I opposed the cartel. What makes market economies work is competition. Cartels are illegal inside the United States, and they should be illegal globally. The Council of Economic Advisers had become a strong ally of the Antitrust Division of the U.S. Justice Department in pushing for strong enforcement of competition laws. For the United States now to help create a global cartel was a violation of every principle. Here, however, more was at stake. Russia was struggling to create a market economy. The cartel would hurt Russia, by restricting its sales of one of the few goods that it could market internationally. And creating the cartel would be teaching Russia the wrong lesson about how market economies work.
On a quick trip to Russia, I talked to Gaidar, then the first deputy prime minister in charge of economics; he and I both knew that Russia was not dumping—in the sense in which that word would be used by economists—but we both knew how the U.S. laws work. Were dumping charges brought, there was a good chance that dumping duties would be levied. Nonetheless, he knew how bad a cartel would be for Russia, both economically and in terms of the impact on the reforms he was trying to put into place. He agreed that we should resist as strongly as we could. He was willing to face the risk of the imposition of dumping duties.
I worked hard to convince those in the National Economic Council that it would be a mistake to support O’Neill’s idea, and I made great progress. But in a heated subcabinet meeting, a decision was made to support the creation of an international cartel. People in the Council of Economic Advisers and the Department of Justice were livid. Ann Bingaman, the assistant attorney general for antitrust, put the cabinet on notice that there might have been a violation of the antitrust laws in the presence of the subcabinet. Reformers within the Russian government were adamantly opposed to the establishment of the cartel and had communicated their feelings directly to me. They knew that the quantitative restrictions that the cartel would impose would give more power back to the old-line ministries. With a cartel, each country would be given certain quotas, amounts of aluminum they could produce or export. The ministries would control who got the quotas. This was the kind of system with which they were familiar, the kind of system that they loved. I worried that the excess profits generated by the trade restrictions would give rise to a further source of corruption. We did not fully grasp that in the new Mafiaized Russia, it would also give rise to a bloodbath in the struggle over who got the quotas.
While I had managed to convince almost everyone of the dangers of the cartel solution, two voices dominated. The State Department, with its close connections to the old-line state ministries, supported the establishment of a cartel. The State Department prized order above all else, and cartels do provide order. The old-line ministries, of course, were never convinced that this movement to prices and markets made sense in the first place, and the experience with aluminum simply served to confirm their views. Rubin, at that time head of the National Economic Council, played a decisive role, siding with State. At least for a while, the cartel did work. Prices were raised. The profits of Alcoa and other producers were enhanced. The American consumers—and consumers throughout the world—lost, and indeed, the basic principles of economics, which teach the value of competitive markets, show that the losses to consumers outweigh the gains to producers. But in the case at point, more was at issue: we were trying to teach Russia about market economics. They learned a lesson, but it was the wrong lesson, a lesson that was to cost them dearly over the succeeding years: the way to do well in market economics was to go to the government! We did not intend to teach crony-capitalism 101, and they probably did not need to take crony-capitalism 101 from us; they probably could have learned all that was required on their own. But we unwittingly provided them with a bad example.3
National Security for Sale
The aluminum case was not the first, nor would it be the last instance, where special interests dominated over the national and global goal of a successful transition. At the end of the Bush administration and the beginning of the Clinton administration, a historical “swords to plowshares” agreement was made between Russia and the United States. A U.S. government enterprise called the United States Enrichment Corporation (USEC) would buy Russian uranium from deactivated nuclear warheads and bring it to the United States. The uranium would be de-enriched so that it could no longer be used for nuclear weapons, and would then be used in nuclear power plants. The sale would provide Russia with needed cash, which it could use to better keep its nuclear material under control.
Unbelievable as it may seem, the fair trade laws were again invoked, to impede this transfer. The American uranium producers argued that Russia was dumping uranium on U.S. markets. Just as in the case of aluminum, there was no economic validity to this charge. However, the U.S. unfair fair trade laws are not written on the basis of economic principles. They exist solely to protect American industries adversely affected by imports.
When the U.S. government’s import of uranium for purposes of disarmament was challenged by American uranium producers under the fair trade laws, it became clear that a change in these laws was needed. The Department of Commerce and the U.S. Trade Representative were—with high-level coaxing—finally persuaded to propose changes in the laws to Congress. Congress turned the proposals down. It has remained unclear to me whether Commerce and the U.S. Trade Representative sabotaged efforts at getting a change in the laws by presenting the proposal to Congress in a way that made the outcome inevitable, or whether they fought against a Congress which has always taken a strong protectionist stand.
