The first concerns a small business in a provincial city. In 1992, Ekaterina Likhoda, a young woman from Nizhny Taigil, received help in setting up a small shop from the British Institute of Chartered Accountants. Six years later she wrote to The Times of London to tell what had come of this well-intentioned effort at people-to-people assistance.
First her shop was bombed when she refused an offer of protection from a local gang. After getting no help from the police, she decided a private protection service was a good idea after all and hired a so-called "sports club" to do the job. When she asked the club to help her resolve a legitimate business dispute, involving the failure of a partner to pay for a consignment, she received no satisfaction, so she rashly hired a competing gang to get rid of the sports club. After this led to a shoot-out, she was beaten nearly to death as punishment for stirring up bad blood between the two organizations. Finally the sports club decided she was too much trouble and, despite a long-term lease, threw her out of the shop in favor of another tenant. In the process she lost everything she owned. She is now unemployed and desperate.
The second example, recently chronicled in Moscow Times, shows that even such corporate heavyweights as the oil company Surgutneftegaz are not immune to trouble. In addition to its Siberian production properties, Surgutneftegaz had what it thought to be a controlling stake in Nefto-Kombi, a chain of more than 100 filling stations in St. Petersburg. Sensing that a far-off owner could be outmaneuvered, Nefto-Kombi held a shareholder meeting at which it diluted the parent corporation's control to 11 percent and struck its representatives from the board of directors.
For two years Surgutneftegaz fought the action in St. Petersburg courts, but the courts were friendly to the subsidiary and dragged the suit out on technicalities. Perhaps this had something to do with a deal under which city officials receive cut-rate prices when they fill up at Nefto-Kombi pumps. After two years of battling, Surgutneftegaz simply walked away from the dispute, cutting its losses.
Circumstances like these sever the essential link between private property and prosperity. Efforts to pursue voluntary exchanges and investment opportunities that move resources from lower- to higher-valued uses have no payoff. At the same time, there are abundant opportunities to enrich one's self at the expense of others, destroying value in the process. Ownership becomes irrelevant; all that matters is having the ability and the nerve to grab someone else's property as it floats by.
Each day's news brings new examples. Suppose you manage a coal mine--why not sell the coal below cost to a friendly intermediary and pocket a generous kickback? Suppose you run a construction company--why use your revenues to pay wages when you can divert them to your Cyprus bank account? Suppose your business is refining aluminum--why pay market rates for your electricity when you can use your political connections to get it below cost?
Superficially it looks like a market economy: Goods change hands, assembly lines lurch along, freight moves down the rails, but most people get poorer and poorer while only a few grow rich. The mutuality of gains from trade, which not only fuels but justifies the creation of wealth in a true market economy, simply disappears.
Stabilization without Financial Reform
After secure property rights, many people would list sound money in second place on a list of conditions for a prosperous market economy. By early 1998, sound money seemed to have arrived. Inflation dropped below 10 percent a year and Russia launched a new ruble, shorn of three hyperinflationary zeros and confined to a narrow exchange rate corridor at about six rubles to the dollar. Western leaders were quick to herald these achievements and the monetary austerity that produced them. Why is it, then, that "monetarism," as restrictive monetary policy is called in Russia, has become a term of abuse?
The answer is that monetary policy was not supported by structural reforms of the state budget or the banking system. Consequently, instead of lasting stability, disinflation only created the conditions for the financial crash of 1998. It is worth looking at just how this came about.
The recent monetary history of Russia begins in the late perestroika period, when the central bank printed vast quantities of money to finance an out-of-control budget, while the government used strict price controls to limit inflation. By the end of 1991, when the Soviet Union fell apart, there were about five times as many rubles in circulation as were needed to finance national income at the low, state-mandated prices. This gave rise to the long lines and empty stores that symbolized the period.
The first major act of economic reform, on January 2, 1992, was to decontrol prices. Given the huge excess money supply, the price level leaped upward, rising by 245 percent in January alone. If no new money had been created, inflation would soon have run out of steam. But when inefficient state industries began screaming that they didn't have enough cash to stay in operation, the reformers lost their nerve. A pro-inflation chairman, Viktor Gerashchenko, was installed as head of the Central Bank of Russia, and an unavoidable one-time jump in the price level turned into sustained hyperinflation.
Gerashchenko stayed in charge of the central bank until October 1994, during which period the annual rate of money growth never dipped below 200 percent. But by early 1995, under the new leadership of Sergei Dubinin, the central bank began to apply orthodox monetarist methods. Inflation steadily slowed.
All this would have been fine had it been accompanied by other policies to reform the state budget and the banking system. Unfortunately, no such reforms took place.
When the disinflation effort began, government expenditures at all levels accounted for more than 40 percent of GDP, a higher figure than in the United States or Japan, and very high indeed for a country of Russia's low income level. Tax revenues were over a third of GDP, also high by international standards, but not high enough to prevent a budget deficit of more than 7 percent of GDP. Under Gerashchenko, the central bank had been willing to print enough money to cover the gap, but if headway was to be made against inflation, something else had to be done. There were three options: Cut spending, increase taxes, or borrow.
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