Why Russia’s Politics Matter

Michael McFaul. Foreign Affairs; New York Vol. 74, Issue 1. January 1995.

The results of Russia’s first post-communist election in December 1983 sent a shock wave through the world. Vladimir Zhirinovsky, the nationalist demagogue of the Liberal Democratic Party, captured almost a quarter of the popular vote. The pro-reform bloc, Russia’s Choice, came away with only 15 percent. Provoked by his dramatic outcome, Prime Minister Victor Chernomyrdin promised a new economic course, declaring that the election marked “the end to market romanticism.” In resigning as finance minister, Boris Fyodorov predicted the new course would result in rampant inflation, the return of price controls, and the arrest of privatization, leading to the collapse of the Russian economy by the end of 1994.

A year later, this nightmarish scenario has yet to unfold. Backing away from earlier threats, Chernomyrdin has refrained from reintroducing price controls. Meanwhile, privatization has marched furiously forward, transferring 100,000 enterprises into private hands by the end of 1994. A booming stock market suggests that not all of these privatizations are mere paper transfers. Perhaps most surprisingly, inflation rates remained in the single digits for most of the year.

Admittedly, industrial production continues to decrease, gross domestic production is contracting, and serious enterprise restructuring has just begun. Nonetheless, the performance of the Russian economy in 1984 has exceeded almost everyone’s expectations. What is going on in Russia? How is it that the election of nationalists and communists to the Russian parliament coincided with the beginning of economic stability? Are politics and economics in Russia related at all? Or is this period of stability the calm before the storm?

A Revolution in Midstream

The disintegration of the Soviet Union made old theories about that part of the world irrelevant. In the void, neoliberal models of economic reform began to dominate discussions of change in postcommunist Russia. Monetarist stabilization measures and structural adjustment programs used in the developing world emerged as the guiding principles for transforming communism into capitalism.

The neoliberal framework, however, is insufficient in two critical respects. First, the word reform does not capture the magnitude of change required to replace the Soviet system with a market economy. Rather than amend or improve the Soviet command economy, Russia must dismantle it and develop a market economy. Economic reform formulas based on preexisting private property and markets offer little guidance for dismantlement or creation.

Second, the economic reform theorists discounted politics. They focused on inflation, deficit spending, and exchange rates and considered political issues a distraction. When compelled to comment on political reform, neoliberals in both Russia and the West simply called for shrinking the Russian state, without addressing what kinds of state and nonstate political institutions might help their economic reforms. The belief that economic reform could proceed without political reform was a costly mistake.

Political analysts trying to counter this focus on economic reform have relied too much on analogies to historical transitions to democracy. Change in Russia is distinct from democratic transitions in southern Europe and Latin America in two critical respects. First, in contrast to the transitions in Spain and Chile, the terms of Russia’s transition were not negotiated between outgoing autocrats and incoming democrats. Rather, after intense polarization, the Soviet ancient regime collapsed, leaving the rules of the game ambiguous, uncodified, and subject to constant manipulation. Second, unlike democratic transitions in capitalist economies, Russia’s political transformation is taking place simultaneously with economic transformation. Its budding trade unions, civic organizations, and political parties have difficulty articulating what groups and interests they represent. The “transition to democracy” analogy, therefore, captures neither the logic nor the magnitude of the political change required in Russia.

Russia is in the throes of a social revolution: a rare moment in history in which challengers to the ancient regime attempt to transform the polity and the economy abruptly and simultaneously. Russia’s current revolution is similar in scale and scope to the French Revolution begun in 1789 and the Russian Revolution in 1917. Only its relative peacefulness distinguishes the current revolution from its predecessors.

Understanding change in Russia today as a peaceful revolution in progress is both useful for analysis and relevant for policy because it captures the magnitude and abruptness of the transformation. For Russia to consolidate a market economy and a political democracy requires the demolition of the Soviet ancient regime and the creation of a completely new political and socioeconomic system. The revolutionary model also highlights the relationship between those changes. Political reform cannot be put on hold while economic reform is carried out, nor can economic change be frozen to allow political reform. Rather, economic changes affect political transformation and political changes shape economic transformation. Missing this point has handicapped both an analysis of Russia and reform.

