LIKE MANY OTHER ASPECTS OF RUSSIAN LIFE, the Russian economy underwent a journey through uncharted waters in the early 1990s. First came the disintegration of the centrally planned economy that was a hallmark of the state-controlled economy and then its replacement by an economy operating on the basis of market forces. Some of the former communist states of Central Europe began their process of economic transition two years before Russia and have provided positive models. But Russia lacks experience with market economies and the institutions needed to operate them. Moreover, deeply en-trenched remnants of central planning present challenges in Russia that other countries were able to avoid.
Russia undertakes the transition with advantages and obstacles. Although only half the size of the former Soviet economy, the Russian economy includes formidable assets. Russia possesses ample supplies of many of the world's most valued natural resources, especially those required to support a modern industrialized economy. It also has a well-educated labor force with substantial technical expertise. At the same time, Soviet-era management practices, a decaying infrastructure, and inefficient supply systems hinder efficient utilization of those resources.
For nearly 60 years, the Russian economy and that of the rest of the Soviet Union operated on the basis of central planning--state control over virtually all means of production and over investment, production, and consumption decisions throughout the economy. Economic policy was made according to directives from the communist party, which controlled all aspects of economic activity. The central planning system left a number of legacies with which the Russian economy must deal in its transition to a market economy.
Much of the structure of the Soviet economy that operated until 1987 originated under the leadership of Joseph V. Stalin (in office 1927-53), with only incidental modifications made between 1953 and 1987. Five-year plans (see Glossary) and annual plans were the chief mechanisms the Soviet government used to translate economic policies into programs. According to those policies, the State Planning Committee (Gosudarstvennyy planovyy komitet--Gosplan) formulated countrywide output targets for stipulated planning periods. Regional planning bodies then refined these targets for economic units such as state industrial enterprises and state farms (sovkhozy ; sing., sovkhoz --see Glossary) and collective farms (kolkhozy ; sing., kolkhoz --see Glossary), each of which had its own specific output plan. Central planning operated on the assumption that if each unit met or exceeded its plan, then demand and supply would balance.
The government's role was to ensure that the plans were fulfilled. Responsibility for production flowed from the top down. At the national level, some seventy government ministries and state committees, each responsible for a production sector or subsector, supervised the economic production activities of units within their areas of responsibility. Regional ministerial bodies reported to the national-level ministries and controlled economic units in their respective geographical areas.
The plans incorporated output targets for raw materials and intermediate goods as well as final goods and services. In theory, but not in practice, the central planning system ensured a balance among the sectors throughout the economy. Under central planning, the state performed the allocation functions that prices perform in a market system. In the Soviet economy, prices were an accounting mechanism only. The government established prices for all goods and services based on the role of the product in the plan and on other noneconomic criteria. This pricing system produced anomalies. For example, the price of bread, a traditional staple of the Russian diet, was below the cost of the wheat used to produce it. In some cases, farmers fed their livestock bread rather than grain because bread cost less. In another example, rental fees for apartments were set very low to achieve social equity, yet housing was in extremely short supply (see Housing, ch. 5). Soviet industries obtained raw materials such as oil, natural gas, and coal at prices below world market levels, encouraging waste.
The central planning system allowed Soviet leaders to marshal resources quickly in times of crisis, such as the Nazi invasion, and to reindustrialize the country during the postwar period. The rapid development of its defense and industrial base after the war permitted the Soviet Union to become a superpower.
The record of Russian economic reform through the mid-1990s is mixed. The attempts and failures of reformers during the era of perestroika (restructuring--see Glossary) in the regime of Mikhail S. Gorbachev (in office 1985-91) attested to the complexity of the challenge. Since 1991, under the leadership of Boris N. Yeltsin, the country has made great strides toward developing a market economy by implanting basic tenets such as market-determined prices. Critical elements such as privatization of state enterprises and extensive foreign investment went into place in the first few years of the post-Soviet period. But other fundamental parts of the economic infrastructure, such as commercial banking and authoritative, comprehensive commercial laws, were absent or only partly in place by 1996. Although by the mid-1990s a return to Soviet-era central planning seemed unlikely, the configuration of the post-transition economy remained unpredictable.
Economists have struggled to achieve accurate measurement of the Russian economy, and they have questioned the accuracy of official Russian economic data. Although the market now determines most prices, the Government (Russia's cabinet) still fixes prices on some goods and services, such as utilities and energy. Furthermore, the exchange rate of the ruble (for value of the ruble--see Glossary) to the United States dollar has changed rapidly, and the Russian inflation rate has been high. These conditions make it difficult to convert economic measurements from rubles to dollars to make statistical comparisons with the United States and other Western countries.
According to official Russian data, in 1994 the national gross domestic product (GDP--see Glossary) was 604 trillion rubles (about US$207 billion according to the 1994 exchange rate), or about 4 percent of the United States GDP for that year. But this figure underestimates the size of the Russian economy. Adjusted by a purchasing-power parity formula to account for the lower cost of living in Russia, the 1994 Russian GDP was about US$678 billion, making the Russian economy approximately 10 percent of the United States economy. In 1994 the adjusted Russian GDP was US$4,573 per capita, approximately 19 percent of that of the United States. A second important measurement factor is the extremely active so-called shadow economy, which yields no taxes or government statistics but which a 1996 government report quantified as accounting for about 50 percent of the economy and 40 percent of its cash turnover.
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Historical Background
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Natural Resources
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Agriculture
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Energy
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Banking and Finance
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The Labor Force
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Manufacturing
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Transportation
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Telecommunications
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Foreign Economic Relations
The Soviet economic system was in place for some six decades, and elements of that system remained in place after the dissolution of the Soviet Union in 1991. The leaders exerting the most substantial influence on that system were its founder, Vladimir I. Lenin, and his successor Stalin, who established the prevailing patterns of collectivization and industrialization that became typical of the Soviet Union's centrally planned system. By 1980, however, intrinsic defects became obvious as the national economy languished; shortly thereafter, reform programs began to alter the traditional structure. One of the chief reformers of the late 1980s, Boris Yeltsin, oversaw the substantial dissolution of the central planning system in the early 1990s.
The basic foundation of the Soviet economic system was established after the Bolsheviks (see Glossary) assumed power in November 1917 (see Revolutions and Civil War, ch. 2). The Bolsheviks sought to mold a socialist society from the ruins of post-World War I tsarist Russia by liberally reworking the ideas of political philosophers Karl Marx and Friedrich Engels.
Soon after the revolution, the Bolsheviks published decrees nationalizing land, most industry (all enterprises employing more than five workers), foreign trade, and banking. The peasants took control of the land from the aristocracy and farmed it in small parcels.
Beginning in 1918, the new regime already was fighting for its survival in the Russian Civil War against noncommunist forces known as the Whites. The war forced the regime to organize the economy and place it on a war footing under a stringent policy known as war communism. Under such conditions, the economy performed poorly. In 1920 agricultural output had attained only half of its pre-World War I level, foreign trade had virtually ceased, and industrial production had fallen to only a small fraction of its prewar levels. Beginning in 1921, Lenin led a tactical retreat from state control of the economy in an effort to reignite production. His new program, called the New Economic Policy (Novaya ekonomicheskaya politika--NEP; see Glossary), permitted some private activity, especially in agriculture, light industry, and services (see Lenin's Leadership, ch. 2). However, heavy industry, transportation, foreign trade, and banking remained under state control.
Lenin died in 1924, and by 1927 the government had nearly abandoned the NEP. Stalin sought a rapid transformation from an agricultural, peasant-based country into a modern industrial power and initiated the country's First Five-Year Plan (1928-32). Under the plan, the Soviet government began the nationwide collectivization of agriculture to ensure production and distribution of food supplies to the growing industrial sector and to free labor for industry (see Industrialization and Collectivization, ch. 2). By the end of the five-year period, however, agricultural output had declined by 23 percent, according to official statistics. The chemical, textile, housing, and consumer goods and services industries were also performing poorly. Heavy industry exceeded the plan targets, but only at a great cost to the rest of the economy.
By the Third Five-Year Plan (1938-41), the Soviet economy was once again on a war footing, devoting increasing amounts of resources to the military sector in response to the rise of Nazi Germany. The Nazi invasion in 1941 forced the government to abandon the five-year plan and concentrate all resources on support for the military sector. This period also included the large-scale evacuation of much of the country's industrial production capacity from European Russia to the Urals and Central Asia to prevent further war damage to its economic base. The Fourth Five-Year Plan (1946-50) was one of repairing and rebuilding after the war.
Throughout the Stalin era, the government forced the pace of industrial growth by shifting resources from other sectors to heavy industry. The Soviet consumer received little priority in the planning process. By 1950 real household consumption had climbed to a level only marginally higher than that of 1928. Although Stalin died in 1953, his emphasis on heavy industry and central control over all aspects of economic decision making remained virtually intact well into the 1980s.
Soviet economic growth rates during the postwar period appeared impressive. Between the early 1950s and 1975, the Soviet gross national product (GNP--see Glossary) increased an average of about 5 percent per year, outpacing the average growth of the United States and keeping pace with many West European economies--albeit after having started from a much lower point.
However, these aggregate growth figures hid gross inefficiencies that are typical of centrally planned systems. The Soviet Union was able to attain impressive growth through "extensive investments," that is, by infusing the economy with large inputs of labor, capital, and natural resources. But the state-set prices did not reflect the actual costs of inputs, leading to enormous misallocation and waste of resources. In addition, the heavily bureaucratic economic decision-making system and the strong emphasis on meeting targets discouraged the introduction of new technologies that could improve productivity. Central planning also skewed the distribution of investments throughout the economy.
The aggregate Soviet growth figures also did not reveal either the generally poor quality of Soviet goods and services that resulted from the state monopoly over production or the lack of priority given the consumer sector in the planning process. Eventually, diminishing returns from labor, capital, and other inputs led to a severe slowdown in Soviet economic growth. Furthermore, the availability of inputs, especially capital, labor, and technology, was decreasing. Declining birth rates, particularly in the European republics of the Soviet Union, placed constraints on the labor supply. By the mid-1970s and into the 1980s, average Soviet GNP growth rates had plummeted to about 2 percent, less than half the rates of the immediate postwar period.
Although such rates might have been acceptable in a mature, modern industrialized economy, the Soviet Union still trailed far behind the United States, other Western economies, and Japan, and in the 1980s another challenge arose from the newly industrializing countries of East Asia. Furthermore, the standard of living of the average Russian citizen, which had always been below that of the United States, was declining. In the 1980s, with the advent of modern communications that even Soviet censors found impossible to restrict, Soviet citizens began to recognize their relative position and to question the rationale of their country's economic policies. This was the atmosphere in which the Gorbachev regime undertook serious economic reform in the late 1980s.
During several distinct periods, Soviet leaders attempted to reform the economy to make the Soviet system more efficient. In 1957, for example, Nikita S. Khrushchev (in office 1953-64) tried to decentralize state control by eliminating many national ministries and placing responsibility for implementing plans under the control of newly created regional economic councils. These reforms produced their own inefficiencies. In 1965 Soviet prime minister Aleksey Kosygin (in office 1964-80) introduced a package of reforms that reestablished central government control but reformed prices and established new bonuses and production norms to stimulate economic productivity. Under reforms in the 1970s, Soviet leaders attempted to streamline the decision-making process by combining enterprises into associations, which received some localized decision-making authority.
Because none of these reforms challenged the fundamental notion of state control, the root cause of the inefficiencies remained. Resistance to reform was strong because central planning was heavily embedded in the Soviet economic structure. Its various elements--planned output, state ownership of property, administrative pricing, artificially established wage levels, and currency inconvertibility--were interrelated. Fundamental reforms required changing the whole system rather than one or two elements. Central planning also was heavily entrenched in the Soviet political structure. A huge bureaucracy was in place from the national to the local level in both the party and the government, and officials within that system enjoyed the many privileges of the Soviet elite class. Such vested interests yielded formidable resistance to major changes in the Soviet economic system; the Russian system, in which many of the same figures have prospered, suffers from the same handicap.
Upon assuming power in March 1985, Gorbachev took measures intended to immediately resume the growth rates of earlier decades. The Twelfth Five-Year Plan (1986-90) called for the Soviet national income to increase an average of 4.1 percent annually and labor productivity to increase 4.6 percent annually--rates that the Soviet Union had not achieved since the early 1970s. Gorbachev sought to improve labor productivity by implementing an anti-alcohol campaign that severely restricted the sale of vodka and other spirits and by establishing work attendance requirements to reduce chronic absenteeism. Gorbachev also shifted investment priorities toward the machine-building and metalworking sectors that could make the most significant contribution to retool and modernize existing factories, rather than building new factories. Gorbachev changed Soviet investment strategy from extensive investing to intensive investing that focused on elements most critical to achieving the stated goal.
During his first few years, Gorbachev also restructured the government bureaucracy (see Perestroika , ch. 2). He combined ministries responsible for high-priority economic sectors into bureaus or state committees in order to reduce staff and red tape and to streamline the administration. In addition, Gorbachev established a state organization for quality control to improve the quality of Soviet production.
The Soviet economic reforms during Gorbachev's initial period (1985-86) were similar to the reforms of previous regimes: they modified the Stalinist system without making truly fundamental changes. The basic principles of central planning remained. The measures proved to be insufficient, as economic growth rates continued to decline and the economy faced severe shortages. Gorbachev and his team of economic advisers then introduced more fundamental reforms, which became known as perestroika (restructuring). At the June 1987 plenary session of the Central Committee of the Communist Party of the Soviet Union (CPSU--see Glossary), Gorbachev presented his "basic theses," which laid the political foundation of economic reform for the remainder of the decade.
In July 1987, the Supreme Soviet passed the Law on State Enterprises. The law stipulated that state enterprises were free to determine output levels based on demand from consumers and other enterprises. Enterprises had to fulfill state orders, but they could dispose of the remaining output as they saw fit. Enterprises bought inputs from suppliers at negotiated contract prices. Under the law, enterprises became self-financing; that is, they had to cover expenses (wages, taxes, supplies, and debt service) through revenues. No longer was the government to rescue unprofitable enterprises that could face bankruptcy. Finally, the law shifted control over the enterprise operations from ministries to elected workers' collectives. Gosplan's responsibilities were to supply general guidelines and national investment priorities, not to formulate detailed production plans.
The Law on Cooperatives, enacted in May 1987, was perhaps the most radical of the economic reforms during the early part of the Gorbachev regime. For the first time since Lenin's NEP, the law permitted private ownership of businesses in the services, manufacturing, and foreign-trade sectors. The law initially imposed high taxes and employment restrictions, but it later revised these to avoid discouraging private-sector activity. Under this provision, cooperative restaurants, shops, and manufacturers became part of the Soviet scene.
Gorbachev brought perestroika to the Soviet Union's foreign economic sector with measures that Soviet economists considered bold at that time. His program virtually eliminated the monopoly that the Ministry of Foreign Trade had had on most trade operations. It permitted the ministries of the various industrial and agricultural branches to conduct foreign trade in sectors under their responsibility rather than having to operate indirectly through the bureaucracy of trade ministry organizations. In addition, regional and local organizations and individual state enterprises were permitted to conduct foreign trade. This change was an attempt to redress a major imperfection in the Soviet foreign trade regime: the lack of contact between Soviet end users and suppliers and their foreign partners.
The most significant of Gorbachev's reforms in the foreign economic sector allowed foreigners to invest in the Soviet Union in the form of joint ventures with Soviet ministries, state enterprises, and cooperatives. The original version of the Soviet Joint Venture Law, which went into effect in June 1987, limited foreign shares of a Soviet venture to 49 percent and required that Soviet citizens occupy the positions of chairman and general manager. After potential Western partners complained, the government revised the regulations to allow majority foreign ownership and control. Under the terms of the Joint Venture Law, the Soviet partner supplied labor, infrastructure, and a potentially large domestic market. The foreign partner supplied capital, technology, entrepreneurial expertise, and, in many cases, products and services of world competitive quality.
