How Russia Was Won

Publication date
Tuesday, 03.12.2002

Anders Aslund

Moscow Times, November 21, 2002


Four years ago, Russia was riveted by a horrendous financial crash. Today
that is difficult to believe. The standard judgment now is that this was
precisely the wake-up call that the country needed.

Russia is not only a very stable economy but also a remarkably dynamic one.
After three years of average economic growth of 6.5 percent per year, the
worry is that economic growth will stop at 4 percent this year. The budget
is in surplus; trade and current account surpluses are huge, and the
government's external debt has fallen below 40 percent of GDP. Seldom has a
crisis been resolved more successfully.

Strangely, in his much-hyped new book, "Globalization and Its Discontents,"
the Nobel prize-winning economist Joseph Stiglitz has a chapter titled "Who
Lost Russia?" Stiglitz's answer is the International Monetary Fund and the
U.S. Treasury Department, which encouraged Russia to pursue the policies of
the "Washington consensus," involving 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
European Bank for Reconstruction and Development show that Russia carried
out its reforms far slower than the early reformers in Central Europe and
the Baltics. Reforms were impeded by the Communists and their allies in the
State Duma. 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 a remarkable success in hindsight. Russia's problem
patently was 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 fact
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 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 the summer of 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, the
parliament refused to adopt the necessary fiscal legislation.

The gravediggers consisted of three powerful groups: the "oligarchs,"
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. At first, it appeared as if market
reforms were over, as several Communists entered the government -- but soon
the tables were turned.

The oligarchs lost both money and reputation, and have since been distanced
from central power. The regional governors, who were rightly perceived as
the kingpins of corruption, have since lost half their financial resources
to the federal government. The Communist Party felt the political wind
before the December 1999 parliamentary elections and adopted a market
economic program, but even so it lost badly in the elections. For the first
time, the parliament emerged with a solid reformist majority, which has
driven reform ever since.

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. Surprise, surprise, it turned out that capitalism worked in
Russia as well.

Today, it is all too evident. The financial crash of 1998 taught Russia the
necessary lesson. It demonstrated how socially costly it is to abandon the
narrow path of good economic policy, and a broad market economic consensus
has penetrated the Russian mind.

In effect, the Kiriyenko-IMF program of July 1998 has been implemented ever
since, and the results are impressive by any standard, showing that a
market economy can work wonders in Russia as well. 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 entirely driven by private enterprises
with concentrated ownership.

The original form of privatization, which is Stiglitz's main preoccupation,
appears ever less significant, as many corporations have changed hands many
times (because private property can be transferred through sales or
bankruptcy). The emerging conclusion is, on the contrary, that it does not
matter how an enterprise is privatized -- no strategic restructuring
appears possible before its privatization.



Anders Aslund,
A senior associate of the Carnegie Endowment for International Peace,
Author of "Building Capitalism: The Transformation of the Former Soviet Bloc"

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