Low Fidelity

Russia's pretend capitalism

Virginia Postrel from the November 1998 issue

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Back in 1990, during the glasnost era, Soviet economist Victor Belkin told Americans that the Soviet gross national product was at best 28 percent of U.S. GNP, about half the Central Intelligence Agency's estimate. Once you factored in waste and extremely low-quality goods, he said, the Soviet standard of living was about that of China, much lower than U.S. analysts had believed. Although this estimate and others like it made a splash at the time, American commentators never really internalized the idea that Russians were as poor as Chinese, or that GNP estimates were way off. Neither, in some sense, did the Russians themselves.

Like the old Soviet economy, the new Russian one pretends to be larger and stronger than it is. On paper, everything looks worth much more than its real value. In Russia's old mining and manufacturing sectors, prices are arbitrary, indicating nothing about the market value of the product or labor. These "prices" work only because bills are paid in barter or not at all. Resources do not move from wealth-destroying enterprises into wealth-creating ones. Failing businesses do not disappear; they merely suck resources out of the rest of the economy. Economists Clifford Gaddy and Barry Ickes note that "there were more corporate bankruptcies in the U.S. in the past four weeks than the entire last year in Russia." They have coined the term "virtual economy" to describe what has replaced Soviet socialism.

The virtual economy props up old industrial plants whose products are worth less than the labor and resources that go into making them. Through taxes and IOUs, it continually transfers wealth from the few enterprises that produce value into value-destroying businesses and government payments, such as pensions. Many of the transfers are merely promises of future payments--hence, the miners and railroad workers who strike for back wages and the unpaid pensioners and soldiers who threaten political unrest--but everyone pretends they are based on something real. This process makes Russia poorer and poorer, and its economic problems harder and harder to address. Western aid only makes onmade the situation worse, by allowing the pretense to continue.

It may be, as Gaddy and Ickes pessimistically suggest, that the virtual economy is thoroughly entrenched, that the Russian political system won't tolerate the disruptions of letting value-destroying businesses fail. Even many "young reformers" have political connections to these enterprises and to Russia's "Rust Belt," underscoring the case for pessimism. Pretend capitalism may be the rule in Russia for a long time to come, further impoverishing the nation.

It is, however, just pretend. Russia is not the Soviet Union, but neither is it an example of how markets work. To suggest that it is may sound good on TV, but it's just as ridiculous as upholding Bill Clinton as a paragon of fidelity.