Prior to the presidential election, the Russian media received justified international criticism, even ridicule, for its refusal to report the objective situation in Russia — a number of these critiques have been translated in Russia in the World Economy.1 A curious situation was created whereby everyone in the world except Russia’s people, and foreign businessmen relying on the press produced in the country, were informed of the real facts regarding the Russian economy.
Since the election, in contrast, dozens of analyses of the financial and budgetary crisis of the Russian state have appeared. This financial dimension, however, is still frequently treated as though it were separate from the strategy being pursued in the productive economy - other than via the self-evident point that economic decline results in a fall in budget income.
In reality, the linkages between Russia’s productive economy and the financial sphere go to the core not merely of the crises of the economy but of the state. They demonstrate, with striking clarity, why the economic course chosen in January 1992 cannot succeed.
These issues also relate to the economic programmes put forward at the presidential election. Analysis of the financial sphere, as shown below, demonstrates clearly that the economic programme of the presidential administration is simply unaffordable, and therefore necessarily creates a progressive disintegration of the financial/budgetary system. This is only temporarily halted by transfers of income from the population — by such means as non-payment of wages and devaluation of savings. The latter, in turn, sharply destabilise the political situation.
The aim of the present article is to outline these relations between the productive and financial spheres of the economy in their fundamental aspects. A subsequent article will consider the successive stages in the working through of this process.
Shifts in relative prices since January 1992
Economic developments in Russia in the last four and a half years are a logical, inevitable, product of the shifts in relative prices created following January 1992. These changes are illustrated in Table 1 and Figures 1 and 2.
As may be seen, and as by now is well known, the period since 1992 was characterised by a wrenching shift in Russian relative prices in favour of energy and non-ferrous metallurgy, and less severe, but positive movements in favour of ferrous metallurgy and chemicals (Figure 1). Simultaneously, relative prices moved sharply against machine building, construction materials, the wood and paper industry, food processing and textiles and clothing — the latter groups constituting the core of manufacturing and consumer industry (Figure 2).
It may be noted that monthly price statistics exaggerate price increases compared to annual revisions. Therefore, the absolute figures in Figure 1 and 2 should be treated with caution. The overall trends, however, are sufficiently large as to leave no doubt as to their fundamental features.
Prices and changes in output
The changes in relative prices, in turn, logically produced the changes in output by sector — as illustrated in Figures 3 and 4. The only three sectors of industrial production suffering less than average declines in output were energy, ferrous metallurgy, and non-ferrous metallurgy — and the sector which suffered the next lowest decline was chemicals. These were the four sectors which enjoyed increases in relative prices. Engineering, construction materials, wood and paper industry, food processing, and textiles and clothing, which suffered the worst declines in output, were the sectors which suffered falls in relative prices. The results of the changes in prices, therefore, ‘funnelled’ resources into sectors which were undergoing increases in relative prices — a simple economic development.
In order to complete the picture of the changes in relative prices confronting the Russian economy, a further, international, development must be considered. Since January 1992, inflation was significantly higher than the rate of devaluation of the rouble (Figure 5). In real terms, therefore, Russian produced, rouble denominated, goods have become progressively more expensive compared to their foreign competitors. This, necessarily, severely increased competitive pressure on Russian producers. This, in turn, naturally particular affected spheres where the Russian economy had been underdeveloped during the Soviet period — i.e. manufacturing in general and consumer production in particular.
This shift in relative prices of Russian goods compared to their foreign competitors deepened the trends produced by the domestic price shifts — acting in the same direction, and particularly severely affecting the consumer/manufacturing sector. Domestic and international shifts in relative prices, following January — 1992, therefore were mutually reinforcing.
The effects of the industrial shifts
The above basic processes make clear why the economic policy launched in January 1992 failed to achieve any of its stated goals of correcting structural distortions in the Soviet productive economy. Prior to January 1992 stress was laid on criticism of the underdevelopment of consumer production in the Soviet economy, the problems of the agricultural sphere, and low productivity in the economy. Criticisms of these features was correct — rectifying them is one of the main goals of any constructive economic reform. But the economic course launched in January 1992, far from correcting these distortions, deepened them — by the mechanism of changing relative prices noted above. Indeed, the economic policy produced a ‘shrunken caricature’ of the worst structural distortions of the Soviet economy — an economy only half the size of its predecessor, but even more distorted in favour of energy, raw materials, and heavy industry, and with a lower productivity. The economic policy launched in January 1992 therefore worsened, not improved, the distortions of the former Soviet economy. The features of this ‘shrunken caricature,’ in turn, determines Russia’s financial dynamics.
