Seven years ago, Russia experienced a new dawn of freedom. The communist party had been dissolved and Russia appeared ready to pursue a democratic future. The literary critic Yuri Karyakin spoke for many when he said that, "for the first time in this
century, God has smiled on Russia." (1)
Few at that time could have foreseen the outlines of what exists in Russia today. Many former communist countries are witnessing a new dawn of progress but Russia is becoming a cesspool of poverty, intimidation and crime.
The reason is that during the years 1992-1998, which witnessed a massive attempt to remake Russian society and the Russian economy, Russia once again fell victim to a false idea.
The victory over communism was a moral victory. Millions of people took to the streets not because of shortages but rather in protest over communism's attempt to falsify history and change human nature. As a new state began to be built, however, all attention shifted to the building of capitalism and, in particular, to the creation of a group of wealthy private owners whose control over the means of production, it was assumed, would lead automatically to the enrichment of society and the emergence of a law based state. This notion, dubious under the best of conditions, could not but be pregnant with disaster in the case of Russia, because, in a country with a dogmatic tradition and the experience of 73 years of sustained moral degradation under communism, the creation of a market economy, like the building of communism before it, came to be understood as an end in itself.
The reform process was guided by a group of "young reformers" who were graduates of ideological organizations like Pravda, the journal, Kommunist, and the Institute of the U.S.A. and Canada. Denied the highest positions in the Soviet system, they became radical free marketers without abandoning their Marxist faith in the primacy of economic relations or disrespect for the rule of law. When they finally acceded to power, many of the reformers took it for granted that they were morally superior not because of their fidelity to transcendent values but because they favored private ownership over socialism. The need to provide a legal and ethical framework for the reform process was ignored.
The young reformers' lack of respect for law had two serious consequences. First, it led them to implement the reforms as rapidly as possible, making the destruction of the old system their first priority. (2 ) At the same time, the reformers' lack of respect for the rule of law led them to treat criminals as allies, assiduously creating opportunities for them to enter the economic mainstream. (3)
The speed of the reform process and its criminalization totally subverted the purposes of democracy. The reformers believed that regardless of how the first capitalists acquired their wealth, they would, once they had amassed their capital, begin to behave like rational economic actors and demand the protections of a state based on law. In practice, however, after seven years of reforms carried out in an atmosphere of total lawlessness, Russia was left with an economy which had no place for the rule of law because its operating principle was not productivity but theft.
The reforms were dominated by three processes: hyperinflation, privatization, and criminalization. Their interaction was to facilitate the takeover of Russia by a criminal oligarchy.
The hyperinflation began on January 2, 1992, after the abrupt freeing of prices and it quickly divided the population into a minority of the very rich and a majority of the grindingly poor.
Yegor Gaidar, the first deputy prime minister and head of the government, predicted that prices would increase three to five times and then begin to fall. In the course of ten months, however, prices rose 300 to 400 times, which led to the impoverishment of the population. Within three months, 99 per cent of the money held by Russian citizens in savings accounts had disappeared. Money that had been saved for decades to buy an apartment or a car or to pay for a wedding or a decent funeral was lost causing crises in the lives of millions of people. When Gaidar was reminded that the Supreme Soviet had voted the previous autumn to index the savings of Russian citizens in the event of price liberalization, he replied that the imbalances in the economy were the fault of the previous regime and not the new, reform government. (4)
The wiping out of citizens' savings was followed by the appearance of numerous commercial banks and investment funds, which were totally unregulated. At a time when spiralling inflation pushed ordinary citizens to seek ways to conserve their savings, these investment funds and many commercial banks, a large number of which had ties to high ranking officials, launched massive advertising campaigns, promising rates of return on investment of up to 1200 per cent. Most of these funds were pyramid schemes and when they collapsed, more than 20 million persons lost their savings a second time. (5)
While millions were losing their savings, however, former Soviet government and communist party officials began to use their ties to Russian officialdom to accumulate vast wealth. In fact, the way was well prepared. During the perestroika period, the communist party apparatus had gone into business. Commercial organizations organized under the aegis of the komsomol were freed from taxes for five years and allowed to engage in foreign trade. Since there was otherwise a state monopoly of foreign trade, they were, in effect, allowed to set their own terms in satisfying nearly unlimited demand. The party, in the meantime, used party money, which, at the time, was indistinguishable from government money, to create commercial banks. And factory directors began to strip the assets of their factories. They did this by setting up cooperatives, usually staffed with their relatives, which became middlemen for factory business, charging exhorbitant prices while performing no real service.
