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Email Dr. Palms
Sovetnik Pravitelstva CWA, Tovarichestvo Palmsa, Inc.
Investment Bankers. Washington, United States of America.
From Pomer
On March 10th Douglas Keene forwarded to me copy of your message to him
as follows:
Return-Path: <pomer@cats.ucsc.edu>
Date: Sat, 9 Mar 1996 12:17:33 -0800 (PST)
From: Marshall Pomer <pomer@cats.ucsc.edu>
Subject: IBM plant
To: mfgman@cts.com
Hello,
A fellow economist forwarded to me your important comment on closure of the IBM plant. I am working with a group of prominent economists to, as you say, "influence the situation." The group includes 5 Nobel Laureates and the heads of the major economic research institutes within the Russian Academy of Sciences.I am very eager to be in touch with you.
Best regards,
Marshall Pomer,
Coordinator of the Economic Transition Group
Leonid I. Abalkin
Institute of Economics, Russian Academy of Sciences (RAS)
(Director)
Irma Adelman
University of California, Berkeley
Alexander A. Arbatov
Committee on Natural Resources, RAS (Vice Chair)
Georgi A. Arbatov
USA-Canada Institute, RAS (Director)
Kenneth J. Arrow
Stanford University (Nobel Laureate)
Alexander Bogomolov
A. T. Kearney, Inc.
Oleg T. Bogomolov
Duma, Committee on Foreign Relations (Deputy Chair) and
Institute of International Economic and Political Studies,
RAS (Director)
Sergei V. Burkov
Duma, Committee on Property and Privatization (Chair)
Paul Davidson
University of Tennessee
James K. Galbraith
University of Texas
John Kenneth Galbraith
Harvard University
Sergei I. Glaziev
Duma, Committee on Economic Policy (Chair)
Marshall I. Goldman
Russian Research Center of Harvard University
Ruslan S. Grinberg
Institute of International Economic and Political Studies,RAS
Michael D. Intriligator
University of California, Los Angeles
Victor V. Ivanter
Institute of Economic Forecasting, RAS (Deputy Director)
Dwight M. Jaffee
University of California, Berkeley
Alexander A. Khandruyev
Central Bank of Russian Federation (Vice-Chair)
Lawrence R. Klein
University of Pennsylvania (Nobel Laureate)
Nicholas N. Kozlov
Hofstra University
Wassily W. Leontief
New York University (Nobel Laureate)
Alexander B. Levintal
Committee on Economics, Khabarovsk Territory Administration
(Chair)
Dimitry S. Lvov
Central Economics and Mathematics Institute, RAS
(Deputy Director)
Valery L. Makarov
Central Economics and Mathematics Institute, RAS (Director)
Robert McIntyre
Bowdoin College
Pavel A. Minakir
Far Eastern Division of the Economic Research Institute, RAS
(Director)
Alexander D. Nekipelov
Institute of International Economic and Political Studies,RAS
(Deputy Director)
Douglass C. North
Washington University (Nobel Laureate)
Nicolai Y. Petrakov
Duma and Institute for Market Economy, RAS (Director)
Yuri A. Petrov
Central Economics and Mathematics Institute, RAS
Marshall Pomer
Macroeconomic Policy Institute
Robert J. Schwartz
Economists Allied for Arms Reduction
Stanislav S. Shatalin
Department of Economics, RAS (Secretary-Head)
William G. Shepherd
University of Massachusetts at Amherst
Geliy I. Shmeliov
Russian Agricultural Academy
Nicolai P. Shmeliov
Institute of Europe, RAS
Stepan A. Sitarian
Institute of Foreign Economic Relations, RAS (Director)
Martin C. Spechler
Indiana University
Lance Taylor
New School for Social Research
Lester C. Thurow
Massachusetts Institute of Technology
James Tobin
Yale University (Nobel Laureate)
Yury V. Yaryomenko
Institute of Economic Forecasting, RAS (Director)
From Dr. Palms
Dr. Pomer, there was also attached to this message a copy of your Mission
Statement of the Economic Transition Group and I thought I would share
with you my impressions and conclusions, based upon my seven years of investment
banking experience in Russia.
