Russia in Turmoil

Meeting Report
October 1, 1998

Speakers: Arnold Horelick, Vice President for Russian & Eurasian Affairs, Thomas Graham, Senior Associate, Anders Åslund, Senior Associate, Martha Brill Olcott, Senior Associate

Arnold Horelick: Impressions from Two Weeks in Russia

I’d like to begin this panel discussion by making a couple of points that are essential for understanding what has been happening in Russia during this crisis and what its most important implications are for Russia's future development and for U.S. policy.

First, this crisis has shown that the Yeltsin era is effectively over. His erratic political management helped bring this crisis about and in the end, in the showdown with the Duma in the first part of last month, he was compelled to make a humiliating retreat, shattering what was left of his aura of political invincibility. Now, in failing health, he is left with a Presidential administration that has been gravely weakened by the firing (for defying him) and departure of some of his most effective operatives.

Is there a possibility of one last dramatic move by Yeltsin? Possibly, but it is now very unlikely that he could make it stick.

This means that henceforth Russian politics will be dominated by the Yeltsin succession struggle, which Tom Graham will be discussing. It will not be a propitious environment for any government to make tough policy decisions, especially not in economics. The elevation of Primakov was an effort somehow to avoid a political meltdown. He was a compromise choice, his nomination ended the immediate political crisis occasioned by the absence of any legally empowered Russian government during weeks of financial free fall (not that having a government has made much difference in the three weeks since Primakov was named).

The model of economic reform that Russian governments under Yeltsin have pursued since 1992 -- however imperfectly, haltingly, incompletely -- the one at any rate that several times won the IMF and U.S. administration's Good Housekeeping Seal of Approval for concept if not for execution -- has for the time being, and I believe, probably for the foreseeable future, run its course.

In this country there is a running debate around the question of whether it was the liberal economic model and the priority it gave to monetary and fiscal policy that failed Russia, or was it Russia that failed the model, never really applying it as rigorously as was needed.

In Russia there is not much of a debate about this. Except for the architects of the policy that has now been rejected -- Gaidar, Chubais, and their adherents – the very widely held view in Russia is that the policy was wrong for Russia and those that inflicted it on the country are to blame, as well as the greedy oligarchs and criminalized bureaucrats spawned by the policy, and not so much the Duma, which obstructed its implementation.

However, as interesting as this debate may be to analysts, it is now beside the point. The policies failed because they lacked any substantial political or social base of support critical for economic reform under conditions of political pluralism and constitutional democracy. It was because there was no public trust in the policy or in its authors, or elite consensus behind the policy that the policy pursued could not be implemented.

When the crunch came this summer, international investors finally lost confidence in the ability of the Russian government to implement policy and they pulled out. Whether the policy could have succeeded had it been more consistently implemented is an academic question.

The liberal reformers elevated by Yeltsin failed utterly to build a political and social base of support for the kind of reform course they wished to pursue. They neglected until very late the social safety net aspect of the problems of reform, and behaved as if getting the macroeconomic stability numbers right would somehow automatically lead to growth and prosperity.

Anders Åslund will be talking about the likely policy courses that will now be pursued by a Russian government, the principal positions in which are occupied by senior officials of the Gorbachev perestroika era.

Let me now move on to a few points about the implications for U.S. policy toward Russia of these major political and economic policy changes triggered by the Russian crisis.

First, the U.S. administration is losing its Russian partners, partners to whom the President and his team have been deeply committed, both personally and politically, since Clinton took office in 1993.

Yeltsin has been the bedrock of U.S. policy toward Russia. Helping keep him at the helm has been the policy's overriding priority. And a lot that was unhealthy and unwise in his administration was overlooked, or minimized, because of this priority.

For the U.S., Yeltsin was the guarantor of Russian democracy, the indispensable bulwark against Communism's return, and the assurance of a generally cooperative Russian-American relationship. So long as he held the reins of power firmly in his hands, we could concentrate most of our policy energies on helping Russian liberal economic reformers on the macroeconomic stabilization problems that both they and the U.S. Treasury leadership believed were the keys to successful reform.

Well, Washington now quite clearly if reluctantly sees Yeltsin as a spent force. His decline, moreover, is accompanied by the departure of the liberal economists to whom Washington and the West generally have looked to lead Russia's reform.

The Gaidars, Chubaises, Nemtsovs, Fyodorovs -- all of the key figures who comprised or advised what Washington only a few months ago characterized as Russia's "dream team" Kiriyenko government -- are out. Along with them, the brand of liberal market reform they advocated is also gone.

Is this merely a bump in the road, which they and we will have to wait out, and then they will be back? This is the "Bulgarian scenario" that is talked about by Gaidar and others in "Russia's Choice" circles. The scenario goes like this: as in Bulgaria, after the Communists returned to power in the second phase and their policies brought the country to total economic ruin, disgusted voters after the inevitable failure of the Primakov government, will bring the reformers back to complete the interrupted job they launched in 1992.

It is a very unlikely scenario for Russia. Bulgarian reformers returned to power not merely because their ex-Communist successors brought on an economic collapse, but also because the reformers had built a strong political party and succeeded in mobilizing mass political support for the course of action they proposed to pursue to rescue the economy. The Russian reformers who have now been dismissed have always depended only on the favor of Yeltsin, lack any serious political base in the country at large, and are probably the least likely group to be put in charge in the aftermath of a Russian economic catastrophe. Russia is much more likely to turn to nationalist extremists than to discredited liberal economic reformers in such circumstances of truly catastrophic collapse.