There were several ways of quickly acquiring vast, unearned wealth. One way was by appropriating government credits. In 1992, inflation created a shortage of turnover capital which paralyzed production and prompted the issuance of credits to Russian enterprises whose value reached nearly 30 per cent of the gross domestic product. With the inflation rate at 2500 per cent, these credits were offered at rates of from 10 to 25 per cent. Instead of being used to pay salaries and purchase supplies, however, they were deposited in commercial banks at market rates with the difference split between bank officials and the factory director.
A second way of acquiring great wealth was getting permission to export raw materials. Having abandoned the Soviet era monopoly on foreign trade, the government began to allow anyone to export who could get a license. Insofar as Russian raw materials were bought for rubles at internal prices and sold abroad for dollars, export licenses were akin to permission to print money. In Moscow, they were issued by the Ministry of Foreign Economic Ties, which functioned like a market, granting the licenses in return for bribes with the fee for the license insignificant by comparison with the size of the bribe. Export licenses for products other than oil and gas - e.g., iron, steel, and non-ferrous metals - were usually given at the oblast level, where officials became de facto business partners in the enterprises they were supposedly regulating.
A third source of wealth was subsidized imports. Out of fear that there would be famine in the country in the winter of 1991, the government sold dollars for the importation of food products at 1 per cent of their real value with the difference subsidized with the help of Western commodity credits. The products were sold, however, at normal market prices with the result that the attempt to relieve the country's anticipated food crisis led to the enrichment of a small circle of Moscow traders. The value of import subsidies in 1992 came to 15 per cent of the gross domestic product. (6)
In 1993, the impoverishment of the population and corruption of the reform process spawned a power struggle between the Supreme Soviet, the Russian parliament, and the executive branch of government which ended with the dispersal of the Supreme Soviet, October 4, 1993, and the creation of a new political system which greatly accellerated the growth of the criminal business oligarchy.
The abolition of the Supreme Soviet left only one center of decision making in the country, the presidential apparatus, and its members, convinced of their impunity after the October events, became ever more susceptible to bribery.
At the same time, the Russian revenue system was put under the control of the president, and twelve banks, which had supported Yeltsin in his confrontation with the parliament, were "empowered" to handle government accounts. These banks, by delaying payments on government obligations and using budgetary funds to give short term interbank credits at rates as high as 400 per cent, reaped gigantic profits on the state's money. They were soon joined by regional empowered banks and by enterprise directors who also acquired budgetary money and began to lend it out at interest. In the meantime, the nonpayment of salaries began to be a permanent feature of Russian life.
Soon, the leading Moscow banks became the core of financial political groups, each of which was tied to one or another leading political figure. As their power and wealth increased, the banks began to behave like states within a state, acquiring media outlets and establishing their own security services capable of spying on economic and political rivals as well as tapping the phones of thousands of ordinary Russians. The struggle for power between the financial political groups began to be the principal determinant of the policies of the Russian government.
The second process which contributed to the creation of Russia's criminal business oligarchy was privatization. Privatization both predated and survived the period of hyperinflation. The privatization which took place first is euphemistically described as "unofficial" privatization and it consisted of the uncontrolled and illegal seizure of the economic infrastructure of the country. "Official" privatization took place in two stages; voucher privatization, from October, 1992 to July, 1994, and money privatization, which began in August, 1994 and is still continuing.
