March 11, 1999

The Price of Free-Market ‘Reform’:
A Desperate Russia

By Edward S. Herman

One of the remarkable myths of the West during the 1990s was that "reform" in Russia was a success, even if qualified, and that serious failure has only struck Russia with last year’s financial implosion.

This myth allowed President Clinton to advise Boris Yeltsin last year to avoid a return to "failed economic policies," referring not to the disastrous policies of the Yeltsin years but to those of the prior era (which were characterized by reduced growth rates, but no major absolute declines).

A second myth is that reform has been approved by the Russian people in a genuine, even if imperfect, democratic process. Both myths result from the fact that Western elites have enthusiastically backed the rapid dismantlement of socialist institutions in Russia.

That extreme approach has had seriously adverse economic and social consequences, which would have been featured as demonstrating a dismal failure had they occurred in, say, Castro's Cuba. But those consequences have been largely ignored by the mainstream media.

With the current collapse, the search is on for scapegoats that will deflect attention from the impact of the reforms themselves.

Indeed, "reform" in Russia -- the rapid privatization of the economy and open door to foreign trade, investment and finance -- has been accompanied by a historically unique peacetime economic and social collapse, which has beggared a large majority of the population and reduced Russia to the status of a Third World country.

Between 1990 and 1998, Russian GDP fell by some 50 percent, industrial production and capital investment declined by 90 percent, incomes of 75 percent of the population have been pushed down to subsistence levels or below, and male life expectancy has fallen below that of Indonesia and the Philippines. Over 60 percent of consumer goods are imported, and Russia's main, almost exclusive, exports are oil and gas.

Despite this deindustrialization and economic decline, a small elite, including a substantial criminal element, has prospered mightily, based on trading, financial dealing and smuggling, rather than any productive activity. A large fraction of elite gains have been based on privileged access to government contracts, licenses and national property.

Goldman Sachs banker Andrew Ipkendanz admitted, belatedly, that "Russian elites have plundered the country's capital and funneled most of the proceeds offshore."

As in other Third World countries, boutiques and restaurants catering to the tiny elite (and foreigners) have blossomed, along with homelessness, beggary, crime and mass immiseration.

The prosperity of the urban elite has fooled some foreigners, with reporters finding a "mystery" in the spectacular rise in suicide, infant mortality and death rates. (See Michael Specter, "Climb in Russia's Death Rate Sets Off Population Implosion," NYT, March 6, 1994.)

Reform in Russia has been a catastrophic failure because neither political conditions nor economic institutions existed that would have permitted a successful rapid transition to full-blown capitalism.

The political elite, from Yeltsin on down, were old Communist apparatchiks who, while rejecting Soviet socialism, were by no means democrats. Many were cynical opportunists on the make.

Under their rule, there has been a gigantic looting of public assets, the rapid emergence of a financial and corporate oligarchy, no concern whatever for the deteriorating condition of the mass of ordinary citizens, and no attempt to pace the transition to a market economy in accord with the demands of equity, efficiency or national development needs. In short, this has been a corrupt revolution from above. [See David Kotz and Fred Weir, Revolution from Above.]

The Russian economy was crippled by the breakoff of the other constituents of the Soviet Union, which was an integrated system. It also had a large military production component, and an inefficient industrial system highly vulnerable to foreign competition.

To make the shift to a market economy, Russian industry needed pressure, but it also needed time for change if a national disaster was to be averted.

The "cold turkey" approach imposed by the "reformers," with Western encouragement and pressure, caused a collapse, not only of the industrial system, but agriculture and the medical and social welfare apparatus as well.

It was also anti-democratic since the Russian people never approved this process. Polls from 1990 to the present show that Russians want social democracy, with a major government social service role, not laissez-faire capitalism. They have also strongly opposed the massive theft of public property.

Russian elections have been a travesty. In the important 1996 election, Yeltsin started the campaign with an 8 percent popularity rating, reflecting total public disenchantment with "reform."

Yeltsin publicly sacked Anatoly Chubais, the symbol of reform who was secretly lining up Russia’s “gang of seven” to finance the re-election campaign.

Yeltsin then ran against his own reform policies -- as well as "communism," which was not at issue, with the Communist Party running on a mildly reformist platform, and in no position to re-establish communism even if the party wanted to.

With the oligarchs and state controlling the media, huge illegal spending on the campaign and Western support, Yeltsin defeated both "communism" and reform. On the day after his election victory, he reinstated Chubais to push forward “reform” which included dividing the spoils among Yeltsin’s financial backers.

The West encouraged and pressed for rapid privatization, despite the uncongenial circumstances, because its main objectives were to obtain irreversible institutional changes away from socialism (and social democracy), and to end any military threat from a former military rival. The costs to the Russian populace were of little concern.

Realizing Western ends required joint venture partners -- as in Indonesia and the Philippines -- who would make the necessary changes, without regard to the internal human costs. The Yeltsin team, like Suharto and Marcos, served this role well.

The West is now searching for scapegoats. One is that the "moguls" and "business oligarchs" are irresponsible and have sabotaged reform. But the moguls are the very children of reform, and they supported it all along, as allies of Yeltsin and the prime beneficiaries of his policies.

Another scapegoat is the slowing up of the reform process, which has brought all these wondrous benefits. It is also pretended that the only choices for Russia are between "reform" and Communism.

As with the drunkard who has looked everywhere for his eyeglasses perched on the end of his nose, the solution to the problem of why Russia is imploding is extremely simple -- this is the latest phase of an ongoing "reform" debacle.

Edward Herman is a Professor Emeritus of Finance, Wharton School, University of Pennsylvania.

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