879 February 6,1992 TPIE CREEFING COUNTERREVOLUTION IN RUSSIA LOCAL RESISTANCE TO PRIVATIZATION By Alexandr Urmanov, Ph.D E.L. Wiegand Fellow INTRODUCTION After Bor is Yeltsin won the presidential elections in Russia last June 13, the reformers faced two main tasks in dismantling the communist system. The first objective was to eliminate the political and ideological dominance of the Com munist Party. The second goal was to replace the inefficient state-owned economic system with one based on private property.

August 19 to August

22. All the Communist Party structures were completely destroyed in the wake of the coup. Yeltsin prohibited the activity of the Com munist Party in Russia on August 23, and the local authorities took over its property. The subsequent evaporation of the S o viet Union and the creation of the Commonwealth of Independent States in Alma-Ata on December 11 have made the demise of the Communist Partys rule irreversible Steps Toward Free Markets. Accomplishing the second task of privatizing the economy has been sl o wer. The reason is not a lack of interest on the part of Yeltsins government Following Yeltsins October 28 speech to the Russian par liament, in which he unveiled his program of radical economic nfm, the Rus sian government introduced and the Russian parl i ament passed a number of laws The first task was completed by the defeat of the hardline Communist coup on After completing his term as The Heritage Foundations E.L. Wiegand Fellow, Aled Urmanov has retunzed to the Sorfruzhesrvo (Cooperation) Foundation, where he is Chairman of the Urals Division. The Foundation is located at Lenin Ave. 24-450, Ekaterinburg, 620038, Russia. Telephone (3432) 589-73 1.

Urmanov is a top political advisor to Boris Yeltsin and one of the few professional political campaign mana gersinRussia. to further reform. Examples: the Yeltsin November 17,1991, decree freeing fmign trade from centralized state control; the December 28 Land Privatization decree, which calls for the transfer of much of the collective farms land to private far m ers; and the December 29 Enterprise Privatization decree, which calls for accelerated privatization of state and municipal enterprises. Finally, on January 2,1992, the Yeltsin government took a decisive step toward a market economy by freeing prices, whic h from that time on were supposed to be dictated by the market farces of supply and demand, rather than set by the government bureaucracy.

The Yeltsin government also took administrative steps to assure that privatiza tion occurred at the local level of go vernment. A special Russian government agency, called the Committee for the Management of State Property, was created by the central government to oversee the privatization of state-owned properties by the municipal and regional governments. This Committe e has branches in all regions of Russia. Furthermm, Yeltsin has appointed governors and presidential repmentatives for the re ons to ensure that his economic reform policies are fol lowed by local officials.The presidential representatives have the authori ty to make recommendations to Yeltsin abo-ut which steps should be taken to expedite free market refms in their provinces. They may even recommend removal of local officials who sabotage the xeform.

Serious Problems. Yet, despite all these measures, it is becoming increasingly clear that Yeltsins free market reform has run into serious problems on the local level, Among these are: the local populations ignorance of the new economic rights granted by Russian parliament in Moscow; the seventy-year old habit of relying on Moscow and the state to solve all economic problems; the lingering fear among entrepreneurs that it might be dangerous to operate in the open as opposed to the underground black market.

But the biggest obstacle of all is the unwillingness of the local authorities to allow privatization to proceed a phenomenon that could be called the creep ing countemvolution in Russia. This is much mm than an economic problem.

Speedy and genuine privatization is a key to the survival of Russian democracy..

