Russian economy: trying to please people doesn’t help

20 years ago there was all to play for: the USSR was defunct and Russia was embarking on a bright future. But the much-needed economic reforms have had patchy success. Every time they took a step forward, the government lost both popularity and its nerve. Now the Kremlin no longer has the funds to keep people sweet and another financial crisis must be a real possibility, says Dmitri Travin

Twenty years ago, in September 1991, Russia entered a period of euphoria and great expectations. After the abortive August coup, with leading members of the old Soviet elite behind bars, real power passed to Russia’s president, Boris Yeltsin, who proclaimed his commitment to radical economic reform. It was clear that the USSR was on its last legs, and that life was about to change dramatically.

20 years of disillusionment 

Straight away, in the autumn of 1991, the young economist Yegor Gaidar masterminded a programme of market reform, which was rolled out in 1992. Russia switched from the old Soviet centralised command economy to a free market economy. In the 20 years since, however, the country’s economic course has been much less successful than might have been expected.

The market does exist, and Russians have seen the end of the constant shortages of everything that were the worst aspect of the Soviet economy. But the growth in Russia’s GDP has been due in large part to oil exports, and falls in global fuel prices have affected the country’s entire economy.

'Populism in various forms has dominated practically the entire post-reform 20 year period.'

There has been an obvious lack of investment in sectors other than the power industry. The main reason for this is the absence of protection of private property rights and the consequent serious risk to investors. Corruption is also rife; officials demand backhanders at every turn, and this lays an additional financial burden on business, so reducing its competitiveness.

So what are the reasons behind the fact that in 20 years Russia has been able to carry through only the most essential economic reforms, and has failed to find a solution to a number of key issues? Coincidentally, 1991 also saw the publication of ‘The Macroeconomics of Populism in Latin America’, edited by American economists Rudiger Dornbusch and Sebastian Edwards. This work demonstrated conclusively how populism has a negative influence on economics, and how, instead of effecting essential reform, weak governments and central banks increase government spending and the issue of money, leading to inflation and the flight of capital. Russia has learnt nothing from the Latin American experience, even though Rudiger Dornbusch worked as an advisor to the Russian government in 1991-2.

Putin_oil

The oil bonanza allowed Vladimir Putin to take the populist path and to avoid the badly-needed economic reforms.

Populism in various forms has dominated practically the entire post-reform 20 year period. Both Yeltsin and Putin have been absolutely populist leaders, obsessed with clinging on to power at any price and because of this dragging their feet on most of the changes the country desperately needs.  

What killed Gaidar’s reforms?

The first flashpoint that sparked off an eruption of populism happened in the spring of 1992. At that time Gaidar, who was Deputy Prime Minister for Economic and Financial Affairs, had deregulated prices and was attempting to halt the resulting inflation by cutting government expenditure. He was setting limits on subsidies to loss-making concerns, reducing funding for education and culture and curtailing spending on the army. Yeltsin warned him that these measures would quickly lose the Russian government the wide support it enjoyed among the population in autumn 1991. People did not understand why in the Soviet past everyone was guaranteed a wage, whereas now they were effectively unemployed. Russian citizens expected their rulers to bring in reforms that would fill the shops with consumer goods, but without anyone being worse off - not even employees of unprofitable concerns.

'Even with high oil prices the Kremlin may be able to maintain Russians’ real earnings at their present level, but it is unlikely to be able to increase them at the rate of the last decade.'

Gaidar gave in to Yeltsin in order to keep his job and have the chance of making at least some changes. As a result, the Russian central bank began to offer companies unlimited credit, which provided people with wages, but forced inflation up to 20-30% per month. In these circumstances there was no incentive for anyone to invest in the Russian economy. Businesses played the market for short term gains and took their money out of the country. The loss of production that had begun before the collapse of the USSR continued until 1999.

How economic crisis returned to Russia

The first attempt to bring some order into the Russian economy began in the middle of the 90s. A system of national debt was set up. Instead of printing money and distributing it to business, the government issued bonds and began to supplement its income by borrowing from business. Business leaders were enthusiastic about this opportunity to provide credit for the government, since they had few other means of making a profit. In 1997, inflation fell to its lowest point as a result.

But here political populism raised its head once more. Loans had to be repaid, or creditors at any rate had to be assured that the government was in a position to meet its financial obligations. In a situation where Russia’s GDP was falling each year, and business was finding ever more tax evasion loopholes in legislation, government spending had to be curtailed. This would, however, inevitably lead to a loss of popular support.

In 1996 Yeltsin had to stand for re-election as President, so there could be no question of reducing government expenditure. In 1997, when the government did attempt to make savings, big business demanded its share of the ‘public pie’ as a reward for its support for Yeltsin at the elections. The Kremlin shrank from antagonising business circles, preferring to resort to populism once again, and believing right to the end of 1997 that the financial markets would continue to provide them with long-term credit.