Although they were bold in the context of Soviet history, Gorbachev's attempts at economic reform were not radical enough to restart the country's chronically sluggish economy in the late 1980s. The reforms made some inroads in decentralization, but Gorbachev and his team left intact most of the fundamental elements of the Stalinist system--price controls, inconvertibility of the ruble, exclusion of private property ownership, and the government monopoly over most means of production.
By 1990 the government had virtually lost control over economic conditions. Government spending increased sharply as an increasing number of unprofitable enterprises required state support and consumer price subsidies continued. Tax revenues declined because revenues from the sales of vodka plummeted during the anti-alcohol campaign and because republic and local governments withheld tax revenues from the central government under the growing spirit of regional autonomy. The elimination of central control over production decisions, especially in the consumer goods sector, led to the breakdown in traditional supplier-producer relationships without contributing to the formation of new ones. Thus, instead of streamlining the system, Gorbachev's decentralization caused new production bottlenecks.
Gorbachev's new system bore the characteristics of neither central planning nor a market economy. Instead, the Soviet economy went from stagnation to deterioration. At the end of 1991, when the union officially dissolved, the national economy was in a virtual tailspin. In 1991 the Soviet GDP had declined 17 percent and was declining at an accelerating rate. Overt inflation was becoming a major problem. Between 1990 and 1991, retail prices in the Soviet Union increased 140 percent.
Under these conditions, the general quality of life for Soviet consumers deteriorated. Consumers traditionally faced shortages of durable goods, but under Gorbachev, food, wearing apparel, and other basic necessities were in short supply. Fueled by the liberalized atmosphere of Gorbachev's glasnost (literally, public voicing--see Glossary) and by the general improvement in information access in the late 1980s, public dissatisfaction with economic conditions was much more overt than ever before in the Soviet period. The foreign-trade sector of the Soviet economy also showed signs of deterioration. The total Soviet hard-currency (see Glossary) debt increased appreciably, and the Soviet Union, which had established an impeccable record for debt repayment in earlier decades, had accumulated sizable arrearages by 1990.
In sum, the Soviet Union left a legacy of economic inefficiency and deterioration to the fifteen constituent republics after its breakup in December 1991. Arguably, the shortcomings of the Gorbachev reforms had contributed to the economic decline and eventual destruction of the Soviet Union, leaving Russia and the other successor states to pick up the pieces and to try to mold modern, market-driven economies. At the same time, the Gorbachev programs did start Russia on the precarious road to full-scale economic reform. Perestroika broke Soviet taboos against private ownership of some types of business, foreign investment in the Soviet Union, foreign trade, and decentralized economic decision making, all of which made it virtually impossible for later policy makers to turn back the clock.
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Economic Reform in the 1990s
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Economic Conditions in Mid-1996
Two fundamental and interdependent goals--macroeconomic stabilization and economic restructuring--mark the transition from central planning to a market-based economy. The former entails implementing fiscal and monetary policies that promote economic growth in an environment of stable prices and exchange rates. The latter requires establishing the commercial, legal, and institutional entities--banks, private property, and commercial legal codes--that permit the economy to operate efficiently. Opening domestic markets to foreign trade and investment, thus linking the economy with the rest of the world, is an important aid in reaching these goals. Under Gorbachev, the regime failed to address these fundamental goals. At the time of the Soviet Union's demise, the Yeltsin government of the Russian Republic had begun to attack the problems of macroeconomic stabilization and economic restructuring. As of mid-1996, the results were mixed.
In October 1991, two months before the official collapse of the Soviet regime and two months after the August 1991 coup against the Gorbachev regime, Yeltsin and his advisers, including reform economist Yegor Gaydar, established a program of radical economic reforms. The Russian parliament, the Supreme Soviet, also extended decree powers to the president for one year to implement the program. The program was ambitious, and the record to date indicates that the goals for macroeconomic stabilization and economic restructuring programs may have been unrealistically high. Another complication in the Yeltsin reform program is that since 1991 both political and economic authority have devolved significantly from the national to the regional level; in a series of agreements with the majority of Russia's twenty-one republics and several other subnational jurisdictions, Moscow has granted a variety of special rights and powers having important economic overtones.
The program laid out a number of macroeconomic policy measures to achieve stabilization. It called for sharp reductions in government spending, targeting outlays for public investment projects, defense, and producer and consumer subsidies. The program aimed at reducing the government budget deficit from its 1991 level of 20 percent of GDP to 9 percent of GDP by the second half of 1992 and to 3 percent by 1993. The government imposed new taxes, and tax collection was to be upgraded to increase state revenues. In the monetary sphere, the economic program required the Russian Central Bank (RCB) to cut subsidized credits to enterprises and to restrict money supply growth. The program called for the shrinkage of inflation from 12 percent per month in 1991 to 3 percent per month in mid-1993.
Immediately after the dissolution of the Soviet Union was announced, the Government lifted price controls on 90 percent of consumer goods and 80 percent of intermediate goods. It raised, but still controlled, prices on energy and food staples such as bread, sugar, vodka, and dairy products. These measures were to establish a realistic relationship between production and consumption that had been lacking in the central planning system.
To encourage the development of the private sector, fundamental changes were made in the tax system, including introduction of a value-added tax (VAT--see Glossary) of 28 percent on most transactions, a progressive income tax, and a tax on business income; revisions in the system of import tariffs and export taxes; new taxes on domestic energy use to encourage conservation (a necessary step because energy prices were still controlled); and new taxes on oil and natural gas exports to narrow the gap between subsidized domestic prices and world prices and to prevent domestic energy shortages (see Taxation, this ch.). A fixed exchange rate was to be established for the ruble, which then would become convertible. Many restrictions on foreign trade and investment also were to be lifted to expose Russia to the discipline of world prices.
In 1992 and 1993, the Government expanded the money supply and credits at explosive rates that led directly to high inflation and to a deterioration in the exchange rate of the ruble. In January 1992, the Government clamped down on money and credit creation at the same time that it lifted price controls. However, beginning in February the RCB loosened the reins on the money supply. In the second and third quarters of 1992, the money supply had increased at especially sharp rates of 34 and 30 percent, respectively, and by the end of 1992, the Russian money supply had increased by eighteen times.
The sharp increase in the money supply was influenced by large foreign currency deposits that state-run enterprises and individuals had built up and by the depreciation of the ruble. Enterprises drew on these deposits to pay wages and other expenses after the Government had tightened restrictions on monetary emissions. Commercial banks monetized enterprise debts by drawing down accounts in foreign banks and drawing on privileged access to accounts in the RCB (see Banking and Finance, this ch.).
Government efforts to control credit expansion also proved ephemeral in the early years of the transition. Domestic credit increased about nine times between the end of 1991 and 1992. The credit expansion was caused in part by the buildup of interenterprise arrears and the RCB's subsequent financing of those arrears. The Government restricted financing to state enterprises after it lifted controls on prices in January 1992, but enterprises faced cash shortages because the decontrol of prices cut demand for their products. Instead of curtailing production, most firms chose to build up inventories. To support continued production under these circumstances, enterprises relied on loans from other enterprises. By mid-1992, when the amount of unpaid interenterprise loans had reached 3.2 trillion rubles (about US$20 billion), the government froze interenterprise debts. Shortly thereafter, the government provided 181 billion rubles (about US$1.1 billion) in credits to enterprises that were still holding debt.
The Government also failed to constrain its own expenditures in this period, partially under the influence of the conservative Supreme Soviet, which encouraged the Soviet-style financing of favored industries. By the end of 1992, the Russian budget deficit was 20 percent of GDP, much higher than the 5 percent projected under the economic program and stipulated under the International Monetary Fund (IMF--see Glossary) conditions for international funding. This budget deficit was financed largely by expanding the money supply. These ill-advised monetary and fiscal policies resulted in an inflation rate of over 2,000 percent in 1992.
In late 1992, deteriorating economic conditions and a sharp conflict with the parliament led Yeltsin to dismiss economic reform advocate Yegor Gaydar as prime minister. Gaydar's successor was Viktor Chernomyrdin, a former head of the State Natural Gas Company (Gazprom), who was considered less favorable to economic reform.
Chernomyrdin formed a new government with Boris Fedorov, an economic reformer, as deputy prime minister and finance minister. Fedorov considered macroeconomic stabilization a primary goal of Russian economic policy. In January 1993, Fedorov announced a so-called anticrisis program to control inflation through tight monetary and fiscal policies. Under the program, the Government would control money and credit emissions by requiring the RCB to increase interest rates on credits by issuing government bonds, by partially financing budget deficits, and by starting to close inefficient state enterprises. Budget deficits were to be brought under control by limiting wage increases for state enterprises, by establishing quarterly budget deficit targets, and by providing a more efficient social safety net for the unemployed and pensioners.
The printing of money and domestic credit expansion moderated somewhat in 1993. In a public confrontation with the parliament, Yeltsin won a referendum on his economic reform policies that may have given the reformers some political clout to curb state expenditures. In May 1993, the Ministry of Finance and the RCB agreed to macroeconomic measures, such as reducing subsidies and increasing revenues, to stabilize the economy. The RCB was to raise the discount lending rate to reflect inflation. Based on positive early results from this policy, the IMF extended the first payment of US$1.5 billion to Russia from a special Systemic Transformation Facility (STF) the following July.
Fedorov's anticrisis program and the Government's accord with the RCB had some effect. In the first three quarters of 1993, the RCB held money expansion to a monthly rate of 19 percent. It also substantially moderated the expansion of credits during that period. The 1993 annual inflation rate was around 1,000 percent, a sharp improvement over 1992, but still very high. The improvement figures were exaggerated, however, because state expenditures had been delayed from the last quarter of 1993 to the first quarter of 1994. State enterprise arrears, for example, had built up in 1993 to about 15 trillion rubles (about US$13 billion, according to the mid-1993 exchange rate).
In June 1994, Chernomyrdin presented a set of moderate reforms calculated to accommodate the more conservative elements of the Government and parliament while placating reformers and Western creditors. The prime minister pledged to move ahead with restructuring the economy and pursuing fiscal and monetary policies conducive to macroeconomic stabilization. But stabilization was undermined by the RCB, which issued credits to enterprises at subsidized rates, and by strong pressure from industrial and agricultural lobbies seeking additional credits.
By October 1994, inflation, which had been reduced by tighter fiscal and monetary policies early in 1994, began to soar once again to dangerous levels. On October 11, a day that became known as Black Tuesday, the value of the ruble on interbank exchange markets plunged by 27 percent. Although experts presented a number of theories to explain the drop, including the existence of a conspiracy, the loosening of credit and monetary controls clearly was a significant cause of declining confidence in the Russian economy and its currency.
In late 1994, Yeltsin reasserted his commitment to macroeconomic stabilization by firing Viktor Gerashchenko, head of the RCB, and nominating Tat'yana Paramonova as his replacement. Although reformers in the Russian government and the IMF and other Western supporters greeted the appointment with skepticism, Paramonova was able to implement a tight monetary policy that ended cheap credits and restrained interest rates (although the money supply fluctuated in 1995). Furthermore, the parliament passed restrictions on the use of monetary policy to finance the state debt, and the Ministry of Finance began to issue government bonds at market rates to finance the deficits.
The Government also began to address the interenterprise debt that had been feeding inflation. The 1995 budget draft, which was proposed in September 1994, included a commitment to reducing inflation and the budget deficit to levels acceptable to the IMF, with the aim of qualifying for additional international funding. In this budget proposal, the Chernomyrdin government sent a signal that it no longer would tolerate soft credits and loose budget constraints, and that stabiliza-tion must be a top government priority.
During most of 1995, the government maintained its commitment to tight fiscal constraints, and budget deficits remained within prescribed parameters. However, in 1995 pressures mounted to increase government spending to alleviate wage arrearages, which were becoming a chronic problem within state enterprises, and to improve the increasingly tattered social safety net. In fact, in 1995 and 1996 the state's failure to pay many such obligations (as well as the wages of most state workers) was a major factor in keeping Russia's budget deficit at a moderate level (see Social Welfare, ch. 5). Conditions changed by the second half of 1995. The members of the State Duma (beginning in 1994, the lower house of the Federal Assembly, Russia's parliament) faced elections in December, and Yeltsin faced dim prospects in his 1996 presidential reelection bid. Therefore, political conditions caused both Duma deputies and the president to make promises to increase spending.
In addition, late in 1995 Yeltsin dismissed Anatoliy Chubays, one of the last economic reform advocates remaining in a top Government position, as deputy prime minister in charge of economic policy. In place of Chubays, Yeltsin named Vladimir Kadannikov, a former automobile plant manager whose views were antireform. This move raised concerns in Russia and the West about Yeltsin's commitment to economic reform. Another casualty of the political atmosphere was RCB chairman Paramonova, whose nomination had remained a source of controversy between the State Duma and the Government. In November 1995, Yeltsin was forced to replace her with Sergey Dubinin, a Chernomyrdin protégé who continued the tight-money policy that Paramonova had established.
By mid-1996 many Duma deputies raised concerns about the Government's failure to meet its tax revenue targets. Revenue shortages were blamed on a number of factors, including a heavy tax burden that encourages noncompliance and an inefficient and corrupt tax collection system. A variety of tax collection reforms were proposed in the parliament and the Government, but by 1996 Russian enterprises and regional authorities had established a strong pattern of noncompliance with national tax regulations, and the Federal Tax Police Service was ineffectual in apprehending violators (see Ministry of Internal Affairs (MVD), ch. 10).
In 1992, the first year of economic reform, retail prices in Russia increased by 2,520 percent. A major cause of the increase was the decontrol of most prices in January 1992, a step that prompted an average price increase of 245 percent in that month alone. By 1993 the annual rate had declined to 840 percent, still a very high figure. In 1994 the inflation rate had improved to 224 percent.
Trends in annual inflation rates mask variations in monthly rates, however. In 1994, for example, the Government managed to reduce monthly rates from 21 percent in January to 4 percent in August, but rates climbed once again, to 16.4 percent by December and 18 percent by January 1995. Instability in Russian monetary policy caused the variations. After tightening the flow of money early in 1994, the Government loosened its restrictions in response to demands for credits by agriculture, industries in the Far North, and some favored large enterprises. In 1995 the pattern was avoided more successfully by maintaining the tight monetary policy adopted early in the year and by passing a relatively stringent budget. Thus, the monthly inflation rate held virtually steady below 5 percent in the last quarter of the year. For the first half of 1996, the inflation rate was 16.5 percent. However, experts noted that control of inflation was aided substantially by the failure to pay wages to workers in state enterprises, a policy that kept prices low by depressing demand.
An important symptom of Russian macroeconomic instability has been severe fluctuations in the exchange rate of the ruble. From July 1992, when the ruble first could be legally exchanged for United States dollars, to October 1995, the rate of exchange between the ruble and the dollar declined from 144 rubles per US$1 to around 5,000 per US$1. Prior to July 1992, the ruble's rate was set artificially at a highly overvalued level. But rapid changes in the nominal rate (the rate that does not account for inflation) reflected the overall macroeconomic instability. The most drastic example of such fluctuation was the Black Tuesday (1994) 27 percent reduction in the ruble's value.
