Meiji Japan and post-Soviet Russia · CHAPTER 10 ·
Shock therapy in Russia
Chapter 10 of Remaking the State: Meiji Japan 1600–1912 and Post-Soviet Russia 1964–2000: “Shock Therapy”
On 2 January 1992 Yegor Gaidar’s government freed most prices at once, betting that one sharp change would hurt less than a slow one. Goods returned to the shops, but prices rose about 2,500% in 1992 and wiped out savings, and from October 1992 voucher privatisation handed most ownership to insiders.
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The map above is the world of Russia and the former Soviet Union, October 1993 — The White House shelled.
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BRIEF EXPLANATION — THE ESSENTIAL ARGUMENT
Independent Russia began its economic transition in a hurry, because the government it inherited had empty shops, almost no reserves of gold or foreign currency, and only the printing of new money to pay its bills. Planners had fixed the price of nearly everything, and on 2 January 1992 the team of the young economist Yegor Gaidar freed most prices at once, so that sellers set them as in any modern shop. This was shock therapy, the attempt to introduce market prices, free trade and private ownership as fast as possible, on the theory that one sharp change hurts less than a long one, much as a doctor sets a broken bone in a single movement. Goods returned to the shops, but prices rose about 2,500% in 1992 and wiped out the savings Soviet citizens had built up when there was little to buy. Privatisation, the transfer of state firms to private owners, followed: from October 1992 every citizen received a voucher worth 10,000 roubles to exchange for shares, and by mid-1994 some 14,000 large and medium firms, among them the giant Uralmash machinery works, had been privatised. Most ended up with their managers, so a plan meant to make every citizen an owner chiefly turned factory bosses into owners.
The economic shock became a political crisis, because Russia had not yet decided who governed it. A parliament elected in Soviet times fought the president over the pace of reform, and in September 1993 Yeltsin dissolved it by decree. Its supporters took up arms, and on 4 October army tanks shelled the parliament building, the White House, in fighting that killed between about 150 and 190 people by official counts, and more by some unofficial estimates. In December voters approved, on a turnout that is still disputed, a constitution that gave the president sweeping powers. The same weakness showed on the hatched borderlands of the map, the wars in Transnistria in Moldova, Abkhazia and South Ossetia in Georgia, Karabakh in Azerbaijan and Tajikistan, because a Moscow that could barely govern itself left local Russian garrisons to decide several of them. Russia had to build a market and a state at the same time, and the speed with which it built the first left the second weaker.
The full story
Shock therapy, the plan to bring in market prices and private ownership in one sharp move as a surgeon prefers one operation to many, was chosen because the alternatives looked worse to the men who had to decide. By late 1991 the Soviet state had spent its reserves of gold and foreign currency, shops were nearly empty, and people held far more money than there were goods to buy at fixed prices. Gaidar, aged 35, and colleagues such as Anatoly Chubais, advised by Western economists such as Jeffrey Sachs, argued that only free prices could bring goods back and that reform had to move before the old bureaucracy could regroup. On 2 January 1992 most prices were freed, although energy and some staples stayed controlled. Goods reappeared at prices most people could barely afford, and inflation reached about 2,500% for the year because the central bank kept lending cheaply to failing enterprises. Prices had been freed without control of the money supply, so stabilisation came only years later.
Privatisation, the transfer of state-owned firms to private owners, moved ownership quickly, and its design handed most of it to insiders. Chubais’s programme gave every citizen a voucher with a face value of 10,000 roubles, about 144 million in all, which could be invested in auctions of shares or sold for cash. To win the support of factory directors, the law let employees and managers buy a controlling stake in their own firms, and most chose that option. Managers then bought up workers’ shares, and a few entrepreneurs bought vouchers cheaply; at Uralmash the businessman Kakha Bendukidze gained control this way. The costs fell on people with fixed incomes: output fell by 14.5% in 1992, wages and pensions arrived months late, and male life expectancy dropped from about 64 years in 1990 to under 58 in 1994. Beyond Russia the arrows show refugees: Russians moving back from Central Asia, Georgians fleeing Abkhazia after Sukhumi fell, Tajiks fleeing south into Afghanistan. Privatisation made reform hard to reverse, and it convinced many Russians that the state’s wealth had been handed to a few.
