This paper is a reply to Barry Ickes' critique of my paper “Trust versus Illusion: What is Driving Demonetization in Russia?” in which I show that the data reject Barry Ickes' Virtual Economy explanation of barter in Russia in favor of an institutional explanation based on the lack of trust

Marin, Dalia

English

Universität München: Elektronischen Publikationen

Sonderforschungsbereich/Transregio 15 · www.gesy.uni-mannheim.de 
Universität Mannheim · Freie Universität Berlin · Humboldt-Universität zu Berlin · Ludwig-Maximilians-Universität München 
Rheinische Friedrich-Wilhelms-Universität Bonn · Zentrum für Europäische Wirtschaftsforschung Mannheim 
 
Speaker: Prof. Konrad Stahl, Ph.D. · Department of Economics · University of Mannheim · D-68131 Mannheim, 
Phone: +49(0621)1812786 · Fax: +49(0621)1812785 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
November 2004 
 
 
*Dalia Marin, University of Munich and CEPR   
 
 
 
Financial support from the Deutsche Forschungsgemeinschaft through SFB/TR 15 is gratefully acknowledged.
 
Discussion Paper No. 83 
The Vanishing Barter Economy in 
Russia: A Test of the Virtual 
Economy Hypothesis? Reply to 
Barry Ickes 
Dalia Marin*        
 
 
 
 
 
 
 
The Vanishing Barter Economy in Russia: 
A Test of the Virtual Economy Hypothesis? 
Reply to Barry Ickes∗ 
 
 
 
 
 
 
Dalia Marin 
University of Munich and CEPR 
 
 
 
November 2004 
 
 
 
 
 
 
Abstract 
 
This paper is a reply to Barry Ickes' critique of my paper “Trust versus Illusion: What is 
Driving Demonetization in Russia?” in which I show that the data reject Barry Ickes' Virtual 
Economy explanation of barter in Russia in favor of an institutional explanation based on the 
lack of trust. 
 
 
 
 
 
JEL Classification: D20, G30, O10, P30 
Keywords: imperfect input and capital markets, the virtual economy, trade credit, trust, contract 
enforcement 
 
                                                 
∗ I would like to thank Alexander Protsenko for excellent research assistance. Financial support from the 
Deutsche Forschungsgemeinschaft through SFB/TR 15 is gratefully acknowledged. 
 
 
 
 
 
In this reply I would like to focus on two points raised by Barry Ickes‘ comment on my paper 
“Trust versus Illusion: What is driving Demonetization in the Former Soviet Union?” Ickes 
claims that I cannot test the virtual economy hypothesis (VEH) because of inappropriate data 
and a flawed testing procedure. Let me take each argument in turn. 
 
 
Inappropriate Data: 
 
Ickes argues that by using Ukrainian data rather than data on Russia I cannot test the VEH. 
Unlike Russia, Ukraine is not energy abundant and therefore one should not expect that 
Ukrainian industry is subsidized by scarce imported energy. Because of this difference in 
comparative advantage in energy (particularly oil and gas) between Russia and Ukraine one 
cannot expect the sectoral pattern of cross subsidies to be the same in Ukraine and Russia. 
 
My test of the VEH proceeds in three steps of which only the last step depends on Russia and 
Ukraine to have a similar pattern of comparative advantage. First, I ask whether any cross 
subsidization across sectors can be identified and the test finds no systematic value transfer 
across sectors. So if Ukraine differs in its comparative advantage, the test should still find 
cross subsidization across sectors even if the subsidizing sector will not be energy but some 
other sector. 
 
Second, I ask whether the value transfer of the value creating sector to the value destructive 
sector is more pronounced when the sector receiving the transfer is less efficient. According 
to the VE argument we expect this to be the case, because less efficient sectors will need a 
bigger hidden subsidy in order to pretend to produce value added. The test finds no 
statistically significant relation between the size of the value transfer and the efficiency of the 
sector. 
 
