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Tuesday, December 28, 2010

The Khodorkovsky Verdict: The Power Struggle Is Now On

On December 27, 2010, the Moscow court began reading its verdict. Mikhail Khodorkovsky, once Russia’s richest man and leading industrialist, has been sentenced to a second term. He will not be released until 2017, well after the 2012 presidential election. The Khodorkovsky verdict represents a slap in the face to President Dmitry Medvedev’s “modernization” program, which includes an enhanced rule of law.

Currently, the “tandem” of Medvedev (President) and Putin (Prime Minister) is running Russia. Supposedly, the two will at some point sit down to decide which of them will be the presidential candidate for the 2012 election. Throughout his term, Medvedev has talked in general terms about modernization, corruption, and rule of law with only veiled attacks on Putin. The Russian and international press was shocked by Medvedev’s attack on Putin at his press conference following the Khodorkovsky verdict. Medvedev rebuked Putin, not by name, for his recent remark about the Khodorkovsky case ( “Thieves belong in jail”). In countries with a rule of law, high government officials must refrain from judgments about cases before the courts, declared Medvedev. Medvedev also spoke about the need for more democracy and airing of political ideas, going even so far as to mention the name of Gary Kasparov, who Putin despises. Medvedev has gone from the subtle to the direct.

It is my guess that Medvedev will decide not to contest the 2012 presidential election. Although Putin’s public-opinion ratings are falling and the country is less supportive of a strong state to bring about order, he will realize that his chances are too slim and that he is too weak to prevent Putin’s third term. In such a contest, a freed Khodorkovsky would have been a great asset for Medvedev as a voluble witness to the corruption of the Putin government. Putin cannot allow Khodorkovsky to be a free man.

Although Medvedev has surrounded himself with forward thinking business men and politicians, they can scarcely compete with Putin’s control of the “power” ministries and of oligarchic businesses. “Power” ministries is a peculiar Russian term for those agencies that can arrest, convict, spy, control resources, determine what is said in the press, and assassinate, if need be.

By 2012, Medvedev will likely be a much more popular figure than Putin, especially if Russia’s economic performance remains in the doldrums, which it likely will given the massive levels of corruption. If it were not Putin in the prime minister position, Medvedev would have replaced the prime minister with someone new.

By 2012, Putin will have lost the luster of high popular-opinion ratings (If the rating agencies remain honest), which served as a justification for his “strong hand.” An unpopular Putin can still win easily because his “power men”, including his crony recently appointed the new mayor of Moscow, can deliver the votes and intimidate potential opponents.

Since Lenin’s death in January of 1924, there has never been a change in power that has not been accompanied by a purge in which the old leader’s cronies are removed from their positions. A Medvedev victory would mean the loss of money, power, and privilege (and even jail) for those currently running Russia. This is a threat they cannot afford. Putin holds the upper hand. Medvedev’s cards are weak. He will likely fold when the time comes.

Does Medvedev hold any strong cards. He does, but they are risky to play. Presumably, he would have “kompromat” on Putin’s multi-billion dollar wealth. Also, as President, he has the authority to fire Putin and his government, but in so doing he would run the risk of impeachment in an all-out war. No, the likely outcome is that he will fold. He will probably be the one to announce Putin’s candidacy with a big forced smile on his face.

Saturday, December 18, 2010

Stalin-Putin Justice: The Bukharin-Khodorkovsky Cases

Dec, 12: Vladimir Putin's reply when asked on a national TV call in show about the upcoming Khodorkovsyky verdict: "Thieves should remain in jail."


When the history of Russian justice is written fifty years from now, two landmark court cases will stand out: The death sentence of Nikolai Bukharin in his Moscow show trial of March 1938 and the second prison sentence of Mikhail Khodorkovsky expected December 27, 2010. Both processes teach the same object lesson: anyone who crosses the Kremlin will be punished without mercy. There will be no protection in the courts for the innocent, and the guilty verdict and sentence will be already predetermined behind the Kremlin walls. It also does not matter how preposterous or ludicrous the charges.

Vladimir Putin was born in 1952, only one year before Stalin’s death. But Stalin’s system of justice was institutionalized and survived Stalin and the collapse of the Soviet Union, for use by apt pupils such as Putin. We have intimate knowledge of Stalin’s use of the courts from his many telegrams ordering arrests and trials and dictating the sentence, such as his 1937 authorization to try a group of bakers in open court “with participation of prosecutor and defense, sentence all to death, and publish results in the press.” We lack such records for the Putin regime. We doubt that its sentences are dictated in writing. A safer approach is “telephone justice” whereby the judge is given the sentence by phone.

The weak link in Stalin-Putin justice occurs when the court proceeding is open and the defendant realizes the verdict is set in stone and there is nothing to lose. Nikolai Bukharin was Stalin’s last standing political rival when he was brought before the court accused of murder, assassination plots (including Stalin’s) and espionage for Germany in March of 1938. He had been worked over since his arrest in February. His “confession” was read before the court. In Stalin’s time, death sentences were carried out immediately; Bukharin understood that he had little to lose if he retracted his confession in his final statement. Here is part of what he said in his final statement before Stalin personally censored it for publication in the trial transcripts:

I declare myself politically responsible for the totality of crimes committed by the “Rightist-Trotskyite bloc.” I accept responsibility even for those crimes about which I did not know or about which I did not have the slightest idea. I deny most of all the prosecutor’s charge of belonging to the group, sitting on the court bench with me, because such a group never existed, and it is clear that such a non-existent group cannot be, contrary to the prosecutors’ conclusion, created by the orders of foreign intelligence.

Bukharin’s retraction of his confession sent the judge and prosecutor into a frenzy. They knew that failure could put them in the dock along with Bukharin. They quickly moved to silence him.

Khodorkovsky today stands accused of the ludicrous charge of stealing virtually all of the oil produced by his Yukos oil company. Brave expert witnesses have testified that such a crime was impossible, but Khodorkovsky, like Bukharin, faces an inevitable guilty verdict on December 27. At least he does not face shooting as did Bukharin. Like Bukharin, Khodorkovsky used his “final statement to the court” to tell the audience, including the foreign press, that his conviction has been ordered by the Kremlin and what it means for the justice system. I attach (with some deletions) his eloquent final statement to the court:

I can recall October 2003. My last day as a free man. Several weeks after my arrest, I was informed that president Putin had decided: I was going to have to “slurp gruel” for 8 years. It was hard to believe that back then. Seven years have gone by already since that day. Seven years – quite a long stretch of time, and all the more so – when you’ve spent it in jail. All of us have had time to reassess and rethink many things. Judging by the prosecutors’ presentation: “give them 14 years” and “spit on previous court decisions”, over these years they have begun to fear me more, and to respect the law – even less.

Nobody is seriously waiting for an admission of guilt from me. It is hardly likely that somebody today would believe me if I were to say that I really did steal all the oil produced by my company. But neither does anybody believe that an acquittal in the YUKOS case is possible in a Moscow court.

I remember the end of the last decade and the beginning of the current one. By then I was 35. We were building the best oil company in Russia. We were putting up sports complexes and cultural centers, laying roads, and resurveying and developing dozens of new fields. In short, – we were doing all those things that Rosneft, which has taken possession of Yukos, is so proud of today. We felt hope that the period of convulsions and unrest – was behind us at last, and that, in the conditions of stability that had been achieved with great effort and sacrifice, we would be able to peacefully build ourselves a new life, a great country.

With the coming of a new President (and more than two years have already passed since that time), hope appeared once again for many of my fellow citizens too. Hope that Russia would yet become a modern country with a developed civil society. Free from the arbitrary behavior of officials, free from corruption, free from unfairness and lawlessness. It is clear that this can not happen all by itself, or in one day. But to pretend that we are developing, while in actuality, – we are merely standing in one place or sliding backwards, even if it is behind the cloak of noble conservatism, – is no longer possible. Impossible and simply dangerous for the country.

I am ashamed to see how certain persons – in the past, respected by me – are attempting to justify unchecked bureaucratic behavior and lawlessness. They exchange their reputation for a life of ease, privileges and handouts. It makes me proud to know that even after 7 years of persecutions, not a single one of the thousands of YUKOS employees has agreed to become a false witness, to sell their soul and conscience. Dozens of people have personally experienced threats, have been cut off from family, and have been thrown in jail. Some have been tortured. But, even after losing their health and years of their lives, people have still kept the thing they deemed to be most important, – human dignity.

I think all of us understand perfectly well – the significance of this trial extends far beyond the scope of my fate, and even the fates of all those who have guiltlessly suffered in the course of the sweeping massacre of YUKOS, those I found myself unable to protect, but about whom I remember every day.
Let us ask ourselves: what must be going through the head of the entrepreneur, the high-level organizer of production, or simply any ordinary educated, creative person, looking today at this trial and knowing that its result is absolutely predictable?

