Abstract
Even with U.S. government help, most former Soviet weapons enterprises have produced commercial flops. A willingness to learn from failure could make a powerful difference.
These days, half a billion dollars does not go very far–at least in terms of creating non-weapons-related employment for onetime weapons scientists in the former Soviet Union. Since 1994, the State Department's International Science and Technology Centers and the Energy Department's Initiative for Proliferation Prevention and Nuclear Cities Initiative have together spent nearly $500 million on job creation. There are no definitive data for the number of jobs created for the scientists targeted by these programs, but a few dozen permanent commercial positions would be a generous guess.
As a whole, U.S. efforts to reduce the threat posed by the former Soviet Union's nuclear weapons have been successful. Weapons of mass destruction (WMD) have been eliminated in Russia, Belarus, Ukraine, and Kazakhstan, and the oversight of weapons-usable materials across the region has improved. But the factories and people who develop and build those weapons remain. A large number of weapons scientists have received research grants in an effort to dissuade them from seeking work in their fields abroad, but none of the U.S. programs aimed at generating sustainable work for these experts have succeeded to any significant degree.
The reasons for such poor results vary, but all the programs have suffered from a lack of commercial interest and expertise. In the mid-1990s, during the early stages of the defense conversion program, the private sector got involved, but the programs fell far short of business development and growth expectations. Subsequently, the business community became a vague destination for Russian WMD experts rather than an active participant in creating jobs.
It doesn't need to be that way. A joint U.S. government-business initiative could both reduce the number of weapons scientists in the former Soviet Union and redirect weapons facilities toward nonproliferation activities. But U.S. aid programs need to be restructured to make it so. Increased private sector involvement could help move these vital U.S. foreign programs forward and advance U.S. foreign policy goals. The key is learning from past failures and successes.
When the Defense Department began the Cooperative Threat Reduction (CTR) program in the early 1990s, most people thought it was a great idea. In the process of eliminating weapons factories, new businesses would be established, which in turn would create jobs and broadly contribute to the economic recovery of the region. But few if any people had experience converting former Soviet defense plants or developing commercial applications from research conducted in its weapons institutes. This was true as much for the U.S. companies involved as it was for the officials managing the programs.
Unfortunately, few of the ventures actually worked and fewer survived. Integral, a Belarusian producer of chips used in Soviet missile guidance systems, was awarded $5.8 million from the CTR's defense-conversion budget in 1994 for a joint venture to manufacture low-end integrated circuits. The American partner withdrew because of a “poor business environment,” according to a 1997 General Accounting Office report. Minsk Computer, a Belarusian maker of mainframe computers for the Soviet military, was given $2.5 million in 1994 for a commercial joint venture to produce battery chargers, power supplies, transformers, and wireless modems. The venture never made it past developing prototypes. A 1995 project to convert Mashino-stroyenia, a Russian missile and satellite manufacturer, into a cola-bottling facility failed to get off the ground because the U.S. and Russian partners were not able to work out their business differences. They spent $195,000 of a $5.1 million CTR contract before giving up. And the list goes on.
Most companies that did survive live so precariously today that with time they may also fail. As a result, many people have concluded that the idea was fundamentally flawed and should not be tried again. Congress went so far as to ban any future Defense Department funding for conversions.
But given the unprecedented nature of the undertaking, the results were hardly surprising. No one had ever converted a Soviet military plant. The region was beset by and continues to experience tremendous turmoil, with uncertain markets, predatory government officials, and criminal organizations targeting the emerging private sector. That six or seven out of 20 of the ventures survived is actually a remarkable accomplishment.
Past and current programs may be flawed but–with modifications gained from experience–they can be retooled. In the process of work done in the 1990s, government and private concerns learned valuable lessons to improve the odds of success.
Byelocorp Scientific Inc. (BSI) has experienced both successes and failures in this arena. (The author is executive vice president of BSI.) In 1993, BSI established a joint venture with Belomo, a large Belarusian state enterprise that designed and manufactured optics for the Soviet Union's military complex. The goal of the partnership was to design, produce, and market laser pointers, with components largely supplied by the manufacturing facilities at Belomo. The operation faced problems from the start.
Special spent fuel canisters in Kazakhstan.
