Palms & Company Document

DR PALMS RESPONDS TO RUSSIAN GOVERNMENT REQUEST FOR ADVICE

by

Dr. Pyotr Johannevich van de Waal-Palms

REQUEST FOR ADVICE FROM:

Nick F. Semenov

Director of Science & Technical Expert Center of DIIC

Mosocw, Russian Federation

Defence Industrial Investment Company (DIIC) - is one of organizers and proposed founders of created organisation of IIU. We would like to ask you in detail to explain your view on the more effective using of technical assistance for Russia. What kind of scheme do you offer? What does it mean "non-Russian design"?

We look forward to hearing from you and hope on the long-term co-operation with you.

DR. PALMS RESPONDS:

EFFECTIVE ECONOMIC AID AND TECHNICAL ASSISTANCE TO RUSSIA

January 1996

EXPLANATION OF MY VIEWS

My views are corroborated by the U.S. Government Accounting Office which at the request of the U.S. Congress made an investigation of the way the U.S. Agency for International Development has spent $400 million dollars of government money for technical assistance to Russia. A copy of this report will be provided to you if you wish. It is also available at my WWW pages.

1. Most of the money has gone to large U.S. based multi-national accounting firms and law firms. They are not operators and managers of manufacturing businesses but are consultants with knowledge in Law and Accounting. Such skills are of minimum importance at the early stage of creating solutions for Russian defense industry conversion. This is even more so because there are very few analogies between the practice of law and accounting in the U.S. and in Russia. Accordingly such knowledge has little relevance to solving Russian questions.

U.S. Government tax money is spent by these U.S. consulting firms for the salaries and expenses of their staff. The money is not available for investment in Russian business. The advice, even if it is good advice, is of little benefit to Russia unless it can be implemented. For implementation other variants are demanded.

American Accountants and Lawyers like to think of themselves as matchmakers with U.S. industry but this is not working. Without such activity, the work they do becomes nothing more than gathering data of a demographic and statistical nature and does not lead to the introduction of American firms that have capital to invest and industry specific interest. As a result the money does little for Russia and instead creates employment for highly paid American accountants and attorneys. The existing "technical assistance program does not benefit Russia, it benefits American lawyers and accountants

The same problem exists with American Business centers in Russia financed by "Business Information Services for the Newly Independent States" of the U.S. Commerce Department. This program awards money on a cost sharing basis to American firms by competitive proposal. Since the firms are for profit businesses they must have an income from the expenditure of their money along with the government sharing in these expenses. To accomplish this they require American firms to pay for the services these ABC's offer. Their prices for these services have not been attractive to U.S. Industrialists. Their knowledge of corporate finance and investment banking is at a much lower level that the biggest and best most experienced firms in Investment Banking in the U.S.

As a result the major U.S. corporations do not make use of these ABC's. This program also contains a potential conflict of interest because those who propose to advise Russian Industry are paid by the U.S. government. The result is also not useful for Russian business because the ABC's also lack the credibility to attract U.S. Industrial firms to the proposals of Russian firms and their knowledge of how to prepare such proposals is not of the highest level that is available. They are firms who cannot compete in America with the best and are looking for some way to earn a living with clients who cannot afford the best. They chose Russia because the U.S. Government is willing to hire them to go there. They are not producing results for Russian companies.

There are many other Technical Assistance programs but they all have the same characteristics, (a) potential conflict of interest. (b) Even if competent academic technicians are used who can describe the problem, these consultants do not have the confidence of, or access to, the U.S. private investors with the capital to do something about solving the problem.(c) Analysis of the problem, no matter how competent is useless without implementation of the solution. This is not the proper function of Accountants and Lawyers.

3. It would be more effective if:

• This money were made available to industrial firms in the U.S. who have specific knowledge relating to converting Defense Enterprises. Such frims would use the money to evaluate the methods by which they would invest their capital in Russian business. They much prefer this to relying upon the findings of others.
• The money were made available to a U.S. based office of experienced business brokers/investment bankers who as a first step would identify and interest U.S. industrial companies in specific acquisitions, mergers and joint ventures with specific classification of Russian industry compatible with their industrial classification. These companies are the logical source of technical assistance and technology and "know-how" for revitalizing and modernizing Russian production methods and developing markets internationally for new products manufactured.

4. Shortage of Money is not the Problem.

There are large amounts of money already appropriated by the U.S. government for investment in Russian industry. This includes European Bank for Reconstruction & Development, Defense Nuclear Agency, several investment capital management firms, The World Bank (International Finance

Corporation) US Trade Development Agency, etc., etc., etc.. All of them are having difficulty finding Russian companies they can invest in because:

• The U.S. Govrnment is not equipped to properly prepare business plans, feasibility studies, marketing studies, valuations, structuring of investment terms, etc etc., etc. And neither are Russians experienced in this work.
• U.S. Government tax money is not really the same as risk capital from private business operators. It is tax money, willing to take risks beyond those private capital is willing to take. This money is used by U.S. academicians and consultants to analyze problems and is spent to provide their salaries. It is not used to implement their findings. For that private industry is required. Such links to private capital and industry are not ideally provided by the type people the U.S. government has been hiring to do this work. American industrialists have a slogan. "Those who can, do,. Those who can't teach" There is a certain separation between U.S. academicians and U.S. businessmen. Russia needs mentorship from businessmen not academicians, because it needs their private capital. Academicians and consultants do not have such capital and only spend U.S. government money on providing their knowledge and services describing problems, not solving them.