Third, I ask whether it is the energy sector which subsidizes the manufacturing sector as the 
VEH for Russia claims. Here is where Ickes’ comment bites. If Ukraine is not energy 
abundant like Russia we should see a different sectoral pattern of cross subsidies in Ukraine 
compared to Russia. Therefore, using Ukrainian data to test the VEH might indeed be 
misleading. 
 
 
Why Ukraine is not different 
 
But Ukraine is not as different as Ickes suggests. Although Ukraine has no natural resources 
in oil and gas, Russia depends in its gas and oil exports on Ukraine’s pipelines. 90 percent of 
Russian gas exports are transported through the pipelines of Ukraine. Russia pays for the use 
of Ukraine’s pipelines with gas. The barter deal of Russian gas in exchange for Ukraine’s 
pipeline services covers 40 percent of Ukraine’s total demand for gas. In addition, Ukraine 
 
was stealing a huge amount of Russian gas (720 million USD) going through Ukraine’s
pipelines which made Russia to consider avoiding Ukraine altogether and to build a new
pipeline.  Furthermore, Ukraine has accumulated a huge amount of gas arrears vis a vis Russia
(of 2 billion USD).  Russia depends also in its oil exports on Ukraine’s pipelines, but less so
than in its gas exports.
The mutual dependence between Russia and Ukraine can be clearly seen from Table 1.
Whenever Russia increased the oil price for Ukraine (which happened in 1996 from 51.5
USD/T to 71.2, an increase of 38 percent), Ukraine increased the transit tariff for Russian gas
(from 0.65 USD/tcm/1000 to 1.75 USD/tcm/1000, an increase of almost 170 percent). Thus,
the terms of trade of the Russian oil/Ukraine pipeline service deal shifted in Ukraine’s favor,
lowering the effective price of Russian oil that Ukraine paid. Unfortunately, prices for
Russian oil to Ukraine are not available after 1997. However, the table still shows that
Ukraine lowered the transit tariff for Russian gas in 1998 when Russian oil prices fell and
increased the transit tariff again in 2001 when world oil markets boomed.
Table 1            Mutual Dependence: Russian Oil for Ukraine Pipeline Services
Unit 1994 1995 1996 1997 1998 1999 2000 2001
transit tariffs for
Russian gas
USD
/tcm/1000 km
0,65 0,65 1,75 1,75 1,09 1,09 1,09 1,44
oil prices for
Ukraine
USD/T* - 51,5 71,2 71,4 - - - -
oil prices for ROW USD/T* - 74,2 92,8 102,6 76,9 67,9 139,7 -
Sources: Energy Information Administration, USA; Ministry of Finance, Ukraine
*) Unit Values
A country’s ability to export gas and oil requires both a natural resource in oil and gas and a
pipeline which minimizes transport costs to export markets. Russia has the natural resource,
Ukraine offers the cheapest cost of transport for this natural resource. Although Ukraine has
no comparative advantage in oil and gas it has a comparative advantage in transporting gas
and oil from Russia. Ukraine has always exploited its monopoly position by bargaining for
cheap gas and oil from Russia after the disintegration of the former Soviet Union (FSU). Due
to its geographic advantage, Ukraine continues to have cheap oil and gas even after its
separation from Russia (Russia charges Ukraine an oil price which is 30 percent lower than
for the rest of the world (ROW), see Table 1).
The availability of cheap energy in Ukraine can be seen also in Figure 1 which shows that
Ukraine’s energy consumption per GDP (which includes oil, gas electricity, and coal) is
higher than in Russia and has increased after the collapse of the FSU, while it has remained
constant or has declined in Russia and other smaller Central European Countries.
Figure 1 Energy Consumption to GDP
(BTU per GDP at 1995 USD prices)
Source: Energy Information Administration, USA
To sum up, because of the availability of cheap energy in Ukraine after the collapse of the
FSU the pattern of value transfer across sectors, if it is taking place at all, can be expected to
be similar between Ukraine and Russia. Thus, it is quite appropriate to test the VEH with
Ukrainian data.
Ukraine and Russia are strikingly similar along another dimension: the pattern of barter over
time. After an explosive growth from 8 percent in 1994 to around 60 percent in 1998 barter
and non-cash transactions have declined since 1998 by around 30 to 40 percent  in both