Another version of a "return to liberal reform" scenario, coming mostly out of Yabloko circles, goes like this: Primakov is likely to remain in office as a "political Premier" or effectively as Vice President during the interval leading to the next parliamentary and presidential elections because he is seen as politically indispensable to almost all factions. But his cabinet, and especially its economic policymaking core, will turn over several times as its policies continue to fail. At some point, reformers will be given control of the economic bloc, but they will be reformers of the democratic opposition to Yeltsin governments of the past.

This may be a little more realistic than the Bulgarian scenario that would return the Gaidar-Chubais team by popular acclaim, but not much more; and it sure is not an outcome on which you would want to bet American policy.

Where does this leave U.S. policy? Russia’s financial collapse and deep, economic crisis, the departure of America’s principal Russian partners in work on the Russian economy, and the decline of Boris Yeltsin as the guarantor of Russian democracy and a generally pro-US orientation, these all add up to a serious disappointment and setback for U.S. policy.

The pendulum swing to the left in Russia and low expectations that the new Primakov government will be able to reverse present highly unfavorable trends in the Russian economy leaves U.S. policy in a quandary.

The U.S. continues to have very high stakes in Russia – for obvious reasons, which I need not belabor. Washington does not want to be seen as turning its back on Russia. The administration has on the whole leaned pretty far forward in a favorable depiction of the advent of Yevgeny Primakov. It has pretty much accepted the Russian conventional wisdom that he is the best compromise candidate available to stabilize what was a tense and dangerous political situation.

But Washington is hardly encouraged by the personnel choices Primakov has made to fill senior positions on economic policy in his cabinet and is uneasy about the failure of the new government to present a coherent plan for recovery.

Washington understands that the immediate priority of the Russian government in the runup to the scheduled October 7 strike and protest day is measures designed to ratchet down the tension in key groups that could threaten social order by paying their back wages.

But it is a foregone conclusion that the new Russian government, already in effect printing money, will print much more and there is not much confidence that this can be regulated and fine-tuned so as to prevent hyperinflation.

So Washington in effect will have to take a policy time-out. It is struggling to find a way to do this without signaling to Russia that it is disengaging, while protecting its flank domestically against "Who Lost Russia" charges from the Republican Congress and demands for measures that would even further reduce the Administration’s already limited flexibility and ability to respond positively should Russian policy at some point provide opportunities for doing so.

On the "up" side, this "pause to regroup" in U.S. policy may have some benefits as well as costs. It is probably a plus for trying to stem rising anti-Americanism in Russia for the U.S. no longer to be seen so intimately involved in Russian domestic politics and economic policy.

Despite Washington’s serious misgivings about the direction Russian economic policy appears to be moving, it will want to keep an open mind and signal its readiness to cooperate if and when the Russian government does come up with a coherent economic plan and if it seeks Western assistance in implementing. The U.S. should be prepared to explore the extent to which there may be overlap between what Russia proposes and what the Western governments and institutions believe it is reasonable to support.

Meanwhile, Washington can hope that Russian foreign and security policy will be sufficiently cooperative in the weeks and months to come. START 2 ratification would clearly help to prevent the leftward swing in the pendulum on domestic policy from broadening into a more obstructionist posture in the international field as well.

Thomas Graham: The Domestic Political Situation

Three key features of Russian politics today are the fragmentation of power, the absence of strong leadership at the center, and a sharpening succession struggle.

Over the past decade, we have witnessed a tremendous fragmentation, decentralization, erosion of power in Russia, both politically and economically. In part, this is the result of global trends, especially in technology, which tend to diffuse power and diminish the authority of central governments worldwide. In part, this has been the consequence of the reforms that the Russian government itself has consciously implemented, in an effort to modernize both the economy and the political system. To a greater extent, this has been a by-product of the elite struggles in Moscow itself. The disarray at the center of the system has allowed the more ambitious regional leaders to seize local power and assets, and has compelled the more timid to do the same thing in order to survive.

The recent crisis in Moscow has only accelerated this trend. We see more and more power falling out to the regional leaders. Some have instituted price controls, others have prohibited the export of food from their regions, some talk of instituting local currencies. These trends will continue over the next few months as the crisis unwinds. I would argue that there is no immediate danger of the breakup of Russia along the lines of the Soviet Union breakup in 1991. That is because there are no strong separatist movements in Russia, with the exception of two or three places in the northern Caucasus – Chechnya and Dagestan.

We are going to see a very long period of weak government in Moscow. How long the country can hold itself together when decisions are being made more on a regional basis than on a national basis will have implications for the long-term integrity of the Russian state.

The second group that benefited from the fragmentation of power over the last decade is a group that is generally called the oligarchs in the West and in Russia itself. I would argue that the group is larger than the 7-10 people that are generally viewed as the oligarchs. It includes the big capitalists, who are mostly situated in Moscow, but many of whom are located in the regions. This is a group of individuals who made fortunes largely by seizing state assets or public funds with the connivance of top-ranking government officials. Some of those officials are those who we view as the radical reformers in Russia over the last 7 years.

