The task of inventing a market economy for Russia would have daunted more experienced minds. But the economists to whom President Boris Yeltsin turned in 1991 were sure of themselves, and impatient. They believed they must destroy the principles on which the old Soviet economy had rested, so that a new, Russian one might rise in its place. They thought speed essential, lest chaos or reaction overtake them.
Chaos was not far away, the product both of inefficiencies that had been accumulating in the Soviet economy for decades and of spasmodic attempts at partial liberalization under Mikhail Gorbachev. The price system was a particularly appalling mess. Industries could no longer afford, or could no longer be compelled, to provide goods to the market at the arbitrarily low prices which the government had tried to impose, as it had in the past. But the government feared to free retail prices lest that make consumers even angrier than they were already.
Yegor Gaidar, a former economics editor of Pravda who at thirty-five was given charge of Russia’s economic policy, persuaded Mr. Yeltsin to let prices find their own level and to brave the consequences. A decree freeing prices was published on December 3, 1991, and took effect a month later, on January 2. It worked very much as predicted. Prices doubled or trebled. Producers, importers, distributors, and retailers found it worth their while to offer goods for sale again. There was no popular insurrection. Large quantities of previously scarce items went on sale in the shops and street markets. From this point on Russian retail prices were determined mainly by market mechanisms. One foundation of state control over the economy had been destroyed, almost literally overnight.
The state also controlled economic activity through its near-monopoly ownership of industry. Attacking this form of control was a longer, harder, and generally more contentious process. It was all very well deciding that state assets were to be sold off; but a buyer had also to be found, preferably one capable of making use of them. Yet the buyer of privatized assets was, by definition, the private sector; and one legacy of communism was that Russia scarcely had a private sector. Legerdemain was required. Mikhail Gorbachev’s remark, “When owners have appeared, private property will emerge,” turned out to be less fatuous than it had seemed at first hearing.
The formula eventually chosen by Gaidar and his associates for privatizing most of Russia’s larger state-owned firms and factories was roughly this: workers and managers would decide how much their firms were worth, and would be given the first chance to acquire a controlling interest when the shares were offered. So that the rest of the population had a stake in the process, any Russian citizen could claim, for next to nothing, a voucher that could be tendered for shares in any firm being privatized.
Privatization of industry began in earnest at the end of 1992, continued in 1993 and 1994, and declined at the start of 1995. It affected roughly 18,000 of Russia’s larger firms-leaving out of the count the many more small businesses, mostly retail shops, that were also privatized. Very large firms, particularly in the energy industries, the largest and most powerful in Russia, were excluded from this first phase of privatization on the grounds that including them would have caused too many practical difficulties and too many political and bureaucratic arguments. Agriculture was little affected by privatization. State-owned farms were transferred, technically, to private ownership in 1992, but there was rarely any practical way for individual members of a collective to exercise the property rights they had notionally gained.
The main wave of privatization was a huge achievement for a young and shaky government. The firms privatized between 1992 and 1995 accounted for roughly four fifths of employment and output in the manufacturing industry as of 1991. The change was big enough to rearrange social and political relations within Russia, as well as economic ones. Privatization helped to change the vocation of the state from one of controlling the economy to one of simply interfering with it.
The 1992-1995 privatizations, and their perceived results, are the main subject of Kremlin Capitalism. Andrei Shleifer, a professor of economics at Harvard University, and Joseph Blasi, a professor at Rutgers University’s School of Management and Labor Relations, both advisers to the Russian government, directed a project, the “Russian National Survey,” to track the fortunes of the newly privatized firms. They hired a staff of young economists and researchers who criss-crossed the country to ask managers what they were doing and why they were doing it. The firms in the sample employed an average of about two thousand people. The first round of interviews covered twenty-three firms in 1992, as privatization was being launched; the last one covered 357 firms in 1995 and 1996.
