Nov 2 (Stratfor)
After years of decline, Russia�s flirtation with capitalism has now reached a critical juncture. The experiment with Western-style capitalism has collapsed. And the invention of Russia�s peculiar � and wild � brand of capitalism has ended in outrageous scandal and popular discontent. A decade worth of foreign aid and investment has left Russia a pauper nation.
Burned by its post-Cold War experience, Russia is now poised to turn back the economic clock and to narrow its economic relations with the West. Russian politics increasingly point to a return of centralized, state-directed planning which can direct Western investment, minimize corruption and begin to satisfy everyday Russians. Most major presidential candidates, for example, come from backgrounds of strong state planning.
Why Russia�s economy is hard to quantify.
A decade ago, such planning was known as perestroika. For the West, it was the beginning of Russia�s financial opening. But for Russia, perestroika was an altogether different endeavor. It was a calculated effort by the government�s security apparatus to close the technology gap with the West through foreign investment, while still maintaining the Communist Party�s stronghold. In the coming 12 to 18 months, the new perestroika will attempt to rebuild highly centralized control, while keeping the door cracked for Western capital.
The economy is in such critical condition that a return to some form of centralized planning now presents itself as the only viable option. Though Russian statistics do a poor job of measuring the true state of the economy, they generally portray a situation that cannot continue. Productivity is half of what it was a decade ago. Real disposable incomes have also fallen by half. Up to $500 billion in capital has fled for havens abroad. Foreign investors are expected to pump just $1 billion into the country by the end of this year, down from $2.2 billion last year. [click graph for more on statistics]
Whether the new perestroika succeeds or not, Russia�s relations with the West will change dramatically. The economic situation is so dire failure to control it will likely plunge the country into political crisis and force a break with the West. Even if the return to centralized planning succeeds, relations with the West will narrow sharply. The economy�s wide open, free-for-all will grind to a halt as Western investors wait on bureaucrats to put them into constrictive joint ventures, as now exist in China. Hunting for large returns on investment, the government will have little interest in either small, entrepreneurial investors or portfolio investment.
Either way, Russia is now poised to return to its past. (back to top)
The Truth About Perestroika
There has been a fundamental flaw in the West�s approach to Russia since the end of the Cold War: no one has noticed that there has been no revolution.
The West�s initial elation at the collapse of the Soviet Union ignored the fact that the old regime�s politicians, bureaucracy and attitudes remained intact. Intact alongside them in the late 1980s and early 1990s was Russia�s history of centralized control. Russia had never had an industrial revolution, history of free markets, democracy or rule of law.
Even President Boris Yeltsin inherited a Russia that lacked only the political superstructure of the Soviet empire. Apart from a handful of eager reformers zealously encouraged by the West, Russia�s �new� economy has rested on the same institutions as the old. The Soviet legal system remained in place, as did its socio-economic structures. Even the post-USSR reformist initiative was a legacy of Soviet planning.
The troubles of Russia at the end of the 1990s can be traced directly to the early 1980s, when the ponderous, centralized control of the Soviet Union began a subtle shift in the desperate hope of competing with the more advanced economies of the West. Indeed, Yuri Andropov, former KGB chairman and short-lived general secretary of the Communist Party (CPSU), not only laid the groundwork for perestroika and the collapse of the Soviet Union � but also hopelessly handicapped the reformist effort that has followed.
In the early 1980s, the KGB became aware that the West was rapidly outstripping the Soviet Union in civilian and military high technology. The KGB warned that the Soviets would lose the Cold War. And so, plans were laid to restructure economic relations with the West, through perestroika, and politically, through glasnost. In this way, Russia could capture foreign direct investment and the willing transfer of technology � all while maintaining the Communist Party�s grip on power.
As early as 1984, a select group of Politburo members and KGB First Chief Directorate officers began planning to set perestroika in motion. By 1986, KGB officers and Komsomol officials were building the new economic infrastructure � banks, trading companies, stock and currency exchanges, and corporate shells � that were to attract and exploit Western investment. The KGB and trusted party members in trade ministries were also tasked with generating hard currency from the export of raw materials, which was to be laundered through offshore financial institutions and eventually return disguised as �Western� capital investment.
While the West overlooked it, the KGB in fact permeated the entire perestroika economy. Its officers took executive positions in all the new firms to guide and contain the process. Soviet perestroika law required all foreign investors to have Russian partners. According to officers who took part, the KGB�s Fifth Chief Directorate formed most of the 1989-1990 joint ventures, while the Central Committee of the Communist Party was responsible for the rest. In 1992, an estimated 80 percent of joint ventures included KGB officers. Western businessmen even sought out KGB men as business partners, since they had a reputation for getting things done.
But the fundamental flaw of perestroika quickly became apparent: once the door was open, the Communist Party couldn�t keep control of the economy. On orders from senior officials anxious to safeguard the Party�s assets, the KGB began the first great wave of Russian capital flight since the overthrow of Czar Nicholas II. The KGB used its own foreign residencies, as well as institutions established under perestroika, to hide billions of dollars of Party and state resources abroad. The scale of the KGB project was impressive. From 1989 to 1991, the KGB first chief directorate funneled at least 60 metric tons of gold, 150 metric tons of silver, 8 metric tons of platinum, and from $15 to $50 billion in hard currency abroad, according to Russian investigators.
