Letters to the Editor: Checklist for Action in the Russian Economy

by Michael D. Intriligator, with Robert McIntyre, Marshall Pomer, Dorothy J. Rosenberg, and Lance Taylor

1. The Russian federal government should play a major role in developing a modern, mixed economy, similar to those in France, Sweden, and the United States. Besides monetary and fiscal policies, it should formulate policies for investment, trade, competition, and technological development.

2. The government should engage in an expansionary economic policy, support enterprise restructuring, and implement trade and regulatory policies_policies that would attract foreign investors, bringing expertise and capital into the country. It should maintain tolerable control over inflation and balance of payments deficits to avoid recurrent stability crises. Judicious price and wage regulation would help assure relative price stability in a way that is consistent with overall growth, rather than relying entirely on monetary and fiscal policy. Export growth and access to foreign borrowing are essential to external balance. Restrictions on capital movements would help check capital flight and reduce trade imbalances. For a limited time import tariffs, quotas, or nontariff barriers might be introduced to support the establishment and expansion of domestic production. These policies should be accompanied by measures to prevent foreign loans from financing luxury consumer goods imports.

3. Agreements with the International Monetary Fund and the World Bank_formulations that have provided relatively little financial support to Russia, but have prevented active and expansionary macroeconomic and trade policies_should be renegotiated, and the restrictions lifted. The policies required by the IMF and World Bank were developed largely to deal with structural inflation in Latin America. (The policies have encountered problems there, as well, as seen in Mexico.) But the challenges facing Russia, is of a different nature. Russia needs to be able to engage in expansionary fiscal policy in dealing with inflation, and it should be able to control imports and capital flight.

The assistance of the international financial institutions can be more than made up for by limiting capital outflows. Foreign direct investment, pouring into a receptive and growing economy stimulated by expansionary policies, would easily offset the loss of international financial assistance.

4. Russia's legal system, including its laws, procedures, enforcement, and judiciary, should be reformed and modernized in such a way that it protects property, enforces contracts, and eliminates the criminal underworld. Enforcement agencies should be strengthened in terms of status, funding, personnel, and equipment. The authorities must take strong action to reverse and halt the growing criminalization of the Russian economy. Shock therapy has destroyed much of the structure of the old socialist economy, but it has failed to create the institutions necessary for a market economy. As a result, criminals have been able to create their own institutions.

5. The tax code should be fair, it should promote investment and the formation of new enterprises, and it should be enforced effectively. A well-funded and streamlined tax system would encourage compliance and put government finances on a more stable footing, thus reducing inflation and accelerating economic growth. Tax revenues should be fairly distributed to provide sources for both public investment and the provision of social services.

6. The banks should lend working capital to their client enterprises, as commercial banks do, or they should operate as investment banks, instead of being short-term investment pools, as most are today. If necessary, the government should set up its own banking institutions. (During the Great Depression in the 1930s, the U.S. Government set up the Reconstruction Finance Corporation to replace failed banks. State development banks have also been a key part of successful industrial policy in South Korea and other countries). The government should also set up, or encourage an interenterprise payments mechanism to prevent a further arrears crisis and to avoid the various inefficient forms of barter payment that firms now use to survive.

7. Federal and local governments should work together to set up market institutions, including codified property rights; modern systems in accounting and finance; advertising; insurance; and development of labor, capital, energy, and other input markets. They should also provide performance-based support to private and state-owned enterprises_with performance criteria including_investment, exports, job creation, growth, and productivity. Privatizing state enterprises has resulted in private, unregulated monopolies, and asset stripping and price gouging are prevalent. The government should regulate monopolies or break them up, if necessary. It should also provide appropriate resources to support the training of managers.

8. The government should revitalize the agricultural sector, through limiting food imports and temporarily providing fuel and fertilizer subsidies. Only those collective farms whose members specifically agree on the redistribution of assets should be disbanded . The ultimate goal should be a mixed agricultural system, which should include the surviving collective and state farms.

9. Governments at both the federal and the local level should assume social responsibilities that were previously assumed by state-owned enterprises. A social security system could make up for the pensions lost as state-owned enterprises collapsed and for the private savings eaten up by inflation. (In the United States, during the 1930's, the Social Security system replaced lost corporate pensions and failed private pension plans.) The poverty issue must also be addressed because more and more people are sinking into absolute poverty, including pensioners, displaced workers, and military personnel. Job creation for displaced workers is a major government responsibility. (In the United States the Works Progress Administration was established during the 1930s to provide public work for the unemployed.)

