trillion
rubles from regional and local budgets. That expenditure would
surpass total outlays of the consolidated budgets of all three
levels of government. The compromise version included the
mandate, but provided that it would go into effect only after a
separate authorization bill was enacted.\18\
---------------------------------------------------------------------------
\18\ Vremya MN, June 1, 2001, FBIS-SOV-2002-0601.
---------------------------------------------------------------------------
This complex issue is compounded by the problems of the
Russian Unified Energy Systems (UES) and Gazprom, the
monopolistic electricity and natural gas companies who are owed
68 billion rubles by local consumers. Regional and municipal
administrators often have deliberately avoided their
responsibilities to cover energy bills and have pressured
regional regulators to set the rates below costs. Even those
charges were not fully paid. As a result, UES power plants,
particularly in the North and Far East, lacked funds for
essential coal supplies. Managers of some privatized mines
chose not to ship supplies to generating and heating plants
with overdue debts. So outages occurred in the midst of a hard
winter. Successful reform and eventual privatization of the two
great natural monopolies is partly dependent on adjustments in
the housing and municipal services sector.\19\
---------------------------------------------------------------------------
\19\ Izvestiya, November 23, 2000, p. 6 in CDPSP, v. 52, no. 47,
December 20, 2000, pp. 5-6; Novyie Izvestiya, December 8, 2000, pp. 1-2
in CDPSP, v. 52, no. 49, January 3, 2001, p. 12; Kommersant, January
24, 2001, p. 4; Rossiyskaya Gazeta, February 3, 2001, pp. 2, 6 in
CDPSP, v. 53, no. 5, February 28, 2001, pp. 9-10.
---------------------------------------------------------------------------
No final decision on the strategy for reforming this sector
which affects the household budgets of Russia's families. On
March 15, 2001, the Council of Ministers approved a plan, but
on July 5 switched to a ``new model.'' In the earlier session
plans were approved to have the public pay 100 percent of their
housing, municipal services, and utilities by 2003. If a
family's payments were to exceed 22 percent of its total
income, then they would be entitled to a subsidy equal to the
amount of payments above a threshold percentage. The Chairman
of the State Committee on Construction, Housing, and Municipal
Services estimated that 30 percent of citizens would be
eligible for subsidies. President Putin later said a majority
could apply. Moscow's deputy mayor immediately objected to the
proposed increase in coverage since the city would be required
to spend an additional 18 billion rubles if the new system were
to be in effect. He called for its introduction in 2007 at the
earliest. The governor of Perm Oblast said that subsidies
should begin at 10 to 12 percent of family income. At the
Cabinet session of July 5, a new model gained support. The aim
to keep the family burden under 22 percent was honored and the
deadline delayed. However, direct subsidies to families would
be replaced by a transfer of funds already allocated for
housing and utilities to building associations. These groups
would then be free to contract with service providers instead
of relying on the government-connected types now in place. This
important advance would create competition and lead to lower
charges for building maintenance. Critics point out that such
associations, though provided for in the law on privatizing
housing, are poorly developed and often controlled by small
cliques who exploit their position for private gain. No final
decision has been reached on the question of how to deal with
this controversial issue. Meanwhile, the World Bank and the
Russian Government in the past 6 months have concluded three
agreements to provide $287.5 million for selected projects in
housing and municipal services.\20\
---------------------------------------------------------------------------
\20\ Kommersant, March 20, 2001, p. 8; Moscow Mayak Radio, July 5,
2001, FBIS-SOV-2001-0705; ITAR-TASS, 5 July 2001, FBIS-SOV-2001-0705;
World Bank, Press Releases, December 21, 2000, March 27, 2001, and June
7, 2001; Rossiyskaya Gazeta, May 30, 2001, FBIS-SOV-2001-0531;
Rossiyskaya Gazeta, May 29, 2001, FBIS-SOV-2001-0529; ITAR-TASS, May
29, 2001, FBIS-SOV-2001-0529; Rossiyskaya Gazeta, May 31, 2001, in
FBIS-SOV-2001-0521; Obshchaya Gazeta, July 12, 2001, FBIS-SOV-2001-
0712.
---------------------------------------------------------------------------
Targeting Social Welfare Entitlements
A debate has begun on restructuring the extensive system of
social welfare entitlements established by the Soviet regime.
The Soviet leadership of the ``workers' state'' developed a
system of more than 160 entitlements that operated for seven
decades and consumed over 4 percent of GDP. These benefits
mandated by the center were paid primarily by regional and
local governments at levels far lower than promised. If the
benefits were paid in full, they would probably cost 22 percent
of GDP. Approximately two-thirds of the population qualified
for one or more of the 47 categories. Payments and costly
privileges were awarded to veterans and their children,
pensioners, orphans, disabled, students, families with many
children, rural residents, victims of Chernobyl, victims of
political repression, etc. Only about one-third of benefits go
to those individuals who are classified as needy. For example,
municipal bus companies can barely afford to keep their current
operations functioning and are required to permit nearly two-
thirds of passengers to ride without charge or at reduced
fares.\21\
---------------------------------------------------------------------------
\21\ OECD 2000, pp. 129-136; Moscow News, no. 24, June 21-27, 2000,
p. 2; The World Bank, From Plan to Market, World Development Report
(New York: Oxford University Press, 1996), pp. 77-84; The World Bank,
Balancing Protection and Opportunity: A Strategy for Social Protection
in Transition Economies, May 3, 2000 (Washington, DC, The World Bank,
2000), pp. 24-29, 35-40, hereafter referred to as A Strategy for Social
Protection in Transition Economies; Vremya MN, March 14, 2001, p. 5, in
CDPSP, v. 51, no. 12, April 18, 2001, p. 8.
---------------------------------------------------------------------------
Federal transfer payments have been grossly inadequate.
After 1991 a key stratagem for reducing central government
expenditures was to shift the financial burden down to the
fiscally hard-pressed regions. Regional leaders tried
desperately to restrict the growth of this burden on them
through other means. Laws have been in force since 1993
explicitly prohibiting the center from devolving responsibility
for paying these mandates unless it provided the funds to pay.
However, eligible citizens in 1997 began to bring suits in the
courts against local authorities who refused to pay various
entitlements. Typically, the judges ruled in favor of the
plaintiffs since the statute governing federal transfers to the
regions has ambiguous language stating that mandates are
calculated as part of the formula for determining the sum to be
awarded. The regions have grudgingly paid when courts so
ordered, but overall most of these entitlements are at best
partially honored.\22\
---------------------------------------------------------------------------
\22\ OECD 2000, p. 131.
---------------------------------------------------------------------------
This whole system of social welfare entitlements needs to
be restructured to reduce the number of entitlements and to
redefine the conditions for eligibility so that the needy are
targeted. In his annual budget message for 2002, the President
declared that ``unfunded federal mandates'' need to be
clarified as part of the project to reform budgetary relations
between the center and the regions. Russian leaders are moving
slowly because they understand the political risks when
sensitive vested interests are at stake.\23\
---------------------------------------------------------------------------
\23\ Text of Russian president's annual address to the Federal
Assembly, Russia TV, April 3, 2001, Johnson's Russia List JRL #5185,
April 4, 2001, p. 13 (hereafter cited as Putin's State of the Union
Message); ``Russian Federation President's Budget Message to the
Russian Federation Federal Assembly: On Budget Policy for 2002,''
Rossiyskaya Gazeta, April 23, 2001, FBIS-SOV-2001-0425, p. 5, hereafter
cited as Putin's Annual Budget Message; Rossiyskaya Gazeta, April 24,
2001. FBIS-SOV-2001-0425.
---------------------------------------------------------------------------
Pension Fund Reform Scheduled To Be Enacted in 2001
Prospects for enactment of old-age pension reform in 2001
were good. After much debate, a solid majority of the
leadership including the President supported changes in the
system to ease the future burden on the state budget.
Currently, the extra-budgetary Pension Fund is receiving 82.5
percent of the 29.6 percent of the payroll tax levied to
support the four social insurance funds. It is running a
surplus. The Fund received about 8 percent of GDP. Since 1990
old-age pensions have been reduced to approximately the same
level which is below subsistence for recipients regardless of
years in the work force or total contributions as a result of
inflation. This pay-as-you-go (PAYG) system would need to be
restructured since birthrates have fallen below replacement
level for a number of years. In Russia the ratio of pensioners
to workers will reach a critical stage in 7 to 8 years beyond
which the Pension Fund's budget will operate at a deficit. That
situation would require supplementary appropriations from the
federal budget.\24\
---------------------------------------------------------------------------
\24\ Irina Denisova, Maria Gorban and Ksenia Yudaeva, ``Social
Policy in Russia: Pension Fund and Social Security,'' Russian Economic
Trends, v. 8, 1999, no. 1, pp. 12-23; Sevodnya, September 23, 2000, p.
3, in CDPSP, v. 52, no. 39, October 25, 2000, p. 15; Obshchaya Gazeta,
November 9, 2000, in JRL #4640, November 27, 2000; Putin's State of the
Union Message, JRL #5185, 4 April 2001, p. 12; Rossiyskaya Gazeta, May
30, 2001, FBIS-SOV-2001-0530; A Strategy for Social Protection in
Transition Economies, pp. 1-28; George Kopits, ``Social Security,'' in
Fiscal Policies in Economies in Transition, pp. 291-311.
---------------------------------------------------------------------------
Draft laws for changing the pension system in the medium-
and long-term were scheduled to be enacted in 2001. In March a
major dispute on the structure of the future system erupted at
the Cabinet level on the eve of the first meeting of the
presidentially appointed National Council on Pension Reform.
The director of the Pension Fund, Mikhail Zurabov, slated to be
the rapporteur from the Cabinet to the Council, differed with
the newly defined terms earlier agreed to by the Cabinet. He
wanted to maintain the present system, altering coefficients to
provide a lower rate for pensioners. First Deputy Premier
Mikhail Dmitriyev and Economics Development Minister German
Gref with the support of the President agreed to the
introduction of a partially savings-based system in which the
Pension Fund would be obligated to turn over some of its
financial flows to investment and management companies. On May
30 the National Council approved four draft laws and the
ministries have begun to draw up detailed bills for
consideration by the Duma in September.\25\
---------------------------------------------------------------------------
\25\ Sevodnya, March 6, 2001, p. 1, in CDPSP, v. 53, no. 10, April
4, 2001, p. 11; Izvestiya, April 19, 2001, p. 5 in CDPSP, v. 53, no.
16, May 16, 2001, p. 15.
---------------------------------------------------------------------------
Deeply influenced by the Chilean model, the system is
predicated on the principle that the rates of return from
investment in stock and bond mutual funds will yield higher
returns in the medium- and long-term to pensioners than has
historically been the case from public systems. Six percent of
the social insurance tax paid by employers is to be transferred
to individual pension accounts for participants under 35 and 2
percent for those aged 35 to 50. Individuals over 50 would not
participate in savings-based funds. Since retirement age is set
at 50 for women and 55 for men, their investments would lack
time to accrue sufficient resources. Boris Nemtsov of the Union
of Rightists, Grigory Yavlinsky of Yabloko, and Moscow Mayor
Yuri Luzhkov of Fatherland supported the savings account
system. They advocated that individuals be given the right to
decide whether to use private pension funds or insurance
companies instead of the services of a ``government broker.''
The possible inheritance of the savings account by the worker's
legal heir is also under consideration. Public opinion polls
indicate that 60 percent of those questioned favor the
reform.\26\
---------------------------------------------------------------------------
\26\ Izvestiya, April 19, 2001, p. 5, in CDPSP, v. 53, no. 16, May
16. 2001, p. 15; Vremya MN, July 18, 2001, FBIS-SOV-2001-0718; Moscow
News, no. 29, July 18-24, 2001, p. 3.
---------------------------------------------------------------------------
Advantages to implementing this updated system were
numerous. A huge future burden on the state Budget could be
avoided. The steady flow of cash into investment funds could
help provide the badly needed capital to sustain the
development of the financial services sector. National Council
members understand that the present lack of reliable investment
options is a major deterrent to economic growth. The initial
investments anticipated early in 2003 will probably be in
interest-bearing medium-term state bonds. The stock markets are
still too small to absorb so much money. A higher rate of
return on investments in funds would potentially give latitude
to the government to reduce the payroll tax, all of which is
presently paid by employers.\27\
---------------------------------------------------------------------------
\27\ Sevodnya, September 23, 2000, p. 3, in CDPSP, v. 52, no. 39,
October 25, 2000, p. 15.
---------------------------------------------------------------------------
On April 19, 2001, President Putin submitted a bill to the
legislature to tighten the system for administering pensions.
Originally, the Pension Fund was responsible for collecting its
own revenues, but the task was transferred to the state Tax
Service on January 1, 2001. Eligibility and disbursements were
handled at the regional level. Unfortunately, some governors
have been successful in pressuring lower officials to divert
funds from their intended purpose. Last year regions were given
the right by Presidential decree to transfer power to the
central agencies who would determine eligibility and pay
pensioners. About 30 regions reacted positively. The President
has now asked that this significant change of policy be
mandatory throughout Russia.\28\
---------------------------------------------------------------------------
\28\ Kommersant, April 20, 2001, p. 4.
---------------------------------------------------------------------------
Executing Legal Reform
At the opening session of the national congress of Russian
judges on November 27, 2000, President Putin stated that a high
priority over the next 2 to 3 years was to strengthen and
reform the Russian judicial system. Businessmen needed to be
assured that their property and human rights will be enforced
by the courts. Putin asserted that his aim is to adhere to
international human rights standards. He cited inadequate
funding of the courts as ``a cause of miscarriages of justice''
and the arbitrary hearing of cases by overworked judges. On
June 28, 2001, 4 bills on judicial reform passed the first
reading in the Duma with more than 380 votes for each. During
the second reading the debate will focus on the limits to be
set on the tenure of judges. The goal is to implement the
reforms by 2004.\29\
---------------------------------------------------------------------------
\29\ Izvestiya, Nov. 28, 2000, p. 3 in CDPSP, v. 52, no. 48,
December 27, 2000, p. 10; Nezavisimaya gazeta, November 30, 2000, p. 3
, CDPSP, v. 52, no. 48, December 27, 2000, pp. 10-11; ITAR-TASS, May
29, 2001, FBIS-SOV-2001-0529; Vremya MN, June 21, 2001, FBIS-SOV-2001-
0622; Moskovskiye Novosti, 26 June 2001, FBIS-SOV-2001-0628; Gordon B.
Smith, ``The Disjuncture Between Legal Reform and Law Enforcement, The
Challenge Facing the Post-Yeltsin Leadership,'' in State Building in
Russia, The Yeltsin Legacy and the Challenge of the Future, pp. 101-
122.
---------------------------------------------------------------------------
The courts are overburdened. Sixteen thousand judges heard
more than 5 million civil cases, more than 1 million criminal
cases, and 2 million administrative cases in 2000. Judicial
workloads have tripled in the last 6 years. One thousand judges
are being added in 2001. Though the federal government pays
their salaries, judges and their staffs remain dependent on
regional and local authorities for professional facilities,
housing, municipal services and utilities. Putin proposes to
terminate the requirement that judicial appointments be cleared
with regional officials. Many judges are holdovers from the
Soviet period and have not proven to be willing or able to keep
up with the rapid legal changes that have occurred since then.
The 1970s administrative code for the courts, though much
amended, is still in force.\30\
---------------------------------------------------------------------------
\30\ Izvestiya, Nov. 28, 2000, p. 3, in CDPSP, v. 52, no. 48,
December 27, 2000, p. 10; RFE/RL Russian Political Weekly, vol. 1, no.
18, July 2, 2001, p. 7.
---------------------------------------------------------------------------
The dramatic increase in spending to finance the judicial
system in 2001 is a strong indicator that the Putin
Administration is serious about enhancing the courts'
credibility. At 11 billion rubles ($367 million) in 2001, the
request for 2002 is reportedly for 18.8 billion rubles ($630
million) in 2002. In addition to monies from the regular budget
line, additional sums are to be drawn from the extra-budgetary
Federal Targeted Program for the Development of the Judicial
System to be funded at the level of 44 billion rubles ($1.5
billion) over the next 4 years. Unfortunately, administration
of the court system's budget still remains under the
jurisdiction of the Ministry of Justice which raises the
question of separation of powers. The judges prefer that
responsibility be transferred to the Supreme Court's
Administrative Department to ensure the independence of the
judicial branch.\31\
---------------------------------------------------------------------------
\31\ Sevodnya, Nov. 28, 2000, p. 5 in CDPSP, v. 52, no. 48,
December 27, 2000, p. 10; Moskovskiye Novosti, June 26, 2001, FBIS-SOV-
2001-0628.
---------------------------------------------------------------------------
When Putin withdrew proposed amendments to the Criminal
Procedural Code requiring prosecutors and security agencies to
seek an arrest warrant from a judge before taking an accused
into custody, critics viewed his decision as evidence of a
return to authoritarian ways. The President justified his
retreat by noting such legislation would necessitate adding
3,000 judges and 6,900 court employees at a cost of 1.5 billion
rubles ($50 million) to implement the new court procedures. The
amendments have since been reintroduced over the strong
objections of the Prosecutor-General, Minister of Interior, and
head of the Federal Security Agency. Putin has also announced
his support for introducing jury trials throughout the country
to be effective by January 1, 2003.\32\
---------------------------------------------------------------------------
\32\ Sevodnya, January 23, 2001, p. 5, and Novyie Izvestiya, Jan
24, 2001, p. 1, both in CDPSP; v. 53, no. 4, February 21, 2001, pp. 5-
6; Kommersant, April 4, 2001, pp. 1-2; Moskovskiye Novosti, June 26,
2001, FBIS-SOV-2001-0628.
---------------------------------------------------------------------------
Other measures to strengthen the judicial system have not
fared well. The President has complained about the
unsatisfactory performance of the marshals (bailiffs), still
under the Ministry of Justice, in enforcing decisions. The new
justice of the peace courts designed to handle a large number
of relatively minor matters have been established in only five
regions in the first year. While the center is responsible for
their salaries, the regions are supposed to pay for office and
hearing facilities as well as housing and municipal services.
Putin has now proposed to take the whole justice-of-the-peace
system out of the jurisdiction of regional authorities and
included funds for this drastic step in the 2002 fiscal
year.\33\
---------------------------------------------------------------------------
\33\ Nezavisimaya gazeta, November 30, 2000, p. 3 in CDPSP, v. 52,
no. 48, December 27, p. 10; Mayak Radio, June 28, 2001, in FBIS-SOV-
2001-0628.
---------------------------------------------------------------------------
Raising Educational Standards
A comprehensive plan to restructure the educational system
from preschool through the university level is being
implemented. While Russians are a very literate population, the
quality of education has fallen behind that of advanced
countries. Findings of a study for the World Bank released in
August, 2000, revealed that students in the former Soviet-
dominated bloc now receive on average 5 years less education
than is the norm for the Organization for Economic Cooperation
and Development (OECD) states. A study frequently cited by
Russian sources concludes that the proportion of the Russian
work force rated as highly skilled is now less than 10 percent
compared with China at 28 percent, the United States at 42
percent, and Germany at 54 percent. More than 1.5 million
Russian children between 7 and 15 are not attending school and
15 to 20 percent have low reading and writing skills. Another
36 percent are in schools operating in multiple shifts, which
means that school days are short and extra-curricular
activities are minimal. Vocational education programs and
access to computer training are urgently needed as well as
modern equipment and qualified teachers. Since 1991 per capita
spending for public school students has dropped by 38 percent.
Only 3.2 percent of GDP is allotted to education.\34\
---------------------------------------------------------------------------
\34\ Trud, October 18, 2001, p. 1, in CDPSP, v. 52, no. 43,
November 22, 2000, p. 16; Sevodnya, September 28, 2000, p. 6, in CDPSP,
v. 52, no. 41, November 8, 2000, p. 20; ITAR-TASS, May 24, 2001, FBIS-
SOV-2001-0524; Nezavisimaya gazeta, May 4, 2001. p. 4 in CDPSP, v. 53,
no. 19, p. 4; Rossiyskaya gazeta, June 23, 2000, p. 9, in CDPSP, v. 52,
no. 27, August 2, 2000, p. 8; Sevodnya, September 1, 2000, pp. 1, 3 in
CDPSP, v. 52, no. 35, September 27, 2000, p. 14; Sevodnya, September
28, 2000, p. 6 in CDPSP, v. 52, no. 41, November 8, 2000, p. 20; Novye
Izvestiya, August 9, 2000, p. 12, in CDPSP, v. 52, no. 32, September 6,
2000, p. 12; Hidden Challenges to Education Systems in Transition
Economies, (Washington, DC; The World Bank, 2000), pp. 2-5, 13-27.
---------------------------------------------------------------------------
In August 2000 the Council of Ministers approved the
recommendations for school reform over the next decade
presented by Yaroslav Kuzminov, rector of the Higher School of
Economics. Based on British models the plan is to extend
general education from 10 to l2 years for all students and to
upgrade the quality of instruction. After the tenth grade they
will be assigned to college-preparation or vocational-education
tracks. All curricula are to be revamped with more options for
students. One goal is to connect all schools to the internet
over the next 4 years. Extensive retraining programs will be
required for teachers, e.g., 276,000 in information technology
alone. Vocational-technical education should be upgraded in
equipment and instruction. Kuzminov advocates the doubling of
budget expenditures from the present 3.2 percent of GDP. He
warns that the People's Republic of China will overtake Russia
in trained professionals if a greater commitment is not
made.\35\
---------------------------------------------------------------------------
\35\ Rossiyskaya Gazeta, June 23, 2000, pp. 8-9, in CDPSP, v. 52,
no. 27, August 2, 2000, p. 9; Novye Izvestiya, Aug. 9, 2000, p. 4, in
CDPSP, v. 52, no. 32, September 6, 2000, p. 12; Sevodnya, September 28,
2000, p. 6, in CDPSP, vol. 52, no. 41, November 8, 2000, p. 20; Trud,
October 1, 2001, p. 1, in CDPSP, v. 52, no. 43, Nov. 22, 2000, p. 16.
---------------------------------------------------------------------------
Such a thorough transformation inevitably encounters
hostility and widespread opposition. On February 27, 2001, a
demonstration organized by the teachers' union reportedly drew
300,000 protesters to demand payment of back pay which averaged
3 months in arrears and a 50 percent increase in salary. The
average pay of teachers is below the minimum subsistence
standard set at 1,285 rubles ($43) per month on January 1,
2001. The Deputy Premier responsible for the sector promised to
pay promptly any arrears overdue for more than 1 month and to
raise salaries in the first 6 months of 2002 by 20 percent. She
claimed that the government lacks the resources to pay teachers
as much as other budget-funded employees. Salaries are funded
by the center. Municipal services including utilities, many
supplies and school buildings, i.e., two-thirds of educational
expenditures, are the responsibility of regional and local
governments. Provision has been made to raise teachers' pay by
50 percent in the proposed 2002 federal budget. That will not
calm all their worries about change. Equally striking was the
signature of 1,988,232 teachers in a petition opposing
proposals to restructure the educational system from top to
bottom in February. Many fear that the new system will deprive
their own children of a chance for higher education by sharply
reducing the number of student stipends.\36\
---------------------------------------------------------------------------
\36\ Sevodnya, February, 28, 2001, p. 2 in CDPSP, v. 53, no. 9,
March 28, 2001, p. 13; Trud, April 20, 2001, p. 7 in CDPSP, v. 53, no.
19, June 6, 2001, p. 5; Trud, September. 21, 2000, p. 7 in CDPSP, no.
52, no. 39, October. 25, 2000, p. 16; Obshchaya Gazeta, August 16,
2001, FBIS-SOV-2001-0819.
---------------------------------------------------------------------------
The rectors of most universities are bitterly against the
implementation of proposals that will affect their
institutions' admissions procedures and financing. The rector
of the prestigious Moscow State University stated bluntly:
``Our triumphant system of higher education must not be put
under the complete control of the `invisible hand of the
market.' '' In his State of the Union message, Putin endorsed
new policies designed to increase opportunity for young people
of humble origin living in the provinces. Differentiation by
social class already exists as 82.5 percent of students at
prestigious universities come from a small number of elite
secondary schools. Only 6.5 percent are from ordinary public
schools. The old Soviet system of admissions still dominates
whereby each higher education institution designs and
administers its own tests for admission. Since most state
institutions give the entrance tests only once per year in the
city where they are located and on the same day, failure to
attend means postponing entry into higher education for a year,
taking a second test offered later by a less prestigious
institution, entering the workforce with poor qualifications,
or going into the military. The Ministry of Education has
initiated a pilot project to give a national high school
graduation/college admission exam comparable to the U.S.
Scholastic Aptitude Test (SAT) which is to be conducted by
outside examiners at 20 sites in each of three regions.
Opportunities to collect substantial fees for special tutoring
and bribes to influence decisions on admissions may be
considerably reduced.\37\
---------------------------------------------------------------------------
\37\ Nezavisimaya Gazeta, September 1, 2000, p. 15, in CDPSP, v.
52, no. 35, September 27, 2000, p. 14; Moskovskiye Novosti, no. 47,
November 28-December 4, 2000, p. 19 and Noviye Izvestiya, December 8,
2000, p. 2, both in CDPSP, v. 52, no. 49, January 3, 2001, p. 14; 3
articles in Kommersant, April 26, 2001, p. 8, in CDPSP, v. 53, no. 19,
June 6, 2001, pp. 1-3; Nezavisimaya Gazeta, September 1, 2000, pp. i, 3
in CDPSP, v. 52, no. 35, September 27, 2000, pp. 14-15; Izvestiya,
January 27, 2001, p. 5 in CDPSP, v. 53, no. 4, February 21, 2001, p.
16.
---------------------------------------------------------------------------
Even more threatening to the rectors is a radical
initiative to issue full or partial tuition vouchers to the
best achievers on the national examination. These students will
be able to take their vouchers to any institution of higher
education of their choice. Provision will be made for living
allowances to children from poor families. Those not qualifying
for vouchers will have to pay their own way. As is the case
now, those possessing dollars are likely to gain entry. Whether
or not an institution flourishes will depend to a significant
degree on the competition to attract students with
vouchers.\38\
---------------------------------------------------------------------------
\38\ Kommersant, June 23, 2000, p. 8 in CDPSP, vol 52, no. 27,
August 2, 2000. pp. 8-9; Moskovskiye Novosti, no. 47, November 28-
December 4, 2000, p. 19 in CDPSP, v. 52, no. 49, January 3, 2001, p.
14; Kommersant, April 26, 2001, p. 8 in CDPSP, v. 53, no. 19, June 6,
2001, pp. 1-2.
---------------------------------------------------------------------------
The acquisition of resources to maintain higher education
standards has been a serious problem for rectors since 1991.
State funding for higher education amounts to only 0.6 percent
of GDP. That sum compares unfavorably with 5.2 to 5.5 percent
allotted in France, Germany and the United Kingdom. The state
will continue to fund salaries, the physical plant, utilities
and equipment on campuses. In addition, the rectors will be
encouraged to raise money from private sources with the state
offering matching grants. Already substantial sums have been
acquired from the private sector by renting out facilities or
winning research contracts. Now the government is mandating
that these revenues be reported. It is hoped that 50 percent of
operating revenues will eventually come from non-governmental
sources as well as individual students paying their whole
tuition. Budget resources are unlikely to increase
significantly in the next few years.\39\
---------------------------------------------------------------------------
\39\ Rossiyskaya Gazeta, June 23, 2000, pp. 8-9 in CDPSP, v. 52,
no. 27, August 2, 2000, p. 9; Kommersant, April 26, 2001, p. 8,
Nezavisimaya Gazeta, May 4, 2001, p. 3 and Trud, April 20, 2001, p. 5,
all three in CDPSP, v. 53, no. 19, June 6, 2001, pp. 1-2, 4-5.
---------------------------------------------------------------------------
Conclusion
As explained in this paper, the Putin Administration is
engaged in executing an ambitious agenda of reforms targeted at
overcoming institutional obstacles inherited from the Soviet
CPE era. Budget resources will remain very scarce in the years
immediately ahead. Some changes, e.g., reduction of subsidies
in the housing and municipal services sector as well as social
welfare entitlements would recast basic elements of the old
social contract still in place. Restructuring the pension
system is imperative to lessen the future burden on the
Federation budget and to channel the flow of much needed
resources into the financial services sector. Strengthening a
reformed judicial system is taking place and the charge will be
a relatively light burden on the Treasury. An expensive
upgrading of the quality of education is essential for Russia
to be competitive with G-7 states in global markets and to
sustain economic growth.
Unlike in the early years of the transition, a system of
institutions for the sound management of fiscal affairs now
exists at the federal level. Even without a formal agreement
with the IMF, sound budget policies are being implemented. Too
often the center has achieved the macro-economic goal by
shifting financial responsibility for support of federal
agencies, including the military and social welfare
entitlements, to lower levels of government. Simultaneously,
the center has repeatedly changed the share of revenues
assigned to subordinate authorities which lack the means
required to pay obligations in full. This uncertain situation
makes the implementation of sound budget practices difficult
and often impossible. Inevitably, governors and mayors are
accused of arbitrariness as they reduce payments to match
available funding. Under considerable political pressure the
Putin Administration in August, 2001, proposed a legislative
act to distinguish the responsibilities belonging to the center
and those to the regions and local governments. The agency
responsible for a particular function should be able to fund it
from its own resources. In addition, the division of revenues
should be set until 2005 to make possible reasonable budget
management.
The President and his ministers understand that the key to
retaining the support of a majority of the population for
market reforms is dependent on significant improvements in the
standard of living. The ``socially oriented'' 2002 budget
proposal submitted to the state Duma has at its core a dramatic
increase in the salaries of civil servants and the military by
50 to 70 percent. However, households will have to expend part
of their higher income on increased charges for housing
maintenance, municipal services, and utilities. As these
expenses are phased in, expectations of the public about the
proper responsibilities of the state will likely change to be
comparable to those in the ``social market'' societies of
Western Europe. Such a trend is positive for the interests of
the United States.
RUSSIAN DEFENSE SPENDING
By Christopher J. Hill \1\
----------
contents
Page
Summary.......................................................... 161
Introduction..................................................... 162
The Russian Defense Budget....................................... 162
Defense Spending Outside the Official Defense Budget............. 166
Trends in Defense Spending....................................... 167
The Allocation of Russian Defense Spending....................... 169
Allocation by branch of service.............................. 169
Allocation by function....................................... 171
Financial Aspects of Weapons Production.......................... 174
The Defense Burden............................................... 175
Defense Spending in Dollars...................................... 176
Prospects........................................................ 177
Summary
The published Russian defense budget is an inadequate guide
to the country's total defense spending because many items
which would be incorporated in any Western calculation are
ignored. The true level of outlays last year was approaching
twice the acknowledged figure.
---------------------------------------------------------------------------
\1\ Dr. Hill has worked in a number of government offices in the
United Kingdom. He is currently head of the Defense Economics branch of
the Ministry of Defense (MOD). His doctorate is from Manchester
University.
---------------------------------------------------------------------------
Despite an increase of around 16 percent after inflation in
the last 2 years, overall defense expenditure in 2000 was well
under 40 percent of that in 1992 and just 15 percent of that of
the Soviet Union at its 1988 peak. Moreover, last year almost
three-fifths of the money was spent on personnel, leaving a
hopelessly inadequate level of funding for weapons research,
development, procurement and maintenance. As orders for new
weapons have dried up, defense industries have been hard hit
and many, perhaps most, are now by any normal measure bankrupt.
Russia devotes well over 5 percent of its gross domestic
product (GDP) to defense, twice the North Atlantic Treaty
Organization (NATO) average, but because of inadequate
accounting procedures, both the political and military
leadership is of the view that the burden is under 3 percent.
Total defense outlays in 2000 were equivalent to around $50
billion, the third largest in the world.
The Russian Government hopes to double Defense Ministry
spending per serviceman by 2005 and to triple it by 2010.
Despite plans for substantial cuts in the size of the armed
forces, these goals are unlikely to be realized. The overall
weapons inventory will fall during the rest of this decade.
Only thereafter will capability gradually improve.
Introduction
This paper looks at the financial resources which the
Russian Government has made available for defense over recent
years. It examines what the authorities in Moscow have
themselves said about the level of such spending and assesses
the comprehensiveness and reliability of those statements.
Alternative ruble valuations are then offered as well as a
judgment on the likely real trend in defense outlays once
inflation has been taken into account. This is followed by some
thoughts on the allocation of those funds both by branch of
service and by function. After a short digression on the
financial state of Russia defense industries, the report
returns to its main theme, exploring the burden defense
spending currently places on the Russian economy, comparing
that both with the past and with other countries. In
recognition of the problems many readers have with the use of
rubles, an attempt is also made to convert Russian military
spending into dollars via specially constructed ruble-to-dollar
defense exchange rates. Finally, the piece offers a scenario
for defense spending over the next decade and considers whether
it will be sufficient to support any major resurgence in
military capability during that period.
The Russian Defense Budget
Every year Russia compiles a defense budget. There are
extensive discussions over available funding and priorities
within the Ministry of Defense (MOD) and between that
organization and both the Presidency and the Ministry of
Finance before the government determines its spending plans,
usually in the summer or fall. The figures are then submitted
to the Duma where they are subjected to close scrutiny and in
some years substantially revised. With the calendar and Russian
fiscal years coinciding, the aim is to secure final approval of
the budget before the end of December though this has not
always been achieved.
Table 1 shows the defense budget allocation approved by the
Duma in each of the last 10 years. Massive increases have
occurred in all but 1 year, with an average annual rise over
the entire period in excess of 100 percent.
Unfortunately, the funding actually given to the MOD, now
usually published on a monthly basis, rarely bear much relation
to the figures in the original budget. Outlays have regularly
been revised, formally or informally, during the course of the
year because of changed expectations on inflation, problems in
securing budget revenues or altered perceptions of MOD
requirements. This change has not always been in the same
direction. In 1998, for example, the budget allocation was 81.8
billion rubles but, with the economy in trouble, the MOD was
ultimately allowed to spend only 65.1 billion rubles. The
following year the defense budget as approved by parliament
foresaw outlays of 93.7 billion rubles but this was later
increased to 109 billion rubles while the final count showed
that over 116 billion rubles had actually been spent. In 2000
the budget was revised upward from 143 billion rubles to 154
billion rubles and outlays finally topped 190 billion rubles.
Annual budget outlays for all years since 1992 and monthly
outlays for 1998 through 2000 are given in Tables 2 and 3.
TABLE 1.--THE OFFICIAL DEFENSE BUDGET 1992-2001
[In billions of rubles]
------------------------------------------------------------------------
------------------------------------------------------------------------
1992.................................................... R0.384
1993.................................................... 3.116
1994.................................................... 40.626
1995.................................................... 48.577
1996.................................................... 80.185
1997.................................................... 104.300
1998.................................................... 81.765
1999.................................................... 93.702
2000.................................................... 143.000
2001.................................................... 218.924
------------------------------------------------------------------------
TABLE 2.--OFFICIAL DEFENSE BUDGET OUTLAYS, 1992-2000
[In billions of rubles]
----------------------------------------------------------------------------------------------------------------
Approved Reported final Under/
Year defense budget defense budget overspend in
allocation outlays percent
----------------------------------------------------------------------------------------------------------------
1992............................................................ R0.384 R0.855 +123
1993............................................................ 3.116 7.210 +131
1993 Revised.................................................... 8.327 7.210 -13
1994............................................................ 40.626 28.028 -31
1995............................................................ 48.577 47.800 -2
1995 Revised.................................................... 59.379 47.800 -20
1996............................................................ 80.185 63.900 -20
1997............................................................ 104.300 79.700 -26
1997 Revised.................................................... 83.000 79.700 -4
1998............................................................ 81.765 65.100 -20
1999............................................................ 93.702 116.800 +25
1999 Revised.................................................... 109.000 116.800 +7
2000............................................................ 143.000 190.800 +33
----------------------------------------------------------------------------------------------------------------
Even when these adjustments have been carefully noted,
headline figures on defense spending are of themselves of
limited worth without clear evidence on their coverage and
composition. After decades during which Moscow effectively
refused to provide any meaningful commentary on, or
justification for, its claimed level of outlays, glasnost led
to a gradual opening of the database and by the mid-1990s
intended expenditure in a whole range of sub-categories was
being published. The analysis this generated from both Russian
and overseas scholars appears, however, to have alarmed some in
the Kremlin and thereafter tighter censorship was exercised.
Last year the initial allocation for all of the activities of
the MOD and for the Ministry of Atomic Energy's work on nuclear
weapons were together summed up in just four published line
items. Funding for maintenance of the armed forces and for
military procurement was put into appendices which were
classified. No information has been supplied on how final
spending levels differed from those planned even in the
broadest categories.
TABLE 3.--OFFICIAL DEFENSE BUDGET OUTLAYS BY MONTH, 1998-2000
[In billions of rubles]
----------------------------------------------------------------------------------------------------------------
1998 1999 2000
-----------------------------------------------------
Total Total Total
Monthly to end Monthly to end Monthly to end
outlays of outlays of outlays of
month month month
----------------------------------------------------------------------------------------------------------------
January................................................... R3.7 R3.7 R3.0 R3.0 R11.6 R11.6
February.................................................. 3.6 7.3 4.3 7.3 10.2 21.8
March..................................................... 3.6 10.9 9.0 16.3 20.1 41.9
April..................................................... 4.0 14.9 8.3 24.6 14.0 56.0
May....................................................... 2.5 17.4 7.9 32.5 14.1 70.1
June...................................................... 4.8 22.2 8.1 40.6 12.1 82.2
July...................................................... 2.5 24.7 8.7 49.3 9.8 92.0
August.................................................... 3.5 28.2 8.6 57.9 16.9 108.9
September................................................. 5.4 33.6 13.1 71.0 12.5 121.4
October................................................... 5.5 39.1 12.9 83.9 22.8 144.2
November.................................................. 8.7 47.8 9.6 93.5 19.5 163.7
December.................................................. 17.3 65.1 22.6 116.8 27.1 190.8
----------------------------------------------------------------------------------------------------------------
After an outcry from deputies in the Duma and others, this
policy of concealment was partially reversed for the 2001
budget and the breakdown of intended expenditure was made
available (see Table 4).
Although a significant advance over the previous year, the
2001 budget still leaves over one-third of the defense budget
expenditure unexplained. The vast majority of the money is
almost certainly intended for the state defense order which
covers primarily the research, development and procurement of
weapons and spare parts. However, detailed information in this
area remains classified. There has been no revival of the data
provided through 1997 on the percentage allocation of
procurement spending by branch of service and the costs of
individual weapons programs are rarely mentioned. Moreover,
comparisons with earlier years are difficult because of
structural changes. As the government eventually, and
reluctantly, conceded, most of the apparent rise in defense
spending in 2001 is the result of nothing more than a decision
to fund international peacekeeping activities, military reform
and the railway troops out of the defense budget rather than,
as previously, other parts of the government budget. Nor are
such structural changes unique to this year. In 1995, for
example, some hitherto unacknowledged research and development
outlays were transferred for the first time into the defense
vote. Then, in 1998, military pensions were moved in the
opposite direction, a decision which explains most, though not
all, of the apparent decline in nominal planned spending in
that year. In 2000, part of the MOD's civilian pay bill was
apparently met from outside the defense budget though whether
this continued in 2001 is unclear.
TABLE 4.--THE OFFICIAL DEFENSE BUDGET, 2001
------------------------------------------------------------------------
Billions of Percentage
Budget line item rubles allocation
------------------------------------------------------------------------
Personnel maintenance......................... R91.6 41.8
Monetary allowances including wages for 62.5
civilian personnel.......................
Food...................................... 17
Uniforms.................................. 3.6
Holiday pay and assignments for health 3
care.....................................
Benefits and compensations................ 1.4
Combat training and logistics................. 37.51 17.1
Housing maintenance and repair............ 15.9
Payment for and storage of special fuels.. 12
Transportation............................ 5.7
Maintenance, operation and repair of 1.8
property and installations...............
Other expenditures........................ 1.9
Atomic energy program......................... 5.129 2.3
Mobilization and reserve training............. 2.277 1.0
CIS collective security and peacekeeping...... 2.715 1.2
Education and health care expenditures........ 2.15 1.0
Insurance guarantees.......................... 1.5 0.7
Central military command...................... 0.912 0.4
Defense industries............................ 0.302 0.1
Other (unspecified)........................... 74.829 34.2
-------------------------
Total defense budget.................. 218.924 100
------------------------------------------------------------------------
Although the Ministry of Finance has in recent years
exercised considerable power over the amount of money actually
released to the MOD through the defense budget, it seems
thereafter to have had little ability to monitor its usage. The
MOD has operated through special accounts in the Central Bank
of the Russian Federation (Central Bank of Russia or CBR) to
which others have had little, if any, access. Funds have been
switched between objectives with minimal consultation or
transparency, opening the MOD to accusations of non-
accountability, corruption, waste and political manipulation.
The Ministry of Finance has been trying to wrestle control of
detailed defense budget spending from the generals since at
least 1997 but only over the past year has its campaign begun
to bear fruit. President Putin has now, against the MOD's
wishes, insisted that in future all of the Ministry's payments
must be processed by federal treasury bodies which will be
expected to ensure that monies are spent only in accordance
with the budget law. To assist them a new budget code and
stricter accounting practices are being introduced. The
appointment in March 2001 of Lyubov Kudelina, an economics
graduate with over 20 years' experience in the Finance
Ministry, as a Deputy Defense Minister with special
responsibility for budgets and finance, is clearly meant to
underline the new order. It is, however, too early to say how
effective in practice will be the intended tighter financial
management.
Defense Spending Outside the Official Defense Budget
Russian tallies of final defense spending, though of more
value than the figures contained in planned budgets, still
present an inadequate picture of the true level of outlays.
This is because the government in Moscow operates on a very
different definition of what constitutes defense spending than
the one adopted by NATO countries. Expenditure on many of
Russia's military personnel is not found, as it would be in the
west, in the defense allocation but rather in other parts of
the state budget. Examples include internal security troops,
the federal border guard, the presidential guard, the federal
security service, those forces formally designated for the
protection of the Russian federation and, until this year,
railway troops. In total these organizations contain well over
500,000 people and deploy significant numbers of aircraft,
helicopters, armored combat vehicles, artillery pieces and
patrol craft.
Other elements of defense spending are also located in
supposedly civilian component of the state budget. These
include: research and development work of specific military
interest funded through the basic science and research vote;
subsidies for defense enterprises and defense related
construction as well as support for many defense related so-
called presidential programs, met through the industry, energy
and construction budget; money for conventional arms control
and non-proliferation, including for the destruction of
chemical weapons, treated separately in the state budget;
subsidies to defense industries paid through the allocation to
closed territories; national defense costs defrayed through
provision made to the federations; military courts paid for out
of the justice budget; and, as already mentioned, military
pensions.
There are also a number of off-budget sources of defense
spending. Oblasts and cities have on occasions provided direct
financial assistance for local defense enterprises and military
units \2\ while the factories themselves sometimes subsidize
weapons production and repair out of the proceeds of their
civilian activities, often, it should be said, from ignorance
of true costs. Some money earned from the export of military
equipment is also plowed back into defense, in particular
spending on research and development of new technologies. In
December 2000 Leonid Safronov, Deputy Minister of Industry,
Science, and Technology, announced that the government planned
to impose a duty of 6.5 percent on military exports. The money
thus obtained would then be divided up among new promising
projects. The MOD earns significant sums of money by hiring out
soldiers to local authorities and civilian enterprises, by
leasing property and by selling second hand equipment,
including weapons. These funds are then used to supplement the
central government's budget allocation. Again, both the MOD and
defense factories engage in barter deals, many of whose details
are probably not even reported to the center, and borrow funds
at extremely soft interest rates. And, finally, the MOD saves
much money by delaying payments as long as possible, thus
ensuring, at a minimum, that intervening inflation will reduce
the real value of the debt while hoping that the central
government will ultimately assume responsibility for meeting
the obligations. The latter ploy has proved highly successful.
In late 2000 the government agreed to take over from the MOD
responsibility for debts it had incurred to the defense
industries.
---------------------------------------------------------------------------
\2\ The Moscow city government has, for example, funded major
overhaul work on Russian naval vessels.
---------------------------------------------------------------------------
The total value of off-budget defense spending is very
difficult to estimate and clearly varies widely between years,
dependent partly on the seriousness of the MOD's financial
plight and the condition of the overall economy. Defense
outlays drawn from allegedly civilian parts of the state budget
are easier to identify although some uncertainty obviously
remains. Nonetheless, it seems likely that in 2000 not far
short of half of budget funded defense spending came from
outside the official defense budget. In 1999 the proportion had
been even higher.
Trends in Defense Spending
A major problem with all Russian defense budget figures is
that they are given only in the prices of the year under
consideration. Measuring the real change in spending over time
requires an allowance to be made for inflation. Moscow does not
publish--and probably does not calculate--an inflation rate
specifically for the defense sector. Inflation data for
consumer goods and, indeed, for products offered wholesale is
provided and some commentators have used particularly the first
of these in an attempt to measure real changes in planned
outlays. However, prices in individual sectors of an economy
often change at very different paces, particularly in countries
(like Russia) where general inflation is high and market
mechanisms are inadequately developed, and there is no warrant
for assuming that the price of Russian weapons has, over either
the short or the long term, increased in line with that of
consumer goods. Calculations of the real change in official
defense spending made on this basis are thus of uncertain
validity. Add in the problem of trying to determine the
inflation adjusted level of defense spending outside the
published defense budget when even its nominal level is not
entirely clear and it is obvious that, at the very least, some
method for cross checking the results is needed.
This is provided by the building block approach, initially
developed in the United States during the 1950s. In concept it
is very simple: identify every item that falls within what NATO
would call defense expenditure, determine the outlays on each
of them and then add everything together to produce a figure
for total defense spending. Thus, for example, spending on
weapons procurement is calculated by identifying every system
that has been purchased and how many of each has been obtained
and then multiplying that by the unit price. Similarly,
military pay is determined according to how many servicemen
there are in each rank and the salary, including the various
allowances, given to those ranks. Constant prices of a selected
year are normally used to overcome the problems of inflation.
The method ought to be foolproof. The problem is, of course,
getting hold of all of the inputs. Even in post cold-war
Russia, much of the information is highly classified and some
may not be collated at all. How, for instance, can even the
most dedicated Western analyst hope to identify and price every
piece of new construction or repair at every military facility
or know in detail the cost of work in each field of defense
research? In many areas, there is no alternative but to
aggregate and estimate. Nobody should pretend that the final
results are perfect. They are, however, even for determining
aggregate levels of spending, usually an improvement over
anything that can be obtained by accepting or, indeed,
manipulating Russian Government figures.
Figure 1 shows the real value of total Russian defense
spending over recent years according to building block
calculations carried out by the author. It reveals a stark fall
in outlays through 1998, at which point they were worth only
about one-third of those some 6 years earlier. Such a steep
rate of decline would appear to be unparalleled among major
states that have not suffered defeat in war. There has been
some recovery over the past 2 years but in 2000 total defense
expenditure was still in real terms worth well under 40 percent
of that in 1992 and 15 percent of that of the Soviet Union at
its 1988 peak.
FIGURE 1._TOTAL DEFENSE SPENDING ON NATO DEFINITIONS, 1992-2000
[Billions of rubles at constant 2000 prices]
[GRAPHIC] [TIFF OMITTED] T6171.003
The dramatic decline in defense outlays during the early
and mid-1990s was primarily the result of severe economic
difficulties. Russian GDP fell by over 40 percent between 1992
and 1998, inflation ballooned out of control for a time and
remained high throughout the period, unemployment increased to
around 12 percent of the workforce, living standards for most
people plummeted and the government found it very difficult to
raise the revenue needed to meet its obligations. Beyond this,
however, defense was accorded a much lower priority by
President Yeltsin and most of his senior advisers than it had
been by their Soviet predecessors. The cold war was over, the
West was sympathetic to the regime and, in any case, the
military still possessed huge amounts of modern, serviceable
equipment.
During 1999 and 2000 Russian defense spending rose in total
by an estimated 16 percent after inflation. The beginnings of
genuine economic recovery--GDP grew by about 14 percent over
the same period--meant that, for the first time in years, it
was possible to find extra resources for defense without
hitting significantly either standards of living or the rest of
the economy. Beyond that, however, the military put forward an
increasingly powerful case for more resources. The
international scene appeared to be darkening. NATO's actions in
Yugoslavia were presented as evidence that the West, despite
fine words, remained fundamentally hostile to Russian interests
and was willing to pursue its goals with vigor unless
constrained by the existence of strong Russian forces. Islamic
militancy in Chechnya and Central Asia not only brought home
the reality of the threat to national unity and to Russian
influence in the near abroad but also underlined the weakness
of the Russian forces. No longer was it possible to claim that
weaponry and skills inherited from the days of the Soviet Union
were adequate. Finally, the replacement as Russian President of
Yeltsin by Putin brought to the fore a man with both more
sympathy for security concerns and a greater belief in the need
to keep the military onside.
The Allocation of Russian Defense Spending
One advantage of the building block methodology is that,
with defense spending computed item by item, it is possible to
recompile it according to different definitions. The two most
useful are by branch of service and by function.
allocation by branch of service
Figure 2 shows our estimate of the percentage distribution
of outlays by service in 2000.\3\
---------------------------------------------------------------------------
\3\ For the purposes of this figure the SSBN fleet is considered
part of the strategic forces rather than the navy.
---------------------------------------------------------------------------
The calculations indicate that in 2000 nearly two-thirds of
total defense outlays went to the regular forces, with the
remainder split between the various paramilitary organizations
(border guards, internal security troops and the like), MOD
civilians and certain centralized MOD functions which cannot
sensibly be allocated to a particular service. Within the money
devoted to the regular forces, the largest share went to the
ground forces followed by the air and air defense forces and
the strategic forces. Such distributions usually change only
slowly over time but in Russia during the 1990s there was a
significant enhancement in the proportion of funding allocated
to the strategic forces. The reasons for this are not discussed
by the Russians in public but to a western observer they are
clear. Strategic weapons provide far more ``bangs for the
buck'' than conventional systems and make better sense while
the major threat is thought to come from a technically
superior, nuclear armed, NATO. In the 1970s and 1980s Moscow's
understanding of a war with NATO was, in crude terms, one in
which its heavily superior conventional forces drove through
Germany, placing on Western leaders the unpalatable choice
between surrender or resort to nuclear weapons. In the 1990s,
with the break-up of the Warsaw Pact, this was no longer
practicable. Weapons of mass destruction were now seen as
increasingly essential to offset conventional weaknesses which,
through lack of money and other resources, could not be
addressed.
FIGURE 2._DEFENSE SPENDING BY BRANCH OF SERVICE IN 2000
[GRAPHIC] [TIFF OMITTED] T6171.002
Over the last 2 years there have been some signs that this
emphasis is beginning to be questioned. Many in the MOD have
come to accept that the military problems Russia faces--and is
likely to continue facing over the next decade--cannot be met
by strategic forces. Intercontinental and submarine launched
ballistic missiles are of little use in the conflicts in
Chechnya or the near abroad. The challenge there is from bands
of Islamic militants and the requirement in military terms is
for better trained and better equipped ground and air forces.
The reduction in the relative financial priority for these
branches of service has, it is thought, run counter to Russia's
true needs.
Not all, however, yet share the new thinking. One reason
for the very public spat that occurred over summer and autumn
2000 between the then Defense Minister Sergeyev and the Chief
of the General Staff Kvashnin was the very different
perspectives they held on the relative importance of strategic
and conventional forces. After much hesitation President Putin
appeared to back Kvashnin, agreeing that more money needed to
be put into conventional systems and that--partly to save
money--the Strategic Missile Forces should by 2006 lose their
independence and be absorbed into the air force. The latest
information suggests, however, that the battle is far from
over.\4\
---------------------------------------------------------------------------
\4\ In spring 2001 Kvashnin was still continuing his campaign,
reportedly telling the Academy of Military Sciences that ``the Russian
army is a man with one arm pumped up (that's the Strategic Missile
Troops) while the other is short and dried-up (that's the general
purpose forces). That's not a normal man; it's some kind of mutant. I
can't allow that. It won't work! We'll dry up together!!''
---------------------------------------------------------------------------
allocation by function
In the Soviet era over two-thirds of all defense spending
was typically allocated to the research, development,
procurement and maintenance of military equipment and
supporting infrastructure. This left a smaller proportion for
personnel related expenditure (pay, allowances, pensions, food,
clothing, accommodation, etc.) than in the United States or
United Kingdom despite the very large numbers that the Soviet
Union had under arms. The explanation, of course, was that most
servicemen were conscripts who could be forced to endure
dreadful living standards, receiving in return just pocket
money. The change in the distribution of Russian spending over
the last decade has been dramatic, as our estimates for 2000--
given in Figure 3--demonstrate.
FIGURE 3._DEFENSE SPENDING BY FUNCTION IN 2000 \1\
[GRAPHIC] [TIFF OMITTED] T6171.001
\1\ These figures, being based on NATO definitions of what
constitutes defense spending and how it should be allocated by
category, inevitably differ from the partial data given by the
Russians for the functional breakdown of the defense budget.
Personnel related spending now accounts for approaching
three-fifths of all defense outlays, a significantly higher
proportion than in the West. Despite this, however, the MOD has
still not been able to meet all its obligations. Officer
salaries, once the envy of most employees in the civilian
economy, have fallen dramatically in real terms as infrequent
pay rises have failed by a long way to keep pace with
inflation. Table 5 shows typical earnings for spring 2001.
TABLE 5.--SALARIES OF MILITARY OFFICERS IN SPRING 2001
[Rubles per month]
------------------------------------------------------------------------
Basic Additional
salary payments Total
------------------------------------------------------------------------
Lieutenant in charge of platoon........... R1,627 R743 R2,370
Captain in charge of company.............. 2,080 NA NA
Lieutenant Colonel in charge of battalion. 2,562 953 3,515
Colonel in charge of regiment............. 4,041 NA NA
Major General in charge of division....... \1\ 5,0 1,301 6,329
28
------------------------------------------------------------------------
\1\ A different source gives this figure as 4,786 rubles.
NA--Not available.
Although precise calculations are difficult, it seems
likely on these figures that a pay increase of more than one-
third would be needed to provide most Russian officers with the
same income relative to their civilian counterparts as would be
normal in a western society. Moreover, although the large pay
arrears that built up during the Yeltsin era have now largely
been cleared, neither the recently growing economy nor supposed
government sympathy for the military's plight has changed the
fundamental position of the military officer. Published data
suggests that over the past 2 years the only servicemen to
secure pay rises much above inflation have been those sent to
hot spots such as Chechnya.
Although a large number of officers have been forced to
take second jobs (thus provoking media sarcasm over ``part-time
soldiers''), Russian statistics suggest that at the beginning
of 2001 almost half of service families were living below
subsistence levels and some 170,000 personnel were still on
housing waiting lists. Morale among officers is unsurprisingly
very low while recruitment is increasingly difficult. The
average age of pilots in the air force has reached 37 compared
to 30 in 1992. Frustrated by financial hardship, many officers,
both senior and junior, have turned to corruption. In December
2000 Colonel General Oleynik, head of the Directorate of Budget
and Finance, was dismissed (perhaps a little harshly) for
involvement in the alleged laundering of $450 million of
defense budget funds through a Ukrainian company. As of late
spring 2001, a further 13 generals were also said to be under
investigation for corruption by the military prosecutor. In a
report to the state Duma in May 2001 the Russian Audit Chamber
stated that last year the Defense Ministry lost some 1.5
billion rubles through embezzlement and other illegal
activities
The situation for conscripts is, of course, even worse than
that for officers. As in the Soviet era, pay consists of no
more than pocket money while the quality of benefits-in-kind
(food, clothing, accommodation, etc.) has declined. Diet is at
best monotonous and there have been occasions on which units
have run out of basic foodstuffs. Worn out uniforms are not
replaced and there has usually been no money to repair and
maintain barracks. Sanitary conditions are often appalling.
Inevitably, although discipline has generally been maintained,
there are many reports of suicides, desertions, nervous
breakdowns and physical ill health. On a per capita basis
outlays on medical services in the forces were last year just
one-fifth of those in Russia as a whole--and the latter were,
by either Western or even past Soviet standards, grossly
inadequate.
However insufficient, the money made available to support
servicemen has been generous compared to that directed toward
equipment research, development, procurement and maintenance.
These now account for less than two-fifths of total defense
funding. Although much basic research has continued,
particularly in areas where the cost is not excessive, there
have been problems maintaining momentum through the prototype
construction, testing and evaluation phases. Program timings
have been stretched and in some cases projects survive in
little more than name. Russia's weapons research and
development network, though still extensive and, by West
European standards, achieving impressive results in some areas,
is but a shadow of its former self.
As both total defense outlays and the proportion of those
remaining allocated to equipment procurement have fallen,
orders for new weapons dried up. By the late 1990s the value of
overall weapons production had declined to less than one-tenth
of what it was at the start of the decade. As Table 6 shows,
many key sectors were hit even harder than that.
TABLE 6.--WEAPONS PRODUCTION 1990-2000
----------------------------------------------------------------------------------------------------------------
1990 1992 1994 1996 1998 2000
----------------------------------------------------------------------------------------------------------------
Tanks........................................................... 1,600 500 40 5 10 30
Light AFVs...................................................... 3,400 700 400 300 250 50
Fighters........................................................ 400 150 50 20 30 40
Bombers/ASW/SMAC................................................ 40 20 2 1 0 0
ICBMs/SLBMs..................................................... 120 70 25 20 15 5
Major warships.................................................. 2 2 0 1 0 1
Submarines...................................................... 12 6 4 3 1 1
----------------------------------------------------------------------------------------------------------------
Official figures showing a significant percentage growth in
state spending on defense equipment procurement over the past 2
years must, if true, reflect the acquisition of smaller systems
and spares which attract little publicity. Certainly, there is
little to justify them in terms of major weapons production.
Despite its relative funding priority, the output of ICBMs has
fallen to such an extent that around 60 percent of the missiles
currently deployed are now past the service life originally
planned for them. Tank manufacture has virtually ceased at one
of the two plants still working in the field and only continued
at the other in a desultory manner. Of the two major fighter
production firms, one--MiG--apparently has very few orders
while the principal bomber facility may also have little to do.
Last year it was reported that only 1 percent of Russian
military aircraft had been built since 1995 and almost half of
the fleet dated to before 1985. The shipyards have a similar
shortage of orders. Moreover, with conventional systems, a
large share of the manufacturing that has taken place is aimed
at the export market, particularly China and India, leaving
virtually nothing for Russia's own forces. All of the new
submarines constructed in recent years have, for instance, been
destined for overseas.
The MOD did not just have to give up its hopes of new
weapons systems. Funding has been so tight that it has also
continually postponed necessary maintenance contracts. As a
result, by late 1999, only 30 percent of the ground forces'
helicopters and 60 percent of its tanks were reported as being
in satisfactory condition. The air force claimed around the
same time that some 500 of its fixed wing aircraft and
helicopters were in need of major renovation while the navy
said that three-fourths of the vessels still in service needed
refitting or repairs. These figures, though obviously open to
definitional questions, give an accurate flavor of the
deterioration in capability.
Moreover, even when systems were operational, there was
often insufficient funding to train servicemen fully in their
use. Average flying time for air crews, low by Western
standards even in Soviet times, fell sharply. With just one-
fifth of the fuel supplies the air force judged necessary,
bomber pilots managed on average only 20 hours of airborne
training last year while fighter pilots did even worse,
securing just 10 hours. Around 400 of the 1500 pilots
graduating from military schools since 1995 have apparently yet
to get airborne. The air force has publicly blamed limited
flight training for the 50 percent increase in accidents that
took place last year. The navy has had similar problems. In
2000 warships were reportedly at sea on average for just 6.4
days while the naval air force spent 11 percent less time in
the air than in 1999, itself a poor year even by previous
Russian standards. Ground troops have reported insufficient
fuel to run vehicles and have had to restrict activity.
Infrastructure has also suffered. Excluding military
housing, it currently receives only an estimated 6 percent of
overall defense outlays. Keynote projects have been few in
number and more basic improvements limited. By last year two-
thirds of military airfields were said to be in need of major
overhaul and modernization while only one-fifth of the money
which experts said was needed to tackle the problem was made
available. One report concluded gloomily that, if the situation
did not change, practically all military runways could be out
of service by 2005. Ship repair facilities were also still
ignored; the navy claimed that only 4 percent of the necessary
funding was supplied in 2000. Although in 1997 Russia pledged
to eliminate its chemical weapons stocks within 10 years only
meager progress has been made, largely because of lack of
money. In 2000 the budget allocated little more than one-sixth
of the sum specialists said was required if Russia was to meet
its obligations. Substantially more resources have, however,
been promised for this year.
Financial Aspects of Weapons Production
The MOD's financial problems have inevitably had a knock-on
effect on its suppliers, particularly defense industries. Not
only has much less been ordered but, even when contracts have
been agreed, payments have often been delayed for months.
Without funds the plants cannot pay their own workers or
suppliers and have fallen deeply into debt. Many, perhaps most,
are by any normal measure bankrupt and would in a market
economy have been closed. In Russia they have been left to
stagger on as several restructuring and rationalization plans
have first been heralded and then abandoned once the social and
financial costs have become apparent. Staff are rarely sacked.
Instead they are moved to a shorter working week, often doing
little productive even when in the factory. According to
specialist Russian journals, one-fourth of employees have been
forced to take unpaid leave lasting, on average, 40 days. In
the West individuals placed in such a situation would have left
in large numbers. In Russia, however, workers have remained
tied to the company both by the lack of alternative employment
and by social considerations. For instance, the factory, even
when it cannot pay employees' wages, still owns their flat
which has to be vacated if a job is taken elsewhere.
Unsurprisingly, there is vast overmanning. The aviation and
aerospace industry in Russia employs around eight times as many
people as that of the whole of Western Europe but has an output
that is dramatically smaller. The average age of workers across
defense industry is now well over 50.
The Russian Government has in recent months been preparing
new plans to tackle the crisis in the defense industries.
Firstly, it has said that, with the state budget now in
surplus, decisive action will be taken to settle state debts to
defense industry enterprises. The exact size of these remains a
matter of disagreement between the administration and the
factories but the former fixes them 32.5 billion rubles and has
promised that, by January 1, 2003, half of this will have been
paid in money and the rest covered by bonds. Potentially even
more important for the long term, Deputy Prime Minister Ilya
Klebanov has announced that, in order to reduce overlap and
eliminate waste, a new and major restructuring program is in
preparation for the sector. It is to involve mergers and
closures and be spread over a decade. Full details are as yet
unavailable but some reports suggest that, within the first 3
or 4 years, one-third of the enterprises could disappear.
Funding of 2 to 3 billion rubles a year is said to be needed to
support the program.
Past experience suggests that all schemes should be treated
with caution. Promises of debt repayment could easily evaporate
if the government's financial position were to weaken and any
radical defense industrial restructuring is in our view likely
to be much more expensive than forecast and to face
considerable opposition. Changes will probably be on a much
smaller scale than economists would like or is needed to bring
capacity into line with orders. Moreover, whatever
organizational changes are made, an elderly workforce and
obsolescent production machinery will remain a poor basis on
which to build any rapid and sustained recovery in production
levels.
The Defense Burden
Russian statisticians calculate the financial burden
defense places on the economy by measuring official budget
outlays as a proportion of GDP (see Table 7). For 2000 the
result was 2.7 percent, a little below that in the United
States and broadly in line with the figures for France and the
United Kingdom. The impression given is thus one of moderation.
However, a more accurate comparison, taking into account
military spending funded outside the official defense budget,
suggests that the true burden in Russia last year was well over
5 percent. As such it was twice the NATO average and also
probably twice that in China.\5\ On a more positive note it
should, however, be recognized that the burden has fallen
significantly over the past decade: in 1992 it was on our
estimates approaching 10 percent, one of the largest in the
world.
---------------------------------------------------------------------------
\5\ China admits to a defense burden of only 1.4 percent of GDP
but, like Russia, conceals much of its military spending in supposedly
civilian parts of the state budget and in non-budgetary accounts.
TABLE 7.--THE DEFENSE BURDEN ON OFFICIAL RUSSIAN STATISTICS, 1992-2000
[Final defense outlays as a percentage of GDP]
------------------------------------------------------------------------
Year Percentage
------------------------------------------------------------------------
1992.................................................... 4.7
1993.................................................... 4.4
1994.................................................... 4.6
1995.................................................... 3.1
1996.................................................... 3.0
1997.................................................... 3.1
1998.................................................... 2.4
1999.................................................... 2.6
2000.................................................... 2.7
------------------------------------------------------------------------
The implications for Russian defense reform of this
substantial and ongoing understatement of the burden are not
entirely clear. However, it seems likely that, with both the
government and the military apparently laboring under the
impression that the defense sector is much less of a charge on
society than is really the case, the pressure for radical
change has been weakened. Indeed, in recent years one of the
most persistent refrains in the armed forces' repeated demands
for more funding rather than large scale restructuring has been
the claim that, financially, they are treated badly compared to
their counterparts in many other countries. That argument may
eventually be undermined. Deputy Defense Minister Lyubov
Kudelina has recently called not only for much greater
transparency in spending but also a full analysis of non-
defense budget funding. If conducted properly, this will, of
course, show the Russian forces still absorb what is, by
current international standards, a high proportion of national
resources.
Defense Spending in Dollars
Few Western readers are likely to be wholly satisfied with
expenditure data in rubles, seeking instead numbers in a
currency they believe they can understand. But how can one
convert rubles into, for example, dollars? The methodology
normally adopted is straightforward: a market exchange rate,
quoted in the quality financial press and elsewhere, is applied
via simple division to the published defense budget and a
result thereby obtained. Unfortunately, however, while the
ruble is not freely convertible and while trade constitutes a
relatively small proportion of Russian GDP, there is no reason
to believe that market exchange rates even approximately
reflect the military purchasing power of the currency. The
discrepancy can be enormous. In 2000, for example, the initial
budget allocation for defense was on this approach worth only
about $5 billion, not dramatically more than that of Singapore.
Even taking into account the additional money poured into the
defense budget during the year, outlays were still valued at
under $7 billion, significantly less than those of Canada. The
Russian armed forces (including paramilitaries) are, however,
in terms of manpower nearly 15 times the size of their Canadian
counterparts and they have, in addition to a major strategic
missile capability, 7 times as many large naval vessels, 14
times as many combat aircraft and approaching 200 times as many
tanks.
Statistics derived from market exchange rate conversions
are thus quite obviously seriously flawed--though that does not
prevent them either from being quoted in otherwise serious
publications or for wholly erroneous deductions on the nature
of Russian policy or its industrial efficiency being drawn
therefrom. We prefer to make our own estimates from scratch,
with the goal of measuring the financial cost of replicating
the Russian military effort in the United States.\6\ As before,
we adopt the building block methodology and cover all items
that NATO countries would consider part of their defense
spending. Some simplification of procedures is necessary
because of lack of information but in principle equipment unit
prices are determined according to how much it would cost a
U.S. factory to produce, repair and maintain systems with the
technical characteristics and quality of manufacture that
exists in Russia. Fuel costs are similarly based on U.S. prices
and Russian usage rates. Russian military and MOD civilian
personnel are assigned a dollar valuation dependent on factors
such as their rank, educational standard, training, assessed
morale and (where relevant) leadership skills. The dollar cost
of food, clothing and accommodation takes account of the low
standards normal in Russia.
---------------------------------------------------------------------------
\6\ It does not, however, measure Russian military capability which
reflects resource flows over many years, the efficiency with which
those resources are deployed and a wide range of intangibles. Some
commentators, failing to recognize this and, above all, to
differentiate properly between inputs and outputs, have drawn
conclusions on relative capabilities which--whether valid or
otherwise--cannot be justified simply from defense spending data.
---------------------------------------------------------------------------
The calculations are complex and subject to uncertainty but
the bottom line is that, on our estimates, the United States
could last year have procured the full Russian military effort
for around $50 billion. This puts Russia in third place
globally, far behind the United States itself and--on our
calculations--some way adrift also of China. The latter is
thought to have overtaken Russia in terms of defense resource
allocation around the mid-1990s and now, despite the recent
upsurge in Russian outlays, to devote around 25 percent more a
year to the military. The leading European defense powers, the
United Kingdom and France, together with Japan, still in 2000
lagged behind Russia.
Prospects
At the time of writing (July 2001) the Russian Government
has just approved the basic outlines of the 2002 federal
budget. These show a defense allocation of 262.9 billion
rubles, an increase of 20.5 percent over planned spending this
year. Were inflation in the defense sector to equal that
expected for the overall economy (an admittedly uncertain
thesis), the new budget would involve a real rise in outlays of
over 8 percent, more than twice likely GDP growth. The
proposals are, however, subject as always to scrutiny by the
Duma and are likely to be revised before passing into law.
There are few details on how any additional money is to be
distributed but 9.3 billion rubles will be set aside to provide
servicemen with an above-inflation pay award. Unconfirmed
reports suggest that as a result the monthly salary (including
bonuses) of a platoon commander will rise from 2,370 rubles to
4,012 rubles while that of a battalion commander will be
increased from 3,515 rubles to 6,199 rubles President Putin has
also recently submitted legislation to the Duma which will
bring military salaries into line with that of Russian civil
servants by January 2004. According to preliminary data, this
is likely to require a further rise in military pay over and
above anything given to civil servants. The deputies are
expected to vote on the proposed law in the autumn.
Despite the commitment to increasing pay, Defense Minister
Ivanov has said that he wishes to cut the proportion of the
defense budget going on the maintenance rather than development
of the armed forces from 70 percent in 2000 to 60 percent in
2005 and 50 percent by 2010.\7\ The only way of achieving this
is, as he and other ministers have admitted, by a substantial
reduction in force numbers. Despite inevitable qualms from some
senior military officers, details of these cuts have been
announced. The posts of some 365,000 Defense Ministry
servicemen, 105,000 servicemen from other power ministries and
130,000 civilians are to be axed by 2005. Figures published
separately for the downsizing in individual services do not add
up exactly to these numbers (perhaps suggesting some ongoing
debate) but provide an indication of priorities. Within the
MOD, 180,000 military slots (52 percent) will be lost by the
ground forces, 60,000 (40 percent) by the strategic rocket
forces, 50,000 (29 percent) by the navy and 50,000 (27 percent)
by the air and air defense forces. Among the other departments
with military employees, the Ministry of the Interior will
probably have to surrender 37,000 posts (18 percent),\8\ while
the number of border guards will be reduced by 30,000, railway
troops by 10,000 and ``Emergency Situations'' forces by 4,500.
Further cuts, post-2005, have also not been ruled out though at
the moment they are judged unlikely.
---------------------------------------------------------------------------
\7\ As so often with Russian statements, the language is imprecise
but it seems likely that, by maintenance, Ivanov meant nearly
everything outside the defense order.
\8\ Some sources have said that the reduction will be larger,
perhaps 53,000 posts (26 percent).
---------------------------------------------------------------------------
The Russian authorities have claimed that this reduction in
posts will enable Defense Ministry spending per serviceman to
double by 2005 and triple by 2010. Assuming--as seems likely--
that the starting point for the calculation was the official
figure of almost 1.2 million men serving in the MOD's forces in
2000, this means that real levels of defense spending are
planned to rise by almost 7 percent a year through 2005.
Without any further reductions in posts after 2005, attainment
of the 2010 target would involve a further hike in outlays over
the second 5 year period of about 8.5 percent per annum after
inflation.
These goals are clearly extremely ambitious and we doubt
whether, without a substantial deterioration in the
international political climate, they will be realized. The 8.3
percent growth in GDP achieved last year was in large measure
the result of increased energy and other raw material prices
and the continuing impact of the undervaluation of the ruble on
international markets. The boost provided by these factors is
already starting to subside and although, barring a major
international recession, the days of negative growth seem to be
over, it is probable that over the next decade GDP will rise by
on average no more than 3 to 4 percent per annum. If total
defense spending were to expand at the same pace as the
Russians appear to be planning for the MOD budget and economic
growth were 3 to 4 percent a year then the defense burden would
swell from just over 5 percent of GDP last year to more than 6
percent in 2005 and approaching 8 percent by 2010.\9\ At these
levels it would increasingly impinge on the resources available
either to invest in the civilian economy or improve standards
of living.
---------------------------------------------------------------------------
\9\ The Russian Government will, of course, at the moment be
seeing--and making judgments based on--different and more benign
forecasts of the defense burden. According to German Gref, the Minister
of Economic Development and Trade, the authorities in Moscow are
forecasting annual average economic growth of 5 percent a year through
2010 rather than the 3 to 4 percent we posit. Moreover, they will
equate defense spending with the defense budget, thus omitting all
outlays on military activities funded through other parts of the state
budget or by non-budgetary means. The Putin government may well believe
that, even with the massive hikes planned for defense outlays, the
latter will, in 2010, still account for just 3.5 percent of GDP. This
level has long been seen as reasonable and, indeed, during the Yeltsin
era, became something of a totem target for those seeking increased
spending.
---------------------------------------------------------------------------
Moreover, even if the planned rises in defense spending
were to be obtained, it is doubtful whether the sought after
re-orientation of outlays away from personnel and toward
equipment could be fully achieved. Despite official claims that
there are 1.2 million military personnel in the MOD, we believe
that actual numbers are significantly smaller. Some of the
projected cutbacks may thus involve little more than the
scrapping of vacant posts. In these cases the financial savings
will be minimal. Furthermore, where regular servicemen are
retired, they will be entitled by law to substantial housing
and severance benefits. Independent Russian analysts have
calculated the additional financial cost of cutting personnel
by the planned amount at 21 billion rubles over 5 years, a
figure we believe to be a little too high but which is
nonetheless indicative of the heavy charge on the defense
budget. Former Defense Minister Sergeyev is alleged to have
written last year to Prime Minister Kasyanov arguing that it
was impossible to reduce military personnel numbers by even
50,000 because they could not be provided with their housing
entitlements.
There is also a concern that, in determining the rank mix
needed to yield their planned savings, the authorities are
storing up problems for the future. They have, indeed, said
that almost two-thirds of the eliminated MOD military slots
will need to be those of officers, including a very large
number of senior staff. Insofar as the current force structure
is top heavy, this emphasis makes sense. However, from around
2005 onward, Russia faces a severe and unavoidable demographic
crunch, with the number of 18-year-old males available for
conscription falling within 5 years by over 40 percent. Since
at least the mid-1990s there have been many complaints from the
forces that, even with the existing demographic pool, it has
been difficult to secure sufficient numbers of healthy, well
educated recruits. Unless the number of conscripts is cut more
sharply than is at present envisaged, this problem will become
much more acute toward the end of the decade. If, however, the
government decides to reduce the number of conscripts in line
with availability, the only way of preserving its planned force
size will be to retain more regulars than envisaged. This will
inevitably be costly.
Moreover, there has long been a recognition among Russian
specialists of the benefits of eliminating conscription and
converting the forces to an all-professional basis. Indeed, at
one point, President Yeltsin declared that 2000 would see the
final compulsory inductions into the armed forces. This
deadline has now obviously been shelved but even a gradual
shift over the next decade to increase the proportion of
regulars in the services will add significantly to the wage
bill.
Were the Russian Government to achieve its goals of
tripling defense budget spending per soldier by 2010 and re-
orienting outlays so that by the same date half of outlays were
directed toward ``developing'' rather than ``maintaining'' the
forces, then in real terms the MOD ``development'' budget
(largely weapons research, development and procurement together
probably with additional infrastructure) would rise by around
230 percent over the period. This seems implausibly high and we
have therefore made our own projections. These cover all
defense spending rather than just that funded through the
defense budget. They are based on the assumptions that for the
remainder of the decade total defense outlays will rise in real
terms by 3.5 percent a year on average, in line with GDP, and
that the share of those outlays allocated to development will
increase by much less than Moscow currently envisages. As a
result, development spending is forecast to grow by about
three-fourths, much less than that implicit in the Russian data
but still a very impressive figure.
There are, of course, an almost infinite number of ways in
which this additional money could be allocated. Nonetheless, it
is clear that there will be no immediate, large scale, boom in
weapons procurement. Neither the government nor the armed
forces perceive any great benefit from increased acquisition of
most of the weapons systems currently in the inventory, these
usually having been developed in the 1980s or earlier and now
considered less and less a match for their Western
counterparts. Rather there is a belief that the emphasis needs
to be placed on creating, almost across the board, a new
generation of equipment which contains the latest technology.
In financial terms, therefore, a high priority will probably be
given to weapons research institutes. They are likely to
receive substantial amounts of extra money for better machine
tools and other equipment while their staff, hitherto very
poorly paid, should see their status enhanced. This will, of
course, be accompanied by an expectation of better results but
it is unlikely that many major new weapons systems, including
even those that have been in development status for some years,
will be ready for quantitatively significant levels of
production much before 2007-2008.\10\
---------------------------------------------------------------------------
\10\ According to Yuriy Koptiev, general director of the
Rosaviakosmos state agency, the new fifth generation fighter, the PAK
FA, is unlikely to be ready for delivery to the armed forces before
2011-2012 even if sufficient money is found for its development. The
Russian Government has, indeed, said that between now and 2015 the
armed forces will probably buy only 7 to 10 percent of Russian aircraft
industry output, with a further 13 to 15 percent being purchased by
domestic airlines and the rest exported.
---------------------------------------------------------------------------
Manufacturing facilities will in any case need several
years to prepare for the arrival of new systems. If the
government presses ahead with its much needed reorganization
and restructuring plans, heavy demands will inevitably be
placed on defense industry management. There will be new chains
of command and of supply to forge,\11\ existing equipment and
manpower to relocate or jettison and a more commercially
oriented ethos to instill. Moreover, with many of the promised
weapons systems technically much more advanced than their
predecessors, increasingly sophisticated manufacturing
equipment will have to be bought and staff will have to undergo
training in its use.
---------------------------------------------------------------------------
\11\ The production of large ASW vessels apparently requires the
cooperation of 2,000 sub-contractors!
---------------------------------------------------------------------------
The cost of developing better weapons systems and
modernizing manufacturing plants to produce them in quantity
will be enormous and, if done properly, could easily absorb all
of the additional development funding contained in our
forecast. In practice, however, significant sums are likely to
be diverted for the better maintenance and repair of the
existing weapons inventory. In part this is because, given the
unavoidable delays in bringing new weaponry into service, the
operational life of existing systems will need to be extended,
often well past original expectations. Beyond that, however,
the forces have, since the most recent Chechen conflict, became
increasingly aware that the reliability of many of their older
weapons systems (including associated vehicles) is uncertain
and thus likely to undermine operations and put soldiers' lives
at risk. They will press for a better adherence to recommended
servicing schedules than has been typical over the past decade.
Nonetheless, despite life extensions programs and better
maintenance, many Russian weapons systems are so elderly that
the forces will in practice have little option but to scrap
them in the coming few years. As a result the total inventory
is likely to decline significantly. Exact figures are difficult
to predict but our best forecast for holdings in the major
weapons category is shown in Table 8.
TABLE 8.--WEAPONS INVENTORY IN 2000 AND 2010
----------------------------------------------------------------------------------------------------------------
Modern Major
tanks Combat surface
Year and aircraft combatants
armored Artillery and attack and
vehicles helicopters submarines
----------------------------------------------------------------------------------------------------------------
2000............................................................. 45,000 33,000 2,800 95
2010............................................................. 35,000 20,000 1,900 60
----------------------------------------------------------------------------------------------------------------
It is thus evident that, through 2010, there is unlikely to
be any significant improvement in the overall capability of
Russian forces. Post that date, however, as new weapons systems
begin to enter the inventory in quantity, the picture should
gradually improve. There will be fewer men than at present but
they should be better trained and probably better motivated.
The move away from conscripts toward an all-professional force
could well be completed in this timeframe. Ultimately, although
there is no possibility of Russia's conventional forces being
rebuilt to the point where their strength relative to that of
their Western counterparts is comparable to that enjoyed by the
Soviet military throughout the cold war, they should, with
sufficient funding, re-emerge as a modern and powerful presence
on the world stage.
RUSSIAN FINANCIAL TRANSITION: THE DEVELOPMENT OF INSTITUTIONS AND
MARKETS FOR GROWTH
By David M. Kemme \1\
----------
contents
Page
Summary.......................................................... 183
Introduction..................................................... 183
Development of Financial Institutions and Competitive Financial
Markets........................................................ 185
Why focus on the banking sector?............................ 186
Demonetization and non-payments............................. 188
Financial repression and liberalization..................... 190
The State of the Banking System: Crisis, Recovery and Crisis?.... 198
System characteristics and policy framework.................. 198
Recovery of banking activity................................. 200
Concerns and Issues.............................................. 203
References....................................................... 208
Summary
A well-developed financial intermediation industry
increases domestic savings, efficiently allocates investment
resources to the most productive uses in the economy and
increases the rate of economic growth. In the Soviet economy
the banking system served as a means of collecting household
savings and a means of distributing centrally determined
capital grants to enterprises. Banks then audited enterprise
financial activities to ensure compliance to the financial
plan. After a decade the transition from the Soviet banking
system to a market oriented banking system is incomplete and
fraught with uncertainty. While the number of financial
institutions has increased dramatically, the state sector still
dominates financial sector activity, the legal and regulatory
framework is incomplete, information necessary for risk
management is of poor quality and policymakers and regulators
have been slow to act to improve intermediation services. While
significant progress has been made, the commonly recognized
characteristics of a sound financial system are not yet met.
---------------------------------------------------------------------------
\1\ David M. Kemme is the William N. Morris Chair of Excellence in
International Economics, University of Memphis. The author would like
to thank Josef Brada, Martin Gilman, Kim Iskyan, Lucjan Orlowski and an
anonymous reviewer for helpful comments on an earlier draft.
---------------------------------------------------------------------------
Introduction
The Russian financial crisis of 1998 not only destroyed the
credibility of financial policymakers and the confidence of
investors, but also delayed significant institutional reforms
necessary for long-term economic progress. While the favorable
external environment of the mid-1990s provided support for
domestic reforms and adjustment, events in global financial
markets alone are not sufficient to explain the domestic
financial collapse. Russian financial authorities were not only
determined to prevent exogenous external shocks from spilling
over into domestic financial markets, but also determined to
defend the exchange rate peg as the domestic GKO market
collapsed.\2\ The failure to deepen the reform of institutions
and appropriately manage financial risk at both the macro-
economic and micro-economic level set the stage for crisis. The
deterioration in the terms of trade and the government's
inability to maintain federal revenue flows worsened fiscal
imbalance and overall macro-economic internal balance. Huge
interest rate swings and the devaluation of the ruble destroyed
the balance sheets of major banks.\3\ The Russian economy moved
from a somewhat optimistic macro-economic environment in 1997
and the first quarter of 1998, to financial collapse by the end
of 1998.\4\ By mid-1999 the economy had stabilized and
policymakers were taking measures to bolster the fiscal
system.\5\ Does the positive economic news represent real
progress in domestic structural reform and solid economic
performance? Or, have the increases in the world price of oil
and stabilization of global financial markets provided the
supportive external environment that allows the fragile Russian
economy to grow even without significant domestic reforms?
---------------------------------------------------------------------------
\2\ Gosudarstvennye kaznacheiskie obiazatelstva (GKOs), are short-
term treasury bills. Foreign investors owned about 30 percent of GKOs.
Granville (2000), p. 201 reports that in early 1998 there were some
$365 billion (more than 3,000 percent of the banking system assets) of
outstanding foreign exchange forward contracts, mainly the result of
foreign counter parties hedging their GKO investments. Devaluation
would, and ultimately did, render many banks insolvent.
\3\ See Granville (2000), pp. 196-203 for a description of the GKO
market collapse, resulting devaluation and debt default.
\4\ During the early 1990s there were expressions of concern about
the stability of the banking system and in 1995 there was a liquidity
crisis on the inter-bank lending market. However, some analysts were
dismissive about the possibility of a banking system crisis: ``This
talk about crisis in the midst of one of history's largest banking
booms has an air of unreality to it.'' Warner (1998), p. 335. It was
true that banks had extraordinary opportunities for profits because of
the low cost of funds, but conditions can and did change rapidly. Less
than a year later in the same journal, but after the crisis, Buchs
(1999), p. 700 notes ``. . . it is less the crisis itself but the
timing of the crisis which was a surprise in Russia.''
\5\ For a review of economic performance during the 1990s see IMF
(1999), OECD (1997) and OECD (2000). Selected economic data may be
found in Tables 7 to 9. OECD (1997) Annex V also provides a detailed
chronology of economic events and policy measures. On August 17, 1998
Russian authorities devalued the Ruble, imposed a unilateral
restructuring of GKO debt and declared a 90-day moratorium on private
debt repayments. Estimates of losses to investors range from $20
billion to $90 billion. IMF (1999), p. 39. For a detailed description
of the 1998 crisis see Buchs (1999) and ``What Went Wrong,'' Russian
Economic Trends, September 1998. And for a description of the results
see Westin (1999).
---------------------------------------------------------------------------
This paper focuses on development of the domestic banking
industry not only as an essential element of transition to a
market economy, but also as a necessary factor for long-term
economic growth. There is an extensive theoretical and
empirical literature indicating a significant causal influence
of the level of financial development upon long run economic
growth.\6\ Financial development improves the allocation of
savings to investment opportunities. The possibility of
choosing more productive investments, which in turn generate
higher rates of aggregate economic growth, requires improved
management of liquidity risks, more efficient diversification
of investor's portfolios and higher quality of information
about various projects and investor's abilities. As the demand
for these services arises, specialized institutions develop.
But, the literature indicates that aggregate income and savings
must reach certain levels, or thresholds, before institutions
and markets develop spontaneously. In transition economies
economic policymakers may intervene, providing an environment
for institutional development that may supercede spontaneous
market developments.\7\
---------------------------------------------------------------------------
\6\ The level of financial development is usually described by
measures of ``depth,'' for example, the ratio of banking assets to
gross domestic product (GDP), or market capitalization to GDP, etc.
Berthelemy and Varoudakis (1996) and Pagano (1993) provide a brief
review of the connection between financial development and growth.
Levine (1997) also provides a survey of issues of financial development
and growth, Levine and Zervos (1998) examines potential links between
both stock markets and commercial banks and growth, while Beck, Levine
and Loayza (2000) and Levine, Loayza and Beck (2000) provide more
recent empirical evidence linking financial development to economic
growth.
\7\ The literature discuses two approaches to financial
development. ``Demand following'' financial development follows
widening of markets and product differentiation, which then requires
more efficient risk diversification and control of transaction costs.
This type of financial development is viewed as passive or it plays at
most a permissive role in the growth process. ``Supply leading''
financial development precedes the demand for financial services and
proponents argue it has a clear autonomous positive effect on growth
due to the enhanced ability to mobilize resources, moving them from
traditional to modern, high growth sectors. Supply leading financial
development may dominate the early stages of development or transition,
making possible the financing and increasing the effectiveness of
sectors, institutions and activities neglected under central planning,
until demand following financial development takes over (a la
Gerschenkron, 1962).
---------------------------------------------------------------------------
If one takes a more activist, ``supply leading'' financial
development approach to transition and development,
policymakers first must ask: (1) Among financial institutions
what areas should be developed/supported first? (2) What are
the most appropriate mechanisms to enhance the efficiency of
the financial institutions identified? (3) What is the impact
of competition and what is the optimal level of competition (in
banking)? And, then, more specifically, (4) at what stage of
financial development is the Russian economy and what policies
should be implemented to enhance long term economic growth?
In the next section I briefly address questions one and two
based upon a brief review of the financial development
literature. This provides a framework for analysis of policy
and institutional developments. The following section is a
review of the banking sector's recovery from the 1998 crisis.
Here I also discuss policy and institutional issues which must
be resolved to ensure stable, long-term economic growth. The
last section concludes with concerns and issues to be resolved.
Development of Financial Institutions and Competitive Financial Markets
The Soviet centrally planned economy had little need for a
developed financial sector. The payments system was simple and
sound: cash was used for household transactions and enterprise
deposit transfers were made within the monobank for inter-
enterprise transactions. Capital and investment funds were
available via direct grants from the state budget according to
the central plan. The banking system functioned simply as a
payments system and state auditor to monitor plan
fulfillment.\8\ Monetary policy was accommodating, ensuring
that cash supplies met demand and enterprise deposit creation
from the state budget corresponded to plan, both according to
micro-objectives as well as balancing in the aggregate to
prevent inflation. Barter transactions in both the household
and enterprise sectors and unplanned transactions within the
enterprise sector were tolerated to smooth the operation of the
plan. The financial plan governed the allocation of society's
savings among potential investment opportunities typically
based upon political objectives rather than financial
criteria.\9\ While the banking system in a market economy is a
critical element of the payments system, it also plays an
active role in the allocation of investment resources.
---------------------------------------------------------------------------
\8\ The three primary functions of the Soviet monobank were
financial control of enterprises, dispersement of funds allocated by
the central plan and mobilization of domestic savings to finance
domestic debt of the state sector.
\9\ For the classic description of the Soviet system of money and
banking see Garvey (1977). For a more recent discussion of both Soviet
banking and transition in the early 1990s see Tompson (1997).
---------------------------------------------------------------------------
why focus on the banking sector?
In the Soviet system the banking system did not provide
financial intermediation services. Developed market economies,
though, have both stock and bond markets and developed
financial intermediaries such as banks. There is considerable
discussion about which is more important. There is also a
debate about the effectiveness of universal banking vis-a-vis
specialized banking coupled with stock markets. Despite the
nuances and the different routes taken, developed market
economies have tended to converge toward a similar model of
corporate finance. In developed economies, retained earnings or
internally generated funds account for roughly 60 to 90 percent
of investment financing, bank loans account for roughly 15 to
30 percent and bond and equity offerings just a few percent. In
developing economies both bank loans, accounting for 25 to 35
percent, and equity markets, accounting for as much as 25
percent, play a slightly more important role in investment
financing than in developed economies. While this varies over
time and across countries, retained earnings remain the
dominant source of funds, with bank lending next, and equities
markets relatively unimportant in terms of providing finance
for investment projects. In fact, Stiglitz (1993) argues that
stock markets are primarily a means of sharing risk, not
raising investment funds. When there are production risks,
information asymmetries and costly monitoring, debt contracts
with fixed repayment dates will always be preferred (by
investors) to the purchase of shares with periodic
reimbursement by payments of dividends that are subject to
productivity shocks. Thus, bank intermediation is likely to
play a significantly larger role in investment financing
regardless of stage of development.
Monitoring costs are minimized with debt contracts because
such costs are incurred only in the case of insolvency, while
financing via shares requires continuous, ongoing monitoring.
Banks and lending intermediaries have an advantage over stock
and bond markets because they can be more efficient in terms of
information gathering and monitoring. It is not efficient for
an individual investor to undertake these costs, but banks can
spread them out over many investors (depositors). Because some
of the information collected on the performance of a firm
becomes public, there is also a free rider problem that makes
capturing payment for monitoring costs problematic. With large
diversified portfolios banks can guarantee a yield on deposits
and make a credible commitment to monitoring investment
projects. Thus, the informational advantage of banks as a
source of external financing of investment is a strong argument
in favor of emphasizing the development of the banking system
as a means of enhancing capital accumulation. In fact, Wright,
Buck and Filatotchev (1998) provide evidence that banks in
Russia are beginning to develop oversight and monitoring
relationships with loan recipients, albeit at a relatively slow
pace. Banks may not be superior to stock markets at all stages
of development, however. Both provide diversification and
management of liquidity risk, provide a monitoring mechanism,
which improves the management of resources, and provide means
of evaluating the returns on investment activities, all of
which contribute to the efficient allocation of resources.
Competition among banks and between banking intermediaries and
stock markets leads to lower intermediation costs and
contributes to economic growth. But competition also leads to
increased probability of insolvency, credit rationing and
related adverse effects on growth. The optimal level of
competition is a policy issue of importance in both market
economies and transition economies.
The performance of intermediation services takes a well-
functioning payments system for granted. In any economy a well-
functioning payments system, a reliable and flexible means of
exchange and payment, is necessary for growth. While the Soviet
economy payments system was reliable, it was not flexible and
does not satisfy the needs of participants in a market economy.
Without direct capital grants from the central budget,
enterprise projects must compete for funds, either internally,
from retained earnings, or externally, from bank loans or
securities offerings. Outside-the-payments-system transactions
such as barter are also possible, but are costly. These costs
often eliminate potential productivity gains due to increases
in the division of labor and thus reduce the profitability of
potential projects. In a market economy a financial system with
low transaction costs develops in order to reduce the
opportunity cost of holding money. As a result the payments
system in a market economy evolves toward a credit system
managed by banking intermediaries. Technological advances
continuously reduce the information costs of utilizing credit
while financial assets and credit instruments gradually replace
traditional monetary assets. This is reflected by increases in
the weight of financial activities in gross domestic product
(GDP) as economic development takes place. Thus, the velocity
of narrow monetary aggregates increases after a certain stage
of development and the increase in this measure of velocity is
paralleled by the development of intermediation
technologies.\10\
---------------------------------------------------------------------------
\10\ Note that in very early stages of economic development the
economy is increasingly monetised as transactions become more
complicated and sophisticated, thus there is a secular downward trend
in money velocity. However, after some threshold level of development,
pressure to reduce the opportunity cost of holding money leads to the
replacement of money with credit instruments and an increase in the
velocity of narrow money aggregates. The strong empirical link between
GDP and degree of monetisation is demonstrated by Goldsmith (1969).
---------------------------------------------------------------------------
demonetization and non-payments
In a transition economy changes in the velocity of narrow
money aggregates must be interpreted with caution, however.
Measurement problems are severe. In Russia the method for
calculating GDP is being refined, defining and measuring
monetary aggregates is difficult, and the amount of dollars in
cash in circulation is large and difficult to measure.\11\
Further, significant changes in the behavior of economic agents
have occurred and creation of new monetary and credit
instruments is rapid and unpredictable. Demonetisation in the
Russian economy may increase or decrease velocity for reasons
completely independent of financial development. For example,
in 1994 the Central Bank of the Russian Federation (Central
Bank of Russia or CBR) began to implement more stringent
prudential regulations at the same time monetary policy was
tightened. A crisis in the inter-bank lending market in 1995
led financial intermediaries to innovate, creating new types of
securities to facilitate payments.\12\ There was a rapid
increase in the use of cash surrogates including barter,
sometimes complicated offset arrangements (zachety), bills of
exchange (veksels), and various federal, regional and local
securities.\13\ There was also a rapid increase in payments
arrears. While some of these activities may be considered a
first step toward financial deepening, employing primitive
payments and intermediation technologies with high transactions
costs, such as barter and illiquid offset arrangements, is
clearly a step backward.\14\ Only if orderly secondary markets
for zachety and veksels are developed may it be interpreted as
a step forward. Matters were complicated at this time as the
practice of issuing credit denominated in bills of exchange
allowed banks to facilitate tax evasion, disguise bad loans by
converting them to veksel credits and avoid provision
requirements. Lack of transparency in accounting complicated
matters further as prices varied depending upon the means of
payment, confounding efforts to improve corporate governance,
restructure enterprises and enforce tax and other
regulations.\15\ Corruption and illegal activities also
flourished.\16\ By 1997-1998 money surrogates accounted for
over half of industrial transactions and consolidated budget
revenues. In many regions of the country this share reached 70
percent.\17\
---------------------------------------------------------------------------
\11\ Buchs (1999) reports dollarization of 10 percent of GDP.
\12\ Tightening of monetary policy and higher real interest rates
led to liquidity problems and banks in turn borrowed heavily on the
inter-bank loan market for liquidity. Both volume and rates increased
leading many banks to withdraw from the market. On August 23-24
overnight rates spiked, lending was rationed and the market collapsed.
The Central Bank was only partially accommodating and several hundred
banks failed. See OECD (1997), p. 82 for additional details.
\13\ OECD (1997), Annex II discusses the development of various
money surrogates. Veksels may be promissory notes or, if tradable,
bills of exchange. They perform a much broader role, however, serving
as the equivalent of debt instruments like certificates of deposit,
commercial paper, simple IOUs and bonds.
\14\ While OECD (1997), Chapter 2 describes the introduction of new
securities and means of payment as important innovations and monetary
and institutional changes at this time in a positive tone, the chapter
concludes with a section titled ``Commercial banking in the Russian
Federation: the first signs of stability or impending crisis?''
Conditions deteriorated rapidly from the time of printing and within a
year the financial system collapsed.
\15\ Barter and offset prices tended to be higher than veksel
prices that in turn were higher than cash prices for the same
commodities. See OECD (2000) pp. 91, 92.
\16\ See Gaddy and Ickes (2001), Woodruff (1999) and Commander and
Mumssen (1998) for further analysis of non-monetary transactions and
the impact upon decisionmaking in the Russian economy.
\17\ For additional details on demonetisation see OECD (2000),
Chapter 2.
---------------------------------------------------------------------------
While Pinto, Drebentsov and Morozov (2000) argue for a
complete dismantling of the non-payments system, there were
some positive aspects.\18\ It in fact represented an
evolutionary step in the financial development process. In
response to very contractionary macro-economic policy and the
elimination of direct enterprise subsidies, in a system with
soft budget constraints, cash short enterprises resorted to
non-cash surrogates for payments both with each other and with
the Treasury. Fiscal authorities permitted and enhanced the
development of non-cash instruments for fiscal purposes as a
means of supporting inefficient enterprises, which could no
longer be subsidized directly. As international financial
institutions objected to the use of a particular instrument it
was eliminated, but quickly replaced by another nearly
equivalent instrument.\19\
---------------------------------------------------------------------------
\18\ Note that Pinto, et al. (2000), p. 1, defines non-payments as
(1) arrears and (2) all forms of non-cash settlements including barter,
veksels or promissory notes and tax offsets whereby government spending
arrears and overdue tax payments are mutually cancelled. I focus on
non-cash payments or cash surrogates since these actually are a means
of conducting payments, either at a discount or premium, which may
compete with payments within the banking system.
\19\ For example, treasury tax offsets were employed in 1994-1996
then replaced by direct monetary offsets in 1996, 1997, which were
replaced by reverse monetary offsets in 1997, 1998, which in turn were
replaced by targeted financing. See Pinto, Drebentsov and Morozov
(2000).
---------------------------------------------------------------------------
The share of non-cash transactions varied by industrial
branch, but clearly increased through the 1990s, as indicated
in Figure 1 and Table 1. The increase in offset arrangements in
1996-1998 also paralleled the increase of enterprise payments
arrears, as they became the dominant form of non-cash payments.
While it may be argued that offset arrangements prevented a
further contraction in the economy and to some extent provided
liquidity (some offsets were tradable) they also were very
inefficient as a means of payment since transactions costs were
extremely high and they facilitated the continuing distortion
of relative prices.\20\ With the development of alternative
credit instruments barter should decrease over time.
---------------------------------------------------------------------------
\20\ It is also important to note that a large portion of the
increase in arrears was due to the accumulation of penalties and fines
on enterprises for late payment of taxes and payments to the
government. Government-organization to government-organization payments
arrears do not accrue fines and penalties and thus the proportion of
enterprise arrears to government as a proportion of total arrears
increased. Penalties and fines amounted to 65 percent of all debt to
the Federal budget by the end of 1997. While the initial payment arrear
is viewed by some as an increase in ``soft credit'' to the enterprise
sector, the accumulation of fines and penalties probably should not be.
See Mumssen (1998) and OECD (2000).
---------------------------------------------------------------------------
There are three causes noted for the Russian
demonetisation: (1) barter occurred between enterprises that
had Soviet era links and was facilitated by trade institutions
that act much like Gossnab \21\ did, (2) macro-economic policy,
the elimination of directed credits and high interest rates,
increased the opportunity cost of money, encouraging financial
innovation and the creation of non-money means of payments, and
(3) barter and varying prices for differing means of payment
facilitated tax avoidance. Clearly all three reasons
contributed to the demonetisation, but by 1999 world oil prices
and export earnings increased, and interest rates came down,
all providing greater liquidity to the economy overall, and the
need for monetary surrogates declined. The banking system
stabilized and transaction levels within the payments system
returned to more normal levels. While stable, the system is
still far from liberalized.
---------------------------------------------------------------------------
\21\ Gossnab, the State Committee on Material and Technical Supply,
was one of the most important state committees instrumental in
developing, coordinating and enforcing the central plan during the
Soviet era.
---------------------------------------------------------------------------
FIGURE 1._SHARE OF NON-CASH RECEIPTS FOR INDUSTRIAL FIRMS
[GRAPHIC] [TIFF OMITTED] T6171.028
Source: OECD (2000) p. 85. Original Source: Russian Economic
Barometer.
TABLE 1.--TYPES OF PAYMENTS BY LARGE FIRMS AND NATURAL MONOPOLIES BY INDUSTRIAL BRANCH, DECEMBER 1998
[As a percentage of total payments]
----------------------------------------------------------------------------------------------------------------
Cash Offsets Securities Barter Other Total
----------------------------------------------------------------------------------------------------------------
All firms.................................................. 43.4 29.5 11.5 7.5 8.1 100
Electricity................................................ 19.5 45.2 16.7 4.1 14.5 100
Fuels...................................................... 39.4 36.5 15.2 4.7 4.2 100
Machine-building and metalwork............................. 14.1 37.4 31.3 13.5 3.7 100
Construction and construction materials.................... 26.0 44.6 7.8 18.5 3.1 100
Transportation............................................. 37.4 45.8 11.0 0.3 5.5 100
Light industry and food.................................... 69.8 12.7 4.0 7.6 5.9 100
Agriculture................................................ 65.1 3.3 0.5 28.6 2.5 100
Trade and public catering.................................. 84.4 11.6 3.2 0.3 0.5 100
----------------------------------------------------------------------------------------------------------------
Source: OECD (2000), p. 87. Original source Goskomstat.
financial repression and liberalization
McKinnon (1973) defines financial repression as any policy
or regulation that prevents financial intermediaries from
operating at a level in accordance with their technological
potential. Typical repressive policies of the banking system in
a market-type economy are forms of implicit or indirect
taxation of financial intermediaries or transactions. The most
common are bank reserve requirements with low or zero yield,
ceilings or controls on lending and deposit rates, and the
inflation tax on monetary assets in general. The costs include
the loss in efficiency due to the distortions in interest
rates, credit rationing and overall discouraged savings due to
low deposit rates.\22\ In addition, the market structure itself
must be considered as a potential limiting factor on the
development of the financial system. Stiglitz (1994) emphasizes
market failure and the need for government intervention of
various sorts to improve efficiency in the financial
system.\23\ There is considerable debate in the literature on
both the optimal level of competition and the need for and type
of government intervention, however.\24\
---------------------------------------------------------------------------
\22\ The costs can be significant. In a study of twenty-six
developing countries the inflation tax was estimated at 2.8 percent of
GDP and ceilings on interest rates generated a tax equivalent to 1.8
percent of GDP. See Berthelemy and Varoudakis (1996).
