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Economic Reforms: Steady as She Goes
Russia's transition to a market economy, now coming to the end of its tenth year, may have finally entered a period of stability and predictability. No longer the focus of front-page headlines in the international press, the economic policy agenda seems to be increasingly centered on structural and institutional reforms and the conventional issues facing policymakers everywhere: taxes, budgets, pensions, and trade. In policymaking circles, the spotlight is less on how to deal with the latest crisis and more on how to unleash the Russian economy's vast potential and how to combine its rich human and natural resource endowments to generate sustained prosperity.
Although this newly found confidence is welcome, the Russian transition is far from complete. Russian per capita incomes remain well below those of other transition economies in Central and Eastern Europe. Reflecting major deficiencies in governance, the last 10 years have been extremely costly in terms of human welfare. Reversing the deterioration of a broad range of social and demographic conditions will take a long time. A brighter future beckons, but success is not inevitable. The missteps of the 1990s can be repeated. President Vladimir Putin's administration will have to internalize the painful lessons of the 1990s if it is to achieve the goals it has set for itself: a more stable and prosperous Russia, increasingly engaged with the rest of the world. In particular, the government will have to broaden its policy [End Page 105] focus from macroeconomic stabilization to the formulation and implementation of structural and institutional reforms aimed at creating a more favorable environment for private-sector economic activity.
The Output Collapse
From 1991 to 1996, Russia suffered a cumulative output decline of more than 40 percent, one of the steepest in the region. During much of the 1990s, the economy was exposed to demand and supply shocks, the magnitude of which may have no precedent in recent economic history. On the demand side, the emergence of a new political climate for international relations in the late 1980s led to a major crisis in the military-industrial sector and a permanent drop in purchases of military hardware and other defense-related equipment. Given the magnitude of the former Soviet Union's industrial sector and the prominence of military production within it, this demand shock was proportionally far more severe in Russia than elsewhere in the industrial world. Arms exports by the Soviet Union fell from $20 billion in 1988 to less than $3 billion by 1992. The cumulative output drop in the military sector from 1991 to 1993 was about 60 percent. In 1992 alone, defense orders in the budget fell by 80 percent, contributing to a sharp contraction in investment and a major slump in the construction sector. The collapse of trading arrangements in the region, as other Eastern and Central European partners opened their borders to international trade utilizing world market prices, resulted in sharp drops in Soviet exports to traditional markets. Declining oil production further undermined output growth. The government also drastically cut consumer and producer subsidies, thus adversely affecting household demand.
Price liberalization in early 1992 resulted in significant supply shocks as well. The enterprise sector was gradually deprived of subsidized resources, foreign exchange at low exchange rates, and raw materials at a fraction of the world price. The easy access to credit on preferential terms was gradually phased out. The government began to tax the military-industrial complex, which during the Soviet era had largely been exempt from paying taxes as a way of enhancing its competitiveness. Disruptions to trade and financial relations among the former members of the Soviet Union, which were especially pronounced in the early part of the transition (1992-1993), also contributed to the contraction of output in Russia. The effective disabling of the institutional mechanisms supporting the central plan, without the concomitant emergence of free-market substitutes, compounded these negative factors.
The combination of these elements, culminating...