Russia A History

by Gregory L. Freeze

  Still more striking was the decline in national defence: the budget dropped to one-seventh of Soviet levels, with devastating consequences for the military-industrial complex and the armed forces themselves. The government channelled its few resources into maintaining the strategic nuclear forces in a state of readiness, but had to make drastic cuts in research and development, suspend the acquisition of new weapons, delay payment of paltry wages, and reduce operational funds (to the point where ships stayed in dock and warplanes on the ground). By the end of the 1990s, Russia’s air force and navy were perilously under-maintained and obsolescent; the fleet of nuclear submarines, for example, shrank from 247 to 67 (some of which were not in service). Penury bred corruption and theft, most sensationally in the disappearance of fissionable materials—including, as the chief of the Security Council admitted in 1996, over half of the country’s ‘portable nuclear devices’. Morale plummeted; dearth and dedovshchina (the brutal maltreatment of conscripts by superiors) led to desertion, suicide, and multiple homicides. Not surprisingly, conscription ceased to function properly, as a majority of recruits paid bribes for exemption or simply ignored the draft notices.

  Fiscal crisis and neoliberal ideology combined to force the government to make sharp reductions in social services and cultural needs. In education, for example, state penury—amidst inflation—shrank teacher salaries to nominal sums (when indeed they were paid) and made teachers a salient part of strike movements. Students suffered as well: despite the constitutional guarantee of free education, schools and universities—especially élite institutions—increasingly expected students to pay fees and bribes. Similar woes beset the public health system: universal medical coverage gave way to fee-based services that were beyond the means of 95 per cent of the population. Budget ‘austerity’ also took its toll on culture: the institutions of the fine arts—museums, cinema, theatres, and concert halls—suffered a sharp decline in revenues, not only from state subsidies, but also from an impoverished public (theatre ticket sales, for example, fell by 50 per cent between 1990 and 1997). Cinema fared no better: Mosfilm studios—which had earlier produced 60 feature films a year—produced one or two. Russian film-makers could still produce prize-winning artistic successes (for example, Nikita Mikhailkov’s Burnt by the Sun and Sergei Bodrov’s Prisoner of the Mountains), but the Russian film industry had all but collapsed.

  To compensate for its dwindling revenues, the central government resorted to desperate financial measures. The most notorious was the ‘shares-for-loans’ programme in 1996–8, which used state assets (including oil and mineral companies) as collateral for loans from the leading banks. Although the government could theoretically redeem the property, its virtual bankruptcy meant that the loan was tantamount to sale. And at bargain-basement prices: with the ‘auctions’ rigged and competitors excluded, creditor banks organized the auctions and—predictably—emerged with the winning ‘tender’ and at a fraction of the real market value. For example, Mikhail Khodorkovskii’s bank Menatep acquired Yukos oil (valued at 7 to 10 billion dollars) for a mere 159 million dollars, paving the way for Khodorkovskii to amass fabulous wealth and become the richest man in Russia. All sixteen ‘auctions’ followed the same insider pattern. Yeltsin’s government portrayed the transactions as legitimate ‘privatization’ (privatizatsiia), but observers aptly described it as ‘grabization’ (prikhvatizatsiia). The giveaways enriched the insider but not the state; this ‘fire sale of the century’ failed to generate the vast revenues that it had anticipated.

  The government continued to seek foreign and domestic loans, but found it exceedingly difficult to attract foreign capital, chiefly because Yeltsin’s government was in ill repute and had failed to comply with prior commitments. Not that compliance was easy: the West made loans and credits contingent—with ‘conditionalities’ that dictated a tight money policy and fiscal austerity. That monetary policy reflected fiscal reality, specifically, the imperative need to service public foreign debt, which forced the government to divert revenues from governance, defence, law enforcement, and essential social programmes. The government also had to cut subsidies to unprofitable enterprises (exposing them to bankruptcy and the workers to unemployment) and to reduce social services in such vital areas as education and public health. A desperate Kremlin also resorted to three-month treasury notes to cover gaps in current cash flows. Although that strategy brought short-term relief, it was tantamount to a financial pyramid, whereby the state—with interest rates rising and tax revenues falling—had to borrow more and more just to cover its spiralling debt.

