Without a Map: Political Tactics and Economic Reform in Russia by Andrei Shleifer

From the Publisher

Recent commentators on Russia's economic reforms have almost uniformly declared them a disappointing -- and avoidable -- failure. In this book, two American scholars take a new and more balanced look at the country's attempts to build capitalism on the ruins of Soviet central planning. They show how and why the Russian reforms achieved remarkable breakthroughs in some areas but came undone in others. Unlike Eastern European countries such as Poland or the Czech Republic, to which it is often compared, Russia is a federal, ethnically diverse, industrial giant with an economy heavily oriented toward raw materials extraction. The political obstacles it faced in designing reforms were incomparably greater.

Shleifer and Treisman tell how Russia's leaders, navigating in uncharted economic terrain, managed to find a path around some of these obstacles. In successful episodes, central reformers devised a strategy to win over some key opponents, while dividing and marginalizing others. Such political tactics made possible the rapid privatization of 14,000 state enterprises in 1992-1994 and the defeat of inflation in 1995. But failure to outmaneuver the new oligarchs and regional governors after 1996 undermined reformers' attempts to collect taxes and clean up the bureaucracy that has stifled business growth.

Renewing a strain of analysis that runs from Machiavelli to Hirschman, the authors reach conclusions about political strategies that have important implications for other reformers. They draw on their extensive knowledge of the country and recent experience as advisors to Russian policymakers. Written in an accessible style, the book should appeal to economists, political scientists, policymakers, businesspeople, and all those interested in Russian politics or economics.

Finance & Development - Itzhak Goldberg

This interesting book makes a significant contribution to the ongoing debate about Russian reforms. It is well worth the read.

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Chapter One

The Politics of Economic Reform in Russia

In the seven years between November 1991, and August 1998, a series of Russian governments tried to enact and implement far-reaching economic reforms. Their goal was simple if daunting: to replace an order built on state ownership, central planning, and administrative control with one based on private property, market coordination, and voluntary exchange. The price mechanism would supersede the bureaucrats of Gosplan, and individual initiative would take the place of hierarchical command. Whole libraries of books and decades of history suggested that such changes would yield greater efficiency, faster growth, and more individual freedom. At the same time, reformers knew that any achievements of marketization would survive only if they were also able to create a powerful political coalition in support of free markets.

    In many regards, the reforms introduced during these years were a remarkable success. Most price controls were removed in 1992 and both domestic and foreign trade were liberalized. By August 1996, monthly inflation had been brought down from the January 1992, peak of 245 percent to close to 0 percent. Exports rose from about $54 billion in 1992 to about $87 billion in 1997, and Russia ran a $20 billion trade surplus that year. Markets for corporate shares and government bonds were created from scratch. The proportion of the work force employed in nonstate firms grew from 13 percent in 1991 to more than 60 percent by the end of 1994. As of January 1997, only 9 percent of registered enterpriseswere still entirely state-owned. And, to the surprise of many observers, Russian voters reelected Boris Yeltsin in July 1996 thereby reversing a trend of disenchantment with incumbent reformers that was evident across Eastern Europe.

    Yet in other ways, the course of economic change in the 1990s was both puzzling and troubling. Macroeconomic stabilization was achieved in 1995-96, but only after three years of unsuccessful attempts and that stability later proved to be fragile. An uncontrolled decline in federal tax revenues raised doubts about the state's solvency and eventually precipitated a massive default on government debt in August, 1998. Privatization, though rapidly completed, set up a structure of governance in which managers and workers in many firms had a degree of control that many observers thought excessive. And some of the state's most valuable energy and natural-resource firms were practically given away to a small group of politically connected businessmen through a rigged "loans-for-shares" program. Despite foreign-trade liberalization, certain quotas and other barriers on exports and imports proved extremely resilient. Even in 1998, energy prices remained heavily—and unevenly—subsidized. And although there had been a sharp decline in output in the early years of reform, growth had not yet resumed as of early 1999. At the same time, economic reforms were continually threatened by sporadic strikes, demonstrations, or separatist threats from Russia's far-flung regions. Most worrying for the future, government at all levels appeared weak, corrupt, disorganized, and ineffective at providing basic public goods such as law and order.

    Early accounts of Russia's experience in both the press and academic publications have had difficulty explaining this mixture of achievements and failures. One view, more common among economists than political scientists, is that reforms could have been far more successful. There were other feasible strategies that would have boosted efficiency and growth faster and at a lower social cost. These strategies were not implemented because the reformers, though generally well intentioned, lacked the necessary will and foresight, while the apparatchiks in positions of power were too timid, economically illiterate, or corrupt to act. Stabilization could have been both quicker and more durable had Russia's political leaders been sufficiently determined to resist the pressures of self-interested lobbyists and to collect taxes from reluctant firms, especially those sitting on Russia's vast natural-resource endowments. Privatization could have paid more attention to proper corporate governance. And foreign-trade policy would have been more liberal if the leadership had managed to establish control over a corrupt bureaucracy.

