How the Russian Economy Can Regain Its International Presence - Essay Example

The Demise of the Russian Economy and How It Can Regain Its International Presence When the Russian economy is discussed the focus tends to be on the problems, but it is important to stand back and look at the processes, many of which happen to be beneficial. An outstanding positive fact is that by the end of 1993, the Russian economy had become a market economy. (Tsyganov pp. 259-291) Let us examine this phenomenon from three angles. First, what are the qualifying features of a market economy as distinct from a command economy? Second, what kinds of markets exist? Third, what forms of market-oriented restructuring can we observe? Defining a Market Economy Janos Kornai's book The Socialist System: The Political Economy of Communism (1992) is a useful point of departure for defining a market economy. Five distinctive features of a socialist economy versus a market economy follow naturally from his classification. First, the foremost criterion of the communist economy was the supremacy of the Communist Party, with its ideology and politics, over the economy. This is so evident that it is often neglected. Now it has ceased. The economy has become depoliticized. Second, centralized state allocation, with centralized commands to enterprises on physical output targets and deliveries, has ended. State orders lingered on for some time in 1992 and 1993, but now they have been whittled down to nothing. Vertical, administrative allocation has been replaced by free, horizontal bargaining between independent enterprises. The economy has been liberalized both internally and externally. For imports, all quotas are gone, and the protectionism we discuss amounts to the level of the customs tariffs. For exports, some quotas, licenses, and taxes remain, but export deregulation is proceeding and an important additional step was taken in a presidential edict of May 23, 1994. In spite of periodic setbacks in the internal liberalization, market saturation is increasing steadily. Allocation has become depoliticized (Noren pp. 13-37). Third, as mentioned above, state ownership has been reduced to less than half of the economy. The Russian privatization program has been an astounding success in terms of transfer of ownership from the public sector to private hands. Consequently, the remaining state enterprises are independent, as in a market economy. Ownership has been depoliticized. Fourth, the economy has been monetized and the ruble has become a real, reasonably convertible, currency, with a unified exchange rate that is market-deter-mined and floating. Admittedly, the volume of U.S. dollars in circulation and in Russian bank accounts exceeds the volume of Russian rubles in Russia, but the dollar is also a currency. The problem here is not lack of monetization but the stabilization of the ruble. Fifth, the last major hurdle to making Russia a market economy was to introduce hard budget constraints in enterprises. This was essentially done on September 25, 1993, when President Boris Yeltsin issued a decree abolishing subsidized credits. The refinance rate was already high and rose to 17.5 percent a month--that is, 593 percent a year--on October 15, 1993, and it has stayed high in real terms since then. The budget deficit has been kept fixed at about 9-10 percent of GDP. Thus, since October 1992, Russia and Russian enterprises have faced a severe monetary squeeze, and Russia has reacted exactly as market economies do: the inflation rate has fallen, from over 20 percent a month last year to about 9 percent a month from February through April 1994. As a result, during those months Russia had a positive real interest rate of 9 percent a month, or 180 percent a year. A Russian enterprise in trouble can no longer count on the state to bail it out. Credit has become relatively, though not completely, depoliticized (Aslund p. 5-6). The current attempt at financial stabilization may fail, and the social costs of the Russian transition might rise higher because of gradualism and inconsistency, but even so, a market economy has been created in Russia. What Markets Exist? Some markets existed in the Soviet Union, but today in Russia, almost the full spectrum of markets has evolved, even if some of them are in a rudimentary form. The Soviet consumer has always faced a hard budget constraint and benefited from some choice. In the peasant markets, both buyers and sellers were private individuals with hard budget constraints. Notwithstanding the prevalence of the seller's market, consumer markets of all kinds have developed, and now the sellers, too, act on a market. The labor market was well developed under the Soviet regime. Essentially, people were free to choose their place of work, and state enterprises competed for labor in spite of restrictions on wage sums and wage tariffs for specified categories of workers. At