  In August 1998 that pyramid collapsed. Admittedly, the Yeltsin government was not solely responsible; it was also a victim of a sudden 39 per cent plunge in oil prices (from 18 dollars a barrel in 1997 to 11 dollars in 1998) and the East Asian financial crisis (which frightened off investors from developing markets). But the fundamental problem was a ballooning deficit covered by short-term, high-interest treasury bills. As revenues fell and interest mounted, even a last-minute World Bank loan could not stave off insolvency: on ‘Black Monday’, 17 August 1998, the government defaulted on treasury bills worth 40 billion dollars and offered no clear prescription for extracting itself from the crisis. Yeltsin thundered that the value of the rouble would not fall; it was solid as a rock, and plummeted accordingly. The default pushed Russia’s credit rating to the lowest levels, caused the Russian stock market to lose 88 per cent of its value, ruined five of the ten largest banks, wiped out a third of small and medium businesses, and cut real wages by two-thirds. Not surprisingly, Yeltsin’s approval rating dropped to a mere 2 per cent.

  ‘Catastroika’

  The financial crisis of August 1998 was but the culmination of an unparalleled economic decline precipitated by the disastrous ‘shock therapy’ of Yeltsin’s first term. Although the government retreated from that original strategy, it still adhered to the neoliberal strategy of macroeconomic stabilization, market liberalization, and privatization of state assets. Under pressure from the International Monetary Fund (IMF) and the World Bank, the government eventually brought inflation under control (from 2,609 per cent in 1992 to 11 per cent in 1997), liberalized most sectors, slashed subsidies and social expenditures, and by 1996 had privatized approximately 70 per cent of all state enterprises. The government could boast that it had not only halted the massive decrease in GDP but, for the first time since 1991, had even briefly achieved slight economic growth (in the third quarter of 1997), along with a 600 per cent boom on the Russian stock market.

  By 1998, however, the net result was eight years of catastrophic decline on an unprecedented scale. The GDP dropped a staggering 43 per cent from 1991 to 1997; to put that into perspective, the Great Depression in the United States entailed only a 32 per cent decline; even the colossal devastation of the Second World War reduced the Soviet GDP by just 24 per cent. As Russia hurtled downwards, developed countries enjoyed unprecedented economic prosperity, widened the gap between themselves and Russia, and even threatened to reduce Russia to the rank of a third-world state. The decline was staggering; in 1980 the per capita GDP of Russia was 38 per cent of the United States, but that had dropped to just 4 per cent by 1999. Even when adjusted for purchasing power parity (to offset distortions in exchange rates), Russia’s per capita GDP in 1999 was only 4,200 dollars—slightly more than Botswana (3,900 dollars), but less than Namibia (4,300 dollars) and Peru (4,400 dollars). The post-Soviet depression affected not only industrial production but also agriculture, where gross output contracted by a third and an even greater decrease in the country’s livestock (by approximately a half).

  As important as quantitative decline was the qualitative regression: as investment collapsed and Soviet factories faced keen competition from world markets, Russia devolved into a supplier of raw materials and energy resources. The result was a primitivization of the Russian economy: manufacturing branches (including high-tech and defence industries) either converted to the production of low-grade co
nsumer goods or shut down completely. For example, computer chip production fell from 1.6 billion dollars in 1989 to 385 million dollars in 1995; a leading electronics manufacturer in 1992 was producing shampoo four years later. The aerospace branch that had earlier produced 2,500 planes per annum and accounted for 60 per cent of the world’s fleet was virtually idle; in 2000 it produced just four aeroplanes (compared to 489 by Boeing). As Russian exports concentrated on energy and raw material, the economy became heavily dependent upon volatile markets subject to huge price fluctuations. Agriculture underwent a similar decline. For lack of state subsidies, private capital, and effective demand, agricultural producers reduced the use of fertilizers (by 89 per cent) and even machinery (cutting petrol consumption 74 per cent).