There has been much speculation, both in Russia and here, about the death of the oligarchs as a result of this crisis. I think that is something that has been greatly exaggerated. The impact will vary from oligarch to oligarch, depending largely on the nature of their assets and their empires. Some are going to survive and continue to have considerable influence in the halls of power in Moscow. People such as the heads of Gasprom, the gas giant, or of Lukoil, Russia’s largest oil company -- these are solid structures which still have very solid reputations outside of Russia, and will definitely survive and prosper. Others are going to disappear. Someone like Smolensky at SBS-Agro, who had visions of becoming the super banker of Russia, has watched his fortune disappear over the past several weeks. I see no way for him to resurrect that structure in the near term.

Others are going to have their influence diminished, but they are going to survive and still be players at the center. Someone like Berezovsky -- whose influence has been built not only on his access to huge financial resources, but also to key political players in the political process -- will continue to be a major player.

The more important point that I would like to make about the oligarchs is that this crisis has done nothing to change the very close interconnection between power and property in Russia that is due largely to the weak institutionalization of the rule of law. This means that as oligarchs disappear, we’re going to see new ones emerge over the next few months. So the system itself hasn’t changed, although the faces might change in the near term.

To summarize, the regional leaders have grown stronger due to the crisis in Moscow, and the influence of the oligarchs has diminished, although they remain an important political force. In fact, regional leaders and oligarchs are the two key organized political forces in Russia today. As a rule, you cannot govern Russia against the wishes of the regional elites and the oligarchs. The real trick for any leader in Moscow is to play on the interests of these two groups and the contradictions between and among them to carve out an area of autonomous power for oneself and to gradually nudge the political system.

Primakov may in fact be the best person imaginable to deal with this situation. Really all he has to do is apply his foreign policy experience to Russia. He is dealing with a situation, which I would call "multipolarity in one country." One of his initial steps as Prime Minister has been to give the heads of the eight regional associations the right to participate in the meetings of the Government presidium as non-voting members.

This fragmentation of power has had both plusses and minuses for Russia. On balance I think the positive outweighs the negative because the fragmentation was a necessary step for the development of a genuine federal system in Russia and for the building of a pluralistic society. The key to taking advantage of this promise is strong, capable, and credible leadership at the center.

This brings me to my second point. Russia has not had such leadership since at least the beginning of the year, and this as much, as much as financial and trade problems, lies at the root of the current crisis.

The crisis will not be ultimately resolved until such leadership emerges. Primakov, even if he manages to stabilize the political situation, cannot fill this void, because the crux of the problem lies not in the head of government, but in the head of state, who is invested with enormous constitutional powers and whose power is amplified by the weak institutionalization of the political system.

In other words, the problem is Yeltsin. Since the beginning of the year, Yeltsin's deteriorating health has raised grave doubts about his ability to govern not only among his sworn enemies but also among many of those who financed his reelection victory in the summer of 1996.

Pressure on Yeltsin to step down has been growing steadily, and his support both within the elites and the broader public has collapsed. According to the Public Opinion Foundation, one of Russia's leading polling agencies, those who had no confidence in Yeltsin's leadership rose from 59% in September 1997 to 90% last week. Over two-thirds of Russians believe Yeltsin should step down.

In addition, Yeltsin's health raises concerns that he will not survive his current term, due to end in the year 2000. As a result, the succession struggle has begun in earnest - and electoral calculations militate against the formulation and implementation of programs that could begin to deal effectively with Russia's multiple ills. In short, the resolution of the succession issue is a prerequisite not so much for stabilizing the current situation as for stemming Russia's secular decline.

This brings me to my third and final point on the succession struggle. Let me begin my stressing that I am confident that the succession will take place according to constitutional norms, that is, we will have a democratically elected successor to Yeltsin by the year 2000 at the latest.

This is not because the competing forces are deeply committed to democratic principles; many are not. But all the key political forces are playing by the rules, in large part because none feels strong enough to violate them.

For the past several months, we have witnessed the slow formation of two new camps in Russian politics. In the spirit of Russian politics, where one of the first questions two politicians ask one another is, protiv kogo my dryzhim (against whom are we going to become friends), I would call these two the "anti-Luzhkov" and the "anti-Lebed" camps.

The anti-Lebed camp is slowly consolidating around Moscow Mayor Luzhkov, one of the great beneficiaries of the current crisis. He is in a much stronger position now than two to three months ago for several reasons. Chernomyrdin's failure to win confirmation as Prime Minister have dashed the presidential hopes of a serious rival to Luzhkov (not even Chernomyrdin's closest advisers believe he has a chance of winning the Presidency if he does not occupy Prime Ministership).

Luzhkov has also positioned himself well to expand to both the left and the right on the political spectrum, and he is already engaged in discussions with both the Communists and Yabloko, the democratic opposition to Yeltsin. And he has hit the right populist note with his sharp criticism of the IMF and his nationalist rhetoric.

The crisis has helped clarify the situation in the anti-Luzhkov camp. Initially, there were two potential Presidential candidates, Chernomyrdin and Lebed, and a key member of this camp, Boris Berezovsky, had thrown his weight behind Chernomyrdin. But the dashing of Chernomyrdin's presidential ambitions has left Lebed as the only viable rival to Luzhkov and the one that Berezovsky is now backing.

