RUSSIA WATCH



[pic] RUSSIA WATCH [pic]

No.3, October-November 2000

Graham T. Allison, Director Editor: Ben Dunlap

Strengthening Democratic Institutions Project Production Director: Melissa Carr

John F. Kennedy School of Government Editorial Staff: Emily Van Buskirk,

Harvard University David Rekhviachvili, Emily Goodhue

RUSSIA’S REMARKABLE TURNAROUND

The events of August and early September illustrated the symptoms of Russia’s economic travails—and highlighted a challenge for economic recovery: chronic lack of investment in infrastructure. But figures from the first half of 2000 tell a different story: all the important indicators show Russia’s economy on the rebound.

—See page 4

TOP NEWS OF AUGUST-SEPTEMBER

• Moscow Bomb Blast Kills 13

• “Kursk” Nuclear Sub Sinks During Exercise; 118 Perish

• Moscow TV Tower Blaze Leaves 15 Million Without TV

• At UN Summit Putin Proposes Proliferation-Proof Nuclear Fuel

• Security Council Proposes Troop Cut; Putin Postpones Decision

• Putin Signs New “Information Security” Doctrine

• Gusinsky Hedges on Media-Most Sale To Gazprom; Says He Had Signed Deal With “Gun To His Head”

• Berezovsky Cedes 49% Stake In ORT, Cites Government Arm-Twisting

AUGUST AND SEPTEMBER IN RUSSIA

Kursk Disaster to Spur Military Reform?

Vladimir Putin made military reform a priority even before the Kursk nuclear sub—the pride of the Northern Fleet and vanguard of Russia’s nuclear defenses—sank to the bottom of the Barents Sea during training exercises in August, killing all 118 sailors on board. Only the day before the Kursk sank Putin told his Security Council, “Our task is to work out the future development of the armed forces, taking into account the state’s needs and means; our actions must be based on economy.”

The Kursk tragedy focused the attention of Russian citizens on the dismal state of their country’s armed forces, and brought into sharp relief the difficulties of operating a superpower military on a defense budget one-sixtieth the size of America’s.

The Security Council has proposed a 350,000 troop cut in the nation’s armed forces—from 1.2 million to 850,000. Also on the table is a plan to transfer command of strategic nuclear missiles from the Strategic Rocket Forces to the Air Force. Defense Minister Igor Sergeev, who came to the job after serving as commander of the Strategic Rocket Forces, has bitterly opposed the move. The Chief of the General Staff, Anatoly Kvashnin, who has argued for cutting funding to strategic missile forces and building up conventional forces, appears to have gained the upper hand in his struggle with Sergeev. The General Staff recently announced that 96,000 servicemen, 40,000 of them from the Strategic Missile Forces, will be dismissed from the Army and Navy in 2001.

At a subsequent Security Council meeting at the end of September, Putin postponed a decision on the scale of down-sizing, saying “there will be no wholesale, massive reductions of the Russian armed forces.” Instead, he proposed a “five-year plan” for reforming the military and security structures. Calling for a military that is “more compact but more effective,” Putin raised the possibility of cutting some 600,000 military and security personnel in the next five years. What will the army do with the money it will save? Spend it on training, fuel, and servicemen’s pay, says Putin. A final decision on military reform is expected in November.

In UN Speech, Putin Calls for Proliferation-Proof Nuclear Fuel

In his speech at the United Nations Millennium Summit in September, Putin expressed alarm at plans for the “militarization of outer space,” praised the 1972 Anti-Ballistic Missile Treaty as the “foundation” of disarmament, and called for redoubled efforts to prevent nuclear proliferation. Most notably, he used a portion of his allotted five minutes to advocate a radical plan to help block the spread of nuclear weapons. Putin proposed excluding the use of highly-enriched uranium and pure plutonium—which can serve as components of a crude nuclear weapon—as fuel in civilian nuclear power plants. Instead, he called for implementing existing technology that would allow use of “proliferation-proof” fuel in civilian reactors.

Independent Mass Media: the Few Become Fewer

Vladimir Putin rarely misses an opportunity to extol the virtues of democratic freedoms, especially before international audiences. He has said that a free and independent press is indispensable to Russia’s development as a strong and prosperous country. But when Putin pronounces the words “freedom of press,” they seem to have some special meaning known only to him. Indeed, once, when asked by a reporter about freedom of press Putin responded: “you and I understand that term differently.”

Putin’s contradictory thinking about the role of mass media in Russian society is reflected in the new “information security doctrine,” drafted by the National Security Council and signed by the President in September. Much of the document in fact attempts to address Russia’s legitimate concerns in the area of information security, including protection from hackers, spies, and cyberterrorists. But a few key points illustrate the apparent unease and confusion that many in the Putin government—especially those with a state security background—feel about the relationship between the state and mass media.

For example, the document includes references to the “constitutional rights” of individuals to receive and impart information, and to the state’s need to “defend national interests in the information sector as defined by checks and balances safeguarding the interests of the individual, of society, and of the state.” But it also hints darkly of threats to Russia’s national interests posed by unspecified foreign powers, media outlets, and foreign journalists.

While the new information doctrine represents an effort to define the government’s attitude toward the exchange of information in principle, events of the last two months shed light on the government’s relationship to the press in practice. Russia’s state-run natural gas monopoly, Gazprom, is trying to seize control of Vladimir Gusinsky’s private media company, Media-Most. And influential businessman and one-time Kremlin insider Boris Berezovsky claims he was pressured by Putin’s chief of staff to give up his 49 percent stake in the nationally-broadcast ORT television station.

Were the government to gain control over Media-Most’s NTV station, and Berezovsky’s ORT, the media landscape in Russia would change significantly. Average viewers, who before could choose among three channels—the government’s, Gusinsky’s, and Berezovsky’s—would have only one choice: a channel financed and controlled by the state. Freedom to receive and impart information, which before meant the right to choose among three channels expressing different viewpoints, would mean the right to receive one point of view: the state’s. The government, which before was held accountable for its actions by critical (if sometimes biased) reporting on competing networks, would be free to spin its own version of events, without fear of opposition. As US Secretary of State Madeline Albright said recently, “Nobody is going to believe that the Russian government is committed to media freedom if independent television is under government control.”

