Who Lost Russia?

Out of these chaotic conditions, the rudiments of a new economic order began to emerge. It was a form of capitalism, but it was a very peculiar one and it came into existence in a different sequence from what could have been expected under normal conditions. The first privatization was the privatization of public safety, and in some ways it was the most successful. Various private armies and mafias were set up and, where they could, they took charge. The management of state-owned enterprises formed private companies, mainly in Cyprus, which entered into contracts with the state enterprises. The factories themselves ran at a loss, did not pay taxes, and fell into arrears in paying wages and settling debts between companies. The cash flow was siphoned off to Cyprus. New banks were formed, partly by state-owned companies and state-owned banks, partly by newly emerging trading groups. Some banks made fortunes by handling the accounts of various state agencies, including the Treasury.

Then, in connection with the scheme for privatizing state companies by the distribution of vouchers, a market for stocks was born before the mechanisms for registering stocks and efficiently settling transactions were properly in place, and long before the enterprises whose stocks were traded started to behave like companies. A culture of lawbreaking became ingrained long before the appropriate laws and regulations could be enacted. The proceeds from the voucher privatization scheme did not accrue either to the state or to the companies themselves. At first, the managers had to consolidate their control and service the debts they had incurred in the process of acquiring control; only afterward could they start generating earnings within the companies. Even then, it was more advantageous to hide the earnings than to report them unless they could hope to raise capital by selling shares. But only a few companies reached this stage.

These arrangements could be justly described as robber capitalism, because the most effective way to accumulate private capital if one had hardly anything to start with was to appropriate the assets of the state. There were, of course, some exceptions. In an economy starved of services it was possible to make money more or less legitimately by providing them, for example repair work or running hotels and restaurants.

Foreign aid was left largely to two international financial institutions, the International Monetary Fund and the World Bank, because Western countries were unwilling to put up money from their own budgets. I was opposed to this arrangement on the grounds that the International Monetary Fund is institutionally ill-suited for the job. It operates by getting governments to sign a letter of intent to adhere to conditions governing stability of currency and central budget, among other requirements, and it suspends payments if a government fails to meet the conditions. When a country does not have an effective government, this method practically guarantees that the program will fail. That is what happened in Russia. The central government was unable to collect taxes, and the only way it could meet the money supply targets was by refusing to meet budgetary obligations. Wage arrears and debts between companies built up to unmanageable levels. I argued that a more direct, intrusive approach was needed, and it would have been eagerly accepted at the time. But that would have meant putting up real money, and the Western democracies balked at the prospect.

When the International Monetary Fund extended a $15 billion loan to Russia, I argued in an article published in The Wall Street Journal on November 11, 1992, that the money should be earmarked for the payment of social security benefits and that the disbursement of the funds should be closely monitored. Because of the undervaluation of the ruble, pension payments were only $8 a month, so the money would have been sufficient to pay all the pensions. My proposal was not given serious consideration because it did not fit into the International Monetary Fund’s mode of operation. So I set out to show that foreign aid could be made to work.

I set up the International Science Foundation with $100 million (the eventual disbursements reached $140 million). Our first act was to distribute $500 each to some 40,000 of the best scientists in the hope that this would encourage them to stay in Russia and continue with scientific work. This took only $20 million, and it allowed these scientists to survive for a year. The criteria for selecting the scientists were open, transparent, and objective: three mentions in leading scientific publications. The distribution was accomplished in a few months, with an expense ratio of less than 10 percent, and the scheme assured payments in dollars to each recipient throughout the former Soviet Union. This served to prove that my proposal for controlling the disbursement of funds was practical.

The rest of the money was spent to support research on the basis of an internationally organized peer review process in which the most famous scientists of the world participated. (Boris Berezovsky contributed $1.5 million for travel grants for reasons of his own. This was the only Russian contribution). All the funds were committed in less than two years.

My reasons for supporting scientists were complex. I wanted to demonstrate that foreign aid could be successful, and I selected science as the field of demonstration because I could count on the support of the members of the international scientific community, who were willing to donate their time and energy for evaluating the research projects. But the mechanics of the emergency aid distribution could have been made to work for pensioners as well as scientists.

There were other arguments in favor of helping scientists. During the Soviet regime many of the best brains had joined research institutes where independent thinking was more tolerated than in the rest of Soviet society, and they produced science which was at the cutting edge of human accomplishments. It was a somewhat different strain from Western science, more speculative, less advanced technically except in a few priority areas. Scientists were also in the forefront of political reform. Andrei Sakharov was particularly well known and admired, but there were many others. In addition, there was a danger that nuclear scientists might be enticed away by rogue states.

The entire undertaking was a resounding success and gave my foundation an unassailable reputation. There were many attacks against us because we engaged in many controversial programs. For instance, we ran a competition for new textbooks free of Marxist-Leninist ideology and were accused of poisoning the minds of students. On one occasion the Duma conducted hearings on charges that we were acquiring scientific secrets on the cheap, but the entire scientific community rose in our support and the Duma ended up passing a vote of thanks. When I say that history would have taken a different course if the Western democracies had come to the aid of Russia after the collapse of the Soviet system, I can therefore rely on much supporting evidence. Imagine how differently Russians would feel about the West today if the International Monetary Fund had paid their pensions when they were starving!

