1   Privatization and the Russian transition

Perspectives

The Russian Mass Privatization Programme (MPP) of 1992–94¹ was the largest single privatization project ever undertaken, in terms of the number of companies and employees it affected. More important, it created the foundation of a market economy in Russia.

This chapter aims, first, to provide a brief background for our history of decision making in the early 1990s. We place that decision making in the context of the economic inheritance of Russia – the political, legal and constitutional mêlée within which reform was introduced, including the attempted coup in August 1991 and parliamentary opposition in September 1993. As Appel (2004: 179) cautions in her comparison of privatization in the Czech Republic and Russia, one must not “lose sight of the context in which the region’s privatizers found themselves in the early 1990s”. As reform was planned, there were tectonic shifts in the configuration of actors and interests in politics, introducing an urgent practical need to bring this reform – already mandated in the summer of 1991 – to completion.

Second, we aim to show the evolution of perspectives on the reforms. Initially the response was positive; however, in later years, for many policy-oriented economists after the mid-1990s, the Russian transition seemed an example of what went wrong with the Washington Consensus. The international aid community is often held responsible for the state of the Russian economy in the mid-to late 1990s. in the Conclusion to this chapter, we see perspectives on Russian privatization as still not entirely settled.

The first step is to put some flesh on the bones of those events. We then aim to arrive at what we believe is a balanced view of this reform, warranted by the evidence, and the lessons we might learn from it.

Background to privatization in Russia

Pressure for reform, 1985–1991

Some generalizations about the economic and political context of reform apply to all the transition economies of Eastern Europe and the former Soviet Union. Decades of faltering productivity growth rates put pressure on the governments to exact radical market-oriented reform. To this pressure was added a popular desire, more apparent in some countries than others, for political reform, the creation of democratic institutions and the introduction of civil rights (Fish 1997; Pickles and Smith 1998; Fidrmuc 2003). In these countries, obtaining support for reforms by government was often a smoother process than in Russia and the Commonwealth of Independent States (CIS), where expectations could not be anchored in hopes of European Union (EU) accession.

The mounting pressure for economic and political reform in the Russian Federation was accompanied by declarations of sovereignty among the Soviet republics, which led to the fracturing of central political authority. Throughout 1991, as the Soviet economy stagnated, the soon-to-be break-away republics, including the Russian Soviet Federative Socialist Republic (RSFSR), began to execute economic reform without consulting the central authorities of the Soviet state. Both the Russian and the Soviet parliaments passed legislation that enabled private and quasi-private ownership before 1992, resulting in simultaneous policy formation at different levels of government. The process was chaotic and associated with fierce conflict over means and ends.

Mikhail Gorbachev,² the head of the Soviet Union, had failed to implement a clear programme of institutional or economic reform, in part because his government was focused on political reform, indeed the future of the Soviet Union (Breslauer 2002; McFaul 2004: 140).³ Gorbachev’s cautious policies and vacillation between inviting reform proposals and rejecting them showed both the power of leading communist opponents to stall and shape industrial privatization and his own reluctance on the issue of private property rights. So, in 1991, the legislation underlying ownership of Russia’s industrial assets remained ambiguous. Laws emanating from both the Soviet and the Russian parliaments were incomplete and often contradictory.⁴ The focus of political debate and reform was less on economic reform and more on the very existence of the country itself.

Even without a full programme, Gorbachev started the privatization process which led to “spontaneous privatization”. The Communist Party of the Soviet Union (CPSU) in 1991 had agreed to remove small businesses and traders from state ownership. A Standing Socioeconomic Commission of the CPSU Central Committee report, dated 20 May 1991, advocated rapid privatization of light industries, the food industry, and trade and services; but it advocated state ownership for natural resources and leaseholding and shareholding mechanisms for the state industrial sector.⁵ The speed of change was to be slow, in fear that “excessive haste, or God forbid, compulsion” might lead to serious social unrest.⁶ One driver of legislation in Gorbachev’s government was the formidable interests of industrial ministries, which aimed to control privatization.

After the failed August coup, Boris Yeltsin,⁷ then the President of the RSFSR, showed a strong commitment to both political and economic change. He banned the former ruling Communist Party and converted the central planning economic regime to a state apparatus less engaged with the economy and more accommodating to markets (McFaul 2001: 127; Sakwa 2002: 32; Gros and Steinherr 2004: 228). He secured Gorbachev’s resignation on 25 December 1991, which triggered the dissolution of the Soviet Union, and gained recognition of the United Nations for the Supreme Soviet of the Russian Federation⁸ as the government of the successor state. The Russian Federation now held a permanent appointment at the Security Council.

