Reevaluating U.S. Defense Conversion Assistance to Russia

Photo by Jonathan McIntosh/Flickr |

By Lisa Bergstrom |

When the agreement with Russia on the Cooperative Threat Reduction (CTR) program, popularly called the Nunn-Lugar program, expired in June 2013, many in the security community eulogized the program’s efforts to secure and dismantle weapons of mass destruction (WMD) and their associated infrastructure in former Soviet Union states.[1] Few retrospectives, however, had much to say about CTR’s short-lived and troubled attempts “to facilitate the demilitarization of defense industries and the conversion of military technologies and capabilities into civilian activities.”[2] From its authorization in 1992 until Congress prohibited it in 1996, such defense conversion assistance was always a small part of a once billion-dollar-a-year program. The Department of Defense (DoD) directly or indirectly funded only about 16 defense conversion projects in Russia and a smaller number in Belarus, Ukraine, and Kazakhstan.[3] Yet, although it was too small to have any significant effect on the overall Russian economy, defense conversion assistance represented an important long-term investment in a former adversary. It was intended to help shrink the economic and political influence of the military-industrial complex, discourage the cash-strapped Russian defense industry from making irresponsible arms sales, and prevent WMD and missile specialists from seeking employment abroad. While Congress may have been premature to remove defense conversion from the CTR mandate, DoD’s approach to conversion assistance was flawed and politically unsustainable from the outset. If the United States provides defense conversion assistance to other overly militarized economies, it should adopt a less centrally-managed approach.

Twenty years after DoD signed the first contract for one of its so-called “Fast Four” Russian conversion projects in 1994, defense conversion assistance deserves another look. By the early 2000s, many commentators, citing the numerous setbacks conversion projects experienced throughout the 1990s, deemed U.S. efforts a failure, and the once extensive literature on Russian defense conversion had dried up. Yet, despite largely negative perceptions, the projects’ success rate compares favorably to estimated U.S. defense conversion success rates. Several projects that were failing in the late 1990s and early 2000s appear to have later become successful.[4] An examination of the U.S. experience in Russia can provide lessons learned for any future defense conversion assistance.

Russia’s Defense Industry and the Soviet Legacy

Russia inherited from the Soviet Union a defense industry unprecedented among industrialized states in its size and share of the economy. At its height, the Soviet defense industry had 2,000-4,000 production enterprises and research facilities, with a workforce estimated from 6.5 to as high as 14 million people.[5] By contrast, U.S. defense industry employment around at the end of the Cold War was1.4-1.9 million people. Estimates of Soviet military budgets as a share of GDP range from 15-25 percent or more, while the U.S. share was 6 percent of GDP at its height.[6] Complicating these estimates is the fact that 20-40 percent of the output of defense enterprises was civilian.[7] Unfortunately, this phenomenon did little to prepare defense enterprises for conversion because civilian work was kept almost entirely separate.[8]

Several features of the post-Soviet defense industry made conversion even more challenging. The Soviet defense industry had always been guaranteed the best personnel and access to resources. As for other industries, the state had provided defense enterprises’ inputs and covered their expenses; thus the enterprises had no capital for investments.[9] Many defense enterprises provided much needed services to their workers and communities, such as health clinics. As a result, two analysts characterized the Soviet defense industry as “arguably the most centralized, geographically isolated, inflexible and least prepared part of the economy for the market transition.”[10] These problems were compounded by a weak internal market and general chaos in Russia, with unclear property rights and regulations.

Swords to Plowshares: A Tricky Transformation

Defense industries generally do not operate in a free market. Defense firms often have only one buyer — the government — for which they often produce relatively few, very expensive items, with cost overruns that would be unacceptable in a more competitive market. Often, governments pay for research, whether the research is successful or not. The Arms Control and Disarmament Agency looked at defense conversion by U.S. firms in reports in 1966 and 1990. Both reports concluded that failures were much easier to find than successes.[11] The 1990 study reported that defense contractors considered about 85 percent of conversion projects “doomed to failure.” Another study for General Dynamics found that 80 percent of commercial acquisitions by defense contractors were unprofitable.[12] The United States’ most successful defense conversion assistance, to Germany and Japan after World War II, does not make a practical model. The defense industries of the defeated powers, “rather than being converted, were destroyed and then rebuilt by benevolent occupiers.”[13]

