Capitalist Collapse

How can Russia Recover?

by David M. Kotz

Dollars and Sense magazine, November/December 1998


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 exists.

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.

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 bailout loan.

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 chaos.

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 tax arrears!

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 include:

* 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 agriculture.

* 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 foreign currency.

* 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.

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