There are a number of other entrepreneurs/investors who have invested
capital in Russia who would also like to comment and I ask your permission
to share this with them, so you may receive the benefit of their concrete
financial experience.
Here then are my remarks which I have interjected within your Mission
statement for ease of reference.
>
> MISSION STATEMENT OF
> THE ECONOMIC TRANSITION GROUP
>
> To promote economic development and democratization in
> Russia and the other republics of the former Soviet Union, a
> moderate approach to economic transition is needed. It is vital
> to steer clear of the extremes.
A very extreme economic transition has already occurred and been completed
which evidences the following characteristics:
1. Expropriation of the natural resources and infrastructure, formerly
presumed to be held in common by the population of the Soviet Union, by1%
of the population consisting of the power elite or "nomenklatura"
2. A 75% reduction in the real income of 99% of the population through
manipulation of the laws and a combination of inflation (caused by printing
rubles) and manipulation of currency exchange controls so as to limit real
income by "reverse income distribution". In effect the real value
of GDP has been confiscated by the elite through a system of exclusive
export licenses which require domestic producers to sell their exportable
products to the nomenklatura at below market prices. Exporters then realize
the full world-market prices through export.
3. Those who manage to circumvent these mechanisms are required to sell
the foreign exchange earned to the "government" at below real
value thus returning to the nomenklatura the real market value of exported
GDP that has slipped through their bureaucracy.
4. Through these mechanisms the economic transitions has been abrupt,
unjust, and socially and morally inequitable. Legal activity is now immoral
and unjust and real economic development has become illegal. There is a
disincentive to be "law-abiding" and accordingly there is no
voluntary compliance with tax regulations. Tax collections are less than
50% of projected revenues.
5. The new private capital interests of the Russian establishment have
caused them to abandon the support of social programs such as health, education,
environment. These can no longer rely on industry for their financial support.
Accordingly life expectancy has suffered an unprecedented decline, a negative
birth rate has developed, and there has been a massive dislocation of the
work force which is not accurately reported in statistical information,
which is generally unreliable.
6. GDP is still on the decline and the economy continues to disintegrate.
7. The total potential impact of all economic aid programs world-wide,
unprecedented in size even by the Marshall plan, has been offset by "flight-capital".
Unlike post World War II Europe which used currency controls to rebuild
its industry, Russia's nomenklatura has used similar controls to "export"
capital to its private accounts abroad. Currency controls have been used
to limit and select the participants, not to eliminate the practice.
8. The "little-guy" in Russia has demonstrated amazing adaptability
and entrepreneurship in sustaining economic survival, but he has been working
with a small residue of what were formerly the resources of Russia. For
the most part he fails to understand how he has been exploited and sold-out
by a power structure that does not represent the Russian people.
9. Economic policies and regulations are counter-productive to economic
reconstruction, foster under employment and unemployment, and serve the
interests of a Marcos, Noriega, Shaw of Iran type elite which has divided
the monopoly board amongst themselves.
>
> One extreme, the "big bang" or "shock therapy" approach,
> has proven unsuccessful in Russia both on political and economic
> grounds.
That depends upon the viewpoint of the decision maker. The nomenklatura
of Russia are well satisfied with the results and are content to let humanitarian
aid of other nations provide for the dis-enfranchised population of Russia.
While giving lip service to IMF and World Bank guidelines and blaming them
for the results observed, and deemed "unsuccessful" by Western
nations, they are in reality quite content with the "system"
they are employing. One might say that the West is helping the nomenklatura
achieve its purposes which are quite different from those of the West.
The possibility remains that in the long run the West, once it achieves
its political purposes of threat reduction, might address the issues of
justice and law within the Russian Federation and re-shuffle the cards.
For the moment it appears the West considers it inconvenient and undiplomatic
to raise these issues.
> The hope was to leap suddenly to laissez faire capitalism
> by quickly reducing the power of government and rapidly privatizing
> the economy.
The leap to laissez faire capitalism in fact occurred but with an enormous
"transfer" of public funds to private ownership and increased
economic power of those "in-government" but not "of-government"
by Western standards. Power is now "off-the-books".
