The Next Asian Tiger? Promoting Prosperity in the Russian Far East

(Archived document, may contain errors) 997 August 18,1994 THENEXCASIANTIGER PROMOTING PROSPERITY IN THE

RUSSIAN FAR EAST INTRODUCTION As the nuclear belligerence of North

Korea threatens to engulf the Korean peninsula in military

conflict, the Russian Far East, long the preserve of Stalin's co

ncentration camps, brown bears, and Siberian tigers, may be on the

verge of sharing in the growing prosperity of Asia and the Pacific

Rim. The Russian Far East comprises lands stretching from Lake Baikal

in Siberia to the shores of the Sea of Japan and the Sea of Okhotsk

at the edge of the Pacific Ocean. Ma- jor cities include Chita in

Eastern Siberia, the industrial center of Khabarovsk, and the port

city of Vladivostok on the Sea of Japan. Some of its administrative

territories are larger than European s t ates and populated almost

exclusively by Russians and Ukraini Since the collapse of the

Soviet Union in 1991, the Russian Far East has improved its 1 anS

economic ties with Japan, South Korea, and China. Since 1990 the

percentage of ex ports attributed to Russian Far Eastern joint

ventures with foreign firms in such indus tries as lumber, oil and

gas, and seafood harvesting has grown from 2 percent to over 30

percent. Moreover, while producing only 5 percent of Russia's Gross

National Product the Far East a ccounts for 20 percent of its joint

venture partnerships between Russian private companies and foreign

investors vestors from Asia and elsewhere around the world, drawing

hundreds of thousands, if 2 Such growth in foreign trade could

transform Russia's ba ckyard into a magnet for in 1 2 Vladimir

Ivanov Federation on the Pacific: Does the Crisis Lead to Collapse

Eurasian Repom, Winter 1993. p. 68. George Rose and Igor Korbatov Doing Business in the Russian Far

East ern Europem Reponer, Vol. 4, January 31,199 4, p. 106. not

millions, of unemployed Russians from the rust belts in the Ural

Mountains and Si beria to a region that may develop closer economic

ties with Vancouver Tokyo, and Se attle than with Moscow and St.

Petersburg An economic take-off in the Rus s ian Far East would

help to integrate Russia and the Newly Independent States (NIS)

into the economy of the Pacific Rim, where annual economic growth

below 8 percent is considered sluggish. Strong trade with the

United States, Canada, Japan, South Korea, a nd China would provide

export outlets for Rus sian products and offer access by foreign

investors to the untapped natural resources of Siberia. However this potential cannot be unleashed so long as the region

is handicapped by the contradictory and ineffec tive economic

policies of the central government in Mos cow. The best way to

unleash the forces of entrepreneurship in the Russian Far East is

to grant the region more autonomy. If Moscow were to do so, the

region could become a catalyst for economic grow th throughout

Russia. To realize the economic potential of the Russian Far East,

Russia should consider d Declaring the Russian Far East a free

economic zone, opening coastal ter d Abolishing tariffs, import and

export taxes, and customs duties for trade i n the area. This would

attract foreign investment from all over the world while

facilitating Russias bid to join the General Agreement on Tariffs

and Trade (CAW and the Asia-Pacific Economic Cooperation forum, a

17-mem ber multilateral trade organization f ormed in 1989 ritories

to the free flow of foreign investment and trade. d lifting

cumbersome restrictions on the movement of hard currency in and out

of the area. Russian banks and enterprises are bound by the un

wieldy regulations of the Central Bank in Moscow. Foreign banks

operating in Russia likewise are severely restricted in their

ability to serve Russian clients. These arbitrary regulations hamper the foreign economic