countries (see Marin and Schnitzer 2002).  What explains this striking similarity in the time
pattern of barter in these two countries? Why was barter exploding before 1998 and vanishing
after the financial crisis of August of 1998?  Russia is an oil exporter, Ukraine is an oil
importer. The ruble depreciated by about 50 percent after the August financial crisis, while
the hryvnia showed only a modest decline. The strong devaluation of the exchange rate and
booming world oil markets have both been argued to have contributed to the vanishing barter
economy. However, the different behavior of the exchange rates and in the importance of oil
in these two countries suggests that  some other force must be at work to explain the striking
similarity in the time pattern of barter.
Is the VEH a candidate explanation? To construct an argument for the vanishing barter
economy along the lines of the VEH one has to find a reason why in 1998 the energy
producers stopped providing subsidies to the manufacturing sector. Is it because the energy
producers had less money available? Or because manufacturing firms suddenly started to
create value in 1998? The booming world oil markets and the associated increase in rents of
the energy sector should have made it easier rather than more difficult for this sector to
transfer value to the rest of the economy. Why then has barter started to decline in 1998? The
VEH does not seem to offer an answer.
50
70
90
110
130
150
1992 1993 1994 1995 1996 1997 1998 1999 2000
19
92
=1
00
Poland Russia Ukraine Hungary 100
In order to find an answer for the decline in barter we have to turn to the financial sector. One
common feature between Ukraine and Russia that the VEH does not touch upon is the
financial sector. Russia and Ukraine are the transition countries with the lowest level of bank
intermediation (see Huang,Marin,Xu 2002). Banks practically did not lend to the real sector
and firms used barter trade to finance production. Banks financed the government budget
instead. With the collapse of the treasury bills market after the August 1998 crisis banks
lending behavior changed drastically. They stopped to finance the government budget and
have started to lend to firms. Huang, Marin, Xu (2002) argue that the financial crisis of 1998
helped these economies to get out of a banking development trap which explains why barter
has dropped and why output has recovered in Russia and Ukraine for the first time since the
fall of communism.
Flawed Testing Procedure
Ickes claims that the empirical test is flawed because it rests on how accurately I separate
purchases from sales in barter transactions. How can I distinguish buyers and sellers in barter
deals when both sides of the transaction involve goods? I thought about this question quite a
bit when I was designing the questionnaire. But when the questionnaire was tested in a pilot
among a few firms, this turned out to be a non issue.  Firms seldom had a problem to separate
the sale from the purchase in a barter deal. The reason is that typically buying firms faced
payment difficulties. The selling firm in fact gave a trade credit to the buyer. Therefore, there
was a time delay between the “sale” and the “goods payment” in more than 50 percent of the
barter transactions. The time period between the “sale” and the “goods payment” varied
between 1 and 7 month in barter transactions in transition countries and between 6 month and
10 years in barter contracts in international trade (see Marin and Schnitzer (2002) for barter as
trade credit). Because of this separation in time between the sale and the purchase in barter
contracts (barter is a trade credit which is repaid in goods rather than cash) the firms involved
in the deal (and we researchers) could easily identify the seller (the firm which gave a trade
credit) and the buyer (the firm receiving the trade credit). This way, we could avoid an
arbitrary classification of sellers and buyers which is Ickes main concern.
References:
H. Huang, D. Marin, Ch. Xu (2004),  Financial Crisis,  Economic Recovery,  and Banking
Development in Russia, Ukraine, and Other FSU Countries, International Monetary Fund,
IMF Working Paper No 04/105.
D. Marin and M. Schnitzer (2002), Contracts in Trade and Transition: The Resurgence of
Barter, Cambridge: The MIT Press.


