Empire state building

November 4, 1994

Robert Skidelsky argues that the West would be foolish if it did not come to the aid of Yeltsin's Russia.

When Boris Yeltsin took over the presidency of the Russian Federation in June 1991 he found himself prisoner of a still Communist parliament, and inheritor of a collapsed economy and a collapsed state. In Mikhail Gorbachev's last year output fell by 16 per cent and the distribution of food supplies had broken down. The only organ of the once vaunted Soviet planning system that still worked was the printing press, which went on automatically pumping out money: official inflation was running at almost 300 per cent a year. The 15 republics Gorbachev had set up claimed the right to issue their own roubles, to collect taxes, and to own all the industrial property in their regions. When the Soviet Union government collapsed in December 1991, Russia was on the verge of both hyperinflation and mass starvation.

Yeltsin's finance minister, and in effect prime minister, Yegor Gaidar, embarked on the transition to capitalism, his "shock therapy", in January 1992. This had three features: price liberalisation, restoration of state finances, and privatisation. In that first year the Russians suffered terribly, their living standards dropped by as much as 50 per cent. They only kept going by taking to their plots of land and growing their own food.

Gaidar tried to balance the budget by cutting military orders, slashing agricultural subsidies, social expenditures, and state salaries. He also set a new VAT tax at 28 per cent. By April 1992 he was close to his aim. Under threat of bankruptcy, he hoped to force Russian industry to convert to supplying for the market. But the shock was too great. The communists in parliament got their own man, Victor Gerashchenkov, made chairman of the central bank, and he immediately turned on the printing presses. Credit issues by the bank to the government, to the state enterprises, and the ex-Soviet republics expanded enormously to 40 per cent of Gross Domestic Product in 1992. Inflation rose to over 1,000 per cent.

Gaidar stayed on to get the privatisation programme underway. There were about 250,000 state enterprises, no legal private entrepreneurs to buy them, no capital market. The privatisation law provided a mechanism for all Russians to become shareholders in the economy. But he made damaging concessions to the industrial lobby. The law allowed managers and workers to buy majority shares in their own enterprises. Life might not be so bad after all for party hacks transformed into owners of joint stock enterprises, provided the credits from the central bank kept flowing.

Meanwhile, opposition increased. The duma refused to ratify Gaidar as prime minister in December 1992, and Yeltsin appointed Victor Chernomyrdin, a colourless bureaucrat, formerly head of the Soviet Union's gas ministry. Parliament rejected Yeltsin's proposals to strengthen the presidency and tried to impeach him. Yeltsin decided to act decisively. In a televised broadcast of September 21 he announced the suspension of the Congress of People's Deputies and the Supreme Soviet, and elections for a new parliament. When the duma refused to disperse after a fortnight's siege and tried to seize the state television station Yeltsin sent in the tanks. The election results of December 12-14 were a serious setback for him. His new constitution, giving him sweeping new powers, was approved by a large majority. But the reformers were left in a clear minority in the new 450-seat duma. The real victors were the misnamed Liberal Democrats led by Vladimir Zhirinovsky standing on a platform of law and order combined with imperialist bombast. They won 24 per cent of the vote.

So, what are the prospects? What basic changes to the system have taken place? And what tangible results have the reforms achieved for the Russian people? The continuation of democracy and stability depends on both.

Privatisation has been the big success of the reforms. By July 1994, 15,000 medium and large-scale enterprises, employing over 70 per cent of the industrial workforce, had been privatised. A new decree of July 1994 will focus on cash-based sales of the remaining state enteprises to strategic investors. By mid-1994, more than 70 per cent of state-owned small businesses in the retail trade, catering, and consumer services had been privatised and 30 per cent of all housing units were in private hands. Today there are 700,000 registered small businesses operating in Russia. Many more are illegal. Obviously this represents a large growth in new enterprises. Little progress has been made in privatising agriculture, but there are 300,000 small private farms which, occupying only 5 per cent of agricultural land, produce the largest share of many basic foodstuffs.

Unemployment has remained low, though it is set to rise. Rusting Russian firms have hung on to their workers like the dead souls in Gogol. Low unemployment suggests an absence of restructuring. But this turns out to be wrong. Employment in Russian industry had fallen by 9 per cent by the end of 1993, but had increased rapidly in trade, health, education, and financial services. By the end of 1993, 20 per cent of workers had changed jobs, exactly what should happen in a restructuring.

The great problem remains the budget deficit and its financing. Inflation having fallen to about 100 per cent this year is set to rise again as another great wave of credits is unleashed for agriculture and heavy industry. Russia's obsolete industrial plant still churns out goods it cannot sell and takes delivery for goods it cannot pay for. Peter Karpov, deputy-director of Russia's federal bankruptcy agency, says: "It is the product of our old system in which goods were traded according to a central plan, and money was like an amusing but insignificant little musical accompaniment." As long as the industries have an open line to the central bank, hyperinflation can always return, and the state's finances will remain desperately fragile.

