RUSSIAN ECONOMY
Communist Economic Systems
Russia’s transition to planned
economics
In a planned economy, the __________ regulates or
“plans” p_____________ and p________
Planned economies are also called
_____________economies
From the late 19___s to 19___, the Soviet Union
operated under a planned economy
The ideology of __________________ inspired
the use of this system
encourages____________ownership of
means of production
Conversion to a planned economy began after the end
of the ___________________in ______________
The ________________ seized control of Russia after
this war
__________________ (1870-1924) led the Bolsheviks
during the war
The Soviet government ___________________
agriculture in the late 19____s and 19____s
Collectivization formed communities in which
property is shared
Property was owned by the ______________, not
individuals
______________(1878-1953) spearheaded
collectivization
succeeded Lenin as leader of the Bolshevik Party
The Bolshevik Party became the _________________
Party of the Soviet Union
STALIN’S REFORMS
Stalin aimed to transform Russia into a __________ economy
In this economy, ____________ and society belonged
collectively
to all workers
Stalin eliminated the class of people who owned
property without contributing ____________
This class is referred to as the “____________”
To achieve this goal, the government attempted to
__________________all private property
This included
all factories and equipment,
which were known as “_________”
Russia’s transition to market-based
economics
•
Russia now operates under a market-based
economy
–
Transitioning from a planned to market-based
economy took _______ years (19___-20___)
– Most of the transformation occurred in the 1990s
• Russia no longer operates under communism
• ECONOMIC GROWTH:
– Russia experienced rapid growth from 19___ to 20__
– Growth ended abruptly with the
________________________in 2008
•
Russia faces significant challenges
– Several problems stall Russia’s development in the
global economy
Forms of Property
• Three forms of property comprise the
“classical” socialist system
– state-owned firms,
– budgetary institutions, and
– cooperatives
Three Organization Types
State-owned firms
•
There were both
– NATIONAL FIRMS
– REGIONAL FIRMS
State-owned Firms
• National firms
– under the jurisdiction of national-level ministries
• Regional firms
– under the jurisdiction of provincial and local governments
• THE “BIG BUT”:
– Economist Janos Kornai: categorizing firms as state-owned =
meaningless because…
– subnational governments were controlled by the national
government
• All income from production contributed to
• STATE COFFERS
• Firms could not be
• bought or sold
These firms provided employment
and housing on a massive scale
• The place of employment included all
essential
-- social services
• Workers had access to
– apartments, daycare, schools, and other social
services
• This system gave rise to the communist
___________to________ system of social
services
These firms provided employment
and housing on a massive scale
• State-owned firms encompassed
most _____________industry
– auto plants and
– defense factories
• The Soviet model emphasized
economies of scale in every
industry
• Economies of scale describes
the gains a firm achieves from
– Expanding production
• Individual plants commonly
employed over
– 100,000 workers
• Due to this living and working situation,
laborers lacked ____________. In order to
move, workers had to acquire a
– new job, residence, and housing permit
• A housing permit was called a _____________
• The process of moving took years
• Low worker mobility _____________the
process of devising production plans
– Government planners needed to keep track of
labor at every individual firm
• _____________________ of state-owned
firms started in 1992
Budgetary institutions
• Budgetary institutions included
–
–
–
–
–
–
universities,
research and educational institutions,
Training centers,
trade schools,
hospitals, and
museums
• ____________or_______________________budgets
funded budgetary institutions
• Budgetary institutions had no obligation to make
____________cover___________________
Cooperatives
Comrade, come join
the KOLKHOZ!
