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Russias Transition From Neoliberalism To State Led Capitalism Economics Essay

Introduction

The phenomenon of capitalist globalisation which has unfolded during the past decades has brought about unprecedented advances for the Western world. Through competitive free market processes, capitalist globalisation has led to tremendous technological and economic progress, allowing human beings to enjoy various freedoms and opportunities. Capitalism is therefore taken to be the driving force behind socio-economic progress, and pivotal to globalisation.

In general, capitalism is a socio-economic system, in which the production of goods and services and their subsequent market exchange takes place. The productive assets are privately owned (either individually or jointly) and the resulting profit, which leads to wealth accumulation, is the main driving force behind economic life. Money is used as a medium of exchange, which determines the distribution pattern of the productive output, the levels of investment and the income differentials. The role of the state is to establish a legislative system which can guarantee private property rights of owners over the proceeds of their production. Furthermore, a capitalist structure may be developed in the context of either a strong or a weak state, and may be placed in either an actively participatory or subject political culture. The state may be a part of the integrated global economy, or alternatively remain embedded in a local economy (Lane, 2000).

The Cold War era dichotomized the debate on the supremacy of the capitalist system. Once the collapse of the countervailing Soviet Union and its communist regime was imminent, capitalism became the hegemonic socio-economic system. President Yeltsin and his administration were convinced that embracing the neoliberal ideology of the Washington Consensus [1] was the sole way towards the newly-formed Russian Federation’s economic development. This represented the beginning of a joint effort by the West and the new Russian government to globalise the Russian Federation along the lines of the neoliberal ideal (Stiglitz, 2002). This involved introducing an Anglo-American type capitalist structure by creating goods-, asset- and labour markets, minimising the role of the state and its intervention in the economy and opening the economy to international competition. Previously government-owned assets had to be rapidly privatised in order to form a self-motivated business class (Barnes, 2003; Lane, 2006). However, the introduction of these neoliberal reforms, and thereby the attempt to import an Anglo-American type capitalist structure into Russia, did not result in the intended wealth creation, democratisation and economic stabilisation. In fact, a decade of liberalisation left the country weakened, lawless and indebted, not at all comparable to a modern Western capitalist system (Stiglitz, 2002). It was only in the second decade of Russia’s transition, after the crisis in 1998 and the change of political power, that the economic situation in the country showed signs of improvement as a more favourable business environment finally developed (Letiche, 2007; Rosefielde, 2007; Sakwa, 2008).

This essay sets out to explore the differences between the two opposing decades of Russia’s transition from a socialist economy in terms of the state’s approach towards economic reform and policy. Placed in the context of globalisation, the impact of the country’s structural changes on both SMEs and big business is put into perspective. The initial attempt to import an Anglo-American capitalist structure did not deliver the expected results, resulting in the shift towards a state-led approach to capitalism. This has helped Russia establish itself as a more prominent actor within the process of capitalist globalisation and constitutes an important lesson for transition countries regarding their development process and journey towards capitalism.

Russia throughout the 90s – Shock therapy and its effect on Russian businesses

The socialist economy of the Soviet Union was organised and functioned in ways radically different to capitalist market societies. The state controlled and coordinated all sectors of the economy. A system of state ownership of all resources and industrial activities was implemented, which did not tolerate the existence of any autonomous economic units. The government had control over employment and wage rates, price levels and investment distribution (Rosefielde, 2007). It is obvious that a capitalist class did not exist in former Soviet states, and the building of such a class was a major task to be executed during Russia’s transition from communism.