Of course, the struggle for control of Media-Most and ORT is not really so simple. Media-Most is heavily indebted to Gazprom and has been negotiating a shares-for-debt swap because it is unable to meet the payments. The company’s owner, Gusinsky, is facing fraud charges for allegedly moving its prime assets offshore. The gas company won a court order freezing the media outlet’s shares after accusing Gusinsky of failing to pay debts and reneging on an agreed sale of $773 million in cash and debt cancellation.

Berezovsky, who claims he was threatened with imprisonment if he refused to give up his shares in ORT, used the TV network and its chief political commentator, Sergei Dorenko, to propel Putin into the presidency by viciously attacking his opponents last year. When Berezovsky announced in September that he would give up control over his 49 percent stake in the company, it turned out that he was entrusting its management in a select group of journalists and intellectuals—many of whom are actually working for Berezovsky.

If the battles between ORT and its government minders, or between NTV and its creditors, were routine disputes among media empires in an established market economy, the solution might be simple: let the two giants and their lawyers duke it out in court; if they can’t resolve their dispute, viewers can always change the channel.

The problem in the Russian case is that ORT and NTV are the only alternatives most Russians have to government owned and managed TV.

The media are rather like another democratic institution in post-Soviet Russia: political parties. Parties are also weak, fragmented, and subject to pressure at the fringes. They are also highly dependent on big business and big power on the national stage. Yet Russia’s political system functions because existing parties represent a range of views and positions that roughly correspond to the beliefs of their members and constituents. The pluralism of the media market works in the same way. Having a range of imperfect choices is not ideal, but it is better than having no choice at all.

It is probably natural that Putin, in his effort to “restore order” in Russia, which is itself a highly popular proposition among ordinary Russians, should get around to straightening out the state’s relationship with the press. And it may be unrealistic to expect that a former KGB colonel, no matter how sincerely he espouses democratic ideals, should place the interests of “freedom of press” above the interests of state security.

But it is noteworthy that a Russia attempting to make the leap into the 21st century global economy is at the same time closing off its citizens from the outside world. Attempting to transform its economy into one in which information is the most valuable commodity, the government is simultaneously restricting the flow of information into and within Russian society.

Freedom of press in Russia is not dead—yet. Cases of outright censorship by the state are still few, and the state tolerates criticism that would have been unthinkable ten years ago. But pluralism of ownership and control of the country’s biggest and most influential media outlets is under attack, and the prospects for true media independence—financial as well as editorial—appear to be diminishing.

–Ben Dunlap

Russia’s Economy:

Rising from the Ashes?

Of the 190 nations around the world, which national economy has:

• Doubled its economic growth rate from 3 percent in 1999 to more than 7 percent per annum in real terms during the first half of 2000;

• Over the same period has more than doubled real disposable incomes of its citizens;

• In the first half of 2000, seen personal consumption increase by 7.8 percent, capital investment by 14 percent, and government consumption by 6.2 percent;

• In the first half of 2000, reduced inflation by half from the rates observed in 1999;

• More than doubled its national reserves as its currency has strengthened relative to the dollar;

• Had a trade surplus of $35 billion in 1999 which is on a schedule to double in 2000, with a current account surplus of more than $25 billion in 1999 that will increase significantly in 2000;

• Seen Central Bank reserves more than double in the past year;

• Had its debt rating upgraded twice in the past year;

• Seen federal government revenues more than double in the past year;

• Run a primary account surplus of more than 4 percent with an overall surplus of almost 2 percent of GDP;

• Seen its stock market increase by more than 125 percent in dollar terms in the past year;

• Seen foreign direct investment more than double in the past year.

Which national economy?

Russia.

The fact that so much good news seems so surprising, indeed almost incredible, reflects a combination of resentment for the August 1998 crash (“fool me once”), fatigue with Russia, and skepticism. While such sentiments are understandable reactions to recent experience, they can distort perceptions of Russia today.

As Vladimir Putin has agreed, Russia’s economic growth following the August 1998 crash has been due in large part to rising price of oil on the world market (oil prices have tripled since the end of 1998), and the devaluation of the ruble, which made Russian goods relatively cheaper on foreign markets and spurred growth in domestic production based on import substitution. Russia’s oil and gas exports, which account for a third of all exports and some 15 percent of GDP, have helped fill the state’s coffers and given the economy a needed boost.

Russia’s strength and potential in the energy sector are indeed impressive. But in the long run, Russia cannot support its large, complex industrial economy based solely on advantageous energy prices. Oil prices won’t stay high forever, and supplying raw materials to the West is no way to move Russia into the “new” global economy.

Moreover, the oil and gas industry faces a severe investment crunch. Old reserves are being depleted and the efficiency of existing production operations is impaired by broken and obsolete equipment. With the typical cost of bringing a new field onstream between $8 and $10 billion, most Russian companies are unable to develop new fields on their own. Squeezing the remaining oil out of old fields, like the Samotlor field in Western Siberia, will also require billions of dollars in investment.

Russia could attract up to $60 billion in new oil and gas investment over the next decade if production-sharing agreements (PSAs), which give foreign energy companies special legal protection, were properly implemented. Putin has expressed support for PSAs, which may help overcome the protectionist tendencies that have held up a workable PSA law for years.

The events of August and early September illustrated symptoms of Russia’s economic decline—and highlighted a challenge for economic recovery: chronic lack of investment in infrastructure. The sinking of the Kursk nuclear submarine and the blaze that nearly destroyed the Ostankino TV tower, which supplies some 15 million citizens with their only television access, were not directly caused by failures in the Russian economy. But they focused the nation’s attention on the lack of investment in infrastructure over the last ten years that has dangerously depleted the country’s technological and industrial capacity.

Russia invests very little, even compared with other emerging economies. In 1998, for instance, Russia’s domestic investment as a percentage of GDP was half of Hungary’s, behind Indonesia, Argentina, and Brazil. Gross domestic investment has fallen an average of 20 percent per year in the last ten years. Last year’s investments accounted for a mere 22 percent of the 1991 figure. Foreign direct investment in Russia since 1993 amounts to about $10 billion—roughly 10 percent of estimated capital flight from Russia in the same period. Cumulative net foreign direct investment (FDI) in Russia from 1992 to October 1999 amounted to $11.7 billion, according to then Prime Minister Putin, compared with over $350 billion in China during the same period. Net FDI in Russia in 1999 amounted to about $2 billion, out of a global total of $827 billion.

