Russia’s Economic Interests (Part 1)

August 2, 2011
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We all know that the world is unfair. The most useful question to ask is how much poverty is economically necessary, how much is a product of policies that can be alleviated?

A related question is how financial and fiscal austerity hurts the national economic interest. This problem is especially relevant in Russia today, since the Soviet-era safety nets have been removed without creating a balanced and self-growing industrial revival. Can Russia “afford” the costs of raising much of its population out of poverty? To put this question the other way around, what are the losses to Russia of not overcoming poverty?

The IMF from the 1960s through 1980s, followed by the European Union more recently, have advised governments to balance their budgets and international payments by imposing austerity plans. These fiscal and financial austerity policies have been self-defeating. They have not helped economies grow. From Latin America to Latvia and now Greece, we can see the waste of economic potential that poverty has caused by following this neoliberal “poverty as official policy.” It slows growth and makes economies less competitive and weaker – and more dependent on foreign creditors. Domestic markets stagnate, and the most educated individuals emigrate.

So the main task at hand is to explain a better policy – one that aims to overcome poverty to spur a thriving domestic market, and to elevate low-income families into an economic resource rather than a burden.

How much poverty is unnecessary? Is poverty simply the result of bad economic policy?

For starters, it is necessary to distinguish between how much poverty is “economically” justified and how much is unnecessary. There are many ways to get rich, and countries are experiencing various kinds of poverty. The good news is that much of today’s poverty does not stem from technological or other “objective” causes such as low productivity. Rather, it stems from special interests carving out privileges to extract income without any technologically necessary cost of production, but simply by ownership of “tollbooths”: land, mineral rights, or basic monopolies and banks privileged to create credit.

Poverty and austerity are the result of special interests monopolizing the economic surplus at the expense of the economy at large. The main rentiers falling into this category are the financial class, landowners and natural resource owners at the top of the economic pyramid. It is to them that the bottom 90% are indebted and must pay interest, rent, user fees and other access charges. Rent seeking is an economically unnecessary burden – and one from which the classical economists sought to free society. The idea of a “free market” from the Physiocrats and Adam Smith down through John Stuart Mill and the 19th century socialists was to free industrial capitalism from the rentier class that itself was a carry-over from Europe’s feudal epoch.

However, today’s neoliberal advisors turn this classical idea of free markets upside down. Their idea of “free” markets is one free of government price regulation, “free” of taxation on land rent, monopoly rent, financial interest and other categories of what the classical economists called “unearned income.” So we find ourselves with two quite different ideas of the economy. The classical idea was to grow by avoiding “artificial poverty,” purely extractive forms of wealth-seeking at society’s expense.

The neoliberal idea is to dismantle the government’s ability to regulate markets to steer growth and economic advance in the national interest. They claim that this is an alternative to centralized planning. But the reality is that it simply centralizes planning in the hands of bankers – primarily those of Wall Street and the City of London, followed by financial interests in satellite economies and other subordinate partners in this policy.

Neoliberal economists endorse this as being the “natural” way in which economies grow and accumulate wealth. Their concept of “wealth” in this case takes the form of financial riches and special privileges, not the means of production, education and skills, or research and technology. In this respect, “bad” forms of wealth-seeking have become the major threat to national economic growth and power today. This in turn results from a failure to draw the classical economic distinctions between productive and unproductive investment.

To analyze the dynamics of wealth and poverty, we need to review the dynamics that polarize rich and poor in different economies, and then suggest national policies to best cope with this polarization in ways that will best serve Russian national interests and those of other countries.

I suggest to focus on public tax policy and infrastructure investment to steer wealth to expand national output and living standards, because this is the line of least resistance in overcoming poverty and economic polarization spurred by bad taxes – not by taxes as such, but by dysfunctional taxes favoring special interests at the expense of the economy at large.

How did it go wrong?

In Western textbooks the wealthy are supposed to earn income and grow rich by investing in economic growth. Corporate profits are re-invested in new plant and equipment, to raise productivity. Credit is supposed to finance investment that will generate enough new income to pay off loans with interest, leaving a profit for the entrepreneur or other investor.

Since the 19th century, industrialists have justified their personal wealth by claiming to use it to invest in building up the economy’s stock of capital, employing more labor in the process – and of courses, donating to charity, especially to universities and policy “think tanks” these days. The business schools and lobbying tanks that they endow depict them as wise managers of companies run by industrial engineers. But this is not what happens in reality. It is easier to make money by predatory means. That is how the great American fortunes were made, by the railroad land barons, and by Wall Street railroad and stock market manipulators. Heavy industry was turned into trusts that fought against labor unionization, against the drive for safer and better working conditions, and to raise prices without regard for costs.

The vested interests broke away from classical political economy’s value system that underlay this takeoff. The break was mainly over the claim that all wealth is “earned.” There’s no recognition of unearned wealth achieved at other peoples’ expense. This “value-free” doctrine rejects not only Marx, but also Adam Smith, John Stuart Mill and other classical economists. Every way of getting rich is now deemed to be “productive,” in proportion to the wealth it creates at the top of the economic pyramid. The neoliberal Chicago economist Milton Friedman went so far as to claim that “There is no such thing as a free lunch.”

