The Heritage Foundation

Backgrounder on Asia

August 18, 1994

August 18, 1994 | Backgrounder on Asia

The Next Asian Tiger? Promoting Prosperity in the Russian Far East

(Archived document, may contain errors)

997 August 18,1994 THENEXCASIANTIGER PROMOTING PROSPERITY IN THE RUSSIAN FAR EAST INTRODUCTION As the nuclear belligerence of North Korea threatens to engulf the Korean peninsula in military conflict, the Russian Far East, long the preserve of Stalin's co ncentration camps, brown bears, and Siberian tigers, may be on the verge of sharing in the growing prosperity of Asia and the Pacific Rim.

The Russian Far East comprises lands stretching from Lake Baikal in Siberia to the shores of the Sea of Japan and the Sea of Okhotsk at the edge of the Pacific Ocean. Ma- jor cities include Chita in Eastern Siberia, the industrial center of Khabarovsk, and the port city of Vladivostok on the Sea of Japan. Some of its administrative territories are larger than European s t ates and populated almost exclusively by Russians and Ukraini Since the collapse of the Soviet Union in 1991, the Russian Far East has improved its 1 anS economic ties with Japan, South Korea, and China. Since 1990 the percentage of ex ports attributed to Russian Far Eastern joint ventures with foreign firms in such indus tries as lumber, oil and gas, and seafood harvesting has grown from 2 percent to over 30 percent. Moreover, while producing only 5 percent of Russia's Gross National Product the Far East a ccounts for 20 percent of its joint venture partnerships between Russian private companies and foreign investors vestors from Asia and elsewhere around the world, drawing hundreds of thousands, if 2 Such growth in foreign trade could transform Russia's ba ckyard into a magnet for in 1 2 Vladimir Ivanov Federation on the Pacific: Does the Crisis Lead to Collapse Eurasian Repom, Winter 1993. p. 68.

George Rose and Igor Korbatov Doing Business in the Russian Far East ern Europem Reponer, Vol. 4, January 31,199 4, p. 106. not millions, of unemployed Russians from the rust belts in the Ural Mountains and Si beria to a region that may develop closer economic ties with Vancouver Tokyo, and Se attle than with Moscow and St. Petersburg An economic take-off in the Rus s ian Far East would help to integrate Russia and the Newly Independent States (NIS) into the economy of the Pacific Rim, where annual economic growth below 8 percent is considered sluggish. Strong trade with the United States, Canada, Japan, South Korea, a nd China would provide export outlets for Rus sian products and offer access by foreign investors to the untapped natural resources of Siberia.

However this potential cannot be unleashed so long as the region is handicapped by the contradictory and ineffec tive economic policies of the central government in Mos cow. The best way to unleash the forces of entrepreneurship in the Russian Far East is to grant the region more autonomy. If Moscow were to do so, the region could become a catalyst for economic grow th throughout Russia.

To realize the economic potential of the Russian Far East, Russia should consider d Declaring the Russian Far East a free economic zone, opening coastal ter d Abolishing tariffs, import and export taxes, and customs duties for trade i n the area. This would attract foreign investment from all over the world while facilitating Russias bid to join the General Agreement on Tariffs and Trade (CAW and the Asia-Pacific Economic Cooperation forum, a 17-mem ber multilateral trade organization f ormed in 1989 ritories to the free flow of foreign investment and trade. d lifting cumbersome restrictions on the movement of hard currency in and out of the area. Russian banks and enterprises are bound by the un wieldy regulations of the Central Bank in Moscow. Foreign banks operating in Russia likewise are severely restricted in their ability to serve Russian clients.

