The debacle of European social-democracy

In the elections to the European Parliament held on 4-7 June 2009 all parties of social-democratic inspiration obtained reduced support or were defeated outright everywhere – with the exception of Greece that confirms the general rule – in spite of the financial and real tsunami of 2008-2009 (extended at least to 2010 in terms of labour unemployment). What are the causes of the defeat of the European “Left”, at a time when they should have benefited from the crisis and harvested anti-cyclical electoral consensus?

In our previous post (The Fall and the Original Sin of Socialism, 9 November) we argued that Soviet-type socialism suffered from the original sin of Nikolai Ivanovich Bukharin and Rosa Luxemburg, i.e. their assertion that socialism marked the end of political economy as a science: neglect of economic laws was instrumental in eventually bringing down the entire system and the Wall that was built in 1961 to shelter it. The whole European social-democratic left was also tainted by the original sin of socialism, in believing that, somehow, economic laws could be suspended by socialists. And when, in the late 1990s, with the rise of the Third Way of New Labour and of the German Neue Mitte, social-democracy tried to mend its ways, in some respects it did not change radically enough, in most respects it went too far in embracing the hyper-liberal doctrine. Moreover, together with its old-fashioned economic dogmas, the new social-democracy jettisoned its best traditional political values. The global economic crisis of 2008-9 and the glaring failure of the hyper-liberal model caught the European “Left” on the wrong foot, unprepared to respond, split into litigious factions and voided of its political backbone. Hence its debacle and its abysmal prospects in the short and the long run.

Impossible Demands

The pretence that economic laws can be ignored or suspended under socialism is a common feature of both the extreme left – with Potere Operaio in Italy promising a life as rentiers to all workers adopting their misguided strategy of “refusal to work”, or with the May 1968 Parisian slogan “Soyez réalistes, demandez l’impossible” – and of democratic socialism. For instance, at the time of the Labour Party Conference in Blackpool in 1949, Aneurin Bevan was declaring that "The language of priorities is the religion of socialism", thus confirming the muddled thinking and the neglect of a proper economic assessment of policy alternatives by social-democratic leaders. The notion of “priorities” is of course a contradiction in terms, since by definition there can only be one priority. What is being talked about is targets, not priorities, and the desirable trade-off between targets must be decided and specified. Old-style socialism, including the Soviet version, was generally committed to a plurality of mutually conflicting and often inconsistent “priorities” (see our post on Singular Priorities, 23 September 2009).






















For a long time – until New Labour came to power in the UK (1997) – rarely if ever did anybody in the social-democratic camp ask whether there might be feasibility limits to the welfare state – no matter how desirable; whether and how opportunistic behaviour (more pretentiously labelled “moral hazard” in economic theory) by welfare users should be taken into account; whether an economy characterized by dominant private ownership and enterprises might prosper and grow without profit margins sufficient to both finance and promote investment. Whether an economy open to trade and (both inward and outward) investment flows should not worry about its own international competitiveness. Whether there might be limits – though flexible, but therefore dangerously uncertain – to public expenditure, whether this was financed by rising public debt or by rising inflation. Whether public enterprises have a growth-promotion role not only in the production of energy and steel, but also in that of processed foods and textiles.

Trades Unions found themselves in a conflict of interest with the rest of the population that did not belong to them – representing mostly men and employed men at that – both in countries like the UK, where the Labour Party traditionally is the political arm of Trades Unions, and in countries like Italy where almost every party has its own Union. Not a conflict of interests as blatant and scandalous as that in which the Italian left unforgivably has permitted (especially in 1996-2001) a TV monopolist to rule the country, but a conflict of interests nevertheless. However, Trades Unions (including, indeed especially, Italian Trades Unions) have to some extent redeemed themselves from the original sin sooner than left-wing parties, recognizing that the wage rate is not a/the “independent variable” of the capitalist market economy, but on the contrary it depends on the internal and international factors indicated above, and therefore is subject to a “compatibility” test of Unions’ targets (for a survey of these discussions, in which in Italy Claudio Napoleoni played an important role, see Cavalieri 2006). Trades Unions everywhere are still leaning towards impossible claims, especially in demanding the preservation of jobs in non-viable, even bankrupt companies and industries in the current crisis, but at least they are aware of the economic implications of their negotiating stances.

The excess rebound after the Fall: Third Ways

The Fall of the Wall and the victory, that at the time seemed definitive, of hyper-liberalism, towards the end of the 1990s provoked a late and exaggerated conversion of European social-democracy to such hyper-liberalism, or at any rate to neo-conservatism, first in the transition countries of central eastern Europe by right and left governments alike, then in western Europe under the leadership of New Labour and its Third Way, replicated by the German Neue Mitte (see Blair 1998, Blair and Schroeder 1999, Giddens 1998). By the end of 1998 thirteen out of the then fifteen EU member countries (not Ireland and Spain) had social-democratic or left-wing coalition governments; social-democrats also held a dominant position in the European Parliament, which they promptly lost in 1999.

The new project of Tony Blair and Gerhard Schroeder was committed to traditional socialist values: “Fairness and social justice; liberty and equality of opportunity; solidarity and responsibility to others: these values are timeless. Social democracy will never sacrifice them” (Blair and Schroeder, 1999). However it differed from similar previous attempts in three major respects:

1) Acceptance of the primacy and desirability of markets, fully recognising their global nature in the modern world. “The market is part of the social organisation we desire, not just a necessary means which we reluctantly admit that we need, and need to master” (Karlsson 1999). Social-democratic policies were to be implemented using market instruments instead of direct controls and the management of state enterprises.

2) Rejection of public ownership and public enterprise, supporting private entrepreneurship and continued privatisation. The repeal of the fundamental Clause IV of the old Labour Party Constitution meant not just the removal of nationalization from the new agenda, but a commitment to continued privatization of state assets. “Government does all it can to support enterprise but never believes it is a substitute for enterprise… we want a society which celebrates successful entrepreneurs just as it does artists and footballers – and values creativity in all spheres of life” (Blair and Schroeder, 1999). And, above all,

3) Affordability, i.e. fiscal discipline and monetary restraint, rejecting Keynesian policies of public deficit and debt, and inflationary monetary expansion. “Sound public finance should be a badge of pride for social democrats”. “… deficit spending cannot be used to overcome structural weaknesses in the economy that are a barrier to faster growth and higher employment. Social democrats also must not tolerate excessive levels of public sector debt. Increased indebtedness represents an unfair burden on future generations. It could have unwelcome distributive effects. All the money spent on servicing high public sector debt is not available to be spent on other priorities [sic] including increased investment in education, training or the transport infrastructure”. (Blair and Schroeder 1999).

Undoubtedly these were moves in the right direction, for a socialist economy to become efficient and sustainable. Except that some social-democratic governments did not move fast or far enough in some respects, but by and large, most of them went much too far on the rebound (see Nuti 1999).

Under-shooting

Third Way leaders were still caught in the old ways: Blair and Schroeder do not talk of the costs and benefits of policy alternatives but of “priorities”, just like Aneurin Bevan. The pretence that socialism could suspend economic laws still permeates actual and proposed policies. For instance, Lionel Jospin and Fausto Bertinotti (while in Government) proposed the reduction of the working week to 35 hours by law – without proportionally lowering weekly wages below the level that they would have had without the reduction in hours. The consequent increase in unit labour costs in any open economy unfailingly would have led to a rise in unemployment.

Oskar Lafontaine, then German Minister of Finance, proposed to lower pensionable age from 65 to 60 years, which would have aggravated intolerably the already large and increasing burden of an aging population. An equally expensive proposal in Italy was the subsidised “scrapping” of employees over 50, as long as employers continued to pay social contributions to retiring age. This would have simply moved retiring workers into the black economy, and worsened income distribution by age among pensioners. Third Way policies failed to reckon with the black/informal economy as an effective, organised opposition to any government in general and to social-democratic governments in particular – an-economy-within-an-economy and a state-within-the-state.

Romano Prodi, while President of the EU Commission, proposed that excess reserves of the European Central Bank (ECB) should be mobilised to fund additional public investment. Central bank reserves can only be mobilised through additional monetary expansion, which if desired could be induced without reducing reserves and if undesired should not take place just because excess reserves are available. There was indeed a case for additional public investment concerted at the European level, but this was independent of excess ECB reserves, and was not promoted by the new approach.

The latest instance of the social-democratic belief that the laws of economics can be bent is Gordon Brown’s proposal, at the G-20 Finance Ministers’ meeting of 7 November 2009 in St Andrews, of a global tax on financial transactions. There are no global governance institutions that could introduce it and enforce it globally: it is sufficient for one country not to introduce the tax, for that country to provide the entire world with the opportunity to avoid it. And even if the tax was genuinely introduced as a global tax, it could be avoided by transactions in cyberspace, now much more secure than in 1972 when the tax was proposed by James Tobin. In today’s world, the proposal is a non starter, and it was treated as such by G-20 financial leaders and the world economic press.

