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The Transition of Russia to Capitalism Report


Russia, in an attempt to end communism and adopt capitalism, engaged herself in a number of reforms after the collapse of the Union of Soviet Socialist Republics (USSR or the Soviet Union). Beginning late 1980s, the new nation started massive economic reforms aimed at relieving the state ownership of the process of production and encouraging private and corporate ownership of the process.

Backed by the west, the International Monetary Fund and the World Bank, the Russian government, under Boris Yeltsin and his group of young advisors, started the Neo-Liberalism, a transition period that would see the country undergo massive privatization, liberalization and stabilization (Kosals, 2006).

Nevertheless, Russia’s economy faced serious problems and failed to achieve the capitalism dream as planned, instead it faced rapid decline, increased corruption and reduction in vital state gains (Kosals, 2006).

Scholars have identified a number of issues that faced the transition of the Russian economy to capitalism, causing the decline. Scholars state that Russia failed to achieve a dynamic capitalist economy and instead, it achieved a malevolent form of capitalism known as “crony capitalism” or “mafia capitalism” (Abdelal, 2001).

The cause of the problem is based on the process of expropriation of the state assets initially controlled by the state during the Soviet Union era. A small group of people, probably less than 100, appropriated the state assets during the transition period.

They were individuals with strong connection with powerful state officials and integrated into criminal groups or clans. They developed notorious oligarchs with an aim of making money through banking and trade (Guriev & Rachinsky, 2005).

To achieve this, they took the advantage of the poor legal framework developed during the transition period, which allowed them to siphon off enormous profits from the state assets and transfer them to offshore accounts (Guriev & Rachinsky, 2005).

The economic advisors and policy makers behind the transition to capitalism failed to note the need for strong and effective legal frameworks for ensuring a smooth and directed transfer of state assets to private ownership (Abdelal, 2001).

Russia failed to have in place effective anti-corruption laws, institutions and the will to deal with the oligarchs. It seems that both the western advisors and Yeltsin’s group of young advisors overlooked the important impact of developing a legal framework to regulate and monitor the transition (Abdelal, 2001).

In turn, the oligarchs obtained huge profits through appropriation, especially by deriving gains the state fuel and metal industries on the world markets. The primary problem was that the oligarchs made almost no investment in the country, leaving the country in a poor state of investment, even in the gas, oil and metallurgical industries that were supporting the economy (Abdelal, 2001).

As a result, fuel and mineral production declined and the existing reserves increasing became depleted (Exhibit 1). Poor investment meant that exploitation of new ventures and reserves derailed (Kosals, 2006).

Thirdly, the Yeltsin advisors overlooked the need for investing in the infrastructure, communication, transport and agriculture. Instead, much of the investments were in small industries such as services, catering and trade (Exhibit 2). The new capitalist enterprises were often small and unincorporated private companies that were unable to make large profits or pay high wage levels (Exhibit 3).

The neoliberalism used in the transition period has also been cited as one of the major factors that caused the decline of the economy and failure to achieve a functional capitalism economy. In particular, the Russian government and policy makers applied neo-liberal shock therapy, where there was all shock and no therapy.

In particular, price liberalization destroyed Russia’s working capital for its enterprises (Abdelal, 2001). The country also embarked on the liberalization of the administration-command system by dismantling it, but this only deprived investment finance while restrictive financial policies increased the cost of credit and over-valuation of the exchange rate.

Cheap imports were excessive in the Russian market because of the freeing of international trade, while lack of legal regulation of privatization allowed criminals to expropriate the valuable state assets (Abdelal, 2001).

Who is to blame for Russia’s failed transition?

In fact, a number of forces are to blame for the problems facing Russia’s transition to capitalism and the detrimental consequences on the economy and social system.

First, Russia’s history is partly to blame, considering the complexity of the communist system between 1917 and 1989, where the Soviet Union controlled and owned the process of production (Abdelal, 2001). State corporations had been the key to economic development, which achieved its peak during the mid-20th century.

In addition, the previous regimes (before the collapse of the USSR) concentrated more on military expenditure, especially during the cold war. The military consumed huge percentages of the nation’s budget, with the state of Russia being the major financier of the budget.

The country was deprived of capital for investment as well as social development because the military and foreign affairs were more important to the cold war USSR than other sectors of the economy. Thus, it was necessary to ensure that these forces were controlled and dismantled before privatization.

