Fact and Fancy about Post-Communist Economic Reforms

November 21, 2000
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by Michael S. Bernstam and Alvin Rabushka

In the October 11, 2000, edition of The Financial Times, Martin Wolf, economics columnist, wrote a review of the International Monetary Funds World Economic Outlook, October 2000. http://www.imf.org/external/pubs/ft/weo/2000/02/ The title of Mr. Wolfs article was Avoiding the trap of transition: The former communist countries that have done best have ensured that goods can be bought more freely than judges.

Mr. Wolfs article endorses the IMFs standard prescription for growth in post-Communist economies. We believe that the IMFs assessment is more fancy than fact.

Apart from a sharp decline in living standards, the greatest loser in Russias economic reforms has been plain facts. It is important to separate fact from fancy. A detailed treatment of the points that follow appear in our ongoing book, From Predation to Prosperity, posted on our web site at http://www.russiaeconomy.org/predation.html.

Fancy: Russia implemented tough reforms. China did not.

Fact: In the 1990s, Russias GDP declined 47 percent, Chinas grew 152 percent. Since 1978, Chinas economy expanded sevenfold. Russia expects 67 percent growth in 2000, but forecasts for 2001 and beyond are in the 45 percent range. China is growing at 8 percent, with bright prospects.

Fancy: China had it easy as an agricultural country. It could apply new technologies and organizational know-how from advanced economies. Russia had to transform its outmoded industrial base, a slow, tough process. Contraction was necessary and inevitable in Russia.

Fact: Before 1978, industry generated over half of Chinas GDP. But this is beside the point. The advantage of transforming inefficient industry is greater than the advantage of backwardness. No effort, investment, and time are needed to gain from industrial reform. Consider Russian tractors. Russia makes tractors which sell for $50,000 on world markets. But each tractor requires $60,000 worth of raw materials. Each tractor subtracts $10,000 in value from raw material inputs. In addition, tractor workers receive $30,000 in wages. The $40,000 subsidy comes from the $60,000 of the initial (and partly wasted) output. With market prices and without subsidies, tractor firms go bust. But this would be good! The economy has $60,000 of raw materials to sell, instead of $50,000. Growth spurts 20 percent overnight, while workers can still be paid. Halting value subtraction is addition. Russia was poised to grow instantly. Western studies estimated value subtraction in the USSR and Eastern Europe under central planning as 3234 percent of output, which implies 50 percent built-in growth.

Fancy: Countries which conducted IMF-advised reformsliberalization, stabilization, and privatizationperformed better than laggards.

Fact: The opposite is true. Russia liberalized, privatized, and stabilizeduntil the financial collapse of August 1998more than any other post-Communist economy. Eastern European countries that privatized and liberalized later contracted less and recovered faster. China, the greatest success, took a different path. Its leaders split the economy in two, one part controlled by the government, the other, new entrants, was let to start from scratch. This new-entrant economy now produces 78 percent of GDP. Some parts, Town and Village Enterprises, grow at 25 percent a year. Across 42 post-Communist economies, the less that countries followed the IMF-trinity of stabilization, liberalization, and privatization (call it SLiP), the better they performed. For years the IMF used a smaller sample that excluded China. As the IMF added China and other successful countries to its sample in the October 2000 World Economic Outlook, the link between SLiP and performance disintegrated. Our analysis of 42 countries appears at http://www.russiaeconomy.org/predation/pdf/chapter2.pdf.

Fancy: Russia is a private market economy, China is still heavily state-controlled.

Fact: Some 78 percent of Chinas GDP is produced by new-entrant enterprises. While not fully private or free, they are not subsidized nor do they subsidize others. Their income is earned and retained by themselves. Their income is privatethis is the keyregardless of whether property is privately-owned or not. New Chinese enterprises are free from income redistribution, socialization, and predation. In Russia, despite widespread privatization, nearly 80 percent of national income is socialized through hidden subsidies and cross-subsidies. This amounts to nearly-total socialism without central planning or big government. This non-governmental socialism operates through the payments system. Whatever enterprises do not pay for inputsand thus get freesuppliers charge the public and the government. Enterprises collect taxes (value-added tax, income tax withholding, payroll taxes), but do not fully remit the proceeds. They simply confiscate public income. To offset this fiscal shortfall, the government prints money, disbursing it through banks as subsidies to enterprises, enabling them to remit additional taxes. This cycle occurs several times a year, effectively socializing 80 percent of GDP. Exchange is free, enterprises are private, but income is socialized. This is communism with a lower-case c, a new species of socialism. Conventional thinking focused on the false dichotomy of market versus government. It missed the real dichotomy of market (private income) and socialism (common income). Paradoxically, liberalization and privatization begot non-governmental communism. Central planning is akin to a single nation-enterprise. When Communism collapsed, the government lifted controls and privatized enterprises. These newly-privatized enterprises quickly formed a network that confiscated public income, drove monetary policy, and redistributed subsidies. Until the network (little c communism) is broken up, Russia will continue to experience defaults and contraction. Only high oil prices have given the country its current breathing space. For a full explanation of the origin of Enterprise Network Socialism, See http://www.russiaeconomy.org/predation/pdf/chapter1.pdf.