Mostly, too much too late

In most other respects, the Third Way internalized and absorbed fully the entire theoretical apparatus of the hyper-liberal model.

Thus privatization found no limits, under-selling the family silver and dissipating state assets in all sectors, as well as mortgaging future state revenues through unrestrained securitization practices and other forms of creative finance. More state assets per year were privatised by Lionel Jospin in France in 1997-98 (25bn ECU in under two years) than by Margaret Thatcher (135bn ECU at 1998 prices in 17 years); large scale privatisations were implemented throughout social-democratic Europe. Public utilities, if not privatized outright, were entrusted to PPP – Public Private Partnerships – that reduce public investment requirements at the cost of guaranteeing attractive safe profits for private investors, and therefore higher prices for consumers, outside market control. Generalized de-regulation, especially in financial markets, instead of the desired competition generates monopolies, corrupts governance and facilitates the rise and diffusion of illegal practices.

New Labour set strict limits to its own fiscal policy, namely the “golden rule” that over the course of an economic cycle the government will borrow only to invest, and a self-imposed 40% ceiling on government debt (Blair 1998) – much stricter than those imposed by the Maastricht Treaty and by the so-called Growth and Stability Pact (a limit soon to be blatantly violated by Gordon Brown). Monetary discipline was sanctioned by Central Banks’ complete independence from government, rooted on the fragile foundations of the theory of rational expectations (that denies the existence of a long-term trade-off between inflation and unemployment thus leading to the delegation of inflation targets to Central Banks). The very first act of the New Labour government in 1997 was to grant independence to the Bank of England and to strip it of financial supervision – something which they regretted but did not seek to reverse in the 2008-9 crisis.

Affordability and long-term sustainability, also labeled “pragmatism”, may and often do mean cutting welfare provisions, pensions, education and health. Of course this approach assumes that alternative opportunities for cutting expenditure (eg on weapons, agricultural subsidies, on the cost of government itself) or raising revenue (eg taxing wealth) have already been exhausted, or are otherwise unavailable. That you cannot have something for nothing is a corollary of affordable social-democracy; citizen rights also involve obligations, work-fare may have to accompany welfare.

Monetary and above all fiscal rigour led to the loss of popular support for the Left, although initially such policies were more widely supported than one might have expected, in the name of either the stabilization of public finances or the sacrifices required by the Maastricht Treaty for those countries that sought membership of the euro-zone.

Competition has been largely neglected by the Left, although greater competition in the market for goods and services would have certainly contributed to create additional employment much more effectively than any increase in labour market competition through the measures of labour mobility and wage flexibility accepted and implemented by the Left. New Labour introduced minimum wage legislation, and signed the Maastricht Treaty’s Social Chapter from which the Conservative John Major had opted out, but at the same time ended free university education, reduced benefits for single parents, raised tax rates on pensions. All these measure grossly reduced equality of opportunities in exchange for gaining trade union narrow goals available only to the employed, and to the detriment of the young, women and the old . The fight against tax evasion and fiscal paradises remained perfunctory and ineffective regardless of the left or right inclination of governments.

Corruption has tainted left wing national and local governments – whether displayed in the Italian traditional left strongholds or through the endemic overclaims of British MPs for expenses. The fact that corruption was cheap made it worse, not better. Unions-backed governments concentrated their efforts in the protection of organized employed workers, neglecting the unemployed, the precariously employed, the self-employed. Old age pensioners, in particular, have been victims of the privatisation and marketisation of pensions provision, through the needless and costly transformation of Pay As You Earn, re-distributive systems, to Fully Funded, capitalised systems whose resources have been decimated by the latest global crisis (See our post "First You Pay Then You Go", 13 June 2009, and the two subsequent posts). Educational and training support opportunities have been restricted - despite 'priorities' and goals - by depriving the poor of support as well as access.

Small and medium size enterprises have not enjoyed much favour with social-democratic governments, while co-operatives have been continuously attacked and, in many countries, often subjected to a perverse process of de-mutualisation that has privatized their social capital to privileged stakeholders. This is another doubtful New Labour’s first, leading to the transfer of over £70bn from social to private ownership in what can be described only as a self-appropriation process by insiders on a scale reminiscent of Russian privatizations in the 1990s.

At the end of the 1990s Germany’s Neue Mitte replicated New Labour’s policies of downgrading the role of the state, de-regulating the labour market, reducing the coverage of the welfare state, endorsing “structural reforms”. In 2003-2004 Gerhard Schroeder’s government promoted Agenda 2010, one of the most ambitious reformist programmes in Europe. It included the reduction of unemployment benefits to favour labour mobility; greater freedom to dismiss employed workers; drastic cuts in pensions and raising pensionable age to 67; a 25% reduction in the basic rate of income tax and other tax cuts; higher health charges. The measures were in line with the market liberal approach of the EU Lisbon Strategy and its 2010 deadline. Unemployment, poverty and inequality rose significantly as a result.

Populist temptations

At the same time, among other reasons, to compensate their electorate of institutional changes that had nothing to do with either social-democracy or modernization, and under the competition of centre-right governments, European social-democrats began to indulge in populist policies. Here “populism” is understood as the adoption of policies which are aimed at bribing selected groups of society for blunt electoral purposes, that are not sustainable other than for a short time and must later be reversed at a cost. Again, the UK leads under Gordon Brown in the promotion of one of most spectacular forms of populism, namely the encouragement of consumption expenditure by the population on credit, whether current consumption through credit cards and bank overdrafts, or the purchase of houses on mortgages, regardless of the borrowers’ capacity to repay. This is a damning responsibility of both the Bush and the Blair-Brown administrations in the genesis of the global crisis of 2008-2009.

Other governments not directly involved in this credit scam – also on the left – have effectively connived through the omission of controls and appropriate checks which were their responsibility but which they abdicated in the hyper-liberal euphoria. Another form of generalized populism – right and left – has been that of indulging in protectionist temptations – which in turn have reduced competition in goods and services and thus, if they have temporarily protected wages and jobs, have also raised labour migration pressures.

The loss of traditional political values

As if this were not enough, the liberal conversion of the left has certainly not encouraged new responsibilities or even the defense of their traditional values. Civil rights were sacrificed, particularly by New Labour, to increase civil management and control but under the pretext of fighting terrorism. The separation of powers, equality before the law, the laicity of the state (especially in a country like Italy) have suffered. Environmental protection and reclamation have been sacrificed to public expenditure savings and private profit; the degradation of urban centres and the cementification of the countryside have continued unabated. A non-negligible share of votes have been lost by the Left to one or more green parties, often available but unreliable as coalition partners.

Instead of promoting peace, New Labour and to some extent other European governments right and left have joined the USA in illegal imperialist wars for the conquest of major resources, particular oil, and to set in place institutional and physical surveillance structures, under the pretext of “exporting democracy”. Moreover Blair, co-responsible for launching the Iraq conflict under false claims, to add insult to injury was touted as a credible candidate for the first Presidency of the European Union, not only by New Labour but also by other left parties such as, to its utter shame, the centre-left Italian Partito Democratico.

International solidarity has paled into insignificance, both in the absolute terms of aid provision to less developed regions, and in comparison with the speed and the scale with which financial resources have been provided for the bail-out of financial institutions in the current crisis. This represents a diversion of welfare support from the population at large to capitalist investors. Inequality of both wealth and incomes has generally increased regardless of right or left governments. Equality of opportunities has been impaired by expenditure cuts and higher fees in higher education; research expenditure has suffered.

Liberty

The worst drawback of the new project was the neglect of traditional social-democratic political values. Dahrendorf (1999) notes that “one word appears almost never – and never in a central place – in all the these [Third Way] speeches and pamphlets and books, the word, liberty”. “This is no accident. The ‘third way’ is not about either open societies or liberty. There is indeed a curious authoritarian streak in it, and not just in practice”. For the UK, Dahrendorf cites the deconstruction of traditional democratic institutions actually advocated by Giddens (1998), with referendums and focus groups instead of parliaments, and the proliferation of agencies and quangos which evade civic control; we could add the creation of cabinets at local authority level which exclude elected representatives from much decision making and pay cabinet members more highly.

Other instances of this authoritarian design are: compulsory saving by workers for the reform of the welfare state, insistence on everyone working (including the disabled and single mothers), compulsory work under threat of loss of benefits. The danger, particularly for the UK, is what Dahrendorf calls “the Singapore syndrome”, whereby “the political class becomes a kind of nomenklatura which remains unchallenged because of the apathy of many, and when those who do not fit are silenced, nobody raises his or her voice”. There is a need to give back to freedom its rightful place in any social democratic design.