These arbitrary regulations hamper the foreign economic relations of Russian businesses and stem the development of the region and of the country as a whole d Eliminating regulations on the export of socalled strategic commodities such as sugar, timber, fertilizers, and plastics. The Russian government has declared that over three hundred commodities are strategic goods requir ing export l i censing by Moscow bureaucrats This licensing process not only encourages official corruption, but also stifles economic growth d Cancelling regulations requiring Russian companies to sell 50 percent of their hard currency earnings to the state This measur e would reduce the cost of doing business in the area and eliminate the unfair competitive edge now enjoyed by the foreign-owned enterprises and joint ventures that are exempt from these regulations d Providing a ten-year tax holiday for foreign and domest i c investment abolishing the most burdensome taxes, and introducing a 10 percent consumption tax instead. This would simplify what is today one of the most 2 THE I punitive, arbitrary, and complicated tax systems in the world. Lower taxes would stimulate e m ployment, investment, and economic growth d Establishing economic missions in Japan, Korea, China, Taiwan, the U.S and Canada to promote investment in the Russian Far East d Setting up a privately administered bank for regional development. Capi tal could be provided by multilateral lending agencies such as the World Bank and private international investors d Protecting the environment by developing tourism and running an effi cient national park system. The potential for tourism in the Russian Far East is enormous. Tourism could generate billions of dollars in revenue that could be used to clean up the polluted Pacific landscape and save the Siberian tiger and other endangered species d Privatizing major infrastructure projects and opening them to Western a nd Far Eastern investors d Devising laws and regulations that allow for the negotiation and en forcement of contractual obligations between parties, regardless of their nationality d Boosting law enforcement against organized crime and corruption. This co u ld be done by creating a professional, highly paid special police force, per haps with the help of the U.S. and other Western countries. In addition, deregu lation of the economy would decriminalize many of the activities, such as im port and export licen s ing, that breed corruption d Resolving the Northern Territories problem with Japan. This would re move a major disincentive for increased Japanese investment IMPERIAL PAST The Russian Czars brought the Far East under their control during the 17th to 19th c enturies. For most of Russias history, Moscow was interested in the region because of its abundance of such natural resources as furs, fish, and gold. In the 17th century fur pelts accounted for more than half of the Russian empires hard currency revenue, and the desire to gain access to the furs in the Siberian forests was a strong incentive for eastward expansion. In addition, gaining access to the Pacific Ocean through such naval bases as Vladivostok and Port Arthur was seen as a vital strategic goal.

A fter the czarist empire collapsed in 1917, the city of Vladivostok and the surround ing Maritime Province declared itself an independent republic. The Russian Far East then became one of the most important battlegrounds of the Russian Civil War. In 1919 a small expeditionary force of U.S. and Japanese troops landed at Vladivostok to assist the White Army against the Bolsheviks. By 1922, however, the Russian Far East was completely under communist rule 3 During and after World War 11, the Soviet government d eveloped a vast military-in dustrial complex in the region, and Vladivostok became a huge base for the Soviet Navys Pacific Fleet. The town of Komsomolsk-na-Amure on the Amur river became a nuclear submarine construction center while military aircaft were built in the city of Khabarovsk, the old Russian government center in the region 4 Terrible environmental damage was done when decommissioned nuclear reactor cores were dumped into the Sea of Okhotsk in the 1980s, polluting the water and Kam chatka Penins u la's pristine beaches. The fish became contaminated but were sold to an unsuspecting Soviet population. Throughout the Soviet period, Moscow extracted enor mous valuable resources from the region while the government remained its major em ployer and suppl ier of investment capital.

It is no surprise that after centuries of such abuse, Far Easterners jumped at the first opportunity presented by Mikhail Gorbachev's perestroika to gain more freedom. The Russian Federation Supreme Soviet established in 1989 the Nakhodka Free Economic Zone near Vladivostok. Located only a couple of hours drive from Vladivostok Nak hodka is a huge port capable of servicing 33 cargo ships simultaneously. Last year alone, it handled nine million tons of logs, ores, fertilizer, and o ther raw materials This zone was seen by many Far Easterners as a means to gain some measure of free dom from Moscow But the zone experienced many of the same problems seen through out Russia today, including the absence of a workable commercial code and a lack of re spect for the rule of law and property rights. The Russian Supreme Soviet delayed pass ing a Free Economic Zone law, thus stalling legislation that would have encouraged eco nomic development in the Far East and other areas of the Russian Fede r ation As the Nakhodka experiment has shown, the existing approach, with the parliament and bureaucracy in Moscow deciding every case, is not working. During 1990 and 1991, the Russian Supreme Soviet authorized the establishment of thirteen Free Eco nomic Zones. They were not very successful. Local governments were denied the power to grant tax exemptions or legislate pro-business customs and foreign exchange re gimes.

The failure of the free economic zones can be attributed mainly to the contradictory and ineffective economic policies of the central government In May 1994, the Russian government announced export tariff exemptions for foreign enterprises and joint ven tures! Unfortunately, the May 1994 decision covered only businesses registered before Janu ary 1,1992, and after January 1,19

94. Ventures created in 1992-1993 period were not covered by the legislation.

President Yeltsin issued another decree in May 1994 reducing the corporate income tax to 30 percent, simplifying the tax structure, and abolis hing some of the numerous ar bitrary and punitive taxes. Unfortunately this was accompanied by a decision to raise taxes on individual incomes of over 1,0oO a month to 50 percent and to increase prop erty taxes. With social security and other payments, Ru ssian workers are paying over 80 percent of their income in taxes.

