Russian Revolution

On <?xml:namespace prefix = st1 ns = “urn:schemas-microsoft-com:office:smarttags” />December 2, 2003, Andrei Illarionov, Russian President Vladimir Putin's chief economic adviser, stunned green activists the world over when, speaking on behalf of the President, he announced that Russia would not ratify the Kyoto Protocol on climate change “in its present form.”  Kyoto cannot go into effect unless ratified by countries responsible for at least 55 percent of the world's emissions.  Because the United States has rejected Kyoto, Russia, with a 17 percent share of world emissions, effectively has veto power over the entire treaty.  Illarionov's announcement was Kyoto's death knell, and it caught green activists unaware.  However, given Illarionov's support of free markets and close ties to President Putin, this outcome was not unexpected. <?xml:namespace prefix = o ns = “urn:schemas-microsoft-com:office:office” />

In 2000, President Putin hired Illarionov as his top economic adviser and endorsed his ambitious goal to double the size of Russia's economy in 10 years.  A month before Putin's public rejection of Kyoto, Illarionov pointed out that the treaty's emissions reduction targets would make this goal impossible.  He told attendees at the United Nations World Climate Change Conference, held September 29-October 3 in Moscow: “No country in the world can double its GDP with a lower increase in carbon dioxide emissions.” 


At the conference, Putin said that Russia did not intend to ratify Kyoto—but stopped short of the firm rejection conveyed by Illarionov in December—so it should have been clear then that Illarionov had Putin's ear on Kyoto.  The day after Illarionov's announcement, Deputy Economic and Trade Minister Mukhamed Tsikhanov said that Russia was moving towards Kyoto ratification, but Illarionov retorted, “The statement was made physically by me, but the words I was using were those of the Russian president.”  That Putin has not contradicted Illarionov should demonstrate that he trusts his economic adviser implicitly.  Indeed, Putin supports Illarionov in other areas and has enacted many of his policy proposals, which are now the leading edge of a Russian economic revolution.


A Long, Hard Road


Illarionov, 40, has been called a radical reformist, but he insists that his free-market views would be considered mainstream in other countries, just not in Russia, whose Soviet-warped polity he once compared to “a mixture of Brazil and Mexico of the 1960s and present-day Zambia and Nigeria.”  For Illarionov, helping to put Russia on the path to prosperity has been a long, hard road.


The son of two teachers, and, like Putin, a native of St. Petersburg, Andrei Illarionov received a Ph.D. in economics from St. Petersburg State University and came to Moscow in the early 1990s as President Boris Yeltsin launched Russia's first market reforms by freeing prices.  He began his policy career in 1992, as an economic analyst in Yeltsin's government, under reformer Yegor Gaidar.


Gaidar, who had served as economy and finance minister, was named acting prime minister in June 1992, but was forced to resign at the end of that year.  He was replaced by Viktor Chernomyrdin, but stayed in Yeltsin's government as a senior economic adviser.  However, both Illarionov and Gaidar resigned in 1994, accusing Chernomyrdin of backtracking on reforms initiated by Gaidar.


After leaving government, Illarionov, a fan of Ayn Rand, headed the Institute for Economic Analysis, a Moscow-based free-market think tank, which he helped found.


The Ruble Collapse


The August 1998 collapse of the ruble brought Illarionov notoriety as the first analyst to sound the alarm.  He pleaded unsuccessfully with Prime Minister Sergei Kirienko's government to allow a controlled devaluation of the ruble to avert the crash, and argued that loans and policy advice from the International Monetary Fund (IMF) had exacerbated the crisis.


A month after the ruble collapse, Illarionov brought his case to Washington.  Testifying before the U.S. House General Oversight and Investigations Subcommittee on the topic of IMF lending, he said: “The Fund program set a number of unrealistic targets to be met by the Russian authorities, including those for the rate of inflation, real GDP growth, and the trade balance.”


Illarionov pointed out that the IMF package, approved in July 1998, overestimated exchange rates.  It projected ruble exchange rates to the U.S. dollar at 6.22 in 1998 and 6.53 in 1999, but the ruble fell to 20 to the dollar by early September, less than two months after the Fund approved the package.  This overestimation led to the policy recommendation that monetary and exchange rate policies remain unchanged, since it seemed to be working to control inflation.  “In reality,” Illarionov told the committee, “given the low level of international reserves, the current account deficit since the second quarter of 1997, and growing capital flight from Russia, it was critically important to implement serious changes in monetary and exchange policy as early as in December 1997 and certainly in May or June 1998.  The postponement of such changes led to the aggravation of currency crisis and to a substantially higher rate of devaluation of the ruble.”


