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Much of what we took for granted in our free market system and assumed to be human nature was not

nature at all, but culture. The dismantling of the central planning function in an economy does not, as some had supposed, automatically establish a free market entrepreneurial system. There is a vast amount of capitalist culture and infrastructure underpinning market economics that has evolved over generations: laws, conventions, behaviors, and a wide variety of business professions and practices that has no important functions in a central planned economy.

- Alan Greenspan, 1997[1] On July 3, 1991, one month after the presidential victory of Boris Yeltsin, and still one month before the failed coup that would usher in the final Soviet collapse, Russia passed a landmark law prescribing a program of sweeping privatization.[2] This law would not be implemented in any serious way for nearly a years time, but the writing was on the wall: markets were coming to Russia, and a serious discussion of their construction was vital. Hopes were high for the transition, both in Washington and in Yeltsins inner circle, but what followed was, uncontroversially, a disaster. Although the Russian economy has shown some signs of recovery in recent years, the

history leading up to the Russian financial collapse of 1998 is one of hasty, ideologically-driven decisions, an overweening reliance on so-called human nature, and mutual manipulation between Yeltsins Kremlin and eager-to-help foreign institutions like the International Monetary Fund. Much literature has been written speculating whether the unwise economic and financial decisions of post-Soviet Russia were, in fact, politically unavoidable. Rather than venture too deeply into this complex territory, I will attempt to sketch out the flawed assumptions behind these decisions, as treated by Greenspan in the epigram above, and the unfortunate consequences that would disprove them. A brief overview of pre-liberalization Soviet economic conditions is necessary. While they are difficult to describe in capitalist terms, some have compared the USSR to an enormous corporation.[3] The transfer of raw materials and produced goods, as within different departments of the same company, did not involve monetary exchange or surplus value.[4] State-owned enterprises had no financial dealings, no marketing, and no direct control over purchasing or sales. Factory managers were, like the workers they oversaw, state employees, not entrepreneurs.[5] The term enterprises, then, is misleading, as Soviet industries, for all their many social functions, were meaningless in the language of capital, ex-

cept as assembly plants. Markets as such only existed in their illegal, black form, and never on too large a scale. The conventional wisdom that bureaucratic corruption, in the monetary sense, was rampant throughout Russias socialist history is highly disputable. The accumulation of wealth in the Soviet banking system, let alone in foreign bank accounts, was well nigh impossible, so any corruption that existed was limited to the petty benefits of direct consumption.[6] As we will see, although the structure of centralized corruption that asserted itself after the Soviet collapse may have mirrored Party structure, it was not, as such, directly tied to it. Thus, the mandate for privatization, which may have seemed unequivocal to outsiders at the time, set forth a nightmarish array of forking choices in practicality. The primary question, of course, was: privatization for whom? The Yeltsin administration, in its mad rush to privatize, was adamant that this privatization occur on all levels of industry, rejecting the Dengist reform scheme that, in China, had legalized and encouraged entrepreneurship alongside existing public industries.[7] While, at first, the factory managers may have seemed like ideal candidates for this private takeover, encouraging a level field for Russias first steps toward liberalization, it would not promote rapid economic growth. Managers, as mentioned in the previous paragraph, were driv-

en by production, not profit, lacked any financial experience, and were still, so to speak, psychologically communist.[8] Re-training was a possibility, but it would take time and effort that Yeltsin found counter-productive. Local bureaucrats, too, would have to be left out for fairly evident reasons, although bribery, Yeltsins administration acknowledged, would have to be systematically deployed to lubricate the process. The solution ultimately implemented was the joint work of Jeffrey Sachs, Andrei Shleifer, and then vice-premier Anatoly Chubais, neoliberal economists and advocates of the Coase theorem, an economic axiom stating that so long as private property exists and is well-protected, rational self-interest will naturally rebuild a market economy from the bottom up.[9] [10] The identity of the initial possessor of property, then, becomes effectively irrelevant. The economists proposed a system of vouchers to be handed out, for small nominal prices or for free, to the general working-class population. These vouchers could then be used to purchase shares in mutual funds or in previously public enterprises.[11]Shleifer referred to this project as spontaneous privatization.[12] As he said himself, its chief advantage was its sheer rapidity.[13] The idea was appealing in its logical simplicity, since there could be no logical reason to resist the free vouchers. Additionally, on the surface, it seemed more Marxian than even the dead

