Impact of EU free-trade agreement on Ukraine

EU and Russian perspectives on pros and cons of imminent FTA reflect their respective political agendas.

Mid-October 2013

Russia and the EU are Ukraine's leading partners for trade, investment and remittances. In the lead-up to the crucial summit of the EU's Eastern Partnership, at which　an EU-Ukraine free-trade　agreement (FTA)　will probably be signed, the EU and Russia have presented sharply divergent visions of the likely impact on Ukraine, as they each emphasise different stages of the trade-liberalisation process. Also, both leave out aspects of the story inconsistent with their preferred narratives. Ukraine may have more options for dealing with intensified competition than suggested by Russia, but implementation of EU business rules in Ukraine is likely to prove tougher than implied by the EU.

 

Ukraine is set to be admitted to the EU's so-called deep and comprehensive free trade area (DCFTA) at the end of November, after more than five years of negotiations. This is an integral part, and perhaps for Ukraine the key attraction, of the country's fast-developing integration into the EU. There are two main aspects to the deal. The first removes most trade tariffs and quotas for imports and exports between the two sides, while allowing Ukraine a more gradual elimination of trade restrictions in some "sensitive" Ukrainian segments in industry and agriculture to give local producers more time to adapt to the step-up in competition. The second is the reform of commercial laws and regulations to bring them into line with EU norms. Besides these, the DCFTA should chip away at non-tariff barriers, improve food safety and animal welfare, simplify trade administration and develop mechanisms for solving trade disputes. The deal will permit the extension of the liberal trade regime to new businesses and provides for the gradual incorporation of public procurement into the arrangement. These last are among the "unprecedented" measures behind the EU's use of the "deep and comprehensive" label.

 

Divergent visions

While trying to tug Ukraine into their respective economic blocs, the opinions of the EU and Russia differ on what Ukraine might expect from the opening of its markets and harmonisation with EU rules. For the EU, the DCFTA sets a framework for the modernisation of Ukraine's trade and economic development, which will boost real GDP and the population's buying power. It points, for example, to an immediate yearly net gain of €100m for Ukraine from the elimination of trade duties alone. Russia, by contrast, following a recent step-up in its efforts to block the westward drift of a number of former Soviet states, has issued dire warnings about the destructive economic and political impact that the DCFTA will inevitably have on Ukraine, leading　Sergei Glazyev, a Russian presidential aide, to label the step "suicidal". As Ukraine's poor-quality products will fail to compete on EU markets, Russia's argument goes, its exports will fall and its large external deficit expand. With funds scarce and reserves low, this could trigger a currency crisis and macroeconomic destabilisation, leading to financial catastrophe and perhaps even, it has been suggested, the collapse of the Ukrainian state. Russian officials have made it clear that inauguration of the EU FTA may not only lead to a more permanent disruption of Ukrainian exports to Russia, but may also render void their existing border treaties. By highlighting the potential political and social costs for Ukraine, Russia has implied that it might stir up unrest, and perhaps separatist sentiment, in areas of Ukraine dominated by ethnic Russians, such as Crimea and the Donbas.

Under the weather

The Ukrainian economy is certainly in bad shape. Because of this, it remains vulnerable to external shocks and destabilisation. In April-June 2013 real GDP fell year on year for a fourth successive quarter. In July and August, industrial output and exports continued to decline. In these months, the current-account deficit widened markedly, taking it to US$10.2bn in January-August, only a little down from US$10.5bn in the same period of 2012, a year in which the largest imbalance in the post-Soviet era was recorded. Reflecting these developments, the rise in international borrowing costs to emerging markets, following indications in May of a possible wind-down　of the US Fed's bond-buying programme, has been especially sharp for Ukraine. This forced the central bank to use its own reserves to meet a series of substantial debt repayments. By August, foreign-exchange reserves had dropped by US$3.7bn compared with April, to US$19.8bn. This was probably one factor behind a rise in devaluation expectations and an increase in foreign-currency demand among the Ukrainian population, prompting a return to intervention in currency markets in September. As a result, reserves climbed only modestly in that month, despite the receipt of a cheap loan from Russia's Sberbank.

The long and the short of it

Both the EU and Russian narratives about the DCFTA's impact on Ukraine have some truth to them, but look at different time frames. Over the longer term, by encouraging specialisation in areas in which Ukraine is least inefficient compared with the EU, Ukraine should make economic gains—gains maximised by the status of the EU as the world's largest single market. The Ukrainian population should also benefit from a wider range of products of better average quality, lower prices and, eventually, through a degree of wage convergence, higher living standards. Moreover, the quality of the country's own products should increase, sharpening their competitiveness in non-EU markets. The harmonisation of business rules should attract greater levels of foreign investment.

However,　in the short run, as competition diverts resources to stronger sectors, Ukraine could again be subject to another period of disruptive economic adjustment, involving business closures and job losses. In Poland and Croatia, for example, the shipyards were hit under similar circumstances, and many of Latvia's engineering business suffered a similar fate. Further, the groups of people who lose out in the short run may not be the same ones　that benefit eventually, owing to skills mismatches. Finally, greater adherence to EU norms of trade administration, safety and labour conditions is likely to be more costly than　maintaining　the status quo.

 

Off the radar

At the same time, there are important considerations missing from either scenario. Although Russia is keen to emphasise the precariousness of Ukraine's external-trade position, it does not mention that a key reason for this is the high price that it charges Ukraine for gas. Moreover, Ukraine still has the option of currency devaluation, which should discourage imports and boost foreign sales, narrowing the trade gap. On financing, large loans are likely to be forthcoming from Western institutions as long as Ukraine is able to agree—as seems prudent—to a new programme with the IMF. As for the ideal scenario of trade liberalisation on which the EU's promises depend, it is likely to come up against the hard reality of Ukraine's political economy, as it has developed since independence. This has seen a weak state gradually overcome by business-political associations whose typical modus operandi is to sustain profits by preventing market entry of competitors (rent-seeking). In principle, the provisions of the DCFTA on competition, public procurement and　working conditions promise fundamental challenges to this system. It will be interesting over the next few years to see how they fare.

Forks in the road

Economic prospects in the CIS in 2011

Main patterns of growth in 2010
A drop in real GDP of almost 6% in the east European transition economies in 2009 was the most severe of the regional recessions of that year. Beginning in the first quarter, however, most of east European economies saw a return to economic growth in 2010, which averaged about 3% for the year. In the main, the recoveries were export-led, with the lagged effects of large international stimulus packages, and in some cases substantial multilateral aid programmes, also playing a role. The pace of growth in domestic demand was generally much weaker, or in some cases remained negative. In particular, investment remained weak, depressed by low levels of business confidence linked to the uncertainty of the macroeconomic outlook, as well as to spare production capacity. In addition, household spending was weighed down by low levels of consumer confidence linked to poor employment prospects, high unemployment, falling or slowing wage growth, high levels of indebtedness, the paucity of credit as banks continued to repair their balance sheets, and a drop in workers' remittances.
Notably, the recoveries in the economies of the Commonwealth of Independent States (CIS) were generally stronger than for regional economies further west. The contrast was starkest between those economies that had been tipped into recession in 2008-09 by a fall in external demand and international commodity prices, and those that, before the crisis, had relied for rapid growth on domestic credit booms fuelled from external borrowing. Some of the bigger countries in the CIS, such as Russia and Ukraine, exemplify the first situation, whereas a number of countries in the Baltics and the south-eastern Balkans exemplify the second. [Some latest growth figures, highs, lows, averages, contrasted with rates before the crisis.] A second contrast with the countries of central-eastern Europe is that, whereas their prospects are bound up with those of the EU, where unfolding sovereign debt crises in peripheral countries have threatened the integrity of the common currency, the crucial relation for many CIS countries is with developments in Russia and Kazakhstan, the leading hydrocarbons-exporting economies within the organisation.
Finally, the political uprisings in the Arabian Peninsula and Arab North Africa may hold mixed economic and political prospects for the authoritarian hydrocarbons producers in the CIS, boosting state resources by pushing up hydrocarbons prices on world markets, while at the same time providing potentially replicable models for political confrontation with authoritarian state apparatuses.

