Dr. Illarionov’s 13% solution

Media Appearances, Globalization, Frontier Centre

The man leading the current economic revolution in Russia is a 39-year-old economist, who says he has little time for the International Monetary Fund and the itinerant group of Harvard-trained economists who have been spearheading free-market reforms in many developing countries over the last decade.

Andrei Illarionov, the controversial economic advisor to Vladimir Putin, who believes part of the solution to rebuilding Russia’s crumbling economy is a 13% flat tax, spoke Tuesday at the Frontier Centre for Public Policy in Winnipeg.

It’s not that Russian economist Andrei Illarionov doesn’t believe in the free market. In fact, for many, his ideas are even more radical than those of the IMF and the Harvard economists.

It’s just that Dr. Illarionov is impatient. In fact, in the eight months that he has acted as the personal economic advisor to Vladimir Putin, the Russian President, he has singlehandedly launched more successful free market reforms in his country than the IMF and the Harvard economists combined.

“Russia for many years has been struggling with IMF packages,” said the economist in an interview from Winnipeg, one of the stops on a North American lecture tour, partly organized by the Winnipeg-based Frontier Centre for Public Policy. “Yet, quite a substantial portion of their [IMF] recommendations were simply wrong.”

According to Dr. Illarionov, who served briefly as an advisor to former prime minister Viktor Chernomyrdin, the two main recommendations of the IMF — increase taxation and maintain an artificially high exchange rate — eventually led to economic depression and negative economic growth. In order to sustain a high exchange rate for the Russian ruble, Russia was forced to borrow more than US$20-billion a year from the IMF between 1995 and 1997, a situation that eventually led to the country’s economic crisis two years ago.

“The IMF suggestions only resulted in increasing foreign debt, but did not allow the economy to start to grow,” he said, comparing the situation with a similar crisis in Brazil in 1999. “The IMF did almost the same thing in Brazil by encouraging the country to support an artificially high exchange rate.”

For Dr. Illarionov, the European model espoused by the IMF does not work in a place like Russia, an economy based on natural resources, foreign debt, corruption and economic growth fuelled by rising oil prices. He compares his country to “a mixture of Brazil and Mexico of the 1960s and present day Zambia and Nigeria.

“They just don’t understand what they are dealing with when they go into a country like this,” said Dr. Illarionov of IMF officials.

Similarly, he has nothing nice to say about the work of celebrated Harvard economist Jeffery Sachs, who arrived in Russia in 1991 to help reform the economy.

“His participation was not very serious,” said Dr. Illarionov, referring to Prof. Sachs. “I would attribute neither successes nor failures to him. He would simply meet the president for one hour at a time and call himself a presidential advisor.”

For his part, Dr. Illarionov, who is the principal architect of Mr. Putin’s “Strategy for Development,” spends nearly all of his time consulting with the Russian President on economic reforms that will lead to what they hope will be 10% growth per year.

In Russia, Dr. Illarionov’s ideas are considered “radical,” a term he says perfectly demonstrates the backwardness of thinking on economic policy in Russia. He is one of the founders of the Moscow-based Institute of Economic Analysis, considered the most radical free market think-tank in a country where the state, until very recently, controlled every aspect of economic life.

For Russians, one of his most radical ideas is to drastically reduce the size of government — nothing short of a Herculean task in a place that used to boast one of the world’s most bloated bureaucracies. His goal is to reduce government size from 35% of the economy to 17%, cutting back the state’s social obligations and involvement in the economy in the space of a few years.

“The modern state should be concerned with such things as protecting property rights and enforcing external defence,” said Dr. Illarionov, who studied economics in Russia, Austria, England and at Georgetown University in Washington.

“It is not the business of a state to set prices or quotas,” said Dr. Illarionov. “I have a magical solution for countries to get rich quickly. It’s called economic freedom, which means giving people the freedom to trade freely, produce and invest freely, with minimum intervention from the state.”

For Dr. Illarionov, a centrist state, imposing myriad regulations and heavy taxation contributes to the growth of an underground economy and increased crime. In order to escape government regulations, many small businesspeople move underground, creating what he calls a “shadow economy” that contributes nothing to the overall growth of the larger economy because people do not pay taxes.

“You can’t really blame them,” he said. “People who work in the shadow economy are just trying to escape the government in order to make ends meet.”

Similarly, too much government interference contributes to increased rates of crime. He says the Russian mafia flourished as a direct result of high taxes and government regulations that created a black market.

In order to rectify the situation, Dr. Illarionov encouraged Mr. Putin to implement what many observers say is the economist’s most radical measure: a 13% flat tax in a country well-known for its high level of tax evasion and corruption. The simplified tax structure will replace a progressive income tax in which wealthy Russians can be taxed up to 35%.

The tax, which comes into effect Jan. 1, is lower than taxes in some of the world’s most sought-after tax havens. Liechtenstein, for instance, has a higher flat tax rate of 17%.

“In Russia, poor people pay taxes in full, and many rich people find ways to avoid paying them,” he said. “How could we solve such a problem and create an incentive for everyone to pay tax?”

The solution was to come up with a rate that was low enough for everyone to pay, and would discourage wealthy Russians from stashing their financial assets in foreign tax havens.

By simplifying the tax structure and reducing the size of government, Mr. Putin’s team hope to attract more foreign investment, which Russia desperately needs in order to meet their ambitious strategy of 10% growth per year.

Unlike other formerly centrist economies, such as China, which are implementing free market reforms gradually, Mr. Putin and his economic team say they want to revolutionize the Russian economy as soon as possible.

But Dr. Illarionov says he still has his work cut out for him. He says the biggest obstacle to economic change in Russia is people’s attitude to reforms.

“Our main constraints are wrong-headed ideas about what Russia needs,” said Dr. Illarionov. “We have too many ideas inherited from the past. And that is ultimately the hardest thing to change.”