Stability is important for growth and anyone familiar with China’s history realizes that the fear of instability runs deep in this nation of over 1 billion people. Ultimately, growth and prosperity, widely shared, are necessary, if not sufficient, for long-run stability. The democracies of the West have, in turn, shown that free markets (often disciplined by governments) succeed in bringing growth and prosperity in a climate of individual freedom. As valid as these precepts are for the past, they are likely to be even more so for the New Economies of the future.
In its quest for both stability and growth, China put creating competition, new enterprises and jobs, before privatization and restructuring existing enterprises. While China recognized the importance of macrostabilization, it never confused ends with means, and it never took fighting inflation to an extreme. It recognized that if it was to maintain social stability, it had to avoid massive unemployment. Job creation had to go in tandem with restructuring. Many of its policies can be interpreted in this light. While China liberalized, it did so gradually and in ways which ensured that resources that were displaced were redeployed to more efficient uses, not left in fruitless unemployment. Monetary policy and financial institutions facilitated the creation of new enterprises and jobs. Some money did go to support inefficient state enterprises, but China thought that it was more important, not only politically but also economically, to maintain social stability, which would be undermined by high unemployment. Although China did not rapidly privatize its state enterprises, as new enterprises were created the state ones dwindled in importance, so much so that twenty years after the transition began, they accounted for only 28.2 percent of industrial production. It recognized the dangers of full capital market liberalization, while it opened itself up to foreign direct investment.
The contrast between what happened in China and what has happened in countries like Russia, which bowed to IMF ideology, could not be starker. In case after case, it seemed that China, a newcomer to market economies, was more sensitive to the incentive effects of each of its policy decisions than the IMF was to its.
Township and village public enterprises were central in the early years of transition. IMF ideology said that because these were public enterprises, they could not have succeeded. But the IMF was wrong. The township and village enterprises solved the governance problem, a problem to which the IMF gave scant attention, but which underlay many of the failures elsewhere. The townships and villages channeled their precious funds into wealth creation, and there was strong competition for success. Those in the townships and villages could see what was happening to their funds; they knew whether jobs were being created and incomes increased. Although there may not have been democracy, there was accountability. New industries in China were sited in rural areas. This helped to reduce the social upheaval that inevitably accompanies industrialization. Thus China built the foundation of a New Economy on existing institutions, maintaining and enhancing its social capital, while in Russia it eroded.
The ultimate irony is that many of the countries that have taken a more gradualist policy have succeeded in making deeper reforms more rapidly. China’s stock market is larger than Russia’s. Much of Russia’s agriculture today is managed little differently than it was a decade ago, while China managed the transition to the “individual responsibility system” in less than five years. The contrasts I have depicted between Russia on the one hand and China and Poland on the other could be repeated elsewhere in the economies in transition. The Czech Republic received accolades early on from the IMF and the World Bank for its rapid reforms; it later became apparent that it had created a capital market which did not raise money for new investment, but allowed a few smart money managers (more accurately, white-collar criminals—if they did what they did in the Czech Republic in the United States, they would be behind bars) to walk off with millions of dollars of others’ money. As a result of these and other mistakes in its transition, relative to where it was in 1989, the republic has fallen behind—in spite of its huge advantages in location and the high level of education of its populace. In contrast, Hungary’s privatization may have gotten off to a slow start, but its firms have been restructured, and are now becoming internationally competitive.
Poland and China show that there were alternative strategies. The political, social, and historical context of each country differs; one cannot be sure that what worked in these countries would have worked in Russia, and would have been politically feasible there. By the same token, some argue that comparing the successes is unfair, given the markedly different circumstances. Poland began with a stronger market tradition than Russia; it even had a private sector during the Communist era. But China began from a less advanced position. The presence of entrepreneurs in Poland prior to the transition might have enabled Poland to undertake a more rapid privatization strategy; yet Poland as well as China chose a more gradualist approach.
Poland is alleged to have had an advantage because it was more industrialized, China because it was less so. China, according to these critics, was still in the midst of industrialization and urbanization; Russia faced the more delicate task of reorienting an already industrialized but moribund economy. But one could argue just the converse: development is not easy, as the rarity of successes clearly demonstrates. If transition is difficult, and development is difficult, it is not obvious why doing both simultaneously should be easy. The difference between China’s success and Russia’s failure in reforming agriculture was, if anything, even greater than the two countries’ success in reforming industry.
One attribute of the success cases is that they are “homegrown,” designed by people within each country, sensitive to the needs and concerns of their country. There was no cookie-cutter approach in China or Poland or Hungary. These and all the other successful transitioning countries were pragmatic—they never let ideology and simple textbook models determine policy.