\23\ Stiglitz (1994) notes seven types of market failure: (1)
monitoring as a public good, (2) externalities of monitoring, selection
and lending, (3) externalities of financial disruption, (4) missing and
incomplete markets, (5) imperfect competition, (6) Pareto inefficiency
of competitive markets, and (7) uninformed investors. He then provides
a taxonomy of government interventions which may be appropriate. Levine
(1996) provides a framework for policy analysis and government
intervention. Harwood and Smith (1997) provides an extensive look at
financial development strategies for developing countries.
\24\ For example, Jaramillo-Vallejo (1994) takes issue with
Stiglitz's arguments for government intervention.
---------------------------------------------------------------------------
With virtually no lending activity, strict controls on
deposit accounts and rate ceilings and complete monopolization
of the banking system during the centrally planned era, the
Russian banking system has evolved from what may be considered
an extreme in terms of financial repression. To complicate
matters Russian bank management was not prepared to operate the
newly created commercial banks as profit maximizing banks in a
market economy.\25\ Russian banks were not able to identify
potentially profitable investments, due to the lack of business
reputations and reliable credit histories, predominance of
insider control (politically supported) in enterprises, weak
contract enforcement and an underdeveloped legal system.
Although bank managers are slowly developing the skills to
engage in effective project appraisal and monitoring, they have
weak incentives to develop these skills as long as there are
alternative, cheaper sources of high profits, like government
securities.
---------------------------------------------------------------------------
\25\ Tompson (1997) argues that at least through the mid-1990s
Russian banks really did not bank. They did little to collect deposits
and did little lending except to the state. A large share of their
liabilities were free and a large share of their assets were idle.
Banks maintained a high level of excess reserves even during highly
inflationary periods. This activity is not necessarily financial
repression via government policies, but by poor management. Iskyan and
Besedin (2000) call Russian banks ``bank-like institutions'' and Schoor
(2001) maintains most banks are simply treasury operations of their
enterprise owners.
---------------------------------------------------------------------------
The benefits of liberalization seem obvious, but the pace
and timing of liberalization are critical. Many argue that the
fiscal deficit must be under control prior to liberalization
because significant increases in interest rates to dampen
growth or control inflation may lead to adverse selection in
bank lending activity, thereby threatening the soundness of the
banking system. In addition, many argue that a perfectly
competitive banking industry will underprovide financial
services because of the public good nature of the information
on profitability of entering the deposit market by individual
banks and the high cost of entering the market. Thus, Hellman,
et al. (1997) argue that ``mild'' financial repression may be
beneficial because it creates rent opportunities that enhance
incentives for financial deepening and deposit
mobilization.\26\ And Van Wijnbergen (1983) argues that
informal financing that developed early in many developing
economies may actually be more efficient than intermediated
financing in a liberalized system. But this is true only if the
informal sector has higher quality information on risk and
lending opportunities. While all three caveats may apply to the
Russian economy to a limited extent, recent research indicates
that the effects of financial liberalization on economic growth
are ``not subsumed by other economic reforms or proxies for the
development of capital markets and financial intermediation.''
\27\ Therefore liberalization, per se, should proceed as
quickly as possible.
---------------------------------------------------------------------------
\26\ It is difficult to ascertain what level of repression is
optimal. E.g., mild financial repression may include deposit rate
ceilings, which enhance franchise values. However, if ceilings and
other regulations diminish competition and hinder the efficient
allocation of resources diminishing growth then liberalization is in
order.
\27\ Bekaert and Harvey (2001), p. 11.
---------------------------------------------------------------------------
A liberalized financial system contributes to overall
economic growth by increasing savings. Financial markets and
banking intermediaries improve the mobilization of savings,
providing higher than expected yields and greater
diversification of risk. This in turn encourages financial
savings rather than the purchase of consumer durables (or real
assets with a low rate of return). Such a reorientation of
savings reinforces the deepening of the financial system.\28\
This pattern may not be observed in the transition economy as
pent up consumer demand is released in the initial period. The
financial crisis in Russia (as well as other transition
economies) then introduced skepticism on the part of savers and
weakened the credibility of the financial system overall. The
fact that there is no universal deposit insurance system for
Russian savers also discourages savings. Because Sberbank is
the only institution with state support perceived to be
equivalent to deposit guarantees, households transferred
deposits from independent, private commercial banks to
Sberbank.\29\ The share of total household deposits held by
Sberbank increased from just over 50 percent in mid-1994 to
over 85 percent by January 1999, then declined slowly to just
over 75 percent in April 2001. One reason that other commercial
banks, private and state-owned, cannot compete in the deposit
market is because they lack the deposit guarantees that
Sberbank offers implicitly. Thus, to increase savings
government policy should reduce the risks to depositors
associated with saving via bank deposits by developing a system
of deposit insurance and by eliminating the household deposit
monopoly Sberbank enjoys. There has been tremendous resistance
to this, however, as evidenced by the continuing discussion of
the proposed federal laws on deposit insurance.\30\
---------------------------------------------------------------------------
\28\ Actually, income and substitution effects make the a priori
outcome on growth indeterminate.
\29\ The August 1998 crisis led Sberbank to lose half of its net
assets when the government defaulted on GKOs. The government bailed out
Sberbank, whereas depositors at other failing institutions (Menatep,
Most, SBS-Agro, Inkombank, Mosbusiness Bank, and Promstroibank) were
required to transfer deposits to Sberbank at unfavorable terms. See
Buchs (1999) p. 693 and Schoers (2001).
\30\ The Antimonopoly Ministry, however, has initiated three
proceedings against Sberbank and the CBR since the beginning of this
year. However, all decisions taken concerning the promotion of
competition in the banking sector must be submitted to the CBR, which
``seems to deliberately hinder any attempts to achieve this task.''
Russian Economic Trends, (April 2001), p. 6. It should also be
emphasized that Sberbank's advantages in the deposit market also
contribute to an inefficient allocation of capital at the macro-level
since its assets are held predominately in government securities or
loans to large state-owned enterprises, replicating investment patterns
of the Soviet era.
---------------------------------------------------------------------------
A liberalized system also improves the allocation of
resources, increasing capital productivity and economic growth.
The inherent difficulties of resource allocation, with
productivity risks, insufficient and imperfect information on
the return on investment and entrepreneurs' skills, provide
opportunities for creation of financial intermediation
services. Financial institutions provide diversification of
risks associated with productivity and demand shocks, manage
liquidity risks and evaluate potential projects and
entrepreneurs. These activities increase the rate of economic
growth by increasing the resources invested in productive
activities, increasing technological specialization,\31\
reducing the premature liquidation of capital \32\ and
increasing productive efficiency. Evaluating projects and
entrepreneurs, essentially assessment and monitoring, has very
large fixed costs which financial intermediaries can spread
over many investors, no one of which would be willing to pay
the initial fixed costs. The intermediary can evaluate more
projects, collect more information and provide it in a
standardized form to large numbers of investors who then choose
among varying levels of risk depending upon their risk
preference. As a result of better assessment of risk and better
information, more resources can be directed toward the most
productive or profitable projects. Monitoring and diversifying
systemic shocks also allows an increase in resources invested
in productive, but riskier projects, therefore increasing the
overall productivity of the economy's capital stock.
---------------------------------------------------------------------------
\31\ To reduce the risk of disruption in the demand for products
produced with highly specialized technologies (technology risk) firms
often invest in less specialized and therefore less productive,
flexible technologies. Therefore, diversification via activities of
financial intermediaries, allows more investment in highly specialized,
more productive technologies.
\32\ The law of large numbers reduces the probability that all
depositors/investors withdraw at the same time.
---------------------------------------------------------------------------
The working of financial intermediaries described above
stands in stark contrast to the allocation of capital in the
Soviet system in which crude indicators of effectiveness,
imperfect information and political forces guided central
planners' investment decisions. The Russian banking system is
painfully evolving from one which served as the agent of
central planners toward a system of market driven, profit
oriented financial intermediaries. But it is far from that
goal. First, the financial services industry is far from
competitive. Although the number of commercial banks is large,
just over 1,300, activity is highly concentrated. As of April
2001, Sberbank accounted for over 75 percent of household
savings deposits. Sberbank accounts for about 20 percent of
lending and Vneshtorg Bank accounts for about 5 percent. These
banks have very little lending experience and will likely favor
large enterprises in priority sectors not unlike the Soviet
pattern of investments. As Table 2 indicates total domestic
credit as a share of GDP is about 60 percent of the comparable
market economy and private sector credit relative to GDP is
less than 50 percent of the market economy benchmark. Second,
while the number of privately-owned banks is decreasing, the
state also continues to found new banks, Rosiiski Bank
Razvitiya (the Russian Development Bank) in 1999 and
Rosselkhozbank (the Russian Agricultural Bank) in 2000, which
are likely to have different investment objectives, enjoy the
implicit guarantees of the state, and therefore will likely
provide directed, soft credits to industry and agriculture.
Given that private sector lending activity is lagging
dramatically (as indicated in Table 2) a more appropriate
policy may be the creation of institutions subject to market
discipline, but designed to meet the financing needs of small
and medium enterprises in the private sector. On the positive
side, smaller, regional banks, which were less affected by the
1998 crisis, are in a position to expand their activities.\33\
---------------------------------------------------------------------------
\33\ See Schoors (2001)
TABLE 2.--TOTAL DOMESTIC CREDIT AND PRIVATE SECTOR CREDIT AS PERCENT OF
GDP AND MARKET ECONOMY BENCHMARK
------------------------------------------------------------------------
1994 1999
------------------------------------------------------------------------
Total domestic credit, percent of GDP................. 31.7 32.7
Market economy benchmark, percent..................... 52.0 51.3
Proportion of benchmark level......................... 61.0 63.7
Private sector credit, percent of GDP................. 12.1 11.5
Market economy benchmark, percent..................... 44.2 43.3
Proportion of benchmark level......................... 27.4 26.6
------------------------------------------------------------------------
Source: Derived from Tables 1 and 2 of Fries and Taci (2001). Benchmarks
are based upon regression estimates of each ratio as a function of GNP
per capita for a sample of 127 market economies. See Fries and Tacci
(2001) for details.
Third, information on enterprise performance, potential
investment returns and entrepreneurial talents is very limited
and of poor quality regardless of whether intermediaries or
individual investors collect the information. In fact, even
official, legally required information is often incorrect.\34\
Fourth, most banks are acting primarily as treasury operations
of their owners or acting implicitly as an agent of the
government in lending activities, in effect continuing the
history of centrally directed capital grants, but now with a
weak expectation of repayment. As indicated in Tables 3 and 4
loans (claims on the private sector) account for roughly one-
third of the banking sector's assets. Tompson (1997) notes in
1995 that only 49.5 percent of assets were nominally income
earning, probably much less if non-performing loans were
excluded.\35\
---------------------------------------------------------------------------
\34\ Iskayan and Besedin (2000), p. 5 reports that ``a CBR audit of
financial statements submitted to it found that roughly half of a
representative group of banks systematically falsified reports.'' In
addition, even if information reported is correct, Russian accounting
standards make it difficult to understand an enterprise's condition and
inter-enterprise payments problems, and non-payments, make it difficult
for managers to assess their own enterprise's performance, much less to
convince potential lenders/investors.
\35\ Thomson (1997), p. 1176. Note the level of lending was low and
very short term, typically 30 to 60 days. No doubt the high and
variable inflation of the time was a significant deterrent to lending.
Although inflation has been reduced banks still tend to lend short term
to finance transactions (e.g., imports) or acquisitions rather than
longer term investment projects.
---------------------------------------------------------------------------
The distribution of assets indicates moral hazard issues
remain a serious problem. It was suggested above that the
introduction of deposit insurance would enhance competition,
increase aggregate savings and improve the allocation of
liabilities within the banking system. A second, perhaps more
important reason to introduce a system of risk-based deposit
insurance, is that an explicit system of guarantees is a more
efficient means of reducing moral hazard and improving resource
allocation than the current system of implicit guarantees.
Since the financial institution itself determines the size of
the implied guarantee, the institution can expand the implicit
subsidy by doing more and riskier lending. Explicit risk-based
guarantees can be limited, however. By pricing the deposit
insurance in accordance with the institution's risk profile,
moral
TABLE 3.--CONSOLIDATED ACCOUNTS OF CREDIT INSTITUTIONS
[In million rubles, December 31] \1\
----------------------------------------------------------------------------------------------------------------
1995 1996 1997 1998 1999 2000
----------------------------------------------------------------------------------------------------------------
Reserves \2\.......................... R36,712.3 R47,123.4 R72,974.5 R67,762.9 R160,017.3 R301,124.5
Foreign assets........................ 46,149.4 72,874.8 72,717.3 219,593.0 370,651.3 476,581.8
Claims on general government.......... 62,638.5 150,721.3 194,689.0 259,401.6 437,675.2 526,020.7
of which, claims on governments of 721.7 2,790.4 18,691.8 24,445.6 19,870.5 18,531.3
constituent territories of RF and
local self-government bodies.....
Claims on non-financial state 62,460.4 69,371.4 33,217.4 33,078.8 46,901.2 73,972.6
enterprises..........................
Claims on non-financial private 133,786.8 157,337.2 236,438.4 345,962.6 521,644.8 867,132.2
enterprises and households...........
Claims on other financial institutions 525.0 242.0 8,075.9 7,270.7 13,060.2 14,525.0
-------------------------------------------------------------------------
Total assets.................. 342,272.4 497,670.1 618,112.5 933,069.6 1,549,950.0 2,259,356.8
=========================================================================
Demand deposits....................... 69,331.9 87,303.0 162,532.1 149,470.7 249,673.7 443,020.9
Time, saving and foreign currency 124,496.6 164,898.7 158,714.8 283,996.1 456,527.8 680,646.9
deposits.............................
of which, deposits in foreign 55,255.7 69,447.7 80,454.7 190,872.7 290,212.9 420,090.5
currency.........................
Deposits, access--temporarily ......... ......... 6,270.5 22,595.1 10,223.6 6,373.3
restricted \3\.......................
Money market instruments.............. 11,858.5 30,372.2 42,435.9 43,311.9 107,817.2 191,059.0
Foreign liabilities................... 29,969.8 58,892.5 104,197.4 203,136.8 222,626.6 248,920.7
General government deposits........... 9,741.1 11,557.2 18,236.1 20,676.5 28,671.8 54,547.2
of which, deposits of governments 4,251.9 4,210.6 9,139.9 10,148.2 15,626.8 36,641.8
of constituent territories of RF
and local self-government bodies.
Obligations to monetary authorities... 8,005.1 6,798.8 8,779.8 71,893.6 200,121.4 205,439.4
Capital accounts...................... 66,687.8 123,817.5 143,909.4 157,594.7 293,199.4 437,265.2
Sundry (balance)...................... 22,181.5 14,030.3 -26,963.5 -19,605.7 -18,911.6 -7,915.9
----------------------------------------------------------------------------------------------------------------
\1\ From the consolidated balance sheets of credit institutions, Sberbank Savings Bank, and Vneshekonom Bank.
\2\ Reserves of credit institutions comprise cash reserves in vaults and their funds in accounts with the CBR.
\3\ Deposits with temporarily limited access comprise funds in accounts with credit institutions which cannot be
used by their holders within a certain time limit in accordance with a contract or transaction terms or
current conditions of a credit institution's activity.
Source: The Bulletin of Banking Statistics, various issues, CBR.
TABLE 4.--SELECTED ASSETS AND LIABILITIES OF COMMERCIAL BANKS, INCLUDING SBERBANK
[In billion rubles]
----------------------------------------------------------------------------------------------------------------
Bank
savings
Claims on Claims by
Total the on the Russian Foreign Foreign
assets general private citizens currency liabilities
government sector (ruble deposits
household
deposits)
----------------------------------------------------------------------------------------------------------------
1995.......................................... R342.3 R62.6 R133.8 R70.6 R55.3 R30.0
1996.......................................... 497.7 150.7 157.3 118.4 69.4 58.9
1997.......................................... 622.7 191.5 225.9 148.2 80.5 104.2
1998.......................................... 933.1 259.4 346.0 149.5 190.9 203.1
1999.......................................... 1,549.7 437.7 521.6 211.1 290.2 222.5
2000.......................................... 2,259.4 526.0 867.1 304.2 420.1 249.0
2001 (April).................................. 2,472.0 561.3 989.2 342.5 477.1 256.4
----------------------------------------------------------------------------------------------------------------
Source: Russian Economic Trends, June 2001, Original Source: Goskomstat, CBR.
hazard can be limited and discrepancies between depositors',
insurers' and lenders' risk tolerances are narrowed. Thus, a
system of risk-based deposit insurance benefits not only
individual depositors, but also reduces system risk by reducing
moral hazard. A prerequisite for an effective system of risk-
based deposit insurance is the ability to measure risk, i.e.,
accurate financial information and uniform accounting standards
providing greater transparency of bank activity. Legal reforms
in the Russian banking system are gradually providing the
foundations for these prerequisites, but currently, accurately
measuring risk exposure of individual banks is difficult if not
impossible.
The financial system is not passive in a market economy,
but accelerates growth in the real sector. The organization of
financial intermediation networks is expensive, however. The
level of financial sector development and economic activity is
inter-related. Because the bulk of costs in establishing an
intermediation network are the initial fixed costs, threshold
effects are typical. An economy develops a specific type of
intermediation system corresponding to the overall level of
economic activity, which may be proxied by the level of per
capita income. Then as per capita income increases, at some
point the benefits of expanding or innovating within the
intermediation system are perceived and capturable, the next
stage of financial development begins. The benefits of
deepening the financial system have a positive effect on
overall economic growth and create the possibility of a
circular relationship between financial development and growth.
In this case a ``virtuous circle'' in which high income levels
support development of the financial system and development of
the financial system makes possible higher rates of growth. On
the other hand, an underdevelopment trap or low-level
equilibria may result. In an underdeveloped economy with few
growth prospects, low-income levels make the development of the
financial system impossible, which in turn hinders the
allocation of resources to investment and further weakens
growth.\36\ When financial institutions are inadequately
developed selecting more flexible, less specialized, and
therefore less productive technologies mitigates production
risk. But reduction in risk by technological flexibility in
production weakens the incentives to develop financial markets
and banking intermediaries that involve substantial fixed
costs. This results in a low level equilibrium with an
underdeveloped financial system.\37\ A more developed financial
system enables selection of more specialized, more risky but
more productive production technologies. And, the resulting
increase in risk is more easily diversified and mitigated by
the existence of a developed financial system.
---------------------------------------------------------------------------
\36\ See Greenwood and Jovanovic (1990), Levine (1992b), Townsend
(1983).
\37\ See Saint-Paul (1992).
---------------------------------------------------------------------------
Before turning to a description of the Russian banking
system it is important to realize that the banking industry in
a market economy is typically not a perfectly competitive
industry, but characterized by varying degrees of imperfect
competition. Thus, in a transition economy policies should
encourage competition, recognizing that the optimal level of
competition is unclear. Natural imperfections in the banking
system in a market economy arise due to the information
intensive functions of the system. The activity of gathering
and processing information on investments involves large fixed
costs, which leads to imperfect competition and market
segmentation. Because lenders (savers) and investors
(borrowers) are generally not the same individuals there are
information asymmetries since investors have better access to
information about the quality and likely success of investment
projects than lenders do. Therefore the functioning of
financial markets is characterized by adverse selection and
adverse incentives. Although banking is often monopolistically
competitive Stiglitz (1994) argues greater competition is a two
edged sword. Compression of intermediation margins via greater
competition erodes profits and makes the system more vulnerable
to productivity shocks as it increases the possibility of
insolvency. Unlike other sectors insolvency in the banking
sector can have wide spread negative repercussions on the rest
of the economy as the volume of lending and activity in the
real sector decline. Also, when a bank goes bankrupt the
information it has collected on its particular clients or
sector of lending activity may simply disappear. If so this
leads to borrower rationing, which has a negative impact upon
growth--the opposite effect that we would expect from
compressing intermediation margins. The optimal level of
competition, or the optimal intermediation margin, is not that
of a perfectly competitive market. Reaching that optimal level
is difficult in a well-functioning market environment and
particularly difficult in a transition environment like that of
Russia today.
The State of the Banking System: Crisis, Recovery and Crisis?
system characteristics and policy framework
While the overall level of financial development in a
transition economy is difficult to measure, traditional
indicators of financial development indicate the Russian
financial sector is underdeveloped vis-a-vis market economies
even after the crisis and stabilization of the system. As Table
5 indicates banking system assets as a percentage of GDP has
increased from 22.2 percent in 1995 to 32.0 percent in 2000.
This ratio for a market economy is typically in the 50 to 60
percent range.\38\ Loans to GDP has increased from 8.7 percent
to 12.3 percent. Banking system capital as a percentage of GDP
has fluctuated, but averaged about 5.5 percent, in the range of
a market economy, typically 5 to 6 percent.\39\ While these
aggregate measures seem to be improving it should be noted
again that total domestic credit relative to GDP is about 60
percent of the comparable market economy and private sector
credit relative to GDP is well less than half that of the
comparable market economy (see Table 2). Further, these
proportions have not changed during the last 5 years.
Importantly the aggregate measures conceal the fact that the
Russian banking industry is highly concentrated. At the end of
1997, just prior to the 1998 crisis, the top 5 banks accounted
for 36 percent of total assets, and the top 50 accounted for 71
percent.\40\ Also, as mentioned above, Sberbank holds roughly
75 percent of household deposits. Including enterprise deposits
the top 5 banks accounted for 58 percent of ruble deposits and
the top 50 banks accounted for 65 percent at the end of
1997.\41\
---------------------------------------------------------------------------
\38\ Great Britain and Japan are extremes with bank system assets
as a percent of GDP at 270 percent and 159 percent in 1990 and 1993
respectively. Warner (1998), Table 2.
\39\ Note though that GDP has fluctuated greatly and published data
are sometime suspect. Therefore these ratios should be interpreted with
caution. See Iskyan and Besedin (2000) p. 21.
\40\ Russian Federation (1997), p. 88.
\41\ Russian Federation (1997), p. 88.
TABLE 5.--BANKING SYSTEM CHARACTERISTICS (END OF PERIOD)
[In percent]
----------------------------------------------------------------------------------------------------------------
1995 1996 1997 1998 1999 2000
----------------------------------------------------------------------------------------------------------------
Assets/GDP................................................ 22.2 23.2 25.1 34.0 32.6 32.0
H.H. deposits/GDP......................................... 4.6 5.5 6.0 5.5 4.4 4.3
Loans/assets.............................................. 39.0 31.6 36.3 37.1 33.7 38.4
Loans/GDP................................................. 8.7 7.3 9.1 12.6 11.0 12.3
----------------------------------------------------------------------------------------------------------------
Source: Calculated from Tables 2 and 7.
Since 1998 bank restructuring has taken place, albeit at a
pace that some see as too slow. The crisis led to a dramatic
decline in bank capital and a deposit run on the large Moscow
banks leaving the majority of them insolvent. The CBR adopted
emergency measures forcing six large commercial banks to
transfer the bulk of household deposits to Sberbank, with any
remaining deposits frozen.\42\ This prevented further
withdrawals by the population and stabilized the payments
system. However, the CBR was unable to move quickly to close
large insolvent banks, which were at the heart of the
influential Financial Industrial Groups, or to extend
rehabilitation credits in a timely manner. Although the bank
had the power to revoke licenses and take over the management
of insolvent banks, the attempts to do so immediately after the
crisis were unsuccessful.\43\ Legal delays and political
maneuvering allowed assets to be transferred from the failing
institutions to newly created shell banks and balance sheets
were unilaterally restructured. Although the Agency for
Restructuring Credit Organizations (ARCO) was established
rather quickly, in November 1998, its effectiveness also was
limited in the early period after the crisis.\44\ It was
capitalized with 10 billion rubles, the state holding 51
percent of its shares and the CBR 49 percent, an amount
estimated at about 10 percent of that necessary for a complete
recapitalization of the banking system.\45\
---------------------------------------------------------------------------
\42\ These banks were Inkombank, SBS-Agro, Moct Bank, Rosiiskii
Kredit, Menatep and Promstroibank. Also see OECD (1997) Annex I for a
discussion of the largest 23 banks prior to the crisis.
\43\ For example, the CBR's initial attempt to revoke the license
of Inkombank was contested in court and it was not until June 2000 that
the revocation of the license was allowed to stand and a Moscow
arbitration court named external managers to liquidate the bank. See
Iskyan and Besedin (2000) for a chronology of this case and a primer on
asset stripping. Also see Schoors (1999). Another notable case is that
of Promstroibank. In July 1999 the CBR withdrew Promstroibank's license
and it was declared bankrupt. Various government officials declared
their support of Promstroibank, the bankruptcy procedures were halted
and the license suspension declared illegal, even though the bank was
insolvent. In November 2000 an arbitration court ruled the CBR's
actions were legal and proceedings were to continue. See Russian
Economic Trends (November, 2000), p. 17.
\44\ It lacked funding and authority. Its first board meeting was
held in March 1999. See Russian Economic Trends, March 1999, p. 3.
\45\ Russian Economic Trends, December, 1998, p. 3
---------------------------------------------------------------------------
By mid-2000 the results of ARCO's modest efforts were
becoming visible.\46\ Temporary administration was imposed upon
Most Bank in May and Vneshtorg Bank purchased it in October
2000. SBS-Agro and Mezhkombank were bankrupted. Bankruptcy
proceedings continue with Promstroibank and Menatep,
Mosbusiness Bank and Imperial Bank remain in receivership, or
are battling for survival.\47\ The first bank to emerge from
ARCO management, in 2001, is Chelyabkomzembank, purchased by
Rosselkhozbank the wholly state-owned bank created in April
2000. A restructuring plan for Uneximbank was approved and
shareholders approved its merger with Rosbank (the bridge bank
of Rosiiski Kredit).\48\ In addition, the Central Bank is
expected to divest itself of ownership in all banks. It sold
its interest in five Russian-owned foreign-based banks
(rosagranbanks) to Vneshtorg Bank this year and will sell its
ownership in Vneshtorg Bank by 2002 and in Sberbank by 2004.
---------------------------------------------------------------------------
\46\ While there are tangible results of ARCO's efforts critics
maintain they are negligible since these banks are very small compared
to the overall banking system and these bailouts may be seen as
benefiting incompetent managers and therefore increasing moral hazard.
The overall benefit to the banking system remains an open question.
\47\ See Russian Economic Trends, various issues, (2000), (2001).
\48\ Note that Uneximbank may be the only bank to be successfully
restructured without assistance from ARCO or any other state agency.
Russian Economic Trends, October 2000, p. 13.
---------------------------------------------------------------------------
The foundation of the Russian banking system is provided by
two fundamental laws, the Law on Central Bank of the Russian
Federation and the Law on Banks and Banking Activity and by
various parts of the civil code, in particular bankruptcy
provisions and the tax code. The CBR carries the responsibility
for not only monetary policy, but also bank licensing and
prudential and regulatory oversight. Although the banking laws
originated from the Soviet era, they have been amended many
times. The 1995 amendments gave the Central Bank greater
independence and made it the lender of last resort.\49\
---------------------------------------------------------------------------
\49\ For additional details see OECD (1997), pp. 83, 84.
---------------------------------------------------------------------------
In 1999 Russian authorities provided a stronger foundation
for bankruptcy and bank rehabilitation, and the framework to
accelerate the process of bank restructuring by passing two new
laws. The Law on Insolvency of Credit Organizations
strengthened the CBR's intervention powers and the Law on
Restructuring of Credit Organizations (June 1999) gave sole
responsibility for restructuring banks to ARCO, provided for an
equitable and transparent mechanism for shareholder write
downs, and empowered ARCO to invalidate transactions made with
the intent to defraud depositors and creditors of insolvent
banks.\50\ In spring 2001 the Duma passed three bills
(incorporating most of the Putin government's proposal referred
to as the Gref program or the ``IMF package'') which gave the
CBR additional supervisory powers, introduced the legal
concepts of a banking group and holding, streamlined the
procedures for bankruptcy of credit organizations and revised
the responsibilities of bank founders, shareholders and
managers.\51\ Inter alia, specific legal criteria were
introduced to facilitate the CBR's actions to withdraw banking
licenses and initiate bankruptcy procedures which are expected
to eliminate the legal wrangling typical of most recent actions
initiated by the CBR. Given the new legislation it appears that
a second phase in bank restructuring may now be undertaken.\52\
---------------------------------------------------------------------------
\50\ IMF (1999).
\51\ See Iskyan and Besedin (2001), Appendix B for a summary of the
Gref program and the corresponding legislation.
\52\ Russian Economic Trends, June 2001, p. 8.
---------------------------------------------------------------------------
recovery of banking activity
Only recently has macro-economic performance allowed banks
to rebuild reserves and slowly increase the level of confidence
of depositors and investors. Growth in the banking sector has
been driven by the overall positive developments in the real
sector and increasing demand for banking services. Bank loans
increased 66 percent in 2000 and nine out of ten banks were
reporting profits. By the first quarter of 2001 assets of
commercial banks reached 93 percent of the pre-crisis level in
real terms, and hard currency assets were 43 percent of total
assets.\53\ As personal incomes recovered, household deposits
in the banking sector have increased and the share held by
Sberbank has stabilized at just over 75 percent in June 2001.
(Also see Figure 2.) By spring 2001 lending had increased to
about 40 percent of assets in the Russian banking sector. This
is improved, but still very low compared with the 80 to 90
percent typical of a bank in a developed market economy.
Further, Sberbank and Vneshtorg Bank, the two largest state-
owned banks, accounted for most of the lending to the real
economy.\54\
---------------------------------------------------------------------------
\53\ Russian Economic Trends, June, 2001, p. 7.
\54\ Russian Economic Trends, May 2001, p. 6.
FIGURE 2._HOUSEHOLD DEPOSITS IN SBERBANK AND OTHER COMMERCIAL BANKS
[In billion rubles]
[GRAPHIC] [TIFF OMITTED] T6171.038
Source: Russian Economic Trends, June 1999, p. 4. Original
Source: Goskomstat.
Although lending has increased, Russian commercial banks
still hold unusually large amounts of non-income producing
excess reserves, illustrated in Figure 3. Due to the high risk
of lending to the productive sphere of the economy loans amount
to less than 45 percent of assets. Nearly 15 percent of assets
are held in non-interest bearing accounts at the CBR. Given the
high inflation environment this obviously impacts bank
profitability. The lack of lending to enterprises, investment
into the real economy, also limits economic growth. This is not
a new phenomenon, however. Throughout the 1990s banks held very
low levels of income earning assets.\55\ This is attributable
to the inability of bank managers to find, evaluate and monitor
viable investment projects, and extreme caution with respect to
the possibility of bank deposit runs and risks associated with
inter-bank lending. The government has pressured banks to
increase lending and, as mentioned above, created two new
banks, Rosiiski Bank Razvitiya (the Russian Development Bank)
and Rosselkhozbank (the Russian Agricultural Bank), to expand
lending in critical areas.\56\
---------------------------------------------------------------------------
\55\ See OECD (1997), pp. 85-86.
\56\ Of course the consequences of such pressures are problematic
to the extent that related-party lending some of which may not be
market driven intermediation, and lending to state institutions
distorts the allocation of financial capital. Related-party lending and
its consequences is very difficult to measure, however. See Iskyan and
Besedin (2001) p. 15.
---------------------------------------------------------------------------
Increased lending is a double-edged sword, however. The
rapid increase in bank lending requires increased diligence
upon the part of bank regulators. Although bank capital
increased 43 percent in 2000, undercapitalization is still a
serious problem.\57\ Total equity capital is no more than 6
percent of GDP. Further, under relatively weak supervision many
banks violate existing accounting rules, supplying the CBR with
false financial statements. Regional offices are alleged to
ignore the exaggerated statements of financial performance.
According to the CBR 60 percent of banks overstated their
profits and equity in official reports. At the same time CBR
regional offices classified 9 percent of these banks as stable
and with no faults. In addition, according to the CBR at least
20 percent of the banks classified as stable may be in
difficulty.\58\ To improve financial reporting, in October 2000
the CBR launched the introduction of international accounting
standards (IAS) for six banks. For these banks IAS-based
reports will be provided in 2001. Other banks are expected to
adopt IAS reporting, but over a process of many years. While
adopting IAS is highly beneficial, CBR authorities at all
levels must also be diligent and determined in enforcing
prudential regulations. While significant legislative progress
has been made, CBR regulatory efforts are still insufficient.
---------------------------------------------------------------------------
\57\ This is for the banking system. Of the approximately 1,300
banks, the 1,115 smallest have capital ranging from $0.1 million to $5
million (Iskyan and Besedin (2001), p. 14). Many of these institutions
simply conduct treasury functions of their enterprise owner or operate
as foreign exchange offices rather as banks
\58\ Russsian Economic Trends, July 2000, p. 14.
FIGURE 3._SHARE OF COMMERCIAL BANKS' CLAIMS ON THE PRIVATE SECTOR AND
SHARE OF EXCESS RESERVES IN TOTAL ASSETS
[In percent]
[GRAPHIC] [TIFF OMITTED] T6171.037
Source: Ivanova and Schoors (2000), p. 5.
Concerns and Issues
It is clear that Russian policymakers have made much
progress in reconstructing the banking system in the aftermath
of the 1998 crisis. Recent legislation has increased the
authority of the Central Bank to expedite bankruptcy and
restructuring programs for individual banks and the economic
recovery has provided an environment for improving bank
profitability. The banking system in the aggregate, however, is
still far from a vibrant, sound banking system. Koch (1998)
provides a framework for analysis of the banking system
presented in Table 6. In each of the six categories there is
substantial work to be done.
TABLE 6.--INDICATORS OF A ROBUST FINANCIAL SYSTEM
------------------------------------------------------------------------
-------------------------------------------------------------------------
1. Legal and juridical framework
Well-defined property rights and contract law
Market contracts easily enforceable in practice
Ability to pledge and seize collateral
Well-developed bankruptcy code
2. Accounting, disclosure and transparency
Loan valuation, asset classification and provisioning practices
reflecting sound assessment of counterparties
Effective and regular auditing mechanisms
Information on the creditworthiness of financial institutions made
publicly available on a regular, frequent basis
Timely publication of relevant aggregate financial data (macro-
economic indicators, reserves, banking sector statistics, etc.)
Availability of impartial credit rating or credit information
facilities
3. Stakeholder oversight and institutional governance
Capital adequacy requirements commensurate with risk
Replacement of management for poor performance
Enforceable legal liability of managers
Pervasive use of effective systems of risk management and internal
control
4. Market structure
Financial sector open to qualified new entrants, including those
from abroad
Share of foreign participants in total assets
Financial sector concentration ratios
Liquid inter-bank money and capital markets
Regulations permitting a full range of financial instruments
Sound and effective payment and settlement systems
5. Supervisory/regulatory authority
Independent from political interference in the daily conduct of
supervision and appropriate accountability for achieving clearly
defined objectives
Power to force disclosure, impose penalties, etc.
Adequate resources for staffing, training, compensation
Conducts supervision on a consolidated basis
Shares information with other supervisors
Verification of information on risk management and internal control
systems and on asset quality by regular examinations or external
audits
Adherence to norms established by international consultative bodies
(Basle Committee, etc.), in principle and in practice
Measures to address particular types of risk:
Evaluation of risk management systems
Connected lending
Risk exposure and loan concentration
Special attention to foreign currency and interest rate risk
management and exposures
Heightened scrutiny of asset quality and capital adequacy in the
face of sharp asset price movements
Strategy for addressing financial insolvency:
Procedures for prompt corrective action or the equivalent
Appropriate exit policy
6. Design of the safety net
Explicit rather than implicit deposit insurance, paid for by banks
and targeted especially toward protecting small depositors
Appropriate allocation of losses among stakeholders
Stringent conditionality for the use of public money
------------------------------------------------------------------------
Source: Koch (1998). Original source: Group of Ten (1997).
As mentioned above new legislation improved the legal
juridical framework, but much of the legislation is untested in
practice. The bankruptcy code is improved, but it is too early
to tell if legal challenges and political pressures have been
eliminated from the process. Accounting, disclosure and
transparency is improving and the CBR's recent project on IAS
is a tremendous step. However, even when bank reporting reveals
problems authorities have been reluctant to take appropriate
actions. For example, in the spring of this year the CBR
reported ``the risk exposure of Russian banks exceeds all
reasonable limits.'' \59\ But the CBR does not appear to be
taking any action to ameliorate excessive risk exposure. Will
the CBR be able and willing to take a more active approach in
system risk management?
---------------------------------------------------------------------------
\59\ Russian Economic Trends, April 2000, p. 6. While banks may be
lending to more risky ventures there is also a serious problem in
matching the term structure of assets and liabilities. Approximately 25
percent of loans are for terms of 1 year or more whereas about 14
percent of liabilities are for 1 year or more. Without a highly liquid,
capital market with sufficient depth a liquidity crisis may easily
develop.
---------------------------------------------------------------------------
The 1998 crisis revealed that stakeholder oversight and
institutional governance was a serious problem. New legislation
was required to better define the legal liabilities of managers
and enable management to be replaced during the restructuring
process. Internal controls were notoriously weak and creditor
rights were not clearly delineated and forcefully represented
by authorities during the early phase of restructuring.
Managers were able to strip the assets of banks and effectively
rob depositors and creditors. ARCO still holds ownership stakes
in over a dozen banks in the process of restructuring and new
legislation will likely enable the process to work more
smoothly in the future. However, political pressure and legal
challenges will not likely disappear.
Market structure issues, ranging from the concentration of
the industry, efficiency of financial products markets,
relative lack of lending to the private sector, ease of entry
and development of new financial institutions are a serious
concern. Certain markets remain nearly monopolized. Sberbank's
domination of the household deposit market gives it enormous
power in the enterprise lending market. Further, many argue
there remains too much state ownership to effect competitive
market-oriented behavior on the part of financial institutions.
Sberbank and Vneshtorg Bank are more than 50 percent owned by
the Central Bank, ARCO has a dominant share of over a dozen
institutions, and the Russian Federal Property Fund owns a
majority of Roseksim Bank. The creation of the Russian
Development Bank and the Russian Agriculture Bank seem to move
the industry toward greater participation by the state rather
than less, and greater lending to state-owned enterprises
rather than to the private sector. In addition, state
organizations account for very large shares of deposits and
assets for many banks. All of which provides tremendous
opportunity for political pressures to influence bank behavior.
One positive factor is that the Duma has required the Central
Bank to divest itself of ownership of commercial banks by 2005.
Exactly how this is done is of critical importance. To date the
Central Bank has sold its stake in five rosagranbanks to
Vneshtorg Bank--ownership remained in the state sector. While
this does remove one conflict of interest and enables the
Central Bank to take a slightly greater arms length view of
these banks, the state still has ownership of them and
political pressures are only one small step further away.
In addition, money and capital markets lack depth and
breadth, which in turn may allow an individual, apparently
healthy, participant to precipitate a market wrenching
liquidity crunch.\60\ In 1995 the Central Bank was slow to
provide additional liquidity and nearly 200 banks failed. Can
the Central Bank identify participants with excessive risk
exposure and limit their participation to dampen system risk?
Tough supervisory and prudential regulation is required. Given
the admissions of rather lax enforcement of existing
regulations, not so stringent enforcement of loan
classification and provisioning requirements and the propensity
for individual banks to distort information in the reporting
process, serious questions remain.
---------------------------------------------------------------------------
\60\ For example, in May 2001 Infobank, a creditworthy institution
with many large retail customers, nearly went bankrupt defaulting on
payments on the inter-bank credit market. This could have precipitated
a liquidity crisis similar to that of 1995. Russian Economic Trends,
June 2001.
---------------------------------------------------------------------------
Finally, the safety net for depositors, an explicit,
universal deposit insurance program, paid for by the banks, but
targeting household depositors is critical. It is the
foundation for creating greater confidence in the banking
system and increasing the amount of savings mobilized and
available for investment. It also allows smaller banks to
compete with Sberbank for deposits, promotes competition,
reduces moral hazard and diversifies system risk. Yet the Duma,
after much debate and many readings has failed to act.
In summary, tremendous change has taken place in the
Russian banking system through the 1990s and since the 1998
crisis. The overall economic environment has improved and
supported the recovery of the financial system (see Tables 7 to
9). It is an open question however, whether or not the systemic
changes and the attitudes of regulators and policymakers have
changed sufficiently to prevent a banking crisis comparable to
that of 1998.
TABLE 7.--SELECTED ECONOMIC ACTIVITY
----------------------------------------------------------------------------------------------------------------
Nominal
Nominal expenditures Real
Real GDP, consumption Real on new expenditures
Nominal GDP (seasonally of goods and consumption construction on new
(In billion adjusted) services (In of goods and and construction
rubles) (1997 = 100) billion services \2\ equipment and
rubles) \1\ (1995 = 100) (In billion equipment
rubles) (1997 = 100)
----------------------------------------------------------------------------------------------------------------
1995........................ R1,540.5 102.6 R664.8 100.0 R267.0 128.5
1996........................ 2,145.7 99.1 950.1 97.9 376.0 105.3
1997........................ 2,478.6 100.0 1,124.0 100.9 408.8 100.0
1998........................ 2,741.1 95.1 1,339.9 95.5 407.1 88.0
1999........................ 4,757.2 100.2 2,191.7 82.7 670.4 92.7
2000........................ 7,063.4 108.6 2,911.4 91.0 1,165.2 108.8
2001 (April)................ ............ ............ 1,114.3 93.0 331.0 110.2
----------------------------------------------------------------------------------------------------------------
\1\ Series on consumption and investment differs slightly from SNA concept.
\2\ Nominal consumption deflated by CPI.
Source: Russian Economic Trends, February 2001. Original Source: CBR.
TABLE 8.--MONETARY AGGREGATES (END OF PERIOD)
----------------------------------------------------------------------------------------------------------------
Outstanding
Net Net M0--currency stock of
Monetary international domestic in M2 \3\ GKOs and
base (In reserves \1\ assets \2\ circulation (In OFZs
billion (In billion (In (In billion billion nominal (In
rubles) dollars) billion rubles) rubles) billion
rubles) rubles)
----------------------------------------------------------------------------------------------------------------
1995................................... R103.8 $7.7 R68.1 R80.8 R220.8 R73.7
1996................................... 130.9 1.7 123.0 103.8 288.3 237.1
1997................................... 164.5 4.0 142.1 130.4 374.1 384.9
1998................................... 210.4 -8.4 249.3 187.8 448.3 NA
1999................................... 324.3 -3.2 0.0 266.5 704.7 NA
2000................................... 519.6 16.0 88.6 419.3 1,144.3 184.2
2001, April............................ 531.1 20.4 NA 435.4 1,210.0 189.5
----------------------------------------------------------------------------------------------------------------
\1\ Since June 2000 net international reserves and net domestic assets are estimated by RET.
\2\ Net domestic assets of the monetary authorities equal monetary base minus net international reserves. Net
domestic assets are calculated using exchange rates of 27 rubles per dollar for 2000, 24.18 rubles per dollar
for 1999, 6.0 rubles per dollar for 1998, 5,560 rubles per dollar for 1997, 4,640 rubles per dollar for 1996,
and 3,550 rubles per dollar for 1995. In 1999 there were some changes in methodology for net domestic assets
and net international reserves data.
\3\ M2 includes currency in circulation, demand deposits, and time deposits (there is a break in the series from
December 1996, from then it includes only deposits at banks with active licenses).
NA--Not available.
Source: Russian Economic Trends, June 2001, original source: CBR.
TABLE 9.--INTEREST RATES (AVERAGE ANNUAL RATES) \1\
----------------------------------------------------------------------------------------------------------------
GKO
average RTS
CBR Lending Deposit Overnight secondary index,
refinance rate \2\ rate \2\ inter- market monthly
rate \1\ (percent) (percent) bank rate yield, all average
(percent) (percent) maturities (01.09.95
(percent) = 100)
----------------------------------------------------------------------------------------------------------------
1995......................................... 185 320.3 102.0 190.4 161.8 80.9
1996......................................... 110 146.8 55.1 47.6 85.8 160.3
1997......................................... 32 32.0 16.8 21.0 26.0 427.9
1998......................................... 60 41.5 17.1 50.6 NA 277.6
1999......................................... 57 40.1 13.7 14.8 NA 106.9
2000......................................... 32 24.2 6.5 7.1 12.7 199.5
2001, April.................................. 25 17.4 3.5 ......... .......... 166.0
----------------------------------------------------------------------------------------------------------------
\1\ Unweighted monthly average.
\2\ Data prior to January 1997 are not compatible with current methodology. From 1998 data on lending rate are
for commercial banks excluding Sberbank.
NA--Not available.
Source: Russian Economic Trends, June 2001, original source: CBR.
References
Aoki, Masahiko and Yujiro Hayami, eds. The Institutional
Foundations of East Asian Economic Development. (New
York: St. Martin's Press, Inc., 1998).
Aoki, Masahiko, Kevin Murdock, and Masahiro Okuno-Fujiwara
(1997) ``Beyond the East-Asian Miracle: Introducing the
Market-Enhancing View,'' in Aoki, Kim and Okuno-
Fujiwara. Asian Economic Development. New York: Oxford
University Press Inc., 1996.
Beck, Thorsten, Ross Levine and Norman Loayza (2000) ``Finance
and the Sources of Growth,'' Journal of Financial
Economics, 58: 261-3000.
Bekaert, Geert and Campbell R. Harvey (2001) ``Economic Growth
and Financial Liberalization,'' NBER Reporter, Spring
2001, 8-11.
Balino, Tomas J.T., David S. Hoelscher and Jakob Horder.
``Evolution of Monetary Policy Instruments in Russia,''
IMF Working Paper WP/97/180, December 1997.
Berthelemy, Jean Claude and Aristomene Varoudakis. (1996)
``Models of Financial Development and Growth: A Survey
of Recent Literature,'' in Hermes, Niels and Robert
Lensink (Eds.) Financial Development and Economic
Growth: Theory and Experiences from Developing
Countries (London: Routledge, 1996) pp. 161-191.
Borish, Michael S., Wei Ding and Michel Noel (1997) ``The
Evolution of the State-owned Banking Sector during
Transition in Central Europe,'' Europe-Asia Studies,
49,7:1187-1208.
Buch, Claudia M. (2000) ``Capital Market Integration in
Euroland: The Role of Banks.'' German Economic Review
1, 4:443-464.
------. (1998) ``Russian Monetary Policy-Assessing The Track
Record.'' Economic Systems, 22, 2: 105-145.
Buchs, Thierry (1999) ``Financial Crisis in the Russian
Federation,'' Economics of Transition, 7,3: 687-715.
Bulatov, Alexander (2001) ``Capital Formation in Modern
Russia,'' Working Paper.
Bulletin of Banking Statistics, various issues. The Central
Bank of the Russian Federation.
Commander, S. and Mumssen, C. (1998), ``Understanding Barter in
Russia,'' EBRD Working Paper No. 37, December 1998.
Demirguc-Kunt, and Ross Levine (1996) ``The Financial System
and Public Enterprise Reform: Concepts and Cases,'' in
Hermes, Niels and Robert Lensink (Eds.) Financial
Development and Economic Growth: Theory and Experiences
From Developing Countries (London: Routledge, 1996) pp.
161-191.
European Bank for Reconstruction and Development, (1998)
Transition Report 1998: Financial Sector in Transition
(London: EBRD).
Fries, Steven and Anita Taci (2001) ``Banking Reform and
Development in Transition Economies,'' Working Paper,
European Bank for Reconstruction and Development.
Gaddy, Clifford G. and Ickes, Barry W. (2001) ``The Virtual
Economy and Economic Recovery in Russia,'' Transition
Newsletter 12,1:15-20.
Garvey, G. (1977) Money, Financial Flows, and Credit in the
Soviet Union (Cambridge, MA: Ballinger Publishing,
1977).
Global Development Finance 1999, Volume I (Washington, DC. The
World Bank Group 1999).
Goldsmith, R.W. (1969), Financial Structure and Development,
(New Haven: Yale University Press, 1969).
Granville, Brigitte (2000) ``Moral Hazard and Burden Sharing:
The 1998 Russian Debacle as a Turning Point,'' in
Granville, Brigitte (Ed.) Essays in the World Economy
and its Financial System (London: The Royal Institute
of International Affairs), pp. 196-217.
Greenwood, J. and B. Jovanovic (1990), ``Financial Development,
Growth, and the Distribution of Income,'' Journal of
Political Economy, 98, pp. 1076-1077.
Harwood, Alison and Bruce L.R. Smith, Editors (1997)
Sequencing? Financial Strategies forDeveloping
Countries, (Washington, DC: Brookings Institution
Press, 1997).
Hellmann, Thomas, Kevin Murdock, and Joseph Stiglitz (1997)
``Financial Restraint: Toward a New Paradigm, The Role
of Government in East Asian Economic Development. New
York: Oxford University Press Inc., 1996. In Hermes,
Niels and Robert Lensink (Eds.) Financial Development
and Economic Growth: Theory and Experiences from
Developing Countries (London: Routledge, 1996) pp. 161-
191.
Hermes, Niels, and Robert Lensink, Eds. Financial Development
and Economic Growth: Theory and Experiences from
Developing Countries. New York: Routledge, 1996.
Iskyan, Kim and Andrey Besedin ``The Russian Banking Sector:
Countdown to Crisis,'' Renaissance Capital, Banking
Sector. October, 2000.
------ and ------. (2000) ``Russian Banking Sector: A Desert of
Reform--But Hope Persists,'' Renaissance Capital,
Banking Sector October, 2001.
Ivanova, Nadia and Koen Schoors (2000) ``The Central Bank
Policy: Challenges for 2000,'' Russian Economic Trends,
March 2000, pp. 3-9.
Jaramillo-Vallejo, Jaime (1994) ``Comment on `The Role of the
State in Financial Markets,' by Stiglitz,'' Proceedings
of the World Bank Annual Conference on Development
Economics (Washington, DC: International Bank for
Reconstruction and Development, 1994).
Koch, Elmar B. (1998) ``Banking Sector Reform in the Transition
Economies--A Central Banking Perspective,'' Economic
Survey of Europe, 1998, No. 2. pp. 67-81.
Levine, Ross (1997) ``Financial Development and Economic
Growth: Views and Agenda,'' Journal of Economic
Literature, 35: 688-726.
------. (1996) ``Financial Sector Policies: Analytical
Framework and Research Agenda,'' in Hermes, Neil and
Robert Lensink, Eds., Financial Development and
Economic Growth: Theory and Experiences from Developing
Countries (London: Routledge, 1996).
------, Norman Loayza and Thorsten Beck (2000) ``Financial
Intermediation and Growth: Causality and Causes,''
Journal of Monetary Economics 46:31-77.
------ and Sara Zervos (1998) ``Stock Markets, Banks, and
Economic Growth,'' American Economic Review 88,3: 537-
558.
Lin, Justin Yifu (1998) Transition to a Market-Oriented
Economy: China Versus Eastern Europe and Russia.
Orlowski, Lucjan (2001) ``Central European Economies in the
Aftermath of the Russian Payments Crisis,'' In
Orlowski, Lucjan (Ed.) Transition and Growth in Post
Communist Countries: The Ten-Year Experience
(Cheltenhum, UK: Edward Elgar, 2001), pp. 148-165.
McKinnon, Ronald I. (1994) ``Gradual versus Rapid
Liberalization in Socialist Economies: The Problem of
Macroeconomic Control,'' Proceedings of the World Bank
Annual Conference on Development Economics (Washington,
DC: International Bank for Reconstruction and
Development, 1994).
------. (1973), Money and Capital in Economic Development,
Washington DC: The Brookings Institution.
Mehrez, Gil and Daniel Kaufmann. (1999) ``Transparency,
Liberalization and Financial Crises,'' Working Paper,
The World Bank.
OECD Economic Surveys, Russian Federation 1997. (1997) (Paris:
Organization for Economic Cooperation and Development,
1997).
OECD Economic Surveys, Russian Federation, Economics. (2000)
(Paris: Organization for Economic Development, 2000).
Pagano, Marco (1993) ``Financial Markets and Growth: An
Overview,'' European Economic Review, 37: 613-622.
Pinto, Brian, Vladimir Drebentsov, and Alexander Morozov.
(2000) ``Dismantling Russia's Nonpayments System:
Creating Conditions for Growth,'' World Bank Technical
Paper N. 471. Europe and Central Asia Poverty Reduction
and Economic Management Series. (Washington, DC: World
Bank, 2000).
Russian Economic Trends, various issues.
``Russian Federation: Recent Economic Developments,'' 1999 IMF
Staff Country Report No. 99/100 (Washington, DC:
International Monetary Fund, 1999).
Schoors, Koen. (2001) ``The Credit Squeeze During Russia's
Early Transition: A Bank-Based View,'' Economics of
Transition 9, 1:205-228.
Schoors, Koen. ``The Mired Restructuring of Russia's Banking
System.'' Russian Economic Trends, 1999 #4: 35-45.
Schoors, Koen. ``Soviet Economic Disintegration Revisited: The
Collapse of the Soviet Payments System and It's Role in
the Economic Decline of the Former Soviet Republics.''
Working Paper.
Shleifer, Andrei and Robert W. Visny (1995) ``A Survey of
Corporate Governance,'' Discussion Paper #1741, Harvard
Institute of Economic Research.
Stiglitz, Joseph E. (1993) ``The Role of the State in Financial
markets,'' Proceedings of the World Bank Annual
Conference on Development Economics (Washington, DC:
International Bank for Reconstruction and Development,
1994).
------. (1994), ``The Role of the State in Financial Markets,''
World Bank Economic Review, 8, pp. 29-52.
Sussman, O. (1993), ``A Theory of Financial Development,'' in
A. Giovannini (ed.) Finance and Development: Issues and
Experience, Cambridge: Cambridge University Press, pp.
29-57.
Tompson, William (1997) ``Old Habits Die Hard: Fiscal
Imperatives, State Regulation and the Role of Russia's
Banks,'' Europe-Asia Studies, 49,7: 1159-1185.
Townsend, R.M. (1983), ``Financial Structure and Economic
Activity,'' 73, pp. 895-911.
Vishwanath, Tara and Daniel Kaufmann. ``Towards Transparency in
Finance and Governance,'' Working Paper, The World
Bank: Sept. 1999.
Warner, Andrew (1998) ``The Emerging Russian Banking System,''
Economics of Transition, 6,2: 333-347.
Westin, Peter, (1999) ``One Year After the Crisis: What went
Right?'' Russian Economic Trends, September, 1999 pp.
3-9.
``What Went Wrong,'' Russian Economic Trends, September 1998,
pp. 1-8.
Wright, Mike, Trevor Buck and Igor Filatotchev (1998) ``Bank
and Investment Fund Monitoring of Privatized Firms in
Russia,'' Economics of Transition 6,2: 361-387.
Woodruff, D. (1999) Money Unmade: Barter and the Fate of
Russian Capitalism (Ithaca: Cornell University Press,
1999).
Breakup of Monopolies: Energy, Transportation and Agriculture
THE RUSSIAN ENERGY SECTOR: CURRENT CONDITIONS AND LONG-TERM OUTLOOK
By Matthew J. Sagers \1\
----------
contents
Page
Summary.......................................................... 213
Introduction..................................................... 217
Oil Sector...................................................... 219
Crude oil production......................................... 219
Oil exports.................................................. 223
Refinery operations and oil consumption...................... 226
Gas Sector....................................................... 231
Gas production............................................... 231
Gas exports.................................................. 233
Gas consumption.............................................. 234
Coal Sector...................................................... 236
Electric Power Sector............................................ 239
Electricity production....................................... 239
Electricity consumption...................................... 239
Organizational structure..................................... 242
The Russian Federation's Primary Energy Balance in Long-Term
Perspective.................................................... 244
References....................................................... 252
Summary
Energy production holds a central place in the economic and
political life of the Russian Federation, as the country is a
leading energy-producing country, ranking first in the world in
gas production, third in oil production, fifth in hydro and
nuclear generation, and sixth in coal production. The reform
and re-emergence of this key part of the economy are integrally
linked to the country's overall economic transformation and
recovery, due not only to the energy sector's direct impact on
gross domestic product (GDP) and overall value-added in the
economy, but also to its importance in foreign exchange
earnings and Russia's fiscal stability. Similar to the overall
economy, however, Russia's energy sector initially experienced
a sizable decline coincident with the launch of Russia's
transition from a centrally planned to a market-type economy,
although after bottoming out in 1997, it has since been rising.
2000 was a very good year for Russian energy production, with
aggregate primary energy output rising by 2.1 percent; oil
production climbing by 6.0 percent; coal production up by 3.5
percent; and electricity generation increasing by 3.8 percent;
however, natural gas production declined, falling by 1.1
percent.
---------------------------------------------------------------------------
\1\ Matthew J. Sagers was Director of Energy Services at PlanEcon,
Inc. until October 2001 when he shifted positions to Director, Energy
Economics for Eurasia and Eastern Europe at Cambridge Energy Research
Associates. He holds a Ph.D. in Geography from The Ohio State
University.
---------------------------------------------------------------------------
Broadly speaking, energy sector reforms over the past
decade have typically lagged behind those in the economy at
large. But increasingly, the outcome of general economic
reforms will depend to a large extent upon the success of those
in the energy sector. If properly managed, Russia's energy
resources can help accelerate the economic reform process; if
poorly managed, it can easily hinder that process.
Russia's principal energy policy document is the Energy
Strategy of Russia to 2020, which was officially approved by
the government in November 2000.\2\ The Energy Strategy states
Russia's priorities for its long-term energy policy and the
mechanisms for its implementation. The Strategy is set within
the context of a resumption of economic growth in Russia, and
there is a broad concern that, given the poor state of the
Russian energy sector, it may not be able to provide for both
increasing energy demand within Russia as well as generate the
energy exports needed to sustain economic growth. Thus, the
Strategy continues to emphasize improvements in energy
efficiency and reform of energy pricing structures.
---------------------------------------------------------------------------
\2\ Government of the Russian Federation, 2000.
---------------------------------------------------------------------------
The Energy Strategy's projections for energy supply to 2020
are based on a major change in energy policy outlook. It
expresses major concern over the energy security risk from what
is deemed to be too high a dependence on natural gas. The
Strategy envisages a change in the fuel mix such that the share
of natural gas in total primary energy consumption decreases
from about 50 percent in the late 1990s to 42 to 45 percent in
2020. In its place, the share of coal is planned to increase
from 17 to 18 percent in the late 1990s to 22 percent in 2010
and to 21 to 23 percent in 2020. Nuclear energy is also slated
to increase, expanding to 6 percent in 2020 from current levels
of 5 percent, while oil's share in primary energy consumption
will remain practically unchanged. The Strategy projects
primary energy production in Russia in 2020 in a range of 1,525
to 1,740 million metric tons of coal-equivalent (mtce) (1,068
to 1,218 million metric tons of oil equivalent [mtoe]).\3\
---------------------------------------------------------------------------
\3\ The energy data presented in this report are given in the
metric units commonly used in Russia rather than standard U.S.
measures. An exception is Russian aggregate energy balances, which are
reported here in the usual international standard of million metric
tons of oil equivalent (mtoe); Russian aggregate balances are presented
in terms of million metric tons of coal equivalent (standard fuel or
mtce) while U.S. aggregate balances are often presented in quadrillion
British thermal units (btu) (or quads). The conversion coefficient to
mtoe from mtce is 0.7. Similarly, oil production is reported in million
metric tons (mmt) per year instead of million barrels of oil per day
(mbd), for which the conversion coefficient is 0.02 (i.e., 7.3 barrels
per metric ton of oil). Natural gas production is reported in billion
cubic meters (bcm) per year (at 20 deg.C and a pressure 760 mm of
mercury) instead of the U.S. measure (billions of cubic feet [bcf]
measured at 15 deg.C and 760 mm of mercury); the conversion coefficient
from bcm to bcf is 35.315.
---------------------------------------------------------------------------
However, PlanEcon's most recent energy forecast for
Russia\4\ takes an entirely different tack. It does not view
the large dependence on gas as a particular cause for concern;
instead, this is viewed as a natural consequence of Russia's
massive reserves of natural gas. The PlanEcon forecast projects
total output of primary energy in 2020 in Russia at a much
higher level than in the Strategy (1.446.3 mtoe, 46.7 percent
higher than the 2000 figure), combined with less energy
consumption, and therefore higher energy exports. In
particular, coal production is expected to resume its long-term
secular decline; oil output is expected to continue to recover
(albeit slowly); and gas production is anticipated to turn
around shortly, due both to improvements in the domestic
investment climate (reflecting higher prices and toughening
payment conditions) and to more buoyant demand from expanding
economic activity in the region. Thus, natural gas is expected
to garner a steadily rising share of Russia's energy production
over the next two decades, reaching 58.3 percent by 2020. Over
the entire 2000-2020 period, aggregate primary energy output in
Russia is projected to increase at an annual average rate of
about 1.9 percent in the PlanEcon forecast.
---------------------------------------------------------------------------
\4\ Sagers and Movit, 2001.
---------------------------------------------------------------------------
For the most part, this forecast presumes the
implementation of the bulk of the measures outlined in the
proposed Putin-Gref reform program. This program includes
general reliance on market forces and mobilizing private
investment, strong elements of commercialization and
marketization in the reform of the ``natural monopolies'' in
the gas and electric power sector, particularly in terms of
price reform, and the prospects of fairly strong economic
recovery.
In PlanEcon's energy forecast, Russian oil production is
projected to grow at an average rate of 1.4 percent per year
over the entire 20 year period to 2020, to reach 392.7 million
metric tons (mmt) in 2010, and then 423.2 mmt by 2020. The
official Russian Energy Strategy to 2020 envisions oil output
at 335 mmt in 2010 and 360 mmt in 2020, an average annual rate
of growth over the 20 year period of only 0.5 percent. The
Strategy's overall oil production forecast seems far too
conservative given what was achieved in 2000 (e.g., higher
investment, expanded drilling, more new fields) and the changes
in the investment climate that are likely to be realized over
the next few years.
Despite Gazprom's current worries over its ability to
produce gas in the future (a key feature of the Strategy's
outlook), in PlanEcon's view, the decline in Russia's gas
output is largely an organizational/institutional issue related
to the lack of incentives to invest rather than a question of
reserves or even the capacity to mobilize investment. Thus,
with the current direction of reforms in the gas sector (albeit
quite modest), production is likely to be able to turn around
relatively quickly to support rising gas demand. PlanEcon
projects Russian gas output in 2005 at 642.6 billion cubic
meters (bcm), expanding to 797.0 bcm in 2010 and 1,030 bcm in
2020; gas output growth is forecast to average 2.9 percent per
annum over the 20 year period.
In contrast, the Russian Energy Strategy, because of its
goal of diminishing the domestic economy's reliance on gas,
projects gas output at only 655 bcm in 2010 and a mere 700 bcm
in 2020. Furthermore, the expanded production is largely geared
toward higher exports, while domestic consumption is envisioned
as remaining relatively flat over the next two decades.
The Energy Strategy takes the view that energy consumption
in Russia has become too unbalanced in favor of gas. In
particular, the Strategy calls for greater use of coal and
nuclear power to meet the increased demand for electricity. The
Strategy projects a decline in the share of gas in Russian
primary energy consumption to about 40 percent by 2020, led by
a decline in the share of gas in fuels use by the electric
power sector from the current 62 percent to 51 percent by 2020.
Concomitantly, according to the Strategy, the share of coal in
primary energy consumption will rise slightly over the 20 year
period, to about 22.5 percent by 2020.
PlanEcon's view is that coal and nuclear are not only
intrinsically much more expensive than gas, but also come with
enormous environmental liabilities. Therefore with huge
reserves of relatively economic and clean natural gas, we
forecast that Russia's reliance on coal for power generation
and process heat is likely to wane further. The declining
relative importance of metallurgy in the country's aggregate
economic output should also serve to reduce the share of coal
in primary energy consumption as well. Thus, by 2010, PlanEcon
projects that the share of gas will be up to 57.1 percent, and
that it will rise further, to 60.6 percent, by the end of the
forecast horizon in 2020.
Russian coal production, in energy equivalent terms, is
projected to slowly decline over the forecast horizon in the
PlanEcon forecast (-0.5 percent per year on average). In
contrast, the Energy Strategy envisions coal production rising
to 320 mmt in 2010 and over 400 mmt in 2020. In the Strategy,
major technological breakthroughs are postulated in coal
production, processing and transportation that result in
declining costs, and therefore end-user prices, of coal. In
PlanEcon's view, such a prognosis seems highly unlikely,
particularly the geographic locus of both production
(increasingly concentrated in Siberia) and energy consumption
(in European Russia).
The projected level of primary electricity production in
the current PlanEcon forecast envisions the completion of only
six new (1,000 MW) nuclear units during the forecast period,
including four before 2005. The recently approved Energy
Strategy calls for the completion of five new units (which were
already well advanced in construction during the Soviet period)
before 2005, identifying these as the cheapest generating
capacity (in costs per MW or per kWh) that Russia could bring
on stream. PlanEcon concurs in this assessment mainly because
of the sizable investment that has already been sunk into these
units. However, PlanEcon does not consider the Strategy's
longer term plans for further nuclear expansion beyond these
initial units to be realistic.
On the demand side, PlanEcon projects that the growth in
primary energy consumption will lag well behind the trend in
aggregate economic activity. Primary energy consumption is
projected to rise at an average rate of only 1.7 percent per
year over the 20 year period.
The projection of primary energy production and consumption
provides a forecast for their difference, or net energy exports
for Russia. Russian net energy exports reached a trough in 1993
at 302.8 mtoe, a decline relative to 1990 of 24.4 percent. Net
energy exports are projected to rise to 565.3 mtoe in 2020, an
increase of 55.5 percent above the level of 2000. This is
projected to be comprised mainly of oil and gas, with gas
surpassing oil in importance in the export mix by 2015.
Introduction
This report provides an overview of Russia's energy sector,
particularly its current situation, and provides an assessment
of its long-term outlook. The Russian Federation is a leading
energy-producing country, ranking first in the world in gas
production, third in oil production, fifth in hydro and nuclear
generation, and sixth in coal production. In 2000, the Russian
Federation produced in aggregate 997.8 mtoe of primary energy
(i.e., energy not resulting from the transformation of other
sources).
Energy production holds a central place in the economic and
political life of the country. In the Soviet period, the energy
sector was developed to provide resources for heavy industry
and the defense-related sectors, as well as to earn foreign
exchange for financing vital imports. Under present conditions,
the emphasis has been shifted to the creation of an efficient
market economy, which in the long run will be able to provide a
higher level of well-being for the country's population.
The reform and re-emergence of this key part of the economy
are integrally linked to the country's overall economic
transformation and recovery, due not only to the energy
sector's direct impact on GDP and overall value-added in the
economy, but also to its importance in foreign exchange
earnings and Russia's fiscal stability.\5\ In 2000, the energy
sector accounted for perhaps 16 percent of value-added in the
economy (GDP) and about 45 to 48 percent of Federal budget
revenues as well as 54.0 percent of foreign exchange earnings
and 29.0 percent of the gross value of industrial output in the
country. In the current situation, raw materials extraction,
particularly of fuels, figures as a key engine of economic
growth, generating vital foreign-exchange earnings and
attracting foreign investment.
---------------------------------------------------------------------------
\5\ Sagers, Kyukov, and Shmat, 1995.
---------------------------------------------------------------------------
Similar to the overall economy, however, Russia's energy
sector initially experienced a sizable decline coincident with
the launch of Russia's transition from a centrally planned to a
market-type economy. By 1997, Russia's primary energy
production had plunged to a low point of 956.5 mtoe, a level
only 71.6 percent of the peak output achieved in 1988 (of
1,393.5 mtoe).
However, Russia's aggregate primary energy production has
risen for the third consecutive year in 2000 (+2.1 percent),
representing a significant recovery after declining by 26.8
percent in the period 1990-1997 during the initial period of
Russia's difficult transition from a planned economy. The
sizable increase registered in oil and coal production last
year was tempered by a slight downturn in gas production.
Broadly speaking, energy sector reforms over the past
decade have typically lagged behind those in the economy at
large. But increasingly, the outcome of general economic
reforms will depend to a large extent upon the success of those
in the energy sector. If properly managed, Russia's energy
resources can become a major contributor to the general welfare
and help accelerate the economic reform process; if poorly
managed, it can easily hinder that process.
Russia's principal energy policy document is the Energy
Strategy of Russia to 2020, which was officially approved by
the government in November 2000.\6\ The Energy Strategy states
Russia's priorities for its long-term energy policy and the
mechanisms for its implementation. This is the most recent in a
series of energy policy documents laying out a strategy for the
energy sector under the transition to a market economy,
including its immediate predecessor, the Basic Guidelines for
the Energy Policy of the Russian Federation to 2010 (approved
in October 1995). The new Energy Strategy specifies the main
trends, tasks, and objectives of energy policy to 2020. It
states that the highest priority is the most efficient use of
the country's fuel and energy resources so that the fuel and
energy sector can be harnessed to improve the living standards
of the population.
---------------------------------------------------------------------------
\6\ Government of the Russian Federation, 2000.
---------------------------------------------------------------------------
Similar to President Putin's overall economic strategy,
Russia's Energy Strategy is based on the assumption that to
continue social and economic reforms, to overcome the economic
crisis, and to initiate stable development, Russia needs a
strong state power. The document states that a strong state
power in Russia means a democratic, law-based and active
Federal state, and that the state's role is to become an
efficient coordinator of the economic and social reforms,
determine optimal purposes and parameters of national
development, and create conditions and mechanisms for their
implementation.
The social and economic part of the Energy Strategy has
been developed to address the following tasks: (1) to create
acceptable living standards for all categories of the
population; (2) to create a strong state and ensure human
sovereignty; (3) to create an efficient and competitive
economy; and (4) to ensure an honorable place for Russia in the
world community. The document posits that this will not be
possible unless long-term economic growth is ensured (minimum
of 5 to 6 percent per year). To ensure such growth rates, the
following should be implemented: (1) strengthening the economic
functions of the state; (2) normalization of monetary and
credit systems and restoration of budget equilibrium; (3) full-
scale capital renewal and rational structural policy; (4)
development and implementation of publicly acceptable and
socially responsible economic policies to ensure priority
growth of the real income of the population; and (5)
stimulation of the purchasing power of enterprises and
population for products, goods, and services, especially those
locally made.
The development of the fuel-energy complex should meet the
above stated parameters of the economic development of Russia.
Thus, the Energy Strategy determines the demand of the country
in fuel and energy required for economic growth, taking into
account the expected structural, technological and territorial
changes, and develops a forecast for the development of the
fuel-energy complex and its main industries.
Price and tax policy remains the linchpin of the mechanisms
driving the Energy Strategy forward. The goal is to skillfully
conduct price and tax policy in combination with anti-monopoly
measures to keep the fuel and energy sector a major source of
budget revenues and to alter the wasteful character of energy-
intensive branches of the Russian economy.
Oil Sector
crude oil production
The Russian Federation (Russia) remains one of the world's
major petroleum-producing countries, currently ranking third in
the world behind Saudi Arabia and the United States. Since
Russia also has accounted for about 90 percent (more or less)
of the former Soviet oil output for several decades, when the
former U.S.S.R. led the world in oil production between 1974
(when it surpassed the United States) and 1991, so did Russia.
Russia is also one of the leading oil exporters in the world
and ranks among the world leaders in oil reserves, with an even
greater oil potential.\7\
---------------------------------------------------------------------------
\7\ Sagers, 1996.
---------------------------------------------------------------------------
Russia's oil sector was particularly negatively affected by
the launch of Russia's economic reforms and initially
experienced a severe depression. By 1996, Russian crude oil
production had plunged to only 301.2 mmt, a level barely half
(52.9 percent) of the peak output achieved in 1987 (of 569.5
mmt).\8\ In 1997, production actually turned around slightly,
rising by 1.5 percent. Although the improving trend reversed in
1998 (a year of financial crisis in Russia), as output
experienced a slight dip, it then recovered again in 1999 and
surged in 2000. Perhaps not so surprisingly, annual trends in
Russia's GDP show a similar pattern.
---------------------------------------------------------------------------
\8\ The energy production data cited in this paper for Russia as a
whole or regional totals are usually taken from reports issued by the
Russian State Statistics Committee (Goskomstat Rossii), while
production data for individual companies or enterprises are taken from
published statistical reports issued by the Ministry of Energy (i.e.,
the monthly bulletins Statistika, Dokumenty, Fakty or Itogi raboty
Mintopenergo).
---------------------------------------------------------------------------
The current upward swing in Russian crude oil production
began in early 1999, and continued to gain momentum throughout
2000. Overall for the year as a whole, Russian oil production
was up by 6.0 percent, to 323.2 mmt.
A number of elements were involved in producing the
turnaround in Russian output, but given that the upturn began
in the second quarter of 1999, clearly the major underlying
driver for this recovery was the sharp rebound in international
oil prices that occurred after March 1999, when the
Organization of Petroleum Exporting Countries (OPEC) (in
collaboration with some major non-OPEC producers such as
Russia, Mexico, and Norway) agreed to reduce their oil output
and exports to international markets. The resulting rise in
world oil prices led to a substantial increase in revenues for
the Russian producers, and allowed them to increase capital
spending on upstream development. At the same time, production
costs (in dollar-equivalent) for the Russian producers were
reduced substantially in the wake of the sizable devaluation of
the ruble associated with Russia's financial crisis of 1998,
greatly increasing the sector's profit margins.
Another dimension of the turnaround reflects a number of
positive changes in the investment climate in the Russian oil
industry that enabled this supply/investment response by the
producers to take place. The combination of Vladimir Putin's
accession to President in March 2000 together with the
parliamentary elections of 1999 (substantially altering the
composition of the state Duma, Russia's lower house of
Parliament) have had a role in this. The policy directions
taken by the Putin government toward the oil sector build on
some important achievements that actually preceded Putin's
accession to power, such as the beginning of tax reform
(introduction of part 1 of the new Tax Code) and passage of the
Amending and Enabling Laws to the Law on Production-Sharing (in
early 1999).
The strong surge in Russian oil output has been largely
driven by high international oil prices that boosted the
revenues of the Russian producers, which they plowed back into
capital spending. Capital investment in the upstream oil sector
in 2000 more than doubled from the 1999 level in real terms
(+102.4 percent according to the Ministry of Energy), at 110.6
billion rubles ($3.9 billion at the average exchange rate for
the year).\9\ Of this, 34.5 billion rubles (31.2 percent of the
total) was spent on drilling activity. Development drilling in
the sector increased by a whopping 80.3 percent in 2000, to
8,286,000 meters, and the number of new wells completed
increased by 56.3 percent, to 3,405.
---------------------------------------------------------------------------
\9\ The exchange rate does not reflect the true purchasing power of
ruble expenditures in the upstream oil sector vis-a-vis the dollar.
Real investment activity is much higher than indicated by the
conversion of ruble outlays into dollars at the average exchange rate.
---------------------------------------------------------------------------
The largest contribution to the higher production level in
2000 continued to come from well work-overs, which reduced the
number of idle wells to 31,940 by the end of the year (i.e., to
only 22.5 percent of the total well stock compared to 24.2
percent at the end of 1999). This combination of new wells and
restarted old wells added over 19 mmt to annual production
capacity in 2000.
``New oil,'' however, is also becoming noticeable again
after virtually disappearing in the mid-1990s. A total of 43
new fields were brought on stream during 2000, the largest
annual number in almost two decades. These new fields
contributed relatively little to aggregate production during
the year (a mere 546,000 tons), but the contribution of all so-
called ``new fields'' (those that have been in production less
than 5 years) \10\ was a more substantial 16.1 mmt in 2000, or
5.0 percent of national production last year.
---------------------------------------------------------------------------
\10\ Similarly, a total of 36 new fields produced their first oil
in 1999. This included 18 new fields by the Russian oil majors, 15 by
independent Russian companies, and 3 by foreign producers. In 1998, a
total of 20 new small fields were brought on stream.
---------------------------------------------------------------------------
In 2000, a total of 132 enterprises (companies) were
producing oil in Russia according to Goskomstat; however, the
bulk of these (110) are small, producing less than 1 mmt
annually, and only 12 companies produce more than 10 mmt per
year. Although the proportion is declining over time, the bulk
of Russia's oil production is still produced by the large oil
enterprises that previously were part of the former U.S.S.R.
Ministry of Oil (95.5 percent in 1992 and 91.6 percent in
2000).
Gazprom remains the largest single producer outside these
oil enterprises,\11\ but as production by joint ventures (JV)
with ``foreign'' companies has surged, these have now become
the largest component of production outside the traditional oil
enterprises. At the same time, there has been a proliferation
of other new types of oil producers, including Russian
``independent'' (or private) companies and geological
exploration enterprises.
---------------------------------------------------------------------------
\11\ Gazprom's contribution to Russian petroleum output amounted to
some 10.2 mmt in 1992 and by 2000 had almost returned to this level
(10.0 mmt); i.e., Gazprom has produced 2.6 to 3.2 percent of the
Russian total during the last decade. Much of this would be gas
condensate, although Gazprom does produce some oil as well. Total
output of gas condensate (at least that proportion of gas liquids
output included in the crude petroleum production statistics; i.e.,
``lease'' condensate as opposed to ``plant'' condensate) in Russia was
9.7 mmt in 1999 and 10.4 mmt in 2000, or about 3.2 percent of Russia's
total annual petroleum (crude oil plus condensate) output.
---------------------------------------------------------------------------
Among the various groups of producers, aggregate production
rose substantially (+8.1 percent) for the largest and more
important producing group, the large Russian vertically
integrated companies (VICs); \12\ their combined aggregate
output amounted to 296.3 mmt in 2000 (or 91.7 percent of total
national output). Among the leaders in expanding production in
2000 were: Rosneft (+6.3 percent); Surgutneftegaz (+14.2
percent); Yukos (+11.4 percent); and Tyumen Oil Company (TNK),
whose output was up by 23.4 percent.\13\ Russia's largest oil
producer was Lukoil, at 62.2 mmt, with its acquisition of Komi-
TEK. The second-largest Russian producer is Yukos, at 49.5 mmt
(following the consolidation of the Eastern Oil Company [VNK]
into Yukos).
---------------------------------------------------------------------------
\12\ The Russian oil industry was reorganized in the 1990s into a
few large VICs which combine geological exploration, crude production,
oil refining, and distribution and retailing of refined products in one
integrated structure. These companies have also been largely
privatized, although the share of federal government ownership in some
of them remains quite sizable, and republic-level administrations also
own sizable stakes in some of the ``regional'' VICs. Current plans call
for the eventual sale of most of the remaining shares still held at the
Federal level to raise funds for the budget. The interest in
establishing a state-owned ``national'' oil company, championed
periodically since 1995, has largely waned since the election of
President Vladimir Putin in March 2000. Currently, the Russian oil
sector includes 11 large VICs, which collectively accounted for 88.2
percent of national crude production and 78.9 percent of total refinery
throughput in 2000. The oil pipeline systems are not part of this
``privatized'' structure, but so far remain largely state-owned (some
shares have been distributed to employees and some plans for further
privatization have been mooted); they function as service-for-fee
carriers, serving all the various companies. The pipelines are
administered by two entities. One, Transneft, operates the crude
pipeline network, while the other, Transnefteprodukt, operates the
product pipeline network.
\13\ The TNK figure includes the takeover of Sidanko's
Kondpetroleum and Chernogorneft (now TNK Nyagan and TNK Nizhnevartovsk,
respectively).
---------------------------------------------------------------------------
The output of the smaller, ``independent'' producers, which
until 2000 had generally been far more dynamic than the large
VICs, included 10.826 mmt produced by small Russian companies
(+22.2 percent compared to last year), as well as 19.105 mmt
officially credited to the foreign joint ventures (+4.6 percent
versus last year), and 2.188 mmt produced by the Khar'yaga and
Sakhalin-2 PSAs (production-sharing agreements). Thus,
``foreign'' companies (the JVs and PSAs together) accounted for
21.3 mmt in 2000, or 6.6 percent of Russia's total oil
production last year.\14\
---------------------------------------------------------------------------
\14\ The level of foreign involvement in JVs must be viewed with
some caution. Many allegedly ``foreign'' partners are in fact Russian-
owned (although foreign-registered) companies, as they are not clearly
identifiable international oil companies. The real role of Russian
companies is likely to grow further, as some of them are buying out the
original foreign JV partners.
---------------------------------------------------------------------------
Although the immediate situation appears quite positive,
many of the underlying fundamentals in the oil sector remain
quite poor; the transition to a market-type economy has proven
to be very difficult. Many of the economic and fiscal policies
implemented tended to be highly unfavorable for the energy
sector, particularly in the initial phases of the reform
process, although policy has tended to become more rational
over time. The fiscal burden on upstream operations was by and
large based on revenues and not on net profit--and thus
penalized exploration and production in high-cost environments
(particularly applicable in the period previous to 1998 with
the strong ruble). Also, domestic energy prices initially
remained controlled while those for most other goods were
liberalized (causing the oil sector's production costs to
skyrocket with the high rate of inflation), taxes have remained
oriented to budget (as opposed to investor) needs, the
regulatory regimes need to be streamlined and clarified, and
access to export markets continues to be restricted.
At the same time, Russia's oil industry has undergone the
most liberalization and commercialization within the entire
energy sector. The breakdown of the old central command
structures and de-monopolization under privatization, coupled
with the proliferation of new producing entities, the formation
of a quasi-market for oil domestically, the liberalization of
prices, and the (partial) liberalization of exports, point to
the tremendous changes that have occurred within this sector
since 1991. The Russian Government has made considerable
progress in clarifying the sector's administrative structure,
establishing the level of competence of different levels of
authority (Federal, regional, and local), and putting the
sector on a firmer legal foundation. Nonetheless, all of these
issues remain unsettled and much more still needs to be done.
In fact, there was noticeable back-sliding on reform in the
period after 1998, particularly in the area of exports, with
administrative limitations again being imposed on crude and
product exports.
While the fundamental problem in the oil industry is an
economic one, partly caused by the ongoing economic transition,
objective technical factors are also important.\15\ Russia's
prolific West Siberian oil province is very mature,\16\
although its depletion can be attenuated by proper reservoir
management and development of small and difficult fields; at
the same time, a new oil basin with reserves similar in size to
West Siberia's is not on the horizon. Thus, the key factor
determining Russia's level of oil production in the future
essentially hinges on just how long West Siberia's current
plateau of 200 to 220 mmt per year can be maintained, while new
reserves are put into production in less mature provinces such
as Timan-Pechora and Sakhalin.\17\ Longer term, new provinces
such as East Siberia, the Pechora Sea, or the Russian sector of
the Caspian, are likely to make sizeable contributions to the
country's overall production profile.
---------------------------------------------------------------------------
\15\ ``Osnovniye,'' 2000.
\16\ West Siberia first faced a ``production crisis'' in 1983-1985.
The downward trend then was reversed (albeit for only a couple of
years) through a massive injection of financial and material resources.
But after reaching an all-time peak of 418.6 mmt in 1988, West Siberian
production then plunged to less than half this level by 1996.
\17\ Sagers, 1996.
---------------------------------------------------------------------------
Production costs and international oil prices are crucial
considerations in the prospects for maintaining West Siberia's
current production plateau. But it should be technically
possible to attenuate West Siberia's maturation with the help
of modern reservoir management and modern tertiary recovery
techniques to maximize reservoir drainage, and formation and
well treatment in less permeable reservoirs. Several alliances
have been formed to this effect between Russian companies and
Western service companies like Halliburton and Schlumberger,
and these are beginning to show some positive results.\18\
---------------------------------------------------------------------------
\18\ TNK signed an exclusive deal with U.S. Halliburton to provide
sophisticated oilfield services for its fields in 1999, while Yukos has
a similar arrangement with France's Schlumberger dating from 1998.
According to McKinsey Report: Russian Oil (February 2001), the actual
total factor productivity (the combined measure of labor and capital
productivity) of the Russian oil industry is only about 30 percent of
international levels. The main reasons for the productivity gap at the
operational level are lower oil recovery (due mostly to less hydro-
fracturing and poor reservoir management techniques), and inefficient
drilling because of low quality drill bits, cleaning muds, and cement
being used.
---------------------------------------------------------------------------
Water-flooding, which has been employed in West Siberia
since the very beginning to quickly boost output to maximum
levels, has resulted in an increasingly large water cut. By
1990, the water cut was 76 percent for Russia as a whole, and
72 percent for the West Siberian fields; the average had been
only 50 percent as recently as 1976. Currently, water
encroachment in Russia is 70 to 90 percent at nearly all of the
large fields. Injection of (associated) gas (which also has the
advantage of reducing gas flaring) has been slow to be
introduced, still accounting for only 1.9 percent of Russian
oil production in 1999. Conversely, the share of oil produced
from free-flowing wells dropped from 51.8 percent in 1970 to
only 12.0 percent by 1990, and by 1999 was down to 8.4 percent.
oil exports
Russia is one of the largest oil exporters in the world,
currently ranking second behind Saudi Arabia. In the peak year
of 1988, Russia exported 256.5 mmt of crude beyond its borders,
of which 132.1 mmt (51.5 percent) went to the other former
Soviet republics. However, the amount of crude oil Russia has
shipped to the rest of the former Soviet Union has declined
dramatically since the break-up of the U.S.S.R. in 1991: in
2000, Russia's crude oil exports to all countries amounted to
144.5 mmt, but only 21.2 mmt (14.7 percent) was exported to the
former Soviet republics (Table 1).\19\ In contrast, Russia's
crude exports to countries outside the former Soviet Union were
up by 11.6 percent in 2000, to 125.3 mmt, actually surpassing
the previous peak of 124.4 mmt achieved in 1988.\20\
---------------------------------------------------------------------------
\19\ This has been due to a combination of factors, including a
decline in demand associated with the large contraction in economic
activity, the financial difficulties of the refining sector in these
republics, and the breakdown in inter-republican trade and payments
mechanisms. In particular, Russia rapidly increased the prices being
charged in inter-republican trade toward those prevailing on the world
market after 1992, causing the importer-republics built up large
payments arrears, and as a result, led Russia to withhold supplies and
divert them to hard currency markets. Because of this leverage, non-
payments by the importing republics for oil have remained relatively
modest in comparison with natural gas or electricity.
\20\ In aggregate, Russia's crude exports in 2000 generated $25.319
billion according to Goskomstat, or 178.8 percent more than in 1999.
The average export price rose from $105.3 per ton in 1999 to $175.2 per
ton in 2000. Exports to the non-Commonwealth of Independent States
(CIS) generated $23.0 billion (an average of $179.9 per ton), while CIS
exports generated $2.4 billion (an average of $139.7 per ton).
---------------------------------------------------------------------------
Russia's international exports of crude oil had contracted
sharply between 1988 and 1991 under the old Soviet Government,
falling by 45.4 percent, from 124.4 mmt to only 56.5 mmt in
1991. The Soviet Government had forced virtually the entire
drop in domestic crude oil production into a reduction in
exports. Since 1992, Russia's international exports have
continued to rise with the marketization of the sector despite
a host of administrative impediments and limits on exports.
The East European countries (then including Eastern
Germany) were traditionally the largest destination for Russian
crude. The region as currently defined (i.e., without Eastern
Germany) saw its Russian crude imports contract to as little as
12.9 mmt in 1994, representing 14.5 percent of Russian
international exports. This amount has since tripled, reaching
36.3 mmt in 2000 (29.0 percent of Russia's non-former Soviet
Union exports).
TABLE 1.--OIL BALANCE FOR THE RUSSIAN FEDERATION
[In million metric tons]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Crude oil production................................. 516.2 462.3 399.3 353.9 317.8 306.8 301.2 305.6 303.3 305.2 323.2
Refinery throughput.................................. 295.5 286.5 257.2 220.1 180.6 179.0 173.8 176.3 162.9 170.1 174.1
Direct use of crude/residual \1\..................... 10.5 20.0 11.1 16.7 15.0 12.4 6.3 8.6 9.7 6.1 10.9
Refined products consumption \2\..................... 250.6 228.7 216.5 176.6 138.7 137.9 121.2 121.6 113.3 120.3 112.6
Oil exports
Crude oil........................................ 219.9 173.9 141.7 127.6 126.8 122.3 125.6 126.8 137.1 134.5 144.5
Foreign...................................... 99.3 56.5 66.2 79.8 89.0 91.3 103.0 105.6 111.9 112.3 123.4
Other republics.............................. 120.6 117.4 75.5 47.8 37.8 31.0 22.6 21.3 25.2 22.2 21.2
Refined products................................. 50.7 63.6 43.0 44.8 43.4 45.4 56.6 60.6 53.8 50.8 61.9
Foreign...................................... 37.9 41.6 25.3 34.3 38.0 42.1 55.0 58.4 51.2 47.8 58.4
Other republics.............................. 12.8 22.0 17.6 10.5 5.4 3.3 1.6 2.2 2.6 3.0 3.5
Oil imports
Crude oil........................................ 18.8 18.1 10.7 10.5 4.6 6.9 4.5 6.1 6.4 5.6 6.3
Foreign...................................... -- -- -- -- -- -- -- -- -- -- --
Other republics.............................. 18.8 18.1 10.7 10.5 4.6 6.9 4.5 6.1 6.4 5.6 6.3
Refined products................................. 5.8 5.8 2.3 1.3 1.5 4.3 4.0 5.9 4.1 0.9 0.4
Foreign...................................... 0.2 0.7 0.9 0.2 0.4 1.4 1.8 3.5 2.4 0.4 0.1
Other republics.............................. 5.6 5.1 1.4 1.1 1.1 2.9 2.3 2.3 1.8 0.5 0.3
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Balancing item.
\2\ Apparent consumption (production minus exports plus imports).
Earlier, Eastern Europe's oil demand was declining, and
they also sought to diversify their imports. More recently, oil
demand has recovered, and these countries have found Russia to
be an economical source of imports due to existing delivery
infrastructure. The bulk of this oil arrives via the Druzhba
Pipeline, which delivers crude to the Czech Republic, Slovakia,
Hungary, Poland, and Eastern Germany, and occasionally, the
former Yugoslav republics.
The other major destination for Russia's crude is Western
Europe. These countries took 54.3 mmt of crude from Russia in
2000. The amount of Russian oil going to Western Europe has
declined since peaking at 70.5 mmt (79.2 percent of Russia's
total international exports) in 1994. Like Mexico and the North
Sea, Russia/former Soviet Union represents a major source of
non-OPEC oil. The presence of Russian/former Soviet Union oil
has been a welcome addition to the West European market,
helping to diversify sources from too heavy a reliance on the
Gulf region and OPEC. Most of the West European countries
purchase oil from the Russia, although typically it represents
less than 10 percent of total oil supplies for any individual
country.
Russia's non-former Soviet Union crude exports in 2000
included 112.4 mmt shipped out through the main Russian
pipeline system operated by Transneft, plus another 12.9 mmt
(10.3 percent of the total) exported via other routes,
including railroad shipments and through other minor ports. The
share of exports carried by these minor routes continues to
ratchet upward, probably because the main means used by the
Russian Government to limit exports is control over Transneft's
pumping schedule. In 1999, Russia's exports outside the
Transneft system amounted to 8.6 mmt (7.7 percent of the
total).
According to the Ministry of Energy, in 2000, Transneft
moved a total of 314.8 mmt of crude in its pipeline system (5.1
percent more than in 1999). It delivered 312.5 mmt, of which
160.9 mmt was to Russian refineries, and 124.4 mmt of crude was
shipped to export destinations outside the territory of the
former Soviet Union (39.8 percent of the total shipped). In
turn, this included 112.4 mmt of Russian crude and 11.7 mmt of
transit crude (from Kazakhstan, Turkmenistan, and Azerbaijan),
and another 0.35 mmt from Belarus that joined the pipeline
system there on its way to Poland.
Despite the fact that total flows in the Russian oil
pipeline system are now much less than before because of the
precipitous decline in Russia's crude oil production (Russian
pipeline shipments declined by 43.3 percent between 1990 and
2000, from 497.9 mmt to 294.6 mmt according to Goskomstat
figures), constraints in Russia's crude oil pipelines have been
a bottleneck since mid-1993.
The key constraints are at the export ports and the
pipelines supplying them, particularly at Novorossiysk,
Russia's major oil export port on the Black Sea. The reason for
the emerging export constraints is that previously a large
portion of the total crude flow was dispersed to refineries
across the former Soviet Union, and a substantial amount was
delivered to Eastern Europe via the Druzhba Pipeline. But with
the dramatic decline in oil demand in the former Soviet Union
(and to a lesser extent in Eastern Europe), a much larger
proportion of the total flow has become focused upon the small
number of export ports that dispatch crude to other
international markets. The former Soviet Union pipeline system
was designed mainly to move crude to internal consuming
centers, while international exports were of much less
importance. As a result, much of the core system in the
interior of Russia now has huge redundant capacity.
Of Russia's own export shipments handled by Transneft in
2000, 53.2 percent (59.8 mmt) moved out via marine ports and
46.8 percent (52.6 mmt) moved out via the Druzhba Pipeline to
Eastern Europe. Russia has made more of the marine terminal
space, especially at Novorossiysk and Odessa, available for
Caspian transit crude. The major marine terminals handled a
total of 70.5 mmt in 2000, representing 56.7 percent of the
overall total, while 53.9 mmt (43.3 percent) went out via the
Druzhba Pipeline (Table 2). Compared to 1999, Druzhba shipments
increased by only 1.6 percent while marine shipments increased
by 13.6 percent. The large growth in marine shipments was
mainly due to the new Butinge terminal in Lithuania, although
all the other major terminals also handled more crude in 2000.
The addition of the new Butinge terminal in Lithuania in
mid-1999 added another 8 mmt of annual marine export capacity
to the former Soviet Union pipeline system. Even so,
collectively the overall capacity utilization at the major
marine terminals was still almost 90 percent in 2000 (Table 2).
There is some remaining spare capacity at Ventspils and
Butinge. But substantial new capacity is expected to be
available shortly, with both the Primorsk (Baltic Pipeline) and
the Yuzhnaya Ozereyka (Caspian Pipeline Consortium) terminals
slated for completion in 2001.
The Druzhba Pipeline's aggregate capacity utilization is
also quite high, increasing to 90 percent in 2000 (Table 2).
However, the southern branch of the Druzhba (to the Czech
Republic, Hungary, and Slovakia) remains underutilized, while
the northern branch (to Poland and Germany) is now full. The
increased flow in 2000 was concentrated entirely in the
northern branch of the Druzhba that serves Poland and Eastern
Germany.
refinery operations and oil consumption
The Russian Federation has a large refining sector,
comprising 28 plants considered ``full fledged'' refineries. In
addition to these petroleum refineries, Russia also has about a
dozen other oil processing plants, including lube plants,
oilfield topping plants, and specialized gas condensate
processing facilities.
The 28 main refineries had a total primary distillation
capacity that the Ministry of Energy reported as 296 mmt at the
beginning of 1999. Collectively, these facilities therefore
operated at a capacity of only 58 percent in 1999 compared with
87.5 percent as recently as 1990, even though almost 45 mmt of
distillation capacity has been officially liquidated since
1990. Utilization varies considerably from refinery to
refinery. Clearly, with so much excess capacity and the
likelihood that refinery runs are going to fall even lower and
remain there for some time, a massive rationalization of
refining capacity is in store. Much of the redundant refining
capacity is concentrated in the Volga and Urals regions.
TABLE 2.--FORMER SOVIET UNION CRUDE OIL EXPORTS BY EXPORT POINT (TRANSNEFT SYSTEM)
[In thousand tons]
----------------------------------------------------------------------------------------------------------------
Capacity
Export point 1994 1995 1996 1997 1998 1999 2000 (mmt/yr)
----------------------------------------------------------------------------------------------------------------
Total (sum).................... 94,343 95,805 104,836 105,807 115,018 115,099 124,386
Ports (sum).................... 53,451 54,084 60,851 60,633 63,580 62,058 70,473
Capacity utilization (in 73.2 74.1 81.1 80.8 84.8 78.6 89.2 73
percent)......................
Russian oil (reported).... 50,474 51,439 57,056 58,281 58,762 53,735 59,822
(Difference).............. 2,977 2,645 3,794 2,352 4,819 8,323 10,651
Novorossiysk.............. 30,003 29,018 31,706 31,090 32,870 33,066 37,363
Capacity utilization (in 88.2 85.3 93.3 91.4 96.7 97.3 95.8 34
percent)..................
Russian crude......... 28,903 28,111 29,989 30,258 29,893 30,021 34,906
Kazakh crude.......... 1,100 906 1717 712 199 436 1,699
Azerbaijan crude...... -- -- -- 120 2,778 1,877 561
Turkmen crude......... -- -- -- -- -- 731 198
Ventspils................. 11,609 12,103 14,355 14,579 14,549 13,029 13,620
Capacity utilization (in 64.5 67.2 79.8 81.0 80.8 72.4 75.7 18
percent)..................
Russian crude......... 10,952 11,520 14,258 14,574 14,549 13,029 13,620
Kazakh crude.......... 657 583 97 4 0 0 0
Tuapse.................... 4,407 4,431 4,652 4,778 6,107 5,149 5,699
Capacity utilization (in 88.1 88.6 93.0 95.6 122.1 103.0 114.0 5
percent)..................
Russian crude......... 4,407 4,431 4,642 4,758 6,107 5,149 5,699
Kazakh crude.......... 0 0 10 20 0 0 0
Odessa.................... 7,432 8,532 10,138 10,186 10,054 10,265 10,724
Capacity utilization (in 92.9 106.7 101.4 101.9 100.5 102.7 107.2 8
percent)..................
Russian crude......... 6,232 7,377 8,167 8,691 8,212 5,536 2,530
Kazakh crude.......... 1,200 1156 1971 1496 1,842 4,729 8,194
Butinge................... -- -- -- -- -- 550 3,067
Capacity utilization (in -- -- -- -- -- 13.8 38.3 8
percent)..................
Russian crude......... -- -- -- -- -- 550 3,067
Druzhba Pipeline (sum)......... 40,892 41,722 43,985 45,174 51,438 53,040 53,913
Capacity utilization (in 68.2 69.5 73.3 75.3 85.7 88.4 89.9 60
percent)..................
Russian oil (reported).... 38,808 39,706 41,381 42,879 49,117 49,927 52,573
(Difference).............. 2,084 2,016 2,604 2,295 2,320 3,113 1,341
Druzhba Northern Route: 68.9 68.5 78.6 79.7 95.9 104.5 110.3 35
Capacity utilization (in
percent)......................
Germany................... 17,276 15,873 17,670 16,766 18,898 20,024 20,403
Russian crude......... 16,276 14,957 16,126 15,664 18,457 19,052 19,533
To refineries..... ........ ........ 12,837 12,938 18,457 19,052 19,533
To Rostock ........ ........ 3,288 2,726 0 0 0
(export)..........
Kazakh crude.......... 1,000 917 1544 1103 441 972 871
Poland.................... 6,850 8,108 9,857 11,115 14,658 16,558 18,195
Russian crude 6,066 7,339 9,171 10,225 13,551 14,416 17,845
(shipments)...........
Kazakh crude.......... 500 519 385 490 725 1,791 0
Belarussian crude..... 284 250 300 400 382 350 350
To refineries..... ........ ........ ........ 9,921 13,273 14,408 16,217
To Gdansk (export) ........ ........ ........ 1,194 1,385 2,150 1,978
Druzhba Southern Route: 67.1 71.0 65.8 69.2 71.5 65.8 61.3 25
Capacity utilization (in
percent)......................
Czech Republic............ 6,506 7,117 5,942 5,785 5,594 4,822 3,714
Russian crude......... 6,306 6,928 5,692 5,785 5,265 4,822 3,714
Kazakh crude.......... 200 189 250 0 329 0 0
Slovakia.................. 4,971 5,058 5,303 5,335 5,711 5,555 5,506
Russian crude......... 4,871 4,967 5,203 5,151 5,267 5,555 5,386
Kazakh crude.......... 100 92 100 184 444 0 120
Hungary................... 5,289 5,565 5,213 6,172 6,577 6,081 6,095
Russian crude......... 5,289 5,515 5,188 6,055 6,577 6,081 6,095
Kazakh crude.......... 0 50 25 118 0 0 0
--------------------------------------------------------------------------------
Total Kazakh 4,100 3,828 6,001 4,122 3,980 7,928 10,883
shipments.....
Total Kazakh 4,070 3,813 6,001 4,142 3,980 8,072 11,610
shipments
(reported)....
----------------------------------------------------------------------------------------------------------------
Note: Kazakh amounts by individual exit point are only approximate.
Russia's refineries are not very sophisticated, with
limited secondary processing capacity. Petroleum products are
obtained mainly via straight-run distillation processes
(primary refining), the method with the simplest technology and
lowest costs; there is relatively little use of cracking or
other secondary refining processes.
