Explaining rise of barter in Russia : Virtual Economy vs . Monetary Issues

Just a few years into the market economy, in the mid 90’s Russian economy experienced a rapid increase barter trading as enterprises avoided use of money. Determining the true cause and driving force behind this demonetization became a hot topic. Two different schools of thoughts evolved: those who adopted the virtual economy hypothesis as the explanation and those who favored monetary issues in the economy as the cause. This paper lays out both sides in detail and provides an analysis of the two. I find that while the monetary school argument draws upon direct empirical results, the virtual economy hypothesis presents a stronger argument and has empirical foundations that are not too far behind. ________________________________________________________________________ I would like to thank Dr. Richard Ericson for his input and guidance in this project. Introduction In a command economy, producers’ goals and actions are determined by orders from higher authorities. Ultimately, the highest authority makes centralized planning and decisions, hence the term Centrally Planned Economy. Unlike market economics, the command economy enterprise is not concerned with maximizing profits or satisfying shareholders’ interests, as it simply wants to follow its superior‘s instructions and plans. Such was the way Russian economic enterprises operated prior to 1989, during the communist era. Further, the role of money was extremely limited and passive in the command economy of Soviet Union. The roles included nothing more than “a mere accounting entry in the books of the state bank” (Ericson, 1997), a method to monitor financial flows in order to “check on implementations of financial plans. Cash is only involved in things like wage payments and consumer purchase” (Ericson). Whereas in a traditional market oriented economy, money was the essential economic instrument for transactions, counting unit of indication for economic values, the credit system and etc. The former Soviet Union had an essentially demonetized economy. After its collapse, the country has been moving towards becoming a market oriented economy. Given its size and impact on the rest of the world, the transition of Russian economy is a topic of great importance. As with any transition, unheard and unusual economic phenomena have been taking place in Russia. One such phenomenon 1 The Soviet Economy had a dual monetary system: industrial and household money. Household money is the cash used by households for consumer goods purchase and thus it is called cash-money. On the other hand, industrial money is for inter-enterprise use only and exists only on in deposit slips and accounting books. Thus, it is called non-cash-money.