Despite Yeltsin’s political departures from the previous regime, he did not call elections for a new Congress of People’s Deputies⁹ and he postponed plans for a new constitution. Thus, from 1991 to 1993, parliamentary and presidential authority was derived from the constitution of the previous Russian republic, originally drafted in 1977, and subsequently amended (not least to incorporate the role of president).¹⁰

Without a new constitution, or a new popular mandate, Yeltsin had little choice but to work with the existing Russian parliament (Congress of People’s Deputies) and with the Supreme Soviet that governed between its sessions. This strategy meant that, at least initially, he depended on key allies in the Supreme Soviet (of which he had previously been chairman), especially Ruslan Khasbulatov,¹¹ its current chairman, who helped Yeltsin secure temporary extraordinary powers to rule by decree in November 1991, and to push preliminary approval of the government’s Privatization Programme through the Presidium of the Supreme Soviet in December 1991.¹²

Yeltsin’s decision to rule by decree no doubt lessened incentives for further institutional reform and weakened the essentially democratic credentials that he held when he became president.¹³ Nevertheless, he was the only figure who could claim a popular national mandate. He was the leader of the political movement Democratic Russia, had been the head of the Russian Supreme Soviet,¹⁴ was elected the chair of the Russian Congress of People’s Deputies, and, from June 1991, was the elected president of the Russian Federation.¹⁵ Although he seized control “from the top of a tank”, he did so in defence of parliamentary rights (Gustafson 1999: 29).

However, the political weight bestowed upon parliament in the early 1990s allowed it not only to award powers to Yeltsin, but also to challenge his government. In the Soviet era, there had been no separation of power between government branches, and the Supreme Soviet had made and executed the laws. Ruslan Khasbulatov on 13 January 1992 sharply criticized the reform programme as leading to a chaos that might serve a dictatorship. On 20 January, he called for the government to resign and for society “to realize the difference between the government and the Supreme Council”.¹⁶

Against this political force, the government provided no unified front. It essentially comprised a weak coalition of conservative and reform interests. Yeltsin’s non-ideological stance was reflected in the different backgrounds and opinions of the members of his own government. Yeltsin chose to stay above the fray, to the extent that it was possible. His role, as Burbulis put it, was as brakeman and regulator or arbitrator as well as locomotive.¹⁷ Colton (2008: 247) describes Yeltsin’s “migration” as president to a position where “he had done Russia a service by shielding it from a revolution. He preferred the emollients ‘radical reforms’, ‘democratic reconstruction’, ‘reformist breakthrough’, or if revolutionary verbiage could not be helped, ‘quiet revolution’ (tikhaya revolyutsia).”

From his fragmented political base, with resignations and new additions to his team, Yeltsin faced challenges in building the foundations of a market economy that were political as well as economic in nature. With the buildup of a strong lobby within the government against mass privatization of industry and favouring workers’ collectives, he nevertheless had to construct a reform that would address the pressing needs of the Russian economy, while paving the way for longer-term benefits through better corporate governance and overall efficiency. Meanwhile, his foreign policy moved towards closer relations with Europe and the United States, while his domestic policy embraced reform and institutional change, replacing the command administrative system (Lane and Ross 1999; Breslauer 2002). At the time, the political challenges in Russia were considerable and pressure for legal reform was building. In Russia, as in Central Europe, mass privatization was seen as a key reform in market transformation, and its larger message, addressed to communist politicians, was that the total state ownership of enterprise was over.

Further, the economy was in a parlous state in late 1991, and the question of “when to do what” was not a political priority. As McFaul observes (2004: 141), “no one within the Russian government cautioned against going ‘too fast’”. Yegor Gaidar,¹⁸ the architect of the radical economic reforms and one of the leading politicians in Yeltsin’s first government, later reflected that when Yeltsin formally assumed the reins of power at the end of 1991, the country was on the brink of catastrophe. With the collapse of the Soviet communist state and no immediate succession to a new democratic one, the country lacked key elements necessary for a functioning state and economy.¹⁹ It was in these circumstances of institutional chaos that Yeltsin and his government set about the reform process.

The decisions

The 1992 Privatization Programme was approved by the Russian parliament within six months of price and trade liberalization. With a single, albeit incomplete, price and trade reform on 1 January 1992, the government ended the autarkic closed system that enabled the functioning of the command economy. The pace and the order of changes in Russia were forced on the government, as Anatoly Chubais explained in an interview on Russian TV with Aleksandr Radov, who asked “Why did you rush?”