Without it, the freeing of prices will not fill the markets with goads or control in flation. Without the competition of numerous private enterprises, the old state mo nopolies simply will charge more for the same shoddy products without increas ing produ c tivity or improving quality. If higher prices do not put mm goods on the shelves soon, even the traditionally patient Russian people may revolt against the free market policies of the Yeltsin government and precipitate a roll-back of Russian democracy 1 O n October 22 the Russian Supreme Soviet passed the law suspending local elections for a year 2 To curb this creeping counterrevolution, and to spur privatization at the local level, the Yeltsin government should Press the Russian leglslature to pass laws r e moving local government obstacles to free enterprise For example, the right of local governments to demand export licenses from businesses should be prohibited. These licenses, which are often required for sell ing products outside of regions, greatly hin d er private business activity I Order local branches of the State Committee for the Management of State Property to use funds from the sale of state property to stimulate growth of private enterprises, help to reduce the 10&billion ruble budget deficit, an d to ad dress the needs of the popuiatlon, rather than to purchase more state property Local branches of the State Committee for the Management of Private property BT~ tasked by the Yeltsin administration with the sale of state property. However the funds f rom the sale often are used for acquiring more property for the Russian government. Instead of expanding the government sector of the Russian economy, the profits from the sale should be used for low-intemt loans to private businesses, for reducing the bu d get deficit, and for local social spending such as soup kitchens, hospitals, and schools I Allocate funds from the central Russian governments budget to enable the Presidents reglonal representatives to acquire offlce space and equipment and to hire staff and nongovernment researchers for independent survey and analysls of the local prlvatizatlon data.

Although the Presidents representatives m tasked to expedite privatization in the provinces, they are often handicapped by their dependence on local authori ties for office space, equipment, and staff. This makes them hostages to local bureaucracies and, as a result, the Yeltsin government receives a distorted picture of the local privatization effort. It is necessary to allocate special funds to enable the r epresentatives to operate independently of the local authorities I Coordinate the reform efforts of the Russian government and Russian entrepreneurs.

This would enable Yeltsins regional representatives, who m the engines of economic refoxm in local communi ties, to link up with private entrepreneurs and to form a common front against the intransigent local bureaucracy Facllitate contact between foreign investors and Russian businesses.

This would enable local businessmen to form their own contacts with fore ign investors and experts, allowing them to bypass local officials who try to steer for eigners to invest in state-run enterprises that they control 3 TIE REASONS FOR LOCAL BUREAUCRATIC RESISTANCE TO PRIVATIZATION Despite the defeat of the August 19 Augus t 21 Communist coup in Moscow most of the officials on the local level are former Communist bureaucrats, who are hostile to free market reforms and have excellent connections with bureaucrats of similar background on the national level. They are there beca use it is impossible to change the entire staff of local and central bureaucracies in the few months that have passed since August.

Local government officials are opposed to free market reforms because they threaten their control over the local economy. On ce real privatization occurs, no one would need bureaucrats to manage the economy, and local government power over the population would be much more limited, as it is in the West.

In some places, the bureaucratic resistance to privatization is supported b y the population. After centuries of authoritarian czarist rule and seventy years of Soviet totalitarianism, many Russians look to local authorities to solve problems in all areas of life. That is especially true of the economy. Under increasing pres sure from the population'to overcome food shortages, reduce inflation, and halt the decline in the standard of living, the local authorities who resist privatization argue that the only way for them to fulfill the popular expectations is to directly manage loc al economic affairs, despite what the central government in Moscow wants.

Fear of Markets. Another source of bureaucratic resistance to privatization is the local authorities' fear that a free market would create huge political problems for them. Thus, for example, in the Ural Mountains region and Western Siberia the lion's share of the population is employed in heavy industry and military production. In many towns, especially smaller ones, virtually the entire popula tion is employed by a single plant. In such areas the local authorities provide food for the population by forcing the peasants on the state-controlled collective farms to deliver their produce at artificially low prices. If the land is privatized, if collec tive farms disintegrate and the mar k et begins to dictate prices, the local authorities, who have neither money nor barter goods to offer peasants in ex change for food, will end up with tens of thousands of hungry people on their hands. This will lead rapidly to a popular revolt against loc al authorities. It is precisely this type of revolt that local bureaucrats seek to prevent by opposing land privatization.

Finally, Russian local governments have a direct monetary interest in maintain ing int rusive control over the local economy. For example, the local governments serve as mediators between foreign businessmen and local companies. In addition to the income from commissions and bribes, this activity also results in all sorts of junkets abroad. In the Ekaterinburg (formerly Sverdlovsk) region, most of the last year's hard currency budget of the regional government was spent on trips abroad for the officials 4 Another source of revenue is licensing of exports. In most areas of Russia, in order to take their guds out of the region, businesses must be licensed by the local authorities. Authorities grant such licenses but only in exchange for a hefty share of a companys profits. Often their share reaches as much as 50 percent of a companys profits 44 M UlrJICIPALIZATION INSTEAD OF PRIVATIZATION Under pressure from the Yeltsin government to privatize, most local govern ments in Russia try to avoid a direct confrontation with Moscow. Rather, they engage in indirect sabotage of the privatization program. T he most common strategy is to create what might be called as-if private enterprises, which are in fact owned by the local authorities. This process may be called municipaliza tion.

