The Russian economy has also changed. It is transforming itself from a centrally managed to a market economy—but a very peculiar market economy. The economic stagnation that began a quarter of a century ago has become a steep production decline. Inequality has also increased, and mass poverty has become a fact of life. Russia’s economic decline is unprecedented in recent economic history. Most surprising, the decline has taken place in a country well-endowed with natural resources, a relatively well-educated labor force, and rich industrial and technological traditions. For Russia the abnormal seems to be entirely normal. The question to ask is what surprises does the future also have in store?

A Coming Boom?

Whatever happened to "the coming Russian boom," the one prophesied by Layard and Parker just a couple years ago? Russia’s initial conditions were always understood as worse than those in Central Europe: its distance from a market economy was greater, its socialist period lasted longer, its structural deformations (such as the share of military and civilian heavy industries) were greater, its socialist economic reforms were negligible, its economy and society were more closed, and the share of the private sector in its economy was almost nil. Russia also lacked such forces of civil society as the Catholic Church (as in Poland) or an independent intelligentsia (as in Hungary). The introduction of transport costs, absent under Soviet planning, induced great relative price shifts in the geographically enormous Russia. The dissolution of the Soviet system exposed the absence of several critical institutions in Russia.

But how positive are these factors? The relative ease with which Russia has received foreign assistance—witness the repeated easing of IMF conditionality—may well have been a burden in disguise, as Russia has been able to substitute assistance for reforms. As for natural resource endowments, while it is true that Russia gained handsomely as a higher share of energy exports have been priced at world market levels, this windfall may have contributed to the further concentration of Russian exports on basic commodities. Experience also advises caution: worldwide it is clear that bountiful natural resources are more often a handicap than a source for growth and prosperity.

In assessing the potential of the Russian economy, four specific features of the economy demand special attention: duality, distribution of property rights, nonmonetary aspects, and regional influences.

Dual Economy

Russia has the markings of a dual economy. It has a dynamic export sector consisting of oil, gas, raw materials, and some basic processed goods like chemicals. And while these exports generate about one-fourth of Russian GDP (this is no longer a closed economy), they provide only a small number of jobs. Most jobs are in the domestic branches of the economy. So, while many raw and basic processed materials are exported, Russian industry and services mainly produce goods that are competitive only in home markets—resulting in undervaluation of the ruble and low real wages.

A dual economy is sustainable and may generate growth—particularly when commodity prices are high. That fact has been demonstrated by many commodity producers in developing countries. But a dual economy also provides little welfare for most of the population and tends to generate wide income differentials. A dual economy, therefore, has an authoritarian tendency.

Although Russian officials talk about maintaining and developing the technological basis of the economy, recent Russian policies have contributed to the creation of this dual economy. If this trend continues, Russia can remain Europe-oriented in her foreign economic policies, but it will be a one-sided integration with the world markets, because domestic jobs need protection. Domestically, a crucial question would be the willingness and ability of the central authorities to tax some of the revenue received by the exporters to use for infrastructure maintenance and redistribution. This tax revenue would also need to be shared across regions, whose exports earning potential is very unevenly distributed.

Property Rights

Russia’s distribution of property rights is unique. As a consequence of the mass privatization path chosen, company insiders own most Russian industry, agriculture, and services. Employees are quite often majority owners, but managers are always the active owners. The position of insiders was strengthened by the 1998 crisis, as their potential challengers—domestic and foreign outside investors—lost the ability or appetite to invest in Russian firms. Because there is no previous experience with property rights, any speculation on their economic impact must be tentative. But theoretically and in recent practice such inside owners:

Nonmonetary Exchange System

Russia may be a market economy but it is not really a monetary economy. Ordinary market economies and transition economies usually have a M2 (the wide money stock, consisting of cash and deposits) to GDP ratio of 60 percent or higher, depending on characteristics of the financial system. In Russia the ratio of ruble M2 to GDP was never close to 20 percent and is now below 10 percent. In addition to rubles, Russians hold and an unknown but presumably large amount of dollars abroad, as a store of value. Also, a variety of quasi-monies—usually IOUs issued by the authorities, banks, and companies—are used. Finally, about half the industrial production is based on barter.

While the ingenuity of complicated multilateral barter arrangements is admirable, a nonmonetary exchange-based economy has several handicaps:

Regional Decisionmaking

Russia, once a unitary state, is undergoing long overdue regionalization, but with little design and consistency. Russia’s regions, with an average population of 1.9 million, are too small to become true economic agents on their own. A single large industrial enterprise is usually depended on for jobs, social services, and tax income and is often a hotbed of cronyism, insider deals, and corruption. In principle, regional decisionmaking is close to the population and easier to monitor than central decisionmaking. In practice, however, regional economic policies are often worse than those that the center wants to pursue. But there is also a silver lining: some good practices have spread from one region to another—a solid argument for the competition of foreign and domestic investment.

Can Something Be Done?

Russian authorities should adopt three priorities. First, Russia should recognize that as a European economy it is medium-size at most, with a $370 billion GDP in 1998—about 2.5 times that of Finland—and a weight in the world economy that is smaller than, for instance, Sweden’s. All official expenditure commitments should be reassessed with this in mind, and only commitments that can be financed from available resources should be maintained.

Second, Russian authorities should also work to abolish the nonmonetary economy by declining to accept anything but money as tax revenue.

Third, the authorities should help new private economic activities. Public sector barriers—licensing, taxation, inspections, and legislation and its implementation—must change if Russia is ever to become a wealthy and stable society. But reaching that goal demands that the country be rebuilt: state, institutions, the economy, capital stock, infrastructure, the civil society, and the values of the people—almost everything.