Following the collapse of the Soviet Union, the first decade of transition from a centrally-planned

economy to market economy was disastrous for Russia: nominal gross domestic product (GDP) fell
from USD 516 billion in 1990 to USD 196 billion in 1999, which represented a plunge of over 60%. In
an attempt to address the economic turmoil and follow the recommendations from the IMF, the
Soviet government began to privatize many Russian industries during the 1990s. Important
exceptions were, however the energy and defense sectors.

Crude oil, petroleum products and natural gas comprise roughly 58% of total exports, iron and steel
represent 4% and other mining sector related exports including gems and precious metals account
for about 2.5%. Sales to Europe represent over 60% of total exports while Asia has an export share
of roughly 30%. Russian exports to the United States, Africa and Latin America combined represent
less than 5% of total shipments.

Russia’s main imports are food and ground transports, which represent 13% and 12% of total
imports, respectively. Other significant imports include pharmaceuticals, textile and footwear,
plastics and optical instruments. Exports peaked in 2012 reaching USD 527 billion; imports peaked
in 2013 reaching USD 341 billion.

The economic transition theory of a planned economy being reformed to a market

economy was quite different before the collapse of the Soviet Union. The 1990s
produced new literature about this transition based on real life observations of
countries in different situations. Russia is quite an exceptional case; it is one of the
largest countries in the world and it was the main power in the USSR also its political
constraints differ from other countries. So its transition must differ greatly from those
of the other ex-communist countries. This brings us to the question of what kind of
transition should be applied to the planned economy in the case of Russia? Rapid
growth of “shock therapy” is based on the quick establishment of functioning markets,
quick restructuring of enterprise, and the creation of conditions for new business set-
ups, which in turn creates high demand for market institutions. An alternative to
“shock therapy” is the “gradualist approach” to liberalization and privatization. The
“gradualist approach” allows for a more balanced structural adjustment(2). The
components of transition were typically classified in four major dimensions. First the
Microeconomics of transition focused on creating markets and market price signals
throughout privatization. Second, the macroeconomics of transition centred on
creating a money-financial system, specifically a financial infrastructure and
developing new a new fiscal role for the state, through the budgetary process to guide
macroeconomic performance. Third, major emphasis has been placed upon
international economic integration, specifically on new trading arrangements and
policies. Finally, transition has had to consider the safety net, or the infrastructure and
policies for the provision of medical services, unemployment benefits, pensions, and
the like which earlier were handled quite differently(1). The approach to transition
that Russia has chosen plays a major role in understanding the difficulties of
stabilizing its economy and importance of each of the four dimensions specified.

The breakup of the Soviet Union added more pressure on the Russian economy and
contributed to already a great crisis. A decision had to be made on what kind of
approach to use to the transformation of the planned economy to a market one. Boris
Yeltsin and his cabinet decided to undertake the “Shock therapy” or “Big bang”
approach, liberal economic policies which were used by the International Monetary
Fund, the World Bank and the U.S. Treasury Department. Boris Yeltsin used the
political situation at that moment to implement this approach. The political vacuum at
the end of the planned socialist era provided an opportunity for change, if change is
not implemented quickly, the downturn of the economy at the start of transition can
result in discontent and resulting retrenchment(1). So we shall look at some of the
four main dimensions mentioned earlier to see how the transformation did in the
initial years and what the main difficulties were.

First let us look at the microeconomics of transition, privatization in particular. The

privatizations first phase was called “voucher privatization” with voucher being
distributed to every one of the 148 million Russian men, women and children. These
voucher’s could be used to buy shares of Russian companies or be sold a newly
developed secondary market, which lets us to the assumption that people with greater
wealth could acquire them and thus a greater share of a company. But the government
still retained parts of shares which allowed them to interfere in the decision making of
the company. The second stage was to sell the remaining shares of enterprises were
sold through investment tenders, cash auctions, or specialised auctions(1). This was a
major opportunity for certain people with contacts, certain information about the
selling of the stocks and access to financing. These “insiders” could misuse their
position and knowledge to obtain more profitable stocks and manipulate with their
prices, thus accumulating a great amount of wealth. This lead to a massive
redistribution of income in the direction of greater inequality. The top 20 percent of
highest earning household accounted for slightly more than 35 percent of the total
income in 1991 compared to almost 50 percent in 1995(1). The difficulty of “shock
therapy” concerning privatization was the speed at which the new private sector was
emerging. The number of work places in the state owned enterprises was diminishing
and the work places in the private sector were increasing, but due to the differences in
speed this process contributed to the already high unemployment. After the breakup of
the Soviet Union regions which had only one industry suffered greatly from
unemployment. The decrease of output due to decrease in demand (e.g. arms industry)
called for a reduction in labour force. The process of privatization only made this
more of a difficulty for transformation. Another issue concerning privatization were
prices of goods, the lack of market forces drove these prices up after the government
removed price controls. Combined with the money overhang inherited from the Soviet
Union Russia this problem spilled over to macroeconomics of transition causing huge
rates of inflation.

Since 1992, Russia’s economic authorities have repeatedly attempted to control and
lower the country’s inflation rate. At times they achieved temporary victories. On
three separate occasions, the monthly inflation rate was pushed down by eight or more
percentage points. But on each of these occasions the success was transitory: within
months the price level soared again. Against this background, the sustained tapering
fall that began in January 1995 stands out(4). Such situation and the central banks
mistrust of the reforms President Yeltsin implemented was itself a difficulty for the
transition process. Another macroeconomic difficulty in the transition process was the
issue of taxes. Market economies rely primarily on sales taxes and on payroll taxes
and personal income taxes to collect revenues. The structure of Russian taxes in 1995
have shown that the major source of revenue were profit taxes and sales taxes also
unusually very important special taxes, like export taxes or transportation taxes, which
play relatively minor roles in the West. The state’s inability to identify and measure
personal taxable income was the problem. Record keeping on wages and income has
been very poor, and enterprises have found ways to conceal payments to workers and
employees. State tax collections have been severely damaged by the decline in
economic output, by the fact that much economic output is underground in the so
called “second market” and out of the reach of the taxing authority, by the ability of
influential enterprise to bargain down their tax obligations, and by the general decline
in tax disciplines(1). Federal tax collections have dropped sharply since the beginning
of reform – from 17.8 percent GDP in 1992 to 10.1 percent in 1997. This collapse in
federal revenues contrasts with a relatively stable trend at the regional and local
levels. Between 1992 and 1997, regional consolidated budget tax revenues (including
local) actually rose slightly, relative to GDP, from 11.9 to 12.6 percent. Because of
the week federal collections, revenues of the consolidated budget – central, regional,
and local budgets combined – fell from an estimated 29.7 percent of GDP in 1992 to
22.7 percent in 1997. And if revenues of federal extra budgetary funds such as the
pension funds are included, the drop between 1992 and 1996 is almost 10 percent(4).
The tax problem also contributed to the budget deficit which was already present
before the collapse. Trying to deal with the budget deficit by increasing the money
supply only sharpened the problem of inflation.
Economic factors: Limited wealth, limited
economic streams
Wealth concentrated at the top. 
After the Soviet Union collapsed, Russia’s economic strategies needed a
change. Instead of continuing with the planned economy, the smarter decision
was to move towards a market-based system. Yet, even with this change, the
majority of Russia’s wealth is contained by officials. Most of Russia’s major
industries — from transport to social media — are controlled by the Russian
government. 
An economy that’s vulnerable and limited by the mining industry.
Building and selling weaponry aside, Russia’s main production is oil, gas,
aluminum, and steel. Although these resources are typically sought after, the
prices fluctuate based on supply and demand. This means the majority of
Russia’s economy can be strong, but it’s vulnerable to human demand too. 

Diversifying economic streams.

Yet, relying so heavily on crude oil puts Russia’s economy at a standstill. The
government is aware and means to diversify its economic streams, particularly
by focusing on import substitution. In doing so, the country may need to adapt
the current taxation system and create new monetary policies — one such
policy may involve making the ruble (Russia’s currency) competitive with
others.

Russia is one of the top 15 largest economies in the world by nominal GDP.
Its economy grew by 2.3% in 2018 which was higher than the forecast of
IMF’s 1.7% and its own economy ministry’s forecast of 1.8% (The Japan
Times, 2019). A strong growth of 5.3% in the construction sector has
contributed to the overall growth significantly. Russia has more than $460
billion in reserve and can withstand any global economic shocks (Evans,
2019).
Russian economy is heavily dependent on oil and gas. It produces around 11
million barrels of oil a day. In fact, oil and gas make up 59% of Russia’s
exports (Evans, 2019). Other top exports of Russia are as follows: iron and
steel, cereals, precious metals, machinery including computers, wood,
fertilizers, and aluminium (Workman, 2019). The country exported
approximately $449.3 billion worth of goods around the world in 2018. The
main imports of Russia are machinery, equipment and transport, chemicals,
food and agricultural products. China and Germany are two of the top import
partners of Russia.
As mentioned above, Russia is a key part of the BRICS (Brazil, Russia, India,
China and South Africa) group. It has undertaken a number of initiatives to
encourage foreign investment. Recent infrastructure developments have also
immensely improved the logistical efficiency of doing business in the
country.

t has been almost 25 years since Russia transitioned to a market economy in the 1990s. The
transformation of the economy opened up previously non-existent opportunities for new businesses
and ventures. The Russian private sector reacted quickly, promptly filling major gaps left behind by the
state-run economy, particularly in serving end customers. Growing consumer appetites, the expanding
middle class, and rising disposable income additionally contributed to this trend. TThe new economic
environment also opened a gateway to the world for young companies, in the form of access to capital,
markets, and technologies. As a result, the last two decades have seen the rise of many new dynamic
firms with not only domestic, but also international ambitions.

Nevertheless, little is known about entrepreneurship in Russia. For a long time, it had been largely
overlooked as something happening in parallel to the main developments in the Russian economy and
viewed as a side effect rather than a driving force. Meanwhile, Russia’s image continues to be defined
primarily by natural resources. Indeed, Russia stands high in global oil, gas, coal, metals, forestry, and
other commodity export rankings. These industries collectively account for almost 95% of Russia’s $500
billion in exports. What is less known is that their share in the country’s $2 trillion GDP hovers around
15%. This is according to Russian Federal State Statistics, which is sometimes criticized for its transfer
pricing mechanism; however, the World Bank gives a similar number of 18.7% in its estimations, which
are based on resource rent. (Federal State Resource Statistics, 2013; World Bank 2012). What is
important is that up to 85% of the Russian economy comprises industries with no relation to
commodities or natural resources (see1). Arguably, it is this 85% where the contribution of newly
emergent private firms is most significant.

