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Adventures of diamond dilettantes

01 april 2019

In January-February 1959, Moscow hosted the 21st Congress of the Communist Party of the Soviet Union (CPSU). Semyon Borisov, the first secretary of the Yakut Regional Committee of the CPSU spoke at the congress and said literally the following: “One of the most important tasks of the non-ferrous industry in this country, as indicated in the report made by Comrade Nikita Khrushchev, is the organization of the world's largest diamond mining center in Yakutia. Considering the country's need for diamonds, the party organization and workers of this republic decided to increase diamond production by the end of the seven-year period not 14 times as much, but 20 times as much to the level of 1958 production without additional capital investments. Allow me to assure the XXI Congress of the Communist Party of the Soviet Union that our commitment to increase diamond output will be fulfilled and exceeded. (Applause)". After a couple of months, the USSR National Planning Committee headed by Aleksey Kosygin made an adjustment to the effect that diamond production should be increased not 20, but 25 times as much! This figure has been officially set as the target for Yakutalmaz, the company engaged in diamond mining. The USSR unequivocally stated that it was going to exploit the Yakut diamond deposits in the most merciless way and that the country’s newly discovered “hard currency workshop” was ready to flood the world diamond market with freshly mined millions of carats of diamonds.

This new surge of Khrushchev’s insane initiatives coincided with the change of the curator overseeing the diamond industry. Anastas Mikoyan, who had enormous experience in formal and informal negotiations with the Western elite and who understood the diamond market well, was transferred to the diplomatic field and withdrew from the diamond business. At the helm of this industry he was replaced by Alexey Kosygin, a graduate of a textile institute and an absolute dilettante in the diamond sphere, who was mainly engaged in solving the problems of the Soviet light industry under Stalin. In Russian historiography, Kosygin is considered to be a man of faith, reformer and almost an economic genius. No one, however, can deny the fact that all his reforms miserably failed. Kosygin was pulled to the first position in the government’s economic block by Khrushchev - as a reward for loyalty. Stalin, on the other hand, was not of a very high opinion of him - in 1948, he appointed Kosygin as finance minister, but held him in this position for several months only, as the appointee clearly could not cope with the key ministry.

The powerful intensification of diamond mining operations in Yakutia could not but alarm De Beers. The market was clearly not ready to digest such an amount of diamonds, and there was no doubt that these diamonds would be exported — the USSR’s own needs for industrial diamonds did not exceed one tenth of the declared production target. The problem required a quick solution. In the fall of 1959, Philip Oppenheimer, head of De Beers’ Central Selling Organization arrived in the USSR, and the first official contract for the supply of rough diamonds between the USSR and De Beers was signed. Soon after this visit, specialists from the USSR Ministry of Finance started to frequent the leading diamond manufacturing countries to “familiarize themselves with diamond manufacturing.” Based on the results of these missions, numerous reports were presented painted in rosy colors, and in 1961 the USSR Council of Ministers (with Khrushchev as Chairman and Kosygin as his First Deputy) decided to establish the Soviet diamond-cutting industry.

Despite the fact that the above-mentioned reports described diamond-cutting industries in other countries (for example, in Israel) quite adequately, usually as a complex of small (10-15 workers) private enterprises with low profit margins, minimal bureaucracy, low management costs, being responsive to rapidly changing markets, Kosygin decided to create a whopping monster - a network of giant state-owned diamond-cutting factories with thousands of staff. Kosygin was a complete zero in the diamond business, but he was well versed in textile production and from a young age he firmly learned that ready-made trousers always cost more than the material from which they are sewn, and the cost of pants in mass production is always lower than the cost of individual tailoring. So, the Soviet diamond-cutting industry was tailored according to these tailor templates. For the sake of justice, it should be noted that this “outstanding reformer” applied similar ideas to all branches of the country’s industry he managed to reach, which resulted in the deafening “success” of his reforms.

Diamond-cutting factories were built in Smolensk, Kiev, Moscow, Vinnitsa, Barnaul, Gomel, Yerevan and Shakhrisabz. The total number of employees at these factories exceeded 20,000 people, with three managers per worker in core operations. For comparison, there was one manager per eight workers engaged in core operations of the diamond-cutting industry in Israel. There were very strict corporate manufacturing standards developed in the USSR, thanks to which the “yield” of polished diamonds did not exceed 50% (that is, half of rough diamonds supplied to these factories were simply turned into dust).

From its very birth until the end of the USSR, all this diamond-cutting industry was a loss-making business. The efficiency ratio (the ratio of the value of polished diamonds to the value to rough diamonds used to make them) was at best 0.93 (in Israel, it was 1.3). Simply put, "Kosygin" polished diamonds were cheaper than rough diamonds from which they were made. This sad result was convincingly proven by a special experiment conducted by Almazuvelirexport’s employees in 1970, for which they selected two almost identical parcels of rough diamonds (according to an independent estimate, the discrepancy in their value was only 0.5%). One parcel was used by Smolensk-based Kristall to make polished diamonds in keeping with the corporate manufacturing standards, while the second parcel was kept as a control lot. When put up for sale in the free market, the polished diamonds made from the first parcel were estimated at 86% of the rough diamonds’ value in the second parcel. It is curious that this experiment was sanctioned by Kosygin himself and its results were known to him. However, the "reformer" did not take even the smallest steps to remedy the situation.

