RUSSIA transition

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Published on October 26, 2007

Author: Heather

Source: authorstream.com

RUSSIA:  RUSSIA The Setting:  The Setting Large country Population of 146 million Area: 17075 Thousand sq. km., 1.8 times the size of U.S. Lot of it waste land Resource rich Oil, natural gas, coal, many strategic minerals, timber Lots of land Legacy of Socialism:  Legacy of Socialism No history of capitalism System of central planning in place since 1928 Culture of dependency on government No understanding of private property Land Capital No understanding of entrepreneurship Always taught that capitalism and private ownership are evil Suspicion of success Slide4:  PERESTROIKA AND GLASNOST Phase Date Description I 1985–early 1986 Rhetorical period. A lot of talk about reform but few specifics. II 1986–early 1988 Legislative period. Creation of superministries, new laws on self-employment, state enterprise, cooperatives, and property. III 1988–1989 Attempted implementation of reform. IV 1989–1991 Failure. Abandonment of the perestroika (economic restructuring) model in favor of more radical reform. 500 Days to A Market Economy:  500 Days to A Market Economy In early 1990 a committee established under the leadership of Stanislav Shatalin, provided so-called Shatalin Report, titled 500 Days: Transition to Market. It was deeply critical of the foundations of the Soviet system of centralized planning and sought to replace it with private property and liberalized market prices. Slide6:  During the summer of 1991 a group of Soviet reformers and Western academics gathered and drafted what became known as the Grand Bargain, under which the Soviet Union would commit to rapid economic and political reform, in return the West would provide very substantial economic aid. Gorbachev rejected the plan. While vacationing in the Crimea in August, he was the target of a coup led by Communist Party leaders. This led directly to the breakup of the Soviet Union. On December 25 Gorbachev resigned. On January 2, 1992, Yeltsin launched a new phase of liberalization of the Russian Economy, known as the Gaidar Reforms. The Gaidar Reforms:  The Gaidar Reforms Rehabilitation of the Ruble Market Liberalization Privatization Constructing a Social Security System Converting the Defense Sector Failed (so far) Transition:  Failed (so far) Transition 1985: Gorbachev takes power Perestroika begins Per capita GDP (1995 dollars): $3,548 1989: growth turns negative per capita GDP: $3,795 December of 1991: Soviet Union ceases to exist and transition begins Per capita GDP: $3,473 1998: economy begins anemic recovery (?) Per capita GDP: $2,130 2000 per capita GDP: $2,455 (71% of 1991) Slide9:  $3,473 $2,455 $2,130 Slide10:  However, lower cost of living in Russia than in U.S. makes these numbers appear worse than they are Purchasing Power Parity (PPP) adjusts for cost of living Per capita GDP measured in PPP declined from $9,797 in 1991 to $7,090 in 1996 and then rose to $8,377 in 2000 By comparison, U.S. per capita GDP in 2000 was: $31,996 (1995 US$) $34,142 (PPP) Political Change:  Political Change Communist Party abolished in 1991 New constitution ratified in 1993 parliamentary system head of state is President with enormous power relative to other branches Boris Yeltsin until 1999 Vladimir Putin acting President Dec., 1999 and President May, 2000 President appoints Premier (head of government) and all government ministers Slide12:  Bicameral legislature Federation Council (upper house) members appointed by top executive and legislative officials of federal administrative units (states) State Duma (lower house) members popularly elected Judiciary all judges nominated by president and appointed for life by Federation Council Slide13:  Institutions of democracy poorly established Yeltsin period power struggle between president and legislature control of government by “Russian Mafia” former nomenklatura and criminal elements that formed Yeltsin’s inner circle and maintained complete control of political agenda Putin period Putin achieves cooperation of legislature influence of Russian Mafia continues corruption rampant declining living standards and widening inequality threatens political and social security see “Russia Renewed?” by Daniel Treisman (Foreign Affairs, November/December 2002) Legal Framework:  