In July 1995, the RCB announced its intention to maintain the ruble within a band of 4,300 to 4,900 per US$1 through October 1995, but it later extended the period to June 1996. The announcement reflected strengthened fiscal and monetary policies and the buildup of reserves with which the Government could defend the ruble. By the end of October 1995, the ruble had stabilized and actually appreciated in inflation-adjusted terms. It remained stable during the first half of 1996. In May 1996, a "crawling band" exchange rate was introduced to allow the ruble to depreciate gradually through the end of 1996, beginning between 5,000 and 5,600 per US$1 and ending between 5,500 and 6,100.
Another sign of currency stabilization was the announcement that effective June 1996, the ruble would become fully convertible on a current-account basis. This meant that Russian citizens and foreigners would be able to convert rubles to other currencies for trade transactions.
The essence of economic restructuring, and a critical consideration for foreign loans and investment in Russia's economy, is the privatization program. In most respects, between 1992 and 1995 Russia kept pace with or exceeded the rate established in the original privatization program of October 1991. As deputy prime minister for economic policy, the reformist Chubays was an effective advocate of privatization during its important early stages. In 1992 privatization of small enterprises began through employee buyouts and public auctions. By the end of 1993, more than 85 percent of Russian small enterprises and more than 82,000 Russian state enterprises, or about one-third of the total in existence, had been privatized.
On October 1, 1992, vouchers, each with a nominal value of 10,000 rubles (about US$63), were distributed to 144 million Russian citizens for purchase of shares in medium-sized and large enterprises that officials had designated and reorganized for this type of privatization. However, voucher holders also could sell the vouchers, whose cash value varied according to the economic and political conditions in the country, or they could invest them in voucher funds.
By the end of June 1994, the voucher privatization program had completed its first phase. It succeeded in transferring ownership of 70 percent of Russia's large and medium-sized enterprises to private hands and in privatizing about 90 percent of small enterprises. By that time, 96 percent of the vouchers issued in 1992 had been used by their owners to buy shares in firms directly, invest in investment funds, or sell on the secondary markets. According to the organizers of the voucher system, some 14,000 firms employing about two-thirds of the industrial labor force had moved into private hands.
The next phase of the privatization program called for direct cash sales of shares in remaining state enterprises. That phase would complete the transfer of state enterprises and would add to government revenues. After that procedure met stiff opposition in the State Duma, Yeltsin implemented it by decree in July 1994. But the president's commitment to privatization soon came into question. In response to the monetary crisis of October 1994, Yeltsin removed Chubays from his position as head of the State Committee for the Management of State Property, replacing him with little-known official Vladimir Polevanov. Polevanov stunned Russian and Western privatization advocates by suggesting renationalization of some critical enterprises. Yeltsin reacted by replacing Polevanov with Petr Mostovoy, a Chubays ally. In the ensuing eighteen months, Yeltsin made two more changes in the chairmanship position.
In 1995 and 1996, political conditions continued to hamper the privatization program, and corruption scandals tarnished the program's public image. By 1995 privatization had gained a negative reputation with ordinary Russians, who coined the slang word prikhvatizatsiya , a combination of the Russian word for "grab" and the Russianized English word "privatize," producing the equivalent of "grabification." The term reflects the belief that the privatization process most often shifted control of enterprises from state agencies to groups of individuals with inside connections in the Government, the mafiya , or both. Distrust of the privatization process was part of an increasing public cynicism about the country's political and economic leaders, fueled by the seeming failure of Yeltsin's highly touted reform to improve the lot of the average Russian (see Social Stratification, ch. 5).
The second phase of the privatization program went ahead with the sale of state-held shares for cash. Although the process was virtually complete by the end of the first quarter of 1996, the Government failed to garner expected revenues. Meanwhile, Yeltsin's June 1996 bid for reelection brought a virtual halt in privatization of state enterprises during the campaign period. In February 1996, the Procuracy announced a full-scale investigation into privatization practices, in particular a 1995 transaction in which state banks awarded loans to state firms in return for "privatization" shares in those enterprises (see The Procuracy, ch. 10). This loans-for-shares type of transaction characterized the second phase of privatization; banks provided the government badly needed cash based on the collateral of enterprise shares that banks presumably would be able to sell later. But most of the twenty-nine state enterprises originally slated to participate withdrew, and the banks that received shares appeared to have a conflict of interest based on their role in setting the rules of the bidding procedure. In the most widely publicized deal, the Uneximbank of Moscow received a 38 percent interest in the giant Noril'sk Nickel Joint-Stock Company at about half of a competing bid. Other banks and commercial organizations joined the traditional opponents of privatization in attacking the loans-for-shares program, and in 1996 the Government admitted that the program had been handled badly. As a result of corruption allegations, the State Duma formed a committee to review the privatization program. And Prime Minister Chernomyrdin requested off-budget funds to buy back shares from the banks.
Because the faults of the Yeltsin privatization program were an important plank in the 1996 presidential election platform of the Communist Party of the Russian Federation (Kommunisticheskaya partiya Rossiyskoy Federatsii--KPRF), the strongest opposition party, Yeltsin's campaign strategy was to reduce privatization as far as possible as a campaign issue (see The Executive Branch, ch. 7). Part of that strategy was to shift the privatization process from Moscow to the regions. In February 1996, a presidential decree simply granted shares in about 6,000 state-controlled firms to regional governments, which could auction the shares and keep the profits.
After Yeltsin's reelection in July 1996, his financial representatives announced continuation of the privatization program, with a new focus on selling ten to fifteen large state enterprises, including the joint-stock company of the Unified Electric Power System of Russia (YeES Rossii), the Russian State Insurance Company (Rosgosstrakh), and the St. Petersburg Maritime Port. The Communications Investment Joint-Stock Company (Svyazinvest), sale of which had failed in 1995, was to be offered to Western telecommunications companies in 1996.
The new, postelection privatization stage also was to reduce the role of enterprise workers in shareholding. Within the first years of such ownership, most worker shares had been sold at depressed prices, devaluing all shares and cutting state profits from enterprise sales. Therefore, to reach the budget target of 12.4 trillion rubles (about US$2.4 billion) of profit from privatization sales in 1996, distribution was to target recipients who would hold shares rather than sell them immediately.
Despite periodic delays, the inept administration of the program's more recent phases, and allegations of favoritism and corrupt transactions in the enterprise and financial structures, in 1996 international experts judged Russia's privatization effort a qualified success. The movement of capital assets from state to private hands has progressed without serious reversal of direction--despite periodic calls for reestablishing state control of certain assets. And the process has contributed to the creation of a new class of private entrepreneur.
As of mid-1996, four and one-half years after the launching of Russia's post-Soviet economic reform, experts found the results promising but mixed. The Russian economy has passed through a long and wrenching depression. Official Russian economic statistics indicate that from 1990 to the end of 1995, Russian GDP declined by roughly 50 percent, far greater than the decline that the United States experienced during the Great Depression. (However, alternative estimates by Western analysts described a much less severe decline, taking into account the upward bias of Soviet-era economic data and the downward bias of post-Soviet data.) Such a decline, however, was to be expected in an economy going through the transition from central planning to a market structure. Much of the decline in production has occurred in the military-industrial complex and other heavy industries that benefited most from the skewed economic priorities of Soviet planners but have much less robust demand in a freer market.
But other major sectors such as agriculture, energy, and light industry also suffered from the transition. To enable these sectors to function in a market system, inefficient enterprises had to be closed and workers laid off, with resulting short-term declines in output and consumption. Analysts had expected that Russia's GDP would begin to rise in 1996, but data for the first six months of the year showed a continuing decline, and some Russian experts predicted a new phase of economic crisis in the second half of the year.
The pain of the restructuring has been assuaged somewhat by the emergence of a new private sector. Western experts believe that Russian data overstate the dimensions of Russia's economic collapse by failing to reflect a large portion of the country's private-sector activity. The Russian services sector, especially retail sales, is playing an increasingly vital role in the economy, accounting for nearly half of GDP in 1995. The services sector's activities have not been adequately measured. Data on sector performance are skewed by the underreporting or nonreporting of output that Russia's tax laws encourage. According to Western analysts, by the end of 1995 more than half of GDP and more than 60 percent of the labor force were based in the private sector.
An important but unconventional service in Russia's economy is "shuttle trading"--the transport and sale of consumer goods by individual entrepreneurs, of whom 5 to 10 million were estimated to be active in 1996. Traders buy goods in foreign countries such as China, Turkey, and the United Arab Emirates and in Russian cities, then sell them on the domestic market where demand is highest. Yevgeniy Yasin, minister of economics, estimated that in 1995 some US$11 billion worth of goods entered Russia in this way. Shuttle traders have been vital in maintaining the standard of living of Russians who cannot afford consumer goods on the conventional market. However, domestic industries such as textiles suffer from this infusion of competing merchandise, whose movement is unmonitored, untaxed, and often mafiya -controlled.
The geographical distribution of Russia's wealth has been skewed at least as severely as it was in Soviet times. By the mid-1990s, economic power was being concentrated in Moscow at an even faster rate than the federal government was losing political power in the rest of the country. In Moscow an economic oligarchy, composed of politicians, banks, businesspeople, security forces, and city agencies, controlled a huge percentage of Russia's financial assets under the rule of Moscow's energetic and popular mayor, Yuriy Luzhkov. Unfortunately, organized crime also has played a strong role in the growth of the city (see The Crime Wave of the 1990s, ch. 10). Opposed by a weak police force, Moscow's rate of protection rackets, contract murders, kickbacks, and bribes--all intimately connected with the economic infrastructure--has remained among the highest in Russia. Most businesses have not been able to function without paying for some form of mafiya protection, informally called a krysha (the Russian word for roof).
Luzhkov, who has close ties to all legitimate power centers in the city, has overseen the construction of sports stadiums, shopping malls, monuments to Moscow's history, and the ornate Christ the Savior Cathedral. In 1994 Yeltsin gave Luzhkov full control over all state property in Moscow. In the first half of 1996, the city privatized state enterprises at the rate of US$1 billion per year, a faster rate than the entire national privatization process in the same period. Under Luzhkov's leadership, the city government also acquired full or major interests in a wide variety of enterprises--from banking, hotels, and construction to bakeries and beauty salons. Such ownership has allowed Luzhkov's planners to manipulate resources efficiently and with little or no competition. Meanwhile, Moscow also became the center of foreign investment in Russia, often to the exclusion of other regions. For example, the McDonald's fast-food chain, which began operations in Moscow in 1990, enjoyed immediate success but expanded only in Moscow. The concentration of Russia's banking industry in Moscow gave the city a huge advantage in competing for foreign commercial activity.
In mid-1996 the national government appeared to have achieved some degree of macroeconomic stability. However, longer-term stability depends on the ability of policy makers to withstand the inflationary pressures of demands for state subsidies and easier credits for failing enterprises and other special interests. (Chubays estimated that spending promises made during Yeltsin's campaign amounted to US$250 per voter, which if actually spent would approximately double the national budget deficit; most of Yeltsin's pledges seemingly were forgotten shortly after his reelection.)
By 1996 the structure of Russian economic output had shifted far enough that it more closely resembled that of a developed market economy than the distorted Soviet central-planning model. With the decline in demand for defense industry goods, overall production has shifted from heavy industry to consumer production (see The Defense Industry, ch. 9). However, in the mid-1990s the low quality of most domestically produced consumer goods continued to limit enterprises' profits and therefore their ability to modernize production operations. On the other side of the "vicious circle," reliance on an outmoded production system guaranteed that product quality would remain low and uncompetitive.
Most prices are left to the market, although local and regional governments control the prices of some staples. Energy prices remain controlled, but the Government has been shifting these prices upward to close the gap with world market prices.
Russia is the largest country in the world; it covers a vast amount of topographically varied territory, including much that is inaccessible by conventional modes of transportation. The traditional centers of economic activity are almost exclusively located in the more hospitable European part of Russia, which once offered considerable coal and natural gas to drive heavy industry (see fig. 7). But the European fuel base was largely depleted by the 1980s, forcing Russia to rely on Siberian deposits much farther from the industrial heartland.
Russia is one of the world's richest countries in raw materials, many of which are significant inputs for an industrial economy. Russia accounts for around 20 percent of the world's production of oil and natural gas and possesses large reserves of both fuels. This abundance has made Russia virtually self-sufficient in energy and a large-scale exporter of fuels. Oil and gas were primary hard-currency earners for the Soviet Union, and they remain so for the Russian Federation. Russia also is self-sufficient in nearly all major industrial raw materials and has at least some reserves of every industrially valuable nonfuel mineral--even after the productive mines of Ukraine, Kazakstan, and Uzbekistan no longer were directly accessible. Tin, tungsten, bauxite, and mercury were among the few natural materials imported in the Soviet period. Russia possesses rich reserves of iron ore, manganese, chromium, nickel, platinum, titanium, copper, tin, lead, tungsten, diamonds, phosphates, and gold, and the forests of Siberia contain an estimated one-fifth of the world's timber, mainly conifers (see fig. 8; Environmental Conditions, ch. 3).
The iron ore deposits of the Kursk Magnetic Anomaly, close to the Ukrainian border in the southwest, are believed to contain one-sixth of the world's total reserves. Intensive exploitation began there in the 1950s. Other large iron ore deposits are located in the Kola Peninsula, Karelia, south-central Siberia, and the Far East. The largest copper deposits are located in the Kola Peninsula and the Urals, and lead and zinc are found in North Ossetia.
Climatic and geographic factors limit Russia's agricultural activity to about 10 percent of the country's total land area. Of that amount, about 60 percent is used for crops, the remainder for pasture and meadow (see table 15, Appendix). In the European part of Russia, the most productive land is in the Central Chernozem Economic Region and the Volga Economic Region, which occupy the grasslands between Ukraine and Kazakstan. More than 65 percent of the land in those regions is devoted to agriculture. In Siberia and the Far East, the most productive areas are the southernmost regions. Fodder crops dominate in the colder regions, and intensity of cultivation generally is higher in European Russia. The last expansion of cultivated land occurred in the late 1950s and early 1960s, when the Virgin Lands program of Nikita Khrushchev opened land in southwestern Siberia (and neighboring Kazakstan) for cultivation. In the mid-1990s, about 15 percent of the working population was occupied in agriculture, with the proportion dropping slowly as the younger population left rural areas to seek economic opportunities elsewhere (see Rural Life, ch. 5).
Grains are among Russia's most important crops, occupying more than 50 percent of cropland. Wheat is dominant in most grain-producing areas. Winter wheat is cultivated in the North Caucasus and spring wheat in the Don Basin, in the middle Volga region, and in southwestern Siberia. Although Khrushchev expanded the cultivation of corn for livestock feed, that crop is only suitable for growth in the North Caucasus, and production levels have remained low compared with other grains. Barley, second to wheat in gross yield, is grown mainly for animal feed and beer production in colder regions as far north as 65° north latitude (the latitude of Arkhangel'sk) and well into the highlands of southern Siberia. Production of oats, which once ranked third among Russia's grains, has declined as machines have replaced horses in farming operations.
Legumes became a common crop in state farms in the 1980s. Potatoes, a vital crop for food and for the production of vodka, are grown in colder regions between 50° and 60° north latitude. Sugar beet production has expanded in recent years; the beets are grown mainly in the rich black-earth districts of European Russia. Flax, also a plant tolerant of cold and poor soils, is Russia's most important raw material for textiles, and the country produced about half the world's flax crop in the 1980s. Flax also yields linseed oil, which together with sunflowers (in the North Caucasus) and soybeans (in the Far East) is an important source of vegetable oil. Production of fruits and vegetables increased as private farms began to expand around 1990. In the mid-1990s, the largest yields in that category were in cabbages, apples, tomatoes, and carrots.
