In the late 1980s, the West pressured Russia into switching from a Communist government to a democratic state. The central government of Russia then made a strategic decision to switch from a command economy to a market economy. The local governments were put in a position where they had to take control over the economy without much guidance from the central government to make it successful. During this transition through the 1990s, Russia’s Gross Domestic Product (GDP) fell 36% by the end of the decade . In an attempt to decentralize the government, programs such as the mass privatization program and the loans-for-shares program were put into effect to help aid the transition from the command economy to a market economy; however, the local governments and businesses were uncooperative in making these programs successful.
A command economy is an economy controlled and operated by the central government. The central government controls the price and supply of products rather than the market forces. The government also decides what goods and services are produced and how they are supplied to the consumers. In 1991, with the election of Boris Yelstin, the central government decided to switch from this command economy to a market economy. A market economy is controlled by various market forces based upon the supply and demand curve. In a market economy people pay what they believe is a fair price for a certain item.
Prior to the dissolution of the Soviet Union, declines in output and increasing shortages were causing citizens to spend between 40 and 68 hours a month standing in line. After Yeltsin came to power, he introduced radical economic reforms, transitioning the economy from a government-controlled command economy to a market economy.
The abrupt change from a command economy to a market economy was introduced with shock therapy. One day, the economy was run by the central government, and the next it was based on a supply and demand curve. This shock therapy caused inequity in the country and most of the enterprises were privatized and stripped of their assets, causing chaos to break out throughout the country (Millar, 2009).
In June of 1991, Boris Yelstin became the first elected president of Russia, marking the beginning of a noncommunist Russian state. In December, Yelstin decided to dissolve the Soviet Union making Russia independent. The transition from command based to market based began with a decentralization process. This is the process of transferring power from the central government to local governments. During the decentralization process, Russia transferred economic and political control to the local governments and maintained few central policies . With the lack of central policies, the government had less power to invoke the policies that were adopted by local governments. The central government also did not establish clear directions about the types of activities and policies they wanted the local governments to follow, causing chaos between the local governments and the central government.
Since Boris Yelstin introduced radical economic reforms, most prices were liberalized. In 1993, Yelstin began a mass privatization program which transferred shares in most firms from the government to their managers, workers and public . In 1994 nearly 70 percent of the Russian economy was controlled by private firms. Since prices were liberalized and local firms had control, lines in stores disappeared and goods began reappearing. This is because store managers could control what and how much they stocked. Since they controlled their stock, they could meet their customers’ needs and wants more efficiently than before. These reforms, however, were not well accepted by everybody. Some groups wanted to keep the economy in government control. Because of this, the parliament, the well-organized communist party, and entrenched industrial interests resisted nearly all of the reforms.
The loans-for-shares program was another part of Yelstin’s plan. This program was an attempt to help balance the budget before the 1996 election. The loans-for-shares program was a program where businessmen would loan money to the government, and in return, valuable natural resource enterprises were turned over to them. This program also accelerated the consolidation of a few large financial groups led by oligarchs . No limitations were set on how much a certain oligarch could acquire. Because of the lack of limitations, many oligarchs gained more power than the government intended causing monopolies in key areas of the economy such as the lumber and oil industries.
The local governments played a vital role in stabilizing the economy after the transition. Their job was to protect and stabilize the economic structure while, at the same time, attracting new industry to the area (Mitchneck, 1995). They were to establish the primary control over political and economic decisions. To do this, they had to budget themselves to fund and create entrepreneurial activities. Entrepreneurial activities are defined as involving risk, with the local government assuming a public role of identifying market opportunities and mobilizing the resources to accomplish their goals (Mitchneck, 1995). Entrepreneurial activities include declaring Special Economic Zone status (SEZ), declaring sovereignty, and establishing barter contracts with other localities and firms (Mitchneck, 1995). By increasing these entrepreneurial activities, the local government was developing activities that were meant to establish certain regions as zones where market-oriented reforms and international trade could occur with minimal oversight from the central government.
The local governments tried to protect themselves by pushing for economic self-preservation (Mitchneck, 1995). The types of activities sponsored by the local governments were heavily dependent on the local conditions. Some of these conditions included the per capita local budgetary expenditures, local employment structures, and demographic composition. As governments studied these conditions, they had to determine what was best for their locality and what actions they would take to protect their future. Some of the local government’s actions followed the policies set by the central government; however, a majority of them disregarded the central government’s policies. They didn’t pay the proper taxes to the central government so that they could keep the money for their own personal need (Mitchneck, 1995).
Intergovernmental fiscal relations and local conditions can help explain how many of the local policies were formed. Many local governments wanted to gain power quickly so they could have more control over their economic and political situations. Local governments increased their political power by upgrading their administrative status. They did this by increasing the control the local government had over the regional economies and enforcing more regulations on the citizens. By doing this, some local governments broke policies created by the central government. Prior to the transition, local governments never had to budget themselves and were used to receiving money from the central government. However, with this transition, they had to rely solely on the income they gained from taxes. Some of these local governments in overwhelmingly ethnic Russian regions refused to send these tax revenues to the central government. This caused a high amount of tension between the two levels of government (Mitchneck, 1995).
The decentralization process produced many different local policies that caused chaos and introduced insecurity for Russian firms (Hitt, Ahlstrom, Dacin, Levitas, & Svobodina, 2004). Because of this insecurity and uncertainty, research suggests that managers took action to increase their chance of survival in the short term. To reduce insecurity, many managers decided to focus on short-term goals that would only benefit the firm for a short period of time rather than focusing on long-term goals that would protect the firm in the future. Even though the government created policies to help protect firms, managers refused to follow them because they were afraid that the government would not be there to protect them in the future. Because of the uncertainty of being protected in the future, firm managers were afraid that they would not be able to value long-term investments.
After reviewing the programs and the results of the programs set forth by the central government, we can create a strategy that would have been more beneficial for the economic transition. Different types of policies and slowing the transition would have prevented the chaos that happened during the economic transition. Intermittently introducing new reforms and policies to slowly transition the economy would have increased the probability of success. This would have allowed local governments to adjust at their own pace. It also would have allowed new business managers to read and comprehend the new policies issued to them (Millar, 2009). According to Millar, Russia should have created industrial polices to guide domestic investment to reduce the risk so that foreign investors would be less reluctant to invest in Russia.
During the rapid transition from a command economy to a market economy, the local governments and central governments clashed causing more distress in the economy. Local governments did not follow the few policies created by the central government. Communication between the two levels of government caused the economic transition to be less successful and more time consuming than intended. To prevent these clashes, the central government could have intermittently introduced new policies for the transition rather than using shock therapy. They also should have created industrial policies to help increase foreign investments in the Russian economy. With these changes, the Russian economic transition, which was unorganized and relatively chaotic, could have been more successful and less traumatic to the economy and intergovernmental relations.
Hitt, M. A., Ahlstrom, D., Dacin, T., Levitas, E., & Svobodina, L. (2004). The Institutional Effects on Strategic Alliance Partner Selection in Transition Economies: China vs. Russia. Organization Science, 15 (2), pp. 173-185.
Millar, J. R. (2009). Papa Schaeg on Economic Reform in Russia. Problems of Post-Communism, 56 (1), pp.47-52.
Mitchneck, B. (1995). An Assessment of the Growing Local Economic Development Function of Local Authorities in Russia. Economic Geography, 71 (2), pp. 150-170.
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