| BUSINESSWEEK ONLINE : APRIL 26, 1999 ISSUE | ||||||||
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| INTERNATIONAL -- EUROPEAN COVER STORY
Russia: What Happens When Markets Fail (int'l edition) Easter has replaced Revolution Day as the most widely celebrated holiday in Russia. This Easter, my last in Russia, I spent with my friend Marina Nikolaevna Chudakova. At 73, she was too tired to attend Easter services, which started Saturday at midnight and continued almost till dawn. But she invited me to share her Easter meal. Her 78-year-old husband, Alexander Yevgenevich Chudakov, was in the hospital with heart problems. Their combined monthly pensions total $100. When Alexander feels strong enough to work at his physics lab, he brings in an additional $70 a month. But the Chudakovs are hardly starving. The Easter table was loaded with caviar, dyed eggs, and cakes. As a physicist in the Soviet era, Alexander Chudakov was given a spacious five-room apartment in the center of Moscow during the 1950s. He also inherited two country houses from his father, who had been a prominent engineer. These dachas provide the Chudakovs with a tremendous cushion. They spend the summer months in one of the dachas and rent it out to me and a group of my friends for $1,200 a month in the winter. For their other dacha, the Chudakovs also receive $1,500 a month. By Russian standards, they live well and can afford not just food but also other consumer goods, medicine, and even trips to the U.S. Other pensioners aren't so lucky. Galina Filatova, 62, retired seven years ago from her job at an apparel factory. But her pension is only $15 a month, and sometimes it is paid several weeks late. She lives with her son, daughter, and son-in-law--all unemployed--in a decrepit two-room apartment in Kuzminko, a grimy neighborhood on Moscow's southeastern outskirts. To survive, she works nights as a security guard at the factory. That gives her $25 a month and an occasional bonus of clothing, which she sells at a nearby metro station. Galina spends nearly all of her income on food for herself and her children--and, she confesses, on vodka for her 36-year-old son, an alcoholic. ''He will die without vodka,'' she says matter-of-factly. NEVER-NEVER LAND. That's life in post-crash Russia. The Chudakovs and Filatovs reflect the realities facing Russians since the country defaulted on its debt and devalued the ruble last August. A few years ago, many in Russia and the West thought the country was on the road to creating a more advanced capitalist economy, where Russians could rely on their skills to generate wealth--rather than live off communist-era privileges or simply scrape by. But the financial crisis has highlighted just what happens when markets fail. In the months before the crash, it was already apparent that Russia was developing its own brand of capitalism. Now the country is operating in a kind of economic never-never land that seems to grow stranger by the day. This is an economy that defies Western logic. You have to live here and talk to people to understand how they can keep going when they don't get paid. Most companies are essentially bankrupt but keep cranking out goods. You have to travel outside Moscow to get a feeling for how an economy can function when there is no effective banking system and never enough cash. Only in Russia could companies get away without paying their electricity or heating bills yet rarely face power cutoffs. To keep the electricity company from turning off the lights, the government makes up for its missing payments with a tax credit. MAKESHIFT ECONOMY. It's a bizarre and oddly flexible economic model. Some economists call it the ''virtual economy,'' because real money, real goods, and real output play such a small role. It is, in fact, a three-tier economy. The Russian currency, the ruble, is used mainly to buy necessities such as food. IOUs, barter, and ''surrogate currencies'' are used in most dealings involving companies. Instead of paying cash wages, the giant Magnitogorsk Metal Works issues its employees cards that can be used in company-owned shops and the city department store. Russians, meanwhile, keep their savings in dollars. Nearly as many dollars as rubles--the equivalent of $35 billion--are believed to be circulating in Russia's economy. Even President Boris Yeltsin calls Russia's economy ''freakish'' these days. ''We have become stuck halfway in our transition from the planned and command economy to a normal market economy,'' he told the Russian people in his recent State of the Nation address. Freakish or not, Russia's exploding barter economy has more in common with its Soviet and Czarist predecessors than with a Western market economy. Yet the makeshift setup has sheltered most Russians from the worst effects of August's meltdown. When the government defaulted on $40 billion in short-term debt and devalued the ruble, most Russians had little or no money in commercial banks. Most owned no stocks or government bonds. Workers who were paid in goods cared little about the value of the ruble. And just a minority of enterprises held loans from banks. So ordinary Russians stayed calm. Now, it's clear that Russia's economic transition could last well into the next century. Prime Minister Yevgeny M. Primakov isn't pushing reforms such as industrial restructuring, which would put