relations of Russian businesses and stem the development of the

region and of the country as a whole d Eliminating regulations on

the export of socalled strategic commodities such as sugar, timber,

fertilizers, and plastics. The Russian government has declared that

over three hundred commodities are strategic goods requir ing

export l i censing by Moscow bureaucrats This licensing process not

only encourages official corruption, but also stifles economic

growth d Cancelling regulations requiring Russian companies to sell

50 percent of their hard currency earnings to the state This measur

e would reduce the cost of doing business in the area and eliminate

the unfair competitive edge now enjoyed by the foreign-owned

enterprises and joint ventures that are exempt from these

regulations d Providing a ten-year tax holiday for foreign and

domest i c investment abolishing the most burdensome taxes, and

introducing a 10 percent consumption tax instead. This would

simplify what is today one of the most 2 THE I punitive, arbitrary,

and complicated tax systems in the world. Lower taxes would

stimulate e m ployment, investment, and economic growth d

Establishing economic missions in Japan, Korea, China, Taiwan, the

U.S and Canada to promote investment in the Russian Far East d

Setting up a privately administered bank for regional development.

Capi tal could be provided by multilateral lending agencies such as

the World Bank and private international investors d Protecting the

environment by developing tourism and running an effi cient

national park system. The potential for tourism in the Russian Far

East is enormous. Tourism could generate billions of dollars in

revenue that could be used to clean up the polluted Pacific

landscape and save the Siberian tiger and other endangered species

d Privatizing major infrastructure projects and opening them to

Western a nd Far Eastern investors d Devising laws and regulations

that allow for the negotiation and en forcement of contractual

obligations between parties, regardless of their nationality d

Boosting law enforcement against organized crime and corruption.

This co u ld be done by creating a professional, highly paid

special police force, per haps with the help of the U.S. and other

Western countries. In addition, deregu lation of the economy would

decriminalize many of the activities, such as im port and export

licen s ing, that breed corruption d Resolving the Northern

Territories problem with Japan. This would re move a major

disincentive for increased Japanese investment IMPERIAL PAST The

Russian Czars brought the Far East under their control during the

17th to 19th c enturies. For most of Russias history, Moscow was

interested in the region because of its abundance of such natural

resources as furs, fish, and gold. In the 17th century fur pelts

accounted for more than half of the Russian empires hard currency

revenue, and the desire to gain access to the furs in the Siberian

forests was a strong incentive for eastward expansion. In addition,

gaining access to the Pacific Ocean through such naval bases as

Vladivostok and Port Arthur was seen as a vital strategic goal. A fter the czarist empire collapsed in 1917, the city of

Vladivostok and the surround ing Maritime Province declared itself

an independent republic. The Russian Far East then became one of

the most important battlegrounds of the Russian Civil War. In 1919

a small expeditionary force of U.S. and Japanese troops landed at

Vladivostok to assist the White Army against the Bolsheviks. By

1922, however, the Russian Far East was completely under communist

rule 3 During and after World War 11, the Soviet government d

eveloped a vast military-in dustrial complex in the region, and

Vladivostok became a huge base for the Soviet Navys Pacific Fleet.

The town of Komsomolsk-na-Amure on the Amur river became a nuclear

submarine construction center while military aircaft were built in

the city of Khabarovsk, the old Russian government center in the

region 4 Terrible environmental damage was done when decommissioned

nuclear reactor cores were dumped into the Sea of Okhotsk in the

1980s, polluting the water and Kam chatka Penins u la's pristine

beaches. The fish became contaminated but were sold to an

unsuspecting Soviet population. Throughout the Soviet period,

Moscow extracted enor mous valuable resources from the region while

the government remained its major em ployer and suppl ier of

investment capital. It is no surprise that after centuries of such abuse, Far

Easterners jumped at the first opportunity presented by Mikhail

Gorbachev's perestroika to gain more freedom. The Russian

Federation Supreme Soviet established in 1989 the Nakhodka Free

Economic Zone near Vladivostok. Located only a couple of hours

drive from Vladivostok Nak hodka is a huge port capable of

servicing 33 cargo ships simultaneously. Last year alone, it

handled nine million tons of logs, ores, fertilizer, and o ther raw

materials This zone was seen by many Far Easterners as a means to

gain some measure of free dom from Moscow But the zone experienced

many of the same problems seen through out Russia today, including

the absence of a workable commercial code and a lack of re spect

for the rule of law and property rights. The Russian Supreme Soviet

delayed pass ing a Free Economic Zone law, thus stalling

legislation that would have encouraged eco nomic development in the

Far East and other areas of the Russian Fede r ation As the

Nakhodka experiment has shown, the existing approach, with the

parliament and bureaucracy in Moscow deciding every case, is not

working. During 1990 and 1991, the Russian Supreme Soviet

authorized the establishment of thirteen Free Eco nomic Zones. They

were not very successful. Local governments were denied the power

to grant tax exemptions or legislate pro-business customs and

foreign exchange re gimes. The failure of the free economic zones can be attributed mainly

