On import substitution, Fukuyama, eternal growth and more

My conversation with James Pethokoukis from the American Enterprise Institute.

1.  Russia is a nation with vast natural resources, a well-educated population, and a deep scientific base. Yet on a per person basis, Russia is only the 67th richest nation in the world. Why?

The problem with Russia is what I called her “circular economic history”. To get rich, nations need internal and external peace, not chaos. One might remember Adam Smith’s famous statement that “peace, easy taxes and tolerable administration of justice” are sufficient for countries to transit from very low to very high income.  Russia has not had that experience for a whole century. The period of fast economic growth after the elimination of serfdom in 1861 –that is, before the end of slavery in the United States—ended with the World War I and then with the Bolshevik revolution and the Civil War. Another acceleration of growth in the 1930s through Stalinist industrialization was stopped by World War II. The growth rebound of the 1950s-60s slowed down under Brezhnev—but at least there was no decline then. The decline came with the dissolution of the Soviet Union  and the transition to capitalism. Russian GDP decreased by more than 40% (more than the American GDP declined during the Great Depression). In the final episode of the “growth-to-war-and-back” dynamic, the relatively good performance of Putin’s Russia up to about 2012, has now definitely ended with the war.

One can discuss other, perhaps more fundamental, reasons for the lack of technological advance of Russia, but I wanted to highlight a very simple fact which is often overlooked: to become developed and rich, countries need stability and constant growth over long periods of time. For every reasonable person (but Russia’s president), this simply translated into the fact that Russia needed at least fifty years of peace, stability and tolerable administration of justice to reach advanced countries. It never got that chance.

 2.  How long will Western sanctions on Russia continue, and what will be the long-term effect on the political economy of Russia?

I think that the sanctions will continue for several decades because the problems opened up by Russia’s invasion of Ukraine are exceptionally difficult to solve politically. They are as difficult, if not more so, as the Middle Eastern problem (Israel-Palestine), or the Cypriot problem (Northern Cyprus) or that between India and Pakistan (Kashmir). None of these problems has been solved in the past 50-70 years. So neither will the Russia-Ukraine problem be solved, which in turn means that Western sanctions, and especially American sanctions, will remain in force.

The sanctions will have a devastating impact on Russia’s economy. That impact is of the medium- to long-term nature. It is meaningless to focus on daily or weekly gyrations in the interest or exchange rate, as many people do. 

Russia will need to proceed to import substitutions under the unique circumstances where import of foreign-made machinery that is normally needed to launch import substitution is impossible. Russia will thus have to proceed to what I called “regressive import substitution”, that is to replace today’s Western-produced goods, starting from combine-harvester and cars and airplanes to chips and Novocain (for dental surgeries) with inferior old-fashioned domestic substitutes. In other words, the policy will be, willy-nilly, to go backwards in terms of technological developments and/or to try to reinvent everything anew by own forces. Nobody in history has even been forced to do so.

It is in that respect that the “regressive” import substitution is fundamentally different from Stalin’s import substitution that was, in the technical part, based on Western, that is, on advanced technology of that time.

The idea that China will somehow help Russia in not having to go backward is partially true. But China will be very careful not to fall under the secondary US sanctions. In addition, China cannot replace the West in all technological fields.  China herself depends in many areas on cooperation with the West.

Let me just mention that in 5-6 years, Russian civilian air transport will not be able to service far-flung areas: one may not be able to travel by plane directly from Moscow to (say) Vladivostok. In many respects, Russian way of life will regress, technologically, to the 1980s. Yes, one can say, but people did live, and many very well, in the 1980. That is true—but it is a very different thing to live with the technology of the 1980s in the 1980s from living with the technology of the 1980s today.

 3.  Is it still proper to call Russia an oligarchy, or is it now apparent that the oligarchs are benefactors of the state with no influence?

This is a very good question. Before the war, when the sanctions were just threatened, the assumption in the West was that oligarchs were sufficiently influential so that the fear of losing all (or almost all) of their assets will concentrate their minds and push them to dissuade Putin from the invasion. This did not happen. So the assumption on which this whole idea of threatening  sanctions on the oligarchs was based was faulty. This is important to keep in mind for two reasons.