  Russia also suffered a major degradation in fixed capital and human resources. Given the dearth of investment (because of scanty foreign direct investment, capital flight, high interest rates, and tight money policies), Russian machinery became obsolescent and hence progressively less competitive on international and even domestic markets. The losses in human capital were also immense, especially because of the massive ‘brain drain’ that robbed the country of much of its talented, educated élite. The degradation applied even to those who stayed, as many—especially the young—abandoned education and technology for the higher-paying jobs in the trade and business sector.

  Despite rosy expectations, transition brought devastating economic decline. Liberalization gave Russian producers access to global markets, but also exposed them to its volatility, prices, standards—which could have a major impact on production costs and profitability. For example, Soviet energy prices were but a third of those prevailing on world markets; deregulation of domestic energy prices thus gave inefficient enterprises little chance to survive. Moreover, the break-up of a single Soviet ‘economic space’ suddenly deprived producers of their traditional sources of supply and sale. Indeed, the former Soviet republics looked elsewhere, and inter-republic trade within the CIS shrank 70 per cent in the 1990s.

  While some decline was inevitable, the magnitude of what happened in the 1990s surpassed even the direst predictions. One factor was the acute dearth of capital investment, which plummeted by 92 per cent between 1989 and 1997. Thus, given the depreciation of existing plants and machinery (increasingly obsolescent and depleted), Russia actually experienced a disinvestment, with fixed capital declining 12 per cent by 1998. The state, given its fiscal woes, was powerless to stop this decline in capital investment. Nor did Russia’s ‘new entrepreneurs’ provide the needed capital. Most lacked the resources; privatization simply conferred property rights, often on insiders who lacked the capital or business acumen to modernize or even sustain these enterprises. One observer offered this apt description of the privatization of large-scale state enterprises: ‘We sold off a herd of elephants at rabbit prices, and now a new class of owners is trying to feed them at the price of a carrot a day.’ Insider privatization did not create a class of innovative entrepreneurs but simply spawned a class of businessmen who openly declared that politics was the fast track to personal enrichment, not innovation and investment. Thus ‘entrepreneurs’ not only corrupted politicians, but politicians corrupted the ‘entrepreneurs’. And once successful, the entrepreneurs hastily spirited their ill-gotten gains abroad, with the capital flight of the 1990s exceeding 200 billion dollars.

  This haemorrhage of precious capital far exceeded the paltry influx of foreign investment—a cumulative 29.4 billion dollars, with just 12.8 billion coming as foreign direct investment (FDI). That was far short of the fabulous sums predicted by Western economic advisers and promised by Western political leaders. Apart from loans (intended to promote monetary stabilization, but increasingly used to service Russia’s foreign debt and to line anonymous pockets), international agencies and private investors found the Russian market too corrupt and risky, especially in the case of FDI. The tales of the defrauded, even murdered, deterred all but the most adventurous. As a result, Russia attracted a fraction of global investments (for example, under 1 per cent of global FDI in 1995—less than Peru’s share, a tenth of China’s). Even more striking was the contrast with East European states, where the per capita FDI was twelve times higher. The capital famine (given depreciation, hence net disinvestment) resulted in ‘deindustrialization’ and concentrated the country exports in the volatile market for raw materials, metals, and energy resources.

  Bad policy—driven by the neoliberalism of foreign creditors and Western consultants—exacerbated the country’s economic problems. The chief economist of the World Bank later observed that the reformers were ‘overly influenced by excessively simplistic textbook models of the market economy’, which inspired a mystical faith in the ‘market’, gainsaid the role of the state, and ignored the need to construct the institutional foundations of a market economy. As the state failed (its institutions collapsing, its finances withering, its power declining), it could not design and implement a prioritized economic strategy like that successfully employed by the ‘Asian tigers’. Indeed, as Yeltsin traded state property and privileges for political support, Russia devolved from a ‘command economy’ into what the Nobel Laureate Douglas North decried as the ‘anarchy … that we have been observing in Russia’.

