What went wrong with Russia in the 1990s

What went wrong with Russia in the 1990s

On the origins of Putinism

Matthew Yglesias

Mar 15

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Who lost Russia?

Or, more prosaically, how is it that Russia is ruled by a despotic and expansionist regime while the vast majority of post-communist Europe is peaceful, more-or-less democratic, and willingly integrated into the western system?

After all, though the war in Ukraine is new, the conflict with Ukraine dates back to Russia seizing Crimea in 2014, which came on the heels of a decade of deteriorating relations between Russia and the United States. And this is all grounded in the fact that Vladimir Putin, having consolidated power at home, clearly had no interest in turning his country into a supersized version of Australia or Canada focused on exporting natural resources and being chill. Nothing Putin did before this month was nearly as costly as invading Ukraine, but he has long had Russians paying a high price in order to maintain a large military establishment and an independent industrial capacity. Different choices would have left Russia with less autonomy, but higher living standards — a tradeoff that Putin was happy to ignore because he’s not accountable to a meaningful domestic political opposition, and he and his friends all enjoy very high living standards.

The roots of this dysfunction, like Putin’s term in power, lie in the 1990s.

After all, he didn’t come to power by overthrowing the pro-western regime of Boris Yeltsin — Putin was installed in office by Yeltsin and his “family” of advisors and benefactors, all of whom were themselves very corrupt. In essence, the post-Soviet reform process of shock therapy failed. Rather than creating a market economy and broad-based prosperity, it gave birth to a Putin-led kleptocracy that controls such a large share of the world’s natural resources that it believes itself untouchable.

This failed reform era is, I think, not broadly well understood. A lot of anti-Putin politics is tied up with the fate of Yeltsin era elites who, understandably, don’t want to be honest about how Putin came to power in the first place. Western elites don’t like to talk about the bad ideas they gave cover to, but the western leftists who rightly criticize the wholesale looting of Russia’s resource wealth tend to paint with too broad of a brush, tarring the entire reform period with the sins of one specific aspect of it and overstating the role of western advisors versus bad acts by Yeltsin’s government.

What “shock therapy” was and wasn’t

The popular understanding of these reforms — that the Russian government did something called “shock therapy” at the urging of western neoliberal advisors and that it went poorly — contains both important points of truth and important confusions.

I really recommend that anyone who’s interested in this read Branko Milanovic’s article drawing a distinction between a set of dramatic macroeconomic reforms (floating exchange rates, ending price controls, fiscal austerity) that he calls the Big Bang and the separate but approximately simultaneous decisions about the privatization of industry. Milanovic’s point is that the Big Bang was not only correct but essentially unavoidable. In the countries in question, he writes, “by the time reforms took place, the government no longer controlled the economy.” Laws may or may not have been on the books, but actual prices paid and currency exchange rates were in fact fluctuating on the black and gray markets as the command economy had completely ceased to exist. It’s possible that had these countries made certain earlier policy decisions differently, they could have done something gentler and less disruptive than the Big Bang reforms.

But they didn’t and their economies were in total free fall, so “under such conditions, macro stabilization or the Big Bang had no alternative; its role was simply to validate what was already happening but in a most pernicious and chaotic way.” By legalizing market prices and market exchange rates, the Big Bang essentially made it possible to have a legal economy that functioned — not super well, because the countries still had tons of problems, but it was possible to make goods and provide services in exchange for money and do it legally. And in Poland and many other places, the economy did bounce back from the shock.

Separate from these reforms was the privatization of state-owned businesses, which on some level didn’t work as western advisors had hoped it might (see this critique from the IMF’s John Nellis).

Their idea — and this really was hardcore neoliberalism — was that eastern European state-owned enterprises really need Mitt Romney-style restructuring to become more efficient. But the voucher process mostly ended up giving ownership of companies to the workers and managers of the firms themselves, and handing ownership over to insiders just meant that the new owners were change-averse (especially in terms of lost jobs) and didn’t really want to do much of anything.

