Containment Lite: U.S. Policy Toward Russia and Its Neighbors: Economic Collapse

Special Report
Containment Lite: U.S. Policy Toward Russia and its Neighbors
By John Feffer

Economic Collapse

The economic system bequeathed by the Soviet Union to Russia was more a burden than a benefit. Although the Soviet Union had achieved remarkable growth rates in the immediate postwar era, the economy entered a long period of stagnation in the 1970s that lasted into the Gorbachev era. Gorbachev unshackled Soviet culture and injected new life into the Soviet political system. But he was not successful in reviving the Soviet economy, which had deteriorated into barter, corruption, inefficiency, and mismanagement.

With the collapse of the Soviet Union and the rise of Russia came the promise of a new direction. In 1992, after introducing market reforms virtually overnight, Boris Yeltsin predicted results in less than a year. The U.S. government joined in the chorus of support. Despite rosy predictions, the Russian economy has only gone downhill since. Industrial production has plummeted as has the standard of living for most Russians. A sharp divide between rich and poor has opened up, with 70-80% of Russians at or below subsistence level. Homelessness, particularly of children, is widespread in the large cities, and pensioners have grave problems making ends meet. And if it’s bad in the big cities, it’s even worse in most regions where public services have fallen apart and conditions have reverted to the 19th century.

In August 1998, with oil prices plummeting, the Asian financial crisis dealt yet another blow to the Russian economy. Real GDP fell by nearly 5% in 1998, with a similar drop expected in 1999.¹⁵ Annual inflation is expected to go into triple digits in 1999.¹⁶ Even nature has not cooperated: in 1998, Russia suffered its worst harvest in over 40 years.¹⁷ In the wake of the August crisis, the International Monetary Fund (IMF) suspended its latest package of aid, and in February 1999, Standard and Poor’s gave Russia a de facto default rating because the country didn’t meet its interest payments.¹⁸ By early 1999 conditions had deteriorated so much that many Russians viewed the Brezhnev period, a notorious era of stagnation, as a "golden age."¹⁹

IMF Loans to Russia, Jan. 1992 - June 30, 1999
(in billions of $U.S.)

loan_chart.gif (8364 bytes)

Source: Constructed from IMF data. Available at http://www.imf.org/external/np/tre/tad/expurch2.cfm

In September 1998, former Foreign Minister Yevgeny Primakov took over the reins of power as Prime Minister. Considered a consummate politician with a preference for state intervention in the economy, Primakov was hard-pressed to use the mechanisms of the central government to solve Russia’s problems. With a huge foreign debt, a good portion inherited from the Soviet days, Russia is caught in the third world development trap of constantly falling behind in servicing its debt. The international community, led by the United States, is dictating fiscal conservatism, which makes Keynesian deficit spending impossible. Meanwhile, Russia's federal government can’t collect the taxes necessary to keep it afloat (the major players are the worst offenders—the huge energy company Gazprom, for instance, owed the federal government approximately $1.9 billion as of July 1998²⁰). Although criticized in the West for its creeping statism, the government under Primakov’s direction often tilted in the supply-side direction: its economic plan called for reducing the profit tax from 35% to 30% and cutting the value added tax (VAT).

The U.S. government isn’t doing much to help Russia rebuild its industries. For instance, the Clinton administration has threatened to restrict imports of cheap Russian steel, which would cost the Russian steel industry an estimated $1 billion in sales.²¹ The U.S. has threatened to undercut the Russian space industry, one of the few world-class showpieces it has left, and has sought to contain the expansion of Russia’s energy interests in the Caspian region. Though U.S. sanctions against Russia for selling military technology to Iran are laudable from the nonproliferation point of view, Washington has simply not provided enough in conversion assistance so that Russia’s military-industrial complex can redirect its production toward domestic needs. (Currently, with an arms export strategy based on selling sophisticated weaponry at low prices, Russia has climbed back to become the second largest supplier in the world and is challenging the US for the top spot.)²²

Whenever the Russian government has made noises about reining in the more destructive aspects of markets, Washington has provided stern lectures.²³ Secretary of State Madeleine Albright, for instance, wondered aloud to a business group in October 1998 whether the Primakov team, in "turning back the clock," truly understood "the basic arithmetic of the global economy."²⁴ The "basic arithmetic" in this case applied not only to the laws of supply and demand but also to the sheer amount of money the U.S. could withhold if Primakov and company departed from the IMF recipe.

