Home Alone 2
The greatest foreign policy blunder of the Bush administration has been its neglect of Russia's needs in the year since the collapse of the Soviet Union. American stinginess (not to mention that of the Europeans and the Japanese) has made President Boris Yeltsin's task vastly more arduous and has strengthened the hand of the hard-liners, who are once again trying to reverse the economic reforms at the current meeting of the Russian Congress.
Despite the great stakes of the West in the success of Russia's reforms, actual Western support has been minuscule. Indeed, the contrast of high-sounding rhetoric and little real support has had an enormously corrosive effect on Russian politics. The reformers have been derided for trusting in the West. Hard-liners have urged a return to inward-looking policies, declaring that the West has shown itself to be unreliable and hostile to Russia's efforts.
The mismanagement of the aid effort is a startling tale. On October 28, 1991, just a month after the attempted coup, Yeltsin announced that Russia would embark on the most dramatic democratic and market reforms in history. This remarkable speech was followed by silence from Western leaders. A few weeks later Yeltsin appointed a government of brilliant young reform economists, wisely skipping two generations of economists who Yeltsin sensed were still mired in the misconceptions of the old system.
The leading finance officials of the Western governments arrived soon after in Moscow. One would assume that these officials met with the new Russian government to see how the West could help with the mind-boggling task of stabilizing the Russian economy. But the purpose was rather different. The officials spent the entire week pressing Russia and the other republics to continue paying the interest on the old Soviet debt, an impossible demand, given the lack of financial reserves. The new Russian government signed on, despite the sure knowledge that it would have to default on the agreement within days.
In January Secretary of State James Baker convened a White House meeting of more than forty countries to discuss Western assistance--a good opportunity to display Bush's global leadership. But the administration was more interested in a smooth meeting than in substance. Afraid that the Russian government might use the occasion to appeal for meaningful financial assistance, Baker did not invite a single Russian official to participate. There was no talk about Russia's real financial needs, only about highly visible "humanitarian assistance," such as food credits, which fell far short of Russia's actual needs.
At that point the G-7 countries assigned the International Monetary Fund to be the West's agent in Russia's reforms. One should have some sympathy for the organization. It is the only one in the world that has a relatively clear view of how Russia can most effectively reform its economy, and that speaks clearly about the urgent need for Russia to cut its budget deficit and get its monetary policy under control. But it also is an exceedingly cautious bureaucracy, unwilling to take initiatives unless strongly prodded by the leading Western governments. Sure enough, the IMF took its cue from the G-7 last January when it told the Russians that Russia really didn't need much financial help in 1992.
In March the Russian government demanded from the IMF a professional assessment of its financial needs. To the IMF's credit, it reversed its position and acknowledged that in fact Russia's financial needs were significant. Partly as a result of this, and partly due to political hammering on Bush by Richard Nixon and Bill Clinton about the need to do more for Russia, the G-7 governments announced at $24 billion aid package on April 1. This had one crucial effect. It helped the reformers in the spring session of the People's Congress make it through the political pitched battle with the hard-liners.
The Russian government immediately asked the IMF for a detailed description of the $24 billion program. There had been no discussions of specific projects, the organization of the aid effort, or even the sources of the funds. And alas, the IMF couldn't come up with an explanation of the program. It devised four contradictory explanations over four months, admitting in private that there really was no organized program--only suggested sums of how much support Russia might receive from various sources, including the IMF, World Bank. Western governments, and debt rescheduling. Again, it was not the IMF's fault: there was simply no G-7 policy to grab on to.
In the end, there was no organized aid effort at all. Russia received about $8 billion in short-term credits to import grains and other basic goods. Most of these loans had actually been arranged in 1991 and were simply being implemented in 1992. Since these are short-term credits, about $2.5 billion is coming due in 1993 (not to mention the amounts on the pre-1992 loans), and Russia will be unable to pay it off. Russia received another $500 million or so in humanitarian grants. The IMF lent $1 billion this summer, but under the proviso that the funds not be touched in 1992. And the World Bank has lent $600 million, with another $100 million to $200 million on its way, perhaps by the end of the year. Russia's debts were not rescheduled in the first eleven months of 1992, though a serious effort to do so is finally under way.
All in all, the Western effort has amounted to around $10 billion of unstructured lending: no program, no timetable, no attempt to link the vast majority of the funds to actual reform measures. In the absence of significant international assistance, the Russian reformers have had to make unappetizing and risky compromises, such as occurred after the April session of the People's Congress, with an inflationary flood of money channeled to the military-industrial complex. The government is also acceded to demands of the hard-line parliamentarians for a change in Central Bank management. The old head of the Central Bank under Gorbachev became the new head of the Russian Central Bank. Although the government thought it was making a few modest concessions, the results have been close to disastrous. The Central Bank promoted an explosive growth of the money supply by issuing credits to the old industrial dinosaurs. The money supply rose around three times in five months (nearly 30 percent per month), and the country was brought back again to the brink of hyperinflation. Monthly inflation now runs at around 30 percent per month.