At the time, laser pointers were a relatively new product internationally. One of the key components, the diode, was not produced in the former Soviet Union, and though Belarusian labor and material costs made it possible to produce a low-priced product, the lack of commercial experience meant Belomo's engineers were unable to develop a functional and aesthetically appealing laser pointer quickly enough. The company achieved an acceptable design only after considerable input from Western engineers, and then quality control was so problematic that the rejection rate was close to 20 percent.
Byelkamit employees work on pressure vessels for Western oil companies in a former torpedo plant in Kazakhstan.
On top of that, the Belarusian government and Belomo's management had very different expectations about the venture. Both thought the U.S. money would go to the Belarusian side of the enterprise, and when it became clear that funds would be managed by the commercial partners, they began to look for ways to raise local costs in order to direct more money into the accounts they controlled. When an Asian diode manufacturer entered the market with a product at half the price of the joint venture's product, it put an end to any possibility of success.
At the other end of the spectrum, in 1995, BSI converted a Soviet torpedo plant in Almaty, Kazakhstan, to Byelkamit, funded in part through the CTR program. In that case, control of the plant was entirely in the hands of BSI, which not only brought in Western management but an existing product line (cryogenic storage vessels) and a European customer base. The strategy did not initially depend on local markets but instead made them a long-term target: Kazakhstan's potential as a globally significant market for oil and gas equipment was promising–and has since proven to be real.
Instead of trying to create a new technology or product, which even in developed Western markets is a highly risky undertaking, BSI management focused on restructuring the plant and training staff and workers to obtain the international quality certifications and efficiencies that would be necessary to win contracts from the Western oil and gas companies investing in Kazakhstan's fields. The approach also made it possible to obtain work from the Energy Department, supplying storage canisters for spent fuel from Kazakhstan's BN-350 breeder reactor.
Tempting the private sector
In addition to the obvious product, market, and management advantages Byelkamit exhibited over Belomo, one other lesson can be gleaned from the company's experiences: Successful private sector involvement in nonproliferation activities requires more than seed capital. Developing markets have historically attracted interest from the developed world because of the perception that with inherently high risks come high returns. The actual record, however, both in more traditional “emerging markets” and particularly in the former Soviet Union, has been one of high risk and low returns.
A distillation column, built by Byelkamit, in Karachaganak, Kazakhstan.
Except in the raw materials sectors, the single most important obstacle facing U.S. and European companies investing in the former Soviet Union today is that they have no credible way to realize a sufficient return on their investment. Local financial markets are too poorly developed for companies to issue shares or sell to a strategic investor. Businesses need to recover their investments and earn a sufficiently high return through profits alone–not a reasonable expectation in the former Soviet Union unless one is asset stripping.
This is where U.S. programs have fallen short of their potential. An efficient and powerful mechanism at the government's disposal is the use of long-term contracts to supply goods or services that, for example, CTR or the Energy Department use in their weapons elimination and Materials Protection, Control, and Accountancy projects. When CTR financed BSI's conversion of Byelkamit, it received in return not only a privatized civilian factory in place of a weapons plant, but a supplier of manufactured goods for other U.S. nonproliferation programs. Imagine if this had been done by design. If CTR had packaged seed capital with long-term contracts from the beginning, it would have guaranteed the joint venture's initial viability and made its long-term growth and survival more likely by providing a core market.
Such contracts would essentially be the lifeblood of the new ventures and, of course, leverage U.S. programs, providing a much higher return on dollars spent in the region.
With time, the ventures would undoubtedly find additional commercial markets for their products and begin a second stage of growth and diversification. At that stage it would be important for the government to find ways to provide low-cost working capital. Because the margins on most industrial manufacturing businesses are low, high interest rates on working capital act as a strong disincentive to investment. Some successful companies, even with a strong flow of contracts from multinational customers or the U.S. government, have to pay interest rates of 12-18 percent for loans. (These are not the rates of opportunistic private banks, but of U.S.-funded aid organizations such as the European Bank for Reconstruction and Development and the Central Asian-American Enterprise Fund.) At the same time, the factory must compete with suppliers from other developing countries who are often willing to sell at cost and have access to subsidized financing. This has resulted in work going to foreign companies, particularly when local content rules are not enforced.
