The origins of the Second Cold War: an essay in interpretation

  Branko  Milanovic

It is a truism that the origins of the Second World War are to be found in the way the First World War ended. The same is true for the Second Cold War whose beginnings we are witnessing these days. The way the First Cold War ended was sufficiently ambiguous that it gave rise to two narratives which are incompatible and have led to the current impasse. That they would eventually do so was, I think, clear to many people for years although some (like myself) thought that it was bound to happen later, with a post-Putin rise of Russian nationalism.

What are the two narratives? The first one is shared by many people in the former Soviet Union, socialists  in the West and seemingly paradoxically by the hard-core Reaganites. According to this view, the end of Communism, and then incidentally the break-up of the Soviet Union, was due to the recognition by the Soviet elite of both political and economic advantages of liberal capitalism.  The Soviet economic growth has been on the declining trend since the mid-1960s, technological progress was slow or nil, the stifling hand of the government was everywhere. People yearned for more political freedom and also for more consumer goods: better shoes, jeans, vacations in the West. To Reagan himself, as Jack Matlock’s memoirs (“Reagan and Gorbachev”) make abundantly clear, this was  self-evident:  every sane person faced with the evidence of Soviet and American progress would choose the latter. He thus regarded Gorbachev’s vacillating recognition that the Soviet Union needs to modernize itself  both politically (glasnost) and economically (perestroika) as “natural”, a thing that everybody with impartial interest of his people at heart would choose. For Reagan, the end of the Cold War was thus not a victory of the United States over the Soviet Union. It was a joint victory of common sense over an “evil empire”. In other words, it was a “joint victory”, a victory wrought by him and Gorbachev,  by the US and the USSR, and all the people in both countries. 

The left-wing people and socialists depart from Reagan in only one, important, respect. For them a peaceful transformation of socialism into democracy was possible because socialism, unlike fascism, had its ideological roots in the ideas of Enlightenment. Thus socialism was always internationalist, pro-equality and pro-democracy. Faced with the evidence that its own “people’s democracies” led in effect to a dictatorship of a narrow bureaucratic elite (Milovan Djilas’s “new class”), socialists simply opted for a pluralistic democracy. There was nothing inherent in Communist ideology that was against democracy. On the contrary, they found “bourgeois” democracy less democratic than an ideal Communist democracy because the former  discriminated people according to income. But if in practice multi-party system did a better job in protecting human rights, why not adopt it? 

To be sure, Communists and socialists did not “buy” the second part of the equation, privatization, but at the time of the end of the Cold War this was a subsidiary question. Socialists in Eastern Europe, and some in the West, thus believed that the end of the Cold War would usher in a pluralistic democracy with a significant role of the state, similar to that in West Germany at the time. This was not a position limited to Gorbachev and his supporters. It was, for example, shared by the first and last democratically elected East German government and by communist parties (which later became socialist parties) all over Eastern Europe: in Poland, Hungary, Slovenia, Bulgaria.  It found its early expression in the two books published in the 1970s, by a Czechoslovak and an East German, both reluctant dissidents: Ota Šik (“The third way”) and Rudolf Bahro (“The alternative”). It was to be democracy with socialist colors.

How does the second narrative differ from both Reagan’s and socialist narrative of “joint victory”? In that second narrative, shared by most of the US political class and the  “commentariat”, the end of the Cold War came through relentless long-term political and military pressure applied by the United States on the Soviet Union. It was simply a conflict between two superpowers: a stronger one won, the other lost. The ideological element is of course present in the narrative, but rather as an embellishment to provide an ideological justification for a worldwide crusade to combat Communism (an equally worldwide movement) and to enable the winner to claim the mantle of mankind rather than just of the United States. In that “realist” or “US victory” narrative, the Cold War was indeed the war of two countries, like most wars in history. The ideological element is no more present than in the 5^th BC century war between Greeks and Persians. These two also held conflicting theories of the state but no one would deny that the war won by one group (“race”, as it used to be called) rather than by the other.

