Russia
Nowotny, Thomas
WHY DID the Russian economy go into a nosedive? Should one blame Russia? Or the capitalist system and especially financial markets? The crisis built up as the Russian government failed to...
...Consider a small if revelatory incident...
...Can anyone say it was better adapted to Russia's specific problems and traditions...
...If they compare life under the 22 n DISSENT / Spring 1999 old system to today's, only a small minority can discern a change for the better...
...as did the prices for some of the key Russian exports, such as oil, gold, timber, and aluminum...
...In nearly all of the formerly communist countries, the decline of investment led to a fall in agricultural production and to drastic de-industrialization...
...Prices generally "overshoot" and become too high to clear the market...
...Finally, protection is not available from police but bought from assorted mafias...
...IIIfounded, prejudiced advice from abroad is also to blame...
...Who Is to Blame...
...Jeffrey Sachs imagined in 1993 that "events have disproved the idea of a 'homo sovieticus...
...They created an illusion that Russia was on solid ground when, in fact, it was floating on a bubble...
...It is both a consequence and a precondition for an ever wider and broader division of labor, which, in the end, has to be based on efficient common institutions...
...That is why official constitutional arrangements have been supplemented by "neocorporate" elements that assure all groups of some participation in political decision making regardless of the outcome of competitive elections...
...Nonetheless, they started from a low base...
...The level of indebtedness—while increasing fast—was actually quite low by international standards...
...This mythical being could simply change in any which way and at will institutions, values, and expectations...
...Soviet communism aimed to be a "westernizing," "modernizing" movement...
...Banks do not profit by an optimal allocating of capital but through emptying the treasury by subscribing to over-priced government bonds...
...Russia's peculiarities certainly complicated Russian modernization...
...After 1989, Vienna urged the OECD to see this as a useful example...
...Everything is demanded from government, while nothing is rendered to it...
...But the left should also be cautious in its conclusions...
...Here too, the West European experience can provide some guidance...
...It was only in the early 1990s that Europe's wealthiest lands removed the remaining controls on the movement of capital...
...Originally, this expansion of government debt did not cause apprehension...
...Several European countries—such as Switzerland, the Netherlands, or Austria—have been riven by ethnic or religious strife in the past, and these old wounds can be reopened through polarizing politics...
...Their own ideological delusions were primary...
...Some aid was provided either multilaterally through the International Monetary Fund (IMF) or the European Union (EU) or DISSENT / Spring 1999 n 2 POLITICS ABROAD bilaterally by various countries...
...Management skills were deficient...
...It filled the gap by borrowing money...
...And not all of these failures are homegrown...
...COMPLETE FREE mobility of capital, for instance, might be useful in a "perfect" market economy...
...neither in communism nor in perfect democracy and a market economy...
...Yet if Russia's present problems cannot be ascribed to its conditions at the outset of communism, that doesn't mean that unique difficulties are not at play...
...Most political parties represent their own leaders and not the voters...
...Accelerated inflation was inevitable after the demise of central planning...
...Still, western advisers continued to speak as if the main problem was not insufficient supply but an overabundance of money (and credit...
...Social conditions that had worsened have become better...
...What was lacking was a predictable, long-term, and strong engagement...
...Servicing this debt became excessively costly...
...It flaunted urbanization, schooling, public health care, modern weapons, space travel, and so forth...
...Even fifty years after World War II, most West European countries still think it wise to regulate the market for rental apartments...
...The consequence was instability in young and untested financial systems...
...Overall demand for raw materials and semi-finished products plummeted...
...POLITICS ABROAD obscurantist and anti-rational...
...My country, Austria, was in dire straits after World War II when it received Marshall Plan aid...
...If plant closures become widespread, an expansionary macroeconomic policy is needed to stimulate the economy and to promote the emergence of new firms to soak up unemployment...
...only endless inefficiency, decay, corruption, and crime...
...Of course, all these are interlinked...
...this process can be reversed...
...Remote from the centers of European modernity, its politics were shaped by the imperial court...
...The point of public service seems to be personal power and enrichment...