Increased production of fodder crops and expansion of pastureland have supported Russia's livestock industry, although economic conditions have caused cutbacks in animal holdings. Cattle are the most common form of livestock except in the drier areas, where sheep and goats dominate. The third-largest category is pigs, which are raised in areas of European Russia and the Pacific coast that offer grain, potatoes, or sugar beets as fodder. Only very small numbers of chickens are kept, and frozen chicken has become one of Russia's largest import items.
Agricultural reform has proved to be a tough challenge for Russia during its transition to a market economy. The challenge comes from the legacy of the Soviet period and from deeply imbedded cultural biases against individualism. Because of agriculture's vital economic role, large-scale agricultural reform is necessary for success in other sectors. In the mid-1990s, however, private initiative was not rewarded, and inefficient input distribution and marketing structures failed to take advantage of agricultural assets.
Under Stalin the government socialized agriculture and created a massive bureaucracy to administer policy. Stalin's campaign of forced collectivization, which began in 1929, confiscated the land, machinery, livestock, and grain stores of the peasantry. By 1937 the government had organized approximately 99 percent of the Soviet countryside into state-run collective farms. Under this grossly inefficient system, agricultural yields declined rather than increased. The situation persisted into the 1980s, when Soviet farmers averaged about 10 percent of the output of their counterparts in the United States.
During Stalin's regime, the government assigned virtually all farmland to one of two basic agricultural production organizations--state farms and collective farms. The state farm was conceived in 1918 as the ideal model for socialist agriculture. It was to be a large, modern enterprise directed and financed by the government. The work force of the state farm received wages and social benefits comparable to those enjoyed by industrial workers. By contrast, the collective farm was a self-financed producer cooperative that farmed parcels of land that the state granted to it rent-free and that paid its members according to their contribution of work.
In their early stages, the two types of organization also functioned differently in the distribution of agricultural goods. State farms delivered their entire output to state procurement agencies in response to state production quotas. Collective farms also received quotas, but they were free to sell excess output in collective-farm markets where prices were determined by supply and demand. The distinction between the two types of farms gradually narrowed, and the government converted many collective farms to state farms, where the state had more control.
Private plots also played a role in the Soviet agricultural system. The government allotted small plots to individual farming households to produce food for their own use and for sale as an income supplement. Throughout the Soviet period, the productivity rates of private plots far exceeded their size. With only 3 percent of total sown area in the 1980s, they produced over a quarter of agricultural output.
A number of factors made the Soviet collectivized system inefficient throughout its history. Because farmers were paid the same wages regardless of productivity, there was no incentive to work harder and more efficiently. Administrators who were unaware of the needs and capabilities of the individual farms decided input allocation and output levels, and the high degree of subsidization eliminated incentives to adopt more efficient production methods.
The Gorbachev agricultural reform program aimed to improve production incentives. Gorbachev sought to increase agricultural labor productivity by forming contract brigades consisting of ten to thirty farmworkers who managed a piece of land leased from a state or collective farm. The brigades were responsible for the yield of the land, which in turn determined their remuneration. After 1987 the government legalized family contract brigades and long-term leasing of land, removing the restrictions on the size of private agricultural plots and cutting into the state's holdings of arable land.
Although Gorbachev's reforms increased output in the agricultural sector in 1986, they failed to address fundamental problems of the system, such as the government's continued control over the prices of agricultural commodities, the distribution of agricultural inputs, and production and investment decisions. In the contract brigade system, farmers still had no real vested interest in the farms on which they worked, and production suffered accordingly. In the 1980s, the Soviet Union went from being self-sufficient in food production to becoming a net food importer.
The Yeltsin regime has attempted to address some of the fundamental reform issues of Russian agriculture. But agricultural reform has moved very slowly, causing output to decline steadily through the mid-1990s. Reform began in Russia shortly before the final collapse of the Soviet Union. In December 1990, the Congress of People's Deputies of the Russian Republic enacted a number of laws that were designed to restructure the agricultural sector and make it more commercially viable. The Law on Peasant Farms legalized private farms and allowed them to operate alongside state and collective farms, to hire labor, and to sell produce without state supervision. The same session of the congress passed the Law on Land Reform, which permitted land to be bequeathed as an inheritance from one generation to the next, but not to be bought or sold. The government also established the State Committee for Agrarian Reform, whose responsibility was to oversee the transfer of available land to private farming.
The main thrust of Yeltsin's agricultural reform has been toward reorganizing state and collective farms into more efficient, market-oriented units. A decree of December 1991 and its subsequent amendments provided several options to state and collective farmers for the future structure of their farms. The decree required that farmers choose either to reorganize into joint-stock companies, cooperatives, or individual private farms, or to maintain their existing structure. Under the first two arrangements, workers would hold shares in the farms and be responsible for managing the enterprises. An individual farmer could later decide to break from the larger unit and establish private ownership of his or her share of the land, as determined by an established procedure.
This restructuring program has progressed slowly. Although 95 percent of the state and collective farms underwent some form of reorganization, about one-third of them retained essentially their earlier structure. Most of the others, fearing the unstable conditions of market supply and demand that faced individual entrepreneurs, chose a form of collective ownership, either as joint-stock companies or as cooperatives. The conservatism of Russia's farmers prompted them to preserve as much as possible of the inefficient but secure Soviet-era controlled relationships of supply and output.
As of 1996, individual private farming had not assumed the significance in Russian agriculture that reformers and Western supporters had envisioned. Although the number of private farms increased considerably following the reforms of 1990, by the early 1990s the growth of farms had stalled, and by the mid-1990s the number of private farms actually may have dropped as some individuals opted to return to a form of cooperative enterprise or left farming entirely. By the end of 1995, Russia's 280,000 private farms accounted for only 5 percent of the arable land in Russia.
A number of factors have contributed to the slow progress of agricultural reform. Until the mid-1990s, the state government continued to act as the chief marketing agent for the food sector by establishing fixed orders for goods, thus guaranteeing farmers a market. The government also subsidized farms through guaranteed prices, which reduced the incentive of farmers to become efficient producers.
Perhaps most important, effective land reform has not been accomplished in Russia. The original land reform law and subsequent decrees did not provide a clear definition of private property, and they did not prescribe landholders' rights and protections. The nebulous status of private landholders under the new legislation made farmers reluctant to take the risk of proprietorship. In March 1996, President Yeltsin issued a decree that allows farmers to buy and sell land. However, in April 1996 the State Duma, heavily influenced by the antireform KPRF and its ally, the Agrarian Party of Russia (representing the still formidable vested interests of collective and state farms), passed a draft law that prohibits land sales by anyone but the state. Recent opposition to the new notion of private landownership is based in a strong traditional Russian view that land must be held as collective rather than individual property.
However, in 1996 several factors were exerting pressure on the agricultural sector to become commercially viable. The federal government has retreated from its role as a guaranteed purchaser and marketer, although some regional governments are stepping in to fill the role. And private markets are emerging slowly. Increasingly, Russian agricultural production must compete with imported goods as the gap between domestic prices and world prices narrows. In addition, the fiscal position of the federal government has forced it to reduce subsidies to many sectors of the economy, including agriculture. Subsidies are among the targets of major budget cuts to comply with the standards of the IMF and other Western lenders and achieve macroeconomic stabilization.
Like the rest of the economy, the Russian agricultural sector has experienced a long, severe recession in the 1990s. Even before the dissolution of the Soviet Union, the output of grains and other crops began to decline, and it decreased steadily through 1996 because of the unavailability of fertilizers and other inputs, bad weather, and major readjustments during the period of transition. In 1995 overall agricultural production declined 8 percent, including a drop of 5 percent in crop production and 11 percent in livestock production. That year Russia suffered its worst grain harvest since 1963, with a yield of 63.5 million tons.
The most dramatic declines occurred in livestock production. Farmers reduced their holdings of animals as the price of grains and other inputs increased. As meat prices rose, the composition of the average consumer's diet included less meat and more starches and vegetables. Reduced demand in turn exacerbated the decline in livestock production.
Energy plays a central role in the Russian economy because it drives all the other elements of the system--the industrial, agricultural, commercial, and government sectors. In addition, energy, particularly petroleum and natural gas, is the most important export and source of foreign exchange for the Russian economy. Experts forecast that the energy sector will continue to occupy this central position until Russian manufacturing reaches a level competitive with the West.
Russia's self-sufficiency in fuels and power generation puts the country in a good position for future economic growth and development. But Russia is also one of the most energy-dependent countries. The International Energy Agency of the Organisation for Economic Co-operation and Development (OECD--see Glossary) estimated that in 1993 it took 4.46 tons of oil equivalent (TOE) to produce US$1,000 of Russia's GDP, compared with an average of 0.23 TOE to produce US$1,000 of GDP for the OECD member countries.
Russia's excessive consumption of energy results from the Soviet system, which artificially priced energy far below the level of world market prices and thus subsidized it. Soviet energy-pricing policies disregarded resource utilization in the quest for higher output volumes and discouraged the adoption of conservation measures. Soviet planners also skewed resources toward the defense-related and heavy industries, which consume energy more intensively than other sectors of the economy. Until the 1980s, the national economy managed to survive under such policies because of the Soviet Union's rich endowment of natural resources.
The problems that plagued the Russian energy sector in the last decades of the Soviet Union were exacerbated during the transition period. Since 1991 the output of all types of fuel and energy has declined, partly because of plummeting demand for energy during a time of general economic contraction. But the energy sectors also have suffered from the intrinsic structural defects of the central planning system: poor management of resources, underinvestment, and outdated technology and equipment.
The structure of energy and fuel production began to change dramatically in the 1980s with the exploitation of large natural gas deposits. In the mid-1990s, natural gas accounted for more than half of Russia's energy consumption, a share that is expected to increase in the next decades. Oil accounts for another 20 percent, a proportion that is expected to remain approximately constant. Coal and other solid fuels, water power, and nuclear energy account for smaller shares that experts predict likely will decline after 2000. Despite the waste of fuel in the Russian economy, Russia manages to produce a surplus of energy for export. Exports, particularly of natural gas and oil, have accounted for 30 percent of Russian energy production, and this share is expected to hold steady.
Russia's drive to become a market economy should help to alleviate some of the problems of the energy sector. Russian energy pricing policies have changed. Since January 1992, energy has been gradually deregulated, closing the gap between world market prices and domestic prices and forcing consumers to conserve. Russia is also adopting Western technology and more efficient management techniques that will improve productivity in the sector.
Russia ranks third in the world in oil production, after Saudi Arabia and the United States. Estimates place proven and potential oil reserves at 8 to 11 billion tons. Russia's oil production peaked in 1987, then began a decline that continued through 1995. In the latter year, the yield was 741 million barrels, 13 million barrels less than the previous year. Output for the first quarter of 1996 was 182 million barrels.
Wasteful Soviet oil exploration and extraction techniques depleted wells, which often fell far below their potential capacity. Soviet technology was not capable of exploring and extracting as deeply and efficiently as Western technology. These handicaps have been instrumental in Russia's plummeting oil production during the last two decades. In 1994 the number of oil wells drilled was only one-quarter the number drilled in 1983. About two-thirds of Russia's oil comes from Siberia, mostly from huge fields in the northwest part of the region. The main European oil and gas fields are located in the Volga-Ural region, the North Caucasus, and the far north of the Republic of Komi (see fig. 9).
Russian oil companies are vertically integrated units that control the entire production process from exploration to transmission. The largest company is Lukoil, which, according to some measurements, is the largest oil company in the world. The dominance of a few large companies has made all stages of petroleum exploitation and sale extremely inefficient. National and local government policies have discouraged individual retailers from establishing independent gasoline storage facilities and stations; therefore, retail gasoline likely will continue to be in very short supply (only 8,900 stations were operating in Russia in 1995). Until January 1995, government policy applied quotas to oil exports, and until July 1996 tariffs were applied to oil exports. Both policies, resulting from the gap between controlled domestic prices and world market prices, aimed at ensuring a sufficient supply of oil to meet domestic demand; both were lifted as the gap narrowed.
The search for new oil deposits has been a primary force in Russia's foreign policy toward states to the south. Russia has staked its claim to the Caspian oil reserves that Western companies are exploring in conjunction with Azerbaijani, Turkmenistani, and Kazakstani state companies. The presence of Western interests and the strong role being played by Iran and Turkey, Russia's traditional regional rivals, have complicated this policy, which aims to achieve maximum benefit from Russia's position on the shore of the north Caspian. Also a source of international controversy is Russia's insistence that Caspian oil flow northward through Russian pipelines rather than westward via new lines built through Georgia and Turkey (see Foreign Investment in Oil and Gas, this ch.).
Russia is also one of the world's largest natural gas producers. Its proven reserves have been estimated at 49 billion cubic meters, or roughly 35 percent of the world's total. Natural gas has also been one of the most successful parts of the Russian economy. In the early 1980s, it replaced oil as the Soviet "growth fuel," offering cheaper extraction and transportation. Although output has dropped in the 1990s, the decline has not been as severe as that for other energy sources or the rest of the economy. Natural gas production peaked in 1991 at 727 million cubic meters, then dropped throughout the early 1990s. But 1995 production, 596 million cubic meters, was an increase from the previous year. After European gas fields in the Volga-Ural region dominated the industry through the 1970s, production shifted to giant fields in Siberia. The Urengoy and Yamburg fields in the West Siberia region are among the most productive; the former is the largest field in the world. Soviet plans called for rapid development of new reserves in the Yamal Peninsula in the Arctic Ocean north of Urengoy, but environmental problems and infrastructure costs slowed development. Hasty construction and poor maintenance have caused chronic breakdowns and accidents in the long pipelines of Russia's natural gas delivery system (see Transportation, this ch.).
The State Natural Gas Company (Gazprom) has a virtual monopoly over Russia's gas production and transmission. A vertically organized enterprise, the company has been reorganized into a joint-stock company, in which 40 percent of the shares remain under state control. Company employees hold another 15 percent, managers of the company hold 10 percent, and the remaining 35 percent were sold at public auction. Gazprom controls a network of regional production associations. Its management, which once was headed by Prime Minister Viktor Chernomyrdin, has been accused of corruption and tax evasion.
For more than 150 years, coal was the dominant fuel supporting Russia's industries, and many industrial centers were located near coal deposits. In the 1960s, oil and natural gas overtook coal when plentiful reserves of those fuels became available and the coal shafts of the European Soviet Union (located primarily in what is today Ukraine) were being exhausted. Russian coal reserves are estimated at 200 billion tons, an amount that experts say is more than ample for current usage trends. Siberia and the Far East produce about three-quarters of Russia's coal, with the European contributions coming largely from the Vorkuta field (Pechora Basin) in Komi, the Urals, the eastern Donets Basin in the southwest, and the Moscow Basin. Largely untapped coal fields lie in the Siberian Tunguska and Lena basins. Productive fields in Siberia are located along the Trans-Siberian Railroad, making their exploitation more economical. The largest operational sources in that region are the Kuznetsk, Kansk-Achinsk, and Cheremkhovo fields. Coal is one of the less important sources of energy because its labor-intensive extraction makes production much more costly than other fuels. Rossugol', the Russian coal company, controls coal production through regional associations that are organized as joint-stock companies. Russian coal production has declined markedly over the last decade, and the coal industry has suffered a long series of strikes. Coal miners, among the best paid industrial workers of the Soviet period, have organized strikes that have gained national attention to protest the industry's long delays in paying wages. Experts predict that coal output will continue to dwindle as its relative usefulness in industry and domestic applications is reduced. In 1994 Russia produced 249 million tons of coal, and in 1995 the total rose to 255 million tons. Production for the first quarter of 1996 was 71 million tons.
