1. April 19, 20011 What Happened in Russia, 1991-2001, and Why? (And what are the implications?) Simon Johnson, MIT Sloan sjohnson@mit.edu http://web.mit.edu/sjohnson/www/research.htm

2. April 19, 20012 What happened in Russia, through August 1998?

3. April 19, 20013 What happened in Russia, in August 1998?

4. April 19, 20014 What happened in Russia, since August 1998?

5. April 19, 20015 Explaining divergence in transition Convergence across Eastern Europe and the former Soviet Union in stabilization, liberalization and privatization No convergence in economic outcomes: most of the former Soviet Union trapped with high unofficial economy and low tax revenues/few public goods What explains this divergence? Extent of “institutional reform” (EBRD 1999 measures: e.g., regulatory burden, corruption) see also micro surveys of entrepreneurs

6. April 19, 20016 Solutions: to protect entrepreneurs (1) Reform of bureaucracy and regulation control of corruption is key (Daniel Kaufmann) reduce and simplify regulations (2) Need local government to support development fiscal reform helpful (Shleifer and Treisman) lessons from China (3) Stronger constraints on arbitrary executive action improve functioning of court system oversight and transparency from legislature (Poland)

7. April 19, 20017 Conclusion: institutions are a first-order macroeconomic issue 1) Protect entrepreneurs against expropriation Essential for investment and growth Helpful for registration of activity/payment of taxes Need effective constraints on the executive 2) Protect outside investors (against entrepreneurs!) Rapid growth is possible with weak outside investor protection, tending to favor large incumbents/powerful families But crises are larger and more persistent when outside investors are more vulnerable New rules are essential, new regulators are helpful, new markets are possible almost everywhere

8. April 19, 20018 Short-term prospects August 1998 crisis: a blessing in disguise? Output and export boosted by devaluation Real exchange rate steady Inflation under control, for now GDP recovery, hard to sustain BUT important problems are not being resolved

9. April 19, 20019 Four Trends Better managed firms consume the weak Successful firms are tied to local government Local/regional governments delay restructuring No serious pressure for protectionism

10. April 19, 200110 How normal is Russia? Normal aspects response to devaluation firms make money capital is leaving

11. April 19, 200111 Unusual features low revenues for federal government relative to spending large firms and banks do not go bankrupt incredible system of barter (the most effective corruption in the world?) bank credit doesn’t matter

12. April 19, 200112 Four scenarios (to 2005) #1: Leap to a liberal market economy (like Poland) local governments like control not free entry large firms prey on small firms who will dismantle the political barriers to entry/growth for new small firms?

13. April 19, 200113 #2: Strong business groups + government (like Malaysia or Korea or Mexico) already evident in Moscow (e.g., Sistema) could grow at 2-5% per year and attract capital inflows but vulnerable to collapse: confidence is fragile with weak institutions (see Asia)

14. April 19, 200114 #3: “Roving bandits” continual fighting for control of assets gradual decline of physical assets increase in emigration high level of violence

15. April 19, 200115 #4: Russia turns inward (like Belarus) large protectionist barriers would have to defeat the large enterprises could have an initial boom, followed by decline and even collapse

16. April 19, 200116 One summary picture Weak institutions (corruption/rule of law) do NOT necessarily prevent growth (see Indonesia) but they do create fragility capital comes in when a boom is expected and then runs if a slight downturn management and government theft is endogenous

17. April 19, 200117 Fat tails in Russia’s Future Pre-Crisis Post-Crisis Oops... Our View Pre and Post Crisis Conventional models