Russian Economic Reform

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1992 Article: “Russian Reformers and the IMF Get It Wrong.”

I first visited Russia in October 1991, after also visiting Hungary, Poland and Czechoslovakia. I again visited Poland and Russia in April/May 1992, and wrote the text below. In 1992 I met with Richard Layard, the British economist, who was then an adviser to the Russian Government. He told me how he and a fellow economist (who was Polish) boarded a Moscow-based plane in London with the idea that reform needed to be carried out gradually and with care. However, by the time they arrived in Moscow they had decided that it would be best to implement reform as quickly as possible, including the use of “shock therapy”. Layard told me that they thought there was a “less than 50% chance of this working, but it was worth a try”. Such—“worth a try”—was the low standard of economic advice being offered to Russia at that time.

Text of my May 1992 article:

“The economy of the Russian Federation will almost certainly deteriorate over 1992 and 1993. In particular, industrial production is likely to decline significantly in the state enterprise sector and both unemployment and underemployment will rise. Given the breakdown of much of the system of relationships that made the centrally planned economy, there is probably little that can be done to prevent this fall.

What economic policy makers can do, however, is influence the extent of the fall. Unfortunately, the Government’s pronounced economic policies (as outlined in the ‘Memorandum on the Economic Policy of the Russian Federation’ which was agreed with the IMF in March) are likely to exacerbate the difficulties. If implemented, they may even carry some risk of pushing the economy into an abyss.

The essential flaw in the stated economic policy is that it is one that is designed to appeal to the West in the pursuit of international financial help. Moreover, this appeal to the West is really to that side of Western opinion that believes that markets can solve all problems if only governments would get out of the way. Thankfully, for the West at least, not all Western opinion makers and governments have such an extreme view, let alone act on it.

The Russian Government’s program would be tough and ambitious even by Western standards. In particular, a program of the Government’s type might impede structural reform in a Western country by putting too much emphasis on fighting inflation and not enough on keeping the level of demand and production high enough to ensure that both existing and new enterprises have an incentive and an ability to invest to produce market goods and services.

This is precisely what happened in New Zealand in the late 1980s and the early 1990s. In the early 1980s New Zealand had a reputation as one of the most government controlled economies in the OECD. A comprehensive and effective program of privatization and micro-economic reform (eg by reduction of subsidies) was undertaken and there has been little criticism of this. Unfortunately the heavy emphasis on fighting inflation (which included the use of a very tight monetary policy) led production to stagnate and the level of employment in 1992 to be lower than in 1986.

Yet, for all of its government controls in the early 1980s, New Zealand was a long way from being a Russia. It already had a very large and experienced market sector. But even here, the lessons were clear. Structural reform takes a lot of time and effort and the macro-economic policies must be appropriate.

Closer to home, for Russia, is Poland. After much bravado about the success of its economic policies in 1990, the Polish economy has deteriorated significantly.

A number of experts on the Polish economy now point to three main lessons that should be learnt from the Polish experience. Firstly, too much emphasis should not be placed on reducing inflation and achieving currency convertibility. (The inflation issue lesson is the same as for New Zealand.) Secondly, a very great degree of focus needs to be given to basic issues such as the taxation system, banking system, legal system etc. which allow market economies to function effectively. Thirdly, there needs to be greater recognition that privatization is necessarily a slow and complex process.

If the Government’s ‘Memorandum on the Economic Policy of the Russian Federation’ is to be taken literally, Russia is to repeat many of the Polish (and New Zealand) mistakes.

Firstly, the ‘Memorandum’ says that it is intended to reduce the average monthly level of inflation to between 1% and 3 % in the last quarter of 1992. This is a fairly low and precise target and might be possible given the reversal of excessive price rises in the first part of 1992.

