Courtesy Reuters

Russia's Virtual Economy

BEYOND THE BAILOUT

The immediate causes of Russia's current financial crisis are clear -- a large budget deficit and an inability to service the debt, especially short-term dollar liabilities. Equally straightforward steps to solve these problems have been widely proposed. Moscow is being asked to reduce its budget deficit by collecting more taxes and cutting spending. International financial organizations and Western countries in July pledged an emergency loan package of $17 billion to stabilize the immediate financial crisis and restructure the short-term debt. These measures, it is argued, will allow the government to get back to the business of market reform.

But such measures cannot remedy Russia's economic problems. They are premised on a fundamental, but nearly ubiquitous, misunderstanding of the Russian economy, which goes something like this: Russia showed early success in market reform, but progress has been slowed by widespread corruption, crime, and incompetence. The explosion of barter arrangements and nonpayment of wages and taxes is due to faulty management of enterprises. Poor tax collection has weakened the state. Overcoming these obstacles is a formidable challenge, but if they can be surmounted, movement toward the market can continue.

In fact, most of the Russian economy has not been making progress toward the market or even marking time. It is actively moving in the other direction. Over the past six years, Russian companies, especially in the manufacturing sector, have indeed changed the way they operate, but to protect themselves against the market rather than join it. What has emerged in Russia is a new kind of economic system with its own rules and its own criteria for success and failure.

The new system can be called Russia's virtual economy because it is based on an illusion about almost every important parameter: prices, sales, wages, taxes, and budgets. At its heart is the pretense that the economy is much larger than it really is. This pretense allows for a larger government and larger expenditures than Russia can afford. It is the real

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