August 1998

and
The Development of
Russia’s “
Post-Communist Political
Economy
 Abstract
Russia’s experience of financial crisis has been novel:
crisis was followed by growth rather than depression,
and did not lead to any increased role for foreign
economic agencies or actors in Russia’s economy
This novel experience resulted from the structure of
Russia’s economy in the 1990s, the limited role of
financial intermediation in the Russian economy and
rising oil prices
Consequently, the chief outcome of crisis has been
political, the renewal of central political authority and
a reining in of major economic interests
This has helped to solve the problem of state finances,
which was the source of the 1998 crisis, but neither
economic growth nor increased central political
authority have managed to deal with the problem of
capital deficiency in Russia so that it remains
dependent on energy exports to continue growing
Potentially, this leaves Russia exposed to ‘resource
curse’ problems.
While these have been avoided so far, the absence of
constraints on political leaders might lead to such
problems in the future
Introduction
This paper explains Russia’s post-crisis development
by arguing that crisis was both caused, and its
economic effects ameliorated, by the structure of the
Russian economy and its ‘demonetization’ during the
1990s
This demonetization consisted of, first, the use of
monetary substitutes or surrogates such as bills of
exchange, promissory notes, barter or payment in kind
instead of money in exchanges between producers and
customers, memployers and labor, taxpayer and the
state, in place of rubles
This meant that there was considerable continuity between
Soviet and post- Soviet economy: economic activitywas not
commercialized, and subsidies and unprofitable economic
production continued
Second, demonetization meant that the post-Soviet Russian
economy did not develop an extensive system of financial
intermediation
As a result, one of the main economic legacies of central
planning, the shortage of investment resources relative to
demand and what was needed to modernize the economy,
and a consequent underdevelopment of credit and financial
liquidity, was not tackled after 1991
Demonetizationmeant that the Russian state
struggled to avoid economic crisis throughout the
1990s
Central political authorities fought to gather taxes and
raise revenue and were resisted by the tendency of
local authorities and enterprises to use barter,
payment in kind etc. to support economic continuity
Equal to any economic impact of August 1998 was its
effect on Russia’s internal political balance
The changes in Russia’s internal political balance
produced by crisis enabled greater state control over
the economy

However, neither the state’s new authority over the

economy nor economic growth have resolved the
fundamental structural problems of the Russian
economy, namely that it is energy dependent and
capital deficient, with a low level of monetization
Central political control has developed under Putin
rather than the capacity of the state to manage the
economy

The Russian state has not got the administrative capacity

to develop or manage a regulatory framework that can
stabilize its relations with powerful economic groups
and is unable to manage the economy in any other way
other than by the coercive domination of major
economic interests
 THE ROOTS OF
THE AUGUST 1998
CRISIS

STATE
AND
ECONOMY IN RUSSIA, 1992–98
Structure of the Russian Policy
Russian adapted to follow neo-liberal policy
prescriptions at the and of the 1991 and reform was
launched with the liberalization of prices in 1992

 Reform was soon heavily contested and opposition

was too great
Resim eklemek için simgeyi Attitudes of
Yeltsin against
tıklatın Argument

Yeltsin maintained
credible
commitment to
reform and gurantee
his own political
survival

He compromised on
both reform policy
and the composition
of the government
Effects of the compromises
These compromises
created a looming fiscal
crisis for the Russian
state throughout the
1990s as the failure of
economic reform meant
there was no
stabilization of state
revenues or expenditure
This crisis was shaped by
the structure of the the
Russian Economy.

The bulk of the Russian

economy, that is most of its
manufacturing industries,
became demonetized and
dependent on resource
transfers from the energy
sector to subsidize
production
Resim eklemek için
“Oligarchs
simgeyi tıklatın
Those sections of the economy not
demonetized were where Russia had a
revealed comparative advantage, the energy
and metals sectors of the economy

These sectors became linked with Russia’s

commercial banks from the mid-1990s to
create a group of economic actors who have
been labeled ‘oligarchs
Fail of Yeltsin’s Regime
Yeltsin regime could not stabilize the relationship
between these two parts of the Russian economy, the
demonetized and resource dependent, and the
oligarchic, and the state or get either to support
market reform

They both squeezed the state financially

Because of that fail…..

Central political authorities were unable to halt this

drain on the state budget.

