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. Last Updated: 07/27/2016

Russia Puffs Behind In Transition Sprint

Little more than six years after the fall of the Berlin Wall, the Czech Republic is well on its way to establishing itself as a strong and dynamic European economy. Annual inflation in the single digits, moderate economic growth, a stable currency and rising personal incomes go hand in hand with an ongoing transformation at the enterprise level, often with foreign backing. The revival of the Skoda auto works is under way with investment from Germany's Volkswagen, while the country's telecommunications system is seeing more than $1 billion in overhaul with help from Dutch and Swiss partners.

A badge of approval for the Prague government's efforts came last fall with an invitation to become the 26th member of the Organization for Economic Cooperation and Development, the think tank of the industrialized world. The Czech Republic's formal accession in December made it the first former Soviet-bloc country to join the unofficial ranks of the world's rich countries. Hungary and Poland are expected to be granted membership in the coming months.

The achievements of the Czech Republic underscore the state Russia finds itself in today. The contrasts are telling. On the macroeconomic front, inflation in Russia is measured by the month, not the year; the ruble had lost much of its value against the dollar before it was stabilized last summer, whereas the Czech crown was pegged early and has retained most of its worth. No major Western automakers are lining up for joint ventures with their ailing Russian counterparts. Last December's much-heralded auction of a stake in the telecommunications network Svyazinvest to the Italian operator STET collapsed weeks later over terms of the sale, and substantial improvement to the country's crackling lines is nowhere in sight.

In seeking to explain the differing fortunes of Russia and the Czech Republic and other Eastern European countries in transition, economists cite a host of factors, from the burdens of history to the pace and nature of reformist polices. Some could have been foreseen at the time the Berlin Wall came down, others are more a result of what came afterward.

Russia has suffered in particular from the more rigid structure of its economy under communism, the hyperinflation of 1992 to '93, and -- in what still casts a perilous shadow -- far greater political turmoil than has afflicted its onetime allies.

"If you take the collapse of the Soviet economy in '91, it was far worse than anything we saw in Eastern Europe," said Anders ?slund, a senior associate at the Carnegie Institute in Washington, who has been an adviser to the Russian and now the Ukrainian government. "They had a completely different starting position."

Moreover, Russia got a later start. Whereas Poland launched its controversial "shock therapy" reforms in 1990 and the Czech Republic at the start of 1991, it was not until Jan. 1, 1992 that the Yegor Gaidar government enacted a much less far-reaching program of trade and price liberalization, and then without the tight monetary policy necessary to hold down inflation.

"If you look within the CIS and Eastern Europe, the countries that reformed fastest at the start are now the countries that are recovering," said Peter Boone, an economist at the London School of Economics and an adviser to Moscow and other post-communist governments. "Russia is a more intermediate case. ... It's not what would be called shock therapy."

Pain Without Gain

Five years on, Russia's economic decline at last seems to have bottomed out, with a contraction of a modest 4 percent in 1995. A compilation of government and private-sector forecasts by the European Bank for Reconstruction and Development projects 1996 growth at 1.6 percent. Michel Camdessus, managing director of the International Monetary Fund, last month predicted recovery between 2 percent and 4 percent this year and up to 6 percent later in the decade.

Even a modest revival would put Russia at a similar stage in the transition cycle to Hungary and the Czech Republic, which recorded their first positive growth figures in 1994, of 2 percent and 3 percent respectively. Poland, which adopted what many consider the most far-reaching reforms, showed a turnaround of 3 percent as early as 1992 and grew an estimated 6 percent last year. Slovenia, another star performer, grew 1 percent in 1993 and also an estimated 6 percent in 1995.

Russia has endured far more pain in the interim, however. The economy officially is producing less than half what it did in 1990, versus 86 percent in Hungary and 97 percent in Poland, according to statistics compiled by the EBRD. Even allowing for unreliable figures, the scale of the contraction has been unprecedented.

A sharp fall in output may have been inevitable, given the Soviet Union's propensity for producing lots of things that nobody wanted, especially military hardware. What was not inevitable, many economists say, was the sharp rise in inflation that accompanied reforms.

"The failure of the Russian monetary and financial authorities to get inflation down more rapidly has been a key factor in making the Russian transition more painful" than in Eastern Europe, said Keith Crane, director of research at PlanEcon, a Washington-based consultancy. "Lots of countries went through the transition and had relative prices as screwed up as in Russia, yet had lower inflation."

Prices in Russia soared more than 2,300 percent in 1992 and 840 percent in 1993, slowing to a little over 200 percent in 1994 and about 130 percent last year. For the Eastern European countries, rates in 1995 were in the 10 percent to 30 percent range, and even at their worst in the early '90s rarely hit triple digits.

The main differences in Russia, Crane and other economists said, were loose state credits to enterprises and the IMF-encouraged maintenance of a CIS ruble zone into 1993, which essentially allowed former Soviet republics to print money at Russia's expense. Also, as much as $50 billion in capital fled the country, seeking haven from inflation but depriving the country of a key source of investment.

"The basic problem was that reformers never got control of the Central Bank," ?slund said.

Stanislav Gomulka, another expert at LSE, noted another difference between the Moscow government and those in Eastern Europe.

"Generally Russian reformers were much more friendly toward enterprises than toward citizens," he said. No-hope enterprises were granted credits to keep operating, while the value of wages and pensions were steadily eroded by the resulting inflation, alienating many voters from the very idea of reform.