Slogans and Soundbites

The lack of a sound intellectual superstructure for the new Third Way was papered over by propounding new formulas and slogans of little content. The “stakeholder economy and society” was supposed to diffuse participation in decision-making and economic performance not only among stockholders but also among holders of other “stakes”, or legitimate interests, which individuals possess in their capacity as employees or consumers or simply as citizens. It was part of the pre-1997-election Labour agenda, but was quietly dropped after the elections – not a great loss, for it was an empty formula (see Nuti 1997).

Other formulas and sound-bites include: calls for modernisation, partnership, de-centralisation, community, technology, responsibility – mostly preceded by “new”; “free but compassionate markets”; Blair’s commitment to bridge “the false opposition … between rights and responsibilities, … between the public and private sectors, between an enterprise economy and the attack on poverty and exclusion” and so on. At least to some extent, these empty or suggestive propositions have been the deliberate product of party propaganda manipulating the electorate by means of the same advertising gimmicks as those used in promoting mass consumption. But as Giddens (1998) recognizes, “A precept of successful advertising … is that image alone isn’t enough. There must be something solid behind the hype, otherwise the public see through the façade pretty quickly” (p. 155). A lot more competence and, not least, imagination would have been needed to flesh out a positive and more appealing New Third Way.
After-thoughts?

An almost exclusive recent exception to the wholesale sell-out of social-democracy is José Luis Rodríguez Zapatero’s Spain, whose future political prospects however are just as grim as in the rest of Europe. Today there are some signs of after-thoughts, especially in Italy and Germany. In his electoral campaign for the leadership of the PD, the former, acting secretary Dario Franceschini apologised profusely to entrepreneurs of North-East Italy for having treated them as exploiters, potential tax evaders and capital exporters, instead of producers deserving attention and respect. The newly elected PD secretary, Pierluigi Bersani, made his victory address at a meeting with Prato artisans. Too little too late, and little credibility. In Germany Die Linke, the social democratic party of the Left founded by Oskar Lafontaine in 2007, in the October 2009 elections has recovered a million voters out of those lost by the SDP (which has has not learned anything from the debacle); the Greens have reached over 10% of the vote; altogether a feasible left wing coalition commands today 46% of the vote against 48% of the government coalition.

Right-wing competition

Since its very beginning the new Third Way was wrong-footed by neo-liberalism – by adopting the private sector with open arms precisely at a time when former neo-liberals were moving towards more critical positions. At the heart of the new Third Way there was “profound pessimism”, an acceptance that: “The fundamental architecture inherited from the neo-liberal era cannot be disturbed; globalisation cannot be controlled or tamed; growing inequality can only be at best mollified. We are, in short, at the mercy of nature and the market” (Jacques 1998).

More recently, the social-democratic agenda has been subjected to unfair competition by center-right parties. Some of the traditional values of the left, such as employee participation in enterprise profits, and the upholding of tenured employment, have been hijacked (literally scippati) by the Italian centre-right government, that has appropriated them and therefore succeeded in broadening their own consensus. It is disconcerting to see the Economy Minister Giulio Tremonti to exalt the value of employment stability (“il posto”) with Silvio Berlusconi’s blessing, while CISL Trade Unionist Raffaele Bonanni has only just discovered the obvious principle that “precarious” (untenured) employment should be paid more and not less than stable employment; the fact that it is paid less is evidence of a perverse segmentation of the labour market. It is equally disconcerting to see employee profit-sharing schemes being proposed by Labour Minister Maurizio Sacconi with the opposition of the left wing Union CGIL.

In 2008-2009 the massive fiscal stimulus and monetary expansion agreed by the G-20 as a collective response to the global crisis, with the blessing of the IMF now endorsing Keynesian macroeconomic policies – makes the monetary and fiscal restraint advocated by New Labour and its rejection of Keynes positively retrograde. A total of $18 trillion were mobilized globally to bail out banks and other financial institutions since September 2008, while the amount of total development aid over the past 49 years was only $2 trillion, or just eleven percent of the money found for financial institutions in one year (United Nations, 24 June 2009).

A dismal future

Today the European left, including its Italian wing, is completely wrong-footed, isolated, fragmented in countless warring factions due to profound and widespread dissent on the relative weight to be given to militancy and to co-operation, without ideas or proposals, and therefore – barring the unlikely miracle of a large-based alliance eventually coalescing around a radical programme yet to come – the left is condemned to lose and lose over and over again, with a total certainty because of its deep conviction that it will lose. And it deserves to lose.

In order to understand how de-railed is the left today one has only to read what, even in October 2009, an authoritative socialist leader like Lionel Jospin – French Premier 1997-2002 – writes on the current capitalist crisis: “And now let us talk about socialists. Who are they, historically? They are the supporters of a form of social organization in which the general interest prevails over private [particuliers] interests and who, against the injustices perpetrated by capitalism, want to assure by means of reforms the most just distribution of wealth [richesses].”

Wrong, Lionel. No one can claim to know what is the general interest and nobody is willing to delegate to you its definition let alone its implementation. The political problem is precisely the confrontation and composition of individual interests in order to reach, collectively and democratically, after a good fight, the definition of a compromise that can represent a passable form of general interest. And the distribution of incomes and wealth – a distinction that probably escapes both Lionel Jospin and the French Group for the Re-Distribution of Wealth (that has just published a futile Report, see Oro 2009) – will have to take into account not only distributive justice but also the incentives and the efficiency associated with it. Up to a point – which in fairness has not yet been reached – both equality and growth can be enhanced pari passu, but sooner or later a disagreable trade-off between the two necessarily appears, Lionel, forcing unpleasant choices of which you do not seem to be aware. And there is an international dimension that seems to escape you completely.

A new, credible and attractive programme of European social-democracy needs to emphasize economic and political participation at all levels; genuinely restore co-operative and mutual values and institutions; assert a continued commitment to equality of opportunities, possibly by pursuing the notion of a basic income or citizens' income. We can and should debate these and as many as possible other new ingredients.


REFERENCES

Blair Tony (1998), The Third Way: New Politics for the New Century, Fabian Society Pamphlet 588, London.
Blair Tony and Gerhard Schroeder (1999), The Way Forward for Europe’s Social Democrats – A Proposal, The Labour Party, London, June.
Cavalieri Duccio (2006), Scienza economica e umanesimo positivo: Claudio Napoleoni e la critica della ragione economica, Biblioteca Storica degli Economisti Italiani, Franco Angeli.
Dahrendorf Ralph (1999), La Repubblica, giugno.
Giddens Anthony (1998), The Third Way – The Renewal of Social Democracy, Polity Press, Cambridge and Blackwells, Oxford.
Jacques Martin (1998), Good to be Back, Marxism Today, special single issue November/December.
Jospin Lionel (2009), Les socialistes face à la crise du capitalisme, Jean Jaurès Fondation, Paris, October.
Karlsson Mats (1999), Third way, Neue Mitte or Old Wine in New Bottles?, Conference on “Dilemmas of globalisation”, IPPR, Bellagio, 27-28 February.
Nuti D. Mario (1997), Democracy and Economy: What Role for Stakeholders?”, Business Strategy Review, pp. 14-20.
Nuti D. Mario (1999), “Making sense of the Third Way”, Business Strategy Review, Vol. 10, n. 3, Autumn 1999, pp. 57-67.
Oro Stéphanie et les members du groupe «Partage des richesses» (2009), Le partage des richesses et les moyens de corriger les inégalités, 9 October, Paris.

The Fall and the Original Sin of Socialism

The Fall of the Berlin Wall, whose twentieth anniversary is celebrated today, signified not just the Fall of the Iron Curtain and of the whole system developed behind its shelter, but also the “Fall” in a biblical sense: Man was driven away from what many hoped, though wrongly, might be a Garden of Eden. In this vein, then what has been the “original sin of socialism”, the sin leading to the Fall.

The Original Sinners

Without doubt the original sin of socialism was committed by Nikolai Ivanovich Bukharin (1888-1938) and Rosa Luxemburg (1871-1919). They are guilty of asserting, with unforgivable arrogance, that “socialism marks the end of political economy as a science”. They were followed, as is the way with original sin, by all of socialist mankind; by Rudolf Hilferding (1877-1941), as well as by the majority of Bolshevik economists (as we are reminded by, among others, Brus 1973; see the Appendix below for citations and sources). This sin is the origin of the decisionism and the voluntarism typical of economic management in the Soviet Union and in the countries that adopted its system, that eventually led to the Fall.

