July/August 2001

THINK AGAIN

By Anders Aslund
BIO: Anders Aslund is a senior associate at the Carnegie Endowment for International Peace. His book Building Capitalism: The Transformation of the Former Soviet Bloc (Cambridge: Cambridge University Press, 2001) will be published in September.
 

Russia

The Soviet Union stoked mythology by being a closed society, allowing people to allege just about anything without being exposed as wrong. Ironically, Russia's transformation into an open society has engendered its own mythology. With Russia's faults laid bare for all to see, Western politicians and media have commonly described the former superpower as a nation in decline, beset by corruption and a collapsing infrastructure. But most of these flaws are remnants of Soviet mismanagement only now being put right.
 

"The Russian Economy Has Collapsed"

Not true. According to official Russian statistics, gross domestic product (GDP) plummeted 44 percent from 1989 to 1998. However, this figure is grossly exaggerated because of the peculiar quirks of communist and post-communist statistics.

Under communism, everybody padded output to reach targets in the planned economy, while nobody cared about the quality (or even the usefulness) of the items produced. For instance, even though the Soviet Union manufactured more than six times as many tractors as the United States, its agricultural output lagged far behind because production was so wasteful. Much of Soviet manufacturing was unfit for consumption, and Russians flocked to alternative, imported goods that flooded the market following the liberalization of foreign trade. The subsequent decline in the production of useless final goods and unneeded inputs was not a tragedy but a desirable change. At least one fifth of Soviet output fell into one of these categories, and the estimated GDP of the Soviet era should be reduced accordingly.

After communism, the statistical measurement of output shrank far more than its actual level. According to the best estimates, the underground economy accounts for at least one quarter of this purported contraction. Thus, the Russian economy hasn't collapsed. Rather, it is more accurate to say that, until 1998, the economy stagnated because of sluggish and incomplete reforms. Russia's level of economic development remains where it was during the Soviet era, roughly on par with Brazil.

Nor has Russia developed a new "virtual economy" based on barter rather than money. The share of barter transactions in Russian industry peaked at 54 percent in August 1998, but the financial crash curtailed this system of hidden subsidies that had been the norm for Russian enterprises. Nonmonetary transactions fell like a stone as Russian industry realized it could no longer depend on the state and would have to earn real money in the marketplace. Today, the virtual economy is marginal.

According to the latest official data, Russia achieved a GDP growth of 5.4 percent in 1999, 8.3 percent in 2000, and growth continues today. While many systemic problems remain, Russia appears to have attained a critical mass of market reforms and privatization. (The same is true of several other countries in the region, such as Kazakhstan, which are also booming.) Considering the enormous distortions left behind by communism, that is a splendid achievement.
 

"Shock Therapy Was a Failure"

No. The new conventional wisdom is that Russia's economic and social troubles are the result of radical economic reforms (such as price liberalization and privatization) that were launched too fast and too soon. But the economic mayhem preceding the collapse of the Soviet Union-the legacy of years of gradual, inadequate reforms-left former Russian President Boris Yeltsin with little choice.

More than 20 other former communist countries undertook market economic reform in parallel with Russia; the most successful countries, with high growth and contained corruption (notably Poland and Estonia) undertook far more radical reforms. Virtually all the problems in Russia today-excessive state intervention, corruption, high tax rates, lingering inflation, and limited rule of law-are indications of insufficient reform efforts.

For two years, Russia has experienced substantial economic growth and considerable structural improvements in the wake of the horrendous financial crash that shook the world in August 1998. That financial crisis reduced the financial wealth and political power of two of the most corrupt groups in Russia: the oligarchic tycoons and the regional governors. More surprisingly, it convinced both the communists and the population at large that there was no alternative to a real market economy.

Russia's real problem was too little shock and too much corrupt state therapy in the form of subsidies to the country's elite.
 

"Privatization Has Only Generated Corruption"

Wrong. Instead of saying that privatization has generated corruption, it would be more accurate to say that it has generated national wealth. Since 1997, Russia's private sector has created no less than 70 percent of the country's GDP.

Corruption is usually defined as "the misuse of public power for private gain," but privatization permanently deprives public servants of public property, so they can no longer charge money for the privilege of using it. Today, the bribery that plagues Russia is not related to privatization but is overwhelmingly connected with law enforcement, tax collection, and state intervention.

In general, the higher the level of privatization that an ex-communist country has attained, the higher economic growth it has achieved. Russia is atypical in having been more successful in privatization than in other market reforms, such as price liberalization. Therefore, people tend to blame Russia's privatization for the country's shortfalls, while it would be more logical to complain about the dearth of other reforms. The scourge of Russian enterprises is scores of state inspectorates that regularly extort money from businesspeople.

