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. Last Updated: 07/27/2016

Russia's Great Economic Boom

It began in the early '90s. A flood of foreign investment poured into the country. Foreign languages were common on the streets of Moscow and St. Petersburg. By '97, the ruble had become fully convertible. Russia's growth rate for the decade was to average out at over 8 percent per annum. In the process, the country mobilized so much overseas capital it became the world's largest foreign debtor.


This is not a rosy-tinted and highly improbable investment portfolio brochure for the next few years. It is what happened in Russia 100 years ago.


History is, of course, full of specious parallels. But what is worth some study for economists and politicians of this decade is why, how and with what results Russia managed to achieve its economic sprint at the end of the 19th century, a pace which faltered and then picked up again in the years before the World War I, before being stopped dead by the 1917 Revolution.


It does not take a great leap of imagination to see similarities between that time and the national predicament today. The final decades of the last century were, like our own age, a period of major technological change. By the late 1880s, industrialization was going ahead at a rapid pace in all the more advanced economies. Railways were a key component, and the new lines required huge investment. In America, Brazil and Argentina large loans were being taken out to fund expansion. In Russia, with its backward economy and huge distances, construction did not really get going until the late 1860s, and railway lines were still sparse when the 1890s dawned.


Today, Russia once again needs massive investment in its infrastructure if it is to bridge its technological bridge with the West. Railways are no longer critical, but if Russia is to compete it must replace creaky airliners, rebuild leaking oil pipelines and, to take advantage of the communications revolution, put in place a nationwide up-to-date telecom network.


The central economic prerequisites for this to happen are macro-economic stabilization and massive financing. These are the same hurdles that faced tsarist Russia 100 years ago.





Witte's Boom


The key date for Russia's industrial boom was 1893, when Tsar Alexander III appointed Sergei Yulevich Witte as the new minister of finance.


Witte, of Baltic Dutch extraction, was born in Tbilisi, university educated in Prussia, and had worked for private railroad companies in Ukraine before coming to St. Petersburg. In 1889 he had been made head of the railway department of the Minister of Finance. A rough diamond among the slick manners of the capital, he went down badly among society sophisticates. Opportunistic and unscrupulous, he was at times a poor political tactician, but he was a shrewd analyst, and he stood out for his competence, vision, and capacity for hard work. He was to become the driving force in the attraction of foreign capital and in Russian economic policy.


An autocrat and nationalist, at home with tsarist absolutism in principle if not always in practice, Witte believed in the promise of Russia's untapped wealth. New rail networks would be the means to economic growth. They would solve the transport bottlenecks that had exacerbated the great famine of 1891. They would give Russian agriculture access to foreign markets, and they would unlock the beginning-to-be-glimpsed mineral wealth of the Russian and Central Asian interior.


Equally important, the new lines were to fill the gaps in the transport infrastructure which had been so obvious when the Crimean War broke out in 1854, and which had contributed in no small part to Russian defeat. There was also a pressing need to build up Russian power against a rapidly industrializing and often hostile Germany.


Witte's first concern was to raise cash. Witte's biographer, Theodore Von Laue, defines his economic policy as fivefold: stabilizing the Russian currency, balancing the budget (an aim which proved to be impossible); financing the railways; attracting foreign capital; and promoting an active balance of payments.


In the Russian manner, Witte thought big. His rationale in carrying out the most ambitious plan for modernization in Russia since Peter the Great sounds very much like that of the Yegor Gaidar government on privatization: "In Russia it is necessary to carry out reforms quickly and hurriedly," Witte said. "Otherwise they will not succeed for the most part, or will be watered down."


The means he used to reach that end also sound familiar today. First, high tariff walls were maintained -- levies averaging 33 percent, some of the highest in the world -- taxing heavily the predilection of the Russian aristocracy for im to build up Russian power as a counterweight to Germany, whose victory in the Franco-Prussian War was all too fresh, while French banks soon learned they could make more money on dealing with Russian finance than at home. They willingly abetted Witte's plans.


