ECONOMY AFTER BREAK UP OF THE SOVIET UNION

ECONOMY AFTER BREAK UP OF THE SOVIET UNION

Like many other aspects of Russian life, the Russian economy underwent a journey through uncharted waters in the early 1990s. First came the disintegration of the centrally planned economy that was a hallmark of the state-controlled economy and then its replacement by an economy operating on the basis of market forces. Some of the former communist states of Central Europe began their process of economic transition two years before Russia and provided models. Russia lacked experience with market economies and the institutions needed to operate them. Moreover, deeply entrenched remnants of central planning presented challenges in Russia that other countries were able to avoid.[ Source: Library of Congress, July 1996 *]

When the Soviet Union broke up, the industrial base collapsed and the economy shrunk dramatically. In the 1990s, Russia was in a depression. It's GNP declined by 50 percent in the 1990s. Growth was -3 percent in 1990; -12 percent in 1991; -13 percent in 1992; -10 percent in 1993; -12 percent in 1994; -4 percent in 1995; -4 percent in 1996; 1 percent in 1997; -4 percent in 1998; 5 percent in 1999; 8 percent in 2000.

In some places in Siberia 70 percent of the economic enterprises collapsed. The landscape was dotted with ghost towns and abandoned factories. The opening of economy created more opportunities for organized crime and corrupt bureaucrats and oligarchs. But in some places, despite the high rates of inflation and decline of industrial inputs, real incomes remained remarkable stable.

Capitalism took hold quickly in some sectors in Moscow and St. Petersburg, where American dollars were highly visible, shopping malls beckoned shoppers and the streets were filled with advertisements and neon schools. Capitalism has also hit second-tier cities like Nizhniy Novgorod, Yekaterinburg, Khabarovsk and Vladivostok but took hold in provincial towns at a slow pace.

Soviet Union classless society was fragmented into haves and haves not. Capitalism improved the lives of a lucky elite. Most people were been left behind. They felt resentful about the unfairness of the new system.

A number of studies in the 1990s provided in-depth coverage of various aspects of the Russian economy. The PlanEcon series Review and Outlook for the Former Soviet Republics offers short summaries of most aspects of the economy. The Economist Intelligence Unit's quarterly Country Report: Russia analyzed key economic indicators against the background of political and international conditions, with statistical information. The Congressional Research Service of the Library of Congress and the World Bank issued series of useful studies on individual aspects of the economy and the reform program, with the latter concentrating on conditions for investment and business activity. The Organisation for Economic Co-operation and Development (OECD) offered a 1995 economic survey on the Russian Federation, a detailed analysis of the entire domestic economic structure and its supporting elements. Energy Policies of the Russian Federation: 1995 Survey , from the OECD's International Energy Agency, analyzes the status and potential of Russia's energy sector. Anders Aslund's How Russia Became a Market Economy describes the reform process from the 1980s through 1995.

Gangsters and Other Problems in the Post-Soviet Economy

In addition to the chronic tax collection failure, institutional remains of the Soviet era also continued to plague economic progress. In many large plants, the economic reforms of the early 1990s left control with the same managers who had run the plants for the state. In the post-Soviet years, managers took advantage of Russia's new free-market atmosphere, and the lack of effective commercial legislation, to line their own pockets—often in cooperation with criminal organizations—while paying little attention to plant productivity. In 1996 the Government increased subsidies to some major automobile and defense plants, reversing the direction of privatization and further diminishing incentives. [Source: Glenn E. Curtis, Library of Congress, July 1996 *]

Another obstacle to economic stability was the pervasive influence on economic activity of the mafiya—as commonly used in Russia, a term including gangsters, dishonest businesspeople, and corrupt officials. In the 1990s, Russia was suffering the effects of an increasingly prosperous national network of criminals who extort protection money from an estimated 75 percent of businesses and banks. Individuals refusing such payments often were the victims of violent crimes. In 1995 gangs controlled an estimated 50,000 private and state enterprises and had full ownership of thousands more. Unlike organized criminal groups in the West, which specialize in illegal activity such as drug trafficking and prostitution, Russia's mafiya spans the entire range of the economy, discouraging private enterprise and siphoning off 10 to 20 percent of enterprise profits that were neither taxed nor reinvested in legitimate business. Organized crime also was involved in the movement of a huge amount of capital--estimated at $1 to $2 billion per month--out of Russia in the mid-1990s. Such activity prospered mainly because of strong links with corrupt officials; an estimated 30 to 50 percent of organized crime's proceeds was spent on bribes to procurators, police, and bureaucrats.*