The transformation of Russia, which started in the early 1990s, was a consciously coordinated process, evoked and carried out by both domestic and foreign political leaders, who attempted to import an Anglo-American capitalist structure into the country and pursue neoliberal economic policies. The strategy developed to ‘globalise’ Russia was known as ‘shock therapy’, as it signified a rapid and radical change from one economic system to another (Stiglitz, 2002). Its implementation began with the elimination of price controls over goods, aiming to rapidly create a market economy. This was to be achieved through price- and trade policy liberalisation, which on its part would stimulate competition; and through privatization, which would create private property as the only successful way of creating incentives for new entrepreneurs. Meanwhile, the convertibility of the ruble had to be ensured and its value had to be stabilised, implying inflation controls and tight fiscal policy (Molchanov, 2005). Such was the stabilisation/liberalisation/privatisation programme that was intended to transform Russia’s economic and business life. Overall, state activity was to be brought to a minimum, while a neo-liberal framework of free markets, perfect competition and minimal government intervention was to be introduced (Sachs, 1995).

However, the disappointing outcome of Russia’s transformation turned out to be a surprise for its optimistic reformers. By the mid-1990s it was already becoming obvious that the country needed less shock and more therapy. The instant price liberalisation led to sky-rocketing inflation figures, which quickly robbed people of their savings, necessitating tighter monetary policy by raising the interest rate (Stiglitz, 2002). Furthermore, as hyperinflation impoverished the population, the majority of the Russians could not benefit from the second major pillar of the reform – mass privatisation (Shleifer and Treisman, 2005). In fact, privatisation was a very important aspect of Russia’s restructuring, since it was to lay the foundations for a market economy and demand-led production. However, this is where complications arose. First of all, with the majority of the population being excluded from this process, most Russian enterprises were given away to few politically-connected magnates (so-called oligarchs) (Rutland, 2005a). Second, the opening of the capital markets, which was also part of the restructuring programme, allowed the oligarchs to transfer the majority of their assets to foreign bank accounts, since keeping their money in the country at that point meant making an incredibly risky investment in a country which is in deep depression (Stiglitz, 2002). Indeed, after almost a decade of reforms Russia was riddled with inflation, corruption and lawlessness and on the verge of a crisis. The government was becoming increasingly indebted to the international financial institutions (the IMF and the World Bank), nevertheless continuing to give away its valuable assets to oligarchs, who on their part were taking tremendous amounts of wealth out of the country (Shleifer and Treisman, 2005).

It becomes obvious from the above analysis that the two social groups that became the main actors in this transformation process (and were to lay the foundations of the previously non-existant capitalist class) were the until-then-dominant administrative stratum and the acquisition stratum. The former consisted of the current political leaders who possessed executive power over economic activities, while the latter was composed of skilled workers and potential entrepreneurs, who (while previously disadvantaged) had the potential to become the new capitalist class in charge of Russia’s big businesses (Lane, 2006). As a result of the policies employed during the first years of transition the administrative stratum was significantly weakened, while the acquisition stratum was both politically and economically empowered. Hence, the latter came to realise the potential for asset ownership and wealth creation, which can be identified as the first signs of class interest within the ‘new’ Russian society (Lane, 2006).

Moreover, the above process demonstrates the extent to which the acquisition stratum strived to emulate the Anglo-American consumption model. This suggests that the globalising tendencies of the neoliberal model became the major driving force behind Russia’s transition from state socialism. Therefore, the process of building a capitalist Russian society and a property-owning class was strictly overseen by the international political elites, the US government and the IFIs as intermediaries (Rosefielde, 2007). Notwithstanding the initial high expectations, what these foreign and local ambitions resulted in could be roughly described as ‘chaotic capitalism’, which bore very little resemblance to the ‘model’ Anglo-American capitalist structure (Lane, 2008). The new social and economic system that was developed in Russia during the first decade of transition lacked the support of a solid institutional structure, thus provoking social fragmentation.

As a consequence, large-scale private enterprise in the country was characterised by high degrees of uncertainty, elite disunity, criminalisation, corruption, and rent-seeking (Hoff and Stiglitz, 2004). Furthermore, few large corporations had assumed control over a considerable part of the economy, including natural resource industries, and even gained political power (Guriev and Rachinsky, 2005). Despite the tycoons’ rapid acquisition of political and economic power, they failed to win any support from the Russian society. In fact, their legitimacy was rather fragile, given their involvement in lawless practices, tax evasion and asset stripping (Hanson and Teague, 2005).