The struggle over reform became a struggle over the state itself, and it ended with tanks. Russia was still governed under an amended Soviet constitution that gave both the president and the Congress of People’s Deputies, a large Soviet-era parliament able to rewrite the constitution, a claim to supreme authority, so neither side would yield. The Congress forced Gaidar out in December 1992, and on 21 September 1993 Yeltsin dissolved it by a decree that the Constitutional Court ruled illegal. Deputies barricaded themselves inside the White House, and on 3 October their armed supporters attacked the mayor’s office and the Ostankino television centre; the next morning tanks shelled the parliament into surrender. In December a referendum approved a new constitution with 58.4% of the vote, while the nationalist Vladimir Zhirinovsky’s party won the largest share of the votes cast for parties, a sign that hardship had pushed many voters towards nationalism. Russia’s democracy acquired a powerful president at the price of using force to settle its first constitutional crisis.
DEEP EXPLANATION — EVIDENCE & INTERPRETATION
Shock therapy or gradualism?
The debate over Russia’s reforms is one of the sharpest in modern economic history. Jeffrey Sachs and Anders Åslund argued that speed was essential: a collapsing economy could not wait, partial reforms had already failed under Gorbachev, and a short window of political opportunity had to be used before opponents regrouped. Åslund later argued that Russia’s problem was too little shock, because the central bank kept printing money and the government kept subsidising energy and industry, so inflation lasted years instead of months. Joseph Stiglitz, a former World Bank chief economist, argued the opposite: markets need institutions, including courts, property rights, regulation and tax collection, and freeing prices and selling assets before these existed invited theft. Peter Reddaway and Dmitri Glinski called Gaidar’s approach “market Bolshevism”, a revolution imposed from above with little regard for its victims. Comparisons are often drawn with Poland, whose shock therapy in 1990 succeeded faster, and with China’s gradual reforms. The evidence suggests that the sequence of reforms mattered as much as their speed.
Why voucher privatisation produced insiders
Voucher privatisation was designed as a political deal as much as an economic programme. Chubais and his advisers wanted ownership transferred quickly, so that a return to central planning would become impossible, and they needed the cooperation of the factory directors who actually controlled the enterprises. The law therefore offered employees and managers the chance to buy 51% of their own firm’s shares, and about three-quarters of enterprises chose this route. Andrei Shleifer and Daniel Treisman argue that buying off powerful insiders was the price of getting reform through at all. The results disappointed most ordinary citizens. Many sold their vouchers for small sums or invested them in funds that later vanished, while managers consolidated control and often sold off their firms’ property for private gain instead of investing. Russians coined a pun turning the word for privatisation into “grab-itisation”. By mid-1994 most of Russian industry was in private hands, yet few firms had owners with the money or the incentive to modernise them.
The October crisis and the 1993 constitution
The conflict of 1993 grew from a legal deadlock. The Russian constitution in force was a Soviet document of 1978, amended hundreds of times, which made the Congress of People’s Deputies the supreme body of state while also creating a powerful elected president. Both sides could cite it, and neither would yield. Timothy Colton’s biography of Yeltsin shows a president who believed the parliament was blocking reform and who chose decree and force over compromise; his opponents included both communists and nationalists, some of whom were armed. The constitution approved in December 1993 resolved the deadlock in the president’s favour. The president appoints the prime minister, may dissolve the Duma, the new lower house of parliament, if it rejects his nominee three times, issues decrees with the force of law and dominates the government. Michael McFaul argues that this design, adopted after violence and on a disputed turnout, laid foundations for the more authoritarian presidency that followed. Russia’s transition fixed its rules in a moment of crisis, as Japan had done in 1889 at a moment of calm.
Key places on the map
On this day
Why it happened
The Soviet economy left too much money and too few goods. Perestroika had left a huge overhang of savings, a budget financed by printing money and an empty network of state shops. Holding prices down only meant longer queues and more rationing, while letting them go meant sudden inflation. Any government in 1992 would have had to choose between these bad options, and Gaidar chose to free prices at once in the belief that delay would only make the shock larger.
