Commissars over Chaos: Ominous signs are emerging that Russia is forsaking its vision of a free market for the old pipe-dream of economic utopia. Martin McCauley explains what is threatening to kill reform and what it will mean

SHORTLY before he was sacked from the Russian government for taking an unscheduled business trip to London, Andrei Illarionov, the Prime Minister's chief economist, spent a sybaritic evening with local officials in Ulyanovsk, Lenin's home town.

As the evening drew to a close, the reformer was given a plain envelope to hand to the Prime Minister, Viktor Chernomyrdin. It was, it turned out, a request for 3bn roubles to subsidise a local aviation plant. Mr Illarionov describes how he took the letter gingerly to the Prime Minister, expecting to be bawled out, but in fact Mr Chernomyrdin seemed quite ready to accede to the request.

Widespread subsidies, which the out-of-favour reformers once saw as the bane of the economy, are back in fashion. So too are predictions of calamity for the economy under the stewardship of Mr Chernomyrdin, who has called for an end to 'the age of market romanticism'.

The abandonment of a tight monetary regime has led Boris Fyodorov, the reformist ex-finance minister, to declare that inflation will be running at 2,000 per cent if the government, as expected, embarks on a spending binge to prop up bankrupt enterprises making goods no one wants to buy.

Inflation subsided to a low of 12 per cent a month in December, but no one expects that to last. Production, which is thought to have slumped 20 per cent in 1992, is still falling fast.

The external picture is equally depressing. A meeting of Group of Seven finance ministers has been called for 26 February to discuss the deepening economic crisis in Russia. High on the agenda is whether to continue delaying Russian repayment of dollars 15bn ( pounds 10bn) debt principal and interest due at the end of April.

Russia desperately needs the extension, but a condition would be reaching an accord with the IMF on economic reforms, a development the Fund says is unlikely now reformers have quit the government.

In elections on 12 December last, Russians rejected the course adopted by the government over the past two years: a rapid move to a market-based economy.

The master magician, Yegor Gaidar, whose shock therapy (all shock and no therapy to most Russians) was launched in January 1992, was sent packing, and Mr Chernomyrdin, a stolid, ex-Soviet bureaucrat, emerged a clear winner.

His first move has been to embark on a spend, spend, spend policy in an effort to halt falling production. Alexander Zaveryukha, the deputy Prime Minister in charge of agriculture, has already promised the farm sector about 34 trillion roubles of extra credit (up to roughly pounds 5bn).

A new parliament, together with four-room apartments for the deputies, is to be built at a cost of dollars 500m. Clearly the government does not believe Russia is subject to the laws of Western economics. The country is not to be ruled by the market but by the conscious decisions of its leaders.

In his rhetoric at least, Mr Chernomyrdin maintains that economic reforms will continue and that the march to market is unstoppable. This, however, is as much as anything else an attempt to reassure Western governments and institutions, so that international aid is not curtailed. The truth is completely different.

Russia has always had a love-hate relationship with the market, swinging, often violently, from one extreme to the other since the onset of industrialisation in the 1890s. Only a minority of Russian workers and intellectuals has ever regarded the market as desirable, and this minority has always had an affinity with the West.

Many Russians still instinctively reject the market as a Western ploy to take over the country. Russian political and economic culture is predominantly collectivist and egalitarian. Individual enrichment is repellent and distasteful.

Russia's insularity makes it difficult now for her people to conceive of solutions which are not home-produced. It is hard to overcome 75 years of Communism, which preached that private property was trade exploitation. Is there much in Russia's history to nourish the belief that the country will ever move to the market?

Russians first acquired trading skills through contact with the German Hanseatic League and the Oriental merchants who traded in silk and other valuables.

But even by the time of the Bolshevik Revolution in 1917, Russia was still way behind the rest of Europe in the development of a market-based industrial and agricultural economy. The Communists began to believe that the laws of economics did not apply to Russia and that a Communist economy could be constructed rapidly. They were to be quickly disillusioned.

The New Economic Policy (1921-28) forced them back to the market and sound money. However, the Bolsheviks had no intention of allowing the market to dictate to them. They were determined to remain in the driving seat. The commanding heights of the economy - steel, energy, transport and utilities - stayed in the state sector. Light industry, agriculture and trade were to be exposed to the market.

The Communists quickly found that industry was dominated by monopolies that were difficult to regulate. The terms of trade swung against agriculture. The peasant ate more and marketed less. The market solution would have been to increase the prices paid by the state for peasants' grain, but the commissars did the opposite, thinking this would force the peasant to market more.

The five-year plans, launched in 1928, promised to achieve many objectives, but chief among them were elimination of the market, expansion of production at hitherto unheard-of rates, and transformation of the Soviet Union into a leading world power. Utopianism again surfaced.

Stalin and his cohorts began to believe they could override the laws of economics, even the laws of mathematics. The years 1930-2 were the highpoint of this phase, as gigantomania ruled.

The emphasis placed on defence brought into being the military-industrial complex, which was the favoured core of the economy. This was to have ominous consequences later. However, in the short term it was a resounding success: the Soviet Union defeated Germany, giving the planned economy a tremendous psychological boost.

During the war, costs were irrelevant, as survival depended on production. This loosened central control of the economy, as enterprises collaborated horizontally and regionally to achieve planned targets. After the war, the central planners and ministries tried to reimpose vertical control, but never totally succeeded.

Developments in industry were mirrored in agriculture. Brutal collectivisation in the early 1930s deliberately eliminated the successful farmers and convinced the rest that there was no way back to private farming.

