There were weighty reasons of state why this resistance was ignored. Russia had no choice but to industrialize. Witte, the Minister of Finance and chief advocate of industrialization, made his case largely in political and military terms, because he knew that they would appeal to Nicholas II. In February 1900, in a memorandum to the Tsar, he argued, consciously or unconsciously echoing the nineteenth-century German political economist Friedrich List, that
without her own industry [Russia] cannot achieve genuine economic independence. And the experience of all nations indicates palpably that only countries which enjoy economic independence have also the capacity fully to unfold their political might.*
To prove his point, Witte pointed to China, India, Turkey, and Latin America.
Persuasive as this argument was, fiscal exigencies were even more so: Russia urgently needed capital to balance the budget, to broaden the revenue base of the Treasury, and to ease the tax burden of the peasant. The alternative was state bankruptcy and possibly widespread agrarian unrest. Thus fiscal considerations overrode the interests of internal security, pushing the Imperial Government to take the “capitalist” road with all its social and political consequences.
Russia has suffered chronic budgetary deficits ever since the middle of the nineteenth century. There were the immense costs of serf emancipation, the provisions of which committed the government to advance the landlords 80 percent of the value of the land given to their ex-serfs: this money the peasants were supposed to repay over forty-nine years, but they soon fell into arrears. Then there was the costly Balkan War of 1877–78, which caused the Russian ruble to lose 60 percent of its value on foreign exchanges. The government also incurred heavy expenses in connection with its involvement in railroad construction.*
Russia lacked the capital to meet such expenditures. Her revenues rested on a very narrow basis. Direct taxes in 1900 accounted for only 7.9 percent of state income, a fraction of what advanced industrial countries drew from this source. The bulk of the revenues derived from taxes on consumption: sales taxes and customs duties (27.2 percent), proceeds of the liquor monopoly (26 percent), and operations of railways (24 percent). This covered the ordinary expenses but not the military outlays and the costs of railroad construction. Russia partly made good the deficit with sales of grain abroad: in 1891–95 she exported on the average 7 million tons of cereals a year, and in 1902, as much as 9.3 million.60 Most of the revenue, directly and indirectly, came from the peasant, who paid a land tax as well as taxes on articles of necessity (salt, matches, kerosene) and vodka. In the 1870s and 1880s, Russian Finance Ministers obtained the money with which to try to balance the budget mainly by increasing taxes on articles of consumption, which had the effect of forcing the peasant to sell grain that the government then exported. The famine of 1891–92 made clear the limits to such practices: the peasants’ ability to pay, it was now acknowledged, had been exhausted. Fears arose that the continuation of the policy of squeezing the peasant could lead to chronic famines.
On taking over the Ministry of Finance in 1892, Witte adopted a different policy: rather than squeeze the countryside, he borrowed abroad and worked to increase the country’s wealth through industrialization. The development of productive capacities would, he was convinced, improve living standards and, at the same time, enhance government revenues.61 He had initially believed that Russia could raise the capital for her industrialization at home, but he soon realized that domestic financial resources were insufficient62—not only because capital was in short supply but because affluent Russians preferred to invest in mortgages and government bonds. The need for foreign loans became especially pronounced after the crop failures of 1891 and 1892, which forced a temporary curtailment of grain exports and resulted in a fiscal crisis.† Russia’s foreign borrowing, which until 1891 had been on a modest scale, now began in earnest.
To create the impression of fiscal solvency, the Imperial Government occasionally falsified budgetary figures, but its main device to this end was a unique practice of dividing the state budget. The expenses comprised under the “ordinary” budget were more than covered by domestic revenues. Those incurred in maintaining the armed forces and waging war, as well as building railroads, were treated as “non-recurrent” and classified as “extraordinary.” This part of the budget was met from foreign borrowing.
To attract foreign credit, Russia required a convertible currency.
By maintaining in the 1880s a foreign trade surplus, largely with the help of grain exports, and by intensive gold mining, Russia managed to accumulate enough bullion to adopt in 1897 the gold standard. This measure, carried out by Witte in the teeth of strong opposition, made the paper ruble convertible on demand into gold. It attracted massive foreign investments in state obligations as well as securities. Stringent rules on bank-note emissions and an excellent record of debt servicing earned Russia a high credit rating, which enabled her to borrow at interest rates only slightly above those paid by Germany (usually 4 or 4.5 percent). The bulk of the foreign money—four-fifths of that invested in state bonds—came from France; the remainder was supplied by British, German, and Belgian investors. In 1914, the total debt of the Russian Government amounted to 8.8 billion rubles, of which 48 percent or 4.2 billion ($2.1 billion or the equivalent of 3,360 tons of gold) was owed to foreigners: at the time, it was the largest foreign indebtedness of any country in the world.63 In addition, in 1914 foreigners held 870 million rubles of state-guaranteed securities and 422 million rubles of municipal bonds.
Fiscal needs also drove the government to encourage industrial expansion as a means of broadening its tax base. Here, too, foreign capital flowed readily, for European investors believed that Russia, with its huge population and inexhaustible resources, needed only capital and technical know-how to become another United States.64 Between 1892 and 1914, foreigners placed in Russian enterprises an estimated 2.2 billion rubles ($1.1 billion), which represented approximately one-half of the capital invested in these enterprises during the period.65 The largest share (about one-third) of these investments went into mining, mainly petroleum and coal; the metalworking, electrical, and chemical industries as well as real estate also benefited. French capital accounted for 32.6 percent of that money, English for 22.6 percent, German for 19.7 percent, and Belgian for 14.3 percent.66 Witte estimated in 1900 that approximately one-half of all Russian industrial and commercial capital was of foreign origin.*
Such heavy foreign involvement in the economy led conservative and radical opponents of Witte alike to claim that he had transformed Russia into a “colony of Europe.” The charge had little merit. As Witte liked to point out, foreign capital went exclusively for productive purposes† —that is, enhancing Russia’s productive capacity and therefore her wealth. It was in large measure owing to the growth of the non-agrarian sectors of the economy, made possible by the infusion of foreign capital, that the revenues of the Treasury between 1892 and 1903 more than doubled (from 970 million to 2 billion).67 It has also been pointed out that foreign investors did not simply “milk” the Russian economy by repatriating their profits, but reinvested them, which had a cumulatively beneficial effect.* In this connection, it is often ignored that the economic development of the United States also benefited greatly from foreign investments. European investments in the United States in mid-1914 are estimated to have been $6.7 billion.† twice the capital invested by Europeans in Russia. “In considerable measure the funds for the national expansion and development [of the United States],” writes an economic historian, “had been obtained from abroad.”68 And yet the role of foreign capital is rarely mentioned in American histories and never led to charges that it had made the United States a “colony” of Europe.