08.05.2006
Back into the Future, Or Cold War Lessons for Russia
№2 2006 April/June
Vitaly Shlykov

Member of the non-governmental Council on Foreign and Defense Policy; in the early 1990s, deputy chairman of the RF State Defense Committee.

 

Sixty years ago, on March 5, 1946, Winston Churchill, at that
time the former U.K. prime minister, gave his famous Fulton speech
that is generally seen as the formal declaration of the Cold War.
Churchill described the ideological division of Europe as an “Iron
Curtain,” urging consolidation in the face of the Communist
threat.

Unlike the 1941 Nazi attack, Churchill’s comments did not catch
Joseph Stalin unawares. Just one month before Churchill’s speech,
Stalin had told his country to prepare for a new war. In his no
less famous speech to the electorate on February 9, 1946, he said:
“We need to ensure that our industry produce up to 50 mln tons of
cast iron, up to 60 mln tons of steel, up to 500 mln tons of coal,
and up to 60 mln tons of oil. Only this can safeguard our
Motherland and prevent contingencies.”

Churchill of course realized that Stalin needed such amounts of
steel, oil and gas not for peaceful competition with capitalism.
From his previous war experience, he knew that arms production
hinged primarily on the availability of metal and fuel. The Soviet
leader probably knew this even better than Churchill.

Stalin could not have easily forgotten that even the superiority
the Soviet Union had over the enemy in tanks and aircraft at the
beginning of the war could not save the Red Army from devastating
defeats: almost all of the military hardware that the Soviet Union
had accumulated in the prewar years was destroyed within the first
several months of the war. Nonetheless, despite colossal losses
caused by the Nazi invasion, Soviet industry eventually produced
far more weapons than Germany. Even in the difficult conditions of
1942, the Soviet Union managed to produce six times more tanks than
Germany (24,700 compared with 4,100) and 10,000 more combat
aircraft, although Soviet industry produced 8.5 mln tons of steel
compared with Germany’s 35 mln tons.

The Soviet Union’s more productive industry in comparison with
German industry was due to a more effective mobilization system
that was adopted in the U.S.S.R. in the late 1920s. It was based on
the U.S. mobilization model that prioritized dual-use technology in
arms production and supplies. The Soviet Union built, with U.S.
assistance, huge state-of-the-art tractor and motor plants, while
the tractors and motor vehicles were so designed that their key
parts and components could be used in the production of battle
tanks and aircraft. The Soviet State Planning Agency (Gosplan)
rejected the Nazi approach, which provided for the creation of
specialized military production facilities, as extremely
labor-intensive and leading to immobilization of resources. The war
confirmed the advantages of the U.S.-Soviet mobilization model.
Both the United States and the Soviet Union were building 30,000
tanks a year whereas Nazi Germany, despite the priority of tanks in
its war strategy, was unable to put out more than 4,000 machines a
year (the production of one Tiger tank required about 200,000
man-hours).

In the prewar years, the Soviet leadership did not emphasize
boosting military production or increasing the military’s numerical
strength. Rather, it focused on the development of the basic
branches of industry (metallurgy, the fuel and energy complex,
etc.) as a basis for the mobilization of production in the event of
war. The archives of the State Planning Agency show that before
1939, investment in the basic sectors of the economy and general
machine-building was several times higher than investment in
military production, with the quality of civilian products being
every bit as good as those of the military use.

Despite the existence of military threats along the entire
perimeter, the Soviet Union maintained a relatively small army
until the outbreak of World War II with 500,000 to 800,000 men.
Stalin decisively rejected the demands of the military
establishment for the creation of a mass army (up to 250 divisions)
with tens of thousands of tanks and aircraft, and even called
Marshal Mikhail Tukhachevsky a “Red militarist” for making such
demands. Instead, he channeled the bulk of the available resources
to the development of machine-building and basic sectors of
industry.
 
MOBILIZATION SOVIET STYLE

Not surprisingly, after World War II the prewar mobilization
system that had proven so effective was completely restored. The
armed forces were downsized from 11 mln to 2.7 mln in 1947, while
the military industry was decisively converted to civilian
production. The share of military output in gross industrial
commodity output shrank to 3.3% from 6.9% in prewar 1940. Capital
investment in the military industry in 1946-50 was half of the
prewar (1938-41) level.

Investment in raw materials and basic sectors of the national
economy was a priority throughout the Soviet era. Furthermore, the
list of resources included in the mobilization plan was constantly
expanding. The appearance of nuclear weapons and missiles required
absolutely new materials, alloys, rare-earth metals and elements,
and so forth. Under the plan, in 1960 the country was to increase
the output of copper by 60%, aluminum 210%, lead 42%, zinc 77%,
nickel 64% and tungsten concentrates 57% on 1955. In 1957-60, twice
as many resources were provided to increase the fixed productive
capital of the non-ferrous industry as in 1951-55.

