August 8, 1994 | Lecture on Russia
Jeffrey B. Gayner is a Senior Fellow atMe Herita ge Foundation. From November 1992 to April 1994 he was Director of The Heritage Foundation's Moscow Office. He spoke at Ile Heritage Foundation on June 9, 1994. ISSN 0272-1155 C 1994 by Ile Heritage Foundation.Democratic Debacle After less then three y ears in which democratic procedures have first been introduced in the Russian body politic, the experiment is becoming a debacle. President Yeltsin, courageously if haphazardly, pursued both political and economic reform policies since he rose to power wi t h the collapse of the Soviet Union. Appropriate to a newly emerged democratic state, Yeltsin con- tinually obtained his greatest source of political strength from democratic processes he had largely instigated, starting with his own election as President o f the Russian Federation in June 1991 against the hand-picked candidate of then-President Mikhail Gorbachev. He was able to re- affirm popular support for his policies in the referendum of April 1993 when he prevailed on all four propositions put before t h e voters, even including support for his controversial market-ori- ented economic policies. But a six-month stand-off with the Supreme Soviet thwarted reform initiatives, and by the time the new elections were held last December, democratic exhaustion had set in. Then a combination of apathy and the rise of various strains of opposition forces, from ultra-nationalist to Communist to representatives of the nomenklatura, appealed effectively to most voters. This set in motion the deterioration of reform that now dominates Russia. Four important characteristics emerge in examining what one may begin to call the democratic debacle in Russia. First is the popular dissatisfaction with the results of previous elections and the rise of political apathy. Having prev iously voted for Yeltsin, and then later for his policies, people newly accus- tomed to democracy expected changes promised by him to transpire. When little evidence existed of the positive changes resulting from ostensibly reform policies, the people eit h er did not vote or voted "nyet." The fall in popular participation in elections has been dramatic, with 20 million fewer voters going to the polls in December 1993 than in June 199 1, and the fall-off con- tinued just as dramatically in regional elections in March. In St. Petersburg they even held polls open an additional day to get voter turnout above the 25 percent threshold of eligible voters needed to validate the elections. In many individual districts, the threshold was not achieved, thus many seats o n councils and other governing bodies throughout Russia will be vacant. In Moscow council voting in December, "none of the above" triumphed in many of the districts. The second, somewhat perverse characteristic of the democratic process has been the abili t y of Communists and those with vested interests in the status quo to increasingly prevail in elec- tions. Ironically the Communists, who enthusiastically voted in meaningless elections for seventy years, maintained their peculiar habits when voting began t o matter; thus, the Commu- nists continued to vote and therefore have made up an increasingly large percentage of the vote in a rapidly shrinking electorate. They also used their former front group methods of operating by working through other parties wit h non-Communist names, such as the Agrarian Party and Women of Russia to augment their strength. This has led to what Segodnya (Today) columnist Vladimir Todres calls the "Red revenge' in the elections. The other understandable but distressing characterist i c of politics in Russia has been the rise to power of administrators with name recognition and special-interest credentials. Aleksei Golovkov, the local coordinator for the reform-oriented Russia's Choice lamented this fact in the upper house, or Federati o n Council, elections. These elections were entirely determined by dis- trict balloting where he said that "the United Communists and the United Democrats are pygmies in comparison with the 'Administration party."' Fully 130 of 171 senatorial seats elected in bal- loting by regions were won by presidents and premiers of national autonomous districts, governors, heads of soviets, and other important figures in the Russian provinces. With almost the single exception of Boris Nemtsov, governor of Nizhny Novgor od, they made their careers in the Communist Party; yet at the same time they remain outside the new Communist Party struc-