Fortunately, Russia still has some instincts for self-preservation. Yeltsin, his reform Cabinet, and even the Central Bank have recognized that Russia's policy of unchecked subsidies to industry must be reversed. In late November Yeltsin issued a decree making the Central Bank part of the government, rather than under the control of the Parliament, where the industrial lobby holds sway. This may or may not be an empty gesture. All will depend on Yeltsin's political strength in the coming weeks and months. And as before, that strength will depend largely on whether he finally receives meaningful support from the West.
The situation is dangerous but far from hopeless. In fact, although the monetary situation is abysmal, much else about the economic reforms is looking bright. The public is not only acquiescing in but is actually supporting the move to a market system. There has been no social explosion, no important unrest at the grass roots. The privatization of the economy is surging forward, with thousands of enterprises converting themselves into joint stock companies under the guidelines of the government's privatization program. The government is distributing "privatization checks" to every Russian citizen, which may be used to buy shares in state-owned companies, in auctions that will start next month.
Decentralized, market-based behavior is taking root throughout Russia. Enterprises in the Urals and in Siberia are engaged in extensive barter trade with Chinese firms. Manufacturing enterprises are waking up to export opportunities in the West. Yes, there is massive smuggling in order to avoid taxes and to keep funds outside the countries, but perhaps more important, there is an enormous growth in market-oriented trade. Although virtually all Russians complain about the various "mafias" that direct the flow of goods, there is much more competition and honest trade than when the society was run by the one vast mafia of the Community Party.
Even the decline in industrial production should not be mourned. As in Eastern Europe, much of the shrinkage is in the old military-industrial complex, which frees up resources for other sectors of the economy. A new service sector is taking root, seen most clearly in the tens of thousands of kiosks that have opened up in Moscow in recent months. In Poland over the past three years the same transformation--from heavy industry to services and consumer industries--has led to a successful remaking of the economy, a process that most Poles enthusiastically endorse. Incidentally, even the most feared consequence of reforms, unemployment, remains at a mere 1 percent of Russia's labor force, vastly below the unemployment rates of market economies. Unemployment will grow, surely, but along with the growth of new opportunities in the economy.
The key for Russia is to persevere in the basic four lines of reform: macroeconomic stabilization, liberalization of economic activity, privatization of state-owned resources, and construction of a social safety net to support the vulnerable groups in the population left behind by the market changes. Stabilization is most urgent, since a real hyperinflation could derail all of the rest of the reforms. Although each part of the agenda is under serious attack by the old guard (who think about heavy industry and almost nothing else), the West still has a chance to play a pivotal role by supporting the main themes of reform.
Assuming that the reformers survive the coming political onslaught, as looks likely, the urgent need will be to reinforce the stabilization program in January and carry forward on the rest of the reforms. The Western assistance in 1995 should be geared to provide maximum political and economic support to the basic contours of reform. Rather than announcing a pile of cash, as the G-7 did in April, the West should work with the Russians to establish a series of projects, each directed at a key aspect of reform. The following kind of package makes sense:
An emergency social fund, to help pay for unemployment compensation, emergency medical support, and supplements to pensioners. The fund would be supported by direct grants of the Western countries, on the order of $8 billion in total (of which the U.S. share would be about one-fourth). This program would help to allay current anxieties that the unemployed will be left to fend for themselves. Obviously, such a fund would help to cover direct budgetary needs without resort to the ruble printing press.
An industrial restructuring fund, to help pay for military conversion and other industrial restructuring operations. This money would be in the form of long-term loans from export credit agencies, the World Bank, and the European Bank for Reconstruction and Development. About $8 billion per year could be divided among military conversion, agroindustry, and energy development.
A small business loan program, modeled on U.S. efforts in Poland and Czechoslovakia, to make hundreds of thousands of loans throughout Russia to small private-sector enterprises. Such a fund, lending about $1 billion per year, could be managed by the EBRD.
Balance of payments support from the IMF, to help cover foreign exchange needs, both for imports and for currency stabilization. The money would be divided between a normal IMF loan, of about $4 billion, and a special ruble stabilization fund, of about $6 billion. In addition, Russia's payments on the old Soviet debt would be deferred, though not canceled.
The direct U.S. budgetary costs would be about $3 billion per year (about 1 percent of defense spending), with the rest covered by Western Europe, Japan, the international financial institutions, and off-budget export credit agencies. As with the support going to Eastern Europe, the financial package would not be enough to rebuild Russia (a task properly left to the Russians), but it would be pivotal in helping the economic reforms take root.
This is the kind of program that could fire up the imagination of the millions of Russians trying to find their place in Russia's rapidly changing order. They would have vastly more confidence that basic needs would be met in the event of unemployment; a better chance to start a private business; and hope for their factory's future if it is eligible for long-term restructuring assistance. All Russians would be aided by a stable, convertible currency made possible by meaningful support from the IMF.
only the G-7 can put this kind of package on the table and monitor its implementation. And only the president of the United States can lead the G-7 to take these steps. With some forethought by the new Clinton team, January 1993 can mark a period of decisive regeneration for Russia as well as for the United States.
Jeffrey Sachs is professor of economics at Harvard University and an economic adviser to the Russian government.