An equally important and no less valuable contribution the government can make to U.S. investors is the deterrence or protection provided by the bilateral treaties under which all threat reduction and nonproliferation programs operate. The extortionist practices of state and criminal structures throughout the former Soviet Union represent a high cost of doing business and a fundamental obstacle to broadening U.S. private sector investment. A high-profile bilateral treaty that explicitly lays out the tax and customs rules for U.S. government-funded ventures is an important safety net for investors. When myriad local government officials come around trying to extort bribes, it helps to show them the bilateral agreements and threaten to go way over their heads to resolve the problem. This costs the government nothing, while shielding the ventures from being squeezed out of business.
Finally, by regularly bringing managers of companies that have succeeded in the former Soviet Union together with U.S. officials who have been part of successful programs, new ventures and government initiatives can benefit from the lessons already learned, reducing costs and increasing the chances of creating commercially sustainable businesses.
The return for the U.S. government on the Byelkamit conversion has been substantial: A large weapons plant has been taken out of the world's supply chain, and permanent commercial jobs have been created in its place. Subsequent U.S. government nonproliferation projects have been able to operate more efficiently and effectively in the region. This experience can be duplicated.
Focus on the workers
Seed money, contracts, financing, and treaties all help conversion enterprises survive, but government programs also need a significant shift in their approach to scientists and developers themselves. If the goal is creating commercially sustainable employment for weapons designers and technicians, U.S. nonproliferation programs should be restructured to focus on the needs of these particular individuals–not the institutes at which they work. Currently, International Science and Technology Centers, the Initiative for Proliferation Prevention, and the Nuclear Cities Initiative (NCI) engage people through their historical employers–state weapons institutes and enterprises. In many cases, this effectively results in providing life-support to the weapons complex, rather than actively supporting a transition to the private sector and economic growth. Under the current system, the mission has crept into underwriting a broad range of research, the value and beneficiaries of which are often unclear, and which might ultimately threaten U.S. national interests.
By far the cheapest way to prevent the proliferation of weapons expertise would be to pension the people at risk and pay to have their activities monitored. Given the nature of their expertise, the Russian FSB (the successor to the KGB) and its counterparts in the other former Soviet republics are no doubt already keeping an eye on them, so the U.S. government should be able to limit its participation to providing them a good life under the circumstances.
If, for political reasons, pensions are not a viable response, the United States needs to buy jobs for these people. The real question should then be how to maximize the return on U.S. funds spent in this area. (The combined 2004 budget request from the Energy, Defense and State Departments for programs aimed at redirecting weapons expertise is a combined $193 million.) Short of developing new businesses to take over plants, the most direct and cost effective first step would be to market the individuals targeted by the programs to U.S. and European firms through head-hunting agencies. The success rate here will probably not be very high because of language and cultural barriers, but the cost is negligible, and it will help reduce the pool of individuals that more expensive programs will have to address.
Next, the International Science and Technology Centers and the Initiative for Proliferation Prevention should expand the range of their programs to allow use of grant funds to pay the salaries of former weapons scientists for work at private companies, as well as directly finance R&D projects they work on as employees of these companies.
In the early 1990s, BSI funded a research proposal on magnetorheological fluids (MRF) from a group of scientists in Belarus. MRF showed promise in a wide variety of commercial applications, from automotive damping devices to optics finishing. After favorable initial research into optics finishing conducted with the University of Rochester's Center for Optics Manufacturing, the project gained interest and further funding from the U.S. government's Small Business Innovation Research (SBIR) program. Researchers went on to develop a commercially viable optics-finishing machine, and BSI funded the startup of a new company, called QED Technologies Inc., to make and market the product. The machine has now been sold to every major manufacturer of high-end optics in the world.
Programs like the Initiative for Proliferation Prevention or NCI should be playing the SBIR role in the former Soviet Union. (At press time, though, the NCI itself was in danger of dissolution, as the United States threatened to let the NCI agreement expire on September 22 unless Russia accepted broader liability protection for U.S. workers and corporations involved in joint projects.) But the U.S. government should be funding the private sector, not the U.S. national labs or the Russian weapons institutes, to create jobs for weapons designers and technicians who pose a serious threat of proliferating weapons of mass destruction. If, at the same time, products can be delivered to other nonproliferation or threat reduction programs, the government will get more for its foreign policy funds. If the program can contribute in some small way to the economic recovery of the region, so much the better.
Indiana Republican Sen. Richard Lugar (center) visits the converted torpedo factory in Kazakhstan, which the Energy Department now contracts for work.
