Facing New Challenges
April 15 - 21, 2002
Recently, Andrew Wilson, CIPE Senior Program
Officer for Central Europe and Eurasia, had the opportunity to
interview Anders Åslund, a renowned expert on Russia and the former
Soviet republics and a senior associate at the Carnegie Endowment for
International Peace. Mr. Åslund is the author of a new book on this
subject: Building Capitalism: The Transformation of the Former Soviet
Bloc (Cambridge: Cambridge University Press, 2001).
relationship between democracy and markets is a theme that has been
present in quite a few of your writings. In your opinion, to what
extent does democracy help the development of a market economy and, on
the other side, does the development of markets help to stimulate
Markets and private ownership generally exist together with democracy.
But you can point out some exceptions, largely East Asia, which has
not been very repressive, and Chile under Pinochet. In the
post-communist region you have specific conditions that make it all
the more important to have democracy in order to get markets. The
first element is that the state was so dominant in these countries
that in order to stop the state from intervening you have to have
democratic control over the state.
Establishing a market economy required first
privatizing the state enterprises, but political opportunists and
former communist managers took full advantage, selling themselves
these properties very cheaply. Democracy is a way of stopping the
privileged nomenclature from taking everything. There is an extremely
close correlation between market economic reform, privatization, and
democracy. Central Europe and the Baltic states have done all of it.
They are fully democratic, they are about three-quarters privatized,
and they have recently gone to market economics. At the other end you
have countries that are totally state controlled, totally state owned,
and fully fledged dictatorships, in particular Belarus, Turkmenistan,
CIPE: You have
written about countries implementing only partial economic reforms and
compared these to countries that implement full reforms and no reforms
in Eastern and Central Europe. What is the effect of partial reforms?
Central Europe and the Baltic States where they have instituted
complete reforms they are doing very well. The situation is more
interesting in countries that have undertaken only partial reforms
like Russia and the Ukraine, compared to those that have undertaken no
reforms, like Belarus, Turkmenistan, and Uzbekistan.
The argument against partial reform is that it is
worse than no reform because if you fail then you're worse off than if
you hadn't even tried. I disagree. What we have seen over the last
three years, it is that these partial reforms in Russia, Ukraine, and
Kazakhstan in particular, have taken hold. Russia has had an average
growth rate of six per cent during the last three years. And while
these countries did become rent-seeking societies, it was short lived.
define "rent-seeking" and rent-seeking behaviour?
MR. ÅSLUND: Rent-seeking
is earning an excess profit over market, the competitive market
equilibrium. Rent-seeking behaviour is an attempt to get a privileged
position on the market through state subsidies or regulations.
Essentially, the Russian financial crash of '98
demolished the rent-seeking society as it had been established, and
what we are now seeing is splendid growth this year. Russia will have
probably six per cent of growth. The Ukraine and Kazakhstan will
probably both have ten per cent growth. That means that you have new
groups in society becoming empowered and they will not allow the old
rent-seeking system to come back there. The last three years have
shown us that it's better to undertake some reform than not undertake
any reforms at all, and that any reform is really an investment in the
It's true, however, that you can end up in a reform
trap. Politically, if you don't do enough reform, the people will be
unhappy because the economic performance will be poor. This results in
the communists getting a lot of support, and when the communists are
strong, reforms can't be implemented because they don't want to move
towards a market economy.
Economically you have the problem of privatization.
Investors will first seek to buy up state properties cheaply and
liquidate them. They won't care about investing in the enterprises and
restructuring. There will be limited growth and limited investment in
private companies until something like 60 per cent of state owned
property is privatized.
Another problem is in terms of deregulation. When
you have rent-seeking mechanism, like state subsidies or other
regulations from which some rent-seekers make a huge amount of their
rent (profit), those people will buy political power. You'll get a
conservation of the rent-seeking mechanism, and this is quite
resistant. In order to break it up, you really need the kind of shock
that comes when a country's deficit has been too big for too long,
usually, the amount of the debt burden becomes excessive, as with the
case of Bulgaria in '96 and Russia in '98. It is this type of
financial crisis that brings change.