people out of work just before parliamentary elections in December and presidential elections in June, 2000. So every day, Russia's virtual economy grows deeper roots. In the six months since he was appointed Prime Minister, Primakov has done little to curb the proliferation of IOUs. To get a sense of how this jury-rigged system works, take a look at the local economy of Perm, a city of 1 million ringed by smoke-belching refineries and sprawling defense plants in the Ural Mountains. Because the surrounding region produces oil and gas, Perm is wealthy by Russian standards and has a ready source of hard currency. Yet the government is so short of cash that the city's 83,000 public employees aren't paid on time and services such as the water utility are on the verge of collapse. Why isn't there more money? One answer lies with companies such as Lukoil, Russia's biggest oil company and a major employer in the Perm region. The local government lets Lukoil and its affiliates pay only half their taxes in cash. They pay the other half with IOUs, known as veksels, which the company pledges to redeem later for oil. But the local government doesn't need oil: It needs money to pay for public services. Lacking cash, it gives veksels to suppliers as payment for goods and services, and passes them along to public institutions such as schools, in lieu of operating funds. Noncash forms of payment now make up 45% of the city's $80 million annual budget. BIKES FOR MEAT. All this has given rise to a new business in Perm and other cities: traders who buy veksels for rubles and resell them to customers who actually need oil or other commodities. The traders usually pay only 50% of the veksels' face value, leaving public agencies chronically starved for cash. Perm's school administrators are now experts in barter and other improvised solutions. One school principal recently persuaded city authorities to grant a tax credit to the local power company to prevent it from shutting off her school's lights and heat. ''I'm capable of fixing up these deals, but you can imagine how much time it takes,'' the exasperated principal says. Why does the government agree to take these IOUs? Local authorities say they have little choice because even wealthy companies such as Lukoil don't have enough money to pay their taxes. Lukoil gets hard currency for exports, but the government requires it to sell a large percentage of its oil in Russia to customers who often don't pay. So even with middlemen taking a big cut, the authorities reason, IOUs pump at least some money into government coffers. By contrast, the poorest companies must rely totally on barter. One is Velta Co., a crumbling factory on Perm's outskirts. Once it was one of the Soviet Union's biggest bicycle makers, supplying the military with bicycles and exporting to Eastern Europe. Now privatized, it has almost no cash coming in, and production has slumped from 1 million bikes a year to 200,000. Exports have dried up, and the Defense Ministry can't pay for its orders. In most countries, such a company would go bankrupt. Yet in Russia, Velta stumbles along. Sitting in his office in Velta's dingy administration building, Executive Director Vladimir Mironov, 49, acknowledges that the factory is so inefficient that the bikes it makes aren't worth enough to cover the cost of production. Yet Mironov is determined to keep it running. ''After all, bicycles are needed by many people,'' he says, hopefully. So Velta keeps making bikes, swapping them for raw materials and electric power to keep the factory running. The company doesn't pay taxes, but local authorities look the other way because Velta supplies free heat to nearby apartment buildings. The biggest losers at Velta are its 4,000 employees, who for more than a year have been receiving one bicycle a month instead of a paycheck. These days, the factory parking lot is an impromptu bazaar where workers and their relatives hawk bicycles. ''We are luckier than those people over at the chemical plant. At least our factory gives us something we can sell,'' says Rosa Mikhailovna, one of more than two dozen people trying to sell bikes in the blowing snow one morning. Mikhailovna, whose husband works at the plant, admits she probably won't find a buyer for her ten-speed bike, though she is asking only $25. Yet with luck, she may trade it for meat to supplement her family's diet of potatoes and pickled vegetables from their garden. ''By doing this, we can live O.K.,'' she says. INSIDER DEALS. Odd as it may seem, even basket-case factories such as Velta provide a good living for the middlemen. While Mikhailovna stands patiently in the snow, Yuri Polushkin, 38, and his associates sit down to lunch a few kilometers away in the lavish headquarters of FSG Sintez, a company that negotiates barter deals between factories. As waiters serve grilled salmon and pour glasses of Spanish wine, Polushkin outlines how his business works. ''Let's say there's a company that has some metal and needs to raise cash to pay its electric bill,'' he says. ''We could help them swap some of their metal to a farm. Then we take food from the farm and sell it to stores or restaurants for cash.'' Such barter chains often involve more than a dozen companies, Polushkin says. Even as factories such as Velta slide deeper into debt, Sintez has prospered, posting $46 million in