The Strange Case of Russian Capitalism

Russian Outlook
This is the first in the series of quarterly analytical essays devoted to key issues in the Russian political, social, and economic transition written by Leon Aron, resident scholar and director of Russian studies at the American Enterprise Institute. The next (spring 1998) issue will discuss Russian foreign policy and U.S.-Russian relations.

Russian capitalism is a subject of heated debate in academic and business circles. Some see nothing but robber barons, a giant mafia in place of government, universal theft, economic stagnation, ostentatious luxury for a few, and impoverishment for millions.

This is a grossly oversimplified and distorted picture. Russian capitalism is real and increasingly robust. It has already begun benefiting Russian society in small but critical ways. Yet the severe deficiencies pointed up by the critics are just as real. Russian capitalism is full of incongruities and contradictions. The best way to put them in perspective and arrive at a more or less coherent picture is to recall the beginning.

No matter how much and how long a system develops, from the Big Bang to the conception of a baby, the first billionth of a second, the first hours, days, and months define much of the result. So it is with economic and political revolutions. A great deal in the present character and the future course of Russia's six-year-old capitalism may be explained and forecast by recalling the circumstances that attended its birth.

Four powerful antecedents combined to shape the character of Russian post-Communist economy. First, there was the legacy of Russian and Soviet economic and political arrangements profoundly antithetical to modern market economy. Second, a dire economic and political crisis--from the depth of which the economic revolution was launched--resulted in the abruptness and speed of the change that left practically no time for laying down institutional, legal, and social foundations of "civilized" capitalism. The third factor was democracy, which in the West came centuries after private property and capitalism had been firmly established but in Russia overlapped with it. Finally, as in most other post-Communist societies, the new Russian revolution was "velvet": it left the economic ruling class (the industrial nomenklatura) in charge of the nation's wealth.

The Russian Inheritance

The transition from traditional societies to modern capitalist democracies took centuries of gradually expanding islands of societal autonomy and self-rule, of corporate and individual sovereignty wrested from the king first by the church and the nobility and later by towns, guilds, corporations, and universities. Strengthened at the same time were the institution of private property and its legal underpinnings: commercial law, the contract, and an impartial court. The two processes were parallel and mutually reinforcing.

By comparison, the soil in which the seeds of Russian capitalism were planted on January 2, 1992, was not just hard or barren. In key elements its composition was the direct opposite of the one from which Western capitalism had risen. Apart from the monumental economic distortions, waste, and militarization that were the legacy of the Soviet state, post-Communist Russia inherited four centuries of patrimonialism: a system of rule in which political authority presupposed substantial (often nearly complete) control not only of the nation's economy but of the individual property of the state's subjects as well. Property rights (which in the West contributed so greatly to the political autonomy of civil society and eventually to the emergence of democracy) had been weak in Russia even before the Bolsheviks established a near-perfect patrimonial state that owned the livelihoods of the entire population.

Russian patrimonialism and Soviet state socialism had thwarted the development of interlocking networks of laws, institutions, and what Montesquieu called "habits of the heart," which undergirded capitalism over the past two centuries and endowed it with its "civilized" character. Virtually to the day of its sudden collapse, the totalitarian ancien régime relentlessly sought to extirpate, suppress, subvert, or coopt voluntary associations in which the habits of self-governance, personal responsibility, and peaceful reconciliation of interests could have been instilled and reproduced: neighborhoods, religious associations, charitable organizations, clubs.

After depriving generations of political liberty and economic and social autonomy, the Communist regime delivered to its successor not citizens but wards of the state. In the absence of an even rudimentary social contract between the Russian state and Russian society, the former was viewed by the latter as the absolute master and provider but never as a partner. The people's compliance with laws was a product of terror and fear rather than of freely assumed obligation. Decades of contest with unjust and often irrational rules turned Russians into a nation of lawbreakers. Ferocious individualists, jealously protective of their private space, resourceful and wily fighters for personal amenities--they were at once dependent on the state for everything and deeply resentful, cynical, and hostile to it, or, for that matter, any organized political power. In the words of a leading Russian political sociologist, the forced "Communist collectivism" has been replaced by "nonliberal individualism."1

The signs of the unprecedented normative and institutional void from which Russian capitalism emerged are ubiquitous, vivid, and deep. What Marx called "primary accumulation" was everywhere and at all times attended with crass inequality, fraud, indignities, and cruelty toward the weak (all of which had long ago and happily faded from the collective memory of the West). The Russian case was made even less attractive by the absence of even minimally restraining mitigation by the church, by the professional association or the corporation, or by the habit of charity or personal responsibility.