Evaluating the stance of monetary policy is difficult in any country. Monetary policy was not tight enough in 1991 and this is one of the factors contributing to very high inflation. However, there has been a significant risk that the tighter monetary policies in early 1992 in the pursuit of very low inflation would combine with attempts to tighten fiscal policy to crush the economy. This would impede the process of reform and recovery. Not only do existing enterprises need bank credits to restructure, and new enterprises need credits to begin, but budget deficit reduction inspired large decreases in government expenditure may launch a vicious circle of lower expenditure, weaker economic activity, lower tax revenue, increased budget deficit, lower expenditure etc.

There are some signs, however, that the ‘Memorandum’ will not be taken literally in this area. After a very tight monetary stance in the first two months of 1992, there has been as easing of monetary policy and an increase in central bank credits to commercial banks (and thus industry and agriculture). While this has probably increased the risks of higher inflation, it was probably necessary to avoid an almost complete industrial collapse in late 1992.

Secondly, while the ‘Memorandum’ discusses structural changes there is too little emphasis on the need for rapid and vital reforms in the accounting, banking and legal spheres, including anti-monopoly legislation. It is almost as if this very important component of an effective market economic system will rise by itself.

This criticism also applies to an aspect of macroeconomic policy. It would be acceptable to all but the most ideological anti-government Westerners that a larger than suggested Budget deficit (in the memorandum it is suggested that the deficit should be 1% of GDP in the first quarter of 1992, down from over 20% in 1991) would be acceptable if it could be financed by selling ruble denominated government securities into the domestic market. Even recognizing the difficulties, an insufficient amount of attention is being given to developing a market for such securities.

Thirdly, the mooted rapid pace of privatization in the ‘Memorandum’ is unachievable and dangerous. According to the memorandum, the ‘programme for 1992 envisages the privatization of 50 % of enterprises (organizations) in the building materials industry, wholesale trade and public catering, of 60 % of enterprises in the food industry, agriculture and retail trade, as well as 70% of enterprises in the light industry, construction, automobile transport and repair.

The pace of privatization is unachievable because of the lack of an existing market and institutional framework to support it. This pace is dangerous because of the massively disruptive effect that ownership changes and reorganization will have on the already mangled process of production in medium and large enterprises. Small enterprises and some service sectors, of course, may be privatized rapidly with less disruption. The other danger with rapid privatization of larger enterprises is that its lack of control may deliver many state assets into the hands of only a few groups who will then exercise monopoly powers and control over the economy. This appears to be a particular danger in Russia.

Having made these points, it should be emphasized that the Russian Government should not change its basics policy direction.

Rather than changing the direction of reform, the Government should slow the overall pace of policy change and re-orientate towards the building of mechanisms and institutions that will allow a market economy to function. This would reflect a recognition that one economic system (irrespective of how badly it is functioning) cannot be replaced by another “overnight”. In practical terms, this means that the Government would need to continue to play a significant role in determining both production and prices in parts of the economy. Some State plans would still be needed not only to ensure the continued production of many useful goods and services, but to ensure that as massive defense production is wound down the freed resources (both man and material) are put to some productive use. The market itself, will not be able to handle this huge task.

Finally, it is worth putting the view that Russia needs to find its own way of reforming. It may be that countries such as Hungary or those of East Asia provide more appropriate examples of what to do than the very “free-market” approach. It is more likely, however, that they will only provide bits and pieces. A very thoughtful and pragmatic approach is needed, for the risk remains that economic reform policies orientated excessively toward acquiring international financial help may end up doing more harm than good.

Past Articles on the work of each of the 21 Expert Groups can be accessed here:

Moscow as an International Financial Center (IFC)

This article initially appeared in the December 2014 issue of “Baltic Rim Economies” published by Pan-European Institute.

In 2010 the Russian government launched the Moscow International Financial Centre (MIFC) project and sought international assistance, including from TheCityUK (the self-described “representative voice of Financial Services in the UK”). A Memorandum of Understanding between the MIFC Taskforce, TheCityUK and Vnesheconombank was signed in Moscow in 2011 in the presence of President Dmitri Medvedev and Prime Minister David Cameron.

Subsequently a number of reports were produced, mainly by TheCityUK and the IBRD.

