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Russian winters
are notorious in history for their length and severity –
and the winter of ‘98-99 has proven itself to be no exception.
But snow and frigid temperatures are among the least of the problems
faced by the Russian people as high unemployment, runaway inflation,
and growing government debt add to the burdens imposed by climate
and history. In fact, the economic picture is in many ways more
bleak than the weather – which offers at least the promise
of spring. Russia‘s economic future contains no certainty,
and indeed, seems to hold little hope. Crushed by surging inflation
of 200% per year, the economy was further crippled as the ruble
lost 50% of its value in terms of U.S. dollars from August to
December, 1998. And on top of it all, Russia is destitute, the
money on which she would build her future has disappeared.
Analysts have
discovered that the Russian government is essentially broke. But
how can that be, when the United States and the International
Monetary Fund (IMF) poured billions of dollars into Russia in
the wake of the collapse of the Soviet Union? Impossible as it
might seem, the billions deposited in Russian banks are simply
not there.
Where did
the money go? It went south – literally. In point of fact,
the money didn‘t actually disappear; it just left
Russia as deposits in Swiss bank accounts, to purchase villas
on the French Riviera, to finance luxury vacations in Morocco,
and as countless other expenditures and investments outside the
country. Knowing where it went frees our attention for the more
important question: Why did the money leave Russia?
The immediate causes of the disappearance – corruption
and the search for stable investments – are relatively easy
to discern.
- Stories
in the news, and anecdotes from tourists and businessmen tell
of "unchecked" individual and institutional corruption.
Corruption that started in the Soviet Union and continued after
the fall has allowed individuals to use political power to amass
economic power. Unfortunately, it isn‘t hard to find instances
of egregious abuses in which foreign financial assistance has
simply been "diverted" into personal accounts. For
example, Boris Berezovsky, President Yeltsin‘s former Deputy
National Security Advisor, is reportedly worth $3 billion, and
while in office, purchased a $70 million French Chateau on an
annual salary of only $43,000!
- Even people
of honesty and integrity are reluctant to leave their money
in the Russian economy, a fact that serves to remind us of a
tried and true economic adage: Money moves from less stable
economies and assets to more stable economies and assets.
Money is fleeing the instability of the Russian economy as those
with wealth seek safer places to hold their money and assets.
The annual rate of inflation hovers around 200% and the government
is unable to secure and protect rights to property. Given the
circumstances, stashing money in Switzerland or buying villas
on the Riviera, places where inflation in measured in single
digits and property rights are routinely and vigorously enforced,
is both rational and predictable.
Thus, it becomes
clear that the disappearing money is, in reality, a symptom of
a greater disease – economic instability that facilitates
corruption and encourages capital outflows. In searching for an
explanation of this fundamental instability, we find that in Russia
– as in many other struggling economies in the world today
– both inflation and the lack of enforceable property rights
to assets are the result of a breakdown in the rule of law. In
the case of Russia, this breakdown is part of the burdensome legacy
of the Soviet Union.
Generally,
we define "rule of law" to mean the existence of clear
and enforced laws and statutes, and to indicate the opposite of
the "rule of men," in which the arbitrary exercise of
power substitutes for laws and statutes. While we recognize the
importance of the rule of law in governing our social behavior
and interactions – protecting us from others who would do
us harm – we should not overlook its significance in our
economic lives. We depend on the rule of law to provide the cornerstone
for economic stability by protecting rights to property and by
enforcing contracts. A breakdown in the rule of law leaves property
vulnerable and makes contracts unenforceable, increasing the likelihood
of individuals and businesses losing their assets to unscrupulous
buyers and sellers. By contrast, in societies where the rule of
law is firmly in place, an individual cheated in a transaction
can use the force of law to recover his assets and/or have the
cheater punished.
A less obvious,
but equally important, effect of the rule of law is to enhance
people‘s sense that the future is both safe and, to some
extent, predictable. If the rule of law does not function, or
functions poorly or sporadically, it is more difficult to assess
the future, and the probability of instability increases. Economic
choices become more risky and people avoid or reduce economic
transactions.