Contrary to the Western view, the Soviet top brass did not think
that the Soviet Union had military superiority over its possible
adversaries. It operated on the assumption that in the event of
war, the West would easily compensate for its lack of available
weapon systems with the greater mobilization capacity of its
industry. The purportedly huge mobilization resources in the United
States and other NATO countries, which were also on an increased
state of alert (as the Main Intelligence Directorate of the General
Staff regularly reported), were a decisive factor in the constantly
growing arms production levels in the U.S.S.R. According to the
Pentagon, from 1974 till 1982, the Soviet Union produced 5.9 times
as many ICBMs as the United States (2,035 compared with 346,
respectively); 2.7 times as many tanks (17,350 and 6,400); 7.6
times as many infantry fighting vehicles and armored personnel
carriers (36,650 and 4,800); twice as many tactical aircraft (6,100
and 3,050); 1.2 times as many large surface battleships (85 and
72); 2.3 times as many multirole submarines (61 and 27); 16.5 times
as many SSBNs (33 and 2); 1.6 times as many nuclear tactical
missiles (5,850 and 3,550); and 38.1 times as many field artillery
pieces and multiple rocket launchers (13,350 and 350) (Annual
Report to the Congress. Caspar W. Weinberger, Secretary of Defense.
Fiscal Year 1987. P. 24).

Could the United States have overstated Soviet arms output?
There are no grounds for this conclusion. Actually, the United
States seems to have underestimated the size of the Soviet military
arsenals. For example, the Americans believed that the Soviet Union
had produced 30,000 nuclear warheads and 500 to 600 tons of highly
enriched uranium. As a matter of fact, according to former Soviet
Atomic Energy Minister Vladimir Mikhailov, the Soviet Union had
produced 45,000 warheads and 1,200 tons of weapons grade uranium
(The New York Times, September 26, 1993). The U.S. estimate of
Soviet tanks at a little over 50,000 was also incorrect; in fact,
the Soviets possessed 64,000 (other sources put the number as high
as 68,000). 

Clearly, the Soviet Union strove not to fall behind the
Americans in anything, maintaining its own mobilization capability
on the same level.

Pressure by the General Staff to meet the requirements of
mobilization plans was especially pronounced in continuous-flow
production (aluminum, coke, etc.). A good case in point was in the
production of aluminum, of which the Soviet Union produced 4 mln
tons annually. Aluminum was not exported since it was considered to
be strategic material. According to the State Planning Agency, not
more than one-fourth of total rolled aluminum products were used in
military production. In the civilian sector, aluminum was used only
in the production of kitchen utensils and in the construction
industry. Some of it went into the mobilization reserves, but there
were simply not enough storage facilities for the aluminum that was
produced over the decades, thus a considerable part of aluminum was
presumably smelted down again. There is a story attributed to Boris
Yeltsin, who said in the 1990s he had witnessed a scene in
Sverdlovsk when a brand new tank left the factory where it had just
been made, crossed the street, and entered another factory where it
was immediately smelted.

To provide fuel for tens of thousands of tanks and aircraft in
wartime, many oil refineries were built, thereby producing more
fuel than could be consumed in a peacetime economy.

It was an absurd situation. The Soviet economy had long exceeded
the targets for steel, coal and oil production that Stalin had set
in 1946. Nevertheless, there was a shortage of those products in
the real economy that worked frantically to produce even more. At
the same time, collective farm fields were littered with millions
of tons of parts and components from broken tractors – in effect,
disposable, single-use machines – while tractor production was
steadily growing. Industrial equipment and machine tools were
becoming more and more metal-intensive. Mounds of fertilizers were
left sitting along railroad tracks in the open air, rendered
useless by the rain and the elements, because the fertilizer-making
plants were operated mainly as a resource base for the ammunition
industry.

Many economists came to the conclusion that extravagance and
waste were inherent features of a planned economy. They figured the
only way of ending the madness was through the liberalization of
prices and freedom of enterprise. They failed to see, however, that
during World War II Soviet industry had been quite effective and
probably more cost-effective than the German or even the U.S.
economy.

