Low Fidelity

Russia's pretend capitalism

Bill Clinton once had hundreds of affairs, he told Monica Lewinsky, but after he turned 40 he resolved to be faithful to his wife. He cut back on his sexual adventures. Yet Clinton still committed adultery, and he still got in trouble.

The conclusion is obvious: Fidelity is a crock, a "utopian religion," "the great illusion of our era." If it weren't for his blinkered devotion to the foolish ideology of fidelity, Clinton wouldn't be facing the possibility of impeachment.

Not even the fiercest Clinton defender would make such a ludicrous argument. No one in their right mind would claim that Clinton's reckless sexual behavior and its consequences stem from a zealous dedication to marital fidelity. And no one who offered such a patently ridiculous line would be respectfully interviewed on PBS news shows or published in The Washington Post.

But if you're talking about Russia a different standard applies. It's conventional wisdom that fidelity leads to adultery.

From experts both inside and outside Russia, we hear that the country's economy is falling apart because of unregulated free markets and too much reform. Leftists are ecstatic. Ever since the collapse of the Soviet Union they've been looking for a club with which to beat back the idea that markets lead to progress and prosperity. What could be better than economic turmoil in Russia? It's even the same country that made socialism look so bad.

Economics columnist Robert Kuttner puts it most rhetorically, calling the "Russian implosion" a casualty "of the great illusion of our era--the utopian worship of free markets…an almost lunatic credulity in pure markets and a messianic urge to spread them worldwide….With serious aid, we could have helped true reformers build an effective democratic state and a modern mixed economy. Instead, the Russians got laissez-faire gangster capitalism." Markets equal the mafia.

NYU professor Stephen Cohen, a former Sovietologist and Gorbachev devotee, is more measured, as befits a man whose talking head appears regularly on PBS. But, like Kuttner, he blames Russia's troubles on an "American crusade to transform Russia into a replica of American democratic capitalism," a model he doesn't like much anyway. He says, "We have to drop this dogma about the notion that there's only one way to reform the country. Russia's changing course….The state is coming back to try to save the nation." In Cohen's morality tale, the Russian state apparently withered away in 1991, taking with it all business regulations and social spending; it is only now reviving.

Now that Russia is done with its foolish experiment in free market capitalism, goes this line of argument, the country's economic policies can be pragmatic and humane. "Now there is hope for a more realistic policy," former Gorbachev economics adviser Oleg Bogomolov told The New York Times after the ascension of Prime Minister Yevgeny Primakov brought communists back into economic-policy positions. "Now it is not just one side that can express their ideas, like our liberal radical economists. We are all in favor of reforms, but not reforms for their own sake, but reforms which serve people."

From these accounts, and less tendentious ones as well, you might well think that Russia has been following some sort of laissez-faire model for the past seven years: that Moscow had become the new Hong Kong. Like Bill Clinton's ventures in fidelity, however, Russia's experiment with "free markets" combined a small change in behavior with a lot of good-sounding talk. In truth, Russia no more adopted a market economy--even in a mixed, social-democratic European way--than Clinton stayed faithful to his wife.

What Russia is actually experiencing is the second collapse of socialist planning. It is true that under international pressure Russia adopted "shock therapy" policies: freeing prices, privatizing some industry, and curtailing inflation. Those policies are what Cohen terms "nitwit, monetarist reforms," equating them with free markets.

But prices, sound money, and a modicum of private property do not a market economy make. They are necessary but not sufficient. The competition and feedback that distinguish real markets are missing in Russia. As economist Hernando de Soto observed of his native Peru, what shapes this economy is "bad law" and the absence of good law. Russia has loads of regulations to curtail enterprise, yet the government exercises pathetically little power to enforce contracts or punish crime. Economist Daniel Kaufmann finds that Russian senior managers or business owners must devote 30 percent to 40 percent of their time to meeting with public officials, compared to 5 percent to 10 percent in Chile or El Salvador. Bribes cost $30,000 a year for a small enterprise in Russia, and those bribes don't even reduce the time lost to meetings with officials.

Similarly, in a 1995 survey of small shop owners in Moscow and Warsaw, 76 percent of the Russians said they needed a "roof"--a private substitute for state law enforcement, providing physical protection and "dispute resolution"--to operate, compared to only 6 percent of the Poles. In Moscow, 39 percent said they'd been contacted by the criminal racket in the past six months, where only 8 percent of the Poles had. Yet the Russian officials who can't be bothered with fighting crime have plenty of time to stifle enterprise: It takes 2.71 months to register a business in Moscow vs. 0.72 months in Warsaw; Moscow shops were inspected 18.6 times in the previous year, compared to nine times in Warsaw; and 83 percent were fined vs. 46 percent in Warsaw.

Economist Andrei Schleifer, who conducted the survey with a colleague, notes that the results accord with private conversations. Russian entrepreneurs "always point to multiple permits, inspections, registrations, all requiring interactions with multiple officials many of whom need to be bribed before the necessary documents are issued….To compare this to the situation in Poland, in February 1996 I asked a wealthy Polish businessman how difficult it is to open a shop in Poland. He answered immediately: `Oh, it is very, very difficult. There are now so many shops and so much competition that it is impossible to make money.' But, I insisted, remembering my Russian conversation, `What about permits, registrations, inspections, bribes, and other obstacles from the government?' `These are not a problem,' answered the businessman, `but the competition is awful; I would never recommend opening a shop in Poland.'"

From the grassroots, in other words, Russia's economy doesn't look much like a dynamic, capitalist system driven by competition and consumer choice. In a real market system, competitors--not bribe-demanding bureaucrats--drive entrepreneurs crazy.

Small shops may have to fight bureaucrats and crime lords, but at least they produce value for customers. The heavy industry that still makes up a huge proportion of the Russian economy, and employs many Russian workers, does not. It survives because Russia's economy is still run on socialist lines, with investment decisions made to serve centralized political power rather than decentralized economic competition.

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.