Real GDP in Russia will have fallen by about 40 per cent since the start of the reforms -- as far as the figures can be trusted. But the fall in living standards has been much less, and consumption has started to recover. Surveys of household spending show that this year households bought about 80 per cent of the amount they did in 1991. Since they also grow more of their own food, and housing and heating are still provided virtually free for most, real living standards may not be worse than they were under Gorbachev, though that is low enough -- the average Russian wage is under $100 a month. However, there is evidence of a severe deterioration in healthcare, education, and transport systems. The death rate in Russia has been rising, male life expectancy falling, and infectious diseases, including diptheria, cholera, syphillis, whooping cough and food poisoning are all on the rise.

The main question mark over Russia today is the future of the state. Russia has been less a laboratory for shock therapy than a testing ground for the theories of Hobbes. The shocks occurred because the state broke down. That breakdown has not been halted. The basic problem is the continuing erosion of the central state's fiscal base through tax evasion, criminality, fiscal separatism (the withholding of taxes by the regions) and a flight from the rouble. The state's revenues have been shrinking ever since 1990: today the central government collects under 10 per cent of Russian GDP in taxes. This is not enough to provide the public goods -- law and order, administration, payments for the army and vital social services, a sound monetary system -- needed to maintain its authority. The dwindling of its authority in turn increases tax evasion, criminality, etc.

Part of what the state loses in revenues goes to the criminal gangs, the Russian mafiosi. There is no lack of gruesome semi-facts to support the idea of a criminal takeover of Russia by sections of the old communist nomenklatura and their armed retainers. Some 40 per cent of the turnover of goods and services is now controlled by organised crime; an estimated 100,000 criminals are organised in 3,000 to 4,000 gangs; the Russian murder rate is estimated at ten times that of the United States, no slouch in these matters. On July 14 of this year, the speaker of the duma admonished members for coming into the chamber armed with handguns. More seriously, some of the gangs have been stealing and exporting parts of nuclear weapons scheduled for demolition.

What makes the situation politically explosive is the interaction between criminality and territorial fragmentation. The autonomous regions are bristling with soldiers and weapons, mostly outriders of the old Soviet army; civil wars rage in some of them. There are 25 million ethnic Russians in the newly independent republics. There is an obvious temptation for Russia to try to restore "law and order" and solve its fiscal crisis by rearming and reasserting its old empire by force -- Zhirinovsky's programme.

Can the West help? The Harvard economist Jeffrey Sachs has put forward the imaginative suggestion that the West should help rebuild the authority of Yeltsin's government by financing a part of its budget deficit for a number of years, partly to establish a proper social security system. It is the combination of manager-worker ownership and the firms' responsibility to provide their workers with hospitals, schools, kindergartens, and other services which gives the industrial lobby in parliament its power to wrest credits from the state as an alternative to the enterprises being restructured by outside private capital. Sachs wants the West to provide Russia with a $14 billion stabilisation loan to finance a budget deficit of up to 9 per cent of GDP. Together with a modest increase in domestic bond financing, this would reduce the annual rate of inflation to 60 per cent. Western governments would simply buy Russian bonds up to the required amount.

The transfer to the Russian government of sums of this order, possibly over several years, is a decision which can be taken only at the highest level, though their amount should not be overestimated: the US government still spends $4 billion annually on defence. In the absence of supervision, a lot of the money would probably be wasted. After the Second World War the US, as victor, could insist on conditions and supervise the channelling of Marshall Aid to Europe and equivalent help to the Japanese. For a state which has not been defeated in war, supervision is hard to accept.

Still, the gamble is worth taking. The question is: can the West afford to let the first pro-market democratic government the Russians have had for nearly 80 years collapse? It is argued that the reversal of capital flight would soon solve the revenue problem. Why should the West prop up the Yeltsin government when Russians are spending billions of dollars every year in the West? This puts the cart before the horse. The return of fugitive capital, and investment in the Russian economy, especially in its rich resources of energy and raw materials, depends on confidence in the state. Confidence in the state depends on its ability to provide the public goods of a commercial society. Ability to provide these public goods depends on its revenue and administrative apparatus.

The collapse of Boris Yeltsin's Russia would be the worst disaster which could befall the Russian people, its "near abroad", Central Europe, and the West. Investment in the Russian state is demanded by hard-headed self-interest. And in the midst of all the now fashionable pessimism, let us not forget what a wonderful event in world history it was when the Berlin Wall came down. It was an "evil empire". Acting generously towards Russia now is our securest guarantee that it will never return.

Lord Skidelsky is professor of political economy at Warwick University and chairman of the Social Market Foundation.

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