The causes for the incredible imbalances and wastefulness of the
Soviet economy in the 1980s become more comprehensible when it is
understood that mobilization for war in the Soviet Union was
elevated to cult status. That cult was a factor in the policy of
Mikhail Gorbachev and even the liberal reformers of the 1990s. On
April 18, 1991, when the Soviet economy had hit rock bottom and was
on the verge of collapse, Mikhail Gorbachev signed off on
presidential Decree No. 1812, On Urgent Measures to Improve the
Country’s Mobilization Readiness, pursuant to which, on June 30,
1991, the government issued a resolution, On Financial Support for
the Mobilization of the National Economy, thereby providing
compensation to industrial enterprises for the costs involved in
the maintenance of mobilization capacities. In early December 1991,
the State Committee for Defense of the Russian Federation (RSFSR),
where I was deputy chairman (the chairman was Gen. Pavel Grachev),
received a draft government resolution, signed by Yegor Gaidar, on
financing mobilization activities in the national economy, which
repeated word for word the old plans of the Soviet State Planning
Agency. The only difference was that the word “U.S.S.R” was
replaced with “RSFSR.”

At a Russian Defense Council session in November 1997, it turned
out that the main enforceable legal document on mobilization
readiness of the national economy was the 1986 mobilization plan
that, among other things, provided for military supplies to the
armed forces of the long defunct Warsaw Pact. The government only
addressed the mobilization problem when President Vladimir Putin,
at a Security Council session on November 27, 2001, observed that
“our economy is no longer centrally planned,” while mobilization
rules had been in effect since “days of yore,” and that the
mobilization structure of the defense-industry complex was
bloated.

WRONG DIAGNOSIS

There is a commonly held belief that the Russian leadership
inherited a ruined country from the U.S.S.R., with references made
to the empty store shelves and depletion of state gold and hard
currency reserves which, according to Yegor Gaidar, stood at a mere
$55 mln at the time he came into office. Of course, if only these
two indicators are used to assess the state of the economy, today’s
abundance of goods and the country’s impressive gold and hard
currency reserves favorably contrast with the 1991 situation.
However, once the material and technological resources (as opposed
to its financial resources) that Russia had at that time are
compared with what it has now, the situation will look very
different. As a matter of fact, Russia inherited from the Soviet
Union material of colossal value that with a certain level of
knowledge and effort could be quickly converted both into hard
currency and consumer goods. Not everyone realizes that this
legacy, as opposed to the energy of the “freed-up market,” produced
the state’s hard currency reserves, full store shelves,
multibillion personal fortunes, and even tens of billions of
dollars under the mattresses of ordinary Russians.

The main objective of the Soviet mobilization system was to
accumulate the maximum possible amount of material resources in the
event of world war. This accumulation was secured by several
methods.

One primary method was the construction of so-called state
reserves in the form of reserves and stocks of foodstuffs, drugs,
fuel, metals, timber, equipment, railroad tracks, etc. These stocks
were stored at thousands of special facilities dispersed throughout
the Soviet Union and strictly monitored and controlled by the
state; to that end, there was a special government agency with the
status of ministry (Goskomrezerv). These reserves were to be used
not only in wartime, but also in various emergencies (natural
disasters, severe winters, crop failures, etc.).

Another method of accumulating wartime reserves was the creation
of mobilization stocks (e.g., raw materials, equipment, components)
designed exclusively for the production of specific types of arms
in the event of wartime mobilization. They were stored, as a rule,
at the same enterprises where a particular weapon system was to be
deployed in case of war.

The main mobilization resources that Russia inherited from the
Soviet Union, however, did not come from Goskomrezerv or defense
enterprise stocks, but from production capacities that had been
created in the raw materials and basic sectors of industry for
wartime exigencies. Whereas the Goskomrezerv and defense-enterprise
resources were worth tens of billions of dollars together, the raw
materials and basic sectors of industries for mobilization were
worth hundreds of billions.
Still, the largest share of investment did not go into the defense
industry, but rather into the development of basic industrial
sectors, the raw materials sector and associated transport
services. Furthermore, their share in aggregate investment was
constantly growing. Whereas in the 1960s-early 1970s, the share of
investment in the fuel and energy complex was 10%, in 1980 it rose
to 12%; and between 1986 and 1990 it rose to 14% of the total. By
the mid-1980s, the transport sector accounted for 12.4% of total
investment, whereas in the 1960s-early 1970s it stood at only 10%.
New industrial facilities were created at higher rates than average
for the production of new materials. For example, the Soviet Union
was producing more titanium than the rest of the world taken
together.

Growth of investment in raw materials and basic sectors of
industry was of course secured at the expense of other sectors,
primarily the production of consumer goods. As a result, demand for
consumer goods, more or less balanced until the 1970s, was no
longer met by domestic production alone.

Attempts to compensate for the shortage of consumer goods with
imports only further unbalanced the economy since the Soviet
wartime economy model was originally developed as a closed and
self-sufficient system. It remained as such until the 1970s when
grain, followed by consumer goods, began to be imported on a large
scale, which in turn pushed up the export of oil and natural gas.
Meanwhile, the Soviet wartime economy model was absolutely not
designed for such exogenous impacts, which provoked shortages of
consumer goods, inflation in place of price stability (and even
regular price reductions in the postwar years), money supply growth
in place of strict monetarist policy, and the devaluation of the
ruble.