> As a result, prices in Russia are now better aligned
> with world levels,
In effect this is nothing more than implementation of the same policy
of "managing the company store". Domestic consumption at subsidized
prices takes money out of the pockets of the "new-owners". Higher
prices limit consumption of the exploited and releases more GDP for export
where the proceeds can be divided by the nomenklatura rather than in the
pay-checks of the population (oil for example). Even imports serve this
purpose, allowing the establishment to realize the profits rather then
share them with domestic production (food for example).
The disappearance of government funding (subsidies and grants) to agriculture
and industry reflects the reality that such money now comes out of the
private pockets of the nomenklatura. It has been discontinued, not because
of any enlightenment or reform but because the cost is being paid by 'someone"
whereas in the past it was merely a redistribution of the common ownership.
A similar reduction has occurred in military budgets. One might say that
those in power in Russia have been given a real entrepreneurial incentive
to reduce military budgets by virtue of the "profit-sharing"
system "privatization" has provided to "the establishment".
> enterprises are more free to respond to market
> opportunities, and the scope for individual initiative has
> expanded.
This is a mirage. All the appearances of market opportunities exist
but are cleverly negated by the economic policies and tax laws. A capitalist
in a market economy with a 100% tax rate is still a socialist. When the
proceeds are usurped by an elite minority it is a dictatorship. Free and
monitored elections only decide who will be the exploiter. The absence
of rule-of-law based upon justice belie these external appearances. The
Russian population is thereby rendered a great disservice and remains a
confused and uninformed bystander, unable to identify or support true reform.
If they sense the real game being played, they construe Western silence
as condoning and participating. For too long moral issues have not won
the day and cost 30 million lives. The people of Russia can not be expected
to lead without role models.
> But the radical reformers did not provide a politically
> acceptable program to reduce enterprise subsidies, frustrating
> their intentions both to rid the economy of antiquated enterprises
> and to bring about macro-economic stability.
I do not believe that is what happened. The exploitation has been so
extensive and "flight capital" so rampant that industrial reconstruction
has been impossible. The possibility of capital substitution from outside
Russia has all but evaporated as a result of "government" policy
to unilaterally re-write agreements so as to tax the fair return on investment
that successful capital investment demands. Having closed the door on long
term economic growth through capital appreciation, subsidies, albeit reduced
subsidies, now remain the only way to keep the population under control.
To the nomenklatura, it constitutes an "affordable" cost of exploitation.
measured against profits (flight capital). It is a reasonable insurance
premium for civil peace.
> Even more telling,
> they assumed that flourishing private businesses would sustain the
> economy, but their program engendered economic disruption, growth
> of the "Mafia," and political instability, which have been ruinous
> for the business climate.
The program itself did not engender economic disruption. Rather the
rules which allocated profit created a 'haves" and "have-nots"
struggle which is a struggle for power in a corrupt system. The alternative
of just reward for development of individual creative and productive potential
does not exist without rule-of law. The Mafia is the population's effort
to compete with 'government". Crime could be eliminated by a system
of laws which allocate rewards to their producers. The West has failed
to insist upon the morality of a market economy and its dependence upon
justice and law, which made a market economy successful in the West. Its
absence dooms the Russian experiment to failure, which is what you are
noticing.
>
> The other extreme is to shield Soviet-era enterprises from
> market competition.
No one seriously believes that could work nor are the remaining subsidies
indicative of a belief that that could work.
> Advocates of protection are tempted to
> disregard the need to reduce inflation,
The state of Russian industry reflects the counter-productive economic
policies which prevent reconstruction in the normal course of affairs.
Industrial subsidies are not a significant factor in Russia's inflation.
That is a diversion. The problem is the intent of the power structure.
If Russia operated under the laws of any industrialized nation its highly
educated work-force and natural resources and infrastructure, as antiquated
and obsolete as some of it may be, could be turned into an economic power
house capable of world-wide competition within five years.
Inflation would be eliminated once you:
If those steps were taken it would not even be necessary to recover
illegal flight capital by force. But justice would suggest some reallocation
of Russia from the nomenklatura to the population.
> close unsalvageable state
> enterprises, relax governmental licensing of entrepreneurial
> activity, decontrol prices not subject to monopoly power, and
> institute property rights.
