Following the Same Old Map

Meet the new program -- same as the old program. Garfield Reynolds and Matt Bivens lay out the details of an economic strategy worked out between Russia and the IMF, and ask whether it will work.

A year after the now-infamous July bailout package failed to bail Russia out, the Kremlin and the International Monetary Fund have kissed and made up. The IMF has swallowed hard over the outrageous FIMACO scheme f through which Central Bank reserves were, for reasons never adequately explained, routed through a shell company based in the Channel Islands, an offshore haven notorious for money laundering. "The central issue is, were we lied to?" Stanley Fischer, the No. 2 man at the IMF, said this week. "The answer to that, coming out of [an audit of FIMACO] is unfortunately 'yes.'"

Fischer's harrumph aside, the IMF has coughed up another $4.5 billion f along with a stern warning that if corrupt Russian officials play any more shenanigans with IMF money, or tell any more lies, than the IMF is going to get really, really strict!

In return, the Russian government and Central Bank have signed a Statement on Economic Policies. This document lays out the policies-for-IMF-cash trade-off that the government and the bank pledge to pursue.

The new plan is: Return to the old plan. The Russian government and Central Bank contritely admit as much. They state that much of this new program is a list of tasks left over from previous IMF programs, and add, "[we] intend to fully implement these earlier specified measures now."

In other words, it's the IMF triumphant again. There is no self-examination on display, no introspection, no alternative voices. It's the same situation as at the beginning of the year, when the IMF hosted a conference pegged to the 10th anniversary of "the transition process" f as the IMF and World Bank crowd refer to work moving the formerly communist world to capitalism. The keynote speaker at this February conference was, of all people, Yegor Gaidar f the former prime minister and obedient IMF pupil. (In a lovely and precious phrase, the IMF newsletter summarized Gaidar's performance by saying he "provided a tour d'horizon of the Russian experience.")

Papers presented at the conference included a defense of privatizations around the former Soviet bloc that f as described on the IMF web site f conceded that some had been "hasty" and favored "the agile and well-connected," but concluded, "there is no reasonable alternative to continuing privatization."

Russia's Statement on Economic Policies is even more blas?. "Potential benefits from ? privatizations ? have been diminished owing to the absence of transparency in the process and a failure to ensure that economic gains were broadly distributed among the population."

That is an awfully charitable account of Russian privatizations, which have seen the nation's oil and gas fields, her precious metals and even her television airwaves parceled out to a few insiders for next to nothing f a corruption-fueled fire sale, similar to those seen in Mexico, Brazil and other Third World lands, that has cost the Russian people billions of dollars.

Arguably privatization, which created the so-called oligarchy of powerful vested interests with no real legitimacy, has done more to set back the creation of both democracy and a market economy than any other government policy. This is now so broadly recognized that even the World Bank's new chief economist, Joseph Stiglitz, could note in a recent paper on Russia that privatization has been a "dubious achievement."

"After all, it is easy to simply give away state assets, especially to one's friends and cronies; and the incentives for doing so are especially strong if the politicians conducting the privatization exercise can get a kickback, either directly or indirectly as campaign contributions," Stiglitz says.

"Consider the incentives facing the so-called oligarchs in Russia. They might well have reasoned: democratic elections will eventually conclude that their wealth was ill-begotten, and there will thus be attempts to recapture it. They might have been induced to follow a two-fold strategy: on the one hand, to use their financial power to gain sufficient political influence to reduce the likelihood of such an event; but, assuming that that strategy is inherently risky, to use the other hand to take at least a significant part of their wealth out of the country to a safe haven."

Stiglitz wonders why Russia just gave away, say, Norilsk Nickel f which in 1995 was earning on average $2 billion a year from exports, but was sold to Uneximbank for $170 million. (The government deputized Uneximbank to organize the Norilsk Nickel auction; Unexim evaluated all bids and pronounced itself the winner). Instead, he suggests, why not leave such properties state-owned fbut give management generous incentive contracts to run it like a real business?