The average age of Russian manufacturing plants and equipment is three times higher than the OECD average. The share of production equipment that has served over 15 years is now 46 percent. The necessary updates and replacements will require trillions of dollars. The country has essentially been living on borrowed time since perestroika.

Despite legitimate concerns about Russia’s ailing infrastructure, prospects for future growth and investment are promising. President Putin has spoken candidly about his country’s economic challenges and seems prepared to press for real reform. His government’s economic plan includes simplification and reduction of taxes; prudent monetary and fiscal policy that ensures a balanced budget; renegotiation, reduction, and repayment of external debt; guarantee of property rights; reversal of capital flight; attraction of foreign investment; strengthening rule of law; and alleviation of poverty. Some parts of the plan, such as a revolutionary 13 percent flat tax, have already been pushed through parliament.

Investor confidence appears to be returning to Russia as well. Fixed capital investment in 1999 rose by 4.5 percent to $28 billion, or 15 percent of GDP, with a further 5 percent rise expected in 2000. Gross domestic investment was up 5.6 percent in 1999. Foreign direct investment in 1999 was up almost 20 percent over 1998 levels, and foreign investment in the first half of 2000 is up 12 percent over 1999 levels. Many of the companies that pulled out of the Russian market in 1998 are now cautiously moving back in. As Pepsico head Don Kendall said recently: “Compared with last year, our sales are up 100 percent in Russia. For us that’s a very good indicator of the business climate in the country.”

Investment in Russia is not only a question of Russians’ prosperity. It is a basic requirement for the Russian state and society to function: to provide a secure defense, protect citizens from environmental hazards, and ensure the most basic democratic freedoms.

Much of the success of the Putin government’s economic reforms will depend on the government itself. But investment—both foreign and domestic—will undoubtedly play a key role. –Ben Dunlap.

Retooling Russia’s Nuclear Cities

By Matthew Bunn

Matthew Bunn, Assistant Director of the Science, Technology and Public Policy Program in the Belfer Center for Science and International Affairs at Harvard University's John F. Kennedy School of Government, is a former adviser to the White House Office of Science and Technology Policy, where he took part in a wide range of U.S.-Russian negotiations relating to security, monitoring, and disposition of weapons-usable nuclear materials.

In Russia today, there remain ten entire cities, home to three quarters of a million people, built only for the purpose of designing and producing nuclear weapons and the nuclear material for them. These cities, once secret, still closed off from the outside world by barbed wire and armed troops, now receive only one-seventh the funding for weapons work they received a decade ago. In the post-Cold War world, Russia does not need and cannot afford such a vast nuclear complex — and the effort to sustain it without the budget to do so creates serious perils, not only for Russia but also for the entire international community. At the same time, these cities, with tens of thousands of highly skilled scientists and engineers willing to work for wages far below what their counterparts in the West receive, represent an important opportunity for Russian and Western business.

The dangers are dramatically highlighted by the 1998 arrest of an arms expert at Sarov (formerly Arzamas-16), Russia’s premier nuclear weapons design laboratory, for spying on behalf of Iraq — a development investigators blamed on the “very difficult financial position” facing Russia’s nuclear experts. In November 1998, at Snezhinsk (formerly Chelyabinsk-70), Russia’s other major nuclear weapons design lab, 3,000 workers went on strike, protesting “constant undernourishment, insufficient medical service, and inability to buy clothing and footwear for children or to pay for their education.” In the same year, a group of conspirators at another of Russia’s largest nuclear weapons facilities attempted to steal 18.5 kilograms of highly-enriched uranium (HEU), an essential ingredient of nuclear weapons.

It is in the interest of both Russia and the rest of the world to cooperate to shrink Russia’s nuclear weapons complex to an affordable size suitable for its post-Cold War missions — and the United States and Russia are attempting to do just that through a new program known as the Nuclear Cities Initiative (NCI). This effort complements direct efforts to improve security and accounting for nuclear material, or control of nuclear secrets, in Russia’s vast nuclear complex. For unless the root causes of the desperation that can create incentives to steal nuclear material or sell nuclear secrets can be addressed, no amount of treating the symptoms is likely to be fully effective.

A small non-government group of Russian and American experts, the Russian-American Nuclear Security Advisory Council (RANSAC) has been working with both governments to address this challenge for several years. RANSAC provided many of the ideas that convinced the two governments to establish NCI, convinced the US Congress to provide NCI its first funding, and has been advocating new approaches to strengthen the effort since then, while continuing to research the issue.

The scale of the problem is daunting, however. The nuclear facilities in these 10 cities still employ more than 120,000 people — about 60 percent of whom work on “defense orders.” The Ministry of Atomic Energy (MINATOM) plans to reduce the number of defense workers in these cities by 45,000 over the next five to seven years. To prevent mass unemployment among the custodians of nuclear materials and secrets, tens of thousands of tenuous current civilian jobs have to be preserved, tens of thousands of new jobs created, and tens of thousands more people will have to be encouraged to retire (through provision of a livable pension).

MINATOM estimates the cost of creating one new sustainable job at roughly $10,000, making the total cost of re-employment roughly $500 million — with a comparable amount needed to close and clean up the facilities to make way for new businesses (and another $300 million needed to replace the heat and power provided by the reactors still producing weapons-grade plutonium in two of the nuclear cities).

Sustaining and creating jobs on a large scale is difficult anywhere in Russia, but in the nuclear cities — intentionally designed to be remote and difficult to access, still requiring a six-week background check by the Federal Security Service before any visit, even more unaccustomed to free markets and business development than most of the rest of Russia — it is a particularly formidable challenge.

Russia is making substantial investments of its own resources in this daunting task, and having some considerable success. And although progress in creating jobs through the joint NCI effort has been slow, some opportunities now appear to be opening up.