In 1996 some twenty-nine nuclear reactors were operating at nine sites: Balakovo on the northwest border of Kazakstan, Beloyarsk in the southern Urals, Bilibino in northeastern Siberia (the only station east of the Urals), Kola in the far northwest, Kursk near the Ukrainian border, Novovoronezh on the Don River, St. Petersburg, Smolensk west of Moscow, and Tver' northwest of Moscow. Altogether these facilities accounted for 10 percent of Russia's energy generating capacity in 1994. The plants are operated by regional joint-stock companies in which the Ministry of Atomic Energy (Minatom) controls 51 percent of the shares. The nuclear energy sector has undergone financial problems because of government funding reductions. The industry has turned to selling goods related to nuclear energy--equipment and instruments, nuclear fuel, medical isotopes, and fertilizers.
The industry's financial problems, along with the disaster that occurred at the Chernobyl' plant in Ukraine in 1986, have raised questions about nuclear safety. Western countries have provided financial assistance in some cases because of their concern about Russia's lax standards of handling nuclear materials and the continued use of outmoded equipment. Russia's piecemeal environmental laws have led to indiscriminate dumping and burial of radioactive wastes, which are creating severe environmental problems. The theft of nuclear materials has become another source of danger emanating from Russia's nuclear energy program (see Environmental Conditions, ch. 3; The Crime Wave of the 1990s, ch. 10).
Nevertheless, experts predict that nuclear energy probably will play an important role in the Russian economy if enough investment is available to expand existing capacity. In 1992 Minatom announced plans to double nuclear energy capacity by 2010, but ensuing financial problems have caused a reduction of that goal, and no new capacity has been added since the breakup of the Soviet Union. The International Atomic Energy Agency (IAEA) projects that construction of new capacity will not begin until after 2005, even if the investment climate is favorable.
Much of the conventional fuel produced in Russia is burned to produce electric power. The Unified Electric Power System operates Russia's electric power plants through seventy-two regional power distribution companies. The power system consists of 600 thermal generating systems, more than 100 hydroelectric plants, and Russia's nine nuclear plants. Of the total rated generating capacity of 205 gigawatts, only about 188 gigawatts were available as of 1996. In 1995 Russia's power plants generated a total of 846 million kilowatt-hours, compared with 859 million kilowatt-hours in 1994. Generation for the first quarter of 1996 (normally the peak demand period of the year) was 268 million kilowatt-hours.
In 1993 natural gas provided 42 percent of electricity production; hydroelectric plants, 19 percent; coal, 18 percent; nuclear power, 13 percent; and other sources such as solar and geothermal plants, 8 percent. Natural gas and coal are burned at thermoelectric plants, which produce only electricity, and at cogeneration plants, which produce electricity and heat for urban centers. The largest hydroelectric plants are located on the Volga, Kama, Ob', Yenisey, and Angara rivers, where large reservoirs were built in massive Soviet energy projects. Thermoelectric and hydroelectric plants--located in Siberia because of available fuels and water power--send power to European Russia through a system of high-voltage transmission lines.
Consumption of electric power divides into the following categories: industrial, 61 percent; residential, 11 percent; the services sector, 11 percent; transportation, 9 percent; and agriculture, 8 percent. Regional energy commissions control the price of electricity.
In the mid-1990s, many analysts consider the oil and gas industries to be the best targets for foreign investment in Russia. The record of foreign investment in that period illustrates both the potentials and the pitfalls of such ventures. Experts have concluded that the Russian oil and gas sector will require large amounts of foreign capital to improve output. According to some estimates, the oil sector will require US$30 to US$50 billion in new investment just to maintain the mid-1990s level of production. To return production to its peak levels will require an estimated US$70 to US$130 billion in new investments, which clearly would have to come from foreign sources. The Russian oil and gas sector also would benefit from infusions of Western technology and expertise. However, according to a 1995 report by Cambridge Energy Research Associates, key figures in the oil industry, most of whom were schooled in the isolated Soviet-era approach to commerce, have been indifferent or hostile to Western management methods.
By the end of 1994, the oil and gas sector accounted for about 38 percent of total foreign direct investment in Russia, but the total input was only about US$1.4 billion. Although Western companies are poised to commit large amounts of capital for exploration, as of 1996 most foreign investment had gone to repairing and maintaining current facilities. Some analysts have estimated that foreign investment in the oil and gas sector could reach US$70 billion by the year 2000.
Among several United States oil companies active in Russia, Texaco heads a consortium in the largest project, the development of oil fields in the Timan-Pechora section of the Komi region north of the Arctic Circle. The project, under negotiation since 1989, has an estimated potential of US$45 billion in investment over the next fifty years. Conoco, a subsidiary of the DuPont de Nemours chemical firm, leads a consortium of United States and European firms and a Russian firm in the Polar Lights project to explore Siberian oil fields. Two United States companies, Marathon Oil and McDermott, along with the Japanese companies Mitsui and Mitsubishi and Britain's Royal Dutch Shell, are engaged in one of several projects to explore for oil off Sakhalin Island on the Pacific coast. The last two projects each could bring in as much as US$10 billion.
Nevertheless, Russia's generally poor investment climate and other obstacles such as special taxes have discouraged additional investment in gas and oil. As of mid-1996, a tax of about US$5 per barrel was imposed on oil exports, and a tax of about US$2.60 was levied per 1,000 cubic meters of natural gas exported. Foreign and domestic firms were also subject to royalty payments to the Government for the privilege of drilling for oil. Foreign investors have argued that reduced profit margins are a substantial obstacle to the support of some projects. Some major oil investors have received tax exemptions, but delays in rebate payments have created additional deterrents.
Experts have agreed that establishing a viable financial sector is a vital requirement for Russia to have a successful market economy. In the first five years of the post-Soviet era, the development of Russia's financial sector as an efficient distributor of money and credit to other parts of the economic structure has mirrored the ups and downs of the rest of the economy. In 1996 some elements of the central planning system remained obstacles to further progress.
The financial system of the Soviet period was a rudimentary mechanism for state control of the economy. The government owned and managed the banking system. The State Bank (Go-sudarstvennyy bank--Gosbank) was the central bank and the only commercial bank. In its capacity as a central bank, Gosbank handled all significant banking transactions, including the issuance and control of currency and credit, the management of gold reserves, and the oversight of transactions among enterprises. Enterprises were issued money and credits in accordance with the government's planned allocation of wages and its management strategy for other expenses.
Wages were paid only in cash, and households used cash exclusively for making payments. Checkbooks, credit cards, and other alternative forms of payment were not available in the Soviet Union. Wage earners could keep savings deposits in the Savings Bank (Sberbank), where they earned low interest, and these funds were available to the government as a source of revenue. Two other banks also existed prior to 1987. The Construction Bank (Stroybank) provided investment credits to enterprises, and the Foreign Trade Bank (Vneshtorgbank) handled financial transactions pertaining to trade.
In 1987 and 1988, the Gorbachev regime separated commercial banking operations from Gosbank and replaced the two specialized banks with three banks to provide credit to designated sectors of the economy: the Agro-Industrial Bank (Agroprombank), the Industry and Construction Bank (Promstroy-bank), and the Social Investment Bank (Zhilsotsbank), which managed credits for the social welfare sector. The Soviet economy also had state-controlled insurance firms, but other forms of finance such as stocks and bonds did not exist.
In the 1990s, Russia's financial sector, particularly its banking system, has been one of the fastest changing elements of the economy. Although changes have moved clearly in the direction of market principles, in the mid-1990s much additional reform was necessary to achieve stability.
The Russian banking system has developed from the centralized system of the Soviet period into a two-tier system, including a central bank and commercial banks, that is the standard structure in market-based economies. The Russian Central Bank (RCB) assumed the functions of Gosbank in November 1991, and Gosbank was eliminated when the Soviet Union dissolved one month later. In its first years of existence, the RCB functioned under the guidelines of the 1977 Soviet constitution and Russian laws passed in 1990, which made the bank essentially an arm of the Russian parliament, whose members manipulated bank policy to help favored enterprises.
Russia's 1993 constitution gave the RCB more autonomy. However, the president has substantial influence on bank policies through his power to appoint the bank chairman, who in turn wields extensive authority over bank operations and policy. (The nomination is subject to the approval of the State Duma.)
Viktor Gerashchenko, a former Gosbank chairman, was the first chairman of the RCB. In late 1994, he resigned under pressure from President Yeltsin after the so-called Black Tuesday plunge of the ruble's value on exchange markets (see Monetary and Fiscal Policies, this ch.). Yeltsin named Tat'yana Paramonova to replace Gerashchenko, but she remained acting chairman throughout her tenure because the State Duma refused to approve her appointment. Powerful Duma members opposed Paramonova's policy of restricting credits to favored industrial sectors. In November 1995, the Duma approved Yeltsin's nomination of Sergey Dubinin to replace State Paramonova; Dubinin remained in that position through the end of Yeltsin's first term as president in mid-1996.
The Law on the Central Bank, enacted in April 1995, provides the statutory authority for the RCB. Under the law, the RCB is responsible for controlling the country's money supply, monitoring transactions among banks, implementing the federal budget and servicing Russia's foreign debt, monitoring the foreign-exchange rate of the ruble, implementing Russian exchange-rate policies, maintaining foreign currency reserves and gold reserves, licensing commercial banks, and regulating and supervising commercial banks.
The RCB has had the greatest impact on Russia's economy through its role in monetary policy. The RCB controls the money supply by lending funds to commercial banks and by establishing their reserve requirements. For several years after its establishment, the RCB issued direct credits to enterprises and to the agricultural sector at subsidized rates. Such credits were directed via commercial banks to politically influential sectors: agriculture, the industrial and energy enterprises of the northern regions, the energy sector in general, and other large, state-run enterprises.
In the early years, the RCB also financed state budget deficits by issuing credits to cover Government expenditures. The availability of such credits played a central role in the high inflation that the Russian economy endured between 1991 and 1994. In 1995 new legislation and regulations reduced this type of credit by prohibiting the use of credit to finance state budget deficits, and recent RCB chairmen have raised discount rates for RCB borrowing by commercial banks. Such restrictions have been heavily influenced by requirements of the IMF to maintain strict fiscal and monetary standards to be eligible for international financial assistance (see Foreign Debt, this ch.).
Initially, the RCB's regulation of commercial banks also was lax because the banking sector grew rapidly as the centralized economy collapsed and because Russia had no experience in establishing a market-based system. In the early and mid-1990s, the failure of regulation led to a plethora of new commercial banks, most of which were of dubious quality.
In the mid-1990s, the World Bank (see Glossary) assisted the Russian government in establishing a core of large banks, called international standard banks, that met the standards of the Bank for International Settlements (BIS--see Glossary). The new banks must conform to strict standards for the size and interest rates of loans; the size of a bank's capital base; the volume of loan reserves that banks must maintain; and the scrutiny under which banking activities will be monitored. The International Standard Bank program anticipates that the core of banks that meet its requirements will grow until the entire banking system conforms to the BIS criteria.
Meanwhile, plans called for the RCB to remain the foundation of the Russian banking system. Its success will depend greatly on its retaining as much independence as possible from both the executive and the legislative branches of government and on bank officials' ability to maintain credible monetary policies.
By the end of 1995, Russia had nearly 3,000 commercial banks. However, most of these banks were small and had little capitalization. A large portion of them are financially linked to companies and act exclusively as conduits of subsidized credits to these enterprises. The financial health of such institutions is highly questionable, and experts forecast that many of them will merge into larger, more viable institutions or go bankrupt as the RCB continues to tighten its requirements and as the role of cheap credits diminishes.
The commercial banking system has a core of large, viable banks that have attained financial credibility and that experts expect to remain in operation under any foreseeable economic conditions. The former state-controlled specialized banks of the Soviet system form the foundation of the current commercial banking system, including the six largest commercial banks in Russia. In 1991 three of the banks--the Agroprombank (subsequently renamed Rossel'bank), the Promstroybank, and the Zhilsotsbank (reorganized into Mosbusinessbank)--were reorganized into joint-stock companies and became independent commercial operations, forming the foundation of the commercial banking system.
The Soviet-era Savings Bank (Sberbank) was reorganized as the Sberbank of Russia, with the RCB holding controlling shares. In 1996 the Sberbank held between 60 and 70 percent of Russians' total household savings; that figure decreased from 90 percent in 1991 as other commercial banks began to provide competition. The Foreign Trade Bank (Rosvneshtorgbank) also remains state-controlled, and it continues to handle most foreign transactions, although by the mid-1990s it received competition from newer, privately owned banks. The Moscow International Bank handles business between the large Russian banks and Western banks. Sberbank and Rossel'bank have systems of nationwide branches.
The types and quality of services that the Russian banking system offers to the public are still rudimentary according to the standards of Western industrialized countries. They are unable to offer diverse and efficient customer services because the Soviet Union had no retail banking tradition and because Russia lacks the sophisticated infrastructure, especially high-speed telecommunications and trained staffs, on which modern Western financial institutions depend.
Most of the commercial banks offer their customers savings deposit accounts, and the more established banks provide foreign-exchange services, investment services, and corporate services. Bank checks are still rarely used in Russia because check clearance is a long process. Some banks offer debit cards that allow customers to have payments for goods and services deducted directly from their bank balances. Some banks also offer credit cards to customers with impeccable credit ratings. The continued predominance of cash transactions has slowed the rate of Russia's commerce.
Although foreign banks have played a larger role in the Russian economy in the mid-1990s, that role has met substantial resistance from nationalist factions. In early 1996, the State Duma passed a statute prohibiting the RCB from licensing foreign banks that did not have operations in Russia before November 1993. However, opponents of such a policy have pointed out that efforts to protect the fledgling domestic banking sector from foreign competition also deny access to Western financial techniques that eventually would improve the competitiveness of Russian banks.
A Russian securities market has evolved with the rest of the economy. When the first Russian stock market was established in 1991, few private companies existed to offer shares, so trading activity was quite low. The securities market got a large boost from the Russian government's privatization campaign. Shares in privatized firms were issued, and then a secondary market emerged for the privatization vouchers that the government issued to each citizen (see Privatization, this ch.). As the first phase of the privatization program ended and companies' capital requirements rose, an efficient securities market became increasingly important.
Russian laws and regulations of the stock market and other elements of the securities market have not kept pace with the growth in the industry, fostering irregularities in the market. Among the most infamous was the operation of the MMM investment company, which developed into a pyramid scheme guaranteeing investors very high returns on their investments. A number of Russian small investors, whose savings had been eroded severely by inflation, were attracted to the scheme and eventually lost large sums of money. The head of MMM, Sergey Mavrodi, was arrested and jailed on tax fraud, but the MMM case underlined the lack of Western-style commercial laws in the Russian legal system. The Russian securities market also lacks a modern communications infrastructure, so registration and reporting of financial transactions are very slow.
In 1993 the Government added a new element to the securities market by issuing treasury bonds to help finance its budget deficits. In addition, Russian citizens are able to buy and sell rubles for foreign currency at selected banks. The exchange rate is established through weekly auctions on the Moscow International Currency Exchange (MICEX).
Insurance remains a small part of the Russian financial market. In 1996 approximately 200 insurance companies were operating in Russia, including the privatized versions of former Soviet state insurance companies. According to experts, Russia's relatively new financial institutions are likely to face a long period of adjustment as weaker banks close or merge with stronger banks, and a regulatory framework must be developed to ensure public confidence in the banking system and enable banks to offer reliable support in the development of private enterprise--a role that has expanded rapidly in the first five post-Soviet years. Other aspects of the financial system, such as securities markets, also lack the degree of standardized regulation required for large-scale domestic participation. However, as the private sector's role in the national economy grows and as Russia develops needed regulations and infrastructure, the securities markets and other nonbank financial institutions are expected to follow the banks as important elements of the economy.
