The Russian Meltdown: Don’t Blame Capitalism

March 23, 1998 • Commentary
By Stephen Moore and James Carter

Capitalism has failed. That’s the spin that European socialists and American liberals are attaching to the economic meltdown in Russia. The Russians have finally discovered “the high costs of a free market,” writes left‐​wing economic commentator Robert Kuttner.

Whatever the cause of the Russian economic free fall, it is absurd to blame the free market. There has never been anything resembling capitalism in Russia. It is a nation that has no rule of law, no property rights, no culture of capitalism and a currency of no value. Trying to engage in normal commerce in Russia today is like trying to drink chicken broth from a fork. The lawless economic environment is virtually the antithesis of Adam Smith’s notion of free‐​market capitalism.

At the root of virtually every national economic crisis — whether in Asia, Europe, Africa or Latin America — is a collapse of the currency. So it is with the ruble today. After several years of monetary prudence, the Russian government has committed the age‐​old sin of trying to inflate its way out of its economic woes. After the devaluation this summer, the ruble lost half its value relative to the dollar. Latest reports are that inflation is running at nearly 40 percent a month. Russian peasants standing in lines at stores complain that prices rise three times before they reach the checkout counter. Hyperinflation appears to be right around the corner.

Cronyism is another debilitating feature of the Russian economy. According to the Hudson Institute, “20,000 crimes connected with official corruption are recorded every year, but this is probably less than 1 percent of the real total. A recent poll of Moscow businessmen revealed that several thousand bribes are given and taken in the capital every day.” Corruption and crime act as confiscatory taxes and make normal, unfettered commerce a virtual impossibility.

[B]y wrongly blaming capitalism for this economic virus, the Russians are rejecting the very policy prescriptions that can arrest the decline.

Few Americans appreciate the extent of the economic collapse in Mother Russia. The Russian economy has a comparative advantage in virtually nothing, other than arms production and Vodka, and now the “reformers” in Russia want to nationalize the liquor industry. The “Made in Russia” label is a pseudonym for junk. While in Silicon Valley, I recently spoke with a CEO from a major semiconductor company who had recently visited a leading Russian chip maker. He said the plant was an anachronistic joke. It was producing purely copy‐​cat technology — that was literally 5–10 years out of date. This in an industry in which a technology 18 months behind the curve is obsolete.

Bad policies translate into disastrous economic results. The accompanying table indicates the extent of the economic contraction. The stock market is in free fall, having lost 80 percent of its value in a year (the equivalent of the U.S. stock market’s falling from 8,000 to 1,600). Industrial production and gross domestic product have sunk by almost 10 percent since January. Store shelves are emptying. One standing joke in Russia is that an elderly woman bought three bags of sugar “before the hoarders could get a hold of it all.” Social statistics are grim as well. Life expectancy has actually fallen by several years over the past decade, and two leading causes of death are suicide and alcoholism.

What is worrisome is that, by wrongly blaming capitalism for this economic virus, the Russians are rejecting the very policy prescriptions that can arrest the decline. The snake oil ointments now under consideration by the Russian government are disastrous: even more money created to liquidate bad debts, renewed economic subsidies for favored industries and higher taxes and stiffer tax collection efforts. No wonder investors are fleeing while they still can.

What should be the U.S. response to this Russian crisis? First, we should stop treating Russia as an economic ally and start treating it as the national security threat that it still is. Russia is America’s 32nd largest trading partner and ranks behind Ireland, Israel and even the Dominican Republic. It accounts for a puny 1 percent of world trade. Economically, Russia is an inconsequential Third World nation. But its nuclear arsenal makes it a first‐​class military threat. First Deputy Prime Minister Yuri Maslyukov recently told the Wall Street Journal that a top priority of the Russian government is “to develop a more accurate missile system.” The instability of the Russian government makes a powerful case for accelerating development of a U.S. strategic defense initiative.

Second, we should stop pouring good money after bad into Russia via the International Monetary Fund. One high‐​ranking IMF official recently conceded in the Los Angeles Times that “we don’t know what happened” to the last $5 billion IMF installment. American taxpayers should not be forced to fund a welfare safety net for U.S. banks and investment firms that foolishly dumped money into a country that is notoriously inhospitable to capital. It is a breach of Congress’s fiduciary duty to require U.S. taxpayers to repeat George Soros’s $2 billion investment folly.

Finally, the profoundly ineffective Clinton administration foreign policy toward Russia should be dismantled. The Clinton White House has placed too much emphasis on democracy in Russia and too little on encouraging genuine capitalism. Pseudo‐​democratic elections in Moscow have led only to a game of political Russian roulette, in which one former communist bandit the is replaced with another.

Polls now indicate that a majority of Russians would favor a return of the communists if an election were held today. What they long for is some sense of order. It is critical for U.S. foreign policy makers to try to convince the Russians that chaos and economic decline were not caused by capitalism — but by its enemies at home and abroad.

Anatomy of a Meltdown
Vital Russian Economic and Social Statistics, 1998
Inflation rate reported 200%
Unemployment rate (est.) 12%
GDP growth rate -8%
Industrial production -11%
Stock market change -80%
Ruble relative to dollar August 1 — September 30 -50%
Population growth rate -0.07%
Russian life expectancy (male) 56 yrs.
About the Authors
Stephen Moore is director of fiscal policy studies at the Cato Institute. James Carter is a former economist at the Republican National Committee.