The Vanishing Barter Economy in Russia: A Test of the Virtual Economy Hypothesis? Reply to Barry Ickes

This paper is a reply to Barry Ickes' critique of my paper 'Trust versus Illusion: What is Driving Demonetization in Russia?' in which I show that the data reject Barry Ickes' Virtual Economy explanation of barter in Russia in favor of an institutional explanation based on the lack of trust

EconStor (ZBW Kiel)

Open Access LMU ( Ludwig-Maximilians-Univ. München)

Sonderforschungsbereich/Transregio 15 · www.gesy.uni-mannheim.de Universität Mannheim · Freie Universität Berlin · Humboldt-Universität zu Berlin · Ludwig-Maximilians-Universität München Rheinische Friedrich-Wilhelms-Universität Bonn · Zentrum für Europäische Wirtschaftsforschung Mannheim  Speaker: Prof. Konrad Stahl, Ph.D. · Department of Economics · University of Mannheim · D-68131 Mannheim, Phone: +49(0621)1812786 · Fax: +49(0621)1812785                      November 2004   *Dalia Marin, University of Munich and CEPR      Financial support from the Deutsche Forschungsgemeinschaft through SFB/TR 15 is gratefully acknowledged. Discussion Paper No. 83 The Vanishing Barter Economy in Russia: A Test of the Virtual Economy Hypothesis? Reply to Barry Ickes Dalia Marin*               The Vanishing Barter Economy in Russia: A Test of the Virtual Economy Hypothesis? Reply to Barry Ickes∗       Dalia Marin University of Munich and CEPR    November 2004       Abstract  This paper is a reply to Barry Ickes' critique of my paper “Trust versus Illusion: What is Driving Demonetization in Russia?” in which I show that the data reject Barry Ickes' Virtual Economy explanation of barter in Russia in favor of an institutional explanation based on the lack of trust.      JEL Classification: D20, G30, O10, P30 Keywords: imperfect input and capital markets, the virtual economy, trade credit, trust, contract enforcement                                                   ∗ I would like to thank Alexander Protsenko for excellent research assistance. Financial support from the Deutsche Forschungsgemeinschaft through SFB/TR 15 is gratefully acknowledged.      In this reply I would like to focus on two points raised by Barry Ickes‘ comment on my paper “Trust versus Illusion: What is driving Demonetization in the Former Soviet Union?” Ickes claims that I cannot test the virtual economy hypothesis (VEH) because of inappropriate data and a flawed testing procedure. Let me take each argument in turn.   Inappropriate Data:  Ickes argues that by using Ukrainian data rather than data on Russia I cannot test the VEH. Unlike Russia, Ukraine is not energy abundant and therefore one should not expect that Ukrainian industry is subsidized by scarce imported energy. Because of this difference in comparative advantage in energy (particularly oil and gas) between Russia and Ukraine one cannot expect the sectoral pattern of cross subsidies to be the same in Ukraine and Russia.  My test of the VEH proceeds in three steps of which only the last step depends on Russia and Ukraine to have a similar pattern of comparative advantage. First, I ask whether any cross subsidization across sectors can be identified and the test finds no systematic value transfer across sectors. So if Ukraine differs in its comparative advantage, the test should still find cross subsidization across sectors even if the subsidizing sector will not be energy but some other sector.  Second, I ask whether the value transfer of the value creating sector to the value destructive sector is more pronounced when the sector receiving the transfer is less efficient. According to the VE argument we expect this to be the case, because less efficient sectors will need a bigger hidden subsidy in order to pretend to produce value added. The test finds no statistically significant relation between the size of the value transfer and the efficiency of the sector.  Third, I ask whether it is the energy sector which subsidizes the manufacturing sector as the VEH for Russia claims. Here is where Ickes’ comment bites. If Ukraine is not energy abundant like Russia we should see a different sectoral pattern of cross subsidies in Ukraine compared to Russia. Therefore, using Ukrainian data to test the VEH might indeed be misleading.   