October 16, 1999    
This Date's Issues: 3565 • 3566 • 3567

Johnson's Russia List
#3567
16 October 1999
davidjohnson@erols.com


[Note from David Johnson:
1. Keith Henderson: GLASNOST II -- AN UNFINISHED RUSSIAN NATIONAL ANTHEM 
WITH AN EMERGING DEMOCRATIC CHORUS: RUSSIAN AND GLOBAL CORRUPTION IS AT A CRITICAL CROSSROADS.
2. Current History: James R. Millar, The De-development of Russia.]


*******


#1
Date: Sat, 16 Oct 1999 
From: Daniel Parker Reneau <dpreneau@yahoo.com>
Subject: TraCCC testimony


Dear David:


I am sure that you are familiar with the Transnational
Crime and Corruption Center at American University
(TraCCC). Keith Henderson, co-Director of the Center,
recently provided an excellent, and very timely, House
testimony about international corruption, focusing on
Russia. I think the readers of the "Russia List"
would be greatly interested in Mr. Henderson's insight
on the subject. 


Here is the URL address of the TraCCC for anyone who
may be interested in learning more about the Center:
http://www.american.edu/transcrime


The testimony was presented before the House
International Relations Committee and the House
Banking Committee on October 7th, 1999, and September
23rd, 1999, respectively. 



GLASNOST II -- AN UNFINISHED RUSSIAN NATIONAL ANTHEM 
WITH AN EMERGING DEMOCRATIC CHORUS: RUSSIAN AND GLOBAL
CORRUPTION IS AT A CRITICAL CROSSROADS
By Keith Henderson
Co-director of the Transnational Crime and Corruption Center at 
American University


Thank you Mr. Chairman and Members of the Committee. 
It is an honor for me to appear
before you today and I will try my best to share my
candid thoughts and reflections on my past and
current anti-corruption work and welcome your
questions. My main interest is in advancing a global
and Russian anti-corruption agenda and in sharing both
lessons learned during my tenure at USAID
from 1993 to March 1999 and my current activities at
The Transnational Center for Crime and
Corruption (TraCCC) at The American University. You
may know that TraCCC is the brainchild
of my esteemed colleague, Professor Louise Shelley,
who formed the center in 1995 with seed
money from the MacArthur Foundation. Our main
objective is to undertake academic and applied
research on global crime and corruption problems,
through creative multi-disciplinary partnerships
with scholars and practitioners in targeted countries.
With support from the U.S. Department of
Justice and others, we have helped establish sister
centers in four Russian cities and one in Ukraine. 
With the Chairman’s permission I will now try to
summarize my testimony for the Committee.

In 1997, Elena Bonner, former dissident, human rights
activist and widow of the Nobel
Peace Prize laureate Andrei Sakharov, made an
observation that I believe sums-up the current
general state of affairs in Russia: 


“The intelligentsia seems to have abandoned its
historic calling of compassion and
assistance in the favor of grabbing crumbs dropped by
the corrupt and powerful.” 


Ms. Bonner further noted that while considerable
freedoms had been achieved in a relatively
short period of time, the collapse of the education
and healthcare systems, forced military
conscription, unconstitutional pre-detention law
enforcement policies, abominable prison conditions
and substandard wages and living conditions made many
of the former concerns of dissidents look
trivial. She called upon the international community
and the Russian leadership to refocus its
attention on core societal values and goals, such as
freedom of the press and rooting out corruption. 
I believe her comments set the stage not only for
today’s discussion, but they also argue for a global
anti-corruption summit and raise several important
questions. 


QUESTION ONE. Is Corruption both a Russian and
international problem that requires
global solutions?


Over 130 years ago during an earlier reform era, Czar
Alexander II, as told by one French-
Russian historian, identified Russian corruption as a
centuries old problem that was a major
deterrent to Russia’s integration with the West. The
historian observed that the causes of
corruption that existed then remained applicable today
(1896): (i) a society ruled by men not
laws; (ii) a secretive, restrictive bureaucracy that
stifles justice and the press and the
development of strong state institutions; (iii) a weak
civil society unable to check government
action and (iv) a disdainful citizenry. These are the
same core problems facing Russia today.


The political, economic and social problems facing
Russia, the U.S., Europe and the global
financial system stem in large part from our
collective failure to fully acknowledge, understand or
respond to what is now recognized as one of the
biggest threats to global economic growth and
political stability -- public and private “grand”
corruption. This phenomenon has greatly limited the
power of the State to play a positive role in
developing society in countries around the world. 


While the effects of grand or high-level corruption
have negative economic and political
consequences on all countries, including the United
States, they have a disproportionate negative
impact on developing and transition countries and any
subsequently emerging middle class. Indeed,
many development specialists of all disciplines,
including economists, lawyers, political scientists,
CEO’s and policy makers, now believe that systemic
corruption in developing and/or transition
countries, such as Russia, makes long-term sustainable
economic and political development
virtually un-achievable. However, because most people
in positions of power around the world,
whether in the public or private sector, have chosen
to treat grand corruption much like the global
AIDS/HIV epidemic -- either under a cloak of silence
or with rhetoric. 


There is still no serious, concerted, holistic effort
underway to address or prevent
Russian, regional or global corruption. From my
perspective, most in the international
business community, the family of multi-laterals and
donors, as well as most public officials,
including the USG, are all moving too slowly and are
behind the learning curve. In short, no
one is taking the responsibility for leadership on a
key foreign policy, national security issue. 

Institution-Building


There are myriad reasons why key reforms in Russia
have had limited resonance. Many are
truly beyond U.S. or European control and relate to
Russia’s embryonic embrace of democracy and
capitalism and the unprecedented revolution underway. 
Thus, even though it has been ten years
since the fall of the Iron Curtain, from a historical
and pragmatic perspective, the notion that the
U.S. or anyone else lost Russia seems at once
premature, naive and unrealistic. As this Committee
knows well, it takes generations, not years, to build
democratic institutions, a market economy, a
viable civil society and a rule of law culture. 