The obvious conclusion a thinking person can make is chilling in its stark simplicity: the power bureaucracy can do anything. There is no right of private property ownership. A person who collides with “the system” has no rights whatsoever. Even though they are enshrined in the law, rights are not protected by the courts. Because the courts are either also afraid, or are themselves a part of “the system”. Who is going to modernize the economy? Prosecutors? Policemen? Chekists? We already tried such a modernization – it did not work.

A country that tolerates a situation where the power bureaucracy holds tens and even hundreds of thousands of talented entrepreneurs, managers, and ordinary people in jail in its own interests, instead of and together with criminals, – this is a sick country. I will not be exaggerating if I say that millions of eyes throughout all of Russia and throughout the whole world are watching for the outcome of this trial. They are watching with the hope that Russia will after all become a country of freedom and of the law, where the law will be above the bureaucratic official.
Where supporting opposition parties will cease being a cause for reprisals.
Where the special services will protect the people and the law, and not the bureaucracy from the people and the law. Where human rights will no longer depend on the mood of the tsar. Good or evil.

I am not at all an ideal person, but I am – a person with an idea. For me, as for anybody, it is hard to live in jail, and I do not want to die there. But if I have to – I will not hesitate. The things I believe in are worth dying for. I think I have proven this. And you opponents? What do you believe in? That the bosses are always right? Do you believe in money? In the impunity of “the system”?

Wednesday, December 15, 2010

Khodorkovsky Verdict Delayed

Former Yukos Chairman, Mikhail Khodorkovsky's verdict in his second Moscow trial was supposed to be delivered today, December 15. Without warning or notice, the court announced that the reading of the verdict has been delayed until December 26. The reason for the delay is obvious: Western newsmen leave Moscow between Christmas and New Year. Few will be in the Moscow court room to hear the predictable guilty verdict and the new prison sentence.

The Kremlin wants as little attention as possible. The Khodorkovsky case is becoming uncomfortable. There is widespread recognition that the charges are a sham and that Khodorkovsky is being kept in jail for political reasons. As a prisoner of conscience and a well known figure, a free Khodorkovsky could be a serious challenger to the Kremlin. The Kremlin needs to keep the verdict as quiet as possible because it is now attracting attention from civil rights advocates in Europe, who increasingly assign political dissident status to Khodorkovsky.

The Khodorkovsky case also exposes as false President Medvedev's so-called campaign to establish a rule of law in Russia. How can there be talk of rule of law when the most prominent rule-of-law case is the sham Khodorkovsky trial?

Wednesday, December 8, 2010

The Ruffin-Gregory Award for the Worst Treatment of Climate Change in an Economics Textbook

I did not know until yesterday that there is a prize that bears my name. The Ruffin-Gregory Award was established by a protector of the faith in global warming for the purpose of “hounding out of print” the economics text that has the worst treatment of climate change. That the award is named after us, I guess, means that our Principles of Economics is the worst of all time!

The Cancun conference has again brought climate issues to the forefront, and an e mail from a colleague, whose economics text was recently awarded an F in climate change (and a threatened boycott of the publisher’s books), brought the existence of the Ruffin-Gregory Prize to my attention.

I had long forgotten that, in 2000, Roy Ruffin and I received complaints about our treatment of global warming in our seventh edition of Principles of Economics. Our publisher (Addison Wesley) was threatened with a boycott if it did not withdraw our text. Our sin was to suggest that the scientific method should be applied to three questions: (1) is global warming occurring, (2) is global warming caused by human consumption of fossil fuels, and (3) is global warming bad for our future. At the time we were writing (1999), we knew that there was no “normal earth temperature” in terms of geological time and we also that temperatures in the medieval warming period were higher than contemporary standards. Moreover, we had a healthy skepticism of computer modeling of such things from our first-edition discussion of the fatal flaws of the Club of Rome-MIT model, which famously predicted we would long be out of natural resources by today. These seemed like legitimate grounds to call for the application of the scientific method to our three questions on climate change. Whatever answers the scientific method produced would be fully acceptable to us. We did not and do not have any stake in the outcome. Let the chips fall where they may.

Over the past decade, much has happened: Nobel prizes for Al Gore and the IPCC, the “100% consensus” on global warming and its causes and consequences, and ClimateGate. My own personal view is that we still do not have solid answers to the key question of the human contribution to climate change. It is heartening to know that the Ruffin-Gregory Award is still alive and well (and that we now know it exists). It is also informative that economics textbooks are still being threatened by the climate police with boycotts for departing from climate orthodoxy. The one disheartening note is that some economic textbook authors seem to be deliberately aiming for an A grade.

Sunday, December 5, 2010

Putin, Russian Democracy and Wikileaks

It will take years for the United States to restore its image as a trustworthy diplomatic partner. U. S. diplomacy has suffered a severe set back and its national security has been damaged by the Wikileak dumps of classified documents.

The Wikileaks revelations on Russia provide a rare candid view of the Russian leadership, the state of Russian democracy, and the prevalence of corruption and thuggery at the highest levels of government. In this regard, the Wikileaks documents confirm what outside experts have suspected. It is perversely comforting to know that U.S. diplomats understand the reality of Russian politics irregardless of the optimistic tone of the “reset” of relations with Russia at the beginning of the Obama administration.

These leaks clearly show that the Russian government is corrupt to the core and that the corruption starts at the top. U.S. diplomats understand that Putin, despite his nominal number two position, still calls the shots and that Russia is run by incorrigible ex-KGB officers, whose mindset is that the U.S. is the enemy. Our diplomats also understand that Russian democracy is dead and will continue to be moribund for the foreseeable future.

These leaks also show the sensitivity of Putin to charges that he is personally corrupt. Attempts to investigate Putin’s personal wealth have likely resulted in assassinations of investigative reporters, and it seems that Putin’s most violent reaction to the published leaks relate to internal discussions of his personal wealth.

The secret dispatches from our diplomats in Russia paint a bleak but realistic view of the state of affairs in Russia.

Saturday, November 27, 2010

Russia Admits Guilt on Katyn At Last

Russia’s Duma admitted, after more than a half century of denial, that the Katyn massacre of more than 22,000 Polish officers and administrators was ordered by Stalin and signed off by the Politburo. Historians have had access to the Katyn “smoking gun” document since the early 1990s: a request from Lavrenty Beria to the Politburo for permission to execute the Polish POWs in Soviet hands signed by Stalin and other members of the Politburo. The Russian cover up began after German forces were driven from Eastern Poland, Belorussia, and Ukraine. The cover story was that the Poles had been executed by the Germans, and that was Stalin’s position during the Nuremburg Trials. In order to maintain good relations with Communist Poland after the war, Russia was forced into some weak admissions – that perhaps the Poles were executed by rogue elements of the secret police without permission from the Kremlin. Only during the Yeltsin years was the smoking gun document handed to the Polish side. The Putin administration avoided any outright admissions of guilt and did not restrain a cult of “Katyn deniers,” who claimed that it was the Nazis after all who executed the Polish officers. Recent suits of Polish family members in Russian courts brought no satisfaction: there was too little evidence, the bodies had never been identified, and the culprits were long dead anyway.

Russia’s admission of guilt was issued for the purpose of improving relations between Poland and Russia. It has not been backed by an official statement by either Putin or Medvedev, but it is clear that the Duma would not have acted without their consent. The Duma’s admission should be the first step in a fairly long process. Russian authorities must rehabilitate the victims (who were executed for treason) and presumably offer their survivors compensation. This will not be an easy process. The Soviet archives suggest that thousands of case records were destroyed under Nikita Khrushchev. Moreover, the executions were carried out in a variety of locations (not only the Katyn forest), and the exhumation results so far have identified only a handful of victims.

Katyn will continue to sour Russian-Polish relations despite this considerable progress.

Tuesday, November 23, 2010

North Korea Provocations: Completely Predictable

Adm. Mike Mullen, chairman of the Joint Chiefs of Staff, recently said that North Korea remains predictable in its unpredictability. Mullen’s view is incorrect: North Korea’s unprovoked shelling of Yeonpyeong Island combined with its deliberate revelation of a formerly secret uranium enrichment facility are totally predictable. The North has a simple goal: They want legitimization of their regime (and indirectly the North’s next “beloved leader”) by being treated as an equal at a negotiating table with the United States. North Korea has learned well the lesson of all totalitarian regimes: aggressive behavior brings more rewards than cooperation. The shelling of Yeonpyeong Island (almost next door to South Korea’s international airport) was made even more predictable by the limp response to the North’s sinking of a South Korean naval vessel with substantial loss of life and national grief. It is now clear that the North is confident that renegade behavior can only result in benefits and no costs. This is a dangerous position for South Korea and the United States to be in, but both have themselves to blame.