First, we have no idea why oligarchs are being punished today. I guess, for not being powerful enough. The West is saying to them, “now, we know that you are not powerful, and we shall punish you for that”. Isn’t that bizarre? I wrote about that here.

Second, the nature of Russian oligarchy had changed in a fundamental way between Yeltsin and Putin. I have written about that in 2019 here. To put it simply, under Yeltsin, oligarchs were calling the shots. Take for example the famous Winter of 1996 meeting of top Russian billionaires in Davos when, together with George Soros, they decided to fund Yeltsin’s presidential campaign, bring US advisors and consultants, and do everything to help Yeltsin win in June (1996). They succeeded and were richly rewarded through the infamous loan-for-shares deal.

With Putin things changed, albeit gradually. He was indeed brought to power by Berezovsky who believed that he, Berezovsky, would be the puppeteer and Putin the puppet. In truth, however, Berezovsky ended up hanging (probably) himself in his former house in England. Under Putin, top oligarchs (not necessarily all) could keep their assets only if they did not contradict the interests of the state, as defined by Putin and the ministries of power, and they could augment their wealth if they did what the state told them to do. The power relationship between the ultra-rich and the political rulers had reversed. It seems that in Washington and London they were unaware of that change until 24 February 2022; or perhaps they pretended not to be aware of it.

4.  You've said that capitalism is "the sole socioeconomic system in the world." Is that likely to change in the long term?

To understand what I mean and to answer your question,  let’s go back to the definition of capitalism that I use in “Capitalism, Alone”. It is not a very original definition. It was used by both Karl Marx and Max Weber. It is simple. It is powerful and it locates the “mode of production” in the way production is organized, not (as amateurish definitions of capitalism and socialism do) in the way distribution proceeds.

To call a country capitalist, the definition requires first, that most of production be carried on by companies whose assets are privately owned, second, that the owners of assets directly or indirectly manage the companies which in turn use hired labor to produce things or services. The fact that labor is hired is important: workers do not play an entrepreneurial role, they are just told what to do. The system of production is fully hierarchical. Finally, economic decision-making is decentralized.

Now, do we have serious proposals to change any of the three parts of that definition so that we move away from capitalism? I do not see them. To be clear, let’s see what it would imply, that is, let’s list the conditions under which capitalism would change in a substantial way. For example, if assets were nationalized. This is obvious. Second, if most of production is done by small-scale producers (worker-owners). In that case, there would be no hired labor. In effect. laborers (who are at the same time capitalists as well) exert the entrepreneurial role. And third, if economic coordination is centralized, say through an explicit plan or heavy government regulation of key activities.

As I said, I do not see any of these elements being much supported today. However, I can imagine some changes. For example, there may be in the future more companies that look like today’s start-ups. People with ideas canvass capital. In that case, the capitalist is no longer directly or indirectly the “decider”; he or she is just the lender, the investor. Capital is still private, it gets a return, but the fact of ownership does not give the right to manage production. That role belongs to labor, actually to the people with ideas. A system where owners of money are simply providers of that money with no managerial role and where that role falls to labor is no longer capitalism in the sense that I defined it. This is one change that I can imagine.

Another is the process that I documented in ”Capitalism, Alone” for the US and several advanced economies. I call it “homoploutia”. That means that an increasing proportion of people who are (say) in the top 10 percent of US total  income distribution are both in the top 10 percent of income distribution by capital, and in the top 10 percent of income distribution by labor. In other words, they are not just rich people: they are amongst the richest workers, and amongst the richest capitalists. This is a very different, “new” capitalism: in the classical capitalism, the richest capitalists are not amongst the richest workers. They do not bother to work; they run their companies. But now, you can have a highly educated manager who has a very high labor income, saves from that income, invests, and realizes very high capital income that places him among the top 10% of capitalists,, while he/she is already among the top 10% of workers. This is, as I said, a big change compared to the past. It has some positive, and some negative features. But I will leave it to the readers of “Capitalism, Alone” to find out what they are.

5.  What did Fukuyama get right and wrong in "The End of History?"

I deeply admire Fukuyama’s work in “The Origin of Political Order”. It is, I think, a first-class book. I have written two reviews, here is one.