This is how municipalization works: The local government is the owner of mo st of the local industrial park and land (the rest is owned by the central Russian government). Instead of just selling a factory, a store, a building, or a piece of land to anyone who wants to buy, local officials may offer to lease the property in stead . The profit from such sales or leases are often invested by local govern ments in buying more factories, stores, real estate, or land.

Preferred Business. In addition to municipalization of state-owned property the local governments seek to retain control over the economy by subtler means.

For example, they set up private businesses with municipal or former Com munist Party money, which they then give or loan to a trusted private entrepreneur who is usually a former member of the local nomenklatura, as th e occupants of high positions in the Party, industry, or government 8fe called. Be cause of their past, they have both professional and personal connections to local government officials. It is no accident that in many Russian provinces the owners of the largest private firms in Russian towns are members of the local govern ment or their representatives.

These officials and their private partners become owners of what may be called preferred businesses, because they receive special treatment from the local government. For example, local governments supply them with such scarce commodities as raw materials, fuel, and transportation. They also get preferential treatment in renting or buying buildings for their enterprises. Local bureaucrats sometimes channel foreign investors their way which enables them to form joint ventures with foreign businesses. While nominally private, such preferred busi nesses are, in fact, another form of municipalization because they are owned or controlled and manipulated by local bureaucracies CREEPING PRIVATIZATION Bureaucratic resistance is a serious obstacle to privatization. It has slowed the pace of privatization considerably. Still, the local governments that are opposed to privatization have failed to stop private economic activity altogether. Instead, it 5 often assumes abnormal forms. This process may be called creeping privatiza tion.

Speculators. The moving force behind creeping privatization are the scwtlled speculators. In Russian, this term describes someone who buys low, usually from subsidized state-owned store or enterprise, and sells at a higher, market price on the black market, which is essentially free market activity prohibited by law. Because of the perennial shortages, distribution bottlenecks, and cormption inherent in a socialist economy, speculation becomes the only efficient means of bringing quality consumer goods to those willing to pay the market price for them.

Until a few years ago, engaging in any kind of production of goods and ser vices outside th e state sector was a criminal offense and meant a prison term. As a result, most of the Soviet private entrepreneurs were forced to become speculators. The situation has changed since private business activity gradually became legalized in Russia in the l a te 1980s. First, the number of speculators has increased tremendously. The lure of making a lot of money fast and without risk ing a jail term attracted thousands of young people, most of them under thirty into this kind of economic activity. Having reach e d adulthood since 1985, under glasnost and perestroika, these young businessmen are not afraid of the state and are more prone to take the risks of large-scale transactions than were the previous generations of underground entrepreneurs. Second, unlike ol d er speculators who were forced to hold down a government job to avoid criminal charges of social parasitism, the new private businessmen work for themselves full time. Many do not have any other profession or trade except making money. Thus, a totally new social class professional private entrepreneurs is emerging in Russia.

Because of the slow progress of privatization in Russia, most of these young professional entrepreneurs continue to engage mostly in speculation, or as it is beginning to be called in Russia, brokering. Unlike their older colleagues, how ever, many of the new businessmen no longer are content with quickly making a lot of money and then quitting. Rather, they want to make a permanent career of business. 66Forced99 Privatization. One of t he ways in which the young entrepreneurs succeed in wrenching the productive sector of the economy from the hands of local bureaucracies may be called forced privatization. Many speculators have accumulated huge sums of money, often as high as hundreds of millions of rubles. At the same time, hundreds of state-owned enterprises, especially in the military and heavy industry sectors, which have few products anyone wants to buy, lack operating capital. Many have problems even meeting the payroll. And local a uthorities often are unable to help them out because of huge budget deficits.

