The tight monetary policies also contributed to the use of barter. With a shortage of money, workers were paid in kind—with whatever it was that the factory produced or had available, from toilet paper to shoes. While the flea markets that were established everywhere throughout the country as workers tried to get cash to buy the bare necessities of life gave a semblance of entrepreneurial activity, they masked huge inefficiencies. High rates of inflation are costly to an economy because they interfere with the workings of the price system. But barter is every bit as destructive to the effective workings of the price system, and the excesses of monetary stringency simply substituted one set of inefficiencies for a possibly even worse set.
Privatization
The IMF told Russia to privatize as fast as possible; how privatization was done was viewed as secondary. Much of the failure of which I wrote earlier—both the decline in incomes and the increase in inequality—can be directly linked to this mistake. In a World Bank review of the ten-year history of transition economies, it became apparent that privatization, in the absence of the institutional infrastructure (like corporate governance), had no positive effect on growth.12 The Washington Consensus had again just gotten it wrong. It is easy to see the links between the way privatization was done and the failures.
For instance, in Russia and other countries, the lack of laws ensuring good corporate governance meant that those who could get control of a corporation had an incentive to steal assets from the minority shareholders; and managers had similar incentives vis-à-vis shareholders. Why expend energy in creating wealth when it was so much easier to steal it? Other aspects of the privatization process, as we have seen, enhanced the incentives as well as opportunities for corporate theft. Privatization in Russia turned over large national enterprises, typically to their old managers. Those insiders knew how uncertain and difficult was the road ahead. Even if they were predisposed to do so, they dared not wait for the creation of capital markets and the hosts of other changes that would be required for them to reap the full value of any investments and restructuring. They focused on what they could get out of the firm in the next few years, and all too often, this was maximized by stripping assets.
Privatization was also supposed to eliminate the role of the state in the economy; but those who assumed that had a far too naive view of the role of the state in the modern economy. It exercises its influence in a myriad of ways at a myriad of levels. Privatization did reduce the power of the central government, but that devolution left the local and regional governments with far wider discretion. A city or an oblast (regional government) could use a host of regulatory and tax measures to extort “rents” from firms that operated in their jurisdiction. In advanced industrial countries there is a rule of law which keeps local and state governments from abusing their potential powers; not so in Russia. In advanced industrial countries, competition among communities makes each try to make itself more attractive to investors. But in a world in which high interest rates and an overall depression make such investments unlikely in any case, local governments spent little time creating attractive “environments for investment” and focused instead on seeing how much they could extract from existing enterprises—just as the owners and managers of newly privatized firms themselves did. And when these privatized firms operated across many jurisdictions, authorities in one district reasoned that they had better take what they could grab before others took their own bites out of assets. And this only reinforced the incentive of managers to grab whatever they could as quickly as possible. After all, the firms would be left destitute in any case. It was a race to the bottom. There were incentives for asset stripping at every level.
Just as the radical “shock therapy” reformers claim that the problem with liberalization was not that it was too fast, but that it was not fast enough, so too with privatization. While the Czech Republic, for example, was praised by the IMF even as it faltered, it became clear that the country’s rhetoric had outpaced its performance: it had left the banks in state hands. If a government privatizes corporations, but leaves banks in the state’s hands, or without effective regulation, that government does not create the hard budget constraints that lead to efficiency, but rather an alternative, less transparent way of subsidizing firms—and an open invitation to corruption. Critics of Czech privatization claim the problem was not that privatization was too rapid, but that it was too slow. But no country has succeeded in privatizing everything, overnight, well, and it is likely that were a government to try to do instantaneous privatization, there would be a mess. The task is too difficult, the incentives for malfeasance too high. The failures of the rapid privatization strategies were predictable—and predicted.
Not only did privatization, as it was imposed in Russia (as well as in far too many of its former Soviet bloc dependencies), not contribute to the economic success of the country; it undermined confidence in government, in democracy, and in reform. The result of giving away its rich natural resources before it had in place a system to collect natural resource taxes was that a few friends and associates of Yeltsin became billionaires, but the country was unable to pay pensioners their $15-a-month pension.
The most egregious example of bad privatization was the loans-for-share program. In 1995, the government, instead of turning to the Central Bank for needed funds, turned to private banks. Many of these private banks belonged to friends of the government who had been given bank charters. In an environment with underregulated banks, the charters were effectively a license to print money, to make loans either to themselves or their friends or to the government. As a condition of the loan, the government put up shares of its own enterprises as collateral. Then—surprise!—the government defaulted on its loans; the private banks took over the companies in what might be viewed as a sham sale (though the government did go through a charade of having “auctions”); and a few oligarchs became instant billionaires. These privatizations had no political legitimacy. And, as noted previously, the fact that they had no legitimacy made it even more imperative that the oligarchs take their funds quickly out of the country—before a new government that might try to reverse the privatizations or undermine their position came to power.
