What Happened in Russia, 1991-2001, and Why? (And what are the implications?)

1. What Happened in Russia, 1991-2001, and Why? (And what are the implications?) Simon Johnson, MIT Sloan sjohnson@mit.edu http://web.mit.edu/sjohnson/www/research.htm

2. What happened in Russia, through August 1998?

3. What happened in Russia, in August 1998?

4. What happened in Russia, since August 1998?

5. Explaining divergence in transition • Convergence across Eastern Europe and the former Soviet Union in stabilization, liberalization and privatization • No convergence in economic outcomes: most of the former Soviet Union trapped with high unofficial economy and low tax revenues/few public goods What explains this divergence? Extent of “institutional reform” (EBRD 1999 measures: e.g., regulatory burden, corruption) see also micro surveys of entrepreneurs

6. Solutions: to protect entrepreneurs (1) Reform of bureaucracy and regulation • control of corruption is key (Daniel Kaufmann) • reduce and simplify regulations (2) Need local government to support development • fiscal reform helpful (Shleifer and Treisman) • lessons from China (3) Stronger constraints on arbitrary executive action • improve functioning of court system • oversight and transparency from legislature (Poland)

7. Conclusion: institutions are a first-order macroeconomic issue 1) Protect entrepreneurs against expropriation • Essential for investment and growth • Helpful for registration of activity/payment of taxes • Need effective constraints on the executive 2) Protect outside investors (against entrepreneurs!) • Rapid growth is possible with weak outside investor protection, tending to favor large incumbents/powerful families • But crises are larger and more persistent when outside investors are more vulnerable • New rules are essential, new regulators are helpful, new markets are possible almost everywhere

8. Short-term prospects • August 1998 crisis: a blessing in disguise? • Output and export boosted by devaluation • Real exchange rate steady • Inflation under control, for now • GDP recovery, hard to sustain BUT important problems are not being resolved

9. Four Trends • Better managed firms consume the weak • Successful firms are tied to local government • Local/regional governments delay restructuring • No serious pressure for protectionism

10. How normal is Russia? Normal aspects • response to devaluation • firms make money • capital is leaving

11. Unusual features • low revenues for federal government relative to spending • large firms and banks do not go bankrupt • incredible system of barter (the most effective corruption in the world?) • bank credit doesn’t matter

12. Four scenarios (to 2005) #1: Leap to a liberal market economy (like Poland) • local governments like control not free entry • large firms prey on small firms • who will dismantle the political barriers to entry/growth for new small firms?

13. #2: Strong business groups + government (like Malaysia or Korea or Mexico) • already evident in Moscow (e.g., Sistema) • could grow at 2-5% per year and attract capital inflows • but vulnerable to collapse: confidence is fragile with weak institutions (see Asia)

14. #3: “Roving bandits” • continual fighting for control of assets • gradual decline of physical assets • increase in emigration • high level of violence

15. #4: Russia turns inward (like Belarus) • large protectionist barriers • would have to defeat the large enterprises • could have an initial boom, followed by decline and even collapse

16. One summary picture • Weak institutions (corruption/rule of law) do NOT necessarily prevent growth (see Indonesia) • but they do create fragility • capital comes in when a boom is expected • and then runs if a slight downturn management and government theft is endogenous

17. Fat tails in Russia’s Future Conventional models Our View Pre-Crisis Pre and Post Crisis Oops... Post-Crisis