RUSSIAN ECONOMY

Communist Economic Systems

Russia’s transition to planned economics

In a planned economy, the __________ regulates or “plans” p_____________ and p________Planned economies are also called _____________economiesFrom the late 19___s to 19___, the Soviet Union operated under a planned economy

The ideology of __________________ inspired the use of this systemencourages____________ownership of means of production

state

command20 91

Marxism- Leninism

public

roduction rice

Conversion to a planned economy began after the end of the ___________________in ______________

The ________________ seized control of Russia after this war__________________ (1870-1924) led the Bolsheviks during the war

The Soviet government ___________________ agriculture in the late 19____s and 19____s Collectivization formed communities in which property is shared Property was owned by the ______________, not individuals

______________(1878-1953) spearheaded collectivizationsucceeded Lenin as leader of the Bolshevik Party

The Bolshevik Party became the _________________ Party of the Soviet Union

Russian Civil War 1920Bolsheviks

Vladimir Lenincollectivized

20 30

community

Joseph Stalin

Communist

STALIN’S REFORMS Stalin aimed to transform Russia into a __________ economy

In this economy, ____________ and society belonged collectively to all workers

Stalin eliminated the class of people who ownedproperty without contributing ____________This class is referred to as the “____________”

To achieve this goal, the government attempted to __________________all private property This included all factories and equipment, which were known as “_________”

Socialistproperty

laborcapitalists

nationalize

capital

Russia’s transition to market-based economics

• Russia now operates under a market-based economy– Transitioning from a planned to market-based economy

took _______ years (19___-20___)– Most of the transformation occurred in the 1990s

• Russia no longer operates under communism• ECONOMIC GROWTH:– Russia experienced rapid growth from 19___ to 20__– Growth ended abruptly with the

________________________in 2008• Russia faces significant challenges– Several problems stall Russia’s development in the global

economy

twenty 91 11

99 08

global economic crisis

Forms of Property

• Three forms of property comprise the “classical” socialist system– state-owned firms,– budgetary institutions, and – cooperatives

Three Organization Types

State-owned firms

• There were both– NATIONAL FIRMS– REGIONAL FIRMS

State-owned Firms• National firms

– under the jurisdiction of national-level ministries• Regional firms

– under the jurisdiction of provincial and local governments• THE “BIG BUT”:

– Economist Janos Kornai: categorizing firms as state-owned = meaningless because…

– subnational governments were controlled by the national government

• All income from production contributed to• STATE COFFERS

• Firms could not be • bought or sold

These firms provided employment and housing on a massive scale

• The place of employment included all essential -- social services

• Workers had access to – apartments, daycare, schools, and other social

services• This system gave rise to the communist

___________to________ system of social services

cradle grave

These firms provided employment and housing on a massive scale

• State-owned firms encompassed most _____________industry – auto plants and – defense factories

• The Soviet model emphasized economies of scale in every industry

• Economies of scale describes the gains a firm achieves from– Expanding production

• Individual plants commonly employed over – 100,000 workers

heavy

• Due to this living and working situation, laborers lacked ____________. In order to move, workers had to acquire a – new job, residence, and housing permit

• A housing permit was called a _____________• The process of moving took years• Low worker mobility _____________the

process of devising production plans– Government planners needed to keep track of

labor at every individual firm• _____________________ of state-owned

firms started in 1992

mobility

PROPISKA

simplified

PRIVATIZATION

Budgetary institutions• Budgetary institutions included– universities, – research and educational institutions, – Training centers, – trade schools, – hospitals, and – museums

• ____________or_______________________budgets funded budgetary institutions

• Budgetary institutions had no obligation to make ____________cover___________________

National regional government

income expenditures

Cooperatives

• Cooperatives operate similarly to state- owned firms but were mostly located in _________________

• The cooperative, or collective farm, was called a _______________

• Like state-owned firms, cooperative farms operated on a ___________ scale

• Farms included social services such as ___________• In the 1930s, Stalin collectivized agriculture by

stripping all citizens of _______________• The state assumed ownership of all _________

Comrade, come jointhe KOLKHOZ!

agriculture

KOLKHOZmassive

housing

propertyoutput

COLLECTIVIZATION

• ECONOMIC MOTIVES:• steady supply of grain

for________• The state believed

larger farms would produce more ________________ than smaller farms

• POLITICAL MOTIVES: bureaucratic control of farmers prevented them from fighting back– Farmers could not become a

social, political, or economic force

– They fit seamlessly into the body of the Soviet system

– They could not • leave the farm or • outsource labor

– Essentially, farmers always remained members of • the “collective”

cities

efficiently

Summary of socialism

• Socialism replaces __________ownership with __________ ownership– The state owns all property