Reformers believed speed protected reform. Gaidar, Chubais and their Western advisers feared that communists and the old ministries would block change if it moved slowly, as they had blocked Gorbachev’s. Fast privatisation was meant to create a class of owners with a stake in the new system, making a return to planning impossible. The goal of irreversibility shaped choices that put speed above fairness or careful design.
Two branches claimed the same authority. Russia entered independence with a parliament elected in 1990 under Soviet rules and a president elected in 1991, governed by a constitution that gave both of them supreme powers. As inflation and falling living standards made reform unpopular, the parliament turned against the president’s government. Without agreed rules for resolving the conflict, each side used the powers it had until force decided between them.
The Union’s collapse broke trade and supply. Soviet factories had depended on suppliers spread across fifteen republics, and independence turned these links into foreign trade, often paid in roubles that new states were printing on their own. Until 1993 Russia shared its currency with republics that could create rouble credits, which fed inflation. Output fell as supply chains broke, so part of the decline blamed on shock therapy came from the dissolution of the Union itself.
THE TURNING POINT
Prices freed, 2 January 1992. The freeing of prices is the hinge of Russia’s economic transition because it ended the planned economy in a single day, 2 January 1992. From that morning prices took over from officials the job of rationing goods, and the empty shelves of 1991 filled again. The same decision destroyed most household savings, set off years of high inflation and made the government’s reforms deeply unpopular, which fed the political conflict of 1993. Every later controversy, from vouchers to the oligarchs, grew from choices made in the weeks around this date, when speed seemed the only defence against collapse.
What it changed
A new owning class took shape. Privatisation created millions of nominal shareholders and a much smaller group of managers, bankers and traders who gained real control. The bankers who built fortunes in these years, among them Vladimir Potanin and Mikhail Khodorkovsky, would soon lend money to the state in exchange for its best companies. Ownership had changed hands faster than the laws meant to govern it.
A presidency above parliament. The constitution of December 1993 gave the president power to appoint governments, issue decrees and dissolve the Duma. Yeltsin used these powers to govern through the crises of the 1990s, including the decision to go to war in Chechnya, and his successor inherited a constitutional framework already tilted towards a strong executive.
The borderlands were left to Russia’s soldiers. Ceasefires in Transnistria in 1992, South Ossetia in 1992, Abkhazia in 1994 and Karabakh in 1994 left Russian troops as peacekeepers or garrisons in several successor states. Russia’s role in these conflicts gave it lasting influence over its neighbours, and it set precedents for how Moscow would treat breakaway regions inside its own borders.
DISCUSSION QUESTION — Did shock therapy cause Russia’s economic collapse in the 1990s, or was it a response to a collapse that had already begun?
Critics such as Joseph Stiglitz, Peter Reddaway and Dmitri Glinski argue that freeing prices and selling assets before building institutions caused hyperinflation, theft and a fall in output deeper than the Great Depression in America. Defenders such as Anders Åslund and Yegor Gaidar reply that the Soviet economy was already collapsing by 1991, with empty shops, no reserves and a budget financed by printing money, and that the breakup of the Union broke supply chains no policy could have saved. Some argue that Russia’s reforms were too timid, since inflation continued because the central bank kept printing money. Comparisons cut both ways: Poland’s rapid reforms worked better, while China’s gradualism worked in a very different society. A strong answer distinguishes the collapse that Russia inherited from the way its costs were distributed, and it asks who decided that distribution. The transferable insight is that markets become fair only when the institutions that govern them already exist, however fast or slowly the change is made.
An interesting fact
The economist who ended Soviet price controls came from the heart of Soviet culture. Yegor Gaidar’s grandfathers were Arkady Gaidar, the author of children’s adventure stories that generations of Soviet pupils read in school, and Pavel Bazhov, whose Ural folk tales became a classic Soviet book and a famous ballet score. His father was a naval officer and Pravda correspondent who had reported from Cuba. Gaidar himself worked as an economics editor of the party’s theoretical journal Kommunist, the ideological voice of the Central Committee, before becoming the architect of Russia’s market reforms at 35.
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