Sanctions Return Russian Economy to the 1990s

U.S. and allied economic sanctions on Russia are having a real impact. The Russian government has been trying to shield its citizens from the impact by imposing strict capital controls and promoting import substitution policies. Continued energy revenues are also mitigating some of the effects as well.

However, as the ill-advised war in Ukraine drags on, Russia's economy will begin to look similar to the one in the early 1990s. This is already apparent in certain sectors, where the lack of western products and parts is causing local companies to use Russian-made goods. The clock is turning back to the time described in the upcoming book, "Wind of Change", which tells the insightful and satirical story of an American trying to help bring former Cold War foes together.

Did Putin Create the System that Gorbachev Wanted to Save?

With the passing of the last Soviet leader Mikhail Gorbachev, a man whose policies and actions, contrary to his initial objectives, led to fall of the USSR and the end of the Cold War, it would be worthwhile to examine whether he might have prevented the demise of the USSR had he taken a path resembling that of current Russian President Vladimir Putin. I am not stating in this article that the USSR should have survived or was worth saving. I am simply posing a theoretical argument.

On Christmas Eve 1991, Mikhail Gorbachev signed the document that officially dissolved the Soviet Union. On Christmas Day, he resigned as the General Secretary of the Communist Party. The following day, millions of Soviet citizens and viewers around the world watched as the Soviet flag was lowered for the last time over the Kremlin. The Soviet experiment lasted just under 70 years. For six years, Gorbachev introduced greater openness (glasnost) in society and economic restructuring (perestroika). These changes, however, were not enough to prevent the collapse of a country that was one of the world’s two superpowers. Researchers have written a great deal about the causes of this collapse. Some have argued that the collapse was inevitable; the inherent structure of the Soviet system was not sustainable. Others have viewed the way in which the reforms were implemented as the actual catalyst for the system’s demise. If Gorbachev had taken a different approach, which focused mainly on improving the economy without increasing political freedom, the Soviet Union would perhaps have had a realistic chance of surviving.

So why did Gorbachev fail? Gorbachev’s actual political and economic choices did not save the Soviet system but rather led to its rapid demise. Although younger and more open to new thinking, Gorbachev was still the product of a Soviet upbringing. His education and experiences were forged within the framework of the socialist system in the USSR. Gorbachev continued to believe his reforms could be supported through Leninist ideology. It was not until 1989/1990 that he began to realize that reliance on Party teachings would not be effective. This was much too late to pivot to other areas of support. He had no deep understanding of market economics and relied on economic advisors who had no direct experience functioning within the type of economy that was needed to cure the ills of the Soviet economic model. His chief economic advisors, Abel Aganbegyan and Tatiana Zaslavskaya, were Marxist-trained economists. Both Aganbegyan and Zaslavskaya had been critics of the Soviet system, having consistently called for needed reforms. Yet their thinking was framed in Marxist terms. They were not able to provide the guidance that could have enabled Gorbachev to make better decisions on economic policy. In fact, his economic advisors were proposing reforms similar to those proposed in the Khrushchev years and which were squashed during the Brezhnev years. New, modern ideas based on market economics were needed. Unfortunately, Gorbachev and his economic team failed early on to take advantage of the goodwill built with western countries by requesting managerial and financial support. Gorbachev’s fatal error was his failure to see the need to shift the economy to a more consumer-based one. This was a failure from which he was unable to recover. He promised the benefits of perestroika to Soviet citizens without delivering on those promises.

Gorbachev’s insistence on greater freedoms in expression and in politics, especially in the absence of economic improvement, proved an obstacle to progress and actually worked counter to his reform agenda. His decision to promote glasnost concurrently with perestroika did not provide him the luxury of executing a gradual, long-term strategy for improving the economy. Soviet citizens needed to see an immediate and positive impact on their standard of living. Gorbachev’s mixed approach did not deliver immediate results, and created disillusionment and resentment amongst a population now encouraged to express these feelings. Criticism came from all sides, leaving Gorbachev to undertake ever more drastic policy swings to placate these competing groups. In the end, he was left with no reliable base of support either on the left or the right. Each side became more radicalized in its positions. Supporters of reform went on to find other political leaders judged more effective, i.e. Yeltsin. Those still loyal to the current system turned more hardline in their views resulting in the 1991 putsch to remove Gorbachev and to re-establish a more traditional Brezhnev-type government.

