A Visit to Russia

A short visit to a few places in Russia, the largest country on earth, provides merely a brief, incomplete view of the lives and mores of the people. A connoisseur of the arts, visiting cultural centers, may be enthralled by the unique cultural history, the artistic and literary achievements of its people. A political observer may be interested in the colorful history of government, its ever-changing features and functions, and the ideological and psychological factors that underlie political phenomena. An economist visiting the country may ponder the causes of the appalling private poverty together with astonishing public splendor. He may even reflect on the ways and means that would allow such talented people to improve their living conditions.

The political and economic ties that bound the Soviet Union for some seventy years cannot be cast off in a year or even a decade. They left their indelible marks not only on the political and social institutions which encompass economic life, but also on the psyche and mores of the people. A nation that, for centuries, has endured the dictates of omnipotent czars and commissars cannot be expected to find its way to the light of democracy in a few years. A nation that, for two generations, has been deprived of private property in production cannot possibly develop a market order in a few months. Without an educational and ideological foundation, without tradition and experience, it cannot be surprising that the great dual undertaking of building democracy and capitalism is a difficult and arduous task.

A few economists had expected the disintegration of the Soviet Union ever since Ludwig von Mises had demonstrated the "impracticability of socialism" in his 1922 opus, Socialism. He had pointed out that "in a socialist community the possibility of economic calculation is lacking: it is therefore impossible to ascertain the cost and result of an economic operation." The Soviet system was a chaotic system that was destined not only to enslave and impoverish its people but also to degenerate and finally disintegrate. But no one could foresee the time and manner of breakup. This writer had braced himself for a violent confrontation and civil strife among the various sinews of Soviet power: the Communist cadre, the reformers, the armed forces, and various regional and national interests. Actually, except for an August 1991 Communist Party coup that failed, for an October 1993 revolution which cost some 200 lives, and for some confrontations with ethnic groups seeking independence, especially the Chechens, the breakup of the U.S.S.R. proceeded remarkably orderly in Russia. In breakaway states such as Moldavia, Armenia, Azerbaijan, Georgia, and Tajikistan, it was rather destructive and bloody.

The final disintegration apparently set in when, in 1985, the General Secretary of the Communist Party and leader of the Soviet Union, Mikhail Gorbachev, launched his perestroika, an ambitious program for reforming the Soviet system. It unleashed powerful reform forces over which his government gradually lost control. It revealed the social and ethnic unrest and the disarray of economic life. The coup and its quick collapse signaled the disintegration of the Soviet empire. On December 25, 1991 Mikhail Gorbachev resigned, thereby acknowledging the dissolution of the U.S.S.R.

The leader of the reform forces and the hero of their victory was Boris Yeltsin who, in the first popular elections in June 1991, had been elected president of the Russian Republic. He immediately embarked upon ambitious reforms that were to transform the command system into an individual-enterprise market order. Several steps needed to be taken. First, goods prices had to be set free so that supply and demand would direct production and clear away all goods shortages. Next, was the task to privatize all state enterprises, including the giant monopolies. Third, was the need to privatize agricultural land, breaking up the large Soviet collectives and state farms. Fourth, was the need to privatize not only all facilities of retail distribution but also all kinds of housing. Finally, in order to stabilize the currency, the large budget deficits flowing from heavy state subsidies to inefficient enterprises had to be eliminated. Such were the great tasks for the reformers.

When Boris Yeltsin embarked upon his 500-day privatization program he faced the unwavering opposition by the anti-reform forces in the Duma, the Russian national parliament. The powerful Communist Party, which still commanded one-third of the popular vote, together with the Agrarian Party, and various nationalist groups, opposed all economic reforms. They waged an ongoing battle over every measure of reform which nevertheless moved forward by fits and starts. When President Yeltsin sought to decontrol all goods prices, as of January 1, 1992, the opposition managed to continue the controls on basic foods and essential oil products, which aggravated their shortages while non-essential products soon came to the market. With prices soaring, the rate of inflation exceeded 20 percent per month and the ruble fell from 120 to some 400 to the U.S. dollar. Traders and dealers earned profits, giving rise to a new entrepreneurial class, but pensioners and workers on fixed incomes suffered severely. They naturally voiced their loud opposition to the reforms.

