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Fixing the Economy

What I want you to know: The Russian economy has been through some tough times, but it is on the upswing and it will not be long before we see Russian products competing in our own marketplace.

 

I. Background

Definitions:

Command Economy = Managed economy (Planners).  Prices are set artificially.  Often, they are not close to the price for that product in a market economy.

 

Market Economy=Prices are determined by the natural interaction of supply and demand in the market.  Prices are equal to real value. The Soviet economy was a command economy.  The concentration of labor and resources was in heavy industry (especially in the military-industrial sector). Sacrifices were in consumer goods.  Soviet consumers had to deal with shoddy products and shortages.  The sectors of agriculture, transport, and service were ignored.

 

II.  Gorbachev’s Perestroika.

There was a gradual but controlled move towards a market economy.

A. June 1987: Law on State Enterprises

    -Was designed to move enterprises to full-cost accounting over a two-year period.  Began the process of rolling back the frontiers of the State by starting to dismantle the huge planning Bureaucracy. 

B. May 1988:  Law on Cooperatives

    -Removed restrictions on cooperative economic activity (stopped in 1929) and opened the door to privatization.

*Gorbachev’s reforms were efficient at demolishing the command economy but failed to put a viable alternative in its place.

III. Yeltsin Era: “Let the good times roll!”

At the end of the Gorbachev era, many elements of the command economy were still evident, including state subsidy of many enterprises, controlled prices, a centralized supply system, etc. With the break-up of the Soviet Union, Yeltsin felt free to pursue a policy of radical economic reform.

A. “Shock Therapy” 

    This was a sudden and rapid move towards a market economy.  It was supposed that although it would be painful, it was better to get it over with quickly than do it slowly.

January 1992:

1. Prices freed.

2. Government subsidies to industry were cut back.

3. Full autonomy and financial accountability to state-owned enterprises.

4. To soften the blow to the people, the Russian government maintained a commitment to a program of social welfare to help the needy.

5. To force monetary stability, Yeltsin’s government pursued a policy of trying to balance the budget.

6. Opening the economy to the world market would promote competition, inward investment, and efficiency.

B. Privatization continued during this period.  There was a move to privatize services, the retail sector, and the establishment of joint-ventures with foreign ownership.  State-owned housing, farming, and eventually the industrial sector was privatized.

    1. In October of 1992, the government approved two plans for privatizing state-owned industry:

        a. Managers, directors, and employees got shares of their firms.

        b. Vouchers were distributed to the population which represented their nominal share of the state-owned industry.  Vouchers could be used to buy shares or simply sold for cash.

        c. Results

        1.  By the end of 1993, 2/3 of the 14,500 firms picked for privatization had been transformed into joint-stock companies owned mainly by their workers.

        2. It is estimated that by the end of 1995, 73% of the industrial assets had been transferred to private hands.

        3. The Government continued to control key sectors.

*By purchasing and accumulating vouchers is how many people got fantastically rich in Russia.  Most of the average people had no idea what the worth of their vouchers really had if accumulated and cashed in or purchased ownership of industry. 

 

**Former officials, directors of factories, and former communist officials used their positions to acquire shares in their factories dishonestly.

   C. Costs

       1. 1989-1996 GDP fell by 60% with a greater decline in industrial output.

       2. There was widespread tax evasion, corruption, and tax fraud, and that severely hampered the government’s indebtedness (recall, IMF loans in the early ’90s). 

       3. Because of the failing economy, politically people chose Communists and Nationalists in the Duma elections of ’93 & ‘95 over democratic, reform-minded candidates.

       4. By September 1997, unemployment had risen to 9% of the workforce (65 million Russians). This resulted in delayed payment, payments-in-kind, multiple jobs, unofficial or illegal commercial deals, and growing one’s own food at the dacha. 

 

*It is estimated that only about 10% of the population experienced a real increase in income between1991-96.  Recall Oligarchs and New Russians.  The rest lost out.

    D. Financial Crisis of August 1998

        On August 17th, 1998, the Russian Government announced the devaluation of the Ruble and a 90-day moratorium on the payment of external debts by commercial banks.  The Government was bankrupt.  