Recommendations

Russia’s economic policy has evolved to address the changing priorities for economic development, but
Russia has not moved boldly enough to significantly increase competitiveness. The period between 1998
and 2004 was characterized by the need to achieve stability after the preceding economic and political
volatility, a task at which the government has been very successful through a combination of its own
policies and favorable external circumstances.
After 2004, however, it became increasingly clear that further progress could only be achieved with
deeper structural changes. The government decided that these changes would require a more active
role of the government, because existing institutions were too distorted or ineffective for a productive
economy to emerge naturally, a view also shared by foreign analysts.145 Our analysis suggests that this
policy shift has failed to produce the changes necessary to significantly enhance Russian
competitiveness.

Figure 31: Major Recent Russian Economic Policy Initiatives

We see three root causes for the disappointing policy results: First, Russia has not made any real
progress in addressing weaknesses in its political and legal context and in crucial areas of the business
environment. These weaknesses continue to be a burden on the economy. Even more importantly, they
seriously undermine the potential of otherwise sensible policies like investment funds, special economic
zones, and cluster efforts to succeed. Policies will remain largely ineffective as long as context and
business environment weaknesses remain, even with policies that apply best practices from other
countries. Recent policies, such as the newly announced Mid-Term Program146 that includes many
sensible initiatives, are in danger of also being ineffective unless serious reforms of context take place.

Second, Russia has recently made a number of policy choices that are actually harmful to
competitiveness. The government has reacted to existing structural problems in the economy in ways
that exacerbate these problems, rather than providing effective solutions.

 In its relations with the oligarchs—private economic interests that achieved enormous wealth
through uneconomic transactions in early transition—the government has taken steps to reduce their
role and bring their activities in line with national economic interests. Establishing the authority of the
government versus strong private interests was a logical step.147 But the Russian government applied a
mix of non- transparent measures through different institutions with unclear authority. The threat to
prosecute companies for alleged tax evasion has been a frequent tool to put pressure on companies.
This undermined the credibility of the effort and further eroded the legal and political context for all
firms.

 In a number of industries—automotive, aerospace, and metals—the government has taken an

active role to facilitate restructuring to enhance competitiveness. A strong government role in this
process seems inevitable in the Russian context because the financial sector is not mature enough to
manage such a transformation alone. But the Russian government has mistakenly tried to exert strong
influence on the way companies are actually run, and placed individuals with strong political links in

leading positions, rather than to open competition and put in place a transparent governance process.
This threatens to seriously harm competition and productivity by making the government both a
regulator and a market participant.

 In the oil and gas sector, the government has taken steps to increase the government’s share of
oil and gas revenues. Previous contracts had arguably been negotiated when the Russian government
was in a very weak position. Similar steps to increase the government stake have been taken in other
natural-resource rich economies. But the Russian government has used methods such as the threat to
withhold environmental licenses and the auctioning of former Yukos property in processes that were
perceived to favor government-owned companies. This approach further erodes trust in due process
and the Russian legal and administrative system. In other countries, governments often maintained
private participation while increasing their share of revenues.

Third, policies set by different Russian government ministries continue to work at cross- purposes. While
some in government want to create a more competitive business environment, others want government
to micromanage through regulation and create powerful companies with political as well as economic
missions.

Finally, Russian leaders clearly have very different views of what drives competitiveness and national
prosperity. These differences in opinion go beyond the usual policy disagreements that are present in
many governments, and strike to the heart of the goals of the nation itself. Is the goal politics or
prosperity for citizens? There is no clear mechanism to resolve these incompatible aspirations. Instead,
conflicting signals threaten to cancel each other out and, even worse, create a high level of uncertainty
about future policies. This is a climate in which even good policies have little chance of achieving their
full positive impact. o Create an efficient and independent legal system. Creating sound procedures to
enforce the law and protect individual rights is necessary to increasing the credibility and impact of
government policies. Crucially, the government needs to resist the temptation to interfere with the
judiciary, even when decisions might not go in the direction it prefers. Given its legal system shortages,
Russia should work with international organizations and agreements, such as the WTO, to ensure
credibility of adherence to policies.

o Improve the capabilities and professionalism of political institutions. Stronger government

institutions, with a system of checks and balances, are the only effective way to achieve political
stability.148 Political reform in this direction will be complicated but necessary. Ensuring orderly
transfers of power, and continuity in policy direction, are especially crucial.
o Use competitive principles to improve the delivery of public and social services. Improving public
and social services is needed to increase productivity and will be essential to engaging the support of the
majority of Russians for further economic reforms. One priority is to reform the health care system using
value-based competition principles.149 Among other steps, health care provision could be opened

up to both public and private providers to drive a step-change improvement in health care delivery and
open up a huge new market for entrepreneurship.

4.1.2.2. Improving the General Business Environment

Without further improvements in the business environment, Russian companies will remain stuck in
low-value competition and restructuring will be limited. While there are many aspects of the business
environment that need to be addressed, the near term priorities are (1) opening up real competition, (2)
simplifying and modernizing the administrative roles of government, (3) addressing weaknesses and
bottlenecks in factor conditions, and (4) transforming legacy assets in education and research into
sustainable competitive assets.

Increase the level of competition in the Russian economy. Many weaknesses in the Russian economy
such as low productivity, limited and slow restructuring of industries and companies, and cost-based
company strategies are the result of restricted or limited competition. Russian policy today attempts to
address such weaknesses through government intervention. This treats the symptoms, not the root
causes. Competition—far more than private ownership per se—is at the heart of a functioning market
economy.

Without more competition, competitiveness upgrading will languish. 150

o Deepen opening to international trade and investment. Russia has taken important steps
through the WTO accession process to open its markets to the global economy. Russia is clearly lagging
in both imports and FDI, however, further progress now needs to be made, through tariff reforms, a
thorough a review of custom practices and administrative simplifications, and the active development of
supporting and related industries to facilitate the entry of foreign companies into Russia.
o Strengthen enforcement of competition laws. Russia has taken an important first step with the
approval of a new competition law. Competition policy needs to drive

structural changes, eliminate dominant market positions, and ensure that competitive practices are
aligned with productivity. The law has to be applied equally to all companies, including those that are
government-owned.

o Enhance competition among regions. Russia need to make targeted investments in logistical
infrastructure and eliminating all restraints and inefficiencies of internal movement of goods and
services. This will expand market size, open competition, and reduce dominant market positions.

o Strengthen the governance, transparency, and depth of the financial markets. Russia has made
good progress in the development of its financial markets. But these markets are still small, and
vulnerable to global or domestic shocks. A vibrant financial market will continue to improve the supply
of capital and strengthen competition through a stronger market for corporate control. This will drive
restructuring of companies and industries. More efficient financial markets would also reduce the role of
business groups as internal capital markets, opening competition further.

Streamline and limit the role of government in the economy. Russia has failed to achieve sufficient
improvement in the administrative rules and processes needed for a modern economy, while remaining
too directly involved in the control of companies.

o Improve administrative transparency, professionalism, and efficiency. With a more reliable and
efficient administration, corruption will decline, the costs of doing business will fall, uncertainties and
delays that hinder investment decisions will be reduced, and competition will rise. There is an urgent
need in Russia to reduce, simplify, and streamline rules and regulations at all levels of government. Past
incremental approaches to administrative reform have not succeeded.

We recommend that all administrative functions and approvals related to companies be concentrated in
a single new agency which operates in one-stop business development offices located in each region
and city. These offices would have full
transparency through posting all transactions on the Internet, fixed time limits for review and approval
processes, and a well compensated professional staff. This approach is already being taken in Russia’s
special economic zones, and supported by new dedicated courts. Such an approach would bypass the
problems of existing agencies.

o Create a new governance structure for government-linked companies (GLCs). Without more
professional management of GLCs, Russia will see not only substandard performance but also harm
competitiveness of the Russian economy through uneconomic practices, monopoly power in key
sectors, and distortions due to political influence. Strong independent regulators and full scrutiny of
GLCs by competition authorities are needed to ensure that these companies do not distort markets and
undermine Russia’s productivity.

Government needs to define clear performance objectives for each GLC, provide transparency in their
results, and establish governance structures independent of the political process. GLCs need to have
transparent economic goals to ensure that their behavior does not get politicized. GLCs need effective
boards with members selected based on their abilities. Management teams need to be hired and
evaluated based on merit and be able to operate free of political interference.

GLCs have rarely succeeded in not harming national competitiveness, much less contributing to it.
Countries with successful GLCs have created clear economic objectives and governance (Singapore), and
ensured that companies were exposed to a high degree of competition (Singapore, South Korea, Dubai).
The lack of competition and effective governance in Russian GLCs is problematic, much more so than the
presence of government ownership per se.

Economic conditions seemed to improve somewhat in Q3, after GDP shrank at the sharpest rate in a
decade in Q2. In Q3, economic activity fell at a much softer pace than Q2’s average, supported by a
gradual recovery in the vital industrial sector, as manufacturing firms continued to ramp up capacity,
which partly offset sliding mining output. Moreover, the easing of restrictions should have boosted
household spending: The drop in retail sales softened considerably in Q3, which, coupled with an
uptick in consumer confidence, points to returning consumer demand. That said, a weaker ruble and
rising unemployment rate likely tempered the rebound. Externally, conditions were more downbeat:
Merchandise exports continued to slide in July–August amid constrained domestic oil output and
depressed global crude prices. Turning to Q4, worsening private sector conditions and surging new
Covid-19 cases threaten to derail the fragile recovery.
Russia Economic Growth
GDP is set to contract at the sharpest pace in over a decade this year, as exports, investment
activity and consumer demand all plunge due to Covid-19. Next year, the economy should rebound
as the pandemic is expected to subside, with fiscal and monetary stimulus further supporting the
recovery. Geopolitical risks and the uncertainty over the pandemic cloud the outlook, however.
FocusEconomics panelists project GDP to rebound and grow 3.1% in 2021, which is down 0.2
percentage points from last month’s forecast. In 2022, growth is seen slowing to 2.3%.

