Gradualism vs Big Bang reforms — The stories of India and Russia

The last 25 years of the twentieth century saw many countries reform their economies from central planning system to market economies, like Russia, China, Vietnam and India. The final decade of the century marked the collapse of USSR, and the Russian federation which inherited, among other things, the economic crisis from USSR introduced changes in the way its economy was managed by the state and attempted to become a market economy. India too, pushed by the 1991 balance of payments crisis, reformed itself from a system that was significantly inspired by the Soviet model to abolish industrial controls and liberalize trade in the years to come. However, the path chosen by these two nations are not very similar. While the Russian reform effort has been called “big bang reforms‟ or shock therapy, the Indian reform effort is described by terms like “incremental‟ and “gradualism‟. Russia chose to liberalize trade, abolish industrial control and privatize, all at the same time. On the other hand, India abolished industrial controls, liberalized trade slowly (trade liberalization was done in phases), and privatization is still an area with strong political opposition.

The Russian Shock Therapy
When Boris Yeltsin became the first president of the Russian federation, he and his advisors felt that Russia needed reforms that were as far reaching as possible and enacted in the shortest time possible. This could have probably been driven by Russia’s experience with reforms in the past — they had always been inconsistent, including Mikhail Gorbachev’s reforms. Yeltsin is believed to have said that no single reform attempt of Russia had ever been done completely and that he wanted to reform his country irreversibly. The state of the Russian economy then also pushed the reformers to act quickly. The economic output was declining rapidly and almost every good was under- produced. It was felt that freeing up of prices was essential to incentivize production and reduce the shortage of goods. The pace of Russian reforms was thus much faster than the pace of Indian reforms. On January 2, 1992 led by Yegor Gaider (an economist advocating reform and Yeltsin’s close adviser), Russia liberalized prices. About 90 % of consumer goods and 85 % of intermediate goods were now to be priced by the market and not the state. The prices in the food sector and energy sector were still controlled by the government, but they were raised. While prices rose immediately by around 25 times, there were no mass protests as shortages began to reduce. For continuous expansion of trade, a presidential decree was signed on freedom of trade so that any Russian could sell any product anywhere in Russia. This was complemented by the almost complete liberalization of imports in the first 6 months of 1992 to decrease shortages and increase competition. Privatization was done in the end of 1992. But even before that managers started to take control of state run companies. In early 1992, there was a huge public debate about privatization. Some critics of privatization put forth the argument that Russians cannot be self interested entrepreneur after 70 years of socialism which the reformers did not buy. However, communist party insiders got special privileges in state enterprises and there was a view that
only such influential section of the population would gain from privatization.

Nevertheless, the reformers went ahead with privatization with about 90 % of small enterprises and 70 % of medium enterprises changing hands in just two years. However, the distribution of purchase shares for these companies was believed to have been distorted and these firms going to private hands did not have the desired economic effect for the next couple of years. Some of the most valuable Russian state-run entities were transferred to private hands in what was called a „loan-for-shares‟ arrangement. A group of businessmen who had acquired shares in banks proposed that they would loan money to the Yeltsin administration in return for shares in strategic companies “in trust‟. When the loan matured, the government had two options — to buy back the shares by paying the amount or let the businessmen keep their
shares in the companies. This scheme became highly controversial. Businessmen and banks that were left out started to criticize arrangement and attempted to discredit those who had gained shares. Even some reformers began to distance themselves from the arrangement and the officials who approved it. Besides tarnishing the image of the reformers and the Yeltsin administration, it also made reforms itself a target of political criticism. There is another pillar of economic reforms — stabilization. When the economy is in a crisis and is subject to structural changes, pain is imminent, especially in the form of inflation that is out of control. It is very important to rein in inflation and keep it manageable. In Russia, the government tried to keep a control on the money supply and hence inflation by reduced fiscal deficit. There was a 70 % decrease in defense spending in the early 1990s, but other than that the administration did not take any significant measure to reduce spending. This was because price liberalization meant that the government no longer needed to support state enterprises financially. Initially, the attempt was successful as the government’s budget moved from a deficit of 31% in early 1991 to a positive, albeit very small, surplus in 1992. This, however, did not mean that the war was won and the fiscal deficit was in control. It was continuous work throughout the 1990s. Inflation was still very high in absolute terms and when investors began to pull their funds back from Russia, it led to the financial crisis of 1998. In effect, in 5 years, Boris Yeltsin transformed Russia from a centrally planned economy to a market economy. The success of the attempt is debatable though, as the reforms did not translate into immediate benefit for Russia as opposed to the experience of countries like India and China.

The common man especially suffered immensely during the transition. The GDP was shrinking, but inflation was very high (Table 1). Many people were hence worse off compared to the situation during communist rule in USSR, though the system had structurally changed.