But he got 1989 wrong. This is what we see clearly now. There were two mistakes. First, the revolutions of national independence and self-determination that were essentially nationalist revolts were proclaimed by Fukuyama and other maîtres à penser of the time to be the revolutions of democracy. This was a puzzle to me from the onset.  If these were the revolutions of democracy, liberalism and multi-nationalism, why were all three communist federations broken up instead of just being democratized? Why, to use a contrast, was Spain democratized and kept as a democratic, ethnic-based federation, while all communist ethnic federations were broken-up? Clearly, there was something more than just democratization, and that more was ethnic self-determination. This was the key feature of East European revolutions; democracy was contingent.

The entire ideology of 1989 sidestepped that question. It is a fundamental question, because answering that question not only highlights the true nature of the  revolutions, but answers the question of what motivated a number of wars, including the current one, that we have witnessed since 1989. There were 12 wars in the so-called transition countries. All of them were fought in the former communist federations, and 11 out of these 12 wars were the wars about borders. (The only war that was not about borders was the civil war in Tajikistan.) Thus the answer about what motivated these revolutions must be obvious to all—but to the most dogmatic minds.

But, even if Fukuyama were somehow right in his explanation of 1989, the broader point he made, following Hegel, regarding a terminus in the evolution of human institutions, namely, democracy in the political sphere and capitalism in the economic sphere, is simplistic and unlikely ever to be realized. As Fukuyama’s own “Origins…” shows, human experience, be it different peoples’ history, philosophy, economic background, institutions, “culture” etc., is so diverse that believing that one system will fit all such diverse needs and beliefs is nothing short of utopian. And the danger with Fukuyama’s utopia, like with all utopias, is that the desire to conjure them up into existence inevitably leads to conflict. If we believe that Russia and China, and Egypt and South Africa, and Nigeria and Brazil, and Iran and Algeria, and Burma and Saudi Arabia, and everybody in this wide world would be better off if they had one system, the Western political system, logically we have to convince them of that. And if they are stubborn in persisting in the “wrongness of their ways”, we have to wage wars on them. Thus Fukuyama’s utopia leads to an endless string of conflicts.

6. Why is economic growth important? Haven't we achieved enough and we can just redistribute what we have?

We will never achieve enough because the human desire for “betterment”, as Adam Smith called it, has no limits. If we had a limited appetite for all things, we could imagine a stationary society. But our needs are not physiological; they are socially-determined. Every development creates new needs. We did not have a need for mobile phones before they existed. But we have that need now. We do not have a need to fly to Mars for a weekend outing right now (even if Elon Musk might feel that way). It seems slightly bizarre to us today to have such a “need”. But in several generations, it will not be so bizarre. It will be like our “need” to go on vacation to Mexico or Italy. Thus economic growth and needs are, if you will, in a dialectical relationship: more growth creates new needs that require more growth to satisfy them. There is no end to that.  

 

Hopelessness?

 That today’s world situation is the worst since the end of the Second World War is not an excessive, nor original, statement. As we teeter on the brink of a nuclear war, it does not require too  many words to convince people that this is so.

The question is: how did we get here? And is there a way out?

To understand how we got here, we need to go to the end of the Cold War. That war, like the World War I, ended with the two sides understanding the end differently: the West understood the end of the Cold War as its comprehensive victory over Russia; Russia understood it as the end of the ideological competition between capitalism and communism: Russia jettisoned communism, and hence it was to be just another power alongside other capitalist powers.

The origin of today’s conflict lies in that misunderstanding. Many books have already been written about it, and more will be. But this is not all. The Euro-American world took a bad turn in the 1990s because both the (former) West and the (former) East took a bad turn. The West rejected social-democracy with its conciliatory attitude domestically and willingness to envisage a world without adversarial military blocs internationally for neoliberalism at home and militant expansion abroad. The (former) East embraced privatization and deregulation in economics, and an exclusivist nationalism in the national ideologies underlying the newly-independent states.

