Liberalization and Stabilization - Five Years After

Dear friends and colleagues,
First, I would like to express our gratitude for accepting our invitation to participate in the Conference.

I will divide my speech into two parts. Unfortunately, I shall have to spend some time on issues, which are, in my opinion, very understandable, or even trivial. However, they still raise some doubt in Russia. In the second part, I will try to  focus on the factors which seem to me more interesting and less elaborated.

During the past seven years ( with account of Eastern Europe), or the five years, if we restrict ourselves to the post- Soviet zone, a unique experience of implementation of various economic policies has been accumulated. For this period of time, the post- Soviet governments were headed by politicians who were clear liberals or devoted communists. Accordingly, they were trying to carry out liberal, or communist policies. The post- Soviet zone tried both hyperinflation, successful and failed stabilization, and attempts to carry out populist experiments. We currently have an opportunity to lean on this very rich experience. That is why any reasoning on post- socialist transformation cannot- as it was before- be of an abstract character. It should be oriented, first of all, to a thorough research into respective processes. Without this, today any reasoning about post- socialist transformation is just ridiculous.

Thoroughly following the relevant international publications on post- socialist transformations, works  which are published,  views presented in public, one may think that today researches are divided into two categories. The division line may be drawn  neither by their political views, nor by scientific partialities. They are merely divided into those who really studied into practice of post- socialist transformation, and those who have not done this. Transition fr om the first group to the other one may be very simple. Foe example, in 1994 a brilliant US economist Mrs. Irma Adelman, together with a range of both Russian and American experts, signed rather a confusing letter on post- socialist transformation. The letter showed their good intents along with their lacking understanding of the processes of that moment. Then she decided to look into the real process of post- socialist transformation and, together with her colleague, published an excellent article on this issue in 1996. This work, firstly, proves what we have debated on the issue over the past years; plus, it includes some very interesting, new conclusions. Of the latter, the most important one apparently is the statement that it is the historical duration of socialism which is a crucial parameter determining the level of progress on the path of liberalization and emergence of private institutions in the post- socialist zone, - the parameter which overweighs all other ones. The longer the socialist period has been, the less developed private and market institutions are. This factor overweighs policy fluctuations, difference between various tactics of reforms, etc. It is one of examples when one makes a transition from abstract reasoning to the analysis of real life and actual experiences.

By the start of post- socialist transformation, at least in Russia, and to some extent, in the world, there were three rather widely spread statements- theses which are reiterated in Russia, as if nothing had happened over all these years. First of them is that inflation after socialism should have a non- monetary nature; it should be determined by structural factors, monopolization of economy. The other one is that financial stabilization is impossible without the stabilization of output. The third one is that it is necessary to implement privatization first and to liberalize economy afterwards. Once stated, say, in 1990, it was a set of hypotheses required proof. Today, we have a seven-, or five- year, in terms of post- Soviet zone, experience, which allows an unambiguous verification of them.

So, the first thesis of the non- monetary nature of post- socialist inflation: it was rejected completely by the development of events. Inflation rates in the post- socialist countries fluctuated greatly. We witnessed everything: from hyperinflation in Yugoslavia to deflation in Croatia in 1994. However, in all the cases the price rise rates with different lags were determined by the preceding rates of monetary mass growth. The lags were, of course, bigger in large countries with more advanced financial markets, they steadily grew in the course of transformation, say, in Russia- roughly from 4 months to 6 months. At the same time they were shorter in the smaller economies and less developed financial markets, such as Ukraine, wh ere the lag accounted for practically one or two months. However in all the cases, two factors- inflation inertia and preceding rates of monetary mass growth- allowed to predict, with a high level of reliability, dynamics of inflation in a country.  At least in the cases when annualized inflation rates are over 40%, the impact of such regularities is inevitable. In the case of lower inflation rates, some other, more complicated problems arise, and this is well known from the economic theory. However, in terms of high inflation rates, currently it is recognized fairly definitely that they are a monetary phenomenon after socialism, too.

