Paper presented to the International Financial Institution Advisory Commission on January 18, 2000. Revised, February 15, 2000

1. Introduction

When the Soviet Union collapsed at the end of 1991, this process had been under way for quite some time. Any reasonable observer realized that the Soviet Union could not survive after the failed coup by Communist hard-liners in August 1991. Already then, the three Baltic states became fully independent. If anything, the surprise was how slowly and peacefully the collapse of the Soviet Union occurred (Åslund 1991; Dobbs 1997).

Since the fall of 1989, the end of communism and the Soviet empire had been a dominant theme in international discourse, and the importance of these events was never in doubt, as was made evident by enormous publicity.

Post-communist transition had been well analyzed with the transitions in Poland, Hungary and Czechoslovakia in 1990 and 1991. A huge intellectual discussion had taken place on the economics of transition, and there was even a "Washington consensus" established (Williamson 1990), which also applied to Eastern Europe. A vast economic literature reflecting this consensus for the post-communist world by many of the leading economists in the world had been published in 1990 and 1991 (e.g. Blanchard, et al, 1991; Fischer and Gelb 1991; Kornai 1990; Lipton and Sachs 1990; Sachs 1990ab, Sachs and Lipton 1990). A similar literature had developed about democratization as well (notably, Huntington 1991).

The European Bank for Reconstruction and Development (EBRD) had been established in 1989/1990 to support market economic transformation not only in East-Central Europe but also in the Soviet Union. In mid-1990, the Managing Director of the IMF flew to Moscow to launch a major study for the G-7 on how to reform the Soviet economy and the criteria under which Western economic assistance could effectively support such market economic reform (Gould-Davies and Woods 1999). At the end of 1990, four big international economic organizations – the IMF, the World Bank, the OECD and the EBRD – undertook a major study of the Soviet Economy, which involved dozens of professionals from all these four organizations, and the publication of a three-volume study was greeted as a major event, as the Soviet authorities had never before released so much information. The report advocated a radical and comprehensive reform program of the Polish type (IMF, et al, 1991).

In June and July 1991, a Grand Bargain initiative was elaborated by a number of prominent Harvard scholars and Russian economists on how to reform the Soviet economy with substantial Western support for the G-7 meeting in London in July 1991 (Allison and Yavlinsky 1991). In spite of considerable Western sympathy, the proposal was not accepted. From this time, it was clear that Russia wanted full-fledged Western support for market economic reform. However, Soviet President Mikhail Gorbachev failed to make a sensible proposal himself, and his political control was so obviously waning.

The aftermath of the August coup clarified two major outstanding issues. First, the Soviet Union was over, and the relevant entities were the union republics. Second, Russia had opted for democracy, and Boris Yeltsin had already been elected President of Russia with a majority of 59 percent of the votes cast in free and democratic elections in June 1991. The victory was all the more impressive as the ruling Communist Party campaigned against Yeltsin in all force.

Remaining questions were whether Russia would opt for a serious market economic reform and whether it would find reasonable economic politicians who would be able to carry it out. On October 28, 1991, Russian President Boris Yeltsin (1991) made the greatest speech of his career to the Russian parliament. He presented a comprehensive radical economic reform proposal, and he appealed for Western support of all kinds.

We are prepared, in cooperation with foreign specialists, to immediately disclose the strategic data necessary for admission into international organizations and to accept the basic principles set forth in the charter of the International Monetary Fund. We will make an official appeal to the International Monetary Fund, the World Bank and the European Bank for Reconstruction and Development, inviting them to work out a detailed plan for cooperation and participation in the economy (Yeltsin 1991).

His speech was overwhelmingly approved by a vote of the Russian parliament. A week later, President Yeltsin undertook a radical government reform. He abolished almost all of the dozens of branch ministries, cut the government staff sharply, and he appointed a completely new government with young reformers, largely drawn from economic research rather than from old political or bureaucratic cadres.

It appeared reasonable to expect the outside world to do whatever it could to support the Russian transition to a market economy. Personally, I had anticipated approximately this course of events. In early September soon after the abortive August coup, Professor Jeffrey Sachs and I went to Moscow to figure out who would run the upcoming reform. We met with several alternative reform leaders, but it was unclear who would take the lead. David Lipton and I went there in mid-September. At the end of that trip we had learned that five alternative economic government teams had been formed. We thought the best one was formed under Yegor Gaidar and Aleksandr Shokhin, and we left Moscow with an agreement that we would come back and work with them as advisors, when they were appointed ministers. This happened on November 8, and David Lipton and Jeffrey Sachs flew in immediately to see how we could help. We tried to help the reformers in government until all of them but Chubais were ousted in January 1994.

Seldom has a major event in history been so obviously positive and so evident in its coming. Naturally, the West should have offered strong and positive support. Alas, the mystery is that it did not, and the question we now pose is why and what different international agencies actually did.

2. The Tasks and Their Importance

To get a perspective upon what should have been done, we may start with the outcome of the transition in the whole of the former Soviet Union and East-Central Europe. A number of regression analyses have been made about the impact of various factors on output and their correlation in the whole region, and these works are largely in agreement (EBRD 1999; Berg, et al, 1999; Havrylyshyn and Wolf 1999; De Melo, et al, 1996; Åslund, et al, 1996).

