The Consequences

A policy of shock therapy was introduced at the beginning of 1992, and it had dramatic results. Industrial production and national income fell rapidly for several years. By 1998 industrial production had fallen to 45 per cent of its 1989 peak, and gross domestic product (GDP) to 55 per cent. The fall in output over the first three years was comparable to what happened in the United States during the Great Depression of 1929–32.

In Russia, however, the recession lasted far longer – seven years. At the same time, price liberalization, which caused an immediate 245 per cent rise in prices, led to uncontrolled hyperinflation that wiped out the savings or many people. The worst year was 1992, when producer prices rose over 3,000 per cent, and it took several years to bring inflation under control. Because prices of basic foodstuffs, energy and transport were still controlled by the state (a policy that itself caused problems) consumer prices fell less, but real wages nevertheless fell dramatically, by as much as 60 per cent. The transition was a catastrophe.

Though most Russians experienced enormous hardship during the years after 1992, some did not. The change is hard to measure reliably because access to goods under the communist regime depended as much on contacts, party membership and political influence as on income, but there seems little doubt that there was a spectacular increase in inequality. Income distribution was grossly uneven: as a class of very rich people emerged, the proportion of Russians living in poverty rose from 2 per cent to 50 per cent. The poor went hungry, but Moscow’s streets were congested with Mercedes cars.

One problem was that, although the aim of liberalization was to create competition, many businesses were able to use the state bureaucracy to sustain monopolies. Corruption was rife and people continued using and exploiting the state bureaucracy as they had learned to do under the Soviet regime. Trade might now be legal, but local governments could require licenses, creating openings for bribery.

Laws and regulations to restrain monopoly were weak. The legal system was undeveloped, and because of the corruption and patronage inherited from the Soviet system, there was no law enforcement mechanism that was independent of the interested parties. In an environment where bending or breaking rules was norm, establishing a legal system was an enormous challenge.

In addition, some privatization was ad hoc. Managers might end up with de facto control of enterprises. There were great incentives, given the high degree of uncertainty, to engage in asset stripping rather than attempt to earn profits through productive activity, for wealth generated by asset stripping could then be moved outside the country. Besides, though considerable efforts were made to ensure that privatization took place in a reasonably equitable manner, large sections of Russian industry were privatized in a way that seemed, to many observers, designed to create a small group of immensely wealthy oligarchs who were prepared to support the government. The government borrowed money from private banks, giving shares in some of the largest and most valuable government enterprises as collateral, and then defaulted on its loans. The enterprises passed into the hands of the banks’ owners for next for nothing, creating a small number of billionaires who were well placed to remove their funds to safer investments in the West. The wealth was immediately moved abroad, in the massive flight of capital out of Russia that characterized the transition process.