Petrostate:Putin, Power, and the New Russia

by Marshall I. Goldman

  From his own background in international finance Casey understood that the Soviet Union depended heavily on petroleum exports to pay its international bills. This included not only payment for massive imports of grain (by the late 1970s, the Soviet Union had become the world’s largest importer of grain) but for imported factories (for example, large chemical plants) and technology that the USSR was unable to produce itself. These imports were also important in providing the Soviet Union with the wherewithal needed for its military-industrial complex. According to Schweizer, Casey thought that if he could somehow shrink the value of the USSR’s petroleum exports, that shrinkage would force the Soviets to curtail their involvement not only in Afghanistan but elsewhere in the world. All of this suggests, however, that Casey was unconvinced by the earlier CIA predictions that Soviet oil output would fall. If those earlier conclusions had been right, the Soviet hard currency earnings would have been reduced without any need to seek Saudi help and, short of money, the Soviet Union would have been forced to withdraw from Afghanistan. A drop in hard currency export earnings would also have hurt industrial investment within the USSR itself. Except for the revenue earned from petroleum and to a lesser extent natural gas exports, the Soviets had virtually no other way to pay their external bills. Consequently, Casey sought ways to reduce the USSR’s earnings from its petroleum exports. While he might not precipitate the Soviet Union’s collapse, at least he could weaken its structure.

  To implement this ingenious scheme, Casey sought out the Saudi leadership in 1985 and, according to Schweizer, urged them to increase their output and export of crude oil. By expanding world supply they would precipitate a drop in world oil prices. Casey argued that this would not only help the U.S. economy but would seriously hamstring the Soviet economy and presumably force the Soviets to curb their adventures in Afghanistan.

  What was the exact cause and what was the effect even now is not known precisely. As reflected in Table 2.1, Saudi output fell to a sixteen-year low in 1985 after hitting an all-time high in 1980. Then after King Fahd’s visit to Washington to see President Reagan in February 1985, the Saudis did pump more oil.33 Output in 1986 rose 45 percent over 1985 (see Table 2.1).34 But perhaps equally if not more important, increased petroleum pumped from the North Sea and West Siberia hit the market at the same time. As anticipated, average prices in 1986 fell to half of what they had been the year before, to $25.63 a barrel (see Table 2.1). By 1988, average prices dropped even further to $24.71.

  We could only guess at the time what the impact of the fall in prices was on the Kremlin leadership. With the benefit of hindsight, Casey appears to have anticipated correctly. Relying on Politburo archives, Yegor Gaidar reports that Soviet leaders were in near panic. The drop in prices, he says, cost Russia $20 billion a year.35 Their financial condition was evidently much worse than we on the outside knew. It was widely believed that even if oil prices were to fall, the Soviets could use their large stocks of gold to pay their bills. But Yegor Gaidar now reveals that by early 1986, they had only $7.6 billion left, not the $36 billion in gold that most outside observers at the time assumed. Most of their gold had already been sold to pay for earlier grain imports. In 1963, for example, Khrushchev spent one-third of the country’s gold to import 12 million tons of grain.36 Once oil prices started to fall, not only did each barrel of petroleum exported earn fewer dollars but the drop in export earnings also forced the Soviets to reduce their industrial imports and the investment they needed to sustain oil production.37 This in turn affected morale already shaken by the turmoil precipitated by Gorbachev’s 1985 perestroika campaign. As a result, crude oil output began to drop sharply. By 1990, crude oil output was down about 10 percent (see Table 2.1), which meant a further reduction in imports and the need to borrow even more money from foreign banks and governments.

