How billions of dollars were stolen from the Russian people
Through voucher privatisation, Russia tried embracing capitalism, but the experiment went horribly wrong - it gave rise to the billionaire Oligarchs who today control the economy
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After the fall of the Soviet Union in December 1991, Russian leaders knew they had to make radical changes to kickstart the nation’s economy.
The choices made by them over 30 years ago have led to the present-day scenario, in which oligarchs wield significant influence over crucial sectors of the economy.
Russia's Financial Problems and their Proposed Solution
It's 1992, and the Soviet Union has been dissolved.
Russia finds itself grappling with the consequences of years of economic mismanagement, which have left the economy on the verge of collapse.
State-owned companies, once the primary revenue earners, are struggling to sell their goods due to the breakdown in trade with former Soviet Republics, leaving them without their traditional customer base.
The new government is struggling to secure funds to pay pensions and other essential social security benefits. Daily use items are becoming hard to find, salaries are being paid in kind, and bartering of goods has become a means of survival for many.
Against this backdrop, President Boris Yeltsin, Russia's first democratically elected leader, embarked on a program of radical reform aimed at rapidly transitioning the economy from a command-and-control system to a market-driven one.
Yeltsin and his team of economic reformers faced challenges from the old guard, who felt threatened as their vested interests were challenged. An attempted coup in August 1991 by Soviet hardliners against the reformers almost derailed the entire project.
With people barely making ends meet and savings rapidly eroding, the Yeltsin administration, under the advisement of the IMF, decided to implement "shock therapy"—rapidly unleashing market forces—to jolt Russia into embracing capitalism.
Shock Therapy: Transforming State Driven Economies into Market Systems
Proponents of shock therapy believe that sudden, substantial changes in economic policy can quickly transition an economy from a centrally planned system to a market system.
This approach aims to cure problems such as hyperinflation, shortages of goods, and excessive subsidies while jump-starting production, reducing unemployment, and improving living standards.
Key features of shock therapy include:
Lifting price controls
Eliminating government subsidies
Privatizing publicly owned entities
Implementing higher tax rates
Reducing government spending
Liberalizing trade
At the time, Poland, Czechoslovakia, Hungary, and other transitioning economies had seen success with implementing shock therapy policies.
Poland's Mass Privatization Program (MPP)
Poland's Mass Privatization Program is an example of successful shock therapy implementation. The program converted 512 medium and large enterprises into joint stock companies, with the shareholding generally divided as follows:
15% of the shares were given to company employees free of cost
60% was allocated to National Investment Funds (NIFs), which were licensed portfolio investment funds
The remaining 25% was held by the Treasury
The NIF are close ended funds. 85% of NIF’s share capital was distributed to Polish households at low or no cost, with the balance set aside to compensate NIF management.
By granting majority control to NIFs, these funds were able to oversee the restructuring of their portfolio companies. The NIFs enacted significant management changes, eliminated non-productive assets and surplus capacity, introduced numerous firms to the stock market or sold them to strategic investors, and either liquidated or began bankruptcy proceedings for failing businesses.
This approach aimed to instill Western practices of corporate governance and build wealth for shareholders rather than meeting the output targets set by the Polish State.
Under this program, households could freely trade their shares of the NIFs, and the NIFs could freely trade the shares of their portfolio companies. This process effectively took these companies off the hands of the State.
Seeing the success of reforms in Poland, Russia embarked on its own form of privatization with the help of the International Monetary Fund (IMF) and the World Bank.
Russia's efforts aimed to emulate the positive outcomes experienced by other transitioning economies that had implemented shock therapy policies.
How did the IMF get involved in Russia’s Privatization?
In the first week of 1992, Russia’s President Boris Yeltsin applied for IMF membership.
At that time, Russia was facing a difficult economic situation: the country owed $66 billion in external debt while possessing only around $2 billion in net gold and foreign exchange reserves. Russia's ability to service its debts, maintain confidence in the Ruble, and avoid a rapid descent into chaos hinged on securing cooperation from creditor countries.
The Group of Seven (G7) countries, who were also creditors to Russia, recognized the gravity of the situation. They emphasized that the IMF needed to take on a central role as a policy advisor, lender, and coordinator of western assistance to ensure the cooperation of creditors.