Legal Framework Democratic and market-oriented laws exist The institutions to interpret and enforce them are weak, underfunded, understaffed, and corrupt judiciary regulatory/prosecutory agencies Judges and lawyers a holdover from former system in which law was held in low esteem and judges and lawyers were considered a part of the parasitic classes so despised in socialist ideology poorly paid and therefore vulnerable to corruption poorly trained not enough of them Slide15:  Summary of legal system in Russia: corrupt contracts unenforced by legal system enforced by thugs with guns bankruptcy rare soft budget constraint continues Many years before a fully functional legal system will be in place a major barrier to transition in Russia Slide16:  Political instability and dysfunctional legal system inhibits investment, both domestic and foreign domestic capital formation in Russia in 1998 $7 billion compared to $50 billion in China foreign direct investment in Russia in 1998 was $2.7 billion compared to $41 billion in China China a much poorer and less developed country but much more politically stable if not less corrupt Microeconomic Aspects:  Microeconomic Aspects Shock therapy versus gradualism January 1992 Russia embarked on a policy of shock therapy – sort of most prices freed except energy, medicines, consumer necessities, public utilities defense spending cut way back subsidies to SOEs cut new tax system foreign trade liberalized currency made convertible (within limits) Slide18:  Impact of shock therapy GDP falls standard of living falls dramatically unemployment rises continues through 1996/7 with weak recovery since Privatization:  Privatization Small-scale privatization immediate and easy shops, cafes, farms, apartments, etc., mostly bought by workers and managers Large-scale privatization of SOEs much harder and slower three stages vouchers 1992-1994 auctions 1994-1997 case-by-case sale of SOEs 1997-present Voucher Privatization:  Voucher Privatization Every Russian citizen given vouchers worth 10,000 rubles Vouchers could be sold for cash put in investment fund that used them to purchase shares of enterprises sold in auctions used to purchase shares in individual enterprises sold in auctions Slide21:  Vouchers actively traded on organized exchanges throughout Russia the largest exchange in Moscow was trading around 100,000 per day privatized around 60% of industrial assets and employment by 1994 most assets purchased by managers and workers of the SOEs did not provide capital or management expertise needed by privatized SOEs Stage Two: Cash Auctions:  Stage Two: Cash Auctions Second stage was to sell shares in auctions for cash rather than vouchers Purpose to raise revenue for state budget Foreign entities not permitted to participate Raised very little revenue Most sales at ridiculously low prices to former elite Stage Three: Case-By-Case Sales:  Stage Three: Case-By-Case Sales Open to foreigners Expert advising on timing and method of sale and valuation By 2000, a little more than 130,000 SOEs privatized about 70% Impact of Privatization:  Impact of Privatization Most privatized SOEs owned either by workers and managers from before privatization (insiders) or by former elite or criminal elements Did not bring much-needed capital or management expertise Did not result in much revenue for state budget total proceeds of sales about $12 billion Highly corrupted, resulting in sales at low prices to former nomenklatura Slide25:  Majority Owners of Private-Sector Corporations, 1995 and 1996 Privatizations (percent) Majority Owners 1995 1996 Employees 59 64.7 Rank and file 26.7 30.5 Managers 2.3 4.2 Top managers 0.4 0.4 General director 0.4 0.8 No majority insider 29.4 28.8 Nonstate outsiders 17.3 19.8 State 3.1 2.6 None 20.3 12.8 Note: Numbers do not add to 100% because of rounding. SOURCE: Joseph R. Blasi, Maya Kroumova, and Douglas Kruse, Kremlin Capitalism: Privatizing the Russian Economy (Ithaca, N.Y.: ILR Press, 1997). Privatization of Agriculture:  Privatization of Agriculture Soviet agriculture amazingly inefficient for every 12 tons of potatoes harvested only three tons got consumed and two of those were consumed by livestock lacked storage facilities, transportation, and distribution channels Russia inherited a mess resulting from low priority of agriculture in planning Slide27:  Recall that, under