• Capitalists could no longer __________workers– All members of society collectively worked and owned

property• Public ownership of production transferred the

responsibility of allocating resources from __________mechanisms to ________________ economic planning

PRIVATEPUBLIC

EXPLOIT

MARKET BUREAUCRATIC

CENTRAL PLANNING SYSTEM

The Planning System: The role of bureaucracy

• The bureaucracy planned all economic activity – top-down fashion– Fulfilling plans was compulsory

• planned economy sought to eliminate the anarchy of the market– state would organize the economy on a national scale– bureaucracy, not the market forces, controlled the vitality of a

firm• Bureaucratic planning sought – to distribute goods more equitably– goal followed the ideals of Marxism

Five-year plans dictated the Soviet economy

• Each five year plan was split into annual plans– Five-year plans functioned as

statements of policy intent rather than specific plans

• The first plan: 1928• The last plan: deteriorated in

the late 1980s

CENTRAL PLANNING

• Planning involved – determining inputs and – estimating outputs for each individual factory

• This task was enormous, especially since the Soviet Union spanned 13 time zones– Flawed estimations often resulted in shortages– A lack of inputs caused a lack of outputs

CENTRAL PLANNING

• Plans determined each firm’s level of – technical development, – capital investment, and – trade

CENTRAL PLANNING

• A system of bureaucracy-controlled price lists designated prices of all goods

• Gosplan manually calculated every aspect of the entire Soviet economy

• For most of this period, planners lacked access to computers

BUREAUCRATIC RESPPONSIBILITIES

The role of managers and labor• Plans required

coordination of – the Communist

Party, – State ministries,

and – individual firms

The role of managers and labor• Gosplan strategies to break these systems

down into manageable parts– Planners disaggregated the plan in a downward

flow of information– Higher levels sent directions to lower levels• State plans did not recommend or suggest actions• The term “command” economy derives from this process

– Planners received an upward flow of information• While drafting a plan, planners received information from

lower levels• Lower levels contributed nonbinding recommendations

about target output levels

The role of managers and labor• The bureaucracy chose managers at every

level of the economy– Each manager held a specific and mandatory role

in each plan– Plans specified the amount of labor allocated to

each sector and factory

Incentives and attitudes

• Plans required firms to produce exactly the amount stated in the plan– managers lacked motivation to innovate– No reward for producing a surplus

• But the state punished managers for failing to meet plan targets– Managers could be

• removed from office, • sent to a labor camp, or • accused of sabotage

• An accusation of sabotage could lead to a death sentence

Central Planning and Central Management

• Motivation: intrinsic– ideological sense of duty to the Communist Party

• Motivation: extrinsic - bonuses for good work– awards and – privileges

• In addition, – political power and prestige provided sources of

motivation– For some, material benefit and fear were

motivators

Central Planning and Central Management

• BIG “BUT”: the penalties of taking risks outweighed the potential rewards– Without ownership,

managers lacked incentive to exceed the bare minimum

– Janos Kornai states…

Among managers, “SERVILITY and a

HEADS DOWN MENTALITY prevailed.

Economic distortions

• A chronic “shortage” economy emerged in almost every sector– The planning system misestimated the supply and demand

for goods• In a free market economy, changes in price eliminate excess

demand and supply– This shortage condition affected consumer goods

Managers had built-in incentives to underreport production:

• Ensured that plan targets for the next year would not exceed the firm’s capabilities– A firm that could produce 150% of the target plan

might produce only 101%– This signaled improvement but not enough to

cause expectations of it to increase– Managers • hid extra output and • sold it on the black market

Outputs differed in proportion to inputs

• Target plans – only specified that firms meet a goal, – not fully utilize the allocated inputs

• As a result, – excess inputs existed in some sectors – while shortage existed in others• This caused

– poor allocation of resources and – waste

STATE PRIORITIES:

• Socialism overemphasized rapid growth– Quantity of production took precedence over

quality– Inferior quality of goods still impedes Russia’s

ability to compete in world markets• The state prioritized industrial production over

consumer production

SUMMARY of PROBLEMS:

SHADOW ECONOMY / BLACK MARKET

• RESPONSE to the chronic “shortage” state– A black market is called a shadow economy– economic activity that lacks official state approval

• In the socialist system, private property and private means of production do not exist

• Black market participants circumvented price lists and other restrictions of the system