Unofficial privatization began during the perestroika period as soon as government organizations were given permission to engage in commercial activity. Government officials, secretly and without any legal basis, began to take over their agencies and reorganize them as private enterprises. In place of ministries, they organized "concerns." In place of the state distribution system, they created commodity exchanges and in place of the state banks with their regional branches, they organized commercial banks. The new commercial enterprises used the same suppliers, the same buildings, and the same personnel. Only the name of the organization changed. But the assets of the organization became the property of its new "owners." (7)
Wild privatization was followed by voucher privatization, which began in October, 1992. Each Russian was entitled to a voucher with a face value of 10,000 rubles (the salary of an auto worker,) which was redeemable for a share of Russian industry. The vouchers, were of little help to most Russians who were rarely paid dividends on them and had no say in management even when they invested their voucher in their own factory.
The vouchers were very useful, however, to those who could accumulate them in great numbers. This led criminal and commercial structures to buy them up as quickly as possible. In some cases, agents bought vouchers on the street from indigents and alcoholics, often for a bottle of vodka. In other cases, these groups organized voucher funds which advertised on television, promising high dividends and then either did not pay the dividends or simply disappeared. In this way, criminal and commercial structures accumulated huge blocks of vouchers which they used to buy up the most desirable factories, often at giveaway prices. (8)
In the last days of voucher privatization, the federal property fund put more than a hundred of Russia’s most valuable enterprises on sale at once, causing a sharp fall in the value of shares which were scooped up by the voucher funds. (9)
When voucher privatization was succeeded by money privatization in the latter part of 1994, the population was already divided into a handful of organizations which could participate in it and the vast majority of the population which could not. The pressure to put property into private hands as quickly as possible, however, did not relent and it led to the selling off of many of the country's remaining industrial enterprises, including the most desirable, at absurdly reduced prices.
The first step was to set a price for the concerned enterprise. Generally, the factory director and officials of the relevant ministry decided on the price on the basis of an estimate of the cost of the buildings and equipment. These figures could be artifically lowered by using one or two year old prices and writing off usable equipment. Or, to discourage outside investors, they could be artificially raised. Once a price was established, it needed to be approved by the local state property committee, which usually offered no objections.
If a powerful group was interested in the factory, the next step was to eliminate real or potential competition. Insofar as the auction was organized by the local property fund which was subordinated to the governor, the party with influence in the region was in a position to manipulate the auction by falsifying documents or gaining information about the competing offer. In fact, many of the auctions took place only on paper. In cases where auctions actually were held, competing bids often came from firms which worked for the victor. It was only in very rare cases, that true competitive bidding took place and, in the event that a powerful group was outbid by an insistent competitor, the successful bidder could easily pay for his tenacity with his life.
The prices for which these enterprises were sold stunned Russian society; 324 factories were sold at an average price of less than $4 million each. "Uralmash," the giant machine building plant in Sverdlovsk was sold for $3.73 million, the Chelyabinsk Metallurgical Combine went for $3.73 million, and the Kovrovsky Mechanical Factory, which supplied the Russian army, the Ministry of Internal Affairs and the security services with firearms, was sold for $2.7 million. (10) Telephone companies were sold for $116.62 per line compared to rates of $637 per line in North America and $2083 in Hungary. The "United Energy Systems" power generating company was sold for $200 million. In Central Europe, a company which similar kilowatt production would be worth $30 billion, in the United States, $49 billion. (11)
Russian oil companies sold tested oil wells for $.04 per realized barrel compared to the North American price of $7.06 per barrel. The Murmansk Trawler Fleet, which consisted of 100 ships, each of which was less than ten years old and was worth $20 million when released, was sold for $3 million. The North Sea Steamship Company was also sold for $3 million. (12)
On September 9, 1994, the bulletin, "Independent Strategy," wrote: "The greater part of the basic productive funds of Russia are being sold for somewhere around $5 billion. Even if one considers that in Russia, the price of the basic means of production is equal to her gross domestic product [in the West, it usually is at least 2.6 times higher]... in effect, 300 to 400 billion dollars; the sum realized in privatization is minimal. For this reason, the agency recommends English investors not to miss the chance and to take part in the purchase of Russian enterprises." (13)
In late 1994, the Russian government, in response to pressure from the World Bank to reduce the rate of inflation to one per cent a month and balance the budget, ceased printing money to meet current expenses, including the payment of salaries. The situation became increasingly untenable and to meet its obligations, the government began to borrow money from commercial banks in return for shares in desirable, non-privatized industries.