Lebed has also emerged a stronger candidate out of this crisis, because he bears no responsibility for it and because, unlike Luzhkov, he can exploit the pervasive anti-Moscow sentiment throughout Russia.

At present, the two are running neck-to-neck in the opinion polls. It is too difficult to predict which one will win -- or if either one of them will win -- because much will depend on when the elections are actually held, whether Yeltsin is still alive at the time, and what the economic conditions are both across Russia as a whole and within individual regions, especially Moscow and Krasnoyarsk.

Anders Åslund: The Economic/Financial Scene

Russia is effectively today in hyperinflation. What we are seeing is that the economy is collapsing, and this will, of course, have massive consequences.

First, we saw in the summer that all financial markets fell -- the stock market, the bond markets and debt markets, and credit markets. As a natural consequence, the banking system virtually collapsed in mid-August before the devaluation. This means that the payment system has collapsed. Approximately two-thirds of banks throughout the country are not operating. This also means big losses in the bank system and enormous pressure on the Central Bank for emission.

The devaluation has brought about a total currency fluctuation so the exchange rate has now fluctuated between 7 and 21 rubles/dollar in the last three weeks. This fluctuation is likely to go downwards. As an immediate effect of this, there was a financial panic so that prices of many domestic goods increased more than on imported goods. This means a shortage of commodities. Also, a shortage of cash. As a natural consequence of this, inflation has exploded. Until July, there was annual inflation of barely 6%; in August, monthly inflation was at 15%; during first 3 weeks of September, 45%. So probably inflation in September will reach 50%, which is the threshold of hyper-inflation.

The real economy is collapsing accordingly. The GDP fell by 4.5% in July, 8.2% in August, and presumably by more than 10% in October. The official forecast is that GDP will fall in the second half of the year by 10%. If anything, this is optimistic. My guess is that GDP is likely to fall 15-20% by the end of this year.

The part of the economy that is collapsing is the modern, monetized economy, what you see in Moscow and the big cities. It is trade, finance, and other modern services. Three-quarters of the Russian inter-enterprise transactions are carried out through barter. One of the effects has been that imports have virtually stopped. Because of constantly fluctuating exchange rates, regional authorities have imposed price controls. Those that import goods can not charge a price that is profitable, so they don’t even take the risk.

There have been large bankruptcies and huge layoffs of staff. My guess is that a few hundred thousand young professionals have been laid off in Moscow alone. This is the young, new middle class that is being massively sacked, the group that has been worst hit. They have no other jobs and few of them will be able to go abroad. The visa regime has become stricter against Russians.

On top of this we have a government that is as clueless as it is helpless. In particular, Prime Minister Primakov, Central Bank Chairman Viktor Gerashchenko, and First Deputy Prime Minister Yuri Maslyukov, who don’t know what to do. Primakov has consulted his old colleagues from the 1990 Gorbachev government. I presume he hasn’t thought of economics much after that. Maslyukov was head of Gosplan and has learned nothing and forgotten nothing. Gerashchenko made his career on hyperinflation and he was very successful in that – why change your winning strategy? Below this there is a decent Minister of Finance, Mikhail Zadornov, who is against emission. He will lose in this struggle.

The government policy has become clear today, when Kommersant Daily published Masyukov’s program. It was a bit worse that I had expected. What Maslukov is proposing is primarily a massive emission of increasing the money supply by 60% by the end of this year. Gerashchenko is comparatively moderate – he only wants to increase it by 30%. If you plan for emission in this situation, you are bound to get something much worse. This means that hyper-inflation is definite.

Maslyukov also is proposing a fixed exchange rate, and as far as I can understand, a multiple exchange rate with far-reaching currency controls. In order to improve the budget, he proposes both substantial tax cuts, primarily on enterprises and more expenditures, primarily for industry. He wants the indexation of wages and pensions, and licensing of exports and imports. Such measures represent a return to the Gorbachev economic strategy that failed so totally in 1991.

The worst is that he is not joking with us. What will be the effect of this? We saw already in September that tax revenues fell by almost half for the federal level. The regions will be pressed. We are already seeing that regions like Kaliningrad are taking over the federal tax service and keeping the revenues for themselves. They are introducing massive price and export controls so that food does not leave the regions.

You can’t pursue this policy for long without an external default. Two weeks ago I asked Chubais and Gaidar about this. Chubais thinks Russia will default within two months and Gaidar within four. External default before the end of this year is definite.

In this situation when the Russian government is determined to do wrong, the West can do nothing. There is no way that the West can influence this situation.

What is the fundamental problem? Why did we end up in this situation? I think that the general answer is very clear. We have known the problem and nothing has been done about it. Why hasn’t anything been done? The short answer is that there have been corrupt elites competing for every penny rather than thinking even minimally about the common future of the country. More specifically, we have had a large, corrupt federal government apparatus, which expanded by almost 2 percent of the labor force under Chernomyrdin. There has been no incentive to be a decent top-level businessman. The incentives have been in favor of corruption. Of course this also comes down to the Duma, which has communists and nationalists favoring a very regulated economy that naturally leads to massive corruption.

