Created 2/21/1996
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Privatizing Russia

by Maxim Boycko, Andrei Shleifer, and Robert Vishny
(Cambridge, MA: M.I.T. Press, 1995)

The French and the Russian Revolutions

The French Revolution began in 1785, when the magnitude of the fiscal collapse in the finances of the ancien regime royal government became clear, when the political nation reached a consensus that things could not continue as they had been, and when the first steps toward reform were proposed. But France did not become a stable social-democratic mixed-economy industrial democracy until the establishment of the Third French Republic in 1871, or perhaps not until the establishment of the Fifth French Republic in 1958.

The real Russian Revolution began in 1985, when the magnitude of the economic and ecological catastrophe of the ancient regime Communist government became clear, when the political nation began to wonder whether continuation of the past might be impossible, and when the first steps toward reform were taken. Russia is not yet a stable social-democratic mixed-economy industrial democracy--if it follows the trajectory of France, the story that in Russia began a decade ago will not reach its end until 2071, or perhaps 2158.

In fact, there is every reason to think that the Russian Revolution is barely begun. Ten years after the first signs of the French Revolution take us only to the fall of Robespierre, with not even the first sign of the French Revolution's dominant figure, Napoleon. So the Russian Revolution will have many twists and surprises: we should not expect to even be able to begin to draw up a balance sheet, or to assess the value of what has happened so far, because the story is still so incomplete. Zhou Enlai in the 1960s answered the question "What do you think of the French Revolution?" with "It is too soon to tell." This is the right attitude to take toward the ongoing Russian Revolution: it is too soon to tell.

Nevertheless, we can begin to describe what has happened--although what it means and what its long-term implications will be must wait for the twenty-first or, more likely, the twenty-second century.

The Diagnosis

Maxim Boycko, Andrei Shleifer, and Robert Vishny have been near the center of one of the most important parts of the Russian Revolution so far--Anatoly Chubais's "privatization" program. Now they have written down their view of what went on--and of why it was such an important step. Some 15,800 enterprises, employing some 17.8 million people, were transformed from "state" enterprises--responsible to the Subministry for Textiles, or some other such government body--to "private" enterprises: corporations where ultimate legal "ownership" rests with shareholders who elect a board of directors that then hires and fires senior managers.

That such a privatization program was an important thing to do follows from Boycko, Shleifer, and Vishny's vision of the problem of Russia's economy. There is a sense in which their view of the problem is very new-fashioned. It is built on recent thinking in law and economics and the economics of institutions and property rights.

There is another sense in which their view of the problem is very old-fashioned. Karl Marx would have understood what they are talking about instantly: the political organization of society had become a hindrance to the development of productive forces; it was a fetter blocking the development of the mode of production.

As Boycko, Shleifer, and Vishny see the pre-Gorbachev Soviet Union, it was an economy in which what they call "cash flow rights"--claims on the social surplus in excess of workers' wages and material costs produced by an enterprise--were widely distributed throughout the society; but what they call "control rights"--the power to make decisions as to who should manage the enterprise, how it should be managed, and how it should evolve--were concentrated in the hands of that oligarchy of power-seeking politicians that made up the nomenklatura of the Communist Party.

Thus increasing the economic efficiency of the enterprise was low down on the list of goals of those who made managerial and investment decisions: they saw some benefits from figuring out how to make products that consumers found more attractive, or how to cut costs to produce more output from the labor and materials inputs they had available, or how to boost the productivity of the enterprise through skillful investment that built up its capital stock. But their stake in improving the effectiveness of the enterprise as a social surplus-producing mechanism was limited.

By contrast, their stake in making the enterprise function as a generator of political power and obligation was very great. Doing favors for your boss, or your boss's boss, or your future boss, or those who might enable you to displace your boss have direct and massive impacts on the quality of your life. Thus at every margin there is a strong temptation for enterprise managers to sacrifice a little bit more out of productive efficiency in order to gain a little bit more in terms of favors owed the managers by others, or in terms of political obligations created. None of the countervailing forces at work in the industrial mixed economies of the West to keep enterprises interested in increasing productive efficiency functioned in the Soviet Union: managers did not gain and lose status vis-a-vis their peers by their success or failure at generating a social surplus (that is, a profit); shareholders did not occasionally rebel and force out managers who they believed had done a bad job at managing the enterprise; corporate raiders able to convince banks that they would do a better job at managing the enterprise never seized control; and bankruptcy--the ultimate market sanction on an enterprise that does not match the productive efficiency of its competitors--never happened.