In theory, the "loans for shares" program provided for competition for the blocks of shares with the winner determined by who could offer the largest credit to the government. In practice, however, the winner was the bank with the closest "informal" ties to the government and the scheme, although it facilitated the handover of the most profitable Russian enterprises to the country's oligarchs, provided very little in badly needed revenue to the government. In 1995, for example, the total revenue from the mortgage auctions of twelve of Russia's most profitable enterprises, including oil companies, was only around $1 billion or about one sixteenth of Russia’s budget deficit. (14)
Once an enterprise had been "mortgaged," the proprietary bank was free to exploit it and when the government failed to pay back the bank loans, which, given the state's revenue shortage, was always the case, it was up to the bank which held the mortgage to organize the final sale of the concerned enterprise. Unsurprisingly, the enterprises, in all cases, became the property of the banks which had provided the original loans.
In 1995, Oneximbank won control of 38 per cent of Norilsk Nickel the giant non-ferrous metals producer in exchange for a $170 million loan to the government. Two years later, in August, 1997, it paid $250 million to retain the stake. After its repayment of the loan was deducted, the government had gained a mere $80 million for a major share in the plant which produces 90 per cent of Russia's nickel, 90 per cent of its cobalt, and 100 per cent of its platinum.
In the meantime, Oneximbank was free to exploit the giant combine as it saw fit. Norilsk Nickel was one of Russia's leading earners of hard currency but by the spring of 1997, it owed its workers 1.2 trillion rubles in back wages. It was common for workers to faint from hunger and for the first time in decades in 1997, the children of Norilsk were not sent out of the Polar city for the summer. This raised the question of what Oneximbank was doing with the money which it earned from the combine. According to Obshchaya Gazeta, Norilsk Nickel was not paying workers their salaries because the bank was involved in highly profitable projects that required enormous amounts of cash. One such project was paying early on promissory notes from the federal government to the regional administrations in return for 20 to 30 per cent of the note's face value. Insofar as the government has a debt of more than 50 trillion rubles to employees in the budget sphere, it was often unable to pay on these notes itself and commercial banks used the income generated by their enterprises to buy these notes instead of using it, for example, to pay their workers. (15)
In fact, the empowered banks, which now control roughly 50 per cent of the economy of the country, began to feed continually off the state budget. They collected interest on budgetary funds, used the money to acquire the most valuable Russian enterprises, and then used the revenue from the enterprises to make super profits by, in effect, lending money back to the government.
The loan for shares scheme changed the relationship between major financial institutions and the government. The banks had long enjoyed the protection of patrons in government but, for the first time, the banks were in a position to put pressure on the government. Officials now had to go to the banks to discuss such questions as changes in interest rates and the size of the government's indebtedness. Having created powerful banks by entrusting them with the government's money, the government fell into dependence on them.
With the approach of the presidential elections, it became clear that the government not only would not be able to repay the loans it had taken but, on the contrary, would need new loans which led to plans to put some of the country's most valuable properties, such as the Perm Motor Factory, which produces aircraft engines, Aeroflot and Szvyazinvest, the telecommunications holding company, up for auction with the banks that had received shares in the enterprises dictating the conditions.
The banks, for their part, acted to support the government which had enriched them, contributing an estimated hundreds of millions of dollars to the Yeltsin re-election campaign. The legal spending limit was $3 million. In this way, they helped to assure Yeltsin's victory. (16)
The third process which gave rise to Russia's criminal business oligarchy, and the one which left its stamp on the other two, was the process of criminalization.
