PRIVATIZATION IN NACC COUNTRIES Defence Industry Experiences and Policies and Related Experiences in Other Fields COLLOQUIUM 1994 ********* COLLOQUE 1994 PRIVATISATION DANS LES PAYS DU CCNA Experiences et politiques des industries de defense et experiences comparables dans d'autres secteurs Colloquium 29-30 June, 1 July 1994 Brussels --------------------------------------------------------- PRACTICAL SOLUTIONS FOR STIMULATING RUSSIA'S PRIVATE SECTOR Robert Watters The business of politics and the politics of business in Russia have received their fair share of negative press in recent months. But Robert Watters says that this country is ripe for investment. He offers three practical solutions to help kick-start this country's private sector. Firstly, encourage training and education, secondly press governments to focus technical assistance money directly at the developing Russian private sector - not on another feasibility study. And thirdly, he urges western governments and companies to be patient and look at Russia as a long term investment. Robert Watters is President of the Information Systems Company, American International Trading,Brussels/Moscow When, at midday on the second day of the meeting of NATO foreign ministers in December 1991, Ambassador Nikolai Nikolkaiyevich Afanasyevskiy was obliged to report to the North Atlantic Cooperation Council that the Soviet Union had dissolved and that he no longer had the authority to speak for the USSR, no one would have thought that 30 months later we would be meeting at an official NATO Colloquium to discuss the subject of defense conversion. Many of those who were in Room 16 of the NATO Headquarters that rainy afternoon believed that the USSR and Russia were on the verge of collapse. The political and economic structures were so uncertain that many doubted that Russia would survive without falling into civil disorder and possible civil war. Yet - two and one-half years later - Boris Nikolaevich Yeltsin has visited Naples to press again for Russian admission into the Group of Seven. The Setting ----------- Although by living and working in Russia on a daily basis we sometimes are tempted to do otherwise, we must admit that there has been an incredible, irreversible, and (with the exception of the events of October 1993) a mostly peaceful revolution in Russia. Yes, obstacles remain - loads of them - in completing the transition to a full market economy. Many Western companies are evaluating daily their investment tactics and strategies. Some small companies are leaving. Others are consolidating their present positions and have decided to maintain, though not necessarily strengthen, their positions over the next six months. But others have decided to come in strong, to take advantage of what they consider to be a real, and perhaps temporarily open, window of opportunity. For them, even though the dangers of Russia's falling back into a period of tumultuous inflation are present, they believe that the climate for foreign investment has improved, and they are willing to take the plunge. The role of privatization ------------------------- One constant impulse for this movement forward - and against stiff odds - has been the privatization effort. And among others, there has been one consistent reason for its success: the Russian leadership which pioneered the privatization effort listened to Western advice. Anatoly Chubais's inner circle of Maxim Boyko, Vassilyev and others, working closely with experts from Western governments and financial institutions - some seconded to their staffs, and others not - and backed by an energetic International Finance Corporation/World Bank team, kept the program moving ahead. The model three-step program they introduced is well known, as is the fact that they chose to begin the installation of the program in the city of Nizhni Novgorod, thanks to the initiative and imagination of the political leadership of Nizhni - the young and dynamic oblastÕ governor, Boris Nemtsov; his deputy for international affairs Evgeniy Gorkov, and the then Nizhni mayor, Dmitriy Bednyakov. This group, backed by the IFC/World Bank Development team, began the privatization of small and medium enterprises in March, 1992, introduced the privatization of the transport sector with the first public auction of trucks in October, 1992, and followed with subsequent land auctions in 1993. As part of the governmental effort to encourage progress in the defense conversion area, the U.S. government sent to Nizhni - through the auspices of the International Executive Service Corps - advisors to assist the local government in its defense conversion efforts. These men, and their wives, surveyed 43 defense-related enterprises, and finally selected eight for further cooperation in defense conversion projects. This description is not to say that it has been easy. There are problems in this conversion effort - many of them. One particular problem in the process, which has surfaced repeatedly, concerns the process in which the property is privatised. Many of the investment funds now active in Moscow - the Russian - American Enterprise Fund, The Paine Webber Fund, the funds from the European Bank for Reconstruction and Development, the U.S. Ex-Im Bank and others - are often finding in researching the applications of Russian enterprises for this investment money that factories have merely been taken (or stolen) from the State in the name of privatization. Consequently, in working with these newly privatized companies, foreign investors must remain diligent to insure that their Russian foundation is solid. Among Western observers resident in Moscow there is a wide range in the forecasts of ow the future will develop. Over the last month we have talked with Moscow-based representatives of several investment funds, whose combined available capital is in the range of 800 million dollars over the next two-to-three years. The pessimists -------------- The pessimists - many of whom have been in country for less than one year - charge that in terms of economic planning there is no plan, there are no clear goals or objectives, no-one is in charge. They argue that President Yeltsin