A Normal Country

Andrei Shleifer and Daniel Treisman

From Foreign Affairs, March/April 2004

Summary:  Conventional wisdom in the West says that post-Cold War Russia has been a disastrous failure. The facts say otherwise. Aspects of Russia's performance over the last decade may have been disappointing, but the notion that the country has gone through an economic cataclysm and political relapse is wrong--more a comment on overblown expectations than on Russia's actual experience. Compared to other countries at a similar level of economic and political development, Russia looks more the norm than the exception.

Andrei Shleifer is Whipple V.N. Jones Professor of Economics at Harvard University. Daniel Treisman is Associate Professor of Political Science at the University of California, Los Angeles. For full references and data sources see http://papers.nber.org/papers/w10057.

Comparing Russia and Ukraine is particularly instructive. Ukraine had a large population (about 52 million in 1991), an industrial economy, significant natural resources, and a political culture similar to Russia's prior to transition. Unlike Russia, it retained the old communist leadership, albeit renamed, and pursued more cautious reforms, keeping a much larger share of the economy in state hands. Yet its official GDP per capita dropped 45 percent between 1991 and 2001 -- almost twice as much as Russia's.

From this comparative perspective, Russia performed roughly as one might have expected. The best estimate is that Russia's genuine output decline between 1990 and 2001 was small and that it was completely reversed by 2003, following two additional years of rapid growth. Considering the distorted demand, inflated accounting, and uselessness of much of the pre-reform output, it is likely that Russians today are on average better off than they were in 1990.

KRONY KAPITALISM?

The 1990s were a decade of extreme macroeconomic turbulence in Russia. Between December 1991 and December 2001, the Russian ruble's value dropped by more than 99 percent against the U.S. dollar. In 1998, three years after the authorities managed to stabilize inflation, a speculative crisis broke through the central bank's defenses, forcing the government to devalue the currency. Many people concluded that Russia's attempts at economic reform had failed.

Yet Russia's crash was not an isolated phenomenon: it came in the middle of a wave of similar currency crises around the world. As bad as the 99 percent drop in the ruble's value sounds, International Monetary Fund figures show that 11 other countries -- including Belarus, Brazil, Turkey, and Ukraine -- suffered even larger currency declines during the 1990s. Moreover, although the ruble's value fell by a massive 61 percent in just two months during 1998, similar or larger two-month currency collapses occurred 34 times in 20 other countries from January 1992 to December 2001. The consequences of Russia's devaluation were also less dire than was claimed at the time. In fact, the move was followed by a sustained growth spurt and a reinvigorated drive toward liberal economic reform.

The manner in which economic reforms were carried out in Russia is also said to have exacerbated economic inequality. Privatization is often portrayed as the primary culprit. The European Bank for Reconstruction and Development (EBRD), for example, blamed the loans for shares scheme for generating "sharp increases in wealth and income inequality" in the mid-1990s. Inequality has certainly increased markedly in Russia since the fall of communism. According to Russia's official statistics, the Gini coefficient for money income -- a measure of inequality within a country ranging from zero (which indicates perfect equality) to one (which implies absolute inequality) -- rose from 0.26 in 1991 to 0.41 in 1994, before stabilizing at about 0.40.

However, privatization cannot have caused the rise in inequality, for one simple reason: the rise in inequality came first. Russia's Gini coefficient rose most sharply between 1991 and 1993 and peaked in 1994, before any effects of privatization -- such as restructuring or rising dividend income -- could have materialized. Nor was unemployment responsible. In 1992 and 1993, unemployment remained below 6 percent. It grew higher after 1994, peaking at 13.2 percent in 1998, but during this time inequality actually declined slightly.

According to Branko Milanovic, a development economist at the World Bank, 77 percent of Russia's inequality increase can be attributed not to privatization, unemployment, or rising business profits, but to growing disparities in wages. Although some Russians worked in successful firms that rapidly benefited from the free market and open trade, others remained in declining firms and in the state sector. As unfortunate as the growth of inequality in Russia has been, it is largely the result of the inevitable upheavals associated with rationalizing economic activity.

Russia's economic reforms are often said to have created a small class of oligarchs, who acquired valuable companies for extremely low prices in the loans for shares auctions and then stripped the companies of their assets. Asset-stripping is said to be responsible for depressed investment and poor economic growth.