The uneconomic system

Remember? In the 1920s the “genetic” school of planning, that aimed at facilitating natural economic trends, was defeated by the so-called “teleological” (or “purposeful”) school, seeing the plan as an act of war, of aggression on the economy (for a survey see Charemza and Kiraly, 1990). Priority was given to investment over consumption, to investment in heavy industry over light industry, so as to produce steel that would produce more steel and ever more steel, regardless of the needs of the population. Many other targets were given priority, and as a result nothing at all had effective priority; the actual or opportunity costs of alternative targets were ignored or neglected. “There is no fortress that a Bolshevik cannot conquer”, Joseph Stalin loved to say. “2 + 2 = 5” was the planners’ arithmetic, and in fact the first five-year plan of 1929-32 was implemented in four years – and never mind the cost. When reality could not be forced to comply, change was faked: fake genetic miracles were claimed; just as economic plans were frequently the object of fake realizations.

The ratchet principle applied: if today we produce 100 it is imperative that tomorrow we should produce 110 - an effective incentive to conceal productive potential rather than mobilize it. There was a programme of innumerable campaigns, each centered on a single objective to be promoted regardless of cost. Stakhanovism concentrated on the exceptional performance of shock workers (with the assistance of countless, nameless helpers). Tight or taught planning had an essential role: it was believed that by aiming at impossible targets one would obtain more than by lowering the sights. This strategy occasionally might actually work, but it soon reaches the point where it defies the laws of physics and becomes a losing strategy: aiming at the Moon misses all desirable targets within closer reach. By the 1970s realised socialism in Poland was boasting that “Polak wszystko potrafi” (A Pole is capable of anything). We have seen and admired the results achieved by the Polish people: it was true, but certainly not in the sense meant at the time by Edward Gierek.

In its most spectacular and damaging form, the violation of economic laws in the socialist system consists in the adoption of the impossible target of maintaining low and stable prices, while goods are available in quantities lower than those necessary to validate such prices given their demand. Hence the inevitability of shortages, queues, black markets – as well as the absolute impossibility of introducing market elements into the traditional planning system: this is why all the numerous projects of economic reform in the direction of market socialism, in the 1960s-1980s throughout the socialist bloc, failed one after another, in one country after another.

All these are the implications of the pretense that socialism should not be subject to economic laws, both in general and in the specific Soviet-type model. In general, input-output type technical relations, and the optimization of production methods, must necessarily continue to hold in any economic system, no more no less than the laws of thermodynamics. And a fortiori economic laws of market equilibrium must hold in the specific Soviet-type system in which money was still used to pay wages and distribute consumption goods, even though prices were administered and supply was not affected by consumer sovereignty, so that Bukharin et al. could legitimately claim that the “law of value” no longer held.

Gorbachev’s responsibilities

For the persistence of this economic regime of shortages, queues and repressed inflation, Mikhail Sergieyevich Gorbachev bears a major responsibility. A great statesman, a generous, courageous and charismatic leader, Gorbachev was a lawyer: in economics he was an illiterate, surrounded by economically illiterate advisors. He believed that it was possible to maintain low prices and at the same time contain demand within the narrow, inadequate limits of production and imports. He believed that market imbalance was a necessary feature of his revolution, and bought expensive time by getting into debt with foreign lenders. Which is how the Soviet Union reached bankruptcy, economic collapse, literally famine conditions (agreed the famine was due more to the inefficient distribution system than to the lack of food, but the distribution system is also an integral part of any economic system).

What if...?

Suppose Gorbachev had recognized the continued validity of economic laws under socialism, would he have managed to modernize the Soviet system instead of sinking it? He would have had to give priority to economics over politics, and at best he could have followed the examples of those other economies that managed to combine public ownership and Communist Party political control with the mobilization of market forces domestically and internationally, like China, Vietnam, Belarus, Uzbekistan ( see Nuti, 2009). An authoritarian system is a very high price to pay for economic success, but this was still a possibility – except that once such an alternative is implemented it is extremely difficult to change course, because of its inertia and resistance to change.

Admittedly, in suffering the consequences of the original sin of socialism, Gorbachev was doubly unlucky in the very bad, if accidental, timing of his coming to power: his perestroika happened at a time of world recession and a low price of his oil, and coincided with the global victory of the hyper-liberalism of Ronald Reagan and Margareth Thatcher. Ten years earlier (in 1975) perestroika would have benefited from a higher oil price that would have provided the resources necessary to stabilize the economy and avoid Russia’s default. Twenty years later – i.e. today – the crisis of the hyper-liberal model and the global crisis of 2008-2009 would have allowed the Soviet Union or its component republics to implement a different economic model. A model, that is, with a greater role for the state and public ownership, the provision of larger amounts of resources by international economic institutions, subjected to lesser conditionality constraints – as it is happening today at the global level, with the IMF e the G-20 having taken on new and surprising functions approaching those of a Global Lender of Last Resort.

What about social-democracy?

At this point, what can we say about the failure that recently struck - with the exception of Greece that confirms the general rule - the whole of European social democracy, in spite of the financial and real tsunami of 2008-2009 (probably extended to 2010 at least in terms of labour unemployment). What are the causes of the defeat of the European “Left”, at a time when they should have benefited from the crisis and harvested anti-cyclical electoral consensus? This question deserves a post of its own but, in a nutshell: Social-democracy was also tainted by the original sin of Socialism, at least until the late 1990s and the Third Way of New Labour and the Neue Mitte that, unfortunately, overshot on the rebound.


Nikolai Ivanovich Bukharin (9 October 1888 – 15 March 1938)

and Róża Luksemburg (5 March 1871 – 15 January 1919)


APPENDIX: THE CLAIM OF THE END OF POLITICAL ECONOMY UNDER SOCIALISM

Brus (1973) notes that “In the course of the development of Marxist economics it was sometimes reckoned that political economy would come to an end at the same time as the capitalist system. Among those holding such views were those whose names are an integral part of the history of Marxism – Hilferding, Bukharin, Rosa Luxemburg”. Of political economy there would remain “… only technical problems, technical balance laws of production, a science of the rational organization of productive forces “.


Cohen (1980) talks of Bukharin’s conviction that “political economy and its traditional categories were not applicable to a post-capitalist society”. “As soon as we take an organized social economy, all the basic “problems” of political economy disappear: the problem of value, price, profit, and the like. Here “relations between people” are not expressed in “relations between things,” and social economy is regulated not by the blind forces of the market and competition, but consciously by a ... plan. Therefore here there can be a certain descriptive system on the one hand, a system of norms on the other. But there can be no place for a science studying “the blind laws of the market” since there will be no market. Thus the end of the capitalist commodity society will be the end of political economy”(from Bukharin 1979, cited by Cohen 1980, p. 93).


Rosa Luxemburg writes: “If political economy is a science that deals with the particular laws of the capitalist mode of production, then the reasons for its existence and its function are confined to the period of life of the latter, and the political economy will lose its basis as soon as that mode of production will have ceased to exist” (Luxemburg 1925, in Waters 1970 p. 244). “Consequently, the end of political economy as a science represents a historical world task“ (Luxemburg 1925, in Waters 1970, p. 248).

Rudolf Hilferding forcefully expressed the idea that “Centralized control of the economy on a national and eventually an international scale would allow for conscious social regulation of both production and distribution and create the objective conditions for a planned economy no longer subject to regulation by the law of value” (Mattick, 1983; see also Howard and King 2003).


Hilferding appears to believe that economic laws can be suspended even in the political struggle for socialism. According to Breit and Lange (1934) he “invented a theory of so-called political wages, arguing that, using its political strength in the democratic state, the working-class movement imposes on capitalism higher wages than those resulting from the capitalist laws of supply and demand. It turns out that this took no account of the nature of capitalist ownership. It is not possible to impose in a capitalist economy a distribution of income that is different from that determined by the automatic operation of the laws governing the capitalist economy, the laws of supply and demand and competition.”

Magdoff (1985) asks whether there exist economic laws under socialism. “The idea that objective economic laws are not present in a socialist economy was, in fact, orthodox doctrine in the Soviet Union up to the early 1950s.” It was Stalin, of all people, who maintained in his 1952 “Economic Problems in the USSR” that planning must respect economic laws. But these for him were not, say, the law of the Walrasian adjustment of price to excess demand, or the law of the Marshallian adjustment of production to the difference between price and marginal cost. Stalin’s “laws” were no more than slogans such as the "Economic law of planned proportional development” or the “Economic law of distribution according to labour”. Not to speak of the so-called “Economic Law of the ever fuller satisfaction of the constantly growing material and cultural requirements of all people through continued development and improvement of social production based on the highest technology”. In other words, pure propaganda/junk, on which even an orthodox communist like Harry Magdoff maintains evident reservations.

However Stalin recognizes that the so-called “Law of value”, otherwise known as the market, continues to hold under socialism to the extent that commodities continue to exist: this, heavily disguised, is the true and belated innovation of Stalin’s text, however contradicted and nullified by the endemic and permanent repressed inflation that blocked all market-oriented reforms attempted after his death, and therefore eventually led to The Fall.