• Cooperatives operate similarly to stateowned firms but were mostly located in
_________________
• The cooperative, or collective farm,
was
called a _______________
• Like state-owned firms, cooperative
farms operated on a ___________ scale
• Farms included social services such as ___________
• In the 1930s, Stalin collectivized agriculture by
stripping all citizens of _______________
• The state assumed ownership of all _________
COLLECTIVIZATION
• POLITICAL MOTIVES:
bureaucratic control of
farmers prevented them
from fighting back
• ECONOMIC MOTIVES:
• steady supply of grain
for________
• The state believed larger
farms would produce
more ________________
than smaller farms
– Farmers could not become
a social, political, or
economic force
– They fit seamlessly into the
body of the Soviet system
– They could not
• leave the farm or
• outsource labor
– Essentially, farmers always
remained members of
• the “collective”
Summary of socialism
• Socialism replaces __________ownership with
__________ ownership
– The state owns all property
• Capitalists could no longer __________workers
– All members of society collectively worked and
owned property
• Public ownership of production transferred the
responsibility of allocating resources from
__________mechanisms to ________________
economic planning
CENTRAL PLANNING SYSTEM
The Planning System:
The role of bureaucracy
• The bureaucracy planned all economic activity
– top-down fashion
– Fulfilling plans was compulsory
• planned economy sought to eliminate the
anarchy of the market
– state would organize the economy on a national scale
– bureaucracy, not the market forces, controlled the
vitality of a firm
• Bureaucratic planning sought
– to distribute goods more equitably
– goal followed the ideals of Marxism
Five-year plans dictated the Soviet
economy
• Each five year plan was split
into annual plans
– Five-year plans functioned as
statements of policy intent
rather than specific plans
• The first plan: 1928
• The last plan: deteriorated in
the late 1980s
CENTRAL PLANNING
• Planning involved
– determining inputs and
– estimating outputs
for each individual factory
• This task was enormous, especially since the
Soviet Union spanned 13 time zones
– Flawed estimations often resulted in shortages
– A lack of inputs caused a lack of outputs
CENTRAL PLANNING
• Plans determined each firm’s level of
– technical development,
– capital investment, and
– trade
CENTRAL PLANNING
• A system of bureaucracy-controlled price lists
designated prices of all goods
• Gosplan manually calculated every aspect of
the entire Soviet economy
• For most of this period, planners lacked access
to computers
BUREAUCRATIC RESPPONSIBILITIES
The role of managers and labor
• Plans required
coordination of
– the Communist
Party,
– State ministries,
and
– individual firms
The role of managers and labor
• Gosplan strategies to break these systems
down into manageable parts
– Planners disaggregated the plan in a downward
flow of information
– Higher levels sent directions to lower levels
• State plans did not recommend or suggest actions
• The term “command” economy derives from this
process
– Planners received an upward flow of information
• While drafting a plan, planners received information
from lower levels
• Lower levels contributed nonbinding recommendations
about target output levels
The role of managers and labor
• The bureaucracy chose managers at every
level of the economy
– Each manager held a specific and mandatory role
in each plan
– Plans specified the amount of labor allocated to
each sector and factory
Incentives and attitudes
• Plans required firms to produce exactly the amount
stated in the plan
– managers lacked motivation to innovate
– No reward for producing a surplus
• But the state punished managers for failing to meet
plan targets
– Managers could be
• removed from office,
• sent to a labor camp, or
• accused of sabotage
• An accusation of sabotage could lead to a death
sentence
Central Planning and Central Management
• Motivation: intrinsic
– ideological sense of duty to the Communist Party
• Motivation: extrinsic - bonuses for good
work
– awards and
– privileges
• In addition,
– political power and prestige provided sources of
motivation
– For some, material benefit and fear were
motivators
Central Planning and Central Management
• BIG “BUT”: the
penalties of taking
risks outweighed the
potential rewards
– Without ownership,
managers lacked
incentive to exceed the
bare minimum
– Janos Kornai states…
Among managers,
“SERVILITY and a
HEADS DOWN
MENTALITY prevailed.
Economic distortions
• A chronic “shortage” economy emerged in almost
every sector
– The planning system misestimated the supply and demand
for goods
• In a free market economy, changes in price eliminate excess
demand and supply
– This shortage condition affected consumer goods
Managers had built-in incentives to
underreport production:
• Ensured that plan targets for the next year
would not exceed the firm’s capabilities
– A firm that could produce 150% of the target plan
might produce only 101%
– This signaled improvement but not enough to
cause expectations of it to increase
– Managers
• hid extra output and
• sold it on the black market
Outputs differed in proportion to
inputs
• Target plans
– only specified that firms meet a goal,
– not fully utilize the allocated inputs
• As a result,
– excess inputs existed in some sectors
– while shortage existed in others
• This caused
– poor allocation of resources and
– waste
STATE PRIORITIES:
• Socialism overemphasized rapid growth
– Quantity of production took precedence over
quality
– Inferior quality of goods still impedes Russia’s
ability to compete in world markets
• The state prioritized industrial production over
consumer production
SUMMARY of PROBLEMS:
SHADOW ECONOMY / BLACK
MARKET
• RESPONSE to the chronic “shortage” state
– A black market is called a shadow economy
– economic activity that lacks official state approval
• In the socialist system, private property and private means of
production do not exist
• Black market participants circumvented price lists and other
restrictions of the system
• Some analysts believed the black market kept the
system alive
– The black market remedied some of the failures of the
planning system
– It also fueled corruption at every level of the economy
• Russia still feels the effects of the black market today
MIKHAIL GORBACHEV: VITAL STATS
• Born:
– 1931
• Became General Secretary
of the Communist Party:
– March 1985
• Ousted from office:
– 1991
Problems facing Gorbachev upon
entering office
• Soviet Russia’s stagnating economy
was the greatest challenge
– planning system lacked flexibility
– complexity of calculating economic
needs exceeded the capabilities
• Tim COLTON believed planners could
not anticipate the need for
computerization
• As the economy’s size and complexity
increased, so did planning failures
• Values and motivation suffered
under the overbearing state
TIM COLTON
Morris and Anna Feldberg
Professor of Government and
Russian Studies and the Chair
of the Department of
Government at Harvard
University
Reform and reconstruction
• Gorbachev immediately
recognized a need for an
overhaul of the economy
– This goal = perestroika,
literally translating to
“reconstruction”
• did not intend to establish a
market-based liberal system
• sought to reform the existing
communist system
Criticism
• Many critics argued that Gorbachev ignored the
Soviet economy
– They compared his actions to Chinese leader
Deng Xiaoping’s actions in the 1980s
• They accused him of “sequencing” reform
– This practice involves favoring “easier” political
reforms
• In contrast, Gorbachev began his reforms with
the economic challenge
• Gorbachev’s economic policies
– between 1985 and 1991
– Followed 4 phases
Phase 1: 1985-86
• Recovering Worker Productivity and
Infrastructure
Anti-alcohol campaign
• First, Gorbachev tackled worker absenteeism
and low labor productivity
• He initiated an anti-alcohol campaign to
reduce chronic alcoholism among workers
– The campaign closed down some alcohol factories
– Some Russians resorted to producing bootleg
liquor
• This created the unintended sugar shortage
• The consumption of bootleg liquor also meant that
productivity remained low
Uskorenie
• Gorbachev attempted to invest in old
infrastructure
• launched an uskorenie,
– literally meaning “acceleration”
– acceleration of investment in old plants and
factories
• The Soviet Union lagged behind the West’s
technological progress
• Poor infrastructure impeded labor
productivity
• The two programs were fundamentally
incompatible, because
– one reduced government revenue and
– the other demanded more government spending.
