Distinguishing post-communist privatizations from the Big Bang

 From time to time there are articles that criticize the initial 1990s reforms (the Big Bang) in several East European countries and Russia, and they invariably mention the role of Jeff Sachs (often in a negative context like here). This is not a piece written in defense of Sachs, but in defense of the Big Bang reforms at that point in time and in those countries. I emphasize “at that point in time” and “those countries” because the conditions faced by Poland, Russia, and Yugoslavia (the three cases I know reasonably well and where Sachs was involved) were very special and in most respects incomparable with other cases of macro adjustments. In these reforms which (I believe) were both inevitable and successful, Jeffrey Sachs played a very positive role.

But my point is broader: the opprobrium that is often heaped at the Big Bang comes in part from the lack of knowledge of the contemporary conditions, and from easy conflation between macroeconomic reforms and privatization, which indeed began at approximately the same time, but were two distinct processes. While the Big Bang was successful and after a year of output decline and reduced real wages allowed Poland to grow fast, and would have certainly done the same for Russia, the hurried and inequitable privatizations created a kleptocratic oligarchy whose net contribution to innovation was close to zero but whose ability to extract surplus from political connection was infinite.

These two subjects (macro stabilization in the late 1980s-early 1990s and privatization) are topics for a whole book—and more. I want to give here just a bird’s-eye-view of the problem as it existed in Poland in 1989, Yugoslavia in 1990, and Russia in 1992. The Polish case is the one that I am most familiar with because I worked on Poland, spent months in the country between 1987 and 1990, know or at least have met all the main protagonists, including Sachs, and used to speak the language. I have written about Polish stabilization here (unfortunately it is pay-walled with an outrageous price, but if you write to me I will be happy to send you the article) and of course, I have written a lot about inequality and poverty before and after the reforms—like e.g. a book here here or an article there).

The most important thing to know is that  by the time reforms took place, the government no longer controlled the economy. This was therefore not a standard type of macro adjustment, like in (say) Egypt or Argentina, where the economy is behaving “normally” but there are fiscal or external-sector imbalances. In the Polish case, the economy was in a free fall, several exchange rates existed, hyperinflation was already present, enterprises were neither under the control of government ministries, nor subject to market; the power battles (who decides on work discipline, to whom to sell the goods, from whom to buy, where to borrow) were waged within every single enterprise, and all the way to the top of government. Neither coercion nor incentives were any longer operative.

Under such conditions, macro stabilization or the Big Bang had no alternative; its role was simply to validate what was already happening but in a most pernicious and chaotic way. Instead of closing eyes before multiple exchange rates, to unify them in one; instead of promising subsidies which the government could no longer deliver because its taxation ability collapsed, to eliminate them formally; instead of pretending to impose price controls (or the price freeze like in Yugoslavia) which the government had no ability to enforce, to legally allow all prices to be market-determined.

So the Big Bang was less a standard program of macro adjustment than a simple validation (or legalization) of what was there. It was acceptance of the fact that  government’s writ was no longer. It essentially said, in economics, and as of now, the government has no political power to do much beyond its minimal functions; it will have to abandon the rest to the market, and at some further point, when political legitimacy is restored after elections and some degree of stability is reintroduced, it will try to create a more balanced economy. This is indeed what happened in Poland.

A different issue was privatization. It was not entirely separated from macro stabilization because once macro situation improved, lack of clear ownership (either by workers, or by the state or by private capitalists) meant that it was not obvious who would make economic decisions and who would be the residual income claimant. But formally, and substantively, it was a separate issue.

Here of course Russia is the best example. It was not Gaidar’s reforms, which took place under even worse conditions than in Poland—when the country was on the verge of famine and even a possible civil war—that were responsible for what happened since but privatization. Privatizations’ effects, unlike those of macro stabilization, were long-term and they continue today. For Russia to privatize its economy would have never been easy, given the amount of wealth that existed and needed to be distributed, and difficult starting conditions. (One should not forget that in both Poland and Yugoslavia agriculture was mostly private.) But Russia under political pressure of Yeltsin’s cronies, chose the worst possible privatization strategy that included (1) an ostensible egalitarian voucher privatization, where vouchers were quickly bought for quasi-nothing from the impoverished population, and (2) a top-driven privatization that in 1996 was legalized under the title of “loans-for-shares”, a misnomer which actually meant private sector’s loans to corrupt and penniless government so that it could conduct the electoral campaign and make Yeltsin reelected. And in return the government would then give away, for nominal amounts, the most valuable state assets.   

Informal and formal privatizations, which in Russia began as early as 1988, and were “crowned” by the loans-for-shares, are the root cause of Russian problems  today and might continue for a number of decades. These problems are political. Privatization created a set of “political” billionaires who presumed that they could become the government (see my review of Paul Klebnikov’s book on Berezovsky). Putin, whom they brought to power in the expectation that they will control him, clipped the wings of the most ambitious and ruthless amongst them, and brought in his own “cadre” to let them be enriched. But the struggle between the first set of billionaires, many of whom Westerners, who enriched themselves under Yeltsin, and were unhappy from being excluded from the next division of the spoils, and the second set of billionaires, the Putin’s “team”, continues to this day, not only in Russia but across the world. Many of the first group have used millions that they have stolen from Russia to set a number of political think-tanks whose main role is to fight Putin, under the pretext of transparency and democracy, but in reality in the hope that they would again be able to exploit the mineral resources.  Putin’s team in order to stay in power applied the same rules: the permission to get rich is given only in exchange for political loyalty.

None of that existed in Poland, and the fact that Poland, despite massive economic growth has been a country with only a handful of billionaires, shows that it was inequitable privatizations that are at fault, not the long-forgotten and indeed successful macro stabilization of the late 1980s. In criticizing what went wrong then, we need to keep these two issues separate.