The key economic assignment was to build a market economy, primarily to liberalize prices and trade as well as unify the exchange rate. Over time, analyses attach ever more importance to such structural reforms, primarily liberalization of foreign trade and prices.

However, high inflation inevitably resulted, when prices were liberalized in the presence of great shortages, with a monetary overhang of unsatisfied demand at given prices, soft budget constraints of state-owned enterprises and weak monetary and fiscal controls. Therefore, macroeconomic stabilization was a prerequisite for economic recovery. The standard view is that little growth is likely, as long as inflation is over 40 percent a year (Bruno and Easterly 1998; Fischer, et al, 1997).

The role of the state or governance are issues that are difficult to define, but they are becoming perceived as ever more important. In broad terms, the task was to move from arbitrary repression to the rule of law. Democracy has turned out to be vital for the success of economic reform in the former Soviet bloc. In general, there is a positive correlation between a market economy and democracy, but in the Soviet bloc the correlation is extremely close (Åslund, et al, 1996; EBRD 1999).

Initially, many argued that privatization was the all-decisive issue and that no success could be expected without privatization. Privatization and other reforms are positively related, but the positive effects of privatization have been less apparent in the former Soviet Union than in Central Europe. The argument is now being made that successful reform countries have beneficial privatization, while in less reform-oriented countries privatization has rather become a means of rent-seeking groups to maintain their power and influence on state policy to their own benefit (EBRD 1999).

Joseph Stiglitz (1999), until recently chief economist of the World Bank, has questioned the usefulness of radical reform, arguing that it did not work in Russia. Stiglitz’s arguments boils down to an advocacy of stakeholder privatization, although that was exactly what happened in Russia. He seems to imply that the only problems were in the field of privatization, and he does not appear aware of how the Russian privatization took place. He has no comment on the regression analyses of the output development in the transition countries. His provocation coincided with extensive Russian writing arguing the opposite, namely that the problem was that Russia had not had any radical reforms (e.g. Aven 1999; Fedorov 1999).

It appears pretty obvious what should have been done in economic reform in Russia, and our question is therefore whether the international community could have been more effective in supporting radical and comprehensive market economic reform in Russia.

3. The Distribution and Financing of the Key Tasks

The International Financial Institutions (IFIs) have performed at least four different functions in the post-communist transition to a market economy.

  • Financing of international reserves and investments;
  • Organization of co-financing;
  • Supervision of the implementation of relevant economic policy conditions;
  • Provision of economic advice.

Their support has been provided in four different sectors. The focus of international cooperation with Russia has been macroeconomic stabilization, and the international organization to carry out this work has been the IMF. Altogether, the IMF has issued $19.5 billion in loans to Russia. However, the first large loan ($6.8 billion) was not concluded until 1995.

Structural reform have been the theme of the World Bank and various bilateral agencies, such as US AID and the UK Know-How Fund. The World Bank has committed a total of $11.8 billion, and it has disbursed at least $6 billion to Russia, most of which has been conditions on structural reform, though not spent on it. Bilateral technical assistance for structural has been far less, probably in the order of $2 billion. US AID has spent a total of $5.45 billion on Russia from 1992 to 1998 (McFaul 1999), but most of that went to food aide and denuclearization. The EU technical assistance organization TACIS spent a total of slightly over $1 billion in Russia from 1992 to 1997 (EC 1998).

The World Bank, US AID and the EBRD have been the three agents dealing with privatization. TACIS kept out of privatization, as it considered privatization too ideologically controversial. Several of the World Bank adjustment loans have some relation to privatization. The total amount of technical assistance connected with privatization is probably in the order of a few hundred million dollars.

Governance, the rule of law and democratization have received little attention and little money. Initially, various bilateral agencies did something in this realm. For instance, US AID spent about $130 million on programs on democratic reform in Russia from 1992 to 1998 (McFaul 1999). The total amount of technical assistance has probably amounted to a few hundred million, because US AID might have done almost half of the work in this field.

4. Timeliness and Efficacy of Execution

In all discussion of international support for economic transformation in Russia, the focus has been on macroeconomic stabilization. Privatization has also attracted a great deal of attention, but it has required relatively small resources. Structural reforms, which have turned out to be so important, have not received the necessary support. For long, governance was barely an issue.

Focus on Macroeconomic Stabilization, But a Slow Start

Macroeconomic stabilization has been the dominant economic theme in international support for Russia for many reasons. First, while post-communist transformation was an unknown subject as a whole, macroeconomic stabilization was well known and not all too different, and few doubted that it needed to be done. Many prominent economists said approximately the same things. Second, there was one strong international organization, the IMF, for this task. Third, substantial international financing needed to be raised to replenish the exhausted Soviet international reserves and facilitate debt servicing, and relevant recent international experience for such tasks existed. The world had just organized such financing for Poland at the outset of 1990 and for Czechoslovakia in early 1991, and similar financing was organized for the three Baltic states in 1992. The international community's approach to Russian financial stabilization can be seen as a number of more or less chronological steps and the IMF has been the all-dominant agency (Sachs 1995; Åslund 1995; Gould-Davies and Woods 1999).