present, the Russian labor market is highly unregulated and, unlike many Western countries, Russia has no incomes policy. The crucial missing market in the old economy was the inter-enterprise market for goods and services. Today, enterprises conclude contracts with one another directly. Both an inter-enterprise market and a wholesale market have developed. There is no longer any alternative to market deals, since state orders have dwindled to a minimum. Markets for apartments and private plots of land have long existed, although they were semi legal at best. Now they have been fully legalized, and there is an extensive market of privatized flats and private houses; the commercial real estate market is still rudimentary because property rights have not yet been clarified. Financial markets did not exist at all under the old regime. Now, one after the other is emerging. Russia has about 2,000 commercial banks. Most of them are tiny and lack professionalism, but the Russian banking system is developing from the bottom up. About twenty Russian commercial banks have reached such standards that they can make deals on the telephone. Several commodity exchanges have developed into stock exchanges. Their main preoccupation has been to trade vouchers, but after the vouchers have disappeared, they will automatically turn to stocks. Trade in stocks is being concentrated in a few relatively well functioning stock exchanges. The voucher privatization has given rise to about 650 voucher funds or investment funds, which are prime movers on the stock market. Foreign currencies are being traded at six exchanges. In 1993, the issuing of treasury bills became a regular feature of the capital market of Russia. About a thousand insurance companies have been set up. Fraud and lack of professionalism are common phenomena on these emerging financial markets, but the markets are developing fast and spontaneously (Kwiecinski pp. 45-64). Market-Oriented Structural Changes Abound The proof of the market economy is that market-oriented structural changes actually take place. What we are interested in is restructuring prompted by demand and costs rather than by government policy or supply bottlenecks. The statistics offer plenty of evidence of such changes. First, the proportions of GDP produced are becoming less distorted. In 1993, when GDP fell officially by 12 percent, transportation, a sheer cost item, plummeted the most, by 25 percent. This shows that enterprises finally had started bothering about costs. Industrial production declined more than GDP, which is good because Russia has been severely over industrialized. Consumer-oriented branches did not contract much, if at all: agricultural production fell officially by 4 percent, housing construction increased by 1 percent, and retail trade rose by 2 percent. In reality, all these indicators are likely to be understated because many private activities are not recorded. Besides, a financial sector developed. Second, for industry, demand dominated over supply problems and determined the decline of production during the second half of 1993. The manufacturing of arms and agricultural equipment, which had been highly subsidized, declined greatly. A large number of products that nobody wanted to buy were no longer produced. Third, the proportion of the consumption side of GDP became more normal, as private consumption increased from a minimal 36 percent of GDP in 1992 to a still small 41 percent of GDP in 1993. Considering that some two-thirds of GDP goes into private consumption in Western countries, the consumption share should increase a lot more if stabilization is reinforced. Fourth, the distribution of enterprises over different sizes is becoming more normal. Small enterprises are no longer absent but account for 12 percent of employment, and there are 75,000 small private manufacturing enterprises. (Klimov pp. 34-41) Fifth, a recent feature of Russia's development is that enterprise managers are now being replaced on a large scale. Reports from shareholders' meetings indicate that over one-tenth of the incumbent managers are being sacked by the shareholders, and this tendency is accelerating as many enterprises come to a standstill. Privatization has undermined the previously unchallenged position of the enterprise managers, and stricter stabilization policies have exposed their incompetence. Sixth, the country structure of Russia's foreign trade is becoming more normal, in accordance with the gravity theorem, which says that a country trades primarily with rich countries in its neighborhood. About 60 percent of Russia's foreign trade outside the former Soviet Union was with the West, and only 15 percent with the former COMECON countries. Similarly, the trade with other former Soviet republics fell by 50 percent from 1991 to 1993. This is a positive structural normalization; bloc protectionism has ceased. Seventh, while