It is under these circumstances that forced privatization takes place. A speculator approaches the manager of a near-bankrupt state plant and offers to in vest in it in exchange for a share of the enterprise. Reluctant as the managers may be to go private, even partially so, they have no choice because they have run out of operating funds. Although slow and gradual, forced privatization allows 6 private entrepreneurs to engage in direct and expanding production activity over which local authorities have little control HQW THE RUSSIAN GOVERNMENT PROMOTES PRIVATIZATION The Russian central government is well aware of the obstacles to privatization on the local level. To help overcome local bureaucratic resistance, the Yeltsin government uses three administrative tools: 1) direct appointment of Heads of Local Administration governors for the regions; 2) dispatching the Presidents Representatives to the provinces; and establishing local branches of the State Committee for the Management of Private Property.

Heads of Local Administration. On October 22,1991, the Russian Supreme Soviet (parliament) approved Yeltsins decree suspending local elections throughout Russia until the end of 19

92. The reason: the temporary hardship and dislocation caused by the transition to the free market may cause a political back lash hm which Russias new leftist political forces, which includes former Com munists, stand to gain.

Instead, to assure that free market reforms remain on track, Yeltsin began in the fall of 1991 to appoint Heads of Local Administrations to Russias regions.

Several factors, however, seriously diminish the effectiveness of Yeltsins appoin tees. First, since they are not elected, the y lack legitimacy and are not seen as rep resenting the will of the majority of the local population. Second, in many areas the Heads of Local Administration are up against entrenched, resilient, and politi cally very skillful local bureaucracies that see k to undermine the privatization ef fort. That means that even the best intentions and orders of the Head of the Local Administration are likely to be frustrated by passive bureaucratic resistance of their subordinates.

Representatives to local governments in the aftermath of the August 19-21 coup. The Presidents Representatives have the task of reporting to Moscow on the pace of privatization in the regions. In the case of direct sabotage of the free market reform by lo cal officials, the Representatives may even recommend that such officials be fired by the President.

Yet, while they certainly keep pressure on the local authorities to expedite privatization, Yeltsins private envoys often have neither sufficient expertise nor enough staff to see through and overcome the various ruses and stalling k-khni ques employed by the local opponents of privatization. Such techniques include for example, municipalization and the special treatment given preferred busi nesses, which a r e nominally private but are, in fact, controlled by the local authorities Presidential Representatives. Yeltsin began appointing his special envoys or Lacking the means to collect and analyze data on the progress of privatization in their provinces, the P r esidents Representatives tend to send to Moscow whatever facts and figures the local bureaucracy gives them, such as, for example the number of privatized retail stores. Yet many of these stores may be not be 7 privatized at all, but merely municipalized, or taken over by the city governments.

Furthermore, even if privatization is genuine, privatizing retail trade, while impor tant, is not as critical as privatizing industry, real estate, and agriculm. Yet the Representatives often have no data at all abou t the progress of privatization in these areas. As a result, the picture painted by the Representatives often is mis leadingly rosy.

The State Committee for the Management of State Property. Created by the Council of Ministers of Russia, the State Committ ee for the Management of State Property is the main Russian government agency in charge of privatization. It is tasked with selling state property to private entrepreneurs. The term state proper ty here describes the property of the central Russian govern m ent, as opposed to the property in the hands of local authorities. Usually, state property is what used to belong to all-Union ministries in Moscow, such as, for example, large in dustrial plants, military plants, factories producing electronic equipment, and trucks.

The State Committee for the Management of State Property has branches in all Russian provinces (obZmtC in Russian). Their task is to sell state property, such as stores, factories, and plants, to private entrepreneurs. There is, however, a ser ious danger that the proceeds from the sale of the state property owned by the central government will be invested by the local Committees in buying local property, thus making the Government of Russia the owner. As a result, instead of diminishing state o wnership of industrial enterprises, the local Committees may, in fact, increase it by adding new assets to the state ownership HOW THE RUSSIAN GOVERNMENT CAN SPUR PRIVATIZATION IN THE REGIONS The Russian democratic revolution is now in its second, critica l stage. The pre vious phase, that of spectacular political collisions at the top, is gone at least for the time being. Instead, the fate of Russian democracy is being decided in the difficult daily struggle for free market refms at the local level, in the fight with the experienced bureaucrats who oppose privatization.