This connection was not new in the post-Soviet era; already in the Brezhnev era, officials took bribes from the underworld as the black market responded to gaps in Soviet production. In the early post-Soviet years, reformers implicitly condoned such activity in the hope that it would hasten the development of a legitimate private-enterprise sector. In 1993, however, government measures against criminals were stimulated by publicity about Russia's crime wave and by the success of ultranationalist political groups who stressed the crime issue. Many of the Yeltsin administration's law enforcement decrees of 1993 and 1994 were of questionable constitutionality, and they had had little overall effect in the mid-1990s because law enforcement agencies remain corrupt.*

Economic Reform in the 1990s

Two fundamental and interdependent goals--macroeconomic stabilization and economic restructuring--mark the transition from central planning to a market-based economy. The former entails implementing fiscal and monetary policies that promote economic growth in an environment of stable prices and exchange rates. The latter requires establishing the commercial, legal, and institutional entities--banks, private property, and commercial legal codes--that permit the economy to operate efficiently. Opening domestic markets to foreign trade and investment, thus linking the economy with the rest of the world, was an important aid in reaching these goals. Under Gorbachev, the regime failed to address these fundamental goals. At the time of the Soviet Union's demise, the Yeltsin government of the Russian Republic had begun to attack the problems of macroeconomic stabilization and economic restructuring. As of mid-1996, the results were mixed. [Source: Library of Congress, July 1996 *]

The program laid out a number of macroeconomic policy measures to achieve stabilization. It called for sharp reductions in government spending, targeting outlays for public investment projects, defense, and producer and consumer subsidies. The program aimed at reducing the government budget deficit from its 1991 level of 20 percent of GDP to 9 percent of GDP by the second half of 1992 and to 3 percent by 1993. The government imposed new taxes, and tax collection was to be upgraded to increase state revenues. In the monetary sphere, the economic program required the Russian Central Bank (RCB) to cut subsidized credits to enterprises and to restrict money supply growth. The program called for the shrinkage of inflation from 12 percent per month in 1991 to 3 percent per month in mid-1993.*

Economic Restructuring Measures

Immediately after the dissolution of the Soviet Union was announced, the Government lifted price controls on 90 percent of consumer goods and 80 percent of intermediate goods. It raised, but still controlled, prices on energy and food staples such as bread, sugar, vodka, and dairy products. These measures were to establish a realistic relationship between production and consumption that had been lacking in the central planning system. [Source: Library of Congress, July 1996 *]

To encourage the development of the private sector, fundamental changes were made in the tax system, including introduction of a value-added tax (VAT) of 28 percent on most transactions, a progressive income tax, and a tax on business income; revisions in the system of import tariffs and export taxes; new taxes on domestic energy use to encourage conservation (a necessary step because energy prices were still controlled); and new taxes on oil and natural gas exports to narrow the gap between subsidized domestic prices and world prices and to prevent domestic energy shortages. A fixed exchange rate was to be established for the ruble, which then would become convertible. Many restrictions on foreign trade and investment also were to be lifted to expose Russia to the discipline of world prices.*

Obstacles to Economic Reforms in Post-Soviet Russia

Resistance to Post-Soviet economic reforms came from Communists in parliament, old-line "red managers” and the oligarchs who expected preferred treatment. Short term interests took precedence over long term interests. Unprofitable coal mines, for example, remained open, sucking up subsidies, when the money could have been spent training and relocating workers.

Companies were unwilling to boost efficiency and productivity and simply tried to survive. Workers continued to work for little or even no pay so they could hold on to benefits such as housing and health care. State-owned companies lacked the hustle to increase market share and relied on state-wage credits to stay afloat. The government played a game of giving out credits and subsidies in dribbles and drabs and state wages were paid in a similar manner.

Most company stock was bought up by employees who voted at shareholder meeting to keep the Communist- era managers and maintain the status quo out of fear of losing their jobs. The managers in some cases continued producing the same shoddy goods and failed to change.

Even though most companies were losing money, there were only a handful of bankruptcies a year. Despite being bankrupt and unable to pay their workers, Russian factories stayed afloat with cheap credit, a practice critics said caused hyperinflation and discouraged long-term investment

Small companies, especially those that made goods for which there was strong demand— like canned food, or noodles— prospered after ousting their Communist managers and making products that consumers wanted and implementing incentive-based wages.

