Free-Market Medicine in Russia Has the patient recovered? Reforming the economy of the old Soviet Union was never going to be easy. To replace central planning with free markets and enterprise would involve a radical transformation of economic life. But following the rise to power of Boris Yeltsin in Russia in 1991, this is just what was attempted. The following policies were adopted in early 1992: ? Price controls on 90 per cent of items were abolished. But with shortages of most goods, it was hardly surprising that prices rose dramatically. ? Business was given easier access to foreign exchange and foreign companies were encouraged to invest in Russia. ? The largest privatisation programme in the world was launched. In many of the new private companies, workers were to become the principal shareholders. These reforms represented a massive shock to the old system. With the virtual abandonment of price controls, prices soared and by the end of 1992 inflation had reached a massive 1527 per cent. These huge price increases led to falling demand, but the disruption to the economy also led to falling supply. In 1992 output fell by nearly 20 per cent and the purchasing power of wages fell by 40 per cent. The government’s budget deficit (the excess of government spending over government tax receipts) rose from 1.5 per cent of national income in the first quarter of 1992 to 15 per cent by the final quarter. Perhaps most significantly, the money supply rose nearly 600 per cent between January and October. Many commentators began to wonder whether the economy could escape the slide into ‘hyperinflation’ when money would become virtually worthless. Critics argued that the costs of reform were intolerably high. The Russian economy, inherently weak and resistant to change, was unprepared for the radical nature of the policy and the reform programme could not be sustained. They highlighted the following weaknesses inherited from the old system: ? Many Russian companies are virtual monopoly producers. If they run into trouble, as many have done, this leads to huge shortages throughout the economy. 2 ? Industry, being used to taking orders from above, has been slow to adapt to economic change and the rigours of the marketplace. Much of it is highly inefficient and wasteful, making a poor use of very scarce resources. Estimates suggest that in the early 1990s Russia used 15 times as much steel and 6 times as much energy as the USA per unit of national output. ? With the freeing of prices, many firms in a monopoly position simply raised prices and reduced output. That way they could increase profits but with less effort. Supporters of reform recognised these weaknesses, but maintained that they only strengthened the arguments for changing the old system. In addition, they argued that the reform package of 1991/92 did not go far enough. Price controls on certain goods remained. Price mark-ups in state shops were limited to 25 per cent, oil prices were controlled and imports were subject to a 20 per cent tariff (customs duty). Some supporters of reform argued that an economic slump was the necessary medicine required to drive the old sickness out of the system. It would force inefficient producers out of the market, and the competition for survival would lead to greater productivity and ultimately to long-term prosperity. For a while in the mid-1990s it appeared that the reforms were succeeding in bringing about an economic recovery. By early 1998, annual inflation had fallen to 10 per cent, thanks largely to the government successfully capping its spending. The rouble, after a disastrous collapse on the foreign exchange market in 1994, seemed to have stabilised. Output, having fallen every year since 1992 (and by as much as 13 per cent in 1994), was at last beginning to rise. ?15 ?10 ?5 0 5 10 1990 1995 2000 2005 2010 2015 2020 Annual percentage increase in real GDP Notes: Figures from 2020 based on forecasts Source: Based on data in World Economic Outlook (IMF, April 2020) Figure 1 Russian economic growth But then disaster hit. In August 1998 there was a financial crisis. Amid massive speculation, the Russian stock market crashed, capital poured from the country as international investors pulled out, and the value of the rouble plummeted on the foreign exchange market, falling from around 20 US cents to under 4 cents. 