Failure of both reforms
• Both initiatives failed
– socially
– economically
• The anti-alcohol campaign worked against the
investment project
– Closed alcohol factories reduced state revenue
• Decreased revenue hindered increases in investment
• Neither initiative improved
– worker discipline,
– economic productivity, or
– infrastructure
• Workers still consumed bootleg liquor
• The budget deficit increased
Phase II: 1987-88:
Glasnost and Demokratizatsiia
Glasnost
• A policy that allowed greater public discussion
– Gorbachev initiated it at the
• in 1987
• Central Committee of the Communist Party PLENUM
– A plenum is a planning meeting
• allowed citizens to openly discuss the merits of the
communist and market systems
– The Soviet Union had never allowed this level of free speech
– Glasnost enabled
• the Soviet media and
• politicians
to discuss issues freely
– Politicians of this time comprised a new super parliament in 1989
• jumpstarted discussion on private property
– The subject had always remained taboo
Demokratizatsiia
• introduced limited accountability into Soviet
politics
• The term demokratizatsiia translates to
“democratization”
• It enabled greater participation of
interest groups in the political process
Introduction of private property
rights
• “Cooperative” enterprises introduced quasi-property
rights
– These firms operated in the
• commercial and service sectors
– “Cooperative” enterprises
• lacked clear governance or ownership structure
• They offered business initiative among a small group of entrepreneurs
• Gorbachev granted managers more autonomy on what to
produce
– Managers still had limited opportunities to explore new
markets
• Gorbachev maintained the collective farming system
– He refused to reinstate private farming
– Intermittent food shortages persisted
MANAGERS JUST WANT TO HAVE FUN
• Gorbachev gave managers more freedom from
bureaucratic control. As a result, managers…
– privatized firms behind planners’ backs
– increased activity on the black market
– acquired money that they later used to participate in
privatization
• HALF-MEASURES
– These partial reforms worsened the economic situation.
– Gorbachev passed up his chance to implement sweeping
reforms before the onset of stagflation in 1989.
No sweeping economic reform
• Gorbachev tended to compromise with conservative
members of his Politburo
– The Politburo consisted of a cabinet of elite communist party
officials
• Compromising stalled implementing far-reaching economic
reforms
– He missed the chance to initiate reforms before the onset of
stagflation
• Stagflation describes inflation with zero or negative economic growth
– This presents the worst possible situation for an economy
– Normally high growth accompanies inflation
» This concern still plagues China’s economy
• Gorbachev may have lacked the means to initiate
widespread economic reform
– may have lacked enough control within the Communist Party
– may have lacked desire for change
• He believed in the communist system, not liberal capitalism
Phase III: 1989: Stagflation and the Fall of
Communism in Eastern Europe
• Stagflation
• the Fall of Communism in Eastern Europe
Phase III: 1989
Collapse of communism in Eastern Europe
• Gorbachev’s reforms met a receptive
audience in Eastern Europe
• The Berlin Wall fell in November 1989
ECE Satellite Governments Fell
• Several satellite communist governments in
Eastern Europe followed suit
– The collapse destroyed guaranteed markets for
inferior Soviet goods
– This loss further damaged the Soviet economy
Gorbachev’s indecision
• Gorbachev attempted to please both radical
reformers and conservatives
– As a result, his inconsistent policies deepened the
economic crisis
• Reform efforts created larger budget deficits
– Sustained subsidies to industry drained the state’s
funds
• Inflation plagued the economy even as growth
declined
– The economy experienced stagflation
– Too much currency was circulating
– High wages also caused inflation
PROBLEMS
• The state lacked a mechanism to collect taxes
• Restrictions on the development of cooperative
movements prevailed
• The practice of barter grew
– Barter involves trade without currency
• Agriculture experienced limited reform
• The Soviet Union faced widespread food shortages
– This problem had not plagued Russia since World War II
• The economy experienced negative growth rates
– Production fell by about 10% per year until 1991
• The Soviet Union collapsed in 1991
SUMMARY
Phase IV: 1990-91: Boris Yeltsin and
Reform Alternatives
The Five Hundred Day Plan
• summer of 1990
• a group of young Russian economists devised
a plan
• dubbed it the Five Hundred Day Plan
The Five Hundred Day Plan
• Gorbachev adviser and
economist
Stanislav Shatalin led
the project
• Economist
Grigori Yavlinsky also
helped produce the plan
SHOCK THERAPY
• sought to imitate