Russia Economy Data

2015 2016 2017 2018 2019

Population (million) 147 147 147 147 147

GDP per capita (USD) 9,289 8,699 10,718 11,371 11,583

GDP (USD bn) 1,361 1,277 1,574 1,669 1,700

Economic Growth (GDP, annual variation in %) -2.0 0.2 1.8 2.5 1.3

Consumption (annual variation in %) -9.5 -2.6 3.7 3.3 2.5

Investment (annual variation in %) -10.6 1.3 4.7 0.1 1.5

Industrial Production (annual variation in %) 0.2 1.7 3.8 3.5 2.3

Retail Sales (annual variation in %) -9.8 -4.8 1.2 2.8 1.6

Unemployment Rate 5.6 5.5 5.2 4.8 4.6

Fiscal Balance (% of GDP) -2.4 -3.5 -1.4 2.6 1.8

Public Debt (% of GDP) 13.5 13.2 14.6 14.9 15.3

Money (annual variation in %) 11.3 9.2 10.5 11.0 9.7

Inflation Rate (CPI, annual variation in %, eop) 12.9 5.4 2.5 4.3 3.0
 2015 2016 2017 2018 2019

Inflation Rate (CPI, annual variation in %) 15.5 7.1 3.7 2.9 4.5

Inflation (PPI, annual variation in %) -   -   -   -   -  

Policy Interest Rate (%) 11.00 10.00 7.75 7.75 6.25

Stock Market (annual variation in %) 26.1 26.8 -5.5 11.8 29.1

Exchange Rate (vs USD) 72.88 60.27 57.63 68.88 61.91

Exchange Rate (vs USD, aop) 61.06 67.05 58.33 62.68 64.75

Current Account (% of GDP) 5.0 1.9 2.1 6.8 3.8

Current Account Balance (USD bn) 67.8 24.5 32.4 114 64.7

Trade Balance (USD billion) 148 90.2 115 194 163

Exports (USD billion) 341 282 353 443 418

Imports (USD billion) 193 191 238 249 255

Exports (annual variation in %) -31.3 -17.5 25.3 25.5 -5.7

Imports (annual variation in %) -37.3 -0.8 24.5 4.3 2.5

International Reserves (USD) 368 378 433 468 554

External Debt (% of GDP) 38.1 40.1 32.9 27.3 28.9

SAMPLE REPORT
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Russia Economy Overview

Economic Overview of Russia

Following the collapse of the Soviet Union, the first decade of transition from a centrally-planned
economy to market economy was disastrous for Russia: nominal gross domestic product (GDP) fell
from USD 516 billion in 1990 to USD 196 billion in 1999, which represented a plunge of over 60%. In
an attempt to address the economic turmoil and follow the recommendations from the IMF, the
Soviet government began to privatize many Russian industries during the 1990s. Important
exceptions were, however the energy and defense sectors.

The devaluation of the Russian ruble in 1998—after the financial crisis known as the ruble crisis—
together with the uninterrupted upward trend that oil prices experienced in the period from1999 to
2008 propelled the Russian economy—heavily reliant on its energy sector exports—to grow at an
annual average rate of 7%. Russia was among the hardest-hit economies by the 2008-2009 global
economic crisis: the economy plunged 7.8% in 2009 as oil prices plummeted and foreign credit dried
up. The economic contraction was the sharpest since 1994, but no long-term damage was caused
due to the government and Central Bank’s proactive and timely response to ring fence key sectors of
the economy, in particular the banking sector, from the effects of the crisis. As a result, Russia’s
economy began to grow again and increased 4.5%, 4.3% and 3.4% in 2010, 2011 and 2012,
respectively, before slowing to 1.3% in 2013 and 0.6% in 2014.

The Russian economy experienced two major shocks in 2014, narrowly avoiding recession with
moderate growth of 0.6%. The first shock was the sharp decline in oil prices during the third and
fourth quarter of 2014, exposing Russia’s extreme dependence on global commodity cycles. After
fluctuating within a tight band near USD 105 per barrel from 2011-2013, crude oil prices ended 2014
at less than USD 60 per barrel. The second shock was the economic sanctions resulting from
geopolitical tensions, which negatively affected investor appetite for Russian investments. Capital
flights and high inflation compound Russia’s economic woes as the economy registered the steepest
contraction since 2009 contracting 3.7% in the full year 2015. Forecasts are pointing to an end to the
recession coming soon in 2017.

Inflation has been falling rapidly since August 2015, when it reached a peak of 15.8%. Along with the
fall in inflation, Central Bank lending rates have been reduced. Russian bonds and equities are
performing well against those of other emerging markets and a modest recovery in oil prices has
bolstered economic sentiment.

Considering that the price for Urals oil will average USD 38 per barrel in 2016, the Central Bank
expects the economy to contract between 0.3% and 0.7% this year, which is less than the Bank’s
previous estimate that saw the economy contracting between 1.3% and 1.5%. The Bank expects the
economy to expand at a rate of between 1.1% and 1.4% in 2017, assuming that Urals oil prices
average USD 40 per barrel. Previously, the Bank had expected the price for Urals oil to average
USD 35 per barrel and had projected economic growth rising to within a range of minus 0.5% and
plus 0.5% in 2017.

Following the economy’s collapse in 2015, analysts surveyed by FocusEconomics expect the
Russian economy to continue contracting in 2016, although at a more moderate pace.
FocusEconomics Consensus Forecast panelists project that Russia’s GDP will fall 0.7% in 2016,
which is up 0.1 percentage points from last month’s forecast. Panelists expect the economy to
expand 1.3% in 2017.
Russia’s Balance of Payments

Russia’s current account records regular trade surpluses largely due to exports of commodities such
as crude oil and natural gas. From 2010 to 2014, Russia’s average current account surplus was
USD 66.8 billion, reaching a peak in 2011 at USD 98.8 billion.

Russia’s balance of payments suffered a significant terms-of-trade shock in the fourth quarter of
2014 as a result of falling oil prices, which were, in part, offset by a drop in imports. Simultaneously,
geopolitical uncertainties and related sanctions in 2014 resulted in large capital outflows, further
deteriorating Russia’s BoP. Private sector capital outflows increased from USD 60.7 billion in 2013
to USD 130.5 billion in 2014. During the same period, capital and financial accounts of the Russian
Federation fell from a deficit of USD 45.4 billion to a deficit of USD 146 billion (2.2% and 7.8% of
GDP, respectively).

Russia’s economy registered the steepest contraction since 2009 last year as a combination of
external factors—such as a plunge in oil prices and international sanctions—coupled with structural
weaknesses took a heavy toll on growth. The economy contracted 3.7% in the full year 2015, which
contrasted the meagre growth registered in the previous year. However, the contraction in the
Russian economy in the second quarter of 20167 was the slowest since the recession began in late
2014. Comprehensive data showed that GDP contracted 0.6% annually in Q2, which came in above
the 1.2% decrease recorded in Q1. Although industrial production shrank in September, falling at the
fastest pace seen in 8 months, it is expected to expand slightly in 2016 after suffering the worst
contraction in six years in 2015.

Russia’s trade structure

Crude oil, petroleum products and natural gas comprise roughly 58% of total exports, iron and steel
represent 4% and other mining sector related exports including gems and precious metals account
for about 2.5%. Sales to Europe represent over 60% of total exports while Asia has an export share
of roughly 30%. Russian exports to the United States, Africa and Latin America combined represent
less than 5% of total shipments.

Russia’s main imports are food and ground transports, which represent 13% and 12% of total
imports, respectively. Other significant imports include pharmaceuticals, textile and footwear,
plastics and optical instruments. Exports peaked in 2012 reaching USD 527 billion; imports peaked
in 2013 reaching USD 341 billion.

In August of 2015, Russian exports amounted to USD 25.0 billion, which marked a 39.7%
contraction in annual terms. This marked the 10th consecutive contraction at a double-digit rate.
Imports totaled USD 16.5 billion, which marked a 34.7% year-on-year contraction.

Russia’s trade surplus is narrowing rapidly. Russia’s trade surplus narrowed to USD 4.4 billion in
August of this year, which came in dramatically below the USD 8.8 billion registered in the same
month last year and the USD 16.2 billion the prior year. August’s result prompted the 12-month
rolling surplus to decrease to USD 99.5 billion, the smallest accumulated surplus in over a decade.
The fall in the trade surplus continues to reflect the free fall that Russian exports have registered
over the last few years.

Following a period of heightened volatility, oil prices have recently stabilized especially since the
extraordinary meeting of the OPEC Conference in Algiers in the last week of September, which
concluded with a commitment to freeze oil production at between 32.5 and 33.0 million barrels a
day. Analysts expect the commitment to be honored by most members at OPEC’s official meeting in
November where non-OPEC oil exporters are also encouraged to sign on the dotted line. The re-
establishment of OPEC’s price leadership prompted global oil prices to spike, including for Urals oil.
On 30 September, the price for Urals oil settled at USD 46.3 per barrel, which was 4.6% higher than
at the end of August. Urals oil has also recovered from the lows registered earlier this year and was
31.8% on a year-to-date basis.

Russia’s Monetary Policy

The Central Bank of Russia (Bank Rossii), founded in 1990, has several responsibilities in
compliance with the Russian Constitution and Russian Federal Law: maintaining the value and
stability of the ruble, overseeing Russian financial institutions (including acting as a lender of last
resort), managing Russia’s foreign reserves and foreign exchange, and setting short-term interest
rates, which is one of the main instruments of the bank’s monetary policy implementation.

Low oil prices and sanctions shocks to the Russian economy resulted in the ruble losing 46% of its
value against the U.S. dollar in 2014, prompting policies from the Bank Rossii aimed at stabilizing
the financial system. Bank Rossii raised its key interest rate in December 2014 by 650 basis points
to a lofty 17% to curb runaway inflation caused by the weakened ruble (core inflation reached 11.2%
in December 2014, year-on-year). Bank Rossii spent USD 27.2 billion in October 2014 and USD
11.9 billion in December of the same year on interventions to support the ruble.

Russia’s Central Bank gradually reduced interest rates over the course of 2015, starting the year at
17.00% and reduced to 11.00% by July. Interest rates were kept steady for nearly a year until June
2016 when they were cut by 50 basis points to 10.50%. In making the decision to cut interest rates,
the Central Bank indicated that authorities were more confident about the evolution of inflation and
noted the positive results of a drop in inflation expectations and decreased inflation risks against a
backdrop of their slowly but surely recovering economy.

Since then there has been a noticeable drop in inflation, which drove the Bank to cut rates in
September 2016 from 10.50% to 10.00%. Authorities did however state that in order to cement a
sustainable fall in inflation, “the current value of the key rate needs to be maintained till end-2016
with its further possible cuts in 2017 Q1-Q2.” Considering its decision, the Bank remains confident
that with a still relatively-tight monetary policy, inflation will fall to 4.5% in Q3 2017 and decrease
further toward its 4.0% target at the end of 2017. The bank also indicated that it will hold off from
further monetary easing until the first or second quarters of 2017.

Russia’s Exchange Rate Policy

On 10 November 2014, Bank Rossii un-pegged the ruble from a dual-currency (U.S. dollar and euro)
basket band, ending two decades of exchange rate controls and moving Russia to a free-float
exchange rate system. The Central Bank also ended the regular interventions with the ruble, but
signaled that it remained committed to intervening in support of the Russian currency in case there
were risks to financial stability. As the ruble continued to slide against the greenback because of
falling oil prices and higher uncertainty among investors, the Central Bank decided to continue
intervening in the foreign exchange market, costing the Central Bank hundreds of millions per day.

