Transitions from Communism to
Markets
If You Asked Me in the mid 1980s
When the Berlin Wall Would Fall
In 1991
• The Soviet Union, in a peaceful fashion, split up
– There was the breakup of the Union of Soviet Socialist
Republics (USSR)
• Population of 290 million in 1990
• Biggest successor state was the Russian Federation with a
population of 150 million in 1990
• Second biggest was the Ukraine at 50 million in 1990
• 15 different countries—Estonia, Latvia, Lithuania, Belarus,
Ukraine, Moldova, Georgia, Armenia, Azerbaijan, Uzbekistan,
Turkmenistan, Tajikistan, Kyrgyzstan, Kazakhstan, Russian
Federation
And The Loss of Political Control
Economics of Transition
• Obviously there is a big political history, but
the goal here is the economics of transition
– A transition away from a centrally planned
communism to a market-friendly system
• We will use Russian and Poland as our 2
example counties
Depression and Political Freedom
• Included a big expansion of political and
economic freedom—including real elections
• Freedom House puts together an index of
political freedom and democratic rights—
measures voting, participation, turnover of
politicians
– Most of there countries were at about 25% of the
US level of democratic freedom in 1989
– By the mid-1990s, they were at about 60% of the
US level
Economic Freedom
• Also have indices—how free are markets. How
controlled are their prices, how free is foreign
trade, how easy is it to start a business
• 0 is pure socialist and 100 a market economy
– Countries like Russia went from a 3 in 1989 to a 70
by the mid-1990s
Depression
• Huge economic decline
• A mild US recession has about a decline in real
GDP of between ½ an 1 percent in a year
• A deep recession could be 2 percent in a year
• The Soviet economy fell by roughly half, which
was worse than the Great Depression in the
US
• Fortunately, growth restarted by 1994
Growth
• The graph show a dramatic fall, but it also
show the subsequent rise
• Often as high a 7 % per year for a decade
• Question we need to ask—was that fall as bad
as it looks
Government, Quantity, & Quality
What Changed?
Other Indicators
• Electricity demand only fell by about ½ as
much—bad, but not as bad
• Note that many businesses use electricity and
now that they had to pay market prices, the
businesses may just be using it more
efficiently
• The average living space per person rose from
15 square meters in 1990 to 19 square meters
in 2000
Other Indicators
• Private ownership of cars doubled
– 14 cars per 100 households in 1991
– 27 cars per 100 households in 2000
• Tourism rose from 1.6 million going abroad in
1993 to 4.3 million in 2000
• Percentage with running water increased from
66% to 73%
• Share with hot water increased from 51% to
59%
• Share with central heating increased from 64%
to 73%
Economic Shocks Brought Related
Social Problems
• Crime doubled from 1991 to about 1995—and
roughly double again by the early 2000s
• The average business paid 10 – 20% of
revenue as protection money to local gangs
• From 1991 to 1993, the marriage rate
declined by 20%, and the birth rate fell by 12%
• Life expectancy for men has fallen from 64
years in 1989 to 57 years in 1994—heart
disease, suicide, alcoholism, murder
US Census Bureau
• Our census bureau also provides estimates of
the population of other countries
– 147 million in 2000
– Predict 140 million by 2010
– Predict 109 million by 2050
– That is a drop of ¼ in 50 years
– ?? All in a period that is not plague or warfare
Demography is Destiny
• Smaller countries tend to mater less on the
world stage
• Don’t believe me—ask someone from Ecuador
or New Zealand
Why Was the Economic Transition
Away From Communism So Hard?
• Most think that a transition to markets should
spur more transaction and more growth
– It has now that we are a couple decade out, but
why so harsh at the beginning
• One reason—the market economy has an
invisible market infrastructure
Difficult
• Soviet systems just followed orders from the
planners
• Many firms were supported with subsidies in
the Soviet system and now were facing reality
for the first time
• Soft budget constraint
Difficult
• A worker in a market economy know that pay
and even the job depends on how hard you
work
Story
• A group of Soviet economic planners visited a
vegetable market in London.
– Walked around and were incredibly impressed
– Why? No huge lines. No shortages. No
mountains of spoiled veges that nobody desired
I, Pencil
Culture Change
• This is probably the reason for the increased
death rate of men
• Alcohol, violence, and stress
Another Difficulty
• Russian and many other countries
experienced a hyperinflation
• Took off and often reached 1000% per year
• Many said that if you take away price controls
you should expect crazy prices
Why Hyper?
• You do not get a hyperinflation of that
magnitude with just a readjustment of prices
– There must also be a surge of buying power
– People had large savings from the old days that
they had not been able to spend
• Often called a monetary overhang
– Government was also running huge budget
deficits and handing out many subsidies
– The central bank had not been reformed so it was
also handing out large loans
For an Economy to Work
• To get an economy to work you do not need to
get the inflation rate all the way down to 0
– Some studies suggest that if you can get it below
40% the economy can at least begin to function
– When these countries got their inflation down to
lower double digits, they could get started a year
or two later
– By the late 1990s, inflation in Russia and Poland
was running at around 10% a year
Privatization Process
• How can you move from state ownership to
private ownership
Transition
• In Russia, 120,000 firms went from state to
private control between 1991 and 1993
• In Poland, about 1,300 firms were privatized
this is about 1/6 of the total firms
• In the Czech-Republic, they sold all stateowned firms in a voucher system
All Had Problems
• In Russia, the difficulty was that the sell off
was rigged so that the existing managers and
employees had the best chance to own the
company
• I can see why they would want to do that, but
in practice it translated into a few rich
investors gained control of most of the firms
and did it very cheaply
In Many Eastern European Countries
• They got their voucher, used it to buy some
stock, and immediately sold the stock to
someone else.