The West Does Nothing, Early 1992

On October 28, 1991, President Yeltsin appealed as never before or later for international assistance in his grand radical reform speech. His newly-appointed young radical reform government was working night and day preparing their reforms. A strong informed Western opinion demanded action. For instance, in November 1991, the New York Times wrote in an editorial: "The challenge for the West is to encourage Mr. Yeltsin’s real, radical program by giving attentive assistance now" (International Herald Tribune, November 13, 1991). On December 17, 1991, an editorial in the Financial Times stated: "Now is the first and, perhaps, the last chance for the west to promote radical economic reform in the former Soviet Union."

Alas, the leading Western governments had no intention to support any reform in Russia. In mid-November 1991, the new Russian reform government received the Deputy Ministers of Finance of the G-7, effectively headed by US Under-Secretary of Treasury David Mullford. During four days of negotiations, the G-7 deputies were only prepared to discuss one issue: the joint and several responsibility of the soon-to-be former Soviet republics for the full Soviet debt. To judge by their actions, they see to have been aware of the impending break-up of the Soviet Union, but their only short-sighted interest was to secure their claims on the Soviet Union, which they also did in an untenable way. The young Russian reformers were shocked and dismayed by the G-7’s total disinterest in their reform plans. The next Western initiative was equally irrelevant to reform, a large international conference on humanitarian aid to the former Soviet Union in Washington, D.C., in late January 1992. No Russians were invited. The obvious purpose of this meeting was to avoid any discussion of serious reform and macroeconomic stabilization. Admittedly, on April 1, 1992, US President George Bush and German Federal Chancellor Helmut Kohl had declared their intent to mobilize a Western aid package of $24 billion for Russia, but this claim was never substantiated or rendered credible (Åslund 1995, pp. 214-7). In April, the reformers faced a massive onslaught by the now anti-reformist parliament, and by June 1992 President Yeltsin effectively gave up and appointed a number of reform foes, including Viktor Chernomyrdin, Deputy Prime Ministers. One of the reasons for the political failure of the Russian reform government was that it did not get any support at all for reform from the West.

The leading Western policy makers blew it. It is difficult to understand how they could be so unwise. The only party that could have made significant decisions was the US President, but he did nothing. A number of factors seem to have contributed to this extraordinary passivity. The Bush administration seems to have been among the last to realize that the Soviet Union was breaking up, and it seems to have been interested in shoring up the Soviet Union until the very end, as evident from President Bush’s "chicken Kiev" speech in August 1991. Another reason was that the Bush administration was highly reluctant to provide any international financing. It did nothing to finance the stabilization of the Baltic countries in 1992 either, though there the Europeans fortunately put up the money. The forthcoming presidential elections in November 1992 seem to have rendered the administration totally ineffective, and a republic conviction prevailed that international assistance was unpopular with the voters. The Bush administration was generally slow in its decision making, as evident even from the reaction to the Iraqi invasion of Kuwait. The very problem was that the Soviet collapse was so peaceful and democratic that it did not seem to require any urgent action. Personal factors were also relevant. Soviet President Mikhail Gorbachev was favored over Russian President Yeltsin, although only the latter was democratically elected. Gorbachev’s aide Grigory Yavlinsky was preferred over Yeltsin’s reform leader Yegor Gaidar, who was not really known in Washington. In February 1992, the well-informed Washington Post columnist Jim Hoagland concluded that the US did not provide any support to Russia because President George Bush reckoned that Boris Yeltsin was a transitional figure (International Herald Tribune, February 12, 1992). As the Financial Times prophesized, this was the only big chance the West got to support reform in Russia. The responsibility must rest with President Bush and his closest aides.

The money discussed was really peanuts in comparison with the benefits. The US gained enormously through the demise of the Soviet Union. In 1985-6, the US spent on 6.2 percent of its GDP on defense, because of the Soviet nuclear threat. This share has fallen steadily since 1987 and in 1998-9 US defense expenditures were just 3.2 percent of GDP. By this standard, in 1999 the US benefited $259 billion or 3.0 percent of GDP in a peace dividend. Cumulatively, the US has gained more than $1 trillion in reduced defense expenditures after 1991 thanks to the demise of the Soviet nuclear threat. This peace dividend that has single-handedly eliminated the US government budget deficit. Compare that number with the request of about $25 billion in support for Russian economic reform in 1992 or the $6 billion for a stabilization fund.

In fact, the West gave over $12 billion to Russia in 1992, but not for but against reform. This money was issued as commodity credits which merely benefited commodity traders and their corrupt conduits. These export credits were bilateral and they are not conditioned on any reform measures. Nor were they coordinated with any international financial institution (Åslund 1995). Thus, the Western policy was neither to support reform in Russia nor to use the international financial institutions for that purpose, while a substantial amount of money was spent.

The Destabilizing Ruble Zone, 1992-93

The most disturbing episode in terms of economic advise was that the IMF did not advocate the breaking up of the ruble zone in 1992 (Åslund 1995). The effect was that initially 15 mutually independent central banks competed in issuing the maximum amount of money, because the more money one newly-independent country issued, the larger share of the total GDP it reaped. This situation could be compared with the prisoner’s dilemma. The Baltic republics departed from the ruble zone around mid-1992 without prior encouragement from the IMF, while the IMF did encourage Kyrgyzstan to leave the ruble zone in May 1993. Of the eleven states that remained in the ruble zone in mid-1993 all but Russia experienced hyperinflation – more than 50 percent inflation in the course of one month. In Russia, the reformers were in favor of breaking up the ruble zone, but they were not fully in charge, and virtually without external allies they lost out. In other former Soviet republics, the communist establishment was clearly in favor of keeping the common currency, which included cheap raw materials from Russia and subsidized credits.