These extreme ideologies, East and West, were the very opposite of what people of goodwill hoped for. The world they wished for, after Western colonial and quasi-colonial wars and Soviet invasions ended, was the world of convergence of the two systems, with mild social-democracy in both, dissolution of war-mongering alliances, and end of militarism. They got nothing of the sort: one system swallowed the other; social democracy died or was corrupted or co-opted by the rich, and militarism through adventuresome foreign invasions and NATO expansion became the new norm. In the former Third World, the victory of the West led to the reinterpretation of the struggle against colonialism. It was now shorn of all of its domestically progressive elements. This facilitated massive corruption in the newly liberated countries.

The “trivialists”, the intellectuals who misunderstood, either because of their lack of perspicacity or pure interest, the nature of the changes in Eastern Europe, proclaimed the revolutions of 1989 to have been the revolutions of liberalism, multiculturalism, and democracy. They failed to notice that if they were the revolutions of multiculturalism and tolerance, there was hardly any need to break multinational states. Nay, that such a break-up was antithetical to the idea of multiculturalism. Nationalism was thus conflated with democracy.

The trivialists succeeded in turning the progressiveness of the post-War on its head. Instead of development and progress meaning a combination of the best elements of market (capitalist) economy and socialism, elimination of power-politics in world affairs, and the adherence to the rules of the United Nations, progressiveness in their new reading of history meant unbridled market economics at home, “liberal international order” of unequal power abroad, and pensée unique in ideology.

Instead of a social-democratic capitalism with peace, to be progressive began to mean neo-liberalism with the permission to wage war on anyone who disagreed with it. Instead of mild and innocuous mixture of socialism and capitalism at home and equal power of all states internationally, we got served the power of the rich at home, and the power of big countries internationally. It was a weird return to the quasi-colonial hegemony, taking place—incongruously, at first—at the time of “liberal victory”.

The rest, from today’s perspective, seems almost preordained. The virulent nationalism of Eastern Europe that fueled the revolutions of 1989 finally engulfed the most powerful country in that part of the world: Russia. Xenophobic nationalism is the same everywhere: in Estonia, Serbia, Ukraine, Russia or Azerbaijan. But the greater the country, the more destabilizing and imperialistic it is. What began as the nationalist revolutions in Eastern Europe ends now as the revolution of unchained nationalism in Russia: the same ideological movement but with the regain of “lost” territories as its objective rather than their “liberation”.

The rule of the rich locally and of the powerful internationally seems so ideologically entrenched today that no hope of betterment, no hope of national nor economic equality seems on the horizon. A lot of responsibility for this disastrous state of affairs lies on the “trivialists”, the intellectual elite who defined, promoted, and defended this pernicious ideology of inequality. The hopelessness envelops not only the present where we stand on the precipice of the extinction of a part of humankind, but the future too. Progressive thought has been vitiated, remodeled, and extirpated. The medieval darkness, under the name of “liberty”, is descending.

The rule of nihilists

 A friend sent me recently an abbreviated version of Xi Jinping’s January 2013 speech to the members of the Central Committee of CPC (the English translation is here). The speech is often mentioned, generally in the context of greater ideological control and “authoritarian tendencies” of Xi Jinping, but I have not read it until I got it from him.

It is rather fortuitous that I read it now, almost ten years after it was pronounced, because it sheds light on the very current problem of the Russian war on Ukraine. This statement might come as a surprise to many (“What does Xi’s speech of 2013 have to do with Mariupol 2022”) but I will explain it in the rest of the text.

Xi’s argumentation is very tight and logical. One may agree or disagree with the objectives posited by Xi and even some interpretations, but there is no doubt that the main points regarding the role of the CPC in making China first independent, and then strong are true, as well as his point that "ideological nihilism" leads to the end of the system, and, implicitly, to the disastrous outcomes that we see today in Russia.

Two points are worth highlighting. Xi’s interpretation of the end of the Soviet Union, and his accent on ideology.

Xi sees the break-up of the Soviet Union and the end of the CPSU as the result of “ideological nihilism”: the ruling strata have ceased to believe in the advantages and the value of the system, but lacked any other ideological coordinates within which to situate their thinking. (Incidentally, I have noticed that when I recently read Andrei Kozyrev’s, Yeltsin’s minister of foreign affairs, book of memoirs, reviewed here; the book is striking by its total absence of any ideology.)