Those who benefited from the largesse of the state, or more accurately from Yeltsin’s largesse, worked hard to ensure Yeltsin’s reelection. Ironically, while there was always a presumption that part of Yeltsin’s giveaway went to finance his campaign, some critics think that the oligarchs were far too smart to use their money to pay for the election campaign; there was plenty of government slush funds that could be used. The oligarchs provided Yeltsin with something that was far more valuable—modern campaign management techniques and positive treatment by the TV networks they controlled.
The loans-for-share scheme constituted the final stage of the enrichment of the oligarchs, the small band of people (some of whom owed their origins, reportedly at least, partly to mafialike connections) who came to dominate not just the economic but the political life of the country. At one point, they claimed to control 50 percent of the country’s wealth! Defenders of the oligarchs liken them to America’s robber barons, the Harrimans and Rockefellers. But there is a big difference between the activities of such figures in nineteenth-century capitalism, even those carving out railway and mining baronies in America’s Wild West, and the Russian oligarchy’s exploitation of Russia, what has been called the Wild East. America’s robber barons created wealth, even as they accumulated fortunes. They left a country much richer, even if they got a big slice of the larger pie. Russia’s oligarchs stole assets, stripped them, leaving their country much poorer. The enterprises were left on the verge of bankruptcy, while the oligarch’s bank accounts were enriched.
The Social Context
The officials who applied Washington Consensus policies failed to appreciate the social context of the transition economies. This was especially problematic, given what had happened during the years of communism.
Market
economies entail a host of economic relationships—exchanges. Many of these exchanges involve matters of trust. An individual lends another money, trusting that he will be repaid. Backing up this trust is a legal system. If individuals do not live up to their contractual obligations, they can be forced to do so. If an individual steals property from another, he can be brought to court. But in countries with mature market economies and adequate institutional infrastructures, individuals and corporations resort only occasionally to litigation.
Economists often refer to the glue that holds society together as “social capital.” Random violence and Mafia capitalism are often cited as reflections of the erosion of social capital, but in some of the countries of the former Soviet Union that I visited, one could see everywhere, in more subtle ways, direct manifestations of the erosion of social capital. It is not just a question of the misbehavior of a few managers; it is an almost anarchic theft by all from all. For instance, the landscape in Kazakhstan is dotted with greenhouses—missing their glass. Of course, without the glass, they fail to function. In the early days of the transition, there was so little confidence in the future that each individual took what he could: each believed that others would take the glass out of the greenhouse—in which case the greenhouse (and their livelihood) would be destroyed. But if the greenhouse was, in any case, fated to be destroyed, it made sense for each to take what he could—even if the value of the glass was small.
The way in which transition proceeded in Russia served to erode this social capital. One got wealthy not by working hard or by investing, but by using political connections to get state property on the cheap in privatizations. The social contract, which bound citizens together with their government, was broken, as pensioners saw the government giving away valuable state assets, but claiming that it had no money to pay their pensions.
The IMF’s focus on macroeconomics—and in particular on inflation—led it to shunt aside issues of poverty, inequality, and social capital. When confronted about this myopia of focus, it would say, “Inflation is especially hard on the poor.” But its policy framework was not designed to minimize the impact on the poor. And by ignoring the impacts of its policies on the poor and on social capital, the IMF actually impeded macroeconomic success. The erosion of social capital created an environment that was not conducive to investment. The Russian government’s (and the IMF’s) lack of attention to a minimal safety net slowed down the process of restructuring, as even hardheaded plant managers often found it difficult to fire workers, knowing there was little standing between their fired workers and extreme hardship, if not starvation.
Shock Therapy
The great debate over reform strategy in Russia centered on the pace of reform. Who was right, in the end—the “shock therapists” or the “gradualists”? Economic theory, which focuses on equilibrium and idealized models, has less to say about dynamics, the order, timing, and pacing of reforms, than one would like—though IMF economists often tried to convince client countries otherwise. The debaters resorted to metaphors to convince others of the merits of their side. The rapid reformers said, “You can’t cross a chasm in two leaps,” while the gradualists argued that it took nine months to make a baby, and talked about crossing the river by feeling the stones. In some cases, what separated the two views was more a difference in perspective than reality. I was present at a seminar in Hungary where one participant said, “We must have rapid reform! It must be accomplished in five years.” Another said, “We should have gradual reform. It will take us five years.” Much of the debate was more about the manner of reform than the speed.
We have already encountered two of the essential critiques of the gradualists: “Haste makes waste”—it is hard to design good reforms well; and sequencing matters. There are, for instance, important prerequisites for a successful mass privatization, and creating these prerequisites takes time.13 Russia’s peculiar pattern of reforms demonstrates that incentives do matter, but that Russia’s kind of ersatz capitalism did not provide the incentives for wealth creation and economic growth but rather for asset stripping. Instead of a smoothly working market economy, the quick transition led to a disorderly Wild East.
