How can Russia Recover?
by David M. Kotz
Dollars and Sense magazine, November/December
Russian scientists were once famous for launching he world's
first space satellite. Their counterparts today survive by growing
vegetables in their small yards. These are not retirees enjoying
some well-deserved leisure time gardening, but prime age workers-miners
and teachers as well as scientists-trying to meet basic needs
in the face of economic collapse. People go to work every day
and do whatever their employer asks, yet weeks and months pass
without a single paycheck. They stay on the job because at least
it provides some fringe benefits, and no alternative paying job
This has been the meaning of Western-inspired "reform"
to a majority of public and private sector workers in Russia.
But the media began calling it a crisis only in August of this
year, when Russia stopped making timely payments to Western bankers
and other investors who had taken a chance on Russian bonds.
After imposing years of suffering on ordinary Russians, Russia's
Western-inspired 'neoliberal" program for rapidly building
capitalism appears to have finally collapsed under its own weight.
This program was devised seven years ago by top economic advisors
to Russian President Boris Yeltsin's government, working closely
with specialists from the International Monetary Fund (IMF).
Any visitor to Russia can see the effects of the IMF program.
The nation's economic output has fallen by half and its investment
by three-fourths since 1991, with no recovery in sight. Money
is so scarce that half of economic transactions are conducted
through barter. A small group of influential insiders has been
handed ownership of the former Soviet Union's most valuable properties,
while the majority has been plunged into poverty and hopelessness.
The economic and social collapse has caused more than two million
premature deaths since 1991, due to sharp increases in alcoholism,
murder and suicide, infectious diseases, and stress-related ailments.
Despite the unprecedented economic depression, until recently
Russian bankers kept getting richer and the stock market soared,
buoyed by the lucrative trade in Russia's valuable oil, gas, and
metals. Western banks helped to finance the speculative binge
that drove up Russian stock prices, making it one of the world's
best-performing stock markets in 1997. Then in the late spring
of this year, Russia's stock market began to fall and investors
started to pull their money out of the country.
The Clinton administration, fearing that Yeltsin's government
would not survive a looming financial crisis, pressed a reluctant
IMF to approve a $22.6 billion emergency loan on July 13. This
bailout proved unsuccessful. Four weeks later the financial crisis
resumed as investors fled and Russia's government had to pay as
much as 300% interest to attract buyers for its bonds.
After Washington rejected Yeltsin's desperate plea for still
more money, Russia did the unthinkable: it was forced to suspend
payment on its foreign debt for 90 days, restructure its entire
debt, and devalue the ruble. Panic followed, as Russia's high-flying
banks teetered on the edge of collapse, depositors were unable
to withdraw their money, and store shelves were rapidly emptied
of goods. The financial collapse produced a political crisis,
as President Yeltsin, his domestic support evaporating, had to
contend with an emboldened opposition in the parliament.
What caused the financial crisis?
Two immediate developments turned Russia's euphoria into financial
crisis. One was the growing realization that the IMF had failed
to resolve the Asian financial crisis, despite huge loans and
the imposition of severe economic measures (known as "structural
adjustment programs") upon the suffering Asian countries.
This created a ripple effect in the late spring of this year,
spreading fear of the world's "emerging markets" among
international investors. Equally important was the sharp drop
in oil and other raw material prices during 1998. This caused
the value of Russia's oil exports, its main source of foreign
currency earnings, to fall by almost half in the first six months
of 1998 compared to the same period of 1997. Together, these two
developments led investors to begin removing their funds from
Russia suddenly began slipping into a classic debt trap. Although
the government's deficit was running at only a moderately high
rate of 5% of GDP, by early summer the growing flight of capital
out of the country forced the government to pay rapidly escalating
interest rates on the money it borrowed to finance the deficit.
To make matters worse, Russia mainly sold very short term bonds,
some coming due in a matter of weeks after issue, which only deepened
its repayment problem. By July, Russia's monthly interest payments
exceeded its monthly tax revenues by 40%. Realizing this was unsustainable,
investors began a stampede for the door despite the IMF's huge
But the underlying cause of Russia's financial debacle runs
deeper than the Asian financial flu or short-term movements in
raw material prices. The ultimate cause of Russia's financial
collapse is nearly seven years of free fall in its real economy.
The financial sector cannot prosper indefinitely while production
of real goods and services is collapsing.
... At the IMF's urging, Russia rapidly dismantled its pre-existing
economic system-abolishing central planning, eliminating controls
on imports and capital movements, and privatizing most state enterprises.