The lack of swift, focused reforms allowed the entrenched Soviet bureaucracy to dig in its heels and to hinder the successful implementation of his economic reforms. Gorbachev thought he could utilize the vast Soviet bureaucratic machine as the engine for implementing his reforms. He thought that the bureaucrats would become promoters of his reform agenda with proper reorganization and better incentives. As in any country, the state bureaucracy exists primarily to protect and further its own privilege and power. Bureaucrats see political leaders come and go. They play the long game and prolong the execution of any policy seen as a threat while waiting for the new ideas to lose traction/support. The proposed reorganization of Soviet ministries directly threatened the interests of the key bureaucrats, mainly bulwarks of the current system. These ministries were able to defend their interests and block the implementation of key reforms as Gorbachev failed to devise a clear, focused strategy. This muddled approach enabled the ministries to drag out or simply to ignore the implementation of reforms. This reaction of the ministries severely hindered any potential positive impact on the economy.

Gorbachev also failed to appreciate the changes affecting the world’s other main Communist country, China. During this same period, the Chinese government, led by Deng Xiaoping, was experiencing similar problems as the USSR but addressing them very differently. When asked why he didn’t follow the Chinese model during an interview in 2011, Gorbachev responded by adding that “This would have meant dismantling the economic structure of state socialism while keeping the political system as it had always been. But, in order to reform our country “the Chinese way,” we would have had to have a different country—probably populated by the Chinese…” Gorbachev seemed to not understand the importance of economic over political change in the minds of the Soviet people. China was just beginning to recover from the damage resulting from the disastrous policies of Mao Zedong era, which had ravaged the Chinese economy. In contrast to the USSR, China did not opt for greater openness in expression and politics but rather took advantage of the changes taking place in the Chinese countryside by local farmers who were, on their own initiative, splitting up collective land. The local farmers increased the agricultural output to supply the population. The Chinese leadership then devised a strategy to rapidly transform the Chinese economy to become more competitive. This resulted in a dramatic improvement in the daily well-being of most Chinese citizens. That is not to say that China did not adjust its political system. Certainly, China restructured its ministries and created new incentives for its bureaucracy, but it was done while maintaining its one-party system. Certain elements of democratic systems such as competition, accountability, and limited decision-making power were instilled into the bureaucracy. Yet, Communist party hegemony was not questioned.

Key factors in the success of the reforms in China were speed and decisiveness. With the support of the Chinese Communist Party (“CCP”) senior leadership, Deng Xiaoping composed a comprehensive and aggressive plan to accelerate the Chinese economy based on market principles. Unlike Gorbachev, Deng did not take a gradual approach and introduce contradictory policies. China introduced its economic reforms quickly before any significant opposition could arise. Like Gorbachev, Deng used the ministries as his engine for driving reforms into practice. What the Chinese leader did differently, though, was change the one-man rule structure of these ministries into a collective leadership, thereby reducing the power of the single ministry leader. Term limitations and mandatory retirements were also introduced to further reduce the power of the ministries. The Soviet leader continued to rely on the individual ministry heads, which maintained their own personal power bases and were better able to resist reform. The Chinese cascaded these reforms into the bureaucracy's lower levels, creating income and revenue generation incentives. Lower-level cadres were evaluated on specific economic growth targets and penalized for failure to meet these targets. Political openness was also penalized. Gorbachev was not able to create significant change within the lower levels of the Soviet bureaucracy due to resistance from ministry leaders. In fact, he argued that he faced stiffer resistance than the Chinese leadership, “In China, economic reforms faced no resistance from the party bureaucracy. In the Soviet Union, the nomenklatura—the party and economic bureaucracy—was extremely strong; they had stopped previous attempts at reform.”

China had a capitalist past and had welcomed, although under tight restrictions, assistance from western countries.

The Soviet Union did not immediately look at itself as a strong economic partner with the West. Economic reforms under Gorbachev aimed to improve the domestic economy for the wrong reasons. Gorbachev believed a strong domestic economy would increase the USSR’s military and ideological competitiveness with the West. The USSR never saw itself as a major supplier, beyond the energy and military sectors, to non-communist countries. Foreign investment was viewed in domestic terms. The USSR would allow limited foreign investment in the form of joint ventures to improve internal consumption. However, investors never had confidence in the Soviet legal/tax structure to make significant enough investments. On the other hand, Deng Xiaoping had a model that he could use for expansion throughout mainland China: Hong Kong. Chinese authorities in Beijing had seen strong economic growth in Hong Kong under British rule. In the 1960s and 1970s, Hong Kong served as a low-cost producer of consumer goods for western countries. It was no surprise that just over the border from Hong Kong, Shenzhen became the showcase city for China’s economic reforms.

