The Heritage Foundation

Backgrounder #856 on Russia

September 23, 1991

September 23, 1991 | Backgrounder on Russia

Guidelines for Aid to the Soviet Union


(Archived document, may contain errors)

856 September 23,1991 GUIDELINES FOR AID TO THE SOVIET UNION INTRODUCTION Hours after the failm of the August 19 coup in Moscow, Western politicians began calling for massive aid to the country still known technically as the Soviet Union. In Gemany, Chancellor Helmut Kohl immediately renewed his pleas for bailing out the Soviet economy and received strong support for his efforts from French President FranGois Mitterrand. In the United St a tes, House Majority Leader Richard Gephardt from Missouri proposed on August 30 a $3 billion Soviet aid package. Two days ear lier, House Armed Services Committee Chairman Les Aspin, the Democrat hm Wis consin, urged Congress to cut Americas defense spend ing by $1 billion and to use the money to assist Moscow.

Aspin and others may have good intentions, but their schemes will hurt, more than help, the prospects far genuine economic reform in what remains of the Soviet Union and its successor states. Needed to jump-start the economies of the Soviet republics are sweeping free market reforms-cumncy convertibility, freeing prices, trade liberaliza tion, quick and massive privatization, deregulation-and the increased trade and for eign investment that will acco m pany these reforms. To be sure, it is in the interest of the U.S. and other Western countries to assist the independent republics now emerging from the Soviet Union in carrying out these reforms and making the difficult transition from command to market e conomies. The right way to do this, however, is to encour age the republics to help themselves by building new free market institutions, becom ing competitive on world markets, and improving their credit-worthiness.

Creating Economic Hardship. Of course, t here also is a wrong way to help. Mas sive aid to what remains of the Soviet centei will retard the efforts of the republics to achieve their in&pendence and help to prop up crumbling and inefficient government and economic institutions. Government-to-gov e rnment loans, whether to the center or to the new republics, will turn the successor states to the Soviet Union into Western dependents, saddling U.S. taxpayers with long-tern obligations and creating resent ment and economic hardship in,the newly-created states.

Those who wish to help the people of the Soviet Union should remember that U.S foreign aid has had a dismal track record the past four decades in promoting economic development. The U.S. experience in Africa and Latin America-where government to-g overnment aid often served only to perpetuate dictatorial regimes while economies stagnated-should serve as a reminder of how not to help the people of the Soviet Union and its successor states.

So far George Bush wisely has resisted calls for a massive a id package to the Soviet Union. The issue of aid, however, is at the top of Congresss agenda. Aspin, Gephardt and others will try to seize the initiative with their expensive and counterproductive aid plans. Many members of Congress are hoping to use the i ssue of Soviet aid as a pretext to bust last years budget agreement with the White House and call for even greater increases in domestic spending. To avert this, Bush and Congress should adopt a set of guidelines for aiding the people of the crumbling Sov i et Union by fostering its transition from a centrally-planned state economy to a voluntary association of free market successor states WHAT WASHINGTON SHOULD NOT DO Guideline #1: Do not channel aid through the Soviet central government in Moscow. Instead, any aid granted should be given to the republics, preferably to the private sector.

Guideline #2: Do not grant government-to-government loans either to the cen tral government in Moscow or to the republics. Such loans only will sad dle these governments with debt they cannot afford.

Guideline #3: Do not provide US. taxpayer-backed export or loan guaran tees. These will not reduce the risk of loans to unstable governments. They simply transfer the risks to the American taxpayers.

Guideline #4: Do not assi st financially in currency convertibility until Mos cow, or the republics, adopt an independent monetary system truly out side of direct political control. Only an independent monetary authority can tighten the monetary supply to reduce inflation and take the other necessary but sometimes politically difficult monetary decisions.

Guideline #5: Do not support Soviet membership in the International Mone tary Fund (IMF) or the World Bank.The Soviet Union is dying. Member ship should be considered for the republics or some successor association of republics once they have achieved ind e pendence and instituted necessary free market refcmns WHAT WASHINGTON SHOULD DO Guideline #1: Organize emergency food aid, if needed, and insist on control Guideline #2: Use the Index of Economic Freedom as a guide to insist on over its distribution progr e ss in economic reform as a condition for U.S. assistance to the indi vidual republics. The index outlines the necessary elements of a market econ 2 omy such as protection of private property rights, limited government regula tion, and private banking and financial institutions. Only those republics mak ing progress in enacting these and other reforms which greatly expand eco nomic freedom should be eligible for U.S. assistance.

