Russia’s Success Story

Anders Aslund. Foreign Affairs. Volume 73, Issue 5. September/October 1994.

Chernomyrdin Pulls It Off

The Russia emerging today is very different from what pessimists have prophesied. It is not falling apart but coming together. The new political institutions function. Strikes are rare, and no serious social unrest is on the horizon. Incredibly, most of the Russian economy, measured by either employment or output, has been privatized in just two years. Russia has already become a market economy, but one in the midst of a long-overdue and massive restructuring. In short, Russia has undergone fundamental changes and appears to be on the right track.

The Western caricature of Russia as a destitute country on the verge of either collapse or falling into the hands of fascists could not be more wrong. Naturally, things are far from perfect, but no one thought communism would go away without costs. In a new openness all problems are discussed in the Russian media, and often exaggerated. But few in the West write about Russia’s successes, like the end of shortages and the risk of famine. Moreover, the true disaster of other former Soviet republics is often confused with Russia’s. Of course major problems such as crime and inflation remain in Russia but even monthly inflation fell to five percent in June. More daunting is the task of building a system of rule of law, which has been a cumbersome process all over Eastern Europe. The situation is worse in Russia, but far from hopeless.

Nation-Building Is Working

Russia’s parliamentary elections in December 1993 left the West in despair. The extreme nationalist Vladimir Zhirinovsky was touted as Russia’s new leader. In fact, his Liberal Democratic Party gained only 14 percent of the seats in the State Duma, the lower house of the new Federal Assembly, and a bare handful in the Federation Council, the upper chamber. Zhirinovsky’s impact on Russian policy-making has been minimal, and his deputies have deserted him in droves. The real winner of the elections has turned out to be Prime Minister Viktor Chernomyrdin, a 55-year-old engineer of traditional Soviet stock who was not even a candidate for parliament.

Until December 1993, Russia’s fundamental political problem was that it suffered from the Soviet Russian constitution, which declared the predemocratic parliament sovereign. The old Supreme Soviet took its sovereignty and supremacy seriously, trying to exercise both executive and judicial power. In December 1993 the voters ended this anomalous situation by adopting a new constitution. Reminiscent of the French constitution, it provides for a parliamentary system with an ordinary division of power between a strong executive and a parliament reduced to a legislative role. It is not surprising, therefore, that Russian politics has acquired a certain resemblance to French politics, with a weak parliament and continuous strife between the staffs of the president and prime minister.

The new State Duma has proved far more responsible and moderate than expected. The most common complaint is that it does not adopt more laws, but the prolific and arbitrary lawmaking of the old Supreme Soviet prompted the introduction of safeguards against hasty decisions by the Duma. A vital improvement is that the deputies of the Duma are disciplined by 11 political parties, which act in coordination. Single deputies can no longer be bought, as the parties check vested interests. Previously, state enterprise managers comprised the main pressure group, but their party, the Civic Union, received only two percent of the popular vote last December and failed to get representation in the Duma. As in most modern democracies, agrarians form parliament’s main lobby, with 12 percent of the deputies.

Prophecies that the Russian Federation would suffer the same fate as the Soviet Union have not held. Parliamentary elections and the adoption of the new constitution through a referendum were acts of nation-building that reinforced Russia’s legitimacy. After all, 85 percent of the population is ethnically Russian, so the ethnic underpinnings of separatists are weak. Potential separatist entities are all less democratic than Russia a fact that undermines their legitimacy. Since most economic powers have devolved from Moscow to regional governments, there is little incentive to claim independence. At the beginning of 1994, Russia introduced a new tax system based on enlightened ideas of fiscal federalism. As Moscow no longer irritates the regions, their protests have died down.

After two years of tortuous and destabilizing ambiguity, with several republican central banks issuing rubles, the ruble zone was finally dissolved last year. The cost of this institutionalized monetary irresponsibility was high. No less than 10 of 15 former Soviet republics experienced hyperinflation last year. Only the most reformist states–the Baltic states, Russia, and Kyrgystan–escaped such hardship.

Russia has effectively nationalized the ruble and prompted all the other republics except war-ridden Tajikistan to introduce their own currencies. Each republic is now responsible for its own monetary policy, which is a prerequisite of monetary stabilization. In early January, Russia and Belarus signed an agreement on monetary union. After many additional negotiations and a few accords, free trade has been agreed on, but monetary union remains elusive. If it were created, monetary union would hardly be destabilizing, because Russia insists its central bank would be the sole issuer of money, while the National Bank of Belarus would cease to function as a central bank.