The Russian Duma, like its predecessor, the Supreme Soviet, is stalling important amendments to laws on foreign investment and natural resources. This precludes greater Western participatio n in the development of Siberian oil, gas, coal, and diamond depos 3 3 4 Vladimir Ranenko he FEZs' Economic Prospects International Affairs, Nos. 11-12, 1993, p. 32.

According to the decision, only joint VenNreS With at least thirty percent of Western par ticipation, or at least ten million dollars of investment, are exempt from the tariff and tax 5 its that would benefit Russian Far Easterners. In the absence of a special Free Trade Zone law and a strong legal infrastructure, foreign investment in the Nak hodka Free Economic Zone has been poor, totalling only $1 18 million. Industrial production by joint ventures in 1993 was only $54 million.

The Moscow bureaucracy continues to resist the decentralization that is needed if the Far East regi on is to reach its full potential. Through stifling regulation of economic ac tivity, bureaucrats are choking economic growth and breeding corruption, inefficiency and misery. Far Eastern businessmen and their Western counterparts often spend more time de a ling with government ofices in Moscow than tending to their businesses back home. Even simple business transactions, such as opening a factory or obtaining a min ing license, involve a frustrating permit approval process through ministries in Moscow often accompanied by bribes at every level of the bureaucracy 5 Rich in Resources, Poor in Infrastructure The Russian Far East is a cornucopia of natural resources and, under the right circum stances, could become a magnet for foreign investment. Oil extraction off the shores of Sakhalin Island would spur economic growth throughout the entire region. Japans Min istry for International Trade and Industry (MITI) is drawing up plans to turn the port of Niigata on the Western coast of Japan into a major import facil i ty for Russian gas; the Western Japanese Aomori prefecture also is interested in Russian gas; and there are plans to build a huge 5,OOO-kilometer pipeline to import Sakhalin gas to South Korea and Japan including Mitsubishi, Mitsui, Nissan, Honda, Gold St a r, Daewoo, and Hyundai among others-already have established a presence in the area. Numerous Chinese companies trading in consumer goods and foodstuffs are grossing over $900 million a year. Indeed, a separate FEZ recently was created on both sides of th e Russian-Chinese border adjacent to the cities of Blagoveshchensk and Heihe?

The Russian Far East is important also because it links the Pacific Rim with the Eur asian continent. The Russian Far East is adjacent not only to China, Korea, and Japan but als o to Eastern Siberia, which is rich in such minerals as diamonds, gold, platinum oil, and gas. Ports at Vladivostok, Nakhodka, and Vostochny serve as tenninals for the tramSiberian railway and as eastern gateways to Russia, the Commonwealth of Inde penden t States, and Europe.

Because of its prime location, and despite the often hostile business and investment climate, the region has begun to attract some Western investors. For example, the US.

Overseas Private Investment Corporation (OPIC) and the Europea n Bank for Recon struction and Development (EBRD) in May 1994 announced a gold mining project in the Russian Far East. The project is being conducted by a joint venture called Omolon which includes U.S. Cyprus Amax Minerals and five regional Russian compa nies 6 Owing to the appearance of the Sakhalin and Nakhodka FEZs, Asian industrial giants 5 Personal interviews, January-May 1994 6 7 Intercons Daily, March 21,1994, p. 2, and Ivanov, Federation on the Pacific. p. 76.

Russia to Build Cross-border FreeTrade Zone. Zinhua Geneml Overseas News Service, January 4,1994 6 Omolon will develop the Kubaka gold and silver deposits near the city of Ma gadan. OPIC will provide 150 million for insurance and 55 million in invest ment guarantees,8 and the EBRD will pro vi d e 55 million in fmancing. A feasibil ity study by Vancouver-based Kilborn En gineering Pacific Corporation concluded that the Kubaka deposit has 2.2 million ounces of proven recoverable gold re serves and 1.7 million ounces of silver re serves. The seven- year project calls for the deposits to yield 326,000 ounces of gold and 255,000 ounces of silver annu ally?

Increasing the number of such projects however, is hindered by a lack of infra structure. The region lacks transportation and communication links, d ata process ing services, hotels and adequate hous ing for foreign businessmen and their families. For example, the price of real estate in the two major cities Khabarovsk and Vladivostok, is skyrock eting because of a lack of .dequate hous ing and office space. In 1992, a standard Russian one-bedroom apartment sold in Vladivostok for 15,000; it is now twice as expensive, and land in or near the port facil ity has tripled or quadrupled in price.