This moral vacuum exacerbated another common feature of societies undergoing a rapid capitalist expansion or "de-etatization" of the economy. Like beached whales, the state possessions--huge but no longer shielded by fear--are waiting for the vultures to tear them apart. The newly empowered and hungry private entrepreneur meets a weakened but still omnipresent and rich state represented by a venal bureaucracy that controls the access to the beach with licenses, quotas, and credits. Repeated in thousands of daily transactions, this encounter is the key source of corruption and organized crime in transitional societies (post-Communist and post-etatist) from Estonia to China and from the Czech Republic to Mexico and Argentina. And nowhere is the whale bigger and in few, if any, places is the habit of honesty and self-restraint more eroded than in Russia.

In the short run, the most detrimental bequest of the omniscient patrimonial state and of atrophied personal responsibility that it spawned is the mammoth budget deficit. It is a result of the state's enormous social and economic presence and commitments, on the one hand, and rampant tax evasion, on the other. Around 7.5 percent of the gross domestic product, the deficit is uncomfortably close to the Mexican case, where the government too financed the deficit of around 8 percent of the GDP by short-term government bonds and was eventually forced to devalue the peso in 1994–1995 at the cost of severe economic dislocation and political destabilization.

In addition to the military-industrial complex2 with a payroll of tens of millions, among the heaviest burdens inherited from the Soviet state are the subsidies for housing and utilities. The average Russian family pays no more than 3 percent of the real service costs. Even in Moscow, Russia's most expensive city, the average tenant pays only 17.6 percent of the cost of electricity, heating, and telephone.3 The housing subsidies now cost the Russian state more than the entire defense budget.

Another stark and debilitating legacy is the communal ownership of land. Except for a brief interlude at the beginning of the twentieth century, when Prime Minister Petr Stolypin (1906–1911) attempted to create a class of independent farmers by granting them titles to individual plots, the land in Russia was owned by the crown, feudal lords, the mir (the village commune) or, after Stalin's collectivization (1929–1932), the state.

From 1993, the Communist-led plurality in the Duma (the lower house of the Russian legislature, the Federal Assembly) has resisted the privatization of land to further the agenda of the most important communist constituency: the rural nomenklatura of chairmen of kolkhozes and sovkhozes, who effectively continue to rule most of the Russian countryside. In July 1997 President Boris Yeltsin vetoed the land code passed by the Duma because it banned citizens from selling, giving away, or mortgaging farmland. (Yeltsin called the legislation "the most reactionary of documents ever passed by the Russian parliament.")4

The Economic Crisis

The character of Russian capitalism was further shaped by the deep economic crisis in which the market revolution was launched. Five years of Mikhail Gorbachev's half-hearted, on-again, off-again tinkering with the "socialist market," as well as his well-meaning but incompetent policy of increasing salaries and subsidies in the absence of growth in productivity or budget revenues, had left Russia in the worst of two worlds: between the fatally undermined command economy and a still suppressed market.

The result, by the fall of 1991, was a contraction of the economy by 13 percent of GDP; a budget deficit of 30 percent of GDP; inflation of 138 percent;5 an empty state treasury; the collapse of the ruble, which had lost 86 percent of its value against the dollar; and barter trade. In October 1991 the Vnesheconombank, which handled foreign trade, declared that it could no longer service foreign debt and defaulted on domestic hard currency accounts.

No one who visited Moscow in the fall and winter of 1991 will forget the absolutely bare shelves in food stores. The shortages were on a scale unknown in Russia since the end of World War II. Sugar, salt, matches, potatoes--all were rationed, if they could be found at all. With famine, civil war, and the country's disintegration not only possible but probable (and widely predicted by many Russian and Western experts), the price liberalization of January 2, 1992, and the beginning of privatization half a year later were undertaken in haste and with an urgency that left neither time nor energy to engineer, test, and deploy even rudimentary structures and institutions of liberal democratic capitalism. The country, state, and democracy were saved but at a considerable cost.