As was the case with privatization, the modern stage of criminalization in Russia began during perestroika. The Gorbachev era reforms started with the legalization of "cooperatives," which became the only privately run businesses in the Soviet Union. The cooperatives quickly prospered but, viewed as ideologically illegitimate, they were left without police protection at a time when it was illegal to hire private guards. They therefore became tempting targets for coercion and gangs began to be formed all over the country to extort money from them.
By 1992, nearly every small business or street kiosk in Russia was paying protection money to gangsters. As a source of wealth, however, shops and kiosks could not compare to the state budget and when, after the beginning of the Gaidar reforms, criminal gangs saw that former Soviet officials were using their connections to acquire vast, unearned wealth, they began to use terror to take over the enterprises that the former officials had established. One sign of the gangsters' activities was the growing number of bankers and businessmen who fell victim to contract murders. (17)
The criminal terror against well connected Russian businessmen, however, was short lived. Soon, the gangsters, businessmen and corrupt officials began to work together. The gangsters needed the businessmen because they required places to invest their capital but, in most cases, lacked the skills to run large enterprises. For their part, businessmen needed the gangsters to force clients to honor their obligations. Before long, nearly every significant bank and commercial organization in Russia was using gangsters for debt collection.
The bandits' methods were simple. The debtor was contacted and informed that the gang knew his address and all of his movements and if he did not pay his debt by a certain date, he and his family would be killed. Usually, this was enough to induce payment, in which case 50 per cent of the money went to the gang. In cases where the debtor was unable to make good the debt, he was usually murdered.
The partnership between business and crime did not stop with debt collection. It rapidly became clear that gangsters could be used for many purposes, from eliminating unwanted competitors to "persuading" potential business partners to soften their terms in contract negotiations. The most successful bankers and entrepreneurs became those with the closest ties to criminal structures.
Soon, Russian commercial organizations consisted of businessmen, whose principal skill was a talent for connections, corrupt officials who approved their projects in return for bribes, and gangsters who collected debts and eliminated competition. Increasingly, it became impossible to tell the difference between businessmen and gangsters. An unsuspecting Russian entrepreneur could easily find that in the event of a failure to agree on terms with a seemingly respectable businessman, his “partner” was ready to threaten his life.
By 1997, a ruling criminal business oligarchy was in place. A small group of bankers and businessmen, all of them previously unknown, had gained control of the majority of the Russian economy.
Many have compared Russia's new capitalists with the nineteenth century "robber barons" in the United States. The comparison, however, is misleading. Instead of creating industries and investing in them, Russia's new capitalists have divided up the property of the former Soviet Union and sent the proceeds out of the country, preparing for the day, in many cases, when they will follow their capital to the West.
If profitability in the real economy is about 5 per cent, gaining control of former state monopolies or access to the state budget can produce profit margins of several hundred percent so the new capitalists directed their efforts not at developing their enterprises but at bribing high ranking officials, creating an economy where crucial business decisions were based not on economic considerations but on the influence of corrupt ties. (18)
The result for Russia has been social ruin and political instability.
The decline of Russian society has many aspects. In the first place, Russia, with the richest natural resources in the world, is on the verge of economic collapse. In the period since 1992, the country’s gross domestic product fell by half. This did not happen even under German occupation. (19) Russia now resembles a classic third world country, selling its raw materials - oil, gas and precious metals - in order to import consumer goods.
The value of investment in Russia has fallen every year for the last eight years and is now roughly 20 per cent of what it was in 1991. (20) For lack of adequate investment, many sectors of Russian industry, including the food industry, the textile industry, and microelectronics have nearly disappeared.
Russia's newly rich do not invest in Russia because, having acquired their money, for the most part, illegally, they fear that a future government will subject their wealth to confiscation.