The main, interlinked policy dilemmas
With the recovery having gained purchase, governments are now turning to a number of tough common policy dilemmas. The first weighs fiscal austerity against growth, because of the potential damage of withdrawing budgetary support before economic recovery has become self-sustaining. This concern is accentuated by the expectation of a downturn in global economic growth in 2011, as the boost from the big international stimulus packages fades. Thus, with fiscal and growth imperatives pulling in opposite directions, the benefits of running a loose monetary policy are likely to be cast in a favourable light, at least for a time longer. This is because maintaining liquidity could help to sustain economic activity, both directly, through its impact on domestic demand, and indirectly, by way of aiding the repair of bank balance sheets. This second effect could encourage a return to higher rates of credit growth, which plummeted during in the crisis and which are still well below the rates seen in the boom period. Without this, lower rates of economic growth will remain the norm for longer. However, for some governments, the return of inflationary pressures, both from rising international prices for commodities and food, and, further off, from individual economies as consumption demand begins to revive and spare capacity to dwindle, will create pressures in the opposite direction, pitching the desire to boost economic growth against the need to contain the pace of rise in the general price level. Another policy priority facing some governments across the region, and especially a few of the weaker economies in the CIS, will be the need to pursue policies to maintain external stability in the face of large external deficits and the build up of external debt.

Policy and performance in Russia and Kazakhstan
In both Russia and Kazakhstan, high and rising prices for hydrocarbons internationally, relative to 2009, will continue to sustain economic recovery in 2011. In Russia, the pick-up of consumer demand has been relatively unhindered by an overhang of private debt. In contrast, despite some progress in 2010, in Kazakhstan the inability of households and firms to pay pack loans—aggravated by the depreciation of the tenge that was induced by a sharp fall in inflows of foreign-exchange from the end of 2008 as a result of the global financial crisis—continues to place limits on the lending of the Kazakh banks, as they are forced to raise provisions against non-performing loans (NPLs). Thus, NPLs across the banking sector had risen to 26% in the first half of 2010, according to the IMF. Domestic credit growth in Kazakhstan dropped from a peak of almost 80% year on year in 2006, to just below 7% in both 2009 and 2010, according to the Fund. (In contrast, the peak rate of annual domestic credit growth in Russia was lower, at around 44% in 2007, and it dropped much less steeply, to around 22% in 2010.) This will restrict the speed of growth not only of the domestic economy, but also of its smaller Central Asian neighbours in particular. It should push policymakers in Kazakhstan to keep short-term policy interest rates low for the near future.
Of the two, Russia would thus appear to be in a better position economically to attempt to reduce the fiscal deficit in 2011. The possibly short-term boost to hydrocarbons export earnings as a result of a fresh round of political turmoil in the Middle East, which has stoked market fears over supply, should ease official plans to bring down the fiscal deficit, which reached the equivalent of almost 6% of GDP in 2009. Nonetheless, addressing the underlying problem of a structural non-oil fiscal deficit could remain, or even be discouraged by the same development.
Another important factor to keep an eye on for assessing regional economic prospects is the construction sectors in both countries, which continue to perform poorly, reflecting both excess capacity and a reluctance of the financial sector to lend. Construction is traditionally a large employer of migrant workers from other countries in the CIS and will thus feed into the prospects for a revival of private consumption and some kinds of investment in those states, through the link of remittance returns.

Fiscal consolidation in Central Asia

Fiscal consolidation is required not only as the payoff for any fiscal expansion undertaken during the economic crisis: following events in Greece in the first half of 2010, there is the additional incentive for governments to do so to try to convince international lenders of their fiscal rectitude. The kind of response possible will depend on the resources available. Broadly, just as hydrocarbons exports had allowed some countries to build up funds to draw on to cushion the full impact of the fall in external demand during the recession, so the recovery of oil prices and revenue will afford them greater room for manoeuvre for fiscal consolidation during the recovery. Kazakhstan and Azerbaijan both appear to be aiming for fiscal consolidation in 2011. In practice, in Kazakhstan this is planned to happen not only by means of a reduction of transfers from the NFRK, the sovereign oil wealth fund, but also through the imposition of an export duty and a progressive income tax. In Azerbaijan, overall deficit reduction is planned to go hand in hand with a rise in transfers from SOFAZ, its own oil windfall account, for social and infrastructural programmes, as well as part of the medium-term goal of industrial diversification. On the revenue side, non-oil fiscal consolidation will be hampered by an expected sharp slowdown in economic growth in 2011 linked to a fall in oil production volumes, which will put a dent in the growth of fiscal inflows. Hydrocarbons revenue may discourage necessary structural reforms in Turkmenistan and Uzbekistan.

Pulling the rug

More notes from May 2009

The possible impact of the global economic crisis on political instability in Central Asia and the Transaucasus
The level of trust in a range of political institutions across the counties of eastern Europe and the former Soviet Union was low even before the onset of the ongoing global financial and economic crisis, but it will make the situation worse.
In broad terms, the consequences of the crisis have been transmitted to the countries of Central Asia and the Transcaucasus through the impact of the financial meltdown and fall in hydrocarbon prices on the region's leading economies. For many former Soviet countries, the consequent fall in trade, remittances and investment inflows has already started to be felt, although not evenly, in terms of declining incomes and rising unemployment—two factors that tend to presage outbreaks of social and political unrest. However, economic stress on its own would not usually be enough to cause an outbreak of unrest. Rather, it is the interaction of economic stress with specific political and social factors already in place that is crucial.

Much in common
The states of Central Asia, the Transcaucasus and Russia share a number of these underlying factors associated with political upheaval. For instance, all of them, except Russia, have had a limited existence as independent states, all emerging as national entities only with the demise of the Soviet Union in 1991. In many, low levels of public trust hinder the effectiveness of political and governance systems, all of which are also mired by high levels of corruption. Finally, all of them, except Russia and Kazakhstan, are surrounded by countries that are also prone to the structural causes of unrest. This is the so called bad neighbourhood effect, which is one of the main causative factors behind political stability, according to the political science literature.