Forget that, says Russia and the IMF. Their eyes are squarely focused on the short term, and there are bills to be paid f not least to the IMF itself.

Russia needs dollars, fast. Eurobonds and World Bank loans are also coming due, and Boris Yeltsin's Kremlin has big and expensive plans for parliamentary and presidential elections over the next 10 months. The Russian government has built another round of fire-sale oil company privatizations into the 1999 budget revenues, which it hopes will raise a paltry $750 million, and the IMF has nodded approvingly.

So aside from this cautious two-step on privatization, what else is in the cards? The Statement on Economic Policies is a complex document, but it can best be summed up thus: Cut as much government spending as possible f but keep taxes high.

It would be hard to find an entrepreneur in Russia who believes keeping taxes high f instead of dramatically drawing them down f is going to encourage investment or growth. But, that's the plan: Pay more taxes, get less service for them, and take comfort in the fact that Russia is paying the IMF on time.

The Tax Code is to be amended to increase "the powers of the tax authorities by eliminating the need for the Tax Ministry to use the already overburdened court system." Does this mean there will be no appeal whatsoever, should the tax men in black ski masks come a-calling? Is any short-term gain in revenues worth the long-term costs in frightened-off investment?

The Statement targets the oil and gas sector, and this seems fair enough f particularly given the sordid privatization history, but also given soaring world oil prices and the ruble devaluation, which has lowered their tax burden in dollar terms (and oil companies think in export dollars).

But soaking the poor f or the regions, who are also targeted by the Statement to have more revenue squeezed out of them f is apparently easier than soaking the oligarchs. So far this year the government has managed to impose an export tax of 5 euros per ton on crude oil. It recently retreated from raising it to 7.5 euros per ton, even though the price for crude oil has more than doubled this year. Gazprom, meantime, has continued to receive generous treatment. The government has suspended an export tax on gas and has lowered domestic excises, all told costing the budget more than $500 million (or about 2 percent of budget revenues).

Revealingly, the same Statement that hungrily adds new taxes f on luxury cars, on sick workers f and jealously warns against lowering existing taxes such as VAT f apologetically pledges a retreat on only one kind of tax: export taxes, like those on oil and gas. "We intend to review and abolish these measures as soon as Russia's financial conditions permit," the government writes.

Why? Because these taxes f which raise the cost of oil, gas and other goods for Western consumers f are ideologically offensive to the IMF. They impinge upon "free trade." Indeed, the government Statement discusses these taxes separately, under trade policies.

So much for bringing in more revenue. Let's move on to spending less. The Statement says, "the number of positions in the federal executive authorities was reduced during 1998 by about 79,000, or 19 percent, and additional reductions in employment have also been seen in transport, education and health care. We will continue progress in these areas in 1999."

Amazingly, of all the people Russia could be firing, the IMF and the government have agreed concretely only on the firing of teachers and doctors. However, there have been a few new hires, to whit: "A new federal commission has been established to examine options for further streamlining the civil service." The government also commits itself to conduct a "public expenditure review" this year, one that will cover "at least the health and education sectors."

Consider what else the government could be cutting. The Central Bank, for example, employs 100,000 people, and salaries there are immense by Russian standards. Chairman Viktor Gerashchenko and his predecessor, Sergei Dubinin, have earned twice what U.S. Federal Reserve Chairman Alan Greenspan is pulling down. If you are looking for cuts, why not look hard here?

But no, the IMF is firm that the Central Bank must remain "independent" f which, given the FIMACO deal, seems to mean "answerable to no one." Instead, the government will seek cuts in "at least the health and education sectors."

At the same time, the government will seek to hike the "social contributions" businesses factor into their payroll taxes. If the government gets its way, sick benefits for the first three days of an employee's illness will be paid by the employer, not written off as a deduction.

The Statement does express concern about pensioners, and it mandates a 60 ruble ($2.45) raise in the minimum monthly pension f one that the government expects will be partly funded with proceeds from the sale of American and European food aid.

