CAPITALISM

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					RUSSIA

The Setting
• Large country
– Population of 145 million – 1.8 times the size of U.S.
• Lot of it waste land

• Resource rich
– Oil, natural gas, coal, many strategic minerals, timber – Lots of land

Legacy of Socialism
• No history of capitalism • System of central planning in place since 1928 • Culture of dependency on government • No understanding of private property
– Land – Capital

• No understanding of entrepreneurship • Always taught that capitalism and private ownership are evil
– Suspicion of success

Failed (so far) Transition
• 1985: Gorbachev takes power
– Perestroika begins

• 1989: growth turns negative
– per capita GDP: $2,693 (in 2000 US $)

• December of 1991: Soviet Union ceases to exist and transition begins
– Per capita GDP: $2,465

• 1998: economy begins recovery
– Per capita GDP: $1,511

• 2003 per capita GDP: $2,138 (87% of 1991)

Index of Per Capita GDP in Russia
(Per Capita Income in 2000 US$)

120 $2,465 $2,138 80

100

Index (1991 Income = 100)

60

$1,511

40

20

0 0 1 2 3 4 5 6 7 8 9 10 11 12 Year of Transition (0=1991)

• However, lower cost of living in Russia than in U.S. makes these numbers appear worse than they are • Purchasing Power Parity (PPP) adjusts for cost of living • Per capita GDP measured in PPP declined from $9,774 in 1991 to $6,244 in 1998 and then rose to $8,720 in 2003 • By comparison, U.S. per capita GDP in 2003 was:
– $35,566 (2000 US$) – $35,484 (PPP)

Political Change
• Communist Party abolished in 1991 • New constitution ratified in 1993
– parliamentary system – head of state is President with enormous power relative to other branches
• Boris Yeltsin until 1999 • Vladimir Putin acting President Dec., 1999 and President May, 2000 • President appoints Premier (head of government) and all government ministers

• Bicameral legislature
– Federation Council (upper house)
• members appointed by top executive and legislative officials of federal administrative units (states)

– State Duma (lower house)
• members popularly elected

• Judiciary
– all judges nominated by president and appointed for life by Federation Council

• Institutions of democracy poorly established
– Yeltsin period
• power struggle between president and legislature • control of government by “Russian Mafia”
– former nomenklatura and criminal elements that formed Yeltsin’s inner circle and maintained complete control of political agenda

– Putin period
• • • • Putin achieves cooperation of legislature influence of Russian Mafia continues corruption rampant declining living standards and widening inequality threatens political and social security • see “Russia Renewed?” by Daniel Treisman (Foreign Affairs, November/December 2002)

Legal Framework
• Democratic and market-oriented laws exist • The institutions to interpret and enforce them are weak, underfunded, understaffed, and corrupt
– judiciary – regulatory/prosecutory agencies

• Judges and lawyers a holdover from former system in which law was held in low esteem and judges and lawyers were considered a part of the parasitic classes so despised in socialist ideology
– poorly paid and therefore vulnerable to corruption – poorly trained – not enough of them

• Summary of legal system in Russia:
– corrupt – contracts unenforced by legal system
• enforced by thugs with guns

– bankruptcy rare
• soft budget constraint continues

• Many years before a fully functional legal system will be in place
– a major barrier to transition in Russia

• Political instability and dysfunctional legal system inhibits investment, both domestic and foreign
– domestic capital formation in Russia in 1998 $7 billion compared to $50 billion in China – foreign direct investment in Russia in 1998 was $2.7 billion compared to $41 billion in China – China a much poorer and less developed country but much more politically stable if not less corrupt

Microeconomic Aspects
• Shock therapy versus gradualism
– January 1992 Russia embarked on a policy of shock therapy – sort of
• most prices freed
– except energy, medicines, consumer necessities, public utilities

• defense spending cut way back • subsidies to SOEs cut • new tax system • foreign trade liberalized • currency made convertible (within limits)