If we had had the opportunity to act as we wanted, the problem of privatization would have been resolved first. Of course, it would have been even better to restore the financial situation to health first, and only after that to free prices. We found ourselves in a situation where the economy was on its deathbed. Either we took emergency measures right away and got it out of this state, or we would quite simply be dealing with a corpse.²⁰

Thus, price liberalization came first, then stabilization with fiscal tightening, then privatization. Yeltsin, who had little knowledge of economics, nevertheless knew that change was needed. And, indeed, a survey taken by the USSR State Committee for Statistics in March 1991 had found widespread appreciation of the need for “radical change”.²¹ Just under half (45 per cent) the population was prepared to accept the temporary hardship that would come about as a result of radical reforms. The commentator for Izvestiia observed: “I must repeat, however, that people are perfectly well aware that there is no alternative to a market economy and that change cannot be avoided.”²²

It was understood at the time that inflation would complicate stabilization efforts (Choksi and Papageorgiou 1986; Feige 1991). In Russia, inflationary pressure powerfully contributed to undermining the classic transition strategy. The initial rise in the price level was far higher than expected – exceeding 250 per cent – associated mostly with a larger than expected monetary overhang from the Soviet era and an underprediction of the effects of a large initial devaluation.²³ There were no doubt also structural reasons, such as the move from a dual to a unitary monetary system for the jump in the price level.²⁴ Difficulties also stemmed from Russia being a federative state – without the enviable fiscal control of unitary states like Poland and the Czech Republic. Autonomous regional borrowing along with discretionary budgeting imperilled fiscal stability throughout transition. For the severity of inflation, the policies of the Central Bank, headed by Viktor Gerashchenko,²⁵ were in part responsible. Accountable to parliament rather than to the government, Gerashchenko continued to issue credits to enterprises. Nor was it clear whether the government was united in its desire to control the budget. Yeltsin himself was “a hard sell” on the subject of controlling the money supply (Colton 2008: 243). Viktor Gerashchenko pointed out that it was “the government asking us through Parliament to provide [enterprises with] credit”.²⁶ Where credits were not issued by the Central Bank, enterprises issued credits to one another, which resulted in huge pressure on the centre to pay the enterprises’ workers. Rapid inflation persisted throughout 1992 and the decline of the economy accelerated. The rampant inflation²⁷ hardly provided favourable conditions for the Mass Privatization Programme, which began in the autumn of 1992.²⁸

The hope had been that the effects of price shocks would only last for a limited period.²⁹ In a television address, Yeltsin himself told the nation, that the reform process “will be tough for us … but this period will not be long. We are talking about 6–8 months.”³⁰ By the end of 1992, however, the turnaround in Russia’s economic fortunes had failed to materialize. Gaidar had left the government. Anatoly Chubais was the leading reformer, made responsible for the execution of the Privatization Programme.

Privatization was the policy that reformers were hoping would lead to early benefits, initially in giving securities of value to the population and later in accelerating restructuring and efficiency. So, despite these inauspicious conditions, the government went through with the drafting of the Privatization Programme for 1992, passing it in June 1992.³¹ It became one of the few pieces of economic reform legislation that had both parliamentary and executive approval. It included a list of categories for companies that were to be privatized. For medium to large companies, the programme laid out three alternative approaches to privatization. Controversially, one of these allowed the purchase of the majority of shares in a company by its own workforce.³² That move, often regarded as a concession to the industrial lobby, certainly helped build a coalition in support of the programme (Boycko et al. 2001).

However, while the “supply side” of privatization gained parliamentary support, the demand side did not. A Presidential Decree of 18 August 1992, which authorized the issue of tradable vouchers (as opposed to illiquid privatization accounts),³³ was perceived by parliamentary opponents as contradictory to the spirit of the 1991 Privatization Law, under which the 1992 Programme was passed.

The Privatization Programme set out the terms for voucher acquisition by citizens and their redemption at auctions for shares of medium-size firms. Big companies, including companies in the extractive sector, were excluded from privatization. The voucher decree was modelled in part on the Czech experiment, but the vouchers were to be individually subscribed for, and to be tradable, thus offering Russian citizens as a whole, and not only the labour collectives, a stake in Russian industry.

