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Some Warnings for the East: What Former Socialist Countries Need to Know

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For the last three years, the Eastern European countries and the republics of the former Soviet Union have been trying to escape from their socialist past. Democratic governments have been elected, and market reforms have been promised. Yet, in each of these countries, the socialist economic structures still exist to one extent or another. Seventy to ninety-five percent of the industrial sectors of their economies remain in state hands. Government subsidies are poured into failed state enterprises. Bureaucracies resist the economic changes that would undermine and finally eliminate their financial and political power. Political divisions in the various parliaments prevent any consistent, long-run policies from being implemented. And ethnic disputes in many of them have — or threaten to lead to — violence and civil war.

In practically all these Eastern European countries, unfortunately, another major problem retarding the instituting of radical market reform is a fundamental ignorance of sound economic principles. This is most acute in the former Soviet Union. In the Spring 1992 issue of the Journal of Economic Perspectives, authors Michael Alexeev, Clifford Gaddy and Jim Leitzel explain the state of “Economics in the Former Soviet Union.” They describe the two schools of Soviet economics: the political economists and the mathematical economists. “Soviet political economists were primarily engaged in extending Marxist economic analysis through the creation of a ‘political economy of socialism,’ as well as by continuing critiques of modern capitalism,” the authors point out. The mathematical economists, on the other hand, have concerned themselves with economic forecasting models and “optimal planning” models. In these mathematical models, the authors say, “There is no behavioral modeling, nor any appeal to individual rational economic behavior.”

Almost none of these economists, they emphasize, are well versed in anything like “Western” economics. They “may have seen or even read the works of a few Western authors — for instance, Paul Samuelson’s Economics, first published in Russian in 1964 — but such works are limited in number and accessibility.” As a consequence, though Soviet economists were given a form of professional training, “the profession in question was not economics — at least not as it is conceived in the West.”

Their deficiency in knowledge about Western economics is being repaired. Academic economists, economic research institutes and international economic organizations are bombarding Eastern Europe with literature, advice and proposals for the transformation of their economics.

But the economic lessons that they am being taught by their Western tutors, while superior to the disaster of socialist central planning, will, if implemented, lead not to the free market but instead to the instability and dead end of the welfare-interventionist state. The press emphasizes that these visitors from the West are showing their Eastern European hosts the way to a free market. In fact, what many of these Western economists are moving are antimarket principles and ideas.

What the Eastern Europeans need, therefore, is to be saved not only from their socialist past but from dangerous ideas for their future. The following are some warnings they need to have if they are not to replace one set of wrong ideas with another.

Lesson 1: Inflation and unemployment are not caused by the free market. The immediate rise in prices that has occurred when price controls have been removed demonstrates just how artificial were the state-established prices under socialism. The higher prices reflect the actual scarcity and availability of goods, given the demand for commodities and services in the society. The freed prices are merely “telling the truth” about the poverty that socialism has left in its wake. It is socialism, not the market economy, that has caused the unemployment many initially experience with the end of socialist management. The end of state control and planning of industry reveals the extent to which the employment created by the state was completely artificial. The market is telling people that they have been at work making things that nobody but the state wanted produced — and that they need to redirect their efforts towards the production of things that people actually value and may be willing to pay for overtime.

If prices keep rising higher and higher, the cause of this is not the market but rather the state’s continual expansion of the money supply to cover its expenditures and to pay for continuing subsidies to unprofitable state enterprises. If unemployment persists for many in the society, it is because the government has not allowed the market to create jobs. That is, the state has failed to create the legal framework for recognition and enforcement of private-property rights, has not sold off state enterprises and resources, has not lowered taxes, has not ended inflation, and has not eliminated state interference with production and exchange.

Lesson 2: The market economy does not produce an unfair distribution of wealth, and the welfare state does not create social justice. The market economy does not “distribute” wealth. In a free market, with unregulated free and competitive exchange, each worker tends to earn a wage reflecting his contribution in the manufacturing of some product demanded by consumers. Employers estimate what they think consumers might be willing to pay for various products; then they compete against each other to hire workers with various skills to make those products. The incomes earned by people are neither fair nor unfair. They are merely the result of judgments by consumers and employers about the potential value for services rendered.

The welfare state does not create “more just” outcomes than those produced by the market. What the welfare state does is to politicize social relationships. Rather than peoples’ income and wealth being the result of voluntary and competitive exchange, they are now influenced and determined, to one degree or another, by coercive redistribution by the state. Each individual’s standard of living is made dependent upon the amount of power and influence they, and various groups they belong to, possess in the political process. Only a true free-market economy depoliticizes social relationships by making these relationships matters of private agreement and contract; thus, the market economy reduces political power and eliminates political privilege.

Lesson 3: Foreign-government credits, subsidized loans, and humanitarian aid will make the transition to a market economy more difficult and will only reinforce the forces opposing change. Financial credits and loans from organizations like the International Monetary Fund and the World Bank will invariably take the form of government-to-government aid, with the monetary resources provided being distributed through the very bureaucracies that have no incentive to see their own authority in the former Soviet Union undermined or ended. Even if there are strict provisos that the funds supplied should be used for the support and encouragement of new “private enterprises,” it will still be the government and the state agencies assigned the responsibility to distribute the funds who still decide who is “worthy” of receiving such assistance. Western organizations will be supplying the money for the former Soviet republics to institute a perverse form of “planned” free enterprise.

Humanitarian aid in the form of subsidized or free food to Russia and the other former Soviet republics will also undermine the incentives for privatization of farming. The psychological consequences of more than half a century of collectivized fanning and the unavailability of farming equipment and supplies make many collective farmers reluctant to take on the uncertainties of private fanning. Free or subsidized Western food supplies to Russian consumers will only result in diminishing the profit incentives that might otherwise work to overcome the fears on the part of farmers to make the plunge into privatized agricultural production. Western food subsidies will only serve the interests of the state-collective farm managers who have no desire to lose their control over people and production in rural Russia.

Why do many in these former Soviet republics worry that a market economy means inflation and unemployment — that capitalism produces unfair distributions of wealth — that economic development and progress need the support of various forms of governmental foreign aid? Part of the mason is the carry-over of their own socialist thinking of the past. But another and crucial reason is that the Western economists who offer advice and consultations on transitions to a market economy believe these fallacies as well. Both the East as well as the West are still in the ideological grip of “the economics of socialism.” And neither the East nor the West seems to have the ability to escape from these dead ideas of the past.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).