REFERENCES


Brus Wlodzimierz (1973), Economics and Politics of Socialism: Collected Essays, Routledge and Kegan Paul, London.
Bukharin Nikolaj Ivanovich (1979), The Economics of the Transition Period, Routledge and Kegan Paul, London.
Breit Marek and Oskar Lange (1934), “The Way to the Socialist Planned Economy”, Translated by Jan Toporowski, History of Economics Review, http://hetsa.fec.anu.edu.au/review/ejournal/pdf/37-A-2.pdf
Charemza Wojciech and Julia Kiraly (1990), Plans and Exogeneity: The Genetic-Teleological Dispute Revisited, Oxford Economic paper, vol. 42, issue 3, 562-73.
Cohen Stephen F. (1980), Bukharin and the Bolshevik Revolution: a political biography 1888-1938, Oxford University Press.
Howard M.C. and J.E. King (2003), “Rudolf Hilferding”, in Warren J. Samuels (Ed.), “European Economists of the early 20th century”, vol. 2, Elgar, Cheltenham.
Magdoff Harry (1985), “Are there economic laws of socialism?”, Monthly Review, July-August.
Mattick Paul (1983), “Capitalism and Socialism”, Marxism: Last Refuge of the Bourgeoisie? http://us.geocities.com/collectiveact/pm_cas.htm
Nuti D.M., "A counter-factual alternative for Russia's post-socialist transition", in Grzegorz W. Kolodko and Jacek Tomkiewicz (Eds), 20 Lat Transformacji, Wydawnictwa Akademickie i Profesjonalne, Warsaw 2009.
Waters Mary-Alice, Ed., (1970), Rosa Luxemburg Speaks, Pathfinder Press, New York.

Last Rites

On 2 October the IMF General Director Dominique Strauss-Kahn, in Istanbul ahead of the 2009 Annual Meetings of the World Bank Group and IMF, gave a speech at the Central Bank of Turkey entitled “Making the Most of a Historic Opportunity”. “Countries are diverse, but civilization is one, and it is necessary to participate in this single civilization for the progress of the nation”, he said, quoting a magnificent but very ambiguous sentence uttered 75 years ago by Kemal Atatürk, the founder of the Republic of Turkey. One could argue that civilization's progress is the result of different countries and cultures sorting out their differences in peaceful dialogue, and that the best path for civilization can only be assessed afterwards by results.

In his speech, Strauss-Kahn takes – rightly – a positive view of the global macroeconomic policy response to the current crisis, and outlines “three principles that can frame our efforts to re-shape the post-crisis world…: First, international policy collaboration is essential. Second, financial stability demands better regulation and supervision. And third, the international monetary system must be more stable, and anchored by a global lender of last resort.” No question about the soundness of the first two principles. The third principle – which naturally envisages the IMF taking on the expanded role of “International Lender of Last Resort”, is so sketchy as not to mean very much at all.

Traditionally a National Central Bank acts as a Lender of Last resort by providing unlimited liquidity on demand, in the currency it manages, to banks within its currency area, at a penal rate against good quality financial assets. Thus for instance on Black Monday (19 October 1987) the Fed immediately announced its readiness to act in that capacity. Or, the Bank of England made the same announcement in July 1991 at the time of the BCCI (Bank of Credit and Commerce International) collapse. The statements alone were sufficient to calm down financial markets.

More recently the Governor of the Bank of England, Mervyn King, in his letter to the Treasury Committee on 12 September 2007, discussed the rescue of Northern Rock in these terms:

“Central banks, in their traditional lender of last resort (LOLR) role, can lend “against good collateral at a penalty rate” to an individual bank facing temporary liquidity problems, but that is otherwise regarded as solvent. The rationale would be that the failure of such a bank would lead to serious economic damage, including to the customers of the bank. The moral hazard of an increase in risk-taking resulting from the provision of LOLR lending is reduced by making liquidity available only at a penalty rate. Such operations in this country are covered by the tripartite arrangements set out in the MOU [Memorandum of Understanding] between the Treasury, Financial Services Authority and the Bank of England. Because they are made to individual institutions, they are flexible with respect to type of collateral and term of the facility. LOLR operations remain in the armoury of all central banks.”

It should be immediately clear that “Lender of Last Resort” is an inappropriate label for any role that the IMF might take in providing global liquidity in a crisis. Presumably it would provide finance denominated in the currency basket known as Special Drawing Rights. But to whom? To commercial banks throughout the world (as the label suggests), including investment banks, and hedge funds, or only Central Banks, and/or governments? And against what? Government paper, illiquid but marketable assets, toxic assets, or in the form of an unsecured loan? If against nothing, on what scale? At what interest rates and, above all, subject to what conditionality? Clearly before even beginning to talk about an international lender of last resort there is a very great deal of detail that need to be considered and settled. As we all know “The devil is in the detail.”

Transition economies: a worse nosedive than anticipated

“At the start of this year, the global economic crisis was hitting central and eastern Europe with unimaginable force. Any illusion that this region was somehow immune from the “western” credit crunch and the subsequent financial squeeze was definitively quashed. Output was declining at startling rates that would only become apparent much later in the Spring.”
“But the danger signs were everywhere. There was real risk of a genuine emerging market crisis – that financial systems in a number of countries would collapse entirely, that currencies would run out of control, that there could be sovereign defaults.” (Anthony Williams, EBRD Head of Media Relations, The road to a fragile recovery, 16 October 2009)

Now they tell us

I don’t remember the EBRD ever signaling any such danger. Slowdown, yes, in their forecasts for 2009 and 2010, that from optimistic growth expected in May 2008 got progressively worse to insignificant growth in January 2009 and an average 5.2% contraction for the 29 countries of EBRD operation in May 2009. I suppose it is part of the institutional duties of the EBRD not to encourage pessimistic expectations that may become self-fulfilling, but then we should note this for future reference and remember that, when the EBRD forecasts a significant slowdown, what they really mean is an impending disaster.

How was the disaster averted? “That this horror scenario didn’t happen – Anthony Williams continues – was a result partly of unprecedented international support, with the EU and organizations like the IMF providing huge macroeconomic packages that were flexible and tailored to specific country needs [to Latvia, as well as Hungary, Ukraine, Romania and other CEE]. Other IFIs, including the EBRD, stepped in to provide micro support to banking groups and corporates with little or no access to liquidity. Crucially western banks, a dominant force in financial sectors in many countries in central and eastern Europe, did not retrench as feared. The authorities in eastern Europe responded with policies aimed at dealing promptly and effectively with the crisis, even though those responses were in some cases immensely painful and politically unpopular.”

At least in Latvia, it is not at all clear that a systemic crisis has been averted. And evidence that western banks “did not retrench as feared” has not been provided by the EBRD; perhaps they will in due course, in their Transition Report 2009 due in November 2009 or elsewhere. Did western banks really not retrench at all, or on average? Did they retrench less than feared, and how much were they feared to retrench and by whom? Certainly not by the EBRD. And recently Swedbank, the largest Swedish lender in the Baltic region, “has threatened to scale back its presence in crisis-hit Latvia if the country goes ahead with controversial plans to limit the amount lenders can collect from mortgage-holders” (Stefan Wagstyl, 28 September 2009).

Otherwise, is everything fine now in transition economies? It might be in the Czech economy, which has been taken off the list of EBRD countries of operation because it no longer needs its credit – the first to deserve this upgrade – and, most annoyingly, off EBRD statistics. Not fine at all in the 28 EBRD remaining client countries (including Turkey since last year), where the average nosedive now expected for 2009 turns out to be more pronounced than the Bank anticipated in May 2009: a contraction of 6.3% instead of 5.2%, with Estonia, Latvia, Lithuania, Armenia and Ukraine expected to decline by well over 10%.

“Signs of positive growth in the third quarter of 2009 suggest that the recession is now bottoming out in many countries of the EBRD region. However, any upturn in 2010 is likely to be fragile and patchy.” (EBRD press report, 15 October 2009) For 2010 the EBRD now forecasts an average growth for the region of about 2.5%, which is 1% higher than it forecast in May 2009, but since it starts from a level which is now 1.1% lower than it was expected then, the higher growth forecast for 2010 actually masks a lower absolute level of GDP than previously anticipated. And “There are likely to be significant cross-country differences in output growth in 2010”, with Latvia, Lithuania, Hungary and Bulgaria expected to continue to contract until 2011. “It is also clear that the social costs of the global economic crisis are only likely to be felt in earnest next year, when corporate bankruptcies and unemployment will continue to rise”, said EBRD Chief Economist Erik Berglof (Ibidem)
.
The same factors that transmitted the global crisis to transition economies – the contraction in world trade and tight credit conditions – are now causing its continuation. “The Institute for International Finance, a bankers’ group, estimates that in 2007 $382bn – more than 40 per cent of the financial flows into all emerging markets – went into CEE. The IIF forecast in June that even with all the extra support the IMF, the EU and the EBRD are putting into the region, this year’s figure would be about zero” (Stefan Wagstyl, FT, 28 September 2009).