A central factor in Russian success was the campaign to "buy the press" -- not the Russian press, but the French. In a way which would be impossible today with modern mass media, Russia managed to manipulate French public opinion. Witte's agents bought critical acquiescence from economic and financial publications through timely contracts for advertising inserts, and the Russian Embassy in Paris offered "expert analysis" on the Russian economy which put prospects in rosy hues.


Though there was in France a large Russian community, who knew the reality of life back home, Witte's publicity campaigns drowned out any opposition. France's petit bourgeois flocked to the romantic image of Russian development. They remained largely ignorant of a country with often chaotic government, low productivity, a scarcely working legal system and low standards of business ethics.


At home, a railway-building boom was set going. When railway development started in earnest in the 1860s, it was led by the private sector. In the 1880s, the government partially nationalized the industry, in order to rationalize line development. But it helped the private railways by giving state guarantees at specified interest rates on their loans. Under the Witte scheme, the state and non-state railways vied with each other in what seemed to be a generally positive manner, while the government retained control over the overall shape of the network.


The centerpiece of the development plan was the Trans-Siberian railway, a great engineering undertaking long mooted but awesome in its challenge. It was officially launched in 1891, and took 10 years to complete. It cost around 800 million rubles, a massive sum, but was built, like many other Russian railways, on the cheap, with light rails, narrow roadbeds, steep gradients and sharp curves.


The Russian network made rapid strides. In 1890 Russia had ranked fifth among the great powers in its railway network. By 1900 it was No. 2 after the United States. The railway industry employed 400,000, and was the largest industry in the country.





Decline And Fall


The great decade of growth lasted until the turn of the century. Following bad harvests which started in 1897, the government was forced to cut expenditure, and in 1899 tightened the money supply and reduced its orders for railway construction, a move which had immediate repercussions. Then, on Sept. 23, there was a crash on the St. Petersburg stock exchange, and several banks collapsed. Two major Russian companies went bankrupt and industrial depression spread quickly.


The crisis continued in many branches of industry until 1903, and a hesitant recovery was cut short by the Russo-Japanese war of 1904-05, and then by the 1905 Revolution.


Russia's dependence on overseas capital for government loans and private investment meant that it was vulnerable to changes in the world economy, which also worsened at the turn of the century with higher interest rates and a decline in investment flows.


Witte stepped down as finance minister in 1903, but his political career was not yet finished. For six short but crucial months over the period of the 1905 Revolution he became de facto prime minister. Almost as his last act he negotiated a loan from France of 2,250 million gold francs, the largest loan ever made to Russia. After his dismissal he faded from sight, and completely dropped out of the picture of Russian policy-making.





A Verdict


There is no doubt of Witte's competence as a manager. He was the consummate Russian technocrat of the age, the "executive director of the great economic corporation of the Russian people," as he described himself.


Witte also brought off his economic revolution at a remarkably low cost. Putting the ruble on the gold standard squeezed the populace, but once it was achieved Russia borrowed money at an average of between 3.8 and 6.6 percent, refinancing less advantageous loans negotiated by Witte's predecessors in the process -- much lower rates than the premium of Russian risk warranted.


The economy began to grow rapidly. "Russia was on track at the turn of the century," said Harvard historian Marshall Goldman in a telephone interview, "to draw level with the other great powers on many indicators of industrial power."


In the three decades before the outbreak of world war, Russia had industrialized more quickly than any other major power. The achievement was all the more remarkable considering the rate at which Russia had been losing ground against its rivals beforehand.


The new rail links made it much easier to export grain -- an end much encouraged by low railway tariffs on export routes. The position of Russian agriculture improved.


Perhaps most important, the Trans-Siberian brought about the opening up of the Far East and the mass colonization of Siberia.


It is easy to reel off the achievements. But there are doubts that Witte's technocratic policies were correct.


