It was the fall of 1996, Boris Yeltsin had just trounced the Communists in a landmark presidential election, and the U.S. ambassador to Russia was in an ebullient mood. After 3 1/2 turbulent years, Thomas R. Pickering was going home. But before he left, he wanted to share his vision of Russia's future with American businessmen lining up to invest billions of dollars in what was already being called the "Wild, Wild East."

"Within three years," the ambassador predicted, Americans could travel to towns like Sochi and Samara as easily "as they now travel to Chicago and Cleveland." They would be able to stay in "more than three-star hotels" and rent American cars. The "fabulous Russian Far East" would be as economically vibrant as the rest of the Pacific Rim, including Singapore, Japan and California's Silicon Valley. Russian tax laws and accounting standards would "approach Western norms." Overall, doing business in Russia would become "more structured, more predictable and less risky."

A highly respected diplomat who continues to shape U.S.-Russia policy as undersecretary of state for political affairs, the State Department's No. 3 position, Pickering concluded his predictions by forecasting that Russia would be "one of America's top trading partners" by the fall of 1999.

Three years after the ambassador's farewell address to the American Chamber of Commerce in Moscow, Russia ranks 30th in the list of American trading partners, sandwiched between Colombia and the Dominican Republic. Hertz and Avis have yet to penetrate the (practically nonexistent) car rental market in the Russian provinces. Russia's gross national product has plummeted by nearly 50 percent over the last decade. More than 60 million Russians -- nearly half the population -- live below a very low official poverty line.

The Russian economy's collapse has been accompanied by a collapse of many American illusions about Russia, and by an increasingly sharp debate about U.S. policy toward the former Communist superpower. Clinton administration officials who used to point to economic reform in Russia as a foreign policy success are busily defending themselves against charges of naivete and boosterism. Reports of massive Russian money laundering through the Bank of New York have raised new questions about the logic of pouring international loans into a country that is hemorrhaging an estimated $10 billion to $15 billion a year in capital flight.

The finger-pointing over "Who lost Russia?" threatens to spill over into next year's U.S. presidential election campaign. Foreign policy advisers to George W. Bush, the leading Republican presidential candidate, are attempting to link Vice President Gore to the failure of economic reform in Russia because of his much ballyhooed relationship with former prime minister Viktor Chernomyrdin. For their part, the Democrats accuse the Republicans of throwing away the best chance of influencing future events in Russia during the period of 1991-92, in the immediate aftermath of the collapse of communism.

In recent months, what used to be known as the "Washington consensus" on how to deal with Russia has burst wide open. The World Bank, in particular, has emerged as a hotbed of dissent on Russia policy, with its chief economist suggesting that the early emphasis should have been placed on building institutions -- a working court system, for example -- rather than the traditional set of monetary guidelines favored by the International Monetary Fund.

What is most noticeable in this debate is a dramatic reduction of American expectations about Russia and a growing realization that the establishment of free-market democracy may require decades to accomplish. U.S. officials no longer talk very much about the benefits ordinary Russians have derived from moving toward Western-style capitalism. Instead, they stress the geopolitical rewards reaped by the United States from engaging Russia.

"Our working relationships with Russian leaders from President Yeltsin down have paid off in terms of the safety and security of the United States," maintains Deputy Secretary of State Strobe Talbott, the architect of the Clinton administration's Russia policy. He ticks off a long list of achievements in the "nuclear-strategic field," including the dismantling of the Communist state, Russian troop withdrawals from the Baltic nations, cooperation on Bosnia and Kosovo, the denuclearization of Ukraine in exchange for Russian security guarantees and work on nuclear nonproliferation.

A Joke on Moscow Streets

From the Russian point of view, the balance sheet seems much less favorable. Many experts fear a backlash that will undermine Russia's integration with the West.

"We kept on giving them money and advice even though there were concerns about corruption," said Don Jensen, a former U.S. diplomat in Moscow. "As a result, the U.S. is associated in the minds of many Russians with a failed reform, a discredited leader and criminality. The U.S. is not associated with the rule of law and the building of democracy."

A joke on the streets of Moscow these days, according to World Bank staffer John Nellis, goes this way: "Everything the Communists told us about communism was a complete and utter lie. Unfortunately, everything the Communists told us about capitalism turned out to be true."

The present gloom in Washington over Russia's economic prospects contrasts dramatically with the determined mood in January 1993 when President Clinton took office. The administration had a clear idea of what it thought needed to be done in Russia. Talbott, whose friendship with Clinton goes back to their experience as Rhodes scholars at Oxford, had made his journalistic reputation as a Russia expert. Other administration officials had acted as informal advisers to Russian market reformers led by Yegor Gaidar and Anatoly Chubais.