Within the IMF, the Research Department went against the maintenance of the ruble zone, but it was defeated by the regional department and the management of the IMF. The IMF Executive Board seems to have favored the ruble zone out of ignorance. Outside of the IMF, the EU was strongly inclined to the maintenance of one currency zone, as the EU was about to establish the European Monetary Union. Among academics, Thomas Sargent (1986) had recently analyzed the disastrous consequences of the maintenance of the common currency of several successor states of the Hapsburg Empire. Only Czechoslovakia that had departed early had escaped high inflation, while the other successor states had experienced very high inflation because of the uncontrolled emission of a common currency. The same case was strongly put for Russia and other former Soviet republics (Sachs and Lipton 1993; Hansson 1993). The economics of a currency zone with several centers of emission was well known, and the result was disastrous.

Financing after Reform Had Stalled, 1992-94

Soon after the radical reform attempt had faded in 1992, various Western leaders seem to have woken up and realized that it was for real, but then it was already too late. Now a period began that has been characterized as "We (Russians) pretend to reform and you (the IMF) pretend to finance us." The IMF concluded several loan agreements on conditions that were either soft or not credible or both, while providing small loans, and Russian implementation was a persistent problem.

The worst of these loans was formally a stand-by agreement, approved on August 5, 1992, just after the reforms had ended and Russia was heading in the direction of hyperinflation with massive credit emission under the renewed Chairman of the Central Bank Viktor Gerashchenko. The conditions were not unreasonable, but it was evident that the agreement was not serious, as Gerashchenko was dead against its essence, although he signed it. The IMF disbursed $1 billion for no good purpose, and the World Bank topped up with $600 million in a rehabilitation loan.

In early 1993, Boris Fedorov had become Minister of Finance and Deputy Prime Minister and he struggled to conclude an IMF agreement. A so-called Systemic Transformation Facility (STF) was approved on June 30, 1993 with a one-year credit of $3 billion, of which half was issued at the time. This agreement did bring about important structural improvements, as it was conditioned on the elimination of import subsidies through the full unification of the exchange rate, the abolition of subsidized credits and several other less important conditions, which were complied with in the course of 1993. However, the agreement was very soft in macroeconomic terms. The STF had been invented to help countries that had failed to achieve ordinary IMF stand-by agreements, and it allowed a much larger budget deficit. The consequence was that the IMF turned soft and accepted budget deficits of up to 10 percent of GDP in some countries. Even if the agreement had been complied with, it would not have been sufficient to bring macroeconomic stability. However, in the fall of 1993, the Central Bank exceeded the IMF limits, and Boris Fedorov decided not to request the second STF tranche. Still, the structural accomplishments were substantial and lasting, and the lay the foundation for future stabilization.

In 1994, Prime Minister Viktor Chernomyrdin was fully in charge, and he was averse to hard policy decisions, as he was very much a representative of the old energy lobby. Even so, the IMF renewed its STF agreement in April 1994, and issued the remaining tranche of $1.5 billion. The Russian government was in no reform mood and followed the law of least resistance. In October 1994, the ruble exchange rate collapsed by 27 percent in one day, after a period of large budget deficits and excessive monetary emission.

Domestically, the policy of half-measures had been discredited. Within the IMF and its shareholders, there was little support for the STF and its soft conditionality, and it was swiftly phased out. Arguably, it had been introduced as a temporary measure. Its defenders argue that it had served its purpose and that a faster stabilization was not possible, but it did imply a slow stabilization.

In 1995, the IMF and the Russian Government Got It Right

The currency crisis in October 1994 and the ensuing rising inflation shook up the Russian establishment, and macroeconomic stabilization became a political priority. The IMF had been continuously engaged with the Russian authorities and was ready to go along. Chubais was put in charge of macroeconomic policy as First Deputy Prime Minister, and in the spring of 1995 macroeconomic stabilization was finally put on track. Russia concluded its first full-fledged stand-by agreement with the IMF in April 1995, with $6.8 billion in financing in one year. The Russian government reduced the general government deficit from 10.4 percent of GDP in 1994 to 5.7 percent of GDP in 1995, although revenues fell by 3.6 percent of GDP. The government’s trick was to cut enterprise subsidies by no less than 7.1 percent of GDP and regional transfers by 2.5 percent of GDP, while socially important expenditures were maintained (see table 1). With strong IMF support, Chubais won the struggle within the government over the elimination of the tax exemptions for favored lobbies. By the summer of 1996, financial stabilization had been attained. Inflation dropped to 22 percent in 1996 and to 11 percent in 1997.

