Apart from these moral issues, there were straightforward economic issues. The IMF’s bailout money was supposed to be used to support the exchange rate. However, if a country’s currency is overvalued and this causes the country’s economy to suffer, maintaining the exchange rate makes little sense. If the exchange rate support works, the country suffers. But in the more likely case that the support does not work, the money is wasted, and the country is deeper in debt. Our calculations showed that Russia’s exchange rate was overvalued, so providing money to maintain that exchange rate was simply bad economic policy. Moreover, calculations at the World Bank before the loan was made, based on estimates of government revenues and expenditures over time, strongly suggested that the July 1998 loan would not work. Unless a miracle brought interest rates down drastically, by the time autumn rolled around, Russia would be back in crisis.
There was another route by which I reached the conclusion that a further loan to Russia would be a great mistake. Russia was a naturally resource-rich country. If it got its act together, it didn’t need money from the outside; and if it didn’t get its act together, it wasn’t clear that any money from the outside would make much difference. Under either scenario, the case against giving money seemed compelling.
In spite of strong opposition from its own staff, the Bank was under enormous political pressure from the Clinton administration to lend money to Russia. The Bank managed a compromise, publicly announcing a very large loan, but providing the loan in tranches—installments. A decision was taken to make $300 million available immediately, with the rest available only later, as we saw how Russia’s reforms progressed. Most of us thought that the program would fail long before the additional money had to be forthcoming. Our predictions proved correct. Remarkably, the IMF seemed able to overlook the corruption, and the attendant risks with what would happen with the money. It actually thought that maintaining the exchange rate at an overvalued level was a good thing, and that the money would enable it to do this for more than a couple months. It provided billions to the country.
The Rescue Fails
Three weeks after the loan was made, Russia announced a unilateral suspension of payments and a devaluation of the ruble.6 The ruble crashed. By January 1999, the ruble had declined in real effective terms by more than 75 percent from its July 1998 level.7 The August 17 announcement precipitated a global financial crisis. Interest rates to emerging markets soared higher than they had been at the peak of the East Asia crisis. Even developing countries that had been pursuing sound economic policies found it impossible to raise funds. Brazil’s recession deepened, and eventually it too faced a currency crisis. Argentina and other Latin American countries only gradually recovering from previous crises were again pushed nearer the brink. Ecuador and Colombia went over the brink and into crisis. Even the United States did not remain untouched. The New York Federal Reserve Bank engineered a private bailout of one of the nation’s largest hedge funds, Long Term Capital Management, since the Fed feared its failure could precipitate a global financial crisis.
The surprise about the collapse was not the collapse itself, but the fact that it really did take some of the IMF officials—including some of the most senior ones—by surprise. They had genuinely believed that their program would work.
Our own forecasts proved only partially correct: we thought that the money might sustain the exchange rate for three months; it lasted three weeks. We felt that it would take days or even weeks for the oligarchs to bleed the money out of the country; it took merely hours and days. The Russian government even “allowed” the exchange rate to appreciate. As we have seen, this meant the oligarchs would need to spend fewer rubles to purchase their dollars. A smiling Viktor Gerashchenko, the chairman of the Central Bank of Russia, told the president of the World Bank and me that it was simply “market forces at work.” When the IMF was confronted with the facts—the billions of dollars that it had given (loaned) Russia were showing up in Cypriot and Swiss bank accounts just days after the loan was made—it claimed that these weren’t their dollars. The argument demonstrated either a remarkable lack of understanding of economics or a level of disingenuousness that rivaled Gerashchenko’s, or both. When money is sent to a country, it is not sent in the form of marked dollar bills. Thus, one cannot say it is “my” money that went anywhere. The IMF had lent Russia the dollars—funds that allowed Russia, in turn, to give its oligarchs the dollars to take out of the country. Some of us quipped that the IMF would have made life easier all around if it had simply sent the money directly into the Swiss and Cyprus bank accounts.
It was, of course, not just the oligarchs who benefited from the rescue. The Wall Street and other Western investment bankers, who had been among those pressing the hardest for a rescue package, knew it would not last: they too took the short respite provided by the rescue to rescue as much as they could, to flee the country with whatever they could salvage.
By lending Russia money for a doomed cause, IMF policies led Russia into deeper debt, with nothing to show for it. The cost of the mistake was not borne by the IMF officials who gave the loan, or America who had pushed for it, or the Western bankers and the oligarchs who benefited from the loan, but by the Russian taxpayer.
There was one positive aspect of the crisis: The devaluation spurred Russia’s import-competing sectors—goods actually produced in Russia finally took a growing share of the home market. This “unintended consequence” ultimately led to the long-awaited growth in Russia’s real (as opposed to black) economy. There was a certain irony in this failure: macroeconomics was supposed to be the IMF’s strength, and yet even here it had failed. These macroeconomic failures compounded the other failures, and contributed mightily to the enormity of the decline.
