Chapter 5: Who Lost Russia? This is a chapter about Russia’s disastrous transition from a planned economy to a market economy in the 1990s.
Main idea: The IMF and the US Treasury aggressively promoted price liberalization, stabilization, and privatization in Russia without taking care to build the market or social institutions necessary to ensure that these measures led to a successful, smooth transition characterized by the growth that people kept foolishly predicting would arise. 1. For the majority living in Russia, life under capitalism has been even worse than Communists predicted it would be.
Middle class has been devastated.
System of crony and mafia capitalism has been created
Democracy and free press are fragile.
Incomes today are lower than they were a decade ago and poverty is much higher.
While Russians can be blamed for the failure of this transition, so must western advisors, especially from the US and the IMF.
2. Something has gone wrong with privatization in Russia and the more than twenty countries that emerged from the Soviet empire.
IMF insistence that Russia maintain an overvalued currency and supporting that belief with billions of dollars of loans crushed the economy.
The failure to change/address social and political institutions contributed to failure of transition.
THE CHALLENGES AND OPPORTUNITIES OF TRANSITION
1. Stiglitz compares Russia’s transition to that of the US transitioning from a war economy to a market economy after World War II and the transition of Taiwan and China to market economies.
important difference between Russian and the US example: Russia lacked market institutions prior to transition. In US, these institutions were simply suspended during war and resumed after.
Russia needed both resource redeployment and the wholesale creation of market institutions.
Taiwan and China faced similar challenges to Russia, but both had impressive success.
The radical transformers in Russia didn’t pay enough attention to ex. of China and Taiwan and ignored advice of Russian historians, economists, and sociologists.
2. Russian institutions were similar to those in the west, but did not perform market-like functions.
Firms produced goods, but they did not make decisions. Told what to produce, given inputs.
Entrepreneurship lay in circumventing laws (precursor to breakdown of “rule of law” in transition.)
Prices set by government. Some prices were set artificially low.
Lack of legal and regulatory frameworks to ensure that markets operate in a fair manner.
Market reformers in Russia have paid insufficient attention to building these market institutions.
Social institutions are also important. Lack of social safety net (unemployment insurance) and housing market prevent effective restructuring (hiring and firing of employees) necessary for transition.
3. Challenges facing Soviet Union:
move from one price system to a market price system
create markets and institutional infrastructure of market economy
privatize all state property
create new kind of entrepreneurship and new enterprises to efficiently redeploy resources.
BUT Russia had some advantages: resource rich, especially in technically educated people. With cutbacks in military spending, there’d be money left to increase peoples’ standard of living.
4. Contentious debate over speed of reform:
“Shock Therapy” – experts who believed Russia needed to privatize quickly, creating a large group of people with vested interests in capitalism, to avoid reversion to communism. Strongly voiced by US and IMF.
“Gradualists” believed that if Russia moved too quickly, reforms would be a disaster. Wisdom of this approach is finally being recognized.
THE REFORM STORY
1. Shock Therapy:
First round: Instantaneous price liberalization -- prices freed overnight in 1992. Resulting inflation wiped out savings. First mistake. Capital was used up.
Prices for natural resources were kept low. People got rich through rent seeking. – buying oil in Russia and selling it in the West.
Second Round: Stabilization to reduce inflation. Tightened monetary policy by raising interest rates.
Third Round: Privatization – supposed to bring about positive restructuring of the economy. But this never occurred.
3. Radical restructuring a failure:
After 1989, GDP in Russia fell year after year. Recession has lasted over a decade.
1990-1999: Russian industrial production fell by almost 60% and GDP fell 54%.
4. Privatization led to asset stripping, not wealth creation.
Pressured by US, World Bank and IMF to privatize quickly, state turned over its assets for a pittance and did so before effective tax system was in place.
Thereby created a powerful class of oligarchs and businessman who siphoned off funds and deposited them in Swiss bank accounts.
Russian government borrowed billions from IMF, yet, unable to pay pensions or welfare payments.
The 1998 Crisis
Higher interest rates provoked by East Asian crisis.
Russian economy collapsed when oil prices fell.
Ruble was overvalued – imports flooding in, but domestic producers hard time competing.
Massive disguised unemployment. Wage payments in arrears. Workers paid with bartered goods.
Overvalued exchange rate great for rich businessmen.
