Download Chapter 15: The Transition from Communism to a Market Economy

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Chapter 15: The Transition from Communism to a Market Economy in
Russia -- Continued (revised November 2006)
1. Capital Markets
Capital markets are the means by which the savings of the population are
channeled to the businesses for the purpose of buying new capital goods. In the United
States, this important function is performed by banks and other financial institutions. But
such institutions did not exist in the former Soviet Union. Russia has been trying to
develop new capital markets, but it has not totally succeeded as of yet.
As of 1988, there were just four government owned banks in the entire former Soviet
Union. Then under the Gorbachev reforms, cooperative banks were allowed for the first
time. Between 1988 and 1990, almost 1,000 new cooperative banks were created. One of
these, the MOST Bank, started by Vladimir Gusinsky, was discussed in Chapter 14. By
1995, there were over 2,000 banks in existence in Russia. Most of these were small
banks. Over time, some of these banks consolidated into larger banks while many other
banks failed. As of 2000, there were 1,349 banks in existence in Russia.
For Russian households, about 2/3 of savings were held either as domestic currency
(rubles) or as foreign currency (US Dollars). Only 1/3 was held in a financial institution.
And of the money that was held as savings in financial institutions, about 85% was
saved in one bank, called the Savings Bank (Sberbank). This bank is majority owned
by the Central Bank of Russia and has branches all over the country. Its deposits are
government guaranteed. The other banks in Russia receive very few deposits from
households. Instead, their deposits come from businesses or from government agencies.
The households simply distrust these banks and with good reason. Many have been
poorly run and had inadequate funding. Accounting standards have been very weak. In
1994 and 1995, there were more than 1,000 pyramid scheme scandals. About 30 million
people became victims of these scandals. Many of the banks speculated in the foreign
exchange market and went broke. And it didn’t help that, in a period of high inflation, the
new banks paid savers an interest rate that was less than the inflation rate (that is, a real
interest rate that was negative).
This distrust of the new private banks came at a time when the savings of Russian
households rose considerably. In the mid-1980s, Russian households saved only about
5% of their incomes, on average. By any standard, this is a very low percent. By the mid1990s, this had risen to almost 30%, a very high savings rate. Economists are not certain
as to why this large increase in savings occurred. It could have been a result of
increasing uncertainty, it could have been a result of the great reduction in programs for
retirement, disability, or health care, it could have been a result of the new ability to buy
homes or apartments, or it could have been a result of other changes. The problem is that
for the enterprises to be able to borrow money to purchase new capital goods, these
savings need to be placed in financial institutions. And as we saw, this was not
happening.
Compounding the problem was the fact that those private banks that did have
funds to lend were very reluctant to lend them to the new Russian enterprises.
Russian enterprises were not good potential borrowers because they had commonly
incurred debt that they could not pay. The total debt of the Russian enterprises was
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extremely high. And a considerable portion of all of the wages and salaries were unpaid,
as noted in Chapter 14. Most of the banks, fearful of the uncertain political climate and
of the inability of the enterprises to repay loans, either refused to make loans at all or
would not make them for longer than one year. Instead of lending to the new Russian
enterprises, the private banks, who received their deposits from businesses or
government agencies, either held them as foreign money in banks in the West or
used them to buy debt of the Russian federal government. Even the Savings Bank
loaned most of its deposits to the federal government. (They bought what are called
GKOs – similar to American Treasury Bills.)
The financial crisis of 1998 will be discussed below. At that time, the Russian federal
government defaulted on its debt. The GKOs became essentially worthless and many of
the banks holding them became insolvent. In the 9 months after the crisis of August of
1998, the value of the commercial banks fell over 50%. After the crisis, the restructuring
of Russia’s banks proceeded very slowly. In general, the new private banks have not yet
been particularly relevant to Russian economic development.
Investment funds, similar to mutual funds in the United States, were slow to develop
in Russia. Russian Investment funds hold only about 10% of the shares of Russian
corporations. (Compare this to the 60% owned by investment funds in the Czech
Republic.) So banks, investment funds, and even foreign investors have not been
significant sources of financing for Russian enterprises.