What is likely to happen? There is an almost 99% chance of total meltdown of the economy. I think there might be two months of Primakov, followed by a total discrediting of his government, and then Luzhkov comes in (who has been arguing for similar policies) showing that he can do as badly, and after that, why not the communists in a couple of months? Something like this is very possible. Whatever is true politically today is likely to be totally different tomorrow.

I saw one opinion poll that showed that 57% of the population were against emission, and only 25% were in favor of it, which suggests that people might better understand a market economy than we give them credit for.

Finally, what kind of scenarios are likely? I think that this is a very good parallel to the Bulgarian economic collapse two years ago. It is likely to be faster and the political effects might be slightly different. The alternative would be like Slobodan Milosevic’s Yugoslavia, where you have a stabilization but no liberalization, nor any far-reaching democratization. The third scenario is sheer chaos, which I refrain from elaborating on. I find it difficult to believe that after hyperinflation some kind of populist-like Luzhkov or Lebed would be a plausible alternative.

Martha Olcott: The Spill-Over Effect to the Neighboring States

The bad news is that it is very hard for the Soviet successor states to insulate themselves from the economic and political impact from Russia. The good news is that there are probably a few things that we could do. My concern is that we are so overwhelmed by the crisis in Russia that we are not spending enough time looking at the impact of what is going on in Russia on other states. Combined with this is the reluctance of the states themselves to talk about the severity of the impact of Russian crisis. They don’t want to further destabilize investor confidence in them.

Part of what is going on in Russia is a systemic crisis. This is the part that is affecting the other CIS states. Declining global confidence is exaggerated by the collapse of the ruble economy. As Yeltsin fades, the power of leaders in other states may diminish as well.

I’d like to highlight three different economic problems that characterize the states, and I concentrate on the Caspian states.

There is a general decrease in investor confidence. (Kazakhstan’s bank and currency ratings have been downgraded after the collapse of the ruble.) That meant that they had to postpone several treasury note emissions and also their third euro-bond emission. It also led to a thirty- percent drop in the value of their currency. What this has led Kazakhstan to do, because they are committed to a balanced budget, is to sell off a bunch of resources at a much lower rate than they had planned. As they try to increase investor confidence, what they are essentially doing is offering "bargain basement" oil and gas. That in the long run is not good for the state.

A characteristic of all these states is that they did not separate themselves fast enough from the ruble zone and now they can’t fully insulate themselves from the collapse of the ruble. They are not part of the ruble zone formally, but they are still affected by what goes on in the ruble economy. There is declining trade with Russia, which in Kazakhstan’s case comprises more than half of trade with Russia. This collapse is occurring in many ways: state-to-state trade, increased pressure on debtors to meet obligations to Russia, Russian investors pulling out their stakes. In Armenia, Russians held more GKO’s than anybody else.

The Caspian states are losing their remittances from Russia. Wages earned in Russia and transferred back home are a principal source of income for about a third of all households in Azerbaijan and Georgia, and a smaller but significant number of households in the other Caspian states. In addition, pensioners throughout the region are dependent upon support from Russia. This is especially critical in Kazakhstan. The collapse of the Russian banking system has cut off these revenues. Millions of dollars worth of ruble transfers will disappear forever with the collapse of these banks.

Moreover, the Russian collapse is going to permanently take away the jobs of many of these people. In fact, for the first time people living in Russia are going to be travelling to neighboring states to seek employment rather than the other way around.

Signs of Yeltsin’s political mortality are further emboldening the opposition in many other CIS countries, as they appear to signal that the time might be right to stage transitions in these other countries as well. Because the regimes are having a hard time delivering economic goods, oppositions have strengthened. As everybody is going to see Yeltsin’s departure, it will be an attractive time for illegal replacements of other leaders or quasi-replacements. Azerbaijan shows the most visible signs of elite struggle. Public manifestations of opposition to Aliev have been mounting. While honest estimates are hard to come by, the crowd at the most recent demonstration seems to have been four or five times the official figure of 5000 (but well below the opposition’s claim of 100,000). These demonstrations are certainly cutting into Aliev’s legitimacy, although much will depend on the size of the voter turnout on October 11.

Finally, can the U.S. respond? If we want these leaders to survive until legally-based successions, we must focus on the shorter-term risks these states face. The most important problems concern budget-balancing, social safety valve issues, and not just concern with the longer-term investment climate. Even without the spillover effects of the Russian turmoil into the successor states, they will be in extreme duress in next two to three years, way before any of these major investments will start to provide revenue. Here I think we can help them insulate, if we take a shorter-term perspective.

QUESTIONS and DISCUSSION

The names of those who posed questions have been omitted. Please also note that those parts of the discussion that are inaudible in the taped recording are not included in the transcript.

Question: It's not a great surprise that Russians have devalued the ruble. The ruble is the only currency left among commodity producing countries that has already fallen by 20-30 percent this year. The big surprise was the shock that led to the collapse of global financial markets since August is that Russia would default on its multiple-currency debt, not dollar security, not d-mark securities, but ruble securities. Every country in the twentieth century that has had a domestic debt problem had just had inflation... Why did Russia pursue an action that would destabilize its own banking system, which created problems for all those corporations with GKOs and then just guarantee to reduce all this stuff to the markets indefinitely? Why didn’t they just go the route of having an inflationary solution to the deficit problem?