• Impact of shock therapy
– GDP falls – standard of living falls dramatically – unemployment rises – continues through 1996/7 with weak recovery since

Privatization
• Small-scale privatization immediate and easy
– shops, cafes, etc., mostly bought by workers

• Large-scale privatization of SOEs much harder and slower
– three stages
• vouchers 1992-1994 • auctions 1994-1997 • case-by-case sale of SOEs 1997-present

Voucher Privatization
• Every Russian citizen given vouchers worth 10,000 rubles • Vouchers could be
– sold for cash – put in investment fund that used them to purchase shares of enterprises sold in auctions – used to purchase shares in individual enterprises sold in auctions

• Vouchers actively traded on organized exchanges throughout Russia
– the largest exchange in Moscow was trading around 100,000 per day

• privatized around 60% of industrial assets and employment by 1994 • most assets purchased by managers and workers of the SOEs • did not provide capital or management expertise needed by privatized SOEs

Stage Two: Cash Auctions
• Second stage was to sell shares in auctions for cash rather than vouchers • Purpose to raise revenue for state budget • Foreign entities not permitted to participate • Raised very little revenue • Most sales at ridiculously low prices to former elite

Stage Three: Case-By-Case Sales
• Open to foreigners • Expert advising on timing and method of sale and valuation • By 2000, a little more than 130,000 SOEs privatized
– about 70%

Impact of Privatization
• Most privatized SOEs owned either by workers and managers from before privatization or by former elite or criminal elements • Did not bring much-needed capital or management expertise • Did not result in much revenue for state budget
– total proceeds of sales about $12 billion

• Highly corrupted, resulting in sales at low prices to former nomenklatura

Privatization of Agriculture
• Soviet agriculture amazingly inefficient
– for every 12 tons of potatoes harvested only three tons got consumed and two of those were consumed by livestock – lacked storage facilities, transportation, and distribution channels – Russia inherited a mess resulting from low priority of agriculture in planning

• Recall that, under the planned system, agriculture was organized in state and collective farms but individuals could farm private plots • Private plots accounted for only 3% of arable land but a large proportion of agricultural output
– third of milk and meat – two thirds of potatoes and eggs

• Indicates degree of inefficiency of state and collective farms

• Collective farms given to their workers • State farms broken up and auctioned off starting in 1994
– many unsalable because of geographical location or obsolete equipment – process of sales controlled by local politicians and highly corrupted

• 1996 decree allows farm land to be sold, bought, mortgaged, bequeathed as long as it stays in farming

• 90% of agriculture controlled by large, inefficient collectives that operate like they did during planning • Continue to be subsidized
– soft budget constraint

• Lack infrastructure
– distribution channels – storage facilities – adequate refrigeration – marketing expertise – obsolete equipment

Financial Markets
• Purpose to pool individuals’ savings and allocate them to most efficient uses • Includes banks as well as securities markets • No real financial markets in planned system
– role of banks to allocate credit, funded out of the state budget, to enterprises according to plan

• Needed to start from scratch

Two-Tiered Banking System
• Began in 1988 under perestroika • Significant reform not achieved until 1995
– Federal Law of the Central Bank of Russia

• Gosbank split in two
– central bank – commercial banks

• Roles of the Central Bank
– monetary policy – licensing and regulation of commercial banks

• About 2,000 commercial banks
– mostly small and undercapitalized – most associated with specific industries – loans short term and generally restricted to associated industry and to those with contacts
• not being allocated efficiently

– During early ’90s CBR issued massive amount of money and government made direct grants to enterprises from state budget
• hyperinflation resulted

• CBR performance improved since 1995 law and inflation has come down but still high
– 22% in 2001

• Little public confidence in banks
– poorly capitalized – no deposit insurance

• With inflation high and confidence in banks low, demand deposits low • Much loan activity in form of directed credit from CBR

Securities Markets
• For trading of debt (bonds) and equity (stocks) instruments
– including government debt instruments

• Poorly developed, unregulated, and segmented • Not that much need since much of the capital enterprises get comes in the form of directed credits from CBR and government subsidies
– don’t need to issue debt of equity instruments when you have soft budget constraints

