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How USSR Privatization Can Inform Aid Policy Today

May 10, 2010 1 comment

When the USSR fell apart in the early nineties, the former communist countries had some serious economic restructuring to do. In no state was this more important than in Russia, at that time the largest planned economy in the world. It had become clear that Russia would abandon its communist system in place of the free-market through a process of privatization and liberalization, but the best strategy for this process had yet to be determined, and the new Russian government was at a loss.

Enter the west, the IMF, and Jeffrey Sachs.

Acting as advisers to Yeltsin’s government, they recommended the implementation of Sachs’ economic brainchild: the crudely named “shock therapy.” Rather than deliberate and gradual reforms, Sachs’ policy prescribed that the planned-to-free-market economy transition should happen basically entirely overnight.

The idea may have been noble: the sooner the country embraced a free market, the sooner it could leave behind the painful inefficiencies of a planned economy. But just like its psychological counterpart that often left subjects traumatized and hurt, the rapid transition was disastrous for Russia. After the introduction of capitalism in Russia, the poverty rate increased thirty-fold, per capita incomes fell drastically, and life expectancies dropped significantly due to an inability to afford even simple medicine. In fact, the shock therapy was so destructive it took a full decade for Russia to return to its pre-transition GDP, and by then, most of the country’s wealth had ended up in the hands of a small number of oligarchs.

Unsurprisingly, the Russian shock therapy strategy has been widely seen as an economic disaster.

However, the reason for this failure is not the underlying economic theory, as the central tenets of the free-market are well confirmed. Rather, the failure was something familiar to much of our development policy today: a willful ignorance of the role that culture plays in economic functioning and growth.

Simply put, the economic system of a country has great influence on the cultural institutions of the nation. After decades of living in a planned economy, the cultural impact of communism in Russia was huge. Russians lived with a set of norms, understanding, and experiences that did not correlate with a free-market system. This meant that capitalism needed to be introduced gradually with a focus on promoting concurrent cultural adaptation.

Effective economic growth, as was the goal of Sachs’ shock therapy in 1992 and is the goal of development policy today, necessitates cultural understanding. But far too often, development strategists find it more convenient to ignore that fact, believing that what works in western countries will function flawlessly, efficiently, and immediately everywhere else.

(Taken to its logical extreme, you get something like Paul Romer’s “charter cities”, where people from rich nations would build cities with rich-nation rules and systems for developing countries. The idea is, apparently, that people in developing countries are incapable of developing their own nations; only when rich-nation saviors come in with their economic system and a healthy dose of imperialism can these people have any hope of being lifted out of poverty. Romer calls culture a “side effect”. Look out for a future post on this atrocity…)

This is not to say, of course, that we should abandon what has worked for western nations in our quest to assist developing nations. The free-market, for example, is the most powerful economic engine that we have discovered, and its further effective employment in the poorer nations of the world could greatly help residents spur economic growth. But as Russia has showed us, such economic tools do not work in a vacuum, but only by collective interaction with the cultural norms and ideas of a complex country.

Sachs believed shock therapy would work for Russia because it had worked previously in Latin America. But as is so often forgot, different parts of the world are, well, different. And so, due to what can only be described as an enormous collective western ego, Russia experienced something so economically destructive it made the Great Depression look easy.

Let’s not inadvertently now force that on the developing world, too.

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Categories: Aid