Throughout the first half of the 1990s, international financial institutions warned Russia that major adjustments were needed in the structure and the administration of the country's tax-collection system. However, in 1996 few meaningful changes had emerged. Tax reforms until that time had emphasized revenue from income, consumption, and trade, with the value-added tax (VAT--see Glossary), corporate profits taxes, and personal income taxes accounting for 60 to 70 percent of total revenue (see table 16, Appendix). Beginning in 1993, experts have pointed to changes in the bases and rates of the profit tax and the VAT as a major cause of declining revenues. Between 1993 and 1994, the ratio of taxes collected to GDP declined from 41 percent to 36 percent, although the percentage of GDP paid in taxes already was lower in Russia than in any of the Western market economies. In the first quarter of 1996, only 56 percent of planned tax revenue was realized.
The system in place in 1996 taxed the profits of enterprises heavily, especially in comparison with the tax burden of personal income. In 1993 business profit taxes were three to seven times higher than in Western economies, and personal income taxes were two to four times lower. That emphasis was not conducive to expanding investment, and many non-wage sources of income were not captured by personal income tax standards. According to a 1996 estimate, Russians kept US$30 billion to US$60 billion in foreign banks to avoid taxation.
The VAT, which is levied on imported and domestic goods, is set at 21.5 percent for most purchases and 10 percent for a specified list of foods. Administration of that tax is complicated by uneven compliance and accounting rules that do not define clearly the amounts to be classified as value added. Taxation on the extraction and sale of natural resources is a major revenue source, but the current system yields disproportionately little revenue from the energy sector, especially the natural gas industry. Excise taxes are levied on merchandise of both domestic and foreign origin. The tax on imported luxury items ranges from 10 to 400 percent, and the rate on imports has been kept higher than for domestic products in order to protect domestic industries.
Taxes on trade are a major revenue source. In the mid-1990s, export taxes became a more important source of revenue as other types of trade control were eliminated. Frequent changes in the tariff schedule for imported goods have led to confusion among importers. The average tariff rate in mid-1995 was 17 percent, but a reduction of maximum rates was announced for the medium term.
Russia's taxation agency is the State Taxation Service (STS), which was established to administer the new market-based tax system installed in 1991 and 1992. Although in the mid-1990s its staff of 162,000 employees was much larger than tax agencies in Western countries, the STS has been hampered by poor organization, inadequate automation, and an untrained staff. Training and reorganization programs were announced in 1995, and some streamlining has resulted in separating the roles of various levels of government, identification of tax-eligible individuals and corporations, and application of penalties for tax evasion and tax arrears.
Experts have identified the most serious defect of the tax administration system as the ad hoc granting of tax exemptions, which distorts the overall revenue system and undermines the authority of administrators. The most problematic examples of this practice are exemptions granted to agricultural producers and the oil and natural gas industries.
Literacy and education levels among the Russian population (148 million in 1996) are relatively high, largely because the Soviet system placed great emphasis on education (see The Soviet Heritage, ch. 5). Some 92 percent of the Russian people have completed at least secondary school, and 11 percent have completed some form of higher education (university and above). In 1995 about 57 percent of the Russian population was of working age, which the government defined as between the ages of sixteen and fifty-five for women and between the ages of sixteen and sixty for men, and 20 percent had passed working age. Women make up more than half the work force.
Although size, age, and education would seem to place the Russian labor force in a good position to participate in developing a modern, industrialized economy, it is not clear that the skills that Russian workers attained during the Soviet period are those required for a market economy. In 1994 the construction, industry, and agriculture sectors employed 53.5 percent of the work force, and the services sector employed 37 percent, a distribution typical of developing economies. By contrast, 67 percent of the United States labor force is in the services sector, and 22 percent is in agriculture, industry, and construction, a configuration typical of modern industrialized market economies. The Russian pattern reflects the emphasis that Soviet economic planners placed on the nonservice sectors. Even among the highly skilled labor force, the Soviet economy (and the national education system as a whole) skewed training toward the sciences, mathematics, and engineering and gave little attention to education in management and entrepreneurship. This pattern of work training and general education has continued in the 1990s; according to experts, its continued presence indicates that the economy may not be able to depend on younger workers to expand the fund of service-sector skills needed for a modern market economy. In any case, as the Russian economy progresses toward a market structure, middle-aged and older workers will increasingly find themselves playing a marginal role.
The living standards of Russia's workers have been eroded by two factors. First, the severe depression of the country's extended economic transition has left a large share of the work force either unemployed, underemployed, or receiving reduced wages. Second, labor lacks an effective organization to protect its interests. Neither trade unions from the Soviet era nor new, independent organizations have provided effective, united representation. As of mid-1996, negative conditions had not yielded the large-scale unrest that many experts had predicted in the working class.
The growth of unemployment has been the bane of many of the Central and East European countries in the transition from centrally planned to market economies. Russia's unemployment rate has been hard to measure accurately because many firms unofficially furlough workers but leave them on company rolls. This practice is a vestige of the paternalistic Soviet era, when the presence of workers in an enterprise often had no relation to that enterprise's actual production. Many of these furloughed workers find gainful employment in the private sector, where wages often go unreported. Such a system results in a haphazard, inefficient allocation of the labor force.
Western and Russian analysts have relied on International Labour Organisation measurements, which indicate that at the end of 1995, Russian unemployment had reached 8.2 percent (see table 17, Appendix). The Russian journal Ekonomika i zhizn' estimated the figure at 8.6 percent, or 6.3 million people, for the first quarter of 1996. Although the last figure still is below the unemployment rates of Poland and some other countries in transition, the full extent of unemployment has been masked by extended subsidies that delayed the shutdown of large Russian enterprises. In 1995 nearly half of plant directors surveyed said that they had more workers than they needed.
Unemployment varies considerably according to region. Moscow's unemployment rate, the lowest in Russia, was 0.6 percent in March 1996. The Republic of Ingushetia, which also has had the highest immigration rate because of its proximity to Chechnya, reported a rate of 23.5 percent in December 1995. In March 1996, Ivanovo, a textile center east of Moscow, had a rate of 13 percent, and the Republic of Udmurtia, a center of the struggling military-industrial complex, reported 9.4 percent (see The Defense Industry, ch. 9). At that time, women constituted 62 percent of Russia's officially unemployed, and 37 percent of the total were people below the age of thirty.
The Federal Employment Service (Federal'naya sluzhba zanyatosti--FSZ), the agency in charge of issuing unemployment benefits and placing unemployed workers, had only 3.7 percent of the working population registered for benefits in March 1996; many jobless workers do not register because benefits are so small (averaging US$22 per month in 1995) and because, after the guaranteed employment of the Soviet era, joblessness entails a significant stigma for many Russians. However, as the average term of unemployment grew from six to eight months between 1994 and 1995, more workers participated in FSZ programs. In 1995 the service placed an estimated 1.7 million workers in new jobs. That year, 9.8 million workers left positions and 8.7 million were hired, and the majority of those who left did so voluntarily--many because wages were not paid--rather than because of dismissal. Shortages exist in some types of skilled labor, and some companies actively recruit workers.
By 1995 delays in wage payment had become a chronic problem even in profitable Russian enterprises. In many cases, enterprises simply passed along the burden of late payments of state subsidies and customer debts. At the end of 1995, the Government owed a total of US$112 billion of subsidies, of which about 27 percent were more than three months overdue. Most of its debt was to the military and energy sectors. Through 1995 an average of 19 percent of wages were paid late, and in January 1996 a total of US$2.1 billion was overdue in agriculture, construction, industry, and transportation. The State Committee for Statistics (Goskomstat) began keeping separate statistics for wages formally paid and those actually delivered. The payment record of privatized enterprises was worse than that of state enterprises, and in many cases workers were paid in merchandise rather than in cash. In early 1996, the average rates of overdue payment were 62 percent in ferrous metallurgy, 86 percent in oil extraction, and 22 percent in food processing.
In his presidential campaign, Yeltsin promised to abolish state-sector wage arrears and to encourage improvement in the private sector. By squeezing the national budget, Yeltsin achieved temporary results in the state sector, but his promise had no effect on other enterprises. Officials proposed several programs to raise average wages and streamline the inefficient system by which wages are delivered, but no meaningful reform had been achieved by mid-1996. In July 1996, coal strikes in the Far East, southwestern Russia, southern Siberia, and the Urals threatened a nationwide shutdown in response to continued payment failures in that industry.
Beginning in 1921, Lenin's Soviet government made industrial modernization a priority. But it was under Stalin that the system of central planning was fully developed and the industrialization of the Russian Republic reached its peak. Throughout the Stalin period, investment resources were directed into heavy manufacturing at the expense of consumer or light industry.
During the later Soviet period, economic reformers such as Nikita Khrushchev attempted to shift some resources to the consumer industries, but the emphasis eventually shifted back to heavy and military industries. This emphasis was especially strong while the Soviet Union was building its military base during the Cold War. In the 1970s, manufacturing productivity declined. As part of his perestroika program in the late 1980s, Gorbachev redirected resources to consumer goods, but the effort proved insufficient to forestall the decay of the manufacturing sector.
In the 1990s, Russia urgently needed a revival of the manufacturing sector to provide employment and steer the restructuring of industrial priorities away from the impractical Soviet emphasis on subsidized heavy industry and the military-industrial complex (MIC). Although a substantial share of Russia's MIC enterprises underwent full or partial conversion to civilian production and most manufacturers were partially or fully privatized, manufacturing output continued a general decline in the mid-1990s (see table 18, Appendix). This trend had slowed by 1995, when the decrease in total industrial production was 4 percent compared with 1994; the 1994 total had been 23 percent below that of 1993.
The Soviet Union's ferrous metallurgy industry was a showpiece of centralized planning of heavy industry. The fast-growing industry, vital in supplying other heavy industries with semifinished inputs, led the world in output in the 1970s and the 1980s. Beginning in the mid-1980s, however, ferrous metallurgy did not keep pace with the demands of domestic industry and foreign markets for more sophisticated and stronger metal materials. Many older plants with outmoded technology remained in full production; Soviet plans called for refitting the industry in the 1990s, but Russia's resources have not been sufficient for such a massive project.
In 1994 the ferrous and nonferrous metallurgical industries accounted for about 16 percent of industrial output. In 1996 more than 80 percent of Russia's steel output came from eight plants, although about 100 plants were in operation. Among the industry's most important products are pipe, pig iron, smelted steel, finished rolled metal, and shaped section steel. The four largest steel enterprises are the Novolipetsk and Cherepovets metallurgical plants, located southeast and north of Moscow, respectively, and the Magnitogorsk and Nizhniy Tagil metallurgical combines, located in the Ural industrial region. In 1995 the Cherepovets plant was re-formed as the Severstal' (Northern Steel) Joint-Stock Company. In the mid-1990s, more than half of Russia's steel production came from the outmoded open-hearth furnace process; the more modern continuous casting method accounted for only 24 percent of output.
In the first half of the 1990s, the steel industry was hit especially hard by Russia's overall economic decline, which caused domestic consumption to drop sharply; by 1996 only 50 to 60 percent of capacity was in use. Between 1991 and 1994, output of rolled steel dropped from 55.1 million tons to 35.8 millions tons. Foreign sales were especially important as the only source of hard currency for some enterprises, accounting for as much as 60 percent of output in some cases. In 1995 Russian exports increased by 30 percent, making Russia the second largest exporter of ferrous metals in the world. The profitability of such sales dropped substantially between 1994 and 1996, however. Much of the steel industry's domestic business was payment in kind to input suppliers and railroads. Production costs are raised by the prices of such domestic inputs as coal and iron ore and transportation, which averaged at or above world levels in 1996. Another major cost to the ferrous metallurgy sector is social support programs for workers. Those costs in turn raise domestic metal prices above international levels.
The Noril'sk Nickel Joint-Stock Company dominates Russia's nonferrous metallurgy industries. It controls nearly all of the country's aluminum and nickel production and 60 percent of copper production. The largest operations in the industry are Noril'sk Nickel in northwestern Siberia and Bratsk Aluminum, Krasnoyarsk Aluminum, and Sayan Aluminum in south-central Siberia. More than 90 percent of Russia's aluminum comes from six smelters. Some smelters have been privatized and export their semifinished products. Inputs, especially alumina (of which Russia has little), became much more expensive in the mid-1990s, as did transportation and electricity costs. At the same time, export revenues fell.
In 1993 Russia's automotive industry produced 956,000 passenger automobiles, a decrease from the 1991 figure of 1,030,000 automobiles. During the Soviet period, the industry had gained a reputation for extremely slow production of very unreliable vehicles. In the mid-1990s, the plant rated most efficient, the Volga Automotive Plant (Avtovaz) at Tol'yatti, required about thirty times as long to assemble an automobile as the leading plants in Japan. All Russian vehicle plants operated at far below capacity, with outmoded machinery and bloated work forces. Avtovaz, the most productive plant, operated at about 70 percent of capacity, and the Gor'kiy Automotive Plant (GAZ) in Nizhniy Novgorod was the only other major plant operating above 30 percent in 1995. The two main truck manufacturers, the Likhachev Automotive Plant (ZIL) in Moscow and the Kama Automotive Plant (KamAZ) in Naberezhnyye Chelny, have suffered especially from reductions in orders by their main customers--the armed forces and collective farms. GAZ has successfully marketed a light truck, of which it sold 75,000 in 1995, mainly to small businesses. The traditional Soviet truck was a heavy diesel model with limited service life.
Although demand for passenger automobiles has increased substantially in Russia over the last twenty-five years, output has not responded even in the post-Soviet period. In 1994 only eighty-four autos were registered per 1,000 people. In the mid-1990s, all automobile plants retained the Soviet style of organization, which is incapable of self-financing or effective marketing. The lack of post-Soviet government subsidies has placed most enterprises in danger of extinction. Some Russian enterprises have proposed joint ventures with Western firms, but in many cases the Russian partners lack funding for such ventures. Meanwhile, foreign imports further endanger the industry: in 1994 only 65,000 automobiles were imported legally, but another 250,000 to 500,000 entered Russia illegally. Therefore, most new cars in Russian cities are foreign. (In 1996 government vehicles were exclusively Audi, Mercedes-Benz, Saab, or Volvo). Exports of Russian passenger cars declined in the early 1990s.
In the Soviet period, the machine-building industry was at the center of the industrial modernization programs that required a steady supply of capital equipment to respond to new demands. However, the inefficient organization of industrial planning caused bottlenecks in crucial programs and generally unreliable performance. The industry is concentrated in the European part of Russia, with major facilities in Moscow, St. Petersburg, Nizhniy Novgorod, and the Ural industrial region. (Russian machine building includes the automotive, construction equipment, and aviation industries as well as the tractor, electrical equipment, instrument making, consumer appliance, and machine industries.)
Between 1985 and 1995, production of most categories of machines decreased significantly, mainly because of declining domestic orders. For example, by 1992 production of metal-cutting machines had dropped by 20 percent, washing machines by 47 percent, turbines by 36 percent, and tractors by 45 percent. In 1993 production of about one-third of sixty-two major categories of products declined by at least 50 percent. In 1995 production for the entire machine-building complex was about 4 percent below the 1994 level.
The most important branch of light industry is cotton textiles, which has production centers in Ivanovo, Kostroma, Yaroslavl', and about two dozen smaller cities between the Volga and Oka rivers east of Moscow. The economic slump of the 1990s had a dramatic effect on textile production and other light industries. In 1995 Russia's light industry suffered the sharpest drop in production of all economic sectors, slumping by an estimated 25 to 30 percent compared with the previous year. Prices for light-industry goods increased by an average of 2.9 times in 1995 after having increased by 5.6 times in 1994.