Public Finance
• Roles of government in market economy
– allocation
• correct externalities
– e.g., pollution

• provide public goods
– e.g., national defense, police protection

• prevent monopolies

• Redistribution of income
– from rich to poor – from workers to retirees

• Stabilization
– fiscal policy – monetary policy

Paying For All This
• Borrowing
– requires functioning securities market

• Taxation
– not much need in a planned economy as resources directly allocated – transition requires the development of a whole new system of taxation to be paid by a people who are not used to paying tax

Structure of Government
• Several levels of government
– one central government – regional governments – local governments – many special government entities with own taxing authority
• pensions, social insurance, employment, medical insurance

Revenue Sources
• Federal
– VAT (40%)
• similar to a sales tax

– business profit tax (13%) – excise taxes (18%) – personal income tax (2%)

• Regional and local
– – – – – – VAT (12%) profit tax (20%) personal income (16%) property tax (11%) transfer from federal budget (18%) other (20%)

• Tax system overly complex and poorly administered
– – – – over two hundred taxes many exemptions narrow tax bases tax avoidance a major problem

Foreign Trade
• Prior to transition
– trade was almost all with CMEA partners – trade was conducted by trading agency
• enterprises shielded from trade

– trade outside CMEA had to be conducted in dollars or other convertible currency
• ruble not convertible • state bank in charge of trade financing had to keep reserves of currencies

• Transition involved
– giving enterprises right to trade
• not a problem

– making the ruble convertible
• much more difficult • requires establishment of market for rubles • began by setting very limited range of trade activities conducted with market exchange rate and other rates more favorable to the state for others
– e.g., a rate for repatriation of profits by foreign firms

• Full convertibility achieved in 1996
– helped by IMF stabilization fund

• Exchange rate depreciating steadily over time due to inflation
– official rate during socialist period maintained at 1 ruble = 1 dollar
• at end state permitted tourists to exchange at black market rate of over 30 rubles per dollar
– market rate depreciated to between 3,500 to 5,100 in 1995 – 6,000 plus in 1997 when new ruble issued at 1 new ruble = 6,000 old rubles

• adjusting for inflation, ruble actually appreciating • current account positive, capital account negative
– capital flight – very limited foreign investment

Evaluation of Russia’s Transition
• Many failures, few successes
– corruption is rampant
• resource allocation to highest bribe rather than most efficient producer • Russia controlled by criminal oligarchy

– horrible income distribution
• no middle class • a few (the criminal oligarchy) are very rich and everyone else is very poor

– poor social safety net

– deep and extended economic contraction
• in spite of Russia being the richest country in the world in terms of natural resources

– political instability
• Yeltsin period very unstable
– kept replacing the government

• • • •

Putin period better lack of checks and balances lack of well-developed political parties lack of foreign and domestic investment due to high level of political instability
– China much more stable and has enormous foreign investment

– uncertain property rights
• renationalization
– Yukos

• rule by decree rather than rule by law

– rapidly declining population
• men dying early
– male life expectancy under 59 years » down from 69 in 1990 » alcohol and diet

• no one having kids
– in 1995, children 0-14 were 21% of total population; in 2005, they were 15%

Prospects for the Future
• Bleak for a very long time • The collapse seems to have halted but sustained recovery will depend on much greater political and economic reform than seems to be on the horizon

Russian Economic Performance 1991-2005 (%) Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Growth -5.3 -14.6 -8.6 -12.5 -4.0 -3.3 1.7 -5.0 6.8 10.0 5.3 5.2 7.9 7.7 6.9 Inflation 128.6 1490.4 887.8 307.3 144.0 45.8 15.1 18.5 72.4 37.7 16.5 15.6 13.9 19.6 19.6 Unemployment 0.1 5.3 5.9 8.1 9.7 9.9 11.8 13.3 13.4 9.8 8.9 8.6 7.9 7.9


				
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posted:1/31/2010
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