Why Ukraine is not different  But Ukraine is not as different as Ickes suggests. Although Ukraine has no natural resources in oil and gas, Russia depends in its gas and oil exports on Ukraine’s pipelines. 90 percent of Russian gas exports are transported through the pipelines of Ukraine. Russia pays for the use of Ukraine’s pipelines with gas. The barter deal of Russian gas in exchange for Ukraine’s pipeline services covers 40 percent of Ukraine’s total demand for gas. In addition, Ukraine  was stealing a huge amount of Russian gas (720 million USD) going through Ukraine’spipelines which made Russia to consider avoiding Ukraine altogether and to build a newpipeline.  Furthermore, Ukraine has accumulated a huge amount of gas arrears vis a vis Russia(of 2 billion USD).  Russia depends also in its oil exports on Ukraine’s pipelines, but less sothan in its gas exports.The mutual dependence between Russia and Ukraine can be clearly seen from Table 1.Whenever Russia increased the oil price for Ukraine (which happened in 1996 from 51.5USD/T to 71.2, an increase of 38 percent), Ukraine increased the transit tariff for Russian gas(from 0.65 USD/tcm/1000 to 1.75 USD/tcm/1000, an increase of almost 170 percent). Thus,the terms of trade of the Russian oil/Ukraine pipeline service deal shifted in Ukraine’s favor,lowering the effective price of Russian oil that Ukraine paid. Unfortunately, prices forRussian oil to Ukraine are not available after 1997. However, the table still shows thatUkraine lowered the transit tariff for Russian gas in 1998 when Russian oil prices fell andincreased the transit tariff again in 2001 when world oil markets boomed.Table 1            Mutual Dependence: Russian Oil for Ukraine Pipeline ServicesUnit 1994 1995 1996 1997 1998 1999 2000 2001transit tariffs forRussian gasUSD/tcm/1000 km0,65 0,65 1,75 1,75 1,09 1,09 1,09 1,44oil prices forUkraineUSD/T* - 51,5 71,2 71,4 - - - -oil prices for ROW USD/T* - 74,2 92,8 102,6 76,9 67,9 139,7 -Sources: Energy Information Administration, USA; Ministry of Finance, Ukraine*) Unit ValuesA country’s ability to export gas and oil requires both a natural resource in oil and gas and apipeline which minimizes transport costs to export markets. Russia has the natural resource,Ukraine offers the cheapest cost of transport for this natural resource. Although Ukraine hasno comparative advantage in oil and gas it has a comparative advantage in transporting gasand oil from Russia. Ukraine has always exploited its monopoly position by bargaining forcheap gas and oil from Russia after the disintegration of the former Soviet Union (FSU). Dueto its geographic advantage, Ukraine continues to have cheap oil and gas even after itsseparation from Russia (Russia charges Ukraine an oil price which is 30 percent lower thanfor the rest of the world (ROW), see Table 1).The availability of cheap energy in Ukraine can be seen also in Figure 1 which shows thatUkraine’s energy consumption per GDP (which includes oil, gas electricity, and coal) ishigher than in Russia and has increased after the collapse of the FSU, while it has remainedconstant or has declined in Russia and other smaller Central European Countries.Figure 1 Energy Consumption to GDP(BTU per GDP at 1995 USD prices)Source: Energy Information Administration, USATo sum up, because of the availability of cheap energy in Ukraine after the collapse of theFSU the pattern of value transfer across sectors, if it is taking place at all, can be expected tobe similar between Ukraine and Russia. Thus, it is quite appropriate to test the VEH withUkrainian data.Ukraine and Russia are strikingly similar along another dimension: the pattern of barter overtime. After an explosive growth from 8 percent in 1994 to around 60 percent in 1998 barterand non-cash transactions have declined since 1998 by around 30 to 40 percent  in bothcountries (see Marin and Schnitzer 2002).  What explains this striking similarity in the timepattern of barter in these two countries? Why was barter exploding before 1998 and vanishingafter the financial crisis of August of 1998?  