Tuesday, December 9, 2014

The Coase theorem and methodological nationalism

When I calculate or read about these astonishing numbers regarding wealth concentration in Russia (top decile holds 85% of all assets; see p. 33 of the Credit Suisse  Global Wealth Report), I cannot but think about the people who made all of this possible. I was then working on “transition countries” in the Word Bank research department, and was able to see what was happening. I travelled to Russia, knew lots of people who worked there and “advised” the government and had a chance to witness the overall disarray and dissolution of the country. But leaving aside the economists who found in all this chaos their own financial interests, most were driven by economic ideology which, when it came to privatization, argued three things. 

(1) Be a revolutionary. We need to privatize fast because “the window of opportunity” is now and Communists may be back any moment. Do like the French revolution did with Church lands: give it or sell to anyone because it would be hard to nationalize later. 

(2) Coase theorem. It does not matter for efficiency to whom the assets go. For sure, assets will be given for free to the people close to Yeltsin and the “family”, and who really do not know what to do with them, much less manage them efficiently, but this is a distributional matter. The efficiency will not suffer. The newly rich will sell these assets quickly to the entrepreneurs who  know how to manage them. Everything will end in the best possible manner. 

(3) Demand for the rule of law. Once you do that, there will be immediately demand for the rule of law, even if privatization is done in the most lawless and non-transparent fashion. The new millionaires will, like the robber barons in the United Stares, demand the rule of law because they need to protect their newly acquired wealth.

It is clear that if your hold these three views, you would do exactly as the privatizers did in Russia (and Ukraine) in the mid-1990s. Why did economists hold these views? 

I think because of a wrong paradigm which first, disregarded distributional  issues by simply relegating them outside economics, and second, because they failed to take into account globalization. Their views were based on “methodological nationalism”. 

Consider points  (2) and (3). They go together. Point (2) says that the distribution is immaterial, and that the market left to itself will ensure efficiency however distribution goes. But for dynamic efficiency you need point (3): you need people who would, even if originally they stole the assets, turn around and demand the rule of law. And presumably, who will be politically sufficiently strong to get it. 

(2) is wrong because once the rules are broken in such an egregious and unjust manner, this will for a long time remain a political problem. There would be temptation to break the rules again, and to seize the assets that were once stolen, or to give them to the others. This is exactly what Putin is doing now when he simply redistributes assets from the plutocrats  he does not like to those he does.  And interestingly, there is no much protest because nobody believes that these assets rightfully belong to the people who have them. So, Putin takes from A and gives to B, and it really does not matter to the public who A or B are. For most people, they are equally corrupt.

Point (3) is wrong because it failed to take into account that with globalization you do not need to fight a dubious struggle for the rule of law in your own country. A much easier course of action is to take all the money, and run away to London or New York where the rule of law already exists and where nobody will ask you how you got that money in the first place.  A number of Russian plutocrats, and increasingly Chinese, are taking this route. It makes total sense from the individual point of view. And it also shows  how our economic thinking has not caught up with the economic reality. 

In the 19th century, it made sense for the Rockefellers et al  to fight for property rights in the United States because there were few places where they could go and squirrel away their money. Moreover, how ever much robbery the barons did, they were industrialists, that is engaged in some kind of business. But people who became suddenly rich in Russia were political cronies who were totality uninterested in running steel mills or nickel “kombinats”.  They did not even care if they run them aground, so long as they could cash out, and move to the Riviera.

The lesson: do not think that distribution and efficiency can be neatly compartmentalized, kept as it were in different boxes; and check if your theories work when you have a world where capital movements are almost entirely free and difficult to control, and where the rich can easily move from one “jurisdiction” to another. Our methodological  nationalism is getting more obsolete by the day.

PS. Those who harbor some doubts about what I wrote or disagree with my description of the Russian privatization should read this article by Black, Kraakman and Tarassova, the best piece on the topic that I have read.

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