>
Everything has value and is salvageable to some extent. Spin-offs, Chapter
11 reorganizations, divestitures, assets recovery etc. are all techniques
creative Russians take to like a duck takes to water. It isn't necessary
to close anything, just to remove the obstacles to reconstruction and revitalization.
Even monopolies should be decontrolled. In the strictest sense there are
no more monopolies in a global economy. Rather than play games with import
duties it would be better to let international competition determine the
allocation of the tools of production and the distribution of labor. Russia
has little to fear in such a competition.
> To promote economic progress and avoid political
> instability, economic changes must be introduced gradually with a
> deliberate and methodical approach, taking account of the cultures
> and institutions of the republics of the former Soviet Union.
It is too late. The pie has already been divided. Before Russia can
return to and resume economic evolution "corrections" have to
be instigated. If they are introduced gradually instead of radically, it
will take Russia twenty years longer to reconstruct starting today, then
it would have five years ago. It is not adequate to say, 'we made a mistake,
lets slow down now" We have to say "Lets correct the mistake,
so we can start from where we were five years ago". We have to give
the population back the tools they have lost in this shuffle.
> Free markets alone cannot be expected to bring about the enormous
> reallocation of resources required to transform a militaristic
> command economy to a prosperous consumer economy. Without a strong
> government program, the attempted transition will continue to
> produce the following results:
Russia has no government in the sense that economists mean it. The best
thing for Russia now is a weak government when it comes to commerce. It
is the people who have to bail out the government. They are the ones who
produce and support. The government consumes. If you create a level-playing
field and rule-of-law, the planet will rush to utilize the potential of
Russia. The best way to prevent that is to envision a "strong government
program". Productive creativity is not a "program". No government
has the ability to duplicate with a program the individual creativity of
the individual. Let him go to work unrestricted.
Here is my vision
>
> þ decline in domestic production;
Reversed by an influx of capital utilizing Russia labor and ingenuity
to produce OEM parts and products for willing customers world-wide. Another
Taiwan, Hong Kong, China
> þ rapid inflation;
Elimination of inflation by turning off the printing presses. You may
remember 1980 and the very high U.S. prime rate of interest and inflation,
which was solved by Japanese buying of our Treasury Notes. That enabled
the U.S. to shut off the presses which had been financing our deficits.
> þ rise in imports of finished goods to an extent that is
> extinguishing demand for domestic products;
Increasing substitution of imports with domestic production as the population
gets to work and competes with imports.
> þ criminalization of the economy and increase in violent
> intimidation;
De-criminalization of the economy as law abiding productive citizens
exclude parasites from their purses and have recourse to the law to protect
what is theirs to keep.
> þ deterioration of public services, including health care,
> education, and public safety;
Increasing restoration of the ability of industry to support public
services with taxes on their growing export profits as GDP is transferred
from nomenklatura flight capital to individual communities realizing market
prices for their production
> þ decrease in public investment in economic infrastructure;
The departure of government from private commercial and industrial activity
and regulation of it, and the financing of economic infrastructure from
a growing GDP tax base.
> þ decline in living standards and a startling increase in
> economic inequality.
>
A rise in living standards and a startling elimination of economic inequality
as a la Marcos, the world takes a second look at where Russia's resources
are and who owns them and how they got them.
> To a significant degree, privatization coupled with
> extensive corruption is siphoning off existing wealth, contributing
> to the destitution of the majority. Public assets are being
> transferred to a narrow stratum that has been oriented toward quick
> liquidation and immediate private gain. Enormous mineral assets,
> which should assure future prosperity, could be plundered. Wealth
> is leaving the former Soviet Union in the form of capital flight
> and extravagant expenditure on imported luxuries. It should
> instead be invested in economic restructuring.
>
Your previous paragraph provides a clear description of why my vision
is the logical approach to reform.
> Fewer and fewer citizens are willing to believe that
> enrichment of a small upper stratum represents the first stirrings
> of a revitalized economy.
The phenomena itself is not in disrepute, the methodology used is accompanied
by the regulatory policies of the nomenklatura, it is clear continuation
will continue to prevent the population from reaching anywhere near its
full productive potential and will continue to utilize "reverse transfer
payments" to allocate personal income to the elite.