        Results:

         1. Ruble fell to half its value.

         2. Prices of food changed hourly.

         3. Inflation soared.

         4. People and Enterprises scrambled to get their money out of the banks.  Most failed and their savings and accounts were wiped out in the suspension of the banks.

         5. Belief in the future of the Government and economic reforms disappeared.  The Government was dissolved within the week.

         6. The emerging middle-class was destroyed.

         7. Many said that the crisis was worse than our Great Depression.

 

*Silver Lining:  As a result of this crisis, many say that it was the death of the speculative economy based on quick mega-profits and financial manipulations.  It was replaced by a real producing economy with professional managers quickly replacing the poorly educated newly rich Russians with bad manners.  It was the beginning of a new era in the Russian Economy.

THE RUSSIAN ECONOMY REVISITED IN 2003

What I want you to know:  The Russian economy is in a growth mode.  The Government has set high goals and is determined to reach them.  Essential laws protecting property rights and worries about the aftermath of the wealth redistribution of the early 90s have overshadowed Putin’s Governments efforts. 

I. After the August Crisis

Professional political managers came to power.  The Left and radicals became less popular.  

Results:

=This means that society no longer entertains the illusion that somebody else, and not the people themselves, can quickly change their lives for the better. 

=People learned to count on themselves to improve their lives. 

=Irreversible market reforms are the result

1. Statistics:

A. The middle-class has grown to up to 25% in cities.

B. People are trusting the banks again.  Over twice as much has been deposited in banks over pre-crisis amounts.

    1998=$2.9 Billion

    2003=$7 Billion

C. Consumer spending is up in travel, auto purchases, home improvement, electronics, and furniture.

D. By June 2002, real cash incomes had exceeded August 1998 pre-crisis levels by 5.4%.  Wages in June 2002 were 18.7% higher than wages in 1998.

Managing Russia After the Crisis

09 October 2009

By Odd Per Brekk

 

The international crisis dealt a severe blow to the Russian economy. The lower oil prices and reversal of international capital flow to emerging markets hit the country hard because the shocks struck just as the economy was on a steep upturn and Russia’s dependence on oil made it particularly vulnerable.

As a result, economic activity fell precipitously. Faced with this challenging turn of events, the government mounted an economic policy response that was swift and unprecedented in its scale and contents. The banking pressures were addressed through large-scale liquidity injections and rescue of problem banks, while fiscal policy became expansionary. At first, the Central Bank allowed gradual exchange-rate depreciation into early 2009, drawing on its foreign reserves to moderate the pace. This allowed banks and corporations to bolster their foreign exchange positions and brought the ruble in line with the new fundamentals implied by lower oil prices.

Looking forward, the global economy suggests a slow recovery as it will be facing deleveraging, corporate restructuring, and slow job growth. Similarly, Russia cannot expect a rapid return of high oil prices or large capital inflows. We should therefore foresee a fairly modest recovery in Russia combined with a weaker balance of payments than in recent years.

 

This sobering outlook has important implications for the country’s economic strategy. Clearly, the government’s response over the last year has helped preserve stability, which is a prerequisite for the resumption of growth. In fact, since mid-2009, there have been signs of economic stabilization. But large challenges remain. The central goal will be to turn the tentative signs of a rebound into lasting economic growth while preserving the stabilization gains. In this regard, Russia faces delicate trade-offs, as well as room for improving the boost to economic growth, both in the short and longer-term.

Consider first the short-term policy priorities. Ensuring a healthy banking system will be critical for the resumption of credit supply. This underscores the need for a proactive and comprehensive strategy so that banks have the capacity to lend once the economy recovers. Key elements of this strategy should include mandatory stress tests of major banks to obtain better assessments of their viability. These tests should, above all, reveal whether banks have adequate capital or have the ability to raise more capital if needed, either from private sources or from the envisaged bank recapitalization by public funds.