Two key assumptions underpinned the administration's approach to Russia. The first was that "President Yeltsin is the personification of reform in Russia," in Talbott's phrase. "It is impossible to support reform and reformers without putting a name to reform in the current context, and that is President Yeltsin's name." Yeltsin was viewed as the man who had vanquished the Communist dragon during the hard-line coup attempt of August 1991 -- and the leader best placed to introduce democratic, market-oriented reforms.

The second assumption, almost an article of faith for Russian reformers and their Western supporters, was that Russia's salvation lay in tight monetary discipline, rapid economic liberalization and a massive privatization program. While the reformers were well aware of the risks of "shock therapy" -- unemployment, social discontent, opportunities for corruption -- it was believed that these problems would resolve themselves if the economic medicine were applied with sufficient vigor.

Over the next few years, both assumptions would come under increasing attack, not only by outside critics, but also within the U.S. government and institutions such as the IMF and the World Bank.

The earliest signs of dissent came from Soviet experts in the State Department and the U.S. Embassy in Moscow who were skeptical about Yeltsin's reformist intentions and Russia's ability to endure shock therapy. Misgivings about the "Russia First" policy championed by Talbott surfaced initially among the Russia experts on the State Department's policy planning staff, according to several former staff members. During the fall of 1993, the policy planning staff produced a stream of memorandums arguing for a less Yeltsin-centered policy.

"It is one thing for an ambassador to suffer from `clientitis,' but it is the job of the White House and the State Department to put it in context," said Charles Gati, a former member of the planning staff. "They allowed clientitis to spread from our embassy in Moscow, where it is expected, to become official policy."

In the U.S. Embassy in Moscow, what one former diplomat described as "open warfare" was underway between the economic section, which was responsible for implementing U.S. aid policies to Russia, and the political section, which prided itself on its hard-headed analysis of Russian reality. In its cables to Washington, the political section consistently painted a much less rosy picture of events in Russia than that described by Clinton administration spokesmen.

E. Wayne Merry, who was head of the political section from 1991 to 1994, recalls a long, dissenting telegram he sent in early 1994 that criticized America's "evangelical attempt" to remold Russian society in its own image. He argued that such efforts would almost certainly fail because Russia -- unlike Eastern European countries such as Poland and the Czech Republic -- had little tradition of free markets or the rule of law. The United States, in Merry's view, would end up getting blamed for the failure of shock therapy.

Some IMF and World Bank officials also had misgivings about the policies they were charged with implementing. Jean Foglizzo, the IMF's first Moscow representative, said that the fund's tight-credit approach failed to take into account the fact that Russia is a country where "normal relationships between borrowers and banks do not exist."

"What happened in Russia was that as soon as you started to try to apply tight monetary policies, people stopped paying their bills," and the economy reverted to a primitive form of barter, Foglizzo said.

Central to the efforts of the Russian reformers, and the present debate over what went wrong in Russia, was the decision to embark on a program to privatize state-owned enterprises, the largest of its kind ever attempted. There were political as well as economic reasons for proceeding as rapidly as possible. The creation of a large property-owning class was seen as the best guarantee against a revival of communism.

Selling to the Oligarchs

Such details as who acquired control over former state assets, and for what price, seemed less important than the speed at which the socialist superstructure could be torn down. Chubais, who was leading the privatization charge, was quoted as saying, "I try to act as if I only have two weeks left in office, and I try to think what I can do in 14 days to make sure the Communists never come back."

It quickly became apparent that such words as privatization and economic reform -- even democracy -- meant entirely different things in the Russian context than in the American context. Russian privatization has come to mean the wholesale transfer of valuable state assets to a small group of tycoons known as oligarchs who are more interested in shipping anything of value out of the country than in investing their profits in domestic production. Moreover, inefficient factories were handed over to their Soviet-era managers, who bitterly resisted the necessary downsizing and restructuring.

"We were too willing to accept the Russian reformers' view that it didn't make any difference who ended up with the assets initially," said Charles Blitzer, who was chief economist in the World Bank's Moscow office from 1992 to 1996. He added that the West "bought into the idea" that the new owners would push for a law-based society "because no one wants their sons to grow up to be the crooks they are."

Clinton administration officials defend the early stages of the privatization program as a significant contribution to dismantling the old totalitarian state. But they distance themselves from the more controversial second stage of the program, which began at the end of 1995. Under what was known as the "loans for shares" deal, oligarchs were permitted to gain control of the crown jewels of the Russian economy, including oil companies, in return for ludicrously low cash payments to the government.

Although U.S. and IMF officials say they voiced opposition to the "loans for shares" scheme at the time, they did practically nothing to stop it. The IMF came through with a $10 billion, three-year loan to Russia -- the second biggest loan in the fund's history -- in early 1996 at the height of the scandal, just as Yeltsin was gearing up for a presidential reelection campaign against Communist challenger Gennady Zyuganov.

No attempt was made to link the loan to an honest privatization program. IMF officials, who note that overseeing microeconomic issues such as privatization is the job of the World Bank, say the loan was justified because Russia had met the fund's targets on indicators such as inflation and the budget deficit.