2ture and instead represent "clan interests" such as agriculture, the defense industry, or trade or- ganizations. Third, the triu mph of President Yeltsin in the adoption of the new constitution has become a Pyrrhic victory. While the document provides a source of political stability that Yeltsin has con- solidated in his recent post-election campaign for a Treaty on Social Accord s i gned on April 29, 1994, the new constitution has largely been irrelevant in terms of its impact on either political or economic reform. The enormous powers the new constitution vests in the presidency represent a potential threat to democratic government i n Russia in the future. This is one reason why Vladimir Zhirinovsky, who wants to establish a dictatorship, supported the ratification of the con- stitution. The enormous powers the constitution vested in Yeltsin have not been used to force reforms on a r e luctant Congress; instead, their only occasional use has often thwarted previous reforms, as noted in their economic impact which is discussed later. Far from using his new powers, Presi- dent Yeltsin abdicated powers he had to his Prime Minister, Victor C hernomyrdin, who could never have been characterized as a stalwart of reform. This leads to the fourth and greatest irony of the democratic debacle in Russia: the rise to power of those with the least public support or, indeed, no support at all in the el e ctions. During the elections, the most prominent characteristic was the collapse of the center in Russian politics. The three reform-oriented parties got about 30 percent of the vote, the ultra-nationalist party got 23 percent and the Communists and their agrarian and women allies got 28 percent. Only one centrist party of sorts, the Democratic Party, even got into the parliament with just 5.5 percent of the vote. The Civic Union Party, the political party closest to the views of Victor Chernomyrdin, did n o t even get representation in the parliament. Yet the Prime Minister has proceeded to adopt policies of the parties that had no political support. Moreover, he forced out of the government representatives of Russia's Choice, the party coalition which won m o re seats in the parliament than any other. Instead major ministries were given to representatives of the Party of Russian Unity and Accord, which won only 6.8 percent of the vote. Chernomyrdin himself, of course, did not stand for election, but instead mo stly stood aside from the elections. Yet, ironically, he turned out to be the biggest winner without getting any votes. Maybe he can claim to represent the si- lent majority that did not vote for any of the parties that got elected. Economic Retreat Regard less of what the basis of political support for Prime Minster Chernomyrdin might be, no doubt exists that he has clearly run the government since the exodus of key reform leaders Ye- gor Gaidar and Boris Fyodorov in late January. The initial declaration o f independence for a Chernomyrdin econon-dc policy came with his explicit statement: "I will say that market romanti- cism has ended." He specifically said he would change policy on fighting inflation: "From mainly monetarist measures, we will go over to o t her measures that have been used in many countries." He would not say what those measures are, but when an associate of his was asked at the Davos meeting in Switzerland what those non-monetarist measures were he said "That shall remain a secret." And the y have remained a secret. This led the former Finance Minister and leading reformer Boris Fyodorov to bluntly state: "I don't know what 'non-monetarist methods' of fighting inflation means." While lauding the in- itial restraints on credits by the Chernomy r din government that kept down inflation, Fyodorov noted that general indecision grips the government, stating that "the government failed to pro- duce a clear-cut strategy thus stretching the period of indecision to three months since the cabinet reshuffl e."
3The ministers in the government have been similarly sharp in their criticism of the reformers who were forced out. The Deputy Prime Minister for Agriculture, who has the largest credit-issu- ing agenda in the government, criticized Fyodorov in a mo st revealing comment; Alexander Zaveryukha, an Agrarian Party member of the government, said that "Comrade Fyodorov didn't have enough knowledge of Russia, and the main thing he was afraid of the Russian people ... he didn't know Russia-1 draw the conclus i on that he didn't love Russia." Thus, the problem with reform was that Comrade Fyodorov suffered from a love gap. Surprisingly, inflation has seemingly remained under control in recent months, and remained at about 8 percent through May. This has led Chem o myrdin and his colleagues to vigorously pat themselves on the back and give the back of their hands to the predecessor Gaidar group that cre- ated all the momentum and policies that led to the plunge of inflation rates. At the time the reformers left offi c e, inflation came down to a monthly rate of 9.9 percent in February, in con- trast to an average of 20 percent per month throughout 1993. Cumulatively, inflation ran at 1,000 percent in 1993, only half of the 2000 percent of the previous year. Quite simpl y , Chernomyrdin had little choice of policies when he took over economic policy. In the end, he and the Central Bank have used monetary policy to control inflation. Their incen- tive to constrain inflation was the allure of the $1.5 billion in IMF pledges o f support for Russia if inflation and government deficit spending were brought under control. That money clearly was coveted as the means to sustain major government subsidy programs, many of which, especially for agriculture, were included in the initial budget adopted by the parliament. The budget of the parliament, worthy in its detail of the best juggling-act deficit planners in the U.S. Congress, came in with the appropriate 60 trillion ruble deficit. (about $35 billion) or the IMF-required 9 percent o f GDP. But by mid-May, after the IMF $1.5 billion check had al- ready been cashed, the