Unable to understand the situation at the beginning of the
perestroika era, politicians, the majority of economic experts, and
the media attributed all economic woes to excessive defense
spending. Academicians Yuri Ryzhov and Oleg Bogomolov, followed by
Mikhail Gorbachev in April 1990, stated that military spending was
at 20% of GDP, while Gen. Vladimir Lobov, chief of the General
Staff, stated in late 1991 that military spending was over
one-third of GDP. However, even those estimates could not explain
the depth of the economic crisis that hit the Soviet Union in the
late 1980s-early 1990s.

During World War II, the United States was annually spending up
to 45% of its GDP on the war effort, while industrial growth stood
at an annual rate of 16.9%. During the war years, its investment in
the economy increased 65%, industrial production doubled, while
power-generating capacity increased by 75%. None of that spending,
however, was achieved at the expense of the people’s living
standards. On the contrary, real wages during the war grew 50%
amidst almost full employment, while per capita food consumption
increased 15% to 25%.

The Soviet Union was also spending more than one-half of its GDP
on the armed forces. Despite the tremendous destruction and losses
it sustained in the war, it managed to not only achieve prewar
production levels soon after the war but also create nuclear
weapons and their delivery means within the shortest possible time
span. By contrast, Russia, 15 years after the breakup of the Soviet
Union, has yet to reach the prewar production level even though
military spending (including on arms procurement) has been reduced
many times over.

Meanwhile, it is still widely believed that the
military-industrial complex brought the U.S.S.R. to economic
collapse. Defense Minister Sergei Ivanov once said that in the
Soviet era, the military budget was as large as 25% to 30% of GDP,
and that “we all know what happened very well.” Other politicians
suggest that the share of the military-industrial complex was even
higher. For instance, Yevgeny Primakov in his book, Eight Months
Plus, writes that “the defense sectors of industry created up to
70% of GDP,” while Gavriil Popov, in a recent TV interview, put the
figure at 80%.

None of these estimates are backed up by statistics. Gosplan’s
official data, for example, show that in the late 1980s, the
defense industry employed 9.5 mln people (including 6.5 mln to 7
mln in the Russian Federation) of the total 130 mln workforce,
consuming 20% of sheet steel, 9.3% of rolled steel and 23.6% of
rolled aluminum products, while the complex’s fixed productive
capital was 6.4% of the Soviet aggregate.

A wrong diagnosis leads to a wrong course of treatment. Having
declared the military-industrial complex guilty of ruining the
economy, Mikhail Gorbachev decided to reduce arms procurements (by
10% to 20%) and launch a comprehensive program for converting the
defense industry to civilian production. However, he carried out
those initiatives in such a manner that made the economic situation
even worse. All production capacities that were freed as a result
were immediately transferred to mobilization reserves and thus
demobilized. As for the five-year conversion program that was
adopted in December 1990, it simply provided for the creation of
new capacities to produce civilian goods (40 bln rubles for
production and 36 bln rubles for R&D programs). That huge
investment was only supposed to double civilian production.

MISSED OPORTUNITIES

To put the Russian economy on a peacetime footing, Russia could
have simply resorted to America’s post-WWII experience involving
the demilitarization of its economy. That experience was all the
more valuable since the Americans dismantled their military
industry rapidly, as well as painlessly for their population,
without economic recession or soaring inflation. By 1948, U.S.
military spending fell to 3.2% of GDP from 43% in 1944, while 12.4
mln people were released from defense production. Employment in the
aircraft industry, for example, fell from 2.202 mln in November
1943 to 240,000 in 1947. The figure leveled off at 256,000 in 1950;
in the shipbuilding industry, the figure went from 1.778 mln to
138,000, respectively; and in the artillery and small arms
production, from 1.436 mln to 24,000. By June 1950 (the beginning
of the War in Korea), the number of people employed in the military
industry promptly returned to the 1940 level. Unemployment
increased from 1.2% in 1944 to 3.9% in 1946-48. That level was much
lower than in 1940 (14.6%) or 1941 (9.9%). Although GDP
naturally  shrank (by 1.9% in 1945, 19% in 1946 and 2.8% in
1947), already in 1948 it began to grow (by 3.9%). FRS interest
rates, which had stayed at 1% throughout the war and the first
postwar years, rose slightly to 1.34% in 1948. As for inflation,
the only surge (2.8%) was registered in 1948, but was brought back
to normal the following year.