the planned system, agriculture was organized in state and collective farms but individuals could farm private plots Private plots accounted for only 3% of arable land but a large proportion of agricultural output third of milk and meat two thirds of potatoes and eggs Indicates degree of inefficiency of state and collective farms Slide28:  Collective farms given to their workers State farms broken up and auctioned off starting in 1994 many unsalable because of geographical location or obsolete equipment process of sales controlled by local politicians and highly corrupted 1996 decree allows farm land to be sold, bought, mortgaged, bequeathed as long as it stays in faming Slide29:  90% of agriculture controlled by large, inefficient collectives that operate like they did during planning Continue to be subsidized soft budget constraint Lack infrastructure distribution channels storage facilities adequate refrigeration marketing expertise obsolete equipment Financial Markets:  Financial Markets Purpose to pool individuals’ savings and allocate them to most efficient uses Includes banks as well as securities markets No real financial markets in planned system role of banks to allocate credit, funded out of the state budget, to enterprises according to plan Needed to start from scratch Two-Tiered Banking System:  Two-Tiered Banking System Began in 1988 under perestroika Private banks were allowed Significant reform not achieved until 1995 Federal Law of the Central Bank of Russia Gosbank split in two central bank (CBR) commercial banks Roles of the Central Bank monetary policy licensing and regulation of commercial banks Slide32:  About 2,000 commercial banks mostly small and undercapitalized most associated with specific industries loans short term and generally restricted to associated industry and to those with contacts not being allocated efficiently During early ’90s CBR issued massive amount of money and government made direct grants to enterprises from state budget hyperinflation resulted Slide33:  CBR performance improved since 1995 law and inflation has come down but still high 22% in 2001 Little public confidence in banks poorly capitalized no deposit insurance With inflation high and confidence in banks low, demand deposits low Much loan activity in form of directed credit from CBR Slide34:  Grouping Banks by Capital, 2001* Number Share of Total (%) Less than 3 million rubles 121 9.1 From 3 million to 10 million rubles 203 15.3 From 10 million to 30 million rubles 304 22.9 From 30 million to 60 million rubles 260 19.6 From 60 million to 150 million rubles 184 13.9 From 150 million to 300 million rubles 108 8.1 300 million rubles and more 147 11.1 Total 1,327 * Paid in authorized capital as per articles of association and registered by the Bank of Russia. SOURCE: Central Bank of Russia, Bulletin of Banking Statistics 2002. Securities Markets:  Securities Markets For trading of debt (bonds) and equity (stocks) instruments including government debt instruments Poorly developed, unregulated, and segmented Not that much need since much of the capital enterprises get comes in the form of directed credits from CBR and government subsidies don’t need to issue debt of equity instruments when you have soft budget constraints Public Finance:  Public Finance Roles of government in market economy allocation correct externalities e.g., pollution provide public goods e.g., national defense, police protection prevent monopolies Slide37:  Redistribution of income from rich to poor from workers to retirees Stabilization fiscal policy monetary policy Slide38:  Income Distribution: Percentage Share of Each Quintile (1980 and 1991 to 1997) 1980 1991 1992 1993 1994 1995 1996 1997 Top 33.4 30.7 38.3 41.6 46.3 46.9 47.1 47.4 Second 23.1 22.8 26.5 24.8 23.0 22.4 21.3 21.1 Third 18.6 18.8 17.6 16.7 15.2 15.0 14.9 14.8 Fourth 14.8 15.8 11.6 11.1 10.2 10.2 10.5 10.4 Bottom 10.1 11.9 6.0 5.8 5.3 5.5 6.2 6.3 Total 100 100 100 100 100 100 100 100 Notes: Data are for total money income. SOURCE: Goskomstat, Russia in Figures (Moscow: State Committee on Statistics of the Russian Federation). Paying For All This:  Paying For All This Borrowing requires functioning securities market Taxation not much need in a planned economy as resources directly allocated transition requires the development of a whole new system of taxation to be paid