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Nodir Ataev

Professor Jerry Pohlman

EC-406-A International Economics

April 17, 2010

Transition from a Centrally-Planned Economy to a Free-Market Economy in Kyrgyzstan

Bordered on the north by Kazakhstan, on the east by China, on the south by China and

Tajikistan, and on the west by Uzbekistan, the landlocked republic of Kyrgyzstan has seen its

fortunes ebb and flow since it became independent after the collapse of the Soviet Union in

1991. Although the country is widely seen as one of the leaders among the former Soviet

republics in economic reform, it remains one of the poorest countries in the world. The recent

uprisings over widespread poverty, corruption, and cronyism that ousted President Kurmanbek

Bakiyev clearly show the economy of Kyrgyzstan is very troubled. Overall, the transition from

the centrally planned economy of the Soviet era to a free-market system has been slow and

painful for this small, mountainous country.

HISTORICAL BACKGROUND

In 1876, Russian forces incorporated the area that is now Kyrgyzstan into the Russian Empire. In

1924, Kyrgyz lands became an autonomous Oblast of the Union of Soviet Socialist Republics

(USSR), and in 1936 they became a full Soviet Socialist Republic (SSR). The republic was

officially known as the Kirghiz Soviet Socialist Republic (KSSR). It was also commonly known

as Kirghizia.1 After “conflict over constitutional and economic issues brought the Soviet Union

1 Although after declaring independence in 1991 Kyrgyzstan acquired its present name, dropping

Kirghizia, the Russians have kept calling the country Kirghizia, vexing the Kyrgyz.

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to the brink of civil war and prompted its disintegration into fifteen volatile successor states in

1991”, on August 31, 1991, Kyrgyzstan became an independent nation (Colton). In October of

1991, Askar Akayev, a physicist and president of the Kyrgyz Academy of Sciences who had

been Kirgiz SSR’s president since 1990, was re-elected president in the country’s first direct

presidential elections. On December 21, 1991, Kyrgyzstan entered the new Commonwealth of

Independent States (CIS), a loose alliance for economic and political cooperation among the

former Soviet Republics.

On March 2, 1992, Kyrgyzstan became a member of the United Nations. On May 5,

1993, the country ratified its first post-Soviet constitution. Askar Akayev was reelected president

in December 1995. In 1996, he called for a referendum on constitutional amendments that

strengthened the president’s power. Although the constitution limits presidents to two terms, “the

Constitutional Court of Kyrgyzstan ruled in 1998 that Akayev’s first term, which began under

the old constitution, should not be counted” (“Askar A. Akayev”). Akayev was reelected for the

second time in 2000 in an election marred by irregularities. In March 2005, the so-called Tulip

Revolution ousted Mr. Akayev from presidency. The protests erupted after the government was

alleged to have meddled in the parliamentary elections of 2005. Afterwards, opposition politician

Kurmanbek Bakiyev came to power as people hoped he would be a more progressive leader. He

won another term as president last year in an election that was full of fraud, according to

independent monitors. On April 7, 2010, bloody protests over Mr. Bakeiyev’s repressive rule

erupted across the county that forced him to flee the county and resign.

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KYRGYZ ECONOMY DURING THE SOVIET PERIOD

Soviet policies had a big impact on the life of the Kyrgyz people. The traditional Kyrgyz way of

life was based on nomadic livestock-herding. During the collectivization campaigns of the 1920s

and 1930s, many nomads were settled. Professor of Political Science at Stetson University

Eugene Huskey writes: “The Soviet government consolidated all arable and grazing lands into

large state-owned farms, and by the mid-1930s the majority of Kyrgyz had been forcibly settled

to work on these farms”. To try to make the USSR self-sufficient, each republic was highly

specialized. Some countries supplied certain crops, others raw materials, and still others

industrial products. For example, Uzbekistan alone supplied about 64 percent of Soviet cotton

(Mayhew et.al. 48). Like other Central Asian republics, Kirghizia produced more intermediate

products. During the Soviet period, large scale agricultural reforms were carried out. In the pre-

WWII period, industrialization in Kirghizia was less and slower than in other parts of the USSR.

In 1941, many large-scale enterprises were evacuated to Kirghizia, especially to the capital

Frunze (Frunze was renamed Bishkek after the country became independent in 1991). These

enterprises produced machines, guns, missiles and ammunition.

