Russia’s Troubled Economic History

Published on May 30, 2017

Originally published in Alger Magazine.

Among Leo Tolstoy’s most remarkable works is “How Much Land Does a Man Need”. The short story follows Pahom, a peasant who claims that if he had enough land, even the devil wouldn’t frighten him. Upon hearing this, the Devil accepts this as a challenge and gives Pahom a chance to gain as much land as he desires for a meager price, only to snatch it all away. The Devil’s trick was to construct a scheme where Pahom could walk around as large an area as he wanted, starting at sunrise, marking his route with a spade along the way. If he reached his starting point by sunset, the entire area of land his route enclosed would be his, but if he did not he would lose his money and his land. Pahom walked far and wide, coming upon better and better land as the day progressed. Unable to reach his starting point by sunset, and exhausted from his long expedition, Pahom dies at the feet of the laughing Devil. Was it avarice that doomed Pahom — an insatiable desire for power and wealth — or was it his blindness to his own limits? Much of Russia’s contemporary history has been a struggle for the pursuit of power and glory on the international stage, but the nation has ignored its own limits — which are not military, but economic.

Understanding Russia in the first quarter of the 21st century requires an understanding of the history of the USSR, and how leaders like Lenin, Stalin, and Gorbachev shaped the nation’s domestic and foreign policy, and contributed to the country’s economic and military overreach. From its birth in the middle of the First World War, up until the New Economic Policy of 1921, Lenin’s communist utopia was closer to a failed post-revolutionary state. The massive capital grab by the state and attempts at redistributionist policies resulted in widespread unemployment, famine, and lack of access to essential government services. The failure of the direct jump from imperialism to communism led Lenin to reconsider the nation’s transition, and adopted the New Economic Policy (NEP) as a bridge between an imperial Czarist state and his desired communist state. The NEP was a combination of a capitalist economy with a communist state regime. Through the existence of private enterprise, and the nationalization of large industries to prevent a resurgence of imperialism, Lenin kept trade active under restricted, but relatively fair, market conditions. Food appropriation and requisitioning systems were abolished, and free trade among farmers and enterprises was promoted. Unfortunately, Lenin’s death in 1924, and Stalin’s subsequent rise to power cut off the NEP’s potential success prematurely.

Stalin instituted the USSR’s first five year plan in 1928, which focused on increased industrial output and collectivization of agriculture. The latter forced farmers to work on small collective farms and to sell their product and surplus at prices far lower than market value. Agricultural production in the early 1930’s fell by more than 30 percent, leading to widespread famine. Over time, Stalin’s unrealistic industrial output quotas, which only increased if they were met, disincentivised production and innovation while promoting a culture of cronyism and dishonest reporting of results. Stalin’s policies might have caused widespread famines, an average of a thousand executions a day in 1937 and 1938, and massive internal displacement. However, the same policies made the USSR an industrial nation before the start of the Second World War — a key factor in the Allied victory. The war brought heavy devastation onto the Soviet Union, destroying 25 percent of all capital equipment, 40 percent of all urban housing, and leading to severe labor shortages. The five year plans’ unrelenting focus on unfeasible production targets, and ignorance of the value of open markets and free enterprise was blind idealism in action. The plan ultimately set the stage for the eventual failure of the USSR.

Every subsequent leader from Khrushchev to Chernenko propagated largely the same domestic policies, and attempted to expand Soviet involvement and influence abroad. The suppression of anti-Soviet uprisings in Poland and Hungary, the confrontation with China, the missile crises in Cuba and Turkey, and other ideological conflicts of the Cold War were all attempts at expanding foreign influence.The refusal of any leader before Gorbachev to promote internal economic reform and increasing reliance on oil exports exposed the union to significant risk from fluctuating oil prices. The 1979 invasion of Afghanistan was the last straw. In the aftermath of an oil crisis that devastated the largely resource dependent Soviet economy, the military campaign was, and still is, considered by many as the USSR’s equivalent of the Vietnam War. The failed invasion kicked off a series of events that contributed to the dissolution of the Union. Wars are expensive and require fiscal justification, and as the USSR’s economy was losing pace, failing to pull off any technological and infrastructure triumphs, the sunk military expenditures drained much needed capital. With an economy whose flaws were obscured by the sheer magnitude of oil exports, those flaws were invisible to the world outside the Iron Curtain.