Heterogeneity

Transition countries with a fixed exchange rate regime – excluding euro-zone members but including Bulgaria, Latvia or Lithuania – are facing a slower and more painful adjustment, the burden of which falls on wages and prices and therefore ultimately demand and employment. Other factors explaining country heterogeneity are the differences in their fiscal positions, the weakness of banking systems, and dependence on commodity exports. The full set of the EBRD October forecasts is reproduced below, or can be downloaded from the EBRD website ).

“Russia’s economy is expected to shrink by 8.5 per cent on a year-on-year basis in 2009, followed by a rebound in late 2009 and growth of about 3 per cent in 2010 year-on-year. Kazakhstan will suffer a much milder output decline this year (of about 1.5 per cent) but the recovery is expected to be weak, in the order of +1.5 per cent.”

“Relatively faster 2010 growth, in the order of between about 2 and 5 per cent is expected in some internationally competitive countries with relatively sound pre-crisis banking systems, such as Albania, Poland, Slovakia, and Slovenia.”

“Some commodity rich countries including Azerbaijan, Mongolia, Turkmenistan, and Uzbekistan, whose financial systems were smaller and less affected by the crisis, and whose growth is mostly driven by commodities, are also expected to grow faster in 2010, in the order of 5 per cent or more.”

“In Hungary, which was hit particularly hard at the start of the crisis, the crisis has been contained thanks to strong international support as well as sound domestic policies. However, its growth is expected to remain slow in 2010 due to necessary fiscal adjustment and a continued credit crunch. It is expected to show slightly negative growth next year, driven by a weak economy in late 2009 and early 2010” (EBRD press report, 15 October 2009, cited above).

Divergence?

The crisis spells – at least temporarily – a reversal in the convergence process that had accompanied EU enlargement. In 1999-2008 income per head in the EU (15) grew at an average yearly rate of 1.41%, and in the Euro-zone at 1.47%, while in the new member states it grew at 2.00% (Poland) or more (from 2.29% in Hungary to 4.17 in Romania). “Growth over the medium term in the EBRD region is also likely to be below the trend experienced over the last decade” (Erik Berglof, quoted). The crisis is reinforcing the heterogeneity of national performances among transition economies and within the EU.

It is true that some of the factors making for vulnerability to external shocks – such as trade openness, economic and financial integration – are also factors that will reinforce recovery trends in an upturn. But there are other vulnerability factors – such as weak banking systems, fiscal over-stretching, or high private and public indebtedness made worse by mismatching of assets and liabilities – that need tackling before the global upturn can be expected to pull national economies out of recession or stagnation. And membership of a single currency area can make countries more resilient to a downturn but cannot be a cure after the event: a rush to a precipitous euro-zone enlargement today – necessarily preceded by a devaluation – apart from being against the Maastricht rules would not make any sense.

EBRD capital increase

Before the crisis the EBRD was confronted with demands from the US, its largest shareholder, to reduce the scale of its activities in transition economies. Now, as anticipated last May, the Bank is seeking a 50 per cent capital increase, an extra €10bn, from its shareholders – some 60 governments, including European Union members, the US and Japan – to compensate for the decline and reversal of capital inflows into the area. Thomas Mirow, the EBRD president, in a letter to shareholders warns that working with its current €20bn capital, the Bank would have to limit its annual lending to about €8bn in 2009-10 and reduce it to €6bn thereafter. “Activity would shrink while the recovery is still precarious,” while “raising the capital by €10bn to allow the bank [would] commit €9bn-€10bn annually, or €20bn in total extra funding in 2010-15. By mobilizing extra capital from private investors, the total additional funds raised could reach €60bn” (Stefan Wagstyl, FT, 28 September 2009). A final decision will be taken at the EBRD’s next annual meeting in Zagreb, in May 2010.

Mr Mirow states that “The region will need to change its growth model – away from reliance on easy finance and commodities, and towards the development of domestic financial markets, strong institutions and a diversified production base.” If conditions improve “further and faster than is currently expected”, the extra capital might not be needed and could be returned after a review in 2015. Not a chance, regardless.

Markets can be expensive

In Central Eastern Europe and the Former Soviet Union the transition to an open market economy was accompanied by the rise and persistence of unemployment, the rise of inequality and of poverty. These phenomena were particularly serious because they meant a drastic reversal of earlier conditions of full employment, greater equality and low poverty incidence. Moreover higher inequality could not be justified as the reward for efficiency, as in normal market economies, but – particularly in Russia – was mostly the result of unrestrained pillage by privileged operators.

Before the Fall

The traditional, pre-Transition, Soviet-type system was characterized by full employment of labour, indeed by over-full employment: excess demand for labour at the prevailing wage rate. While full employment was obviously desirable, it was not the result of a specific policy but the by-product of persistent repressed inflation, i.e. excess demand for commodities at artificially low prices below equilibrium, which translated into excess demand for labour. Of course there was nothing positive about over-full employment, which was only a cause of high labour turnover and inflationary wage drift, which in turn contributed to the perpetuation of a state of excess demand for goods.

Wealth was almost entirely in public hands (in Albania even private ownership of cars was forbidden); the little that remained private was a source of direct satisfaction rather than income. By itself, this made distribution of income among the population more equal than in a market economy where income is derived also from private wealth (which is always more unequally distributed than labour incomes). There were also factors making for greater equality across Soviet republics and countries within the bloc: the emphasis on industrial development in every country, regardless of efficiency considerations; the socialization of enterprise profits and their re-distribution via the state budget; large scale subsidies via the All-Union Soviet budget, and via the under-pricing of raw materials and oil within the USSR and Comecon.

By World Bank standards of poverty – equivalent to $2.15 per head per day at 1996 Purchasing Power – in the socialist countries of Europe and Central Asia in 1988 on average fewer than 4% of the population lived in such absolute poverty.[1]

Unemployment

The initial prolonged recession of the early 1990s was naturally accompanied by shrinking employment and the rapid emergence of labour unemployment, converging to similar average values and dispersion typical of European Union countries. The many queues for goods typical of the old, typical shortage economy were replaced by a single but much longer queue for jobs. In the CIS, however, there were lower rates of job loss and limited job creation, leading to an increase in under-employment and reductions in real wages.[2]

Table 1 provides data for unemployment rates and employment ratios for 1998–2006. While unemployment remained high in Central and Eastern Europe, it tended to decrease in the rest of the area. Employment ratios did not have a clear trend, with several countries remaining under 60% and only a few being close to the Lisbon target of 70% for the EU member states. Employment rates tended to be higher in the CIS countries than in CEE countries, but this partly reflect higher under-employment and lower unemployment benefits.
The global economic crisis of 2008–2009 has already raised unemployment and reduced demand for migrant labour.

Table 1. Unemployment rates and employment ratios in CEE/CIS


Source: UNICEF (2006), TransMONEE data bank, updated 2009, Florence.
Note: Results from national Labour Force Surveys, except for Albania, Belarus, Armenia, Azerbaijan, Kazakhstan (2004 and 2005), Kyrgyzstan, Tajikistan and Uzbekistan, which are official data. The different sources may use different criteria, for example for registering unemployment, working activities in the informal sectors, temporary jobs.

Inequality


Egalitarian ideals associated with socialist ideology should not be exaggerated. First, there was significant residual real inequality due not so much to monetary income differentials but to privileged access to goods for the Party nomenklatura: this was no small matter, as it affected access to housing, motorcars, holiday facilities, health and education, foreign travel, imported and luxury goods as well as simple items of daily consumption which were in scarce supply for the ordinary citizen. Second, in 1931 Josef Stalin in person had condemned the “leftist leveling of wages” (uravnilovka), and urged the introduction of sharp wages differentials between skilled and unskilled and between difficult and easy jobs. And there were prizes for managers for plan-fulfilment and over-fulfilment, discretionary prizes for workers, money to be made by mediators (tolkach) in the informal semi-legal exchange of materials among enterprises, in the black and grey markets among consumers, the reliance on "pull" (blat’) through "acquaintances" (znakomstvo) to obtain scarce goods and services; a few legal markets, such as kolkhozian food markets and flea markets (barakholki). Bribes and large gifts (prinoshenie) were also common. All these factors distorted the significance of the degree of inequality as measured through official monetary incomes.