First, the stabilization of the Russian economy and national budget during 1999 and 2000 has already dramatically improved the situation in the nuclear cities. Months-long wage arrears have largely vanished, guards are no longer leaving their posts to forage for food, and new businesses are slowly being established.

Second, President Putin seems to understand the issue: he devoted a few lines of his five-minute speech at the United Nations Millennium Summit to the control of plutonium and highly-enriched uranium, the essential ingredients of nuclear weapons. He traveled to Snezhinsk soon after taking over as Acting President and spoke of a vision for eventually opening the cities, after the most modern security systems had been installed for the nuclear facilities themselves. After the Kursk tragedy, he signed a decree increasing pay for nuclear workers; and he has made tough decisions to unilaterally reduce Russia’s active strategic nuclear forces.

Third, after years of largely failed conversion efforts, MINATOM has put together a coherent conversion program that includes competition among projects for funding, based on specified business criteria, with some independent review of proposals.

Some substantial successes have already been achieved — often independent of U.S. help. In one of Russia’s uranium cities, a kilometer-long building that once housed a massive gaseous diffusion uranium enrichment facility was shut down, cleaned out, and modified to produce audio and videotapes under license to the German firm BASF; it profitably produced some 10 million tapes last year.

Fourth, within the context of the NCI effort, new “Open Computing Centers” have already been established at Sarov and Snezhinsk, allowing former weapons scientists to use their formidable computing skills on software development on contract to Western firms. Intel has been employing a group of former weaponeers at Sarov for some time, and Motorola is now writing substantial contracts there. International development centers — which provide facilities and computing capacity to visiting businessmen, and a full range of business consulting services, from help with business plans and proposal development to assistance in making contacts with potential investors and strategic partners — have been established in Zheleznogorsk (formerly Krasnoyarsk-26) and Snezhinsk. On a trip to Russia this summer, Secretary of Energy Bill Richardson christened the opening of the Sarov “Techno-Park,” 10 buildings that once were part of the Avangard nuclear weapons assembly and disassembly facility, which will now be opened for commercial development. The first contracts are with the German firm Fresenius, to produce components for kidney dialysis equipment.

Despite this good news, NCI is struggling. Although RANSAC had originally recommended a four-fold focus on business development, energy R&D, environmental and cleanup R&D, and nonproliferation analysis and R&D, NCI has focused almost exclusively on the extraordinarily difficult task of creating commercial jobs in these closed cities, whose personnel have precious little market experience. Both the Russians and the U.S. Congress are growing impatient that so few new jobs have been created so far.

Congress, meanwhile, has seen NCI as a nebulous and open-ended jobs program for Russians, of which the nonproliferation benefits were impossible to quantify, and has thus been quite skeptical about its budget. Seeing that this growing skepticism on both sides could destroy the program if left unchecked, Sen. Pete Domenici (R-NM) sponsored legislation this year that sought to tie substantially increased funding for NCI — crucial if the job is to get done — to Russian agreement to a set of measurable milestones for the shut-down of weapons production facilities. In effect, Domenici’s message was: “more money for jobs in return for more shut down of facilities that threaten the United States.” This approach — modified by hard-liners to include less money and more stringent conditions than Domenici had originally proposed — passed the Senate, and is now in conference with the House.

The ultimate question–whether it will be possible to shrink Russia’s nuclear weapons complex to a sustainable size and re-employ its people in civilian jobs before disaster strikes — remains unanswered. There is an enormous amount of work to do, and Domenici’s initiative, crucial though it is, is only a first step.

But there is also a wide range of remarkable opportunities created by the vast underused talent pool in Russia’s nuclear cities. Approaches such as the Open Computing Centers — where Western firms can contract for work by Russian experts that can be done over the internet, without having to tie up fixed capital investments in the uncertain Russian environment — are particularly promising. With expertise across a broad range of science and technology, if Russia’s nuclear experts become better able to market themselves, they may have a bright future in the huge global market for contract R&D. As the Russian economy stabilizes, Western firms may become more willing to make the capital investments that will be needed to take advantage of some of the other skills in the nuclear cities, from precision welding to high-tech assembly.

For more information on the nuclear cities, see:

Helping Russian Downsize its Nuclear Complex: A Focus on the Closed Nuclear Cities,

Regular updates from the Russian-American Nuclear Security Advisory Council:

The Next Wave: Urgently Needed New Steps to Control Warheads and Fissile Material



Firms interested in exploring opportunities in the nuclear cities should contact the Nuclear Cities Initiative:

Saving the Russian Economy

and the Global Environment

By Karen Filipovich

Karen Filipovich is a Fellow and Associate Research Director at the Environment and Natural Resources Program at Harvard University’s Belfer Center for Science and International Affairs.

Minimizing climate change is likely to be one of the greatest challenges of the 21st century. To meet this challenge, the world must work together to limit greenhouse gases, such as carbon dioxide, being emitted into the atmosphere because of human activity. Establishing and limiting rights to emit greenhouse gases, and setting up a mechanism for trading those rights, will benefit countries like Russia, which can sell rights, and countries like the US, which can buy them.

One proposed plan for emission trading envisions setting up a market to distribute the rights to emit greenhouse gases. The current scheme discussed internationally is outlined in the Kyoto Protocol, an international agreement that both the US and Russia have signed, but not ratified. Under the Kyoto Protocol, Russia would be able to sell any unused rights to emit greenhouse gas credits that represented emissions below 1990 levels, a potential pool of several million tons worth of greenhouse gas credits that could be sold on the world market. In contrast, the US must reduce its emission to 7 percent below 1990 levels by 2008-2010, a level it is unlikely to meet by itself, so the US is likely to be an eager credit buyer. There are two sources of potential credits in Russia: “hot air,” due to decreased emission from decreased economic activity, a controversial type whose status is not resolved internationally; and real reductions that come from efficiency gains in the Russian energy, industrial and transport sectors.

If reductions are made after rights are assigned, then Russia stands to make billions of dollars in the coming decades. The money alone will not solve Russia's economic woes, of course, but Russia’s active engagement in an emission trading market would have two additional benefits. First, setting up the framework for trading would help develop the same legal, regulatory, and financial institutions that are necessary for international trade in other areas. Second, incentives to keep its own greenhouse emissions low would help Russia modernize and streamline industry, infrastructure and energy use. Such a development is clearly good for Russia’s economy.