Thus it is not surprising that the pre-Gorbachev Soviet economy was less "efficient" in the sense of delivering a lower standard of living all across the income distribution than the mixed economies of the industrial West. What is surprising--what is still surprising, at least to me--is the magnitude of the shortfall. It now looks as though the Soviet economy delivered a material standard of living perhaps one-tenth that of the United States, and perhaps one-fifth of what one would have expected from the "normal" trajectory of a successfully-industrializing European economy beginning this century at the level of economic development that Russia possessed in 1900.

Something around eighty percent of the potential economic productivity of the country was sacrificed as a result of what Boycko, Shleifer, and Vishny call the politicization of the economy. The Bolshevik replacement of enterprise managers with a keen interest in improving the efficiency of their enterprises as productive operations by enterprise managers with a keen interest in using their enterprise as a base to accumulate political power and do reciprocal favors proved to be incredibly expensive.

Creating a Bourgeoisie

How to change this? How was Russia to accomplish what Boycko, Shleifer, and Vishny call the depoliticization of the economy, by which they mean the creation of enterprise managers who focus on increasing productive efficiency, and the withdrawal of politicians to a set of political-economic functions--balancing off the broad interests of different groups, setting up the institutional framework for a market economy, tweaking the distribution of income, investing in infrastructure, and making it easy and straightforward for people to invest in the country and in themselves--that they can do well, or at least less badly? How to change this in view of the fact that politicians live by power exercised or ostentatiously not exercised--that they seek to maximize their ability to do favors for others, and to maximize the number of favors they have done in the past?

Karl Marx knew the answer: when the political organization of society is blocking the development of the productive forces of the economy, you need what he called a bourgeois revolution: you need to transfer a very large chunk of political power to people who have a direct and strong interest in rapid economic growth. Once this bourgeois revolution is accomplished, practicing politicians find that there is a large arena in which they gain political power--and place others under obligation--not by sacrificing productive efficiency to do favors, but by doing the favor of enhancing productive efficiency.

Anatoly Chubais's privatization program has been a powerful step toward such a bourgeois revolution : it has created a bourgeoisie--a class with a strong and direct interest in rapid economic growth. Some 25% of the shares of the nearly 16,000 enterprises privatized are in the hands of "outsiders"--those who used the privatization vouchers distributed to the Russian people on a per-capita basis to purchase shares in companies at the privatization auctions. Some of the remaining shares are still held by the government. Some of the remaining shares are now held by employees. A large chunk of the remaining shares are held by firm managers.

A smaller chunk of shares were sold at auctions than I, or many others, think was ideal. Why should those managers lucky enough to have been in top positions at well-functioning enterprises have wound up with such a large stake? But Boycko, Shleifer, and Vishny convincingly argue that Russian privatization could not have taken place without such a distribution of shares to the enterprise's "insiders." As they see the situation, firm managers and to a lesser degree firm employees already had effective control over what the firm produced and whether it created any social surplus. Any privatization program had to be better than the status quo for a firm's top managers or it simply would not happen. And the only way to make a post-privatization distribution of shares attractive to firm managers was to grant them a large chunk of the shares.

Of Russia's 100,000,000 voters, 40,000,000 now hold shares in privatized firms and in mutual funds.

Will It Work?

If the Russian privatization program is going to work in its largest, broadest sense, we should start to see motion along two different axes.

First, Russian firms should begin to show a much greater concern with productive efficiency. Managers now have a large financial stake in enterprise profitability, and should turn a lot of energy that was in the past devoted to other goals to increasing productive efficiency. A large chunk of the extra social surplus created will accrue to managers and other shareholders as increased market value of the enterprise. But an even large chunk will accrue to consumers and workers in lower product costs and higher real wages.

Anatoly Chubais saw this transformation underway from his position in Yeltsin's cabinet. As the authors report:

Chubais...explained to us the evolution of managerial thinking. In 1991, enterprise managers came to him to lobby for inputs, such as cement. In 1992 and 1993, after [he end of price controls] they came to lobby for cheap credit [access to working capital at a low rate of interest]. In 1994, after privatization, they started coming to lobby for favorable disposition of [remaining] government-[owned] shares, and for help with foreign investors...