Some of the key musical notes absolutely essential to
creating a Russian democratic
rhapsody with an economic chorus have been written in
a relatively short period of time. However,
some notes must be re-written, harmonized and receive
broader, sustained public and international
support. The most important institution, an
independent media and investigative journalism, is
finding its voice, although it is still too weak and
inexperienced to sing loudly or in key. The
makings of an independent judiciary, in the form of
Russia’s new Constitutional Court, is also
beginning to emerge. 


Judicial Reform 


The Constitutional Court, and to a lesser degree the
Supreme Arbitration Court, are
beginning to resolve disputes between competing
branches of government, private citizens and
businesses,
respectively, that will help protect the personal and
private property rights of citizens and 
businesses. These judicial decisions and some of the
legal reforms that have occurred are creating
the legal foundation necessary to sustain democratic
and economic reforms. While some of these
new rules of the game need further revision, the real
challenge today is implementation and
enforcement. Effective, fair, timely enforcement of
these new rules will provide the missing notes
to Russia’s emerging national anthem and will
ultimately determine Russia’s long-term future and
place in the new world order. This legal
infrastructure and the evolution of a rule of law
culture is
absolutely essential to support a market-based
democratic society and the empowering music of an
independent media and investigative journalism. 


Parliamentary Reform


Whether one agrees with all of its policies or
actors, a viable, independent parliament must
also be part of the equation. In just a few short
years we are beginning to see the Duma assume some
responsibility for governing and taming the volatile
and complex economic and political forces
shaping Russia. Public participation through elected
representation and a system of checks-and-
balances no longer seems to be an illusory goal As
this institution becomes stronger and more
representative, the melodies being written and/or
edited by diverse parliamentary composers, in
conjunction with other important voices within Russian
society, should help generate more public
support for democratic principles and free markets. 
This kind of public dialogue is essential to the
consensus building process that must take place before
corruption can be minimized and to sustain
reforms.


Civil Society 


Most important, advocacy groups, political parties,
business and professional associations
and civic groups, at the local and national levels,
are stronger and are beginning to play in harmony. 
In short, civil society is beginning to monitor more
closely the overall direction and music-making
process of Russia’s orchestra leader. This is the
most encouraging sign that Russia is on the right
page of music, however slow its composition.


However, in order for this music to be captured in
the hearts of Russians, we must refocus
and redouble our collective efforts. This kind of
prevention-oriented agenda should be balanced with
a credible law enforcement agenda. Accountability,
civil society oversight and institution-building
are key watch-words of the day. 


Global Anti-Corruption Dialogue/Treaty


It is therefore incumbent upon the United States,
along with its G-8 partners, to launch a
global anti-corruption initiative. If the United
States does not assume a leadership role in this
endeavor, more financial crises, political and
economic instability and poverty will likely result.
Many transition and developing countries will never
become part of the new world order and the
mutual goals of economic growth and democratic
governance will never be fully realized. 


QUESTION TWO. What lessons have the U.S., the
multi-laterals and the international
community learned through their experience in Russia?


This is a difficult question to answer since events
are ever-changing and remain embryonic. 
However, I will attempt to outline a few key points
that stand-out in my mind, based upon my own
personal efforts and observations made during the 1993
to 1999 time-frame. As the senior rule of
law and crime and corruption advisor to USAID’s Bureau
for Europe and New Independent States
from July 1993 to March 1999, I had the privilege and
opportunity to play a small part in one of the
most important and historical revolutions of our time.
For sure, the early reform days were exciting and
challenging times, and many of us, like the
Russian people, had high expectations that in
retrospect were unrealistic. Our programmatic efforts
were also undertaken without a holistic grand strategy
and with little coordination with our European
allies. Some of this was unavoidable initially, given
time constraints, evolving volatile political
events, our inexperience in the region and the
complexity of the task at hand. However, over time
it became clearer that there were some “underground”
forces at work and that they were stifling
many important economic and political reforms. 


Support for small patronage networks


Ten years after the fall of the Iron Curtain, there
is growing evidence that the informal and
formal patronage networks that existed prior to the
break-up of the FSU are either still intact or
stronger than ever. This is true both in-country and
transnationally. The result is systemic private
and public corruption that makes sustainable economic
and political reform extremely difficult if not
unattainable. Democratic pluralism, a system of
checks and balances and an independent media and
judiciary are still only ideals captured on paper and
are not a reality. 


Corruption within the law enforcement community and
the judiciary presents the highest
barrier to sustainable political and economic
development. Many believe that until this
conspiratorial network and unreformed bureaucracy is
cleaned-up, that little can be done to address
organized crime and corruption. Fundamental civil
service reforms, the adoption and effective but
fair implementation of international law enforcement
protocols and new criminal procedure codes
must be undertaken as a first step to sustainable
reform


Failure to make judicial reform and fighting crime and
corruption a high priority issue 


According to various business surveys, the twin
problems of organized crime and corruption,
coupled with “unpredictable judiciaries”, seriously
impedes long-term trade and investment. The
result is that GDP has fallen dramatically since 1989
and public trust and confidence in democratic
free markets has been badly shaken. In addition, many
believe that no real middle class with is
emerging.


These three inter-related problems promote capital
flight, money laundering and organized
crime, inhibit institutional and political development
and the free flow of information. The result
is that the banking and financial systems in these
countries are under-regulated and are often
controlled by organized criminal networks and/or
corrupt public officials and private sector
oligarchs.


Western Complicity 


There is also growing evidence that “Western” private
sector complicity in playing by the
current corrupt rules of the game is an important
factor that both discourages the development of a
rule of law state and encourages public cynicism. Too
often U.S. advisors act as intermediaries or
facilitators between corrupt public officials and the
private sector and appear to have sometimes
unduly influenced U.S. foreign policy for their own
private gain. 