Russia is an oil exporter, Ukraine is an oilimporter. The ruble depreciated by about 50 percent after the August financial crisis, whilethe hryvnia showed only a modest decline. The strong devaluation of the exchange rate andbooming world oil markets have both been argued to have contributed to the vanishing bartereconomy. However, the different behavior of the exchange rates and in the importance of oilin these two countries suggests that  some other force must be at work to explain the strikingsimilarity in the time pattern of barter.Is the VEH a candidate explanation? To construct an argument for the vanishing bartereconomy along the lines of the VEH one has to find a reason why in 1998 the energyproducers stopped providing subsidies to the manufacturing sector. Is it because the energyproducers had less money available? Or because manufacturing firms suddenly started tocreate value in 1998? The booming world oil markets and the associated increase in rents ofthe energy sector should have made it easier rather than more difficult for this sector totransfer value to the rest of the economy. Why then has barter started to decline in 1998? TheVEH does not seem to offer an answer.5070901101301501992 1993 1994 1995 1996 1997 1998 1999 20001992=100Poland Russia Ukraine Hungary 100In order to find an answer for the decline in barter we have to turn to the financial sector. Onecommon feature between Ukraine and Russia that the VEH does not touch upon is thefinancial sector. Russia and Ukraine are the transition countries with the lowest level of bankintermediation (see Huang,Marin,Xu 2002). Banks practically did not lend to the real sectorand firms used barter trade to finance production. Banks financed the government budgetinstead. With the collapse of the treasury bills market after the August 1998 crisis bankslending behavior changed drastically. They stopped to finance the government budget andhave started to lend to firms. Huang, Marin, Xu (2002) argue that the financial crisis of 1998helped these economies to get out of a banking development trap which explains why barterhas dropped and why output has recovered in Russia and Ukraine for the first time since thefall of communism.Flawed Testing ProcedureIckes claims that the empirical test is flawed because it rests on how accurately I separatepurchases from sales in barter transactions. How can I distinguish buyers and sellers in barterdeals when both sides of the transaction involve goods? I thought about this question quite abit when I was designing the questionnaire. But when the questionnaire was tested in a pilotamong a few firms, this turned out to be a non issue.  Firms seldom had a problem to separatethe sale from the purchase in a barter deal. The reason is that typically buying firms facedpayment difficulties. The selling firm in fact gave a trade credit to the buyer. Therefore, therewas a time delay between the “sale” and the “goods payment” in more than 50 percent of thebarter transactions. The time period between the “sale” and the “goods payment” variedbetween 1 and 7 month in barter transactions in transition countries and between 6 month and10 years in barter contracts in international trade (see Marin and Schnitzer (2002) for barter astrade credit). Because of this separation in time between the sale and the purchase in bartercontracts (barter is a trade credit which is repaid in goods rather than cash) the firms involvedin the deal (and we researchers) could easily identify the seller (the firm which gave a tradecredit) and the buyer (the firm receiving the trade credit). This way, we could avoid anarbitrary classification of sellers and buyers which is Ickes main concern.References:H. Huang, D. Marin, Ch. Xu (2004),  Financial Crisis,  Economic Recovery,  and BankingDevelopment in Russia, Ukraine, and Other FSU Countries, International Monetary Fund,IMF Working Paper No 04/105.D. Marin and M. Schnitzer (2002), Contracts in Trade and Transition: The Resurgence ofBarter, Cambridge: The MIT Press.

Contracts in Trade and Transition: The Resurgence of Barter,

Xu (2004), Financial Crisis, Economic Recovery, and Banking Development

https://epub.ub.uni-muenchen.de/13468/1/83.pdf

The Vanishing Barter Economy in Russia: A Test of the Virtual Economy Hypothesis? Reply to Barry Ickes

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