Over time the drain got bigger as those sectors that

were not demonetized had an incentive to act in the
same way as the demonetized sectors and delay or
avoid tax payments.
This was to have two effects
First, it was to push the state to try to back up its poor
domestic revenue collection by seeking funds from
abroad. This was to tip Russia over from imminent to
actual crisis in August 1998
Second, it laid the foundation for the political changes
that were to follow August because it meant that the
relationship between central political authorities and
big business interests was already under stress on the
eve of crisis.
Demonetization was a complex process but at its heart was
a structural deficit of credit and capital inherited from the
USSR
This was caused by the high demand for investment
inherited from the Soviet system, where soft-budget
constraints and inefficiency in resource allocation and
usage created high rates of investment
Russia thus inherited an economic system from the USSR
that was accustomed to significant inputs of capital and
used to operating without accounting for the use of capital
or improving the efficiency with which capital was used
The collapse of the Soviet economic system meant that
the supply of cheap capital and credit economy dried
up

Russia’s reformers also took money out of the economy

through subsidy cuts and the nascent banking sector
favored financing arbitrage and currency speculation
rather than extending loans to industry
The combination of Soviet collapse, reformist subsidy cuts
and the preferences of the financial sector to fund trade
rather than production meant that enterprises had to use
another Soviet legacy, relational capital, the good will
inherited from relationships developed under planning, to
support economic activity
It enabled resistance to reform by subverting
commercialization (seeking profit through cost
management, reaction to prices etc.), and was central to
demonetization as the use of monetary substitutes
depended on negotiating the acceptance of monetary
substitutes
Trust built-up in the Soviet era greased the wheels of
this negotiation so that production could be
maintained in spite of costs and recreated subsidies
and soft-budget constraints
Soft-budget constraints persisted as state and labor
were deprived of income through simple non- or
delayed payment of wages and taxes, or as payments
were made in kind, through tax offsets or by
promissory notes
The ‘value’ of these payments in kind/offsets/notes
was set at a rate higher than the value of the goods
produced and traded
In thisway, loss-making activitywas hidden, the loss
being born by labor or the state through falling
consumption and decreasing tax revenues
By 1997, some 40% of all tax revenues paid to the
central state was in kind
Subsidies persisted through transfer of value from the
energy sector to industry
The transfer of value from the energy sector to the rest of the
economy was centered on Gazprom
Gazprom and other energy firms received tax concessions
which further denied the state revenue
Regional governments colluded with enterprises by allowing
the payment of taxes in kind and pressuring energy companies
to take payment in kind
Firms that were making goods that could be sold at a cash
profit had an incentive to join in behaviors developed in
demonetized sectors because paying taxes and bills in kind at
inflated pricesmeant that they could divert any money they
made to other profitable uses such as buying government debt
Gazprom
Demonetization was thus self-reinforcing; it sucked in
more and more sectors and enterprises as firms either
took the decision to join in, or were forced to do so by
trading partners

This meant that while there was a form of capital flow

to enterprises – in the shape of value transfers from
energy firms – there was very little actual investment
in the economy or restructuring of economic activity
Indeed, demonetization and the opacity in economic
activity that it created inhibited restructuring by
blocking foreign investment – investors could not
distinguish where profits could be made in a
demonetized economy – and hid areas – other than
energy and metals – where Russia might have had a
comparative advantage
As a result, foreign direct investment in Russia during
the 1990s was small and heavily skewed towards the
energy and metals sectors
Pressure on the budget helped create the oligarchic
strand of the Russian economy
Russia’s oligarchs were formed by two policies
developed to deal with the fiscal effects of
demonetization
The government first passed over control of those
industrial sectors where Russia had a revealed
comparative advantage, and second, accessed the
resources that the banks accumulated in the early
1990s through the short-term government debt market
THE IMPACT OF THE AUGUST
1998 CRISIS

FROM DEMONETIZATION
TO
A RESOURCE CURSE?
The actions of the government after Yeltsin’s 1996 re-
election in trying to improve tax collection and the
focus on the FIGs(financial-industrial groups) had
already presaged a time when the state would change
its relationship to the economy

The crisis added stress by throwing in to doubt

Yeltsin’s ability to provide concessions and control
access to power
 Resim eklemek için simgeyi
The government of tıklatın
Sergei Kiriyenko
resigned and a more
independent
government under
Yevgeny Primakov was
appointed
Resim eklemek için
simgeyi tıklatın
Primakov’s appointment
as Prime Minister, and
his better relations with
the Duma, gave the
impression that he would
be best placed to succeed
Yeltsin at his scheduled
retirement in 2000
Opinion of the Regional Political Leaders