    Other observers have gone to great lengths to explain why radical reforms in Russia—even those already successfully completed—were outright impossible. One variant of this argument focuses on the country's cultural uniqueness and the inhospitable environment its history has created. The late and partial development of Russian capitalism, the weakness of the prerevolutionary middle class, and the indoctrination and atomization of seventy years of Soviet rule, this theory suggests, have left citizens distrustful, cautious, insufficiently individualistic, unconcerned with profit, hostile toward private initiative, and generally poorly equipped for life in a modern market economy. As a result, the social networks, institutions, and expectations that structured economic interactions in Russia in the 1990s simply could not support an order based on impersonal exchange and impartial legality.

    A different version of the thesis that reform in Russia was doomed to fail follows from the assumption that the existing socially inefficient outcomes were actually desired by some powerful actors. The unreformed or partially reformed economy was a treasure trove of "rents" for an entrenched elite of "rent seekers" who would be extremely difficult to dislodge. In an economy shaped by the efforts of the most powerful actors to maximize their rents, no socially desirable change could come about.

    In this book, we reject both of these perspectives: implementing economic reform in Russia was neither straightforward nor impossible. We disagree with those who believe that a frictionless transition to the economically optimal arrangement would have been attainable if only the political leadership had shown greater resolve and foresight. And we believe experience has proven that some market reforms were feasible in Russia, despite the country's history and political culture, and despite the evident struggle over rents. There were ways to construct and implement reform policies even in a world of homo post-sovieticus and blatant rent seeking. Understanding why some reforms were successfully implemented and others were not is crucial not only for the future development of Russia but also for the design of reform programs in other places and times.

    Under Yeltsin's leadership, a number of economists turned politicians—Yegor Gaidar, Anatoli Chubais, Dmitry Vasiliev, Boris Fyodorov, and others—struggled to introduce reforms in a difficult political context. Former researchers at the leading Moscow and St. Petersburg institutes, most had no experience in politics or administration. They had to learn on the run and some succeeded at this better than others. By contrast, President Yeltsin was an intuitive politician who had little detailed grasp of economics. He reshuffled governments repeatedly, continually sought out new allies and compromises, and from time to time left his economic reformers hanging out to dry. Yet during this entire period, though often beating tactical retreats under pressure from the opposition, he consistently stuck to the main lines of a market-oriented economic policy—private property, free exchange of goods and services, and borders open to trade.

    The reformers in Yeltsin's governments believed that the market economy was the best way forward for Russia. But they also had a broader political objective: to create political support for an open economy, to get President Yeltsin reelected, and to stay in power themselves. At the beginning, there were few tensions between these political and economic goals, since eliminating central direction of the economy and introducing basic market institutions were both economic and political imperatives. Toward the mid-1990s, as the reformers suffered political setbacks and the goal of getting President Yeltsin reelected in 1996 became paramount, tensions between economic objectives and the political compromises necessary to secure them became more pronounced. These tensions were most extreme when the reformers had to broaden political coalitions and to cope with political obstacles that blocked the implementation of reforms. Finding a feasible path around such obstacles is what this book is about.

The "When" and the "How" of Reform

When do reforms occur? Why do governments adopt particular economic reforms at particular moments and fail to do so at others? Why do many promising reforms, once enacted by law or decree, languish on the books without ever being implemented? We call these questions the "when" of reform. The search for answers to them has yielded an extensive literature.

    Some contend that reforms tend to be introduced at moments of economic or political crisis. Extreme inflation or drops in output prompt radical solutions; the collapse of one political regime creates opportunities for the next to restructure institutions. Others have tried to link reform experience to the character of the political order: perhaps Pinochet-style authoritarian governments are better at carrying out effective economic reforms than are democracies. Or more subtle institutional differences might explain which countries reform successfully. Scholars have debated the effects of two-party versus multiparty systems; one-party versus coalition governments; parliamentary versus presidential constitutions; and unitary versus federal states.

    Though broad-ranging, this literature has so far proved somewhat inconclusive. Some governments have exploited moments of economic crisis or "extraordinary politics" to implement effective reforms while others have not. Still others have implemented reforms at moments of relative continuity or calm. Russia's macroeconomic stabilization, for instance, occurred not in early 1992, at the moment of post-Communist euphoria and hyperinflationary emergency, but in 1995 at a time of high but not extreme inflation, long after the public's honeymoon with Yeltsin had given way to postnuptial regret. Reforms have variously occurred—and failed to occur—in authoritarian regimes and in democratic ones, in countries with fragmented party systems and in those with disciplined two-party systems, under coalition governments and under one-party governments, and under dependent as well as insulated executives. In some parts of the world, multiparty systems and coalition governments have been associated with poor macroeconomic policy. In others—in particular, Eastern Europe—the countries with the most fragmented party systems, insecure coalition governments, and uninsulated executives have implemented the most effective and durable reforms. In short, general explanations of the "when" of reform have so far proved elusive.