Guideline #3: Restructure U.S. technical assistance programs. These should cut through bureaucratic red tape and give the republics access to experts from the U.S. private sector, not just government bureaucrats aid. Most Favored Nation trade status should be offered to emerging repub lics aid The republics cannot be permitted to be c ome addicted to Western government handouts Guideline #4:.Promote increased trade and investment as an alternative to Guideline #5: Require, and monitor, cuts in military output as a condition for Guideline #6: Announce a date in advance when the aid prog r am will end THE DISINTEGRATION OF THE SOVIET UNION The Soviet economy is in a freefall with no parachute in sight. Communist central planning and decades of annual defense expenditures amounting to roughly 25 percent of gross national product (GNP) have y i elded aThird World economy. Six years of Mikhail Gorbachevs stumbling toward reform, while failing to fundamentally disman tle and transform the communist economy, have further exacerbated an economic slide that began in the early 1980s.The GNP declined 1 0 percent in the first half of 1991 and likely will fall another 8 percent to 10 percent by years end. Foreign trade is down 37 percent. Inflation is over 100 percent annually and could reach 1 ,OOO percent by next year. Those wishing to conduct major econ omic transactions must barter rather than use the worthless ruble.

Not only is the Soviet economy falling apart, but the Soviet state is disintegrating.

Twelve of the fifteen republics have proclaimed their independence. All the republics including the hu ge Russian Federation, have declared sovereignty over resources within their boundaries. Gorbachev has been reduced to little more than a figurehead and arbiter of disputes between the republics. Control over economic policy rapidly is flowing to the repu b lics-many of which plan to introduce their own currencies. Al though the Congress of Peoples Deputies, the Soviet parliament set up in 1989, voted overwhelmingly on September 5 to dissolve the old union, and to create a new volun tary association of indep endent states, any plan for political union is unlikely to with stand the tremendous centrifugal forces of nationalism.

Major U.S. Stake. Americas interest is in the continued &colonization and decen tralization of the Soviet Union into free and independen t states. The independence of the republics is the Wests best assurance that the Soviet Union never again will rise to pose-a.military threat. Independence also fulfills the longstanding dreams of self-deter mination for millions. America has a major stak e in a successful transition to a market economy in Russia and the other republics. Prosperity will increase the probability that 3 I Tajikistan Uzbekistan U BREAKAWAY REPUBLICS OF THE SOVIET UNION Scale 500 Miles H Fully Independent a Declared Independenc e a Declared Soverelgnty iascent democratic institutions will survive, and will mean greater investment opportu iities for American businesses and huge, new markets for American exports. This will nvigorate U.S. companies and make the American economy stro nger.

Bush and Congress should seek to ensure that U.S. aid helps the development of narket institutions and the rapid growth of private business, rather than propping up u1 irredeemable and discredited Soviet economic system. To do so, Bush should set brt h a clear set of guidelines for assisting the peoples of the Soviet Union WHAT WASHINGTON SHOULD NOT DO Guideline #1: Do not channel aid through the Soviet central government in Moscow.

The Soviet Union is fast becoming a historical footnote. Nearly all a uthority for eco nomic policy-making is flowing rapidly from central authorities in the Kremlin to the republics. The September 2 Ten-Plus-One agreement between Gorbachev and the lead ers of ten republics ended the old union and sounded the death knell fo r centralized rule. The agreement called for a new, voluntary, multi-tiered confederation and for re ducing the responsibility of the central government to ensuring the security of a com mon military-strategic space and coordinating economic and foreign po licy issues.

Central economic ministries soon will be abolished and all-union state enterprises and control of other property will Evert to the republics. Moreover, the republics are divid ing up between themselves gold reserves and other resources previou sly controlled by the central government 4 Some argue that the central government is capable of implementing the kind of com prehensive, radical economic reform plan that is needed to save the Soviet economy from collapse. Grigory Yavlinsky, the economist in charge of economic reform for the Soviet Unions new Committee for the Management of the National Economy, for ex ample, is a strong proponent of a unified reform plan. But even he admitted on Septem 1 ber 6 that the cmnt political situation makes any a ll-union economic reform program unworkable and unrealistic. Says Yavlinsky, There is no place for reform on an all- union level.