But even as he made this claim, the U.S. and European economies were becoming more and more about how to get a free lunch. By the 1980s a new form of economic polarization occurred. If industrialists were getting rich by squeezing out more profits to invest in capital, industrialization would have called for more employment, and also higher-grade labor. Instead, wealth has concentrated at the top of the economic pyramid by financial means, and by creating monopolies bought and sold on credit – on terms where the gains are paid out as interest and dividends. While industrial profits have shrunk, the financial sector has increased its share of reported profits in the U.S. national income and product accounts (NIPA) to 40 percent. This phenomenon has gone hand in hand with de-industrialization of the U.S. economy – and also those of the post-Soviet states, I should add.

Why is the gap between the rich and poor growing?

This question can be answered on two levels. On the global level, the gap is widening between rich creditor nations and poor debtor countries (most recently Ireland and Greece). Domestically, economic polarization is increasing mainly between creditors and debtors – that is, between the financial sector and the rest of the economy. So both globally and in individual nations, economies are buckling under the attempt to pay debts that have grown beyond the reasonable ability to pay. Today, debt service absorbs most of the economic surplus: corporate profits, real estate rents, personal income over and above basic needs, and even government revenues over and above necessary public maintenance charges.

When banks and other financial institutions siphon off the economic surplus, they use most of it to extend yet further loans – to extract yet more interest and fees, until finally the economy buckles in poverty. The financial sector today thus plays the role that Ricardo, Adam Smith and the Physiocrats assigned to landlords.

Internationally, the global economy has been polarized largely as a result of the International Monetary Fund (IMF) and World Bank imposing fifty years of bad economic policy that favored North America and Europe vis-à-vis the rest of the world. Credit was lent to governments to create infrastructure, but this was almost entirely associated with the export sector rather than to develop domestic economies.

After the Soviet Union dissolved in 1991, most of its members followed the neoliberal advice of the IMF and World Bank – and the Harvard Boys – and simply turned over the most lucrative resources in the public domain (minerals and fuels, real estate, public utilities, hotels, transport systems, etc.) to well-connected individuals and those working through banks. U.S. and other Western interests then helped these individuals move their money out to the West, while selling post-Soviet enterprises and real estate.

Domestically, in each economy the bubble economy raised the price of housing, forcing consumers to take on a lifetime of debt to afford it. The rental income was turned into interest. Educational fees also were imposed, financed by student loans. In the United States, these loans cannot be wiped out via bankruptcy. Many students took on debt that will take a number of decades to pay off – without regard for their ability to earn income as unemployment levels rise.

The financial sector also funded the takeover of companies. Raiders used corporate cash flow (ebitda: earnings before interest, taxes, depreciation and amortization) to pay their bankers and bondholders, and simply to buy up their own stock in an effort to increase its price – and hence, the value of their own stock options. Industrial companies were run by Chief Financial Officers, not by industrial engineers or even salesmen. The aim was not to make the economy richer, but to make themselves wealthier – not by new direct investment, but by disinvesting, downsizing and outsourcing, and in the end by asset stripping.

This was the mentality of the neoliberals who came to “help” Russia during the 1990s. They did not come to exploit your labor by hiring it and squeezing out surplus value. They didn’t want much to do with your labor at all. They wanted your raw materials resources on the cheap. They wanted to help your leading scientists and industrial engineers to emigrate to America, because the United States was producing mainly financial graduates, not technology-oriented graduates. And they wanted your flight of capital as well as skilled labor.

The financial polarization process went hand in hand with fiscal polarization. From the 1980s onward in the US, the tax burden was shifted off the higher wealth brackets and onto employees – onto the middle classes and indeed, the bottom 80% of the population. Taxes on real estate and financial gains were slashed to only a fraction of income taxes (if such gains were taxed at all). Meanwhile, public social spending on Social Security, Medicare and other programs were treated as “user fees” and financialized – paid for in advance by employees (up to a $102,000 cut-off point), providing the government with enough revenue to cut taxes on wealth. The result was that the tax system became regressive instead of progressive.

The result is that average wage levels in the United States have not risen since the late 1970s. But the tax burden has risen, as has the cost of obtaining housing, an education and medical care. This has shrunk markets for goods and services. And the U.S. economy is now entering a deep L-shaped recession/depression, as is Western Europe. Most of the population is being squeezed and getting poorer. So this certainly does not seem a good model for Russia and other post-Soviet economies to follow (as the sad example of Latvia shows).


Part 2: How to Reverse Economic Polarization and Poverty: Policy Conclusions for Russia

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One Response to Russia’s Economic Interests (Part 1)

  1. Russia: Reversing Economic Polarization And Poverty - Analysis on August 14, 2011 at 11:20 pm

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