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What Russia Must Do to Recover from Its Economic Crisis

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What Russia Must Do to Recover from Its Economic Crisis No. 1296 June 18, 1999 WHAT RUSSIA MUST DO TO RECOVER FROM ITS ECONOMIC CRISIS ARIEL COHEN, PH.D. When President Bill Clinton meets Russian Primakov cabinet, which was dominated by President Boris Yeltsin on June 20 at the summit of Soviet-era stalwarts who tried to implement poli- the world’s seven leading industrialized countries cies favoring rust-belt − (the G 7) in Cologne, Germany, the discussion industries and the state Produced by likely will focus on the current economic crisis in sector. Unless the new The Kathryn Russia. The reforms attempted by Moscow economic team undertakes and Shelby Cullom Davis between 1992 and 1998 were poorly planned and a significant new reform International Studies Center executed, and riddled with corruption. They were plan, however, it is doubt- unable to stop Russia’s economic decline. A recent ful that these officials will Published by agreement with the International Monetary Fund be any more able to pull The Heritage Foundation (IMF) for $4.5 billion in new credits is not likely Russia out of its economic 214 Massachusetts Ave., N.E. to reverse this trend. What Russia must do to morass than their predeces- Washington, D.C. recover from its economic implosion is to put in sors were. 20002–4999 (202) 546-4400 place a new economic team with leaders who http://www.heritage.org understand the principles and policies of market Russia is suffering from economics and will undertake a new round of the effects of an unprece- comprehensive reforms. dented ten-year slump. Unfortunately, the war in Kosovo and a pro- According to Moscow’s tracted political crisis in Moscow have distracted Institute of Economy Russia’s power elite from attending to the deterio- in Transition, the 1999 rating economy. The communist-dominated Duma inflation rate may reach 50 tried but was unable to impeach President Yeltsin, percent. Unemployment is who then fired Prime Minister Evgeny Primakov approaching 18 percent. In the six months (thought by many to be Yeltsin’s successor) and between July 1998 and January 1999, the installed a relatively centrist government under consumer price index rose over 90 percent and new Prime Minister Sergei Stepashin, a senior average monthly wages dropped from $177 to security official. The new economic team under $57. Domestic and foreign investment dropped Stepashin should be an improvement over the to 20 percent of 1990 levels. Overall, Russia’s No. 1296 June 18, 1999 economic prospects appear to be worse than they short-term treasury bills (GKOs) and short-term were 100 years ago, when the market-based econ- bonds (OFZs) held by foreigners. omy was growing at 5 percent to 7 percent a year. To reverse Russia’s economic free-fall, the new This systemic economic crisis is the result of Russian government under Stepashin must under- many distinct problems: take a comprehensive program of reforms as quickly as possible. Specifically, it should: 1. An obsolete industrial base that manufactures non-competitive goods—a byproduct of the •RReduce crime and corruption; economy that formed around the gigantic •SStrengthen the rule of law by reforming the Soviet-era military-industrial complex; judicial system; 2. A barter-based domestic economy, subsidized •SSecure current and future foreign loans with by the state through artificially cheap raw collateral, such as oil fields and gold mines; materials and energy; •IImprove debt management and concentrate it 3. A large budget deficit, which accrued as the within a high-level government agency; result of the punitive and poorly administered tax system; •RReform the tax system; 4. Sharply declining oil and commodity prices in •EEliminate the barter system in non-competi- 1997 and 1998, which caused foreign cur- tive goods and services, and abolish the use of rency revenues to decline; barter to pay local and federal tax arrears; 5. The devaluation of the ruble in August 1998; •SStop the disruption of interstate commerce by regional governors; 6. A shrinking federal budget; and •PPass a land code to encourage the develop- 7. An inability to service foreign debt, a decline in ment of construction, private farming, and domestic and foreign investment, and capital agribusiness; and flight since 1987 amounting to more than •CConsider the benefits of a currency board. $150 billion. President Clinton will soon have an opportunity Clearly, misdirected economic policies and to convey to President Yeltsin the importance adverse market conditions have combined to cre- America places on Russia’s economic recovery. ate the most prolonged economic depression in Jump starting the economy, facilitating entrepre- Russian history. Instead of working to resolve neurship, and attracting domestic and foreign these problems, however, the Russian government investment, however, will require a new economic chose to deal with the crisis by replacing market reform package that goes beyond the failed quasi- reforms with foreign borrowing. Today, Russia socialist