What happened in Russia in '98 is quite typical.
There were three groups that were really badly hurt strategically.
First, the oligarchs — made up of former communist managers of state
owned enterprises and other party leaders who used their positions to
profit from privatization — were weakened when the state took back
its prerogative. The oligarchy no longer called themselves oligarchs
instead they called themselves businessmen. They could no longer
afford to buy political power because they lost a lot of money to the
The other group that was hurt was the regional
governors, which in Russia in '98 were really the epitome of state
corruption. The worst corruption was at a regional level and the
biggest enterprise subsidies were at that level. After the financial
crash, these governors were weakened politically so that the federal
government could take control of tax revenues, manage the state debt
and balance the budget.
The third group that was weakened, most
surprisingly, was the communists, because what the financial crash
showed was that halfway reforms don't work. We tend to talk about it
as crony capitalism with the emphasis on capitalism, but it was more a
perception that this was halfway communism, and after all, everybody
realized that the old system didn't work. So then you have to go to
real capitalism. Before the parliamentary elections in December '99,
the Russian communist party actually changed its economic programme so
that it became in favour of reform.
This did not happen right away and the immediate
reaction everywhere was that the Communist Party would benefit from
this, and indeed, several top communists joined the government. But
one year later, the afterthought was that it's really halfway reforms
that don't work, and nobody really supported the resurrection of the
communist planned economy.
The result is that Russia has now an enormously
clean market economic system, much more, I think, than you see
virtually anywhere in the West, because people are so much more aware
of the principles of the market economy. There's a much more acute
awareness of what a market economy is and why it's necessary to have
it than virtually anywhere else.
CIPE: In a
country as large as Russia, can the central government alone move
reform forward, and in the case of the regions, how do you see the
reform process moving into the regions?
think that the first point is to say is that the federation had become
far too weak in relation to the regional governments. If you take it
in the terms of the economy, the regions until '98 had about 15 per
cent of GDP and the federation had nine per cent of GDP. In the U.S.,
the federation has about 20 per cent of GDP and the States a bit more
than ten per cent. So two-to-one is the U.S. ratio, and the Russian
ratio then was one-to-two. The Russian federal revenues are now about
17 per cent and the regional revenues something like eight to nine per
cent of GDP, and I think that these are much more proper proportions.
Economically, the proportions have been properly established, and the
federal government is far more transparent than the regional
governments. That's the economic side.
Politically, what happened in the summer of '98 was
that the regional governors prevented the balancing of the federal
budget by not allowing more money to go to the federation, so they
were directly responsible for the financial crash. I think redoing the
tax system, if they had accepted that could have still in July '98
possibly averted the crash.
Another political part is that the regions are far
less than accountable or transparent than the federation. Moscow has
20 to 25 daily newspapers, while in the regions you only have one
dominant newspaper that is controlled by the government. So when
talking to democracy activists in Russia, you find that in Moscow,
they are concerned about Putin's power, but in the regions, the
democracy activists look to Putin's strength as a possibility of
getting their totally undemocratic regional government somewhat under
So there's actually a democratic pressure in favour
of stronger federal powers because the federation is more democratic
than the regions, and after this has worked for some time, I think
that the regions will come back politically because they have lost
legitimacy now by being undemocratic and being more corrupt than the
Therefore, I'm not too worried about Putin's policy
on federal-regional relations, but I basically think that to get the
regional governors out of federation policy you want to have some kind
of senate where you have regional interests represented but not by the
same governors. The current structure of the federation council is
approximately like this and I presume that Putin has taken the German
federation council sort of as his model. I would argue that Putin has
greatly improved federal-regional relations, improved transparency,
and improved democracy in this regard.
The concern about Putin is that this is a top-down
reform we are seeing, and it would be nicer if it were a more
grassroots-oriented reform. Ukraine is pursuing that kind of reform,
simply because the elite consensus has broken down. The new consensus
is about corruption and debt, and, therefore the top members of the
elite can no longer collude on how to make money on the state. The
result is that they are losing influence and power and the country
benefits because new businesses can be created without any dependence
on government subsidies.