Under these conditions, aid to the central government would only slow the process of decentralization now taking place in the former Soviet Union and allow the organs of central power to retain some degree of control. The last vestiges of the command economic system, such as the central bureaucracies and planning agencies, will try to hold onto power as long as they can. Massive foreign aid is their only hope of prevent ing near-term extinction. The U.S. should not assist their cause. Instead, any assistance given by the U.S. should go directly to the emerging private sector in the republics 1 1 A Bleak Economy Dims Soviet Hopes f or a Free Market. New York Times, September 9,1991, p. 1 5 Turning to the Private Sector. The other frequently proposed use of loans and grants to the Soviet Union is to help build airports, communication networks, energy plants, railroads, roads, water s y stems, and wastewater treatment facilities. These need to be modernized if the people of the Soviet Union are to enjoy a standard of living comparable to that of the West. But while substantial investment is needed to do this the U.S. and other Western co u ntries should not pour billions of taxpayer dollars into the coffers of the central or republican governments to finance this task. Rather, Wash ington should encourage the republican governments to use the emerging private sec tor. In Britain, Chile, Mex i co, and elsewhere the private sector is building, operating and, in many cases, even owning airports, bridges, communication services, wastewa ter treatment plants, and water supply systems. These projects have been tremendously successful. Private invest ment can increase competition-thereby keeping costs low and quality high. It also can improve efficiency and service, and decrease the costs to government.

Another problem is that loans and grants to governments would increase, rather than decrease, the po liticization of the economy. They would be channelled through govern ment bureaucracies and agencies, thus increasing the power of the nomenklatura, or communist bureaucratic class, that brought the Soviet economy to its present soq state. Moreover, kt lo a ns to the central government inevitably would be used by Gorbachev and the remnants of the bureaucracy to pressure the republics in negotia tions, since the central government would decide to whom and where loans were di rected. right grants are far bette r than loans. Congress and the Bush Administration are more likely to be cautious in spending money if they know that it will never be repaid. Such caution would not exist with loans. Most important, with grants the citizens of the re publics at least woul d not be loaded down with massive debts that they will resent and be tempted to repudiate, and which would destroy their international credit 2 Although it is best not to give any cash to the central or republican governments, out Guideline #3: Do not prov ide U.S. taxpayer-backed export or loan guarantees.

Other frequently proposed sources of U.S. foreign assistance to the Soviet Union are, first, government-backed risk insurance and export guarantee programs for U.S. exporters and investors doing business in the Soviet Union and, second, govern ment-backed loan guarantees.

Risk insurance programs and some loan guarantees are administered mainly by two U.S. agencies: The Export-Import Bank (Eximbank) and the Overseas Private Invest ment Corporation (OPIC Ex imbank gives export credit insurance for U.S. fms and medium- and long-term loan guarantees to buyers of American exports. After a seven teen-year hiatus, Eximbank resumed its operations in the Soviet Union this year after 2 -William D. Eggers, Yellow Lig h t for Eastern Eumpe: Beware Four Economic Development Myths, Heritage FoundationBackgrounder No. 796, November 13,1990, p. 5 6 Bush waived the restrictions of the 1974 Jackson-Vanick amendment which denies Most Favored Nation (MFN) status to counmes that restrict or deny immigration.

OPIC supports private investors in developing countries by insuring businesses against political risk and also by financing investments through loans and loan guarantees.

Subsidizing El ite Corporations. According to a 1986 Office of Management and Budget (OMB) report, a mere eighteen U.S. companies, including such giants as Gen eral Electric Corporation and Westinghouse Electric, receive over 65 percent of Ex imbank assistance. In pract i ce, Eximbank winds up subsidizing trade between foreign counmes and an elite group of American corporations. Moreover, the Eximbank has been in financial trouble for years. The bank has a terrible delinquency rate on its loans 48 percent of outstanding lo ans are delinquent-and between 1982 and 1988 the Banks net operating losses equaled $2.3 billion?

OPIC also benefits mostly giant multi-billion dollar U.S. corporations. Example: In fiscal year 1989, fully 77 percent of all OPIC investment guarantees were given to only eight major American companies, including American Express Bank, Ltd Coca Cola Export Corporation, Citibank, and Chase Manhattan Bank! These corporations surely can afford to buy private risk insurance from such fms as Lloyds of London.

They prefer, of course, the cheaper government-subsidized risk insurance, which does not reflect the real risks of investing in unstable foreign nations private bank loans to the Soviet Union or the republics. This means the U.S. govern ment agrees to pay off the loans if the debtor is unable or unwilling to do so. Loan guarantees expose the U.S. to financial risk.They also distort the efficient working of the capital market and usually result in unwise and inefficient uses of scarce capital.