    In this book, we do not look for them. Rather, we consider a different question: how does reform occur? Even if it is difficult to predict when reformers will turn up in power, when genuine opportunities for reform will exist, and when reformers will make the "right" decisions to exploit them, it may be possible to say something about how a reform must be structured to be politically feasible.

    Our subject, in other words, is the design of politically feasible reform packages. Consideration of the tactics politicians must use to accomplish major policy changes dates back at least to Machiavelli. The classic treatment in economics is Hirschman's examination of economic reforms in Latin America. In political science, Huntington has presented an illuminating analysis of the tactics of democratization around the world over the last thirty years. Our perspective is similar to both Hirschman's and Huntington's. A more recent and growing literature in political economy considers how political constraints affect the outcomes of different reform strategies. Some contributions concern reform sequencing. Dewatripont and Roland show that when reversing reforms is costly and reform in one sector conveys information about the chances for success in another, pursuing one first may offer a higher expected value than doing both simultaneously. They also model how, when the results of reform for individuals are uncertain, the order in which two consecutive reforms are carried out may enhance or decrease the chances that the whole package is brought to completion. Other economists have studied how the prospect of future elections may affect the strategies of incumbent reformers who wish to avoid a popular backlash or to prevent their successors from reversing reforms.

    In some ways, this book fits squarely into this body of work. We are also interested in how early reforms affect the coalitions that emerge to support or oppose subsequent ones, and in how electoral and other constraints affect reform strategy. But, in other ways, the focus here is quite different. First, we approach the problem inductively rather than deductively. We are less concerned with proving the possibility or impossibility of certain reforms under abstract conditions than with observing which techniques have succeeded or failed in concrete settings. Second, most, though not all, of the research on economic reform published to date focuses on voting in a majority-rule legislature. As such, it fits into the central tradition of political economy, exploring the ways in which voting in different institutional contexts produces particular policies. In our analysis, however, we appeal to a different political economy tradition, which examines the logic of interest-group competition. In a fluid political setting, where the implementation of policies is as important and as difficult as their enactment, and where enactment relies on agreement among powerful political groups rather than a vote, elections are only one of many arenas in which interest groups compete.

    This book examines the strategies pursued by reformers in Russia to prevent hostile interest groups from blocking the enactment and implementation of reforms. We consider three attempts at reform—two successful and one unsuccessful. In these three cases, the relevant interest groups as well as the relevant strategies varied, but there were common elements in the structuring of successful reforms—the how of reform. This question is logically quite distinct from that of when reforms do or do not occur. An early reformer and a late reformer, a crisis reformer and a postcrisis reformer, a dictator and a democrat, a leader of a divided government and a leader of an undivided government all have to deal with existing interest groups and their ability to obstruct change.

    An analogy may help to clarify the distinction between the "when" and the "how" of reform. Reforming an economy is like making one's way through a steep, uncharted mountain range. Whether or not a path exists is defined by historical conjuncture and political institutions, while the context of crisis influences how urgently the mountaineers look for it. But even if a path exists and the mountaineers are prepared to look for it, they may still not find it. By studying contour maps after the expedition ends, one can determine whether there was a path for them to find—in other words, whether or not a politically feasible reform package existed. From watching the climbers' attempts to master different mountains, one can also derive generalizations about what sorts of ranges are easiest to traverse (low ones!). But predictions about who will get through and when—the "when" of reform—will always be subject to considerable error. Whether or not reformers manage to navigate successfully cannot always be reduced to some measure of their "skill" or "political will," just as it is not always the most skilled or determined mountaineer who makes it through an unfamiliar mountain range first. In contrast, by evaluating the climbers' efforts, by studying their false turns and lucky discoveries and understanding why particular attempts succeeded or failed, one may be able to pinpoint the best ways to look for paths when traveling without a map. This is what we mean by the "how" of reform.

    This view has important implications. To begin, it suggests a certain skepticism about the search for general answers to the "when" of reform: success depends on the mountaineers' concrete choices, which are situation specific. Equally important, success is not only a matter of "right" choices, it also depends crucially on the conditions the mountaineer encounters along the way—how steep the mountains are, how unpleasant the weather is. A climber who finds a way through the Pyrenees will not necessarily make it through the Andes. Precise instructions on where the path runs in one mountain range may not be much use for traversing another. Instead, climbers would be well advised to seek more limited lessons about how to navigate by the sun, how to ford streams and rappel down boulders, and what techniques will enhance their chances of survival in the open. Any successful reform in a complicated political situation requires improvisation and cannot be planned entirely in advance.