Sunday, November 7, 2010

Where Is the Outrage? The Khodorkovsky Berlin Declaration

On October 25, 2003, Russia’s path to a totalitarian kleptocracy was cemented with the arrest of Russia’s wealthiest man, Mikhail Khodorkovsky, at Novosibirsk Airport. Khodorkovsky’s Yukos Oil Company was seized and was subsequently cannibalized by Vladimir Putin and his associates. On May 31, 2005, Khodorkovsky was sentenced to nine years in prison. Having served most of his time, Khodorkovsky is in Moscow waiting to be sentenced to a new term under new charges. He will likely not emerge from prison until he is an old man.

In dealing with Khodorkovsky, Putin has taken a page from Stalin’s book. Stalin charged his political enemies with imagined Nazi espionage, poisonings, and political assassinations. Although Yukos paid more taxes than all other Russian oil companies combined, Khodorkovsky was sentenced in 2005 for tax fraud. The fantastic new charge against Khodorkovsky is that he personally stole the entire production of Yukos – quite a feat, given that Yukos was audited by Price Waterhouse and its production accounted for.

Where is the outrage? Just as “a rich man will hardly enter the kingdom of heaven” so will Khodorkovsky hardly be granted the status of “dissident” or “prisoner of conscience” that he justly deserves. The Russian public and the world community take little notice of his political repression.

Khodorkovsky is indeed a political prisoner of Putin’s Russia. Among his political sins were to contribute his wealth to rival political parties and to set up charitable foundations for independent educational, scholarly, and political thinking. Such activities made him the most likely challenger to Putin. His greatest sin was to convert Yukos into a company run according to Western standards of management, accounting, and corporate governance. Yukos, under Khodorkovsky, was Russia’s most highly capitalized company, well on its way to achieving a market value consistent with its reserves. A “clean” Yukos could not be allowed to stand: It would lay bare the vast corruption dragging down the market values of other energy and mineral companies in the hands of Kremlin-friendly oligarchs.

Putin took other pages from Stalin’s playbook. While ordering the arrest and “turning over to the courts” of political rivals, Stalin also dictated their sentences, usually death. There is little doubt that Khodorkovsky’s new sentence will be dictated by “telephone justice” (a telephone call from the Kremlin). Putin is also copying Stalin’s public humiliation of political rivals. Khodorkovsky appears in court imprisoned in a glass cage.

Khodorkovsky was given fifteen minutes at the end of his trial to make a final statement. His words are worthy of considerable note:

“What must be going through the minds of the entrepreneur, or the senior manager, or simply an ordinary educated, creative person, watching our trial, and knowing that its result is absolutely predictable? The obvious conclusion is chilling in its stark simplicity: it is that the forces of power can do anything….Millions of eyes throughout Russia and the world are watching this trial … with the hope that Russia will still become a country of freedom, and law is above the bureaucrat. Where supporting opposition parties is not a cause for reprisals. Where special services protect the people and the law, and not the bureaucracy from the people and the law. Where human rights no longer depend on the mood of the czar, good or evil.”
Khodorkovsky chose not to take the easy path of other out-of-favor oligarchs by fleeing the country with much of their wealth intact, to luxurious residences and ownership of sports teams abroad. He was offered this option but did not take it.
“I am not a perfect person, but I am a person with an idea. For me, as for anybody, it is hard to live in jail, and I do not want to die there. But if I have to, I will. The things I believe in are worth dying for.”

To its great credit, Amnesty International Germany is using the occasion of Khodorkovsky's closing statement to present a "Berlin Declaration", signed by several prominent Germans to demand the end of "injustice" in Russia. The declaration has been signed by Nobel prize winner Herta Müller, actress Katja Riemann, Marieluise Beck from the Green Party and Markus Meckel from the Social Democrats. The declaration is to be delivered to the Russian Embassy after November 15.

To add your name to the letter below, email your full name, country of residence and profession with "Berlin Declaration" in the subject line.

http://www.khodorkovskycenter.com/news-resources/stories/add-your-signature-amnesty-international-germany-s-declaration-russian-injust

Wednesday, November 3, 2010

Obama's Defeat: View From Berlin

The eight PM Tagesschau (Show of the Day) on Channel 1 is the major source of news for Germans. On Wednesday November 3, the Tagesschau devoted about one third of its coverage to the U.S. elections. The grave announcer and the similarly somber Washington correspondent related that President Obama suffered a major loss. Pictures of Tea Party protesters dressed in historical garb were flashed across the screen to introduce German viewers to the “extremists” who were threatening to take over the Republican Party from its “reasonable” (vernuenftige) wing. There was a brief mention that the new Republican “radicals” wanted a smaller state, but the new constellation of Congress will result in “trench warfare,” “ideological battle,” and an attempt to repeal Obama’s major achievement – health care reform. The general tone was one of disbelief that the American voters could turn into such a mob of radicals.

Monday, October 25, 2010

The Fragile Chinese Communist Party

In our piece “Why Are the Chinese So Afraid of Liu Xia-bao” http://dailycaller.com/2010/10/15/why-are-the-chinese-so-afraid-of-liu-xia-bao/ Yuri YarimAgaev and I argued that the Chinese one-party monopoly is much more fragile than people think. The granting of the Nobel Peace Prize to a Chinese dissident, we argued, was a serious blow that could lead to ripple effects by emboldening others to speak out. This has already begun: Although the event has attracted remarkably little attention, more than five hundred prominent Chinese, almost all of them party members, signed an open letter demanding the end of censorship of the media and internet as a violation of Article 35 of the Chinese constitution. Many of the signers are retired party officials, whose positions are sufficiently elevated that they can be reprimanded only by the Politburo itself. Even more sensational, among the initiators of the open letter are the former head of Mao’s chancellery, the former editor of the People’s Daily, the former head of the central propaganda department, and the former president of the Beijing University for Politics and Law. More people signed their open letter than signed Liu Xia-bao’s Charter 08. At a minimum, this open letter tells us that there are indeed splits between reformers and hardliners in the leadership of the Chinese communist party, which faces a substantial turnover in leadership. If this is the case, China could be nearing a milestone similar to the USSR in March of 1985 when the Soviet Communist Party elected its first reform General Secretary, Mikhail Gorbachev.

Thursday, October 7, 2010

Comment on Michael Warren: Why Germany’s Unemployment Rate is Lower

Michael Warren in his article “Why Germany’s Unemployment Rate is Lower” concludes that Germany’s practice of Kurzarbeit (“short work”) is a primary factor behind Germany’s shrinking unemployment rate. On this, see: http://www.weeklystandard.com/blogs/why-germanys-unemployment-rate-lower

Kurzarbeit has been a part of German labor legislation since the days of Bismarck and the Weimer Republic. It was used on a massive scale in Eastern Germany after reunification, but its use as a counter-cyclical measure in 2008 and 2009 was unprecedented. Some 1.5 million German workers were on Kurzarbeit in this period. The number is currently about 800,000. If all Kurzarbeiter had been unemployed, Germany unemployment rate would almost have doubled.

We can contrast Germany’s Kurzarbeit with the implicit wage contract model used with negative effects by the U.S. auto and steel industries. With Kurzarbeit, a cyclical downturn means a reduction in work hours. Workers continued to be paid their regular hourly wage, but earn less because of the fewer hours. The lower earnings are subsidized around 60 percent by unemployment insurance and other subsidies. In the U.S. implicit wage contract model, cyclical downturns mean layoffs. Laid off workers do not seek other jobs because they are paid well above market wages, and it is better for them to wait to be recalled. Moreover, they receive unemployment benefits to cushion the income loss of the layoff. In both cases, employers benefit by not losing skilled workers who would have to be replaced with costly job searches and training during the upturn.

The Germans are learning that Kurzarbeit is not a panacea. Like U.S. unemployment insurance, it subsidizes not working and makes it more attractive. Like in the United States, political pressure results in extensions of benefits; so that Kurzarbeit threatens to become a permanent feature of the labor market even during upturns. Evidence of this is the fact that Kurzarbeit has spread into economic branches that were not affected by the downturn.

I would venture that Kurzarbeit is only one of several factors that explain the falling German unemployment rate. Other factors that could be equally as important are the growing use of Leiharbeiter (rent-a-workers) and the pretence that employees are independent contractors. Leiarbeiter are “rented” from intermediaries and can be hired and fired at will. Sham independent contractors (a prime example is truck drivers who “lease” their truck from their employer) fall outside of Germany’s strict and cumbersome rules on employee firing.