successful example of
economic
“shock therapy”
• Borrowed idea from
Poland
The 500 Day Plan
GORBY’S RESPONSE
• He rejected the 500 Day Plan by the fall of
1990
– favored a slower and more conservative approach
to change
– wanted to retain price controls for another two to
three years
• Gorbachev appointed a likeminded
conservative prime minister
Elections across the Soviet Union
• The Soviet Union began to lose legitimacy as
an economic and political union
• Its 15 constituent republics, including Russia,
started electing new leaders
• Gorbachev authorized these elections
Boris Yeltsin
• (1931-2007)
• June 1991: became Russia’s first popularly elected
president
– Gave Yeltsin greater political legitimacy than Gorbachev
– Gorbachev
• remained the unelected President of the Soviet Union
• the unelected General Secretary of the Communist Party
YELTSIN
• held various positions
before becoming president
– Member of the Politburo
– Provincial Communist Party boss
– Elected speaker of a new Russian parliament in
1990
• Yeltsin disagreed with Gorbachev’s lagging
rate of reform
– He initiated much more rapid reform, leaving
Gorbachev behind
Gorby’s Last Days
• Yeltsin’s popularity and power
rivaled Gorbachev’s
• challenge pressured Gorbachev
to pursue radical market
solutions—but it was too late
• Gorbachev’s Politburo
attempted a coup in August
1991
– effectively removed Gorbachev
from office
Gorby’s Last Days
• By December 1991, the Soviet Union
completely collapsed
– The union dissolved into 15 new and separate
countries
– Russia was the largest of these new countries
– It adopted the title of the Russian Federation
Gorbachev’s Legacy
• Gorbachev’s half-measures and indecisive
reforms deepened the Soviet Union’s
economic crisis
• By the end of 1990, political motives diverted
reform efforts from economic needs
• By the end of 1991, shortage and inflation
persisted
– The inflation rate loomed at over 100%
The Economy Before the Collapse
• Pre-existing problems
– Although Gorbachev may have fallen short, the
Soviet Union’s system deteriorated on its own
– Production levels declined throughout the late
1970s
– They hit a free fall in the late 1980s under
Gorbachev
Growing State Sector Presented
Problems
• The state controlled almost every economic
activity
– By 1991, most people were on the state payroll
• Although the economy appeared fully employed, many
people did nothing
– “We pretend to work and you pretend to pay us” became a
popular saying
• Post-Soviet policymakers feared increasing
unemployment
• Minimal pensions and wages necessitated that people
work after retirement
Problems with STATE SECTOR
• Chronic shortages caused by sub-optimal planning was
an enduring problem
• Industrial production far outstripped consumer
production
– This imbalance contributed to the low standard of living
• Economic growth under the planning system carried
high costs
– The system created inefficiency
• Because of the system’s emphasis on economies of
scale, MONOPOLIES dominated the economy
– Massive firms operated efficiently as monopolies
LACK OF INCENTIVES
• The Soviet economic system discouraged technological
innovation
– the West developed computer hardware and telecommunications
– Even with a strong post-secondary education system, Soviet
Russia fell far behind
• The lack of incentive to improve production yielded poorquality goods
– Soviet Russia’s manufacturing sector could not compete globally
– Instead, the Soviet economy relied on natural resource exports,
especially oil and gas
• But global oil and gas prices were falling
• The Soviet economy could no longer protect itself from world
competition
– Before 1989, the Soviet Union rarely traded with non-communist countries
• These conditions exposed the Soviet Union to the “resource curse”
Flaws of the Soviet system
• Money had no real value since prices did not reflect supply and
demand
– Price lists determined prices for everything sold in the Soviet Union
• Additionally, the ruble could not be converted in international
markets
– About 3,000 different exchange rates existed for almost every item in
foreign trade
– The state controlled conversion rates
• Two types of rubles with different values existed in the economy
– Enterprise accounts used one type
– Consumers used the other
• The Soviet economy lacked important financial institutions and
markets
– These missing essentials included
•
•
•
•
a private banking system,
a real estate market,
a stock market, and
private companies
Negative growth rates
• Exacerbated by Gorbachev’s reforms, these
conditions stunted growth
• By the collapse of the Soviet Union on December 25,
1991, growth rates hit -17%
– Growth rates had declined from +3% in 1989
REFORM UNDER BORIS YELTSIN
• The fifteen newly independent states of the
former Soviet Union diverged in their methods of
economic reform.