The value of the ruble first began to fall in early 2014 after several years of an exchange rate of
roughly 30 RUB per USD, as the country was acutely affected by weak economic growth, high
geopolitical risks following the annexation of Crimea and the outbreak of war in Ukraine. However, it
was with the collapse of oil prices at the end of 2014 when the ruble’s value could not defy gravity
and thus began its free fall against the U.S. dollar, with the currency bottoming out at 68.5 RUB per
USD on 16 December. Throughout 2015, the Russian ruble has been on a roller coaster. High
volatility and strong fluctuations in oil prices have weighed heavily on the country’s currency. The
beginning of 2015 saw strong volatility in the foreign exchange market, but the Russian currency
stabilized within a corridor of 50 to 60 RUB per USD at the end of the first half of the year. There was
another episode of strong volatility at the outset of second half of the year and, on 24 August, the
Russian currency closed the trading day at 70.9 RUB per USD, which was even lower than the
aforementioned low point of the December 2014 ruble crash and represented a new all-time low.
The sharp drop in August was primarily a response to falling oil prices and rising fears regarding the
effects that the shockwave caused by China’s stock-market crash could have on the global
economy. The ruble closed 2015 at 72.9 RUB per USD—a 30% loss in value compared to the end of
2014.

Fluctuations of the Russian ruble are largely driven by the price of oil, which along with gas, is
Russia’s main commodity export. The currency took a dramatic fall to an all-time low of 82.4 RUB
per USD on 21 January 2016, as oil prices fell to lows not seen in over a decade. It has gradually
stabilized between 60 and 70 RUB per USD as the economy has improved and oil prices have crept
back up since January 2016.

Russia’s Fiscal Policy

Since the country’s 1998 debt crisis, a nearly decade-long environment of favorable commodities
prices (particular in the energy sector), a relatively weak ruble and tight fiscal policy allowed Russia
to run budget surpluses from 2001 to 2008 until the global financial crisis hit.

Russia depends heavily on its energy exports. In fiscal year 2008, oil and gas revenues reached a
peak, accounting for half of the Russian federal budget. However, since the global financial crisis hit
the country in 2009, the Russian economy began to run fiscal deficits. In 2012, 2013 and 2014
Russia ran budget deficits representing -0.02%, -0.7% and -0.6% of GDP, respectively. The
exception was the year 2011, when the Russian budget incurred a 0.8% of GDP surplus.

Low oil prices and a collapse in domestic demand and imports as the economy fell into recession
decimated fiscal revenues in 2015. In fact, the impact of low oil prices on Russia’s fiscal revenues
raised questions about the country’s long-term economic prospects as well as fiscal sustainability.
With the decline of energy prices and the Russian government's dependence on energy revenues to
fund its budget—revenues from oil and natural gas represented around 52% of the Russian budget
—forced the Russian government to rethink its fiscal policy. The Finance Ministry announced in early
September 2015 that it had decided to suspend the fiscal rule—a law designed to limit government
spending.

The fiscal rule went into effect in 2013 to prevent the government from wasting windfall oil revenues
and instead divert them into rainy-day funds. The rule also aimed to limit government expenditure to
projected non-oil revenues, oil revenues calculated using long-term historical oil prices, and a fiscal
deficit of at no more than 1.0% of GDP. At the time the rule was created, Russian authorities were
concerned that the income generated from rising oil prices would encourage pro-cyclical spending.
However, within the context of weak economic growth and oil prices at just half the level observed in
2014, Russia faced the opposite problem.

Because the budget rule limits government spending to long-term historical oil prices, if the law were
to continue into 2016, it would have implied a reference price higher than the one that was forecast
for 2016—which was an average USD 50 per barrel.

Officially, the fiscal rule was suspended temporarily. Some advisors, among them former-Finance
Minister Alexei Kudrin, voiced support for suspending the rule, at least for a year. Moreover, in
addition to the suspension of the fiscal rule, the government also announced a transition from a
three-year budget plan to one-year budgeting. The three-year budget plan was designed to force the
government to take a medium-term approach and avoid making unsustainable pledges. All in all, the
changes to the budget process paved the way for a more accommodative fiscal stance in an effort to
mitigate the low oil prices and weaker economic growth.

Some analysts suggest that, with sizeable reserves and low public debt, Russia can afford to run a
modest fiscal deficit without imperiling fiscal sustainability. The fiscal deficit ended at 2.8% in 2015.

Russia has two fiscal buffers, the Reserve Fund and the National Welfare Fund (NWF), both of
which have been under pressure as a result of deteriorating economic conditions. The Ministry of
Finance indicated that the budget deficit projected for 2015 (RUB 2.7 trillion, equivalent to 3.8% of
GDP) would be covered by the country’s Reserve Fund, rather than by raising debt. Unfortunately,
the government was unable to sustain that deficit due to the inability to fund it. Due to international
sanctions, the government has been unable to borrow from abroad. The government allowed for
increased discretionary use of NWF resources in December of 2014 in order to help stabilize the
financial system. The Russian government had no choice but to continue to draw down on the NWF.

ust as leaders of the Soviet Union had to create their own command socialist systems, leaders of
the economies making the transition to market capitalist economies must find their own paths to
new economic systems. It is a task without historical precedent.

In this section we will examine two countries and the strategies they have chosen for the
transition. China was the first socialist nation to begin the process, and in many ways it has been
the most successful. Russia was the dominant republic in the old Soviet Union; whether its
transition is successful will be crucially important. Before turning to the transition process in
these two countries, we will consider some general problems common to all countries seeking to
establish market capitalism in the wake of command socialism.

Problems in Transition
Establishing a system of market capitalism in a command socialist economy is a
daunting task. The nations making the attempt must invent the process as they go
along. Each of them, though, faces similar problems. Former command socialist
economies must establish systems of property rights, establish banking systems,
deal with the problem of inflation, and work through a long tradition of ideological
antipathy toward the basic nature of a capitalist system.

Property Rights
A market system requires property rights before it can function. A property right
details what one can and cannot do with a particular asset. A market system
requires laws that specify the actions that are permitted and those that are
proscribed, and it also requires institutions for the enforcement of agreements
dealing with property rights. These include a court system and lawyers trained in
property law and contract law. For the system to work effectively, there must be
widespread understanding of the basic nature of private property and of the
transactions through which it is allocated.

Command socialist economies possess virtually none of these prerequisites for

market capitalism. When the state owned virtually all capital and natural resources,
there was little need to develop a legal system that would spell out individual
property rights. Governments were largely free to do as they wished.

Countries seeking a transition from command socialism to market capitalism must

develop a legal system comparable to those that have evolved in market capitalist
countries over centuries. The problem of creating a system of property rights and
the institutions necessary to support it is a large hurdle for economies making the
transition to a market economy.

One manifestation of the difficulties inherent in establishing clear and widely

recognized property rights in formerly socialist countries is widespread criminal
activity. Newly established private firms must contend with racketeers who offer
protection at a price. Firms that refuse to pay the price may find their property
destroyed or some of their managers killed. Criminal activity has been rampant in
economies struggling toward a market capitalist system.

Banking
Banks in command socialist countries were operated by the state. There was no
tradition of banking practices as they are understood in market capitalist countries.

In a market capitalist economy, a privately owned bank accepts deposits from

customers and lends these deposits to borrowers. These borrowers are typically
firms or consumers. Banks in command socialist economies generally accepted
saving deposits, but checking accounts for private individuals were virtually
unknown. Decisions to advance money to firms were made through the economic
planning process, not by individual banks. Banks did not have an opportunity to
assess the profitability of individual enterprises; such considerations were
irrelevant in the old command socialist systems. Bankers in these economies were
thus unaccustomed to the roles that would be required of them in a market
capitalist system.

Inflation
One particularly vexing problem facing transitional economies is inflation. Under
command socialist systems, the government set prices; it could abolish inflation by
decree. But such systems were characterized by chronic shortages of consumer
goods. Consumers, unable to find the goods they wanted to buy, simply
accumulated money. As command socialist economies began their transitions,
there was typically a very large quantity of money available for consumers to
spend. A first step in transitions was the freeing of prices. Because the old state-
determined prices were generally below equilibrium levels, prices typically surged
in the early stages of transition. Prices in Poland, for example, shot up 400% within
a few months of price decontrol. Prices in Russia went up tenfold within six
months.

One dilemma facing transitional economies has been the plight of bankrupt state
enterprises. In a market capitalist economy, firms unable to generate revenues that
exceed their costs go out of business. In command socialist economies, the central
bank simply wrote checks to cover their deficits. As these economies have begun
the transition toward market capitalism, they have generally declared their
intention to end these bailouts and to let failing firms fail. But the phenomenon of
state firms earning negative profits is so pervasive that allowing all of them to fail
at once could cause massive disruption.

The practical alternative to allowing firms to fail has been continued bailouts. But
in transitional economies, that has meant issuing money to failed firms. This
practice increases the money supply and contributes to continuing inflation. Most
transition economies experienced high inflation in the initial transition years, but
were subsequently able to reduce it.

Ideology
Soviet citizens, and their counterparts in other command socialist economies, were
told for decades that market capitalism is an evil institution, that it fosters greed
and human misery. They were told that some people become rich in the system,
but that they do so only at the expense of others who become poorer.

In the context of a competitive market, this view of market processes as a zero-sum

game—one in which the gains for one person come only as a result of losses for
another—is wrong. In market transactions, one person gains only by making others
better off. But the zero-sum view runs deep, and it is a source of lingering hostility
toward market forces.
Countries seeking to transform their economies from command socialist to more
market-oriented systems face daunting challenges. Given these challenges, it is
remarkable that they have persisted in the effort. There are a thousand reasons for
economic reform to fail, but the reform effort has, in general, continued to move
forward.

China: A Gradual Transition

China is a giant by virtually any standard. Larger than the continental United
States, it is home to more than 1.3 billion people—more than one-fifth of the
earth’s population. Although China is poor, its economy has been among the
fastest growing in the world since 1980. That rapid growth is the result of a gradual
shift toward a market capitalist economy. The Chinese have pursued their
transition in a manner quite different from the paths taken by former Soviet bloc
nations.

Recent History
China was invaded by Japan during World War II. After Japan’s defeat, civil war
broke out between Chinese communists, led by Mao Zedong, and nationalists. The
communists prevailed, and the People’s Republic of China was proclaimed in
1949.