Subject to these qualifications, pre-transition measures of inequality, such as the Gini coefficient (=0 for absolute equality; 1 for absolute inequality, a situation in which one subject takes all) were impressively low in the Soviet Union and Central Eastern Europe, about 0.25-0.30. From 1989 to 2004 Gini coefficients increased significantly nearly everywhere in the transition, to around 0.35-0.40. Indeed, in many countries especially in the CIS they soon surpassed the degree of income inequality normally found in western market economies. The exceptions are the Czech Republic, where the Gini coefficient was and still is lower, though rising from 0.198 to 0.235; Belarus, with a similar trend; and Slovenia where it fell slightly from 0.265 to 0.243 between 1991 and 2004 (see UNICEF 2006).

“In recent years inequality has either increased at a much slower rate, or – in some cases – even declined. For example, in those CIS countries, where levels shot up in the mid-to-late 1990s, there have been signs of reductions; while in the Central European countries, where levels increased less dramatically in the 1990s, rates of increase have continued to be slow but steady. However, in most of the region, levels of inequality have remained high in the period of economic recovery, suggesting that growth has not always been inclusive in nature” (UNICEF, 2009).


An apparently similar degree of income inequality – Russia in 2007 had a Gini coefficient of 42%, i.e. a more equal income distribution than China’s 47% – can conceal a profound diversity. In China, and in “normal” capitalism, income inequality depends mostly on entrepreneurial success and is the price to be paid for efficiency; in Russia it depends primarily on the pillage of national resources during the transition and therefore it is a form of inefficient inequality.

Table 2. Trends in disposable income inequality, selected countries, 1989-2006

Figure 1. Gini coefficient of income distribution in China and Russia, 1978-2006[3]
Source: Popov (2009).

Poverty

Post-socialist transition, by itself and together with the associated deep and protracted recession, brought about a drastic increase in poverty. By 1998 it was estimated that, in the transition countries of Europe and Central Asia, one out of every five people survived on less than $2.15 per day (at 1996 Purchasing Power), whereas a decade earlier “fewer than one out of twenty-five lived in such absolute poverty” (World Bank, 2000). “There is little doubt that poverty has increased dramatically in the region. Moreover, the increase in poverty is much larger and more persistent than many would have expected at the start of the process.” By 1998 the people living in poverty had reached 20%. Poverty began to fall after 1998, with the generalized resumption of economic growth; by 2003 the poor represented only 12% of the population.[4]

With respect to the predicament of the poor in developing countries, the material hardship associated with poverty in the transition was made much worse by the drop from earlier achieved levels and expectations, and the loss of security. Sudden large scale unemployment, prolonged nonpayment of salaries, unpaid or decimated pensions, hyperinflation and loss of savings, the loss of free or subsidized social services “made people feel unusually vulnerable, powerless, and unable to plan for the future.” For most of the new poor, transition brought “the destruction of "normal" life and accustomed social patterns.”[5]

“The highest levels of absolute poverty are in poor countries of Central Asia”: Tajikistan (70 percent), and the South Caucasus (with Georgia with a poverty rate of 50 percent in 2003). “Yet most of the poor and vulnerable in the transition countries of the Region are in large middle-income countries such as Kazakhstan, Poland, Russia, and Ukraine.” Those most at risk are “the young, residents in rural areas and in secondary cities. The unemployed, people with little education, and those belonging to underprivileged minorities, such as the Roma are also at great risk. Most of the poor are working poor”.[6]

Russian $-Billionaires

Conversely, in the early 2000s Russia saw a spectacular increase in the number of dollar billionaires. In the Soviet era there might have been, at most, a dozen dollar-millionaires in the shadow economy. In 1995 there were no billionaires in Russia. In 2007, according to Forbes, Russia had 53 dollar-billionaires, in third place after the US (415) and Germany (55), but in second place in terms of their wealth, which in Russia totaled $282 billion ($37 billion more than Germany’s billionaires). In 2008 the number of billionaires in Russia increased to 86, with a total wealth of over $500 billion, corresponding to one third of a year’s GDP. Russia’s “primitive accumulation” took the form of privileged access to natural resources at prices lower than in the world market, to subsidized credit and to privatized assets also on privileged terms.


Trends in the current recession


In a recession such as that of 2008-2009 it is plausible to conjecture that initially inequality falls – because the rich lose proportionally more than those who have less to lose – and poverty rises because the poor cannot afford to lose what they have (viceversa in a boom). This is probably what has been happening in transition economies, though it is too early to tell. If the crisis lasts, losses among the poor – primarily through unemployment – become more substantial, and inequality as well as poverty may increase.

Lack of markets can be expensive. But so can the operation of markets. Is this an integral part of the human condition?

[1] World Bank (2000), Making Transition Work for Everyone: Poverty and Inequality in Europe and Central Asia, Washington D.C.
[2] UNICEF (2009), Innocenti Social Monitor 2009, Florence.
[3] Popov Vladimir (2009), “The long road to normalcy: where Russia now stands”, Conference Paper, UNU-WIDER, Helsinki, 18-19 September 2009.
[4] Alam Asad, Mamta Murthi, Ruslan Yemtsov, Edmundo Murrugarra, Nora Dudwick, Ellen Hamilton, and Erwin Tiongson (2005), Growth, poverty and inequality – Eastern Europe and the FSU, World Bank, Washington.
[5] World Bank 2000.
[6] Alam et al., 2005.

Plans and Markets: A Matter of Life and Death

The twentieth anniversary of the Fall of the Berlin Wall on 9 November 1989 has generated a mushrooming of conferences on the subject on the run-up to that date, often taking place in parallel. On 18-19 September 2009 in Helsinki, WIDER – the World Institute for Development Economics Research, United Nations University – organized a major international conference: “Reflections on Transition: Twenty Years after the Fall of the Berlin Wall”. One of the most exciting papers was presented there by Elizabeth Brainerd (Brandeis University), on “The Demographic Transformation of Post-Socialist Countries: Causes, Consequences and Questions” [still password protected until the end of the month; I will provide a link anyway in the near future]. This excellent paper really drives home the fact that plans and markets are a matter of life and death. In the past twenty years transition countries have experienced spectacular demographic changes, remarkable both in scope and speed, in many ways converging towards Western Europe.

Fertility, marriage, childbearing

“The formerly socialist countries were characterized by a distinct pattern of fertility and family formation: marriage and childbearing took place at relatively young ages (compared with Western Europe) and were near-universal”. Rates of childlessness were near the biological limit of about 5 per cent; in 1965-1989 the Soviet fertility rate had stabilized at about the replacement level of fertility of 2.1 children per woman. Abortion rates were high.

In contrast, “Virtually every country in Eastern Europe and the Former Soviet Union [FSU] experienced a steep decline in fertility beginning in the late 1980s or early 1990s”, as illustrated in Figure 1. Bulgaria and Ukraine fell below the lowest fertility level ever recorded in a European country during peacetime. The abortion rate actually fell (in Russia it plummeted from over 100 per 1000 women aged 15-49 in 1990 to 50 in 2000; in the early 1990s Poland introduced a near-ban on abortion). The decline in birth-rates was due to contraceptives being better and more readily available and to the rapid increase in the financial cost of abortion.

There was a rapid shift towards later (first) childbearing throughout Eastern Europe (see Figure 2); former Soviet republics continued early and near universal first births, with the postponement of second and higher-order births, but are generally moving in the same direction.

Figure 1. Total Fertility Rate. Selected Countries.

Figure 2. Age at first birth. Eastern Europe and France, 1970-2007.

The connection between this trend and the post-socialist transition process is confirmed by these changes being slower in the transition laggards like Belarus. Age at first marriage has also increased, approaching that of Western Europe (Figure 3).

“The share of extramarital birth increased across the region beginning in the early-to-mid-1990s; the highest rate is in Estonia (nearly 60% of all births) which rivals the out-of-wedlock birth rates of Scandinavian countries.” In Russia – and probably elsewhere – the increase in extra-marital births reflects to a large extent a shift from registered marriage to cohabitation.

Figure 3. Age at first marriage, women, 1970-2007

Figure 4. Percentage of births out of wedlock. 1970-2007

A most disturbing development is the “striking upward trend in the sex ratio [of males to females] of children age 0 to 4 in all three Caucasian republics”: Armenia, Azerbaijan and Georgia, where it has risen above the biological norm of 1.05, matching the ratios prevailing in India and China. This may reflect selective abortion, due to wider availability of sex detection before birth, and/or an actual or perceived deterioration in the condition of women.

