Background. After years, even decades of growing disenchantment of the Russian people with their government leadership and inability to provide a stable economy, Russia of the 1990’s was about to experience even more turbulence in an attempt to provide stability, economic growth and become a superpower on the world stage once again. As the end of the Cold War drew to a close, Russians demanded more freedom and independence from the old Soviet-style ways of operating their country and thus led to a break from the Soviet Union in 1991. While Gorbachev attempted to maintain his power and keep the Soviet Union united, the fate of Russia had already been decided and a new leader emerged by the name of Boris Yeltsin. However, unbeknownst to the Russian citizenry, their country was about to experience greater instability and deterioration in their economy by way of ill-advised reforms, more specifically poorly planned tax policies, inexperienced leadership, lack of and disrespect for rule of law, continuous changing of laws and their Constitution, inefficient and upside-down government infrastructure, absent institutionalization, increased foreign government debt (see Exhibit 12), hyper-inflation (see Exhibit 7D), devaluation of their currency and finally a contraction of their national GDP. These serious issues, or flawed attempts to make Russians lives better, resulted instead in corruption, violence, poor national health, distrust of government leadership, and a bankrupt country. The 90’s could be described as a “lost decade” and a time of “outlaw capitalism”. While the attempts at economic and judicial reforms were necessary, they were made by leaders unfamiliar with market economies and lacked a history within Russia on which to make sound policies.
Reforms. The GDP of Russia in the 1990’s fell by more than 50 percent as millions of lives and their living standards were destroyed. Russians fell into poverty, hyperinflation could be argued to have caused poor health on a national scale, and inequality nearly doubled as incomes dropped and jobs were lost on a grand scale. The Gini coefficient of Russia during this time increased from .27 to .48, mostly during Yeltsin’s first term. A major cause was due to loose monetary policy by the Central Bank of Russia. Both the economy and politics were whipsawed throughout the 1990’s due to never-ending changes in policies. Boris Yeltsin was able to gain power to start implementation of his reforms by getting approval from the Congress of People’s Deputies, the supreme authority in Russia. He was given authority to make any and all necessary changes in the structure of the government, assign political appointees without approval from parliament and by decree to mandate changes to the economy. This was to all be done in one year. However, the Congress of People’s Deputies was dissolved just two years later. This was because Yeltsin was blocked for his nomination of Yegor Gaidar for Russian Prime Minister. As Yeltsin pushed back by stating that he had “special powers” to push his reforms, the vote went back to the Congress of People’s Deputies but fell short of impeachment. This example of political infighting was one of many roadblocks that led to true reform and Russia unable to make strides toward an improved economy. The second step for Yeltsin to implement reforms. which ultimately led to economic destruction for most of the population, began with the “Young Reformers” in the early 90’s. They were young and too inexperienced to deal with implementing such a massive change to a market economy from a command economy in a country the size of Russia. Their goals were to free prices of most products and release them from state-control, ease the import processes, make large changes in the tax system, erase the budget deficit, squeeze monetary policy, and privatize most of the companies in Russia still under government control. These were grouped into liberalization of price and trade, stabilization of the macroeconomy and privatization. While these attempts were valid, they were poorly planned and implemented incorrectly. The first notion that something would go wrong for the “young reformers” is that they tried to implement these changes in one year. Boris Yeltsin even imagined the process taking six months. This process came to be known as “shock therapy”. Furthermore, because these young reformers were appointed by Yeltsin himself, they were not easily held accountable and had free reign with which to start the process of reforms. During the liberalization and stabilization process, Yeltsin appointed Viktor Gerashchenko as chairman of the Central Bank of Russia but Gerashchenko contradicted Yeltsin and his reformers by arguing against tight monetary policy. Yeltsin apparently failed to ensure his appointees were like-minded and on board with his reform measures.
As for privatization, the groundwork for a greater negative impact on Russia was about to take place. The reformers had it in their mind that it would be satisfactory to put private property in the hands of individuals and businesses without the proper institutions in place to ensure a smooth transition or that rule of law would maintain the system going forward. Without any controls in place, the firms involved in privatization would simply take, grab or even steal. It was naïve at best for the reformers to assume the owners would be good stewards of their new assets as the inefficiencies continued with the same managers still in place. Furthermore, the public was largely left out of the auction process because they were held extremely speedily, in large numbers, privately, not well-publicized or primarily for friends of the ruling party members. There was a great missed opportunity for the government to raise higher amounts of money in the auctions as many outsiders and foreigners were very willing to pay a premium to what those involved in the process actually paid.