Marxist state: as Shleifer pointed out, they, not Lenin, were granting the people collective ownership of the means of production.[14] However, Shleifer approvingly notes that, over time, full worker ownership would likely result in the maintenance of the Soviet system, but that most workers, especially the poor, will probably have sold their shares already[15] and a capitalist meritocracy will have emerged. It is this last note that reveals the true course the plan would take. In a time of severe financial uncertainty, the selling off of vouchers was very rapid indeed. Since the accumulation of wealth was, as was mentioned, quite difficult under socialism, the pool of Russians with money and financial expertise was tightly restricted to representatives of the former black markets. According to a former deputy premier, Chubais realized the owners will mostly be criminally oriented people. But, he said, there are no others.[16] Under the Coase theorem, this made sense, since the fact of ownership should override any possible criminality on the part of the owners, and competition, after all, would erode monopoly over time. Yeltsin addressed the monopolization problem by claiming that the change in legal structure would give rise to innovative small enterprises in the first months of privatization.[17] However, in the short term, the potential gains to be had from competing for existing industries far outweighed the

prospect of the slow struggle of developing a small business in a frankly chaotic economy.[18]Furthermore, as we will see, the new businessmen-mafiosos cozy relationship with the new Russian government made it undesirable for either party to promote diversification.[19] At the same time, price liberalization without accompanying currency reform had brought about skyrocketing inflation; the frantic rush among the broad population to convert their rubles into material goods or dollars only worsened inflationary pressures.[20] This inflationary explosion was the predictable result of the sudden introduction of a monetary economy, and Yeltsin and his circle had anticipated it, but by late 1991 the Russian president was claiming that after the initial shock economic stabilization would gradually ensue.[21]Unfortunately, the sudden annihilation of real incomes, in conjunction with the broad populations complete inexperience with capitalism, had precluded any kind of healthy business climate, much less a Western-style service sector.[22] On the other hand, the Russian Central Bank benefited overwhelmingly from this inflation via seigniorage, while the various commercial banks created under Gorbachev received residual benefits from the Central Bank in the form of cheap credits and corporate welfare in the form of above-competitive loan rates.[23]Logically, it was in the

interest of the new banking elite to keep inflation as high as possible, which boded ill for the general population. [24] Nor were the banking elite involved in productive activities: the complicity between the central and commercial banks encouraged Mafia involvement, the importation of luxury goods, and asset seizing.[25] Sachs had hoped to counteract the lack of currency reform with foreign aid, and, in fact, foreign credits accounted for 116 percent of tax revenue in 1992.[26] [27] However, rampant tax avoidance among the commercial elite worried the international community and put Russias credibility in serious danger. Nevertheless, despite intermittent cutoffs over tax concerns, the IMF looked the other way even in 1996, offering a credit of $10 billion with the understanding that Yeltsin and his circle would remain in power, the alternative being the majority-holding communist party.[28] [29] The cash-strapped Russian government initiated a second wave of privatization in 1995, auctioning off shares in state enterprises to the commercial banks as collateral for loans. Scandal ensued when insider dealings became apparent, with some banks winning auctions they themselves had organized, additionally receiving underwriting expenses for their efforts.[30] [31] This caused an international scandal and the invention of the term oligarchs in the Western media to describe the Russian commercial

elite.[32] As Jerry Hough points out, however, Western coverage contained the strong implication that the banking oligarchs had arranged the whole scheme against the government in order to maximize their control of profitable industry.[33] This offered considerable credibility among foreign investors, both to the commercial banks and the industries they were buying up. In reality, though, the arrangement went the other way around, with the commercial banks pressured into buying shares in unproductive industries (less productive, certainly, than the oil and foreign exchange dealings which had previously been their livelihood) by a central government on which they were totally dependent.[34] The ruse was successful, leading to overconfidence in Russian finance among Western traders, who treated it as a promising emerging market like any other.[35] Over the following years, government debt expanded drastically, with both the central and regional governments issuing bonds to stay afloat. Russian companies followed suit, albeit at a smaller scale, and the total national debt, both public and private, was estimated at $210 billion in late 1998.[36] The majority of bonds-issued were very short-term, which would have disastrous effects after the Asian financial crisis of 1997.[37] Interest rates rose precipitously as Western investors pulled their money out of more and more foreign investments, creat-