Donor Corruption. Donor non-transparency and
non-accountability comprise another part
of this problem. The public does not have access to
the details of various loans or reform programs
and thus can not serve to monitor government or donor
activity and the proper distribution of funds
Corruption within the donor community or associated
with donor programs negatively impacts
public perception and confidence and stifles the
emergence of a middle class with vested long-term
interest. While recent public and business surveys in
Georgia and Albania indicate that donor
corruption is perceived as less serious than
corruption within the law enforcement community
(including tax and customs), it is seen as a
contributing factor to the overall corruption problem.


This finding may be significant since there is little
serious investigative journalism or reporting on
this topic in either the Western or FSU press.
Moreover, few high-level public officials or rich
businesspeople are ever held fully accountable.


Current IMF, World Bank or USAID staff guidelines
still do not require formal corruption
analyses in their overall country reports or
strategies. Even when corruption is deemed to be
systemic, no formal loan or program conditionality is
required and there is no consensus among
donors as to what the minimum terms of conditionality
should be. There is very little information
sharing among either donors or between donors and the
national or international law enforcement
community.

Even today most donors do not have clear employee or
contractor guidelines related to their
obligation to report serious corrupt acts internally
or externally. Moreover, they do not have the
auditing or oversight mechanisms or staff to monitor
programs or loans, much less the political will. 
Indeed, donors do not want to become more accountable
and see this function as someone else’s
problem. 


Financial Sector Corruption. Continued reliance on
some of the financial institutions and
outdated rules -- both in the West and in Russia,
coupled with our seemingly blind or naive eye, is
also part of the complicity problem. Our failure to
fully acknowledge and understand that some of
these institutions are criminally controlled and that
some march to the tune of corrupt public officials
and/or entrepreneurs, is a problem yet to be seriously
addressed by anyone. Recent country, regional
and global financial crises, such as occurred in
Russia, Indonesia, South Korea and all point to the
need for prompt and concerted action. 

HIID and Bank of New York Cases 


Elements of the Harvard Institute for International
Development’s Russia economic and 
legal reform program investigation and the Bank of New
York “Russian money laundering” case,
while not factually analogous, both illustrate many
inter-related corruption problems both inside and
outside the donor community, as well as many complex
international development/law enforcement
challenges. 


Whatever the facts and findings in the Bank of New
York money laundering case, it is
representative of larger, inter-related global
problems: Weak, non-transparent, global and country
financial systems, poor oversight and accountability,
strong transnational criminal networks
and official and corporate corruption.


In both the HIID and BN Y cases, inadequate
governmental and non-governmental oversight
of public and private players and public funds,
coupled with weak law enforcement and unclear laws,
has led to myriad and compounded economic and
political problems for both Russia and the U.S. 
A lack of competition within the public procurement
process and too much government political
intervention are also significant contributing causes
of the resulting problems.


These cases also illuminate the need to enhance
competition and structure corruption
safeguards into programs at the outset. These
safeguards should include “know your employee”
rules, as well as “know your customer” rules. Due
diligence is key. This is particularly important
when dealing with little-known people and
institutions, such as banks, in transition countries..
In
both cases it appears as though donor funds were
misused and that people in positions of trust were
colluding with corrupt public and private sector
people and entities. 


Further, these cases also clearly illustrate the need
to enhance international law
enforcement cooperation and accountability, as well as
the need to concentrate on financial sector,
corporate governance and internal donor reforms. 
Other key high priority reforms include: (i)
the adoption of international accounting and auditing
standards that promotes fair audits and
shareholder accountability (ii) progressive bankruptcy
codes that allow enterprises to reorganize
fairly and quickly (iii) international public
procurement codes and regulations that ensure
competition promote transparency and (iv) transparent
(post) privatization processes. 


Some of the people involved in both cases appear to
have ties to corrupt former and current
public officials as well as to corrupt private sector
businessmen and/or organized crime figures.


We do not know exactly how these cases will unfold;
however, the cast of seemingly linked
characters/entities and the complexity and depth of
some of their questionable activities, calls into
question the USG process and laws by which these
individuals were originally employed and
operated. 


In short, in both cases multiple criminal
investigations related to several individuals involved
in different transactions are underway and the USG’s
and business community’s integrity and
reputation have been called into serious question. 
The long-term economic and political fall-out on
USG relations with Russia, the financial community and
on reforms in general, is not yet fully
understood.


QUESTION THREE. When Did We Know That Corruption
Should be a Serious Issue?


1994/95 -- The Loans-For-Shares Scheme/the Yeltsin
Anti- Crime Decree and the HIID
Case.. Reasonable people can certainly disagree on
this question -- to a point. However, in hindsight
most analysts now identify the 1995 “loans-for-shares”
scheme as a clear indication that some of the
“reformers” we were working closely with had ulterior,
self-interested motives. That event, coupled
with the 1994 Yeltsin Organized Crime Decree, which
gave the Ministry of Interior almost limitless
powers to arrest and prosecute individuals outside the
scope of the new Russian Constitution, should
have sent important signals to all that organized
crime and corruption was occurring at very high
levels within the Russian Government. This decree
provoked a national and an international outcry,
from some quarters, but the Russian Government
summarily rejected these concerns. Many analysts,
including myself, believed that the degree was a
strong indicator that the Russian national security
forces were heavily influencing the reform agenda. 


I do not pretend to be an expert on the
loans-for-shares scheme and I do not know all of the
facts intimately. However, no one seriously questions
the fact that the scheme had serious flaws that
called into question the motives of key “reformers.” 


Anders Aslund at Carnegie, a well and highly
respected Chubais protege and long-time
Russia watcher, acknowledged that the scandal
“blemished” both Chubais and large scale
privatization in general. In an October 1999 Foreign
Affairs article, Aslund noted that a few large
banks were allowed to privatize (buy at
bargain-basement prices) enterprises at auctions they
themselves controlled. Many lawsuits and volatile
wars among bankers and the managers of these
enterprises occurred both during and after this
process. In the end, while only 15 enterprises were
involved, several notably represented some of 
Russia’s most valuable assets -- oil: Yukos, Sibneft
and Sidanko. He observed that the new majority owners
did not behave like self-interested
proprietors but just continued the management theft --
primarily by selling the products below
market prices to their own trading companies. 


