Free Market Russia

Case 1.7

Free-market Medicine in Russia

Has the patient recovered?

Reforming the economy of the old Soviet Union was never going to be easy. To replace central planning with free markets and enterprise would involve a radical transformation of economic life. But following the rise to power of Boris Yeltsin in Russia in 1991, this is just what was attempted. The following policies were adopted in early 1992:

• Price controls on 90 per cent of items were abolished. But with shortages of most goods, it was hardly surprising that prices rose dramatically.

• Business was given easier access to foreign exchange and foreign companies were encouraged to invest in Russia.

• The largest privatisation programme in the world was launched. In many of the new private companies, workers were to become the principal shareholders.

These reforms represented a massive shock to the old system. With the virtual abandonment of price controls, prices soared and by the end of 1992 inflation had reached a massive 1527 per cent. These huge price increases led to falling demand, but the disruption to the economy also led to falling supply. In 1992 output fell by nearly 20 per cent and the purchasing power of wages fell by 40 per cent.

The government’s budget deficit (the excess of government spending over government tax receipts) rose from 1.5 per cent of national income in the first quarter of 1992 to 15 per cent by the final quarter. Perhaps most significantly, the money supply rose nearly 600 per cent between January and October. Many commentators began to wonder whether the economy could escape the slide into ‘hyperinflation’ when money would become virtually worthless.

Critics argued that the costs of reform were intolerably high. The Russian economy, inherently weak and resistant to change, was unprepared for the radical nature of the policy and the reform programme could not be sustained. They highlighted the following weaknesses inherited from the old system:...