An entry about the economy of the Kirghiz Soviet Socialist Republic in the 1973 edition

of the Great Soviet Encyclopedia states:

In the all Union division of labor Kirghizia specializes in the production of

nonferrous metals (antimony and mercury), agricultural machines, electrical

engineering goods and instruments, wool and silk fabrics, and granulated sugar. In

1971 industry accounted for 55.7 percent of the gross social product, agriculture

for 22.5 percent, construction for 12.8 percent, transportation and

communications for 2.2 percent, and trade and public catering for 2.9 percent. …

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Kirghizia accounts for 0.7 percent of all the people employed in Soviet industry,

0.9 percent of all the nation’s capital investments, and 1 percent of the gross

agricultural output (1971). (Otorbaev et. al. 494)

In their book Central Asia, Bradley Mayhew, Richard Plunkett, and Simon Richmond

quote a Russian humorist who wittily summed up the story of the Soviet Union: “After titanic

effort, blood, sweat and tears, the Soviet people brought forth a new system. Unfortunately, it

was the wrong one” (36). Starting from 1970, the development of the Soviet economy slowed

down, and this slowdown eventually led to economic stagnation. In the 1980s, it became clear

that the centrally planned economy of the Soviet Union was falling apart. Rising inflation,

shortage of food, misallocation of resources, disorder in economic relations between enterprises,

wasteful use of energy and raw materials, low level of productivity, and dissatisfaction with low-

level life standards and economic development all contributed to the collapse of the Soviet

Union. In the 1980s, Mikhail Gorbachev started the programs glasnost (Russian for “openness”)

and perestroika (“restructuring”) to bring about political and economic reform. These reforms

allowed the problems of the USSR to be uncovered and become public knowledge. In 1991, the

Soviet republics began to declare independence as people demanded a better life and more

freedom.

POST-SOVIET ECONOMIC REFORMS IN KYRGYZSTAN

Although Soviet rule changed many aspects of life in Kyrgyzstan for the better, the country,

along with the other Central Asian republics, was one of the poorest republics in the Soviet

Union. Statistics for the last years of the Soviet Union show that even though about 16 percent of

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USSR’s population lived in Central Asia, 64 percent of USSR’s poor lived in these republics

(Mayhew et. al. 48).

Transition economies face a number of challenges. One central issue is the speed at

which change occurs. Two approaches have been suggested to the transition from a centrally-

planned economy to a free market-driven economy: shock therapy and gradualism. Shock

therapy, sometimes referred to as the big bang approach, is a policy of rapid economic reform. It

entails: (1) eliminating government control over economic activities, (2) financial stabilization,

(3) privatization, and (4) globalization (Engelmann et. al.). Gradualism, on the other hand,

advocates taking steps more slowly, changing one aspect of the economy first so that it can be

the ground for the next one.

Kyrgyzstan has been committed to a market economy after independence. The fact that

Kyrgyzstan quickly started to privatize government-owned enterprises, introduced its own

currency, and liberalized prices shows that the country has implemented the big bang approach

to reform. Kyrgyzstan introduced its own currency som on May 10, 1993, replacing the Soviet

ruble, the first former Soviet republic to do so. The current exchange rate is 45.2 Kyrgyzstani

soms per US dollar as of April 2010 (“Official Exchange Rates”).

A number of steps were taken to bring about the transition from the centrally planned

economy of the Soviet era to a free-market system. We can categorize the reforms into

privatization, liberalization of prices and trade, and institutional reforms. Privatization is one of

the most important steps for transitional economies to take. During the Soviet Union, almost all

assets were owned by the government. The Kyrgyz government started to privatize small and

medium enterprises in the early 1990s, and beginning 1995 it started to privatize large-scale

enterprises. By the end of the decade, no less than 75 percent of enterprises had been privatized

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(Huskey). Currently about 70 percent of farm land is privately owned (“A Rocky Path to

Success”).

In the soviet economy, all prices were fixed by the state. Liberalizing prices was another

important step in the transition from the planned economy of the USSR to a free market

economy. In Kyrgyzstan, liberalization took place for the first time in 1991. Prices were

liberalized further after the price liberalizations in Russia in 1992. The liberalizations were

followed by hyperinflation. In the first quarter of 1993, the inflation rate was 29 percent per

month ("Kyrgyzstan"). The skyrocketing inflation was one of the reasons for the adoption of the

som. Along with price liberalizations the Kyrgyz government initiated trade liberalization in the

early 1990s. The loss of economic relations with the other Soviet republics was destructive to the

Kyrgyz economy:

The breakdown of established trading relationships following the dissolution of

the USSR severely depressed the economy of Kyrgyzstan. Markets for the

country’s highly specialized industries disappeared and the high cost of fuel

imports—subsidized during the Soviet era—drained the country’s money

reserves. By 1995 the gross domestic product (GDP), which measures the total

value of goods and services, had fallen to 54 percent of its level in 1990. (Huskey)

To bring about the transition from the centrally planned Soviet economy to a free-market

economy, the economic structure of Kyrgyzstan needed to be reformed. First of all, new laws

were needed to regulate the economy and establish property rights. The renowned American

economist Frederick Mishkin writes “A country can have a successful economy only if it has

strong property rights, that is, if it protects a person’s property from expropriation by the

government or other parties” (19). The country needed new market institutions that were

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nonexistent during the Soviet period. Kyrgyzstan’s central bank, the National Bank of the

Kyrgyz Republic, was organized in 1992. The civil code, criminal code, and labor code of the

country were all changed to create the foundations of a market economy.