Russia borrowed on high interest rates as a result
July 1998, IMF came through with a $4.8 billion rescue
IMF pushed policies that made the crisis, when it happened, even worse. Pushed Russia into borrowing in foreign currency. When ruble devalued, found it more difficult to repay loans in foreign currency with rubles that were worth less.
IMF partially responsible for the eventual suspension of payments by Russia on debts.
1. Despite many reasons not to give Russia money, the IMF gave $11.2 billion and wanted World Bank to give $6 billion and Japanese government to give rest. This package left Russia with a legacy of debt.
Evidence of corruption in Russia was clear.
Providing money to maintain exchange rate was bad economic policy.
Russia was a resource rich country, didn’t need the money, needed better direction.
World Bank was under political pressure from Clinton admin to give money despite this compelling evidence that it was a bad idea.
The Rescue Fails
1. Three weeks after loan, Russia suspended payments and devalued the ruble. Ruble crashed.
Oligarchs funneled loan money out of Russia. IMF denied that this was happening.
After loan, Wall Street and western investment bankers rescued as much as they could and fled.
2. On good unintended consequence: devaluation spurred Russia’s importing sectors. Goods in Russia finally took a growing share of home market. Unintended by IMF, etc.
THE FAILED TRANSITIONS
Russia transformed from industrial giant to natural resource exporter.
Only Hungary, Poland, Slovenia, and Slovakia have GDP of a decade ago.
Russia in 2000 has a GDP 2/3 of GDP in 1989.
Moldova’s output is less than 1/3 of what it was a decade ago.
3. Consensus that most people experienced a marked decline in their basic standard of living.
life spans over three years shorter in Russia than before transition.
food, clothing, housing all have deteriorated.
spending on military should have shifted to spending on consumption goods – didn’t
Increased Poverty and Inequality
Today, Russia’s level of inequality is equal to that of Latin America, even though in 1989 Russia lacked the legacy of inherited wealth.
1989 only 2 % poverty in Russia. By 1989, 23% living in poverty.
2. The middle class was devastated and those who could, emigrated.
inflation wiped out savings. Wages didn’t keep up with inflation, so real incomes fell.
Cutbacks in health and education further eroded standards of living.
Middle class historically central to creating a society based on rule of law and democratic values.
HOW MISGUIDED POLICIES LED TP THE FAILURES OF TRANSITION
The IMF chose to emphasize monetary targets, budget deficits, and the pace of privatization – everything else, like competition and legal frameworks – were secondary. The consequences were serious, privatized firms sought to establish monopolies and cartels to enhance their profits. 1. Tight monetary policy contributed to the inefficient use of barter, destructive to the price system.
in the absence of infrastructure, privatization has no positive effect on growth
there was a lack of laws ensuring good corporate governance, so stealing was rampant.
Local and state government passed regulatory and tax measures to extort rents from firms in their jurisdiction, instead of passing incentives to attract businesses.
Gave away natural resources before had in place a system of taxation
Loans for share program – most egregious example of privatization. In 1995, central government turned to private banks for funds. The banks printed money and gave loans to government on basis of state collateral. Government defaulted on loans, and private banks took over companies in sham sales. Oligarchs became instant billionaires. No political legitimacy. final stage in the enrichment of oligarchs. Oligarchs sent their money out of Russia.
Privatization in Russia undermined confidence in government, democracy and reform.
3. In Russia, an anarchic theft by all because of the erosion of confidence in the future.
Transition in Russia eroded social capital by showing that people got wealthy, not by working hard, but by using political connections to get state property on the cheap in privatizations.
IMF shunt aside issues of poverty, inequality, and social capital.
4. Russia shows that it is hard to design good reforms well and that sequencing matters. It takes time to create the important prerequisites for a successful mass privatization. Incentives matter.
5. The Bolshevik Approach to Market Reform: Radical reformers in Russia were trying simultaneously for a revolution in economic regime and in structure of society -- failed at both.
forcing rapid change on reluctant population, supported by international bureaucrats.
Economist Ronald H. Coase argued that in order to achieve economic efficiency, well-defined property rights are essential.
Radical reformers took Coase’ theory too far – belief that the mere existence of a group with vested property interests will lead to establishment of market infrastructure.
Not true! Income distribution does matter.
Concentration of media power also bad: need active and critical media to ensure that decisions reflect the general interests of society. Policies not subjected to critique they deserved.
Chapter 6: Unfair Trade Laws and Other Mischief
1. IMF policies linked to the political judgments of Clinton administration’s Treasury that worried that Russia would slide back into communism.