Why is it that Germany, with its Sozialstaat, has become so innovative in making its labor market more flexible? The German economy relies on export markets and is located next to cheap labor markets in the East. If German firms cannot compete with lower wage markets, firms and jobs leave Germany. There is therefore incredible pressure to find innovative ways to compete in export markets. Formal German labor market rules not only impose huge social benefits costs on employers. They make it very difficult to lay off or fire workers during downturns. For this reason, German companies are reluctant to hire new employees into jobs governed by these rules. Were it not for Kurzarbeit, Leiharbeit, and independent contracting, German unemployment would today be higher than those of the United States.

Germany is, in effect, becoming a dual labor market in which a shrinking number enjoy the vast benefits of the Sozialstaat and a growing number are working in highly competitive labor markets.

In addition to other responsibilities, the author is a Research Professor at the German Institute for Economic Research, Berlin.

Wednesday, October 6, 2010

Yes, Putin Fired Luzhkov

Some observers have written that Russian President Dmitry Medvedev was responsible for the September 28 firing of Moscow Mayor Yury Luzhkov. They interpret it as a bold move on Medvedev’s part to assert himself and lay the foundations for his presidential campaign in 2012.

I still stick to my original interpretation: Luzhkov was fired to remove the most viable alternative to Putin’s return to presidential power. Luzhkov was fired by Medvedev for the simple reason that only the Russian President has the authority to remove regional leaders. Putin assumed this ant-democratic authority during his presidency, and it is now being exercised by his proxy, Medvedev.

There is one simple reason why Medvedev will not be the President of Russia in 2012. He is not a member of the KGB club that runs Russia today. Putin installed former KGB officers in the key positions of government and industry to create a “KGB state.” In Russia, all changes at the top mean a reshuffling of positions of wealth and power. If Medvedev were to become president, a “purge” would occur. Medvedev would put his people in place and Putin’s KGB clan would be the losers. They will not allow this to happen.

The only interesting question is the timing of the Luzhkov firing. He was able to remain in this position so long because he was popular among Muscovites. He might be corrupt but he got things done. The summer forest fires around Moscow dented his image as an efficient administrator. His popularity rating had sunk to thirty six percent by summer’s end. The timing was right for his removal and Putin moved swiftly.

Although Luzhkov vowed to fight on, his actions after his firing are telling. He resigned from United Russia, a party he helped found, and he is complaining loudly about the sorry state of Russian politics, without really doing anything. These actions underscore the complete monopoly of power of the Kremlin.

Tuesday, September 28, 2010

A Comment on Germany's Health Care

Translation: Wife to fireman: "He is old and sick. He does not want to be a burden to the health care system." Fireman to man on ledge: "My respects. Your motives are noble." (Caption below: Be sure to select emergency personnel with care!)

Successions in Moscow, Pyongyang and Caracas

It has been a remarkable three days. In Moscow, Russia’s third most important political figure, Yury Luzhokv, the long-serving mayor of Moscow, was unceremoniously sacked. In Pyong-Yang, the son of Kim Jong-Il was named a major general. In Caracas, the opposition to Hugo Chavez won some fifty percent of the popular vote and almost 40 percent of the seats in parliament. All three events tell us something about the most important political successions that lie before us.

Although Luzhkov was fired by President Dmitry Medvedev (who has the official power to remove regional officials), he was really fired by Vladimir Putin to rid the country of the one politician who could contest him for the presidency in 2012. Luzhkov was fired for corruption and incompetence. The corruption charge is true. Luzhov’s control over Moscow was so complete that he was rarely challenged on his wife’s wealth, who became a billionaire through Moscow city contracts. His standard response to questions: “I have nothing to do with my wife’s business.” Luzhkov took kickbacks from companies doing lucrative business in Moscow, some of which he turned back to the city. Incompetent he was not. Compared to other Russian cities, Moscow is one of the best run. It is notable that Luzhkov had to be fired, rather than accepting a face-saving position elsewhere. He chose to stand and fight. As a price for this defiance, he may be dragged through the courts and suffer the same fate as Mikhail Khodorkovsky, who will spend most of his adult life in jail. Luzhkov’s is a cautionary tale to any other regional official, most of whom have enriched themselves through their offices: “Moscow (Putin) is your boss. You can only keep your office and your riches if you are unhesitatingly loyal.” It is important for Putin that they all know this lesson as the 2012 election campaign begins.

North Korea is run by a military council headed by the “beloved leader” Kim Jong-Il. Although the North Korean Communist Party is a key element in the power structure, it is trumped by the military. In this sense, North Korea is unlike the Soviet Union, where the party kept the military on a short leash. It was Kim Jong-Il’s father who invented the family succession in a communist state. In 1980, the last party congress named Kim Jong-Il the successor to his father. Prior to that, in other communist states, the sitting leader could not allow even the mention of a successor for fear it would become reality. Accordingly, the deaths of communist leaders were usually followed by disruptive power struggles. The family succession ensures that the leader-father can continue without the threat of overthrow, expulsion or scapegoating. In North Korean, party congresses are called only when important decisions need to be rubber stamped. The upcoming party congress, which will be the first in three decades, is clearly being called to approve the first steps of the eventual transition of power. Family succession has now become standard fare in dictatorships (Raol and Fidel Castro, Assad father and son, the Aliev father and son and so on). At least the North Koreans added something to the repretoire of dictators.

The parliamentary elections in Caracas are either the last gasp of democracyor a rebound. Despite long odds, Venezuelan voters cast as many or more votes for anti-Chavez candidates as for his supporters, despite the bullying, machinations, and corruption of the Chavez machine. The election left Chavez short of the supermajority required to allow him legally to rule by decree. The most likely outcome is that democracy’s days are numbered. Chavez can spin the election to his advantage (“I still have the most seats in parliament”). Despite an economy in shambles, sporadic electricity, and food lines, Chavez had avoided what would have been a disastrous defeat in the case of a fair election. If I were to guess, I would venture that yesterday’s election was democracy’s last gasp.

Saturday, September 18, 2010

The Mystery of Russian Grain Exports: It’s the Prices, Stupid!

A Soviet joke: A hick from the north is asked by his friend to bring back meat from Moscow. “I don’t know Moscow,” he responds. “How do I find meat?” Answer: “Just go stand in the longest line you can find.” The original punch line: The hick returns with no meat. He spent all his time standing in the line at Lenin’s mausoleum! My new punch line: The hick returns without meat and tells his friend: “I have brought you bread, instead.” Most readers will not understand what is going on. It is a joke because bread was the one food product you could buy anytime and anywhere. My joke sheds light on why Russia (and Ukraine) are again major grain exporters, despite the fact that grain production is no greater than in the 1970s and 1980s when Russia was a major grain importer. It also explains one of the reasons for the collapse of the USSR: the fact that low bread prices imposed huge costs on the Soviet state, exceeded only by its huge defense burden.

Let me start with some facts: Russia became Europe’s breadbasket in the 1870s. It was only around the turn of the century that the United States matched Russia in grain exports. Under Stalin’s rule, agriculture was collectivized and the best peasants deported, imprisoned or killed. By 1972, the Soviet Union started importing huge quantities of grain from the United States and other countries, driving up world food price throughout the rest of the 1970s.

Agriculture has been slow to reform after the breakup of the Soviet Union. The rural population is old; it is still not legal to buy and sell agricultural land; and there have been no substantial new investments in agriculture. Russia, in the last three years, has averaged around one hundred million metric tons of grain; The Russian Republic’s contribution to USSR grain production was also about one hundred million metric tons in 1985, a year in which one fifth of grain consumption had to be covered by imports.

Contemporary Russia has transformed itself from a grain importer to exporter not because it is producing more. It is consuming less grain domestically, leaving a “surplus” for export. Skeptics may say that this is a sign of poverty, that the Russian diet is deteriorating. It is the opposite: Russians no longer have to make do with just bread. They can buy what they want with the money they have. For the older generation, this is a novelty. In the Soviet period, the state set food prices low. After all, this was a worker-peasant state and food should be affordable to all. Low food prices were not simply an act of benevolence on the part of the leadership. Attempts to raise food prices were met with bloody riots, such as in Novocherkassk in June of 1962. After 1962, there were no more attempts to raise food prices, except by stealth. Party leaders could not forget that the Bolshevik Revolution began with bread riots in March of 1917. Communist functionaries thereafter lived with fear of a bread riot in their district. Near the end of Gorbachev’s chaotic rule, rumors of shortage could still empty bakeries of bread.