to the contradictory and ineffective economic policies of the

central government In May 1994, the Russian government announced

export tariff exemptions for foreign enterprises and joint ven

tures! Unfortunately, the May 1994 decision covered only businesses

registered before Janu ary 1,1992, and after January 1,19 94. Ventures created in 1992-1993 period were not covered by the

legislation. President Yeltsin issued another decree in May 1994 reducing the

corporate income tax to 30 percent, simplifying the tax structure,

and abolis hing some of the numerous ar bitrary and punitive taxes.

Unfortunately this was accompanied by a decision to raise taxes on

individual incomes of over 1,0oO a month to 50 percent and to

increase prop erty taxes. With social security and other payments,

Ru ssian workers are paying over 80 percent of their income in

taxes. The Russian Duma, like its predecessor, the Supreme Soviet, is

stalling important amendments to laws on foreign investment and

natural resources. This precludes greater Western participatio n in

the development of Siberian oil, gas, coal, and diamond depos 3 3 4

Vladimir Ranenko he FEZs' Economic Prospects International Affairs,

Nos. 11-12, 1993, p. 32. According to the decision, only joint VenNreS With at least

thirty percent of Western par ticipation, or at least ten million

dollars of investment, are exempt from the tariff and tax 5 its

that would benefit Russian Far Easterners. In the absence of a

special Free Trade Zone law and a strong legal infrastructure,

foreign investment in the Nak hodka Free Economic Zone has been

poor, totalling only $1 18 million. Industrial production by joint

ventures in 1993 was only $54 million. The Moscow bureaucracy continues to resist the decentralization

that is needed if the Far East regi on is to reach its full

potential. Through stifling regulation of economic ac tivity,

bureaucrats are choking economic growth and breeding corruption,

inefficiency and misery. Far Eastern businessmen and their Western

counterparts often spend more time de a ling with government ofices

in Moscow than tending to their businesses back home. Even simple

business transactions, such as opening a factory or obtaining a min

ing license, involve a frustrating permit approval process through

ministries in Moscow often accompanied by bribes at every level of

the bureaucracy 5 Rich in Resources, Poor in Infrastructure The

Russian Far East is a cornucopia of natural resources and, under

the right circum stances, could become a magnet for foreign

investment. Oil extraction off the shores of Sakhalin Island would

spur economic growth throughout the entire region. Japans Min istry

for International Trade and Industry (MITI) is drawing up plans to

turn the port of Niigata on the Western coast of Japan into a major

import facil i ty for Russian gas; the Western Japanese Aomori

prefecture also is interested in Russian gas; and there are plans

to build a huge 5,OOO-kilometer pipeline to import Sakhalin gas to

South Korea and Japan including Mitsubishi, Mitsui, Nissan, Honda,

Gold St a r, Daewoo, and Hyundai among others-already have

established a presence in the area. Numerous Chinese companies

trading in consumer goods and foodstuffs are grossing over $900

million a year. Indeed, a separate FEZ recently was created on both

sides of th e Russian-Chinese border adjacent to the cities of

Blagoveshchensk and Heihe? The Russian Far East is important also because it links the

Pacific Rim with the Eur asian continent. The Russian Far East is

adjacent not only to China, Korea, and Japan but als o to Eastern

Siberia, which is rich in such minerals as diamonds, gold, platinum

oil, and gas. Ports at Vladivostok, Nakhodka, and Vostochny serve

as tenninals for the tramSiberian railway and as eastern gateways

to Russia, the Commonwealth of Inde penden t States, and

Europe. Because of its prime location, and despite the often hostile

business and investment climate, the region has begun to attract

some Western investors. For example, the US. Overseas Private Investment Corporation (OPIC) and the Europea n