Curiously, it proved possible to undertake a financial stabilization, by cutting subsidies, although the government was dominated by industrial lobbies. The causality is not obvious, and the explanations are many. First, an underlying reason was that the initial transition rents had dwindled. Subsidized credits and import subsidies were gone, and export rents were small. The sharp cut in subsidies made it at long last credible that profit seeking would become more profitable than rent seeking in Russia. Second, at long last the Russian government and the Central Bank pursued a coordinated economic policy, aiming at macroeconomic stabilization. Third, for the first time, the IMF was considering substantial credits, and its stand-by loan in 1995 amounted to 2 percent of GDP, which gave the IMF real political weight. Fourth, the immediate cause was the currency crisis of October 1994, which greatly upset the Russian elite and created a political momentum for reform. Fifth, the reformers in the government fought better than ever. Their method was to hit all important interest groups at the same time rather than offering them any trade off. Enterprise subsidies and regional transfers were cut by two thirds. For those who lived on budget subsidies, this felt like shock therapy. Finally, Gaidar’s party Russia’s Choice was actually the largest parliamentary faction, providing the reformers with a good base in the State Duma.

1996: All Politics

1996 was a year of no reform. The communists opposed market reforms, and the government contained no senior reformer. The government let the budget deficit rise from 5.7 percent of GDP in 1995 to 8.4 percent of GDP in 1996, distributing pre-election gifts. The real yields of the treasury bills reached 150 percent a year before the presidential elections, as the government tried to sell more than the market was prepared to buy in the face of great political risks. Moreover, access to the market was informally limited to privileged Russian banks, excluding both foreigners and households, making the treasury bill market a source of rent seeking. Interest payments of the federal budget increased from 3.3 percent of GDP to 5.7 percent of GDP as almost 4 percent of GDP went to the payment of yields on treasury bills (Illarionov 1998). The IMF insisted on the opening of this market to foreign investors, which did lead to lower treasury bill yields, but it also exposed Russia to a dangerous dependence on short-term foreign capital, attracted by the still very high real yields. Hardly anything was done to attract household savings.

In the spring of 1996 the IMF concluded a three-year loan program, an Extended Fund Facility (EFF), with Russia of $10.2 billion, although no senior member of the government seemed seriously concerned about reform. The program requested a budget deficit of 4.0 percent of GDP as the stand-by for 1995, but it was never a credible proposition. This was all too obviously a political decision to secure President Yeltsin’s re-election, supported by the G-7. Germany and France issued substantial credits for this reason, which in effect allowed the Russian government to increase the budget deficit further. Saved Yeltsin was, but at the expense of economic policy. The EFF agreement set the stage for Russia’s ensuing boom and bust. The soft IMF agreement convinced foreigners and Russians alike that Russia was too big – or too nuclear – to fail, and that anything goes in Russia. The IMF did delay a tranche in September 1996, but then the IMF had little leverage, because the IMF agreement unleashed an extraordinary inflow of private foreign portfolio investment. It rose from $8.9 billion in 1996 to $45.6 billion in 1997 or 10 percent of GDP. Meanwhile, foreign direct investment increased from only $2.5 billion in 1996 to $6.2 billion in 1997 (RECEP February 1999). Roughly half the foreign portfolio investments went into federal government bonds and half to other bonds and stocks.

The IMF Regains Its Economic Credibility, 1998

The IMF started becoming relevant again in late October 1997, as the effects of the international financial crisis began hitting Russia. The government had no choice any longer; it was compelled to cut the budget deficit. However, a soft budget deal effectively between the oligarchs and the communists had been settled in October 1997, and it took time for the government under Prime Minister Chernomyrdin to change gear. It did so only slowly and gradually. Eventually, President Yeltsin found himself forced to sack the Prime Minister in March 1998. It took another month before Parliament finally approved of his new Prime Minister Sergei Kirienko, and as the government was finally formed in May, Russia faced a full-fledged financial crisis.

The Kirienko government was not particularly fast or resolute in its handling of the financial crisis, and it was pressured by the IMF to cut the budget deficit in the face of very high real interest rates. Another problem was that the exchange rate was pegged and seemed too high. At that time, any devaluation would have put half the banks in bankruptcy because of their currency balances. The Kirienko government did accept most of the IMF advice on budget cuts and new tax laws to raise revenues, and the IMF granted a large additional credit of $11.2 billion. However, the Russian government failed to get most of the federal revenue measures adopted by the State Duma. As a consequence, the IMF did issue a reduced first tranche of $4.8 billion, but the Russian finances could no longer be saved without a devaluation or a default. On August 17, the government did both. It defaulted on its domestic debt, and the value of the ruble soon fell by three quarters.

Effectively, the IMF restored its economic credibility by not extending yet more credit, thus leaving Russia no alternative but to default. Half of Russia’s banks did go bankrupt and many other enterprises faced bankruptcy, too. In the end, the financial crash showed that there was a real hard budget constraint even in Russia. In the aftermath of the financial crash, the Russian economy has seen a quick recovery. In 1999, Russia saw industrial growth of 8 percent and total growth of almost 2 percent. While the devaluation was a catalyst, the qualitative improvements have been palpable. All kinds of arrears have fallen sharply after the financial crash, and barter fell by one third in the first year. Ironically, the financial crash delivered the cure that nobody else, neither the Russian government nor the West, could offer. Still, as the IMF was instrumental in allowing the crash, it should be given some acknowledgement. Yet, another exchange rate policy earlier on could at least have mitigated the crash.

