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:

Russian pension reform – a long road!

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

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

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:

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Published on September 09 2012

It’s time to sack Andrei Belyaninov!

At a forum last week, Prime Minister Medvedev was questioned by a German businessman about Russia’s notoriously bad customs procedures.

Medvedev replied:

«Когда я разговариваю с руководителем нашей таможенной службы [Андреем Бельяниновым], он мне задает вопрос, на который не так просто отвечать, он говорит: вы сами определитесь, чего вы от нас хотите, чтобы мы просто контролировали порядок ввоза и вывоза товаров, чтобы законы соблюдались — это одна цель, или вы хотите, чтобы мы зарабатывали для государства большие деньги — это другая цель, и мы [сейчас] этим занимаемся».

“When I talk with the head of our Customs Service (Andrei Belyaninov), he asks me a question that is not so easy to answer when he says: you decide what you want from us; that we just control the order of entry and export of goods so that the laws are respected – this is one aim; or do you want us to earn big money for the state – this is another aim, and we are (now) doing that.”

Medvedev went on to say Russia needs to get the “proportions” right between “opening the road for business” and raising revenue. While too much can be read into Medvedev’s choice of words, I am tempted to ask whether the choice being offered by Belyaninov is really between enforcing the law or acting as a “by any means” revenue raiser for whoever can get their hands on it!

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Published on July 15 2012

Serdyukov and Medvedev — normal?

Russian language “Vedomosti” carried an article, “Пострадал за городки”, last week which was quite informative in a banal sort of way.

The article covered internal Medvedev-headed cabinet discussions on 26 June about transferring unused military property – social infrastructure and housing – to local government and regional authorities. This infrastructure is generally not in good-shape and the meeting discussed the transfer of money to local and regional authorities for its maintenance. Medvedev has earlier directed that a methodology for the calculation of these subsidies be prepared by 15 June.

«Есть методика?» Medvedev asks if there a methodology, but is told by Vice-Premier Dmitry Kosak that there are only some proposals from the Ministry of Finance that have not been agreed with others.

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Published on July 01 2012

Perverted “Strategic” Privatization!


According to press reports last week, the Medvedev government will this week try to firm up various aspects of planned privatizations in the period to 2017. At this stage, the privatization plan is basically the same as was approved by then president Medvedev in August last year – with the exception of companies in the “fuel and energy” sector.

(For more background, see my 18 July 2011 article entitled “Medvedev should ease up on ‘privatization’!” and my 31 July 2011 article entitled “Privatization – ‘what to’ and ‘how to’!” by clicking on “Expert Group 15: Managing government property and privatization” in the right-hand column.)

It appears that the great majority of state assets in the “fuel and energy” sector (with the exception of Gasprom) are going to be consolidated under the control of 100% owned Rosneftgas, whose chairman of the board is likely to be Igor Sechin.

Rosneftgas already owns about 77% of Rosneft, whose CEO is also Sechin, and about 11% of Gasprom. Rosneftgas will now also take equity positions in a number of other large “fuel and energy” sector companies which are fully or partly owned by the state.

According to Elvira Nabiullina, assistant to President Putin (and former Minister of Economic Developmemt), the idea is that Rosneftgas will be an “investor at the stage of pre-sale development”. That is, Rosneftgas will inject capital into these companies and prepare them for privatization when market conditions are better and/or when the companies themselves are in a better financial condition.

These companies will issue additional shares (so boosting their own capital) to Rosneftgas which will finance their purchase with its present cash holdings and dividend flow (from its shares in Rosneft and Gasprom). As well, it has the capacity to borrow significant funds in the market (if necessary, using its shareholdings as collateral).

The Ministry of Economic Development has, according to an “Vedomosti” article last week, suggested that by 2017 the state exit from shareholdings in the following way:

completely (with the exception of a “golden share” which will permit state representatives on the board of directors to veto certain types of transactions) from Rosneft, RusHydro (hydro-electricity producer in which state shareholding is about 60%), Zarubezhneft (state controlled, and engaged in the oil sector outside of Russia), and subsidiaries of MRSK-Holding (the Inter-regional Electricity Distribution Grid of which the state owns about 54%);
completely (with no-golden share) from Inter-RAO (which mainly has various energy producing assets);
and sell the state holding in Transneft (oil pipeline monopoly) down to 75% (is presently about 78%).