Capitalism and Democracy

Another fundamental characteristic that marked the emergence of Russian capitalism was its coincidence with electoral democracy. This concurrence was absent in the West, where capitalism was centuries older than universal franchise, and in most Southeast Asian and South American nations, where capitalist modernization preceded democracy by at least several decades. When Macaulay described what we today call liberal capitalism as a system in which "the authority of law and the security of property were found to be compatible with a liberty of discussion and individual action," the implied order--first, private property protected by law; second, democracy--corresponded to the historical record of the classic evolution.

In Russia (as in other post-Communist nations), the sequence was reversed: democracy came first and commanded an incomparably greater popular allegiance than the free market. Capitalism was a consequence (and not always an intended one) of a revolt against the totalitarian Communist state.

This coincidence matters a great deal because of the fundamental heterogeneity of capitalism and democracy. In older capitalist democracies, equality and subjugation to the will of the majority, which are at the heart of democracy, coexist in relative harmony with inequality and liberty of individual action, which are the essence of capitalism, although not without occasional tension. In Russia, as in other post-Communist societies, the conflict is raw and constant.

In macroeconomic policy, this uneasy partnership, in which democracy is the much stronger partner, has produced what might be called capitalism-by-majority. It accounts for much of the inconsistency and contradiction of the market reforms and the glacial speed with which economically urgent but politically unpopular policies are implemented. (One needs only to look at today's France and Italy, where the state is perceived as the guarantor of "economic rights," or New York City with its "rent-controlled" housing to appreciate the political constraints that democracy imposes on the market even in far more mature capitalist societies.)

Perhaps in no other instance has democracy's impact on the course of the Russian market revolution been more immediate and pronounced than in the repercussions of another common feature of anti-Communist revolutions: the historically unprecedented preservation and subsequent return of political and economic elites of the ancien régime. One of the most celebrated features of the anti-Communist revolutions of 1989–1991 was their "velvet," nonviolent character. Other revolutions killed off, arrested, exiled, or at least dismissed the old ruling classes; these bought theirs out. The post-Communist "velvet" was the largest political bribe in history. The Communist nomenklatura handed over political power practically without a shot (Romania was the only exception) in exchange for effective ownership of the state assets that they had administered on the Communist Party's behalf. When the music of communism stopped, they kept the chairs.

The defeat in the cold war did not wipe the Russian political slate clean--as had, in the case of Germany, Italy, or Japan, defeat in World War II. On the contrary, granted complete freedom of political participation, the former Communist nomenklatura successfully deployed its unmatched organizational resources, skills, and solidarity to thwart and dilute the capitalist transition.6


The first and second phases of privatization (1992–1995) determined a great deal for years, perhaps decades. Quite apart from the errors, malfeasance, and simple ignorance that invariably accompany such mammoth undertakings, the result was in many ways preordained by two "genetic" factors.

First, the patrimonialism of the Soviet state was replicated on the local level, where enterprises owned and operated the kindergartens, hospitals, schools, and housing of their workers and, in many cases, entire towns, cities, and "workers' settlements." As the party's grip relaxed toward the end of Gorbachev's rule, the managers of these enterprises (soon to be known as "red directors") emerged as the most powerful and coherent interest group in Russian politics. The second factor was the velvet revolution, which left "red directors" in possession of all the economic assets and privileges that they enjoyed in Soviet times.

How, under these circumstances, does one go about privatization? One could, in a Bolshevik fashion, send armed detachments to tens of thousands of state-owned enterprises, forcibly eject old managers from their offices, and severely restrict the rights of the employees to buy shares in order to ensure the fair treatment of outside buyers and a subsequent enterprise restructuring (which, in almost every case, would have meant massive layoffs). This scenario, in the case of Russia in 1992, would have been a recipe for civil war.