• This section will focus on Russia’s reform process
as implemented by President Boris Yeltsin.
Between the fall of the Soviet Union in 1991 and
the end of Yeltsin’s presidency in 2000, Russia
made great strides in
– breaking down the planning system and
– opening the door to privatization.
Shock Therapy in Theory
• The return of shock therapy
– Fall of 1991, Boris Yeltsin
surveyed reform options
– He settled on the plan put forth
by a group of young economists
led by Yegor Gaidar
– Yeltsin appointed Gaidar
prime minister
– Gaidar advocated rapid
transition to a market economy
through “shock therapy”
SHOCK THERAPY demanded three
immediate and simultaneous reforms
SHOCK THERAPY in THEORY
• These three key policies inflicted a short-term
“shock” on the population
– Prices increased suddenly
– Inflation quickly reached high levels
– Unemployment rose as the state allowed
unprofitable industries to fail
• Market mechanisms would eventually kick in
– Gaidar expected the economy to grow within
three years
• The economy would stabilize well before Yeltsin was
up for re-election
Shock Therapy in Practice
• Elimination of price controls
– Shock therapy began with the sudden freeing of prices
on January 2, 1992
• Average prices increased by 245% overnight
• Production dropped as expected
– With relaxed import controls, foreign goods filled the market
– Larger cities imported the most foreign goods
• Freed price controls and relaxed import controls solved the
chronic shortage state
– But prices mostly surpassed the average Russian’s budget
– Gaidar assured Yeltsin that market mechanisms would push prices
down
– He believed Russian manufacturers would try to match the quality
of foreign goods
» He also believed they would offer lower prices to Russian
consumers
BACKLASH!
• By April 1992, industrial enterprise managers
opposed shock therapy
– They were referred to as “red managers”
– They opposed the end of subsidies to their firms
– Some refused to restructure to accommodate
market mechanisms
– Others lacked the means to restructure even if
they wanted to
• Debt accumulated as managers traded for industrial
inputs without money
– In the early 1990s, barter economies existed in both
agriculture and industry
The end of shock therapy
• To assuage opposition, the state issued Central Bank credits
to firms in the spring of 1992
– They also increased printing of the ruble
• This compromise caused spikes in the budget deficit and
inflation
– These effects especially hurt consumers
• This violation of fiscal austerity and deficit control signaled
the end of shock therapy
– All other areas of the reform plan receded as well
• Russia opted for more gradual reforms after 1992
– This path necessitated abandoning several aspects of
liberal market reform
Privatization in Theory:
3 Main goals of privatization
• 1st: creation of a middle
class
• 2nd: creation of a market
economy
• 3rd: separation of ownership
from management
Privatization in Theory:
1st goal of privatization
• First, creation of socioeconomic stratification,
particularly a middle class
– Private property rights and ownership would allow
classes to form
– Economically, middle classes provide a reliable
source of taxation
– Politically, they represent varied interests that
support political pluralism
• Political pluralism contributes to the creation of a
democracy
Privatization in Theory:
2nd goal of privatization
• Second, creation of a market economy
– Yeltsin’s main political legacy is destroying
the communist economic system
– The introduction of private property
prevented an easy return to the old
system
– Economist Anders Aslund believes
two thirds of an efficient market economy
must be private
• No more than one third of national
employment can exist in the public sector
Privatization in Theory:
3rd goal of privatization
• Third, separation of ownership from
management
– In the planned economy, managers did not legally
own their firms
– They only controlled them because of their access
to information about the firm
– Newly empowered managers lacked oversight
from a board of directors
• They pocketed extra money from selling excess products
on the black market
Yeltsin hoped to introduce managerial
accountability to a board of directors
• This principle was referred to as corporatization
– He intended to incentivize managers with the
principles of supply and demand
– Directors would assess managers on profit and loss,
instead of political criteria
– Competitive managers would replace poor-quality,
command-era managers
Privatization in Practice
• Gaidar and Yeltsin passed
the privatization legislation
June 1992
• They initiated the program
month later, in July 1992
in
a
– The program attempted to satisfy conflicting
ownership claims between managers, local
governments, and workers
State Committee on Property:
• created the State Committee on Property to oversee the
process
– This committee was also called the Goskomimushchestvo
• They classified firms eligible for privatization
– Small firms employed less than 200 employees
– Medium firms employed 200-1,000 employees
– Large firms employed over 1,000 employees
• The committee divided firms into
– federal, provincial, and municipal property
• They forced specific firms to privatize
–
–
–
–
–
Wholesale trade
Retail trade
