Reformers Face Task of Overhauling Ruined Economy

DESPITE the unending flux in the former Soviet republics, one constant remains - the pressing need for economic reform.Goods and services must be restored to a deprived people on the brink of disaster. But communism's demise has so far brought only increased hardship without any sudden rise of capitalism. Even as Mikhail Gorbachev's failure to halt the economic slide led to the shift in power to the republics, reformers there have also been reluctant to take the bold measures needed for fear of political consequences. They have yet to lift subsidies, close money-losing state industries, impose price hikes, and tighten fiscal policies to end free entitlements - from transportation to health care - that burden government budgets. United States Central Intelligence Agency Director Robert Gates, a longtime Soviet watcher, worries that "the enormous economic and social challenges facing most of these new democratic forces may overwhelm them." Indeed, public patience has snapped for reforms that, since perestroika's introduction in 1985, have done little more than disrupt daily life with food and fuel shortages, suspension of social services, and unemployment. In the midst of instability, the question remains whether the republics can move quickly enough to stave off total economic collapse. While ethnic and nationalist conflicts flare up and the armed forces are restless, Soviet centrists such as President Gorbachev and Soviet Foreign Minister Eduard Schevardnadze say such a collapse might come in the difficult winter ahead. Mr. Gates echoes an oft-expressed fear in Moscow that coming hardships "could produce a return to authoritarian government, whether led by reformers desperate to feed the people and stave off an explosion or by nationalists driven by a xenophobic, atavistic vision of Russia." The reform challenge is complicated by breakup of the centralized state into independent republics and the new Common- wealth of Independent States. The main hope for reform rests with Russian President Boris Yeltsin, the leader of the largest, richest, and most populous republic. The former boss of the industrial city of Sverdlovsk has long been accused of doing little on the economic front, falling back instead on populist rhetoric. But Mr. Yeltsin has finally embarked on a radical reform program (see story at right) drawing praise from foreign analysts. "They're working at an extraordinary pace now, but it's hard to see, because it's behind closed doors," says Anders Aslund, director of the Stockholm Institute for Soviet and East European Economics, who was in Moscow last week to discuss reform prospects and progress with Yeltsin and his chief economic advisor, Yegor Gaidar. "Clearly, the Russian reforms are all-out liberal," adds Mr. Aslund, who warned that Yeltsin's previous go-slow approach was perilous. Mr. Gaidar acknowledges the program is full of political risks, as unemployment, soaring prices, and housing shortages set in. He has said publicly that it will be tough to sustain support for these "very unpopular" measures. Plans to privatize huge state monopolies (see Part 2 tomorrow) and to make the near-worthless ruble convertible - essential early steps in reform - are still on the back burner. Last week Russia postponed until Jan. 2 its first tough action on reforms - the plan to lift price controls. Other republics have embarked on uneven reforms, and half-way measures have created more problems than they have cured. The most pervasive problem across the former Soviet empire is that, as privatization gets under way, former Communist bureaucrats are commercializing state property for their own gain. In the Ukraine, for example, local leaders have emphasized privatization. Selling off state assets to the emerging private sector ideally releases the government of its costly obligation to shore up inefficient industry, reduces the budget deficit with proceeds from sales, and helps establish a market economy. While over 1,500 such companies have been formed in the Ukraine, state assets - from machinery to plants - have been purchased by former Communist officials who are relatively well-off and, given their close connections to the state enterprises, well-poised to pay very low prices. Aslund says the line between what's fair and what's embezzlement has not been drawn. Prices are still fixed and far from being determined by the market. Kazakhstan, the largest of the Central Asian republics, is busy establishing private property laws. It is among the richest of the republics in raw materials, with enormous potential for economic growth if local and foreign investments can be stimulated. While the republic's leaders clearly recognize that private property is the seed from which capitalism grows, they are at best "enlightened despots," says Aslund, an advisor to republican economic planners. As the Central Asian republics now intend to join the new Commonwealth of Independent States, most republics will need to press for key reforms: price liberalization, a revamped distribution system, a new legal framework for a market economy, financial institutions that can help pay for reforms, and a social safety net to catch the millions of workers that will be displaced by plant and farm closures. Conversion of the vast Soviet military-industrial complex - which has accounted for more than 25 percent of economic activity - is a top priority. Huge investments are needed from local and foreign investors to help shift defense production to the manufacture of consumer goods. State resources are also needed for transportation and communication networks and to provide credit for a fledgling private sector to purchase plants and equipment.