In urging remedial economics courses and praising the IMF’s role in the last seven years of Russian reform, Albright and company seem to have forgotten that they’d already identified a group of radical market enthusiasts willing to abide by the international community’s guidelines. Indeed, with their intimate knowledge of the basic arithmetic of the global economy, these Russian reformers robbed the international lenders blind.

This clique of Russian economists and bureaucrats came to the fore in 1992 when the West applied the policies of "shock therapy" developed in Eastern Europe to the already shaky post-Soviet economy. Shock therapy involved a rapid destruction of the old system and the substitution of neoliberalism (also known as the "Washington consensus"). Price controls were lifted practically overnight. Because the state did not simultaneously disband the monopolized production and distribution system, the result was hyperinflation and the destruction of personal savings. Incomes fell. Russian industry had its feet knocked out from under it. Agricultural production dropped. In came a flood of imports that few could afford.

The shock therapists, who administered all shock and very little therapy, were a select crew. On the American side were Jeffrey Sachs, director of the Harvard Institute for International Development (HIID), and his contacts in the Clinton administration, such as Lawrence Summers and David Lipton, both in the Treasury Department.²⁵ Chief among the Russian "reformers" was Anatoly Chubais. The Harvard Project wrote the new Russian laws; Chubais and his cronies happily bilked the Russian public. Political analyst Boris Kagarlitsky, in testimony before the U.S. Congress after the August crisis, cited many examples of this misuse of international funds, including the Russian Central Bank’s "bacchanalia of waste" and the $5 billion from the World Bank (intended to restructure the coal industry) that "simply disappeared."²⁶ In February 1999, Moscow was abuzz with news of up to $50 billion that the Russian Central Bank had secreted overseas in a shell company on the island of Jersey.²⁷ Estimates of capital flight over the last seven years range from $50 billion to as high as $230 billion.²⁸

Total Overall Debt for Russia (1998)
Inherited $100 billion	Accumulated $44 billion	Total $144 billion
Foreign Debt: The Russian Government maintains substantial foreign debt. Approximately $100 billion of Russia's foreign debt was inherited from the Soviet Union—Russia assumed all of the foreign debt of the Soviet Union in exchange for the other NIS countries abrogating any claims to the FSU's foreign assets. The remaining amount of foreign debt has accumulated since the break-up. Russian total foreign debt grew approximately $20 billion between 1996 and 1998, to roughly $144 billion. Of the total debt, approximately two-thirds is principal, while the remaining amount constitutes interest and payment arrears accumulation. Compared to its debt dating from the Soviet era, Russian entities have minor payment arrears to OECD countries. In June 1996 the Russian Government reached a settlement on rescheduling $38.7 billion in old Russian sovereign debt to Paris Club members, and in October 1997 Russia was admitted to the Paris Club of creditor countries. In December 1997 Russia signed a closing agreement with the London Club for a program to restructure $32 billion of debt over a period of 25 years. According to plan, in 1998 Russia is to pay $17.9 billion in foreign debt service to the Paris and London Clubs. Resolutions of the outstanding bad debt between Western government and Russian commercial creditors under the Paris and London clubs opened up the possibility of resolving the estimated $7 billion of unsecured debt owed foreign companies, as well as the recovery by 2004 of up to $12 billion from developing countries with debts to Russia. Budget Deficit: Russia reported a budget deficit of 3.2%, or R86.5 billion, for 1998. International estimates of Russia's budget deficit, however, tend to be at least a few percentage points higher than Russian estimates. In 1997, for example, the Russian Government reported a budget deficit of 3.3% of GDP, but other sources, such as the IMF, estimated Russia's budget deficit to be closer to 7.7%; in 1996 Russia reported a 3% deficit, while many other sources estimated the deficit to be 5%. One source of the variance is differing methods used to calculate deficit figures—Russian Government methods do not include debt service payments (interest on debt). For 1999, the Russian Government plans a 2.5% budget deficit, but this figure is widely believed to be unachievable.
Source: Business Information Service for the Newly Independent States, Commercial Overview of Russia (Washington, DC: Dept. of Commerce, June 1999). Available at: http://www.mac.doc.gov/bisnis/country/9906russia1.htm

