*A Second Go at a “Second Economic Revolution”?

Frontier Centre, Role of Government, Uncategorized, Worth A Look

On March 6, 1997, in the annual state-of-Russia address to the Federal Assembly, President Boris Yeltsin outlined a package of reforms that some Russian observers called a second economic revolution.

The label was not hyperbole. Following the first wave of price liberalization and privatization of 1992-1995, the package aimed at dismantling the Soviet welfare state, which had survived the velvet revolution of August 1991. More than a critical reduction in the budget-busting expenditures for the social sphere, this was an attempt to change the fundamental relationship between the Russian state and its citizens.

Fiercely resisted by the leftist majority in the Duma, hampered by Yeltsin’s ill health, checked by the economic slowdown in the wake of the “Asian flu” economic crisis at the end of 1997, and undermined by the mushrooming budget deficit, the reform momentum was buried in the financial collapse of August 1998. Exactly three years later, this past March economic advisers to President-elect Vladimir Putin revealed to the Russian press key planks of an economic strategy—The Strategy of Development for the Russian Federation to the Year 2010—with a thrust identical to the 1997 package’s. Adopted by the government on June 28, the package of reforms arrived at a time far more propitious—both politically and economically—than its 1997 forerunner did. Such timing is not likely to be repeated soon. If Russia fails to embark, at long last, on a second economic revolution in the coming months, the dream of rapid economic progress, as well as social and political stabilization, may not be attainable for years, perhaps decades.

The Soviet Welfare State

The Soviet welfare state, which continued virtually unchanged in post-Communist Russia, was ubiquitous, expensive, and utterly impoverished. The main reasons, in addition to waste, corruption, and incompetence, were the poverty and the backwardness of the Soviet economy outside the bloated military-industrial complex.

In 1989, the last year before the economic crisis became uncontrollable, the official poverty level was set at 75 rubles ($5) per person per month; 43 million citizens (or 17 percent of the population) had lower incomes.1 Every third pensioner in the city and eight of ten in the countryside received less than 60 rubles (or $4) a month.2 A single mother was entitled to 10 rubles per child.

According to the Soviet minister of health, Yevgeny Chazov, in 1988 1.2 million hospital beds (or 35 percent of the total) had no access to hot water; every sixth hospital bed was located in facilities without any running water; and 30 percent of all Soviet hospitals did not have indoor toilets. In 1988 the Soviet Union had a rate of infant mortality higher than forty-nine nations, including Barbados and the United Arab Emirates.3

One hundred million Soviet citizens (a third of the country’s population) had less living space than prescribed by the miniscule Soviet “sanitary norm” of 9 square meters per person.4 In 1990 only 51 percent of Russian living space was supplied with hot water, 66 percent had running water at all, and 64 percent had central heating.5 Half of Soviet schools had no central heating, running water, or indoor toilets.6

Along with what might be called open (or social) welfare expenditures, the Soviet state incurred astronomical expenses in the maintenance of hidden economic welfare. Lack of incentives, low productivity, negligence, and obsolete equipment resulted in huge systemic losses. “They pretend that they pay, we pretend that we work,” ran a popular Soviet adage. The Soviet economy was value-subtracting (or virtual, to use the currently fashionable term) on a giant scale: up to 30 percent of the inputs lost value in the production process.7 The salaries of millions of Russian workers who produced goods that were either unwanted or unusable were a form of unemployment compensation—with wasted labor and resources added to the expense.

Most of the open and hidden welfare expenditures were paid for by the four major Soviet exports—oil, natural gas, gold, and weapons—and by the ever-increasing domestic sales of vodka. The latter doubled between 1958 and 1984 and accounted for at least 14 percent of state income, with a devastating effect on public health.8 Premature deaths directly or indirectly caused by alcohol accounted for about one-fifth of all deaths in the USSR. Between 1964 and 1980 male life expectancy fell by five years, from sixty-seven to sixty-two years.9

The Maintenance of the System

A totalitarian state could maintain such a patently and fundamentally distorted system for decades. Funding was not a problem since the state owned the economy. Since the state controlled prices, inflation was hidden and manifested itself in ubiquitous shortages, long queues, and the giant black market for all goods and services of quality.