Dynamics within the financial system
The financial system of all countries, reduced to essentials, is the mechanism for transferring funds from capital accumulation (savings) to investment. All other transactions are simply, mutually cancelling, transfers and are, in comparison to this fundamental aspect, purely secondary.
The pattern of transfer of funds between sectors, in all normally functioning economies, is also essentially the same — reflecting the necessary constraints of investment in different sectors. Personal savings, and consumer industry, produce a surplus of funds, which are transferred to heavy industry to meet the investment requirements of the latter. In principle such a transfer of funds may be via the stock market, banks, the state budget, or by other means — but this does not alter its essence. In no major industrialised country, even those with the most successful heavy industrial sectors, such as Japan, Germany and South Korea, can the investment needs of heavy industry be met from within its own resources. Heavy industry, in all countries, is inseparable from large scale bank lending, and usually state subsidies, which, in turn, require for their financing a pool of capital created in other economic sectors.
Lack of an investable surplus
In Russia it is evident that the above financial mechanism cannot operate. Consumer industries are in a state of collapse - and incapable of generating any surplus. In the personal sector, in January 1992 a huge, once and for all, transfer of funds from privatc individuals to owners of heavy industry, took place via expropriation of the population’s saving by inflation - this was the fundamental significance, in terms — of transfer of resources, of the
rapid rise of heavy industrial prices after January 1992, together with the simultaneous, almost total, devaluation of small, non-dollar, savings. However the population, severely warned by this experience, now concentrates savings in foreign currency - which partially protects it against similar future expropriationary tendencies by heavy industry, but at the expense of making it extremely difficult to mobilise these funds for investment.
Heavy industry, therefore, drained other sectors of resources through the shift in relative prices in its favour. But it is, as in all countries, incapable of meeting even its own financial needs for investment — and no mobilisable reserves exist in other sectors for transfer to it. For this reason for example, the energy sector, which has received the largest favourable movement of relative prices, has not been able to reverse the decline in production. Even in non-ferrous metallurgy, which saw some reversal of the decline in production in 1995, amid favourable international price trends, no investment capable of reversing technological obsolescence has taken place. This situation determines the dynamics on financial markets.
Russian financial markets
Analysing Russian financial markets, those which exist are, of course, highly imperfect. One expression of this is the extremely diverse rates of return existing in different market sectors — rates of profit on the interbank lending market, on the GKO market, within the share market etc. can differ sharply. In a perfectly functioning financial system the rate of retum would be identical in all sectors, and in the developed financial markets of the West, the difference between rates of return in diverse markets is far lower than in Russia.
Within this diverse framework, however, it is evident that by far the largest, and most important, financial market is that for GKOs. This pre eminent position of the GKO market has been consolidated since the severe crisis of the interbank lending market in August 1995. In the first week of October 1996, weekly turnover on the GKO market was $3 billion, compared to $1.7 billion on the interbank lending market, and less than $0.2 on the main share market. The $6.3 billion issue of GKOs in September dwarfed capital raising on any other Russian financial market. The GKO market, therefore, determines the parameters of financial markets in Russia, and illustrates most clearly the dynamics of supply and demand for capital in the economy.
Trends in real interest rates
Given the high, and variable, rate of inflation in Russia, any study of financial trends must utilise real, and not nominal, rates of return (i.e. profit over a period, minus inflation during the same period). Figure 6, therefore, shows the real rate of return on 3 month GKOs since October 1993. Figure 7 shows the rate of return on 6 month GKOs since these began to be regularly issued in August 1994.
The trends in both cases are identical. With inevitable periodic fluctuations, relating to major economic/political events, the trend is a rise of real interest rates. This trend, on Russia’s most important — financial market, gives precise information regarding the underlying conditions of supply and demand for capital.