Looking back decades later, you can see that Nellis was mostly right that this didn’t work that well. Poland’s economic transition has been pretty successful, for example — but that’s been driven overwhelmingly by foreign companies opening up operations in Poland, not by privatized Polish businesses becoming successful. The Czech auto brand Skoda does well, but the government privatized it by selling it to Volkswagen. In most cases, though, I’m not totally sure there was a practical alternative to the privatization vouchers. Foreign investors were not clamoring to pay top dollar for busted-out SOEs, Russia did not have a domestic class of leveraged buyout specialists, and governments weren’t going to sell nearly worthless businesses to foreigners for pennies so that they could immediately start massive layoff campaigns. At the end of the day, most of the companies that went down this road ended up alright.

But in Russia, there was a second round of privatizations, mostly in the natural resource sector, that amounted to wholesale looting of the companies.

The loans-for-shares fiasco

Turning a state-owned company into a worker-owned company makes sense in a range of circumstances (this is something I’ve advocated we do with the U.S. Postal Service, for example).

But when the value of an enterprise is overwhelmingly in its ownership of natural resources, that’s much less compelling since it generates a huge windfall for a tiny subset of the workforce. Poland does not have much natural resource wealth, and Polish agriculture was mostly privately-owned small farms even under communism, so the country did not face this question in a very sharp way. But Russia has tons of natural resource companies, most of which were exempted from the initial round of privatization. In lots of places — including Saudi Arabia, but also Mexico and upstanding western nations like Norway — natural resource wealth is just managed by state-owned companies forever. But Russia’s SOEs were not particularly well-run or profitable, even though in principle they were very valuable due to the underlying resource assets.

So with the state facing budgetary crisis and the Yeltsin team concerned that ex-communists would return to power, Yeltsin’s government came up with a plan:

Sell the state-owned enterprises to raise money for the government.

Let the new owners restructure the valuable SOEs to power Russian productivity and economic growth.

Create a new class of rich business owners who would financially support Yeltsin’s reelection and oppose the ex-communists’ return.

In the abstract, that’s certainly a plausible idea. But the actual implementation, as described by Marshall Goldman in a 2004 Foreign Affairs article, was basically just looting:

Not long into the process, ownership of some of Russia's most valuable resources was auctioned off by oligarch-owned banks under a scheme called “Loans for Shares.” Although they were supposedly acting on behalf of the state, the bank auctioneers rigged the process-and in almost every case ended up as the successful bidders. This was how Khodorkovsky got a 78 percent share of ownership in Yukos, worth about $5 billion, for a mere $310 million, and how Boris Berezovsky got Sibneft, another oil giant, worth $3 billion, for about $100 million.

When it came to dealing with the oligarchs, the government was generally unable to exercise much control. Since the state was very weak, these “new Russians” paid little or no taxes on their purchases. And if most American robber barons had at least created something out of nothing, the Russian oligarchs added nothing to what already was something. Virtually all their wealth came from the seizure of Russia's raw material assets, which until 1992 had been owned and managed by the state.

It was this — not the Big Bang macroeconomic reforms and not the initial round of privatizations — that laid the groundwork for contemporary Russia’s dysfunctional politics. And while I described the invasion of Ukraine as “worse than a crime, it’s a mistake,” this was absolutely a crime.

The Big Bang was clearly correct given the circumstances Russia faced at the time, and the voucherization was probably better than any plausible alternative. But while it’s not 100 percent obvious to me what the best approach to the natural resource wealth was, “let well connected Russian bankers steal the resources” was obviously not the right approach. It was just a cataclysmic act of corruption.

The rule of the oligarchs

Today people often refer to the Putin-aligned clique of Russian billionaires as “oligarchs,” but I think that’s largely a misnomer. Contemporary Russia is an autocratic state in which the autocrat allows some of his key allies to enrich themselves. But there is no oligarchy.

By contrast, when I was in Nizhny Novgorod on an exchange program in 1998, the country was ruled by oligarchs. The rigged privatizations happened in 1995, and the newly enriched crooks generously opened their wallets to finance a 1996 re-election campaign for Yeltsin, who started the year deeply unpopular but (with generous financing, American campaign operatives, and the support of Bill Clinton) ended up pulling off 54 percent of the vote.