ing a vicious cycle. By August 1998 the Central Bank had stopped supporting the ruble entirely.[38] The commercial banks veneer of independence and power was shattered as most of them declared bankruptcy and disappeared along with any insurance they had offered.[39] While commercial banks had failed regularly during the first years of marketization, the number of banks left after the ruble collapse was one-third of the 1996 figure. [40]The borrowing frenzy that had led to the crisis was partially a result of the IMF policy of 1993, which had successfully curbed hyperinflation (halving it over the course of the year) but had suppressed real industry and investment with a very high ruble exchange rate and a high central discount rate; additionally, it had unconditionally enforced short-term capital mobility in an economy that was simply unprepared to deal with it.[41] [42] As seen above, the presumption that privatization any privatization would lead over time to a healthy market economy was seriously flawed, while the lack of serious thought about regulation made highly centralized corruption an inevitability. Anatoly Chubais, in a later interview, would later simultaneously defend his creation of the oligarchs and blame them for the financial collapse, claiming that they thought they ruled the world and could do anything.[43] Considering that state debt in Russia at the time of the collapse was five times that of the commercial banks, this claim seems misplaced, to say the least.[44]

Furthermore, since 1995 or before, Yeltsins government had been ignoring IMF calls for improved tax collection and heightened transparency, through what the Fund itself must have known was blatant money laundering, to the amount of 45 trillion rubles of state money.[45] The picture that emerges is overwhelmingly one of complicity, not betrayal, between the public and private banks. As the financial crisis deepened, the IMF had attempted to intervene with a rescue package of nearly $23 billion in July 1998.[46] This was entirely unsuccessful in preventing Russia from either devaluing the ruble or defaulting on its debt, both of which occurred over the course of the next month.[47] The IMF withdrew any further loan offers by the end of August.[48] Still, Russias economy recovered with surprising speed, a fact which can largely be attributed to rising world oil and gas prices between the end of 1998 and 1999.[49]Nevertheless, it was clear that more considered institutional reform was vital. In 2000, the Russian government instituted a series of such reforms, improving budget and taxation measures and designed at promoting competitive access to the remaining sectors in the process of privatization.[50] As a result, GDP growth in the early 2000s was steady, hovering around 7%, real income grew, and inflation hovered around 10%.[51] Also, a stabilization fund was introduced, which reached $35 billion in 2005.[52] Direct in-

vestment rose to $9.4 billion by 2004.[53] Thirteen IPOs were made public in 2005, nearly twice as many as in the previous decade combined.[54] Unfortunately, the monopolistic, inegalitarian nature of early Russian capitalism has by no means been reformed. Twenty-three businesses are responsible for one-third of output.[55] Small businesses did eventually surface, but accounted for only ten percent of GDP in 2004.[56] Poverty and inequality remain rampant, and the income gap has only increased in recent years.[57] Banking remains highly centralized.[58] A 2006 report on Russias developing market status, published by the World Bank, provides further insight. Equity market capitalization reached $500 billion, with 277 stocks admitted for trade by the end of 2005.[59] However, stocks are concentrated in the oil, gas and telecommunications sectors, with most secondary trading occurring abroad due to high transaction costs, with domestic institutions remaining underdeveloped.[60] Even now, 99% of stock trades on the Russian trading system are between foreigners.[61] The authorities, with the aid of the Frankfurt School of Finance and Management, are engaged in an ongoing project to unify Russian markets, reduce risk, and introduce IAS as a universal standard.[62] IPOs on the domestic market still are, however, slow in coming, as the monopolies tend to try their luck abroad, while smaller enterprises fear unethical takeovers should