Åslund: An inflationary solution would also have brought the banking system to the complete halt, so I don't think that there were many obligations…(inaudible)…

Question: At Carnegie I’ve heard that Russia’s future is bright, that a market economy is an accomplished fact, that politically democracy is spreading, participational talk. Now I hear that the market economy is retracing its steps, that the political democracy is not taking root, in fact, there is a Milosevic in Russia. Now, a question to Arnold: how come most analysts in Washington failed to anticipate this crisis?

Horelick: Since I agree with the premise of the question, I am the wrong person to address the question to. I respectfully hand that over to Anders, who comes closest at this table to fitting the description of the people whose explanations you are after.

Åslund: I wouldn’t argue that I’ve been wrong. The big question here is explaining. I was discussing this with Chubais and Gaidar. I think that Gaidar’s conclusion is interesting. When we were arguing in early 1992, I was very much pushing for early elections in Russia but the whole government was against this idea. They said: "We don't have time for it. On top of it, (inaudible)… and the parliament will not accept it." Now Gaidar argues that there can be no reformist legislation without a reformist majority in parliament. The parliamentary majority for an economic market reform really turns out to be a fundamental precondition. I had thought that privatization in Russia could function as a substitute for the parliamentary base, drawing, for example, upon European land reform in the first half of the 19^th century that functioned as a base for the democratization that later happened. With the intrusive Soviet-style government, that turned out not to be possible. This conclusion holds very well for Bulgaria and Romania that did not go anywhere when they had post-communist majorities in the government. Or take Ukraine or Belarus. This is a general conclusion: the problem is that you need a parliamentary majority for economic reform. Otherwise, you are not likely to succeed. But I don't think it was obvious that this would be the case.

Mathews: How much of what we failed to see about what was really happening was a result of what we felt that we had to see in support for the Yeltsin government? How much was self-delusion?

Graham: This is a difficult question to answer. Of course, because I was part of it for four years, reporting from Moscow and I am not really in a position to reveal what I was reporting at that time. This all began in the Gorbachev years. We didn’t really understand what had happened in the collapse of the Soviet Union. We saw it as a revolution when in fact there was a great deal of continuity that we didn’t see, particularly in the political system. There was an argument in 1991 over whether they should have held parliamentary elections. And, perhaps, they should have. We must remember that in 1991 Yeltsin’s allies were people like Rutskoi and Khasbulatov, the same people he had problems with in 1993. So it is not clear to me that an election in 1991 would produce a parliament that would have been any more favorable to the reforms undertaken by Chubais and Gaidar in 1993. Second, I think we did get caught up in our own ideology of the "end of history," worldwide victory of markets and democracy, and we continued to look for evidence that this was in fact happening rather than the contrary evidence. We saw this in the reporting from Western correspondents in Moscow, and if you were working in the government, you wanted to report policy success. We paid less attention to information that suggested that we should change the policy, or that it wasn't working out the way it should have.

In our analysis of current Russia and Soviet Russia, we were too focused on Moscow, and too focused on a small group of individuals, who we abdicated responsibility to report on Russia for us, a group that had a vested interest in its succeeding and obtaining Western support along the way. If we had traveled more to the union republics during the Soviet period, or into the regions of Russia over the past several years, we might have found that reform was not working in a way it was depicted in Moscow or in Washington. In fact, it had a much tougher road to travel than any of us thought it would.

Question on fragmentation: How can any successor deal with this? No matter who becomes the next president there is continued fragmentation and an inability to govern Russia. You get a government that really is a government of coalition that works with the regions, really changes the nature of power and makes it cooperative decision making to make it a different kind of Russia. Or an authoritarian leader who will impose order on all these groups. Which way do you see things going?

Graham: The problem with any authoritarian coming to power in Moscow today is that he is going to find out that all those levers in the Kremlin are not connected to much of anything. You have to reassert your control inch-by-inch within the Kremlin and in Moscow and beyond. Any authoritarian leader would find tremendous resistance outside of Moscow. It seems that the solution to the problem, if there is one, is not cooperation with all 89 regional leaders, but a political leader who is smart enough to realize that there are really only a dozen or so regions that count much because of population, resources that they have and where they are located in the country. The real trick is to find a way within the institutional structure of Russia now to bring those people into the decision process, to cut some deal with them that allows you to collect taxes and extract resources from those areas so that you can begin to rebuild the institutions of the central government. I have in mind three: first of all, the security agency, the military and police forces that will allow you, in fact, to enforce decrees across the country. The trade-off might be investing whatever types of resources you have in developing the economies of those regions. If that happens, I don't know at this point. I don’t see any political leader in Moscow with Moscow base that has a handle on the regional nature of the problem in Russia. Most of them, like Primakov himself, tend to fear disintegration and then they look for solutions, largely trying to compel these regions to do something when they don't have any lever to do it. So I am not optimistic on that regard. The one leader, who may have a chance of doing this is Alexander Lebed because he is not Moscow-based, has never been a part of Russian the elite the way Luzhkov and even Yavlinsky have been. He is based in Krasnoyarskii Krai, in fact, doing a lot of work with governors in that region, trying to form a broad-base coalition for him.