There is yet another way for companies to obtain the funds they need to finance their
purchases of new capital goods. They can sell shares of stock to the public. This requires
the development of a securities, or stock, market. By 1995, there were already some 66
different stock exchanges operating in Russia. The privatization process described in the
previous chapter provided training for future brokers, as many got their start by trading
vouchers. Yet, the Russian stock markets have not become as significant as had been
hoped (as of the date of this writing). One reason is that information to potential
buyers of stock is inadequate. Information is inadequate for at least two reasons. First,
most trading is done on an over-the-counter basis. There is no equivalent of the
American Dow Jones Average or NASDAQ that is relayed to potential stock buyers all
over the country. Therefore, it is difficult for potential buyers to know what is occurring
on the Russian stock markets in a timely manner. Second, information about the
companies is also difficult to interpret. The Russian accounting system is different
from that used in the United States or Europe. In Russia, the goal of the accounting
system has been to find ways to understate profits so as to reduce corporate taxes. The
goal has not been to accurately measure the profits of the company. Until 1994, the
Russian stock markets were dominated by pyramid schemes (swindles). Laws protecting
stockholder rights were slow to develop in Russia. When those laws were finally enacted
in the late 1990s, they were poorly enforced. A third reason that Russian stock
markets have yet to become a significant factor in Russian economic development is
that management often holds the majority of the shares (as noted in the previous
chapter) and is hesitant to sell its shares of stock.
Foreigners have been very important buyers in the Russian securities markets,
especially the stock of energy companies. By the end of 1996, foreigners held about 15%
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of the stock of the 50 largest Russian companies. Since 1996, foreign pension funds
bought much of this stock. Foreigners retreated from Russian stock markets during the
crisis of 1998 (discussed below). But some foreigners achieved great wealth buying stock
in Russian companies (which, as noted in the previous chapter, were very undervalued).
Because of the problems of banks and securities markets, the buying of new
capital goods by enterprises declined significantly in the 1990s. This decline was a
main reason for the economic problems suffered by Russia in the 1990s (see below).
Throughout the 1990s, most new capital goods were paid for out of the profits of the
Russian companies. Less than 10% of the capital goods were paid for by borrowing
from the new banks or by selling shares of stock. Developing institutions that will
allow the newly privatized enterprises to borrow or sell shares to pay for new capital
goods remains a challenge for Russia. But there is a huge need for new capital goods if
Russia is to grow economically. The “Economic Freedom Index” estimates the
investment climate in 161 countries. In 2000, Russia occupied 121st place. This poor
investment climate acts to hold down economic growth in Russia.
2. Stabilization
One of the main problems faced by Russia in the early 1990s was rampant inflation.
As mentioned above, prices rose 250% in 1992 as the prices were freed from government
regulation. That was to be expected. What was not expected was that prices would keep
on rising – typically at a rate of 25% per month! This is called hyperinflation. Prices in
Russia rose at the following rates per year:
1991
1992
1993
161% 1994
2,506% 1995
840% 1996
204%
1997 10.97%
128.6% 1998 84.5%
21.8% 1999 36.8%
Under the end of the 1980s, the world had recorded only 16 cases of hyperinflation. But
from 1989 through the early 1990s, there were 11 more cases, all in the Eastern European
countries undertaking the transition from communism.
This magnitude of inflation makes it impossible for markets to function in an efficient
manner. This high rate of inflation also destroys the savings of the well-to-do and the
elderly. And this high rate of inflation undermines confidence in the ruble. Few people
wanted to hold rubles. Instead, in most regions of Russia, transactions took place in
American dollars. So, in order to get the Russian economy to grow, and also in order to
help Boris Yeltsin get re-elected as President of Russia, it was necessary to get the
inflation under control. This required reducing the growth of the number of rubles in
circulation (the Russian money supply).
The hyperinflation had been connected to very large budget deficits (the Russian
government spending more than it took in as tax revenues). This is explained in the
section on the Russian Financial Crisis below. As a percent of GDP, Russian budget
deficits were the following:
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1992
1993
18.9% 1994 10.4%
7.3% 1995 6.0%
1996 8.9%
1997 7.6%
1998 8.0%
1999 1.1%
For perspective on these data, consider that the very large American budget deficits in
2002 and 2003 were not much more than 3% of the American GDP. These very high
Russian budget deficits were financed by the creation of new rubles. (The Russian
government had to pay for the spending that exceeded its tax revenues. It did this by
printing new money.) “More rubles chasing fewer goods” is a sure recipe for inflation.
The hyperinflation of the 1990s was also connected to the large amount of central
bank loans. The Bank of Russia (the Russian central bank) would simply create the
new rubles to lend to some Russian enterprises. This, once again, meant there was
more money in Russia. And more money chasing fewer goods causes inflation.