  Because Gorbachev and his programs were so popular in the West, there were many calls to be supportive. This gave birth to “a grand bargain” proposed by Graham Allison, dean of the Kennedy School of Government at Harvard University.38 But a growing number of foreign suppliers and bankers came to realize that the USSR’s financial plight was so serious that the Soviets might not be able to repay any such loan. This in turn led them to withhold credits. This only served to increase anxiety in the Kremlin.39 Yegor Gaidar recounts that as the financial situation continued to deteriorate, out of desperation Gorbachev found it necessary to contact Chancellor Helmut Kohl of Germany. He begged for immediate help, explaining that the situation in the USSR had become “catastrophic.”40

  All of this had a destabilizing impact on the USSR. By 1988, faced with intermittent bad harvests, an empty treasury, an increasingly unpopular war in Afghanistan, and a domestic economy in turmoil as it sought to free itself from some of the excesses of central planning, Gorbachev and some of the other Soviet leaders were finally forced to acknowledge that the Soviet Union had overextended itself.41 Its economic wherewithal could no longer support its imperial pretensions. That explains at least in part Gorbachev’s decision to begin the withdrawal of Soviet troops from Afghanistan on February 15, 1989. (It is hard to resist making comparisons with the United States fighting in Vietnam and Iraq.)

  Admirers of CIA chief Casey credit him and his efforts with Saudi Arabia for forcing the Soviet Union’s retreat in Afghanistan and by extension for the collapse of the USSR itself two and a half years later.42 Undoubtedly the increase in world petroleum output and the resulting drop in price that followed seriously undermined the Soviet Union’s international financial creditworthiness and its ability to support its own and its East European satellites’ economies.43

  But was the cause and effect so straightforward and so simple? Prices in 1985 did indeed fall from $50 a barrel (in 2005 prices) to $24 a barrel in 1988. While the Saudis did increase production in 1984, 1985, and 1986, they actually reduced production in 1987. Belatedly in 1988 they again made an increase but to a level less than they produced in 1980 and 1981. Whatever the cause, the Soviets did evacuate Afghanistan on February 15, 1989, but only after Soviet output hit its peak. The Saudis boosted output in 1990 by 70 million tons, much more than the 50-million-ton increase in 1988. But by 1990 the war had already come to an end. If the Saudi increase in production had such an impact on USSR prices, why didn’t oil prices fall in 1980 when the Saudis were pumping two and three times as much oil as they pumped in the mid-1980s, and why did Saudi Arabia wait until the 1990s, rather than in 1985, after Casey’s intervention, to make major increases in production?

  As Gaidar’s research into the minutes and correspondence of the Politburo makes clear, there is no doubt that the fall in world petroleum prices did hurt the Soviet Union.44 But the collapse was due to more than the drop in oil prices. After 1987 there was also a drop in Soviet oil production, which also hurt earning power. The lower prices undoubtedly did contribute some to the drop in output, just as it was to do in the early and mid-1990s. But did lower prices have that much effect on the Ministry of Petroleum and its affiliates? In the Soviet era, profits and prices were not all that important as a stimulus to production. What mattered were targets set by the plan. Market incentives came into play only after privatization. Admittedly the increased use of water injection cited by the CIA in its 1977 report did hamper production, but it was not an unsolvable problem. The CIA prediction that Soviet oil production would fall and the USSR would soon become a major importer notwithstanding, we will see to the contrary in Chapter 5 that Soviet oil production did increase again—and substantially— after 1999.

  While there may have been a connection between increased Saudi oil output, lower oil prices, and the Soviet Union’s collapse, the Bill Casey intrigue does not explain why the USSR did not collapse in 1980–1981 when Saudi output was at a record high, double what it was in 1986. Note even at the 1980–1981 high point of production, the USSR still produced more petroleum than Saudi Arabia. It was only in 1992 that Saudi output exceeded Russian output. Despite the elevated level of produ
ction, oil prices were actually at a record high then. It may have been that the anxiety created by the Soviet invasion of Afghanistan in 1980 had a greater impact on oil prices than the increased Saudi output. But the fact that prices did not fall until 1981— and that the Soviet Union was unaffected, at least in the early 1980s— suggests that while Casey’s efforts to undermine the Soviet Union’s economy may have had an impact, it cannot be argued that his conspiring with the Saudis was the sole or even the most important cause of its collapse. Nonetheless, Casey’s involvement is yet another bizarre episode in this fascinating and ongoing interplay of geology, economics, ideology, politics, and greed.

