ECONOMIC TRANSITION OF RUSSIA Lecturer – Oleg Deev oleg@mail.muni.cz John Maynard Keynes in 1925 •“The economic system of Russia has undergone such rapid changes that it is impossible to obtain a precise and accurate account of it… Almost everything one can say about the country is true and false at the same time” Key factors of Russian economic development •The largest country in the world - 17,075,400 square kilomètres • • Key factors of Russian economic development •The world’s largest reserves of mineral and energy resources • • Key factors of Russian economic development •Conflict between the center and the periphery (diversity of population, nationality and religion) •160 different ethnic groups and indigenous people •Religion groups – Russian Orthodox Christianity, Muslim, Buddhism, Catholic, Protestant, Jewish, beliefs (shamanism, pantheism, paganism, etc.) •Induction into religion takes place primarily along ethnic lines •Majority of ethnic groups are settled in certain areas •In modern Russia these ethnic group have a partial sovereignty – 21 republics with its own constitution, president, and parliament within the Russian Federation •The public finances are generated in the regions, transferred to the center, and only then re-allocated back to the regions • • • • Key factors of Russian economic development •Conflict between the center and the periphery (diversity of population, nationality and religion) • • • Key factors of Russian economic development •Lack of investment in infrastructure •One of the world’s longest webs of railways, highways and subways •the European part is more developed than the Asian part • • Key factors of Russian economic development •Vast territory •Natural resources •Conflict between the center and the periphery •Lack of investment in infrastructure •Authoritarian nature of governance to control the territory •Huge expanses on defense and military •The origins of investments are mainly internal • • • Starting conditions of the transition in late 1980s - social •Low level of social inequality •as low as in Scandinavian countries •Relatively low level of corruption •Relatively low crime and mortality rates •Immense investments in the human capital •Free high-quality education in every level •One of the best education system in the world •Free health care to all citizens •Relatively high life expectancy level •Highly developed pure science and innovation at the theoretical level • • • • • • • • • Starting conditions of the transition in late 1980s - economic •Centralized bureaucratic allocation replaced market allocation •Economic policy making was strictly hierarchical •Macroeconomic situation – closed economy with the volume of money exceeded the volume of goods; •Microeconomic situation – people demanded other goods than those supplied •No initiative behavior among people and enterprises •Economic distortion of prices •Structural dysfunction of the economy (with prevailing heavy-industries enterprises) •Large budget deficit – more than 6% of GDP •Excessive foreign debt – 30 to 40% of GNP •Falling oil prices •Economic growth – 1 to 3% • USSR economic experiments of systematic changes •1920s – NEP – New Economic Policy •1930s – Industrialization & Collective farming •1950s – Khrushchev’s reforms •1960s – Brezhnev’s reforms •1980s – Gorbachev’s reforms – transition to indicative planning; introduction of some market mechanisms – leased enterprises, family farming, joint ventures with foreign capital •ended up with political democratization •Reforms did not change the planned nature of the economy Objectives •Restructuring of the national economy •Macroeconomic stabilization Goals •Deregulation and promotion of competition •Prices and interest rates liberalization (if to let go the prices, the output might be saved) •Liberal foreign trade police (open market) •Establishment of property rights •Development of the market economy institutions Starting the transition •Boris Yeltsin Yegor Gaidar Price liberalization – early 1992 External liberalization - 1992 Privatization – since 1988 •Spontaneous privatization (1988-1991) •control over some industrial assets was acquired by their managers •this accounted for only several thousand enterprises, a small part of the Soviet industry •Voucher privatization (1992 - 1994) •each voucher were corresponding to a share in the national wealth •vouchers were distributed equally among the population, including minors •vouchers could be exchanged for shares in the enterprises to be privatized •low price of vouchers $7-10 – less than an average monthly wage •most shares were acquired by the management of the enterprises Privatization – since 1988 •Loans for shares (1995) •included most oil, gas and other natural resource-based companies, which were highly profitable ones