Food services
Construction
Consumer services
SUMMARY: Firms classified by the
State Committee on Property
Privatization options
• Firms could choose between three different paths of
privatization
– These options differed in the percentage of shares owned
by insiders
• Insiders include managers and workers of the firm
– The firm
• auctioned off their remaining shares or
• traded them for vouchers
– All three options granted insiders favored access to shares
• They allowed for over 25% insider ownership
• Gaidar made this sacrifice to incentivize managers to participate in
privatization
– This decision was political, not economic
• Critics called this a “giveaway”
– They believed this concession prevented separation of ownership and
management
Privatization in Theory: VOUCHERS
First stage of privatization: voucher
program
• firms had the option of auctioning off shares
– Share auctions began in December 1992
• Thousands of auctions occurred every month
between December 1993 and June 1994
• Firms traded shares for vouchers through the
voucher program
• The voucher program began in August 1992
– This phase of privatization was brief
– Vouchers had to be claimed by the end of January
1993 and invested by July 1, 1994
VOUCHERS
• The state distributed privatization vouchers to
every man, woman, and child
– The effort hoped to involve public sector workers in
the process of privatization
• Doctors and teachers did not privatize their firms but could
still participate
• Citizens could trade their vouchers for shares of
privatizing firms
– This feature aimed to create a vibrant stock market
• Initially, each voucher held a value of 10,000
rubles in shares
– When the first privatization legislation passed in June
1992, vouchers were worth $84
• Russians received an average of $50 a month in wage
– Vouchers held considerable value
Russians could use their vouchers in
various ways
• Buy shares of the firm they worked for (as long as
it underwent privatization)
• Buy shares of other privatizing firms
• Buy shares through mutual funds
– This diversified their portfolio and spread risk across
different firms
• Buy shares in a voucher fund
• Sell them
• Give them away
VOUCHER PROGRAM
• Firms resisted the voucher program because
they did not receive money from it
– In May 1993, Yeltsin stated that firms must sell
29% of all shares for vouchers
– This proved moderately successful as the average
came closer to 20%
• Citizens invested most vouchers by 1994
– The first stage of privatization finished that year
Second stage of privatization:
auctions of state holdings
• July 1994
• auctioning off remaining state holdings for cash
– Firms received part of the proceeds as capital for restructuring
– The government received the rest of the proceeds
• The government aimed to finance its budget deficit without
increasing inflation
– They anticipated billions of dollars of revenues
• The government also intended to create larger blocks of
shares for foreign investors
– Foreign investors could then increase their role in corporate
governance
• During the second stage of privatization, the benefits to
insiders decreased
The second stage of privatization failed
in many ways
• Vladimir Polevanov, the more conservative
Minister of Privatization, froze privatization
– Nationalists and communists in
parliament influenced this decision
– Polevanov advocated the
re-nationalization of many firms
– This prospect scared off
foreign investors
“Loans for shares” scheme
• failure of the second stage
of privatization made the
government desperate for
revenue
• In 1995, the Russian
government settled on the
“loans for shares” scheme
• They auctioned off
– 12 blue-chip companies
– to a group of commercial
banks
“Loans for shares” scheme:
• All interested bidders, foreign and domestic,
could participate
• The bank offering the largest loan to the
government won a block of shares
• Banks could not sell the shares until
September 1, 1996
• They could only keep a third of the capital
gains after they sold the shares
• The government made 1 billion dollars
Corruption in the “loans for shares”
scheme
• On the surface, bidders
appeared to support the
government
– However, banks mainly
wanted to control Russia’s
largest companies
• Ultimately, the Russian
government could not repay
the loans
– The banks assumed ownership
of the companies
The “loans for shares” scheme
spawned a backlash
• Few banks had the strength to participate
• Participating banks organized auctions
themselves
– This system presented a conflict of interest between
auction participants
– By the end of the process, banks openly quarreled
• The process tainted the reputation of
privatization
• It transferred a large portion of the economy to a
small group of wealthy business people
– This group became known as “the oligarchs”
SUMMARY: Loans for Shares
THE OLIGARCHS
• 1n 1991 Baturina founded
INTECO (Интеко),
– Construction, though it began
as a plastics business.
• husband Yuri Luzhkov,
became the mayor of
Moscow in 1992,
– corruption
– he awarded municipal
contracts to his wife's
company.
– For instance, the contract to
produce 85,000 seats
for Luzhniki Stadium,
Moscow's largest stadium, in
1995
•
controlled 20% of
construction in Moscow
• Baturina then bought shares
– in Gazprom and
– Sberbank.