Reflecting the lack of sophistication of the sector, the
depth of refining is quite low. This indicator, defined as the
share of premium products (essentially light products and
lubes) in the output mix, was a mere 64.3 percent in 1998 for
Russian refining overall compared with over 85 percent in
advanced Western countries. Furthermore, this indicator
deteriorated during the 1990s, falling from 65.0 percent in
1991, although there has been some improvement since 1994 (when
it dropped to 61.3 percent).
The Energy Strategy to 2020 envisages substantial
development of the oil refining industry through the
construction and modernization of capacity, particularly the
deepening of the refining process. Such reconstruction should
also improve environmental conditions by reducing emissions as
well as reducing the energy and material costs of production.
The modernization is also aimed at improving the refining
industry so that the quality of its products can be brought up
to world standards. Thus, the Energy Strategy calls for the
depth of refining to be increased to 75 percent by 2010 and 85
percent by 2020. This is to be accomplished by a broad program
of refinery modernization and the installation of additional
secondary processing capacity, particularly new cracking
facilities.
The last decade saw a sharp plunge in refinery operations
associated with the ongoing economic transition. Although
Russia's refinery runs had been declining since 1980 (peak
throughput in Russia was in 1980 at 325.2 mmt), during the
1980s throughput only slowly drifted down. But beginning in
1992, with the launch of economic reforms, crude runs by
Russian refineries began to contract sharply. The decline
lessened somewhat in 1995-1997, due partly to stabilization in
internal refined product consumption, but mostly was due to a
deliberate policy of fostering refined product exports. In
1998, a year of economic crisis, throughput dropped rather
sharply again, to 162.9 mmt; at that point, throughput was down
to only 54.7 percent of what it was in 1990.
The government had tried repeatedly during the 1990s to
hold refinery throughput at much higher levels (in an effort to
``fix'' consumption of refined products at existing levels and
``stabilize'' the economy), but to little avail; it also was
usually counterproductive. This was due to reasons largely
having to due with the refineries' inability to pay much higher
prices for crude and the financial insolvency of their
customers. But this policy was more ``successful'' in 1999-2000
as the government reined in crude exports and forced higher
deliveries to the refineries. This was through a mechanism that
required specified deliveries to domestic consumers to be met
before producing companies were allowed access to Transneft's
pipeline system for exports. As a result, refinery throughput
rose in 1999-2000, reaching 170.1 mmt in 1999 and 174.1 mmt in
2000.
Longer term, the Energy Strategy envisages growth in
refinery throughput to 220 to 225 mmt by 2015-2020. This volume
is projected as providing 130 mmt of light products (gasoline,
diesel, and kerosene) with the greater depth of refining
anticipated. At the same time, production of mazut is
anticipated to drop from 53 mmt currently to 30 mmt.
While Russian refinery runs would normally be expected to
rebound with the turnaround in product consumption as the
overall economy re-expands, throughput of 220 to 225 mmt is
probably economically unwarranted. First, aggregate product
demand is currently less than 120 mmt, and is likely to grow
fairly slowly over the coming two decades. Second, increased
depth of refining should limit the need for higher throughput
to provide sufficient light products. Third, the level of
refined product exports, now running at 50 to 60 mmt annually,
is likely to contract substantially as higher domestic crude
acquisition prices and higher railroad transport tariffs erode
profit margins on product exports. This is likely to result in
throughput levels somewhat lower than now even by 2020.
The Russian Federation is a large consumer of refined
products. Aggregate apparent products consumption (throughput
minus product exports plus product imports) peaked in 1987, at
257.0 mmt. Following the launch of Russia's economic reform
program in January 1992, bringing with it large declines in
overall economic activity (GDP, industrial production, and
transportation) combined with increases in (relative) fuel
prices, consumption of refined products in Russia fell sharply.
Overall consumption of refined products had contracted by 55.2
percent by 1998, reaching 113.3 mmt. In 1999, however, buoyed
by a stabilizing economy and administrative limits on product
exports, apparent consumption of refined products increased by
6.7 percent, to 120.9 mmt. In 2000, despite both continued
limits on product exports and brisk economic growth, aggregate
consumption of refined products dropped again, by 6.5 percent
to 112.5 mmt. Russian statistics (from Goskomstat) report that
gasoline consumption (sales/deliveries to the domestic market)
in 2000 dropped by 4.8 percent, to 23.2 mmt; diesel fuel
consumption increased by 5.1 percent, to 49.2 mmt; and residual
fuel oil (mazut) consumption fell by 3.8 percent, to 41.9 mmt.
With the transition to a market economy, oil ``demand'' is
undergoing structural changes, both by sector and by product.
The composition of aggregate economic output is shifting away
from heavy industry toward services. An emerging middle class
is leading to sharp increases in private car ownership and use.
Thus, the importance of traditional consumers, such as industry
and electric power, in overall oil consumption is declining,
while the relatively limited development of trucking and
private automobiles is being redressed. As a result, changes in
demand clearly favor lighter products at the expense of
residual fuel oil (mazut).
Transportation is obviously the key sectoral component of
the increased demand for light products. By 1999, the share of
transportation had increased to about 50 percent of Russia's
aggregate (civilian) petroleum product consumption, compared to
39 percent in 1990. The share of electric power (powerplants
and boilers) had dropped to about 20 percent, compared to 31
percent in 1990. Similarly, industry's share had dropped as
well, to about 18 percent, and agriculture's share had
contracted to under 6 percent, about the same as the domestic
sector (households and municipal use).
Gas Sector
gas production
Russia is the world's leading gas producer. Russian
production increased by nearly 8 times between 1970 and 1991,
growing from 83.3 bcm to a peak of 642.9 bcm. During the 1990s,
Russian gas production declined as the economy went into a
tailspin, but the decline was surprisingly small given broader
trends in the Russian economy. While Russian GDP declined by
about 43 percent between 1990 and 1998 and aggregate industrial
output plunged by about 56 percent, Russian gas output
contracted by a mere 7.7 percent. Russian natural gas
production has been able to virtually ``defy gravity'' and
remain relatively stable because it was buoyed by surprisingly
strong domestic consumption, which has been, in turn, a
function of low prices and unusually easy payment terms.\21\
Another element that also supported the level of output was a
large build-up in underground storage.
---------------------------------------------------------------------------
\21\ Sagers, 1999.
---------------------------------------------------------------------------
Russian gas production fell from a peak of 642.9 bcm in
1991 to a low of 571.1 bcm in 1997, before recovering to 591.0
bcm the following year. In 1999-2000, Russian production has
declined slightly; in 2000, gas production declined by 1.1
percent, to 584.2 bcm. The decline in output in 2000 occurred
despite rising demand for gas, both within Russia and the
former Soviet Union as well as in Europe (see below).
The Russian gas industry is dominated by the Gazprom, the
world's largest gas production, transmission, and exporting
company. Gazprom, the successor of the old U.S.S.R. Ministry of
the Gas Industry, is a privatized company, although still
retaining a substantial Russian Government shareholding. In
2000 Gazprom produced 89.5 percent of total Russian gas
production; controlled virtually all the gas transported
through Russia's high-pressure pipelines; controlled all gas
exports outside the former Soviet Union; and provided about 20
percent of Federal budget revenues and around 16 percent of
Russia's total export revenues.
Although the bulk of natural gas production within Russia
is by enterprises of Gazprom, production outside Gazprom is
becoming relatively more important. Traditionally, this was
mainly comprised of associated gas recovered by oil producers.
But an important trend in the last few years has been the
appearance of new so-called ``independent'' gas producers that
collectively now produce almost as much gas as the oil
companies do.
Also, Gazprom's production has fallen significantly in the
last year or two--in 2000, by more than 20 bcm to 523.1 bcm--
giving rise to considerable speculation that a substantial and
irreversible production decline is imminent for Russian gas.
Gazprom produced 523.2 bcm in 2000 (89.6 percent of the
Russian total), as its production declined by 4.1 percent
compared to 1999. Gazprom cited the ``exhaustion of its main
fields'' as the principal reason for the decline, combined with
the lack of cash to invest in new fields. However, gas
production by other entities increased in Russia; non-Gazprom
output increased from 45.1 bcm in 1999 to 61.0 bcm (+35.3
percent) in 2000. The major oil companies delivered marginally
higher volumes of gas in 2000 (+4.5 percent, to 31.0 bcm), but
the major increase (+232 percent, from 10.5 to 24.4 bcm) came
from new, so-called ``independent'' gas producers, most
noticeably the Itera group. Output by Itera's subsidiaries
alone amounted to 18.0 bcm in 2000. Itera plans to increase
output to 30 bcm in 2001.
Over the next few years and well into the future, the
Energy Ministry expects that Gazprom's share of Russian
production will continue to contract. Thus, a key problem for
Russia is establishing a workable regulatory framework to allow
such ``independents'' easier access to Gazprom's pipeline
network. This remains a major focus of the government's ongoing
reforms of the so-called ``natural monopolies.''
Gazprom complains that its ability to fund investment
remains very limited because of low domestic prices and high
non-payments by domestic and Commonwealth of Independent States
(CIS) customers. Gazprom's plan is to hold its production in
2001 at 523 bcm, and claims to have sufficient investment funds
to ``support'' production at a level of about 530 bcm per annum
after that. If correct, this would mean that any increases in
production would have to come from non-Gazprom production;
i.e., ``independent'' producers and joint ventures. Moreover
given Gazprom's forecast decline for its fields currently in
production (see below), it would also mean that a great deal of
new capacity has to be brought on stream over the next two
decades.
Aggregate investment in the gas sector amounted to 90.5
billion rubles in 2000 ($3.2 billion at the average exchange
rate), a decline of 11.6 percent in real terms according to the
Ministry of Energy. But it appears that investment spending
picked up strongly in the second half of the year, a rather
belated response to a substantial improvement in revenues and
cash receipts for the sector in 2000. It appears that Gazprom
was far more reticent to plow back its higher revenues into
upstream investment than the oil companies were.\22\
---------------------------------------------------------------------------
\22\ Gazprom reported that its investment outlays on various
projects (not just in Russia) amounted to 101.2 billion rubles in 2000
($3.6 billion) compared with 79.1 billion rubles ($3.2 billion) in
1999.
---------------------------------------------------------------------------
Gazprom's claims of insufficient cash to fund investment is
becoming less and less credible as Gazprom's cashflow has been
bolstered not only by rising international gas prices, but also
by improved payments and higher prices domestically. Gazprom
reported a profit of 60.7 billion rubles ($2.1 billion) in 2000
as the company's total revenues jumped 63 percent, to 498.1
billion rubles ($17.2 billion), with export revenues almost
doubling to 294.3 billion rubles ($10.2 billion) and domestic
sales increasing by about 20 percent, to 118.7 billion rubles
($4.1 billion).
In particular, the share of payments for gas by Russian
consumers improved dramatically in 2000, from only about 63
percent in 1999 to about 71 percent in 2000, and the share of
cash in total payments improved from 53 percent in 1999 to 71
percent. Combined with the domestic price increase that went
into effect in May 2000 (of 20 percent), the sector's real cash
receipts (sales volume average price
average percent payment average percent payment in
cash) in 2000 from domestic sales would be about double what
they were in 1999. The outstanding arrears owed by Russian
consumers for gas actually dropped in 2000, from 108.3 billion
rubles at the beginning of the year to 81.4 billion rubles
($2.8 billion) at the end of the year, a decline of 24.8
percent, or $931 million. However, the debts owed by CIS
countries increased by 14.8 percent in 2000, to a reported 58.0
billion rubles ($2.0 billion).
gas exports
Russia is the largest gas exporter in the world, shipping
over 200 bcm beyond its borders since 1998 (217.1 bcm in 2000,
or 37.2 percent of production), including 129.0 bcm to
countries beyond the borders of the former U.S.S.R. and 88.1
bcm to the former Soviet republics (Table 3).
Between 1990 and 1996 (when they bottomed out), Russia's
gas exports to the other former Soviet republics plunged by
52.3 percent (Table 3). This sizable decline, from 153.2 bcm to
73.0 bcm, was caused by two primary factors. First, demand for
natural gas declined due to a substantial decrease in general
economic (especially industrial) activity in these countries.
Second, most of the importing republics amassed enormous debts
for natural gas, making Russian suppliers anxious about
delivering any more gas without payments being made. As of the
end of 2000, Russia was owed 58 billion rubles ($2.0 billion at
the average exchange rate for the year) by the other republics
for natural gas (according to Russian statistics): Ukraine owed
39.7 billion rubles ($1.4 billion); Belarus owed 6.0 billion
rubles ($208 million); and Moldova owed 12.3 billion rubles
($426 million).
Russia exported 129.0 bcm in 2000 to destinations outside
the former Soviet Union, including 38.6 bcm to Eastern Europe,
80.1 bcm to Western Europe, and 10.3 bcm to Turkey. These non-
former Soviet Union exports increased by only 1.7 percent in
volume terms in 2000 (Table 3); the bulk of this increment was
actually realized to just one country, Turkey, as exports to
both Eastern Europe and West Europe remained almost flat.
Gazprom expects to export 135.0 bcm to countries outside the
former Soviet Union in 2001, however, an increase of 4.7
percent.
With ``Russian'' gas exports to the former Soviet Union
countries amounting to 88.1 bcm in 2000, this represented a
sizable 13.3 percent increase compared to 1999 (Table 3). In
turn, this was comprised of 4.8 bcm to the Baltic states and
83.3 bcm to the CIS countries. Although some 23.3 bcm of this
is evidently ``re-directed'' gas from other countries (or re-
exported gas), this can be considered to be ``Russian'' gas
because of the role of Itera as the consignee, both on the
import and export contracts. In 2001, ``Russian'' exports to
the former Soviet Union should be much lower because of the
switch in the structure of Ukraine's gas supplies. Gazprom
reported that it expects to ship only 53.3 bcm of Russian gas
to the CIS and Baltic states in 2001 (including both its own
and ``independent'' exports), of which about 30 bcm will be to
Ukraine.\23\
---------------------------------------------------------------------------
\23\ The only ``Russian'' gas that Ukraine expects to receive in
2001 is the in-kind payment (by Gazprom) for transit services; the
remainder of its supplies are slated to come from Turkmenistan
(although Itera remains the intermediary). But Ukraine's national oil
and gas company Naftohaz Ukrainy expects to transit less gas in 2001
than it did in 2000, and to therefore receive a smaller payment than
expected. In 2000, it moved 123.5 bcm, of which 112.3 bcm was to Europe
(outside the former Soviet Union), and 11.3 bcm to CIS countries.
Although its contract with Gazprom calls for transit of 124.6 bcm in
2001, Gazprom is making increasing use of the new pipeline through
Belarus and Poland, and actual shipments through Ukraine are declining.
Naftohaz Ukrainy projects that it may transit less than 110 bcm to
Europe in 2001, and total transit may be less than 120 bcm.
---------------------------------------------------------------------------
Ukraine remains the largest customer for Russian gas in the
former Soviet Union. Russian customs statistics report that
Russia exported only 39.7 bcm to Ukraine in 2000, while Ukraine
itself claims that its gas imports amounted to 60.7 bcm,
comprised of 27.9 bcm from Gazprom and 32.8 bcm from Itera. The
27.9 bcm was what Gazprom paid for Ukraine's transit services,
and the Itera imports would represent a combination of Turkmen
imports arranged through Itera (1.9 bcm) as well as Itera's
``own'' gas (from Russian or Turkmen sources).
gas consumption
Despite the attention given Russia's international gas
exports, natural gas is produced mostly for internal Russian
consumption (representing 68.4 percent of production in 2000).
Over the past 20 years, natural gas has made significant
progress in replacing the previously most important sources of
primary energy, coal and oil, in Russia's primary energy
balance. In 1990, natural gas accounted for 43.1 percent of
Russia's primary energy consumption, and by 2000, the share of
gas had edged up to over half of total consumption at 52.2
percent (Table 6).
During the 1980s when the gas industry was growing so
rapidly, the massive increments in gas supply were absorbed by
directing most of it to a few very large industrial consumers,
especially electric power stations, but also including iron and
steel plants and nitrogenous fertilizer centers. This minimized
the need for the construction of an extensive network of
distribution lines to serve more dispersed consumers such as
the housing and municipal sector (including households).
Gas consumption (end-of-pipe deliveries) in Russia peaked
at 409.0 bcm in 1991. Apparent gas consumption (including
pipeline use) in Russia also peaked in 1991, at 468.7 bcm
(Table 3). By 1997, with the declines in economic activity and
some energy efficiency gains, apparent consumption of natural
gas in Russia bottomed out at 377.5 bcm, down 19.5 percent
compared to 1991, and actual deliveries to consumers dropped by
19.3 percent between 1991 and 1997, bottoming out at 330.0 bcm;
since then, apparent consumption has climbed back to 404.4 bcm
by 2000, and actual deliveries to 347.1 bcm.
Since the second half of the 1980s, electric power has
accounted for the largest share of natural gas consumption in
Russia. In 1990, out of 404.0 bcm of natural gas in total
deliveries, electric power stations used 179.0 bcm, or 44.3
percent. In 2000, electric power took 136.4 bcm, or 39.2
percent of all sales to domestic consumers.
TABLE 3.--GAS BALANCE FOR THE RUSSIAN FEDERATION
[In billion cubic meters]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Gas production....................................... 640.6 642.9 640.4 617.6 606.8 595.4 601.5 571.1 591.0 590.7 584.2
Gas consumption (total apparent)..................... 460.7 468.7 454.7 453.2 424.4 408.4 409.5 377.5 390.8 389.8 404.4
Deliveries....................................... 404.0 409.0 395.3 382.1 348.0 339.0 336.8 330.0 331.6 339.9 347.1
Pipeline use/changes in storage \1\.............. 56.7 59.7 59.4 71.1 76.4 69.4 72.7 47.5 59.2 49.9 57.3
Pipeline use and losses (reported)........... 63.6 63.5 59.6 57.1 56.3 54.2 56.3 47.7 53.0 53.0 51.0
Change in storage (residual)................. -6.9 -3.8 -0.2 14.0 20.1 15.2 16.4 -0.2 6.2 -3.1 6.3
Gas exports.......................................... 249.7 173.0 195.3 171.0 184.4 190.6 196.5 198.4 202.5 204.5 217.1
Foreign.......................................... 96.5 90.0 88.9 92.7 105.8 117.4 123.5 116.7 120.5 126.8 129.0
Other republics.................................. 153.2 83.0 106.4 78.3 78.6 73.2 73.0 81.7 82.0 77.7 88.1
Gas imports.......................................... 70.1 13.8 7.0 6.6 2.0 3.6 4.5 4.9 2.3 3.6 37.3
Foreign.......................................... -- -- -- -- -- -- -- -- -- -- --
Other republics.................................. 70.1 13.8 7.0 6.6 2.0 3.6 4.5 4.9 2.3 3.6 37.3
Kazakhstan................................... ....... ....... 3.9 3.5 1.6 3.2 2.0 2.7 2.3 3.6 5.3
Turkmenistan................................. ....... ....... 3.1 3.1 0.3 0.3 1.9 1.9 -- -- 29.1
Latvia....................................... ....... ....... -- -- -- -- 0.7 0.3 ....... ....... 0.6
Uzbekistan................................... ....... ....... ....... ....... ....... ....... ....... ....... ....... ....... 2.4
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Balancing item.
Industry remains the second largest consumer of natural gas
in Russia. In 1990, Russian industry used 165.7 bcm of natural
gas (41.0 percent of the total), primarily in chemicals,
machine-building and metalworking, ferrous metallurgy, and the
oil and gas extraction sector. These four sectors accounted for
over 71 percent of all industrial consumption in Russia in
1990, or almost 29 percent of total gas deliveries at that
time. But as industrial activity contracted with the
transition, the share of industry in Russian gas consumption
also declined, at least through 1998, bottoming out that year
at 94.0 bcm, representing 28.4 percent of total consumption.
In 1990, the volume of gas used in the municipal sector and
housing reached 42.3 bcm, or 10.5 percent of total Russian gas
deliveries. Since 1990, the relative importance of the
municipal sector has climbed as industrial consumption has
declined, as the amount used by the housing and municipal
sector has slowly increased. Its share had climbed to 27 to 28
percent by 1999-2000, actually rivaling that of industry.
Coal Sector
Russian (gross) coal production declined by 41.3 percent
between 1990 and 1998, from 395.3 mmt to 232.2 mmt, largely
reflecting the contraction in consumption with the transition-
related economic decline. However, production did turn around
in 1999 and 2000, reaching 257.9 mmt in 2000. In 2000, this was
comprised of 171.7 mmt (66.6 percent of the total) of ``hard''
coal (i.e., of bituminous or anthracite rank) and 86.2 mmt
(33.4 percent) of lower-rank lignite.
The bulk of Russian coal (over 80 percent) is produced in
Siberia, far from the main energy-consuming centers of the
country in European Russia. The principal producing basins
include: the Kuznetsk Basin (in West Siberia), with an output
of 114.0 mmt in 2000; the Kansk-Achinsk Basin (in East
Siberia), with an output 39.9 mmt in 2000; the Pechora Basin
(in northern European Russia), with an output of 18.4 mmt in
2000; and South Yakutia (Far East), with an output of 10.1 mmt
in 2000.
Not surprisingly, the principal areas of increase in 2000
were the Kuznetsk Basin in West Siberia (+4.6 percent) and the
Kansk-Achinsk Basin in East Siberia (+9.8 percent); the older
producing areas in European Russia did not do quite as well.
These two large Siberian basins now account for 61.2 percent of
national coal production. Although underground-mined coal
expanded in 2000 (by 1.6 percent), coal mined in open-pits
expanded by 4.2 percent, raising the share of open-pit-mined
coal to 64.6 percent.
The expansion in coal output in 2000 was heavily driven by
rising export demand, although internal (apparent) consumption
was up slightly as well. Russia's exports of coal to
international markets (beyond the territory of the former
Soviet Union) grew quite rapidly in 2000, jumping by 69.8
percent, to 37.3 mmt (Table 4). Russia's coal exports to the
former Soviet Union countries were up as well, although more
moderately (+6.6 percent), to 6.1 mmt.
TABLE 4.--COAL BALANCE FOR THE RUSSIAN FEDERATION
[In million metric tons]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Coal production...................................... 395.3 353.3 337.3 305.0 270.9 262.2 255.0 244.4 232.2 249.1 257.9
Coal consumption (apparent).......................... 398.4 361.1 337.5 305.0 274.9 251.2 249.5 237.3 223.7 237.4 239.9
Coal deliveries to consumers (reported).......... ND ND ND ND 272.6 259.0 205.6 197.8 196.4 210.0 205.8
Coal exports......................................... 49.2 37.4 40.5 28.7 23.3 29.6 25.6 22.9 23.5 27.7 43.4
Foreign.......................................... 20.0 17.5 18.1 20.2 17.6 21.0 18.5 18.1 18.3 22.0 37.3
Other republics.................................. 29.2 19.9 22.4 8.5 5.7 8.5 7.1 4.8 5.2 5.7 6.1
Coal imports......................................... 52.3 45.2 40.7 28.7 27.3 18.5 20.1 15.8 14.9 16.1 25.4
Foreign.......................................... -- -- -- -- -- 1.0 0.7 1.1 0.3 0.1 0.0
Other republics.................................. 52.3 45.2 40.7 28.7 27.3 17.5 19.3 14.7 14.7 16.0 25.4
--------------------------------------------------------------------------------------------------------------------------------------------------------
ND--No data.
This strong export performance reflects not only the effect
of higher prices (the average export price for Russian coal in
December 2000 was $28.3 per ton [$26.9 per ton for non-CIS and
$38.8 per ton for CIS sales] compared with $15.4 per ton in
December 1999), but also the benefit from the sizable reduction
in costs achieved with the devaluation of the ruble in 1998.
These have made Russian coal exports much more profitable for
the producers and highly competitive in export markets.
Reflecting rising demand from the strong economic rebound
in 2000, Russia's coal imports surged as well, increasing by
58.5 percent, to 25.4 mmt (Table 4). Most of this coal is
imported from Kazakhstan. Thus, apparent coal consumption in
Russia also grew, reflecting the expansion in economic activity
and expanded thermal electricity generation. Apparent
consumption in Russia amounted to 239.9 mmt in 2000, up 1.0
percent compared to 1999. However, reported deliveries to
consumers actually declined, dropping by 2.0 percent, to 205.8
mmt. Consumption mainly increased in electric power stations
(+8.8 percent, to 135.2 mmt), coking/metallurgy (+3.6 percent,
to 42.1 mmt), and the municipal sector (+9.6 percent, to 13.0
mmt).
Despite the turnaround in output in 1999-2000, Russian coal
production in PlanEcon's energy forecast is projected to slowly
decline over the next two decades (see below). In contrast, the
Russian Energy Strategy envisions coal production rising to 320
mmt in 2010 and over 400 mmt in 2020. In the Strategy, major
technological breakthroughs are postulated in production,
processing and transportation that result in declining costs,
and therefore end-user prices, of coal. This is viewed as
making coal a cost-effective energy choice for consumers in
European Russia.
The Russian coal-mining sector has been only slowly
transformed in the last 5 years or so as the government has
pressed forward on a difficult restructuring program under the
impetus of the World Bank. In 2000, the sector included about
65 coal producers, including 60 already corporatized as coal-
mining companies (not including subsidiaries), as well as 5
producers still organized as state enterprises; these companies
worked 106 open-pit mines and 114 underground mines.\24\ Three
of the more prospective companies were privatized in 2000,
reducing the number of companies in which the federal
government still holds a majority of shares to 24.
---------------------------------------------------------------------------
\24\ During most of the 1990s (until December 1997), operational
responsibility for the Russian coal-mining sector rested with a central
body known as the Russian Coal Company or Rosugol. Rosugol was
disbanded in connection with the agreement on the distribution of loans
and credits from the World Bank for coal sector restructuring.
---------------------------------------------------------------------------
As a result of the ongoing restructuring program for the
sector, over the 1994-2000 period, a total of 134,200 workers
have been shed, of which 23,500 were let go in 2000, and about
170 of the worst mines have already been closed. Because of
this, productivity has been rising (in 2000, this improved to
108 tons per worker per month), and with higher domestic and
international coal prices in 2000, has substantially reduced
the need for direct government subsidies. But the government
still provided ``selective assistance'' to 70 mines in 2000.
The Ministry of Energy's program for 2001 calls for subsidies
of 8 billion rubles ($270 million), of which it would like to
direct 3.1 billion rubles (38.5 percent) to investment projects
rather than the closures and social payments that have
dominated up to now. What has also improved the finances of the
sector is the improved situation for payments by consumers.
Over the first 11 months of 2000, consumers actually paid for
86.2 percent of the coal they received, of which 46 percent was
in cash. In January 2000, this had been only 54 percent and 38
percent, respectively.
Electric Power Sector
electricity production
Electricity generation in Russia closely follows
consumption trends; only a relatively small proportion of
electricity production is exported. As the economy slowed in
the late Soviet period, generation increases started to slow
dramatically in the latter half of the 1980s, and began to
decline in 1991. Then with the transition-related difficulties
of the 1990s, electricity production fell sharply. By 1998,
when aggregate production bottomed out at 827.2 billion
kilowatt-hours (kWh), output had declined by 23.6 percent from
the 1990 peak of 1,082.2 billion kWh. Since then, output has
risen slightly with economic re-expansion, reaching 878.1
billion kWh in 2000 (Table 5). Production in 2000 was comprised
of 66.3 percent from thermal stations, 18.8 percent from hydro-
stations, and 14.9 percent from nuclear stations.
Thermal generation in Russia increased by 3.2 percent in
2000, to 582.3 billion kWh. At the same time, primary
electricity generation grew substantially, as nuclear
generation increased by 8.8 percent, to 130.5 billion kWh, and
hydro-electric generation increased by 2.7 percent, to 165.3
billion kWh.
The increased requirement for thermal generation put
Unified Energy Systems of Russia (UES), the electricity utility
which runs most of the Russia's thermal plants (see below), in
a tough situation because Gazprom periodically threatened to
reduce gas supplies last year, citing non-payments. However,
UES actually ended up consuming more gas in 2000 than in 1999
(136.4 bcm vs. 134.1 bcm) as well as consuming more coal (132.5
mmt vs. 121.8 mmt). UES' fuel mix for thermal generation in
2000 shifted only slightly away from gas: to 66 percent gas,
28.6 percent coal, and 5.4 percent oil (residual fuel oil);
this compares with 67.5 percent gas, 26.0 percent coal, and 6.5
percent oil in 1999.
electricity consumption
Electricity consumption in Russia started to fall in 1991
as the economy began the transition. The drop in (gross)
electricity consumption (measured as production minus net
exports) continued through 1998, when it bottomed out at 809.1
billion kWh, 24.7 percent less than the peak of 1,073.9 billion
kWh achieved in 1990. Following the recent economic turnaround,
consumption increased in both 1999 and 2000.
TABLE 5.--ELECTRICITY BALANCE FOR THE RUSSIAN FEDERATION
[In billion kilowatt-hours]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total production..................................... 1,082.2 1,068.2 1,008.5 956.6 875.9 862.1 847.2 834.1 827.2 846.2 878.1
Thermal stations................................. 797.1 780.1 716.3 662.6 601.1 586.4 583.6 568.3 566.3 563.3 582.3
Hydro-stations................................... 166.8 168.1 172.6 175.0 177.0 176.4 154.8 157.5 158.7 160.9 165.3
Nuclear stations................................. 118.3 120.0 119.6 119.0 97.8 99.3 108.8 108.3 102.2 122.0 130.5
Exports (-).......................................... 43.3 47.2 44.0 43.4 41.7 38.0 31.8 26.8 26.4 22.5 14.8
Imports (+).......................................... 35.0 35.1 27.7 24.7 22.2 18.4 12.3 7.1 8.3 8.4 1.6
Apparent consumption................................. 1,073.9 1,056.1 992.2 937.9 856.4 842.5 827.7 814.4 809.1 832.1 864.9
Losses and self-use.................................. 154.6 153.4 149.7 142.0 160.6 167.0 164.1 161.6 160.2 163.9 ND
Transmission losses.............................. 84.2 83.9 84.1 79.8 73.0 71.9 70.6 69.6 69.0 70.6 ND
Power station use and losses..................... 70.4 69.5 65.6 62.2 87.5 95.1 93.5 92.0 91.3 93.4 ND
Domestic deliveries.................................. 919.3 902.7 842.5 795.9 695.8 675.5 663.6 652.8 648.9 668.2 ND
Industry and construction........................ 574.3 552.5 505.3 450.4 359.5 345.1 331.4 329.4 320.7 336.9 ND
Agriculture...................................... 96.4 103.4 102.9 103.8 97.7 88.6 85.9 78.1 75.0 72.0 ND
Transportation................................... 103.8 96.7 86.8 76.7 68.4 65.2 64.9 63.5 60.0 60.6 ND
Housing/municipal sector (urban)................. 144.8 150.1 147.5 165.0 170.3 176.6 181.4 181.8 193.1 198.6 ND
Industry (including power stations).............. 644.7 622.0 570.9 512.6 447.0 440.2 424.9 421.4 412.0 430.3 ND
--------------------------------------------------------------------------------------------------------------------------------------------------------
ND--No data.
The decline in electricity consumption during the period
was much less than the overall decline in economic activity.
This reflects a combination of several factors, including the
relatively slow reform and commercialization of the sector
(manifestations of which are low end-user prices and high
levels of non-payments) as well as a high proportion of
``overhead'' or ``fixed'' consumption; i.e., consumption that
occurs irrespective of direct production or economic activity.
For example, a factory must be lighted and the assembly line
turned on regardless of whether it produces only one item or a
hundred.
According to the Ministry of Energy, (gross) electricity
consumption rose in 2000, although only by 3.7 percent, to
864.9 billion kWh.\25\ This indicates that the electricity
intensity of the aggregate economy (kWh consumed per unit of
GDP) is improving somewhat as the economy re-expands; i.e., the
inverse situation of what occurred earlier in the decade as GDP
declined.
---------------------------------------------------------------------------
\25\ Net exports of electricity from Russia can thus be calculated
as the difference between reported production and consumption in 2000
at 13.2 billion kWh, down from 14.1 billion kWh in 1999. Russia's
exports of electricity (invoiced) in 2000 were reported as 14.849
billion kWh by Goskomstat, a decline of 38.5 percent from 15.346
billion kWh in 1999 (although total exports in 1999 amounted to 22.5
billion kWh). Thus, imports in 2000 would be 1.6 billion kWh.
---------------------------------------------------------------------------
The growth in Russian electricity consumption in 2000
occurred despite a much tougher payment policy by UES. Driven
by the need to come up with sufficient cash to pay for its fuel
deliveries (especially of gas), UES was willing to cut off non-
payers, even if they were entire regions or major enterprises
or even key defense facilities. With the tougher approach, UES
had lifted the share of payments by Russian consumers to 100
percent by the end of the year, with the share of cash in these
payments increasing to 74.2 percent.
Final electricity consumption (actual deliveries to
consumers) declined by 29.4 percent between 1990 and 1998, from
919.3 billion kWh to a low point of 648.9 billion kWh. In 1999,
final consumption increased to 668.2 billion kWh (Table 5).
Final consumption fell slightly more than apparent electricity
consumption because of a slower rate in the fall of electricity
use at power plants and transmission losses.
Electricity consumption in Russia has been dominated by the
industrial sector (particularly heavy industry), with a
correspondingly small share by the residential and commercial
sector. Whereas electricity consumption patterns shifted away
from industry to the commercial and residential sectors in
other countries over the course of their development, the
Soviet development experience remained fixated upon
industrialization, with the result that there was relatively
little shift in this regard in Russia through the 1980s. In
1990, the industrial sector still consumed 60.4 percent of
total final electricity consumption, while the residential
sector accounted for a mere 8.4 percent; combined, residential-
commercial users (the domestic sector) still accounted for only
18.9 percent of total final electricity consumption in 1990.
But such a shift is evident during the ongoing re-
orientation of economic activity under the transition to a
market-type economy. During the 1990s the sectors experiencing
the greatest decline in electricity use have been industry and
transport. Industrial electricity consumption (including the
construction sector) fell by 41.3 percent between 1990 and
1999, dropping its share of final consumption to 50.4 percent
in 1999. Industrial electricity consumption finally turned
around in 1999 with the industrial recovery. In contrast,
electricity consumption in the household and commercial-
municipal sector generally has been rising throughout the
transition period. The combined share of the domestic sector
(households-commercial users) in final consumption in 1999 was
29.7 percent.
organizational structure
The Russian electricity sector is now administered and run
by three key entities: the large joint-stock company known as
RAO UES (Russian Joint-Stock Company of the Unified Energy
Systems of Russia); the 72 regional distribution companies (the
energos); and the nuclear power operator, Rosenergoatom, which
has exclusive responsibility for the nuclear stations (except
for the Leningrad nuclear station which operates separately).
The government's organizational plan for the electric power
sector laid out in 1992-1993 intended for each of the
distribution companies to operate in the context of a Russian
electricity ``market,'' both generating electricity themselves
from their own smaller stations as well as buying power from
the large stations (independent producers) to supply their
customers if needed or selling power into the grid if they
generated a surplus. One of RAO UES' major tasks was to arrange
a ``Federal wholesale electricity market'' (FOREM) through its
operation of the transmission system. As dispatcher and
operator of the high-voltage grid, it plays a crucial role in
maintaining system stability and wheeling electricity to
deficit power networks from those with a surplus. The Central
Dispatch Office, which coordinates the seven regional power
pools of the RAO UES network, was corporatized, with 100
percent of its statutory capital owned by RAO UES. The various
regional dispatch offices (for each regional power pool) are
subsidiaries of RAO UES as well.
RAO UES was organized and officially registered as a joint-
stock company on December 31, 1992. It essentially absorbed
many of the enterprises and activities of the former Rosenergo
``concern,'' the successor of the old U.S.S.R. Ministry of
Electric Power. At that time, the Russian Government planned to
hold onto 51 percent of the new holding company's shares
(although up to 30 percent was planned to eventually be
transferred to local administrations, and currently the
regional administrations vote 30 percent of the government
shares in the energos), 21 percent was sold to employees of the
enterprises that comprise the company both for privatization
checks and for cash, and 15.1 percent was distributed to the
population through check auctions (in February and June 1994),
while another 7.1 percent was reserved for cash sale or
auction. By early 2000, the government's stake in RAO UES had
been reduced to 52.7 percent, with about 22 percent purchased
by foreign institutional investors, about 6 percent in
preferred (non-voting) shares in the hands of employees, and
the remainder held by Russian institutional investors and
individuals.
The local distribution companies, or energo, were
incorporated into the RAO UES holding as ``daughter''
subsidiaries; RAO UES was intended to hold a 49 percent stake
in each energo (on behalf of the state). Thus, RAO UES was
given broad control over the sector and was intended to
represent the government's interests in the power sector.
However, due to several structural factors, RAO UES has been
unable to effectively exert its control and manage these
widespread assets successfully. This largely reflects the fact
that RAO UES bears the ministerial administrative legacy from
its Soviet predecessor plus the conflict between its role as a
commercial company and that of a state-owned managerial body
for the sector; an additional factor is that with the changes
in the operating environment since 1990, it is simply too
difficult for RAO UES to effectively manage the entire sector.
Many energos, supported by local government
administrations, have taken a more independent line, with
particularly strong opposition coming from the surplus power
regions that objected to having valuable generating assets
taken from them. As a result, various compromises have been
reached. Still, for most of the energos, RAO UES did receive a
46 to 51 percent stake (giving it a majority of votes depending
upon the particular composition of preferred versus common
shares for each energo), and it has a 100 percent stake in 8
others, while in only two it holds no shares.
In turn, the energos include within their structure the
smaller electric power stations (of less than 1,000 MW for
thermal stations or less than 300 MW for hydro-stations),
comprising about 480 stations. The energos own 118 GW of
capacity, but operationally retain roughly 135 GW (about 63
percent of the Russian total), including about 65 GW of heat-
and-power stations (TETs) and 30 GW of smaller thermal and
hydro plants. Each of the smaller stations is, in turn, a
``daughter'' company of the local distribution company; i.e.,
it is itself a joint-stock company with 49 percent of its
shares owned by the larger distribution company.
While a large component of RAO UES' holdings is comprised
of the regional distribution companies (almost 60 percent of
its charter capital lies in its holdings of the energos), this
is not the only component. RAO UES also holds the large
(independent) stations \26\ as well as the bulk of the high-
voltage transmission grid system (over 330 kV) and some
auxiliary operations, such as research institutes, design
bureaus, and construction enterprises. Thus, RAO UES has been
described as the world's largest holding structure.
---------------------------------------------------------------------------
\26\ The scheme establishing RAO UES intended to strip the largest
thermal stations (over 1,000 MW) and hydro-electric stations (over 300
MW) out of the energos where they previously had been administered, and
put them in RAO UES' hands, which together with RAO UES' control of the
high-voltage transmission grid, would lead to the formation of a
wholesale electricity market among the regions. With the loss of the
large stations, few of the energos would be self-sufficient in
electricity.
---------------------------------------------------------------------------
Russia's 51 larger stations (hydro-electric stations [GES]
of more than 300 MW and thermal stations of more than 1000 MW)
were supposed to be separated from the energos and were
initially intended to become ``daughter'' companies within the
RAO UES holding. These 51 stations (comprising a total of 96 GW
or 45 percent of Russian total installed capacity), despite
being incorporated into RAO UES, are described as being
``independent'' power producers.
Similar to what happened among the energos, however, not
all the stations followed the national scheme. Only 23 of these
stations are wholly under RAO UES (comprising 41 GW), while 9
stations (comprising 16 GW) are ``leased'' back to the local
energos and 17 either remained with the energo, became an
energo ``daughter'' company like the smaller stations, or were
privatized under regional programs. Of these 17, 4 were
privatized by the (autonomous) republics; 4 were
``incorporated'' by local authorities; and 5 were
``incorporated'' under different decrees or rules. In other
cases, special purchase rules for the output of these stations
has been agreed, further limiting the benefits to RAO UES from
ownership. Thus, in a variety of ways, control over many of
these larger stations has not remained with RAO UES as
intended, but has often slipped back to the energos.
The nuclear stations also supply electricity to the network
independently (their output is purchased both by RAO UES as
well as by some of the energos directly). They are under the
administration of the Russian Ministry of Nuclear Power,
Minatom, or more properly, the government holding company under
that ministry known as Rosenergoatom (except for the Leningrad
station, which operates independently).
The Russian electric sector remains in a state of flux, and
since the existing organizational structure creates a number of
problems for the system in terms of operation and management,
it is slated to undergo additional changes. A general
restructuring plan for the sector was recently approved by the
government, more or less along the lines of an earlier proposal
mooted by Anatoly Chubais, the chief executive of RAO UES. The
key elements of the plan envision the central government
holding (RAO UES) divesting itself of generation and
distribution assets, and refocusing its activities on the
``natural monopoly'' element of transmission. Change will be
difficult, however, both because of the effective
decentralization that has occurred and because the power sector
has become extremely politicized at both the national and
regional levels.
The Russian Federation's Primary Energy Balance in Long-Term
Perspective
The main trends, tasks, and objectives of energy policy to
2020 are embodied in Russia's recently approved Energy Strategy
of Russia to 2020.\27\ This is the most recent in a series of
energy policy documents laying out a strategy for the energy
sector and mechanisms for its implementation under the
transition to a market economy. Its immediate predecessor was
the Basic Guidelines for the Energy Policy of the Russian
Federation to 2010 (approved in October 1995).
---------------------------------------------------------------------------
\27\ Government of the Russian Federation, 2000.
---------------------------------------------------------------------------
A major difference between the 1995 and 2000 documents is
their macro-economic contexts. In 1995, Russia's economy was
still contracting, and the reduction in primary energy
requirements concomitant with that was largely viewed as a
factor facilitating the task of supplying the country with
energy and allowing foreign exchange to be generated by
exporting the surplus. In contrast, the 2000 Strategy is set
against a background of a resurgent economic growth, and its
focus is mainly upon meeting the growing energy needs of a re-
expanding economy. There is an overarching concern that, given
the poor state of the Russian energy sector, it may not be able
to meet the increasing energy demand nor provide the vital
exports needed to sustain the economic transformation. Thus,
even more so than in the past, the 2000 Energy Strategy
emphasizes improvements in energy efficiency and reform of
energy pricing structures as principal mechanisms.
The new Energy Strategy's projections for energy supply to
2020 are based on a major change in energy policy outlook given
the concern of an energy security risk from a deemed too high
dependence on natural gas. The Strategy envisages a change in
the fuel mix such that the share of natural gas in total
primary energy consumption will decrease from levels of about
50 percent in the late 1990s to 42 to 45 percent in 2020. In
its place, the share of coal is planned to increase from 11 to
12 percent in 1998 to 22 percent in 2010 and 21 to 23 percent
in 2020. Nuclear energy is also slated to increase, expanding
to 6 percent in 2020 from current levels of 5 percent, while
oil's share in primary energy consumption will remain
practically unchanged.
The Strategy projects primary energy production in Russia
in 2020 at 1,525 to 1,740 million tons of coal-equivalent
(1,068 to 1,218 mtoe), primary energy consumption in 2020 at
2,090 to 2,325 million tons of coal-equivalent (1,464 to 1,628
mtoe), and net energy exports at 565 to 585 million tons of
coal-equivalent (396 to 410 mtoe).
In contrast, PlanEcon's current energy forecast for
Russia\28\ projects a substantially different picture for 2020,
with a higher level of aggregate energy production, a lower
level of consumption, and a higher level of exports. By 2020,
PlanEcon's current energy forecast\29\ projects total output of
primary energy in Russia at 1.446.3 mtoe, 10.7 percent above
the 1990 level, and 46.7 percent higher than the 2000 figure
(Table 6).
---------------------------------------------------------------------------
\28\ Sagers and Movit, 2001.
\29\ Sagers and Movit, 2001.
---------------------------------------------------------------------------
In the PlanEcon forecast, coal production is expected to
eventually resume its long-term secular decline; oil output is
expected to continue to recover (albeit slowly); and gas
production should be able to turn around shortly, due both to
improvements in the domestic investment climate (reflecting
higher prices and toughening payment conditions) and to more
buoyant demand from expanding economic activity in the region.
Thus, natural gas is expected to remain the largest component
of Russia's energy production. The share of natural gas in
primary energy output rose to 47.9 percent in 2000, and is
projected to reach 58.3 percent by 2020.
Over the entire 2000-2020 period, aggregate primary energy
output in Russia is projected to increase at an annual average
rate of about 1.9 percent. While output of crude oil and
natural gas is projected to rise considerably over the next 20
years, primary electricity production is anticipated to remain
more or less stagnant (due mainly to high capital costs), and
coal output (in energy equivalent terms) is expected to resume
its long-term slide as rising extraction costs and prohibitive
transport charges erode its markets.
TABLE 6.--PLANECON'S FORECAST OF THE PRIMARY ENERGY BALANCE OF THE RUSSIAN FEDERATION TO 2020
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2005 2010 2015 2020
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Production (mtoe)........................................ 1,306.1 1,233.4 1,157.8 1,071.7 1,011.8 991.2 982.8 956.5 961.4 977.4 997.8 1,081.4 1,229.8 1,364.1 1,446.3
Shares (in percent):
Coal................................................. 14.5 13.5 13.8 13.5 12.8 12.8 12.5 12.3 11.5 12.3 12.5 11.3 9.6 8.6 7.8
Oil.................................................. 39.5 37.4 34.2 32.1 31.2 31.0 30.6 32.0 31.5 31.2 32.4 33.7 31.9 30.3 29.3
Natural gas.......................................... 40.1 42.6 45.3 47.2 49.1 49.1 50.1 48.8 50.3 49.4 47.9 48.6 53.0 56.2 58.3
Primary electricity.................................. 4.8 5.3 5.7 6.2 6.2 6.4 6.1 6.3 6.2 6.6 6.8 6.0 5.2 4.7 4.5
Other................................................ 1.1 1.2 1.0 1.0 0.7 0.7 0.6 0.6 0.5 0.5 0.5 0.3 0.2 0.2 0.1
Consumption (mtoe)....................................... 905.9 905.0 814.8 768.9 692.9 667.9 640.2 609.9 606.9 622.0 634.2 679.0 745.7 829.4 880.9
Shares (in percent):
Coal................................................. 20.5 18.4 19.0 18.5 18.7 18.1 18.2 18.3 17.2 18.0 17.6 19.1 16.9 15.6 13.8
Oil.................................................. 29.5 29.4 26.5 23.4 21.8 22.1 19.8 21.2 20.1 20.2 19.3 18.4 17.5 15.1 18.5
Natural gas.......................................... 41.6 43.7 45.4 48.6 50.1 50.0 52.3 50.3 52.7 51.3 52.2 52.8 57.1 43.3 60.6
Primary electricity.................................. 6.8 7.0 7.6 8.1 8.4 8.8 8.7 9.2 9.3 9.8 10.2 9.1 8.1 7.4 6.9
Other................................................ 1.6 1.6 1.5 1.4 1.1 1.1 1.0 0.9 0.7 0.8 0.7 0.6 0.4 0.5 0.2
Net exports (mtoe)....................................... 400.2 328.4 343.0 302.8 318.9 323.3 342.5 346.7 354.4 355.4 363.6 402.5 484.1 534.7 565.3
Coal................................................. 3.4 -0.0 4.4 2.9 0.4 6.3 6.7 5.7 6.4 8.3 13.0 -7.5 -8.0 -8.6 -8.2
Oil.................................................. 249.2 195.4 180.0 164.2 164.8 159.3 174.4 176.3 181.1 179.5 200.5 239.4 262.0 267.4 260.4
Natural gas.......................................... 146.9 130.3 154.0 131.4 149.3 153.2 157.0 160.2 163.8 164.4 147.1 167.0 226.1 271.9 308.5
Primary electricity.................................. 0.6 2.8 4.6 4.3 4.5 4.5 4.5 4.5 3.1 3.2 3.0 3.5 4.0 4.1 4.6
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Note: Historical figures through 2000.
Nonetheless, oil is projected to see a slight decline in
its share of primary energy production, despite steadily rising
output. This is because longer term, it is uncertain if the
investment needed by the sector to sustain and expand oil
output will continue to be forthcoming. The single most
important determinant of oil investment is the tax regime, so
the longer term prospects for Russian oil production are
largely dependent upon tax reform. In its present form, the
Russian oil taxation system has several major defects. The main
problem is that it depends excessively on revenue- or volume-
based rather than profit-based taxes. Until the circumstances
of extraordinary high international prices and low production
costs in 1999-2000, the existing Russian tax system resulted in
unacceptable returns on virtually all categories of investment.
Yet, maintaining the recovery in the oil sector depends
heavily on investment to replace the declining volumes of
``flowing oil.'' The Duma is slated to act on tax reforms for
the oil sector in 2001, and the remaining normative acts needed
to complete Russia's regime for production-sharing agreements
for oil and gas production, are also slated to be completed as
well. These measures should allow investment in the oil sector
to continue to rise. Combined with improved effectiveness in
the sector's application of investment resources, this should
assure a steadily rising volume of ``new oil'' sufficient to
more than offset the decline of ``flowing oil.''
Thus, Russian oil production is projected to continue to
rise over the forecast period by PlanEcon, although growth is
expected to slow over time. During the next decade, oil output
is projected to expand steadily at about 1.5 percent per year
before slowing to about 0.5 percent per year in the period
2016-2020. Russian oil production is projected to grow at an
average rate of 1.4 percent per year over the entire 20 year
period to 2020, to reach 392.7 mmt in 2010, and then 423.2 mmt
by 2020.
The official Russian Energy Strategy to 2020 envisions oil
output at 335 mmt in 2010 and 360 mmt in 2020, an average
annual rate of growth over the 20 year period of only 0.5
percent. The Strategy estimates that to reach these production
targets, investments of $42 billion (expressed in constant
ruble equivalent compared to 1999) will need to be mobilized
over the next decade, and another $80 billion will be needed in
the following decade. This is an average of $6 billion per year
over the 20 year period compared with the 1999 investment level
valued at $2.0 billion (see above).
In general, these Russian estimates of investment
requirements seem reasonable with the Strategy's oil production
forecast. However, the overall oil production forecast seems
far too conservative given what was achieved in 2000 (e.g.,
higher investment, expanded drilling, more new fields) and the
changes in the investment climate that are likely to be
realized over the next few years.
In contrast, natural gas production in Russia is largely
dependent upon developments in consumption. Despite Gazprom's
current worries over its ability to produce gas in the near
term, in PlanEcon's view, the decline in Russia's gas output is
largely an organizational/institutional issue related to the
lack of incentives to invest rather than a question of reserves
or even the capacity to mobilize investment. Thus, with the
current direction of reforms in the gas sector (albeit quite
modest), production is likely to be able to turn around
relatively quickly to support rising gas demand, although
growth will still remain fairly moderate. It will be driven
upward by a combination of internal consumption needs and
export demand in the former Soviet Union countries and non-
former Soviet Union. PlanEcon projects Russian gas output in
2005 at 642.6 bcm, expanding to 797.0 bcm in 2010 and 1,030 bcm
in 2020; gas output growth is forecast to average 2.9 percent
per annum over the 20 year period.
In contrast, the Russian Energy Strategy, because of its
goal of diminishing the domestic economy's reliance on gas,
projects gas output at only 655 bcm in 2010 and a mere 700 bcm
in 2020. The average annual growth rate envisioned in the
Strategy for gas production is thus a mere 0.9 percent over the
20 year period. The expanded production is largely geared
toward higher exports, while domestic consumption is envisioned
as remaining relatively flat over the next two decades.
Clearly, such limited expansion would be favorable for
Gazprom, as the organization is not really challenged in
achieving this output. Such a situation that is essentially
non-threatening to Gazprom's current dominance in the Russian
gas sector.
In fact, the Strategy reflects Gazprom's current
sensibilities, and projects output from Gazprom's three main
producing fields (Urengoy, Yamburg, and Medvezh'ye) to decline
from the current level of output (400 bcm) to a mere 87 bcm by
2020, necessitating a relatively high level of investment in
replacement production capacity. Such a high rate of decline
for the main fields (-7.2 percent per annum on average) seems
excessive given the past experience with the large fields
exploiting West Siberia's Cenomanian reservoirs. PlanEcon's
forecast for Russian gas production envisions a much lower rate
of decline in Gazprom's main existing fields (3.1 percent per
annum on average), but nonetheless requires a substantial
expansion of ``new gas'' (775 bcm by 2020). To achieve this,
organizational/institutional changes will be needed in the
Russian gas sector to support the development of more gas
outside Gazprom (by so-called ``independents'').
Russian coal production, in energy equivalent terms, is
projected by PlanEcon to slowly decline over the forecast
horizon (-0.5 percent per year on average). In contrast, the
Energy Strategy envisions coal production rising to 320 mmt in
2010 and over 400 mmt in 2020. In the Strategy, major
technological breakthroughs are postulated in production,
processing and transportation that result in declining costs,
and therefore end-user prices, of coal. Such a view seems quite
unrealistic, however.
The projected level of primary electricity production in
the current PlanEcon forecast envisions the completion of six
new (1,000 MW) nuclear units during the forecast period,
including four before 2005. The recently approved Energy
Strategy calls for the completion of five new units (which were
already well advanced in construction during the Soviet period)
before 2005, identifying these as the cheapest generating
capacity (in costs per MW or per kWh) that Russia could bring
on stream. PlanEcon concurs in this assessment mainly because
of the sizable investment that has already been sunk into these
units, particularly recently; the first of these units (Rostov
No. 1, a VVER-1000) was started up in February 2001. Commercial
generation of power at the new unit is expected to occur in
October 2001.
However, PlanEcon does not consider the Strategy's longer
term plans for further nuclear expansion beyond these initial
units to be realistic. The Strategy calls for 12 GW of new
nuclear capacity (12 units) to be installed by 2010, pushing
installed capacity to 33.2 GW and nuclear generation in the
country up to 220 billion kWh, to be followed by further
expansion and modernization of older units that would boost
installed capacity to 48.4 GW in 2020, producing 320 billion
kWh (19.8 percent of the Strategy's projected total for
electricity generation). In comparison, Russia's nuclear
stations produced 130.5 billion kWh in 2000, or 14.9 percent of
total production. PlanEcon's forecast projects nuclear
generation of only 106 billion kWh in 2020 (8.2 percent of
total generation), largely because of the retirement of 13.2 GW
of nuclear capacity over the 20 year period, which is only
partially offset by the installation of the 6.0 GW of new
nuclear capacity.
In thinking about the long-term outlook for the Russian
Federation's primary energy balance, one of the most important
factors in a functioning marketized economy (which Russia hopes
to become) is energy demand. In turn, one of the most important
demand drivers is the path of aggregate economic activity
(GDP).
PlanEcon projects that Russia's economic re-expansion will
continue in the future, although at a much slower rate than in
2000 (at least initially)--GDP growth is projected to average
3.8 percent per year in 2001-2005 and 4.6 percent in 2006-2010,
before accelerating to 5.5 percent in 2011-2015. But in the
subsequent 5 year period (2016-2020), economic growth is
projected to slow to 3.5 percent per annum on average. Average
GDP growth over the 20 year period is projected at 4.4 percent.
Two factors that will slow growth in the near term is
rising domestic prices for energy and transportation and
tougher payment conditions (particularly for electricity and
gas). These developments, overdue since the 1998 devaluation
that depressed these regulated prices in real terms, will
reduce the profitability of many traditional, Soviet-style
activities (particularly in industry). These were resuscitated
and given a second lease on life by the tumultuous events of
1998. Nonetheless, economic growth is anticipated to remain
fairly strong throughout the forecast period, although there
remains a high degree of uncertainty in the pace of economic
reform and the underlying economic policies that will be
pursued by the Russian Government under President Vladimir
Putin. Not surprisingly, the official Russian Energy Strategy
envisions even more rapid growth than this, with average annual
growth rates in the range of 5.5 to 6.2 percent.
But because a fairly rapid pace of structural change in the
Russian economy would be commensurate with such high rates of
economic growth (together with other adjustments), PlanEcon
projects that the growth in primary energy consumption will lag
well behind the trend in aggregate economic activity. Primary
energy consumption is projected to rise at an average rate of
only 1.7 percent per year over the 20 year period. While the
energy intensity of the Russian economy in 2000 was
considerably higher than in the Soviet period, improvements in
the energy efficiency of the economy have occurred in the last
few years, and this pattern is expected to continue by
PlanEcon, perhaps even at a more rapid rate. The improvement in
energy efficiency in the economy is projected in the range of
2.0 to 3.3 percent per year over the 20 year period by
PlanEcon, averaging about 2.7 percent per annum. In the final
period of the forecast (2015-2020), the aggregate energy
elasticity (the rate of change in energy consumption per the
rate of change in GDP) is projected to decline to a value
closer to recent Western historical experience (i.e., to 0.3 to
0.4). Thus, by 2020, aggregate energy intensity is projected to
decline to 64.4 percent of the 1990 level.
The official Energy Strategy is even more aggressive in
projecting energy savings potential in the economy. Despite
postulating much higher underlying economic expansion (see
above), it projects that primary energy consumption will grow
an average of only 1.3 percent per year between 2000 and 2020.
The shares of individual fuels in meeting aggregate primary
energy needs in Russia changed significantly over the course of
the 1990s, and PlanEcon believes that they will continue to
change in similar directions over the next two decades. The
share of natural gas has risen from 41.6 percent in 1990 to
52.2 percent in 2000. By 2010, we project the share of gas will
be up to 57.1 percent, and that it will rise further, to 60.6
percent, by the end of the forecast horizon in 2020. Most of
the gain in the share of gas takes place at the expense of
coal. From a share of 20.5 percent in 1990, coal had already
experienced a decline in importance to a low point of 17.2
percent of total primary energy consumption by 1998, before
rebounding to 18.0 percent in 1999 and 17.6 percent in 2000.
PlanEcon forecasts that coal's share of the total will rise
again in 2001, to 19.9 percent, before heading back down to
19.1 percent in 2005, with a further drop by the end of the
forecast, to only 13.8 percent by 2020.
The Energy Strategy envisions a very different picture. The
Ministry of Energy, the Strategy's principal author, thinks
that energy consumption has become too unbalanced in favor of
gas. In particular, the Strategy calls for greater use of coal
and nuclear power to meet the increased demand for electricity.
The Strategy projects a decline in the share of gas in Russian
primary energy consumption to about 40 percent by 2020, led by
a decline in the share of gas in fuels use by the electric
power sector from the current 62 percent to 51 percent by 2020.
Concomitantly, according to the Strategy, the share of coal in
primary energy consumption will rise slightly over the 20 year
period, to about 22.5 percent by 2020.
PlanEcon's view is that coal and nuclear are not only
intrinsically much more expensive than gas, but also come with
enormous environmental liabilities. Therefore with huge
reserves of relatively economic and clean natural gas, PlanEcon
forecasts that Russia's reliance on coal for power generation
and process heat is likely to wane further. The declining
relative importance of metallurgy in the country's aggregate
economic output should also serve to reduce the share of coal
in primary energy consumption as well.
PlanEcon anticipates that the share of oil/petroleum
products in meeting primary energy consumption will decline
further before rebounding slightly by 2020. Although demand for
motor fuels will increase as the Russian economy is
increasingly motorized and the fleet of cars and trucks
continues to grow, this will be partially offset by the
retirement of the sizable fleet of less fuel-efficient
gasoline-powered trucks and the improvement in the fuel
efficiency of vehicles more generally. Additionally,
restructuring away from heavy industry will further depress
demand for residual fuel oil (mazut) under industrial boilers,
while mazut as well as coal will face heavy competition from
less expensive natural gas. The share of petroleum products has
fallen from 29.5 percent in 1990 to only 19.3 percent by 2000.
Over the forecast period the share of petroleum products is
projected to decline to 17.5 percent in 2010 and 15.1 percent
in 2015 before rising to 18.5 percent in 2020.
The projection of primary energy production and consumption
also provides a forecast for their difference, or net energy
exports for Russia. Russian net energy exports reached a trough
in 1993 at 302.8 mtoe, a decline relative to 1990 of 24.4
percent. The greatest share of the decline took place in net
exports of oil, as the lack of investment resources and the
impact of the general economic decline fell heavily on the oil
extraction sector. Net oil exports in 1993 were at only 65.9
percent of the 1990 level, and were even further below the peak
reached in the late 1980s.
Net oil exports are now expected to surpass the 1990 level
(of 249.2 mtoe) already in 2008, and reach a peak of 267.4 mtoe
in 2015 before dropping slightly over the ensuing 5 years to
260.4 mtoe in 2020. The expansion of Russian oil output is
anticipated to decline over time, causing a decline in net
exports at the end of the forecast because of higher growth in
demand projected at that time (i.e., 2.3 percent per year in
2016-2020) when restructuring of mazut and low-octane gasoline
consumption is of less consequence.
Net exports of natural gas have remained constrained during
most of the 1990s by the lack of absorption capacity by
customers in international markets (primarily Europe) and
elsewhere in the CIS. Partly because of limited demand growth
in the importing countries (as well as institutional barriers
to mobilizing investment to expand production in Russia), net
exports of gas remained stagnant at around 150 to 160 mtoe (180
to 200 bcm) in the late 1990s. But with continued inroads by
gas in displacing coal and mazut in the CIS and Eastern Europe
and modest expansion of West European and Turkish demand for
Russian gas, net exports of gas are projected to rise rather
steadily in the later periods. Some new markets are also likely
to be pioneered in Asia as well for Russian gas from Sakhalin
and perhaps East Siberia as well. Net gas exports are forecast
to reach 308.5 mtoe (377.1 bcm) by 2020, 2.2 times the level
that characterized the low point of 1991.
PlanEcon anticipates that Russia will not retain its
position as a small net exporter of both coal and electricity.
The net surplus for coal is expected to become a slight net
deficit already in 2001, and the gap will steadily expand over
the next two decades. Russia's own exports of coal to the non-
former Soviet Union are expected to be more than offset by
rising imports of coal from Kazakhstan. But a small net trade
surplus in electricity is projected to remain over the 2000-
2020 period.
References
Goskomstat Rossii (Gosudarstvennyy komitet Rossiyskoy
Federatsii po statistike), Sotsial'no-ekonomicheskoye
polozheniya Rossii 2000 god, Moscow: 2001.
Goskomstat Rossii, Sotsial'no-ekonomicheskoye polozheniye
Rossii 1999 god, Moscow, 2000.
Goskomstat Rossii, Rossiyskiy statisticheskiy ezhegodnik,
statisticheskiy sbornik, Moscow: 2000.
Goskomstat Rossii, Rossiyskiy statisticheskiy ezhegodnik,
statisticheskiy sbornik, Moscow: 1999.
Goskomstat Rossii, Promyshlennost Rossii, statisticheskiy
sbornik, Moscow, 1995.
Government of the Russian Federation, Energy Strategy of Russia
for the Period to 2020: Main Provisions, Moscow,
November 2000.
GVTs Energetiki, Itogi raboty Mintopenergo Rossii 1999 god,
Moscow: 2000.
GVTs Energetiki, Itogi raboty Mintopenergo Rossii 1998 god,
Moscow: 1999.
McKinsey Report: Russian Oil, February 2001.
Mintopenergo (Ministerstvo Topliva i Energetiki Rossiyskoy
Federatsii) and IPROEnergo (Assotsiatsiya institut
pravovykh osnov energoeffektivnosti), Toplivo i
energetika Rossii, Moscow: 1999.
Mintopenergo (Ministerstvo Topliva i Energetiki Rossiyskoy
Federatsii) and IPROEnergo (Assotsiatsiya institut
pravovykh osnov energoeffektivnosti), Toplivo i
energetika Rossii, Moscow: 1998.
``Osnovniye kontseptual'niye polozheniya i razvitiya
neftegazovogo kompleksa Rossii'' (Basic Concepts for
the Progress and Development of the Oil and Gas Complex
of Russia), Neftegazovaya Vertikal', 1: January 2000
(Web address: ww.ngv.orc.ru).
Sagers, Matthew J., and Charles Movit, ``Projected Developments
in the Primary Energy Balances of the Former Soviet
Republics to the Year 2020, `` in PlanEcon Energy
Outlook. Washington, DC: PlanEcon, Inc., July 2001.
Sagers, Matthew J., Valeriy A. Kryukov, and Vladimir V. Shmat,
``Resource Rent from the Oil and Gas Sector and the
Russian Economy,'' Post-Soviet Geography, 36, 7: 389-
425, September 1995.
Sagers, Matthew J., ``The Russian Gas Industry in 1998 and
Prospects for the Future,'' in PlanEcon Energy Outlook.
Washington, DC: PlanEcon, Inc., April 1999, 147-217.
Sagers, Matthew J., ``Russian Crude Oil Production in 1996:
Conditions and Prospects,'' Post-Soviet Geography and
Economics, 37, 9: 523-587, November 1996.
AGRICULTURAL REFORM: MAJOR COMMODITY RESTRUCTURING BUT LITTLE
INSTITUTIONAL CHANGE
By William Liefert \1\
----------
contents
Page
Summary.......................................................... 253
Introduction..................................................... 254
Main Elements of Agricultural Reform............................. 255
How Reform Has Changed Agricultural Production, Consumption, and
Trade.......................................................... 257
The pre-reform Soviet agriculture and food economy........... 258
Price liberalization......................................... 260
Trade liberalization......................................... 262
Fall in output was inevitable part of market reform.......... 263
Current support and trade policies........................... 264
Effects on U.S. agricultural trade........................... 265
Consumption and food security concerns....................... 266
Farm Restructuring and Institutional Market Infrastructure....... 268
Private farms................................................ 268
Household plots.............................................. 271
Former state and collective farms............................ 272
New agricultural operators and a new spirit of enterprise?... 274
Could Reform Turn Russia into a Major Grain Exporter?............ 276
Conclusion....................................................... 278
References....................................................... 280
Summary
Economic reform in Russia has substantially changed the
volume and commodity mix of agricultural production,
consumption, and trade. The main development has been the large
drop in output, with the livestock sector being particularly
hard hit. During the 1990s livestock output and animal
inventories both fell by about half. However, the production
decline has been an inevitable part of market reform, as the
hefty Soviet-era subsidies to agriculture dropped severely. The
contraction of the livestock sector has ended the large imports
of grain and soybeans needed during the Soviet period as animal
feed. On the other hand, imports of meat and other high value
products have increased. These changes have affected U.S.
agriculture, as Russia has become the top foreign market for
U.S. poultry, in some years taking nearly half of all poultry
exports.
---------------------------------------------------------------------------
\1\ William Liefert is a Senior Economist with the Economic
Research Service (ERS), U.S. Department of Agriculture (USDA). The
author thanks Stefan Osborne, Bryan Lohmar, Zvi Lerman, and Mary Anne
Normile for helpful comments, though he bears full responsibility for
any remaining shortcomings. The opinions expressed in this paper are
the author's alone and do not in any way represent official USDA views
or policies.
---------------------------------------------------------------------------
Institutional change, which involves farm restructuring and
creation of the commercial and public infrastructure that a
market-oriented agricultural economy needs, has been
disappointingly slow. Private farms account for only 2 to 3
percent of agricultural output, while the former state and
collective farms continue to dominate the organizational
structure of agriculture. Although officially reorganized, with
many becoming ``joint stock companies,'' these farms have not
substantially changed their systems of management and internal
incentives inherited from the Soviet period. No federal
legislation exists that allows genuine private ownership of
agricultural land, which precludes development of a land
market. In the absence of major institutional reform in
agriculture, productivity growth in the sector during the
transition period has been negligible at best.
Introduction
This paper surveys developments within the Russian
agricultural economy since reform began in the early 1990s.\2\
The paper focuses on two main questions: how has reform changed
the commodity volumes and structure of Russian agriculture
(production, consumption, and trade), and how has the
institutional reform of Russian agriculture progressed?
Institutional reform involves such matters as farm level
restructuring and creation of the commercial and public
infrastructure that a market-oriented agricultural economy
needs.
---------------------------------------------------------------------------
\2\ The paper draws heavily on a forthcoming ERS study (Liefert and
Swinnen) that examines how reform has changed agricultural production,
consumption, and trade in the transition economies of the former Soviet
bloc. Another forthcoming ERS study (Cochrane et al.) focuses on how
reform in the transition economies has specifically restructured the
livestock sector. Sources on Russian agricultural developments during
transition include ERS (annual to 1996, 1997, and 1998), OECD (annual),
and OECD (1998). Much of the data presented in the paper are from ERS
and Organization for Economic Cooperation and Development (OECD)
databases.
---------------------------------------------------------------------------
The major commodity-related development during transition
has been the large fall in production, especially in the
livestock sector. Total agricultural output has declined by 40
percent compared to the pre-reform period, and production of
livestock goods about 50 percent. The drop in output is
important for U.S. policymakers and agricultural interests, for
three main reasons. The first is that it has strongly affected
U.S. agricultural exports. During the Soviet period, the
U.S.S.R. was a major importer of U.S. grain, soybeans, and
soybean meal, used primarily as animal feed for the country's
growing livestock herds. The severe downsizing of the livestock
sector in Russia (as well as in the rest of the former
U.S.S.R.) during transition has largely terminated these
imports. Russia is now importing substantial amounts of meat
and other livestock products, especially poultry. Consequently,
Russia has become the largest foreign market for U.S. poultry,
in some years taking nearly half of all poultry exports.
Another reason commodity developments are important for the
United States concerns policy advising and technical
assistance. The Russian agricultural establishment argues that
the contraction of agriculture, especially that of the
livestock sector, is a catastrophe for the country, and that
state policy toward agriculture should focus on returning
output to pre-reform levels. To accomplish this goal,
agricultural interests lobby for a substantial increase in
subsidies and trade protection for the sector, as well as other
policy interventions into agricultural markets that would be to
the sector's advantage, such as raising prices for agricultural
output relative to input prices. The United States, as well as
the European Union (EU) and international organizations such as
the World Bank and European Bank for Reconstruction and
Development (EBRD), have been heavily involved in policy
advising and technical assistance with Russian agriculture.
Therefore, it is important that the Russian agricultural
establishment and advising Western bodies generally agree on
the explanations as to why the main reform-related developments
within the sector have occurred, the drop in output being at
the top of the list.
The third reason the United States should be concerned
about Russian agricultural commodity developments is that the
drop in production and consumption during transition has raised
questions about Russia's food security. Both the United States
and EU have responded by providing Russia with food aid (most
recently in 1999-2000).
The paper is organized as follows. The first section
examines the main elements of Russian agricultural reform. The
next section examines how reform has changed Russian
agricultural production, consumption, and trade, highlighting
the role that price and trade liberalization played in
commodity restructuring. Subsections discuss how the
restructuring has affected U.S. agricultural trade, the current
status of Russian support and trade protection for agriculture,
and the consequences of commodity restructuring for food
consumption and food security.
The next section examines institutional developments, in
particular farm restructuring and creation of market
infrastructure for agriculture during transition. The focus
concerning farm restructuring is on the three major types of
agricultural producers--private farms, household plots, and the
former state and collective farms. The section concludes by
looking at new types of agricultural producers--large
vertically integrated agri-food enterprises--which some Russian
agricultural specialists believe could be a progressive force
in Russian agriculture, perhaps raising productivity and
injecting a stronger entrepreneurial spirit into the sector.
The paper's last section examines the possibility that
effective reform could turn Russia into a major exporter of
grain, as some Western specialists forecasted at the beginning
of transition.
Main Elements of Agricultural Reform
Agricultural reform in Russia has involved four main
elements: (1) market liberalization; (2) farm restructuring;
(3) reform of upstream and downstream operations; and (4)
creation of supporting market infrastructure. Market
liberalization involves removing government controls over the
allocation of resources and output, thereby allowing the market
to become the main means of allocation. It includes the key
reform policies of liberalizing prices and trade and
eliminating subsidies to agricultural producers and consumers.
By changing prices, incomes, and other key monetary values that
influence the market decisions of producers and consumers,
market liberalization has resulted in major changes in the
commodity volume and mix of countries' agricultural production,
consumption, and trade. Liberalization and its effects thereby
mainly address the question of what goods are produced and
consumed in the agricultural economy. Market liberalization
also links the macro-economy to agriculture. Macro-developments
such as inflation and movement in the exchange rate affect the
key variables (prices, consumer income) that drive agricultural
markets.
Farm restructuring changes the nature or system of
production at the level of the actual producer. It involves how
farms are owned, organized, and managed, that is, how goods are
produced. Key policies are privatization and land reform, which
directly affect incentives for using labor and other resource
inputs.
Market liberalization and farm restructuring affect output
and consumption in different ways. Market liberalization
changes the mix of goods produced and consumed in a way that
better satisfies consumers' desires for goods, but without any
necessary improvement in the system or technology of
production. Farm restructuring entails changes by producers in
the nature of production that could increase productivity. This
would allow more output to be produced from a given amount of
input, which would increase the total quantity of goods
available for consumption.\3\
---------------------------------------------------------------------------
\3\ Another way of explaining how market liberalization and farm
restructuring differently affect the economy is with the concepts of
(1) allocative efficiency and (2) technical efficiency and
technological change. By changing the mix and distribution of output in
a way that better satisfies consumers' desires, market liberalization
increases allocative efficiency. The gains to consumers occur without
any necessary improvement in the economy's overall (or any sectoral)
production function. Conceptually, market liberalization results in
movement along the economy's existing production possibilities
frontier. By allowing more output to be produced from a given amount of
input, farm restructuring increases technical efficiency. The move by
underachieving farms to the best domestically available production
practices results in movement from within an economy's production
possibilities frontier to the frontier. If the improvement occurs
because farms move to a new superior system or technology of
production, the farm restructuring spawns technological change. This
shifts the production possibilities frontier out.
---------------------------------------------------------------------------
Market liberalization and farm restructuring are
nonetheless interrelated. The main way is that market
liberalization can help motivate farm restructuring. The desire
to increase profit, or the fight just to stay in business, can
spur producers to reduce costs by changing their system of
production. The pressures from market competition are the key
to the relationship. However, market liberalization by itself
will not inevitably lead to farm restructuring--producers must
still make the actual changes in how they produce.
The third element of agricultural reform is transforming
upstream and downstream operations. Upstream activities concern
the supplying of agricultural inputs, while downstream
activities cover storage, transportation, processing, and
distribution. The transformation of these previously state-run
operations that were well-integrated into the planned economy
into privatized, market-oriented, and competitive enterprises
not only would improve their productivity and performance, but
also help farms improve theirs.
The fourth element of agricultural reform is the creation
of supporting market infrastructure. This involves establishing
the institutions and services, whether commercially or publicly
provided, that a well-functioning market-oriented agricultural
economy needs. These include systems of agricultural banking
and finance, market information, and commercial law that can
clarify and protect property, enforce contracts, and resolve
disputes. Development of market infrastructure and the
transformation of upstream and downstream operations are
closely related, and in some respects might be hard to separate
from each other. For example, in many isolated regions within
Russia, the collapse of the planned economy has deprived farms
(especially small ones) of any channels for obtaining inputs,
or for selling, storing, or processing their output. In other
words, upstream and downstream linkages, as well as the market
infrastructure (such as market information) that could allow
farms to find new linkages, are completely lacking.
The four elements of agricultural reform identified in this
paper are roughly comparable to the taxonomy of reform elements
developed by the World Bank (Csaki and Nash, 2000) for
agriculture in all transition economies of the former Soviet
bloc. The World Bank reform elements are (1) price and market
liberalization; (2) land reform and privatization; (3)
privatization and reform of agro-processing and input supply
enterprises; (4) rural finance; and (5) institutional reforms
(largely involving public services). Market liberalization
corresponds to World Bank element No. 1, farm level
restructuring to World Bank element No. 2, reform of upstream
and downstream operations to World Bank element No. 3, and
market infrastructure to World Bank elements Nos. 4 and 5.
How Reform Has Changed Agricultural Production, Consumption, and Trade
Since reform began in the early 1990s, Russian agriculture
has experienced major commodity restructuring--that is, major
changes in the commodity volume and mix of agricultural
production, consumption, and trade. The main feature of the
restructuring has been a substantial drop in agricultural
production, especially in the livestock sector (Table 1).\4\
During the 1990s meat production, as well as livestock
inventories, fell by about half.
---------------------------------------------------------------------------
\4\ For data on Russian agricultural production and trade, as well
as analysis of issues involving Russian agriculture, see the briefing
rooms on Russia at the ERS Web site www.ers.usda.gov. ERS briefing
rooms also exist for agriculture in the other transition economies of
Ukraine, Hungary, and Poland.
---------------------------------------------------------------------------
The data in the table are based on countries' official
production numbers, which exaggerate the decline in output. In
the pre-reform period farms had an incentive to overstate their
production in order to look better with respect to output
performance, while in the transition period farms have an
incentive to understate production, in order to avoid taxes and
buttress their argument that they need more state support.
Also, the difficulty of measuring output by private and
household producers adds to the undercounting of transition
production. Yet, even if not wholly accurate, the official
numbers clearly show a large decline in output. The downsizing
of the sector has also coincided with a major drop in
consumption of livestock products (Table 2).
Table 1 shows that the drop in agricultural production has
been part of an economywide decline in output. Given that
Soviet planners favored production of capital goods over
consumer products, one should not be surprised that the
elimination of central planning strongly hit industrial
production (especially heavy industry such as metallurgy and
chemicals). However, since foodstuffs are the most fundamental
of consumer purchases, a major decline in agricultural
production might seem counterintuitive. Yet, the main reason
agricultural output has fallen in Russia during the transition
period is the same as why industrial output and gross domestic
product (GDP) have declined--consumers' desires for goods have
replaced planners' preferences as the dominant force in
determining what goods are produced, consumed, and traded. As
with heavy industry, the contraction and commodity
restructuring of agriculture in Russia has been an inevitable
part of market reform.
TABLE 1.--CHANGES IN PRODUCTION
------------------------------------------------------------------------
Production
Commodity index
------------------------------------------------------------------------
Aggregate:
Total agriculture..................................... 60
Total crops........................................ 69
Total livestock products........................... 52
Total industry......................................... 50
Gross domestic product (GDP)........................... 61
Crops:
Grain.................................................. 61
Sunflowerseed.......................................... 106
Sugar beets............................................ 40
Potatoes............................................... 93
Vegetables............................................. 101
Livestock products:
Meat................................................... 48
Milk................................................... 61
Eggs................................................... 68
Livestock inventories:
Cattle................................................. 53
Pigs................................................... 45
Poultry................................................ 56
------------------------------------------------------------------------
Note: The production index gives average annual production (or
inventories) over 1997-1999 relative to average annual production (or
inventories) over 1986-1990, with 1986-1990 = 100.
Source: USDA.
Agricultural production has dropped severely in almost all
the transition economies of the former Soviet bloc, though
particularly in the countries of the former U.S.S.R. In most
transition economies, total agricultural output fell during the
1990s by 25 to 50 percent. The ensuing explanation for the
sector's downsizing applies to a fair degree to all these
countries. To examine the downsizing of Russian agriculture,
one must first explore certain features of the pre-reform
Soviet agricultural economy.
the pre-reform soviet agriculture and food economy
In the late 1960s the leadership of the Soviet Union
decided to increase production of livestock goods, a policy the
East European countries of the Soviet bloc generally followed.
Consequently, from 1970 to 1990 livestock herds and output in
these countries grew by 40 to 60 percent. For example, in the
former U.S.S.R., Poland, and Hungary, meat production in 1990
was higher than in 1970 by 63, 43, and 57 percent (Economic
Research Service (ERS) databases). The rise in feed
requirements caused by the growing herds stimulated the crop
sector. In the late 1980s the average annual output of feed
grain in the former U.S.S.R. was up by about half compared to
the late 1960s. The feed requirements of the former U.S.S.R.
were so great that the country also became a substantial
importer of grain, soybeans, and soybean meal, much from the
United States (Table 3).
TABLE 2.--PER CAPITA CONSUMPTION OF FOODSTUFFS BY COUNTRY
[In kilograms]
----------------------------------------------------------------------------------------------------------------
Great
Foodstuff Poland Hungary Romania Russia Ukraine U.S.A. Germany Britain Japan
----------------------------------------------------------------------------------------------------------------
1990:
Meat.............................. 73 101 74 75 68 113 96 72 38
Milk (excluding butter)........... 230 178 99 \1\ 18 \1\ 184 256 224 227 65
Cereals........................... 145 148 173 4 \1\ 164 109 94 93 133
Potatoes.......................... 144 58 59 \1\ 16 131 55 81 105 25
4
106
1997:
Meat.............................. 66 84 50 48 32 117 83 73 42
Milk (excluding butter)........... 204 156 179 145 156 254 236 234 68
Cereals........................... 157 113 205 156 160 116 83 95 118
Potatoes.......................... 136 66 82 125 126 62 79 113 26
----------------------------------------------------------------------------------------------------------------
\1\ Figure for entire U.S.S.R.
Source: United Nations Food and Agriculture Organization.
TABLE 3.--AGRICULTURAL IMPORTS BY THE FORMER U.S.S.R. AND RUSSIA
[In thousands of tons]
------------------------------------------------------------------------
Former U.S.S.R. Russia
Commodity -----------------------------------
1986-1990 1995-1998 1995-1998
------------------------------------------------------------------------
Total imports:
Grain........................... 35,720 2,150 2,860
Soybeans and soybean meal \1\... 4,500 850 190
Meat............................ 810 1,970 1,670
Imports from the United States:
Grain........................... 13,700 660 190
Soybeans and soybean meal \1\... 1,720 160 20
Meat............................ 2 1,200 990
------------------------------------------------------------------------
\1\ In soybean equivalent.
Note: Figures give average annual values over the period. Imports by the
former U.S.S.R. in 1995-1998 are from beyond the region, while imports
by Russia for 1995-1998 are from both beyond and within the former
U.S.S.R.
Source: USDA.
By 1990 per capita consumption of livestock products and
foodstuffs in general in the pre-reform transition economies
compared favorably to levels in many Organization for Economic
Cooperation and Development (OECD) nations (Table 2). Since per
capita GDP in the U.S.S.R. and Eastern Europe was at most only
half the OECD average, these countries were producing and
consuming high-cost livestock products at a much higher volume
than one would expect based on the countries' real income. This
``achievement'' came at a price, as large state subsidies, to
both producers and consumers, were necessary to maintain the
high levels of production and consumption. For example, by 1990
direct budget subsidies to the agriculture and food economy in
the U.S.S.R. equaled about 10 percent of GDP, with the bulk
going to the livestock sector. The subsidies created price
gaps, whereby the prices paid to producers exceeded those
charged to consumers. In the late 1980s agricultural producer
prices in the aggregate exceeded consumer prices by about 75
percent (Liefert and Swinnen).
A major feature of the pre-reform Soviet food economy was
that consumer prices for foodstuffs were set so low that output
could not satisfy all the demand generated by the prices. In
the pre-reform period long lines of shoppers and bought-out
food stores were commonly interpreted in both the Soviet Union
and the West as signs of major food shortages. However, low
state-set consumer prices that overly stimulated demand were
the main cause of these ``market shortages,'' rather than
inadequate supplies of foodstuffs in volume terms (as the
inter-country comparison of consumption in Table 2 shows).
price liberalization
The lead policy of economic reform in Russia was price
liberalization. This involved the corollary policy of reducing
or eliminating state budget subsidies needed to maintain the
gaps between prices paid to producers and prices charged to
consumers. The result was that the market became the dominant
force in determining prices and the quantities of goods
produced and sold. The fall in producer prices from ending the
price gap lowered production.
Price liberalization had two other more indirect but
nonetheless significant effects on markets for agricultural
products. These came from the drop in consumer income and the
deterioration in the terms of trade for agriculture that
accompanied the liberalizing of prices. The freeing of prices
led to high economywide inflation, in the early reform years in
the hundreds of percent annually. The massive inflation
substantially reduced consumers' real income, and
correspondingly purchasing power, as prices economywide rose by
a greater percent than wages and salaries. By the late 1990s
real per capita income in Russia was only about half the level
of 1990 (PlanEcon). The income decline reflects not only the
drop in pay for workers who kept their jobs, but also the rise
in unemployment during the transition period.
The degree to which changes in real income affect the
market for a specific foodstuff depends on how sensitive demand
is to income variations (income elasticity of demand). Among
foodstuffs, demand for livestock products is relatively
sensitive to changes in income (income elastic). This means
that declining income particularly hurt the livestock sector.
The fall in demand cut production further. The downsizing of
the livestock sector also lowered demand for animal feed (feed
grains and oilseeds), and thereby upset those markets. Since
the bulk of grain output in Russia is used as animal feed (as
in most countries), the contraction of the livestock sector
largely drove the decrease in grain production, rather than a
decline in human demand for grain products.
In fact, for certain foods, such as bread and potatoes,
demand can rise rather than fall when income decreases
(inferior goods). Table 2 shows that during the transition,
consumption of cereals in Russia has remained generally steady
while potato consumption has increased, suggesting that in
Russia potatoes might be inferior goods.
The second way price liberalization affected agricultural
markets was on the supply side, by raising the real prices for
agricultural inputs. In the inflation following price
liberalization, prices for agricultural inputs rose by a much
greater percentage than prices for agricultural output. This
increased the real prices producers had to pay for inputs, or
in other words, worsened producers' terms of trade. In Russia,
agriculture's terms of trade declined during the 1990s by about
75 percent. For example, in Russia in 1992, wheat producers on
average had to sell 0.3 tons of output to purchase one ton of
nitrogen fertilizer. In 1997 they had to sell 1.4 tons of wheat
(Russian Federation, 1998). Higher input prices decreased the
amount of inputs used in production, which reduced output
further. For example, in Russia from 1990 to 1997, fertilizer
use per hectare fell 80 percent, from 88 to 16 kilograms
(Russian Federation, 2000).
Price liberalization could result in input prices rising
relative to output prices for two reasons. The first is that in
the pre-reform period prices for inputs were set lower relative
to their production cost than were prices for output. When
prices were then freed, prices for inputs had to rise more than
prices for output to reach the value of the real cost of
production. Such price-setting behavior means that in the pre-
reform period producers were subsidized not only through direct
budget subsidies, but also indirectly through the price system.
The second possible reason input prices could rise relative
to output prices involves not just market liberalization but
also the market structure for suppliers of agricultural inputs.
In the pre-reform period farms were typically dependent for the
supply of any particular input on just a few, and perhaps only
one, large state distributor(s). During the early reform years,
markets were liberalized and the input distributors privatized
without the latter being broken up into smaller competing
units. During the transition period farms have accused the
large suppliers of using their monopoly-type market power
inherited from the Soviet period to charge higher prices than
would be possible if a number of smaller competitive suppliers
existed, prices that exceed the input producers' costs of
production.
Although this problem has probably existed to some degree,
gauging the degree of the problem is difficult. In Russia,
local authorities continue to help the large former state and
collective farms obtain inputs, often at below market prices,
in return for the farms' willingness to sell them a certain
amount of output at agreed-upon prices. Since the prices of
both inputs and output exchanged in these deals often deviate
from existing market prices, it is difficult to determine
whether farms are on net gaining or losing from the
arrangement. Given that Russian regional governments have been
paternalistic toward their local agriculture, fearing that
defunct farms would create unemployment and food security
problems, they have probably not used this relationship much to
farms' disadvantage.
trade liberalization
The second major reform policy that affected commodity
restructuring in agriculture was trade liberalization. When
Russia liberalized trade, domestic producer prices for most
agricultural goods lay above world market prices (OECD, 1998).
This was yet another way that the pre-reform system subsidized
Russian agriculture--setting domestic producer prices above
world prices. The fall in prices to world levels during the
transition period further reduced agricultural production.
The Soviet Union was a major agricultural importer of
products from outside the Soviet bloc (with most of the imports
going to Russia). The main imports included feed grain,
soybeans, and soybean meal, needed to feed the growing
livestock herds. The reform-driven contraction of the livestock
sector has severely reduced these imports (Table 3).\5\ Instead
of importing feed to maintain their expensive livestock herds,
Russia and the other countries of the former U.S.S.R. are now
importing meat and other livestock products directly. From the
second half of the 1980s to the period 1995-1998, average
annual meat imports by the countries of the former U.S.S.R.
rose by about 125 percent (Table 3), with Russia taking the
bulk.\6\
---------------------------------------------------------------------------
\5\ This point takes issue with the criticism commonly made of the
Soviet Union that it could not even feed itself. Rather than allaying
food shortages, the imports of animal feed were used to maintain
artificially high levels of livestock production and consumption.
\6\ The reason the data in Table 3 stop at 1998 is that in 1999 and
2000 the United States and EU gave Russia substantial food aid. The
official Russian foreign trade data do not distinguish between
commercial imports and food aid, and separating out the two categories
of inflows would be overly difficult.
---------------------------------------------------------------------------
The switch by Russia during transition from being a major
importer of animal feed to a major importer of meat and other
livestock products suggests that the country has a comparative
disadvantage in the production of livestock products relative
to animal feed; that is, it produces meat and other livestock
products at a higher cost than it produces animal feed,
relative to world market prices. Liefert (1994) supports this
conclusion. He finds that at the end of the Soviet period, the
U.S.S.R. had a general comparative disadvantage in agricultural
goods vis-a-vis industry, and within agriculture a comparative
disadvantage in meat production compared to grain. That
agricultural trade during the Soviet period appears to have
been inconsistent with comparative advantage shows the extent
to which trade was driven by policy rather than economic
rationality. Liefert (forthcoming) finds that in the late
1990s, despite the major production and trade adjustments that
had occurred during almost a decade of transition, Russia
continued to have a comparative disadvantage in meat production
vis-a-vis grain.
In addition to meat, Russia's main agriculture and food
imports include other high-value products such as fruit,
processed foods, beverages, and confectionary products, as well
as the bulk crop sugar (mainly from Ukraine). A negligible
agricultural exporter, Russia has maintained a large trade
deficit in agriculture (Table 4).
TABLE 4.--AGRICULTURAL TRADE BALANCE
[In billions of U.S. dollars]
----------------------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998
----------------------------------------------------------------------------------------------------------------
Total trade
Imports......................................... $9.62 $5.95 $10.7 $13.18 $11.56 $13.36 $10.27
Exports......................................... 1.65 1.67 2.78 2.67 3.2 2.48 2.2
Net imports..................................... 7.97 4.28 7.92 10.51 8.36 10.88 8.07
Trade with the United States
Imports......................................... 1.13 1.22 0.65 1.03 1.33 2 0.83
Exports......................................... 0.02 0.02 0.02 0.02 0.04 0.03 0.03
Net imports..................................... 1.11 1.2 0.63 1.01 1.29 1.97 0.8
----------------------------------------------------------------------------------------------------------------
Source: USDA and OECD.
fall in output was inevitable part of market reform
The analysis shows that commodity restructuring in Russia
has been an inherent part of market liberalizing reforms. Price
and trade liberalization substantially changed prices and
incomes--the two main factors on which producers and consumers
base their decisions to produce, buy, and sell goods. Changes
in these variables in turn induced major changes in
agricultural production, consumption, and trade. The decline in
output, particularly in the livestock sector, was inevitable.
Price liberalization caused output for a typical good to fall
for three reasons--elimination of the gap between producer and
consumer prices, the drop in consumer income, and the rise in
inputs' real prices, with the last two effects occurring from
economywide price liberalization. Trade liberalization added a
fourth reason production could drop, since world prices lay
below domestic producer prices for most agricultural goods.
A parallel way of explaining why reform has reduced output
is by identifying how the pre-reform system directly and
indirectly subsidized agriculture, and how price and trade
liberalization caused production to drop by eliminating these
subsidies. The three main types of subsidies were direct budget
subsidies from the government (which maintained the gap between
producer and consumer prices), the domestic price system which
kept prices for agricultural inputs low relative to producer
output prices and the real costs of production, and the price
and trade system which kept domestic producer prices above
world trade prices.
That the decline in agricultural output has been a
necessary consequence of market liberalization means that the
change in output is an unsuitable indicator of the success of
agricultural reform. The degree to which output has fallen in
individual countries is largely a measure of the extent to
which agriculture in the pre-reform period was subsidized,
planners' preferences for goods deviated from consumers'
preferences, and the structure of countries' production and
foreign trade differed from that based on comparative
advantage.\7\
---------------------------------------------------------------------------
\7\ Although examining why industrial output has also fallen during
the transition period is beyond the scope of this report, the general
reasons are the same as those given for agriculture. Planners' desires
for goods dominated over those of consumers, industrial production was
subsidized (especially in heavy industry), and production and trade
were not driven by countries' comparative advantage vis-a-vis the world
market. Thus, industry also was an overexpanded sector of the economy.
---------------------------------------------------------------------------
current support and trade policies
Although the various types of direct and indirect subsidies
to Russian agriculture steadily diminished during the 1990s,
state support to agriculture has not been wholly eliminated.
Relative to agriculture's share in GDP of 7 percent, budget
subsidies by the federal government are low, comprising less
than 2 percent of the federal budget, and just a fraction of 1
percent of GDP. However, as federal subsidies to agriculture
diminished during the decade, subsidies by regional and local
governments increased, such that in the aggregate they
currently exceed total federal budget support. Regional
governments are concerned about both the local food security
and employment consequences of falling output and unprofitable
farms within their jurisdictions. With their growing support to
agriculture, local governments have gained influence over
farms. As mentioned earlier, they typically help their farms
obtain inputs, often at low or subsidized prices, in return for
the farms' willingness to sell them output at agreed-upon
prices.
Farms are also subsidized indirectly by the recurring
policy of writing off of debt. Farms habitually receive ``soft
credits,'' either from state or quasi-state lenders, which are
usually written off. During the 1990s most Russian former state
and collective farms were unprofitable (currently about 50
percent are), and yet virtually none have gone bankrupt and
closed down. That unprofitable farms can keep functioning means
that their creditors (both input suppliers and lenders)
indirectly subsidize them by either not calling in debt or
eventually abolishing it.
Foreign trade policy in agriculture currently is not overly
protectionist. Import quotas do not exist, with the exception
of sugar (directed mainly at Ukraine). Import tariffs for most
agricultural goods range between 10 and 20 percent, with 30
percent being the maximum. Some exports are also restricted, in
particular sunflowerseed. Sunflowerseed exports are taxed,
mainly to keep domestic output within the country to help
national processors (crushers) suffering from excess capacity.
The dismantling of the state monopoly over foreign trade,
and the array of prices and trade controls that were part of
the monopoly, has substantially narrowed the gap between world
and domestic producer prices for agricultural goods. As a
result, the indirect subsidy to Russian agricultural producers
during the Soviet period from receiving prices above world
trade prices has declined significantly.\8\
---------------------------------------------------------------------------
\8\ For detailed discussion and data concerning support to Russian
agriculture during the transition period, see OECD 1998.
---------------------------------------------------------------------------
However, agricultural trade restrictions have been stronger
at the regional rather than federal level. Regional and local
governments commonly restrict outflows of agricultural output
from their jurisdiction. This hinders not only export beyond
the borders of Russia, but also agricultural trade within the
country. The most benign-possible reason for the flow
restrictions is that regional authorities wish to protect their
own consumers by ensuring that local supplies are adequate. The
most malign-possible reason is corruption, as officials might
exploit the regional price differences created by these
restrictions to earn easy profits. Such controls work to
segment regional markets from each other, as well as cut
regional markets off from the world market. Without these
restrictions Russian agricultural exports probably would not be
much higher, but imports would be lower. The controls prevent
regional output from reaching the large cities, such as Moscow
and St. Petersburg, where domestic output competes with
imports.
Russia began its negotiations for accession to the World
Trade Organization (WTO) in 1994, and could finally gain
admission within the next few years. The two main areas of
negotiation concern market access (involving import
restrictions such as tariffs and quotas) and domestic support.
Compared to most other countries (whether in the WTO or not),
the levels of Russia's current tariffs and domestic support to
agriculture are neither particularly high nor low. Although
Russia's negotiated terms of entry could reduce these amounts a
bit, the effect on import volumes might not be substantial, at
least in the near term. However, WTO accession would bind the
country to maximum allowable levels of tariffs and domestic
support, which would prevent Russia from raising the levels in
the future.
Accession would also facilitate the development of a
transparent, rules-based, and predictable trading system, the
lack of which is probably the biggest current impediment to
trade. For example, Russia has used arguments concerning health
and safety to restrict imports of poultry from the United
States. By binding Russia to the WTO's Agreement on the
Application of Sanitary and Phytosanitary Measures, accession
would require that any Russian complaints raised on this issue
comply with WTO rules and procedures. A potential problem
concerning WTO rules' enforcement for Russia, though, is the
proliferation of support and controls by regional and local
governments (such as the bans on outflows). Although these
measures might conflict with WTO rules and commitments (just as
they often violate Russian federal law), enforcing WTO
disciplines at such decentralized levels of government could be
difficult.\9\
---------------------------------------------------------------------------
\9\ For further discussion of Russia's WTO accession involving
agriculture, see Liefert (1997).
---------------------------------------------------------------------------
effects on u.s. agricultural trade
The Soviet Union was a major market for U.S. grain,
soybeans, and soybean meal (Table 3). The reform-driven changes
in agricultural production and trade in Russia and the other
countries of the former U.S.S.R. have strongly affected U.S.
agricultural trade. U.S. exports of the above commodities to
the region have fallen substantially (Table 3). However, the
United States has moved from exporting almost no meat to the
region in the pre-reform period to being a major meat exporter.
The bulk of the exports are poultry, with most going to Russia.
Since the changes in Russian agricultural trade are being
driven by the economic fundamentals of comparative advantage,
rather than any short-run ``disruptions of transition,'' the
changes in the volume and structure of U.S. agricultural
exports to Russia and the rest of the former U.S.S.R. region
are not likely to be reversed in the foreseeable future.
During the second half of the 1990s, Russia took nearly
half of all U.S. poultry exports. Poultry accounted for about
three-fourths of all U.S. agriculture and food exports to
Russia in value terms, and imported poultry (mainly from the
United States) provided over half of all poultry consumed in
Russia. Other U.S. agricultural exports include red meat and
processed foods. As the United States imports virtually no
agricultural products from Russia, during the 1990s it ran an
agricultural trade surplus with the country annually averaging
about $1 billion (Table 4).
Russia's financial crisis that hit in August 1998 severely
cut the country's agricultural imports, seriously hurting U.S.
exports. One of the main consequences of the crisis was
depreciation of the ruble vis-a-vis the U.S. dollar and other
major Western currencies by about 75 percent, as the exchange
rate quickly fell from about 6 rubles to the dollar to 25
rubles. In the fourth quarter of 1998, total Russian
agricultural imports were down by about 80 percent compared to
the previous year, and by 2000 had recovered to only half the
pre-crisis level. U.S. agricultural exports (again especially
poultry) to Russia crashed in late 1998, though have since
steadily rebounded. By early 2001 U.S. poultry sales to Russia
were close to pre-crisis levels (230,000 metric tons in the
first quarter of 2001).
In 2001 and 2002 U.S. meat exports to Russia might also
benefit from the outbreak of both mad cow disease (Bovine
Spongiform Encephalopathy, or BSE) and foot-and-mouth disease
in the EU. The EU has been Russia's main source of imported
beef and pork. In early 2001 Russia, along with other countries
such as the United States and Canada, banned the import of all
EU meat (though poultry was later allowed). In 1999 and 2001
Russia also forbade imports of pork from China, because of
foot-and-mouth disease outbreaks there. Although it is unclear
how long the meat import embargoes imposed by Russia will last,
the bans, as well as lingering Russian suspicion concerning
imported meat from the EU and China, could provide U.S. beef
and pork producers with at least a short- to medium-term
opportunity to expand exports.
consumption and food security concerns
The drop in agricultural production during reform has
coincided with a fall in consumption of livestock products
(Table 2). In discussing food security in Russia, the Western
media commonly give the decline in agricultural output and
consumption as evidence that transition has seriously worsened
food security. Although transition has created a food security
problem, the cause of the problem is not the drop in
agricultural output, nor is it more generally insufficient food
supplies. As mentioned earlier, before reform, Russia had high
per capita levels of consumption of most foodstuffs, including
meat and other high-value livestock products, compared with
even rich OECD nations. The best evidence of the adequate
availability of foodstuffs during transition is that, even with
food supplies and consumption being relatively high in the pre-
reform period, consumption of staple foods such as cereals and
potatoes has remained steady or even risen (Table 2).
Consumption of high-value livestock products has fallen during
transition. As mentioned before, however, per capita GDP in
Russia and the rest of the U.S.S.R. before reform was at most
only half the OECD average. Consumption of ``luxury'' livestock
products has therefore declined during transition to levels
more consistent with the country's real income.
Reform has threatened food security in Russia not because
of inadequate overall supplies of foodstuffs, but because of
problems involving access to food for segments of the
population and certain regions within the country. The
inflation and rising unemployment of the transition period
increased poverty, such that food became less affordable to a
growing share of the population. The groups most vulnerable to
poverty are those dependent on the state welfare system for
their income (such as pensioners), which has declined in real
terms because of inflation, and workers who have lost their
jobs or suffered a decline in their real wages, largely because
they are (were) employed by industries producing goods for
which demand has dropped during reform. Reports suggest that as
much as 30 percent of the Russian population might be living
below the poverty level.
In addition, as discussed earlier, agricultural surplus-
producing regions commonly restrict the outflow of foodstuffs.
Whether the authorities' motive is to protect their consumers
by strengthening local supplies or to benefit corruptly from
the price arbitrage opportunities created by the restrictions,
the controls can prevent food-deficit regions from obtaining
needed supplies.
In 1999-2000, Russia received substantial food aid from the
United States and EU. U.S. aid for the 2 years totaled over 3
million metric tons (mmt) of commodities worth about $1.1
billion, while the EU gave 1.8 mmt, worth almost $0.5 billion.