Ye1 tsin government should Press the Russian legislature to pass laws removing local government To overcome this resistance and facilitate the transition to free market, the obstacles to free enterprise.

The names of most of the local bureaucrats opposed to privatization are well known. Yet because many of them have been elected to their positions, the Yeltsin government cannot remove them wholesale without discrediting democracy itself. At the same time, the central government and the Russian SupRme Soviet can change laws, removing some of the most powerful weapons from the arsenal of the local bureaucrats. While waiting for local elections, the Yeltsin government should urge the Supreme So v iet to pass laws outlawing some of the anti-reform activities of local governments 8market reforms. However, their effectiveness is seriously diminished by their de pendence on the local authorities for material support, such as office space, office equip m ent, staff, and experts As a result, in many provinces the representatives 9 become hostages to the local governments. This dependence jeopardizes the in tegrity of their oversight authorities will improve their ability to collect data on privatization an d analyze the situation in the provinces. They will be able, for example to pay independent non-government research centers and individual experts to conduct in-depth sur veys and offer recommendations. This in turn, would mean that the Yeltsin government w ould receive a more comprehensive and more truthful picture of what is happening in the country Coordinate the reform efforts of the Russian government and Russian Making the presidents representatives financially independent of local entrepreneurs To ove r come the resistance of local authorities to privatization, the Russian government needs local allies. Perhaps its best allies are local entrepreneurs. So far, however, the government has done very little to build bridges to local businessmen much less to coordinate the efforts with them. For example, the Council of Businessmen created under the Russian governments aegis in January 1992 does not represent the entire Russian business class but only a small part.

In addition to expanding the membership in the Council of Businessmen to in clude a broader cross-section of Russian entrepreneurs, the Russian government should work to gain the trust of entrepreneurs and secure their assistance. Thus for example, Yeltsin and his aides should meet periodically with b usinessmen in the Kremlin to hear their assessment of the economic situation and ask their ad vice. Likewise, Yeltsins envoys to the provinces should meet with the repre sentatives of local businesses to assess the pace of privatization, discuss the obsta cles to it, and coordinate solutions Facilitate contact between foreign Investors and Russian buslnesses.

Foreign investment and joint ventures of Western and Russian entrepreneurs are much more than simply economic transactions. Russian entrepreneurs, who for decades have been forced to operate underground, have very little experience in running legitimate businesses. Business ethics, taxes, property rights, arbitra tion, labor relations all these issues are new to them, especially in the provin ces. Work ing directly with foreign businesses or observing how they operate will be an invaluable learning experience that would greatly facilitate market reforms on the local level.

The best way to attract foreign entrepreneurs to Russia is to create a most favore d-status for them. Yeltsins January 23 decree suspending customs tariffs is an important step forward. Further legislation is needed that would contain as few limitations as possible on the scope and nature of the activity of foreign entrepreneurs in Russ i a. For example, lowering taxes and facilitating repatriation of profits abroad would produce a very beneficial effect 10 CONCLUSION Boris Yeltsins bold free market reform program faces many obstacles, but none as threatening as the bureaucratic opposition from local governments. Local government officials subvert privatization in different ways. They may refuse to sell local property to a private entrepreneur. Or they may lease state-owned enterprises to cronies for their private gain. Or they may use the f unds gained from privatization to acquire more state property. Whatever their method, they are a menace toYeltsins free market revolution and need to be stopped if Russians are to crawl out of the current economic crisis This can be done by passing laws t h at prohibit local licensing of businesses and other obstacles to the free flow of goods and services. Further, funds gained from the sale of state-owned enterprises should not be reinvested in other state-run enterprises, but should be used to extend low- i nterest loans to private businesses or lower the budget deficit. And the Yeltsin government should bypass local governments when promoting its reforms, encouraging budding private entrepreneurs to form direct contacts not only with the refmist central gov e rn ment, but also with foreign companies which may want to invest in local in dustries ments of Russia. It would be a pat tragedy if the great democratic and free market revolutions fomented in Moscow were undone by the venality and obstinence of petty of ficials in the countryside The legacy of the communist command economy lives on in the local govern-