An Island of Capitalism?

A Marxist economist creates his own enterprise zone.

On remote Sakhalin Island in the Soviet Far East, the local Communist Party has established a business club. Western observers, now accustomed to the growing number of economic initiatives in the Soviet Union, no longer think twice about such revelations. Throughout the country, proposals abound for a stock market, banking reform, establishing a convertible ruble, encouraging small businesses, introducing land ownership, and even allowing profits. But unilaterally, the local government of Sakhalin oblast (region) has announced its intention to develop a free-market demonstration project and has started to implement many of these initiatives.

Valentin Fyodorov, chairman of the Regional Executive Committee of Sakhalin oblast, models his economic reforms on Western institutions, desiring to raise the standard of living on the island. In 1987, Fyodorov, then a professor at the Plekhanov Institute, an orthodox Marxist school of economics, was already frustrated by the slow pace of perestroika and was convinced that real economic reform could not be centrally planned but would have to grow from individual initiatives. He dreamed of setting up a free-market experiment far away from the meddling hands of Moscow's central planners to demonstrate to the nation the system's advantages. To find ways to implement his ideas, he sought advice from American and Japanese businessmen. Fyodorov's proposals captivated Fred Kiesner, a professor of management at Loyola Marymount University in Los Angeles. Kiesner then made five trips to Moscow to help Fyodorov learn more about the ways of Western business.

Fyodorov realized that the implementation of his radical economic reforms would be most successful if he were able to win popular support for his ideas in an isolated area. In the spring of 1990, Sakhalin oblast held a democratic election for posts on the Regional Executive Committee. Fyodorov seized the opportunity and moved from Moscow to the oblast specifically to run for office. Campaigning on a free-market platform, he received an overwhelming 85 percent of the vote, won a seat on the committee, and was subsequently appointed chairman—essentially governor—of the oblast.

The oblast appeared ideal for a free-market experiment. Eight time zones away from Moscow, the island is just 25 miles from Japan and ideally situated in the Pacific Rim. It has vast oil, coal, and timber reserves as well as a large natural harbor and a land mass about the size of South Carolina. The residents include a large minority of Koreans who have retained a cultural affinity for entrepreneurship. The major drawback for the oblast is that it contains the Kuril Islands—over which both the Soviet Union and Japan claim sovereignty—but Fyodorov hopes to turn even this to his advantage and has recently proposed declaring the island chain a joint free-enterprise zone with Japan. This problem will take years, if not decades, to resolve.

Though only in office since April 1990, Fyodorov has worked at a feverish pace to translate his ideas for economic reform into reality. During this time, Kiesner has been to Sakhalin Island twice and has played an instrumental role in helping Fyodorov set the rusty engine of the market in motion.

Though Western economists generally advocate an immediate "shock therapy" transition from a command to a market economy—freeing prices, breaking up monopolies, selling government property—Fyodorov argues that this approach won't work in Sakhalin oblast. He cites two reasons: The local standard of living there is too low (50 years behind even Moscow), and the new democratic government is only beginning to gain public trust. The short-term chaos of an overnight transition could rapidly lead to civil strife and put the fragile democratic institutions at risk. Kiesner describes Fyodorov's strategy as similar to that of a large corporation that is switching computer systems: "You want to make sure that the new system is ready before you disconnect the old."

Fyodorov's strategy tries to simultaneously expand the market sector of the economy and reduce the planned sector. He is pressuring Moscow to reduce the output required by the central plan from the oblast's factories each year. With only a small market sector at first (but expanding every year), managers have a lot of room to learn effective business practices through trial and error. Managers are encouraged to make the most of their production capacity and can sell any output exceeding plan targets on the nascent market. Theoretically the enterprises can keep their profits, but such essentials as defining profits and standardizing accounting procedures haven't been worked out.

Now able to sell their products directly to consumers, companies struggle with such basic Western business problems as market research and advertising. Fyodorov not only allows such practices, he is inviting American and Japanese businessmen to teach them. Kiesner reports that though no state firms have yet been privatized, the managers are already beginning to act less like bureaucrats and more like Western business executives. For example, the manager of an ice cream production facility declares that due to huge demand, the plant is adding new flavors and expanding production. Elsewhere, a clothing manufacturer pores over the pages of a J.C. Penney catalogue, seeking Western fashion ideas.

Fyodorov's attacks on the legendary legal and bureaucratic hurdles for individuals who want to establish small businesses have also resulted in striking changes. He has stated that the role of the government should be to aid entrepreneurs, not hinder them, and he has been cutting the layers of government red tape that impede even the smallest business transaction. As a result, corner flower stands, produce markets, and small restaurants are popping up throughout the region. The hiring of employees, a fundamental taboo of Marxism, is now permitted to a limited extent.

In addition to the corps of American and Japanese businessmen that advises him, Fyodorov takes advice directly from his constituents. He has his own radio talk show during which citizens call in to voice specific complaints or make requests to streamline government paperwork and business-licensing procedures. Fyodorov has donated government office space to develop an infant-business incubator—a central office where young businesses will be able to share equipment and experiences, and consult with American and Japanese volunteers. Once strong enough, the young businesses will move out to their own quarters, allowing new enterprises to benefit from the facilities and services. The reforms that Fyodorov has enacted are quite radical by Soviet standards.

Unfortunately, any reforms led by Fyodorov face a serious impediment: The chairman still unconsciously retains many basic Marxist beliefs. American business consultants may have taught Fyodorov how to establish the institutions of the marketplace. But the mindset of Marxist indoctrination remains. He still adheres to the socialist premise that the government must direct capital, resources, property, and even human labor to achieve "socially beneficial" results. Like Soviet officials at all levels, he can list the structures and institutions necessary for the operation of a market economy yet distrusts the seemingly random decisions made in a market system—a fault shared by many Westerners.