Meanwhile, the reforms after the fall of the Union lay the foundations of Russian small entrepreneurship, which did not exist as an economic activity during the communist regime. Therefore, the first few years after the start of the reforms are associated with a considerable rise in the number of small private businesses in the country. By 1995, small enterprises constituted 65% of all Russian businesses (Radaev, 2001). However, the political and economic environment in Russia at the time was extremely hostile to their further development. Not only were they neglected by policy makers (who were overly concentrated on macro-economic indicators), but the direct consequences of the ‘shock therapy’ policies created a particularly hostile environment for SMEs. High levels of income inequality, widespread corruption and the lack of rules and laws to eliminate the risk and uncertainty of the economic and financial environment resulted in rather high SME failure rates, further triggering their law-evasive behaviour and increasing involvement in the informal sector (Astrakhan and Chepurenko, 2003; Kihlgren, 2003).

Furthermore, since all the invested money had left Russia and people lost their savings due to inflation, it was particularly difficult for SMEs to gain access to necessary funding and to transferable business knowledge (Duflo and Senik-Leygonie, 1997). This left small businesses isolated from both the economic and political sphere and devoid of any bargaining power. By the end of 1999 there were around 890,000 small [2] enterprises in Russia. This number however has been stable throughout most of the decade, a proof for the rather limited development of SMEs at the time (Radaev, 2001). Furthermore, the share of SMEs in the total number of employment at the end of the 90s was barely 10%, while their share in the total number of enterprises was only 65%, compared to the staggering 90% on average for EU countries (Federal State Statistics Service, 2009). Hence, the pronounced underperformance of Russian small entrepreneurs resulted from the lack of state support and the tremendous economic and political pressures.

Overall, by the end of the 90s Russia had undergone tremendous economic reform in the form of full price liberalisation, mass privatisation and receding state intervention. A style of market capitalism was established which, despite the high hopes of both Russian and foreign reformers, substantially differed from the Anglo-American capitalist structures. Russia’s big businesses had ended up in the hands of the politically connected oligarchs who assumed ownership over major sectors of the Russian economy, and engaged in asset stripping, corruption and political interference. Furthermore, the development of small entrepreneurship was hampered by the unstable economic environment, while much-anticipated economic growth and development did not occur during the first decade of transition.

Russia in the new millennium – Signs of revival

However, after the ’98-crisis and the change of political power (Yeltsin was replaced by president Putin), Russia’s economic horizon has significantly improved in terms of real GDP per capita, business environment and standard of living (Estrin, Kolodko and Uvalic, 2007). There are two separate reasons for the positive turn in Russia’s economic development at the end of the century. First of all, the effective depreciation of the immensely overvalued ruble that took place at the end of 1998 can be identified as a very crucial precondition for macroeconomic stabilisation. This gave way to a period of recovery, lasting until the beginning of 2000, during which the country’s cost-price structure was brought in line with internationally competitive conditions (Letiche, 2007). Moreover, during this initial recovery phase and following the currency devaluation, output was mainly generated through import substitution. There was a tremendous reduction in the amount of imports, accompanied by an increased volume of exports, including non-energy exports. Therefore, by the end of 1999 Russia’s balance of trade had soared and brought about an equally rapid increase in retained earnings and profits. This in turn caused a considerable increase in investment, both in the industrial and the agricultural sectors (Letiche, 2007).

The second reason behind Russia’s economic revival is the rapid increase in energy prices, which occurred at the beginning of 2000. The combined functioning of these two factors – the depreciation of the ruble and the rising energy prices, in the setting of an overall enabling environment provided by the new political administration allowed for a rapid improvement in the economic conditions in the country throughout the second decade of Russia’s transition. This is reflected in the country’s GDP growth rate – it has shown a steady increase from 5.3% since the end of 1998, to 6.3% in 1999 and the impressive 10.0% in 2000, finally stabilising at an average of about 6.5% during 2000-2005 (compared to a negative GDP growth rate all throughout the 90s) (Letiche, 2007).

