THE ILLEGAL ECONOMY UNDER GORBACHEV: GROWTH AND IMPLICATIONS (SOV 90-10020)

Created: 4/1/1990

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The Illegal Economy Under Gorbachev: Growth and Implications

istorical review programanitized

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Illegal Economy Under Gorbachev: Growth and Implications,

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conomy UnderGrovrih and Implicit lion!

KeySoviet "'shadow"includes illegal produciion of goods

Mmiearmsciviccj. andtf-lhe-counler sales, and black-marketgrown

under Gorbachev. Muchof this growth hii resulted from tbeSoviet

-or aaa#tl (An

fforts to reform society and impiove economic perfoimance

niiaicohol campaign, for eaample, led directlyharp

Increase in tUegal alcohol production and diverted revenue* from the slate

secioi lo producers and distributors operating ouuide Ihe law. Governmeni

revcnuei stagnated, while budgetncreased itcadtly, resulting

arge budget deficit This deficit pumped money into Ihe economy that

unmatched by increases in the legal availability of consumet goods and

services, creating hechonse condilion* for the gro-th of blict-maikct

activities Larns pernwiiog more private initiative provided addition*!

oepott unit ic* tor tbe shadow economy'* growth

Theeeonoscv on* probably served at somethingafeiy rahe enabling beiter-otT eoarsntner* ic aceuire badly needed goods and services, bul il hat* alt*e* acerbated locialedueed the slate's ibility is meet pressing consumernd offered incentive) for increasingly serioui and violent crime. Real and pcicetvcd connect ions between Ihe shadow economy and cooperalive et'.leipiises have contributedopular backlashll cnlicptcneurs in the cooperative sector. Resulting restrictive legislation will make it harder foi cooreraiive* to contributeolution or Ihr economy'* problems The regimes plan lo item Ihe gtowth of Ihe sltadnu economy thiough betlei law enforcement ii likely lo yield minimal results, as long as the incentives to commit such crimes rcmair. Itiong

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Haa Illegal Economy Under Gorbachev: Growth and Implications *

"Shadow" Economy Before &oit-cbr> When Gorbachev came to powerhe sittc-cooirocled system for producing ind distributing goods and services and the "shadow"diverse collection of private economic activities let-bidden under Sovietcceiisted uneasily for some lime The inefficient siatc production and disiri-button system provided fertile ground for the growth of such activities as Mack-mar keieeilng.ground" prodocban. and under'tie-counter sales.low stale prices enroenied black-market trading, while the poor quality of itaie supplied goods and services ensured high demand and high prices for belief quality goods and services supplied by prixte entrepreneurs. Stealing from ihe itaie was-ioely viewed as an easy and victimless crime, and the regime's inattention lo mm iter inf. personalwhich are not subject lo large directit easy to conceal earnings derived from unsanctioned economic activity

The supplementary goods and services delivered by ihe shadow economy to the pepubtioo partiallyfor the failings of the state distribution system. In addition, illegal operators respondingto consumer demand could often use resources mote effectively than could stale enterprises, whirh responded to central plans and largely ignored eoi-sumer preferences. Al ihe same time, however* the shadow economy reduced the quality and Quantity of state production through the diversion of siitemachinery, and labor lo the private economy.

Impact of Corbashei's Policies Despite rJorbacheVi early ernphaUiOti law grid oroci and his effort! to eliminate Ihe iiKllicicrKy thai allowed illegal ecu noourish, weItis policies contributed lo lie shadow economy's growth. Gorbachev's aniialcohol campaignor example, spuncd rapid growth in the Illegal production and distribution of spirits bysharply re-ducinB Iht availability of alcohol in tine stores. As

consumers turned lo illegalnd homebrew, the stale's sirablc lai and sales revenue declined and the shadow economy reaped enortrout profits. Ac-curding lo economist Abel Aganbegyan. before it wis abandonedhe aniialcohol campaign cost ihe stale economy St billion rubles in threeots that contributed greatly to ihe growth of Ihe stale deficit