The Kosygin diamond-cutting monster contributed to the emergence of a black diamond market in the USSR, the cost of fighting which must also be accounted for as losses. Under Stalin, not a single criminal case was initiated on account of embezzlement of or illegal operations with rough diamonds, but after the creation of Kosygin factories, diamond crime came to full blossom bringing about a powerful criminal syndicate, which included corrupt employees of diamond manufacturing factories in Armenia, Ukraine, Belarus, Russia and had extensive international ramifications; the scale of theft resulted in several death sentences. Due to new channels of illegal sale of rough diamonds, criminal elements intensified their activity right in the mining areas in Yakutia and the Urals.

Eventually, the diamond-cutting industry of the USSR receiving supplies of magnificent and expensive rough from Yakutalmaz and UralAlmaz turned a significant part of it into garbage being at the same time generously subsidized from the country’s national budget. In the last years of the USSR, such subsidies exceeded $ 200 million annually, which accounted for up to 25% of the proceeds from the sale of rough diamonds to De Beers. And as soon as the subsidies ceased due to the collapse of the USSR, the Kosygin brainchild instantly drew its last breath. The question of who could benefit from this three-ring circus may be considered rhetorical. Of course, the main beneficiary was De Beers. The Kosygin diamond-cutting industry objectively played the role of a mechanism that reduced the pressure on the global rough diamond market: almost half of the gem-quality diamonds mined in Yakutia went into this abyss, partially turning into dust, while the rest went to the polished market, which – unlike the rough market – was free of monopolistic regulation and where risks and competition were high.

Why did the USSR create such a degenerative industry? Of course, Kosygin was not a De Beers lobbyist: a small-minded business executive, faint-hearted, not too proactive, but generally unselfish. What happened was just a trivial thing: Philip Oppenheimer, being an outstanding diamond business professional (there is reason to believe that it was him who “gifted” the idea of ​​creating a diamond-cutting industry to Kosygin) easily sized up and gracefully outplayed the dilettante. Pants are indeed more expensive than a piece of fabric from which they are sewn, right? Well, if you understand this, why doubt any longer!

However, the historical lesson was not learnt, and in the early 1990s, "sovereign" Yakutia created its own national diamond-cutting industry. The ideological inspirer was Academician Vladimir Larionov, an excellent specialist in metallurgy, but an absolute dilettante in the diamond business. The same old slogan was brought into play: processed goods are more expensive than raw materials. There were established dozens of diamond-cutting factories, which were given tax and financial preferences unprecedented in world practice, and up to a quarter of the then output of ALROSA was supplied to this industry. The result was quite logical: bankruptcy and liquidation. Incidentally, the corruption component in this Yakut project was much more powerful than in Soviet times, but this difference is not important in this context.

The third attempt to step on the same rake was made by way of creating a so-called "Far Eastern diamond cluster". The economic effect of this sluggish adventure is not yet obvious, but something suggests that it will be similar to the previous ones.

The diamond industry, by virtue of its illusory simplicity, often becomes a haven of energetic dilettantes gushing with effective initiatives. Cutting a diamond is not the same as creating a microchip or assemble an aircraft engine, in this case everything is quite primitive, isn't it? The result is that we see endless attempts to get the desired added value from a thriving national diamond-cutting industry, ingenious schemes of “investment diamonds”, diamond-based cryptocurrencies, financial derivatives and other kinds of similar nonsense. Since the time of “outstanding reformer” Kosygin, there have been dozens of such projects in the Russian diamond industry, and the losses they inflicted amount to billions. But lately, the industry has revealed a rather rare type of conservative dilettante aspiring to peculiarly understood basic ways and ignoring revolutionary innovations.

Thus, Evgeny Agureev, Director of the United Selling Organization (USO) of ALROSA, recently was categorical in stating that this Russian company would not deal with synthetic diamonds under any circumstances. Earlier, he also expressed the opinion that the Lightbox project of De Beers affects the industry’s trust. The criticism of Mr. Agureev, whose experience in the diamond business is as much as 2 years, looks very impressive to De Beers, which has been playing the role of industry moderator for a measly 130 years. This is certainly a bright indicator of the powerful potential modern ALROSA has, thanks to which the company has already achieved results that were just unthinkable five years ago.

In fact, Lightbox is a win-win bet: in the case of complete separation of synthetic and natural diamond markets (which is extremely unlikely in our opinion), the project will obviously work to strengthen the “natural” division of De Beers and form an additional profit center, this time in the field of synthetics, which – and this is important – is beyond the zone of political influence projected by resource nationalists in southern Africa. In the event of a merger of these markets and in case certain categories of natural diamonds will be replaced by synthetic diamonds (which is already happening), this project is a way to “bite off” a hefty part of the modernized market using dumping and marketing capabilities of De Beers. And again, this is a great tool to cool the "hotheads" in Botswana and Namibia.

As for trust, there are no problems with this either - a dilettante is always trusted by a professional, since the first one is easy to size up. And it does not matter whether such a dilettante is generating a flood of activity or posing as a conservative, he will definitely get his prize - polite applause from his competitor.

Sergey Goryainov, Rough&Polished