Science, even an imprecise science like economics, is concerned with predictions and analyzing causal links. The predictions of the gradualists were borne out—both in the countries that followed their strategies, and in the shock therapy countries that followed the alternative course. By contrast, the predictions of the shock therapists were not.
In my judgment, the successes in countries that did not follow IMF prescriptions were no accident. There was a clear link between the policies pursued and the outcomes, between the successes in China and Poland and what they did, and the failure in Russia, and what it did. The outcomes in Russia were, as we have noted, what the critics of shock therapy predicted—only worse. The outcomes in China were precisely the opposite of what the IMF would have predicted—but were totally consonant with what the gradualists had suggested, only better.
The excuse of the shock therapists that measures called for by their prescription were never fully implemented is not convincing. In economics, no prescription is followed precisely, and policies (and advice) must be predicated on the fact that fallible individuals working within complex political processes will implement them. If the IMF failed to recognize this, that itself is a serious indictment. What is worse is that many of the failures were foreseen by independent observers and experts—and ignored.
The criticism of the IMF is not just that its predictions were not borne out. After all, no one, not even the IMF, could be sure of the consequences of the far-ranging changes that were entailed by the transition from communism to a market economy. The criticism is that the Fund’s vision was too narrow—it focused only on the economics—and that it employed a particularly limited economic model.
We now have far more evidence about the reform process than we did five years ago when the IMF and the World Bank rushed to the judgment that their strategies were working.4 Just as matters look strikingly different today than they did in the mid-1990s, so too in another decade, we may, given outcomes of reforms now underway, have to revise our judgments. From the current vantage point, however, some things seem clear. The IMF said
that those who engaged in shock therapy, while they might feel more pain in the short run, would be more successful in the long. Hungary, Slovenia, and Poland have shown that gradualist policies lead to less pain in the short run, greater social and political stability, and faster growth in the long. In the race between the tortoise and the hare, it appears that the tortoise has won again. The radical reformers, whether the star pupils like the Czech Republic or the slightly unruly ones like Russia, have lost.5
THE ROAD TO THE FUTURE
Those who are responsible for the mistakes of the past have had scant advice for where Russia should go in the future. They repeat the same mantras—the need to continue with stabilization, privatization, and liberalization. The problems caused by the past now have forced them to recognize the need for strong institutions, but they have little advice to offer on what that means or how it is to be achieved. At meeting after meeting on Russian policy, I was struck by the absence of a strategy either for attacking poverty or enhancing growth. Indeed, the World Bank discussed scaling back on its programs in the rural sector. This made sense for the Bank, given the problems that its previous programs in this area had caused, but it made no sense for Russia, given that this was where much of the country’s poverty lay. The only “growth” strategy proposed was that the country had to adopt policies that would repatriate the capital that had fled the country. Those who held this position overlooked that this recommendation could mean making a permanent fixture of the oligarchs, and the kleptocracy and crony/Mafia capitalism that they represented. There was no other reason for them to bring their capital back, when they could earn good returns in the West. Moreover, the IMF and U.S. Treasury never addressed the fact that they were supporting a system that lacked political legitimacy, where many of those with wealth had obtained their money by stealth and political connections with a leader—Boris Yeltsin—who too had lost all credibility and legitimacy. Sadly, for the most part, Russia must treat what has happened as pillage of national assets, a theft for which the nation can never be recompensed. Russia’s objective in the future must be to try to stop further pillage, to attract legitimate investors by creating a rule of law and, more broadly, an attractive business climate.
The 1998 crisis had one benefit, to which I referred earlier: the devaluation of the ruble spurred growth, not so much in exports, but in import substitutes; it showed that the IMF policies had indeed been stifling the economy, keeping it below its potential. The devaluation, combined with a stroke of luck—the enormous increase in oil prices in the late 1990s—fueled a recovery, from an admittedly low base. There are lasting benefits from this growth spurt; some of the enterprises that took advantage of the favorable circumstances seem on the road to seizing new opportunities and continued growth. There are other positive signs: some of those who took advantage of the system of ersatz capitalism to become very wealthy are working for a change in the rules, to make sure that what they did to others cannot be done to them. There are moves in some quarters for better corporate governance—some of the oligarchs, while they are not willing to risk all of their money in Russia, would like to entice others to risk more of theirs, and know that to do so they have to behave better than they have in the past. But there are other, less positive signs. Even in the heyday of very high oil prices, Russia was barely able to make its budget balance; it should have been putting money aside for the likelihood of a “rainy day” when oil prices come down. Russia’s recovery remains uncertain. As we noted earlier, years after the beginning of the transition, Russia had still failed to become a “normal” market economy—let alone a real democracy. Its dependence on natural resources meant that its economy fluctuated with the vagaries of oil and gas prices. It had evolved into a sui generis form of state capitalism, with parts of the economy dominated by oligarchs who had little choice but to do Putin’s bidding. A transition that was supposed to bring unprecedented prosperity resulted in Russian per capita income increasing from 15 percent of that of the United States in 1989 to 16 percent of that of the United States twenty-six years later!