An interest rate is the price of capital. More precisely, it indicates the balance between supply/ creation of capital, and demand for its utilisation (investment). The extraordinarily high real rates of interest in Russia indicate that the supply of capital is far lower than demand — i.e. extremely high prices merely register a grave imbalance in supply and demand.
Any explanation for this imbalance based on a view that the level of investment (demand for capital) in Russia is very high may be immediately disregarded. Investment in Russian has fallen precipitously — and continues to do so (Figure 8). By the first half of 1996, investment in the Russian economy was only 30% of its level in 1989. Demand for capital, therefore, is not rising but falling. The reasons for very high interest rates, the severe imbalance between supply and demand for capital, therefore can only lie in the fact that the supply of capital is falling even more rapidly than the demand for it.
To place these features in a more fundamental context, and to understand the most basic trends taking place within the economy, the above factors should be integrated into an international pattern. In particular, having noted that the price of capital in Russia is abnormally high, the cost of the other principal factor of production, labour/wages, must be brought into the equation
The fundamental qualitative features of the Russian economy, in terms of the relative prices of factors of production within it, may be easily characterised. Russia, due to the legacy of the Soviet education system, possesses a large supply of highly skilled/educated labour. In the key spheres of science and technology, educational/skill standards in Russia are at least on the same level as those of the advanced industrial countries, and in no way qualitatively inferior in other sectors. However, the price of this skilled labour is extremely low in international terms. The average manufacturing wage in the U.S., for example, is $28,000 per year — plus $11,000 per annum in holiday pay, social security contributions etc.. The average yearly wage in Russia, in December 1995, was $1,300.2 On average, Russian wages, with approximately equivalent skill levels, are less than one twentieth of those in the US.
In contrast, capital in Russia is extraordinarily expensive in international terms. To give a (rough) quantitative comparison, in 1995 the average real annualised interest rate on a six month GKO (nominal rate minus inflation) was 72.4%. h the US the real annualised interest rate for six months borrowing was 4% — 6% nominal interest, minus 2% inflation. That is, while labour is less than one twentieth the price in Russia compared to the US, capital is more than ten times as expensive. While the above, of course, is only a very crude calculation, due to disparities in real purchasing power of money in the two economies, nevertheless the orders of magnitude involved graphically show the — essential feature of the situation - Russia’s economy, in terms of international comparisons, is characterised by inexpensive skilled labour, and extremely expensive capital.3 Given such a relative pricing of factors of production, the only international economic strategy for Russia is to specialise in sectors which require relatively small amounts of capital (the high cost factor), and relatively large amounts of skilled labour (the low cost factor).
The actual pattern of Russian production
In contrast to the only rational pattern of economic development, dictated by the relative prices of its factors of production, Russia’s pattern of output since January 1992, as analysed above, is the exact opposite of that which is required. The prioritised sectors of production — energy, nonferrous metallurgy, ferrous metallurgy, chemicals — are those with the highest capital to labour ratios of any economic sector — with equivalently, relatively, low ratios of labour to output. The present economic course, therefore, requires huge quantities of the factor ofproduction in short supply, and with a high price (capital), and relatively small quantities of the factor of production of which there exists a large supply and a low price (skilled/education).
This consequences for the financial system of such a radical misallocation of resources are evident. Prioritisation of sectors requiring the greatest amounts of capital per unit of output severely increases the demand for the factor of production in shortest supply — capital. If the priority sectors of production are those with the highest demands for capital, in an economy characterised by shortage of capital, it is evident that the price of capital will inevitably be extraordinarily high. Leave aside all secondary, and conj unctural, factors and the present acute shortage of capital in Russia, reflected in its extraordinarily high interest
rates, is therefore an inevitable product of a pattern of development which is totally inappropriate for the relative prices of the factors of production within it.
The end result of such a process is evident. It is impossible to finance the investment requirements of Russia’s present pattern of economic development in a country with an acute shortage of capital — the capital demands of Russian’s present pattern of production simply cannot be met. This inevitably creates, first, the extraordinary high price of capital, and then a progressive disintegration of the financial system — state budget, banks. In order to reduce the real price of capital, the state is forced into devaluation of the rouble (to reduce real dollar interest rates) and higher than anticipated inflation (to reduce the effect of high nominal rates). Both involve significant economic effects on the population.