Efforts To liarPrlratr laiilaitw. Gorbachev sought to harness and legible ihe ihano- economy's beneficial aspectsnew laws on cooperatives and individual labor. In pattioular. Icgittalion enacted78 substantially cipanded Ihe scope of private economic activity and loosened the eligibility requirement for participation. Moscow hoped that increased legal private produciion ef goods andwould boost the consumer sector, preempt illegal operators, arc provide the itaie evenue source ihal oihorwise would have gone un tippedapid rise in the number of legal euoperalivn.this legislation failed to item the groivth of the shadow economy. According to Soviet press rcpom. many illegal operators chute io remain "in theto avoid taxei and hiratsment hy ihe auihori-ties, many activities remained unsanctioned, and Ibe growth of tht private lector crested new oppOttuntiies fee criminal activity

n iSt SAaitw Economy. Severe problems tt tire Soviei corn timer sectorS89 nested even mare fnorable conditions for the growth of illegal economic ictmly Rapidin money .worries unmatched by increases in ihe availability of consumer cOods or official inceases ii prices resulted in ineitreine imbalance between dctnand and supply lit resi>onse ia these changing Circumstances, illegal opeiatoi* iliic'icd more and morey from the s'aic retail tradender-the-counter sales, bribery, ind thcfl, and prices an the bLtck markete

t

^nfijrffnrr

markrI trade In cvaiumrr -innti hit come in

play an increiilnf ly impew Unl rale tn both vholetalc

flnd retailewdi*V

Urfc-tuk diversion of consumer iced*iofi cemti. ismrvfti inoi^c* cvtka, Trocks arriveai local ar cbonscs 11

eave filled witb etootMtvd*v* <klii*kd far

ukfcpBiin conference ia Ocict crater Rythko* cnlkd retail tradeshe Moil cr.nir-Md4cn sector* of Ihc national ccono ny"urc i)onference on tbe (ubjett i* ,mhret-erne Soviet>

fcatrMan A 1staled that them tierade SotcR WdaWiidtra

MOfeOrtt. attordtnt to Soriei opt*lit iKcfe arc hut*

lenses sisooaicd with the dlvciiion of toodi frorn ihr formal to the shadow economy Aceordini tonne eccuvomist wiiii'ai in the Soviet pr*m# "Opcfaioi. often deliberately dcttroy .yototi to neat ariont of warehouses.centeri. and

id ilton rates' -net* O* cUnsatc Si

iwnwani lacunu ofeiabkt. fraj*.

ecr. tW-Vundi and ere* (cm of

iScrujand* of head of livestock are detsroyed everyhe iiadittonoily hirh met rrpoMcdte durtatand storste hrJp ii>iversion of prr*-duct*on to ite biact mat

Law, tivtmtarte|mjwtof^rx^deat laacifn rxcwomrahoptoiidcd new

TrN* Soviet pens hatf

.'kiifn Rcerdt, mlSIMC

itibtidiitf ;mph. military hardoa^e. andalt abroad for hard currencyK often

buy'Rt and Olher htch*dcnMnil WeiicMt-*

io fellinflated prtcct on the So**e< blaci markcivi<<fcd cianifec ofealaa

j Mr live effort by ainpw"Wlt< of

cococ' .ef laeferue

The eUvelaawnent ol >cnni *enundriiinMict few Sovicit in iravd nbrontln-created the lW'fr1 currency tn ihc ttwldw

#a

attanaiiiT Atav1 incofrormncmKne veremlltonm the black markci. oniaei hand.altohreat ta fjfca]

Ge'-ba* So*mtnajnanai^#erict MnrriM-tK CtjnKit-t. up to pcfcent of

l by Ihc

lfd: tiorut Or ftMntidr

Opcraietfi *itutfow cconofny

j orianucat

iMC'rnnlrtftWU4"-

rf *h'cir*iin ;iriAUrMitfiHcufand iMfnin.-il

fi gradf" ini numhrrrccjiont of ihr

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loibtiling Sovietband in thciiadcw economy it engaged km only in tradilicnal ihaiow ccooomy act ivitiu bul alio in more aeriooi and 'ioteni crime. He rcroiti. lot cuni|ila. that in organised crime group* ircratly uncovered lit Moicew had divided tae city into ipheeei ol mfin which they rent rcQed coopc'iiivri. foreign mi nr. cy ipeculaton. and preeOtaiea, aad tngagfd ia croaked car ulu.ad aaaimiaiu borglarici