The U.S. governme nt already faces a staggering $6 trillion in financial liabilities through the governments programs of direct lending, loan guarantees, and insurance programs? As the Savings and Loan crisis attests, U.S. taxpayers could well wind up having to make good o n these expanding liabilities Capital Distortions. There also will be calls for the U.S. government to guarantee The Soviet Union is not a good credit risk for the U.S. government. The Soviet gov ernment already owes over $500 million to Japanese fms and o v er $150 million to U.S. businesses with no payments likely anytime soon. Until real economic reforms are in place, and the political situation stabilizes, the climate for foreign investment in the former Soviet republics will not be favorable, and the ris k s of investing will be great. Loan guarantem do not reduce this risk. Instead, they simply transfer the risks and liabilities to the backs of American taxpayers 3 Karen LaFolleUe, Government Loans for the Soviet Union: A Disservice to U.S.Taxpayers and So v iets Alike, The Cato Institute Foreign Policy Briejing, No. 8, April 26,1991 4 Melanie Tammen, Aiding Eastern Europe: The Leveraged Harm of Leveraged Aid, The Cato Institute Policy Anulysis, No. 139, September 10,1990. p. 23 3 Ronald Utt. The Six Trillion Dollar Debt Iceberg: A Review of the Governments Risk Exposure, Heritage Foundation Buckgrounder, No. 774, June 28,1990, p. 6 7 Guideline #4: Do not assist currency convertibility until Moscow, or the republics, adopt an independent monetary system outsid e of direct political control For Western businesses to invest in the Soviet Union, they fmt must believe that they can make a profit. This means, eventually, that they will have to be confident that the rubles they earn can be converted, or traded-in for h ard Western currencies like the dollar or yen, that are useable on world markets. Right now the ruble is not convertible. If it simply were declared so, there would be a mad rush for everyone holding worthless rubles to trade them in for dollars. This wou l d shake markets world wide and thus is infeasible ible into hard currency. American and Soviet experts led by Soviet economist Grigory Yavlinsky in July called upon the West to help make the ruble convertible. Under this plan, which was endorsed and promo ted by Gorbachev at the July meeting of the so called G-7 industrial democracies, the U.S. and other Western countries would de posit between $3 billion and $10 billion in hard currency reserves in

a so-called cur rency stabilization fund that the Soviet government could draw on to exchange for ru bles. In theory, none of the money would be used. The purpose would be to create enough confidence in the ruble so, whenallowed, people would not feel the need to ex change rubles for dollars, thus preventing th e mad rush for dollars feared by econo mists.

This approach has been successful in Poland, which sharply devalued its currency the zloty, and then tied its value directly to the dollar. The zloty is now largely convert ible. Importers can hly purchase fore ign currency with zlotys at the official selling rate, and individuals are allowed to retain their foreign currency accounts and buy and sell foreign money. Previously all of these transactions had to be approved by the state.

Long Way Off. While successf ul in Poland, there are three reasons why this ap proach will not work in the Soviet Union. First, the ruble cannot be made convertible until a program of deep budget cuts and economic reform is put in place because the budget deficits are financed by sim p ly printing mMe rubles. Examples of these re forms are tight monetary policy, the institution of realistic interest rates reflecting mar ket forces, and the elimination of easy credit for state enterprises. These reforms are still a long way off. The Sovi e t and republican governments have failed to resist popu lar pressures for new social programs and wage increases, and are unlikely to soon drastically cut public spending trol the money supply. The Soviet central bank, or Gosbank, consistently has inflate d the money supply and thus is mainly responsible for destroying the ruble. The Soviet mint is now printing rubles at four times the rate of 19

87. Gosbank head Viktor V.

Gerashchenko predicts that 240 billion rubles will be in circulation by the end of t he year, up from 136 billion rubles in January. Although the authors of the currency stabi lization fund plan insist that the new bank would be independent from government con trol, there is reason to believe that it would be subject to the same political forces that induced Gosbank to inflate the money supply. Like Gosbank, the new independent Several plans have been put forward to gradually or partially make the ruble convert Second, the plan for a currency stabilization fund relies on a new central bank to con 8 state bank likely will print more money or devalue the exchange rate, thus causing South American-style hyperinflation.

Third, many of the newly declared independent republics do not plan to use the So viet ruble as a currency. They plan on issui ng their own currencies. Thus, there may be no central government or central tank which can draw on the currency stabilization fund.