Therefore, far from the financial crisis being separate from the structure of the productive economy, it is merely a logical expression of it. All that occurs is that the form of this worsening inability of the economy to finance its pattern of development periodically changes — in one phase being expressed in non-payments of wages, in another by a crisis of the banking system, in an other by extraordinarily high rates of — interest in the GKO market, then by inflation, in another by devaluation etc. Like a springy mattress, if this crisis is pushed down in one point, it merely shoots up in another. While the locus in which the crisis expresses itself can be changed by government action, the fundamental problem cannot be tackled without dealing with its cause — i.e. prioritisation of the sectors with the highest demands for capital in an economy characterised by acute shortage of capital.
Was it possible to predict the problem in advance?
Finally, was it possible to predict this pattern of development? Or were those who launched the economic course of January 1992 simply suffering from some general ignorance?
In reality it was perfectly possible to see the consequences. In addition to material by other authors, this was, for example, written by the present author in January 1993 regarding a similar attempt, at that time, to ‘stabilise’ the Russian economy:
‘On 2 January 1992 former premier Gaidar introduced a policy which fundamentally altered prices in the Russian economy in terms of both their international and domestic determinants:
‘(i) Internationally a process was begun of attempting to move Russian relative domestic prices towards world relative prices;
‘(ii) Domestically almost all prices were liberalised.
‘Given the historical starting point of relative strengths and weaknesses of the Russian economy the consequences for money supply, output, and the exchange rate of these shifts in prices are easily traced.
‘The strengths of the former Soviet economy were its creation of independent heavy industry and its historically high growth rate - according to the calculations of Angus Maddison, the West’s foremost expert on long term historical economic statistics, the USSR and Japan were the only large countries in the twentieth century, before the recent successes of China, to reduce the gap in GDP per capita between themselves and the advanced industrial countries. These achievements, however, were accompanied by distortions in the economy with major consequences for price relations... Most importantly for present purposes domestic energy prices, in world terms, were held at a low level relative to industrial prices.
‘Once this framework of former Soviet price relations is taken into account then the consequences for the price structure of the attempt, commenced under Gaidar, to shift Russian relative domestic prices towards world levels, and to open the economy to international competition, are clear. The huge shift in prices this involves, in turn, necessarily had enormous consequences for the money supply and the exchange rate.
‘More precisely Gaidar’s goal of shifting to world prices corresponded not simply to the government’s general theoretical framework but to two practical objectives:
‘(i) to the concept put forward by the IMF, in its A Study of the Soviet Economy, that Russia should become primarily a supplier of raw materials to the world market while its industry rapidly shrank. This required that Russian domestic energy prices should rise substantially to reduce internal demand for energy and thereby release energy resources for export;
‘(ii) to the concept that international competition would overcome the consequences of monopolisation in the Russian domestic economy - i.e. if competition did not exist domestically it would be provided internationally.
‘The price consequences of these shifts are obvious. In terms of international relations, while the former government did not fully liberalise energy prices these began to rise rapidly towards world levels... The decision to move towards world energy price levels, therefore, introduced an enormous price increase into the Russian economy quite autonomously of the money supply. A similar, if less violent, price increase came from the movement towards world prices of raw materials...
‘The price increase produced by the new relation between Russian and world prices in turn directly interrelated with the domestic structure of the Russian economy. As the IMF acknowledge Russian industry is dominated by its monopoly sectors. However given:
‘(a) the large size of the Russian economy;
‘(b) its limited capacity at present to export,
‘it is quite impossible to finance any quantity of imports sufficient to create large scale competition on the domestic market - ie it is illusory to believe that the consequences of monopolisation could be overcome by international means...
‘The consequences of this for prices are clear. In addition to setting their own monopoly prices the monopoly sector can pass the energy price increase onto its customers. The monopoly structure and the pressure on energy prices to move towards world prices, therefore, combined to produce huge inflationary waves in the economy - quite autonomously of the money supply...
‘However.., it follows inexorably that when prices rise, for international and domestic reasons stated, then, if the money supply does not rise at least as quickly as prices, output must fall...