    Even in apparently inauspicious conditions, there are often ways to move forward. As Hirschman noted of Latin America in the 1960s: "the roads to reform are narrow and perilous, they appear quite unsafe to the outside observer however sympathetic he may be, but they exist." Unlike most studies of reform in transitional economies, which focus on the mountain peak at the journey's end, we hope in this book to cast some light on the path itself. If some of the insights appear familiar—and many will to readers of Hirschman—we contend that they have been largely neglected in most early discussions of economic-reform packages in the post-Communist countries and almost entirely neglected in thinking about Russia's transition. Our objective here is to redress this balance.

"Stakeholders" during the Transition

Efficiency-enhancing reforms almost always threaten the distributional interests of certain powerful social actors. These actors benefit materially from existing inefficient arrangements and fear losing these benefits if the system is reformed. Such actors often have the power to prevent reform, either through centralized action in the political arena to prevent enactment or through decentralized efforts in particular locations to prevent implementation. We call such actors the "stakeholders" in the existing arrangements because they have formal or informal control rights over how these arrangements are either maintained or changed. The role of the reform entrepreneur is to overcome the stakeholders' resistance to reform.

    But how? To be successful, a strategy must remove all vetoes over enactment and implementation of reform. There are two ways that a stakeholder can be neutralized. Either he must be expropriated of the stake that gives him leverage. Or he must be coopted—persuaded not to exercise his power to obstruct. In Machiavelli's language, men can either be "pampered or crushed."

    If a stakeholder's control rights give him a veto at the level of reform-policy enactment, then expropriation means cutting him out of the policy process or of the dominant coalition in the central policy arena. If the stakeholder's leverage is over the implementation of policy rather than its enactment, then expropriation means undermining his ability to subvert the implementation.

    One way for the reformers to expropriate recalcitrant stakeholders would be simply to deprive them of their rights. Typically, this requires significant political and organizational capacity on the part of the reform government. For example, General Douglas MacArthur, with American troops under his command, could force the prewar owners of Japanese zaibatsu to break up their business empires. But President Yeltsin, despite his enormous and rather arbitrary powers to sign decrees, fire members of his government, and make policy declarations, from the beginning lacked the ability to expropriate important stakeholders unilaterally. His attempts to do so were repeatedly blocked by the parliament, by the courts, by regional leaders, and even by members of the government itself. Implementing such expropriations was even more difficult than enacting them. Perhaps the most interesting reason to study the tactics of reform in Russia during this period is precisely the virtual impossibility of government-imposed expropriation of the antireform stakeholders.

    Another approach to expropriation is to turn one group of powerful stakeholders against another. The government may encourage one group of stakeholders to take over rights from another and then refuse to use its law-enforcement machinery to protect the rights of the first group. As illustrated in chapter 2, the reformers involved in Russian privatization encouraged the workers and management of individual enterprises to defy the wishes of the central ministries, shaking off their remaining levers of control. This means of expropriating stakeholders has been an important tactic of Russian reforms during this period.

    Cooptation, by contrast, implies not dealing the stakeholders out of the game but dealing them new cards. The reform entrepreneur does not remove the stakeholder's veto power, but creates incentives for him not to exercise it. This may involve an explicit bargain in which the stakeholder agrees to permit reform and receives some benefit as a quid pro quo. Or it may involve creating opportunities that give the stakeholder an independent interest in reform.

    If expropriating stakeholders is difficult, coopting them is not much easier. Because they benefit materially from existing inefficiencies, stakeholders are unlikely to relinquish their veto without compensation. Yet the government rarely has a reserve of cash with which to buy their cooperation. How can it persuade them?

    One of the major tenets of this book is that transforming stakeholders from opponents to supporters of reform often requires the creation of rents by the government that these stakeholders can be offered in exchange for their support. An obvious paradox arises. The goal of reform is to reduce rents and rent seeking. But a fiscally poor government's main lever is the ability to create rents through enacting legal and regulatory restrictions. In fact, it often is its only lever. While all rent-generating restrictions have dead-weight costs, some have greater costs than others. The task of the reformer in a weak state is to persuade stakeholders to give up more socially inefficient ways of receiving rents in exchange for less socially costly payoffs (see table 1.1).

Table 1.1 Main reform tactics

2. Break up antireform coalitions—both in central policy arena and in specific locations of implementation—by coopting certain actors (offering quid pro quos in return for supporting reforms or creating opportunities for them to benefit from reforms directly). Target such bargains selectively to undermine internal organization of antireform coalition.

