Letter to the Editor

The "Checklist" Is Correct
by Stanislav Menshikov

The "Checklist for Action in the Russian Economy" (Transition, September-October 1995, page 10) rightly points to a serious bias in the Russian govern-ment's current economic policies: macroeconomic policies rely too heavily on monetarism. The "Checklist" is correct in suggesting a more "expansionary economic policy" for Russia, one that "is consistent with overall growth." In an economy where half of the available capital and close to a fifth of total labor are not utilized, reliance on fiscal and monetary restriction is tantamount to using a weight-reduction diet to treat a patient suffering from severe malnutrition. What that patient needs is more, not fewer calories, hydrocarbons, proteins, fats, and vitamins. Today's Russia is like that patient: it needs a compassionate doctor, attentive to the needs of the poor, not a rich man's doctor who becomes dictatorial and impatient when treating the poor.

The "Checklist" also rightly indicates that inflation in Russia is of a "different nature" than inflation in Latin America. At present the Russian economy is suffering not from excess demand due to excess money supply but from falling aggregate demand and the inability of most producers to find a sufficient number of domestic consumers who are able to pay. Thus far in 1995 real disposable income has fallen by 10 percent and real wages by 29 percent. Wages are less than half of what they were in 1991. Half of all consumer goods sold in Russia are bought by a well-to-do elite that constitutes only 20 percent of the total population; in contrast, the lower economic brackets account for 40 percent of the population but buy only 16 percent of economic goods. The middle class—usually the principal consumer in any developed market economy—has been effectively wiped out by fiscal and monetary restriction imposed on top of high inflation.

In such an economy stabilization and economic recovery are impossible unless monetary and fiscal restriction is supplemented by active stimulation of aggregate demand. In such an economy inflation is generated mainly by nondemand factors. Wage-pushed inflation might have been the case two years ago, but not now. Between June 1994 and June 1995 average wages rose by a factor of 2.4 while wholesale prices increased by a factor of 3.7. Industrial production fell only slightly during that period (but the level is only half what it was in 1991), meaning that unit labor costs rose much slower than prices.

Either way, inflation is neither demand-pulled nor labor-cost-pushed. And thus, the finance restriction that has led to widespread delays in the payment of wages (and pensions) has had little if any constraining effect on inflation. But it did prevent recovery of industrial production, which in the first half of 1995 fell by 5 percent compared with the same period in 1994, and was 4.4 percent lower than in the second half of the year.

Nor did fiscal and monetary restraint help curb inflation; average monthly wholesale price increases reached 13.6 percent for the first half of 1995, up from 11.6 percent for the same period in 1994, and from 9.6 percent, measured for the second half of 1994. The boast of having brought consumer price inflation down to 4.6 percent this August from 18 percent in January impresses only those whose memory is failing; in January 1994 inflation rose to 17.9 percent and fell to 4.6 percent in August 1994—in other words, the 1995 reduction is almost identical to the pattern established the year before.

The principal source of inflation in Russia today is the upsurge in energy and raw materials prices. This is the result of the monopolistic or oligopolistic position of these industries, which are able to export a large part of their output while limiting supply to domestic customers. Via cost-push this inflation has been transmitted to final products due to the numerous barriers to competition that organized crime has erected to restrict the free entry into markets of both consumer and producer goods.

Privatization, which could have promoted competition, was implemented in a way that led to criminalization of the economy and therefore to its further monopolization. Restraints to competition have become a continuous rather than one-time factor in diffusing inflation. The actual degree of monopolization is much higher than suggested by traditionally used indicators.

So I agree with the "Checklist" when it calls for significant changes in Russian economic policy, suggesting, among other things, stimulation of aggregate demand and supply-side measures. Of course, the list is hardly a concrete agenda for action since it was meant to outline a general approach rather than a detailed action plan.

