The bigger the organization and the bigger the mistake, the less you hear.

Ivan Denisovich

By Ray Finch

David, an acquaintance, Ivan Denisovich, asked that you print this letter.

Dear Mr. Camdessus,

Have you ever built a brick wall? If you want the wall to stand for more than just a couple of years, you've got to ensure that there is a solid foundation. If the base is not square and strong, the wall will collapse in only a few years.

A large wall collapsed here in August 1998. It was not a question of bad bricks or thin mortar. The foundation was rotten and will have to be replaced. While more bricks will allow the wall to be rebuilt, it too will fall if the current base remains.

My friend Boris is an alcoholic. Every six months or so, he swears he's going to hit the wagon and give up drink, but because his foolish friends are constantly forgiving his indulgence and giving him money (he swears that he needs the money for his family), he loses his motivation to quit.

Instead he takes the money and drinks until he's in a stupor. Often when he is drunk he says many stupid things, sometimes even swearing against those who lent him money. His wife is sick with consumption and his children, whose names he barely remembers, are hungry and have no shoes.

Is it a crime to lend Boris any more money? Have you ever flushed a toilet? This image comes to mind when I think of your lending more money to this government.

Let me tell you a story. In 1991, I had my life's savings in the bank. In a matter of weeks, this money was flushed away by inflation. Seven years later, the toilet flushed again. And you are about to lend more money to the government who is responsible for flushing the toilet.

Mr. Camdessus, have you ever noticed during your trips to Moscow the number of dollar exchange points? These are the truest indicator of the Russian people's trust in the currency and the government. We don't have any banks, where money is saved and invested back in the country. We have banks for laundering money. Most of our wealth is being stolen and siphoned offshore. Even our Central Bank has no faith in the ruble.

I'm no economist, but why doesn't the IMF pay Russian creditors directly? If the IMF is merely loaning more money to Russia so Russia can use this same money to pay back other creditors, why not just cut out the middleman? This will prevent the well-fed Central Bank (and the legions of corrupt bureaucrats) from taking their usurious cut.

Let me tell you what will likely happen if you don't lend the money. Our "liberal and democratic" government will first resort to printing more rubles to appropriate the billions of dollars saved in mattresses of the Russian populace. They will do this under the guise of paying foreign creditors like yourself and avoiding default (so they might be able to borrow more money in the future). The real reason is simpler.

Having stolen what they could abroad, our "liberal" government will now turn on its own people. This will lead to a high rate of inflation, which will hopefully lead to popular dissent and ultimately a change of government.

I know that many of you in the west fear that in such a scenario the communists will return to power. This fear demonstrates your lack of faith in the Russian people. First, we've been down that road and know where it leads. Second, forget about the political labels, Russia has never had, and will never have a communist government. Nor has it had a democratic government. What we have had for the better part of the past century is a quasi-criminal government.

IMF credits are merely helping to maintain this status quo. The foundation needs to be changed.

For us in the bottom 80% of the population, it makes very little difference whether you give this aid or not. We still won't get paid. Whatever monies were earmarked for helping the Russian people will be stolen long before it ever reaches our level.

You talk about Russia's need to improve tax collection. Let me fill you in on a little secret. This aid-dependent government of ours is running a little scam. They pretend that they are taxing the people, and we pretend that we are paying.

Don't believe the budget figures. We are forever filling the 5-year plan in four. Sometimes I think that this IMF aid is used solely to pay the salaries of the bloated Russian bureaucracy.

A long time ago, I served time as a political prisoner. Though I can now read a newspaper (if I can afford it), or watch TV (if I'm not too exhausted from work), the kasha tastes the same today as it did 40 years ago. True, the barbed wire has been removed and I now can complain out loud, but the guards are as surly and injustice still reigns. An equally onerous economic chain has replaced my political fetters.

You are deceiving yourself if you believe that by providing more credit to the current Russian government you are helping Russia. Russia does not lack wealth. It lacks honesty and a sense of justice, and more IMF monies will do little to correct this shortage.