‘The vicious circle set up by the above processes is evident. The increase in prices, flowing inevitably from energy price rises and monopolisation, led to an increase in the money supply, which led to a collapse in the exchange rate, which led to further price increases, which led to a further increase in the money supply, which led to a further fall in the exchange rate etc. -- i.e. a rapidly heightening spiral of inflation was established... It is this situation that the new tight money package proposed by Mr Fyodorov is supposed to tackle by means of reintroducing tight money.
‘Shorn of inessentials the fundamental conception of Mr Fyodorov’s package is therefore clear. It hopes that a decrease in the rate of growth of the money supply will lead to a decrease in the rate of growth of prices.But.., it in fact follows that, as prices will continue to rise for the reasons outlined, a tight money policy will cause output to collapse.
‘If this process is considered in more detail, an output collapse will necessarily follow any introduction of Mr Fyodorov’s package because the attempt to reduce the rate of increase of the money supply is not accompanied by any measures to control prices...
‘Deputy prime minister Fyodorov has made clear that the fundamental process of attempting to raise energy prices to world levels will continue... the increase in prices from monopolisation of the domestic economy will continue - because the monopolisation which exists in Russia is of physical production, not just ownership, and therefore privatisation, which is supposed to be the instrument to counter monopolisation, will not alter the situation.’4
‘ Even earlier the same author predicted in an article whose main points were prepared in April 1992:
‘The mistake of the Russian government is that it fails to understand the specific character of the Russian economy and applies policies designed for a quite different structure - the competitive economies of the West. The economies of Russia, Eastern Europe and China must, instead, be defined as specific “dual economies” constituted by (i) an almost pure monopoly sector which operates according to the laws of monopoly economy (ii) a non-monopoly sector which, for theoretical purposes, may be considered as operating according to laws of perfect competition. The specific dynamic of the economy results from the interaction of the two sectors.
‘Once the character of these dual economies is understood then their laws, and the policies necessary within them to achieve success, are clearly defined.., first the dynamic within the monopoly sector of the dual economy will be considered and then the relation between the monopoly and non- monopoly sectors.
‘The difference between the Russian monopoly structure and the structure of a Western economy is worth repeating... In the West enterprises with more than 1,000 workers account for only 20-33% of employment. Even in an extremely concentrated and capital intensive sector, such as Japanese semi-conductors, the top five firms only account for 60 per cent of production. A Japanese automobile plant has 13,000 firms, many small and competing, directly and indirectly supplying it.
‘The Russian economy in the industrial sphere is closer to a perfect monopoly structure than anything in the West. Furthermore the hopes of the Russian government that either privatisation or international competition can offset the effects of this monopoly structure are illusory as (i) monopolisation is of physical production, not simply ownership, and therefore privatisation will not change the situation (ii) given Russia’s problems with exports, no amount of imports sufficient to create large scale competition on the domestic market can be financed.
‘The laws of operation of monopoly economy are well known - and have been applied by many Russian economists in pointing out the errors of the government’s policies. In the former economic system monopolies either produced to planning targets and, because of price controls, could in any case only maximise profits by increasing output. With a transition to full price liberalisation a monopoly’s rational profit maximising market strategy is to reduce output and increase price...
‘If the dynamic created within the monopoly sector is for output to decline and prices to increase then the relation of the monopoly to the non-monopoly sector is equally clear. Underfull price liberalisation monopoly output declines but simultaneously its prices rise relative to the non-monopoly sector...
‘The “scissors crisis” between agricultural and industrial prices, the fact that... the agricultural crisis is even deeper than the industrial crisis, is one manifestation of this. Although food prices rise rapidly the price of industrial inputs into agriculture, from the monopoly sector, increase even more quickly ... Crushed between a decline of demand on one side, due to impoverishment of the population, and a rise in input prices on the other, the agricultural sector is thrown into profound crisis.
‘However the same process, with specific modifications, operates in relation to other non-monopoly sectors. It is for these reasons that full price liberalisation in Russia has produced a deep crisis within the small private business sector...
‘This dynamic is strategically decisive not only in itself but, in particular, because the relation between the monopoly and non-monopoly sectors is inseparably connected to the single most important historical distortion of the domestic Russian economy - its underdevelopment of individual consumption...
