The Trouble With Oligarchs

An answer, finally, to a question which has been bugging me for ages. Conversations between me and Harvard Institute types about the disastrous "shock therapy" experiment in Russia where an attempt to build capitalism in one country ended up killing a fair chunk of the population have always tended to go like this:

Me: What the hell happened? How did you fuck up Russia so badly? People call Art Laffer a crap economist, but he never starved a million people to death! What were you guys smoking?
Harvard Institute type: Oh it was terribly sad. Our policy mix was about right, but, unfortunately, the whole thing was derailed by the botched privatisation program
Me: I'll say it was fucking botched! GDP fell by 42%! Life expectancy fell by seven years! I simply do not believe that a freaking privatisation program, a fairly mild supply-side reform, no matter how badly designed, could have that kind of immediate and catastrophic macroeconomic effect!
Usher: Excuse me sir, would you mind lowering your voice and minding your language? Professor Shleifer is about to make his speech
HI Type:Well the problem is that because the privatisation program was handled badly, the national assets ended up in the hands of a small group of oligarchs.
Me: So fucking what? They were in the hands of a small group of oligarchs before the privatisation! In any case, how does this affect output?! When people find out that their employer has been taken over, they might slack off a little, but they don't suddenly decide to down tools, go home and starve to fucking death! There's got to be more to it than that!
Somewhat more burly usher: Excuse me sir, would you mind stepping outside ...?

Which has always been the kernel of my argument. Terribly unfair and corrupt or not, handing over ownership of a factory from this bunch of gangsters to that bunch of gangsters doesn't stop the wheels turning. Surely to goodness, the Harvard Institute must have made some other criminally stupid mistake to do so much macro-level damage in such a short time?

The answer to which was, "yes and no". Fundamentally, what we have to realise that, at an economic rather than a political level, what's bad about oligarchs is a monetary perniciousness rather than a moral one. The fact that they're crooks is economically neutral. However, the fact that they know they're crooks, and they suspect that they're going to get found out soon, can have disastrous effects. Think about it this way:

A party apparatchik can be a pretty venial and horrible person. But there's only so much self-dealing he can do for himself under a communist system. He can get a bloody fine dacha, the best food and drink, good clothes and a couple of mistresses and that's it. Don't get me wrong; it was possible under the Soviet system to live a lifestyle not unlike that of a Western millionaire if you played the game right. Let's assume that the actual consumption of the oligarch class was unchanged post privatisation.

The trouble with a capitalist robber-baron as opposed to a corrupt commissar is that because he's a capitalist, he is concerned with accumulation as well as consumption. Specifically, his goal is not just to live like a king, but to take as much of the cash flow of his factories as he can, convert it into dollars and stash it somewhere outside Russia where the people he's meant to be answerable to can't find it. In the balance of payments, this shows up as a negative item on the capital account (ie, by depositing the money in a foreign account, he is increasing the claims of Russians on institutions outside Russia). When you have the entire productive industry of the country owned by people like this, then the capital outflows can be pretty massive.

Unfortunately, for a country in Russia's stage of development, you would normally want to see capital inflows, not outflows, which was rather the problem. Billions of dollars in aid and investment went into Russia between 1990 and 1998, but most of it just ended up providing the liquidity for capital flight. And of course, as one learns in the dull national accounts lecture in the first week of your macroeconomics course, a negative item on the capital account has to have as a counterpart a positive item on the current account; to accomodate the capital flight, Russia had to run a current account surplus. Which is pretty tricky; given that Russian exports to the outside world were more or less fixed in the short term, the only way to create the surplus was through import reduction or "domestic demand compression". Which is exactly what happened; Russia experienced a huge and horrendous depression precisely because an item which is usually small enough to be forgotten about (the drain on domestic liquidity brought about by capital flight on the part of criminals) became significant enough to be large relative to the domestic money supply. So the *really* stupid policy of the Harvard Institute was to impose the open foreign exchange and capital markets which made the capital flight possible.

Interestingly, there is a corollary to this "monetary theory of kleptocracy". Note that most of the bad effects of the kleptocrats took place because they converted their (local currency) profits of theft into dollars, draining the economy of hard currency. Because of this, we can credibly hypothesise that there is one case in which you could hand the entire economy over to robber barons and it wouldn't really matter at all. That would be the case in which the local currency is the global reserve currency, so that the kleptocrats are happy holding their wealth in local currency. In other words, the one country in the world which has literally nothing to fear from becoming a gangster state is the United States of America!