Apart from Russia’s improving economic climate, the political and macroeconomic reforms introduced by Putin’s presidency at the end of 1999 have deeper implications for the development of the small as well as the large enterprises in the country. It is only after the second half of 2000 that Russian SMEs became the object of special policy measures and consequently assumed a more prominent and important role in the economy (Rutland, 2005a). The number of SMEs in the country increased rapidly and by 2004 amounted to over 8900 thousand, which represented 94% of all enterprises in the country. Furthermore, the share of SMEs in total employment had also reached the considerably higher level of 49%, also approaching European levels (Federal State Statistics Service, 2009). While during the 90s the development of small entrepreneurship was weak and highly obstructed by the political dominance of the oligarchs, significant changes can be observed under the new administration. A number of reforms, specifically aimed at SMEs were introduced to help small-scale Russian entrepreneurship gradually take shape. One of the first areas targeted by president Putin was the ease of setting up a business. New laws were introduced aimed at reducing the bureaucratic difficulties small firms face during the processes of registration, licensing and inspection, thus reducing the set-up waiting time. However, the most important and radical step taken by the new administration was reforming the tax system, introducing significant changes and reductions to the benefit of small companies (Rutland, 2005a).

On the other end of the spectrum, the large oligarch-controlled enterprises such as Gazprom, Lukoil, Severstal, etc., which previously made little sense as business units, have also undergone a massive transformation. A series of reforms introduced by the new administration paved their way to becoming functional firms, able to operate competitively in an economic environment. First of all, the currency devaluation following the 1998 crisis and the overall economic stabilisation brought about a new confidence among the business circles about the ability of the domestic output to increase. Moreover, this constituted a signal that conducting a business at home is now a more profitable alternative to asset stripping (Sakwa, 2008). In addition, the greater political stability and the stronger leadership of president Putin contributed to the positive transformation of Russian businesses (Maury and Liljeblom, 2009), even if it was only the message sent by the reforms programme that had the growth-stimulating effect, rather than the actual results of the reforms. Furthermore, the most significant reforms which Putin set out to introduce almost immediately were to significantly improve the rule of law, establish a stronger system of tax control (Desai et al., 2007) and change the relationship between the state and the oligarchs (Glaeser et al., 2003). During a meeting between the president and the oligarchs the new rules of the game were laid out, namely that the business tycoons were allowed to keep their (sometimes illegally) acquired businesses as long as they ran them competitively and did not interfere in state politics. This resulted in the reinforcement of the state’s power vis-a-vis the oligarchy and other institutions (Thompson, 2004; Maury and Liljeblom, 2009).

Historically, the only legitimacy of capitalism as a socio-economic structure in which the wealthiest population decile (the ‘elite’) can appropriate an excessive amount of national income [3] is that they are able to develop the productive capacity of the economy by investing back into the system and introducing important dynamics (Palma, 2008). During the 90s, Russian oligarchs did not represent a dynamic capitalist elite, and were in fact rather greedy and unwilling to invest back in the economy (their asset stripping tendencies are a well-documented fact). What Putin achieved through face-to-face meetings was to challenge the oligarchs to deliver and force them to earn their legitimacy, by exiling the oligarchs out of the political realm and confining them to the economic. In order to remain an oligarchy they had to invest back in the economy and deliver growth, productivity and technological transformation. This is a crucial departure from Russia’s economic system in the 90s, and it was achieved by the direct intervention of Putin and his administration. Such an intervention strongly resembles an authoritarian approach of the state towards resolving economic issues, thus going against the legacy of the Washington consensus and the neoliberal ideal. However, instead of destroying the oligarchic class, the above reforms in fact succeeded at radically transforming Russian big businesses. Not only has it increased the number of the oligarchs and their respective wealth, but it has also placed the Russian economy on a positive growth path. Moreover, the nature of the game differs radically from the previous decade, with a stronger and better enforced rule of law [4] (Desai, et al., 2007; Sakwa, 2008).

