Stuck in Transit: Rethinking Russian Economic Reform

Can Russia Regain the Political Will to Implement Essential Economic Reform?

Last year was supposed to be the time of a big push for reform in Russia after a long period of inactivity. But since the financial crisis of 17 August 1998, when delays in reforms, the lack of fiscal discipline and an overvalued exchange rate finally forced the government to devalue the rouble and default on its debt obligations, the Russian economy has been ‘stuck in transit’ – unable to make the leap to a fully functioning market system and with the political process now paralysed by campaign fever.

A new CEPR Report, Stuck in Transit: Rethinking Russian Economic Reform, explores the traumatic events of August 1998, their underlying causes and the deep flaws they exposed in the process of reform. Drawing on a series of major new research programmes at the Russian European Centre for Economic Policy (RECEP) in Moscow, the Report discusses the policy options for rebuilding the Russian economy once the elections are over. Among the contributors’ findings:

• Economic growth without structural reform. In the immediate aftermath of the crisis, many forecasters predicted hyper-inflation and a large and rapid fall in production. But this gloomy scenario has not yet materialized: the Russian economy has been on a path of recovery with impressive growth rates in industrial production, albeit from a low base and mainly in import-substituting activities.  
  

• The benefits of devaluation. Commentators tend to focus on corruption and the absence of the rule of law as the main causes of the crash. But the depression in Russia’s industrial heartland was largely caused by the success of macroeconomic stabilization. The rouble’s collapse freed industry from the uncompetitiveness of the former exchange rate, allowing steady growth for the first time in a decade.
  

• Arrears. From the beginning of transition, non-payments have been pervasive: from the state to its employees and providers of goods and services; from taxpayers to the state; and from firms to firms. All these arrears are linked: enterprises under duress run arrears, first to the budget, and then to other enterprises and their own employees. This ranking follows the line of least resistance. It is clearly less dangerous to upset the tax collector than to upset colleagues or employees.
  

• Can’t tax or won’t tax? Russia’s legendary failure to collect taxes is frequently cited as the most glaring sign of the weakness of the Russian state. But calculations of Russia's tax capacity reveal that, across federal, regional and local budgets, Russia collects about as much in taxes – 33% of GDP – as would be expected for a country of its income and economic structure, based on international comparisons.
  

• Fiscal federalism. The already weak tax base of the localities has been weakened, increasing their dependence on the regions. The localities should be given additional sources for their own revenues. And overall, the federal government should demonstrate its credibility in implementing a policy of tax discipline by bankrupting large non-payers and repossessing their assets; and following rules on distribution.
  

• Financial-industrial groups (FIGS). The Russian government has allowed and even encouraged the growth of FIGs, which involve close relationships between financial institutions and industrial enterprises. This may well have been justified given the advantages they provide for their members in terms of economic performance. But it is vital to bear in mind that FIGs have a negative effect on competition and flexibility, both of which are crucial for long-term growth.
  

• The barter economy. One of the striking features of Russia’s transition has been the enormous growth in the use of barter. Barter is more common in larger enterprises and in more concentrated industries, but the likelihood that an enterprise will engage in barter is independent of its financial position. That implies that since the search costs of finding countertrade partners are very low, the economy may be in a trap where barter is so common that it is less costly to make exchanges without money.

The Report concludes that this month’s parliamentary (Duma) election and the presidential election scheduled for June 2000 have created a post-crisis environment in which politicians are taking a cautious approach to economic policy - doing as much as possible to do as little as possible. This has both positive and negative consequences: positive in that policies have become predictable, but negative in that the political will to engage in the large-scale institutional and structural reforms essential to sustainable recovery is still absent.

Once Russia recovers from campaign fever, a new Duma and eventually a new president will have to face the underlying structural problems and lack of institutional development. The fundamental challenge of rebuilding a constituency for implementing the necessary reforms remains.

Notes for Editors:

Stuck in Transit: Rethinking Russian Economic Reform is edited by Erik Berglöf and Romesh Vaitilingam. Berglöf is Director of the Russian European Centre for Economic Policy (RECEP) and the Stockholm Institute of Transition Economics and East European Economies (SITE); he is also a CEPR Research Fellow. Vaitilingam is an independent writer and consultant.

RECEP is a bright new member of the international research community and a front-line revitalizing force in the renewal of Russian economic research. The Centre is managed by a consortium led by SITE and including CEPR and DELTA in Paris; it is funded by the European Union’s Tacis programme, which provides grant finance for know-how to foster the development of market economies and democracy in the New Independent States and Mongolia.

The Centre for Economic Policy Research is a network of over 500 researchers based throughout Europe, who collaborate through the Centre in research and its dissemination. CEPR helps its Research Fellows and Affiliates develop projects, obtain their funding, administer them and disseminate their results. The Centre’s research ranges from open economy macroeconomics to trade policy, from the economic transformation of Central and Eastern Europe to regionalism in the world economy. The views expressed in CEPR publications and meetings are those of the authors and speakers. CEPR takes no responsibility for these views, and does not take any institutional policy positions. 

For further information, please contact Romesh Vaitilingam on (44 117) 983 9770 or (44) 468 661095; Rita Gilbert at CEPR on (44 20) 7878 2917; or Erik Berglöf in Stockholm on (46 8) 736 9676.

For further information about CEPR, please contact Rita Gilbert, Tel: (44 20) 7878 2917 or email: rgilbert@cepr.org.