Gorbachev came to the G7 summit in July ultimately hoping for a massive package of aid and credit from the West. The G7 leaders came to the summit divided over the issue of aid - the European heads of state, particularly Kohl, preferred some sort of massive aid program, but Britain, the U.S. and Japan preferred a much more scaled-back approach, which is essentially what Gorbachev got. What's behind the difference of opinion among the G7 leaders?

Well, I don't think going to the G7 Gorbachev expected a lot of allocation of aid. He didn't indicate as much in his letter to the G7. It isn't fair to assume that Graham Allison and Gregory Yavlinsky are speaking for Gorbachev; in their earlier version, when they had numbers, they talked about $30 billion. Gorbachev never asked for that. Therefore, I would say that the Soviets were never so ill-advised to ask for a large, lump-sum, open-ended commitment. But, at the same time, what they did expect from the London summit was accession to the Bretton Woods institutions; and I think they were sorely disappointed on that, since they followed up with a letter to the institutions, which did cause some perturbations.

You're talking about the Soviet application for full membership in the International Monetary Fund and the World Bank?

Yes, the application for full membership. There's nothing in the [IMF or World Bank] charter about membership or non-membership. But I think the Soviets always considered the U.S. proposal for associate membership to be second-class status; and, although they may have been advised - certainly that was what the media reported that that was what was being expected - I'm told that it was a considerable source of disappointment in the Soviet Union and among the people who would have looked at accession in a more substantial way.

It seems to me, at least, that the Soviet application for full membership in the International Monetary Fund was sort of a bargaining chip for Gorbachev to say " Okay, 141 withdraw my application for full membership in return for something." Does that ring true to you at all, or do you think they really just want to press ahead with this immediately?

They're in a rush; they need to press ahead immediately. If you look at the Soviet economy at the present time, one of its principal problems is hyperinflation - a high monetary overhang and budget deficits. How can a country such as the Soviet Union effectively address the problem of hyperinflation? With a " shadow program" ? Without a stabilization fund? By lectures? By tutorials? By exposure to workshops? That's not going to get a stabilization program; I mean, that's not going to get an effective stabilization fund introduced, and the process of stabilization of the ruble placed underway.

The parallel with the Polish zloty is relevant, and it is different because the stabilization fund had to be somewhat larger. How much larger depends on the type of stabilization fund. Actually, the Soviet Union has far more assets. They have far more deposits of gold. They have oil. Poland has very little in the way of cashable, bankable assets. And the Soviet Union has less inflation than Poland did.

But it's more than that. In order to have an effective stabilization fund - and effort - you have to have very strong surveillance, conditionality, and discipline. That is what the IMF has done with Poland and with other countries where it's been reasonably successful. The Soviet Union not only requires that, but they also require that because even though they passed legislation setting up a central bank, in effect giving the legal powers to a bank, they cannot effectively control the issuance and the currency without external discipline, in my opinion. They cannot develop the cadres necessary to run a federal reserve Bundesbank-type operation. And, therefore, I think Mario Nuti of the European Community, when he says how strong could be the " procrastination," as he calls it, could be catastrophic, has a point.

And, hence, the Soviet economic reformers' effort to push for a two-tiered federal reserve system?

Well, the two-tiered system is important in itself. It provides not only the central bank, independent of political authority, which controls the issuance of currency and influences the real interest rate and provides for a monetary stabilization. But also, the other tier is a competitive commercial banking system which provides for a market for capital, for currency. And in that sense, it's part of the marketization process.

But if marketization is to be successful, and if the Soviet Union is to integrate into the world economy, it has to attract substantial private investment - which is quile possible in the oil fields right now. But it has to do something soon about the currency - that's the key issue. Now they could wait until 1992, as Yavlinsky, in fact, suggests; but that's quite a long time.

You mentioned the IMF's role in currency stabilization, and I've heard reports that the Soviets have increased their platinum sales of late, and I'm wondering if we should also expect, then, that they'll increase their sales of gold and other precious metals to raise a lot of hard currency quickly for some sort of stabilization scheme, or are they going to have some sort of gold-backed stabilization fund themselves?

The stabilization process is not just an economic exercise. In order to absorb the excess purchasing power, and to cushion somewhat the stabilization process, there is a set of trade-offs. How do you absorb the purchasing power?