Nikita Khrushchev perceived that the central bureaucracy was stifling initiative, and launched an assault on the central ministries which almost cost him his position. He dissolved most of them and devolved their functions to more than a hundred councils of the national economy. However, all he achieved was the replacement of the central bureaucracy with more than a hundred local bureaucracies.

He was soon to learn that politicians' control over ministries and enterprises was limited. They had formed powerful interest groups, and had developed networks of contacts that permitted them to resolve their problems in ways beneficial to themselves. The bureaucrats and the managers exacted their revenge in 1964, when Khrushchev was dispatched to the scrap-heap.

Leonid Brezhnev presided over the slow decline of the Soviet economy. As a consensus-building politician, he was ill-equipped to diagnose and deal with the cancer eating away the country's vital organs. However, he presided over the apogee of Soviet power in the mid-1970s, when it appeared for an instant that Moscow would overtake Washington. Marxist-Leninist regimes sprouted in the Third World, but they were all an economic liability. All this set in train an arms race that gradually crushed the country. High oil prices cushioned Russia for a time.

Mikahil Gorbachev, when he took over in 1985, did not have the background or experience to divine what was really wrong. His first love was agriculture, and he was later to complain that the military-industrial complex was a law unto itself. Querying its expenditure or access to funds was taboo, even in the Politburo. Hence no one had an overall view of the economy. This consisted of many segments, with each one attempting to maximise its access to investment and resources. It had become so complex and monopolistic that it was impossible to devise a reform which would have integrated it and made it more efficient.

Mr Gorbachev, in his well- meaning way, exacerbated the problem. The law on state enterprise, which took effect in the beginning of 1988, gave enterprises control of the wage fund. They immediately paid everyone more and thus began the inflation spiral which gradually devastated perestroika.

The anti-alcohol campaign reduced state revenue and the old habit of printing money to cover the shortfall returned with a vengeance. Mr Gorbachev's desire to remove the party's influence over the economy overlooked the vital co-ordinating role it had played. Now there was no co-ordination.

The demand for autonomy and then independence by some republics speeded up the disintegration. A market did emerge, but its ethos was that of the black market. It was stimulated by the shortages of the late Brezhnev era, but was given a powerful boost by the anti-alcohol campaign. Trade became legitimate again and was seized upon by motley groups. They understood their margins would be greater if competition could be stifled, so their goal was to build monopolies.

The Soviet Union collapsed under its own weight, not as a result of military defeat or intervention from outside. This was tremendously important psychologically; there was no general perception that the old system and ways had had their day and that a radical transformation was necessary. Those who viewed the collapse of Communism as a victory were a small minority, favouring a market economy, democracy and Western values. Those who viewed the collapse as a defeat form the great majority.

The corruption which has accompanied the move to the market has alienated many. Privatisation is often seen as the laundering of the ill-gotten gains of the mafia.

Does this mean that Russia, as in 1917, will abandon the market and buck the universal trend towards market economies?

The record of Russian industry and agriculture over the past two years is not very reassuring. The Gaidar administration attempted to use monetary instruments to force enterprises to restructure. However the managers' lobby was too powerful, and convinced Boris Yeltsin social unrest would result if enterprises were forced to close.

There are now more than 300,000 private farms in Russia, occupying about 8 per cent of the arable land. However, they eke out a difficult existence, as access to credits (banks lend to collective and state farms), inputs (enterprises are not interested in supplying small amounts of equipment) and transport are constant headaches. They cannot offer land as collateral, as they only lease it.

Even under Mr Gaidar, many of the pro-market decisions of the government were slowed down or blocked by low-level bureaucrats.

A market of sorts has emerged, but it is almost exclusively concerned with trade. There are more than 2,000 commercial banks, but many of them are fragile and usually extend only seven-day to three- month loans. However, the top 50 banks dominate the market and are often closely interlinked. Contracts are virtually unenforceable in Russian law and nowhere is the maxim 'let the buyer beware' more appropriate. Businesses have devised their own techniques for the collection of bad debts. An employee of a commercial bank left his hotel without paying a dollars 10,000 bill. The hotel then took another foreign employee of the bank hostage until the money was paid. Bankers who do not pay protection money are liable to be shot.

Will the burgeoning market flourish or will it be nipped in the bud? Where will Mr Chernomyrdin's Communist disdain of sound money lead to? There are three possible scenarios.

According to many Western economists, what is now happening will result in hyper-inflation (over 30 per cent monthly) within six months, bringing Russia to the point of financial and economic collapse. This will then demonstrate to the Russian people that there is no third way between Communism and the market. President Yeltsin will then step in, having given Mr Chernomyrdin enough rope to hang himself, and call on the arch-monetarist Boris Fyodorov to form a government. Financial stabilisation will then be the top priority of the administration, with bankruptcies the order of the day.

Hyper-inflation will accelerate and the government will lose all authority. Chaos and conflict will dominate.

Hyper-inflation will accelerate and threaten chaos and civil war. Only a brutal military dictatorship will be able to restore and maintain order. If Mr Yeltsin goes along with this, he remains in office. If not, he is removed.

The West is praying for option one. It would then enter into a partnership with Mr Fyodorov, who is trusted abroad and a very able economist, and the billions the IMF has failed to disburse will flow eastwards. Options two and three are Armageddon scenarios. The Yugoslav conflict has taught everyone that once a civil war gets under way, it is extremely difficult to halt it. Better spend money beforehand to prevent it breaking out.

Martin McCauley is chairman of the department of social sciences, School of Slavonic and East European Studies, University of London. He is working on a 'Survey of Russian Banks'.

(Photographs omitted)