Now, whether you believe one or the other narrative, has sharply different implications on how you see later developments. If you think that the US won the war, you expect the USSR, and Russia as the principal successor of the USSR, to fully acknowledge that fact and to basically behave like a defeated power, transferring most of the responsibility  for its defense and foreign policy to the winner. Russia, in that view, should not be only an ally, but rather a soft protectorate, like Italy. Italy now (although not during the Cold War) can do more or less as it pleases in domestic policy, but when told that the US needs its soldiers, “rendition” services or bases it does not demur nor asks too many questions. The expansion of NATO is thus not to be regarded with surprise or alarm either. If Russia, as it reasonably should, accepts that it has been defeated, it does not need to worry about NATO but to join it, and play in it a subaltern role, providing people and territory as needed.

If you believe the first narrative, however, things look very different. USSR, and Russia, are not defeated powers. They have just rejoined the bloc  of “free nations” where Russia should play a role commensurate with its size and importance. If, for example, England and France were allowed to retain a measure of influence over their former colonies, codified in the  two alliances (Commonwealth and Communauté Franco-africaine), so should Russia retain it over the countries with which it shares language, culture and history, within the Commonwealth of Independent States, an organization expressly created to soften the break-up of the Soviet Union. But this expectation will seem to somebody who believes in the “US victory” narrative, preposterous, ill  concealing an attempt to reestablish Russian dominion over what came to be  known as the “near abroad.” And who knows, perhaps to create a new dominion further afield at some later date.

The attitude towards NATO expansion is similarly different. If NATO was created to defend capitalism and democracy against state ownership and dictatorship, what is its function after the end of the Cold War, “joint victory” proponents ask? Who is supposed to be its target if Communism is dead? The believers in joint victory will totally fail to comprehend the reasons behind NATO expansion, and will naturally and gradually come to the conclusion that the real new target is Russia. In other words, they will, as economics tells us people do, go through a process of adaptive expectations and gradually charge their understanding of the terms under which the Cold War ended: from believing in joint victory they would come to agree that it was really a defeat of Russia.

But if you hold this view in Russia, the implications are pretty clear. The first one is revanchism.  In the same way that the French army after the defeat by Prussia in 1870, was called “l’armée de la revanche”, the new Russian army will become “l’armée de la revanche”. In the same way that Germany was shocked to have learned when it went to Paris in 1919, that it was there not to sign an armistice but a capitulation on very costly terms, thus the Russia under Putin began to reassess how the Cold War really ended. It is this reassessment, with its logical implication, combined, as was the case in the Weimar Germany, with the feeling of humiliation and of social disaster of the 1990s, which is driving today’s Russian resentment and resurgent nationalism.

There are two further points worth mentioning where the two narratives clash:  the Yeltsin years and the dissolution of the Soviet Union. To many in the West, who were happy to see a powerful foe like the USSR change its ways, Russia's 1990s looked chaotic but basically benign and good. If pain there was it was, in the view of those who were not paying the costs, necessary. Even the term “transitional recession” was invented in economics to cover something that came to be thought as inevitable. (Never mind that no economist ever predicted that the end of central planning would lead to a deep economic depression; everybody expected the very opposite. Milton Friedman, to his credit, was honest to acknowledge it.) 

But to the people who lived in Russia at the time, the Yeltsin years were the nightmare years when not only oligarchs battled with own private armies in the streets, but when people’s  incomes were halved, savings evaporated, jobs disappeared, public assets were pillaged, and many were forced into literally selling family silver, or prostitution and crime.  The Russian depression 1990-96 was far deeper than the US Great Depression and three times  as deep as the current Greek GDP decline. Life expectancy went down dramatically (the largest peacetime decline, ever), alcoholism and murder rates sky-rocketed, divorces increased, population growth became negative. For those who went through all of this, to claim that the Yeltsin years were the golden years of democracy and that their economic leaders at the time were “the Dream Team” as Vice-President Gore famously called it, sounds like a cruel irony. 

But this is still not sufficiently appreciated.  Only recently, I read proofs of a book by one of top world economists. He dealt, among other health catastrophes, with the Soviet/Russian one too. But it seemed to me that he was discounting its magnitude and horror precisely because he somehow thought it pre-ordained: reasonable people should have understood, it was implied, that transition meant they would lose their jobs, have real wages cut in half, and die 5 years earlier. For many, transition to capitalism indeed translated into sheer hopelessness, alcoholism, and eventual early death either from untreated diseases or suicides. Transition in Russia was a catastrophe in some ways worse than war because there was no shared objective among people, no solidarity, and, unlike the glimmer of hope in victory that never dies in wars, there was only despondency. 