Parliament felt compelled to raise defense spending by an additional 17 trillion rubles (about $ 10 billion) after being told that any increase less than that would "le a d the army to disintegrate." Meanwhile, despite an almost endless series of tax increases, or because of them, revenue figures continue to be revised downward. During the first quarter of 1994, tax col- lection came up short by 3.4 trillion rubles or 15 p e rcent below budget. While one can anticipate a renewal of inflationary problems, another economic initiative in the last six months has already been a clear disaster. This pertains to the taxation policies that have been ostensibly designed to bring in mo r e government revenue and thus close the deficit and ful- fill one of the EMF goals. While one might again blame the indirect influence of RAF policies for the general goal, the specific taxes and their range and complexity are a uniquely Russian night- Ma re. Recent problems began with Yeltsin decree number 2270 of December 22, 1993, which gave cities and regions the right to levy their own taxes. While one might generally laud this move to- wards federalism, what it in effect meant was that local governments could add to existing central government taxes and the only constraint was a ceiling set on the combined taxes. In the case of profit taxes, the decree of December 1993 meant that the federal profit tax would stand at 13 percent and local governments could add another 25 percent for a combined profit tax of 38 percent. Just to add a further complication, banks and insurance companies had a different ceil ing of 42 percent. To demonstrate the bewildering array of taxes that now come to devastate the economic land- scape of contemporary Russia, it may be easiest to simply list a few of them. Among the federal taxes are the following:
4Value-Added Tax. The value-added tax was increased from 20 percent to 23 percent ear- lier this year; and, in one of the most contentious rulings, it was decided that the tax would apply to foreign investments and foreign loans. In other words, if you wanted to invest $ 100 m illion in Russia, you would initially have to pay 23 percent or $23 million for the right to do this. This interpretation remains under review, as foreign companies contend that it would virtually destroy the prospect of investment in Rus- sia. Indeed, in the first three months of this year, total foreign investment in Russia amounted to only $180 million. Overall foreign investment in Russia in 1994 is ex- pected to fall by one-third from 1993 levels of $1.5 billion; this is a trivial amount even compared to the other countries of Eastern Europe where $3.2 billion was in- vested in 1993. Payroll Tax. This amounts to 39 percent of one's income; on top of this, the Moscow government added another one percent with the revenue going to support education. Trans p ort Tax. One percent of the total payroll of businesses. Import and Customs Duties. New increases in proposed customs duties were an- nounced to go into effect March 15, 1994, but the doubling of average tariffs to 15 percent and new tariffs on food items such as 20 percent on sugar were put on hold until July 1. They were suspended for three months following outraged opposition by large Russian cities that feared vital imported food supplies would rise substantially in price. The new import fees would hit particularly hard at the fledgling auto import business where overall taxes had averaged 93 percent of the value of cars. With new rates in effect, for example, a Peugeot with a retail price of $15,300 would sell for $37,000 in Russia when all taxes were p aid. In one of the more bizarre justifications of the new increases, the Deputy Prime Minister who also holds the position of Economic Minister, Alexander Shokhin, referred to the new tariffs as "a difficult compromise between the interests of the consume r and the interest of the producer. They are not ideal, but they will force Western firms to invest in the Russian economy because they will have to produce here." In other words, it allegedly will be too ex- pensive to export goods to Russia. Taxing "Russ i a." Even the use of the name of Russia in the title of your company or product is subject to a central government tax. But just to make this tax especially un- fathomable, there are three different means of calculating it: Some companies must pay 0.4 perc e nt of turnover, certain other categories of businesses pay only .04 per- cent of turnover and yet others must pay 100 times the minimum monthly wage. Local governments and cities have their own tax systems which further complicate economic operations in R ussia. In Moscow, where most businesses attempt to operate, there are 51 sepa- rate taxes. Besides the 25 percent corporate profits tax noted above, one finds other interesting taxes such as: Housing Tax. This 1.5 percent tax passed by the Moscow governmen t is a tax based on revenue of a company. Realizing that profits taxes do not generate income because almost no one makes a profit, new taxes seek to raise revenue even from companies losing money. Assets tax. This tax consists of an additional 1.5 percen t tax on existing assets; it simi- larly seeks to gain revenue regardless of profitability by taxing your fixed assets (similar to our property taxes).