Professor Blasi and his colleagues do not claim to have produced a general account of Russian reform. They offer statistical data covering a large sample of privatized firms, and supply only a modest amount of economic, social, and political background. For their economic overviews they have “relied…repeatedly,” they say, on another recent work, How Russia Became a Market Economy, by another foreign adviser to the Russian government, the Swedish economist Anders Aslund.* They plan, they say, to write “a series of articles in academic journals” to present “an in-depth review of the statistical evidence, and a discussion of other scholarly research.”
They warn that they were not able to obtain much in the way of reliable financial data about the companies with which they dealt: accordingly, company finances are scarcely discussed. The privatization of residential property and of small commerce, and the government’s sale of shareholdings in huge oil and minerals firms to a handful of banks in 1995-1996, are touched upon; but they fall outside the main scope of the story. Finally, though the central inquiry of the book concerns ownership, the authors note that it is often impossible to establish as a matter of fact who does own any given firm in Russia, since rules to compel disclosure of corporate ownership either do not exist or are not followed.
Clearly, these are limitations. The result, nonetheless, is not only a useful sketch of what Russian reformers thought they were doing when they sold off their country’s industry, but also a comprehensive account of what Russian managers thought they were doing when they and their workers bought it. The authors identify the managers’ chief aim as preserving the control of the factories they had enjoyed under communism. In this aim the managers succeeded, largely by abusing their administrative powers-a fact that may help to explain why so much of Russian industry performed not much or no better after privatization than it had beforehand.
Between January 1993 and January 1996 Russia’s industrial output fell by roughly a third-even though the country’s total consumption of goods and services rose slightly over the same period. The privatized firms tracked by the Russian National Survey got rid of 23 percent of their employees between 1993 and 1996, but the slump in output left them operating at barely half capacity. In the course of shrinking, therefore, they tended to grow still less efficient. As for labor relations under the new dispensation, millions of workers found that any changes were for the worse. It became commonplace for managers to pay wages late, or not at all, knowing that employees had nowhere else to turn. An anecdote lurking among the statistics speaks volumes:
One of our research visits to a factory manager was interrupted by an elderly woman who was distraught because she needed 5,000 rubles (about $1) for medicine for her son. She had not been paid in months. The manager told her there was no money, and sent her away.
Money or no money, the managers were not going to give in easily. The final round of interviews in 1995-1996, when much of the Russian manufacturing industry was manifestly in a state of collapse, produced the finding that:
More than two-thirds [of general managers] said that they and their employees would oppose selling a majority of shares in the enterprise to an investor who would bring the entire amount of capital necessary to modernize and restructure the firm.
Even the usually self-effacing authors could not stifle a comment here, observing: “This mentality is suicidal. It makes no business sense.”
So what went wrong? Specifically, many firms were part of a defense industry that lost its purpose in life with the end of the cold war. Many relied on sales and supply networks that were shattered by the breakup of the Soviet Union. Most lacked elementary skills in marketing and financial management that had been unnecessary in the planned economy.
More generally, however, Russia had privatized much of its property without having created conditions in which the new private owners would feel secure, or even understand fully their role. The government, it might be argued, had little choice, given its intention to turn Russia into a market economy in which industry was under private ownership. It could have begun either by theorizing about private ownership or by practicing it, and it chose to practice it. That said, however, the Russian government and state proved to be afflicted by an unforeseen ineptitude in doing the things that governments and states in market economies are supposed to do-collect taxes, enforce contracts, maintain the value of the currency, and protect the weak, for whom social services have grown ever more threadbare. At the end of 1996, for example, state pensions, offering a bare subsistence even when paid, were at least three months overdue across a third of Russia.
Lack of efficiency and discipline in the government and civil service, exacerbated at all levels by venality, incompetence, and inexperience, contributed to an economic slump that was longer and deeper than any adjustment to a change in the structure of ownership should have required. The resolve and the ability of any firm that wanted to do business honestly were undermined. The easiest way to survive in the “new Russia” was to lie to the tax man, pay off the protection racketeers, bribe the local bureaucrats, barter for supplies, and pay workers months late, if at all. The system did not merely allow all of these things: in effect, it demanded them if companies were to survive.