Turning to budget policy, the cautious fiscal policy of the past has left Russia with a low public debt level and sizable buffers, creating “fiscal space” for relaxation. But the size of the relaxation should not be so large as to undermine the quality of public spending. Moreover, the use of the Reserve Fund for budgetary financing is effectively the same as printing money for this purpose, and this could easily threaten the stability of the ruble. The good news is that with a better composition of the fiscal stimulus, Russia could achieve the same boost to domestic demand with lower fiscal deficits. To this end, the fiscal stimulus should enhance social safety nets and infrastructure projects. Also, the government should keep in mind longer-term fiscal policy objectives. Emphasizing self-reversing spending categories now would allow more flexibility in budget policies later. The more convincing the medium-term fiscal plans are, the stronger the fiscal boost will be today.

On the monetary policy side, the Central Bank is facing a balancing act. Inflation is coming down and may undershoot the target this year. But at the same time, the ruble remains vulnerable to swings in oil prices, banks are still liquid, and the fiscal expansion may renew pressures. On balance, however, the gradual relaxation of monetary policy envisaged by the Central Bank would seem appropriate. But there is clearly a need for careful implementation to avoid instability while keeping an eye on capital flows, the exchange rate, and depositor confidence.

Looking beyond the crisis, there is broad consensus on the need for Russia to achieve economic diversification. This would help Russia realize its economic potential and also make the country less vulnerable to the vagaries of financial and commodity markets. Diversifying would not necessarily mean an increase in hi-tech industries but could equally well involve such sectors as light industry and tourism. To achieve real diversification, however, Russia will need significant investment.

The reform agenda is well-known. The most important priorities are a rollback of state control, easing of entry for new firms, reforms of the public sector, strengthening anti-corruption efforts, and gaining accession to the World Trade Organization. While the commentary on Russia’s medium-term policies tends to focus on these structural reforms, we should not lose sight of the macroeconomic foundations for balanced economic growth.

Both medium-term government budget policy and monetary policy will play critical roles in how Russia recovers. As for medium-term budget policies, the central issue is how the country over time would best benefit from its natural resource wealth. One option would be to conservatively aim for a public spending level consistent with the income that the government will derive from petroleum over the long haul. Taking the 2009 budget as the starting point, this would require considerable restraint in government spending once the economy recovers, while at the same time underlining moving forward with deep and comprehensive public sector reforms. Other options toward fiscal viability entail large fiscal adjustments. Whichever option is pursued, conservative fiscal policies will preserve Russia’s competitiveness and limit “Dutch disease” by avoiding excessive reliance on natural resources.

The second important condition for achieving sustained growth is to anchor inflation at a low and stable level. This can be achieved through higher domestic savings and investment. To this end, formal inflation targeting must become a goal of the government. The Central Bank has been making progress on the technical preparations for formal inflation targeting. Encouraging recent examples include increased exchange-rate flexibility and more public statements explaining interest rate decisions.

Russia must now concentrate its efforts on how to foster sustained growth. For the near term, the government’s strategy on the banking and budget sides should aim to facilitate early recovery and protect stability. Russia has vast economic potential, and unleashing it will require a deliberate and broad economic strategy that encompasses sound macroeconomic policies and structural reforms.

Odd Per Brekk is senior resident representative at the International Monetary Fund in Moscow.

STUDY GUIDE QUESTIONS

Fixing the Russian Economy

1. What is the Command Economy?

2. What is the Market Economy?

3. Describe the Soviet Economy (3).

4. Describe two major reforms from the Perestroika era.

5. What did Perestroika do to the economy?

6. What was Shock Therapy? (3)

7. What is a voucher?

8. Name the two ways that State industry was privatized in October 1992.

9. What were the results of this privatization?

10. What did most people do with their vouchers?

11. How did the former bosses get a big piece of Russia?

12. Name two costs of the efforts at fixing the Russian economy?

13. How did the Russians survive this period?

14. What happened on August 17th, 1998?

15. What were the results of this crisis?

16. Why do the Russians say that the August Crisis has a silver lining?

Economy Revisited

1. Why is it important that after the crisis the government began to be run by professional political managers?

2. Name 3 positive things that happened as a result of the August 1998 Crisis.

From the CIA World Factbook: Russia:

1. What is the estimated GDP per capita (per person) last year?

2. What is the Russian currency?

3. What are Russia’s primary export commodities?

4. What is the number one import commodity?

From “Managing Russia After the Crisis”

1. Why does Odd Per Brekk suggest that the Russian economy will recover slowly after the 2009 world economic crisis?

From the 2021 OECD Economic Forecast for Russia

1. According to the OECD, is Russia’s GDP expected to grow (+) in 2021?

The Prompt

1. The Women: Read this excerpt below of an economic case study of three women and their lives right at the time of economic transition from planned to free-market.

