The transformations Russia underwent in the 1990s were nothing short of extraordinary. Almost overnight, the former Soviet Union (USSR) changed from a communist dictatorship into a multiparty democracy with regular elections. Its centrally planned economy realigned to a capitalist order based on markets, free enterprise and private property. These were significant changes, but for many Western experts and observers, they were perhaps too much, too fast.
Today, the 1990s decade is recalled not as much for Russia’s economic reform, but rather for the associated crime and corruption that haunted those years. Journalists and politicians often describe the country as a collapsed and criminal state, pointing to the huge disparities in income and living standards among its people that the reforms have allegedly caused. According to statistics published by Russia’s Higher School of Economics, 75% of the population disapproves of the 1990’s privatization program and demands revision. According to a recent report by Credit Suisse, the “oligarchs,” or Russia’s richest 1%, own 30% of the entire population’s personal assets, a massive disparity in wealth that is purported to have held back Russia’s economic growth from its true potential, and for which the rapid transformations of the 1990s, and particularly the way in which they were executed, are often held responsible.
This article takes a retrospective look at these historically significant transformations, particularly privatization, that Russia went through during the 1990s, analyzing the various ways in which they have affected the Russian economy. While privatization, in principle, made the Russian economy more efficient, the way in which it was executed tarnished the perceptions of economic agents about the new, liberalized system, and therefore the trust they placed in it.
The situation that Boris Yeltsin inherited from Mikhail Gorbachev, USSR’s last leader before the Union’s dissolution in June 1991, was disastrous. Ever since the 1970s, the USSR had been losing its economic power at the world stage. GDP per capita was steadily declining and living standards were falling. According to the CIA World Factbook, by 1990, USSR’s GDP was less than half of the United States’. These negative trends worsened in the USSR’s final years, 1989 and 1990, during which the country witnessed declines in output, huge shortages and fears of a complete economic and political collapse. According to a 2002 paper by Leon Aron, in 1989, the average citizen spent 40 – 68 hours a month standing in line, reflecting the difficulty to acquire even the most basic consumer goods in Russian markets. In April 1991, less than one in 8 respondents to an opinion poll said that they had recently seen meat in state stores, and less than one in 12 had seen butter. In fall 1991, CNN predicted widespread starvation for the coming winter, making the need for a drastic overhaul of the economy all the more urgent.
In October 1991, two months before the official collapse of the Soviet regime and two months after the August 1991 coup against the Gorbachev regime, Yeltsin and his advisers, including reform economist Yegor Gaidar, established a program of radical economic reforms. The program was ambitious, and the record to date indicates that the goals for macroeconomic stabilization and economic restructuring programs may have been unrealistically high.
The program laid out a number of macroeconomic policy measures to achieve stabilization. It called for sharp reductions in government spending, targeting outlays for public investment projects, defense, and producer and consumer subsidies. The program aimed at reducing the government budget deficit, imposing new taxes and controlling inflation. Crucially, the reformers planned to liberalize trade and make the ruble convertible, thus opening up Russia’s economy to the world.
In January 1992, most prices were liberalized. Queues disappeared and goods reappeared in stores. A mass privatization program, implemented during 1993–1994, transferred shares in most firms from the government to their managers and workers, as well as the general public. By mid-1994, almost 70 percent of the Russian economy was in private hands. In 1995, with the help of the International Monetary Fund, Russia stabilized the ruble. In just a few years, Russia’s economy had undergone a complete turnaround and had put the necessary reforms in place to progress rapidly towards economic liberalization and stability, or so it seemed on paper.
Implementing these reforms, however, proved extremely difficult, as Professors Andrei Shleifer and Daniel Treisman, of Harvard University and UCLA respectively, argue in a 2005 paper. The parliament had entrenched industrial interests and resisted almost every measure of reform. As part of the 1996 political campaign, and in an attempt to balance the budget, Yeltsin agreed to a “loans-for-shares” program, whereby some valuable natural resource enterprises were turned over to major businessmen in exchange for loans to the government. As Shleifer and Treisman write, this highly controversial program accelerated the consolidation of a few large financial groups, led by the so-called “oligarchs,” who wielded great political and economic influence.