Equally striking was what happened next, in the mid-1990s. Much to the embarrassment of the Reagan and Bush administrations, the United States was far behind in the sweepstakes on privatization in the 1980s. Margaret Thatcher had privatized billions, while the United States had privatized only a $2 million helium plant in Texas. The difference, of course, was that Thatcher had far more and far larger nationalized industries that she could privatize. At last privatization advocates in the United States thought of something that few others would, or could, privatize: USEC, which not only enriches uranium for nuclear reactors but also for atomic bombs. The privatization was beset by problems. USEC had been entrusted with bringing in the enriched uranium from Russia; as a private firm, this was a kind of monopoly power that would not have passed scrutiny of the antitrust authorities. Worse still, we at the Council of Economic Advisers had analyzed the incentives of a privatized USEC, and had shown convincingly that it had every incentive to keep the Russian uranium out of the United States. This was a real concern: there were major worries about nuclear proliferation—about nuclear material getting into the hands of a rogue state or a terrorist organization—and having a weakened Russia with enriched uranium to sell to anyone willing to pay was hardly a pretty picture. USEC adamantly denied that it would ever act counter to broader U.S. interests, and affirmed that it would always bring in Russian uranium as fast as the Russians were willing to sell; but the very week that it made these protestations, I got hold of a secret agreement between USEC and the Russian agency. The Russians had offered to triple their deliveries, and USEC had not only turned them down but paid a handsome amount in what could only be termed “hush money” to keep the offer (and USEC’s refusal) secret. One might have thought that this itself would have been enough to stop the privatization, but not so: the U.S. Treasury was as adamant about privatization at home as it was in Russia.
Interestingly, this, America’s only major privatization of the decade, has been beset with problems almost as bad as those that have befallen privatization elsewhere, so much so that bipartisan bills have been introduced into Congress to renationalize the enterprise. Our forecasts that the privatization would interfere with the importation of the enriched uranium from Russia proved all too prescient. Indeed, at one point, it looked as if all exports to the United States might be held up. In the end, USEC asked for huge subsidies to continue with the importation. The rosy economic picture painted by USEC (
and the U.S. Treasury) proved false, and investors became angry as they saw share prices plummet. There was nervousness about a firm with bare financial viability in charge of our nation’s production of enriched uranium. Within a couple of years of privatization, questions were being raised about whether Treasury could, with a straight face, give the financial certification required by the law for USEC to continue to operate.
LESSONS FOR RUSSIA
Russia had a crash course in market economics, and we were the teachers. And what a peculiar course it was. On the one hand, they were given large doses of free market, textbook economics. On the other hand, what they saw in practice from their teachers departed markedly from this ideal. They were told that trade liberalization was necessary for a successful market economy, yet when they tried to export aluminum and uranium (and other commodities as well) to the United States, they found the door shut. Evidently, America had succeeded without trade liberalization; or, as it is sometimes put, “trade is good, but imports are bad.” They were told that competition is vital (though not much emphasis was put on this), yet the U.S. government was at the center of creating a global cartel in aluminum, and gave the monopoly rights to import enriched uranium to the U.S. monopoly producer. They were told to privatize rapidly and honestly, yet the one attempt at privatization by the United States took years and years, and in the end its integrity was questioned. The United States lectured everyone, especially in the aftermath of the East Asia crisis, about crony capitalism and its dangers. Yet issues of the use of influence appeared front and center not only in the instances described in this chapter but in the bailout of Long Term Capital Management described in the last.
If the West’s preaching is not taken seriously everywhere, we should understand why. It is not just past injuries, such as the unfair trade treaties referred to in earlier chapters. It is what we are doing today. Others look not only at what we say, but also at what we do. It is not always a pretty picture.
CHAPTER 11
BETTER ROADS TO THE MARKET
AS THE FAILURES of the radical reform strategies in Russia and elsewhere have become increasingly evident, those who pushed them claim that they had no choices. But there were alternative strategies available. This was brought home forcefully at a meeting in Prague in September 2000, when former government officials from a number of the Eastern European countries—both those that were experiencing success and those whose performance was disappointing—reappraised their experiences. The government of the Czech Republic headed by Vaclav Klaus initially got high marks from the IMF because of its policy of rapid privatization; but its management of the overall transition process resulted in a GDP that, by the end of the 1990s, was lower than the country’s 1989 level. Officials in his government said they had no choice in the policies adopted. But this contention was challenged by speakers from the Czech Republic and those from the other countries. There were alternatives; other countries made different choices—and there is a clear link between the different choices and the different outcomes.
Poland and China employed alternative strategies to those advocated by the Washington Consensus. Poland is the most successful of the Eastern European countries; China has experienced the fastest rate of growth of any major economy in the world over the past twenty years. Poland started with “shock therapy” to bring hyperinflation down to more moderate levels, and its initial and limited use of this measure has led many to think that this was one of the shock therapy transitions. But that is totally wrong. Poland quickly realized that shock therapy was appropriate for bringing down hyperinflation, but was inappropriate for societal change. It pursued a gradualist policy of privatization, while simultaneously building up the basic institutions of a market economy, such as banks that actually lend, and a legal system that could enforce contracts and process bankruptcies fairly. It recognized that without those institutions, a market economy cannot function. (In contrast to Poland, the Czech Republic privatized corporations before it privatized the banks. The state banks continued to lend to the privatized corporations; easy money flowed to those favored by the state, and privatized entities were not subjected to rigorous budgetary constraint, which allowed them to put off real restructuring.) Poland’s former deputy premier and finance minister, Grzegorz W. Kolodko, has argued that the success of his nation was due to its explicit rejection of the doctrines of the Washington Consensus.1 The country did not do what the IMF recommended—it did not engage in rapid privatization, and it did not put reducing inflation to lower and lower levels over all other macroeconomic concerns. But it did emphasize some things to which the IMF had paid insufficient attention—such as the importance of democratic support for the reforms, which entailed trying to keep unemployment low, providing benefits for those who were unemployed and adjusting pensions for inflation, and creating the institutional infrastructure required to make a market economy function.