In general, the U.S. had little luck achieving the post-Cold War “peace dividend.” Even as it assisted Russia in converting its defense industry, the Clinton Administration promoted arms sales as a way to sustain the U.S. defense industry.[14] Many enterprises had to merge into or be acquired by other defense companies. Some, like Raytheon, tried and failed to diversify. However, while defense employment did decline, as a whole the U.S. defense industry managed to weather the 1990s intact until the War on Terror brought higher military spending.[15]

Russia Attempts Defense Conversion

Moscow tried several strategies for defense conversion: assigning more civilian production to defense enterprises in the late 1980s; cutting off most state support in the “shock therapy” of 1992; and a more gradual approach for the rest of the 1990s.[16] No strategy was particularly successful. Russian officials estimated conversion would cost $150 billion, twice Russia’s GDP in 1992.[17] Yet, the government could afford very little conversion funding and often did not pay for its arms orders, depriving defense enterprises of capital.[18] Defense production plummeted: in 1992 it was at 62 percent of 1991 production levels, reaching as low as 13 percent of 1991 production in 1997, before gradually rising. But Russia’s civilian production, including that at defense plants, also fell to 37 percent of 1991 production by 1998.[19] Defense enterprises did not convert to civilian production; civilian production simply fell less fast. One institute wrote in 1996, “Instead of defense conversion, what we are witnessing is the destruction of the military-industrial complex.”[20] Russians were justified to call it defense konvulsiya instead of konversiya.

Many defense officials and nationalist politicians touted foreign arms sales rather than conversion as their salvation, but were mostly disappointed. Russia’s arms procurement budget fell 68 percent as part of shock therapy, forcing the Kremlin to promote arms exports both as a source of funding for conversion and as its own business.[21] Proponents mistakenly claimed increasing arms sales would be easy, since the Soviet Union sold many billions of dollars of cheap, decent-quality weapons in the 1980s. However, the Soviet defense industry never paid market value for its inputs, the Soviet Union gave a quarter of its arms exports to allies for free, and the global market had declined.[22] Exports did climb in the 1990s, but much of the rise came from old stocks and sales, and did not reach the level needed to subsidize the defense industry or fund conversion.[23]

Although the Russian defense industry has shrunk greatly since the Cold War, it seems to have found more success in waiting out the downturn than in actually converting. In 2009, the sector employed 2.5-3 million people, 20 percent of industry employment, though it faces an aging workforce and solvency problems.[24] Arms exports totaled a post-Soviet record of $15.2 billion in 2012. Domestic weapons procurement is also increasing. Putin is planning $700 billion in arms spending by 2020. In 2012, he fired a defense minister who had refused to buy certain poorly-made Russian weapons.[25] While the Russian military needs modernization, the petro-dollar-derived spending is largely aid for defense enterprises and their blue-collar workers, the sort of voters who form Putin’s political base.

U.S. Assistance

Congress first authorized DoD to transfer up to $40 million for defense conversion in the Former Soviet Union Demilitarization Act of 1992. The Cooperative Threat Reduction Act of 1993 provided new appropriations for defense conversion assistance, along with environmental restoration of former military sites, housing for demobilized officers formerly responsible for strategic nuclear forces and other programs. The law also established a private, non-profit Demilitarization Enterprise Fund (later the Defense Enterprise Fund, DEF) to invest in conversion projects with government and private capital. Unlike most CTR programs, defense conversion was not limited to WMD capabilities. DoD’s list of 150 eligible enterprises in the former Soviet Union covered those engaged in the development or production of WMDs and their delivery systems, subcomponents, command and control, and strategic defenses; thus the list included conventional capabilities.[26]

The United States supported defense conversion to prevent defense workers from selling their skills abroad (particularly important in the case of WMDs) and to improve economic, and thus political, stability. The Clinton Administration also argued that expanding the CTR mandate to defense conversion, housing and environmental restoration would help convince Ukraine, Belarus, and Kazakhstan to give up the nuclear weapons they inherited.[27] Many Russian defense enterprise managers were eager to work with their former adversary. One researcher who interviewed defense managers in 1992 found that many had $100 million research proposals to offer U.S. firms.[28]