Economic Growth under Oligarchical Capitalism
In a 2002 paper, Joseph Stiglitz, an economist and professor at Columbia University, accuses the oligarchs of stripping assets from the companies they acquired and hence depressing investment and economic growth. Undeniably, Russia’s big business is indeed dominated by a few tycoons. Yet, this is quite common for most developing capitalist economies and middle-income countries such as Brazil, Mexico and Malaysia. As La Porta, the Nobel Foundation Professor of Finance at Dartmouth College, and Shleifer point out in their 1999 paper, even in most developed countries the largest firms are either state or family controlled. This inevitably suggests close ties to politics, with big businesses receiving large loans and subsidies from the government.
Have Russia’s oligarchs depressed economic performance? Russia’s tycoons, like those elsewhere in the developing world, grew rich in part through deals with the government. But as Shleifer and Treisman argue, the claim that this accounts for poor growth in Russia is irrational. Russia’s sharp decline in official output came before, not after, the oligarchs emerged on the scene in 1995–1996. A few years of stagnation were followed by rapid growth. In fact, oligarch-controlled companies have performed extremely well, far better than many comparable companies that remained under the control of the state or their Soviet-era managers. Such companies were, in fact, responsible for much of the dramatic increase in Russia’s output in the following years, as well as the astonishing stock market boom. Consider three of the most notorious cases: through “loans-for-shares,” Mikhail Khodorkovsky (now in prison) obtained a major stake in the oil company Yukos, Boris Berezovsky (now in exile) won control of the oil company Sibneft along with his then-partner Roman Abramovich, and Vladimir Potanin acquired the nickel producer Norilsk Nickel. Between 1996 and 2001, the reported pretax profits of Yukos, Sibneft and Norilsk Nickel rose in real terms by 36, 10 and 5 times respectively, according to Russia’s Ekspert database, pulling the Russian economy upwards as they grew.
That Russia’s privatization increased living standards and benefited the economy is hard to argue against. As Sergei Guriev, the Rector at the New Economic School in Moscow, and Aleh Tsyvinski, a Professor of Economics at Yale University pointed out in a 2011 article, market competition, private enterprises and responsible macroeconomic policy generally lead to increased efficiency and growth in the economy. Indeed, Russia’s economic reforms eventually resulted in historically high growth rates. According to Rosstat (Russian Federal State Statistics Service), the number of cars per capita quadrupled between 1991 and 2011. As a result of trade liberalization, Russia foreign trade grew from 3-4% of GDP in the 1980s USSR to 44% in 2012.
Moreover, although high commodity prices played a part, privatized and new enterprises were the fastest-growing segment of Russia’s post-communist economy, and the government played an important role by maintaining a balanced budget, providing macroeconomic stability and using oil revenues to create significant foreign-currency reserves. The major cog in this economic drive was, indeed, the privatized industries.
Privatization: Efficiency vs. Equality
“Unlike the Czech Republic and Poland, privatization in Russia did not result in a change of elites … The Soviet elite was strong enough to keep hold of power even after the collapse of the USSR, and rational enough to choose privatization as a method to preserve this power and legitimize the new form of it, thus exacerbating inequality.”
Increased efficiency, however, wasn’t the only effect privatization had on the economy. It has been said that Russia’s economic reforms, such as privatization, exacerbated economic inequality. According to the European Bank for Reconstruction and Development, the “loans-for-shares” scheme implemented in 1995 disproportionately benefitted a small group of financiers, the oligarchs. This has led to very sharp increases in wealth and income inequality— by 1997 the Gini coefficient of income inequality was around 0.5 for Russia, significantly higher than USA’s 0.3 at the time, with a higher index representing greater inequality.