To be sure, much remains to be done to get an effective international emission rights market up and running. These markets only work if the rights are clearly defined and certified, with enforcement provisions that ensure that parties who try to fake credits are not able to profit from them. In a market for an intangible product like greenhouse gases, it is crucial that the reduction can be tracked, accounted and certified. Without that assurance, buying a credit is no better than buying a “genuine” Rolex from a vendor in a dark alley. At the international level, debate still rages on the exact nature of the necessary rules, rights and obligations, but the outline is clear. Good regulation, careful accounting, and a way to enforce transactions are necessary components of this market.

Applying these principles to Russia would require significant work. Like most countries, Russia has no framework in place for national or international emission trading. Moreover, Russia lacks the basic infrastructure on which to build the necessary institutional arrangements to begin emission trading. Russia’s Environmental Ministry—a logical place to build such a regulatory structure—was demoted to a mere committee by Yeltsin, and then folded into the Ministry of Natural Resources (this is a bit like putting a wolf in charge of guarding the sheep), by Putin.

Careful accounting is also a challenge in the Russian case. Though national emission inventories do exist, and the country certainly has the technical skill to execute accurate accounting, a tradition of secrecy still prevails. Large companies like Gazprom are reluctant to divulge information necessary for proper greenhouse gas accounting, fearing it will give away too much information about its operations to outsiders. However, even here, signs of greater interest and acknowledgement of the need for outside verification can be seen. The electric company Unified Energy Systems (RAO-UES) recently agreed to allow the US-based NGO Environmental Defense to perform an audit on its internal greenhouse gas inventory.

Finally, contract enforcement is weak. If a trade goes bad, it isn’t completely clear how an injured party would gain redress. For the system to work, all parties must be confident that a greenhouse gas trade will be enforced and that the proper emission reduction occurred.

Potential gains for both Russia and the US make it worthwhile to take on these challenges. Creating a system that can allow this market to flourish will enhance foreign investment in Russia, bring in needed funds and help establish the infrastructure Russia needs to plug in to the global economy. The added benefits of helping to protect Russia’s environment and moderate the effects of global warming are no less important.

Harvard University’s Environment and Natural Resources Program, Directed by Dr. Henry Lee, is conducting research and holding a high-level workshop on this topic in October with the aim of analyzing challenges to the development of emission trading in Russia.

Why Invest in Russia?

By Catherine Gorodentsev

Catherine Gorodentsev is Coordinator for the U.S.-Russian Investment Symposium at Harvard University.

“Why invest in Russia?” a colleague asked me recently. “The place is falling apart!” Those words sum up the pessimism of many Americans towards Russia’s investment climate. Most readers of the daily newspapers take away nothing but a barrage of bad news about the world’s largest country—understandably so, as disasters such as the sinking of the Kursk submarine dominate the headlines. Meanwhile, the successes of Russia’s economy and the promising reforms of President Putin’s government pass by unnoticed.

There is no denying that the country has an ailing infrastructure and that many important reforms, especially with regards to property rights and investor protection, must be enacted before Russia can be considered a strong bet for investors. But there is also significant progress that should not be ignored. It’s time to take stock of the facts.

In July, the Duma and the Federation Council approved a radical tax reform package that will kick in next year, introducing a 13 percent flat tax. And the Duma is set to vote on a budget for 2001 in October—the first balanced budget Russia has ever had. President Putin has introduced more promising structural reforms in his first five months of office than President Yeltsin did in five years.

Economic indicators show that the economy appears to be turning a corner. Russia has experienced record growth in GDP this year. Official state figures show that GDP rose 10 percent in the first seven months of 2000 in year-on-year terms. Industrial output is growing and was 8.6 percent higher for the first half of this year compared with the same period in 1999.

Central Bank reserves are growing steadily each month. The nation’s gold and hard-currency reserves rose by $400 million to $24.2 billion in the first week of September alone. Annual inflation is expected to be around 20 percent, down from 36 percent a year ago, and consumer confidence is growing steadily.

The international financial institutions, including the IMF and World Bank, have given Russia high marks this year by resuming talks and loans. In August, World Bank officials praised the reforms in Russia’s coal industry and pension system and released a $250 million payment much needed for further restructuring.

Taking a cue from these indicators, investors have been cautiously entering or re-entering Russia’s markets. For the first half of 2000, foreign investment in Russia was up by 11.9 percent, or $4.78 billion compared to $4.27 billion for the same period in 1999, according to Interfax. The largest investment came from the United States ($747 million), Germany ($540 million), the Netherlands ($528 million), and Cyprus ($523 million).

Manufacturing industries accounted for the largest share of foreign investment in the first half of 2000, followed by the food industry, iron and steel, fuel, engineering and metal working, nonferrous metallurgy, and pulp and paper. Russia continues to play a key role on the global level in some manufacturing sectors, such as chemicals and aerospace.

Oil giant Shell announced in September that it plans to pump $5 billion into the Sakhalin II oil project in Russia's Far East. Companies like Ford, Gillette, Philip Morris, and French dairy giant Danone have all established multi-million dollar production facilities in Russia this year. DaimlerChrysler and Pizza Hut have opened new retail centers.

And dozens of small and medium-sized firms have recently opened shop in Russia to take advantage of e-commerce and other Internet opportunities in what some are calling the next revolution in Russia, the Information Revolution. Microsoft's local representation office in Moscow has just set up a project to help students in remote areas improve their computer and Internet skills in an effort to bring learning and career opportunities to these more distant regions. With a highly skilled and educated population, Russia should provide fertile ground for the burgeoning e-revolution.

Although challenges remain, Russia is on its way towards achieving sustainable economic growth and establishing an attractive environment for investment.

Firm Ground for Putin’s Reforms

By Eric Lohr

Eric Lohr is an Assistant Professor of Russian History at Harvard University.

Vladimir Putin has rammed a few promising economic reforms through the Duma already. If he is really serious about modernizing the economy, he will need to put the reforms on firm ground – with a comprehensive land reform program that allows private land ownership. A perfect opportunity is coming up, as the Duma plans to consider a new land code for Russia this fall.