The railroads and highways of the Russian Far East are in dis repair. The Soviet-era Baikal-Amur railroad, which runs north of the czarist-built trans-Siberian, is often closed for repairs. For long stretches it consists of a single track. There are no links be tween the Baikal-Amur railroad and the old trans-Siberi a n railway and no links with railways in European Russia, Korea, or China. Roads throughout the region are poor and traffic from the Far East into Siberia and European Russia is hampered by the ab sence of bridges over the Amur and Lena rivers Similar prob l ems afflict the regions telecommunications system. Western business men accustomed to faxing information from their computer screens and conducting 8 Inrercons Daily, June 9,1994, p 2. As a part of its plans to boost insurance and investment guarantees to American corporations doing business in the former Soviet Union area, OPIC announced in May 1994 that it will increase its commitment from $1 billion to $2.5 billion 9 Infercons Daily, June 9. 1994, p. 2 10 Rose and Korbatov, Doing Business in the Russian Far East, p. 106 7 business via cellular telephones in their cars soon learn that telephone service in the Russian Far East is worse even than in the Western parts of Russia around Moscow.

Some of these problems are being corrected slowly. In Khabatovsk, the Marriott Cor poration is building a five-star hotel; Japanese companies are developing commercial real estate; and the French Thomson electronics conglomerate is overhauling the air traf fic control system at the local airport. Contracts have been awa r ded to foreign compa nies for expansion of the airport at Vladivostok, and planning for a much larger interna tional airport has begun Feasibility studies also are being conducted for the conversion of some military air fields to commercial use. For examp l e, a military airfield in Yelizovo, Kamchatka which is halfway by air between Hong Kong and the West coast of North America, is being used as a refueling stop by a California-based company. It finds the Kamchatka airport to be cheaper and more convenient than the nearby Narita airport in Japan. Here American ingenuity and Russian defense conversion have combined to create a lucra tive business venture.

Some modest progress also is being made in satellite communications, digital ex change networks, and micr owave transmission facilities. Joint ventures with American and Japanese telecommunications firms such as AT&T, MCI, and U.S. West are provid- ing satellite telephone connections from hotels, long-distance calling, and E-mail sew ice 12 NATURAL SPLENDOR A N D THE POTENTIAL FOR TOURISM Throughout the Russian Far East are large and virgin forests, majestic rivers, crystal clear lakes, and unspoiled mountain ridges. The Kamchatka peninsula, which protrudes into the Sea of Okhotsk, is as pristine as the American West of the 1860s. With fewer than half-a-million people, and with its geysers, bears, and rivers that run red with salmon, this is an area that could beckon to Japanese, Chinese, and American tourists.

Despite this potential, the absence of effective lan d management and game preserve techniques are threatening the ecological balance of the region. For example, poachers have nearly killed off the Siberian tiger, which is valued for its fur and bones, and used for traditional Chinese medicines. Even the ma l e tigers reproductive glands are prized by wealthy Chinese for use in aphrodisiac soups. Once the kings of the Siberian jungle only some 150 of these magnificent cats are left in the forests around Khabarovsk, the administrative center located in the hear t of the region.

However, there are signs of hope. In the Kronotsky and South Kamchatka nature re serves on the Kamchatka peninsula, specialized Russian and joint venture companies bring in wealthy Japanese and American clients for safari expeditions and t ourism. In some areas, the only transportation for adventurous travellers is by helicopters which are provided by Russian and Russo-Japanese joint venture companies. Westerners are 11 Yelizovo is located near Pmpavlovsk-Kamchatsky, capital of the Kamchatk a peninsula 12 Rose and Korbatov, Doing Business in the Russian Far East, p. 108 8 flocking to the largest geyser natural park in the world, and salmon fishermen pay hand somely to spend a week or two on the banks of some of the clearest streams on Earth R ussian experts estimate that the region could generate $1 billion in tourist revenue by the year 2005 THE DISPUTE OVER THE KURILE ISLANDS An economic boom in the Russian Far East would require the participation of Japan.

Technically; however;Russia and Jap an have never ended the Second World War. The sources of this conflict are well-known. Promising to invade Japan after the victory in Europe, Stalin in July 1945 broke his 1941 nonaggression pact withTokyo and occu pied the southern half of Sakhalin and t h e Southern Kurile islands (see map).13 Despite Japans willingness to recognize Russias claims to Sakhalin Island after World War 11 in exchange for the return of the Kuriles, Stalin persisted in occupying the Northern Ter ritories. As a result, Russo-Japa nese relations have been poisoned for the past four dec ades. Tokyo has never recognized the Russian occupation of these islands.