Second, Russian politics should take on a somewhat different flavor. Better police protection of persons and property from crime. Government policies that avoid macroeconomic chaos. Free trade. Land privatization. Macroeconomic stabilization. Creation of a commercial law code. Further reforms to allow a mixed economy to function more productively. There are now forty million voters who have a direct material interest--most small, some large--in the continuation of economic reform to make private enterprise more profitable.

As Boyko, Shleifer, and Vishny write:

[P]erhaps the most significant consequences of privatization are political. Privatization has created a class of property owners who have become the clear economic beneficiaries, and political supporters, of further liberalization of the Russian economy and society. This class is not limited to a few brokers and traders driving BMWs around Moscow, as some Western observers would like to believe. These property owners include the 40 million Russians holding shares in privatized firms and in mutual funds who want their investment protected. They also include the millions of people working for the growing service sector.

In a country of 100 million voters, these are significant constituencies, which will throw their weight behind such critical reforms as land privatization, stabilization, and free trade. More important, the new property owners support the economic reformers who continue their struggle against communists and nationalists. Privatization and reform have created powerful political interests that are injecting some liberalism into Russian politics.

Will this creation of a class with a direct material interest in successful economic reform and economic growth be enough to allow Russia to escape another generation or two of political turmoil and economic distress? Almost surely not. Will it be enough to make even ex-Communist and proto-fascist politicians shade their policies in ways that are somewhat more favorable to economic growth? Almost surely yes--as long as democracy stands.

Would a More "Gradual" Approach Have Been Better?

Western critics of Yeltsin, Gaidar, and Chubais usually accuse them of trying to do too much too fast. They believe that a more "gradual" approach to reform--as was undertaken in China--would have produced less disarray and discontent with reform, while still yielding solid gains in terms of increased production and higher standards of living. Thus--critics argue--if Russia had followed a reform program more like China's, reformers would today be in a much better position to do more than they in fact are.

Boycko, Shleifer, and Vishny agree that:

Go-slow advocates are surely right that price liberalization has hit the poorer members of society the hardest, and that their welfare payments have not kept up with inflation. Reforms would have been moe popular, and politics less divisive, if social payments received a higher priority. Part of the problem, of course, was that the anti-reformers insisted on pumping resources into [supporting inefficient existing] industry and agriculture...

Boycko, Shleifer, and Vishny do not say--but should--that the failure of the industrial West to provide massive aid to cushion the transition in Russia will be judged by historians as one of the most hideous and disastrous wastes of opportunity in the twentieth century. The U.S. spent some $6 trillion in today's dollars over the past three decades preparing to defend itself against the Soviet Union. Yet it has not been willing to commit even a quarter of one percent of that sum to an economic aid program to improve the chances that Russia becomes a stable industrial democracy--and thus never again a threat to the national security of the United States--over the next generation.

In addition, it is hard to see Chinese development as an overwhelming success. Political liberalization has not yet begun. Police states are nasty places to live. China has grown very rapidly in percentage terms, but from a very, very low initial base. And China's bureaucrats and industrialists are moving some $20 billion or more a year on net out of China and into New York, London, Frankfurt, Tokyo, and Zurich in the belief that they want foreign assets outside of the control of China's government as an insurance policy should the political wheel turn.

Deng Xiaoping has been a good emperor, interested in economic liberalization and growth and able to override the forces that have traditionally made China's bureaucrats the enemies of economic growth. But what can we say about his successor? And his successor's successor? At some point China's political organization will either collapse into civil war on its own, or once again become a binding contraint on economic growth.

I think that when either of these possibilities comes to pass, it will be much harder to criticize Yegor Gaidar's attempt to do as much as possible as quickly as possible in order to push reform past the point of no return.

Back-Cover Quotes

This book presents and spirited and persuasive defense of Russia's approach to privatization and economic reform. It explains the urgent need for market reform and democratization in Russia. I hope that it is widely read.
--Yegor Gaidar

Privatization has made a giant step toward transforming Russia into a market economy. This book provides a first-hand account of its trials and successes by my closest advisers. I recommend it to all those interested in economic reform.
--Anatoly Chubais

The best economic policy always marries thought and action. This book shows how powerful economic ideas, some traditional and some from the latest journals, are changing history. The authors did remarkable things in Russia, and now they have written a remarkable book.
--Lawrence Summers


Created 2/21/1996
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Associate Professor of Economics Brad De Long, 601 Evans
University of California at Berkeley; Berkeley, CA 94720-3880
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