Public criticism of the unfairness, wastefulness, and decrepitude of the Soviet welfare state was forbidden. The real economic situation, especially the budget, was a closely guarded state secret. In his memoirs, Mikhail Gorbachev recalled that when he was de facto deputy general secretary, he and Nikolai Ryzhkov, the chairman of Gosplan, asked Yuri Andropov for access to real budget figures. “You are asking too much,” General Secretary Andropov responded. “The budget is off limits to you.”10

The data on poverty, the health crisis, the catastrophic shortage of housing, pandemic alcoholism, and rising mortality were strictly classified. State ownership of all mass media, censorship, customs control, and the jamming of Western radio broadcasts prevented the truth from reaching the public. For the overwhelming majority of Soviet citizens, comparisons with the standard of living outside the country were impossible: visits even to the “fraternal nations” of Soviet-occupied Eastern Europe (let alone the “capitalist countries”) were restricted to a few thousand members of trusted cadres who were instructed before the trips what they should and should not talk about upon their return.

Residence restrictions kept the homeless and destitute away from major cities. Beggars were sent to labor camps. Attempts at protest—whether by workers, war veterans, or pensioners—were nipped in the bud, with organizers arrested on the spot, often beaten, and dispatched to prisons or KGB-run “psychiatric hospitals.” Independent trade unions were swiftly crushed; strikes were illegal and brutally suppressed.

All changed with Gorbachev’s policy of glasnost in the late 1980s, the demise of the one-party state, and the establishment of crude but real multiparty democracy under President Yeltsin in the early 1990s. The Communist-led opposition controlled the freely elected Duma. Workers could protest and strike. Millions of Russians—between 16 and 20 million in 1997 alone11—traveled abroad and returned determined to demand a better life from the regime. Poverty, puny salaries, environmental degradation, a short life expectancy, the housing crisis, and pensioners’ plight became the subject of daily stories in hundreds of newspapers and television programs.

A Common Problem

Coping with the legacy of an extensive social welfare system is hardly a peculiarly Russian problem. How to restructure the wasteful and threadbare welfare state, how to dispose of the surplus work force in the hopelessly noncompetitive public sector of the economy, and what to do about bloated government bureaucracies—these have been key dilemmas from Mexico to the Czech Republic and from Estonia to South Korea as nations have moved from a protected, even autarchic economy to an open market and from authoritarian paternalism to democracy. Exacerbating the situation are such inevitable short-term consequences of privatization and an open market as unemployment, a growing disparity in monetary incomes, and the flaunting of new wealth by the new rich, who, unlike the party nobility of the ancien régime, see no reason to conceal their superior status.

The resulting political and economic dynamics are also well established. Parliaments, often dominated by leftist populists, adopt budgets with ever greater social spending and subsidies for public-sector or nominally private loss-making enterprises involving such politically sensitive constituencies as coal miners or farmers. With tax revenues not even remotely commensurate with skyrocketing expenditures, the result is burgeoning budget deficits, weaker national currencies, higher interest rates, and heavy indebtedness to international financial institutions.

In the worst-case scenario, the vicious circle closes as governments seek to make ends meet by selling debt at astronomically high rates of return and by increasing already unrealistically high taxes. Next come depressed equity prices, stifled direct investment in the economy, capital flight, the shift of an even greater portion of economic activity into gray or black areas—and a further shrinking of the tax base. The government is confronted with Hobson’s choice of reigniting inflation by printing money or delaying (or reducing) already meager welfare benefits and cutting government services further.

Today the leader of the post-Communist transition, Poland, struggles with a budget deficit topping 8 percent of GDP—much of it incurred by subsidies to the public sector. China spends an estimated one-third of its state budget to keep afloat loss-making plants and factories. In an effort to shrink the budget deficit, Argentina this past spring cut the wages of public-sector workers by 10-15 percent. Last year Brazil sought to resolve the same predicament (in large measure caused by the salaries, benefits, and pensions of the bloated civil service) by introducing taxes on state pensions and imposing painful across-the-board cuts in the public sector.

