Chapter Eight
ON THE ECONOMIC IMPLICATIONS OF (MIS)UNDERSTANDING
MARKETS IN TRANSITION COUNTRIES
J.A. Kregel
Marx would have been perplexed by the absence of working-class consciousness; Lenin would have been appalled by the failure to act; Hayek would have been baffled by the absence of spontaneous order. Only Karl Polanyi would have been able to provide a logical explanation of the "Great Transformation" that is currently taking place in the former Soviet Union. Indeed, he would probably have predicted what is now occurring. He would also have been able to explain why Jeffrey Sachs and other western advisors to the Russian Federation are unmoved as they witness the spectacle of collapse and disarray from which they deduce the success of their policies for building a democratic market society. The simple explanation is their failure to understand the distinction between the substantive and formal definitions of the market.
For once man's everyday activities have been organized through markets of various kinds, based on profit motives, determined by competitive attitudes, and governed by a utilitarian value scale, his society becomes an organism that is, in all essential regards, subservient to gainful purposes. Having thus absolutized the motive of economic gain in practice, he loses the capacity of mentally relativizing it again. His imagination is bounded by stultifying limits. The very word economy evokes in him not the picture of man's livelihood and the technology that helps to secure it, but recalls instead a particular set of motives, peculiar attitudes, and highly specific purposes, all of which he is used to calling economic, even though they are mere accessories to the actual economyNot the permanent and abiding features of all human economies but the merely transitory and contingent ones appear to him as essentialsIn his ignorance, he can grasp neither the true preconditions of survival nor the less obvious ways of attaining the possible. This obsolete market-mentality is, as I see it, the chief impediment to a realistic approach to the economic problems of the oncoming era.1
Thus the groups of housewives driven by hunger and despair to selling kittens in underground passageways are identified as exhibiting market behaviour and using capitalist initiative to create markets. The problems of producing "man's livelihood and the technology that helps to secure it" are thus completely ignored by the admiration for the existence of these ladies whose actions are no longer controlled by Gosplan, but are now "subservient to gainful purposes."
Polanyi would also have been able to explain to us why the advice based on this conception of the economy has been not only ineffectual but counterproductive: "Nowhere has liberal philosophy failed so conspicuously as in its understanding of the problem of change."2 He pinpointed as the cause of this failure the presumption that rapid change will lead to rapid economic conversion and adjustment which will redirect individuals and resources displaced by change to alternative occupations, "but--this is the point--only in a market economy can such compensating effects be taken for granted." (p.34) "However natural it may appear to us to make that assumption, it is unjustified." It is precisely this assumption of rapid market-led adjustment which is used by the proponents of shock therapy to justify their introduction of stabilisation policies as necessary first steps to transformation. It is necessary to eliminate the "distortions" caused by price subsidies, inflation, and lack of profit incentives linked to private property to allow the market to produce the desired transformation. Yet they fail to notice that the "market" does not yet exist.
To those who argued in favour of the benefits of rapid change Polanyi cautioned:
It should need no elaboration that a process of undirected change, the pace of which is deemed too fast, should be slowed down, if possible so as to safeguard the welfare of the community A belief in spontaneous progress must make us blind to the role of government in economic life. This role consists often in altering the rate of change For upon this rate, mainly depend[s] whether the dispossessedadjust themselves to changed conditions without fatally damaging their substance, human and economic, physical and moral; whether theyfind new employment in the fields of opportunity indirectly connected with the changes; and whetherthose who lost their employment through the change are able to find new sources of sustenance. The time-rate of change compared with the time rate of adjustment will decide what is to be regarded as the net effect of the change. But in no case can we assume the functioning of the market laws unless a self-regulating market is shown to exist. Only in the institutional setting of market economy are market laws relevantit [is]the modern economists, whose strictures imply the prior existence of a market systemwho strayed from the facts. (loc. cit.)
In analysing the process of introducing a democratic free-market economy into the former Soviet Union, anyone familiar with the early "stabilisation policies" proposed for the transition to a market economy could not but have been struck by the naive belief manifested in the ability of the market to provide the necessary adjustments. For not only were markets assumed to exist, institutional structures common in the industrialised economies were also assumed to emerge miraculously with the introduction of private property. Plans for reform thus contained recommendations for balanced government budget policies in conditions in which there was no integrated system of taxation or controls on expenditures. Such plans also recommended that monetary policy be conducted so as to produce positive real interest rates, in a system with no money or capital market, no system of commercial bank lending to private enterprise, nor any appreciable private investment.