The Chinese economy offered more opportunities for western business than the USSR, whose products, as noted, had an international reputation for poor quality. China had a population that had an entrepreneurial culture. In contrast, the Soviet Union and the Russian empire had limited historical experience with a market economy. Thinking in market terms was not ingrained in much of the Soviet population, many of whose ancestors had been peasants. Furthermore, Stalin and Brezhnev harshly suppressed innovation and entrepreneurism. Due to a more logical reform strategy and rapid implementation, China experienced surprising economic growth during the same period in which the USSR saw production decline, inflation increase, and political opposition grow to threaten the existence of the entire system.

With hindsight, it is easy to say what Gorbachev should have done in order to save the Soviet Union. Events move much more slowly when one has the benefit of viewing them through the lens of 30 years. What is clear is that had Gorbachev committed more quickly and decisively to perestroika, even at the expense of glasnost, his reform agenda would have had a better chance of success. Taking a more pragmatic approach more closely resembling the Chinese model could have enabled the Soviet leader to have demonstrated early success, which would have been crucial to building popular support and allowing for time to implement deeper, more transformational economic reforms. The muddled, middle-of-the-road path taken by Gorbachev caused general dissatisfaction leading to his failure, and ushered in the Yeltsin era with its chaotic approach to market economics that brought the country to the brink of bankruptcy. The result was the appointment of Vladimir Putin, who, although not fundamentally altering Russia’s economy and its reliance on energy, has focused on economic stability while placing greater controls on political and press/expression freedoms.

Putin seemed to learn the lessons of the Gorbachev/Yeltsin era. Putin took advantage of the rapid increase in world oil prices in the early 2000s to build significant hard currency reserves. These reserves were maintained to offset future drops in oil prices. During his early terms in office, the oil fund reserves allowed Putin to consistently improve Russia's economic growth rates, thereby increasing the standard of living for Russians. The Russian people have generally been supportive of Putin’s approach. They have accepted the increasingly tighter political and press restrictions in return for greater economic security. However, it remains to be seen how long this support lasts as political/personal restrictions have further tightened and strict western sanctions resulting from the tragic invasion of Ukraine demand additional economic sacrifices. Nevertheless, Putin may have established what Gorbachev set out to create with his reforms in the 1980s. Had Gorbachev instituted a system similar to Putin, the Soviet Union might still exist today.

Putin Follows the Mold of Traditional Russian Leaders

Russia's aggression against Ukraine has caused many in the West to re-evaluate their opinion of Vladimir Putin. Disappointment and disillusionment with the Russian President's recent hostile actions appear prevalent among most U.S. and European leaders. Much time has been spent by experts, government officials, and journalists trying to understand Putin's motives for attacking Ukraine and what drove him away from closer integration with the U.S.-led global security framework. These inquiries imply that something fundamentally changed with Putin and that his current decisions are an aberration from prior behavior. Seen in historical context, Putin's policies and actions are consistent with traditional Russian leadership.

The Russian Empire, which arguably began with Ivan the Terrible's victory over the Khan of Kazan in the mid-sixteenth century, was built via military expansion. Ivan's victory established Russia as a formidable military power, resulting in Russia's ability to push the empire eastward across the Volga River and southward to the Caspian Sea. A century later, Peter the Great recognized his country's military and social backwardness compared to Europe. Tsar Peter instituted reforms to modernize Russia's military and social/government organization, mirroring the great European powers. Peter's actions began the conflict within Russia between admiration of the West (culture, arts, progress, military power) and, at the same time, opposition to western values that is seen to run counter to Russia's "special mission", connected to Russian orthodoxy and nationalism. This conflict continues in Russia to this day. For all of Peter's perceived western admiration, he employed his modernized military to further expand the Russian Empire westward. Despite the fact that his social reforms were based on western models, the Tsar kept firm control over the empire, actually increasing the autocratic power of the Tsar. Peter's legacy showed that Russia would absorb what it needed from the West but would stop short of adopting European values that challenged the Russian autocratic state.