Here is Xi: “Why did the Soviet Union disintegrate? Why did the Communist Party of the Soviet Union fall to pieces? An important reason is that in the ideological domain, competition is fierce! To completely repudiate the historical experience of the Soviet Union, to repudiate the history of the CPSU, to repudiate Lenin, to repudiate Stalin was to wreck chaos in Soviet ideology and engage in historical nihilism. It caused Party organizations at all levels to have barely any function whatsoever. It robbed the Party of its leadership of the military. In the end the CPSU — as great a Party as it was — scattered like a flock of frightened beasts! The Soviet Union — as great a socialist state as it was — shattered into pieces.”

The lack of belief in the system stemmed from the failure of the Soviet Union in the economic arena, and inability to propose a system of participation in the decision-making that appealed to, or was acceptable to, most of its population. The roots of the debacle were both economic and ideological.  Once the party loses the control of the ideology, Xi argues, once it fails to provide a satisfactory explanation for its own rule, objectives and purposes, it dissolves into a party of loosely connected individuals linked only by personal goals of enrichment and power.

The party is then taken over by “ideological nihilism”. While in some cases, this ideological void caused by the disappearance of communist ideology was filled by nationalism, it was almost nowhere filled by liberalism (as I argued many years ago in this piece, namely that the revolutions of 1989 were not revolutions of democracy but of national independence and self-determination). This however was not –as we can see from Xi’s speech—the worst outcome. The worst outcome, and perhaps what Xi fears for China, is that the country be taken over by people with no ideology whatsoever but with an entirely cynical and self-serving desire to rule. This is what happened in Russia where the Communist Party of the Soviet Union was succeeded, and the country hijacked, by the ideological nihilists of the intelligence services.

The ideological nihilists of the KGB were often seen, in the West, as much more preferable rulers than communists. Thus for John Lewis Gaddis,  perhaps the most well-known US historian of the Cold War, the only praiseworthy Soviet leader before Gorbachev (in The Cold War: A New History) was Beria precisely because Beria was completely non-ideological and willing to serve any system so long as he remained in charge. In the latter days of the Soviet Union, KGB people were seen as the only ones who could impose some order and get the economy growing. Hence the election of Andropov to lead the CPSU—a total reversal of the traditional subservience of the intelligence apparatus to the Party. (It is not for nothing that Stalin never allowed Cheka in its various appellation to decide on policies, but only to execute them, at times literally by shooting people.) The dependence on the intelligence service was repeated in the last years of Yeltsin’s rule when four out of his last five prime ministers (a position from which the person would quasi-automatically succeed Yeltsin) were linked with KGB (Primakov, Stepashin, Kirienko and finally Putin). This intellectual void enabled the rule of ideological nihilists—people who by the very nature of their jobs were pragmatists to the bone, without any concern with, or interest in, ideology.

The focus on the external features of one’s rule, and disregard of ideology that motives those in power, leads many liberal commentators to speak of “autocracies” of Xi and Putin as if they belonged to the same specie. But, as Xi’s speech shows, they do not. What differentiates them is that in one case there is an attempt (I cannot judge how successful) to preserve the hegemonic rule of the communist ideology, and therefore to control the organs of brute power (the Army and the police), and in the other case, there was a complete replacement of the ideological and the political by pragmatism of power.

Unlike the original and very ebullient commentators of the end of communism who liked to think that its end will bring forth the flowering of democracy, Xi rightly puts the emphasis on something much more grim and perhaps realistic: “ideological nihilism” that opens the way to adventuresome policies devoid of any ideological or even logical justifications. They might have been, as in the case of Putin’s Russia’s attack on Ukraine, adopted either because of misjudgment or because of a desire to provide same superficial nationalist veneer to an otherwise ideologically empty regime. Whatever the case, they were unmoored from any ideology. Xi is right to argue that once belief in a better society of the future and focus on economic success that is supposed to bring that future society along are abandoned, the power is surrendered to “opportunistic cliques” who may plunge their countries into wars and destruction either because they believe in nothing or because they are in search of some justification for their nihilistic rule.