Viktor Victorious

Contrary to common perception, Russia has in fact resolved many basic institutional problems. Pore than anyone else, Prime Minister Chernomyrdin has exploited the new situation to his own political advantage. Yet many have failed to note his growing power. When Chernomyrdin visited Washington in June as the head of a high-level delegation, his visit was barely reported in the American media, but this little-noticed man has been Russia’s prime minister since December 1992.

To a large extent, it is by his own design that Chernomyrdin has persistently been overlooked and underestimated both at home and abroad. He uses his low profile to reinforce his power. Although Yegor Gaidar belonged to the government for only three months last year, in the election campaign he was blamed for everything that had gone wrong in Russia because Chernomyrdin kept out of the public’s view.

Chernomyrdin has good relations with most important institutions. As the last Soviet minister of the gas industry, his basic constituencies are the gas and related oil and chemical industries. Those rich industries can provide him with all the money he needs for future political campaigns. ore important, they are winners in the transition to a market economy.

Rather than joining any political party, Chernomyrdin maintains good relations with most of them and is perceived as a centrist. His government contains five deputies from the liberal-conservative party Russia’s Choice, including Minister for Foreign Affairs Andrei Kozyrev and Minister of Privatization Anatoly Chubais. However, Chernomyrdin also keeps Agrarian Party member Alexander Zaveryukha as deputy prime minister for agriculture. Chernomyrdin’s balancing act between reformers and conservatives reinforces his own power. Wherever the political center is, Chernomyrdin occupies it, but he consistently tries to form broad coalitions.

The heart of Chernomyrdin’s power is his personal staff of about two thousand officials, who increasingly check the power of the ministries. Admittedly, President Yeltsin has a staff twice that size. The difference is that the presidential administration is rife with tension between conservatives and reformers, rendering it ineffective, while Chernomyrdin prefers gray but loyal and effective executives from the gas industry and has forged personal links with many regional governors. One weakness is the difficulty that the socially awkward and taciturn Chernomyrdin has accepting policy advice from strong ministers. The more ministers he selects himself, the weaker and grayer his government looks.

In his public statements Chernomyrdin follows the popular line of the day, minimizing controversy. He is interested not in pressing views but in building and exercising power. After the December elections, Chernomyrdin joined in criticizing the reformers with statements such as “the period of market romanticism is over” and that the fight against inflation would shift to “non-monetarist measures.” By appearing to give up any attempt at serious monetary stabilization, he compelled the forceful reformers and Deputy Prime Ministers Gaidar and Boris Fyodorov to resign from his government, but he divided the reformers by accommodating the effective reformer Chubais in his cabinet.

However, the antireform mood after the elections was soon reversed The ruble fell like a stone on the free exchange market in January, and inflation rose, while the West reacted with disappointment and concern. A week after Gaidar and Fyodorov departed, Chernomyrdin declared himself a “market romanticist,” and the most irresponsible economic decisions that prompted Gaidar’s resignation were reversed. Quietly and mostly in private, Chernomyrdin refused requests for new expenditures, although President Yeltsin was keen on offering handouts. The financial and monetary stabilization initiated by Fyodorov in the fall of 1993 continued. Chernomyrdin rid himself of the most conspicuous liberals for political reasons, but he maintained both their policies and their aides.

Tight Money

Chernomyrdin froze the October 1993 stabilization policy in its original form, but that policy had been designed only as a first step toward financial stabilization, and changing circumstances made it ever more inadequate. Russia’s budget deficit has been held constant at about nine percent of GDP, too high but not out of control. Increasingly, inflation has been fought with strict monetary policy. Fyodorov prompted the Central Bank of Russia to raise its refinance rate to 17.5 percent per month in October 1993, when monthly inflation was 20 percent. The tight monetary policy brought down inflation, and in November 1993 Russia achieved a positive interest rate, which reduced inflation further. The nominal refinance rate has stayed high, although the monthly inflation rate has remained around eight or nine percent since February 1994, leaving Russia with a real interest rate of about 100 percent a year–the highest in the world.