In considering the importance of the issue, Putin would do well to study the attempts of one of his predecessors. The experience of Peter Stolypin, Russian prime minister from 1907 to 1911 and one of the most remarkable leaders in Russian history, can elucidate some of problems and possibilities for the Putin era. Stolypin is primarily remembered by historians for one major reform that he attempted: the creation of private property in land.

The similarities between Stolypin and Putin are noteworthy. Stolypin came to power in the wake of a revolution which brought Russia its first parliament and limited constitution. Like Putin, he built his early popularity on his image as a Russian patriot and as a tough and energetic proponent of order. However, Stolypin used the police and army extensively in civilian affairs in an attempt to restore order in a society rent by violence. In the process he trampled on human rights and sharply curbed recently acquired democratic freedoms. Putin has already shown some proclivity for this darker side of Stolypin’s program. But, in the end, historical assessments of Stolypin have come to rest on his land reform efforts, and the same could be true for Putin.

To this day, one of the most striking differences between Russia and most other countries in the world is the fact that few Russians have ever had the right to own land. For centuries, Russian peasants have toiled on land which is not their own. Almost a decade after the collapse of the Soviet Union, over two thirds of all Russian agricultural land remains in state hands, and much of the “privately owned” land in Russia actually still belongs to collectives rather than to individuals.

Stolypin’s land reform, introduced in 1906, came close to creating individual private land ownership on a broad scale. In only ten years, more than one in five peasant households filed petitions to become private land owners. According to Stolypin, the reform’s success would have been crucial not only to Russia’s prosperity, but also to its political stability, since land ownership would give owners a stake in the system.

However, we will never know if the reform could have succeeded fully, because its implementation was interrupted by Stolypin’s assassination in 1911 and then by the outbreak of World War in 1914. The revolutions of 1917, which culminated in the expropriation of all privately owned land in the countryside, drove the final nail into the land reform coffin.

Stolypin has become popular again in Russia after decades of vilification by Soviet authorities – and land reform is once again tentatively under discussion. Several prominent members of Putin’s economic team have declared their support for a comprehensive land reform and the pro-Kremlin Unity party is pushing for a new land code in the Duma this fall. Putin himself said earlier this year that “farmers should not have any fears that someone could take away their land,” and he has signaled several times that he will support a comprehensive reform. But, the Communist and Agrarian factions in the Duma are already pressing to emasculate reform proposals, and opposition to a land reform remains strong in a country that has already seen its industrial assets snatched up in a highly unfair privatization scheme.

Despite the dangers, a comprehensive land reform should be attempted. For to do nothing unfairly leaves the entire rural economy in the corrupt hands of the old Soviet-era collective farm bosses. Allowing Russians to own land could rapidly transform Russia’s rural economy by giving farmers a source of collateral for loans to invest in their own farms. It could help accomplish the same goals that Stolypin declared a century earlier—”to give opportunity to the capable, industrious peasant” and create a more stable, loyal and prosperous countryside. Centuries of communal and collective ownership have failed miserably. It is time for Russia to move to private property in land.

A new land code is crucial not only for Russia’s farmers, but also for anyone in Russia who wants a guarantee that the land under their home, store or factory unequivocally belongs to them. Until a land code is passed, the uncertainty of such rights will remain a barrier to the kind of long term domestic and foreign investment Russia sorely needs. Not only does state ownership make long range planning more difficult for a business, but it also gives corrupt local officials a powerful lever for extortion and control. Even the best bank reforms and financial stabilization efforts will ultimately founder unless they are based on real ground-level ownership. Not least, a new land code could give the government a steady and large source of revenue through property taxes, a major source of taxation in most countries that has contributed nothing to Russian coffers.

The collective farm directors and their Duma allies have successfully blocked fundamental reform for nearly a decade. But Putin may be able to use his still strong popularity to push through a strong new land code—if he makes the issue one of his priorities.

Stolypin originally sold his land reform program with the slogan: “We need a Great Russia.” It would not be surprising if Putin presented a land reform in similar terms. The task is no less daunting, and no less important than it was a century ago. And if Russia is ever to become “great” again—or even moderately prosperous—it will need to create private property in the countryside.

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Could Russia Have an Investment Boom,

If It Were to Turn to Authoritarian Capitalism?

By Vladimir Boxer

Vladimir Boxer is a Fellow at SDI, where he has been pursuing research on democratization and elections in Russia since 1997. He first became active in the Russian pro-democratic movement in 1988. His political experience includes co-chairing the winning national election campaign of “Democratic Russia” in 1990 and directing political advertising for Yeltsin’s presidential campaign in 1991.

The favorite question, given by Russian journalists and politicians to “the sharks” of American business, is, “Why does the US invest hundreds of billions into the economy of communist China, but investments in Russia, all the same an electoral democracy, are a hundred times less?” In answer they, as a rule, hear that democracy and human rights are very important, but investors love stability. That is what totalitarian China is able to provide which Russia can not by any means. The Russian elite more often interpret similar explanations as a fairly transparent hint:

Establish order; if it is impossible to do any other way, than do it with an iron hand; provide with that a guarantee for foreign investors-and money will pour into the Russian economy like a river. And if, during this process, human rights suffer and democracy is stifled temporarily, then we will close our eyes before those inevitable costs. Those are not actually fundamental values for us as capitalists. They are more a part of the intellectuals of the left. Our governments will of course make noise, but they will not enact any serious sanctions; they will not jeopardize a relationship with a nuclear power. After some time the intergovernmental relationships will return to it’s normal level. But then again, Russia will have its investments, and we will have our profits.

To a considerable degree it is namely this similar interpretation of the answers or of the moods of foreign investors that explain the proposals of the ever more popular among leading Russian politicians and business executives to reverse democracy partially or even fully, and at the same time accelerating the market processes. Depending on taste, either the Chinese or Chilean (under Pinochet) model of the authoritarian market presents itself as the required conditions of an investment boom.