I abstained from personally investing in Russia, partly to avoid any conflict of interest but mainly because I did not like what I saw. I did not interfere, however, with my fund managers who wanted to invest, and I also approved their participation in a Russian-run investment fund on equal terms with other Western investors.

I attended the World Economic Forum in Davos in January 1996 where the Communist presidential candidate, Gennadi Zyuganov, was well received by the business community. I met with Boris Berezovsky, and said to him that if Zyuganov was elected he would not be safe in Russia. I wanted him to support Grigory Yavlinsky, whom I considered the only honest reformer among the candidates, but I was naive. I did not realize to what extent Berezovsky was involved in dirty dealings with Yeltsin’s family. According to his own public statements, my warning about his safety concentrated his mind. He got together with the other leading Russian businessmen who were attending the Davos conference and they formed a syndicate to work for Yeltsin’s reelection.

That is how they became the oligarchs. It was a remarkable piece of political engineering: Yeltsin started with an approval rating of lower than 10 percent and they succeeded in getting him reelected. The campaign was managed by Anatoly Chubais. I do not know the details, but I can use my imagination. When one of Chubais’s aides was caught leaving the Russian White House, the headquarters of the prime minister and his government with some $200,000 in a suitcase, I am sure it was not play money. The oligarchs extorted a heavy price for their support of Yeltsin. They received shares in the most valuable state-owned companies as security against loans they made to the state budget in an infamous “loans for shares” scheme. After Yeltsin won the election, these companies were put up for auction and the oligarchs divided them up among themselves.

I know Chubais well. In my opinion he is a genuine reformer who sold his soul to the devil in order to fight what he called the red-brown menace, a combination of nationalism and socialism, which he believed would come to dominate Russia unless he did something to prevent it. After Yeltsin’s reelection he again took charge of the economy, but he had difficulty controlling the oligarchs. I was greatly encouraged when Yeltsin brought Boris Nemtsov, the reform governor of Nizhny-Novgorod, into the government and treated him as his adopted son. Chubais was tainted by the elections but Nemtsov was clean: he could stand firm where Chubais could not. I took this as a signal that the Yeltsin regime under the leadership of Chubais genuinely wanted to move away from robber capitalism toward legitimate capitalism. The budget deficit and money supply were kept within bounds and back taxes began to be collected. Inflation and interest rates declined. Shareholder rights were better respected and the stock market boomed. Foreign money poured into both stocks and debt instruments. Russian borrowers could obtain five-year loans at only 250 base points above the London inter- bank rate.

It was against this background that I decided in 1997 to participate in the auction of Svyazinvest, the state telephone holding company. I agonized over the decision. I was aware of the pervasive corruption in Russia. It would have been easier to keep my hands clean by sticking to philanthropy, but I felt that Russia needed foreign investment even more than philanthropy. If Russia could not make the transition from robber capitalism to legitimate capitalism, all my philanthropy was in vain. So I decided to participate in a competing bid for Svyazinvest that turned out to be the winning one. This was the first genuine auction in which the state was not shortchanged. Although we paid a fair price, just under $2 billion, of which my funds put up nearly half, I calculated that it would prove to be a very rewarding investment if the transition to legitimate capitalism came to pass.

Unfortunately that is not what happened. The auction precipitated a knockdown, drag-out fight among the oligarchs, a falling-out among thieves. Some of the oligarchs were eager to make the transition to legitimacy while others resisted it because they were incapable of working in a legitimate manner. The main opponent of the auction and its outcome was Boris Berezovsky. He vowed to destroy Chubais after his allies lost the election. I had a number of heart-to-heart talks with him but I did not manage to dissuade him. I told him that he was a rich man, worth billions on paper. His major asset was Sibneft, one of the largest oil companies in the world. All he needed to do was to consolidate his position. If he could not do it himself, he could engage an investment banker. He told me I did not understand. It was not a question of how rich he was but how he measured up against Chubais and against the other oligarchs. They had made a deal; they must stick to it. He had to destroy or be destroyed.

I came to witness at close quarters an astonishing historical spectacle in which powerful oligarchs tried to reverse the results not only of the auction but of the entire effort of the government to control the oligarchs. I was watching people fighting in a boat while the boat itself was drifting toward a waterfall. As part of a campaign of charges and countercharges, Berezovsky revealed that Chubais had received $90,000 from a phony book contract, which was in fact the other oligarchs’ payment for his services as Yeltsin’s campaign manager. Chubais was weakened and distracted by the constant need to defend himself. Tax collections required his personal intervention if they were to go forward, and tax revenues fell. There was a dangerous drift downward in the economy just as the Asian crisis of 1998 began to make its effects felt. It culminated in Russia defaulting on its internal debt in August 1998, which shook the international financial markets.

The effect on the Russian economy was less devastating than was expected at the time. The default on treasury bills brought relief to the budget; the recovery in oil prices helped both the fiscal and the trade balance; and the devaluation announced by Yeltsin in the summer of 1998 led to increased demand for domestic products. After the initial shock caused by the collapse of the banking system, the economy hit bottom and began to recover. The banks and the oligarchs suffered serious losses, but within a year Russian GNP was higher than it had been before the financial crisis. Even the foreign creditors were offered settlements which they found advantageous to accept.

(To be continued)