Russia privatized its economy but failed to transform it. Most of the old businesses are bad. Most of the new ones are little better. What is to be done?
A decade ago, the demise of the Soviet Union astounded the world. The collapse of Russia's economy since then has been, in its own way, equally astounding. State-owned businesses have been privatized, prices are deregulated, and competition abounds. Yet unlike Poland, whose per capita gross domestic product has shot up by 20 percent since 1989, Russia has seen its per capita GDP--now at a paltry 15 percent of US levels--fall by more than 30 percent in the same period (Exhibit 1). Meanwhile, the country's stagnating productivity stands at less than 20 percent of the US level (Exhibit 2).
How could such a collapse occur? To paraphrase Tolstoy, healthy economies are all basically alike; each unhealthy economy is unhealthy in its own way. The McKinsey Global Institute's recently completed year-long study of the Russian economy explored the performance of many of its most important industries: cement, confectionery, dairy, food retailing, general merchandising, hotels, petroleum, residential construction, software, and steel.  Our findings confirm the severity of Russia's predicament. These ten industries average only 19 percent of US productivity levels, with software leading the group at 38 percent and cement in last place at 7.
The old and the new
In today's Russian economy, old and new facilities alike perform dismally. Labor productivity in Soviet legacy assets, which operated at roughly 30 percent of US productivity levels in 1992, has dropped by half, which indicates that those assets haven't reduced their labor forces despite a sharp fall in demand from once captive consumers who now have access to products from around the world. For example, oil production--buffeted by a decline in domestic demand and in exports to the countries of the former communist bloc--has fallen by half since its 1988 peak, hut employment in the industry still stands at roughly Soviet-era levels. Similarly, employment in the cement and steel industries remains at 1990 levels, while production has dropped by 60 percent.
Performance is bleak even in industries, for instance, residential construction, that have not been affected directly by foreign competition. The government finances more than half of all such construction in Russia. Although officially submitted to open bids, the contracts are almost invariably awarded to exSoviet companies closely affiliated with local authorities, which give these enterprises contracts in return for promises not to lay off …