Late 1999: New Politicization of the IMF

After the crash, the IMF naturally took a very hard position on Russia. Surprisingly, the new Russian government under Prime Minister Yevgeny Primakov did tighten the budget considerably, and the devaluation greatly helped it collect federal revenues, as foreign trade taxes go to the federal level. Structural reforms were now in the forefront, and the Primakov government showed no apparent interest in them. Eventually, Russia and the IMF did conclude a new stand-by agreement of $4.5 billion for one and a half years in July 1999, and a first tranche of $640 million was disbursed.

The IMF applied its conditionality much more strictly now, and insisted on full implementation of structural conditions. Moreover, the IMF did add new conditions introduced by the G-7 because of concerns about corruption in Russia. As a result, a second tranche was delayed repeatedly. In December 1999, Russia had carried out nearly all the macroeconomic conditions and almost all the structural ones as never before, but even so the IMF did not issue the money. Although it was not publicly stated, Russia was being punished by the G-7 for its military action on the Russian territory of Chechnya.

Strong International Support for Privatization

The process of Russia’s privatization has been well researched (Boycko, et al, 1995; Blasi, et al, 1997). In this sphere, Russia had strong leadership from 1991 to 1994 in Minister of Privatization and Deputy Prime Minister Anatoly Chubais. He swiftly developed a nationwide privatization administration. His group elaborated a sensible privatization program, and an impressive political compromise that made the mass privatization possible.

International technical assistance was primarily provided by the World Bank, the US AID and the EBRD. These organizations seem to have been able to work uncommonly well together in Russian privatization, but they were given clear guidance by their Russian partners, who collaborated excellently with their Western donors. The international agencies were providing all kinds of needed technical assistance, and privatization went ahead at a greater speed than anybody could have anticipated.

Privatization is often criticized, but the Russian mass privatization seems to have been the most orderly and equitable privatization. The worst privatization – of the oil and gas companies – occurred later and without foreign assistance. The problem was not that the privatization was rushed, as the privatization in 1992-94 is generally deemed the best. The main rents to the most wealthy had been acquired earlier through management theft rather than formal privatization. The later privatizations have occurred in other post-Soviet countries, the worse they appear to have been. Many of the problems blamed on privatization are really the effects of lacking deregulation.

Little International Support for Structural Reform

Structural reform is a catch word for many measures. Initially, the most important structural reforms were the liberalization of prices and trade. The Gaidar government started very well in early 1992, with substantial deregulation. However, it faced three critical problems in this sphere. First, domestic commodity prices remained controlled at a very low level, which also compelled the government to control exports through licenses and quotas. Commodity exports became a major form of rents. Second, the reformers failed to impose a unified exchange rate for imports, as the subsidization of food imports was perceived as vital social need. Third, Gaidar managed to introduce complete freedom of enterprise in January 1992, but it was curtailed by the mayors of the big cities in April.

The remarkable fact is that the West did not offer any support in 1992. The Russian government did undertake substantial trade and price liberalization then. If the IMF and the World Bank had provided financing conditioned on further liberalization at that time, much could have been done before the domestic resistance was mobilized. Instead, in the first half of 1992, Western governments poured export credits for food of more than $12 billion over Russia which went against reform as they were designed to go straight into the pockets of rent-seeking commodity traders. Fortunately, Boris Fedorov managed to get much of the necessary liberalization accomplished in 1993 with strong support of the IMF and the World Bank, but at that time the resistance of the vested interests was more organized and few reformers remained in the government. No Western agency ever offered significant support for the freedom of enterprise that Gaidar so bravely managed to maintain in 1992, which led to an explosion in the number of small enterprises in Russia.

The World Bank has issued a number of adjustment loans which have been conditioned on a large number of structural reforms and the IMF programs have increasingly emphasized structural reform measures. However, later attempts at various structural reforms, including tax reform, have not been all too effective, as the vested interests that opposed liberal reforms were too strong at that stage. Indeed, the EBRD (1999) Transition Report 1999 emphasizes the importance of getting on the right reform track, and the Russian experience is a good illustration. The Gaidar government did a great deal, but the long-lasting Chernomyrdin government (December 1992 – March 1998) gave priority to the vested interests.

Governance Received Little Early Attention

The development of the state and governance has been lagging behind. The best that can be said is that primarily US AID did a great deal to support the drafting of laws. A lot of exchanges of various kinds have taken place, but there is little doubt that it could have been done much more efficiently and on a larger scale. Increasingly, governance has been a subject of IMF and World Bank conditionality, which has drawn more attention to governance.

5. Conclusions of Experiences

These observations lead us to a large number of conclusions, some comforting, while others are less so.

A first devastating observation is that one of the most obvious windows of opportunity we shall ever see in world history was missed in early 1992. As nobody acted, many may be blamed, but the natural focus of criticism is US President George Bush and his closest collaborators. The international community seems to have been trapped between a desire to support the building of market economy and democracy in Russia and a contrary inclination to keep Russia down. The natural compromise was to do little. The ineffective Western support for Russian market economic reform is primarily an expression of an actual political choice and not a matter of technique. The availability of information was so great that only those who wanted to disregard the information could do so.