The privatization process of manufacturing enterprises by way of sale of corporate stock was complex and slow. In many cases, privatization vouchers were issued to every man, woman and child, which allowed them to bid for state enterprises and property put up for sale at public auctions. But an inefficient, loss-suffering enterprise depending on continuous state subsidies may have no market value whatsoever if the new owners are prevented by law and regulation to improve the operation and eliminate the losses. In fact, a single labor law that prohibits the efficient employment of labor and the dismissal of unproductive labor may deprive an enterprise of market value, even liquidation value. If the corporate stock of such an enterprise nevertheless is sold to a multitude of uninformed buyers, they are likely to lose it soon to waiting creditors, that is, to banks, suppliers, or even government officials. The property may ultimately settle in the hands of the liquidators themselves or their relatives, or Party bosses or traders experienced in the ways of politics.

The reformers also encountered resolute opposition on all levels of labor where socialistic habits remained entrenched. Managers and workers preferred to rely on government subsidies rather than on their ability to render valuable services to customers. They could always count on the support by many government regulators who, with red tape and costly delays, rendered all privatization efforts rather inefficient and cumbersome.

The privatization of land proved to be even more difficult. The sale of a large state farm or cooperative extending over many square miles requires a viable capital market. Surely, the land may be assigned to the multitude of agricultural workers who linger in want and poverty. They may be granted the legal title to the land they have tilled feudally or communally since time immemorial. But a legal title does not provide the productive capital needed to work the land nor does it prevail over the countless laws and regulations that limit the use of land. No wonder that, throughout the years, the opposition in the Duma waged an ongoing battle against all efforts at privatization.

The sale of the facilities of retail distribution undoubtedly made the greatest progress. Knowledgeable managers who used to supply the black markets of the Soviet system could easily turn into private entrepreneurs who capably serve their customers. Capital requirements may be minimal and restrictive regulations may be circumvented as readily as they were in the command system. Even the connections to the sources of supply are as useful in the market order as they are in the command order.

Finally, the stabilization of the currency proved to be the most difficult of all reforms. Currencies, after all, are monopoly issues by governments or their agencies directed and manipulated by the politicians in power. All democratic governments are party governments that love to buy popularity and power with liberality in spending. Nearly all governments around the globe indulge in deficit spending and inflate and depreciate their currencies at various rates. Unable to raise sufficient tax revenues, the Yeltsin government unhesitatingly resorted to deficit spending and currency expansion. The rate of inflation soared to 900 percent in 1993 and thereafter declined gradually to 300 percent in 1994, 100 percent in 1995, and just 22 percent in 1996.

By 1996, just five years after the launch of market reforms, the ruble had fallen to some 5,500 to the U.S. dollar. President Yeltsin was still locked into continuous conflict with the anti-reform lobbies in the Duma. Yet in the democratic election in July, he was re-elected, with the voters in Moscow, St. Petersburg, and other large cities providing most of his support. The Communists held on to some one-third of the popular vote which they had commanded since 1991.

The Russian economy continued to hover between the old and the new, the command order, the market order, and the black-market order. The living standards varied greatly between the new entrepreneurial class and the people relying on government jobs and support. Public enterprise debt was growing exponentially as state enterprises failed to pay each other for goods and services. Wages went unpaid for long periods of time, which generated much labor unrest and led to many strikes by miners, teachers, and other government employees. In contrast, the service industry was booming. By then one-half of the working population was privately employed. More than 70 percent of industrial companies were in private hands, as well as some 90 percent of the fuel industry, and practically all ferrous metals enterprises. Only one-third of housing had been privatized as buyers were weary of rent control, high taxes, and many repair bills. Even a few thousand farms had been privatized, producing some two percent of the needed food supply. The people in Moscow, St. Petersburg, and other cities continued to depend primarily on imported foods.

In 1997 a team of young reformers, appointed by President Yeltsin, pushed ahead with privatization and liberalization of the Russian economy. In order to privatize more urban housing, they continued to subsidize all utilities even in housing they privatized. And just like the older team of reformers, they relied heavily on central bank financing which, in the summer of 1998, led to a major financial crisis. It forced the government to conduct a currency reform, issuing new rubles in exchange for old at the ratio of one new for 1000 old. Yet, the new ruble soon suffered massive devaluation from about 6 to the U.S. dollar in August to more than 20 in December. Goods prices soared. By then, the market reformers and their capitalistic ideas were thoroughly discredited, and many Russians were eager to return to the command order. Even many friends and advocates of capitalism in Russia as well as abroad concluded that the Russian transition to the market order may take more than a few years – it may take several generations.