The Crushing Burden

After three-quarters of a century of totalitarian socialism and autarchic economy, the Russian predicament—while hardly unique—might well be unprecedented in scale. In addition to providing free medical care and higher education12 for all citizens regardless of income, the state pays pensions to all women older than fifty-five and all men older than sixty. Niggling though many such payments are, with pensioners making up 27 percent of the population the program’s cost is equivalent to 8 percent of GDP.13

Russians are entitled to myriad benefits and subsidies. Altogether, in a country of 150 million people, 100 million can claim 156 “social payments, privileges, and grants” allocated by federal laws for 236 different “categories of population” (including World War II veterans, children, invalids, and college students). Cashing in all such claims would cost the federal treasury a staggering 15 percent of Russian GDP. Fortunately for the Russian state, many are either unaware of their entitlements, do not bother to apply, or prefer not to subject their incomes to scrutiny. Still, these social policy expenses consume 6 percent of the federal budget (or nearly 2 percent of GDP), with payments to the truly needy small and often tardy as a result.14

The single most expensive blanket subsidy underwrites residential housing and utilities. When prices for other goods and services were liberalized in 1992, rents remained frozen. Federal legislation requires that no household be forced to pay more than 20 percent of total income on housing. When a tenant’s salary or pension is delayed, it is a common practice for the tenant to stop making rent and utility payments.15

Although 50 percent of housing has been privatized (that is, given to the tenants free of charge or for a nominal sum), tenants today pay for only 54 percent of the real cost of maintenance and services (gas, electricity, telephone, water, heat).16 Disbursed regardless of the tenants’ incomes, housing subsidies cost the federal treasury 4 percent of the GDP—a percentage point more than Russia spends on defense.17

The Ruinous Economic Policy

Despite a dramatic decrease in state control of the economy since 1992, the state still owns 14,000 enterprises. In one of the most authoritative and objective foreign studies of the Russian economy, the McKinsey Global Institute estimated that, in 1999, 30 percent of the country’s work force and 50 percent of factories and plants were using industrial assets that were “not worth upgrading because they [were] either sub-scale or rely on obsolete technology.”18 Russian economists estimate that about one-fourth of all enterprises are in a nonmarket sector: they are unable to manufacture and sell products “at prices that exceed expenses.”19

These loss-making enterprises (whether state-owned or nominally private) are supported by the federal budget both directly (through the payment of salaries and the extension of state-guaranteed loans, which are rarely, if ever, repaid) and indirectly (through tax forgiveness or free natural gas and electricity supplied by state-controlled monopolies). Such enterprises are hopelessly in debt. The total sum of their debts is equivalent to 65 percent of Russian GDP.20

Together with housing subsidies, the industrial policy annually costs the state an equivalent of 8 percent of GDP. The total obligations of the federal government mandated by current laws are equivalent to 62 percent of national GDP, while the federal budget equals 35 percent.21 The giant disparity is a key source of the structural crisis of the Russian state and economy.

The 1997 Plan

As in almost all new democracies, social spending by the post-Communist Russian state increased steadily after 1991 and by 1994 grew by 5 percent of GDP, reaching, perhaps for the first time in Russian history, 50 percent of all government expenditures.22 In addition to its wastefulness, the policy of blanket subsidies inherited from Soviet times was also palpably inequitable: the wealthy and middle-class households received most transfers. Despite the nominal growth of social spending, the poor suffered from the meagerness and tardiness of assistance, and health care, education, and infrastructure suffered from sporadic, across-the-board budget cuts.

Although, as a result of privatization, the state owned only three of every ten enterprises and was responsible for less than 20 percent of the backlog in salaries (the rest had been mismanaged or stolen by enterprise owners, managers, and local authorities), the state was universally expected to pay up. In the end, with many infuriating delays, it did. (In 1998, the year of the Russian financial crisis, the salaries of miners alone were to consume $919 million, more than 1 percent of the federal budget. By August of that year, the government had paid $4 billion to settle miners’ strikes. Flying in the face of declared government policy of fiscal restraint, the settlement was one of the factors responsible for the final phase of the flight from the ruble, the panic in the stock market, and the ruble devaluation on August 17.)