Strangely, the standard comparison is between privatization in Russia and Poland, with the allegation that Poland privatized more slowly. In fact, Poland started off with a large private sector that was bigger than Russia's. But Poland undertook more reforms in nearly all spheres, suggesting that, if Russia had not privatized so fast, it would probably have been in the doldrums.

Ukraine has implemented most reforms, including privatization, more slowly than Russia. As a consequence, Ukraine's privatization has been of worse quality than Russia's, with more ownership going to managers and employees and less being sold on open markets. Ukrainian corporate governance remains far worse than in Russia, where nearly 800 enterprises actually paid dividends to their shareholders last year.
 

"Russia Can't Collect Taxes"

Sheer disinformation. Russia collects one third of its official GDP in general government revenues, slightly more than the United States, whose citizens complain that taxes are too high. Not only has Russian tax collection been high, it has also been very stable.

The misperception over Russian taxation is the result of superficial observations. Most outsiders, including the International Monetary Fund (IMF), tend to focus on federal revenues-but those represent only a part of total revenues, which also include regional and local tax revenues, as well as several extrabudgetary funds, notably the pension fund.

Another source of confusion is that many observers, including some Russians, take for granted that Russia should have state revenues as high as Western Europe or the former Soviet Union, ignoring that such taxation harmed growth in both places. For Russia, a more plausible tax rate, in line with its level of economic development, would be 15 to 25 percent of its GDP.

The real problem is not that Russia can't collect taxes, but that the government collects too much. These revenues are improperly spent and aggravate corruption. According to the World Bank, no less than 16 percent of Russia's GDP went to enterprise subsidies in 1998. (Small wonder that state finances crashed.) Furthermore, tax collection is ruthless. The lawlessness of the tax inspectors has emerged as one of the most serious concerns of the post-Soviet era.

The obvious solution that emerged was a low, flat tax rate. As of this year, Russia introduced a flat income tax of only 13 percent (a rate that the United States and Western Europe could only dream about). Instantly, income tax revenues rose by 70 percent as people abandoned expensive tax-avoidance schemes.
 

"Russia's Infrastructure Is Falling Apart"

Think again. Dramatic news stories, such as the tragic sinking of the submarine Kursk and the fire that engulfed the Ostankino television tower in Moscow, have created the impression that Russia is coming apart at the seams.

In fact, Russia has seen an extraordinary improvement in its infrastructure. Investment in fixed assets (i.e., buildings, equipment) increased by 18 percent last year-a healthy investment ratio of 20 percent of GDP (higher than the standard U.S. ratio of 16 percent). Admittedly, the U.S.S.R. had an investment ratio of about 30 percent of GDP, but that was an indication of waste. The Soviet Union was notorious in its neglect of infrastructure and its maintenance. Today, privatization and market pricing have revived much of the country's infrastructure. Free-market competition has fostered an incredible expansion in the telecommunications industry. Airports and airlines have likewise improved. Road construction is up. New ports have been built around St. Petersburg. Whereas ruins once blighted the landscape of even the Soviet capital, modern-day Russia has initiated a widespread building boom.

Problems of maintenance persist where state monopolies linger, notably in the natural-gas monopoly Gazprom, the state-owned oil pipeline monopoly, and partly in the public utilities.
 

"Russia Desperately Needs Foreign Investment"

Not quite true. Throughout the world, from East Asia to post-communist Eastern Europe, exports, not foreign direct investment (FDI), have led all economic takeoffs. Even Poland, the most successful transition economy, didn't see annual FDI rise over $100 per person until 1998. In contrast, Hungary and the Czech Republic succeeded in attracting large foreign investments early on, but those investments did not prove to be all that beneficial for economic development. After all, most investment is nearly always domestic.

Russia doesn't need foreign capital to boost its investment rate. Although the country has a persistent large capital flight of more than $20 billion a year, it has a higher investment ratio than the United States. This capital flight reflects the country's high level of savings being invested abroad-a resource for the future. Enterprises, as well as wealthy individuals, prefer to keep their money in safe banks outside of Russia where the legal systems are stronger.

Yet, the Russian investment climate remains poor because of excessive bureaucracy and corrupt law enforcement. Russia has to solve this problem to make its fledgling economic growth sustainable.
 