At the same hearing, Illarionov also noted the market-distorting effects of government-driven lending: “Decisions to provide financing for Russia, motivated by political rather than economic considerations, have given rise to the problem of moral hazard,” by providing “unearned financial assistance,” which can lead the recipient to “become even more irresponsible than it was before.”  In the Russian case, this included excessive government spending and borrowing.


Putin Comes Calling


Illarionov was right; the IMF was wrong.  In the fall of 1999, he was hired as an analyst at the Center for Strategic Planning, an economic policy think tank set up by then-acting President Vladimir Putin.  Putin—picked by ailing outgoing Russian President Boris Yeltsin to succeed him on December 31, 1999—was elected President of Russia on March 26, 2000.


That same month, the Center for Strategic Planning unveiled The Strategy of Development for the Russian Federation to the Year 2010, the Putin government's new economic platform, co-authored by Illarionov, along with fellow liberal reformers German Gref, Alexei Kudrin, and Alexey Ulyukaev.  The document set an ambitious reformist agenda, including deregulation of the economy, strengthening of property rights, closing of money-losing state enterprises while providing temporary assistance to displaced employees, replacing the state-funded pension system with private accounts in a state-controlled pension fund, phasing out housing subsidies while targeting assistance to the truly needy, and introducing competition in the provision of utilities.


In April 2000, Putin appointed Illarionov as his top economic adviser, and endorsed Illarionov's vision of doubling the size of the Russian economy in 10 years and his proposal for a 13 percent flat tax.  Putin also endorsed the Strategy of Development's proposal to cut government spending to about half its current 35 percent share of GDP, which Illarionov insists is necessary for Russia to be able to double her GDP in 10 years.


The Future of Reform


Illarionov has not been shy about his goals and has pursued them aggressively.  Shortly after his appointment as Putin's top economic adviser, Illarionov brought to Moscow some of the world's most successful free-market reformers, including José Piñera, the architect of Chile's innovative public pension privatization and current director of the Cato Institute's Social Security reform project, and New Zealand's former Finance Minister Roger Douglas and former Treasury Secretary Graham Scott, who helped implement free market reforms in that country.  So far, the prospects look good for replicating their successes in Russia.


Reforms advocated by Illarionov and enacted by Putin's government have already yielded impressive results, giving Russia GDP growth of 9 percent in 2000, 5 percent in 2001, and 4 percent in 2002.  Last month, the Russian government revised its GDP growth estimate for 2003 to 6.6 percent


Government downsizing has cut the state's share of GDP to about 35 percent currently, down from a 40 percent GDP share from 1995 to 1998.


One of the most notable reforms is a 13 percent flat personal income tax, enacted in January 2001.  As George Mason University economist Peter Boettke points out, it has been a supply-side success story, lessening everyone's tax burden while boosting government revenues, which have nearly doubled, from $6.2 billion in 2000 to nearly $12 billion in 2002.  In January 2002, a 24 percent flat corporate profits tax came into effect.


Boettke also notes that these and other reforms—including greater protection for private property—have helped reduce black market activity by encouraging more and more people to bring economic activity above ground.  “You can't really blame them,” Illarionov says.  “People who work in the shadow economy are just trying to escape the government in order to make ends meet.”


More reforms are likely on the way.  Pension reform is moving along.  And last November, Illarionov called for allowing private companies to build oil and gas pipelines and other infrastructure projects.  “The creation of private-owned infrastructure is, in point of fact, the sole way to get away from monopoly in this key sphere of the economy,” he said. 


More importantly, the Russian rejection of the Kyoto Treaty shows that Putin supports Illarionov's rejection of any policies that would keep Russia's economy from surging ahead.  This is great news for Russia and serves as an example for the rest of the world.  Politicians everywhere would do well to heed Illarionov's words from a December 2000 interview:


“I have a magical solution for countries to get rich quickly.  It's called economic freedom, which means giving people the freedom to trade freely, produce and invest freely, with minimum intervention from the state.”