> Widespread distress and disillusionment
> are discouraging private investment and spurring the emigration of
> the talented. Although most remain staunchly committed to peace
> and freedom, nationalist extremism is gaining momentum and
> re-armament is becoming a real possibility. Recently achieved civil
> freedoms, already eroded, may not endure.
Widespread global recognition that this is a fixed game are denying
the nomenklatura any further support. Russians voting with their feet,
is the democratic process in action. The Russian population should not
be discouraged from voting. Nationalist extremism is nothing more than
one "family" vying with another for the right to become an exploiter.
It will not take long for the Russian population to recognize that none
of the present alternatives offers them anything but continued bondage.
Without economic freedom there is no civil freedom. The modest improvement
in civil liberties should prompt no one to support exploitation.
> A coherent program is required to create a viable market
> economy, with an emphasis on restraining inflationary demands.
I have suggested what such a freeing of the economy would consist of.
It should constitute a withdrawal of government from the commercial and
economic arena rather than a program of continued regulation in an arena
where government has no competence. Let the slogan be "All this is
not specifically prohibited is permitted" instead of "All that
is not specifically permitted is prohibited". Don't make people buy
the right to be.
> If inflation accelerates, flight from money may commence and the
> resulting hyper-inflation would be socially wrenching and could
> stall altogether economic reform.
Economic reform is stalled. It can't move backwards. The spoils have
been removed. Inflation will accelerate as long as the printing presses
run and currency exchange controls are used to support flight capital instead
of eliminate it. Flight from rubles into money commenced five years ago
and has siphoned off most of what Russia had in 1989. Hyper-inflation,
if it comes, may be the one force that restores sanity. We have the opportunity
to take less painful and productive steps before it comes to that if we
face realities.
> A reduction in subsidies for
> enterprises, including limits on credits from the central bank, is
> essential.
The nomenklatura will continue to give back a portion of the spoils
to maintain civil order. It isn't an economic system. It is a safety valve
on exploitation during what is essentially a period of the absence of economic
reform and an alternative for it.
> Other changes to help restrain inflation should be
> implemented in a manner that will not further worsen income
> inequality. They might include increased domestic production, more
> funds from abroad, selective controls on real wages and key prices,
> support for the exchange rate, lower import barriers, restrictions
> on capital flight, reductions in the degree of monopoly, and a
> better designed and enforced tax system to include real estate
> taxes and more progressivity.
>
When Russia elects a government that represents the people it can be
expected to implement such constructive change. While in the interests
of Russia and the Russian people, such steps are currently not in the interest
of those who control the power structure and therefore it is fruitless
to recommend such action. It will not be taken.
> Fighting inflation is hardly sufficient. Indeed, reducing
> subsidies and tariffs risks further collapse of production. The
> strategy of economic transition should contain successful elements
> of the development programs in China and the other newly
> industrialized Asian nations. As part of a comprehensive plan, a
> program to gradually decrease subsidies would be more palatable
> politically than past futile efforts to call a sudden halt.
Transition from "subsidy" to "investment" occurs
when economic viability is restored. The "reversal" of policy
which is necessary to bring about such transition is what is not palatable
to the existing power structure. A gradual decrease in subsidies is irrelevant.
The cause of subsidies lies in the lack of economic freedom to produce
viability.
>
> Most state enterprises are highly inefficient, many are
> thoroughly corrupt, and few are oriented toward productive
> investment. Often subsidies end up as funds sent abroad. Thus
> the subsidy program must be revamped to curb abuse and compel major
> reforms consistent with the market economy, including the
> introduction of employee and managerial incentives and the laying
> off of surplus workers.
It is the tolerance of abuse which maintains the civil peace in a system
based upon corruption. You can't apply the policies of a rule-of-law system
to Russia unless you treat the causes.
> While a large share of the subsidies
> supports the functioning of state enterprises as mini-welfare
> states, the reallocation of surplus workers would be facilitated if
> public funds were used instead to both strengthen a universal
> social safety net and provide retraining.