In the early 1990s, both the U.S.S.R. and Russia seemed to have
even more favorable conditions for a transition to a peacetime
economy than the United States had in 1945. Even if Gorbachev’s
estimate (20% of GDP) is taken for granted, the militarization
level of the Soviet economy was only half of the U.S. level (45%).
The Soviet military industry employed 9 mln people compared with 13
mln to 14 mln in the United States; the Soviet military had a
numerical strength of 5 mln people, whereas the U.S. military was
13 mln. Furthermore, the Americans had to carry out a conversion
program single-handedly with no outside assistance – on the
contrary, they had to help others. Meanwhile, the Soviet Union was
offered substantial assistance from other countries – both in
expertise and in financial aid (e.g., many billions of dollars paid
by Germany for the withdrawal of Soviet troops).

Why, then, did Soviet GDP halve, and why has Russia still not
recovered to its former level 15 years later? Why did inflation in
the 1990s jump to over several thousand percent a year and why did
unemployment get out of control?

Because we did the exact opposite to what the Americans did in a
similar situation.

So what exactly did the Americans do? First, as mentioned
earlier, they drastically scaled down their military production,
while keeping this transition on extremely generous terms for the
arms suppliers. In particular, the U.S. government compensated up
to 90% of the losses that companies incurred due to the
cancellation of military contracts. The U.S. Congress established
an expedited, fast track procedure for financial settlements on
cancelled contracts, contrary to protests from the Comptroller
General who insisted on a preliminary audit to prevent abuses by
contractors. The Congress argued that the procedure proposed by the
Comptroller General would have frozen billions of dollars in
working capital, especially in small- and medium-sized
businesses.

Second, the U.S. government sold, at a fairly moderate price, or
leased to private companies the majority of the 1,600 plants that
it had built during the war. Many plants, which became unnecessary
in peacetime, e.g., 51 synthetic rubber-making plants, were simply
closed.

Third, in expanding the civilian production, the government gave
priority to stimulating public demand. It not only preserved the
huge deferred demand, which by the end of the war stood at about
$160 billion (equal to annual GDP), by keeping inflation in check,
but also implemented measures to increase it. In particular,
demobilized servicemen were paid a total $20 billion from the
federal budget in the first three postwar years. Another $1.5
billion came from state treasuries. That was very big money, even
by contemporary standards. To put these expenditures into context,
the entire U.S. military budget in 1947 was $11.7 billion.

This radical scaling down of U.S. military production deprived
the majority of arms producers from lucrative defense contracts.
This change of events forced them to switch to civilian production,
which, combined with popular demand for such products, enabled the
United States to move from wartime to a peacetime economy without
recession, serious inflation or unemployment, and provided an
impetus to business activity. In the 1944-48 period alone, consumer
spending on durable goods tripled while the volume of housing
construction exceeded by tenfold the prewar level.

The Yeltsin-Gaidar government did exactly the opposite. First,
in the absence of any military threat, it preserved an
unjustifiably high level of military production. In particular, the
1992 defense production order was huge. It included 110 combat
aircraft (without strategic bombers), 30 ICBMs, 28 submarine-
launched strategic missiles, and 8 strategic bombers. To understand
the burden that this production placed on the Russian economy, it
is enough to compare the 1992 defense contract with the current
one. In 2006, the Defense Ministry ordered just 6 Topol ICBMs, no
submarine-launched strategic missiles, and 8 combat aircraft,
including one strategic bomber.

During one Cabinet session (chaired by the RF Secretary of
State, Gennady Burbulis) where the 1992 arms production order was
the subject of debate, the military, led by the chief of the
General Staff, objected to the inclusion of ICBMs and strategic
bombers into the defense order, asking instead for more funding for
the procurement of spare parts and housing construction programs.
However, Deputy Minister of Economy Ivan Materov, the keynote
speaker, defended the production of the unnecessary missiles and
bombers by arguing that it was necessary to provide employment in
the defense sector.

It was with the same rationale that on March 17, 1992, Yegor
Gaidar signed off on a state order for the production of $5.4
billion worth of arms and military equipment for export, which was
almost four times as large as Soviet arms exports in 1991 ($1.55
billion). It turned out later that the Russian defense industry
managed to sell abroad only $1.1 billion worth of arms produced
under 1992 contracts, leaving unsold about 400 tanks, 200
self-propelled artillery systems, 16,000 missiles of different
types, and many other weapons.

Second, unlike the Americans, neither the Gaidar government, nor
the Chernomyrdin government that replaced it, took any steps to
close or restructure defense enterprises that were in effect
redundant or operating below capacity, or to transfer them to the
reserves. Russia inherited from the Soviet Union 1,700 defense
industry enterprises; today, Russia’s defense industry complex
still has 1,700 enterprises even though many of them have long
ceased producing military goods. While the Americans, within just a
few years, reduced the number of people employed in the aircraft
industry almost 10 times (to 240,000 in 1948), in 2000, the Russian
aerospace industry had 1.2 mln employees who produced $2 billion
worth of goods, whereas the aerospace industry of entire Europe
produced $72 billion worth of goods with 800,000 employees.

