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In Russia, A Journey Back To The Future


Economics

IN RUSSIA, A JOURNEY BACK TO THE FUTURE

It's a sunny Saturday morning in June, and the road to Nizhni Novgorod is crowded with Muscovites eager for a spin in the country. We pass several sooty manufacturing plants in Moscow, then skirt the southern edge of Izmailovski Park. Soon the fumes and dull cement-block apartment buildings give way to clear air and tiny roadside dachas, dots of green and red and blue topped by sagging roofs and Russian gingerbread. Kerchiefed women sell just-picked herbs along the roadside.

I am traveling with my colleague Rose Brady, BUSINESS WEEK's Moscow bureau chief, to the city of Orekhovo-Zuevo, population 150,000, about 60 miles east of Moscow. In two hours, we arrive in the city and follow the main road to our destination: A series of solid, red brick buildings lining the Kliazma River, many dating from the 1890s. We pull into the courtyard at No. 76 Lenin St.

We are on the grounds of what is today the Orekhovo-Zuevo Textile Factories Assn., a state-owned industrial combine of 16 textile factories. At the turn of the century, these buildings housed the cotton mills of Savva Morozov & Sons Manufacturing Co. and Vikul Morozov & Sons Manufacturing Co. My great-grandfather, Ivan Vikulovich Morozov, was the last director of Vikul Morozov & Sons. He, my great-uncles, and their cousins presided over a textile-weaving empire here and in two other locations that at its zenith in 1914 employed more than 50,000 workers and had annual sales of 100 million rubles, equivalent to $650 million today. Among the more notable Morozovs were a despotic strike-breaker, a collector of Impressionist art, and a donor to the Bolshevik cause. All the Morozov assets were seized in 1918, by order of Lenin.

Now it is 74 years later, and we arrive in Orekhovo-Zuevo not knowing what we will find. We have been conducting interviews about the planned privatization of industry, the centerpiece of the economic program through which Russian reformers hope to construct a market economy. Despite criticism of the government, the conviction has taken hold that privatization will proceed.

SELLING OFF. On July 1, President Boris Yeltsin decreed that the process begin (page 52). By Nov. 1, all state enterprises--except a group of strategically important ones, such as producers of nuclear weapons and space systems--must be turned into joint-stock companies. Then, the state sell-off will begin. The goal is to transfer state ownership of approximately 130,000 enterprises and thousands of small shops into private hands. Already, in Moscow, St. Petersburg, and Nizhni Novgorod, the three biggest cities, a few businesses have been sold.

"The main goal," says Anatoly B. Chubais, chairman of the state committee for property management, also known as GKI, "is to have owners in Russia." Only that way, says Chubais, will Russia achieve a new social structure, complete with a middle class that provides social stability and has a stake in the future. And only then will economic reform be irreversible. That's politically crucial for Yeltsin's government, which wants progress before winter sets in. The longer it takes for a new class of owners to grow, the greater the chance that communist and nationalist opponents will make political capital out of economic hardship.

Russian reformers are embracing a principle that Westerners have long held axiomatic: Ownership forms the bedrock of legal, institutional, and social relations in most economies, especially in the developed world. There, not everyone is an owner, but everyone has the opportunity to become one. Only if people are owners or have that prospect, economists believe, do they care enough to preserve and maintain property, to invest time, effort, and money for future reward. On a small scale, home ownership offers that chance. More broadly, private ownership of the means of production provides that opportunity for society at large so that enlightened self-interest ultimately benefits everyone.

The Russian government targeted small shops and enterprises for privatization first, and light industries, such as textiles, next. In Russia, industries such as textiles and food processing are more competitive than the monopolies that exist in heavy industry, and so may be better able to find markets, control costs, and make profits as economic reform proceeds.

In January, the first economic shock came with the lifting of price controls, and prices rose 4 to 20 times on everything from vodka to meat to oil. Wages rose, too, but the squeeze on incomes and production has been dramatic, and enterprises have built up huge debts to one another of more than 2 trillion rubles to keep going. Many are nevertheless strapped for cash.

As we climb the well-worn, century-old iron treads of the staircase to our appointment in Orekhovo-Zuevo, I'm gripped by a combination of curiosity and apprehension. Anything is possible. The enterprise might be tottering, suffering from crumbling sales. Cheap clothing from Asia is already being hawked on the streets of Moscow, and many mills are having trouble paying hard cash for cotton from Central Asia. The managers might be digging in, unwilling to privatize or modernize. Their welcome might prove chilly.

Or it might not. Sergei V. Babanov, the 43-year-old general director of the enterprise, greets us warmly. He is smooth and charming in manner, interested in the family connection, and ready to talk about how the textile combine is faring. According to Babanov, the enterprise is surviving better than most, and he and his managers are eager to become controlling owners.

The Orekhovo-Zuevo Textile Factories Assn. is today one of the largest textile operations in Russia, with an annual capacity of 200 million meters of cloth and expected sales of nine billion rubles, or $70 million, this year. The factories produce everything from cotton thread to artificial fur to finished clothing, and about 10% of the goods are exported, mostly to Europe. Babanov says sales were up 14% in volume terms last year, quite a feat at a time when many enterprises were losing sales.

About 15,000 people work at the factories--4,000 fewer than four years ago, after Babanov arrived from another textile operation and began shaking things up. He decentralized, allowing managers to operate each of the 16 factories independently. He put about 300 engineers and technicians on a merit-pay scheme, and adopted a new variable pay scale for workers, linked to actual output. The work force declined through attrition and layoffs.