Regional political leaders saw Yeltsin’s weakness as an

opportunity to organize independently and maximize
their bargaining power over the choice of his successor
But,
Yeltsin, however, was able to reassert himself politically and
control the succession process so that the effect of the August
1998 crisis was to separate the politics of Yeltsin’s succession from
elite interests
The divide between government and parts of the business elite
(although this was not yet as strong as it was to become later
under Putin), and the weakening of the center’s control over the
regions that the crisis exacerbated or created either neutralized or
made these forces competitors in the succession struggle, rather
than parties that negotiated the result of that struggle as they had
negotiated to ensure Yeltsin’s 1996 re-election
Yeltsin dictated who was to succeed him rather than brokering a
succession deal
In the absence of negotiation he was forced to find a
successor from within his administration – eventually
choosing Vladimir Putin – and use the extensive
formal powers of the presidency to reclaim some
degree of control over the political process
Yeltsin’s ceding of authority to him, developed a
bandwagon effect that swamped the efforts of his
rivals
Relationship Between Yeltsin and
Viladimir Putin

Putin’s hard line towards Chechnya helped as war

restarted there at the end of September 1999, as did
the shallow impact of the 1998 crisis on Russian
industry
 Putin Won the
Resim eklemek için simgeyi Presidency
tıklatın The net effect of these
changes was that Putin won
the presidency in 2000

The only real question was

whether Putin would secure a
first-round victory, which he
did – in which Putin made no
promises to any group, voter
or vested interest, to win, but
did talk about liquidating the
oligarchs as a class, echoing
the Stalinist threat to ‘rich’
peasants from the late 1920s
Attack to Oligarchs
Free of campaign debts because the political fallout of
the August 1998 crisis had divided the Kremlin from
Russian elites, Putin was able to begin the reassertion
of central state control very quickly after his election
He reined in regional leaders and began to attack
‘oligarchs’ with media interests, particularly Vladimir
Gusinsky and his Media-Most group, and Boris
Berezovsky, who had a 49% stake in
Obshchestvyennoye Rossiskoye Televidyeniye (ORT),
the main Russian TV channel
Strong Signal to Business Leaders
Action against ‘oligarch’ media interests was
accompanied by the opening of investigations in to the
privatization and tax payments of other FIGs

Together, the investigations and the takeovers of

business media interests were a strong signal to
business leaders that the political situation had
changed, and not in their favor
Warned Them

Putin made this signal even more explicit in a meeting

held with business leaders in July 2000

Putin, whilst appearing conciliatory, warned them that

further interference in politics would no longer be
tolerated
The growth of the central executive authority has not,
however, created a state that has the ability to
transform Russia and has had only a minimal impact
on economic growth

Political changes lagged behind economic recovery

Growth started before the first moves against oligarchs
or regional leaders and thus helped complete the
political realignment that followed the August 1998
crisis rather than the other way around
Balance of Political Power

Political realignment in favor of central political

authorities continued unabated across Putin’s two
terms as president but despite the numerous changes
Putin made to the balance of political power, the
capacity of the state has remained low
Hovewer,
Corruption is still a major, and in some accounts
growing, problem, and the overall effectiveness and
competence of many state agencies is still low

Changes in central executive power have thus not

quickly translated into changes in public
administration so that change has been more
rhetorical than actual as far as the state generally is
concerned
Fearing that,

They would be next, privately owned oil companies

reacted to the moves against Media-Most and
Berezovsky by expanding production massively
The export value of oil, gas and metals nearly doubled
in dollar terms between 1998 and 2002

This was partly due to increased prices and partly due

to increased export volumes. Volume growth was
particularly marked in 2000, the year in which Putin
expanded his power, when oil exports were 171.5% of
what they had been in 1999; this level of output was
more or less maintained in 2001 and then expanded
again in 2002
A large proportion of post-1998 growth was thus not
planned or balanced, but the result of a scramble by
oligarch oil firms to cash in before property rights were
lost

State administration may not have improved but the

ability of political authorities to control elements of
the economy without opposition has grown.
Indeed,

The state’s economic role has partly developed in order

to prevent opposition from consolidating

Initial attacks on oligarch media interests helped to

build-up presidential authority after Putin’s election
There was an element of pure politics
about the extension of the state’s
economic role the effect was, as in other
late developing states, to substitute
bureaucratic management of the
economy for the development of state
capacity to manage market economic
activity by creating regulatory
frameworks of law and bureaucracy
This has led some analysts to describe
the development of Russia under Putin
as heading toward a form of state
capitalism
From 2005, state interference in the economy extended
beyond the political logic of controlling the economy to
stymie opposition
There were moves to curtail foreign investment through
legislation; the blocking of the sale of companies like Siloviye
Mashiny (Power Machines, which produces equipment for
the energy sector and nuclear power) to foreign firms; more
state representatives were placed on company boards, such
as the board of Avtovaz; Sibneft (Roman Abramovich’s oil
firm)was sold to Gazprom and the state increased its holding
and control of Gazprom itself
Overall, state ownership of Russia’s equity market
capitalization rose from20% to 30% between 2003 and
mid- 2006