...Competitive democracy can itself become inflammatory when political parties exploit such problems for their own narrow ends...
...There is no world government or world central bank to assume such a role...
...Unfortunately, part of the Russian political elite–the now discredited "reformers"—believed all this...
...This takes much longer and depends on a successful learning process and on positive feedback from prior steps taken by a new regime...
...Instead it only makes for rent inflation in times of social hardship and declining real wages...
...Austria financed an OECD inquiry into whether similar experiments could assist ex-communist countries...
...This can hardly come as a surprise...
...But all of these impediments were present in Japan too, and Japan became the world's number-two economic power...
...The most obvious flaw is the failure to collect taxes...
...there was underinvestment in sales and marketing...
...Much "catching up" had to be done...
...Again, who "lost" Russia...
...Adjusting to meet demand would have required higher investments in those enterprises...
...By moving in and out quickly, short-term foreign capital (portfolio capital) often wreaked havoc, leading to untimely revaluations or devaluations and damaging rises and falls in local interest rates...
...Polls—and also elections—show that voters now prefer the old centrally planned economy to the current "capitalist" one by a wide margin...
...They have to be closed...
...The same logic is valid—more so—for countries in the turmoil of transition...
...In August 1998, when the withdrawal of foreign credits, the flight of capital, and the devaluation of the ruble disrupted the financial system, the downward slide resumed...
...This was to the detriment of other potential debtors who might have invested the money to produce dearly needed goods...
...The Russian crisis is only one very specific dimension of a major economic crisis that threatens a repeat of the 1930s...
...All that would be needed is maximal freedom for DISSENT / Spring 1999 n 23 POLITICS ABROAD that all-knowing, self-transforming creature...
...The huge budget gap is not due to exploding expenditures but to ever lower receipts...
...They also attracted foreign buyers, and many Russian banks borrowed from Western banks (in Western currencies) in order to purchase these high-yielding papers, Western bankers were willing to "roll over" debt when it became due, which was often, as most of the government debt was short term...
...These highly paid economic advisers peddled visions of a perfect economic order and never initiated a real dialogue with the Russians...
...They have led to civil war in some (Croatia, Serbia, Albania), and simmering tensions in others (Macedonia...
...Efforts to create more sophisticated financial institutions should have been pursued cautiously because they are difficult to manage...
...hence economic growth has been beyond its grasp, and so, too, political stability...
...He lives in London...
...This story is representative of a whole approach to economic and political transformation...
...By December wealth was reduced by another 15 percent...
...Evidently, Sachs and his like were wrong...
...Corporations especially refused to pay up for the simple reason that the majority of them are broke...
...Russian reality insisted otherwise...
...Economists are notorious for disregarding history and institutions...
...Countries such as Spain and Italy that had been in comparable circumstances in 1937, but that followed a "capitalist" path, developed much more rapidly.* It would seem that Russia too, would have been better off following a "capitalist" path and therefore ought to resist the present temptation to return to its earlier ways...
...Western economic institutions and western economic advisers are culpable too, because Russia's reality, practical solutions, and the problems of transformation were never their chief concern...
...Undoubtedly, the "markets" have to bear their share of guilt...
...But such changes are cosmetic if not supported by deeper transformations in the expectations, attitudes, and behavior of persons and institutions...
...Was communism really better...
...Taxes are not paid...
...After that, everything will arrange itself...
...By itself, privatization doesn't produce the inputs needed for an efficient transformation of formerly state-owned firms...
...Obviously, then, privatization could not be an easy, speedy, and quasispontaneous process...
...The world financial markets are also guilty...
...Yet history demonstrates that there are some exceptions and for good reasons...
...Government bonds sold easily because of the high interest Moscow was willing to pay...
...This is in comparison to Spain's 51 and 81 and Italy's 81 and 105...
...Production has collapsed...
...The economic structures in the former lands of the Soviet Union are today even less adapted to actual demand than in the era of central planning...
...A central planning apparatus can be dismantled and political freedom and elections established in a short period of time...
...It is wrong because under all circumstances, and especially in the current ones, Russia is dependent upon massive assistance from wealthier countries...