Reducing this source of inflation in the new Russian democracy was difficult because
some important political interests in Russia were benefiting from these central bank
loans. First, the central bank of Russia earned interest when it made loans to various
enterprises. The interest payments on these loans indeed became a major source of the
profits of the central bank. About 2/3 of these profits went into a social fund to
“stimulate the performance” of the central bank’s employees. It was also rumored that
some employees of the central bank were receiving bribes from certain enterprises to gain
access to these central bank loans. So the central bank’s employees had an interest in
maintaining these loans and therefore in keeping the growth of the money supply high.
Second, the commercial banks benefited from the central bank lending. First,
although they did not lend much to enterprises themselves, they handled the loans from
the central bank to the enterprises and earned fees for doing so. Second, they were also
able to take bribes from enterprises seeking access to these loans. Third, they were able to
direct some of the central bank loans to enterprises that were owned by the commercial
banks (or by the banks’ managers). Fourth, the commercial banks gained from inflation
because they took in deposits and paid a negative real interest rate on these deposits
(that is, the interest they paid did not even equal the rise in prices). They used these
deposits to speculate on commodities or on foreign exchange to try to earn high profits.
(In contrast, it would be illegal for American banks to do this.) Not only did the
commercial banks desire to maintain the policy of central bank lending to enterprises,
they were in a powerful political position to lobby to maintain this policy. They had this
powerful political position because they provided money to help finance electoral
campaigns and because they provided attractive places of employment for the
government ministers after they left office.
Third, there were the enterprises that received the loans from the central bank.
These loans were very substantial and were made at negative real interest rates (again, the
interest rate paid did not cover the rise in prices). Favored enterprises gained greatly
from these cheap loans. Managers of these enterprises and their unions lobbied strongly
to maintain these loans. What existed was a good example of what is called the special
interest effect. The small group of people who gained from the loans that caused the
inflation was very conscious of the gain they received and were well organized to lobby
for the continuation of the policies that generated these gains. The victims of the
hyperinflation, the population in total, were disorganized and were not well aware that
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the cause of the hyperinflation was the large amount of loans from the central bank.
There was no pressure group arguing for an end to the inflation.
Inflation continued at very high rates through 1999. Then, as we will see below, the
Russian financial crisis occurred. This was an economic disaster for Russia. Overall
production in Russia was 30% lower in 2000 than it had been in 1990. The financial
crisis provided the motivation to take action to reduce the inflation rates. This
required first getting control of the budget deficits. The budget deficit fell from 8.9% of
Russian GDP in 1996 to 1.1% of GDP by 1999 (see above). Since 2000, as you can see in
the data below, the Russian budget has been in surplus (revenues have exceeded
spending). A good part of this has been the result of increasing revenues from oil as the
price of oil has risen. Reducing inflation also required getting control of the Russian
money supply. This has not been done, as you can see in the data below. (For perspective,
in the United States, the money supply rarely rises by more than 5% per year.) By
American and European standards, inflation rates were still high in Russia through 2005.
However, they are projected to come down into single digits in 2007, 2008, and 2009.
But at least by 2000, the hyperinflation was over.
Year
2000
2001
2002
2003
2004
2005
Year
1997
1998
1999
2000
2001
2002
2003
2004
2005
Inflation Rate Budget Surplus as a Percent of GDP
20.8%
1.4%
18.6%
3.0%
15.1%
1.7%
12.0%
1.7%
11.7%
10.9%
Growth Rate of the Money Supply (M-2)
29.8%
21.3%
57.5%
61.5%
39.7%
32.4%
50.5%
35.8%
38.6%
3. Entrance into the Global Economy
Another major aspect of the transition from communism to a market economy has
been the opening of Russia to the world economy. We know that resistance to
international trade (autarky) had been part of the communist economy. In the communist
period, the ruble exchange rate had been set arbitrarily by the government. Russian
people had been prohibited from owning foreign currencies. If the new Russia were to
become open to international trade, the Russian ruble had to become convertible. This
means that the ruble had to be traded freely in the foreign exchange markets of the world.