• Some analysts believed the black market kept the system alive– The black market remedied some of the failures of the planning

system– It also fueled corruption at every level of the economy

• Russia still feels the effects of the black market today

MIKHAIL GORBACHEV: VITAL STATS• Born: –1931

• Became General Secretary of the Communist Party: –March 1985

• Ousted from office: –1991

Problems facing Gorbachev upon entering office

• Soviet Russia’s stagnating economy was the greatest challenge– planning system lacked flexibility– complexity of calculating economic

needs exceeded the capabilities• Tim COLTON believed planners could

not anticipate the need for computerization

• As the economy’s size and complexity increased, so did planning failures

• Values and motivation suffered under the overbearing state

Morris and Anna Feldberg Professor of Government and Russian Studies and the Chair

of the Department of Government at Harvard

University

TIM COLTON

Reform and reconstruction

• Gorbachev immediately recognized a need for an overhaul of the economy– This goal = perestroika,

literally translating to “reconstruction”• did not intend to establish a

market-based liberal system• sought to reform the existing

communist system

Criticism

• Many critics argued that Gorbachev ignored the Soviet economy– They compared his actions to Chinese leader Deng

Xiaoping’s actions in the 1980s• They accused him of “sequencing” reform– This practice involves favoring “easier” political reforms

• In contrast, Gorbachev began his reforms with the economic challenge

• Gorbachev’s economic policies – between 1985 and 1991 – Followed 4 phases

Phase 1: 1985-86

• Recovering Worker Productivity and Infrastructure

Anti-alcohol campaign

• First, Gorbachev tackled worker absenteeism and low labor productivity

• He initiated an anti-alcohol campaign to reduce chronic alcoholism among workers– The campaign closed down some alcohol factories– Some Russians resorted to producing bootleg

liquor• This created the unintended sugar shortage• The consumption of bootleg liquor also meant that

productivity remained low

Uskorenie

• Gorbachev attempted to invest in old infrastructure

• launched an uskorenie, – literally meaning “acceleration”– acceleration of investment in old plants and

factories• The Soviet Union lagged behind the West’s

technological progress• Poor infrastructure impeded labor productivity

• The two programs were fundamentally incompatible, because– one reduced government revenue and – the other demanded more government spending.

Failure of both reforms

• Both initiatives failed – socially– economically

• The anti-alcohol campaign worked against the investment project– Closed alcohol factories reduced state revenue

• Decreased revenue hindered increases in investment

• Neither initiative improved – worker discipline,– economic productivity, or – infrastructure

• Workers still consumed bootleg liquor

• The budget deficit increased

Phase II: 1987-88: Glasnost and Demokratizatsiia

Glasnost• A policy that allowed greater public discussion

– Gorbachev initiated it at the• in 1987 • Central Committee of the Communist Party PLENUM

– A plenum is a planning meeting

• allowed citizens to openly discuss the merits of the communist and market systems– The Soviet Union had never allowed this level of free speech– Glasnost enabled

• the Soviet media and • politicians to discuss issues freely

– Politicians of this time comprised a new super parliament in 1989

• jumpstarted discussion on private property– The subject had always remained taboo

Demokratizatsiia• introduced limited accountability into Soviet

politics• The term demokratizatsiia translates to

“democratization”• It enabled greater participation of

interest groups in the political process

Introduction of private property rights

• “Cooperative” enterprises introduced quasi-property rights– These firms operated in the

• commercial and service sectors– “Cooperative” enterprises

• lacked clear governance or ownership structure• They offered business initiative among a small group of entrepreneurs

• Gorbachev granted managers more autonomy on what to produce– Managers still had limited opportunities to explore new markets

• Gorbachev maintained the collective farming system– He refused to reinstate private farming– Intermittent food shortages persisted

MANAGERS JUST WANT TO HAVE FUN

• Gorbachev gave managers more freedom from bureaucratic control. As a result, managers…– privatized firms behind planners’ backs– increased activity on the black market– acquired money that they later used to participate in

privatization• HALF-MEASURES

– These partial reforms worsened the economic situation.– Gorbachev passed up his chance to implement sweeping

reforms before the onset of stagflation in 1989.

No sweeping economic reform• Gorbachev tended to compromise with conservative members

of his Politburo– The Politburo consisted of a cabinet of elite communist party officials

• Compromising stalled implementing far-reaching economic reforms– He missed the chance to initiate reforms before the onset of

stagflation• Stagflation describes inflation with zero or negative economic growth

– This presents the worst possible situation for an economy– Normally high growth accompanies inflation

» This concern still plagues China’s economy

• Gorbachev may have lacked the means to initiate widespread economic reform– may have lacked enough control within the Communist Party– may have lacked desire for change

• He believed in the communist system, not liberal capitalism

Phase III: 1989: Stagflation and the Fall of Communism in Eastern Europe

• Stagflation• the Fall of Communism in Eastern Europe

Phase III: 1989Collapse of communism in Eastern Europe

• Gorbachev’s reforms met a receptive audience in Eastern Europe

• The Berlin Wall fell in November 1989

ECE Satellite Governments Fell

• Several satellite communist governments in Eastern Europe followed suit– The collapse destroyed guaranteed markets for

inferior Soviet goods– This loss further damaged the Soviet economy

Gorbachev’s indecision• Gorbachev attempted to please both radical

reformers and conservatives– As a result, his inconsistent policies deepened the

economic crisis• Reform efforts created larger budget deficits– Sustained subsidies to industry drained the state’s funds