With limited options available, Yeltsin agreed to the conditions imposed by the G7 countries.
The IMF played a vital role in shaping and implementing economic policies, while the World Bank provided financing and assistance in executing the policy details.
Although the exact advice provided by the IMF and World Bank is unclear, the IMF's pivotal role in guiding Russia's economic transformation suggests that the organization was privy to the details of the country's plans, including the privatization of state-owned assets.
Transferring Ownership of State Assets: Will It Lead to Profitability?
To reduce the strain on the country's finances, the Russian government adopted the Czechoslovakian model of free voucher privatization- transferring assets to its citizens.
Following the collapse of the Soviet Union, the government inherited numerous unproductive firms. The primary goal was to transform these sprawling enterprises into profit-seeking businesses that would no longer depend on government subsidies for survival.
Voucher privatization was driven by a team of reformers led by Yegor Gaidar and Anatoly Chubais. Gaidar advocated for free market reforms, such as abolishing price controls and cutting defense and industrial subsidies, while Chubais, an economist, was tasked with overseeing mass privatization.
Chubais launched into transferring state assets, which included manufacturing plants, factories, refineries, warehousing facilities, land, retail stores, media outlets, at breakneck speed.
The initiative began on 1st October 1992, with every Russian citizen receiving "privatization checks," or vouchers.
In total, 148 million vouchers were distributed. The vouchers had a notional value of 10,000 rubles ($40), with the market pricing them between $5 and $30, depending on the general perception of Yeltsin and his reforms.
Vouchers could be traded for cash, used to buy shares in companies, exchanged for stakes in investment funds set up to make collective bids on state property, or used to purchase agricultural land, state land reserves, forests, and municipal housing. The goal of the vouchers was not to raise funds but to allow Russians to own assets, an alien concept in a former Communist regime.
The distribution of assets was determined by the number of vouchers presented rather than the highest bidder.
For example, if only one person showed up with a single voucher, they would receive the entire block of shares or property being sold. If eight people presented one voucher each and one person presented two vouchers, the eight people would control 80% of the company, while the individual with two vouchers would own 20%.
The validity of each tranche of vouchers was limited to one year, with the 1992 tranche set to expire on 31st December 1993. This meant that billions of assets were being privatized within an extremely short time span.
The Challenges of Transitioning to a Market Economy
For decades, Russians were accustomed to a communist system where the State dictated what they could grow and eat, which goods were produced, and how they could decorate their homes. The sudden opportunity to own a piece of their employer's company presented a significant challenge, as it required faith in the success of the reforms and the future value of the shares. Moreover, the concept of joint-stock companies and their valuation on emerging stock markets was unfamiliar to most Russians.
Considering these complexities, it's not surprising that the average Russian, preoccupied with the daily struggles of staying warm and putting food on the table, was unsure about how to handle these vouchers. Many chose to sell them, as the immediate benefits of doing so outweighed the potential long-term gains in a system they did not yet fully understand or trust.
The Wild West of Voucher Trading
Here is an excerpt from the book "Red Notice" by Bill Browder, which inspired this piece. In it, he describes the chaotic scene of voucher trading as it unfolded:
The Russian people had no idea what to do with the vouchers when they received them for free from the state and, in most cases, were happy to trade them for a $7 bottle of vodka or a few slabs of pork. A few enterprising individuals would buy up blocks of vouchers in small villages and sell them for $12 each to a consolidator in larger towns. The consolidator might then travel to Moscow and sell a package of a thousand or two thousand vouchers at one of the picnic tables on the periphery of the exchange for $18 each. Finally, an even bigger dealer would consolidate them into bundles of twenty-five thousand vouchers or more and sell them for $20 each at the centre tables. Sometimes individuals would bypass the whole process and lurk around the outskirts of the exchange, trying to find good prices on small lots. In this profusion of cash and paper, there were hustlers, businessmen, bankers, crooks, armed guards, brokers, Muscovites, buyers and sellers from the provinces – all of them cowboys on a new frontier.
It was truly a new frontier, and there were plenty of robber barons waiting in the wings to take advantage of the situation as it unfolded.
One of the most prominent examples of the complexities and pitfalls of Russia's privatization process was the case of Gazprom, the country's natural gas giant.