  3

  Pirates Unleashed

  Privatization in the Post-Soviet Era

  THE USSR IS NO MORE

  The disintegration of the Soviet Union unleashed a cascade of centrifugal forces, both political and economic. In 1992, after the USSR broke up into fifteen independent and occasionally hostile countries, a Moscovite traveling to Kiev or Minsk could do so only if he had a passport for foreign travel. If that Moscovite tried to ship goods to Ukraine, Belarus, or Uzbekistan, he would have to send them through customs, pay a tariff, and accept payment for his goods in something other than rubles. None of this had been necessary before when they were all brother republics within the USSR. Equally disquieting, Boris Yeltsin, the hero in putting down the August 1991 coup attempt and the duly elected president of Russia, had serious drinking and health problems (both physical and mental). This made it impossible for him to focus properly on matters of state. Yeltsin had no problem forcing the breakup of the USSR and spinning off the other fourteen republics (including Ukraine and Belarus that were Slavic), which before the revolution were provinces of the Russian empire. But in an action that haunts Russia today, Yeltsin decided that Russia would not let anyone else split off from Russia and so ordered his troops to put down an insurrection in Chechnia, a relatively unimportant but problematic region within Russia’s boundaries. Unlike Ukraine and Belarus, which share Slavic ties to Russia, Chechnia is a Moslem rather than a traditionally Slavic region. It was forced into the Russian empire in the late nineteenth century. If instead Stalin had decreed that Chechnia was an independent republic like its neighbor Georgia, it too might have been spun off as a newly independent country and no one would have complained.

  In addition to the political fragmentation, the breakup of the country and the disappearance of that unified economic space hit Russia very hard and pushed it toward bankruptcy. While the CIA in the 1980s once estimated that the Soviet Union’s gross domestic product (GDP) was about half that of the United States, by 1992 the agency concluded that the Russian GDP had fallen to about 10 percent of the U.S. GDP. Some economists such as Simon Johnson, Daniel Kaufman, and Andrei Shleifer suggest that this is an understatement. They argue that the official statistics do not reflect the full growth of the just legitimized private sector.1 Given the turmoil of the times, that may be true, but there is little doubt that most of the traditional industrial sectors suffered badly. By 1996, for example, petroleum production, the country’s crucial sector, was off 47 percent from 1987. Some of the decline was due to poor production practices of the sort described earlier by the CIA. But even more important, the rivalry to privatize the various oil fields, refineries, and pipelines was at its peak and inevitably very disruptive. Equally discouraging, with oil prices in the mid-1990s hovering around a low $20 a barrel (in 2005 adjusted prices) there was not much incentive to increase productive capacity.

  Virtually no Russian petroleum company increased production from 1990 to 1999. For many observers, it appeared that petroleum production was declining, almost as the CIA had predicted. Much of the industry was privatized in the mid-1990s and almost all the new owners seemed more interested in stripping and sending assets outside the country while they could still do so and before what many assumed would be a violent and far-reaching reaction. Capital flight from the country as a whole was thought to be on the order of $1 billion a month. To top it off, the country was racked with inflation (prices rose twenty-one-fold in 1992) and the government budget was running serious deficits because few of those who should be paying taxes did so.

  The failure to pay income tax typified the problems encountered in the transition to a market-type economy. Private ownership became the new model, replacing central planning and state ownership of the country’s factories, stores, and farms. In the Soviet Union, state taxes were levied as a turnover tax included as part of a product’s retail price and so unnoticed by the buyer. The income tax that everyone paid also went unnoticed, having already been deducted from workers’ cash envelopes before they received them. In the same way, the enterprise income tax was also automatically withheld by the state. Consequently, there was no need to file an income tax form nor send in an individual tax payment. As a result, only a few economists were aware that the Soviet Union even had taxes. That is why it was common for Russians to insist that the Soviet Union was superior to the United States not only because it had no unemployment or inflation but because it had no taxes.