• Inflation plagued the economy even as growth declined– The economy experienced stagflation– Too much currency was circulating– High wages also caused inflation

PROBLEMS• The state lacked a mechanism to collect taxes• Restrictions on the development of cooperative movements

prevailed• The practice of barter grew

– Barter involves trade without currency• Agriculture experienced limited reform• The Soviet Union faced widespread food shortages

– This problem had not plagued Russia since World War II• The economy experienced negative growth rates

– Production fell by about 10% per year until 1991• The Soviet Union collapsed in 1991

SUMMARY

Phase IV: 1990-91: Boris Yeltsin and Reform Alternatives

The Five Hundred Day Plan

• summer of 1990• a group of young Russian economists devised

a plan• dubbed it the Five Hundred Day Plan

The Five Hundred Day Plan

• Gorbachev adviser and economist Stanislav Shatalin led the project

• Economist Grigori Yavlinsky also helped produce the plan

SHOCK THERAPY

• sought to imitate successful example of economic “shock therapy”

• Borrowed idea from Poland

The 500 Day Plan

GORBY’S RESPONSE

• He rejected the 500 Day Plan by the fall of 1990– favored a slower and more conservative approach

to change– wanted to retain price controls for another two to

three years• Gorbachev appointed a likeminded

conservative prime minister

Elections across the Soviet Union

• The Soviet Union began to lose legitimacy as an economic and political union

• Its 15 constituent republics, including Russia, started electing new leaders

• Gorbachev authorized these elections

Boris Yeltsin• (1931-2007) • June 1991: became Russia’s first popularly elected

president– Gave Yeltsin greater political legitimacy than Gorbachev– Gorbachev

• remained the unelected President of the Soviet Union• the unelected General Secretary of the Communist Party

YELTSIN

• held various positions before becoming president– Member of the Politburo– Provincial Communist Party boss– Elected speaker of a new Russian parliament in

1990• Yeltsin disagreed with Gorbachev’s lagging rate

of reform– He initiated much more rapid reform, leaving

Gorbachev behind

Gorby’s Last Days• Yeltsin’s popularity and power

rivaled Gorbachev’s• challenge pressured Gorbachev

to pursue radical market solutions—but it was too late

• Gorbachev’s Politburo attempted a coup in August 1991– effectively removed Gorbachev

from office

Gorby’s Last Days• By December 1991, the Soviet Union

completely collapsed– The union dissolved into 15 new and separate

countries– Russia was the largest of these new countries– It adopted the title of the Russian Federation

Gorbachev’s Legacy

• Gorbachev’s half-measures and indecisive reforms deepened the Soviet Union’s economic crisis

• By the end of 1990, political motives diverted reform efforts from economic needs

• By the end of 1991, shortage and inflation persisted– The inflation rate loomed at over 100%

The Economy Before the Collapse

• Pre-existing problems– Although Gorbachev may have fallen short, the

Soviet Union’s system deteriorated on its own– Production levels declined throughout the late

1970s– They hit a free fall in the late 1980s under

Gorbachev

Growing State Sector Presented Problems

• The state controlled almost every economic activity– By 1991, most people were on the state payroll• Although the economy appeared fully employed, many

people did nothing– “We pretend to work and you pretend to pay us” became a

popular saying• Post-Soviet policymakers feared increasing

unemployment• Minimal pensions and wages necessitated that people

work after retirement

Problems with STATE SECTOR• Chronic shortages caused by sub-optimal planning was an

enduring problem• Industrial production far outstripped consumer production

– This imbalance contributed to the low standard of living• Economic growth under the planning system carried high

costs– The system created inefficiency

• Because of the system’s emphasis on economies of scale, MONOPOLIES dominated the economy– Massive firms operated efficiently as monopolies

LACK OF INCENTIVES• The Soviet economic system discouraged technological

innovation– the West developed computer hardware and telecommunications– Even with a strong post-secondary education system, Soviet

Russia fell far behind• The lack of incentive to improve production yielded poor-

quality goods– Soviet Russia’s manufacturing sector could not compete globally– Instead, the Soviet economy relied on natural resource exports,

especially oil and gas• But global oil and gas prices were falling• The Soviet economy could no longer protect itself from world

competition– Before 1989, the Soviet Union rarely traded with non-communist countries

• These conditions exposed the Soviet Union to the “resource curse”

Flaws of the Soviet system

• Money had no real value since prices did not reflect supply and demand– Price lists determined prices for everything sold in the Soviet Union

• Additionally, the ruble could not be converted in international markets– About 3,000 different exchange rates existed for almost every item in foreign

trade– The state controlled conversion rates

• Two types of rubles with different values existed in the economy– Enterprise accounts used one type– Consumers used the other

• The Soviet economy lacked important financial institutions and markets– These missing essentials included

• a private banking system, • a real estate market, • a stock market, and • private companies

Negative growth rates• Exacerbated by Gorbachev’s reforms, these

conditions stunted growth• By the collapse of the Soviet Union on December 25,

1991, growth rates hit -17%– Growth rates had declined from +3% in 1989

*Millions died in industrialization and collectivization .*People’s demands outpaced system’s capabilities.