Most exposed
Those states most at risk because of pre-existing structural weaknesses—the Kyrgyz Republic, Tajikistan and Georgia—share a number of relevant traits in common. The Kyrgyz Republic and Tajikistan exhibit a high degree of ethic fragmentation; for example, conflicts between the ethnic Kyrgyz majority and the Uzbek minority, which is concentrated in the south of the country, have been a persistent source of political tension in the Kyrgyz Republic since independence. Tajikistan and Georgia have both experiences of at least two major episodes of political instability in the recent historical past. Tajikistan, for instance, suffered two bouts of all-out fighting in its five-year civil war of the 1990s, in which at least 50,000 people were killed (fuelled, among other things, by ethnic rivalries). For its part, not only has Georgia seen the outbreak of armed conflict as a part of it effort to bring its breakaway regions of South Ossetia and Abkhazia under control—most recently and disastrously in August 2008—but the existing political order has been overturned by force more than once. The first time was in the early 1990s, when the nationalist president, Zviad Gamsakurdia, was ousted in a coup. His successor, Eduard Shevardnadze, was kicked out in turn in a peaceful, large-scale social protest following a falsified election in the so-called Rose Revolution of November 2003. (Demonstrations in the Georgian capital, Tbilisi, ongoing since April 2009 against the authoritarian drift of the current president, Mikheil Saakashvilli, have suggested to may observers that a similar pattern may be about to be repeated.)
Another important factor, shared by the Kyrgyz Republic and Georgia, is that they are held to be regimes of an intermediate type. That is, they benefit from neither the public consent necessary for the working of a consolidated democracy, nor the combination of institutions and resources for repression necessary to maintain wholly authoritarian rule. Additionally, Georgia's susceptibility to the underlying causes of unrest is greatly heightened by the combination of its intermediate regime type and a fractional polity (mainly reflecting the inability of the central authorities to exercise political control over the country's breakaway regions, which make up 10-15% of Georgia's territory). On the other hand, Georgia's better economic starting point puts it in a healthier position to deal with the consequences of the economic crisis than either Central Asian country. The likely impact the regional economic downturn on unemployment rates in the Kyrgyz Republic and Tajikistan thus put them at highest potential exposure to political instability overall.

Look at the fine print
Finally, at the beginning of 2009, suffering electricity shortages and blackouts, facing factional fallouts within the ruling group, a unifying opposition and a looming economic downturn, the government of the Kyrgyz Republic began to look vulnerable to a financial crisis. However, a large aid package from Russia in February has since turned the situation around completely. This shows the importance of looking at detailed country case studies, in combination with quantitative comparative models, when assessing vulnerability to political unrest in specific cases.

Economic crisis in Central Asia and the Transcaucasus

Some notes from May 2009

In many of the economies of Central Asia and the Transcaucasus, the low level of development of their financial sectors and their low level of participation in the international capital markets were thought likely to insulate them from the impact of the global financial and economic crisis, which surfaced in the US property market in the second half of 2007.

With the escalation of the crisis since in September 2008, however, two clear channels of transmission of the crisis to the region have emerged. The first is directly, through precipitous declines in the prices of the region's main commodity exports—most notably hydrocarbons, but also metals. The second is indirectly, through the impact of financial turmoil on the real economies of Russia and Kazakhstan.

These two factors will have a differential impact, depending on the extent that each economy depends on Russia and Kazakhstan for sources of economic growth, as well as on whether they are net exporters of hydrocarbons (Kazakhstan, Azerbaijan, Uzbekistan and Turkmenistan) or importers (Kyrgyzstan, Tajikistan, Georgia and Armenia). These factors will condition the likely severity of the impact of the global crisis on the economies of particular countries, as well as their response to it.

For many countries in the region, economic growth held up reasonably well in 2008. In the case of the hydrocarbons exporters, this was because of very high prices for oil in the first half of the year. In other cases, the continued strength of neighbouring economies until the final months of 2008 helped to sustain the inflows of workers' remittances on which they heavily depend (the IMF estimates that remittances to the Kyrgyz Republic equalled around 25% of GDP in 2008, and for Tajikistan the figure was 50%). The increased price for gold was an additional factor sustaining foreign earnings for Uzbekistan and the Kyrgyz Republic, for which gold is a leading export item. However, the final quarter of 2008 and the first quarter of 2009, very sharp falls in trade and industrial output across the region—in part, as nervous businesses drew down on stocks—signalled that the crisis has arrived.

For the main hydrocarbons exporting countries, the fall in oil prices presented not only the prospect that the severe deterioration in the terms of trade would have a strong negative impact on domestic demand growth, but also that it would greatly reduce current-account surpluses and put pressure of fiscal revenue. Nonetheless, for many of these countries, including Kazakhstan and Azerbaijan, the oil boom of the past eight years has allowed them to build up a financial buffer, in the form of oil windfall funds, with which to tackle the effects of the crisis.

In contrast, for the hydrocarbons importing countries, the benefits of falling oil and food prices—two of the main factors behind the year-long inflationary surge across the region from the second half of 2007—are unlikely to make up for the multiple impacts of the regional economic downturn.

In Russia, the downturn was triggered by rising risk aversion globally, with a very rapid reversal of capital flows forcing an expensive defence of the rouble and, in January 2009, an eventual exchange-rate devaluation. In Kazakhstan, the foreign lending to domestic commercial banks, which was used to fund a credit boom in the non-oil sector, came to a halt much earlier, in late 2007, precipitating a sharp fall in property prices and a rapid slowdown in the construction sector—previously two of the drivers of Kazakh GDP expansion.

In the years since Russia's 1998 financial crisis, the region's trade dependence on Russia has declined, although for some countries—Kazakhstan, Uzbekistan and the Kyrgyz Republic—trade with Russia was still equal to 4-5% if GDP in 2008. More important perhaps this time around, according to a study by the IMF, is the likely negative impact on growth of a fall in financial flows from the region's largest economies. More tangibly still, especially for the Kyrgyz Republic and Tajikistan, but also for Georgia and Armenia, is the likely swift cut back in remittance inflows. This will not only affect consumption and poverty levels, but also investment demand, through the cut back in demand for residential construction and small business start-up capital.

Broadly, the responses of the various government's have been as follows:

• to try to protect the financial sector (especially important in Kazakhstan);
• to attempt external stabilisation and, if necessary, exchange-rate adjustment;
• if possible, to initiate fiscal measures to counter the impact that the drop in demand has on living standards; and
• to try to continue with measures to improve the business environment so as to put the economy on a better footing to attract investment once the worst of the global crisis passes.

Using either their own resources or those of foreign donors, this combination of strategies has a chance to allow the economies of the region to avoid severe destabilisation in the short term. However, threats to maintaining broad economic stability will depend on the length and depth of the crisis—in particular, whether Russia and Kazakhstan are able to resolve the problems in their domestic banking sectors. It could also depend on an absence of major outbreaks of social and political unrest, which would disrupt the implementation of anti-crisis measures, but to which the Kyrgyz Republic, Tajikistan and Georgia look acutely exposed.

More Tulips in the spring?

Prospects for political instability in Central Asia
Outbreaks of unrest, as far apart as Vladivostok and Kiev, Latvia and Bulgaria since the end of 2008 seem likely to be only the first stirrings of far greater eruptions of social protest in the year to come, as the full impact of the global economic crisis is felt. These events thus raise starkly the question of the possible implications that the global economic crisis might have for political stability in the region—that is, not just for the continued rule of incumbent governments, but also for the continued existence of established political systems.

For the Kyrgyz Republic, this question takes the form of whether the political system that has developed since September 2007 is sufficiently robust to face down any possible surge in political and social unrest, stoked by the economic downturn, or weather it would be more prudent to expect a re-enactment of the "Tulip Revolution" of 2005, in which perceptions of corruption and electoral falsification led to mass demonstrations and the removal of the previous president, Askar Akayev.

