POLITICAL ECONOMY

Russia

How does one build capitalism, with private property and open markets, in a country that historically has had little of either? This is the challenge now facing Russia as it moves away from communism, and as with other aspects of Russia, the results have been mixed, creating an economic system that is neither communist nor fully capitalist. Russia's political economy remains in a state of transition-or more skeptically, a state of paralysis.

As did other former communist countries, in the 1990s Russia undertook on a series of dramatic reforms in order to privatize state assets and free up market forces. Looking to the lessons of Poland and acting on the advice of western economic advisors, Russia opted for a course of "shock therapy," rapidly dismantling central planning and freeing up prices, with the hope that this would stimulate competition and the creation of new businesses. The immediate result was a wave of hyperinflation-in 1992 alone the inflation rate was over 2000 percent. Savings were wiped out, the economy sank into recession, and tensions deepened between Yeltsin and parliament, helping to foster the violent clash between the two branches of government in 1993. The Gross Domestic Product contracted dramatically; only by the late 1990s had it begun to grow again.

At the same time, Russia began the process of privatization, which was equally problematic. Privatization started with the distribution of vouchers to the public, so that they could purchase shares that would give them ownership in formerly state-owned businesses. However, in many cases businesses were not sold off to a large number of shareholders but became subject to "insider privatization," with the former nomenklatura directors of these firms acquiring the largest share. Therefore, wealth was not dispersed, but concentrated into the hands of those who already had strong economic and political connections. Despite the power of this old nomenklatura elite, however, a small number of new businessmen quickly emerged from various ranks of society, taking advantage of the environment to start up new businesses and buy old ones and amassing an enormous amount of wealth in the process. These new tycoons became known as "the oligarchs" and were noted for their control of large amounts of the Russian economy (including the media), their close ties to the government, and the accusations of corruption surrounding their rise to power. The problem of the oligarchs was compounded in 1996, when the government instituted the "loans for shares" program. Strapped for cash (and fearful of a Communist Party victory in the 1996 presidential elections), the Yeltsin administration chose to borrow funds from the oligarchs in return for shares in those businesses that had not yet been sold off by the state-in particular, the lucrative natural resources industry and the energy sector. Overall, foreign investment played a very small role in the Russian privatization process.

Debate continues over whether the particular policies of marketization and privatization were a mistake. Critics argue that market reforms failed to take into account the institutional constraints of Russia, among them the absence of private enterprise, a weak civil society and a risk-averse culture, the absence of the rule of law, and the centralization and large scale of industry. Moreover, the privatization process was not geared toward encouraging foreign investment and a greater distribution of assets, but toward empowering a narrow elite that could support those in power. Others retort that given the weakness of economic and political institutions in Russia, no reform was likely to be easy and that, if anything, Russia suffered from reforms that were too conservative, rather than too radical. Despite these differences of opinion, Russia's ongoing economic problems are not simply the result of economic reform. Many of these problems were a function of the Soviet order that have now reached a crisis stage, and the question of whether a different set of economic policies would have produced a different a result remains open.

Economic Policies and Issues

Where do the economic reforms of the 1990s leave Russia today? Certainly, we can point to a number of gloomy statistics and observations. Poverty rates in Russia are very high, ranging from 20 to 50 percent of the population depending on how the numbers are calculated. Inequality is another problem, being higher than in any country in western Europe or North America. Economic growth, while on the rise, has been predicated largely on the export of natural resources such as oil and gas, rather than the development of finished products or services. Businesses by and large continue to be hindered by state regulations, high taxes, corruption, organized crime, and insider connections. Observers have noted that one result of these hindrances is that Russia has become a country of many very small businesses and a few very large ones. Small enterprises are able to "fly under the radar," escaping the detection of state officials or organized crime, while very large firms wield enough clout to manage such problems on their own (and are themselves often connected to government, criminal activity, or both). But medium-sized firms lack the ability to either escape notice or fend off adversaries. This is bad for Russia; according to one Russian government estimate, poor regulations alone cost the country nearly US$6 billion a year. These problems limit foreign investment, serving as a form of protectionism or quasi-mercantilism. As of 2000, foreign direct investment was around US$20 billion, while in Poland, with a population only one-third the size of Russia's, FDI was over US$40 billion. Still, there is room for optimism. In spite of the chaotic nature of privatization and marketization, over 70 percent of Russia's GDP is now in private hands.

As part of its reform plans, the Putin administration has sought to boost economic activity through a various new policies. Some tax and property rights reforms have been implemented, and further changes in this direction could help establish a predictable climate for business and foreign investment. At the international level, Russia is negotiating entry into the World Trade Organization as a way to promote exports and investment. Finally, Putin has gone after a number of the oligarchs in order to restrict their power, though this seems directed less at fostering economic development than bringing to heel those who might exert leverage on the government. Although they helped put Putin into power through such means as media support, several of the best-known oligarchs have now fled the country to avoid prosecution.

In the future, the Russian economy faces a number of thorny issues, such as the decline of older infrastructure, education, and social services. Liberalizing markets and property alone will not be enough to make Russia prosperous-it will also require investments in society. For a state with relatively limited budgetary resources like Russia, this is a challenge.