REFORM UNDER BORIS YELTSIN

• The fifteen newly independent states of the former Soviet Union diverged in their methods of economic reform.

• This section will focus on Russia’s reform process as implemented by President Boris Yeltsin. Between the fall of the Soviet Union in 1991 and the end of Yeltsin’s presidency in 2000, Russia made great strides in – breaking down the planning system and – opening the door to privatization.

Shock Therapy in Theory• The return of shock therapy– Fall of 1991, Boris Yeltsin

surveyed reform options– He settled on the plan put forth

by a group of young economists led by Yegor Gaidar

– Yeltsin appointed Gaidar prime minister

– Gaidar advocated rapid transition to a market economy through “shock therapy”

SHOCK THERAPY demanded three immediate and simultaneous reforms

SHOCK THERAPY in THEORY

• These three key policies inflicted a short-term “shock” on the population– Prices increased suddenly– Inflation quickly reached high levels– Unemployment rose as the state allowed

unprofitable industries to fail• Market mechanisms would eventually kick in– Gaidar expected the economy to grow within three

years• The economy would stabilize well before Yeltsin was up

for re-election

Shock Therapy in Practice

• Elimination of price controls– Shock therapy began with the sudden freeing of prices on

January 2, 1992• Average prices increased by 245% overnight• Production dropped as expected

– With relaxed import controls, foreign goods filled the market– Larger cities imported the most foreign goods

• Freed price controls and relaxed import controls solved the chronic shortage state– But prices mostly surpassed the average Russian’s budget– Gaidar assured Yeltsin that market mechanisms would push prices down– He believed Russian manufacturers would try to match the quality of

foreign goods» He also believed they would offer lower prices to Russian

consumers

BACKLASH!

• By April 1992, industrial enterprise managers opposed shock therapy– They were referred to as “red managers”– They opposed the end of subsidies to their firms– Some refused to restructure to accommodate

market mechanisms– Others lacked the means to restructure even if they

wanted to• Debt accumulated as managers traded for industrial

inputs without money– In the early 1990s, barter economies existed in both

agriculture and industry

The end of shock therapy• To assuage opposition, the state issued Central Bank credits to

firms in the spring of 1992– They also increased printing of the ruble

• This compromise caused spikes in the budget deficit and inflation– These effects especially hurt consumers

• This violation of fiscal austerity and deficit control signaled the end of shock therapy– All other areas of the reform plan receded as well

• Russia opted for more gradual reforms after 1992– This path necessitated abandoning several aspects of liberal

market reform

Privatization in Theory: 3 Main goals of privatization

• 1st: creation of a middle class

• 2nd: creation of a market economy

• 3rd: separation of ownership from management

Privatization in Theory: 1st goal of privatization

• First, creation of socioeconomic stratification, particularly a middle class– Private property rights and ownership would allow

classes to form– Economically, middle classes provide a reliable

source of taxation– Politically, they represent varied interests that

support political pluralism• Political pluralism contributes to the creation of a

democracy

Privatization in Theory: 2nd goal of privatization

• Second, creation of a market economy– Yeltsin’s main political legacy is destroying

the communist economic system– The introduction of private property

prevented an easy return to the old system– Economist Anders Aslund believes

two thirds of an efficient market economy must be private• No more than one third of national

employment can exist in the public sector

Privatization in Theory: 3rd goal of privatization

• Third, separation of ownership from management– In the planned economy, managers did not legally

own their firms– They only controlled them because of their access

to information about the firm– Newly empowered managers lacked oversight from

a board of directors• They pocketed extra money from selling excess products

on the black market

Yeltsin hoped to introduce managerial accountability to a board of directors

• This principle was referred to as corporatization– He intended to incentivize managers with the

principles of supply and demand– Directors would assess managers on profit and loss,

instead of political criteria– Competitive managers would replace poor-quality,

command-era managers

Privatization in Practice• Gaidar and Yeltsin passed

the privatization legislation in June 1992

• They initiated the program a month later, in July 1992– The program attempted to satisfy conflicting

ownership claims between managers, local governments, and workers

State Committee on Property:• created the State Committee on Property to oversee the

process– This committee was also called the Goskomimushchestvo

• They classified firms eligible for privatization– Small firms employed less than 200 employees– Medium firms employed 200-1,000 employees– Large firms employed over 1,000 employees