To this end, the Economist Intelligence Unit has developed a Political Instability Index to facilitate comparison of countries' vulnerability to unrest, conceived as a product of the interaction of underlying social and political factors brought into sharper relief by economic distress. For this reason, the overall index is made up of two component indices: one that tries to capture underlying vulnerability, and a second that measures economic distress. (For the full results and methodology, see here and here.)

Table: Political Instability Index for Russia and Central Asia in 2009

Although the Kyrgyz Republic does not rate as the east European country most vulnerable to political instability in 2009—that accolade goes to Ukraine—within Central Asia, it vies with Tajikistan for this position, with the two ranked in joint 33rd place globally, along with countries that include Myanmar and Argentina, on an overall score of 7.1, out of a maximum possible instability score of 10. This marks the two Central Asian states as slightly more susceptible to unrest than Columbia, but slightly less susceptible than Sierra Leone.

In our index, the Kyrgyz Republic, along with Tajikistan and Uzbekistan, starts off at greater risk from the impending economic stress, on the assumption that poorer countries are less well-equipped to cope with it. However, the overall political instability scores for all countries in the region, and Russia, worsen significantly in 2009 relative to 2007, reflecting a large increase in their scores for economic distress. This is because, in light of the intensification and spread of the world economic crisis to the region, all of them face a significant risk of a fall in real GDP per head this year—of more than 4% in the case of Russia—and all except Kazakhstan are at significant risk of the rate of unemployment rising above 10%.

For all of the countries in question, corruption is rated as high, and all of them, except Russia, have only become independent states in recent years—that is, since the fall of the Soviet Union in 1991. Tajikistan is scored as slightly more vulnerable to the underlying causes of unrest than the Kyrgyz Republic, partly because it has a greater number of large-scale episodes of political instability in its recent past (an estimated 50,000-100,000 people were killed in its five-year civil war in the 1990s), and partly because its infant mortality rate is higher than expected for its level of income level, a measure that stands in as an indicator of the level of social provision. The Kyrgyz Republic, however, is more vulnerable as a political regime that is neither fully democratic nor wholly authoritarian, whereas all the other Central Asian countries (but not Russia) have the advantage, from the point of view of state stability, of being authoritarian regimes. Additionally, Uzbekistan, Turkmenistan and Russia are more ethnically homogeneous.

Consequently, the least we can say is that for a young, semi-democratic state in a "bad neighbourhood", mired by corruption and enjoying a low level of public trust in its institutions, the expected earthquake of falling living standards and rising joblessness has a high chance of shaking the foundations of the country's political institutions, even if, on its own, this would not necessarily be enough to bring these institutions down.

When you walk through a storm

How will the global economic crisis affect the Kyrgyz Republic?
Up until recently, the view was widely held that countries such as the Kyrgyz Republic would to a great extent be protected from the effects of the global credit crunch by their lack of integration with international financial markets. In late 2008, however, the global financial and economic crisis, having surfaced in the US property market a year earlier, deepened and spread rapidly across eastern Europe. From September the crisis swept over Russia, the region's largest economy, as investors withdrew, and the Russian Central Bank (RCB) was forced to make massive drawdowns on its reserves to increase liquidity in the banking system and to try to prevent a rout of the rouble. Kazakhstan had been an earlier casualty of the drying up of the international credit markets. Because of their size, the spillover of the world financial crisis into the real economies of the two countries has sharply worsened the short-term outlook for regional economic growth. The question of the likely impact on the Kyrgyz Republic has thus become more pressing, and has already forced an adaptive reformulation of Kyrgyz economic policy. At the same time, the country continues to grapple with the aftermath of a number of severe economic shocks from an earlier phase. By tracing some of the knock-on effects of these developments, the scale and complexity of the problems confronting Kyrgyz economic policymakers becomes apparent.

Impact of the regional economic slowdown
Reduced foreign demand. Between them, Russia and Kazakhstan bought around 40% of Kyrgyz exports in 2007. Most obviously, therefore, the regional economic slowdown will substantially reduce the growth in external demand for Kyrgyz goods, making the domestic economic growth rates achieved during the past couple of years more difficult to sustain. By tightening the limits on revenue growth to the budget, it will also constrain the ability of the government to deal with the multiple consequences of economic deceleration.
Reduced foreign investment. Russia and Kazakhstan are both heavily dependent on oil. Until the recent past, they were both also significant players in the international bond and syndicated loans markets. With these capital flows to the region drying up or declining significantly, and the price of oil plummeting from its mid-year peak, it would be prudent—based on purely commercial rather than geo-strategic grounds—to expect a scaling back of foreign investment. On preliminary figures from the National Statistical Committee (NSC), for 2008 as a whole, fixed capital investment from all sources, at Som29.2bn, was already down by more than 5% on 2007. In turn, a reduction in investment will have a negative impact on economic growth and add to difficulties in covering the widening external imbalance.
A slowdown in remittance inflows. Russia and Kazakhstan have been the main sources of inflows workers' remittances to the Kyrgyz Republic. At US$715m in 2007, according to the World Bank, remittances equalled almost one-fifth of the country’s GDP in that year, and were assessed at approximately the same level in 2008. At the beginning of November the head of the Kyrgyz State Committee for Migration and Employment estimated the figure for 2008 at between US$800m and US$1bn. Curiously, local press reports suggest that there has as yet been no large-scale return home of migrant labour from these destinations, but a slowdown in the growth of remittance inflows, particularly as the economic crisis takes its toll of the Russian and Kazakh property and construction sectors, is certain. This will restrain the expansion of household disposable income, and thus the pace of growth of private consumption. It could also add to unemployment and wage competition if migrants begin to return home in large numbers.
Spillover from the Kazakh banks. Although the Kyrgyz financial system has been protected by its underdevelopment and relative lack of international integration, the impact of the crisis in international credit markets on Kazakh banks—which own about half of the Kyrgyz Republic's commercial banks—has already seen a steep slowdown in the growth of "credit to the economy", which peaked at above 110% year on year in late 2007, according to the IMF, but slowed to annual growth rates of 20-30% a year later. The sharp deceleration in credit growth, in combination with a likely tightening up of lending criteria, will affect businesses that had been planning to expand by using resources from outside the firm, as well as the borrowing of households, thus subduing the expansion of private consumption and domestic investment demand.

The effects of other economic shocks
The inflationary surge. In the year from the middle of 2007, a surge in global prices for food and fuel was the main factor behind a rise in inflation, which peaked at 32.5% year on year in July 2008, although it has since tumbled, in line with falling commodity prices, to below 17% in October. According to preliminary figures from the NSC, consumer price inflation crept back up 20% in December 2008, probably under the impact of currency weakening. This compares with a target range originally set for the year of 12-15%. The Kyrgyz Republic’s peak rate was high even for the region. This is mainly because the Kyrgyz economy is heavily reliant on external sources for these items. Thus, as well as boosting inflation, the increased cost of food and fuel significantly raised the country's import bill in 2008, opening up the current account to more than 6% of GDP in 2008. The same development also put additional pressure on budget revenue, as the government tried to replenish its reserves of food and fuel, and to cushion the impact of the prices rises on the population.

