Shock without Therapy

The Russia Hand: A Memoir of Presidential Diplomacy
By Strobe Talbott. Random House, 457 pages, $29.95


The Oligarchs: Wealth and Power in the New Russia
By David E. Hoffman. PublicAffairs, 567 pages, $21.00


Russia's Post-Communist Economy Edited by Brigitte Granville and Peter Oppenheimer. Oxford University Press, 551 pages, $29.95


The New Russia: Transition Gone Awry Edited by Lawrence R. Klein and Marshall Pomer. Foreword by Mikhail Gorbachev. Stanford University Press, 451 pages, $24.95

In the late days of 1992, economist Axel Leijonhufvud of UCLA got in touch with me. Leijonhufvud was then an adviser to the new country of Kazakhstan. He had written a penetrating analysis of how free-market policies would destroy the industrial structure of the old Soviet Union, and with it the livelihoods of many millions living there. Leijonhufvud asked that I find a way to convey his papers to Strobe Talbott, who had just assumed a position as President Clinton's special adviser on Russian matters. Through a personal connection, I forwarded the materials to Talbott.

The anecdote is trivial, except for two points. First, it illustrates that there were economists who did know just how disastrous the "shock therapy" program then under way in Russia would prove. The notion that no one knew has been widely used as an alibi since then, but it is false. Second, there is no evidence that this information made any impression on Talbott, nor indeed on anyone in the Clinton administration.

Talbott's memoir, The Russia Hand, helps to clarify why this could be so. Talbott knew Russia. The opening pages evoke his youthful visit -- and that of his friend Bill Clinton a year later -- to the Soviet Union, the great shades of Russian intellectual life (from Mandelstam to Brodsky) encountered over the years, and how the young scholars "quietly detested" the system. (It is Clinton, not Talbott, who is the Russia hand of the book's title.) Though Moscow was "better heated" than Oxford in 1968, the Soviet Union was drab and repressive. The regime had a criminal past; in the present, it is seen distributing "stale bread and rotten sausages." It did not occur to Talbott that the alternative -- well-stocked shops selling excellent produce that almost no one can buy -- might, for many Russians, prove to be worse.

Once he achieved a position of power, Talbott shared with Clinton a tendency to view diplomacy in terms of contests and teams. Friends had to be supported, their adversaries opposed. This meant in practice that support for Boris Yeltsin took precedence over policy, time and again. (On one occasion, to make the metaphor explicit, Talbott finds Clinton watching a Yeltsin speech on one television and an Arkansas Razorbacks game on the other. "You know who I'm rooting for, in both cases," the president explains.) When an honest old Soviet, Georgi Arbatov, aligned with Yeltsin's opponent Ruslan Khasbulatov in 1992, "spewing accusations about how the government was bankrupting the state and beggaring the people," Talbott was "saddened." That the accusations had merit did not enter his mind, even though he could see for himself (and says so) that inflation was running 2,500 percent per year, with "devastating" effects on consumers and pensioners (that is, on all ordinary Russians).

Talbott was inclined to trust the economic issues to the hard-charging Lawrence Summers, then deputy secretary at the Treasury Department. Summers was a fierce ally of the so-called reformers in Russia, and of the International Monetary Fund, which of course he controlled. On one occasion, he explained to then–Prime Minister Viktor Chernomyrdin that, as Talbott puts it, "The rules that governed IMF lending weren't arbitrary or intrusive -- they were a reflection of the immutable principles of economics, which operated in a way similar to the rules of physics." Talbott relates this without irony. He does, however, give Vice President Al Gore credit for conceding, after the meeting and out of Summers' earshot, that the "hard realities of Russian politics" might also have a place in the equation.

Those hard realities included a cast of characters who scarcely figure in Talbott's cosmos. They were the "oligarchs" whose grab for Russia's wealth David Hoffman has chronicled in an impressive account that follows the careers of six of them. Of these, four are men of business: Alexander Smolensky, Mikhail Khodorkovsky, Boris Berezovsky, Vladimir Gusinsky. One is the free-marketeering official Anatoly Chubais (now the electricity czar, as much a monopolist as anyone else), and the last is the mayor of Moscow, Yuri Luzhkov (in his case a power broker from an entirely different tradition, more Richard Daley than William Randolph Hearst).

