Download Shock Therapy Economic Subordination Sham Stablization

Robert Stack
Ishay Hadash
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Definition: Rapid and radical
implementation of market privatization and
trade liberalization, intended to create
socioeconomic change.
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Thesis: Long Russian stagnation with new
government power created a political support
in Shock Therapy. One can argue, that foreign
influence together with social need for change,
inspired the new economic path.
1918 Revolution
1992 Reform
Lenin
Yeltsin
Communism
Capitalism : Laissez-faire
War-Communism
Shock Therapy
Karl Marx
Foreign powers
Command Economy
No Government Intervention
Domestic Market
Guided by foreign influence
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Educated population
Skilled Labor
Widespread of technological and
scientific expertise
Abundant natural resources
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Administrative command: domestic market
Shock Therapy: foreign intervention
In 1992 Yeltsin stormed parliament and
changed policy from gradual to radical
economic transformation.
IMF held Russia hostage because of her
national debt
Removal of financial support through ending
subsidies and trade taxation
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GDP level was ½ after the economic reform
Steep decline in standard of living
Crime rates skyrocketed
Wealth distributed among small portion of the
population
Increase in mortality rates and sharp decline in
education levels.
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Shock Therapy in Russia was essentially a
copy of the IMF plan to 3rd world
countries.
Complete price liberalization
Supported high exchange rate of Ruble
Removal of tariffs for complete trade
liberalization
Swift privatization and fiscal austerity
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Government reforms led to high inflation
Decline in population purchasing power
Foreign goods had economic advantage
Discourage investment and saving
Self-perpetuating cycle of increased tax
arrears to firms due to increase in
inflation for firms
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Import tariffs and Export tariffs removed
Bankrupted domestic producers of agricultural
and manufactured products due to inability to
compete with foreign producers
Imported goods increased by 50% between
1994-1997
Exports of raw materials expanded
Decline in Tariff Revenues compensated by
increase in taxes
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Russia lacked financial institutions that other
countries have after 70yrs of communism
Severe organizational defects
Firms suffered from difficult financial transition
Lack of currency control by central bank
Capital Equipment outdated and averaged 15yrs
Oil and gas industry are dependent on world
energy prices
Russian people could not obtain even basic
needs
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President Yeltsin reelected to office in 1996
Attempt to balance the economy by stabilizing
the currency, issuing government bonds, and
lowering the lending rates
Temporary improvement in real wages and
rising domestic demand was a misconception
for the real performance of the economy
Fiscal deficit remained substantial
Ruble crisis of 1998
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Initial Conditions – “On the eve of the Russian
financial crisis, Macroeconomic indicators for central Asia
had shown major improvements with respect to 19921994…data for the region showed that a recovery of
economic activity was finally underway… Private and
public consumption were growing rapidly following a
recovery of real wages (1996) “ (Page 5)
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Paper indicating the effects of Russian crisis on
the region
Quote indicate the “Bubble Economy” created
in the Region
https://www.imf.org/external/pubs/ft/wp/
2001/wp01169.pdf
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Shock Therapy components included:
 “Liberalization”- International trade and capital flow
 “Privatization”- Private ownership
 “Stabilization”- balance the value of the currency
The Russian government accomplished the
first two components but never succeeded
in stabilizing the Ruble (1992- Aug 17,1998)
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The ruble was held at artificially high exchange
rate resulting in high interest rate
Foreigners purchased high yield short term
government bonds
high interest rates lead to more foreigners
borrowing, which in turn causes appreciation
of the ruble
In 1998 there was a $6 billion dollar deficit in
current account
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After 1998 foreign investors withdrew assets
and capital flight resulted out of fear of default
Fiscal deficit forced government to borrow
more, while interest rates continued to climb
causing them to borrow even more.
In 1998 debt servicing by the government
increased from 14% to 50% of federal revenues
By 1999 Russia was scheduled to pay $17
billion to foreign creditors which was
equivalent to the entire federal deficit
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As a result of lower production tax collection
decreased
Moral Hazard: Profitable firms not willing to pay
taxes
Nonprofitable firms could not afford to pay taxes
Amnesty for tax debts was possibility
Firms engage in illegal/hidden money
transactions away from the tax system
In 1998, tax arrears were 2½ times greater then
the market money supply
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Shock Therapy: Drowned into economic
system that didn't fit the social, cultural, and
financial needs of the country
Economic Subordination: Western influence
guided economic transformation from
domestically driven to foreign governance
Sham Stabilization: Attempt in balancing the
economy ignored required reforms in fiscal
investment, tax collection, and capital flight
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Klein, Lawrence and Pomer, Marshall. “The
New Russia: Transition gone awry”. Stanford,
California: Stanford University Press, 2001.
Damjanovic, Tatiana and Pastor, Gonzalo. “The
Russian financial crisis and its consequences
for central Asia”. International Monetary
Fund,1998. Retrieved: November 29, 2009
https://www.imf.org/external/pubs/ft/wp/
2001/wp01169.pdf