A shortfall hydroelectric power. In 2008 a shortfall in domestic production of hydroelectric power because of low water levels in the Toktogul Reservoir constituted a second major economic shock. This necessitated further fuel and electricity purchases from within the Central Asian region (November 2008, Economic policy), at an additional cost of US$60m, on IMF estimates (the then minister of energy, Mr Balkibekov, put the figure at US$88m), widening the trade gap further, taking international reserves uncomfortably close to the "safe" level of three months of import cover, and adding again to unplanned government spending. The power shortages already appear to have had a direct impact on industrial production, which, excluding production from the booming Kumtor gold mine, contracted in real terms by just over 2% in 2008, according to NSC figures, compared with growth of over 10% in 2007. Over the same period, electricity output shrank by more than 20%.

Inflationary outlook. Although falling commodity prices and a slowdown in the economy has eased upward pressure on the price level from these sources, in 2009 other factors will work in the opposite direction. Thus, the new year saw another steep rise in the price of gas imports from Uzbekistan, to US$240 per 1,000 cu metres in 2009, from US$145 per 1,000 cu metres in 2008. Other factors likely to boost inflation include the raising of utility tariffs as part of the programme of energy sector reform, and the impact of imported prices through the sharp nominal depreciation of the som.

Off the top of my head

Needless to say, I've had a bit of an interest in revolutions—and even The Revolution—for quite some time. What counts as a revolution? What are the different kinds? What are the common causes, trajectories and consequences? Of late I have found my interest turning to these issues again. My main interest is in contemporary political situation around the world, especially in eastern Europe. However, it seems to me best to start with "the classics". I have therefore begun to study the English, French and Russian revolutions, as well as state breakdowns in the Ottoman Empire, pre-modern China and Japan. Before I get too far into that, I had occasion to jot down some thoughts on the possible implications of the wave of political rebellion in the former Soviet Union in recent years known as the "colour revolutions".

Are colour revolutions a thing of the past in CIS countries?
The colour revolutions in a number of former Soviet countries in the early years of the present decade—the Rose in Georgia in 2003, the Orange in Ukraine in 2004 and the Tulip in the Kyrgyz Republic in 2005—came as something of a surprise to observers, many of whom thought that the cause of democratic development in these countries was either intractable or hopeless.

To understand the potential future relevance of this model of popular political rejuvenation, it is necessary to understand the features and processes that the separate events had in common. All of the political regimes then in existence in these countries might described as semi-democratic at best, in which elites from the communist era were in an alliance of convenience with business factions who had been able to enrich themselves by taking advantage of the market distortions that develop in the transition from planned economies. Additionally, each of the upheavals was sparked by fraudulent national elections, although in all cases extensive violence was avoided.

Operationally, the "colour revolutionaries" faced a weak or divided authority, headed by an unpopular leader who was linked in the public mind with corruption; crucially, the fault lines ran through competing branches of the security services, which made the use of force against the demonstrators more difficult. The revolutionaries were well organised, and used the media—which in all cases remained largely free—as well as modern technology, such as mobile phones and the Internet, to spread information quickly—for example, of the variance between exit polls and official vote results.

Another vital, but controversial, element in the mix was that of technical help from outside. This came not just from Western election-monitoring teams or non-governmental organisations (NGOs), but, notably, from the leaders of the Serbian student movement, Otpor! (Resistance!), which was instrumental in mobilising the opposition that brought down the regime of Slobodan Milosevic in Serbia in 2000. (For example, they ran workshops on how to raise funds, and how to "brand" the revolution.)

Not least, the colour revolutions came as a surprise to the region's incumbent governments—which is probably one of the main reasons for their success. We know now, however, that in the wake of the Orange Revolution, Russia's leaders and their political advisers held several high-level meetings to address the question of how to respond systematically to the challenge to their positions represented by these popular disturbances in the "near abroad". The actions of the Russian government since then—its crackdown on domestic opponents, the resubordination of most of the media, and the sparing of no effort to allow any semblance of real competition disturb the desired outcome to the parliamentary and presidential elections of 2007-08—testify to the likely conclusions of these meetings, and are behind the rise of the popular description of Russia's polity under Vladimir Putin as a "managed democracy".

There is some evidence that the "counterrevolutionary" methods so developed have been disseminated to other incumbent governments in the CIS—most recently, perhaps, in the practice in the Kyrgyz Republic in December 2007, where, for all the show of a vibrant and inclusive the parliamentary election, a comprehensive package of electoral, registration and security measures appear to have been in place to prevent the population opting for the wrong result.
Therefore, the short answer is that, yes, colour revolutions are likely to be a thing of the past in the CIS, because the same combination of circumstances is unlikely to recur in just the same way again—not least, because specific measures have been developed to prevent just such an outcome. This does not mean, of course, that the problem of political stability has been solved by the increased authoritarianism that has characterised many CIS regimes in the recent past—this would not be possible until the conditions giving rise to the instability are abolished—but, rather, that any popular, successful political convulsions in the future are likely to happen in creative and unexpected ways, reacting against the reaction.

If you want things to stay the same, everything has to change

In her recent book, Central Asia’s Second Chance, Martha Brill Olcott attempts to address an apparent contradiction at the heart of contemporary US foreign policy in the Central Asian region. This contradiction is that the failure of the current Bush administration to encourage democratic development more actively—instead relying on partnerships with authoritarian regimes out of short-term expediency linked to the prosecution of the so-called war on terror—risks reproducing long-term security threats to the West because of the potential for ongoing political, social and economic discontent to catalyse anti-Western terrorism.

She argues that the attention and resources of the US administration have been diverted from vital long-term democracy-promotion projects by the war on terror itself, and that this is shown by the low and declining level of US regional funding, which was just US$210m in 2004 (compared with US$1.9bn and US$2.7bn for the more significant US allies, Egypt and Israel, in the same year).

A second important theme of the book is that the nation-building approach adopted by international bodies may have been counterproductive for the region—in particular, in view of the interdependent histories, transport infrastructure, and energy and water resources of the countries involved, the country-specific approach may have encouraged rivalry and protectionism, hindering the development of a regional market.

In some ways, this is a frustrating book, since the author seems to share uncritically the terms and perspectives of the US policy establishment, so that the reader has the feeling of wading through quite a lot of policy-wonk material before getting to a discussion of the details of what has happened regarding the political systems of the Central Asian states themselves (the book might thus more accurately have been called America’s Missed Second Chance in Central Asia).

However, in relation to these political systems, the author makes the points that the countries' leaders were all products of Soviet political structures, and that their emergence, practically intact, from the wreckage of the Soviet Union following the failed Moscow coup of 1991 meant that they lacked the legitimacy that might have been conferred upon them had they risen to power as leaders of independence struggles. Although none of the region’s citizens enjoy as full a range of political rights and civic freedoms as those of the formerly communist countries of central and eastern Europe, there is some variety in the types of political systems that have obtained in Central Asia in the independence period, running along a line from “semi-democratic” to fully authoritarian, with the Kyrgyz Republic usually conceived of as the most democratic and Turkmenistan as the least.