The design of the voucher distribution model accorded particular privileges to insider purchasers. To some extent, voucher privatization in Russia mirrored the outcomes in the Central and Eastern European (CEE) economies, which were similarly characterized by insider trading. In Russia, however, this was also in part a decision to “trump” laws put in place under Gorbachev, which had allowed “leasing for purchase” and other forms of “spontaneous privatization”, which were to be superseded by privatization. So, for example, these earlier laws had allowed managers to lease, or in other ways transfer, the value of their enterprises’ assets to shell companies owned by friends or to set up joint ventures with foreign partners (Thomas 1993; Carlin et al. 1995; Bornstein 1999). Though vouchers aimed to involve citizens and provide a sense of fairness, and though worker ownership was in accord with the traditions of Russia, it was, as we shall show, unlikely that voucher privatization and insider ownership could, in the short term, help Russia to restructure its industry. Additionally, voucher distribution meant that the state was not going to raise any revenue from privatization. The limitations of what could be achieved through privatization were understood by policy makers at the time; nonetheless, the programme garnered support, not least because it was deemed superior to any other option available.

The Russian Privatization Programme was developed and implemented in the context of chaotic institutional transition. Its political champions navigated through the corridors of reform with lightning speed, attempting simultaneously to resolve supply and demand problems, while dismantling the Soviet command economy. Thus, while to some extent the Russian Privatization Programme paralleled similar programmes in the CEE, the political situation, the industrial structure of the country, and cultural heterogeneity complicated the reform process in Russia, making it qualitatively different to those in many other post-communist countries in the region.

Perspectives on privatization

A large body of empirical literature has addressed the outcomes of privatization in post-communist countries. It has asked if fundamentally changing the ownership structure of firms resulted in improved performance of firms, restructuring and greater efficiency.³⁴ It is not our objective to evaluate this literature, except in one regard. It is an important finding that after 20 years, no robust difference in performance has been established among countries as a result of different methods of privatization. Estrin et al. (2009: 702) write:

Commencing with the macro studies, we find that the results suggest that privatization, especially when accompanied by complementary reforms, may have a positive effect on the level of aggregate output or economic growth. However, one of the most widely debated issues of transition (e.g., Kornai 2001), namely the effect on aggregate output and growth of rapid privatization (frequently accompanied by dispersed ownership) versus slower privatization (often with more concentrated ownership), remains unresolved.

It was widely acknowledged at the time that privatization alone was insufficient to produce positive results, which could be gained only from a larger reform strategy, by coordinating what Svejnar (2002: 5) later called “type 1” (macro-economic stabilization, price liberalization and dismantling institutions of the communist regime) and “type 2” (legal reform and institutions for regulating a market economy, including privatization) reforms (Svejnar 1990; Lipton and Sachs 1990; Blanchard et al. 1991; Aghion and Blanchard 1994; Estrin et al. 2009). In other words, significant as it was in ending the essence of the communist state – total state ownership of the means of production–privatization was by no means enough to jump-start a well-functioning market economy.³⁵

Voucher privatization has nevertheless taken much of the blame in academic literature for Russia’s long recession (Wedel 1998; Black et al. 2000; Shlapentokh 1993; Stiglitz 2002; Woods 2006). Along with weak corporate governance in Russia, the reform is credited with the pervasive corruption observed in the country by the end of the 1990s (Varese 2005). Privatization has been credited as the main driver of recession (Black et al. 2000; Kolodko 2000; Goldman 2004), even though, by early 1992, Russia was already in the grip of runaway inflation and widespread seizure of firm assets. This chapter attempts to explain why this single reform – no less successful than similar reforms in other transition economies – has seemed the main factor in Russia’s unfortunate and enduring economic recession, and why the authors of this reform, rather than general economic conditions and a larger policy failure, were to such an extent held to blame.

The early reputation of privatization

In the first few years of the reform, observers noted the efficacy of the decentralization process, which demonstrated the federal state’s considerable capacity to transfer thousands of state-owned firms to the private sector without halting economic activity or undermining the political order in the short run (Lieberman and Rahuja 1995; Nellis 1995; Estrin and Stone 1997; Appel 2004). The reform was carried out with speed and an effective media campaign. Despite the enormous size of the country, the reform established private ownership in an economy “more heavily distorted by communist planning than most (and in an environment more intensely politicized than elsewhere)” (Lieberman and Rahuja 1995: 7, 29). An impressive all-Russian auction centre was in place after March 1993: brokerages and exchanges were established in the regions. Leeds and Harman (1995: 111) report that “despite a continuous array of roadblocks, the Russian privatization program has indeed become the catalyst for market-oriented reforms and it has established solid foundation for the development of a securities market”.