• The committee divided firms into – federal, provincial, and municipal property

• They forced specific firms to privatize– Wholesale trade– Retail trade– Food services– Construction– Consumer services

SUMMARY: Firms classified by the State Committee on Property

Privatization options• Firms could choose between three different paths of

privatization– These options differed in the percentage of shares owned by

insiders• Insiders include managers and workers of the firm

– The firm • auctioned off their remaining shares or • traded them for vouchers

– All three options granted insiders favored access to shares• They allowed for over 25% insider ownership• Gaidar made this sacrifice to incentivize managers to participate in

privatization– This decision was political, not economic

• Critics called this a “giveaway”– They believed this concession prevented separation of ownership and management

Privatization in Theory: VOUCHERS

First stage of privatization: voucher program

• firms had the option of auctioning off shares– Share auctions began in December 1992

• Thousands of auctions occurred every month between December 1993 and June 1994

• Firms traded shares for vouchers through the voucher program

• The voucher program began in August 1992– This phase of privatization was brief– Vouchers had to be claimed by the end of January 1993

and invested by July 1, 1994

VOUCHERS• The state distributed privatization vouchers to every

man, woman, and child– The effort hoped to involve public sector workers in the

process of privatization• Doctors and teachers did not privatize their firms but could still

participate

• Citizens could trade their vouchers for shares of privatizing firms– This feature aimed to create a vibrant stock market

• Initially, each voucher held a value of 10,000 rubles in shares– When the first privatization legislation passed in June 1992,

vouchers were worth $84• Russians received an average of $50 a month in wage

– Vouchers held considerable value

Russians could use their vouchers in various ways

• Buy shares of the firm they worked for (as long as it underwent privatization)

• Buy shares of other privatizing firms• Buy shares through mutual funds– This diversified their portfolio and spread risk across

different firms• Buy shares in a voucher fund• Sell them• Give them away

VOUCHER PROGRAM

• Firms resisted the voucher program because they did not receive money from it– In May 1993, Yeltsin stated that firms must sell

29% of all shares for vouchers– This proved moderately successful as the average

came closer to 20%• Citizens invested most vouchers by 1994– The first stage of privatization finished that year

Second stage of privatization: auctions of state holdings

• July 1994• auctioning off remaining state holdings for cash

– Firms received part of the proceeds as capital for restructuring– The government received the rest of the proceeds

• The government aimed to finance its budget deficit without increasing inflation– They anticipated billions of dollars of revenues

• The government also intended to create larger blocks of shares for foreign investors– Foreign investors could then increase their role in corporate

governance• During the second stage of privatization, the benefits to insiders

decreased

The second stage of privatization failed in many ways

• Vladimir Polevanov, the more conservative Minister of Privatization, froze privatization– Nationalists and communists in

parliament influenced this decision– Polevanov advocated the

re-nationalization of many firms– This prospect scared off

foreign investors

“Loans for shares” scheme

• failure of the second stage of privatization made the government desperate for revenue

• In 1995, the Russian government settled on the “loans for shares” scheme

• They auctioned off – 12 blue-chip companies – to a group of commercial

banks

“Loans for shares” scheme:

• All interested bidders, foreign and domestic, could participate

• The bank offering the largest loan to the government won a block of shares

• Banks could not sell the shares until September 1, 1996

• They could only keep a third of the capital gains after they sold the shares

• The government made 1 billion dollars

Corruption in the “loans for shares” scheme

• On the surface, bidders appeared to support the government– However, banks mainly

wanted to control Russia’s largest companies

• Ultimately, the Russian government could not repay the loans– The banks assumed ownership

of the companies

The “loans for shares” scheme spawned a backlash

• Few banks had the strength to participate• Participating banks organized auctions themselves– This system presented a conflict of interest between

auction participants– By the end of the process, banks openly quarreled

• The process tainted the reputation of privatization• It transferred a large portion of the economy to a

small group of wealthy business people– This group became known as “the oligarchs”

SUMMARY: Loans for Shares

THE OLIGARCHS

• 1n 1991 Baturina founded INTECO (Интеко), – Construction, though it began

as a plastics business. • husband Yuri Luzhkov, became

the mayor of Moscow in 1992, – corruption – he awarded municipal

contracts to his wife's company. – For instance, the contract to

produce 85,000 seats for Luzhniki Stadium, Moscow's largest stadium, in 1995

• controlled 20% of construction in Moscow

• Baturina then bought shares – in Gazprom and – Sberbank.