Gaidar: New Economics, Old Politics

Neglect of the political aspects of Russia’s transformation was most apparent during the first two years after the Soviet collapse. The economic aim was clear—-transform the Soviet command economy, based on state ownership of the means of production, into a Russian market economy based on private property. Toward that end, Russian President Boris Yeltsin appointed Yegor Gaidar as deputy prime minister in charge of the economy. Like all good revolutionaries, Gaidar and his economists were guided by an ideological blueprint consisting of three stages of policy initiatives: price liberalization, macroeconomic stabilization, and privatization. The program acquired the unfortunate label of “shock therapy.”

The plan made sense as a blueprint for economic transformation, but Gaidar’s program lacked a political strategy. After all, Yeltsin, Gaidar, and Russia’s first post-Soviet government inherited not only a collapsing economy but a collapsing state. Yeltsin did take some important steps toward transforming the Soviet political system immediately after the August 1991 coup, when he banned the Communist Party, subordinated several Soviet institutions to the Russian state, and, most dramatically, in December 1991 dissolved the U.S.S.R. itself. Yeltsin, however, failed to take several other key steps: he did not push for the ratification of a new constitution, he did not call for new elections for either the parliament or local government officials, he failed to create his own political party, and he left in place many Soviet political institutions, including first and foremost the Russian Congress of People’s Deputies. Failure to take those steps resulted in the emergence of a hybrid state—an incompatible conglomeration of post-communist institutions grafted onto lingering Soviet-era institutions—that could not execute radical economic reforms.

The greatest achievement of the Gaidar government was price liberalization. When Gaidar abolished price controls in January 1992, almost everyone predicted riots, strikes, and general social unrest. None of those scenarios came to pass. The peaceful transition toward free prices was a monumental step for a state that had controlled prices for over 60 years.

Price liberalization was possible in large part because of the political context. After his brave defiance of the coup plotters in August 1991, Yeltsin’s tremendous popularity gave his government unchallenged legitimacy and authority. The Soviet Army and the KGB, which might have challenged him, were paralyzed or in disarray after the putsch. Yeltsin’s political opponents were dwarfed by pro-Yeltsin movements like Democratic Russia. The Congress of People’s Deputies granted Yeltsin the power to rule by decree in November 1991, giving Yeltsin near-authoritarian power. These political conditions made this first step of economic reform possible.

Freeing prices, however, is a relatively straightforward act that requires neither time nor strong: governmental administration. Stabilization are much more complicated, requiring sustained political support and an effective state bureaucracy. Neither existed in Russia in 1992. As expected, the January 1992 price liberalization produced a sharp rise in inflation. In retrospect, however, it is striking how low inflation rates were during those first few months of reform in comparison with later on. Monthly inflation rates steadily declined from 38 percent in February 1992 to 9 percent in August 1992.

Bad politics, not bad economics, unraveled those initial successes. Tight government expenditures threatened directors and workers of large state enterprises. These groups worked through the Congress of People’s Deputies to launch an assault against Gaidar and his reform plan and pressured Yeltsin to add three of their allies to his government. From that moment on, radical reformers no longer controlled government spending. Soon thereafter, government transfers to state enterprises and unpaid debts between enterprises increased dramatically.

Worse, Gaidar’s government lost control of monetary policy. Under the 1977 Soviet Constitution, it was unclear which branch of government controlled the bank. Such ambiguity allowed Viktor Gerashchenko, who was appointed head of the Russian Central Bank in the spring of 1992 as part of a compromise with industrialists, to define his own monetary policy. Gerashchenko promptly cleared debts between enterprises and provided cheap credit for state enterprises. Monthly inflation soared to 25 percent by the end of the year.

Gaidar’s strategy for privatization was also undermined by politics. The original privatization program drafted by Gaidar and his colleague, Anatolii Chubais, gave insiders—directors and workers—a minority stake in their enterprises and then allocated to outsiders the majority of shares in each enterprise through a voucher system. In making outsiders the majority owners, this plan aimed to discipline enterprise directors to pursue profits for shareholders rather than job stability for themselves and their workers.

Gaidar’s team had hoped to implement their privatization program by presidential decree. Opposition forces in the Congress countered that such an important act must have legal force. In the end, Yeltsin decided to submit the program for parliamentary approval. Before it became law, over 100 amendments were added, including two new options for privatization that allowed managers, in cooperation with their workers’ collectives, to acquire majority ownership in their enterprises.