Changes in the Russian Economy in the 1990s

In mid-1996 the national government appeared to have achieved some degree of macroeconomic stability. According to official Russian data, in 1994 the national gross domestic product (GDP) was 604 trillion rubles (about $207 billion according to the 1994 exchange rate), or about 4 percent of the United States GDP for that year. But this figure underestimated the size of the Russian economy. Adjusted by a purchasing-power parity formula to account for the lower cost of living in Russia, the 1994 Russian GDP was about $678 billion, making the Russian economy approximately 10 percent of the United States economy. In 1994 the adjusted Russian GDP was $4,573 per capita, approximately 19 percent of that of the United States. A second important measurement factor is the extremely active so-called shadow economy, which yields no taxes or government statistics but which a 1996 government report quantified as accounting for about 50 percent of the economy and 40 percent of its cash turnover. [Source: Library of Congress, July 1996 *]

By 1996 the structure of Russian economic output had shifted far enough that it more closely resembled that of a developed market economy than the distorted Soviet central-planning model. With the decline in demand for defense industry goods, overall production has shifted from heavy industry to consumer production. However, in the mid-1990s the low quality of most domestically produced consumer goods continued to limit enterprises' profits and therefore their ability to modernize production operations. On the other side of the "vicious circle," reliance on an outmoded production system guaranteed that product quality would remain low and uncompetitive. Most prices were left to the market, although local and regional governments controlled the prices of some staples. Energy prices remained controlled, but the Government shifted these prices upward to close the gap with world market prices. *

In the mid 1990s, Russia's market economy remained partially formed, with some parts far advanced and others lagging behind. Critical, unfilled needs included the following: substantial improvement in the taxation system, which is poorly enforced and fails to encourage private initiative or foreign investment; a comprehensive rather than a piecemeal set of commercial laws to establish consistent business conditions; continued reform of the banking system, including removal of corrupt elements and ineffectual commercial banks; continuation of meaningful privatization, including reform of voucher distribution, expansion of the entrepreneurial class, and restoration of public confidence in privatization as more than redistribution of wealth among the entrepreneurial elite; continued government spending discipline to keep exchange rates, budget deficits, and inflation under control; establishment of agencies to promote trade and distribute information; and wage reform to ensure timely payment and gradually relieve the intense social pressure caused by the increase of the have-not part of Russia's population. *

Progress in the Russian Economy in the 1990s

In the first half-decade after the end of the Soviet Union, Russia made significant strides in restructuring its economy and providing an environment for the operation of market forces rather than state control as the fundamental principle of the economic system. By 1995 more than half of the recorded GDP came from the private sector, with considerable unreported private activity also contributing to the vitality of the economy. Almost all prices are now market determined. Most of Russia's state enterprises have been placed under some degree of private control, although many continue to operate in much the same way as before privatization. By making the ruble convertible in foreign trade and other current-account transactions, Russia has accelerated the integration of its economy with those of the rest of the world.[Source: Library of Congress, 1996 *]

As of the mid 1990s, a half decade after the launching of Russia's post-Soviet economic reform, experts found the results promising but mixed. The Russian economy passed through a long and wrenching depression. After years of double-digit declines, gross domestic product (GDP) shrank by only 4 percent in 1995. GDP per capita in 1995 was $4,224. Unemployment rose steadily, to around 8.5 percent in 1996 even though official Russian numbers reported about half that amount. Inflation, very high in 1994, under much better control under new government policy in 1995-96; April 1997 rate 1.2 percent. Economy increasingly dependent on foreign investment, multilateral loan agencies, and rescheduling of foreign debt. Privatization nearly complete but meeting political opposition to transformation of large state firms. Most prices determined by market. Role of organized crime significant, and much economic activity officially unaccounted for.

Official Russian economic statistics indicated that from 1990 to the end of 1995, Russian GDP declined by roughly 50 percent, far greater than the decline that the United States experienced during the Great Depression. (However, alternative estimates by Western analysts described a much less severe decline, taking into account the upward bias of Soviet-era economic data and the downward bias of post-Soviet data.) Such a decline, however, was to be expected in an economy going through the transition from central planning to a market structure. Much of the decline in production has occurred in the military-industrial complex and other heavy industries that benefited most from the skewed economic priorities of Soviet planners but have much less robust demand in a freer market.