What about other costs? The Defense Ministry is in the middle of a $150 million-a-year vanity peacekeeping force in Kosovo. The Finance Ministry is still running a strange and arcane oil barter deal to maintain a Soviet-era listening post on Cuba. Russia f which claims, probably quite rightly, that it can't afford to pay its debts to the world f has offered $150 million in aid to Yugoslavia. The Kremlin has indulged in some IMF-loan-sized price tags just to fix up a few of its palaces. And the state-owned Gazprom gas monopoly is accepting payments from Belarus in the form of food and possibly from Ukraine in demobilized Tu-160 Backfire bombers f the latter perhaps useful for buzzing Iceland the next time an IMF tranche is slow to arrive, but not very helpful otherwise.

The Statement insists barter deals like Gazprom's are on the way out. But the Statement is not proactive when it comes to, say, pushing through START II f something that even the much-maligned government of Yevgeny Primakov was ready to do, out of recognition that START II saves Russia money (because both Russia and the United States have to build and maintain fewer nuclear missiles). Nor does the Sergei Stepashin government or this Statement show much interest in fighting pervasive corruption f even though corruption costs the state far more than does, say, health care and education.

It is perhaps the IMF's fatal flaw that it believes mandating cuts in social spending to be an economic matter, one it's competent to push f but mandating cuts in military or foreign policy spending to be a political matter beyond its purview.

Another major goal is to run a budget surplus for 1999, and an even bigger one in the 2000 national budget. No deficit spending.

Japan rebuilt its economy after World War II largely on deficit spending. The United States revived its economy after the Great Depression largely on deficit spending. Ordinary people in the West live their lives on what amounts to personal deficit spending, in the form of housing mortgages.

Russia is 10 years into an economic collapse. But the IMF surveys the wreckage and, Herbert Hoover-like, insists the market is on its way. (The only difference now is that instead of "a turn in the business cycle," the hopeful talk is of "globalization.") Instead of trying to encourage Russia to run a healthy deficit f one that involves real investment in the economy and not just capital flight f the IMF forbids state-led deficit investment across the board.

Given that corruption is such a huge problem in Russia, it's hard to argue in favor of printing money. But what's striking is the absolute, almost dogmatic, refusal to even talk about it. Russia is in the middle of an economic downturn; the IMF insists it run a contractionary, anti-growth fiscal policy; and if anyone asks why, they're met with shock. In Russia, about the only people who ever discuss a Rooseveltian New Deal approach to economics are the Communists and, to a lesser extent, the Yabloko party of Grigory Yavlinsky.

Instead, the private sector is to provide the investment, the IMF says. This will happen when bankruptcy laws and other tools are in place for "industry restructuring."

But that isn't happening. Yet another paper presented at the IMF's "10 years of transition" conference reported that, while the Baltics and Central and Eastern Europe are growing, Russia remains "a net exporter of capital." In other words, more is being whisked out of the nation than invested in it. Interestingly, the study by IMF scholars found that neither inflation nor openness to the global economy f those two IMF preoccupations f seemed to influence which country got how much investment. Instead, this depended more on "legal and political climates."

For example, investment is wary of places where the tax authorities wear ski masks, where the hijacking of an entire oil company is met with a hand slap for "hastiness" and where IMF loans wander cheerfully across the Channel Islands.

Moving hurriedly along, the IMF and the Russian government have a different answer: bankruptcy laws. Bankrupt everyone who owes someone else money. Pretty soon barter will disappear, wage and pension arrears will wither away and the economy will be booming.

A new bankruptcy law f which the government, with wild optimism, promises will be approved by parliament by Oct. 31 f is the Holy Grail.

Now certainly it would be a welcome change if insolvent monsters such as the Baltic Shipping Co. f which has been a drag on the St. Petersburg area's economy for most of this decade f could be either liquidated or recapitalized.