It became increasingly clear that a sound fiscal base (and, with it, a strong currency and a low rate of inflation) would be unattainable without a fundamental restructuring of the state’s social and economic policies. Without such radical reforms, Russia would continue to suffer from capital flight, crushingly high interest rates, and woefully inadequate direct investment in the economy and infrastructure. There was little, if any, hope of overcoming the Soviet legacy and lifting education, health care, pensions, and benefits for the needy to the level of what the Russians called the civilized world. The country’s progress toward sustained growth, a modern economy, and an affluent society would forever be halting, fragile, and vulnerable to external factors, most of all, the price of oil.

Such was the thrust of President Yeltsin’s sixty-six page address to the Federal Assembly on March 6, 1997. A chronically impoverished state, incapable of meeting its obligation to society in a timely and effective fashion, was not worthy of its citizens’ trust. The crisis of confidence in turn precipitated a vicious circle: seeing little return from their taxes, people were even more reluctant to pay them and further undermined the state’s ability to discharge its duties.23

Yeltsin proposed phasing out housing subsidies (which then consumed a quarter of the federal budget) and requiring tenants to pay an increasingly larger share of rent and utilities, while the state tried to open the natural gas, water, and electricity supply to market competition.24 (Without such competition, a kilowatt of electricity cost more than twice as much as in the United States, while gas and water were almost as expensive as in Scandinavia, though with much worse service.25)

The state-funded pensions were to be gradually transformed into private funds closely supervised by the state. Such a system, Yeltsin said, would not only save the treasury trillions of rubles but would also make people the true masters of their savings, no longer dependent on the state and impervious to the “blunders and arbitrariness of the bureaucrat.” At the same time the elimination of universal entitlements would be accompanied by targeted, means-tested assistance to low-income families and individuals.26

Finally, Yeltsin proposed to replace the interconnection of “property and power,” which corrupted and stifled both business and the state, with a separation based on the clarity of rules, equality in the treatment of all businesses, and the impartial enforcement of laws, particularly for contractual obligations, the rights of shareholders, and corporate governance. “The state cannot and must not directly interfere in the affairs of private enterprises,” Yeltsin declared. “But it must create stimuli for them to self-reform.”27

The Engineers of the Second Attempt

Spelled out in a 450-page document, The Strategy of Development for the Russian Federation to the Year 2010, Putin’s new program is both radical and comprehensive—bolder and far more elaborate and technically fluent than Yeltsin’s 1997 prototype. The package of reforms was developed by the Center for Strategic Planning, a think tank set up by Putin, then acting president, to produce such a blueprint.

In large measure the document’s authority derives from its key contributors, a who’s who of the leading liberal economists inside and outside government. Although young (none is older than forty-four), all are seasoned bureaucratic infighters, with service in local or federal governments. Like many of Russia’s top pro-reform officials (and Putin himself), the project’s thirty-six-year-old coordinator and center director, German Gref, is an alumnus of the radical democratic administration of St. Petersburg’s Mayor Anatoly Sobchak (1991-1996). Gref’s specialty is privatization, first in St. Petersburg and later as deputy federal property minister.

Alexei Kudrin (thirty-nine) began his career alongside Putin and Gref in the Sobchak administration as first deputy mayor and as chairman of the city’s finance and economy committee. Kudrin was a deputy to Anatoly Chubais, privatization tsar and inflation slayer, when the latter was the head of the presidential administration in 1996, and in 1997 was first deputy minister of finance in charge of debt management and social reform. A leading advocate of drastic spending cuts and tight monetary policies, Kudrin caused a stir (and prompted a public rebuke by Yeltsin) when he announced in March 1998 the government’s intention of cutting the federal bureaucracy by 200,000 people.

Professor Alexey Ulyukaev (forty-four) was the chairman of the Council of Economic Advisers in the 1991-1992 government of Prime Minister Yegor Gaidar and until recently was Gaidar’s deputy at the Institute for the Study of Transitional Economies.

