The world’s most unequal economy

Dusan Repcak
Mar 9 · 6 min read
source: https://quillette.com/2018/05/10/two-arguments-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 economy planned to reduce wealth inequality beyond what others could imagine. The Soviet regime used steeply progressive taxation of income and inherited wealth, the welfare state, and nationalisation in an attempt to put an end to 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 it rise. Conservative leaders in the UK, US, and much of the West promoted ideas of trade liberalisation, regressive taxation, and financial deregulation. The divided city of Berlin perhaps best illustrated the contrast between these two ideologies and served as a focal point during the dissolution of the USSR in 1991. It was under this context that Russian president Boris Yeltsin initiated a process of economic transformation: by the means of “shock therapy”.

Shock therapy and its consequences for inequality

Shock therapy is a set of policies that are used to rapidly transform a planned economy into 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 1992–94, the privatisation of about 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 a high concentration of ownership among the Russian mafia, which the government feared.

Russian privatisation voucher from 1992, source: http://www.parisglobalist.org/voucher-privatization-russia-nationalistic-capitalistic-policy/

Despite even higher participation rates than in Czechoslovakia, the nature of the vouchers allowed 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 became known as the oligarchs and would amass great wealth as a result.

Shock therapy had another impact on inequality in Russia. 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 combined with a withdrawal of state subsidies caused prices to rise so high it resulted in hyperinflation; the consumer price index increased 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 1990s.

Both the Voucher privatisation and hyper-inflation caused a drastic increase in income and wealth inequality across Russia. The top 10% 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 reached peak values between 1993–96. This contrasts with the top 10% and top 1% income share series with peak levels in 2007–2008. The reason for this is the particularly low bottom 50% share in the early 90s, which reveals one of the main limitations of the 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. This illustrates the need to go beyond the coefficient numbers to measure inequality, especially since it also cannot account for offshore wealth.

How the Gini index is calculated, source: https://www.ezyeducation.co.uk/ezyeconomicsdetails/ezylexicon-economic-glossary/1267-gini.html
How different Lorenz Curves can result in the same Gini coefficient. source: https://www.researchgate.net/publication/304255998_Beyond_inequality_A_novel_measure_of_skewness_and_its_properties/figures?lo=1

The trade surplus paradox

Since the early 1990s, Russia has run large trade surpluses every year driven by exports in oil and gas, averaging about 10% of national income annually. In other words, for more than 20 years, the Russian economy has been exporting about 10% of its annual output in excess of what it has been importing. In theory, this should have led to a massive accumulation of foreign assets. Paradoxically, the net foreign assets accumulated by Russia are surprisingly small: only about 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.

Offshoring wealth in tax havens, source: https://nouvelle.news/2020/07/canada-has-a-tax-haven-problem-nothing-is-happening-about-it/

Who benefited from this “missing” wealth? Firstly, it has been the small group of foreign investors, who made profits on the Russian stock market boom between 1998–2008. Secondly, there are Russian nationals, who are now foreign residents. Finally, there are Russian residents, whose wealth is offshored in tax haven countries like Switzerland, Cyprus, and Monaco. Global Forbes Billionaire data shows that 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 about 85% of national income (as of 2015), equalling 50% of total Russian financial wealth. This simply means that Russian oligarchs own approximately as much wealth abroad as the entire country does within its borders.

For the reasons mentioned above, it should be clear that the Gini coefficient is not an ideal measure of inequality. Although the Russian Gini coefficient has increased over the past decade, it hit record lows of 36.8 in 2016. Ironically, this was the year when Credit Suisse Wealth Report claimed Russia to be the most unequal economy in the world, with the top 1% sharing almost 65% of the total wealth; this number is unprecedented. The top 1% share now stands about 58%, 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.

Share of wealth by income percentiles in Russia, the US, and the UK, source: https://www.nber.org/system/files/working_papers/w23712/w23712.pdf

Fragile equilibrium

It is hard to doubt that inequality levels in modern Russia are now comparable to Tsarist Russia. This appears to be largely the legacy of a flawed voucher privatisation scheme, as well as the hyperinflation 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, the latest surveys show that about 45% of Russians have a monthly income of 15 000 rubles (£146), with the monthly expenses for a family household estimated at around 60 000 rubles (£587).

It is important to remember the Russian historical context. The drastic failure of Soviet communism plays a role in the high tolerance for inequality. 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, this equilibrium is fragile.

Russian protests 2021, source: https://www.aljazeera.com/opinions/2021/1/23/navalny-has-become-putins-main-challenger

In January 2021, the Russian opposition leader Alexej Navalny released a documentary “Putin’s Palace. The history of the world’s largest bribe”, where he describes connections between Putin and Russian oligarchs. The documentary was published on Youtube and has more than 100M views. In reaction to the documentary, Putin has experienced the largest series of protests throughout his presidency across 112 cities, and as such the socio-economic equilibrium today seems more fragile than ever. Whether the current oligarchic regime will persist, we are yet to find out.

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