Mao set about immediately to create a socialist state in China. He nationalized

many firms and redistributed land to peasants. Many of those who had owned land
under the old regime were executed. China’s entry into the Korean War in 1950 led
to much closer ties to the Soviet Union, which helped China to establish a
command socialist economy.

China’s first five-year plan, launched in 1953, followed the tradition of Soviet
economic development. It stressed capital-intensive production and the
development of heavy industry. But China had far less capital and a great many
more people than did the Soviet Union. Capital-intensive development made little
sense. In 1958, Mao declared a uniquely Chinese approach to development, which
he dubbed the Great Leap Forward. It focused on labor-intensive development and
the organization of small productive units to quickly turn China into an
industrialized country. Indeed, households were encouraged to form their own
productive units under the slogan “An iron and steel foundry in every backyard.”
The Great Leap repudiated the bonuses and other material incentives stressed by
the Soviets; motivation was to come from revolutionary zeal, not self-interest.

In agriculture, the new plan placed greater emphasis on collectivization. Farmers

were organized into communes containing several thousand households each.
Small private plots of land, which had been permitted earlier, were abolished.
China’s adoption of the plan was a victory for radical leaders in the government.

The Great Leap was an economic disaster. Output plunged and a large-scale
famine ensued. Moderate leaders then took over, and the economy got back to its
1957 level of output by the mid-1960s.

Then, again in the mid-1960s, power shifted back towards the radicals with the
launching of the Great Proletarian Cultural Revolution. During that time, students
formed groups called “red guards” and were encouraged to expose “capitalist
roaders.” A group dubbed the “Gang of Four,” led by Mao’s wife Jiang Qing, tried
to steer Chinese society towards an ever more revolutionary course until Mao’s
death in 1976.

China’s Reforms
Following Mao’s death, pragmatists within the Communist Party, led by Deng
Xiaoping, embarked on a course of reform that promoted a more market-oriented
economy coupled with retention of political power by the Communists. This policy
combination was challenged in 1989 by a large demonstration in Beijing’s
Tiananmen Square. The authorities ordered the military to remove the
demonstrators, resulting in the deaths of several hundred civilians. A period of
retrenchment in the reform process followed and lasted for several years. Then, in
1992, Deng ushered in a period of reinvigorated economic reform in a highly
publicized trip to southern China, where reforms had progressed farther. Through
several leadership changes since then, the path of economic reform, managed by
the Communist Party, has continued. The result has been a decades-long period of
phenomenal economic growth.

What were some of the major elements of the economic reform? Beginning in
1979, many Chinese provincial leaders instituted a system called bao gan dao hu
—“contracting all decisions to the household.” Under the system, provincial
officials contracted the responsibility for operating collectively owned farmland to
individual households. Government officials gave households production quotas
they were required to meet and purchased that output at prices set by central
planners. But farmers were free to sell any additional output they could produce at
whatever prices they could get in the marketplace and to keep the profits for
themselves.

By 1984, 93% of China’s agricultural land had been contracted to individual

households and the rate of growth in agricultural output had soared.

At the industrial level, state-owned enterprises (SOEs) were told to meet their
quotas and then were free to engage in additional production for sale in free
markets. Over time, even those production directives were discontinued. More
importantly, manufacturing boomed with the development of township and village
enterprises, as well as various types of private endeavors, with much participation
from foreign firms. Most price controls were abolished. The entry of China into the
World Trade Organization in 2001 symbolized a commitment towards moving
even further down the road of economic reform.

In effect, China’s economy is increasingly directed by market forces. Even though

five-year plans are still announced, they are largely advisory rather than
commanding in nature. Recognizing the incomplete nature of the reforms, Chinese
authorities continue to work on making the SOEs more competitive, as well as
privatizing them, creating a social security system in which social benefits are not
tied to a worker’s place of employment, and reforming the banking sector.

How well has the gradual approach to transition worked? Between 1980 and 2006,
China had one of the fastest-growing economies in the world. Its per capita output,
measured in dollars of constant purchasing power, more than quadrupled. The
country, which as late as 1997 was one of the poorest of the 59 low-income-
countries in the world, is now situated comfortably among the more prosperous
lower-middle-income countries, according to the World Bank. Figure 34.6
“Soaring Output in China” compares growth rates in China to those achieved by
Japan and the United States and to the average annual growth rate of all world
economies between 1985 and 2006.
Figure 34.6 Soaring Output in China
 China’s growth in per capita output from 1985 to 2006 greatly exceeded rates recorded for Japan, the United States, or the
average of all nations.
Source: World Bank, World Development Reports, 1997, 1998, 2004, 2005, 2006 Table 1.

Where will China’s reforms lead? While the Chinese leadership has continued to
be repressive politically, it has generally supported the reform process. The result
has been continued expansion of the free economy and a relative shrinking of the
state-run sector. Given the rapid progress China has achieved with its gradual
approach to reform, it is hard to imagine that the country would reverse course.
Given the course it is on, China seems likely to become a market capitalist
economy—and a prosperous one—within a few decades.

Russia: An Uncertain Path to Reform

Russia dominated the former Soviet Union. It contained more than half the Soviet
people and more than three-fourths of the nation’s land area. Russia’s capital,
Moscow, was the capital and center of power for the entire country.

Today, Russia retains control over the bulk of the military power that had been
accumulated by the former Soviet Union. While it is now an ally of the United
States, Russia still possesses the nuclear capability to destroy life on earth. Its
success in making the transition to market capitalism and joining as a full partner
in the world community thus has special significance for peace.

Recent History
Russia’s shift toward market capitalism has its roots in a reform process initiated
during the final years of the existence of the Soviet Union. That effort presaged
many of the difficulties that have continued to plague Russia.
The Soviet Union, as we have already seen, had a well-established system of
command socialism. Leading Soviet economists, however, began arguing as early
as the 1970s that the old system could never deliver living standards comparable to
those achieved in market capitalist economies. The first political leader to embrace
the idea of radical reform was Mikhail Gorbachev, who became General Secretary
of the Communist party—the highest leadership post in the Soviet Union—in
1985.

Mr. Gorbachev instituted political reforms that allowed Soviet citizens to speak
out, and even to demonstrate, against their government. This policy was
dubbed glasnost, or “openness.” Economically, he called for much greater
autonomy for state enterprises and a system in which workers’ wages would be
tied to productivity. The new policy, dubbed perestroika, or “restructuring,”
appeared to be an effort to move the system toward a mixed economy.

But Mr. Gorbachev’s economic advisers wanted to go much further. A small group
of economists, which included his top economic adviser, met in August 1990 to
draft a radical plan to transform the economy to a market capitalist system—and to
do it in 500 days. Stanislav Shatalin, a Soviet economist, led the group. Mr.
Gorbachev endorsed the Shatalin plan the following month, and it appeared that
the Soviet Union was on its way to a new system. The new plan, however,
threatened the Soviet power elite. It called for sharply reduced funding for the
military and for the Soviet Union’s secret police force, the KGB. It would have
stripped central planners, who were very powerful, of their authority. The new plan
called for nothing less than the destruction of the old system—and the elimination
of the power base of most government officials.

Top Soviet bureaucrats and military leaders reacted to the Shatalin plan with
predictable rage. They delivered an ultimatum to Mr. Gorbachev: dump the
Shatalin plan or be kicked out.

Caught between advisers who had persuaded him of the necessity for radical
reform and Communist party leaders who would have none of it, Mr. Gorbachev
chose to leave the command system in place and to seek modest reforms. He
announced a new plan that retained control over most prices and he left in place the
state’s ownership of enterprises. In an effort to deal with shortages of other goods,
he ordered sharp price increases early in 1991.

These measures, however, accomplished little. Black market prices for basic
consumer goods were typically 10 to 20 times the level of state prices. Those
prices, which respond to demand and supply, may be taken as a rough gauge of
equilibrium prices. People were willing to pay the higher black market prices
because they simply could not find goods at the state-decreed prices. Mr.
Gorbachev’s order to double and even triple some state prices narrowed the gap
between official and equilibrium prices, but did not close it. Table 34.1 “Official
Versus Black Market Prices in the Soviet Union, 1991” shows some of the price
changes imposed and compares them to black market prices.
Table 34.1 Official Versus Black Market Prices in the Soviet Union, 1991

Item Old price New price Black market price

Children’s
2–10 rubles 10–50 rubles 50–300 rubles
shoes

Toilet paper 32–40 kopeks 60–75 kopeks 2–3 rubles

Compact car 7,000 rubles 35,000 rubles 70,000–100,000 rubles

Bottle of vodka 10.5 rubles 10.5 rubles 30–35 rubles

Mikhail Gorbachev ordered sharp increases in the prices of most consumer goods early in 1991 in an
effort to eliminate shortages. As the table shows, however, a large gap remained between official and
black market prices.
Source: Komsomolskaya pravda

Perhaps the most important problem for Mr. Gorbachev’s price hikes was that
there was no reason for state-owned firms to respond to them by increasing their
output. The managers and workers in these firms, after all, were government
employees receiving government-determined salaries. There was no mechanism
through which they would gain from higher prices. A private firm could be
expected to increase its quantity supplied in response to a higher price. State-
owned firms did not.
The Soviet people faced the worst of economic worlds in 1991. Soviet output
plunged sharply, prices were up dramatically, and there was no relief from severe
shortages. A small group of government officials opposed to economic reform
staged a coup in the fall of 1991, putting Mr. Gorbachev under house arrest. The
coup produced massive protests throughout the country and failed within a few
days. Chaos within the central government created an opportunity for the republics
of the Soviet Union to declare their independence, and they did. These defections
resulted in the collapse of the Soviet Union late in 1991, with Russia as one of 15
countries that emerged.

The Reform Effort

Boris Yeltsin, the first elected president of Russia, had been a leading proponent of
market capitalism even before the Soviet Union collapsed. He had supported the
Shatalin plan and had been sharply critical of Mr. Gorbachev’s failure to
implement it. Once Russia became an independent republic, Mr. Yeltsin sought a
rapid transition to market capitalism.

Mr. Yeltsin’s reform efforts, however, were slowed by Russian legislators, most of
them former Communist officials who were appointed to their posts under the old
regime. They fought reform and repeatedly sought to impeach Mr. Yeltsin. Citing
health reasons, he abruptly resigned from the presidency in 1999, and appointed
Vladimir Putin, who had only recently been appointed as Yeltsin’s prime minister,
as acting president. Mr. Putin has since been elected and re-elected, though many
observers have questioned the fairness of those elections as well as Mr. Putin’s
commitment to democracy. Barred constitutionally from re-election in 2008, Putin
became prime minister. Dimitry Medvedev, Putin’s close ally, became president.

Despite the hurdles, Russian reformers have accomplished a great deal. Prices of
most goods have been freed from state controls. Most state-owned firms have been
privatized, and most of Russia’s output of goods and services is now produced by
the private sector.