In fact before one interprets the other people’s answers, one should learn to ask the proper questions. It is not the American government that invests the hundreds of billions of dollars into the Chinese economy, but private investors, and not only American. The role of the Administration and Congress of the US consisted only in that they cleared away the political barriers to their relationship based on business cooperation with Beijing and promoted definite, though limited, guarantees of investments, in case that they are or will be established. Whether to invest or not was already a choice of the particular private investors. They had many different alternatives, but they chose China and not, for example, Portugal or South Dakota. The question of China’s nuclear status, as well as the whole of its military power or international influence, of course were the chief reasons in the political decision of the American leadership to soften relations and establish economic cooperation with the largest country. But they had no bearing on the subsequent choice of every single investor. Both major entrepreneurs and minor shareholders invest their own money not for reasons of national security, but for their own profits. The attraction for the private investors does not correlate with the military power and political rank of the particular state. The latter circumstance, which the Russian elite fails to understand, makes it impossible for modern Russia to have a significant increase of investments if Russia chooses the authoritarian way.

However soft the hypothetical reaction of Western governments to the authoritarian turn of Russia, the reaction of main stream media, and the other institutions that influence modern public opinion in Western post-industrial society, is very easy to predict. It will be unambiguously negative for the following reasons:

1) The Russian authoritarian capitalism will be associated in the Western social consciousness not with a step forward, as with the first pro-market reforms of China, but as a step back from the prolonged attempts at transition to a market democracy.

2) Russia is vigorously seeking to be accepted as an integral part of Europe, and from that point of view, it succeeded primarily to the extent that Western public opinion expects Russia to behave in accordance with the standards of modern Europe. This entails commitment to the development of institutions of civil society, to the transition to the ethical norms of post-industrial society and so on. The example of Yugoslavia shows that while Western public opinion is inclined to tolerate what it considers manifestations of barbarism in the countries of the third world, it will not tolerate the same acts on the territory of Europe.

3) As a result of the integration processes in Europe and the expansion of NATO, the influence of Poland, Hungary, The Czech Republic, and several other countries of Eastern Europe on Western public opinion has been strengthened. The public opinion (and leaders) of those countries are extremely alert, and react with suspicion to any, even hypothetical signs of Russian authoritarianism, because they perceive behind that a revitalization of imperialist politics.

4) Equally biased to indications of Russian authoritarianism are the Eastern European diasporas in the U.S. Their influence is disproportionately high in relation to their population. This owes to the fact that the emigrants from these countries are concentrated in the swing states. The Russian diaspora is also historically very sensitive to any anti-democratic tendencies in Russia. To that, add the influence of the more and more numerous Muslim population in the countries of Western Europe.

5) Over the last few years the attitudes of Western left-liberals towards the Russian political dynamic has grown steadily more critical. They are particularly more sensitive to violations in two spheres: social justice issues and violations human rights. Of course, nobody has seen the society where the social equality will coexist with an unconditional respect for the human rights. Therefore, left-liberals, depending on their ideology, are ready to forgive the retreat in one of these spheres, if it were accompanied by success in the other one. But it impossible to imagine anything they hate more than authoritarian capitalism. And these liberals in many ways define the dominant trends among educated people of Western society, including main stream media.

6) At the same time, authoritarian leanings of the Russian government will be criticized by conservative republicans in U.S., as it will substantiate their accusations that the Clinton administration took too soft a course with Russia and had lost all vigilance.

If not the Chinese model, but the Pinochet model were to be adopted by Russia, then almost all of same above-mentioned reactions of Western public opinion would still apply. The relatively mild reaction of the US government and its allies, as well as Western conservative public opinion toward Pinochet in the 1970s should not fool proponents of authoritarian capitalism in Russia. Then it was due to the logic of the cold war and the struggle against the communist threat. Also, Chile never presented a military threat to the West. Yet it is important notice the prevailing enthusiasm of current Western public opinion toward the criminal prosecution of Chile’s dictator.

Is it possible that there will be large scale Western investments in an authoritarian Russia with such negative Western public opinion? For examples we need not go very far. Even the biased and superficial information, given by the press regarding the Russian money in the Bank of New York and the complicated relationship between Putin and the oligarch-controlled press seriously cooled the enthusiasm of American investors. I don’t think that they are getting caught up in the details, such as who is right-Gusinsky or Gazprom, and did the Bank of New York really launder Russian Mafia money or was that simply a widespread way of conducting import and export operations in Russia. Most importantly, they feel that by getting involved in business in Russia, one might come under fire from critics at home, or even worse, involuntarily become involved in some inappropriate activities. For these reasons, they think it is better to wait until conventional wisdom again favors business in Russia.

If the investors come to these conclusions based only on the heated press of the oligarchs and suspicions broadcast to the West that the current Russian leadership is considering an authoritarian turn, then you can imagine what the investors’ reaction would be if this actually happened. A few big Western businessmen, of the type who had worked with the communist regime, would not be scared off by the authoritarian turn. However, an investment boom requires thousands and thousands of investors, the majority of whom began their careers during the 1970s or later. That potential combination of people represents a section of Western post-industrial society with all of its stereotypes, representations, and rules, whether they be for better or for worse. They have a habit of checking their actions and intentions against the characteristic instruments of the institutional framework of Western society. This is not the framework that existed 30 or 100 years ago. For the current generation of investors, public opinion, the position of mainstream media, political correctness, and etc. are not empty words. They are important and genuine factors which determine the attitude in their home countries about investing abroad. And as experience has shown, that attitude is as important in deciding about investments, as the investment climate abroad.

Russia and Money

By Andrei Uglanov

Andrei Uglanov is the First Deputy Editor of Russia’s largest independent weekly newspaper, Argumenty I Fakty.

In the West there is the false impression that Russia is a half-destitute country, not only according to the living standards of its population, but also the amount of money available for domestic investment. I shall refer to the example of the newspaper where I work, Argumenty I Fakty. One very highly-placed individual, who enjoyed friendly relations with me, approached our publishing house with a proposition: he would fund any project up to $1.5 billion. As it turned out, that money had been sitting for many years in Western banks as a result of imperfections in Russian legislation.

For some time—between five and eight years—Russian businessmen were concerned with only one thing: saving their money, living well and affluently in the West, and ensuring for their families and relatives the highest standard of living for decades to come. You can understand them—wealth fell upon them like a golden rain, like snow on their heads. But, as it seems, everything becomes tiresome sooner or later—even wealth. And, inclined to headlong adventurism, these Russians, or at least some portion of them, began to miss their country and began to make the first very cautious attempts to return their money to Russia by market means.