Privatization of Gazprom: A Tale of Concentration of Wealth and Power
The privatization process at Gazprom was intended to distribute ownership among employees, public, and the government. However, it ultimately led to a concentration of wealth in the hands of a few well-connected individuals.
By 1994, the initial distribution of Gazprom's shares promised a fair ownership structure:
33% of shares were bought by 747,000 members of the public in exchange for vouchers
15% of the stock was allocated to Gazprom employees
The state retained 40% of the shares
Foreign investors owned the majority of the balance, 12%
However, this shareholding structure soon changed, as the entire process was rigged against the very people it intended to benefit.
President Boris Yeltsin appointed Viktor Chernomyrdin as Gazprom's first chairman. Chernomyrdin later held the position of Prime Minister and appointed his deputy Rem Vyakhirev as CEO, solidifying control over the company.
Under Chernomyrdin's Prime Ministership, lax state regulation allowed Gazprom to pay minimal taxes and dividends to the state, effectively depriving the public of the benefits of ownership.
Towards the end of the century, many of Gazprom's assets, such as wells, pipelines, and distribution networks, were distributed among executives' wives, children, and mistresses.
Significant assets were stripped and spun off to ITERA, a company that was relocated from Russia to Jacksonville, Florida, in what appeared to be a deliberate attempt to move valuable resources beyond the reach of the Russian State and public.
The lack of institutions capable of enforcing laws, combined with a lack of transparency and public accountability, allowed mafia organizations to expand their influence in the absence of proper oversight.
The Problems with Privatization
The ambitious attempt to privatize the Russian economy broke down spectacularly and was riddled with issues, including:
Employees Losing Out
Managers frequently exploited quotas for workers, securing the majority of shares for themselves or purchasing them from employees at low prices.
Hindering Auction Tactics
Executives of large companies reportedly used underhanded tactics to ensure insiders could purchase shares at low prices during voucher auctions. For example, Surgutneftegaz, a large oil company in Siberia, was rumored to have closed the airport the night before their auction, while another oil company supposedly put up a roadblock of burning tires on the day of their auction to prevent people from participating.
Disadvantages for Ordinary Citizens
In the opaque landscape of Russian privatization, outsiders found it challenging to obtain reliable information. Company revenue figures, assets, and their worth were closely guarded secrets, accessible only to those in positions of power or with the right connections. Awareness of upcoming auctions was not widespread due to a restricted media environment.
Foreign Investment Challenges
Initially, privatization allowed anyone, including foreigners, to purchase vouchers and acquire former state-owned property. However, successful investment required insider connections to navigate the complexities of transferring funds into Russia and selecting profitable companies.
The depreciating ruble, deteriorating business climate, and skepticism towards the nascent stock market all contributed to foreign asset managers making hesitant moves in Russian industry.
Organized Crime Profits
Criminal groups funneled dirty money into Russia's economy, while wealthy Russians and oligarchs took billions in legal profits and parked them in safer European banks. For example, ITERA, a company mentioned above, moved to Florida to safeguard its assets.
Interior Ministry specialists reported widespread legal breaches in privatization, including forged documents, violence, and even murder to seize properties. Despite these crimes, asset transfers proceeded.
Before a public auction, word often spread that an "authority" had their eye on the property, subtly warning others not to compete. At the auction, the "authority's" representative would arrive with a group of thugs. Law enforcement data suggests that as much as 70% of auctioned real estate was prearranged to go to predetermined individuals.Criminals also exploited the voucher system by making millions of fake vouchers and reusing old ones due to officials' failure to properly cancel them. In one instance, a St. Petersburg official in the State Property Committee was arrested on charges of criminal negligence after discovering that city officials had canceled only 10% of the 8 million privatization vouchers used at auctions.
Syndicates also targeted and exploited the older, more vulnerable population, using violence and forged documents to gain control of 53 firms in St. Petersburg and Murmansk. They posed as aid distributors to obtain retirees' addresses, coercing them into surrendering shares for low sums. Personnel heads were similarly pressured to release employee lists for exploitation. Resistant management were given special deals or faced intimidation.
By 1994, 15,000 state-run enterprises had undergone privatization under the program, with approximately 70% of the Russian economy now in private hands. It was estimated organized crime controlled over 40,000 privatized enterprises including 400 banks and 47 exchanges.