The second point on which the two narratives differ is the break-up of the USSR. To the people who hold the joint victory view, the break up was not necessary. Once the USSR became a democratic state, there was no reason to break the county. Logically, the two are totally different processes: a person can indeed be for democracy and federalism. Change of the political system does not imply change in the borders of the country: if the two were correlated, new countries would spring up and die yearly. Being in favor of democracy, autonomy and federalism (all three!) is in effect a position held by majorities in today’s Spain, Canada and the UK.  It was not different in the USSR. The break-up was all the more painful  as many, particularly those of mixed ethnic parentage, considered themselves Soviet rather than Russian, Ukrainian or Georgian. The break-up of the country left them without a homeland. It is in that context that Putin’s statement about the break-up of the USSR representing one of the greatest  tragedies of the 20^th century makes sense. 

But to those who think that the break-up was a necessary complement of democratization,  Putin’s statement will sound like a not so veiled attempt to reestablish Russian hegemony. I have to include a personal observation here, gleaned from a conversation with a high US official, very knowledgeable of Russia, to show how the two things (political system and the existence of a country) were in the eyes of many Western observers undistinguishable. I made, to me (coming from the former Yugoslavia), rather obvious point that many people in the USSR were both federalist and democrats. He looked at first surprised, and  then candidly acknowledged:” Yes, you are right; we never thought of that. We saw the two as mutually exclusive.”   

[Even today, as for example in a recent, and otherwise excellently documented, paper by Daron Acemoglu, Tarek Hassan and James Robinson (“Social structure and development: a legacy of the Holocaust in Russia”), the authors treat a positive answer to the question posed in the 1991 Gorbachev referendum “are your in favor of maintaining USSR as a federation of equal democratic republics” as a proxy for being…a Stalinist. It seems the authors never thought through the elementary politics.]

When differences  in how people regard and understand the same events are so sharp, and touch so many things from their daily experience, it is not surprising that they will interpret today’s moves by the other side differently, and rather menacingly. It is hard to see how, under such circumstances, war can be avoided. So far the title of this essay has “Second Cold War” in it. Let us hope there will be no need to change it.

Nit-Piketting continued

Debraj Ray’s original review of Piketty’s book was, appropriately, called “Nit-Picketty.” His reply to my critique of his critique, published here, could be called Nit-Picketting II or nit-Picketting big time. It brings no new points and thus leads our discussion to a close. I would organize my own nit-Debrajing into two parts, substantive and stylistic.

Substantive. Debraj has identified a weakness in Piketty’s model on which he spends some nine pages, denying the importance of the key insight of the book, and that weakness is as follows.  r>g is not sufficient to guarantee either an increasing share of capital in total income (over time), nor increasing inter-personal inequality (over time, too) because it does not take into account what capitalists do with the r which they receive as income. They can consume it all, or consume enough of it so that the portion which is reinvested (r*) becomes less than g.  Never mind that historically in the literature r was used, as Piketty does in his book,  to indicate both the rate of return on capital and the subsequent rate of increase of the capital stock (under the simplifying but sensible assumption that capitalists just turn around and reinvest all their capital income). Never mind that all empirical studies show that propensity to save increases with income and that capitalists tend to be rich, and hence save proportionately more, so that their consumption will be insufficient  to overturn the r>g inequality.  Debraj has found a small, even trivial, point, and yes, he insists  r has to be written as r*=r-cc,  where cc is capitalists’ consumption out of their return (all expressed in terms of capital stock), and if Piketty were to  write r*>g  then, yes, everything would be fine, but you see, just writing r>g is all wrong. Without cc, no going.  r>g  “implies nothing”, but r*>g would solve everything.  

Why not go further? Do we really know what capitalists will do with their r? They might give away a fair share of it. Denote the portion  of their capital return which they donate by dd, and then write a new relationship that should be even more satisfying: r-cc-dd>g.  However absurd this game of adding additional ways capitalists can use not to reinvest their full capital income is, adding  dd makes more sense than adding cc.  At least it is empirically justified. While for consumption/income ratio we know that it goes down as income goes up, for charity we know that it behaves exactly in the way to reduce r* as it increases with income. So capitalists will indeed have a positive dd, while for most of the others dd will be zero. Here I have now discovered that Piketty’s conclusions need to be modified in a yet another important way.

