POL354 Lecture 14 – Economic Transformation
Thursday, January 19, 2012
The transition itself started with a very clear set of assumptions by the leadership of the country
that any political transition had to be either preconditions/co-conditioned with a major
transformation of the economic structure of the country.
The assumption is that there is a very clear linkage (causal) between the type of economic
regime and the type of political regime that exists in most countries. Socialism is inconsistent
with the construction of a democracy, especially the type of Socialism that existed in the Soviet
Union. What is required for modernization/democratization is the emergence of a capitalist
The Soviet Union had an economy that was inconsistent with democracy. The argument was
that along with the establishment of democracy, the old economic regime had to be dismantled.
Economic and political power had to be separated. Private ownership had to be set up. Need for
a legal framework that would guarantee private rights, etc…
Western democracies that evolved with the emergence of capitalism did so because capitalism
provides certain assets which are critical to democratic governments – Socialism had reached its
capacity in terms of producing and distributing goods. Capitalism generates the
resources/conditions for higher education which is needed to produce a large middle class
which are willing to recognize the legitimacy of a certain regime regardless of if they fully
benefit from that regime. Civil society also comes with capitalism.
A strong democracy requires a level of economic development that is consistent with both a
relatively affluent society as well as a strong enough economy to provide for a state which itself
is strong and which has certain functions assigned to it that it can afford to carry out (social
programs, infrastructure, defence). Much of the power originally exercised by the state is
transferred to the public sector which allows the government to carry out a range of functions
which are society wide.
The Soviet system could not provide this – it was a command-administrative economy. There
was virtually no space for the private productions/consumption of goods and services. Economy
was closely monitored and contained. The entire economy was planned and administered by
the state i.e. Counsel of Ministers. All consumption came from purchase by the state – exclusive
monopoly on the distribution of goods on the retail level – this had to be broken down.
There were no prices in the Soviet Union, instead compliance was insured through a number of
State organizations who monitored there behaviour of administrators and workers.
There were imperfections in the planning system, flow of information, irrational expectations, in
this system. Much of these distortions were due to a large number of informal adjustment
mechanisms that were not counted into the planning of this system. A good deal of corruption
was built into the system – breaking the rules for the sake of the state/personal advantage.
By the early 1980s it was clear that this system was not working. There was a significant
economic slow down in the early 80’s. Growth rates indicated recession/depression like conditions. Serious management problems became evident, the quality of the goods and
services produced was at a continuing low level, and agriculture was constantly weak – yields
constantly unstable/unpredictable. There was also technological backwardness (despite
Western assumptions) – this was a mechanism that would keep the Soviet Union permanently
behind the West.
Gorbachev describes this as a pre-crisis situation – one which requires dramatic attention. Opts
to try a number of quick fixes on the existing system as a temporary strategy. Tries to reorganize
some of the basic units of the economic system. Attempted to put another level of bureaucracy
in place to monitor lower levels. Called for the conversion of military to civilian production to
expand the base of consumer production and because the Soviet military produced better goods
than the civilian sector.
Gorbachev recognized the importance of foreign trade. First set of options for Gorbachev was to
fix the existing system – very much reminiscent of Khrushev and Brezhnev.
1986 – Gorbachev presents the vision of transformation, puts in place policies that will direct
change of a more radical nature. Takes the 1920s (New Economic Plan) as his model in order to
legitimize what he did – reminds everyone of the true Leninist course to Socialism which was
meant to be State control with some degree of space for private entrepreneurial activity.
Gorbachev scraps the Social contract which provides everyone with the right to a job/security –
but this limited access to high wages. Introduces a new set of laws allowing for larger wage
differentials based on individual –instead of collective – performance. This also created job
insecurity. Gave the right to fire people/reorganize work force based on real needs to managers.
This meant that management was allowed to move in the direction of providing savings for itself
that it could retain and use for other purposes.
Significant change that took place in the labour contract major reform as opposed to a quick
Gorbachev envisions a radical change in the system – introduces new bills that provide
economic space for private enterprises (called collectives). Individuals can now set up
establishments legally to provide a large range of services that consumers need (i.e.
restaurants). Severe restraints – initially only members of a family could set them up, or those
who were ‘un-employable’. This is a radical reform of the socialist command-administrative
system. Gorbachev set up a place in society for private entrepreneurial activity.
This takes off and expands very rapidly, especially in the consumer goods sector. The reform
however encounters enormous resistance. Conservatives have strong vested
interest/ideological commitments to the existing system. They have their own outlets in terms
of the media through which they can challenge the legitimacy of the reform. Gorbachev is put
into the position, for the first time in Soviet history, where a leader is subject to real criticism
while in power.
Tremendous resistance in the system by lower level bureaucrats who feel threatened by the
radical change – happy where they are. Challenged by others who work more effectively and
make take their jobs. Tremendous amount of public opposition. Instances of violence, discussion amongst the people.
