With or without such a provision, strong intervention of government was required. But the intervention of the government would have aimed at financial restructuring—establishing clear ownership of firms, enabling them to reenter credit markets. That would have enabled them to take full advantage of the opportunities for export that resulted from their lower exchange rate. It would have eliminated the incentive for asset stripping; it would have provided them with strong incentives to engage in any real restructuring that was required—and the new owners and managers would have been in a far better position to guide this restructuring than international or domestic bureaucrats, who, as the expression goes, had never met a payroll. Such financial restructuring did not require huge bailouts. The disillusionment with the large bailout strategy is now almost universal. I cannot be sure that my ideas would have worked, but there is little doubt in my mind that the chance of success with this strategy was far greater than with the IMF’s plan, which failed in ways that were perfectly predictable, at huge costs.
The IMF did not learn quickly from its failures in East Asia. With slight variants, it repeatedly tried the large bailout strategy. With the failures in Russia, Brazil, and Argentina, it has become clear that an alternative strategy is required, and there is today increasing support for at least some of the key elements of the approach I have just described. Today, five years after the onset of the crisis, the IMF and the G-7 are all talking about giving greater emphasis to bankruptcy and standstills (short-term freezes on payments), and even the temporary use of capital controls. We will return to these reforms later, in chapter 13.
THE ASIAN CRISIS has brought many changes that will stand the countries in good stead in the future. Corporate governance and accounting standards have improved—in some cases putting these countries toward the top of the emerging markets. The new constitution in Thailand promises a stronger democracy (including a provision embracing the citizens’ “right to know,” not even included in the U.S. Constitution), promising a level of transparency certainly beyond that of the international financial institutions. Many of these changes put in place conditions for even more robust growth in the future.
But offsetting these gains are some real losses. The way the IMF approached the crisis has left in most of the countries a legacy of private and public debt. It has not only frightened firms off the excessively high debt that characterized Korea, but even off more cautious debt levels: the exorbitant interest rates forcing thousands of firms into bankruptcy showed how even moderate levels of debt could be highly risky. As a result, firms will have to rely more on self-finance. In effect, capital markets will work less efficiently—a casualty too of the IMF’s ideological approach to improving market efficiency. And most important, growth of living standards will be slowed.
The IMF policies in East Asia had exactly the consequences that have brought globalization under attack. The failures of the international institutions in poor developing countries were long-standing; but these failures did not grab the headlines. The East Asia crisis made vivid to those in the more developed world some of the dissatisfaction that those in the developing world had long felt. What took place in Russia through most of the 1990s provides some even more arresting examples why there is such discontent with international institutions, and why they need to change.
CHAPTER 9
WHO LOST RUSSIA?
WITH THE FALL of the Berlin Wall in late 1989, one of the most important economic transitions of all time began. It was the second bold economic and social experiment of the century.1 The first was Russia’s transition to communism seven decades earlier. Over the years, the failures of this first experiment became apparent. As a consequence of the 1917 Revolution and the Soviet hegemony over a large part of Europe after World War II, some 8 percent of the world’s population that lived under the Soviet Communist system forfeited both political freedom and economic prosperity. The second transition in Russia as well as in Eastern and Southeastern Europe is far from over, but this much is clear: in Russia it has fallen far short of what the advocates of the market economy had promised, or hoped for. For the majority of those living in the former Soviet Union, economic life under capitalism has been even worse than the old Communist leaders had said it would be. Prospects for the future are bleak. The middle class has been devastated, a system of crony and mafia capitalism has been created, and the one achievement, the creation of a democracy with meaningful freedoms, including a free press, appears fragile at best, particularly as formerly independent TV stations are shut down one by one. While those in Russia must bear much of the blame for what has happened, the Western advisers, especially from the United States and the IMF, who marched in so quickly to preach the gospel of the market economy, must also take some blame. At the very least, they provided support to those who led Russia and many of the other economies down the paths they followed, arguing for a new religion—market fundamentalism—as a substitute for the old one—Marxism—which had proved so deficient.
Russia is an ever-unfolding drama. Few anticipated the sudden dissolution of the Soviet Union and few anticipated the sudden resignation of Boris Yeltsin. Some see the oligarchy, the worst excesses of the Yeltsin years, as already curbed; others simply see that some of the oligarchs have fallen from grace. Some see the increases in output that have occurred in the years since its 1998 crisis as the beginning of a renaissance, one which will lead to the recreation of a middle class; others see it as taking years just to repair the damage of the past decade. Incomes today are markedly lower than they were a decade ago, and poverty is much higher. The pessimists see the country as a nuclear power wavering with political and social instability. The optimists (!) see a semiauthoritarian leadership establishing stability, but at the price of the loss of some democratic freedoms.
Russia experienced a burst of growth after 1998, based on high oil prices and the benefits of the devaluation which the IMF so long opposed. But as oil prices have come down, and the benefits of the devaluation have been reaped, growth too has slowed. Since then, as Russia deindustrialized, it became increasingly dependent on oil. When the oil prices boomed, as in the years before the global financial crisis, Russia boomed; when the oil prices fell, Russia went into recession.