Other corruption• Organized crime groups often purchased

shares from failing firms at little cost– This practice stripped the firm of value• Purchasing shares this way did nothing for capital

stock or the economy in general

The effects of the privatization program

• By 1996, 75% of large and mid-sized firms successfully underwent privatization– Almost 90% of industrial output also privatized

• Conservatives called privatization a “crime against the nation”

• Privatization succeeded in redistributing assets– They did not reach the middle class as originally intended

• The efforts did not provoke major social revolt– However, many people took issue with the speed of its implementation

• Privatization also occurred at the same time as other pervasive negative changes– As a result, the public linked privatization and negative changes

PRIVATIZATION by the Numbers

Causes of the 1998 Economic Crisis

• Non-inflationary measures• Growing DEBT

Non-inflationary measures

• By 1996, inflation and the ruble exchange rate stabilized– The years 1996 and 1997 were characterized by

stabilization and low inflation– The ruble reached a semi-convertible state– Russia achieved stabilization by stopping the

Central Bank from printing money• Reducing the money supply decreased inflation

Non-inflationary measures• The government borrowed money to handle the growing

deficit– issued short-term treasury bills and some longer-term treasury

bills– received loans from the International Monetary Fund

• Federal revenues decreased and the state reduced spending– Federal and regional governments failed to collect taxes

• This setback benefited large oil and electrical firms– They provided energy to firms who could not afford it– In return, the state allowed them to export without paying taxes and tariffs– Over time, these firms accrued tax debts to the government

Non-inflationary measures

• The state also withheld wages from state-sector employees– In 1996 and 1997, the state fell behind on

payment of wages and pensions– Russians worked for no pay

Growing debt• By late spring and summer of 1998, the state started

borrowing foreign currency– These loans financed their troubling domestic short-term debt– In the first eight months of 1998, Russia’s foreign debt

increased by 18.5 million dollars• This reduced the foreign currency reserves required to support the

ruble

• On July 20, 1998, the International Monetary Fund offered Russia aid– The package they offered aimed to finance wages and

domestic short-term debt– Instead, Russia used the package to attempt to save the ruble

and failed

Effects of the 1998 Financial Crisis• The financial crisis occurred on August 17, 1998

– Russia devalued the ruble– defaulted on its domestic and international debts

• The crisis eliminated all savings in Russia• Devaluation of the ruble made imported goods too expensive

– Russians returned to purchasing domestic products• This increase in consumption boosted the recovery of domestic industry

• By 1999, Russia’s economy started to grow for the first time since the collapse of the Soviet Union– The recovery of domestic manufacturing played a part– Increases in prices for raw material exports also contributed greatly– Growth continued until the global financial crisis in 2008

OIL

VLADIMIR PUTIN & DMITRI MEDVEDEV

• Economic Growth from 2000 to 2008– President Vladimir Putin (elected in 2000)– In his first term (2000-2004), he enacted a series

of reforms drafted by Yeltsin• Flat income tax of 13%• New legal code• Systems to prevent money laundering• Regime for liberalizing currency• Reduction of taxes on profits from 35% to 24%• New land code allowing Russians to own commercial

and residential land

Putin’s Reforms

GDP reaches 8.5% in 2000!

• GDP reached an all-time high of 8.5% in 2000 and sustained high levels growth

Economic growth

• Between 1999 and the summer of 2008, Russia’s economy grew rapidly– The result:• budget surpluses,• no foreign debt, and • sizeable hard-currency reserves

• Inflation remained modest• GDP growth reached an all-time high in 2000

RUSSIAN GDP

Rising oil prices

• Russia’s growth coincided with a rise in prices for Urals crude oil– This crude oil blend was Russia’s chief export• Price of barrel increased

– from $12 USD in 1998 – to $70 in 2007

• increased government and personal income– Higher incomes increased demand for

manufactured goods and commercial services

Professor Philip Hanson

Professor of the Political Economy of Russia and Eastern Europe, Retired Emeritus

Centre for Russian and East European StudiesUniversity of Birmingham

“It is by their indirect effects … that oil and gas price rises fuelled Russian growth.”

RUSSIAN OIL

THE RESOURCE CURSE

• The resource curse describes negative effects associated with abundant natural resources– Some economies experience • increasing debt, • nationalization of resources, • government corruption, and • negative growth

– Russia experienced many negative consequences due to its supply of natural gas and oil

SUMMARY: Resource Curse

Dutch disease

• Russia’s heavy volume of mineral exports invoked a sharp inflow of foreign currency– This influx created a high exchange rate– As a result, domestic manufactured goods became

too expensive• Russians purchased imported goods instead

• This phenomenon is called Dutch disease

SUMMARY: Dutch Disease

Decay of other industries

• Russia was excessively dependent on oil exports

• While Russia grew with the record growth of oil prices, Putin loosened fiscal policy– He began permitting oil companies to take on

debt– Imports increased with the onset of Dutch disease

STABILIZATION FUND

• In 2003, the state established a Stabilization Fund to store resource extraction tax revenues– This store of money was intended to serve

as an emergency fund if oil prices fell• The state could use the money to –fight inflation or –defend the ruble