State your thoughts on the following:

· What would you have done to survive during this time?

· How do you think this could have been prevented? Do you think it could have been prevented?

· How can Russia become a “Rule of Law” nation?

In the discussion please post your thoughts on how these women lived and the economic choices that they had to make. One student discovered this economic tool to help her understand the value of the ruble and purchasing power from 1997 to the present. If you like numbers, please visit: The inflation Tool

WOMEN & SURVIVAL

Excerpts from a study done by Michael Buraway, Pavel Krotov, and Tatyana Lytkina; “Domestic Involution: How Women Organize Survival in a North Russian City”. Found in: Victoria E. Bonnell and George W. Breslauer, eds., Russia in the New Century: Stability or Disorder (Boulder: Westview Press, 2001).

Background Notes: This study was done in a small arctic town called Syktyvkar in the Komi Republic. There are two factories focused on-the city’s garment factory (Red October) and its furniture factory (Polar). The interviews were conducted in 1994-95 and then the subjects were re-interviewed in 1998-1999. The portions taken are verbatim from the text.

Marina: For a Roof over One’s Head

The stereotypic Soviet citizen often has been described as a dependent, bereft of initiative, passive in the face of adversity, helpless without state handouts, and jealous of those who enrich themselves. At first sight, Marina looked as though she fit the stereotype. When we interviewed her in 1995, she was still working at Polar, hanging on in the hope of early retirement (at the age of 45), to which she would be entitled based on her hazardous work. But she was denied this because her registered job classification was not designated as hazardous. Still, she didn’t leave even though by 1995, wages had been irregular and falling for two years and most workers had already left. She complained a lot about all the stealing that was taking place at the enterprise, both by workers and by managers. She recently had turned down a job in retail since such work-so she said-was immoral.

At the age of 47, in February 1998, Marina was laid off. She received 1,500 rubles in kind (a divan), half of the six months’ liquidation wages owed her by the law. At the time of our second interview (April 1999), she was still waiting for the remaining 1,500 rubles. When the six months were up, she registered at the Employment Agency in search of work but so far had found none. “Who wants to employ a pensioner,” she says, “when there are so many young people looking for work?” So she depends on monthly unemployment compensation of 375 rubles (75 percent of her regular wages-the amount provided for by law, for the first three months of unemployment) in food, and another 310 rubles in medical assistance for her son, who has chronic asthma and gastritis.

Marina lives with her second husband, who also worked at Polar until wages became irregular. He quit in 1993 for a construction company job, which also failed to meet his expectations, after which he took a job caring for the Municipal Parks. Again, he didn’t last six months before turning to unemployment. That was in 1994. Now he is working for the Ministry of Internal Affairs as a joiner. He receives 300 rubles a month, more or less regularly, but again only in kind–a bus pass, food. The latest insult was 100 rubles worth of so-called Humanitarian Aid, which was, as Marina described it, only fit for their dogs. He used to do odd jobs on dachas, building stairs or bathhouses, but as Marina asked rhetorically, “Who has the money to pay for such work nowadays?”

Marina and her husband have two children, a daughter of 16 and a son of 15. Marina frequently mentions her son’s disability, which often keeps him out of school. She is proud of her daughter’s outstanding academic accomplishments and is hoping that through connections she may somehow go on to the university. These accomplishments are even more amazing, given their deplorable housing conditions. The four of them live in one room of a ramshackle, frame cottage: Marina’s sister, who receives the minimum unemployment benefit of 130 rubles, lives with her young daughter in a smaller, adjoining room. It is difficult to comprehend how the six of them can exist together in this tiny, dark, dank space. They heat their room with a small store, carry water from an outside wall, and use an outhouse.