In Ukraine, there are today seven million
enterprises registered. In Russia, there are three million enterprises
registered. So Ukraine has one registered enterprise on seven people.
Russia has one on 50. Russia has become a very big
enterprise-dominated economy, and reform oligarchs have now become the
big, strong businessmen. This is quite similar to what you had in
Sweden or Finland at the early stages of their economic development. I
think it's much better if you have the small enterprise development
like in Ukraine.
The critical economic decision that helps small
enterprise development is to introduce lump-sum tax that is fixed for
a substantial period for small business, so small businesses have only
one relationship with government, paying the lump sum tax, one a year,
and not being subject to inspections or certification or licensing.
of reforms did Ukraine undertake?
MR. ÅSLUND: Ukraine
is one of the most interesting transitions and the reason why anything
happened was that Ukraine was on the verge of collapse. It was really
facing an external shock, and while the foreign debt was not very big,
Ukraine had no credit so it couldn't get any financing. Such a
hopeless situation requires a man with great credibility both at home
and abroad, which happened to be the very reformist president of the
national bank, Victor Yushchenko. After being appointed Prime
Minister, he used this brief time when the country was really hanging
by a thread to undertake a few major reforms.
His first decision was to abolish 250 government
positions and regulations that gave privileges to many businessmen.
Then he appointed one of the oligarchs Yulia Tymoshenko as Deputy
Prime Minister for Energy and she was happy to go after the other
oligarchs. You need a person who understands how the money is being
made. My assessment is that she took four billion dollars in current
annual revenues away from the oligarchs with her policies, cleaning up
the energy sector, particularly in gas and electricity, and that was
about 13 per cent of GDP.
Profound land reform placed half of the land in
real private hands and the harvest this year is up by 50 per cent.
Also a lump sum tax for small businesses, which had been there
already, really took off in the last two years so that there is huge
growth in agriculture and in industry of 17 per cent so far this year.
CIPE: Do you
think this economic success will translate into greater political
Yes, and you can see this immediately. The oligarchs were buying up
all the newspaper and broadcast advertising preceded the last
presidential elections in October-November '99, and they could do so
because they had so much money from the state. Now, they don't have
the money and they can't run commercials. One of the television
channels is now owned by one of the more progressive Russian groups
and they are running probably the best television channel in Ukraine.
Since the oligarchs are not likely to dominate the media as they did
the last time around, the elections will be more competitive.
the oligarchs and the communists seem so weakened in the region what
is the next big threat to reform?
With the oligarchs under control, the problem is the police, the
security services, and the tax collectors. These are now the three
most criminal organizations. The big issue today is to get judicial
reform to clean up law enforcement. Russia has adopted federal laws on
judicial reform and this is a fundamental change.
articles you suggest that foreign investment should not be a big
priority, and that most investment is domestic.
The West heavily overemphasizes foreign investment because it's a
Western interest. Azerbaijan has received the most foreign investment
at about 20 to 25 per cent of GDP in the last year. There's nothing
positive to be said about corporate governance in Azerbaijan, property
rights, legal rights, liberalization. Out of 21 countries, and there
has been a slight improvement in recent years, but it's only small,
and, of course, Azerbaijan is one of the true dictatorships in the
In Central Europe, the countries with the least
foreign investment, relatively, are Poland, the Czech Republic and
Hungary. Hungary is a success story, but it has been lagging behind
Poland in growth rates. The Czech Republic got a lot of foreign direct
investment in relation to the size of its economy and it has been
pretty stagnant in the second half of the 1990s. In Russia, foreign
direct investment is two percent of GDP while total investment is
about 20 per cent of the GDP. So it's not so important in terms of the
total. This is not to argue against foreign direct investment, but it
should not be seen as a panacea.
CIPE.ORG FEATURE SERVICE