Perhaps a second problem among managers was a failure, common in Russian economic and political debate, to grasp the notion of creating wealth-that transactions are possible that will make everybody better off. They had been brought up in a society whose obsession was with the distribution of a “wealth” that was assumed to pre-exist. Soviet-era debate tended to proceed on the basis that everything was a zero-sum game: that there was a fixed quantity of wealth in the country, or power in the world. For A to be rich, B must be poor; for A to be strong, B must be weak. Trade and investment were essentially methods countries used to exploit one another.
Such a zero-sum approach on the part of privatized-factory managers may have encouraged them to hoard their resources and to resist outside investment. To put it mildly, this was not the ideal approach with which to build a business.
The manner by which Russian managers maintained their control of industry defied the intentions of the economists who designed the privatization program. Each participating firm was invited to convene a general meeting and choose between one of three models for its privatization. The choices were meant to balance the interests of managers with those of the rest of the workforce, and of outside investors.
A first option offered a sort of “free ride” to employees. The workforce as a whole could have 25 percent of the firm’s share capital for nothing, but in non-voting form; it could buy another 15 percent at a discount from the “book value”(alleged assets minus liabilities) placed on the firm for the purposes of the sale. But the rest of the shares could be sold to anybody, even to a new controlling investor. A second option ensured that control remained within the firm. The workforce could buy 51 percent of the shares by paying a premium over book value; the state could sell off the other 49 percent as it wished.
A third option was designed for more sophisticated companies, where workers had confidence in management, and management had confidence in its ability to plan. A management team could negotiate to buy from the state as much as 30 percent of the shares on the basis of a business plan. The state would offer other employees a further 20 percent shareholding. If the plan failed, the managers would forfeit their shares. The first option was chosen by a quarter of Russian firms; the second by almost three quarters of them. Only 3 percent of firms chose the third.
On paper, rank-and-file employees emerged owning a bigger slice of privatized firms (40 percent in 1996) than managers did (18 percent). But in practice, only managers made the decisions, managers dominated the board of directors, and only the managers knew where the money was banked and could make use of it. A presidential decree said that company boards should be broadly representative of shareholders, but few companies respected this. Trade unions were weak, for historical reasons: communism had little use for them save as a tool of management.
Before a general meeting, just in case the employees might act independently, they were often pressed to give proxies to management. (Blasi et al. report that at least a third of workers gave proxies to management in 1995. They also record a suspicion that the proportion was higher, but was understated by managers reluctant to admit to the practice.) By accumulating shares through intermediaries, managers may also have managed to own or control more of their companies than they cared to admit. It was relatively easy for managers to use the company’s own funds to buy shares that could be parked under management’s control in subsidiaries, pension funds, or banks.
Nor did privatization vouchers have quite the hoped-for effect in mobilizing citizens to collaborate in ownership. Issued in June 1992, they carried a nominal value of 10,000 rubles-about $84, while a factory worker’s monthly wage was about $50. Few workers chose to exercise their rights directly. An opinion poll taken late in 1994 found that 8 percent of respondents had used their vouchers to buy shares in the firms where they worked; 6 percent had bought shares in other firms; 30 percent had invested their vouchers in a mutual fund; 39 percent had sold their vouchers, or given them away. For the disposition of vouchers of the remaining 17 percent no answer was recorded.
Many of those who joined voucher funds were cheated, pure and simple. The worst of these unregulated funds solicited vouchers and cash from the public, and, to put it simply, stole them. Reputable financial institutions, sensing a bargain, were also in the market for vouchers as well. One foreign investment bank acquired 17 million vouchers on behalf of clients-the assigned rights of roughly 12 percent of the Russian population. The buying-up of vouchers provided an early opportunity for professional investors to build up stakes in privatized firms that appeared to be undervalued. Some fortunes were undoubtedly made. Many firms were being sold at their managers’ valuation, and managers, intent on acquiring control, had every incentive to set prices low. Blasi et al. found that “on average, the general directors surveyed in 1994 and 1995 said that they paid 40 times less [for their shares] than the enterprises were worth” (though that claim smacks of bravado).