Kyrgyzstan has relied on help from the developed countries for the transition to a market

economy. In 1992, the country joined the World Bank (“Country Brief 2009"). The International

Development Association (IDA), which is the part of the World Bank that helps the world’s

poorest countries, has assisted the country “through eight policy operations supporting the

governments’ reforms efforts [sic], particularly in the area of privatization, agriculture, finance,

fiscal reforms, pension reforms, business environment, utility and tax reforms and strengthening

social protection to compensate the poor for utility tariff increases ("A Rocky Path to Success").

Kyrgyzstan was the first former Soviet republic to join the World Trade Organization (WTO) in

1998.

CURRENT ECONOMIC CONDITIONS

The table above shows that in 2009 services accounted for 53 percent of GDP, agriculture

for 31 percent, and industry for the remaining 16 percent ("Kyrgyzstan"). Despite the recent rise

16%

31% 53%

GDP - Composition by Sector

Industry

Agriculture

Services

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in services, the Kyrgyz economy has been predominantly agricultural. Agriculture is a very

important part of Kyrgyzstan’s economy. The major crops include grains, vegetables, fruits,

tobacco, and cotton. The raising of sheep and cattle remains a significant part of the economy.

Agriculture employs 48 percent of the workforce, according to the CIA World Factbook.

Services have become the largest sector of the economy. This can be partly explained by

the increase in the number of small businesses (“Country Profile: Kyrgyzstan”). With its

picturesque landscapes, Kyrgyzstan could potentially become a tourist destination. However, the

tourism industry has grown slowly. In the early 2000s, an average of around 450,000 tourists

came to Kyrgyzstan annually (ibid.)

Once, the Kyrgyz economy was entirely agricultural. During the Soviet period, it was

industrialized to a large extent. After the dissolution of the USSR, however, input costs

skyrocketed and the markets for the country’s goods disappeared. By 2009, industry made up

only 16 percent of GDP ("Kyrgyzstan"). Many Soviet-period factories have closed down, and

those that are functioning are inefficient because of lack of funds, mismanagement, and aging

equipment.

Kyrgyzstan has extensive deposits of gold. Kumtor Gold Mine, which is 100% owned by

the Canadian mining company Centerra Gold, is a major contributor to the Kyrgyz GDP. A fall

in output at the Kumtor gold mine caused a 0.2 percent decline in GDP in 2005. The country’s

GDP grew 8.5 percent in 2007 and 7.6 percent in 2008, partly due to higher gold prices

internationally. It fell 0.9 % in 2009 because of decreases in remittances (mostly from Kyrgyz

citizens working in Russia) and in investment after the global financial crisis and to lower gold

production. The table on the next page shows real GDP growth rates for the years 2001 through

2009. The data was taken from IMF World Economic Outlook 2009 (194).

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Although a wide range of steps have been taken to create the foundations of a market

economy and improve the overall economic performance, Kyrgyzstan remains one of the poorest

countries in the world. The 2009 World Bank Country Brief reads “The Kyrgyz Republic is a

low-income country with a gross national income (GNI) per capita of $780 in 2008 (Atlas

method).” With 35 percent of its population living below the poverty line, Kyrgyzstan qualified

to join the International Development Association (IDA), which is the part of the World Bank

that provides assistance to the poorest countries. The country has very weak property rights. The

so-called Tulip Revolution over corruption, nepotism, and government meddling in

parliamentary elections that ousted President Askar Akayev in 2005 and the recent bloody

uprisings over rampant corruption, blatant cronyism, mass unemployment, and widespread

poverty that forced President Kurmanbek Bakiyev to flee Kyrgyzstan show the country is very

troubled, both politically and economically. Both of the revolutions were followed by pillaging,

looting, and destruction of property.

Unemployment has remained high since the country became independent. The official

unemployment rate was 18 percent in 2004, but the actual rate must be higher because many

people see no point in registering for benefits, engage in grey economy, or are simply

5.3

0

7 7

-0.2

3.1

8.5 7.6

0.9

-20

-15

-10

-5

0

5

10

15

20

2001 2002 2003 2004 2005 2006 2007 2008 2009

An

nu

al P

erc

en

t C

han

ge

Real GDP Growth

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underemployed. In 2006, approximately 500, 000 Kyrgyzstani people worked in Russia,

Kazakhstan, or Tajikistan (“Country Profile: Kyrgyzstan”).

