Toward a Russian market economy

Table of contents

1. Introduction

2. Russian transformation – a positivist view

3. Shock therapy and the fear of partial reform

4. Partial reform and its deeper origins: the weight of history

5. Conclusion: Russia’s prospects for the future

6. Bibliography

1. Introduction

Transforming the decrepit Soviet command economy into a competitive market system with free prices and private ownership certainly belongs among the Herculean tasks of 20th century policy making. The reforms initiated since 1991 were pragmatic in their conceptual approach but ultimately driven to a large extent by idealistic zeal on the part of those who designed them. This idealism was not only reflected in the intention to “building capitalism”^[1] but, in doing so, also to create a stable democracy and, hopefully, what Boris Yeltsin once called a “normal society.” Fifteen years into Russian independence, a look back at the transformation period shows an ambiguous picture. Wide-ranging reforms were implemented indeed. However, they came at a high price and produced all sorts of unintended consequences. As Hedlund notes, “it was clearly beyond doubt that the Russian state at the time of Yeltsin’s departure was in deep trouble.”^[2] In short, that great edifice “capitalism” turned out to have a tilted foundation. Hedlund goes as far as claiming that Russia’s market economy in fact constitutes a “bad case of predatory capitalism.”^[3] If this assertion is actually correct, the question remains as to how an allegedly meticulous plan to “build capitalism” from scratch has borne a result that does not match the high expectations of the reformers. More specifically: is “predatory capitalism” to be considered simply an aberration of an essentially beneficial transformation scheme or was the predatory element built-in, suggesting a fundamentally flawed approach to reform? If so, what were the underlying reasons for a suboptimal outcome? There are several possible interpretations that lend themselves to further analysis, two of which seem especially salient. First, it could be argued that the reform process was one-dimensional, focusing too strongly on purely economic issues while losing sight of others (such as institution building and fostering social unity) that are equally crucial components in the emergence of a strong state. Second, and on a more fundamental level, one could ask whether the notion of „building capitalism” is valid in the first place. The statement itself implies that by following a prescriptive economic methodology, this highly complex construct, capitalism, can actually be built, a bold claim indeed. As will be shown later, there were too many intervening factors effectively rendering the idea of a linear approach to transformation questionable at best.

It is these questions and assumptions that we wish to answer and test in the following pages. The story told by radical reform advocates is compelling in the sense that it is cogent within the limited confines of economic logic. However, it is not exhaustive. Rather, it should be regarded as a snapshot view from a very specific – and in particular: an ahistorical – perspective. We will contrast this perspective with an alternative interpretation of reform that takes into account exogenous factors, namely culture and history. As Hedlund suggests, “there are good reasons why economics in particular would be insensitive to the highly specific conditions that marked Russia’s attempted economic transition.”^[4] We will begin our remarks with a short overview of the transformation process according to the positivist view of the economist and radical reform advocate Anders Åslund. The purpose of the discussion is not to merely recapitulate the chronology of transformation but rather to point out the underlying assumptions on which economic policy rested. These are crucial for understanding why reform deviated from the path forecasted by the proponents of radical reform. In a second step, we will attempt a critical appraisal of theses assumptions and look at some of the adverse implications that followed from them. Third, a different interpretation of the transformation process will be introduced that puts path dependence at the center of analysis, putting the approach taken by radical reformers in a different light. Finally, as a concluding remark, we will briefly go into the practical consequences as implied by the two different approaches regarding the strength and stability of the Russian Federation, the prospects for liberal democracy, and the prospects for an effective market economy.

2. Russian transformation – a positivist view

The economic legacy Mikhail Gorbachev left to Boris Yeltsin in December 1991 was disastrous. As the Soviet Union started to disintegrate politically in the late 1980s, the economy had increasingly deteriorated. The domestic product was continuously shrinking, accompanied by “ever greater wastage and inefficient use of resources.”^[5] The USSR member states had started to withhold tax revenues from the central government. The state, in turn, was still sending subsidies to enterprises, but it was getting less and less in return. Additionally, once the Russian company directors were allowed to make their own budget decisions, they started lining their own pockets and those of their workers. Between 1989 and 1991 wages had been allowed to rise significantly to three times their normal rate, and social benefits were increased 25% in 1991 alone.^[6] The combination of rigid prices, falling production and continuous printing of money fuelled rampant inflation. All these developments put immense pressure on the budget deficit which jumped to over 30% of GDP in 1991 up from 2% at the beginning of Gorbachev’s tenure as Secretary General. Not surprisingly, the USSR defaulted on all its debt by the end of the year. The economy had totally spun out of control.

Such were the circumstances when president Yeltsin took charge of the economic policy of the Russian Federation. While the political reforms introduced by Gorbachev had been radical at the outset (even if in the end not decisive enough), the economic ones were piecemeal and eclectic. Although the Party had officially started to discuss a possible transition to a market economy under Gorbachev, the existing proposal for such a transition was rejected, and no comprehensive and structured reform did ever emerge. Yeltsin, in turn, saw himself as a true revolutionary in the long tradition of Russian history and was intent on approaching the topic vigorously:

“I turn to you with determination to stand unconditionally on the road of profound reforms and for support of this determination by all strata of the population…The time has come to act decisively, firmly, without hesitation…The period of movement with small steps is over…A big reformist breakthrough is necessary…The goal I have set before the government is to make reform irreversible.”^[7]

