The decision to transform the economy of a huge country without the benefit of the rule of law led not to a free market democracy but to a kleptocracy with several dangerous economic and psychological features.
In the first place, the new system was characterized by bribery. All resources, at first, were in the hands of the state; businessmen thus competed to “buy” critical government officials. The winners were in a position to buy more officials, with the result that the practice of giving bribes grew up with the system.
Besides bribery, the new system was marked by institutionalized violence. Gangsters were treated like normal economic actors, which tacitly legitimized their criminal activities. At the same time, they became the partners of businessmen who used them as guards, enforcers, and debt collectors.
The new system was also characterized by pillage. Money obtained as a result of criminal activities was illegally exported to avoid the possibility of its being confiscated at some point in the future. This outflow deprived Russia of billions of dollars in resources that were needed for its development.
Perhaps more important than these economic features, however, was the new system’s social psychology, which was characterized by mass moral indifference. If under communism, universal morality was denied in favor of the supposed “interests of the working class,” under the new reform government, people lost the ability to distinguish between legal and criminal activity.
Official corruption came to be regarded as “normal,” and it was considered a sign of virtue if the official, in addition to stealing, also made an effort to fulfill his official responsibilities. Extortion also came to be regarded as normal, and vendors, through force of habit, began to regard paying protection money as part of the cost of doing business.
At the same time, officials and businessmen took no responsibility for the consequences of their actions, even if they led to hunger and death. Government officials helped organize pyramid schemes that victimized persons who were already destitute, police officials took bribes from leaders of organized crime to ignore extortion, and factory directors stole funds marked for the salaries of workers who had already gone months without pay.
From "Criminal Communism" to "Criminal Capitalism"
Satter said that Russia's transition from "criminal communism" to "criminal capitalism" had occurred in three stages: hyperinflation, privatization, and criminalization. Hyperinflation began on 2 January 1992, when the Gaidar government freed virtually all prices, consequently wiping out the life-savings of millions of Russians. According to Satter, this same government also chose to ignore a law passed by the Supreme Soviet calling for the indexation of savings accounts in the event of price liberalization, deeming it the responsibility of the old regime. Yet while the majority of the population was being driven into poverty by inflation, a group of well-connected insiders was becoming very rich.
Satter mentioned several ways in which people with access to the state budget and ties to state officials were able to amass wealth including: establishing and fooling the public into investing in pyramid schemes, speculating in dollars, obtaining lucrative licenses to export raw materials, and appropriating and collecting interest on state credits that were supposed to support industry. Satter asserted that by the time privatization got underway, the country was already divided into haves and have-nots.
This hyperinflation had been briefly preceded by "wild privatization," during which government and party officials began to privatize whatever they could get their hands on, noted Satter. Former government officials who had once been in charge of state resources became the new owners and proceeded to sell off these resources. In addition, an amendment to the law on cooperatives allowed factories to create cooperatives within the framework of the factory, which encouraged massive theft as factory directors were now given the means to establish cooperatives through which to write off and sell factory supplies.
However, according to Satter, the real theft of the state's most valuable enterprises began with money privatization in 1994. At "public" auctions for state property, the bidders for the most desirable enterprises were well-connected to local officials, with the results of these auctions being largely determined in advance. The loans-for-shares program, in which the government exchanged shares of enterprises for loans, greatly benefited the banks empowered by Yeltsin in 1993 to handle government accounts. These banks used government money to make short-term loans at extremely high rates of interest. Then, having made a profit using the government's money, the banks were able to loan it back to the government in exchange for valuable enterprises. This is how the much-talked-about oligarchy came into being and eventually began to dominate the political and economic scene, explained Satter.