The whole scheme was better suited to a country more schooled in the ways of the market, and better equipped with professional expertise, than Russia was at the time. Blasi et al. defend the absence of rigorous pre-sale valuations by saying that a Western-standard external audit on every one of 18,000 firms would have set privatization back at least 150 years. That is a deliberate exaggeration, but we can doubt how sure of their estimates any evaluators would have been in the circumstances. In the past year alone the value placed by the stock market on many big, much-appraised Russian firms has fluctuated tenfold and more, and in conditions far more settled than those between 1992 and 1995.
Not surprisingly, there was a huge public backlash against privatization. Many people felt they had been cheated, or that the natural order had been overturned and chaos substituted. For at the same time as Russian industry was being privatized, and for a variety of reasons that had much to do with the failings of the state, a small minority of Russians were becoming rich, a large majority of Russians were staying poor or becoming poorer, and crime of every sort was rampant. Cause and effect became blurred. A privatization expert with the World Bank, Ira Lieberman, found that
every time we polled the Russian population on privatization, it was clear their responses were colored by the overall anger at inflation and the broader economic reforms. Privatization served as a lightning rod for other angers.
It served, too, as a huge political bonus for the Communist Party, whose economic base it had helped undermine. Promising a return to public control of the economy, and investigations into “criminal” privatizations, the Communists and their close allies won a third of the seats in the Duma, the lower house of Russia’s parliament, in a general election in December 1995. Blasi et al. suspect, correctly, that privatization may not be as irreversible as its champions would wish, even now:
It might not be so hard for the state to nationalize or renationalize the top few hundred firms that represent the real industrial, oil and gas, and utility powerhouses of the nation.
It might not be sensible, either. But even there, the debate is open. Jeffrey Sachs, another Harvard professor and past adviser to the Russian government, has been among those calling for a re-establishment of state control over Gazprom, the huge Russian gas monopoly, the privatization of which seemed designed mainly to make its management rich.
An association in the public mind with crime and corruption did much to give privatization its bad name. The association was a logical one: crime and corruption are all-pervasive in Russia. But it is not true that they were largely caused by privatization.
In view of the extent to which they shape the business environment in Russia, crime and corruption do not receive their due in Kremlin Capitalism-perhaps because managers preferred not to talk about such matters, whether they were practitioners or victims. And, as the authors note, organized crime was preoccupied more with preying upon industry than with owning it. It preferred cash to fixed assets. But a conclusion the authors go on to reach, that “the influence ascribed to [organized crime] is far in excess of the hard evidence,” invites the answer that, well, it depends what you mean by hard evidence. In 1995 alone the Russian Business Roundtable, an organization of leading executives, lost nine of its top thirty officials to assassins. That is quite enough “influence” for most tastes.
Aside from denouncing professional killers and leg breakers, there is, however, a limit to the extent that one can usefully moralize about the interpenetration of crime, business, and government in Russia. The temptations to criminality were immense, its boundaries ill-determined, deterrents almost nonexistent, the alternatives unrewarding. The weight of federal and local taxes, the mounds of permits and permissions needed to do almost anything, and the arbitrary powers of bureaucrats made it almost impossible to run a business entirely legally even if one wanted to-and even if one could find law-abiding pockets of officialdom with which to collaborate.
Fraud became as much a factor in corporate finance as, say, depreciation. Owners did it; or racketeers did it for them. Inflation helped. You could always siphon money out of the firm, and put it back when it was no longer worth anything. Falsifying paperwork to conceal embezzlement was a minor inconvenience when paperwork was being falsified in any case to evade taxes. In industry, the key trick of crooked executives was to intercept cash as it came into the firm-from sales revenues, from government subsidies, even from other investors. The more cash that was intercepted, the less the firm had on hand to pay its suppliers, its wages, even the tax liabilities to which it admitted. Entire industries were left operating on barter and bad debts.
Did the government intervene to protect the interests of the shareholder class which its privatization program had created? Not nearly enough. Many officials were busy looking for opportunities themselves. If you were lucky enough to control a flow of funds into or out of government, you “designated” a bank to handle the money; you then used the cash to play the markets in cahoots with your banker. Small wonder that money never seemed to arrive to pay teachers, or feed soldiers, or cover fuel bills in remote regions. It was stuck in a bank somewhere making a handful of people rich.