5Now if a businessman gets terminally distressed with all of the taxes and regulations in Russia an d decides to pack up and go home, he then discovers the final parting insults of the tax system. On January 24, 1994, the State Customs Committee imposed a 60 percent duty on the import and export of personal belongings such as clothing, furniture, and ap p liances. The duty is for "goods not intended for industrial or commercial activities" and applies to everything valued at over $2,000, but you lose the exemption if you ship items out by rail or truck. Finally, a December rule was issued that you must als o list all books you are taking out of the country by name, publisher, and date of publication and submit this list prior to departure to get clearance. Beyond the all-pervasive tax system, anyone attempting to set up and operate a business in Russia must also overcome a huge regulatory apparatus riddled with corruption; and once a busi- ness is actually established, the mafia, moves in for 15 percent to 20 percent of receipts. As the editor of the business magazine Delovie Lyudi, Alexander Leviko, stated: "If a new business owner survives Russia's bureaucrats and racketeers, he still has to deal with unstable laws, un- friendly banks and excruciating taxes." Thus, the President of the Union of Small Businesses praised the fortitude of anyone who succeeds, c alling the Russian businessman the smartest in the world: "He surmounts obstacles, contrives to outsmart the state, and he manages to evade taxes, and moreover, can hide his money abroad; in order to start his own business he will ex- hibit a truly amazin g ingenuity." In short, business can only succeed in Russia if one follows the bitter remarks of a Russian poet 200 years ago who said: "In Russia only legislators read the laws, and only lunatics obey them."I Privatization and Economic Policy The one refo rm program that has progressed unabated through all the economic and political turmoil has been the privatization program. But even this remarkable program is now threat- ened by the magnitude of taxation coupled with the lack of a legal framework for pri v ate enterprise. In the largest transfer of government property into private hands in the history of the world, the Russian government completed stage one of privatization by the July 1, 1994, dead- line set when the Supreme Soviet approved the program in 1 992. Under the able leadership of the one prominent reformer left in the Yeltsin cabinet, Deputy Prime Minister Anatoly Chubais diligently pursued the implementation of this controversial program as a means of beginning the fundamental transformation of t h e entire Russian economy. More than 100,000 state companies were transferred to the private sector, including 15,000 major factories that produced two-thirds of all Russian industrial output. Widespread ownership was achieved through the distribution of 1 44 million vouchers to all Russian citizens; eventually 600 voucher investment funds emerged with 40 million shareholders.
1 Prime Minister Chernomyrdin acknowledged the nightmare of taxation and regulation in a speech to meeting of Western business executi ves in Moscow on June 26, 1994. At that time he said the government would introduce a five-year tax holiday for businesses and stabilize taxation legislation, allow duty-free imports of production components and allow retention of hard-currency earnings. U nfortunately, the plan may come as too little and too late for foreign businesses which have heard such promises before and then confronted an increasingly complex and costly environment to operate in Russia. Moreover, even if developed the plan will then go to the parliament where its fate is doubtful. Thus, doubts concerning prospective Western investments in Russia will also continue.6
Unfortunately, the formal transfer of ownership under privatization has primarily been achieved by turning companies over to the previous workers and managers. If this had been done in the context of other fundamental reforms then it could have been the beginning of productive companies. Some marginal gains have been achieved as pride of ownership and profit incentives have worked their way into former state enterprises. However, only with more innovation and in- vestment coupled with access to markets and more efficient production techniques can the newly privatized companies begin to thrive. But thus far tax policies p revent the accumulation and rein- vestment of earnings; and the entire environment of hostility to business prevents the effective utilization of either domestic or foreign capital. Indeed Russia remains a net exporter of capital in the world. The net est i mated outflow of about one billion dollars of funds from Russia each month about equals the anticipated amount of total private investment expected in Russia the cur- rent year. Only with the massive flow of capital into the newly created privatized enter prises will they succeed in jump starting the Russian economy. But at present this potential engine of devel- opment remains stalled by the taxation and regulatory environment that has stymied economic growth in general.