Los Angeles Times November 22, 1998

PERSPECTIVE ON RUSSIA The Dismal Decade: Failure East and West Corruption, the IMF, inadequate monetary policies all share credit for the collapse of reform.

By Jeffrey D. Sachs, a Professor of Economics at Harvard University and Director of the Harvard Institute for International Development

As Russia's economy spirals out of control this fall with a collapsed currency, default on foreign debts, a plummeting economy and the worst harvest in years, an assessment must be made of what went wrong with Russia's reform process.

I served as an economic advisor to President Boris Yeltsin from November 1991 to January 1994. More than a few people have blamed my advice--a charge I must decline. The advice that I gave: Eliminate price controls, stop subsidies to loss-making state enterprises, make the currency convertible and open the economy to trade. This kind of economic medicine produced an end of hyperinflation and strong economic growth in Poland, Estonia, Slovenia and other economies that I advised.

The same advice would have worked in Russia, but it was not followed. My real frustration in Russia was not the failure of these suggestions, but the fact that the Russian government did not pursue real reforms. The West bears a lot of responsibility for the failure of Russia to pursue these reforms. The Yeltsin government was financially and politically very weak. In the case of Poland, the West gave several critical kinds of help, including: the zloty stabilization fund, a time-out on debt-servicing payments, and a cancellation of half of Poland's debts. But the hard-nosed Western attitudes weakened the Yeltsin government and eventually contributed to its collapse.

Additionally, the advice of the International Monetary Fund was atrocious. Someday some serious historians will get a look at the IMF's books and see the utter incompetence of that institution's advice and behavior in Russia. The IMF convinced the Russians not to introduce a separate national currency in 1992. The fact that all 15 successor states of the Soviet Union shared a currency in 1992 meant that each of the new countries introduced highly inflationary monetary policies, since the inflationary effects were absorbed by the other countries.

Also, the Russians were highly corrupt, especially after the end of the Gaidar government in 1992. Viktor Chernomyrdin presided over one of the most corrupt privatization processes in world history. Tens of billions of dollars of natural resource exports were given away free to politically connected insiders in the Russian regime. The U.S. administration just stood by as this corruption continued. Nobody in the U.S. or the IMF wanted to hear a bad word about the Chernomyrdin government. That government was on our side, it was said repeatedly. The corruption poisoned the Russian political process, but nobody in the Western leadership wanted to say a word about it at the time.

In the end, the corruption and the lack of reform undermined the Russian fiscal system. The government could not or would not collect taxes, especially from politically powerful firms. Nor did the government raise revenues by selling its valuable natural resources; instead they gave them away. In the end, the government went bankrupt.

For two years, the government borrowed heavily from foreign investors by selling them the now-famous ruble-denominated Treasury bills. Foreign investors put lots of money into these treasury bills because they thought that the IMF would always bail out Russia if necessary. They were almost correct. The IMF put in $22 billion in emergency loans, but it wasn't enough, given the extensive rot of the Russian fiscal system.

Why did the Russians allow this to happen to their society?

Almost nobody in Russia knew anything about democracy or market economy. Unlike Poland, which had national traditions and experience in both, Russia simply lacked the historical knowledge and trained personnel to manage a market economy. The situation was even worse than in China, which still had people familiar with trade and commerce from before the 1949 communist revolution.

Also, Russia is more geographically isolated from Western markets than is Central Europe or China. Russia has no large coastal economy, for example, which has been the real fuel of China's rapid growth. Russia has little direct economic contact with Western Europe, except through natural resource exports. Transport costs between Western Europe and Moscow are much higher than between Western Europe and locations in Central Europe.

Third, Russia lacks a civil society. Most of it was killed off by Lenin, Stalin and their successors. There are no powerful organizations independent of the state, such as the Catholic Church or the Solidarity Trade Union movement in Poland. The result is that the Russian government is not constrained in its actions by independent power centers. When the government engages in full-scale corruption, no one is powerful enough to protest.

Lastly, Russia did not experience a complete political change as did Central Europe. Even though the Soviet Union disintegrated, many of the key institutions of the Communist era were maintained. The Communist Party continued to have authority and a presence.