The modern economist, whether evaluating the impact of changes in a historical context (the passages quoted above refer to revisionist economic historians) or evaluating the impact of the changes required to replace central planning as an organising concept for the economy of the former Soviet Union, thus makes the same error of assuming what has to be proven, of taking for granted the spontaneous creation in the Russian economy of what has only been built up through three hundred years of conscious effort and direct government intervention in the capitalist economies.
The three great pillars of the transition programme recommended by western experts and international institutions--the elimination of price controls, the opening of the economy to foreign trade and capital flows, and the privatisation of state property--have exactly the same intention of turning labour, land and money into commodities freely traded for gain in the market. The Russian economy was to be transformed from one in which economic activity was embedded in the social structure, in which prices were fixed as equivalencies which allowed certainty in exchange, in which reciprocity and redistribution prevailed--to a system based solely on gain from profit.
The direct and indirect influence of Polanyi's The Great Transformation on those who drafted The Market Shock3 on behalf of the Agenda Group should be clear and obvious. Polanyi was not in favour of turning back the clock with reference to the introduction of machine production; he appreciated that the machine could not be stopped. He was rather interested in the possibility that it could be introduced without, however, the accompanying "satanic mills." The Agenda group took a similar position to the problem of the transformation of the Central and Eastern European economies: namely, to ensure that the end result would be positive, rather than negative.
It seemed clear that there was a large degree of similarity between Polanyi's "Great Transformation" and the problems faced in converting the former planned economies into market-based economies. The Group followed Polanyi in criticising the tendency of the major reform proposals to accept the "economistic fallacy," of taking not only the operation of supposed laws of the market for granted, but also the existence of appropriate market institutions. A great deal of attention was thus given to the process of creating markets through creating conditions in which market-making could develop, and providing a basis for a more gradual transformation process.
Not only did the policies recommended by the international institutions depend on the operation of markets and market laws which did not exist, the ensuing stabilisation policies precluded the state from playing an active role in the process because this contradicted recommended budgetary policies. Thus our book The Market Shock placed emphasis on the necessity for an active role of government in creating markets in a way which avoided the doing of "fatal damage" to the human and social fabric of the country. This meant an active role for the state in both fostering the growth of the market and in putting a brake on the rate of change so as to keep it within the rate of adaptation of the people.
But here there was a fundamental contradiction in the transformation process, for it implied that government should simultaneously have one foot on the accelerator, pushing for "market reform," and the other foot on the brake, defending society from the impact of the market in terms of unemployment, falling living standards, and deprivation. In the transformation taking place in Eastern Europe there is no economic driving force equivalent to the role played by the introduction of machine production in bringing into existence the "satanic mills." The decision to introduce the "market" as well as the decision to do it by means of a "market shock" was not an economic imperative, it was a political decision.
It is most probable that the original idea behind glasnost and perestroika (which seems to be a forgotten word in market Russia!) was to try to engineer a controlled entry or soft landing in the market economy. But the impediments to change turned out to be stronger than the impetus for change within the government. The "shock therapy" was thus an attempt to use the slogans of the market and economic reform to wrench power from the defenders of the old regime. For the common mortal this shift has turned out to be much more rapid and much more brutal than the introduction of the machine age and the English industrial revolution.
There are many advocates of the free-market reform movement who argue that there was no Big Bang, just as revisionist economic historians denied the hardships of the Industrial Revolution. They argue that since there are still parts of the economy which have not been fully and completely given up to re-organisation by means of free markets driven by the profit motive, Russia has not introduced real shock therapy.
Polanyi would say that such advocates have misunderstood the nature of the uprooting experience of passing from a system in which certain fundamental needs were supplied centrally to one in which each individual exists only for himself and his own gain. Somewhat inconsistently, it is these same people who usually point to the relative successes that have so far been achieved in terms of the proportion of total output produced by the private market sector, or to the increase in incomes of individuals operating in the market sector. Again, they have not considered Polanyi's explanation of the fact that the introduction of the market system can at one and the same time bring about an increase in real wages above historical levels, and also lead to widespread "cultural denigration." This is precisely what appears to be taking place in Russia today as prima ballerinas are forced to sell their physical prowess in the market as go-go dancers and prostitutes as they accept efficient allocation of their resources by following the profit motive. There is no disputing that their real incomes are clearly higher than they were under the old system .
Polanyi placed great emphasis on the role of the state as an agent for slowing the rate of change to compatibility with the rate of adjustment. But this counterbalance, which works when pluralistic liberal democracies are developing market systems, does not seem to carry over to oligarchies in the process of being transformed from command to market systems. Since it is the government itself rather than the machine that is the source of the push to the market, any attempt to temper the rate of change appears as obstructionism and draws opprobrium and criticism from abroad. Indeed, it is now the case that the very existence of democracy has been identified with rapid progress toward market reform, so that any action to stem the tide of change is viewed as anti-democratic and subject to condemnation both inside and outside the country. The simple attempt to protect society from the ravages of the market by slowing the rate of change to match the rate of adaptation is branded as revisionist, or worse, communist.