Fundamentally, Debraj and I do not disagree.  It is just that I think that his point is (yes, I must say so again: the 2^nd time) trivial, and while logically correct,  all empirical evidence about savings, and all our views about the essential features of capitalism,  show that it is not valid.  For it to be valid, either rich people should not be capitalists, or average propensity to save of the rich people should be less than of the poor. Manifestly, neither is true, and Debraj agrees with it. In other words, Debraj wants to drive his small logical point to an end which is in contradiction with everything which we know about the behavior of capitalists and the nature of capitalism.

Stylistic. I personally like Debraj and admire his work. I was extremely impressed by his presentations and writings. He is a brilliant economist. In addition, for those who do not know him, he looks like a Greek demi-God. His thinking is at the same level. But even demi-Gods should get used to mortals disagreeing with them, and even of having to repeat the same thing 97 (or was it 98?) times.  

Where I disagree and agree with Debraj Ray’s critique of Piketty’s Capital in the 21s Century.

Two people whose opinion I hold in very high esteem have told me, “Read Debraj Ray’s critique of Piketty; It is the best written yet.” I have read it before, but only in parts, and have focused on a few rather unimportant points in the first part of Debraj’s piece. So I decided now to read it carefully, and in full. It is a short piece, some 9 pages long. It is very well and clearly written. There are many things with which I agree.  But there are also many with which I do not. Let me start, because it is more fun, with the latter.

Debraj’s s key point is summarized in the last two sentence of his annex: “All I am saying is that it [any growth model] explains why r exceeds g. But the fact that r exceeds g explains  nothing about the rise in inequality.” At face value, it is a pretty damning critique of Piketty. First, r>g inequality is, as Debraj shows, a feature of any model of growth. It has nothing to do with being a “contradiction of capitalism.” Second, if inequality increases it is not because r is greater than g, as Piketty argues, but because capitalists have a higher marginal propensity to save. A bit earlier Debraj calls the much praised r>g inequality a “red herring.”

Let me now explain why I disagree with Debraj. While r>g (or r>=g) may be a feature of all growth models it is still a contradiction of capitalism for three reasons: because returns from capital are privately owned (appropriated), because they are more unequally distributed (meaning that the Gini coefficient  of income from capital is greater than the Gini coefficient of income from labor), and finally and most importantly because recipients of capital incomes are generally higher up in the income pyramid that recipients of labor income. The last two conditions, translated in the language of inequality mean that the concentration curve of income from capital lies below (further from the 45 degree line) the concentration curve of income from labor, and also below the Lorenz curve. Less technically, it means that capital incomes are more unequally distributed and are positively correlated with overall income. Even less technically, it means that if share of capital incomes in total increases, inequality will go up. And this happens precisely when r exceeds  g.

It is indeed a contradiction of capitalism because capitalism is not  a system where both the poor and the rich have the same shares of capital and labor income. Indeed if that were the case, inequality would still exist, but r>g would not imply its increase. A poor guy with original capital income of $100 and labor income of $100 would gain next year $5 additional dollars from capital and $3 from labor; the rich guy with $1000 in capital and $1000 in labor with gain additional $50 from capital and $30 from labor. Their overall income ratios will remain unchanged. But the real world is such that the poor guy in our case is faced by a capitalist who has $2000 of capital income and  nothing in labor and his income accordingly will grow by $100, thus widening the income gap between the two individuals.

So, if K/L ratios were the same along the entire income distribution, r>g would not have any special meaning. I grant that to Debraj. But precisely because the K/L ratio in capitalism is most emphatically not equal along income distribution (and we do not have a single historical example  where it was), but is rising, we do get increasing income inequality driven by r>g.