3. Where necessary, use rents to coopt antireform actors into activities which give them incentives to support reform. Exchange more socially costly rents for less socially costly ones.

    Russia's successful 1995-96 macroeconomic stabilization provides one example of such an exchange (see chapter 4). To stabilize the currency, the government had to lure major commercial banks away from the business of channeling inflationary credits and speculating on the falling ruble into the less inflationary business of trading government bonds. Extremely high treasury bill yields were necessary to attract the banks, and the government maintained these high returns by limiting access to the market. By holding out one rent, the reformers persuaded a major stakeholder to give up another, and to support the reform.

    In this book, we consider three areas of reform—privatization, macroeconomic stabilization, and tax reform—from the perspective of cooptation and expropriation of stakeholders. We explore how the Russian reformers attempted to reach their goals, sometimes successfully, sometimes not. Our analysis of one important failure—the government's inability to enact tax reform—also points to a way in which the government might have been more successful. Finally, a clearer understanding of the compromises necessary to push reforms forward makes possible a more complete assessment of the costs and benefits of reforms. The emphasis on the "how" of reform forces us to compare the policies that were actually pursued to those that might also have been politically feasible, rather than to the infeasible policies emphasized by most critics of the actual reforms.

    In principle, the approach taken here can be used to analyze a variety of reforms. For example, trade liberalization or securities-market reform in Russia could be examined from a similar perspective. Two of our cases—privatization and macroeconomic stabilization—are often considered "policy" reforms, while changing the tax system is generally viewed as an "institutional" reform. We do not draw a sharp distinction between these categories. As Russia's experience demonstrates, changing policies—tightening the money supply, for instance—often calls for a restructuring of both political and economic institutions, while reforming institutions often requires appropriate government policies and political strategies.

    It is not true, as is sometimes argued, that the Russian reformers focused only on macroeconomic policies and neglected institutional reform. Major reforms of the tax system were enacted in late 1991 even before price liberalization occurred. Attempts at legal reform, securities-market reform, and trade liberalization achieved at least moderate success. The same individuals—Gaidar, Chubais, Vasiliev, and Fyodorov—were involved in the battles over different types of reform from monetary and fiscal policy, trade liberalization, and privatization to reforming the tax and regulatory systems. All four of them expended considerable time and political resources on trying to enact legislation that would create new market-compatible rules of the game in different economic spheres. That they had less success in some areas such as the reform of regulatory bureaucracies and the tax system requires an explanation, but it cannot simply be attributed to neglect, ideology, or lack of effort.

Stakeholders and the Russian Reforms

Who were the stakeholders in inefficient institutions in 1990s Russia? What levers did they have to obstruct reforms? In any country and policy area, a variety of factors combine to determine the identity of the most powerful interest groups and the cleavages among them. Historical tradition, economic structure, and inherited political institutions all play a role. In countries in transition, there is one additional important factor: the effect of recent reforms themselves. Each attempt at economic or political change reshapes the terrain on which subsequent reforms must be built.

    The landscape of power that Yeltsin inherited had already been redrawn quite extensively by Gorbachev's early reforms, which had empowered new financial and regional interests. Deliberate decentralization and administrative decay had devolved most of the control over state enterprises to their managers and workers. In the last years of Soviet rule as the organization of the Communist Party weakened, the leaders of regions and republics within Russia had expanded their political leverage and local control. Spontaneous privatization and the loosening of export rules had eased the way for those with access to raw materials to earn enormous profits. Banking reforms had liberated branches of the state banks from central tutelage and legalized the emergence of hundreds of new private banks. Workers had won the right to strike, and some had ostentatiously demonstrated their willingness to use it.

    Ironically, it was the early beneficiaries of reform who created the greatest obstacles to its continuation. The main stakeholders in Russia were neither the reformers' hard-line Communist ideological opponents nor the social groups most victimized by deteriorating economic conditions. These groups, while suspicious of or hostile toward reform, lacked the power to oppose it effectively. As in some other countries, the most forceful resistance actually came not from the "losers" of early phases of reform but from the "winners." Partial reforms create enormous profit opportunities for certain well-placed actors, who exploit disequilibria in transitional markets and gain control over assets in a system of weak property rights. In Russia, as in some other post-Communist states, such early beneficiaries had the most to lose from the completion of privatization, stabilization, liberalization, and fiscal reform. And they were prepared to use their growing resources to defend their stakes.

