‘Reform’ Goes Tumbling With Ruble Devaluation

Monday’s devaluation of the Russian ruble and the temporary debt default was inevitable but not a long-term solution. The problem is a fundamentally flawed economic reform that Boris Yeltsin has kept afloat with a financial pyramid game. It has now collapsed. It would be a mistake to provide a huge Western bailout unless the reform strategy, which the West has forced on Russia, is fundamentally changed.

We should not forget how few expected this collapse a month ago. On July 13, the International Monetary Fund agreed to a large loan and encouraged Russia to exchange much of its short-term ruble debt into long-term dollar bonds. The Russian RTS market index had been in the mid-130s in the previous week, but by July 20, it had risen to 193. The head of emerging markets of Bank of America was one of many proclaiming that Russia is “off the fear list.”

A week later, the RTS was back to 143 and by Aug. 13 it had reached 101. Talk about volatility. Moreover, the banking system had ground to a halt. Clearly the solution did not address the real problem.

Devaluations help countries with trade deficits. But Russia continues to run a large foreign trade surplus. Russia’s difficulty is a massive 10-year depression, and Yeltsin has tried to ward off the political consequences of this in the large cities by keeping their standard of living artificially high, especially in Moscow. To pay for the subsidies to these cities, Yeltsin cut investment over 80%, refused agricultural reform so he could pay collective farmers very little for their harvest, cut medical services outside the largest cities and paid wages in these areas with great delay.

With investment being starved, industry could not retool to produce new goods, and agriculture could not obtain machinery, fertilizer and pesticides. Grain production this year is 50% lower than under Mikhail Gorbachev, and the number of cattle, dairy cows and chickens are down some 75%.

Life expectancy for men, already abysmally low under communism at 63 years, fell to 57. Some 3 million people in Russia died who would have been alive if the old life expectancy rates had been maintained. Lack of medicines and a balanced diet were key reasons.

As the system ran down at home, Yeltsin increasingly turned to foreigners for money. But it was a a ponzi scheme in which foreign money received one month was used to pay high interest rates on last month’s 30-day bonds. As the pyramid grew, so did the interest payments. As private investors, already shaken by events in Asia, increasingly refused to play in the game, it collapsed.

We now face a monumental mess. The likelihood that Yeltsin will be overthrown is high. His only hope is to form a coalition of experienced politicians, some of them Communists, with a new reform policy.

The alternative is a ruler such as retired Gen. Alexander I. Lebed, with the most unpredictable of foreign policy consequences, virtually all of them unpleasant. Many defenders of the IMF reform policy in the West see Lebed as an Augusto Pinochet who might make their policy work if only he ruled with an iron hand and if the West provided one last huge bailout. But no one who has read what Lebed has said about Mormons, Jews, former Foreign Minister Eduard Shevardnadze and the Yeltsin reformers—and how he said it—can have the slightest faith he will follow the IMF’s and the West’s bidding.

A strong and growing majority even of Russian youth in our polls from 1993 to 1997 thought that Western economic advice was motivated by a desire to weaken Russia. We need to counter this. All Russian food and medicine imports are now much more expensive. We need a major humanitarian program—not a loan, but a gift—of food and medicine to get the Russians through the winter. It is not only in our vital interest, but a moral duty given our role in imposing our brand of economic reform since 1991.

But basically the disaster in Russia in wake of the disaster in Asia shows that we must revise our understanding of economic development. Investment is key to growth, and domestic investment must almost always precede large-scale foreign investment. When market institutions are weak, investment must be supported by government. Countries with infant industries need protectionism, as the U.S. did in the 19th century.

If such a policy is introduced, many will speak of the end of reform. Instead it would mean the beginning of a period of real reform. The West needs to play a constructive rather than destructive role in the changes that are coming, because the foreign policy consequences will be high.