First, the economic criticisms. The emphasis on railways, which ate up as much as 10 percent of government expenditures during the boom years, neglected the development of Russian expertise in other new industrial sectors. More than one-half of the total 3.45 billion rubles invested in the railways came from domestic sources, money that could have been spent elsewhere. Whole swathes of the fast-growing Russian economy came to be dominated by foreigners, notably the new iron and steel industry in the Ukraine.


Witte overestimated the capabilities of domestic entrepreneurship to take advantage of the opportunities his policies laid open. Consumer industries remained neglected, and exports were overwhelmingly of agricultural produce and raw materials.


The railways themselves often lost money, with the government picking up the tab, and the Trans-Siberian produced less revenue than expected. The government's support for the private sector effectively subsidized often unscrupulous and corrupt companies.


Critics at the time said the Russian market was too poor to absorb the output of the industrial revolution, of which the railways were part.


"Russia had incurred the largest foreign debt in the world, and to keep the funds flowing in needed to offer above-average market rates to investors; yet the outward payments of interest were increasingly larger than the 'visible' trade balances: in sum, a precarious situation," writes Paul Kennedy in "The Rise and Fall of the Great Powers."


In military terms, in rectifying many of the logistical failures that beset the country during the Crimean War, such as the lack of railways south of Moscow, Witte was undoubtedly successful. When the German threat crystallized into war in August 1914, the Germans were surprised by how quickly the tsar's troops arrived at the front.


The domestic results of Witte's policies, however, are another matter. His economic revolution was bought largely at the expense of the standard of living of the working population.


Witte was heavily criticized at the time for the hardship he forced on Russian households to satisfy his railway-building mania, particularly in the slump which came in 1900. Some ministers actively opposed him.


Mark Harrison, a reader in economics at the University of Warwick, says that Witte had to fight "powerful vested interests, such as the Ministry of the Interior, which was worried by the threat of political destabilization, and was actively supporting workers' groups opposed to 'Jews and financiers.'"


In the end it was internal politics that proved more crucial for the tsarist regime than great power status. Professor G. Grossman, in a telling phrase in "The Industrialization of Russia and the Soviet Union," says "this extraordinary swift growth of industry ... tended to outpace the modernization of society." The Witte system not only produced relative hardship in the countryside, it also resulted in a rapid growth in an urban proletariat living in abject poverty. Capitalists were already an unpopular breed in Russia in the 1890s: By 1910, urban unrest had risen to pandemic proportions.


In 1917, it was to lead to civil war.


Harvard's Goldman believes that on balance, Witte's economic policy was the right one. "Russia was expanding at a time when technology was suited to it," he said, underlining the multiplier effect on employment of railway construction on steel production, and then on machine tool makers, and so on.


Nevertheless, he believes Witte may have pursued his goals too singlemindedly, a failure he says is characteristic of Russia's top-down system of government, whether under the tsars or today.


"Historically there has been a danger of being over-zealous, of being 'dizzy with success,' to coin a phrase," he said.





The Sting In the Tail


After the Bolsheviks took power, they requisitioned the railways without compensation. In January 1918 they repudiated all the country's overseas debt, and all interest was stopped on domestic borrowings, except on small holdings.


The total default by the world's biggest debtor was an unprecedented act. It was part of the reason the Allied Powers intervened in the war against the Bolsheviks. Russia was effectively out in the cold in the world of foreign finance until the 1960s, when there was some compensation as a means to the Soviet Union to resume borrowing.


French investors recovered some of the money lent to the private sector in Russia, but, says R?n? Girault, professor emeritus at the Sorbonne in Paris, the losses in Russian state bonds amounted to one quarter of all French overseas loans. Much of this money had been small 'p?re de famille' placements by middle-class petit bourgeois investors. The French tried to negotiate repayment with the Bolsheviks during the '20s, but they failed.


For those who had not pulled out before the Bolshevik Revolution, the romance of Russian investment turned for many into the loss of their shirts.