This is text from a presentation prepared for The Aspen Institute Congressional Program on “U.S.-Russia Relations,” Berlin, August 15-21, 1999. Show “We are stuck halfway between a planned, command economy and a normal, market one. And now we have an ugly model—a cross-breed of the two systems.” It has been one year since Russia’s financial collapse of August 1998. Those dramatic events forced a substantial shift in thinking inside and outside Russia about the near-term prospects of the Russian economy. Exaggerated optimism gave way to deep pessimism and cynicism. Unfortunately, we are still far from adequately acknowledging the extent of the problem. What sort of an economy is it? Is it a barely reformed planned economy, a half-reformed economy, a deeply flawed market economy, or is it something different from either its starting point—the planned economy—or its desired end point—a developed market economy? The confusion is exemplified by the mixture of metaphors in the quote from Boris Yeltsin at the right. These metaphors are not only mixed: they are incompatible. A hybrid is not an evolutionary halfway point. It represents a distinct entity, which may or may not be capable of self-perpetuation. The biological metaphor is a good one for Russia’s economic development. Russia is not “halfway” to the market. It is not even on that track. Russia’s economy has mutated. It is a hybrid, a distinct economic system, neither a nonmonetized command economy nor a monetized market economy. It is something qualitatively new, with its own rules of behavior. In the following I will address the nature of this system, and use it to draw up some scenarios for the future. Unfortunately, one scenario that I consider so unlikely as to be unworthy of consideration is that Russia will have a “normal” market economy, one characterized by marketization, monetization, and modernization. The Virtual Economy The thesis I will outline is what Professor Barry Ickes of Pennsylvania State University and I have called “Russia’s virtual economy.” Our arguments begin with recognition of the huge burden of Russia’s Soviet past. Owing to the structural legacies of the previous system, the majority of Russia’s enterprises, especially those in the core manufacturing sectors, cannot survive in an even partially competitive market, and certainly not in one that is open to significant import competition. The market value of the things the Russian enterprises produce is smaller than the value of what is needed to produce them. And yet the collapse of these industries is socially and politically unacceptable, even when it might be economically rational to close and replace them. The result of these enterprises’ struggle to survive—and of a social consensus that they should survive—is a peculiar, new, and possibly unique, economic system that has evolved in Russia. In this system, the enterprises can continue to produce their fundamentally noncompetitive goods—which are generally the same products they produced under the Soviet system, produced in the same way—because they avoid the use of money. Avoiding money, through the mechanisms of barter and other forms of nonmonetary exchange, allows the goods to be arbitrarily priced. They are overpriced, giving the appearance of more value being produced than is actually the case. Overpricing of manufactured output, especially when it is delivered to the government in lieu of taxes or to value-adders, mainly energy suppliers, in lieu of payment, is the primary mechanism for continued subsidization of unprofitable production in the Russian economy. This mechanism is the most important motive for the use of barter and other nonmonetary exchange. As much as 70 percent of transactions among industrial enterprises in Russia avoid the use of money. Similarly, offsets, barter, and the like account for 80-90 percent of tax payments by these major industrial enterprises. The demonetization of Russia’s economy is important because it is the mechanism that allows value-destruction to continue and to be hidden. To sum up, the virtual economy has two hallmarks: value-subtraction and pretense. That is, (1) a large part of the economy is not creating value, but destroying it, and (2) almost everyone who participates in the system pretends this is not happening. They collude in maintaining a veil of nontransparency to protect the pretense, something that is especially important to underscore. Far from being mere innocent self-delusion and wishful thinking, the pretense has serious negative consequences. Because of the illusion that there is more value being produced than there actually is, there are exaggerated claims on the value that is produced. In particular, this is the problem of Russia’s budgets. The apparent low rate of tax collection on the revenue side and the failure of the government to meet its spending obligations on the outlays side, most notably the unpaid wages and pensions, both result. In addition to nonpayments, the government also resorted to borrowing to cover the gap caused by “too many claims on too little value.” But with the borrowed funds just being used to compensate for value destroyed, not for laying the basis for value creation, the debt became a pyramid. This was compounded, fairly massively, by the rampant corruption and looting in the Russian economy. Professor Ickes and I called this “leakage of value” from the virtual economy. Borrowing while destroying the ability to repay guaranteed one outcome: a debt trap. In that sense, last year’s financial collapse was inevitable. Only its timing was uncertain. That was the impact of Asia and the oil price decline. Why No Reform: Time Is the Enemy The virtual economy had become consolidated by perhaps as early as 1994. As a result, fundamental reform of the Russian economy—dismantling of the virtual economy—has become nearly impossible. Indeed, some well-intentioned efforts to reform it at the margins may even have made it more sustainable. This will remain true in the future. While the coming months and years may bring renewed attempts at reform, they will almost surely fail. Each time, the task will become more difficult. Let me mention four reasons for this bleak conclusion that time has been, and remains, the enemy of reform in Russia:
To sum up all these reasons, then: compared to six or seven years ago, the process of reform today—again, by that I mean reasonably complete marketization, monetization, and modernization—would be (1) more unattractive to begin with; (2) more difficult technically and more costly to successfully complete; (3) more painful for the population to endure; and (4) more burdened by accumulated past unpaid costs, past debt in the broad sense. Without Reform, What Will the Economy Look Like? Perhaps the simplest way to summarize where things are now headed is to say that more and more of the Russian economy will look like the agricultural sector. The pattern in agriculture is the following. A very small number of large farms are oriented to production for the market, while the rest produce mainly for themselves. These self-subsistence farms have almost no interaction with the urban industrial economy. They do not deliver food to the cities; they do not receive industrial goods from them. As a consequence of their detachment from the urban economy, the self-subsistence farms and the regions around them are almost totally demonetized. There, the only cash that circulates at all originates from government transfers such as pensions and child benefit payments. The private sector is not banned in agriculture. Some independent family farms struggle on, but they continue to be squeezed by taxes and regulations, and their market access is limited. Market-constrained and tax-squeezed, they are becoming more and more indistinguishable from the ubiquitous family garden plots. Meanwhile, the plots themselves—the most primitive form of agriculture—are playing an even bigger role as the main source of food for Russian households. This trend, now dominant in agriculture, is the one industry will follow: subsidization (either overtly or via a virtual economy scheme) of an increasingly limited number of major enterprises, with most smaller ones cut off. Those cut off do not die, however. They subsist, but only to supply the very basic needs of the workers and communities around the plants. There will be little or no investment in these enterprises. They will be sustainable, but at a very low level. Consequences and Predictions What are the implications for Russia’s economy if it continues along this track? I will discuss four of them, in increasing order of their importance to us in the West: (1) the question of growth; (2) development of the private sector; (3) the national integrity of the economy; and (4) the ability of the public sector to fulfill its tasks and obligations.