To be sure, as Blasi et al. (1997: 2, 48) caution, short-term judgements were impressionistic: “One month Russia is all Mafia, the next months all emerging stock market, then all communism, then all entrepreneurial savvy.” There was excitement in 1994 when the Russian stock market seemed to take off, but then it crashed. Russian investment privatization, or voucher funds, first drew note as they multiplied in a few years, and then disappointed the observers, who later assessed them as having been mismanaged and failed to bring about transformation (Volgin and Milner 1995: 55; Pistor and Spicer 1997).

The Washington Consensus³⁶ was important in the early positive reputation of Russian privatization. John Williamson’s seminal Washington Consensus, a policy prescription advocating macroeconomic stabilization and the opening up of trade and investment, encapsulated the reformers’ priorities, which conformed to the views of many development economists who were shaping international aid policies at the time. During this period, there was “more privatization, deregulation, and trade liberalization in Latin America and Eastern Europe than probably anywhere else at any point in economic history” (Rodrik 2006: 974).

It is important to underscore, however, that while international agencies were supportive of the Russian plans, significant international aid for Russian privatization began only in 1992.³⁷ Initially, the Russian government worked on the privatization programme with little help from international agencies. In March 1992, the World Bank sent a mission to Russia, providing early guidance on the use of vouchers. The mission included experts who had worked on the Czech privatization, to which the Russian programme bore some resemblance. However, the World Bank advised that “privatisation [was] not an end in itself”.³⁸ Unlike some of the Central European countries, Russia privatized its enterprises before restructuring them, with millions of vouchers distributed to management and employees. In reviewing the Russian privatization, the US Government Accountability Office (GAO) observed that restructuring could be complicated if the new share owners objected to it.³⁹ Despite reservations regarding restructuring, the GAO determined that assistance for privatization was a successful, if not cost-effective, project. More than 70 million vouchers were distributed during the course of the programme, with many of the distribution centres evolving into active market institutions.⁴⁰

Among others who supported the highly positive international consensus, naturally, were the reformers and some of their advisers, whose works cited Russia’s privatization for its demonstration of the applicability of certain “fundamental economic principles” (Boycko et al. 1995: vii). The achievements were indeed extraordinary. For example, Lieberman and Rahuja (1995: 7) remark that the Russian government had moved forward with impressive reform plans and implementation: “From December 1992 to February 1994, nearly 9,500 large scale enterprises, employing 11 million people, were privatized, creating 40 million new shareholders.” One of the most successful of the European post-communist restorations of private ownership in law and its dominance in the economy, they wrote, the Russian programme assumed a grander scale than the more controlled reforms in Poland, the Czech Republic and Slovakia. It was more comprehensive in the sense that vouchers were more widely distributed, with over 20 million company employees gaining access to vouchers, far more than in any programme elsewhere. And the privatization took only 27 months to complete from the introduction of the bill to parliament until the closure of voucher auctions.

Russian privatization served as a model for others. Twenty-five countries used some form of mass privatization as either a primary or a secondary method (Estrin 1997). Nine countries used management-employee buyouts as their primary mechanism, with six more using them as their secondary method. Only five countries used direct sales as the primary privatization method – and these five were among the most developed and advanced transitional economies. Estrin (2002a: 109) writes:

Mass privatization was an excellent solution to the problem that state ownership was omnipresent and domestic wealth holders were insufficient to buy the assets. The mass privatization strategy also facilitated an extremely speedy ownership change in most transition economies, as few countries had contained a private sector of any significance in 1990.

Nellis (1995: 1) wrote that Russian privatization was “the one bright spot in the generally bleak Russian economic landscape”. The transformation of half the state-owned enterprises into joint stock companies with privileges for workers’ collectives, he commented, although a forced compromise, designed by Anatoly Chubais, was an achievement, undermining potential opposition from workers and managers by distributing vouchers. In 1994 and 1995, the political accomplishment of Russian reform was widely viewed as one of the most significant in all respects in Central and Eastern Europe (Appel 2004: 93).

Reception of reform: mid-1990s

Views of reform grew more tentative when Russia, in common with most other countries of the former Soviet Union and in contrast to the leaders in Central and Eastern Europe, failed to recover quickly from a deep transformational recession. The costs of institutional transformation, and perhaps of early policy flaws,⁴¹ were severe. Economists began more widely to question the appropriateness of the privatization models used and, particularly, the speed of reform. The negative appraisal worsened in subsequent years as a consequence of a growing lack of transparency in the privatization process, especially after 1994 (when the MPP had come to an end). Before the turn of the century, the condemnatory views came to dominate popular literature. Privatization is totemic in a sweeping criticism of the broader economic reform programme of the Yeltsin regime.