An in-depth analysis of the situation in Russia during the transition may indicate that the Yeltsin government is to blame for its lack of vision and ability to tackle the social and historical problems before embarking on rapid transition process.

For instance, the regime failed to implement and institute effective legal frameworks for controlling and regulating the process of privatization (Abdelal, 2001). Had the country embarked on the effective legal system, the oligarchs would have lacked the opportunity to embezzle the country’s finances.

Yeltsin’s advisors, especially the group of young economists and political scientists hired by the presidency to oversee the transition process, failed to note the need for a slow but effective transfer of the economy from state control to private ownership (Abdelal, 2001). They believed in a rapid and haste transition, probably aiming to copy the west, without noting the negative impacts of rapid loss of state control of the transition process.

In fact, critics of neo-liberalism have shown the differences between Russia and other formerly socialist/communist nations like China, Uzbekistan and Vietnam. These states embarked on a slow but effective process governed by law and retaining state strong state control of the market system during their transition periods.

In addition, countries such as China used restrictive laws to preside over a dynamic transition based on a dynamic growth based on investments in infrastructure, manufacturing, education, health, mining, technology and processing industries (Exhibit 4). Thus, Russia’s inability to take such steps failed the transition process, eventually destroying the once vibrant economy.

Moreover, Yeltsin’s lack of involvement of all the state organs such as the legislature and the continued allocation of huge sums of money to the military after the collapse of the Soviet Union contributed to the failures in the economic transition process.

For example, Yeltsin’s government sought to structure the government while also undertaking the rapid transition system (Kosals, 2006). Politics inferred with the economic reforms during the period, especially after Yeltsin announced rapid reforms in the legislature, including a snap parliamentary election after dissolving the legislature.

There massive protests as most parliamentarians objected the move and refused to leave the parliament buildings, but Yeltsin used the military to remove them. After these events, the political will to oversee a smooth and effective transition failed greatly because the presidency was not willing to involve the legislature, which made it difficult to enact and implement effective laws to reduce the impact of the oligarchs (Kosals, 2006).

The government further failed to impose hard budget constraints on several traditional enterprises while also failing to provide both direct and indirect credits as well as subsidies to the companies facing collapse.

Years after the collapse of the communist union, the state bodies, especially at the local and regional levels, have continued to place bureaucratic limitations permitting such issues as private land ownership and agreements for shared resource exploitation (Kosals, 2006).

Moreover, the government is yet to show significance commitment to encourage the establishment of the rule of law in order to secure property rights, trade contracts and reduce the degree of corruption.

What should be done?

To reverse the effects of the shock therapy and the failed transition, Russia should embark on a new system governed by the rule of law.

First, it must enact and implement strong and effective anti-corruption laws in order to secure the economy from distractors such as economic cartels that own the production process. Such laws should be used to control the private ownership of corporations and control of major economic sectors.

Secondly, laws should be put in place to ensure investment in importance economic sectors such as banking, oil, metallurgic, communication, transport mining and processing industry. Infrastructure development must be given priority in the national budget in order to encourage large-scale investments while also cutting the amounts of resources spent on military expenditure (Kosals, 2006).

In addition, the government must reduce the reliance on traditional enterprises and encourage foreign direct investment while also reducing the entry of cheap products from foreign markets in order to save the local industries from excessive losses. Bailing out of the loss-making corporations should further be enhanced in order to prevent economic crisis.

Appendix

Figure 1: Key economic indicators in the transition-era Russia

Key economic indicators in the transition-era Russia

Figure 2: The collapsing rate of investment during the transition period

The collapsing rate of investment during the transition period

Figure 3: The increasing rate of unemployment during the transition era

 The increasing rate of unemployment during the transition era

Figure 4: Russia’s GDP trend during the transition

Russia’s GDP trend during the transition

References

Abdelal, R. E. (2001). Russia: The end of a time of troubles? Harvard, MA: Harvard Business School.

Burawoy, M. (2002). Transition without transformation: Russia’s involutionary road to capitalism. Locating Capitalism in Time and Space: Global Restructurings, Politics and Identity, 269-90.

Guriev, S., & Rachinsky, A. (2005). The role of oligarchs in Russian capitalism. The Journal of Economic Perspectives, 19(1), 131-150.

Kosals, L. (2006). Interim outcome of the Russian transition: clan capitalism. Kyoto Institute of Economic Research Working Paper, 610.

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