What is the myth?
‘No rewriting of history can change the fact that neo-liberal reform produced undiluted economic decline [in Russia].’ That is the myth. Perhaps more consequential than anything else has been its wholesale adoption by all but a tiny minority of the Russian people. The Russian population’s aversion to the reformers of the 1990s lies behind the minuscule electoral support for their latter-day equivalents. The most successful opposition politician, Alexei Navalny, campaigned before his imprisonment against graft and corruption, not for free-market reform.
Who advocates or subscribes to it?
The quote above is from a distinguished economist, the Nobel laureate Joseph Stiglitz, writing in the Guardian in 2003. Like many on the left in the West, he took a dim view of the Russian reformers’ policies in the first decade after the collapse of communism, linking those policies directly with the collapse of the Russian economy between 1989 and 1999.
This myth, that liberal reforms devastated Russia in the 1990s, appeals to some European policymakers. It appeals especially to those, on left or right, who take a benign view of Vladimir Putin’s regime. Hungary’s prime minister, Viktor Orbán, is an example.
Why is it wrong?
There is no getting away from the facts that (a) market reform was attempted in the 1990s and (b) the economy collapsed. But (b) was not caused by (a). The gap between the neoliberal – or, more precisely, liberal – agenda and what was actually done in the Russian economy was huge. The real problem, in other words, was that the reforms as initially envisaged were not implemented.
Western advice, channelled mainly through the IMF, the World Bank, the OECD and the European Bank for Reconstruction and Development, was, very broadly speaking, based on the so-called Washington Consensus. According to this set of guidelines, ex-communist countries, so far as their economic transformation was concerned, needed to undertake liberalization, stabilization and privatization. That is, they had to free prices, including the exchange rate; they had to get inflation under control by managing the money supply and the public finances; and they had somehow to ensure that the bulk of productive assets passed from state to private ownership.
The failure to stabilize the economy was the most significant failure of the whole reform, and it happened contrary to the will of the reformers.
There was much debate about the desirable speed and sequencing of these measures. The majority view was that the whole suite of policies should be carried out as swiftly as was compatible with transparency and accountability: ‘shock therapy’. And indeed, the countries that moved fast and in a more or less orderly fashion endured only rather short ‘transition recessions’ and went on to strong growth.
These key ingredients of economic transformation from communism to capitalism were on the agenda of Yegor Gaidar’s government in 1992. But that government was too weak to push them through. Indeed, by speaking of themselves as only the reform ‘wing’ of the government, the ‘young reformers’ betrayed the constraints they were under. A hostile parliament ensured that Gaidar was only an acting prime minister, and he did not last the year.
The great bulk of prices were freed on 2 January 1992. Notoriously, by end-year the consumer price index had risen by 1,500 per cent. If the government could have had its way, the result would have been a one-off increase of much smaller proportions. But the government did not control the central bank; the parliament did. It appointed a central bank head who pumped up the money supply. This not only increased and prolonged inflation; it delayed the shake-out of uncompetitive firms by providing credit where there would otherwise have been hard budget constraints on producers. A struggle over the money supply continued for several years. The inflation rate was reduced to 25 per cent only in 1996. The failure to stabilize the economy was the most significant failure of the whole reform, and it happened contrary to the will of the reformers.
The greatest attention, however, has been paid to the shortcomings of privatization. Here the political situation forced the reformers into damaging compromises. For the bulk of large-scale enterprises, the plan had been to follow the Czechoslovak model of mass privatization where citizens were issued with vouchers that could be used to purchase shares in any enterprise. Meanwhile, Russian managers were grabbing control of enterprises and wanted the official privatization process to allow this to continue. Anatoli Chubais, who was in charge of mass privatization, was forced to allow an option whereby the workforce of an enterprise could vote to use its vouchers on its own workplace. This was popular. It mostly resulted in the Soviet-era bosses controlling the factories.