The newly emerging business sector also participated in the "bacchanalia." One mechanism for this monumental theft was the handover of thousands of enterprises to insiders rather than to the public at large. In 1995, Chubais presided over this loans-for-shares privatization, which distributed Russia’s best and brightest enterprises to its worst and most corrupt "red capitalists." Oil companies like Surgutneftegaz and Sidanko went for bargain-basement prices. Many privatized companies fell under the control of organized crime syndicates. Chubais’s attitude toward the diversion of aid to shadowy business types was to "let them steal," for money would transform the crooks into legitimate capitalists.²⁹

The shell game continues today. As political scientist Michael McFaul writes, "Through complex arbitrage schemes, the withholding of wages, and the use of parasitic ‘offshore’ companies…directors can amass individual wealth while their companies continue to operate in the red."³⁰ No wonder the average Russian thinks that capitalism is by definition dikii, or savage. And the culprits? The U.S. General Accounting Office, investigating HIID’s activities in Russia, determined that at least two directors—Andre Shleifer and Jonathan Hay—had used their inside connections for personal profit (both were fired). Chubais, meanwhile, became head of Russia’s electricity monopoly, United Energy Systems of Russia.

The motives for Washington’s insistence on Russia’s swift, monetarist transition to capitalism are complex. U.S. economists and politicians, in cooperation with the IMF, focused on a single method for untangling from communism, a model developed and applied in Poland with mixed success. The Bush and Clinton administrations were also suspicious of allowing the Russian state to play a stronger role in economic recovery because of their residual antipathy toward any state authority emanating from the Kremlin. By acting quickly, the Western advisors expected to get the worst of the transition over before the public could vote the "reformers" out of office (economic pain is rarely popular at the polls). And the U.S. government, pressured by business interests, wanted to establish a playing field in Russia that benefited U.S. commercial interests, particularly in the energy and mining sectors.

U.S. businesses are interested in Russia for very good reasons. Russia has an educated work force, a strategic location straddling two continents, and a generous supply of natural resources, including gold and timber. But energy is the true jewel in the Russian crown. Oil and natural gas currently represent 60% of Russian exports and 25% of federal revenues. Even with the fall in energy prices, Russia can parlay its resources into hard currency—if the profits don’t accrue principally to foreign companies, and if the U.S. government stops trying to undercut the future expansion of Russian energy interests in the Caspian Sea.

A good deal of oil lies beneath the Caspian Sea. The problems in getting that oil to market are manifold, not the least being the countries surrounding the potential oil fields—Azerbaijan, Iran, Kazakhstan, and Turkmenistan. Russia wants to work with the latter three countries to build a pipeline that (at least in part) runs through Russia. In that way, Russia can maintain an interest in the region. The U.S., meanwhile, has exerted heavy pressure on a consortium of eleven major oil companies to build a 1,400-mile pipeline from Baku in Azerbaijan to Ceyhan in southern Turkey, skirting Russia altogether.

Key Economic Indicators (1998*)
Income, Production and Employment
Real GDP Growth (%)*	-9.9
Per Capita Personal Income ($US)*	888
Unemployment Rate (%)*	11.5
Money and Prices (growth)
Consumer Price Index (%)	56.4
* Due to the large ruble devaluation in August and September 1998, and the abrupt change in direction of many indicators of economic activity, estimates are baed on partial year figures.
Source: US Department of State, "1998 Country Report on Economic Policy and Trade Practices: Russia." Available at: http://www.state.gov/www/issues/economic/trade_reports/europe98/russia98.html

The U.S. plan suffers from numerous problems. The original estimates of 178 billion barrels are now thought by independent experts to be closer to 17.8 billion (a problem compounded by the current buyers’ market). The estimated cost of the pipeline has recently risen by another $1 billion. The pipeline would pass through a very unstable Georgia, home to major insurgencies in Abkhazia and South Ossetia. The U.S. project also necessitates paying off Turkey, a strategic ally, and continuing to overlook this NATO member’s continuing human rights abuses.³¹

But the plan’s most important failing is that it denies Russia any piece of the pie. Russia believes it has natural interests in this region that the U.S.—halfway around the world—does not.

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