Russia's economic problems and challenges

Economic Reform in Russia

Since 1992, Russia has undergone a complex process of economic transition. It is a process that has been made more difficult due to the lack of theoretical and practical guidelines on the problem of transforming a communist command economy into an open capitalist one. All the existing theories on such a transformation tended to focus on the reform of rural subsistence economies, rather than on an industrially developed one, such as Russia. Yet, despite the absence of an effective economic blueprint, the state of the Russian economy, at that time, was such that the Yeltsin government was required to take action quickly, in order to save the country from economic ruin.

However, the radical reforms which were introduced in January 1992, and were termed 'shock therapy', did not prove to be successful and, rather than encouraging the growth of a market economy, they produced an awkward hybrid of capitalism and old-style Sovietism. Russian policymakers, and many foreign economists, expected that the influence of communist ideology would eventually give way as the disciplines of capitalism took over, but the Soviet political conditions and culture appear to be offering a greater degree of resistance towards capitalism and the market than was originally imagined. Therefore, unlike in Poland where 'shock therapy' rapidly transformed the economy into a market system, the reforms initiated by the Yeltsin administration, and those which have followed, face a continuing struggle to break Russia's link with its communist past, and transform it into an efficient, functioning market system.

Background Information.

The major, distinguishing factor of the Soviet economy was its overtly political nature which, unlike a market system determined by indicators such as supply and demand or profit and loss, was driven solely by state decisions and requirements. The economy was almost entirely owned and managed by the state, which took all of the key decisions regarding production, investment, distribution and price, with issues such as quality being of secondary, if any, importance. The result was the production of huge quantities of poor-quality goods, for which there was little demand, which had been produced at an internationally uncompetitive cost. However, these economics survived due to the provision of large-scale state subsidies and the maintenance of protectionist trade policies that severely limited the import of goods into the Soviet Union. The priorities for the Soviet state had long been the heavy industries and the military and, due to the massive state investment in these areas, Soviet production of steel outstripped that of the West until as recently as the 1980's, while military spending had consolidated Russia's position as a superpower. Yet, when Gorbachev assumed power in 1985, he took control of an economy which was in a state of decline and which, in the years 1980 to 1985, had witnessed a growth of virtually zero and had been overtaken as the world's second largest economy by that of Japan (Rutland, 1996, p156).

Gorbachev attempted to de-politicize the Soviet economy and introduced certain aspects of a market system, including the encouragement of foreign investment and, in July 1987, the legalization of private retailing and service outlets, which effectively broke the state monopoly of ownership. The most important policy reform to be introduced by Gorbachev was the Law on State Enterprises (January 1988) which also became known as 'cost-accounting'. This was a cornerstone of Gorbachev's attempt to introduce a 'third way', which was somewhere between the old centrally planned system and a free market economy, and it devolved increased power to individual business enterprises and placed an increased emphasis on their ability to produce profits. However, this and other measures introduced by Gorbachev failed to fundamentally change the way in which the Soviet economy operated, and the system of state subsidies continued (Aslund, 1995).

In the light of Gorbachev's failed reforms there was a call for the introduction of a more radical approach and, in 1990, Shatalin and Yavlinsky proposed their 500-day program which sought to convert the Russian economy into a fully fledged market system in less than eighteen months (Bowker and Ross, 2000). Although Gorbachev gave his approval to the plan, the combination of growing opposition from the agricultural and defense industries, and the reduction in his personal authority, on the back of his previous failures, meant that the plan was never introduced and, with no viable alternative, the economy in Russia in 1990 began a decline from which it has yet to recover. By 1991, the Soviet State budget deficit had reached critical proportions and, with the economy now in terminal crisis, it was claimed that the Soviet economy, rather than being reformed, had simply collapsed (Rutland, 1996, p.152).

After his rise to power in August 1991, Yeltsin believed that the only viable means of rebuilding the Russian economy was by the introduction of market reforms and installed Yegor Gaidar as acting Prime Minister, handing him the task of introducing systematic economic reform. Gaidar duly launched his 'shock therapy' in January 1992, which involved the liberalization of prices and foreign trade, and the introduction of strict fiscal and monetary policies. A second round of reforms, such as privatization and reforms of commercial and bankruptcy law, was delayed, leading to criticism from many economists and reformists. The policies, introduced by Gaidar, had an immediate effect and, although some were positive, such as an increase in the goods available to the consumer, the vast majority was negative. Inflation soared, investment collapsed, agricultural production fell by more than 50% between 1992-95, while the consumption of goods and services fell by a third during the same timespan (Aslund, 2001). The persistence of high inflation and weak investment resulted in the steady decline of the Russian economy and, in 1998, cuts were made to state spending in an attempt to stabilize the economy. Hardest hit were health, education and defense, and although private industry was affected, it tended to pass on their losses to workers and creditors by refusing to pay wages or debts, with one survey estimating that only 25% of the Russian workforce were receiving their wages in full and on time (Bowker and Ross, 2000).

The failure of successive attempts at economic reform, allied to the effects of the worldwide economic crisis of August 1998, has resulted in the present Russian economy becoming a hybrid system that has evolved into three tiers. The first tier is an economy which appears to act in accordance with market signals, but is, in fact, operating outside of the official financial economy and has forged strong links with organized crime, making it possible to avoid the majority of taxes and state regulations, in what is known as the 'shadow economy'. The second tier is composed of the large businesses that are forced, by their size and market visibility, to act within the official economy. These companies can, however, manipulate the market to their own advantage and use their economic strength to influence the government's economic policy. Finally, there is a third tier of mainly 'old-style' companies who have changed little, if at all, since the Soviet communist days, and maintain the economics of state subsidies and non-payment of wages, taxes and debts (Bowker and Ross, 2000).