    Such battles were fought in many arenas. To be enacted reform policies usually had to be passed as laws in parliament. Parliament could also threaten at any point to vote no confidence in the government. Under the pre-December-1993 constitution, the 1,068-member Congress of People's Deputies and the smaller Supreme Soviet it elected had supreme authority; a majority vote in the congress or a majority in both houses of the Supreme Soviet was enough to remove the prime minister from office. The congress also selected Constitutional Court justices and the chairman of the central bank, and it could amend the constitution. With the adoption of a new constitution in December 1993, the Soviet-era parliament was replaced by a State Duma (lower house) and Council of Federation (upper house). The Duma—elected half by proportional representation, half in single-member constituencies—initiated most legislation. The Council of Federation, with two representatives from each of the country's regions, could veto bills, but it could be overruled by a two-thirds majority in the Duma. Under the new constitution, the parliament's power to vote no confidence was far more limited. The president could ignore such a vote twice and on the third vote could, in most circumstances, choose to dissolve the Duma instead of surrendering his prime minister. But parliament's right to pass the budget and other laws affecting the economy still gave it an effective veto over many aspects of reform. Yeltsin could also issue decrees on questions on which the law was silent—and the government could also issue resolutions—but the parliament could overrule such decrees or resolutions by passing new laws.

    Some of the most important policy decisions in macroeconomic stabilization were made not by parliament or the government but by the central bank. The bank could issue credit at its own discretion and did so lavishly until late 1993. It, thus, constituted a third arena from which reform policies might or might not emerge. At the same time, the bank's employees had a strong personal interest in the country's monetary policy—they constituted a major stakeholder, as discussed below. Its chairman was appointed by and could be removed by parliament. The December-1993 constitution declared the central bank to be independent of both parliament and the president, but it gave the president the right to nominate the bank's chairman, subject to confirmation by the State Duma. The president also had the right to recommend his dismissal. The 1995 law on central banking left this system of appointment in place and declared the bank to be both independent and accountable to the State Duma.

    Getting reforms enacted made little difference unless they were also implemented. The struggle over implementation occurred in numerous locations, from local banks to tax service branches and enterprise directors' offices. Methods of obstruction ranged from outright disregard of central legal documents to a repertoire of evasion tactics or more overt challenges. Protests and strikes by workers or regional populations, pickets of government offices, the blockade of railways, and other bids for public attention often threatened to ignite waves of copycat actions that could undermine central authority still further. Reformers often surrendered policy objectives to appease selected protesters and prevent such escalation.

    Coalitions of antireform stakeholders changed from issue to issue and over time. In privatization, two groups dominated—the industrial managers and workers—who had acquired effective control over the assets and cash flow of the "state-owned" enterprises during the late Gorbachev reforms (see table 1.2). These two groups were able to undermine plans for privatization that threatened their control, both at the enactment phase (by lobbying members of parliament and threatening to strike) and at the implementation phase (through their occupation of the enterprises themselves). Reformers made large concessions to workers and management to enlist their support. They also offered smaller concessions to coopt the other stakeholder groups: regional governments, which could affect the profitability of privatized enterprises through their economic policies, taxes, and utility prices and which could oppose privatization legislation in the upper house of parliament; and the central ministries, which through their places in the cabinet controlled a considerable fraction of the government itself. While reformers appeased the ministries with some control over privatization of "strategic" enterprises, they also expropriated them of their remaining control rights over most companies.

    With the early successes of mass privatization, the focus shifted to macroeconomic stabilization. One of the two main stakeholder groups in this case comprised the recipients of the subsidies and credits that caused inflation—industrial enterprises, collective farms, and budget-sector organizations. The second united the central bank and the commercial banking sector, both of which had profited handsomely from the inflation tax. The subsidized organizations and the banking sector together formed a powerful political lobby in 1992-93, which successfully undermined early attempts at strict monetary policy.

    This coalition had several tools at its disposal. First, the proinflation lobby quickly captured the center vote—and therefore the majority—in parliament. Parliament, by threatening a vote of no confidence in the government or simply by passing its own spending legislation, could force expansionary policy on the government. Second, industrial managers threatened to bring their workers out on strike. Such threats were credible at this time for a simple reason: most enterprises had little to lose from joining general strikes since they were either unprofitable or hindered by supply-side bottlenecks. Third, no monetary policy—whether restrictive or inflationary—could be implemented without the cooperation of the Russian central bank. The bank itself earned enormous profits from monetary expansion that went largely into a social fund for central bank employees. Fourth, the commercial banking sector had considerable influence in parliament. Its protests against a central bank chairman who restrained credit increases somewhat in early 1992 led to his prompt removal and replacement by a more expansionist successor. Together, the commercial banks and the central bank could credibly threaten to slow the country's financial system to a crawl if the government continued to press for credit restrictions. Both the central bank and the commercial banks had a positive incentive in a period of high inflation to delay the flow of money through the financial system, since money en route could be used to speculate.