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The creation of a convertible Russian ruble took several years to accomplish. In
April of 1991, the Russian government authorized currency exchanges. Russians were
permitted to hold foreign currencies for the first time. However, for much of the 1990s,
there were limitations on these holdings of foreign currencies. Those who earned foreign
currencies by selling abroad were required to sell a portion of them to the Russian Central
Bank. This, of course, reduced the incentive to earn foreign currency. Although there are
still some restrictions today, the Russian ruble has been trading in foreign exchange
markets. Throughout most of the 1990s, the Russian ruble depreciated in relation to the
dollar. This depreciation has resulted from the very high inflation rates experienced in
Russia. In 1998, there was a major economic crisis in Russia (to be discussed below).
The Russian ruble was converted into the New Russian Ruble at the rate of 1000 old
Russian rubles to 1 new Russian ruble. At the time of this writing (2006), it took about
26.7 new Russian rubles to buy $1 (this would be 26,700 old Russian rubles). You can
see the rapid depreciation of the Russian ruble in the 1990s in the following table:
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Russian Rubles Per Dollar
179
572
1582
4562
5126
5785
9965 Old Rubles (9.965 New Rubles)
25,400 Old Rubles (25.4 New Rubles)
27.0 New Rubles
28.16 New Rubles
30.14 New Rubles
30.7 New Rubles
29.0 New Rubles
28.3 New Rubles
In 1998, the Russian ruble was not sold on foreign exchange markets at all for awhile due
to the great political uncertainty in Russia. The depreciation of the Russian ruble, the high
inflation rates in Russia, and the restrictions on holding foreign exchange made it difficult
for the new Russia to become fully engaged in international trade. However, as you can
see in the data, since 1999, the Russian ruble has not depreciated very much (25.4 to the
dollar in 1999 compared to 26.7 to the dollar in 2006). This stability, combined with
lower inflation rates and easing on the restrictions against holding foreign exchange, has
eased Russia’s transition into the global economy.
In addition to the problems of making the ruble convertible, in the 1990s, there was
only a weak commitment on the part of the Russian government to open Russia to
international trade. Exports were still regulated by export taxes, quotas, and licenses.
(These quotas and licenses were a source of income for government officials through the
receipt of bribes.) Domestic producers in many Russian industries also were
protected from imports through tariffs and import quotas. It should be no surprise
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that the amount of trade actually fell after 1990. This decline in trade contributed to the
economic disaster of the early 1990s in Russia. But from 1993 to 2003, trade
rebounded very well. Russian exports fell from over $70 billion in 1990 to over $40
billion by 1992. But after that, they increased considerably (except for 1997 and 1998)
and reached almost $140 billion by 2003. Since 1999, Russian exports have been
increasing at rates of more than 5% each year.
The collapse of communism brought a quick and large-scale reorientation in the
direction of Russian trade. Most of this took place in the early 1990s. In 1990, nearly
all of Russia’s exports had gone to the countries that were then part of the Soviet Union
or were part of the Soviet Bloc. By 2002, only about one-fourth of Russia’s exports went
to these countries. In 2004, more than half of Russia’s exports were going to the countries
of the European Union and another 6% was going to the United States – areas that had
received practically no Russian exports as late as 1990.
The change in Russia’s trade appears to have followed the law of comparative
advantage well. Again, most of this change appears to have taken place in the early
1990s. Russia has been exporting those goods for which it has a comparative
advantage (natural resources such as oil) and has been importing those goods for
which it has a comparative disadvantage (consumer goods and capital goods). The
opening to the world economy has brought a large-scale reduction in the proportion
machinery goods in Russian exports and an expansion in the proportion of energy. The
importing of consumer goods has provided the main competition for Russian industry
(recall that Russian industry has tended toward monopoly).
As of this writing (2006), Russia is not a member of the World Trade Organization
(WTO). It has signed an agreement with the United States to become a member very
soon. But it is still the largest non-member, despite having first applied for membership
in 1993. Its accession as a member has been hotly debated both inside and outside of
Russia. Becoming a member of the WTO would require Russia to reduce its restrictions
on imports. This would hurt those Russian companies that have been protected against
imports. Those people represent a strong political interest. But becoming a member of the
WTO would also open the markets of the other 150 WTO member countries to Russia’s
exports. Studies indicate that Russia becoming a member of the WTO could cause a
large increase in Russia’s exports to WTO member countries. Accession to the WTO
would also make Russia part of a rules-based trading system. This should provide an
incentive to improve rules-based governance within Russia. (As you might guess, this is
opposed by those whose wealth is derived greatly from bribery.) Accession to the WTO
would also make foreign investment in Russia more attractive. This is the major reason
that Russia has sought entry. As a prelude to its accession to the WTO, Russia has been
negotiating bilateral market access deals with major WTO member countries. In 2004, it
signed such a deal with the European Union.