A new and effective capitalist market system was supposed to appear
rapidly through individual initiative, if only the government
kept out of the way. But in the contemporary world building a
capitalist system requires an active state role and a considerable
period of time. With its old economic system dismantled and no
new one to take its place, the economy and society descended into
The IMF also insisted that, to combat inflation, Russia must
pursue a tight fiscal and monetary policy-that is, make sharp
cuts in public spending and keep money and credit scarce. This
assured that plunging demand for goods and services would bring
on a major depression. Eventually the Russian government found
it could meet the mandatory IMF spending reduction targets only
by increasing delays in paying workers and suppliers. Unpaid suppliers
could not pay their own workers, spreading a chain of unpaid wages
and taxes through the economy.
No amount of stern IMF moralizing about how Russia must start
collecting taxes could succeed under such conditions. For example,
there has been much noise about the government's failure to force
Gazprom, the privatized natural gas monopoly, to pay its enormous
back taxes. But it turns out that, due to IMF-required public
spending cuts, the government's unpaid gas bills exceed Gazprorn's
When the financial crisis struck Russia, the IMF actually
insisted that the solution was more of the same-more cuts in government
spending, higher taxes, and tighter credit. For a country suffering
from a 50% decline in production, this is absurd advice. Any economics
textbook notes that such measures, by further reducing the demand
for goods and services, will only make an already severe recession
worse-as President Herbert Hoover proved during 1929-32.
An Alternative Strategy
Russia's neoliberal strategy appears to have finally reached
a dead end. It has failed in economic terms, and it has few supporters
left in Russia-although this does not deter the Western powers
from demanding that Russia "stay the course." Advocates
of the neoliberal strategy always insist that, in any event, there
is no alternative.
Russia's left and center opposition has indeed developed and
argued for an alternative economic strategy. Many of Russia's
best economists have participated in drawing up detailed economic
plans. These plans have three main principles in common: 1) the
recovery of Russian industry and agriculture must take center
stage; 2) the economy should be directed toward producing consumer
goods for the domestic market, rather than exporting raw materials
and relying on imported consumer goods; 3) the state must play
an active role in economic recovery and long-run economic development
instead of leaving it to the "free market."
Some specific policies that opposition groups have proposed
* Create a large public infrastructure investment program
in transportation, power, communication, and sanitary facilities.
This would both increase demand and ease supply bottlenecks.
* Immediately pay back wages to government employees, back
pensions to retirees, and debts owed to non-state enterprises
for goods and services delivered to government agencies. This
would facilitate payment of wage arrears by non-state firms and
would stimulate demand for Russian output.
* Steer credit away from speculation and instead provide it
at low cost for productive uses in industry, construction, and
* Renationalize those enterprises that were given away, or
sold at less than true value, to influential insiders and criminal
elements. This would help to establish the principle that economic
reward should come from effective labor, not from insider influence.
* Increase public spending on science, technology, education,
and public health. This is necessary for the long-term health
and welfare of the economy and population.
* Establish temporary protection of selected domestic industries
and agricultural products, to provide Russian producers an opportunity
to modernize and thus compete with foreign firms on a more equal
footing. It is not desirable for a large, industrialized country
such as Russia to become dependent on imports for over half of
its consumer goods. (Moscow food processors currently import an
estimated 85% to 90% of their raw materials.)
* Redirect a major part of Russia's energy and raw materials
toward use by Russian industry rather than export to the world
market, while still using some primary product exports to earn
* Control capital flows in and out of Russia, with the aim
of stopping capital flight by the oligarchy and discouraging excessive
dependence on short-term foreign loans.
* Use exchange controls to redirect the foreign currency earnings
from Russia's exports away from the purchase of Mercedes automobiles
and other luxuries and toward products essential for the welfare
of ordinary consumers and for rebuilding Russian industry.
Apart from the renationalization plank, none of the above
policies are very radical. Many of them were used at some point
during the New Deal era by the U.S. government, which explains
why the Russian opposition continually refers to the American
New Deal as an inspiration for its program!
If Russia decisively turns away from neoliberalism and embraces
a program something like the above, there is a good chance its
disastrous economic collapse would be reversed, followed by economic
recovery and expansion. Russia does not require Western aid or
investment. It has everything it needs: abundant raw materials,
an educated and skilled labor force, a diversified economic base,
and a potentially large domestic market.
If Russia can be freed from the neoliberal policies that have
shackled and destroyed its economic potential, it can begin to
grow and develop again. Ironically, a growing Russian economy
might well attract the kind of long-term foreign investors that
would be helpful, although not essential, for its development.
Such investors have shied away from a Russia made unstable and
impoverished by seven years of neoliberal policies. K
David Kotz teaches economics at the University of Massachusetts-Amherst.