policies of the former Primakov cabinet. owes more than $150 billion to the West, includ- Moscow needs modern market institutions to ing over $90 billion from its Soviet-era debt to develop quickly, but this effort will not succeed Western governments (the “Paris Club”), and $51 unless the rule of law is firmly in place. billion of post-1992 Russian Federation debt. This “new” debt involves $19 billion to the IMF; $18 —Ariel Cohen, Ph.D., is Senior Policy Analyst in billion to Western commercial banks (the “London Russian and Eurasian Studies in the Kathryn and Club”), Eurobonds, and bilateral foreign govern- Shelby Cullom Davis International Studies Center at ment loans; and $14 billion in ruble-denominated The Heritage Foundation. No. 1296 June 18, 1999 WHAT RUSSIA MUST DO TO RECOVER FROM ITS ECONOMIC CRISIS ARIEL COHEN, PH.D.1 When President Bill Clinton meets Russian leaders who have experience with markets and President Boris Yeltsin on June 20 at the summit of solid plans to restructure the economy. the world’s industrialized countries (the G−7) in Cologne, Germany, the current economic crisis in The war in Kosovo and a Produced by Russia should occupy much of their discussion. protracted political crisis in The Kathryn The economic reforms attempted under Yeltsin Moscow have distracted and Shelby Cullom Davis between 1992 and 1998 were poorly planned, the attention of Russia’s International Studies Center ineptly executed, and plagued with corruption. power elite from attending They did little to stop the decline. The foundations to the serious economic Published by of a real free-market economy, with complex mar- situation. The communist- The Heritage Foundation ket institutions and the rule of law, failed to take dominated Duma tried but 214 Massachusetts Ave., N.E. root. failed to impeach President Washington, D.C. 20002–4999 The result is a situation that undermines the Boris Yeltsin. Former Prime (202) 546-4400 faith of ordinary Russians in free market systems Minister Evgeny Prima- http://www.heritage.org and participatory government and discourages for- kov—thought by many eign investment.2 Russia is defaulting on loans observers to be Yeltsin’s from foreign creditors, and a recent agreement successor—was fired, and a with the International Monetary Fund (IMF) for relatively centrist govern- $4.5 billion in new credits will not reverse its ment was installed under a problems. What Russia needs is new economic 1. The author thanks Gerald O’Driscoll, Senior Fellow in Economic Policy at The Heritage Foundation, and Roger W. Robin- son, William Casey Chair at the Center for Security Policy, for their comments on this paper, and Heritage interns Isabelle Congras and Vasili Gurchumelidze for their research assistance. 2. “Russia Economy: Investor Survey; Attitudes to the Market,” ISI Emerging Markets, from Economist Intelligence Unit, April 23, 1999, at http://www.securities.com/sgi-bin. Note that 60 percent of Western companies operating in Russia put new investment plans on hold and 30 percent have cancelled investments. No. 1296 June 18, 1999 new Prime Minister, Sergei Stepashin, a former reforms as quickly as possible. Such a program senior security official. should include: This political instability makes policy consensus •RReducing crime and corruption; on basic principles of post-communist reform •RReforming the judicial system to strengthen difficult. Yeltsin appointed Nikolay Aksenenko, a the rule of law; former national railway executive and close family friend, as First Deputy Prime Minister with wide •SSecuring foreign loans with natural resources economic powers instead of nominating a strong as collateral; reform economist. New Prime Minister Stepashin •CConcentrating debt management in a high- backed the nomination of Victor Khristenko, a level government agency; politically weak bureaucrat, as another First Dep- uty Prime Minister. These appointments should be •RReforming the tax system; an improvement over the individuals in Primakov’s •EEliminating the use of the barter system rather cabinet, but appointing new people by itself will than cash in non-competitive goods and ser- not solve Russia’s problems. Without a strong pro- vices and payment of tax arrears; reform team with experience in the market, it is doubtful that Stepashin and his team will be able •SStopping the disruption of interstate com- to pull Russia out of its economic morass. merce by regional governors; •PPassing a land code to encourage the develop- Russia’s economy is in an unprecedented ten- ment of construction, private farming, and year slump. Foreign debt stands at about $150 agribusiness; and billion, and Russia has little chance of meeting its repayment schedules. Moscow has defaulted on •CConsidering the possible benefits of a much of its foreign obligations. Domestic and for- currency board. eign investments stand at 20 percent of their 1990 These steps would help the new government to rates. Estimates of capital flight since 1987 run jump-start the economy, facilitate entrepreneur- between $150 billion and $300 billion.3 ship, and attract domestic and foreign investment.
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