The Road to the Market; If Yeltsin Can Stay the Course on Economic Reform, Russia Will Prospe

By: Jeffrey D. Sachs

DESPITE MUCH advice from U.S. Sovietologists that Boris Yeltsin should "compromise" with his opponents, Russia's crises cannot be solved by an "inside-the-beltway" deal in Moscow between genuine democratic reformers led by Yeltsin and the unrepentant apparatchiks of the Russian congress. Russia needs a real democratic breakthrough in which the Russian people will be allowed for the first time to choose their constitutional future -- their unfinished transition to true democracy.

There is certainly a small risk that Yeltsin would lose a referendum if unelected regional leaders tried to block the polling. Nonetheless, it is the congress that reneged on its own deal, struck last December, to hold an April vote; and it is Yeltsin who champions the people's voice. Yeltsin is not afraid of elections. Neither should we be. Yeltsin knows that despite the economic hardships inherited from the old system, the Russian people want to move forward.

Throughout Russian history, reformers have had to battle petty rulers who have used state power to defend their privileges. Russia's greatest economic reformer before the Bolshevik revolution was Pyotr Stolypin, who like Yeltsin had to fight a reactionary parliament (the Duma). But Stolypin depended on the backing of the vacillating Czar Nicholas II; Yeltsin is bolstered by the much deeper currents of public support. Yeltsin has also taken extremely important actions on economic reform, at least in areas where he has not been blocked by the parliament.

And make no mistake: Where reforms have been implemented, they are working. When Yeltsin began his radical reforms in January 1992, Russia was plagued by food shortages, empty shops and the real fear of hunger in major cities. Russia has passed its second winter without mass hunger because free-market prices have allowed for normal trading. Like the rest of the world, Russia now manages to get goods to the market.

To be sure, the economic crisis remains severe. The communist legacy is harsh, and reactionaries continue to block what is needed. Indeed, Russia's reforms have not come too quickly; they have been a century too slow. The congress not only resists private land ownership (as the Duma did) but tries to hobble the privatization of trade and industry, although Yeltsin and his privatization minister, Anatoly Chubais, have so far succeeded in privatizing 50,000 enterprises.

More than any other single factor, though, it is high inflation that has demoralized Russian society and put the reforms and democracy itself at risk. The Russian Central Bank, controlled by the parliament, has quadrupled the money supply in eight months, fueling a galloping inflation. As John Maynard Keynes sagely observed, the irresponsible increase of domestic currency is devastating because it "engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose." The Russian public variously blames the "monopolies," the "mafia," the IMF, the Jews and of course the reformers themselves for the monetary disaster. Many Sovietologists have blamed the reformers rather than the obstructionists for the high inflation, confirming Keynes's insight. This basic confusion over the source of the crippling inflation, and the remedy for it, is a major factor in undermining support for democracy and for Yeltsin himself.

Even though Yeltsin will almost certainly win any popular vote, his support is being sapped by inflation, now running at about 20 percent a month. Part of the solution is simply taking control of the Central Bank and throwing out the apparatchiks who are debauching Russia's currency. But the problem goes deeper. Even after responsible management of Russia's money is set in place, there will remain powerful pressures for inflationary finance. And it is at this point that Western aid can make a decisive difference.

The outlines of Russia's stabilization strategy are clear. The rampant increase in the money supply must be stanched while the West helps to meet urgent needs that are temporarily beyond the financial means of the Russian government. Credits to state enterprises cannot be cut off entirely, but they must be cut sharply; under the best of circumstances, these enterprises will need financial support for long-term restructuring, particularly in energy, agroindustry and conversion of military plants to civilian use, and much of this can come from international sources. Similarly, the rampant money printing to pay for budget deficits must stop; at the same time, the Russian government must find a non-inflationary way to pay for vital social needs, including unemployment compensation, basic pensions and housing for the military. International assistance can help finance this social spending. Finally, as the Russian government has already instructed this week, the Central Bank must stop issuing ruble credits to the other "commonwealth" states forthwith. Russia is too broke to pay its own bills, much less those of other countries.

