Duśan Repčák explores the story of how a nation focused on equalising income became the world’s most unequal economy – and uncovers fundamental flaws in the way we usually measure inequality.
During the first half of the 20th century, World Wars and the Great Depression compressed the incomes of the wealthiest across Europe. Despite this historically low inequality, one nation embarked on a plan to reduce wealth inequality beyond what others could imagine. The Soviet Regime in Russia and its satellite states used steeply progressive taxation of income and inherited wealth to finance the welfare state and nationalisation of industry in an attempt to end private property. In short, the aim was to reduce monetary inequality to the lowest level in human history.
Whilst the USSR tried to mitigate inequality, the West saw its rise. Conservative leaders in the UK, US and much of the West promoted ideas of trade liberalisation, anti-progressive taxation and financial deregulation. The divided city of Berlin perhaps best illustrated the contrast and conflict between the two ideologies and served as a focal point during the dissolution of the USSR altogether in 1991. It was under this context that contemporary Russian president, Boris Yeltsin, initiated a process of economic transformation by the means of ‘shocktherapy‘.
Shock Therapy and its Consequences for Inequality
Shock therapy is a set of policies used to rapidly transform a planned economy to a market economy; such policies include not only trade liberalisation and withdrawal of state subsidies, but also an immediate release of price controls and privatisation. Between 1992 and 1994, the privatisation of around 15,000 Russian state-enterprises took place in the form of ‘voucher privatisation’; a privatisation policy used relatively successfully earlier in Czechoslovakia. The vouchers, which could be exchanged for shares in former state enterprises, were distributed equally across the population. This was meant to prevent high concentration of ownership among the Russian mafia, which the government feared.
Despite even higher participation rates than in Czechoslovakia, the nature of the vouchers encouraged poorer segments of the population to exchange their vouchers for cash rather than to invest. As a result, small groups of individuals in the management of privatised firms were able to buy back large quantities of vouchers at relatively low prices and, in some cases, obtained highly profitable deals with public authorities. These groups of individuals soon emerged as oligarchs and would amass great wealth as a result. In the USSR, prices were often kept artificially low for decades, as the market equilibrium was distorted by the use of price controls. Their sudden release during shock therapy sparked off hyper-inflation; the consumer price index was multiplied by a factor of 5000 between 1990-96. Not only did living costs for Russians increase dramatically, but household financial assets (mostly Soviet-era saving accounts), which amounted to 80% of national income, were worth close to nothing by the late 1990’s.
Both voucher privatisation and hyperinflation caused a dramatic increase in income and wealth inequality across Russia. The top 10% of earners’ income share rose from 25% of national income in 1990 to 45% in 1996, whereas the bottom 50% share dropped from 30% of national income in 1990 to less than 10% in 1996. Voucher privatisation played a key role in the former and hyper-inflation exacerbated the latter. Interestingly, the Gini coefficient reaches peak values between 1993-96: this contrasts with top 10% and top 1% income share series with peak levels in 2007-2008. The reason for this is due to the particularly low bottom 50% share in the early 90’s, which helps reveal one of the main limitations of Gini Coefficient. Because different Lorenz Curves can result in the same Gini Coefficient, the curve actually tells us very little about the reality of inequality for particular segments of the population by income percentile. This illustrates the need to think beyond the coefficient numbers to measure inequality, especially since it cannot account for offshore wealth.
The Trade Surplus Paradox
Since the early 1990s, Russia has run a large trade surplus every year driven by exports in oil and gas, averaging about 10% of national income annually. In theory, this should have led to a massive accumulation of foreign assets. Paradoxically, the net foreign assets accumulated by Russia are surprisingly small, around 25% of national income by 2015. How can we explain such a low level of net foreign wealth accumulation? The net foreign assets can appear small on paper because offshore wealth in tax havens is unrecorded in national statistics. There has been evidence of widespread use of offshore entities organising financial and business transactions with those who benefited from Russian trade surpluses. Who benefited from this “missing” wealth? First, it has been the small group of foreign investors who made profits on the Russian stock market boom between 1998 and 2008. Second, there are Russian nationals, who are now foreign residents and have diverted their assets abroad. Finally, there are Russian residents, whose wealth is offshored in tax haven countries such as Switzerland, Cyprus and Monaco. Global Forbes billionaire data shows this final group of Russian residents are the main beneficiary of trade surpluses, since the vast majority of Russian billionaires have residency in Russia.
Since these activities happen under the surface, details about exact numbers are unclear, but conservative estimates show that offshore wealth reaches 85% of national income (as of 2015), equalling 50% of total Russian financial wealth. In other words, Russian oligarchs own approximately as much wealth abroad as the entire country does within its borders. It should be clear that the Gini coefficient is not a sufficient measure of inequality. Although the Russian Gini coefficient has generally increased over the past decade, it hit record lows of 36.8 in 2016. Ironically, this was the year Credit Suisse Wealth Report claimed Russia to be the most unequal economy in the world, with the top 1% sharing almost 65% of total wealth; this number is unprecedented. The top 1% share now stands at 58% by this metric, leaving Russia as the most unequal country in the world. For comparison, the top 1% share in the US is about 35%, and 22% in the UK.
Inequality in Context
It is hard to doubt that inequality levels in modern Russia are now comparable to Tsarist Russia. In fact the very top income shares may be even larger in Russia today. This appears to be largely the legacy of a flawed voucher privatisation scheme, as well as the hyper-inflation and offshoring of wealth that followed. At the same time, extreme inequality seems to be more acceptable when average living standards are comparably higher between the periods of modern and Tsarist Russia. That being said, latest surveys show that around 45% of Russians have monthly income of 15 000 rubles (£146), with the monthly expenses for a family household (two parents and one child) estimated at around 60 000 rubles (£587). It is important to remember the Russian historical context. The drastic failure of Soviet communism and history of bloody revolution plays a role in the high tolerance for inequality without major uprising. One can argue that the reality in Russia today is that extreme inequality is acceptable, as long as billionaires and oligarchs appear to be loyal to the Russian state and perceived national interests. However, it is worth noting that history – as well as signs from current Russian politics – suggests that this equilibrium is fragile. Indeed, in January 2021 the Russian opposition leader Alexej Navalny released a documentary which describes connections between Putin and Russian oligarchs, which has coincided with the largest series of protests throughout his presidency, across 112 cities. The socio-economic equilibrium today seems more fragile than ever. Whether the current oligarchic regime will persist, we are yet to find out.
Perhaps equally fragile may be the continued reliance by academics and politicians on the Gini coefficient as a sure-fire way of measuring inequality. The story of modern Russian inequality shows that different income groups can be affected in different ways without this showing up on the coefficient number. If the nature of Russian inequality can be arguably confused by opposite changes in the coefficient, then perhaps a new cardinal inequality measure needs to be agreed on. For the Gini coefficient in Chile, at a time of great national protest and anger about inequality, to show up lower than stable democracies like Germany, Sweden and Denmark, there must be some credibility to the idea that this number may not tell us what need to know about the reality of inequality between income groups.