Crimtotfeiiiltt. Tke aborKcaoaaei oiI Law oa (arptiixrrti have leacrd kgtny "tlercd prime tuurveiKi io nake freovent farayi bail into ibeto keep theMeWra aAoat The failure ofnor adequate leial roureei of vjpply for prinie Kinr.eiiei. loi ciamtwt. all forced coocculivca loreaon to the ihadnw ecmco> to obtainhave utuilli been itc-lt* ficen tbe farm! economy. To operate without Iccal fOvirnmcnl hiraumcnt, mot com. roopolltlvten muil often tribe official! In either iniltncc.ovuiot ihe law makii the troperaiivei tnoe. vulnerable to eiiortion ai the handi of racketeer Accordingoviet picii ccenmom. "Thru an iw. cemtteaopen in aeitherbide by law and iboi be irantunc lo blackmail, ur lo tUlivai More often Ibaa not. Ihe liritut ofaw-tbiding cooperative won't nay in buiineit feeven when coapeeutKne do no break Ihe Law, ihey ate tempting targets for lhahc

down!lijcd Oiire The head ofgroup sf

Movcm eoopeiim we*nitted! thatad prwcciian momet coal ihe eny'i cooperativeseillieei ritbfca lait year (vee hat" JJ

Eajarermttt. Trw So-eri have tee*lo ccrb what lacy retard ai an 'aiwan

^

crmewaie" the cutting la*ew rains, lacieuita street crimereaboawa oi law aiid order hat livened the anratmaofway from ibethndow eeonomv.illegal opera ion freer reia. According to ufliusl Hainiiei. Overall Crime increased il percent lait year, bai

"mercenary"'of which are (dated

ihe ihsdowK> to li

The criminal invemgationI preparedope with Ihe wrgiiif etit-ie rile Moreover. Ihe

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-

mtltla itself i> often corrupt, and many of tuart reportedly paid off by operators in Ibe shadow economy.esult. oSiciili in the justice system admit that there hasharp decline in bringing perpetrators of economic crime to justice

f the Growth In Ibr. There has been much debate in the Soviet proas over the tute of the thadow economy. Both Soviei and ettern experts agree thatifficult to measure accurately, and estimates of its stu vary neatly (sec iint-'j. State Planning Committee (Caspian) economist Tatyaaa Kotyaetna. who has published the most scholarly Soviet studies of the shadow economy,thai many recent unofficial estimates arcfor political reasons -the growth of tbe shadow economy hasause for partystimates thai the value of goods and lenient produced or distributed by the shadownow amountsillion rabies (Soviet CNP iii!liony her estimate, abouiitlion Sovietcomparedlate labor forceOinvoked in the shadow ccoaomy. Many or these individuals have full-time jobs ia the stale sector and cntaic ia illegal economic activities either after hours or during work. According toovietis tics piblished for ihe firs! limeyear,9 the illegal interne of eitirmtabillion rubles, includingillion from ibe illegal production and ilkillion from under-ihe-ecunice dealings by workers in trade, public dining, and health andservices; andillion from tie resile of stolen construction materials, automobiles, spare parts, and gasoline

Whatever the shadow economy'! value, it islarge, and the lurge generated by ihecurreni erins in the consumer sector Sai alarmed Soviei leaders According io Bakaiir. the sits do- economy is tbe asoti dangerous criminal threat to Soviet society Its growth ii threatening to ih- Goihiche. icgime inmportant respect

Income Inegualiliet. The itiuoiwctet tea Income Inequalnies ind limits the stale's abJilyaintain Ihe living standard of lover[roups. While Soviet price policy has litem pled

t^tfllljenlril

eep essential goodsin ihc reach of everyone, ibc large-scale diversion of ihete goods into (be black market hai lefl titlebare and nested ihe poorer stratum ofelderlyout of the markei. Al tie lame lime, those -bo can obtain foods In short supply, often by bribery or theft, areosition lo earn profits many limes larger than ihe average titleTbe large amount of purchasing power in ibc hands of many Sonetexacerbates the situation. According lo'* 'Volatile* money wilh nothing to spend it on has provided the basisubstantial redistribution of income by unlawful methods-^bribery, speculation, and racketeering."