Every politician would like to see it done on the supply side. You absorb the purchasing power by a currency reform, like the partial one that Pavlov introduced. You bring in the issue of large denominations of rubles, and then you confiscate it. Or you could sell assets, like gold, like platinum or other precious metals. Or you could borrow. And then the pain on the demand side would not be as great or as precipitous. And price liberalization might be sequenced, and perhaps a little more selective. It would be prudent to agree to leaving out continuing subsidizing, although they did in the case of coal in Poland; they did agree to some exceptions in their program. But the more the program is focused on the demand side, the more shock there's going to be, the more painful it will be. So who's going to decide that. Well, it's best if the country proposes and the IMF accepts; and that's the way it's structured, because it has to be a program that's acceptable and not have the regime overthrown. There are cases when people claim the IMF programs have led to eroding of regimes; but, nonetheless, it is a program that requires austerity in some degree.

One of the things that's very important in the transition is that many of the political leaders can understand the words in terms of stabilization of currency, introduction of a commercial banking system, of a central bank, of independence, and so forth - but don't understand it in the context of their old habits and their desires, and their natural desires that every political leader has in dealing with a central bank - whether it be Kohl, dealing as he was with Pohl or Bush on occasions with Greenspan. The political leadership always wants growth. They always want employment. And the bank's responsibility is to maintain stability; and these are trade-offs. So if you don't have the external discipline, there's a lack of understanding. I don't think Pavlov or Ryzhkov or many others could really come to understand that if you're printing money in the back of the bank, and trying to balance the accounts in the front of the bank. that it won't work. Monetary policy is both a question of economic understanding, but also, it's a psychological thing.

Does [Gosbank chief] Zakharov understand that?

Many of Gosbank's bankers spend a tour at Moscow Narodnii in London - in a British bank with Soviet capital, and they become exposed. Boris Federov understands - he was the finance minister under Yeltsin, and is now the head of the Soviet branch of the European Bank for Reconstruction and Development.

But the problem is the difference between system and cadre. It's not only the [Communist Party] apparatus that has to be changed - the apparatchiki may change - but there's still that mentality and they have to be put into a new system, and, to use IMF terminology, surveilled, watched, disciplined and conditioned, which means that the availability of resources is controlled on the basis of performance, and there's that incentive. Without this kind of a program, if you want to discipline, you damn well better have something to discipline with. And if you're a fund, or a bank, this better be money; you've either got to keep it or not. So a " shadow program," you know: " Comrade, you're not doing it right," or " Comrade, if you don't do it better, you don't get any more money" - there's a considerable difference.

Going back to the first question. Are you saying that there wasn't a difference of opinion among the G7 leaders about direct aid to the Soviet Union?

I think there are differences of view in a geopolitical position - the concern about maintaining the composition of the Soviet Union. I think there are some differences of view as to how critical the maintaining of the center is, and Gorbachev as the person to do it. But I don't think the major differences are explained by that. I think they're more in tune on the major differences. Bush would like to maintain a Soviet Union because I think Bush comes to this as Baker does, looking at it from the great power standpoint, that is to say arms control and regional issues. And now, for the first time, the first summit, economic issues are beginning to find their way onto the agenda - not massively. But the key issue is: what are you going to do in the Middle East; what are you going to do with Cuba; what are you going to do on the follow-on to START; the follow-on to CFE; maybe even the Northern Territories, that brings Japan in. And the other issues are important issues, but I don't think they rank high on the scale of motivation. What should rank high on the scale of motivation is the relationship between the economic health of the Soviet Union and Western profits and in commerce and in energy and other areas, and it could be a substantial market. Likewise, if it goes down, if it disintegrates in that regard, you could have economic phenomena of which migration, not the least of the problems which we're worried about, could mean the flood of Russians who are going to at least cross our territory or try to stay here. But, also the absence of the Soviet market at the present time could have a devastating effect on Central Europe and Eastern Europe, and the potential turnaround is very prospective for Western Europe. But there is a commercial sense I think that differentiates the views, not at the London summit; it may emerge more at the Moscow summit, and it may emerge more at the next G7 summit - and it should be more of a factor, but it isn't as yet.

Yavlinsky was listed as a member of Gorbachev's delegation to the G7 summit, and he was in London at the time, but he refused to participate in the delegation. Is this an indication that Gorbachev included more elements of Pavlov's " anti-crisis program" in the G7 proposal?

I have a copy of the letter and the appendices; it isn't long on specifics, and one can still see in Gorbachev's statements the flexibility to be less than specific on implementation. The key areas of settlement of an economic sort are still not open. For example in the Union republic treaty one of the critical issues, in addition to monetary stabilization, is that it isn't clear that there will be one currency and one central bank.