To privatize state firms, Russian citizens were issued vouchers that could be used
to purchase state enterprises. Under this plan, state enterprises were auctioned off.
Individuals, or groups of individuals, could use their vouchers to bid on them. By
1995 most state enterprises in Russia had been privatized.

While Russia has taken major steps toward transforming itself into a market
economy, it has not been able to institute its reforms in a coherent manner. For
example, despite privatization, restructuring of Russian firms to increase efficiency
has been slow. Establishment and enforcement of rules and laws that undergird
modern, market-based systems have been lacking in Russia. Corruption has
become endemic.

While the quality of the data is suspect, there is no doubt that output and the
standard of living fell through the first half of the 1990s. Despite a financial crisis
in 1998, when the Russian government defaulted on its debt, output recovered
through the last half of the 1990s and Russia has seen substantial growth in the
early years of the twenty-first century. In addition, government finances have
improved following a major tax reform and inflation has come down from near
hyperinflation levels. Despite these gains, there is uneasiness about the long-term
sustainability of this progress because of the over-importance of oil and high oil
prices in the recovery. Mr. Putin’s fight, whether justified or not, with several of
Russia’s so-called oligarchs, a small group of people who were able to amass large
fortunes during the early years of privatization, creates unease for domestic and
foreign investors.

To be fair, overcoming the legacy of the Soviet Union would have been difficult at
best. Overall, though, most would argue that Russian transition policies have made
a difficult situation worse. Why has the transition in Russia been so difficult? One
reason may be that Russians lived with command socialism longer than did any
other country. In addition, Russia had no historical experience with market
capitalism. In countries that did have it, such as the Czech Republic, the switch
back to capitalism has gone far more smoothly and has met with far more success.
Try It!
Table 34.1 “Official Versus Black Market Prices in the Soviet Union, 1991” shows three
prices for various goods in the Soviet Union in 1991. Illustrate the market for compact cars
using a demand and supply diagram. On your diagram, show the old price, the new price,
and the black market price.

Case in Point: Eastern Germany’s Surprisingly Difficult Transition Experience

Figure 34.7
Gavin Stewart – The fall of the Berlin Wall – CC BY 2.0.

The transition of eastern Germany was supposed to be the easiest of them all. Quickly
merged with western Germany, given its new “Big Brother’s” deep pockets, the ease with
which it could simply adopt the rules and laws and policies of western Germany, and its
automatic entry into the European Union, how could it not do well? And yet, eastern
Germany seems to be languishing while some other central European countries that had also
been part of the Soviet bloc are doing much better. Specifically, growth in real GDP in
eastern Germany was 6% to 8% in the early 1990s, but since then has mostly been around
1%, with three years of negative growth in the early 2000s. In the early 1990s, the Polish
economy grew at less than half east Germany’s rate, but since then has averaged more than
4% per year. Why the reversal of fortunes?

Most observers point to the quick rise of wages to western German levels, despite the low
productivity in the east. Initially, Germans from both east and west supported the move. East
Germans obviously liked the idea of huge wage increases while west German workers
thought that prolonged low wages in the eastern part of the country would cause companies
to relocate there and saw the higher east German wages as protecting their own jobs. While
the German government offered subsidies and tax breaks to firms that would move to the
east despite the high wages, companies were by and large still reluctant to move their
factories there. Instead they chose to relocate in other central European countries, such as the
Czech Republic, Slovakia, and Poland. As a result, unemployment in eastern Germany has
remained stubbornly high at about 15% and transfer payments to east Germans have totaled
$1.65 trillion with no end in sight. “East Germany had the wrong prices: Labor was too
expensive, and capital was too cheap,” commented Klaus Deutsch, an economist at Deutsche
Bank.
While the flow of labor has primarily been from Poland to Germany since the break-up of
the Soviet bloc, with mostly senior managers moving from Germany to Poland, there are
some less-skilled, unemployed east Germans who are starting to look for jobs in Poland.
Tassilo Schlicht is an east German who repaired bicycles and washing machines at a Soviet-
era factory and lost his job in 1990. He then worked for a short time at a gas station in his
town for no pay with the hope that the experience would be helpful, but he was never hired.
He undertook some government-sponsored retraining but still could not find a job. Finally,
he was hired at a gas station across the border in Poland. The pay is far less than what
employed Germans make for doing similar jobs but it is twice what he had been receiving in
unemployment benefits. “These days, a job is a job, wherever it is.”
Sources: Marcus Walker and Matthew Karnitschnig, “Eastern Europe Eclipses Eastern
Germany,” Wall Street Journal, November 9, 2004, p. A16; Keven J. O’Brien, “For Jobs,
Some Germans Look to Poland,” New York Times, January 8, 2004, p. W1; Doug Saunders,
“What’s the Matter with Eastern Germany?” The Globe and Mail (Canada), November 27,
2007, p. F3.
Try It!
There is a shortage of cars at both the old price of 7,000 rubles and at the new price of
35,000, although the shortage is less at the new price. Equilibrium price is assumed to be
70,000 rubles.
Figure 34.8
Political and economic context
Russia’s interventions in Ukraine and illegal annexation of Crimea in
2014, the chemical attack in Salisbury in 2018, and the use of a
chemical weapon on Russian territory in 2020, pose a challenging
backdrop for British businesses operating in Russia. There are
limitations on pursuing some activities in Russia but legitimate business
can continue and UK exports remain robust in both goods and services.

The Department for International Trade (DIT) (formerly known as UK

Trade & Investment) continues to support British companies in the
market with a range of services including targeted events, sector-specific
advice, market introductions and trade missions.
Russia is the world’s 11th largest economy by GDP according to the IMF
´s estimates for 2020. The economy declined by a relatively modest
3.1% in 2020 thanks in part to lighter-touch COVID-19 restrictions.
However, the outlook remains subdued due to sanctions and structural
constraints. Macroeconomic policy continues to prioritise stability;
government debt remains low, even after the pandemic, and inflation is
low and stable. The IMF predicts growth to be 3.0% in 2021 and return
to pre-crisis levels by 2022. A $400bn government spending programme,
the ‘National Projects’, could push growth higher and presents
opportunities for businesses in areas like infrastructure, financial
services, healthcare and education.

Although Russia has the smallest population of the BRIC economies, it

is the wealthiest in per capita terms by a considerable margin. This
means that it has a relatively large middle class, though recent low
growth has suppressed their real incomes. Consumers nonetheless seek
quality and innovation within a growing retail sector.

Russia’s domestic supply of consumer goods and services is still

underdeveloped – so there are opportunities to develop new business
e.g. e-commerce. Growth is currently sector-specific e.g. mining,
hydrocarbons and agriculture.

Heightened political tensions and the Russian government’s focus on

import substitution have made some companies more wary of buying
foreign goods and services. However, Russians understand that British
exports provide some of the highest quality, most innovative goods and
services available. Significant opportunities remain in, for example,
consumer goods, luxury, education and machine tools.

Russia’s investment climate is mixed. It reached 28th position in

the World Bank’s Doing Business rating in 2020; it currently ranks higher
than China, India and Brazil. However, there are concerns about the rule
of law, transparency and access to credit. These concerns pose
challenges for domestic and international investment but major Western
companies continue to have a large presence in Russia in a range of
sectors including energy, finance, business services, consumer goods,
automobile and engineering. Despite the sanctions and the economic
downturn, a number of companies are continuing to invest.
In 2011, Russia, Kazakhstan and Belarus entered into a Customs Union.
In 2015 the union evolved into the Eurasian Economic Union, which
consists of a Customs Union and a Single Economic Space. Armenia
and Kyrgyzstan has since joined the Union. The organisation is still
developing, but regulation of various different sectors and technical
regulations are now being set centrally by the Eurasian Economic
Commission. The Eurasian Economic Union’s ultimate ambition is for
free movement of goods, services, capital and labour

EU sanctions
The UK government and our international partners, including the EU,
have introduced sanctions against Russia’s interventions in Ukraine and
the illegal annexation of Crimea. These sanctions mean that trade and
investment with Russia in specific targeted areas and/or with specific
entities/individuals is illegal.

We are working hard to secure full implementation of the Minsk

Agreements and work with our international partners to ensure future
stability and prosperity in the region. To achieve these objectives we will
use the full range of our diplomatic channels and keep our overall
engagement with Russia under constant review.

Information about the restrictive measures that have been implemented

can be found on the GOV.UK site. If in doubt, businesses should consult
the Business Support helplines. UK businesses should be mindful of the
potential risks and challenges of working in a sanctions environment.
Business should continue to pay close attention to the Russia sections of
the DIT and FCDO.
Companies may also need to be aware of sanctions regimes imposed by
other countries, for example, the US.
The EU’s restrictive measures are targeted, so legitimate business may
continue where sanctions do not apply. Companies should consult the
information about sanctions on the GOV.UK site and if in doubt
contact DIT Russia who can share contact details for Moscow based law
firms familiar with the sanctions regime.

It is important that companies research sanctions thoroughly and take

advantage of the advice offered by DIT. We expect UK companies to
stay strictly within the law.

Human rights
Russia is a country of concern for human rights issues. See the FCDO
Annual Human Rights Report on Russia for more details.

Bribery and corruption

Bribery is illegal. It is an offence for British nationals or someone who is
ordinarily resident in the UK, a body incorporated in the UK or a Scottish
partnership, to bribe anywhere in the world. In addition, a commercial
organisation carrying on a business in the UK can be liable for the
conduct of a person who is neither a UK national or resident in the UK or
a body incorporated or formed in the UK. In this case it does not matter
whether the acts or omissions which form part of the offence take place
in the UK or elsewhere.

Corruption is endemic in Russia and is a major concern for businesses

operating there.The Russian government continues to state its
commitment to reducing corruption and other damaging informal
practices but they remain a challenge in practice. Russia fell
in Transparency International’s Corruption Perceptions Index in 2018 to
138 out of 180 countries.
Visit the Business Anti-Corruption portal which provides advice and
guidance about corruption in Russia.
Read the information provided on our Bribery and corruption page.
Terrorism threat
There is a high threat from terrorism. Although there is no indication that
British nationals or interests have been specific targets, attacks could be
indiscriminate, including in places frequented by foreigners. You should
remain vigilant in all public places, including tourist sites and crowded
places, particularly where access is not controlled (eg open-air events
and markets) and in major transport hubs.

Previous attacks have targeted transport infrastructure, including

airports, buses, trains and metro systems. Further attacks are likely, and
could take place anywhere in Russia.

See the FCDO travel advice.