STABILIZATION FUND

• In 2008, the government divided the Stabilization Fund into two separate parts– The Reserve Fund and – the National Prosperity Fund

• government did not use the money to improve the poor manufacturing sector– Russia’s manufacturing received little attention even

after the collapse– The economy lacked alternative industries when oil

prices plummeted in 2008

Critique by Analyst Evgeny Gontmakher

• The state did not invest in improving oil extraction technology and infrastructure– This problem greatly hindered Russia’s ability to

recover from the 2008 financial crisis– When oil prices crashed in 2008, so did the

Russian economy• Russia’s economy mirrored the conditions of the period

following the 1998 crisis

Analyst Evgeny Gontmakher

“This is all a result of --incorrect economic policy, --oil dependence, --and rampant corruption. Until the system changes, these problems will persist.”

Increased government ownership• Government ownership of the economy increased

between 2003 and 2007• The state pressured firms to invest instead of allowing

market forces to provide incentives• State ownership of oil expanded considerably– The state-controlled natural gas company Gazprom

purchased Sibneft– The government also took over gas company Yukos and oil

company Rosneft– Government control of oil rose from

• 19% in 2004 to over 50% by 2008– The Russian gas industry has not undergone privatization yet

GAZPROM swallowed Sibneft

Yukos swallowed

Rosneft

The growth rate of oil production fell between 2004 and 2007

• Exports fell proportionally

The 2008 Global Financial Crisis:Calm before the storm

• Dmitri Medvedev: presidency, spring 2008– Russia was in an unprecedented period of prosperity

• The stock market thrived– Foreign direct investment grew rapidly

• But investment remained low compared to other emerging markets

• Real disposable income increased by over 10% a year– Consumer spending increased remarkably

• Unemployment fell from 12% in 1999 to 6% in 2008– Poverty fell from 41% at subsistence minimum to 12%

The BRIC

• Russia became a part of four notable emerging markets, collectively known as BRIC– Brazil– Russia – India – China

The Global Financial Crisis• began in September 2008• Between June 2008 and January 2009, Russia’s stock

market lost 70% of its value– The ruble lost 1/3 of its value against the dollar

• The Central Bank increased spending to save the ruble but failed

• Russia’s foreign reserves fell from rising corporate debt, bank trouble, and credit issues

• Inflation hit a 14-month high of 13.9 by February 2009• According to Bank of America Securities-Merrill Lynch,

industrial output fell by 16% between October 2008 and February 2009

REVENUE & GROWTH

• Government revenue fell by 28% in the first quarter of 2009– A decrease in commodity prices, including Urals

crude oil, caused this reduction• Urals crude oil was Russia’s primary mineral export

• GDP growth declined to -0.2% in 2009– Russia experienced budget deficits for the first

time since the 1998 economic crisis

Global Financial Crisis: Russia by the Numbers

Stunted recovery

• By the first quarter of 2009, Russia exhibited• the same ailments as it did in the 1990s– Negative growth– High unemployment– High inflation– Low oil export prices– Weak manufacturing

1998 Recovery

• Prudent fiscal policy • rising oil prices– aided Russia’s transition out of the 1998 crisis

• Boris Yeltsin’s administration established these policies before Putin entered office

Putin’s Authoritarianism

• Putin introduced a more authoritarian developmental model– He implemented more • autocratic• state-led economic policies

– Russia’s growth did not result from these policies– In fact, Putin’s approach stunted Russia’s ability to

transition out of the 2008 crisis

RECOVERY

• Recovery depended on several factors that would prove difficult to achieve– Domestic consumer demand would have to

increase• High unemployment and inflation strongly worked

against this goal– World oil prices would have to rise• The global recession suppressed demand for oil

– The state would have to implement prudent fiscal policy

Russia Today

• Enduring problems–Russia’s manufacturing sector fails to

compete in the global marketplace• Russia can only compete in raw materials

exports• Russia’s GDP over-relies on oil and gas• The economy is at the mercy of world

markets

MODERNIZATION & MEDVEDEV

• Dmitri Medvedev initiated a new “modernization”– The effects of the global

economic crisis necessitated that Russia diversify its economy

– Dependence on oil exports made Russia’s economy fragile

Skol’kovo Innovation District

• Medvedev launched the construction of a Russian Silicon Valley called Skol’kovo– This project intended to use Russia’s educated labor force

to innovate new products– Medvedev located the site in a new economic zone

outside Moscow– Skol’kovo will probably not

contribute significantly to GDP for years or decades

MEDVEDEV’S PROMISED REFORMS

• Medvedev promised to stabilize Russia’s – legal regime– approach to property

This change would encourage and protect foreign investors