The issue is who has the right to tax and who has control of the revenue - and how are they shared? And how are they shared as related to monetary stabilization? Because will the union republics, for example, as well as the center have a requirement for balanced budgets? All of the actions to date in the various republics in their Supreme Soviets have been more populist on balance than. you might say, conservative. And it's not surprising. Politicians always vote for new programs and not for taxes. Also, the question on privatization which is not clear is what destatization is. Destatization should mean laissez-faire; it should mean take the Party and the ministerial system out of the process of dispersing assets as well as engaging in the privatization process. One step toward that was Yeltsin's decree to abolish all the Party nomenklatura from the enterprises. That's an important step. Yet, Gorbachev muddied this by opposing it. Now, I don't think conditionality should permit that, because if you have the old system of state orders and command economy and party dominance and intervention, the old system carries over with some new patina of technology and so forth, and this may be represented by a very important organization called the Scientific and Industrial Association, headed by Arkady Volsky. The point is that if you misread why Chile did alright, and misread why other countries did alright and say that it was because they had a dictatorship not in spite of the fact that they had a dictatorship, most of the countries that people often refer to are countries that have a market system and they have imperfections in the market and limitations on democracy; but it's a sea of markets in which the operation took place. So, at any rate, Gorbachev also muddied that. And I think the idea in the monetary stabilization program which is essential to the market is that the difference between the market and price changes is a critical psychological issue. I don't think that Ryzhkov and Pavlov ever understood that if you have the wrong prices, you don't just change the prices by the Committee on Prices - that's not a market. And that's the kind of understanding that's not clear; it's not clear where Gorbachev stands on that.

Those are crucial elements in regard to Yavlinsky because I think Yavlinsky can see a number of things, some of which I just mentioned, as very ambiguous. And they're kinds of things that were ambiguous back in January when Shatalin was here and was telling us: " I talked to Gorbachev. He understands. We're committed. We're going forward. It's implemented." And the next day we're back into the cave of the KGB and Pavlov. I think Gorbachev has a very, very difficult balancing act politically, and he may be playing it just the way he needs to; and he's survived. But on the other hand, from the standpoint of a professional economist, this is worrisome; this ambiguity is worrisome. Further, what role would Yavlinsky play? Would he be the guy standing in the back of the room, and by his presence saying whatever is proposed he supports? How does he know what was finally going to be interpreted as what was proposed? What's there to gain from Yavlinsky being there and standing up as a son of a certifier - as a witness to the wedding, so to speak?

Yavlinsky's plan seems to be a reincarnation of Shatalin's " 500 Days" plan with some modified elements in the transition's timetable. Pavlov's " anti-crisis" program is a much more conservative plan. The struggle between these two plans seems to parallel the Shatalin/Abalkin/Ryzhkov period of reform proposals. Yet, the tide seems to be more in Yavlinsky's favor this time. Why does Yavlinsky's plan garner more support this time? Is it simply a change in the political currents, or just the simple realisation that the economic conditions are now much more severe?

The general tide has to be considered in the context of radical versus conservative. The popularity of the party and the importance of the elective process have become increasingly evident. And the unpopularity of many of the conservative institutions, including the military - and especially their claim on resources - have become unpopular. This, in turn, has created a feeling of " Let's give it a shot!" There are all sorts of reservations about the unknown and lots of people are very concerned; and as the conservatives use this specter of unemployment - and it's real one! There is a good possibility of unemployment. There is also a possibility that they will suffer before they gain. So, those elements presumably have been somewhat all overbalanced by the fact that the others have had their day - more than their day. And I think that Pavlov as another Ryzhkov is not a Ryzhkov. Ryzhkov is a man of stature, and Pavlov isn't a man of stature.

Also, I think there's a Russian historical dimension that has to do with the time of year. January and June and July are different, and when you've got the crop in the fields. But January is a terrible time to make changes.

And Gorbachev has to rely more on the military in order to get the harvest in. In other words he relies on the mobilizational aspects of the society in order to, for example, get the harvest in as well as other crucial economic activities that can't be done now without the help of the military or local party officials.