Read the information provided on our terrorism threat page.
6. Protective security advice
There are protective security issues attached to doing business in
Russia; business people need to be conscious of the following activities
of the local security service (FSB):

 IT attack against office computers, laptops, PDAs and other

electronic devices
 physical, audio and video surveillance
 approaches to staff
 interception of telephone calls (landline and mobile), texts,
emails, fax and post
 searches of offices, homes, vehicles and (especially) hotel
rooms (including safes)
For specific advice email MoscowBusinessSecurity@fcdo.gov.uk
Read the information provided on our protective security advice page.
Intellectual property
IP rights are territorial, that is they only give protection in the countries
where they are granted or registered. If you are thinking about trading
internationally, then you should consider registering your IP rights in your
export markets.

Read the information provided on our Intellectual Property page.

Organised crime
Read the information provided on our organised crime page.

Department for International Trade

contact
Contact us on tradeinvestmentmoscow@fcdo.gov.uk

Russia in 2020: Will the Economy Grow

Faster?
The fundamentals are in place. But what will it take for the
Russian economy to finally pick-up speed?
By Jake Cordell
Dec. 25, 2019
    
Russian policymakers have favored stability over growth. Is that about to change?
Pixabay / MT
How do you achieve fast growth, without compromising macroeconomic stability? That is the
central dilemma which has faced Russian policymakers since 2014. 
When it came to making a choice between the two, stability won out nearly every time.
Following the annexation of Crimea, provision of support for pro-Russian separatists in Eastern
Ukraine and interference in the 2016 U.S. Presidential Election, Russia pulled itself — and
others pushed it — away from the international economy.
“Russia has created a model where it has a very closed economic system, but also a system that
cannot generate growth. You can have stability or growth — and Russia has chosen stability,”
said Saxo Bank’s chief economist Steen Jakobson.
As a new decade starts, however, Russia believes it has found a way to achieve both. 
It plans to use the government war-chest built up through half a decade of ultra-conservative
macroeconomic policy to kick-start a new growth chapter and boost living standards, all while
keeping the economy safe from economic storms. Doing so will be no small feat.
2020: Fresh Start

“The previous five-to-seven years of a conservative policy mix was not an easy time for
economic growth,” said Sofya Donets, economist at Renaissance Capital. “But it prepared a
perfect starting point — almost a textbook case — for a nice fresh start.”
At the cost of faster growth, Russia now boasts what Elliott Auckland, chief economist of the
International Investment Bank (IIB) calls “an incredible balance sheet”: a sovereign wealth fund
of more than $125 billion, a government budget surplus that hit almost 3% of GDP in 2018 and
net public debt of zero.
Russia also has stable and relatively low inflation, a sustainable banking sector and a free-
floating exchange rate that leaves the ruble less dependent on oil prices than before.
Hopes for capitalizing on this position rest squarely on how the government will choose to use
those impressive resources. Of the dozen analysts spoken to by The Moscow Times, government
spending — how much, when and on what — was almost the only factor they cited that has a
realistic chance of delivering faster economic growth in 2020. 
MT / FRED

“Russia could do so much more. The problem is the policy mix of the government has been
super-conservative,” said Auckland. “If you look at the shift in policies that have occurred over
the past year, with the National Projects and the Central Bank cutting rates, they are now
becoming a bit more expansionary.”
Officially, the government plans to spend19.5 trillion rubles ($310 billion) in 2020 — a 6.5%
nominal increase compared to 2019. That includes allocations under Russia’s flagship six-year
$400 billion National Projects which will step-up in 2020. Alongside that, Russia is also set to
experiment with how to open the purse-strings of its $125 billion national wealth fund (NWF),
and start investing future oil profits in the economy, now that the government is close to its
desired safety buffer of 7% of GDP.
The Central Bank, too, will do its part, cutting interest rates toward 5% by the end of the year,
economists forecast, in a bid to stimulate borrowing.
Conservatism reigns

Even with this extra stimulus, the growth pick-up is predicted to remain underwhelming.
The World Bank forecasts an expansion of 1.6% next year, and the International Monetary Fund
(IMF) has pencilled in 1.9%. Even optimistic predictions, such as the IIB’s 2.5% “only sound
good when compared to recent levels,” said Auckland, adding that the Russian economy should
be aiming for a lot more.
“In relative terms, there is not too much to be proud of,” said Ekaterina Trofimova, a partner at
Deloitte CIS. “Technically, this is not stagnation or recession, [but] in relative terms, Russia is in
recession: We keep losing our very small portion of the global GDP pie.”
Some are also unconvinced by Russia’s commitment to its new-found free-spending mantra.
Looking over the government’s proposed budget for the next few years, ING’s chief economist
Dmitry Dolgin wrote in a research note: “We interpret this as more of a verbal response to
growth concerns rather than an actual willingness to sacrifice accumulated macro stability in
favor of a short-term boost to the economy.”
The hesitancy for more adventurous spending plans may stem from the man ultimately pulling
the strings.
NEWS
WHAT COULD RUSSIA’S ECONOMY LOOK LIKE AFTER PUTIN?
READ MORE

“Putin prefers a very conservative approach to spending and wants to keep a comfortable budget
and financial reserve cushion,” said Chris Weafer, head of consultancy Macro Advisory.
As he enters his 21st year at the helm of the Russian state, there is little evidence Putin might be
willing to fully embrace a new economic agenda and risk what he sees as Russia’s progress
toward economic sovereignty. He has repeatedly shown a fondness for reserve-building and a
fear of going too deep into the red — for instance, by making paying-off Russia’s IMF debt one
of his first priorities upon entering the Kremlin.
In addition, the latest developments in the debate over whether — and how — the government
should start to spend its NWF also question whether the state is ready to shake its preference for
saving.
On current oil prices, Russia could have up to 10 trillion rubles ($157 billion) in extra oil profits
to invest over the next three years — a prize Russian businesses had been eyeing up.
“They will not get anywhere close to that,” said Deloitte’s Trofimova. “New requirements for the
distribution of this fund are such that … very few companies will qualify. You certainly won’t
see these trillions of rubles being used.” Recent proposals given a green light by prime minister
Dmitry Medvedev would cap the total investment at one —  not 10 — trillion rubles ($15.7
billion) over the next three years.
How to spend it

Then there’s the question of whether the Russian government has the ability to actually spend
more, even if it wanted to.
After years of under-spending, Russia has a trillion ruble investment backlog, ING’s Dolgin
calculates — something that will “test whether the institutional, administrative and legal
framework [will] allow [the government] to power through large state-funded capital projects.”
“The National Projects are a great idea, and they’ve been funded, but actually implementing
them is a very different story,” said Steen Jakobsen, chief economist at Saxo Bank. Official data
shows most of the program’s spending tracks are already behind schedule.
“It’s not a lack of resources, it’s really the willingness,” said Apurva Sanghi, lead Russia
economist at the World Bank.
“Our state officials are concerned about distributing cash,” said Trefimova. “Just imagine
yourself in the position of somebody who signs papers … you would prefer to be blamed for
inefficiency, instead of going to jail if an investment goes bad. That is why I’m not really
optimistic that government spending can improve investment that much.”
NEWS
HOW BIG IS RUSSIA’S SHADOW ECONOMY AND WHY DOES IT MATTER?
READ MORE

However, in 2020, the pressure to spend is set to escalate, economists say — something which
could help bureaucrats resolve their stubborn under-fulfillment problem.
“Domestically in 2020 the main challenge for the President and the government will be socio-
economic,” said economist Vladimir Miklashevsky. “Russian consumers’ discontent with the
current economic policies and GDP growth of under 2% may cause more open public
disagreements. Thus, the government may intensify its infrastructure spending.”
“As we head toward mid-term, the president will increasingly pressure the government to
improve economic performance and especially to grow household incomes,” Macro Advisory’s
Weafer said. “That’s because the president is expected to focus more on political succession in
the second half of his term and, to be able to do that, the economy needs to be improving.”
Another factor is Russia’s next parliamentary elections, scheduled for 2021, the IIB’s Auckland
said. “I expect from 2020 we’ll already start to see a pick-up in spending.” 
“The government has a lot of ways to stimulate the economy,” he added. “Even if it goes back on
the National Projects it … can raise pensions or public sector salaries.” Auckland also expects
the strict terms and conditions over how future oil profits are invested to be relaxed as the
government gears up to full-time electioneering, and the recent increase in VAT could also be
reversed in a bid to convincingly end Russia’s five-year living standards squeeze.
Geopolitical opportunities

Up against increased domestic pressure, however, Russia may be cautious about sacrificing its
hard-won stability in the face of global economic and geopolitical headwinds.
Despite the rhetoric, “Russia is still a very open economy … it will not be able to escape any
global downturn,” said the IMF’s Annette Kyobe. And with energy pipelines
to Germany, southeastern Europe and Chinacoming online in 2020, Russia is set to become even
more integrated in the global energy economy — and vulnerable to fluctuations in demand for
oil and gas.
Then, there is the great unknown for 2020: the U.S. Presidential Election. Russia is likely to
feature prominently in the campaign, and analysts expect Moscow to continue its de-
dollarization drive as congressmen and candidates clamour to appear tough on the Kremlin by
threatening new financial sanctions.
“Russia could become a little more protected,” said Eurasia Group’s Jason Bush. “But the idea
that it can protect itself from serious sanctions is massively over-blown. It’s like if you have
1,000 nuclear warheads being fired at you, and you manage to shoot half of them down — it’s
not that much help.”
Toward a new growth model

In the face of such competing tensions both at home and abroad, the Russian dilemma — craving
stability but lusting after growth — is not going to be resolved in 2020, the World Bank’s
Apurva Sanghi said. 
Analysts expect higher government spending to boost the economy — but not by much  — and
doubt the extent to which Putin can completely u-turn on six years of conservative economic
policy.
But with domestic pressure intensifying, a balance sheet growing heavier every day and the idea
of a post-Putin Russia coming into sharper focus, 2020 could be an important experiment in how
Russia tries to tip the balance towards growth.
“We are at a crossroads where things need to change, because you cannot have 3.5% growth in
an isolated economy. It doesn't work like that,” said Saxo Bank’s Jakobsen. “With low growth,
it’s not unlikely that Russia could have a recession in 2020. Maybe change comes from this lack
of change.”
“Russia can reach 3.5%, but only in a more open model. It went for stability for some very good
reasons. But the time is now up for renewing the model.”

https://www.themoscowtimes.com/2019/12/25/russia-in-2020-economy-grow-faster-a68624
https://www.google.com/amp/s/www.brookings.edu/opinions/will-the-russian-economy-rid-
itself-of-dependence-on-oil/amp/

Russian economy
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Why did it prove so difficult to stabilise the Russian economy in the initial
years of post-communist transformation?