Things have improved slightly in the past year or two. Virtually all the money readily available for embezzlement has been embezzled. High inflation-enemy number one of economic and financial stability-has been brought down, thanks in large measure to prodding from the International Monetary Fund. Organized crime has become a bit better organized, and less prone to destructive feuds. The biggest companies are starting to impose a little more order on the world around them. Firms in the oil and gas industry have been among the first to acquire the rudiments of corporate governance, as their managers have come to understand that international financial markets penalize heavily firms which fail to produce reliable accounts, or fail to respect the rights of outside shareholders. The top twenty or thirty banks have grown noticeably more disciplined about managing their balance sheets, and admitting to their problems, since the Central Bank came under the control of a national bank governor, Sergei Dubinin, willing to knock some sense into them.
Some of the banks have also started to understand they have something to gain by planning for the long term: the cleverest and best-connected of them joined forces in 1995 to persuade the government to launch another round of privatization involving the shareholdings in companies previously deemed too big or too sensitive to privatize. The result was a series of rigged “auctions” through which control of much of Russia’s natural resources was passed to a handful of investors at bargain-basement prices. Why so cheaply? Because the investors, mostly banks, had friends in government. A new oligarchy was declaring itself.
And here, perhaps, is hope of sorts. Russia is developing a tier of financial and industrial groups, centered on eight or ten big banks and energy firms, which are sophisticated enough to have some glimmerings of enlightened self-interest and, to have, at the same time, a general interest in the orderly functioning of society. They are also scheming enough to get their way with a fragmented, disorganized, and often corrupt government. In view of the difficulty the government has shown in reforming itself from within, even self-interested pressure on the government from without has its virtues. A precursor in setting the trends toward industrial pressure on central government and collaboration with it was Gazprom, Russia’s gas monopoly. In May 1992 its managing director, Viktor Chernomyrdin, joined the government, and in December he became prime minister. Last year Vladimir Potanin, co-founder of Russia’s biggest private bank, Oneximbank, was made Mr. Chernomyrdin’s deputy. Another financier, Boris Berezovsky, has become Mr. Yeltsin’s deputy national security adviser. The banks and industrial groups are reinforcing their political power by buying up the press and television. Vladimir Gusinsky, whose Most-Bank group helped pay for Mr. Yeltsin’s re-election campaign last year, shares control with Gazprom of one of the three main national television channels. Mr. Berezovsky controls another. (He has just sued Forbesmagazine for, according to his spokesman, publishing an arti-cle that falsely states Mr. Berezovsky is responsible for murder and for running a criminally corrupt business organization.)
The current oligarchy combining business and government is still in the process of entrenchment. A change of president could sweep it away. While it lasts and struggles toward permanence, its carving up of the economy is not a pretty sight to behold. But at least there is a sense that more assets are being concentrated in relatively competent hands, and that the parts of government that recall the world of Dead Souls are being encouraged to improve their efficiency. Foreign investors, deciding that Russia may, after all, regain its rank as a developed nation, have responded by pushing the stock market up sharply.
Ironically, the people least touched by this new optimism may well be the workers in those firms and factories whose privatization seemed to hold out so much hope in 1992. The success stories in Russia now are the banks, the oil companies, the telecommunications firms, the property developers, the service industries, and small commerce. The middle ground of manufacturing industry-the firms sold off in 1992-1995-remains mired in low-wage, low-tech stagnation. The outlook for these firms may improve if the economy manages its first real growth this year, as widely forecast, and if the tax system is simplified next year, as promised. But many companies will be beyond saving in anything like their present state. For all their protestations to the contrary, their managers and workers will find they have no choice, if they are to survive, except to surrender both to outside investment and to restructuring involving yet further loss of jobs. As one Russian joke (or half-joke) has it: “We know now that everything they told us about Communism was false. And everything they told us about capitalism was true.”
March 27, 1997