The Russia Conundrum

CHAPTER 3

A TURNING POINT

Gorbachev’s reforms created opportunities for those capable of seizing them. But decades of the Soviet state had destroyed people’s capacity for initiative and few took up the challenge of private enterprise. People were so used to the state taking all the decisions for them – providing them with a minimal wage for minimal work, basic accommodation, heating and food – that they had lost the ability to think and act for themselves. For those of us willing to risk it, perestroika offered the possibility of great rewards. Menatep Bank thrived; by the standards of the time, my partners and I were well off.

But there was a problem. The hardline communists were angry at Gorbachev’s flirtation with capitalism and were threatening to overthrow him. In August 1991, they staged a putsch. Tanks were on the streets, Gorbachev was detained in his holiday home in Crimea and the coup leaders were promising to take Russia back to the old days by reversing his political and economic reforms. If they succeeded, our businesses would have been crushed and there could have been personal consequences for us and our families. People were scared that all the rights and freedoms that had come to us since perestroika began would be lost forever. That’s why I joined Boris Yeltsin on the barricades around the Russian parliament, even though not everything about the Yeltsin administration – including the nepotism and incipient corruption – was to my liking. The coup plotters ordered tanks and troops to take over the streets of Moscow and sent the elite Alfa KGB unit to storm the Russian parliament building to destroy us. The people of Moscow linked arms and swore to stand in the way of the tanks. Some of them were shot or crushed to death, but we were defending freedom and democracy. We were defending ourselves and everything we had achieved. That is why we took the decision not to surrender. It was one of the most emotional moments of my life.

When I stood on the barricades in those dramatic August days, I was 28 and a successful businessman. Since earlier that year, I had been an adviser to the prime minister of the Soviet Union, Ivan Silayev. I had a personal stake in the economy and in the reformist policies of Gorbachev and his team. I went to defend the Russian White House because Silayev was there and because it was my duty to stand up for the liberal policies we had been promoting, policies that the coup plotters were seeking to destroy. Perhaps I didn’t fully realise the significance of what was happening, but I went with passions running high. The August events confirmed my commitment to democracy and the market economy.

August 1991 changed everything for Russia, and for me. The heroism of the Russian people and the collapse of the coup secured the way for a free-market democracy. In a few turbulent months between August and December 1991, the USSR was dissolved and Boris Yeltsin, president of a newly independent Russia, inherited power. Mikhail Gorbachev had started the move towards a market economy, but his measures were limited and tentative. He wanted to strengthen the communist system by encouraging a minimal amount of economic enterprise; the last thing he wanted was to bring communism crashing down. But that was exactly what happened.

People stand on a barricade in front of the Russian White House in Moscow, 21 August 1991

The unexpected turn of history thrust Boris Yeltsin into a role that I don’t think he had fully anticipated. In opposition, he had espoused radical economic reforms, including an end to the old centralised Soviet command system, but now he had to implement them. In the exhilaration of his victory over the hardline communists, Yeltsin committed himself to the programme of ‘economic shock therapy’ propounded to him by Western economists. These were the so-called ‘Chicago Boys’, young technocrats led by Harvard University’s Jeffrey Sachs, who came flooding into Russia at the behest of the US leadership, aiming to transform Russia from a stagnant communist central command system into a rejuvenated market economy where private enterprise would breathe new vigour into the state. Their ideas were enthusiastically backed by economic liberals in Yeltsin’s Reform Cabinet, most notably Prime Minister Yegor Gaidar and the privatisation guru Anatoly Chubais. The Chicago Boys convinced Yeltsin that he had no time to lose, that delay would increase the scale of the task, and that the transformation had to be completed before the communists could regroup and turn back the clock. Only by creating a new business elite and a middle class with a stake in the system, they argued, could they be sure the communists would never regain power; leaving the economy full of nationalised industries would make it easy for communism to return. The Chicago Boys had previously had some success in post-Jaruzelski Poland, and even more so in Augusto Pinochet’s Chile – but these were countries with a living memory of capitalist traditions, while Russia, a country that had no such history, was totally unprepared for the radical changes they were proposing.

The reformers accepted that the speed of the change would cause short-term pain, but believed the long-term gain would make it worthwhile. Yeltsin’s first step in late 1992, masterminded by the Chicago Boys and implemented by Gaidar and Chubais, was a voucher scheme that aimed to transfer ownership of Russia’s state industries to the Russian people. Every citizen was sent a voucher worth 10,000 roubles (approximately $60), each one representing a very small stake in the country’s economy. It was an attempt to create a shareholding middle class, but it was destined to fail.