Backing With Gold. An alternative approach that does not rely on the discretion of a Soviet central-bank is-needed. One op tion is to back a Russian ruble with the Soviet Unions vast gold reserves, rather than Western hard currency. The Central Intelligence Agency estimates that the Soviet Union has around $25 billion in gold, while Roger Robinson, former Senior Director for I nternational Economic Affairs for the National Security Council during the Reagan Administration, believes the gold reserves may have fallen to between $12 billion and $17 billion, which now is being divided up among the republics. Judy Shelton, an expert on the Soviet economy from the Hoover Institution, proposes that the Russian Republic help create a new monetary system among the republics by making the ruble convertible into gold6 The other republics then could peg the value of their national currencie s , such as Lithuanias Zitas, to the gold-backed Russian ruble. The advantage of this approach is that the republics would not need Western financial assistance because Soviet gold, rather than Western hard currency, would be used to back up the currencies. The danger, however, is that the non-Russian republics would be dependent upon the continued good faith of the Rus sian Republics monetary authority.

Another option for achieving convertible currencies in the republics has been pro posed by Johns Hopkins University Professor of Economics Steve Hanke and George Mason University economist Kurt Schuler? The republics would set up currency boards, outside of political control, similar to those already operating in Hong Kong and Singapore. Under such a system, the republics would not have central banks. In stead the currency boards would issue notes and coins that would be backed directly by a foreign currency such as the dollar. Citizens and businesses could exchange these notes and coins for dollars at a fixe d rate. Market farces, rather than politicians and un controlled government spending, would determine the money supply. This would en sure that the republics have a stable and reliable currency that can be converted to hard currencies. To further enhance t he currency boards independence and accountability three of the five members of the board should be foreigners-for instance, an Ameri can, a German, and a Japanese-while two would be local nationals.

Low Reserves. Economist Joe Cobb of the Washington-based Alexis de Tocque ville Institute estimates that reserves totalling $4 billion would be sufficient to back currency boards in all fifteen former Soviet republics. The Soviet Union now has hard currency reserves of between $1.5 billion and $10 billion to b a ck the boards. However hard currency reserves will become very low by the end of the winter if large pur 6 Judy Shelton, A Bretton Woods System for Ex-Soviets, The Wall Street Journal. September 4,1991, p. A12 7 Steve H. Hanke and Kurt Schulw. Currency Bo a rds for Eastern Europe, unpublished manuscript. April 24,1991 9 chases of Western consumer items are made. It may, therefore, be necessary to provide some Western assistance to operate the currency boards. Schuler estimates that the West would probably ne e d to provide no more than 20 percent of the total reserves necessary for setting up the boards. The U.S Western Europe, and Japan should con sider advancing the dollars needed to set up these currency boards. Because they would be outside of political con t rol and because three foreigners approved by the West as board members would have considerable influence, currency boards would be a far wiser investment than putting taxpayer money into a Soviet central bank Guideline #4: Do not support Soviet membership in the International Monetary Fund (IMF) or the World Bank.

Some Western leaders such as Germanys Helmut Kohl urge that the Soviet Union be granted immediate membership in the International Monetary Fund and the World Bank. The n ear complete collapse of central government power after the August 19 coup attempt make such calls anachronistic. When asked if he would consider becom ing the new Foreign Minister of the Soviet Union, former Soviet Foreign Minister Eduard Shevardnadze sa id, When there is no U.S.S.R. what do you need a Minister for? Similarly, the dying Soviet state does not need membership in the IMF and the World Bank.

Once the political situation in the Soviet Union stabilizes, IMF and World Bank membership for fully in dependent republics should be considered. However, until that time comes, the U.S. should continue to insist that the IMF and World Bank give only technical assistance, not loans, to the republics or some successor association of the re publics WHAT WASHI NGTON SHOULD DO Guideline #1: Organize emergency food aid, if needed, and Insist on control of its distribufion.

The Russian government on September 9 asked the U.S. and other Western countries to grant emergency food aid this winter to the Soviet Union. T o stave off possible star vation and widespread food riots this winter, U.S. humanitarian assistance, coordinated with private American charities, is appropriate.

Grain harvests in the Soviet Union are down significantly from last year. This years harvest is expected to be only 135 billion tons, compared to 190 billion tons last year.

The drop is due in part to poor weather, but mostly to the man-made problems of the Soviet Unions centrally planned economy: shortages of fuel and spare parts for har vestin g equipment, breakdowns in the transportation system needed to move grains from the countryside to the cities, and the inefficiency of collectivized agriculture. To make matters worse, farmers are refusing to exchange their produce for the valueless ruble , thus causing hoarding of foodstuffs in the countryside.

The first step is to determine whether in fact there will be a serious food shortage this winter. Similar alarms were raised last year, yet a food crisis never materialized.

Undersecretary of Agriculture Richard Cmwder and a team of experts already are in 10 the Soviet Union to determine, among other things, the extent of the food problem and the areas likely to be hardest hit.