There have been attempts to resolve the dispute. In 1956, the Soviet government pro visionally recognized Japans claims to the two southernmost Kurile Islands, Shikotan and the Habomais, while Japan promised to give up its rights to Sakhalin. However, the drawn-out peace talks failed because Moscow refused to vacate the Southern Kuriles.

From 1989 to 19 92, the Soviet and later Russian governments were close to restoring Japanese sovereignty to the islands in return for economic assistance from Tokyo, but Russian nationalists repeatedly derailed these efforts, arguing that these territories are forever R u ssian and should never be returned Kurile Islands. In March 1994, apparently mindful of the strong showing of hard-line communists and nationalists in the December 1993 elections, Russian Prime Minister Victor Chernomyrdin told Japanese Foreign Minister T s utomu Hata that the dispute would not be resolved soon ilt is not the kind of problem that can be solved in one leap.14 In the same meeting, however, Chernomyrdin also called for negotiations to resolve the territorial dispute in Japan and to conclude a R usso-Japanese peace treaty as soon as possible.

Japanese economic assistance to Russia, and especially to the Russian Far East, is de pendent on a resolution of the Kuriles Islands dispute. Without the nod fromTokyo, vi tal Japanese investment in the regio n will not materialize Over the last year, the Russian government has sent out mixed signals concerning the 15 13 Ihe Southern Kuriles, referred to as Northern territories by the Japanese, include the islands of Kunashiri, the Habomais (a chain of small i slands Etorfu (Irurup in Russian and Shikotan 14 Intercons Daily, March 21,1994, p. 1 15 RFE-RL. Daily Report, March 22,1993, p. 2 9 WHAT ISTO BE DONE The Russian Far East could become the engine of economic growth for all of Russia.

The Russian government should be looking to the example of China, where the intro duction of liberal economic policies tripled the living standard of the people in ten years. Pulled along by the southern economic engine, the Chinese economy grew at an average rate of 1 1.2 per c ent from 1991-1993, and the forecast for the years 1994-2003 is for an annual growth rate of at least 8.6 percent. l6 Prime Minister Chernornyrdin was so impressed with-these bustlingzones during-his May 1994 visit to China that he declared his full suppo r t for the Chinese experiment and he promised to implement such reforms in Russia If Russia waits to achieve similar results, the Russian Far East, with its vast resources and geographic proximity to the successful Chinese model is a logic$ place to start T hus, the Russian government should consider r/ Declaring the Russian Far East a Free Economic Zone (FEZ The Soviet legislature created the first FEZs in 1989 as a capitalist experiment. One of the first was the FEZ of Nakhodka. Another major FEZ, operatio n al since 1992, is on Sakhalin Island. In the spring of 1994, a huge oil development project off the shores of Sakhalin, known as Sakhalin-2, with estimated resources of over 8.5 billion barrels, was moved one step closer to implementation. The signing of a protocol between a Russian state-owned oil company, Rosneft, and an in ternational consortium known as 4MS will bring Western investments total ling over $10 billion to the venture during the next ten years. Non-Russian in vestors include Marathon Oil Co McDermott International Inc Mitsui, Mit subishi, and the Royal Dutch Shell Group. The deal was finally signed by Prime Minister Chernomyrdin during his visit to Washington, D.C on June 22,1994 To sustain the momentum of economic development, the Russian F a r East needs foreign investment and free trade zone laws that allow local authorities and the business community freedom of action. Both Russian and foreign observers have called for the passage of such laws to end the climate of economic and investment u n certainty in the area. If Russias lawmakers continue to stall the needed com prehensive legal reform as they have been doing since 1990, the legislatures of the Russian Far East administrative regions should agree among themselves on a com mon free trade z one law and pass it simultaneously, thus taking responsibility into their own hands. The future law should incorporate the ideas of economic freedom and practical experience with Free Economic Zones found in China, Hong Kong Singapore, and Dubai where gov e rnments have reduced taxes and regulation dra matically, allowing the free movement of capital, goods, and people. These actions have fostered some of the most impressive economic growth in this century 16 World Bank economic forecast, June 1994 17 Nakl~o d ka as a Model for Russian Free Economic Zones. an international conference, Inremarionuf Affuirs. Moscow 1993 10 The proposed law should also prevent government bureaucrats from turning the Free Trade Zone into a cash cow for themselves through the overre g ulation of for eign and domestic business, preferential sales of licenses, and other means of cor ruption practiced elsewhere in Russia. Specifically, the Russian law should privat ize port facilities and abolish the current requirements for governmental p ermis sion to export goods, with the exception of weapons and military technology items d Abolishing tariffs, import and export taxes, and customs duties for fop eign trade To stimulate trade and investment, most government duties which today are prohibit i vely high and punitive, should be abolished. Taxes to abolish: a 26 percent oil export tax, a 130 percent automobile import tax, and an 80 percent tax on foreigners incomes over $l,OOO a month. Such tariffs and taxes impede international commerce and indu s trial output. They also lead to corruption, as customs and tax officials use their positions sonal enrichment. The only function that should be left to the customs officials should be to prevent unauthorized trade in regulated materials and substances suc h as drugs and arms a source of per Getting rid of export tariffs will facilitate Russias joining the General Agree ment onTariffs and Trade (GATT) and becoming a full member of the World Trade Organization WTO which will issue regulations dealing with tra d e in commodities and raw materials. It is in Russias interests to expose its large but in efficient industry to international competition to increase productivity In addition Russian consumers will benefit from an abundance of goods from various foreign s o urces. Harmonizing Russian export policies with international practices would enhance Russias integration into the international trade system d Lifting cumbersome restrictions on the movement of hard currency in and out of the area Allowing free movement o f hard currency into and out of bank accounts will make it easier for investors to conduct business in the Russian Far East. All restrictions on hard currency transactions, such as the forced exchange of half of their foreign currency proceeds by Russian compa nies, should be abolished. Businesses should be able to move deposits, profits and investments freely anywhere in the world.

