Jenny Yang David Hauge. “Russian reformers, placing too much faith in the free market, gave too...
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Transcript of Jenny Yang David Hauge. “Russian reformers, placing too much faith in the free market, gave too...
Jenny Yang
David Hauge
Transition and Government
“Russian reformers, placing too much faith
in the free market, gave too little attention to government’s role”
Quote
December 25th, 1991: Gorbachev resigns as USSR president
December 31st, 1991: Soviet Union officially dissolved
Post-Soviet Russia Boris Yeltsin becomes president - elected June
1991 Soviet Administrative Command system needs
restructuring Within days of dissolution, Yeltsin employs
program known as “Shock Therapy”
Collapse of the Soviet Union
“Shock Therapy”(1) Liberalization – provides freedom(2) Privatization – provides incentives(3) Stabilization - provides the
environment so that private enterprises can thrive
Transition to Capitalism
Soviet Command System
Government determined prices
Firms produce what government authorities decide
Relied on government oversight to curb malfeasance and incompetence
Market determined prices Firms produce to maximize
profit Relies on market
competition to curb malfeasance and incompetence
Comparison Free Market System
Competitive-equilibrium modelConsumers selfishly maximize utilityFirms maximize profitPrices adjust to ensure supply-demand
equilibriumThree essential elements
Market-determined pricesProfit maximizationCompetitive markets
Market Economy
Belief:Resources allocate efficiently and create
prosperityThree elements would emerge
spontaneously once the command system was terminated
If there is a problem, it is because the government is intruding
Primary challenge: Keep government out of the economy
Market Economy
Results:Industry stunnedSteep drop in living standardsTransfer of wealthCorruptionCollapse of Investment
Realization:Government necessary in multiple roles
Market Economy
In the Soviet era, prices poorly reflected economic cost False assumption: Decontrolling prices would
allow Russian economy to leap forwardPrice controls removed on January 2nd, 1992
Inventory reappeared on store shelves Price increases were enormous Industry hobbled government revenue fell
Importance of government Price regulation merits a restrain on inflation,
slows change in the price structure, and is imperative for monopolies
Prices
In the 1960’s, Soviets increase enterprise autonomy Began using profit as a measure of performance But, other two essential elements absent
During Shock Therapy, there was a struggle for control over previously state-owned enterprises and their assets Costly paternalistic practices Autonomous profit-maximizing firms, even in
competitive markets, don’t automatically serve the public interest
Importance of government Suitable institutions necessary to channel profit
maximization and serve the public interest
Profit
In Soviet economy, there were no wholesalers to provide backup inventory, products supplied by monopolies
Hope that with Shock Therapy, competitive markets would emerge overnight Instead, organize crime and anticompetitive
structures evolved, controlled by oligarchsImportance of government
Encourage growth of wholesalers and middlemen and protect them from criminal infiltration
Dismantle monopolies and disallow mergers that would reduce competition
Minimize licensing requirements and open economy to capital inflows
Competition
Transition is about change, equilibrium is inherently static
Government initiatives needed to address:ChangeCriminalizationDe facto colonizationInequality
Institutional framework needs to be sound
Looking Deeper
Absence leads to uncooperative behavior, criminalization and social disorder
Only government can: Define property rights Provide genuine security for private property Ensure enforcement of contracts without
violenceFormation is a gradual processRegard for common good is vital
Institutional Framework
Escalating corruption and economic inequalityDemand decreased
InflationSupply channels were disruptedRuble appreciated dramatically
Russian products less competitiveFear of collapse in the exchange rateFurther erosion of demand
Problems
Defined: Government intervention to foster development of particular sectors of the economy
Conflicts liberalization-privatization-stabilization requirements of transition
But, virtually all successful modern economies have relied upon government intervention to support industrialization (U.S., Germany, Japan, China, etc.)
Provides assistance in the short run so that industry can be internationally competitive in the long run
Simple empirical model suggested: Four Spheres Directs attention to actual economic conditions
Industrial Policy
Largest of the four: accounts for 40% of employment
Demise under competitive-equilibrium modelMarket discipline, even if improved, won’t
revitalizeGovernment intervention:
Don’t revive firms lacking potential Facilitate movement of labor and capital to
lawful, dynamic businesses Intelligent industrial policy also needed
Sphere One: Industry and Agriculture
Essential issue: who benefits from nation’s wealth?
Under CE model, private ownership is superior Government doesn’t capture gains
Oil production fell in 1990’s as investment declined Foreign companies offered technology and
finance Russian capitalists reluctant, didn’t want to
lose controlGazpromGovernment monitoring and control is
required to tax fully the economic rents from natural resources
Sphere Two: Natural Resources
33% of employmentImportance of government in formative
stages of transitionDependence on low-cost transportation
and communicationBanksOther public services:
Health careEducationLaw, public safety and environmental
protection
Sphere Three: Public Services
Most relevant to CE model, appropriate for government to be more limited
Obstruction by control over housing Do need to curb crime
Decrease in formation of new businesses, attributed to mafia intervention Extortion Intimidation of competitors Bribery
Sphere Four: Small Business
Limiting government is consequential for growth of sphere four However, deliberate government action required in other three
spheres Since they are intertwined, improved conditions in any one
inevitably benefit the others Sphere two delivers financial resources to sphere three In turn, providing lawful economic environment and functional market
institutions essential for sphere one and the rest of the economy
“A government program responsive to all spheres would build market institutions, maintain aggregate demand for Russian goods and provide judicious support for economic development.”
Summary
Clifford Gaddy and Barry Ickes - 1998“An economy is emerging where prices are
charged which no one pays in cash; where no one pays anything on time; where huge mutual debts are created that also can’t be paid off in reasonable periods of time; where wages are declared and not paid; and so on. . . This creates illusory or ‘virtual’ earnings, which in turn lead to unpaid, or ‘virtual’ fiscal obligations, with business conducted at nonmarket, or ‘virtual’ prices.”
Table
The Virtual Economy
Basically, this economy has arisen for two reasons: Most of the Russian economy takes away value Most participants pretend that it doesn’t
The Virtual Economy