...If we look at the experiences of some other ex-communist countries further to the west, we can see that they too suffered a decline after the breakdown of communism...
...But this cannot be accomplished overnight...
...Or so the argument goes...
...Entrepreneurship would not have to be cultivated...
...These are essentially twofold (a) communism existed for a longer period in the Soviet heartland than in (most of) its satellites...
...An intellectual, political, and institutional vacuum was the result, and it was filled by often anarchical and criminal forces set free by the collapse of the old communist institutions...
...That is never easy, especially if they are large ones provide jobs for whole communities...
...Even advanced Western Europe finds it hard to attain the U.S...
...AGAIN, WHO is to blame...
...It is evident that the market for Russian government debt had overreached...
...The basis of their elaborate intellectual constructs is "homo oeconomicus," conceived as being the same in all times and places...
...They must come from other sources, either the national government or foreign investors or foreign countries and international organizations...
...In fact, many of the "Russia" factors are present in all countries on the threshold of economic and political modernization and they haven't condemned to failure all efforts to catch up with democratic and richer lands...
...Economic "theory" says it is wise to abolish all price controls as rapidly as possible...
...From Economics to Politics Political consequences were inevitable...
...In fact, change required time—more specifically, a time of transition, of being neither here nor there...
...But this policy has drawbacks...
...All these are valid observations...
...Over a few weeks, the actual economy cannot have changed as dramatically as the markets for Russian debt...
...Similar fractious cleavages exist in many of the former communist countries...
...Instead, western applause urged on breakneck efforts to establish stock exchanges...
...The Russians or the "markets...
...They would have been patient as long as steady progress was discernible...
...The vast majority is worse off by far...
...The list goes on...
...Communism had retarded their long-term development...
...One form of American assistance that proved particularly effective was the establishment of "productivity centers" to teach entrepreneurs and employees a broad range of skills and know-how...
...This behavior on the part of the financial markets is irrational in the sense that it does not correspond to developments in the actual economy...
...Ideological Privatization The prevalence of ideology over practical considerations had its most damaging consequences, though, in the process of privatization...
...Also, for most of the time, Russia exported more than it imported...
...Most Russians were probably never taken in by the promises of instant perfect democracy and wealth...
...They were, after all, symbols of having become truly "capitalist...
...somehow it would be there, pre-cooked, ready to serve...
...Bleary-eyed enthusiasm for Russian economic prospects was followed by wholesale pessimism...
...At that time, at the outset of transition, very drastic measures to constrain it might have made sense...
...Washington now argues that it is mainly up to Russia to extricate itself from its predicament...
...Sure the process would be painful, but it would be short...
...What Russia's crisis proves is that markets are constructed in processes that need political guidance together with the support of strong and efficient public institutions...
...Democrats are now a minority...
...Instead it was provided with an idealized vision of what could be at the end...
...and (b) from the very specific character of events in Russia since communism collapsed...
...Russia in particular was not provided with practical advice on how to overcome the difficulties that were bound to arise on the way to democracy and the market...
...They therefore called for high interest rates...
...Much of it was re-exported to the foreign bank accounts of a few wealthy Russians...
...This outlines the policies that might have been suggested by a practical adviser concerned to adapt Russian firms to market requirements...
...In 1917, Russia was still a feudal, agrarian society...
...Put "homo oeconomicus" in charge...
...But, of course, Russia is also a victim of the creeping worldwide economic crisis...
...Any such help alone cannot and should not salvage firms with no prospects of survival in the harsher conditions of a market economy...
...This was the creature the Russians were supposed to embody...
...In the meantime it boosts rental income for the few well-to-do...
...It was even less realistic for Russia...
...Freeing prices for rental apartments therefore does not result in their increasing availability...
...The failure of an unrealistic vision of a "pure" capitalism is not the left's victory...
...Reform" now has a pejorative connotation, and Russia is drifting away from the other countries of Europe...
...It could not be compared to Central and Eastern Europe...
...The sole surviving superpower might have mobilized the international community to provide some viable substitutes, but the United States became rather detached...