Most of the U.S. and EU aid was targeted to food deficit
regions, while some of the U.S. aid was distributed by private
voluntary organizations to the poor and elderly.\10\
---------------------------------------------------------------------------
\10\ One of the motivating factors in the large aid to Russia was
worry about the effects on food availability of Russia's economic
crisis of 1998. As discussed earlier in the report, the crisis
substantially depreciated the Russian ruble vis-a-vis Western
currencies. By raising the price of imported foodstuffs, the
depreciation cut food imports in half. It has been a commonly held
belief during the transition that Russia imports over half of its food.
If true, the large drop in imports following ruble depreciation could
by itself threaten food security. However, the Economic Research
Service of USDA has calculated that even before Russia's crisis,
imports accounted for only about a fifth of the country's total food
consumption. Poultry (mainly from the United States) was the only major
foodstuff for which imports have been providing over half of domestic
consumption. Imports do account, though, for over half of the food
consumed in major cities such as Moscow and St. Petersburg.
Extrapolating the experience of the big cities to the entire country
might explain how the misconception developed concerning the importance
of imports to total national food supplies (see Liefert and Liefert,
1999).
---------------------------------------------------------------------------
These distribution policies reflect the wisdom of targeting
food aid to needy social groups and regions. Such distribution
will not only have the strongest possible humanitarian effect,
but also limit any potential harm to agricultural producers.
Funneling food aid to the poor who have reduced purchasing
power and to food deficit regions where food prices are high
will minimize the injury that food aid can cause agricultural
producers by depressing prices.
The reform-driven drop in agricultural production and
consumption in Russia is part of the economywide reallocation
of resources away from producing and consuming goods favored by
planners and the political elite to goods favored by consumers.
It might seem surprising to describe foodstuffs as goods more
favored by planners than consumers. Yet, as previously
discussed, the high levels of agricultural production and
consumption of foodstuffs during the pre-reform period required
large direct and indirect subsidies to both producers and
consumers. Once market liberalization and the decline in
subsidies resulted in foodstuffs reflecting the full cost of
their production, consumers switched from buying high value
livestock products to other goods and services. Reform has in
fact created entirely new goods, and in particular services,
which consumers were starved of under the old regime and to
which demand has turned during reform. Some of the worry in
both Russia and the West about declining food production and
consumption during reform has been based on the misconception
that by their very nature, foodstuffs must be more favored by
consumers than planners, such that the general public must on
net inevitably suffer if reform reduces consumption.
Farm Restructuring and Institutional Market Infrastructure
This paper argued earlier that because the contraction of
agricultural output has been an inherent part of market reform,
output is a misleading indicator of reform progress within the
sector. A more appropriate indicator is growth in productivity,
that is, farms' ability to produce more output from a given
amount of inputs. Productivity growth would increase farm
output and profitability, improve the cost-price
competitiveness of Russian production vis-a-vis the world
market (which in the Russian context mainly means competing
better against imported foodstuffs in the country's large urban
markets), and save resources that could move out of agriculture
to produce goods in other sectors of the economy.
The changes in Russian agriculture that could raise
productivity must come in the major areas of agricultural
reform (other than market liberalization) identified at the
start of the paper--farm restructuring, changes in upstream and
downstream operations, and development of institutional
infrastructure. However, progress in these areas to date has
been disappointing, from the point of view of both the actual
changes made and improved productivity performance.
Developments will be examined from the point of view of the
three main types of agricultural producers during the
transition period: private farms, household plots, and the
former state and collective farms.
private farms
At the start of reform many Russian agricultural reformers
hoped that private farms would be the vanguard of successful
market-driven reform of agriculture. By 1995 about 280,000
private farms existed in Russia, comprising 5 percent of all
farmland, and producing 2 percent of total agricultural output
(Table 5). The average size of the farms in 1995 was 43
hectares (106 acres).
TABLE 5.--SHARE IN AGRICULTURAL OUTPUT OF DIFFERENT PRODUCERS
[In percent]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Private farms Household plots \1\ Former state and collective farms
Commodity --------------------------------------------------------------------------------------------------------
1995 1996 1997 1998 1999 1995 1996 1997 1998 1999 1995 1996 1997 1998 1999
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total output................................... 1.9 1.9 2.4 2.1 2.5 47.9 49.1 51.1 59.2 57.2 50.2 49.0 46.5 38.7 40.3
Grain.......................................... 4.7 4.6 6.2 6.8 7.1 0.9 0.8 0.8 0.9 0.9 94.4 94.6 93.0 92.3 92.0
Sunflowerseed.................................. 12.3 11.4 10.8 10.9 12.6 1.4 1.6 1.4 1.5 1.3 86.3 87.0 87.8 87.6 86.1
Sugar beets.................................... 3.5 3.3 3.5 4.0 5.4 0.6 0.7 0.8 0.8 0.8 95.9 96.0 95.7 95.2 93.8
Potatoes....................................... 0.9 0.9 1.0 1.0 1.0 89.9 90.2 91.3 91.2 92.0 9.2 8.9 7.7 7.8 7.0
Vegetables..................................... 1.3 1.1 1.5 1.8 2.1 73.4 76.8 76.3 79.6 77.0 25.3 22.1 22.2 18.6 20.9
Meat \2\....................................... 1.5 1.7 1.6 1.6 1.7 48.6 51.6 55.9 56.9 59.4 49.9 46.7 42.5 41.5 38.9
Milk........................................... 1.5 1.5 1.5 1.6 1.7 41.4 45.4 47.2 48.3 49.7 57.1 53.1 51.3 50.1 48.6
Eggs........................................... 0.4 0.4 0.4 0.4 0.4 30.2 31.2 30.4 30.1 29.4 69.4 68.4 69.2 69.5 70.2
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Includes garden plots.
\2\ Liveweight (before slaughter).
Source: Russian State Committee for Statistics.
Since 1995 private farming has not grown by much, in terms
of either number of farms or the farms' share in total output
(though average farm size has increased to 58 hectares). A
number of serious impediments exist to their growth and
prosperity. Although these obstacles hurt all types of
agricultural producers to some degree, they are the most vexing
for private farms. One impediment is the absence of full
private ownership rights in agricultural land. A 1993
Presidential Decree sanctioned private property in farmland.
This has allowed individual farmers to obtain and use farmland
for private gain, as well as de facto pass the land on to their
heirs. Most private farmers acquired their land in two ways.
The first was the reorganization of former state and collective
farms in 1993, whereby farm members were given shares of land
which they could choose to farm individually. The second way
was purchasing land from the state land reserve, which was
created at the beginning of reform from land taken from former
collective farms.
However, private farmers do not fully own their land, and
can only sell it back to the state land reserve. Also,
foreigners cannot purchase farmland. What is most lacking is
federal legislation passed by the Duma which gives individuals
full legal title to farmland, which they could sell to others.
The Yeltsin Administration pushed for legislation that would
allow full private property in farmland, and it appears that
some in the Putin Administration also support such a position.
However, the Duma, in which conservative agrarian interests
have been strong throughout the transition period, has
consistently opposed such legislation. In June 2001 a law in
the Duma passed its first reading (three ``readings'' are
necessary to become law) that would allow private ownership of
land. However, the law sidesteps the issue of ownership of
agricultural land, by stating that agricultural land will be
handled in future legislation. If no federal legislation is
passed in the near to medium term that specifically addresses
the question of farmland, regional (oblast) legislation would
probably determine the specific conditions of its ownership and
use. Although some regions have passed liberal legislation
concerning agricultural land, others have enacted very
conservative laws that deny private ownership.
The mass of conflicting federal and regional laws and rules
concerning farmland has had the collective effect of preventing
the development of an agricultural land market. One negative
consequence of the absence of private ownership of farmland and
a land market is that farmers cannot use their land as
collateral for debt. Current law in fact prohibits farms from
mortgaging their land. This makes it virtually impossible for
them to obtain commercial loans. A second negative effect is
that without the security of full ownership, farmers have
reduced incentive to invest in developing their land.
Other major impediments to the development of private
farming concern the third and fourth major elements of Russian
agricultural reform identified at the start of the paper--
upstream and downstream linkages and supporting market
infrastructure. Upstream and downstream linkages and market
infrastructure have all been weak during the transition period.
During the Soviet era farms received inputs directly from the
state and also gave their output directly to the state
distribution system. Private farmers, however, must secure
inputs for themselves and also market their output. The
commercial channels for doing so were non-existent at the start
of reform, and grew only slowly during the 1990s.
Private farmers not only need to establish these key
linkages, but they also need supporting commercial and public
institutions and infrastructure that a market-oriented
agricultural economy requires. They in particular need a
financial system that allows fast, affordable access to
capital, a system for quick and inexpensive dissemination of
market information (where can one buy and sell, and at what
price?), and a strong system of commercial law that protects
property and enforces contracts. Infrastructure and services in
all these areas are weak. Virtually no system of private
commercial finance exists for agriculture. A recent publication
on Russia's agro-food economy (Wehrheim et al., 2000) argues
that undeveloped institutions and infrastructure are the main
problem facing the sector. The absence of this infrastructure
increases the risks and transaction costs of doing business.
Another endemic problem in Russia that raises transaction
costs is extortion and bribery, a consequence largely of the
dysfunctional legal system. The problem is particularly serious
for sellers of agricultural products. The easily identifiable
and perishable nature of their output makes them vulnerable to
vandalism by extortionists or corrupt officials who want to
punish those who thwart them. In addition to poor institutional
infrastructure, private farmers (like the entire sector) are
plagued by deficient physical infrastructure. Although storage
is inadequate, the main weakness is transportation,
particularly the poor road system.
Yet another major impediment to the development of private
farming is resistance by the farmers' parent farms. The
managers of the former state and collective farms do not
support, and often actively oppose, having their workers spin
off private farms. Weak institutional infrastructure and
upstream and downstream linkages increase private farmers'
vulnerability vis-a-vis their parent farms, for it makes them
dependent on the farms for obtaining inputs and marketing their
output.
household plots
As during the Soviet period, households on the former state
and collective farms have small plots that they can
independently cultivate. The plots average no more than half a
hectare in size (about one acre). Yet, as during the Soviet
period, they produce a disproportionate share of the country's
agricultural output. The share has steadily risen during the
transition period (mainly because output by the former state
and collective farms has dropped), such that they now account
for more than half of all production (Table 5). The plots
produce mainly livestock products, potatoes, and vegetables,
and virtually no bulk crops, such as grain and oilseeds. The
households typically consume part of their output themselves
and sell the rest, usually directly to consumers at local
farmers' markets. During the reform period there has also been
growth in output by garden plots tended by the general
population.
The household plots' disproportionate share in output
raises the question of whether they could serve as the
foundation for developing a market-oriented agricultural system
based on privately owned household farms. The plots'
achievement, however, is deceiving. A major reason for their
``success'' is their strongly symbiotic (parasitic?)
relationship with their parent farms, through which the
plotholders obtain inputs (such as animal feed) inexpensively
or for free. Despite the official statistics which identify the
share of these plots in total farmland as only 3 percent, the
plotholders also use some of their parent farms' land for their
own purposes. The amount of land they actually utilize could be
as high as 10 to 15 percent of the total (OECD, 2001). If the
plots were wholly privatized, they would face the same
challenges as the struggling private farms described earlier,
in particular the problem of obtaining inputs through
commercial means.
The plotholders would face these hurdles with the
additional handicap of being much smaller than existing private
farms. Even if the plots increased in area tenfold, they would
still be very small. Russia could end up with a situation
similar to Poland, the only country of the Soviet bloc that had
small peasant-run farms, where farms currently average about 8
hectares in size (20 acres). The unproductivity of such a
scenario is shown by the fact that agriculture in Poland
accounts for only 5 percent of the country's GDP, but has 25
percent of the labor force. Small plots in Russia would in
particular suffer from diseconomies of scale in producing bulk
crops, which require heavy machinery for planting and
harvesting. Although the productivity of Russia's household
plots demonstrates the beneficial effect on incentives from
giving farmers the freedom to farm for their own gain, such a
system of small non-capitalized plots would be technologically
and organizationally pre-modern in nature.
former state and collective farms
The dominant agricultural producers in Russia (if not in
terms of total output, then in institutional structure and
influence) continue to be the former state and collective
farms. They hold about 85 percent of all farmland and produce
about 40 to 45 percent of total agricultural output (Table
5).\11\ They account for most bulk crop production. In 1993 the
state and collective farms of the Soviet era were forced
officially to reorganize. Many became ``joint stock
companies,'' while others became some sort of cooperative or
collective association. As joint stock companies, the farms
issued vouchers to all workers and managers, which gave them a
claim to a share in the farms' land and other assets.
Individuals could use these vouchers to obtain land to work as
private farmers.
---------------------------------------------------------------------------
\11\ Because the former state and collective farms produce most of
the country's bulk crops, their output volumes are sensitive to the
weather. A major reason these farms' share in total agricultural output
slips in 1998-1999 to only about 40 percent is because poor weather
caused low harvests, especially of grain. The statement that these
farms currently account for about 40 to 45 percent of total output
assumes average weather conditions.
---------------------------------------------------------------------------
With the collapse of central planning, farm managers were
given the freedom and responsibility to make their own
production decisions, obtain inputs, and market their output.
As a result, their position within the farms strengthened
considerably. Farm management has been conservative during the
reform period, such that little real change has occurred
concerning farm organization, administration, and the system of
internal work incentives. Farm productivity has increased only
negligibly, if at all. Lerman et al. (2001) calculate that
during 1992-1997, total factor productivity in Russian
agriculture rose only 7 percent (in total over the period, not
annually). Voigt and Uvarovsky (2001) compute that during 1993-
1998, total factor productivity on the former state and
collective farms fell 15 percent (in total). Both Sedik et al.
(1999) and Voigt and Uvarovsky (2001) find that technical
efficiency on the former state and collective farms, which
measures the productivity performance of farms relative to the
most productive farms in the country, has fallen during the
transition period. This means that farms in general have moved
further away from, rather than closer to, the best possible
production practices within the country.
Because of the unlikelihood that private farming as
previously described will flourish in the near to medium term,
the ``reorganized'' former state and collective farms will
probably continue to dominate agriculture in the foreseeable
future (say the next 10 years). What are the chances that these
farms will evolve into more dynamic and productive enterprises?
The farms face some major handicaps inherited from the
Soviet period in changing their nature and behavior. One is
that during the Soviet era farms did not specialize in
production. Although very large (state farms averaged about
38,000 acres and collective farms 15,000 acres), they usually
produced dozens of commodities. If a farm had the capability to
produce a certain agricultural good, it usually did. Such non-
specialization contrasted sharply with industrial policy during
the Soviet period, whereby a huge enterprise might be the
country's sole producer of a major product. The growing
influence of local government over farms during the reform
period has reinforced the tendency to diversify rather than
specialize in production, as local governments worry about food
security. Greater specialization would reduce farms' production
costs by allowing them to capture economies of scale.
Another handicap is the farms' tradition of providing
social welfare services for their workers, which includes
health, education, housing, and entertainment. Although the
quality of these services has declined during the reform
period, the general obligation remains. According to a farm
survey, these services increase farms' total costs by 10 to 30
percent (Uzun, 2001). Yet another handicap is the relationship
household plotholders have vis-a-vis their parent farms, by
which the former obtain inputs at the latter's expense.
According to the same farm survey, this relationship raises
farms' costs by another 20 percent (Uzun, 2001). Non-
specialization in production, provision of welfare benefits,
and service as a conduit for free inputs to plotholders all
impede farms' ability to become market-oriented profit-
maximizing and cost-minimizing producers.
In addition to reducing the burdens just identified, there
are two general ways farms could become more efficient and
productive. The first would simply be to shed existing
unproductive inputs, especially labor. The relative
unproductivity of agricultural labor is shown by the fact that
agriculture currently accounts for about 7 percent of GDP, but
has 14 percent of the country's total labor force. (In
comparison, agriculture's share in the labor force in the
United States is only about 2 percent--which is also primary
agriculture's share in U.S. GDP--and in the EU 5 percent.) Poor
labor productivity in Russia keeps production costs high and
farm wages and income low.
An advantage of raising productivity by shedding labor is
that it does not require a change in the existing system or
technology of agricultural production. The drawback is that it
requires economic developments outside of agriculture. The rest
of the economy must grow in order to generate new jobs for
agricultural workers.\12\ Local governments resist attempts by
farms to pressure workers to leave, out of fear it will add to
unemployment. The collapse of the national social welfare
system during the transition period also discourages workers
from leaving the farm. Workers are understandably reluctant to
face the prospects of both unemployment and a social welfare
system inferior to that they currently enjoy.
---------------------------------------------------------------------------
\12\ More generally, Lerman (1999, 2000) finds a correlation
between GDP growth in transition economies and growth in agricultural
output. GDP growth not only increases the quantity of agricultural
inputs available to farms, but also helps develop the agricultural
services and commercial infrastructure that farms need to function and
reduce operational and transaction costs.
---------------------------------------------------------------------------
The second way farms could increase productivity would be
from genuine farm restructuring--that is, a major improvement
in how farms are managed and internally motivated, which would
increase the incentives to use resources more productively.
Throughout the transition period, farm management has opposed
such major changes, while the agricultural establishment in
general has defended the existing system.
Rather than advocating major systemic reform of
agriculture, managers and agricultural policymakers argue that
improvement should come in two different ways. The first way is
by restoring the various types of support that existed during
the Soviet period, such as direct government subsidies to
agriculture and high output prices relative to input prices.
The main complaint of agriculture during the reform period is
that the deterioration in its terms of trade has made inputs
unaffordable. The second way is by acquiring superior Western
technology. Yet, unless major improvements are made in the
systemic nature of agriculture (effective farm level
restructuring supported by the necessary institutional
infrastructure), Russian agriculture might not effectively use
the superior material technology and therefore fail to raise
productivity.
The reason the Russian agricultural establishment has
resisted major reform is probably some combination of a genuine
belief that the main problems in agriculture are not systemic
in nature, and that major systemic changes would threaten their
power and privileges. This writer is in fact sympathetic to the
argument that Russian agriculture lacks the mentality necessary
to implement major reform. The Russian agricultural
establishment appears to be stunned by the huge contraction of
the sector, particularly the halving of livestock operations.
Adding to the shock is the mindset inherited from the Soviet
period whereby the main goal and performance indicator of
economic activity was rising output (rather than growing
productivity or consumer satisfaction).
new agricultural operators and a new spirit of enterprise?
There is evidence that some new forms of farm organization
and ``agricultural operators'' are emerging in the country
(Rylko, 2001). A feature of these new producers is that they
are very large (around 36,000 hectares, or 85,000 acres, on
average), and often are vertically integrated enterprises,
combining primary production, processing, and distribution.
Most of these new operations have not evolved from the former
state and collective farms, but rather have been created by
entities outside of primary agriculture, such as banks, input
suppliers, agro-processors, or industrial enterprises. The
apparent motive for the move into primary agriculture is that
they think it will profitably complement their existing
business (such as input supply or processing). Uzun (2001)
finds that the most successful of the former state and
collective farms are also very large, the hypothesis (backed by
some evidence) being that they have lower per unit costs of
production from economies of scale. Uzun argues that one reason
these farms are successful is that they specialize in
production much more than most former state and collective
farms.
Nonetheless, the evidence is too new and slight to argue
that these new operators and large former state and collective
farms are the wave of the future. Yet, it is telling that the
most dynamic new types of farm organization in Russia involve
large and integrated enterprises, rather than smaller family-
type farms.
Is there any recent evidence that Russian agricultural
performance in the aggregate is improving, perhaps because of
the benign influence of these new types of producers? The
economic crisis of 1998 provided a good test of Russian
agriculture's ability to respond to opportunities to expand
output. The extreme depreciation of the ruble following the
crisis severely cut imports and raised agricultural producer
prices expressed in domestic currency. A large Russian
production response would show that market incentives and
mechanisms were working reasonably well.
However, it appears that agricultural output has responded
to this opportunity only mildly. Although total agricultural
output increased in 1999 and 2000 by 3 and 5 percent, this was
mainly because weather improved in those years over the
terrible weather year of 1998 (which produced Russia's lowest
grain harvest in decades). In 2000 total agricultural
production was still 4 percent lower than in 1997 (admittedly a
very good weather year).
The change in production of livestock products is a better
indicator of response than the change in crops, given that
Russia is a larger importer of livestock products compared to
crops and that livestock output is not so vulnerable to the
weather. In 1999 livestock production declined 4 percent, while
aggregate output in 2000 was roughly unchanged. The 2000
performance in fact represents some progress, since it was the
first year since reform began that livestock output did not
fall. Other positive indicators in 2000 were that farm
profitability improved (the number of unprofitable farms fell
from 54 percent to 48 percent), and output of agricultural
inputs rose (Serova, 2001).
All this evidence supports the conclusion that the isolated
effect of major ruble depreciation on agricultural output has
been positive, though not robust. Some Russian agricultural
specialists believe more generally that in the last couple
years an improvement has occurred in the attitude and behavior
of agricultural enterprises (farms and processors). Enterprises
better understand and accept the challenges (and opportunities)
of producing for a market-driven economy, and thereby are
becoming more concerned about productivity, cost minimization,
marketing, and the need to be self-financing.\13\ Such opinion
provides some basis for optimism, though it is unclear how
prevalent and deep the changed behavior is. In its most recent
review of Russian agriculture, the OECD (2001) argues that any
current upturn in the sector might be a response more to short-
run and reversible favorable developments, such as good weather
and ruble depreciation, rather than to any major improvement in
business mentality or behavior.
---------------------------------------------------------------------------
\13\ This information is based mainly on the author's recent
conversations with agricultural specialists in Russia.
---------------------------------------------------------------------------
This writer believes that it is still too early to conclude
that a definite improvement has taken place in the attitude and
performance of Russian agricultural producers. Although
productivity growth is needed to make Russian agriculture
profitable and competitive, the motivation within the sector to
make the necessary systemic changes to raise productivity still
appears rather weak. Motivation could be imposed on the sector
from outside by the state enforcing a genuine ``hard budget
constraint.'' This would involve ending soft credits and
requiring farms punctually to pay all debts, that is, to become
genuinely self-financing. However, the agricultural
establishment and local governments resist this, and no other
force pushes for it. As a result, although most farms have been
unprofitable during the 1990s, hardly any have gone bankrupt,
as they muddle on with de facto subsidies from soft credits.
Almost all farms continue to function despite a huge sectorwide
drop in production, and with agriculture still employing almost
as much labor as in the pre-reform period.
Could Reform Turn Russia into a Major Grain Exporter?
When Russia began economic reform in the early 1990s, U.S.
agricultural interests worried that reform might not only
eliminate the large U.S. exports of grain and soybeans to the
country, but also turn Russia into a major grain exporter.
Using forecasting models, Liefert et al. (1993) and Tyers
(1994) predicted that if reform succeeded in significantly
raising agricultural productivity in Russia, the country would
become a major grain exporter, perhaps up to 20 million tons a
year.\14\ Johnson (1993) argued that by simply reducing waste
and thereby raising utilizable output of grain, which is one
form of productivity growth, Russia could have exportable
surpluses.
---------------------------------------------------------------------------
\14\ The forecast by Liefert et al. was for the former U.S.S.R. in
the aggregate, though it would be unlikely that the region could become
a major grain exporter if Russia were not exporting.
---------------------------------------------------------------------------
The reason Russia has not become a grain exporter is that
the farm level restructuring and creation of supporting
infrastructure that would raise productivity have not occurred.
This means that the forecasters were not necessarily wrong in
their predictions, since their forecasts were based on the
general premise (fleshed out with specific assumptions) that
ambitious and effective reform would be pursued.
However, even if reform succeeded in raising productivity
in grain production, this might be insufficient to move Russia
toward grain exports. The forecasting studies just identified
examined the effect of reform within the agricultural economy
alone. The studies correctly forecast that the isolated effect
of productivity growth in grain would be to improve the trade
balance in the product. Productivity growth would stimulate
exports by reducing per unit costs of production, thereby
making domestic output more price competitive vis-a-vis imports
and the world market--in other words, the productivity growth
would improve Russia's comparative advantage in the product.
Assume, though, that reform raises productivity uniformly
throughout the economy (for all inputs used to produce all
goods), say by 50 percent. Because of the inverse relationship
between productivity growth and costs of production, production
costs for all goods would fall also by a uniform percentage.
(Under standard assumptions, the per unit costs would drop by
one-third.) Since comparative advantage depends on relative
costs and prices, Russia's structure of comparative advantage
would not change. If Russia were a relatively high cost
producer of grain before the uniform productivity increase, it
would remain a relatively high cost producer, because per unit
costs for all goods would change by the same percentage. This
means that if Russia were a net importer of grain or any other
good before the productivity growth, it would be economically
profitable for the country to continue importing the good.\15\
---------------------------------------------------------------------------
\15\ Conceptually, productivity growth would shift the domestic
supply curve for grain to the right, thereby increasing output.
However, by lowering the production cost of all goods by a uniform
percentage, the productivity rise should appreciate the country's
currency (under standard assumptions by an amount equal to the
productivity growth). The appreciation would lower the good's world
price expressed in domestic currency. The drop in price would increase
domestic consumption and reduce domestic production. Thus, the
country's trade deficit in the good might change little. Liefert (1994)
examines the relationship between productivity growth and comparative
advantage, particularly as applied to transition economies.
---------------------------------------------------------------------------
An example of this general point is that ever since Great
Britain repealed the Corn Laws in the middle of the 19th
century which opened the country up to free trade, it has been
a major importer of agricultural goods. Over the past 150 years
Britain has had significant productivity growth in agriculture
in absolute terms. However, because productivity growth has
occurred throughout the economy, Britain remains a high cost
producer of agricultural goods relative to other goods it
produces, and thereby has continued as a large agricultural
importer.
If Russia currently does not have a comparative advantage
in grain, as appears to be the case, it can develop a
comparative advantage and thereby become a major exporter only
if productivity growth in grain production exceeds that in most
other areas of the economy. The southern half of the European
part of the former U.S.S.R. has highly favorable natural
conditions for agriculture, particularly grain production--
excellent soil and climate and generally adequate (though
inconsistent) precipitation. Once that region, which covers
Ukraine and southern European Russia, adopts world-standard
production technology, creates reasonably efficient systems of
farm organization and management, and builds institutional
infrastructure to service agriculture properly, it will most
likely have a comparative advantage in production of grain and
various other crops, such that it should be a major exporter.
This would be consistent with the region's history of being a
large grain exporter. However, during the transition period,
agriculture has been one of the most conservative and anti-
reform sectors in Russia (as well as Ukraine), and there is no
firm evidence that it will become significantly more
progressive during the next 10 to 15 years (the new farm
operators notwithstanding). Thus, during at least this time
frame, the likelihood that agriculture will outperform the rest
of the economy in productivity growth to become a major
exporting sector appears dim.\16\
---------------------------------------------------------------------------
\16\ Using a forecasting model for Russian agriculture, the
Economic Research Service of the USDA predicts that during the next 10
years Russia remains a net grain importer (though of only a couple
million tons a year). The forecasts are based on assumptions that
productivity growth in the grain sector, as well as throughout
agriculture, is slight (ERS, 2001).
---------------------------------------------------------------------------
Conclusion
During the transition period, Russian agricultural output
has fallen in volume terms by 40 percent. The livestock sector
has been hit the hardest, with production and animal
inventories both down by about half. The decline in
agricultural production, however, has been an inevitable
consequence of market reform. The main reason for the output
drop is that consumers' desires for goods have replaced those
of planners and the political leadership as the dominant force
in determining what goods are produced and consumed. The
policies that engineered the switch from planners' to
consumers' preferences as the driving force of production and
consumption were price and trade liberalization. These policies
reduced or eliminated the array of Soviet-era subsidies to
agriculture that maintained artificially high levels of
production and consumption. Agriculture was subsidized three
general ways: (1) through direct budget subsidies from the
government; (2) through the domestic price system whereby the
prices farms had to pay for inputs were set low relative to
output prices and to the real costs of production; and (3)
through a price support system whereby the prices agricultural
producers received for their output were kept above world trade
prices.
The restructuring of agricultural production and
consumption has strongly affected U.S. agricultural exports.
The Soviet Union was a large importer of grain, soybeans, and
soybean meal, needed to feed growing livestock herds, with the
United States being a major supplier. The contraction of the
livestock sector has pretty much ended these imports. In their
place, Russia has been importing substantial amounts of meat.
These changes have strongly affected U.S. agriculture, as
Russia has become the largest foreign market for U.S. poultry.
Research at the Economic Research Service of the U.S.
Department of Agriculture (USDA) shows that the switch from
importing animal feed to maintain a large livestock sector to
importing meat and other livestock products is consistent with
Russia's comparative advantage in agriculture--that is, the
country produces livestock goods at a relatively higher cost
than it produces animal feed.
The production decline has been accompanied by a fall in
consumption of many foodstuffs, particularly livestock products
such as meat and milk. This has raised concerns about food
security. Although transition has created a food security
problem for Russia, the cause of the problem is not the drop in
agricultural output, nor is it more generally insufficient food
supplies. Before reform Russia had high per capita levels of
consumption of most foodstuffs, compared even to rich OECD
countries. Although consumption of expensive livestock products
has dropped, consumption of staple foods such as bread and
potatoes has remained steady or even increased.
Reform has threatened food security because of problems
involving access to food. Reform has increased the number of
poor who lack the purchasing power to sustain adequate diets.
Also, impediments to the flow of foodstuffs within the country
have prevented food-deficit regions from obtaining supplies
from surplus-producing areas.
That the fall in agricultural production has been a
necessary part of market reform shows that output is an
inappropriate indicator of reform progress. Better performance
indicators for Russian agriculture are productivity growth
(getting more output from a given amount of inputs) and cost
reduction. In addition to increasing output, productivity
growth would make domestic production more price competitive
vis-a-vis the world market, and free up resources that could be
used to produce goods in other sectors of the economy (such as
the fast-growing service sector).
Productivity growth and cost reduction could be achieved
two main ways. The first is through effective farm
restructuring, which involves changing farms' internal systems
of organization, management, and incentives for workers. The
second is by reducing transaction costs for farms and
enterprises by creating the institutional infrastructure that a
market-oriented agricultural system needs. Necessary
institutional infrastructure includes systems of rural banking
and finance, market information, and commercial law that can
clarify and protect property, enforce contracts, and resolve
disputes. This infrastructure would also strengthen the
upstream and downstream linkages that connect agricultural
producers to their input suppliers and output processors and
distributors.
To date, progress in farm restructuring and growth of
institutional infrastructure has been disappointingly slow.
Private farming has not taken off, and currently accounts for
only 2 percent of agricultural output. A major reason is that
the mass of conflicting laws concerning the use of agricultural
land does not allow for full private ownership of land, which
prevents development of an agricultural land market. This hurts
private farmers' incentives to invest in their land, as well as
their ability to get loans, since they cannot use land as
collateral. Russian agricultural producers in general, but in
particular private farmers, have also suffered from the fact
that commercial and public institutional infrastructure for
agriculture remains very undeveloped.
The household plots maintained by workers on the former
state and collective farms now produce over half of the
country's total agricultural output (mainly livestock goods,
potatoes, and vegetables). A major reason for the plots'
``success,'' however, is their symbiotic relationship with
their parent farms, which allows plotholders to obtain inputs
inexpensively or for free. Without this crutch, the plots would
face all the challenges of private farms, with the added
handicap of being only a fraction of their size.
The former state and collective farms continue to dominate
the organizational structure of Russian agriculture. Although
forced in 1993 officially to reorganize, with many becoming
``joint stock companies'' owned by their workers, the farms
have done little to change how they internally operate. Farm
managers and the agricultural establishment generally oppose
systemic changes in agriculture, probably from some combination
of a genuine belief that the main problems in Russian
agriculture are not systemic in nature, and fear that major
changes would threaten their power and privileges. Most farms
have been unprofitable throughout the transition period, and
get by largely from continued soft loans from either state or
quasi-state lenders that are eventually written off.
Some new types of producers are appearing in Russian
agriculture, in particular large vertically-integrated
enterprises, often created by input suppliers or processors.
Some Russian agricultural specialists argue that farms and
processors in general are becoming more reconciled to the
challenges and opportunities of producing for a market economy,
and thereby are growing more concerned about productivity, cost
reduction, and marketing. However, the evidence is still too
slight to conclude that these new producers, and attitudes,
represent the future of Russian agriculture, and that they will
lead to a substantial improvement in agricultural performance.
If such improvement is not forthcoming, the main consequence
for U.S. agriculture is that Russia will not become a major
agricultural exporter, and will likely continue as a big meat
importer.
References
Cochrane, Nancy J., coordinator. Livestock Production in
Transition. Economic Research Service, USDA,
Agriculture Economic Report (forthcoming).
Economic Research Service (ERS), USDA. Former USSR,
International Agriculture and Trade Reports, annual
1992-1996.
Economic Research Service, USDA. Newly Independent States and
the Baltics, International Agriculture and Trade
Reports, May 1997.
Economic Research Service, USDA. Transition Economies,
International Agriculture and Trade Reports, May 1998.
Economic Research Service, USDA. USDA Agricultural Baseline
Projections to 2010. Staff Report WAOB-2001-1, Feb.
2001.
Johnson, D. Gale. ``Trade Effects of Dismantling the Socialized
Agriculture of the Former Soviet Union.'' Comparative
Economic Studies 35, 4:21-31, Winter 1993.
Lerman, Zvi. ``Land Reform and Farm Restructuring: What Has
Been Accomplished to Date.'' American Economic Review
89, 2:271-275, May 1999.
Lerman, Zvi. ``From Common Heritage to Divergence: Why the
Transition Economies are Drifting Apart by Measures of
Agricultural Performance.'' American Journal of
Agricultural Economics 82, 5:1140-1148, Nov. 2000.
Lerman, Zvi, Yoav Kislev, Alon Kriss, and David Biton.
``Agricultural Output and Productivity in the Former
Soviet Republics.'' Presented at Meeting of the
American Agricultural Economics Association, Chicago,
ILL, August 2001.
Liefert, William M. ``Economic Reform and Comparative Advantage
in Agriculture in the Newly Independent States.
American Journal of Agricultural Economics 76, 3:636-
640, August 1994.
Liefert, William M. ``NIS and Baltic Countries Look to Join the
WTO.'' Agricultural Outlook, Economic Research Service,
USDA, Nov. 1997, pp. 26-30.
Liefert, William M. ``Comparative (Dis?)Advantage in Russian
Agriculture.'' American Journal of Agricultural
Economics (forthcoming).
Liefert, William M., Robert B. Koopman, and Edward C. Cook.''
Agricultural Reform in the Former USSR.'' Comparative
Economic Studies 35, 4:49-68, Winter 1993.
Liefert,William M., and Olga Liefert. ``Russia's Economic
Crisis: Effects on Agriculture.'' Agricultural Outlook,
ERS, USDA, June 1999, pp. 15-18.
Liefert, William M., and Johan F.N. Swinnen. Changes in
Agricultural Markets in Transition Economies. Economic
Research Service, USDA, Agriculture Economic Report
(forthcoming).
OECD. Agricultural Policies in Transition Economies: Monitoring
and Evaluation, annual 1993-1997 (with slight variation
in yearly titles).
OECD. Agricultural Policies in Emerging and Transition
Economies, annual 1998-2001.
OECD. Review of Agricultural Policies: Russian Federation,
1998.
PlanEcon. Review and Outlook for the Former Soviet Republics,
Washington, DC, annual.
Rylko, Dmitri N. ``New Agricultural Operators, Input Markets,
and Vertical Sector Coordination.'' Presented at
Workshop on Russian Agricultural Input Markets,
Golitsino, Russia, July 2001.
Russian Federation, State Committee for Statistics. Rossiiskii
Statisticheskii Ezhegodnik (Russian Statistical
Yearbook), Moscow, annual.
Sedik, David J., Christian S. Foster, and William M. Liefert.
``Economic Reforms and Agriculture in the Russian
Federation, 1992-1995.'' Communist Economies and
Economic Transformation 8, 2:133-148, 1996.
Sedik, David J., Michael Trueblood, and Carlos Arnade.
``Corporate Farm Performance in Russia, 1991-1995: An
Efficiency Analysis.'' Journal of Comparative Economics
27, 3:514-533, Sept. 1999.
Serova, Eugenia. ``Russia: Agri-Food Sector in 2000.''
Presented at OECD Global Forum on Agriculture, Paris,
April 2001.
Tyers, Rod. Economic Reform in Europe and the Former Soviet
Union: Implications for International Food Markets.
Washington, DC: International Food Policy Research
Institute, Research Report 99, 1994.
Uzun, V.Y. ``Organizational Types of Agricultural Production in
Russia.'' Presented at Workshop on Russian Agricultural
Input Markets, Golitsino, Russia, July 2001.
Voigt, Peter, and Vladimir Uvarovsky. ``Developments in
Productivity and Efficiency in Russia's Agriculture:
The Transition Period.'' Quarterly Journal of
International Agriculture 40, 1:45-66, 2001.
Wehrheim, Peter, Klaus Frohberg, Eugenia Serova, and Joachim
von Braun, editors. Russia's Agro-food Sector: Towards
Truly Functioning Markets. Dordrecht, Netherlands:
Kluwer Academic Publishers, 2000.
Human Capital and the Social Contract
RUSSIA'S DEMOGRAPHIC AND HEALTH MELTDOWN
By Murray Feshbach \1\
----------
contents
Page
Summary.......................................................... 283
Introduction..................................................... 284
Demographic Markers.............................................. 285
Fertility........................................................ 288
Migration........................................................ 289
Mortality........................................................ 290
HIV/AIDS......................................................... 290
Other Health Status Issues....................................... 297
Some Positive Signs.............................................. 299
Selected Environmental Health Issues............................. 301
Foreign Assistance and Unmet Needs............................... 304
Summary
The demographic and health meltdown in Russia during the
first half of the 21st century is based on trends already
evident or emerging. The overall population and health decline
starts with children born to women with poor reproductive
health, and proceeds to high premature mortality of Russian
males.
---------------------------------------------------------------------------
\1\ Dr. Murray Feshbach is currently a Senior Scholar at the
Woodrow Wilson International Center for Scholars of the Smithsonian
Institution. He began work in October 2000 on policy implications of
the population, health and environmental problems in Russia. He retired
as Research Professor Emeritus from Georgetown University in July 2000.
During this period he spent much of 1986-1987 as Sovietologist-in-
Residence at NATO headquarters in Brussels, Belgium, working directly
for Lord Carrington, Secretary-General. Prior to Georgetown University,
he was Chief of the U.S.S.R. Population, Employment and Research and
Development Branch, Foreign Demographic Analysis Division, U.S. Bureau
of Census, until his retirement in 1981 from this organization. He
joined the Census Bureau in 1957 after several years working on the
Soviet Economy Project at the National Bureau of Economic Research, in
New York, during 1955 to 1956.
This paper is a revised, enlarged and edited version of ``Russian
Population Meltdown,'' Wilson Quarterly, volume XXV, no. 1, Winter
2001, pp. 15-21. Also see, Murray Feshbach and Alfred Friendly, Jr.,
Ecocide in the U.S.S.R., Health and Nature Under Siege, New York, Basic
Books, 1992 and Murray Feshbach, Ecological Disaster, Cleaning up the
Hidden Legacy of the Soviet Regime, New York, Twentieth Century Books,
1995.
---------------------------------------------------------------------------
Human immunodeficiency virus (HIV)/acquired
immunodeficiency syndrome (AIDS) and its co-infection with
tuberculosis are now in early but virulent stages. If present
trends continue, these infections will have an increasingly
negative effect on life expectancy and overall health of the
Russian population. Mental retardation of the young adds
another severely negative factor to future Russian health.
Accumulative consequences of this demographic and health
meltdown will be deterrence of an economic revival, reduction
of military capabilities and dampening of morale of the
populace. Migration into Russia is not likely to fully offset
the effects of this demographic and health decline. Only large-
scale Chinese in migration would stem the decline of the
Russian population.
Introduction
In his first annual presidential address to the Russian
people on July 8, 2000, President Vladimir Putin listed the 16
``most acute problems facing our country.'' Number one on the
list, topping even the country's economic condition and the
diminishing effectiveness of its political institutions, was
the declining size of Russia's population. Putin put the matter
bluntly. The Russian population is shrinking by 750,000 every
year, and thanks to a large excess of deaths over births, and
insufficient migration to compensate for the mortality/birth
ratio, it looks likely to continue dropping for years to come.
If the trend is not altered, he warned, ``the very survival of
the nation will be endangered.''
Unfortunately, even Putin's grim reckoning of the numbers,
based on official projections made by the State Statistical
Agency, may understate the dimensions of the calamity
confronting his country. Its birthrate has reached
extraordinarily low levels, while the death rate is high and
rising. The incidence of HIV/AIDS, syphilis, tuberculosis,
hepatitis C, and other infectious diseases is soaring, even as
the Russian health care system is vastly underfunded and
insufficient for the need. Perhaps 40 percent of the nation's
hospitals and clinics do not have hot water or sewage. Seventy-
five percent or more of pregnant women suffer a serious
pathology during their pregnancy, such as sepsis, toxemia, or
anemia.
Only about 25 percent of Russian children are born
healthy. At the same time, the infant mortality rate had
significantly declined, at least according to official
statistics in the last 5 years, but increased again in 2000.
The leading Russian pediatrician Aleksandr Baranov estimates
that only 5 to 10 percent of all Russian children are healthy,
a much lower proportion than the official figure.
As if these challenges were not enough, Russia bears the
burden of decades of environmentally destructive practices that
have a direct, harmful impact on public health. Their legacy
includes not just conventional pollution of the air and water
but serious contamination around many nuclear and chemical
sites throughout the country. In Dzerzhinsk and Chapayevsk, 2
of the 160 ``military chemical cities'' that produce chemicals
for the military-industrial complex, the rate of spontaneous
abortions or miscarriages is 15 to 34 percent of conceptions--a
strong indication of chromosomal aberrations induced by the
local environment. Yet a weakened Russia lacks the means to
contain ongoing pollution or to begin the monumental task of
environmental cleanup. The decline in the size of the Russian
population, and in Russians' general health, vastly increases
the difficulty of creating the economic wealth upon which such
a cleanup--and so much else--depends.
It is not only compassion that should arouse the concern of
the West. While some may cheer the weakening of this sometimes
less-than-friendly power, still armed with large numbers of
nuclear, biological, and chemical weapons, Russia's decline
raises the twin prospects of political disintegration and
subsequent consolidation under an authoritarian leader overtly
hostile to Western interests. The nation's problems, in any
event, can no longer be thought of as somehow only its own. An
unclassified U.S. national intelligence estimate warned that
the global rise of new and re-emergent infectious diseases will
not only contribute to social and political instability in
other countries but ``endanger U.S. citizens at home and
abroad.'' \2\ All new cases of infectious diseases (including
HIV/AIDS at about 42,000 per year) in the United States have
nearly doubled, to some 170,000 annually, since 1980. In
Russia, the numbers of major diseases have increased many
multiples. For example, new incidence of HIV/AIDS, officially
recorded as 1,000 new cases in 1995, was over 56,000 by the end
of 2000; all epidemiologists and commentators in Russia and at
UNAIDS believe this number is actually 5 to 10 times higher.
And radioactive contamination from Russia's deteriorating
weapons stockpiles, its decommissioned (but not unloaded)
nuclear rods and reactor compartments from submarines, and from
sunken ships and submarines such as the Lenin nuclear
icebreaker and the Kursk nuclear submarine, poses a threat of
unknown dimensions, particularly to the nearby Scandinavian
countries.
---------------------------------------------------------------------------
\2\ Issued by the National Intelligence Council, as: Global
Infectious Disease Threats to the United States, Washington, DC, 2000,
60 pp.
---------------------------------------------------------------------------
Demographic Markers
The broad outlines of Russia's looming demographic decline
can be sketched in stark terms. Russians are dying at a
significantly faster rate than they are being born. Even in
Germany and Italy, which also record more deaths than births,
the difference is only about 10 percent. In Russia deaths have
exceeded births by a multiple of 1.8 to 2.0 since the early
1990s (Figure 1). In 2000, the number of births in Russia was
1,259,400, while the number of deaths was 2,217,100--both
increasing compared to 1999. The net natural increase declined
more than the previous year because deaths increased even more
than births.\3\ From the regional point of view, births
increased in 70 regions, while deaths increased in 78 of the 89
administrative-territorial units. Nonetheless, deaths still
exceeded births by 1.8 times in 2000, the same disparity as in
1999. In the first 4 months of 2001, the population shrank, by
308,800 persons, to 144,500,000 (including net migration),
according to Interfax News Agency, on June 22, 2001. If this
were to continue throughout the year, the net decline in the
population of Russia, would be over 900,000 persons, a number
150,000 greater than the one Putin cited in his speech only 1
year earlier. By age group, the decline during the period 2000
to 2016 of persons younger than 16 will be over 8 million, from
29,044,400 to 19,871,600, or by 32 percent; Goskomstat's
projection for the working age population (16- to 59-year-old
males and 16- to 54-year-old females, inclusive) will drop by
6.4 million persons over the first 15 years of the period, from
86,359,400 to 79,967,900 at the beginning of 2016, or by 7
percent.
---------------------------------------------------------------------------
\3\ Goskomstat, online Web site: www.gks.ru, February 2001, under
the rubric ``Sotsial'no-ekonomicheskoye polozheniye v Rossii.'' Also
see footnote 4.
---------------------------------------------------------------------------
FIGURE 1._HOW RUSSIA COMPARES, 1980-1999
[GRAPHIC] [TIFF OMITTED] T6171.027
As negative as Putin's declaration was, it was based on the
relatively optimistic projections of the State Statistical
Agency, Goskomstat. This scenario assumes a small decrease in
the total fertility rate beginning in 2000, a small increase in
the mortality rate, and a large decrease in net in-migration.
But only the latter projection is remotely plausible. However,
if one expects large numbers of Chinese and/or illegal migrants
from Afghanistan, China, Kurdistan, Southeast Asia and others
to contribute to the economy, and settle in as residents, this
could change markedly. As noted later, one leading migration
specialist expects a significant number of legal Chinese
migrants to settle into the east of the country; the political
and social implications may be very serious; the economic
consequences could be very positive.\4\
---------------------------------------------------------------------------
\4\ Predpolozhitel'naya chislennost naseleniya Rossiyskoy
Federatsii do 2016 goda (Statisticheskiy byulleten), Moscow, 1999, pp.
113 and 144. All projections from this source use the medium variant.
This variant incorporates an assumption that total fertility rates in
Russia will approximate those of western countries over a period of
time (i.e., be lower than currently), that mortality will decrease in
the first year of life, and that migration will be small from
``Russian-speaking diaspora'' in Belorussia, Ukraine, Baltic States and
Moldavia, and only a slow ``repatriation'' from the remaining CIS
countries. Ibid., p. 5.
---------------------------------------------------------------------------
By 2050, I believe, Russia's population will shrink by one-
third. In other words, it will drop from 144.7 million at the
beginning of 2001 to about 100 million, a blow that even a
stable, prosperous country would have difficulty sustaining.
The draft version of the United Nations' World Population
Prospects. The 2000 Revision. Highlights, (ESA/P/Wp.165, 28
February 2001, table 15), projects a drop of 41,233,000 for
Russia between 2000 and 2050, the largest in absolute terms for
any country included in the report. Based on the medium variant
projection this would yield a figure of 104,258,000. The next
largest decline, in absolute terms, occurs in Ukraine
(-19,609,000), and then Japan (-17,876,000). Italy and Germany
are expected to witness declines of 14.5 million and 11.2
million, respectively, over the same half century. However, in
relative terms only four countries exceed the relative decline
(of 28.3 percent) in the Russian Federation--Estonia (46.1
percent), Bulgaria (43.0 percent), Ukraine (39.6 percent), and
Georgia (38.8 percent) and Guyana (33.7 percent)--all except
one, in the eastern European region.\5\ Many western European
countries also are projected to experience population declines,
but not nearly as severe as that in Russia. While I believe
that the assumption of relatively stable or improving
mortality, and of an improvement in total fertility rate, as
assumed in the United Nations (UN) projection are not likely I
understand that any projection of 5 decades is at hazard to
begin with. But the evidence presented below would seem to
indicate that a lower variant projection would be more
realistic in Russia than even the decline projected by the
medium variant.
---------------------------------------------------------------------------
\5\ UN Population Projections, Revision 2000, table 15.
---------------------------------------------------------------------------
My projections, growing from a model developed for West
Germany by the Population Reference Bureau, are less
apocalyptic than those of various Russian officials, Duma
members, and demographers. A new study produced under the
auspices of the Institute of Social and Political Research of
the Russian Academy of Sciences, for example, predicts that the
Russian population will decline to between 70 and 90 million by
2045. If one takes the annual 750,000 decrease noted by Putin
and multiplies it by 50 years, the result is a drop in
population of 37.5 million persons, to a net total of 108
million--not far from my estimate of 100 million.
A model used by Dr. Yuri Komarov, former head of the
Medical and Socio-Economic Information Institute of the Russian
Ministry of Health, developed a projection of 94 million
population in 2050. Dr. Nataliya Rimashevskaya, Director of the
Institute of Socio-Economic Problems of the Population of the
Russian Academy of Science, projected a population of 55
million in 2050 (this probably should have been indicated as
the projected population in the year 2075 as other individual
Russian demographers have projected). Anatoliy Vishnevskiy and
Yevgeniy Andreyev (head of the Demographic and Human Ecology
Center of the Institute of Scientific Forecasting and
Laboratory Chief at the Center, respectively), published
another set of projections in the January 2001 issue of Voprosy
ekonomiki. In the worst case scenario, that is, a continued
drop in births and increases in deaths, with zero net in-
migration, the result is 86.5 million population in 2050. The
better case scenario, with a rise in the total fertility rate
to two children per woman (which is very unlikely, as they also
indicate) and no change in mortality rates (also very unlikely,
as noted below) yields only 94.5 million.\6\ The United Nations
Revision 2000, cited above, projects a high of 113 million in
2050, 104 million as the medium projection, and 96 million as
the low variant. (Personal communication from a staff member of
the UN Population Division.) Thus, a decline of some 45 to 50
million over the first half of the century is not out of line
with many other projections.
---------------------------------------------------------------------------
\6\ Anatoliy Vishnevskiy and Yevgeniy Andreyev, Voprosy ekonomiki,
January 2000, p. 33.
---------------------------------------------------------------------------
The U.S. population, meanwhile, is projected by the U.S.
Bureau of the Census to grow from today's 285 million to 396
million in 2050, a level almost four times the UN-projected
Russian population.
TABLE 1.--NUMBER OF FEMALES, AGES 20-24, 25-29, AND 20-29
------------------------------------------------------------------------
Year 20-24 25-29 Total
------------------------------------------------------------------------
2000 (As of September 1).................. 5,415 5,118 10,533
2003...................................... 5,728 5,311 11,040
2006...................................... 5,988 5,539 11,527
2010...................................... 5,827 5,923 11,750
2013...................................... 4,681 6,069 10,751
2016...................................... 3,721 5,527 9,247
2019...................................... 3,539 4,258 7,797
2022...................................... 3,592 3,589 7,181
2025...................................... 3,742 3,536 7,279
2029...................................... 3,914 3,681 7,595
2032...................................... 3,886 3,839 7,725
2035...................................... 3,721 3,917 7,638
------------------------------------------------------------------------
In broad demographic terms, one can say that Russia's
population is being attacked by two pincers. On one side is the
fertility rate, which has been falling since the early 1980s.
Russian women now bear little more than half the number of
children needed to sustain the population at current levels. In
absolute terms, the number of annual births has dropped by
half, to 1.2 million in 2000, since reaching a high of 2.5
million in 1983. Due to Russia's rising mortality rates,
fertility would need to reach 2.15 births per woman just to
reach the simple population replacement level. As of 1999,
however, the total fertility rate stood at 1.17 births per
woman (the total fertility rate for 2000 has not yet been
published (early July 2001), but is likely no higher than 1.20,
or may even be as low as 1.10). That is to say, Russian women
bear an average of 1.17 children over their entire fertile
life, ages 15 to 49. Fertility would need to rise by some two-
thirds to reach the replacement level of 2.1 to 2.15, at
current mortality levels; that is, over 750,000 additional
births per year.
Fertility
Some Russian demographers take comfort from the fact that
their country is not entirely alone, since deaths exceed births
in a number of European countries. But in countries such as
Germany and Italy, the net ratio is close to 1.1 deaths to
every birth. In Russia, deaths exceeded births by 929,600 in
1999, a ratio of 1.8 to 1. If health trends and environmental
conditions are not dramatically changed for the better, Russia
could see two or more deaths for every birth in the not-too-
distant future.
Goskomstat's projection points to an increase in fertility
from 1.184 in 1999 up to 1.205 in the year 2000, then a
continual decline to 1.160 by 2015.\7\ In the UN Revision 2000
projection, the anticipated total fertility rate is slightly
higher than Goskomstat's, and will be 1.18 in the period 2010-
2015. It rises to 1.36 in 2020-2025, and only in 2045-2050,
does it reach to 1.75 children per woman (let alone to 2.1 or
2.15). Goskomstat's projection likely is based on a hopeful
extrapolation of trends at the end of the 1990s, but neither it
nor the UN projection takes fully into account the serious
deterioration of Russians' reproductive and general health.
Also working against the hoped-for mitigation of the population
decline is the harsh reality that the number of women in the
prime childbearing ages of 20 to 29 is declining and will
continue to fall sharply, while the rates of sexually
transmitted diseases among men and women (which affect
fertility) and gynecological illnesses are both rising. Between
the year 2000 and 2037, the number of 20- to 29-year-old
females (the age group in which two-thirds of births take place
in Russia) will decline from 10,530,000 to 7,431,000. A short
interval of increase, to a peak of some 11,840,000 from 2000 to
2009, will be dramatically reversed during most of the rest of
the first quarter of the century. This reflects the precipitous
decline in births after 1987. These are persons already born.
However, the likely outcome is a fall in the total fertility
rate due to qualitative and quantitative reasons, as explained
below.
---------------------------------------------------------------------------
\7\ These and other official demographic projections are from
Goskomstat RF, Predpolozhitel'naya chislennost naseleniya Rossiyskoy
Federatsii do 2016 goda (Statisticheskiy byulleten), Moscow, 1999, 132
pp.
---------------------------------------------------------------------------
The ranks of eligible parents, especially fathers, are
being thinned not just by deaths but by illnesses such as
tuberculosis, HIV/AIDS, alcoholism, drug abuse, and other
causes, including infertility. Even as disease and mortality
take more and more young people out of the pool of potential
parents, attitudes toward childbearing have changed for the
worse. An estimated two-thirds of all pregnancies now end in
abortions (excluding spontaneous abortions).
Moreover, the recorded number of abortions excludes those
performed in private clinics or illegal facilities, which if
known would raise the ratio of artificially induced abortions
to births even higher. Equally important is the frequent
negative consequences of multiple abortions on the fertility of
these women; up to 30 percent are reported to become ill or
infertile.
According to a study published in late June 2001 under the
auspices of the Agency for Social Security of Russia, 30
percent of young females do not wish to have children because
of the economic hardships they confront. This source also cites
the declining health of 33 percent of 17-year-old females which
has led to a decrease in the ability to have children.\8\
Fifteen to 20 percent of all Russian families experience
infertility, with 10 to 15 percent of females infertile, and
some 5 to 10 percent of males. It is hard to see how the hoped-
for fertility gains will occur. Yet without a doubling or even
tripling in the total fertility rate of Russian women, and a
sharp decline in mortality, a steep decline in Russia's
population seems unavoidable.
---------------------------------------------------------------------------
\8\ The time period over which the decrease took place is not cited
in the original source. S. Bazal'chuk, ``Opros. Pir vo vremya chumy,''
Moskovskaya Pravda, 29 June 2001, p. 2, from Eastview Press Web site.:
http://udb.eastview.com. According to an ITAR-TASS News Agency report
of March 10, 2001, ``every third married couple suffers from [one] form
[or another] of sterility. Report by Anna Bazhenova. ``Only Every Fifth
Newborn in Russia is Practically Healthy.'' The latter source is
somewhat more negative than the other reports.
---------------------------------------------------------------------------
Migration
Legal migration should fall far short of the numbers needed
to ensure an overall increase in the population. Goskomstat now
projects a decline in net immigration from 132,000 in 1999 to
less than half that number in 2015 (at 60,600).\9\ Only massive
immigration of Chinese could suffice to compensate for the
trend, and this one would think would be unacceptable to the
Russian authorities. Nonetheless, while it is likely not to
occur, one of the leading migration specialists in Russia,
Zhanna Zayonchkovskaya is cited in an article published in June
2001, that she expects that ``the Chinese in Russia may become
the second largest ethnic group after Russians and an
inalienable component of the Russian labor force.'' \10\ If
this bold assertion comes to fruition, it will change many
social and economic parameters very significantly; but then
Russia may not be Russia as we have known it until now.
---------------------------------------------------------------------------
\9\ Predpolozhitel'naya chislennost naseleniya Rossiyskoy
Federatsii do 2016 goda (Statisticheskiy byulleten), Moscow, 1999, 144
pp.
\10\ V. Yemelyanenko, ``Chinese Happiness'' Izvestiya, 23 June
2001, online version. A fascinating new approach toward making this
migration more viable is the announcement that a marketing network of
made-in-China commodities will be established beginning in August 2001.
The network will be set up in 22 Russian cities, with headquarters in
Vladivostok. Asian Pulse, July 2, 2001 cited in Lexis-Nexis. And how
many will accompany and/or be permanent staff members for this
activity? How will the Russian national-patriots react to this putative
``yellow peril'' about which they have always been paranoid?
---------------------------------------------------------------------------
She continues:
``. . . the effectiveness of the labor market and the
country's social stability will depend in the future
directly on how well the authorities manage to organize
the coexistence with immigrant groups . . . [especially
if] 10 to 20 million Chinese will live in the Russian
Federation. Only a growth in immigration of this
magnitude will compensate sufficiently for the decline
in births and the rise in mortality.'' \11\
---------------------------------------------------------------------------
\11\ Ibid. The German Government also is rethinking its attitude
toward restrictions on immigration of workers due to impending
demographic decline in their population.
---------------------------------------------------------------------------
Mortality
Mortality rates are also assumed to rise in the official
Goskomstat calculation, but much less markedly than I
anticipate. The Goskomstat projection through 2015, shows a
crude death rate of 14.3 deaths per 1000 population in 2000
(exceeded in reality in both 1999 and 2000, with reported rates
of 14.7 and 15.3 deaths per 1,000 population, respectively) and
a projection of increases up to ``only'' 15.0 deaths per 1000
population in 2015, barely above the reported rate in 1999, let
alone the ``excess'' in 2000 as reported. Some further
perspective on the Russian situation is provided by a
comparison with the United States, which projects an average
life expectancy at birth and survival rates for specific age
groups that are far from the best in the world--especially
among American 15- to 19-year-old males, who kill themselves
with drugs, alcohol, and motorcycles. But in the United States,
a boy who lives to age 16 has an 88 to 90 percent chance of
living to age 60. His Russian counterpart has only a 58 to 60
percent chance. And those chances are shrinking.
HIV/AIDS
Tuberculosis, like HIV/AIDS, also is one of the maladies
whose surging incidence is not reflected in current Goskomstat
projections. The disease flourishes among people weakened by
HIV/AIDS, alcoholism, and poverty. Findings by the research
institute of the Russian Federal Security Service during the
1990s projected enormous numbers of deaths from tuberculosis.
According to the Russian Ministry of Health, the number of
tuberculosis deaths increased by 12 percent in the 1998-1999
period. The 1999 death toll from tuberculosis of 29,000 was
about 15 times the number in the United States, or nearly 30
times greater when measured as deaths per 100,000 population in
both countries. The number of new cases increased from 50,640
in 1990 to 124,044 in 1999. Correspondingly, the number of
deaths increased slightly more proportionately from 11,571 to
29,078 (or a case/fatality ratio of 22.8 deaths per 100 new
cases in 1990 up to 23.4 in 1999).\12\
---------------------------------------------------------------------------
\12\ Ministerstvo zdravookhraneniya Rossiyskoy Federatsii,
Zdorov'ye naseleniya Rossii i deyatel'nost uchrezhdeniy
zdravookhraneniya v 1999 godu, statisticheskiye materialy, Moscow,
2000, p. 51. See also, http://www.minzdrav-rf.ru/cgi-bin/
show.pl?rubr=19&doc=551.
---------------------------------------------------------------------------
The Russian Ministry of Health Web site reports that after
a major shortfall in funding in 1998 (that is, only 58.3
million rubles, equivalent to $2.1 million at a rate of 28
rubles per dollar) of the 460.0 million rubles approved in the
1998 Federal Budget actually was funded; in 1999, however, the
full amount of 485.8 million rubles was fully allocated. In
addition, a larger sum was provided for capital investment and
reconstruction work of anti-tuberculosis facilities. Perhaps
they feel that this pattern creates sufficient expectations of
full funding internally to reject the proposed loan of the
World Bank, for some $100 million for tuberculosis needs ($50
million for AIDS).
Many Russian authorities also underestimate the future
impact of HIV/AIDS, spread chiefly by intravenous drug use and
sexual contact. Dr. Vadim Pokrovskiy of the Federal Center for
AIDS Prevention and Treatment, Russia's leading HIV/AIDS
epidemiologist and the most aggressive messenger of the future
AIDS-related difficulties facing the Russian Government and
population, estimates there will be 5 to 10 million deaths in
the years after 2015 (deaths that, again, I believe from the
logic of the numbers and discussions in Moscow, are not
reflected in the population projections). Most of the victims
will be 20 to 29 years old, and most will be males--further
diminishing the pool of potential fathers. According to
information cited on the online Web site of the Canadian AIDS
Research Project in 1999, it was reported in the Russian press
that ``most Russian HIV/AIDS patients die within 3 to 5 years
after infection.'' \13\ Several other key pieces of
information, and/or projections add to the burden of this
disease on the Russian population now and in the future. The
Russian AIDS Center projects that within 5 years, there will be
up to 5 million HIV positive individual patients. (How many
will not be patients, and therefore not recorded in this number
is unknown, but would undoubtedly add significantly to this
number.)
---------------------------------------------------------------------------
\13\ It is not clear whether these deaths occur among those whose
illness has shifted from HIV to AIDS, or all persons starting from HIV.
Moskovskiy komsomolets, 16 August 1999, p. 4, cited in http://
aidsrussia.org/English/news/99Oct28/99oct28.html.
---------------------------------------------------------------------------
As a consequence, the first 4 months of 2001 found 27,500
new cases of HIV\14\ and by the end of the 5th month, according
to a staff member of the Ministry of Health, Dr. Irina
Kochkarova, the number of new cases was 63,000 (apparently more
than doubling from the end of the previous month).\15\ Thus,
the prediction that
---------------------------------------------------------------------------
\14\ Anastasiya Kuzina, ``Russia Will be Bankrupted Not by
Bureaucrats but by AIDS. Each HIV-Infected Person Already Costs the
Treasury $10,000 per Year,'' Moskovskiy komsomolets, 16 May 2001, p. 2.
And if the Federal Budget for 2001 allocates 42.96 million rubles
(which when divided by 28 rubles per dollar equals about $1.5 million
for 300,000, 700,000 or 1 million HIV/AIDS patients, is sufficient for
150 patients!
\15\ Cited in Emily Charnock, ``Health Official Says HIV is
Soaring; Cases Double in Five Months,'' The Washington Times, 17 June
2001, p. A8.
``in 5 years' time, every 30th inhabitant of Russia
will be infected . . . Bearing in mind that HIV
primarily affects young people (90 percent of cases are
persons aged 15 to 29), every tenth person under the
age of 30 will be a carrier of the virus.'' \16\
---------------------------------------------------------------------------
\16\ Kuzina, loc. cit.
The Moskovskiy komsomolets report adds that if one looks at
the increase in sexual transmission (heterosexual and
homosexual) almost doubling from 6.0 percent of the total
number of new cases of HIV in 2000, to 10.3 percent in the
first quarter of 2001, is extremely worrisome. Dr. Kochkarova
is cited as also asserting that the actual number of HIV-
positive people is five to seven times higher than the official
figures. And, the article continues, if the sexual transmission
rate reaches 30 to 40 percent of the new incidence ``and this
will be a cinch for us,'' the virus will have gone far beyond
just the infectious drug use (IDU) community.
The most direct comparison between a reported and asserted
number is revealed in an article about the etiology, co-factor,
and prevalence of tuberculosis, injection drug use, and HIV/
AIDS in St. Petersburg. Problemy tuberkuleza provides
remarkable details and information about these
interconnections. To the point at hand, specifically, it
contains a figure of 300,000 HIV-positive individuals who are
drug abusers.\17\ Simultaneously, the latest officially
registered number (prevalence) of cases of HIV/AIDS in St.
Petersburg is 7,582 cases at the end of 2000. In addition, more
than half of this total (4,712) was recorded during the first 4
months of 2001.\18\ If the 300,000 figure is to be believed,
and the trends continue, mortality will be even higher than
projected by Goskomstat and the UN, unless and until a vaccine
is found, distributed, and properly administered in time to
mitigate this impending demographic disaster.
---------------------------------------------------------------------------
\17\ K.I. Volkova, A.N. Kokosov, and N.A. Brazhenko, ``Tuberkulez v
period epidemii vich/spida i narkomanii,'' Problemy tuberkuleza, no. 2,
February 2001, p. 62.
\18\ In contrast, a figure of 1,011 in all (prevalence) was
reported for September 1, 2000. Cf. Anna Bazhenova, ``Russia to Have
Over 1 Million HIV-Infected by Year End,'' ITAR-TASS News Agency, 3
April 2001 and V.V. Pokrovskiy et al., ``Razvitiye epidemii VICh-
infektsii v Rossii,'' Epidemiologiya i infektsionnaya bolezn, no. 1,
January-February 2001, p. 14, and ``Chislo VICh-infitsirovannykh
rastet,'' SPV Vedomosti, 3 May 2001, p. 1. It would appear that the
figure of 300,000 and these numbers are irreconcilable, even with any
reasonable multiplier. However, a dissenting view on the numbers of
HIV-positive persons is expressed by Dr. Nikolay Fedorov, head of the
Department for Gene Testing of Blood and its Components, of the Central
Scientific Research Institute of Transfusional Medicine and Medical
Equipment, of the Russian Academy of Medical and Technical Sciences and
of the Ministry of Health. He advocates the use of gene testing and not
just testing for antibodies, which he indicates give many false
positives. He blames, in part, poor quality reagents and careless
laboratory personnel. Thus, it is not the testing per se, but the
mechanics of the test process. See, Andrey Vaganov, ``VICh-infektsiya:
prigovor ne okonchatel'nyy,'' Nezavisimaya gazeta, July 6, 2001, p. 2.
The rate of false-positives in the United States perhaps is 3 percent,
but most are verified or rejected by additional antibody testing and
the Fedorov proposition apparently is exaggerated. Is this also a form
of denial of the serious extent of the problem in the Russian
Federation?
---------------------------------------------------------------------------
Moscow reported a rate of only 2.5 new cases of HIV
nationally per 100,000 population in 1998. However, if we apply
the reported number of new cases of HIV in 2000 (56,471) to the
total population, the rate increases to 38.8 per 100,000
population (derived by dividing 56,471 by 1,455--the population
in 100,000 units, mid-year 2000 estimate). The U.S. HIV
incidence rate was 16.7 new cases per 100,000 population in
1998. There are major regional differentials in the rates of
infection. The Baltic port city of Kaliningrad and its
surrounding oblast held the unhappy distinction of recording
the highest official rate of HIV increase, at 76.9 new cases
per 100,000 in that year. Moscow city and Moscow Oblast, as
well as Irkutsk Oblast, and several others, however, are
currently overtaking it.
The burden of this disease will not fall only on the
general population or the economy ensuing from treatment costs,
but also on the armed forces of Russia. According to
correspondent Anastasiya Kuzina, an internal use only document
obtained by Moskovskiy Komsomolets, points to the growing
incidence of HIV/AIDS within the military and rising concern
among the leadership over this phenomenon.\19\ AIDS (read HIV,
even though the original cites the later aspect of the illness)
penetration into the military was classified as secret for 13
years, until 2000. The report was signed by Dr. P.
Mel'nichenko, Chief Public Health (Sanitarnaya) Physician of
the Ministry of Defense, and entitled, ``Internal [Sluzhebnoye]
Letter on HIV-Infection Morbidity in the World, in the Country
and in the Armed Forces of the Russian Federation.'' The
upsurge in Injection Drug Use in the general population has
been reflected in the draftees into the military forces. Some
of the infected military draftees reportedly have been
sentenced under Article 228--the Drug Addiction Article. Still
others may have joined to avoid their own medical care debt and
to be cured by the military medical services. ``As in civilian
life, the number of infected soldiers in our power structures
[that is, not just the armed forces, per se, but also the KGB/
FSB, the internal security troops, etc.] began to double
annually [except for 1998 and 2000], and half were registered
as being ill in the last 2 years alone.'' \20\ The numbers of
those officially diagnosed with HIV/AIDS in the military are:
1991--4; 1992--2; 1993--2; 1994--7; 1995--2; 1996--29; 1997--
72; 1998--46; 1999--117; and 2000--110. The total is 391.
Apparently, however, these numbers apply only to soldiers and
sailors, not officers and warrant officers. The same source
gives a total of ``about 550 soldiers and officers.'' Through
1996, only 13 officers and warrant officers were afflicted with
HIV, but the number implied here for this category is about
150. In July 2001, Izvestiya was reporting that the Armed
forces daily found up to 2 HIV-positive conscriptees, and in
recent years over 800 persons were infected with the disease.
Compounding the illness problem for the military are reports of
illiterate conscripts coming even from the Moscow Oblast (46 in
all) and the rejection of over 500 drug addicts in one region
(Samara Oblast) for military service. The former figure implies
a possible serious increase in illiteracy among 18-year-old
males. In 1999, only 22 such illiterate persons were drafted
from all of Russia, not from 1 of the 89 administrative-
territorial units. If the latter continues to expand and
combine with the impending decline in the numbers of 18-year-
old males (beginning in 2005, 18 years subsequent to the major
decline in births commencing in 1987), then the pressure on the
military to reduce its demand for manpower is clear from this
point of view, let alone from budgetary or national security
concerns.\21\ Beginning in 2000, three-fourths of new cases
were diagnosed in Moscow city, Moscow and Irkutsk Oblasts;
until 1999, 80 percent were found in Kaliningrad Oblast. The
spread beyond just one oblast must be very worrisome to the
military.
---------------------------------------------------------------------------
\19\ Described in ``Politika i ekonomika. VICh-polozhitel'naya
armiya,'' Moskovskiy komsomolets, 1 March 2001, p. 2.
\20\ Ibid. Also see Yelena Stroiteleya and Aleksandr Chuykov,
``Strel'ba na porazheniye. Nasha armiya prodolzhayet voyevat protiv
sebya, Izvestiya, July 10, 2001, p. 1.
\21\ ``Russian army received 46 illiterate conscripts from the
Moscow region [oblast],'' Ekho Moskvy Radio (in Russian), 1100 GMT, 4
July 2001 (from FBIS CEP20010704000162) and ``Over 500 Drug Addicts
exempted from military service in Samara Region [Oblast],'' from http:/
/www.militarynewsru/fcl--l/enews.asp?id=64646 (from FBIS,
CEP20010705000076). Another example of the prevalence of the lack of
formal education among young males is the report about the situation in
Kurgan Oblast, Western Siberia, is reported on Russian Public TV (ORT),
0500 gmt, 16 April 2001, as cited by BBC Monitoring, April 16, 2001,
that ``Every sixth conscript has only an elementary education of four
grades. Almost half of those recognized as physically fit for service
left school after the 7th or 8th year of studies.''
---------------------------------------------------------------------------
Sexually transmitted diseases have seen incredible rates of
increase during the past decade. These diseases cripple and
kill, damage reproductive health, and are associated with the
spread of HIV/AIDS. The causes can be traced to the explosion
of pornography and promiscuity; the growth of prostitution,
notably among 10- to 14-year-old girls; and, especially, drug
abuse involving shared needles and syringes. In 1997, the
Ministry of Internal Affairs estimated that the market for
illegal drugs was around $7 billion, 600 times greater than in
1991 (assuming little inflation in prices during the period).
Drug abuse and addiction is getting younger and more
widespread. According to Dr. Tatyana Dmitriyeva, a former
Russian Minister of Health, and head of the well-known Serbskiy
Psychiatric Institute (with a history of political
involvement), is quoted by Interfax about the devastating
increase of addiction among young people. Whether she is
paraphrased or quoted is not clear, but in the report of July
8, 2001 from Interfax, she is cited as indicating that:
``the number of adult drug addicts has increased 8
times; over the past 10 years, that of teenage drug
addicts has multiplied 18 times. The growth of drug
addiction among children under [15] years of age is
even more shocking--by 24.3 times . . .''
Exacerbating even these numbers is her revelation that
``the percent of children [that is, those of 0 to 14 years of
age who are drug abusers] has increased from 5 percent in the
late 1980s to 26 percent in 2000.'' Even Moscow now does not
have the highest rate of drug addiction, she notes, but Siberia
at 313.2 addicts per 100,000 population, is distinctly higher
than even the Far East (at 184.8 per 100,000 population), but
the Far East is higher than in Moscow, with a figure of 154.3
per 100,000 population. While one could hope that the reference
to ``addiction'' is more in the line of ``abuse,'' and not yet
quite so serious, but even the latter is a foreboding precursor
for the future health of the population of Russia.
The Russian Ministry of Health reported 450,000 new cases
of syphilis in 1997, and Goskomstat published a figure of close
to 405,000. Even if there is a 10 percent difference in the two
numbers, these are the last reasonably accurate statistics we
are likely to have, thanks to a 1998 law that imposes prison
terms on syphilitics who contract the disease and are drug
abusers. Presumably, the new law has reduced the number of
persons willing to seek treatment. Therefore, the numbers of
persons recorded as having the illness are below the
``correct'' figures since that date. Just as one would predict,
the number of registered new cases of syphilis declined in 1998
and 1999.\22\ However, the explosion in new cases of HIV, and a
concomitant increase in the estimated number of drug addicts,
belie the latest figures on syphilis. The ``epidemiological
synergy'' between HIV/AIDS and other sexually transmitted
diseases (including gonorrhea, which is vastly under-reported
in Russia) suggests not only that syphilis is more widespread
than reported but that further increases in the incidence of
HIV/AIDS can be expected.
---------------------------------------------------------------------------
\22\ There were 342,657 new cases recorded in 1998 and 271,699 in
1999. Zdorov'ye . . ., 2000, p. 55.
---------------------------------------------------------------------------
The 1998 law that classified drug addicts as criminals
ensured that few addicts--a group at high risk for HIV--will
seek treatment. Dr. Oleg Zykov, president of the No to
Alcoholism and Drug Addiction Foundation, in 1998, warned that
as a consequence of this law:
``We will see an increased risk of complications and
overdoses; the death rate among drug addicts will rise;
incidence of HIV/AIDS will rise; [and] the illegal
market of drug-related services will begin to develop
quite intensively.'' \23\
---------------------------------------------------------------------------
\23\ Cited in Yelena Salina, ``Vchera v Rossii nachali sazhat
bol'nykh. Narkomafiya kayfuyet!,'' Komsomol'skaya Pravda, 16 April
1998, p. 1. The Open Society Institute, funded by George Soros, issued
a report prior to the UN General Assembly Conference on HIV/AIDS held
in June 2001, stipulating that ``Authoritarian governments in states of
the former Soviet Union which punish illegal drug users'' are enhancing
the potential for a marked increase in AIDS. Agence France Presse,
``Punishing drug users fueling risk of AIDS explosion in former
U.S.S.R.: report,'' June 23, 2001. From the press coverage of the
report, this clearly includes Russia. For the United States, see the
Centers for Disease Control (CDC) report of May 18, 2001 issue of the
Morbidity and Mortality Weekly Report (vol. 50, no. 19), p. 377.
All predictions unfortunately are beginning to be reflected
in the subsequent period. U.S. experience also clearly follows
this pattern according to the Centers for Disease Control
(CDC): ``Approximately one third of acquired immunodeficiency
syndrome cases and one half of new hepatitis C cases are
associated with injection drug use.''
The contribution of IDU individuals to the soaring HIV
rate, as well as those with venereal diseases (and non-IDU
groups of the population) was documented by Pokrovskiy early in
2001, covering the years 1994 up to September 1, 2000 (Table
2).
While the overall number of persons who were found to be
HIV-positive among those who were examined--therefore possibly
leaving out a significant number who were not examined--jumped
from 161 in 1994 to 39,052 by September 2000. The internal
distribution shown here encompasses a variety of transmission
etiologies, with IDU the largest (at 16,646 cases), the
incarcerated (5,088), those with venereal diseases (1,552), and
other categories, including adults who are found positive when
``clinically detected'' (which would seem to mean that the
illness was asymptomatic and possibly at a late stage of
development), and an ``other'' category not shown in the
original source, but which is derived as the residual from the
other groups and the total. It would appear to be a catch-all
category for doctors who could not find the direct cause of the
infection. Nonetheless, it is one-fifth to one-fourth of the
total number of new cases per year.
TABLE 2.--NUMBER OF HIV POSITIVE IN RUSSIA, BY CATEGORY, 1994-2000
----------------------------------------------------------------------------------------------------------------
Category 1994 1995 1996 1997 1998 1999 2000 \1\
----------------------------------------------------------------------------------------------------------------
Drug addicts........................................ 0 0 442 1,286 929 6,171 16,646
Persons with venereal disease....................... 27 19 90 201 231 829 1,552
Blood donors........................................ 3 6 23 59 69 189 378
Pregnant women...................................... 8 8 18 92 122 296 480
Prisoners........................................... 3 5 218 893 800 3,010 5,088
Clinically detected adults.......................... 61 59 385 932 799 5,195 5,366
Other............................................... 59 96 385 890 1,085 4,439 9,182
-----------------------------------------------------------
Total........................................... 161 193 1,511 4,353 4,035 20,129 39,052
----------------------------------------------------------------------------------------------------------------
\1\ As of September 1, 2000.
We are also informed of the number examined in each
category, and the rate of infection per 100,000 of those
examined. For drug addicts, the rate ranged from an unlikely
zero in 1994 to 3,315.14 per 100,000 examined by September
2000. And the latter rate (of 3,315) is more than 20 times
higher than the rate for all categories examined (at 153.62),
clearly demonstrating the impact of the IDU scourge, and
inexorably related to the growth figures given by Dmitriyeva,
cited above (Table 3).
Perhaps linked to this risk of complications cited by the
author is information about the number of pregnant women who
are simultaneously found to be afflicted with syphilis. The
number of those ill per 100,000 pregnant women in Moscow Oblast
increased by 8 times in only a few years. That is, from 92 to
710 per 100,000 in the 5 year period 1993 to 1997.\24\ The
number of pregnant women tested ranged from 135,000 in 1993 to
121,000 in 1997.
---------------------------------------------------------------------------
\24\ In absolute terms, the number increased from 124 to 860 in the
5 year period. K.K. Borisenko, L.I. Tichonova and A.M. Renton,
``Syphilis and other sexually transmitted infections in the Russian
Federation,'' International Journal of STD & AIDS, no. 10, 1999, p.
667.
---------------------------------------------------------------------------
The data on the impact of syphilis by age group demonstrate
that youth is not a deterrent to the spread of the disease. A
systematic set of data on notification rates, that is new
incidence, by selected age group and the total population, by
sex, in the years 1990 to 1997, demonstrates this clearly
(Table 4). Females aged 0 to 14 were found to be syphilitic at
a rate (including congenital syphilis) per 100,000 population
in this age group at 0.1 in 1990, and at 14 per 100,000 in
1997. This rate of increase must reflect not only better
reporting, the increase in pregnant women with this illness, as
well as child prostitution which bodes ill for reproductive
health in the future.
TABLE 3.--HIV POSITIVE RATE PER 100,000 PERSONS EXAMINED IN RUSSIA, 1994-2000
----------------------------------------------------------------------------------------------------------------
Category 1994 1995 1996 1997 1998 1999 2000 \1\
----------------------------------------------------------------------------------------------------------------
Drug addicts......................................... 0 0 415.19 733.82 413.14 1,723.98 3,315.14
Persons with venereal disease........................ 3.05 1.97 6.97 13.59 15.43 47.64 77.82
Blood donors......................................... 0.07 0.15 0.54 1.5 1.83 4.93 8.94
Pregnant women....................................... 0.19 0.24 0.63 3.25 4.99 11.88 18.44
Prisoners............................................ 0.58 1.01 43.62 137.35 113.16 361.31 520.49
Clinically detected adults........................... 1.19 1.33 8.53 19.72 16.54 87.61 83.16
Other................................................ 0.83 1.7 5.5 13.45 16.36 64.77 111.54
----------------------------------------------------------
Total............................................ 0.73 0.98 7.71 21.32 20.07 91.34 153.62
----------------------------------------------------------------------------------------------------------------
\1\ As of September 1, 2000.
TABLE 4.--NOTIFICATION RATES PER 100,000 POPULATION OF NEW CASES OF
SYPHILIS BY SEX AND AGE GROUP IN RUSSIA, 1990-1997
------------------------------------------------------------------------
Category 1990 1991 1993 1994 1995 1997
------------------------------------------------------------------------
All ages:
Male...................... 5.9 7.9 36.3 92.7 188.8 286
Female.................... 4 6.7 31.6 80.3 166.5 266
Ages 0 to 14:
Male...................... 0.1 0.1 0.6 1.4 3 8.6
Female.................... 0.1 0.2 1.1 3.4 6.7 14
Ages 15 to 17:
Male...................... 2.7 4.6 15.2 65.3 129.7 317.1
Female.................... 8.8 14.1 89.4 217.4 436.5 564
------------------------------------------------------------------------
Other Health Status Issues
The health status of the population is not only a function
of the incidence and prevalence of tuberculosis, HIV/AIDS, and
syphilis, as discussed above. There are issues of smoking,
alcoholism, hepatitis B and C, micro-nutrient supply and
avitaminosis, which are discussed briefly in the following
materials. Subsequent to this section, materials related to
environmental health hazards follows.
More concern over smoking levels in eastern Europe and
Russia has been expressed by the World Health Organization in
the past year. Smoking is a habit among an estimated 70 percent
of Russian males and one-third of females, and multinational
tobacco companies aim to increase their sales in the country.
The World Health Organization estimates that some 14 percent of
all deaths in 1990 in the Soviet Union and eastern Europe were
traceable to smoking-related illnesses; it expects that number
to rise to 22 percent by 2020.
Alcohol consumption reflects an epidemic of alcoholism.
Russian vodka produced for the domestic market (usually in
half-liter bottles) comes with a tear-off top rather than a
replaceable cork or screw top presumably because it's assumed
that the bottle, once opened, will not be returned to the
refrigerator. An estimated 20 million Russians--roughly one-
seventh of the population--are referred to as being alcoholics.
Russia's annual death toll from alcohol poisoning alone may
have risen to 35,000 in 2000, as compared with 300 in the
United States in the late 1990s.
Hepatitis B has sharply increased in incidence, between
1998 and 1999, increasing from 52,561 new cases to 64,140, in
the 2 years.\25\ The then sole producer of vaccines for the
disease told me in Moscow in September 2000, that only 1.3
million doses are produced annually to meet a total demand of
13 to 14 million doses; perhaps 4 million are now produced by a
number of firms and imported, but still far short of demand.
Perhaps even more alarming in the long run are increases in the
incidence of hepatitis C, an illness that chiefly attacks the
liver and requires a very costly, perhaps unaffordable
treatment protocol, especially when combined with other needs
for medical services and their attendant costs. The disease is
often fatal. New incidence in Russia is given as 30,254 in
2000, up by almost 2,000 cases in the year compared to 1999.
The comparable hepatitis C figures for the United States are
2,895 in 2000, down from 3,111 in 1999.\26\
---------------------------------------------------------------------------
\25\ Zdorov'ye . . ., 2000, p. 49.
\26\ Zdorov'ye naseleniya i sreda obitaniya, no. 1, January 2001,
p. 34 and CDC, Morbidity and Mortality Weekly Report, vol. 49, Nos. 51
and 52, January 5, 2001, p. 1169. The U.S. figure may be some ten times
too low based on other CDC publications; the Russian figure probably
also is much higher.
---------------------------------------------------------------------------
Micro-nutrients are in short supply, especially iodine. No
iodized salt has been produced in Russia since 1991, and little
or none has been imported. However, an important contribution
of supplies of iodized salt and production equipment has been
made by Kiwanis International through a $900,000 fund earmarked
for this purpose. The UNICEF office in Moscow, opened in 1997,
includes solving the Iodine Deficit Deficiency disorder as one
of its priorities. In young children, iodine deficiency causes
mental retardation. A World Health Organization cartographic
presentation provides a set of rates among all countries of the
world who consume iodized salt shows that in Russia, only 30
percent of them have iodized salt as part of their diet. Other
information would seem to contradict such a high
proportion.\27\ The United Nations Development Program (UNDP)
regional offices report that ``only 15 percent of the total
amount of common salt is being iodized'' throughout Central and
Eastern Europe, the Commonwealth of Independent States, and the
Baltic States. Thus, in Russia alone, it is very unlikely that
the 30 percent figure is correct, and all the attendant
consequences to such a shortfall is clearly another negative
potential for young persons, in particular.
---------------------------------------------------------------------------
\27\ See especially, two issues of the Kiwanis International
magazine Web site, http://www.kiwanis.org/magazine/99may/99may--
russia.html; and http://www.kiwanisinternational. com/magazine/01june/
russia.html; and the Moscow Office of the United Nations Development
Program (UNDP), http://www.undp.ru/eng/NewsletterSepPage7.htm.
---------------------------------------------------------------------------
Avitaminosis is common. A longitudinal study by the
Institute of Nutrition of the Russian Academy of Medical
Sciences finds shortages of folic acid as well as vitamins A, B
complex, D, and E among 30 percent of the population. This
shortage of vitamins can cause an individual's system to be
unable to resist pathogens, and may contribute to the high
levels of some diseases. Malnutrition may well have contributed
to the incredible increase in anemia, especially among pregnant
women. For all adults, the rate of anemia per 100,000
population increased from 222.3 in 1993 to 392.8 in 1998.
Correspondingly, for children ages 0 to 14, inclusive, the
anemia rate increased by 58 percent, from 926.4 to 1463.0 per
100,000 children over the same period of time.\28\
---------------------------------------------------------------------------
\28\ See the section on Nutrition and Health of the Population in
Ministerstvo zdravookhraneniya Rossiyskoy Federatsii, Sanepidnadzor
sluzhba, Gosudarstvenny doklad ``O sanitarno-epidemiologicheskoy
obstanovke v Rossiyskoy Federatsii v 1998 godu,'' Moscow, 1999, pp. 69-
74, especially p. 70.
---------------------------------------------------------------------------
Heart disease exacts a toll more than twice that in the
United States and Western Europe. The death rate from heart
disease per 100,000 population in Russia is 843.8 in the 11
month period of January-November 2000, up from 810.2 in over
the same period in 1999. In contrast, there were 267.7 deaths
per 100,000 population in Belgium, 317.2 in the United Kingdom,
and 352.3 in the United States. Cancer is becoming more common.
New cases increased from 191.8 per 100,000 population in 1990
to 200.7 in 1998, with a death rate of about 205.0 in 1999 and
206.0 in the first 11 months of 1999 and 2000, respectively
(the U.S. age adjusted rate for the year 1998 is 204.4). The
incidence in Russia is likely to rise as a consequence of long-
term exposure to low doses of radiation from decades of nuclear
testing, as well as to benzo(a)pyrene, dioxin, and other
industrial carcinogens. As in so many other cases, official
statistics understate the problem. There is significant under-
reporting of breast cancer, for example, especially among women
of Muslim origin, who are reluctant to seek treatment from male
doctors.
Some Positive Signs
None of this is to say that there are not some positive
aspects in the health provision area in Russia. Three-and-one-
half years after the adoption of a new ``Kontseptsiya of
Development of Health Care and Medical Research'' in November
1997, a Draft Resolution on the Progress of this Kontseptsiya
of the Board of Directors of the Russian Ministry of Health,
dated 20-21 March 2001, was adopted. The unpublished document
reviewed the goals for the period 2001-2005 and for the period
ending in 2010. It is quite frank regarding problems which
still persist, but it also makes some very reasonable positive
remarks about progress in the health care field. Better
financing, more efficient use of these funds, and a reduction
in the deficit are spelled out. In addition, While they do not
provide precise numbers on the number of procedures or on their
success rate, it is impressive that the numbers for the year
2000 suggest that cardiac operations overall have doubled,
bypass surgery has increased by 150 percent, hemodialysis by
100 percent, kidney transplants by 50 percent, and bone marrow
transplants by 900 percent. While these probably were small in
number in the base period, it is quite an improvement in the
availability of medical services. Many new Federal Programs
such as anti-diabetes mellitus, anti-HIV/AIDS, anti-
tuberculosis and others are being implemented (though other
information would indicate major shortfalls in their funding to
date), and new programs scheduled for endorsement in 2001
include high blood pressure, oncology, and sexually transmitted
diseases. At least the issues are being confronted, but how
long it will take to overcome the very significant size of the
problems is still unclear. Words such as alarming, grave,
serious threat, and similar descriptors are utilized in the
review of the status of morbidity levels of various diseases
and condition. Priority goals for the period ending in 2010
include:
``Reduction of the rate of premature deaths from:
Cardiovascular diseases; Accidents, trauma and
suicides; [and] Malignant neoplasms; Combating diseases
of particular significance in the present demographic
circumstances of this century: Diseases threatening the
reproductive ability of mothers and neonatal diseases;
Diseases of the elderly. Combating diseases that pose a
threat to the health of the nation as a whole:
Tuberculosis; HIV/AIDS; drug addiction; alcoholism; and
sexually transmitted diseases. (p. 8)
More specification of child health other than ``neonatal
diseases'' would be helpful in describing these priorities. But
that they are the priority goals serves to underscore the
internal depiction of the problems they face.
The listing of resolutions and decrees needed and
responsible agencies to implement the Kontseptsiya are quite
detailed. It can only be hoped that they will be successful in
these endeavors given the depth of the problem and its
implications for domestic and foreign policy.\29\
---------------------------------------------------------------------------
\29\ From an unpublished pdf file found in http://www.google.com,
entitled: The Ministry of Public Health of the Russian Federation. The
Board (Collegium) (Draft) Resolution 20-21 March 2001, Progress in
Implementing the ``Kontseptsiya of Development of Health Care and
Medical Research,'' Objectives for the period 2001-2005 and for the
period ending 2010, 27 pp.
---------------------------------------------------------------------------
Childhood vaccination rates for tuberculosis, diphtheria,
whooping cough, and other diseases have risen significantly
since 1995. Vaccination for rubella (German measles), which
causes birth defects when contracted by pregnant women in the
first trimester, was added to Russia's prescribed immunization
calendar, but only in 1999. However, rubella vaccine is not
produced in Russia, and very little is imported; 597,000 cases
of rubella were reported in 1999, and only 453,000 in 2000. In
comparison almost no cases of rubella was found in the United
States, due to immunization. The comparable figures for rubella
at all ages and both sexes, in the United States, are 271 and
152, respectively, in these 2 years.\30\ As noted earlier,
hepatitis B vaccine is now produced by Russian and jointly
owned firms with foreign manufacturers, nonetheless it still
falls far short of needs. Moreover, contributing to the
shortfall in medications and their supply, is the qualitative
issue of laboratory standards. No laboratories in Russia meet
good management practice and good laboratory practice even as
late as 2000; they will be required to meet good management
practice standards by 2005. A long time for this to be
accomplished and expensive, but very necessary to ensure the
quality of vaccines and medications produced in the country.
Hospital to hospital contacts from throughout the United States
and the former Soviet Union have been helpful in improving the
situation, albeit clearly limited so far. Countries other than
the United States also have major contacts and provided
services for health needs.
---------------------------------------------------------------------------
\30\ Same sources as for footnote 26.
---------------------------------------------------------------------------
While there are a few encouraging signs, the larger trends
support the vision of looming demographic catastrophe. And a
number of other developments also offer dark portents for the
country's future rates of fertility and mortality, and for the
general health of its people, especially its children.
Selected Environmental Health Issues
To all the foregoing challenges to the Russian future we
must add a daunting array of environmental ills. Russia will
have to cope with a legacy of industrial development undertaken
virtually without heed of the consequences for human health and
the environment, just as it will have to contend with the
consequences of decades of testing and stockpiling of nuclear,
chemical, and biological weapons.
The crises that temporarily focus worldwide attention on
these problems, such as the 1986 Chernobyl nuclear power plant
accident, only begin to hint at their severity. The news media
beamed shocking reports of the 1994 Usinsk oil spill around the
world, but it was only one of 700 major accidents and spills
(defined as those involving 25,000 barrels of oil or more) that
occur every year in Russia, spreading phenols, polyaromatic
hydrocarbons, and a variety of other toxic chemicals. As Victor
Ivanovich Danilov-Danilyan, the former head of the State
Committee on Environment, noted about the extent of all of
these oil spills, that these losses are equivalent to about 25
Exxon Valdez spills per month!
Radioactivity remains a continuing concern. After the 1963
Test Ban Treaty barred open-air atomic weapons testing, the
nuclear powers continued to conduct underground tests. But
there was an important difference in the Soviet Union. There,
many of the nation's more than 100 nuclear explosions occurred
in densely populated regions such as the Volga, as well as in
the Urals and the less densely populated Yakutiya (Sakha)
regions. After first denying that any of those explosions had
been vented into the atmosphere, then Minister of Atomic
Industry Viktor Mikhaylov later admitted when in Norway (not in
Russia) that venting had occurred in 30 percent of the
underground blasts.
What the potential for human health hazards within the ten
formerly secret nuclear cities devoted to the development and
production of nuclear weapons in Russia remains largely a
mystery. Around the city of Chelyabinsk, a thousand miles east
of Moscow in the Urals, some 450,000 Russians face unknown
risks from a series of spills and accidents that occurred from
the late 1940s to the 1960s. And area rivers may have been
tainted by seepage from nuclear waste directly injected deep
underground at the Krasnoyarsk, Dmitrovgrad, and Tomsk nuclear-
related sites. Near the Tomsk-7 facility, the site of a serious
nuclear accident in 1993, Russian and American
environmentalists found evidence of phosphorous-32, a
radionuclide with a half-life of only about 2 months. The
discovery strongly suggests that radioactive wastewater used in
cooling Tomsk-7's two remaining plutonium producing plants was
illegally dumped. Thus, health hazards emanating from nuclear
contamination is not only a matter of past practices.
Chemical pollution is widespread. Even in Moscow, which is
home to much heavy industry, there is evidence that pollution
has caused genetic deformities in the young. In a study of the
impact of chemical, petrochemical, and machine-building
industries on human health, the Russian Ministry of Health
found that newborns suffered congenital anomalies at a much
higher rate (108 to 152 per 10,000 births) in industrial cities
than in rural localities (39 to 54 per 10,000). Dangerous toxic
emissions from the mining and metallurgical combine in Norilsk,
still is reported (in Novaya Izvestiya, 28 April 2001, pp. 1,
4) as emitting 8,450 kilograms (8.45 tons) of industry-produced
poisons per capita per year; 98 percent of which is sulfur
dioxide. Alarming cases of mercury pollution, which causes
illness and birth defects, have been reported (though aggregate
official data have never been published). Three years ago, 16
tons of mercury was released upriver from the major northern
city of Arkhangel'sk. A plant in Usol'ye-Sibirskoye of Irkutsk
Oblast, when shutting down, spilled 25 tons of mercury. Due to
mercury poisoning, mental deficiency and hypoxia was reported
by Segodnya (on December 3, 1998, p. 7) among the illnesses
suffered by 100 (sic) percent of newborns in Angara. Mercury
has accumulated in the systems of area residents, and the
dilapidated tanks leaked almost all the mercury into the
ground. Moreover, in the 25 year period the plant had been in
operation, some 550 tons ``at least'' had penetrated the ground
near the facility, as well as in the Angara River. Perhaps ``in
10 years'' it will be safe for the residents of the area.
Simultaneously, mercury reportedly has affected the population
of Sayansk city, as well as the Bratsk reservoir.\31\
---------------------------------------------------------------------------
\31\ See the summary of the Novyye Izvestiya article of December 1,
1998, p. 2 and of Segodnya of December 3, 1998 p. 7, in The Current
Digest, vol. 50, no. 48, 1998, p. 17. Also FBIS translated the text of
the ``Segodnya'' broadcast of November 30, 1998, on NTV, at 1900 gmt.
The latter source called it the ``biggest environmental disaster of
recent years.'' From FBIS, ``Siberian Plant Accused of Massive
Environmental Damage,'' FTS 19981201001018, December 1, 1998.
---------------------------------------------------------------------------
Another heavy metal, lead, is the underlying factor in a
widespread pattern of nervous system and psychological
impairments. Detailed data and information are now available
from a joint Russian and American effort to determine the
amount of lead contamination in the country and its human
health impact, particularly on the young. The results show that
the load rates far exceed the Russian (and U.S.) PDK (maximally
allowed considerations). In the survey, it was found that 44
percent of children in 120 Russian cities ``may have blood lead
levels (BLL) that exceed the Centers for Disease Control
standard of 9.9 micrograms per deciliter (mcg/dl) and a total
of nearly 2.4 million children'' may be affected. But based on
recent evaluations published in American medical literature
indicating that a BLL above 5.0 mcg/dl is harmful, then some
portion of the 2.6 million children with 0-9 mcg/dl detected--
perhaps 1 million, for a total of 3.4 million children are
affected. If there are some 27 million children under age 15,
then the 3.4 million total affected by neuropsychological and
mental deficiency problems, would represent some 12 percent of
all children. And this is from lead pollution alone.
The incidence of mental retardation among children (0 to 14
years of age) ensuing from such levels is noted to be as much
as 75.7 percent in Krasnoural'sk, a town located in Sverdlovsk
Oblast in the Middle Urals region, where lead car batteries
were produced and copper smelting took place. There, the
average content of lead in the blood of children is 13.1
0.5 mcg/dl. If one utilizes a broader definition,
of complications of the nervous system and impaired
psychological development, the share increases to 82.5 percent
of all children 0 to 14 years of age, inclusive, in this city.
Krasnoural'sk plants emit some 155 to 170 tons of lead per
year; an unbelievable level, and devastating for the future of
the city.\32\ Serious attention to this issue has led to a new
method for producing car batteries, which will at least save
some youngsters from such health hazards in the future.
---------------------------------------------------------------------------
\32\ P. 124, in the full report, Doklad . . . cited below. A
follow-up summary of the activity was published for USAID by MEASURE
Communication, Lead in the Environment and Public Health in Russia;
Five Years of American-Russian Collaboration. 1995-1999. (Place and
date are not given, but likely is Washington, DC, in the year 2000. The
original summary report in English, was published in Moscow in 1997,
under the title: White Paper: Lead Contamination of the Environment in
the Russian Federation and Its Effect on Human Health, Issued by the
State Committee for Environmental Protection of the Russian Federation,
48 pp. The Russian-language, full report, also issued by the State
Committee, is: Doklad o svintsovom zagryaznenii okruzhayushchey sredy
Rossiyskoy Federatsii i yego vliyaniii na zdorov'ye naseleniya. Moscow,
1997, 233 pp. 200 copies.)
---------------------------------------------------------------------------
The most striking information for current purposes of this
paper is the information from a set of bar charts (without
precise numbers) on the ``Percentage of children with elevated
blood lead levels in selected Russian cities.'' From this
chart, we can determine (roughly) that in Krasnoural'sk, the
city referred to above, 78 percent of all children had high
blood lead levels, split between 63 percent of all children (0
to 14 years of age) who had elevated blood levels over 9.9 to
14.9 micrograms per deciliter (mcg/dl), and 15 percent who had
15.0 or more mcg/dl. Belovo was the next worse city with 51
percent of all children affected, followed by Gus-Khrustalnyy
with 36 percent, Saratov with 23 percent, Volgograd with 28
percent, and so forth.\33\
---------------------------------------------------------------------------
\33\ Lead in the Environment, op. cit., p. 13. Also see the
unpublished paper by Valerie M. Thomas, Princeton University, and Anna
O. Orlova, Johns Hopkins School of Hygiene and Public Health, entitled.
``Soviet and Post-Soviet Environmental Management: Lessons from a case
study of lead pollution.'' The paper was accepted for publication in
AMBIO of June 22, 2000.
---------------------------------------------------------------------------
Using the survey of 43 cities designated as Lead Project
Sites, it was estimated using this same U.S. Environmental
Protection Agency (EPA) biokinetic model, that 1.9 million
children throughout urban Russia were likely to have behavior
and learning problems because the lead content of their blood
was between 10 and 19 mcg/dl. Some 400,000 additional children
had 20 to 44 mcg/dl lead in the blood and needed a medical
check-up and a subsequent test for lead in their blood, and
90,000 children with 45 to 69 mcg/dl lead content were in
immediate need of therapy within 48 hours.\34\ Hopefully
treatment and other measures were promptly and properly
undertaken. A number of appropriate steps were initiated,
including adoption of a national program to decrease lead
contamination. The 1999 National Environmental Action Plan and
the 2000 National Environmental Health Action Plan, set a very
high priority on lead reduction. Leaded gasoline production is
expected to continue to decrease.\35\ However, the national
plans may be aborted if the new environmental administration
sets other priorities. The new environmental administration,
the Ministry of Natural Resources, which absorbed the functions
of the State Committee on Environment, now is headed by its
third Minister in 1 year's time; whether there will be
continuity in following up on this very serious problem is
clearly not discernible at this juncture. The main function of
the new ministry is to develop and exploit the nation's oil and
gas reserves, and not to protect the environment and human
health.