If food aid in fact is needed, it should not become a crutch for the in efficient Soviet agricultural system. Emergency food relief should be accompanied by an announce ment it will be cut off by winter's end. If food aid is continued into the next harvest, it will distort the developing private food market and bankrupt local farmers because they will not be able to compete against the free or subsidized foodstuffs from the West. Already, tiny private family plots, comprising less than 3 percent of agricultural land, produce over a quarter of Soviet agricultural output. Privat izing 30 percent of ag riculture by next year's harvest would guarantee plentiful foodstuffs for next winter and aid no longer will be needed.

Hoover Model. The emergency food aid program also must be designed to ensure that food reaches needy citizens. La st year, about 70 percent of food aid sent to the So viet Union ended up rotting in warehouses, being sold on the black market, or sold for profit by corrupt officials. To prevent this from happening again, the U.S. should look to the model of Herbert Hoo v er's humanitarian relief effort to Russia in the early 1920s. After garnering $20 million in food aid from the U.S. Grain Corporation, a fed eral agency, Hoover enlisted the assistance of private philanthropies and corporations to send over $80 million of food and supplies to Russia in the hard years following World War I and the Civil War.8 The U.S. retained complete authority for supervising the relief effort. All food was distributed directly by the American Relief Administra tion, a government agency, which employed thousands of Russian citizens in kitchens set up throughout the country.

Bush should nominate a well-known business leader to coordinate a joint private and public sector food relief program along the lines of the Hoover program. To ensure t hat the food reaches hungry citizens, the U.S. should insist on complete control over the distribution of food aid in the Soviet Union. America then could decide whether to set up kitchens throughout the republics, or use local groups such as churches, sc hools and community organizations to distribute the food.

One new element not used by Hoover should be injected into the plan. Some of the food relief should be sold for rubles-which then would be taken out of circulation.

The reason: most people have ple nty of rubles, but nothing to buy with them. By pull ing some rubles out of circulation, the U.S. could reduce inflation Guideline #2: Use the Index of Economic Freedom as a guide to insist on progress in economic reform as a condition for U.S. assist anc e to the individual republics.

If America ends up sending aid directly to the republican governments, it should be done in a way that guards against waste and prevents aid from being used to prop up 8 Arthur E. Farnsley, II Humanitarian Aid in the Twentiet h Century: Private and Public in Doug Bandow, ed U.S.

Aid to the Developing World: A Free Market Agenda (Washington D.C The Heritage Foundation: 1985 p. 15 11 holdover communist bureaucracies. Each republic will have to be judged on its merits.

To ensure this, aid should be tied to progress in enacting basic economic reforms. A good measurement for such progress is an Index of Economic Freedom that passed the Senate in July. Sponsored by Senator Connie Mack, the Florida Republican, the index def i nes the key elements of a market economy. These include protection of private property rights, free pricing systems, limited government regulation of the economy private banking and financial institutions, free trade policies, and low taxes rying out refo r ms listed in the index. Tying all aid to the adoption of free market re forms would create competition among the republics for Western aid and provide a powerful incentive for each republic to move quickly and broadly in reforming its eco nomic system Gui deline #3: Restructure U.S. technical assistance programs.

The Bush Administration proposes helping the Soviet Union improve its food distri bution system, convert its military industrial complex for civilian purposes, and better develop its oil, gas, and other energy resources. If done effectively, technical assis tance can be a critical catalyst in the initial-stages of building a market economy. For instance, American experts could advise republican governments and businesses on how to create financial institutions and capital markets, protect private property rights train managers, and privatize state-owned enterprises.

Most foreign technical assistance programs, repttably, are unsuccessful in promot ing the development of free market institutions. The technical assistance offered by the U.S. through its Agency for International Development (AID), for instance, is widely regarded throughout the developing world as particularly unhelpful. AID has been criti cized by East Europeans and by American busines s es and private organizations as inef fectual and overly bureaucratic. Typically, AID sends teams of bureaucrats with little or no private sector experience and little knowledge of local circumstances on short term junkets to Eastem Europe to offer advice. Congressional hearings on AID last year found countless instances of waste, fraud, abuse, and bureaucratic inefficiency in the agency. Each year the AID Inspector General has found new failures, such as poorly designed projects, ineffective management and use of resources, poor decision making, and simple waste9 British Success. AIDS experience in Eastern Europe and throughout the develop ing world demonstrates that it is not capable of adapting quickly to new circumstances.