Russia's Role in the World The thir d area where a retreat from reform is evident concerns the character of Russian foreign policy. The rise of nationalism within the Russian body politic has led to a broad debate to rede- fine Russian national interests in international affairs. However, R u ssians seem to have nearly as much trouble of clearly redefining their role in the world as does the Clinton Administration in defining the American role in the world. But a general feeling exists in Russia that the country re- mains a great power and des e rves to be treated as such. This issue has come to the forefront in the ongoing debate over the "Partnership for Peace" proposal and whole developing relationship between Russia and NATO. Over and over again, various Russian leaders have reiterated the po i nt that President Yeltsin made when he spoke of 46a special agreement with NATO, corresponding to the position and role of Russia in world and European affairs, to our country's military might and nuclear status. 992 Instead of Russia joining the other em e rging democracies in Central Europe in their rush to join NATO and the European Community, Russia is now increasingly concerned with carving out its own exceptional place as a kind of "neutral" in a world divided now between the West and those countries s e eking to become part of the West. Much of this is derived from the effec- tive exploitation of a sense of wounded national pride in Russia concerning events that have transpired in recent years. In particular, Vladimir Zhirinovsky's campaign effectively e x ploited the understandable empathy Russians in Russia had for the plight of Russians left outside of Rus- sia when the Soviet Union dissolved into 15 separate states with ethnic Russians in the majority in only one of them. Overall, it has been estimated that 25 million ethnic Russians resided out-2 In late June 1994, Russia formally joined the Partnership for Peace and also signed an agreement with the European Union to accelerate Moscow's economic and political integration into Europe. Alluding to the continuing economic hurdles that Russia faced in Western Europe, President Yeltsin appropriately noted that the accord "will enable Russian entrepreneurs to claw their way into Western markets for the first time." Key Russian exports such as steel, textiles, and minerals will continue to face stiff t r ade barriers. Russia had a similar ambivalent attitude toward her new arrangements with NATO. While willing now to join with other former Warsaw Pact allies in joint maneuvers with NATO and regular cooperation, Russia continued its adamant opposition to i ts former allies joining into moTe formal security relations with the West. At a meeting in Istanbul, Russia opposed entry of Central European states into theWest European Union, the security element of the European Union.