State-led capitalism

From the above analysis it becomes clear that by liberalising the economy, president Yeltsin managed to lay the foundations of what resembled a capitalist class, allowing the Russian oligarchs to accumulate their wealth. However, the form of capitalism created during the 90s was chaotic and lacked an enforced institutional framework. Furthermore, the crucial forces of market competition which were necessary to discipline the new tycoons into running legitimate industries beneficial for the country’s economy were also absent. By the end of the decade it was already clear that this situation was highly inefficient and unstable. What was observed after the change of political power in 1999 was that president Putin pushed Russia in a rather different direction towards capitalism – namely, through a strong form of state-led capitalism (Lane, 2008).

In the context of post-Soviet transition, a state-led capitalist structure implies that Russia’s economy operates on the basis of cooperation between the state, the market and competitive and cooperative economic institutions, similar to Western economies. However, the role of the market remains limited, while the state assumes a regulative role and creates the necessary institutions. Furthermore, in a state-led capitalist structure ownership is allocated to both government-run and private businesses, which operate in cooperation with financial institutions (Kohli, 2004; Lane, 2000). Kohli (2004) describes cohesive-capitalist states, which create important linkages with society’s major economic groups in pursuit of economic growth. Examples of such government structures in other developing countries include Korea under Park Chung Hee and Brazil during Estado Novo. The justification behind the adoption of such a structure (instead of importing an Anglo-American capitalist model) is that it better fits local Russian economic and political conditions, hence proves to be more stable and sustainable in the medium run. Moreover, this ‘tailored’ structure can better guarantee economic accumulation (in terms of GDP growth and factor accumulation), since the cooperation between state and business allows rents earned from various industries to be better channelled by the state (Lane, 2000).

The positive changes observed on Russia’s economic horizon (as described above) have occurred after president Putin assumed power and introduced policies quite different from what Yeltsin’s administration had envisaged. Once the puzzle of reforms is put together, it presents the new face that capitalism has assumed in Russia. The state still maintains a substantial degree of ownership in most sectors of the economy and remains powerful when it comes to its influence on private enterprise. Nevertheless, it also actively creates and stimulates employment, enforces the rule of law and ensures that comprehensive welfare is achieved and maintained. In fact, under president Putin the country has had a functioning form of capitalism for the first time since the fall of the Soviet Union, which meets all the above features of state-led capitalism (Lane, 2008). Moreover, the analysis suggests that this consolidation of state power and the resulting political stabilisation have exerted a positive impact on the overall business conditions in the country. The introduction of a new state-led capitalism, tailored to fit local country conditions, has been followed by an increase in overall business confidence, thus benefitting both the SMEs and large enterprises in Russia (Hanson, 2004; Rutland, 2005b; Sakwa, 2008).

However, the response that Russia’s new capitalist structure has generated throughout the West has generally been negative. The success achieved in terms of transforming big businesses, ensuring tax collection, and wealth accumulations are often presented as ‘despite’ Putin’s authoritarian ambitions (Shlapentokh, 2009). Moreover, Putin’s administration is often accused of its departure from democracy and its alleged infringement of the principles of ‘good governance’ (for example in Letiche, 2007). However, such ideological accusations are unsurprising, since they are mirrored by Putin’s departure from the core ideas of the Washington Consensus. In fact, this exchange bears much resemblance to the rather sceptical Anglo-American response to China’s state-led development plans and gradualist approach to socio-economic reform.

Since the late 1970s China has pursued a very cautious and gradualist approach towards reform, resisting foreign pressures for rapid change. However, a large body of western scientists, heavily embodied in the spirit of the Washington Consensus, expressed a profound pessimism towards this approach. During the 1990s, the Chinese communist party was deemed unable to lead the reforms, while the confidence in Russia and its adoption of neoliberalism was overwhelming. No western commentator could have then predicted the achievements of China, which are so obvious today. Thirty years of incredible success of Chinese policies in virtually every aspect of development have revealed that the most dynamic aspect of capitalist globalisation has occurred under the leadership of the Chinese communist party (Nolan, 1995).

