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.