The gradual process of privatization allowed restructuring to take place prior to privatization, and the large firms could be reorganized into smaller units. A new, vibrant small enterprise sector was thus created, headed by young managers willing to invest for their future.2
Similarly, China’s success over the past decade stands in marked contrast to Russia’s failure. While China grew at an average rate of over 10 percent in the 1990s, Russia declined at an average annual rate of 5.6 percent. By the end of the decade, real incomes (so-called purchasing power) in China were comparable to those in Russia. Whereas China’s transition has entailed the largest reduction in poverty in history in such a short time span (from 358 million in 1990 to 208 million in 1997, using China’s admittedly lower poverty standard of $1 a day), Russia’s transition has entailed one of the largest increases in poverty in history in such a short span of time (outside of war and famine).
The contrast between China’s strategy and that of Russia could not be clearer, and it began from the very first moves along the path to transition. China’s reforms began in agriculture, with the movement from the commune (collective) system of production in agriculture to the “individual responsibility” system—effectively, partial privatization. It was not complete privatization: individuals could not buy and sell land freely; but the gains in output showed how much could be gained from even partial and limited reforms. This was an enormous achievement, involving hundreds of millions of workers, accomplished in a few years. But it was done in a way that engendered widespread support: a successful trial in one province, followed by trials in several others, equally successful. The evidence was so compelling that the central government did not have to force this change; it was willingly accepted. But the Chinese leadership recognized that they could not rest on their laurels, and the reforms had to extend to the entire economy.
At this juncture, they called upon several American advisers, including Kenneth Arrow and myself. Arrow had been awarded the Nobel Prize partly for his work on the foundations of a market economy; he had provided the mathematic underpinnings that explained why, and when, market economies work. He had also done path-breaking work on dynamics, on how economies changed. But unlike those transition gurus who marched into Russia armed with textbook economics, Arrow recognized the limitations of these textbook models. He and I each stressed the importance of competition, of creating the institutional infrastructure for a market economy. Privatization was secondary. The most challenging questions that were posed by the Chinese were questions of dynamics, and especially how to move from distorted prices to market prices. The Chinese came up with an ingenious solution: a two-tier price system in which what a firm produced under the old quotas (what it was required to produce under the old command-and-control system) is priced using old prices, but anything produced in excess of the old quota is priced using free-market prices. The system allowed full incentives at the margin—which, as economists are well aware, is where they matter—but avoided the huge redistributions that would have occurred if the new prices were instantaneously to prevail over the enti
re output. It allowed the market to “grope” for the undistorted prices, a process that is not always smooth, with minimal disturbance. Most important, the Chinese gradualist approach avoided the pitfall of rampant inflation that had marked the shock therapies of Russia and the other countries under IMF tutelage, and all the dire consequences that followed, including the wiping out of savings accounts. As soon as it had accomplished its purpose, the two-tier price system was abandoned.
In the meanwhile, China unleashed a process of creative destruction: of eliminating the old economy by creating a new one. Millions of new enterprises were created by the townships and villages, which had been freed from the responsibility of managing agriculture and could turn their attention elsewhere. At the same time, the Chinese government invited foreign firms into the country, to participate in joint ventures. And foreign firms came in droves—China became the largest recipient of foreign direct investment among the emerging markets, and number eight in the world, below only the United States, Belgium, the United Kingdom, Sweden, Germany, the Netherlands, and France.3 By the end of the decade, its ranking was even higher. It set out, simultaneously, to create the “institutional infrastructure”—an effective securities and exchange commission, bank regulations, and safety nets. As safety nets were put into place and new jobs were created, it began the task of restructuring the old state-owned enterprises, downsizing them as well as the government bureaucracies. In a short span of a couple of years, it privatized much of the housing stock. The tasks are far from over, the future far from clear, but this much is undisputed: the vast majority of Chinese live far better today than they did twenty years ago.
The “transition” from the authoritarianism of the ruling Communist Party in China, however, is a more difficult problem. Economic growth and development do not automatically confer personal freedom and civil rights. The interplay between politics and economics is complex. Fifty years ago, there was a widespread view that there was a trade-off between growth and democracy. Russia, it was thought, might be able to grow faster than America, but it paid a high price. We now know that the Russians gave up their freedom but did not gain economically. There are cases of successful reforms done under dictatorship—Pinochet in Chile is one example. But the cases of dictatorships destroying their economies are even more common.
Globalization and Its Discontents Revisited Page 37