Following Russia's liberalization of wages and prices and the start of its privatization programme in January 1992, real GDP collapsed by some 19% over the year and is falling further in 1993. In Discussion Paper No. 839, Research Associate Chris Doyle uses survey data to assess the reforms' effects on income distribution. Inequality increased markedly, so the incomes of some 18.5% of the population were below the official subsistence level by the end of 1992. This growth of poverty has led the government to maintain measures such as subsidies to basic consumer goods which damp producer incentives; it may do better to rely on income support and thus free prices to perform their proper signalling role.

Increased income inequality risks fuelling social discontent and political instability. This will make investment less attractive and thus exacerbate the initial output decline, and it is also increasing tensions between federal and local governments. Local authorities with stronger fiscal positions can use subsidies to strengthen their political stock relative to the centre and thus pursue greater autonomy, while poorer regions remain vulnerable. Although the privatization programme is egalitarian in design, the severity of its overall reforms also favours a swift concentration in the ownership of firms' equity.
According to Doyle, the fall in households' absolute incomes is likely to undermine the political legitimacy the reforms require, but the federal government is financially too weak to tackle the growing poverty problem, which Western aid should therefore be targeted to alleviate. This would be best achieved by means-tested supplementary benefits, but many local authorities' continued provision of consumer subsidies that disproportionately benefit those on higher incomes is likely to impede any systemic reforms emanating from the centre. The provision of an effective social safety net to avert further growth in poverty is therefore a most appropriate area for targeting foreign aid.

The Distributional Consequences of Russia's Transition
Chris Doyle

Discussion Paper No. 839, September 1993 (AM)