Hedlund makes the interesting observation that “there is a striking parallel between Lenin and Yeltsin, in the sense that both were possessed by a determination to undertake a complete break with the past, and to start with a clean slate.”^[8] Indeed, and in accordance with Yeltsin’s decision to become the political icon for a new Russia, standing on a tank in front of the Russian White House on 19 August 1990, personifying Russia’s liberal spirits that were revolting against its old communist leaders, and running for the post of first democratic president of Russia, he was also convinced that this was his chance to radically change the economic system and ban the communists from return, by effectively abolishing the dilapidated economic remains of their seventy year rule. In this grand scheme of a sweeping politico-economic adjustment, every single privatized firm would become a visible banner against communist ideology, and every newly endowed owner of private property would become a proponent of the capitalist system. The enormous task of transferring state property into private hands was conferred upon a group of young Russian reformers, most prominently Yegor Gaidar, Anatoly Chubais and Boris Fedorov, who were assisted by a group of Western economists. They shared Yeltsin’s strong views on the validity and viability of a radical approach to transformation, albeit for different reasons. While the Russian president, in his intent of leaving a revolutionary legacy behind, was interested in radicalism as such, the reformers more narrowly believed in the powers of neoclassical economics. Both, however, intended a clean break with the past in order to create a new functioning Russia. As a side note, it is interesting to read what sources cited by Hedlund have to say about the relationship between the president and the radical reformers: “[…] the kind of economic reform approach that was initiated under Yeltsin placed economics in the service of his political agenda.”^[9]

It is not the aim of this chapter to retell the transformation process in detail. Instead, we will try to focus on the underlying assumptions that guided economic policy and refer to specific events to illustrate our points when necessary. Suffice it to say at this point that the initial reform push between 1991 and 1994 followed a “familiar stop-and-go pattern”^[10] with advances and backlashes following one another in short intervals. The reformers were chiefly concerned with three major elements of transformation: creating a liberalized market economy, achieving macroeconomic stabilization and implementing large-scale privatization of the enormous public sector. In effect, these elements constituted a “sequence of many distinct choices over time on separate components of an overall reform.”^[11] The paramount question was – and still remains contested – to choose between two omnibus reform programs: whether reform should proceed radically or gradually. For the economists in charge of Russian transformation, the answer was clear. They opted for an approach that became known as “shock therapy.” Åslund provides one explanation for this choice, namely that “the deeper the systemic crisis, the more radical the influential economic thinkers.”^[12] Considering the Russian economy’s severe state at the end of 1991, this generalization can certainly not be refuted outright. However, apart from the specifics of the Russian case, there were a number of explicit early advocates of radical reform, such as Leszek Balcerowicz, Jeffrey Sachs and David Lipton who strongly influenced the thinking of the aspiring Russian reformers. The former had pioneered the Eastern European transformation process with the successful implementation of a “big bang” in Poland that set the precedent for the dismantling of communist economies. This was positive in the sense that it set the ball of reform rolling and encouraged other Socialist countries to follow suit. However, the Polish example had the unintended disadvantage of conjuring up a fallacy. It was readily assumed in other economies that the Polish reformers’ “prescriptions applied for other countries in similar predicaments.”^[13] As we shall see later, this assumption characteristic for the bulk of development economists was highly problematic.

What, then, was the essence of radical reformist thinking? First of all, the Russian reformers emphasized speed and comprehensiveness in conducting economic policies. This stemmed from a concern to reach critical mass as soon as possible, thus making the reforms effectively irreversible and preventing a backlash.^[14] In view of the great uncertainty among the population, the need to form a social consensus was dismissed outright. It would only slow down the pace of reforms.^[15] The gradualist approach, in contrast, was much more skeptical regarding the benefits of market forces. Rather, slow liberalization and privatization were seen as a trade-off to make reforms politically possible. This view strongly contrasted with the radical reformers’ second major concern, namely the persistence of rent seeking behavior and corruption at large. Gradual reforms, according to the radical critique, would leave too much room for personal enrichment, graft and inefficient economic activity, thereby harming economic performance. Closing as many loopholes as possible by implementing reform quickly and comprehensively was seen as a compelling answer to this problem. Poland, Czechoslovakia and Estonia were the role models of choice, as they had implemented consistent radical reform programs swiftly.^[16] The bottom line of radical reformist thought, then, was that shocks were vital for economic transition.^[17]

[...]

^[1] A. Åslund, Building Capitalism. The Transformation of the Former Soviet Bloc (Cambridge: University Press, 2002).

^[2] S. Hedlund, Russian Path Dependence (London, New York: Routledge, 2005), p. 6.

^[3] S. Hedlund, Russia’s “Market” Economy. A Bad Case of Predatory Capitalism (London: UCL Press, 1995).

^[4] Hedlund (2005), p. 7.

^[5] Åslund (1995), p. 41.

^[6] J. Blasi, Maya Kroumova and Douglas Iten, Kremlin Capitalism. Privatizing the Russian Economy (Ithaca: Cornell University Press, 1997).

^[7] Åslund (1995), p. 64.

^[8] Hedlund (2005), p. 265.

^[9] Hedlund (1999), p. 145.

^[10] J. Hellman, “Winners Take All: The Politics of Partial Reform in Postcommunist Transitions,” World Politics 50.2 (1998): 215.

^[11] Hellman, p. 222.

^[12] Åslund (2002), p. 75.

^[13] Åslund (2002), p. 77.

^[14] Åslund (2002), p. 79.

^[15] Åslund (2002), p. 82.

^[16] Åslund (2002), p. 109.

^[17] Åslund (2002), p. 441.