Satter then commented on the final stage of the rise of the criminal state in Russia--criminalization. In short, the first cooperatives were established at a time when all property in the Soviet Union belonging to the state was completely unprotected. It was also illegal to have a private security service. Both of these factors made the first Russian businessmen attractive targets for criminals. As the number of independent businessmen grew, the underworld experienced phenomenal growth. With no one to protect them, Russia's new economic elite, composed largely of corrupt insiders, had no choice but to turn to criminal gangs for protection. Eventually, Russian businessmen found gangsters useful in other aspects of business, including curbing the growing epidemic of non-payment of debt.
According to Satter, as these groups became more interwoven, the entire commercial and political apparatus in Russia was poisoned. On a final note, Satter reflected that the only rule in business and political life in Russia continues to be the rule of force and that without the rule of law, Russia has no hope of resurrecting itself.
GAIDAR: The loans-for-shares deals took place at a time when I hadn't worked in the government for a long time. There were people with more authority, who were responsible for that question. That would be Yeltsin, Chernomyrdin, Anatoly Chubais.
But I discussed that subject, at least with Chubais, many times, and I had my own
understanding of the situation. In my opinion, the major motive at that moment was a political one, connected with providing stability and not allowing the return of communists to power. In 1995, a large portion of the property in Russia belonged to the so-called Red Directors, people who sympathized with the Communist party, who stole money from their enterprises, which they directed badly. And the point was that they were not attracted to the new regime. And if I understand correctly, the loans-for-shares deals were first and foremost directed at creating a critical mass of influential and powerful political forces that would have been vitally interested in not allowing the return of the communist regime. For these deals, we paid endlessly a great deal during the second term of Yeltsin's presidency. Masses of things that we dreamed about, that we could have done in the second term of Yeltsin's presidency, were not done because there was this compromise. A great many characteristically unpleasant features of Russian capitalism today were brought about as a result of that series of compromises. Nonetheless, when, in the intervening years, I asked myself the question: would it have been better to take the risk of the communists coming to power and see what would have happened, knowing what the Communist party was and knowing what Russia was like and knowing how dangerous the situation was for ourselves and for the rest of the world-well, I cannot convince myself that this would have been better.
YAVLINSKY: Loans-for-shares privatization was a way of creating criminal capitalism in Russia. We learned a very important lesson [in the process], by the way. Karl Polanyi, as you know, wrote a book Open Society and Its Enemies, and he described two main enemies of the open society-fascism and communism. In the last 10 years Russia has found out that open society has one more enemy. That enemy is capitalism that is not limited by laws, by civil institutions, by tradition, by belief, by trade unions, by anything-simply the wild will for profit at any price. That was the key idea of privatization here, that was the key of all changes here.
INTERVIEWER: Yegor Gaidar believes that loans-for-shares privatization was a
necessary evil that helped save the country from the surging communist party.
YAVLINSKY: It's not true, because it's very likely that [those behind the scheme]
were paying the communists to [reinforce this point of view]. It would have been
much better not to pay the communists and to take a different approach. The mob of communists in the country was growing together with the poverty. Communism is a social disease coming from poverty. You can have a lot of disease from poverty. For example, if you have no soap you have a lot of disease. Communism is something like that. If you have a poor society and poverty in the country, you have communists. The reform as these guys were doing it was creating more and more poverty. And the poverty was producing more and more communists. So it was absolutely possible to use a different approach and not to distribute the property between 10 personal friends. There was no need for that. The task was to give the property to millions of people. The [privatizers] were not doing anything for small and middle businesses, and that was one of the key issues. They were all the party of big business. But the big business in Russia was [corrupt] business.
One of the main reasons why in Eastern Europe the reforms were very successful
and in Russia they were not was that in 1991 in Eastern Europe the real democratic revolutions happened. New people came to power. It was a real replacement of the political elite, like it was after the war in Germany and Japan, when the Nazi leaders were completely ripped out and new people came in. The same happened in Eastern Europe after 1991. In Russia it was [different]. The same people changed their jackets and changed the portraits in the rooms, and instead of saying "Communism" and "Lenin" and "five-year plan" started to use "market democracy" and "freedom" as their key words-with the same substance that was with "Lenin" and "Communism" and "five-year plan." They came to power, and you can see: we had Mr. Yeltsin, who was a member of the Politburo, as president of the country. For ten years we had a member of the Politburo as a leader of the country. But we also had 8 or 7 Prime Ministers during the 10 years; all of them were members of the Central Committeeof the Communist Party or representatives of the KGB, with one minor exception of Kirienko, who was a Komsomol leader of his region. So it was the mentality of these people, the approach to life of these people that was the main factor of our failure.