As a transitional arrangement, this might not have been too bad. What really destroyed the reputation of the Russian privatization process was the loans-for-shares auctions of a handful of giant oil and metals companies – the big earners of the economy (the gas ministry, spanning the whole gas industry, had turned itself into Gazprom). In rigged auctions with predetermined results, the likes of Yukos Oil and Norilsk Nickel were sold to the new banks for sums that seemed in retrospect tiny.
Never mind that Chubais did not allow a second round of such auctions. Never mind that there was a risk that the Communists might be elected into government; already in 1995 they had won control of the parliament. The reputation of the Russian privatization process was ruined.
Liberalization was the only part of the reform agenda that was fulfilled. On its own, in the absence of stabilization, that was toxic. Privatization of a sort did go ahead, but in a way that distorted the reformers’ original vision and left lasting problems. State capture by the oligarchs was made possible by the distortions in large-scale privatization.
One positive result of the changes that did occur is underappreciated. In the financial crisis that overtook Russia in 1998, the rouble was forced into a drastic devaluation: from six roubles to the US dollar very quickly to around 20. Import prices rocketed. There was an opportunity for Russian firms to step in and produce import substitutes. Would they take it? Many observers were doubtful. The old economy as it was at the beginning of 1992 had consisted of entities without the structure or incentives to increase supply in response to an upward shift in demand. But in the event, enough restructured firms opted to make import substitutes to begin the economic recovery. Higher oil prices later supported further growth.
A comparison of Russia’s difficulties with the Polish reform experience is instructive. In Poland, the Balcerowicz Plan of 1989 was similar to what the Russian reformers had intended – indeed, Gaidar’s team learnt from it. But Polish shock therapy was successful: GDP fell for only two years and then grew strongly. In Russia, from 1992 output fell for six years and by a total of around 40 per cent, making it a miserable decade. Could shock therapy have worked in Russia? It wasn’t implemented, so we shall never know.
It was social and political opposition that blocked reform in Russia. Perhaps the mere existence of that opposition made the attempt an impossible mission? In Poland, reform amounted to the removal of an alien system imposed by a foreign power. In Russia, central planning was home-made: part of the Soviet way of life. Polish people had the prospect of ‘joining Europe’. Liberalization, stabilization and privatization could be seen as the route to joining the EU, which was then an attractive destination. Any sense in which Russia might ‘join Europe’ was always more contested.
Even so, the Gaidar team proceeded in a way that did not help its cause. Its members called themselves a ‘kamikaze’ crew and assumed that the bulk of the people and the managerial establishment were against them. The general population was deemed to be too ignorant to be persuaded of the advantages of reform, so there was little effort to communicate the point of what was being attempted.
What is its impact on policy?
The myth that liberal reform caused a depression in Russia is beneficial for the current Russian leadership. It provides Western policymakers dealing with Moscow with the notion that a liberal economic order is simply not feasible for Russia; and supports the illusion that those who, in the name of freedom and justice, campaign against members of the security and law enforcement agencies (the siloviki) and their corruption and asset-grabbing are tilting against windmills. Yet it is precisely the 2.6 million siloviki who stand between Russia and a more efficient and dynamic economy. It is true that the erosion of their power is not in sight. But it is what the majority of the Russian business community wants to see. In the longer term it cannot be ruled out.
What would good policy look like?
If economic reform itself had damaged the Russian economy, it might be argued that Russia is somehow immune to a liberal economic order. This closes minds to other possibilities. It is right that the US government should have complained about the silovik-driven house arrest in Russia of American investor Michael Calvey on trumped-up charges. It would be even better if Western officials also complained to the Russian authorities about the 5,000-plus Russian businesspeople held in preventive detention; most are held on equally dubious grounds.
In general, any notion that Western ideas are responsible for Russia’s economic problems should be treated with scepticism. The experience of economic reform in the 1990s illustrates an obvious truth: what happens in Russia, given its size and resources, depends primarily on choices made by Russians.