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Economies in Transition: Shock Therapy in the Russian Federation

The inherent weaknesses of communism in the Soviet Union, China, and elsewhere were evident by the final quarter of the twentieth century. These economies quaked under the pressure of sluggish economic growth, stifling bureaucracies, low productivity, and a host of other economic problems. In addition, the people's standard of living in the communist nations continued to lag further behind that of the Western capitalist countries. In response, most communist countries sought a new path to economic prosperity, one that emphasized certain free market principles rather than Marxist doctrine. National strategies to achieve a transition toward free market economies differed, however. The Russian Federation adopted shock therapy in the early 1990s to jump-start its transition to capitalism.

The dissolution of the Soviet Union in December 1991 signaled the collapse of communism in central and eastern Europe and central Asia. It also signaled the beginning of an epic transition in the region as 28 countries sought to institute market reforms into their economic systems, and democratic principles into their political systems. Collectively, these 28 countries were called the transition economies, or transition countries. Twelve of the 15 former Soviet republics, now independent countries, also joined together into a loose confederation called the Commonwealth of Independent States (CIS) to ease the transition.

Since the early 1990s Russia's shock therapy approach to economic transition has generated mixed results. In the realm of economic reform, shock therapy relied on the implementation of aggressive government policies to rid the country of communist-era baggage and to institute new practices based on market principles. These reforms began under the leadership of Boris Yeltsin, who served as president from 1992 to 1999. Later reforms were instituted by Vladimir Putin, who served as Russia's president from 2000 to 2008, prime minister from to 2008 to 2012, and president again from 2012 to the present. The four cornerstones of Russia's shock therapy were mass privatization, limited government, competitive markets, and global connections.

Mass privatization transferred many state-owned properties such as farms, factories, mines, and retail stores to the private sector. Privatization occurred through the distribution of ownership vouchers, the sale of stocks, public auctions, and other means. Privatization was most successful in small and medium-sized enterprises (SMEs), mainly in light industries, services, construction, and retail trade. More problematic was privatization of large state-owned enterprises (SOEs) and the collective farms, each stuck in the mire of outdated capital, mismanagement, and endless subsidies that rewarded inefficiency. During the early 2000s reversals occurred as some privatized industries, such as the airlines and arms industries, came under the government's control. Unresolved was what to do with thousands of large, inefficient SOEs that dotted the Russian landscape.

Limited government removed many government restrictions on private sector business activity. Gosplan, the state planning agency, was disbanded. Reforms targeted the building of a legal framework to guide and protect private property rights, profits, and business activity—including policies to ensure compliance with contracts, clarify bankruptcy codes, adopt standardized accounting procedures, deregulate industries, reduce licensing restrictions on businesses, and reduce business subsidies. In the early 2000s a new land code permitted private ownership of land in the cities, while a new labor code expanded firms' freedom to hire and fire workers.

Competitive markets required individuals and firms to recognize and respond to the invisible signals of the price system. To reduce distorted prices in the economy, reforms eliminated most government controls on prices in the early 1990s. The predictable shortterm result was hyperinflation, as the inflation rate soared to nearly 2000 percent in 1992 and 900 percent in 1993.[1] As the economy adjusted to market-determined prices, inflationary pressures eased, and in 2012 consumer prices rose by just 6.5 percent.[2] Russia also deregulated and liberalized business activity, and privatized thousands of small and medium-sized firms to promote competition.

Efforts to rejoin the global economy, the final cornerstone in Russia's transition, have progressed since the early 1990s. During the late 1990s and 2000s, government stabilization policies and market-oriented reforms made Russia's business climate more hospitable for international trade and long-term foreign direct investment (FDI). As a result, Russia recorded consistent trade surpluses during the 2000s. In 2011 its trade surplus in goods and services hit $163 billion, a surplus that was built largely on oil exports.[3] In addition, Russia attracted an average of $53 billion per year in FDI from 2007 to 2011, more than 10 times the FDI it attracted during the unsteady early years of its transition.[4] Another achievement was Russia's admission into the World Trade Organization (WTO) in 2012. Membership in the WTO required Russia to significantly reduce import quotas and tariffs and liberalize foreign investment regulations in key areas such as banking, insurance, telecommunications, transportation, and retail and wholesale trade.[5]

  • [1] International Monetary Fund (IMF), “Table 13: Countries in Transition; Consumer Prices,” World Economic Outlook, May 2000 (Washington, DC: IMF Publications, 2000), 215.
  • [2] IMF, “Table A7: Emerging Market and Developing Countries; Consumer Prices,” World Economic Outlook: April 2013 (Washington, DC: IMF Publication Services, 2013), 158.
  • [3] World Trade Organization (WTO), “Table 1.7: Leading Exporters and Importers of World Merchandise Trade, 2011,” and “Table 1.9: Leading Exporters and Importers in World Trade in Commercial Services, 2011,” International Trade Statistics, 2012, 26, 28
  • [4] United Nations Conference on Trade and Development (UNCTAD), “Annex Table 1.1: FDI Flows, by Region and Economy, 2006–2011,”World Investment Report 2012 (New York: UNCTAD, 2012), 172; World Bank, “What Can Transition Economies Learn from the First Ten Years? A New World Bank Report,” Transition Newsletter 13, no. 1 (January–February 2002): 14
  • [5] WTO, “Working Party Seals the Deal on Russia’s Membership Negotiations,” WTO: 2011 News Items, November 10, 2011; WTO, “Ministerial Conference Approves Russia’s WTO Membership,” WTO: 2011 News Items, December 16, 2011
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