Andrei Illarionov (thirty-eight), who joined the Strategy of Development group at the latter stages of its work, has the unique reputation of a professional Russian economist more liberal than Gaidar. Since 1994, when he resigned as the director of the Center for Economic Reform in Viktor Chernomyrdin’s government and set up his own small but influential think tank, the Institute of Economic Analysis, Illarionov has been Russia’s most vehement and relentless public proponent of sweeping budget cuts and a critic of domestic and foreign borrowing. An avid fan of Ayn Rand, Illarionov spoke a few months ago at a press conference to mark the first Russian translation of Rand’s works. “Every import tariff and every limit on foreign-exchange transactions is a blow to our consciousness,” Illarionov said. “Every tax acts against our freedom.” In a recent article Illarionov quoted Adam Smith: “The less the state busies itself with the economy, the better it is for the economy.”29

In April and May, Illarionov brought to Moscow some of the world’s leading economic liberals to comment on the Strategy of Development: the authors of New Zealand’s free-market reforms Roger Douglas (former finance minister) and Graham Scott (former secretary of the treasury); the father of the social security privatization in Chile, José Piñera; Arnold Harberger, a professor at the University of Chicago and one of the legendary “Chicago boys” who helped to design the radical free-market reforms in Chile in the 1970s; and the former finance minister of Peru, Carlos Bologna. Illarionov also arranged their meeting with Putin, whom José Piñera presented with a sample copy of the passbook used in the Chilean pension savings system.

All key authors of the Strategy of Development have top positions in the Putin administration: Illarionov became the president’s personal economic adviser and presidential envoy to the G-8 group; Kudrin was appointed deputy prime minister and minister of finance; Gref was given the portfolio of minister of economic development and trade; and Ulyukaev is now first deputy minister of finance.

The Key Elements of the Strategy of Development

At the heart of the reform package are a radical reduction of the state’s social obligations and its involvement in the economy; gradual privatization of many services now provided by the state; targeted and means-tested benefits for the needy; the creation of simplified, uniform, and transparent rules for business; and a drastic reduction of the tax burden on individuals and businesses.

Pensions. The uniform, state-funded system will gradually be replaced with individual accumulation accounts, based on individual contributions to the state-controlled pension fund. Private pension funds will be actively encouraged, with contributions tax-deductible up to the specified limit. The retirement age will be raised to sixty-five for both men and women. The savings and profit from individual retirement accounts are expected to allow a 20 percent increase in pensions by the year 2004 and 100 percent growth by 2010.

Housing. Closely following the 1997 design, the Strategy of Development suggests a three-part solution: phasing out blanket subsidies, targeting assistance to the poor, and introducing market competition in the provision of utilities and services. Tenants will pay full housing costs, while the truly needy will receive subsidies in cash. The reforms mandate privatization of management, maintenance, and utilities. The housing shortage is to be alleviated by private construction and long-term mortgages.

Economic Policy. The Strategy of Development prescribes a “sustained policy of reducing the state’s presence in the economy.” The state’s main economic objective should be instead “creating conditions for the emergence of the effective private owner.”30 Among the most urgent tasks are the defense of property rights (especially the rights of shareholders), improved corporate governance, equality of all businesses before the law, and deregulation of the economy.

A significant number of state-owned enterprises are to be sold (including all profitable coal mines) while most of the others are slated to become joint-stock companies in which the state will retain some interest. Loss-making enterprises will no longer be sustained indefinitely by subsidies, free access to electricity and gas, and tax write-offs. Instead, the government will provide temporary unemployment benefits for workers and grants to local authorities to help maintain kindergartens, schools, and hospitals formerly financed by such enterprises in company towns.

“A New Social Contract” and Taxes. Perhaps the most remarkable feature of the reform package is its underlying philosophy. Not since 1992-1993 has so radically and unabashedly liberal an economic vision informed a proclaimed government policy. Reversing not just Soviet but Russian tradition as well, the Strategy of Development attempts nothing less than to establish the primacy of the free economic agent (entrepreneur) over the state as the most important factor of the country’s economic progress and prosperity: “Market competition [is] the key regulator of economic development. World practice and the history of Russia itself have demonstrated convincingly that … sustained economic growth and a nation’s welfare can be achieved under the conditions of the freedom of private initiative only where market competition secures the realization of private interests in the interests of society.”31

The Russian economy would grow “only as a result of work by private business. The state admits that it is in business’s debt,”32 according to Professor Ulyukaev. A steep reduction of the share of national wealth appropriated by the state through taxation is seen by the creators of the program as the key to rapid expansion and modernization. Illarionov has repeatedly called for slashing the federal budget from the equivalent of 35 percent of GDP today to 20 percent or even 17 percent. Only so drastic a reduction, he insists, would secure a sustainable growth of the Russian economy at 5 percent—and perhaps as high as 8 percent—a year.

