Canadian Commentary: International

The Cart before the Horse:
How the Free-Marketers Screwed Up Russia

November 1998

When Russia emerged from a Communist economy in the early 1990s, a whole series of economic advisors descended upon the country from the United States. Russia was pretty much forced to listen to them, as a condition for receiving the stabilization funds it needed in order to make the transition to a capitalist economy. However, all of the best-laid plans of the economic advisors went awry; none of the standard solutions they trotted out worked out as planned. Privatization and deregulation resulted in a mafia economy run by a few well-connected oligarchs. Free trade and free circulation of capital led to an over-dependence on imports, and then the recent collapse of the ruble and, with it, the economy.

Was this the fault of the Russians for not implementing the policies correctly? Not really. These policies could never have worked according to plan in an economy such as Russia's. It was the fault of the advisors for not realizing that their simplistic nostrums, developed in the comfort of the wealthy U.S., did not apply to the complex Russian situation.

The arrogance of the free-market advisors had two aspects. The first was the failure to realize that their precious free-market economy is in fact an extremely delicate entity. It can only survive in an atmosphere in which there is

  1. Coherent, enforceable regulation. Without regulation, companies that respect their society are quickly forced out by companies that feed parasitically off their society. These antisocial companies then swallow capital and effort unproductively while creating a backlash against private enterprise in general, fatally undermining the system. See the Russian banking sector.
  2. Rule of Law. Genuine competition on the basis of efficiency can only survive where other forms of power - notably corruption and the use of force - are tightly constrained. Otherwise, whoever has money, power and influence will simply use it to force out their competitors, regardless of their relative efficiency. The result is not growth, but stagnation. This is exactly what has happened in Russia.
  3. Effective democracy and free press. Without it, power coalesces in the hands of a few people, creating corruption and stagnation, and resulting in a backlash. See points 1 and 2.
  4. EFFECTIVE TAXATION. None of the above is possible if the government cannot pay for police, inspectors and law courts, and does not have the power and resources to stand up to powerful sectors of society.

When Russia emerged from communism, it did not have any system of regulation or any set of laws designed to govern a free-market economy. Nor did it have any kind of coherent taxation system. The first thing that needed to be done - BEFORE any attempt to impose a free market - was to create a logical, enforceable taxation system that would provide the government with a steady cash flow to replace the income from government enterprises. After this was in place, coherent economic laws and regulations needed to be put into place, and the police and courts trained to deal with them. Only then would Russia have been ready for full-scale privatization and a free market. Instead, the economic advisors pushed Russia to plunge right into a privatized, deregulated economy - with the predictable result that the privatized companies fell into corrupt hands, and the economy degenerated into lawlessness.

The second form of arrogance was the assumption that there is only one possible economic model, that of the free-market United States, characterized by low regulation, low social security, and free trade. In fact, quite different economic models have been just as successful - notably the social democratic model of northern Europe, and the corporatist, protectionist model of East Asia. Both of these models have recently suffered difficulties, but for four decades they succeeded very well. Notably, they succeeded in nations where 1) the economy had been devastated, 2) there was a strong traditional culture and belief in collective action. Both of these conditions applied to post-Communist Russia; neither applied to the United States. At the same time, this arrogance requires a certain amount of amnesia - after all, the U.S. and many other industrialized nations first built their industry behind protectionist barriers before being converted to free trade (once their industries had reached a certain maturity).

To suggest the imposition of free-market solutions for Russia was like prescribing an exercise regimen to a man with pneumonia. Instead, while a coherent taxation and justice system were being developed, the Russian economy should have been nurtured and allowed to develop a certain amount of internal vitality before it was exposed to free trade, free flows of capital, and wholesale privatization and deregulation. Russia has a large internal economy; if it had been protected, Russians themselves would have gradually developed their own free market and learned to provide supply where there was demand. There would have been an incentive to develop Russian goods instead of simply importing everything with money gained from selling natural resources - a development that was unsustainable and led directly to the recent collapse. The only good thing about the collapse is that it will evenutally lead to where the whole process should have started in the first place - as exports are now unaffordable, Russians will learn to improve their own products and manufacture what they need for themselves. They will simply have to do it with a lot more pain than was really necessary. The danger is that the government will never manage to stand up to the oligarchy created by premature privatization, and will not be able to create a real taxation and justice system. In that case, Russia will remain an unstable mafia state for many years. As the western powers continually try to cope with the resulting headaches, they will have only themselves and their economic advisors to blame.

Nov. 5, 1998

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