Aslund then goes on to observe that the barrier to
reform in Russia has never been the
workers or the people, who have been exceedingly
complacent. Rather, the threat has always come
from elites who want to live on corruption. I concur
with Aslund’s analysis and conclusion that
the best way to control these kind of “forces” is
through effective democracy. 

Other unusual circumstances that raised similar
concerns in my own mind related to the fact
that the USG made a concerted decision not to properly
oversee implementation of HIID’s critical
legal and economic reform program and not to award
such a large award through traditional
competitive procedures. Further, my request for a
routine Agency report regarding background on
the new Russian “legal reform” entity being
established to receive over $80 million in USAID and
World Bank support was first accepted in an
interagency meeting and then denied without a full
explanation (see the 1996 GAO HIID Report # 97-27). 


April 30, 1996 -- Congressional Testimony Before the
House Committee on
International Relations. Professor Louise Shelley,
now my colleague at The American University,
Louise Freeh, the Director of the F.B.I., and Eric
Seidel, Deputy Attorney General in New York,
John Deutch, Director of the Central Intelligence
Agency, and others, were among the first to
publically sound an organized crime/corruption warning
call with respect to certain forces operating
within Russia and the United States. Director Deutch
noted “that a link between the governing elite
and the criminal elements impedes the ability of the
Russian Government to meet the population’s
expectations of social justice, a quality of
opportunity and improved living standards.” He also
noted
that the law enforcement forces were understaffed,
underfunded and plagued with corruption. 
Professor Shelley, Director Deutch and N.Y. Deputy
Attorney General Seidel also testified that
organized crime’s hold on the Russian banking
community was a serious problem that had to be
addressed. Finally, several noted that Russian
organized crime was estimated to control up to 40%
of the Russian economy.


1997 ­ The First Anti-Corruption White Paper and
Strategy 


During the spring of 1997, upon my own initiative but
with the blessing of USAID’s Europe
and New Independent State’s Bureau, I authored the
U.S. government’s first white paper on
corruption. Over the next six months, this paper was
discussed in an number of interagency settings
and with various individuals inside and outside of
government. This paper, which outlined the
causes of corruption in the FSU and possible
programmatic solutions, was adopted as the official
USAID strategy for addressing corruption in the region
in the winter of 1997. Key elements of this
holistic strategy, which focused on mutually
supportive trade and investment, good governance and
civil society issues of common interest, were later
included in the State Department’s first formal
policy statement on Russian corruption in late 1997 or
early 1998. I submit it for the record as an
attachment to this testimony. That said, a
comprehensive anti-corruption initiative, with or
without donor support, has yet to be launched in
Russia. 


QUESTION FOUR. What Can Be Done To Address Corruption
and What are Some Of the
Lessons Learned From Our Experience In Russia? 


First. Do not attempt to create big or little czars
or czarinas. Putting all of your reform eggs in one
basket without broad public participation, support and
oversight is a recipe for failure. It also
undercuts fundamental democratic principles and opens
up the process to corruption.


Second. Insist on transparency within the donor
community. On the giving end, the public has a
right to know how their money is being spent
(developed countries); on the receiving end, the
public
has a right to participate in the decision-making and
monitoring of this money (developing and
transition countries). I can not tell you have many
times I have been told by donors and potential
donor recipients that corruption is rampant within the
old boy network that exists both here and
abroad. Potential recipients and everyday citizens
are now very suspicious of the U.S. and others
offering to lend them a helping hand.


Third. Advance an international Global
Anti-Corruption Treaty and Minimum Terms of
Conditionality for donors that is prioritized and
mandatory. Donors could not make specified kinds
of loans or participate in certain reforms unless
these minimum terms were agreed to in full. 
Adequate support for an independent judiciary, media
and civil society, as well as health and
education programs, must be part of this package. 


Fourth. Give the OECD Anti-Bribery Treaty and the
Organization of American States Anti-
Corruption Treaties some impetus and teeth. More
intensive, creative monitoring mechanisms that
include civil society and business community oversight
must be part of this package. In addition,
international corporations should be held legally
accountable for corrupt complicity. Strengthening
key multi-lateral organizations and enhancing the U.S.
diplomacy and capacity to implement foreign
policy is an essential step in the new world order.


Fifth. Enhance international law enforcement
cooperation/communication through more informal
and formal structures/procedures. More regional,
sector focused , interdisciplinary training programs
that are tied to short and long-term reforms and
strategies are needed so that people (properly vetted)
can develop mutual trust and share transnational
“knowledge.”


Sixth. Promote the flow of “corruption” information
among donors and between donors and the law
enforcement community. This should include legal and
ethical obligations that all requires government
employees and businesses to report on “suspicious
transactions.” Passage and implementation of
Access to Information, Whistle-Blower laws and
policies that provide legal and political protection
to
whistle-blowers, prosecutors, police, judges, policy
makers and journalists is paramount. Until the “code
of silence” is broken and “culture of secrecy” within
governments there is little hope of exposing or
rooting out corruption.


Seventh. Promote more competition in the public
procurement process and international best practices
and good governance principles in both the private and
public sectors. Many international best practices
and standards have or are emerging within the last few
years but most countries, particularly those in
the transition and developing world, do not know
whether or how to implement them. Particular
attention should be given to some of the hard work
that has been done by various international bodies
including the World Trading Organization, the
Organization for Economic Cooperation and
Development and various professional international
business and trade associations (e.g.,
accounting/auditing/banking/corporate governance/trade
and investment, etc). 