There is that dilemma. That's one of the reasons why Gorbachev's actions have to be considered against the pragmatic problems he has. Last fall, before January, when the party was sabotaging the harvest, you had Gorbachev in effect telling Popov and Stankevich " Hey, why don't you guys bring in the harvest?" Remember the potato harvest? They wouldn't order the oblast obkom, in Moscow oblast, wouldn't order the factory workers, who normally went out and picked potatoes, to go out. He said " I can't do it. I don't have the power." What he was saying was " You bastards, you're giving us all these slogans and so forth - you deliver!" And Stankevich had no power; he couldn't order anybody. I think what Stankevich did was go to an agriculture ministry official and made a deal with cars, with Zils.

I was there in September when there was a report in Sovietskaya Rossiya that there was going to be a bread shortage - and it was concocted! They put more than half the bakeries in Moscow on repair at the same time. Sure, you're going to have a bread shortage if you close all the stores. But that's what the party was doing. Well, Gorbachev can say " Well, I know they're screwing it up. I know they're sabotaging." But Yeltsin put it in the context of " Well, what do I do about it." So I think the pendulum is switching, and the power is weakening. And my feeling on that order of Yeltsin's is that there's another pattern; and that when Yeltsin has a liberal decree, the center follows. I think Gorbachev would like to follow at this point on the nomenklatura', but going to that party congress again, and the Central Committee, and getting them to agree to his program at the congress - well. he's the judas goat leading them down the line. Yeltsin would get decimated by the party if he tried to play that role. But if Gorbachev didn't play that role, the still very potent bureaucracy would sabotage it.

It just seems that, in a longer sense, maybe even in a short-term sense, there seems to be more of a change to pluralism, federative pluralism, pluralism in the sense of elections; if you aren't elected you don't have a badge, pechat, legitimacy. It's important that Gorbachev is not elected. It's important that Yeltsin is elected. That's new; therefore, I don't think it's easy to explain. I don't think you can go to the past with the Westernizers and Slavophiles and the history and it always comes back to the same thing sort of thing, and find that something different is happening - and something right now is different. And it seems to me that this is very close to the perelom, you know, the turning point. And the turning point is the destruction of the old system.

If you have a monetary stabilization program that commits to convertibility - commits to it - then that's the end of the old command economy system from the bureaucratic standpoint. From the systemic standpoint and the cadre system, it goes when you have an independent central bank and a commercial banking system.

So what didn't Graham Allison and Yavlinsky understand?

They're talking about step by step. I'm saying that the first step is the important one.

So you're saying that sequencing is irrelevant?

No. I'm not saying that. I said the first step is the definitive one. It's a dialectic step. If you look at the program, they talk about numbers of days and numbers of programs - 2,300 days or whatever - and each position is seemingly part of an equally valued sequence. You've seen that in three regards the first step of a monetary system which implements a program that will stabilize the currency and will control it - the internal exchange rate - and has the institutions to enforce it. And privatization, which means you will set up a system whereby the state and the party are disassociated from control. And an intermediary agency - a state property fund - is not a surrogate for the old system; it's a Treuhandstalt, like in Germany, that's the state property fund. Well, I shouldn't have even mentioned it since it brings up all sorts of other questions - but it's a different group; it's an intermediary group whose function is to prepare the assets for equitable and efficient disbursement. Equitable and efficient as measured by whom? Through the democratic process. What are they doing in Poland and Czechoslovakia and Hungary? They're debating! The old Honecker-type or Husak-type would say " No. We've got to modernize, so let's bring in technology. But let's not cross this bridge without staying in charge, keeping our assets. We'll convert. We'll admit our sins and join the church - the new ideology of the market."

But the point on the federative principle is the degree of equality, of sharing power. The Union republic treaty - however it's implemented - is a hell of a change in sharing of power; it eliminates the old central system. So, what I'm saying is the first step is a critical one - it's a crucial threshold. And when you want to ask the question " Is the process irreversible?" you've got a fairly good answer at the beginning. That's important because then it's appropriate for Western commitment, not only for assistance but for investment.

Everyone - Graham Allison and Yavlinsky and Sachs included - should recognize that the Soviets are reaching this stage, that they're deterministically reaching this crucial threshold; and that's the grand picture that everyone seems to be missing is that they are, indeed, reaching this critical threshold?

That's right; and that it's a substantial qualitative change.

A sea-change.

A sea-change. A dialectic change. Or, to put it in terms of step by step, it's not going over the Urals, it's going over the Rockies.