Subsequent Tsars would follow Peter's example of instituting western-style reforms until such reforms impacted their rule. Early in her reign Catherine the Great, wanting to be recognized as an "enlightened sovereign", encouraged liberal reforms in education and even invited a certain degree of public debate regarding the Tsar's policies. When these debates became uncomfortable, however, the Tsar abruptly reimposed censorship controls. Catherine expanded the Russian Empire to a great extent, using both diplomatic and military means. Russia was recognized as one of the great powers in European politics. In the later years of her reign, she became increasingly conservative, reversing some of her earlier reforms. In the late nineteenth century, Tsar Alexander II introduced wide-ranging social and military reforms in Russia, the most significant of which was the emancipation of the serfs in 1861. These reforms occurred, as with other Tsars, in the early part of his rule. Initially welcomed by many Russians, these reforms did allow greater political freedom and produced adverse economic consequences for the elite, and ended up being widely opposed by both conservatives and liberals. Several assassination attempts dampened Alexander's interest in further reforms. An assassin succeeded in killing the Tsar in 1881. Russia's last Tsar, Nicholas II, although not considered a reformer, did approve changes (such as the creation of a semi-autonomous parliament or Duma) under growing public dissatisfaction and the military failures of WWI, resulting in a weakening of the Tsar's power that was a contributing factor to Nicholas' abdication in 1917.

Soviet leaders inherited this historical paradox of simultaneously interacting and opposing the West. Soviet founder Lenin, realizing that his country's disastrous adoption of War Communism during Russia's Civil War would lead to economic collapse, re-instituted limited forms of capitalism, relying heavily on western, mainly European, management. With victory assured and the Communist Party's power was no longer under threat, Lenin and then Stalin reimposed strict state controls. Stalin's policy of rapid industrialization in the late 1920s and 1930s modernized much of the country's heavy production, but at a tragic human loss. The defeat of Nazi Germany in WWII resulted in the U.S.S.R. becoming one of the two global superpowers. After Stalin's long rule, Nikita Khrushchev, known for his fiery anti-western rhetoric, implemented some limited economic reforms. He admired the efficiency of American food producers during a trip to the U.S. in the late 1950s. Soviet premier Leonid Brezhnev, after replacing Khruschev, also initially tried to tinker with the Stalinist system. As his rule entered its second decade, however, he lost any energy and interest in reforms and hardened his position vis-a-vis the U.S. and its allies. Both Khruschev and Brezhnev entertained economic reforms of the Soviet system but did not tolerate political changes. Both leaders showed their willingness to use military force to quash any political threat to the Soviet regime, as witnessed in Hungary in 1956, Czechoslovakia in 1968, and Afghanistan in 1979.

The arrival of Mikhail Gorbachev in 1985 signaled a departure from prior Russian/Soviet leaders. Aware of the unsustainability of the Stalinist system, Gorbachev implemented his famous policies of "perestroika" and "glasnost". Unlike in the past, the new Soviet premier introduced both economic and political reforms. He sought closer relations with the West, which he saw as necessary to provide needed know-how and financial assistance. Gorbachev did not, however, envision the end of Communist Party rule. When the economic promises of "perestroika" did not materialize, the more liberal political environment created by "glasnost" threatened the Party's power and privileges. A poorly planned coup d'etat was attempted by hardliners in the Party in August 1991, including the brief arrest of Gorbachev. The coup failed when thousands of ordinary Russians took to the streets to oppose the power grab by "grey men". Former Moscow Party boss Boris Yeltsin became the public face of the coup opposition. Yeltsin, who had been a member of Gorbachev's inner circle but had fallen out of favor by criticizing the slow pace of reforms, leveraged the coup attempt to promote himself as leader of the Russian Federation, eventually leading to the dissolution of the U.S.S.R. on New Year's Eve 1991.

Boris Yeltsin led a country emerging from seventy years of totalitarian Communist rule and in search of its new identity. Yeltsin supported the adoption of a western-style market economy and liberal democracy. Yeltsin's team, consisting of liberal Russian economists and encouraged by the U.S. and European governments, proposed a policy of "shock therapy" that would rapidly transform Russia into a market-oriented democracy. Russia also perceived that it had lost its status as a great power due to the break up of the Soviet Union. The expansion of NATO in several former Warsaw Pact countries in the late 1990s added to this sense of loss. The imposition of such drastic changes in a country lacking the West's experience in citizen participation in government and business resulted in confusion and disillusionment. Poor planning and execution led to a financial crisis in 1998 characterized by hyperinflation and the near collapse of the ruble. A feeling of chaos reigned in Russian society. The crisis severely eroded support for Yeltsin and western-style democracy and was a major contributor, in addition to the unpopular war in Chechnya, to Yeltsin's decision to resign from the presidency in December 1999.

Yeltsin named little-known Vladimir Putin as his successor. The former KGB officer enjoyed growing popularity due to his perceived toughness in the war in Chechnya. Many Russians believed Putin could end the chaos and restore stability and national pride. Putin initially presented himself as a liberal, appearing to court closer relations with the West. Putin leveraged the West’s eagerness to incorporate Russia into the international economic and security system to obtain Russia’s entry into the G-7 (renamed the G-8), promote foreign investment, and create European energy dependency. Putin’s criticism of NATO’s involvement in Bosnia and expansion of former Warsaw Pact countries was under-appreciated by western governments. Putin nevertheless allowed the U.S. military to use a Russian air base for supply operations at the start of the Afghan War. As Russia’s economy improved, bolstered by strong energy prices, and revamped its military, Putin’s tone began to change.