they offer shares.[63] Minority shareholder protection, as in the early days of privatization, is severely lacking.[64] Record-keeping and accounting procedures, which were jerry-rigged for the benefit of foreign investors during pre1998 investment euphoria, are still highly fragmented and difficult to navigate for domestic investors.[65] As the World Bank concludes, more rigorous regulation standards, in conjunction with a less centralized banking system, will be necessary to promote healthy domestic markets. Not much institutional change followed the 2008 world financial crisis, which had resulted in the emptying-out of Russias foreign exchange reserves and a 35% devaluation of the ruble against the dollar.[66] Russia responded, in addition to a $222 billion total bailout, by lowering corporate taxes and extending Central Bank loans to previously foreign-financed commercial banks and enterprises, as well as repeating a call for transparency in corporate ownership.[67] Stable growth quickly resumed, with Russia less reliant on foreign investment than previously. Of course, this policy also represents a continuation of the close ties between the commercial and central banks seen earlier, but with IMF and other international pressure off, and clearer financial expectations set, Russia is unlikely to see a repeat of 1998.

Even setting aside the question of the very necessity of rapid market reform, there is little question that the Yeltsin administrations initial privatization measures were as much political moves as financial ones, directed at showing the international community that it was intent on destroying communism once and for all. Currency reform, which would have provided a cushion for the initial shock of price liberalization, was rejected solely on the basis of its taking too long, an estimated nine months, to process.[68] Nor was the rise of the so-called oligarchs inevitable. A more gradual program, perhaps structured on the Dengist model, could have offered more time for trial and error and for the population to adjust to an entirely new socioeconomic system. Furthermore, the unconditional political support, in the interest of maintaining a continuous program of privatization, offered by the Western powers (including, scandalously, USAID and the IMF) to Yeltsin and Chubais offered their government an enormous amount of room for shady financial maneuvers, the manipulation of tax revenue, and the strengthening of a new financial-governmental elite that put the Party elite to shame in its corruption. This undemocratic, caudillostyle approach to political power also allowed Yeltsin to make economic and financial decisions that were not beneficial, either in the short or the long term, to the general population. The idea, of course, was that natural market forces would make initially shocking policy moves more

amenable to the public over time, excusing the lack of attention put into developing capitalist market infrastructure beforehand. While many of the more egregious economic effects of shock treatment have, indeed, been curbed over time, high poverty rates and gross inequality continue to plague Russia, and the domestic stock market is still, practically speaking, irrelevant, except to a few commercial banks with foreign interests. Many productive industries were stripped for personal benefit by their new owners after the transition, leaving the Russian economy disproportionately dependent on the sale of natural resources. However, the existence of the banking oligarchy as a kind of extended government banking system, so disastrous in 1997 and 98, has not proved entirely deleterious in recent years. The loans given out by the Central Bank following the 2008 crisis reduced Russias reliance on foreign capital and prevented a repeat of the previous decades calamity. Furthermore, the Central Bank has been a powerful regulatory force, and, since 2003, has worked to bring the various commercial banks in line with its own regulatory standards.[69] As in the early years, money laundering and the financing of mob activities remains a problem, but much of the external pressure leading to government money laundering has vanished.[70] Although the Russian economy and finan-

cial system are no longer in any immediate danger from within, as was the case in 1998, the general population continues to feel the squeeze of the initial distribution of property and industry, with a death rate nearly twice that of the United States and a poverty rate of 15-20%, although statistics have improved markedly from the early days of market reform, when the poverty rate was 40% or higher. [71] Russia, for better or for worse, is moving forward. Whether this justifies the initial round of shock therapy, or merely demonstrates the success of improved government and regulatory practices is left for the reader to decide. In either case, given the inadequate checks and balances that existed during the first decade of Russian capitalism, the abuses that took place in the closelyrelated public and private sectors should not be surprising.

[1] Jerry F. Hough, Logic of Economic Reform in Russia (Washington, DC: Brookings University Press, 2000), 4. [2] Andrei Shleifer (Jeffrey D. Sachs, ed.), Transition in Eastern Europe Volume 2: Restructuring (Chicago: University of Chicago Press, 1994), 1.