The reform minded Gorbachev came into power in 1985, promising reform and removing Soviet troops from Afghanistan. The economy of the USSR saw a period of stagnation from 1979 to 1985, instigated in part by the Nixon shock. The planned economy was not flexible enough to adapt to the needs of a malleable modern economy. On the political front, Gorbachev’s refusal to provide military support to soviet satellite states played a role in instigating the revolutions of 1989, and the fall of the Berlin Wall that ultimately brought down the iron curtain. Gorbachev is remembered as the man who oversaw the dissolution of a superpower, but the missteps in so doing had momentous impacts. As Deng Xiaoping’s China transformed from a Communist state into a non-democratic market economy, Gorbachev hastily decided to pursue democratic politics and a market economy. The end of the Soviet experiment in 1991 led to a period of economic chaos in Russia due to mismanaged reform efforts and sinking global commodity prices — culminating in the financial crises of 1998. Gorbachev’s attempt at democratic reform was stymied by economic problems, and was then essentially abandoned.

When Vladimir Putin came into power in 1999, Russia was in a state of chaos. The implementation of a concise and structured taxation system, deregulation of important industries, and fiscally consolidatory policies brought on an era of unprecedented strength to the Russian economy. Rising commodity prices and the administration’s control over money supply aided in boosting growth, consumer confidence, and in the creation of a national reserve fund. The credit crunch of 2008 and the drop in oil prices in 2011 did not bode well for Russia. Their refusal to diversify away from commodities, aggressive military spending, and refusal to relinquish control of the oil industry had significant negative effects on the Russian economy. Severely depleted reserves, increased inflation, and increased poverty were just some of the effects of these policies. But even with worsening domestic conditions, Mr. Putin maintains the Soviet tendency of aggressively displaying international power.

When Ukraine, a former Soviet state, took steps towards joining the European Union, Russia launched an invasion into the Crimean peninsula. The confrontation with the West in Syria, their alleged influence in the 2016 U.S. elections, and incursive military exercises, all come to show that Russia is trying harder than ever to maintain dominance on the world stage, and may not be paying attention to necessary domestic economic reforms. The North Star for the Russian economy should be the attraction of foreign investment, and prevention of stagnation. This however, requires a change in the role of the Russian government in economic activity.

In the face of falling oil prices, economic sanctions, and an economy that lacks diversification, Russia has thus far managed to prevent a serious crisis through competent macroeconomic policies. In 2014, with falling commodity prices, increasing capital outflows, and shrinking growth, Putin could have taken the traditional route out of trouble. But instead of propping up the economy by taking on more debt, increasing government expenditure, and making cheap credit available domestically, consolidatory measures were taken. Russia stopped pouring its foreign reserves in an attempt to prop up its currency, and let the ruble depreciate massively. Due to these measures, inflation has reduced to 5 percent — a third of it’s 2015 level, debt is stable as a percentage of GDP, and the rate of capital outflows is reducing. Such policies, while successful in the short run, are not endlessly sustainable. And while Mr. Putin continues his displays of military power in Syria and Ukraine, he must acknowledge that the Russian economy is running out of cards to play. Acquiring stability in the face of collapse is impressive, but not a permanent solution. Growth needs to be promoted as well. Poorly functioning state-owned companies are being used to provide steady employment opportunities, but simultaneously prevent the modernization of industry and of labor laws. The nationalized oil, space, and banking industries are characteristic of developing nation government intervention that will hold back Russia’s growth potential due to lack of incentive to innovate. The devalued currency has made the service of foreign debt more expensive, but fiscal consolidation measures are a step in the right direction. Putin’s attempts at internal economic stability are commendable, but are far from what is necessary to promote long-term investment driven growth. The key missing factor in growth — foreign investment — will be difficult to procure as long as sanctions are held against Russia, and as long as Western nations still view them unfavorably due to their military actions.

Tolstoy’s wisdom is clear when looking at Russia today. As Mr. Putin marches his country down what may seem like a glorious path — much like Pahom did as he continued to see more fertile and beautiful land — a consideration of constraints is in order. A strong economy and a strongman leader do not have a history of aligning well. A hundred years have transformed what used to be Lenin’s communist dream, to what today looks closer to the imperial oligarchy he wished to avoid. With economic decentralization, and larger integration with the world market, Russia would prevent a return to its expansionist and self-destructive Soviet past, and lead it on the path to growth and prosperity.