• That is nice, but it does not create broad
ownership. They have different incentives
when they are not owners
• Others held on to the stock, but then voted for
the firm to pay huge dividends and prevented
the firm from investing for the future
• More interested in quick money—not growth
Privatized Firms Are More Efficient
How To Recreate The Basics Of
Government
• The main functions of taxes and spending needed
to be updated
• Old Russian tax system was a mishmash
– Most was a payroll tax on wages
– They would pay you wages and then tax back 40 or
50%
– The had this complicated web of cross-subsidies
– Remember the government can set some prices high
and others low and them pocket the difference
As the Planned Economy Fell Apart
• As the planned economy fell apart the method
of taxing fell apart
– Tax collections had been 42% of GDP in about
1989
– Collections were down to 32% of GDP by the mid1990s
– Remember that this is not just 10 percent point
less it is also from a much smaller GDP
– By the late 1990s, Russians were collecting only
about half of what was due because of tax evasion
Need a Basic Tax Code
• Something like a sales tax to get things started
• Everyone will pay and this will help so that the
government can administer the tax code
• This is what happened slowly in Eastern
Europe, but Russian remained chaotic and
used oil revenue in place of a well-functioning
tax code
Change in Public Spending
• Under the old Soviet system basically
everyone got subsidies for everything
• The is what low state control prices meant
• Government spending was often ½ of GDP in a
planned economy
– About 20% went to defense
– Another big chunk went to food and housing
subsidies
Examples
• Bread prices were not allowed to rise since
the 1950s
• Housing was so subsidized that in the early
1980s they were trying to give away Moscow
apartments for free. And nobody wanted
them because if you got the apartment you
would need to pay to keep up the building
Changes
• This has been a difficult transition
• In a market economy you can not subsidize all
of the people all of the time
• That means they need to pull back on the
subsidizes that benefit the middle class and
the wealth and focus in on helping the poor
and elderly
Elderly
• The elderly people really suffered in the
transition
– There was an economic downturn
– The hyperinflation made their savings worthless
– Pension were too low to live on
– Too old to work
Could They Have Done This With
Fewer Problems
• Russia and most the successor states had a
rapid transition also now as a big bang
transition
• China has used a more gradual transition and
had better results so far
• Of course, I am comparing apples to oranges
A Few Notes About China
• China is vastly poorer than Russia
• Much more ag than Russia
• China had a crazy social and political situation
in the decades leading up to the change
• The government of China was not as fully
developed and, therefore, need less
dismantling
• Plus, they did not grant political freedom
Easy to Understate What Happened
• If someone in 1985 had said the USSR would
– Liberalize their economy
– Liberalize their politics
– Sold off the privatize companies
– Gone through a hyperinflation and a depression
– Stabilized it all and started rapid growth
– CRAZY
What is the Likely Trajectory for
Transition Economies?
• Starting point—what is the base line?
– Compare Russia to the US
– Compare to Africa
– Compare to USSR
• Andrei Shleifer—A Normal Country (2005)
– Compared to other counties with similar
economic development, they look about average
Russia’s GDP in International
Perspective
Ranking
Economy
Total GDP
(millions of
Dollars)
1
United States
13.200
2
China
10.000
3
India
4.200
4
Japan
4.100
5
Germany
2.600
6
United Kingdom
2.100
7
France
2.000
8
Italy
1.800
9
Brazil
1.700
10
Russian Federation
1.700
11
Spain
1.200
12
Mexico
1.200
13
South Korea
1.200
14
Canada
1.100
15
Indonesia
900
Think About it in Per Capita Terms
• Russian is an upper-middle-income country
Transition Population
Economies (Millions)
Per Capita
GDP
Other “Upper Population
Middle Income” (Millions)
Countries
Per
Capita
GDP
Russia
142
$12.000
Argentina
39
$15.800
Ukraine
46
$7.600
Brazil
188
$9.000
Kazakhstan
15
$8.900
Venezuela
27
$7.500
Poland
38
$15.400
Malaysia
26
$11.700
Hungary
10
$19.600
Turkey
73
$9.000
Czech
Republic
10
$22.800
South Africa
47
$12.000
Romania
21
$10.100
Upper-Middle Income Issues
Why Am I Stating This
Russian Strengths
• Inflation under control
• Good education system
• Good science and technological system
• The real question is what will they do with the
strengths they have
• They have grown strongly since the late 1990s,
but that has been fueled by oil
Oil and Gas Production
• 13 percent of Russia’s GDP in 1999
• 32 percent of Russia’s GDP in 2007
– A much larger share of a much larger GDP
Rule of Law
• Ownership, contract, and debt need to follow
a rule of law
Alternatives
• If you want alternatives, look all across
Eastern Europe
• Those countries have fostered strong ties with
Europe
– Poland and a number of neighbors have joined the
European Union
– Why? Trade! They want to sell to high-income
countries
– Why? They can borrow the culture and
institutional infrastructure of Europe