International support for the reform effort as a whole was poorly coordinated. For Poland and Czechoslovakia, the West as G-24 (the OECD countries) had provided effective action. The G-24 also provided effective financial support of a total of $1 billion to the three Baltic countries in mid-1992, to which the US hardly contributed. The G-7 had started preparing the coordination of international aid to the Soviet Union as early as at its summit in the summer of 1990, and it had undertaken a big operative study for this purpose with the four big international economic organizations. However, the G-7 effectively abandoned this effort and left the various international organizations to do whatever they could on their own without any particular haste. At the face of it, the G-7 was less effective than the G-24. Both at the time and in hindsight, it seems obvious that it would have been much better to have one coordinating agency so that structural reform, governance, macroeconomic stabilization and privatization had all been integrated into one comprehensive reform policy, which is widely perceived to be the best option (World Bank 1998). In effect, the IMF was to take the lead on Russia. One reason was that the IMF leadership was much more aggressive and the IMF was faster to act than any other international organization. Another reason was that macroeconomic stabilization was an obvious first issue. Moreover, the IMF had large funds. However, the IMF had no prior relevant experience of the region, but nor had any other organization. Clearly, this was a US choice as the IMF was liked by both the US administrations involved (Gould-Davies and Woods 1999). To a considerable extent the IMF has done exactly what it has been asked to do by its major shareholders.

A major problem with the IMF in Russia is that the organization has been forced to deal with serious political issues, while it has been supposed to be a technical, economic agency. A common view among IMF staffers is that it would be better for the IMF to stay out of Russia, as the organization is time and again forced to abandon its principal stand because of political vagaries of the leading shareholders. The loans in 1992 and 1994 were clearly politically motivated, and the EFF of 1996 prepared the ground for the financial crash in 1998. In late 1999, on the contrary, Russia was not given credits in spite of essentially complying with the conditions for political reasons. The main problem was not the conditions but that credits tended to be disbursed even when conditions were palpably unfulfilled. Gradually, the IMF has adjusted to this problem by demanding more prior actions.

Among international economic organizations, the IMF has undoubtedly been the most effective and the most respected in the Russian government, but it has only been effective on macroeconomic stabilization in a narrow sense, as the conventional wisdom has been that the IMF is not really serious about most structural conditions. Only fiscal and monetary restraints were perceived as really important to the IMF. Its technical advise has largely been highly considered by the Russian government.

The World Bank has also been important. It has had a broader front of activities, but that has also meant that it has been less focused and less effective. It has tended to be slower in its actions than the IMF, and its agreements are overloaded with lots of small conditions which distract from the most important conditions. Over time, the World Bank has become more focused on essential structural reforms that are doable, and it has abandoned its previous preoccupation with investment projects, that did not work out.

The EBRD has been useful in bringing in expertise early, training investment bankers for the region and undertaking the very useful annual Transition Reports. However, from the beginning it has had such a narrow mandate that it could hardly make much of an impact. It was supposed to provide financing only, if a project would not take place without it and preferably not more than one third of the total financing. It was meant to operate as a private investment bank, which implied that it had such high transaction costs that it could hardly finance any project of less than $5 million. Some 60 percent of its financing was supposed to go to the private sector, but good large private enterprises existed only in the most advanced reform countries. As a consequence, the EBRD could not do much anywhere early on, and there was only a brief period when its financing was essential. Either it lost money or it was irrelevant for transition. It had clearly been better for transition if the billions of dollars allocated to the EBRD had been used for co-financing of IMF programs instead. The leverage of IMF programs has clearly declined in the 1990s, as less co-financing has been available apart from debt restructuring.

No international organization has been preoccupied with international trade issues, which has been a serious void. The WTO has been very passive and is likely to remain so. Although Russia applied for membership of the WTO in 1993, the WTO has been virtually absent in Russian foreign trade policy. It has neither set standards nor provided technical assistance. The World Bank has to a limited extent functioned as a substitute.

On technical assistance, the IMF and the World Bank seem to enjoy the highest reputation, followed by the UK Know-How Fund and the US AID, while the EU TACIS has a disastrous reputation in Russia as well as throughout the CIS. Educational exchanges and development have been haphazard and uncoordinated.

Bilateral credits have largely undermined rather than supported reforms. The substantial commodity credits in 1992 are the case in point. The German and French credits in support of the Yeltsin election campaign in the spring of 1996 did not help reform. The contrary example is Japanese government credits that are firmly conditioned on reforms in anon-bureaucratic fashion, since they are co-financing adjustment loans from the World Bank.

Among various reforms, only privatization was carried out fast and effectively thanks to the Chubais group provided strong domestic leadership. The West responded with adequate and well-coordinated support, in spite of great political and technical complications. The design of the privatization was based on Russian political realities, while all kinds of Western technical knowledge was utilized.

Macroeconomic stabilization was not fast but eventually it was done thanks to the IMF and its substantial financing. The stabilization was designed by the IMF and the Russian government responded in 1995, because Chubais led the stabilization efforts skillfully that year. Any assessment of the IMF is dependent on whether one considers a stabilization in 1992 a real possibility or not. The IMF did utilize the next option.