---------------------------------------------------------------------------
\34\ Ibid., p. 12.
\35\ Ibid., p. 16.
---------------------------------------------------------------------------
Other heavy metals such as cadmium and arsenic are
prevalent in the air and land throughout much of Russia. In the
Arctic north, wind-blown heavy metal salts and other pollutants
from the city of Norilsk's nonferrous metallurgical plants have
left the land barren and treeless for 75 kilometers to the
southeast. Lakes and rivers everywhere are badly polluted by
heavy metals dumped by industry and allowed to run off
farmland. Estimates by the Yeltsin-era Ministry of Ecology and
more recent observers suggest that only 25 to 50 percent of
Russia's fresh water is potable.
Foreign Assistance and Unmet Needs
The world has not been blind to Russia's plight. By late
1998, the United States and other donors had sent a total of
more than $66 billion in aid, according to a U.S. Government
estimate. The list of donors includes even South Korea, and
recently officials of the European Union and the World Health
Organization have recognized the need to act aggressively. But
the aid has been inadequate and piecemeal, and/or its delivery
has been hampered by corruption and inept administration. The
frightening reality is that it may already be too late to help.
In a pessimistic assessment, perhaps deliberately
hyperbolic to draw attention to the various problems of the
economy and society, Andrey Iliaronov, an economic adviser to
President Putin, has pointed to 2003 as the year of reckoning,
when the demographic crisis, the crumbling infrastructure, and
the burden of massive foreign debt may combine to deal a
crippling blow to Russia's remaining productive capacity--and
thus, to its ability to help itself.
Where will the money come from for all the myriad
improvements needed in reproductive and child health, for
tuberculosis prevention and treatment, for HIV/AIDS cocktails
of protease inhibitors? (Especially now that the Putin
government has rejected a proposed $150 million loan from the
World Bank for these specific needs.) Who will supply the $200
billion needed to clean up the water supply over the next 20
years, or the $79 billion over 10 years for highway transport
improvement as stipulated by Prime Minister Kasyanov or the $10
to $12 billion to clean up chemical weapons storage sites, or
the hundreds of billions of dollars to clean up nuclear waste?
Yet at the same time, It is reported that Moscow spends $1
billion per year conducting the war in Chechnya. The list of
needs is depressingly long, and the Russian Government has not
always taken the right steps to address them. And yet, despite
how dismaying the task may seem, and how long the odds of
success, we cannot simply ignore the ruin in Russia. The United
States and other nations of the world have a profound interest
in helping to avert an economic and demographic Chernobyl that
would give a fearful new meaning to the word meltdown.
SOCIAL WELFARE: A SOCIAL CONTRACT
By Judyth L. Twigg \1\
----------
contents
Page
Summary.......................................................... 307
The Collapse of the Safety Net and Its Social Implications....... 308
Inequity and the Search for a Unifying Idea...................... 314
The State Response to Social Crisis.............................. 318
Sources of Societal Cohesion and Identity........................ 321
Conclusion--Looking to the Future................................ 324
Summary
A large number of the Russian people have suffered
significant losses from the dissolution of the social contract
they enjoyed with the Soviet regime. The sudden withdrawal of a
meager but comprehensive safety net covering health care,
pensions, employment, housing, and other services has resulted
in widespread poverty and disillusion. Health and demographic
crises, increasing drug and alcohol abuse, and family breakdown
are both causes and symptoms of unprecedented post-Soviet
psychological alienation and withdrawal. Thus far, the
government response to these social crises has been uneven.
However, a handful of effective societal coping mechanisms,
including strong interpersonal networks, non-governmental
``civil society'' institutions, and the re-emergence of a
significant middle class, provide some cause for optimism.
---------------------------------------------------------------------------
\1\ Judyth Twigg, Ph.D. in Political Science from MIT, is currently
Associate Professor of Political Science, Virginia Commonwealth
University. Segments of earlier versions of this paper were originally
prepared under the auspices of the Social Cohesion Study of the
Carnegie Corporation of New York's Russia Initiative (available at
www.carnegie.org), and for the Carnegie Endowment for International
Peace, to be included in its forthcoming volume Russia: Ten Years
After. The author thanks Andrew Kuchins of the Carnegie Endowment and
Deana Arsenian and David Speedie of the Carnegie Corporation for their
permission to reprint the work here. Thanks also to John Hardt for
important comments on previous drafts.
---------------------------------------------------------------------------
The human costs of the Soviet regime were unquestionably
and unbearably high. Few would argue for a return to the
political repression, pervasive economic and bureaucratic
inefficiency, corruption, and general malaise that plagued late
Soviet society. From the perspective of the Russian people,
however, not everything about the Soviet Union was bad. In
particular, an extensive and universal social safety net was an
important positive element of Soviet rule. Free education and
health care, a comprehensive and diverse system of pensions and
social benefits, job security, and extensively subsidized
housing, basic foodstuffs, public transportation, child care,
and vacations all contributed to a meager but reliable floor of
living standards for the vast majority of the Soviet people.
Upward social and economic mobility may have been severely
limited, but there was little reason to worry about slippage
down the socio-economic ladder.\2\
---------------------------------------------------------------------------
\2\ See Bertram Silverman and Murray Yanowitch, New Rich, New Poor,
New Russia: Winners and Losers on the Russian Road to Capitalism
(Armonk, NY: M.E. Sharpe, 1997), p. 22.
---------------------------------------------------------------------------
Despite ubiquitous and sarcastic undercurrents about the
flaws in the safety net and the inadequate labor incentives
provided by the command economy--``we pretend to work, they
pretend to pay us'' being the most popular expression of a
common sentiment--the implied social contract of the Soviet era
was a critical thread in the fabric of Soviet society. People
accepted a low standard of living in exchange for economic and
social security and equity. While economic inequalities did
indeed exist, in the form of an extensive network of perks and
privileges for the politically powerful and well-connected,
they were carefully and mostly successfully hidden. To the
extent, therefore, that Soviet consumers were aware of and
craved unavailable luxury or convenience items--or even basic
essentials of decent quality--there was a sense that the lack
of consumer goods affected everyone equally. Everyone enjoyed
the security of a rudimentary but all-encompassing social
welfare network. On the flip side, living standards were not
high, and the routine inconveniences borne of material
shortages were a constant irritant, but these too were a
universally shared fate.
This common economic and social circumstance, together with
a slow but gradual improvement in living standards during the
late Soviet period, was a critical source of societal cohesion.
A significant portion of the Soviet Union's national identity
and political legitimacy derived from its provision of social
benefits. As long as everyone viewed the state as the guarantor
of some basic level of material comfort and survival, and to
the degree that this guarantee extended universally to all
segments of the population, the Soviet people could ``buy in''
to at least some portion of the regime's propaganda about the
success of the socialist experiment.
Over the last decade, the stress of market reform has
ripped apart the Soviet safety net. The jolt of the sudden
transition to capitalism has left the state unable to maintain
the bulk of the social benefit package that generations took
for granted, producing unprecedented poverty, material
inequities, and socio-economic schisms. As a result, Russian
society has become unanchored. One of its major sources of
national identity and cohesiveness--the perception of socialist
equity--has been fractured. The high expectations engendered by
the early promises of reform have been devastated by a decade's
worth of suffering and hardship. The Russian people's well-
documented yearning for order and stability derives at least in
part from nostalgia for the days when the social contract was
honored, the safety net was intact, and life for many was not
consumed by a daily struggle for basic survival.
The Collapse of the Safety Net and Its Social Implications
The Russian Government's acceptance of fiscal
responsibility in the early 1990s forced it to slash social
spending. Budgets for schools, kindergartens, health
facilities, sanatoria, day care, and a myriad of other formerly
state-provided services plummeted. Wage arrears for workers in
the state sector reached epidemic proportions. At the same
time, workplace-based social benefits, substantial during the
Soviet era, were also eroded by the sudden demand for
enterprises either to become profitable or to go out of
business. Inflation decimated savings, and wage and benefit
increases could not keep up with even more rapidly rising
prices. The state could no longer afford to subsidize a basic
floor of material living standards for the entire population.
As a result, a significant percentage of the Russian people
have sunk into poverty. Anecdotal horror stories surrounding
this phenomenon abound: the grandmother arrested in Ryazan in
October 2000 for trying to sell her grandson for $90,000 so
that his organs could be removed and sold in the West, or
patients in Omsk with multi-drug-resistant tuberculosis (TB)
marketing their disease-saturated phlegm to desperate customers
anxious to infect themselves so that they can buy food with the
money from a disability pension. But these sensationalist
accounts should not mask the larger and more important fact
that 30 to 40 percent of Russians now grind out a living below
the poverty line, with those estimates varying depending on how
poverty is defined. Most analysts agree, however, that the
government's definition of a ``minimum subsistence'' income--
the amount of money required to purchase a basket of basic food
and other consumer goods, and the figure on which pensions,
child allowances, and other post-Soviet-era benefits are
based--is woefully meager. In other words, these poverty
levels, at monthly incomes of around $30 to $45, or the
equivalent of less than $1 a day, represent real hardship. One
analysis in early 2001 showed that the minimum monthly income
in Novgorod Oblast could barely feed five cats. Bread
production in Russia continues to increase each year, since it
remains one of the few affordable staples as the overall
purchasing capacity of the population dwindles. For the average
Russian citizen, consumption levels have fallen by half since
1992, and only one family in six is better off now than it was
then.\3\
---------------------------------------------------------------------------
\3\ Michael Slackman, ``Sold for His Organs,'' Newsday, November 5,
2000; Valery Filonenko, ``A New Method of Obtaining Disability Benefits
Threatens to Sweep Omsk: Infecting Yourself with Tuberculosis,'' Noviye
Izvestiya, October 21, 1999, p. 5; ``Poverty Hits Across the Country,''
RFE/RL Newsline, Vol. 5, No. 35, Part I, February 20, 2001; ``Russians
Buy More Bread as Poverty Bites,'' ITAR-TASS, October 5, 2000; Igor
Semenenko, ``State Debates Poverty As Wealth Gap Grows,'' Moscow Times,
October 18, 2000; Christopher Williams, ``Economic Reform and Political
Change in Russia, 1991-1996,'' in Christopher Williams, Vladimir
Chuprov, and Vladimir Staroverov, eds., Russian Society in Transition
(Aldershot: Dartmouth Publishing Company, 1996), pp. 11-12.
---------------------------------------------------------------------------
The root causes of poverty in today's Russia are
unemployment and low-paying jobs. Although official
unemployment figures hover around 2 percent, these statistics
are notoriously difficult to interpret. On the one hand, they
mask a significant level of underemployment among workers still
officially categorized as enterprise employees but who actually
perform little or no work and therefore receive few or no
wages. These ``unpaid vacations'' may encompass as much as
another 7 to 8 percent of the work force. On the other hand,
the official statistics also miss what may be a significantly
larger phenomenon, the substantial number of people working in
the shadow economy, with wages paid off the books (largely for
purposes of tax evasion). But these workers' unreported incomes
most often involve unskilled labor, poor work conditions, and
low pay. Both reported and unreported wage rates in Russian
industrial enterprises and business offices remain frequently
at levels comparable to developing countries, meaning that
getting a job is no security against poverty.
Poverty in today's Russia is also largely a female
phenomenon. In the late 1990s, nearly 80 percent of Russia's
unemployed people were women. The vast majority of single
parents are women, and more than 80 percent of them have no job
at all. The Russian labor code guarantees that a new mother can
take a 3 year unpaid leave without losing her job, but
employers almost never comply, and many employers hesitate to
hire a woman with small children for fear that she will take
frequent sick leave. Few single mothers receive child support,
and the alimony law is rarely enforced. Bureaucratic red tape
prevents many of the neediest single parents from claiming the
scanty, untargeted child benefit offered by the state; only 30
percent of the poorest families claim their monthly child
stipend.\4\
---------------------------------------------------------------------------
\4\ Sophie Lambroschini, ``Russia: Report Says Women Bear Brunt of
Poverty,'' Radio Free Europe/Radio Liberty, September 27, 2000; Anna
Badkhen and Anna Andreyeva, ``Lack of State Support Hits Single Parents
Hard,'' Moscow Times, September 7, 2000.
---------------------------------------------------------------------------
Although Russian culture still prides itself on cherishing
its children as a precious national asset, the declining
material and social position of children has been one of the
most alarming consequences of the post-Soviet transition. The
single most potent predictor of poverty during the transition
period has been the birth of an additional child to a family.
The poverty rate among families rises steadily with the number
of children, to the point where nearly three-fourths of
families with four or more children are poor. Thanks to these
economic trends, well over 1 million children in Russia aged 14
to 18 have been unable to finish high school in the last
decade.
Substandard living conditions are taking their toll on
children's health, starting at the very beginning of life.
According to the Russian Academy of Medical Sciences, because
of an overall decline in the health of the population, poor
prenatal care, and other factors, only 30 percent of Russian
births can now be classified as ``normal.'' Leading Russian
physicians now speak of the ``deceleration,'' or the mental and
physical deterioration, of children and teenagers. More than 70
percent of Russian young people aged 10 to 15 suffer from
chronic diseases, the number of disabled persons in that age
group is growing at an alarming rate, and the incidence of
mental disorders among teenagers has increased fourfold in the
last decade. These statistics are troubling in and of
themselves, but when put into socio-demographic context--this
is the post-Soviet generation that is supposed to transform
Russia into an energized, market democracy--they are genuinely
alarming.\5\
---------------------------------------------------------------------------
\5\ ``Only 30 Percent of Russian Births Are `Normal,' '' RFE/RL
Newsline, Vol. 4, No. 194, Part I, October 6, 2000; Children in the CIS
Countries: Statistical Handbook (Moscow: Interstate Statistical
Committee of the Commonwealth of Independent States, 2001), pp. 118-
119; ``Russia Sees Huge Rise in Incidence of Mental Illness,''
Interfax, April 5, 2001; ``70 Percent of Russian Youth Said
Unhealthy,'' RFE/RL Newsline, Vol. 5, No. 61, Part I, March 28, 2001;
``Russian Health Ministry Points to Deterioration of Russian Teenagers'
Health,'' Interfax, March 27, 2001.
---------------------------------------------------------------------------
The most extreme manifestation of these negative trends is
the problem of abandoned and orphaned children. In the words of
one orphanage director, ``I can tell how bad things are by the
way families are starting to ask us to take their children.
Families in Russia are falling apart.'' Networks of foster care
and adoption services are still underdeveloped, and therefore
almost 700,000 children must live in orphanages. Having been
raised in an institutional environment, the long-term prospects
for these children are not positive. According to recent
Russian Government estimates, 40 percent of them will end up in
prison, and another 30 percent will become alcoholics. Even
more striking, the country is now home to 1 to 4 million
homeless children, with that number largely dependent on the
weather; more kids take to the streets in the summer months,
and return home when the cold becomes unbearable. This seasonal
variation hints at the peculiar nature of this ``social
orphanhood''--more than 90 percent of these street children
have one or more living parents who have simply lost the
psychological or material wherewithal to raise their offspring
(usually due to alcoholism or unemployment). Either they have
voluntarily abandoned their sons or daughters, or the state has
stripped them of parental rights.\6\
---------------------------------------------------------------------------
\6\ UNICEF, ``After the Fall: The Human Impact of Ten Years of
Transition,'' November 1999; ``Who Cares? A Special Report on Street
Children,'' The World Bank, Spring 2000; Colin McMahon, ``Russia Slowly
Faces Growing Problem: Social Breakdown Sentences Children to Life on
Streets,'' Chicago Tribune, April 1, 2001; David E. Powell and Heidi A.
Holzfaster, ``As Orphans Multiply and Languish, Russia `Decrees,' ''
Boston Globe, December 10, 2000; ``Homes From Home: Russian Orphanages
Boom as Children Founder,'' AFP, April 18, 2001; Masha Gessen, ``Not
Good Enough, Even for Orphanages: No One Wants Babies of HIV-Positive
Mothers,'' U.S. News and World Report, April 16, 2001; Viktoria
Molodtsova, ``Is An Orphan's Lot Always An Unhappy One?'' Rossiiskaya
Gazeta, March 2, 2000, pp. 1, 4; ``Neglected Children Plagued By
Alcoholism,'' RFE/RL Newsline, Vol. 4, No. 224, Part I, November 17,
2000.
---------------------------------------------------------------------------
The plight of parentless children is but one manifestation
of the breakdown of the Russian family. Elderly Russians are
increasingly neglected, becoming known as the new bezprizorniki
(unsupervised ones) because their adult children are too busy
with their own lives to attend to the needs of their parents.
On the whole, however, elders are generally better off than
children and single parents, since the pension system is one of
the few elements of the social safety net that has remained a
political priority. Divorce, while remaining at about the same
rate as in Soviet times, is increasingly costly for women and
children. The number of weddings has declined over the last
decade. More and more children are being born out of wedlock.
An increasing number of intact families are opting not to have
children at all, or to have just one child. In the last 10
years, the number of children in Russia has dropped by over 4
million, a manifestation of declining birth and fertility
rates. While some of this drop stems from medical infertility,
much is due to conscious choice. Low birth rates are a direct
message from people who have lost faith in their society, and
who have little confidence that their social and economic
circumstance is likely to improve. A recent survey of new
mothers in one Russian region showed that 14 percent had
reacted with horrified, suicidal feelings upon learning that
they were pregnant, wondering how they would possibly support a
new, dependent life. Little wonder that there are two abortions
for every child born in Russia.\7\
---------------------------------------------------------------------------
\7\ ``Problems Mount for Old, Young, and Women,'' RFE/RL Newsline,
Vol. 5, No. 54, Part I, March 19, 2001; ``Making Transition Work for
Everyone: Poverty and Inequality in Europe and Central Asia,'' The
World Bank, September 2000; Olge Nesterova, ``Russian Family Is
Changing,'' Trud, May 17, 2001; Amelia Gentleman, ``Wanted: More
Russian Babies To Rescue a Fast Dying Nation,'' The Observer (U.K.),
December 31, 2000.
---------------------------------------------------------------------------
Women's degraded economic positions have caused them to
suffer in other ways as well. Hundreds of thousands of women
have voluntarily turned to a life of prostitution, and tens of
thousands more have been duped into sex slavery through an
extensive European and Asian network of trafficking in women.
At home, Russian women are now, even more than in Soviet times,
routinely the victims of domestic violence. Between 12,000 and
16,000 Russian women each year are killed by their spouses, and
another 50,000 suffer severe injuries--10 times the comparable
U.S. figures. Only six shelters for abused women exist in the
entire country, all the result of private or local initiatives.
Russian culture still sees victims as somehow ``deserving''
their fate, and a lack of legal protection follows those
cultural assumptions.
This view of women is unsurprising, given the blatant sex
discrimination and sexualization of women that has accompanied
the market reform process. The ideological doctrine of
socialist gender equity has given way to a routine of overtly
sexist remarks during parliamentary debates, job advertisements
that specify positions for ``attractive'' females under age 30
``bez komplexov'' (without complexes, or willing to perform
sexual favors), and open street vendor sales of sexually
explicit publications. One mid-1990s survey indicated that over
half of Russian women had been the recipient of sexual advances
by their job supervisors.\8\
---------------------------------------------------------------------------
\8\ ``Pollsters Report Findings on Women's Issues,'' RFE/RL
Newsline, Vol. 5, No. 48, Part I, March 9, 2001; Maria Kotovskaya, ``A
Modest Little Castle in Switzerland and a Romantic Candlelit Dinner,''
Nezavisimaya Gazeta, December 25, 1998, p. 14; Valerie Sperling, ``The
`New' Sexism: Images of Russian Women during the Transition,'' in Mark
G. Field and Judyth L. Twigg, eds., Russia's Torn Safety Nets: Health
and Social Welfare during the Transition (New York: St. Martin's,
2000), pp. 173-189.
---------------------------------------------------------------------------
Not surprisingly, breakdown at the societal and family
level is producing individual-level pathologies as well. One in
three Russians now have psychological problems, a 50 percent
increase in the last decade, and the country's suicide rate is
now among the highest in the world (and four times the U.S.
rate). Work hours lost to psychological problems have been a
significant factor in the country's loss of economic
productivity. Over the last 10 years, disability certification
for mental health reasons has grown more dramatically than for
any other kind of illness. Meanwhile, Russia's mental health
care infrastructure can accommodate only about 200,000 people,
far below the capacity needed to cope with this growing
problem, and even that network of facilities is rapidly
decaying for lack of resources and investment.\9\
---------------------------------------------------------------------------
\9\ ``One-Third of Russians Suffer `Psychological Disorders,' ''
RFE/RL Newsline, Vol. 5, No. 24, Part I, February 5, 2001; Yury Bliyev,
``No One's Safe from Poverty or Illness,'' Meditsinskaya Gazeta,
October 22, 1999, p. 7; Nina Fokina, ``One Flew Over in a
Straitjacket,'' Trud, October 29, 1999, p. 6; Colin McMahon, ``Russian
System Isn't Coping At All With Surge in Mental Disorders,'' Chicago
Tribune, February 1, 2001; ``One in Three Russians Has Psychological
Problems,'' RFE/RL Newsline, Vol. 5, No. 69, Part I, April 9, 2001.
---------------------------------------------------------------------------
Of course, the most well-known and visible manifestation of
Russians' inability to cope with the stresses of the post-
Soviet transition is the vodka bottle. The average Russian man
now drinks three half-liter bottles of vodka each week, and
consumption levels appear to be steadily increasing. Alcohol is
clearly a major contributor to the country's demographic
crisis, accounting as it does for the growing rate of traffic
and industrial accidents and cardiovascular disease in middle-
aged men. Alcoholic parents produce many, if not most, of the
country's abandoned children. If the country had a functioning
network of battered women's shelters, it would be filled with
victims of domestic violence perpetrated by drunken boyfriends
and husbands. Yet vodka remains cheaper than milk, supported by
a state that relies on almost $500 million in annual revenues
from alcohol duties. Despite efforts by the health ministry to
call attention to this problem, the government continues
programs like rewarding a few select oblasts over the May 2001
holidays with additional vodka allocations as a prize for
``good work'' carried out during the preceding 12 months. A
draft law that would limit advertising for alcoholic beverages
and promote public health campaigns about alcohol consumption
has remained stalled for several years.
Illegal drug use is also a growing problem, to the point
where the health ministry refers to it as an ``epidemic.''
Between 3 and 5 million Russians are regular drug users. One-
third of the country's urban population has tried illegal
substances at least once. The rate of drug addiction has
increased more than sevenfold in the last decade, with an even
greater explosion among children and teenagers and a pattern of
usage where Russian young people abandon ``light drugs'' for
heroin and other more dangerous narcotics far more quickly than
is the norm in other countries. Russian specialists are also
concerned about a recent drop in the age threshold for drug
use, from 16 or 17 a few years ago to 12 and 13 today.
Injectable drug use is the almost exclusive transmission vector
for Russia's growing HIV/AIDS problem.\10\
---------------------------------------------------------------------------
\10\ ``Alcoholism Is Becoming a National Security Problem,''
Sevodnya, May 26, 1999, p. 6; ``More Youths End Up Addicted,'' RFE/RL
Newsline, Vol. 4, No. 249, Part I, December 29, 2000; ``Up To 5 Million
Russians Are Drug Users--Health Ministry,'' Interfax, February 21,
2001; ``Russian Drug Addicts Unofficially Put at 3 Million--
Parliamentary Official,'' Interfax, December 28, 2000.
---------------------------------------------------------------------------
Illicit drugs are also a major factor in the country's
growing problem with violent crime. Although crime rates fell
slightly in the late 1990s, current levels still represent a
significant increase over the Soviet period. Coupled with an
unwieldy, often arbitrary judicial system, these crime levels
have bestowed Russia with the world's largest prison
population. One out of every four Russian adults has either
been in one of the country's overcrowded, brutality-ridden
prisons, or has had a family member there. The government's
attempts to reform its penal system have generally involved
mass amnesties, with the unfortunate result that tens of
thousands of actively infected TB patients--Russia's jails are
its main breeding grounds for a sweeping TB epidemic--have been
released into the general population.\11\
---------------------------------------------------------------------------
\11\ Fred Weir, ``Russia To Revise Crime, Penalty,'' Christian
Science Monitor, January 9, 2001.
---------------------------------------------------------------------------
These social pathologies are not limited to Russia's urban
areas. Rural Russia has become increasingly isolated. Telephone
and postal service throughout the country's vast land mass
remains poor and unreliable, many regions still go without
dependable electricity, and transportation to many areas is
problematic. Soviet-era programs to build and maintain rural
infrastructure, including houses and roads, gas and water
supplies, and communication networks, have been largely
abandoned. As a result, villagers--who comprise about one-
fourth of the country's population--must rely solely on radio
and sometimes television as their primary contact with the rest
of the country. This social isolation also extends to the
economic realm. In Soviet times, the planned economy moved
agricultural products to the cities, and manufactured goods
back to the countryside. The lack of investment in rural
infrastructure has now decimated Russian agriculture, to the
point where most specialists estimate that it will take two
generations to recover, and the country must routinely import
food.
According to several recent studies, Russian rural
communities have responded to this circumstance by becoming
autarchies largely outside the market economy. These
communities are able to grow or make most of that they need for
their people to survive, albeit at a relatively primitive
level. Barter has resurfaced as the primary form of exchange of
goods and services, and due to centuries-old village norms of
equity and mutual support, nobody within the community goes
without basic necessities. The good news is that nobody is
starving to death, in a country where famine did indeed ravage
the landscape several times in the twentieth century. Despite
the existence of this community-based network of mutual
support, however, Russia is currently undergoing a process of
rural depopulation. Fewer employment opportunities and lowered
living standards in the villages are pushing young villagers
toward the perceived range of better conditions in the
cities.\12\
---------------------------------------------------------------------------
\12\ Margaret Paxson, ``The Cultural Dimension of Agricultural
Reform: Social Organization and the Metaphysics of Exchange in Rural
Russia,'' lecture at the Kennan Institute of the Woodrow Wilson
International Center for Scholars, Washington, DC, January 29, 2001;
Gennadi Zhuravlev, et al., ``The Socio-Demographic Situation,'' and
Vladimir Staroverov, ``Antagonisms in Russian Society,'' in Williams,
et al., Russian Society in Transition, 1996, pp. 66-67 and 122-124.
---------------------------------------------------------------------------
Inequity and the Search for a Unifying Idea
Perhaps most important in terms of societal cohesiveness,
the stratification of society according to income level has
increased dramatically during the post-Soviet period. The gap
between rich and poor is steadily growing, as is the absolute
number of both very rich and very poor. At the end of the year
2000, salaries for the 10 percent of households with the
highest income in Russia were 32 times those in the lowest
income decile, and the richest households' total incomes were
44 times higher. The new rich, or ``New Russians''--former
Communist Party leaders, bureaucrats, and others who had the
skills, connections, and good fortune to take advantage of the
opportunities presented by the transition--rapidly became
objects of considerable scorn in the early and mid 1990s. Their
combination of garish displays of excessive wealth with lack of
education and manners made them the butts of a whole new genre
of jokes. (Two New Russians meet on the street. ``Hey, Vasya,
where did you get your nice tie?'' ``At the Valentino store.
Cost me $2,000.'' ``That's nothing, I know where you can get
the same tie for $5,000!'') But their profligate spending,
particularly in Moscow and other major cities, drove up the
price of new housing, public entertainment, and other goods to
the point that ordinary people suddenly found those things out
of reach.
The new poor, by contrast, are those who work for the
government or other still-public industries, including a wide
array of skilled workers and former intelligentsia. They have
suffered through the humiliation of meager and often late wage
payments, or in-kind compensation in the form of goods like
bras, caskets, and manure, and the need to supplement the
scientific or technical positions that continue to harness
their intellectual capacities with second and sometimes third
jobs as taxi drivers, cooks, or janitors. For some of these
people, the fall from a Soviet-era position of prestige and
privilege has been dramatic. Workers in the scientific,
industrial, and military sectors, particularly those located in
the ``closed cities,'' realized the best payoffs the Soviet
social contract had to offer. (Indeed, their membership in the
``First Circle'' carried with it a unique clause in the social
contract: denial of interaction with the international
scientific community and the tightest reins on their freedom of
expression, in exchange for material benefits.) But those
benefits, based primarily on priority allocation of scarce
physical resources, have now disappeared. They have been
replaced by a monetarized system in which current earnings and
budget revenues available to these former elite cannot begin to
match the perquisites that were formerly associated with place
of work and politically mandated access. In this regard, the
Soviet-era social pyramid has been inverted. Oligarchs and
traders are now the primary claimants to government largesse,
while highly educated specialists (who still, incidentally,
suffer from limitations on their freedom of expression in the
``closed cities'') have suddenly and unexpectedly become
beggars.\13\
---------------------------------------------------------------------------
\13\ ``25 Russian Regions Extricate Themselves from Poverty,''
Trud, December 23, 2000; ``Number of Impoverished in Russia Declines,''
RFE/RL Newsline, Vol. 5, No. 4, Part I, January 8, 2001.
---------------------------------------------------------------------------
One late 2000 Russian Government economic development
strategy report described the situation in these terms: socio-
culturally and economically, two unequal social layers have
formed over the last decade. About one-fifth of the population
has maintained or improved on its standard of living since the
Soviet era, and a minority of those, about 5 to 7 percent of
the population, have been able to adopt an essentially Western
lifestyle, complete with modern spending and consumption
habits. These people have been able to transcend Soviet
assumptions and mindsets regarding the personal work ethic and
the appropriate role of the state. To them, the free market
rewards those with skills, tenacity, and ingenuity. Their post-
Soviet success has rendered the collapse of the old safety net
irrelevant to them; they no longer need its protections.
By contrast, the almost half of Russians who are subject to
persistent poverty have become jealous and indignant over the
new inequities. In their world, growing inequality has little
to do with the natural results of free-market competition.
Instead, success for the few has stemmed not from hard work,
but from dishonesty and ``blat''--political and social
connections. The gap between expectations and reality for these
people has been psychologically as well as economically
devastating. The disappointment and resentment among those who
mistakenly thought they would benefit from the marketization of
the economy has been profound, particularly when success seems
often to stem from criminal behavior and financial speculation
rather than the production of legitimate goods and services.
Surveys have repeatedly shown that most Russians view the
primary beneficiaries of the transition period as ``swindlers
and manipulators,'' while few agree that ordinary, honest
people have reasonable opportunities to increase their incomes
and living standards. Hard work and a good education do not
necessarily translate into a better life, and to the limited
extent that they do, the latter is increasingly difficult to
obtain. Declining public support for education and the rise of
expensive private schools at all levels have seriously
diminished one of the few remaining channels of social
mobility.
The dynamic of this new, very public division of society
into the haves and have-nots has exacerbated centuries-old
Russian anger at the separation and exploitation of the masses
by their masters. The well-known mantra about what the Russian
people currently crave--order and stability--encompasses not
just social and economic stability, but also a fundamental
sense of social justice. The gap between winners and losers in
post-Soviet Russia still may not match the level of inequality
in the United States, but the rate of explosion of inequality
in Russia has been so rapid that people indoctrinated in the
socialist mind-set have had little time to adjust. As a result,
Russia has lost all sense of a common national identity. In the
midst of socio-economic chaos, no common set of unifying
principles has emerged to replace the ideal, flawed as it was,
of Soviet socialism. Gorbachev's perestroika undermined much of
Russian tradition, forcing society to question its history, its
political culture, its achievements as a superpower, the
essence of its national dignity. For over a decade since then,
the Russian people have been struggling with questions that cut
to the core of their identity. What values do we hold? What
values do we want to transmit to our next generation? How can
we regain a sense of pride and patriotism? For a few, the
answer lay in Western-style individualism borne of the free
market and of liberal political democracy. For the majority,
however, that path has been tainted by the stain of crass
commercialism and materialism and the gross inequities produced
by shock therapy.
Those people have struggled to find alternate social
moorings. They feel isolated and abandoned. Most say that they
can now count only on themselves in times of trouble; only a
small minority claim they can rely even on family and friends.
Only 30 percent are able to recall anything positive that has
happened to them recently. Moscow's most popular radio station
airs catchy tunes with lyrics that reflect the pessimism of
post-Soviet life, songs about war death, death from hepatitis,
and most strikingly, a number one single from early 2000 called
``You Have AIDS (And That Means We Will Die).'' This national
malaise indicates that Russia continues to suffer a wrenching
psychological upheaval. The symptoms of its discontent extend
far beyond what would be considered ``normal'' for a country
undergoing the pangs of economic development, or even the
sacrifices now routine for a post-socialist transition. Almost
nobody has had confidence in the ability of public authorities
to put the country back on the right track.\14\
---------------------------------------------------------------------------
\14\ ``Nearly Four-Fifths of Russians Are Nostalgic About Soviet
Union,'' strana.ru, March 15, 2001; ``Russians Have Trouble Recalling
Good Times,'' RFE/RL Newsline, Vol. 5, No. 77, Part I, April 20, 2001;
Gael Turine, ``Russia's Homeless,'' Time Europe, January 31, 2001;
Alexander Khlop'ev, ``The Transformation of the Social Structure,'' in
Williams, et al., Russian Society in Transition, 1996, pp. 93-106;
Vladimir Shlapentokh, ``A Normal System? False and True Explanations
for the Collapse of the U.S.S.R.,'' Times Literary Supplement (U.K.),
December 15, 2000; Masha Gessen, ``Rockin' To Sad Songs,'' U.S. News
and World Report,'' March 19, 2001.
---------------------------------------------------------------------------
A dramatic cultural sea change has formed an integral part
of this national identity crisis. Even factory workers and taxi
drivers in the Soviet era could recite Pushkin, wax lyrical
about the latest achievements of the Kirov ballet and the
Chekhov theater, or discuss the finer philosophical nuances of
Tolstoy and Dostoyevsky. Stagnant as life may have been under
Brezhnev, it afforded people time and energy to think private
thoughts and to place those ideas within a rich cultural
context. The transition to the market swept away this luxury.
Pushkin and Tolstoy have been replaced with the most base and
commercial representations of Western popular culture, with
billboards sporting half-naked women advertising Levi-Strauss
``dzhinsy'' or Marlboro cigarettes. The television and film
industries have become similarly dominated by American imports.
Only 10 percent of the movies shown in Russian theaters in the
mid-1990s were actually produced in Russia. And the domestic
Russian media has responded by sinking to the lowest common
denominator. Representatives of the Russian Orthodox Church
have blamed Russian television and cinema for many of the ills
currently plaguing Russian society, and one of Russia's leading
film directors has accused Russian television of turning
today's children into a ``generation of monsters.''
In practical terms, the most common response to the last
decade's social and economic upheaval has been apathy, spiced
with a generous dose of hopelessness. Cynicism reigns. There
are no longer ``honest'' or ``dishonest'' ways to make money--
just ``easy'' or ``hard.'' There have been practically no mass,
public displays of discontent over the initial economic
contraction in 1992, the financial crash in 1998, and the
months' and years' worth of nonpayment of salaries. Instead,
only a small minority of people express an interest in protest
actions. Most Russians avoid reading about or discussing
politics at all.\15\
---------------------------------------------------------------------------
\15\ Vladimir Chuprov and Julia Zubok, ``Youth and Social Change,''
in Williams, et al., Russian Society in Transition, 1996, p. 132.
---------------------------------------------------------------------------
Those few who do seek political expression of discontent
are increasingly turning to extremist outlets. A small but
expanding number of young people, even those with good jobs and
higher educations, are joining radical Communist and Socialist
groups to protest wage inequalities and economic dislocations.
Even more disturbing are the growing ranks of neo-Nazi youth
groups across Russia that have been violently targeting non-
Russians, particularly those from the Caucasus and Asia. Of the
small number of Russian youth who express a strong interest in
politics--no more than 5 or 6 percent of the total--over half
claim to favor fascism. The two Chechen wars have provided more
than ample fuel to this fire. Although it would be
inappropriate to exaggerate the scope of these trends at the
present time, it is a situation likely to be exacerbated if the
Russian Government pursues its currently proposed policy of
increased immigration as a solution to its demographic
problems.\16\
---------------------------------------------------------------------------
\16\ ``Russian Youth Seen Turning Left,'' RFE/RL Newsline, Vol. 5,
No. 50, Part I, March 13, 2001; Valerii Solovei, ``Dragon's Teeth: A
Look at Right-Wing Extremism Among Russian Youth,'' Vek, No. 17, April
2001.
---------------------------------------------------------------------------
Russian youth, although more individualistic,
entrepreneurial, and adaptable than their parents, may be the
most severely impacted by this crisis of values. Society has
not offered them the ``vospitanie''--the process of deliberate
instilling of society's positive values--that their parents
enjoyed, primarily because society has been uncertain about
what those values are. Their formative years have been ones of
turbulence and upheaval. Unable to derive meaning from society
as a whole, lacking crucial societal anchors, many of them seem
to believe in nothing larger than themselves. While this may
bode well for their ability to survive in a competitive market
economy, it also has led a significant number of them into a
life of crime; well over half of Russia's racketeers are under
30 years old, and the crime rate for juveniles under 18 is
higher than that for adults. The country desperately needs a
mechanism to re-engage its young people and harness their
considerable energies in a productive direction.\17\
---------------------------------------------------------------------------
\17\ Igor Ilynsky, ``Law and Order,'' in Williams, et al., Russian
Society in Transition, 1996, pp. 234-235.
---------------------------------------------------------------------------
The State Response to Social Crisis
The Russian Government's response to the social crises of
the 1990s has been, at best, uneven. The problems have stemmed
both from shortages of revenue, and from ineffective allocation
and distribution of the scarce resources on hand. The economic
growth rates Russia has enjoyed over the last 2 years (albeit
largely dependent on relatively high world oil prices) provide
a window of opportunity for enhanced financing of reform
efforts in the social sphere. But even during times of relative
plenty, the budgetary choices are difficult. Debt servicing,
the armed forces and military industry, and direct subsidies to
individuals and regions continue to hold significant claims to
any surplus budget revenues. And pouring more money into social
benefits sectors still plagued by Soviet-era inefficiencies and
perverse incentives does not constitute effective reform.
Ironically, in many cases, austerity may go hand in hand with
improved efficiency. Recent policy in the housing sector is
illustrative here. Over the next several years, the Putin
regime will phase out subsidies for housing and utilities,
purportedly in an effort to free revenues for badly needed
capital investment in the utilities infrastructure. Citizens
who now average 5 percent of their monthly incomes on rent,
heat, and water will be expected to pay up to 22 percent of
their household budgets for these services. This reform
presents both opportunity and danger. Smartly implemented, and
with careful and appropriately targeted subsidies for the
needy, it can revive a crumbling physical infrastructure and
introduce market-based productivity to a huge sector of
Russia's economy. Otherwise, however, it will evolve solely as
another (monstrously significant) rip in the social safety net,
with the basic material needs of a huge percentage of the
population once again disregarded.\18\
---------------------------------------------------------------------------
\18\ ``Russian Federation Housing and Utility Services: Policy
Priorities for the Next Stage of Reforms,'' World Bank Report No.
17483-RU, February 25, 1998.
---------------------------------------------------------------------------
Government policies toward health are illustrative of these
dynamics as they operate in the social sector as a whole. The
government has addressed declining health status through a
series of market-oriented reforms that have produced genuine
progress in some areas, and unintended negative consequences in
others. Chronically underfunded at around 3 to 4 percent of
gross domestic product (GDP) in Soviet times, and cut to barely
more than half that today, Russian hospitals and clinics exist
on a shoestring. A system of nationwide compulsory medical
insurance instituted in 1993 held out some promise for extra
cash but, like the state budget, it suffers from chronic
underpayment and late payment of taxes. Despite the earnest
efforts of most physicians and nurses, dreadful quality of
medical care is often the result. A shockingly high percentage
of health facilities have no hot water or sewage systems, and
most still use glass syringes and reusable needles, with
sterilization procedures far below Western norms. Patients
suffer long waits even for urgently needed care. A long list of
medications is not only unaffordable, but unavailable. Perhaps
most disturbing, a higher quality of services, in a system
where comprehensive free medical care is constitutionally
guaranteed, is now routinely provided only to the small number
of people with the ability to pay for it. State-owned clinics
openly (and illegally) demand money for such basic services as
a spot at the head of the queue, accurate diagnoses, routine
attention from ward nurses, anesthetics and other drugs, and
the like. One recent study found that one-fourth of St.
Petersburg residents were required to pay more than 20 percent
of their monthly incomes for their most recent medical
encounter, and another reports that a shocking 59 percent of
all health care spending in the country consists of out-of-
pocket payments (compared to about 25 percent in the United
States). Perhaps inevitably, health care has succumbed to
market forces, but in a chaotic and uncontrolled manner that
has left the most vulnerable parts of the population
unprotected. Universal access to some level of free medical
care, one of the hallmarks of the Soviet system, has been
destroyed.\19\
---------------------------------------------------------------------------
\19\ Yu. Shevchenko, ``Primary Measures for Development of the
System of Health Care in the Russian Federation,'' Zdravookhraneniye
Rossiyskoy Federatsii, No. 2, 2000, pp. 3-8; Igor Sheiman, ``Forming
the System of Health Insurance in the Russian Federation,'' Social
Science & Medicine, No. 39, 1994, pp. 1425-1432; Mark G. Field, David
M. Kotz, and Gene Bukhman, ``Neoliberal Economic Policy, `State
Desertion,' and the Russian Health Crisis,'' in Jim Yong Kim, et al.,
eds., Dying for Growth: Global Inequality and the Health of the Poor
(Monroe, Maine: Common Courage Press, 2000), pp. 155-173; David E.
Powell, ``The Dismal State of Health Care in Russia,'' Current History,
October 1998, pp. 335-341; Judyth L. Twigg, ``Unfulfilled Hopes: The
Struggle to Reform Russian Health Care and Its Financing,'' and Julie
V. Brown and Nine L. Rusinova, ``Negotiating the Post-Soviet Medical
Marketplace: Growing Gaps in the Safety Net,'' in Field and Twigg,
Russia's Torn Safety Nets, 2000, pp. 43-64 and 65-82; V.E. Boykov, et
al., ``Participation of the Population in the Financing of Health
Care,'' Zdravookhraneniye, No. 2, 2000, pp. 32-46.
---------------------------------------------------------------------------
The crux of Russia's health problems, of course, lies not
only at the federal level. The 1993 Law on Self-Governance
devolved primary responsibility for health and health care to
the regions and municipalities. The situation with now-bankrupt
enterprises, and the resulting taxation and budget crises, have
left governors with unfunded mandates to provide an array of
social services, including health. Corruption and incompetence
in some areas have permitted this situation to fester,
untreated, for over a decade. A handful of Russia's
administrative regions, however, are providing more
comprehensive and promising examples of systemic reform.
Samara, for example, is universally heralded as a pathbreaker
in this area. Its progress seems to derive from the confluence
of a variety of important factors. First of all, regional
political leaders have afforded health care top and consistent
political priority. Diligent efforts by regional health
insurance bodies and landmark legislation passed by the oblast
Duma have resulted in practically full funding of health care
budgets for the past 3 years. It is impossible to overstate the
uniqueness of this situation. Literally every other one of
Russia's 89 regions struggles with late or underpayment of
health insurance taxes, leaving their coffers underfinanced and
therefore their universal coverage promises impossible to
fulfill. In contrast, Samara has voluntarily added benefits to
the list of basic health services mandated by law.\20\
---------------------------------------------------------------------------
\20\ Alexei M. Lavrov and Alexei G. Makushkin, ``Extrabudgetary
Funds as a Channel for Territorial Redistribution of Public Finances,''
Chapter 7 of The Fiscal Structure of the Russian Federation: Financial
Flows Between the Center and the Regions (Armonk, NY: M.E. Sharpe,
2000), p. 133; Judyth L. Twigg, ``Russian Health Care Reform at the
Regional Level: Status and Impact,'' forthcoming in Post-Soviet
Geography and Economics, 2001.
---------------------------------------------------------------------------
Samara's success also stems from its creative efforts to
spend each health care ruble efficiently and effectively.
Having abandoned the Soviet-style, central planning-oriented
provider reimbursement mechanisms that remain the norm in most
of the country, Samara now has in place an array of incentive
structures to discourage wasteful spending at hospitals and
clinics. The region is also developing a network of general
practitioners, in an effort to overcome the Soviet habit of
unnecessary and expensive physician overspecialization. The
presence of family doctors affords patients greater freedom of
choice and a higher quality of comprehensive services on a
cost-effective outpatient basis.
Samara also encourages state physicians to offer paid
services within regular polyclinics and hospitals. Due to high
start-up costs, there is still a relatively small number of
physicians in private practice. But many state facilities now
offer private, fee-based services alongside those covered by
the state, and patients can choose to make these legal
additional payments either for treatments not covered by basic
national insurance, or for higher quality or more comfortable
provision of state-mandated services. This mechanism has now,
for the first time, provided physicians with an incentive to
work harder and offer higher standards of care, despite the
fact that their state salaries are still mandated according to
rigid salary scales. They compete for the opportunity to
provide these paid services, and they keep a portion of the
proceeds earned from the business they attract. Visits to some
of Samara's clinics that offer paid services and therefore
enjoy this additional income, and those that do not, offer a
striking comparison. The former contain at least some modern,
Western equipment, and are undergoing significant capital
repair, with evident new construction and remodeling. The
latter continue to exhibit the shoddy construction and
technical standards that were a hallmark of meager Soviet
health care quality.
The success of Samara's reforms is difficult to dismiss,
with dramatic reductions in infant mortality rates in recent
years (12.2 infant deaths per 1,000 live births in 1998,
compared with a figure of 16.5 for Russia as a whole) and an
undeniably greater return on each health care ruble. The
lessons of its experience--the importance of stable leadership
and policy continuity in the health and social sector, and the
magnitude of what can be accomplished when high political
priority is assigned to these issues--should be instructive for
other regions throughout the Russian Federation.\21\
---------------------------------------------------------------------------
\21\ Rudolf Galkin, ``They Can't Discredit Reform,'' Meditsinskaya
Gazeta, January 5, 1996, p. 4; Galkin, ``Samara's Model of
International Health Care,'' Meditsinskaya Gazeta, March 15, 2000, p.
6; ``Health Care of a Region: Samara Oblast,'' Meditsinskaya Gazeta,
June 17, 1998, pp. 5-10; Judyth L. Twigg, ``Samara Leads the Way with
Innovative Medical Practices,'' Russian Regional Report, Vol. 5, No.
32, September 7, 2000; author's interviews with health administrators
and providers in Samara, March 2000.
---------------------------------------------------------------------------
Russian reformers at the national level have conceptualized
federal policies to regulate the health sector's transition to
a market economy, taking into account the need for regulatory
mechanisms that maintain access for the poor and discourage
wasteful spending. These include reducing the Soviet-era focus
on expensive inpatient care, instead performing routine tests,
therapies, and even surgeries on an outpatient basis where
appropriate; training a new generation of family practice
physicians to overcome the Soviet habit of overspecialization;
permitting patients to choose their own physicians, clinics,
and hospitals, so that the benefits of competition can be
realized; removing physicians from rigidly set government wage
scales, so that they feel a monetary incentive to provide more
and better treatment; adopting provider reimbursement
mechanisms other than fee-for-service, or worse, Soviet-style
fee-per-hospital-bed-occupied, which encourages inappropriately
long lengths of stay and gross inattention to quality of care;
and monitoring insurance company and provider behavior to limit
adverse selection and eliminate or regulate the provision of
paid services. In a handful of Russian regions, these and
similar policies have been implemented to varying degrees, some
with impressive results. Samara's example demonstrates that the
key ingredients to success are attentiveness to the health
sector and political will among leaders at the regional level,
which should be applauded and encouraged where they exist.
Certainly a significant increase in health budgets should be
one of the first priorities of Russian social policy. However,
given the obvious difficulties in achieving meaningful
increases in health budgets, measures to improve fairness and
efficiency are essential to ``cure'' Russian health care. But
while the federal and some regional governments have, to
varying degrees, conceptualized some appropriate and even
innovative policies, the legacy of Soviet-era institutions and
mind-sets has in most regions continued to put the brakes on
reliable, consistent implementation of effective reform.\22\
---------------------------------------------------------------------------
\22\ Christophe Raison, ``Regionalisation et crise sanitaire en
Russie,'' Revue d'etudes comparatives Est-Ouest, Vol. 29, No. 3, 1998,
pp. 207-239; ``Basic Directions in the State Regulation of the
Development of Health Care in the Russian Federation for the Years
2000-2010,'' Problemy Sotsial'noy Gigieny i Istoriya Meditsiny, No. 3,
2000, pp. 3-14; I. Nazarova, ``Reform of Health Care: Pros and Cons,''
Zdravookhraneniye, No. 5, 2000, pp. 29-36; V. Shchepin, ``Structural
Effectiveness in the System of Treatment-Preventive Care in the
1990s,'' Problemy Sotsial'noy Gigieny i Istoriya Meditsiny, No. 3,
2000, pp. 24-27; Yu. Shevchenko, ``Primary Measures for the Development
of the System of Health Care in the Russian Federation,''
Zdravookhraneniye Rossiyskoy Federatsii, No. 2, 2000, pp. 3-8.
---------------------------------------------------------------------------
Sources of Societal Cohesion and Identity
Given the government's mixed success at addressing the
country's ongoing social difficulties, how has Russian society
survived the last decade's assault on its most basic structure
and principles? Russian people and families have relied on a
variety of coping mechanisms, some involving social structures
held over from the Soviet past, others newly emergent from the
chaos of market reform. Primary among the former are informal
interpersonal networks. These ``kitchen table'' groups are
close circles of family and friends that, during the Soviet
era, not only served as trusted confidants but also as networks
of mutual provision of scarce consumer goods. Now, in many
cases, these informal circles continue to provide material and
psychological support, serving as the primary or only remaining
source of cohesion and stability for many people. A similar
psychological and economic impact is being engendered by
intergenerational transfers of wealth. It is well known that
some young adults who have navigated the transition period
relatively successfully have financially supported their less
adaptable middle-aged and elderly parents throughout the last
decade. Recent studies have further indicated that family
survival in many other instances is being maintained almost
entirely by older Russians ``giving until it hurts'' to their
adult children and grandchildren, particularly in rural areas--
food from the dacha, money, whatever they have.\23\
---------------------------------------------------------------------------
\23\ Cynthia Buckley, ``Family Matters: Intergenerational Wealth
Transfers and Survival Networks,'' presentation at conference ``From
Red to Gray: Aging in the Russian Federation,'' University of Texas,
Austin, April 6, 2001.
---------------------------------------------------------------------------
In addition, many Russians are returning to the symbols, if
not fully to the substance, of the Russian Orthodox Church.
Well over half of Russians now call themselves Orthodox, and
millions of baptisms were performed in the aftermath of the
Soviet collapse. The Church has deliberately tried to place
itself at the center of a post-Soviet Russian national
identity, referring repeatedly to a uniquely Orthodox ``Russian
idea'' or ``Russian soul.'' But over the last decade, while
successful in opening new parishes and monasteries, the Church
has been less effective in bringing its essence to the center
of people's lives. Basic knowledge of Orthodox doctrine and
theology remains low. As a result, many Russians have turned to
other faiths, a phenomenon to which the Orthodox Church has
responded jealously. It has masterminded a law that restricts,
and may ban, the activity of many of the thousands of non-
Orthodox religious groupings in Russia, excepting only those
deemed ``traditional,'' such as Islam, Buddhism, and Judaism.
Officially sanctioned discrimination against religious
minorities, to the extent that it fosters a climate of
divisiveness and intolerance, may undermine spirituality and
religion as a sustainable source of family stability and
societal cohesion.\24\
---------------------------------------------------------------------------
\24\ Scott Peterson, ``A Russian Resurrection,'' Christian Science
Monitor, December 21, 2000; Giles Whittell, ``Moscow Tightens Its Grip
on Rival Faiths,'' The Times (U.K.), January 2, 2001; Paul Goble,
``Russia: Analysis from Washington--A Religious Flowering,'' Radio Free
Europe/Radio Liberty, April 19, 2001; U.S. Department of State, ``2000
Annual Report on Religious Freedom: Russia,'' September 5, 2000;
Elliott Abrams, ``In Russia, `Liquidating' Churches,'' Washington Post,
November 14, 2000.
---------------------------------------------------------------------------
Russia is also now home to a burgeoning network of over
300,000 registered non-governmental organizations (NGOs), with
many designed to provide families and individuals with social
services and support. The obstacles these groups face are
substantial, from ridiculous bureaucratic registration
requirements to monitoring of their activities by the federal
security services. Fund-raising also remains problematic for
these groups, although some are now beginning to navigate the
waters of public-private partnership, and others have been
blessed by the largesse of well-known tycoons like Potanin and
Berezovsky anxious to create positive public images for
themselves through philanthropy. And many of them still suffer
from public suspicion based on the fact that corrupt
businessmen and politicians often set up illegitimate NGOs for
purposes of money laundering. Nevertheless, many of Russia's
most talented people are choosing careers in this ``third
sector.'' To the extent that they grow and thrive, these
networks of NGOs may prove instrumental in progress toward a
climate of self-generated social welfare to replace the
paternalistic model of state provision. Even more important, to
the extent that they can link their efforts through regional
and national associations, they can provide the foundation for
a genuine civil society, creating a sense of ``common good''
and perhaps also the foundation of a stable, liberal
democracy.\25\
---------------------------------------------------------------------------
\25\ Sophie Lambroschini, ``Russia: NGOs Just Beginning To Take
Root,'' Radio Free Europe/Radio Liberty, October 13, 2000; Joseph
Boris, ``Russian NGOs Threatened, Praised by Officialdom,'' UPI,
January 4, 2001; ``Good Works,'' The Economist (U.K.), March 24-30,
2001; ``Putin Wants Dialogue with Civil Society, Welcomes Its Growth,''
RFE/RL Newsline, Vol. 5, No. 112, Part I, June 13, 2001; Marcia Weigle,
Russia's Liberal Project: State-Society Relations in the Transition
from Communism (University Park, PA: Penn State University Press,
2000), pp. 333-379; 1999 Human Development Report for the Russian
Federation, pp. 114-125; James Richter, ``Promoting Activism or
Professionalism in Russia's Civil Society?'' and ``The Case for
Assisting Russian NGOs,'' Policy Memos 51 and 137, Program on New
Approaches to Russian Security (PONARS), November 1998 and April 2000;
Jeffrey Checkel, ``Access, Influence, and Policy Change: The Multiple
Roles of NGOs in Post-Soviet States,'' Policy Memo 80, PONARS, October
1999.
---------------------------------------------------------------------------
Government authorities have also recently attempted quite
deliberately to re-establish a positive, distinctively Russian
national identity. In a clear effort to build a new foundation
for political legitimacy, President Putin is overtly
cultivating a new patriotism, a new national pride--a sense
that the country's past and present are nothing to be ashamed
of, an attempt to step out of the shadow of a decade of socio-
economic turmoil and more recent disaster such as the sinking
of the Kursk. The restoration of the old national anthem was
the first step; the second was the restoration of basic
military training and patriotism classes in the public schools.
In March 2001, the government announced a full-blown, $6
million ``patriotic education'' program designed to counter a
wave of ``indifference, individualism, cynicism, unmotivated
aggression, and disrespect for the state'' evident since the
collapse of the Soviet Union. Over the next 5 years, the
project will attempt to reshape the education system through
new history and other textbooks, influence the mass media (with
prizes offered to journalists, writers, and filmmakers whose
work exemplifies the goals of the program), and create a
network of ``military-patriotic youth clubs'' around the
country. Whether these efforts are intended to foster
positively directed Russian nationalism or a cult of
personality around Putin himself is debatable, but in many ways
they are clearly falling on fertile ground. Recent consumption
patterns--``nasha'' products are now preferred over Western
brands, and not just because of the price differentials with
imported goods resulting from the August 1998 ruble
devaluation--and numerous public opinion polls are now
revealing a rejection of things Western. Consumer nationalism
is leading advertisers to stress the ``Russian-ness'' of their
products--even if those products are made by Western firms.
U.S. confectioner Mars' newly launched candy bar, for example,
is called ``Derzhava''--the Russian word for ``power,'' and an
unofficial slogan of the strong Russian state.\26\
---------------------------------------------------------------------------
\26\ Mark Franchetti, ``Russian Children to Train for War,'' The
Sunday Times (U.K.), September 3, 2000; Susan B. Glasser, ``Letter from
Russia: Patriotism, Selling Like Hot Cakes,'' Washington Post, May 9,
2001; ``Russia's School for Patriots,'' AFP, March 15, 2001; Fred Weir,
``Moscow Pitches Patriot Games,'' Christian Science Monitor, March 22,
2001.
---------------------------------------------------------------------------
One important constituency for a new, positive Russian
nationalism is the emergent middle class. Significant evidence
suggests that this new middle class has energetically arisen
from the rubble of the 1998 financial crisis--middle class not
only in income and wealth, but also in outlook and behavior.
They vacation abroad. They frequent cinemas and theaters and
the country's most recent craze, bowling alleys. On average,
they hold a significantly more optimistic view of the future
than the rest of the population. Many of them are young
professionals who believe in the virtue--and in the
possibilities--of hard work, and they are determined to build a
Russia within which they and their children can succeed. They
manage to save some money, and they purchase major durables
like cars and houses. They typically invest whatever profit
they make back into their ventures, creating jobs and the
foundation for a stable economic base. Although it constitutes
no more than 10 to 15 percent of the population, remains
vulnerable to shifts in the economy, and is located primarily
in Moscow and a handful of other major cities, this emergent
social stratum, plugging the gap between rich and poor, could
serve as a powerful foundation of the necessary context for
stability and cohesiveness. They are a significant cause for
optimism.\27\
---------------------------------------------------------------------------
\27\ ``Russia's Middle Class Emerges from the Wreckage,'' AFP,
November 6, 2000; Rob Parsons, ``The Rise of Russia's Middle Class,''
British Broadcasting Corporation, January 11, 2001; Paul Starobin and
Olga Kravchenko, ``Russia's Middle Class,'' Business Week, October 16,
2000; Anna Raff, ``Middle Class Is Back and Growing,'' Moscow Times,
September 26, 2000; ``Looking for the Middle Class,'' Finansovaya
Rossiya, No. 4, February 2001, p. 5; Tatyana Maleva, ``Middle Class:
The Doors Are Closing,'' Vremya Novostei, August 8, 2000, p. 3.
---------------------------------------------------------------------------
Conclusion--Looking to the Future
The Russian people have been subjected to seemingly
unbearable humiliation and hardship over the last decade. It's
hard not to ask why they've tolerated it. Why aren't masses of
impoverished, disaffected, alienated Russians marching in the
streets, demanding an improvement in their living conditions
and in their social environment? Some Russian analysts
cynically--but perhaps with a grain of truth--claim that the
history of the Russian masses demonstrates a love of suffering,
a craving for martyrdom. Others observe that many Russians have
quite evidently chosen a more individualistic form of protest
through withdrawal to the vodka bottle or the heroin needle, or
more broadly, through withdrawal from active participation in
society as a whole. Still others might cite a fear of disorder,
of even more disruptive and destructive chaos if significant
demands for change are made. And many observe that most
Russians have been too preoccupied and exhausted by the daily
struggle for survival to muster up the necessary energy to
complain. Centuries-old Russian stoicism--an older Russian,
looking back on her life, might observe that the last decade
represents just one of many ups and downs for Soviet and
Russian society--certainly goes a long way toward explaining
the Russian people's acceptance of their fate.
Perhaps the cultivation of symbols and slogans can serve as
a rallying point around which people can restore the national
identity they so desperately need. But resurgent patriotism, no
matter how heartfelt, will not erase the grinding poverty and
gross inequities that continue to plague the Russian socio-
economic landscape. The most important social questions for
Russia today cannot be solved by surface propaganda. They can
be addressed only by moving a significant portion of the truly
depressed people and places throughout the Russian Federation
stably into that new middle class. Regenerating the necessary
degree of social mobility will require a restoration, albeit
significantly amended and adapted to market circumstances, of
the old social contract.
Why, beyond the obvious humanitarian concerns, should these
social issues in Russia assume importance for U.S.
policymakers? Elsewhere in this volume, Russia's historical
endowment with superior natural and human resources is noted.
Appropriate concern is voiced over the deterioration of the
country's physical infrastructure--its roads and bridges,
communications networks, and utilities. But perhaps even more
important for the long term, largely because its repair is a
much more complex and long-term proposition, is the degradation
of Russia's human capital. The evidence presented here suggests
that the physical and psychological health of Russia's human
resources have suffered tremendously during the transition
period, as has the incentive structure governing human
development. This decline, due in large part to the rupture of
Soviet-era social safety nets, carries with it enormous
economic and political implications. Democracy, economic
reform, and stability in Russia are largely dependent on the
emergence of a stable middle class engaged in the development
of a robust civil society. A social landscape stratified into
haves and have-nots, with the majority of the population
disengaged from a government it no longer trusts to provide
even a minimal safety net of social protections, may nudge the
Russian voting public toward a preference for a return to the
past. Only a healthy, energetic, positively motivated
population can provide the necessary spark to reform the
country's economy, revitalize its society, and rebuild its
national security institutions. And a politically,
economically, and militarily stable Russia is much more likely
to emerge as a friend and partner to the United States than is
a Russia filled with uncertainty, insecurity, and continued
collapse and decay.
=======================================================================
LONG-TERM PROSPECTS FOR RUSSIA'S ECONOMIC GOVERNANCE
=======================================================================
LONG-RUN PROSPECTS FOR THE RUSSIAN ECONOMY
By James R. Millar \1\
----------
contents
Page
Summary.......................................................... 329
Introduction..................................................... 330
The Current Condition of the Russian Economy and of Economic
Reform......................................................... 332
Economic measures............................................ 332
Politics, military reform and foreign policy................. 334
Putin as leader.............................................. 336
Why is Putin popular?........................................ 336
Implications for the sustainability of economic reform and
growth in Russia in the near future........................ 337
Prospects for the long run................................... 338
The future of Russia as a market economy: the transition in
historical perspective..................................... 339
The probable structure of the Russian economy in the long run 341
References....................................................... 344
Summary
Long-run forecasts are particularly hazardous, and that has
to be especially the case when it comes to Russia. Enormous
changes have taken place over the past one and a half decades.
Gorbachev undermined the stability of the system in his attempt
at reform. Yeltsin destroyed the old political and economic
system in what can properly be called a revolution. His
replacement, Putin, remains largely a mystery. How committed is
he to continued market reform and to democratic processes? It
is too early to tell with any confidence.
---------------------------------------------------------------------------
\1\ James R. Millar is a Professor of Economics and International
Affairs and the Director of the Institute for European, Russian and
Eurasian Studies at the George Washington University, Washington, DC.
---------------------------------------------------------------------------
One thing is clear, the economic transition, defined as
radical change, is over. The population is exhausted and
opposed to further radical change. The Putin government has
benefited from the beneficial effects of the 1998 financial
crisis upon Russian domestic industry and upon an unusually
high and steady price of oil on world markets. In the short
run, the economy appears relatively healthy. There are warning
signs on the horizon, however, for the price effects of
devaluation are wearing off, and the world market price of oil
is unlikely to rise further or to remain at the current level.
Consequently, steps need to be taken to provide alternative
sources of economic growth. Putin's words thus far have been
impressive. His actions have been more ambiguous.
Chances are good that the economy will falter in the short
run, or, at best, improve gradually. The best prospect for
continued gradual reform in Russia is represented by the
proximity of the European Union (EU). It is a major customer
for Russian exports, and so are the Eastern European countries
now in line for accession to the EU. The conditions for
admission to the EU are essentially identical with those
required for a successful economic transition to a workable
market economy, and the charter spells out these requirements
in chapter and verse.
Long-run prospects of developing a complete market economy
in Russia are quite good. An examination of world economic
history reveals what appears to be an inexorable trend away
from economies based on custom and command toward market
relations. The current emphasis upon globalization represents a
continuation of this trend. In historical perspective, the
Soviet economic experiment with central planning represented a
deviation from the trend line. Thus, Russian and the other
transition states are returning to the trend line, to a more
optimal relationship between markets and government
intervention in the economy. Although prospects are good that
this movement will continue in Russia, it does not follow that
progress in economic welfare will be achieved readily. A market
economy may be the best solution for the allocation of
resources, but until individual countries and/or the
international economy learn to steer clear of currency crises,
trade conflicts and depressions, sustained economic growth will
be difficult to attain. Russia will be fortunate to reach the
status of Brazil or Mexico in the long run. Catching up with
the G-7 countries, with the EU or even with the leading
countries of Eastern Europe appears unlikely for the
foreseeable future.
Introduction
Burke ever held, and held rightly, that it can seldom
be right . . . to sacrifice a present benefit for a
doubtful advantage in the future. . . . It is not wise
to look too far ahead; our powers of prediction are
slight, our command over results infinitesimal. It is
therefore the happiness of our own contemporaries that
is our main concern; we should be very chary of
sacrificing large numbers of people for the sake of a
contingent end, however advantageous that may appear. .
. . We can never know enough to make the chance worth
taking. There is this further consideration that is
often in need of emphasis: it is not sufficient that
the state of affairs which we seek to promote should be
better than the state of affairs which preceded it; it
must be sufficiently better to make up for the evils of
the transition. (John Maynard Keynes, Treatise on
Probability, cited in Robert Sidelsky, John Maynard
Keynes. The Economist As Savior, 1920-37, p. 62.)
Lord Keynes is here discussing Edmund Burke's philosophy of
governance and reform. The statement was condensed in The
General Theory, where Keynes stated simply that ``in the long
run, we are all dead.'' The quote from Burke represents Keynes
commitment to what has been the Anglo-American tradition of
avoiding revolutionary change in favor of step-by-step,
brokered reform of the economic system.
In contrast, economic reform under Boris Yeltsin was
radical and utopian. Shock therapy was expected to entail large
costs for the population in the short run, but provide
substantial benefits in the future. It turned out, however,
that the cost was much greater and the period of sacrifice much
longer than the radical reformers and Western advisors
anticipated.\2\ They clearly did not ``know enough to make the
chance worth taking,'' and the benefits of the reforms in
Russia have yet to prove ``sufficiently better to make up for
the evils of the transition.''
---------------------------------------------------------------------------
\2\ Millar, James R. ``The Failure of Shock Therapy.'' Problems of
Post Communism, Fall 1994.
---------------------------------------------------------------------------
Russia from the time of Peter the Great through the Soviet
period has a history of radical change imposed from the top on
the population, change that has almost always entailed very
large costs on the contemporary population in the name of
future benefits. The Bolsheviks carried out a series of
campaigns, such as mass collectivization, rapid
industrialization, the Virgin Lands program, that were
typically imposed from the top and implemented with little
concern for the underlying population, whether opponents or
not. Yeltsin followed this tradition like a good Bolshevik
despite his renunciation of the Communist Party. Price
liberalization in 1992 wiped out personal savings of the
population at large. Hasty privatization of Soviet enterprises
and natural resources transferred public wealth into a very
small number of private hands to a degree unprecedented in
history. Real income crashed for most Russian citizens. Poverty
and unemployment caused untold misery for Russian pensioners,
the working class and the farmers. Only a few have benefited in
the short run. Some improvement is now taking place in the
medium term, after 10 years, but much remains to be done to
turn the Russian economy into a workable and stable market
economy. And there is no assurance that the positive rate of
growth of gross domestic product (GDP) that Russian has
experienced for the past 2 years can be sustained.\3\
---------------------------------------------------------------------------
\3\ Hedlund, Stefan. Russia's ``Market'' Economy: A Bad Case of
Predatory Capitalism. London, UK: UCL Press Limited, 1999.
Bush, Keith. ``The Russian Economy in June 2001,'' Russia and
Eurasia Program, CSIS (June 2001), E-document.
---------------------------------------------------------------------------
Vladimir Putin has thus far eschewed radical economic
reform, preferring instead to work with the Duma to promote a
series of measures designed to make the economy more responsive
to markets and the global economy. He may be labeled a
gradualist to date, and willing to compromise with the foes of
a liberal market economy rather than confront them. What is the
prospect that he will indeed be able to achieve gradually what
his predecessor Boris Yeltsin failed to achieve by brute
political force? What does the long run hold for the Russian
economy? The concern of this paper is to try to specify what
that long-run prospect is likely to be, with due deference to
how ``slight'' our powers of prediction are and the uncertain
command Russian leaders have over results.
The Current Condition of the Russian Economy and of Economic Reform
An examination of reform successes and failures among the
25 independent countries that emerged from the Soviet Empire
reveals that a strong, unambiguous commitment to economic
reform has been an important, if not the most important,
variable. The most successful states have been those that
wanted desperately to get out from under Soviet power. They
have sought to link their fortunes with Europe, especially to
the European Union. Also critical, almost all had experienced a
period of independent existence as states before coming under
Soviet influence.\4\ As in almost all of the former republics
of the U.S.S.R., the leadership in Russia has been ambivalent
about introducing the reforms necessary to create a workable
market economy and ambivalent also about its relationship to
Europe.
---------------------------------------------------------------------------
\4\ Millar, James R. ``The Post Cold-War Settlement and the End of
the Transition: Implications for Slavic and East European Studies,''
NewsNet, The Newsletter of the AAASS (American Association for the
Advancement of Slavic Studies), January 2001, v. 41, no. 1.
---------------------------------------------------------------------------
Yeltsin's commitment to economic reform was never constant,
and it diminished over the years of his erratic rule. His
successor, Vladimir Putin, remains something of a mystery. Is
Putin a cautious, but determined reformer seeking step-by-step
reform in the spirit of Lord Keynes and Edmund Burke? A recent
statement on Russia Day, a celebration of the tenth year since
Russia was declared a republic, might qualify Putin for this
title: ``Everything we endured over the past decade, all our
experiences, successes and failures, shows one thing--any
reform only makes sense when it serves the people.'' \5\
---------------------------------------------------------------------------
\5\ Johnson's Russia List #5295; Reuters: Jon Boyle.
---------------------------------------------------------------------------
Or is he primarily concerned with maximizing political
power primarily in order to keep himself in power? Putin has
certainly talked like a real reformer, but his actions have
been more difficult to interpret. The high world market price
of oil has provided a large windfall gain for Putin's
government, as has the vigorous response of Russian industry to
the benefits of the devaluation of the ruble that followed the
1998 financial crisis. The question is: How effectively has
Putin utilized this period of relative prosperity? What has he
actually done to sustain economic growth after the windfall
gains of 2000 and 2001 have been exhausted?
economic measures
At the outset of his presidency, Putin indicated that he
planned to reduce the political and economic power of the
wealthy individuals known as ``oligarchs'' who benefited so
greatly from privatization of Russian industry and natural
resources. Thus far two of the most prominent and vocal
oligarchs, Boris Berezovsky and Vladimir Gusinsky, have been
thoroughly undermined. Gusinsky has apparently lost his media
empire, and Berezovsky has gone from kingmaker (for both
Yeltsin and Putin) to political outcast. However, Putin's
motive appears to have had less to do with economic power than
with the desire to quiet criticism from their media
enterprises. Putin obviously does not appreciate criticism, and
he has effectively crushed the independent media in Russia by
undermining Berezovsky and Gusinsky. More recently,\6\ Putin
engineered the removal of Rem Vyakhirev, who had been CEO of
the giant natural gas monopoly Gazprom since 1992, and replaced
him with Aleksei Miller, a long-time Putin loyalist. Vyakhirev
was a variant type of oligarch, one appointed essentially by
the government to manage a huge partly private, partly state
enterprise. In replacing Vyakhirev, Putin has strengthened his
hand in many respects because Gazprom is such an important cash
cow for the budget. If Miller manages Gazprom more efficiently
and does not use access to its great wealth mainly for his own
personal enrichment, this change will represent a major
economic advance. That is yet to be seen. The verdict on
Putin's policy toward the oligarchs is, therefore, not yet in.
The remaining oligarchs, with the exception of Anatoly Chubais,
who has metamorphosed from radical reformer to oligarch and now
runs the national electricity monopoly, are lying low
politically, which may be the price they must pay to keep their
ill-gotten wealth intact.
---------------------------------------------------------------------------
\6\ New York Times, May 30, 2001.
---------------------------------------------------------------------------
The Minister of Economic Development and Trade, German Gref
has produced a 10 year plan for the Russian economy that was
officially adopted by Prime Minister Mikhail Kasyanov in June
2000,\7\ but it has yet to be truly engaged. Curiously, the
plan has certain earmarks of Soviet-era long-term plans, and it
may meet the same fate--to be announced with great fanfare and
then forgotten. Meanwhile, Presidential economic advisor Andrei
Illarionov has bitterly criticized Gref's plan as
insufficiently reformist and unrealistic. Illarionov, who seems
to be something of a loose cannon, continues to quarrel with
Anatoly Chubais, CEO of RAO UES (Unified Energy Systems of
Russia), concerning reform and management of the energy
monopoly. He has also criticized the Prime Minister sharply for
even suggesting earlier this year the possible postponement of
payments of principal and interest to the Paris Club,\8\ and
they have had other public quarrels too. Meanwhile, Putin has
maintained silence regarding these conflicts among his economic
advisors. Apart from a tax reform and, more recently, urban
land tenure reform, progress on the many economic reforms that
are needed has been modest at best. Everyone agrees, for
example, on the need for better corporate governance, but no
one seems to be doing anything other than talking about it.
Similarly, restructuring and reform of commercial banking and
the financial system generally have been oft mentioned but
rarely acted upon convincingly.
---------------------------------------------------------------------------
\7\ Russian Journal, June 29, 2000.
\8\ Lipman, Masha. ``The Indecisive President.'' The Washington
Post, February 6, 2001.
---------------------------------------------------------------------------
Andrei Illarionov also forecast (wrongly it now seems)
bleak economic performance for 2001 to the European Business
Club in Moscow January 16: ``The party is over and the hangover
is about to begin.'' He stated that the Prime Minister had had
nothing to do with successful economic growth in 2000. It was
``sparked by sky-high oil prices and the rapid depreciation of
the euro to the U.S. dollar.'' \9\ In June, Illarionov,
addressing members of the American trade chamber, amazed his
audience by arguing that ``Russia has no need of investments or
credits.''\10\ Meanwhile, Kasyanov has been urging investment
in Russia during his foreign trips. The question is: Where was
Putin? Are his economic advisors allowed to say anything they
want; to quarrel publicly without official resolution of the
issues?
---------------------------------------------------------------------------
\9\ Semenenko, Igor. ``Illarionov Warns of Looming Gloom.'' Moscow
Times, January 17, 2001.
\10\ Izvestia, June 4, 2001.
---------------------------------------------------------------------------
Privatization of rural land remains deadlocked. Putin has
urged the regional governors to support ``coherent land
legislation'' and a federal land code. German Gref, Mikhail
Kasyanov and Andrei Illarionov all agree on the economic
benefits private land tenure would bring about. Recent
developments indicate that urban land, which comprises less
than 10 percent of all land area in Russia, will be opened to
private, and perhaps even foreign private, ownership. But the
opponents of privatization of rural land in the Duma continue
to oppose it on ideological and historical grounds.\11\
---------------------------------------------------------------------------
\11\ Lambroschini, Sophie. ``The Government Uncertain Role to Land
Privatization.'' Part 1, RFE/RL, February 9, 2001.
---------------------------------------------------------------------------
Urban land has been controlled by mayors and regional
governors for local ends and personal profit, and they may
still find ways to frustrate or restrict private ownership.
Agricultural land has always been treated as commons or as
communal property, and even most peasants want it to stay that
way. The result is that action on land tenure continues to be
controversial and stagnate, which contributes to a poor
environment for foreign direct investment.
politics, military reform and foreign policy
What is true of economic policy is true generally. Putin's
policies have been anything but bold, coherent and decisive.
Putin has had relatively good relations with the Duma, but he
has yet to push reforms through it vigorously. He was
successful in establishing federal control over the various
provincial regions last year, at least pro forma. The regional
governors were ousted from Parliament, but, in the end, they
were allowed to appoint their replacements. Also, the maximum
of two terms for the 89 regional leaders was revised in January
2001, allowing 69 of them to run for a third term. As one
observer put it, ``In other words, as long as the governors
don't challenge Putin's authority, they can continue to rule as
they have been [doing] . . . .''\12\ The jury is still out on
how effective Putin's seven presidential super-governors will
be in reigning in the regional governors. A recent Radio Free
Europe/Radio Liberty (RFE/RL) Russian Federation Reform
Roundtable discussion among American scholars suggests that the
reform has been quite ineffective.\13\ The jury is still out on
how effective Putin's seven presidential supergovernors will be
in reigning in the regional bosses.
---------------------------------------------------------------------------
\12\ Moscow Times, Editorial, January 29, 2001.
\13\ Johnson's Russia List #5226, April 27, 2001.
---------------------------------------------------------------------------
Putin has also succeeded in silencing media criticism of
him and his government. Grigory Yavlinsky, head of the small
liberal party, has described Putin's policies harshly as
``National Bolshevism.'' What is happening to the country, he
stated recently, is ``sham freedom of speech, sham independent
judiciary, sham elections, sham multi-party system and a sham
separation of powers.'' The Putin regime displays, according to
Yavlinsky, ``Absence of any notion of the value of human life,
any idea that there are inalienable rights and freedoms.''\14\
---------------------------------------------------------------------------
\14\ Johnson's Russia List #5058, Moscow Times, January 30, 2001.
---------------------------------------------------------------------------
Some progress has been made recently on military reform.
The conflict between the chief of the general staff, Anatoly
Kvashnin, and the minister of defense, Igor Sergeev, over what
the relative priorities ought to be between strategic missiles
and conventional weapons and troops may have been resolved in
favor of Kvashnin recently, but it is too early to tell. But no
resolution is apparent regarding the deep reforms of the
military that budgetary constraints require. The military
continues to deteriorate, along with the defense industry,
which is deeply in debt. Russian military leaders have yet to
confront the limitations they face after years of budgetary
priority in the Soviet period. Today the budget for the
military is, at best, one-fifth that for the U.S. military.\15\
Once again Putin has not spelled out a clear cut policy. The
submarine Kursk episode shows that Putin is prepared to allow
the military to lie to the public and the world about the
probable cause of the sinking. This recalls Soviet times when
high officials and military personnel sometimes maintained a
lie despite the fact that only the least informed foreigner or
domestic citizen believed them.
---------------------------------------------------------------------------
\15\ Dr. Christopher Hill, British Ministry of Defense, London,
Briefing, January 31, 2001.
---------------------------------------------------------------------------
In foreign policy Putin has sought to restore economic and
political relations with the Soviet Union's old allies: Iran,
Iraq, Cuba, and North Korea. It has also strengthened relations
with China. The Foreign Minister, Ivanov, has stated that the
Near Abroad, that is, the former republics of the U.S.S.R.,
falls within Russia's sphere of influence. The implication is
clear, Putin has been seeking to restore Russia's dominant
position in the region and, to the extent possible, restore the
Soviet empire through energy dependency, aggressive military
exercises, showing of the flag, and minatory behavior in the
Caspian region. With the exception of China, the countries
Putin is reaching out to are either global outcasts or economic
basket cases. It is an alliance of losers. The policy could be,
therefore, a costly one internationally and economically. The
attempt to attain hegemony over the so-called Near Abroad
represents a serious drain on Russia's resources. So does the
apparently interminable war in Chechnya. What the new conflict
between the United States and Afghanistan portends for Russian
foreign policy is still not clear, but it has all the makings
of a quagmire that Russian might not be able to avoid.
Interestingly, and related to ``empire envy,'' is the
restoration of some Soviet symbols and the creation of new
patriotic ones. The Soviet hymn has been resurrected and
refurbished. Red banners have been restored for the military,
perks have been created for the President that are competitive
with those received by the American president. And Putin has
traveled abroad to high visibility events where he can be
photographed consorting with the world's powerful leaders.
These activities, which have little to do with reform, have
been met with approbation by the general public.
Putin's positive response to the terrorist attack on the
United States and to America's declaration of war on
international terrorism appears to contradict his policies to
date designed to restore former allies and republics of the
U.S.S.R. to Russia's sphere of influence and support. Not only
has he moved sharply back toward the Western camp, he has
acceded to U.S. action in Afghanistan and, more surprisingly,
to the placement of U.S. troops and other military assets in
Uzbekistan and perhaps elsewhere in Central Asia. He will
ultimately have to choose between creating a ``multi-polar''
counterweight to U.S. hegemony in the world and becoming a
junior partner in the international alliance against terrorism.
It is too early to tell how he will resolve this contradiction,
but he cannot waffle for very long.
putin as leader
On balance, Putin appears to be rather indecisive. If one
reads only his speeches, Putin provides accurate diagnoses and
reasonable prescriptions as remedies, but the follow through
has been weak.\16\ Putin avoids direct conflict with his
subordinates. When trouble arises, he tends to back down, or to
claim he knew nothing about the issue, or that he has no
authority in the case in question, or remains silent. Time-
Europe correspondent Paul Quinn-Judge writes:
---------------------------------------------------------------------------
\16\ Putin's January 1, 2000 speech, ``Russia at the Turn of the
New Millennium.'' Web page of Russian Federation, http://
pravitelstvo.gov.ru.
``The pessimistic variant is that, when major
problems arise, Putin will opt for the easy way out--
blaming enemies, stifling criticisms and muddling
through.''\17\
---------------------------------------------------------------------------
\17\ ``The Politics of Mind Over Matter,'' Time-Europe, January 22,
2000.
---------------------------------------------------------------------------
According to Alexandr Tsipko:
``Like many of his predecessors, solving moral and
political problems comes more easily to Putin than
solving social and economic problems.''
``Gorbachev's glasnost rehabilitated truth, ethics
and common human values. Putin has rehabilitated
Russian patriotism, national dignity, statist integrity
and the consolidation of Russian statehood.''
``The task of maintaining . . . the national
consensus . . . will be in constant conflict with the
task of modernizing Russia and implementing market
reforms.''\18\
---------------------------------------------------------------------------
\18\ Jamestown Foundation Prism, A Monthly on Post-Soviet Studies,
January 2001, Vol. VII, Issue 1, Part 2
---------------------------------------------------------------------------
why is putin popular?
Survey research specialist Yuri Levada states that: ``He
has given Russia leadership.'' Paul Quinn-Judge writes:
``Putin's first year has turned out to be a
remarkable example of mind over matter in public
opinion. There have been few major accomplishments,
several disasters and some ominous developments in the
field of human rights and press freedom.''\19\
---------------------------------------------------------------------------
\19\ Time-Europe, January 22, 2000.
The simple answer may be a variant ``Linda Tripp''
phenomenon. Judging by his behavior, Putin does not really have
to consult the polls because he is ``just like them.'' He
clearly regrets the breakup of the U.S.S.R. and Russia's loss
of military power and respect in the world community. He is
suspicious of markets and prefers state control of heavy
industry, the military-industrial complex, communications and
the media, banking and transportation. He is in favor of a
paternalistic and strong state. The public agrees on every
count.
implications for the sustainability of economic reform and growth in
russia in the near future
The outlook for economic reform and continued economic
growth over the next year or so is positive, but only
marginally so. Gorbachev sought to reform the Soviet socialist
economy, to make it more humane and more responsive to the
popular will by introducing certain elements of a market
economy. The reform failed. Yeltsin led a revolution that
destroyed the coordinates of the Soviet economy and attempted
to replace it with market institutions. The revolution achieved
partial success. The planned economy was destroyed totally, but
the disastrous economic consequences of the revolution for the
population at large and the capture of it by the nomenklatura
caused it to grind to a halt. Putin is now leading a partial
restoration of Russia, a pause in the radical changes that have
been taking place since perestroika and glasnost were
introduced in 1988-1989. In this sense the economic transition
is over, but, of course, a good deal remains to be done to
complete market institutions.
Putin is restoring hope for the future, the sense that
Russia will again assume her proper place as a major power in
the world, that domestic order will be restored, corruption
will be curtailed and that the economy will rebound. He has
also created the hope that these ends may be accomplished
without further violent disruptions to society. In the short
run these aspirations are doomed to disappointment. Economic
growth is more likely to stagnate than to be maintained, for
too much depends at present upon the uncertain price of oil and
of other natural resource exports, such as gas and metals, and
upon the diminishing boost to domestic production from the 1998
devaluation. Foreign direct investment is unlikely to increase
significantly until reforms in corporate governance, commercial
banking and competition policy are enacted. The distraction
caused by empire aspirations will continue to drain the
treasury and inhibit economic reform. Also, despite brave
statements to the contrary, Putin has yet to tackle the problem
of public or private corruption.
Thus far, Putin has been more focused upon the accumulation
of power than upon its exercise. This is a sign of insecurity
by a leader who, above all, wants to remain in power.
Completion of the reforms necessary to turn the Russian economy
into a functioning, workable globally competitive economic
system will require the expenditure of power and the risk, as
Gorbachev discovered, of removal from power. Putin's caution
may, therefore, slow the reform process and highlight instead
the pageantry and ritual of the process of restoration. This is
not to say that the Soviet economy or the Communist Party will
be restored. They are dead and gone and cannot be resurrected.
What Putin is trying to restore is the national pride and will
of the Russian people. This is a necessary but insufficient
condition for the completion of market reform and successful
entry into the competitive global economy. At present, however,
the most likely outcome is gradual change, with economic
stagnation a close second. A much bleaker picture was presented
in a recent Russian Government Report, which forecast the
conjuncture of three major negative trends in the year 2003.
The economic infrastructure will crumble. The demographic
crisis will peak. And external debt service will become
overwhelming.\20\ Like the ``wonderful one-hoss shay,'' the
Russian economy might go ``to pieces all at once . . .''.\21\
---------------------------------------------------------------------------
\20\ Weist, Fred. Christian Science Review, February 15, 2001.
\21\ Holmes, Oliver Wendell. ``The Wonderful One-Hoss Shay.''
http://www.library.utoronto.ca/uetl/rp/poems/holmes9.html.
---------------------------------------------------------------------------
prospects for the long run
In October 1980 a conference was held at Airlie House in
Virginia which ``had as its theme the long-term prospective
growth of the Soviet economy.'' The conference was organized by
Professors Abram Bergson and Herbert Levine, two very senior
specialists on the Soviet economy. The list of contributors and
participants reads like an honor role of Soviet specialists.
Their charge was to appraise economic prospects to the year
2000.
Participants considered several scenarios, but, in the
end, the consensus was that the Soviet economy would continue
to ``muddle'' on without radical changes for the next two
decades. In summing up his reaction to the presentations,
Seweryn Bialer, in ``Politics and Priorities,'' concluded:
In sum, we can anticipate no fundamental changes in
the Soviet Union during the 1980s despite intense and
divisive discussions concerning economic reforms, a
number of organizational policy initiatives,
experimentation with the economic structure, and
significant political conflict.\22\
---------------------------------------------------------------------------
\22\ The Soviet Economy Toward the Year 2000, p. 419.
Needless to say, the forecasts produced in 1981 were
history by 1988 much less 2000. The picture painted for the
year 2000 was totally off, whether predictions of GDP,
population, agricultural production, development, planning and
management or politics. Like everyone else, the top specialists
on the Soviet economy were blindsided by Gorbachev and Yeltsin.
Soviet specialists' experience in this attempt to project
current trends 20 years into the future must give pause to any
attempt to do the same today with Putin's Russia. The analysis
and forecast that follow differ in two respects from those
produced at Airlie House. First, The Soviet Union had
experienced a decade or more of stagnation under Leonid
Brezhnev. Russia, by contrast, has undergone radical change and
much political and economic instability over the past decade.
Further radical economic change is highly unlikely because the
population is exhausted and opposed to new economic
experiments. Putin appears to oppose radical change too. The
transition is over for Russia. Second, the Bergson-Levine
volume was not based on any explicit theory of economic and
social change. Pure extrapolation is always dangerous.
the future of russia as a market economy: the transition in historical
perspective
Peering into the future cannot be based merely on an
extrapolation of current trends. An examination of Russia's
place in the historical process of economic development may
provide some insights into what we can expect the Russian
economic developments to be over the next several decades.
A debate engaged Western economists during the 1950s and
1960s over the possible convergence of socialist systems, such
as the Soviet Union, and capitalist systems, such as the United
States. The debate over convergence appears in a quite
different perspective today in the light of the universal
collapse of the Soviet command economy and the contrasting
vitality of capitalist systems. Two positions in the debate
were considered extreme and highly unlikely outcomes by most
participants in the debate. Marxists anticipated the overthrow
of capitalism and worldwide convergence on a Communist economic
system. The expansion of Soviet power in East Europe, Mao's
success in China, and the attraction of Marxism for many
underdeveloped countries provided a foundation for the
viewpoint. For the Marxists, market institutions represented
merely a transitory stage in human history, one that would be
followed by equity in economic allocations and, consequently,
an end to economic conflicts caused by scarcity.\23\
---------------------------------------------------------------------------
\23\ Marx, Karl. Capital: A Critique of Political Economy, New
York, NY: The Modern Library, 1906.
---------------------------------------------------------------------------
The other extreme view was expressed most fully by
Friedrich A. von Hayek. He expected the abandonment of central
planning in the socialist economies because of the inherently
superior efficiency of market economies in solving the crucial
``economic problem,'' that is, the rational allocation of
resources among competing alternative uses. The argument held
that central planning cannot substitute for markets because
there are simply too many supply and demand equations for any
central agency to solve satisfactorily. Decentralized decision
making by private individuals represented the only successful
way to do so historically.\24\
---------------------------------------------------------------------------
\24\ Hayek, Friedrich A. The Road to Serfdom. Chicago, IL: The
University of Chicago Press, 1957.
------, ed. Collectivist Economic Planning. London, England: Butler
& Tanner Ltd., 1935.
---------------------------------------------------------------------------
Neither argument for unilateral convergence gained much
traction in the debate of the 1950s and 1960s. Mutual
convergence was instead the prevailing view. Capitalism and
socialism were conceived as occupying opposite ends of a
spectrum, with the U.S. and Soviet economies near either
extreme. Proponents of mutual convergence viewed socialist and
capitalist economies as moderating their distinctive
institutions and becoming more alike. Welfare capitalism was
developing in the West, and, at the same time, socialist
economies were experimenting with the introduction of market
elements.
The most sophisticated version of mutual convergence was
put forward by the Nobel Prize winning economist Jan Tinbergen.
His main contribution was the ``theory of the optimal regime.''
Tinbergen recognized the inevitability of a trade off between
economic efficiency and economic equity in any actual human
society. There exists, he assumed, an optimal regime that
rational men and women would ultimately recognize and work
toward, one that balanced the benefits of efficiency against
those of equity. If so, extreme regimes, such as the United
States and the Soviet Union, would prove unstable, and each
would approach the mean. Thus, he predicted convergence under
which the Soviet Union would gradually introduce markets,
reduce government intervention in the economy and allow a
greater role for private property. Similarly, the United States
would develop increasingly as a welfare state, strengthen
government regulation of markets and increase public ownership
of productive property. Capitalist and socialist systems would,
therefore, converge over time on the optimal economic
regime.\25\
---------------------------------------------------------------------------
\25\ Tinbergen, Jan. ``Do Communist and Free Economies Show a
Convergence Pattern?'' Soviet Studies. 1961, vol. 12, n. 4, pp. 335-
341.
------. ``The Theory of the Optimum Regime,'' in Klaasen, L.H.,
L.M. Koyck and H.J. Witteveen, eds. Selected Papers. Amsterdam,
Holland: North-Holland Publishing Company, 1959, pp. 264-305.
---------------------------------------------------------------------------
In retrospect, Tinbergen's theory, and others like it based
on rational choice and political pragmatism, appears seriously
flawed. The implicit assumption that the U.S. and U.S.S.R.
economies were equidistant from the optimal regime may be seen
today to have been wrongheaded. Von Hayek's analysis has fared
much better as a prediction. When the planned economies were
opened to the global economy they wilted like tropical plants
deprived of a hothouse. The egregious extent to which these
economics had become distorted as a result of central planning
based on quantitative orders and arbitrary pricing of final
goods and services confirmed Hayek's point. Soviet-type
socialism was clearly highly inefficient in the allocation of
resources and in fostering innovation. The problem was
efficiency, not equity. Command economies may be highly
effective in mobilizing resources for a specific purpose, such
as a war or to develop the atomic bomb, but they have failed to
compete successfully with capitalist economies in the long run.
For longer periods, the absence of flexible prices,
entrepreneurship and local decision making was costly in
efficiency and growth.
It is not necessary, however, to abandon Tinbergen's notion
of an optimal regime, a regime that balances equity and
efficiency. The Soviet economy was, it seems, the historical
outlier, and it is now presumably being modified in the
direction of the optimal regime. Support for this view is
provided by another Nobel Prize winner, J.R. Hicks, in his
Theory of Economic History (1969). Hicks is interested in the
rise of the market as an historical phenomenon, and he views
the non-market economy, which includes the command economy, as
an older form of economic organization. He traces the evolution
of markets from the earliest periods of recorded history.
Markets originated for the conduct of external trade, but
gradually penetrated the domestic economy. First, there was the
growth of internal trade in goods. Second, was the extension of
the market to include labor services. Subsequently, land and
capital became subject to the market. Domestically, the market
has continued to broaden its coverage, displacing, for example,
what had been considered family obligations to children and
parents with paid services. The system of custom and command
has gradually retreated as we have moved toward a cradle to the
grave market economy. The temporal sequence by which markets
have penetrated personal as well as business relationships is
telling, for a similar sequence may be seen in the transition
economies of today.
Morris Copeland, quite independently, developed a
complementary theory of economic history, one that stresses the
critical role of money and credit in market economies as
sources of economic discretion, and, by implication,
rationality. Money implies the existence of prices, wages and
interest rates and thus the possibility of multilateral trade.
The spread of pecuniary institutions co-developed with markets
and facilitated efficient trade.\26\
---------------------------------------------------------------------------
\26\ Copeland, Morris. Essays in Socioeconomic Evolution. New York,
NY: Vintage Press, 1981.
---------------------------------------------------------------------------
Seen in this light, the Soviet-type socialist economy was
an historical regression, a deliberate, conscious attempt to
reverse fundamental historical processes. Soviet economic
institutions were created for the explicit Marxist intention to
minimize and eventually eliminate markets, money, credit,
prices and wages. It is not surprising that the Soviet economy
performed well in WWII as a way to mobilize and concentrate
resources on a limited number of goals. However, the attempt to
maintain the command economy indefinitely implied the need for
a permanent emergency, and the cold war afforded a rationale.
The Hicksian-Copeland understanding of the spread of the market
economy implies, therefore, that Russia is today back on the
track of normal evolution of markets and market instruments
after a long and costly deviation. Russia, and the other former
republics of the U.S.S.R., traveled the longest and farthest
along this historical deviation. As the theory suggests, it has
been the most difficult for Russia and the other former
republics of the U.S.S.R. to redevelop those markets that were
relatively underdeveloped at the time of the 1917 Revolution,
such as the markets for urban and rural land, or that were
extirpated thoroughly by the Bolsheviks, such as investment,
financial and existing productive asset markets. It has also
proven difficult for them to establish true commercial banking
systems, effective and equitable corporate governance
institutions and workable competitive markets. Attempts to
catch up with capitalist institutions in the more advanced
countries have been opposed by Marxist ideologues, Soviet
traditionalists, and a deep-seated and widespread popular
belief in the uniqueness of Russia's mission in the world.
Economic interests vested in the monopolistic and oligopolistic
structure of enterprise ownership that Russian-style
privatization created have also been obstacles to further
reform.
the probable structure of the russian economy in the long run
At the outset of radical economic reform under Yeltsin in
Russia there were a number of economists and policy makers in
the West who dreamed of creating the perfect capitalist system
in Russia. The collapse of communism and central planning was
viewed as a ``clean slate.'' Jude Wanniski, for example, wrote
in 1992:
It is possible to imagine a future of Russian
capitalism that asserts itself early in 21st century as
the envy of the world. . . .
The Russian people are now engaged in nothing less
than designing the basic architecture of a brand new
country. Why not consider all possibilities? Why not
design the Russian system of capitalism to be the best?
\27\
---------------------------------------------------------------------------
\27\ Quoted in Millar, James R. ``The Economies of the CIS:
Reformation, Revolution, or Restoration?'' in The Former Soviet Union
in Transition, Volume 1, Study Papers submitted to the Joint Economic
Committee Congress of the United States. 103d Congress, U.S. Government
Printing Office, Washington, DC: 1993, p. 36.
By the ``best'' Wanniski clearly meant an economy in which
state ownership and intervention in the economy would be even
less than in the most advanced capitalist countries, such as
the United States. As a more ``pure'' capitalist system, the
transformed Russian economy would outperform the rest. Jan
Wanniski's idea that Russia might leapfrog the west in
perfecting capitalism has proven an idle dream. Old economic
institutions and behaviors do not ordinarily disappear without
a trace, and especially where the they have continuing support
from the population at large, including the leadership.
The Gosplan has disappeared, but surveys both before and
after the collapse of the Soviet economy reveal that very
substantial majorities still expect the government to provide,
for example, price stability, job security, subsidized housing,
free medical care, and free public education through college.
Similarly, the majority has repeatedly indicated a preference
for public ownership of railroads, airlines, heavy industry,
communications, banks and other large-scale enterprises such as
the defense industries.\28\ In addition, many enterprises and
public institutions still operate like company towns and have
yet to rationalize employment. The Russian economist Nikolay
Shmelev aptly pointed out that it had taken ``three
generations'' to build the ``insane asylum'' that was the
Soviet economy and that it would take at least three more to
escape from it. To escape will require changes in both the
thinking and the behavior of citizens and leaders alike.\29\
---------------------------------------------------------------------------
\28\ Millar, James R. ``Empire Envy, Stop-Go Economic Policies, and
Political Constraints in Economic Reform in Russia.'' Problems of Post-
Communism. 1998, vol. 45, no. 3.
------. ``Prospects for Economic Reform. Is (Was) Gorbachev Really
Necessary?'' in Lee, J.J. and Walter Korter, eds. Europe in Transition:
Political, Economic and Security Prospects for the 1990s. Austin, TX:
Lyndon B. Johnson School of Public Affairs, 1991.
\29\ Millar, James R. ``The Economies of the CIS: Reformation,
Revolution, or Restoration?'' in The Former Soviet Union in Transition,
Volume 1, Study Papers submitted to the Joint Economic Committee
Congress of the United States. 103d Congress, U.S. Government Printing
Office, Washington, DC: 1993, pp. 34-54.
---------------------------------------------------------------------------
In the 1920s Vladimir Lenin persuaded the Bolsheviks to
give up the attempt to go directly from capitalism to
socialism. The Great War and the revolutions and civil war that
ensued had left the economy in ruins, and Lenin realized that
the Bolsheviks were too few and too inexperienced to build a
new economy from scratch. Consequently, the Bolsheviks
introduced the New Economic Policy (NEP), which permitted
small-scale private enterprise both in rural and urban areas,
but reserved what Lenin called the ``commanding heights'' to
state ownership and control. The commanding heights included
heavy industry, electric power generation, transportation,
communications and banking. It was anticipated that eventually
the superiority of the socialist state sector would allow it to
crowd out the private sector. The New Economic Policy was
relatively successful, and, partly for this reason, it was
destroyed by Joseph Stalin's introduction of rapid
industrialization and forced mass collectivization in the
1930s.
What has been developing in Russia over the last decade is
not Wanniski's pure capitalism, but a modified version of the
NEP. Let's call it the neo-NEP. Small business is private, but
the ``commanding heights'' are mostly shared by the state and
the oligarchs. Privatization in Russia often did not break
cleanly with state ownership. The state, as in the case of
Gazprom for example, maintained either a controlling or a
significant minority position as shareholder. Thus, the state
also has appointed members of the boards of these enterprises
and, occasionally, even the director himself. This kind of
sharing between the state and private capital is not uncommon
in Europe, and it is likely to remain a feature in Russia for
the indefinite future.
Although Russia is not now a candidate for accession to
the European Union, the institutional structure of the EU can
be expected to shape Russian economic and legal institutions in
substantial degree in the future. In fact, the EU is much more
likely to influence economic development and reform in Russia
than are the International Monetary Fund (IMF) and World Bank,
both of which are associated with major policy failures in the
transition economies. The EU is an important trading partner
and likely to become increasingly important over time, if only
because Russia is such an important source of energy supplies
to Europe. Russia also trades with East Central and East
Europe, and many of the countries are either on the path to
accession or hope to be in the near future. The EU has spelled
out in chapter and verse just what a country needs to do to
harmonize its institutions with those of Europe. Russia is
certain to be influenced both directly and indirectly to
harmonize with Europe. This is the most optimistic outlook for
the future of capitalism in Russia.\30\
---------------------------------------------------------------------------
\30\ Implications for Slavic and East European Studies,'' NewsNet,
The Newsletter of the AAASS (American Association for the Advancement
of Slavic Studies), January 2001, v. 41, no. 1.
---------------------------------------------------------------------------
As many observers have noted, the criteria for accession
to the EU are essential the same as the requirements for a
successful transition to a workable market economy from the
Soviet-type model. Accession indicators that are used to
determine eligibility for membership include measures of the
extent of large-scale and small-scale privatization, of success
in restructuring enterprises to harden budget constraints,
rationalize production and improve corporate governance. They
also seek to measure the degree to which markets are
competitive, prices have been liberalized and import and export
restrictions have been eliminated. In addition, banking and
financial institutions are evaluated against international
standards of regulation and performance. Basically, the
accession process involves modeling the transition economy upon
the most successful members of the EU.