This has been a dismal decade for Russia. Economic decline has accelerated. The early years of democracy have produced economic chaos. The West has failed to provide useful support. The situation is dire, but not lost. Russia is still maintaining its new and fragile democratic institutions. This gives some hope for continued peaceful change. After years of failed Western support, let's take the IMF out of the picture and start a new and fresh approach to support for Russia.

Central European Economic Review November 1998 Reproduced with permission of the Central European Economic Review, ®1998 Dow Jones & Company, Inc. All Rights Reserved Worldwide

WHAT WENT WRONG IN RUSSIA?

By John Odling-Smee Director of the International Monetary Fund's (IMF's) European II Department, which supervises the progress of Russia's IMF-sponsored stabilization program.

On Aug. 17, a reformist Russian Government and the Central Bank jointly announced an extraordinary package of measures. In a single stroke, they abandoned their commitment to a broadly stable exchange rate. And they unilaterally froze some of the country's external and internal debt. The move dealt a major blow to the reform effort and sent shockwaves through global capital markets. These measures came less than one month after the International Monetary Fund's Executive Board had approved an $11 billion financing package to support the Russian reform effort (of which $4.8 billion was disbursed before the program went off track).

What went wrong? And what are the chances that the reform process will restart?

Time to clean up the mess!

The immediate cause of the crisis was the collapse of the financial markets' confidence in Russia. By July, the Russian government had lost its ability to roll-over maturing treasury bills when they matured. Investors were growing fearful of the default and devaluation, and they were opting to pull their money out of their ruble-denominated investments instead of routinely reinvesting them, as they had done up to that point.

Problems were mounting in the banking sector as well, mainly because asset prices were falling. And global investors were growing increasingly risk-adverse after the spectacular collapse of some once dynamic Asian economies. Taken together, these developments led to a mounting conviction that the fiscal situation in Russia could be unsustainable.

After six years of effort, the push to scale back public-sector spending and gathering more taxes had not progressed as quickly as had been hoped. To avoid inflationary financing, the government's budget deficit was being covered through external and internal borrowing. As a result, the interest burden on the budget was growing ever larger. Nevertheless, it should be appreciated that by mid-1998 the government had made significant progress in cutting its reliance on domestic borrowing. Improvement should have been enough to permit the government to avoid defaulting on its treasury bills. But the loss of confidence was already too great. In August, investors refused to continue rolling over their treasury bill investments. Their decision pushed the government into default.

The fundamental question is not why investors got nervous, but why the underlying fiscal problems proved so intractable. The Russian government certainly did not lack advice and technical assistance, which were generously provided by the IMF, World Bank, and many bilateral donors (especially from the US and the EU).

The bottom line is that Russia's problem in financing its government spending was really a symptom of a deeper malaise. In particular, there was insufficient agreement and will among the leadership of the country - broadly defined - to impose the fiscal discipline needed to pursue successful reforms. The Government granted widespread tax exemptions to its friends, and failed to pursue tax evaders aggressively, especially large enterprises and the energy sector. This policy, together with the government's willingness to run-up arrears, contributed in an important way to a culture of non-payment and barter, which spread throughout the economy and made tax collection even more difficult.

Even when Government decisions were taken and supporting legislation passed, difficult measures were still often not being implemented by regional governments. Municipalities often wanted little more than to keep their local businesses afloat.

However, it must be emphasized that prior to the Aug. 17 decisions, the Russians were making serious progress in stabilization and reform. The inflation rate had fallen to an annual rate of about 7% by mid-1998, and there were signs of some modest growth in gross domestic product as early as 1997. There was also movement on the structural front. The Central Bank had developed a serious capacity for implementing monetary and exchange-rate policy and the Ministry of Finance was in the final stages of putting a treasury into place to improve expenditure control.

At the same time, it should also be noted that many of the structural problems encountered in Russia - especially the weak government and corruption - could be said to be inherent in the process of institution building in any transition economy.