It is not surprising that the debate over who lost Russia has had such resonance. At one level, the question is clearly misplaced. In the United States it evokes memories of the debate a half century ago about who lost China, when the Communists took over that country. But China was not America’s to lose in 1949, nor was Russia America’s to lose a half century later. In neither case did America and the Western European countries have control over the political and social evolution. At the same time, it is clear that something has clearly gone wrong, not only in Russia but also in most of the more than twenty countries that emerged from the Soviet empire.
The IMF and other Western leaders claim that matters would have been far worse were it not for their help and advice. We had then, and we have now, no crystal ball to tell us what would happen if alternative policies were pursued. We have no way of running a controlled experiment, going back in time to try an alternative strategy. We have no way of being certain of what might have been.
But we do know that certain political and economic judgment calls were made, and we know that the outcomes have been disastrous. In some cases, the link between the policies and the consequences is easy to see: The IMF worried that a devaluation of the ruble would set off a round of inflation. Its insistence on Russia maintaining an overvalued currency and its supporting that with billions of dollars of loans ultimately crushed the economy. (When the ruble was finally devalued in 1998, inflation did not soar as the IMF had feared, and the economy experienced its first significant growth.) In other cases, the links are more complicated. But the experiences of the few countries that followed different policies in managing their transitions help guide us through the maze. It is essential that the world make an informed judgment about the IMF pol
icies in Russia, what drove them and why they were so misguided. Those, myself included, who have had an opportunity to see firsthand how decisions were made and what their consequences were have a special responsibility to provide their interpretations of relevant events.
There is a second reason for a reappraisal. Now, more than ten years after the fall of the Berlin Wall, it is clear that the transition to a market economy will be a long struggle, and many, if not most, of the issues that seemed settled only a few years ago will need to be revisited. Only if we understand the mistakes of the past can we hope to design policies that are likely to be effective in the future.
The leaders of the 1917 Revolution recognized that what was at stake was more than a change in economics; it was a change in society in all of its dimensions. So, too, the transition from communism to a market economy was more than just an economic experiment: it was a transformation of societies and of social and political structures. Part of the reason for the dismal results of the economic transition was the failure to recognize the centrality of these other components.
The first Revolution recognized how difficult the task of transformation was, and the revolutionaries believed that it could not be accomplished by democratic means; it had to be led by the “dictatorship of the proletariat.” Some of the leaders of the second revolution in the 1990s at first thought that, freed from the shackles of communism, the Russian people would quickly appreciate the benefits of the market. But some of the Russian market reformers (as well as their Western supporters and advisers) had very little faith or interest in democracy, fearing that if the Russian people were allowed to choose, they would not choose the “correct” (that is their) economic model. In Eastern Europe and the former Soviet Union, when the promised benefits of market reform failed to materialize in country after country, democratic elections rejected the extremes of market reform, and put social democratic parties or even “reformed” Communist parties, many with former Communists at the helm, into power. It is not surprising that many of the market reformers showed a remarkable affinity to the old ways of doing business: in Russia, President Yeltsin, with enormously greater powers than his counterparts in any Western democracy, was encouraged to circumvent the democratically elected Duma (parliament) and to enact market reforms by decree.2 It is as if the market Bolsheviks, native true believers, as well as the Western experts and evangelists of the new economic religion who flew into the post-Socialist countries, attempted to use a benign version of Lenin’s methods to steer the post-communism, “democratic” transition.
THE CHALLENGES AND OPPORTUNITIES OF TRANSITION
As the transition began in the early 1990s, it presented both great challenges and opportunities. Seldom before had a country deliberately set out to go from a situation where government controlled virtually every aspect of the economy to one where decisions occurred through markets. The People’s Republic of China had begun its transition in the late 1970s, and was still far from a full-fledged market economy. One of the most successful transitions had been Taiwan, 100 miles off the shore of mainland China. It had been a Japanese colony since the end of the nineteenth century. With China’s 1949 revolution, it became the refuge for the old Nationalist leadership, and from their base in Taiwan, they claimed sovereignty over the entire mainland, keeping the name—“the Republic of China.” They had nationalized and redistributed the land, established and then partially privatized an array of major industries, and more broadly created a vibrant market economy. After 1945 many countries, including the United States, moved from wartime mobilization to a peacetime economy. At the time, many economists and other experts feared a major recession would follow wartime demobilization, which entailed not only a change in how decisions were made (ending versions of command economies in which wartime governments made the major decisions about production and returning to private sector management of production) but also an enormous reallocation of production of goods, for example, from tanks to cars. But by 1947, the second full postwar year, production in the United States was 9.6 percent higher than 1944, the last full war year. By the end of the war, 37 percent of GDP (1945) was devoted to defense. With peace, this number was brought down rapidly to 7.4 percent (1947).