DoD provided defense conversion assistance to Russia through two main programs: a set of projects sometimes called the “Fast Four” and the DEF.[29] This does not include Department of Defense, State, Energy, or Commerce programs to repurpose only nuclear, biological, or chemical weapons facilities; programs to redirect individual scientists; or economic assistance not specific to defense conversion.[30]

The first round of conversion assistance was the Fast Four: four streamlined, model conversion projects that could smooth the way for the U.S. private sector to operate in the unfamiliar Russian environment.[31] In consultation with the Russian government, DoD selected four Russian defense enterprises and asked US companies to submit bids for joint projects. DoD wanted to begin the projects as quickly as possible, which precluded building relations between the U.S. and Russian firms before the projects. In June and July of 1994, DoD signed contracts worth $16.9 million with four U.S. businesses.[32]

Of the four projects, two could be considered successful. The first failed miserably because DoD paired NPO Mashinostroyenia, one of Russia’s most famous military design bureaus of missiles and space rockets, with a U.S. cola maker, an insultingly low-technology enterprise.[33] Out of 17 U.S. bidders, DoD chose the Double Cola Company of Tennessee to convert Mashinostroyenia’s nitrogen building into a cola bottling facility.[34] Though other bidders had proposed projects based on the institute’s space and missile technologies, DoD awarded the $5.1 million contract using its standard practice of taking the lowest bidder.[35] In the end, the two sides could not reach agreement. Double Cola asked to be released from the contract, which DoD canceled after having disbursed only $195,000. Another project had some early success remanufacturing dental chairs, but ran out of funds to complete investments.[36] A third had early difficulties finding customers, but later transformed into a successful hearing aid company.

The final project was a qualified success, though it employed only between between 10 and 60 Russian defense workers.[37] DoD awarded Rockwell International Corp. a $4.1 million contract for a project, not a joint venture, with the State Scientific Research Institute of Aviation Systems (GosNIIAS). GosNIIAS was to modify hardware and software for a satellite-based air traffic control system intended for the Russian market. This was the only Fast Four project to develop a commercial spin-off of a Russian firm’s military technology. Such high-tech spin-offs were the favorite type of joint project for defense workers and Russian officials, because it leveraged Russia’s proud scientific-technical achievements and improved Russia’s access to high technology. The firms sought a Russian government contract for their system, which could have been worth $80-100 million and created 200 jobs at GosNIIAS.[38] They did not get the contract, which led some commenters to consider the project a failure. However, Rockwell was pleased enough to create a long-term partnership with GosNIIAS, and GosNIIAS later worked on civilian projects with other western companies.[39]

After the Fast Four, DoD provided conversion assistance through the DEF. Established in 1994, the DEF was one of eleven enterprise funds created to promote private enterprise in former Soviet bloc states. All were independent, non-profit entities receiving government funds and government oversight; very few managed to attract private capital (the DEF was not one).[40] Although DoD had proposed $118 million for the fund, it could only obligate $51.7 million before Congress denied additional CTR funding for the DEF in early 1996. A final $15 million in FY1997 from the State Department’s Freedom Support Act funds brought DEF funds to $66.7 million. The DEF provided loans or equity financing worth $38.3 million in about twelve projects in Russia and a few in Kazakhstan and Ukraine.[41] Early DEF investments were often low-tech goods, while later investments focused on telecommunications and did not require Western partners. The change in strategy did not improve returns, due to both the deteriorating Russian economy and DEF mismanagement, detailed below.[42] At least seven projects failed outright, though it can be difficult to distinguish a failure for the DEF itself from a failure for conversion. For example, RAMEC, a personal computer producer, defaulted on its loans to the DEF but is still in business today. Another venture lost the DEF over $1 million but laid 600 km of cable in Russia.[43]

The legislative mandate for defense conversion assistance was short-lived. Congress banned the use of CTR funds for defense conversion in the FY1997 Defense Authorization Act, along with job retraining and environmental remediation. Projects that had already begun could continue, and the DEF continued investing its funds. The FY2000 Defense Authorization Act made the restrictions permanent.