But there is more to industry restructuring than mere bankruptcy f particularly when the entire economy, and not just one factory, is dying. As the World Bank's Stiglitz has written, "When a single firm is restructured in an economy operating at full employment, firing underemployed workers has beneficial effects, partly because those workers get quickly redeployed to more productive uses. When, however, there is already massive unemployment, firing workers moves them from a situation of underemployment to no employment f not necessarily a transfer that leads to an overall increase in the productivity of the economy. ?

"By the same token, when there is systemic bankruptcy, selling off assets may make little sense: who is there to buy them?"

No, even an aggressive pursuit of bankruptcy law is unlikely to bring new investment. For that, as some IMF scholars have noted, Russia needs a better legal and political climate.

When the IMF tries to improve "the legal and political climate," it talks about "transparency." The Central Bank, the government, commercial banks f all are encouraged to be "more transparent," to provide more information about their business dealings.

There is a problem with this logic: It assumes that such business dealings stand up to scrutiny. Consider again the Statement's discussion of privatizations f it seems they were so widely condemned "owing to the absence of transparency in the process." But, of course, it's the exact opposite: They were condemned because they were, in their own arrogant way, utterly clear. The auctions were rigged, the nation's treasures in effect stolen.

Consider another potential absurdity: the IMF's discussion of establishing a Treasury system.

As it is now, and has been for years, Russian government agencies run their transactions and park their budgets in commercial banks. Tax payments are made via banks; funds to rebuild Chechnya were shipped through banks; the State Customs Committee accounts, the road fund and other state pools of money are parked in commercial banks. For years, Russian government officials have complained about this system, arguing that commercial banks skim off hefty chunks and play risky and profitable games with the rest. For years there has been talk of establishing a Treasury.

Now the idea once again is gaining momentum. Move all money over to a Treasury system and it will be safe.

But, this is the same Yeltsin team that has let corruption run wild, and most observers agree that the Kremlin is lining up resources for the elections f from the coffers of Gazprom and the Unified Energy Systems national power company to the television stations. Who is to say that the Treasury won't just be another Kremlin scheme along these lines? Who is to say, in the post-FIMACO era, that the Treasury won't park the nation's money in the Bahamas?

After all it has been through in Russia, the IMF seems unable to even entertain such possibilities.

Then there is Russia's debt burden. "Total external debt of the federal government now stands at about $150 billion, or 90 percent of GDP," the Statement reads. "The government's scheduled external debt service is projected to amount to 90 percent of federal budget revenues."

Ninety percent of the budget f just to pay debts! Of course, Russia is not going to pay all of those debts. It is already squirming to escape Soviet-era debts. But even if it succeeds, the 2000 national budget draft now under consideration would devote 40 percent of revenues to debt servicing.

How could this happen? These debts were taken out with the approval, even the encouragement, of the IMF. And this is just national government debt, not Moscow or Nizhny Novgorod municipal debts or corporate debts.

What was the IMF thinking? Why didn't it counsel caution? Why didn't it insist at least some of this money be spent productively f instead of nihilistically, in Chechnya and in corruption?

The next decade will see the painful, drawn-out renegotiations of all these debts. The IMF will be collecting its share, even as it tsk-tsks at Russia's foolishness for getting into such a mess. But arguably the IMF and Russia share at least equal culpability for the economic collapse here; why doesn't the IMF share at least some of the cost, and write off some of the $16 billion Russia owes?

In the end, of course, the Statement of Economic Policies is a massive fiction, one that is already unraveling. Does anyone on either side of the Atlantic Ocean really believe the State Duma will pass the laws Stepashin and Gerashchenko have signed it up to pass? (See box).

But despite some bold poetic license here and there, this is the accepted and eternal blueprint. These are the policies Russia must follow to be rewarded by the IMF f and, in turn, by the other Western financial institutions, from the London and Paris clubs to the World Bank to international financial houses. And it seems on even a cursory examination to be a flawed and dogmatic blueprint. Russia needs change f but so do its Western allies and advisers.