Constant Russian per capita GDP in 2010 US dollars (Blue curve) and its percent change from a year earlier (red curve).
Image Credit: St. Louis Federal Reserve District Bank/FRED
Data courtesy of the World Bank

Russia is in deep economic trouble. Just how much trouble and what it portends is a matter of heated and extensive controversy. Yet, since both the economic and political stability of Russia is at stake, and since Russia presents a grave military threat to NATO and the United States, it is an important subject to think about.

Russia’s Economic Problems

There are two major sources of Russia’s serious economic problems. The first and more serious is the crony-capitalist nature of the Russian economy. As I almost always do when I use the term “crony capitalism”, I must mention that crony capitalism is not capitalism at all, but rather the exact opposite of capitalism. In fact it is a variety of socialism called fascism. Through his crony-capitalist buddies, many of whom are ex-KGB officers like Vladimir Putin himself, Putin is able to control the direction of the economy. Yet, if the Kremlin is controlling the allocation of capital, rather than Adam Smith’s Invisible Hand, they will push capital in directions that are not helpful for many if not most of the economic agents (those who supply or buy goods) in the economy, upsetting the balance of many supply-demand relationships. The Invisible Hand is a metaphor for how the law of supply and demand acting together with the law of marginal utility regulates what and how much of every good is produced, and simultaneously determines the market price for each good. The way in which they operate guarantees maximal economic efficiency with the least waste of capital in the form of either shortages or surpluses. I have discussed how only the operation of the Invisible Hand can guarantee this happy result in several different ways. A more classical explanation is provided in the post Why Socialism Does Not Work; in terms of its analogue in biological evolution in Adam Smith’s “Invisible Hand” and Evolution; in terms of homeostatic feedback in Feedback Loops and Economic System States and in Economic System States, Feed back Loops, and Adam Smith’s Invisible Hand; and finally in terms of mathematical chaos theory in the posts Central Planning for Chaotic Social Systems and Chaotic Economies and Adam Smiths’s Invisible Hand.

The second major source for Russia’s economic problems is more situational in nature. The situation has been created by the collapse of the price of oil and other commodities in the international markets, while Russia’s exports are mostly oil and other petroleum products, and a few other commodities such as iron and steel, aluminum, and copper. The exports of these commodities provided almost half of the government’s fiscal revenue, and now that oil prices and those of other commodities have crashed, both the Russian government and people are in a world of hurt.

You can see this in the plot of Russian per capita GDP and its growth rate in the plot above, which shows that per capita GDP declined approximately 4% last year. In fact Russia has been in a deep and painful recession for the last eighteen months. It is actually useful to look at GDP and its growth rate over all the time since the fall of the Soviet Union in 1991, which is shown below.

As you can see, the Russian GDP per capita fell continuously from before the fall of the Soviet Union until 1999 when it began positive growth at 6.4%, The red arrow marks when Putin succeeded Boris Yeltsin in power in 2000. Growth was then fairly constant at an average of 6.9% until it began to fall in 2008, due to the fall of demand from their overseas customers. Like economies all over the world, Russia was experiencing the pain of the Great Recession of 2008-2009. In 2009 there was a one year dip into negative territory at -7.8%. However, after recovering positive growth the next year, the Russian per capita GDP fell continuously until finally the economy has been in recession for the last 18 months.

Since what is plotted above is per capita GDP, I should mention that any decline is not due to a stagnant economy with a rapidly rising population, as in so many third world countries. Indeed, as shown below, the Russian population began to fall soon after the dissolution of the Soviet Union and did not stop its fall until 2009, when the population stabilized and began very slow growth.

One myth circulating among many, apparently especially among the Russians themselves, is that Russia’s economic problems under Yeltsin were due to malevolent westerners (e.g. the western advisors Jeffery Sachs,  Anders Åslund, and David Lipton) persuading naive Russians (i.e. Yeltsin) to adopt neoliberal economic policies encouraging free-markets. Yet the record above shows the Russian economy was already in free-fall under the old Soviet Union. As with any other lumbering vessel, the Russian ship-of-state could not turn around on a dime. What the record also shows is that Yeltsin began to turn the economy around in the early 1990s to finally achieve positive growth just before Putin took over.