Russia has learned many lessons. In the aftermath of communism, many of its people swung from the old religion of Marx to the new religion of free markets. The sheen has been taken off this new religion, and a new pragmatism has settled in.
There are some policies that might make a difference. In cataloging what has to be done, it is natural to begin by thinking about the mistakes of the past: the lack of attention to the underpinnings of a market economy—from financial institutions that lend to new enterprises, to laws that enforce contracts and promote competition, to an independent and honest judiciary.
Russia must go beyond its focus on macrostabilization and encourage economic growth. Throughout the 1990s, the IMF focused on making countries work on getting budgets in order and controlling the growth of the money supply. Although when conducted in moderation, this stabilization may be a prerequisite to growth, it is hardly a growth strategy. In fact, the stabilization strategy contracted aggregate demand. This decrease in aggregate demand interacted with misguided restructuring strategies, to contract aggregate supply. In 1998, there was an active debate about the role of demand and supply. The IMF argued that any increase in aggregate demand would be inflationary. If this were true, it would be a terrible admission of failure. In six years, Russia’s productive capacity had been cut by more than 40 percent—far deeper than the reduction in defense, a far greater loss in capacity than occurs in any but the worst wars. I knew that the IMF policies had contributed greatly to the reduction in productive capacity, but I believed that lack of aggregate demand still remained a problem. As it turned out, the IMF again proved to be wrong: when the devaluation occurred, at last domestic producers could compete with foreign imports, and they were able to meet the new demands. Production increased. There had indeed been excess capacity, which IMF policies had left idle for years.
Growth will only succeed if Russia creates an investment-friendly environment. This entails actions at all levels of government. Good policies at the national level can be undone by bad policies at the local and regional level. Regulations at all levels can make it difficult to establish new businesses. Unavailability of land can be an impediment just as lack of availability of capital can be. Privatization does little good if local government officials squeeze firms so hard that they have no incentive to invest. This implies that issues of federalism have to be attacked head-on. A federalist structure that provides compatible incentives at all levels has to be put into place. This will be difficult. Policies aimed at curtailing abuses at lower levels of government can themselves be abused, to give excessive power to the center, and deprive local and regional authorities of the capacity to devise creative and entrepreneurial growth strategies. Although Russia has stagnated overall, there has been progress in a few localities—and there is concern that the Kremlin’s recent attempts at reining in local authorities will in fact stifle these local initiatives.
But there is one factor essential to establishing a good business climate, something which will prove particularly difficult to achieve given what has happened over the past decade: political and social stability. The huge inequality, the enormous poverty, which has been created over the past decades provides fertile ground for a variety of movements, from nationalism to populism, some of which may not only be a threat to Russia’s economic future but to global peace. It will be difficult—and likely take considerable time—to reverse the inequality that was created so quickly.
Finally, Russia must collect taxes. Collections should be least difficult in Russia’s dominant natural resource businesses, since revenues and output in the natural resources sector are in principle easily monitored, so taxes should be easy to collect. Russia must put firms on notice that if taxes are not paid in, say, sixty days, their property will be seized. If taxes are not paid and the government does seize the property, it can reprivatize it in a way that has more legitimacy than the discredited loans-for-share privat
ization under Yeltsin. On the other hand, if the businesses do pay their taxes, Russia, the Russian government, will have the resources to attack some of the important outstanding problems.
And just as those who owe taxes must pay what they owe, those who owe money to banks—especially the banks that are now in the hands of the government as a result of defaults—must be made to pay those debts. Again, this may entail an effective renationalization of the enterprise, a renationalization to be followed by a more legitimate privatization than had occurred previously.
The success of this agenda is predicated on there being a relatively honest government interested in improving the common weal. We in the West should realize this: there is relatively little that we can do to bring that about. The hubris of those in the Clinton administration and the IMF, that they could “pick” those to support, push reform programs that worked, and usher in a new day for Russia, has been shown for what it was: the arrogant attempt by those who knew little of the country, using a narrow set of economic conceptions, to change the course of history, an attempt that was doomed to failure. We can help support the kinds of institutions that are the underpinnings of democracies—building up think tanks, creating space for public dialogue, supporting independent media, helping to educate a new generation that understands how democracies work. At the national, regional, and provincial level there are many young officials who would like to see their country take a different course, and broad-based support—intellectual as much as financial—could make a difference. If the devastation of its middle class represents the longest-term threat to Russia, then while we cannot fully reverse the damage that has been done, at least we can work to stop its further erosion.
Globalization and Its Discontents Revisited Page 38