The oligarchs are a lively lot, far from the polished CEO of Western corporate culture. They came up from the second tier of Soviet society: Chubais launched himself from a research institute in Leningrad, Khodorkovsky from the Komsomol (the Young Communist League, the main Soviet youth organization), Gusinsky from a failed attempt to break into theater. They amassed vast wealth and power by cunning and by strong connections to Soviet power. For instance, while Gusinsky tangled with the KGB, he maintained relations with parts of it, including, Hoffman deduces, by informing.

The oligarchs quickly learned that the big money was not in business but in foreign loans and hard-currency speculation. Borrow rubles, buy dollars, wait for the ruble to fall, sell the dollars, pay back the ruble debt, pocket the difference. So long as the ruble interest rates were below the pace of devaluation, this was a surefire money machine -- a ticket to wealth and power fueled by connections rather than by work. Sell bonds, buy a company. Run a pyramid scheme and soak up billions of rubles from a financially illiterate, gullible and desperate population while a weak or indifferent government stood by. Russia went directly from collapsed communism to decadent capitalism, with no intervening period of industrial success.

Nor did American observers fail to notice. In 1995, as Hoffman relates, diplomat Thomas E. Graham received permission to publish, in Russia, a full and perceptive account of the emerging clan structure. But Washington learned nothing. As Hoffman writes, "What Graham saw did not neatly fit into the Washington idea of brave reformers led by Yeltsin and Chubais fighting off the Communists."

Ultimately both Hoffman's account and Talbott's come to the same place: the inevitable default, devaluation and economic collapse of August 1998. This brought stolid common sense, in the form of Yevgeny Primakov, to power in Russia, a curbing of the oligarchs to some degree and modest improvements in Russian economic conditions. The difference here is that Hoffman (and here one has to say, in spite of his strange sympathy for the characters he is describing) understands how it happened, whereas for Talbott and Summers it is purely a matter of us-against-them (and Primakov got no help from us). Talbott's account bears witness:

In frequent, often gladiatorial encounters with Larry Summers and other visitors from Washington, Primakov blamed many of Russia's problems on his predecessors ("your darlings, the young reformers"), on our administration for backing them and on experts from the IMF ("your university boys who come here to teach us as though we were dunces"). ...It was one more repudiation of the Westernizing theme that Andrei Kozyrev had represented in Russian foreign policy and that [Yegor] Gaidar and [Boris] Fyodorov had stood for in economic policy. In its place was economic nationalism."

Hoffman and Talbott deal with the commanding heights, with the personalities and narratives of power. But neither can offer the deeper survey of Russian economic conditions now available in two books, Russia's Post-Communist Economy, edited by Brigitte Granville and Peter Oppenheimer, and The New Russia: Transition Gone Awry, edited by Lawrence R. Klein and Marshall Pomer. Yet to understand what really happened -- not merely at the level of power politics but in human terms -- books such as these are necessary, voluminous and academic though they are.

Granville and Oppenheimer's volume contains 17 papers by 26 authors, mostly British and Russian, on many topics. Some articles are of mainly technical interest, a few are ideological in character and one, an essay on small business by Anders Åslund, a former Swedish diplomat who helped to create the free-market policy disaster in Russia, is merely a tract. But others manage to combine compact presentation of detail with flashes of insight.

In an overview, the editors point to several cataclysmic consequences of the abandonment of central planning, which dropped output by 20 percent to 40 percent throughout post-communist Europe. These were the wholesale rejection by consumers of domestic production (in favor of Western imports) and the "disappearance of supply links and marketing channels." The first effect meant that exporters also did not want to supply their Eastern European partners: Only hard-currency exports, if you please. The second effect meant that newly emancipated firms were sent forth to face the "market" -- which in any event did not want their products -- without eyes, ears or brains. As an evolutionary strategy, this was unlikely to produce survival, let alone successful adjustment.