Other corruption
• Organized crime groups often purchased
shares from failing firms at little cost
– This practice stripped the firm of value
• Purchasing shares this way did nothing for capital
stock or the economy in general
The effects of the privatization
program
• By 1996, 75% of large and mid-sized firms successfully
underwent privatization
– Almost 90% of industrial output also privatized
• Conservatives called privatization a
“crime against the nation”
• Privatization succeeded in redistributing assets
– They did not reach the middle class as originally intended
• The efforts did not provoke major social revolt
– However, many people took issue with the speed of its
implementation
• Privatization also occurred at the same time as other
pervasive negative changes
– As a result, the public linked privatization and negative changes
PRIVATIZATION by the Numbers
Causes of the 1998 Economic Crisis
• Non-inflationary measures
• Growing DEBT
Non-inflationary measures
• By 1996, inflation and the ruble exchange rate
stabilized
– The years 1996 and 1997 were characterized by
stabilization and low inflation
– The ruble reached a semi-convertible state
– Russia achieved stabilization by stopping the
Central Bank from printing money
• Reducing the money supply decreased inflation
Non-inflationary measures
• The government borrowed money to handle the
growing deficit
– issued short-term treasury bills and some longer-term
treasury bills
– received loans from the International Monetary Fund
• Federal revenues decreased and the state reduced
spending
– Federal and regional governments failed to collect taxes
• This setback benefited large oil and electrical firms
– They provided energy to firms who could not afford it
– In return, the state allowed them to export without paying taxes and
tariffs
– Over time, these firms accrued tax debts to the government
Non-inflationary measures
• The state also withheld wages from statesector employees
– In 1996 and 1997, the state fell behind on
payment of wages and pensions
– Russians worked for no pay
Growing debt
• By late spring and summer of 1998, the state started
borrowing foreign currency
– These loans financed their troubling domestic short-term
debt
– In the first eight months of 1998, Russia’s foreign debt
increased by 18.5 million dollars
• This reduced the foreign currency reserves required to support the
ruble
• On July 20, 1998, the International Monetary Fund
offered Russia aid
– The package they offered aimed to finance wages and
domestic short-term debt
– Instead, Russia used the package to attempt to save the
ruble and failed
Effects of the 1998 Financial Crisis
• The financial crisis occurred on August 17, 1998
– Russia devalued the ruble
– defaulted on its domestic and international debts
• The crisis eliminated all savings in Russia
• Devaluation of the ruble made imported goods too
expensive
– Russians returned to purchasing domestic products
• This increase in consumption boosted the recovery of domestic
industry
• By 1999, Russia’s economy started to grow for the first time
since the collapse of the Soviet Union
– The recovery of domestic manufacturing played a part
– Increases in prices for raw material exports also contributed
greatly
– Growth continued until the global financial crisis in 2008
VLADIMIR PUTIN & DMITRI
MEDVEDEV
• Economic Growth from 2000 to 2008
– President Vladimir Putin (elected in 2000)
– In his first term (2000-2004), he enacted a series
of reforms drafted by Yeltsin
•
•
•
•
•
•
Flat income tax of 13%
New legal code
Systems to prevent money laundering
Regime for liberalizing currency
Reduction of taxes on profits from 35% to 24%
New land code allowing Russians to own commercial
and residential land
Putin’s Reforms
GDP reaches 8.5% in 2000!
• GDP reached an all-time high of 8.5% in 2000
and sustained high levels growth
Economic growth
• Between 1999 and the summer of 2008,
Russia’s economy grew rapidly
– The result:
• budget surpluses,
• no foreign debt, and
• sizeable hard-currency reserves
• Inflation remained modest
• GDP growth reached an all-time high in 2000
RUSSIAN GDP
Rising oil prices
• Russia’s growth coincided with a rise in prices
for Urals crude oil
– This crude oil blend was Russia’s chief export
• Price of barrel increased
– from $12 USD in 1998
– to $70 in 2007
• increased government and personal income
– Higher incomes increased demand for
manufactured goods and commercial services
Professor Philip Hanson
“It is by their indirect
effects … that oil and
gas price rises fuelled
Russian growth.”
Professor of the Political Economy of Russia and
Eastern Europe, Retired Emeritus
Centre for Russian and East European Studies
University of Birmingham
RUSSIAN OIL
THE RESOURCE CURSE
• The resource curse describes negative effects
associated with abundant natural resources
– Some economies experience
•
•
•
•
increasing debt,
nationalization of resources,
government corruption, and
negative growth
– Russia experienced many negative consequences
due to its supply of natural gas and oil
SUMMARY: Resource Curse
Dutch disease
• Russia’s heavy volume of mineral exports
invoked a sharp inflow of foreign currency
– This influx created a high exchange rate
– As a result, domestic manufactured goods became
too expensive
• Russians purchased imported goods instead
• This phenomenon is called Dutch disease
SUMMARY: Dutch Disease
Decay of other industries
• Russia was excessively dependent on oil
exports
• While Russia grew with the record growth of
oil prices, Putin loosened fiscal policy
– He began permitting oil companies to take on
debt
– Imports increased with the onset of Dutch disease
STABILIZATION FUND
• In 2003, the state established a Stabilization
Fund to store resource extraction tax revenues
– This store of money was intended to serve
as an emergency fund if oil prices fell
• The state could use the money to
–fight inflation or
–defend the ruble
STABILIZATION FUND
• In 2008, the government divided the Stabilization
Fund into two separate parts
– The Reserve Fund and
– the National Prosperity Fund
• government did not use the money to improve
the poor manufacturing sector
– Russia’s manufacturing received little attention even
after the collapse
– The economy lacked alternative industries when oil
prices plummeted in 2008
Critique by Analyst Evgeny
Gontmakher
• The state did not invest in improving oil
extraction technology and infrastructure
– This problem greatly hindered Russia’s ability to
recover from the 2008 financial crisis
– When oil prices crashed in 2008, so did the
Russian economy
• Russia’s economy mirrored the conditions of the period
following the 1998 crisis
Analyst Evgeny Gontmakher
“This is all a result of
--incorrect economic policy,
--oil dependence,
--and rampant corruption.
