Russia’s Phony Capitalism

Grigory Yavlinsky. Foreign Affairs. Volume 77, Issue 3. May/June 1998.

Will Russia be run by democrats or oligarchs? The signs are worrying. The West would rather not dwell on the extent to which Russia’s market is dominated by robber barons and permeated by crime and corruption. Russia’s democracy is weak, with unfair election campaigns, a compromised media, and few checks on the presidency. The West cannot afford to let Russia descend into chaos, which might mean losing control of Russia’s arsenal of weapons of mass destruction, but its two-faced NATO expansion policy hurts the democrats’ chances.

Oligarchy or Democracy?

Russia faces a watershed decision. The vital question for Russia is whether it will become a quasi-democratic oligarchy with corporatist, criminal characteristics or take the more difficult, painful road to becoming a normal, Western-style democracy with a market economy. Communism is no longer an option. That was settled in the 1996 presidential election.

Russians will make this fateful choice and be its principal victims or beneficiaries. But its consequences to Americans, Europeans, and others who share this shrinking globe should not be underestimated. Contrary to the widespread view in the United States that Russia is essentially irrelevant or of secondary concern, our continental country, stretching from Eastern Europe to upper Asia, will be important in the next century because of its location between east and west, its possession of weapons of mass destruction, its natural resources, and its potential as a consumer market.

Unlike previous choices in recent Russian history, the decision will not be made on a single day by a coup or an election. Rather, it will evolve through the many decisions made by Russia’s millions of people, leaders and ordinary citizens alike, over the coming years. Even President Boris Yeltsin’s sacking of much of his cabinet in March, while deeply disturbing, was one more bump along the road, not the end of the journey. Nevertheless, the route chosen will be no less important than the choices made earlier in the decade in its effect on the society in which our children and grandchildren live. Corporatist states, marked by high-level criminality but bearing the trappings of democracy, differ more than is sometimes recognized from Western-style market democracies. Their markets are driven by oligarchs whose highest goal is increasing their personal wealth. Freedom of the press and other civil liberties are suppressed. Laws are frequently ignored or suspended and constitutions obeyed only when convenient. Corruption is rife from the streets to the halls of power. Personalities, contacts, and clans count for more than institutions and laws. For examples, one need only reflect on the unhappy experiences of many Latin American countries in the 1970s and 198os.

Alternatively, in Western-style democracies, markets are driven by the consumer. Government economic policies are intended to serve the nation, not those in power. Through hard work, citizens can succeed. Personal freedom is universally respected, including the right to express opinions that differ from those of the government. Civilian rule is unchallenged. Corruption is normally minimal and its spread swiftly checked. Laws and constitutions are respected by both government leaders and citizens. The contrast with oligarchy is stark. Over the past year, increasing numbers of Russians have come to appreciate that their country stands at a fork in the road.

Russia’s Robber Barons

The Russian economy today shows signs of evolution toward Western-style capitalism on the one hand and the consolidation of corporatist, criminal-style capitalism on the other. Western conventional wisdom emphasizes the former and thus sees a Russia moving steadily toward a market economy. Indeed, Russia has managed to lower inflation and, within reasonable limits, stabilize its currency. Moscow is a boomtown. Some of the newly established and privatized corporations that operate with international mentalities and ambitions are making their way to the top. Certain regions of the country have received favorable international credit ratings, and a handful of Russian companies have held successful international bond issues. Young people are now ready to adapt to the new market system and steer clear of crime as the country develops new rules. The International Monetary Fund, while occasionally delaying tranches of its $10 billion loan because of poor tax collection, always seems to reinstate them after promises by senior Russian officials to do better. All this seemingly points toward the path of a normalized Western market economy.

But while Russia has its economic success stories, many aspects of the economy suggest that it is moving toward a corporatist market in which corruption is rampant. The most important of these trends is the rise of the Russian oligarchs, who have created a form of robber-baron capitalism. Far from creating an open market, Russia has consolidated a semi-criminal oligarchy that was already largely in place under the old Soviet system. After communism’s collapse, it merely changed its appearance, just as a snake sheds its skin.

The new ruling elite is neither democratic nor communist, neither conservative nor liberal-merely rapaciously greedy. In an interview published in the Financial Times in November 1996, one Russian tycoon claimed that the country’s seven largest bankers, who became the core of Yeltsin’s reelection campaign, controlled more than half the Russian economy. No one doubts that these nomenklatura capitalists have had a profound impact on the Russian economy, but their market of insider deals and political connections stands in the way of an open economy that would benefit all Russian citizens. The robber-baron market cannot tackle important social and economic questions. It is primarily concerned with issues that affect its masters’ short-term power and prosperity.

