The Wild East
 I
have a chapter in a forthcoming Reuters Publishing title:
The Wild East - negotiating the Russian financial
frontier
Peter Westin
Here is a recent draft of the chapter:
Draft Dated September 13, 2000
Tight Politics and Easy Economics…
The New Russian Model Looks to Latin America
by Dean LeBaron
My first contact with the Soviet Union was in 1989 at a meeting in
Cambridge, Massachusetts for leaders of that country's military
industrial complex to explore how to bring Western capital and Western
capitalist practices to enterprises in the Soviet Union. The Soviets
sent their first team and the US fielded a class-three farm team.
Clearly the Soviets were disappointed and talk among themselves rudely
displayed their disinterest in "not serious" discussions. I
was a speaker and seemed to say something that resonated with them…I
talked about opportunity to use their world-class technical skills in
Western markets. They visited my home; for many, that was the first
chance they had to see how Westerners, outside of movies, lived their
everyday lives. And they came to my office where, at their request, each
wanted a one-on-one consultation about their individual problems.
Usually these were something on the order of "I have 250,000 people
employed in my tank factory but only enough work for 5,000. Who will
fund us until we figure what else we can do?"
The plan was clear to the Soviets. Reduce military spending on both
sides. After all, if there was no Cold War threat, why continue to arm
against one another? Instead, take part of the hundreds of billions in
dollar equivalents and spend it on joint investments. It seemed so
simple to them and attractive.
At the invitation of the Gorbachev government, I went to Moscow to
see for myself. This visit was arranged within a few days of the
invitation since Batterymarch's private plane gave me rather more
flexibility of scheduling than would normally be possible. And I found
the problem to be greater than I had imagined. Soviet factories reminded
me of scenes from nineteenth century English sweatshops. But managers
were resourceful in facing problems that would cripple their plants
every day and then in solving them. Meanwhile, research facilities,
without resources, produced advanced ideas, often without practical
application.
I could see that splitting factories into parts would produce smaller
units that could be nurtured. Nominally the partnership was between my
firm, Batterymarch Financial Management, which was an adviser to major
US institutional investors and which had no government affiliation
whatsoever, and the Military Industrial Commission (the "State
Commission") whose first deputy chairman, Vladimir Koblov, was our
direct liaison. I went to work for about two and a half years with a
team of a dozen US and Russian specialists and personally spent about
one week every month in residence. A committee of ministers from the
eight ministries that reported to the State Commission was created to
guide this joint effort and, most importantly, to learn what we were
doing. In the course of our work together, we developed respect for each
other and close friendships.
The 5,000 military enterprises under the State Commission controlled
about 25% of the national economy and certainly its most technologically
advanced portion. Otherwise how could it have engendered fear for fifty
years in the developed Western economies? Or so the logic went.
Together with Russians from the State Commission, we staffed an
office in Moscow across the street from the USA-Canada Institute, a
well-regarded think tank that some said had KGB roots. Our American
staff was elegantly housed in a government dacha in Lenin Hills,
normally reserved as a guesthouse for official delegations. The
residence functioned like the small luxury hotels which have become
popular in major cities, although ours might have had special
electronics equipment for audio output to receivers in locked rooms in
the basement. Russian guests would rarely hold conferences inside,
preferring walks in the adjacent and private park grounds.
Although never stated, it was the impression of the Western staff
that the privileges we were accorded-access to communications, food from
the Kremlin, crack drivers with traffic-stopping rights, and free access
in and out of country in our private plane-indicated that the
intelligence services were partners too. And there was a directive by
President Gorbachev to give us what we needed. We were on a fast track
because the Soviets wanted to partner with the West and quickly. They
had to get their private economy going because, no matter what, the
public economy was imploding.
Extraordinary people staffed the hundreds of enterprises we saw. With
few resources but their own wits, they produced ingenious solutions to
problems that we in the West would have solved by buying our way out of
with more hardware, more factories, more R&D, or more something.
These were luxuries not open to the Soviet firms. The directors of
enterprises were resourceful. Each day presented new issues to them
which could wipe out their companies. And they survived. Their systems
were dysfunctional but their leaders developed methods to cope. A
combination of Western systems and Russian talent would produce dramatic
results.
But the odds of finding good enterprises to benefit from new
investment were not attractive. The Soviet companies were huge and cash
starved…desperate for cash. This epoch was legendary for its lack of
consumer goods and lines waiting for anything. Light bulbs would be
cycled forward from fixtures where visitors had been toward ones in
their new destination. Soap would be put in washrooms just before
visitors came and removed very quickly when they left. Food would be
hoarded to put on a hospitable spread for guests.
Every enterprise had a conversion program, trying to find a way to
make a living in a non-military, consumer-oriented world.
Nobel-prize-class scientists were designing plastic toy pianos for an
unknown commercial market. Tank firms talked about car designs and joint
ventures.