‘The historical underdevelopment of individual consumption in Russia is clear... This... was disastrous from the point of view of production - destroying the incentive to work. However it also profoundly distorted the structure of the supply side of the economy...
‘The low percentage of consumption concentrated production in sectors requiring very high investment per unit of output (heavy industry, energy) and underdeveloped sectors with much higher ratios of output to investment (light industry, services). This by itself dictated a low productivity of capital.’5
These analyses, in essence, fully capture the process of shifts in relative prices against consumer industry, and in favour of raw materials, energy, and heavy industry which has been taking place in the last four years in the Russian economy — and whose consequences are analysed above.
In short, the price process described above, and therefore their consequences for output, were fully foreseeable in advance — because they were predicted. It was merely those at that time in the administration who catastrophically failed to see what would be the consequences of their economic policies. Therefore, those who launched the economic course of January 1992 were not merely on the same level of ignorance as everyone else, but made disastrous, and foreseeable, errors regarding the analysis of the Russian economy. The financial crisis which is taking place is merely the transposition into the budgetary/banking sphere of their radical failure to understand the Russian productive economy.
The crisis of non-payments of wages
The most acute financial crisis currently gripping the economy, that of non-payment of wages, is merely the expression of the above processes. As the financial demands created by the industrial strategy outlined above, based on energy/raw materials, are objectively impossible to meet, the only way to attempt to temporarily halt the collapse of the financial system is to make radically increasing economic attacks on the population. Far from the rapidly mounting tide of nonpayment of wages being difficult to predict in advance, it followed inevitably both from the general economic course, and the specific methods used to attempt to temporarily conceal its consequences during the presidential election campaign. As was written in the article ‘So far wages are paid, but after the election forget about it,’ on 1 June.:
‘Following events on financial markets is not most people’s idea of fun. But if they learn that these markets show, with certainty, that they will not be paid wages or pensions after June, the matter may appear of considerably greater interest.
‘This is exactly Russia’s current situation. The administration claims that it is solving, or has solved, the problem of non-payment of wages and pensions. In reality, not merely have not all overdue wages been paid — notably in the private sector, but the methods used by the administration to make payments before the presidential election guarantee that the population will not be paid, on a much greater scale, after it. This is not hypothesis, but the inevitable, and quantifiable, result of financial decisions which have already been implemented. It is reported in the foreign press, and bankers base their decisions on it. But such information is systematically suppressed in most of the Russian media.
‘The background to the coming, massive, non-payment of wages and pensions is the creation, by current policies, of a deepening financial crisis of the state, and the recent announcement by the government of a series of policy decisions.
‘The general background is that, starting in late summer 1995, a new decline of production commenced. Industrial output fell by 8% in six months after August. This, inevitably, fed through into a sharp fall in tax revenue. Government income fell by almost half between August- October 1995 and January- February 1996—from 15.4% to 8.3% of GDP...
‘President Yeltsin at the beginning of 1996... issued the famous promise to pay back wages and pensions by the end of March. The figures given above on the budget, however, show that the administration had destroyed the possibility to finance this. Only two means were available to disguise temporarily, until the presidential election, this inability to pay wages and pensions. The first was to temporarily divert funds from the budget’s other sections, such as investment and agricultural credits...
‘However, the most important means utilised to temporarily disguise govemment inability to pay wages and pensions was huge borrowing $10 billion was borrowed over 3 years from the IMF, and an emergency $3 billion was received from France and Germany. These will severely worsen Russia’s future debt situation.
‘But the largest, and shortest term, borrowing was domestic — on the market for Short Term State Obligations (GKOs)...
‘These decisions which have already been taken — accumulating a huge debt in the pre-election period, maintaining a tight money policy to comply with the agreement with the IMF, and rejecting devaluation — leave the administration with no way out of the debt trap which it created, to temporarily give the impression of paying the population, other than to cease paying pay wages and pensions. This will have to be done immediately after the election, and on a far larger scale than previously.’