"Russia Suffers from a Terminal Health Crisis"

Exaggerated. Granted, the statistics from Russia today are shocking: Male life expectancy plummeted from 64 to 57 years from 1989 to 1994, and the country's population is declining by over half a million each year. But statistics alone do not tell the whole story.

The population decline has two causes. The first is low birthrates, which are typical of Europe as a whole. The communist economic incentives for young people to have children early have disappeared. Today, as in many Western countries, Russian women postpone childbearing. The other cause is high death rates. The population pyramid is badly skewed since there were so few births from 1930 to 1945 on account of government terror and war; the large age group born before 1930 is now dying.

According to the most recent U.N. projections, Russia's population decline (28 percent through 2050) is not drastically worse than that in parts of Western Europe. Thus, population decline is not a particular Russian problem, but an issue across Europe. The situation is far worse for Estonia and Bulgaria, where the U.N. projects a natural population decline of more than 40 percent through 2050.

The drop in male life expectancy, even as women thrive, is common not only in Russia but in East Slavic and Baltic countries as well. (Strangely, the war-ridden and truly impoverished countries Georgia and Armenia have not recorded any such decline.) The direct causes are cardiovascular disease and accidents, fueled in part by alcoholism. The dramatic decline in life expectancy can be explained by former Soviet President Mikhail Gorbachev's antialcohol campaign-which temporarily limited access to alcohol and thus boosted life expectancy by a couple of years-followed by a sudden increase in alcohol consumption when the exorbitant Soviet-era sales taxes on vodka disappeared.

Nothing suggests that average healthcare standards in Russia have fallen. The quality of healthcare is closely linked to infant mortality, which plunged by 17 percent from 1993 to 1998. Both public and private expenditures on health have risen sharply as a share of GDP. Capitalism has made medicines widely available that were unknown during the Soviet era, and the equipment at hospitals has greatly improved.

Yet, some problems are cause for genuine concern. One is the proliferation of drugs and aids, both of which are the inevitable consequences of becoming an open society. The other worry is the tuberculosis epidemic (a new drug-resistant strain of the disease is particularly troubling). Moreover, as the healthcare system remains predominantly public, it suffers from all the problems of low salaries, low efficiency, and bribery, which were typical of the public sector under communism.
 

"Russia Has Been a Black Hole for Western Aid"

Nonsense. A profound misperception prevails that Western aid to Russia has been enormous. In fact, it has been trivial. From 1992 to 2000, total U.S. Agency for International Development (USAID) commitments to Russia amounted to $2.6 billion. But actual disbursements are always less: Russia has received only about $200 million a year in grant aid from the United States, while the European Union gave barely $150 million a year.

In addition, the United States has given food aid, partly in grants, partly in credits-but that has been at the behest of the U.S. agricultural lobby and qualifies more as financial aid for U.S. farmers. (In fact, it has hampered agricultural reform in Russia.) The United States has also financed denuclearization in the former Soviet Union, but once again that is driven predominately by U.S., not Russian, interests.

Russia has drawn nearly $15 billion in stabilization credits from the IMF, all of which must be paid back with interest, and Russia has already returned almost half that amount. The World Bank has committed a total of $12 billion, but that is also in the form of credits that must be repaid with interest.

Thus, since the Cold War ended, the Western public grants of real assistance to Russia come to a grand total of about $5 billion (equivalent to the total U.S. foreign aid to Israel and Egypt in a single year), most of which has been spent on Western consultants.

For its part, the United States has benefited enormously from the peace dividend that came with the disappearance of the Soviet military threat. In the 1980s, the United States spent 6 percent of its GDP on defense, compared with 3 percent ($300 billion a year) at present. Americans should thank Gorbachev and Yeltsin, not former President Bill Clinton or the U.S. Congress, for wiping out the U.S. budget deficit. Russia's gift to the United States of $300 billion a year should be compared with the much discussed U.S. compensation of a measly $200 million a year, a difference in dignity of 1,500 times.

Even so, Western aid has accomplished a lot in Russia. The IMF has assisted in the Russian financial stabilization at no cost to U.S. taxpayers, and so the fund can now declare victory and go home. At minimal cost, USAID and the World Bank have contributed to the largest privatization effort the world has ever seen, which may yet emerge as a great success. Consultants have helped foster such a profound change in Russian economic thinking that the prevailing mind-set is now even more market-oriented than Western Europe's.

In short, Western assistance to Russia has been an astounding success considering the paltry amounts. Rarely has so little money made such a difference. Yet, if more had been given early on, much more could have been attained.
 