  PRIVATIZATION AND CHAOS

  When the state transferred ownership of all those stores and factories to private owners, all that changed. Since it no longer could make deductions automatically, beginning in the late 1980s the state had to find some way to induce the new private owners as well as individual wage earners, voluntarily on their own, to send in taxes. That was something the public had never done before. Few could be expected to do so voluntarily just because some state official said they should. Given that tax rates were 30 percent or more and that the state was ill prepared to chase after tax delinquents, it was not surprising that in 2000, even after nearly a decade of private ownership, only 3 million Russians out of the 70 million who were supposed to pay taxes actually did so.2

  Similarly, after the transition, there was as yet no market mechanism in place where producers and consumers could meet, be informed, and deal with one another. In the days of the USSR, there was no need for such a market mechanism because Gosplan, the Central Planning Agency, and the various central ministries did the job, even if poorly. But after 1991, when Gosplan and the ministries lost their power to make such allocations, Russians seeking to acquire even simple things such as a mattress, a saw, or a jacket did not know where to go. Imagine then how difficult it was for a factory director in search of a ton of coal or a specialized machine tool to find what he was looking for. Russia’s retail stores had little or no experience in dealing with an independent manufacturer and supplier. Moreover, some of the supplies allocated previously by Gosplan came from factories that were now located in newly independent countries that no longer would take rubles. This was not only because it was no longer their local currency but because of the hyperinflation in Russia mentioned earlier.

  For that matter, the privatization process itself was problematic. In an effort to win political support for his new bottom-up democracy, Yeltsin agreed to privatize the heretofore centrally planned, state-owned economy. The state issued every Russian citizen a 10,000-ruble voucher redeemable in newly issued shares of the enterprises being privatized. The intention was to ensure that every Russian would not only derive some benefit from the dismantling of the old system but would also have a vested interest in the success of the new market system. But after being subjected to seventy years of state propaganda against capitalism, few Russians understood why a share of stock in the new Russian companies was worth owning or had any value, especially at a time when Russia was in such a sorry economic condition. Not surprisingly, when the market value of their voucher fell to the equivalent of $25 and then $10, most Russians opted to sell their newly allocated voucher and its entitlement to a share of stock for a bottle of vodka or a few rubles. Vodka was concrete and pleasurable, rubles were tangible, but the stock was abstract and at the time little more than a piece of paper. So the vast majority of Russians had little more than a passing hangover or a few rubles to show fo
r seventy years of communism.

  Even worse, because of politics, greed, a flawed design, and corrupt implementation, a small number of investors ended up in control of most of the previously state-owned enterprises. One group of these newly rich, so-called oligarchs were former government officials. They simply took over ownership of the state properties that they had been managing as agents of the government. Another group of owners emerged from a seamier stratum of black market operators and money changers. While despised in the Soviet era for their anti-social black market activities, they nonetheless had learned how to operate in a shortage environment by mastering market practices even if they were illegal at the time. Consequently when markets and private ownership were legalized and no longer anti-social, these previously underground operators found themselves at a significant advantage. This group stood in marked contrast to the former government bureaucrats who were used to issuing decrees in the rigid world of state ownership, unconcerned by what the consumer might or might not actually want. These former bureaucrats found themselves ill-equipped to operate in a market environment where consumers had choices and could not be dictated to.

  DIVIDING UP THE SPOILS

  In this chaotic environment, in a short time a growing number of these newly rich oligarchs became billionaires. But that did not necessarily mean they were good managers. Certainly none were self-made men comparable to a Bill Gates of Microsoft, Edwin Land of Polaroid, Fred Smith of Federal Express, Steve Jobs of Apple, or Michael Dell of Dell Computers. Even those adept at adapting to the market derived most of their wealth from seizing what had been state assets and in a large number of cases by stripping assets from those companies. These enterprises, taken over by the new oligarchs, were spun off from previously state-owned enterprises within the country’s various ministries.