If the West provides financing for industrial restructuring and social needs (an amount close to the $ 24 billion promised but not delivered in 1992) while the Russian government reestablishes monetary discipline, runaway inflation can end while vital needs are being met. The end of high inflation would in turn bolster political and economic reforms, and these more basic reforms in turn would lay the foundation for economic growth, foreign investment and democratic rule. Western assistance cannot and need not be enough to make Russia rich, but it can be enough to help make Russia financially stable.

This strategy is time-tested; monetary stabilization supported by international aid has been the starting point for dramatic economic turnarounds throughout history. Ludwig Erhard's monetary stabilization after World War II, backed by the Marshall Plan, led the way for Germany's economic miracle; the so-called Dodge Plan in Japan in 1949, with U.S. support, prepared the way for Japan's postwar boom; the Balcerowicz Plan in Poland in 1990, combined with debt forgiveness from the West, ended shortages and hyperinflation and also set the stage for Poland's current economic recovery. But we also must be clear about what this strategy cannot achieve.

It cannot -- and should not -- prevent a significant cutback in production by Russia's traditional heavy industry. In 1990, the Soviet Union produced 160 million metric tons of steel, while the United States, perhaps 10-15 times larger economically, produced only 80 million tons. Now that Russia is cutting back on MiGs, tanks and aircraft carriers, steel production is also falling accordingly. This may initially cause a decline in Russia's measured GNP, but it is hugely favorable for the human welfare of Russia's citizens. Resources freed from the old industrial sectors will make possible a boom in new service sectors, as well as new industrial production aimed at consumer goods and exports.

The Russian Central Bank's naive attempt to preserve the old sectors by pumping in cheap credits has not only failed (even when it keeps production going, there are no customers for the goods), but the resulting inflation is strangling healthy industry as well as wiping out the real value of working capital and making rational business calculations impossible.

For the same reasons, every country in Eastern Europe has experienced a decline in industrial production of more than 30 percent since the end of 1989, but the fastest reformer, Poland, has had the smallest decline. Poland alone enjoyed a resurgence of overall industrial growth in 1992, based on new consumer goods and export sectors.

Russia's economy is, of course, different from Germany's or Japan's or Eastern Europe's, but its vast natural and human resources should enable it to experience highly favorable developments, assuming that similar market reforms and monetary stabilization are put in place.

n recent weeks, the Russian government has spelled out its detailed strategy for stabilization and market reform to the G-7, the group of seven Western industrialized nations. Deputy Prime Minister Boris Federov has outlined a stabilization program and a specific set of ideas on using aid to bolster it. It is now up to the West to respond to this request.

President Clinton has already passed the first test of U.S. leadership by moving rapidly to back Russia's democrats. The next test will come at the Vancouver summit with Yeltsin, when Clinton will set forth the U.S. response to Russia's aid request. The third test will follow when the G-7 as a whole will assemble in Tokyo to consider support for Russia's reforms.

For an American president deeply engaged in domestic economic reform, Russian economic aid represents a large and unwelcome agenda. But it cannot wait, even for purely economic reasons, as Clinton himself has noted. In a CBS News interview last week, Clinton pointed out that if Russia reverts to a "highly nationalist nuclear power that forces us to spend more of our money keeping our guard higher, then that's money that will be diverted from the future of the working families and their children." Of course our interests in Russian democracy go far beyond financial calculations.

Yeltsin obviously bears the greatest individual responsibility for Russia's democracy, but Clinton, as the leader of the democratic world, has an enormous role to play. He understands that in supporting Russia's only freely elected leader, he is not personalizing foreign policy, but rather supporting the democratic process itself. With such resolve from Yeltsin and Clinton, democracy in Russia will triumph.

Jeffrey Sachs is professor of international trade at Harvard University and an economic adviser to the Russian government.