However, the Asian financial crisis sparked a rapid flight of foreign investment. The government could no longer service its sovereign debt. In August 1998 it was forced to default on its domestic debt and abandon its support of the rouble, whose exchange rate fell five-fold over a short period.

Putin’s Dilemma

Russians’ real earnings fell dramatically, not thanks to harsh government cutbacks, but as a result of the flight of capital from the country. The 1998 crisis was a positive development for the Russian economy, as the cheap rouble made Russian goods more competitive. There was a marked fall in imports, and Russian firms began to supply relatively cheap goods for the internal market.

The Russian economy’s recent troubles seemed to be a thing of the past. The country was also fortunate to be able to capitalise on steeply rising oil prices, and the government’s coffers were full to overflowing. Vladimir Putin, who came to power in 2000, enjoyed wide popularity thanks to a combination of rising real earnings and a hard line on Chechen separatism. His relative youth was also a plus factor: he could not be held responsible for the hardships of the 90s. Many pundits hoped that Putin would reject populist politics and push through reforms that would bolster Russia’s long term competitiveness.

Meeting pensioners

In Putin’s Russia the votes of pensioners and veterans have ensured the Kremlin its essential majority in parliament. During the current election campaign Medvedev and Putin have made a great many promises at meetings with their representatives. But can they keep their word if the economy remains unreformed?

Initially Putin did in fact show some common sense and an understanding of the dangers lurking in populist politics. A sensible reform package reduced the tax burden on Russian business. Capital began to emerge from the shadow economy and tax revenue to increase.

However, Putin decided he needed to maintain his high popularity rating among the voters and soon abandoned any further reforms that would have sustained Russia’s economic effectiveness. Thanks also to high oil prices, he had no need to either fall back on the populist measure of printing extra money or increase the national debt. Oil kept the treasury full and Putin gave a significant proportion of the income back to the people in the form of low taxes and social benefits, so maintaining his popularity.

In 2005 another reform removed some of the benefits enjoyed by the population. This caused wide resentment among Russians, and the government quickly handed out financial compensation to those who had lost benefits. Possibly that was the moment when Putin realised that any attempt at reform would antagonise the population at large and that if he wanted to retain his popularity it would be better not to undertake any further changes.  

What lies ahead? 

The current president, Dmitry Medvedev, has made no changes to Putin’s policies, although he has often spoken of the need for a high-tech economy and an end to Russia’s dependence on oil revenue. Perhaps their good old populist strategy can sustain Russian leaders’ ratings a while longer. But a serious question arises.

'Russia needs serious reforms, but the likelihood of their happening is lower today than it was ten years ago, since the Kremlin has run out of the spare cash that would allow it to introduce reform without seriously affecting living standards.'

Even with high oil prices the Kremlin may be able to maintain Russians’ real earnings at their present level, but it is unlikely to be able to increase them at the rate of the last decade. But people are used to seeing Putin as a miracle worker who constantly makes life better. Consequently, the next few years will inevitably see a fall in the popularity of Russia’s leaders. The Kremlin will manage to sustain it for a while by manipulating popular opinion, but this means of hanging on to power also has its limits.

Russia needs serious reforms, but the likelihood of their happening is lower today than it was ten years ago, since the Kremlin has run out of the spare cash that would allow it to introduce reform without seriously affecting living standards. What is more likely is that in the near future Russia will once again eat up/go through its oil riches. Corruption will also increase, since those in power will take their money out of Russia and move their families to London and other European centres in the expectation of yet another Russian financial crisis.

About the author

Dmitri Travin is Research Director at the European University in St. Petersburg's Centre of Modernization Studies

Read On

Market Reforms, 20 Years Later. Economic, political and cultural forces have boosted Poland but fallen short in Russia, by Jeffrey Sachs, Scientific American, August 3, 2010

Tradition Breaks Reform, by Leonid Sedov, Russia In Global Affairs, No. 4 Oct.-Dec. 2009

More On

Dmitri Travin

Russian reforms, twenty years on. Introduction

In the autumn of 1991, a group of young economists headed by Yegor Gaidar started working on a series of economic reforms for Russia.  In celebration of this 20th anniversary, we are this week publishing a series of 5 articles. They are written from various standpoints and consider the successes and the failures of these reforms.

On the one hand, it is clear that there have been qualitative changes in Russia, which have led to it becoming more or less a market economy. 

On the other hand, the authors’ assessment of the rate of change, the results of privatisation, the influence of the politics on the economy, the scale of corruption and the development of the banking system has led them to conclude that Russia today is in a very difficult place because the changes have ground to a halt.

These 5 articles are the fruit of cooperation between openDemocracy Russia and 2 of St Petersburg’s academic institutions: the M-Centre [Centre for the Study of Modernisation] at the European University of St Petersburg, and the Friedrich von Hayek Institute.