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Commonwealth of Independent States12 Former USSR Republics
3 groups of countries
Russia
UkraineBelarus Moldova
ArmeniaGeorgia
Azerbaijan
Kazakhstan Uzbekistan Kyrgyzstan
TurkmenistanTajikistan
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China vs Russia
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Transition Recession: Why?• Subsidies to state enterprises cut (Credit crunch)
•Decline in population income•Decline in trade within CIS and with CEE•Russia’s energy subsidies to other countries cut – 1990: $40 bl to union republics, $18 bl to CMEA– Dependent: Ukraine’s imports 85% of its natural gas from Russia
•Disorganization of production– Transaction costs: New borders, tariffs, new currencies, check
points – Informal links between enterprises broke down– Integrated power grids and water systems collapsed– Rail transportation to/from remote areas deteriorated– Telecommunication sector under-developed – Putin on disintegration of USSR: “national tragedy of an enormous
scale”•Wars, refugees, resettlement– 3 mil Russians returned from other republics
•High interest rate (contractionary) monetary policy
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• Lack of financial markets• Restructuring shock, no entrepreneurial experience•Defense spending cut– “bad” output– Defense spending as share of GDP
USSR 1987: 17% 1990: 12%
Russia 1992: 5.5% 1997: 3.8%
•Welfare higher even if output is lower?– Production shifted to“good” output – No lines to purchase goods –high income consumers better off
•Official data overstates collapse – Informal sector– Over-valued output at old prices• USSR reported higher than actual growth
• Smaller recession – in countries that integrated in world economy faster – In non-reformers, Uzbekistan and Belarus
Transition Recession: Why?
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Informal Economy• Unreported activities, not measured• 50% of GDP, 40% of cash turnover• Moonlighting, barter, unofficial production• Household food production• “Shuttle trading“ by 5-10 million entrepreneurs – transport and sale of consumer goods – 1995: some US$11 billion worth of goods
• Why useful to know size of shadow economy? – Tax collection: informal economy erodes tax base and leads to higher
government debt– Official data underestimates household income– Formulating policyMeasuring Informal Economy
• Direct estimates of income or household expenditure by survey– not reliable, people conceal revenues
• Indirect methods– demand for cash relative to broader monetary aggregates – electricity consumption - high correlation with GDP
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Employment and Wages
• Large-scale privatization of money-losing state owned enterprises should increase unemployment– East Germany and Poland: 16% in
1994• Russia: low unemployment rates – 1994: 6.3%
• High under-employment– "hidden" unemployment – workers on administrative leave, part-
time– labor hoarding– workers attached to enterprises by
wage arrears
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Health in Transition
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Virtual Economy by Gaddy and Ickes
• Workers, managers, regional governments adapt to environment that threatens their survival• 2 sectors of Russian economy:–Export-oriented (oil and gas)
• value-adding, cash-based –Domestic (other sectors)
• value-subtracting, non-cash• inefficient, same output & technology as under central planning• average age of plant and equipment
1980: 9.5 years, 1995: 14.1 years• Gazprom supplies gas to domestic
economy at low $28 / ‘000 cubic meters –gets paid with arrears– in exchange for the right to keep export
profits• Corruption, looting, barter, offsets• Stable equilibrium–Participants pretend it’s not
happening
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“Lawless Capitalism Grips Russian Business”
The Washington Post November 7, 2000
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•Moscow - center of banking and foreign investment
often to exclusion of other regions
Russian Business Environment, mid
90s
• Organized crime, protection rackets, contract murders, kickbacks, bribes– Most businesses not able to function without
paying for mafia protection– violence to enforce contracts
• State dependent on criminal structures– enterprises did not have money to pay taxes– government borrowed at high interest rates
from commercial banks – banks lend to the government government’s
own money
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Ineffective financial intermediaries• Adverse selection effect of high interest rates
– Only high risk individuals borrow– Default if high risk project not successful – Low risk – low return projects not undertaken– Bad loans for banks, low public confidence in banks – Government intervention possible - Interest rate subsidies, deposit
insurance• Bank runs, failures:
– Latvia, Lithuania : 1995– Czech Republic, Bulgaria, Romania : 1996-97– Russia: 1992 - savings in Sberbank frozen and destroyed by hyperinflation
1996-98 - bank runs, withdrawal of deposits, failures