The thesis that US funding was insufficient to allow it to influence positively the political outcomes in the region (in particular, to minimise the chances of political instability by helping to pave the way for the smooth, democratic handover of power) is illustrated by the case of the Kyrgyz Republic. Here, the author argues, such a policy had the best chance of success in the early years of the present decade, because of the country's experience of rapid democratic development in the early 1990s, and because the desire of the then president, Askar Akayev, to compete for prestige with other Central Asian leaders would have predisposed him to accept a high degree of conditionality in return for grant assistance for political reforms already under way, such as of local government, electoral mechanics and anti-corruption programmes. However, the sums involved were too small to yield any decisive influence (funds from the Freedom Support Act for democracy-building were just US$1.16 per head for the Kyrgyz Republic in 2002, although this was the highest per-head level of funding from the US for any country in the region). Instead, therefore, Akayev’s increasing authoritarianism went unchecked, and the chain of events leading up to the Aksy killings of 2002 and resulting in the president’s ouster in the Tulip Revolution of March 2005, while illustrating the greater political influence of public protest in the Kyrgyz Republic relative to its Central Asian neighbours, also began a curious phase of political instability and constitutional struggle that is probably not yet over. Indeed, the regime of Kurmanbek Bakiyev, which replaced Akayev’s, appears to have reproduced many of the features of its predecessor, re-employing many of its personnel, and adopting many of its operation and control techniques.

A sea of troubles

Economic transition in Central Asia
Richard Pomfret’s book, The Central Asian Economies Since Independence, is a clear and reasonably up-to-date account of the economic developments in the first 15 or so years since the collapse of the Soviet Union thrust independence upon the five former Soviet republics—Kazakhstan, the Kyrgyz Republic, Uzbekistan, Turkmenistan and Tajikistan—that comprise the Central Asian region. Taking into account both the similarities and differences in their starting positions, Pomfret outlines the distinctive policies adopted by each of the new countries in response to common political and economic disruptions, and tries to relate these policies to the subsequent economic performance and prospects of each.

The broad picture
At the start of transition in 1991, the Central Asian countries inherited a number of shared features. They:

• began with very similar economic and political systems, based, respectively, on central planning and the constitutionally enshrined leading role of the Communist Party;
• were among the poorest republics in the Soviet Union, with around 30-50% of households living below the poverty line in 1989 (defined as a monthly income of less than Rb75), compared with a figure of 5% for the Russian republic;
• had relatively high levels of human capital for their income levels;
• had functioned as suppliers of primary products and minerals; and
• had a low indigenous capacity for economic management.

In addition, they faced a number of common deficiencies, disruptions and shocks, including:

• a lack of experience of independent nationhood, so that attempts at nation-building had to go hand in hand with attempts at economic reform, complicating reform;
• economic disorganisation, which was brought on by the shift from central planning and the split of the single Soviet economic unit;
• disruption of inter-republican trade links by new national borders; and
• the stoking of hyperinflation by the attempt to maintain the rouble zone, with prices in all five countries exceeding 50% per month in 1992.

These were the main factors behind the very steep output falls across the region at the start of the transition process, although other factors may be expected to have exaggerated or ameliorated the impact on living standards. First, there are valuation problems linked to the nature of the transition itself that make measurement difficult. For example, it is hard to value products for which demand dried up following the introduction of market mechanisms, or to account for changes in product quality or the introduction of new kinds of products. Second, the impact of output falls on living standards was likely to have been exacerbated by the cessation of transfers from the central Soviet authorities, as well as by the widening of income inequality. Third, in the Soviet economy energy products were undervalued and manufactures overvalued, so that a change in the terms of trade brought about by a shift to world market prices might have been expected to favour energy producers such as Kazakhstan and Turkmenistan. Fourth, in Tajikistan, the exceptionally steep falls in output were the result of the destruction of the centrally planned economy by two bursts of civil war, which only came to an end in 1997.

In tandem with these steep falls in output, all of the new central Asian states suffered a loss in budgetary revenue, not only absolutely, but also relative to declining GDP, creating dilemmas of how to achieve both macroeconomic stability at the same time as maintaining social programmes (in most cases, this was not possible).

Bearing in mind that the region suffers from a number of common international trade data deficiencies, in 1994-97 the foreign trade of the Central Asian economies began to recover from the initial transitional shocks and disruptions, and, with high trade to GDP ratios, all may be said to have quickly developed into open economies.

A closer view
The Kyrgyz Republic. Policy choices: The Kyrgyz Republic embraced the standard Western advice concerning stabilisation and reform (often referred to as the "Washington consensus"), for which it received extensive multilateral support. Price liberalisation and enterprise reform took place rapidly. Later on, in 1998, the country was rewarded for its choice by becoming the first of the former Soviet countries to be allowed to join the Word Trade Organisation (WTO).

Stabilisation: The Kyrgyz Republic introduced a national currency, the som, in 1993 as a prerequisite to asserting macroeconomic control, and it was the first country to curb hyperinflation, bringing the average rate of monthly price increases below 50% in 1995.

Output performance: Description. As a result of the economic disruptions and shocks that affected the whole region in the early phases of transition, output in the Kyrgyz Republic fell by a cumulative 45% in 1991-95. Manufacturing output also dropped sharply, and the increase in the contribution of agriculture to GDP in these years is probably explained by the migration of the newly unemployed from the cities to the countryside to look for work. Following the years of recovery from the low base so created—that is, in 1996-97—economic growth has been moderate and subject to wide fluctuations.

Explanation. The radical reform and stabilisation policies probably contributed to the steepness of the fall in output in the Kyrgyz Republic in the early transition era. The failure of the expected gains of its radical policy choices to materialise is perhaps explained the republic’s paucity of readily tradable resources, in contrast to some of its neighbours. Also, low levels of initial income and human capital, exacerbated by emigration of skilled (often Russian) staff, perhaps hindered the establishment of well-functioning market institutions. The fluctuations in GDP output are linked to an overreliance on gold production of the Kumtor mine.

Budget and debt: Anxious to maintain its social programmes, in the 1990s the Kyrgyz government did not allow expenditure to fall as far as revenue, keeping the government deficit fairly wide, at about 4% of GDP at least, until the early 2000s. To avoid inflationary financing, the authorities plugged the gap by borrowing from international financial institutions, building up a large external debt, which rose from zero at the start of transition to the equivalent of 139% of GDP in 1999, according to the World Bank. This was a negative development for at least two reasons: first, the borrowing was not used to invest in productive ventures that could later generate earnings from which government revenue could accrue and the original borrowing be repaid; second, debt repayments on the accumulated sum have acted as an ongoing drain on scarce public funds ever since.

Foreign trade: After a recovery, total trade turnover fell in 1997-2002.

The Triumph of the West

After some time away from blogging—mostly trying to get to grips quickly with the politics and economics of the Kyrgyz Republic—I intend to get back on track with my studies of maths and economics more broadly, starting with a critical review-stroke-summary of How Capitalism Was Built, a new book by Anders Åslund in which he outlines the main sequence of events of the transition process in eastern Europe and the former Soviet Union, as well as the theoretical and policy debates linked to them.

Contest of Viktors

I've been in the Donbass for a week, doing a bit of research.

Ostensibly, political tensions are rising in the run up to the vital parliamentary election, set for the end of September.

The picture shows the campaign poster backing the Ukrainian president, Viktor Yushchenko. This is on Artema Street, the main road through the middle of Donetsk, which is the centre of power of the president's rival, Viktor Yanukovych, and his vehicle, the Party of Regions: that is, at the centre of a region said to be inimical to the "Orange Revolution" of 2004. The quote from Mr Yushchenko at the top of the poster says: "MPs have to create laws, but they cannot hide from them." For an apparently liberal grouping, the backdrop of the raised clenched fist—the universal symbol of workers' power—seems to me a little incongruous.