On 29 June, the same newspaper carried an article by the author entitled:
‘Do as much as you can before the financial crisis.’ This noted:
‘On 1 June Pravda carried an analysis of the rapid growth of state debt, due to the efforts of the administration to temporarily pay wages and pensions during the election campaign. Since then, the situation has worsened... The first symptom of the onset of this financial crash came at the beginning of June when the Central Bank was forced to transferS trillion roubles from its reserves to the state bud ge — to finance the administration’s short term spending during the election. The Bank responded by raising the rouble reserves which commercial banks must maintain with it from 18% to 20%. The Bank subsequently admitted that, since the beginning of April, it had run down its foreign currency reserves from $16 billion to $12.5 billion due to spending to defending the rouble’s exchange rate — in effect using $3.5 billion to subsidise the administration’s election campaign. Central Bank chairman Dubinin also revealed that the Central Bank had transferred 25 trillion roubles to the government — almost equal to its entire tax income of 33 trillion in the same period. Under the impact of these events, on 13 June... the rate of interest paid on State Short Term Obligations (GKOs) rose to 215%...
‘The driving force behind these events is the further rise of the debt which the administration has accumulated in order to try to temporarily pay wages and pensions during the election. Neither huge inflows of foreign credits — $10 billion over three years from the IMF, and an emergency $3 billion from Germany and France — nor the secret operations revealed to have been undertaken by the Central Bank, proved sufficient to finance the administration’s promises...
‘Neither inflation nor devaluation are enough to solve the scale of problem the government faces... the only course the present administration can undertake is massive non-payment of wages and pensions. This will be made worse by the restarting of other government programrnes which, at present, have been suspended in order to transfer their funds to paying wages. If inflation is not accelerated above levels anticipated in the budget, and more rapid devaluation is not undertaken, then nonpayrnent of wages will have to be even higher than anticipated.. By May non-payment of wages, mainly in the private sector, had risen to 23.5 trillion roubles. After the election this will be joined by tens of trillions of roubles.’
The predictions of this article were, of course, fully confirmed. By August wage arrears reached 36 trillion roubles, in September more than 40 trillion, and the country was gripped by the rising tide of non-payment of wages.6 In short, as with the previous price shifts, it was entirely possible to foresee this development.
The aim of this article is to show, in detail, that the crisis in the financial system is not separate from, but is an inevitable expression of, the developments in the productive economy. The prioritisation of sectors with the highest capital requirements per unit of output (energy, raw materials), in an economy with a severe shortage of capital (such as Russia’s), inevitably leads to a progressive collapse of the financial/budgetary system under the weight of the impossible demands placed on it. This process was predictable in advance — but not by those who launched the economic policy of January 1992, as they suffered from a wholly false theoretical and practical analysis of the Russian economy. The crisis of non-payment of wages, in turn, is merely an effect of the attempt to achieve the impossible — i.e. to finance the current pattern of industrial production. It also, therefore, was just as predictable as were the price shifts which produced current economic developments.
The fact that the financial crisis is merely an expression of the developments in the productive economy, however, has an inevitable consequence. It is not possible to solve the financial crisis by means such as appointing emergency tax commissions - this is merely to temporarily tackle the effects without dealing with the causes. The only way to prevent the deepening of the financial crisis, and the political instability it creates, is to correct the pattern of development of the productive economy. That, in turn, can only be achieved by changing the price structure which emerged from January 1992 — as this drives the entire economic process. Only the state has sufficient power to alter this price structure — but it can only succeed as part of an overall economic strategy, and not a series of ad hoc measures.
Subsequent articles will deal with the phases of the working through of the economic processes described above, and the necessary strategy which must be undertaken to create a healthy economic dynamic.
1. See Russia in the World Economy 18 September 1996.
2. Economist Economic Indicators 27 April 1996. Goskornstat, Current Statistical Survey No. 1 in 1996.
3. Put in more fundamental terms it possesses an extremely high level of investment, and therefore supply, of skilled labour, ‘human capital,’ and a very low supply of physical/financial capital.
4.‘The Fundamental Errors in Principle of the New Economic Proposals of Mr. Fyodorov’ — prepared for the Russian parliament, January 1993.
5.‘Why the Economic Reform failed in Eastern Europe and Russia, and Succeeded in China,’ Questions of Economics November 1992.
6. ‘Inflation high point in report,’ Moscow Times 16 October 1996.