A hectic search for a formula that would satisfy the "red directors" and the increasingly recalcitrant, nationalist, and Left-populist Supreme Soviet, inherited from the Soviet era, resulted in an arrangement that left two-thirds of the stock in the hands of managers and employees. Subsequently, 144 million privatization "vouchers" were distributed (one to every Russian man, woman, and child), to be exchanged for shares in any privatized enterprise. Yet the novelty of the procedure, the passivity of the Russian workers and their trade unions, management's near-complete mastery over them, and the absence of a legal and accounting infrastructure to protect the rights of outside investors combined to produce a corporate governance that was hardly conducive to transparency and accountability. Worst of all, the first phase of privatization (1992–1994) did little to effect the desperately needed radical restructuring of the Russian economy, which was a key objective of the entire exercise. Only one-fifth of all the Russian firms were majority owned by outsiders in 1996, 6 percent majority owned by one blockholder, and 5 percent by several blockholders.7

Still, next to the perpetuation of state ownership of the economy, this insider "nomenklatura privatization" was viewed by Russian reformers as a lesser evil. As the testimony of those in charge makes quite clear, the objective during the first phase was not so much to secure immediately the best management of the assets for a particular enterprise but to depoliticize the Russian economy: to remove as many economic assets from the state's control as quickly as possible. "Controlling managers is not nearly as important as controlling politicians," wrote associates of Russia's privatization tsar, Anatoly Chubais, "since managers' interests are generally much closer to economic efficiency than those of the politicians."8

The reality proved far grimmer than the theory. After seventy-five years of a state-owned economy, red directors behaved more like corrupt civil servants than entrepreneurs. Control was preeminent, productivity and workers' well-being secondary and tertiary. Indicative of this mentality were the results of a survey of Russian managers conducted in 1995 and 1996. Two-thirds of those polled said that they "and their workers" would oppose selling a majority of the shares of their enterprises to outside investors even if an outsider would bring all the capital necessary to modernize and restructure the firm.9

Forced on their own, most managers sought "rent" from the assets and political connections, not profit from production and innovation. The response to the gradual diminution of subsidies and the cancellation of state orders was not restructuring, developing new products, or searching for new markets. It was lowered production, the sale of inventory, profligate and reckless borrowing, withholding of taxes, and the accrual of enormous interenterprise debts. In these strategies, the "red directors" were encouraged by their ability to secure a flow of state subsidies in the form of "loans" at a negative (that is, below inflation) interest rate. In 1993 and 1994 the subsidies to the enterprises amounted to, respectively, 9 percent and 5 percent of the Russian GDP.10 The regime's timidity in forcing bankruptcies of failed enterprises,11 further strengthened managers' belief in their political invincibility and in the eventual demise of market reforms. All they had to do was to wait--and live well while doing so.

Stage Two of Privatization

Many features of Russian capitalism hardened after the second stage of privatization (1995–1996), when the Kremlin moved from giving away state property to selling off some of Russia's blue-chip companies. This operation, in which twenty-nine of the country's most profitable and largest enterprises were auctioned, became known as the loan-for-shares deal. The state, desperate to plug huge gaps in the budget and to tame inflation (both resulting largely from the industrial subsidies and inflationary budgets adopted by the Supreme Soviet, which lasted until September 1993), received loans from the private banks in exchange for the "management" of the state's shares in the enterprises offered as a collateral. In reality, this was a sale (or, at best, a long-term lease) of choice assets, for there was little hope that the Russian state would ever repay the loans.

It quickly became apparent that there were few domestic buyers; even fewer were those whose wealth had been obtained entirely by legal methods and who were not in one way or another connected to organized crime. And none could afford to pay anywhere near the book value for the shares. As foreign investors stayed away, frightened by political instability and high inflation, the shares were "sold" at insider auctions at bargain-basement prices and to politically better connected (and more "generous") banks, many of which acted as the organizers of those same auctions.

The FIGs

The economic system that thus emerged in Russia sharply diverges from the traditional capitalism of what might be called the North European or Anglo-Saxon variety, inherited and refined by the United States. Instead, the Russian variation incorporated, in a considerably cruder edition, some of the worst features of what might be called the French-Italian-Asian versions of capitalism: secretive, tightly closed, bank-led corporate "families" or "financial-industrial groups" (the FIGs) with intimate political connections similar to the South Korean chaebols and Japanese keiretsus; incestuously overlapping and interchangeable political, corporate, and bureaucratic elites; bureaucratic sway over the economy stemming from either the state's direct ownership or dirigisme (intervention, direction, or control); the corruption that such arrangements inevitably breed; economies driven by banks and exports, instead of the stockmarket and domestic demand; "authorized" (upolnomochennye) banks in which, in the absence of a state treasury system, the Russian government deposits its revenues; subsidized credits, "informal" lending practices, and loose (or nonexistent) disclosure rules, which result in mountains of bad loans; the absence of independent institutions of banking and stock market oversight; crushing taxes and nigh-universal tax evasion; protectionism for select industries and restrictions on foreign participation in the economy, especially in banking; a giant underground economy; and organized crime.