Currently, foreign banks are prohibited from functioning on an equal footing with local banks For example, until June 1994, i nternational banks were allowed to serve only non-Russian clients This situation could change because of an im pending Yeltsin decree, but it is still unclear whether, when, and how foreign banks will be allowed to operate Only ten foreign banks, includin g Citibank and Chase Manhattan, are now permitted to transact business in Russia. Russian banks often provide poor service, make costly mistakes, and leak information to organ ized crime; therefore, it is in the interest of Russian businesses and private c lients to be free to choose whether to invest, borrow, and create partnerships with for eign or domestic banks.

What makes limitations on international banking in Russia even more damag ing to commerce is Russian bankers lack of expertise in internationall y accepted banking practices, especially in trade financing and investment. For example, let 11 ters of credit are standard tools of trade finance that guarantee payment by the buyer to the foreign seller. But letters of credit are not accepted by Western banks when they are drawn by Russian banks. This slows trade and investment activities and must be remedied by allowing foreign banks and financial services corpora tions to operate freely. Foreign banks should be allowed to provide a full array of servic e s to their international and Russian clientele d Eliminating regulations on the export of so-called strategic commodities such as sugar, timber, fertilizers, and plastics. The Russian government has declared over three hundred commodities, including sugar , timber, and some fertilizers, to be strategic goods that require export licensing by Mos cow bureaucrats. Such classification only allows bureaucrats to enrich them selves by selling licenses and taking bribes for their services. Indeed, there is a thriv ing black market in real and fake export licenses. Especially lucrative are licenses for oil exports, certificates allowing the sale of Russian urea fertilizer to China, and licenses for timber and lumber transactions.

Such military goods as radioactive ma terials, weapons, and sensitive weapons technologies should be regulated, but it is unreasonable and punitive to classify nonmilitary goods and raw materials like sugar as strategic. In 1992, for exam ple, Russian bureaucrats forced businessmen to donate p rofits from sugar sales to municipal budgets and demanded as much as 10 percent of the value of transac tions in kickbacks as a precondition for granting export licenses for ammonia fertil izer 18 a/ Cancelling regulations requiring Russian companies to s ell 50 percent of their hard currency earnings to the state. Russian businesses are re quired to sell 50 percent of their hard currency earnings to the National Bank.

For example, if a Russian company earns one million dollars, it can keep half turning the other half over to the National Bank. The law is a relic of the So viet period, when the hard currency receipts of all government-owned enter prises were expropriated by the state This law should be abolished. It represents a burdensome tax on business, a s ru ble assets depreciate at the rate of inflation (500 percent in 1993) and there is no in dexation of savings. Russian companies are punished by having to hold depreciat ing ruble assets. In addition, this regulation is a major impedment to trade and i n vestment throughout Russia. It prevents businesses from planning their budgets be cause of the constantly changing exchange rates a/ Providing a tenyear tax holiday for foreign and domestic investment abolishing most burdensome taxes, and introducing a 1 0 percent con sumption tax. The Russian Far East must compete for international invest ment with such Asian economic dynamos as Taiwan, Thailand, Singapore, and Vietnam. In all of these countries, there is some degree of tax holiday for im 18 Personal inte r views with members of the Califmia-RussiaTrade Association, October 1992 12 ported capital; foreign investors do not pay taxes for two to seven years and later pay reduced corporate taxes, often at a rate below 25 percent. Thus, for eign businesses receiv e an incentive to invest in emerging markets. To attract international financing for regional economic development, and to attract the needed manpower from the European part of the Russian Federation and abroad, tax holidays should be introduced. This shou ld include abolition of the income tax, specifically the high personal income tax (which can reach up to 80 percent) introduced in June 19