At recent debates at Harvard University’s U.S.-Russian Investment Symposium and at the Davos World Economic Forum, Western investors sharply criticized the robber-baron mentality of many Russian business leaders and the process of privatization under former Deputy Premier Anatoly Chubais. As George Soros put it, first “the assets of the state were stolen, and then when the state itself became valuable as a source of legitimacy, it too was stolen.”

Last summer’s auction by the state of the Svyazinvest telecommunications giant is an example of how these tycoons operate. This auction was to be the first where competitive bids were held for a privatizing company. Unlike earlier auctions, where the tycoons collaborated to gain huge shares of industry for a fraction of their actual worth, during the Svyazinvest auction the leaders of the rival industrial syndicates could not agree on who would get the company and were therefore forced to bid against each other. The “bankers’ war” that ensued was fought not with bullets but through allegations of graft aired by their media outlets. As a result, some of these tycoons were removed from their government posts and corruption charges were leveled against Chubais and his privatization team. Such a fiasco hardly suggests a healthy capitalist system. Worse, as of this writing, the same players are positioning themselves for a second round in the war-the auction of the Rosneft oil company.

There are many reasons why a country with nuclear, chemical, and biological weapons should not be allowed to slip into the chaos of rule by semi-criminal, corporate, oligarchic robber barons. Unfortunately, those who believe that the capitalism of the robber barons will eventually give way to a market economy that benefits all in society, as occurred in the United States at the turn of the century, are mistaken. America had an established middle class with a work ethic and a government that remained largely free of robber-baron infiltration. The American tycoons were still investing in their own country. Russia’s robber barons are stifling their homeland’s economic growth by stealing from Russia and investing abroad. In the late 1990s, Russia has no emerging middle class, and the oligarchy, which is deeply involved in the government, can alter policy for its private benefit.

In the meantime, while the big boys-they are all men-fight over an ever larger piece of the Russian economic pie, the government has been unable to create economic conditions in which the majority of Russians can thrive. The problem is not only that the majority of Russians remain worse off than before the economic transition began, but that they cannot become better off. The economy is stagnating at half its 1989 level. Real incomes have fallen by a third, and living standards in most regions have deteriorated to levels not seen in decades. Government attempts to curb inflation resulted not only in tremendous wage and pension arrears, but also in the government’s inability to pay its bills for the goods and services it consumed. This led to total disarray in payments, with up to 75 percent of goods and services either paid in kind, or by promissory notes that cannot be cashed, or transacted through illegal channels to dodge taxes entirely. In real terms, government pensions and wages were cut to 40 percent or less of their original value, and the government still cannot collect enough taxes to cover these expenses. Tax receipts have fallen to less than zo percent of the country’s GDP. Meanwhile, external debt has skyrocketed, and domestic debt, which was next to nothing just a decade ago, has reached almost 15 percent of GDP. Servicing these debts, paid out to local bankers and foreign speculators at exorbitant interest rates, will take no less than as percent of total government expenditure in 1998. The current Russian market economy has created a handful of super-wealthy individuals while leaving the rest behind to struggle. It is no wonder that these economic policies resulted in some 250 communists and 50 ultranationalist Zhirinovskyites being elected to the 4So-seat State Duma in 1995.

Furthermore, Russia is bedeviled by a corruption problem reminiscent of Latin America’s in the 1970s and 1980s. The European Bank for Reconstruction and Development ranks Russia as the most corrupt major economy in the world. Graft permeates the country, from street crime to mafia hits to illegal book deals in Kremlin corridors to rigged bids for stakes of privatized companies. Recent polls by the Public Opinion Foundation show that Russians believe the best way to get ahead is through contacts and corruption. When asked to select criteria needed to become wealthy in today’s Russia, 88 percent picked connections and 76 percent chose dishonesty. Only 39 percent said hard work. Anyone who attempts to start a small business in Russia will encounter extortion demands from the mafia, so there is no incentive for entrepreneurship. Better to stay home and grow potatoes at your dacha. A crime-ridden market cannot be effective. With no certainty about the future, with or without inflation, nobody will invest. Such a market can support the current level of consumption-which for the majority of the population means semi-pauperhood-for some time, but it does not and cannot provide any progress.

With such problems, despite the good news about the Russian economy over the last year, it is clear that the Russian market is still veering toward the corporatist, criminalist, oligarchic path.

An Unfinished Democracy

Russia’s current democratic institutions also deserve a mixed review. Certainly there are reasons for optimism. Russians are freer than at any time in their history. They can now read what they like, travel, talk, worship, and assemble. Russia’s citizens have quickly grown accustomed to these liberties. Technological advances such as the Internet, fax machines, and mobile phones will make it impossible for any one source ever to monopolize information in Russia again. Through this continuous contact with the world, with each passing day, Russia becomes a more normalized society.