3 But far from collapsing into chaos, the Russian economy then began to recover and after a fall in national output of over 5 per cent in 1998, it grew by 6.4 per cent in 1999 and 10.0 per cent in 2000. Unemployment, which had reached 13.3 per cent in 1998 was beginning to fall and inflation, which had shot up to 85 per cent in 1999, was down to 21 per cent by 2000. From 2000 to 2008, the economy continued to grow strongly, with real economic growth averaging over 7 per cent between 2000 and 2007. Both inflation and unemployment were on a downward trend. By 2007 inflation had fallen to 9.0 per cent and recorded unemployment had fallen to 6.2 per cent. However, the global financial crisis of 2008/9 led to a fall in the rate of economic growth and Russia struggled to regain the growth rates of the first part of the twenty-first century. In 2009, the economy contacted by 7.8 per cent and unemployment rose to 8.2 per cent. Despite this, growth for 2010–12 averaged 4.4 per cent, considerably more than most developed countries. However, with a fall in oil prices, growth slowed in 2013 and then, with the crisis in Ukraine and the imposition of sanctions on Russia by western countries, growth slowed further. This was compounded by a further dramatic fall in oil prices, which between June 2014 and January 2015 had fallen from around $114 to $50 per barrel. Economic growth was a mere 0.5 per cent in 2014 and then plummeted to –2.8 per cent in 2015 (see Figure 1). It then recovered somewhat to –0.2 in 2016 and then to 1.5 in 2017 and 1.7 in 2018. However, the economy then moved into recession in 2020 as the coronavirus epidemic took hold. Macroeconomic data for Russia are available the IMF’s World Economic Outlook. Critics of reform, even in the light of the gains up to 2014 and mild recovery since, still point to the hardship experienced by many Russians. In addition to the official unemployment of around 5.5 per cent, there is an estimated additional 5 per cent hidden unemployment. About 13 per cent of Russians (some 19 million people) live below subsistence level, compared with just over 20 per cent in 1997. It is worth noting that the official poverty figures for Russia have fluctuated very sharply over the past decade. 0 2 4 6 8 10 12 14 1990 1995 2000 2005 2010 2015 2020 Unemployment (% of workforce) Notes: Figures from 2020 based on forecasts Source: Based on data in World Economic Outlook (IMF, April 2020) Figure 2 Russian unemployment 4 Some, the ‘New Russians’, have become very wealthy – some legitimately, but some through criminal activities (the rise of the Russian Mafia has been a disturbing development). The rise of the wealthy further serves to highlight the growing divide between rich and poor. The old certainties have gone. No longer will the state guarantee employment and a moderate standard of living for all. Today’s market system in Russia is one where the strong gain and the weak lose. As we saw above, uncertainties worsened in 2014, as economic sanctions were imposed on Russia by Western countries in response to the Russian annexation of the Crimea and military intervention in eastern parts of Ukraine. The effect was a decline in Russian exports. The effects of sanctions were compounded by a dramatic fall in oil prices, which fell from around $110 per barrel in mid-2014 to under $30 per barrel in early 2016, before recovering somewhat to around $50 per barrel later in 2016 and to around $75 by 2018 (see Figure 3 below). Russia is a major exporter of crude oil, petroleum products, and natural gas, with revenue from these products accounting for some 65 per cent of Russia’s export earnings (depending on oil and other fuel prices). But, despite attempts by OPEC and Russia from 2016 to agree on restricting output to support oil prices, these agreements did not last. There was another major attempt in April 2020 to support oil prices in the context of falling demand brought about by the coronavirus pandemic, but this only had a relatively minor effect and oil prices were still driven largely by demand 0 20 40 60 80 100 120 140 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 $ per barrel Source: Europe Brent Spot Price FOB (Dollars per Barrel), (US Energy Information Administration) Figure 3 Brent Spot Crude Oil Prices ($ per barrel, daily) The fall in export earnings as a result of sanctions and falling oil prices led to a fall in the value of the rouble. In mid-2014, 100 roubles were worth around $3. By early 2016, this had fallen to just $1.30, although it appreciated a little thereafter and had risen to $1.74 by September 2017, only to fall again to $1.40 by August 2018 and, despite a subsequent small rally, to $1.33 by April 2020. The depreciation of the rouble pushed up prices of imports, which reduced living standards. If sanctions were to continue and oil prices to remain low, this would act as a significant brake on Russian economic growth.
question:
In a market economy would you expect higher prices to lead to lower or higher output and Would increased competition tend to reduce or increase inequality?