  The bad advice was not always disinterested: Western countries—particularly the United States—benefited from the economic collapse which marginalized and impoverished the former superpower. Given the close nexus between the West and economic reform (reinforced by propaganda campaigns, like that financed by the United States to sing the praises of privatization), a majority of Russians suspected that the West had deliberately caused economic havoc in order to achieve economic colonization of Russia and to ensure America’s global hegemony. Some Western advisers exploited Russia’s plight for personal gain. In the most notorious case, the US Justice Department charged that the Harvard Institute for International Development (which had received 40 million dollars in government grants and controlled a portfolio of 350 million dollars in aid) had mishandled the aid money and that its principals had engaged in insider trading. Such revelations filled the Russian press, reinforcing popular disenchantment and distrust of the government, market reforms, and their Western sponsors.

  Society: Polarization, Degradation, and Deviance

  The impoverishment of the many and enrichment of the few had a profound, polarizing impact on society. Whereas the Soviet regime engaged in egalitarian ‘levelling’ (especially in the post-Stalin era), the post-Soviet order was unabashedly anti-egalitarian. One index of economic stratification, the decile ratio (comparing the income of the top 10 per cent with the bottom 10 per cent), leaped from a relatively egalitarian 4 : 1 (1990) to 15 : 1 (1994) and remained at that level for the rest of the 1990s. Another measure is the Gini coefficient, with 0 being total equality, 1.00 total inequality; analysts regard 0.20–0.30 as relatively egalitarian, and anything over 0.40 a sign of growing income disparity and inequality. In Russia’s case, the coefficient jumped from 0.26 in 1991 and climbed to 0.40 in 1999. Although increasing inequality also characterized Western societies in the 1980s and 1990s (the Gini index, for example, rising to 0.31 in Western Europe and 0.43 in the United States), the differentiation in Russia was both more extreme in scale and more compressed in time.

  The minuscule élite of wealthy Russians—derisively called ‘new Russians’, a pejorative for the uncouth nouveau riche—were in fact not so new: approximately two-thirds of them, especially the first wave, used their party, especially Komsomol (the communist youth organization), connections to acquire assets and amass capital. They went from party cards, not rags, to riches. Mikhail Khodorkovskii, at one point the wealthiest billionaire in Russia, began in the Komsomol organization, where he used its connections and resources to start a computer business that eventually turned into a huge financial and industrial empire. Much the same was true of the other tycoons. Apart from buying political influence and special privileges, su
ch ‘entrepreneurs’ often had ties with organized crime—an association admitted by some 40 per cent in one poll, with the real rate doubtless being much higher. Ironically, Soviet criminalization of the black market forged a natural link between economic and ordinary criminals, producing a close nexus between the new market economy and organized crime.

  But it was a corrupt state, not the Komsomol or organized crime, that enabled the richest to appropriate state property on a massive scale. In most cases, the new economic élite relied heavily upon insider connections, especially during the ‘shares-for-loans’ in 1996–8. Not that the chief officials were unaware of what was happening. Anatolii Chubais, the architect of privatization (which earned him approval abroad and opprobrium at home), told an interviewer in 1997 that the oligarchs ‘are stealing absolutely everything …. But let them steal and take property; they will become owners and decent administrators of that property.’ Beneath the Olympian heights of the ‘seven oligarchs’ was a small stratum of lesser winners who occupied key positions and profited accordingly. The proliferation of luxury imports (more top-of-the-line Mercedes being sold in Moscow than in Europe), the construction of palatial mansions, and the flood of spendthrift Russians to élite shops and resorts in the West all attested to the fabulous wealth of the ‘new Russians’.

  Well below them was a small middle class, with modest resources and incomes but a few times the average wage—though light years removed from the élites. It was partly on the basis of cultural, occupational, and educational descriptors that they imagined themselves to be part of a ‘middle class’. However, compared with those on subsistence wages, this middle class enjoyed access to Western goods unimaginable in Soviet times. Private car ownership, while increasing in the 1970s and 1980s, doubled in the 1990s (jumping from 63.5 to 128.1 per 1,000 residents) and included vast numbers of imports. Still, this ‘virtual middle class’—in terms of sheer size, assets, income, and political influence—bore scant resemblance to its peer in Western Europe.