THE ECONOMIC IMPACT OF DEEP CUTS IN WEAPONS PRODUCTION IN RUSSIA AND UKRAINE (D

Created: 10/23/1991

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The Economic Impact of Deep Cuts in Weapons Production in Russia and Ukraine tLmmmW

memorandum is partpecial series designed Lo prvnidi continuing annfyns and rtjincmtru ofprevious judgments on the dramalicaltj shifting SovieX scene.

Summary

Recent statements by senior republic leaden-particularly those of Russia and Ukraine-suggest that there is support among some of the leadership to completely halt weapons productionhree-year period. Even if-as is likely-reduction is not halted outright, economic deterioration and force reductions promise substantial production cuts-certainly well overercent for at least several years. Such cuts would encourage potential foreign governmental creditors that their investments would not be used for militaristic purposes, and would free up substantial quantities of materials and components for civil use. Sharp cutbacks also would create turmoil, probably massive unemployment, and loss of hard currency export earnings. Moreover, slow progress in creating market-based economic systems in the republics could lengthen and deepen the transitional problems. Dramatic weapon production cuts and corresponding plant conversion would make it extremely difficult to reestablish current weapon production capabilities over the

The Proposed Standdown

* Several republic leaders have recently raised the ideaomplete halt to weapons production over the next three yeaneans of facilitating economic recovery and defense conversion- Russian Vice President Aleksandr Rutskoy, in charge of Russian defense industry conversion, announced in mid-September that he had proposed halting weapons production for three years. Earlier in the month, the USSR deputy minister of defense industry said that the Committee for Management of the National Economy was considering halting all weapons production. These claims were echoed most recently by Russian Deputy Minister of Defense Vjtah/ Shrykov, Defense Ministry official responsible for conversion in Russia, who claimedecent conference in Washington DComplete halt to weaponsforpart of bis own plan for which hereat deal of support Shrykov added that he was hoping to get the Russian Supreme Soviet to vote positively on it in the near future. During the three yeararge number of weapons plants would be retooled and converted to civil production. All of these men suggested that the state would continue to pay the wages of defense Industrial workers during the halt in military prcduc^on.ttjjp MHr^

eeting with French President Mitterand in early October, Ukrainian President Leonid Kravcbuk also declared himself inomplete halt to weapons production in Ukraine, which contains roughlyercent of Soviet defense industry. Kravchuk's thinking on this issue appears less developed than that of his Russian counterparts, however; the previous week, while visiting shipbuilders in Nikolayev, he spoke of the need to assure them supplies and allow them to continue building naval vessels. Nevertheless, statements by Ukrainian Minister on Questions of the Defense Complex and Conversion V. I. Antonov support the idea that Ukraine is contemplating radical cuts and possibly cessation of all weapons production in the near future. |fl

Russian and Ukrainian views on defense cuts are important, because the defense industrial base of the former USSR is largely concentrated in these two republics, with roughlyercent of defense industrial enterprises in Russia and IS percent in Ukraine (seehe concentration of major final assembly facilities in these republics is even higher. Should theyoratorium on production, the implications for the Soviet economy are

tether this flood of released resources wouldroportionately beneficial efiectdepends on how well the economy is prepared to absorb them.

The Potential Pluses-

One of the greatest impactsalt in weapons production would achieve-and probably one of the main intentions of those proposing it-would be the final destruction of the priority for defense industry so firmly ingrained in the Soviet economy. In the past, the entire economic system-the planning process, the protective bureaucracy, and the weapons acquisition and funding system-has shielded resources devoted to the military from diversion to other uses. Changes over the past few years have wiped away most of these, but many weapons production programs continue, in part due to inertia: lacking new central guidance, entrenched bureaucrats throughout the system have continued to try to shield defense production from the worst ravages of the Sovietomplete halt to weapons production would finally erase the priority of the defense industries to skilled labor, materials and components, and plant and equipment, greatly diminish the defense-industrialistsonstraint on

A complete halt in weapons production would affect millions of people directly and potentially freeast quantity of many of the resources currently in insufficient supply in the Soviet economy- These resources are transferable to civil uses, however, to different extents:

o Most materials used in the production of weapons-specialty steels, construction materials, and engineering fibers, fortransferable and most are readily transferable (seeany of theseas specialtyin great demand in the civilian sector.

o Many of the components and other intermediate products-such as bearings, composites, and, most importantly,also fairly easily transferred from .military to civilian production, although in many cases intermediate goods used in defense industry are built to specifications that exceed the requirements of crvilactor that boosts costs considerably. Many of these products are badly needed in civilian production. In other cases, however, intermediate goods used in weapons systems are special purpose, and because of their nonstandard design, either cannot be used in civilian products at all or could only be used if the products were redesigned.

o Freed-up defense industrial labor, particularly highly skilled workers, could alsoeeded boost to civil industry over the long run. In the short run, such transitions are difficult due to the limited geographic mobility of the workforce. Most importantly, it is concentrated in Russia, where demographic trends have augured poorly for the future workforce.

o The freeing up of defense plant space and equipment, if sufficient funds for conversion arc found, could provide the nucleus for future growth in civilian production. Such conversion will be more time-consuming and expensive than the Soviets had originally envisaged, however, and it would be several years before substantial civil payoff would be realized.