Table 1: GDP growth and inflation in Russia 1992–97

Source: World Bank

Also, no one had expectations for the Russian economy during the transition period. Economic activity had taken place in different conditions and under a different set of institutions in the Soviet Union. The economic players had to learn to work with the new incentive structure. There were no such things as cost minimization or marketing in a planned economy, but suddenly these were important for the privatized industries. Also import liberalization meant that products from other countries which were produced using superior technologies (Europe and USA gained superiority in computers especially) had an edge and Russian industries had to compete — this was a welcome change but something that caused pain in the transition period.
Also there were other problems of distortion in Russia like the “rent seeking machine‟. The enterprise managers partially gained control over state enterprises during the Gorbachev period and were masters of the transition period. Some industries continued to get loans and credit from the central government despite the prices of their products having been deregulated. This resulted in them keeping their costs artificially low and profits high. The managers of energy firms also gained from arbitrage. When the energy industry was still controlled by the government, prices were low in Russia and high abroad. They bought oil and gas in Russia and sold them abroad for artificially high profits. Their activities hurt the Russian economy as personal interest and public interest diverged under the system during the transition period.

India and incremental reforms:

India’s experience with reforms has been rewarding right from the beginning as shown by the GDP growth data (Table 2). Industrial controls or more popularly called as ‘license permit raj’ was abolished in 1991, but trade liberalization did not happen in one go. It was done in phases and sometimes an external push was required. On the privatization front, there are virtually no sectors in India with a public sector monopoly, but not many public sector units have changed hands to the private sector till date. It continues to be a politically debated and strong opposition against privatization are still being voiced by various individuals and parties.

Table 2: GDP growth and Inflation data of India

Source: World Bank

A number of data points can be shown to argue that India‟s reform process has been very gradual. For example, the long standing process of reservation for small scale industries has gradually been brought down. In 1993, 2 years after the far reaching reforms, 842 items were reserved for the small sector. It was still more than 800 in 2001, was decreased progressively to 239 in 2007. In 2008 the number was suddenly reduced to 35 and by 2011 it was just 20.
(Source: Various issues of Annual Report, Ministry of Micro, Small and Medium Enterprises, Government of India).

Trade policy has also been reformed significantly. Before the reforms, there used to be import restrictions and high tariffs. The policy of import substitution i.e. to produce indigenous substitutes for all goods was strictly followed. This policy was beginning to be changed during the “reforms by stealth” of Rajiv Gandhi administration when more goods were being added to the Open General License list. Goods in this list were almost freely importable. This list was slowly being populated and this way without abandoning the policy of import substitution, the then government was able to reduce barriers to import “in stealth”. Import licensing was discontinued for capital goods and intermediates in 1993. However, removing quantitative restrictions on consumer goods and agricultural products was done only on April 1, 2001 which too, was partly due to a ruling by WTO on a petition filed by USA. Progress in reducing tariff protection has not been steady and much slower. Table 3 shows the weighted average of import duty rates in India from fiscal year 1991–92 to 2002- 03. Clearly, it cannot be said with confidence that in this period tariff protection was abolished or at least that it was going to be abolished in future.

Table 3 Weighted average import duty rates in India

Source: Report of the task force on employment, Planning Commission, 2000

As the discussion proceeds towards Foreign Direct Investment, while India is currently experiencing a good time with FDI, sectors were opened up to FDI in phases. Even in 2016, there was an announcement increasing the number of sectors in which FDI was allowed through the automatic route. It was the 2017 Union Budget which proposed to abolish the Foreign Investment Promotion Board, which came to be considered as a bureaucratic
organization slowing down FDI.

The actual impact of the recent shift towards self-reliance in goods and capital will be felt in the future, once data becomes available. Till then, data and policies prior to the “Atmanirbhar Bharat” initiative are considered.

Conclusion
As different as they are as countries, India and Russia have had very different experiences with liberalization. The academic debate on shock therapy versus gradualism has not been settled yet. The experiences of the countries also have not won the debate convincingly.

While India experienced a much smoother transition from central planning to market economy, Russia too exhibited remarkable economic performance, after it emerged from the 1998 financial crash. Its economy has slowed down now for various reasons but reforms did help the Russian economy perform better. Another difference between India and Russia during the 1990s was that the former was already a reasonably mature democracy while
Russia was only beginning to decentralize power and build democratic institutions. In India, democracy meant that reforms had to be implemented by political consensus and negotiations along with public opinion building exercises leading to a gradualist reform agenda. On the other hand Russia had to resort to shock therapy because, as Yeltsin feared, gradual reforms
might be backtracked in the future. Also, the perestroika reforms under Gorbachev did not achieve much success in the USSR. In a way, it can be said that the choice regarding the manner of economic transition was forced by the political system and scenario at that point of time in both the countries.

References:
Dehejia, Vivek, 21st November 2014,”Do big bang reforms succeed?‟ (Article for mint)

Ahluwalia, Montek, 2002a, “Economic reforms in India since 1991: Has Gradualism Worked?” Journal of Economic perspectives 16(3), 67–88.
Transition to market economic reform in China and Russia

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Writes in free time. Views personal. If it helps to get more readers, well I’m your typical IIT-IIM person. Always up for debating my views.

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Tejkiran Kannaluri Magesh

Writes in free time. Views personal. If it helps to get more readers, well I’m your typical IIT-IIM person. Always up for debating my views.