• Financial scandals– Russia, Albania, Romania, 1994-94 - Collapse of financial pyramids
• Causes of bank runs and financial scandals– non-performing loans to state-owned enterprises– quick financial liberalization allowed too many new banks– inexperience of bank management with risk assessment– deposit rates below inflation rate– no deposit insurance
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Exchange Rate Regimes• Float (Flexible Rate):
– value of national currency determined by market
• Peg (Fixed Rate): – central bank buys and sells domestic currency to maintain
exchange rate against a foreign currency– possible only if central bank has enough foreign exchange reserves
to defend the peg– helps fight inflation– currency boards: Latvia, Estonia, Bulgaria
• Managed (“dirty”) floats• Adjustable (“crawling band”) pegs
– Poland, Hungary– Russia: “crawling band" started at 4,300-4,900 Rb = $1
Slowly depreciating due to inflation1997: 6,000 Rb = $11998 currency reform: 1 new Rb= 6,000 old Rb
Success of transition is not crucially dependent on exchange rate regime
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Russian Financial Crisis ‘98• 1997:
– Low inflation rate– Stable convertible ruble– Budget deficits (G-T) 7-8% of GDP– Deficit financed with short-term ruble-
denominated government debt• Annual interest rates >140%• Russian banks borrow from foreign banks to
invest into government debt – Asian financial crisis
• IMF loan $22.5 billion in July ’98, with conditions– Contractionary fiscal policy • cut spending, high taxes, tight credit
– Keep strict exchange rate band • Russian government ran out of reserves
buying rubles to support exchange rate• August 1998 default:– Devaluation of Rb by 34%– Unilateral restructuring of Rb-denom.
government debt due btw 8/19/98- 12/99– 90-day moratorium on private sector
payments on external liabilities
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1998: Appeal of Devaluation• Oil prices fell in 1998 to $11 from $23 in 1997
• Example
Year ExRate Oil barrel Oil barrel
p=$20 p=$10
1997 $1 = Rb 5 Rb 100 Rb 50
1998 $1 = Rb 10 Rb 200 Rb 100
•Real Effects of Devaluation –Cheaper Rb domestic exports increase, imports decrease
–good for exporters – import-substituting domestic production increases
–Leads to a recovery and output growth –Lower trade deficit (Exports < Imports) or higher trade surplus
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Devaluation• Economist, August 1998: • “Devaluation will not do
much to create jobs in industry, because Russia’s miserable output of manufactured exports— chiefly clunky cars, vodka and weapons —is not very price-sensitive.
• Although imports will become dearer, those relatively affluent consumers who favor French cosmetics and German cars are unlikely to find Russian goods acceptable substitutes.”
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Who made money on the default?• Raw material exporters + local economies based on them
– did nothing different but earned 4 times as much cash• Bankers charged clients up to 50% withdrawal fees• Medium size banks and insurance companies
– did not hold much government debt– charged clients higher service fees for ‘safer’ transactions
• Money changers: demand for $ increased, so did fees• Medium size companies, bank clients with idle money
– Have Rb1,000 sitting in your account for some time?– Buy $$ at Rb5=$1 ($200)– 30 days later, sell $$ at Rb10=$1 (Rb2,000)– Do not show this transactions in the books- as if still Rb1,000– Convert extra Rb1,000 into $$
• Borrowers who took out loans before banks went bankrupt• Buyers shortly after devaluation paying old ruble prices
– eg. Car for $300 at new exchange rate• State
– Did not return $60 billion worth of debt– Wage, pension and tax arrears fell in $$$ terms
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Consequences• Collapse of the banking system
– Most of 1,600 banks made insolvent overnight
• Temporary contraction in output and trade – payments system paralyzed for
over a month • Inflation 138%
– wiped out household savings– reduced private wealth
• Incomes fell– Poverty rate rose by 50%
• Capital outflow – in 2000 $18.4 billion, 18% of
GDP, higher than in 1999• Central Asia
– competitiveness and living standards declined
• Brazil– re-evaluation of risks lead to
crisis in in 1999
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Could Have Avoided Crisis with Right Policies?
• Gradual ruble depreciation: print rubles to pay off debts, stop convertibility for a while– Inflation better that massive bankruptcies, loss of savings
• Capital controls to stop capital flight• Public infrastructure investment
– transportation, power, communication, railways, public buildings • Pay back wages to stimulate demand for Russian output• Attract investment, domestic and foreign, for
modernization– Political instability – Functional legal system – Low cost credit for domestic production
• Renationalize enterprises that were sold at less true value • More public spending on science, technology, education• Temporary protection of selected industries and agriculture• Export less raw materials and energy, redirect more to
domestic production – diversify economic base