GOOD AS OLD. Output and profits grew, allowing managers to plow $30 million into new machinery this year. Today, Babanov boasts, the technology is as good as it was when the Morozovs ran the factories--an astounding reflection in itself on what decades of central planning did to Russian industry. Indeed, a few of the state-of-the-art English looms that clattered in these mills a century ago were still used until a decade ago.

In January, the textile combine raised prices 15 to 20 times. Today, a meter of basic cotton cloth costs 60 rubles (about 46 cents) on the domestic market, while it's priced at 75 cents a meter for export. Wages have been raised repeatedly over the past year, to the current average of 6,500 rubles a month, or about $50. That's about three times the level for most industrial jobs in Russia. Moreover, the wages have actually been paid, because the combine avoided the cash crunch that gripped many other enterprises. Fabric is sold for cash to stores, trading houses, and private middlemen--some of whom produce carloads of cash for cloth.

Rising prices, climbing interest rates, and evaporating sales are forcing managers elsewhere to be as flexible as those at Orekhovo-Zuevo. Over the past year, for instance, directors at Krasny Proletary, a Moscow machine-tool manufacturer, have scrambled to change their product mix, boosting the output of wood processing machines that crank out panels for do-it-yourself dacha builders and cutting back on production of expensive and sophisticated lathes. The enterprise still had to lay off about 500 people over the last year, pushing the payroll down to 4,800, and an additional 20% may be let go next year after the enterprise privatizes, says Director Yuri Kirillov.

Privatization and industrial restructuring are sure to bring massive unemployment--estimates range from 5 million to 11 million unemployed by yearend, out of a work force of 86 million. The Russian government plans to channel state funds to the hardest-hit industries and regions, such as workers in military factories in the Ural Mountains, where unemployment could reach 25%. And it hopes to create a new agency for "reconstruction and development," which will retrain workers and create new jobs.

In the meantime, it is the directors of enterprises who must confront the new economic forces. Today, those managers may be old party hacks or young mavericks, representatives of the nomenklatura or shock troops of a new economy. The ones who are surviving in the crisis environment, whatever their background, are doing so by their wits. For this reason, some believe that sizable ownership should be their just reward. "Today, the managers in industry that we have are the wealth of the country. . . . If a director buys the majority of the shares and he is a good manager, it is good for the enterprise," says Georgi Khizha, Russian deputy minister for industry and a former manager.

BUYOUT PLAN. Babanov, for one, believes dynamic leadership should be well compensated. Over lunch, he and two of his managers describe their plan: A 25% share of nonvoting stock would go to the workers and 5% of the voting shares would be sold at book value to the managers. So far, the plan looks like one of the options proposed by GKI. But there's more: Over the course of three or four years, managers would purchase 37% of the voting shares, and the remainder would be sold openly.

It's a bold and nervy plan that heavily favors managers. Our Saturday visit prevented us from quizzing workers, but Babanov says that in the weeks following our visit, he put his plan before the workers, and two-thirds had already approved it by July 15. The managers at Orekhovo-Zuevo are determined to proceed, and believe a clause in Yeltsin's recent decree permits such a plan. "The guys who have the initiative, the guys who really want to do it, for sure will be private one way or another within a year," predicts Andrei Shleifer, Harvard University economist and adviser to GKI.

Objectively, I should be troubled by the concentration of ownership that Babanov and his managers seek. Subjectively, I should be rankled by the idea of some youthful go-getters staking a claim to the factories my forebears once owned and ran. In a cordial toast, Babanov seems to acknowledge the strange conjunction of past and present, suggesting that one day I might become a shareholder--by purchasing a share or two. Certainly, no one is about to give me any shares; there is no procedure in Russia for returning private property to former owners or their descendants, as there is in Germany and Eastern Europe. Yet I am not discomfited by what I have heard and seen here, only relieved and, in a strange way, heartened.

LIVING HISTORY. The buildings that my great-grandfather and his cousins built for the workers--kindergartens, schools, public baths, a hospital, a theater--are all still standing. The barracks housing, in which workers' families once lived in cramped quarters, has been converted to offices and libraries. The hospital, with its art nouveau wrought-iron railing, is now being restored. And a museum details the Morozov enterprises' history.

The stewards of this history seem oddly respectful of the Morozov paternalism--one that in some ways was a capitalist forerunner of the way many Soviet state enterprises provided for workers and their families. Today, Babanov scowls at news reports that factories are forced to close kindergartens. In Orekhovo-Zuevo, the kindergartens have remained open.

But whether they can remain so indefinitely is uncertain. Privatization will force many enterprises into bankruptcy, while those that survive will stumble along toward a new market economy. It took the entrepreneurial families of pre-revolutionary Russia four or five generations to move from being disreputable traders plying their wares at the annual fair in Nizhni Novgorod to becoming established industrialists in Moscow and St. Petersburg. Now, Russia's reformers are trying to telescope the process--and move it forward at the same time.

A frisson goes down my spine as we pass the buildings my great-grandfather once patrolled, where modern looms now turn out artificial fur for stuffed animals and winter coats. Entrepreneurialism and capitalism once thrived here, in a primitive form. Now, after a hiatus of 75 years, there is a chance that they can reemerge, grow and evolve, and eventually help people to live a better life. I can only hope that happens.Karen Pennar, with Rose Brady, in Orekhovo-Zuevo


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