"Russia Needs a General Pinochet"

No, thanks. Many Russians and foreigners alike think Russia's problem is a lack of a strong leader, and quite a few consider democracy an impediment to arduous economic reforms (the arguments of the modernization school). Similarly, proponents of a Chinese model for Russia favor dictatorship over democracy. Worse, these ideas are popular among the Russian elite.

Throughout the world, democracy and market reform are positively correlated, and in the former communist world this correlation is extremely close. The reason is obvious: The main threat to successful transformation comes from the old, powerful elite, which usurped the state for private gain. Democracy and vibrant media are the best checks on that elite. Nor is strong presidential power beneficial to reforms. The transitional countries with the least amount of reform are all under presidential rule, while the most liberal countries have parliamentary systems, which can check the power of centralized government.

Much of the antidemocracy sentiment stems from the perception that political stability is good for reforms. But, in practice, the opposite is true. The long tenure of the infirm President Yeltsin and the passive Prime Minister Viktor Chernomyrdin provided Russia with a "stability" that favored the corrupt elite. Poland, the three Baltic countries, and Bulgaria have changed governments on average almost every year for the last decade, and they are among the most successful reformers.

Contrary to common opinion, communists do not threaten truly radical reforms, such as in Poland and Estonia. (In recent years, old communists have won elections in only two countries, Romania and Moldova, where government officials had implemented very timid reforms.) The Russian communists have remained relatively strong because of the slowness of Russia's reforms. Yet, these reforms have progressed far enough to keep the communists at bay.

The idea that democracy is bad for reform presumes that the elite is good and wise, while the common people are stupid and shortsighted. All evidence, however, suggests that the unlawful enrichment of the elite is the problem. The population needs to be mobilized and organized to check its excesses, and the most effective means of popular control we know is democracy and the freedom of the press. The widespread disregard for democracy and the repression of media are the greatest dangers in Russia today.
 

"President Clinton Lost Russia"

Hubris. First of all, Russia is by no means lost-only in some people's imagination. It is both pretentious and incorrect to think that the United States could have dictated what happened in Russia. Although Russia no longer is a superpower, it remains a huge sovereign country with great influence on world affairs. The very idea that the United States "lost Russia" suggests disrespect for other countries' sovereignty. The United States had one brief opportunity to influence Russia's future. That was in early 1992, when Russia had a government under Prime Minister Yegor Gaidar that was serious about attempting radical economic reform. The United States, however, did nothing to support these efforts when a little assistance could have changed the course of history. Yet, the U.S. president at the time was not Bill Clinton but George Bush. No such historical chance returned, and George Bush's epitaph should be "the man who slept when the Cold War ended."

Russians increasingly believe that President Yeltsin was wrong in trying to establish friendly relations with the United States, complying with its many demands, while China's hard-line foreign policy toward Washington was more successful. The United States expanded NATO against Russia without offering anything in return. The U.S. media and Congress persistently criticize Russia more often than China. Many Russians even argue that China has been wise to maintain a hard dictatorship in the face of U.S. hegemony.
 

WANT TO KNOW MORE

A large body of literature has been published about the new Russia. For the general reader, Chrystia Freeland's Sale of the Century: Russia's Wild Ride from Communism to Capitalism (New York: Crown Business, 2000) offers the best analysis of the oversized personalities and great issues of the 1990s. Another excellent book that focuses on how the business environment developed is Rose Brady's Kapitalizm: Russia's Struggle to Free Its Economy (New Haven: Yale University Press, 1999).

The grandest academic work for this period is Leon Aron's favorable biography Yeltsin: A Revolutionary Life (New York: St. Martin's Press, 2000). For those who want to understand Russia's voters, there is no better book than Timothy J. Colton's Transitional Citizens: Voters and What Influences Them in the New Russia (Cambridge: Harvard University Press, 2000). The greatest political history of the 1990s is Michael McFaul's forthcoming book Russia's Unfinished Revolution: Political Change from Gorbachev to Putin (Ithaca: Cornell University Press, 2001).

On Russia's economic transformation, a basic source remains Anders Aslund's How Russia Became a Market Economy (Washington: Brookings Institution Press, 1995). Maxim Boycko, Andrei Shleifer, and Robert W. Vishny lucidly explain the Russian privatization program in Privatizing Russia (Cambridge: MIT Press, 1995). In The Grabbing Hand: Government Pathologies and Their Cures (Cambridge: Harvard University Press, 1998), Andrei Shleifer and Robert W. Vishny provide the best theoretical understanding of the complex post-Soviet economy.

"For links to relevant Web sites, as well as a comprehensive index of related Foreign Policy articles, access www.foreignpolicy.com.

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