Ititnoiti Foliiieal Tmiantime of worsenirtg political tensions, the growth of the shadow economy is another source of public discontent Illegalhave grown bolder, and their high profits art now much more visible lo Iheellerlate worker published in Pronto last stmmer. for example, dcftrlbedoung woman set up shop on Ihe street and sold cases of slate-made butter for several limes Ihe tlaie price. The writer tipressed outrage at the new "brarenntss" of speculators. "These dealers used lo operate somewhathe"and they dealt in small lots- Qui here you hadcasts Her self-confidence made me ibdig-nam "

Gtoiroi' hai led to regular reports of crime in tbe SOvkI press, and this hat abo incrciied publicor the shadow economy. As life has become harder for Ihe average worker and Ibe earnings of profiteers has become more visible, traditional public acceptance of the shadow economy rot increasingly turned to resentment. The authorities' inability lo control ihe problem has caused such resentmeni to takeolitical colorm Accordingenin grad'spany leader. Bom Gidaspov, mt highly visible corruption of the second economy is giving risedistrust, malice, and aggression-on the pan of ihe public

J'ii.Viiii* Agalmi Coopernrirer. Not surprisingly, ihe more visible cooperatives, rather than illegalhave borne the brnni ol public biiterrscss. Sratc workers have been particularly vociferous in iheir complaints againsl the cooperative movement, ofirn

vie-mg it as in eitcnsion of the shadow economy.or mmple, ihe All-Union Central Counts! of Trade Unions (AUCCTU)harpainste3emsn" cooperatives, clttrg Ing thai iheaesimply buy ap or Steal cheap title goods and resell them at an enormous profit. The irade union lobbiedan on these activities. Opposition to newly visible "millionaires" hasallying poiol for recently formed traditionalist workers' groups, including the Leningrad United Workers* Front. One worker writes, 'People see ho- Iht bigwigs of the shadow economy and ihe pteudc-eoopertiivcs are gellinghc lirrtpk person is more and mote frequently asking the Question: whythere more and more difficulties for those -ho arc working honestly al slate enterprises'"

In port,esell of public outcry againstia9 the Supreme Soviel approved amendments io the Law on Cooperatives that banned "middlrmtn"'that purchase and then resellencouraged local government* io sei price limitsbasic necessities sold by Ihe cooperatives. The decree called fot more sirIngrnt tan inspections and other efforts lo ensure cooperatives make lull payment of taies. In response to complain* thai illegal mooey is being launderedCaspian has submitted proposals io ibcof Ministers to enable Moscow to monitorcash ind noncash transactions Cooperatives -ould bt prevented from putting revenues in prrvaie accounts, and cash withdrawals would be restricted to funds to ply wages cover travel eipenses. and buy raw ma knits

Moscow Starehnolution In ihe short term,pproaching the ihado-econorrifroblem Tor law enforcementtoongncisures against thr shadow economy ate being plannedpariroidtr elTori to comtul ntingraft programuld greatly increase rctourcet for law enforcement, for eiample. has been prepared and foruarded foeby Ihc Council of Ministers. Accordinc lo ihe Sovietraft law sharply increasing fines ind

(.Uulid'HiuK.

jail termsuses In luce ind speculation has alia been put forward, and special aaiu lo combatcrime hive been set up within Itw enfocceitteniiu tioos.

9 Moscowecond speciSI eichangc rate fot (he ruble in an eflbellcen growth of Ihe hard currency stack market. The rale, which It for noncommercial transaction) only. effers6 rubiesheboiler than Ihe official rale ofoopecks pero date, however. Ihe special ruble exchange rale has had Utile success in once-waging worrits to exchange ibeii tablet solely through official channels because blacb-markei dealers have been willing lo pay up ioubles per dollar io counter the government's ertoils to drive ibem out of busancu

Moil Soviet leaders reeoiniie that, in the ton* term, Habiliaiion of the consumer sector will be necessary before iny real proiress eaa be made in reducing ibe site of Ihe shadow economy. Moscow has launched an all-out effort io achieve this goal. The economic siabitiiaiion program callspercent annual increase in the production of consumer goods and services over ihe scat two years, la be supplemented by stepped-up import* of consumer goods. To meet these targets, Moscow Is diverting defease resources and inveslnteal in heavy industry io consumer areas. This pros ram. as miny Soviet lead, ert now admit, is almost certain to come up short because it filli to ivbitanlitlly eliminate or neutialiie sources of ncets demand and because ihe long-neglected consumer industries lark Ihe capacity and needed inputs lo meet plan target* Additional siabili-laiicn measures are now being debaled