revenues last year and building its own casino, health club, and the restaurant where Polushkin and his colleagues dine. Middlemen such as Sintez aren't the only ones who profit from the barter chain. Because companies agree among themselves on the value of goods being traded, there's plenty of room for insider dealing by top managers. Government authorities get in on the act, too, because regional governments often hold a stake in privatized industries. The losers are unpaid workers and citizens who can't get basic services from their broke government (table). ''When you don't get paid in cash, it's unclear how to value the goods,'' says Alexander Blavatnik, vice-president of Access Industries, a New York-based investment firm with industrial holdings in Russia. ''There's great opportunity for midlevel managers and traders to manipulate the price and siphon money from the company to their own pockets.'' This crazy setup developed because the government never took the tough steps necessary to transform Russian industry. After privatizing most state enterprises in 1993 and 1994, the government never forced unproductive enterprises to go out of business. Such a move would have put representatives of the socialist managerial elite and their workers out on the street. The barter economy has also grown as a direct result of the Kremlin's weakness. The government has failed at one of its primary responsibilities--collecting taxes. The situation has grown even worse since August's financial crash. With little cash coming in, the federal government has no money to send to regional governments for social services, the military, or state-sector wages. It has trouble running the judicial system and enforcing federal laws. So regional governors, power companies, and factory directories all across Russia have resorted to barter, veksels, and debt swaps to keep their economies running and their political power intact. In the process, they have become quiet supporters of the bizarre system. Managers, governors, and bureaucrats all have grown rich from the price inefficiencies, which camouflage insider dealing, bribes, and money laundering. ''These practices have become so implanted that it's difficult to uproot them,'' says Alexander Bekker, an economic analyst for the daily Segodnya. These days, regional governors and other local leaders are taking advantage of the breakdown to grab even more power and property. Ironically, many are using a new Russian bankruptcy law as their weapon. The law allows creditors to go after debtors in court, but local politicians and factory managers are using it to seize control of enterprises in their regions. ''OUT OF CONTROL.'' In the Volga region, for example, Samara Governor Konstantin Titov is demanding that local branches of oil giant Yukos, now controlled by Moscow tycoon Mikhail B. Khodorkovsky, be transferred to his government to cover back taxes. Vladimir Potanin, head of the once-powerful Interros financial group, is under siege from creditors and competitors in Siberia and the Urals who want to grab his near-bankrupt Sidanko oil company, the country's fourth-largest. ''The situation is out of control. The local creditors do whatever they like with the company,'' Potanin complains. He and Russia's other tycoons have lost both money and political clout since last August. Boris A. Berezkovsky, once a close ally of Yeltsin, is under investigation for alleged money-laundering and fraud. It all adds up to a bleak picture for Russia. Although many companies and individuals can keep going on barter and veksels for now, the economy is likely to shrink a further 6% this year, after plunging 5% in 1998. The past seven years have shown just how difficult it is to transform a huge, complicated country like Russia. The Yeltsin government has wasted many opportunities and lost the trust of the people. It will take a new leader after next year's elections--and a great deal of time--for the Russians to trust their government, their banking system, and their currency. Most important, the next Russian leader will finally have to find a way to boost industrial productivity by closing down worthless companies. In the meantime, the government faces a desperate battle collecting taxes to pay for social services. No one wants to support a corrupt system that cheats them out of their savings every few years through devaluation or default. SURVIVAL INSTINCT. For the Russian people, their saving grace is their ability to press on despite economic hardship. In many ways, Russians are entrepreneurs of survival, and Russia's multitiered economy is just another example of their ingenuity. Imagine what Russians might be able to do if their entrepreneurial natures were put into productive work rather than negotiating barter deals or devising hustles to avoid taxes. Russian leaders might be surprised at the result if they would only tackle the country's dilapidated industry and free businesspeople from corruption so they could set up new companies. Such a prospect looks dim. Still, as I prepare to leave Russia after six years working here, I hope that somehow Russians get to live in a more stable, prosperous democracy. They deserve a chance. By Patricia Kranz With Carol Matlack in Perm and Rose Brady in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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