There is, however, one technica l assistance program that is well regarded throughout Eastern Europe-the British Know How Fund. This was first launched in June 1989 in Poland and other funds were developed for Bulgaria, Czechoslovakia, Hungary, and the Soviet Union. These funds are desi g ned to help erect the framework for a market The republics should receive American assistance only if they make progress in car 9 Bryan T. Johnson, At AID, New Inspectw General Reports Canfm Need for Reforms, Heritage Foundation Backgrounder Update No. 16 6 , August 9,1991 12 economy by relating British know how in banking, capital market development, fi nancial services, privatization, and other critical areas stance, British experts have filled key positions in Polands Ministry of Finance and Ministry of O w nership Changes, and in the Czechoslovakian Federal Ministry of the Economy. According to East Europeans, a major advantage of the Know How Fund over other technical assistance programs is its flexibility. Unlike AID programs Know How Funds permit East Eu ropeans to have a greater say in who will be hired and for what purposes.

Britains. The U.S. government would provide vouchers to the republic governments and some emerging private businesses, which they could use to purchase the services of American consu ltants and firms. This would eliminate a layer of bureaucracy and give the republic governments greater control over what kind of technical assistance they receive. The vouchers then would be redeemed for cash in a small U.S. office set up to administer t h e program. The office could be either a part of AID, or preferably, it could be associated with the Department of the Treasury. The main responsibilities of the office would be attending to paperwork and guarding against corruption The British government funds private sector experts to assist Eastern Europe. For in An American version of Know How Funds would be slightly different from Guideline #4: Promote increased trade and investment as an alternative to aid.

The U.S. and other Western countries can best promote economic development in the republics by reducing trade barriers and encouraging increased foreign investment.

Trade protectionism in industrial countries costs the Third World more in lost ex ports than the total of all foreign assistance they receive America can promote in creased trade with the former Soviet republics first by granting Most Favored Nation trading status to those newly independent republics committed to moving toward a market economy. This will grant these republics the lowest possible U.S. tariffs on their products, a privilege now enjoyed by over 100 countries. Another way to encour age greater trade with the republics is by proposing free trade area agreements with those republics that adopt free market reforms. While none o f the republics now meet the necessary requirements mainly because their industries are all state-owned and prices are still set by the state-most of the republics eventually could be candidates.

Increasing American investment in the republics also will be necessary to stimulate economic growth. Investment by American and Western firms will supply these coun tries with hard currency, entrepreneurial skills, managerial and marketing expertise jobs with higher wages, technology, and capital for investment. I n most of the less de veloped world, multinational corporations-not Western development experts-have been responsible for training local populations in business management and marketing 10 Development and the Natwnal Interest: U.S. Economic Assistance into the.2lst Century, United States Agency for International Development, Washington D.C February 1989 13 This already is happening in Eastern Europe. American computer giant International.

Business Machines Corporation is establishing a Computer Technology a nd Develop ment Center in Budapest and General Elecmc Corporation is introducing modem man agement techniques and worker training programs there. Eastman Kodak Company is setting up a management training center in the Polish city of Konstancin.

As Latin Americans have discovered it is far better for foreign businesses to invest directly in the economy than it is for Western banks to grant loans to the government.

The reason: the money is invested by businessmen from the West rather than by gov ernment bur eaucrats. More important, unlike Western bank loans, if the multinational corporation fails, its stockholders alone-and not the taxpayers of the debtor and credi tor nations-suffer the consequences of the loss.

In addition to offering MFN status for the r epublics, the U.S. can encourage greater investment by reducing taxes on American businessmen who work there. Currently Americans working overseas are allowed to exempt $70,000 of the amount they earn working in a foreign country from U.S. income taxes. T his amount should be increased to $140,0

00. By doubling the amount of foreign income deducted from U.S. taxes for businessmen working in the republics, the U.S. would create greater incentives for higher-paid, senior executives to work there Guideline #5: Require and monitor cuts in military ou tput as a condition Reforming the Soviet economy must include drastic cutbacks in military spending.

The Soviet Union remains the most militarized state on earth. With an economy per haps half the size of Americas, Soviet arms output still surpasses that o f the U.S. and all its allies combined. In Russia and Ukraine, up to 50 percent of industrial output is military-related. NATO Secretary General Manfred Woerner said in Brussels on Sep tember 7 that the Soviet military-industrial machine continues to outp r oduce the West and still commands the best brains and resources. Unless the republics divert sub stantial resources from the military sector, they cannot hope for economic recovery or months. The best hope for a rapid shift from a military to civilian-bas e d economy will be the quick development of a private sector capable of absorbing the scientists technicians, and other workers who no longer will be building weapons. In the mean time, there are important steps that the Russian and other republican govern ments can take to demonstrate to the West that they are serious about this conversion of the de fense sector.