Disillusionment with radical reform is now common among economies in transition.
The Clinton administration tended to make allies with people in the right who supported radical reforms (averse to allying with people who held positions in the Communist Party). These people didn’t pay attention to distributional or social consequences of reforms.
Many of those whom we allied ourselves were more interested in enriching themselves than with creating a westernized market economy.
2. As problems arose, the IMF and US Treasury officials ignored the facts, denied reality, suppressed discussion and threw more good money after bad.
3. Stiglitz met with a senior advisor to the Russian government about spurring Russian economic growth. The US didn’t want him to go, but he went anyway.
Noticed that in contrast to Washington, a healthy policy debate in Moscow about complicated matters like the high exchange rate, economic growth, and inflation.
Russia was trying to open these complicated matters to discussion while the US was suppressing debate. Ironic and sad.
4. By siding so firmly with the corrupt people in charge of privatization, the US Treasury and IMF sided themselves with policies that at best promoted the interests of the wealthy in Russia.
WHAT SHOULD HAVE BEEN DONE
1. The West’s long-term interests would have been better served if we stayed out of close involvement with particular leaders and provided broad-based support to democratic processes. Could have supported young, emerging leaders in Moscow and the provinces who were anti-corruption.
2. Stiglitz wishes there had been an open debate about Russian strategy during the Clinton administration. But, President never got a chance to hear the full range of views and issues.
US INTERESTS AND RUSSIAN REFORM
1. There are many who believe that the failed policies were deliberate. Conspiracy theories take it too far, but the fact is that US commercial and financial interests were represented in the policies.
Example: July 1998 bailout of Russian government was just as much for Western banks that stood to lose billions of dollars.
2. Broader special interests in the US affected policies in the way that made US look hypocritical.
US supports free trade but domestic protectionist interests use “free trade laws” to construct barriers to imports.
Under free trade laws, domestic companies that believe a foreign rival is selling a product below cost to request that the government impose special tariffs – dumping duties – to protect their business. Often seen as evidence of pure protectionism.
The economic basis of r determining whether a foreign company is selling something “below cost” is often made with little evidence.
The Aluminum Case
1. Aluminum prices fell in 1994. US domestic interests claimed that Russia was dumping aluminum into the US.
Economic analysis showed that Russian companies were not trying to dump in the US.
Paul O’Neill, the head of Alcoa, proposed the creation of a global aluminum cartel, which would restrict output to raise prices. Threatened to use the antidumping laws if the cartel was not created.
3. Stiglitz and Russian reformers within the Russian government were anti-cartel.
State Department valued order above all else, so they supported the cartel.
National Economic Council supported the creation of a cartel.
Cartel was created.
2. Cartels are illegal inside the US; thus the US role in creating a cartel was a violation of principle.
Cartel would hurt Russian economy by restricting sale of one of the few goods that it could market internationally.
Cartel taught Russia wrong lesson of how market economies work.
Consumers throughout the world
Russia – they got a bad lesson in market economics. We taught them crony capitalism 101. We provided them with a bad example.
National Security for Sale
1. Historical “swords to plowshares” agreement made between Russia and US in which US Enrichment Corporation (USEC) would buy Russian uranium from deactivated nuclear warheads and bring it to the US for use in nuclear power plants. Sale would provide Russia with needed cash while disarming Russia – two lauded goals.
American uranium producers argued that Russia was dumping uranium.
No economic validity to this charge.
Clear that a change in antidumping laws was needed. Dept. Of Commerce and US Trade Representative proposed changes to Congress, but Congress turned them down.
Privatization of USEC itself was best by problems.
secret agreement between USEC and Russian agency wishing to sell uranium in which the USEC turned down the Russian offer to triple deliveries, paying them hush money to keep the deal secret. Very sketchy.
UNEC has been discredited, especially after asking for import subsidies to continue with importation. People disillusioned with this privatization.
LESSONS FOR RUSSIA
Russia given crash course in textbook economic but saw that their teachers (the US) departed from this ideal.
we preached trade liberalization but shut our doors to imports.
We said that competition was vital, but then created an aluminum cartel and gave monopoly rights to import enriched uranium to the US monopoly producer.
We told them to privatize rapidly, but the one company we privatized – USEC—took years and was beset by problems and in the end it integrity was questioned.
We lectured everywhere about crony capitalism, especially post-East Asia crisis, but them these influences were present in our own economic decision making.