At low food prices, consumers had to stand in line for just about everything. They often returned home without the goods they wanted, but at least there was always bread, which cost only a few kopeks. Bread was like a safety valve into which unspent food money flowed. In effect, the Soviet state had an implicit contract with the people that they could always get cheap bread, no matter what. Cheap bread, however, also met waste. Throughout the Soviet period, there were accounts of peasants feeding bread to hogs.

This implicit contract sounds noble, but it had unintended consequences that hastened the end of the Soviet Union: It caused the USSR, with some of the richest agricultural land in the world, to become a grain importer. State agricultural subsidies became the second largest item (behind defense) in the state budget. Food problems revealed to Soviet citizens the weaknesses of the system.

The commitment to make bread available to all at a dirt-cheap price meant that there had to be enough of it. In terms of real economic costs, Soviet bread became among the most expensive in the world. Because its retail price was below the cost of production; state subsidies to state and collective farms equaled around four percent of GDP (more than the cost of running the entire government). Even that was not enough. There was no way Soviet agriculture was going to produce enough grain to satisfy the artificially-inflated domestic demand. Starting in 1972, the Soviet Union began to import large quantities of grain, which it paid for with foreign credits and energy exports. These policies made the contradictions of the Soviet system apparent to all: The country that should have been the bread basket of Europe was forced to import grain, paying for it with its earnings from the one product that it could sell at a profit in world markets – energy. When world energy prices were low, the Soviet Union had to borrow from the West, accumulating foreign debt that reached alarming proportions by the standards of the time. All of this to make sure that any and every family could buy bread for kopeks.

We economists (not all) tend to preach the “allocative efficiency” of market prices. We warn that rent controls, subsidized interest rates, and other interventions into the price system have unintended consequences that overwhelm the original “good” intention. In the case of Russia, the almost incalculable unintended consequences are evident from a “natural experiment.” We see a Soviet Russia with low prices of food products but bread prices are particularly low. We then see a Russian Federation with market prices for food. In both cases, the domestic production of grain is about the same. In the Soviet case, food subsidies consume a large portion of the state budget, scarce foreign exchange is used for grain imports, foreign debt is piling up, and people cannot buy the food products they want. In the Russian Federation case, food subsidies have disappeared, the country is earning foreign exchange not only from energy but also from grain, foreign debt is being repaid. In the Soviet Russia case, the country is hostage to grain suppliers. In the Russian Federation case, Europe is hostage to Russian natural gas supplies and world grain prices are affected by Russia’s export policies.

There will be a sequel to this piece. It shows that Russian agriculture is still in the early phases of reform. It is producing about the same amount as it did during the disastrous Soviet period of collective and state farming. When Russian and Ukrainian agriculture reach their potential, world grain markets will be changed forever. We do not know how long we will have to wait to see this happen.

Putin 2012? Should There Be Any Doubt?

The media is abuzz with Vladimir Putin’s new “Putin2012” web address. This, along with other hints that he has been dropping, reveal that he intends to return to the presidency in 2012. Another hint is that the state-controlled media has begun a campaign of innuendo against Moscow Mayor Luzhkov, one of Putin’s few possible rivals in an election campaign.

We really do not need such hints and maneuvers to know that Putin will seek to return to the presidency in 2012. The simple reason is that he cannot afford not to. There has been one succession since Russian independence: the handover of power from Boris Yeltsin to Vladimir Putin as the last century ended. It now appears that the second succession was no succession at all. Dmitry Medvedev was put in as a place holder until Putin can constitutionally return to the presidency. Notable about Medvedev is that he does not have KGB ties in a state run by former KGB officers. As such, he lacks the power to go against Putin in the 2012 presidential election.

Putin must remain in power because this is the only way he can protect himself from future unpleasantness. The deal that the Yeltsin family and Yeltsin-favored oligarchs struck with Putin and the KGB was that they would not prosecute Yeltsin or his family and that the oligarchs could keep their business empires. Putin kept the first part of the deal, but he removed all uncooperative oligarchs – either to jail or to posh exile in London.

Putin must now ask himself whether he can strike a credible deal with an incoming regime for himself that will insure him the same two things – freedom from prosecution and keeping the enormous wealth he has secretly accumulated in the course of his presidency. The answer is no. Putin could not be sure that a new regime might find it in its interest to go after him at some point. Perhaps, the new leaders will need a scapegoat to explain why things are not going well. He understands it will not matter whether the new leaders are his “best friends” or not. As Stalin used to say: “Friendship is friendship but business is business.”

Putin is chained to the office by the same lack of rule of law that makes other types of contract enforcement impossible. In an authoritarian/totalitarian state, whoever is in power is the law, and is free to change the law at any time. There would therefore be no mechanism for Putin to enforce a contract with a new regime.

Tuesday, September 7, 2010

Do We Need a New Economics 101?

As we began to write our Principles of Economics text (Roy Ruffin and Paul Gregory, Principles of Economics) exactly thirty years ago, economics was in disarray, shaken by the stagflation that was not supposed to be. Ours was among the first to introduce the new ideas of the 1980s -- rational expectations, Barro-Ricardo equivalence, the natural rate of unemployment, moral hazard, and new Keynesian economics. At that time, Economics 101 was taught, with few exceptions, the unabashed Keynesianism of Samuelson and McConnell. Principles textbooks are intended to give a sense of the state of economics. Selected by committees, they must at least try to give a balanced viewpoint. Although labeled “conservative,” our text garnered strong sales for a decade. We must have done something right.

Will the deep recession, which likely ended in late 2009, require a rethinking of economics, as did stagflation? Compared to other economic downturns of the past forty years, the current recession definitely stands out. Its probable 20-month duration is greater than the previous peak of 16 months (and the 40-year average of 11 months); its peak unemployment of 10.2 percent was exceeded only by the 10.8 percent of 1981-82 (The 40-year average was 7.8 percent); and the 4.1 percent loss of output well exceeds that of previous recessions. Moreover, it follows a long period of economic growth, interrupted by extremely mild recessions, dubbed “the Great Moderation.” The current recession, despite its severity, pales in comparison to the Great Depression with its 25 percent unemployment rates and loss of a quarter of GDP. The threat of a repeat of this catastrophe was remote, although politicians could not resist invoking its image.

In 1980, policy makers despaired that “the rules of economics were no longer working.” The Phillips Curve had taught that we had a policy choice of inflation or unemployment and had no instructions for when both rose at the same time. Rational expectations provided the new paradigm: As inflation crept up due to the energy shocks of the 1970s and central banks created more money to combat the resulting unemployment, people began anticipating higher and higher inflation, which led to the incredibly high interest rates of the late 1970s and early 1980s. The new policy prescription was that inflationary expectations had to be beaten by a draconic and steady policy of monetary restraint, despite its negative effects on GDP and unemployment. A more positive message was that inflationary expectations could change quickly and in a positive direction if people became convinced that economic policy would be enlightened and consistent.

Complaints are again being voiced that “the laws of economics are not working.” Despite easy money, zero interest rates, and massive increases in government spending, unemployment rates remain high, and consumer and investment spending remain anemic. We may still face a double-dip recession. Are we, in 2010, facing a “new” phenomenon similar to stagflation of the late 1970s? Do we need entirely new ways of thinking? Can “contemporary” economics can explain these recent policy disappointments. Let us examine each of these failures to determine if they were expected or unexpected.

1. The failure of the fiscal stimulus to raise output and employment.

The Obama administration’s assurances that increased federal spending would have a potent effect through the multiplier have not proven to be true. This is not a surprising outcome at all. Contemporary economics long cast doubt on the multiplier – the notion that $1 of extra government spending would raise GDP by more than a dollar. The Keynesian multipliers of Samuelson and McConnell apply to an economy in which wages are stuck, and there is an almost infinite supply of workers prepared to work at going wages. Unemployment could therefore not be reduced by lower wages. In such a circumstance (that Keynes thought to apply to deep depression), increases in government spending have magnified effects on output and employment. (Much of “modern” Keynesianism is therefore about finding reasons for sticky wages in today’s economies). In contemporary texts, aggregate supply and demand replaced the Keynesian multiplier. The steeper the positive slope of the aggregate supply curve, the smaller the effect of a stimulus program. Moreover, the more the effects of stimulus are anticipated, the smaller its effect. We decided in 1980 (with surprisingly little resistance) to drop the multiplier from our text. It is therefore surprising that the Keynesian multiplier has played such an important role in the current policy debate. Is this again an example of Keynes’ warning that we are hostages to the outdated ideas of dead economists? The demise of the multiplier is not the only reason for questioning fiscal stimulus. The Keynesian model assumes that public debt does not affect consumer behavior. The Barro-Ricardo equivalence theorem teaches, to the contrary, that deficit spending can be offset as people cut private spending to prepare for tax increases that are sure to come. The current increases in private saving that have accompanied today’s soaring deficits are striking confirmation of this proposition. There is yet another effect: government spending “crowds out” private spending (More government spending for education or medical care mean less private spending for both). This “crowding out” may be particularly strong today as the government expands into more activities that were traditionally the responsibility of private individuals.