94. In the U.S where there is a venerable tra dition of paying the income tax, marginal rates are relatively low comp ared with the rest of the world. In Russia, where the state takes draconian measures to collect income tax, revenues are shrinking. Income tax rates are extremely high, while evasion and corruption of the tax collecting authorities are ram pant In order t o maintain the tax base the income tax should be abolished and a 10 percent consumption tax imposed In addition, excise taxes could be placed on alcohol and tobacco, and reasonable fees for using roads, bridges, and airports could be instituted. If the Rus s ian state wants to collect revenue, it should remem ber that it is much easier to collect taxes from businesses. This proposed tax re form will provide economic stimulus for domestic and foreign investment and for individual work while increasing tax coll e ction by at least 50 percent. d Establishing economic missions in Japan, Korea, China, Taiwan, the U.S and Canada to promote investment in the Russian Far East. The govern ment should establish a Far Eastern Foreign Economic Authority modeled on the U.S. T rade Representative's office. This new entity could establish over seas missions as many U.S. states have done to attract foreign investors and promote commerce in those countries. Obvious cites for Russian Far East of fices include Tokyo, Beijing, Shangh a i, Hong Kong, Seattle, San Francisco and Vancouver d Setting up a privately administered bank for regional development. With capital from the World Bank, the Asian Development Bank, the European Bank for Reconstruction and Development, and private investo r s, a Russian Far East bank could provide the seed money for ports, airports, roads, and tele communications systems. It also could underwrite investments in oil and gas exploration, diamond, coal, and gold mines, as well as service projects such as hotels and restaurants. The Russian government should allow such investments to be channeled into private rather than government-owned projects cient national park system. Sound land and game preserve management is needed to save species and uphold the ecologica l balance of the region, as well as to make the region attractive for tourism. Experience in Tanzania, Zim d Protecting the environment by developing tourism and running an effi 19 I am grateful to Joe Cobb, John M. Senior Fellow in Political Economy at th e Heritage Foundation, for an incisive discussion of Russian tax issues 13 babwe, Kenya, and South Africa shows that large animals can draw huge tour ist crowds which generate high revenues To achieve this goal, national parks must be professionally organi z ed and run by private operators. If unique Far Eastern wildlife is destroyed, potential income from tourism will be lost. In the long run, the region may generate more hard currency from safari tourism than logging and other commercial activities can prod u ce in the short run To utilize this potential fully, the management of the Kronotsky and South Kam chatka nature reserves, which between them comprise 3.5 million acres and 22 ac tive volcanos, could leam profitable and safe safari management methods in A m erican national parks. They could look to the examples of the Yellowstone and Grand Teton parks in the U.S. or the Kruger and Serengeti national parks of Af rica. Game reserves, with equity ownership by the local villagers, should be cre ated for Siberian tigers and brown bears, both of which are endqngered by poach ers 20 d Privatizing major infrastructure projects and opening them for Western and Far Eastern investors The Russian government does not have the billion dollars needed to upgrade facilities a n d air control equipment at such Far East em airports as Vladivostok, Yelizovo, Khabarovsk, Magadan, and Yuzhno Sakhalinsk. International traffic at these airfields has exploded since the fall of the Soviet Union. These airports should be privatized. A mod e l. for this could be the successful privatization of the international airport in Prague2lThe Czech example shows that private-public partnerships and outright privatiza tion can build up railroads, highways, and port systems successfully In addi tion to r elieving the transportation bottlenecks, such development would em ploy hundreds of thousands of Russian workers and engineers now searching for jobs. Moreover the central government could encourage the migration of unemployed labor from the rustbelts to d evelopment in the Far East?2 d Devising laws and regulations that allow for negotiation and enforce ment of contractual obligations between parties regardless of their na tionality The Russian parliament is stalling on the passage of legal reform that wou l d allow for the enforcement of Western-style contracts. Other legal safeguards missing in Russia include protection foi intellectual property and a workable real estate law If the central government fails to pass legislation protecting business practices t he Russian Far East should go it alone. With Western legal assistance, regional legislators could develop and implement a comprehensive package of laws that would allow for successful functioning of the market, leaving the central govern 20 I am grateful t o my Heritage colleague John Shanahan for a useful discussion of game preservation methods 21 Gerald Shea and Ann Baker, me Rague Airport Project: Privatization for Infiastmture Development, BNA Eastern Europe Reporter, Vol. 4, No. 3 (Janua~y 31.1994 p. 1 14 22 For a full discussion, see Ariel Cohen, llussian Draft Constitutions: How Democratic Are They? Heritage Foundation Backgrounder No. 9

