Privatization of Russian Economy: What Went Wrong?

Emergence of Russian economy after the collapse of Soviet Union and how the Chicago school economists ruined the Russian economy by promoting the ideas of free market economy is quite popular amongst the people who neither understand market economy nor Soviet planned economy. I’ll try to summarize the key factors associated with this transition and how the entire process was destined to fail from the very beginning. To understand the events which happened from 1992 onwards requires a background knowledge of Soviet economy in 80s and the impact of Perestroika on Soviet economy. In 80s, Soviet economy was primarily sustaining itself on the basis of hydrocarbon export. Soviet economy was utterly unproductive, highly energy intensive and devoid of innovation except in military industrial sector. The inefficiency was concealed by the careful manipulation of prices which were deliberately kept low to show the higher efficiency on paper.

Soviet economy was unlike any economy which we know today. All the economic decisions were made by the central planning committe manned by Communist party officials. What had to be produced, how much had to be produced, where it had to be produced, where it had to be sold, wages of the workers, prices of the commodity and everything else related to economy were controlled from the top. Factories were run by the enterprise managers who were appointed by the government who operated without any economic constraint. When Gorbachev came into the power, the oil prices collapsed by 70% in the international markets in 1986 and he was left with no choice but to bring systemic reforms in Soviet economy. He brought two key reforms under the economic aspect of Perestroika – Laws on State Enterprises (LSE) and Laws on Corporations (LC). Under the first, enterprise managers were supposed to be appointed and controlled by the local Communist party officials and the control of central ministeries on factories was reduced. Under LC, three or more individuals could now form a cooperative and start their own business where government won’t intervene.

In any closed political system, bringing such reforms produce negative results. As soon as enterprise managers realized that they had more power, they used it to meet their own objectives. They increased the wages without increasing productivity. They withheld the payment of taxes and willfully colluded with local party officials to have absolute control on the affairs of their factories. One has to be mindful of the fact that enterprise managers were nothing but Communist party officials. However, what hurt the Soviet economy most was enterprise managers started transferring the assets of state owned factories to the cooperatives which they formed with the support of Communist party officials. This was a crucial factor in the debacle what Russia witnessed later. So, as a result of Gorbachev’s policies, the taxation revenue decreased, cost of running factories went up and state assets were appropriated. By the time Soviet Union collapsed, Soviet economy was suffering from substantial international debt, high inflation as a result of printing currency and recession due to the slump in output of the economy. This is the kind of economy which Boris Yeltsin inherited.

Boris Yeltsin focused on three domains to revive the Russian economy: 1. Fixing the macroeconomic fundamentals by tightly controlling the supply of currency and reduction in budgetary deficit by reducing expenditure 2. Removing the price controls in economy by letting market dynamics determine the prices 3. Privatizing the state owned companies which were extremely inefficient and unproductive. Let’s look into how Russia did in each domain. In 1992, Russia reduced its military expenditure by 80% and cut the government subsidies to the state enterprises substantially. It also resisted the pressure to increase the money supply. However, as these companies had survived only on the basis of government support and their products couldn’t compete with others in market, volume of production went down and unemployment increased. Yeltsin couldn’t continue with this policy and had to start subsidies and state support to companies again.

In the domain of price control, as Soviet economy was always a shortage economy, it was again the similar situation but with a major difference. Prices could increase based on the demand unlike the previous regime when price was fixed. Inflation increased substantially in 1992 but it gradually decreased as the supply of consumer goods increased. It was an area where Yeltsin did relatively well. The most controversial one was privatization. There were two suggested approach: gradual reform and rapid privatization. Gradual reform meant further expenditure on state support for government owned companies but Russian government did not have money left to undertake such measures. It went for the rapid privatization path. As I explained earlier, under Communist rule, the only powerful group of people were the ones who were connected with the Communist Party. This was also true when Russia was in its nascent stage. So, the only group of people who benefitted from the privatization drive were the ones having access to state machinary.

Yeltsin adopted two approach for this purpose – giving the enterprise managers and employees option to own shares in the new companies and gifting vouchers to citizens so that they could have their own share too. In reality, the first group was too powerful to let the second group have any share and the whole process was political. This process was further worsened when Yelstin realized that he might lose to Communist Party candidate in 1996 election. To finance his election expenditure, he took money from the new business magnets which he had created and in the return, he transferred the ownership of key oil and metal industries to these group of people. Russia’s then largest private oil firm Yukos was a product of such fraud. This move was the final nail in the coffin of privatization of Russian economy. So, if there are factors which are actually responsible for this entire mess then those ones include the first and foremost Communists who created such economic system, Communist party officials who appropriated the state wealth for their personal fortunes and Boris Yeltsin’s desire to hold power at any cost.

Published by Satish Verma

Read. Contemplate. Write.

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