Internally, that is within Russia, criticism of the project emerged early among those leading the parliamentary opposition and also from within the government. Even those who might be considered reformers were critical, including Grigory Yavlinsky, an economist and the leader of the liberal Yabloko party. This domestic criticism later affected perceptions abroad, especially following the loans-for-shares (LFS) operation in 1995.⁴² The review of privatization laws and policies carried out by the Audit Chamber of the Russian Federation was highly critical (“Analiz” 2004). The critics viewed the LFS, probably the seminal event undermining the positive view of privatization, as unfair, benefiting the government and the oligarchs at the expense of society as a whole. In addition to divesting the state of valuable assets at a time when their market price was low, losing substantial revenue for the state, the LFS considerably weakened the government’s credibility domestically and abroad, even in the eyes of fervent supporters of the Russian Privatization Programme (Lieberman and Kopf 2007: 325–6).

The non-transparent nature of the LFS and its outcomes led some observers to call into question the actions of the elites driving the privatization and the role of international donors guiding reform policies. Freeland’s Sale of the Century (2000), for instance, describes the pervasive corruption, which she attributes to the ambitions of the elites who supposedly exploited the chaotic conditions in the country to coordinate privatization to their advantage. She finds, further, that a small coterie around Yeltsin, led by Anatoly Chubais, the minister in charge of privatization, manufactured the LFS mainly to assist the victory of Yeltsin in the 1996 presidential elections (Freeland 2000; Goldman 2004). Freeland posits that the oligarchic elites were backed by western agencies, though to our knowledge no official international agency advised on or condoned the LFS.⁴³

Like Freeland, Wedel (1998) criticizes international donors’ seeming proclivity to “back people”, as opposed to policies. In her book, Wedel links US aid to the Yeltsin regime and the privatization project, weaving a personal scandal into the reform narrative. According to this account, international donors made Yeltsin’s government “the gatekeeper for hundreds of millions of dollars in G-7 taxpayer aid, subsidized loans, and rescheduled debt” (ibid.: 122), in essence, sponsoring a small clique around “the ‘St Petersburg Clan’ or the ‘Chubais Clan’”. While there is validity to the observation that western agencies come to the assistance of particular policy makers, rather than basing their assistance only on the soundness of the policies themselves, it can be argued that for transition aid to have been effective, it had to be given to reform-oriented governments and have been negotiated and managed for those governments by key individuals. This was a lesson learned from prior experience in Latin America, where economies showed little benefit from the extension of unwelcome aid (Tsikata 1998: 75).⁴⁴ So, although large areas of government were broadly and deeply affected by ongoing consultations with international advisers, in many areas, such as agriculture, international agency expert advice was limited. Furthermore, Wedel’s argument that US aid to Poland and Russia comprised “too often poorly conceived and structured projects … [which] … led to impasse or even disaster” (ibid.: 6) shows little understanding of how aid worked and, specifically, how aid for privatization actually functioned.⁴⁵

What went wrong?

Into the late 1990s, when the Russian economy had not yet emerged sustainably from its transformational recession – again, by contrast with the more advanced Central European states – policy analysts focused exclusively on what went wrong. Some focused on Russia’s initial conditions, which predisposed it to a particular vulnerability to transition reforms. Russia had no experience with market reform, in contrast to countries in Central Europe, particularly Poland and Hungary, where there had been partial marketization in the 1980s. Russia’s industrial structure and external trade patterns were initially more distorted than in Central Europe. The weakness of law enforcement institutions and the strength of the industrial lobby and other opponents of markets were attributed by some economists to legacies of the Soviet era (Gaddy and Ickes 2002; De Melo et al. 1997; Krueger and Ciolko 1998; Heybey and Murrell 1999; Popov 2000: 35). Others traced the failure of macroeconomic reform in Russia in large part to the state of chaos at the end of perestroika, chaos far worse than in former East Germany, Hungary, the Czech Republic and Slovakia (Dabrowski 1997: 41–2). An excessive supply of money, in combination with mainly fixed prices, led to repressed inflation and forced savings. As the planned economy disintegrated in the late 1980s, relaxed economic discipline in Russia drove the annual rate of growth of M2 up to 15 per cent and increased the velocity of money, while investment collapsed and output began to plunge.