10. The government should rebuild the health system to reverse the trend of deterioration. The steady loss of highly qualified specialists and the continuous deterioration of health facilities and supplies should be halted. Similarly, programs are needed to address the environmental catastrophe facing Russia. Ecological devastation will increase health hazards and further erode Russia's natural resources.

11. The government should support the educational system, which is declining as teachers and administrators, under financial pressure, seek other careers and as facilities decay. Rebuilding educational assets, human and physical, would have a substantial payback over time. Similarly, scientific and technological research should be revitalized through renewed government support to prevent the loss of talent. These skilled professionals are capable of turning out products that are competitive in worldwide markets, so they should be encouraged and helped to participate in the market economy.

Michael D. Intriligator is Professor of Economics, Political Science, and Policy Studies at the University of California, Los Angeles. Robert McIntyre is Professor of Economics at Bowdoin College, Marshall Pomer is American Coordinator of the Economic Transition Group, Dorothy J. Rosenberg is Research Fellow at the Institute for Policy Studies in Washington, D.C., and Lance Taylor is Professor of Economics at the New School for Social Research.

The IMF and the World Bank Prevents What?

by Dmitri Tulin

Dmitri Tulin of the IMF and John Nellis of the World Bank comment on the "Checklist for Action in the Russian Economy."

The policy measures proposed in the Checklist for Action in the Russian Economy, can in no way be regarded as a direct alternative to the recommendations made by the International Monetary Fund. A major part of the proposed actions, especially those having to do with structural policy and social security safety net, would undoubtedly win the unanimous support of the Fund's Board. Furthermore, similar measures (although in an abridged version, since the Fund is not specialized in such policy issues) are traditionally recommended by the Fund to its program countries, including Russia.

It is common knowledge that financial stabilization policies in transition economies may not be sustainable unless they are supported by adequate structural and social policies, and unless the transformation of the legal and institutional frameworks of the society has kept pace with the rising austerity on the fiscal and monetary sides. It is likewise understood that disinflation by itself_however important this policy objective might be_does not necessarily guarantee sustainable economic growth and prosperity, if not accompanied by a number of other factors and policy actions.

Opinions at the IMF would be split on some of the actions suggested by Mr. Intriligator, such as direct administrative control of commodity prices and wages, the foreign trade regulations, and the foreign exchange restrictions. Nonetheless, the Fund has never been excessively aggressive or obtrusive in imposing its views on a member country if the country has proved its ability to succeed in disinflationary efforts while preserving some of its unique policy features.

There is, at least, one point on which the Fund would strongly and unanimously disagree with authors of the "Checklist," namely, on the allegation that the agreements with the IMF and the World Bank "have prevented active and expansionary macroeconomic policies" and, thus, "should be renegotiated and the restrictions lifted" (point 3 of the Checklist). The latter statement by Mr. Intriligator is too general and is too poorly supported by facts to require a detailed critical analysis. Nonetheless, the Fund has a number of weighty arguments with which to challenge the author's assumptions.

First, prudent and well-balanced monetary and fiscal policies do not prevent healthy economic growth, at least, not in the medium-term perspective. Conversely, we have all witnessed an explicit positive correlation between the strength of stabilization programs and the general economic performance of economies in transition.

Second, in it programs with the IMF, Russia was given full discretion in the selection of "active" or less active macroeconomic, trade, and investment policies. Moreover, the Russian authorities followed much of Mr. Intriligator's advice, putting in place active trade and foreign exchange controls and restrictions, desperately fighting capital outflows, selectively applying administrative control on prices and wages, inviting foreign investment, subsidizing the agricultural sector, and trying as much as possible to secure the existence of collective and state farms.

Third, Russia has failed so far to accomplish any of the stabilization programs agreed with the Fund, which places the Fund's critics in an awkward tactical position, since in such a case any unbiased observer would be inclined to attribute Russia's unsatisfactory economic performance to noncompliance with the Fund's policy recommendations, rather than to the deficiencies of these recommendations.

Finally, the author's comparison of the size of the multilateral financial assistance to Russia with possible capital inflows_given the establishment of better economic policies_does not seem fully relevant and free of contradictions. It might seem that the author opposes Russia's reliance on the Fund for external financing and favors instead the alternative source of private capital inflows. But in reality, the resources of the Fund and the World Bank can never be substitutes for funds from capital markets. Although, arrangements with the IMF do provide member countries with access to Fund resources, a more important benefit is improvement in their international credit ratings. The IMF and the World Bank are recognized world-wide as "rating" agencies and catalysts for capital markets. It is probably for this reason_in acknowledgment of the role the Fund and the World Bank play in the markets_that the author urges Russia to "renegotiate," but not to break, its arrangements with the multilateral financial institutions.