At the same time, money is being moved out of the country in enormous quantities. The Ministry of Internal Affairs estimates that in recent years, $350 billion has been exported illegally from Russia. (21) This money is taken out of the country in suitcases past the customs at Sheremetevo-2 airport, transferred abroad in sums of less than $10,000, or sent as payments to dummy firms controlled by the sender for services that were never rendered.
Without the broad based creation of wealth, the government is deprived of the possibility to finance itself through the collection of taxes. The cash strapped government promulgates draconian tax legislation that only inspires ever more sophisticated ways of avoiding payment. In 1997, 30 per cent of expected taxes were never collected and a fifth of what was collected was paid not in cash but in trade offs and barter. (22)
The economic disaster has been accompanied by a demographic catastrophe.
Between 1990 and 1994, male life expectancy fell by more than six years. It is now 57, the lowest in the industrial world. Of those Russian boys who reach the age of 16 this year, only 54 out of every 100 have the statistical possibility of living to celebrate their 60th birthday. One hundred years ago, 56 out of every 100 16 year old boys in the provinces of European Russia could expect to live to be 60.
Over two million people in Russia are now thought to be infected with tuberculosis and the number of cases of active tuberculosis officially registered doubled from 50,000 in 1991 to almost 100,000 in 1996. The number of new cases of syphilis has increased 57 times in seven years, from 8,000 in 1990 to 450,000 in 1997. Other medical threats posed by the breakdown of society and the system of public hygiene are polio, cholera and even plague. (23)
At the same time, many Russians are living under conditions of acute stress. The delay in paying salaries in Russia as a result of profiteering at all levels of the economy is now from three to eight months and, to avoid starvation, many Russians are forced to grow their own food. At the present time, 40 per cent of all food consumed in Russia is raised on private plots. (24)
The growing desperation which the economic situation inspires has contributed to suicides and accidents and a sharp increase in the rate of violent crime.
Perhaps most serious for the long run, however, is the fact that pervasive lawlessness has led to an inversion of social morality. If under communism, normal standards of right and wrong were denied in favor of the supposed “class values” of communism, people in Russia today are losing the ability to distinguish between legal and criminal activity.
The markets in every Russian city are controlled by bandits who collect a share of the proceeds from each vendor. This system is so well established that the gangsters calculate the share owed to them based on an examination of the vendors' receipts and may agree to defer payments in light of special circumstances, creating, through force of habit, the impression that they are actually performing a needed function.
Other businessmen hire private security agencies or even sign contracts with police agencies, like the Ministry of Internal Affairs or the Federal Security Bureau (FSB,) which, in an eerie perversion of the meaning of law enforcement, provide guard services to businessmen for a price.
The breakdown of moral standards in Russia is also reflected in the appearance of a market in hired killers. Any Russian can now order a murder simply by contacting the criminal gang that is “protecting” him. The cost of killing someone in Russia depends on the level of the intended victim’s security. The better he is protected, the more it will cost to kill him. But because the breakup of the security services created a pool of unemployed cutthroats with weapons experience and contract killers are almost never caught and so assume no risk, the cost of a professional murder in Russia, in general, is very low.
The confluence of Russia’s economic, demographic and moral crises has had a particularly devastating effect because it comes at time when the country is in need of a massive renovation of existing capital.
According to studies carried out by the World Bank, the conversion of the military industry and renewal of civilian manufacturing require an investment of up to $90 billion whereas the investment needed to stabilize the output of the oil industry, which has fallen by 50 per cent since 1988, is estimated at anywhere from $35 to $100 billion over a five year period. (25)
Within the next two years, it is anticipated that 22 per cent of Russia’s hydroelectric and 29 per cent of its thermoelectric generating capacity will need to be retired and within 12 years, this will be the case for 58 per cent of the country’s thermoelectric capacity and a third of its atomic energy capacity. (26)
The decay of the capital stock includes not only industrial but also agricultural, infrastructural and human capital. Work on soil amelioration has come to an almost complete halt and Soviet era infrastructure - housing, heating and sewage system, pipelines and transportation arteries - is not b