Russia’s opening to the world economy has also been impaired by Russia’s foreign
debt. Russia took over the debt of the former Soviet Union and then added some of its
own. By the mid-1990s, this debt of the Russian government exceeded $100 billion
dollars. The need to pay this foreign debt is the reason that those who earn foreign
currency by selling products abroad have to sell part of that foreign currency to the
Russian Central Bank.
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Finally, let us very briefly mention Russia’s agricultural sector. One would expect
Russia to become a major exporter of agricultural products. Under communism, Russia
was an importer of grains despite having some of the best agricultural land in the world.
Yet in the new Russia, reforms of the agricultural sector have been minimal. Most
farms are still either state farms or collective farms. Agricultural performance in the new
Russia has been poor. Meat, milk, egg, and grain production all declined considerably
in the 1990s and have rebounded only slowly. Russia has failed to become a major
exporter of agricultural products as of yet.
The Russian Financial Crisis of 1998
By 1997, Russia had become one of the most popular destinations for financial
managers in the United States and Europe to invest their money. Russia was considered
safe because it was believed that if any problem occurred, Russia would be bailed out by
the International Monetary Fund. Russia, after all, was too big and too nuclear to be
allowed to fail.
As we saw, in 1997 Russia had a government budget deficit. As with any other
country with a government budget deficit, it financed this deficit by borrowing. The
Russian government borrowed on a short-term basis from foreign financial institutions.
(These were called GKOs.) These loans were payable in rubles, not dollars. But the
ruble – dollar exchange rate had been reasonably constant, so the lenders did not fear that
they were taking much risk. The foreign lenders liked these loans because they paid
interest rates in the 20% to 30% range and because their short term (3 months) made the
risk seem low (they did not think that much could go wrong in only three months). By the
end of 1998, Russians owed foreigners about $214 billion in total.
By early 1998, foreign financial institutions had become less willing to buy the
Russian government debt (that is, to lend to the Russian government) for several
reasons. First, the recession in East Asia reduced the demand for oil and natural gas,
Russia’s main export products. Second, the problems of East Asia caused financial
managers to look more negatively at all emerging markets, including that of Russia.
Third, there was political uncertainty when, in the spring of 1998, President Yeltsin fired
his Prime Minister. While President Yeltsin maintained his position (despite an
impeachment attempt in 1999), the rest of the government had been changed several
times. In a year and a half, there had been four new governments. And fourth, in May of
1998, the coal miners, tired of having their wages go unpaid, began a strike, blocking the
Trans-Siberian Railway. Faced with the unwillingness of foreign financial institutions to
lend it the money that it needed, the Russian government was forced to raise the interest
rates it would pay. Within one month, these interest rates had topped 150%.
The reduced willingness of the financial institutions to lend to Russia should cause the
Russian ruble to depreciate against the American dollar. (When foreign financial
institutions lend to Russia, they need to buy Russian rubles to lend to the Russian
government. But now, they were lending less. So they would be buying fewer Russian
rubles, reducing the value of the Russian ruble.) However, both the Russian government
and the International Monetary Fund desired that the ruble – dollar exchange rate remain
stable. So, in July of 1998, the International Monetary Fund arranged for a $22.5 billion
loan to Russia to help support the ruble-dollar exchange rate. (Russia was to use these
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dollars to buy Russian rubles and thereby prevent the Russian ruble from going down in
value.) In return, Russia promised to lower its budget deficit significantly (partly by
collecting the taxes due from those that had been avoiding paying their taxes). In
addition, the Russian government agreed to exchange part of its short-term debt for
longer-term bonds. These longer-term bonds were to be repayable in dollars. The new
longer-term bonds of the Russian government were bought mainly by Russian private
banks. The Russian private banks paid for these bonds by borrowing in dollars from
foreign financial institutions. Because the government sold more and more of these bonds
to finance its budget deficits, the prices of these bonds fell. The decline in the prices of
the bonds caused the value of the assets of the Russian banks that held these bonds to
decline as well. As the value of the assets of the Russian banks declined, the foreign
financial institutions feared that the Russian banks would not be able to pay their debts.