With the process moving forward, albeit slowly, and a declared willingness on the part of the Russian Government to implement stabilization and reform measures, the international community deemed continued support warranted.

The key lesson from the crisis is the central role played the need to make rapid progress in scaling back the size of the state. This involves major and often painful reform of the budget on expenditure side - including rationalizing social benefits, restructuring the military, and eliminating subsidies to inefficient state enterprises. On the revenue side, it involves ensuring that the natural resource sectors and the newly emerging enterprises pay their fair share of taxes.

More broadly, it requires a willingness by the government to enforce financial discipline in its own operations and throughout the economy. This, in turn, will lead to the fundamental micro level restructuring that soft budget constraints postponed.

In an environment like the one in Russia today, external financial support is not enough. The crucial ingredient is a government and parliament genuinely committed to structural reform and willing to implement measures that may be politically unpopular. In other words, the government must be prepared to assume full "program ownership". In this sense, it is clear that the ready availability of international financial support was only partly effective in encouraging the reform process in Russia. Regrettably, it has also permitted the postponement of some of the tough measures necessary to plug fiscal gaps.

Meanwhile, private investors in both the Russian equity and bond markets, poured many billions of dollars into Russia. This also served to reinforce the feeling in Moscow that the economy could be made successful without a need for deeper structural reforms. Indeed, some Russian politicians even thought that the reform effort spearheaded by the IMF could be abandoned altogether, since sufficient finance from private sources was readily available with no strings attached.

Despite the severe setback to both international and domestic credibility occasioned by the Aug. 17 measures, significant headway has been made in building a market economy--although it is not always apparent given the turbulence today. Progress has also been made in creating a political class with a stake in the continuation of the reform process. This allows for some confidence that a serious determination to press ahead with transition will return to Russia.

As for the IMF, future programs will have to tilt the balance sharply in the direction of actual measures to improve the fiscal situation, and not just promises that these measures will be taken in the future. The role of borrowing, especially short term borrowing, to fill fiscal gaps will also have to be rethought so that governments do not make themselves vulnerable to sudden changes in investor sentiment. In Russia, serious structural reforms will also need to be implemented, including genuine transparency in the privatization process, improvements in corporate governance, and the creation of an effective bankruptcy mechanism. Finally, the leadership of the country must demonstrate genuine "ownership" of the next reform program and be prepared to undertake serious, sweeping, and potentially unpopular reform measures.

Washington Post December 1, 1998

Editorial: Helping Russia

Russian officials desperate for more dollars from the International Monetary Fund have settled on two rather odd tactics. One is to insult the fund, which -- according to Prime Minister Yevgeny Primakov -- employs "young kids who've seen almost nothing in life" who, "without knowing our situation, start to dictate or recommend some kind of development plans." In addition, Russia has taken to threatening the fund -- with all the terrible things that Russia will do to itself if more loans are not forthcoming. Foremost among these self- inflicted wounds, Mr. Primakov warns, will be printing more rubles to make up the shortfall, a strategy likely to result in hyperinflation.

Presumably IMF officials won't make decisions based on personal pique. They certainly understand that Mr. Primakov, with his insults, is playing to a domestic audience. But the damage he does is not primarily to IMF egos. His blaming of outsiders is corrosive domestically because it forestalls Russian understanding of what Russians must do to solve their economic problems. Putting a gun to his own head isn't any more effective; it simply further erodes international confidence in Mr. Primakov's government.

It makes no sense for the IMF to lend large sums to the Russian government if that government has no sensible plan to restore the nation's economic health. The money will be frittered away, as past loans have been, and future generations of Russians will be that much more in debt. Russia needs to collect more taxes. It needs to adopt a realistic budget. It needs a host of reforms that neither the IMF nor any other outsider can impose.

This does not mean the fund, the United States or other friends of Russia should just cut the country loose. There are kinds of assistance that continue to make sense, even as the government flounders. These include programs championed by Sen. Richard Lugar and former senator Sam Nunn to safeguard and reduce Russia's nuclear arsenal; programs aimed at deepening Russian democracy; and assistance to independent media, environmental groups and other nongovernmental organizations trying to enrich civic life.