Bank for Recon struction and Development (EBRD) in May 1994

announced a gold mining project in the Russian Far East. The

project is being conducted by a joint venture called Omolon which

includes U.S. Cyprus Amax Minerals and five regional Russian compa

nies 6 Owing to the appearance of the Sakhalin and Nakhodka FEZs,

Asian industrial giants 5 Personal interviews, January-May 1994 6 7

Intercons Daily, March 21,1994, p. 2, and Ivanov, Federation on the

Pacific. p. 76. Russia to Build Cross-border FreeTrade Zone. Zinhua Geneml

Overseas News Service, January 4,1994 6 Omolon will develop the

Kubaka gold and silver deposits near the city of Ma gadan. OPIC

will provide 150 million for insurance and 55 million in invest

ment guarantees,8 and the EBRD will pro vi d e 55 million in

fmancing. A feasibil ity study by Vancouver-based Kilborn En

gineering Pacific Corporation concluded that the Kubaka deposit has

2.2 million ounces of proven recoverable gold re serves and 1.7

million ounces of silver re serves. The seven- year project calls

for the deposits to yield 326,000 ounces of gold and 255,000 ounces

of silver annu ally? Increasing the number of such projects however, is hindered by a

lack of infra structure. The region lacks transportation and

communication links, d ata process ing services, hotels and

adequate hous ing for foreign businessmen and their families. For

example, the price of real estate in the two major cities

Khabarovsk and Vladivostok, is skyrock eting because of a lack of

.dequate hous ing and office space. In 1992, a standard Russian

one-bedroom apartment sold in Vladivostok for 15,000; it is now

twice as expensive, and land in or near the port facil ity has

tripled or quadrupled in price. The railroads and highways of the Russian Far East are in dis

repair. The Soviet-era Baikal-Amur railroad, which runs north of

the czarist-built trans-Siberian, is often closed for repairs. For

long stretches it consists of a single track. There are no links be

tween the Baikal-Amur railroad and the old trans-Siberi a n railway

and no links with railways in European Russia, Korea, or China.

Roads throughout the region are poor and traffic from the Far East

into Siberia and European Russia is hampered by the ab sence of

bridges over the Amur and Lena rivers Similar prob l ems afflict

the regions telecommunications system. Western business men

accustomed to faxing information from their computer screens and

conducting 8 Inrercons Daily, June 9,1994, p 2. As a part of its

plans to boost insurance and investment guarantees to American

corporations doing business in the former Soviet Union area, OPIC

announced in May 1994 that it will increase its commitment from $1

billion to $2.5 billion 9 Infercons Daily, June 9. 1994, p. 2 10

Rose and Korbatov, Doing Business in the Russian Far East, p. 106 7

business via cellular telephones in their cars soon learn that

telephone service in the Russian Far East is worse even than in the

Western parts of Russia around Moscow. Some of these problems are being corrected slowly. In

Khabatovsk, the Marriott Cor poration is building a five-star

hotel; Japanese companies are developing commercial real estate;

and the French Thomson electronics conglomerate is overhauling the

air traf fic control system at the local airport. Contracts have

been awa r ded to foreign compa nies for expansion of the airport

at Vladivostok, and planning for a much larger interna tional

airport has begun Feasibility studies also are being conducted for

the conversion of some military air fields to commercial use. For

examp l e, a military airfield in Yelizovo, Kamchatka which is

halfway by air between Hong Kong and the West coast of North

America, is being used as a refueling stop by a California-based

company. It finds the Kamchatka airport to be cheaper and more

convenient than the nearby Narita airport in Japan. Here American

ingenuity and Russian defense conversion have combined to create a

lucra tive business venture. Some modest progress also is being made in satellite