Eighth. Promote more long-term
institution-building/reforms related to entities that
can provide a
check on governmental action (judiciaries, financial
regulatory bodies, independent auditing agencies,
ombudsmen, small business associations, advocacy
groups, etc).


Ninth. Promote policies that promote more cooperation
between the executive and parliamentary
branches and more interagency coordination.


Tenth. Promote more academic and applied research
related to understanding the causes and costs of
corruption -- particularly the full economic and
political impact of systemic corruption. More private-
public partnerships are needed in order to create
viable solutions to complex problems and to stay one-
step ahead of organized crime and corrupt public
officials.


Eleventh. Enhance communication and engagement within
the global and intelligence communities,
donors and the business community and more due
diligence needed to protect the global financial
system and donors. “Know your customer” and “know
your employee” rules need to be strengthened..


*******


#2
Date: Wed, 13 Oct 1999
Subject: The De-development of Russia by James R. Millar
From: "Bill Finan" <billfinan@snip.net>


>From the October 1999 issue of Current History
Copyright 1999 Current History, Inc.


The De-development of Russia
By James R. Millar
James R. Millar, editor of the journal Problems of Post-Communism, is a
professor of economics and international affairs at George Washington
University and director of the Institute for European, Russian, and
Eurasian Studies.


The specter of Lenin has haunted Russia since the end of the Soviet Union
in December 1991. Should his body be removed from the mausoleum that
dominates Red Square and be given a proper burial? Or should it remain
enshrined, as the Communist Party of Russia insists, serving as a monument
to the true achievements of the Soviet Union? President Boris Yeltsin and
Russia's anti-Communist forces, critics of Lenin's legacy, have offered a
third alternative by threatening to remove his corpse in the dead of night,
cremate the remains, and bury them with Christian rites (although rough
treatment of Lenin's embalmed body could stir up popular anger).


Ambivalence toward Lenin's legacy reflects that of most Russians and their
legislators toward persisting Soviet institutions, attitudes, and
behaviors. The sources of ambivalence are twofold. First, Russians continue
to tell pollsters that they want a society and economy that embody many
aspects of the former Soviet social system. If given a choice, most would
opt for free public education and medical care, as well as public ownership
and operation of heavy industry, banks, transportation, communications,
electric power, and, in lesser numbers, light industry. Second, market
reforms, especially price liberalization and privatization, have proved
disastrous for the majority of the population and have led, not
surprisingly, to a certain nostalgia for the stagnant years under Soviet
General Secretary Leonid Brezhnev's reign.


Yet some positive developments have also occurred since the end of Soviet
Communist Party rule, especially in the realm of civil and economic rights,
such as the growth of private enterprise, access to foreign travel and
products, internal mobility, private ownership of apartments and dachas
(and the land under them), and the availability of privately owned autos.


A composite index summarizing all the changes that have taken place since
1985, when Soviet leader Mikhail Gorbachev first announced economic
restructuring and political openness-perestroika and glasnost-might show a
positive net gain for a majority of Russian citizens, but it would probably
be a very slim majority. A few, perhaps 10 percent (located almost
exclusively in major urban areas), might have a substantial gain in total
welfare. A larger number, perhaps 40 percent (most over 40 years of age),
would register a substantial decline in welfare. The remainder would fall
in between.


These numbers underscore why Russians have become highly skeptical of the
promises Yeltsin has made regarding the benefits of democratization and
marketization. Further economic reform in Russia is without strong popular
support. The bursting of the financial bubble on August 17, 1998 ended the
series of radical reforms initiated by Yeltsin and his entourage in January
1992. The current phase is precarious, as Yeltsin's latest government seeks
to avoid further default, devaluation, and, ultimately, bankruptcy in the
international economy.


Deformed reform


Russia's descent into the third world began in 1975, when the Soviet
Union's high postwar growth rates began to fall. The trend thereafter was,
if still positive, gradually downward through Leonid Brezhnev's last years
in power in the late 1970s. Gorbachev developed perestroika and glasnost in
1985 to reverse this trend. 


Although the economy's increasingly poor performance was the main stimulus
for reform, its eventual collapse was a consequence of the unanticipated
political destabilization of Eastern Europe and the Soviet Union that had
been brought about by reform; only in this sense did the Soviet planned
economy play a role in the collapse of the Soviet Union. The Soviet
population did not at any time repudiate the Soviet planned economy, a
point critical to understanding the ambiguous attitude that most Russians
now take toward market reforms.


With the formal dissolution of the Soviet Union in December 1991, a second
phase of reform was initiated by Russian President Yeltsin and a team of
market-oriented economists in January 1992. This was a grand experiment
with radical market reform, and the young Russian reformers and their
Western advisers naively expected success by as early as September of that
year. "Shock therapy," as the strategy was labeled, succeeded in freeing
many prices and effectively undermined the system of central planning, but
it failed, in the end, to create a properly functioning market economy. A
subsequent crash privatization program also was unable to create conditions
conducive to the operation of a healthy market economy.


The third phase of economic reform in Russia began in 1995 under tutelage
of the International Monetary Fund. The imf began to make available a
series of major loans to Russia ($6.2 billion in 1995), subject to certain
"conditionalities" regarding official economic policy. The policies imposed
by the imf in exchange for financial support are widely known as the
"Washington Consensus," which called for a tight monetary policy coupled
with an effort to reduce or minimize the deficit and achieve a primary
surplus in the government budget to decrease outstanding debt. The Yeltsin
administration never succeeded in achieving a significant primary surplus,
and government debt continued to grow. The imf also obliged the government
to finance the deficit by floating domestic short-term treasury notes,
known by their acronym, gko (this was in addition to the funds that were
made available by the imf, the World Bank, the European Bank for
Reconstruction and Development, and the German government). After the 1996
presidential election, which a large imf loan (a three-year commitment of
$9 billion) helped Yeltsin win, the government also began to float gkos to
foreign transactors, and many commercial banks and city governments
imprudently followed suit.