The Strategy of Development called for the elimination of the multigrade income tax system and the reduction of income tax from the highest rate of 30 percent to a 13 percent flat rate. Dozens of levies, including the universally hated turnover tax (rarely paid in full), will be eliminated, and deductions for business-related expenses introduced. All businesses will be subject to the same rules: the thousands of loopholes, breaks, and tax-forgiveness schemes for favored (usually loss-making) enterprises will be scrapped; the filing of individual and corporate tax returns will be radically simplified. Passed by the Federal Assembly in July, most of the changes will go into effect on January 1, 2001.

More startling still for Russia is another premise of the reform package. The traditionally grand, mysterious, and omniscient Russian state—at once the infinitely munificent and stern father—is reduced to the society’s humble servant, contracted by society for specific jobs and paid accordingly. “By paying taxes, we, the citizens, buy from the state a service—the fulfillment of its basic functions,” Ulyukaev explained. “The price and the quality [of the work] must be negotiated.”33

According to a major Russian newspaper, the implementation of the program would be “a death sentence to the Soviet social system and to the ideology of dependency.”34 Ulyukaev called the arrangement “a new social contract” between the Russian state and society.35

The Economic and Political Contexts

A second economic revolution would occur under uniquely favorable circumstances, which would make the painful adjustments easier to implement. The economic dynamic is better now than at any other time in post-Communist Russia. High oil prices have swelled the state’s coffers and, for the moment, have eliminated the budget deficit. The devalued ruble has boosted exports, while a decrease in imports has revived the domestic consumer goods industry (especially food processing and clothing).

Compared with the same period in 1999, in the first half of 2000 the monthly industrial output expanded 8-10 percent, while GDP grew 7 percent. A trade surplus exceeding $20 billion has brought the country’s gold and hard currency reserves to the highest level since fall 1997. Projections show that reserves could reach $20 billion within the next few months. The annual rate of inflation is likely to be no greater than 20 percent—the lowest since the August 1998 crisis.

Tax receipts are at an all-time high. The monthly capital flight shrank to one-fifth of what it was two years ago. The record budget surplus has wiped out the pension and salary arrears. Family incomes in the first half of the year grew by 10 percent and precipitated a retail boom.

The political context for the overhaul of the Russian welfare state is also better today than at any other time since the August 1991 revolution. For the first time since 1991, there is almost a national consensus on the advantages of the free market, private enterprise, lower taxes, a tight monetary and fiscal policy, and limited state involvement in the economy. The Duma elections of last December ended seven years of leftist populist dominance of the parliament. Since last fall, public opinion polls register significant and steady gains both in consumer confidence and in individuals’ sense of their own well-being.

Putin continues to enjoy a honeymoon in the parliament, while his popularity and the trust in his leadership remain the highest for a Russian chief executive since Yeltsin’s election in 1991. In his state-of-Russia address on July 8 President Putin appeared to endorse the thrust of the Strategy of Development. The “key role of the state in the economy,” he declared, was “without a doubt, the defense of economic liberty,” and the state’s main practical task was to ensure the proper functioning of “the institutions that sustain the market.”36

Among the main directions of economic policy, the president singled out the defense of property rights, “equal rules of competition,” “liberation” of entrepreneurs from a “bureaucratic yoke,” a decrease in the “tax burden,” and an end to “universal state paternalism.” The last objective, Putin said, is dictated both by the imperatives of efficiency and by the need to “unlock human potential, to make man responsible for himself and his family.”37