Messrs. Tulin and Nellis do not state point-blank that expansionary economic policies are out of order. If they believe, as I do, that such policies are not incompatible with fiscal and monetary discipline, then why not give that advice to the Russian authorities? This would certainly help change the lopsided monetarist mentality prevailing in the Moscow ministries. If not, chances are that a new, left-centrist government would turn the tables completely against both monetarism and the Fund.

Stanislav Menshikov is a Russian economist and currently a visiting professor at the Erasmus University, Rotterdam, Netherlands.

Helpful Data Utilized under Doubtful Methodology

In his recent publication ("Electricity Consumption and Output Decline—An Update," Transition, vol. 6, no. 9-10, pp. 19-20), Istvan Dobozi presents some additional data on changes in electricity consumption as they compare with official data on GDP decline in some Central and East European countries during 1990-94. Mr. Dobozi further develops arguments he published earlier in collaboration with Gerhard Pohl (Transition, vol. 6, no. 1-2, p. 17) to prove that electricity consumption is a suitable proxy for real output trends in the region. Based on his findings, Mr. Dobozi asserts in particular that the current level of decline in output in the former Soviet Union is, on average, underestimated to a greater degree than is the decline in CEE countries.

Today, everybody would probably agree that all official data on decline in output in the FSU are greatly overestimated. There is some consensus that the cumulative fall in output over the past four years has been about one-third of 1990 GDP—not half, as claimed in government statistics. However, it does not mean that the real level of economic activity can be calculated using the available data on electricity consumption. As Vincent Koen mentioned in his comments (Transition, vol. 6, no. 4), the dynamics of electricity consumption is not a more reliable summary economic indicator than official real GDP measures.

The data presented by Mr. Dobozi should be interpreted without over generalization. It is true that for three countries in the region—Bulgaria, Hungary, and Poland—the cumulative change in electricity consumption appears to be close to the cumulative change in GDP. But these observations are an insufficient basis for claiming there is a universal relationship between these two indicators for transition economies. In particular, electricity consumption data are inadequate to confirm a hypothesis on unitary elasticity of decline in output.

Given the wide variety in both economic conditions and economic policies across the transition economies, one might expect, contrary to what Mr. Dobozi suggests, that the countries in the region would show substantial variation in the dynamics of their energy consumption. The methodology proposed by Dobozi-Pohl ignores the crucial policy factors that influence energy consumption, such as the level of domestic energy prices, the progress of enterprise reform, the hardness of budget constraints, and the speed of structural adjustment in both output structure and energy consumption mix. It also ignores the fundamental cross-country differences in energy self-sufficiency: other factors being equal, one might expect that the relationship between output decline and energy consumption would be different in energy-rich countries (Kazakhstan, Russia) than in some Eastern European states that are heavily dependent on energy imports and consider the imposition of energy-saving policies a priority for strengthening national independence and security.

On the whole, that a wider gap was reported between the former Soviet Union's drop in electricity consumption and its decline in GDP, compared with some other countries in the region, does not necessarily indicate a higher degree of underreporting of economic activity. The level of underreported output in Russia, according to some estimates, is comparable to that in Bulgaria and Romania.

What makes the former Soviet republics different is their better access to energy resources and, probably related to that, the generally slower rate of economic reforms in the FSU—the FSU countries have experienced a much slower increase in relative energy prices, enormous subsidization of personal consumption in the housing sector, and a much less aggressive path toward enterprise reform. Russia, which dominates the regional energy markets, until recently has provided its neighbors with underpriced energy (compared with export prices to the rest of the world). Open borders within the FSU have helped consumers in other former republics to get fuel at low Russian domestic prices via smuggling. Under such circumstances, not surprisingly, incentives for saving energy appeared to be weak in the former Soviet Union. Thus, the degree of underestimation of economic activity in the FSU seems to be less than a direct comparison of electricity consumption data with official GDP numbers would suggest.

Analysis of output contraction during the transition is still an important problem for most countries in the region. However, it seems doubtful that a better understanding of this phenomenon can be reached using simplistic and primarily technical approaches.

Lev Freinkman
Consultant
Russia Country Operations
World Bank