2. The failure of Obama’s 2009 tax rebate to stimulate private spending.

The textbooks of the 1980s introduced the Friedman-Modigliani permanent income hypothesis, which taught that temporary changes in current income (such as from a one-shot tax reduction) have no effect on consumer spending. Indeed, this proposition has been substantiated in the many failures of temporary tax cuts from the administrations of Johnson (1968) to George W. Bush (2001, 2008). Short term tax rebates remain politically appealing despite the evidence of their impotence because they show a government “doing something” about the economy. We have sufficient evidence to conclude that only tax changes that are perceived to be durable affect real outcomes. Hence, Friedman-Modigliani predicts that a one-year (or even two year) extension of the Bush tax cuts will have little or no impact on consumer spending. If anything, economists should have been surprised if the tax rebates of 2009 had had any effect whatsoever. Any positive impacts of the 2009 tax rebates would have been swamped by the persistent chatter about higher taxes – on energy, the expiration of the Bush tax cuts, “hidden” taxes associated with health care, value added taxes, and eliminating the cap on social security taxes.

3. The persistence of high unemployment.

The administration’s economic advisors were clearly unduly optimistic about unemployment. The textbooks of the 1980s substituted the natural rate of unemployment (of Friedman and Edmund Phelps) for the crude Keynesian concept. The natural rate hypothesis placed unemployment in the context of cost-benefit analysis. If the costs of remaining unemployed are high, the unemployment rate will fall. Hence, if unemployment compensation is generous and long lasting, the unemployment rate will remain higher than it would have otherwise. In fact, empirical studies found that unemployed persons remarkably found jobs just as their unemployment benefits were expiring. Other studies showed that the higher unemployment in the European welfare states was partially due to unemployment insurance becoming an entitlement. Admittedly, it is politically difficult to place time limits on unemployment insurance, but the administration’s extensions are on the verge of making unemployment insurance a permanent entitlement.

4. The lack of private investment and job creation.
Keynes wrote “in the long we are all dead.” His multiplier is dead, but his writings about uncertainty and investment remain as relevant as the day they were written. Keynes emphasized in his writings about “animal spirits” that business expectations can shift quickly. As businesses become pessimistic, they cut back. The future is always uncertain, and the greater the uncertainty, the fewer investments and the fewer workers hired. We live now in a world of great uncertainty. We do not know our future tax liabilities; businesses do not know what their employee health care costs will be. Boards of directors are less free to make compensation decisions; government bureaucrats now increasingly do either directly or through political pressure. Businesses cannot calculate their bottom lines and until they can, their best strategy is to sit tight. Lenders with first claims to assets have been told to go to the back of the line in some cases; others have been told to renegotiate mortgages. The result: little investment and little lending. In a word, businesses fear that the rules of the game are being changed by an administration that is unfriendly to them. These points are not to be found in Economics 101 textbooks. They are evident and have been with us since Adam Smith and before. Our main economic message to countries with poor institutions is to settle on reliable rules of the game; we have not followed our own advice. In my view, this is the main reason for the “failed” recovery.

The last three years will be dissected and analyzed by generations of economists. Their main question should be why the “Great Moderation” ended with such severe consequences? Was this a failure of private markets or public policy? We already know the immediate cause: the abrupt end of the housing price bubble and the associated collapse of mortgage and security markets worldwide. Some one half of private wealth in the United States was in home equity. The collapse of this wealth would inevitably bring the entire economy down with it. But were these events the result of market excesses or policy blunders? The argument for market excesses rests on the failure of asset markets to properly value risks. The argument for policy failure rests on the deliberate use of public institutions to underwrite high risk mortgages with the aim of making Americans home owners whether they could afford it or not. For a long time, we were warned that public lenders (Fannie and Freddie) were technically insolvent, but few law makers were willing to pay attention, on either side of the aisle. The textbooks of the 1980s introduced moral hazard. Applied to financial markets, moral hazard rears its head when lenders assume that a lender-of-last resort will bail them out. They therefore take risks they otherwise would not have. With moral hazard, it becomes extremely difficult for private markets to value risk because of moral hazard and the fact that the outcome depends on unpredictable government actions and reactions.

There is no need for a new Economics 101. What we have experienced over the past two years is nothing new. There is nothing unexpected that has happened. Events however should serve as “teachable moments. What is surprising is that Keynesian economists do not seem to have learned its lessons.

Paul Gregory is the co-author with Roy Ruffin of Principle of Economics, the first edition of which appeared in 1982 with Scott, Foresman.

Preserving History: The Strange Case of the Lakoba Papers

The N. A. Lakoba papers, one of the most fascinating collections at the Hoover Institution Archives, contain the personal papers of one of Stalin’s closest friends, Nestor Lakoba, the party boss of Abkhazia (now part of Russian-occupied Georgia) and Stalin’s host on his frequent visits to the Black Sea resort of Sukhumi. The crown jewel of the collection is Lakoba’s personal photo album, filled with candid pictures of Stalin and his retinue hunting and fishing; it also contains Lakoba’s personal papers, including his official health certificate, which indicates that he was almost completely deaf. Most documents are in Lakoba’s own hand, including his personal notebook containing his candid musings. Secret correspondence with and reports from his informers reveal his concern about encroachments on his authority by political rivals, including Georgian boss Lavrenty Beria.

Shortly before Christmas 1936, Beria poisoned Lakoba during a dinner in Beria’s home. Lakoba’s body was returned from Tbilisi to Sukhumi by special train; he was buried with full honors in the Sukhumi botanical garden. Beria was among the mourners, somberly carrying a funeral banner in honor of his old friend. In the aftermath of the murder, Lakoba’s extended family was either executed or imprisoned, and those associated with him were accused of being part of his plots to kill Stalin and other Soviet leaders. Before their arrest, the family, having learned of Beria’s plan to burn the body to destroy evidence of the poisoning, secretly reburied his body in an undisclosed location, presumably near his home village. Despite torture, Lakoba’s wife took the secret to her grave.

In reading the autobiography of Lakoba’s sister-in-law (more than a quarter-century his junior), I came across the following account of how the Lakoba family saved his archives from Beria’s grasp and certain destruction:

“In this difficult time, Saria [Lakoba’s wife] and Musto [her younger brother] succeeded in saving Nestor’s archive. In the presence of witnesses, they burned in the courtyard letters from Trotsky and other dangerous letters. Other documents they placed in a box, which they packed in thick paper and then hid in a hiding place under the floor of their house. When Musto [one of the few to survive] returned from prison and exile in 1955, he found that their house had been turned into a dormitory of a technical institute. The package was not in the secret hiding place. Workers, who remodeled the floors, had found the box. Musto began a personal investigation of its whereabouts. He learned that it was in the possession of local authorities (who did not understand what it was), and to his astonishment the box was returned to him. To his surprise, the archives was remarkably well preserved. After Musto’s death, the archives went to his son.”

Lakoba’s sister-in-law thus provides us with one link in the chain of events that eventually brought the Lakoba archive to Hoover and tells us that the family burned documents that it felt would be incriminating, such as the correspondence with Trotsky. The candid photos of the vacationing Stalin have been widely reproduced in many books on Stalin. The collection is also a valuable source on the history of Abkhazia, which, even in Lakoba’s time, had separatist tendencies. Abkhazia and its capital city, Sukhumi, today have a government appointed by Putin and are occupied by Russian troops.

When I read through the Lakoba archive in July, it was in the hands of the capable Hoover Archives preservation staff, who were applying preventive care to the eighty-year-old photographs. It is fortunate that the Lakoba archive ended up at Hoover. In a poorly funded Russian state archive, there is no telling what its condition would be today (or if it would even be accessible).

Thursday, August 19, 2010

General Motors "Profit"

We are being told that the turnaround in General Motors profit is a remarkable success for its management and for its majority shareholders (the US and Canadian governments), who now hold about seventy percent of its stock. Over the last six months, GM has earned $2.1 billion in profits versus the thirteen billion it lost over the same period last year.

The "secret" to GM's success is evident from its income statements. From January 2009 to its takeover on July 7, GM paid $16 billion in interest payments. From July 8 to year end, it paid $5 billion. For this period, its expenses were thus reduced by $11 billion as its debt was converted into shares owned by the U.S. and Canadian governments. Without this equity bailout, GM would still be losing almost $9 billion, instead of its reported profit. Notably, there has been no reduction in GM's pension liabilities to its workers.

It seems to me that just about any company could achieve such a turnaround if the government were willing to take its debt and convert it into shares.