The Moscow Tribune, January 15, 1999

SOUR GRAPES

By John Helmer

It was the ancient Greek lawyer Aesop, who popularized the practice of dramatizing his courtroom points by telling fables populated by well-known animals with human foibles.

It was Aesop who invented several terms we still use today, like "sour grapes" and "swan song".

It was a combination of both that led the former Finance Minister, former Deputy Prime Minister, and former chief tax collector, Boris Fyodorov, to reveal what he had told John Odling-Smee, two days before the Russian government devalued the rouble and defaulted on its domestic debt.

Now Odling-Smee ought to be a household name in Russia. Noone else, with the possible exception of Boris Yeltsin, has been continuously in charge of Russia's government since 1991. Odling-Smee is an official of the International Monetary Fund (IMF). He was the man to whom Fyodorov presented himself at the Metropol Hotel on Saturday, August 15, after Fyodorov learned that Prime Minister Sergei Kirienko and Central Bank chairman Sergei Dubinin had decided to devalue and default.

"Something suicidal is being prepared," Fyodorov told Odling-Smee, according to Fyodorov's published recollection of their meeting. Kirienko, he urged the IMF functionary, "should be barred from incorrect actions." Fyodorov recalls that Odling-Smee was stonily silent. The IMF, according to Fyodorov, "knew everything before me, and supported it de facto."

Another version of what happened has depicted the mini-tsar Odling-Smee, the day after Fyodorov's visit, threatening to expel Russia from the IMF, if the plan went ahead without protection for the foreign banks holding the default bonds. Yet another version suggests that a combination of Odling-Smee's threats, and those of Russia's leading commercial bankers induced Kirienko and Dubinin to add one measure that hadn't been thought of at the start. This was a 90-day moratorium for Russian banks and enterprises on repayment of their debts abroad. This converted the default into an opportunity for the insiders to empty their tills, and leave the government with the mess. Odling-Smee, reportedly satisfied that this privilege extended to the foreign bankers, as well as to the Russians, agreed.

Odling-Smee hasn't remained silent about what happened on the fateful days of the August financial crash. On the contrary, he has written a public exoneration of everything he, Kirienko, and Dubinin did. According to him, the August crash was an unfortunate surprise that had interrupted such modest marvels of policymaking, as "significant progress in cutting (government) reliance on domestic borrowing", "signs of modest growth in GDP", and "serious progress in stabilization and reform."

Blame for the crash, according to Odling-Smee, was easy to pin. The federal government and parliament lacked the "will to impose the fiscal discipline needed"; the regional governments avoided implementing "difficult measures"; and city governments "often wanted little more than to keep their local businesses afloat." Since all this government was at fault, Odling-Smee has declared the only lesson to be learned from the affair is to get rid of them, leaving himself in charge. This manoeuvre he calls "scaling back the size of the state."

It's an idea Aesop used when defending a politician with the fable of the fox, the hedgehog and the blood-sucking fleas. The fox had lost his footing while crossing a river, and was wedged between two rocks in the fast-moving current. There he was attacked by swarms of fleas. A sympathetic hedgehog offered to drive the fleas off, but the fox demurred. "These fleas are already full of me," he said. "If you take them away, others will come with fresh appetites, and drink all the blood I have left."

Aesop thought that was a powerful argument for leaving a blood-sucking official in place, so that his replacements would not be even more rapacious. Former minister Fyodorov might have tried that Aesop line on Odling-Smee, but Odling-Smee was already a step ahead of him, having rehearsed the same argument more than once with his bosses at the IMF. The fox they were intent on saving was themselves. The fleas they are content to suffer are their friends.

Now the months have rolled by as swiftly as the stream in which the fox was stuck. The fleas have kept up their blood-sucking. And so it turns out that another deputy prime minister of another Russian government has presented himself to Odling-Smee, this week in Washington.

"Something suicidal is being prepared," Yury Maslyukov announced, as if he didn't know how many times before Odling-Smee, wedged firmly in his chair, had heard it.