Countries are scored on each of the eight principal
indicators on a scale ranging from ``1'' for little progress,
to ``4+'' for achieving standards and performance typical for
advanced industrial economies. According to my own rough
estimate, Russia's scores today range from a ``2+,'' for
example, on large-scale privatization and corporate governance,
to a ``3+'' on price liberalization and foreign trade and
foreign exchange system policies, for an overall score of ``3''
or ``3-.'' These scores would not be sufficient to earn Russia
membership, but they are indicative of the progress that has
been made in market reform since 1991. The neo-NEP model
described above as most nearly characteristic of the Russian
economy today need not hamper further progress so long as
enterprises controlled by the state singly or jointly with
private interests meet governance and other requirements. The
long-run outlook is, therefore, positive if the Putin
government continues to press consistently for gradual reform
and avoids foreign policy adventurism and domestic distortions
caused by corruption and an ambiguous commitment to join the
world economy as a full member.
Russia is moving haltingly, therefore, toward the ``optimal
regime'' Jan Tinbergen envisioned. It will never get there, of
course, but the historical processes of marketization and
pecuniarization are back at work in Russia, after 70 years or
so of regression. Russia's economy is not going to be closed to
the global economy. International trade is too profitable and
memory of the failure of autarky and central planning is too
fresh for that.
It is highly likely, therefore, that Russia will become a
full-fledged market economy in the European style. It does not
necessarily follow that the market economy that develops will
be any more successful than many other late developing market
economies, such as Brazil, Mexico or Argentina. Stop-go
economic policies are the most likely policies in these
countries because reform will always run into public
resistance. The adverse economic consequences of stopping
reform eventually generate another round, which, in turn, again
generates public resistance. Escaping from this circular
process is Russia's challenge in the long run, as it is for so
many countries aspiring to develop. Putin may not to be up to
the job, it is too early to tell, but a successor may do so if
Russia continues to focus on Europe as a trade partner. On the
other hand, empire envy may prevail, thereby limiting Russia's
options in the long run as well as today.
References
Aslund, Anders. How Russia Became a Market Economy. Washington,
DC: The Brookings Institution, 1995.
Bergson, Abram and Levine, Herbert S. eds. The Soviet Economy
Toward the Year 2000. London, England: George Allen &
Unwin, 1983.
Bush, Keith. ``The Russian Economy in June 2001,'' Russia and
Eurasia Program, CSIS (June 2001), E-document.
Copeland, Morris. ``Communities of Economic Interest and the
Price System,'' in Chandler Morse, ed. Fact and Theory
in Economics. Ithaca, NY: Cornell University Press,
1958.
------. Essays in Socioeconomic Evolution. New York, NY:
Vintage Press, 1981.
Dobson, Richard. Is Russia Turning the Corner? Changing Russian
Public Opinion, 1991-1996. Washington, DC: Russian,
Ukraine, and Commonwealth Branch Office of Research and
Media Reaction, U.S. Information Agency, 1996.
Ellman, Michael. ``Against Convergence.'' Cambridge Journal of
Economics. 1980, vol. 4, pp. 199-210.
Hayek, Friedrich A. The Road to Serfdom. Chicago, IL: The
University of Chicago Press, 1957.
------. ``The Use of Knowledge in Society.'' Economic Review.
1945, vol. 35, no. 4. pp. 519-530.
------, ed. Collectivist Economic Planning. London, England:
Butler & Tanner Ltd., 1935.
Hedlund, Stefan. Russia's ``Market'' Economy: A Bad Case of
Predatory Capitalism. London, England: UCL Press
Limited, 1999.
Hicks, John. A Theory of Economic History. London, England:
Oxford University Press, 1969.
Hill, Christopher. British Ministry of Defense, London,
Briefing, January 31, 2001.
Holmes, Oliver Wendell. ``The Wonderful One-Hoss Shay.'' http:/
/www.library.utoronto.ca/uetl/rp/poems/holmes9.html.
http://pravitelstvo.gov.ru.
Izvestia, June 4, 2001.
Johnson's Russia List #5058, Moscow Times, January 30, 2001.
Johnson's Russia List #5226, April 27, 2001.
Johnson's Russia List #5295; Reuters: Jon Boyle.
Lambroschini, Sophie, ``The Government Uncertain Role to Land
Privatization.'' Part 1, RFE/RL, February 9, 2001.
Lipman, Masha, ``The Indecisive President.'' The Washington
Post, February 6, 2001.
Marx, Carl. Capital: A Critique of Political Economy, New York,
NY: The Modern Library, 1906.
Millar, James R. ``The Post Cold-War Settlement and the End of
the Transition: Implications for Slavic and East
European Studies.'' NewsNet, January 2001, v. 41, no.
1.
------. Susan J. Lintz, ed. The Soviet Economic Experiment.
Chicago, IL: University of Illinois Press, 1990.
------ and Elizabeth Clayton. ``Quality of life: Subjective
Measures of Relative Satisfaction,'' in Millar, James
R., ed. Politics, Work and Daily Life in the USSR. New
York, NY: Cambridge University Press, 1987, pp. 31-60.
------. ``Empire Envy, Stop-Go Economic Policies, and Political
Constraints in Economic Reform in Russia.'' Problems of
Post-Communism. 1998, vol. 45, no. 3.
------. ``The Failure of Shock Therapy.'' Problems of Post
Communism, Fall 1994.
------. ``The Economies of the CIS: Reformation, Revolution, or
Restoration?'' in The Former Soviet Union in
Transition, Volume 1, Study Papers submitted to the
Joint Economic Committee Congress of the United States.
103d Congress, U.S. Government Printing Office,
Washington, DC: 1993, pp. 34-54.
------. ``Prospects for Economic Reform. Is (Was) Gorbachev
Really Necessary?'' in Lee, J.J. and Walter Korter,
eds. Europe in Transition: Political, Economic and
Security Prospects for the 1990s. Austin, TX: Lyndon B.
Johnson School of Public Affairs, 1991.
------. ``The Importance of Initial Conditions in Economic
Transitions: An Evaluation of Economic Reform Progress
in Russia.'' Journal of Socio-Economics. 1997, vol. 26,
no. 4, pp. 359-381.
Moscow Times, Editorial, January 29, 2001.
Mundell, Robert A. ``The Great Contractions in Transition
Economies,'' in Blejer, Mario I. and Marko Skreb, eds.
Macroeconomic Stabilization in Transition Economies.
Cambridge, England: Cambridge University Press, 1997,
pp. 73-99.
New York Times, May 30, 2001.
Pigou, A.C. Socialism Versus Capitalism. London, England:
Macmillan, 1968.
Quinn-Judge, Paul. ``The Politics of Mind Over Matter,'' Time-
Europe, January 22, 2000.
Russian Journal, June 29, 2000.
Semenenko, Igor. ``Illarionov Warns of Looming Gloom.'' Moscow
Times, January 17, 2001.
Sidelsky, Robert. John Maynard Keynes. The Economist As Savior,
1920-37. Viking Penguin, 1994.
Time-Europe, January 22, 2000.
Tinbergen, Jan. ``Do Communist and Free Economies Show a
Convergence Pattern?'' Soviet Studies. 1961, vol. 12,
n. 4, pp. 335-341.
------. ``The Theory of the Optimum Regime,'' in Klaasen, L.H.,
L.M. Koyck and H.J. Witteveen, eds. Selected Papers.
Amsterdam, Holland: North-Holland Publishing Company,
1959, pp. 264-305.
Tsipko, Alexandr. Jamestown Foundation Prism, A Monthly on
Post-Soviet Studies, January 2001, Vol. VII, Issue 1,
Part 2.
United States Information Agency. ``Economic Reform Unpopular
in Both Russia and Ukraine.'' Opinion Analysis.
Washington, DC: USIA, 1998.
Weiss, Fred, Christian Science Review, February 15, 2001.
Wiles, Peter. ``From the Other Shore.'' Encounter. 1963, vol.
20, no. 6, pp. 84-90.
RUSSIA'S EVOLUTION AS A PREDATORY STATE
By Peter J. Stavrakis \1\
----------
contents
Page
Summary.......................................................... 347
The Predatory State: Model and Characteristics................... 349
Official corruption, cronyism, and clan politics............. 349
Ambiguous boundaries between key societal sectors and
institutions............................................... 351
Difficulty in consolidating the rule of law.................. 352
Efficient informal communication networks.................... 353
Societal withdrawal and economic marginalization............. 354
Recentralization and atrophy of regional authority........... 355
Explaining Russia's Affinity for the Predatory State............. 356
Old wine in new bottles: the ``recomposition'' of traditional
Russian power.............................................. 357
Appearance matters: ``presentability'' and the image of
democracy.................................................. 359
The legacy of imperial success............................... 361
Conclusions and Implications for the West........................ 363
Summary
The decade since the collapse of the Soviet Union has seen
the lively debate regarding the future of Russia move from
early exuberant optimism, through growing concern, to deep
pessimism. Official pessimism.\2\ Official Western policy has
avoided either extreme, but there is little doubt that
America's vision for Russia early on reflected considerable
optimism for the transition to free market democracy.
Regrettably, Russia proved to be more complex than prevailing
theories of democratization and development could have
anticipated. The end of the Yeltsin era left scholars and
policymakers hopeful for Russia's future, yet deeply concerned
that their hopes might not be fulfilled.
---------------------------------------------------------------------------
\1\ Dr. Peter J. Stavrakis is in the Political Science Department
of the University of Vermont. His doctorate was from the University of
Wisconsin.
\2\ Jeffrey Tayler presents the pessimistic view that the past
decade has been the beginning of Russia's long--and seemingly
permanent--descent from Great Power to international nonentity,
``Russia Is Finished,'' The Atlantic Monthly, May 2001.
---------------------------------------------------------------------------
President Vladimir Putin has now been in office for more
than eighteen months, yet there has still been no persuasive
account of the direction in which the new president is leading
Russia. This is partly because many in the West have no
persuasive, coherent model for understanding Russia other than
as an emerging liberal democratic society. The purpose of this
essay is to present an alternative framework for understanding
Russia and, in so doing, provide policymakers with a model that
more reliably informs them of Russia's future development. The
central premise of the model is straightforward: post-Soviet
Russia is not destined to be a liberal, free market democracy.
Instead, a form of elite rule is being consolidated that, while
principally corrupt, nevertheless retains considerable economic
regenerative capacity. Understanding this emerging political
system--the predatory state--makes it possible to recognize the
motive forces driving Russia toward considerable social
stability, a primarily productive economy, and a potentially
influential role in global affairs.
This is not to deny the considerable achievements in
Russian reform during its first post-Communist decade:
tolerably free democratic elections, the emergence of a free
press, mass privatization, and considerable decentralization of
governance, to name a few. The worrisome thing, however, is
that President Vladimir Putin has aggressively pursued a
prominent rollback of key reform achievements, and provided
clear signals that Russia will move in directions different
from those of liberal democracy: (1) prospects for economic
recovery have improved, yet capital flight remains high and the
revival of production is reliant on the vagaries of the oil
export market; (2) privatization consumed Russian reform, but
the state and a handful of economic oligarchs retain control
over core enterprises and private ownership of agricultural
land remains taboo; (3) state power is being recentralized and
evidence accumulates daily that societal institutions such as a
free press are being suppressed by renascent security organs;
(4) earlier images of democratic governance have been replaced
by an informal network of clan and crony rivalry, suffused with
a kind of violent politics and corruption that harkens back to
the first days of Soviet power; and, (5) previous hopes for the
emergence of a limited state have been eclipsed by the
renaissance of the strong state.
The Putin era differs from the freewheeling chaotic
struggles of the Yeltsin era--a period more akin to the
populist despotisms seen elsewhere in the developing world.
Under Putin, talk of state weakness has ceased, and clan
politics continues, albeit in a more regulated fashion than
previously. There is in the record of the past 2 years a sense
that the basic elements of liberal democracy are being forcibly
molded to suit Russian tastes and filled with a more familiar
traditional content. Putin's policies reflect less a
qualitative break with the past than a re-ordering of the ranks
of privileged oligarchs and the institutionalization of the
norms of political conduct--it is a bureaucratized variant of
the disorderly blend of post-Communist populism that
characterized the Yeltsin years. The rough edges of elite
conflict have been smoothed off, the state has returned to its
privileged position in society and economy, foreign investors
now mull over not whether, but when and how, to re-enter the
Russian market; and being from St. Petersburg or the Federal
Security Service (FSB) has gained a level of respectability and
influence that grates against the sensibilities of the
Muscovite elite. This is no democracy, to be sure, but it is
unmistakably the case that some form of order is taking shape
out of the ruins of the past decade. Russia, in Shakespeare's
words, may be madness, but there is method to it.
The remaining sections are devoted first to an explanation
of the nature of the predatory state and illustrations of its
core characteristics present in contemporary Russia. A section
devoted to explaining why Russian elites prefer the predatory
state to the alternative of liberal democracy follows this. On
the face of it, it is difficult to comprehend why a system
interpenetrated by pervasive criminalization and corruption;
weak legal and administrative institutions; and extensive state
intervention (or ownership) would be preferred to the stability
and productivity that liberal democracy promises. The final
section presents some of the implications of the predatory
state model for Russia's future, and its relations with the
West.
The Predatory State: Model and Characteristics
Russia's recent past and more distant future are best
explained by the model of the predatory state derived from the
experience of post-imperial and post-colonial polities. The
developmental path of these societies moves from state crisis
to an equilibrium in which authoritarian elites exploit
informal networks and corrupt practices to enhance their power
and wealth at the expense of society. This produces a pattern
in which an externally strong state undergoes a period of
(often substantial) growth and influence. The economic and
social marginalization attendant to predatory practices,
however, generates growing vulnerabilities that in time may
return the state to instability and crisis.\3\ Predatory elites
sustain themselves through the arbitrary, coercive absorption
of successful autonomous spheres of economic and social
life.\4\ Free markets and civil society are hostage to
political elites who are free to intervene whenever and
wherever this appears financially profitable or politically
useful.
---------------------------------------------------------------------------
\3\ A similar case of predatory state behavior was earlier observed
in Africa: ``hybrid regimes [in which] an outward democratic form is
energized by an inner authoritarian capacity, especially in the realm
of economic policy.'' Thandika Mkandawire, ``Crisis Management and the
Making of `Choiceless' Democracies,'' in Joseph, Richard ed. State,
Conflict and Democracy in Africa (Boulder, Co.: Lynne Rienner, 1999).
\4\ More detailed examples of these processes can be found in Peter
Stavrakis, Shadow Politics: The Russian State in the 21st Century
(Carlisle, Pa.: U.S. Army War College, Strategic Studies Institute,
December 1998).
---------------------------------------------------------------------------
A brief review of some of the main features of the
predatory state reveals its success in capturing key aspects of
contemporary Russian experience.
official corruption, cronyism, and clan politics
Perhaps the most glaring defect of post-Soviet Russia is
the pervasiveness of official corruption, which extends up to
the highest level of the political elite and is so widespread
it is often assumed to constitute an aspect of ``normal'' life.
Transparency International has consistently ranked Russia as
one of the most corrupt countries in the world, placing it
firmly in the neighborhood of post-colonial societies where
predatory practices abound.\5\ Enormous transfers of wealth
occur within the framework of transitional societies, so some
corruption linked to the reform process is unavoidable. What
distinguishes Russia from most other states, however, is the
scale of corrupt practices and the actors involved: Russia's
ambitious privatization program was among the largest transfers
of property in history, whether measured by the number of
enterprises affected, or the potential wealth that changed
hands. Still more importantly, corruption was not restricted to
a narrow segment of economic actors, but was instead embraced
by government officials--even ``reformers''--and quickly became
accepted practice.
---------------------------------------------------------------------------
\5\ In 1999 Transparency International ranked Russia as 76th--a
mere 9 places away from the rock bottom score of 85th. This suggested a
level of corruption similar to that found in Nigeria, Indonesia, and
Ukraine.
---------------------------------------------------------------------------
The second stage of the Russian privatization process is
perhaps the best example of the interwoven nature of corruption
and cronyism in the setting of predatory practices. Following
the voucher stage of privatization (which brought its own form
of graft with it), Anatoly Chubais, former Chairman of the
Russia State Property Committee and Chief of Staff to Yeltsin,
and Vladimir Potanin, former head of Uneximbank, concocted the
``loans for shares'' privatization. A select group of seven
``court'' banks were provided controlling shares in the crown
jewels of the Russian economy in exchange for loans the Russian
Government needed to cover its budget deficit. This arrangement
ostensibly permitted the government immediate access to
finances while preparing the ground for the sell off of key
industries that would generate still more revenue. The scheme
was blatantly corrupt, however, as the favored banks all had
intimate links to the reform government, and they subsequently
purchased Russia's richest assets at far below the market
value.\6\
---------------------------------------------------------------------------
\6\ Author interview with Iuri Iurievich Boldyrev, Deputy Chairman,
Accounting Chamber of the Russian Federation, January 15, 1997.
Boldyrev also covers this episode in ``V strane sozdany ideal'nye
usloviia dlia korruptsii,'' Novaia ezhednevnaia gazeta, October 28,
1996, p. 1.
---------------------------------------------------------------------------
The loans for shares scheme also demonstrated the
willingness of Russian reformers to use economic reforms to
preserve their hold on political power. The need to use the
privatization process to create a critical political
counterweight to clans opposed to Yeltsin has been acknowledged
recently by Russians involved in the struggle for reform.\7\
The scheme had its origins as far back as 1994 and amounted to
a ``crude trade of property for political support'' \8\ that
played a pivotal role in bringing into existence the financial
oligarchy. Russian oligarchs such as Boris Berezovsky, Vladimir
Gusinsky, Mikhail Khodorkovsky, Peter Aven, and others returned
the favor by providing crucial financial and media support for
Yeltsin's re-election in 1996.\9\
---------------------------------------------------------------------------
\7\ Vladimir Mau, ``Rossiiskie ekonomicheskie reformy glazami
zapadnykh kritikov,'' Voprosy ekonomiki (1999) no. 11. Mau is an
economist sympathetic to the privatization policies of Chubais and
Potanin.
\8\ Chrystia Freeland, Sale of the Century: Russia's Wild Ride from
Communism to Capitalism (New York: Crown Business, 2000), p. 169.
\9\ Boris Berezovsky affirmed this in unequivocal terms in an
interview for the Financial Times, December 1, 1996.
---------------------------------------------------------------------------
The reliance on cronies and clans at the expense of formal
government capacity meant that Russian elites had to actively
undermine the efforts of agencies responsible for combating
corruption. Hence, Russia was witness to numerous bizarre
instances of alleged reformers attacking or debasing the very
institutions and individuals they ostensibly sought to imbue
with effective authority. When, for example, Yuri Skuratov
began to take seriously his position as Procurator and
initiated investigations of Kremlin officials--including
Yeltsin's family--he was soon the target of kompromat: the
release by Skuratov's opponents of compromising documents,
whose negative political impact outweighs their often
questionable legal status. The tactic succeeded, as Skuratov
soon found himself embroiled in a scandal that resulted in his
removal from office. Even out of office, Skuratov defends the
validity of his investigation, and has recently released the
names of top-ranking officials whose illegal dealings in
Russian treasury bonds (GKOs) he maintains helped trigger the
1998 financial crisis: both of Yeltsin's daughters, Chubais,
Viktor Serov, former foreign minister Andrei Kozyrev, and five
deputy finance ministers.\10\
---------------------------------------------------------------------------
\10\ ``Former Prosecutor Fingers Top Politicians for Money
Laundering,'' Russia Today citing Agence France Presse, August 22,
2001, http://www.europeaninternet.com/russia. Skuratov also alleges
that Russian officials sold their insider information to the West, and
claims that members of the ``so called Harvard Project [used] U.S.
taxpayers' money to buy GKO bonds.''
---------------------------------------------------------------------------
A similar fate befell the effort to form a professional
civil service, which had not existed in Russia since the
October Revolution. In an effort to assume direct control over
the process, Chubais used foreign assistance funds to construct
Russia's massive privatization program. Russian Privatization
Centers (RPCs) were created to implement the program, yet the
RPCs needed to recruit personnel. A ready pool of labor was
found among government personnel loyal to Chubais, who were
secretly paid for their consulting services. Chubais could
count on finding many recruits because his government was
responsible for the low wages paid civil servants.
Privatization thus triumphed in Russia only by compromising the
possibility of a genuine civil service.\11\ Putin has recently
ordered the formation of a commission, headed by Prime Minister
Mikhail Kasyanov, and charged it with developing a plan for
reforming the civil service by the end of 2001.\12\ It is,
however, the third such effort to address civil service reform
since the collapse of the Soviet Union.
---------------------------------------------------------------------------
\11\ More information on civil service reform is in Stavrakis,
Shadow Politics. Boldyrev's interview with the author (note 5 above)
also confirmed this.
\12\``Putin Forms Commission to Reform State Service,''
Russia Today, August 22, 2001, http://www.europeaninternet.com/
russia.
---------------------------------------------------------------------------
ambiguous boundaries between key societal sectors and institutions
In contrast to modern democracies, which place
extraordinary importance on a clear delimitation of the legal
and political boundaries among institutions, predatory states
eschew formal efforts to sustain such meaningful divisions.
This sacrifices considerable clarity and efficiency, but the
trade off for post-imperial elites comes in their ability to
remain key players in virtually all spheres of society. An
entrepreneurial class independent of state activity has clearly
emerged in Russia over the past decade, but it is overshadowed
and increasingly constrained by far more powerful
``entrepreneurs'' who owe their existence to the state's
decision to vest them with property and protection. In doing
so, predatory states retain the ability to select the specific
composition of the ``entrepreneurial'' class and thereby retain
direct influence over the development of the market. This
process has been documented in post-Soviet Russia,\13\ but it
is most vividly illustrated by the government's formal policy
of having top government officials sit on governing boards of
the country's major economic enterprises, such as Unified
Energy Systems (UES, the state electricity monopoly) and
Gazprom. Putin's recent ouster of Gazprom chief Rem Vyakhirev
and replacement with Aleksei Miller was an excellent
opportunity for serious structural reform, yet the Russian
Government has maintained that even after reforms, Gazprom will
retain its monopoly over gas exports.\14\ Similarly, the reform
of UES recently approved by the government calls for the break
up and privatization of power generation but creates a state-
owned monopoly to operate the entire national grid.\15\ This
also appears to reflect a victory of the informal clan network
over formal institutions. It is the brainchild of Economic
Development Minister German Gref and largely ignored the
recommendations of the State Council in favor of a plan that
allows Anatoly Chubais to retain control over energy reform--
and custody of the state-owned power grid.\16\
---------------------------------------------------------------------------
\13\ Details on cronyism and the creation of the economic class in
Russia can be found in: Olga Kryshtanovskaia and Stephen White, ``From
Power to Property: The Nomenklatura in Postcommunist Russia,'' in
Graeme Gill, ed. Elites and Leadership In Russian Politics (London:
Macmillan, 1998); and, Olga Kryshtanovskaia, ``Smert' oligarkhii:
oligarkhiia soderzhala gosudarstvo v litse ego kliuchevykh
chinovnikov,'' Argumenty i fakty, no. 46, November 11, 1998, p. 5. Jean
Francois Bayart captures the essence of this in the African setting:
``The state is the prime (though not the only) channel of accumulation
. . . Even the successful businessmen in the informal sector are highly
dependent on the state because they need constantly to circumvent
regulations and obtain official permits. It is, therefore, otiose to
seek to establish a conceptual difference between the private and
public sectors.'' Bayart, ``Civil Society in Africa,'' in Will Reno,
Corruption and State Politics in Sierra Leone (Cambridge: Cambridge
University Press, 1995), p. 16.
\14\ Statement of Deputy Prime Minister Viktor Khristenko on August
6, 2001; RFE/RL Security Watch , August 13, 2001; http://www.rferl.org/
securitywatch/index.html
\15\ ``Electricity Monopoly Reform Plan Adopted,'' Russia
Watch no. 6 (June 2001), p. 2; http://www.ksg.harvard.edu/bcsia/
sdi.
\16\ Marina Volkova, Vladislav Kuzmichyov, ``Ssora Grefa i
Illarionova stavit vlast v situatsiiu buridanova osla,'' Nezavisimaia
gazeta, June 20, 2001. Gref and Chubais are both from the ``St.
Petersburg clan'' that has dominated much of post-Soviet politics.
---------------------------------------------------------------------------
difficulty in consolidating the rule of law
Given the centrality of illegal practices to sustaining
elites in power, predatory states reflect a profound weakness
in consolidating effective judicial and police institutions,
despite a formal commitment by elites to combat crime and
corruption. In this respect, Putin's goal of restoring ``law
and order'' carries with it a hypocritical ring present in
developing economies: coherent formal institutions of coercion
and control will emerge, yet they will intentionally refrain
from enforcing meaningful distinctions between public and
private, legal and illegal, formal and informal.\17\ Western
exhortation and advice to fight crime is therefore unlikely to
alter Russian elites' preference for using coercive
institutions to advantage one set of clans at the expense of
others in the struggle for control over resources.
---------------------------------------------------------------------------
\17\ Vadim Volkov, ``Politekonomiia nasiliia, ekonomicheskii rost i
konsolidatsiia gosudarstvo,'' Voprosy ekonomiki (1999) no. 10.
---------------------------------------------------------------------------
Indeed, despite having pledged to restore legality in
public life, Putin has in actuality done little more than
revive the coercive power of the state by resuscitating
security organs.\18\ The principal thrust of more efficacious
enforcement bureaucracies, however, has not been on eliminating
the shadow (underground) economy and corruption in society at
large. Instead, Putin has marshaled his forces toward the goals
of molding clan behavior to his satisfaction and restraining
the sphere of civil rights. This explains the simultaneous
crackdown against the likes of Berezovsky and Gusinsky, while
ignoring credible claims that Prime Minister Mikhail Kasyanov
(known popularly as ``2 percent Misha'') owes most of his
considerable wealth to kickbacks.\19\ Here Russian behavior is
consistent with the predatory state: strong bureaucratic
structures exploiting vague and shifting boundaries between
illegal and legal activity. This feature of the state allows
the Russian president to exploit illegal means when useful, yet
still rely on formal institutions to implement such policies.
Reformers in the Central Bank of the Russian Federation
(Central Bank of Russia or CBR) exhibited similar skill in
exploiting ambiguities in international financial regulations
to reap additional profits.\20\
---------------------------------------------------------------------------
\18\ Coulloudon maintains that Russia's numerous anti-corruption
campaigns have had a moralistic aim, with no real effort to attack
structural problems underlying corruption; ``Corruption and Governance
in Russia.''
\19\ When the author referred to Kasyanov as ``7 percent Misha'' in
conversation with a senior official at Iukos Oil Company, the official
shook his head and immediately added the correction: ``It was 2 percent
Misha, a fact he could confirm from his own experience''; June 26,
2000.
\20\ The CBR in 1999 conceded that it channeled some of its
reserves (some sources claim as much as $50 billion) into FIMACO, an
obscure off-shore corporation in Jersey, principally to prevent its
recapture from Western creditors. Sergei Aleksashenko, former Deputy
Chairman of the CBR, admitted that the sequestering of bank funds was
done to protect them from Western creditors. FIMACO was a French
corporation chartered in Jersey. It was 78 percent owned by the Russian
Government. The reform team had deftly exploited western financial
practice to securely channel money to themselves--out of reach of
creditors. More information on the FIMACO affair can be found in
Kommersant and well as in IMF documents.
---------------------------------------------------------------------------
efficient informal communication networks
In contrast to expectations, predatory states possess a
highly efficient informal communications network, but it is one
restricted to a charmed circle. Those individuals blessed with
favorable access to the informal communication network can,
whenever circumstances require it, circumvent formal
bureaucratic structures to achieve their goals.\21\ The speed
at which communication can be passed within Russia is often
staggeringly short--and becomes shorter still whenever the
issues revolve around an opportunity to acquire money.\22\
These networks were developed under Yeltsin and remain intact
under Putin; indeed, there is every reason to maintain them,
for they are remarkably efficient at relaying information in a
short period of time. The common perception of Russia as
incapable of accomplishing anything is misguided: formal
Russian state structures can often accomplish little, yet the
capacity of elite networks to fill in the gap remains
impressive.\23\
---------------------------------------------------------------------------
\21\ Interesting in this regard was the fate of the internal phone
network that in Soviet times was accessible only to high-ranking party
members. It never disappeared, but was instead appropriated by the new
elite who later replaced it with a system more in tune with current
fashion in technology--the predatory elite has gone high tech and
cellular.
\22\ This is especially true whenever foreign assistance funds are
concerned. This is in marked contrast to the slow and deliberate pace
of Western aid agencies. The author was involved in several such cases,
where Russian organizations were able to filter information from
Washington, DC, through Moscow to the regions and back again all in
less than 24 hours.
\23\ The author was present in August 1999 when one governor--
clearly ``in the loop,''--used his cell phone from his regional office
to juggle successive calls to and from Anatoly Chubais and Viktor
Chernomyrdin. He later explained that Yeltsin was angered by the
declaration of a ``left'' electoral bloc by Yuri Luzhkov and Evgenii
Primakov in advance of the December 1999 Duma elections, and had
ordered Chubais to undertake the formation of a ``right'' bloc. Chubais
asked the governor in question to serve as mediator between Chubais and
Chernomyrdin to lay the groundwork for subsequent negotiations. An
agreement proved elusive, but the speed and means by which it was
arranged was impressive.
---------------------------------------------------------------------------
The combination of efficient informal communications, weak
and malleable legal institutions, and institutional ambiguity
helps explain how predatory states are successful in extracting
profit. Several examples reveal how an interventionist state
can move into any promising sphere of economic activity,
molding legal institutions to suit its needs. The arbitrary
nature with which tax laws were interpreted and enforced, for
example, so frustrated General Electric that it elected to
close its Moscow subsidiary.\24\ Similarly, Australia's Star
Mining learned that its purchase of part of Lenzoloto, a small
gold mining business, was invalidated because it purportedly
violated privatization rules. The problem was that ``the laws
are so vague, the bulk of the Russian stock market could easily
be deemed to have breached these rules.'' \25\ Trans-World
Metals, a London-based metals company that has acquired a
substantial portion of the Russian aluminum industry, was also
caught in the maelstrom of elite conflict. Trans-World's sin
was to acquire its investments under the patronage of former
Kremlin security chief Alexander Korzhakov and former First
Deputy Prime Minister Oleg Soskovets. Once Yeltsin fired both
of these men and the aluminum industry came under suspicion of
supporting Aleksandr Lebed, Trans World became an easy target
for state agencies controlled by Chubais and Viktor
Chernomyrdin. Not surprisingly, local Russian officials soon
nullified its stake in at least one major smelter.\26\
---------------------------------------------------------------------------
\24\ Financial Times, 20 March 1997.
\25\ Financial Times, 10 April 1997.
\26\ The Independent, March 15, 1997. Another instance of
expropriation of western interests occurred when the Russian Government
terminated the work of NM Rothschild in developing a $1 billion
telecommunications share offer. The government turned it over to MOST
Bank and Alfa Bank, both of which were members of the charmed ``group
of seven,'' The Financial Times, November 26, 1996, p. 1.
---------------------------------------------------------------------------
Domestic actors are also fair game for the predatory state.
Moscow Mayor Yuri Luzhkov succeeded in 1998 in using a modest
municipal payroll tax on Moscow residents to generate a road
fund of approximately $645 million. Yet the federal
parliament--evidently with executive support--entered the
picture and passed a law requiring that at least half this
amount be spent on the national road system. This effectively
stripped the mayor of control over part of the municipal
budget.\27\
---------------------------------------------------------------------------
\27\ Moskovskii komsomolets, 23 May 1997.
---------------------------------------------------------------------------
societal withdrawal and economic marginalization
Russia's predatory proclivities have had a significant
negative impact on society. Despite having invested
considerable energy in developing an institutional framework
for articulating public sentiment, Russian civil society has
slid toward greater apathy in civic life. Demonstrations
marking the tenth anniversary of the failed Soviet coup (August
19 to 21) were noteworthy only because the police outnumbered
those who felt it important enough to show up on Red Square--a
pale echo of the remarkable and courageous resistance to
communism a decade ago. Public sentiment appears resigned to
viewing its relations to state power solely in tributary terms:
the state takes what it demands, and individuals seek to
achieve their objectives primarily by circumventing its
authority. Predictably, the most significant political parties
today are the Communists and those created at the instigation
of the presidential administration
Political withdrawal is paralleled by economic withdrawal.
Since productive activity is viewed by state elites as
something that can be either expropriated or arbitrarily taxed,
producers retreat from the legal economy to preserve autonomy.
This explains the persistence and growth of the extra-legal,
``informal'' economy in post-Soviet Russia. Consolidating a
stable tax regime in this environment becomes a challenge, for
if a tax regime is viewed by producers merely as a means of
being identified for future expropriation, they have strong
incentives to move production underground where chances of
detection are smaller.
Finally, the marked disparity between Moscow's affluence on
the one hand, and severe economic deprivation in the rest of
Russia, is leading to the creation of a two-tiered economy in
which the vast majority of the population is economically
marginalized and sees little to no chance for improving their
lives.\28\
---------------------------------------------------------------------------
\28\ This was the image of Russia--strikingly similar to many
African societies--described by an official in Putin's administration;
conversation with Vladimir V. Shemiakin, Advisor to the Administration
of the President of the Russian Federation, June 30, 2000.
---------------------------------------------------------------------------
It is precisely here that predatory politics sow the seeds
for potential future instability, for no society can sustain
itself indefinitely on the basis of an economy based
principally on the material well being of its capital city.
Failure to provide the Russian public a meaningful stake in
economic life will lead to an insufficient revenue base that
undermines government policy. Similarly, Russian elites should
by now appreciate the fact that a resigned or alienated
population in the context of sagging economic expectations is a
combination likely to produce a serious challenge to their
legitimacy.
recentralization and atrophy of regional authority
Whereas Boris Yeltsin initially urged Russia's regions to
take as much sovereignty as they could, the style and substance
of President Putin's regional policy has moved in the opposite
direction. The earlier momentum of efforts to decentralize
governance in Russia has slowed significantly, as the
presidential administration's policy initiatives have adopted a
more pragmatic style, leavened with a distinct preference for a
recentralization of political authority. The disorderly parody
of federalism that emerged under Yeltsin certainly made some
degree of recentralization a rational means of restoring order.
But such recentralization was also consistent with the logic of
predatory states, as it maximizes access to potential sources
of economic wealth and deprives regional politicians of the
safety of a constitutional framework. While it is true, as some
commentators have noted, that Putin has yet to clearly
articulate his ultimate objective in regional policy, recent
events support a disturbing trend toward the growth of central
authority. In place of the personalistic style of Yeltsin
(which Putin is said to disdain), the Russian president has
organized the country's regions into seven administrative
districts. The heads of these sit, along with federal
authorities, on the recently created State Council, whose
jurisdiction remains ambiguously defined. The impact on
regional influence is clearer to discern, however: the state
Duma, or lower house of parliament is increasingly
marginalized, and powerful regional governors have gravitated
to lobbying the State Council.
More importantly, while still a prime minister, Putin
announced his view that the various bilateral treaties
concluded during the Yeltsin era that formed the basis for
regional power ought to be scrapped. Accordingly, President
Putin delegated to Tatarstan President Mintimer Shaimiev (who
is a member of the State Council) the responsibility of
elaborating a clear division of powers between the federal and
regional governments. But Shaimiev's working group concluded
that the central government ought to fully legalize these
regional treaties and use them as the basis for a broader
regional policy. This displeased the President so he disbanded
Shaimiev's group, ignored their proposals, and appointed
Dimitrii Kozak, (member of the more loyal presidential
administration) to a new working group on regional issues. This
time, however, Kozak has made plain that his goal is to
formally re-establish the primacy of Moscow (the so-called
``power vertical'') in regional affairs.\29\ In Putin's Russia,
the Kremlin appears likely to demand--and receive--the right to
greater intrusiveness in regional and municipal life than was
envisaged in the more optimistic predictions of the previous
decade.
---------------------------------------------------------------------------
\29\ Vladimir Lysenko, ``Otryzhka demokratiei,'' Novaia gazeta July
19, 2001.
---------------------------------------------------------------------------
Explaining Russia's Affinity for the Predatory State
If the preceding analysis proves more useful in making
sense of developments under President Putin, then it
strengthens considerably the conclusion that Russia has
deviated from progress toward free market democracy. It is
moving toward a predatory state model that consolidates an
authoritarian elite whose principal objective is in managing
social contradictions to its benefit. This raises a central
question: Why have Russian elites rejected the promise of
liberal democracy in favor of a political system that embraces
pre-existing inefficiencies and retains the tension between an
overly powerful central elite and marginalized society that
will surely prove the source of future discord?
Clearly, a major factor at work is the fundamentally
different way in which Russian elites view the potential
payoffs of any reform. Western strategies of reform focused on
how short-term obstacles and dislocations could be managed to
achieve longer-term economic transformation. But in Russia,
Imperial and Communist legacies created a predisposition to
predatory practices, with the result that precious few Kremlin
elites ever had the political security to focus on long-term
goals. They instead preferred to concentrate their energies on
achieving short-term gains by using familiar institutions and
political styles.\30\ Simply put, the benefits of pursuing
immediate gains through traditional means were preferred to the
potential rewards of a risky and uncertain future.
---------------------------------------------------------------------------
\30\ Even Yeltsin era elites initially committed to reform felt
reforms could only be achieved quickly. Hence, Chubais and Boris
Nemtsov viewed their tenure in office as short and accordingly endorsed
a ``shock therapy'' approach. Nemtsov, in particular, was fond of
characterizing himself as a ``kamikaze'' reformer.
---------------------------------------------------------------------------
The impulse toward predatory practice can thus be broken
down into two component parts: a preference for retaining
traditional political styles and values, and the consequent
need to situate them in an institutional setting acceptable to
the outside world. In Russia, an additional factor proved
decisive: the ineradicable memory of success in achieving the
status of Great Power as an empire whose practices rested
heavily on the political precursors of predatory rule. A brief
examination of each of these factors helps explain how Russian
elites could find the rewards of predation greater than those
of a liberal democracy.
old wine in new bottles: the ``recomposition'' of traditional Russian
power
The recomposition of power,\31\ refers to the process
whereby traditional forms of state power are placed into a
modern institutional infrastructure. This results in modern
state agencies operating in distinctly traditional ways.
Eurasian and African states have proven remarkably adept at
this: as new political institutions replace earlier ones, they
are filled with a traditional cultural content. This preserves
the ability of elites to function as in the past
(recomposition); while allowing institutions of power to
acquire the external appearance of respectability.
---------------------------------------------------------------------------
\31\ The term was first employed by Achille Mbembe,
``Democratization and Social Movements in Africa,'' Africa Demos 1
(1990) no. 1; Richard Joseph, ``The Reconfiguration of Power in Late
Twentieth-Century Africa,'' in Richard Joseph, ed. State, Conflict and
Democracy in Africa (Boulder, Co.: Lynne Rienner, 1999).
---------------------------------------------------------------------------
The reason Russian elites would prefer this outcome is
clear: their new responsibility to build a modern state and
economy necessarily entails ceding large spheres of their
authority and subjecting their own actions to the rule of law.
But who among them could willingly consent to this limitation
of their own power? The preferred alternative is to hold on to
the institutional resources of the autocratic center. Reformers
thus become seduced by the very entity they seek to eliminate,
which explains why many veteran reformers of the 1990s find it
impossible to leave the political arena.
The traditional weakness of society also militates against
a breakthrough to modern governance and in favor of a
resurrection of traditional authority. Imperial Russia
exemplified the tragic consequences of perfecting autocratic
power in advance of a free economy and national consciousness.
The state simply overwhelmed and dominated nascent civil
society, depriving it of the opportunity to develop its own
independent identity. Post-Soviet experience repeated this
pattern, as a small group of state elites assumed
responsibility for creating the new property owning classes and
decreeing the formation of political parties and social
organizations.
The combination of strong state and weak society helps
explain why no political elites--reformers or otherwise--
abandoned the familiar context of Russian clan rivalry in favor
of establishing a limited decentralized government and
genuinely free economy. Predatory behavior is linked to the
political elite's inability to see beyond its short-term gains
to the more distant rewards of reform, hence their preference
for political intrigue, a weak legal regime, and a market with
only contingent freedom. State and society drift away from
commitment to genuine reform, as a narrow clique of rulers
contents itself with augmenting the number of select clans
eligible to struggle for central power. Indeed, some scholars
have argued convincingly that the Russian reforms in January
1992 were converted into a political struggle among ruling
elites as early as April of that same year, as then prime
minister Yegor Gaidar opted for compromise with the ``red-
brown'' opposition made up of Communists on the one hand, and
industrialists and entrepreneurs on the other hand.\32\
---------------------------------------------------------------------------
\32\ The most thorough treatment of this period can be found in
Peter Reddaway and Dimitri Glinski, The Tragedy of Russia's Reforms:
Market Bolshevism Against Democracy Washington, DC: United States
Institute of Peace, 2001), chap. 6 passim.
---------------------------------------------------------------------------
The Soviet regime's toleration of illegal and criminal
practices in its later years also provided an important route
for the infiltration of predatory behavior. The Kremlin must
remain first among equals, whether dealing with financial
oligarchs, regional leaders or organized criminal structures
(mafias). Hence, instead of challenging the legitimacy of these
actors or seeking their elimination in favor of a more
equitable order, the predatory state aspires to be the largest
economic oligarch, the most potent of all mafias, and the most
dynamic of all the regions.\33\ Its possession of the reins of
formal state power provides it with a decisive advantage; for
the Kremlin alone among competitors can claim the right to
interact with the outside world. Moscow thus parlays its
privilege into that of a legal entity willing to undertake
illegal actions.
---------------------------------------------------------------------------
\33\ Vadim Radaev examines this phenomenon of the state as the
largest and most influential mafia in society; ``O roli nasiliia v
rossiiskikh delovykh otnosheniiakh,'' Voprosy ekonomiki (1998) no. 10.
---------------------------------------------------------------------------
The rule of law in this setting is a direct challenge to
autocratic power; for it implies an institutional framework
that would inhibit the power of the elite to intervene
arbitrarily in society and the economy.\34\ And while rents
\35\ typically generate the bulk of elite revenues at society's
expense,\36\ predatory states can--where profitable--evince
profound interest in economic development. It is not
development they disdain; rather, it is the need for working
within a legal framework. This allows them to exploit any
lucrative economic activity that emerges in the informal or
criminal sector of society. Their paramount concern is to
exploit this, rather than to find a legal context within which
entrepreneurial dynamism can flourish. Ultimately, what
sustains predatory rule is not some abstract fear of progress,
but the toleration by ruling elites of a political style that
is sufficiently familiar and rewarding in the short-term to
arrest the impetus for genuine reform. Russian elites are not
afraid of the free market; they simply find it far more
profitable to tailor the market to their interests, rather than
risk allowing it to determine the winners and losers in
society.
---------------------------------------------------------------------------
\34\ This comports with the view of Yuri Yurievich Boldyrev who, as
Vice Chairman of the Russian Government's Accounting Chamber, had
extensive experience in battling corruption and efforts to enforce the
rule of law, ``Corruption in Russia as an Element of a System of Total
Lawlessness,'' paper delivered at the Princeton University-Central
European University Joint Conference on Corruption, Budapest, Hungary,
November 5, 1999 (http//:www.coc.ceu.hu).
\35\ Rents are those opportunities for economic gain created by the
state's restriction of the free market. In Russia, government licenses,
restrictions on free trade, state intervention in enterprise decision
making, and rationing of foreign exchange, were ``rent havens''
exploited by well-connected businessmen and bureaucrats. Russia's
second stage of privatization, by restricting eligible recipients of
state property, also fits this category.
\36\ On this point, see: Joel Hellman, ``Winners Take All: The
Politics of Partial Reform in Postcommunist Transitions,'' World
Politics 50 (1998) no. 2, pp. 203-234. This phenomenon has far broader
applicability: Roger Tangri, for example, (1999) has observed in that
Uganda, Kenya, Ghana and elsewhere in Sub-Saharan Africa, privatization
programs came to focus more on the dispensation of lucrative rents to
privileged and well-connected elites than to the original goal of
getting the state out of the private sector; Tangri, Roger. The
Politics of Patronage in Africa: Parastatals, Privatization, and
Private Enterprise (Trenton, NJ: Africa World Press, 1999).
---------------------------------------------------------------------------
appearance matters: ``presentability'' and the image of democracy
States in the contemporary international system cannot
afford either the luxury of isolation or the burden of
exclusion, so it is important to understand how a predatory
state survives in a globalized world. Economic globalization
presses states to demonstrate a commitment to maintaining
domestic institutions ensuring some predictable measure of
transparency, legality, and democratization. Without this, the
foreign investment flows essential to participation in the
global economy simply cannot be guaranteed. Yet, none of the
predatory state's internal characteristics reflect even modest
adherence to these preconditions.\37\ This contradiction
between the international and domestic norms is managed through
the practice of presentability, in which the formal
institutions of market democracy are paralleled by the informal
embrace of practices, norms, and institutions that are animated
by pre-existing political culture. This is necessitated because
predatory states must mediate between promising opportunities
in an international economy they cannot control, and a domestic
socio-economic environment they have structured to their
advantage.\38\ Russia's elites skillfully embrace the rhetoric
of democracy and the free market while yielding little in the
way of public accountability or effective economic reforms.
---------------------------------------------------------------------------
\37\ It is true that many states do not possess these attributes in
full. Some of these are undoubtedly admitted for the ``formal'' reasons
discussed below. Another factor is that Western industrialized nations
and multilateral institutions are not fully confident that potential
Russian misbehavior, unlike that of most other states, can be managed
with existing institutional remedies. China also falls into this
exceptional category.
\38\ Recent discussions of ``virtuality'' in democratic practice
echo similar sentiments. See: Richard Joseph, ``Democratization in
Africa after 1989: Comparative and Theoretical Perspectives,''
Comparative Politics 29 (1997) no. 3, pp. 367-368; Fareed Zakaria's
``illiberalism,'' discusses the similar same phenomenon, though he does
not view culture as the determining factor, ``The Rise of Illiberal
Democracy,'' Foreign Affairs 76 (November/December 1997) no. 6 passim.
---------------------------------------------------------------------------
Western policy has played an important--if unsuspecting--
supporting role in the evolution of presentability, as key
Eurasian, African and Asian states deemed by Western
institutions as too important to fail are evaluated solely on
the basis of formal, rather than substantive, criteria.
Democratic reform acquires a brittle skin-deep quality, though
sufficiently opaque to permit the process of political
recomposition to proceed. The end results are modern formal
institutions filled by a more familiar traditional political
substance.
The elites' preference for presentable, as opposed to
substantive, democratic reform receives a powerful impetus from
the recomposition of traditional power. Since predation is
largely a function of elite political culture and is
indifferent to the architecture of formal institutions, Russia
can absorb much of the formal infrastructure of free market
democracy even as the substance and style of its politics fills
these institutions with more traditional values. The new Russia
conforms neither to the West's desired image of it, nor is it a
simple return to the past--Czars, boyars, commissars and
democrats have blended the dark arts of autocracy with the
``dismal science'' of economics and a pretense of populism,
molding reform to preserve their interests.
Key political and economic developments over the past
decade vindicate the image of Russia as a presentable society:
Democratic presidential elections were largely determined by a
narrow elite with access to state resources. In Yeltsin's case,
his initial support by a cluster of ``reformers'' was augmented
to include financial oligarchs. Putin, by contrast, was
virtually anointed by Yeltsin as the latter's successor, with
strong endorsement from the Kremlin ``family,'' Chubais, and
Putin's allies from St. Petersburg. Political parties are
formed by presidential diktat and sustained in large part by
funds drawn from state coffers. And Putin's appointment to high
office of his former colleagues from within the former KGB has
aided the re-entry of the secret police organs back into the
fold of Kremlin politics. Finally, the rhetoric regarding
separation of state from economy is belied by a policy in which
the government retains crucial share holdings in huge economic
enterprises and government ministers sit on governing boards of
enterprises.
The recent behavior of former privatization chief Alfred
Kokh provides a vivid example of the transition from reformer
devoted to Russia's transformation, into loyal combatant in the
predatory state. In his current incarnation as head of media
relations for Gazprom, Kokh spearheaded the successful effort
to crush NTV, Russia's only independent television network. In
barely 3 years' time, Kokh shifted from a reformer advocating
for free market democracy to a high-ranking member of the
nebulously-defined Russian ``private sector,'' doing the Putin
administration's bidding by crushing an independent voice of
opposition to government policy.\39\
---------------------------------------------------------------------------
\39\ See, for example, Kokh's ``Gusinsky has Made `Freedom' a Bad
Word,'' Russia Watch, no. 6 (June 2001), pp. 19-20; http://
www.ksg.harvard.edu/bcsia/sdi.
---------------------------------------------------------------------------
Presentability is in certain respects the key aspect of the
predatory model, for it explains why Western policy toward
Russia tolerated the persistence of traditional Muscovite
politics. Once Western states had resolved that only Yeltsin
could implement reform, it became imperative to permit him to
secure his domestic political position. Yeltsin, however, had
learned his political survival tactics in the old school;
hence, if the he were to survive as president, he had to resort
to the familiar world of clan politics and not democratic
processes. The West felt obliged to accept this reality, and
did so on the condition that the leading clan reflect the
interests of free market democratic reform. Yeltsin responded
by developing what might be a textbook recipe for a
``presentable'' transition: (1) seizing the rhetorical high
ground and imposing upon all Russian elites (excepting the
Communists) the vocabulary of reform; (2) producing sufficient
substantive changes to permit the West to declare transition a
success; (3) exploiting Communist ineptitude to cast them as
the perfect villain. This allowed Yeltsin to declare outright
war on the ``red-brown'' opposition while simultaneously
replacing many of his shock therapists with old-style economic
managers and restoring state subsidies to enterprises.\40\ This
is the unsettling reality of predatory Russia, which resembles
closely the ``choiceless'' democracies in Africa: \41\ the
domain of electoral rights are broadened with great fanfare,
even as the range of meaningful policy options presented to the
public narrows to the vanishing point. The popular election of
a Russian president is indeed an event unprecedented in
history; but this achievement must be balanced by recognition
that in 1996 and 2000, the Russian public has had the
opportunity only to legitimize the candidate pre-selected by
the elite. That is why presidential elections in Russia have to
date been won only by former Communist Party bosses and
operatives of the secret police.
---------------------------------------------------------------------------
\40\ Tim McDaniel, The Agony of the Russian Idea (Princeton:
Princeton University Press, 1996), p. 153.
\41\ Mkandawire, ``Crisis Management and the Making of `Choiceless'
Democracies.'' Other variants of democracies lacking a democratic
essence: Igor Klyamkin and Lilia Shevtsova compare Yeltsin's regime to
an ``elective monarchy,'' Nevavisimaia gazeta, June 24, 1998; still
others, such as Terry Karl, have noted the phenomenon of
``electoralism,'' where the election procedures function, but a
meaningful choice is absent.
---------------------------------------------------------------------------
the legacy of imperial success
The third fundamental dimension of Russia's evolving
predatory regime distinguishes it from all other similar
systems: Russia is a country with demonstrated success in
achieving Great Power status in the 18th, 19th, and 20th
centuries, and a society familiar with the challenges of
extracting extraordinary results from dysfunctional
institutions. It is precisely for this reason that the thrust
of this analysis is not about inherent Russian weakness but
about the challenges of managing the consequences of Russia's
restoration, and preparing for the next contraction that
signifies yet another turn in the wheel of Russian history. The
focal point is Russia's adaptive response to its historical
crises, which has allowed it to develop a polity distinct from
Western models, and to achieve a substantial measure of
international power and prestige.
Whether as Czarist or Soviet regime, Russia acquired
extensive experience in the global competition for power. The
belief is widespread in Russia that power is a key element in
maintaining a state's--especially a Great Power's--independence
in the international system. The alternatives to this, Russians
fear, are to be penetrated by other states or become the
objects of territorial aggrandizement.\42\ Russia has vivid
memories of both and its ruling elites will find it intolerable
to again be at the mercy of other powers--a view that is
increasingly articulated by oligarchs, bureaucrats, Putin
himself, and even democratic reformers. The dictates of the
International Monetary Fund grate against Russian sensibilities
and Russia has the potential to be far less accepting of the
constraints imposed by international assistance than many other
societies. NATO's military intervention in the Balkans further
reinforces the desire of Russian elites to position themselves
out of the grasp of Western institutions they see as either
depriving them of sovereignty or limiting their freedom of
maneuver. The festering Russian offensive in Chechnya was made
presentable to the West by Putin's exploitation of the
vocabulary of Western politics--as well as its fear of Islamic
fundamentalism--arguing that Russian actions follow the NATO
precedent and seek the objective of destroying alleged Chechen/
Islamic terrorists.
---------------------------------------------------------------------------
\42\ Western scholars have also concluded that these are the most
likely outcomes for much of the developing world. See, for example,
Robert H. Jackson, Quasi-states: Sovereignty, International Relations,
and the Third World (Cambridge: Cambridge University Press, 1990). The
more contentious issue, however, is whether such an outcome will prove
beneficial or detrimental to socio-economic development.
---------------------------------------------------------------------------
The globalization of capital and investment flows is
another factor complicating the predicament of predatory
states, and with which Russia must contend. Increasingly,
economic processes challenge sovereignty without resort to
territorial expansion, and the price to pay for entry into a
globalized world is greater transparency and predictability in
the legal and economic environment. Many other states grappled
with this reality for decades while Russia remained insulated
behind the walls of communism. Russian elites therefore had to
contend with a second shock in addition to the loss of empire:
economic progress threatened a loss of control over domestic
life. This sense of vulnerability and the new requirements and
resources for competition in the state system may prove
precisely the factors capable of persuading Russian elites to
become more than rentier capitalists. Global rivalry may
eventually compel Russia's rulers to focus on raising
productivity in order to restore the institutions (i.e., the
military) that can return Russia to the concert of Great
Powers. But this still cannot ensure the transformation of
Russia into a law-governed state. Indeed, the elites' evidenced
skill in using the illicit side of the global economy suggests
this may be their preferred means for exploiting opportunities
there.
Another factor with a distinctive impact on Russia concerns
still unresolved questions of national identity. Russia was the
center of a multinational empire that denied the existence of
constituent nations. Recent imperial memory lingers in the
Russian consciousness, interacting with memories of power lost.
To the extent that the Soviet mythic legacy continues to
dominate Russian popular thinking, elites will find fertile
soil in the public mood for building a Russian state that
restores a substantial measure of the influence it wielded in
previous eras. Even if not expansionist in content, such a
conception retains the close link between identity and state
power. National self-definition, with prodding from political
elites, could reinforce popular resentment arising from the
loss of sovereignty and serve as an important element to revive
national power.
Russia also possesses a human and natural resource base
that defies comparison with the any other predatory system.
Even with its environment and population threatened, the
enormous investment in education and training in the natural
sciences by the Soviet regime has left a skilled workforce that
can be harnessed quickly. Unlike post-colonial societies that
tend to bristle with economists and political scientists,
Russia can marshal millions of trained engineers, physicists,
chemists and other professions essential to catalyzing a post-
Soviet economic transition. Russia's present malaise, moreover,
should not ignore the reality of a substantial nuclear
stockpile and residual military power. Even a modest
improvement in Russia's economic fortune could allow these
military resources to have a profound impact on international
security.
Finally, there is the unavoidable reality that Russia
simply possesses too much potential for mischief to be left to
the whim of entropic forces. Hence, the dialogue between the
Putin government, international financial institutions, and
Western governments will remain important. But the concessions
already made to Russia's predatory pathway mean that it will
seek only the necessary mix of symbols, gestures and minimal
substantive commitments to persuade the West that it is in
transition to a reassuring destination. If the past decade is
any guide, Russia will certainly attempt to achieve what it
desires while making the West feel good about what it is.
Conclusions and Implications for the West
Viewing Russia as a predatory state carries important
implications for expectations of its domestic development, as
well as for multilateral and bilateral efforts to engage Russia
in international affairs. Russian-American relations will be
far more complex than the recent or even Communist past.\43\
The United States has in the past dealt with dysfunctional
developmental regimes as well as Great Powers, but the
coincidence of the two in one state is rare, if not unique. The
following points are therefore intended to project into the
future some of the main lines of development of a predatory
Russia, with some of its implications for international
politics.
---------------------------------------------------------------------------
\43\ Some of these points are amplified in an Occasional Paper
prepared by the author for The Atlantic Council of the United States:
``After the Fall: U.S.-Russian Relations in the Next Stage of Post-
Soviet History,'' December 1998.
---------------------------------------------------------------------------
(1) Russia is not destined for development as a free market
democracy, nor is it likely to remain an irresponsible power.--
The predatory model suggests that Russian elites will succeed
in integrating a state-economic elite that responsibly
exercises power in pursuit of its own interests, often at the
expense of society. Such a system will undergo considerable
development and restoration of power, but the burdens
associated with sustaining it militate against permanent
stability.
(2) The consolidation of the predatory Russian state does
not exclude the development of capitalism.--On the contrary,
some form of capitalism is inevitable. It will, however, be
heavily textured by an interventionist state and the constraint
of civil liberties.
(3) Successful foreign investment in Russia will require
the ability to establish and maintain constructive relations
with influential clans.--Russian elites will be keen to
encourage investment, but the low value placed upon a coherent
and enforceable legal framework for commercial activity implies
that personal and political factors will be the critical
determinants of which foreigners gain access to lucrative
Russian markets. Moreover, Russian elite motivations will
spring from a desire to enrich themselves and their allied
clans, rather than for budgetary revenues. Hence, so long as
Putin remains president, those Russians linked to him and his
entourage will receive favorable treatment, while those outside
this group become targets for expropriation and political
pressure. In all likelihood, the Putin government will maintain
the practice of the Yeltsin era by offsetting prohibitive or
inhospitable formal conditions for investment with informal
guarantees that circumvent all obstacles. Foreign investors may
well succeed in Russia, but they will have to operate in
fluctuating political conditions, and place greater reliance on
personal rather than institutional guarantees.
(4) The true test of Russia's potential over the long-term
rests on the character of the leader or leaders who succeed
Putin.--This is most likely to occur sometime after 2010. The
historic pattern of Russia's development has been a cycle that
moved through a ``time of troubles,'' then to state
consolidation, and finally, power projection. If the past is
any guide, the next stage in Russia's cyclical development
requires a leader with more dynamism than Putin has exhibited.
Russia thus awaits its leader--or vozhd--who blends his
personal authority with the resources of state (which include
an economy with deep organic links to the government elite) to
undertake the great task of mobilization that has always been
necessary to produce a quantum change in Russian societal
development.
(5) Given his role as a stabilizer rather than a mobilizer,
Putin's policies--foreign and domestic--will likely be
temporizing, focused on providing the time and space needed for
restoration and positioning of Russia for greater future
influence in foreign affairs.--Putin and Russia will seek to
avoid costly engagements abroad in preference for consolidating
a network of relations that expand its influence. It presents
little immediate direct threat to the United States or the
West.
(6) The potential for Russia's return to a consequential
global role rests heavily on the qualities of its next
leader(s).--If the predatory model holds, Putin's successors
will be vetted by the political elite and legitimized through
popular elections. They will not, as was once hoped, be
individuals who worked their way up from the lower ranks of
democratic society to the upper echelons of power.
(7) A decentralized federalism is not in Russia's future.--
While it is doubtful that Russia can return to the level of
centralization of Soviet rule, there is little chance that the
center will consent to surrendering large spheres of its
authority to regional competitors. This is one of the most
complex aspects of Russia's future, for it requires the
articulation of a novel form of government--neither federal nor
wholly central--for which there is no precedent.
(8) Corruption, cronyism, and a vast informal economy will
be integral building blocks of future predatory Russian
society.--The opportunity for the West to radically transform
the dynamics of the informal economy has passed. Privatization
resulted in the transformation of political elites into
economic elites who now claim their place at the table of
Kremlin power. Their reliance on extralegal measures to attain
that status and the future benefits they can expect to derive
from corrupt practices militate against serious reform. But
predatory practice has demonstrated that, given the proper
political conditions, substantial efficient and productive
activity remains possible.
(9) The economic and social costs associated with Russia's
development as a predatory state will still leave it vulnerable
to periods of instability.--The predatory project is attractive
because of the short term gains it provides elites; but the
long-run economic and social costs are undeniably high:
excessively high barriers to entry to the elite, enormous
expenditure of resources to maintain crony networks,
maintenance of extensive oversight over the economy, and
marginalization of society. These factors echo many of the same
problems present at the end of Soviet power: tightening
resource constraints, a diminishing pool of skilled elites, low
workplace morale and productivity, and an unwillingness to cede
political control for the sake of economic gains. The failure
of predatory elites to address basic social problems and
consolidate the foundations of a free market economy may lead
to an accumulation of problems that overwhelm self-interested
elites. Historically, Russia has relied on strong leadership to
avoid such crises. But the collapse of Romanov autocracy and
the implosion of the Soviet Union are clear reminders that
Russia's institutional structures tend to be too rigid and
inflexible to survive crises on their own. In essence, Russian
elites are more adept at surviving socio-economic crises than
avoiding them. The challenge of dealing with Russia in the
future will therefore be more complex than the already daunting
task of dealing with a socio-political order that rejects the
basic essence of liberal democracy; it will also require
engaging a society that, despite recapturing significant global
influence, retains internal tensions that may undermine
stability.
=======================================================================
RUSSIA'S ECONOMIC FUTURE AND U.S. INTERESTS
=======================================================================
U.S. BILATERAL ASSISTANCE TO RUSSIA, 1992-2001
By Curt Tarnoff \1\
----------
contents
Page
Summary.......................................................... 369
A Decade of Assistance........................................... 370
Security programs............................................ 370
Weapons destruction and dismantlement.................... 371
Control and protection of nuclear material............... 371
Demilitarization......................................... 371
Humanitarian programs........................................ 371
Stability programs........................................... 371
Economic reform.......................................... 372
Democratic reform........................................ 372
Social and environmental reform.......................... 373
Criticism and Achievements....................................... 373
Criticism.................................................... 374
Too little, too late..................................... 374
Too much, too early...................................... 375
Too American............................................. 375
To the wrong Russians.................................... 376
The wrong strategy....................................... 376
Achievements................................................. 377
Security program achievements............................ 377
Humanitarian program achievements........................ 377
Stability program achievements........................... 377
The Russia Program Today......................................... 380
Prospects for the Future......................................... 383
Summary
For nearly 10 years, the United States has supported
programs of bilateral and multilateral assistance to Russia.
Although policymakers always anticipated that multilateral
assistance through the World Bank and International Monetary
Fund (IMF) would compose the bulk of global efforts to assist
Russia, throughout this period the United States has maintained
a program of bilateral assistance that more directly and
immediately reflects U.S. interests and priorities. While
smaller than the multilateral effort, as a grant, not loan,
program, bilateral assistance can be employed in a wider range
of situations than multilateral aid.\2\
---------------------------------------------------------------------------
\1\ Curt Tarnoff is a Specialist in Foreign Affairs in the Foreign
Affairs, Defense and Trade Division of the Congressional Research
Service.
\2\ For a discussion of multilateral aid, see the paper ``Russia
and the International Financial Institutions: From Crisis to a Normal
Country'' by Jonathan E. Sanford.
---------------------------------------------------------------------------
The U.S. bilateral program has had three overarching and
related aims--security, stability, and humanitarian. The United
States has sought to achieve security, both U.S. and Russian,
by promoting nuclear and chemical weapons non-proliferation
activities. It has sought stability--Russian and world
stability--by supporting a range of programs to create a
democratic and economically prosperous Russia that would, as a
result, be a cooperative member of the international community.
Its humanitarian programs, like those elsewhere in the world,
transcend specific U.S. strategic and other interests in
Russia--they are a reflection of traditional American values.
As might be evident from the current state of Russia's
economy, society, politics, and military, the numerous and
diverse projects that were developed in order to achieve these
aims have had a mixed record. Over time, as a consequence of
failures, successes, lessons learned, financial constraints,
and program restrictions and conditions, the aid program today
is substantially different in size and scope than it was early
on. How it will change over the next decade is unclear. But in
determining where the program is to go in the future, it may be
helpful to know where the program has been.
A Decade of Assistance
Through September 2000, about $8.8 billion in grant
assistance has been budgeted for programs in Russia.\3\ Roughly
37 percent of these funds have been targeted at security
objectives, 32 percent at humanitarian goals, and 31 percent,
at stability objectives (see Figure 1).\4\
---------------------------------------------------------------------------
\3\ Another $908 million was expected to be allocated for Russia
programs in 2001.
\4\ The United States also provided loan and other guarantees to
support roughly $6 billion in the face value of U.S. goods and
investments to meet trade objectives. As these mostly benefited U.S.
exporters and investors, they are not discussed here.
---------------------------------------------------------------------------
FIGURE 1._OBJECTIVES OF U.S. ASSISTANCE TO RUSSIA: 1992-2000
[GRAPHIC] [TIFF OMITTED] T6171.042
security programs
Of the roughly $3.3 billion intended for security purposes,
most has come from the Department of Defense appropriations,
largely authorized under the so-called Nunn-Lugar Cooperative
Threat Reduction (CTR) Program first approved by Congress in
November 1991. Related programs are also funded and implemented
by the Department of Energy and Department of State. The bulk
of security programs are intended to lessen the potential
threat to the United States posed by Russian nuclear weapons,
material, and expertise vulnerable to sale, theft, or hire by
terrorists or rogue nations. There are several key components
of these efforts.
Weapons destruction and dismantlement
The CTR program has helped Russia meet START I Treaty
limits by facilitating the elimination of delivery vehicles for
nuclear weapons, including SS-18 missile silos and heavy
bombers, and supporting destruction of its chemical weapons
stockpile.
Control and protection of nuclear material
The United States has provided design and construction
assistance for a storage facility for fissile material from
dismantled nuclear warheads, along with the containers for the
transport of warheads and storage of materials. It has sought
to enhance the security of warheads and materials during
transport, storage, and at research facilities by such measures
as providing super-containers, inventory control systems,
sensors, and personnel reliability methodologies. Customs
officials have received training and radiation detectors have
been provided in order to thwart illegal export of fissile
materials.
Demilitarization
U.S. assistance has supported the conversion of Soviet
defense industries into commercial, non-military, enterprises.
Several programs aim to employ Soviet weapons scientists in
peaceful civilian research.
humanitarian programs
Since 1992, the U.S. Government has provided Russia with
$2.8 billion in humanitarian assistance. Almost all of it has
been food aid, delivered under the P.L. 480 Food for Peace,
Section 416(b), and the Food for Progress programs carried out
by the Department of Agriculture. In some cases, food was given
to private voluntary organizations for distribution to the
needy. In other cases, commodities were sold and their proceeds
were used to support development objectives--such as the
cooperative credit system, child vaccination programs, and the
Russian Pension Fund. The U.S. Government has also provided
transport costs for medical and other aid donated by the
private sector, and has contributed to international
organizations working in Chechnya.
stability programs
Programs aimed at creating a stable and peaceful Russia by
facilitating its transition from authoritarian communism to a
free market democracy receive particular attention from
Congress and the public. During the past 10 years, $2.7
billion, mostly funded under the foreign operations
appropriations and authorized under the FREEDOM Support Act has
gone to such efforts. Projects designed to meet these
objectives have been numerous and diverse. The breadth of
purpose and sectors they cover, many of which overlap, make it
difficult to categorize them. They might be put into three
broad baskets.\5\
---------------------------------------------------------------------------
\5\ A fourth, miscellaneous, catch-all group, composes 5 percent of
stability efforts. These mostly include funds for the Peace Corps and
USAID training programs--cross-cutting activities that benefited all
three stability objectives.
---------------------------------------------------------------------------
Economic reform
More than half (54 percent--about $1.5 billion) appear to
have as their primary objective the economic restructuring of
Russia and development of a strong private sector economy (see
Figure 2). Among the projects that sought to meet this need
were efforts to encourage reform of tax, banking, fiscal,
energy, housing, and privatization policies. U.S. funds have
been made available for equity investments in small and medium
business, and loans to small and micro-business. Technical
advice has been provided to farmers and businesses, as well as
opportunities to gain experience in U.S. firms. Various efforts
have been made to encourage U.S. trade and investment in
Russia.
FIGURE 2._U.S. ASSISTANCE FOR RUSSIAN STABILITY: 1992-2000
[GRAPHIC] [TIFF OMITTED] T6171.041
Democratic reform
By the narrowest definition, only 8 percent of stability
efforts in Russia were directly geared toward the development
of democratic institutions and practices. These would include
projects providing advice to staff of political parties and
political election commissions, encouraging the growth of civil
society through offering advice and funding to non-governmental
advocacy organizations, promoting the rule of law through
provision of judicial training programs and expertise on a
civil code, and crime and anti-corruption programs. Democracy
programs, more broadly defined, also have included a wide range
of U.S. exchange programs and small grants to non-governmental
organizations (NGOs), many of which facilitated economic reform
objectives, but whose effect, through exposure to U.S.
institutions or development of indigenous civil society, has
been helpful to democratic development. Just under one-fourth
of stability programs fit into this broader definition.
Social and environmental reform
Social and environmental reform activities account for
about 17 percent of stability efforts. Programs to improve the
social welfare and environmental conditions of the Russian
public, while meeting humanitarian concerns, were largely
intended to bolster the key U.S. objectives of economic and
democratic reform. Experts have argued that the Russian public
would be more likely to support these objectives if they
experienced fewer negative consequences as a result of reform
efforts. Unenforced environmental standards by the Communist
regime and the end of a cradle-to-grave social system has
fostered a dramatic health and environmental crisis in Russia.
Health programs supported by U.S. assistance have sought to
reform health care delivery and financing systems, and they
have targeted specific diseases such as HIV/AIDS and
tuberculosis. U.S. hospitals have provided equipment and
expertise to partner hospitals in Russia. Family planning
assistance has been provided as an alternative to the common
practice of abortion. Russian orphanages have been assisted.
Environmental programs have provided small grants to
innovative indigenous projects and replication of ``best
practices,'' and have supported use of the Internet and e-mail
to strengthen communication between environmental groups spread
throughout Russia. They have supported forest management reform
and reforestation, and pilot demonstration anti-pollution and
energy efficiency projects. To avoid a Chernobyl-like scenario,
the Department of Energy and the Nuclear Regulatory commission
have provided training and equipment to improve the safety of
Soviet-designed power plants.
Criticism and Achievements
When the FREEDOM Support Act was introduced in 1992,
government officials tried to sell the program as a relatively
short-term effort, lasting until fiscal year 1998. However,
even then, many realized that the transition to democracy and
free markets might take a generation or more, depending on the
sincerity and rapidity with which political leaders adopted the
basic framework and laws of a new polity and economy. At the
present time, Russia remains an unfinished work with analysts
ranging from doubtful to hopeful in their views of its future
course.\6\ Views of the U.S. assistance program follow the same
trajectory. Both optimistic and pessimistic perspectives have
helped shape the current program and can provide lessons for
its future.
---------------------------------------------------------------------------
\6\ The former category might include Stephen F. Cohen, Failed
Crusade: America and the Tragedy of Post-Communist Russia, W.W. Norton,
NY, 2000. More hopeful views are expressed by Anders Aslund,
``Underselling Russia's Economy,'' New York Times, January 18, 2000,
and Michael McFaul, ``Getting Russia Right,'' Foreign Policy, Winter
1999-2000.
---------------------------------------------------------------------------
In any case, the role of the aid program in Russia's
progression to what it is today and to what some expect it to
become is hard to define. Even in countries such as South Korea
or Costa Rica where the aid programs were proportionately large
and their political and economic development highly successful,
making a connection between the U.S. programs there and
specific consequences is obscured by the numerous variables
that come into play. The results of some programs are more
easily measured than others, such as numbers of children
vaccinated, which logically means lesser incidence of disease,
or elimination of missile launchers, which directly leads to
the conclusion that U.S. security is enhanced. The immediate
returns on most programs are often straightforward such as
numbers of micro-loans provided or people trained in business
management. How the trainees or loan recipients ultimately
contributed to the broader objective of creating a market
economy, however, is less transparent. If the objective is
concrete, the program budget ``sufficient,'' activities
narrowly focused on the goal, and the recipient environment
cooperative, as was more often the case with security and
humanitarian programs in Russia, the results may be more
transparent. Stability programs had few of these features and
only the short-term results appear ``measurable.'' Further,
U.S. stability assistance was never expected to be the primary
determinant of a successful Russian transition. Its impact
could only be at the margins. Such considerations should be
kept in mind when judging the impact of U.S. assistance
programs in Russia.
criticism
From the time it was launched, critiques of the aid program
have emerged with regularity. Some attacks, many hyperbolic,
had ulterior motives--those linking the aid program to Vice
President Gore as the 2000 election approached or the snipes at
aid implementors made by some unsuccessful applicants for
funds. But criticism came also from knowledgeable individuals
who sought a more effective outcome. The range of criticism can
be summarized as follows: \7\
---------------------------------------------------------------------------
\7\ In addition to these substantive, policy-related, critiques,
observers have raised concerns regarding the administration of
projects, such as the inadequacy of management, ineffectiveness of
implementation, and possible malfeasance of individuals employed in
projects. Some have opposed aid to Russia entirely, arguing that funds
would be better spent on programs in the United States. Among more
recent critiques are: ``Food Aid to Russia: The Fallacies of U.S.
Policy,'' Mark Kramer, Harvard University, October 1999; An Agenda for
Renewal: U.S.-Russian Relations, Carnegie Endowment for International
Peace, December 2000; Collision and Collusion: The Strange Case of
Western Aid to Eastern Europe 1989-1998, Janine R. Wedel, New York,
1998; International Efforts to Aid Russia's Transition Have Had Mixed
Results, GAO, November 2000; Russia's Road to Corruption: How the
Clinton Administration Exported Government Instead of Free Enterprise
and Failed the Russian People, Speaker's Advisory Group on Russia,
House of Representatives, September 2000.
---------------------------------------------------------------------------
Too little, too late
Efforts to assist the democratic and economic transition in
Russia have often been criticized as offering too little
funding, too late. Early on, the George H. Bush Administration
was criticized for reacting too cautiously to the dramatic
changes taking place in the Soviet Union in 1991. CTR security
initiatives came entirely from Congress. Although some small
stability-related programs were proposed by the Administration,
it was not until the April 1992 announcement of the FREEDOM
Support Act, following critical comments from national figures
such as former President Nixon, that a concentrated effort was
made to offer U.S. aid and organize support from international
donors. To those expecting a new Marshall Plan in response to
what appeared then to be a short window of opportunity for
adoption of revolutionary but painful reforms, the U.S.
contribution was considered paltry and half-hearted, and the
bulk of offered international assistance, loans from the IMF
and World Bank, were not appealing to a country reluctant to
add to its debt.
A year later, the Clinton Administration proposed a
significant increase in U.S. assistance--roughly $1.5 billion.
Following this one-time infusion of aid, annual levels
appropriated for Russia quickly declined, settling below $200
million. Throughout the decade, critics continued to remark on
the disparity between the supposed importance of Russia to U.S.
interests and the level of funding for efforts to effect change
there. Although Russia received a greater proportion of
available funding for the region, neighboring nations, such as
Armenia and Georgia, with significantly smaller populations
consistently ranked higher than Russia on a per capita basis.
Too much, too early
Some would argue that a major reason for failed projects
and wasted resources in the early years was the impetus to
spend before there was a serious prospect of success in certain
sectors. Economic reform legislation was developed with U.S.
assistance while a Communist dominated parliament promised to
thwart each measure. Assistance was offered to develop farming
before land was privatized. And foreign investment was
encouraged before rule of law safeguards were in place to
protect investors.
Too American
However much the United States claimed to provide to
Russia, the fact is that much of the focus was self-serving,
and many of the funds never left American hands.\8\ Moreover,
many critics complained that Americans with specific knowledge
of Russia were underutilized in the formulation and
implementation of assistance programs. Stability programs
designed and run by non-expert Americans were accused of
displaying little cultural sensitivity and providing advice
that was inappropriate. Few Russian staff members were hired to
compensate for American ignorance of local matters. This
critique was mostly aimed at the large for-profit contractors
which focused on government policy reform work and dominated
the aid program in the early years. Critics also argued that
inadequate funds were provided to the relatively smaller NGOs
which worked with the Russian grassroots and were more
responsive to local realities and needs. As a result, U.S.
assistance created a degree of public resentment, critics would
argue, instead of the anticipated good will.
---------------------------------------------------------------------------
\8\ A GAO report criticized the DOE Initiatives for Proliferation
Prevention program for providing only one third of its funds to Russian
institutes for employment of scientists. But most security assistance,
in the form of U.S. equipment such as containers, and humanitarian
aid--U.S. commodities--were items requested by the Russian Government.
On the other hand, stability aid was mostly U.S. technical advisers and
equipment, key exceptions being monetary grants to grassroots
organizations, equity investments in private sector firms, and grants
provided for on-lending to small and micro-business. The Russian
Government had little to do with how stability funds were spent.
---------------------------------------------------------------------------
To the wrong Russians
Both the George H. Bush and Clinton Administrations argued
that aid should follow reform. However, some argued that,
partly due to the lack of Russia expertise or a misguided
effort to support the Yeltsin government, aid was provided to
individuals or groups that were not reformist. In particular,
critics pointed to U.S. support for Anatoly Chubais' program of
privatization, which they argue exacerbated income divisions
and helped foster the so-called oligarchs. Policymakers,
according to critics, blindly provided support to individuals
like Yeltsin, despite his inconsistent support for economic
reform and democracy, rather than to democratic
``institutions.'' When a substantial amount of food aid was
provided in 1993, many suggested that proceeds were channeled
through corrupt officials who may have used them
illegitimately. Others argued that congressional directives
funneling funds to specific regions insured ineffective
programs by assisting non-reformers.
The wrong strategy
Some critics disagreed with the mix of programs that were
funded by the United States. They argued, for example, that
stability programs emphasized economic reform efforts while
leaving democracy programs underfunded. Stronger democratic
institutions, they suggested, would have led to more economic
reform. Other critics argued that too much assistance was
provided to programs in Moscow and not enough to the regions.
Others contended that too much went to the reform of Russian
Government policies and not enough to grassroots activities and
the private sector.
Some CTR critics argued that funding the destruction of
chemical weapons was less important than elimination of nuclear
weapons; others that more funds should have gone to insuring
the security of materials used to produce weapons. Some
questioned the wisdom of defense conversion programs, arguing
they subsidized the Russian defense industry and had no effect
on current production capacity. Others suggested that funding
weapons dismantlement while Russia continued to modernize its
systems simply subsidized modernization. Critics of food aid
argued that sale of the commodities lowered local food prices
and harmed Russian farmers, especially the new independent
farmers some aid programs were trying to encourage.
There are many possible responses to the numerous and
disparate criticism made during the past 10 years: It could be
said that, no matter the amount of funds available, little
could be done without a strong commitment on the part of the
Russian Government to support the few Russian reformers who
emerged in positions of power. While, there may have been
American experts on Russia who knew more than Kremlinology, few
of these had experience in running assistance programs, and no
one had expertise on the transformation from communism to
democratic capitalism. Everyone had a formula for how funds
could best be spent. Each donor had different priorities and
did not channel funds into a coherent program for maximum
leverage. Congressional directives caused dispersal of limited
U.S. funds on too numerous objectives.
achievements
In taking aim at individual aspects of the aid program--the
privatization effort, corrupt food aid, insufficient support
for democratization, etc.--critics often promoted the
impression that the whole aid program was in dispute. While
there was much in the critiques that rang true, there were also
many things that could be said to be right with the program,
positive accomplishments, some of which have been noted by the
critics themselves.
Security program achievements
A January 2001 report by the Russia Task Force co-chaired
by former Senate Majority Leader Howard Baker and former White
House counsel Lloyd Cutler found that ``current
nonproliferation programs in the Department of Energy, the
Department of Defense, and related agencies have achieved
impressive results thus far . . .''.\9\ Among these are
elimination of 336 SLBM launchers, 369 ICBM silos, 83 strategic
bombers, 422 ICBMs, and 19 SSBNs. Secure storage of fissile
materials has been enhanced by delivery of 32,000 containers
and by assistance in construction of a storage center. The
stockpile of nuclear weapons is more secure due to upgrades in
inventory and security systems. Interdiction capabilities have
been enhanced by providing border crossings with radiation
detection equipment and guards with training. The employment of
thousands of scientists may have helped prevent a brain drain
of sensitive expertise in weapons of mass destruction and to
some extent has re-directed it toward peaceful, commercial
enterprises.
---------------------------------------------------------------------------
\9\ A Report Card on the Department of Energy's Nonproliferation
Programs with Russia, January 10, 2000, Russia Task Force, Secretary of
Energy Advisory Board, page 1.
---------------------------------------------------------------------------
Humanitarian program achievements
The aid program has provided large quantities of food
assistance to Russia, 1 million metric tons in fiscal year 2000
alone. It has also provided transport costs to deliver more
than $628 million in privately donated food, medical and other
supplies, and contributed to international organization work in
the North Caucasus region. While some of the food deliveries
may not have been necessary, tens of thousands of displaced
persons, children, pensioners, and other needy individuals
received food and pensioners received financial aid from the
proceeds of food sales they may otherwise not have received.
Stability program achievements
While no one will argue that Russia has become a full
fledged western democracy and free market economy, it has
changed radically since the end of the Communist era (and
continues to evolve in directions we can only surmise). Tens of
thousands of private businesses now exist, political parties
and grassroots advocacy organizations proliferate, travel
abroad is unrestricted, an open exchange of information,
including the Internet and a free press exist. Stability
programs did not create this situation, but they nurtured it,
and, to some facets of the new order, the contribution was
arguably significant. Stability programs sought to affect many
discrete aspects of Russian life, but perhaps their greatest
cumulative impact in the long-term may have been the
introduction, dissemination, and practice of new ideas.
Exposure to new ideas.--A large number of assistance
projects sought to change Russia by exposing its government and
citizens to new ideas.
Policy reform.--U.S. technical experts have provided
advice to national and local governments on legal and
administrative reforms in a wide range of sectors.
While many reforms have yet to be implemented, these
efforts have introduced officials to procedures and law
in other countries and may influence future reform
developments. A program to assist fiscal reform, for
example, provided the Ministries of Finance and
Taxation, the Budget Committee of the State Duma, the
regional administrations of six Oblasts, and the
municipal administrations of Novgorod and Tver with
analytical models for forecasting the effects of tax
policy. The program also trained a team of Russian
specialists in these skills.\10\ Housing reform project
staff reportedly contributed views on 160 national laws
and decrees and directly drafted 37 legislative
acts.\11\
---------------------------------------------------------------------------
\10\ Work carried out for USAID by Georgia State University. Final
Report Evaluation of the Impact of Technical Assistance on Russia's
Fiscal Reform and the Identification of Possible Future Work, Carana
Corporation, March 21, 2000, p. 49. Advice on tax administration and
enforcement was also provided by Department of Treasury-appointed
advisers in the Ministry of Finance.
\11\ Work carried out for USAID by Urban Institute. Evaluation
Report: The Russian Housing Sector Reform Project Phases I and II,
Carana Corporation, November 1999, p. 4.
---------------------------------------------------------------------------
Mortgage finance.--Housing reform specialists
introduced the practice of residential mortgage lending
to Russia by drafting a legislative framework for this
activity, writing the industry's ``how-to'' handbook,
and offering technical assistance to banks. By 1998, 47
banks were making mortgage loans.\12\
---------------------------------------------------------------------------
\12\ Evaluation Report: The Russian Housing Sector, p. 28-33.
---------------------------------------------------------------------------
International accounting standards.--U.S. experts
promoted the use of international accounting standards
to Russian business in order to make it easier to
attract investors and qualify for loans and to promote
transparency. In 1999 alone, 3,670 were trained.\13\
---------------------------------------------------------------------------
\13\ Results Review and Resource Request: USAID/Russia, April 2000,
p. 14.
---------------------------------------------------------------------------
Direct exposure to the United States.--Since 1992,
more than 47,500 Russians were brought to the United
States for both targeted education and training and
broader familiarization with U.S. culture and
institutions. For example, the SABIT program provided
experience working in a U.S. business (131 in 2000),
the Cochran program experience in agriculture-related
concerns (50 in 2000), and the productivity enhancement
program management-training internships (425 in 2000).
The Russian leadership program brought promising
leaders for short visits, including home-stays, at the
grassroots level (1,605 in 2000).\14\
---------------------------------------------------------------------------
\14\ Implemented by the Department of Commerce, Department of
Agriculture, and Library of Congress, respectively. The vast majority
of exchange programs (serving more than 32,000 Russians since 1992) are
conducted by the Department of State's Bureau for Education and
Cultural Affairs; USAID has brought over 9,000 Russians to the United
States for project-related training.
---------------------------------------------------------------------------
Person-to-person exposure.--Several programs brought
American volunteers to Russia, emphasizing personal
contact with Americans as much as provision of ``know-
how'' at a grassroots level. During their 2 year term
of service, Peace Corps volunteers (100 in 2000) taught
English and business skills. The Farmer-to-Farmer (150
in 2000), Financial Service Volunteer Corps,
International Executive Service Corps, and others
provided the technical skills of practicing and retired
farmers and businessmen to their counterparts in Russia
on a one-to-one, short-term basis.
Advice and training for business.--Emerging
businesses and their employees received both general
and specialized training in business skills as well as
targeted, individualized advice. Many of the volunteer
programs noted above were aimed at providing experts to
individual business clients to help solve specific
problems, such as how to improve production or
marketing. Nearly 1 million Russian school children
were introduced to concepts of capitalist economics
through Junior Achievement programs.
Creating vehicles for dissemination of ideas.--Many aid
projects sought to increase the capabilities of organizations
that traditionally act as agents of change and disseminators of
new ideas.
Internet networking.--In the first years of the
assistance program, aid was provided to the Initiative
for Social Action and Renewal in Eurasia (ISAR), an
organization which facilitated the sharing of ideas and
strengthened the solidarity of environmental NGOs in
part by establishing an e-mail network system linking
them. Support for Internet access and training at more
than 50 sites throughout Russia has been provided to
alumni of U.S.-sponsored exchanges in order to build
contacts among them and reinforce positive experiences
gained while in the United States.\15\
---------------------------------------------------------------------------
\15\ The Internet Access and Training Program is carried out by
Project Harmony for the Department of State.
---------------------------------------------------------------------------
Think tanks.--To continue the policy reform work
provided by U.S. experts, USAID supported the creation
and strengthening of indigenous Russian think tanks
whose expertise--often former Russian associates of
U.S. technical experts--could be drawn upon by national
and regional governments. For example, the Institute
for Economies in Transition, run by Yegor Gaidar,
received grants for tax, budget, land code, and other
policy studies and providing advice to the government.
The Moscow School of Political Studies trained young
leaders in democratic principles.
Developing civic organizations.--The United States
has aided the development of institutions, such as
NGOs, political parties, and trade unions, that
advocate new ideas and are essential to a healthy civic
society. U.S. assistance helped 5,000 NGOs in 1999
through 48 Russian NGO resource centers.\16\
---------------------------------------------------------------------------
\16\ Work carried out for USAID by International Research and
Exchange Board (IREX), ISAR, and others. USAID Results Review, p. 28.
---------------------------------------------------------------------------
Independent media.--U.S. aid has provided training
and technical assistance to television and print media.
During the 1998 economic crisis, grants were provided
to help independent television stations survive despite
a drop in advertising revenue.\17\
---------------------------------------------------------------------------
\17\ Work carried out for USAID by Internews and others.
---------------------------------------------------------------------------
Developing business support organizations.--
Assistance programs provided support to 33 business
service centers to provide consulting and other
services to small and medium business, and fostered
development of business educational training through
support to 59 business schools.\18\
---------------------------------------------------------------------------
\18\ Service centers work implemented for USAID by Citizens
Democracy Corps, Agricultural Cooperative Development International and
Volunteers in Overseas Cooperative Assistance (ACDI/VOCA), and others;
Morozov schools by the Russian Academy for Management and Market.
Putting ideas into practice.--Through grants, lending
programs and other means, U.S. assistance has helped individual
businesses and civic organizations apply the new
entrepreneurial and democratic concepts often learned through
---------------------------------------------------------------------------
training and technical assistance.
Loans and guarantees.--The United States provided
funds to Russian institutions for on-lending to micro-,
small-, and medium-sized businesses. USAID programs
alone disbursed more than 7,100 micro-loans between
1995 and 1999. U.S. guarantees on bank loans promoted
introduction of consumer finance activities in Russia.
A U.S. assistance program provided guarantees on loans
to enable Russian banks to make their first residential
mortgage and auto loans.\19\
---------------------------------------------------------------------------
\19\ Work carried out by the U.S.-Russia Investment Fund. The U.S.-
Russia Investment Fund also made more than $30 million in equity
investments in more than 30 promising Russian small and medium
businesses. The results, however, are not demonstrably positive at this
time.
---------------------------------------------------------------------------
Grants.--Several programs provided competitive
grants to NGOs to enable them to conduct programs
contributing to reform at the grassroots level. Since
1993, a U.S. funded foundation has provided more than
2,000 grants worth over $50 million to NGOs, local
governments, independent media, and private businesses
seeking demonstrable positive results in the fields of
enterprise development, public administration, and
civil society. Another program awarded funds (87 grants
in 1999, most in the $30,000 range) to replicate
successful environmental practices.\20\
---------------------------------------------------------------------------
\20\ Work implemented for USAID by the Eurasia Foundation and the
Institute for Sustainable Communities, respectively.
---------------------------------------------------------------------------
The Russia Program Today
The U.S. assistance program of today is substantially
different from that of its initial several years. Lessons
learned as a result of failure and achievement, of criticisms
and congressional review during the first years set in motion
an evolving re-evaluation of programs and redistribution of
resources. In many cases, programs were revised internally even
before outside criticisms were made.
By fiscal year 2000, the most recent year for which data is
available, the program's broad profile had shifted dramatically
(see Figure 3). First, program priorities appeared to have
changed. Whereas a 10 year profile showed a near balance
between spending on security, stability and humanitarian
concerns, by fiscal year 2000, there was an overwhelming
emphasis on the security objective, while the stability effort
declined significantly. This relationship is real as well as
proportionate. Security funding increased in absolute terms
over the period and even began to be drawn from the chief pool
of resources available for stability funding, the NIS account
appropriations. Meanwhile, stability funding, as suggested by
NIS account levels, was cut (see Table 1). Cuts came partly due
to the perception that the program was slow in meeting its
economic and political reform objectives. They also reflect
broad cuts in foreign aid following the accession of a budget-
trimming Republican Congress (that have been reversed since
1999). Moreover, cuts were made specifically for Russia
programs in response to concerns regarding Russian Government
behavior abroad and at home.
FIGURE 3._OBJECTIVES OF U.S. ASSISTANCE TO RUSSIA
[Fiscal year 2000]
[GRAPHIC] [TIFF OMITTED] T6171.040
TABLE 1.--U.S. ASSISTANCE TO RUSSIA FROM NIS ACCOUNT
[Dollars in millions]
------------------------------------------------------------------------
Allocation
Fiscal year Administration after
request appropriation
------------------------------------------------------------------------
1992-1993................................ (\1\) $350.0
1994..................................... (\1\) 1,300.0
1995..................................... $379.4 344.2
1996..................................... 260.0 137.0
1997..................................... 173.0 94.8
1998..................................... 241.5 133.2
1999..................................... 225.4 161.2
2000..................................... 295.0 186.6
2001..................................... 161.9 167.8
2002..................................... 167.0 --
------------------------------------------------------------------------
\1\ Prior to fiscal year 1995, the administration did not break down its
NIS account request by country.
Bearing the brunt of budget cuts and criticisms, the
composition of the stability program changed far more sharply
during the decade than did the humanitarian or security
programs.\21\ Perhaps the most striking feature has been a
shift in emphasis from economic reform to democratic reform.
For the whole period, economic reform received 54 percent of
stability funds; but in fiscal year 2000, it received only 31
percent (see figure 4). Democratic reform efforts, on the other
hand, were supported with 24 percent of overall funds, but in
fiscal year 2000 received 47 percent. To be sure, the emphasis
seems to be on exchanges rather than institution-building, but
even the narrowly defined democracy programs now represent 13
percent of stability efforts versus 8 percent during the whole
period. The greater priority now given broad democracy
activities reflects the lack of progress in economic reform
until recently, past criticism that not enough attention was
being paid to democracy-building and person-to-person contacts,
and cuts in assistance to the central government of Russia
which was the recipient of much economic reform aid. The cuts
were the result of congressionally imposed conditions that
subjected half of aid to the central government in fiscal year
1998 and later years to the requirement of a presidential
determination that Russia had terminated sales or transfer of
nuclear reactor technology to Iran.
---------------------------------------------------------------------------
\21\ Within the security program, percentages devoted to weapons
dismantlement, material control, and demilitarization changed little
during the period.
---------------------------------------------------------------------------
FIGURE 4._U.S. ASSISTANCE FOR RUSSIAN STABILITY, 2000
[GRAPHIC] [TIFF OMITTED] T6171.039
By 2000, the make-up of the stability program had changed
in a number of other important ways. Extrapolating from the
experience of USAID, which accounted for roughly half of
stability program activity, very little assistance was still
being directed toward helping the central government of Russia.
Although the central government was the key target of the large
number of policy reform efforts undertaken in the 1993-1995
period--in fiscal year 1996, the first year for which data is
available, accounting for 17 percent of USAID's program--by
2000, central government-related projects accounted for only 7
percent. The proportion is likely smaller today. Support for
private sector activities rose correspondingly, from 68 percent
of the fiscal year 1996 program to more than 82 percent in
fiscal year 1999.
There is also some evidence that, compared with its early
years, the assistance program now has more activities in the
regions than in Moscow and Petersburg (80 percent in the
regions in fiscal year 2000), more funds directed toward NGOs
(75 percent in fiscal year 2000), and more Russian nationals
involved as both implementors and staff. Many of these changes
were featured in the Clinton Administration's Partnership for
Freedom initiative, which was introduced in 1997 largely in
response to the criticisms noted above and in an effort to
recover congressional support. A Regional Investment Initiative
was introduced at the same time, concentrating aid on three
(now four) regional sites in a bid to attract foreign
investment and increase program effectiveness. The two
initiatives promised to alter the presiding aid strategy toward
Russia, and, in this, appear to have succeeded.
Prospects for the Future
Ten years after the assistance program was launched, the
time may be ripe for an assessment (and, in the case of
stability assistance, a reassessment) of the strategies
designed to make each aid objective achievable. A review of the
broader issue of what should be the objectives of the U.S. aid
program in Russia may also be in order.
While the stability program may now have met the main
criticisms of the early to mid-1990s--and scrutiny of
individual projects under this program must continue in order
to enhance its effectiveness--it is not clear whether the
program adequately meets present or future needs. This question
is put into sharper focus in 2001, as the Russian Government at
last appears serious in its support for economic reform
legislation. Some argue that constraints on U.S. support for
economic policy reform--restrictions on aid to the central
government and limited availability of funds--may mean a lost
opportunity for a critical U.S. contribution on this issue. In
view of recent threats to freedom of expression in Russia, the
U.S. program's growing attention to democratic reform would
appear to merit continued, if not strengthened, U.S. support,
but constraints on funding levels and program flexibility may
limit U.S. efforts here as well.
Questions have also been raised regarding the availability
of funding for security programs. The Bush Administration
submitted an fiscal year 2002 request for Energy Department
non-proliferation activities--control and protection of nuclear
materials and demilitarization programs that fund alternative
employment for scientists--that represented a 12 percent
decrease from fiscal year 2001 allocations.\22\ With some
observers arguing for significant increases in non-
proliferation assistance to Russia--the Baker-Cutler report
called for spending $30 billion over the next 8 to 10 years,
and the September 11 attacks generated heightened nuclear
proliferation concerns--Congress restored some, but not all, of
the funding, leaving an 8 percent cut. Efforts by one member to
redirect $130 million to non-proliferation programs did not
meet with success, but indicated that there is likely to be
further discussion in the coming year on how security programs
have met and will continue to meet critical U.S. interests.
---------------------------------------------------------------------------
\22\ An Administration review of non-proliferation programs in 2001
proposed no significant change to Department of Defense CTR programs.
---------------------------------------------------------------------------
In fact, there is dispute over whether relative proportions
of funding going to stability, security, and humanitarian
objectives appropriately represent current and future U.S.
interests. Until now, policymakers have dealt with stability
and security objectives mostly through different funding
spigots and rarely considered the U.S. effort in Russia as a
whole piece. But some analysts would argue that there can be no
sure security for the United States regarding Russia's weapons
of mass destruction unless that country is a more democratic
and economically stable society. All three objectives,
according to this view, are intimately intertwined.
The United States continues to hold a very strong interest
in Russia and the outcome of events there. Whatever the
accomplishments of the past 10 years, U.S. assistance may
continue to play a role in those events. Whether that role
should be expanded--and, if so, how--is likely to challenge
policymakers in the future.
ARMS EXPORTS AND RUSSIA'S DEFENSE INDUSTRIES: ISSUES FOR THE U.S.
CONGRESS
By Kevin P. O'Prey \1\
----------
contents
Page
Summary.......................................................... 385
The State of Russian Arms Exports................................ 387
Making money................................................. 389
Russia's markets............................................. 390
The China market......................................... 391
Cooperation with India................................... 392
The Iran relationship.................................... 393
Understanding Russia's Success................................... 394
The Russian appeal........................................... 394
Constraints on further Russian success....................... 395
The Rationale for Russian Exports................................ 397
Excess capacity.............................................. 398
State policy................................................. 401
Graft........................................................ 404
Impact on the Russian Defense Sector............................. 404
Issues for Congress.............................................. 408
The virtual certainty of continued aggressive promotion of
arms exports by Russia..................................... 408
The limited effects that export success will have on Russian
defense industrial advancement............................. 409
The negative impact that these exports will have in terms of
greater proliferation of high technology weapons systems to
potential U.S. competitors................................. 409
Summary
In recent years, Russia has experienced a significant
improvement in its arms export performance. During the year
2000, Russia signed deals making it the world's second leading
supplier of armaments. Moreover, in contrast to Soviet
experience, the Russian Government and defense enterprises
actually are making money off of these commercial deals.
---------------------------------------------------------------------------
\1\ Dr. Kevin P. O'Prey is Executive Vice President of DFI
International's Government Practice, a Washington, DC-based research
and analysis firm. The analysis presented here is based on work he has
conducted at DFI International, at the Brookings Institution, and for
his doctoral dissertation for the Massachusetts Institute of
Technology. The author would like to thank Ms. Agnes Lee, Mr. Erik
Teleen, and Mr. Graig Saloom for their research assistance and Dr.
Eugene Rumer for providing comments on a previous draft.
---------------------------------------------------------------------------
The implications for U.S. national security and the
Congress are several. First, regardless of the state of U.S.-
Russia relations, the United States will have little leverage
to overcome Moscow's very significant incentives to export as
many weapons as possible to whoever will pay for them. Second,
export success will do little to improve the current poor state
of Russia's military and defense industries. While export
revenues have certainly improved the financial health of some
Russian defense enterprises, overall they are not likely to
help Russia to develop and produce new, technologically
competitive weapon systems. Third and perhaps most important
for the United States, Russia's aggressive approach to arms
exporting will almost certainly contribute to the proliferation
of high technology weapon systems to countries that are
potential U.S. competitors--China and Iran being the most
significant cases in point.
What is the current state of Russian conventional arms
sales abroad and what are Russia's near-term prospects? What
does the answer mean for Russia's defense industrial sector,
for the proliferation of high technology weapons, and, by
extension, for U.S. national security? In recent years,
Russia's state organs and defense enterprises have improved
Russia's performance as an arms exporter. This paper examines
Russia's recent success, the factors that explain it, as well
as their broader implications for Russia and the West.
While Russia's arms sales successes have had a positive
impact on the financial health its defense sector, their
effects have been decidedly limited in scope. Only about seven
to ten of Russia's approximately 1,600 defense enterprises
appear to have benefited significantly from arms sales.
Moreover, even for these fortunate few, arms export achievement
has not translated into success in overcoming the many
structural challenges to the development of profitable firms in
the Russian defense sector. At most, arms export success
appears to have helped a few design bureaus undertake modest
research and development (R&D) initiatives and a few production
facilities to maintain a manufacture that, by historical Soviet
standards, is modest. Translating this R&D and low
manufacturing rate into the production of new, technologically
competitive weapon systems, however, seems exceedingly
difficult.
Overall, the infrastructure of the Russian defense sector
appears to be remarkably immutable. Despite a decade of
economic privation and repeated attempts to reform or downsize
the defense industries, few, if any, defense enterprises have
formally gone bankrupt. Rather than shut their doors, many
plants continue to operate at minimal production levels. While
managerial changes have occurred in many plants, organizational
restructuring has been very limited.
Against this backdrop, there is a broad consensus among
Russian decisionmakers--in government and industry--on the need
to export arms. From the government's perspective, the value of
arms export ranges from diverting the attention abroad of
potential subsidy-seeking enterprises; sustaining key
components of a defense industrial base it can no longer
afford; reducing the per unit costs of defense production; as
well as obtaining hard currency revenues for state and, in some
cases, personal coffers. For industry, exports represent the
potential to restart or maintain modest production levels; to
pay worker salaries; to invest in some new projects; and to
profit on a personal level.
The implications for the U.S. Congress are several. First,
the motivations for continued aggressive Russian efforts in the
global arms export arena are profound and, probably, enduring.
The United States possesses few instruments to discourage
Russian efforts in this arena. Moreover, post-9/11 improvements
in U.S.-Russian security relations are not likely to change
Moscow's export behavior. Second, Russia's increased arms
export success seems unlikely to have much of an impact on
Russia's defense industrial capabilities. While export revenues
improve the financial position of some enterprises, export
success appears fundamentally only to delay inevitable
restructuring. Third, Russia's export efforts will increase the
proliferation of advanced conventional systems to countries
that might pose a threat to U.S. forces--China and Iran being
the most important examples.