communications, digital ex change networks, and micr owave

transmission facilities. Joint ventures with American and Japanese

telecommunications firms such as AT&T, MCI, and U.S. West are

provid- ing satellite telephone connections from hotels,

long-distance calling, and E-mail sew ice 12 NATURAL SPLENDOR A N D

THE POTENTIAL FOR TOURISM Throughout the Russian Far East are large

and virgin forests, majestic rivers, crystal clear lakes, and

unspoiled mountain ridges. The Kamchatka peninsula, which protrudes

into the Sea of Okhotsk, is as pristine as the American West of the

1860s. With fewer than half-a-million people, and with its geysers,

bears, and rivers that run red with salmon, this is an area that

could beckon to Japanese, Chinese, and American tourists. Despite this potential, the absence of effective lan d

management and game preserve techniques are threatening the

ecological balance of the region. For example, poachers have nearly

killed off the Siberian tiger, which is valued for its fur and

bones, and used for traditional Chinese medicines. Even the ma l e

tigers reproductive glands are prized by wealthy Chinese for use in

aphrodisiac soups. Once the kings of the Siberian jungle only some

150 of these magnificent cats are left in the forests around

Khabarovsk, the administrative center located in the hear t of the

region. However, there are signs of hope. In the Kronotsky and South

Kamchatka nature re serves on the Kamchatka peninsula, specialized

Russian and joint venture companies bring in wealthy Japanese and

American clients for safari expeditions and t ourism. In some

areas, the only transportation for adventurous travellers is by

helicopters which are provided by Russian and Russo-Japanese joint

venture companies. Westerners are 11 Yelizovo is located near

Pmpavlovsk-Kamchatsky, capital of the Kamchatk a peninsula 12 Rose

and Korbatov, Doing Business in the Russian Far East, p. 108 8

flocking to the largest geyser natural park in the world, and

salmon fishermen pay hand somely to spend a week or two on the

banks of some of the clearest streams on Earth R ussian experts

estimate that the region could generate $1 billion in tourist

revenue by the year 2005 THE DISPUTE OVER THE KURILE ISLANDS An

economic boom in the Russian Far East would require the

participation of Japan. Technically; however;Russia and Jap an have never ended the

Second World War. The sources of this conflict are well-known.

Promising to invade Japan after the victory in Europe, Stalin in

July 1945 broke his 1941 nonaggression pact withTokyo and occu pied

the southern half of Sakhalin and t h e Southern Kurile islands

(see map).13 Despite Japans willingness to recognize Russias claims

to Sakhalin Island after World War 11 in exchange for the return of

the Kuriles, Stalin persisted in occupying the Northern Ter

ritories. As a result, Russo-Japa nese relations have been poisoned

for the past four dec ades. Tokyo has never recognized the Russian

occupation of these islands. There have been attempts to resolve the dispute. In 1956, the

Soviet government pro visionally recognized Japans claims to the

two southernmost Kurile Islands, Shikotan and the Habomais, while

Japan promised to give up its rights to Sakhalin. However, the

drawn-out peace talks failed because Moscow refused to vacate the

Southern Kuriles. From 1989 to 19 92, the Soviet and later Russian governments

were close to restoring Japanese sovereignty to the islands in

return for economic assistance from Tokyo, but Russian nationalists

repeatedly derailed these efforts, arguing that these territories

are forever R u ssian and should never be returned Kurile Islands.

In March 1994, apparently mindful of the strong showing of

hard-line communists and nationalists in the December 1993

elections, Russian Prime Minister Victor Chernomyrdin told Japanese

Foreign Minister T s utomu Hata that the dispute would not be

resolved soon ilt is not the kind of problem that can be solved in

one leap.14 In the same meeting, however, Chernomyrdin also called

for negotiations to resolve the territorial dispute in Japan and to

conclude a R usso-Japanese peace treaty as soon as possible. Japanese economic assistance to Russia, and especially to the

Russian Far East, is de pendent on a resolution of the Kuriles

Islands dispute. Without the nod fromTokyo, vi tal Japanese

investment in the regio n will not materialize Over the last year,

the Russian government has sent out mixed signals concerning the 15

13 Ihe Southern Kuriles, referred to as Northern territories by the

Japanese, include the islands of Kunashiri, the Habomais (a chain

of small i slands Etorfu (Irurup in Russian and Shikotan 14

Intercons Daily, March 21,1994, p. 1 15 RFE-RL. Daily Report, March

22,1993, p. 2 9 WHAT ISTO BE DONE The Russian Far East could become

the engine of economic growth for all of Russia. The Russian government should be looking to the example of