Consider the island's homesteading plan—a step toward property rights. Last year, the Soviet military handed control of several thousand acres of land over to the Sakhalin oblast government. In turn, over the objections of Moscow, Fyodorov began a homesteading system similar to the American model. Homesteaders can apply for a parcel of land on which they must farm for 10 years before the title is issued. But after receiving title to the property, the new owners still face an array of restrictions limiting their use of the land and freedom to sell it. The government says these restrictions will prevent land speculation and ensure that the property is used for a "socially beneficial purpose."

Left to their own devices, the homesteaders might choose to do anything with the land: build a housing complex, offices, a factory, a health spa, a farm, or something else entirely. In the skewed vision of someone who distrusts the market, any of these choices would be only for personal gain. In the larger picture, the individual will enjoy gain only if he has made a wise choice to produce goods or services that others want. And only through broadening the choices available to island residents can Fyodorov ever hope to significantly improve their lot.  

In truth, Fyodorov has about the same understanding of the free market as the average American politician: Both want to enjoy the prosperity of a market economy but wish to eliminate those elements they believe to be undesirable. Like some American politicians, Fyodorov resists imports, claiming that the standard of living will falter and his island will lose jobs and hard currency if it imports goods that might be produced domestically. He thinks foreign investment exploits the weak, so he only approves outside investment once he has been convinced that it will be in the best interests of his people. Likewise, Fyodorov allows only those domestic business ventures he deems socially beneficial. In a nation with strong free-market traditions such as the United States, such distrust of the market will chip away at the economy's foundation bit by bit, but on Sahkalin Island, where a market scarcely exists, the effect will be prolonged stagnation.

Another problem Kiesner says is that the people of the oblast barely understand how to run a profitable business. "All they see is the rich side of it," he explains. "They don't understand the concept of risk at all. And they don't even begin to grasp how much work is involved."

So Kiesner hopes to teach the residents of Sakhalin how to operate viable enterprises. With a shoestring budget and a corps of American volunteers, Kiesner has brought Fyodorov and Sakhalin's brightest and best to the United States for intensive workshops and hands-on experience. Back in the Soviet Union, the American mentors offer additional seminars and informal advice sessions—with overwhelming success. Kiesner says that when he would tell someone he wanted to give a seminar, "people would appear out of the woodwork to attend."Though he has lectured on the subject worldwide, from Singapore to Ireland to Yugoslavia, nowhere have people listened with such rapt attention as in the Soviet Union. "They would always come up to me after the lecture all excited and tell me that 'Yes, I can do that! I can become an entrepreneur! '"

Another hopeful sign is Fyodorov's open-mindedness. He does not reject any proposal out of hand as too radical. His feisty attitude of "act now—legalize later" has led to constant skirmishes and political battles with the Kremlin. He has attempted to wrestle economic control of the island's natural resources away from the central government so the island can sell them for hard currency. And to expand contacts with the West, Fyodorov has started negotiating with Alaska Airlines to establish a stop at Sakhalin between the United States and Japan. 

Fyodorov wants to do more than bypass the Kremlin's planners: He wants to implement banking and currency reform and establish a stock market. Unfortunately, as long as the oblast remains a part of the Soviet system, such reforms will be difficult to implement.

Even if Fyodorov were a libertarian visionary, he would still have to convert his constituents. Though he was elected with 85 percent of the vote on a free-market platform, the Soviet people's understanding of market economics has been warped by their communist upbringing. They must overcome a deeply ingrained resentment of economic success and the pervasive notion that all people must live equally.

Among the Soviet entrepreneurs, this resentment of the better-off transforms into guilt about their own economic success. Entrepreneurs shy away from open consumption and donate large amounts of their income to civic causes—setting up private schools, charities, helping out other budding entrepreneurs, and the like. Currently such donations are voluntary and greatly benefit the community but this climate of envy could lead to harsh repercussions against those who prefer to purchase consumer goods (as they become more available), reinvest in their businesses, or simply save their money. Fyodorov's shaky faith in free-market concepts makes these challenges even more daunting.

Fyodorov's stated goal remains to transform Sakhalin oblast rapidly into a free-market zone fully functioning in the world economy. He originally gave himself three years to make his economic reforms show definite results and then moved his self-imposed deadline back to two years, fearing that if his people do not see results soon they will become ever more antagonistic toward reform. He now even questions his government's ability to withstand the public hostility of another winter of shortages and food riots.

If handicaps preventing growth and holding down the standard of living continue, the prospects for Sakhalin's long-term success are quite bleak. The residents will be told that they live in a free-market zone, but if their lifestyle does not improve, they may become disillusioned and opt for a return to the more predictable days of central planning.

There is reason for hope. The island's distance from Moscow makes any repression initiated by the Kremlin unlikely. Though the central government has turned back toward the hard-liners, political battles between Sakhalin and the center have not noticeably increased. Fred Kiesner voices little objection to the course of Fyodorov's reforms so far, saying that all things considered, the governor has "done just about everything right." Even if Fyodorov is confused about market economics, Kiesner concludes, his reforms show that the governor means well and is learning. And in the Soviet Union, Fyodorov is the closest thing to a Milton Friedman with actual authority. He still enjoys immense popular support more than a year after his election.

Indeed, the most promising sign for the region is that its leader is receptive to new ideas and innovations. With a parade of Westem business consultants welcomed to advise Fyodorov and teach his people, it may be just a matter of time before Sakhalin's citizens learn to accept and understand the pitfalls as well as the advantages of a market system.

Phaedra Walker is assistant editor of The National Interest.