Secondly. Matters of growth and stabilization. In this case, the situation  is more complicated. In the overwhelming majority of cases, inflation was stopped on the background of continuing decline of production volume. Economic growth started only after the fall of inflation under 40% annualized. If one observes the integrity of post- socialist economies, he will finds out that economic growth usually starts in the second year after the beginning of implementation of serious investment program. Say, for Russia, the implementation of the serious stabilization program started in 1995, therefore t+2 is 1997. Otherwise, the above program starts after lowering inflation under 40- 50% annualized. In practice, the both time periods usually coincide. Obviously, in this case the regularity is not strict, and we cannot completely value factors influencing lags between financial stabilization and start of growth. It is clear that lags should not be equal for different countries, but the general sequence- financial stabilization first, and economic growth afterwards- is true for the overwhelming majority of cases. We are aware of three exceptions. The first to name is Armenia. In Armenia,  economic growth started practically along with the financial stabilization in 1994. We have Mr. Grant Bagratyan, the former Prime- Minister of Armenia here, and he would probably present his view on this issue. However, I think that it was not economic factors, which became crucial in this case, but the end of military operations and weakening of the blockage. Yet there were two examples in Eastern Europe traditionally used as a proof to the statement that economic growth might have started before lowering inflation rates under 50%. One of them is Bulgaria, and economic growth there started under inflation rates over 120%, while the other one is Romania with respective rates over 200%. As for Bulgaria, the matter is closed for today: in 1996, after the production decline, the 10-fold fall of the national currency vs. USD, and the acceleration of inflation rates up to 300% and drop of the monthly salaries and wages in USD equivalent down to 20, the discussion on Bulgarian steady economic growth has been over. As per Romania, the situation is more complicated there. However the development of  the situation in 1996- that is, the combination of a sharp acceleration of inflation rates and the fall of economic growth rates – compels us to  question the problem of steadiness of economic growth in that country. In all other cases, the sequence was of a general nature. It is likely that this regularity was rather strict and actual for  the post- socialist countries.

Thirdly. One needs to privatize economy first, and liberalize it then. In the post- Soviet countries, practically all the possible options were tried. The only thing that has not been tried- no one and nowhere managed to first privatize economy and to liberalize it. The economic history does not know such a case. It is not, of course, a definite proof. One may try to advocate the thesis that, although it has not happened, but it could, and must have been done. This matter is open for discussions. The only thing which must be done is to admit honestly: the thesis concerning probability and urgency of preliminary privatization needs a serious proof, it cannot be taken for granted. The trouble for advocates of this approach is that the number of possible cases proving it diminishes sharply. By the time being, there are only two cases in which one may try to prove the sequence of transformations -  Cuba and North Korea. If this concept cannot be proved in such cases, it is likely to pass to economic history as a sort of hypothesis which was formulated but never tried in practice.

Now, I would like to finish with these, from my viewpoint, rather clear, trivial facts requiring clarification, but not scientific discussion. I would like to proceed with the complex of issues which have been studied into to a less extent.

