Yeltsin: “Painful, but Quick” Reforms?

Yeltsin called Gorbachev's ambiguity irrelevant and dangerous, and promised that real political and economic reforms would be made quickly. It was clear, he stated in the fall of 1991, that the country had to move toward a democratic state and a free-market economy. He had overwhelming public support for this at first. Ordinary people were tired of the long lines, absence of products, and waffling political statements of the Gorbachev period. The Communist political elite had largely prepared itself for the major property grab that would soon follow (see “Privatization and the Rise of the Oligarchs,” below). Foreign policy makers were eager to loan a lot of advice and a little money to the new, ostensibly no longer Communist, government. Yeltsin's chief economic advisors, largely recruited from abroad, were eager to extol the virtues of unrestrained capitalist production and consumption (Sachs & Lipton, 1993). Some of the same economic advisors who had helped transform the Polish economy just a few years earlier declared that the reforms in Russia would be “painful, but quick.” A common estimate was that after about 3 years of a downturn, the economy of Russia would rebound once the necessary restructuring, adjustment, and privatization were completed. Similar predictions were made for most of the other FSU republics.

This was not to be the case. No country has ever attempted such an ambitious and sweeping program of reforms in so little time as Yeltsin wanted to try. Poland's example was not a good analogy. Poland and other Eastern European countries were not at all as deeply socialized as the U.S.S.R. was, and of course they were much smaller. For example, Soviet-style collective farms were never implemented on a large scale in Poland, so most of the agricultural land there had already been in small private holdings during socialist times; privatization of those required only paper shuffling without much physical restructuring. Similarly, industry and retail in Poland were much more consumer-goods-oriented, because Poland's tanks, planes, missiles, power plant boilers, and so on were built for it in the U.S.S.R. So privatizing small factories and shops in Poland was an easier task (Dunn, 2004).

Another recent model of free-market transition is that in China. Market reforms there began in the late 1970s, but the Chinese planners were very cautious. They chose to make changes to the economic framework slowly, carefully, and gradually, without much concession to any democratization. In a way, the country had no glasnost, only perestroika: China remains politically dominated by the Communist Party to this day, with a drastically different economy (Lai, 2006). Russia went the opposite way—almost too much political freedom very quickly, and not enough state control, especially in the first few years of Yeltsin's reign. In hindsight, Chinese-style reforms might have been better for Russia; however, they were simply never an option, given the Soviet people's overwhelming desire for freedom. A very important difference between Russia and China was the attitude of the rulers. The first priority that members of the nomenklatura in Russia set for themselves as early as 1991 was to get rich as quickly as possible in a privatization grab, regardless of the cost to society at large. Waiting years while gradually changing laws sounded foolish to them.

On October 28, 1991, Yeltsin outlined his proposed reforms to the Russian Congress of People's Deputies. On November 6, symbolically on the eve of the anniversary of the Great October Revolution—he appointed the economist Yegor Gaidar as the prime minister (later the deputy prime minister in charge of economic reforms). Gaidar was a grandson of a famous revolutionary writer, and he got the very best education the Soviet system could provide. He liked the works of classic contemporary American and European economists. In fact, he was a good example of a new generation of the Soviet elite: modern, civilized, and Western, with a keen perception of the complexity of the world's real economy, and quite unfettered by communist dogma.

The two main ideas presented in Yeltsin's reform proposal were these:

  • To liberalize prices, so that each vendor could set whatever price the market could bear.
  • To start privatization by allowing pieces of state property to be auctioned off.

On January 2, 1992, the prices in all state stores were allowed to float. Within a few weeks, the shelves were full of goods, including even some items that had been largely absent from the old Soviet stores; however, prices were shockingly high. In most regions, there were monopolist suppliers. Competition could not appear overnight. In the absence of competition and with chronic underproduction, not enough goods were available, so prices went through the roof as dictated by the market. In the first few weeks of 1992, prices doubled, then tripled, and then quadrupled. By the end of the year, the inflation was approaching 1,000%—something the Soviet people had previously only read about in novels about Weimar, Germany, in the 1920s. Riots did not break out, because a handful of staples continued to be provided at subsidized prices via coupons, and also because many people were able to grow some of their food themselves.