Congressional critics believed the United States was subsidizing Russia at the expense of funding defense conversion and other U.S. projects. They also claimed the assistance was not effective, since most facilities were already dormant before conversion. (The Clinton Administration argued fruitlessly that converting dormant facilities would reduce Russia’s need to reopen these plants to rearm itself or export arms abroad.[44]) DoD, however, did little to persuade Congress, because the department was not very supportive of defense conversion, outside of a few high-level officials like Secretary William Perry.[45] Moreover, the U.S, not fully trusting Russia, kept many of the Cold War export restrictions in place. Russians expected joint ventures with the United States would give them access to U.S. high-technology but found instead that Russia became a source of low-cost research and development for U.S. firms that, for legal and financial reasons, would not share their own technology.[46] The slow progress of job creation led more Russians, in particular the security services, to suspect the U.S. was merely interested in spying or destroying Russia’s military power. This suspicion made Russia less cooperative, which in turn strengthened skeptics who argued western assistance merely freed up money for Russia to spend on its military.[47]

The DEF’s troubles did not end when its government funding ceased. Allegations of bribery and mismanagement from a whistleblowing employee set off a criminal investigation in autumn 2000. A devastating DoD audit from December 2000 found the DEF spent $32.6 million of $66.7 million on management costs; had no performance goals; and had no long-term plans.[48] A 2001 audit found that, had DEF funds been subject to the same cost principles as other non-profits with government funds, at least $2.2 million of its expenses would have been unallowable, including $106,800 in Moscow country club fees.[49] By September 2000, the DEF’s net value including investments was only $15.2 million, though some of this decline was due to the 1998 bank crash. The DEF closed in 2003, its money gone.[50]

A Better Way?

Although U.S. conversion assistance was deeply flawed, the program garnered more success than it was given credit for. DoD spent about $88 million on defense conversion projects in four former Soviet countries, creating nearly 4,000 jobs, which was not enough to do more than effect Russian defense conversion at the very margins.[51] Six Russian projects appear to have become long-term successes for defense conversion, though not always successes for their investors. Sharon Weiner, who is highly critical of U.S. conversion assistance, looked at all DoD conversion projects in the former Soviet Union and concluded, “Thirty-four defense conversion projects resulted, of which twelve were at least initially successful, nineteen failed, and the fates of three are not known.”[52] Twelve of thirty-four is a success rate of 35.3 percent; this is better than the 15 percent of conversion projects defense contractors estimated might be successful in the United States. Moreover, DoD projects had the added difficulty of operating in a post-Communist economy.

The relative and limited success of conversion assistance does not mean the United States should repeat its Russian experiences in other demilitarizing countries. A high rate of failure and the many years business ventures often take to become profitable meant that DoD defense conversion projects were ill-suited for the vagaries of Congressional politics. Defense conversion is a long-term endeavor and projects are unlikely to reach success fast enough to please Congress. Converting nuclear or biological weapon facilities may make sense even when economically unsound, however, because these workers have rare skills of interest to terrorists and rogue states. Therefore, these types of programs should still be funded.

A better program might have used loan guarantees and tax incentives to encourage U.S. businesses to start joint ventures with Russian defense enterprises. Such an approach would let partnerships develop naturally and would avoid such high-profile failures as the cola-bottling venture. Other U.S. programs did try different approaches to conversion assistance. For instance, the Commerce Department’s SABIT program provided management training to executives in the former Soviet Union, including for defense conversion, and it still operates.

Few countries today have a militarized economy to the extent that the Soviet Union had, making it unlikely the United States will find itself needing to provide defense conversion assistance anytime in the near future. However, defense conversion has economic, political, and social benefits, and may even promote the peaceful resolutions of conflicts by reducing the size of a group of people likely to support excessive arms procurement and exports. Furthering that conversion is in the long-term U.S. interest. Future planners of conversion assistance should bear in mind that such centrally- managed initiatives as the Fast Four are ill-suited to bringing defense enterprises into the free market. n

Ms. Bergstrom is an MA candidate in the Security Studies Program at Georgetown University’s Edmund A. Walsh School of Foreign Service. Her main academic interest is the study of policy related to science and technology in the context of international security.