Neither effect was foreseen by Western economists, precisely because they expected the market mechanism to cope spontaneously with such problems. And this misplaced confidence was compounded by a Western tendency to have overrated the communist economies in the first place, "partly under the influence of propaganda both from Communist governments … and from the CIA, the latter aptly dubbed by Rodric Braithwaite 'the Nostradamus of the modern world,' Granville and Oppenheimer write. But then they observe:

As soon, however, as the failure of Communist economics was admitted by its former adherents, the consensus expectation in western circles swung to the opposite extreme: if the command-administrative system was such a disaster, then surely its abandonment must bring an instant improvement. Not so, alas.

Here we come to the essential dilemma: The preconditions for a successful market economy did not exist, nor could they be created in any reasonable time. Indeed, as Granville and Oppenheimer point out, they were contradictory. Both property rights and competition are necessary in principle, but an antimonopoly policy would, in the specific circumstances, have simply undermined property rights. The result was that monopolization went unchecked, competition could not emerge and private-property rights became merely a cover for asset stripping, looting and capital flight. Much of this is documented in Russia's Post-Communist Economy, including especially useful essays on the insider domination of enterprise ownership and the unhappy evolution of private banking in the new Russia.

Amid the vast compilation of detail, one set of facts stands out: After 1991, Russians began to die at accelerated rates. A final essay by Christopher Davis gives the numbers:

The crude death rate rose from 11.2 deaths per 1,000 habitants in 1990 to a peak of 15.7 in 1994, dropped back to 13.6 in 1998, and increased again to 15.3 in 2000. … Male life expectancy dropped from 63.8 years in 1990 to a low of 57.6 years in 1994, recovered to 61.3 years in 1998, and then fell back to 59.9 years in 1999.

Many explanations for this have been offered, including stress, violence and alcoholism. Davis, however, points to a different issue: the collapse of health care in post-Soviet Russia.

To be sure, health services in the USSR had been a low state priority: poorly paid, technologically and pharmacologically backward, ill-matched to the rising complexity of diseases in the later years. On the other hand, however, the system did provide care. As Davis writes: "The Soviet medical system provided curative services free of charge on a universal basis through a large network of polyclinics, hospitals, and other facilities." This accomplishment could not, of course, be sustained in the new Russia. And at the same time, the characteristic features of Western health care made their appearance promptly:

A new complication has been the growth of health interest groups with links to private medical care, health insurance, pharmacies, pharmaceutical industries and medical foreign trade. As in the West, these groups disrupt health reform programmes likely to be of general benefit when they threaten to undermine their particular economic interests.

This observation comes close to a general insight. To Russian problems, requiring Russian solutions, Westernizing reform mainly added the pathologies -- without the benefits -- of privatization. Meanwhile the Russian problems did not go away.

In the new Russia, Klein and Pomer have assembled the most coherent critique we are likely to see of the philosophy, strategy and tactics of shock liberalization. With a foreword by Mikhail Gorbachev, an introduction by Joseph E. Stiglitz and contributions from other American Nobelists, including Kenneth Arrow and the late James Tobin, as well as numerous Russians, this book is less fact-filled than Granville and Oppenheimer's tome but more readable.

The early pages of Klein and Pomer are devoted to a critique of the neoliberal program in Russia. Gorbachev's words set a tone:

Shock therapy did irreparable harm. Most dangerous are the social consequences -- the sharp drop in standards of living, the enormous inequality of incomes, the decline in life expectancy -- not to mention impoverishment of education, science and culture. All of this was bound up with deeply flawed privatization, a flare-up of crime, and moral degradation.

But why did this agenda fail so badly? It would be easy, and unquestionably correct, to argue (as Christopher Davis does) that the Westernizers and their acolytes failed to understand the concrete features of the Russian case. Klein, Pomer and their associates, however, make a stronger point: Western reform failed in Russia not only because the recommendations were inappropriate to Russia,but also because they were based on a caricature of economic governance in the "free-market" West. It wasn't merely that the outside advisers did not understand Russia; they weren't very good at economics.