The Russian government repeatedly failed to stanch the red ink. Outstanding
debt owed both domestically and abroad continued to grow, as did the amount
of short-term debt that needed refinancing; repayment terms shrank to
progressively shorter periods at increasingly higher interest rates. A
classic financial bubble was developing. The government, with the help of
the central bank, pressed commercial banks to invest in gkos, to the point
that these short-term instruments became their principal assets. Even the
Russian central bank held gkos and, apparently, also invested a portion of
the country's foreign currency reserves in them indirectly.
The financial instability that shook East Asia in 1997 frightened foreign
holders of gkos. A sharp fall in the price of oil, Russia's primary source
of foreign exchange, intensified their fears. Despite a substantial package
constructed by the imf in July 1998 to shore up the value of the ruble
(bringing total imf commitment to $22.6 billion through December 1998, it
was too late to save it; the government announced a default and devaluation
on August 17, 1998. The bubble had burst, ending the third phase of
Yeltsin's reform. Russia was effectively bankrupt. Once again many citizens
lost their savings, and the government's credit rating plummeted
domestically and internationally. Ten years of ineffectual reform and
consequent economic decline had brought Russia into the third world.


The great contraction


Yeltsin's rule has been a decade of decline, denial, and decay. While other
former centrally planned economies have experienced sharp and protracted
declines in gross domestic product, industrial production, and per capita
income during their transition to the market, the contraction in Russia has
been especially severe and prolonged. Between 1989 and 1999, real gdp in
Russia has declined almost 50 percent. (The decline in real gdp in the
United States between 1929 and 1933 during the worst of the Great
Depression was a little less than 25 percent.) Post-Communist Poland, which
also underwent a transition depression, registered a decline of about 20
percent between 1989 and 1992 before gdp began to climb again. In Russia
the decline has yet to be reversed.


The principal cause of transition depressions in Russia and the other
countries of the former Soviet empire was the breakup of their mutual
trading network. Trade patterns were further disrupted by the desire of
many of these countries to find substitute customers and suppliers for
Soviet Russia. Former Soviet enterprises in Russia also encountered
difficulties in attempting to operate without procurement orders, which
provided additional downward pressure on output. In Russia itself, the
failure of enterprises to take advantage of privatization to downsize and
rationalize production led to reduced output. This explains why Russia
experienced a decline in production and distribution when the old empire
collapsed. It does not explain Russia's continued economic decline and why
the Russian economy has failed to reorganize, rationalize, and reinvest to
become competitive.


That more economies born of the old Soviet bloc are failing to recover than
are succeeding is instructive, and this is especially true for the former
republics of the Soviet Union. Apart from the Baltic nations, there is no
economic success story in the former Soviet Union. The question is not
whether Russia has succeeded in creating a market economy for, by default,
it has markets. The question instead is why Russia has not been able to set
up a workable market economy capable of fostering economic growth and
profitable integration into the world economy.


Neither ready nor willing to reform


The primary reason for Russia's post-Soviet economic malaise is that Russia
simply was not ready for radical market reform. Critical economic
institutions were missing, including a true central bank, a functioning
commercial bank network, and a system of commercial law to protect rights
under contract, resolve economic torts, enforce bankruptcy regulations,
and, in general, guarantee the rule of law in business relationships.
Moreover, Russia's new entrepreneurs were not steeped in business mores
that enforce obligations without the threat of a court of law. No court
system could handle the volume of cases that would result if even a
significant minority of transactors deliberately sought to cheat or
otherwise evade their contractual obligations.


Entire markets were also absent, since the Soviet command economy had no
need for them. These included a market for financial instruments, without
which short- and long-term borrowing by enterprises cannot take place; a
market in investment goods and for new construction; and a market for
existing enterprises. In post-Soviet Russia these three markets have yet to
begin to function as in true market economies, and until they do the
creation of a working market economy in Russia will remain critically
incomplete.


Equally significant has been the lack of commitment to economic reform on
the part of nearly all Russians. As was noted, Soviet citizens on the eve
of the union's dissolution were not critical of central planning and were
generally satisfied with the main Soviet economic institutions. For
example, Russians during the Soviet era indicated high levels of
satisfaction (two-thirds to three-fourths reported being "very satisfied"
or "satisfied") with their housing, jobs, access to medical care and higher
education, and overall standard of living. Similarly high proportions
favored public ownership of heavy industry, transportation, communications,
electric power, banking, and light industry. A substantial proportion
preferred fixed prices, low rents, inexpensive transportation, and free
medical and educational services. Surveys also showed most Russians did not
realize that the hated queues were caused by low prices and free services.


Price liberalization and the inflation that ensued in 1992 met with
disapproval even though goods appeared in the stores and queues
disappeared. The young reformers and President Yeltsin never made a serious
effort to educate the people about market reform or the costs it would
entail. This was partly a result of naovetŽ and partly guile, because the
reformers (namely Yegor Gaidar and Anatoly Chubais) and their Western
advisers (Jeffrey Sachs, Anders �slund, and others) believed the transition
could be carried out before the population rebelled at the cost.


The elite members of former Soviet society, the nomenklatura, have also
shown little commitment to market reform. Because a true revolution did not
bring an end to the Soviet Union, this old elite, which once held positions
controlled by the Communist Party of the Soviet Union, was able to assume
control of privatized establishments and continue to dominate Russian
social, educational, and political institutions. The nomenklatura's weak
commitment to reform was partly the result of not knowing what kinds of
behavior and institutions a market economy required, and partly an
ambivalence about reforms that called for private enterprise and private
ownership of the means of production and of land.


In contrast to the 1917 revolution carried out by the Bolsheviks and their
allies, who had a vision supplied by Marx and were determined to create a
new society at almost any cost, the nomenklatura of the new Russia were
conservatives who sought to protect their privileges, income, and power.
The privatization programs that have been part of the reform effort have
failed to create a class of entrepreneurs motivated to rationalize
production and compete domestically or globally. Instead of focusing on the
bottom line, some of the new owners (especially the so-called oligarchs)
have focused on capturing income streams for personal gain. 