One measure under debateonetary reform designed lo cut execs* purchasing power andue the wealth of the shadow economy The rclaim if supported by such iradiliontlists as Ligachev. the United Workers' Front, and ihe AUCCTI I. Accord-ing to Ligachev. each Soviei eibien couldOW0 lubles for new currencyne-in-onc basis. Individuals with more thin mat amount -mild have to document Iheir income oritlio1 Other Soviei leaders opposeeform. however, believing tin it would be at best a

temporary solution because ihe budgetthe printing of money net hacked up bypersists. Moreovereform would probably not do grctt damage to opera tori In the shadow economy. According lo Ryihkov. "Study dealer*are worth Ihe* tali will be able lo hide titer capital, put It In real estate, valuables, aad other 'ihelien' for diihon-eitly acquired money."

Outlook and Implications

Koryigiai ferecasis ihal tie atnual value or tbe ihidow economy could roe nearlyercent In the neai fewillion rubles. More sericus crime tsiociated with tie shadow economyprobably also increase. Bakatin offered ihi* gloomy prediction al ihe beginning of November:

Crime probably fill hour re rire. In ike pott everyoneonth, bul no. there or,-hoi.OOO. oraturally, ihtrr err profit who mvld like lo pel ihat much moneyraniiuoaal period there tan be no balancednd unbalancedalwoyt lendile in crime

We believe the measures taken bythus far lo item illegal private economie activity will have little ioifiiei because ihey attack only Ihe symptom* of the problem and do not hint lo reduce the high incentive, to operate in the shade eeeoony. Low sine tela.il prices and eiceis purchasing power ia the hands of coasumers wilt combine to increase sueh lelrvities at speculation,e-counter nhs. and misippro-prialioa of government property Moreover, lo avoid entinglemeni vrith the crimxial world, the private sector needs reliable legal sources of supply These wju be diflkbli ro provide, bawe.ee. because enter -prisei have boon given sueh high largei* for consumer gi-yh production they will have few resources to spare The moilay to curb profiteering is to improve supplies and to deecnuol state prices Until thit is done the incentive loueh activities will he strongnforcement of laws costly At Korrarina argues, each new step back from

-nri.l

tt Ihe ban on middleman cooper*, economic icii'liy undergroundkio ihe hands of ihe unfit '

Recently pasted economic ttabiliiattoo meaiures, In our view, increase the incentive to stoat from ihe slate and sell stolen toodirofit. Moscow has also cnacitd temporary legislation to free re or more sulci-ly control pricesumber of essential feed and ron'ced consumer goods. This will likely increase ihe gap between low stale prices and prices thai would balaatc supply and demand, increasing prohti for black marketeers. Because enterprises will have lest of an memfrve to produce load* whose prices are now controlled, shortages may be ciacerbated, further drivirg up black-market prices. Moreover, theefdeenmini lining Ibe private sectoe will be

eomrlcalcdthe rr.in* ccerui" ofltciili who hive

an interest in maintabUng Ihe current How of bribe money and olher illegal perquisites. tsakalin recently expressed cynicism over Moscow's prospects fortab dilemma, stating, "Wc do not have an ethic of privtie enterprise, rather there are iht morals of Ihe sv. inflers of the shadow ecoiomy."

The iipMtiOn of the shitkw economy will complicate Moscow's eltorti to improve ibe lot of Ihe average cnntumci Emergency meaturta to proicci coniumers from lunation wiltimited effect if sine stores are Larrdy empty and illegal channels of diMr thai ion are the only alicanativt Thar* haa been muchby Soiiel eeonomiitt of lb* need loa rite basket ef iiwiprniive good* to be micee itirouch special ehanaalt so lower iaennse grosrpo.

cale ebuerlina of

good* tc-ieruike thai eufoenh task

Fear* about the emergencelass of wealthy and sophisticated criminal* may also slow eoaaonieSoviet lendersd the ipccter ol theeconomy ai an aiturneni in favor of slnvins: additionalallowing pnvaie ownership They fear thit lootcntng central conirolallow the viforous criminal dement lo Hep in andwegmenis id iht economy

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