Income, Education, Uncertainty

Traditional economic theory (exemplified by Gary Becker’s A Treatise on the Family, 1981) predicts an inverse relationship between income and fertility: while children are a ‘normal good’ (“when income increases couples desire more children”), the time-intensive nature of their rearing represents a significant opportunity cost, and its increase holds births down. Brainerd notes that “women’s relative wages have increased on many East European countries” after the transition, thus validating this theory. The trouble is that, for all or most of the ‘nineties throughout the area income per head actually fell, by more than could have been compensated for women by the rise in their relative wages. Thus, pace Becker, the impact of income on fertility that he predicts should have had the opposite sign.

A related explanation offered by Brainerd is “the increase in the [rate of] return to education which has occurred across nearly all transition countries, in turn inducing large increase in tertiary enrollment rates”. Empirical studies “indicate a negative relationship between education levels and the timing of the first birth, and … the strength of this education effect has increased significantly since the start of transition. Women with more education are also more likely to be childless than women with less education”.

But there is a much more convincing argument. “In the context of the transition countries … it seems likely that the uncertainty surrounding the change from a socialist system to a capitalist one would influence a couple’s decision to have children”. Investment theory predicts that “for investment decisions which are irreversible (e.g. children) and which can be postponed, there is an option value in waiting to make the investment”. The role of economic uncertainty is confirmed by a number of empirical studies (showing, for instance, the impact of unemployment uncertainty especially for women on the probability of childbirth in Germany 1992-2002).

There are additional factors: “One of these is the decrease in the number of state-supported nurseries and pre-school facilities and the near-disappearance of daycare facilities provided at enterprises.” Another “simply the decrease in the number of middle-aged men” due to the dramatic increase in mortality rates among men aged 25 - 54 in the 1990s (discussed below); “if women are reluctant to raise a child as a single mother, this too would be expected to account for at least part of the decline in fertility over the period.”

On lower fertility rates, later marriages and childbearing, high and rising extra-marital births, transition countries have come to look more and more like Western Europe.

Mortality

Mortality trends diverged sharply in the FSU and in Eastern Europe. After a rise in life expectancy in the late 1980s, undoubtedly due to Gorbachev’s anti-alcohol campaign, “between 1990 and 1994 the death rate among working age men in Russia increased by 70 percent, from 759.2 to 1323.7 deaths per 100,000 population. Male life expectancy at birth fell from 63.7 years to 57.4 years during that period, while female life expectancy at birth fell from 74.3 years to 71.1 years. A similar increase in mortality rates occurred in many other countries of the former Soviet Union in the early 1990s, in particular in Belarus, Ukraine, and the three Baltic countries.“ Some of these declines were reversed in the late 1990s but their size and large and erratic swings are unprecedented in European countries in peace time and the absence of famines or epidemics.

These mortality trends coincided with the process of transition to a market economy, but the same process was accompanied by opposite trends in Eastern Europe, where “mortality rates fell and life expectancy rose throughout the region”, in spite of similar – though milder and less protracted – trends in GDP losses and unemployment. In particular, “The unprecedented increase in cardiovascular mortality in the former Soviet Union in the early 1990s was nearly matched by an unprecedented decrease in cardiovascular mortality in Eastern Europe.” The difference between the two groups is summarized in Figures 5 and 6.

Figure 5. Male life expectancy at birth. Selected FSU countries



Figure 6. Male life expectancy at birth. Eastern Europe


In the 1990s infant and child mortality declined almost everywhere in the region; the traditionally vulnerable groups, children and the aged, avoided significantly higher mortality during the transition. In the FSU the mortality crisis affected primarily middle-aged men. “In Estonia and Russia (and many other former Soviet countries), the increase in death rates for men age 25 to 54 between 1989 and 1994 was astonishing. In Estonia, for example, the death rate for men aged 40 to 44 increased from 5.93 deaths per 1,000 men in this age group in 1989 to 13.19 deaths per 1,000 in 1994, an increase of 122 percent. Over the entire transition period …, the increase in death rates among middle-aged men remained high in Russia, but had begun to decline in Estonia and the other Baltic republics.” An initial deterioration in life expectancy at birth occurred at the very beginning of the transition in other countries, especially Hungary, but the “pattern of large declines in mortality rates across most age groups by 2007 is similar for all East European countries for which data are available, including the Czech Republic, Poland and Romania”.

The mortality crisis among middle-aged men in the FSU republics was primarily caused by a tremendous increase in deaths due to circulatory diseases (heart disease and strokes; also rising in Bulgaria and Romania in 1989-94) and due to external causes (including suicides and homicides). After the mid-nineties these death rates declined but remained at least as high as before the transition. In the other East European countries, deaths due to circulatory diseases for men in the age-group 25-54 declined substantially between 1989 and 2007; among other things, because of improved diet and better medical care. “… the speed and magnitude of the [mortality] decline in Eastern Europe may be unprecedented”.

“Did Russians drink themselves to death?”

“Most analysts believe that alcohol consumption is one of the major causes of the large swings in mortality in the western former Soviet Union in the 1990s,” together with stress and possibly diet as contributory factors. Stress has been associated with unemployment, increase in inequality, migration and divorce. Artificially low prices for food, especially meat and fats, and scarcity of fruits and vegetables, made for a bad diet. Otherwise, other risk factors – smoking, hypertension and high cholesterol levels – in the FSU were lower than in western countries and mildly improving over the 1990s. Individual alcohol consumption is virtually impossible to estimate; probably two factors raised the impact of alcohol, namely binge drinking (leading to increased arrhythmias and heart attacks) and the consumption of “surrogate” alcohol. Surrogates, all untaxed and cheaper than vodka in alcoholic content, include homemade alcohol (samogon), and “non-beverage” alcohol, such as after-shave, anti-freeze and lighter fluid, all characterized by high content of ethanol and other toxic ingredients ”… Autopsy studies and surrogate alcohol studies provide persuasive evidence that alcohol consumption played an even more important role than previously thought in the increase in deaths due to both cardiovascular and external causes in Russia”.

Brainerd stresses that there remain unanswered questions. “Does alcohol consumption also explain the large swings in mortality in the other countries of the former Soviet Union besides Russia? … Why did drinking become so lethal in the 1990s? … Did alcohol consumption increase a great deal, or the frequency of binge drinking?” We know for certain that the price of food relative to the price of alcohol rose dramatically in the early years of transition in Russia, by a factor of three. The problem is that we do not know the price and income elasticity of demand for alcohol, nor the cross elasticity of demand for alcohol and its surrogates.

Population decline

The arithmetic of falling fertility, plus mortality rising above fertility, leads inexorably to a falling population, and indeed in the last two decades there were significant population decreases in most FSU countries. In Russia the population fell from 147 million in 1989 to 142 million by 2008. The loss, of 3.4 per cent, is much more dramatic if one excludes the substantial migration inflows of over 6 million (net) immigrants into Russia, between 1989 and 2008 – a fall of 11 million in the native Russian population. Table 7 shows that the Russian population decline is much smaller than that of other FSU countries: 20 percent in Moldova and Georgia, nearly 15 percent in Estonia and Latvia, 4 to 10 percent in Kazakhstan, Armenia, Lithuania and Ukraine. Similar declines occurred in Bulgaria and Romania. In the same period populations grew in the Central Asian republics (except Kazakhstan), Azerbaijan and Hungary.

Table 7. Population change 1989-2008

“Population declines are likely to continue in many countries due to the much smaller cohorts of women entering their childbearing years” – a factor which is nearly impossible to offset by the hypothetical increase in fertility that might occur thanks to Putin’s fertility ‘bonus’. Increasing life expectancy and higher immigration may make a more significant contribution to reduce population decline. But it is no accident that Goskomstat forecasts the Russian population to decrease from 142 million in 2008 to 137.5 million in 2025.

Implications

Elizabeth Brainard sees an immediate benefit from population decline, namely the “Solow effect” of raising the average capital/labour ratio and therefore, presumably, labour productivity. This effect is unlikely to materialize: existing capital equipment almost invariably embodies a technique designed for employing a given amount of labour per machine. The scope of ex-post substitutability between capital and labour is bound to be much lower than that ex-ante. Higher capital per man and higher productivity may happen only as a result of new accumulation, but this takes time. It may take twenty years for the higher investment per man (and the higher productivity of labour associated to it) to be diffused throughout the economy. In the meantime, lower capital utilization is more likely to occur than higher labour productivity on old equipment – while in the longer run the population ageing effect of demographic decline will still be operational. Demographic decline also leads to some destruction of human capital. Therefore population decline is bad for economic growth on all counts, in the short as in the medium and the long term.

Economic Determinism?

Elizabeth Brainerd’s riveting study is an eye-opener. It reveals how much our lives are influenced by the policies and institutions of the economic system in which we live, and how rapidly we can adapt to the transition from one system to another. It is frightening to see how much our individual decisions, literally on matters of life and death, are governed by economic incentives. When the state takes care of people from cradle to grave, there are simply more cradles but there may be a faster route to graves.