The availability of such U.S. Government tax money does not influence experienced operators of privately owned industrial businesses to co-invest in projects. Such co-investment is an essential part of the conditions imposed by the U.S. Government for co-investing government capital. The consultants the U.S. government has employed have not been successful in interesting private industrial firms to make such investment and therefore the analysis of problems has not led to investment in the solutions. The government recognizes that it does not have the knowledge to give management or technical advice for operating a business. It has no experience in private business management for profit. It operates at a deficit and only knows how to spend money, received in taxes from industrial firms who earn it. The government does not earn any money.

Since these advisors are employed by the U.S. government they have been polite rasther than frank and candid with Russian industry, in keeping with the policies and procedures of the U.S. Govenrment. U.S. Government policy may be quite different from that of private businessmen. Confusion results when advisors work for the government rather than private business. You may get to hear what you want to hear when you need to hear what you ought to hear.

THEREFORE THE PROBLEM IS NOT LACK OF MONEY. It is not necessary to look for more money, until the money that is already available is able to become invested. The problem is the type of people that have been engaged to provide assistance to Russia with U.S. Government "grants".

5. The first step that should be taken to correct these problems is that the U.S. Government should make funds available directly to organizations like DISC so that it can employ U.S. consultants directly who can approach the solution in the manner I have suggested in paragraph 2. This will also eliminate the conflict of interest that exists when the U.S. Government hires consultants to work for Russian defense conversion projects. How can someone work for the best interests of Russian Defense Conversion when they are paid by the U.S. Government and must follow their policies and instructions. Fiduciary responsibility is owed by the employed party to the party that employs him.

What kind of scheme do you offer? What does it mean "non-Russian design"?

Non-Russian design means this:

• 1. Russian "mind-set" is still unable to grasp that the nature of the solution required is an international mind-set. Like Taiwan, Russia must recover economically by exporting. That is the way to convert its labor and natural resources into world market values. This is explained in detail in my articles on this subject, which I can send if you request them. They are also available in my WWW pages. Simply put, every proposal for investment must involve exports because the average wage does not enable the Russian population to presently pay for consumption of production. That will develop only as GDP is increased. You cannot satisfy Russian consumer needs before you increase there financial capacity to consume.
• 2. International market Economics must have superior power to Russian law because economic laws cannot be changed to accommodate Russian politics. Where a conflict exists the law must be changed. Without this investment is going to be lost. This reality cannot be compromised. So far Russian businessmen are attempting to compromise with and accommodate the law. This is understandable because they lack the frame of reference and experience of operating in a market economy and do not understand the un-reconcileable contradictions between Russian law and economic reconstruction. To correct this barrier requires Western mentorship and solution design. It simply cannot be done from within Russia by Russians at this point. Within five years Russian businessmen can learn the mechanics of this process from their Western mentors and resume control over their business decision making process. The price of capital investment is willingness to accept leadership from those who risk their capital. Russians will not find capital for Russian designed solutions. They are inadequate at the moment. Different experience is needed to make it work.

We look forward to hearing from you and hope on the long-term co-operation with you. My comments here are brief and cannot hope to explain everything in details. The papers I have written about these subjects during the past seven years add up to megabytes of data and cannot be covered in one letter. But on each subject there are very detailed explanations available in my WWW pages with a carefully outlined dialectic on each point.

My representation to you is that all of the necessary ingredients are present and available for achieving the economic reconstruction of Russia. The failure to accomplish this during the past seven years is due only to unwillingness to accept the reality of the necessary cure. ,The present difficulty of Russia is due to its unwillingness to undertake the process that will correct this.

I do not agree with the advice of IMF and American economists during the past 5 years. Economist Robert E Lucas, of the Univerisyt of Chicago, just recently received the Nobel Prize by demonstrating that "models that we thought were fine tuning the economy though monetary and fiscal policy are more or less useless".

Futhermore, Rusisan economic policy ignores the reality of the Russian nomenklatura and the huge Russian "flight capital" balances in the west. It is clear that Russia cannot expect Western private investment as long as the conditions are so unfavorable that Russian capital stays outside Russia.

The stability required for investment demands that Russia be managed politically by public servants of the population and that these "fiduciaries" of the public interest accept and utilize international mechanisms for implementing stable and socially just systems in such instances as those where it cannot as yet control and construct such systems internally.

At the very least Russia must permit and embrace and accept solutions which will make business capital immune from attack and financial damage from the lack of stable systems. That would provide the time for these systems to evolve concurrently with the improvement in the economy.

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