In Yeltsin’s second term, people called this clique of gangster-capitalists “oligarchs” because the idea was that they actually ran the country. The state was very weak. Yeltsin was very weak and dependent on their support. The oligarchs didn’t pay taxes so the state was further weakened, constantly bankrupt, and had difficulty paying people. That generated lots of corruption which was easily taken advantage of by the rich. They were oligarchs, and they ran the place with Yeltsin as their ineffectual figurehead.

And it really was an oligarchy, meaning the oligarchs did not act with total unity of purpose. They agreed about some things, but not about everything — they were rivals in business and politics, not a unified team. From the standpoint of the smallish number of cosmopolitan intellectual types who are disproportionately well-networked with western journalists and observers, this was a pretty good time in Russian history. There was a lot of media freedom, for example, and no single controlling point of view dominated the scene.

But from the standpoint of middle-class people in the Russian heartland (the kind of folks I knew), this was a time of crime and impoverishment. And when Putin took over and consolidated power, he did so not by cracking down on the opposition (which at the time was mostly communists) but by cracking down on the oligarchs. Khodorkovsky and Berezovsky, mentioned in that Goldman piece, aren’t Putin cronies. They became leading figures in the contemporary anti-Putin opposition because Putin’s rise to power came at their expense. In his 2000 campaign Putin promised a “dictatorship of law,” and that is essentially what he delivered. Since all the influential rich people in Russia had gotten rich through acts of brazen corruption, he was in a position to have any or all of them arrested or punished unless they supported him. Some of them did flip to supporting, but quite a few did not — they enjoyed being oligarchs and didn’t want to bend the knee — and they were punished accordingly. The liberal (as opposed to communist) opposition only came into being as a result of this process, and to many Russians, that tainted the liberals with complicity in corruption.

That said, it was clear to external observers from the beginning that Putin’s crackdown bore the hallmarks of a pretextual centralization of power rather than an effort to strengthen the rule of law. And indeed while Putin did very much clip the wings of the oligarchs, he created a new non-oligarchical system that is just as corrupt if not more so.

Could we have stopped this?

In retrospect, the Clinton administration’s close relationship with Boris Yeltsin — and by extension Yeltsin’s relationship with other western leaders and most of the western press — looks terrible.

There were heroic aspects to his resistance to Soviet rule, but fundamentally, Yeltsin was no hero. He’s not the first person in history to have taken a stand against a genuinely awful regime, won power, and then turned out to be a bad leader, and he won’t be the last. But he really did a terrible job as president, not only in his fateful policy errors but also in his unwillingness to try to create a proper democratic political party with an ideology and a policy orientation. Instead, he practiced a kind of weird personalistic politics, rotating through cabinets and eventually landing on Putin as his successor. And the trouble here goes all the way back to the construction of the Constitution of Russia with its strong-president system. Presidentialism is what created the zero-sum 1996 race between Yeltsin and the communists in which there was no good option. And though Putin first took office in 1999, it wasn’t until 2007 that he was able to secure a firm parliamentary majority. A different system could have led to better outcomes, but as president, Yeltsin wanted a strong presidential system and that’s what he got.

Yeltsin’s western advisors come in for a lot of criticism, but — per Milanovic — even though the Big Bang Era was very difficult for most Russians, that really was the right course of action.

The privatizations are a different matter. Andrei Shleifer, a Harvard professor, worked on the first round of privatizations and touted their success in scholarly research and then continued to credulously heap praise even on the second round that set the country on a bad path. Or was he really so credulous? Schliefer and Harvard ended up paying a multi-million dollar settlement to the U.S. government when it turned out he was “making personal investments in Russia while advising the program for the now defunct Harvard Institute for International Development.”

It’s not a great look.

That said, Americans sometimes get so caught up in our domestic politics (Shleifer is friends with Larry Summers, and intra-party economic policy debates among Democrats largely reduce to people’s personal feelings about Summers) that they act as if Shleifer somehow forced Yeltsin to make the privatization auctions corrupt. The fundamental problem was Yeltsin and his team.