The Political Dimension The survivability of Russia’s household sector in this peculiar system comes at the expense of the public (government) sector. But it is the decision about the future of the public sector—the state—that will shape Russia’s future. Consider the following scenarios. They differ in the roles government plays. The first scenario is that of Russia today. This is a “libertarian” virtual economy in which the government intervenes in a minimum way. This especially results in minimal central government control over the regions. The problem here is that value will tend to be kept locally. This means big gaps among regions, ultimately threatening national integrity. There will likely also be a lot of leakage (looting), because the government plays a minimal role in stopping it. The danger is inequity, an even more fragile public sector, and continued looting and corruption. This scenario is unlikely to continue but rather either lead either towards disintegration or generate a backlash and a demand for recentralization. It is theoretically possible that a strong and purposeful enough leader could act to avoid the negative consequences. Such a leader would concentrate on reducing the “leakage” (looting) of the system and on ensuring greater equity by a more even distribution of value. Since it would be more conducive to social peace and territorial integrity, this sort of peaceful virtual economy development might be sustainable for quite a long time. But it may be unreasonable to assume that Russia’s population and regional leaders would hand over power to a strong central administrator who could halt excessive looting and who could appropriate value from powerful regional and corporate interests and redistribute it for the benign purpose of ensuring equity. Unfortunately, a much more likely scenario is, as many observers have noted, a revival of support for strong central authority based on a real or perceived threat to national survival. This scenario is one for a militarized virtual economy. It would be an economy in which the determination of who is the recipient of value through the virtual economy’s mechanisms would be made from the top, on the basis of national priorities, rather than through some raw struggle on the principle of survival of the fittest (or best endowed). There would be priority and nonpriority sectors of the economy, as in the Soviet system. But it would differ from the Soviet system in the relations between the two. In the Soviet system, the priority sector exploited the nonpriority sector. Compulsion was necessary. In today’s variant, most of the nonpriority economy would not be directly exploited. It would be for all intents and purposes outside of the state. There would be, at least initially, less compulsion than in the Soviet system. While there would undoubtedly be some elements of forced requisitioning of materials, forced labor would be less likely. This “militarized virtual economy” is in itself a partial resurrection of the command economy. But even this is not a long-term situation. It could not last very long. Especially if there is pressure to resurrect large-scale conventional arms production (as opposed to a more limited concentration on, say, nuclear and space weapons), it will almost inevitably evolve into a full-scale command-administrative economy. Such a system cannot afford to leave any potential resource out, and that will require compulsion. Conclusion The scenarios I have outlined are admittedly highly speculative. They surely will appear to many to be overly dramatic. I think that this is in part because they attempt to look ahead for more than the immediate future. It is comfortable to think in terms only of what might happen in the next 1-2 years, since the probability that Russia will somehow muddle through for that time is indeed very great. As far as policy is concerned, we can continue as we now are doing: keep bailing Russia out, doing just enough to keep it above water, and pretend that some day, somehow, the country will resume and then successfully complete its progress towards the market. However, I think policy would be better served by acknowledging that Russia is not on the path towards becoming a modern market economy. It has rather developed a new economic system that cannot be “reformed” by marginal efforts, no matter how persistent. It will have to be dismantled. That task may be as big a one and require, from both inside and outside Russia, as much commitment to solve, as the original task of replacing the command economy with a market economy. We should have no illusions that it will be cheap. How a command economy functioned in the Soviet Union?The Soviet command economy coordinated economic activity through the issuance of directives, by setting social and economic targets, and by instituting regulations. Soviet leaders decided on the state's overarching social and economic goals.
Was the Soviet Union a centrally planned economy?The USSR is the quintessential example of a centrally planned economy. A centrally planned economy or a command economy is one where the price and allocation of resources, goods and services is determined by the government rather than autonomous agents as it is in a free market economy.
How would you describe a command economy or centrally planned economy such as communism?What Is a Centrally Planned Economy? A centrally planned economy, also known as a command economy, is an economic system where a government body makes economic decisions regarding the production and distribution of goods.
How did the Soviet economic system work under central planning quizlet?How did the Soviet economic system work under central planning? Party officials told farm and factory managers how much to produce. It also told them what wages to pay and what prices to charge.
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