So the Russian banks received calls from the foreign financial institutions to pay their
debts immediately. Hearing this news, the Russian people feared a collapse of the
Russian banking system. Because of this fear, they withdrew their accounts at the
Russian banks and tried to convert them into dollars. As the runs on banks continued and
grew, the Russian banks could not pay their debts to the foreign financial institutions.
Ultimately, on August 17, 1998, the Russian government defaulted on its borrowing,
both to Russians and to foreigners. Because of Russia’s default, foreign investors lost
considerably. Accounts at banks were frozen and banks were closed. And in August of
1998, as we saw above, the Russian government finally allowed the value of the ruble to
fall.
Once the crisis passed, the Russian economy recovered relatively quickly. (This
was also true for most of the countries that experienced financial crisis in this period.) As
we saw above, budget deficits were reduced by the fall of 1999. Oil prices rose in 1999
and then rose much more after 2003, greatly improving the Russian economic
performance. Inflation rates, while still high by American standards, declined to more
reasonable levels. As we saw, the ruble- dollar exchange rate has basically stabilized
after 1999. The financial crisis caused great hardship in Russia for a couple of years.
However, from the perspective of 2006, it does not appear to have had long-lasting
impacts.
4. Inequality, Poverty, and Health Care
Russia undertook the transition from communism to a market economy relatively
quickly. This has been known as “shock therapy”. (We will contrast this with China,
whose transition was much slower.) One result of the rapid shift to a market economy
has been an increase in inequality in Russia. Inequality is measured by the Gini Index.
This is a number between zero and one. The higher the number the greater is the
inequality of incomes. And the lower the number the greater is the equality of incomes.
According to the official Russian data, the Gini Index rose from 0.26 in 1991 to 0.40 by
2000. The World Bank estimates the Gini Index to be 0.46 in 2000. By comparison, the
Gini Index for the United States is approximately 0.41. So Russia has changed from a
relatively equal society under communism to a society that is slightly more unequal than
the United States. However, it needs to be noted that most of this increase in inequality
occurred in the early 1990s. According to the World Bank, the Gini Index for Russia had
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reached 0.496 by 1994. After 1994, inequality stabilized in Russia but has not been
reduced. The following table shows the distribution of income in 1980 and in 1995 by
quintiles:
Percent of Total Household Income in Russia
Quintile
1980
1995
First
10.1%
5.5%
Second
14.8%
10.2%
Third
18.6%
15.0%
Fourth
23.1%
22.4%
Fifth
33.4%
46.9%
A parallel change has been the increase in the number of people officially poor in
Russia. The official statistics define poverty as not having an income sufficient for
minimum subsistence. According to this measure, the number of Russian people who
were officially poor increased from 11% of the population in 1989 to 30% of the
population by 1995 (a different measure estimates this to be 40% in 1995). In 1995, the
average real wage was only about one-third of its 1991 level and almost half of workingage adults were owed wages. Poverty levels peaked in 1995 and have declined gradually
since then. However, they are still high, reaching about 16% of the population in 2005
(compared to about 13% for the United States and 5% to 10% for most countries of
Europe). Some of this increase in poverty has been related to a decline in the social
safety net. Pensions for those of retirement age (55 for women and 60 for men) have
been maintained and have been adjusted for inflation. Those who are retired have not
been driven into poverty. But support for families with children has been seriously
reduced. Indeed, poverty rates in Russia are highest for families with three or more
children. And benefits for the unemployed have been reduced to less than one-fifth of
their 1991 level at a time during which unemployment was rising and during which
about 80% of the unemployed people are unemployment for at least three months. In the
1990s, government transfers to the poor were reduced significantly. As of 1995,
about 40% of very poor families received no public transfers at all from either the
Russian government or their local governments.