Unlike the Czech Republic and Poland, privatization in Russia did not result in a change of elites. In fact, the Soviet elite successfully adapted to the changing political-economic environment and maneuvered themselves into the positions of wealth and power in capitalist Russia. The Soviet elite often cooperated with the government in exchange for material goods. This attitude remained in post-Soviet Russia, to a large extent explaining the huge corruption problem that Russia is currently experiencing. The Soviet elite was strong enough to keep hold of power even after the collapse of the USSR, and rational enough to choose privatization as a method to preserve this power and legitimize the new form of it, thus exacerbating inequality.
Although privatization is generally, in some shape or form, unjust and controversial (think of the contentious nature of Thatcher’s reforms), much depends on the degree of this injustice. Undoubtedly, the “loans-for-shares” scheme completely undermined the authority and validity of the government, and with it the belief in liberalism. As mentioned earlier, people’s attitude toward privatization is largely negative today – 83% of pensioners demand revision. This attitude towards the government and private property and the feeling of injustice damage the work ethic of the very economic agents that drive the capitalist system and keep it running, making Russia’s model of capitalism ineffective. This is perhaps the most significant way by which Russia’s privatization program has hurt its economy.
Inevitability and Overhang
Since it was not privatization in principle but rather the way in which it was executed that exacerbated inequality, it can be argued that enacting the same reforms differently might have kept inequality at levels lower than where they are today. But would implementing privatization any differently, in context of the circumstances, have been pragmatic? In order to protect property rights and competition, a market economy needs strong political and legal institutions. Such institutions are difficult to build from the ground up, and doing so requires political backing. As Guriev and Tsyvinski point out, Russia’s reformers, contrary to popular belief, understood this challenge from the start. They created a completely new judiciary and tax system, introduced an independent central bank and established fiscal federalism, among other things. But they also realized that these structures would work successfully only if there was political support for them, and that this could come only from private owners, a critical mass of whom thus had to be created as soon as possible. That is why the reformers rushed ahead with privatization, perhaps in the manner that they did. This rush, unfortunately, also meant that privatization took place before corruption was rooted out, and thus involved substantial abuses, which undermined popular support for private property.
It was this unpopularity and controversy of privatization that provided the initial support for Russia’s current model of state capitalism. Through a series of nationalizations, Russia’s government regained control of the economy’s commanding heights. Today, the economy remains paternalistic – the population constantly expects government help. According to Russia’s Ministry of Finance, the share of social expenditures increased from 24-25% of GDP in 1999-2009 to 33% in 2012. Some of Russia’s state companies such as Gazprom have become so large that it is difficult to distinguish between them and the state itself. Making matters worse, government policy has actually protected such companies from competition, giving rise to inefficiencies. This largely explains why annual economic growth slowed from 7% in 1998-2008 to 4% in 2010-2011.
As discussed earlier, the privatization of the 1990s certainly improved economic efficiency but also created the vast inequality that damaged public perceptions about the program. In this sense, the question whether privatization was on the whole beneficial remains highly contentious. Economic and political power in Russia is still intimately intertwined. Although the oligarchs have been blamed for much of Russia’s troubles, they did not directly slow down the country’s economic growth. On the contrary, oligarch-owned companies are responsible for much of the dramatic increase in output in recent years.
The situation in Russia today demonstrates that, in a sense, perception is stronger than reality. Although the economy is in order (GDP per capita increased from 22% of the US level in 2000 to 35% in 2012) and living standards are on the rise, Foreign Direct Investment (FDI) remains very low. In fact, capital outflow now stands at about 7% of GDP. That is a stunning figure, given high oil prices, abundant investment opportunities, and the nearly moribund US and European economies, which are the main recipients of Russia’s fleeing capital. Among other things, this is a result of the aforementioned feeling of injustice and lack of trust in the future generated by the privatization and other 1990s economic reforms. Changing this perception is, perhaps, the way forward for Russia’s economic growth.