49. June 30,1993 14 ment to catch up later. Such legislation would include a locally enforced civil code, laws on co ntracts, a corporate statute, and laws on property rights and land use ing notice on lawmakers that if they fail in their responsibilities, other means will be found by the regions themselves to create a civilized body of laws to enhance their economic de v elopment d Cracking down-on ,organized crime and corruption. The most daunting task of all in the Far East is to stem the crime and corruption that have pene trated all facets of business activity. To guarantee economic freedom is to es tablish and enforc e the rule of law; as one attorney with extensive practice in the region put it, however, the main problem for Western companies is to fig ure out which part of the mafia is capable of delivering the goods and deal with By taking these measures, administra tors in the Russian Far East would be serv A new, highly professional, and well-paid law enforcement organization is needed to eradicate the gangs and to investigate and prosecute corrupt officials.

Such a force could be created with foreign assistance In addition to a law-and-or der approach, the deregulation of economic activities would go a long way toward ameliorating the situation.

World War 11 by signing a peace treaty with Japan should be a key foreign pol icy objective for Russia. In order to recei ve bilateral and multilateral economic assistance himTokyo, Moscow must move beyond the legacy of World War 11 and the Cold War. International assistance from Japan is vital to converting the military industries of the Far East to civilian production and finding mar kets for the regions products in the booming Pacific economies.

There are a number of ways to resolve this dispute. One option is to negotiate a long-term lease of the Kurile Islands from Russia by Japan with sovereignty revert ing to Japan at the end of the lease. Alternatively, a United Nations trusteeship could be established over the islands before Japan assumes sovereignty. Another option: a joint Russian-Japanese administration of the islands for a specified pe riod of time could pave the way for the transfer of the territory to its original owner Japan If the efforts of diplomats are not fruitful in the next three to five years, Russia and Japan should call on outsiders to arrange for final and binding arbitration, with neutral and experi e nced arbiters nominated by both sides. For example, either the hernational Court of Justice in the Hague or a U.N or ASEAN-nominated panel could provide an appropriate forum for resolving Russo-Japanese disputes Or per haps the U.S. could offer its own go o d offices; theTreaty of Portsmouth ended the d Resolving the Northern Territories problem with Japan. Finally ending 23 Interview withTim Bruinsma, Chairman of the California-RussiaTrade Association and a leading legal expert on doing business in the Russ i an Far East, March 1994 15 Russo-Japanese War in 1904 and earned President Theodore Roosevelt the Nobel Peace Prize Russian nationalists such as Sergei Baburin, Alex.ander Rutskoi, and Nikolay Pavlov, will use the Kurile Island question to attack Presiden t Yeltsin and Foreign Minister Andrei Kozyrev and to depict themselves as the true Russian patriots. But bold leadership by Yeltsin and Prime Minister Chernomyrdin can overcome the ac tions and rhetoric of the extreme nationalists, who thus far have preven t ed a satis factory solution of the Northern Territory question and forestalled significant eco nomic development in the Russian Far East CONCLUSION With bold and imaginative ideas, the Russian Far East could undergo the kinds of eco nomic growth experienc e d by California during the decades following the 19th-century gold rush. The Russian Far East is more than adequately endowed with natural re- sources. It is located in the booming Asia-Pacific region, and it is capable of attracting foreign investors. Mo r eover, it could draw millions of the unemployed from the rust belts of European Russia, the Urals, and Siberia In order to fulfill this potential, however, the central government in Moscow would have to pursue policies that unlock the economic potential o f the region. Examples abound in the Pacific Rim of how to turn backward areas into economic success stories If the Russians do it right, American, Chinese, Japanese, and Korean investors and de velopers will not keep them waiting. And all of Russia will b e the beneficiary.

Ariel Cohen, Ph.D Salvatori Fellow in Russian and Eurasian Studies 16

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