In the meantime, both scientific and political debates are focused on the matter of the relation between economic growth rates, opportunities for economic growth and a level of the state pressure on an economy after socialism. In this connection, the hypothesis was put forward (in particular, by our colleague Mr. Andrei Illarionov), the essence of which is that there is some simple function between opportunities for economic growth and the state pressure on economy. Some researches conducted on the basis of global integrities have not showed such an unambiguous function as yet. The research into post-socialist economies has not showed that, either. We can observe the fact that after stabilization  the countries with an abnormally high state pressure on economy regenerate their economic growth, too. I mean an abnormally high level of state pressure comparing with their level of development, i. e. the volume of per capita GDP rate. The countries are Poland, Czech Republic, Slovakia, and Hungary. We also observe that even countries with abnormally low state pressure on economy regenerate their economic growth. It seems impossible to identify relations of this type. If one examines what actually happens with state pressure on economy in post- socialist countries, it should become clear that it experiences uneven crucial changes in the course of liberalization, but then stabilizes at rather a steady level.  In other words, if you see levels of state revenue and expenditure in the second year after stabilization, you may assume, with a substantial degree of probability, that it should become stable for the forthcoming perspective. At the same time, levels of state pressure on economy prove to be rather different for post-socialist countries. In this connection, at present one may single out three groups of post-socialist countries, in terms of level of state pressure on economy which in many ways determines both social and political and social and economic structure of post- socialist society. The first group may be called the “Vyshegrad countries”. These are the countries which, on the basis of different reform strategies, have managed to significantly liberalize their economies and have their finance stabilized, and to cut rather tightly levels of the pressure on their economies. At the same time, they managed to establish an efficient taxation system, to stabilize share of their revenue at the level close to 45- 50% of  GDP and to stabilize their expenditure at the level close to 50% of GDP. I mean Poland, Hungary, Czech Republic, Slovakia, and Slovenia. The other group includes the countries which have experienced an extremely hard crisis in the conditions of post- socialist transition which was often tied to anarchy or war (a civil or external one); those are the countries in which an acute drop of levels of both state revenues and expenditure happened, and production fall was intense. On the background of such processes, a significant  de- jure and de- facto decline of public liabilities in the economy took place. In other words, in such countries the severe social and economic crisis not only paved the way to stabilization of public revenue in GDP at the level of 6-7% of GDP, like in Georgia, but in this connection, the structures of public liabilities proved to be adjusted to the above de- facto. Regardless of the nature of the process (more organized and therefore softer one, like in Armenia, or less organized and more tight one, as in Georgia) the crucial changes de- facto happened in the volume of public liabilities in those countries, in the field of healthcare, education, pensions, etc. No doubt that it was the acute character of the Armenian crisis which formed the background allowed that country to be the first one with serious changes in pension system, increase of the pension age, and a sharply increase of  the share of paid services in healthcare, etc. At the same time, similar things de- facto were happening in Georgia.

And, finally, the third group which stabilized expenditure of enlarged government (consolidated budget plus extra- budgetary funds) at the level close to 30-35% of GDP. This group includes such countries as Romania, Ukraine, Russia, and the Baltic states. They have failed to stabilize the share of state expenditure at the level of the Vyshegrad Group which mostly allows to secure social liabilities inherent in socialism. However, the crisis was not as much utlimate  and sharp to get those liabilities reviewed de- facto or de- jure by the government or the society.  In some countries, one managed to accomplish this to a higher extent, like in the Baltic states, while Russia and Ukraine are the typical examples of an intermediate situation. It is absolutely obvious that we, within the forthcoming decade, will not be ever able to mobilize revenues at a level similar to the Vyshegrad group’s ones. It is hard to figure it out how we would be able to implement that set of social reforms which would lead the volume of our budgetary liabilities to the one we would be able to actually finance. It is the crucial core of current Russian economic and political problems. What are the reasons for significant differences in taxation systems’ capacity? In my view, they are more of social and economic nature, rather than of the technical one. Some experts have paid their attention to a positive relation between the possibility to increase the share of tax revenues in GDP and the level of national, social and cultural homogeneity of the respective societies. The Scandinavian states proved to be capable to mobilize such a high share of GDP in taxes, since they always were the societies with a high social solidarity, and were nationally and culturally homogeneous. It was these factors which allowed them to increase the shares of tax payments to GDP up to abnormally high limits. That resulted consequently in long- term problems in their development, since it was found out that high opportunities for accumulating taxes are also followed  by the pressure on the increase of tax payments, and those spendings find themselves at a level clearly incompatible with a steady growth, and it is hard to cut them down. Actually, the Vyshegrad Group states have the same characteristics (given, of course, a lower level of their development) as the Scandinavian ones- i.e. they all are nationally homogeneous states, with rather a high level of development, they are culturally homogeneous, and managed to mobilize rather a high level of consensus on crucial issues of economic policy. All the above paved the way to a possibility of such a level of mobilizing taxes. Russia is a large country, culturally non- homogeneous, plus it is Federation. To count on such an abnormally high level of tax payments in GDP inherent in market economies means to miss the reality. It should be understood that the limits are of a structural, not technical nature. They cannot be resolved through a mere improvement of tax administration, introduction of two additional taxes, etc. They are set by the structure of the society. I do not mean that one should not improve tax service administration- it must be done, definitely. However, one should merely understand the limits- the extent of our possibilities. In fact, it is the opportunity to mobilize such a high level of taxes, because of which the Vyshegrad states, with their social stability and given an undisputed success of reforms, encounter very difficult problems of growth, as far as the long- term perspective is concerned. We all are aware that a long- term growth is closely related to the level of savings in GDP. The latter is negatively related to a level of generosity of social expenditure financed by the state, in particular, of pension funds. In many countries of the Vyshegrad group, especially in Poland, the respective share is at an abnormally high level, which generally is not characteristic of the countries of such a level of development. Nowadays, Poland spends 16% of its GDP on the pension system, while normally for that country’s level of development  the respective rate should have been around 5-8%. In the conditions of economic growth and relative stability it may be needed to introduce changes in the respective state’s liabilities, but it is politically complicated and unlikely to become a reality. In January, I had a privilege to attend a conference hosted by Professors M. Dombrovsky and L.Balzerovich. This problem is crucial for, and intensively debated in Poland. I have an impression that everyone understands that it should be resolved. However, at the same time, everybody understands that it will not be done.