This deeper problem was recognized at the beginning by Gorbachev, who (as he relates here) had to listen to the advice of the West's political leaders at a G-7 meeting in Houston in 1990:

I was struck in particular by Japanese Prime Minister Toshiki Kaifu. One could have imagined that his remarks were from the representative of a country with no government economic regulation. Similar views were expressed by U.S. President George Bush, Canadian Prime Minister Brian Mulroney, and British Prime Minister John Major. On the other hand … when [French President François] Mitterand said that the economies of all the nations represented at the meeting carried socialist traits as well as capitalist ones, several of those present did not disguise their astonished reactions.

Stiglitz makes the point bluntly: "The failure of the reforms in Russia reflects misunderstanding of the very foundations of a market economy, as well as a failure to grasp the fundamentals of reform processes." But it is Pomer who drives the argument home, with a savage survey of the discussions among American economists concerned with Russia in the early 1990s. Here we find Summers, again, lining up behind the economists' consensus of the day, saying that "the three '-ations' -- privatization, stabilization, and liberalization -- must all be completed as soon as possible." This view did not go unchallenged. But the challenges never got very far. As Pomer relates:

Jeffrey Sachs, the most influential foreign adviser to the Russian government, dismissed criticism of radical reform as "politically motivated rather than analytically sound." Attributing the difficulties to "the legacy of the old regime," he said that the inefficiency of the Soviet system implied that "enormous scope exists for increases in average living standards within a few years." According to Sachs, the key was to end inflation by government austerity "accompanied by rapid privatization of enterprises and swift opening of international trade."

When Sachs presented this assessment before a panel of eminent economists, several questioned the emphasis on speed. Alan Blinder, soon to be appointed to Clinton's Council of Economic Advisers, asked what could be learned from the gradual transformation in China. Sachs said there was "little relevance" since Russian industry was more developed and government control over the economy was more pervasive. These realities, however, suggest that Russia had more capability than China to guide transition in a deliberate manner and that radical change would be more destructive to the productive capacity that was already in place.

Readers of The New Russia will find useful essays from a binational cross section, featuring voices from authentic Western liberalism and from the enduring traditions of Soviet and Russian reform. Short essays devoted to specific sectors -- including agriculture, coal, real estate, education and public-asset management -- provide introductions to the issues facing these sectors now. The authors are realists, as Gorbachev says; they look to the future. Still, the prevailing mood on the Russian side is bitter, and there is a general sentiment of betrayal. As Arbatov summarizes: "Many of my countrymen now understand shock therapy as a conscious design to undermine Russia completely as a great power and transform her into a kind of Third World country. The actual results of shock therapy have not been far from this goal."

Could things have been different? The radicals argue that the failed putsch of 1991 foreclosed on gradualism in Russia. But this is fallacious. The coup gave Yeltsin and his confederates their chance, but it did not impose on them the course of action -- no less bolshevik than the Bolsheviks themselves -- that they took. The neoliberals cannot escape history. When in 1995 China faced a similar decision -- whether to liberalize the external capital account in the wake of the economic slowdown of 1994 -- the Chinese leadership (advised, as it happened, by such American economists as the late Robert Eisner and this reviewer) chose not to do so.

Partly as a consequence of that prudence, Chinese economic expansion continued through the Asian crisis of 1997 and the Russian collapse of 1998.

And for the future? After 1998, Russian economic policy seems to have largely liquidated shock therapy. The new regime presides over a slowly growing, highly unequal economy in an environment of unsteady equilibrium between private oligarchs, regional bosses and central control, exercised through the security forces. In George W. Bush, Vladimir Putin has found an American president whose constituency rests on oil companies and the military, and who appears willing, so far as we can tell at the moment, to let other matters slide. Except when it comes to certain unfortunates such as those in Chechnya, this may not be such a bad thing. The predations of oil companies are, perhaps, less immediately dangerous than those of financiers and economists.

Still, nothing can change what was lost, nor the responsibility of leading American economists, diplomats and politicians -- well-meaning liberals, in many cases -- for the role that they played, in good faith or in bad, in one of the great economic tragedies of a generation.

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