Finally, in the past few years several initiatives have proved that at least some Strategy of Development reforms can be successfully implemented at the local level. In Samara, a city of nearly 950,000 on the Volga, 600 miles southeast of Moscow, the tenants’ share in offsetting housing costs was raised sharply with the simultaneous introduction of means-tested cash subsidies for the poor.38 In the Novgorod region (population 740,000), 300 miles northwest of Moscow, privatization, competitive bidding for services, tenant cooperatives, and increases in tenants’ contributions to rent and utilities payments have reduced subsidies to just 6 percent of the regional budget, while the postreform rents were kept below the northwest Russia average. Savings were invested, in part, into a regional stabilization fund and support for small businesses.39

Sources of Opposition

Despite the president’s free-market rhetoric and the parliament’s adoption of some of the key tax laws, the reform package will not face smooth sailing. Arrayed against it is the same mighty coalition that smothered the 1997 reforms: the powerful state-owned “natural monopolies”; the “red directors” of the subsidized and effectively tax-exempt enterprises; and local and federal bureaucrats whose power and, quite often, supplemental income derive from the power to tax, exempt, and “support.” Led by leftist politicians and Communist-affiliated trade unions, millions of workers at the unprofitable enterprises might resist closures by strikes and civil disobedience. Millions of middle-class Russians will be loath to say good-bye to subsidized housing, even though they can afford to pay most of the cost of rents and utilities.

In a country where a quarter of the voters regularly choose Communists, associating with the Strategy of Development is very risky for a leader. Unlike Boris Yeltsin, who took personal responsibility—and paid an enormous political and personal price—for introducing and protecting price liberalization and privatization and for defending the market reforms, Vladimir Putin is an unknown quantity. His handpicked prime minister, Mikhail Kasyanov (forty-two), while definitely part of the post-Soviet generation of Russian officials, is hardly Gaidar or Chubais, for whom de-Bolshevization of the Russian economy was a mission. A technocrat whose sole distinction until now has been successful negotiations with Western creditors over the restructuring of Russian debts and the resumption of lending, Kasyanov may begin to waver if the implementation of the reform package unleashes a political firestorm.

Putin’s policies have already weakened the reform effort in at least two respects. First, he has been squandering political capital—every bit of which will be necessary to overcome the vested interests opposing the reform—on intra-elite squabbles and on settling scores with former political adversaries among the oligarchs. In the process, he has alienated Russia’s liberal press and has scared off potential major investors, both Russian and foreign.

Still more detrimental is Putin’s attempt to undermine the emergent Russian federalism and the devolution of political power away from the Kremlin (both a part of Yeltsin’s historic legacy) by acquiring the right to dismiss freely elected provincial governors and by transforming the upper house of the parliament into a state council whose members will no longer be governors but will instead be representatives appointed by the president and by local officials. This effort to change the Russian Constitution not only risks antagonizing progressive governors, whose support is vital for the implementation of the reforms, but also contradicts the essence of the Strategy of Development, which premises reforms on maximum decentralization and continuing devolution of economic responsibilities (and assets) from federal to local authorities.

Should he fail to seize the unique chance dealt him by history to reform the social and economic policies of the Russian state, Vladimir Putin might forever be known not for what he accomplished but for what he failed to accomplish—postponing yet again the final liberation of his countrymen’s immense energy and talent and of his country’s equally abundant natural riches from the state’s antiquated, wasteful, and stifling control. Still, an attempt by the Russian government to implement a free-market program of such boldness and scale is in itself an immensely hopeful portent.


1. A. Cherniak, “Edoki po statistike i v zhizni” (Food consumers in statistics and in real life), Pravda, September 1, 1988.

2. Yu. Rytov, “Kak zhivut pensionery” (How pensioners fare), Izvestiya, August 20, 1988.

3. Zoriy Balayan, “Kogda bolezn obgoniaet lekarstva” (When disease is faster than medicine), interview with Minister of Health Care Ye. I. Chazov, Literaturnaya Gazeta, February 3, 1988.

4. Literaturnaya Gazeta, August 31, 1988.

5. Strategiya Razvitiya Rossiyskoy Federatsii do 2010 goda (The strategy of development for the Russian Federation to the year 2010) (Moscow: Center for Strategic Planning, June 2000), p. 57.