Marina and her first husband inherited this cottage—originally, a duplex—from its owner. When they divorced, they split it equally. Her ex-husband sold his half, which lies abandoned and demolished; but Marina and her family refuse to evacuate the other half. The land has been granted to a developer who is eager to erect a new apartment building on this prime real estate near the center of town. But Marina won’t budge. By law, her cottage cannot be demolished until all registered there have been re-housed. At the time of the first interview, she had already turned down a modern two-room apartment, holding out for the three rooms to which she was entitled. Since then, she has been offered a two-room apartment in a frame building, and most recently, space in a hostel. As the offerings of the city council have become less attractive, she has become even more determined to hold out for her three-room fantasy, knowing that until she gets her way, she is denying some private developer sumptuous profits.

Their only other source of sustenance is their dacha, bought some 15 years ago, soon after they married. Until 1992, they used to raise chickens and pigs there but stopped because they didn’t have the money for feed. At the first interview, they were still growing vegetables at the dacha; but by the second interview, Marina was complaining that almost everything they grew was stolen. In the realm of dacha production, as in their income and their housing conditions, their life has progressively deteriorated.

Marina considers herself a troublemaker. At Polar, she protested the ubiquitous stealing as well as her job classification. She has waged a protracted war against the municipality for many years, in the vain hope of improving her deplorable housing circumstance. Bereft of material and skill assets inherited from the past, cut off from redistributive networks, she is reliant on the state for the little income she receives. But she is hardly passive.

Tanya: Working the Kinship Network

While Marina plays her citizenship assets—unemployment benefits, sick benefits, and housing rights—for all they are worth, Tanya works on her social assets, and her diverse kin networks, to keep herself afloat.

Tanya is effectively a single mother. At the age of 44, she shares a one-and-a-half-room apartment in a frame building with her daughter (20) and son (23). At the time of the first interview (1995), she still worked at Red October, but only intermittently because of her asthma and weak heart. Her pay, 200 rubles a month was about half that of her coworkers; and during the previous year, she had seen only 70 rubles a month in cash, having received the rest in kind, at the factory shop. She finally left her job in 1997 because of poor health. She now lives on her disability pension of 400 rubles. She used to do some sewing on the side, but stopped, fearing that the tax inspectors would discover this activity and take away her pension.

Tanya’s first husband died by drowning. She shed no tears over it since he was an inveterate drinker and used to beat her. Her second husband was Bulgarian, a member of Komi’s Bulgarian colony. When communism ended, he returned home to Bulgaria and soon began to send Tanya money. She had even spent six months with him there. At the time of the first interview, she wanted to join him permanently with her daughter; later, she wanted to divorce him. Her life was in Komi, with her two children.

Tanya’s son was wounded while serving in Chechnya. At the time of the first interview, he had recently returned, a changed person from the gentle boy she knew. When his drinking sprees made him abusive and violent, his sister and mother had to leave the apartment. He had been irregularly employed as an electrician, but he rarely saw any wages. Three years later, with tears welling in her eyes, she told us that a year earlier he’d been imprisoned for petty crimes. Tanya’s daughter in contrast—even though she too had found no permanent work-brought smiles on her face. The daughter was about to deliver a baby. Its father was a policeman with no desire to marry her. They hoped he would at least pay child support.

So how does Tanya get by? Her parents in the village nearby help with food (vegetables and sometimes meat). Her mother can sometimes offer her money since she runs a successful practice in homeopathic medicine. Tanya’s eldest sister also helps her with clothes, and in an emergency, with money. As a social worker she doesn’t earn much, but her husband had a lucrative job as a plumber in a meat processing plant until he had a heart attack and died the previous year, at 48. Tanya’s other sister, also older than her, used to work at Red October but is now employed at a kindergarten. She can’t help Tanya materially, but they have always shared their sorrows and delights.

Since the first interview, Tanya’s relationship with her mother-in-law during her first marriage had taken a new turn. As a grandmother to Tanya’s children, she had always helped in small ways. She was of German descent, and like so many of Komi’s ethnic Germans, she had reconnected with her kin. She was now living with her brother in Berlin but continued to visit Komi, as she was employed in German automobile export. She proposed that Tanya marry her other son, the younger brother of Tanya’s first husband and that together with her daughter they move to Berlin. Tanya smiles whimsically at the thought, concluding once more that her future is here in Syktyvkar, close to her own family.