Individuals who acquired substantial portions of profitable enterprises quickly amassed enormous wealth. The majority of companies were undervalued, with prices set based on outdated and sometimes manipulated book assets, leading to sales at significantly lower prices than their actual value, especially when compared to their Western counterparts. Upon listing on the stock exchange, their values soared, ensuring that buyers made substantial returns simply by participating in the auctions.
The Russian oligarch class emerged from the chaos of the swift privatization in the 1990s.
And they soon found a way to make even more money.
Oligarchs' money power supports Russian President’s reelection campaign
By 1995, President Boris Yeltsin had become incredibly unpopular. The reforms failed to revive the stagnating economy, and hyperinflation was draining people's savings. Criminal activities were on the rise, and the government lacked funds to import food and other essentials, as well as to pay salaries and pensions. The operation of welfare programs in schools, hospitals, theaters, and museums—which had previously been state-funded under the Communist regime—was driven into bankruptcy under IMF-World Bank austerity guidelines.
As Yeltsin's popularity continued to decline, Chubais and the Yeltsin administration resorted to a shady scheme known as "Loans for Shares."
Under this arrangement, oligarchs loaned billions of dollars to the government in exchange for shares of Russia's most valuable enterprises. When the government defaulted on repaying the loans, as was anticipated, the oligarchs gained control of these corporations.
The borrowed money was used to fund Yeltsin's campaign, and in return, the oligarchs threw their support behind him. With two of the three major Russian television networks under their control, the oligarchs saturated the airwaves with pro-Yeltsin propaganda. Between the end of 1995 and the election, 12 of Russia's most profitable industrial enterprises were auctioned off to the oligarchs, including nickel smelting company Norilsk Nickel and oil giants Sibneft and Yukos.
For example, Boris Berezovsky and Roman Abramovich acquired a large stake in the oil company Sibneft for about $200 million. In 2009, when Putin renationalized the company, Abramovich sold his stake back to the government for a whopping $11.9 billion. Talk about a windfall!
With the oligarchs' financial backing and media influence, in 1996, Yeltsin was reelected.
Privatization's Legacy: Inequality, Corruption, and Disillusionment
In 1999, Boris Yeltsin and his billionaire allies handpicked Vladimir Putin as Yeltsin's successor, hoping that Putin would protect their interests.
However, once in power, Putin replaced the oligarchs with his own set of loyal cronies, appointing them to positions of power to fortify his reign.
Take what happened at Gazprom as an example,
Feeling threatened that the State did not own a majority stake (50%+) in Gazprom, Putin launched a program of "national champions" to correct this oversight. He fired Viktor Chernomyrdin from his position as Chairman of the Gazprom board, and the Russian government's stock in Gazprom gave Putin the power to vote out CEO Rem Vyakhirev. Replacing them with Dmitry Medvedev as Chairman and Alexei Miller as CEO, both of whom had worked with Putin in the St. Petersburg Mayor's office.
He maneuvered the pieces to consolidate Russia's energy assets under Gazprom and also increased the State's shareholding in the company. Post this exercise in 2005, the shareholding was divided as follows
State holding directly and indirectly via state-owned entities: 50.02% (previously less than 40%)
Russian businesses owning: 29.482%
Russian citizens owning: 13.068% (down from 33% previously held)
Non-Russian citizens owning: 7.448%
For current data see here
It's clear that the "Shock Therapy" approach to privatization made a bad situation worse and has lead to high wealth and income inequality.
Comparing it to the old Soviet era, a report summarized, "The old bureaucrats dominate much of the privatization process, for example, often deciding who gets what at what price. Whereas the Party elite only enjoyed control of the state's resources, they can now appropriate the state's property."
Ironically, one of the primary goals of privatization was to transition Russia from communism to capitalism. However, the process dramatically failed in this regard.
Millions of dollars from loans and rescheduled debt provided by the World Bank, the U.S., and the European Union ended up in the pockets of corrupt tycoons, leaving ordinary Russians economically worse off.
The botched transition, which occurred simultaneously with the impoverishment of the general population, has left most Russian citizens with a negative view of capitalism.
To date, Russia's privatization drive remains the biggest transfer of state assets to private owners in world history.
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Filtered Kapi #57
Sounds like straight out of some novel. Truth is stranger than fiction.
I just think the issue was corruption & may be not privatization.