6. Pravda, June 30, 1988.

7. Robert Conquest, Reflections on a Ravaged Century (New York: Norton, 1999), p. 103.

8. Vladimir Treml, “Gorbachev’s Anti-Drinking Campaign: A Noble Experiment or a Costly Exercise in Futility,” Radio Liberty suppl. 2/87, March 18, 1987, p. 8; Oksana Dmitrieva (deputy chairman of the Budget Committee of the State Duma), “Ekspertiza,” Moskovskie Novosti, February 15-21, 2000, p. 2.

9. Treml, “Gorbachev’s Anti-Drinking Campaign,” p. 8.

10. Memoirs (New York: Doubleday, 1996), pp. 146-47.

11. Igor Birman, “Na Rusi zhivyotsya luchshe chem schitaetsya” (One lives better in Russia than is commonly assumed), Izvestiya, December 4, 1997, p. 2.

12. Between 1992 and 2000 the number of colleges and universities in Russia has grown by 75 percent and that of students by 50 percent (Strategiya, p. 25).

13. Catherine Belton, “Pensions May Get Pinochet Makeover,” Moscow Times, April 28, 2000.

14. Strategiya, pp. 13-14.

15. Linda Cook (Brown University), “Legacies of Entitlement: The Policies of Housing Reform in the Russian Federation.” Paper presented at the Kennan Institute for Advanced Russian Studies, Washington, D.C., May 15, 2000.

16. Ibid. See also Strategiya, p. 56.

17. Strategiya, p. 133.

18. McKinsey Global Institute, Unlocking Economic Growth in Russia (Moscow: October 1999), p. 8.

19. Strategiya, p. 83.

20. Ibid.

21. Ibid., pp. 131, 133.

22. Anders Aslund and Mikhail Dmitriev, “Economic Reform versus Rent Seeking.” In Aslund and Martha Brill Olcott, eds., Russia after Communism (Washington, D.C.: Carnegie Endowment for International Peace, 1999),
pp. 110-1.

23. Boris Yeltsin, State-of-Russia address to the Federal Assembly, March 6, 1997, pp. 15, 21.

24. Ibid., p. 20.

25. Boris Nemtsov, “Za obman nalogovykh sluzhb nado sazhat’ v tyurmu” (Lying to tax collection services must be punished by jail), Izvestiya, March 19, 1997, p. 2.

26. Yeltsin, State-of-Russia address, pp. 19-20.

27. Ibid., pp. 21-23.

28. Catherine Belton, “Putin’s Adviser Extols Ayn Rand,” Moscow Times, April 26, 2000.

29. Catherine Belton, “Putin’s Economist a Reluctant ‘Ultraliberal,’” Moscow Times, April 19, 2000.

30. Strategiya, p. 189.

31. Ibid.

32. “Aleksey Ulyukaev: Sredi nashikh idey net ni odnoy nepopulyarnoy” (Alexey Ulyukaev: There is not a single unpopular idea among those that we are offering), Izvestiya, May 13, 2000, p. 1.

33. Ibid.

34. Georgiy Bovt and Evgeniy Krutikov, “Nevrednye mechty” (Non-harmful dreams), Izvestiya , April 28, 2000, p. 1.

35. Ulyukaev, “Sredi nashikh.”

36. Vladimir Putin, “Vystuplenie pri predstavlenii ezhegodnogo Poslaniya Prezidenta Rossiyskoy Federatsii Federal’nomu Sobraniyu Rossiyskoy Federatsii” (Speech accompanying the presentation of the annual message of the president of the Russian Federation to the Federal Assembly of the Russian Federation), July 8, 2000, p. 9.

37. Ibid., pp. 10-12.

38. Oleg Sysuev, “Personal’noe avto za sobstvenniy schyot” (Personal car paid for with one’s own money), Moskovskie Novosti, April 26-May 1, 2000, p. 7.

39. Nikolai Petro, “The Novgorod Region: A Russian Success Story,” Post-Soviet Affairs 15, no. 3 (July-September), 1999,
pp. 236-37.

Leon Aron is a resident scholar and the director of Russian studies at AEI. #11988