Despite the abrupt release of prices, the second step was slow in coming. Privatization required more preparation. According to the plans drafted by the Ministry of Privatization under the reformer Anatoly Chubais, every citizen of Russia, young and old, was to receive a voucher with a face value of 10,000 rubles. These rubles then could be invested in some state property, either directly at an auction or through an investment fund. However, when the vouchers became available in the spring of 1992, no auctions had yet been set up; thus their value rapidly plummeted. A few enterprising individuals started collecting them, hoping to invest them later, when the auctions would eventually begin. The going rate of
one voucher rapidly went down from the price roughly comparable to that of a new Soviet-built car to the price of a pair of shoes, or even two bottles of vodka. Lots of people simply cashed the vouchers in by selling them to unscrupulous sharks on street corners. A few people managed to hold off until the autumn, by which time a handful of auctions did open.

Chubais, the man in charge of privatization in Gaidar's government, has traditionally been made a scapegoat for the failure of the voucherbased privatization effort (Brady, 1999; Freeland, 2000). Effectively, the charge goes, he deliberately waited an unacceptably long time to begin the auctions, until most people had lost faith in the vouchers. The truth is more complex than that. On the one hand, every single auction had to be planned months in advance. Only some enterprises were attractive enough to be auctioned off quickly. The directors had to be coached, the trade unions persuaded, the prospective buyers found. On the other hand, there was a lot of opposition among the Congress of People's Deputies— and among the Communist-era directors, regional governors, and workers themselves—to the very idea of simply giving away pieces of state property to some unknown figures with vouchers in hand. The possibilities that organized crime or foreign capitalists might take over were particularly feared. The most important (and probably deliberate) failure of Chubais, Gaidar, and Yeltsin was that only a tiny proportion of the total Soviet state assets got auctioned off at all. The idea of a fair distribution of wealth implied by the vouchers consequently went out the window. By September 1992, only a handful of marginal factories had been auctioned off. Correspondingly, few people were able to obtain a piece of the state pie.

The majority of state enterprises were eventually privatized in 1994–1996 through a few very different schemes. One of the main alternatives to voucher-based privatization was the simple reorganization of an enterprise into a stock venture (corporation) or limited-liability partnership. The former Soviet director typically retained a controlling packet of stock, and workers were given a number of shares as well to appease them. This suited most directors just fine, because they wanted to make sure that they would not be deprived of property in the new Russia. To the workers, it also seemed like a better deal; at least they had some shares and knew the director well. Some of the best and most profitable enterprises, such as the Norilsk nickel smelter and many key oil fields and refineries, were turned over to private owners later, in 1996, in a very different loan-for-shares scheme (described below). Yet another scheme was employed by the Moscow city government under Mayor Yuri Luzhkov and in some regions: The regional elite would simply convert real estate, construction companies, or municipal organizations into private or semiprivate ventures, sometimes with very little federal or public involvement, to be directly controlled by shadowy offshore structures ultimately accountable to the governors themselves. This would be a bit like Governor Arnold Schwarzenegger privatizing the Golden Gate Bridge in San Francisco and beginning to collect tolls not for the California state treasury, but for his private venture registered in the Bahamas.

Chubais went on record as saying that he hoped to have a quick privatization, not a fair one. In other words, his main goal was to create a class of owners very rapidly, without ever hoping to please everyone. Ideally, this would lead to competition among the newly created private ventures to produce more and better goods. It required over 10 years for this to become a reality in Russia, and even longer in some other FSU republics. A few natural monopolies were not privatized at all, including the railroad system; the postal service; the military; the unified energy system; the Russian Academy of Sciences; parts of the state telecommunications industry; the oil pipeline monopoly; and most hospitals, universities, and schools. Others, such as the giant Gazprom monopoly, the strategically important TV Channel One, and Sberbank (the largest consumer savings bank in the country), were only partially privatized (i.e., the federal government retained over 50% of stock).

Rosefielde (2007) argues that the privatization process in Russia was inefficient and unfair—an exercise in murky politics rather than economics. Aslund (2007) takes a more positive view of the process, explaining that few other options were realistically available and that the results were quick and impressive. By early 2000, over 80% of the Russian economy was in private hands.