Other economists focused on the critical policy differences between Russia and Central and Eastern Europe (Åslund et al. 1996; De Melo et al. 1996; Brenton et al. 1997). It was thought that the pace of privatization without prior stabilization had not been the best policy. Rogoff (2002) observed:

Now it is clear … creating incentives for genuine restructuring of enterprises was more important than moving property into private hands. Imposing hard budget constraints to force out the chronic loss-makers among the enterprises turns out to have been quite important in inducing restructuring even if the enterprises were still in state hands.

“The furious pace of the sale of assets” was also blamed for opening the door to corruption (Black et al. 2000; Kolodko 2000: 166). Kolodko (ibid.: 156) put it as follows:

[W]hen assets were being dragged through the hectic process of the transfer of property rights, the distortions induced in management and corporate governance were quite serious… . Privatizations which are politically driven, hurriedly executed, and not well planned intensify rather than reduce allocative inefficiency.

To be sure, it was well known from the outset that speedy reform would not preclude self-dealing (Sachs and Pistor 1997). But alongside this disadvantage, the reformers assumed that there would be benefits: the alignment of control and property rights and the provision of incentives for less able insiders to sell the firm to better managers (Blanchard and Aghion 1996). After the fact, however, it became clear that once in control and connected to government, powerful insiders could not be constrained. For example, in Russia, the so-called “strategic” industries, including oil, gas and the extractive industries, continued to have the support of the state. In one of the most searing critiques, Black et al. (2000) argue with this in mind that self-dealing both discredits reform and, in the long run, prevents corrective policies.

Other major faults were found with Russian privatization. Some faulted inconsistency, for example the failure to precede price reform with currency reform (Goldman 2004: 64), the failure to decontrol energy prices (Shleifer and Treisman 2001: 2), and the failure to reform the punitive tax system (Vysokov 1995: 15; Black et al. 2000). As economists tabulated the negative impact of the privatization on the Russian economy, many began to reconsider the soundness of privatization as the focal point of development reform.

The consensus shift

The attack on Russia’s privatization broadened to its “free market fundamentalism”, as Nobel Prize-winning economist Joseph Stiglitz⁴⁶ represented the ideology of the privatizers. It would be difficult to separate this attack on Russian reform from an emerging fault line in aid policy agendas, driven by “new” Keynesianism during the late 1990s. The displacement of the Washington Consensus as the dominant paradigm followed a series of financial crises in the 1990s, affecting Mexico (1994), Asia (1997), Russia (1998) and Brazil (1999).

Stiglitz and many others attribute the poor performance of the Russian economy in the 1990s almost exclusively to the reforms, emphasizing the gap between the goals and the outcomes of privatization, particularly the failure of firms to become more profitable. The overall privatization strategy, Stiglitz (2002: 143–4) wrote,

set the preconditions for decline. Not only was investment halted, but capital was used up – savings vaporized by inflation, the proceeds of privatization or foreign loans largely misappropriated. Privatization, accompanied by the opening of the capital markets, led not to wealth creation but to asset stripping. It was perfectly logical. An oligarch who has just been able to use political influence to garner assets worth billions, after paying only a pittance, would naturally want to get his money out of the country.

From this perspective, at least at the time, the costs of building markets by assumption outweighed the benefits.⁴⁷ However, the context of decision making is not addressed. Neither are the pre-existing spontaneous and widespread privatization, corruption and rampant inflation. Indeed, one objective of mass privatization was to stop the spontaneous privatization that began in 1990 and 1991, and clauses in the June 1992 Programme repealed previous methods of privatization. As we discuss in chapters below, asset stripping emerged in the late Soviet era due to weakness of control over firm management. It then fed on expectations of further property rights reform (Kikeri et al. 1992; Grigoriev 1992; Kornai 1992; Naishul 1992). The 1992 Programme, unlike subsequent waves of privatization, aimed to formalize and regularize the privatization process. It aimed to guarantee that despite “asset stripping”, Russian citizens and other outsiders would gain a stake in the new market economy.

For reform policies to bear the full responsibility for poor outcomes, however, it would be necessary to show that there was a better alternative reform programme available. In essence, this would have been one that would have established the structures of a market economy before embarking on privatization. As we will show, the international institutions were aware that, if such an outcome were possible, it would indeed have been a better policy. However, to have delayed de jure privatization, however imperfect, would have risked the continuation of de facto control being taken of industrial assets, either within or beyond the law, which is precisely the process to which the critics of privatization object. Indeed, arguably, corruption within the privatization process became greater, not less, the longer the delay in its implementation.