The sudden availability of many of these human and material resources could encourage many latent entrepreneurs who have been discouraged by the difficulty of operating in the resource-restricted Soviet economy to come forth. Republic governments could use as much as two-thirds of the savings from the procurement halt to reduce the large budget deficit or subsidize conversion-even if all defense industrial workers continued to be paid, as

CONFIDENTIAL

governments haveoratorium on weapons production would allow governments to divert currency away from purchases of Western machinery and equipment for military production in favor of civil applications,!

And the Potential Minuses-

The Soviet and republic economic systems-bureaucratic structures, laws and regulations, and even ideological underpinnings-are in flux, and market relations are only beginning. Property rights are undeveloped, and there is stilleU-functioning price system. Under the current unsettled conditions, many of the resources released from the defense sector will be used inefficiently or could lead to tbe rise of monopolies and organized crime. The Soviet system has traditionally thrown resources unsuccessfully at problems, and without clearer and more constructive policies on pric and private .property, it is unlikely to meet with greater success

A halt or dramatic cut in production plus the conversion and consolidation of defense industry plants would clearly degrade Soviet defense production capacity and capability as equipment was sold off, workers lost, and component chains destroyed.olicy would also seriously duTJinish industrial mobilization capability; how much will depend on the extent defense industry is downsized and converted. Although Russia and Ukraine have notorresponding halt in, overall defense spending cutsalt in production would certainly heavily impact, as Soviet military researchers and designers^psc profitable outlets for their work and must seek more!

The largest impactalt in weapons production would be 'the layoff of defense industrial workers from failing defense plants. Defense enterprises have already been struggling with the challenge ofajor capital investment program to retool and build new plant capacity for crvil goodsime when income from their main products is declining sharplyesult of decreased military orders. This financialwell as the loss of the perquisites and prestige that have accompanied weapons production-has caused defense industry to lose highly skilled workers.

The halt wouldarticularly severe impact on selected geographic areas where defense industry is highly concentrated. Within Russia, three major centers-Moscow, St Petersburg, and the Urals region-have the greatest number of defense-industrial facilities. According to Soviet press

i , one-fourth of the workers in Moscow ando SO percent of the :rs in St. Petersburg industrial enterprisesnstitutes work for ( se. In some cities of tbe Urals the proportion is even higher and in cases, such as the shipyard iningle major defenses thedominant employer. Although some leaders havecontinuing wages for defense industry workers during the period .tuition, they would clearlyifficult time finding the funds to do aterfax recently reported that St. Petersburg, for example, expects to upjobs-about one-fifth of its workforce-because of cuts in -'rise industry over the coming year, and that the dry is trying to7illion rubles-roughlyubles per worker-for retraining, icow isifferent approach: Moscow radio reports that Deputy /or Yuriy Luzhkov cited potential layoffsfwo million defense workers, and proposedillion rublesity's budget for civilian orders to help keep them employed. In manyse cities defense industry plants provide housing, schools, and other'/ices-support that would likely disappear in .the ocentalt, thus i. .ensifying the impact on the local economy.-1

Even the average Soviet citizen is likely to experience falloutaltcomplete halt in weapons production would deprive the Soviet^ cjcurrency'" *1 -

!ugn some of these earnings have been pumped back7or purchase of Western production equipment, much of ittr recent years has been devoted to purchasing civilian goods from abroad. Moreover, defense-industrial enterprise closings and bankruptcies may also affect the civil goods produced in that sector-which currentlyarge proportion of many consumer appliances and other civil products..

Outlook

Given the turmoil that would ensueomplete halt in production, the potential reaction of the military, and the loss of desperately needed bards unlikely that either Russia or Ukraine will opt for complete cessation. Both, however, are likely to implement further substantialcertainly well overercent for at least several years-arid to seek_qutside help for conversion and consolidation of their defense industries.

If the Russians and Ukrainians really were to completely halt weapons production on their territory, they would face an enormous management challenge to ensure that the massive resources freed were not wasted and that large-scale unemployment did not bring chaos. On the oneassive dose of freed resources could allow those with entrepreneurial spirit

CONrTDENTTAI.

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