Russia "Lost" or "Won"? Instructive Debate in Three Acts

A discussion by three highly recognized figures of the economics and business world sheds light on numerous unresolved issues pertaining to transition. Anders Aslund is a senior associate of the Carnegie Endowment for International Peace and the author of Building Capitalism: The Transformation of the Former Soviet Bloc. Joseph E. Stiglitz is professor of economics and finance at Columbia University, won the 2001 Nobel Prize for economics, had served earlier as the World Bank’s chief economist, and had headed President Clinton’s Council of Economic Advisers. He is also the author of a new book called Globalization and Its Discontents (see Transition, May-June 2002, p. 14). James (Jim) Nail is a partner at the Pharos Financial Group, Moscow, who earlier advised the London-based Soros Fund Management and headed the Research Department at Aton Capital Group in Moscow. The following articles (somewhat shortened and edited by us) were published in the Moscow Times late last year.

Act 1—Anders Aslund: How Russia Was Won

Strangely, in his much-hyped new book Globalization and Its Discontents, Nobel prize-winning economist Joseph Stiglitz has a chapter titled "Who Lost Russia?" Stiglitz’s answer is the IMF and the U.S. Treasury Department, which encouraged Russia to pursue the policies of the "Washington Consensus," which involved price and trade liberalization, financial stabilization, and privatization. His overall judgment is "that Russia’s kind of ersatz capitalism did not provide the incentives for wealth creation and economic growth but rather for asset stripping," a statement that is soundly contradicted by the current reality.

Stiglitz complains that the IMF compelled Russia to undertake excessively radical market reforms, but objective measurements undertaken by the EBRD show that Russia carried out its reforms far more slowly than the early reformers in Central Europe and the Baltic states. The communists and their allies in the Duma impeded reforms. Only after Russia’s reforms had advanced sufficiently far did they breed economic growth, and the August 1998 crisis helped the country cross the critical threshold.

While Stiglitz accuses the IMF of complete failure in the financial crisis, the IMF action appears as a remarkable success in hindsight. Russia’s problem was patently an excessive budget deficit of about 8 percent of GDP. To finance it, the government took too many domestic and foreign credits, which was the main cause of the August financial crash. Stiglitz argues that the exchange rate was grossly overvalued, but in reality, Russia never had a current account deficit. Another alleged problem was tax collection, but the government has persistently collected one-third of GDP in taxes, exactly the same as the U.S. level. Instead, the real budgetary problem was the enormous, corrupt subsidies handed out to enterprises, and the main regulatory problem has been the arbitrary and lawless extraction of taxes.

In summer 1998 Russia had a reformist government under Prime Minister Sergei Kiriyenko. Together with the IMF and the World Bank, his government concluded a radical economic crisis program. The IMF issued a first loan of $4.8 billion, showing that it was serious about helping Russia. Alas, although the country was on the brink of disaster, Parliament refused to adopt the necessary fiscal legislation. The gravediggers consisted of three powerful groups: the oligarchs, the regional governors, and the Communist Party.

As a consequence, the state’s finances had become untenable by August 1998. The IMF and the U.S. Treasury concluded that the political mandate for the necessary fiscal tightening was absent and refused to provide more funds. The government defaulted on its domestic debt and devalued sharply, and society was dealt a tremendous shock. Immediately after the crash the government had little choice but to cut public expenditures—essentially the huge enterprise subsidies—as all sources of financing had dried up. By insisting on payments in real money, the government swiftly reduced barter.

The new Parliament and newly-elected President Vladimir Putin seized on this wave of market economic sentiment, undertaking one fundamental reform after another. They introduced a flat personal income tax of 13 percent and a corporate profit tax of 24 percent; undertook judicial reform; legislated private ownership of land; and adopted new banking laws, a new labor code, and much more. The country has returned two-thirds of the credits it received from the IMF.

Many economists have disputed the importance of speedy privatization, but the Russian economic expansion is driven entirely by private enterprises with concentrated ownership. The emerging conclusion is that how an enterprise is privatized does not matter: no strategic restructuring appears to be possible before its privatization.

Act 2—Joseph Stiglitz: Rewriting History

In his article "How Russia Was Won," Anders Aslund has written another remarkable piece, trying to explain that Russia’s recent "success" is due to its following the advice of the IMF and the U.S. Treasury Department more faithfully, just as its prior poor performance was due to its failure to follow that advice sufficiently faithfully. He argues that the country’s growth since the 1998 financial crisis bears testimony to the fact that he and the IMF are correct, and that the interpretation provided in my recent book Globalization and Its Discontents is wrong.

Russia’s performance since the crisis has been impressive, but its GDP is still almost 30 percent below its level at the beginning of the decade. At 4 percent growth per year, Russia will need another decade to get back to where it was before the beginning of transition. A two-decade transition depression/recession, during which poverty and inequality increased enormously while a few have become extremely wealthy, can hardly be called a victory. And the longer-run prospects are far less rosy than Aslund would suggest. With investment a mere 10 percent of what it was in 1990, even if that investment is better allocated, how can growth be sustained?