On the last day of 1999, President Boris Yeltsin abruptly resigned his presidential position, making room for his appointed Prime Minister, Vladimir Putin, a former career KGB officer. Putin promptly submitted a reform program that was clearly market-oriented. It introduced a flat 13-percent income tax which was designed not only to permit rapid capital formation and economic development but also to reduce Russia's massive black markets, estimated at some 25 percent of the national economy. The Putin program also promised a friendly setting for business, with government regulation and other barriers reduced or even abolished. As tax revenues increased and budget deficits decreased, and even turned into surpluses, the central bank could curtail its issue of new notes which reduced the annual price inflation rate to only 16 percent in 2000 and 18 percent in 2001. At the same time President Putin sought to rein in provincial and regional governments, some 89 altogether, which were conducting economic policy on their own, regulating business and subsidizing unproductive concerns. Some even promoted payment arrears to other regions, some issued ruble surrogates or even advocated a barter system shunning the use of rubles.

President Putin's popularity with the Russian people has remained high ever since he came to power. It enabled him to promote important economic reforms in the Duma which acted favorably on all his proposals, though with reservations in matters of land and banking reform. It did allow the sale of commercial land in towns and cities, some two percent of the total, leaving the crucial issue of farmland ownership to the discretion of regional governments. Russian industrial production showed signs of life resulting from domestic and foreign investment. Private enterprise profits improved significantly, which also boosted government revenue. For the first time tax revenues sufficed to meet the requirements of debt service. The free-market reforms apparently were providing the economic sinew required for economic expansion and better living conditions.

The distance from Communism to democratic freedom and a market order is greater by far than the distance from the poorest market economy to the most productive and prosperous country. Both systems are worlds apart in thought, ethos, and organization. Under the valiant leadership of Boris Yeltsin, Russia covered this distance during the 1990s. As newly elected President he followed the U.S. example acting as his own Prime Minister, leading the way and issuing numerous reform regulations and decrees. Many Russians view him as the father of democratic Russia.

The Russian transition from a harsh command system to an individual enterprise order undoubtedly was arduous and painful for millions of individuals accustomed to the old ways. It introduced an order they did not understand. But many intelligent individuals in positions of State and Party leadership viewed the transition as personal opportunity and chance from which to profit. Experienced in the old ways of "wheeling and dealing" in political relations, they managed to acquire large enterprises by questionable means. They had political influence but little or no economic knowhow and no interest in competing in markets and serving customers. They became the oligarchs, a small faction of politically connected individuals who held sway over the Russian economy.

As the Yeltsin era was drawing to a close, a handful of business associations of successful bankers and businessmen was emerging and buying up entire industries from the oligarchs. They sought to bring order and stability to several industries, such as steel, coal, car manufacturing, aluminum, and even timber. According to the Moscow-based subsidiary of UBS Warburg, a Swiss investment bank, just eight associations now control the 64 largest private companies in Russia. They are laboring and investing to improve their businesses and paying taxes. They are repairing and rebuilding the Russian economy along the lines of a market order, bringing new hope and courage to millions of people.

A key question for future economic conditions in Russia – as it is for all countries – will be how the government chooses to treat successful businessmen and business associations. Most politicians and government officials sincerely distrust business success; nothing sharpens their sight like envy. Moreover, in a transition economy such as the Russian, it is rather difficult to distinguish between various types of nouveaux riches. There are some successful entrepreneurs who honestly and capably serve their customers, painstakingly observing every rule and regulation. There also are numerous entrepreneurs who honestly serve their customers but conveniently violate some harmful law or regulation. And, finally, there are the oligarchs who acquired their wealth through politics which, in such situations, busily turns public property into private wealth. The economic future of Russia obviously hinges on the ways in which the politicians in power will treat the entrepreneurs and their wealth.

Since time immemorial Russia has enjoyed all the prerequisites for economic growth and prosperity. The population of some 140 million is very industrious and highly educated. There are over 500 institutions of higher learning with some 28 million students. More than 40 percent of the population have completed a secondary and some 22 percent a graduate education. The natural resources in Russia undoubtedly are the richest in the world with deposits of coal, oil, gas, iron ore, bauxite, manganese, aluminum ore, gold, and industrial diamonds, spread throughout the vast expanse of Russia. Nearly one-half of the country is covered by forest; only seven percent is cultivated and used for raising crops. Yet, despite its great wealth of natural resources and great labor, Russia ranks among the poorer countries of the world with an official per capita gross national product of some $2,250, which compares with more than $35,000 in the United States or $25,000 in Germany.

We cannot view the future of Russia by her past. Most human life is driven by a dim apprehension of political, social, and economic thought which changes slowly. It shapes habits, predispositions and attitudes, and forges government policies. Economic life is what economic thought makes it – also in Russia. The Russian people have long experience in suffering poverty and hardship. Full of hope, they may yet find their way to comfort and ease – the way of freedom.

Hans F. Sennholz

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