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Who Lost Russia?


The collapse of the Soviet empire in 1989 and the Soviet Union in 1991 offered a historic opportunity to transform that part of the world into open societies; but the Western democracies failed to rise to the occasion and the entire world has to suffer the consequences. The Soviet Union and later Russia needed outside help because an open society is a more sophisticated form of social organization than a closed society. In a closed society there is only one concept of how society should be organized, the authorized version, which is imposed by force. In an open society citizens are not only allowed but required to think for themselves, and there are institutional arrangements that allow people with different interests, different backgrounds, and different opinions to live together in peace.

The Soviet system was probably the most comprehensive form of closed society ever invented by man. It penetrated into practically all aspects of existence: not only the political and military but also the economic and the intellectual. At its most aggressive, it even tried to invade natural science—as the case of Lysenko showed. To make the transition to an open society required a revolutionary change in regime which could not be accomplished without outside help. It was this insight that prompted me to rush in and establish open society foundations in one country after another in the former Soviet empire.

But the open societies of the West lacked this insight. After the end of the Second World War, the United States launched the Marshall Plan; after the collapse of the Soviet system the idea of a similar initiative was unthinkable. I proposed something like it at a conference in the spring of 1989 in Potsdam, which was then still in East Germany, and I was literally laughed at. The laughter was led by William Waldegrave, a minister in Margaret Thatcher’s foreign office. Margaret Thatcher was a staunch defender of freedom—when she visited Communist countries she insisted on meeting with dissidents—but the idea that an open society needs to be constructed and that the construction may require—and deserve—outside help was apparently beyond her understanding. As a market fundamentalist, she did not believe in government intervention. In fact, the formerly Communist countries were left largely to fend for themselves. Some made the grade; others did not.

There is much soul-searching and finger-pointing going on with regard to Russia. Articles are being written asking, Who lost Russia? I am convinced that we, the Western democracies, are largely responsible, and that the sins of omission were committed by the Bush and Thatcher administrations. The record of Chancellor Kohl’s Germany is more mixed. Both in extending credits and in making grants, Germany was the largest financial contributor to the Soviet Union and later to Russia, but Kohl was motivated more by the desire to buy Russian acquiescence in German reunification than to help transform Russia.

I contend that if the Western democracies had really engaged themselves, Russia could have been firmly established on the road toward a market economy and an open society. I realize that my contention runs counter to prevailing views. It is counterfactual because, in fact, the economic reform efforts were dismal failures. One would have to believe in the efficacy of foreign aid to argue that the outcome could have been different; but foreign aid has a bad record and the idea that governmental intervention could actually help an economy goes against the prevailing market fundamentalist bias. So attention is concentrated on who did what that went wrong. But it is exactly the market fundamentalist bias that must be held responsible for the outcome. It militated against a genuine engagement to help the Soviet Union and later Russia.

People felt a lot of sympathy, but it was inchoate. The open societies of the West did not believe in open society as a desirable goal whose pursuit would justify considerable effort. This was my greatest disappointment and misjudgment. I was misled by the rhetoric of the cold war. The West was willing to support the transition with words but not with money, and whatever aid and advice was given was misguided by a market fundamentalist bias. The Soviets and later the Russians were very eager for and receptive to outside advice. They realized that their own system was rotten and they tended to idolize the West. They made the same mistake as I did: they thought the West was genuinely concerned.

I had set up a foundation in the Soviet Union as early as 1987. When Gorbachev phoned Andrei Sakharov in his exile in Gorky and asked him to “resume his patriotic activities in Moscow,” I realized that a revolutionary change was in the making. I have described my experiences elsewhere.1 What is relevant here is that in 1988 I proposed setting up an international task force to study the creation of an “open sector” in the Soviet economy, and somewhat to my surprise—I was then an obscure fund manager—my proposal was accepted by officials in the USSR.

My idea was to create a market sector within the command economy, selecting an industry like food processing which would sell its products to consumers at market rather than command prices (with an appropriate system for transfer from command prices to market prices). This “open sector” could then be gradually enlarged. It soon became evident that the idea was impractical because the command economy was too diseased to nurture the embryo of a market economy. That is, the problem of transfer pricing could not be solved. But even such a harebrained idea from an insignificant source was supported at the highest level. Prime Minister Vladimir Ryzhkov ordered the heads of the major institutions—Gosplan, Gosnab, and so on—to participate. It is true that I was able to attract Western economists like Wassily Leontief and Romano Prodi to participate from the Western side.

Later on I put together a group of Western experts who provided advice to different groups of Russian economists preparing competing economic reform programs. Then I arranged for the authors of the principal Russian proposal for economic reform, the so-called Shatalin Plan, led by Grigory Yavlinsky, to be invited to the 1990 International Monetary Fund/World Bank meeting in Washington. Gorbachev wavered over the plan and finally decided against it. He balked at two issues: the privatization of land, and the simultaneous dissolution of the Soviet Union along with the formation of an economic union. I still think the Shatalin Plan would have provided for a more orderly transition than did the actual course of events.

Soon afterward, Gorbachev fell from power, the Soviet Union disintegrated, and Boris Yeltsin became president of Russia. He entrusted the economy to Yegor Gaidar, the head of an economic research institute who had studied macroeconomic theory from the standard textbook of Rudi Dornbusch and Stan Fischer. He tried to apply monetary policy to an economy that did not obey monetary signals. State-owned enterprises were continuing to produce according to plan even if they were not getting paid for it. I remember calling Gaidar in April 1992 to point out that debt between companies was rising at a rate which was equal to one third of the GNP. He acknowledged the problem but carried on regardless.

When Gaidar failed, an uneasy balancing act followed and eventually Anatoly Chubais, the head of another research institute, emerged as deputy prime minister in charge of the economy. He gave priority to the transfer of property from state to private hands. He believed that once state property had private owners, the owners would start protecting their property and the process of disintegration would be arrested.

That is not how it worked out. A scheme for distributing vouchers which citizens could use to purchase state-owned companies became a free-for-all aimed at expropriating the assets of the state. Managements took control of the companies by cheating the workers out of their vouchers or buying up shares on the cheap. They continued to siphon off earnings and often assets into holding companies based in Cyprus, partly to avoid taxes, partly to pay for the shares they acquired, and partly to build up their assets abroad because they had no confidence in what was going on at home. Fortunes were made overnight, while there was also an extreme shortage of money and credit, both in rubles and in dollars.

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 managements 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.

  1. 1

    Underwriting Democracy (Free Press, 1991).

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