THE FAILED TRANSITIONS
Seldom has the gap between expectations and reality been greater than in the case of the transition from communism to the market. The combination of privatization, liberalization, and decentralization was supposed to lead quickly, after perhaps a short transition recession, to a vast increase in production. It was expected that the benefits from transition would be greater in the long run than in the short run, as old, inefficient machines were replaced, and a new generation of entrepreneurs was created. Full integration into the global economy, with all the benefits that that would bring, would also come quickly, if not immediately.
These expectations for economic growth were not realized, not only in Russia but in most of the economies in transition. Only a few of the former Communist countries—such as Poland, Hungary, Slovenia, and Slovakia—have a GDP equal to that of a decade ago. For the rest, the magnitudes of the declines in incomes are so large that they are hard to fathom. According to World Bank data, Russia in 2000 had a GDP that was less than two-thirds of what it was in 1989. Moldova’s decline is the most dramatic, with output in 2000 less than a third of what it was a decade before. Ukraine’s 2000 GDP was just a third of what it was ten years earlier.
Underlying the data were true symptoms of Russia’s malady. Russia had quickly been transformed from an industrial giant—a country that had managed with Sputnik to put the first satellite into orbit—into a natural resource exporter; resources, and especially oil and gas, accounted for over half of all exports. While the Western reform advisers were writing books with titles like The Coming Boom in Russia or How Russia Became a Market Economy, the data itself was making it hard to take seriously the rosy pictures they were painting, and more dispassionate observers were writing books like The Sale of the Century: Russia’s Wild Ride from Communism to Capitalism.8
The magnitude of GDP decline in Russia (not to mention other former Communist countries) is the subject of controversy, and some argue that because of the growing and critical informal sector—from street vendors to plumbers, painters, and other service providers, whose economic activities are typically hard to capture in national income statistics—the numbers represent an overestimate of the size of the decline. However, othe
rs argue that because so many of the transactions in Russia entail barter (over 50 percent of industrial sales),9 and because the “market” prices are typically higher than these “barter” prices, the statistics actually underestimate the decline.
Taking all this into account, there is still a consensus that most individuals have experienced a marked deterioration in their basic standard of living, reflected in a host of social indicators. While in the rest of the world life spans were increasing markedly, in Russia they were over three years shorter, and in Ukraine almost three years shorter. Survey data of household consumption—what people eat, how much they spend on clothing, and what type of housing they live in—corroborates a marked decline in standards of living, on par with those suggested by the fall in GDP statistics. Given that the government was spending less on defense, standards of living should have increased even more than GDP. To put it another way, assume that somehow previous expenditures on consumption could have been preserved, and a third of the expenditures on military could have been shifted into new production of consumption goods, and that there had been no restructuring to increase efficiency or to take advantage of the new trade opportunities. Consumption—living standards—would then have increased by 4 percent, a small amount but far better than the actual decline.
Increased Poverty and Inequality
These statistics do not tell the whole story of the transition in Russia. They ignore one of the most important successes: How do you value the benefits of the new democracy, as imperfect as it might be? But they also ignore one of the most important failures: The increase in poverty and inequality.
While the size of the national economic pie was shrinking, it was being divided up more and more inequitably so the average Russian was getting a smaller and smaller slice. In 1989, only 2 percent of those living in Russia were in poverty. By late 1998, that number had soared to 23.8 percent, using the $2 a day standard. More than 40 percent of the country had less than $4 a day, according to a survey conducted by the World Bank. The statistics for children revealed an even deeper problem, with more than 50 percent living in families in poverty. Other post-Communist countries have seen comparable, if not worse, increases in poverty.10
Shortly after I arrived at the World Bank, I began taking a closer look at what was going on, and at the strategies that were being pursued. When I raised my concerns about these matters, an economist at the Bank who had played a key role in the privatizations responded heatedly. He cited the traffic jams of cars, many of them Mercedes, leaving Moscow on a summer weekend, and the stores filled with imported luxury goods. This was a far different picture from the empty and colorless retail establishments under the former regime. I did not disagree that a substantial number of people had been made wealthy enough to cause a traffic jam, or to create a demand for Gucci shoes and other imported luxury items sufficient for certain stores to prosper. At many European resorts, the wealthy Russian has replaced the wealthy Arab of two decades ago. In some, street signs are even given in Russian along with the native language. But a traffic jam of Mercedes in a country with a per capita income of $4,730 (as it was in 1997) is a sign of a sickness, not health. It is a clear sign of a society that concentrates its wealth among the few, rather than distributing it among the many.