Not surprisingly, 75 percent of all privatizing enterprises chose those options. As Gaidar candidly admitted in June 1993, “I cannot say that we are satisfied with the scheme adopted by my government, as two-thirds of privatized enterprises are controlled by workers’ groups.” The combination of inside ownership and continued state subsidies—amounting to 22 percent of Russia’s gross national product in the summer of 1993—meant that the structure of property rights changed little in the first two years of economic reform.

The failure to consolidate a new political order in Russia culminated in what Yeltsin in September 1993 called “the loss of authority of state power as a whole.” By then, the Russian state had little capacity to carry out even modest economic reforms. Tragically, this paralysis of state power ended only after armed struggle between the Congress and the president in October 1993.

Chernomyrdin: Finally, New Politics

Less noticed than Zhirinovsky’s success in December 1993 was the act that Russian voters also ratified a new constitution. Compared to Western ones, Russia’s constitution grants inordinate power to the executive branch. Nonetheless, the new document has delineated, regulated, and normalized relations between the president, his ministers, and the new Federal Assembly. This new political context has helped in implementing further economic reform.

The new constitution gives the president the authority to shape the government and economic policy. President Yeltsin, not the parliament, determines who serves in the Russian government. The State Duma, the lower and more influential chamber of the Federal Assembly, can hold votes of no confidence, which it did for the first time in October 1984. Yet successful votes of no confidence do not compel the president to dismiss the government. On the contrary, after two consecutive no-confidence votes, the president can dissolve the Duma.

The new constitution also clarifies the central bank’s role. The central bank can no longer use the promise of cheap credit to conduct its own industrial policy. Since October, transfers to enterprises are controlled by government ministries. Under the new constitution, the president appoints the head of the bank and—as shown after the ruble collapse in October 1994—has the de facto power to dismiss the bank’s chief.

Nominally, the Duma has the power of the purse. But executive control over writing the budget, the lack of transparency regarding budget items, and executive control over all off-budget expenditures has shifted control of financial policy from the parliament to the executive. The government’s budget must still withstand a rigorous parliamentary review. Compared to the previous two years, however, the process of approval and amendment has become clearer, suggesting that the 1995 budget debate will not be as politically or economically destabilizing as earlier ones.

Within its limited jurisdiction, the new Russian parliament’s participation in economic policy has been more organized and productive. The Duma has adopted important market-supporting laws. In July 1994 it passed the second reading (of three) of a new civil code, establishing the legal and economic institutions to guarantee private property rights and enforcement of contracts. Progress in parliament on this monumental code suggests that the agenda has changed fundamentally; the question is no longer whether to develop a market economy, but what kind.

In this new political context, the government has resisted pressure from newly elected parliamentary representatives and maintained the tenets of Gaidar’s economic reform. While communists in parliament claim to have an electoral mandate to roll back Gaidar’s policies, the new divisions of authority make it virtually impossible for the Duma to prescribe new price controls. To almost everyone’s surprise, the Russian government has maintained the general liberalization policy outlined by Gaidar in January 1992.

Chernomyrdin’s government has also achieved real progress toward monetary stabilization. The prime minister tightened monetary and fiscal policy, established positive real interest rates for government credit issued by the Russian Central Bank (a policy first pursued by Gaidar and Fyodorov in October 1993), and curtailed government subsidies to state enterprises. Rather than responding to expenditure requests from the Duma, Chernomyrdin submitted a federal budget to the Russian legislature in spring 1994 that the Duma approved with only minor amendments. The government’s 1995 budget is even more fiscally conservative, with targets of one percent monthly inflation and an annual budget deficit of eight percent. Of course, writing a tight budget is easier than keeping to one. In recent months, pressure from the agriculture, coal, and heavy industry lobbies has resulted in much higher government expenditures. Moreover, the violent gyration of the ruble last October highlighted the fragility of the government’s stabilization policy and raised doubts about the long-term viability of the current economic policy. Nonetheless, no matter how the year ends, the annual inflation rate will be much lower for 1994 than for the previous two years and considerably lower than predicted a year ago. Even with increased year-end spending, Russia’s deficit will still fall below ten percent of gross domestic product for 1994.