Until the system
changes, these problems
will persist.”
Increased government ownership
• Government ownership of the economy
increased between 2003 and 2007
• The state pressured firms to invest instead of
allowing market forces to provide incentives
• State ownership of oil expanded considerably
– The state-controlled natural gas company Gazprom
purchased Sibneft
– The government also took over gas company Yukos
and oil company Rosneft
– Government control of oil rose from
• 19% in 2004 to over 50% by 2008
– The Russian gas industry has not undergone
privatization yet
GAZPROM swallowed Sibneft
Yukos swallowed
Rosneft
The growth rate of oil production fell
between 2004 and 2007
• Exports fell proportionally
The 2008 Global Financial Crisis:
Calm before the storm
• Dmitri Medvedev: presidency, spring 2008
– Russia was in an unprecedented period of prosperity
• The stock market thrived
– Foreign direct investment grew rapidly
• But investment remained low compared to other emerging
markets
• Real disposable income increased by over 10% a
year
– Consumer spending increased remarkably
• Unemployment fell from 12% in 1999 to 6% in
2008
– Poverty fell from 41% at subsistence minimum to 12%
The BRIC
• Russia became a part of four notable
emerging markets, collectively known as BRIC
– Brazil
– Russia
– India
– China
The Global Financial Crisis
• began in September 2008
• Between June 2008 and January 2009, Russia’s stock
market lost 70% of its value
– The ruble lost 1/3 of its value against the dollar
• The Central Bank increased spending to save the ruble but failed
• Russia’s foreign reserves fell from rising corporate debt,
bank trouble, and credit issues
• Inflation hit a 14-month high of 13.9 by February 2009
• According to Bank of America Securities-Merrill Lynch,
industrial output fell by 16% between October 2008
and February 2009
REVENUE & GROWTH
• Government revenue fell by 28% in the first
quarter of 2009
– A decrease in commodity prices, including Urals
crude oil, caused this reduction
• Urals crude oil was Russia’s primary mineral export
• GDP growth declined to -0.2% in 2009
– Russia experienced budget deficits for the first
time since the 1998 economic crisis
Global Financial Crisis:
Russia by the Numbers
Stunted recovery
• By the first quarter of 2009, Russia exhibited
• the same ailments as it did in the 1990s
– Negative growth
– High unemployment
– High inflation
– Low oil export prices
– Weak manufacturing
1998 Recovery
• Prudent fiscal policy
• rising oil prices
– aided Russia’s transition out of the 1998 crisis
• Boris Yeltsin’s administration
established these policies
before Putin entered office
Putin’s Authoritarianism
• Putin introduced a more authoritarian
developmental model
– He implemented more
• autocratic
• state-led
economic policies
– Russia’s growth did not result from these policies
– In fact, Putin’s approach stunted Russia’s ability to
transition out of the 2008 crisis
RECOVERY
• Recovery depended on several factors that
would prove difficult to achieve
– Domestic consumer demand would have to
increase
• High unemployment and inflation strongly worked
against this goal
– World oil prices would have to rise
• The global recession suppressed demand for oil
– The state would have to implement prudent fiscal
policy
Russia Today
• Enduring problems
–Russia’s manufacturing sector fails to
compete in the global marketplace
• Russia can only compete in raw materials
exports
• Russia’s GDP over-relies on oil and gas
• The economy is at the mercy of world
markets
MODERNIZATION & MEDVEDEV
• Dmitri Medvedev
initiated a new
“modernization”
– The effects of the
global economic crisis
necessitated that
Russia diversify its
economy
– Dependence on oil
exports made Russia’s
economy fragile
Skol’kovo Innovation District
• Medvedev launched the construction of a Russian
Silicon Valley called Skol’kovo
– This project intended to use Russia’s educated labor force
to innovate new products
– Medvedev located the site in a new economic zone
outside Moscow
– Skol’kovo will probably
not
contribute significantly
to GDP for years or decades
MEDVEDEV’S PROMISED REFORMS
• Medvedev promised to stabilize Russia’s
– legal regime
– approach to property
This change would encourage and protect foreign
investors