In 1989, Russia\u2019s population was nearly one billion smaller than China\u2019s \u2013 but its economy was 17% bigger. Now the Chinese economy is ten times the size of the Russian economy.<\/p>\n\n\n\n
From Deng Xiaoping\u2019s famous 1978 speech<\/a> into the 1980s and early 1990s, China had been gradually moving away from having a command economy \u2013 an economic system controlled and largely owned by a central authority \u2013 towards an economy where prices are set by market forces. During the perestroika<\/em> (reform) era from 1985 to 1991, Russia had been on a similar path.<\/p>\n\n\n\n In 1989, the means of production in both countries were largely in the hands of state-owned enterprises (SOEs) and there was a widespread view that such enterprises consumed more inputs than they produced in outputs. The inefficiencies inherent in SOEs came from having a multiplicity of conflicting goals, weak managerial incentive structures and a soft budget constraint. Soft budget constraints meant that SOE managers spent more than their enterprise earned in the knowledge that the government would make good the shortfall (Kornai, 1986<\/a>).<\/p>\n\n\n\n Because of these inefficiencies, at the beginning of the 1990s, China and Russia began the process of privatising their SOEs. But they did so in completely different ways, with long-lasting and far-reaching consequences that echo to the present.<\/p>\n\n\n\n Where did Russia go for advice on how to change from a command economy to a market-based one? It turned to the United States and some of the brightest minds of their generation. The US State Department\u2019s Agency for International Development contracted the now-defunct Harvard Institute for International Development<\/a> to advise the Russian government on privatisation and the creation of capital markets.<\/p>\n\n\n\n The policy advice given and implemented was to go for a \u2018big bang\u2019 approach by engaging in a rapid mass privatisation programme. This started in 1992, and by 1994, 14,000 medium and large state enterprises \u2013 or 70% of Russian industry \u2013 had been transformed into joint-stock companies (Hoff and Stiglitz, 2004<\/a>).<\/p>\n\n\n\n Ownership in these newly minted companies was distributed on the cheap to managers and employees. The remaining shares could be bought by Russian citizens using vouchers issued by the government.<\/p>\n\n\n\n Did privatising all these enterprises unleash robust economic growth thanks to removing inefficiencies? Did firm productivity improve thanks to the managerial incentives created by private ownership and the removal of soft budget constraints? As Figure 1 shows, Russia\u2019s GDP plummeted during and after the implementation of the programme. What went wrong?<\/p>\n\n\n\n The architects of the programme had pressed ahead without creating the necessary laws and institutions to protect private property and to prevent self-dealing by managers. They believed that privatisation would result in the emergence of private property owners who would then lobby the government to create laws and enforcement institutions that would protect them from expropriation (Hay et al, 1996<\/a>; Shleifer and Vishny, 1998<\/a>).<\/p>\n\n\n\n Crucially, this did not happen. Instead, company managers and other kleptocrats lobbied to oppose the strengthening of laws and institutions that would protect shareholders (Black et al, 2000<\/a>).<\/p>\n\n\n\n The typical privatisation in Russia resulted in managers and employees owning 60-65%, investors owning 20% and the state holding the remainder (Black et al, 2000<\/a>). Managers engaged in self-dealing to increase their ownership stake and wealth. Self-dealing is where those who control a company use their position to divert wealth away from other shareholders towards themselves (Djankov et al, 2008<\/a>).<\/p>\n\n\n\n Managers increased their initially modest stakes in three ways:<\/p>\n\n\n\n The largest enterprises, mainly those in oil and metals, were not part of the voucher privatisation scheme. Instead, they were auctioned off in a highly rigged manner \u2013 and at very low prices \u2013 to a small number of well-connected men who had made their wealth by expropriating funds and assets from the government (Black et al, 2000<\/a>).<\/p>\n\n\n\n These men, dubbed kleptocrats by the Russian press and oligarchs by Western media, came to control Russia\u2019s largest corporations. They also controlled its major media outlets and, through those, they could manipulate elections.<\/p>\n\n\n\n The rapid and corrupt privatisation process meant that companies were now under the control of their managers or, in the case of the largest ones, under the control of the oligarchs. Those managers and oligarchs had two choices: run their companies efficiently and profitably; or tunnel value out of their company.<\/p>\n\n\n\n They typically chose the latter option because even their property rights were insecure \u2013 assets and profits were stripped out of firms and the proceeds invested in Western democracies. It is estimated that between 1995 and 2001, capital flight from Russia averaged 5% of GDP per annum (Hoff and Stiglitz, 2004<\/a>). The economic collapse of Russia borne out in Figure 1 ultimately resulted in a currency and financial crisis in 1998.<\/p>\n\n\n\n Vladimir Putin\u2019s rise to power in 2000 brought the days of the oligarchs, asset stripping and the erosion of Russia\u2019s wealth to an end. The oligarchs were expected to cooperate with the state\u2019s economic and political objectives or else face exile or worse (Vanteeva, 2016<\/a>). For example, Boris Berezovsky was exiled to London, while Roman Abramovich chose to cooperate with the new regime.<\/p>\n\n\n\n The pillars of Putin\u2019s administration were the siloviki \u2013 veterans of the country\u2019s secret service, the KGB, and other law enforcement agencies. The siloviki were placed on company boards to enforce Putin\u2019s policies and safeguard company assets. Even though Russia returned to its long-standing tradition of authoritarian rule, the Putin regime did not renationalise companies or revert to a command economy (Vanteeva, 2016<\/a>).<\/p>\n\n\n\n Instead, the government became a partner with private business. Putin\u2019s version of state capitalism ensured that in the absence of secure property rights, managers and owners would not engage in asset stripping at the expense of the country or self-dealing at the expense of minority shareholders.<\/p>\n\n\n\nRussia\u2019s \u2018big bang\u2019<\/h3>\n\n\n\n
Reforms under Putin<\/h3>\n\n\n\n
Figure 1: Real GDP in Russia and China, 1989-2020<\/h4>\n\n\n