7side the Russian Federation a nd about 10 percent have already migrated to Russia, with an antici- pated 6 million to 8 million likely to move to Russia in the next four years. Along with ethnic Russians returning to Russia has been the return of Russian military person- nel, but most disconcerting has been the imperial attitude of many of the leaders of the Russian military forces who aspire to cling to existing military bases or even reestablish empire. The com- mander of the Russian border guards in TaJ ikistan said at a news confer e nce on March 3 1, 1994, that the Russian presence was a "confirmation of Russia's strategic interests in the area." More- over, he asserted that "Russian troops will stay here forever." Similarly the Deputy Commander of the Russian forces in Georgia, Vasi l y Belchenko, said: "Russia cannot exist without the Black Sea .... We intend to follow the American doctrine: to es- tablish bases as far as possible from one's borders, but without threatening anyone." The question of threat is the main one to consider, e specially as Russia continues to maintain troop presences in nearly all fifteen states that emerged from the Soviet Union. The Russians have deployed new forces in former parts of the Soviet Union with 1,000 in Abkhazia, 500 in Ossetia (Georgia), 6,000 in TaJikistan and 1,800 in Moldova, as well as about 1,200 sent to Yugo- slavia. Somewhat ominously the Russians are training two fully equipped rifle divisions (of 10,000- 12,000 men) as alleged "peacekeepers." Thus far, the forces have largely been deploye d with the assent of the local regimes, although the representative character of some of the regimes may be questionable. The fundamental issue concerns the role that intimidation may be playing in Russian policies designed to recreate if not a neo-Soviet e mpire, at least a sphere of influence with Russia the leading if not dominant power. Despite odd and sometimes contradictory statements emerging from the Yeltsin Administra- tion at times, I remain convinced that those in charge of foreign policy still se e k harmonious and good working relations with the West. But in all of their actions, they remain conscious of poten- tial political exploitation by nationalists and Communists in Russia of anything they say or do. Thus, Russia moves only cautiously, if at a ll, in its cooperative endeavors with the West. What should be the role of the West in response to Russian foreign policy actions? 1. Sustain the withdrawal of the Russian forces. Despite some movement of Russian troops into new areas, the major movement o f forces has been homeward, with 135,000 troops leaving the Baltic states since 199 1, and the timetable on withdrawal of forces from Germany expected to be completed this August. Pressure must be maintained on getting the remaining 12,000 troops out of L a tvia and 2,600 out of Estonia by previously agreed deadlines, also this August. 2. Neither sanction nor underwrite Russian forces in the "near abroad." To its credit, even the United Nations did not fall for the Russian ploy of having their forces in neig h boring countries being declared "peacekeepers" under U.N. auspices and, more important, financed out of the U.N. pocketbook. Russia can make mutual agreements with neighboring countries but cannot expect others to cover their costs. 3. Encourage non-proli f eration cooperation and denuclearization. The U.S. and Russia have a vital common interest in preventing the proliferation of nuclear weapons and also in de- cornmissioning their own stockpiles. More sustained and extensive cooperation in this area reflec ts the view Russians understandably have of their great power status. Moreover, bilateral relations in this area can be an important source of ongoing contact to deal with rogue potential nuclear powers like North Korea, Iran, or Iraq.
84. Enhance coope ration on military conversion. One of the attractive suggestions put forth by the Russians concerning their special Partnership for Peace arrangement concerned more U.S. support for their military conversion programs. This program has lagged, and it remai n s very much in our mutual interest to accelerate it even if greater costs are entailed on the U.S. side. 5. Greatly improve market access to the U.S. This has been a consistent legitimate concern of Russia and has military implications as reflected by the recent controversial accord on provid- ing expanded Russian sales of uranium in the United States. Also, if we want Russian arms sales abroad to diminish, alternative developing industries need better access to Western markets. 6. Cooperate in policing th e CIS. The former Soviet Union is an ethnic cauldron that Stalin stiffed vigorously for decades, so it is not surprising that it has boiled over when the lid came off. Only through much greater U.S. and Western engagement throughout all of the countries of the CIS can we respond to the now-regular Russian rhetorical question of who will be the police- man of the CIS? The CSCE could play a vital role in cooperation with Russian forces deployed in unstable areas of the CIS. 7. Diversify policy in the region. U .S. policy has remained too Russo-centric, and thus we have failed to fully realize the importance and legitimate interests of other CIS states, particu- larly Ukraine and Kazakhstan. The U.S. needs to take a much higher profile in relations with all four t een new states that emerged from the Soviet Union. Through greater engagement, the U.S. can play a more productive role in fostering cooperation between them and Russia when ethnic or military assets allocations or other questions arise. Russian foreign p o licy, however puzzling and frustrating it has become in recent months, re- mains a welcome change from previous regimes in Russia; thus, the Yeltsin Administration will quite likely exhibit more cooperative policies than may emerge from any successor gove r nment in the Kremlin. So it is necessary to move as vigorously as possible on numerous fronts in devel- oping relations with Russia on foreign policy and military issues. Nonetheless, the United States cannot have its policies in the area become hostage t o the perceived reactions of opponents of Boris Yeltsin. The United States needs a broader regional policy, of which Russia will remain the most important element. -.0. .0. 4. 4.