Structural reforms have been a source of considerable chagrin. The initial Russian reform attempts were the right efforts, but they were ignored by the West, and therefore failed. My view is that they could have succeeded if they had attracted even limited but timely Western support, as speed is vital for successful liberalization. The opposing view is that the Russian reform government was too politically weak to deliver. Some headway was made in 1993, although it was politically much more difficult to get anything done at that time. Domestically, a strong Minister of Finance, Boris Fedorov, focused on the key structural reforms. These issues have primarily been the preoccupation of the World Bank, especially in its structural adjustment loans. However, the Bank has generally carried less authority than the IMF, and its many conditions on structural reform connected with rather small loans have been ignored more often than not by the Russian authorities. Moreover, the World Bank often deals with direct enemies of reform, such as branch ministries that would suffer from any market reform. Acknowledging that the World Bank has had little impact, the IMF has tried to get seriously involved in structural reform, primarily through the Extended Fund Facility of Spring 1996. Yet, the not-very-reformist Russian authorities have perceived that the structural reforms are not really important for the disbursement of IMF loans, as the IMF is seen as totally focused on the budget deficit and monetary expansion.

Today, governance is increasingly seen as almost as important as structural reform, but sadly these issues were all but ignored by Western assistance. Some bilateral agencies tried to do something, but it was piecemeal and minor. Late in the day, the World Bank and the UNDP have put governance on their agendas, but so far little has been accomplished. The issues are still poorly known and investigated; the advice remains vague and not very operative; few resources are devoted to this vital topic. If the World Bank is given the lead on structural reform, it would be natural if it is also taking on a leading role on governance, as these two issues are intertwined. However, competition with the UNDP might encourage both organizations to more action.

In general, the outside world has only been effective when a senior Russian reformer has been in charge of the relevant issue in the government. The President or the Prime Minister have not been key, while the Deputy Prime Minister in question (Chubais, Gaidar and Fedorov) has been. It seems rather meaningless to try to impose anything on the Russian government that the senior policy-makers are not interested in. Pure conditionality makes little or no sense, which is also the general conclusion drawn by the World Bank (1998).

The most important conclusion in the discussion over Western aid to Russia is probably that the West has not become effective because the US administration at the time of real reform on the turn of 1991 was not prepared to do anything. No full window of opportunity has appeared since then, and the West should not fool itself that it can influence everything in Russia.

6. What Can and Should Be Done in the Future?

With every year, the possibilities for the West to make a different in Russia diminishes. Not least, the Russians have suffer from aid fatigue in another sense than the word is usually used. At the same time, a large number of problems have been solved. Russia no longer needs large public funding for the sake of macroeconomic stabilization, nor is the West likely to offer any sizeable amounts.

Russia no longer suffers from a chronic structural budget deficit and it has long had a large trade surplus. Industrial output grew by some 8 percent in 1999 and GDP by almost 2 percent. Russia is coming out of the doldrums. It is true that international reserves remain small because of great capital flight, but one significant reason for the capital flight is that all kinds of Russians do not trust Russian banks and prefer dollar cash or international banks. The only serious macroeconomic problem is its foreign debt of $146 billion or 88 percent of its GDP at the end of 1999. Most of the debt, $99.5 billion, is Soviet debt and new Russian debt is only $46.9 billion. Clearly some debt relief is needed, and that is usually handled by the Paris Club and the London Club. A future debt relief is the most important economic leverage the world community has on Russia. Little role remains for the IMF. Rather than extending the role of the IMF to structural issues for which the IMF does not have traditional competence, it would seem more natural to let the IMF stick to its prime: macroeconomic stabilization. The politicization of the IMF makes this limitation in the IMF’s role all the more desirable.

The privatization has essentially been done with at least 70 percent of GDP arising in the private sector, although a number of individual privatizations remain and a major land reform. The big lingering reform tasks are structural reform and governance, including a major tax reform, land reform and anti-corruption issues. The natural agency for these assignments would be the World Bank. However, it is unclear whether the World Bank will prove effective in Russia and whether Russia will really welcome it. Russia might be better served in managing its reform on its own, now when financial resources are not a critical bottle-neck. Russia needs to become attractive enough to attract large private foreign direct investment.

The time of technical assistance seems to be other in Russia. Whenever the Russian government or Russian enterprises need Western consultants, they may pay for them themselves. Some international enterprise consultants have long refused to work for foreign aid agencies, as they reckon that Russian managers who ask for such support do not really want structural change. Instead, US AID resources should be directed towards the support of education and civil society through exchanges and the like.

Something that instead is becoming increasingly important is trade and here Russia has no international organization to turn to. A Western aim should be to facilitate a speedy accession of Russian into the WTO to support free trade in Russia and provide Russian businessmen with some international safeguards against arbitrary protectionist actions by other countries.

In its present shape, the EBRD seems pretty superfluous. Either of two options could be considered. One possibility is that it is privatized. The other option is that it becomes an ordinary regional development bank. It makes no sense to keep it as a hybrid.

In the end, the West cannot offer Russia all too much now, and the essence of Western policy should be to facilitate openness and exchanges of goods, services and people.


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Table 1

Key Economic Data for Russia, 1992-1999









GDP, $ bn









GDP, annual increase %









CPI % year end









Unemployment %









General government

Revenues % of GDP









Expenditures % of GDP









Budget deficit % of GDP









Private Sector % of GDP









Note: All these data are subject to continuous revisions, but they are all based on standard IMF definitions.

Preliminary estimate

Sources: EBRD (1999), Tanzi (1999), and Brunswick Warburg (1999).