Tanya is not working. Having inherited little from the past other than her sickness, she gets by on minimal support from the state and assistance from her close-knit family (parents, sisters, and mother-in-law). She is the center and beneficiary of a redistributive kinship network. Resignation mixes with the fantasy of escape, as she contemplates her future; but the security of family ties wins the day.

Natasha: The Two-Earner Household

When we first interviewed Natasha in 1995, both she and her husband were receiving unemployment compensation, at 75 percent of their wages. Today, unemployment compensation is set at the so-called minimum wage of 87 rubles a month, except for those who lose their jobs through liquidation or restructuring. Any job would pay better than that, so we were not surprised to learn at our second interview that Natasha had found herself new employment.

Natasha began her work career in 1970, at the age of 16, in what was then a small furniture shop and later became a modern factory of Polar. She worked there for 24 years. When wages became irregular and work stoppages more frequent in 1994, she quit her job. As a worker in the hazardous lacquer shop, she might have retired if she had stayed another four years; but instead, she opted for unemployment compensation for two months, and then found a temporary job as a painter, though her husband’s sister. When this job ended, she again was left unemployed. Her husband, 43 years old, had worked as a carpenter in a local construction company until pay became irregular, whereupon he too left his job for one in the municipality—thanks, again to his sister. Like his wife, he only lasted a few months before returning to the construction industry. Again, pay became so irregular that he left for unemployment, which together with his disability pension came to 500 rubles. At the time of the first interview, they were both on unemployment, bringing in less than 1,00 rubles for a family of four—themselves and their 11-year-old twin daughters. Their income, therefore, was on a par with the poorest of our respondents; but their living conditions, as we shall see, were much better.

Their elder son, age 23, was living in a room in a hostel with his wife and child. He worked as a chauffeur or an enterprise director, which meant that he could use the car for private purposes. Natasha’s daughter, age 21 used to work at Red October and was living with her family in a two-room apartment (inherited from her husband’s parents). Natasha would like to help her daughter, but she can’t even afford to feed, clothe, and buy school supplies for her two younger girls. The only plus in her circumstances is the modern, three-room apartment she received through the municipal queue for large families. They have a plot of land where they grow potatoes, but they have no dacha. They sometimes take the children to Natasha’s parents’ village, where Natasha grows some food, and where her 74-year-old mother helps by knitting clothes for them.

When we returned in July 1997, both husband and wife were employed: she, as a cook in a canteen, and he, with the Municipal Parks. She received a low wage of 350 rubles, with an occasional bonus of 100 or 150 rubles. His wage was much higher, at 800 rubles, but he rarely saw more than 200 rubles, with some of the difference being made up in food. Natasha said they were much better off on unemployment, but when that ran out, they had to find jobs. They were desperately short of cash to pay for their children’s needs.

We interviewed Natasha again in May 1999 and discovered that they were still in the same jobs. She was earning wages and bonuses of between 600 and 800 rubles a month as well as subsidized meals. He was still receiving between 800 and 1,000 rubles, on paper. Wages were usually paid in kind (food and housing maintenance). But in summer there was work on the side, which could bring in 50 rubles a day, plus a meal. On top of this, her husband was receiving a disability pension of 300 rubles a month. They were still having difficulty making ends meet, and Natasha was making plans for her teenage daughters to go to a technical college, where they would learn catering.

In comparison with the three interviewees, Natasha had inherited more from the old regime. She had an extensive network of kin in town and country as well as a modern, three-room apartment. At the time of the second interview, Natasha’s son was trying to exchange the three-room apartment for a two-room apartment for his parents and a separate, single-room apartment for his family. He hoped to then combine this with his hostel room in order to obtain a two-room apartment. But the plan came to naught. Even a seemingly nonfungible asset such as an apartment can be traded in, and the proceeds distributed among family members. Although she appears to be better off than Marina, Tanya, and Sveta, Natasha and her husband struggle daily to meet their family’s basic needs.

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