While the transition has greatly increased the number of those in poverty, and led a few at the top to prosper, the middle class in Russia has perhaps been the hardest hit. The inflation first wiped out their meager savings, as we have seen. With wages not keeping up with inflation, their real incomes fell. Cutbacks in expenditures on education and health further eroded their standards of living. Those who could, emigrated. (Some countries, like Bulgaria, lost 10 percent or more of their population, and an even larger fraction of their educated workforce.) The bright students in Russia and other countries of the former Soviet Union that I’ve met work hard, with one ambition in mind: to migrate to the West. These losses are important not just for what they imply today for those living in Russia, but for what they portend for the future: historically, the middle class has been central to creating a society based on the rule of law and democratic values.
The magnitude of the increase in inequality, like the magnitude and duration of the economic decline, came as a surprise. Experts did expect some increase in inequality, or at least measured inequality. Under the old regime, incomes were kept similar by suppressing wage differences. The Communist system, while it did not make for an easy life, avoided the extremes of poverty, and kept living standards relatively equal, by providing a high common denominator for education, housing, health care and child care services. With a switch to a market economy, those who worked hard and produced well would reap the rewards for their efforts, so some increase in inequality was inevitable. However, it was expected that Russia would be spared the inequality arising from inherited wealth. Without this legacy of inherited inequality, there was the promise of a more egalitarian market economy. How differently matters have turned out! Russia today has a level of inequality comparable with the worst in the world, those Latin American societies which were based on a semifeudal heritage.11
Russia has gotten the worst of all possible worlds—an enormous decline in output and an enormous increase in inequality. And the prognosis for the future is bleak: extremes of inequality impede growth, particularly when they lead to social and political instability.
HOW MISGUIDED POLICIES LED TO THE FAILURES OF TRANSITION
We have already seen some of the ways that the Washington consensus policies contributed to the failures: privatization done the wrong way had not led to increased efficiency or growth but to asset stripping and decline. We have seen how the problems were compounded by interactions between reforms, as well as their pace and sequencing: capital market liberalization and privatization made it easier to take money out of the country; privatization before a legal infrastructure was in place enhanced the ability and incentive for asset stripping rather than reinvesting in the country’s future. A full description of what went on, and a full analysis of the ways in which IMF programs contributed to the decline of the country, is a book in itself. Here, I want to sketch three examples. In each case, defenders of the IMF will say that things would have been worse, but for their programs. In some cases—such as the absence of competition policies—the IMF will insist that such policies were part of the program, but, alas, Russia did not implement them. Such a defense is ingenuous: with dozens of conditions, everything was in the IMF program. Russia knew, however, that when it came to the inevitable charade in which the IMF would threaten to cut off aid, Russia would bargain hard, an agreement (not often fulfilled) would be reached, and the money spigot opened up again. What was important were the monetary targets, the budget deficits, and the pace of privatization—the number of firms that had been turned over to the private sector, never mind how. Almost everything else was secondary; much—like competition policy—was virtually window-dressing, a defense against critics who said they were leaving out important ingredients to a successful transition strategy. As I repeatedly pushed for stronger competition policies, those inside Russia who agreed with me, who were trying to establish a true market economy, who were trying to create an effective competition authority, repeatedly thanked me.
Deciding what to emphasize, establishing priorities, is not easy. Textbook economics often provides insufficient guidance. Economic theory says that for markets to work well, there must be both competition and private property. If reform was easy, one would wave a magic wand and have both. The IMF chose to emphasize privatization, giving short shrift to competition. The choice was perhaps not surprising: corporate and financial interests often oppose competition policies, for these policies restrict their ability to make profits. The consequences of the IMF’s mistake here were far more serious than just high prices: privatized firms sought to establish monopolies and cartels, to enhance their profits, undisciplined by effective antitrust policies. And as so often happens, the profits
of monopoly prove especially alluring to those who are willing to resort to mafialike techniques either to obtain market dominance or to enforce collusion.
Inflation
Earlier we saw how the rapid liberalization at the beginning had led to the burst of inflation. The sad part of Russia’s story was that each mistake was followed by another, which compounded the consequences.
Having set off the rapid inflation through abrupt price liberalization in 1992, it was necessary for the IMF and the Yeltsin regime to contain it. But balance has never been the strong suit of the IMF, and its excessive zeal led to excessively high interest rates. There is little evidence that lowering inflation below a moderate level increases growth. The most successful countries, like Poland, ignored the IMF’s pressure and maintained inflation at around 20 percent through the critical years of adjustment. IMF’s star pupils, like the Czech Republic, which pushed inflation down to 2 percent, saw their economy stagnate. There are some good reasons to believe that excessive zeal in fighting inflation can dampen real economic growth. The high interest rate clearly stifled new investment. Many of the new, privatized firms, even those who might have begun without an eye to looting them, saw that they could not expand and turned to asset stripping. The IMF-driven high interest rates led to an overvaluation of the exchange rate, making imports cheap and exports difficult. No wonder then that any visitor to Moscow after 1992 could see the stores filled with imported clothing and other goods, but would be hard-pressed to find much with a “Made in Russia” label. And this was true even five years after the transition began.
Globalization and Its Discontents Revisited Page 34