However, this problem is of another level compared with those we face today. The essence of our problems is ultimately simple: there is a high level of revenue of the enlarged government, which is attainable after socialism in Russia. It is likely to be close to revenues of the 1996 enlarged government. One may debate if it might be at 1% higher or lower, but it would be very unrealistic to assume that it could be increased by 10-15%. The total volume of public liabilities set by the current  normative acts roughly exceeds revenues at 15%. Given that it is impossible to finance the above, therefore, the dilemma is: either we can implement reforms allowing to correlate our liabilities with actual perspective revenues. It means, of course,  the reform of the system of social support, the housing and communal reform, pension reform, substantial transformations in the field of education and healthcare, military reform, the coal industry restructuring, the agrarian reform etc., or the current ultimately unstable situation would remain in this country i.e. the budget accepts liabilities, then does not implement them, thus becoming the source of both arrears in economy and serious social conflicts. I.e., we constantly hold the country in the situation of the amorphously going crisis. One should understand that the essential problem of the current situation is that we have the aforementioned crisis, and it is the biggest deal to get out of that. The crisis is very unpleasant, it constantly destabilizes the situation at such a magnitude which let it develop for a long time. The 1997 budget strictly follows the 1996 budget guidelines, and everybody- be that the Minister of Finance or the Parliament- is very well aware of this fact. However, there is not a single person who does not realize that once the budget is not financed, it shall affect, first of all, education and healthcare, but everybody pretends that he is unaware of that. Yesterday, we approved the budget, and now, as if those three monkeys, close our eyes and say:  “We do not see it”. They do not see it because they do not want to, otherwise one should have to tell the truth and start preparing some serious decisions which are politically hard. However, there is no political will for undertaking such steps. Nevertheless, there is the most unpleasant way out of this deadlock: for example, to start a mass printing money, to reach hyperinflation, to stabilize finances then, and, at the level of a lower equilibrium, accordingly, to pass through a crisis which would be so severe that one would have to review social liabilities, like in Georgia or Armenia. Frankly, I would not like such experiments to happen in this country. I believe that Russia has tried all the experiments over the last 90 years. In this connection, the key matter, from the economic policy perspective, is the problem of whether the authorities can face the truth. It is not a key question whether they are ready to carry out measures which are absolutely necessary for even not the beginning of economic growth, but for the restructuring of all the budget sphere, considering the real revenue which the state may acquire. Without this, we would have a permanent social crisis, the constant crisis of the public system along with the erosion of confidence in the government’s power, which inevitably paves the way for irresponsible populists’ coming to power.

Thank you.