Question:  I would like to make a comment on what I've just heard. Now we hear everywhere a lot of doomsday scenarios concerning Russia. I won't deny that the situation in Russia is pretty difficult, as it has been during most of time of the reforms. I've just heard that nobody in the Russian government knows what to do about politics or about economics. Well, everyone might have his or her own opinion on that, but let's have a look at the succession of governments of Gaidar, Chernomyrdin, Kirienko and they seemed to know exactly what to do. We've seen what they have done. I don't know whether it will be necessary to change the course of the Russian politics if that policy succeeded. Unfortunately, the policy did not succeed and that's why we have to readjust politics in Russia. I think we should talk not about going back on the reform but we should talk about adjustments of the reform. I think that this government will bring more common sense to the Russian domestic policy. Some things were really foolish and if we continue that policy what would we have now? I don't have the whole country on strike when we talk about fragmentation and the collapse of the whole federation because you must be… (inaudible) …that's not against the market reforms. I think this government has done a few good things already. For example, the back wages to the military were paid this month, soon the students in high school and universities will have their allowances, and maybe by the end of this year we will be able if not to pay back the debt on salaries then to set forth a mechanism to enable Russia to pay salaries and wages every month. I think this is most important. In light of all of that I just ask you to give Primakov, give this government a chance. They are not are not worse than the government before them.

Question: (Questioner spoke of a positive meeting of the Latvian Foreign Minister with Lebed in Krasnoyarsk, "perhaps the friendliest meeting any Latvian has had with a Russian for the longest time.") Governor Lebed pointed out that here there are no Russians, no Latvians, here we are all Siberians. To what extent is Lebed accepted by the regions as one of their own? Is Lebed’s support broad-based? If that were the case, if there is face-off between Lebed and Luzhkov, the regions versus Moscow, wouldn’t the numbers favor Lebed?

Graham: I think it's too early to say at this moment. One of Lebed’s advantages is that he has never really been part of the Moscow and Russian political elite. His experience has been outside of Moscow for the most part – Afghanistan, Transdniestr, and Krasnoyarskii Krai. He also has an advantage of having only served three months in Moscow as the Secretary for Security Council and having been dismissed or fired by Yeltsin. That's something that will give him a lot of favor outside of Moscow as well. The reason I hesitate to answer the question positively is that Luzhkov has also over the past couple of months and years tried to use resources at his disposal to cut deals with regional leaders, largely barter deals or donations of money to keep places like Samara, Saratov, etc. and to earn political I.O.U’s that can presumably be cashed in during elections. I think at this point if we look at the regional support Luzhkov and Lebed are head-to-head. Lebed has greater latitude for expanding that over time therefore, he does not have an interest in early elections, where Luzhkov has probably reached his high point and it a matter of doing it now or declining, relatively speaking, in the polls.

Question: I’ve heard a lot of overly optimistic scenarios for Russia. But I am somewhat struck here by "mea culpa" about how we got it wrong, how we didn't understand, how we didn't see what was going on, if we only gone to the country… I don't think this is really true. There were people like Tom and Arnold who had a realistic view…What was the alternative to supporting Yeltsin? Should we have supported the communists? Should we have supported the enlightened Mr. Luzhkov? Could've the U.S. or should've it had done something else and what is it that we should have done?

Horelick: Earlier on we should have paid more attention and we should have encouraged our partners in Russia to pay more attention to the need to build a social base of support for reform. Russia’s Choice, under the most propitious circumstances imaginable after the October conflict with the parliament, when the press was oriented in that direction, put on its only serious electoral effort, which was a complete disaster. I think it was obvious to anyone on the outside who was watching the campaign on the outside not only didn’t they have a clue, but also they never took seriously the need to educate the gray masses. Since then, there has been no real effort to build a constituency for the kind of reform they were trying to do.

Our failure was partly ideological. That is because we saw Yeltsin as the guarantor of stability in Russia. As long as Boris Nikolayevich was in office, we felt that democracy would take care of itself, that the political system was on an autopilot, that we didn’t have to pay much attention to it. I believe we made a very bad mistake in ignoring Chechnya, which was the greatest violation of democracy. We had an ideology which said, "if you get the macroeconomic stabilization indicators right, if you can control inflation, if you can have a stable currency, then somehow you will then get the economy right, maybe not right away but in due course." We didn’t pay much attention to the real economy, but rather concentrated our efforts and the Russian reformers concentrated their efforts year after year on getting the macroeconomic indicators right. By 1997, it seemed that they got it right, but meanwhile there was no economic growth, no growth in the productive part of the economy to give them a larger tax base. So the mantra was: get macroeconomic stabilization right, that will get the economy right; get the economy right, that will undergird democracy. Get democracy undergirded and you will have a benign and cooperative Russian partner. Meanwhile, Boris Yeltsin would be the watchman at the gates to prevent untoward political developments. I think that was the prevailing attitude in the U.S. political establishment.

Mathews: In the last few years there have been literally dozens of questions like "how did we miss cronyism in South East Asia?" A big part of the answer is that we are dealing with an economy that is brand new in its fundamentals, very like the situation in this country after the civil war when we didn’t have a clue what was going on really with new industrial capitalism we had built and the groups and trusts, and we tried dozens of policies, some of which worked and some of which failed. For a long time we were on a roller coaster.