    The third reform we consider here is the attempt to restructure Russia's system of federal finance so as to reverse the decline in federal tax collections and remove obstacles to economic growth. Here, the two main stakeholders confronting the central government were the regional governments and the large enterprises—most producing oil, gas, and other raw materials—that traditionally paid the bulk of the taxes. The regional governments, through their increasing leverage over regional tax-collection offices, their representation in parliament, and in some cases through their ability to threaten separatism, were able to block federal attempts to reform the tax system in ways that would have reduced their control. Major profitable enterprises—through their influence over parliamentary deputies—could often block legislation they disliked. And, with the help of regional and local governments, they devised numerous tricks to prevent tough tax-collection measures from being implemented against them. The State Tax Service (STS) itself, balancing between the conflicting demands of central and regional governments, had considerable leeway to pursue its own interests.

    Successes and failures in each area of reform recast the balance among stakeholders with which the government would have to grapple on the next reform question. To win in successive rounds, the reformers often had to turn on previous allies and sometimes coopt previous opponents. At times, the effects of one reform helped to expand the coalition for another. The broad handout of property rights to industrial managers during privatization split what had been a united front of most of industry against the government's stabilization plans. A wedge opened between the managers of profitable companies and those of unprofitable enterprises. While the former wanted to attract foreign investment and increasingly favored stabilization, the latter continued to demand large subsidies. As chapter 4 demonstrates, the energy-sector barons, coopted in part by benefits from privatization and in part by generous export concessions, played an important role in appeasing selected enterprises, farms, and public-sector organizations by extending sales credit to them as they were increasingly cut off from direct government aid. This helped to disorganize the resistance to tight monetary policy and to reduce inflation in 1995.

    But sometimes stakeholders coopted to secure one reform became an obstacle to accomplishing the next. The explosive growth of the commercial banking sector began before Yeltsin came to power. Still, various policies of his governments—designed to coopt support for macroeconomic stabilization—helped some of the commercial banks to expand into enormous business empires, spanning finance and raw-materials production. The "oligarchs" at the head of these empires then became major opponents of tax reform and of the effective collection of federal taxes. Ultimately, the reformers failed to outmaneuver their erstwhile allies with grave consequences in the financial crisis of August 1998. This was not inevitable; as shown in chapter 8, a more effective strategy for tax reform that would have more successfully divided the oligarchs from their regional allies was conceivable. Nevertheless, the strategy that managed to break resistance to macroeconomic stabilization in 1995 did complicate the task of reforming public finance in 1996-98.

    Reformers in the government faced these shifting coalitions of stakeholders from a position of extreme weakness. At no time during the seven years from 1992 to 1998 was there a clear proreform majority in parliament. Even in the government itself, reformers were generally a minority, and disagreements between ministers were the most salient feature of Moscow politics. For most of this period, some ministers or deputy prime ministers served as open lobbyists for the interest group that they supposedly regulated. Aleksandr Zaveryukha, deputy premier for agriculture, lobbied vigorously for subsidies to collective farms (see chapter 3). When asked what happened to the funds when they reached the countryside, he is reported to have replied: "I don't have to stand there with a club and monitor how money is spent. My job is to get hold of it." Yuri Shafranik, the fuel and power minister, boasted of having collaborated with oil-company directors to get "their" people elected to parliament "to create our own `energy lobby.'" One member of the government advised the Duma to reject aspects of the government's 1996 budget. The minister in charge of privatization in January 1995 called for the "renationalization" of strategic enterprises. In short, much of the government was loyal to groups interested in delaying reforms. And, after 1996, the president was evidently too ill to impose agreement on policies within his government.

    Between 1992 and 1998, the Russian state apparatus became increasingly decentralized and decayed rapidly (despite growth in its personnel, especially at the subnational level). Many of the rights that central state bodies still held in theory became impossible for them to enforce in practice. Laws and decrees issued in Moscow were often ignored in the regions. When the central government attempted to impose reform on reluctant stakeholders through decrees or exhortation, the results were derisory and often prompted further erosion of the center's administrative levers.

    Despite these numerous obstacles, Russia's reformers did succeed in enacting and implementing key reforms. Successes occurred when, through a combination of expropriation and cooptation of stakeholders, the reformers managed to undermine the status quo coalition and strengthen the proreform coalition sufficiently both in the central-policy arena and in the individual locations where policies had to be implemented. This occurred from 1992 on for privatization and in 1995 for macroeconomic stabilization. These successes resulted from an accurate assessment of the balance of power and interests among economic groups, an appreciation of the opportunities and limits of expropriation and cooptation, and a central strategy to play off some groups against others. They also required considerable improvisation as unsuccessful efforts pointed to new ways to move forward. While some aspects of strategy were consciously designed by key reformers, others emerged largely by trial and error, as the government struggled to get around the numerous and changing political roadblocks. As of early 1999, it had still not managed to reform federal finance—the one major failure we examine here.