Interestingly, in Yenakivo, the sign that I saw for the Party of Regions—which preys on the fears of Ukraine's ethnic Russian minority of domination by their former ethnic subordinates—was written in Ukrainian, and made use of the yellow and light-blue of the Ukrainian national flag. The sign boasted of the region's industrial prowess and, to me, had about it a strong whiff of "political technology".

Although some of the fears of a previously paramount group are undoubtedly real, much of the split between Ukrainians and Russian looks a bit artificial, fomented, stoked. For instance, some of the pro-Russian graffiti (eg "The Donbass is Russian land", sprayed on a corrugated fence along Kuybysheva Street, on the way up to the rather grand-looking railway station) was suspiciously neat and prominent. The posters of the "red-brown" Natalya Vitrenko—the leader of some left-wing-sounding Russian chauvinists masquerading as pan-Slavists—said "No to NATO" and "Ukraine, Russia, Belarus: together we are strong".

An empire tries to strike back

Two articles on the fate and aspirations of contemporary Russia, here and here.

The first, by George Schöpflin on openDemocracy, argues that, domestically, Russia is a "consensual authoritarian" system, "ruled by a rent-seeking elite", and glued together with xenophobia and support from eastern Orthodoxy; internationally, the author spies emergence of neo-imperialism the country's power plays with it hydrocarbons resources and infrastructure.

Though there might be a case for seeing this as neo-imperialism—if that means exercising control through economic strength rather than directly by force—I'm not sure that there's anything wrong per se in charging market prices for your oil. (If it is possible to see oil subsidies as a means of maintaining influence in post-Soviet countries, can raising prices also be? You would have to look at the specific political conditions in each case.) Nor does there necessarily seem much of a territorial claim implicit in the phrase "near abroad".

Also: the definition of "European" as somehow synonymous with democracy seems a little strange, given that half of Europe has only established (or re-established) democratic institutions in the recent past.

The second article, by Perry Anderson in the London Review of Books, is a more wide-ranging and historically well-informed piece. It starts off with the Russian authorities' touchy relocation of the funeral of the assassinated investigative journalist, Anna Politkovskaya, to an obscure cemetery on outskirts of Moscow, which is portrayed as both shabby and fearful, then moves quickly on to a speculative, though broadly plausible, account of the basis of Putin's appeal and high ratings in the opinion polls (basic answer: he's not Yeltsin); the intimate connections, despite differences, between the Yeltsin and Putin regimes; the re-merging of political and economic power under the latter, in parallel with the fusion of the state and security apparatus; the resubordination of the media; the lamentable fate of the liberal intelligentsia (but: they shouldn't have backed Yeltsin); the widespread indifference to the horrors of Stalinism; the demographic catastrophe that looms on the horizon; and the symptoms of ongoing cultural degradation and decline (symbolised by the decadent cult of "retro-Tsarism").

Mr Anderson lays into various commentators over for their benign assessment of the state of contemporary Russia: Andrei Schleifer (neo-liberal crook) and Andrew Jack (neo-liberal dupe/ colonial apologist). Richard Pipes gets a grudging thumbs up for his theory that Russians, hemmed in by a political culture that predisposes them to favour order over freedom, don't necessarily rate democracy that highly.

In addition, the author points to a number of interesting-sounding theorists of contemporary Russia more approvingly, such as Anna Ledvna's study of the informal practices that characterise Russian political and economic life (whenever this topic comes up, I think, for some reason, of the phrase "what you call corruption, we call culture", intoned in a rasping Mafioso baritone), and gives an outline of Dmitry Fruman's idea of Russia's present-day "managed democracy" as the phase of a process that broadly mimics the phases of the Soviet era (but this time heading towards real democracy?). This looks a bit like a regurgitation of the ever-popular "cycles" theory of civilisational ascendancy and decline—a recycling, in fact.

Yet, for all its astuteness in places (on the possible factors behind Putin's appeal, which often looks like a bit a mystery to outsiders), as well as for its obvious erudition and breadth, the essay leaves a certain teenage, "not as bad as Bush and Blair" impression behind it. This impression, while perfectly characteristic of the rather degraded political discourse of the day, still seems to me a bit unseemly in a Marxist historian fast approaching 70.

Under the old regime

Looking through some of my old stuff, I thought that a useful approach might be to "recycle" material from the past, updating it where necessary. Of course, some material does not need updating, since the situation it refers to has passed away. However, the definitions and tools may be of continuing use.

Repressed inflation in STEs
The interlinked phenomena of inflation and shortage in Soviet-type economies (STEs) can be attributed to a number of causes. Inflation is the movement of the aggregate price level for goods and services across the economy as a whole, although, when looking at causes, it is sometimes helpful to distinguish between those that are "one-off" in nature, originating from "outside" the normal workings of the economic system (for example, from mistakes of economic policy, or exogenous shocks, such as a rise in energy prices or a bad harvest), and those that are systemic, when the conditions behind the rise in the aggregate price level are constantly reproduced from within.

Causes of inflationary pressure under state socialism
In the classical model of state socialism, the system-specific causes of inflationary pressure may be listed as follows.

• Persistent labour shortages put upward pressure on wages which, if reflected in actual wage increases for the economy as a whole, will tend to increase production costs.
• As producer-sellers, firms have some vested interest in raising prices.
• Operation of a passive monetary policy may lead to some uncontrolled growth in the money supply.
• There is persistent excess demand at a macro level.

The last of these, excess macroeconomic demand, exerts the strongest inflationary pressure. And although there are also variations in the degree of excess demand prevalent in different sectors of the economy, it is most powerful in the state inter-firm sphere.

From this perspective, perhaps the most important phenomenon to understand is the process of taut or overfull employment planning. This is when the output plan for the enterprise is deliberately set above the firm's production capacity. The aim is to "seek out" resources; for individual managers, increased physical output is also the criteria for promotion. The effects, however, are that firms try to cut corners—for example, by reducing product quality or raising costs. From the point of view of structural constraints on the firm, this presents few problems, since the question of exit of firms from production is not an economic decision but a bureaucratic-political one. The peculiarity of the state property form means that, while in theory it is owned by everyone, in practice, "no one has a true inner interest in ensuring caution in handling money".

Soft budgets, passive money
In effect, the regime of the output plan means that a firm's budget is not a strict restriction on its access to resources. If a transaction seems to be demanded by the plan, a cheque—even one in excess of the firm's budget—will be cleared. Herein lies the "soft" character of financial budgets at enterprise level, and also the "passive" character of money in the inter-firm sphere. "Money" in this sense exists only as an accounting unit and does not exert any buying power. The total monetary demand for firms follows the financing needs of the plan. This is the reason why the term "excess demand" is sometimes considered inappropriate, and we should use the term remembering that it is compromised by the non-market character of the transactions involved. For this reason monetary and fiscal policy has no effect on the level of output. The rationale for Kornai’s observation that the firm under the classical socialist model has no particular interest in limiting its demand for inputs is thus seen to flow from the imposition of “taut” planning.

What symptoms when prices are controlled?
In STEs the symptoms of inflationary pressure are revealed by means other than price rises. This leads us to the question of repressed inflation, which may be introduced by a method of contrast. For while inflationary pressure may lead to a rise in the aggregate price level (open inflation), or actual rises in the prices of goods and services may not find their way into the calculation of the inflation index (hidden inflation), repressed inflation is said to exist when upward pressure on the price level is resisted by administrative control. (It is also defined by Nuti as the rate of change of excess demand.)