In the mid-2000s, Putin’s actions and words began to resemble more traditional Russian leaders. Putin emphasized more and more his country’s ‘special mission’, which historically meant opposition to western culture and values. The critical role of Russia as a great power also became a more frequent theme. In 2007, the Russian president delivered a speech in Munich that sharply criticized the United States' monopolistic position in global affairs, describing it as ‘unacceptable’ and ‘impossible’. Georgia’s desire for closer ties to the European Union and NATO played a key role in Putin’s decision to use military force against the former Soviet republic in August 2008. This action reminded the United States and its western allies of the potential limits of Putin’s commitment to cooperation with the West and foreshadowed events in Ukraine.

The Russian president gradually but consistently introduced measures restricting the free press and opposition political parties. During the 2008 global financial crisis, Putin maintained economic stability by utilizing a special fund created with energy earnings. Many Russians appeared willing to accept the restrictions in exchange for a better standard of living. Putin’s attempt to run for a third presidential term in 2012 was marred by allegations of vote-rigging and sparked massive street demonstrations in many Russian cities. The scale of the protests shocked Putin, who feared a popular uprising that might lead to a ‘color revolution’ similar to what had occurred in nearby Georgia and Ukraine. The experience was a wake-up call for Putin. The Russian president intended to avoid future challenges to his authority and began to enact more draconian policies. Over the subsequent decade, more far-reaching restrictions were placed on journalists and political activists. Violence became more commonplace. Several prominent journalists and political opponents were killed, the most notorious of which was the brazen assassination of Putin critic Boris Nemtsov in 2015. In 2020, Alexei Navalny, widely considered Putin’s primary rival, was poisoned by FSB agents while on a flight in Siberia. Navalny barely survived and is currently imprisoned in Russia. Putin has also not been afraid to go after critics outside Russia.

Perhaps in response to a declining economy and falling approval ratings in the early 2010s, Putin took steps to re-establish Russia as a global power on par with the U.S. and China. Officially part of Ukraine since the late 1950s, Crimea, Putin argued, historically belonged to Russia. Using the pretext of protecting the peninsula's Russian-speaking population, Putin sent unmarked troops into Crimea in 2014. The ‘little green men’ met no resistance and were welcomed by much of the local population. The Russian president wagered that Ukraine’s military was too weak to resist and that the U.S. and NATO would not risk direct war with Russia. Putin won the gamble. Russia added further instability in Ukraine by supporting separatists in two eastern regions, thereby giving Putin continued leverage against Ukraine’s government. The Russian president acted more like a Russian Tsar, trying to expand Russia’s empire. The move bolstered Putin’s popularity at home, allowing him to consolidate his power further.

Putin was recreating the traditional totalitarian police state that existed in Russia under the Tsars and Communists. The state legislative, or Duma, now firmly under Putin’s control, passed new laws further restricting speech critical of the government, rights to assemble and protest, and the ability of foreign organizations to operate within Russia. Many of these measures harked back to Soviet and even pre-Soviet times. As a result, most independent media and social organizations have been suppressed or forced to close, with certain members facing potential imprisonment. In Summer 2020, the Russian people approved a national referendum approving a constitutional change that allowed Vladimir Putin to remain in office beyond his current term ending in 2024. The referendum, heavily backed by the Kremlin, enables Putin to run for two additional terms extending his time as president until 2036. The move effectively gives the Russian leader a life term in office.

Secure in his political position at home, Putin has turned his attention to establishing his legacy. A fundamental tenet was restoring Russia’s status as a global superpower. Russian forces' unprovoked invasion of Ukraine in February 2022 aligned with Putin’s desire to see himself as the leader who reconstructed the Russian Empire. He has even compared his actions to those of Peter, The Great. Despite being surprised by NATO's strong support for Ukraine and Ukraine's stiff resistance, Putin seems intent on continuing the conflict, likely fearful that perceived weakness or defeat would, as with prior Russian leaders, have devasting consequences. Thus, Putin's conduct appears to be in line with historical Russian leaders. Putin as well deals with the eternal Russian paradox of admiration and hostility with the West. Western leaders would do well to look at the past as a guide to the Russian President's future actions to devise their responses.