But, now, Debraj’s answer to that is to point out that this condition is not sufficient for rising inequality.  The requirement for inequality to go up is also that capitalists  should not spend most or all of their income, but rather invest it. Let us be clear: If capitalists were spendthrifts and used all their income on consumption,  there would be indeed no accumulation of capital, we would be in Marx’s simple reproduction, and Debraj would be right. But again this is not the  world we live in.  Not only is the assumption that capitalists save and reinvest 100% of their capital income a standard one in growth models (not because it is fully accurate but because it keeps the main features of the things in sharp relief; remember Marx’s “Accumulate, accumulate, it is Moses and all the prophets”). It also corresponds with empirical data. We indeed know that richer people tend to save greater proportion of their income (and people who receive more of their total income from capital tend to be richer). The other way to state that is to say that propensity to save out of capital income is greater than propensity to save out of labor name. This also tends to be empirically true.

Thus Piketty’s mechanism survives both of Debraj’s attacks. The standard growth requirement that r>g is indeed a contradiction of capitalism because in capitalism, capital owners are private persons and they tend to be rich.  And these rich people save more of their income, and gradually build up more and more of their capital stock, thus creating precisely the process of divergence of which Piketty speaks.

Now, why has Debraj gone astray in his otherwise very lucidly argued paper? Because he essentially assumes that economic processes described by theory of growth are abstract and do not take place in a capitalist environment where indeed the facts are such that capitalists tend to be rich (and not poor), and where such capital owners do not spend all of their income on consumption.

To conclude. If we had a capitalism  where capitalists were poor or a capitalism where capitalists would spend all of their capital incomes on booze and trinkets, yes, Debraj’s critique of Piketty would be right. But it just so happens that these are not the features of contemporary, nor of any other known, capitalism at least over the past 200 years.

This typically neoclassical and ahistorical approach to basically forget that the economic processes occur within a capitalist society, is also the reason why Debraj is wrong to wonder why Piketty calls a mere  identity, namely that the share of capital income in total income is equal to the rate of return  times capital/income ratio a fundamental law of capitalism. Seemingly reasonably, from his ahistorical point,  Debraj exclaims: this is just a definition of capital share in total output! It is an identity. How can it be a fundamental law?

Yes, it can. That definition carries weight in capitalism because it defines how much of total output  will be taken by a special class of population that does not have to work for its income. The more it gets, the less is left for those who have to work. It is not a Fundamental Law of Economics but it is a Fundamental Law of Capitalism.  (I made this point  in my review of Piketty’s book published on the Internet in October last year, forthcoming in the June issue of  the Journal of Economic Inequality). And to realize this, suppose that all capital is socially-owned and that income from capital is distributed equally among all population. Then clearly, capital share would be still the same as before, but this would not be a fundamental law nor a systemic problem since it would not imply unequal distribution of income, nor the existence of a class that does not need to work.

Debraj’s error consists, in my opinion, in not realizing that normal capitalist relations of production (where capitalists tend to be rich) are forgotten when we look at economic laws in an abstract manner. Not doing that is precisely a great virtue of Piketty’s book. Surely, (a) if capital/labor proportions were the same across income distribution; (b) if, more extremely, capitalists were poor and workers rich; (c) if capital were state-owned, all of these contradictions would disappear. But none of (a)-(c) conditions holds in contemporary capitalism. So Piketty’s economic laws and contradictions of capitalism do exist.

Where do I agree wit Debraj? That Kuznets curve cannot be easily dismissed. I am currently working precisely on this idea, alluded to also by Debraj, that we are now witnessing the upswing of the second Kuznets curve since the Industrial revolution. Moreover I believe this is not only the second but perhaps fifth or sixth or tenth such curve in western economic history over the past 1000 years. This is my next project, and there I come very close to agreeing with Debraj.

Does this agreement on Kuznets then, by itself, imply that my defense of Piketty’s mechanism cannot be right or consistent? Not at all. Piketty isolated the key features of capitalist inequality trends when they are left to themselves: the forces of divergence (inequality) will win. But there are also other forces: capital destruction, wars, confiscatory taxation, hyperinflation, pressure of trade unions, high taxation of capital, rising importance of labor and higher wages, that at different times go the other way, and, in a Kuznets-like fashion, drive inequality down. So, I believe, Piketty has beautifully uncovered the forces of divergence, mentioned some of the forces of convergence, but did not lay to rest the ghost of Kuznets inverted U shaped curve.