Anyone trying to come to grips with today's Russia, and particularly with the rise of Prime Minister Vladimir Putin, would do well to take a closer look at the transition period following the collapse of the Soviet Union. Put bluntly, it was catastrophic. Jeffrey Sachs and a team of Harvard economists advised then-President Boris Yeltsin and his policy team to implement the so-called "Washington Consensus": liberalize (open the market to free trade, internal competition and foreign investment), stabilize (cut government spending and debt to bolster the currency) and privatize (reduce government control of businesses). Sachs specially advocated "shock therapy" -- rapidly implementing said reforms -- based on that strategy's success in Poland's post-Communist transition. But in Russia, shock therapy failed miserably. Severe economic depression ensued, worse than America's Great Depression, culminating in a financial meltdown in 1998. Not only did Yeltsin's actions in this time of economic and social chaos leave Russia with the institutional legacy of a strong executive, but public participation in government suffered a blow from which it has yet to really recover. But how on earth did the economic transition fail so miserably?
Three obstacles, all of which should have been evident to anyone familiar with Russia's political history, hampered the attempt at reform. First, reformers ignored Russia's weak legal institutions. State legal institutions are necessary to regulate private economic activity, and Russia sorely lacked them when the Soviet Union collapsed. Unable to enforce sound laws to induce contract compliance, check corrupt officials and ensure proper execution of reforms, Yeltsin could do little to achieve the desired economic results. Trust among businesses waned, and corruption waxed. The fact that a new group of largely corrupt entrepreneurs known as "the oligarchs" used this period to acquire more than half the country's wealth proves that legal rules fell short of sound implementation -- particularly because some oligarchs like Mikhail Khodorkovsky acquired much of that wealth in rigged auctions. Internal business corruption festered under Yeltsin, with members of the old nomenklatura semi-nobility cared for and fed as the heads of companies without an eye to good corporate practice -- as with the gas giant Gazprom, for instance, which was brought under effective state control partly in response to this period's corruption. There were neither social safety nets to cushion the unemployment that comes with economic restructuring nor good macroeconomic rules to prevent irresponsible foreign investment practices, the latter of which exasperated the financial meltdown of 1998.
Secondly, Yeltsin demobilized civil society and increased executive power to help himself implement reforms unobstructed. Yeltsin and his advisers seemed to have operated under a widely accepted (but poorly conceived) economic theory that posited a "J-curve" of economic transition: During Russia's restructuring, net wealth would temporary decrease, and while it would eventually rise again to even greater heights, the economic trough period could sufficiently scare the people into protesting further economic reforms, trapping them in decline. The theory saw immediate costs concentrated among the people in the present while benefits dispersed over the future. Democratic institutions therefore threatened sound economic transition, since the people could use their representation to hamstring seemingly harmful reforms and hamper long-term growth. Yeltsin therefore legally insulated the executive from public accountability to permit unchallenged reforms -- in other words, he created a very strong presidency.
Unfortunately, the strategy both misanalysed the economic situation and misunderstood the relevant actors' interests. Economists have since demonstrated that the J-curve theory in Russia's case was flawed -- they got the distribution of costs and benefits backwards. As the economy enters the J-curve's trough, benefits concentrate among a small group of elites, while costs disperse over the people. During transition, partially initiating economic reforms extends the length of the J-curve's trough and maximizes the benefits for the elites, who profit from the partial transition at the cost of the country as a whole. In Russia's case, financially and politically powerful oligarchs were the real winners of insulated executive power. More democratic institutions or more parliamentary power might have imposed the checks needed to move reforms past the partial implementation stasis and toward real recovery and growth. Bolstering the power of the president hamstrung Russia's real economic reforms and quickly left the country with the legacy of an overly powerful president.
Finally, the economists diagnosed Russia incorrectly in general. As international economist Jagdish Bhagwati stated eloquently, they treated the patient without understanding the disease. A closer examination of the political and social situation should have shown that Russia was not ready to be "shocked" into private ownership and liberalization. Without a legacy of free markets and ownership, entrepreneurs both didn't know how to run businesses efficiently and had no personal incentive to observe ethical business practice. Sachs and his team also overlooked Russia's deeply rooted, cultural fear of unemployment, an unknown phenomenon during the days of the Soviet Union. Out of desperation to keep employment up, planners lowered wages rather than fire workers, a measure that inadvertently decreased efficiency, distorted the market and actually contributed to Russia's depression. There was a period when drivers continued making their regular deliveries without pay simply because they didn't know what else to do. The Harvard team overlooked Russia's permissive attitude toward elite corruption that enabled the rise of the oligarchs who took control of Russia's economy, and whose easy purchase of private business shares itself revealed the people's poor understanding of the concept of private ownership. Worst, the team ignored the social costs of shock therapy: Yeltsin's demobilization of civil society contributed to the stagnant state in which it remains today. Weak civil society and the legacy of fear and depression in that first post-Soviet decade doubtlessly helped Putin consolidate power popularly and contributed to the myth that Russian political culture somehow favors strong executives.
The evidence suggests that had more attention been paid to strengthening healthy legal institutions, contracts would have been enforced, corruption and rent-seeking behavior would have fallen, and foreign aid and investment might have been safer -- perhaps then, the International Monetary Fund might have come through with those loans Sachs assumed Russia would receive. Either strengthening democratic institutions or at least checking executive power would have either avoided a partial reforms trap or at least provided more oversight to the backroom business deals reached under Yeltsin. Finally, paying more attention to Soviet social and political legacies would have avoided issues like the irrational employment policy. Russia was in for a rough period no matter what, of course, but history has made it clear that the ball not only dropped, but sank through the floor.
Oh, and for anyone who's noticed Russia's current economic troubles in our current financial crisis: Remember that Russia's dealt with it before, and the duo of Putin and President Dmitry Medvedev will not risk allowing the Russian people to lose their sense of security and order. Russia's history really puts a damper on the hope that integrating the country into the World Trade Organization can somehow "tame" the country's rise.
Intrigued? Tomorrow afternoon, there will be a symposium on United States-Russian relations in Cabot. Stop by and take a closer look at some of the issues that President Barack Obama will need to overcome for any successful "reset" with the Medvedev-Putin administration. If Russia's economic transition taught us anything, it's that taking a closer look at history and culture is vitally important.
--