And while the degree of state involvement observed currently in Russia is beyond the levels deemed acceptable in laissez-fair economies, this essay argues that, on the basis of the improvements discussed above, state reliance is a more sustainable direction towards Russia’s economic development. It represents a return towards a more prominent role of the state, hence a more cautious and guided approach to development (Lane, 2006). Thus, in this aspect Russia’s new direction strongly resembles China’s transformation based on gradualist and guided policies implemented since the 70s. Moreover, such a strong Russian state is necessary to provide a more solid basis for the operation of small entrepreneurs and is especially important to operationalise and strengthen the country’s large enterprises (Ottung, 2004).

Finally, the above analysis does not imply this particular type of state-led capitalism currently achieved in Russia is the end-form of capitalist structure that, once in operation, should therefore be maintained. This essay only argues that regardless of whether the country makes a transition towards a different, western-type capitalism in the future, the current structure is certainly a good step along the way. Furthermore, it is a better option of political and economic organisation, given the country’s history, local conditions and business characteristics. So far, the striking contrast between the country’s development during the first and the second decade of its transition has suggested that a system of state-led capitalism is certainly more beneficial for the SMEs as well as the big businesses.

Conclusion

The Washington Consensus forms the cornerstone of modern globalisation and it is along these neoliberal lines that the first attempt to globalise Russia after decades of state socialism were made. The adoption of Anglo-American neoliberalism meant that Russia had to rapidly destroy its current economic and political base and build capitalism through industrial and property re-organisation. However, this left the country lawless and indebted, not at all comparable to a modern capitalist system. It was only in the second decade of Russia’s transition – after the change of administrative power, that the economic situation started to show signs of improvement in terms of real GDP per capita and standard of living.

The radical difference between the first and second decade of transition is the state’s approach towards constructing a capitalist structure. Putin formed a stronger state, re-imposed regulation on the oligarchic elite and stimulated the market through import substitution and regulation (Ottung, 2004; Lane 2008). In other words, he constructed a state-led capitalist structure (resembling that of China and Korea), proving that the fatal mistake of the Washington Consensus was to separate economic and social policy while ignoring local societal conditions and institutions.

While the attempt to import Anglo-American capitalism had damaging consequences, Russia is currently on a more effective and suitable path towards economic development. Adopting a state-led capitalist system allows the government to exert influence over the private sector and develop the country’s industrial and business potential. In addition, Putin’s strategy has improved the country’s institutional framework, thus benefitting not only the big businesses but SMEs as well. The latter have enjoyed more policy protection and tax benefits, while the former have been transformed into legitimate businesses. Putin displayed a rather independent authority and worked towards distancing the business tycoons form the political power (Maury and Liljeblom, 2009).

By turning its back on this particular challenge of globalisation to import a blueprint capitalist structure that performed well and delivered elsewhere, but proved highly inefficient within the Russian post-communist setting, Russia in fact established itself as a more prominent actor within the process of globalisation. Being a developing country in a globalising world, Russia had a weak political, economic and social infrastructure (Lane, 2000), which pointed towards the need for assertive presidential power and a balanced combination of market forces and state coordination of the economy.

Furthermore, this should not necessarily be considered as the end form of capitalism that the country has achieved and should therefore maintain. Regardless of whether Russia makes a successful transition to an Anglo-American (or another Western type) capitalist model in the future, the current structure of state-led capitalism is certainly an appropriate direction towards the country’s development.

Finally, at the time when Russia’s transition path was first determined (in the 1990s) many authors suggested that importing Anglo-American capitalism was the right way forward towards development. Very few authors acknowledged the potential of alternative routes such as the Chinese state-guided policies and the ability of the communist party to introduce reforms (instead, popular views demanded that it should be overthrown). And while, the possibility for Russia to develop its own capitalist system tailored to country specificities remained ignored throughout the 90s, modern day Russia has become proof for the possibility to implement such a system which is functional. Unfortunately it also constitutes a proof that simply importing blueprint policy packages is bound to be problematic. This can be taken as a lesson for developing countries in their journey towards capitalism.

Word count: 4,861 words (including footnotes)

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