In his explanation of the counterbalancing forces to the thrust of the market, Polanyi places great weight on the role played by the Speenhamland system in delaying the creation of a full-fledged labour market and thus the full introduction of the market system. He also noted that this system was not edifying for labour, but simply indicated its role as the normal response of the system to excessively rapid change.
Despite the difficulties facing the government in playing its dual role of promotor of the market and protector of the people, there are other forces at work in Russia to counter the speed of change. One of them is the system of state enterprises and the power of the enterprise directors (among whom the Prime Minister belongs) to influence the pace of economic reform. Under central planning, state enterprises were akin to small, decentralised regional governments, providing not only employment, but a wide range of social services to their workers and the other residents of the industrial towns in which they were located. These included schooling, health services, enterprise shops, and even could extend to street cleaning. In the period of penury after perestroika and before the flood of western imports, enterprise shops provided a first line of defence against starvation for their workers. These amalgamations of social, political and economic functions are just as anachronistic in the new Russia based on free markets as the Speenhamland system was in Britain of the 18th century, but they serve a similar purpose of shielding the population from the ravages of change. This explains the great difficulty in transforming them into "efficient" production units, as well as the difficulty in preparing them for privatisation. It also explains why they have survived the attacks of both perestroika and the shock therapy, for they represent the last line of defence of Russian society against the ravages of full and complete introduction of market relations. On grounds of economic efficiency they must be replaced, just as Speenhamland had to be replaced; but this should not blind us to the role they play and the basic needs they represent.
It is interesting to note that Parliament, the seat of democratic decision making, and the Central Bank, seat of independent monetary decision making, have both been willing to risk their sovereignty against the government in order to defend and preserve state enterprises. Members of Parliament understood much more quickly than western economists that privatisation meant that the enterprises would have to shed the very activities which made them a shield to protect the Russian population against the ravages wrought by change in social organisation. They thus fought, not against reform or against the introduction of the democratic free market system, but to save the only institutions which seemed capable of serving as protection from the negative impact of the market. The state enterprises were a tangible representation of the so-called "social safety net" which everyone talks about, but no one seems capable of organising. Responding to the excessively rapid pace of economic change, the democratic voice made itself heard in a Parliament that was bombarded, burned, and disbanded in the name of preserving the rapid pace of "democratic" market reform.
The Central Bank found itself in the same difficulty. It was faced with the choice either of cutting off funding to Parliament for democratically approved government programmes, or of cutting off funding of state enterprises in order to meet the conditions of market-economy monetary control where there were as yet no markets and thus no laws of the market operating to protect the unemployed. The Bank chose to continue to finance Parliamentary measures and the losses of state enterprises rather than risk the massive unemployment and social unrest which might result. The Bank was duly attacked on the one hand as a revisionist saboteur of "democratic market reform" instituted by the government, and on the other by Western "experts" who failed to recognise the significance of the state enterprise system as a defence against the rapidity of social change and increased uncertainty in like economic conditions of the Russian people which were driving this response. Rather than hollow words about "social safety nets" to be provided by a government that cannot organise tax collection, the state enterprises exist and indeed function in this role. If they are to be successfully privatised a solution to this problem must be found.
One possibility would be to try to preserve these social welfare aspects of the enterprises as independent local providers of health and other social services, either under contract with the government or directly with the people. This would avoid having to disband a network of service provisions and create a new system from scratch in conditions in which even the most rudimentary decisions appear difficult.
Polanyi provides a definition of socialism as "the tendency inherent in an industrial civilisation to transcend the self-regulating market by consciously subordinating it to a democratic society." (p. 234) Currently, in the Russian Federation this tendency is branded as anti-reform and thus anti-democratic: it is the Parliament which must be subordinated to the introduction of the self-regulating market; it is the Central Bank which must be subordinated to the self-regulating market, by allowing money to be managed as if it were a commodity determined by the market. Thus, the failure of the Bank to act "independently" against the democratic decisions of Parliament, on the one hand, leads to calls for increased government control, and on the other, to calls for the bank to introduce currency convertibility which would bind its monetary creation activity to the strictures of the market.