...At the dawn of World War II, the wealth of these three countries was much closer to the European average...
...Some resisted this advice, and many who accepted it came to regret it...
...Massive capital flight rather than growing foreign direct investment has been the consequence of easing capital transfer...
...The collapse came last summer...
...These, in turn, depend upon civic culture, trust, and the habit of cooperation...
...Unfortunately, the option of sharp, short, and complete change was never realistic—even in countries (such as Hungary or Poland) that had already dismantled some elements of communism prior to 1989...
...Money that had more or less been forced upon the country was withdrawn at short notice and new credits became unavailable...
...They hesitated to roll over credits and if they did, they demanded a stiff price...
...In the face of national decline, general insecurity, and pervasive corruption, they also opt increasingly for the old political structures...
...Those countries are now on their way to becoming "boringly normal...
...It is true that some rapid changes were possible...
...A confident bourgeoisie had not yet developed and there was no entrepreneurial tradition...
...It is a fact that this capital was wasted...
...For example, supply follows demand very sluggishly—if at all—when it comes to the market for rental apartments...
...Religion was If the average wealth of all of Europe is 100, the wealth of Czechoslovakia was 79 in 1937 and 44 in 1992...
...Privatized" firms, lacking new "owners" in any economic sense of the term, have been highjacked and plundered...
...So the tax problem was also a consequence of the failure of Russian enterprises to adjust to new circumstances and to become viable and productive...
...Foreign "experts" created unrealistic expectations and helped to set the whole process of economic reform on a path that was bound to end in the present disaster...
...There were some ups and downs in this rate of tax collection, but the long-term trend was clearly downwards...
...Already-high interest rates on government bonds increased further...
...How could one overcome these problems...
...But these highly visible achievements are not the essence of modernization...
...This is why Russia now has to import nearly one half of its food and why its social situation is worsening, with rising poverty, alcoholism, and a lowering of life expectancy...
...and in some cases tariff barriers would be a wise complement...
...The point is both right and wrong...
...The massive inflow of foreign capital was simply not used to eliminate basic flaws in the Russian economy...
...Expert" Advice But postcommunist Russia misconceived and mismanaged its transition to a market economy and to democracy...
...Some nonetheless believe that despite all of its shortcomings, communism was suited for Russia because of Russia's distinctiveness...
...Their capital markets are still shallow and poorly regulated...
...The largest share of blame is certainly with the Russians themselves and especially their politicians...
...For geographical reasons, security and thus military issues had always dominated economic calculations...
...They implied that the only plausible factor limiting speed could be lack of political wisdom or courage...
...The shortcomings of the old, state-owned firms were obvious...
...Here is where communism failed and, especially in Russia, did not promote the accumulation of these kinds of "social capital...
...For today's transition countries the shield is provided by undervalued currencies which make foreign products expensive and local products cheaper...
...for Hungary, 63 and 36...
...Although world financial markets deserve sharp criticism— the Kremlin was badly misled by them—they still had provided capital to Russia...
...It was the absence of credible, intermediate goals and successes that led to today's generalized, destructive cynicism...
...Former communist countries were urged nonetheless to lift such restrictions right away...
...Both the Organization for Economic Cooperation and Development (OECD) and the International Monetary Fund (IMF) insisted that rapidity was the key to success...
...One of their chief prejudices concerned the speed of transformation...
...In short, these factors did not force communism on Russia as the sole means to promote development...
...It had become evident that the state could not meet its obligations to creditors because the burden of debt service would have been greater than the taxes it could collect...
...But they have largely recuperated by now...
...Consequently, the money tended to go to the only POLITICS ABROAD debtor who could pay such rates, the government...
...there was limited access to capital...
...Civic, economic, and political culture can grow again in favorable circumstances...
...Most of the economists had only one very simple suggestion instead: privatize...
...Who would not prefer one large surgery to endless meddling with all kinds of cures...
...They will be able to enjoy both greater wealth and democratic governance...
...Finally, though, Russia's crisis warns us against ideological purism and arrogance, especially when it comes from economists...