Now a new effort was made. Politics opened; the press opened; and
young reformers were visible in the front ranks of policymakers. The
West opened everything except enough money, and not soon enough.
Admittedly, more money came through, but it was often in the form of
expensive Western infrastructure consulting and not directly to the
Soviets. Very little of the giveaway-the privatization-of Russian
enterprises went to ordinary people but, curiously, often benefited a
new class of entrepreneurs, the oligarchs, who got very rich on the
spoils. And this money made in these gray, if not black, markets moved
out of Russia in amounts that may have been between $25 billion to $50
billion.
But the West balked at every opportunity to join hands. Perhaps the
best effort was the "Grand Bargain" offered to the G-7 in
London in July 1991. President Gorbachev presented a paper jointly
authored by Graham Allison, dean of Harvard's Kennedy School, and
Grigory Yavlinsky, a highly respected Russian economic reformer. The
title, "Windows of Opportunity: Joint Program for Western
Cooperation in the Soviet Transformation to Democracy and the Market
Economy," tied specific measures of performance to investment
levels. However, attitudes attributed to US President Bush and the
Japanese government rejected the idea in its entirety. When this offer
became the "Grand Bust," the Soviet government lost
credibility.
A month after the G-7 summit, Gorbachev felt his only recourse was to
sign an agreement with the Soviet republics known as the Union Treaty.
The Soviet central government could no longer tax, a power vital to any
state; this fiscal impotence marked the demise of the Soviet Union in
December 1991.
The Soviets must also bear some of the blame. Admirable as Gorbachev
was, and despite the fact that he was betrayed by the West, he made a
fundamental error in trying to reform the political and economic systems
simultaneously. Perhaps he was a victim of an aspect of the Russian
psyche that was exacerbated under communism-an all-or-nothing extremism.
The West had "cheaped out." I believe that a straight line
led from the G-7 meeting to the Union Treaty and, in August 1991, to
tanks in the streets of Moscow.
With a group of investors, I arrived in Moscow on Sunday night,
August 18, 1991, literally on the eve of the kidnapping of President and
Mrs. Gorbachev and the launch of a coup attempt by a group of
hardliners. On August 22, 1991, the third day of the attempted coup, we
met in Leningrad with its mayor, Anatoly Sobchak, and other anti-coup
stalwarts who had congregated to defend the government offices there.
One of Mayor Sobchak's key aides at the meeting was Vladimir Putin, who
would become, eight years later, President Putin. Having served as a
colonel with the KGB in East Germany, Putin had moved to Leningrad and
the offices of Mayor Sobchak, his former professor, where he was put in
charge of that city's privatization and sale of state assets. (By
December, the city was again called St. Petersburg, its original name.)
If the first phase of the political/economic transformation was
Gorbachev's attempt to consumerize the Soviet economy within the
structure of the Soviet Union, the second started in August 1991, with
the failed coup attempt and the ultimate dissolution of the Soviet Union
in December 1991. After the failed coup, the Soviet Union entered its
brief twilight. Gorbachev returned to the presidency of a country that
was falling apart around him. The real power shifted to Boris Yeltsin,
the president of Russia, the largest and strongest state of the former
Soviet Union. Yeltsin was given the mandate. And just as the West had
done, Yeltsin also humiliated Mikhail Gorbachev.
My mandate came from the Soviet government, specifically its
president, Mikhail Gorbachev. So when the August 1991 coup took place,
the message was clear: a new government team would take over. Six months
later we packed up and left.
Despite the command economy's faults, some aspects of it could have
proven useful in the transition period. In fact, some were essential in
the same way that strong leadership is essential to any company that is
reengineering from old processes to new. It is difficult to be
democratic when the job is to allocate scarce resources for future
development rather than to satisfy immediate needs. The weakening of
central authority damaged the reform process.
A period of confusion, looting of assets, and emergence of an openly
expressive society became evident in the next eight years. Gross
Domestic Product, as best one can determine from figures, steadily
declined. The term "bandit capitalism" seemed to fit.
Economics were modeled more after that on the docks of Hoboken, New
Jersey than on mid-American free enterprise. Security meant paying for
protection. And still, no one tried to do anything for the people on the
street, who would stay on the street. We know the result of the bandit
capitalism. It is estimated that hundreds of billions of dollars worth
of state assets have moved into a few private hands, with the
acquiescence of Western officials.
Observers of Russia see crime as endangering both the country's
fragile democracy and its newly-born free market. Yet, paradoxically,
the various "mafiyas" enjoyed a modicum of respect among the
citizenry because they were able to impose and maintain a semblance of
order.