Tuesday, August 17, 2010

The Low Cost of Korean Unification

The Korean President has proposed a reunification tax to prepare for the presumed high cost of Korean reunification. The North has predictably responded with anger and saber rattling. Many of the Korean scholars I have met in Germany believe, on the basis of German experience, that the costs of their reunification would be high, perhaps prohibitively so. The German experience, however, is not an appropriate benchmark for Korea for a number of reasons.

First, the German constitution’s federalism laws call for equal treatment in transfers among the states and also German labor unions demanded wage equality between East and West despite huge productivity differentials at the time of reunification. These two features meant that East Germans had immediate access to Germany’s generous welfare state and that East Germans were required to be paid wages well in excess of their productivity. The result has been persistent and exceptionally high unemployment in the East. In the Korean case, there are no constitutional requirements for equal transfers that I know of. Also the South Koreans can learn from the German experience and avoid the mistake of requiring wage equality between North and South. Another factor is that social welfare transfers in the South are a small percentage of total government, unlike the German case where they are the dominant state expenditure.

Second, East Germany had a large industrial sector, in fact, the most advanced in the communist bloc. After an initial period of optimism, Germany learned that, rather than bringing money into the state budget, former Eastern state enterprises required large subsidies to keep in business and then close down. North Korea has largely an agricultural economy that has been ruined by state and collective farms. We now have the experience of China, Russia and Ukraine that shows that agriculture recovers quickly once freed of collective and state farms. North Korean agriculture will quickly become an asset as opposed to a liability. As its productivity increases, living standards in both the North and South will increase.

Third, German reunification was accompanied by an immediate opening of borders. Although population transfers occurred, they were limited by the equalization of wages and benefits. In the case of Korean reunification, it would seem that borders would have to be opened gradually in light of the huge living standard differentials. Although such a policy might be regarded as harsh, the desperate welfare situation of the North could be immediately remedied, again at relatively low cost. Under any circumstances, the welfare of the population of the North would be improved by a huge factor.

Fourth and finally, there is an implicit and substantial cost to the South of having an unstable nuclear power next door. Although the probability of a nuclear holocaust is low, the cost to the South of such an event would be astronomical. Weighed against the expected-value cost of such a disaster, any economic cost of reunification would be small.

Thursday, August 12, 2010

Russian Agriculture: The Story No One is Telling

Drought will cut Russia’s grain harvest by one quarter. Vladimir Putin, in a burst of populism, bans the export of grain. Grain futures rise in world markets. These headlines obscure a much larger story that no one is telling: Russia, twenty years after the collapse of the Soviet Union, is feeding itself with grain left over to export. Prerevolutionary Russia’s black-earth zone was the breadbasket of Europe. Contemporary Russia is on the path to reclaiming this title.

After Stalin defeated his last opponent in 1929 – Nikolai Bukharin, the proponent of private agriculture -- Russian agriculture collapsed. Russian and Ukrainian peasants were forced into collective and state farms, where they had no incentive to produce. The Soviet Union was forced to admit its agriculture was broken in July of 1972, when it began massive purchases of U.S. wheat, driving up agricultural prices worldwide. Russia had to purchase grain abroad despite the fact that it was spending more than four percent of its GDP on agricultural subsidies.

What has caused this spectacular turnaround that no one has noticed? Is it shining new tractors and combines? Is it new agricultural technologies? No. The answer is that market forces are again directing Russian agriculture. Farmers have turned their backs on collective and state farms. There are again incentives to produce. Food is again being distributed by markets and not the state. Instead of standing in line for food products that are priced ridiculously low, Russian consumers pay market prices and weigh carefully what they buy. Food is no longer a “free good” that no one can get.

Consider the effect of the return to market agriculture on the Russian people. The great Soviet famine of 1932-33 saw a loss of grain output of around twenty percent – a similar figure to the predicted decline of this year. The immediate result was the loss of six million or more lives. Russian-Ukrainian relations still suffer from the aftermath of the great holodomor. In 2010, the worst that the Russian people face is higher food prices. Russia is part of the world economic community. In the worst case, it can import grain this year and resume exports when weather conditions return to normal.

Wednesday, July 21, 2010

The New Russian Security Law: A Return to Stalinism?

Stalin used the notorious “Article 58” to execute or sentence to the Gulag his political victims. Article 58, which was continued under his successors, was applied against people thought to be considering crimes against the state or having the wrong nationality or background. A “crime against the state” could be virtually anything including a “thought crime” or “any act that diminished the economic and social achievements of the state.”
My book “Politics, Murder, and Love in Stalin’s Kremlin” The Story of Nikolai Bukharin and Anna Larina” tells the story of the “crimes” of Stalin’s most prominent victim and his young wife. It is a cautionary tale that says that “benevolent” dictators are rare, despite the current favorable press of the Chinese Communist Party.
The Russian parliament will shortly pass a new state security law, which is reminiscent of the notorious article 58. It gives Russian security services (the FSB which succeeded the KGB) sweeping powers to question people about crimes that have not yet been committed. The fear is that the law will be used to threaten Kremlin opponents, investigative journalists, and businesspersons. These “prophylactic” measures, as they are called in Russian, may also be applied in cases of “state secrets,” where the FSB defines what a state secret is.
Despite the current warming of US-Russian relations, this law confirms that Russia is a “KGB state”. Its state, industry, and media are controlled by former KGB officials with the former head of the KGB, Vladimir Putin, at its head. This fact speaks against a long-term improvement in our relations with Russia.

Saturday, July 3, 2010

Russian Spy Ring: Second Thoughts

The mantra of the press in both the United States and Russia is that the Russian spy ring was not doing any real harm and, if anything, such a comic-opera operation spoiled the reputation of Russia’s intelligence services. It was no more an embarrassing laughing matter that should be shrugged off so that the two countries can go about mending their relations. This was my first reaction as well (see my previous post). I am rethinking my position, while not abandoning my first depiction of the spies’ activities as keystone cops. Why?
First: Russia is now a KGB state. Its head of state is a KGB colonel (Putin: There is no such thing as former KGB). Its economy, state, and media are run by former KGB associates, who have amassed massive wealth and power. As a closed fraternity, they act alike and think alike. Their formative years were spent in the groupthink of the KGB. An intelligence operation of this scope and breadth would have had to be ordered and supported at the top. There is not such thing as a “rogue operation” on this kind of thing. It must have been ordered by Putin himself.
Second: Unlike the Soviet period, there are no constraints on Russia’s new KGB state. In Soviet times, the party stood over the KGB and Soviet rulers from Stalin to Gorbachev were careful to keep it on a short leash. When the NKVD under Nikolai Ezhov threatened to get out of hand during the Great Terror, Stalin stepped in and executed him. When party leaders feared Lavrenty Beria’s power after Stalin’s death they executed him. In contrast, the new KGB state can pretty much do as it wishes without constraints. It is the direct “armed weapon” of the supreme Russian authority, but the supreme Russian authority is itself. As such, it operates without concern for the consequences because indeed there are no consequences. It can openly poison opponents with plutonium; it can assassinate Chechen leaders abroad, it can assassinate uncooperative journalists and never find their killers. It can seize assets of international concerns operating in Russia. All their actions are without consequences.
Third: Russian spying operations would indeed be directed against its greatest perceived enemy – the United States. It would be important for Russia to know our secrets. Russia regards the US as its major enemy because it fears that the US wishes to peel away those countries that fell under its direction in the Soviet period, such as Ukraine, Georgia, and Central Asia. Let us remember Putin’s quote: “The greatest tragedy of the 20th century was the breakup of the Soviet empire.” It also fears a real missile defense system which neutralizes Russian missiles under the guise of protecting ourselves against rogue nations. Although we can cooperate in a number of areas, there are core areas of dispute. As far as Russia is concerned, these core problems will not go away in the near future. Because of the long term nature of this conflict, it makes sense for Russia to implant spies under long-term deep cover.
Fourth: The keystone cops nature of the Russian spy network may be explained by KGB group think, which suggests that all societies have “secrets” that are hidden from the rest of the world. In the USSR, an incredible number of things were classified as secret; the number was so large as to defy credibility. Thus there was a huge chasm between private and public information. Russian scholars have reason to fear restoration of broad definitions of what is secret. The KGB group think cannot really comprehend an open society, enhanced by an open internet. Nowadays, there are few things that are not publicly available. The think tanks that the Russian spies targeted compete among themselves to make available the policy advice they are giving. Placing ten or so spies under deep cover in the hope that they one day discover important intelligence makes sense only if one understands this element of KGB group think. If there are many “secrets” out there, a small number of spies will find them.
Fifth: With the end of communism in Russia, Russian spies no longer have distinct targets of opportunity. This makes the task of deep-cover spies exceedingly difficult. In the old days, they could hope to recruit important members for the communist party, infiltrate unions, newspapers, or Hollywood. They could use past party membership for blackmail. Now the targets of opportunity are poorly defined. Whom should they target? Graduate of Kennedy School? Bond Traders? This means that if you are employed as a spy, you will have great difficulty in finding “deliverables” to justify your pay and expenses, which appeared to be the case with e Russian spy ring.
Finally: The fact that the Russian deep cover spying operation appears inept does not detract from the seriousness of intent. This operation was authorized at the highest levels; it was expensive at a time when international reserves were scarce. Such attempts will be repeated in the future only perhaps in a much more effective form. Hundreds of thousands of Russians live in the United States. It would have been a better strategy to try to recruit those who actually have access to influence or special information.