The historical background is interesting because this is what the classical political economists said in reference to mercantilism: laissez-faire, laissez-passer - get the government out! That meant get the key, get the center and its bureaucracy out of the system or it won't work. I stress this because I think there are two aspects of this that are important in the current context. One is we are legitimately concerned about reversibility and commitment, and I think if we focus on this threshold question, it will be helpful. Secondly, that if they don't make the definitive break, it's going to be much harder. Now when the Group of Thirty, this is the international bankers' group, did their study on financing, they concluded that the changes ought to be rapid - in two to three years. I think they were right for a different reason, namely you've got to make a commitment. Let me give you another example. I've been on the Secretary of Energy's team to develop a U.S. energy policy. So I spent two or three days up in Newport with American multinationals. Question: Can the Soviet bureaucracy - the guys who work in the fields, that you work with, that you're trying to negotiate with - can they run an efficient oil field? The answer is yes; many of them can - but not the guys who are managing it, and not the guys who are negotiating it. They've been operating in a system that says: " production, production, production" and forget the rest. As long as you have that system - and that's the way the nomenklatura and the ministerial representatives run the system; that's the way they believe it should be run. But if you leave that system in, or you leave the managers in and then you get a new set of orders, or you're going to have to work with these outsiders here, that's another reason why the oil companies and gas companies under the European Energy Charter want to have concessions. Concessions mean: we took over - lock, stock and barrel - and then we're going to bring in the trainable people. A lot of them are trainable, and it's a mistake many people have made in many countries that say: " They're ex-Communists; therefore, they're no good." Well, hell, if they're no good you'd eliminate all of the people who were certainly over 20 because they had to work somewhere. Balcerowicz is a member of the party. Klaus is a member of the bureaucracy. I mean that's not the criterion. The criterion is an effective change in the system. And once there's an effective change in the system, you've got the basis. That's where technical assistance becomes important - with money. Because then you can say " Here's how you run the balance of payments section of a central bank." This is not hypothetical. I know the people at the IMF section in charge of setting this up, and our Federal Reserve guys are good at doing this. But then you can say " This is how you perform accounting practices." The energy guys were telling me that the Soviets keep asking them " How do you keep costs down? It's costing us an arm and a leg to produce all this oil." Well, you look around and say " It's pretty obvious why it's costing you so much. You don't have any accounting for one thing. You don't know what's going on. All you know is tons of oil being delivered." So it's systemic.

Let me ask you about the extent of the reform proposals that Gorbachev gave to the G7. Have the republics in the " Nine Plus One" negotiations indeed been given enough economic and political sovereignty to satisfy the West? You brought up the example of the Ukraine and its attempts to inaugurate a separate currency. What is your opinion on that?

The situation as far as the political settlement you have a situation where a lot of ethnic nationalists are the dominant factor in politics and a lot of the elected officers are elected on criteria that they will oppose the center and they will oppose everything the center has traditionally stood for - some of which is good, and some not so good. But to answer your question obliquely, one of the reasons why a monetary stabilization program is well articulated and issued early is important is that it can very usefully be part of the process of dealing with the republics. I had a young man from Rukh sitting next to where you're sitting, and he was saying " We're going to run foreign policy, defense policy, and we're going to issue our own currency. And nobody can get elected in Ukraine without that." In Poland you have a ten-man unit of the World Bank and a couple of IMF people over there, and they're providing assistance that's based on reasonable market conditions. Well, if they can't balance their budget without subsidizing, or can't participate in a stabilization program which is protected without a unified currency, then you can't support them. We can't support it.

Regarding future trade with the Soviet Union. It looks like they're about to get MFN with the United States. And a significant component of Gorbachev's economic reform package seeks to convert defense industries into consumer goods producers. With this in mind, what is the form of trade in manufactured items likely to be. Are there any industrial sectors that have promise in exporting manufactured goods that can compete on the world market in the near future.

Sure. The way into the manufacturing area is through the hard currency they can earn in the resources area - oil and gas and timber.

Which really doesn't relate to MFN, though - those kinds of exports.

The tie-in is the joint ventures are not going to come in unless they can repatriate profits.

The Germans negotiated a very nice bilateral investment treaty and the rubles they earned in Deutsche marks they never got back and someone finally discovered that they were going to have to find some way to convert those rubles into Deutsche marks, and they can't do it in the manufacturing sector without some source elsewhere. So if they're going to bring in Siemens they're going to have to have another source. In the short run you get Siemens to bring their production to Leningrad up to the point where they know they can break into the market - break into the Siemens market!

John P. Hardt is associate director for research coordination at the Congressional Research Service. A veteran observer of the Soviet political and economic scene. Dr. Hardt is also an adjunct professor of Soviet and East European economics at George Washington University.