The people feel a large amount of commitment and loyalty to the regime and feel threatened by
the radical changes introduced to the country.
Gorbachev is confronted with a dilemma – debate: move ahead slowly, quickly, or stop? In
general there are two approaches put forward:
Recognizes resistance in opposition and believes the only way to transition is to transition
quickly “500 day plan”. Has to go ahead quickly, and consolidated otherwise it will be
Argues for gradualism, doesn’t reject the concept outright, but warns that transformation needs
to ensure stability.
Gorbachev has to make a fundamental choice by early 1991 and he chooses in favour of Ryzhkov
and gives up on his vision of real, fundamental, economic transition.
While this is taking place:
June of 1990, Boris Yelstin is elected as the Chief Executive of the Russian Republic. He goes on
to become the first elected President of the Russian Republic. Yelstin had a long history of
conflict with Gorbachev. Sharply criticised Gorbachev for his lack of leadership abilities.
A war of laws which was often constructed around the idea of increased sovereignty for the
republics within the Soviet Union. The Baltic republics had asserted their claim to
sovereignty/succession on the grounds that they had been illegally incorporated in the first
August of 1991 there was a coup attempt on Gorbachev. His authority is virtually disappearing.
The authority/legitimacy of the central government has also been severely undermined. Yelstin
begins to consolidate his government.
Yelstin introduces his program through a set of decrees in late October/early November of 1991.
The type of reform he is proposing is fundamental and transformational in nature and can only
be down within the context of a sovereign state. It appears, for political purposes, that Yelstin
has already established, in his mind, that he is going to dismantle the Soviet Union.
As the president, ultimately the responsibility fell on Yelstin’s shoulders. However, what Yelstin
put in place has a much more complex backdrop – Yelstin was ignorant when it came to
economics. He had to make the decision based on the advice/direction given to him by others.
Two other key actors (1) Igor Gaidar and (2) Anatoly Chubais, both heavily influenced by the
Yelstin’s decision was also pushed by outside forces, in particular the American government who
pushed for the dismantling of the Socialist system and the establishment of a capitalist regime.
The American government gave aid to pro-capitalist groups, gave money under the conditions
that Russia under goes a rapid, total transformation from a state-based economy to a capital- based economy. Also received pressure from the IMF and WB(?) through the form of foreign
aid. The decision was not made solely by Yelstin in isolation, there were a number of individuals
and foreign organizations who pushed Yelstin.
Yelstin’s proposal can be divided into 3 components
1. Stabilization – want to control inflation. Commitment to the emission of currency by the
central bank. Recognize the need to cut back on social programs/subsidies, and in
particular to take a hard look at the defence sector which takes a lot out of the state
budget. Agreed to reduce and eventually eliminate state credits for the entrepreneurial
sector to control the flow of money from the state. Commitment to regulate wages.
2. Liberalization free up state control of aspects of the economy (i.e. prices should be
controlled by supply and demand, rubble) –Understood that the opening of the
economy will lead to a large inflation of the currency. Opening of Boarders for
Imports/Exports and foreign investment – capitalization of new activities had to occur
with the importation of foreign investments.
3. Privatization – creation of a private sector that would rapidly expand and eventually
take over many of the functions of the government. Would get new developments in
technology by generating foreign investments in the country. New investment that
would come from outside the country was not reasonable under the circumstances –
absence of a legal framework to protect external private investors, a large number of
Russians in power used their power in order to expropriate the holdings of foreign
investment companies. Therefore, the primary source of the rapid emergence of a
private sector had to be the state. The Soviet state had a monopoly on assets, had
developed networks of energy distribution/transportation, had a huge industrial
Issue became how to undertake a process a destatization/denationalization, a process by which
the assets of the state were divested and distributed.
What was involved here were a set of assumptions based largely on a Neoliberal ideology with
regard to how Capitalism could be set up within the Soviet Union. The assumption was that
dramatic and decisive action had to be taken to move the country into a situation where most of
its productive forces were moved to private organizations who would take up the task of
rebuilding the economy.
The idea was that there would be a short period of chaos where people suffered greatly, but
once this was completed, a newly invigorated/healthy regime would be created. Shock
Therapy. The image used during the 1990s was the person on the edge of an abyss – have to
cross the abyss in one leap.
Yelstin’s people put in state a plan of destatization. Identified certain critical sectors that should
remain under state control for national interest/security. Also provided the skeleton of a
number of different organizational forms that the new companies could take. They could
emerge as the result of insider transfer (workers/managers take over ownership of a factory
previously owned by State), auctions, etc.
In the first year of the program disaster occurred. IT became increasing evident that this
planned/staged process of privatization had been captured by individuals holding powerful
positions in the state in conjunction with a number of individuals outside of the state who conspired to have assets transferred in a non-transparent fashion. Transfer of funds laundered
from the State itself. The State acted as a protector of individuals outside of the state (Krysha). A
series of pay offs were involved in this. This happens through laundering, insider trading
(through banks), and auctions.