Mr. Tulin is Executive Director in the IMF Russian Office.

Dangers of Dirigisme

by John Nellis

No one should be pleased with the route, the pace, or the social consequences of transition in Russia. Stabilization has not yet been achieved. Production has plummeted. Living standards have fallen; average incomes are estimated to have declined by 43 percent from 1991 to 1993 alone. A recent calculation puts a third of the population below a poverty line. Inequity is rising. Diseases previously controlled have resurfaced. Life expectancy is reported to have slipped by an astonishing six or seven years since 1989 (though this involves many non-economic factors). These are exceedingly grim, facts and numbers. Thus, it is not surprising_indeed, it is welcome _ that concerned observers conclude that the present state of affairs is intolerable, and ask yet again, what is to be done? The question is perfectly legitimate. The problem with the "Checklist" is the answer, which in every case is, "the government should...."

What is it that the government of Russia is being asked to do? It must change, say the authors, it must take a more active and direct role in the economy. Government should intervene more, both to create and nourish the policies, institutions, and firms that contribute to economic growth, and to suppress those activities that detract from it. In part, what is suggested is sensible in the extreme: Government should do more to impose macroeconomic stability and enforce public order; it should seek to enhance competition, increase the stability of the business environment, and encourage foreign investment. Well and good_though the details of precisely how one goes about this are lacking.

The sticking point, however, is the many instances where the Checklist's recommended interventions go far beyond macrostability and public order questions, and espouse a pervasive governmental role in just about all aspects of the economy. The Checklist calls for price and wage regulation, restrictions on capital movements, protection of fledgling domestic industries, expansionary fiscal policy, the setting up of development banks, direct state financial support to public and private enterprises, limiting food imports, and providing fuel and fertilizer subsidies. These and a number of similar actions proposed, say the authors, will lead to the creation of a "modern mixed economy." These tasks are in addition to the exhortation to government to modernize the legal system, eliminate the criminal underworld, and set right the banks, the tax code and collection procedures, the subnational governments, and the health and the education systems.

Would that it could all be done. Would that it could all be done quickly. And would that it could all be done by government.

But the sad fact of the matter is that if it could all be done quickly by government, then socialism would have worked, and Russia would not be in its present sorry situation. The authors of the Checklist certainly do not see it that way; they assert that it was "shock therapy that destroyed the institutions of a socialist economy." They recommend in response an approach based on the implicit assumption that "government" is a neutral, competent defender of the public interest, possessed of a long-term perspective. I believe the authors are fundamentally wrong on both counts. It was the contradictions_to borrow a second term_and inefficiencies of the Soviet system of planning that set in motion the demise of Gosplan, the CPSU, the KGB, and the other institutions of socialism, well in advance of any economic shock therapy program. More to the point, the Russian government simply does not have the resources, the capacity, or the motivation to undertake the daunting array of intensive and expensive interventions called for.

Even if government could undertake the recommended actions, why should one believe that wage and price controls will be "reasonable," that protection for fledgling industries (the most troubled of which, by the way, have been in existence for decades) will be "temporary," that directed credits will be "performance-based?" The experience of many if not most other countries that have attempted these interventionist methods has shown that the approach works rarely, with successes being partial and attributable as much to structural circumstances as to chosen instruments. There are any number of instances where interventions, no matter how well-intended, have provided rents for the few at the expense of the many, and to the clear detriment of economic growth. The authors' answer is that Russian circumstances "are of a different nature" than those prevailing elsewhere, so external experience, at least of the negative sort, cannot be used as a guide _but why this is the case is not explained.

So then, is nothing to be done? Should one assume that what the Russian government is presently doing is either optimal or not likely to be improved? Clearly not; there is much that government can and should change, along the lines advocated in the Checklist, in terms of imposing stability, both economic and social, and laying the foundations of the legal basis for capitalism. But many other desirable government actions are withdrawals from, rather than additions to existing activity. For example, a recent survey of 439 Russian firms (reported on in the July-August Transition) showed that government presently allocates much of its aid to industry to firms that have both large numbers of workers and large losses. The Checklist authors would, presumably, agree that keeping large loss-makers alive was precisely the wrong approach, and recommend that the resources be shifted to assist firms with high potential. They might argue that this latter policy has been seen to work in several Asian countries, which have used targeted, performance-based subsidies and directed credit to further industrial development. There, government intervention has been associated with beneficial outcomes.