Right from the beginning there were fundamental delusions. An early 2011 survey of “260 participants from leading Russian and foreign entities active in the Russian financial market” reported such views as Moscow as a “regional financial centre for CIS”, and “Moscow is where East meets West. It is a blend of different cultures and nationalities. It will be easy for everyone to come to do business”.

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Published on December 25 2014

Ukraine’s Poroshenko is going to Australia: WHY?

Ukraine President Petro Poroshenko will speak in Sydney on 12 December at a Lowy Institute function:

http://www.lowyinstitute.org/events/event-address-his-excellency-mr-petro-poroshenko-president-ukraine

Why is he doing this?  And why it is a bad idea!

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Published on December 09 2014

What do Chinese trade/investment people think about Russia (and vice-versa)?

During the first few weeks of November, I conducted two surveys regarding the attitudes of Chinese and Russians to closer economic and financial relations between their two countries. The surveys were conducted in Shanghai and Moscow, and showed an overwhelming desire — over 90% of respondents in both cases – for closer relations between China and Russia.

The Moscow and Shanghai responses to other questions in the surveys showed more divergence, and in particular seemed to point to the effect of the events in the Ukraine and of US led sanctions on Moscow attitudes.

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Published on November 25 2014

Moscow, London and Shanghai “money” !

In the first week of November I conducted an emailed survey of Russian (mainly Moscow) “educated middle class” attitudes to (mainly) financial issues in Russia and attitudes to Russia’s financial relations with China, the US, Europe, and the UK. Most of the over 1,000 people to whom I sent the survey were my LinkedIn “connections”. (I cast the net quite wide even though I suspected that many of my “connections” would have little interest in such financial matters.)

I wanted to get “financial expert” Russian feedback so, for the purposes of this article,  I subsequently pruned the data to remove all non-Russian respondents and also remove any who did not indicate that “about 50% or more” of their work time involved “thinking about financial issues”.

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Published on November 09 2014

Russia and China: what sort of “relationship”?

In June I spent some time in Moscow talking to Russian banks about financial developments in China,  where I am conducting research on “Opportunities and challenges in developing an international financial centre (IFC): Learnings relevant to Shanghai” for the Shanghai Institute of International Financial Centre (SIIFC), Shanghai University of Finance and Economics.

I decided to go to Moscow for several reasons.

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Published on September 06 2014

Effect of languages (Russian, English, Chinese) on economic and political power

The Russian Liberal Democrat party is reportedly seeking legislation to stop the “conquering march” of foreign words into the Russian language. It wants to punish those responsible for any violation of the norms of the contemporary Russian language”.

But it might be that the Russian language — and economy — needs some help from the Chinese language!

On my first trip to Russia many years ago I realized that I would need to learn Russian if I wanted to seriously understand the Russian economy and its politics. I put more emphasis on learning to read Russian than to speak it.

The Chinese language, however, is a different matter! Learning to read Chinese is extremely difficult and time consuming. Thus, I have concentrated on learning to speak Chinese rather than read. Fortunately, Chinese spoken grammar is simpler than either English or Russian grammar.

For example, the simple Chinese expression “wǒ” (written 我 ) is equivalent to “I” and “me” in English, and equivalent to each of “Я”, “меня”, “мне” and “мной” in Russian.

In reality, except for the rules of grammar, the English “I” and “me” are completely interchangeable – ie they mean exactly the same thing. The Russian case system means that “Я”, “меня”, “мне” and “мной” do often convey different meanings, but in my view Russian could be somewhat simplified (particularly in the presence of prepositions). For example, instead of “У меня” could have “У Я” !!!

What are the consequences (economic and political) of language differences?

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Published on February 21 2013

Russian “middle class” psychology

David Brooks (“The New York Times”) and Gillian Tett (“Financial Times”) have each produced a useful article on the relationship of individual psychology (or personality) to the wider world of government policy – although the articles do it by heading in different directions from essentially the same starting point. The Brooks article suggests that not enough attention is presently paid to the effect of individual psychology (personality) on leadership decisions – and thus on personality when choosing leaders. The Tett article, largely based on the work of Prof. Dennis Smith (a “historical sociologist”), relates individual psychology (personality) concepts to the whole populations of countries. Taken together, the articles act almost like a circle with the two directions eventually meeting each other and encompassing a lot of wisdom that is all too often overlooked when considering issues of public policy.