Yeltsin's appointment of reform economist Anatoliy Chubais as his chief of staff in 1996 was a signal that the advocates of strong reform might overcome the factions that had blocked or weakened reform legislation in the State Duma. But political battles continued over the speed and wisdom of market-oriented reform because strong vested interests continued to advocate state control of remaining economic assets, or even reassumption of state control of privatized assets. *

Sectors of the Economy in the 1990s

Sectors of the Economy in the 1990s: Services: 50 percent of GDP in 1994. Tourism was an important source of foreign currency. Expansion of financial, communications, and information enterprises contributed to growth. Shipping services were also major foreign-exchange earners. Agriculture: 6.3 percent of GDP in 1994. Major products grain, sugar beets, sunflower seeds, vegetables, fruits, meat, and milk. Manufacturing: 28.3 percent of GDP in 1994. Principal products machine tools, rolling mills, high-performance aircraft, space vehicles, ships, road and rail transportation equipment, communications equipment, agricultural machinery, tractors and construction equipment, electric-power generating and transmitting equipment, medical and scientific instruments, and consumer durables. [Source: Library of Congress, July 1996 *]

Mining: Considerable mineral wealth, especially iron ore, copper, phosphates, manganese, chromium, nickel, platinum, diamonds, and gold, was exploited. But production declined steadily from 1990-95. Energy: Russia was self-sufficient in fuels and energy production. Natural gas and oil were the main fuels exploited, coal production declined but was still significant; long-distance fuel transportation was a significant problem. Main electricity sources: coal 18 percent, nuclear 13 percent, hydroelectric 19 percent, and natural gas 42 percent. Industry consumed 61 percent of energy production. Generation capacity 188 gigawatts. Energy exports most important source of foreign exchange.*

Foreign Trade: Trade liberalization was ongoing, and included abolishing export duties, restructuring import tariffs, and ending export registration in 1996. Main trading partners were Germany, Italy, the Netherlands, Switzerland, Britain, the United States, Ukraine, Kazakstan, Belarus, China, and Japan. Exports for 1995 were estimated at $77.8 billion, imports $57.9 billion. The balance of payments was $13.1 billion in 1995. Capital flight was expected to drop to $1 billion in 1996. Foreign investment was strongly encouraged in some sectors, but unpredictable commercial conditions hindered growth. Outstanding Soviet-era debt by Third World countries, between $100 and $170 billion, could make Russia creditor country on balance.*

Pain of Restructuring the Russian Economy

These strides have come at a cost, however. The Russian economy has endured a severe contraction that experts predict will not end before late 1996 or 1997. Many Russians are experiencing the new and disillusioning phenomenon of unemployment as the growing private sector slowly absorbs an increasingly large labor pool jettisoned in the restructuring of the state sector. Many, particularly those of middle age, are finding it difficult to adjust to the loss of the cradle-to-grave social safety net of the Soviet system. The gap between Russia's "haves" and "have-nots," which is determined by the possession of skills, audacity, and connections needed to be successful under the new economic system, widened alarmingly in the mid-1990s. [Source: Library of Congress, July 1996 *]

But other major sectors such as agriculture, energy, and light industry also suffered from the transition. To enable these sectors to function in a market system, inefficient enterprises had to be closed and workers laid off, with resulting short-term declines in output and consumption. Analysts had expected that Russia's GDP would begin to rise in 1996, but data for the first six months of the year showed a continuing decline, and some Russian experts predicted a new phase of economic crisis in the second half of the year.*

Image Sources:

Text Sources: New York Times, Washington Post, Los Angeles Times, Times of London, Lonely Planet Guides, Library of Congress, U.S. government, Compton’s Encyclopedia, The Guardian, National Geographic, Smithsonian magazine, The New Yorker, Time, Newsweek, Reuters, AP, AFP, Wall Street Journal, The Atlantic Monthly, The Economist, Foreign Policy, Wikipedia, BBC, CNN, and various books, websites and other publications.

Page Top

© 2008 Jeffrey Hays

Last updated May 2016

This site contains copyrighted material the use of which has not always been authorized by the copyright owner. Such material is made available in an effort to advance understanding of country or topic discussed in the article. This constitutes 'fair use' of any such copyrighted material as provided for in section 107 of the US Copyright Law. In accordance with Title 17 U.S.C. Section 107, the material on this site is distributed without profit. If you wish to use copyrighted material from this site for purposes of your own that go beyond 'fair use', you must obtain permission from the copyright owner. If you are the copyright owner and would like this content removed from factsanddetails.com, please contact me.