Perhaps the most often cited examples of successful Russian democracy are the Russian elections. Over the past three years, elections have become an accepted part of Russian life. This was hardly always the case. A mere three years ago, debate raged in Russia as to whether the ruling authorities would even allow elections to occur. But from the December 1995 Duma elections to the June 1996 presidential race to the subsequent gubernatorial and regional legislature elections, again and again elections have been successfully held in the Russian Federation. In many of those contests, notably the Duma election and some regional gubernatorial races, opposition candidates from the communist and other parties have won and taken office. With minor exceptions, voting and ballot counting have been peaceful and relatively free, while voter turnout has been higher than that of the United States.

Although the recent elections are a positive development in the creation of Russian democratic institutions, some disturbing trends point to trouble in the future. While international observers have cited Russian balloting as free and fair, Russian campaigns most notably the 1996 presidential election-have been notoriously unfair. Spending limits are routinely ignored. While no actual figures have been disclosed, the 1996 Yeltsin presidential campaign is estimated to have cost at least $500 million. Some put it at an even $1 billion. (By comparison, Bill Clinton’s primary and general election campaigns that year together cost $113 million.) Officially, Russian presidential campaigns could spend only $2.9 million, but Yeltsin’s overspending neither elicited a major outcry nor started judicial proceedings.

Perhaps even more disturbing is the often cited European Institute on the Media survey that documents the media’s flagrant pro-Yeltsin bias. According to the EIM, Yeltsin enjoyed 53 percent of all media coverage, while his closest competitor, Gennady Zyuganov of the Communist Party, received only 18 percent. Yeltsin appeared on television more than all the other candidates combined. Moreover, election coverage was extremely slanted in the president’s favor. Giving candidates a point for each positive story and subtracting a point for each negative one, Yeltsin scored +492 before the first round of the election; Zyuganov earned -313. In the second round, Yeltsin had +247 to Zyuganov’s -24o, despite the fact that Yeltsin disappeared from the public eye a week before the election.

Electoral politics, like much else in Russia, are also at a fork in the road. As Russian political consultants learn more tricks of the trade, the danger increases that they might join with the robber barons to try to turn future Russian elections into nothing but window dressing for irremovable oligarchic rule-as was the case in the Soviet Union, where results were predetermined and the people were an afterthought.

Russia’s democratic institutions have not developed as fully as its elections. As the recent cabinet firings show, the system of checks and balances is underdeveloped, leaving the country prone to the whims of a mercurial chief executive. The rule of law is often not respected. The judicial branch of government remains overly influenced by the executive branch. The lower house of parliament has made some headway in becoming more than a mere talking chamber in which the occasional fistfight breaks out, and the executive branch now has to lobby the Duma to pass the budget, the START II treaty, and other crucial matters. But Yeltsin and his team still reserve the option of bypassing the Duma altogether-thereby ignoring the constitution-if the Duma disagrees with an executive initiative or is unwilling to be co-opted by promises of some new monthly leadership meeting with the president and prime minister. This strategy is routinely applied to the budget, where compromises are made to ensure passage and are then ignored throughout the year. Another example is the persistent rumor that Yeltsin will seek an unconstitutional third term as president.

No successful democracy functions without some kind of political party system, but attempts to develop such a system in Russia have been an unambiguous disappointment. Although political factions boasting varying degrees of regional activity exist within the Duma, a true functioning political party system in Russia has yet to develop, for a number of reasons. First, after yo years of “party rule,” Russians are understandably skeptical of political parties. Second, President Yeltsin’s actions have actively undermined the development of a political party system. By rejecting any party affiliation, the president acts as if parties and party development are an afterthought in the consolidation of Russian democracy. Yeltsin accepts the assistance of like-minded parties when it is politically convenient and distances himself from them when it is not. So no party is the true party of the government, and Yeltsin cannot be held accountable to the people short of a general election. Third, for political reasons, Yeltsin sought in the past to limit the development of parties by trying to abolish the “party list” system that elects half the Duma, seating only parties that win over five percent of the popular vote. In 1995, only four parties did so, and over half of the Duma seats went to parties opposed to the Yeltsin administration. The list system ensures that parties will exist in some part of Russian society, but in 1998, Yeltsin renewed his call to change it. To better control the Duma, he advocates having the entire chamber elected from regional districts, similar to the system used in the U.S. House of Representatives. With more control over local leaders, Yeltsin believes he can influence who wins these Duma seats. In reality, however, organized crime would buy many of the seats. If Yeltsin succeeds in abolishing the party-list system, he will destroy the only arena in Russian society where parties currently exist without minimizing a major source of opposition. Such a strategy would hurt Yeltsin politically, but even worse, it would damage Russian democracy, which needs a functioning party system to allow people to express their views to the government.

