At the start of transition from communist rule, skepticism reigned about the possibility of introducing markets and democracy simultaneously. Drawing on the recent experience of Latin America, many expected economic reforms to impose unbearable costs on society. Furthermore, if given the opportunity to vote, the public would likely register its discontent by reversing economic reforms at the first opportunity. Conventional scholarly wisdom suggested that governments needed to insulate leaders from popular pressures to withstand the inevitable backlash of popular opposition produced by economic reform. New York University political scientist Adam Przeworski’s insightful book Democracy and the Market predicted that economic reforms introduced in the nascent democracies of the region would produce a pendulum swing between populist policies that undermined the economy and harsh economic reforms that undermined democracy. Even optimists who expected democracy and markets to be compatible in the long-run, such as economists Jeffrey Sachs and David Lipton, favored concentrating power in the hands of elected leaders to allow them to make quick decisions and to ward off popular demands to change course in the short-run.

Over the past 15 years, these fears have seemed largely unsubstantiated. Instead, a new conventional wisdom has taken root: democracy is essential for economic reforms. Scholars have repeatedly observed that the most democratic countries in the post-communist region have the most market-oriented economies. The European Bank for Reconstruction and Development (EBRD) Transition Report in 2003 noted: “The evidence suggests that there is a strong link between the depth of democracy and the level of economic reform, particularly with respect to the institutional aspects of transition.” Policymakers have picked up on this theme, touting democracy as a condition for economic transformation. In its Congressional Budget Justifications for fiscal years 2004 and 2005, the US Agency for International Development included a chart depicting the mutually supportive nature of democracy and economic reform. To come full circle, a recent book by journalist Andrew Jack carried the title: Inside Putin’s Russia: Can There Be Reform Without Democracy?

This essay reviews the relationship between democracy and the economy in the former Soviet Union in the last 15 years. It aims to introduce a note of caution into the debate. Contrary to initial expectations, democracy has not been an obstacle to reforming post-communist economies and has been associated with higher levels of economic reform. This is a remarkable and surprising finding. But there is also a danger in overselling the benefits of democracy for economic reform and economic performance as a policy goal. First, the size of the impact of democracy on economic reform is more modest than is commonly appreciated once other factors are considered. Second, while there is a correlation between democracy and economic reform, it is not precisely known how democracy promotes economic reform. Third, it is difficult to discern a direct relationship between democracy and economic growth. Promoting democracy is a valuable foreign policy goal in its own right. Selling democracy based on its economic benefits risks degrading democracy should the economy falter.

The Scope of Economic Reform

The process of introducing markets and private property has never been pretty. This certainly holds for the post-communist world as well. The region has seen great corruption, vast redistribution of wealth, and occasional violence over the last 15 years. These outcomes are not surprising given the extremely inauspicious starting conditions in the former Soviet Union. The former Soviet states began the transformation facing a “Perfect Storm” of repressed inflation, collapsing state institutions, low levels of social trust, ethnic tension, and little experience with private property, democracy, or a market economy. Nonetheless, governments across the 15 former republics of the Soviet Union have introduced a broad array of impressive economic reforms.

Across the region, the bulk of heavy industry and almost all small businesses are in private hands. Prices for the vast majority of goods are set by market forces rather than by planners. The Baltic states have joined the European Union. Even the rather minimal price liberalization and privatization conducted in an economic laggard like Uzbekistan is more extensive than any reforms experienced under the command economy. More generally, the countries of the former Soviet Union have economies nearly as liberal as other lower-middle and middle-income countries who did not modernize via a command economy. The economies of the former Soviet Union are far from efficient and prone to corruption but have come a long way since 1991.

Each year the EBRD rates progress in eight different types of economic reform on a scale in which “one” equals little change from the command economy and “four” equals a standard equivalent to that of a developed market economy. The eight types of reform include large privatization, small privatization, trade liberalization, price liberalization, enterprise restructuring, bank reform, securities market reform, and competition policy reform.

The table on the following page presents the average level of economic reform across the 15 countries of the former Soviet Union for each dimension of economic reform. Post-communist countries have made considerable progress on economic reforms that are technically easy to conduct, such as price liberalization, trade liberalization, and the privatization of small enterprises, while they have faced greater obstacles building institutions to support markets. For example, efforts to create institutions to regulate the banking and securities markets have been particularly difficult.

What is most remarkable is the great variation across countries and over time in the extent of economic reform. Estonia introduced rapid economic reform across a broad range of policies, while Russia made fast progress in some areas, like industrial privatization, and slow progress in others, like corporate governance. Kazakhstan introduced a rather gradual economic reform and made fairly consistent progress, while Uzbekistan pursued rather limited economic reforms. What accounts for this great variation across countries and over time in the extent of economic reform?

Democracy and Economic Reform

The most common argument for this difference focuses on democracy as a critical component of economic reform. This predominant view is captured in a thoughtful review of the literature by Cornell political scientist Valerie Bunce who notes that the relationship between economic reform and democratization in the region “is robust and positive.” The correlation between the level of democracy as measured by the Freedom House scale of political rights and the average level of economic reform as measured by EBRD reform scores in the 15 former republics of the Soviet Union is rather high (.60).