These people hired young economists to present a business card [of reform] to the
world. And they were very successful, because they got about $50 billion in loans
[thanks to] the so-called [economic] dream teams-nice faces speaking English. Mr.
Yeltsin certainly used them, and they brought in money to support the new system.
$50 billion, that's a pretty big number.
INTERVIEWER: What went wrong in Russia's case?
STIGLITZ: Well, there [were] an enormous number of mistakes, one after the other. They began with the shock therapy of liberalization, of eliminating price controls for most of the commodities. The result of that was that there was a massive inflation.
So the high levels of inflation were, in fact, a consequence of the shock therapy
strategy in the beginning. That wiped out the savings of an enormous number of
people. You didn't at that point have any basis of people having wealth to have a
legitimate privatization process. They then had a privatization process that was
corrupt and in which the country's assets were turned over to a few, to the oligarchs.
The strategy was privatization at any cost. Do it quickly, is what the IMF kept telling them. The IMF kept a score card-how many privatizations had you done. But it's easy to privatize, give away the state assets to your friends. And in fact, it's not only easy-it's rewarding, because then they give a little bit of money back to you. So that was the strategy that was advocated and pushed. They then had policies like capital market liberalization before they were ready.
So what did that mean? You had an illegitimate privatization. The people who had
been able to use their political influence to get these billions and billions of dollars of
natural resources for a pittance were then told, Well, you have a choice, keep your
money inside Russia or take it to the United States. United States was having a
boom, Russia, because of the policies, was in a depression. Well, if you were smart
enough to persuade Yeltsin to give these billions of dollars, you were smart enough
to figure out it's better to take your money to the United States or, even better, to
Cyprus, to secret bank accounts, to Switzerland, knowing full well that there'll be a
change in government. When there's a change of government, there'll be a
questioning of whether those privatizations were legitimate. If you had your money in Russia, people might say, we want to do that over again; you effectively stole the country's assets. So the experiences in Russia show that in some sense economists are right: incentives matter. But under the IMF strategy, you put in place incentives that lead to asset stripping rather than wealth creation and to the implosion of the economy rather than to economic growth.
INTERVIEWER: How did this affect the poor in Russia and the average person?
STIGLITZ: A number of things happened that contributed to the increase in poverty. Poverty increased from around two percent to forty percent or more, depending on how you calculate it. [It was] one the most rapid increases in poverty that the world would have seen in that short span of time, apart from a natural disaster. With the tight monetary policies that were pursued and the other policies, firms didn't have the money to even pay their employees. What was tragic about it is while they didn't have enough money to pay their pensioners, to pay their workers, they were giving away the valuable state assets to a few rich people. So in a way, resources were leaving Russia in massive amounts, billions and billions were leaving, with these open capital markets. Russia privatized before they had a good tax system in place.
It's very easy to tax oil, and you can monitor the amount of oil that's being shipped
abroad. It's actually relatively easy. But they privatized it before they put in the
means of taxing this most basic resource of the Russian economy.
And so by not getting the sequencing right, by not pacing right, they lead to the
impoverishment of massive amounts of their people. Then, with the government not having enough revenue, other aspects of life started to deteriorate. They didn't have enough money for hospitals, schools. Russia used to have one of the [best] school systems in the world. Now they didn't have enough money for that. So this began to affect every dimension of people's lives.
U. S. S. R.: The Corrupt Society: The Secret World of Soviet Capitalism
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