No Market Culture

But even a textbook and hitch-free macroeconomic transition policy could hardly have erased decades of ingrained differences between Russia and its neighbors, analysts agree.

"Russia was a couple of generations behind in familiarity with the market at all," said Lou Naumovsky, chief of the Moscow office of the EBRD, pointing to almost universal private land ownership in Poland and experiments with small-business "goulash capitalism" in Hungary in the 1970s.

Moscow's high degree of central planning, along with a "hermetically sealed" attitude toward trade with the West, makes Russia's macroeconomic progress to date "remarkable," he added.

"In Russia in the '50s, '60s and '70s, you had gigantism ruling, you had enormous plants increasing their size without economic rationale," Naumovsky said. "Those are enormous disadvantages compared with, say, the Czech Republic, when a lot of the prewar efficient companies were nationalized" without being laid to economic waste.

Gomulka of LSE said historical factors also help explain the different fortunes of Russia and its former Baltic satellites, whose economies have rebounded strongly after a steep early plunge following the Soviet Union's collapse.

"They didn't have communism in the '20s and '30s, there was much more enterprise culture there," said Gomulka, who advised the Polish government on economic reforms. A fast-growing private sector has helped Estonia, Latvia and Lithuania in transition, as well as close links with Scandinavian countries.

Other former Soviet republics have not been as fortunate. Ukraine and Belarus especially have endured woes similar to industrialized Russia, while the countries of the Transcaucasus and Central Asia had a much slimmer economic base to begin with. Armenia is the only CIS country to have recorded positive growth this decade, although Kyrgyzstan and Moldova have earned high marks for reform from the IMF.

In any event, 70-plus years of communism took a far greater toll on the core of the Soviet Union than most of its neighbors to the west. By 1990, ?slund said, Russia's budget deficit was about 30 percent of gross domestic product, versus about 8 percent in the countries of Eastern Europe. From such a bankrupt starting point, Russia was seriously handicapped in the race to transition.

Perils of Politics

Yet there is one respect in which Russia's current policymakers have only themselves to blame: the battle for power. Political and economic reforms were hardly free from partisan debate in Eastern Europe, but at least tanks were not opening fire on the parliament, and ultranationalists like Vladimir Zhirinovsky were confined to the political fringes. Additionally, military spending has remained far higher as a percentage of GDP in Russia than in the Warsaw Pact countries.

"There were these political factors, infighting in government, uncertainty over the future of capitalism," Gomulka said. "There is this continuation, if you like, of the communist mentality in the approach to enterprises, foreign policy and defense."

Such factors have been a primary reason for the almost minute flows of foreign direct investment to Russia. Multinationals have committed about $1 billion a year to the country since the beginning of reforms, versus $9 billion to Hungary alone in 1994.

Following the Communist triumph in last month's parliamentary elections, a large political cloud hangs over Russia until at least June's presidential poll. Then, however, an influx of foreign portfolio and direct investment, more return of Russian flight capital and more certainty undergirding individual savings and business investment decisions could fuel growth of as much as 5 percent a year for the rest of the decade, some economists say.

"What's holding them up now is political worries the other countries don't have," LSE's Boone said. "Their economic situation right now is great at the macro point of view."

The EBRD's Naumovsky agreed that political prospects were brightening along with economic ones.

"You've seen a modus vivendi between the executive and legislative branch, and even with a larger number of communists that won't really change," the EBRD's Naumovsky said.

Ready to Overtake?

If Russia does turn the political corner, several of its fundamentals are even stronger than conditions in Eastern Europe. A first and obvious one is its natural resources, from fuels to metals to timber, that can provide the raw materials needed for an industrial turnaround.

Another is a huge trade surplus of some $24 billion in 1995 -- amassed in part from exports of those very raw materials -- that Eastern European economies can only envy.

"What that means is they can consume a lot more, invest a lot more over the next few years and not have a balance-of-payments crisis," said Boone of LSE. "That's a big advantage."

Finally, privatization -- despite its hitches -- and the development of capital markets are rated highly in Russia.

"I think the fact that Russia has privatized faster than any other post-communist country will be one of the reasons why Russia will be one of the fast growing countries by the end of the century," LSE economist Richard Layard, a close adviser to the Finance Ministry, said on a recent visit to Moscow.

Further development of a still nascent private sector -- as opposed to simply the transfer of former state enterprises to the hands of the market -- will be critical to Russia's economic growth, as it has been in Poland, Gomulka said.

?slund noted that Russia has developed a private banking sector with a number of "reasonably good" institutions, whereas many of the main lenders in Eastern Europe are still state-controlled.

"That suggests a dynamism in the capital markets that we don't see in Eastern Europe," he said.

There's still no small number of tasks undone.

"The basics for growth in Russia are to get inflation down, to continue to liberalize prices and try to continue to hack away at that bureaucratic thicket that makes it difficult for entrepreneurs to get businesses up and running," Crane of PlanEcon said.

While such an agenda is in a way remedial -- Eastern European countries are now able to concentrate on more microeconomic measures such as labor-market and pension overhaul -- it represents progress as well as a precondition for many further reforms.

"The government has now indicated it will work at the micro level," Naumovsky said.

If optimistic forecasts prove true, the next several years will see Russia catching up to its former allies in many statistical respects and showcasing its greater economic potential. The effect of recent policy mistakes may recede, even if deeper-rooted historical factors remain.

"In deference to Russia there were a couple things they bumped into that Eastern Europe didn't," Crane said. But overall, "it's been a fairly typical transition economy."