To conceal and protect the Party�s fortune, officials formed some 100 banks and other commercial enterprises in Moscow between 1990 and 1991, with 600 more in the regions and still more outside the Soviet Union. One of these, founded in late November 1990 by Eurobank, the Paris based arm of the Soviet Central Bank, was the Jersey based Financial Management Company Ltd. � FIMACO. In 1990, then-Politburo member Primakov negotiated a $1 billion loan from Arab gulf states, which reportedly vanished into FIMACO. FIMACO would later serve the same purpose for the erstwhile reformist Russian government. (back to top)
Russia Today: The Men of Perestroika Return
Ten years later, the truth about perestroika resonates more loudly than ever � though largely unheard in the West. The entire generation of key politicians and businessmen who are now vying for control of the country were intimately involved in perestroika and the export of party assets.
For example, in 1992, Yevgeny Primakov, then head of the Russian Foreign Intelligence Service (SVR), the successor to the KGB�s First Chief Directorate, stifled a parliamentary investigation of Soviet Communist Party capital flight.
Primakov was reportedly one of five senior officials, including Soviet Central Bank Chairman Viktor Gerashchenko, to be briefed by KGB Col. Leonid Veselovsky on the methods available for hiding Communist Party funds overseas. Primakov is not the only senior Russian official with these ties. Some evidence suggests that Prime Minister Vladimir Putin, then a KGB officer in Germany, took part in Soviet capital flight in the late 1980s.
Several Russian oligarchs, now deep in the country�s economic scandals, got their start during this period. Some traded Russian resources under perestroika, purchasing them at cheap, state-subsidized prices and selling abroad at higher, world market prices. Others established and headed banks on behalf of the Communist Party.
All benefited wildly from Russia�s opening to the West. These banks scored huge profits when then-Russian Central Bank chief Viktor Gerashchenko issued them extremely cheap credits. In 1992, with inflation at 2,500 percent, the Central Bank lent the equivalent of 32 percent of Russia�s entire Gross Domestic Product (GDP) at 10 to 25 percent of annual interest rates. A few privileged banks have also handled the accounts of Russian government ministries and agencies, the president�s office, the parliament and regional governments.
The West, in turn, has fundamentally miscalculated, enthusiastically supporting a small group of reformers who administered unpopular shock therapy to the economy in a short-lived program of privatization, liberalization and tight monetary policy. The Russian public has seen its buying power plummet and savings evaporate in hyperinflation, marking the beginning of the Russian public�s disillusionment with reform. Today, real disposable income is down more than 50 percent since 1991.
Nearly 40 percent of Russians earn incomes below the official subsistence level of 787 rubles, or $31, per month.
As they rose in prominence in the early 1990s, reformers came up against both the entrenched Soviet-era managers and the proto-oligarchs. In the early stages of privatization, the reformers handed control of inefficient old Soviet factories to Soviet-era managers � who balked at reform, downsizing and restructuring.
The main clash occurred in early 1992 and effectively marked the end of reform, though Russia has wrestled with it ever since. At the time, Yeltsin, at the urging of his economic advisor, Yegor Gaidar, attempted to undermine the looting of subsidized commodities by liberalizing commodity prices and exports. Russian oil sold domestically at 1 percent of world prices, and those who traded this abroad made $24 billion on the difference in that year alone � the peak of the scheme. The lost revenues amounted to about 30 percent of Russia�s GDP.
Backed by the communists, Viktor Chernomyrdin and others in the state energy apparatus who benefited from the looting challenged Gaidar, arguing the rationalization of prices would destroy Russian industry. Chernomyrdin won, becoming energy minister and later replacing Gaidar as prime minister. The rejection of Gaidar�s reforms both highlighted the pervasiveness of the pre-Soviet apparatus and effectively marked the end of reform. From that moment forward, reformists like Anatoly Chubais, Moscow�s privatization chief, have waged a series of losing battles against the old Soviet apparatchiks and have been forced into shortsighted tactical compromises.
The reformists� losing rear-guard battle has effectively laid the foundation for today�s scandals. Reformists sought to counter the apparatchiks by building up power and influence of a few bankers � soon to be full-blown oligarchs. The oligarchs emerged with the most power and as a result have done the most looting.
In December 1995, Anatoly Chubais, then-first deputy prime minister, struck the first of these Faustian bargains. Reformists have struck them ever since, steadily losing power. In what became known as the loans-for-shares scheme, Chubais convinced a small group of bankers � the rising oligarchs � to issue loans to the government against the collateral of shares in some of the country�s largest and most lucrative firms, including the oil companies Yukos, Sibneft and Sidanko. As expected, the Russian government could not repay its loans at the end of the one-year term, and the oligarchs organized rigged auctions to divide the spoils.
Chubais� second bargain again enlisted the rising oligarchs, in a desperate attempt to keep Yeltsin in power when his prospects looked grim in the run-up to the 1996 presidential election. Most Russians blamed Yeltsin�s erratic economic reform program for the substantial declines in their standard of living and the communists and presidential candidate Gennady Zyuganov capitalized. Chubais called on the oligarchs to finance Yeltsin�s re-election. Having sold the economy to the oligarchs in order to defeat the apparatchiks, Chubais then effectively sold the government to the oligarchs to defeat the Communists at the polls.
The oligarchs fronted the election and Yeltsin prevailed, but not before his personal bodyguard Alexander Korzhakov exposed the financing scheme after catching two of Chubais� campaign staff slipping out of the Kremlin after dark with a satchel full of cash. Korzhakov paid for blowing the whistle with his job, while Chubais and oligarchs Boris Berezovsky and Vladimir Potanin were given jobs in the government.
The resulting unholy alliance of government and full-fledged oligarchs completely eliminated all hopes of reform. Together, the seven oligarchs who backed Yeltsin together controlled 50 percent of the Russian economy. Considering that 40 percent of Russia�s GDP was produced by businesses run by organized crime, according to a 1995 multi-department Russian committee report, the Kremlin had few targets to reform or tax.
All Over the Globe is published by IPA House.
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