The Russian media also earns a mixed review. On the one hand, Russians have a variety of news sources from which to choose. Opposition newspapers exist, and journalists are free to do investigative reporting and write their own opinions. The November book payment scandal, where senior members of Yeltsin’s economic team were revealed to have accepted $500,000 for writing a book on privatization, first broke in the Russian media. Political leaders appear on programs like Hero of the Day and Itogi to explain their views to the people. Even so, in the past two years the media has become entirely controlled by the oligarchs, who are part of the government and use their editorial boards and programmers to promote their own selfish agendas. Nowhere was this more evident than in the Svyazinvest bid last summer, where the resulting “bankers’ war” was played out in the media. By reading a certain paper or watching a certain television station, a Russian citizen got either one or another robber baron’s version of the truth. Depressingly, the Russian service of Radio Free Europe/Radio Liberty remains Russia’s primary supplier of impartial news, just as it was in Soviet times.

In sum, Russian democracy still has a long way to go. True, elections are held, freedoms are respected, parties exist, and the media express divergent views, but such minimum democratic institutions exist in both Latin American and Western democracies. Russia is better off with its imperfect institutions than without them, but they do not yet properly reflect the people’s needs and will.

The West’s Stake

In October 1996, Vladimir Nechai, the director of a nuclear complex near the Ural city of Chelyabinsk, killed himself because he lacked the money to pay his employees and could no longer ensure the safety of his plant’s operations. His suicide underscored the most serious threat to all players in the post-Cold War world: loss of control of the Soviet arsenal of nuclear, biological, and chemical weapons. The increasing risks of chaos in a nuclear power are also evident in the rumors of nuclear smuggling. Russia has thousands of tons of nuclear, chemical, and biological material. Under the rule of a corrupt oligarchy, uranium and anthrax could become black market commodities available to the highest bidder. The control of Russia’s weapons of mass destruction is an issue of world safety that cannot be ignored by Russia or the West.

Russia and the West face other common challenges. Russia borders some of the most unstable regions in the world. For centuries, it has acted as a buffer between those instabilities and Europe. Today this wall is of no less importance as drug trafficking, terrorism, and arms smuggling are becoming rampant. A Russian wall with holes would be dangerous for Europe.

Furthermore, Russia and the West share a desire for stability in order to promote economic development. In recent months, the West has focused on developing the Caspian Sea region’s oil resources. Russia is a key player in the area, and finding a peaceful resolution to the Chechen issue will play a large role in determining how oil leaves the region. Moreover, Russia is arguably the greatest untapped economic market in the world. Stability makes possible the development of Russia’s economy and presents a great opportunity for Western companies and economies.

A Western-style democracy in Russia would be a partner with the West in confronting the challenges of the 21st century Russia and the West would work together better to maintain control over weapons of mass destruction and would be more likely to cooperate in containing regional conflict in explosive areas like the Caucasus and Middle East. Finally, the rule of law would govern business relations and allow for economic development and growth beneficial for both societies.

A corporatist Russian government would be more challenging and less stable. Realists may argue that a corporatist Russian government would value stability above all and therefore cooperate with the West to ensure the status quo. But such a system, although stable on the surface, would be built on false foundations, much like today’s Indonesia, where any change of leadership could undermine the entire order. Nor would it necessarily be a status quo power. Another scenario has such a government becoming contentious and suspicious of Western actions and goals. Cooperation on important global issues would be less forthcoming, and rules and laws would change to fit personalities, hindering economic development.

Russia’s choice will be heavily influenced by the West. Unfortunately, up to this point, the West has not always promoted the correct path. Nowhere is this more evident than in the debate over NATO expansion. If a military alliance moves closer to a country’s borders without incorporating that country, it means that the country’s foreign policy has dismally failed. Talk that this is a different NATO, a NATO that is no longer a military alliance, is ridiculous. It is like saying that the hulking thing advancing toward your garden is not a tank because it is painted pink, carries flowers, and plays cheerful music. It does not matter how you dress it up; a pink tank is still a tank.