The State of Russian Arms Exports
Like the Russian economy more broadly, the Russian defense
industries have turned a corner in the last 2 years. After
hitting bottom in terms of economic performance, some Russian
defense enterprises appear to be showing signs of modest levels
of activities. While a spike in procurement orders due to the
war in Chechnya provided an initial boost, the real basis for
this improved state of affairs has been arms export success.
During calendar year 2000, Russia succeeded in signing arms
sales agreements worth approximately $7.7 billion. As Figure 1
demonstrates, this represents an improvement over 1999 results
by nearly 90 percent and a remarkable 270 percent increase over
the 1998 figure. According to unofficial estimates, Russia's
performance for calendar year 2001 would be comparable.\2\
After a decade of efforts by the government and defense
industries, Russian export promotion is finally paying off.
---------------------------------------------------------------------------
\2\ Richard F. Grimmett, Conventional Arms Transfers to Developing
Nations, 1993-2000, (Washington, DC: Congressional Research Service,
August 16, 2001), Figure 1, p. CRS-21.
By November 2001, Rosoboroneksport was predicting export revenues
on the order of $4 billion for 2001. If historical trends hold, that
would put the overall revenue Figure for Russian arms exports at
approximately $5 billion. See ``In Brief: Arms Sales Near $4 Bln,''
Moscow Times, November 16, 2001, p. 6.
---------------------------------------------------------------------------
Part of Russia's export success can be attributed to a
global increase in the level of the arms trade. After bottoming
out at $24.3 billion in 1997, the level of worldwide arms
transfer agreements increased steadily to $36.9 billion in
2000.\3\
---------------------------------------------------------------------------
\3\ These figures are in constant calendar year 2000 dollars. The
data are from Richard F. Grimmett, Conventional Arms Transfers to
Developing Nations, 1993-2000, Table 8A, CRS-72.
---------------------------------------------------------------------------
Yet Russia's 2000 success also reflects a trend of
increasing market share relative to its non-U.S. competitors in
the global arms trade. Although the United States continues to
hold the dominant position in the market--50 percent of year
2000 arms transfer agreements--Russia has laid claim to a
strong second place with nearly 21 percent of the 2000 value
(See Figure 2). Figure 2 also demonstrates that, with the
exception of 1998, when it signed agreements worth only $2.6
billion, Russia has occupied either second or third place among
global arms exporters since 1995.
The lion's share of Russia's recent success can be
attributed to Asia. As Figure 3 depicts, during the 1997-2000
period, the Asian market accounted for over three-fourths of
Russia's export agreements with the developing world. The
lucrative Middle East market, meanwhile, accounted for a 16
percent share of Russia's agreements. Africa accounted for just
over 6 percent.
FIGURE 1._RUSSIAN ARMS TRANSFER AGREEMENTS WITH THE WORLD, 1993-2000
[GRAPHIC] [TIFF OMITTED] T6171.029
Source: Richard F. Grimmett, Conventional Arms Transfers to
Developing Nations, 1993-2000, 2001.
FIGURE 2._ARMS TRANSFER AGREEMENTS WITH THE WORLD, BY SUPPLIER, 1996-
2000
[GRAPHIC] [TIFF OMITTED] T6171.030
Source: Richard F. Grimmett, Conventional Arms Transfers to
Developing Nations, 1993-2000, 2001.
Even within the Asian market, Russia's success is highly
concentrated to two customers: China and India. Recent Chinese
acquisitions include over 20 Su-30MKK and 8 Su-27UBK fighter
aircraft; a Kilo-class submarine; 13 Tor M1 surface to air
missiles; and 2 Sovremenny class destroyers. Some reports
project China as potentially accounting for between 30 and 50
percent of Russia's arms exports over the next decade. In terms
of India, over the 2000-2001 period, New Delhi signed deals for
the purchase or licensed co-production of over 130 Su-30MKI
fighter aircraft; 310 T-90 tanks; and a Kilo submarine.\4\
---------------------------------------------------------------------------
\4\ Interfax interview with Konstantin Makienko, ``Military-
Technical Cooperation between Russia and China, 17 July 2001, reprinted
on www.cast.ru/english/database1.html?article=102.
---------------------------------------------------------------------------
FIGURE 3._RUSSIAN REGIONAL ARMS TRANSFER AGREEMENTS, 1997-2000
[GRAPHIC] [TIFF OMITTED] T6171.031
Source: Richard F. Grimmett, Conventional Arms Transfers to
Developing Nations, 1993-2000, 2001.
making money
Perhaps more important than the overall value of
agreements, in contrast to the Soviet era and the experience of
the early 1990s, Russia appears to be earning hard currency
from its recent arms sale successes. During the 1980s, arms
export ``success'' on the order of $20 billion a year was
tempered by the fact that the U.S.S.R. typically received hard
currency payment for only one-third of its arms exports.\5\ The
situation did not improve markedly in the early 1990s, as
Rosvooruzheniye, the Russian arms export agency, reportedly
negotiated deals that often involved payments in kind, debt
swaps, or ``soft'' currency, such as Indian rupees. For
example, in a deal that sent MiG-29s to Malaysia, Moscow agreed
to accept one-fourth of the payment in the form of palm oil. In
another case, the director of the Krasnoye Sormovo shipyard
complained that half of China's payment for two diesel
submarines was made up of jogging shoes and women's sandals,
all of which reportedly disintegrated within a month of
delivery.\6\
---------------------------------------------------------------------------
\5\ See Kevin P. O'Prey, The Arms Export Challenge: Cooperative
Approaches to Export Management and Conversion, (Washington, DC:
Brookings Institution, 1995), p. 75 and Pavel Fel'gengauer, ``Rezkoye
sokrashcheniye eksporta otechestvennogo: oruzhiya vpervyye obyavleny
ofitsial'nyye tsifry voyenno tekhnicheskogo sotrudnichestva za 1991
god,'' (Sharp Reduction in Exports of Our Weapons: The First Releases
of Official Figures of Military-Technical Cooperation for 1991),
Nezavisimaya Gazeta, September 29, 1992, pp. 1-2.
\6\ See Sergey Mashtakov, ``MiG i v Malayzii. Kto eshche kupit
nashi istrebiteli?'' (MiG also in Malaysia. Who Else Will Buy Our
Fighters?'' Rossiyskaya Gazeta, September 7, 1994, p. 3; Pavel
Fel'gengauer, ``Torgovlya oruzhiyem ne tak vygodnaya Rossiy, kak
utverzhdayet Rosvooruzheniye,'' [The Arms Trade Is Not As Beneficial to
Russia as Rosvooruzheniye Asserts] Segodnya, March 10, 1995, p. 2; and
Unidentified Correspondent, ``Shibayev, Deputy Chairman of the
Committee for Foreign Economic Relations: If Everyone Were Allowed to
Sell Arms, the Unjustified Competition Would Lead to a Fall in
Prices,'' Komsomolskaya Pravda, February 25, 1992, p. 1, translated in
Foreign Broadcast Information Service (FBIS) SOV 92-039, pp. 31-32.
---------------------------------------------------------------------------
As Figure 4 demonstrates, the situation turned for the
better in 1997 and has been improving ever since. According to
Rosoboroneksport, its predecessor as the official Russian arms
export agency took in hard currency for approximately 90
percent of its sales in 1999 and 2000.\7\
---------------------------------------------------------------------------
\7\ There are no data available for hard currency returns of
enterprises operating independently of Rosvooruzheniye/
Rosoboroneksport.
FIGURE 4._ROSVOORUZHENIYE'S ARMS EXPORTS AND CURRENCY RETURNS, 1995-
---------------------------------------------------------------------------
2000
[GRAPHIC] [TIFF OMITTED] T6171.033
Source: Novichkov, Nikolai. ``Russia Exports $3.6B of Arms in
2000, Sees Strong Growth.'' Jane's Defence Weekly, 2001.
russia's markets
Although some of Russia's client relationships appear only
to be curiosities of the international arms market--e.g.,
purchases by North Atlantic Treaty Organization (NATO) member
Greece and by the United Arab Emirates, which can afford to
maintain relationships with multiple suppliers--the broader
picture is more worrisome. From the U.S. perspective, most
importantly, the principal markets for Russian conventional
arms sales are some of those countries that have been the most
vocal opponents of America's leadership role around the globe.
Although commercial sales do not suggest an anti-U.S. alliance,
in some cases, they could pose threats either through
technology transfer or the direct enhancement of military
capabilities that might be used against the United States or
our allies. The remainder of this section addresses Russia's
most noteworthy partners.
The China market
Beijing clearly ranks as Russia's most important client for
armaments. Although Russia and the People's Republic of China
have had an on-again, off-again relationship in terms of
military-technical cooperation throughout China's Communist
period, ties between the two strengthened considerably during
the 1990s. During this period, Russia's defense complex has
come to look on the China market as essential for its survival.
In a series of 1999 interviews with a range of officials from
the Russian Government and defense industries, virtually all
respondents strongly defended arms sales to China as critical
sources of revenue for Russian enterprises and design
establishments. As one interviewee put it, Russian defense
industrialists may find cooperation with China to be
``degrading'' as they would prefer to work with Western high-
tech partners. However, financially speaking, they find that
they have few options.\8\
---------------------------------------------------------------------------
\8\ Kevin O'Prey, ``Analytical Report of Trip Findings,''
Unpublished Report for DFI International, December 21, 1999, p. B-3.
---------------------------------------------------------------------------
Apparently, only the Russian General Staff had expressed
any objections to military technical cooperation with China.
Reportedly, some General Staff officials argue that in 10 to 15
years, the Chinese military threat could return based on a
foundation of transferred Russian technology. Yet these
arguments do not carry the day as Kremlin decisionmaking is
more focused on near-term financial and domestic political
considerations.\9\
---------------------------------------------------------------------------
\9\ Kevin O'Prey, DFI Trip Report, p. B-3.
---------------------------------------------------------------------------
The full extent of Russian-Chinese cooperation is difficult
to determine through open sources. According to one observer,
one of the conditions that Beijing demands for its cooperation
with Russia is absolute secrecy regarding its agreements.
Reportedly, the Chinese Government explicitly threatens to
terminate any deals that are leaked to the public. The Russian
Government and enterprise managers evidently view the
relationship as important or valuable enough to comply with
these conditions. As a consequence, despite a general tendency
to advertise arms sales success and to discuss defense industry
issues in public, virtually no commentators--official or
unofficial--will touch this subject in any but the most general
terms, either publicly or privately.\10\
---------------------------------------------------------------------------
\10\ Kevin O'Prey, DFI Trip Report, p. B-2.
---------------------------------------------------------------------------
The only restraint on the China relationship currently
appears to be the product of Moscow's concern about Chinese
reverse engineering of Russian technologies. Historically,
China has sought to use arms imports as a means of technology--
rather than hardware--acquisition. In an often-cited example,
Chinese industry evidently reverse engineered MiG-21s purchased
from the Soviet Union as the basis for its J7 fighter aircraft
development. As a consequence, the Russian Government evidently
bars transfer of its highest technology items to Beijing. In
fact, according to one source, Russia permits India greater
access to high technology than it does to China, a fact that
has proved to be a continuing sore spot for Beijing.\11\
---------------------------------------------------------------------------
\11\ For example, according to one observer, cooperation over the
Su-27 program has been constrained by Russian refusal to share advanced
hot zone technology for the Lyulka engine. See Kevin O'Prey, DFI Trip
Report, p. B-4.
---------------------------------------------------------------------------
Last, although technology acquisition is still a priority
for Beijing, recent agreements suggest that the trend for the
Chinese Government currently is in the direction of purchase of
foreign systems, rather than the development of indigenous
capabilities. This development might be due to Beijing's
perceived need to build up its military forces rapidly to match
its foreign policy priorities, or its recognition that its
experience with reverse engineering has not been particularly
effective, or some combination of the two factors. Since the
mid-1990s, Chinese deals with Russia have included:
The purchase of more than 72 Sukhoy 27 fighter
aircraft;
The purchase of 4 Kilo class attack submarines;
Co-production of 200 Su-27 aircraft;
2 Sovremenny-class destroyers and their associated
missile systems;
The purchase of 40 to 60 Su-30MKK fighter aircraft;
and
An agreement to purchase at least 4 upgraded A-50E
Mainstay airborne early warning aircraft.\12\
---------------------------------------------------------------------------
\12\ Richard F. Grimmett, Conventional Arms Transfers to Developing
Nations, 1993-2000, p. CRS-8.
Of particular concern to U.S. national security, many of
these capabilities reportedly are being acquired to improve
Chinese forces for a Taiwan Straits scenario.\13\
---------------------------------------------------------------------------
\13\ See e.g., Interfax interview with Konstantin Makienko,
``Military-Technical Cooperation between Russia and China,'' 17 July
2001, reprinted on www.cast.ru/english/database1. html?article=102.
---------------------------------------------------------------------------
Cooperation with India
Long a client of the Soviet Union, New Delhi has continued
a robust relationship with the Russian defense industries. In
late 2000, Russia concluded a licensed production agreement
with India valued in excess of $3 billion for 140 Su-30MKI
combat aircraft. It also concluded an agreement for the sale to
India of 310 T-90C main battle tanks for about $700 million,
and an agreement to retrofit and deliver the Admiral Gorshkov
aircraft carrier for over $650 million.\14\
---------------------------------------------------------------------------
\14\ Richard F. Grimmett, Conventional Arms Transfers to Developing
Nations, 1993-2000, (Washington, DC: Congressional Research Service,
August 16, 2001), p. 8.
---------------------------------------------------------------------------
In contrast to recent developments with China, New Delhi
appears to view its relationship with Russia as a source not
just for armaments, but also for technology to support India's
growing defense sector. For example, India has a long history
of co-production agreements with Soviet and then Russian
defense industries. The trend continues as New Delhi's recent
purchase of 124 T-90 tanks was exceeded in quantity by the 186
additional T-90s for which India purchased production
licenses.\15\
---------------------------------------------------------------------------
\15\ See Lyuba Pronina, ``Fired Up About Arms,'' The Moscow Times,
September 24, 2001.
---------------------------------------------------------------------------
Despite the recent improvements in U.S.-India ties, New
Delhi's military-technical cooperation with Moscow appears to
be both robust and likely to persist. For one, as noted below,
with a force compromised primarily of Soviet and Russian
weaponry, it would be extremely expensive for New Delhi to
further diversify into NATO-standard equipment.\16\ Second,
Russian weapons are affordable, and Moscow has demonstrated a
willingness to supply India with its most advanced technology.
---------------------------------------------------------------------------
\16\ On the Indian arsenal, see The Military Balance, 1999-2000,
(London: The International Institute for Strategic Studies), pp. 161-
163 and Rahul Bedi, ``India's T-90 Tank Deal with Russia Runs Into
Difficulty,'' The Asian Age, December 1, 2000, pp. 1-2.
---------------------------------------------------------------------------
The Iran relationship
In the past year, Moscow has renewed its cooperation with
Tehran in the conventional military arena. Immediately after
the fall of the Soviet Union, Iran was a major purchaser of
Russian weapons. Among the Russian items acquired by Iran were
MiG-29 fighter aircraft, Su-24 fighter-bombers, T-72
submarines, and Kilo-class attack submarines.\17\ Under
pressure from the United States, Russia largely suspended
conventional cooperation with Iran throughout the 1990s.\18\
However, as a result of the decline in U.S.-Russia relations,
increased economic pressure at home, or both, in 2000 Moscow
notified the United States that it would resume its arms
cooperation with Tehran. True to its word, Russia signed
agreements in December 2000 to provide Tehran with air defense
systems (the S-300 and Tor-M1) and Kamov-50 helicopters.\19\
According to one Russian source, Tehran acquired the advanced
air defense systems to defend the Bushehr reactor complex.\20\
---------------------------------------------------------------------------
\17\ Richard F. Grimmett, Conventional Arms Transfers to Developing
Nations, 1993-2000, p. CRS-8.
\18\ Illicit transfer of ballistic missile technology and broader
nuclear cooperation were notable exceptions to the rule.
\19\ David A. Fulghum, ``Iran Specifies New Weapons Mix,'' Aviation
Week and Space Technology, March 26, 2001, p. 32.
\20\ David A Fulghum, ``Iran Specifies New Weapons Mix,'' p. 32.
---------------------------------------------------------------------------
Subsequently, during a March 2001 visit to Moscow, Iranian
President Mohammad Khatami presented a more robust wish list to
Russian officials. Among the items Khatami sought were:
Tanks;
Patrol boats;
The Shkval and other torpedoes;
Upgrades to its MiG and Sukhoy fighters;
Yakhont anti-ship missiles.\21\
---------------------------------------------------------------------------
\21\ Chris Stephen, ``U.S. Anger as Putin Seals Arms Deal with
`Rogue' Iran,'' The Scotsman, March 13, 2001, p. 13.
In a much heralded October 2001 visit, Iranian Defense
Minister Ali Shamkhami signed a military-technical cooperation
agreement worth up to $300 million annually. Although the
agreement constitutes only a framework, press reports described
Shamkhami as negotiating to purchase Inconder long range
supersonic missiles, Yakhont anti-ship missiles, surface-to-air
missiles, and stealthy patrol boats.\22\ Earlier in the summer,
Iran had signed contracts with Rosoboroneksport for 30 Mi-8
cargo helicopters.\23\
---------------------------------------------------------------------------
\22\ See Nikolai Novichkov and Vladimir Shvaryov, Vremya MN,
October 3, 2001; and Agence France Presse, October 4, 2001, via Lexis
Nexis.
\23\ The total value of that deal was reportedly $150 million. See
Vedomosti, November 1, 2001, reprinted in The Russian Business Monitor,
November 2, 2001.
---------------------------------------------------------------------------
Tehran's wishes aside, there are a number of reasons to
expect some limits on m Moscow's future dealings with the
Iranians. Most significantly, Tehran's wishes certainly exceed
its current means. Regardless of the common cause that Moscow
and Tehran have found in fighting Islamic extremists in Central
Asia, Iran is a financially strapped state. Moreover, Russia
has commercial interests mitigating against a strong
relationship with Tehran. In particular, Moscow recognizes the
transfer of advanced capabilities to Iran will potentially
alienate the Gulf states, who, both individually and
collectively, represent substantially more market potential
than Iran.\24\
---------------------------------------------------------------------------
\24\ Marina Koroleva, interview with Ruslan Pukhov, Director of the
Centre of Analysis of Strategies and Technologies (CAST), and
Konstantin Makienko, Deputy Director of CAST, during Ekho Moskvy Radio
program, 1408 GMT, January 17, 2001, translated in FBIS, January 17,
2001, Document ID: CEP 20010117000369.
---------------------------------------------------------------------------
Understanding Russia's Success
Russia's recent success can be attributed to a broad range
of factors, ranging from the appeal of Russian weapons on the
global market, to the need for defense plants to find any
resource of revenues in the absence of state orders, to the
government's desire either to divert the attention of needy
defense enterprises or to find international funding for its
priority initiatives. Also, for some officials in industry and
government, arms exports are personally enriching. Despite
recent growth in the economy, it is impossible to overstate the
value of hard currency in Russia.
the russian appeal
On the demand side of the equation, Russian armaments are
very attractive commodities in some markets. One of the most
important factors behind this appeal is the affordability of
Russian weapons. Because Russia's defense enterprises are still
the beneficiaries of a range of implicit subsidies, Russian
weapons typically are the product of negative net value or
value subtraction in production: the inputs to the typical
weapon system are worth more on the world market than the final
product itself.\25\ These subsidies are generally not the
product of a defense promoting strategy on the part of the
Russian Government. Rather, they are a by-product of what
economists Clifford Gaddy and Barry Ickes termed the ``virtual
economy.'' \26\ In short, because Russian enterprises do not
pay market prices, key factors of production such as energy are
exchanged at prices well below international market rates.
Furthermore, because barter persists among enterprises, much of
the real value of economic transactions goes unrecorded. As a
consequence, soft-budget constraints persist and Russian
manufacturers can offer prices for weapons that are
considerably cheaper than the input costs.
---------------------------------------------------------------------------
\25\ Vitaliy Shlykov, ``The Potemkin Complex: A Government Program
Cannot Solve the VPK's Problems,'' Itogi, April 10, 2001, translated in
FBIS, April 9, 2001, Document ID: CEP 200110409000302.
\26\ Clifford Gaddy and Barry Ickes, ``Russia's Virtual Economy,''
Foreign Affairs, vol. 77, no. 5.
---------------------------------------------------------------------------
Second, despite the financial and technological struggles
of the Russian defense sector in recent years, some Russian
systems are actually quite competitive technologically on the
global market. For example, Russia has been willing to sell the
state of the art Yakhont, an anti-ship missile that uses
scramjet technology.\27\ In addition, Russia also produces
reliable space launch systems such as the Proton rocket at a
time when there is global shortage in space launch.\28\
Russia's competitiveness in this area is underscored by the
fact that U.S. defense giants such as Lockheed Martin have
entered into joint ventures. Furthermore, although their
electronics components are poor, Russia continues to produce
outstanding air defense missile systems, such as the S-300.\29\
---------------------------------------------------------------------------
\27\ John A. Battilega, David R. Beachley, Daniel C. Beck, Robert
L. Driver, and Bruce Jackson, Transformation in Global Defense Markets
and Industries: Implications for the Future, National Intelligence
Council Report, Russia chapter, p. 9 (Found on http://www.cia.gov/nic/
pubs/index.htm).
\28\ Kseniya Gonchar, Russia's Defence Industry at the Turn of the
Century, Bonn International Center for Conversion, Brief 17, p. 47
\29\ Mark Galeotti, ``Russia's Arms Bazaar,'' Jane's Intelligence
Review, April 1, 2001.
---------------------------------------------------------------------------
Third, Russian defense enterprises and state organs have
demonstrated little discretion in terms of end users.
Governments that find themselves internationally ostracized can
often find a willing seller in Moscow. Generally speaking,
unless a government is under United Nations (UN) sanction,
Russia will sell to it. For example, as noted above, Russia
proceeds with a robust arms sale relationship with China
despite Russian General Staff concerns that Beijing is a likely
future military competitor.\30\
---------------------------------------------------------------------------
\30\ Kevin O'Prey, DFI Trip Report.
---------------------------------------------------------------------------
Finally, the Russians have simply gotten better at sales.
Western participants in recent international arms expositions
observe that Russian presentations have become significantly
more professional. From the attire of the industry
representatives to the quality of their glossy brochures, there
is a marked improvement in the salesmanship of Russian
exporters. Part of the explanation can be traced to learning.
Another part can be attributed to the recently achieved
organizational stability of Russian arms export organizations,
which have been reorganized numerous times over the past
decade.
constraints on further russian success
Yet there are a number of reasons to expect that Russia
will only modestly improve upon its arms export success in the
coming years. Any growth will likely come from Moscow's
existing client base, rather than winning markets in head to
head competition with Western suppliers.
First, interoperability concerns on the part of buyers will
likely continue to hamper Russian arms export efforts. In fact,
the continued success of the United States, United Kingdom, and
France noted in Figure 2, underlines the global trend toward
NATO-standard armaments. Possessing an armaments inventory that
is all of one standard vastly reduces the complexity of
operations and reduces maintenance costs. Few countries can
afford and are willing to maintain an arms inventory that
possesses both NATO and Russian standard equipment.\31\ Even
Russia's former Warsaw Pact allies are shifting to NATO
standard equipment in order to position themselves better for
ultimately joining the NATO alliance.
---------------------------------------------------------------------------
\31\ The United Arab Emirates, which is both wealthy and is seeking
independence from a single arms supplier, is a notable exception.
---------------------------------------------------------------------------
Second, beyond the areas of rockets, airframes, and air
defense systems, Russian weapon systems are generally held in
low regard for their technological levels and overall
reliability. In particular, Russia, for all intents and
purposes, missed the electronics revolution that occurred
during the 1980s and 1990s in other industrialized countries.
Given the importance of electronics to the effectiveness of
most modern weapons systems, Russian arms exporters are
necessarily at a disadvantage. For example, although the Su-27
fighter reputedly has the highest performance air frame in the
world, it's poor electronics capabilities--in terms of avionics
and armaments systems--make it relatively uncompetitive when
compared to analogous systems in the West.\32\
---------------------------------------------------------------------------
\32\ For example, in early 1992, Deputy Minister of Defense, Andrey
Kokoshin, lamented that the Russian electronics sector--a linchpin for
any modern economy--lagged terribly behind world standards. In his
view, this lag had a dangerous multiplier effect, hampering Russia's
ability to compete in the world economy and, for that matter, to defend
itself. See Andrey Naryshkin, ``Andrey Kokoshin ob industrial'noy
politike,'' [Andrey Kokoshin on Industrial Policy], Krasnaya Zvezda,
August 25, 1992, p. 3.
For a western analysis, see Harley Balzer, ``Dismantling Russia's
Technotopia: Six Ministries in Search of an Industrial Policy,'' in
Judith B. Sedaitis, Commercializing High Technology: East and West,
Center for International Security and Arms Control, Stanford
University, January 1996, p. 48.
See also Aleksandr Anatolyevich Ivanov, first deputy chief of
communications of Russian Federation Armed Forces, and Lev Ivanovich
Titov, general director of Telecommunications Systems Development Fund,
Vooruzheniye, Politika, Konversiya, no. 1 (4), 1994, (signed to press
August 4, 1994), pp. 45-50, translated in JPRS-UMA 94-056, pp. 29-32.
---------------------------------------------------------------------------
Decades of Soviet economic inefficiency and backwardness
also took a toll on the capital stock of Russian defense
enterprises. Despite niches of high technology distributed
throughout the defense industries, by 1990 overall the sector
was characterized by technological obsolescence. For instance,
in the late 1980s the chief designer of the Temp aviation
design bureau complained that over a third of his equipment had
been produced before 1940.\33\ Nor did the situation improve in
the weak economy of the 1990s. The decline in investment
surpassed the fall in overall industrial output such that by
1999, the volume of capital investment stood at only 10 percent
of its 1990 level.\34\
---------------------------------------------------------------------------
\33\ I. Mosin and A. Pokrovsky, ``Conversion without Illusion,''
Pravda, June 7, 1990, p. 4, translated in FBIS-SOV 90-116, pp. 75-80.
On production obsolescence generally, see Directorate of
Intelligence, Central Intelligence Agency, The Soviet Weapons Industry:
An Overview, DI 86-10016, September 1986, pp. 29-30.
\34\ Kseniya Gonchar, Russia's Defence Industry at the Turn of the
Century, p. 18.
---------------------------------------------------------------------------
The regional concentration of Russia's export markets is
also a limitation. As noted above, Russia's success relies
heavily on markets in the developing world. Over the 1997-2000
period, among arms exporting countries only China (92.5 percent
of agreements) was more dependent than Russia (90.9 percent) on
developing world arms markets. The United States, United
Kingdom, Germany, and Italy, by contrast, relied on developing
markets for less than 60 percent of their agreements.\35\
Despite the recent expansion of this market, the developing
world by definition lacks substantial financial resources to
invest in arms. The weakness of the global economy is likely to
serve as a further brake on this market in the near term.
---------------------------------------------------------------------------
\35\ See Richard F. Grimmett, Conventional Arms Transfers to
Developing Nations, 1993-2000, Figure 1, p. CRS-21.
---------------------------------------------------------------------------
Furthermore, within the developing world market, Russia
does not have a strong position in the one consistent bright
spot: the petro-dollar infused Near East market. The Near East
accounted for 47 percent of the developing world market over
the 1997-2000 period. As is the case around the globe, the
United States dominates this market with a 61 percent market
share over the same period. Russia, meanwhile, possessed only a
7 percent share.\36\
---------------------------------------------------------------------------
\36\ See Richard F. Grimmett, Conventional Arms Transfers to
Developing Nations, 1993-2000, Table 1E, p. CRS-44.
---------------------------------------------------------------------------
Despite improvements in export salesmanship over the past
decade, Russian arms exporters still can not match the West in
their after sale support. Because they were politically driven,
after sale support--in the form of technical training, spare
parts, and servicing--were not major features of Soviet arms
export deals. Thus, when Russian arms exporters were thrust out
onto a competitive global commercial market, few or none
possessed organizations with this capability, or, for that
matter, experience. Moreover, despite discussion of this
liability throughout the 1990s, Russian exporters appear to
have done little to improve these capabilities.\37\
---------------------------------------------------------------------------
\37\ In October 2001, President Putin reportedly chastised his
Cabinet after hearing complaints from South Korean President Kim Dae
Jung. In particular, President Kim complained of the poor quality of
hardware purchased from Russian in the mid-1990s, lack of maintenance,
and chronic delays with deliveries of parts. Malaysia reportedly had
similar complaints regarding the MiG-29s it had purchased.
See Ivan Safronov, ``Russia May Liberalize Arms Exports,''
Kommersant, October 25, 2001, p. 2.
---------------------------------------------------------------------------
Finally, the collapse of the Soviet bloc has allowed new
competitors to crowd into previously loyal Russian markets.
Beyond the Westward tilt of Russia's former allies in eastern
Europe, this phenomenon includes the market for upgrades of
Soviet weapons systems. Israel, in particular, has aggressively
moved into the upgrade market for MiG-21 aircraft.\38\
---------------------------------------------------------------------------
\38\ See e.g., Mohammed Ahmedullah, ``Russians Say Copycat Firms
Robbing Millions in Spares Sales,'' Defense Week, vol. 22, no. 41.,
October 15, 2001.
---------------------------------------------------------------------------
The Rationale for Russian Exports
The United States and international community appear to
have very little leverage in discouraging Russian efforts to
export armaments as widely and in as great numbers as possible.
In short, Russia's Government and industry possess extremely
compelling incentives to expand their arms sales as much as the
market will bear. Although some of Russia's incentives are
universal to all arms producing countries, others are
particular to Russia's unique circumstances
The first set of reasons for seeking arms exports are
shared by virtually all arms producing countries worldwide. By
increasing the overall number of a production run, exports
reduce the per unit cost of any subsequent purchases of that
item, making weapons production more profitable. Even if the a
government elects not to procure more of a particular model,
exports provide the producing firm with more resources to
invest in new development projects. Moreover, if a government
seeks to maintain a defense industrial base on the cheap,
foreign purchases can keep production lines open--``smoothing
out'' production peaks and valleys--in anticipation of future
procurement orders.\39\
---------------------------------------------------------------------------
\39\ Kevin P. O'Prey, The Arms Export Challenge: Cooperative
Approaches to Export Management and Conversion, (Washington, DC:
Brookings Institution, 1995), pp. 10-11.
---------------------------------------------------------------------------
Beyond these universal incentives, Russia's industry and
government confront pressures generated by the persistence of
excess capacity in the defense industries, the drop in state
procurement orders, and the continued political-economic
importance of defense enterprises to their local communities.
While the rationale behind Soviet arms exports was
geopolitical--to buy influence among Moscow's client states--
during the Russian period the rationale has become
predominantly commercial, oriented toward domestic politics.
The remainder of this section deals with each of these factors
in turn.
excess capacity
From the perspective of Russian industry, the most
compelling reason for greater levels of arms exports is the
persistence of a very large defense industrial base with very
little domestic demand. When the Soviet Union collapsed in
1991, it bequeathed to Russia a defense industrial base with a
size and diversity worthy of a superpower. In all, Russia
inherited approximately 1,700 state owned defense enterprises
and industrial establishments organized into nine functional
ministries (e.g., Ministry of Aviation Industry). Beyond the
official defense complex, defense procurement orders reached
far and wide in the Soviet-Russian economy. According to
Clifford Gaddy, more than one third of all industrial
enterprises had some role in arms manufacture.\40\
---------------------------------------------------------------------------
\40\ Clifford Gaddy, The Price of the Past: Russia's Struggles with
the Legacy of a Militarized Economy, (Washington, DC: Brookings
Institution Press, 1996), pp. 24-26
---------------------------------------------------------------------------
Perhaps as problematic as the sheer number of Russian
defense establishments at a time when the cold war demand was
slacking off was the vast size of these enterprises. By U.S.
standards, these enterprises were enormous. Within the Soviet
defense industries there were approximately 100 enterprises
with over 10,000 employees.\41\ For example, a single facility
such as the Moscow ``Znamya Truda'' [Banner of Labor] Machine
Building Plant--a builder of MiG aircraft--employed 30,000
personnel in 1990.\42\ In contrast, it appears that there are
no more than a handful of U.S. industrial establishments with
more than 10,000 employees.\43\
---------------------------------------------------------------------------
\41\ Clifford Gaddy, The Price of the Past: Russia's Struggles with
the Legacy of a Militarized Economy, (Washington, DC: Brookings
Institution Press, 1996), p. 25.
\42\ U.S. Department of Commerce, Russian Defense Business
Directory--1993, (Washington, DC: U.S. GPO, 1993, pp. 38, 36.
\43\ Although a number of firms possess in excess of ten thousand
employees, few possess such a concentration at a single establishment.
See Paul Joskow, et al., ``Competition Policy in Russia During and
After Privatization, p. 312.
---------------------------------------------------------------------------
Part of the reason for the enormous scale of Russian
defense enterprises was related to the logic of Soviet
economics. The exigencies of the command economic system
encouraged a degree of concentration and autarky in defense
industry organization that is rarely encountered in the U.S.
economy. Constant conditions of scarcity in the supply system
created pressure for self-sufficiency in material inputs as
enterprise managers sought to minimize the degree to which they
depended on outside help.\44\ The Izhevsk Mechanical Plant is a
case in point. A producer of small missiles, the enterprise
possessed shops for the manufacture of all the electronics
components for its missiles, as well as virtually all of the
tools necessary to produce the electronics.\45\
---------------------------------------------------------------------------
\44\ See Ed Hewett, Reforming the Soviet Economy: Equality versus
Efficiency, (Washington, DC: The Brookings Institution), p. 173.
\45\ See Nikolay Belin, ``Izhevskiy oruzheyniki,'' (The Izhevsk
Gunsmiths), Krasnaya Zvezda, September 9, 1992, pp. 1, 4.
---------------------------------------------------------------------------
At both the micro- and the macro-levels, the trend was
toward mass scale at the expense of efficiency. Consequently,
Russia inherited a defense sector that was--and continues to
be--grossly inefficient by Western standards. When comparing
the personnel size of the Russian and European aerospace and
missile production sectors, Russia performs extremely
inefficiently. According to Vitaliy Shlykov, a Russian defense
industry observer, Europe's combined aerospace and rocket
industries generate approximately $2.2 billion in revenues with
98,000 personnel. However, it takes the comparable Russian
industry 800,000 personnel to generate $2 billion in
revenue.\46\
---------------------------------------------------------------------------
\46\ Vitaliy Shlykov, ``The Potemkin Complex: A Government Program
Cannot Solve the VPK's Problems.''
---------------------------------------------------------------------------
During the cold war, the Soviet Government was willing to
absorb the opportunity cost of such a large, inefficient
defense sector because it was producing vast quantities of
weapons to support its superpower competition. However, when
the cold war ended with the collapse of the Soviet regime, the
defense industries saw the domestic demand for their wares drop
off dramatically. One of the first measures of Yegor Gaydar as
acting Prime Minister in 1992 was to reduce state orders for
arms procurement by 68 percent.\47\ State expenditures on
tactical aircraft, missiles, as well as anti-aircraft and air-
launched missiles were cut by 80 percent. Tanks and field gun
expenditures were cut by a dramatic 97 percent.\48\
---------------------------------------------------------------------------
\47\ See Julian Cooper, ``The Soviet defence industry heritage and
economic restructuring in Russia,'' p. 36; and Yegor Gaydar, ``The Race
with the Crisis,'' Novoye Vremya, no. 48, 1991, p. 13, as cited in
Anders Aslund, How Russia Became a Market Economy, (Washington, DC: The
Brookings Institution), p. 66.
\48\ Oleg Vladykin, ``Novaya Armiya so starym oruzhyem. Nuzhna li
Rossiy takaya perspektiva?'' [A new Army with Old Weapons. Is This the
Kind of Prospect Russia Needs?] Krasnaya Zvezda, August 19, 1992, pp.
1-2.
---------------------------------------------------------------------------
Taking the historical view, the cuts in weapon procurement
were remarkable. For example, 3,500 tanks were built in 1988.
But the state ordered only 20 tanks in 1992.\49\
---------------------------------------------------------------------------
\49\ See Peter Almquist, ``Soviet/Russian Procurement Database;''
Marina Chernuka and Vyacheslav Terekhov, interview with First Deputy
Minister of Defense Andrey Kokoshin, ``Nation and Society'' feature,
Interfax, 0545 GMT, July 24, 1992, translated in FBIS-SOV, 92-143, July
24, 1992; and Aleksey Shulunov, ``K chemu vedyet byudzhetnaya
strategiya pravitel'stva.''
---------------------------------------------------------------------------
Nor did the cuts in Russian defense orders stop there.
Figure 5 depicts the relative decline in state arms procurement
spending from 1984 to 2000. Overall military output in the
defense complex in 1999 accounted for only one-third of the
1991 level.\50\ This year only 10 percent of Russian defense
enterprises have any state orders for defense output. Moreover,
there will be no deliveries this year to the Russian Government
of combat aircraft, helicopters, tanks, or other armored
vehicles.\51\
---------------------------------------------------------------------------
\50\ Kseniya Gonchar, Russia's Defence Industry at the Turn of the
Century, p. 4.
\51\ Vitaliy Shlykov, ``The Potemkin Complex: A Government Program
Cannot Solve the VPK's Problems.''
---------------------------------------------------------------------------
Although Russian procurement levels have increased over the
past 2 years, the net effect has not been significant.\52\ As
Figure 5 demonstrates, even with this increase, state arms
procurement funding in 2000 was still only 76 percent of the
1994 level. Given the low levels of the procurement budget, the
practical impact of these investments is small. For example, in
1999, the procurement budget funded only ten Topol-M missiles,
ten satellites, and one Tu-160 strategic bomber.\53\ In 2000,
the aviation industry leading Sukhoy design bureau received
state orders only for an aircraft upgrade development project,
which ended up amounting to only 10 percent of the bureau's
business for the year.\54\
---------------------------------------------------------------------------
\52\ In 1999, then Prime Minister Putin established defense
production for domestic consumption as a priority over conversion and
arms exports. Furthermore, Deputy Prime Minister Klebanov pulled
several converted enterprises back from civilian to military
production. The effect of these measures was to generate 80 percent
growth in the procurement budget in 2000. Kseniya Gonchar, Russia's
Defence Industry at the Turn of the Century, p. 17.
\53\ Kseniya Gonchar, Russia's Defence Industry at the Turn of the
Century, p. 40.
\54\ Interview with Mikhail Pogosyan, General Director of Sukhoy
Aircraft Military Industrial Complex, ``Only a Definite Strategy Can
Attract Money,'' Eksport Vooruzheniy, May-June 2001, p. 18.
FIGURE 5._PERCENTAGE INDEX OF 1994 RUSSIAN ARMS PROCUREMENT BUDGET PLAN
[In constant 1996 prices, where the 1994 value = 100]
[GRAPHIC] [TIFF OMITTED] T6171.034
Source: Kseniya Gonchar, Russia's Defense Industry at the
Turn of the Century, 2000.
The net effect of these cuts in defense orders without
comparable contraction in industry, of course, was substantial
excess capacity. In late 1999, Russian defense sector still had
the capacity to produce 3,500 tanks and 4,500 pieces of movable
artillery per year. Approximately 40,000 people are also
currently employed in duplicating R&D within the strategic
missile program, when the Ministry of Defense estimates that
8,000 to 10,000 would suffice.\55\ The aviation industry is
capable of manufacturing about 350 fixed-wing aircraft and 300
helicopters per year. The actual output in 1998, however,
reached only 100 pieces.\56\ In an indication that this problem
of excess capacity was broadly understood, Ministry of Defense
industrial plan in the early 1990s stipulated that only 220 of
the 1,700 defense enterprises would be essential for Russian
security.\57\
---------------------------------------------------------------------------
\55\ See Anatoliy Sitnov, Chief of Armaments, Ministry of Defense,
interview in Eksport Vooruzheniy, November/December 1999, pp. 20-22, as
cited in Kseniya Gonchar, Russia's Defence Industry at the Turn of the
Century, p. 17.
\56\ Kseniya Gonchar, Russia's Defence Industry at the Turn of the
Century, p. 33.
\57\ See A.A. Kokoshin, First Deputy Minister of Defense,
``Protivorechiya formirovaniya I puti razvitiya voenno-tekhnicheskoy
politiki Rossiy,'' (Contradictions of Formation and Ways of Developing
the Military-Technical Policy of Russia), Voyennaya Mysl, #2, 1993; and
Lt. Colonel Valentin Rudenko, ``My sposobny proizvodit unikal'noye
oruzhiye i etu sposobnost nel'zya uteryat,'' (We Are Capable of
Producing Unique Weapons and This Capability Must Not Be Lost),
Krasnaya Zvezda, March 11, 1993, p. 2.
---------------------------------------------------------------------------
In this environment, arms exports have proven to be the
most important source of income for the defense industries. As
Figure 6 demonstrates, military production for the domestic
market accounted for only 17 percent of defense industry output
in 1999. Production for arms exports, by contrast, accounted
for 37 percent of the defense sector's production. Table 1
provides more tangible evidence of the disparity in output
terms, by specific weapons type.
FIGURE 6._SHARE OF RUSSIAN DEFENSE COMPLEX OUTPUT, 1999
[GRAPHIC] [TIFF OMITTED] T6171.035
Source: Kseniya Gonchar, Russia's Defense Industry at the
Turn of the Century, 2000.
TABLE 1.--ESTIMATE OF NUMBERS OF WEAPON SYSTEMS MANUFACTURED FOR
DOMESTIC AND INTERNATIONAL SALES, 1992-1999
------------------------------------------------------------------------
Domestic Export
Weapon system procurement sales
------------------------------------------------------------------------
Ships........................................... 2 11
Tanks........................................... 31 435
Submarines...................................... 2 10
Aircraft........................................ 7 278
Helicopters..................................... 8 98
Air defense systems............................. 1 22
Armored vehicles................................ 17 217
------------------------------------------------------------------------
Source: Kseniya Gonchar, Russia's Defense Industry at the Turn of the
Century, 2000.
state policy
Excess capacity persists in the Russian defense industries
in large part because the Federation Government has avoided
imposing fundamental reform on the sector throughout the 1990s.
As Kseniya Gonchar argues, Russia's ideal pattern of defense
planning--drafting of the military doctrine, long-term planning
of supply and procurement, and finally contracting--has been
replaced by an adjustment to minimal funding, lobbying, and the
implicit prioritizing of the nuclear forces.\58\
---------------------------------------------------------------------------
\58\ Boris Kuzik, Oboronno-promyshlennyy Kompleks Rossii: Proryv v.
XXI Vek [The Russian Defense Industrial Complex: Breakthrough to the
21st Century] (Moscow: Russkiy Biograficheskiy Institut, 1999), cited
in Kseniya Gonchar, Russia's Defence Industry at the Turn of the
Century, p. 15.
---------------------------------------------------------------------------
Both reform-oriented and more conservative administrations
have viewed the defense industry problem as something to be put
on the back burner. Although neither the managers nor the labor
forces of Russian defense enterprises were powerful political
groups, no Russian Government has had the appetite to take them
on directly.
The primary reason that successive Russian Governments have
been reluctant to take on real defense industry reform has been
the social ramifications of the militarization of the Russian
economy. Estimates of the number of personnel who worked in the
Soviet defense establishment--the lion's share of which was
located in Russia--at the height of the cold war range from 9
to 14 million.\59\ By comparison, in 1990 U.S. defense industry
work provided employment to only 1.5 to 1.9 million
workers.\60\
---------------------------------------------------------------------------
\59\ Julian Cooper offers the estimate of 9 million while Andrey
Kokoshin estimates the number of Soviet defense industry jobs as
ranging between 12 and 14 million. Julian Cooper, ``The Soviet Defence
Industry Heritage and Economic Restructuring in Russia,'' in Lars B.
Wallin, ed. The Post-Soviet Military-Industrial Complex, FOA
Symposium--October 20, 1993, (Stockholm: The Swedish Nations Defence
Research Establishment, 1994), p. 30; and Andrey Kokoshin, ``Defense
Industry Conversion in the Russian Federation,'' Russian Security After
the Cold War: Seven Views from Moscow, in Teresa Pelton Johnson and
Steven E. Miller, eds, (Brasseys, U.S., 1994), p. 48.
\60\ Adjusting to the Drawdown, Report of the Defense Conversion
Commission, pp. 17-18.
---------------------------------------------------------------------------
Perhaps as many as 70 Soviet cities were developed around a
single defense enterprise.\61\ In the extreme case, the
republic of Udmurtiya depended upon defense work for 57 percent
of its industrial workforce. Six other oblasts--the Soviet/
Russian equivalent of a state in the United States--depended
upon defense work for over 40 percent of their industrial labor
forces.\62\ In contrast, in 1991 defense work accounted for
only 8.3 percent of non-farm, private sector employment in the
most defense industry-dependent state in the United States,
Connecticut.\63\
---------------------------------------------------------------------------
\61\ Stepan Sulakshin, ``Dva kvartala na golodnom paykye;'' [Two
Quarters Starvation Rations], Krasnaya Zvezda, May 28, 1994, p. 3.
\62\ See Julian Cooper, The Soviet Defence Industry: Conversion and
Economic Reform, (NY: Council on Foreign Relations Press, 1991) and
Clifford Gaddy, unpublished trip notes, Summer 1992.
\63\ Logistics Management Institute, Impacts of Defense Spending
Cuts on Industry Sectors, Occupations Groups, and Localities, Table 3-
2.
---------------------------------------------------------------------------
Beyond their role in providing employment, Soviet defense
enterprises played a major role in providing social services to
their regions. In the majority of cases, a Soviet defense
worker and his/her family depended on the defense plant to
supply their housing, hospitals, kindergartens, and, even,
vacation facilities.\64\ Even after the onset of Russian
reforms, in some enterprises the social infrastructure employed
over 20 percent of the plant's staff.\65\ One defense industry
official later reported that in 1994, 9 to 25 percent of funds
in the defense complex were devoted to maintaining social
infrastructure.\66\
---------------------------------------------------------------------------
\64\ See, e.g., Yelena Druzhinina, ``The Defense Industry is
Revealing Its Cards,'' Delovoy Mir, November 2, 1991, p. 8 in JPRS-UMA
91-031, pp. 62-64.
\65\ Kseniya Gonchar, ``Employment Aspects of Defense Conversion in
Russia,'' mimeo, May 1994, footnote 13.
\66\ Aleksey Shulunov, ``K chemu vedyet byudzhetnaya strategiya
pravitel'stva.''
---------------------------------------------------------------------------
Therefore, the net effect of this militarization of the
Russian economy is the creation of a direct link between the
financial health of a Russian defense enterprise and the socio-
economic welfare of the surrounding community. For example,
because the Komsomolsk-na-Amure Aviation Production Association
(KnAAPO)--the producer of Su-27 aircraft exported to China--
accounts for 78 percent of the industrial output of the
Khabarovsk Krai, KnAAPO's welfare is the region's welfare.\67\
---------------------------------------------------------------------------
\67\ Alexander Golts, ``A Dead-End. The Defense Industry is Not
Deeply Distributed in Depth: Military Production in Russia is Living on
Foreign Orders for the Time Being but That Can't Continue for Long,''
Itogi, October 24, 2000, translated in FBIS October 31, 2000, Document
ID: CEP 20001031000156.
---------------------------------------------------------------------------
In political terms, the Russian Government has been left
with few options. Moscow has had neither the resources nor the
inclination to increase defense procurement significantly. When
Deputy Prime Minister Ilya Klebanov announced the 2010 defense
program, he promised that the government would increase the
value of defense industry contracts from the current level of
approximately 2.6 percent of GDP to 3.5 percent of GDP in 2006.
But in a blow to any hopes for the development of new systems
and the opening of new series production efforts, the first 7
to 8 years of this 10 year plan emphasize the upgrading and
modernization of existing defense systems.\68\
---------------------------------------------------------------------------
\68\ ``Russia: State Planning to Boost Defense Sector Contracts,''
Interfax, 1351 GMT, March 30, 2001, reprinted in FBIS March 30, 2001,
Document ID: CEP20010330000296.
---------------------------------------------------------------------------
Nor has Moscow been willing to undertake the politically
painful process of streamlining the defense sector by
permitting, encouraging, or even directing failing enterprises
to close. In the same initiative, Klebanov promised to address
excess capacity by reducing the size of the defense industry
from its current level of enterprises from 1,700 to 1,000. The
initiative would also address organizational and efficiency
issues by overseeing the reorganization of leading defense
enterprises into 30 to 40 holding companies.\69\ For example,
by 2006 the reform would concentrate the aircraft sector by
creating two holding companies: one merging MiG, Tupolev, and
Kamov and the other integrating Sukhoy, Ilyushin, and Mil.\70\
---------------------------------------------------------------------------
\69\ Dmitry Safonov, ``Military Industry Reform Approved,''
Izvesitya, July 28, 2001.
\70\ ``RF Government Has Approved Federal Targeted Program for
Reform and Development of the Defense Industrial Complex for 2001-
2006,'' Agenstvo AK&M, July 27, 2001, translated in FBIS, Document ID
CEP2001 10727000193.
---------------------------------------------------------------------------
However, defense industry officials and outside observers
could not be criticized for their pessimism that the reform
would come to pass because it resembled in significant detail
previous, much-heralded government reform proposals. In
particular, Klebanov's plan looked a lot like Kokoshin's plan
of 8 years earlier as well as a series of draft initiatives in
between. Although all of these plans got it right in terms of
objectives, none were ever seriously implemented.
Consequently, rather than carry out real reform or cave in
to industry demands for financial support, both the Yeltsin and
Putin Administrations sought the less painful ``third way'' of
encouraging industry self help through arms exports. As early
as January 1992, President Yeltsin was urging defense
enterprises to find arms exports customers.\71\ In a move that
probably cost it little financially, the Yeltsin government
relaxed restrictions on the types of armaments that could be
exported and vastly increased the share of revenues that
enterprises received from their exports.\72\ The government
also took an active role in promoting defense industry
exports.\73\
---------------------------------------------------------------------------
\71\ Nikolay Burbyga, ``Boris Yeltsin: Russia Has No Special Secret
Policy Regarding Nuclear Issues,'' Izvestiya, Feb. 24, 1992, pp. 1, 3
in FBIS-SOV 92-036, pp. 35-39.
\72\ See Nadezhka Potapova, ITAR-TASS, June 8, 1992 in FBIS-SOV 92-
111, p. 63; and Vremya, Moscow Television, July 21, 1990, in FBIS-SOV
90-143, p. 76.
\73\ For example, even the westward leaning Foreign Minister
Kozyrev described arms export promotion as one of the main reasons for
his May 1992 trip to the Persian Gulf region. See Aleksandr Golts,
``Andrey Kozyrev Spends Six Days in Six Countries Seeking New Partners
for Russia,'' Krasnaya Zvezda, May 6, 1992, p. 3.
On at least one occasion the cash-strapped Federation Government
actually provided credits to a foreign government in order for it to
purchase Russian weapons-related technologies. In March 1992, the
Russian Federation Government agreed to provide credits to India for
the purchase of Russian weapons. Although the Federation is required to
spend some of its revenue in India, the money will also go toward the
purchase of goods that will go directly to Russian defense enterprises.
See Correspondent Nikolay Paklin, Radio Rossii, 1100 GMT, March 26,
1992 in FBIS-SOV 92-060, p. 22.
---------------------------------------------------------------------------
graft
Beyond all the other factors providing incentives for
Russian arms exports, perhaps the most compelling one
throughout the past decade has been personal profit--or
outright graft--by state officials and industry managers.
Because (1) the state of the Russian economy has generally been
poor, and (2) Russia has little that it could export for hard
currency, arms exports have joined the energy industries as the
objects of fairly intense political competition at the top of
the Russian political system. The frequent turnover of the
Russian Government's arms export agencies as well as the
periodic reorganization of these agencies themselves were
evidence of constant competition among elite groups around
Presidents Yeltsin and Putin. For example, in order to help
finance Yeltsin's successful campaign for re-election in 1996,
members of the ``Family''--the political faction of Yeltsin
boosters that included his daughter, Tatyana Dyachenko--put
their own people in charge of Rosvooruzheniye in order to get
access to the hard currency revenues from arms exports.
The benefits for the ``Family'' and anyone else who has
access to arms export deals are not limited to skimming off the
top of any transaction. Merely controlling hard currency bank
accounts and benefiting from the interest provides a range of
benefits that are not available to capitalists exploiting
wholly domestic Russian sectors.
Although defense enterprise managers have argued that they,
not the state organs, should control the export revenues that
they generate, there is no evidence that they are more
magnanimous than state officials. On the contrary, they appear
to be equally oriented toward using their control over these
hard currency accounts for their personal enrichment.
Thus, beyond any well-reasoned policy or political impulse
supporting Russian arms export efforts, there is a more
fundamental reason--elites stand to make more money.
Impact on the Russian Defense Sector
Despite the positive overall picture for Russian arms
export performance in recent years, the effects on the state of
Russian defense industries has been limited in scope. For the
small number of enterprises that have found foreign demand for
their manufactures, export revenues have provided economic
resuscitation. Yet given the very significant economic and
organizational challenges confronting these enterprises, to use
a medical analogy, they have moved from being on life support
to intensive care. Arms exports have improved their
performance, but none of these enterprises appears to resemble
a financially solvent firm. Nor do the prospects seem much
enhanced for technological or procurement breakthroughs as the
widespread economic malaise in the defense industries will be a
barrier to significant R&D and production.
The effects of Russia's arms export success have been
fairly concentrated in a handful of enterprises. Figure 7
details the Russian sources of arms agreements during the year
2000. As the Figure depicts, most the 2000 arms export revenues
were funneled through state coffers. Rosvooruzheniye,
Rosoboroneksport, and Promeksport--three state agencies at the
time charged with promoting exports--accounted for three-
fourths of the year 2000 Russian arms trade. Within this
category, 70 percent of exports were aircraft and related
services. The largest of these projects were supplies and
licensed production of Sukhoy combat aircraft.\74\
---------------------------------------------------------------------------
\74\ Interview with Aleksandr Mikheev, Director of the Air Force
Department of Rosoboroneksport, ``Our Obligations are Being Fulfilled
in Time,'' Eksport Vooruzheniy, July-August 2001, p. 6.
---------------------------------------------------------------------------
FIGURE 7._ENTERPRISE ORIGINS OF RUSSIAN ARMS TRANSFERS, 2000
[GRAPHIC] [TIFF OMITTED] T6171.036
Source: Makienko, Konstantin. Preliminary Estimates of
Russian Performance in Military-Technical Cooperation with
Foreign States in 2000, 2001.
In contrast, only three individual enterprises shared the
remaining one-fourth of export revenues. Of these, the Antey
Concern--the producer of the Tor-M1 surface to air missile
system--was the big winner among individual enterprises, taking
in roughly $500 million. The Tula Instrumentmaking Design
Bureau--the designer and producer of tracked air defense
systems such as the Pantsir--took in roughly $100 million. The
corporate successor to the famed Mikoyan design bureau and
production facilities, RSK MiG, also took in the remainder--
approximately $100 million.
These enterprises also are concentrated in just two
sectors: aircraft and air defense systems. The MiG-29, Su-27,
and Su-30 aircraft variants account for two-thirds of Russian
exports. Air defense systems--principally the competing
versions of the S-300--account for most of the remainder of
Russian exports in 2000.\75\ The picture became a little more
complex in 2001 with the large sale of tanks to India.
Moreover, this picture does not capture the export success of
Russia's nuclear and space industries, which are no longer
counted within the defense complex.\76\
---------------------------------------------------------------------------
\75\ Dr. Mark Galeotti, ``Russia's Arms Bazaar,'' Jane's
Intelligence Review, April 1, 2001.
\76\ On the success of these sectors, see Kseniya Gonchar, Russia's
Defence Industry at the Turn of the Century, p. 4.
---------------------------------------------------------------------------
The principal effect of arms export success has been to
create a class of relatively successful Russian defense
enterprises. Throughout the 1990s, arms export revenues were
the dominant factor in explaining the relative success or
failure of Russian defense enterprise performance. In a survey
of 72 defense enterprises over the 1990-1995 period, I found
that only 15 percent were performing in a way that could be
considered to be relatively successful--e.g., they appeared to
be more or less covering their operating expenses with some mix
of revenues and state subsidies.\77\ The feature that separated
this group from the 21 percent that were failing outright and
the remainder that were ``muddling'' at best was the fact that
they had foreign markets for their arms products.\78\
---------------------------------------------------------------------------
\77\ Kevin P. O'Prey, Russian Defense Enterprise Adaptation--1984-
1995: Coping with Political-Economic Reform and Transformation, MIT
Doctoral Thesis, January 1998.
This figure tracks with current estimates of economist Kseniya
Gonchar, who argues that only one-fifth of the entities within the
defense industry show signs of stability and long-term viability. See
Kseniya Gonchar, Russia's Defence Industry at the Turn of the Century,
p. 4.
\78\ Twenty-one percent of surveyed defense enterprises--the
``basket cases''--were experiencing periodic shut-downs due to a
variety of financial maladies, including an inability to pay energy
bills, wages, and so forth. These shut downs typically involved the
enterprise management locking the gates and sending the workforce on
unpaid leave for weeks at a time.
The majority (67 percent) of surveyed enterprises could be
performing in a way that could only be characterized as ``muddling.''
Although they by and large kept their doors open, they clearly lacked
products whose revenues could sustain them as currently constituted.
See Kevin P. O'Prey, Russian Defense Enterprise Adaptation--1984-1995:
Coping with Political-Economic Reform and Transformation, MIT Doctoral
Thesis, January 1998.
---------------------------------------------------------------------------
Perhaps the best sign of the relative prosperity of arms
exporting enterprises is the fact that they have been hiring
workers. The S-300 producing Antey Concern in Moscow is looking
to hire another 10,000 employees to add to its existing 40,000
personnel. A 1998 report described the Tula Instrumentmaking
Design Bureau--the developer and producer of the Pantsir air
defense system--as hiring 400 new engineers to support its
export-led business. Uralvagonzavod, the beneficiary of the
2000 agreement to supply 310 T-90 tanks to India, was similarly
reported to be hiring personnel to support renewed production
after an extended down period.
Exports have also helped some enterprises undertake the
development of new systems. Most notably, the Tula
Instrumentmaking Design Bureau's deal to sell the Pantsir air
defense system to the UAE apparently includes explicit UAE
financing of the system's final development.\79\
---------------------------------------------------------------------------
\79\ Col. Stanislav Lunev, ``Russia's Arms Sales Destabilizing Gulf
Nations,'' Newsmax, March 28, 2001, reproduced on http://
www.newsmax.com.
---------------------------------------------------------------------------
Yet the Pantsir case appears to be more the exception than
the rule. Without a robust, multi-year government defense R&D
budget, the development of fundamentally new systems appears to
be exceedingly difficult. In the aviation sector, despite the
change of nomenclature, the Su-30 aircraft being sold to China
and India are upgrades of the Su-27. Despite frequent press
references to the imminent development of a fifth generation
Russian fighter to succeed either the MiG-29 or the Su-27, no
financing appears to be in the offing. According to Mikhail
Pogosyan, the General Director of the Sukhoy design bureau, the
biggest obstacle is the lack of state financing: ``Everyone
understands that it is impossible to carry out all the R&D
related to the new generation with [current levels of] budget
funding alone.'' Thus, the Sukhoy design bureau invests some of
the revenues from exports, and hopes to convince foreign
clients to invest in the development of new systems, or to
encourage foreign joint development.\80\
---------------------------------------------------------------------------
\80\ Interview with Mikhail Pogosyan, ``Only a Definite Strategy
Can Attract Money,'' p. 19.
---------------------------------------------------------------------------
The Sukhoy complex of enterprises also provides an
illustration of how export success cannot overcome the
obstacles created by the organizational vestiges of the Soviet
system. The Soviet-era Sukhoy complex included four
geographically dispersed, organizationally distinct entities.
In addition to the Moscow design bureau, there were three
production facilities for Su-27 variants: the Komsomolsk-na-
Amure Aviation Production Association (KnAAPO), the Irkutsk
Aviation Production Association (IAPO), and the Novosibirsk
Aviation Production Association (NAPO). Since the collapse of
the Soviet-era aviation ministry, the managers of these
enterprises have resisted repeated efforts to create a unified
firm. In particular, as the producers of the exported aircraft,
each of the production associations has sought to keep the
resulting revenues for themselves.
Today, the divided approach appears to have mixed results.
While the design bureau and KnAAPO are doing relatively well,
the Novosibirsk and Irkutsk plants hare having difficulty
fulfilling their orders.\81\
---------------------------------------------------------------------------
\81\ Interview with Mikhail Pogosyan, ``Only a Definite Strategy
Can Attract Money,'' p. 18.
---------------------------------------------------------------------------
Perhaps partly in response, like the Yeltsin Administration
before it, the Putin government is seeking to create a unified
firm of all of Sukhoy's components. However the prospects for
this effort are dubious due to the differing forms of ownership
across the different Sukhoy enterprises.\82\
---------------------------------------------------------------------------
\82\ See comments by Ruslan Pukhov in Guy Chazan, ``Russia to
Reduce Weapons Producers in a Bid to Streamline the Defense Sector,''
Wall Street Journal, July 31, 2001.
On Yeltsin era efforts, see Dmitry Safonov, ``Military Industry
Reform Approved,'' Izvesitya, July 28, 2001.
---------------------------------------------------------------------------
Finally, while arms export success appears to provide a
palliative, it cannot overcome the fundamentally weak state of
the Russian defense economy. Across the board, it is clear that
arms export revenues--when they reach the individual
enterprise--can help enterprise directors to pay their bills
and, perhaps, to fund some new initiatives. However, none of
these enterprises appears to be profitable, as they could not
cover their costs without substantial explicit and implicit
subsidies. Nor can they help these plants overcome the
challenges of operating in the transitional Russian economy. In
a telling example, Uralvagonzavod is reportedly finding it
difficult to produce T-90s for its India export orders because
its former sub-contractors have either failed or have moved to
other pursuits.\83\
---------------------------------------------------------------------------
\83\ ``Russia: Uralvagonzavod Not Prepared to Produce Tanks for
Indian Contract,'' Vremya Novostey, March 14, 2001, p. 1, translated in
FBIS, March 15, 2001, Document ID: CEP 20010315000367.
---------------------------------------------------------------------------
Issues for Congress
There are three compelling issues for the U.S. Congress
that emerge from this analysis.
The virtual certainty of continued aggressive
promotion of arms exports by Russia.
The limited effects that export success will have on
Russian defense industrial advancement.
The negative impact that these exports will have in
terms of greater proliferation of high technology
weapons systems to potential U.S. competitors.
In short, despite the improving climate of U.S.-Russian
relations, the United States possesses few levers against
Russia's efforts to sell high technology weapons systems to
anyone who will pay for them. Sanctions or attempts to create
diplomatic linkages are highly unlikely to overcome the very
significant incentives for Moscow to continue to promote
exports. While it is difficult to envision arms export success
helping the Russian defense sector rebuild itself anew into a
competitor with the United States and the West, the
proliferation impact could pose challenges to U.S. forces. The
remainder of this section addresses each of these issues in
turn.
the virtual certainty of continued aggressive promotion of arms exports
by russia
As described above, it is a virtual certainty that Russia
will continue to aggressively promote arms exports for the
foreseeable future. There are virtually no stakeholders in the
Russian political system who have an interest in constraining
Russian arms exports. For the government, arms exports help to
maintain priority defense industrial capabilities on the cheap
while reducing industrial demands for bail outs for the state.
Given the likely enormous amount of financial resources and
time that it would take to reform the defense industrial base--
thereby reducing the political pressure to export--it is
difficult to imagine any government choosing any other course.
Moreover, as arms continue to be one of the only hard currency
generating items that Russia can export, there will always be
prominent figures in the government who stand to profit
personally from export promotion.
For Russian defense industries, export revenues represent
the difference between success and failure. Russian defense
industrialists recognize that aside from intercontinental
ballistic missile (ICBM) manufacture, there are virtually no
prospects for meaningful state R&D or production orders over
the next 5 years at a minimum. If these industrialists do not
find foreign markets for their weapons, they are faced with
very bleak prospects.
Unfortunately, the United States has very little in the way
of moral suasion on this issue. As the dominant player in the
military export market over the past decade (see Figure 2),
Washington cannot credibly appeal for Russian restraint in
terms of general export promotion efforts.
the limited effects that export success will have on russian defense
industrial advancement
Russia's arms export success is not likely to be a vehicle
for the reinvigoration of the Russian defense industrial
complex. Russia's defense industries today are very sick. They
have not overcome the organizational vestiges of the Soviet
period and few, if any, enterprises have developed into viable
firms. By U.S. standards, none of these organizations is
profitable.
Given this environment coupled with the lack of government
resources, the prospects for the development and production of
a wholly new weapon system appear to be very bleak. While the
Russian system can turn out modifications of existing systems
such as the Su-27 fighter, fundamentally new programs require
the large-scale, multi-year funding that appears beyond the
reach of the Russian Government and enterprises for the
foreseeable future. Simply stated, at a time when Russian
enterprises are trying to stay afloat, it is extremely unlikely
that they can take on a robust development program that would
be taxing to even advanced defense industries like that of the
United Kingdom, France, or Germany.
From the U.S. perspective, therefore, the worst-case
scenario is that Russia could return to manufacturing large
quantities of older generation weapons. In the unlikely event
of renewed military competition with the United States and the
resulting political prioritization of domestic Russian
investment, and given the persistence of a large defense
industrial infrastructure, Russia could once again turn out
large numbers of ICBMs, artillery, tanks, and aircraft.
However, continued limitations in electronics and other aspects
of modern military systems would likely hobble this military in
actions against any Western force.
the negative impact that these exports will have in terms of greater
proliferation of high technology weapons systems to potential u.s.
competitors
The more significant problem for the United States and the
West is the proliferation of advanced Russian weapons systems
to potential regional competitors. There is little doubt that
the rationale for China's and Iran's acquisition of Russian
weapons and technologies is at least partly based on improving
their capabilities vis-a-vis the United States. If Iran were to
acquire Yakhont anti-ship missiles, for example, it would put
Tehran in a position from which to threaten U.S. naval forces
and international shipping in the Persian Gulf. Modern air
defense systems, furthermore, might help Iran defend its
nuclear facilities from preemptive strikes. Similarly, Chinese
acquisitions of high performance aircraft and other weapons are
likely based on a desire to improve Beijing's capabilities in
regional competition with the United States.
In this area the United States does possess some options.
Moscow still appears to respect international legal
restrictions. Moscow abides by UN sanctions on its former arms
client in Iraq. It also officially respects the terms of the
Missile Technology Control Regime (MTCR). Although there are
serious questions about illicit cooperation between Russian
missile manufacturers and Iran, among others, it appears that
Moscow is responsive to international pressure whenever these
relationships are exposed. Continued efforts to strengthen
existing international legal regimes governing arms trade--and,
perhaps, developing new ones--appears to be a good return on
U.S. diplomatic investment.
Targeted sanctions, however, do not appear to offer much
promise. Although U.S. sanctions against particular individuals
or enterprises puts the international spotlight on problems,
they cannot overcome the fact that the United States does not
possess economic levers over Russian industry. Most
importantly, Russian enterprises do not care if they are
subject to U.S. sanctions because they do not generally do any
business with U.S. firms anyway. Moreover, in extreme cases, it
is hard to foresee how a cut-off of all Western business with a
Russian enterprise would hurt more than one sizeable contract
with a country like Iran. The only exception to the rule
appears to depend upon tactical diplomatic efforts. In the case
of Iran sales, for example, the United States can encourage the
Gulf states to break off current cooperation and/or rule out
future Russian purchases. The opportunities for similar efforts
with respect to China, however, appear to be limited by the
fact that few Asian countries represent market opportunities
for Moscow.
In sum, therefore, the rationale for Russian arms exports
has become largely based on commercial interests and domestic
politics. Gone are the days when geopolitics drove Soviet arms
transfers. As a consequence, the United States is likely to
have an exceedingly difficult time finding anyone in Moscow or
Russian defense industries willing to listen to appeals for
restraint unless it is in their economic interest. For the
foreseeable future, the Russian Government and defense
industries will be focused on the near-term opportunities
offered by arms exports. Thus, as the Bush Administration and
the Congress evaluate the evolving U.S.-Russian relationship,
both must recognize that the arms trade is almost certainly
going to be a continuing source of disagreement.
U.S.-RUSSIAN TRADE AND INVESTMENT: POLICY AND PERFORMANCE
By Inga Litvinsky, Matt London, and Tanya Shuster \1\
----------
contents
Page
Summary.......................................................... 411
Policy Goals and Vehicles........................................ 412
Bilateral Trade.................................................. 414
Russia, U.S. major trading partner in Central Eastern Europe,
not in the global economy.................................. 414
Trade imbalance increased, 1995-2000......................... 414
U.S. exports to Russia varied but leading exports were stable 415
Some U.S. imports from Russia increased consistently......... 416
Bilateral Investment............................................. 417
Foreign direct investors into Russia......................... 417
U.S. investors in Russia................................. 418
Regions attracting foreign investment.................... 418
Business Environment Issues in Russia............................ 419
Good governance.............................................. 419
Commercial taxation with international accounting standards
(IAS)...................................................... 420
Commercial energy development................................ 420
Russia's accession to the World Trade Organization (WTO)..... 421
U.S.-Russian treaty on mutual protection of investments...... 421
Outstanding Trade Issues with the United States.................. 421
Russia's non-market economy status........................... 421
Trade implications of the Trade Reform Act of 1974 Jackson-
Vanik Amendment............................................ 422
1999 Steel agreements........................................ 422
Prospects for Trade and Investment............................... 422
Summary
The U.S. Administration would like to see business become
a bedrock for overall U.S.-Russian relations. At the same time,
President Putin and the Russian Government are banking on
foreign investment and integration in the global economy led by
the United States to expand and sustain Russia's gross domestic
product (GDP) growth. Thus, U.S. and Russian interests and
policies appear to be in alignment to commence a new bilateral
commercial era.
---------------------------------------------------------------------------
\1\ Inga Litvinsky is the Senior Russia Desk Officer and Matt
London is the Russia and Caucasus Desk Officer for the U.S. Department
of Commerce, International Trade Administration. Tanya Shuster is
Deputy Director and Senior Russian Specialist with the Business
Information Service for the Newly Independent States (BISNIS), U.S.
Department of Commerce. BISNIS provides market research, business
leads, and expert guidance and assistance to U.S. companies with
interests in the 12 Newly Independent States (NIS) countries
(www.bisnis.doc.gov). Chang Suh, an intern with the Department of
Commerce, also contributed to this article.
---------------------------------------------------------------------------
In order, however, to turn these intentions into increased
commercial opportunities so that bilateral trade and investment
can finally take off, concrete steps will be required by both
sides. Finishing Putin's reform agenda with financial, rule of
law, and other institutional reforms are essential conditions
precedent to developing a new Russian business climate capable
of attracting significant new investment. Specific improvements
in corporate governance, tax policy and commercial energy
developments are likewise required. Implementation of bilateral
treaties fostering commercial relations and Russian accession
to the World Trade Organization (WTO) would also be catalysts
for increased trade and investment. If Russia moves closer to
integration into the international economic institutions and
the global market, the United States would need to reexamine
its domestic trade laws in order to address Russia's concerns
regarding trade restrictions, access to the U.S. market and
expansion of appropriate trade and investment promotion
measures.
U.S.-Russian trade and investment increased over the
decade of the 1990s from a very low base. Russia's financial
crisis in 1998 accelerated the trade imbalance and interrupted
the overall upward trends, leading to a setback from which
bilateral trade and investment performance have not yet fully
recovered. Even at the past low level of trade turnover, some
American sectors and enterprises fared rather well, e.g.,
machinery and poultry. While foreign direct investment (FDI) to
Russia was minuscule, the United States led the advanced
western nations as a supplier of FDI. Russia has been far and
away the leading U.S. commercial partner in the region formerly
controlled by the Soviet Union. If trade and investment were to
substantially increase, sectors and enterprises already in the
Russian market would expect to be primary beneficiaries of the
expanding commerce. However, new participants such as small-
and medium-sized businesses may also be able to flourish in a
new business-friendly environment.
The current U.S. Administration is emphasizing the leading
role of the private sector in driving the bilateral commercial
relationship and has warmly welcomed the formation of the
Russian-American Business Dialogue.
Policy Goals and Vehicles \2\
---------------------------------------------------------------------------
\2\ For a good overview of the Administration's commercial policy
toward Russia, see October 5, 2001 remarks by Secretary of Commerce'
Donald Evans to the U.S.-Russia Business Council at www.doc.gov.
---------------------------------------------------------------------------
As the United States seeks to advance its relations with
Russia in all spheres, including development of a new security
framework, the Bush Administration is giving priority to the
bilateral commercial relationship. The Administration would
like to see private business relations become a bedrock for
overall U.S.-Russian relations. For their part the Russians,
under President Putin and the economic reform team led by
Economic Development and Trade Minister Gref, are banking on
increased foreign investment and integration into the global
economy. This development would sustain and expand the
country's GDP growth and favorable balance of payments, which
have been primarily fueled by high oil prices and depreciation
of the ruble in recent years. Thus, in principle, U.S. and
Russian interests and policies are in alignment to commence a
new bilateral commercial era.
While the first Bush Administration and Clinton
Administration conducted business with Russia through a
bilateral Commission made up of eight Committees, the new Bush
Administration has de-emphasized formal intergovernmental
structures and stressed the role of the private sector in
relations with Russia. They have disbanded the previous
Administration's principle vehicle for economic discussions
with Russia, the Joint Commission on Economic and Technological
Cooperation (or ``Gore-Chernomyrdin Commission''), and have
opted for a more informal and decentralized approach to
commercial enhancement.
At the first meetings between Presidents Bush and Putin at
the Ljubljana, Slovenia and Genoa Summits (in May and July
2001), commercial issues were high on the agenda. In Genoa,
Italy, the two Presidents announced formation of a private
sector-led Russian-American Business Dialogue to promote new
business opportunities and make policy recommendations to the
two governments. The creation of the private sector led
Business Dialogue is a recognition that our bilateral
commercial relations are at the beginning of a new era, one
that will be driven by the two countries' private sectors
rather than by the governments.
Following up on the economic discussions between the
Presidents, Commerce Secretary Donald Evans and Treasury
Secretary Paul O'Neill went to Russia in July 2001 to begin to
chart a new business-driven policy with the stated purpose of
expanding bilateral trade and investment. Subsequently, at the
request of President Bush, Commerce Secretary Evans led a
successful business development mission of senior U.S.
executives from a variety of sectors, including Committees on
Energy, Aviation, and Information Technology, to Russia in
October 2001. Several companies, including those new to the
Russian market, signed investment protocols during that visit.
In order to turn these positive intentions into increased
commercial opportunities, trade liberalization and business
environment issues will need to be addressed by both sides. It
is generally acknowledged by trade and investment specialists
in both countries that critical improvements are needed in
Russia's business climate, including corporate governance and
rule of law for business, commercial taxation, and improvements
in the banking system. While Russia is still perceived as a
risky place to do business by domestic and foreign businesses
alike, there have been positive changes in the past year,
including in commercial tax reform and simplification of
business licensing requirements.
Russia's accession to the WTO would be a major catalyst for
increased trade and investment as it would reinforce Russia's
economic reform program and would ensure that Russia abides by
international trade rules. As Russia moves closer to WTO
membership, the United States will need to re-examine its
domestic trade laws. If both sides are to reap the full
benefits of Russia's accession to the WTO, reconsideration of
the Jackson-Vanik Amendment to the Trade Reform Act of 1974 may
be necessary so that permanent normal trade relations (PNTR)
status may be accorded to Russia. The United States may also
need to address Russia's concerns regarding access of Russian
products, such as steel, to the U.S. market.
Bilateral Trade \3\
---------------------------------------------------------------------------
\3\ The analysis of trade and investment performance has been
prepared by Tanya Shuster, Deputy Director of BISNIS. Additional
information on U.S. trade and investment with Russia and other CIS
countries, including data on exports from individual U.S. states to the
NIS, is available via BISNIS Online, www.bisnis.doc.gov. For a more
comprehensive summary of trade between the United States and Russia in
2000, see BISNIS U.S.-Russia Trade Profile, available via the Russia
page of BISNIS Online www.bisnis.doc.gov/russia.html. Data in this
article is from authoritative official sources.
---------------------------------------------------------------------------
russia, u.s. major trading partner in central eastern europe, not in
the global economy
A more detailed examination of the U.S. and Russia trade
activities provides some, perhaps unexpected, perspectives.
Russia has emerged among all countries from Eastern Europe and
the Newly Independent States (NIS) as the United States'
leading trading partner in the region, but nonetheless accounts
for less than 1 percent of total U.S. foreign trade. In 2000
this pattern largely held true, with Russia capturing 80
percent of U.S. trade with the NIS. In this trade, Russia
provided nearly 40 percent of platinum, 14 percent of aluminum
and 3 percent of iron and steel imported into the United
States.\4\
---------------------------------------------------------------------------
\4\ U.S. platinum (palladium) imports from Russia nearly doubled
between 1998 and 2000, to more than $1.6 billion.
---------------------------------------------------------------------------
trade imbalance increased, 1995-2000
According to Russia's Ministry of Economic Development and
Trade, the United States accounted in 2000 for less than 5
percent of total Russian foreign trade but ranked third as a
market for Russian exports, after Germany and Ukraine. However,
if oil and gas are excluded from consideration (the United
States imports a disproportionately low level of oil and gas
from Russia compared to other leading trade partners), the
United States ranks second among all countries as a recipient
of Russian exports. In short, while Russia plays a minor
nominal role in U.S. imports and exports on a worldwide scale,
it remains very important as a trade partner in the region
(former Soviet-bloc countries). The United States ranked lower
(in eleventh place) as an exporter to Russia. The U.S. market
is especially important to Russia as a recipient of certain
products.
U.S.-Russian trade differ from worldwide trade trends
because of significant growth in Russia's trade surplus with
the United States.\5\ (See Table 1 and Figure 1). Russia had
solid growth in its exports to the United States each year
since 1996,\6\ while there was a the sharp decline in U.S.
exports to Russia in 1999 following the financial crisis. The
deficit in U.S.-Russian trade was far more pronounced than
Russia's overall worldwide trade performance, although less
severe than that experienced by Japan.\7\ While Russian total
trade worldwide in 2000 was roughly the same level as in 1995,
U.S.-Russian total trade reached all-time highs in 2000. The
total dollar value of U.S.-Russian trade grew more than 50
percent between 1995 and 2000 largely attributable to the 93
percent growth in the value of U.S. imports from Russia during
the period (the value of U.S. exports in 2000 was only 82
percent of the level in 1995).
---------------------------------------------------------------------------
\5\ Russia's trade surplus with the United States grew 350 percent
between 1995 and 1998, while Russia's trade surplus worldwide grew 240
percent.
\6\ Initial U.S. Department of Commerce data for January-June 2001
indicates a small decline (4 percent) so far for the year in U.S.
imports from Russia, which is attributable at least in part to
declining prices for fuel and other commodities imported from Russia.
\7\ Japan's exports to Russia dropped 57 percent in 1999 over 1998.
The value of U.S. imports declined 48.5 percent. The European Union
(EU) experienced a 45 percent decrease.
TABLE 1.--U.S.-RUSSIA TRADE, 1995-2000
[In billions of dollars]
----------------------------------------------------------------------------------------------------------------
1995 1996 1997 1998 1999 2000
----------------------------------------------------------------------------------------------------------------
U.S. exports........................................ $2.826 $3.340 $3.289 $3.585 $1.845 $2.318
U.S. imports........................................ 4.035 3.561 4.290 5.734 5.805 7.796
-----------------------------------------------------------
Total trade turnover............................ 6.681 6.901 7.579 9.319 7.650 10.114
===========================================================
Trade balance....................................... -1.209 -0.221 -1.001 -2.149 -3.960 -5.478
----------------------------------------------------------------------------------------------------------------
Source: BISNIS.
FIGURE 1._U.S.-RUSSIAN TRADE, 1993-2000
[In billions of dollars]
[GRAPHIC] [TIFF OMITTED] T6171.032
U.S. exports {time} U.S. imports
Source: BISNIS.
u.s. exports to russia varied but leading exports were stable
Initial U.S. data for the first 6 months of 2001 indicate
that the modest recovery continues, although if performance in
the second half of the year is consistent with the first, the
United States will attain year-end export levels only on par
with the mid-1990s. Growth in U.S. exports to Russia of 25
percent in 2000 over 1999 showed some recovery from the effects
of ruble depreciation and other factors. The U.S. exports to
Russia were only $633 million for January-June 1999. For the
same period of 2000, U.S. exports were valued at $1.23 billion.
The value of U.S. exports to Russia for January-June 2001 was
nearly $1.4 billion. U.S. export levels in 2000 and 2001
remained far below levels achieved each year between 1993 and
1998.
Some Russian demand for U.S. imports has emerged in waves.
First, in the early 1990s came demand for U.S. food products,
followed by strong demand for U.S. consumer products. 1995 saw
a surge in demand for construction materials, hotel and
restaurant equipment, and furniture. Following the 1998 ruble
devaluation and financial crisis, Russian consumers cut back
heavily on many imported consumer and manufactured goods, with
Russian companies benefiting from a cheap ruble and stepping up
production, and quality, to meet increased domestic demand.
Still the Russian demand for core U.S. exports was more
stable. The overall portfolio of leading U.S. exports to Russia
\8\ has remained fairly consistent since the late 1990s,
although the relative importance of some categories of goods
has shifted. The leading U.S. exports to Russia in 2000, in
order of dollar sales were: poultry,\9\ aircraft, oil/gas
machinery and parts, uranium, corn and wheat, computers and
components, beef and pork, telecommunications equipment,
electrical machinery, and other machinery. Meat products (which
shifted from a balance of pork, beef and chicken in the mid-
1990s to predominantly chicken in 2000), and machinery have
remained in the top tier of U.S. exports throughout this
period. Prior to 1998, U.S. prepared foods, including sausages,
were among the strong export categories for the United States--
these categories have been all but absent from U.S. exports
since 1998. The granting by the Russian Government of tariff
waivers on U.S. aircraft generated a record-breaking dollar
value of aircraft exports in 1998; this achievement was not
repeated in 1999 or 2000. U.S. food aid and grain packages
resulted in high volumes of wheat exports in 1999 in
particular, although this dropped in 2000.
---------------------------------------------------------------------------
\8\ Determined according to the dollar value of the exports on the
basis of the first two-digits of HS classification. Using two digits is
a fairly broad way of categorizing products. In contrast, a complete HS
classification for a specific product can be up to ten digits long.
\9\ Specifically, frozen chicken quarters, which came to be known
as ``Bush legs'' in Russia and the CIS for their forceful appearance on
the market during the Presidential Administration of George H.W. Bush.
---------------------------------------------------------------------------
some u.s. imports from russia increased consistently
Russian exports to the United States continue to consist
primarily of raw materials. Platinum (palladium), aluminum,
uranium, oil, seafood (crab and fish fillets), iron/steel,
clothing, and nickel were the most important Russian exports to
the United States in 2000 by dollar value. Although iron/steel
played a larger role in the U.S. import profile from Russia
prior to 1999, as did fertilizers, the general group of items
in this ``basket'' of leading imports has remained fairly
consistent. Clothing was the only finished good export that
showed strongly on Russia's export profile to the United States
in 1998 and 2000.\10\
---------------------------------------------------------------------------
\10\ In 1999 clothing did not make the ``top ten'' list, but vodka
did.
---------------------------------------------------------------------------
Bilateral Investment \11\
---------------------------------------------------------------------------
\11\ Additional information about U.S. investment into Russia is
available in the BISNIS Commercial Overview for Russia, available at
www.bisnis.doc.gov/russia.html.
---------------------------------------------------------------------------
Foreign investors have been attracted to Russia because of
its large domestic market, vast supply of natural resources,
and skilled and well-educated labor force. However, the risks
in the Russian market have kept many investors at bay. Russia's
long-term sovereign rating by the international rating agency,
Standard & Poor's (S&P), is currently B- with a stable outlook,
a rating also given to Turkey and India. While FDI in Russia
far outpaced FDI for CIS countries, foreign investment levels
into Russia in 2000 fell far behind the levels S&P reported for
China ($46 billion) and Eastern European countries such as the
Czech Republic ($5 billion). Meanwhile, many potential domestic
investors have sent their money abroad as ``flight capital.''
Russia reported record-high levels of FDI for 2000,
although Russian estimates for total foreign investment \12\
indicate that the country attracted higher levels of total
investment in 1997 and 1998. Cumulative FDI into Russia as of
January 2001 was $16.13 billion.\13\
---------------------------------------------------------------------------
\12\ Official Russian data on total investment reflects direct +
portfolio + other investment, the latter of which includes trade
credits and foreign loans. Estimates of FDI in Russia can vary widely
by source.
\13\ Note: Cumulative FDI does not equal the sum of annual FDI due
to divestment.
TABLE 2.--ANNUAL FOREIGN INVESTMENT IN RUSSIA, 1993-2000
[All countries, in billions of dollars]
------------------------------------------------------------------------
Foreign
direct Portfolio
Year investment investment
(FDI)
------------------------------------------------------------------------
2000.......................................... $4.43 $0.145
1999.......................................... 4.26 0.031
1998.......................................... 3.36 0.191
1997.......................................... 3.90 3.3
1996.......................................... 2.05 3.2
1995.......................................... 1.50 1.5
1994.......................................... 1.30 2.5
1993.......................................... 1.36 0.300
------------------------------------------------------------------------
Source: BISNIS.
foreign direct investors into russia
The United States has been and continues to be the leading
foreign direct investor into Russia, accounting for nearly 35
percent of all cumulative FDI.\14\ Table 3 indicates the
leading foreign direct investors into Russia according to
cumulative investments as of January 2001.
---------------------------------------------------------------------------
\14\ Germany, which has provided more trade credits and ``other
investments'' has had the highest total investment levels into Russia,
but the United States leads all countries as a foreign direct investor
into Russia.
---------------------------------------------------------------------------
U.S. investors in Russia
Many major U.S. companies have approached Russia with an
eye toward developing a long-term commercial strategy. As
indicated above, U.S. companies are active across many sectors.
While the level of U.S. activity in Russia slowed following the
financial crisis in August 1998, the majority of U.S. direct
investors remained in the country, reportedly to protect
sizable investments and further their long-term prospects.
TABLE 3.--TOP FOREIGN DIRECT INVESTORS IN RUSSIA
[By cumulative investment levels as of January 2001]
------------------------------------------------------------------------
Leading investment
Country Cumulative FDI sectors in 2000
------------------------------------------------------------------------
United States.................. $5.49 billion.... Transportation,
fuel,
communications,
engineering
Cyprus......................... 3.24 billion..... Food,
transportation,
fuel, construction
Germany........................ 1.26 billion..... Advertising/
auditing, food,
forestry
Netherlands.................... 1.18 billion..... Transportation, food
Great Britain.................. 982 million...... Construction
Sweden......................... 610 million...... Communications
France......................... 256 million...... Chemical/
petrochemical
Japan.......................... 215 million...... Fuel
Italy.......................... 160 million...... NA
------------------------------------------------------------------------
NA--Not available.
Source: BISNIS.
The American Chamber of Commerce in Moscow counts some 500
U.S. company members as foreign-directed investors in Russia.
Some of the more well-known U.S. companies who have already
made significant investments developing production capability
in Russia are: Caterpillar (a dealer network in Russia/NIS and
in a factory for road building machinery in Leningrad Oblast),
Coca Cola (bottling and beverage production plants across
Russia), ExxonMobil (oil/gas development), Ford (a factory to
produce the Ford Focus in Leningrad Oblast), General Motors
(multiple production projects), Gillette (shaving accessories
factory in St. Petersburg), ICN Pharmaceuticals (pharmaceutical
production in multiple Russian locations), International Paper
(pulp and paper mill in Leningrad Oblast), Kraft (instant
coffee plant in Northwest Russia), Lucent (telephone line
production), Mars (confectionery and pet food production),
McDonald's (at least 60 restaurant outlets in Russia), Procter
& Gamble (production of detergents and cleaning agents), Xerox
(copiers), and Wrigley (chewing gum production). In addition to
these well-known companies, numerous small- and medium-sized
firms are active in Russia.
Regions attracting foreign investment
According to Goskomstat statistics, Moscow city attracted
the most foreign direct investment in 2000, worth more than
$1.47 billion, or roughly 33 percent of incoming FDI. This is
consistent with the city's overall performance in the years
since 1991. Other top regions for FDI were: Krasnodar Territory
(almost $1 billion), Sakhalin ($246 million),\15\ Leningrad
Oblast (just over $205 million), and Moscow Oblast (just under
$205 million). Novosibirsk, Tyumen, and St. Petersburg city all
received between $145 and $151 million. The Yamal-Nenets
Autonomous District in northern Russia received approximately
$100 million in FDI. Volgograd, Sverdlovsk, Samara, Tatarstan,
and Orenburg each received roughly $50 to $77 million in FDI.
---------------------------------------------------------------------------
\15\ In the summer months, when work on Sakhalin Island's multi-
billion-dollar offshore oil and gas development projects is in full
swing, Sakhalin reports the third-highest U.S. expatriate population in
Russia, after Moscow and St. Petersburg.
---------------------------------------------------------------------------
While U.S. firms have invested heavily in the cities of
Moscow and St. Petersburg and in the Leningrad Oblast, American
companies have also moved beyond these population centers into
Russia's regions. Sakhalin Island, with its multi-billion-
dollar offshore oil and gas projects, reportedly has the third-
largest U.S. expatriate community in Russia during the summer
months. U.S. firms are also heavily invested into Western
Siberia (mostly for oil and gas), Russia's Volga regions, and
elsewhere.
Business Environment Issues in Russia
American firms note a number of issues critical to the
development of Russia's business environment, including
improved corporate governance, a fair commercial tax system,
and an investor-friendly regime for the energy sector. Russian
accession to the WTO.
good governance \16\
---------------------------------------------------------------------------
\16\ To assist U.S. companies and to build Russia's capacity and
institutions of rule of law, the Department of Commerce has developed
several specific programs, including a Handbook on Commercial Dispute
Resolution in Russia, as well as Basic Guidelines for Codes of Business
Conduct which was accompanied by training in the United States. There
are plans to develop a Manual on Enforcement of Arbitration Awards and
Court Judgement and a Corporate Governance Guidebook for Enterprises in
Russia as well. Furthermore, the U.S. Government is providing technical
assistance to help Russian Government agencies to stem the high rates
of intellectual property rights (IPR)-related crime.
---------------------------------------------------------------------------
Good governance is a concept which covers good business
ethics, corporate governance, protection of IPR, and effective
commercial dispute resolution. All of these are institutions of
rule of law for business that are attributes of most successful
economies. An evolution in commercial conditions and business
thinking is motivating some Russian managers to improve
business practices and corporate governance for the purpose of
obtaining business partners, capital, and loans. However, it is
generally recognized that much more needs to be done by the
Russian Government and business community.
Russia has made progress in harmonizing its IPR laws with
international norms, but enforcement of laws and regulations
remains poor and the country has not been able to stem the high
rate of IPR-related infringements. Protection of well-known
trademarks is weak, and the high rate of counterfeiting of
consumer goods has become a major issue for U.S. companies
operating in Russia. Another major problem is enforcement of
commercial arbitration awards and court decisions. Indeed,
notwithstanding awards and decisions in their favor, several
U.S. companies have been mired in long standing battles to have
their judgments enforced.
commercial taxation with international accounting standards (IAS)
Russia's onerous tax laws and their inconsistent
application was the number one complaint of both Russian and
U.S. companies in the 1990s. Since 1993, the U.S. Department of
Commerce has co-chaired a Bilateral Tax Working Group with the
Russian Ministries of Finance and Taxation, which allows the
U.S. tax experts to make recommendations on improving the
commercial tax regime. Many of these recommendations have been
incorporated in the new Russian Tax Code. Overall tax laws have
been significantly improved under the Putin Administration,
with Duma passage of Part II of the Tax Code in summer 2000 and
subsequent actions to reduce the commercial tax burden in
summer 2001. Specifically, the personal income tax rate was
reduced to a flat rate of 13 percent; social taxes on
corporations have been unified; business expense deductibility
has been recognized; and the profits tax has been cut from 35
percent to 24 percent. While reducing the tax burden on
entrepreneurs, these actions have resulted in increased tax
collections. The key issue will increasingly become Russia's
commitment to fair tax administration. American companies still
cite arbitrary and confiscatory actions by tax authorities,
alleging that foreign companies are targeted as ``cash cows.''
In order to develop fair and predictable commercial
taxation Russia needs to adopt IAS. IAS is important to
Russia's effort to attract investment through fair taxation. In
evaluating opportunities, international investors typically
insist on reviewing IAS prepared financial documents so that
they ``know what they are looking at.'' By contrast, Russian
accounting standards have been based largely on identifying, in
some cases, concealing tax obligations. Many of Russia's large,
``blue-chip'' companies have already gone to IAS. This is a
positive development which should be encouraged and broadened
to all companies.
commercial energy development
Despite Russia's vast oil and gas reserves and need for
world class exploration experience and technology, U.S. and
other foreign companies have been unable to commit to large-
scale investments. Due to the long-term nature of major oil and
gas projects, energy companies need to be guaranteed a stable
tax and tariff framework, and assured repatriation of profits
over the life of the project. In many resource-rich countries,
the preferred vehicle for multi-year energy projects is a
production sharing regime, in which the host government and the
foreign company split the production and revenue of a specific
hydro-carbon deposit on an agreed-upon basis. Russia passed a
production sharing agreement (PSA) law in 1996, but
implementing regulations have been stalled for most of the
projects. At this time, the primary impediment is opposition to
PSA by Russia's own energy firms and in the parliament.
russia's accession to the world trade organization (wto)
The Russian Government, under President Putin, has made WTO
membership a priority, stating that Russia would like to join
the organization next year in time to participate in a new
global trade round. The U.S. Government supports Russia's
accession to the WTO on commercially acceptable terms and is
providing technical assistance to help Russia meet membership
obligations. In the current interconnected global economy,
Russia understands that it cannot achieve sustained economic
growth without an open trade and investment framework. Adoption
of the WTO's provisions will complement and reinforce Russia's
broader economic reform program and promote transparency and
the rule of law in trade and investment. To join the WTO,
Russia must implement and enforce the organization's agreements
in such critical areas as IPR, standards and certification,
customs valuation, and industrial subsidies. The adoption of
these WTO rules will promote trade and investment
liberalization and harmonize Russian laws and regulations with
international norms, thereby helping to facilitate access of
U.S. goods and services to the Russian market.
The pace of progress toward eventual membership will be
determined by Russia's actions to adopt WTO rules and to make
commercially meaningful market access commitments in goods,
services and agriculture to other WTO Members. In this regard,
the Russian Government will need to make hard decisions about
the pace of trade liberalization and the extent to which they
will commit to opening up the economy in areas that are
priorities for their major trade partners, including
agriculture, civil aircraft, information technology, financial
services.
u.s.-russian treaty on mutual protection of investments
Russia's ratification of the Bilateral Investment Treaty
(BIT) which was negotiated with the United States in 1992 would
send a positive signal to U.S. investors. The BIT, if
implemented, would guarantee non-discriminatory treatment for
U.S. investments and operations in Russia, hard currency
repatriation rights, expropriation compensation, and the right
to third party international arbitration in the event of a
dispute between a U.S. company and the Russian Government.
While the BIT was ratified by the U.S. Senate in 1992, it still
awaits ratification by the Russian Duma.
Outstanding Trade Issues with the United States
Although Russia continues to enjoy a significant trade
surplus with the United States ($5.5 billion in 2000), the
Russian Government has consistently raised several trade issues
with the U.S. Government, including a desire to be treated as a
Market Economy under U.S. trade law, a request to be freed from
the constraints of the 1974 Jackson-Vanik Amendment, and
increased access for Russian products, including steel, to the
U.S. market.
russia's non-market economy status
The Russians believe that their non-market economy status
makes them more vulnerable to various anti-dumping petitions
under U.S. trade law. However, if Russia is deemed a market
economy under U.S. trade law, they will no longer be able to
negotiate quota based anti-dumping suspension agreements with
the U.S. Government and will be subject to possible
countervailing duty actions.
trade implications of the trade reform act of 1974 jackson-vanik
amendment
The Russian Government sees continued application of the
1974 Jackson-Vanik Amendment as trade-disruptive and a relic of
the cold war. In practice, Jackson-Vanik does not restrict
trade as Russia currently enjoys conditional Normal Trade
Relations status with the United States and for some time has
been found to be in full compliance with the emigration
requirements of the legislation. Termination of the application
of Jackson-Vanik clause of U.S. law and granting Russia PNTR
status will require Congressional action. Congress will likely
review PNTR for Russia as Russia moves closer to joining the
WTO, as has been the case for other acceding countries, such as
Kyrgyzstan and Georgia.
1999 steel agreements
Russian steel exports to the United States are currently
subject to three agreements: Agreement Concerning Trade in
Certain Steel Products from the Russian Federation
(Comprehensive Agreement); Suspension of Antidumping Duty
Investigation: Certain Cut-to-Length Carbon Steel Plate from
the Russian Federation; Agreement Suspending the Antidumping
Investigation on Certain Hot Rolled Flat-Rolled Carbon Quality
Steel Products from the Russian Federation. The Russian
Government has indicated that they seek renegotiation of the
1999 Agreements to increase the access of Russian steel to the
U.S. market.
Prospects for Trade and Investment
The history of U.S.-Russian commercial engagement has been
one of small trade and investment with periodic hopes raised
for increases that were consistently dashed by trade and
investment restrictions. Now, for the first time in the long
history of U.S.-Russian commercial relations, including the
Soviet period, there is an expectation of a substantial and
enduring commercial relationship between the two countries. If
this were to occur, it would represent an historic turning
point in the bilateral commercial relationship and represent a
major factor in the overall relationship. The prospective
development is based on official policy and national interest
declarations from both the U.S. and Russian leadership,
projected improvement in the business environment in Russia,
and a new mechanism for promoting commerce based on private
sector initiatives in each country.
However, stated policy and expression of national interest
would have to be translated into concrete changes in the
business environment and market access in both countries.
Improved business environment in Russia requires substantial
implementation of Putin's institutional reform and introduction
of market-friendly systems that reduce risk in investment and
foster competition in trade. U.S. business enterprises look for
improved corporate governance, a commercial tax system,
commercial energy development, adherence to bilateral
commercial treaties and agreements and substantial progress
toward accession to the WTO. Russian business interests look to
their American counterparts for reduced trade barriers, such as
removal of restrictions on most-favored-nation trade, improved
access to the U.S. market, promotion of commercial development
of energy production, and development of assistance through a
favorable official credit policy.
The tradition of Russian and Soviet trade and investment
has been high on hopes for substantial increases in commerce
and low on favorable, enduring results. Severe setbacks, such
as the default on Russian debt and securities in the 1998
financial crisis have been characteristic of the past
commercial relations. Prudence by policymakers requires
evidence of concrete changes in the bilateral business
environments and performance. Even with U.S. sponsorship and
Russian priority for joining the WTO, U.S. policymakers may be
cautious in assuming that by steps toward accession Russia will
effectively join the global capital and commercial market and
develop a new bilateral commercial relationship with the United
States.
Notwithstanding these cautions, there are a number of
reasons to be optimistic about the prospects for the U.S.-
Russian commercial relationship over the next several years.
First, both the Bush and Putin Administrations have
demonstrated their commitment to taking business cooperation to
the next level. Indeed, as a result of recent high-level
meetings, the two governments are already pursuing practical
solutions to achieve measurable results. A checklist of issues
and corresponding time line is being developed, including
advancing work on Russia's WTO accession, consulting on the
market economy status for Russia, and exploring new Export-
Import Bank financing programs.
Second, while in the past West European countries have been
the major trading partners and promoters of commerce with
Russia, the new Russian-American business dialogue is designed
to provide an initiative for development of a major, perhaps
leading, American commercial relationship with Russia. The
Russian business community clearly recognizes the advantages of
developing commercial ties with the United States, which is the
dominant source of international capital, the world's largest
market, and a global technology leader. For the U.S. business
community, Russia, despite the frustrations, remains a market
of considerable potential, especially beneficial at a time of
domestic economic downturn in the United States. The new
Russian-American business dialogue may engender greater
familiarity and trust between the respective business
communities opening the way for new joint commercial projects,
particularly among the small- and medium-sized businesses.
Third, Russia's economy is growing and offering new market
opportunities. Russia's economic reform program is only now
beginning to gain traction, and it is not unreasonable to posit
that conditions will improve if reforms are expanded and
implemented.
On the other hand, expected advancement of U.S.-Russian
trade and investment may not be forthcoming if past patterns of
uncertainties and instability of bilateral commercial relations
return. The path to increased trade and investment is full of
hurdles. Most notably, Russia's business climate and culture
still does not yet inspire broad U.S. investor confidence.
Changing this perception may not be a short term proposition.
Russia may yet give in to impulses toward economic nationalism
and protectionism. Trade disagreements, for example, over
Russian exports of steel to the United States could cloud the
commercial relationship. Other advanced industrial countries,
particularly the Europeans, may more aggressively compete for
the Russian market. Russia's economy remains vulnerable to
external shocks, such as a significant drop in oil prices and/
or a major global recession, that may impede bilateral
commercial development.
Nevertheless, at this time, both governments expect
progress. At a strategic level, a more robust commercial
relationship is in the interests of both countries, business
communities and governments alike. U.S. companies stand to gain
substantial profit if significant new commercial opportunities
are realized. For the Governments of Russia and the United
States, increased bilateral business holds the promise of
stabilizing the overall bilateral relationship.