Third, and most importantly, the Gaidar government effectively
wiped out the same resource on which the United States had relied
in switching to a peacetime economy: specifically, the demand for
consumer goods and production facilities. The colossal financial
resources on private accounts at the Russian State Savings Bank
(Sberbank) were simply frozen. As of January 1, 1992, about 100 mln
Russian citizens (i.e., almost the entire adult population) had 400
billion rubles on 140 mln bank accounts. In 2003, Russia’s
recognized internal state debt resulting from the state’s failure
to return bank deposits, which were frozen on June 20, 1991, stood
at 10.9 trillion rubles ($343 billion).

Yet the lifting of restrictions on the import of goods
irrevocably blocked the path to the demilitarization of the Russian
economy. Russian defense industry enterprises, unable to compete in
the production of consumer goods with cheap imports, had no option
but to hold on to what they knew how to do best – weapons
production. This, despite the fact that the production of weapons
was no longer as profitable as it had been previously.

The backwardness of the civilian sector was directly
proportional to the resources that were denied it in favor of
military production, thus the economy could only barter goods
through a direct distribution of resources at artificially set
prices. If such an economy is abruptly placed on a free market
basis with the lifting of price controls, the entire system of
technological and financial relations will simply collapse. This
was exactly what happened to Russia in the early 1990s.

This skewed economic setup, when the economy does not respond to
a fall in arms procurement and prevents the re-funneling of
resources from the military to the civilian sector, can be
described as structural militarization,
in contrast to militarization that can be measured through the
share of military spending and military production in the national
budget, GDP, etc. In a structurally militarized economy, arms
procurements can come to a halt (which is what happened in Russia
by the mid-1990s), but this will not automatically make the
civilian sector more effective. Furthermore, it is possible for the
economic situation in such a country to worsen.
Paradoxically, in a structurally militarized economy, resources are
mainly wasted not in the defense sector but in the civilian one.
Because the economy is in extremely poor shape, even the
maintenance of the civilian sector requires a colossal amount of
resources: raw materials, energy, machinery and equipment. To
support its pathetic agricultural complex, the U.S.S.R. had to
produce six or seven times as many tractors and several times as
much fertilizer as the United States.

Sooner or later such an economy must collapse, as happened to
the Soviet Union in the late 1980s-early 1990s. The Soviet economy
collapsed not due to the overproduction of arms but rather an
overproduction in the civilian (above all, raw materials and basic)
sectors of industry – similar to how the U.S. economy collapsed
during the Great Depression of 1929-33.

This was ignored by our neo-reformers who attacked the
military-industrial complex as the root cause of all Soviet
economic troubles.

The Soviet economy was a pyramid whose base was comprised of,
according to Academician Yuri Yaryomenko’s definition, “low-quality
resources.” In other words, it was an economy built around raw
materials, basic industrial products (steel, coal, aluminum, etc.)
and an unqualified workforce. At the apex of this pyramid were
advanced technologies and specialists, designers, engineers and
highly qualified workers, i.e., high-quality resources. Thus, the
military-industrial complex was an effective mechanism of
transforming low-quality resources into high-quality resources, but
for military purposes only.

Almost overnight, the pyramid was turned upside down, which
drastically changed the Russian economic environment. Here is an
emotional but accurate description of what happened at that time by
Lev Makarevich, an observer for Finansovye Izvestia and expert with
the Association of Russian Banks:
“Raw materials producers replaced the military-industrial complex
as the unchallenged masters of the country. The Kremlin and the
White House were used as a battering ram to push the
military-industrial complex to the political and economic
sidelines, as graphically demonstrated by its deplorable financial
status and the show trials of its top executives. Today, raw
materials tycoons shape policy and control key appointments in the
presidential staff, the government, major factions in the State
Duma, the Federation Council, many government agencies and
departments, and the regions.”

The opening of state borders for the export of raw materials and
basic goods helped quickly deal with the overproduction problem.
Bequeathed by Stalin and intensified by succeeding Soviet rulers,
mobilization resources were simply dumped on the world markets and
sold off on the cheap. The price of resolving the overproduction
crisis in such a manner proved inordinate.

However, it was not just a matter that industrial production
halved and living standards plummeted. The Americans also paid for
their 1929 crisis with the loss of one-half of industrial
capacities and massive unemployment. But they cut production more
or less evenly. In Russia, however, the Soviet military-industrial
complex was jettisoned, while the raw materials and basic sectors
of industry were given a major boost for further development. As a
result, what is now proudly called the “Russian defense-industrial
complex” is simply a couple thousand enterprises from the Soviet
era that have outlived their usefulness. The present success of
arms export can only delay but not stop the disintegration of the
defense-industrial complex.