An Assessment

Many commentators have listed what the Russian government needs to do to make its country rich, successful, and free. Many of them have also criticized the reformers for missing items on these lists. In June 1996, a group of American Nobel Prize-winning economists, along with some Russian colleagues, published a letter in a Russian newspaper attacking the country's record of economic reform. Issued just a few days before the presidential election and widely interpreted as support for the position of the Communist candidate, Gennadi Zyuganov, the letter presented a lengthy series of demands. It called on the Russian government to establish "property rights, a viable currency, a legal system with enforcement, regulations to deal with monopoly and the theft of newly privatized enterprises, and a simplified and enforced tax code." It demanded that the government "reverse and stop [the] cancer of criminalization and corruption"; "foster expansion and encourage non-inflationary growth"; "restore health services, education, environmental protection, science, and other social investments"; "ensure that rents from mineral wealth are converted into government revenues and public investments"; and "encourage the formation of new competing enterprises."

    We do not disagree with this wish list. Anyone who has witnessed the enormous sufferings of individual Russians in recent years can only share the desire to see all these things come to pass. This book, however, is not about defining what is desirable. It is about understanding how the desirable has been made feasible in the past and can be made feasible in the future. While assessing the course of reforms, the questions we ask are: given the constraints, what has been done, what has not been done, and how well has it been done?

    All the reforms described here rely on the cooptation of some stakeholders, often through the creation of new rents for these stakeholders to replace the old ones. But new rents inevitably create new distortions. Not surprisingly, some critics focus more on the costs of these new distortions than on the elimination of the old ones. Any objective evaluation of such reforms must indeed take such costs into account. The costs come in two forms. First, the new distortions may themselves turn out to be more severe than the ones they eliminate. Second, the new rents often give the coopted stakeholders additional wealth and political power that they can then use to impede other reforms.

    From this point of view, the financial crisis that struck Russia in August 1998 might appear to call into question the wisdom of earlier reform tactics. Compromises made to coopt certain stakeholders into supporting privatization and macroeconomic stabilization empowered these same stakeholders to obstruct later attempts at tax reform. The resulting weakness of public finance eventually led the federal government to default on its debt and devalue the ruble. The direct profits the central bank earned in government securities markets—which coopted it into accepting low inflation—may have left bank officials more concerned about their own wealth than about sustaining the financial system as the crisis unfolded.

    These criticisms, while clearly pertinent, go too far. Early reform strategies had genuine costs, but they did not make the subsequent financial crisis inevitable. Much of the credit for this disaster must go to international factors that had nothing to do with Russia's internal policies. The financial hurricane that hit Russia in August 1998 damaged almost all emerging markets. It began in Thailand, and continued—after Russia—in Brazil. The currencies of Ukraine and Belarus—two post-Soviet countries less advanced in economic reform—also collapsed. Even the currencies of commodity-exporting Australia and Canada suffered. Moreover, between early 1997 and early 1999, the international price of oil—Russia's principal export and a major source of tax revenues—fell by half, with serious consequences for the Russian budget. This cannot be blamed on poor policies either.

    Although bad policies are not solely to blame for the crisis, better policies would have helped. As argued in chapters 7 and 8, in 1997-98 the Russian reformers failed to identify and pursue appropriate tactics to get tax reforms enacted. The tactics they chose were, from the beginning, unlikely to work. At the same time, a more effective strategy to divide and coopt stakeholders—which might have made tax reform politically feasible despite the opposition of the oligarchs—did exist. Neither the shocks nor the policy mistakes of 1998, however, should blind one to the achievements of earlier reforms. They only show that the subsequent failures had serious consequences.

    We take the position, then, that despite the numerous compromises made, many of Russia's reforms were successful, though not as successful as they might have been had fewer compromises been necessary. To put this point in comparative perspective, we contend that many reforms worked less well in Russia than in Poland or the Czech Republic not because the Russian reformers were more naïve, incompetent, or ill-willed than their Polish or Czech counterparts, but because the obstacles they faced were simply harder to overcome. Various factors combined to complicate the task in Russia. A decentralized, ethno-federal political structure created a dynamic of center-region conflict that is largely absent or much weaker in centralized, unitary states. The concentration of profitable enterprises in a few raw-materials-rich regions generated economic inequalities that politics in a democratic system had to confront. And the semipresidential political system that had evolved in Russia by the time reforms began prompted a particularly virulent constitutional struggle between parliament and presidency. Given all these obstacles, the achievements of the Russian reformers during the crucial years of 1992 to 1998 should not be underestimated.