As an adviser to Yeltsin’s Reform Cabinet, I followed the process from the inside. I was never particularly close to Yeltsin himself, but in 1992 I was appointed chairman of the Investment Promotion Fund, with the rank of deputy minister of fuel and energy. I saw at first-hand the mistakes that were being made and I raised the alarm about the pitfalls that awaited us. Many of the problems were down to the Chicago Boys. Much has been written about their role, but I saw with my own eyes how systematically they took apart the country’s national economy and dismantled structures that had taken decades to build up, breaking things that should never have been broken. I don’t know exactly what authority these American consultants had been given – or who gave it to them – but our Russian politicians deferred to them and, when disputes arose, it was the Americans who got their way.

The thing that made me most angry – and one of the reasons I decided to quit – was the way in which the Russian oil industry was unnecessarily torn apart. Despite all advice, the decision was taken to privatise the main branches of activity – mining, processing, marketing and distribution – separately from each other, with the inevitable result that production collapsed. In an industry where the product is mined in inhospitable conditions hundreds or thousands miles from ports and even from populated areas, with little capacity for prolonged storage, it is obvious that any disruption to the established supply chain will lead to problems of shortages, the loss of wells frozen because of inactivity and the destruction of expensive equipment in processing facilities. I argued against the decisions that were taken, but my views were ignored. Ironically, just a few years later, it would fall to me to undo the damage that was done to the oil industry by the misguided policies of the Chicago Boys and their Russian counterparts.

Boris Yeltsin meets with leading industrialists and bankers, including myself, in the Kremlin, 1997

I saw so much going wrong that, in 1993, I stood down from my role in the Reform Cabinet. I told the cabinet that if entrepreneurs like me were not listened to, then we would inevitably take advantage of their mistakes. I decided to go fulltime into business.

The voucher scheme failed because it distorted the realities of the Russian economy. The sums involved were illogical. The population of Russia was 150 million, so 150 million vouchers were issued, meaning that the greater part of Russian industry was being valued at a mere $9 billion. Anyone who did the maths could see this was wrong, and anyone with a business brain could see it presented an opportunity. But most Russians had no experience or understanding of the concept of private ownership and were more than happy to sell their bits of paper for a few roubles. Group Menatep bought up large numbers of vouchers, which were being traded on street corners, and acquired shareholdings in many different industries, including textile mills, chemicals, metallurgy, glass, food processing, wood pulp and paper, fertilisers and oil. It was a risky process because no one was sure what condition these industries were in – the Soviet way was never to open the books; official profit and loss figures were unreliable, and we often discovered huge debts that had not figured in the accounts – but we took the gamble. Many of the firms we bought turned out to be hard to resurrect, several produced no returns and one even went bankrupt; but all enterprise involves an element of risk. When things worked out for us, we were accused of buying businesses on the cheap, but the fact is that we played by the rules that were in force at the time.

I took a hands-on role in running the companies we acquired, some of which we grew into multimillion-dollar businesses; but it soon became clear to me that our portfolio of interests was too big. Menatep needed to slim down; we needed to concentrate on one thing and, in 1996, I chose oil. The decision was partly influenced by the experience I had gained at the Ministry of Fuel and Energy and by my own background in chemical engineering, as well as my business partners’ qualifications in oil engineering. Russia has vast natural supplies, but her state-owned oil companies had been appallingly inefficient, operating at a loss for many decades. The industry was in sharp decline. I could see the wasted potential and I knew how things could be turned round; but Russian law specified that strategic industries should not be sold to private owners. While Yeltsin had managed to privatise many branches of industry, the remaining communist faction in the Russian parliament had fought to block the sale of land, iron and steel, oil and gas.

Times changed, however, when a combination of the inevitable crisis in the old state industries (especially defence), the splintering of the Soviet economic space, the Chicago Boys’ shock therapy and Boris Yeltsin’s clumsy management of the economy resulted in a massively inflated budget deficit that came close to bankrupting the country. Wages and pensions were left unpaid and people lost their jobs. To make things worse, presidential elections were due the following year and the Communist Party, under its new leader Gennady Zyuganov, was leading in the polls. Yeltsin needed cash to keep the economy going and get a grip on the main industries that were spiralling out of control if he were to have any chance of being re-elected. He asked Russia’s leading businessmen, including myself, to come to his aid and we agreed to do so. It was certainly in our interests to prevent a Communist Party victory, as it was already promising to renationalise our businesses and restore the state-run economy of old. In return for our help, the government agreed to revise the law on state industry and put up for sale the assets we were keen to purchase. The whole deal was quite remarkable: we were a bunch of young men who had started out less than a decade earlier doing petty business deals in defiance of a disapproving Soviet state, and now the state was coming to us for help.

Russian businesses advanced Yeltsin around $1.8 billion and, most importantly, helped to end the chaos and stabilise the situation in the big industries, which resumed the payment of taxes to the state and wages to their millions of employees. It allowed the government to head off the massive wave of strikes in both the cities and the regions, and to pay pensions and wages. Yeltsin’s poll numbers rebounded and, in July 1996, he was elected to a second presidential term. In a state-run auction, my partners and I bought the oil company, Yukos. It was a turning point for me that would define the rest of my life.