Goldman Sachs and the dark days of Russia

If the reforms of the early 90s continued there would be no MiG or Sukhoi today. Source: Flickr/SEIU International

If the reforms of the early 90s continued there would be no MiG or Sukhoi today. Source: Flickr/SEIU International

The return of Goldman Sachs to Russia is a throwback to the dark days of the early 1990s when Western advisors played a catalytic role in the collapse of the Russian economy.

In the year 1995 a Russian entrepreneur rigged a public auction and bought a majority share in a state oil company. Using fraudulent bookkeeping, the newly minted capitalist transferred profits from the company into multiple bank accounts outside Russia. In a few short years, he had transferred the ownership of the company to a bunch of illegal offshore companies. Even as millions of Russians were reeling under hyperinflation and poverty brought about by hasty economic ‘reforms’, this entrepreneur became the master of a multi-billion dollar oil company, and consequently the richest man in Russia.

The man was Mikhail Khodorkovsky and his company – Yukos. Khodorkovsky’s spectacular – and notorious – rise, like that of many other oligarchs in post-Soviet Russia, was made possible by the appallingly naïve decisions of a bunch of economic reformers such as Yegor Gaidar, who facilitated the loot of Russia’s fledgling market economy.

Much of this open loot took place under the watch of Gaidar and his colleague Anatoly Chubais, both appointed by then president Boris Yeltsin.

Goldman Sachs and shock therapy

It is delicious irony that back in 1992 it was Goldman Sachs that had been appointed to attract investment into Russia and plant the seeds of capitalism in Russia’s communism-soaked soil.

It wasn’t the only Western advisor. The International Monetary Fund was already offering advice on managing the foreign debt, and Harvard University economist Jeffrey Sachs was working as a consultant on overall economic policies.

In 1992, the Russian government was also receiving similar advice from the US law firm of Cleary, Gottlieb, Steen & Hamilton. Its offices were located just two floors below Gaidar’s. It seemed all you had to do become an advisor was wear a suit and land up in Moscow.

However, many Russians had begun to question the undue influence such advisors were wielding in their country. One member of Parliament alleged the IMF was now running Russia’s economy. Newspaper stories cited examples of American firms swindling gullible Russian partners.

The ‘reforms’ soon kicked in. The first blow, just before winter in 1992, was price liberalisation – free market prices for most goods were introduced and the government could no longer control them.

However, the situation slipped completely out of control. Initially, the government predicted a threefold rise in prices and, based on that forecast, planned increases in pensions and salaries for public servants. In fact, prices rocketed 10-12 times higher than they were prior to the reform.

As a result of the hyperinflation, millions of Russians lost their life savings and found themselves below the poverty line. Many were selling their last family possessions in the streets to survive. Perhaps the saddest sight was that of pensioners reduced to selling their treasured WW II medals for a loaf of bread.

Those were indeed the dark years of Russia. The welfare economy that had ensured cradle to grave security for three generations of Russians was dismantled without a thought as to what would happen to ordinary people.

 The case of Elektronika

The foreign advisors started issuing orders for closing large numbers of plants from the approximately 25,000 state enterprises. One such unfortunate target was Elektronika’s plant in the industrial city of Voronezh in southern Russia. The electronic firm was a leading producer of televisions, radio sets and tape recorders among other things.

Sushil Kumar, who lived in Voronezh those days, said, “Those days anything and everything was on sale. A leading West European electronic firm grabbed the opportunity to buy the shares of Elektronika, ostensibly to improve the quality of Russian electronics and then to produce the Western company’s own products locally.”

About the quality, many foreign users like Kumar were happy with Russian electronics. “Though not as refined as Japanese consumer products, they did their job and more importantly they had a reputation for ruggedness,” he told RIR. “At any rate they were way above the quality of electronics available in India and other developing countries those days.”

However, plans to improve quality existed only in the press releases of the Western MNC. A few months later, it simply closed down the plant. The void that resulted was quickly filled with its own imported products. It was carnivorous capitalism at its best.

Another large Voronezh aviation company, which had earlier produced passenger aircraft, was also shut down. Thousands of jobs were lost.

The closure of the crown jewels of Russian industry, and their sale without adequate compensation to the state or ordinary people was one of the greatest swindles of the 20th century.

The ones that got away

Not all Russian companies faced the guillotine. The Western advisors now asked the Yeltsin Government to cut off subsidies to ‘inefficient’ state companies, which would result in more millions being out of work. In the meantime, the IMF was demanding that inefficient Russian banks be closed down too.

Here the Gaidar team met stiff opposition. The managers of the state companies, well represented in Parliament, demanded his ouster. To be able to continue his reforms, Gaidar asked his Western advisors for $24 billion in loans. Much as the West wanted to close down Russian industry, and in the process remove a major rival from the global markets, it did not have the heart to sink $24 billion into the country. Gaidar was history.

Think about it. If the reforms had continued there would be no MiG or Sukhoi today. The Russian banks that were unscathed by the economic meltdown of 2008 would not have been around. In contrast the Western banking system – which was the IMF’s role model for Russia and the developing world – is in a mess. No wonder IMF advisors have sought alternate careers.

More than one way to market

People who continue to say that Gaidar’s shock therapy was vital because Russia’s state owned sector was a mess are liars. The only question is, are they lying to themselves as well?

For, there was no need to throw Russia’s state sector under the bus. Yes, there was inefficiency, corruption and absenteeism but mark that these were not third world enterprises. These were companies that sent the first spacecraft to land on the moon and Venus; these were enterprises that built mighty icebreakers, submarines and some of the finest aircraft ever built.

As Poland and Czechoslovakia showed, there was a less traumatic path to full capitalism; there was a more humane way to turn swords to ploughshares. Perhaps the best example is China’s state sector, which is competitive enough to overwhelm Western private sector giants. Similarly, India’s state oil majors – once known for their sloth – are today aggressively planting the national flag in nearly every hydrocarbon patch on earth.

However, in their rush to embrace the market and by their blind acceptance of the advice being peddled by the likes of Goldman Sachs, Gaidar and Chubais simply forgot the most important factor – the people.

Goldman Sachs - II

History repeats itself, first as tragedy, second as farce. Nowhere is this adage more appropriate than in present day Russia. Goldman Sachs’s first tryst with Russia was an unmitigated disaster. More than two decades later, whether Goldman Sachs can help attract capital is highly doubtful. Private investment is entirely based on sentiment and goodwill. Russia just needs to curb organised crime and corruption and the rest will fall in place. A country with unlimited natural resources simply doesn’t need to undergo such contortions to attract investment.

Whether Goldman Sachs’ second attempt will be farcical is for time to reveal.

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