[3] Stefan Hedlund, Russias Market Economy: A Bad Case of Predatory Capitalism (London: Routledge, 1999), 35. [4] Hedlund, Russias Market Economy, 71. [5] Hedlund, Russias Market Economy, 67. [6] Hough, Logic, 106. [7] Hough, Logic, 65. [8] Hough, Logic, 118. [9] Shleifer, Transition, 151. [10] Hough, Logic, 70. [11] Shleifer, Transition, 163. [12] Shleifer, Transition, 162. [13]Shleifer, Transition, 159. [14] Shleifer, Transition, 152. [15] Shleifer, Transition, 163. [16] Hough, Logic, 70. [17] Hough, Logic, 72.

[18] Ibid. [19] Hough, Logic, 104. [20] Hedlund, Russias Market Economy, 144. [21] Hedlund, Russias Market Economy, 144. [22] Hedlund, Russias Market Economy, 145. [23] Hedlund, Russias Market Economy, 156-157. [24]Anders Aslund, Russias Capitalist Revolution: Why Market Reform Succeeded and Democracy Failed (Washington, DC: Peterson Institute, 2007), 96. [25] Hedlund, Russias Market Economy, 255. [26] Padma Desai, Conversations on Russia: Reform from Yeltsin to Putin (Cary, NC: Oxford University Press, 2006), 32. [27] Hedlund, Russias Market Economy, 202. [28] Hedlund, Russias Market Economy, 256. [29] Hough, Logic, 219. [30] Hedlund, Russias Market Economy, 257. [31] Hough, Logic, 208.

[32] Hough, Logic, 209. [33] Hough, Logic, 212. [34] Hough, Logic, 218. [35] Hough, Logic, 214. [36] Hough, Logic, 218. [37] Desai, Conversations, 39. [38] Hough, Logic, 226. [39] Hough, Logic, 212. [40] Alya Guseva and Akos Rona-Tas, Uncertainty, Risk and Trust: Russian and American Credit Card Markets Compared, American Sociological Review 66, 5 (2001): 631. [41] Desai, Conversations, 40. [42] Aslund, Revolution, 114. [43] Desai, Conversations, 90. [44] Hough, Logic, 218. [45] Hedlund, Russias Market Economy, 135.

[46] Hedlund, Russias Market Economy, 249. [47] Hedlund, Russias Market Economy, 249. [48] Nigel Gould-Davies and Ngaire Woods, Russia and the IMF, International Affairs 75, 1 (1999), 3. [49] Desai, Conversations, 160. [50] Ibid. [51] Ibid. [52] Desai, Conversations, 52. [53] Ibid. [54] Ibid. [55] Ibid. [56] Ibid. [57] Ibid. [58] Michel Kantur Noel and Yevgeny Zeynep Krasnov, Development of Capital Markets and Institutional Investors in Russia: Recent Achievements and Policy Challenges Ahead (Herndon, VA: World Bank Publications, 2006), x.

[59] Noel and Krasnov, Capital Markets, xii. [60] Noel and Krasnov, Capital Markets, xiii. [61] Capital Discypriotization, Kommersant, accessed May 13, 2011,http://www.kommersant.com/p1075465/r_529/offshore_taxation_financial_regulation/. [62] Noel and Krasnov, Capital Markets, xiv. [63] Noel and Krasnov, Capital Markets, xv. [64] Noel and Krasnov, Capital Markets, 32. [65] Noel and Krasnov, Capital Markets, 39. [66] Russian Economic Report No. 17, World Bank, accessed May 14, 2011,http://siteresources.worldbank.org/INTRUSSIANFEDERATION/Resources/rer17_eng.pdf. [67] Anders Aslund, Russias Top Economist Needs to Face Reality, St. Petersburg Times, accessed May 14, 2011, http://www.sptimes.ru/index.php?action_id=2&story_id=27448. [68] Aslund, Revolution, 96.

[69] The Russian Federation and the IMF, International Monetary Fund, accessed May 15, 2011, www.imf.org/external/country/rus/index.htm. [70] Ibid. [71] Human Development Indices, UN Development Programme, accessed May 15, 2011, http://hdr.undp.org/en/media/HDI_2008_EN_Tables.pdf.

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