In the consumer goods market, too?
First, the boundaries of the debate must be delimited by saying that while the existence of excess demand in the state inter-firm sector of STEs is rarely challenged, the question of the endemic nature of repressed inflation in the market for consumer goods has been hotly debated. Also, the credit expansion typically exhibited in the state inter-firm sector would not have inflationary effects in the consumption sphere unless the (usually strict) separation of the functions of money between the two began to break down—if, for example, enterprise credit was allowed to be used to pay for wage increases and it became someone's income (ie if it was “activised”).

How, then, are we to identify inflation if movements in the price level are ruled out? To those who argue that repressed inflation is endemic to the consumer goods market, the evidence seems obvious: the chronic existence of queues, of shortages and of black-markets. These phenomena seem to testify to real attempts to consume more than is officially being produced. This is the kind of thinking adopted by Kornai in his attempt to construct an "index or partial indicators" from, for example, the number of building orders refused, unfulfilled car orders, or the length of waiting lists for accommodation. Pindak takes an equally direct approach to an analysis of Czechoslovakia between 1972 and 1978 by tracking the decreasing proportions of goods in the market for foodstuffs and industrial products not experiencing supply problems.

Another approach is to look at trends in saving. The theory here is that if consumers cannot make their desired purchases, and the bureaucracy prevents a rise in retail prices that would choke off demand, it is likely to be reflected in the rapid and involuntary growth of savings in relation to income or sales. However, since it is difficult to detect a change in the savings rate which signifies the qualitative change from voluntary to involuntary saving, some observers have pointed to the growth of the money-income ratio in many STEs as evidence of involuntary saving (and hence repressed inflation) which, over time, develops into a monetary overhang: frustrated buying power accumulates over the economy in the form of liquid assets (cash and sight deposits).

Charemza and Gronicki take another approach, using the rational expectations hypothesis to estimate excess demand for consumption and labour both in absolute terms and relative to quantities transacted, the results of which show a U-shaped pattern for excess consumption demand in Poland between 1960 and 1980, bottoming out in 1970, steadily increasing to the mid-1970s at about 8% of total quantity of consumption sales. They also employ a static indicator—the difference between the estimated market-balancing price and the real price—to suggest the strong growth in the level of repressed inflation in Poland after 1970.

From this perspective, macroeconomic rationing—and therefore repressed inflation—is seen as a quintessential and permanent feature of STEs, even in the market for consumer goods. First, because excess purchasing power is often deliberately built into wage settlements by the planners, thus forcing the adjustment process onto consumers; and second, because it is seen as a basis of social discipline (and political power).

The initial criticism of this position must be that visible signs of shortage cannot, without further qualification, be taken as indicators of excess demand at the macroeconomic level. This is because the root causes of the observed phenomena may be microeconomic in character. They might, for example, be the result of inadequacies of distribution rather than production, or they may stem from the rigidities of pricing policy (that is, a problem of relative rather than aggregate prices). These observable indicators may be particularly misleading if we think of repressed inflation as the rate of change of excess demand.

Why do we need to know?
The question of the source of repressed inflation is an important one, as it will influence the choice of stabilisation policies pursued in the period of transition from socialist to capitalist economic systems.

Is aggregation appropriate in STEs?
Within the field, there has been a somewhat heated dispute over the theoretical justification for statistical aggregation, given the nature of Soviet-type economic systems. An example of the aggregative method is an econometric study of Portes and Winter. While arguing that the roots of the problem are microeconomic in character, they maintain the pertinence of a macro approach to an analysis of economic imbalance. They test and reject the hypothesis that excess macroeconomic demand is endemic to the consumer goods markets of STEs. On the contrary, they conclude that from the mid-1950s to the mid-1970s excess supply was the dominant regime in three out of the four countries analysed (Hungary, Poland the GDR and Czechoslovakia).

Kornai, in contrast, contends that in a shortage economy, the idea of excess macroeconomic demand is not an operational category. By this, I think he means that when the consumer is forced to substitute for their original buying intentions, or is deterred from following through the buying intention in any form, the netting out of shortages for some products against surpluses for others is inappropriate, since withdrawal from the market reduces the level of observable shortages; also, perhaps, that quantitative measures fail to take into account qualitative criteria. This may mean that Portes's rhetorical criticism of estimates of excess aggregate labour supply in Western countries because of the phenomenon of the "discouraged worker" may be inadvertently justified.

Holzman's indicator for repressed inflation—the ratio of free market (kolkhoz) prices to state prices for foodstuffs, weighted by share of output and expressed as an index—assumes that the level of repressed inflation in the state sector has a direct impact on the level of prices in the free market. The ratio indicates a decline in the level of repressed inflation in the USSR for the decade after 1955, followed by a period of stability that lasted until the mid-1970s, when a definite, though undramatic, increase occurred until 1979. (However, I couldn’t see from the data what the proportions of the repressed inflation were at the base date.)

It has also been argued that trends in the money-income ratio should be interpreted as a wealth-income ratio in STEs, since the underdevelopment of capital markets means that only a narrow range of assets is available. The trends taken to indicate the development of involuntary saving may therefore be better explained by factors that interpret them as increased rates of voluntary saving. Ofer suggests that two such factors are the need to build up levels of saving: first, to be able to purchase consumer durables when no consumer credit is available; and, second, to offset the deterioration of public services and real levels of social security pay. In addition, a significant rise in the wealth-income ratio is hardly surprising given the very low levels of the ratio that prevailed in many STEs at the beginning of the 1960s. Cotarelli and Blejer suggest that, applying the life cycle hypothesis to consumption behaviour in the USSR, the increase in the wealth-income ratio could be interpreted as resulting from the deceleration of disposable income growth in the period 1965-80.

Conclusions
The hypothesis of endemic repressed inflation in the market for consumer goods thus emerges battered from the criticisms of more nuanced, more plausible interpretations of data and of rigorous econometric analysis. Nuti seems to add to the weight of this criticism by pointing out that the acceleration in the growth of liquid assets could be explained by the higher market-clearing prices on secondary markets, or by the necessity of speculative holdings in conditions of erratic supply—both of which would invalidate the concept of involuntary holdings for the sector as a whole. This might go some way, he suggests, to reconciling the estimates of low overall excess demand in the consumer sphere with concern for market imbalance. However, he goes on to argue that the bulk of the stored up buying power would be pressing on the lower priced, quantity-constrained markets as a result of (I think) the lack of substitutability between (luxury and everyday) goods. Consequently, the level of excess demand could be increasing fast in the state consumption sector, while open inflation in the non-state consumption sector keeps the level of excess demand for the sector overall at a stable level.

Whither Rus?

What's all this about? Why now?

Four thoughts:

• there is currently loads of oil money washing about (so I'm told), boosting the confidence of the ruling elite, who, Nero-like, continue with violin practice while the Third Rome burns;
• America, pinned down, appears relatively weak;
• ahead of the "difficult" changeover in 2008, an appeal to "great power" nostalgia looks as though it might be helpful at home in binding and rallying the swindled masses to the patriotic cause of the state; and
• those proposals for positioning missile-defence systems in central-eastern Europe can't have helped.