by a people who are not used to paying tax Structure of Government:  Structure of Government Several levels of government one central government regional governments local governments many special government entities with own taxing authority pensions, social insurance, employment, medical insurance Revenue Sources:  Revenue Sources Federal VAT (40%) similar to a sales tax business profit tax (13%) excise taxes (18%) personal income tax (2%): tax evasion is high Slide42:  Regional and local VAT (12%) profit tax (20%) personal income (16%) property tax (11%) transfer from federal budget (18%) other (20%) Tax system overly complex and poorly administered over two hundred taxes many exemptions narrow tax bases tax avoidance a major problem Foreign Trade:  Foreign Trade Prior to transition trade was almost all with CMEA partners trade was conducted by trading agency enterprises shielded from trade trade outside CMEA had to be conducted in dollars or other convertible currency ruble not convertible state bank in charge of trade financing had to keep reserves of currencies Slide44:  Transition involved giving enterprises right to trade not a problem making the ruble convertible much more difficult requires establishment of market for rubles began by setting very limited range of trade activities conducted with market exchange rate and other rates more favorable to the state for others e.g., a rate for repatriation of profits by foreign firms Slide45:  Full convertibility achieved in 1996 helped by IMF stabilization fund Exchange rate depreciating steadily over time due to inflation official rate during socialist period maintained at 1 ruble = 1 dollar at end state permitted tourists to exchange at black market rate of over 30 rubles per dollar market rate depreciated to between 3,500 to 5,100 in 1995 6,000 plus in 1997 when new ruble issued at 1 new ruble = 6,000 old rubles adjusting for inflation, ruble actually appreciating current account positive, capital account negative capital flight very limited foreign investment Evaluation of Russia’s Transition:  Evaluation of Russia’s Transition Many failures, few successes corruption is rampant resource allocation to highest bribe rather than most efficient producer Russia controlled by criminal oligarchy horrible income distribution no middle class a few (the criminal oligarchy) are very rich and everyone else is very poor poor social safety net Slide47:  financial problems a mess has had trouble paying debt defaulted in 1998 resulted in credit rating similar to Iraq’s caused by government incompetence cannot service its debts because it is unable to collect its taxes also because of decline in world prices of oil all of this in spite of Russia being the richest country in the world in terms of natural resources political instability Yeltsin period very unstable kept replacing the government Putin period better lack of checks and balances lack of well-developed political parties Slide48:  lack of foreign investment due to high level of political instability China much more stable and has enormous foreign investment becoming a cashless economy wages don’t get paid workers get paid by taking from enterprise enterprises so much in debt they have no cash barter trade very inefficient Prospects for the Future:  Prospects for the Future Bleak for a very long time The collapse seems to have halted but sustained recovery will depend on much greater political and economic reform than seems to be on the horizon Slide50:  Key Macroeconomic Indicators 1998 1999 2000 2001 GDP % growth -4.9 5.4 8.3 5.5 fixed capital Investment % growth -12 5.3 17.4 7 Inflation % per annum 84 37 20 19 Exchange Rate Ruble/$ 10 25 28 29 Unemployment % 13 12 10 9 General Govt. Budget balance -5.4 -0.8 3.6 2 Current account (% of GDP) 0 13 18 10 Source OECD, Survey of Russia, 2002. Slide51:  The tax system needs extensive reform, and attention must be paid both to revenue potential and incentive structure. Many large privatized enterprises remain to some degree on a “soft budget constraint”. Need to absorb more foreign investment. Need to create a real banking sector. Slide52:  This lecture bases heavily on William N. Trumbell’s lecture notes of Econ 454 Comparative Economic Systems at West Virginia University and Chapter 21 from David Kennett (2004)

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