The most important message of NATO expansion for Russians, however, is that the political leaders of Western Europe and the United States do not believe that Russia can become a real Western-style democracy within the next decade or so. In their eyes, Russia, because of its history, is a second-class democracy. Perhaps this is understandable. The combination of Chechnya (an arbitrary war in which Russia unnecessarily killed l00,000 people), the collapse of the Russian army, failed economic reforms, a semi-criminal government, and Yeltsin’s unpredictability has given the West enough justification to conclude that Russia, for the time being, cannot be a dependable partner and that NATO expansion should therefore continue.

Ironically, if the United States explained its push for NATO expansion in these terms to the Russian people, they would at least understand why the alliance is expanding and respect the West for its honesty. But when the West says to Russians: “Russian democracy is fine, Russian markets are fine, Russia’s relationship with the West is fine, and therefore NATO is expanding to Russia’s borders,” the logic does not work, leaving the Russian people and their leaders bewildered and bitter This resentment will only be exacerbated if the West continues its two-faced policy.

Finally, the West’s insistence on promoting personalities rather than institutions also hinders Russia from choosing the right path. The West plays favorites, and I recognize that I am one of them, even though I am not in power. The danger comes when the West, while promoting the rhetoric of democracy and capitalism, backs Boris Yeltsin, Anatoly Chubais, Viktor Chernomyrdin, Boris Nemtsov, and Yegor Gaidar even when they embark on actions that do not promote democracy or markets. When Yeltsin ordered tanks to fire at the Russian parliament, the West supported him, as it did-at least publicly-when he ordered the army to start the war in Chechnya. That led most Russians to believe that had Yeltsin canceled the presidential election in 1996, the West would have backed his choice, despite the fact that the decision would have ended Russia’s nascent democratic experiment.

What Is to Be Done?

A Russia that works for its citizens and plays a constructive role in world politics will be a Russia that has chosen well. To achieve such an outcome, a new set of rules must be established. The most important step is to separate business from political power in order to fight corruption. There must be a decisive break with the legacy of the past, when administrative power stood above the law. Individual businesses should be regulated by legislation, not by government officials or local barons who are often not easily distinguishable from gang leaders. The power of oil and gas tycoons, who generate huge profits using the country’s natural resources, must be curtailed. They should be made accountable to parliament, and their activities should be made transparent and subject to public control.

The present system of economic management, where most large enterprises are run by insiders who disregard the owners’ rights, must be radically reformed. “Collective” enterprises, whose management styles and responsibilities smack of the Soviet era, should be eliminated. In their place, the government must encourage responsible management based on a conception of private property that ensures and protects the owner’s rights. Bankruptcy laws should be fully enforced to help eliminate incompetent managers, crooks, and Soviet-style directors who are unable to adapt to market realities. Enterprises that hold on to workers and produce nothing but debts should be closed or sold.

Open accounting that meets international standards is a prerequisite to controlling corruption. Also required is a strong, independent, and incorruptible judiciary that will hold crooked officials accountable. For easier oversight, senior government officials should sign a declaration of income, property, and expenses for themselves and their families twice a year for review by the independent judiciary. The law making Duma members immune from prosecution should be immediately repealed. The large number of criminals running for Duma seats to gain immunity is repulsive. How can a legislature fight corruption when its members have their own deals on the side?

Free competition must be promoted by encouraging small and medium-sized businesses and by removing the red tape and excessive regulation that stands in their way. Former Soviet monopolies should be destroyed to eliminate domination by a small group of large companies that account for half the country’s GDP while employing only three percent of its labor force. Land reform is also essential, since there can be no stable development in the agricultural sector until the major part of the country’s land is taken from hands of the oligarchic landlords who “inherited” it from the Soviet state. Finally, both power and financial resources must be decentralized. Russia will be doomed to instability and underdevelopment as long as 85 percent of the nation’s money remains concentrated in Moscow. Local initiatives and entrepreneurship should be encouraged if the fruits of economic growth are to be shared among Russia’s numerous regional, social, and ethnic groups.

To ensure that an established middle class emerges, an open market economy must appear based on private property and competition. Unregulated prices, low inflation rates, and a stable currency are absolutely necessary. In Russia, however, these are not sufficient conditions for a competitive economy. Lower and simpler taxes, fiscal controls on oligarchs’ incomes from the use of natural resources, incentives for entrepreneurship, a trustworthy news service, an independent judiciary, and fully developed political parties are also indispensable.

For its part, the West should hold those in power in Russia accountable for undemocratic deeds, in much the same way as it is willing to criticize its allies. Western leaders should apply to Russia the same criteria for evaluating the health of its democracy and the strength of its market economy that they apply to themselves. The West should not give Russia advice it is not willing to take itself This is especially important because, in the 21st century, competition will occur between civilizations and not countries. Although Russia and the West have different histories, they belong to the same civilization. The old rivalries need not endure-if Russia chooses wisely