This was not a case of simple bribery/black mail on State individuals. The State individuals
themselves are involved as partners in transferring assets from the State to themselves and
those separate from the state and bidding for them. While not transparent, these actions were
still known. By mid 1992, increasing public discontent with this process led Yelstin to introduce
is “Voucher program every Russian citizen was issued a $10,000 rubble voucher which could
be used to purchase shares. What happened:
A number of people sold their shares right away (this was encouraged to help inflation)
Rules were put in place to stop unions from pooling their workers vouchers.
The apparent attempt to provide equity and fairness turned out to be a farce.
In early 1996 a decision was made to hold a presidential election in June. Yelstin sets up a
“Loans for Shares” program to help him get re-elected. The State had borrowed millions of
rubbles from state banks. The state defaulted on the loan – banks gain ownership of the assets.
The bank sold this money back in auctions. fundamental corruption of the privatization
process. Corruption both outside of the state and through the state.
Idea of the Oligarchs:
1. Nomenklatura Oligarchs those who became wealthy through their ownership of
private assets as a result of their positions in the state,
2. New/Outsider Oligarchs worked outside of the system
In practice Yelstin’s theory made no sense because it failed to take into account reality – the
legacy of Soviet institutions and the way in which they had worked. It failed to take into account
the absence of both law and a legal culture in Russia – that is either a commitment to act
accordance to the rules or compliance with the rules for fear of consequences. Yelstin was
involved in the corruption of the process.
What happens in this context is a dramatic period of collapse. In the decade of the 1990s Russia
undergoes a process of deindustrializtion/demodernization by virtually all criteria. GDP fell
almost 50% within the decade. The per capita was only 20% of the G7. Labour productivity was
roughly 25% of the United States. 70% of the technological equipment was at least 10 years old.
Financial indicators of collapse rapid inflation, miniscule tax collection by the State, huge
illegal capital flight (roughly $2 billion a year).
The financial system never did develop properly. Banks, which could have been a set of
institutions for savings/investment, were created for laundering money of organized crime.
Monetary indicators the rubble basically collapsed in the 1990s. In 1998 the then prime
minister estimated that 70% of economic activity in Russia was conducted through barter,
factories would pay their workers in kind (when they paid them). Suppliers, especially energy
suppliers, were often paid in veksel –expressed in goods that would be provided rather than
money. The financial system was simply not there to provide the credit and currency that was essential
for the establishment of a viable economy.
There was mass unemployment and underemployment. By the year 2000 the year is roughly
12% (not too bad, but numbers only based on those who applied for support from the State).
Underemployment, run down factories were still run with workers who would do very little.
August 1998 Russia suffers a complete financial meltdown. The rubble lost 2/3’s of its value.
The country defaulted on its international debt and banks crashed. The politics of this crash,
some argue that it was the result of unfortunate economic circumstance. It was actually
Yelstin fires his whole cabinet, including his long standing prime minister –
Chernomyrdin – nominates a new prime minister – Kiriyenko. Yelstin reassures
everyone that there is no problem. At this time the IMF and World Bank are pumping
huge amounts of money into the State.
The state is issuing bonds called GKO(R) and selling them to the banks at 150% interest
rates. The banks in turn are selling these notes to international investors for other
All of a sudden in August of 1998 the entire system collapses. The people holding
GKO(R)’s lose a huge fortune, and the value of Russia as a place of investment falls off a
cliff for a period of time.
The money that had been coming into the state from the IMF and World Bank to prop
up the rubble is no where to be found – was not used to support the rubble and is not in
the State. The money ended up in offshore bank accounts of state officials. Massive
This was a set of events that had been seen by the people involved and had been used
as a way of earning huge amounts of money for their personal bank accounts.
If you place in context the support that Putin gets through the first decade of the 2000s, people
were fed up/devastated by what had happened in the name of capitalism and democracy in the
Recall It was necessary to dismantle as rapidly and completely as possible the old Soviet
command-administrative system. The conjunction of state power and economic power was
inconsistent. Destatization and privatization along with the establishment of markets was
essential for transition.
When confronted with opposition and resistance, Gorbachev held back. Boris Yelstin then
stepped in as the president of the Russian Republic and put forth a radical transformative
proposal in late Fall of 1991 and was legislatively put in place beginning in January 1992.
This proposal was very neo-Liberalist in its ideology. It called for some state intervention to
control the currency but would involve significant dismantling of state ownership.
This would create a period known as shock therapy. This was socially and economically
disruptive but it was believed that the country would emerge from this in better ship and on its
way to marketization and thus the democratization of the country. Argument - The privatization component of this strategy was deeply flawed. This could