According to some estimates, in the last ten years some $40 billion to $160 billion was taken out of Russia and transferred to Western banks. Of course, much of this money is already driving the economies of Western and Eastern Europe, the US, and other countries. But it is not difficult to predict that if propositions of the type I mentioned earlier are realized-—and Russian bureaucrats are smart enough not to discourage these people and press criminal charges against them, but instead encourage them as much as possible—then the situation will change completely. That will set in motion a process similar in character to the huge investment in the Chinese economy that began ten or fifteen years ago. At that time, the wealthy Chinese diaspora—from Hong Kong, Indonesia, the US, and other countries, began to invest their money in the free economic zones on the eastern coast of mainland China. Noting that the Chinese authorities were in no way inhibiting that process, but were in fact encouraging it, the Japanese, Europeans, and American began to invest as well. I think the same will happen with Russia.

Of course, it cannot be said that there is no investment in Russia. But given that Russian businessmen don’t trust the government very much, that investment is of a hidden, “gray” character. In any case, many consumer goods, and some equipment and machines are produced with the participation of Western investors, often under Russian brand names. The most vivid examples are beer, cigarettes, clothing, and to a lesser degree automobiles.

And finally a word in conclusion. For many in the West it may come as a surprise, but in the next few years Russia may experience a genuine technological explosion in the area of high-tech. In any case the Russian Security Council is currently examining programs for developing branches of technology that are considered “cutting edge” throughout the world, instead of branches in which we have already fallen hopelessly behind. One such program will be presented by Mr. Igor Belov at Harvard University’s US-Russian Investment Symposium.

The views expressed by commentators in Russia Watch are not necessarily the views of the Strengthening Democratic Institutions Project, the Belfer Center for Science and International Affairs, the John F. Kennedy School of Government, Harvard University, or the Carnegie Corporation of New York.

Special thanks to John Reppert, Vladimir Boxer, Anya Schmemann, Roman Ilto, and to translator Matthew Lyberg

The Strengthening Democratic Institutions Project works to catalyze support for three great transformations underway in Russia and other countries of the former Soviet Union: to sustainable democracies, free market economies, and cooperative international relations. The Project seeks to understand Western stakes in these transformations, identify strategies for advancing Western interests, and encourage initiatives that increase the likelihood of success. It provides targeted intellectual and technical assistance to governments, international agencies, private institutions, and individuals seeking to facilitate these three great transformations.

This publication is made possible through generous funding from the Carnegie Corporation of New York.

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RUSSIA’S “FREE” PRESS

US Secretary of State Madeline Albright: “Nobody is going to believe that the Russian government is committed to media freedom if the independent television is under government control.”

Pluralism of ownership and control of Russia’s biggest and most influential media outlets are under attack, and the prospects for true media independence appear to be diminishing. See page 2.

PM Kasyanov’s Approval

Rating, March-Aug. 2000

Putin’s Approval Rating, March – Sept. 2000

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Approve

Approve

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Disapprove

Disapprove

Poll figures from VTsIOM polls of 1600, March-Sept. 2000

SEE INSIDE:

* Russia’s economy rising from the ashes?—p. 4

*Media independence in

jeopardy—p. 2

*Military reform—p. 2

*Investing in Russia’s nuclear cities—p. 6

*Saving the Russian economy and the global environment—p. 8

*Why invest in Russia?—p. 9

*The case for land reform—p. 10

*Vladimir Boxer on Russia’s economic development—p. 12

*Andrei Uglanov on Russian investment—p. 14

BACK ISSUES OF RUSSIA WATCH CAN BE FOUND AT: ksg.harvard.edu/bcsia/sdi

4th Annual US-Russian Investment Symposium, October 5-7 at Harvard University. US-RIS@ksg.harvard.edu 617-495-0741



TOP 4 RUSSIAN TV CHANNELS

(potential viewers as percentage of population)

ORT (Russian Public Television)

Broadcasts reach 98% of population

RTR (state-owned Russian Television and Radio)

Broadcasts reach 95% of population

NTV (Independent Television)

Broadcasts reach 70% of population

TV Center

Broadcasts reach 35% of population in

Moscow and 50 other regions

Sources: World Bank, Russian State Statistics Agency, “Russia Business Watch” Summer 2000

STATE-OWNED OIL COMPANY

SOLD TO HIGHEST BIDDER

No visible “foul play”

On September 12 the Russian government sold the Onako regional oil company for $1.1 billion. The winner of the auction was not Roman Abramovich, the businessman and parliamentarian with close ties to the Kremlin, but Tyumen Oil Company (TNK), which bid 2.5 times the starting price for an 85 percent stake in Onako. Foreigners were not allowed to bid, but still the auction looks like a step forward after a decade of transfers of state assets to a politically-connected insiders at bargain prices.

NORILSK NICKEL ANNOUNCES DEAL THAT DILUTES SHARES BY 11.5%

Under the plan, shares in Norilsk Nickel are to be swapped for 88.5% of shares in Norilsk Mining Company, the main production subsidiary. The remaining 11.5% are to be paid for the purchase of Norimet, the London-based trading company. Investors initially feared Vladimir Potanin, the “oligarch” who controls 55% of Norilsk Nickel, was trying to dilute minority shareholders and transfer value out of the company. Norilsk Nickel spokesmen say the restructuring will increase transparency and give minority investors direct control over its main production unit, the Norilsk Mining Company.

WORLD BANK UPGRADES RUSSIA’S GDP CALCULATION BY 57 PERCENT

The World Bank, in its 2000 edition of World Development Indicators, revised the calculations of GDP at purchasing power parity of over 140 countries. With a new figure of $948 billion, Russia moves up from 13th place into the top ten.

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SDI PROJECT, BELFER CENTER FOR SCIENCE AND INTERNATIONAL AFFAIRS

JFK SCHOOL OF GOVERNMENT, HARVARD UNIVERSITY

79 JFK STREET CAMBRIDGE, MA 02138

Phone: (617) 496-1565 Fax: (617) 496-8779

Web site:

Email: SDIJFK@harvard.edu

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