When state enterprises could no longer obtain cheap credit, they demanded straightforward subsidies or state orders from the government. In that way strict monetary policy reinforced the pressure on the budget. In January Chernomyrdin seemed to promise considerable subsidies to agriculture, but he held tight to the government’s purse.

Still, after much lobbying, agriculture did receive subsidies amounting to about four percent of GDP. This measure was unfortunate but commensurate with the agrarian representation in the Duma.

Notwithstanding his cautious language, Chernomyrdin has increasingly become the mainstay of stabilization. This year he took on the formidable Russian military-industrial complex. Throughout the spring it demanded up to 87 trillion rubles, including arms procurement, while the budget offered them 37.1 trillion rubles, that is, 5.1 percent of the expected 1994 GDP.

Most top military officials have publicly lobbied for a larger defense budget. The Federation Council, which is not disciplined by political parties, gave in to the military-industrial lobby and demanded a 55 trillion ruble military budget. Aides stated that the president supported that demand. As usual, Chernomyrdin avoided public controversy, but he refused to give anything more to the military, and after three readings, the State Duma finally adopted the 1994 budget in late June. It overruled the Federation Council and raised the defense budget to only 40 trillion rubles. The Russian military-industrial complex has proven to be a far weaker lobby than the agrarians, as is the case in other democracies.

At present, Chernomyrdin is at a crossroads with regard to stabilization. Despite his caution, he is identified with the attempts at stabilization and their costs. To blame Gaidar and Fyodorov is no longer convincing. Chernomyrdin has gone so far that his rational political choice would be to go all the way and defeat inflation. The budget votes in the Duma show that Russia now has the political base for a proper struggle against inflation. Ironically, the budget was saved by the agrarians, the communists, Zhirinovsky’s deputies, and the center, while many liberals voted against it because they wanted something more austere. Moreover, opinion polls show that Russians hate inflation.

While Chernomyrdin appears perfectly loyal to Yeltsin and denies any higher ambition, his presidential aspirations are hardly in doubt. Because Chernomyrdin has staked much of his reputation on financial stabilization he must succeed to secure his political future. But the present stabilization policy is relatively ineffective, socially costly, and possibly unsustainable. He needs to advance from the groundwork laid by Fyodorov last year.

Russia has accomplished a great deal and should take the final steps toward a stable currency by adopting a fill-fledged stabilization program. The remaining tasks are comparatively simple. First, the budget deficit should be cut to five or six percent of GDP, preferably by reducing subsidies to agriculture and the coal industry. Second, the budget deficit needs to be financed. Half the deficit can be financed through domestic borrowing because a large market for treasury bills has evolved in the past year; the other half can be financed with international credits on the order of $8 billion. Third, the exchange rate should be pegged or fixed, providing a nominal anchor for Russian stabilization. In April 1992 the Group of Seven leading industrialized nations promised Russia a stabilization fund of $6 billion for such an effort. Fourth, the stabilization package needs to be in the form of a standby agreement with the International Monetary Fund, including an agreement on financing the budget. All this is within reach.

Why Are Russians Still Unhappy?

This year the Russian economy has undergone a veritable metamorphosis with surprisingly little acrimony. Because of the monetary squeeze, official industrial output for the first six months of 1994 is 26 percent below that of the same period last year. The corresponding decline during the first half of 1992, when Gaidar launched the transition to a market economy, was only 13 percent, but public protests were much louder then. Russians now realize that the transition to a market economy is both necessary and costly.

The proverbial shortages and long lines are gone. In Russian cities, one finds consumer goods of all kinds produced both in Russia and abroad. Previously unavailable consumer goods, such as stainless cutlery, are now in ample supply. Russian armaments factories were once too arrogant to produce consumer goods. They now scramble to produce whatever they can sell for a profit. Today only three million Russians actually produce arms. The conversion of the military industry has, to a large extent, already succeeded.

Much of the decline in production is not real. Under communism, overreporting was notorious, as enterprises wanted to attain plan targets. Under capitalism, tax evasion, leading to underreporting of both profits and production, is even more endemic. Universally, electricity consumption is closely correlated to real GDP. In 1992 the official Russian GDP fell by 19 percent, but electricity consumption dropped only 6 percent. Last year the corresponding decreases were 12 and 5 percent. The latter figures probably reflect the development of the economy more accurately, indicating that the depression of the Russian economy is wildly exaggerated.