Others, mainly the old Soviet-period enterprise managers, have merely
continued to operate essentially as employment agencies. An existing elite
power structure cannot be expected to carry out a real revolution;
moreover, no one in Russia wants a real revolution. Thus, most
institutions, including educational, research, and civil service
organizations as well as the government bureaucracy and enterprises, are
still headed and staffed by the same people who ran them before 1992.


Empire envy has also weakened commitment to reform in Russia. Both the
Russian elite and population at large have found it difficult to give up
the conception of themselves as citizens of a great power and remain in
denial about the breakup of the Soviet Union. The 14 non-Russian republics
and the former Soviet-bloc countries of Eastern Europe either are
recovering or establishing their identities as nation-states. Russia alone
has lost its identity. Its energy and resources are wasted in attempts to
conserve the old sense of self instead of being invested in building new
market institutions, reforming the military, fighting crime and corruption,
and creating an environment for foreign investment and trade.


Unfortunately, market reform has also been discredited in Russia, and its
principal architects have become pariahs. Real income has declined for most
Russians, secure employment has been lost or transformed into sinecures
that rarely pay wages, personal savings have been decimated, pensions have
been devalued, and prospects for improvement in individual living standards
are slim. A small favored elite has benefited enormously in wealth, income,
and power, and a somewhat larger minority, mainly composed of young people,
has found new opportunities domestically and globally, but the vast
majority of Russians is rightly unhappy at the uneven distribution of the
new economic benefits.


President Boris Yeltsin's commitment to market reform has also fluctuated
with his political fortunes and his health. The reform agenda has depended
on his advisers, but movement of the agenda has required Yeltsin's full
attention. When illness has struck, the reform agenda has stagnated.
Yeltsin's perpetual warfare with the Duma has led him repeatedly to
sacrifice economic reform for political advantage. The recent series of
firings and hirings of prime ministers is a case in point. The Russian
economy was in a precarious state in March 1998, when Yeltsin removed
Viktor Chernomyrdin as prime minister for impinging on Yeltsin's political
turf. His replacement, Sergei Kiryenko, was a young economist with no
political clout and thus unable to deal effectively with parliament on
economic issues. His dismissal after the crash of August 17, 1998 led to
the appointment of Yevgeny Primakov, a man of some political and
administrative substance. Primakov, in turn, despite his success in riding
out the crisis, was removed nine months later, reportedly because of
Yeltsin's political jealousy of his growing popularity with the public at
large and in the Duma. Primakov was replaced in May 1999 by Sergei
Stepashin, a Yeltsin loyalist with no economic background. Three months
later, Stepashin was himself replaced by Vladimir Putin, another kgb
alumnus without economic credentials. Although Stepashin was successful in
obtaining a $4.5-billion loan from the imf, he was apparently
insufficiently loyal to 
Yeltsin and perhaps also too popular.


Yeltsin's intermittent commitment to reform has crippled essential elements
of that reform and undermined the political and economic stability required
to attract foreign direct investment, joint ventures, and even domestic
investment in new plant and equipment.


Future scenarios


Each year for the last seven years most forecasting agencies, public as
well as private, have wrongly predicted an upturn in the Russian economy.
Despite the financial crash of 1998, recent forecasts for 2000 are upbeat
again. Yet the future is particularly obscure in the late summer of 1999,
mainly because of political uncertainty. Not only is it unclear what
factions will control the new Duma to be elected this December, it is
unknown even whether an election will take place. Questions about the
presidential election set for mid-2000 abound as well. Will Yeltsin step
aside for a successor? If so, whom will the successor be? In either case,
what are the prospects for economic reform in Russia for the first decade
of the twenty-first century? Let me propose four alternative scenarios.


The Caretaker Model


The caretaker model was best exemplified by Yevgeny Primakov's tenure as
prime minister from September 1998 to May 1999. Primakov avoided radical
changes; he sought to maintain political stability, tinkered with the
federal budget to improve revenues and reduce expenditures, attempted to
charm (or dupe) international lending agencies such as the imf and the
World Bank, and tried to renegotiate outstanding debt held domestically and
internationally. He was able to gain the cooperation of the Duma on
legislation necessary to restructure debt, win additional international
funding, and attract direct foreign investment. Primakov also managed to
stabilize the economy following the shocks of devaluation and default after
August 17, 1998.


Sergei Stepashin, Primakov's replacement, continued a low-key caretaker
program. Because he was a Yeltsin loyalist, he did not work as well with
the Duma, but he continued the attempt to restructure the budget and
improve relations with international lending agencies (including winning a
new $4.5-billion loan from the imf). Since Stepashin's ouster, Vladimir
Putin has not altered course politically or economically and he is unlikely
to do so in the immediate future.


A caretaker government cannot be expected to solve any major economic
issues. The optimal outcome would be to attain, during the run up to the
parliamentary and presidential elections, the stability and gradual
legislative progress achieved under Primakov and Stepashin. All the
variability in this model, however, is on the downside: things could easily
get worse. Russia continues to disintegrate, as does the top leadership.
The reach of the central government is contracting, and every central
institution-from the military to the police to the civil service-is a
feeble reflection of its past self. If Yeltsin and the "family," as his
close loyalists are labeled, abort the parliamentary elections through one
maneuver or another (such as banning the Communist Party) or thwart
constitutional rule by continuing in office beyond this term, the economy
will again suffer severely.


Yeltsin has repeatedly sacrificed a recovering economy to ensure his own
political dominance. Moreover, the wealth, income, and perhaps even the
freedom of Yeltsin's retinue are threatened by the end of his rule.
Consequently, another confrontation between Yeltsin and the Duma and
Communist Party or a mad political scramble should he die suddenly, cannot
be ruled out.