Unemployment in Russia's textile production centers has been among the highest in the country. In early 1996, an estimated 70 percent of workers in the industry were on furlough or working part-time. The chief cause is the Russian consumers' decline in personal income, hence in demand. In the mid-1990s, consumers purchased most of their textile products at flea markets, which offered both a wider variety of merchandise and cheaper prices than most stores. By the end of 1995, orders for all types of light-industrial production were 48 percent of the average for the previous years. Production declined by 20 percent in fabrics, 21 percent in leather shoes, and 44 percent in knitted goods, but stocks of finished products grew because demand decreased at a faster rate.
The high price of cotton also has hampered the textile industry, which had been accustomed to paying low prices for its raw material when the major suppliers in Central Asia were part of the Soviet economic system. Although their cotton is not of high quality, Central Asian sellers now charge world market prices. (Cotton from the "far abroad," outside the former Soviet Union, is even more expensive, however.) In 1996 industry experts expect some improvement because of expanding export markets in Europe and new investment in light industry by Russia's banks. They also expect an increase in domestic shoe manufacturing in the 1990s because the high import duties on foreign shoes make them twice as expensive as Russian shoes--although in 1996 some 65 percent of shoes sold in Russia were imported. The former member countries of the Council for Mutual Economic Assistance (Comecon--see Glossary) were the chief source of such goods.
The centers of the chemical industry traditionally have been areas where critical raw materials and allied industries were available. Before 1960 plants were near mineral deposits, potato farms, coking coal, and nonferrous metallurgy plants. When oil and natural gas became prime raw materials for chemical production, plants were built near the Volga-Ural and North Caucasus gas and oil fields or along pipelines. In the 1980s, major plants were built at Omsk, Tobol'sk, Urengoy, and Surgut in the western Siberia oil region and at Ufa and Nizhnekamsk in the Volga-Ural region. In the same period, the government gave strong investment and research support to chemical production because of its importance to the rest of heavy industry.
The major divisions of the chemical industry are paints and varnishes, rubber and asbestos products, synthetic tar and plastic products, mined chemical products, household chemicals and washing compounds, mineral fertilizers, chemical fibers and filaments, and paper and pulp. In the 1990s, output has decreased in all of those areas. Among representative products, between 1985 and the early 1990s production of mineral fertilizers dropped by 29 percent, agricultural pesticides by 74 percent, industrial carbon by 28 percent, sulfuric acid by 19 percent, synthetic tars and plastics by 16 percent, paints and varnishes by 43 percent, household soaps by 25 percent, and caustic soda by 15 percent.
Based on Russia's huge supply of timber, a substantial lumber-processing and pulp industry developed in the Soviet period as a subsidiary of the chemical industry. In 1996 Russia's largest pulp and paper enterprises were at Kondopoga near the Finnish border, Bratsk west of Lake Baikal, Syktyvkar in the Republic of Komi, and Kotlas southeast of Arkhangel'sk. Most pulp and paper companies do not own timber resources, but timber suppliers, who lease timberland from the state, generally sell raw materials at below world prices, giving Russian manufacturers a competitive advantage. Some mergers have occurred between suppliers and manufacturing operations.
In the early 1990s, production of raw timber dropped by about 25 percent, mainly because of equipment depletion, lack of credit, higher railroad transport fees, and a drop in construction of lumber roads. In 1993 production of raw timber was 450,000 cubic meters, 75 percent of the 1992 total; production of commercial cellulose was 79 percent of the previous year's total; and of cardboard, 73 percent (see Environmental Conditions, ch. 3).
The transportation system during the Soviet period was organized in the form of vertically integrated monopolies controlled by the central government. Thus, for example, the same administrative agency owned and operated the airports, airlines, and enterprises that manufactured aircraft. The infrastructure eroded seriously in the late Soviet period and requires much modernization and reform, for which Russia relies heavily on foreign investment and aid.
Roads were one of the least-used forms of transportation in the Soviet Union, a characteristic that has continued in the Russian Federation. Soviet industry placed little emphasis on the production of automobiles and other modes of personal transport, and the privately owned vehicle was a relatively rare phenomenon; therefore, the demand for road construction was small. The dominance of the railroads for cargo transport also constrained the demand for the construction of roads. In 1995 Russia had 934,000 kilometers of roads, compared with 6.3 million kilometers in the United States (see fig. 10). Of Russia's total, 209,000 kilometers were unpaved, and 445,000 kilometers were not available for public use because they served specific industries or farms.
The World Bank has estimated that in twenty years the demands of Russia's new economy will increase the road system's share of transportation to 41 percent from its 1992 level of 13 percent. However, in 1992 some 38 percent of Russia's highway system required rehabilitation or reconstruction, and another 25 percent required repaving. Many major bridges also required large-scale repair in the mid-1990s.
Railroads are the dominant mode of transportation. In 1995 Russia had some 154,000 kilometers of railroads, 26 percent of which were electrified, but 67,000 kilometers of that total served specific industries and were not available for general use (see fig. 11). The entire system is 1.52-meter gauge. In 1993 railroads accounted for 1,608 billion ton-kilometers of cargo traffic, compared with the 26 billion ton-kilometers provided by trucks. The prominence of railroads is the result of several factors: the vast distances that need to be covered; the penchant of Soviet economic planners for locating manufacturing facilities in politically expedient areas rather than where raw materials and other inputs were available; and the conditions for granting state fuel subsidies, which provided no incentives to break up cargo transportation into shorter-haul operations that could be covered by road. Cargo traffic is the predominant use of railroads, in contrast to the emphasis on passenger traffic in West European railroad systems (see table 19; table 20, Appendix). This pattern is a product of the Soviet emphasis on heavy industry and production rather than on consumers. In 1992 Russia's railroads accounted for 253,000 passenger-kilometers, and by 1994 the total had dropped to 227,000 passenger-kilometers.
Railroad traffic has plummeted since the beginning of Russian economic reform, reflecting a general decline in economic activity. Between 1992 and 1994, freight haulage dropped from 1.9 million ton-kilometers to 1.2 million ton-kilometers, and Russia's rolling stock and roadbeds deteriorated, mainly because of insufficient maintenance funding. In 1993 an estimated 8.5 percent of Russian rail lines were defective. As a market economy takes shape, experts forecast a smaller relative role for the railroads. The combination of fuel and material costs, substantially higher in the absence of government subsidies, and new alternative routing will likely prompt Russian manufacturers to find more efficient means of transporting goods. For shorter hauls, trucks will replace rail service, and intermodal transportation will receive greater emphasis as an outgrowth of marketization.
Of the modest amount of passenger traffic in Russia, air service accounts for a relatively large portion, although the volume of traffic declined in the first half of the 1990s. In 1990 the monopoly service of Aeroflot, the Soviet Union's state-owned airline, accounted for 22 percent of the total distance passengers traveled, a proportion comparable with the proportion of travel on the airlines of the United States and Canada. However, the contribution of air service to total travel had dropped to 12.5 percent by 1993, and the number of passengers flying was less than half the 1990 total. Subsidized air fares and long-distance flights between cities accounted for much of the air activity in the early 1990s. In 1994 Russia had a total of 2,517 airports, of which fifty-four had runways longer than 3,000 meters, 202 had runways between 2,400 and 3,000 meters, and another 108 had runways between 1,500 and 2,400 meters.
As with the rest of the economy, air travel has declined substantially as prices have increased and travelers' incomes have declined. The airline industry also has undergone major adjustments in the 1990s. Aeroflot, since 1995 a joint-stock company with majority state ownership, remains the main Russian airline. However, more than 200 regional carriers have emerged in the former Soviet Union, and most of them are in Russia. With flights from so many carriers, direct service is now available between regions, including direct flights from the Russian Far East to Japan and Alaska, without the previously obligatory stop in Moscow or St. Petersburg.
At the same time that airlines decentralized, so did reservation systems and navigation control networks, making those aspects of airline travel less efficient. Experts predict that as market forces continue to work in the sector, higher fuel costs and declining passenger demand will force mergers and bankruptcies that eventually will lead to a more efficient system.
The airline industry also must deal with an aging capital stock. As of 1993, some 48 percent of the national system's aircraft were more than fifteen years old. To upgrade, Russian airline services have purchased aircraft from Western firms and demanded more modern aircraft from domestic manufacturers.
Maritime transportation plays an important role in Russian transit, but the country's geography and climate limit the capacity of shipping. Many Russian rivers run from south to north rather than from east to west, constraining their use during the Russian winters.
Russia's major ports providing access to the Baltic Sea are St. Petersburg and Kaliningrad, and Novorossiysk and Sochi are the main Black Sea ports (see fig. 12). Vladivostok, Nakhodka, Magadan, and Petropavlovsk-Kamchatskiy account for the bulk of maritime transportation on the Pacific coast. The largest Arctic port, Murmansk, maintains an ice-free harbor despite its location on the northern shore of the Kola Peninsula. In 1995 Russia's merchant marine had about 800 ships with a gross tonnage of more than 1,000, of which half are standard cargo vessels, about 100 oil tankers, and eighty container ships. Russia also owns 235 ships that are over 1,000 tons and sail under foreign registry. In 1991 the merchant marine carried 464 million tons of cargo.
Navigable inland waterways extend 101,000 kilometers, of which 16,900 kilometers are man-made and 60,400 are navigable at night. Boats of the Russian River Fleet do most of the inland shipping, which accounted for 514 million tons of cargo in 1991. The Russian government has made efforts to decentralize control over water transportation and to separate control of liners from ports.
Although the high price and scarcity of passenger automobiles required Soviet citizens to rely on public transportation, Soviet policy makers gave low priority to civilian transportation. Only six Russian cities have underground systems--Moscow, St. Petersburg, Yekaterinburg, Nizhniy Novgorod, Novosibirsk, and Samara. The extensive and decorative Moscow subway system, built in the 1930s as a showpiece of Stalinist engineering, remains the most reliable and inexpensive means of transportation in the nation's capital.
Elsewhere, buses are the main form of public transportation. In cities, tramways supplement bus service, accounting for one-third of the passenger-kilometers that buses travel. The Russian Federation continues the Soviet-era 70 percent state subsidy, which keeps fares artificially low. This subsidy has been a drain on the budget and has blunted the public's demand for alternative modes of transportation. The system's infrastructure and vehicle fleets require extensive repair and modernization.
In the first half of the 1990s, market forces shifted some of the demand among the various transportation services. Russian policy makers had not prescribed the proper role of the transportation sector in the new economy. However, officials indicated that Russia will follow the Western model of assuming government regulation of transportation systems while reducing state ownership of those systems.
Many state-owned transportation monopolies have been dissolved, but some monopolies such as public transportation are expected to remain in place. The role of government will be to ensure that the systems are commercially viable and allow private systems to emerge. The government also will continue to be responsible for maintaining the quality and availability of the road, air, and water infrastructure and for maintaining standards of transportation safety.
By various measures, Russia's telecommunications infrastructure is inferior to that of most developed industrialized countries. In 1991 only 33 percent of Russian households had telephones, compared with 94 percent in the United States. In 1995 Russia had seventeen telephone lines per 100 inhabitants, compared with thirty-six in Spain, forty-four in Belgium, and sixty-nine in Switzerland.
During the Soviet period, the state controlled all means of communications and used them primarily to convey decisions and to facilitate the execution of government directives affecting the economy, national security, and administrative governmental functions. The Ministry of Communications had responsibility for most nonmilitary communications, and the Ministry of Defense controlled military communications. Other ministries, including the Ministry of Culture, controlled specialized elements of the communications infrastructure.
Moscow maintained control over communications, and regional and local jurisdictions enjoyed little autonomy. This centralization forced the Soviet Union to acquire the means to deliver signals over a vast area and provided the impetus for the development of satellite communications, which began with the launching of the Molniya satellite communications system in 1965. Despite the success of the satellite system, Soviet technology was unable to meet the rapidly growing informational demands of the 1980s. In that period, the Soviet government began to import digital switching equipment from the West in an effort to modernize the national telephone system. The priority given to military and government applications skewed the distribution of new equipment, and officials dedicated relatively few telephone lines and communications facilities to commercial and residential use. In addition, most communications facilities remained concentrated in a few urban areas at the expense of smaller cities and rural regions.
Since the breakup of the Soviet Union, Russia has been engaged in the reorganization and modernization of its communications systems. In this process, control over communications has been decentralized and in large part privatized. In domestic telephone and related communications, control devolved to regional and local enterprises, which were then reorganized into joint-stock companies. Long-distance and international service operations were grouped together into a new organization, Russian Telecommunications (Rostelekom), which itself became a joint-stock company. The federal government has retained control over the national satellite system, telecommunications research and development, and education systems through the Ministry of Communications. Despite ownership changes, in 1995 only about 14 percent of Russia's 24.4 million telephones were located outside urban areas, the waiting list for telephone installation included more than 10 million names, and only 34,100 pay telephones were available for long-distance calls.
By mid-1994 the Russian telephone communications system had been privatized through the voucher program. Employees of the reorganized companies received about 25 percent of company stock, the government retained some shares, and the remainder were sold at public auction. Telecommunications stocks reportedly have been among the most coveted items on the fledgling Russian stock market. Domestic and foreign investors have been especially attracted to stocks in major regional telephone enterprises such as the Moscow and St. Petersburg telephone systems and Rostelekom. But the state has not relinquished its remaining telecommunications shares, showing reluctance to cede full control to the private sector.
Development of the telecommunications infrastructure depends heavily on foreign funding and joint ventures. The Ministry of Communications expected foreign investment in telecommunications to increase by 24 percent in 1996 over 1995, matching domestic investment of US$520 million. In the mid-1990s, state subsidies continue to fall. According to Western experts, that investment level is far below the amount needed over a prolonged period to modernize Russian lines or even to upgrade existing equipment. However, Russia faces stiff competition for foreign capital because Western and Japanese companies already have made substantial commitments to telecommunications modernization and privatization projects in a number of other countries.
Russia's goals for 1996 were the laying of 1,815 kilometers of cable and the installation of 9,500 kilometers of wireless lines, 5,000 long-distance exchanges, and 1.5 million new private telephone lines in urban and rural areas. The latter addition would bring the national total to 26 million lines.
The regulatory framework for telecommunications in Russia remains weak, but it is maturing. The Law on Communications, enacted in 1995, is the chief statute, but the lines of regulatory authority have not been clearly defined. The Ministry of Communications is the chief regulatory agency for "civilian" communications, but military and national security authorities control their own communications networks outside the purview of the Law on Communications.
As Russia's telecommunications systems develop, the regulatory issues facing the Ministry of Communications include frequency assignments, standardization of equipment, levels of competition, and establishment of optimal user rates. The military and internal security agencies traditionally have had priority use of most wireless frequencies, but the newer and expanding commercial and individual users require more access to frequencies. Standardization is needed so that older equipment can operate with the new models on expanded systems. A uniform policy is needed for regulation of telecommunications competition, which varied in the early post-Soviet years. And the Ministry of Communications has not yet established telephone rates that are affordable to the users but provide enough profit for the company to operate and expand.
The government has promoted competition in some sectors. An example is the licensing of a number of companies to provide specialized, dedicated service networks. For cellular telephone lines, the government has encouraged competition in densely populated areas, such as Moscow and St. Petersburg, while developing single provider systems for small areas where demand is limited. For long-distance service, in the mid-1990s Rostelekom competed with local telephone companies for revenues in the potentially lucrative area of interzonal communications. In addition, Rostelekom is facing competition from newer companies that are able to provide long-distance service through their own cables and via satellite. Under these conditions, the shape and size of the Russian telephone system is changing rapidly and responding to the demands of the market.