Much like chaebols and the keiretsus, but to a greater degree, Russian FIGs owe their wealth (and often their origin) to the political connections and the state's intervention in, and regulation and "guidance" of, the economy. They obtained the export licenses and arbitraged between the world market prices on oil and raw materials and the controlled domestic prices (which, for political reasons, Yeltsin could not bring himself to free and which were, at times, up to one hundred times lower). Another source of wealth was duty-free imports, especially food, hard liquor, and cigarettes. In 1992 and 1993, the FIGs profited hugely from credits at the below-inflation interest rate, issued by the Central Bank then controlled by the Supreme Soviet. Finally, most banks at the heart of the largest FIGs were designated as "authorized" holders of government revenues (pensions, custom duties, taxes, salaries) and, in effect, used these enormous resources as short-term interest-free loans.

This is a far from stellar report card. Yet, if history is a guide, neither does this record augur a uniformly cloudy future. First, several decades of keiretsus and the chaebols coincided with political stabilization and the transition from authoritarianism to democracy (in the case of South Korea). And, of course, that was also the time of huge profits for domestic and foreign investors, of industrial expansion, of a remarkably fast growth of national wealth, and of a dramatic rise in the standard of living, some of these characteristics already evident in the revival that the "urban corporatism" of Moscow's Mayor Yuriy Luzhkov brought to the Russian capital.

Some Achievements

Despite these glaring flaws, the Russian version of oligarchic capitalism can already point to several real achievements. The seemingly doomed cohabitation between the reformist, right-of-center executive and the leftist legislature brought to Russia the first nonauthoritarian political stabilization in its history. Inflation is down to 11 percent (compared to 160 percent in 1995 and 24 percent in 1996)--lower than in Poland or Hungary. Competently defended by the Central Bank, the ruble remains stable and de facto convertible. In 1997 the Russian economy ended a free fall: industrial production, which accounted for a third of Russian GDP, grew 1.8 percent, and, for the first time since 1990, the country's GDP registered a minuscule positive growth of 0.4 percent.

Adjusted for inflation, the average wage grew last year at an annual rate of 3.3 percent. In September 1997, the dollar equivalent of the average monthly wage was $175, compared with $75 in September 1993.12 Domestic automobile production is 13 percent higher than in 1996, and an estimated 31 of 100 Russian families now own a car (18 families in 1990). Russian tax collection agencies estimate that 20 million Russians traveled abroad in 1997 (of the total population of 150 million).13

Even in the absence of large-scale privatization of land, market prices, a stable currency, and efficient distribution contributed to a surplus of grain. For the first time since the early 1960s Russia could feed itself. It did not import grain and, in fact, had 10 million tons to export after the 1997 harvest.

In the long run, a number of factors might help mitigate the more dangerous excesses of the Russian version of capitalism. First, the Russian transition coincides with economic globalization, when a dependence on foreign capital imposes greater discipline on the Russian government and the country's financial institutions. More important, unlike the modernizing authoritarian Asian regimes of thirty years ago (and unlike China and Indonesia today), Russia is an imperfect but functioning democracy, with freedom of speech and the press, a political process open to the opposition, and regular, free elections. Along with making transition much more tortuous, contradictory, and lengthy, democracy also made it more consensual and thus politically stable. Popular sentiment for a less corrupt, more open, and more equitable economic system eventually translates into pressures that force change.

Friedrich Hayek wrote that should such a strange society be found in which there were no rich people, it would be better off selecting them by lots and endowing them with wealth at the state's expense. Russia's undeniable advantage over currently more successful post-Communist nations and China is that it has, in fact, undertaken a depoliticization of the economy that is both decisive and unprecedented in scope.14 This move sharply distinguishes Russia from Poland and the Czech Republic, both of which postponed industrial privatization, continued state ownership of inefficient and corrupt banks and subsidies to inefficient industrial enterprises (in the Czech case despite the uncompromising free market rhetoric of its ex-prime minister Vá Klaus), and relied on retail trade, services, agriculture, and foreign investment to revitalize the economy and provide political stability. Following Deng Xioaping's decision not to privatize state-owned industry, China spends today a third of the entire state budget to keep afloat profitless plants and factories.