One step would be for Moscow to halt immediately the production of Intercontinen tal Ballistic Missiles (ICBMs) and Sea-Launched Ballistic Missile s (SLBMs), the most dangerous and provocative weapons in the Soviet arsenal. These missiles, armed with nuclear warheads, can reach American territory in minutes. From 1985 to 1990, Mos cow produced 715 new ICBMs compared to Americas

68. Accelerated with drawal of the last Soviet troops from Gemany, Poland, and the Baltic states would be another sign of good faith. Moscow also should adopt and begin acting on a plan for military reform similar to that proposed last year by Boris Yeltsin aide Major Vladimi r Lopatin for aid This massive shift of resources and manpower will not be completed in a few weeks 14 The U.S. government has not always extended aid indefinitely to foreign countries.

In the early 196Os, for instance, the U.S. inadvertently did South Kor ea and Taiwan a big favor by cutting off economic aid. This forced both countries to remove many gov ernment controls from the economy Trade was liberalized exports were encour aged, and the state's tight grip on the economy was relaxed.13 The result: an economic 1 boom that still is going strong.

The U.S. should ensure that the emerging democracies in the Soviet Union have the same chance to enjoy steady economic growth experienced by South Korea and Tai wan. This means not becoming dependent on the loans of Western countries or multi lateral lending institutions like the IMF and World Bank. Moreover, American taxpay ers should not be expected to finance Soviet or republican government expenditures for decades to come. Therefore, the U.S. should announce t hat foreign assistance from America to the Soviet Union will be cut off at the end of five years. Japan and Western Europe should be pressed to do the same CONCLUSION The political revolution that swept through Eastern Europe a year and a half ago has Ear t h is disintegrating rapidly and long-suppressed peoples are tasting the hits of free dom. There is an understandable urge among many politicians to reward the coura geous democrats of Lithuania, Russia, Ukraine and the other republics with showers of cash . However, massive infusions of aid can do little to alleviate pain in an economy that may well decline by 20 percent this year alone. Large-scale aid, moreover, will do nothing to remove the communist economic structures that are at the root of the eco no m ic crisis reached the Soviet Union with stunning speed and fmality. The last great empire on i 11 paaick Buchanan Hazards of the Foreign Aid Fix Washington Times, September 4,1991, p. G-1 12 The Chilean experience is also illustrative. During the regime o f General August0 Pinochet, Western aid to Chile largely was cut off. In the absence of foreign aid, fiochet implemented radical free market reforms, including largescale privatization such as the privatizing the pension funds. Chile is now one of the weal thiest countries in Latin America 13 Alvin Babushka Tax Policy and Economic Growth in Advanced Developing Nations report prepared for the U.S.

Agency for International Development, 1987, p. 344 15 George Bush should hold his ground in opposing massive aid to the Soviet Union.

Americans overwhelmingly are opposed to a large-scale aid bailout for the Soviet Union. According to a Wall Street Journal-NBC poll, conducted soon after the failed August 19 coup, Americans oppose U.S. aid to the Soviet Union by a 56 -39 percent margin. However, this has not stopped such legislators as Representatives Richard Gephardt and Les Aspin from calling for expensive bailout programs.

Bush should state categorically that the Soviet central government will not receive aid from the U.S. or support for membership in the International Monetary Fund 0 or the World Bank. Any assistance offered should go to the republics, and should be tied to an index of economic freedom to ensure that basic reforms are carried out. This index would gauge each republics progress toward enacting reforms and enhancing economic freedom, thereby promoting sustainable economic growth and development.

The U.S. also should not grant government-to-government loans, loan guarantees, or cash for government construction projects to the Soviet Union.

Increasing Trade and Investment. If needed as a humanitarian measure, temporary emergency food aid should be supplied to the people of the Soviet Union. But U.S pol icy makers must ensure that the food actually reac hes hungry citizens and is not used for political leverage by communist bureaucrats. To avoid this, the U.S. should insist on controlling the distribution of food aid. U.S. assistance for creating a convertible currency should be ma& contingent upon the a d option of an independent monetary system outside of political control. To be effective, technical assistance should be re structured along the lines of the British Know How Funds, which use British public money to pay for private economic counseling of Ea s t European governments. In the long-run, increasing trade and encouraging U.S. private investment is a better way to assist the people of the Soviet Union than foreign aid handouts themselves to reducing drastically the production of military axms. It mak e s no sense for foreigners to sink billions of dollars into the failing Soviet economy while billions of rubles are squandered on the inefficient and wasteful military-industrial complex Foreign aid should not be granted unless the republics-especially Rus sia-commit William D. Eggers Policy Analyst 16

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