Question: There is an argument abroad that challenges [previous questioner’s] premise, which goes like this: the Russian meltdown was the result, at least in part, of exogenous factors and bad luck. Had the price of oil not fallen, if emerging markets hadn’t become poisoned, then they could have muddled through. To what extent do you think that this is fair? Second, for Tom: What do you think are the chances of Anders optimistic scenario coming to pass? His argument is that the best outcome is a Bulgaria scenario, but that requires what has been missing, and that calls for a political constituency for "neo-liberal" measures. As Arnold notes, in Russia there is no constituency for such measures. Under what circumstances might politically relevant Russians (the now-shattered middle class which benefited from these policies but has been apolitical, the oligarchs who've been venal, the regional leaders who are simply getting started) coalesce in favor of what we would regard as an economically sensible policy?

Åslund: In a way I think that Russia would have gone this way sooner or later because the debt exposure is so large. What investment bankers are talking about is that the total loss is $150 billion in Russia. It's a bit too much money. Of course, Russia was very slow to react. When the Asian crisis hit at the end of October last year, when the Hong Kong stock market fell sharply on October 27, Russia had just completed a deal between Chernomyrdin, effectively Berezovsky, and the communists on how to increase the budget deficit.… .(inaudible) …. Therefore, it took Russia 3-4 months to react to the crisis. You can say, if Russia was in a different political track, say if the Asian crisis hit in March of 1997 when Russia was on a different political track then, perhaps, it would have been possible to do much more. So, I think that it was not quite inevitable. In hindsight, everything tends to look very natural.

Graham: Let me take refuge in Arnold’s answer. If there is a movement in that direction, it is not going to be led by those who led the radical reform efforts. I see very few political organizing skills on the part of people like Chubais and Gaidar, and probably the person who understands it best and is closest to the process, someone like Boris Nemtsov, also doesn't impress me as someone who is going to take this by the horns and do something about it. Will there be other forces that will eventually come around to this view that the reform in retrospect looked (inaudible). Certainly so. This will be distributed across Russia but you are not going to find it concentrated in any specific area. What you will see is local efforts at reform, at a time when the center is weak and incapable, which will serve as models for the rest of the country. In the longer period they will become models of economic growth. They will provide a lesson for the rest of the country. That is a more plausible scenario for getting Russia to where we would like it to go. Some national movement that will seize power in the center of Russia or will likely implement this reform.

Mathews: Nemtsov was asked why wouldn't he, Gaidar and Yavlinsky work together on building a political constituency. His answer was: "Three is not such a very small number."

Horelick: Nemtsov has made the case that all the democratically inclined liberals and neo-liberals should get together. He mentioned himself, Yavlinsky, and Gaidar. Frankly, my impression of that is that if Yavlinsky now has 12%, if he unites with Chubais and Gaidar he will have 2%. There is no incentive for Yavlinsky, who controls the largest potential bloc of democratic voters, to unite with them. I think that strategy is a hopeless one.

Question: Would you agree that Lebed frightens the oligarchs a lot less that Luzhkov does because he is somewhat less predictable? My sense of Luzhkov is that he is frighteningly predictable. If he gets into the Kremlin he will destroy some of them and he will subjugate the others, and you have a plutocracy of one. At least Lebed is somewhat unknown. They don't know whether they can buy him, or if they buy him whether he will stay bought. In this very difficult time for Russia and the US-Russian relationship and our policy, how do you make a case for engagement to a skeptical Congressman when all of our partners are either discredited liberals, communists, nationalists, derzhavniki, or crooks and the content of the policy of engagement is either …(inaudible)? And you are reduced kind of to the bottom line which is ten time zones and 20,000 nuclear weapons, kind of North Korean argument with …(inaudible)…. In these difficult times. I personally believe that we have to maintain engagement. Which kind of engagement, and how do we sell it?

Horelick: The Administration is in a quandary because they are looking for a formula that doesn’t promise more than it wants to or can deliver now, that is to say, for the time being, the notion of direct financial assistance through international organizations, much less directly from our government, is out of the question. I think Moscow is beginning to understand that. The deal Moscow wants DC to consider is not so much an early return to the IMF program. I think they are looking for a deal on debt restructuring, which is difficult for the administration precisely for the reasons that you've indicated. However, the exposure of the United States is somewhat less than the exposure of our allies. In return for that, you will get from Primakov an international cooperation dangle like a hard push for START ratification very early on. The best thing the administration can do is to say that is is waiting for this government to get its act together, to say that we are looking for grounds to cooperate with and assist Russia. We’re looking forward to doing that. The problem for the administration with the Congress is going to become intense because they are looking in return for any financial assistance very concrete quid pro quos in foreign and security policy. This will intensify the struggle that we already see where the Republican majority in the Congress tries to limit the administration’s flexibility it has to deal with Russia. It is going to be a very hard call. Policymaking on Russia is going to be a hard challenge.

Graham: A year ago at this time when I talked to these oligarchs, the reason not to support Lebed was that he was unprincipled, unpredictable and would be a disaster if he came to power in Russia. This is one of the reasons they tried to determine whether Chernomyrdin was a viable presidential candidate. He is a good old boy, he is predictable and they finally realized that it simply would not work. He doesn't have a personality, he doesn't have a political base to become president. And then the choice is exactly what you said. You know Luzhkov, you know what his principles are, you know that you are not going to survive in that regime, so let's try Lebed and see what we can do, whether Lebed can be bought or not.