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.

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.

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.

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.

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.

$3 to $7 trillion CBO Underestimate of the deficit

I am no expert on the budget, but my pundit record is a documented 100% accurate. When I was revising my introductory economics text in 2000, I spent about one hour examining the CBO’s budget projection of a $4 trillion surplus by 2010. I concluded that there would be no surplus to speak of (Paul Gregory, Essentials of Economics, 5th edition, p.166). This conclusion was easy. The surplus disappeared if we dismissed the improbable assumption that nominal government spending would increase 2.3 percent a year (versus the historical rate of 7.6%) and recognized that the peace dividend of 1998-2000 was a one time event. The CBO projection also assumed that there would be no recession between 2000 and 2010.

I just repeated the same hour-long exercise with the CBO’s August 2009 projections, which estimate that the cumulated deficit will grow by $7 trillion between 2008 and 2019. Without even looking at the revenue side of the equation (which looks too optimistic to me), I conclude that the CBO projection underestimates the cumulated deficit by $3 to $7 trillion. The deficit grows by $3 trillion if we use the growth rate of government spending over the previous eleven years. It grows by $7 trillion, if we use the historical rate of growth of government spending since 1970. The CBO projection also assumes there will be no recession over the next eleven years. A recurrence of recession would raise the cumulated deficit by a considerable amount depending on its severity.

Even if we accept the CBO’s optimistic revenue projections, I doubt that the growth of spending can be reduced below rates of the last decade or the longer term rates. If I am correct, gross federal debt will be between 110 to 130 percent of GDP in 2019. Federal debt held by the public will be between 80 to 100 percent. These figures do not include the potential impact of an expensive federal government health care reform. These national debt ratios will make the United States look like Italy and Spain.

I therefore have to join the chorus that such deficits are not sustainable and conclude that the alarming deficit projections we have seen are underestimates of the true situation unfolding.