In writings of this persuasion, curiously, examples generally given of abuse are frequently those of companies that were not part of the original Mass Privatization Programme. Rather, such examples focus on companies that were sold for cash, were privatized under special arrangements, or were sold after the mass privatization had finished.

The broad attack on Russia’s policies found support among Russian opponents of the 1992 Privatization Programme and its implementation. Their critique was founded in the ideology of “economic democracy”. That is, members of the academy institutes, who had long been opposed to radical reform and to unlimited private ownership, cited the western critiques in their writing (Shlapentokh 1993: 25).

For two decades from the early 1980s, privatization seemed a global orthodoxy (Megginson and Netter 2001: 5). However, it was now extensively criticized, especially in Russia. Nellis (1999: 3) describes the about-face as “a multifaceted spirit of revisionism”. He summarizes the revisionist view:

There was doubt that sufficient analytical rigor had been used in modeling privatization and in assessing empirical results; that privatization was not socially justified in all firms and contexts; and that revenues for the state and profits for shareholders had outweighed the disadvantages for the poor and the socially excluded.

Scepticism now pervades policy literature, and development theoreticians are shifting towards regionally tailored agendas. There is little question that the Washington Consensus has vanished as a descriptor of donor priorities; instead it is now associated with the negative attribution of “neoliberalism” (Rodrik 2006). The negative consequences of “neoliberal” Russian policies are now a common feature of writing about Russia. Goldman (2004: 22), for example, argues “that the faulty privatization process is responsible for many of Russia’s present-day problems. The oligarchs who are a product of that privatization are responsible for much that has gone wrong”.

Further reflections

From such literature, some comparative political economists have taken a more neutral stance. For example, Appel’s (2004) A New Capitalist Order: Privatization and Ideology in Russia and Eastern Europe, discussing reform in Russia and in the Czech Republic finds much in common: a commitment to speed, reflecting to some degree a pragmatic and flexible approach, and an ideological core, which was liberal in its economic principles and committed to fairness in allowing citizens, and not only workers, to benefit from reform. Appel does not associate the pain, indeed acute suffering, following reform in post-communist societies with particular mistaken and ill-intended acts (ibid.: 178). She argues that, for complex reasons, the cost of compliance in Russia was particularly high due to the extent and organization of opposition, observing that reformers failed to employ ideological justification or use national symbols in support of the restoration of markets, by contrast with the campaigns led by reformers in the Czech Republic. As a result, their opponents reaped the advantage by seizing those instruments of national interest to undermine the reform as a “Western imposition and alien to Russians” (ibid.: 100). The two radical reform governments thus carried out similar reforms; however, for the lack of Russian identity symbolization in information campaigns, she argues, similar policies were judged very differently.

Granville and Oppenheimer (2001: 18) also offer a similar, balanced account, noting the institutional constraints to reform and the danger of misinterpreting statistics. Yet even they allow the suggestion that voucher privatization allowed a new business elite to “steal absolutely everything”.

Finally, there are still economists who continue to view the Russian privatization as highly successful. Åslund (2007: 268), for example, included even the LFS in his view that privatizations were an “unmitigated success” because leaving those enterprises in state hands would have brought about worse outcomes. More recently he has analysed the relationship between levels of privatization in different transition economies and found them to have a positive correlation with democracy and a negative one with corruption.⁴⁸

Among those who have maintained that there was considerable merit all along are the economists at the OECD (2005: 20):

The past thirteen years have seen a dramatic transformation of Russia’s economy. An economy based on state ownership, central planning and a high degree of autarky has given way to one based primarily on private ownership, market forces and integration into the world economy. The private sector, which barely existed in 1991, now accounts for roughly 70% of GDP.

We derive the starting point for our discussion from the continuing ambiguity shrouding a clear evaluation of the Russian privatization process.

Conclusion

All this leaves open a huge question. How should we evaluate what happened in the Mass Privatization Programme in Russia? Effective? Ineffective? We believe that question is best addressed by going back to the events of the time to understand how policy was developed, what it attempted to achieve, and how it was implemented. These will be the subjects of the following chapters.

In the next chapter we are concerned with the substance of the reform. In Chapter 3 we discuss the economic rationale for the Privatization Programme, why the benefits that could be expected from it were limited in the absence of other reforms, and why it was nevertheless accepted as the best course of action. In Chapter 4 we look at the detail of policy and implementation, the dilemmas facing policy makers, and the nature of decision making. In Chapter 5 we go on to look at the later cash privatization, and in Chapter 6 we draw conclusions about how the privatization process in Russia might be evaluated and what we can learn from it.