Having senselessly destroyed the military-industrial complex, we
have lost not simply the opportunities to develop and create new
weapons, but also our place in the post-industrial world. After
all, the Soviet military-industrial complex had concentrated the
basic components of a modern economy: continuous education to high
standards of excellence, a well developed applied and fundamental
science, powerful transport and energy systems, and major head
start and work-in-progress efforts in defense technology.

Why then did Russia’s neo-reformers not use the potential of the
military-industrial complex after the Cold War?

Usually, in explaining their reforms of the early 1990s, the
reformers say proudly that they adopted methods and approaches that
had proven themselves in other countries, that there were no other
ideas, and that only they were ready to assume the responsibility
for leading the economy out of a crisis. This is not so, to put it
mildly. There were alternative proposals, and they were put forward
quite openly. Academician Yuri Yaryomenko, an economic adviser to
Mikhail Gorbachev from May 1991, proposed one well-known and
detailed program. He believed that to break the deadlock, it was
necessary to “transform military power into economic power” by
funneling high-quality resources generated by the
military-industrial complex to civilian sectors of industry, with
the conversion of the defense industry being the main instrument of
such transformation. “Conversion,” Yaryomenko wrote, “is not about
using defense industry enterprises to produce non-military
products, but using the resources concentrated in the defense
sector for restructuring the entire economy.” Yaryomenko stressed
that “most of the special equipment and special technology in the
defense sectors of industry should be scrapped [that was exactly
what the Americans did after the war], since they could not be used
for anything but arms production.”  At the same time, he said
it was vital to separate military production from civilian
production. “Transition to civilian production,” he wrote in August
1990, “should proceed comprehensively, not piecemeal. I am sure
that if the State could move along these lines, we would soon have
major, competitive industrial centers preserving and advancing high
technology and driving effective consumer demand.” Yaryomenko
predicated successful conversion on the abandonment of the
mobilization doctrine and the adoption of a policy of economic
self-sufficiency in order to protect enterprises implementing
conversion programs from external competition.

The present author, who in 1991 was deputy chairman of the RSFSR
State Committee for Defense and Security in charge of conversion
programs, in an interview with the Demokraticheskaya Rossia daily
(June 21, 1991), proposed using mobilization reserves for
conversion purposes, arguing that the Soviet Union had “ideal
conditions for rapid and radical conversion.” Robert R. Nathan, who
had overseen the mobilization of the U.S. economy during the war
and later its re-conversion, noted the interview. During a visit by
a Russian military delegation to Washington in early October 1991,
Nathan said that conversion of the Soviet military industrial
complex would be completed within one and a half to two years, and
if invited, he was ready to act as a consultant for the Russian
government on conversion matters. He also said that after the war
in Korea, he and his consulting agency, Nathan Associates, had for
10 years been helping the economic reconstruction effort in Korea
on behalf of the UN. In comparison with that task, he observed with
a smile, conversion of the Soviet defense industry was a piece of
cake.

At that time, Deputy Secretary of Defense Donald J. Atwood also
volunteered to go to Moscow with a group of experts to share U.S.
re-conversion experience. The Russian government, however, ignored
the opinion of Atwood when he visited Moscow in late October 1991
with a large team of experts. In an interview with Kommersant daily
just before departing from Russia, he said that during his visit he
had not seen any signs of conversion and that no one either in the
Soviet Union or in Russia understood the meaning of conversion.

Russian neo-reformers also ignored the experience of other
countries in their attempts to make the transition from a
militarized economy to a civilian economy. Between July 16 and 26,
1991, a large delegation of Japanese businessmen (including several
experts from the United States) visited the Soviet Union to study
the conversion of the Soviet military industrial complex and offer
consultation in implementing a conversion program based on the
Japanese experience after World War II. The delegation acted on
instructions from the London Summit of the G7 in July 1990 when the
group of leading industrialized countries decided to provide
assistance to the Soviet Union in carrying out conversion programs.
The delegation visited a number of defense industry enterprises,
meeting with many representatives of the Soviet and the Russian
government. In October 1991, a report on the results of the trip
was sent to the Russian government. It was an extensive and
extremely interesting document. It was drawn up into three parts:
an appraisal of the status of Russia’s conversion program, a
detailed description of Japan’s transition from an over-militarized
to a market economy after World War II, and recommendations on
implementing the conversion of the Russian defense industry and
building a market economy. Neither the then Russian government, nor
any subsequent Russian governments, followed those
recommendations.

