Brookings Report Offers Theories on Russia's New `Virtual Economy'

Article excerpt

The following is extracted with permission from a Brookings Institution report entitled: "Beyond a bailout: time to face reality about Russia's `virtual economy' "

The idea that Russia's economic problems can be remedied by collecting more taxes and cutting back on government spending [and] an emergency loan package is premised on a fundamental misunderstanding of the Russian economy.

In fact, most of the Russian economy has not been making progress toward the market, nor even marking time. It is actively moving away from the market. Over the past six years of "radical reform," what has emerged in Russia is something that arguably qualifies as a new type of economic system with its own rules and criteria for success and failure.

The simplest way to understand today's Russian economy is to imagine that it consists of only four sectors. First, there is the household sector. It supplies labor. Second, there is a government, or budget, sector that transfers tax receipts to the households. Third, there is a value-adding production sector (we call it Gazprom for short). We designate these three, respectively, "H" for (households), "B" (for budgets), and "G" (for Gazprom). Finally there is a fourth sector, a value-subtracting manufacturing sector, "M," that encompasses all the rest of the economy (speaking somewhat loosely - but not very).

Think of M as a single plant that takes 100 rubles of labor from H and 100 rubles of gas from G and makes a product worth 100 rubles. It subtracts, or destroys 100 rubles worth of value. But it pretends that it is a value-adder. To do that, it overprices its output.

It claims [the output] is worth not 100, but 300. And everyone else accepts that pretense. They do so because they can use the overpriced output in barter trade with one another (where prices have no meaning) or to pay their own taxes.

Mpays G for the gas by giving it one-third of its final product, claiming it is worth 100 rubles. (In market terms it is worth only 33 1/3). That is fine with G, since it merely passes the product on to B in fulfillment of its tax obligation. (We assume a 100-percent tax rate on value added. …