The campaign to privatize has also benefited from Russia’s new political framework. In October 1993, the Congress of People’s Deputies threatened to halt privatization altogether. Yeltsin’s decision to dissolve the Congress, however, provided a new stimulus toward privatization. Former opponents of privatization, especially directors of large enterprises, rushed to privatize to ensure that they got their piece of the pie before the voucher phase of the program ended in July 1994. By the end of that first phase, over 100,000 enterprises had been privatized.

Approval of a new law to guide the second stage, or cash phase, of privatization has proved difficult. The process of adoption, however, has underscored the new preeminence of the president and his administration in making economic policy. After heated debate, the Duma failed to ratify Yeltsin’s bill on privatization before its summer recess in July. The day after it adjourned, Yeltsin decreed what the Duma had rejected. As a conciliatory signal, Yeltsin incorporated into his decree several amendments suggested during parliamentary debate. Moreover, Yeltsin said that his decree would serve as an interim measure. With the decree in place, however it will be difficult for the Duma to change the law without confronting Yeltsin and his ministers. The two-thirds majority needed in both chambers of Russia’s parliament to override a presidential veto makes it unlikely that a fundamentally different privatization law will be adopted in 1995.

The Economic Need for Political Reform

Russia still lacks many market-supporting state institutions. While greater institutional clarity between the president, government, and parliament has created more propitious conditions for radical economic reform, many other political and state institutions still need revamping or creation to secure Russia’s economic transformation. Russia’s reformers still have not created a new system of social security, an effective retirement system, a welfare program, a jobs training program, or a system of unemployment compensation. Without such a social safety net, the Russian labor market lacks fluidity. Workers still rely on their enterprise directors to provide all their social services. Directors in turn demand state subsidies to cover such expenses as wages, housing costs, and retirement benefits. In nonproductive enterprises, state transfers for wages essentially serve as unemployment compensation from the state. If the state delivered unemployment checks through an independent institution, bankruptcies would be less socially explosive, and unemployed workers might be encouraged to find new employment.

The state also has not institutionalized a legal system to protect property rights, govern bankruptcy procedures, enforce contracts, protect consumers, and ensure competition. Contracts must be totally self-enforcing to work because the state cannot enforce them. In the area of corporate law, disclosure statutes are weak and unenforced, general accounting procedures have not been codified, procedures for shareholder and proxy voting are ambiguous, and no institution governs the payment of dividends. Consequently, stockholders have little access to information about their investments. Adoption of the civil code by parliament is only the first step toward creating these institutions.

Some private market institutions such as banks, commodities exchanges, and stock markets have begun to emerge in Russia spontaneously, but unregulated stock markets have led to abuses. In Russia’s nascent stock markets, insider trading is the rule, not the exception. The absence of a state capable of protecting private and public property rights has also resulted in an explosion of mafia activity and unbridled environmental degradation. Given the weakness of the state, Russian entrepreneurs are compelled to turn to the only force that can protect their property—the mafia. The situation for public property is even worse, as no private individual or group has an incentive to protect or regulate the use of Russia’s commons.

Political reform at the local level will also influence future economic progress. While Russia’s territorial integrity, save Chechnya, now seems secure, important questions about Russia’s federal structure remain, including taxation policy and revenue transfers between different levels of government. Prolonged uncertainty regarding these issues impedes local investment, hampers franchising of Moscow-based banks and firms, and encourages local government corruption.

If relations between central and local government institutions have finally begun to stabilize, the process of dividing power among various local branches of government has barely started. To guarantee the support of local administrators after he dissolved the Congress of People’s Deputies in October 1993, Yeltsin allowed oblast and city heads of administrations (the equivalents of American governors and mayors) to dissolve their local legislatures as well. Some regions have created new legislative bodies called oblast and city dumas. To date, however, poor voter turnout for elections of these new bodies, coupled with the absence of oblast-level constitutions, has undermined the power and legitimacy of these new legislatures. Other regions have not even bothered to create new legislative institutions, while the most ruthless governors, such as Evgenii Nazdratenko in Primorskii Krai, have removed elected officials from office by force.