Experts estimate that Russia must expand its telephone networks from around 24 million telephones to between 75 million and 80 million and provide the modern switching equipment with which they can operate. They further expect that Russia will require an investment of US$150 billion to bring its telephone system up to modern standards. Russia has imported Western equipment in the modernization effort, but this strategy has proved very costly. The Russian equipment industry is trying to revive itself and develop indigenous technology to fulfill its needs.
Foreign investors could be an important source of capital and technology in the Russian telecommunications sector, but in the mid-1990s Russian laws and regulations limited foreign participation to the supply of equipment and services that would not hurt domestic producers. The Law on Communications gives preference to domestically produced equipment, with the major exception of cellular phone production, where officials have welcomed foreign participation. Domestic telephone services are the domain of Russian companies, but foreign companies have established a presence in domestic and international long-distance service.
Russian radio and television are undergoing similar changes (see The Broadcast Media, ch. 7). The programming facilities and transmission operations are separate, as they were in the Soviet system when the central government controlled all of these facilities. After the breakup of the Soviet Union, Russian radio and television programming operations were decentralized at the regional and local levels.
In the mid-1990s, three major countrywide state-owned programming companies provide most programming for the country. They are Russian Public Television (Obshchestvennoye rossiyskoye televideniye--ORT), Russian State Television, and St. Petersburg Television, which primarily serves the St. Petersburg metropolitan area. In 1995 Russian State Television was partially privatized when 49 percent of its shares were sold to private companies, but the company remains under state control.
The privatization process moved large blocks of shares into the hands of banks and powerful entrepreneurs, who formed communications and newspaper empires and used close connections in the Government to lobby for the release of additional state shares in the broadcasting enterprises. In 1996 the two most powerful broadcast entrepreneurs were former banker Vladimir Gusinskiy, head of the Media-Most holding company including the Independent Television (Nezavisimoye televideniye--NTV) network and several prominent periodicals, and Boris Berezovskiy, an automobile entrepreneur whose organization, Logovaz, now controls ORT as well as banking, oil, aviation, and print media enterprises.
Privately owned and operated, independent programming companies are playing a growing role in Russian radio and television programming. As of 1995, some 800 companies were in existence. In 1996 the largest private television channels are TV-6, which reaches sixty cities in Russia and elsewhere with a potential audience of 600 million viewers, and NTV, which serves European Russia and has a potential audience of 100 million viewers. Both companies were founded in 1993.
Transmission facilities are state-owned, and programmers must pay fees to the transmission companies to have their material broadcast. The fee establishment mechanism remains an issue in Russian telecommunications policy. Control over transmission gives the government powerful leverage over the content of broadcasts. In 1996 independent companies were considering cable and direct satellite television services to get into the state-dominated market as transmission providers. In 1992 some 48.5 million radios and 54.9 million televisions were in use. See <"http://www.satisfied-mind.com/directv/">Satellite TV - DirecTV and Dish Network for information about DirecTV and Dish Network.
Because the Law on Communications does not address the question of airtime allocation, policy makers also must grapple with that issue. Subsidies for radio and television broadcasters, including state-owned operations, have been reduced drastically in the first half of the 1990s, meaning that programmers must rely on advertising revenues.
Integrating the Russian economy with the rest of the world through commerce and expanded foreign investment has been a high priority of Russian economic reform. Russia has joined the IMF and the World Bank and has applied to join the World Trade Organization (WTO--see Glossary) and the OECD. It also has been included in some functions of the Group of Seven (G-7; see Glossary).
By the end of 1993, the Russian government had liberalized much of its import regime. It eliminated nontariff customs barriers on most imports, although it still requires some licenses for health and safety reasons. In mid-1992 the government took control of imports of some critical goods, including industrial equipment and food items, which it sold to end users at subsidized prices. In the early 1990s, government-controlled imports constituted about 40 percent of total Russian imports, but by 1996 most such controls had been phased out.
Russia also established a two-column tariff regime in harmony with the United States and other members of the General Agreement on Tariffs and Trade (GATT), which in January 1995 became the WTO. Russia differentiates between those trade partners that receive most-favored-nation trade treatment and, therefore, relatively low tariffs, and those that do not.
Although Russia has eliminated many nontariff import barriers, it still maintains high tariffs and other duties on imports of goods to raise revenue and protect domestic producers. All imports are subject to a 3 percent special tax in addition to import tariffs that vary with the category of goods. Some of the high tariffs include those of 40 to 50 percent on automobiles and aircraft and 100 percent on alcoholic beverages. Excise taxes ranging between 35 and 250 percent are applied to certain luxury goods that include automobiles, jewelry, alcohol, and cigarettes.
The Government has used licensing and quotas to restrict the export of certain key commodities, such as oil and oil products, to ease the effect of price differentials between controlled domestic prices and world market prices. Without such restrictions, Russian policy makers have argued, the domestic market would experience shortages of critical materials. The government finally eliminated quotas on oil exports in 1995 and export taxes on oil in 1996. In addition to customs restrictions, the government imposes other costs on exporters. It charges a 20 percent VAT on most cash-transaction exports and a 30 percent VAT on barter transactions. It applies additional tariffs on the exports of industrial raw materials. By the mid-1990s, much of Russia's foreign trade, even that with the former communist countries of Central Europe, was conducted on the basis of market-determined prices. Immediately after the dissolution of the Soviet-dominated Comecon in 1991, the Soviet Union sought to maintain commercial relations in Central Europe through bilateral agreements. But as market economies developed in those countries, their governments lost control over trade flows. Since 1993 Russian trade with former Comecon member countries has been at world prices and in hard currencies.
In the mid-1990s, Russia still maintained hybrid trade regimes with the other former Soviet states, reflecting the web of economic interdependence that had dominated commercial relations within the Soviet Union. The sharp decrease in central economic control that occurred just before and after the breakup of the Soviet Union virtually destroyed distribution channels between suppliers and producers and between producers and consumers throughout the region. Many of the non-Russian republics were dependent on Russian oil and natural gas, timber, and other raw materials. Russia bought food and other consumer goods from some of the other Soviet republics. To ease the effects of the transition, Russia concluded bilateral agreements with the other former Soviet states to maintain the flow of goods. But, as in the case of the Central European agreements, such arrangements proved impractical; by the mid-1990s, they covered only a small range of goods. Russia now conducts trade with former Soviet states under various regimes, including free-trade arrangements and most-favored-nation trading status.
The volume of Russia's foreign trade has generally declined since the beginning of the economic transition. Trade volume peaked in 1990 and then declined sharply in 1991 and 1992. Between 1992 and 1995, however, exports rose from US$39.7 billion to US$77.8 billion, and imports rose from US$34.7 billion to US$57.9 billion. Many factors contributed to the decline of the early 1990s: the collapse of Comecon and trade relations with Eastern/Central Europe; the rapid decline of the domestic demand for imports; contraction in foreign currency reserves; a decline in the real exchange value of the ruble; the Government's imposition of high tariffs, VATs, and excess taxes on imports; and the reduction of state subsidies on some key imports. Russia's declining production of crude oil, a key export, also has contributed significantly. Until 1994 Russia's arms exports declined sharply because the military-industrial complex's production fell and international sanctions were placed on large-scale customers such as Iraq and Libya (see Foreign Arms Sales, ch. 9).
The geographical distribution of Russian foreign trade changed radically in the first half of the 1990s (see table 21; table 22, Appendix). In 1985 some 55 percent of Soviet exports and 54 percent of Soviet imports were with the Comecon countries. By contrast, 26 percent of Soviet exports and 28 percent of Soviet imports were with the fully developed market economies of Western Europe, Japan, the United States, and Canada. By the end of 1991, Russia and its former allies of Central Europe were actively seeking new markets. In 1991 only 23 percent of Russian exports and 24 percent of Russian imports were with the former Comecon member states. In 1994 some 27 percent of Russian imports and 22 percent of exports involved partners from Central Europe, with Poland, Hungary, and the Czech Republic generating the largest volume in both directions. Western Europe's share of Russian trade continued to grow, and in 1994 some 35 percent of Russia's imports and 36 percent of its exports were with countries in that region. Germany was by far the West European leader in exports and imports, and Switzerland and Britain were other large export customers. In 1994 the United States accounted for US$2.1 billion (5.3 percent) of imports and US$3.7 billion (5.9 percent) of exports; however, United States purchases of Russian goods had increased by more than 500 percent between 1992 and 1994. The total value of trade with the United States in 1995 was US$7 billion; trade for the first half of 1996 proceeded at virtually the same rate (see table 23, Appendix).
Russian trade with the so-called near abroad--the other former Soviet states--has greatly deteriorated. This trend began before the final collapse of the Soviet Union as Russian producers sought hard-currency markets for raw materials and other exportables. As Russia raised fuel prices closer to world market levels, the other republics found it increasingly difficult to pay for Russian oil and natural gas. The RCB extended credits to these countries to permit some shipments, but eventually the accumulation of large arrearages forced the Russian government to curtail shipments. At the end of 1995, Russian trade with the near abroad accounted for 17 percent of total Russian trade, down from 59 percent in 1991. Belarus, Kazakstan, and Ukraine remained Russia's largest partners, as they had been in the Soviet era. The failure to restore inter-republic trade was an important factor in the economic collapse that gripped the region around 1990.
Raw materials, especially oil, natural gas, metals, and minerals, have dominated Russia's exports, accounting for 65 percent of total exports in 1993. Exports as a whole are heavily concentrated in a few product categories. In 1995 ten commodities, all of which are raw materials, accounted for 70 percent of Russian exports. By contrast, for the United States the top ten export commodities account for only 37 percent of its exports.
The lack of diversity in Russian exports is a legacy of the Soviet period, when the central planning regime called for production of manufactured goods for domestic consumption with little consideration for the export market. Given this priority, most of the Soviet Union's consumer goods were of low quality by world standards. Post-Soviet concentration of Russian exportables in a few categories restricts Russia's potential sources of foreign currency to a few markets. And the frequent price fluctuations typical of world raw materials markets also make Russia's export revenues vulnerable to unforeseen change.
Manufactured goods dominate Russian imports, accounting for 68 percent of total imports in 1992. The largest categories of imported manufactured goods are machinery and equipment (29 percent of the total); foods, 16 percent; and textiles and shoes, 13 percent.
Foreign investment is the second major element of Russia's reform strategy to strengthen international economic links. From the late 1920s to the late 1980s, the Soviet government prohibited foreign investment because it would have undermined the state's decision-making prerogatives on investment, production, and consumption.
The perestroika economic reforms of the late 1980s permitted limited foreign investment in the Soviet Union in the form of joint ventures. The first joint-venture law, which went into effect in June 1987, restricted foreign ownership to 49 percent of the venture and required that Soviet administrators fill the positions of chairman and general manager. By 1991, however, the Soviet government allowed foreign entities 100 percent ownership of subsidiaries in Russia.
Although limited in scope, the joint-venture law did open the door to direct foreign investment in the Soviet Union, which provided Russia's economy wider access to Western capital, technology, and management know-how. But the overall limitations of perestroika hampered the joint-venture program. The nonconvertibility of the Russian ruble was an impediment to repatriation of profits by foreign investors, private property was not recognized, government price controls remained in effect, and most of the Soviet economy remained under state control.
The Yeltsin government's commitment to foreign investment has been hampered in some cases by Russia's ongoing debates about the appropriate relationship with the West and about the amount of assistance that Russia should accept from the capitalist countries. Substantial political factions view the infusion of foreign capital as a device for Western governments to intrude on Russia's sovereignty and manipulate its economic condition, and they advocate a more independent course.
The Foreign Investment Law of 1991 provides the statutory foundation for the treatment of foreign investment. The law provides for "national treatment" of foreign investments; that is, foreign investors and investments are to be treated no less favorably than domestically based investments. The law also permits foreign investment in most sectors of the Russian economy and in all the forms available in the Russian economy: portfolios of government securities, stocks, and bonds, and direct investment in new businesses, in the acquisition of existing Russian-owned enterprises, in joint ventures, in property acquisition, and in leasing the rights to natural resources. Foreign investors are protected against nationalization or expropriation unless the government declares that such a procedure is necessary in the public interest. In such cases, foreign investors are to receive just compensation.
In response to demands by foreign oil investors for stronger legal guarantees before making large capital commitments, in July 1995 the State Duma passed the Law on Oil and Gas. It provides a basic framework for other laws and regulations pertaining to exploration, production, transportation, and security of oil and gas. In late 1995, the Duma passed the Production-Sharing Agreement bill, which provides for foreign investors to share output with domestic partners. Among other things, the bill lifts many of the financial impediments by removing excise and customs duties on the exportation of oil by joint ventures, and it requires contract sanctity for the life of the project. But in a clause that drew criticism from the United States business community, the bill requires State Duma approval of new joint-venture agreements on a case-by-case basis. As of mid-1996, the United States Department of Commerce considered the Duma's veto power over such agreements a key obstacle to expanded United States investment in Russia.
By the end of 1995, foreign investment in Russia since 1991 had totaled an estimated US$6 billion, a small amount considering the size of the Russian economy. Of that amount, US$3.2 billion had been invested between 1991 and 1993 and US$1 billion in 1994. Of the approximately US$2 billion invested in 1995, about 28 percent came from the United States, 13 percent from Germany, 9 percent from Switzerland, and 6 percent from Belgium. By sector, 15 percent of 1995 investments went to trade and catering; 13 percent to finance, insurance, and pensions; 10 percent to the fuel industries; and 8 percent to chemical industries. Telecommunications, food processing and agriculture, pharmaceuticals and medical equipment, and housing are in particular need of additional foreign investment.
Russia's overall investment climate has not been robust because of high inflation, a plunging GDP, an unstable exchange rate, an uncertain legal and political environment, and the capricious enactment and implementation of tax and regulatory regimes. Nevertheless, experts predict that improvement in those conditions will bring a strong increase in foreign activity.
Russia inherited a large foreign debt burden from the Soviet Union that clouds its economic situation. Throughout its history, the Soviet Union was a conservative borrower of foreign credits. Its ability to manage international accounts allowed the Soviet Union to obtain both government-guaranteed and commercial credits on favorable terms. But, by the end of the 1980s, the Soviet hard-currency debt had increased appreciably. At the end of 1991, the debt was estimated at US$65 billion, an increase of over 100 percent since the end of 1986.
By arrangement with the other former Soviet states and its creditors, Russia accepted responsibility for repayment of the Soviet Union's entire debt, in exchange for control of some of the overseas assets of the other republics. In January 1996, Russia's total foreign debt was US$120.4 billion, including US$103 billion of the Soviet Union's debt that Russia assumed. Russia has been hard pressed to service that amount.
In March 1996, the IMF approved a three-year loan of US$10.1 billion to Russia. At that point, Russia already had US$10.8 billion in outstanding IMF debts. The first loan payment of US$340 million was paid almost immediately, and it helped Russia to overcome a large budget deficit that it had been trying to cover by issuing securities. The IMF made the early monthly payments of the loan during Russia's 1996 presidential election campaign, despite Russia's failure to comply with several loan requirements. However, once Yeltsin had been reelected, the IMF withheld the July payment because Russia's hard-currency reserves had been severely depleted during the campaign and the tax collection system remained unsatisfactory.
In April 1996, the Paris Club of seventeen lending nations agreed to the largest debt rescheduling procedure in the history of the organization by postponing US$40 billion of Russian debt in order to assist Russia in meeting its international debt payments. The agreement followed the November 1995 provisional accord with the London Club of international commercial bank lenders (which spread repayment of US$32.5 billion over a twenty-five-year period) and the IMF loan of US$10.1 billion in March 1996. The new schedule gave Russia a six-year grace period for repayment on the principal it owes.