The Magazine

Under Western Eyes

What went right and what went wrong in the reform of Eastern Europe.

Jan 28, 2002, Vol. 7, No. 19 • By MELANA ZYLA VICKERS
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Building Capitalism
The Transformation of the Former Soviet Bloc
by Anders Aslund
Cambridge Univ. Press, 550 pp., $27

TWO YEARS AGO in an interview, I asked Mikhail Khodorkovsky, chairman of Yukos Oil and one of Russia's leading oligarchs, whether it was possible to have risen to his financial heights without having been a well-connected Communist before the fall of the Soviet Union. "Of course not," he answered. Since then, few insights into the former Soviet Union's current state of affairs--not the belabored chronicles of Russia's loans-for-shares debacle, not the rationalizations about Ukrainian ex-Communists being better leaders than current Communists, not the bromides that "civil society" will in time cure all the region's ills--have matched the creepy oligarch's refreshingly candid remark.

Until Anders Aslund's "Building Capitalism," that is. Where other writers have described the problems of the 1990s, the Carnegie Endowment scholar Aslund does the hard work of digging into the Soviet period to explain the problems' origins. An economic "big bang" is what separates the region's winners from its losers. The post-Communist countries that failed to reform their economies quickly sank into paralysis so deep it still mires them.

A BIG BANG, most memorably detonated in Poland under Leszek Balcerowicz, requires national leaders to cut budget deficits in order to halt hyperinflation, tighten money supply through an independent, inflation-wary central bank, deregulate prices and end price subsidies, break up monopolies, open up to foreign imports and exports and make the national currency convertible, allow the rise of new private businesses, and sell off state-owned businesses. Economic reforms that failed to include all these elements were sure to fizzle.

What's worse, partial reform--or "gradualism" as Aslund contemptuously terms it--created a breeding ground for corruption. The Soviet Union under Gorbachev is a foremost example of gradualist reform. Back in 1988, the Soviets passed a banking law that allowed the establishment of republic-level central banks. These republican banks offered the USSR's new commercial bankers opportunities to borrow at low interest rates and to hold only minimal sums of money as reserves. The result was an instant class of commercial bankers--running 1,360 banks in Russia alone--who demanded that the state print for them vast sums of rubles that they in turn passed on to well-connected borrowers.

At about the same time, officials in the commodities bureaucracies were arguing that Soviet production would collapse if Soviet oil, natural gas, metals, chemicals, and other goods had to compete against cheaper goods from the outside world. And so, while export regulations blocked whole firms from selling goods on the world market, corrupt officials were able to buy large quantities of domestic goods privately and sell them on world markets at much higher prices.

Similarly, agricultural-sector officials argued that without subsidies to buy foreign food imports, foreign prices would gouge local people and they would starve. The officials got the subsidies, often in the form of credits with which to buy foreign commodities. According to Aslund, they didn't pass on the cheaper prices to consumers but kept the subsidies for themselves. Other enterprise managers made arguments in defense of workers, telling their central governments that without subsidies, layoffs would ensue. These officials opposed unemployment benefits that went directly to the workers, instead sucking funds into the enterprises they managed and pocketing them.

When enterprises failed to pay money they owed the government, they struck deals to "pay" it back through bartered services such as road construction. They'd value the public contracts at a high price, then carry out the work as cheaply as possible, shortchanging the project and eventually bankrupting the government.

Similar corruption, though not as deeply entrenched, existed in Central Europe. In aggressive reforming countries, corrupt "rent seekers" were denied the time and opportunity to entrench themselves. But in slow-to-reform states, corrupt officials established monopolies. Motivated to keep their niches, these rent seekers paid off the politicians along their path to continued wealth. Non-connected, honest reformers could not similarly buy friends and supporters in high places and eventually fell into the "electoral trap of underreform." What's worse, this rotten state of gradualism robbed real reforms of credibility: All the public could see was that "reform" made life seem as bad as before.