TO BEGIN ANEW

On November 3, 1991, I published an article, On Conversion with
Optimism, in Demokraticheskaya Rossia daily, reiterating that the
defense industry could be rapidly converted and the economic
situation turned around. To that end, it was necessary to do
several things:

First, impose a two- to three-year moratorium on arms production
during the conversion period. Of course there were certain types of
military production facilities that could not be brought to a halt,
but they constituted a very small proportion of the total. There
were certain arms production sectors that could be simply closed.
Such a move would release a colossal amount of equipment,
resources, fuel, energy, and so on.

Second, revise the entire system of mobilization readiness,
scrapping the mobilization plan. If enterprises wanted to retain
reserve capacities, they should spend their own resources for it.
The same thing applied to the Defense Ministry. This constituted an
indispensable element of radical conversion.

Third, transfer all enterprises from the control and tutelage of
ministries, making them economically self-sufficient. Otherwise the
process could assume ugly forms, and that kind of conversion
“according-to-the-ministry” would be more trouble than it was
worth.

Fourth, terminate all defense contracts, paying appropriate
compensation to the enterprises and providing them with start-up
capital. It was necessary to create a central administration to
manage property and equipment released as a result of
conversion.

Fifth, declassify defense industry technologies so that they
could be used in the civilian sector. This is a colossal reserve
that could help quickly advance the country’s industry.

The most important thing was to rectify economic misconceptions.
Those who thought that a market economy would automatically lead to
the production of the necessary consumer goods failed to face up to
reality: enterprises in the civilian sectors of industry could not
satiate the market. Russia’s civilian industry was obsolete, weak
and unviable. With normal pricing mechanisms those enterprises
would not be able to recoup their costs (raw materials, energy,
etc.), while the defense sectors of industry with their technology,
equipment, and qualified labor were well in a position to meet
demand.

Of course, directors of the military-industrial enterprises were
concerned above all with their own survival, not the development of
the civilian sectors of industry. Therefore, to convince them about
the need for full conversion, it was essential to demonstrate
beyond any doubt that there would be no return to the old ways. In
other words, what was needed was “shock therapy” for the
military-industrial complex, not for the population, as proposed by
Gaidar. U.S. experience was also helpful in this regard.

Demilitarization of the economy is still a highly relevant
issue, especially concerning the recommendation to separate
military and civilian production. Meanwhile, military and civilian
goods are still produced at the same enterprises. As a result, we
still do not know how much is being spent on defense, while taking
solace in the fact that the share of the military budget does not
exceed 2.7% of GDP. At the same time, real military spending is
determined not by its share of GDP, or the state budget, but by the
economic development opportunities that have been missed as a
result of militarization.

If we look at the past 15 years from this perspective, we will
see that our economy has become even more structurally militarized.
Meanwhile, the raw materials sector was created strictly for war;
there was no consideration for the competitiveness of these
resources on world markets. And it is quite possible that with
every ton of oil, steel and aluminum exported, the country only
became poorer. As a matter of fact, we are now seeing a recurrence
of the situation of the late 1980s-early 1990s, when the
overproduction of raw materials brought the Soviet economy to
collapse. Today, this overproduction has assumed a monetary form,
while its real scale is blurred by the phenomenon of capital
flight. The Stabilization Fund and gold and currency reserves are
steadily growing, but they are not being used to any good effect
either at home or abroad, destroying the non-raw material sectors
of the economy and the social fabric of society. Capital flight and
foreign debt servicing are the only safeguards against an
overproduction crisis (as in 1990-91) and hyperinflation.

However, there is still hope. It must be understood that capital
taken out of the country, together with the stabilization fund, oil
wells and aluminum plants, are the mobilization reserves that we
inherited from the Cold War era, not something that we created, and
that these reserves should be put to effective use.

Russia missed its opportunity to use the end of the Cold War era
for creating a Russian economic miracle like the American
re-conversion of 1945-48. As for the aforementioned recommendations
by the Japanese delegation of industrialists to build a high-tech
economy in place of an over-militarized economy, they are quite
relevant and applicable even now, especially given that the former
head of the Japanese delegation has an office in Moscow. The
experience of South Korea, the FRG and other countries in the
postwar development of a market economy is also very
instructive.

It is now time to recognize that the reform of the early 1990s
was wrong. Such a complex and unique system as the Soviet
militarized economy cannot be restructured by pseudo-market
methods. First of all, it should be demilitarized on the
administrative level, mobilizing the entire power of the state, and
only then can a market economy begin to be built.

The sooner this stage is passed, the sooner Russia will be able
to build a free and bona fide market economy. Furthermore, it is
quite possible that due to endemic corruption and the omnipotence
of bureaucracy, Russia will need the most radical methods of
economic liberalism that was undeservedly compromised in the
1990s.