This is the
situation in Russia today. It is the relative absence of the rule
of law that abets corruption and encourages those with financial
capital to make their investments and purchases in other countries.
And as the money leaves Russia, so do the chances for building
the economy. Yet, given the magnitude of risk, it is hard to blame
individual Russians for being unwilling to start new enterprises
or invest in Russia‘s future. Accepting the current level
of risk can only be considered foolhardy.
In identifying
the causes of economic instability, it is important to acknowledge
the burdensome legacy of the Soviet communism. In the last years
before the fall, 30% of all commerce in the Soviet Union took
place outside the official economy; that is, in black and gray
markets and in outright theft. The final 30 years of Soviet history
were rife with corruption as people learned to survive in a society
devoid of the economic protections offered by the rule of law.
Given this heritage, if we can criticize the current Russian government
for anything, it is only for its failure to reestablish a rule
of law that has long been missing.
Truly, this
is a daunting task. In today‘s Russia, the disintegration
of the rule of law contributes to a vicious cycle in which government
cannot pay for the institutions and personnel to enforce laws
and statutes, and the inability to enforce laws and statutes leads
to further disintegration. Currently, the Russian government is
unable even to enforce the collection of taxes, further reducing
its ability to finance the reestablishment of the rule of law.
It is estimated that only about 4 million of the 60 million Russians
who owed taxes paid them last year. Consequently, the government
doesn‘t have enough money to pay its employees, or must pay
them so little that jobs are unfilled, or are filled by grossly
under-qualified applicants.
Trapped in
a "catch-22," the Russian government has simply printed
money in order to pay its bills. As the printing of money exacerbates
inflation, the stability of the economy is further undermined
and with it, individuals‘ trust in the possibilities of the
future. Without that trust, money poured into Russia will continue
to drain out, as through a sieve, ending up in the more stable
economies to the west. To reverse capital flows back into Russia,
the government must re-establish the rule of law and stabilize
the economy, a truly daunting task given the current reality in
which even inadequate levels of enforcement and protection
are purchased at the price of greater financial instability.
To download
an MS Word version of the above essay, click
here.
Discussions
/ Investigations
- Read descriptions
of the Russia‘s economic problems:
- According
to the essay, "Where Did All the Money Go?" (above),
what are the causes and effects of the instability of the Russian
economy? Complete the following graphic.
- How does
aid from the US and IMF impact the situation? Make an argument
either for or against financial assistance to the Russian government.
- Before
you answer the above question, check out the current situation.
Has it changed since this essay was written in late winter,
1999? What is the annualized rate of inflation in Russia today?
Has the basic economic situation changed?
- You may
also want to read entries in the on-going discussion over
aid to Russia in the American Foreign Policy Council. See
"U.S.
Aid to the Russian Federation" and a rebuttal
commentary.
- Use the
knowledge you have accumulated from the example of capital outflows
in Russia to explain why the smuggling of drug money into
the United States is a continuing problem.
- How could
one reasonably argue that this is a good problem to
have?
- Historically,
tax compliance in the United States has been very high. Quite
simply, most Americans pay their taxes, without any extraordinary
show of force by the U.S. government.
- Given
what you learned in the above essay, how might you explain
this difference between the U.S. and Russia? (Hint: If you
have read the above article, you should know better than to
offer the explanation that Americans are more honest than
Russians!)
- Is having
lots of rules and laws the same thing as having the rule of
law? Explain and give examples.
- Describe
a classroom in which the rule of law is firmly established.
Describe a family.
- Describe
a classroom in which the rule of law is absent or has broken
down. Describe a family.
- Investigate
and/or discuss based on your knowledge of American history whether
each of the following is an example of the breakdown of the
rule of law. Why and how did the rule of law disintegrate? Were
there economic impacts similar to those found in Russia today?
- Salem
witch trials
- Prohibition
- 1960s
Civil Rights movement
- Vietnam
War and protest movement
- Generate
other examples.
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