Just as important, at least some of President Yeltsin's most trusted aides have a remarkably clear understanding (much strengthened by the Asian crisis of the past half-year) of the perils associated with the model of capitalism that Russia seems to have adopted. They see an urgent need for another cycle of economic liberalization that would, in the words of former acting prime minister Yegor Gaidar, further "separate power and property."15

The Second Economic Revolution

Such seemed to have been the goal of the second economic revolution that President Yeltsin heralded in his March 7, 1997, State of Russia address to the Federal Assembly. Among the measures announced by the president were an overhaul of the tax code, a crackdown on tax dodgers and corrupt officials, a smaller and more competent government, welfare reform, and the end of the practice of authorized banks.

Appointed by Yeltsin to design and implement this second revolution (and granted by him unprecedented decision-making power) were the radical reformers Boris Nemtsov, the former governor of Nizhny Novgorod, and Yeltsin's Chief of Staff Anatoly Chubais. Most of what they attempted last year was subjugated to the overarching objective of bringing the deficit down and thus lowering the yield on government debt and encouraging banks to invest in industry instead of in short-term, high-yield government securities (GKOs).

A new tax code, which the leftist plurality in the Duma has held up for over a half-year, fixed the levy on business profit at 30 percent and reduced the general tax burden on the economy from the current 33 percent of GDP to 30.7 percent. It is a vast improvement over the convoluted and constantly shifting maze of over 300 federal and local taxes, with punitive wage taxes of 60 percent and levies on profit, which, if paid in full, often add up to much more than 100 percent of earnings.

A concerted attack was commenced on the unlimited power of FIGs and the "authorized" banks. They can no longer acquire the choicest pieces of Russian industry at bargain-basement prices in rigged auctions. (In August, Yeltsin signed a new privatization law prohibiting loans-for-shares deals.) Instead, a 25 percent stake in the national telecommunication giant Sviazinvest went to the highest bidder, who had to pay the market price ($1.875 billion), half of it in cash. The position of the authorized banks is likely to be significantly undermined by the creation of the Federal Treasury in 1998. In the meantime, Yeltsin ordered the government to hold open competitive bidding among the banks for government deposits, beginning January 1, 1998. Following yet another presidential decree, the Ministry of Finance was banned from guaranteeing bank loans to enterprises. Finally, even such a politically well-connected corporation as the natural gas monopoly Gasprom (Prime Minister Victor Chernomyrdin's industrial alma mater) has been forced to pay billions of dollars in back taxes.

The shrinking of the bloated state budget continued apace. In May 1997, the government imposed sequestering on the state budget, cutting it by 20 percent across the board. Agricultural subsidies were reduced by half, compared with 1996. The largest demilitarization effort in history was given an impetus by Boris Yeltsin's promise to reduce the share of GDP consumed by the military from 5 percent to 3 percent by the year 2000. In fact, following the 80 percent decrease in defense procurement ordered by Gaidar in 1992, the defense share of GDP has dropped consistently from at least 20 percent to 5 percent.

Radical welfare and housing reform, spearheaded by Boris Nemtsov, was designed to reduce expenditures by tightening eligibility, instituting a means-tested system for social benefits, gradually diminishing the rent and utility subsidies, and creating private pension and medical insurance funds.

The Russian economy was opened further to foreign participation by presidential decrees that allowed direct foreign bidding in privatization auctions, permitted foreign exploration of natural resources (oil, gas, iron ore, and gold) on a product-sharing basis (that is, in exchange for a percentage of resources extracted in the future), and lifted restrictions on foreign ownership in Russian oil companies, which had been limited to 15 percent of the shares.