The Union of Soviet Socialist Republics was dissolved by the Russian, Ukrainian and
Belarusian leaders on December 08, 1991. It was replaced by Russia and fourteen
other newly independent states(1). This marked the start of a hard period for the
Russian economy as it was decided to make a transition from a planned to a market
economy not only in Russia but also in most of the ex-soviet countries. The main
problem of transition was finding the right path for this transition to take and reach the
main goals of the transition: macroeconomic stabilization and economic restructuring
within a market economy. This essay will look and evaluate not only this but also
other difficulties which contributed to the hardship of stabilizing the Russian economy
in the initial years of post- communism. We shall look at the state in which the
Russian economy was when the USSR was dissolved. Looking at the policies used in
the transformation we will see which particular spheres had problems which caused so
many difficulties to this process in the Russian economy and draw conclusions
supported by observations. 

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Introduction

The economic transition theory of a planned economy being reformed to a market

economy was quite different before the collapse of the Soviet Union. The 1990s
produced new literature about this transition based on real life observations of
countries in different situations. Russia is quite an exceptional case; it is one of the
largest countries in the world and it was the main power in the USSR also its political
constraints differ from other countries. So its transition must differ greatly from those
of the other ex-communist countries. This brings us to the question of what kind of
transition should be applied to the planned economy in the case of Russia? Rapid
growth of “shock therapy” is based on the quick establishment of functioning markets,
quick restructuring of enterprise, and the creation of conditions for new business set-
ups, which in turn creates high demand for market institutions. An alternative to
“shock therapy” is the “gradualist approach” to liberalization and privatization. The
“gradualist approach” allows for a more balanced structural adjustment(2). The
components of transition were typically classified in four major dimensions. First the
Microeconomics of transition focused on creating markets and market price signals
throughout privatization. Second, the macroeconomics of transition centred on
creating a money-financial system, specifically a financial infrastructure and
developing new a new fiscal role for the state, through the budgetary process to guide
macroeconomic performance. Third, major emphasis has been placed upon
international economic integration, specifically on new trading arrangements and
policies. Finally, transition has had to consider the safety net, or the infrastructure and
policies for the provision of medical services, unemployment benefits, pensions, and
the like which earlier were handled quite differently(1). The approach to transition
that Russia has chosen plays a major role in understanding the difficulties of
stabilizing its economy and importance of each of the four dimensions specified.

USSR legacy

We also have to look at Russia economy in 1991. It is quite important to understand in

what condition was the Russian economy before the transformation. How the reforms
of Mikhail Gorbachev have influenced the initial conditions for choosing an approach
to the transition. Perestroika and Glasnost were two most important reforms for
restructuring and the Soviet system. We are more concerned with Perestroika because
this reform was concerned with the economic system of the Union. With the
Cooperative law of 1988 it allowed for the first time, since Lenin’s New Economic
policy a Private sector to establish itself in the economic system. The government rule
over State owned enterprises was reduced and self governance of the enterprises was
allowed. Nonetheless with the implication of this reform the government plan targets
of 1986-1990 were retained, the orders to the enterprises were almost only from the
government. Also due to the self governance wages were increased without a
proportionate increase in productivity which signalled inflation danger. There was a
great incentive to hide revenue from the government, this inflicted great damage to the
state budget. Prices were also controlled and not determined by market forces. Foreign
investment was also allowed but under a lot of restrictions. The crisis Soviet Union
was facing was already beginning when Mikhail Gorbachev came to power.
Gorbachev was convinced that the communist system could not continue to manage
the economy and society in the old way, and he intended to achieve its modernization
through perestroika. For him the aim was not to transcend the Soviet system but to
achieve its reform (3). But due to the high level of control the government tried to
impose on the newly obtained economic freedom in the system the reforms failed and
by 1990 the Soviet Union was in deep crisis. The government lost control over the
economy. Unprofitable enterprises burdened the budget with requirement for support
by subsidies. With the growing sense of regional autonomy local governments hid
taxes which also damaged the budget. During 1990-1991 industrial and agricultural
output declined dramatically leading to almost 20% fall in GNP and national income.
So we can conclude that the state in which the economy was before the economic
transformation was very hard to handle and a difficulty itself for establishing a
working market economy.

“Shock therapy”

The breakup of the Soviet Union added more pressure on the Russian economy and
contributed to already a great crisis. A decision had to be made on what kind of
approach to use to the transformation of the planned economy to a market one. Boris
Yeltsin and his cabinet decided to undertake the “Shock therapy” or “Big bang”
approach, liberal economic policies which were used by the International Monetary
Fund, the World Bank and the U.S. Treasury Department. Boris Yeltsin used the
political situation at that moment to implement this approach. The political vacuum at
the end of the planned socialist era provided an opportunity for change, if change is
not implemented quickly, the downturn of the economy at the start of transition can
result in discontent and resulting retrenchment(1). So we shall look at some of the
four main dimensions mentioned earlier to see how the transformation did in the
initial years and what the main difficulties were.

First let us look at the microeconomics of transition, privatization in particular. The

privatizations first phase was called “voucher privatization” with voucher being
distributed to every one of the 148 million Russian men, women and children. These
voucher’s could be used to buy shares of Russian companies or be sold a newly
developed secondary market, which lets us to the assumption that people with greater
wealth could acquire them and thus a greater share of a company. But the government
still retained parts of shares which allowed them to interfere in the decision making of
the company. The second stage was to sell the remaining shares of enterprises were
sold through investment tenders, cash auctions, or specialised auctions(1). This was a
major opportunity for certain people with contacts, certain information about the
selling of the stocks and access to financing. These “insiders” could misuse their
position and knowledge to obtain more profitable stocks and manipulate with their
prices, thus accumulating a great amount of wealth. This lead to a massive
redistribution of income in the direction of greater inequality. The top 20 percent of
highest earning household accounted for slightly more than 35 percent of the total
income in 1991 compared to almost 50 percent in 1995(1). The difficulty of “shock
therapy” concerning privatization was the speed at which the new private sector was
emerging. The number of work places in the state owned enterprises was diminishing
and the work places in the private sector were increasing, but due to the differences in
speed this process contributed to the already high unemployment. After the breakup of
the Soviet Union regions which had only one industry suffered greatly from
unemployment. The decrease of output due to decrease in demand (e.g. arms industry)
called for a reduction in labour force. The process of privatization only made this
more of a difficulty for transformation. Another issue concerning privatization were
prices of goods, the lack of market forces drove these prices up after the government
removed price controls. Combined with the money overhang inherited from the Soviet
Union Russia this problem spilled over to macroeconomics of transition causing huge
rates of inflation.

Since 1992, Russia’s economic authorities have repeatedly attempted to control and
lower the country’s inflation rate. At times they achieved temporary victories. On
three separate occasions, the monthly inflation rate was pushed down by eight or more
percentage points. But on each of these occasions the success was transitory: within
months the price level soared again. Against this background, the sustained tapering
fall that began in January 1995 stands out(4). Such situation and the central banks
mistrust of the reforms President Yeltsin implemented was itself a difficulty for the
transition process. Another macroeconomic difficulty in the transition process was the
issue of taxes. Market economies rely primarily on sales taxes and on payroll taxes
and personal income taxes to collect revenues. The structure of Russian taxes in 1995
have shown that the major source of revenue were profit taxes and sales taxes also
unusually very important special taxes, like export taxes or transportation taxes, which
play relatively minor roles in the West. The state’s inability to identify and measure
personal taxable income was the problem. Record keeping on wages and income has
been very poor, and enterprises have found ways to conceal payments to workers and
employees. State tax collections have been severely damaged by the decline in
economic output, by the fact that much economic output is underground in the so
called “second market” and out of the reach of the taxing authority, by the ability of
influential enterprise to bargain down their tax obligations, and by the general decline
in tax disciplines(1). Federal tax collections have dropped sharply since the beginning
of reform – from 17.8 percent GDP in 1992 to 10.1 percent in 1997. This collapse in
federal revenues contrasts with a relatively stable trend at the regional and local
levels. Between 1992 and 1997, regional consolidated budget tax revenues (including
local) actually rose slightly, relative to GDP, from 11.9 to 12.6 percent. Because of
the week federal collections, revenues of the consolidated budget – central, regional,
and local budgets combined – fell from an estimated 29.7 percent of GDP in 1992 to
22.7 percent in 1997. And if revenues of federal extra budgetary funds such as the
pension funds are included, the drop between 1992 and 1996 is almost 10 percent(4).
The tax problem also contributed to the budget deficit which was already present
before the collapse. Trying to deal with the budget deficit by increasing the money
supply only sharpened the problem of inflation.

Raudona – Is wikipedijos, reikia surasti ir pakeisti citatomis is akademinio

saltinio.

1. Kopijuota knyga

2. Natalja von Westernhagen, Systematic Transformation, Trade and Economic

Growth (Developmets, Theoretical Analysis and Empirical Results. Printed Physica-
Verlag Heidelberg 2002, Printed in Germany

3. White S, Gitelman Z & Sakwa R (eds), “Developments in Russian politics 6”

(Palgrave 2005)

4. Without a map

Possible content/plan:

Transition: Theory, Policy and practice

Creating the Institutions of a Russian Market economy

The Macroeconomy : Institutions and policies

Russia’s integration into the global economy

Changing Structure: Leading and Lagging sectors

Economic stagnation: a virtual economy?

Russia in the twenty-first century

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Here's the index maphttps://www.heritage.org/index/heatmap

Hello. According to Heritage Foundation annual index, russia scored higher in business freedom and tax
burden than some of the countries in middle or west europe. Im asking russians who manage a business
inside russia, is it true? Does the bureaucracy in business is not that intrusive? Are taxes for employers
objectively low?[i know i know they could always be lower ;)] Can you freely start a business without
tons of licenses, permits? Are there many businesses forbidden by state for private entrepreneurs? As
for employees, how much of salary they can keep after the gov. taxes? Are health and retirement dues
mandatory by government?

Also Russia scored really low in property rights, this is quite contradicting to the high business freedom
index. I can only explain this in that way -you can freely make your business, but in some time when
your business grow, a mafia or the gov. just visit you and make you a proposition that you cant refuse.
Or harass you using the institutions like tax services, work and building safety, corrupted judges that
want to forfeit your company to the state? This kind of goes with low judical effectiveness score

Russia's labour freedom index is similar to germany, i presume you can't work in many fields, without
necessary permits? This is somewhat similar to my earlier question about the business freedom.

Then you have the monetary index freedom, which russia score lower than most of the europe. What's
with the overall supply of credit for the citizens? I guess you can freely go into bank and take a loan?
Dont understand then why russia scored lower? You can play on the stock market without restrictions?
This also apply to low financial freedom score.