The motivation for the Brooks article seems to have been the US presidential election, while the motivation for the Tett article is the Euro-crisis and the effect of subsequent policies on the populations of countries such as Greece.

To some degree, the concepts covered in the Brooks and Tett articles might also be applied at the intra-country group level.

For example, the humiliation that Putin and Co. are willingly to attempt to inflict on the aspiring Russian “middle class” (for want of a better word) may result in some of the responses mentioned by Tett:
“Typically, it occurs in three steps: first there is a loss of autonomy, or control; then there is a demotion of status; and last, a partial or complete exclusion from the group. This three-step process usually triggers short-term coping mechanisms, such as flight, rebellion or disassociation. There are longer-term responses also, most notably “acceptance” – via “escape” or “conciliation”, to use the jargon – or “challenge” – via “revenge” and “resistance”. Or, more usually, individuals react with a blend of those responses.”

But Tett also wrote that Prof. Smith believes that “Ireland already has extensive cultural coping mechanisms to deal with humiliation, having lived with British dominance in decades past. This underdog habit was briefly interrupted by the credit boom, but too briefly to let the Irish forget those habits. Thus they have responded to the latest humiliation with escape (ie emigration), pragmatic conciliation (reform) and defiant compliance (laced with humour).”

Thus, the responses of the “national psychologies” of Ireland and Greece to their “humiliation” resulting from the Euro-crisis may exhibit significant differences.

The Russian “middle class” is certainly using Irish-style escape, pragmatic conciliation and defiant compliance to cope with its humiliation—- but in the longer term the coping mechanism could become more “pathological”. If this were to happen, I suspect Putin’s response would largely be determined by his personality.

Read more at: http://www.jeffschubert.com/index.php?id=115

Published on October 22 2012

Russian pension reform – a long road!
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I have up until now avoided writing much about Russian pension reform (mainly because of the very long-term nature of the calculations, which means that it is generally not a very exciting issue as well as having a high degree of uncertainty), but both recent events in Russia and a useful recent IMF Working Paper entitled “Reforming the Public Pension System in the Russian Federation” mean that it is time to tackle the issue in more depth – at least in terms of giving an overview of the situation.

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Published on October 08 2012

Sechin, BP and Rosneftegas
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At this time Igor Sechin seems to be facing defeat in his attempts to increase the influence of Rosneftegas (and himself) in the privatization of government owned assets in Russia’s fuel and energy sector. Prime Minister Medvedev (and his economic ministers) are demanding that Rosneftegas hand over most of its accumulated cash to the official budget in order to help pay for President Putin’s pre-election expenditure promises.

This has further stimulated Sechin to seek to develop a relationship between Rosneft and BP.

Are these developments good or bad for “Russian economic reform”?

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Published on September 24 2012

APEC, Russia and Australia
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Both Russia and Australia are experiencing some sort of increase in official interest in Asia. There is nothing cultural in this, as Russians would in their hearts prefer to look toward Europe and Australians would prefer to look toward the US and UK.

Despite the fact that in many ways Russia is geographically better placed to take advantage of the economic growth of China, Australia is likely to continue to outperform Russia in taking advantage of the economic rise of Asia. But with one proviso – which I will address later!

In Russia, the most obvious manifestation of the interest is the huge spending (and often stupidly excessively, a la bridge to Russky Island) on the APEC Summit in Vladivostok and recent creation of a “Far East” Ministry.

In Australia, the most obvious manifestation of the interest is an “Australia in the Asian Century” report being prepared by a team led by former head of the Australian Treasury, Dr. Ken Henry. See: http://asiancentury.dpmc.gov.au/about

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Published on September 09 2012