A few of these local authoritarians have used their power to push the pace of economic reform. However, the consolidation of regional fiefdoms threatens sustained market development. Because the line dividing public and private economic activity is still blurred, especially in the regions, local state governments retain tremendous power to intervene in private-sector affairs. Arrests of businessmen, the confiscation of private property, and the reintroduction of price controls by many regional governments demonstrate that the authoritarian powers reformist leaders use to push through radical economic reform could also allow conservative dictators to halt it.

Another underdeveloped component of Russia’s political transformation is an independent judiciary. Russia’s first Constitutional Court relinquished its authority as arbitrator between the president and parliament in 1993 when the head of the court, Valerii Zorkin, sided with the White House’s defenders during the October 1993 crisis. Since then, the court has ceased to function. In October 1994, Yeltsin submitted for parliamentary approve new nominations for the court, indicating that this institution may soon be revived. Russia’s disappointing first experience with a Constitutional Court and nascent legal culture, however, suggest that institutionalizing a judicial check on executive and legislative power will be a long process.

Finally, the next election could pose the most serious threat to economic reform unless new political institutions, including political parties, are created soon. Russian social and class interests are still in flux, making representation by political parties difficult. Voters in 1995 and 1996 will still be choosing between individuals, not party platforms. Moreover, Russia has held only one post-communist election, thus far relegating parties to a minor role in the development of the new political system. Neither President Yeltsin nor Prime Minister Chernomyrdin are members of political parties, nor has either leader promoted their development. The combination of a weakly articulated civil society, a nascent party system, and continued economic hardship for most Russian voters creates opportunities for demagogues and populists, as Zhirinovsky proved a year ago. Law-and-order candidates who run against both the communist past and the status quo will be difficult to defeat even if the economy rebounds next year.

Support Political Reforms

Until now, American assistance to Russia has focused almost exclusively on promoting market reforms. But without political reform Russia’s revolution will almost certainly fail. Of the $24 billion pledged by the United States in 1992 to support Russian reform, only a fraction has been devoted to promoting political reform. Morever, most of those funds were channeled through multilateral economic institutions such as the World Bank and International Monetary Fund, which have neither the inclination nor the mandate to promote political reform. Technical assistance programs implemented by the U.S. Agency for International Development are also skewed toward economic reform. Of the $2.1 billion allocated for assistance programs through AID in 1994, only $30 million was earmarked for “democratic pluralism initiatives.” Greater support for democratic assistance programs appears unlikely. During his meeting with Yeltsin in October, President Clinton championed trade and investment as the new cornerstones of Russian-American relations; discussion of how to strengthen Russian democratic institutions was not a summit agenda item. U.S. foreign policy makers continue to trumpet democracy as an objective of American policy toward Russia, but the Clinton administration has focused almost exclusively on promoting economic reform, a necessary but insufficient objective for American assistance programs to Russia. To thrive, capitalist-oriented economies require capitalist-oriented states. It is naive to pour millions of dollars into promoting privatization when the legal framework and political support for protecting private property do not exist. Political reform in Russia has helped, not impeded, economic reform. Progress in economic reform requires progress in political reform.

In other post-communist transitions, regimes that consolidated democratic states early on (Poland, Hungary, the Czech Republic) have been more successful in undertaking and sustaining real economic transformation than countries that have not (Romania, Ukraine, Uzbekistan). Surveys of recent economic reform attempts worldwide have demonstrated that authoritarian regimes are no better at sustaining economic reform than democratic regimes. When praising authoritarian reformers in Taiwan or Singapore, one forgets about the economic disasters in Zaire under Mobutu Sese Seko, in the Philippines under Ferdinand Marcos, or in the Soviet Union under Leonid Brezhnev.

America’s overemphasis on economic assistance to Russia is inefficient. Assistance programs for Russian economic reform often subsidize activity that should be paid for by the private sector. Why should American taxpayers pay for feasibility studies of joint telecommunications ventures when AT&T could? Why should the U.S. government train Russian oil technicians when Gasprom could? The private sector, however, will not directly finance programs designed to promote political reforms. Funding for such programs, therefore, must be facilitated by public, as well as U.S. government, support.

The United States, in sum, has no national interest in promoting economic reforms in Russia that are not accompanied by a transformation of the political system. America’s greatest national security nightmare would be the emergence of an authoritarian, imperialist Russian regime supported by a thriving market economy.