When Russia gets a government you can try that idea. I prefer to follow
Newt Gingrich's ideas on education and leave it to the local level
>
> To run an effective subsidy program, a new government agency
> is needed, staffed by honest professionals with substantial
> autonomy from political pressures. Increasingly, this agency
> should take the form of a development bank that encourages reform
> and directs long-term credit to promising sectors. Support for
> enterprises must be tied to performance: technological upgrading,
> productivity growth, export performance, and profitability.
Much better would be to reduce local taxes and let each locality solve
its own problem.
> While industry is finding its place in the global economy,
> there should be temporary tariffs on goods not needed to build
> productive capacity. High tariffs on imported luxuries would boost
> government revenues and conserve foreign exchange, capturing some
> of the disproportionate gains of those able to indulge in lavish
> consumption. Tariffs can also help prevent the onrush of foreign
> goods from thwarting potentially viable firms. Care must be taken,
> however, so that tariffs do not have the effect of either
> encouraging monopolistic pricing or sheltering inefficient
> enterprises.
>
What there should be, can hardly be expected to be fostered by those
who created what is. It's unrealistic to expect the nomenklatura to tax
their own conspicuous consumption. The only effective way to compete with
imports is by competing not protecting. Russian borders are like sieves.
> Vigorous government action to combat corruption is long
> overdue.
This is an oxymoron.
> Violent intimidation, which is preventing competition and
> inhibiting growth, could be restrained by a well-paid strike force
> that would protect complainants, investigate, make arrests, and
> prosecute.
I would suggest the Russian army employed and paid by the United Nations
> It is especially important to counter infiltration of
> the fledgling banking system, not only because of its potential
> role in funding investment but also because it has become a prime
> source of Mafia intelligence used to raise their cut of business
> receipts and divert government subsidies and credits.
It is too late for that. I suggest a step backward first. Why not operate
all Russian banks out of headquarters offices located within Western banks
outside Russia in accordance with Western banking laws.
> Pervasive
> corruption is thwarting government efforts even to tax, making it
> harder to control inflation.
This is an oxymoron. You assume there is more than one party here.
> Continued expansion of corruption, if
> not soon checked, could make it impossible to put in place an
> honest and effective government bureaucracy.
Since there is none in place as yet, how can you request what is in
place to replace itself?
Too Late. Until economic and political power and control of its government
is restored to the electorate, this can't be accomplished.
>
> Notwithstanding the need for a more active government role
> in the transition process, continued devolution of power away from
> Moscow and the military is vital.
What is needed is a more active role of the population and a far smaller
and less active government.
> Unless industrial policy,
> including government subsidies and loans, is insulated from
> excessive demands by the military, the scope for market competition
> will be narrowed.
The degree of military participation in subsidies is nominal. Weapons
demand internationally is not what it used to be. It is already recognized
that military exports offer less opportunity than other production. What
is need is to create an alternative function such as a "sea-bees"
for the military and make them a well paid infrastructure repair team.
Economic assistance budgets offer the military far more promise than funding
from the Russian budget.
> Furthermore, budgetary balance and control over
> inflation is unattainable without additional reductions in the
> military-industrial complex, although conversion programs are
> needed to preserve scientific and technological potential. The
> effectiveness of the conversion programs depends on extensive
> participation by regional and local governments and could perhaps
> be assisted by Western example and financial support.
>
I agree with the described need. I think job retaining and definition
and transition to a new philosophy of public service by the youth of Russia
to infrastructure reconstruction is a more useful focus.
> Thus, bold but judicious measures are required to guide
> economic transition. The goal is not to interfere with market
> forces but rather to facilitate the formation and functioning of
> competitive markets.
>
Such a transition of the military to an engineering corps would indeed
be bold. Competitive markets are functioning but the fruits are being denied
to the creators. Markets can operate but their benefits won't be enjoyed
until economic discrimination is removed from the market.
> The participants in the Economic Transition Group agree to
> develop concrete suggestions for improving the economies of the
> republics of the former Soviet Union:
>
I sincerely hope that my remarks and suggestions are useful to you and
you have my permission to share them with all the members of your committee
to whom I send my regards and encouragement.
Dr. Peter Johannes van de Waal-Palms
Palms & Company, Inc., Investment Bankers, USA. <palms@PeterPalms.com>
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