Even if the elections are held as scheduled and Yeltsin surrenders power
peacefully, no major reform can be expected for several months following
the presidential vote. The best scenario in the short run is stagnation or
marginal progress toward a normal market economy. A slightly more likely
outcome is an ugly political scandal accompanied by continued decline and
disintegration of the Russian economy through the elections of 2000.


The Neo-Stalinist Model


Some have worried that the old Stalinist command-administered economy might
be reestablished should left-wing forces come to power in Russia. But a
comparison of the current economy and that of Brezhnev's time reveals just
how far Russia has come along the path to an open, market-oriented economy.
The threat of a neo-Stalinist revival is merely a bogeyman, not a real
possibility. The central government and its agencies simply do not have the
power or the reach to recreate a centralized economic system. The armed
forces and the security forces are not equipped to enforce the central
government's orders. Russia's borders would have to be closed and autarky
reestablished. Too much power and too many resources have already been
devolved voluntarily or otherwise to the regions. In short, neo-Stalinism
is not an option. The idea is useful mainly to scare Western powers into
maintaining their assistance to the current regime-a strategy that
continues to succeed.


The Neo-Radical Reform Model


As unlikely as a return to the Stalinist economy is, the possibility exists
that radical reformers and their protŽgŽs will again be put in charge of
economic reform. One justification for radical reform was the need to
undermine and destroy central planning-and that was accomplished. Still,
many prices are fixed by the state, or by republican or local governments,
and privatization of enterprises and rural land offers opportunities for
further radical policies. The economists who advocated and implemented
radical reform are, however, universally hated in Russia today, and their
names have become colloquial epithets. More important, radical reform has
always depended on Yeltsin's support and protection. Even if Yeltsin were
to find a way to continue in power after 2000 elections, he would no doubt
be physically unable and emotionally unwilling to initiate a new round of
radical reform. Moreover, those members of his entourage who have profited
from radical reform-the oligarchs, for example-now represent a conservative
force against radical reform. They need political and economic stability to
consolidate their gains and to avoid their confiscation. Indeed, the desire
of the Yeltsin "family" to keep Yeltsin in power or to elect a loyalist is
based on the incompleteness of the prior privatization process. Even the
oligarchs realize that they hold their wealth not by virtue of ownership
sanctioned by law and protected by the courts, but at the pleasure of "Czar
Boris."


Future economic reforms will be modest in scale and gradual in application.
The Washington Consensus that guided imf policy and most orthodox Western
economic development specialists has crumbled in recent years and is being
replaced by a less rigid and more pragmatic and gradual doctrine.
Consequently, no respectable economic adviser in or out of Russia is likely
to urge radical reform. John Maynard Keynes's argument that it is better to
introduce a modest reform with a high probability of success than a
sweeping reform with little chance of success is again acknowledged as
prudent economic policy.


The Neo-nep Model


The New Economic Policy (nep) was Lenin's idea: the central government
would control the "commanding heights" of the economy while small business
and trade remained private. This is probably the best and most likely focus
for reform in Russia in the next 10 years-if the country experiences a
peaceful democratic transition to a post-Yeltsin government in 2000. In
many respects the economy is already moving in this direction. A large
number of regional and local governments has introduced price controls and
even rationing of essentials such as heating oil, gasoline, and electrical
power. Many of these governments are forcing their way onto the boards of
industries that were previously privatized or that have joined with foreign
firms. The Yeltsin "family" has also been placing public officials on
private boards of directors and in management positions in enterprises with
significant cash flows that could be diverted to boost the election
prospects of Yeltsin loyalists. (Should the Yeltsinites lose in the
elections, many may stand to lose the "private" property they have acquired
so cheaply and inequitably.) Either way it appears that the role of the
central government will grow in Russia with respect to management of
large-scale industries, transportation, communications, and energy.


By comparison with developed economies, Russia has a small proportion of
small-scale enterprises (those with under 100 employees). The neo-nep model
would focus on expanding this sector of the economy. This model would
differ from Lenin's nep by the degree to which it would be open to the
global economy. The application of foreign exchange controls, however,
should be expected, along with some rationing and price control, in the
short run at least, and strenuous efforts to rebuild certain sectors of the
economy, such as the defense industry.


Steps toward greater government involvement in the economy are inevitable,
regardless of the government that takes power in 2000-unless, of course,
Russia begins a much more rapid pace of decline as a result of political
upheaval. The West would be wise not to worry much about these trends
because they are unlikely to lead to the reestablishment of a command
system and because Russia has few available options. Russia can also be
expected to continue to dominate what it persists in calling the "Near
Abroad," and it is also likely to seek out economic union with these former
Soviet republics. Until and unless Europe and the United States are
prepared to open their markets to Russia and to invest directly in Russian
industries, a restoration of trade within the newly independent states of
the former Soviet Union is the principal alternative.
Bringing the state back in


Developments in Russia conform to the caretaker model, which is likely to
remain the case until after the presidential elections, unless Yeltsin and
his entourage create political turmoil by refusing to accept a
constitutional political transition. Yeltsin and his retinue have many
economic and potentially legal reasons to avoid surrendering power, but the
social cost of subverting the constitutional system would be high, and
serious conflict could occur. This outcome is the one that friends of
Russia should be working to avoid, which means that Yeltsin must be
encouraged to step down gracefully. The alternative is potentially disastrous.


The neo-Stalinist and the neo-radical reformist models are not probable
under any political outcome. Instead, a peaceful constitutional transition
is likely to produce a neo-nep model, which is the one that allies of
Russia should embrace. Fears that steps toward greater state involvement in
the economy will lead to a neo-Stalinist outcome are groundless. The
problem in Russia is not that the central government is too strong; rather
it is too weak to perform the functions expected of a modern market
economy. Further disintegration of the Russian economy and state is not
desirable because it would foster increased uncertainty and
regional-central frictions that at their worst might yield a Yugoslav-type
conflict.


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