China, where the intro duction of liberal economic policies tripled

the living standard of the people in ten years. Pulled along by the

southern economic engine, the Chinese economy grew at an average

rate of 1 1.2 per c ent from 1991-1993, and the forecast for the

years 1994-2003 is for an annual growth rate of at least 8.6

percent. l6 Prime Minister Chernornyrdin was so impressed

with-these bustlingzones during-his May 1994 visit to China that he

declared his full suppo r t for the Chinese experiment and he

promised to implement such reforms in Russia If Russia waits to

achieve similar results, the Russian Far East, with its vast

resources and geographic proximity to the successful Chinese model

is a logic$ place to start T hus, the Russian government should

consider r/ Declaring the Russian Far East a Free Economic Zone

(FEZ The Soviet legislature created the first FEZs in 1989 as a

capitalist experiment. One of the first was the FEZ of Nakhodka.

Another major FEZ, operatio n al since 1992, is on Sakhalin Island.

In the spring of 1994, a huge oil development project off the

shores of Sakhalin, known as Sakhalin-2, with estimated resources

of over 8.5 billion barrels, was moved one step closer to

implementation. The signing of a protocol between a Russian

state-owned oil company, Rosneft, and an in ternational consortium

known as 4MS will bring Western investments total ling over $10

billion to the venture during the next ten years. Non-Russian in

vestors include Marathon Oil Co McDermott International Inc Mitsui,

Mit subishi, and the Royal Dutch Shell Group. The deal was finally

signed by Prime Minister Chernomyrdin during his visit to

Washington, D.C on June 22,1994 To sustain the momentum of economic

development, the Russian F a r East needs foreign investment and

free trade zone laws that allow local authorities and the business

community freedom of action. Both Russian and foreign observers

have called for the passage of such laws to end the climate of

economic and investment u n certainty in the area. If Russias

lawmakers continue to stall the needed com prehensive legal reform

as they have been doing since 1990, the legislatures of the Russian

Far East administrative regions should agree among themselves on a

com mon free trade z one law and pass it simultaneously, thus

taking responsibility into their own hands. The future law should

incorporate the ideas of economic freedom and practical experience

with Free Economic Zones found in China, Hong Kong Singapore, and

Dubai where gov e rnments have reduced taxes and regulation dra

matically, allowing the free movement of capital, goods, and

people. These actions have fostered some of the most impressive

economic growth in this century 16 World Bank economic forecast,

June 1994 17 Nakl~o d ka as a Model for Russian Free Economic

Zones. an international conference, Inremarionuf Affuirs. Moscow

1993 10 The proposed law should also prevent government bureaucrats

from turning the Free Trade Zone into a cash cow for themselves

through the overre g ulation of for eign and domestic business,

preferential sales of licenses, and other means of cor ruption

practiced elsewhere in Russia. Specifically, the Russian law should

privat ize port facilities and abolish the current requirements for

governmental p ermis sion to export goods, with the exception of

weapons and military technology items d Abolishing tariffs, import

and export taxes, and customs duties for fop eign trade To

stimulate trade and investment, most government duties which today

are prohibit i vely high and punitive, should be abolished. Taxes

to abolish: a 26 percent oil export tax, a 130 percent automobile

import tax, and an 80 percent tax on foreigners incomes over $l,OOO

a month. Such tariffs and taxes impede international commerce and

indu s trial output. They also lead to corruption, as customs and

tax officials use their positions sonal enrichment. The only

function that should be left to the customs officials should be to

prevent unauthorized trade in regulated materials and substances

suc h as drugs and arms a source of per Getting rid of export

tariffs will facilitate Russias joining the General Agree ment

onTariffs and Trade (GATT) and becoming a full member of the World

Trade Organization WTO which will issue regulations dealing with

tra d e in commodities and raw materials. It is in Russias

interests to expose its large but in efficient industry to

international competition to increase productivity In addition

Russian consumers will benefit from an abundance of goods from

various foreign s o urces. Harmonizing Russian export