sits above the fray, and that Alexander Shokhin often is out of Russia attending international conferences. When he is in town, they say, his predilection is to avoid, rather than take, the hard decisions necessary to steer a defined and predictable course. The pessimists also say that absent firm course (almost in any direction) Western investment planners lack the foundation on which to base either tactical or strategic investment decisions, as the planning cycles are more often measured in months rather than years. On the other hand, many of the representatives who have been in Russia for two or more years are much more optimistic. They note that great progress has been made since December 1991. They use the image that Russia is building a causeway from one side of a river to the other. Over the last two years the building blocks have been put in place, and though that foundation may not yet be above the waterÕs flow, if Prime Minister Chernomyrdin continues to push the privatization program aggressively, the causeway will soon emerge. Foreign investors, they continue, should focus on the great progress in the transition to a full and free market economy that has been achieved, not concentrate on the obstacles that remain. Continuing concerns ------------------- From our experience in Moscow we see three main areas that the Russian government must address if they are to continue to make Russia attractive to Western investment. The first is that the privatization process - in fact the evolution of political and economic reform in Russia - is outrunning the government's ability to control, never mind lead, it. The government's proclivity to produce decrees - at the rate of 600 plus per year - in an attempt to catch up to the reality of change is counterproductive, especially as the decrees adopted are contradictory and seldom enforced. This is also a reflection of the reality that over the last three years the authority of the central government has to a large degree vanished, so that enterprise directors or association directors away from Moscow pay little or no direction to the central authorities. The second concern is that even given the attempts of Western governments and institutions to encourage the development of the necessary legal underpinning, one is not yet in place. There still is no understandable or stable tax regime, and there has not been sufficient progress in establishing the rules and procedures for licensing property and granting titles. But more importantly, there still is a severe lack of understanding of Western business practices and procedures at the enterprise level. Thirdly, of course, there is the problem of widespread corruption. Russia now offers a combination of the Alaskan Klondike one hundred years ago and the Chicago of the 1930s. And although in our view the problems are overstated in the Western press, this factor must be taken into account, as one local mafia or another out of the twelve such groups operating presently in Moscow controls much of the banking and public service sectors. Three solutions for Russia -------------------------- To paraphrase the words of a former NATO Assistant Secretary General, what the West must do first to help Russia move forward in the business development sector is to develop the world's largest business school. This need not be at the level of the Harvard Business School or Wharton or Kellogg - but it should address the basic finance and accounting principles that all Western corporations accept and work by. We should encourage and develop exchanges at all levels so that practical day-to-day experience is learned and shared. The U.S. Government program to bring 10,000 young Russian entrepreneurs to U.S. banks and corporations is one step in the right direction, but it is just a start. The results are clear: if Russian enterprise directors can talk the same business language as interested potential Western partners, both sides would benefit and the flow of western capital and investment would increase. Secondly, governments should be pressed at every level to direct technical assistance money directly into the developing Russian private sector. Governments no longer need to fund the second and third tiers of feasibility studies - there have been enough such studies written to paper over Red Square. Instead governments should be looking at ways to stimulate directly the private sector. That approach would pay dividends in the sector we should be aiming to encourage. Thirdly, western governments and enterprises should show patience and resolve, and come to Russia for the long term. The investment climate is improving, the rate of inflation is dropping dramatically; the rouble is now essentially convertible; the Russian government has promised they would seek legislation to grant foreign investors a five-year tax holiday on taxes on profits, the building blocks are slowly being put into place. From the point of view of a small company which has been in Russia since 1989, the political and economic prospects in Russia are brighter now than they have been in the last five years. --------------------------------------------------------- Copyright 1994 NATO All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means: electronic, electrostatic, magnetic tape, mechanical, photocopying, recording or otherwise, without permission in writing from the copyright holders. Authorization may be requested for redistribution of the text on a non commercial base by research and educational services. Requests should be addressed to the Economics Directorate, NATO, via e-mail 'scheurweghs@hq.nato.int'. First edition 1994 ISBN 92-845-0079-6 This is the latest in a series bringing together papers presented at the NATO colloquia organised by the NATO Economics Directorate and Office of Information and Press on economic issues in the former USSR and Central and East European countries. For further information please write to the Director, Office of Information and Press, 1110 Brussels, Belgium. The articles contained in this volume represent the views of the authors and do not necessarily reflect the official opinion or policy of member governments or NATO.