This becomes all the more evident when we look at consumption figures. Private consumption has started rising as a share of GDP from a paltry 40 percent; two-thirds is normal in the West. Real income rose by no less than nine percent last year. Registered retail sales expanded by two percent, but they are probably underestimated; much trade is statistically elusive informal street trade. The increases in sales of individual products, particularly consumer durables, were more impressive. For instance, sales of television sets surged 34 percent. The share of family budgets spent on food was 46 percent, refuting ideas of approaching famine. A construction boom for family houses is evident throughout Russia, and the total number of cars owned by Russians rose by nine percent in 1993.

But if consumption is growing why are Russians not happier? Opinion polls indicate a calm but pessimistic population. In one recent poll, 89 percent of the respondents considered the general situation alarming, a crisis, or a catastrophe, but three-quarters assessed their personal situation as good or satisfactory. The main answers are that many people do not realize they are not worse off and that they care about things other than their material well-being. A massive redistribution of income is taking place. Income differentials have widened, but they are still smaller than in the United States. Many old skills, ranging from teaching the political economy of socialism to mining coal, are losing value, while economics, law, entrepreneurship, banking, and handicrafts have become more valuable. Moreover, people find it difficult to make comparisons when inflation is high and the whole price structure is in flux. Russians earn growing amounts on the side, while their base salaries become less important, but they tend to disregard earnings from incidental trade. Finally, it is difficult to change, and work has become more demanding in the new Russia. If you ask Russians if they work more or less than under socialism, they look at you as if you were mad and say, “More, of course.”

The widespread exaggeration of economic hardship is politically important. Although central state institutions have started functioning in a more balanced manner, ordinary Russians still feel excluded and alienated: nobody asks them for their opinion; nobody tells them anything. Herein lies the real threat of Zhirinovsky. Unlike other Russian politicians, Zhirinovsky talks to and reaches ordinary Russians, especially men. In December 1993 he won over much of the male working-class vote from Yeltsin. A major political challenge is to include Russian workers in civil society through the dissemination of information, organizations, and augmented participation.

Part of the problem is that workers do not really count in the workplace, contrary to popular perceptions. Managers are supreme to an extent unknown in the West. From 1989 until mid-1993, hardly any state enterprise managers were fired in Russia, allowing them to be criminally negligent of their workers. In August 1993, when monetary policy was loose and enterprises awash in money, only 56 percent of workers polled had received their latest monthly wage in full and on time. A common complaint is that managers give themselves extraordinary salaries and fringe benefits. Much of Russia’s capital flight appears to have gone from state enterprises to their managers.

Nevertheless, apart from coal miners, Russian workers rarely strike, even when they have not been paid for months. Nor are workers likely to strike, because they lack both organization and leaders. Real wages seem perfectly flexible. It is easy to find enterprises in which real wages have fallen by 70 percent in one year. Admittedly, managers are loath to lay off workers. But why not keep them on the payroll when they do not even demand pay? They are also useful as pawns in negotiations with the authorities over subsidies. Thus, unemployment stays low, with the most plausible estimate at around six percent.

Taming the Apparatchik

Although the excessive power of enterprise managers continues to cause problems, their powers have been reduced through three measures. First, the formation of a democratically elected parliament, consisting of political parties, has diminished their political influence. Second, as in an ordinary market economy, the monetary squeeze has transformed managers into competitors. Curiously, their protests against tight credit faded as credit grew tighter. Initially all state managers stood united against the state, demanding cheap credit and other subsidies. When the government took a firmer stand, some managers were convinced that the government would give them nothing. They adopted a market-and profit-oriented strategy, breaking the ranks of the state managers, who were divided into winners and losers.

A third measure undermining the omnipotence of state managers is mass privatization, which has shifted power relations both in society and in businesses. The achievements of Deputy Prime Minister Chubais in privatization are astounding: 70 percent of Russian industrial enterprises have been privatized through a scheme of free distribution of vouchers to all Russians. These vouchers could be used to bid for shares at voucher auctions. Two-thirds of shares ended up in the hands of employees of those enterprises; altogether 40 million Russians have become shareholders. As a consequence, managers’ jobs are no longer safe. About one-tenth of them are replaced at the initial shareholder meetings. In such cases, small groups of insiders band together with outside owners against incumbent directors.