A sale of a small packet of FGC (Federal Electricity Grid in which the shareholding is about 79%) shares is foreseen in the privatization program for the next year or so, and there will supposedly be an eventual sale of 25% of Russian Railways (presently owned 100% by the state).

There are also ports. The state’s 20% share in Novorossiysk Sea Port, the country’s biggest sea port, is planned for this year — although Sechin has reportedly being trying to get it included under the Rosneft or Rosneftgas umbrella. Also reportedly slated for sale are 55% of Vanino port and about 25% of Murmansk port.

According to the “Vedomosti” article, Vanino is one of “the largest” ports in Russia and four companies have received Federal Anti-monopoly Service (FAS) approval to bid.

The state share in Rosnano will be reduced to 90%, and the state will also eventually sell additional or all shares in Sberbank,VTB, Aeroflot, Sheremetyevo, Sovcomflot, Alrosa and Rostelecom.

There are thus a lot – and it is a very mixed bag – of assets to be sold. However, there does not seem to be much of an overall strategy – perhaps other than reducing the state share in the economy (which is clearly desirable) and exchanging equity assets for cash (which, in itself, is less clearly desirable in economic terms).

Or, maybe there is a sort of “strategy”!

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Published on June 03 2012

“Decorative” Dvorkovich

Jim O’Neill, of Goldman Sachs and coiner of the BRIC acronym,  struck a positive note on Russia at a recent conference in London, saying: “There are some good faces in the new cabinet. Arkady Dvorkovich is a natural reformer.”

Once again, Jim has demonstrated his shallow knowledge of Russia (See also my posting of 3 December 2011 entitled “BRIC Jim O’Neill’s simplistic thick-brick thinking on Russia!” under “Expert Group 1:  New model of economic growth. Securing macro-economic and social stability” in the right-hand column.)

Dvorkovich is little more than a “decorative” feature in the new cabinet.

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Published on May 27 2012

Putin’s shocking “tank-maker” promotion!

President Putin’s appointment of Igor Kholmanskikh, the head of a military tank assembly line, directly to the position of presidential plenipotentiary (representative) in the Urals district (one of 8 in Russia) is a small disaster for Russia at the PR level and a waste of an opportunity to pursue economic reform.

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Published on May 20 2012

Small steps sometimes better than “strategic” decisions.

The last weeks of Vladimir Putin’s time as prime minister have been filled with a flurry of meetings and statements which might suggest “economic reform” will begin to rapidly accelerate in the weeks after the May 7 presidential inauguration (and presumed return of Dmitry Medvedev as prime minister).

But what is “economic reform”?  Or more precisely, what is sensible economic reform? Is “strategic” economic reform always the best? And, how effectively will reform be implemented?

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Published on May 01 2012

Russian “maneuvers”

Disagreements about economic policy within the Russian government often spill over into the public arena and get reported in the media to an extent which would surprise most people in such English speaking countries as Australia, the UK and the US.

In part, public exposure of internal government economic policy differences reflects less need for government discipline than when faced with an effective political opposition ever ready to attack (particularly as in the Westminster system used in Australia and the UK).

However, it is also partly a way of trying to influence the views of the president and prime minister. President Medvedev has, on occasion, had different views to Prime Minister Putin and has been quite insistent on specific economic measures (such as the payroll based insurance contribution and privatization) even if actual implementation of his demands has been tardy. It will be interesting to see the extent to which such public airing of ministerial differences (and those of official advisers) will continue when the roles of Medvedev and Putin are reversed: Putin will be calling all the shots with Medvedev (psychologically defeated by Putin in the unspoken contest to be the presidential candidate) having little independent authority.

I would also note that the public debates of economic policy by Russian ministers (and various official advisers) are often more sophisticated than what appears in the media of most “modernized” English speaking countries. The Russian system of appointing cabinet ministers is more akin to the US than to Australia or the UK and in the area of economics, at least, the result is often greater intellectual competency. Of course, as in any country, this does not necessarily mean that the final decision makers are competent economic policy makers.

Last week a Higher School of Economics (HSE) “conference” to discuss economic reform essentially turned into a mini-debate on budget issues between Elvira Nabiullina, the Minister of Economic Development, and Finance Minister Anton Siluanov.

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Published on April 09 2012

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