Privatization of State Industries Under Yeltsin

One big mistake Yeltsin did make was the manner in which state companies were privatized, i.e. put into private ownership, to transition from socialism to free-markets. Yeltsin’s goal was certainly praiseworthy enough, since what he aimed to do was to evenly distribute the ownership of state-owned companies to every Russian adult citizen. However, the end result turned out to be very different.

In October 1992, the State Committee for Property Management added up what they thought was the current value of all state-owned companies, and divided the sum by the Russian population number to come up with a per capita share for each Russian citizen of 10,000 rubles. Vouchers for this amount were then distributed to every citizen with the limitation that they could only be used to bid for and buy common stock in companies at various state privatization auctions. In this first phase of privatization some 70% of Russia’s large and medium sized companies were put in private ownership and about 90% of small businesses were privatized.

In a second phase from 1994 to 1997, most of the remaining state enterprises, which included some of the larger, higher valued companies, were sold in direct cash sales. In this way the government completed the shift of state enterprises to private ownership and simultaneously earned some cash.

In what followed most companies came under the control of existing managers and ex-Communist party insiders, as they bought up the shares of their less wealthy countrymen in the first phase, and were more capable of purchasing enterprises in the second phase. Those who finally ended up in control, with their old statist instincts, were those who became known as the Russian oligarchs, and were the seeds for future crony capitalism.

In yet a third phase of privatization from 1998 onward, the Russian government dropped restrictions on foreign investment. Yet, this has failed to move the balance of economic power away from the  oligarchs.

The Problems of Crony Capitalism Under Putin

The problem with the Russian oligarchs is not that they own a great deal, but rather they continue to act as if they were still Communist Party apparatchiks. They do not look for success primarily in supplying a free-market, but instead look for government favoritism to make their sales easy. As we know in our own country, a government can make the way easy for favored companies through tax breaks, regulatory relief (or the opposite for their competitors!), or through the granting of government contracts.

Any such heavy-handed government favoritism has the effect of directing capital allocation towards the favored company and away from where many other people and companies would like to see capital allocated. Since demand for those other things people would like, but receive insufficient or no capital allocation, is not satisfied, the true needs of the economy are not served. If some of those unallocated needs are for intermediate goods needed for producing other goods, then those other goods will not be produced, creating other shortages in the economy. In such a case, a company that can not make as much as they could sell would have to layoff workers to lower costs, creating other economic dislocations. Meanwhile the favored company may produce much more than the private market can absorb, causing an expensive surplus, causing them also to lower production and layoff workers until the surplus inventory is sold off. Unless, of course, government is the only customer, in which case the cost to the rest of the country is the opportunity cost of not having their more desired needs met. Such are the evils of any type of socialism.

And we have seen a great deal of all this in Putin’s Russia. Vladimir Putin and company control the economy through economic favors and threats. As a former KGB lieutenant colonel, Putin just can not break past bad habits. Any businessman who does not cooperate with the Russian political leaders can find themselves bankrupt, in prison, or worse, as the examples of Mikhail Khodorkovsky, Yana Yakovleva, Sergei Magnitsky,  and Vladimir Yevtushenko attest.

Considering all these various facts, one has to wonder just how much social unrest there might be and how stable the current Russian regime might be. I would not get excited thinking the current fascist government in Moscow is ripe for overthrow. After all, although the former communist regime that began with the overthrow of the Tsar in 1917 was ultimately doomed to failure because of the unworkability of its economic policies, it did last three-quarters of a century until its demise in 1991. Authoritarian regimes are remarkably durable. Nevertheless, Russians have seared within them the living memory of the death throes of the Soviet Union. Looking around themselves, they might perceive their current situation is not that different from what they experienced in 1990. If this ever occurs, Putin and company had better watch out!

I will explore some of these thoughts in my next post.

Views: 2,874

GO TO HOME

Sharing is caring!