A Policy Proposal for Economic Reform in
Despite making a recovery after the
1998 market crash, Russia remains weighted with numerous holdovers from the
Communist era that keep its economy from taking advantage of free-market
reforms. In short,
While the causes of
One of the major challenges to reform is the uncooperative nature of the bureaucratic apparatus in carrying out laws and policies enacted by the executive. While Yeltsin and Putin have generally been in favor of free-market reforms, the bureaucrats meant to carry out their policies are often rich oligarchs who stand to lose financially or politically from reform. To combat this, Putin has replaced most of the Yeltsin-era ruling cabinet with his own men, but it is unclear whether they will be any better than their predecessors.
The lack of clearly defined and enforced property rights is another major problem. The communist-era criminal code has only been partially replaced, and each contract must be carefully examined to check whether it contradicts an ever shifting mess of regulations. In addition, it is unclear what success the communists will have in the next election, so long term planning is very difficult because the future is so unpredictable.
Despite an ambitions privatization program, many of the large factories remain state owned, partly because of the fact that their outdated and inefficient production would immediately and properly put them out of business under a free market. However, because the government has so much influence over the banks, it keeps funding these inefficient enterprises to earn the support of the many workers they hire. Many of the factories that were privatized, simply signed ownership to their communist bosses, and because of their pull with the government, stay alive by government aid.
Despite all the issues mentioned above, the biggest challenge to Russian economic growth is probably its monetary policy. The Russian central bank is a direct holdover from Soviet times and needs to change its policy drastically to adapt to a free-market economy. In a capitalist economy, private banks serve to store money and provide investment to business. Because banks lose their investment when a debtor defaults, they are careful to insure that entrepreneurs large and small have sound business plans and refuse to loan to companies whose profits are dubious. The central bank functions independently of private banks (ideally) serving only to manage the size of the monetary supply indirectly by open market operations, varying the discount rate, and setting reserve requirements.
In a socialist economy, the function of the banking system is entirely different. All banks are part of a single system to distribute funds from the central government to individual business and factories. Branch banks don’t care whether any business is profitable or not because the credit risk of any investment is zero, since the government simply sends more money to an unprofitable factory instead of letting it go under. Private savings accounts are small or nonexistent because there is nothing to invest in, and no interest to earn from the investment, and event if there was money to be saved, there is usually nothing to spend it on in the stores. Instead of being independent, the central bank is simply an accounting organ of the state to determine which industry receives what funds. Inflation however is kept low because all large purchases require permission from the state, exchanging rubles into other currencies is illegal, and outside the black market, there is nothing to spend money on anyway.
If the monetary policy of the
Russian government is not bad enough, the International Monetary Fund directly
supported it by funding the government with billions of dollars in loans. Because more and more money was necessary to
support the old state enterprises, the foreign aid went directly into
dilapidated old factories, which often were not producing anything at all, with
most workers employed elsewhere, but registered as working at the factory for
the state salary. As Russian reformer Grigory Yavlinsky said in 1993,
"It has become clear that new Western credits are no longer a remedy for
Inevitably, the ability of the Russian government to pay back loans steadily declined until it was forced to default in its debt in 1998. The IMF failed to learn its lesson however, as it continues to fund inefficient and government favored enterprises all over the world, notably in South America, creating a false sense of economic stability that politicians use to stay in power and the IMF uses to prove its relevance until the country is no longer able to pretend to be able to pay back loans and engages in the familiar scenario of funding payments with inflation while trying to limit citizens ability to spend the new money. At no time is any investment in new, economically efficient infrastructure actually made, something Russians would do well to mind when asking for international loans.
Historically, the inflationary policy of the new Russian government is typical of both Soviet and tsarist era central banking. 3 The nature of printing money to cover losses from inefficient state enterprises means that high inflation will be inevitable unless the government either confiscates private savings accounts or limits the ability to withdraw money from the savings accounts to drastically decrease the real money supply. The former has happened several times during the Soviet era, most recently in 1991, when Gorbachev allowed only a small amount of rubles to be converted into smaller bills, wiping out private savings of millions, and not surprisingly leading to the familiar sight of pensioners begging on the street, which the western media blamed on the effects of privatization rather than irresponsible monetary policy. The 1991 savings confiscation destroyed any remaining confidence in the ruble or the banking system, leading to a mass conversion of rubles into dollars, or dollarization. Today, Russians illegally hold over 40 billion in dollars, five times more than they hold in rubles, 1 and this despite ruble to dollar conversion being against the law. The difficulty in converting dollars to rubles combined with the inflationary instability of the ruble and the socialist era banking system is perhaps the primary factor in the huge underground economy.
The solution to Russia monetary
crisis is simple: the ruble must be made
sound by making it convertible and establishing an independent central bank
which is not a puppet of the government and aims to maintain a stable monetary
supply (as opposed to supporting state industry) as its primary goal. This action would free up many billions of
dollars by giving Russians confidence in the ruble. It would also force the government to pay for
state industries through taxation, not inflation. In the immediate short run, the government
would be force to cut loose thousands of state enterprises – which is why this
policy is so difficult to implement, but in the long run
One way of making the ruble convertible is to make the dollarization of the currency official by creating a currency board to establish a fixed rate of conversion between rubles and dollars. 5 This board must be limited to maintaining the exchange rate it set, so it would be unable to support state firms by inflationary policy, since that would drain its reserve of dollars. Such a board would greatly reduce the size of the black market and enjoy popular support by following earlier dual currency policies employed both by the left and right, only it would be much more orthodox in its ability to control the monetary supply. 3
In addition to cutting lose
failing industries, the government must stop playing
favorites with business. Both the
central and regional government regularly favor
certain companies for lower taxation, less regulation and outright
subsidies. Oftentimes, the businesses
show their appreciation by practically enrolling various bureaucrats on their
payrolls. At other times, bureaucrats are owners or stockholders of the
industries they regulate, as conflict-of-interest laws are practically
non-existent. Additionally, much of the
foreign aid that
A similar problem exists with
both the central and regional government using economic pressure to bend
business to their will. Recently, the
last independent television station in
Despite failing to adopt an
active program of reform,
In conclusion, despite several positive reforms under the Putin administration, Russians needs to take major steps to embrace capitalism if they want to partake in its benefits. The most important reforms are:
A radical reduction in federal and local government regulation. Simple, clear, well publicized, standardized, and long term regulations and laws to establish a clear and predictable rule of law. Increased transparency on both the central and local levels, centrally published regulations, standard forms, and well published government statistics would also help in this area.
A complete privatization of the banking industry. This would stop the hidden flow of money to failing industries and increase access to credit for private entrepreneurs.
Establishment of an independent central bank and a dollar convertible currency to stop inflation, allow people to invest their dollar savings, and secure confidence in the stability ruble.
The IMF and other foreign lenders should exercise much more caution in the policies they promote, by focusing on funding promising private ventures, not corrupt government officials who funnel foreign aid into their own private accounts.
Some of these changes will not be
easy, especially in the short run, but unless and until