Distribution Under Gossnab, the centralized Soviet system that supplied farms and factories from a Moscow command center, state subsidies depressed prices and made everything affordable. Because the government had standing orders and set quotas for output and distribution, agricultural and industrial producers worried only about the quantity of their work, not about its efficiency or quality. Now this system has virtually collapsed. Enterprises no longer enjoy a ready source of raw materials or parts, nor do they have a ready recipient for what they produce. Enterprises, farms, and families scramble for supplies. Aside from mostly barren state shops, people trade in black markets and in a form of barter based largely on access to "surplus" or pilfered supplies from state enterprises. The enterprises themselves are also resorting to barter, trading cars for tons of wheat, sometimes directly or through the network of exchanges that has sprung up around the former Union. Hoarding goods to trade has become a priority. Kiev Train Station in Moscow, for example, is teeming with residents and travelers who have come to claim parcels sent from the Ukraine on the overnight train. Enterprising Russians try to capitalize on the relative availability of goods in the Ukraine by arranging for large train deliveries and then selling the goods at inflated prices in Moscow. Economists say the best way to ensure a flow of goods to market is to free prices. Suppliers would then be confident of fetching competitive prices even as inflation climbs by almost three percent a week. Until production and purchasing power increase, deregulation of prices is painful. The Russian plan to lift controls in early January would push up the cost of basic consumer goods by as much as 500 percent.

Legal framework Laws must be enacted and enforced to nurture a market economy, and protect it from price gauging and bribery. Local and foreign investors lament that they operate in a very-high-risk environment, devoid of a court system in which judgments are steadfast. The sale of property is largely in limbo, because republican and central authorities have yet to decide who owns what - from land to industrial centers. Ivan Silayev, chairman of the Interstate Economic Committee, reminds prospective foreign investors that "not long ago, it was a crime to even speak about ownership of private property." Now, roughly 500,000 independent businesses and farms have begun operations in the former Soviet Union. Local and foreign investors complain that paying off any number of officials on the central, republic and enterprise level is built into the cost of transacting business in the Soviet arena. "When deals go sour, it's usually because the Soviets have their palms extended," says the head of international investments for a large Italian engineering firm. Laws supporting private ownership, sales and profits, taxes and customs, often have been passed on one level - central, republican, or municipal - but rescinded on another. A Washington banker in the early stages of deals in several republics says, "You have to negotiate on many levels.... It's important to negotiate with leaders who are in and on the way up, not with those who are in and on the way out. And it's often hard to tell who's who." The investors repeat a constant refrain when assessing prospects for large-scale investment in Russia and other republics. Until ownership rights are secured, price controls are completely lifted, and state enterprises are disbanded, they say, little foreign capital will flow.

Banking A legal framework must also help regulate commercial banking, which is developing to service the private sector. "Banking is a very important element in the economic reform process," says Jay Mitchell, an economist with PlanEcon, Inc., a Washington-based advisory firm specializing in Soviet and East European economies. "Freeing prices and lifting subsidies are important, but if credit is not available, the reforms will stagnate because the private sector won't develop. Unless you provide new companies with needed financing, they will go under," he says. "And because a legal framework has not been fully put into place, today's environment is dangerous for the banks that do exist. It encourages corruption, principally by those who have access to power and [state] accounts. The people who have access to power are operating in a vacuum, until laws are passed to regulate the banking system." "Commercial banks are popping up," says Aslund, "but they are run by the nomenklatura, who know ways to put state money into private pockets." Moscow Mayor Gavriil Popov's recent move to award Moscow residents ownership of their apartments without payment is a way of providing individuals with collateral. Measures like this could have a long-term impact on Moscow's coffers. When that collateral turns into the ability to invest in new businesses, the city will have a new tax base. Local and republican budgets are bankrupt. Many, but not all, of the republics have agreed to repay the former Union's foreign debt. (Soviet estimates now put it near $100 billion.) Negotiations among the republics have apportioned debt according to the republics' respective contributions to the Soviet Gross National Product. But no matter how exact the debt allocation may be, it is unlikely that it will all be repayed. Domestic priorities prevail. Pensioners, the poor, and those whose wages cannot keep up with raging inflation also will need state assistance. But there is nothing to sustain this "explosion of social expenditures," says Aslund. State revenues have collapsed. Enterprises are anxious to manage their own finances rather than submit to municipal accounts. And a breakdown in export earnings - ranging from drastically reduced oil production to a virtual cutoff of trade with former Comecon partners - has dried up official coffers. Without money, the reform process is powerless. The world's richest countries have been prepared to offer little more than stop-gap assistance to get the Soviets through the winter and prevent default on what they owe the West. The US has called an international conference to discuss what all countries can do to help. Reforms will exact a high price from Soviets already under duress. St. Petersburg Mayor Anatoli Sobchak warns, "If we cannot feed the people, then as the Russian saying goes, 'We will lose our head If people are brought to the brink where they are not able to feed their family, no words about the necessity of reform will persuade them." Politicians have trouble seeing past day-to-day worries to take steps to revitalize the economy. Until they do, moves toward a market economy will be haphazard, says Aslund. By now, he says, current social tensions should have demonstrated to republic leaders that they don't have the luxury of gradualism.

Part 2, on privatization, appears tomorrow.