In 1998 the IMF did not want Russia to devalue and provided billions of dollars to help it avoid devaluation. The high exchange rate and the high interest rates that were necessary to sustain it in the absence of capital controls strangled the economy. The 1998 bailout did not work; the devaluation did work. Excess supply was enormous, and import substitution started to take place, even in the midst of the turmoil. Imports in the year after the crash were down nearly 50 percent relative to the year before the crash, and while some of this decrease reflected the decline in the overall economy, much of it was due to a switch from buying foreign food, clothes, and other goods to Russian-made ones. Later, of course, higher world oil prices gave further impetus to the economy. The profits generated provided funds for expansion, even when the banking system (which had never done much of what banking systems are supposed to do, that is, provide finance for the creation of new enterprises and the expansion of old ones) was slow to recover. Capital controls were imposed, and instead of looking for the best opportunities for investment in New York, those with money looked for opportunities at home.

Yes, the market economy can provide incentives for wealth creation, but unfortunately, under the preceding years of IMF programs, the market economy with high interest rates, illegitimate privatizations, poor corporate governance, and capital market liberalization had provided incentives for asset stripping. Growth was caused by the change in the economic environment, a change that Russia made for itself over the objections of those like Aslund and the IMF.

Aslund has another interpretation: the crash was a wake-up call. The new reformist Parliament elected in December 1999, in tandem with the reformist administration of President Vladimir Putin that took over in 2000, undertook all the reforms that it should have done, and hey presto, growth took off, just as the reformers had said it would all along.

This interpretation has two problems. The first is that growth began before these reforms were in place. Even with the turmoil of default and devaluation, even with the usual 12- to 18-month lag in the impact of devaluation, Russia was growing by 5.4 percent by the end of 1999. The second is that there can be a long gap between legislation and meaningful reform.

Some of the reforms, like those in taxation, were important mainly because they added to the dynamism already present in the economy. If Aslund’s story made any sense, as the reforms actually get implemented and solidified, growth should be taking off, not declining, especially given the high oil prices. Aslund argues that the form of privatization does not matter and asserts that no strategic restructuring appears possible before an enterprise’s privatization. However, theoretical and empirical research at the World Bank and elsewhere, plus the examples of Poland and other countries that took different approaches, has shown that restructuring is possible before privatization, and that how privatization occurs does make a difference, both in the short and the long run. Privatization without good corporate governance typically does not lead to faster growth. It does, however, lead to a whole host of problems.

In the long run, we should be concerned not just with the pace of economic growth, but with the kind of society that is being created. To Aslund, evidently, the concentration of ownership in Russia is of no concern, so long as it generates growth. But the so-called reformers’ view of economics was so tilted, so ideologically driven, that they even failed in the narrower objective of bringing about economic growth. What they achieved was a remarkable decline. No amount of rewriting history will change this.

Act 3—Jim Nail: Stellar Stiglitz Marred

Stiglitz’s rebuttal is marred by a number of inaccuracies, to put it mildly. Stiglitz claims that Russia’s GDP is currently still 30 percent below its prereform level in 1991. Yet if one thinks about this statistic for even a moment, it must obviously be a distortion. All of us who can remember 1991 in Russia know what a year that was: fuel shortages caused aircraft to be grounded at random airfields throughout the country; there was no food, no shoes, no clothing in the shops, no gasoline at the gas stations, no parts for the few cars on the road. The authorities were warning that they would be unable to heat Moscow during the winter. Sugar was rationed. Lines in front of the stores were many hours long. The West was sending humanitarian aid. Prices in the Soviet Union in 1991 were set by decree rather than by supply and demand. Thus the sum total of all goods and services produced, multiplied by their prices, gave a meaningless statistic, not comparable with today’s GDP.

Similarly, Stiglitz claims that investment today is a mere 10 percent of its 1990 level, arguing that it must therefore be inadequate to sustain growth. First of all, like GDP, the 1990 measurement is based on state-set prices, as well as on wildly unrealistic official exchange rates and other misinformation. As many will recall, the black market exchange rate in 1990 was 10 times the official rate. Second, in 1990 a large percentage of the output of Soviet investment goods was devoted to the military: no less than 80 percent of all machine building throughout the 1980s, according to later studies. Third, in the late Soviet period the country had the equivalent of years of GDP locked up in dolgostroi, that is, essentially permanent unfinished construction projects, some of monstrous proportions. Yet ultimately the Soviet Union collapsed because it was unable to provide real economic growth.

Stiglitz claims that the IMF did not want Russia to devalue in 1998, when in reality it was the Russians who did not want to devalue. The strong ruble was the most visible and popular accomplishment of reform. By 1997 some 80 percent of all imports were consumer goods, of which Russian households were starved. Clearly devaluation would curtail this, expropriating the real purchasing power of household savings. Naturally the Russian political elite wished to avoid this.

Strangely, Stiglitz actually denies that the 1998 collapse was a wake-up call for Russian policymakers. Prior to 1998, the Russian fiscal deficit was regularly 7 to 8 percent of GDP. If that had continued after debt funding disappeared in 1998, it could only have been through the printing presses. Thus, there could have been no recovery, and Russia would have fallen into hyperinflationary chaos once again, as it had earlier in the decade. Thanks to Russian policymakers’ refusal to ratchet up fiscal expenditures to match inflation, the chaos was unable to resume.

Apparently Stiglitz believes that a more cautious approach relying on heavier regulation would have been more effective. As he explains, this would have meant postponing privatization, restructuring enterprises through state intervention, and, above all, a restrictive policy toward capital flows. Although mistakes were clearly made in Russian reform, some of them nearly fatal, this vision was not the answer. Restructuring enterprises through state intervention would have been an incompetent, corrupt, never-ending sham. And as to capital controls, they have existed all along. The real challenge remains, as it has been all along, to motivate investment, not to coerce it. Russia has had its share of the latter already.