RUSSIA AND THE INTERNATIONAL FINANCIAL INSTITUTIONS: FROM SPECIAL CASE
TO A NORMAL COUNTRY
By Jonathan E. Sanford \1\
----------
contents
Page
Summary.......................................................... 426
Overview......................................................... 427
A Decade of Special Consideration................................ 428
Prelude and overture......................................... 428
Special association...................................... 428
What is to be done....................................... 428
The 1992 shadow program.................................. 429
Russia joins the IFIs........................................ 431
IFI operations in Russia..................................... 431
The IMF.................................................. 431
The World Bank........................................... 432
The European Bank for Reconstruction and Development
(EBRD)................................................. 434
Composition of the IFI assistance programs................... 435
The IMF.................................................. 436
The EBRD................................................. 437
The IFC.................................................. 438
Five Stages in the Transition from Special Case to Normal Country 439
Disburse regardless: 1992-1994............................... 440
Synopsis................................................. 440
IMF Programs: 1992-1994.................................. 441
World Bank programs: 1992-1994........................... 444
Disburse with compliance: 1995............................... 445
Synopsis................................................. 445
IMF operations: 1995..................................... 445
World Bank operations in Russia: 1995.................... 447
Disburse despite resistance: 1996-mid 1998................... 447
Synopsis................................................. 447
IMF programs: 1996-1998.................................. 448
World Bank programs: 1996-1998........................... 450
Commit in the face of crisis: 1998........................... 453
Synopsis................................................. 453
IMF programs: 1998....................................... 453
World Bank programs: 1998................................ 455
Reconsideration: 1999-2001................................... 457
Synopsis................................................. 457
IMF programs: 1999-2001.................................. 457
World Bank programs: 1999-2001........................... 458
Treating Russia as a Normal Country.............................. 459
Concluding Comments.............................................. 462
---------------------------------------------------------------------------
\1\ Jonathan E. Sanford is a Specialist in International Political
Economy in the Foreign Affairs, Trade and Defense Division of the
Congressional Research Service.
---------------------------------------------------------------------------
Summary
The international financial institutions (IFIs)--the
International Monetary Fund (IMF), World Bank, and European
Bank for Reconstruction and Development (EBRD)--provided
substantial levels of assistance and policy advice to Russia
during the past 10 years. Between 1992 and 2001, the IMF and
the multilateral development banks (MDBs) approved programs of
financial assistance for Russia which totaled altogether about
$59 billion. Of this, $32.5 billion was disbursed, $24.6
billion was canceled, and the rest is awaiting disbursement as
projects are implemented. All of the money lent by the IMF took
the form of balance-of-payments support tied, to varying
degrees, to plans for macro-economic and structural reform. For
the World Bank, over half the money it agreed to lend and
nearly two-thirds the amount it disbursed went for similar
purposes. Many of the World Bank's project loans have been slow
getting underway due to difficulties finding an effective
policy environment for their implementation. Many of the issues
which are the focus of these loans--enterprise reform, reform
in the financial system, corporate governance and the legal
framework, etc.--are matters on which there remains
considerable disagreement between reformers and their
opponents. Most of the assistance from the EBRD and from the
International Finance Corporation (IFC)--the World Bank's
private sector aid facility--has gone to strengthen private
firms and promote growth of the private sector. The EBRD and
IFC have had less difficulty implementing their projects
because these are not directed at core policy issues but rather
at private sector growth.
Until 1999, with the strong support of the United States
and other major member countries, the IFIs treated Russia as a
special case. The standards and guidelines for assistance to
Russia were more relaxed and flexible than those applied to
other countries at a similar stage of development Only one non-
member country--the Soviet Union--ever had ``special
association'' status with the IMF and World Bank and had a
major program of technical assistance committed for its behalf.
No other country besides Russia had a shadow program with the
IMF in place before it became a member. No other group of
countries--Russia and the other struggling former Communist
countries--had a special loan account created for them in the
IMF offering loans with such little conditionality. No other
country, considering its relative size--a gross domestic
product (GDP) barely larger than Turkey, smaller than Argentina
and half the size of Mexico and Brazil--received such a
disproportionately large amount of money and bulked so large
upon the agenda of the IFIs. No other country received large
and increasing loan commitments from the IMF and World Bank at
the same time that it was failing conspicuously to meet the
full performance requirements of its earlier loans.
The IFIs sought through their programs to strengthen the
hand of the Russian reformers and to promote macro-economic and
structural reform in Russia. During the early years, the
establishment of macro-economic stability was the primary goal
and structural reform--change in the basic way the economy is
organized and its underlying operational principles--was an
important but secondary concern. During the latter part of the
1990s, however, the IFIs put increased emphasis on structural
reform. In 1999, the IMF and World Bank canceled most of their
big loan programs for Russia and they shifted their basic
approach. It appears that dissatisfaction with the slow
progress Russia was making with many key types of structural
reform was as great, if not a greater, consideration in 1999
than was Russia's uncertain macro-economic situation.
Today, the IFIs and their major member countries
increasingly view Russia as a ``normal'' country, that is to
say, a country that does not need special standards and special
dispensations. As with most middle-income developing countries,
Russia has major problems and it needs substantial reforms in
the structure and operating principles for its economy. No
large programs of balance-of-payments assistance are planned,
however, and most MDB projects are likely to focus on specific
projects aimed at improving social conditions, promoting
institutional reform, or encouraging policy change in specific
well defined situations. Russia's current macro-economic
situation is such that it does not need new IFI stabilization
or structural adjustment loans (SALs). Given its performance
with structural reform in prior loans--the substantial overhang
of as-yet unsatisfied commitments--Russia is unlikely to
qualify for such loans even if it needed them. The size of the
EBRD and IFC's assistance programs in Russia will likely
depend, in future years, on the level of interest shown by
foreign investors and the private sector. The size and focus of
the IMF and World Bank's future assistance programs in Russia
will likely depend, by contrast, on the types of reforms the
Putin government puts into effect.
Overview
There are four principal parts to this paper. The first
provides an overview of the IFI's operations in Russia. The
composition of their programs are discussed in some detail. The
second part discusses the course of events during the 1990s,
the way the IFIs sought to balance their enforcement of
conditionality with their desire to provide levels of
assistance to Russia sufficient to keep the hope and effort
toward reform underway. The five stages of the process are
labeled here as follows: disburse regardless, 1992-1994;
disburse with compliance, 1995; disburse despite resistance,
1996-1997; commit in the face of crisis, 1998; and
reconsideration, 1999-2001.
The third section relates the IFI's views on their
experience with Russia. As it indicates, the concept that
Russia is a ``normal'' country does not imply that it is a
country without major problems. Rather, it is a country whose
situation is no longer unique and whose problems resemble those
seen in many other developing countries. The fourth section
provides some concluding remarks.
This paper makes extensive use of public documents
available from the IFIs. It also uses some information obtained
through interviews.
A Decade of Special Consideration
prelude and overture
Special association
Since 1987, under Chairman Gorbachev, the Soviet Government
had been pursuing--against considerable internal resistance--a
program aimed at restructuring (perestroika) the Soviet
economy. In 1990, the Soviet Union was in the midst of a deep
financial and economic crisis and Gorbachev reached out to the
West for advice and assistance in dealing with the situation.
At their summit meeting in Houston, in June 1990, the leaders
of the G-7 countries commissioned the World Bank, Organization
for Economic Cooperation and Development (OECD), EBRD, and IMF
to do a study of the Soviet economy. Issued in early 1991, the
four agency study recommended a comprehensive program of
reform. This included the early and comprehensive decontrol of
prices, restructuring of the financial system, clarification of
property rights, and commercialization and privatization of
industry. It also included trade and investment liberalization,
labor market liberalization, and the creation of an affordable
social safety net. The West would provide technical and project
assistance and food aid to help facilitate Soviet economic
reform.
On October 5, 1991, the IMF and Soviet Union signed an
accord giving the U.S.S.R. ``special association'' status with
the IMF. A similar agreement with the World Bank was signed on
November 5. Because it was not a member, the Soviet Union could
not borrow from the two agencies. However, the IMF and World
Bank agreed to provide technical assistance and advice to help
the Soviets stabilize their economy, improve their system for
gathering statistics, reform the banking system, and strengthen
their social safety net. On August 27, the Bank's executive
board created a $30 million special trust fund (using some of
the Bank's net income) to support technical cooperation
programs in the U.S.S.R. during the next 2 years. Most of the
funds were reportedly committed late in the year and not spent
until later. Russia and three other republics eventually signed
the agreement. Until October, according to IMF sources, the
Soviet Government insisted that the IFIs deal with and through
the Soviet Government.\2\ Later, as the handwriting on the wall
became increasingly clear, the IFIs began direct talks as well
with Russia and the other republics.
---------------------------------------------------------------------------
\2\ Interview with John Odling-Smee, Director of the IMF department
responsible for the former Soviet Union, June 14, 2001. On October 14,
the IMF Interim Committee said that assistance would be available ``to
assist the [U.S.S.R.] authorities in moving forward with urgently
needed economic stabilization and structural reforms.'' IMF Annual
Report, 1992. Interim Committee Press Communique, October 14, 1991, p.
126.
---------------------------------------------------------------------------
What is to be done
On October 28, 1991, President Boris Yeltsin delivered a
speech to the Russian Congress of Peoples' Deputies and the
Russian people outlining his plans for radical economic reform
and the transition from state socialism toward capitalism and a
market economy. ``I appeal to you at one of the most critical
moments in Russian history,'' he said. ``Right now it will be
decided what kind of country Russia will be in the coming years
and decades.'' At the time, Russia was not yet an independent
country but the Soviet state was rapidly withering away.
The central focus of Yeltsin's new economic program was
stabilization and economic freedom. Strictly speaking, it was
not to be a ``big bang'' or ``shock therapy'' approach, since
by intention (and by actual events) its provisions were phased
in over a period of time. The macro-economic portion of the
plan was an orthodox stabilization program emphasizing price
liberalization and strict budgetary policy. Major cuts would be
made in the budget deficit, state administration, and subsidies
for enterprises. A fixed exchange rate would be established for
the ruble, Yeltsin said, and it would be made convertible.
Restrictions on foreign trade and investment would also be
lifted. Privatization of small- and medium-sized enterprises
would be a priority and he hoped that one-half could be
privatized within 3 months.
Yeltsin's speech showed the direction in which he wanted
the economy to move. On many key issues, though, it was vague.
He said the country's tax system should be put in order, but
there was no mention of the plummeting rate of tax collections.
He said there should be more competition and a break-up of
monopolies, but there was no discussion of corporate governance
or fundamental change in the structure of state industry. The
banking system should be reformed, but there was no mention of
privatization or new systems of regulation. Monetary and credit
policy should be strictly controlled, but there was no
indication whether he believed the ruble zone should be
continued or dissolved or how the Central Bank of the Russian
Federation (Central Bank of Russia or CBR) would be brought
under government control. Yeltsin admitted that the process of
change would be painful and that ``today in the severest crisis
we cannot carry out reform painlessly.'' Living standards would
decline and it ``will be worse for everybody for about half a
year.'' Afterward, though, he said, prices would fall and the
markets would be full of goods. By fall 1992, he said, ``as I
promised before the elections, the economy will stabilize and
people's lives will gradually improve.''
The 1992 shadow program
Yeltsin called, in his October speech, for the outside
world to come to Russia's aid. ``We turn officially to the IMF,
the World Bank, the European Bank for Reconstruction and
Development and invite them to elaborate detailed plans in
cooperation and participation in economic reforms. He appealed
for developed countries and international organizations to
provide technical assistance and policy recommendations.
``Russia carries out its reforms in its own interests,'' he
indicated, ``and not under external pressure. Help from the
world community can facilitate our movement along this road
considerably and accelerate the reforms.'' Yeltsin promised the
West whatever information or collaboration it would desire.
The same day that Yeltsin spoke, the deputy finance
ministers of the G-7 countries and representatives of eight
Soviet republics, including Russia, signed a memorandum of
understanding (MOU) allowing a moratorium on principal payments
for Soviet debt owed to the G-7. Under the terms of the MOU,
the moratorium could not extend beyond March 31, 1992 unless
the IMF approved a shadow program for Russia.
It is very rare, if not unprecedented, for the IMF to
negotiate a shadow program with a country that is not a member
of the organization. Shadow programs are not unusual. Countries
may negotiate such arrangements with the IMF when they do not
need (or could not qualify) for loans but they wanted to
demonstrate (through IMF endorsement) the basic soundness of
their economic policies. The shadow program allowed the Russian
Government to announce a package of economic policies which had
the IMF's active endorsement. Among other things, this was
supposed to create some basis for international confidence in
Russian policy. It was also intended to assure the country's
creditors that any resources saved through debt relief would
not be dissipated through bad economic policies. The shadow
program was not a condition for Russian membership in the IMF.
However, most people assumed it was a condition for future IMF
assistance. The G-7 also made it clear, when they announced on
April 1 their $24 billion assistance package, that Russia
needed to qualify for a regular IMF standby loan before it
could gain access to those resources.
Agreement on the terms of the shadow program had been
greatly eased by Yeltsin's prior announcement that the road to
transition for Russia should lead through fundamental reforms
to a new market-oriented economic system. There might have been
little room for discussion between the Yeltsin government and
the IMF if he had advocated some ``third way'' between the
market and central planning or a more democratic continuation
of the old system of state economic control. On February 27,
after discussions with the IMF, the Russian Government
announced that it was putting a new economic program into
effect. A few days later, on March 31, the IMF endorsed the MOU
embodying the government's plan. In many ways, the economic
blueprint embodied in the shadow program was the first real
economic plan the government had adopted. It was more specific
than the government's prior announcements and it addressed a
number of key issues on which the government had been vague in
the past.
Most of the provisions of the shadow program were based,
however, on plans or policy goals the government had announced
earlier. It said that inflation would be reduced and the
government's budget deficit would be cut to 1 percent of GDP,
mainly through reductions in military spending and subsidies to
enterprises. The government would adopt a program of targeted
social subsidies to help the worst off and unemployed. CBR
monetary and credit policies would be tightened. Most remaining
price controls on goods and services would be lifted by the end
of March, except for rents, transport, and domestic gas and
energy. (The government had removed price controls for most
products in January.) Domestic oil prices would be freed on
April 20. The value added tax (VAT) of 28 percent--introduced
in January but later withdrawn--would be restored and would be
applied to imports after July 1. A unified regime of export
taxes on energy and raw materials would be established. A
progressive tax on pay increases by state firms, which exceeded
specific norms, would be levied. In June, as promised, the
Russian Government created a unified exchange rate for the
ruble, dropping the old system of multiple exchange rates. In
November 1992, the ruble was made convertible for Russian
residents' foreign trade transactions.
russia joins the ifis
The Soviet Union never joined the World Bank or the IMF. It
was a founding member (1991) of the EBRD, but by agreement the
amount it could borrow from the EBRD was no larger than the
amount it had contributed. In January 1992, the Bush
Administration announced that it supported membership by Russia
and the other former Soviet republics in the IFIs.
In early May 1992, soon after the IMF had endorsed the
Russian shadow program, the executive boards of the IMF and
World Bank invited Russia and the other former Soviet republics
to join. Russia became a full member of the both institutions
in June, with seats of its own on their executive boards. It
received a 3.2 percent quota share in the IMF, making it the
ninth largest member. It got a 1.82 percent voting share in the
International Bank for Reconstruction and Development (IBRD),
the World Bank's near-market-rate loan facility, making it--
along with Brazil--the fourteenth largest member. Russia joined
the Bank's other affiliates at this time. The amount a country
may borrow from the IMF is determined by the size of its quota.
This is not so for the multilateral banks. In early 1992, the
Soviet Union ceased being a member of the EBRD and the 12
successor states became members in their own right. (The three
Baltic states joined in 1991.) Russia got a seat of its own on
the EBRD board.
ifi operations in russia
The IMF
Between 1992 and 1999, as Figure 1 illustrates, the IMF
approved six loans to Russia with a total value of SDR (special
drawing rights) 33.73 billion (about $42.69 billion by the
current exchange rate). Of this, half (SDR 16.16 billion or
$20.45 billion) was disbursed. Access to the rest was
terminated due to non-compliance with loan terms.
FIGURE 1._IMF LENDING TO RUSSIA
[Special drawing rights (SDR) in millions]
[GRAPHIC] [TIFF OMITTED] T6171.049
The World Bank
Likewise, during the same period, as Figure 2 indicates,
the World Bank approved loans to Russia totaling $12.21 billion
from the IBRD. It also approved $412 million in loans or equity
investments from the IFC, its private sector assistance
facility, as well as $249 million in guarantees for foreign
investment through the Multilateral Investment Guarantee Agency
(MIGA). The IBRD makes loans to government agencies or with
government repayment guarantees on near-market-rate terms. As
Figure 3 indicates, more than one-third of the funds approved
for IBRD loans to Russia have not yet been disbursed. According
to data provided by the World Bank's office in Moscow, $2.79
billion of the total was canceled. The remaining $1.75 billion
is awaiting disbursement as work on the relevant projects or
programs goes forward. Table 1 lists the projects the IBRD
approved in Russia in the past decade and the disbursement
status for each.
FIGURE 2._WORLD BANK AID TO RUSSIA (COMMITMENTS)
[GRAPHIC] [TIFF OMITTED] T6171.046
FIGURE 3._IBRD LOANS TO RUSSIA (COMMITMENTS AND DISBURSEMENTS)
[GRAPHIC] [TIFF OMITTED] T6171.047
TABLE 1.--WORLD BANK LENDING TO RUSSIA, 1992-2001
[In millions of U.S. dollars]
----------------------------------------------------------------------------------------------------------------
Date Purpose Status Commitment Canceled Undisbursed
----------------------------------------------------------------------------------------------------------------
8/5/92...........................-----------IMF approves first credit tranche loan------------------------------
----------------------------------------------------------------------------------------------------------------
8/06/92.......................... Rehabilitation 1..... Closed............. $600.0 ........ 0.0
11/24/92......................... Employment Services/ Closed............. 70.0 $14.4 0.0
Social Protection.
12/17/92......................... Privatization Closed............. 90.0 4.0 0.0
Implementation
Assistance.
6/17/93.......................... Oil Rehabilitation 1. Closed............. 610.0 196.0 0.0
----------------------------------------------------------------------------------------------------------------
6/30/93.......................... IMF approves Systemic Transformation Facility (STF) loan, releases first
tranche
----------------------------------------------------------------------------------------------------------------
2/17/94.......................... Highway Closed............. 300.0 19.2 0.0
Rehabilitation &
Maintenance.
----------------------------------------------------------------------------------------------------------------
3/22/94.......................... IMF releases second tranche of STF loan
----------------------------------------------------------------------------------------------------------------
5/19/94.......................... Financial Active............. 200.0 59.5 $66.7
Institutions.
Development.
6/16/94.......................... Ag Reform Extended........... 240.0 118.2 4.1
Implementation
Support.
6/16/94.......................... Land Reform Active............. 80.0 ........ 41.8
Implementation.
Support.
6/21/94.......................... Enterprise Support Active............. 200.0 ........ 163.1
Project.
6/29/94.......................... Oil Rehabilitation 2. Closed............. 500.0 153.4 0.0
11/8/94.......................... Environment Active............. 110.0 ........ 55.5
Management Project.
12/15/94......................... Management and Closed............. 40.0 ........ 0.0
Financial Training.
2/16/95.......................... Portfolio Development Active............. 40.0 ........ 19.0
Project.
3/7/95........................... Housing.............. Active............. 400.0 150.7 71.5
3/9/95........................... Tax Administration Closed............. 16.8 0.1 0.0
Modernization.
----------------------------------------------------------------------------------------------------------------
3/11/95.......................... IMF approves first regular standby loan
----------------------------------------------------------------------------------------------------------------
4/25/95.......................... Emergency Oil Spill Active............. 99.0 ........ 5.2
Rehab/ Mitigation.
5/2/95........................... Energy Efficiency Active............. 106.5 36.5 51.0
Project.
5/16/95.......................... Urban Transport...... Active............. 329.0 77.6 4.4
6/6/95........................... Rehabilitation 2..... Closed............. 600.0 ........ 0.0
11/30/95......................... Standards Development Extended........... 24.0 ........ 3.7
----------------------------------------------------------------------------------------------------------------
3/26/96.......................... IMF approves first extended fund facility (EFF) loan
----------------------------------------------------------------------------------------------------------------
3/28/96.......................... Bridge Rehabilitation Active............. 350.0 195.3 30.3
Project.
4/30/96.......................... Community Social Active............. 200.0 56.5 78.3
Infrastructure.
5/7/96........................... Enterprise Housing Active............. 300.0 43.6 215.8
Divestiture.
5/30/96.......................... Capital Market Active............. 89.0 33.8 35.9
Development Project.
6/4/96........................... Medical Equipment Closed............. 270.0 46.5 14.1
Project.
6/13/96.......................... Legal Reform Project. Active............. 58.0 ........ 32.6
6/27/96.......................... Coal Sector Closed............. 500.0 ........ 0.0
Adjustment 1.
6/27/96.......................... Coal Sector Active............. 25.0 ........ 8.8
Restructure
Implement Asst.
3/27/97.......................... St Petersburg City Active............. 31.0 ........ 7.5
Ctr Rehabilitation.
6/5/97........................... Education Innovation. Active............. 71.0 3.0 57.6
6/5/97........................... Health Reform Pilot Active............. 66.0 ........ 49.6
Project.
6/5/97........................... Bureau of Economic Active............. 22.6 ........ 6.8
Analysis Project.
6/5/97........................... Enterprise Closed............. 85.0 85.0 0.0
Restructuring
Services Project.
6/5/97........................... Structural Adjustment Closed............. 600.0 ........ 0.0
Loan (SAL) 1.
6/5/97........................... Electricity Sector Active............. 40.0 ........ 37.9
Reform Support
Project.
6/25/97.......................... Social Protection Closed............. 800.0 ........ 0.0
Adjustment Loan
(SPAL).
10/7/97.......................... Social Protection Active............. 28.6 ........ 18.0
Implementation
Project.
12/18/97......................... Coal Sector Active............. 800.0 ........ 150.0
Adjustment Loan 2.
12/18/97......................... SAL2................. Closed............. 800.0 ........ 0.0
----------------------------------------------------------------------------------------------------------------
7/20/98.......................... IMF approves second EFF loan and Compensatory and Contingency Financing
Facility (CCFF) loan
----------------------------------------------------------------------------------------------------------------
8/6/98........................... SAL3................. Closed............. 1,500.0 1,100.0 0.0
12/22/98......................... Highway Closed............. 400.0 400.0 0.0
Rehabilitation &
Maintenance 2.
5/13/99.......................... State Statistical Active............. 30.0 ........ 29.0
System Development.
----------------------------------------------------------------------------------------------------------------
7/28/99.......................... IMF approves second standby loan
----------------------------------------------------------------------------------------------------------------
12/22/99......................... Regional Fiscal TA Active............. 30.0 ........ 28.0
Project.
5/23/00.......................... Sustainable Forestry Active............. 60.0 ........ NYE
Project.
12/21/00......................... Water Supply and Active............. 122.5 ........ NYE
Sanitation Project.
2/6/01........................... Moscow Urban Active............. 60.0 ........ NYE
Transport Project.
3/27/01.......................... Municipal Heating Active............. 85.0 ........ NYE
Project.
5/24/01.......................... Education Reform Active............. 50.0 ........ NYE
Project.
6/7/01........................... Northern Active............. 80.0 ........ NYE
Restructuring Pilot
Project.
----------------------------------------------------------------------------------------------------------------
Not Yet Effective. Loan approved by executive board but final contract is not
yet signed.
----------------------------------------------------------------------------------------------------------------
The IFC makes loans to and equity investments in firms in
developing countries in order to promote growth and strengthen
the private sector. It also provides technical assistance and
other forms of operational advice. It does not require
government guarantees, and it charges essentially market rates
for its aid. At some point, when a firm has grown and its stock
has appreciated in value, the IFC will sell it shares. If the
IFC is an investment bank, the MIGA is an insurance company. It
guarantees investors, for a fee, against various types of non-
economic risk, such as expropriation, restrictions on
international currency transfer, and damage from war or civil
strife.
The European Bank for Reconstruction and Development (EBRD)
The EBRD reports that, between 1991 and 2000, it approved
loans or equity investments for Russia totaling =3.41 billion
(about $4.43 billion according to the dollar/euro exchange rate
for 1995 and $2.79 billion according to the rate for 2000). Of
this amount, about =733 million is awaiting disbursement and a
major portion of the balance appears already to have been
repaid. The EBRD charges commercial or near-commercial rates
for its loans and does not require government guarantees. The
current official figures are somewhat at variance with data
taken from the EBRD annual reports. When aggregated, the annual
figures show that the EBRD approved =4.32 billion in assistance
to Russia (about $5.61 billion by the 1995 exchange rate and
$3.97 billion by the 2000 rate). The difference between this
and the total published by the EBRD is probably explained by
cancellations or by funds which were not needed for the
completion of approved projects. It is impossible to determine
the years to which the difference should be assigned. Figure 4
shows the annual amounts the EBRD approved for Russia during
the 1990s.
FIGURE 4._EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT (EBRD)
ASSISTANCE TO RUSSIA
[In millions of euros]
[GRAPHIC] [TIFF OMITTED] T6171.048
composition of the ifi assistance programs
Most of the programs the IMF and World Bank supported in
Russia during the past decade sought to promote macro-economic
stability and structural reform. All of the IMF's loans have
supported these goals and provided balance-of-payments support.
The IMF does not fund projects. For the World Bank, in terms of
the number of loans, most of those for Russia went for
investment projects or programs of technical assistance and
institutional reform. In terms of the amounts of money lent
overall, however, most of the Bank's assistance to Russia took
the form of balance-of-payments support aimed at promoting
broad-based reform in Russia's economic policies and the
structure of its economy. Figure 5 shows that between 1992 and
2001, over half the funds IBRD committed and nearly 65 percent
the funds it disbursed went to these ``big picture'' loans.
Loans to strengthen the oil and gas industry (a major source of
exports and tax revenue) comprised another 10 percent of the
approvals and 11 percent of disbursements. Loans promoting
change in the organization and operations of industry, the
financial sector, the housing market, agriculture and land
ownership, and technical procedures accounted for about 16
percent of commitments and 10 percent of disbursements.
FIGURE 5._IBRD LOANS TO RUSSIA
[GRAPHIC] [TIFF OMITTED] T6171.050
For most active World Bank projects, a large part of the
undisbursed balance will be paid out eventually as
implementation proceeded. By contrast, most of the ``big
picture'' adjustment loans approved in the past decade were
fast disbursing, the proceeds being made to the borrower as
each loan allotment or tranche became effective. Bank-funded
investment projects may take 8 to 10 years for full completion.
The proceeds from the loan are gradually disbursed as work on
the project is completed and the bills from contractors or
suppliers are received. Most disbursements occur during the
middle years of that period. It is worth noting, though, that
many of the projects for Russia approved in the early 1990s--
for example, the loans for financial institutions development,
land reform, enterprise support, environmental management, and
housing in 1994--have used only a small portion of the amounts
originally approved. In several cases, a large portion of the
loan commitment was later canceled due to changes in context or
problems in implementation. In some cases, it seems the Bank is
still waiting for the government to take steps or to implement
policies which it endorsed in the original loan agreement. In
some instances, it appears that necessary legislation has not
yet been passed making it eligible for release.
The IMF's programs generally specified the overall goals
and priorities for macro-economic and structural reform in
Russia. The Bank's adjustment loans often reinforced those
objectives and sought to apply them in particular areas. Many
of the Bank's projects loans also addressed issues of
particular concern. These included, in addition to enterprise
reform, privatization, and capital markets development, other
concerns such as agricultural reform and improvements in tax,
legal, and technical systems. The World Bank had considerable
difficulty implementing many of these loans. (See the amounts
canceled or not yet disbursed on Table 1.) This reflects the
problems the IFIs have encountered generally in their efforts
to promote structural reform in Russia.
The IMF
The principal goals of the IMF's programs in Russia
included fiscal reform (controlling expenditures, increasing
tax collections, reducing the budget deficit), monetary
stabilization (reducing the rate of inflation), and a series of
structural reforms (for instance, accelerating privatization,
restructuring the banking and finance systems and corporate
governance, and implementing legal reform). The Bank's
adjustment programs in Russia had similar goals.
Stabilization and adjustment loans provide a direct
infusion of foreign exchange. This helps bolster a country's
balance of payments, relieving pressure and potentially
promoting growth. However, this is only a temporary effect. The
underlying concept behind these loans is the expectation that a
borrower country can improve its economic situation only if it
makes basic changes in its macro-economic policies and it
adopts structural reforms to enhance the efficiency and
productivity of its economy. In effect, a country cannot reach
its goals unless it is willing to change its course. Generally,
the key government authorities in the borrower country want to
make these changes (that is, they have some degree of
``ownership'' of the project plan.) However, they often face
stiff resistance from other power centers in their country's
decisionmaking system. Some of the proceeds from the loan are
available right away. The remainder is available only when the
borrower country achieves certain pre-set reforms or
performance standards. Such conditionality meets both the
lender and the borrower's needs. The lender knows that the
agreed goals of the program are being achieved and the borrower
knows in advance that it will receive access to additional
funds if it does certain specified things. Among other things,
this presumably helps to strengthen the hand of the reformers
in their country's internal policy debates.
The EBRD
By contrast with the programs supported by the IMF and
IBRD, most of the assistance provided to Russia by the EBRD,
IFC, and MIGA has sought to encourage the growth of the private
sector and to strengthen private firms. According to data
provided by the EBRD, less than 18 percent of the funds
committed through June 30, 2001 for Russia went to state
institutions.\3\ This includes 8 loans to firms predominantly
owned by government and three to government agencies. It also
appears to include loans to firms which have been privatized
but where (for example, many natural monopolies) the government
still own a significant share of the stock.
---------------------------------------------------------------------------
\3\ EBRD signed projects in Russia (table) as of 30 June 2001.
Available from the EBRD Web site at http://www.ebrd.org/english/opera/
country/rusproj.htm under the general heading ``EBRD signed projects in
Azerbaijan.''
---------------------------------------------------------------------------
Initially, the EBRD put strong emphasis on technical
assistance in connection with its loans and investments. By
late 1993, though, it had shifted its attention mainly to
projects. The EBRD began its operations in Russia expecting to
finance projects throughout the Federation. However, with
experience, it shifted plans and consciously focused much of
its assistance to regions more open to reform and foreign
investment. It has also limited the scope of its activities to
areas where it believed it has a comparative advantage.
Figure 6 shows (without regard to public or private
ownership) the sectors of the Russian economy that received
EBRD assistance. The finance sector got the largest share (29
percent). The EBRD put much effort into strengthening Russian
banks, finance and insurance companies and in facilitating new
entries (mostly foreign) in this area.
FIGURE 6._THE EBRD'S RUSSIAN PORTFOLIO
[GRAPHIC] [TIFF OMITTED] T6171.045
Major shares have also gone to the oil and gas sector (19
percent) and manufacturing (19 percent). The latter includes
privatization, food, and agro-industry. Most of the EBRD's
approvals for oil and gas production took place in the first
half of the decade, when Russia's balance-of-payments situation
was very tight. Most of the EBRD's loans or equity investments
in manufacturing were approved after 1995. All loans for mining
were aimed at the extraction and production of metals. None
were made for coal. The EBRD did not specify the sector for
several loans it had approved for Russia.
The EBRD manages a Russia Small Business Fund which
provides funding to small and medium size enterprises in
Russia. The loans are entirely private sector, with no
government guarantees or guidance, and are implemented through
the private banking system. The fund is supported by the G-7
countries, by the EU, and by Switzerland, with an overall
capitalization of $300 million. Of this, $50 million is set
aside for technical assistance. Since inception, the Fund has
disbursed $431 million through 36,720 loans.
The EBRD also has a special Legal Transition Program which
provides policy and technical assistance to improve the legal
and regulatory environment for commerce. The EBRD says that it
has been very successful in generating proposals for regulating
legal entities and for reforming markets and many of its
initiatives have been adopted. It is also focusing increasingly
on issues involving corporate governance.
The IFC
The IFC began its work in Russia in 1991, focusing on the
privatization of state-owned firms and farms near Nizhny
Novgorod. At the request of Russian authorities, it prepared a
manual on privatization, based on its experience with small-
scale privatization in that city, for use elsewhere in the
country. This led, the IFC reported, to the privatization of
some 80 percent of the small enterprises in the country It also
says it helped with the sale of 1,100 medium and large
enterprises as well as the privatization of the trucking
industry in many parts of the country. The IFC says that its
land privatization and farm reorganization program had helped
several hundred state and collective farms distribute land and
property to their members.
In June 2000, the IFC's portfolio in Russia consisted of
$194 million in loans and $117 million in equity investments.
Manufacturing accounted for 55 percent of the total, followed
by financial markets (21 percent), oil and gas (10 percent),
and other activities (14 percent) (Figure 7). The financial
crisis of 1998 seriously undermined many of the IFC's
investments in Russia, particularly those in the banking and
financial services sectors. By January 2001, however, the IFC
had strengthened its portfolio in Russia by restructuring two
large problem projects and writing down the value of several
others.
FIGURE 7._THE IFC'S RUSSIAN PORTFOLIO
[GRAPHIC] [TIFF OMITTED] T6171.044
Five Stages in the Transition from Special Case to Normal Country
During the past decade, the EBRD, IFC, and MIGA have
expanded the size of their operations in Russia as conditions
permitted. Except perhaps for special effort to identify good
project opportunities in Russia, these three agencies did not
treat Russia as a special case and they did not change their
standards or orientation as conditions changed. Their
activities have focused on the private sector. Funds have been
committed and disbursed for projects which the international
agencies believed had substantial prospects for growth. For the
most part, the level and scope of the three agencies reflect
the changing attitudes of domestic and foreign investors in
Russia. Total commitments grew rapidly in the first half of the
decade, peaking in 1997. They fell rapidly in 1998, however, as
the prelude to the August financial crisis and the crisis
itself--with default on foreign debts and a major devaluation
of the Russian currency--caused a major shift in commercial
conditions and investor attitudes. Since the crisis, the EBRD,
IFC, and MIGA have considerably reduced the size of their
operations in Russia. Most observers agree, however, that as
conditions stabilize in that country commercial prospects will
improve and the volume of activity for the three agencies will
increase.
By contrast, the operations of the IMF and World Bank in
Russia have been attuned much more acutely to the policy
environment. The Fund and Bank have worked much more closely
with the Russian Government in the design and implementation of
macro-economic and structural policy change. In some ways,
their programs in Russia have been both counter- and pro-
cyclical. When things were becoming difficult in Russia, it
seems, the IMF lent money to try to counter the undesirable
trend. Then, when things seemed to be going better in Russia,
the IMF lent more money to try to encourage the desirable
trend.
When the economic situation was most precarious early in
the decade, the IMF and World Bank lent substantial sums. The
conditions for their loans during the first several years were
relatively easy and they seem to have disbursed with limited
regard to whether the Russians were complying with
conditionality. In mid-decade, as prospects seemed to improve,
the IMF and World Bank lent larger amounts in order to
consolidate and accelerate the reform process. In 1995, the IMF
and World Bank increased their assistance, their attention to
compliance was more strict, and Russia met most of the loan
terms. The IMF and World Bank continued to lend substantial
sums during the next 3 years. However, they again seemed to be
operating counter-cyclically. They disbursed funds even as the
economic situation was becoming increasingly questionable and
compliance with conditionality was incomplete. After the
financial crisis of 1998, the IMF and World Bank seem to have
reconsidered their approach to Russia. Except for project
loans, they canceled all their outstanding loan commitments and
they pared back the scope of their operations. In the future,
the IMF and World Bank say they will treat Russia the same way
they treat other large middle-income developing countries. As
such, they will likely be reluctant to put large sums into
Russia mainly to encourage the transition process and they will
likely be more rigorous in their requirements for future loans.
disburse regardless: 1992-1994
Synopsis
Between 1992 and 1994, the IMF and World Bank seem to have
disbursed funds to Russia with few restrictions and little
serious conditionality. During these 3 years, the IFIs
committed themselves to lend $7.73 billion to Russia--$4
billion from the IMF, $2.64 billion from the World Bank (of
which $1.96 billion is from IBRD and $680 million is from the
IFC), and $1.09 billion from the EBRD. Of this, $5.71 billion
was disbursed almost right away--$4 billion by the IMF and
$1.71 billion by the World Bank. Many of the conditions which
the IMF and World Bank attached to their loans for Russia
during these years were not very rigorous or demanding. Those
for the World Bank were easily met and the IMF seemed to have
disbursed without strict attention to Russia's performance vis-
a-vis the standards in its loan agreements. On some occasions,
the targets were changed or performance standards were adjusted
in order to permit disbursement to continue.
IMF programs: 1992-1994
In 1992, the World Bank and IMF were under considerable
pressure from the Bush Administration and other major
governments to begin lending in order to stimulate the
transition process and strengthen the hand of the Russian
reformers. This put the IFIs in a difficult spot. It was
increasingly clear that Russia could not qualify for regular
IMF or IBRD loans. Russia's macro-economic situation was
deteriorating. It was not in compliance with the modest goals
of the shadow program. In mid-1992, the Yeltsin government
pulled back from its program of reform in the face of strong
opposition. Key members of the reform team were sacked, to
assuage the opposition and maintain some headway on reform. The
new president of the Central Bank of Russia, Viktor
Gerashchenko, appointed in mid-1992, turned out to have
theories of monetary policy which led him to flood Russia and
other members of the ruble zone with cheap credit. This boosted
inflation and lessened the pressure that market forces might
have exerted toward enterprise reform.
Nevertheless, on August 5, 1992, the IMF approved a SDR 719
billion ($1 billion) first credit tranche loan to Russia. The
amount countries can borrow from the IMF is a multiple of their
quota. Russia's quota in the IMF, at the time of its joining,
was SDR 2.96 billion (then about $4.3 billion). As countries
move into the higher credit tranches, the conditions for access
to IMF funds and the performance criteria for disbursement
become increasingly stringent. This loan was not unprecedented.
Most countries will want to borrow more than the first credit
tranche can provide. However, some have limited their requests
to this level. By borrowing only the amount allowed for a first
credit tranche loan, countries need to meet only modest
requirements for conditionality and they do not need to
demonstrate compliance in order to receive loan disbursements.
Even so, in the case of Russia, the negotiations for the first
tranche loan dragged. To facilitate agreement, the Managing
Director of the IMF, Michel Camdessus, flew to Moscow just
before the start of the G-7 Summit Meeting in Munich in early
July.\4\ The proceeds from the loan were made available right
away. Russia agreed to reduce its budget deficit from 17
percent to 5 percent, but disbursement was not dependant on its
achievement of this goal. This was less stringent than the 1
percent target in the shadow program. Russia also agreed to
reduce its monthly inflation rate from 15 to 20 percent to 10
percent.\5\
---------------------------------------------------------------------------
\4\ For the IMF's statement on the loan, see its press release
number 92/60 dated August 5, 1992.
\5\ For a detailed chronology of IMF loan programs in Russia from
1992 to 1999, see: U.S. General Accounting Office. International
Monetary Fund: Approach Used to Establish and Monitory Conditions for
Financial Assistance. Report to Congress NSIAD-99-168, June 1999, pp.
136-158. It provides a detailed summary of the goals of each program,
Russian compliance, and actions taken by the IMF executive board. For a
detailed review of the assistance programs in Russia sponsored by the
IFIs, United States, and Europeans, see U.S. General Accounting Office.
International Efforts to Aid Russia's Transition Have Had Mixed
Results. GAO-01-8, November 2000.
---------------------------------------------------------------------------
It was not intended that the IMF's first tranche agreement
with Russia would cause the G-7 countries to release the $24
billion aid program they had announced. Officially, the $24
billion assistance package--and the $6 billion ruble
stabilization fund which it contained--would be available only
after Russia successfully negotiated a regular standby loan
program with the IMF. Russia drew down the resources for the
first credit loan by the end of 1992 and added them to its
reserves. Russia's budget deficit and inflation rate did not
shrink as planned, however, and Russia was almost immediately
out of compliance with the terms of its first IMF loan. This
severely constrained its eligibility for future IMF loans.
The IMF noted, in early 1993, that the economic problems
confronting Russia were comparable to those faced by Japan and
Germany after 1945.\6\ Russia's need for external assistance
was also comparable. ``Equally important,'' the IMF reported,
however, ``Russia must be willing and able to pursue economic
policies that ensure that the external assistance has the
desired effects.'' In particular, these included ``measures to
achieve macro-economic stability and rapid progress on a wide
range of systemic reforms.'' Success in those areas, it said,
would ``create the conditions in which market mechanisms will
eventually grow.''
---------------------------------------------------------------------------
\6\ John Odling-Smee and Henri Lorie. The Economic Reform Process
in Russia. WP/93/55-EA, July 1, 1993. Odling-Smee heads the office at
the IMF responsible for Russia. The report seems to have been prepared
for presentation to the IMF executive board earlier in the year.
---------------------------------------------------------------------------
The IMF continued to resist pressure from its major member
countries for expanded assistance for Russia. Russia was not in
compliance with the goals of the first tranche loan and there
were doubts at the time that Russia would be able to comply
with any meaningful conditions the IMF placed on future loans.
The IMF also was reluctant to set a precedent where the normal
rules and standards governing lending were openly waived in the
case of emergencies affecting ``important'' countries. Fund
management worried that other large developing countries would
claim that they too were ``important'' and they too faced
crucial emergencies.
The G-7 found a way around this problem. During their
meeting in Tokyo on April 14 and 15, 1993, the deputy finance
ministers of the G-7 countries announced that a new IMF loan
facility--the Systemic Transformation Facility (STF)--would be
established.\7\ The STF was a response to the concern, as the
G-7 carefully put it, that the IMF's regular loan
conditionality did not provide enough flexibility for a
positive response to the borrowing needs of Russia and other
formerly socialist states. Though designed originally to
benefit the Soviet successor states, eligibility was broadened
to include other non-market economies (Albania, for example) as
well.
---------------------------------------------------------------------------
\7\ Tokyo Summit Economic Declaration: A Strengthened Commitment to
Jobs and Growth. Tokyo, July 9, 1993. The G-7 urged the international
agencies, in the strongest possible terms, to provide more assistance
to Russian. Available from http://www.g7.utoronto.ca/g7/summit/
1993tokyo/communique/job.html.
---------------------------------------------------------------------------
The STF provided quick-disbursing loans to facilitate
stabilization during the early stages of the transition
process. The eligibility criteria were vague. Countries could
borrow if they were experiencing ``severe disruptions in their
trade and payments due to a shift in world market pricing.''
The conditions for access to STF loans were also easier than
those for regular loans. Countries had to demonstrate that they
were trying to solve their balance-of-payments problems and
curb inflation and they had to submit a written statement
describing the goals of their reform program and the steps they
planned to take to attain those goals. The proceeds would be
disbursed in two tranches--the first immediately and the second
within 6 to 12 months.
On June 30, 1993, the IMF executive board approved an SDR
2.156 billion ($3 billion) loan to Russia from the STF. The
first tranche--SDR 1.078 billion ($1.5 billion)--was disbursed
right away. Conditions seemed to be improving in Russia at the
time. In December 1992, Yeltsin had won a referendum and this
gave the reformers some political clout to cut spending. In May
1993, the Russian Finance Ministry and CBR reached an agreement
aimed at reducing the rate of inflation. Steps were also afoot
to tighten the ruble zone. The CBR told other countries they
must either leave the ruble zone or allow the Russian
Government tight control over their monetary policies.
The Russian Government agreed, under terms of the STF
agreement, that it would reduce its budget deficit to 5 percent
of GDP and its monthly inflation rate to a ``low single-digit
level.'' These were, in effect, the unmet goals of the 1992
shadow program and the first tranche loan. The government and
CBR promised not to make loans to clear inter-enterprise
payment arrears. The government also agreed to accelerate
reform in the areas of foreign trade, privatization, and the
legal framework.
In March 1994, when the time came to release the second
half of the STF loan, Russia was not in compliance.
Nevertheless, Camdessus and Prime Minister Chernomyrdin reached
agreement on terms for releasing the second tranche of the STF
loan. Reportedly, Camdessus overruled his staff, which was his
prerogative. He had strong backing from six of the G-7
governments, including the United States. The Russians agreed
they would take strong action to implement the planned macro-
economic and structural reforms. The inflation rate would be
lowered to 7 percent monthly by the end of the year. The IMF
relaxed (from 5 percent to 7 percent of GDP) the target for
reducing the budget deficit. The government promised to improve
its supervision of commercial banks, to establish a budgetary
system devolving responsibilities to the regions, and to
continue privatization. It also promised that, by July, shares
would be auctioned for cash rather than vouchers and new
commercial rules would be announced.
In December 1994, Camdessus outlined the Fund's views on
the transition process in a speech before an economics meeting
in Madrid.\8\ Gradualism was not an effective strategy for the
transition to market economies, he said. Rather, rapid movement
to liberalization, stabilization and structural reform was
needed and those countries that moved furthest would come out
best. Nevertheless, he acknowledged, the achievement of
structural reforms would take a number of years and the
transition process would have to take place within an imperfect
framework. ``The market economy must, as it were,'' he said,
``move into a house that is still under construction.''
---------------------------------------------------------------------------
\8\ Michel Camdessus. ``Supporting Transition in Central and
Eastern Europe: An Assessment and Lessons from the IMF's Five Years'
Experience.'' Second Annual Francisco Fernandez Ordoez Address, Madrid,
December 21, 1993. IMF document 95/2.
---------------------------------------------------------------------------
The following March, Camdessus made another speech,
expressing the view that Russia's transformation effort had
reached a turning point. Progress to date on structural reform
and macro-economic stabilization had been less than
disappointing, he admitted.\9\ However, he said he had
confidence that the Russian authorities would move vigorously
in 1995 to reverse that trend.
---------------------------------------------------------------------------
\9\ Michel Camdessus. ``Russia's Transformation Efforts at a
Turning Point.'' Address to a Conference of the U.S.-Russia Business
Council, Washington, DC, March 29, 1995. IMF document 95/5.
---------------------------------------------------------------------------
World Bank programs: 1992-1994
The World Bank's first country assistance strategy (CAS)
for Russia, approved by the executive board in 1993, specified
that three areas should be given special emphasis in the Bank's
loan program.\10\ Programs to promote private sector
development, privatization and enterprise reform should be
given high priority. Strong emphasis should be accorded to
policy reform and the development of an agreed framework with
the Russian Government into which future operations could be
fitted. Finally, the 1993 CAS said that the Bank should work
with the Russian authorities to develop programs that would
help protect the most vulnerable members of society from the
full pain of the transition process. These were all key
structural reform included in the IMF loan programs approved
during these years.
---------------------------------------------------------------------------
\10\ The World Bank was unable to provide a copy of the 1993 CAS
for Russia. The summary reported here is based on statements in press
releases and other Bank documents issued between 1993 and 1997.
---------------------------------------------------------------------------
Despite the terms of the CAS, most of the funds the World
Bank lent to Russia during this period went for balance-of-
payments support or to increase oil production and oil exports.
The day after the IMF made its first loan to Russia, the World
Bank approved a $600 million loan to ease Russia's balance-of-
payments difficulties by financing needed imports. To qualify
for disbursement, Russia merely had to demonstrate that $350
million from the loan would be used for humanitarian imports
and the other $250 million for imports needed by the private
sector. In June 1993, the World Bank approved a $610 million
loan for Russia to help rehabilitate its oil industry. A
similar $500 million loan was approved in June 1994.
All but $160 million of the $1.33 billion in project
assistance the World Bank agreed to provide Russia at this time
was approved about the time the second STF tranche was released
in 1994. Of this, $810 million sought to encourage enterprise
reform, privatization, agricultural reform, land reform, and
the development of financial markets. Many of these loans,
however, ran into serious difficulties and many of the funds
were not disbursed. One loan in 1992 sought to alleviate social
needs through the establishment of unemployment insurance and
employment services. It also encountered problems with
implementation. A $300 million loan for highway maintenance and
rehabilitation, however, was completed without major delay. In
late 1994, the Bank approved two other modest-sized loans. One
for management and financial training was fully implemented but
another for environmental management ran into serious problems
and remains only half disbursed.
disburse with compliance: 1995
Synopsis
In 1995, the IFIs disbursed substantial sums to Russia and
Russia substantially complied with their loan conditionality.
In 1995, the IFIs approved loans for Russia totaling nearly
$9.5 billion. Of this, $6.8 billion came from the IMF, $1.62
billion from the IBRD, World Bank, and $1.06 billion from the
EBRD. Of this, $7.4 billion was disbursed, including all the
funds committed by the IMF and $600 million fast disbursing
assistance approved by the World Bank. The international
agencies believed, at the time, that Russia had turned a corner
and that economic growth would soon follow. Russia met most of
the requirements of the 1995 IMF standby loan. In the blush of
success following the perceived success of that program, the
IMF approved a $10 billion loan for Russia in February 1996.
That loan (discussed in the next section) was much less
successful. During 1995, the IFC approved $65 million and the
EBRD approved $1.06 billion in assistance to Russian firms.
IMF operations: 1995
On April 11, 1999, the IMF executive board approved an SDR
4.31 billion (then about $6.8 billion) standby loan of for
Russia, a 12 month program. The IMF noted in its announcement
that Russia's economic performance in 1994 was
``disappointing.'' Efforts to reduce the budget deficit and
inflation rate were ``significantly off track'' and the target
for accumulating new foreign reserves was missed ``by a wide
margin.'' In fact, the budget deficit and inflation rate were
twice the levels anticipated by the STF second tranche
agreement. The IMF noted that the CBR had tightened monetary
policy in late 1994 and early 1995, but it said this would not
be sustainable unless major improvements were made in fiscal
policy. In a very unusual step, the IMF specified that Russia's
progress under the new loan plan would be monitored monthly and
funds would be disbursed only with the consent of the IMF
executive board.
The goals of the new standby loan echoed those earlier
plans. Inflation was to be reduced to 1 percent monthly by the
end of 1995. Credit and monetary policy would be tightened
further and the government's budget deficit would be reduced to
6 percent of GDP. The government promised to use non-
inflationary sources of financing in the future to cover the
deficit. In 1994, Russia's real GDP declined by 15 percent. The
new plan hoped to cut the decline to 9 percent in 1995.
The government also pledged to make a major effort to
accelerate action on a wide range of structural reforms.
Prominent were measures to liberalize the trade regime and oil
sector. In particular, the restrictions on oil exports would be
abolished. The government and CBR promised once again that they
would not extend credits or loans to clear inter-enterprise
debts. The government would find other means of resolving those
pressures and breaking up the logjam hampering the mutual
settlement of debts which Russian firms owed to one another.
The government promised to continue cleaning up non-performing
centralized credits and to more tightly monitor the financial
situation of banks. It also promised to accelerate the process
of land reform and to increase the efficiency of its social
spending programs.
In March 1996, the IMF announced that it was very pleased
with the success of the 1995 loan. Reflecting the high hopes it
then had for the future, the IMF executive board approved a new
SDR 6.9 billion (about $10 billion) loan for Russia.
Disbursements would take place over a 3 year period (1996-1998)
and the repayments would stretch over a decade. This was the
largest extended fund facility (EFF) loan the IMF had ever made
and the second largest overall. The largest was the SDR 12.1
billion loan to Mexico approved in February 1995. After Mexico
made an early repayment on that loan, Russia became the IMF's
largest borrower, accounting for nearly one-fourth of the IMF
loans and credits outstanding at the end of July 1996. Russia's
compliance with the EFF loan is discussed in the next section
of this paper.
The IMF reported that Russia's performance the previous
year under the 1995 loan program had been quite satisfactory.
Inflation had fallen to low single digit monthly rates by the
end of 1995, the IMF reported. Signs of industrial recovery
were visible. Real GDP remained nearly stable, shrinking only 4
percent in 1995 (not the 9 percent anticipated.). The IMF noted
that Russia's balance-of-payments surplus (current account) had
widened from $3.4 billion in 1994 to $4.7 billion in 1995.
Moreover, it said, the establishment of an exchange rate
``corridor'' for the ruble had helped stabilize exchange rate
perceptions and was ``generally judged to have been a
success.'' On the structural front, the IMF acknowledged that
Russia's performance was more uneven. The process of
restructuring the banking sector was slow and the pace and
scale of privatization was below expectations. Nevertheless, it
concluded, Russia's overall progress had been significant.
Stanley Fischer observed in June 2001 \11\ that Russia's
compliance with the terms of the 1995 standby were
``exemplary'' and ``for 9 of the 12 months Russia essentially
met all the conditions.'' Previously an economic professor at
MIT, Fischer had become First Deputy Managing Director of the
Fund in September 1994. He became acting Managing Director of
the IMF in early 2000.
---------------------------------------------------------------------------
\11\ Stanley Fischer. The Russian Economy: Prospects and
Retrospect. Speech at the Higher School of Economics, Moscow. June 19,
2001. Available from the IMF Web site.
---------------------------------------------------------------------------
In a paper published in early 1996, Fischer wrote \12\ that
1995 had been the key stabilization point for the Russian
economy. According to his research, he said, growth usually
occurs 2 years after the stabilization point is reached.
However, he cautioned in the 1996 paper, governments must
continue pursuing stabilization policies and structural reforms
if growth is to continue. Establishing a pegged exchange rate
for the currency was helpful, once stabilization had occurred,
he said, but the situation was not sustainable without prudent
government policy and further cuts in the fiscal deficit. In
July 1995, Fischer noted with approval the Russian Government's
decision to institute an exchange rate system where the value
of the ruble would be kept within a certain range in relation
to the dollar.\13\ He observed later, however, in his June 2001
retrospective on the IMF's programs in Russia, that ``the 1995
loan was very successful, but it did put in place the crawling
band exchange rate that was a source of trouble in the
future.''
---------------------------------------------------------------------------
\12\ Stanley Fischer, Ratna Sahay and Carlos A. Vegh.
``Stabilization and Growth in Transition Economies: the Early
Experience.'' Journal of Economic Perspectives, 10:2 (Spring 1996), pp.
45-66.
\13\ IMF Management Welcomes Economic Progress Made by Russia;
Exchange Rate Action Designed to Support Program. News Brief 95/17,
July 6, 1995. Quotes positive remarks by Fischer.
---------------------------------------------------------------------------
World Bank operations in Russia: 1995
In March 1995, 1 month before the IMF approved the new
standby loan, the World Bank commenced a large new program of
lending to Russia. That month, it approved a $400 million loan
to help restructure the housing sector in Russia through the
establishment of a new marketplace for housing. During the 2
months following announcement of the IMF loan, the World Bank
approved another $1.13 billion in loans. This included a $600
million loan on easy compliance terms to ease Russia's balance
of payments by financing needed imports and $99 million to
address a major oil spill problem. All told, during 1995, the
Bank approved $1.62 billion in loans for Russia, its largest
annual total to date.
The Bank's project loans in 1995 sought to promote growth
and address key structural problems. In addition to the loan
which sought to create a marketplace for housing, the Bank lent
$107 million to promote energy efficiency and $329 million to
improve urban transportation. It also approved two smaller
loans to develop standards, identify prospective new loan
projects, and to improve and modernize tax administration. As
in 1992 through 1994, the World Bank did not accelerate its
disbursements on these loans nor did it disburse regardless of
compliance. However, in retrospect, it appears that--as in the
earlier period--many of the Bank's projects were approved
before conditions had matured to a point where they could be
successfully implemented. A major portion of the funds for the
housing and energy efficiency loans were canceled or never
disbursed and most of the funds for the urban transport loan
seem not to have been disbursed until 1998 or after. Likewise,
a major portion of the funds for standards development or
development of the Bank's loan portfolio were not spent until
1998 or remain unspent today.
disburse despite resistance: 1996-mid 1998
Synopsis
Between 1996 and mid-1998, the IFIs disbursed substantial
sums to Russia even though its compliance with conditionality
was limited and their efforts to promote reform met with
considerable resistance. Heavy spending before the 1996
election expanded Russia's fiscal deficit and stoked inflation.
Yeltsin was reelected but the opponents of reform were
strengthened also. The government's ability to deliver on its
commitments for stabilization and structural reform diminished.
Nevertheless, despite major difficulties with compliance, the
IFIs provided Russia with substantial sums of balance-of-
payments support. Between approval of the EFF loan in early
1996 and the onset of the financial crisis in mid-1998, the IMF
disbursed approximately $6.78 billion to Russia. The IMF
suspended disbursements for the EFF program on several
occasions, releasing funds only when the Russian Government
complied with certain conditions of the loan. That compliance
often came slowly and in the face of considerable domestic
resistance. Some of that compliance seems more technical than
substantive. Meanwhile, the World Bank approved nearly $5.14
billion in new loans for Russia. SALs accounted for $3.5
billion of this total, all the proceeds being disbursed during
1996 and 1997. The Bank approved project loans totaling $1.64
billion during these 2 years, mainly in 1996. In retrospect, an
unusually large proportion of those loans encountered serious
problems with implementation and the disbursement of a
substantial share of their proceeds was canceled or
considerably delayed. Meanwhile, during 1996 and 1997, the IFC
approved $28 million and the EBRD approved $2.36 billion in
assistance to Russian firms.
IMF programs: 1996-1998
The IMF agreed in March 1996 to lend Russia SDR 6.9 billion
($10 billion) over the next 3 years. Disbursements for the new
EFF loan would be monitored monthly, as had been the case for
the prior loan. After October 1997, during the second year of
the program, they would be made on a quarterly basis, as is
usual for most IMF loans. Disbursements would be front-loaded,
with 41 percent being available upon compliance in the first
year, 34 percent in the second, and 25 percent in the third.
The Russian Government said it did not intend to borrow again
from the IMF once this program was completed.
The goals of the EFF program were basically the same as
those for the previous IMF programs in Russia. There was more
emphasis, however, on the need for structural or procedural
reforms and--because it was a 3 year program--it was thought
that Russia would have enough time to implement those reforms.
Events proved, however, because of increased inflation as well
as stronger resistance by the opposition, that achievement of
these goals would remain a difficult task.
In the area of macro-economic policy, the government
announced that it would take strong action to reduce the rate
of inflation and the size of its budget deficit. Inflation
would be reduced to a 1 percent monthly rate by year's end and
would decline further, to a single-digit annual rate, in 1997.
The government also declared that it would take the steps
needed to maintain medium-term stability in Russia's balance of
payments. Real GDP growth was expected to accelerate to 2.3
percent annually in 1996 and 5 percent in 1998 and 6 percent or
more thereafter. Consequently, it was expected that Russia's
current account balance of payments would swing into the
negative in 1998, when higher growth would lead to more
purchases from abroad. The Russian authorities said they would
take measures to manage the expected situation without
encouraging inflation. Further cuts in the government's budget
deficit were a critical element of this strategy. The Russians
agreed to reduce the deficit from 5 percent of GDP in 1995 to 4
percent in 1996 and 2 percent by 1998. They also agreed that it
would take major steps to improve tax collections and reduce
delinquencies and exemptions. This would require special
efforts to overcome the political connections and favoritism
which often facilitated tax evasion and tax avoidance of this
type.
On the structural side, the government said it would make
trade liberalization and accession to the World Trade
Organization (WTO) a high priority. It would strengthen the
banking system through improvements in the regulatory framework
and closer attention to the financial health of banks. It would
accelerate privatization while assuring greater transparency
and fairness of the process. It would pursue agricultural
reform, reducing the uncertainties of private farmers,
expanding land reform, and allowing the full private ownership
of land. The security markets would be reformed, improving the
legal framework, reorganizing weak firms, and increasing the
protection for outside investors. The government also announced
that it would strengthen the social safety net by targeting
assistance more specifically to those who needed it and using
the resultant savings to enhance other social programs.
Despite these plans, most of the IMF's efforts in Russia
during this period had to do with the government's difficulty
in achieving the macro-economic goals of the EFF program. The
government made some efforts toward addressing structural
reform issues. However, the results achieved were not
proportional to the goals outlined in the EFF program. The Fund
was less vigorous in its efforts to secure Russian cooperation
with the targets for structural reform than it was for those
involving macro-economic stability.
In 1996, Russian economic performance and the government's
economic policies fell well short of the expectations in the
EFF plan. By July, the budget deficit was well over target. The
IMF raised the annual target to 5.25 percent. Government
spending had increased rapidly in the just-concluded
presidential election campaign. There was little alternative
but to increase the size of the federal budget to accommodate
the higher cost of the government's earlier debt and the new
debt payment obligations recently incurred.
In 1997 and 1998, however, the Russian Government continued
to have problems with its fiscal deficit. Budget figures seemed
to be prepared more to meet the IMF's deficit targets than to
meet real budgetary needs. For example, the budget signed by
Yeltsin in February 1997 projected a deficit equal to 3.5
percent of GDP. This was within the deficit target. The IMF
urged the Russians, however, to include money in the budget to
cover the government's accumulating unpaid interest obligations
and federal wage and pension arrears. This would have widened
the budget gap to nearly 7.5 percent of GDP, well over the
target. The Russian authorities were not convinced by the IMF's
approach to budgetary accounting.
The IMF suspended disbursement of the January installment
of the EFF and Russia received no disbursements for the rest of
the first quarter 1997. The most important threat to fiscal
stability was not rising expenditures but shortfalls in tax
receipts. The IMF suspended disbursements on the EFF loan in
July and August 1996 until the government adopted a package of
measures to increase revenues. The October 1996 tranche was
delayed until December, when revenues increased by 38 percent.
The November and December disbursements were delayed until
February 1997, when the government showed that it had met the
December monetary and fiscal targets and had taken steps to
improve tax receipts. By the end of April 1997, though, Russia
had drawn SDR 2.34 billion ($3.22 billion) from the EFF line of
credit. By April 1998, it had borrowed another SDR 1.5 billion
($2.04 billion) and it got another SDR 1.12 billion ($1.52
billion) in August 1998.
In May 1997, the government received word that tax receipts
would be even lower for the year than expected. This would push
the deficit well over the EFF target. The government
sequestered (freezing or withholding from expenditure) more
than one-fifth of the funds in the national budget in order to
bring down spending. Tax evasion, inefficient collection
methods, and widespread exemptions were taking their toll. To
increase revenues and reduce the deficit, the government
accelerated the privatization process. Income from this source
more than doubled. However, many of the sales were beset with
doubts about corruption and serious concern whether the prices
paid reflected the underlying value of the firms.
By the end of 1997, with these increased receipts and the
major spending cuts taken earlier, the government's budget
deficit was 5.5 percent of GDP, slightly higher than the
revised IMF target. The inflation rate for 1997 was 11 percent,
down by half from the previous year but higher than the single-
digit goal of the EFF program. Most analysts agreed that
sequestering expenditures was not a sufficient method for
achieving those targets. Among other things, expenditures on
social programs had been slashed substantially. Most agreed
that the shrinkage in budgetary outlays could not be sustained.
World Bank programs: 1996-1998
As noted, the World Bank reached new heights in the size of
its loan program for Russia in 1996 and 1997. However, the
overall composition of the Bank's program shifted as it put
increased emphasis on programs addressing the needs of the
overall economy and less on project loans.
In May 1996, Bank President James Wolfensohn echoed the
view that Russia had turned a corner in its transition process.
He told the press that conditions in Russia were much improved
and the Bank would be active ``supporting the major economic
reforms which must be sustained for Russia to achieve
transition to a market economy.'' \14\ A year later, the tone
of the Bank's enthusiasm was somewhat subdued. Nevertheless, in
September 1997, Johannes Linn, the World Bank's vice president
for Europe and Central Asia, reported--while Russia's
performance had been below its potential--the Bank was still
optimistic about its prospects.\15\
---------------------------------------------------------------------------
\14\ World Bank. James Wolfensohn. Statement to the Press. Moscow.
May 23, 1996.
\15\ World Bank Optimistic About Russia's Growth. (Announcing the
SAL1 loan.) News Release No. 98/1492ECA. September 26, 1997.
---------------------------------------------------------------------------
In 1997, the Bank added a new component to its Russian
program. Adopting a new CAS to replace that earlier adopted in
1993, the Bank said there should be more stress on structural
adjustment and policy reform.\16\ Emphasis should also
continue, though, on enterprise reform, institutional reform,
and improvements in education and health. More effort should
also be given to programs protecting the most vulnerable
members of society from the effect of transition and sustaining
the government's budget for social programs. Linn announced
that the Bank's new emphasis on policy reform and adjustment
lending in Russia would ``demonstrate our clear recognition and
full endorsement of the reform measures that are currently
being implemented by the [Russian] government.'' \17\
---------------------------------------------------------------------------
\16\ World Bank Announces Russia Strategy for the Next Two Years.
News Report No. 97/1379/ECA, June 6, 1997. The 1997 CAS was also not
released to the public but its main outlines were described here.
\17\ World Bank Supports Russia's Reforms. December 19, 1997.
---------------------------------------------------------------------------
In 1997, the World Bank approved three large structural
reform loans for Russia totaling $2.2 billion. Two were regular
structural adjustment loans (SALs) and the other was a social
protection adjustment loan (SPAL). The two SALs were nearly
identical, in their form and purpose, to the loans approved
earlier by the IMF. The $600 million from SAL1 was disbursed
right away. The $800 million for SAL2 was disbursed in two
tranches, a few months apart.\18\ Russia agreed that it would
take steps to accelerate privatization, private sector
development, changes in bankruptcy law, reductions in the
budget deficit, improvements in tax administration, reform of
the banking and financial sectors, and improvements in the
social safety net. The World Bank has not reported what Russia
needed to do in order to have access to these loans. Given the
speed with which they were disbursed, however, one may suspect
that the performance requirements were not particularly
demanding. It does not appear that Russia made major steps
toward structural reform at the time it received disbursement
of these funds.
---------------------------------------------------------------------------
\18\ World Bank Announces Russia Strategy for the Next Two Years.
News Release No. 97/1379/ECA, June 6, 1997. Project Information
Document PIC5759. Russia-Second Structural Adjustment Loan (SAL2),
December 23, 1997.
---------------------------------------------------------------------------
The requirements for the SPAL were somewhat more rigorous.
This loan was aimed at protecting the weakest members of
Russian society against potential injury from the adjustment
process. At $800 million, it was the largest single loan ever
made in the Europe and Central Asian region. It sought to
strengthen Russia's social safety net and improve the way
Russia targeted and implemented those programs.\19\ To qualify
for disbursements, Russia had to demonstrate that a certain
amount of social spending was included in its budget and those
expenditures were being used effectively. In effect, the SPAL
was a balance-of-payments support. The government could use the
money from the SPAL to generate the rubles needed to fund the
qualifying social expenditures, but it was not required to do
so. The SPAL did not increase the amount spent for social
programs, but it did help protect the existing programs against
budget cuts. Social spending took a disproportionate share of
the hits, in 1997 and 1998, as the government sequestered
budget authority in order meet the IMF's targets on the budget
deficit. Russia had some difficulty meeting all the
requirements of the SPAL. The final $250 million tranche, which
had been scheduled for release in early 1998, was not disbursed
until after 1999.
---------------------------------------------------------------------------
\19\ World Bank Loan Supports Russia's Social Reforms. News Release
No. 97/1408/ECA, June 25, 1997. Project Information Document PID5638.
Russia-Proposed Social Protection Adjustment Loan (SPAL). June 12,
1997.
---------------------------------------------------------------------------
The World Bank also made two loans, totaling $1.3 billion,
to help restructure the Russian coal industry.\20\ The first of
these (Coal 1), for $500 million, was approved in 1996. In
part, the two loans sought to ease pressure on the government's
budget. Subsidies to the coal industry had been a major
contributor to the deficit. In 1993, these subsidies had
amounted to 1 percent of GDP. By 1995, they had been cut to
one-sixth that level. The new coal loans aimed to reduce them
substantially further. The loans aimed to create a competitive
and sustainable coal industry by promoting commercialization
and privatization of the mines. The loans were not intended to
offset losses or to refurbishment of capital stock in the
mines. To qualify for disbursement, the government would need
to adopt a socially sustainable framework of assistance for
coal communities, including social services and efforts to
improve labor mobility. As with the two SALs and the SPAL, the
government could use the proceeds from the Bank's two coal
loans for any purpose if it could demonstrate that it was
making the appropriate expenditures (in rubles) to sustain the
specified service programs. The second tranche of Coal 2 was
contingent, however, on satisfactory macro-economic
performance. It was delayed for 2 years (until the end of 1998)
and media reports in December 2001 indicate that the last
portion was just being released.
---------------------------------------------------------------------------
\20\ The PID for Coal 1 is not available. However, the program's
objectives are discussed in another publicly available technical
document. World Bank Helps Reform Russia's Coal Industry. News Release
No. 97/1225/ECA. Technical Annex T-6865-RU. Coal Sector Restructuring
Implementation Assistance Project, June 25, 1996. The goals for Coal 2
are discussed in the PID for that program. Project Information Document
PID5852. Russia-Coal Sector Adjustment Loan II. October 29, 1997.
---------------------------------------------------------------------------
Parallel with the new emphasis on adjustment loans, the
World Bank also approved many project loans for Russia during
1996 and 1997 which addressed key concerns identified in the
IMF's loan program and in the 1993 and 1997 country strategy
documents. In 1996, $1.27 billion was approved and in 1997
another $286 million was authorized for this purpose. All told,
$608 million was approved for projects addressing social
issues, such as education, health, and community social
infrastructure. Another $514 million was approved for projects
aimed at private sector development and market reform,
including loans for enterprise reform, enterprise housing
divestiture, capital market development, and reform of the
electrical sector. An additional $350 million was approved for
bridge rehabilitation and $87 million for improvements in the
country's legal system and its capacity for performing sound
economic analysis.
It appears, however, once again, that the World Bank's
efforts to encourage structural reform with projects may have
been somewhat in advance of the projects' feasibility. All the
major project loans approved during 1996 and 1997 encountered
serious difficulties. In several instances, the resistance to
reform was substantial. Several projects were terminated
without ever being put into effect. Of the total amount
approved, $462 million was canceled outright and $575 million--
for some projects, almost the entire proceeds of the loan--
remained undisbursed at the end of June 2001. Many of the
issues the Bank sought to address through these loans--
corporate governance, reform of the legal system, privatization
of large enterprise, and the reform of banks and capital
markets, for instance--were issues on which there remains today
much disagreement between the Russian reformers and their
opponents.
commit in the face of crisis: 1998
Synopsis
In 1998, the IMF and World Bank committed themselves to
lend very large sums in a vain effort to prevent a looming
economic crisis. By 1998, the Russian economic situation was
precarious. Despite past commitments the government had made to
the IFIs, Russia's fiscal and monetary performance was
questionable and progress on structural reform was slow. Doubt
grew in the market about Russia's economic prospects and
pressure against the ruble increased. Previously, when the IMF
and World Bank had approved major loans for Russia, they had
strong reason to believe that the government would seek to
implement the reform provisions of their loan agreement, even
though they knew this effort might face stiff resistance. In
1998, however, the IMF approved new loans totaling $11.2
billion and the World Bank agreed to lend $1.5 billion--the
largest credits either institution had ever approved for
Russia. They did this, moreover, with little evidence that the
government would be willing or able to pursue its planned
program of reform. Very soon after the IMF and World Bank loans
were approved, Russia defaulted on its debts and devalued its
currency and the IMF and World Bank suspended disbursements on
their recent loans. Despite Russia's economic troubles,
investors retained some interest. In 1998, the IFC approved $91
million in assistance (most of it likely, however, in the
first--July to December 1997--half of the IFC fiscal year.)
Approvals by the EBRD in calendar 1998 fell to $304 million, by
contrast, one-third the level of the prior year.
IMF programs: 1998
The Russian Government's budget plan for 1998 projected a
fiscal deficit amounting to 4.8 percent of GDP, a figure that
was again within the EFF deficit target. However, many outside
experts questioned the assumptions underlying its projections
and noted that the planned spending level was about the same as
that for the 1997 sequestered budget. The government announced
plans for strong new efforts to increase revenues and to cut
federal spending further. It also announced plans in the 1998
program for major structural reforms.\21\
---------------------------------------------------------------------------
\21\ Joint Communique of the Chairman of the Russian Federation and
the Managing Director of the International Monetary Fund. February 19,
1998. Available from the IMF Web site.
---------------------------------------------------------------------------
By mid-year, however, Russia was enmeshed in a major
economic crisis. Many analysts doubted whether the government
had the capacity or the will to pursue its announced plans.
Revenue continued to fall; the government resorted to a
pyramid-type borrowing scheme to cover the deficit. World oil
prices declined, removing a major source of Russia's tax
revenue and export income. The financial system was buffeted by
uncertainty. Market confidence was deteriorating, in response
to the country's precarious domestic conditions and contagion
from the Asian financial crisis. The ruble was under heavy
pressure in foreign exchange markets and the CBR was having
great difficulty maintaining the specified exchange rate in the
face of that pressure.\22\
---------------------------------------------------------------------------
\22\ Cf. William Cooper, Russia's Economic Performance Entering the
21st Century, supra this volume.
---------------------------------------------------------------------------
On June 11, the IMF made an announcement \23\ clearly aimed
at calming the market. The IMF executive board would meet in a
week, a spokesman said, to release of the next tranche of the
EFF loan if Russia took certain unspecified steps. It was also
strongly implied that substantial new flows of IMF assistance
would also be coming soon. Nine days later, the IMF executive
board released the last tranche of the 1996 EFF loan. It also
approved a new loan package for Russia totaling SDR 8.5 billion
($11.2 billion). This included a new EFF loan for SDR 6.3
billion ($8.3 billion) and an SDR 2.16 billion credit from the
Compensatory and Contingency Financing Facility (CCFF).\24\ The
new EFF money would be available subject to regular EFF
conditionality. The CCFF money would be available with little
conditionality. Russia drew those funds right away.
---------------------------------------------------------------------------
\23\ Russian Authorities and IMF Reach Understandings on 1998
Economic Policy Statement. News Brief 98/20, June 11, 1998.
\24\ IMF Approves Augmentation of Russia Extended Arrangement and
Credit under CCFF; Activates GAB. IMF press release No. 98/31.
---------------------------------------------------------------------------
The United States and other major member countries strongly
supported the new loan program. One measure of their support
was the source of the funds supporting the EFF credit. Instead
of using its regular funds to finance the new EFF loan for
Russia, the IMF was authorized to draw SDR 4 billion ($5.3
billion) of the total from the General Agreement to Borrow
(GAB). To activate the GAB, the IMF must have the explicit
consent of its member countries. The United States provides
one-fourth of those funds and other advanced industrial
countries provide the remainder. This would be the first time
the GAB had ever been activated for use by a non-
participant.\25\
---------------------------------------------------------------------------
\25\ See the IMF's description of the new Russian loan program in
its 1999 Annual Report, p. 79.
---------------------------------------------------------------------------
The Russian authorities promised to take vigorous steps to
address the turmoil in the financial markets and to restore
public confidence. It would tighten the budget still further,
bolster the CBR's foreign exchange reserves through new foreign
financing, stretch out the maturity of its short-term debt, and
secure the legislature's approval for numerous key structural
reforms.\26\
---------------------------------------------------------------------------
\26\ IMF Management Welcomes Executive Board Support for Russia.
News Brief 98/26, July 20, 1998. Fischer was then serving temporarily
as acting Managing Director of the IMF.
---------------------------------------------------------------------------
All of this, however, was to no avail. The government took
none of the steps it had promised the IFIs. It had not even
recommended to the legislature that key measures in its reform
plan should be adopted. The government's budget difficulties
continued to mount. Market confidence in government policy and
the Russian economy continued to fall. Market pressure against
the ruble reached new heights. The government was faced with a
choice between unilaterally restructuring its debt or devaluing
the currency.\27\ Ultimately, it had to do both. On August 17--
despite contrary assurances it had given to the international
agencies and after it had pocketed the first disbursements on
the new IFI loans--the government announced that it was
suspending payment on its commercial and official debts and the
CBR would no longer to support a specific value for the ruble.
Quickly, the currency fell to about one-third its prior value.
The Russian stock market collapsed. Most private savings were
virtually wiped out. Inflation jumped, as prices sought to
catch up with the new lower value of the ruble, and by December
the rate had reached 84 percent for the year.
---------------------------------------------------------------------------
\27\ In fact, the two choices are interlinked, as the Argentine
crisis of November 2001 has demonstrated. Fischer observed in his June
2001 retrospective review that ``You couldn't restructure the debt
without being forced to devalue, and you couldn't devalue without being
forced to restructure the debt.''
---------------------------------------------------------------------------
Shocking many investors and creditors, the IMF did not step
in as expected with major new infusions of cash to sustain the
ruble and cover Russia's debts. Rather, it suspended
disbursements on its existing loan agreements for Russia. On
March 25, 1999, the existing arrangements were canceled ``at
the request of the Russian authorities,'' as the IMF delicately
phrased the news. At their termination, some SDR 1.12 billion
remained undrawn from the 1996 EFF program and nothing had been
used from the EFF loan approved in 1998.
World Bank programs: 1998
The World Bank's efforts in Russia during 1998 paralleled
those of the IMF. On April 1, Wolfensohn told the U.S.-Russia
Business Council that there had been real movement toward
reform. ``We're not only positive,'' he said, ``but we are
supporting our positive view with real financial resources and
real commitment.'' \28\ On July 13, 2 days after the IMF had
made its announcement, World Bank management made a public
statement aimed at quieting the markets. It announced that it
would be accelerating disbursements on its existing projects in
1999 and its plan to award a large new adjustment loan for
Russia in the very near future.
---------------------------------------------------------------------------
\28\ James Wolfensohn. Address to the U.S.-Russia Business Council,
April 1, 1998. Press Release No. 98/1711/ECA
---------------------------------------------------------------------------
On August 6, the World Bank executive board approved a
$1.5 billion structural adjustment loan (SAL3) for Russia. It
was the biggest loan the Bank had ever made in the Europe and
Central Asian region.\29\ Vice president Linn said the new loan
would ``generate greater transparency, secure greater fiscal
accountability, foster competition, and improve corporate
governance, all of which should help rebuild the confidence
essential for achieving sustained growth in Russia.'' Even so,
the Bank's country director for Russian programs cautioned that
``strong implementation'' of the reforms specified in SAL3
``will now be key to creating confidence in Russia's economic
prospects.'' The new loan required that Russia push ahead
vigorously with key structural reforms in several areas.
Progress with the implementation of these reforms would improve
the stability and productivity of the Russian economy and help
instill new market support for the government's policies.
Eleven days later, however, without implementing any of the
promised SAL3 reforms, the Russian Government defaulted on its
debts and devalued its currency. The Bank immediately suspended
further disbursements under the loan.
---------------------------------------------------------------------------
\29\ World Bank Approves Largest-Ever Loan to Russia for Structural
Reforms. News Release No. 99/1919/ECA, August 6, 1998.
---------------------------------------------------------------------------
The World Bank approved one project loan for Russia in
1998, a $400 million highway rehabilitation and maintenance
credit approved in late December. Previously, transportation
loans of this sort had been implemented with little serious
difficulty, notwithstanding the problems the Bank might be
encountering with its other structural reform loans. This
project, however, was different. A key condition of the loan
required an independent audit of the government's road fund and
other similar trust accounts. Little progress was made in
pursuit of the project and it was soon canceled without making
any disbursements having been made from the account.
reconsideration: 1999-2001
Synopsis
After 1999, the IFIs began to seriously reconsider their
approach to Russia. They terminated many of their loan programs
and substantially curtailed their future plans. In 1999, the
IMF and World Bank each made one more effort to encourage sound
macro-economic policy and structural reform in Russia. The IMF
approved a $4.5 billion standby loan for Russia and the World
Bank disbursed $100 million from the large SAL it had approved
the previous year. Russia almost immediately fell out of
compliance with both, however, and further disbursements were
terminated. The IMF made no further loans. The World Bank
approved project loans totaling $698 million during the next 3
years. Most were for technical and institutional reform or for
humanitarian and social purposes. Almost nothing ($3 million)
has been disbursed on these loans, however, and only two have
become effective. New approvals by the IFC and EBRD remained
low, reflecting the cautious view that investors were taking of
the situation. The IFC approved $123 million in new assistance
during these 3 years while the EBRD approved $582 million in
1999 and 2000. (Data for 2001 are not yet available.)
IMF programs: 1999-2001
The Russian economy rebounded in 1999, spurred by those two
classic remedies for economic stagnation--devaluation and
increased export income. The balance of payments (current
account) had shifted from a $2.7 billion deficit in early 1998
to a $4.8 billion surplus in early 1999. In September 1999, the
IMF staff reported \30\ that ``the period since the last
Article IV consultation with the Russian Federation [1998] has
witnessed perhaps the greatest contrast in the fortunes of the
economy since Russia became an independent state in 1992.''
Article IV of the IMF Articles of Agreement provides that the
IMF will hold discussions annually with each of its members
concerning economic conditions and economic issues affecting
its economy.
---------------------------------------------------------------------------
\30\ Russian Federation: Recent Economic Developments. IMF Staff
Country Report 99/100, September 1999.
---------------------------------------------------------------------------
On July 28, 1999, the executive board of the IMF approved a
new SDR 3.3 billion ($4.5 billion) standby loan for Russia.\31\
It would be a 17 month program, with seven equal disbursements,
the first being released immediately. The board noted, in
approving the loan, that it believed the crisis of 1998 was
mainly due to failure by the government to come to grips with
its fiscal problems and to implement structural reforms. The
current situation gave Russia a promising opportunity to move
forward with reforms. The board noted that the new loan program
would have strict requirements in both areas. The government
and CBR agreed that they would comply with the measures
specified in the 1996 and 1998 EFF arrangements.\32\ The IMF
stated later, in an article \33\ designed to respond to
skepticism, that ``Russia's current economic policies are
deserving of IMF support.'' It noted that several of the
reforms included in the 1998 plan had been put into effect by
Russia's more recent governments.
---------------------------------------------------------------------------
\31\ IMF Approves Stand-by Credit for Russia. Press release 99/35,
July 28, 1999.
\32\ Statement of the Government of the Russian Federation and the
Central Bank of Russia on Economic Policies. July 13, 1999. Available
from the IMF Web site under the title Russian Federation Letter of
Intent.
\33\ ``Why resume lending? Russia's current economic policies are
deserving of IMF support.'' IMF Survey 28:17, August 30, 1999, pp. 273-
274.
---------------------------------------------------------------------------
The IMF executive board indicated, in a commentary released
at the same time, that it believed Russia should try to
normalize relations with its creditors. The IMF demonstrated
again, as it had in 1998, that it would not be the debt
collector or guarantor for foreign creditors. The IMF noted
that Russia did not have enough resources to pay its defaulted
debts and to service its foreign debt under present
circumstances and it urged Russia to approach its Paris Club
and London Club creditors for rescheduling and new debt
relief.\34\
---------------------------------------------------------------------------
\34\ IMF Concludes Article IV Consultation with Russia. PIN 99/67,
August 2, 1999. The IMF board approved the actions reported in this PIN
on July 28, 1999.
---------------------------------------------------------------------------
Sensitive to criticism that it was lending new money to a
country that had just recently defaulted on its debts, the IMF
announced that proceeds from the new loan could only be used to
cover loan payments which were due to the IMF in the following
18 months. In effect, the money would not leave the IMF
building but would be moved from one account (disbursements) to
another (payments due) when appropriate. This announced
procedure was mainly symbolic. Only if the IMF had actually
expected the Russians to default on their IMF debt payments
would the described scenario have been real. Money being
fungible, the proceeds from the 1999 loan would have allowed
Russia to use a comparable amount from its existing resources
for other purposes.
The new standby lasted 2 months. Only about $644 million--
the initial first tranche--had been disbursed before the IMF
suspended and then canceled the program.. Russia was out of
compliance with the terms of the July 1999 agreement almost
immediately. On December 7, 1999, Camdessus reviewed the status
of the Russian program. Important progress had been made on the
macro-economic side, he reported, but this had not been matched
by similar progress in the area of structural reform. Several
structural benchmarks set for the end of September remained
unmet.\35\ ``When these remaining issues have been
satisfactorily resolved,'' Camdessus announced, ``I expect to
recommend completion of the review to the Executive Board.'' In
effect, this suspended further action on the 1999 standby. The
IMF executive board is very unlikely to initiate a program
review or approve a disbursement without such a recommendation
by IMF management.
---------------------------------------------------------------------------
\35\ In particular, he noted, the Russian Government needed to let
contracts for financial management reviews (meeting international
standards) of the Pension Fund, Social Insurance Fund, Medical
Insurance Fund, and Road Fund. It needed to submit to the Duma draft
legislation for reforming the bankruptcy law to prevent abuses and
eliminate related forms of bank fraud. The Duma also needed to pass
such legislation. These and several other matters were actions the
government had pledged to take in connection with the 1999 standby loan
but which were not yet completed.
---------------------------------------------------------------------------
In April 2000, the Russian authorities began making public
suggestions that it might be time for the IMF to approve a new
loan. The Russian press quoted Fischer as saying that the IMF
hoped a new program of assistance to Russia might resume ``in
the near future.'' \36\ Russian officials indicated that they
believed there should be ``a change of conditions of the very
principles of borrowing'' from the IMF and World Bank, implying
that new agreements should require less conditionality and more
cash.\37\ Russian press reports even suggested that IMF
officials were already in Moscow working on the details for a
new loan.\38\
---------------------------------------------------------------------------
\36\ ``Putin's aide says Russia does better without IMF credits.''
ITAR/TASS, April 14, 2000, p1008104t6721.
\37\ ``Russians to address new World Bank borrowing principles.''
ITAR/TASS, April 17, 2000, p1008106t6932.
\38\ ``IBRD, IMF experts to fix cooperation programs with Russia.''
ITAR/TASS, April 24, 2000. P1008114t7733.
---------------------------------------------------------------------------
On April 28, World Bank vice president Linn diffused any
speculation that a new IFI loan program was imminent. Russia's
current economic recovery was due to temporary conditions he
said. Over the long run, though, it needed to carry out reforms
if it wanted to attract domestic and foreign investors. If
Russia does not do this, he concluded, it should not expect to
receive major new credit from the IFIs.\39\ Most observers were
quick to note that, if Russia were unable to arrange a new loan
agreement with the IMF, it would not be able to secure debt
relief through the Paris Club from its official creditors, the
former being a prerequisite for the latter.
---------------------------------------------------------------------------
\39\ ``Russia needs structural reform for steady economic growth.''
ITAR/TASS, April 28, 2000, p1008119t8442.
---------------------------------------------------------------------------
World Bank programs: 1999-2001
The World Bank also reduced the size of its loan program
for Russia substantially after 1998. Exploring whether the
Russian Government might be inclined to move ahead cautiously
with the promised program of structural reforms, the Bank
disbursed $100 million in 1999. As with the IMF program,
however, the Russians rapidly fell out of compliance with the
revised terms of the SAL3 program. The World Bank suspended and
then canceled the program with no further disbursements.
In mid-1999, the World Bank adopted a new CAS for Russia,
replacing the one approved in 1997.\40\ In effect, the new CAS
repudiated its predecessor's heavy emphasis on adjustment
lending and balance-of-payments support. Instead, the CAS said
the Bank should put more emphasis on re-establishing the
foundations for growth and reducing institutional barriers to
growth. Responsibility should be shifted from the IBRD to the
IFC for operations where funds are lent to commercial firms and
for other commercial lending. There should be fewer investment
projects, more emphasis on institutional development, and
greater efforts to improve the performance of the Bank's
existing portfolio, which had dipped alarmingly after August
1998. The Bank should sharpen its focus on poverty reduction.
It should also strive to improve its understanding of the
Russian economy in order to improve the quality of its future
policy advice.
---------------------------------------------------------------------------
\40\ Memorandum of the President of the International Bank for
Reconstruction and Development and the IFC to the Executive Directors
on a Country Assistance Strategy of the World Bank Group for the
Russian Federation. Report No. 19897-RU, December 1, 1999.
---------------------------------------------------------------------------
Between 1999 and 2001, the World Bank approved eight
projects for Russia totaling $689 million, all of them strictly
in accord with the goals of the 1999 CAS. Sixty million dollars
was approved for improvements in official statistical and
fiscal procedures. Another $338 million was approved for
projects with a social or humanitarian focus, such as clean
water and sewerage, education, municipal heating, or
amelioration of conditions for people living in depressed
areas. Another $60 million each was also authorized for
sustainable forestry and urban transport. Only two of these
projects--those for institutional reform--have become effective
and only $3 million has been disbursed. Most of the projects
have not yet been officially signed. In some cases, it appears
that necessary Russian legislation has not yet been adopted.
The Bank seems to be putting a good deal of its effort in
Russia into implementing the projects for Russia it approved in
earlier years. Many of these address key structural reform
issues and require the adoption of new policies or procedures
before they can be fully put into effect.
Figure 5 shows that disbursements for World Bank project
assistance in Russia have been proportionally smaller than
those for Bank adjustment loans. In some respects, however,
this gives an incomplete picture of the situation. Many of the
Bank's projects have been delayed for technical reasons or
because key policy changes have not yet been adopted. However,
in most instances, Bank and Russian authorities believe these
problems will be overcome and most of the proceeds for these
loans eventually will be disbursed. If and when this occurs,
the disbursement shares for these projects shown on Figure 5
will rise.
Treating Russia as a Normal Country
In February 2000, at his last press conference as Managing
Director, Camdessus observed that the illusion of quick
transformations in Russia had been shattered.\41\ The strength
of the resistance to reform there was unique. The IMF had been
repeatedly disappointed, he noted, by insufficient efforts of
the Russian authorities to implement agreed economic measures
and by the lack of support from the state Duma. In April 2000,
Fischer took a somewhat more positive but still skeptical view
in his first major statement on Russia as the new IMF Acting
Managing Director.\42\ He listed a number of needed reforms,
noting that many or most had already been elements of prior
programs financed by IMF loans. Russia's poor effort at
implementation, he said, stemmed from a ``failure to overcome
fierce resistance from vested interests in the face of weak
government consensus.'' There was no lack of good ideas about
reform, he observed. ``What is needed now is to translate this
knowledge and energy,'' he said, ``into a coherent reform
strategy that is backed by strong public consensus and
leadership, and that is implemented.'' (Emphasis in the
original.) If that happens, he concluded, the IMF and the rest
of the international community will be ready to help.\43\
---------------------------------------------------------------------------
\41\ Press conference by Michel Camdessus, April 8, 2000.
Washington, DC Reported by ITAR/TASS News Agency, February 14, 2000,
p1008039t0176.
\42\ Stanley Fischer. Russian Economic Policy at the Start of the
New Administration. Remarks to the conference at the State University:
Higher School of Economics, Moscow, April 6, 2000.
\43\ For further discussion along this line, see: Russian
Federation: Staff Report for the 2000 Article IV Consultation and
Public Information Notice Following Consultation. IMF Staff Country
Report No. 00/145, November 2000; IMF Concludes Post-Program Monitoring
Discussion on the Russian Federation. PIN No. 01/68, July 18, 2001; and
Russian Federation: Post-Program Monitoring Discussions-Staff Report;
and Public Information Notice on the Executive Board Discussion. IMF
Country Report No, 01/102, July 2001. All are available from the IMF
Web site.
---------------------------------------------------------------------------
In July 2001, World Bank vice president Linn summarized the
Bank's current views on the Russian situation.\44\ In 2000, he
noted, Russia had high economic growth (over 8 percent), large
budget and trade surpluses, and a major increase in its
international reserves. However, he noted, the situation was
not sustainable, because it was being supported by high oil
prices and a strongly undervalued currency. When oil prices
fell and the ruble appreciated more toward a more appropriate
value, he predicted, Russia's growth rate would decline. Over
the long run, Linn urged, Russia needed deep institutional
reform in its economy in order to achieve the high investment
levels necessary for broad-based productivity and employment
growth.\45\
---------------------------------------------------------------------------
\44\ Johannes F. Linn. Economic Situation and Outlook in Russia and
Central Asia. Keynote Speech, 6th Berlin Financing Conference, Berlin,
Germany, July 21-22, 2001. Available from World Bank Web site.
\45\ In particular, Linn noted that more progress was needed with
reforms in six areas. For the most part, they were the same structural
reforms the IMF and World Bank had been stressing for years. They
included (1) further reforms in the tax administration, treasury, and
debt management systems, (2) better corporate governance, including
improvements in creditor and shareholder rights, (3) more predictable
legal and regulatory treatment of foreign investors, (4) less
involvement by government agencies-- especial local and provincial
authorities-- in commercial and business matters, (5) a more effective
judicial system, and (6) improvements in the banking and finance
system. The government would also need to take steps to encourage
foreign investment and curb the continued flight of Russian capital.
---------------------------------------------------------------------------
Linn observed that the role of the international agencies
in Russia would likely be much smaller in the future than it
has been in the past. ``Today,'' he asserted, ``Russia requires
much less foreign financial support than it did in the 1990s.''
Therefore, he said, the World Bank would focus more on
analytical, legal, technical, and institutional concerns. In
effect, Linn indicated, there would be fewer projects for
infrastructure and enterprise reform and no broad loans for
structural adjustment. The levels of World Bank aid seen in
prior years were not likely to be seen again.
At some point during 1999, it appears, the IFIs and their
major member countries changed their basic perception of
Russia. Certainly, they had grounds for being disillusioned and
disappointed by Russia's default and devaluation in 1998.
Despite the willingness of the IFIs and others to pledge large
sums to bolster their determination, the Russian Government,
gave way and failed to change course or to pursue promised
reforms. The echos from the shock in Russia reverberated around
the world, putting many other emerging market economies--
Brazil, for example--in peril and requiring major new
commitments of funds by the IFIs.
Camdessus observed, in the month prior to the 1999 loan,
that Russia needed to decide whether it wanted to complete its
transition to a full market economy.\46\ Many key structural
reforms remained to be accomplished, but there seemed to be
reservations in some parts of Russian society as to whether
they should be pursued. In this, he said, Russia was not
unique. Russia had some special economic and political
challenges as it emerged from 70 years of Soviet economic
management. Nevertheless, he observed, ``Russia faces a similar
range of economic problems--macro-economic imbalances,
incomplete structural reforms, weak system of governance, and
heavy use of external borrowing--that were found in differing
degrees in other countries in crisis.''
---------------------------------------------------------------------------
\46\ Michel Camdessus. Russia: In Search of a Vision to Revitalize
Reform. Address to the St. Petersburg Economic Forum, Russia, June 16,
1999.
---------------------------------------------------------------------------
Russia needed to take steps in several areas, he said, if
it were to surmount its current difficulties. It needed to
surmount the barter system and the culture of non-payment. The
government needed to make a ``clear and unambiguous
commitment'' to equity in society. Even more central, the state
needed to adopt a role for itself that was more compatible with
the needs of a market economy. Instead of trying to be the
central actor in the economy, the state should establish and
uphold of the laws and be the ultimate source of basic social
protections. It should be the creator of the legal framework
and the key regulator and monitor of the market's standards and
practices. Equally important, he said, Russia needed to more
clearly distinguish between the government and the institutions
of the economy. In this, Camdessus observed, Russia was not
alone. Many of its problems reflect ``an almost universal
syndrome of incestuous relationships between governments, banks
and enterprises.'' Those who think that Russia is unique, he
said, should look at the newspapers. All around the world, he
observed, one sees demonstrations against ``corruption,
collusion, nepotism,'' criticism of ``crony capitalism'' and
denunciations of ``oligarchism.''
Some of the change in the IFIs' view of Russia may have
arisen as a consequence of the Russian Government's uncertain
responsiveness to concerns arising from the FIMACO affair.\47\
The CBR seemed to show little concern about whether its
activities had credibility for major foreign countries. In late
September 1999, as consideration was being given to a possible
new disbursement on the 1999 IMF loan, the G-7 called for new
mechanisms to monitor Russia's use of foreign loans.
Specifically, it asked the CBR to undertake quarterly audits of
its reserves. CBR Governor Gerashchenko reportedly said that he
thought the idea was ``stupid.'' \48\
---------------------------------------------------------------------------
\47\ In that situation, the CBR diverted $1.2 billion of money lent
by the IMF to an offshore account in the Channel Islands. In 1996, the
funds were reportedly converted to rubles and used to purchase Russian
Government bonds. The government was able to use the revenue from those
bonds to avoid insolvency and to pay wage and pension arrears and make
other key expenditures during the presidential election campaign. The
CBR deceived the IMF as to status of that account, saying it could be
counted among the country's foreign exchange reserves. Some critics are
deeply concerned that money may have been stolen or used to benefit
rich speculators. Other critics worry whether it is proper for IMF
resources to be used improve President Yeltsin's election prospects
during a period when it seemed he might be defeated in his bid for
reelection. CBR Governor Gerashchenko did not inspire confidence in his
explanation of the affair, when he told the Duma that the placement of
funds in FIMACO was merely an effort by the CBR to evade paying Russian
taxes on the earnings, to hide assets from creditors who might
otherwise be able to collect by lawsuit, and to get a better return on
the money than it could get if the CBR managed the account itself.
\48\ Russia is Told to Sell its Offshore Banks--IMF Demand is in
Wake of '96 Underreporting of Central-Bank Funds. Wall Street Journal,
October 1, 1999, p. A13.
---------------------------------------------------------------------------
In June 2001, the author interviewed the key managers of
the IMF responsible for its Russian programs \49\ in order to
solicit their views on the current situation. They sought to
minimize the suggestion that the Russians might have been
seeking new loans the year before. They were merely inquiring,
the IMF managers said, whether the IMF might be willing to
resume implementation of their earlier loan program. The
Russian situation was complicated. On one hand, they observed,
its current macro-economic situation and its balance-of-
payments surplus are strong. It seems unlikely that Russia will
need to approach the IMF for assistance or that the IMF would
find such assistance appropriate. On the other hand, they
agreed upon inquiry, the IMF is unlikely to lend until Russia
begins implementing some of the structural reforms agreed to
earlier.
---------------------------------------------------------------------------
\49\ Interview with John Odling-Smee, Director, European II
Department, and his deputy, Gerard Belanger, by the author at the IMF,
June 14, 2001.
---------------------------------------------------------------------------
This raised questions about the IMF's basic approach to
Russia. Wasn't it vital that Russia move through the transition
process, even if this meant compromise on structural reforms?
Had the IMF limited its leverage and lessened its capacity for
promoting change by its announcements that new loans would be
available only when Russia began implementing needed structural
reforms? Does this mean that--as long as it can keep its macro-
economic situation strong--Russia would be able to postpone any
further action on structural reforms? The IMF managers
disagreed with the underlying premise of these questions.
``Russia is a normal country,'' they reported. It is not unique
and the IMF does not need special standards for its programs
there. Many other countries are also postponing any need for
action on structural reforms through good macro-economic
performance. Several major countries were mentioned. Some day,
the IMF managers noted, these countries may find that their
economic situation is deteriorating and they may ask the IMF
for financial assistance. In that situation, for Russia and for
other countries, the issue of structural reform will come up
again, they said, and the prospective borrowers will know what
they ought to do.
Concluding Comments
It seems likely that Russia will not be receiving major
infusions of assistance from the IMF and the multilateral banks
in the near future. In December 2001, the IMF's chief spokesman
announced that Russia's current situation is ``sustainable
without need for recourse to the Fund or other points of
external support.'' The Russian Finance Minister agreed that
``We will not need IMF credits. Russia has enough of its own
financial instruments which will be used to fulfill the
budget.'' \50\
---------------------------------------------------------------------------
\50\ ``IMF does not expect Russia will need loans.'' Reuters,
December 6, 2001.
---------------------------------------------------------------------------
After their disappointment of 1998, the international
agencies may harbor some reservations about Russia's
willingness to address the hard problems which remain. Russia's
macro-economic situation is reasonably good, but it has not yet
implemented many of the structural reforms it agreed to pursue
in connection with the 1999 loan. The World Bank will continue
funding projects, mainly those addressing social needs or
institutional reform. According to its latest strategy paper,
however, the Bank does not intend to pursue broad systematic
reforms or major adjustment programs. The EBRD will be lending
or investing where it sees opportunities, but is assistance
will mainly target the private sector and not government
programs. Much will depend in the future on the policies the
Putin government pursues and the steps it takes toward
structural change.
There continues to be substantial debate as to whether
Russia benefitted or suffered from its relationship with the
IFIs. In large part, the question depends whether one believes
that a market economy is preferable or whether some type of
state-managed economic system is more to be desired. The IFIs
played a significant role in the past decade urging Russia to
move toward the former goal. Among the G-7 and other foreign
aid donors, they helped assure that there was some minimal
coherence in goals and expectations. No other donor sponsored
an alternative program of economic policy reform with contrary
goals or norms. During the 1990s, the IMF in particular sought
to persuade the Russians to reduce the size of their budget
deficit, to limit inflation, to improve fiscal and monetary
procedures, and to undertake a broad range of structural
reforms. The latter included privatization, elimination of
subsidies for large former-state firms, closer regulation of
the financial health and stability of the financial system,
land and agricultural reform, and other matters. Most of these
were at the heart of the political struggle then going on
between Russian reformers and the opposition. Demonstrably,
Russia failed to comply with the performance criteria in most
of its IFI stabilization or adjustment programs. Toward the
latter part of the decade, the budget deficit and rate of
inflation came down substantially but macro-economic stability
was still precarious. Achievement of many of the key structural
reforms was often partial or incomplete.
Since late 1999, the IFIs have decided that Russia no
longer needs special treatment. From the perspective of the
IFIs (and from that of many of their major member countries),
Russia is now a ``normal'' country and should be treated by the
IFIs in the same manner as they treat other middle-income
developing countries. Russia's current macro-economic situation
is such that it does not need new IFI stabilization or SALs.
Its performance in recent years with structural reform--the
unmet commitments from prior loans--is such that it would
likely not qualify for such loans even if it needed them. The
IFIs will probably give substantial consideration, in any
future discussion of new assistance plans, to the level of
progress Russia will have made in the future with the
implementation of such structural reforms.
-