and were supposed to be sold for cash •industrial assets were leased through auctions for money lent by commercial banks to the government •the auctions lacked competition, as they were largely controlled by favored insiders •scheme that gave rise to the class of Russian business oligarchs, who have concentrated enormous assets •banks and enterprises involved in the scheme stopped seeing an interest in maintaining high inflation Macroeconomic instability Anti-inflation policy – 1992-1998 •First half of 1992 (Gaidar). Growth of money supply was restricted; inflation fell to 10% a month in summer 1992; as a consequence, massive non-payments emerged •First half of 1994 (Chernomyrdin). Tightened monetary policy allowed to bring down inflation to 5% a month in summer 1994; again, non-payments increased •mid 1995: exchange rate based stabilization; inflation brought down to 6% a year (July 1998 to July 1997); currency crisis in August 1998, acceleration of inflation Why high inflation was so persistent? •There was no consensus among major lobbying groups, how to finance reforms, therefore it was impossible to balance the budget •Problems with tax collection: high level of tax evasion in the 1990s. The government was willing, but not able to increase tax revenues •Attempts to tighten monetary policy caused non-payments • What was expected? GNP growth rates, % Results (1991-1998) •Free market •Private business – 70% of GDP •Huge fall in output •High inflation •Income redistribution •Privatization – controversial results •people’s disapproval & emergence of oligarchs •Organized crime and corruption •Capital flight – $20 billion a year •The development of barter economic relations and dollarization •Unemployment and poverty •Deterioration of education system, health care, demographics •Inadequate pension system •Inefficient legal system •Corruption •Existence of shadow economy GDP growth rates, % Personal incomes - % of level in 1991 Human development Human development Human development Russian financial crisis – August 1998 Russian financial crisis – August 1998 Russia's 1998 financial collapse •In a matter of days the exchange lost over 60% of its value •more than in all most Latin American and Southeast Asian countries (except for Indonesia) •Prices increased by nearly 50% in only 2 months after the crisis •as compared to less than 6% annual inflation July 1998 to July 1997 before the crisis •Real output fell by about 6% in 1998 •after registering a small increase of 0.6% in 1997 for the first time since 1989, it fell in January - September 1998, i.e. mostly before the August 1998 crisis Why was the drop so drastic? •Some of the standard explanations •Bad institutions •Natural resource dependence •Bad policies •For a medium income level country, Russia is trade wise open •For a resource dependent country, it has a large population •Financial dependence proved important •Short-term debt was concentrated and fast growing •Dependence of financial intermediation on foreign funding •The dual financial system: households and most companies using domestic markets; some big companies and banks dependent on foreign markets So why the talk of a safe haven? •Politicians were not in the business of doom-saying •Shifting blame to where it belonged: global imbalances •Good grounds why a pure financial crisis might handle Russia softly •Small financial sector; meager role in investment finance •Strong public sector financial position – taxation reform •Households with no financial wealth, little debt: no wealth effect on consumption •Labor markets expected to be very flexible •Boom in industry •After devaluation domestic producers are taking advantage of new export opportunities and the shift in demand from foreign to Russian made goods •Devaluation of the previously overvalued currency restored the previously lost competitiveness •Output was falling in the beginning of 1998, but started to grow in October (unlike in East Asia, where output fell after the currency crises) After the crisis Economic growth – 1999-2008 Output is growing, inflation is under control Challenges for the future •Unpredictable export revenue •Oil price •Energy efficiency needed for maintaining export volumes •Change in gas markets •Regaining budget surplus •Re-accumulating reserve funds a high priority •Expenditure pressure due to recent hikes, long-term needs •Revenue problem due to declining share of energy sector in GDP •Exchange rate policy •Increased flexibility of nominal rate, no pure inflation targeting •Real exchange rate appreciation pressure as financial inflow resumes •Financial system development •Rolling back the state •Need for long-term domestic funding •Pension reform •Increasing dependency ratio •Previous failures to depart from pay-as-you-go •Competitiveness of jobs