There was one important difference between the transition from war to peace, and from communism to a market economy, as I will detail later: Before World War II, the United States had the basic market institutions in place, even though during the war many of these were suspended and superseded by a “command and control” approach. In contrast, Russia needed both resource redeployment and the wholesale creation of market institutions.
But Taiwan and China faced similar problems to the economies in transition. Both faced the challenge of a major transformation of their societies, including the establishment of the institutions that underlay a market economy. Both have had truly impressive successes. Rather than prolonged transition recession, they had close to double-digit growth. The radical economic reformers who sought to advise Russia and many of the other countries on transition paid scant attention to these experiences, and the lessons that could be learned. It was not because they believed that Russian history (or the history of the other countries making the transition) made these lessons inapplicable. They studiously ignored the advice of Russian scholars, whether they were experts in its history, economics, or society, for a simple reason: they believed that the market revolution which was about to occur made all of the knowledge available from these other disciplines irrelevant. What the market fundamentalists preached was textbook economics—an oversimplified version of market economics which paid scant attention to the dynamics of change.
Consider the problems facing Russia (or the other countries) in 1989. There were institutions in Russia that had names similar to those in the West, but they did not perform the same functions. There were banks in Russia, and the banks did garner savings; but they did not make decisions about who got loans, nor did they have the responsibility for monitoring and making sure that the loans were repaid. Rather, they simply provided the “funds,” as dictated by the government’s central planning agency. There were firms, enterprises producing goods in Russia, but the enterprises did not make decisions: they produced what they were told to produce, with inputs (raw material, labor, machines) that were allocated to them. The major scope for entrepreneurship lay in getting around problems posed by the government: the government would give enterprises quotas on output, without necessarily providing the inputs needed, but in some cases providing more than necessary. Entrepreneurial managers engaged in trades to enable themselves to fulfill their quotas, in the meanwhile getting a few more perks for themselves than they could have enjoyed on their official salaries. These activities—which had always been necessary to make the Soviet system merely function—led to the corruption that would only increase as Russia moved to a market economy.3 Circumventing what laws were in force, if not breaking them outright, became part of the way of life, a precursor to the breakdown of the “rule of law” which was to mark the transition.
As in a market economy, under the Soviet system there were prices, but the prices were set by government fiat, not by the market. Some prices, such as those for basic necessities, were kept artificially low—enabling even those at the bottom of the income distribution to avoid poverty. Prices for energy and natural resources also were kept artificially low—which Russia could only afford because of its huge reservoirs of these resources.
Old-fashioned economics textbooks often talk about market economics as if it had three essential ingredients: prices, private property, and profits. Together with competition, these provide incentives, coordinate economic decision making, ensuring that firms produce what individuals want at the lowest possible cost. But there has also long been a recognition of the importance of institutions. Most important are legal and regulatory frameworks, to ensure that contracts are enforced, that there is an orderly way of resolving commercial disputes, that when borrowers cannot re
pay what is owed, there are orderly bankruptcy procedures, that competition is maintained, and that banks that take depositors are in a position to give the money back to depositors when they ask. This framework of laws and agencies helps ensure that securities markets operate in a fair manner, that managers do not take advantage of shareholders nor majority shareholders of minority shareholders. In the nations with mature market economies, the legal and regulatory frameworks had been built up over a century and a half, in response to problems encountered in unfettered market capitalism. Bank regulation came into place after massive bank failures; securities regulation after major episodes in which unwary shareholders were cheated. Countries seeking to create a market economy did not have to relive these disasters: they could learn from the experiences of others. But while the market reformers may have mentioned this institutional infrastructure, they gave it short shrift. They tried to take a shortcut to capitalism, creating a market economy without the underlying institutions, and institutions without the underlying institutional infrastructure. Before you set up a stock market, you have to make sure there are real regulations in place. New firms need to be able to raise new capital, and this requires banks that are real banks, not the kinds of banks that characterized the old regime, or banks that simply lend money to government. A real and effective banking system requires strong banking regulations. New firms need to be able to acquire land, and this requires a land market and land registration.
Similarly, in Soviet-era agriculture, farmers used to be given the seeds and fertilizer they needed. They did not have to worry about getting these and other inputs (such as tractors) or marketing their output. Under a market economy, markets for inputs and outputs had to be created, and this required new firms or enterprises. Social institutions are also important. Under the old system in the Soviet Union, there was no unemployment, and hence no need for unemployment insurance. Workers typically worked for the same state enterprise for their entire lives, and the firm provided housing and retirement benefits. In post-1989 Russia, however, if there were to be a labor market, individuals would have to be able to move from firm to firm. But if they could not obtain housing, such mobility would be almost impossible. Hence, a housing market was necessary. A minimal level of social sensitivity means that employers will be reluctant to fire workers if there is nothing for them to fall back on. Hence, there could not be much “restructuring” without a social safety net. Unfortunately, neither a housing market nor a real safety net existed in the Russia of 1989.
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