Where I do think American policy went awry was in being too worried about Yeltsin failing to be re-elected. In Poland, Aleksander Kwaśniewski got his start as editor-in-chief of a Communist Party youth weekly in the 1980s, served as a cabinet minister in the communist regime, and then won a presidential election in 1995. Ion Iliescu, a veteran of Romanian communism, switched sides at just the right time and had an extensive career in post-communist Romanian politics. Slovakia and Bulgaria had similar trajectories where opportunistic ex-communists were still running the show in the 1990s.

Mid-‘90s worries about the communist comeback in Eastern Europe were part of the reason there was so much concern about Yeltsin losing — would Russia go down that same road? — but again, with the fullness of time, we know that this actually worked out okay. None of these countries become Stalin-type regimes or command economies. In several of them, progressive politics ended up totally discredited and gutted in the early years of the 21st century. This is unfortunate, but the very fact that it happened underscores that ex-communist participation in the electoral process was part of healthy political development. In a world with less fear, there could have been more boldness in saying to Yeltsin “look, if everyone ends up hating you because you sell off the country’s crown jewels for a song, we’re not going to bail you out — you’re just going to lose.” And maybe he’d have done a better job.

What I think is unquestionably true is that at a time when it would have made sense for American policy to be generous to Russia, it was instead narrowly generous to Yeltsin, and that didn’t work out very well.

The “Marshall Plan” that wasn’t

The ‘90s were such a debased time that Richard Nixon passed for an eminence grise, and he made a stir in March of 1992 by vocally calling for more generous aid to the former Soviet Union in the form of a Marshall Plan-style effort to win the peace at the end of the Cold War. This got a bunch of attention in the American media (more coverage here), but conservative economists didn’t like the idea, and ultimately George H.W. Bush smacked it down as too costly, saying at a news conference “where we might have a difference, is we're living in a time of constrained resources. There isn't a lot of money around. We are spending too much as it already is.”

My guess is Bush probably had his finger on the politics of the moment. But interestingly, one person who agreed with Nixon was Joe Biden:

Mr. Nixon's critique has won the respect even of some Democrats, or as Senator Joseph R. Biden, chairman of the Senate Europe subcommittee put it: “It seems to occur randomly, but this time Mr. Nixon has it right. What we need from the Bush Administration is a comprehensive plan to buttress democracy from Prague to Vladivostok. I have urged Secretary Baker to submit such plans to Congress and I have pledged to support the Administration in the bipartisan spirit that these crucial issues demand.”

Could something like this have made a difference?

One interesting question is whether the Marshall Plan made a difference. There’s a view that generous aid from the U.S. is why Western Europe rebuilt rapidly and got rich after World War II. But economic historians have long criticized that view, noting that while the Marshall Plan was pretty big, the scale was still much too small to plausibly account for strong European growth in the 30 postwar years. Bradford De Long and Barry Eichengreen conclude in their seminal 1991 paper that the Marshall Plan worked basically as a carrot to encourage recipients to adopt sensible economic institutions. Looking back on the past 30 years, I think it turns out that the European Union played something like that role for most of Central and Eastern Europe.

But what about Russia? You could imagine a scenario where more generous aid means Russians are better off in 1994-95, the communists don’t do as well in the 1995 Duma elections, and Yeltsin has a higher approval rating. In that case, I think you’d say heading into the 1996 re-election campaign that it would be really dumb to blow everything with corrupt privatization of Russia’s natural resource companies. In the real world with Yeltsin underwater, the corruption had an upside because it funneled state resources into the oligarchs’ pockets and they used some of that money to help Yeltsin win the election. But if things had been going better, maybe all the incentives look different.

Of course, you also could have seen the United States pour in a ton of money, and then Yelstin & Co. decide to be super-corrupt anyway and everyone looks like idiots. People like to cite the Marshall Plan because it worked out well. But success was not foreordained, it was a calculated risk that happens to have paid off. Would Marshal 2.0 have been worth trying if it had only a 50 percent chance of succeeding? Twenty percent? Given the stakes, I tend to think it would have.