China’s household incomes and inequality in the Year I of covid

 There has been an enormous talk of the new inequalities wrought by covid-19 between and within countries: in mortality and morbidity, vaccination rates, style of life (those who had to show up physically at work vs those who could stay at home), unemployment rates, gender, age etc. But it is only now that actual information about income inequality in year 2020, the year I of covid, is becoming available. A couple of months ago, US micro data from the Current Population Survey, harmonized by Luxembourg Income Study, showed a significant decrease in disposable income inequality in 2020. US inequality went down by 1.7 Gini points which is the largest annual drop in at least thirty years. The decrease in inequality was driven by very generous government transfers (2020 CARES Act alone disbursed funds equal to 11% of GDP) whose objective was to help individuals and businesses that were most affected by the epidemic. Since the support was (very broadly) income tested, it helped much more those in the lower income brackets.

            Chinese National Bureau of Statistics has also published (in the Statistical Yearbook for 2021 available here), the data on incomes and distribution in rural, urban areas and for China as a whole. The Chinese data that are provided are rather minimalist (as usual, the Yearbook publishes per capita incomes of only five quintiles for rural and urban areas, and all-China), but they do allow us to see the effects of the crisis, especially when we compare the developments in 2020 with the previous years. It is important to recall that for China, year 2020 was much less traumatic than for almost the entire rest of the world. China’s real GDP per capita rose by almost 2% while more than 100 countries in the world experienced negative growth, and the global real GDP shrank by more than 5%.  

            It is therefore not surprising that the average per capita incomes went up in both rural and urban areas, by respectively 3.9 and 1.4 percent (and for all-China by 2.5%). The faster growth in rural areas also slightly reduced the gap in average incomes between urban and rural areas from 2.7 to 2.6 (i.e., the average per capita income in urban areas is 2.6 times greater than the average per capita income in rural areas). As graph below shows, growth was stronger in rural areas across income distribution: income of every rural quintile increased by more than that of a corresponding urban quintile. Most interesting is what happened to the poorest (first) quintile in the two areas: poorest rural incomes went up by more than 7%, while poorest urban incomes registered a slight negative  growth.

If one looks more carefully at what happened to urban incomes (in red), it becomes apparent that growth in 2020 was pro-rich, in the sense that percentage growth was higher for richer income groups (2.3% for the top group vs. -2.1% for the lowest-income group). In the rural areas, the situation was more mixed, with the poorest, as we have seen, growing the most, while for the others quintiles growth rates were broadly the same. High growth rates among the rural poor may be related to the government explicit policy to eliminate rural poverty that was particularly actively pursued in 2020.

            The overall impact of such changes was that the rural Gini remained unchanged, while the urban Gini increased. It is important to highlight that these Ginis are calculated from only five data points (five quintiles) and thus probably understate the “true” Gini by several Gini points.  China is unusual because its rural inequality is consistently higher than urban. As we note here (graph below), rural Gini is about 35, urban around 32. To obtain the all-China Gini, one needs also to include  the differences in mean incomes between rural and urban areas. Since 2013 (when China unified its rural and urban household surveys), overall inequality was, according to the official sources, remarkably stable at just under 40 Gini points.

For the years for which we have more detailed micro data, and/or rural and urban ventiles, we can compare such results with the ones that we obtain from the much more compressed data published in China’s Statistical Yearbook: in 2013, China’s overall Gini was 43 (based on micro data) and 40 (based on government published quintiles); in 2018, it was 47 vs. 40. The published results therefore underestimate inequality by at least several Gini points.

Government statistics also provide information on aggregate consumption. Here, the interesting result is that per capita consumption decreased in urban areas by 4.5% and increased, by the Chinese standards, by the modest 2.7% in rural areas. Overall real per capita consumption, for the first time since 1978 when such results have been published recorded a decline of 2.2% (see Table 3.1 in the 2021 Statistical Yearbook). It will be noticed that the decrease in consumption occurred while real incomes went up by 2.5%. Thus obviously—if all these numbers are mutually consistent—the share of savings in household incomes must have increased substantially.

            Overall, based on the published numbers, 2020 certainly was not a “normal” year in China either. Household overall income growth slowed down, the poor in urban areas saw negative growth (very unusual), while the real incomes of the poor in rural areas increased by more than 7%. Urban inequality slightly increased. The typical features of China’s distribution, namely that rural incomes are more unequally distributed than urban, and that they are much lower on average, remained unchanged.