However, the "conditions for effective intervention" are numerous and stringent. To borrow a few lines from Adam Schwarz's article published in the Far Eastern Economic Review (August 24, 1995; p. 42), who is evaluating a new volume (edited by Andrew McIntyre), Business and Government in Industrializing Asia, (published by Allen & Unwin, 1995), these conditions include:

• A strong state able to resist social and personal pressures.

• A disciplined and relatively noncorrupt bureaucracy capable of implementing government policies effectively.

• A stress on export promotion and international competitiveness.

• Institutions that allow government and business to communicate.

• Stable and prudent macroeconomic policies.

• Strict reliance on economic criteria in selecting particular forms of intervention.

• A relatively limited role for foreign direct investment.

Russia does not presently meet these conditions.

My fear is that were Russia to adopt an approach that requires institutional capacity that it does not yet possess, the likely outcome would not be an economic turnaround, but rather the entrenchment of rent-seeking, anti-market forces, further sub-optimization of growth, and the prolongation of misery. Russia should certainly be attempting to put in place the institutional base for a strong and competent, market-promoting state, and Russian economic policies will certainly from time to time deviate from the pure market model_perhaps now and then to quite good effect. But for Russia to adopt this panoply of interventionist methods would do more harm than good. Some years ago, Jeffrey Sachs said words to the effect that the event to fear most in postcommunist countries was not a return to central planning_a most unlikely occurrence _but rather slippage into Third World dirigisme of the type practiced in Argentina until so recently. I fear this would be the likely outcome of Russia adopting the recommendations of the Checklist.

John Nellis is Senior Manager in the World Bank's Private Sector Development Department, working this year on the 1996 World Development Report.

We Have Our Own Mafias

by Cyril Appleton

Once again (Transition, no. 5-6, 1995), your contributors ascribe unmerited virtues to Western economies. This time they have failed to recognize that the collapse of a state command economy will inevitably result in a market command economy simply because the structure is still in place for the political creatures of an unregulated market to occupy.

Corruption, fraud, theft, misappropriation, and violence continue to be contributors to the scene as manifestations of the driving force of unregulated markets, human greed. There is no other honest way of describing the accepted guiding principle of "maximizing profit." The same thing applies, of course, after revolutions in the opposite direction.

It would also be a hopeful sign if the practical differences between a planned economy, ordered markets and unregulated markets were recognized. To use a boxing analogy, the first is a contest having one man with his hand tied behind his back, the second is a bout under the Queensberry Rules, while the third is a combat with one contestant wearing iron-spiked gloves_not an unreasonable description of transnational corporations and their tame governments hammering the poverty-stricken peasantry and exploiting child labor.

The banner chapter heading for the heroic figure facing down the dreaded Russian Mafiya would have been awe-inspiring had not shadows been cast by the western Mafia, assorted drug barons, and vice kings laughing in the background. Perhaps they were reflecting upon the different responses made by the Western establishment to Iraq's threat to Kuwaiti and Saudi oil supplies and to the murder, rape, and pillage that have drenched Yugoslavian soil with innocent blood.

The author is Trustee, CADET Development Centre Whitstable, Kent, U.K.

Do Not Neglect Economies East Of Urals

by Richard Pomfret

Your report (Transition, May 1995) on the contributions to the Annual Bank Conference suggests a Eurocentric view of transition. The reform process began in China a decade and a half ago, and the Chinese and Vietnamese economies have been growing for some time, the former spectacularly so. Ignoring the Asian transition economies is even less justified when their populations are considered; China dwarfs all other transition economies, but also the three Indochina countries contain more people than the nine countries spotlighted [during the conference].

Both Eastern Europeans and East Asians have a tendency to consider their own cases special, with little to be learned from the other group. Maybe that is correct, but surely it is the role of the multilateral institutions to question that nationalistic reaction. The past record of both the Bank and the Fund rests precisely on drawing general economic lessons that can be applied, with modifications, across diverse countries; the old Third World was at least as varied as the formerly centrally planned economies are today, so now is not the time to abandon the global approach in favor of a narrowly regional view of comparability.

Especially as the 1996 theme of the influential World Development Report will be the transition process, it is to be hoped that the analysis will not be restricted to the subset of transition economies west of the Urals.

The author is Professor of Economics, The University of Adelaide, Australia