Russia & The Limits of Economics

When the Soviet Union collapsed, the newly free Russian state embarked on what Western experts agreed was the the appropriate course: so-called "shock therapy" wherein price controls and trade were liberalized while industry became privatized and lost its subsidies. Ideally, this would subject the economic system of Russia to market forces, lurching it out of its lethargy and beginning an age of capitalist growth.

Of course, the result was devastating. Russian living standards plummetted, far more than other Eastern-Block countries that had liberalized at a more sedate rate. The question is why? After all, theoretically, the western liberal economists, headed by Jeffrey Sachs, were right. Privatization and liberalization do allow for price signals to get to decisionmakers, which in turn allows for a more efficient function of the market and allocation of capital.

What Sachs and co. failed to heed was the speed limit that the Russian economy could adapt to change. Massive change of whatever stripe, even that which would otherwise be positive in the long term, if it occurs too quickly, and on too broad a scale creates enormous upheaval, dislocation and uncertainty in the economy. Things change too quickly for firms and businesses to effectively respond to the new price signals. Mere uncertainty creates an inability for firms to make rational mid to long-term plans, with devastating results on investment, among other things. Moreover, the rate of change makes firms unwilling to respond to the new price signals, wary that they will no longer apply once the necessary capital is invested to meet them. Due to the swift economic shifts, new demands for products and inputs go unmet, and often disappear as firms collapse due to disjointed supply chains, resulting in long-term deadweight losses for the economy.

Privatization emphasizes in its first stages consolidation of the new enterprise, rather than engaging in new business opportunities or expansion into new areas. This is particularly true of the sort of privatization Russia embarked on, where the buyers, having obtained businesses at a fraction of their true value through corruption or favouritism, have an even greater interest in consolidating their windfall and paying little attention to new opportunities.

Conservatives have always been skeptical of the impetus for change- the story of Russia's economic reforms illustrates the perils of engaging in change in a sudden and dramatic manner. Even positive change, unless a moral imperative, needs to be taken in a gradual and deliberate manner.