CORRUPTION

While no society is immune to corruption, there are big differences in its extent. It has been an

especially grave impediment to growth in Kyrgyzstan. According to Transparency International,

an independent nonprofit organization dedicated to exposing and fighting corruption, Kyrgyzstan

was the 162nd

least corrupt country in the world out of the 180 surveyed in 2009 ("Corruption

Perceptions Index, 2009"). Transparency International annually publishes a Corruption

Perceptions Index (CPI) which measures the perceived levels of public-sector corruption in a

given country. It is a composite index, drawing on different expert and business surveys. The

CPI scores countries on a scale from zero (highly corrupt) to 10 (highly clean). Kyrgyzstan’s

score was 1.9 in 2009, clearly showing that corruption is rife in the country.

In his book The Next Great Globalization: How Disadvantaged Nations Can Harness

Their Financial Systems to Get Rich economist Frederick Mishkin writes:

Corruption is like a cancer in the body of an economy: it weakens and sickens the

economy by reducing the incentives for entrepreneurs to make investments and

work hard to make profits. Corruption is particularly pernicious because it creates

so much uncertainty for entrepreneurs: they can never be sure when the bribe is

enough or whether the corrupt official will keep coming back to them over and

over again to demand more money. Research finds that both lower investment

relative to GDP and lower economic growth are associated with increases in

corruption (21).

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The gruesome situation in Kyrgyzstan has caused one international organization to call

the country a "faltering state" (“Kyrgyzstan: A Faltering State”). “Property is being redistributed

in a chaotic and sometimes violent manner as government, criminals and other interests scramble

for the country’s valuable assets, including many that the Akayev family monopolized” (ibid).

Unless systematic reforms are taken to curb corruption, the country is poised to lose control over

its people, and criminality and violence will prevail.

THE ROAD AHEAD

The International Development Association (IDA) has identified some of the major challenges

that Kyrgyzstan must deal with. These are:

Reducing poverty

Diversifying the economy

Improving the business environment in general and property rights in particular

Reforming the public sector to make it more effective and to curb corruption

Poverty is widespread in Kyrgyzstan. Forty percent of the population lived below the

poverty line in 2006 ("Country Profile: Kyrgyzstan"). Diversifying the economy is necessary

because “the agriculture, hydropower and mining sectors are vulnerable to adverse weather

conditions and natural disasters, and suffer from poor governance, lack of supplementary

services, artificial pricing (in energy sector) and low productivity (especially in agriculture)” ("A

Rocky Path to Success"). The legal system is very weak in Kyrgyzstan. Low salaries make

bribing judges easy. Finally, ineffective governance and corruption remain dire obstacles to

growth.

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Dealing with these issues will be very hard for the troubled country. As indicated in the

report Kyrgyzstan: A Faltering State, “Most worryingly, the government has largely lost control

over public security. The law enforcement agencies lack resources, are severely demoralised, and

have become susceptible to outside pressure. There is growing concern about the influence of

criminal groups”. Instead of trying to address these problems, the government has been busy

dividing power among different parties.

If Kyrgyzstan is to improve its economy, systematic reforms need to be made. There

must be an authentic commitment by the government to restore order, curb corruption, and

establish the rule of law. Also, foreign countries and international institutions such as the IMF

and World Bank should assist the troubled nation. The future of Kyrgyzstan remains gloomy.

Democratic optimism has faded in the country. Referring to the presidential shrubs that looters

dug up from the front garden of Kurmanbek Bakiyev after the recent uprisings, a Guardian

correspondent wrote: “A couple of fir trees were still left in the beds. But the others had all gone,

transplanted – like the rest of Kyrgyzstan – to a new and uncertain future” (Harding).

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Works Cited

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April 18, 2010 <http://siteresources.worldbank.org/IDA/Resources/IDA-

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Microsoft Corporation, 2007.

Colton, Timothy J. Union of Soviet Socialist Republics. N. pag. Microsoft®

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"Corruption Perceptions Index, 2009". Transparency International. April 20, 2010

<http://www.transparency.org/policy_research/surveys_indices/cpi/2009/c

pi_2009_table>.

"Country Brief 2009: Kyrgyzstan". World Bank. March 19, 2010

<http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/ECAEX

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Redmond, WA: Microsoft Corporation, 2007.

Harding, Luke. "Kyrgyzstan Capital Bloodied, Looted and Chaotic after

Overthrow of Bakiyev". Guardian. April 21, 2010

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kurmanbek-bakiyev>.

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"Kyrgyzstan: A Faltering State". International Crisis Group. April 20, 2010

<http://merln.ndu.edu/archive/icg/centralasiakyrgyzstanfaltering.pdf>

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"Official Exchange Rates". National Bank of the Kyrgyz Republic. April 22, 2010

<http://www.nbkr.kg/index1.jsp?item=1562&lang=RUS>.

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