Russia's exports were already determined by markets, the commodity structure of Russia's imports has adjusted to the domestic market. Imports of previously heavily subsidized goods, notably grain and investment goods, have plummeted, while a multitude of import items have emerged on the Russian market, eliminating shortages. Most of the initial structural changes are of a destructive nature, eliminating the production of goods and services no longer in demand. Other measures involve cost cutting. In early 1994, real unemployment began to rise, showing that enterprises are starting to cut costs. The first positive supply effects are apparent in trade. Supply effects in production take a longer time to evolve. The early emphasis on trade and cost cutting prompts public outrage over speculation and destruction, but these are natural stages in the development of a market. If they are not allowed to mature, market development could halt, as has happened in many heavily regulated Third World countries. The vital preconditions of desirable structural changes are that enterprises are independent and concerned about profits, while bargaining is free and prices have adjusted to the market (Kh & Popov pp. 140-144). What Problems Remain? The Russian economy has gone through a fundamental qualitative change, not only destroying the old command economy, but also building up rudimentary market economic institutions. However, much remains before the market economy can start functioning well. First, inflation must be brought down to a reasonable level. Inflation might rebound upward, because the stabilization policies pursued from the beginning of 1994 are hardly sustainable. The budget deficit has been too large and not properly financed, while the monetary policy has been very strict. Extremely high real interest rates of up to 200 percent a year depress the economy more than necessary and provoke resistance against stabilization. The budget deficit must be cut and properly financed, which would allow a reduction of the real interest rate without causing inflation. Crime is the second public concern after inflation, according to a multitude of opinion polls, and rightly so. Communist society was based not on the rule of law, but on obedience. With the breakdown of the old authoritarian system, there was neither law nor obedience. Virtually everything is inappropriate. The legislation is inconsistent, too extensive and yet rudimentary. There are few lawyers, judges, or defense counsels, and their competence and morals are dubious. The prosecutors have traditionally been superior to the judges, and they regret their diminishing role in a system of rule of law. The police are utterly corrupt and demoralized, apart from being poorly trained. Since most of these problems involve training, morals, and the functioning of complex human systems, it will take a long time before the legal system can be relied upon to perform ordinary services. However, this was a characteristic part of the development of capitalism in the nineteenth century. Crime dwindled from the great liberalization in the 1840s until World War I, while all kinds of legal institutions evolved. The rational response to the legal shortcomings was laissez-faire. It will take a very long time before Russia becomes an orderly country, but market economies can cope with quite a bit of disorder, even if this implies that the social costs will be higher than in a more orderly society. The response to corruption must be further liberalization, and, after all, that does happen. The development in Russian politics and the Russian economy has moved on from the period of extraordinary politics to ordinary politics, and the declining amount of news from Russia is a normal reflection of no news being good news. Nobody in his right mind would discuss the possibility of famine in Russia today, although that was a dominant theme three years ago. After all, the market functions, if it is given a reasonable chance. References Aslund, Anders. 'Why Has Russia's Economic Transformation Been So Arduous?' paper presented at the World Bank's Annual Bank Conference on Development Economics (ABCDE), 28-30 April 1999, pp. 5-6. Kh G. Popov, Puti perestroiki. Mnenie ekonomista (Moscow, Ekonomika, 1989), pp. 140-144. Klimov, Sergei. 'Food Aid to Russia: Who Needs It Most?’ Prism: A Bi-Weekly on the Post-Soviet States, 4, 24, Part 2, 11 December 1998. Kwiecinski, Andrzej. The Slow Transformation of Russian Agriculture, The OECD Observer, No. 214, October-November 1998, Review of Agricultural Policies: Russian Federation (Paris, OECD, 1998). Noren, James H. 'Statistical reporting in the states of the former USSR', Post-Soviet Geography, 35, l, January 1994, pp. 13-37. Tsyganov, Yuri. 'Political Background of the Economic Crisis in Russia', in V. Tikhomirov (ed.), Anatomy of the 1998 Russian Crisis (Melbourne, CERC, 1999), pp. 259-291. Read More