Perhaps the most noted change in Russia since the shift to a market economy has
been the decline in health standards. This is best illustrated by the death rate. The
death rate in Russia increased from 7.6 deaths per 1,000 people in 1965 to 11.2 deaths per
1,000 people in 1990 and then to 15.3 deaths per 1,000 people in 2000. The life
expectancy at birth for a Russian was 69.5 years in 1965 and 69 years in 1990 before
falling to 64 years in 2004 (and then rising to 65.8 years in 2005). For males, the life
expectancy at birth fell to only 57 in 1994 before rising. However, it was still only 60 in
1999 (compared to about 75 years for men in the United States and even older for men in
most of Europe). The main explanation for this decline in health standards has been the
large increase in alcohol consumption. (Russian Vodka is commonly 45% alcohol or
more. Binge drinking is common.) Deaths of working age males increased from 30 per
100,000 people in 1991 to 103 per 100,000 people in 1994 before falling back to 46 per
100,000 people by 1998. Some of this excessive drinking may have been caused by
stresses brought on by the transition process. Another explanation for these statistics is
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the increase in crime in Russia. Death rates of males because of murder increased from
23 per 100,000 people in 1990 to 52 per 100,000 people in 1994 before falling back to 36
per 100,000 people in 1998. There does not seem to be any serious malnutrition in
Russia causing the increase in the death rate; but there is evidence that the diets of large
numbers of people became less healthy. Some of the health deterioration may also be due
to environmental problems. Only half of the Russian people in the late 1990s had access
to safe drinking water. And only 15% of the people lived in cities in which the air was
not significantly polluted.
It is hard to blame this health decline on the health care system. The number of
doctors per 1,000 people and the number of visits to doctors are about the same as before.
The number of hospital beds and the number of hospital stays have declined somewhat as
there have been financial constraints on hospitals. The infant mortality rate (deaths before
age one) has actually declined slightly. So the decline in health seems to be related more
to changes in behaviors and less to significant reductions in the availability of health care.
5. Conclusions: Economic Performance in the New Russia
In assessing the performance of the Russian economy, some writers have used the
analogy of a freeway. One can drive around for many miles on city streets, getting lost,
in order to find the entrance to a freeway. But once one does find the entrance, one can
usually travel at great speeds. Using this analogy, Russia has been “looking for the
entrance to the freeway”. As with the driver, its economic performance has not been
good. Once it does “find the freeway”, it is hoped that the Russian economy can grow
very fast. At the time of this writing, the future of the Russian economy appears to be
better than the recent past. Let us examine the New Russia in terms of the goals we set
for an economy in Chapter 1.
Our first goals involve economic growth and the standard of living. As we have
noted, overall production in Russia declined greatly through most of the 1990s. This
decline in production was about 39% between 1991 and 1998. The decline in overall
production largely resulted from the decline in production of new capital goods.
(Purchases of capital goods in 1997 were equal to only 17% the purchases of 1990.) But
it also resulted from the decline in international trade and in agricultural production. The
decline in production in Russia in the 1990s is substantially greater than that experienced
by the United States in the Great Depression of the 1930s (about 25%). It is true that all
of the Eastern European countries that also shifted to a market economy experienced a
decline in production. But for most of these other countries, the decline lasted only about
two years and was followed by growth. For Russia, the decline continued for nearly a
decade. Even if the transition to a market economy is ultimately very successful, the
Russian people paid an enormous cost.
It appears that since the end of the financial crisis, production in Russia has
grown at a substantial pace. Russian GDP and Industrial Production grew at the
following rates in recent years:
12
2001
GDP Growth Rate
Industrial Production
5.1%
4.9%
2002
4.7%
3.7%
2003
7.3%
7.0%
2004
7.2%
8.3%
2005
6.4%
4.0%
If economic growth continues at these rates, the Russian economy will indeed have found
the “entrance to the freeway”.
One mistake that has been made about the former Soviet Union is to assume that it
was a rich country. This mistake was made because the Soviet Union was militarily
powerful. But the former Soviet Union then and Russia today must be classified as a
middle income country. GDP per capita (in purchasing power parity) is about $8,000.
This is similar to Mexico and Turkey. But it is less than one-fifth the level of the United
States. Once it is realized that the standard of living in Russia is low by American or
European standards, one can appreciate that standards of living in Russia have been
rising, albeit slowly. Consumption by households rose about 3% between 1990 and 2002.
Average living space per person increased from 16 square meters to 19 square meters.
This is still very small by American standards. (This is an average of 126 square feet per
person. So a family of four would average about 500 square feet, a small space indeed.)
However, more than half of this living space is privately owned now compared to about
one quarter in 1990. The proportion of households with radios, televisions, refrigerators,
washing machines, and vacuum cleaners has increased. Ownership of cars increased
from 14 cars per 100 households in 1991 to 27 cars per 100 households in 1000. But
while consumption of some goods has increased, consumption of some services that had
been provided by the government has declined. This includes theaters and museums.