It may be incorrect to view the government and the mafiyas as two
distinct entities. Russian politics always had a criminal aspect-tsardom
was once defined as absolute tyranny tempered by assassination-and
Stalin was certainly a criminal by any legal standard. In the 1990s,
neither the people in the government, who had something to hide, nor the
mafiyas wanted a stable political climate. Steady, reliable governments
will not tolerate this level of corruption and criminality. An
unbalanced power structure means political instability, the enemy of
genuine prosperity.
For Russia, capital flight has been a dominant feature of the last
decade, perhaps in the tens of billions of dollars each year. One can
assume that almost none of it was entirely legally obtained…money
laundering, false accounting statements, and tax evasion are rarely
prosecuted as crimes in the Russian systems. Curiously the present
atmosphere of stability seems accompanied by a continuation of money
outflow, perhaps even an increase. But foreign investments are a
counterbalancing inflow.
The Russian public, normally passive and tolerant, and especially the
free press could not reconcile the bandit capitalism-and the speeding
private limousines, the bodyguards in chase vehicles, the contract
killings-with the poverty on the streets. After nearly a decade of free
politics and free economics, this second phase of Russian transformation
was over. A quest for a strong hand and pride in one's country set the
stage for a turn to General Pinochet…excuse me, I mean Colonel Putin.
We have just entered a new phase…one without origin on Russian
soil. Now there is an elected government, rumored to have been selected
by some of the oligarchs, which appears determined to reinstate pride in
central control. The young reformers are still present with their
economic plans, but press critique of the government is curbed. The
military is offered more support. And the oligarchs who may have helped
select President Vladimir Putin (who may have been a member of that same
oligarch circle) may get a little slap on the wrist. In other words, the
new scheme will run the country on tight politics and easy economics.
A military takeover in Russia remained, for a time, a strong
possibility. The army, the one institution that always functioned well
in the Soviet Union, retained some of its traditional prestige. There
seems to be little doubt that Putin was placed in the offices of prime
minister and later as president to forestall something that would be
worse for the "family"…a military coup that was not of their
initiation. His charge might have been, like Pinochet's in Chile, to
restore national pride and leave the economy free to function on global
rules under the direction of the leading business forces already in
place.
While Russia plunges toward an autocratic, single-theme model-restore
pride in the central state-Western governments look for active dissent
as a requisite for signs that democratic leanings have not been stifled.
It would be consistent with the multi-strategy Russian mind to provide
evidence of some dissent but in a carefully controlled manner. So it is
possible to detect the move of a seemingly non-government party under
the direction of Boris Berezovsky, who might be principally responsible
for appointing Putin to the leadership in the first place. Thus,
evidence of dissent could be found but orchestrated behind the scenes.
And real dissent in the form of press freedoms would continue to be
curbed.
It may be that Putin will compromise with a blend of capitalism,
social freedom, and authoritarian rule. Under Putin, Russia is more
likely to have a nationalist party that monopolizes power, rather than a
reversion back to communism. Having broken its ties with communism,
Russia will, most likely, include some communist rhetoric and policies
in its nationalist program but will base its legitimacy on other
foundations.
If it sounds like Chile under General Pinochet, it is. Exactly.
General Pinochet was selected, it is rumored, by the oligarchs of
Chile to correct the communist policies of his predecessor. They wanted
secure politics and freedom to develop markets without government
interference. One of the first sectors they chose to develop was the
management of private savings by, not surprisingly, private financial
firms, the very ones who supported Pinochet.
And Chile was the better for it. The country knew where it was going.
It was not just a level playing field; it was a carefully mapped one.
My experience in Chile began in the late 1980s following the founding
by my firm, in 1987, of the first institutional equity fund to invest in
Brazil. In one of the first meetings with officials in Santiago, I
visited the Finance Ministry for lunch. A group of senior, gray-suited
officials hosted an early afternoon meeting covering the usual topics of
monetary export controls, currency conversions, market restrictions for
foreigners, and the like. Any of the participants could have been the
finance minister, whom I did not expect to be present. Shortly, a
California "beachboy-like" person arrived wearing, I noticed,
open sandals; he sat on the floor. I thought he could have been a
translator, but I guessed wrong. This was Hernan Buchci, the
reform-minded finance minister. Free market reform combined with
cattle-prod politics was the rule.
Of course Chile is not the only recent historical case blending tight
politics and easy economics. South Korea, Singapore, Malaysia, and
Taiwan come to mind, among others. In each situation there was a ruling
elite in a position to exploit the climate of privatization for
themselves in close partnership with government. And the economies
flourished. It is a model of some success and even parallels the
practice of Russia's new partner, China. (Leaders of the Soviet Union
once derided the Chinese to me as "our little yellow Communist
cousins." They now mimic and respect the Chinese.)
Today, looking at Putin's Russia, I think of Pinochet's Chile. If the
parallel holds, the prospect for the future, economically at least, is
quite attractive. Chile has been a model for investment success in Latin
America since that time.
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