The right thing would have been to switch temporarily from printing money to borrowing, thereby immediately slowing inflation and creating a window of opportunity to reform government spending and the tax system. Things got under way well enough in 1995, with annual inflation falling below 100 percent for the first time since reform began. But as the months went by, no progress was made on the budget. Military reform stalled. Tax reform stalled. The federal bureaucracy not only failed to shrink but, incredibly, grew to the point where the government of Russia alone employed more bureaucrats than the whole Soviet Union had in 1990. The deficit remained stuck at over 7 percent of GDP.
Borrowing became an addiction. As the market for government securities neared saturation, interest rates soared and debt service became the largest item in the budget. As ever more securities were sold to pay interest on the old ones, an unsustainable debt pyramid accumulated, just waiting for a shock to send it toppling.
Meanwhile, other opportunities for reform were being lost, one of which was the chance to build a sound banking system. In the early days of reform, banking looked like a sector that might lead Russia to a market economy. As soon they were permitted, hundreds of new, private banks sprouted up. It did not take long, however, for the new banks to discover that taking deposits from savers and making loans to businesses was not the quickest way to get rich. A much more lucrative strategy was to attract central bank credits at interest rates well below the rate of inflation, invest the proceeds in hard-currency assets, and pay off the credits later in devalued rubles.
When inflation slowed, that particular banking scam stopped working, but another one took its place. By 1996, Russian government bonds were paying interest rates of up to 100 percent per year, double or triple the inflation rate. Banks became the largest buyers of Russian government debt, still financing some of their purchases with cheap government credits but increasingly also borrowing dollars and German marks on international financial markets.
Such schemes made the banks so rich and powerful that the seven most influential bankers came to be described as "oligarchs," widely perceived to have dominant influence over the Russian government. Unfortunately, along the way, the banks failed to develop into true financial intermediaries. Instead of being used for loans to businesses, all available funds were sucked into the black hole of the government debt market.
The private sector, already hampered by lawlessness and high taxes, was further choked by the high cost of working capital. A large segment of Russian industry was driven out of the monetary economy altogether, into what has been called the "virtual economy"--a system that operates by the use of barter and monetary substitutes. The lack of transparency of barter deals makes it easier for firms in the virtual economy to evade taxes, something with which one can sympathize, given how high capriciously enforced taxes are.
Still, massive tax evasion caused the government's debt pyramid to grow faster than ever. Meanwhile, the same kind of shadowy barter deals that managers used to cheat the tax authorities also helped them cheat their own shareholders and workers.
Democracy without Social Justice
The economy that Russia inherited from the Soviet Union was so hypermilitarized and ridden with structural distortions that reform could never have gone smoothly. Mistakes were bound to be made, as they were in such success stories of post-communist transition as Poland, the Czech Republic, or the Baltic states. But mistakes can be corrected and their consequences endured so long as democracy and social justice provide essential popular support for reform--so long as people feel that burdens are equitably shared and that they have a stake in the future.
Russia has acquired the forms of democracy. Elections are held in which opposition candidates are usually allowed to compete, and votes (with only occasional exceptions) are counted accurately. The country has a constitution, although one that is not always observed (except for the clauses that give lopsided power to the president). And it has a parliament, which the executive branch has only once blasted out of its headquarters with tanks. But post-communist Russia has not achieved social justice.
To be sure, not everyone agrees on what social justice is. There is the classical liberal model that emphasizes freedom of economic opportunity and the right of people to enjoy the fruits of their own labor. There is the social democratic model, which seeks social justice through redistributive taxes and transfers. And there is the model found in several Asian economies in which government help for the poor relies not on transfer payments but on investment in human capital through health care, education, and building rural infrastructure.
This is not the place to argue the relative merits of these models. It is enough to note that examples can be found of countries and periods in which each has worked well enough to produce supportive democratic majorities for predominantly, if not purely, market-oriented economies.
The Soviet Union had its own model of social justice. In return for acquiescing to the political dominance of the Communist Party, people received a low but guaranteed minimum basket of housing, education, and health care plus a poorly paid but secure job and an early retirement. Although by no means egalitarian, the system did to some degree keep the privileges and pleasures of the powerful out of view of the masses. Soviet leaders never dared to subject the model to the test of free elections, but they were largely successful in keeping social peace.
The tragedy of post-communist Russia is that it jettisoned the Soviet model of social justice without adopting any of those common among successful market economies. The demise of social justice came about in three great waves of confiscation.
The first was the hyperinflation of 1992-1993. Under the Soviet system, people were allowed to save, but not to invest. By the time they retired, many people did manage to save significant amounts, but the only saving vehicles were currency or accounts at the state savings bank. Part of the Soviet social contract was that prices would be kept stable, so that when those savings were spent to supplement meager pensions, the money would have the same purchasing power as when it had been set aside.
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