Oligarchs. While it can be argued the oligarchs played an important role in raising money for the government, the lack of institutions and enforcement of laws allowed the oligarchs to gain power by exploiting loopholes, control of the media, the less powerful and the government since it was in such dire need of money and revenue. (see Exhibit 2B). It also is a safe assumption that as new owners of large enterprises that investment should have risen, it actually declined throughout the decade. (see Exhibit 7B).
Government Structure. The Russian structure of government consists of regional and local governments. But they often operated within their own legal framework and maintained their own sovereignty: tax collection, customs, constitutions. The federal government was unable to assert control over these regions throughout the country and thereby lost necessary credibility to implement reforms. It also lost its ability to collect taxes. As it created new tax laws as part of its reforms, it went too far and caused confusion and overtaxation. With a tax burden in some instances of 110%, it was natural for companies and individuals to find ways to evade the new taxes. Hence a new barter economy began to rise (see Exhibit 5) and only fermented the tax revenue drain for the government. (see Exhibit 3) This oppressive tax policy led to violence and inability to pay its bills to the military and social services employees. The result was a rise in private security businesses and violent mafias offering protection to those with assets and the ability to pay for necessary protection. (see Exhibit 6)
Judiciary Reform. It was until the mid-90’s that laws started to appear in society to maintain order. However this too was short-sighted as there were judges and legal personnel ill-equipped to interpret and execute the laws. Necessary as they were, the legal processes that followed, including arbitration, were consistently polluted by those who had the most political influence and big money. The judiciary was therefore clipped of any ability to carry out serious legal reform due to its inability to enforce the laws they were meant to put in place.
Financial Crisis of 1998. This crisis seemed to be the culmination of all the problems the reforms failed to address. With a default on its debt and devaluation of its currency due to lack of necessary revenue, the economy fell into severe decline, negatively effecting income, living standards and causing unemployment. The blame game directed the problems at the government, falling oil prices and the Asian financial crisis but that is too broad. More specifically it could be said it was a chain of events that began in 1991 with poor monetary policy, a misunderstanding of the order of what is necessary to effect economic reform (institutions before free market activity and privatization) and control of the economic activity at the federal level, not the regional level. These defective policies hurt Russian private citizens as it became extremely difficult to obtain quality healthcare for most of the population. This burden to take care of the population fell back on the government and is evidenced by the large increase in healthcare expenditures. (see Exhibit 2A).
Putin. After the demise and resignation of Boris Yeltsin in 2000, Vladimir Putin gained the presidency. He quickly realized Russia was in a state of chaos and it had to be fixed immediately. With great perception, he made note that Russia’s main problems lay with the weak state that Russia had become. This included lack of rule of law, constitutional consistency and economic and political order. While he believed that the individual would be more free if the state was stronger, (meaning the state could back up and provide support to the individual so the individual would gain economic and political freedom) he possibly began to overreach his authority by suppressing freedom of the press. Nonetheless, he quickly gained political support by strengthening federal laws and thereby diminishing regional laws; he destroyed tax treaties and pacts at the regional level; and he began to correct some wrongs from the 90’s by holding the oligarchs accountable for their exploitations. He brought back a sense of stability and structure and possibly even of trust to Russian society. As much as people dislike his stealth actions and secretive ways, he has certainly improved the economy of Russia as seen in a rising GDP at the beginning of the 21st century. (see Figure 1 in notes).

INTERNATIONAL BUSINESS ENVIRONMENT
MAN6606
DR. KUNDU
HBS Case Analysis

RUSSIA: THE END OF A TIME OF TROUBLES?

CHRISTOPHER TURNER
10-15-13

1 Source: International Monetary Fund (http://www.imf.org)

2. Peter Nolan, China's Rise, Russia's Fall. Macmillan Press, 1995. pp. 17–18. 3. Daniel Treisman, "Why Yeltsin Won: A Russian Tammany Hall", Foreign Affairs, September/October 1996. 4. Theodore P. Gerber, Michael Hout, "More Shock than Therapy: Market Transition, Employment, and Income in Russia, 1991–1995", AJS Volume 104 Number 1 (July 1998): 1–50. 5. Boris Yeltsin (http://www.acs.brockport.edu/~dgusev/Russian/bybio.html

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[ 1 ]. See Graph of Russia GDP at end of paper by IMF