The Bolshevik Approach to Market Reform
Had the radical reformers looked beyond their narrow focus on economics, they would have found that history shows that most of the experiments in radical reform were beset by problems. This is true from the French Revolution in 1789, to the Paris Commune of 1871, to the Bolshevik Revolution in Russia in 1917, and to China’s Cultural Revolution of the 1960s and 1970s. It is easy to understand the forces giving rise to each of these revolutions, but each produced its own Robespierre, its own political leaders who were either corrupted by the revolution or took it to extremes. By contrast, the successful American “Revolution” was not a true revolution in society; it was a revolutionary change in political structures, but it represented an evolutionary change in the structure of society. The radical reformers in Russia were trying simultaneously for a revolution in the economic regime and in the structure of society. The saddest commentary is that, in the end, they failed in both: a market economy in which many old party apparatchiks had simply been vested with enhanced powers to run and profit from the enterprises they formerly managed, in which former KGB officials still held the levers of power. There was one new dimension: a few new oligarchs, able and willing to exert immense political and economic power.
In effect, the radical reformers employed Bolshevik strategies—though they were reading from different texts. The Bolsheviks tried to impose communism on a reluctant country in the years following 1917. They argued that the way to build socialism was for an elite cadre to “lead” (often a euphemism for “force” ) the masses onto the correct path, which was not necessarily the path the masses wanted or thought best. In the “new” post-Communist revolution in Russia, an elite, spearheaded by international bureaucrats, similarly attempted to force rapid change on a reluctant population.
Those who advocated the Bolshevik approach not only seemed to ignore the history of such radical reforms but also postulated that political processes would work in ways for which history provided no evidence. For instance, economists such as Andrei Shleifer, who recognized the importance of the institutional infrastructure for a market economy, believed that privatization, no matter how implemented, would lead to a political demand for the institutions that govern private property.
Shleifer’s argument can be thought of as an (unwarranted) extension of Coase’s theorem. The economist Ronald H. Coase, who was awarded a Nobel Prize for his work, argued that in order to achieve efficiency, well-defined property rights are essential. Even if one distributed assets to someone who did not know how to manage them well, in a society with well-defined property rights that person would have an incentive to sell to someone who could manage the assets efficiently. That is why, advocates of rapid privatization argued, one didn’t really need to pay close attention to how privatization was accomplished. It is now recognized that the conditions under which Coase’s conjecture is valid are highly restrictive14—and certainly weren’t satisfied in Russia as it embarked on its transition.
Shleifer and company, however, took Coase’s ideas further than Coase himself would have done. They believed that political processes were governed in the same way as economic processes. If a group with vested interests in property could be created, it would demand the establishment of an institutional infrastructure necessary to make a market economy work, and its demands would be reflected in the political process. Unfortunately, the long history of political reforms suggests that the distribution of income does matter. It has been the middle class that has demanded the reforms that are often referred to as “the rule of law.” The very wealthy usually do far better for themselves behind closed doors, bargaining special favors and privileges. Certainly it has not been demands from the Rockefellers and the Bill Gates of the world that have led to strong competition policies. Today, in Russia
, we do not see demands for strong competition policy forthcoming from the oligarchs, the new monopolists. Demands for the rule of law have come from these oligarchs, who obtained their wealth through behind-the-scenes special deals within the Kremlin, only as they have seen their special influence on Russia’s rulers wane.
Demands for an open media, free from concentration in the hands of a few, came from the oligarchs, who sought to control the media in order to maintain their power—but only when the government sought to use its power to deprive them of theirs. In most democratic and developed countries such concentrations of economic power would not long be tolerated by a middle class forced to pay monopoly prices. Americans have long been concerned with the dangers of concentration of media power, and concentrations of power in the United States on a scale comparable to that in Russia today would be unacceptable. Yet U.S. and IMF officials paid little attention to the dangers posed by the concentration of media power; rather, they focused on the rapidity of privatization, a sign that the privatization process was proceeding apace. And they took comfort, indeed even pride, in the fact that the concentrated private media was being used, and used effectively, to keep their friends Boris Yeltsin and the so-called reformers in power.
One of the reasons that it is important to have an active and critical media is to ensure that the decisions that get made reflect not just the interests of a few but the general interest of society. It was essential for the continuation of the Communist system that there not be public scrutiny. One of the problems with the failure to create an effective, independent, and competitive media in Russia was that the policies—such as the loans-for-share scheme—were not subjected to the public critique that they deserved. Even in the West, however, the critical decisions about Russian policy, both at the international economic institutions and in the U.S. Treasury, went on largely behind closed doors. Neither the taxpayers in the West, to whom these institutions were supposed to be accountable, nor the Russian people, who paid the ultimate price, knew much about what was going on at the time. Only now are we wrestling with the question of “Who lost Russia?”—and why. The answers, as we are beginning to see, are not edifying.
Globalization and Its Discontents Revisited Page 35