...But even a painful, full-fledged world crisis would not affirm any feasible alternatives, and desperate attempts by Russia to find one will end in disaster...
...Democracy and economic efficiency are not mutually exclusive but support one another— and they need to be buttressed by social concerns and a framework of efficient public and private sectors...
...Practice is another matter...
...In the long run, living in a democratic society nurtures democratic attitudes...
...Prices of most products can be liberalized quickly, as can foreign trade...
...another 7 percent drop is expected in 1999...
...This prospect tells us nothing beyond the fact that capitalism is inherently crisis-prone...
...The Russian currency had to be devalued because whoever could sell rubles and buy foreign currency was doing so...
...The argument is right because outside assistance will be useless without basic changes in Russia itself...
...The figures for Bulgaria are 39 and 26...
...Little entrepreneurship can be found there...
...Hence the need for a step-by-step approach and for intermediate solutions...
...This becomes evident if one compares the economic development of such countries as Czechoslovakia, Bulgaria, and Hungary compared to countries that were never communist...
...Simply breaking their communist fetters would open for them the road to success...
...Just establish "ownership...
...inputs and outputs were overstocked...
...The crisis built up as the Russian government failed to collect the taxes it needed to finance its expenses...
...Free trade is a fine thing—in theory...
...Major highly developed countries almost always shielded their production from foreign competition in the early phases of industrialization...
...Foreign currency reserves seemed sufficient...
...It is now abundantly clear that massive outside assistance would have been needed by Russia right from the start of the transition from communism in order to sustain the emergence of an efficient, competitive market economy...
...THOMAS NowoTr' is an Austrian diplomat and political scientist specializing in East European affairs...
...Top-ranked OECD officials finally dismissed DISSENT / Spring 1999 n 25 POLITICS ABROAD the idea on the grounds that markets would solve all existing problems much faster than such "interventionist" methods...
...It actually destroyed what little had existed at the beginning of the century...
...Countries in transition from communism would have been well advised to maintain some control over foreign capital flows...
...Inequalities in income ceased to widen...
...Privatization has some benefits but it could not provide what was essential: a supply of capable and willing managers, new markets for many of the products of the large Russian firms, and the capital urgently needed for investment (the idea that Russian enterprises would gain substantial capital from issuing stocks was outlandish...
...They believed that one "could cross the abyss in one bold jump," that one could alter everything...
...Some neocorporate structures would have usefully supplemented constitutional designs, but this was not in textbooks on "pure" democracy...
...as soon as liberties were established new entrepreneurs surged forward from the Elbe to Vladivostok...
...Still this doesn't have to mean everlasting economic and political backwardness...
...there were skewed internal incentives and dysfunctional habits and traditions...
...26 n DISSENT / Spring 1999...
...The bubble was punctured as western capital withdrew from emerging markets...
...24 n DISSENT / Spring 1999 But caution was not counseled...
...But the Asian crisis changed the mood of investors...
...Russia needed a trustworthy partner with deep pockets...
...This failure caused the dramatic decline in industrial and agricultural production...
...Investments in the real economy, however, can be high only if interest rates are reasonably low...
...That is why democratic polities need to intercede to soften these sorts of blows with active labor market policies, a tight social safety net, regional development policies, and efforts to attract direct foreign investment...
...If he visited Vladivostok in 1998, Professor Sachs might have to reconsider...
...The situation became increasingly problematic, however, as enterprises failed to adjust to rapidly changing circumstances, and proved incapable of producing basic items such as food and textiles...
...Ditto the liberalization of prices...
...AWISER APPROACH to politics was also needed...
...level of expertise and institutional savvy for success in security markets...
...It sounds enticing: Who would nor prefer one single, very sharp but short pain to a long-lasting one...
...Such schemes have successfully promoted national reconciliation...
...At the beginning of 1998 the Russian economy had started to recover after a long decline in which the gross domestic product (GDP) fell to about half of what it had been under communism...
...Lower receipts from its exports increased the Russian need for external financing, which heightened the pressure against the ruble...
...Pluralization is...
Vol. 46 • April 1999 • No. 2