An Evaluation

"So what do we have after five years of reform?" Chubais was asked last year. "What kind of capitalism has been built, Anatoly Borisovich: state,' nomenklatura,' criminal'?" "It is too early to sum up," Chubais answered: "The process is not complete. There are giant holes in the edifice. Many weight-bearing parts of the structure are not strong enough. Several segments are simply wrong and even harmful. Yes, there is a danger of a nomenklatura capitalism. There is a danger that the half-constructed building will be frozen in its current version: with all the holes and rusty armature. No matter where you look, you see how much has been done--and how much more still needs to be accomplished. Still, there is a real chance for us to finish the construction of at least the main areas of both the state and the economy by the year 2000."16

This is a fairly objective analysis, but its timetable is overly optimistic. Given the crisis in which Russian capitalism was born and the crushing burden of its genetic defects, it is unrealistic to expect Russian capitalism to become liberal and democratic within the next decade. In the meantime, oligarchic capitalism, with the growth, prosperity, and stability that this model brought to Southeast Asia, is the best outcome one can hope for in the Russian case.

In the longer run, Russian development will depend on the outcome of the clash between two fundamental and competing tendencies, both very much in evidence today: statist, oligarchic, authoritarian, closed, and Left-populist, on the one hand, and liberal (in the European sense of the term), democratic, open, and centrist, on the other. A great deal will also depend on the caliber of Russian political leadership, continuing democratic institutionalization, and the state of the world economy. The battle for the soul of Russian capitalism is likely to be tough and long. Its outcome is uncertain. Yet, given the adversity in which the market revolution began and what has been accomplished since January 2, 1992, the chances for success are real and formidable.

Leon Aron is a resident scholar and the director of Russian Studies at AEI.


1. Igor Kliamkin, Polis, no. 4 (1994), p. 62.

2. The estimates of the share of GDP consumed by the Soviet military-industrial complex varied from 15 percent to 30 percent and could be conservatively assumed to be at least 20 percent. Counting family members, between one-quarter and one-third of the Russian population was connected with the defense establishment.

3. RFE/RL Newsline [daily publication of Radio Free Europe/Radio Liberty] February 6, 1998.


4. RFE/RL Newsline, September 25, 1997.

5. Joseph R. Blasi, Maya Kroumova, and Douglas Kruse, Kremlin Capitalism (Ithaca, N.Y.: Cornell University Press, 1997), table 2, p. 190.

6. Of the political and economic elites in Poland, Hungary, and Russia in 1988, one-third remained in the same positions in 1993. (John Higley, Judith Kullberg, and Jan Pakulski, "The Persistence of Post-Communist Elites," Journal of Democracy, no. 2, 1996). The political comeback of the nomenklatura was formalized in parliamentary and presidential elections in Poland (1993 and 1995) and in parliamentary elections in Hungary (1994) and in Russia (1995).

7. Blasi, Kroumova, and Kruse, Kremlin Capitalism, p. 148.

8. Maxim Boycko, Andrei Shleifer, and Robert Vishny, Privatizing Russia (Cambridge: MIT Press, 1995), pp. 11, 65.

9. Blasi, Kroumova, and Kruse, Kremlin Capitalism, p. 179.

10. Ibid.

11. According to the first deputy prime minister at the time, Oleg Soskovets, 35 percent of all Russian enterprises were "technically bankrupt in June 1996. Ibid., p. 178.

12. "Russian Economic Monitor," PlanEcon Report, December 31, 1997, p. 10. Economist Igor Birman contended that, seeking to lower their taxes, employees of many "commercial organizations" report salaries 2.5–3.5 times lower than they actually are. The Russian state statistical administration (Goskomstat) estimated that hidden salaries account for 20–25 percent of the total. Izvestia, December 4, 1997, p. 2.

13. Steve Liesman, "Surprise: The Economy in Russia Is Clawing Out of Deep Recession," Wall Street Journal, January 28, 1998, p. 11.

14. Between 1992 and 1996, Anatoly Chubais directed the largest privatization effort in history: 77 percent of mid-sized and large enterprises and 82 percent of small shops and retail stores. Russian entrepreneurs started 900,000 new businesses. Virtually nonexistent until 1991, by the end of 1997 the private sector of the Russian economy accounted for around 70 percent of the GDP. Blasi, Kroumova, and Kruse, Kremlin Capitalism, p. 26; and Stanley Fischer, "The Russian Economy at the Start of 1998" (Cambridge: John F. Kennedy School of Government, Harvard University, 1998), p. 2.

15. Gaidar, The Days of Defeats and Victories (Moscow: Vagrius, 1997), p. 365.

16. Novoye vremia, no. 48 (1996), p. 7.

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