Continued privatization and restructuring will further discipline managers. Sporadic bankruptcies have started and are bound to increase. So far, the weakest link in privatization has been land reform. Some farmers have begun to break up collective farms from below. A political compromise has been accomplished through the Nizhny Novgorod model, which has been tested successfully. Fifty million private plots and 270,000 private farms accounted for 36 percent of official agricultural production last year. Another weak link is the privatization of commercial real estate, which has a confusing legal basis that is now being clarified.

As a result of these institutional changes, rudimentary checks on the power of managers have been introduced and are likely to grow stronger. They make it increasingly tempting for managers to focus on profits rather than on state subsidies.

Crime Versus Capitalism

Crime has succeeded inflation as the number one public concern. The main argument against Russia becoming a success story is that organized crime is about to take over. The situation is certainly bad, but the murder rate in Moscow remains lower than in most big American cities. Great criminal fortunes were made on exports of price-regulated commodities and subsidized credit, but these bonanzas have been wiped out by deregulation. Licensing enterprises remains a means of extracting protection money, but such abuses are gradually easing. The privatization model chosen everywhere except Moscow has impeded organized crime from making inroads. Crime syndicates have benefited from the excessively slow transition to capitalism, but now capitalism has basically taken hold, making it possible to defeat the mafia.

Russians are demanding that their politicians do something about crime As democracy takes root, no politician is likely to win an election without a plausible program for fighting crime. The media provides plentiful insights about organized crime, which can no longer take advantage of public ignorance. Russian businessmen defend their property and lobby the government for protection. The police now receive modern equipment as well as high salaries.

Major problems in the struggle against crime remain. The most serious are the paltry legal skills and poor ethics of the law enforcement system. It will take many years to upgrade them, but the process has started. Many police are not corrupt and willingly give their lives to uphold the law. The stage is set now for a long and intense struggle between law and crime, but there is little reason to believe that society will lose. The June presidential decree on measures against organized crime is characteristic of the time. On the one hand, it indicates great political anxiety. On the other, its eight alleged violations of the constitution reveal the inadequacy of Russian legal skills.

Ordinary Politics

After half a year of political hibernation, President Yeltsin woke up in the spring and returned to economic policy after a long absence. He seemed jealous of Chernomyrdin’s expanded powers. His aides said Yeltsin thought there was too little reform. Chernomyrdin obliged, and the result was a dozen new presidential reform decrees in May and June. At the same time, the president and his aides pushed for more state expenditures, notably for the military, showing less understanding of the need for monetary stabilization. Despite Yeltsin’s inconsistencies, Chernomyrdin prevailed.

This is a good illustration of the current state of Russian economic politics. Reform is alive and well, but it evolves slowly and undramatically. Mistakes are made, but today real economic interests demand rectification. The government responds somewhat slowly and inaccurately, but not all that badly. Russia has become a pluralist country with checks and balances. Politically, it is reminiscent of India, with its many centers of power, which make it possible for the country to withstand many small disasters without having to face a real catastrophe. For the same reason, however, consistent policies are also implausible.

The time of fast and radical change is over in Russia. Fortunately, much of the transformation has been accomplished. Basic political institutions, such as an elected president, an elected parliament structured by political parties, and a more Western constitution already exist.

Russia has now entered the stage of ordinary politics, when interests are more important than ideas. Compared with what has been achieved already, the remaining tasks are relatively limited. inflation, currently at about 100 percent a year, should be halved. Further liberalization is needed to eliminate the causes of corruption. For a long time, it will be necessary to put the utmost efforts into fighting crime and developing a normal legal system. The tax system is atrociously arbitrary, crying out for fundamental reform. A market economy has been successfully created, but people do not understand that. A major political challenge is to explain the transformation to a market economy to the population, and especially to include the workers in society.

For such assignments, visionaries are unnecessary. They have completed their fundamental tasks and can be replaced by pragmatic consensus politicians with low public profiles like Chernomyrdin. His appearance is a natural political development and an indication of the relative success of Russia’s political and economic reforms. Moreover, Chernomyrdin is one of Russia’s most authoritative politicians. What is worrisome for building democracy is that he bases his power on the state administration and industry rather than on a political party.

Russia has at last become a relatively predictable country. The fundamental political and economic institutions have been created. The time has arrived to end discussions about the pending collapse of Russia. What needs to be discussed now is not what Russia will become, but what it has become.