Clouds of Corruption

At the end of 1996 -- at about the same time that Ambassador Pickering was making his optimistic predictions about Russia's economic prospects -- U.S. intelligence agencies undertook a detailed study of corruption in Russia. The eight-page analysis was titled "Corruption Clouds Russia's Future" and distributed around the government at the assistant secretary level. The study concluded that corruption was virtually endemic to Russia, reaching the highest levels of President Yeltsin's administration.

The study noted that the halting nature of economic reform in Russia, far from creating a level playing field, had spawned opportunities for government officials to enrich themselves. The analysts warned that nationalist and anti-reform politicians were likely to seize on the corruption issue in future campaigns. They also challenged the notion -- favored by American supporters of reform -- that corruption would fade away with economic modernization.

Stung by accusations that the administration ignored such warnings, the White House has compiled a list of statements by Clinton and other senior U.S. officials since 1995 drawing attention to the corruption issue. For the most part, however, officials tended to describe corruption as a blemish on an otherwise successful record, rather than as a phenomenon that went to the heart of Russia's post-Communist transition.

For the Clinton administration and the IMF, Russia was "too big and too nuclear to fail," in the phrase of Anders Aslund, a Washington-based economist close to Chubais and the other Russian reformers.

IMF loans did come with conditions aimed at addressing potential malfeasance. IMF officials point to changes the Russians made at their insistence, such as creating a central budget that forced powerful ministries to report their spending. IMF Managing Director Michel Camdessus recently said he told Yeltsin that Russia would not be given special treatment. Instead, it would be treated "exactly like Burkina Faso."

But financial markets didn't take such claims seriously, IMF economists concede. The widespread belief that the West would bail out Russia encouraged foreign investors to pour billions of dollars into the country's risky short-term government bond market in 1997 and early 1998 -- setting the stage for a catastrophic reversal.

U.S. officials make no apologies for the priority they put on Russian stability. Talbott noted that some critics, comparing the relative importance to the United States of Russia and Brazil, argue that "the only salient difference is nuclear weapons. Well, it's a mighty salient difference."

U.S. Backs a Bailout

One of the clearest illustrations of outside pressure affecting IMF decisions came in late spring last year, as Russian stock and bond markets went into a tailspin and investors stampeded to cash in rubles for dollars. Markets suddenly paid attention to Moscow's burgeoning budget deficit, thanks partly to the spread of jitters from crisis-stricken Asia.

An IMF official who worked on Russia recalls the deluge of phone calls he received from investment bankers and portfolio managers, lobbying for a new IMF bailout. Many foreign investors had been earning sky-high rates of return -- upwards of 50 percent -- from Russian treasury bills, known as GKOs. Now they wanted the fund to use taxpayer-backed resources to ensure that Russia could pay interest and principal on the bills.

"They were saying, `It's got to be a big package, or everything will blow up,' " the official recalled. "One guy got to the point he was calling me three, four times a day."

IMF staffers were skeptical that a bailout would provide more than a short-term fix. But U.S. officials, while acknowledging that risk, believed the new prime minister, Sergei Kiriyenko, ought to be given a chance to deliver on his promises of radical reform. Moreover, they reasoned, some of Russia's problems were beyond its control, and a big IMF loan could help restore calm by assuring the markets that the government would be able to pay its debts and avoid a devaluation of the ruble.

The last weekend in May, Chubais flew to Washington and went to the homes of Talbott and Lawrence H. Summers, then deputy treasury secretary. Chubais warned his hosts that a devaluation would deal a crushing blow to the cause of reform. The upshot was an unusual Sunday statement by Clinton, saying the United States "endorses additional conditional financial support" from the IMF and World Bank.

"Once that announcement was out there, it was the end of the debate," an IMF official recalled. "It affected expectations in financial markets," where investors and analysts concluded that a giant bailout was almost as good as done.

On July 14, the IMF agreed with Russia on a package of loans totaling $22.6 billion. Summers defends the move as a gamble worth taking -- but it failed within days, as the Russian parliament fought to block the promised reforms. The flight from rubles to dollars continued, exhausting Russia's foreign currency reserves. On Aug. 17, the Russian government announced that it was both devaluing the ruble and suspending repayment of GKOs. This time, there would be no bailout from the West.

Salvaging a Policy

A year after the ruble's collapse, U.S. officials and their counterparts at the IMF are trying to salvage what they can from their Russia policy. The IMF has made clear that it will not provide any new loans to Moscow for the foreseeable future, although it will extend the existing debt. Both the rhetoric of reform -- and expectations about the introduction of Western-style democracy in Russia -- have been sharply scaled back.

In the end, says Stanley Fischer, deputy managing director of the IMF, the ability of outsiders to influence events in Russia was probably very limited. "You can move things in one direction or another, and that's what we tried to do with the leverage we had," he said. "On balance, I think we tilted things in a better direction than they would have been otherwise."


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