Tuesday, June 29, 2010

Russian Spies: OK But Keystone Cops?

Contemporary Russia is a KGB state, as the cover of The Economist informed its readers a while back. Vladimir Putin cut his teeth as a KGB operative in Berlin. Much of the Russian state, finance, and industry is run by former KGB agents. The official website of the KGB’s successor organization, the FSB, trumpets the bravery and bravado of agents who thwarted and continue to foil the West’s evil plans. Why should we be surprised that Russian agents are spying in the United States, some apparently under deep cover? In fact, the story makes eminent sense. Putin and the KGB resurgence dates back to the 2000, the year the arrested agents began their deep cover in the United States. Only back then, Russia had less cash than it has today.

What is unexpected is what the new Russian spies appear to be doing. Infiltration of Think Tanks would not seem to yield secret information of value. Our Think Tanks compete among themselves for the attention of policy makers with their prolific working papers and publications. Any respectable foreigner can walk in the front door and ask for such information without much of a fuss. Not knowing about our nuclear secrets, I cannot comment on what Russian spies can learn by learning them. The accounts in today’s press remind one of Graham Greene’s Our Man in Havana, which describes the machinations of a “spy” who fabricates elaborate plots, secret drops, and the like to justify the money he receives. Russia’s spies seem to face a similar problem in convincing their superiors in Moscow to buy them houses and reimburse their vacation travel.

When more comes out, I may stand corrected, but my first impression is that of a Keystone Cops movie.

Saturday, June 26, 2010

Medvedev in Silicon Valley: Do Not Fall For It

The Russian President visited Silicon Valley last Wednesday (June 23). His aim: To establish a Russian silicon valley outside of Moscow. He wanted the assistance and capital of Silicon valley. As usual, Medvedev emphasized that a rule of law would be established in Russia to safeguard foreign investment. Our experience to date in Russia is that promises of a rule of law are cheap. Delivering on that promise is expensive. As I write this piece, Khodorkovsky is still in jail in Siberia, now accused of stealing virtually all the revenue ever generated by Yukos Oil company. BP, ExxonMobil and other energy concerns are rewarded for their billions of dollars investment with de facto expropriation by environmental or tax authorities. Since Russian independence, there are few, if any, western companies, that have earned returns on investment commensurate with the risk. Under Putin, the largest and potentially most-profitable companies are now run by the state either directly or indirectly. The Russian mindset has always been to reserve the real profits for ourselves. If a western venture is about to earn a substantial profit, we must find a way to take it away.

I assume that these lessons are not lost on Silicon Valley. My advice is for them to stay away until that goal on the distant horizon is reached -- a true rule of law.

Thursday, June 24, 2010

Why the Worst Rise to the Top: Hayek, Stalin and Bukharin

Hayek in his renowned Road to Serfdom argued that administered economies tend toward dictatorship and that the dictator is unlikely to be benevolent. Indeed, benevolent dictators are a rarity, which does not prevent some development economists from pitching benevolent dictatorship as the quickest path to growth.

My “Politics, Murder, and Love in Stalin’s Kremlin: The Story of Nikolai Bukharin and Anna Larina” (Hoover Press, 2010) is one of the first case studies of why the “worst gets to the top.” It uses archival evidence of verbatim party debates, transcripts of interrogations, and correspondence to describe the uneven struggle for power between Stalin and Bukharin, the proponent of a form of market socialism. This case study shows that the “soft” Bukharin was no match whatsoever for Stalin who was prepared to use any and all means for as long as needed to win. Whereas Bukharin used theoretical arguments, Stalin used intimidation, appointments, and the distribution of spoils.

My account shows that until July 1928 Bukharin had a considerable following in his fight against Stalin’s application of force to the countryside. Bukharin fought Stalin to a standstill in the July 1928 plenum, but was tricked into signing a “unity statement” to show the party that the Politburo was united. Bukharin knowing that Stalin would renege on the compromises he made at the plenum was tricked into meeting with a disgraced ally of Trotsky in which he revealed the deep fissures within the Politburo to an outsider. Stalin’s agents knew of the meeting, and Stalin now had the evidence he needed. Bukharin was charged with “fighting against the will of the party.” With such a charge pinned on him, the disgraced Bukharin’s political career was over. Thereafter, he public comments in party forums were meet with jeers and disdain.

After his decisive political defeat in 1929, Bukharin attempted to withdraw from public life. He refused to see his former allies. It was his hope that “good behavior” would save his life. This hope was dashed with his death sentence in March of 1938 at the final Moscow Show Trial.

Wednesday, March 17, 2010

When Will China Join the Also Rans?

We better foresee small than big changes. Transitory fads and group think divert us from recognizing obvious signs. In the 1930s, we -- mired in the Great Depression -- were taken in by “heroic” successes of Stalin’s five year plans. In the 1950s, we were alarmed by Sputnik and Nikita Khrushchev’s “We will bury you” boasts. In the 1960s, we dispatched congressional delegations to learn from Germany’s consensus economy and France’s Planification. The 1980s saw the glorification of Japan’s unerring industrial policy and its lifetime labor contracts. In each case, the model which we worried would bury us or admired returned to earth. The Soviet Union is gone after an extended “period of stagnation.” Congress had to form special committees to explain why so few saw this coming. Germany and France are plagued by stagnant growth and high unemployment. Japan has experienced economic stagnation for more than two decades and sees no end in sight.
We now admire the Chinese model. We are told that its technocratic monopoly party makes rational decisions that guide it unscathed through storms of financial crisis and recession. Unlike the clumsy west, it knows how to build roads, whole new cities and stage Olympics – no dithering around with messy democratic decision making. We are now recycling calculations of when our rival will overtake us – only this time round it is China and not Russia.
In all these cases, we actually had the basic insights to foresee the future. Already in the 1920s, Ludwig von Mises and Friederick Hayek explained in painstaking detail why Soviet planning could not work. The postwar German and Japanese Wirtschaftswunders resulted from the technology chasm that had opened vis-a-vis the United States and from the reopening of world trade. Japan’s vaunted industrial policies floundered as it bet on the wrong technologies in an increasingly complex industrial economy.
Nobel laureate W. Arthur Lewis’s 1954 article “Economic Development with Unlimited Supplies of Labor” is the crystal ball we need to assess China’s future: A country with virtually unlimited supplies of labor locked in unproductive traditional pursuits can grow rapidly by transferring it to a “modern” sector, that is UNTIL the transfer is complete. Thereafter, it must grow, like other countries, on the basis of technological progress, which is an entirely different ball game.
China was twenty percent urbanized at the start of its reforms. Now it is officially one half, but in addition millions of rural residents work as migrant workers in construction and industry outside of agriculture. China is therefore nearing the end of its “easy growth” era. This end will likely occur at a relatively low standard of living.
But, could it not be argued that China’s rapid growth will continue after its labor surpluses are exhausted? Will not China’s party technocrats convert China’s high savings rates into spectacular technological achievements? Will they not make the right investment decisions? The answer is no! China’s legal and economic institutions are those of a third world country, with rampant corruption, a weak rule of law, poor protection of property rights, and the allocation of loans by state banks and political officials. Just as Japan’s maligned government-operated postal savings bank system wastes capital; so do China’s local and regional officials and the financial institutions they control. The high rates of capital accumulation simply make such waste less visible. There is a lot of capital to misuse.
There have been no historical exceptions to the requirements to join the top ranks of countries in living standards: limited government interference in economic decision-making, equal application of the rule of law, a small government to avoid waste and rent seeking, low rates of taxation and other burdens on achievement and free international trade with other countries. China is unlikely to improve its performance in these areas. The Chinese communist party is no historical aberration. China has a long, long history of statism, and no intellectual challenge to this tradition. The communist party cannot introduce a real rule of law without a serious loss of its political power. When confronted with the impending end of its growth miracle, China will not change its stripes.