It should by now be clear, if it was not so previously, that direct identification of the "democratic" process with market reforms leads to the elimination of any form of democratic expression of dissatisfaction with the pace of transformation, as well as any state action which is not consonant with the destruction of the defence mechanisms protecting the society from an excessively rapid process of change and the enforcement of market measures. It is now the case that those government bureaucrats who formerly defended the Soviet state are the same as are at present defending Russian democracy by imposing free market reform, insisting on rapid privatisation, and promoting the break up and sale of state enterprises. They are also the same persons who have seen their relative position in society solidified through the privatisation of state assets. They have received, gratis, property rights to their exclusive and privileged living quarters which previously depended on their position in the Party hierarchy, and have used their position to appropriate former state property through asset-stripping of state enterprises, all in their role as representatives of the "democratic" interests of the people. Their position of power and dominance now rests on the firmer foundation of the natural law of property and the IMF, rather than the leading role of the Party in the workers' revolution and the support of the military.
There is clearly a struggle going on today in the Russian Federation, but it is not between advocates of alternative programmes for transformation: it is a struggle for political power. There are no machine owners to provide impetus for the introduction of the democratic free market. However, there is a ready supply of candidates from amongst the former nomenklatura and state bureaucrats, fighting to preserve their position in society. In this they are aided by western economists who cannot distinguish between the substance of economic activity and market behaviour based solely on personal gain. Democracy, free markets, and property rights appear to constitute a firmer foundation for personal privilege and position than to be among the leaders of the dictatorship of the working class in a Soviet system in which there is no incentive for the rest of the population to provide spoils. The gains to be made from occupying the positions of power in a market system are much greater than under central planning. The former nomenklatura have thus adopted the banner of rapid privatisation and free market reform as the best way to preclude any real political change. It is such as these, in the garb of Manchester liberals, who have replaced the "machine" as the driving force for economic change. But it is the sort of change which takes into account only the "mere accessories to the actual economyNot the permanent and abiding features of all human economies but the merely transitory and contingent ones." They ignore the substance, which is the fact that it was the machine that provided changes which produced the basic means of survival for society. As yet, there is no recovery in domestic investment, or domestic production, and the "substance" of subsistence is primarily imports.
There is an additional point which merits consideration in this regard. A great deal of attention has been paid to control of the economy by the "mafia," as well as to the insistence that this phenomenon is a purely "Russian" affair with no relation to better-known foreign counterparts. But, in a population facing cultural denigration, starvation and unemployment, unwilling to return to a system which had provided safety and security only under intolerable conditions of personal unfreedom, the traditional conception of the mafia as guarantor of minimum personal rights and defender of the common man against the uncaring state, does seem to make a great deal of sense. Had Polanyi known more about the organisation of the mafia he might have categorized it along with Speenhamland as a defence mechanism by which society attempted to protect itself from the ravages of excessively rapid change to a market system.
However one might want to call the Soviet Union, it was a system in which the economy was embedded in a network of socio-economic relations, in which a variety of other incentives were substituted for the profit motive. It was not the antithesis of the market system in the form of, say the Potlatch, but nonetheless it was a structured system which functioned without profit and monetary accumulation as primary goals. In the space of less than five years it has been brought into a market system without any of the positive benefits normally associated with the existence of the full-fledged self-regulating market. The defence mechanisms which have been set in motion, along with the implications of stabilisation policy which deny an active role to the state in providing those institutions, have created a situation of stalemate in which little progress is being made towards the creation of the self-regulating market system, but in which basic democratic freedoms are increasingly infringed in order to make more rapid progress. Popular democracy, if now left to itself in Russia, will deny further market reform. The failure of market reform would lead to what Polanyi has called the "issues of early capitalism," "first and foremost popular government." (p. 223) "The reform of the market economy achieved at the price of the extirpation of all democratic institutions," which spread in the 1920s, appears as an increasingly possible solution to the current impasse. In the meantime, international institutions continue to bargain about the size of the budget deficit, the level of real interest rates, and to recommend stabilisation of the rouble exchange rate--and Jeffrey Sachs continues to see the formalistic elements of the market on every street corner. Removal of the Speenhamland system was not easy, but it was required to allow passage to the self-regulating market economy. In the short term it created even more misery and dislocation. Elimination of the system of state enterprises is also necessary, and it will cause the same increase in misery and disruption of the normal conduct of life if it is done without recognition of the resultant impact on the basic conditions of the populace. The end of the 18th century was a time of revolution and political upheaval, as was the 1920s. If the "economistic fallacy" continues to be applied to the problems of Russian transformation, one would expect the same for the Russia of the 1990s.
NOTES
1. Karl Polanyi, The Livelihood of Man. New York: Harcourt Brace, 1977, p. XIV.
2. Karl Polanyi, The Great Transformation. Boston: Beacon Press, 1957, p. 33.
3. J. Kregel, E. Matzner, and G. Grabher (eds.), The Market Shock. Ann Arbor: University of Michigan Press, 1992.