And the deterioration in the overall health of the population was discussed in detail
earlier. So the record on consumption is mixed.
For most people, their income comes from their wages. The wage arrears problem
still exists. A significant proportion of Russian workers did not receive their paychecks
when they were due. Many waited for months. As of 1999, the Russian government
owed an estimated 60 to 75 billion rubles to its workers. Private businesses owed another
70 billion rubles. Adjusting for inflation, the average monthly wage in July of 1999 was
only 65% that of December of 1997. For awhile, many people had no money. Unpaid
soldiers reportedly sold their weapons and uniforms. Many Russians resorted to barter
(the trading of goods for goods) to survive. Russian companies also resorted to barter,
paying their suppliers and even their taxes in kind. And many people moved into selfsufficiency --- growing their own food in small gardens near the cities, making their own
clothes, and so forth. The situation is better for these people today than it was in the late
1990s. But wage arrears are still causing suffering.
Our second goal involves efficiency (both allocative efficiency and productive
efficiency). We have no measure of this. But the opening of the market economy would
seem to have improved efficiency. First, as prices have been liberalized, they are more
likely to be sending signals to companies telling them what goods and services are most
desired by consumers. The response to these market signals could be impaired by the lack
of competition within Russia. However, this may be offset by the increase in imports
13
from abroad. Second, as we noted in the section in Chapter 14 on the oligarchs, there is
evidence that productive efficiency in the companies owned by the oligarchs has
improved considerably. This should not be surprising as there was great waste under
communism and since the owners of the companies are now trying to increase their
profits.
Our third goal involves equity. This was discussed in detail above. Inequality has
increased in Russia and is now quite high. Poverty seems to have increased. A new class
of very wealthy people has emerged. Clearly, the Russian economy is less equitable than
it was before.
Our fourth goal involves full employment and economic security. Clearly, Russia
has more unemployment and less economic security than it did under communism. As of
July of 1999, over 12% of all workers were unemployed. This has fallen since 1999 but is
still relatively high. Not only have unemployment rates increased but the duration of
spells of unemployment has also increased. And the government support for people
unemployed or for people with low incomes has been reduced. For most people of
working age (but not for retirees), economic life is less secure than it used to be.
Our fifth goal involves price stability. As we saw, Russia experienced very rapid
inflation during its transition. For 1992 – 1994, Russia even experienced hyperinflation.
Consumers in Russia sometimes found that the price of a basic product, such as flour (or
vodka), doubled in just a week. The rapid rise in prices virtually wiped out the value
of the savings of the people (which, remember, were held in currency). Since the late
1990s, inflation rates have been lower in Russia. However, they have still been high by
international standards. So while improving, Russia had not achieved price stability by
2005. However, it appears that inflation rates in Russia will be lower beginning in 2006.
So achieving this goal is in sight.
We have not discussed the other goals in these two chapters. One is environmental
quality. As with most middle income countries, this is a major problem for Russia.
Much of the water and the air is polluted. Another goal is military power. Because it is
a nuclear power, Russia is more significant militarily than its economy would suggest.
However, spending of defense in Russia has been reduced greatly since 1990. And
Russia has been engaged in a long war in Chechnya without result. A final goal is
freedom. Russia has established a democracy. But it appears that the situation has
deteriorated since 2000 under President Putin. The government media dominate. The
independent media have been harassed or censored. More than one prominent media
critic of the government has been assassinated. There is some evidence that elections
have been manipulated. As we have seen, bribery is still common. In the World Bank’s
“graft index”, Russia ranks number 142 out of 160 countries. Corporate governance is
very weak. Property rights are not assured. While it is certainly freer than it was under
communism, Russia has a long way to go.
The Russian people were told that the economic reforms would make their lives
better. The jury is still out as to how well this will happen. Russia is a country with the
14
potential for great wealth. It has abundant natural resources, good agricultural land, a
considerable amount of capital goods, and a reasonably educated population. But it
cannot really become a fully developed country until some major changes in its economic
system occur. Most importantly, there needs to be the creation of political stability and a
system of well-defined property rights. Also there needs to be a large reduction in the
amount of criminal activity. Enterprises need to be changed so that those who run them
profit only if the enterprise performs well in markets. Banking and other financial
institutions need to be better developed. A climate needs to be created that will
encourage people, both Russian and foreign, to invest in new capital goods. President
Putin has said that he will step down in 2008. Making these changes will be the main
challenge for the next Russian President.