Memories of 1995 . . .

Jeffrey Sommers

I took George Viksnins' advice to do some dissertation writing. It was the best advice I have received in some time. So, I have faith that he can offer sound counsel :-) Yet, on an evening walk in Riga a visit to the Scandinavian owned Narvessen chain of newsstands that now dot the city's streets inspired my following remarks. I picked up a copy of the Central European Business Review. The most recent issue contained a report on many Central European nations. Latvia was among them. The comments it made evoked memories of my first visit to Latvia in 1995. Then, as now, I was struck as much by the integrity and dignity of its people as I was by the poverty. Indeed, the fact that much of Latvia's misfortune appeared unnecessary multiplied those human tragedies.

My following remarks are made in the spirit of encouraging discussion for policy change. I have outlined below two areas where I, unfortunately, was able to predict errors and unfortunate outcomes from policy mistakes grounded in one, the arrogance of power emanating from hegemonic institutions without challenge (in a sense, functionally similar to the Soviets), and two, how using a different economic theory anyone could have predicted why those policies would fail in their stated aims. I say 'stated,' because, as MIT economist Paul Krugman has asserted, 'bad ideas flourish because they are in the interests of powerful groups. Without a doubt that happens.' And as Chomsky has remarked, 'bad ideas many not serve the expressed goal, but they typically turn out to be very good ideas for their principle architects.' He further elaborates, 'the designers tend to do quite well, though the subjects of the experiment often take a beating.'

In the fall of 1995 social circumstances brought myself, my spouse, and a high placed World Bank advisor to dinner at the then uniquely fashionable Osiris cafe. Latvia had few such elegant cafes at the time and it seemed a natural escape from Riga's daily life for a member of the Bank.

Our World Bank officer was full of optimism about Latvia's and East/Central Europe's prospects for rapid development. There was a light at the end of the tunnel and he clearly saw it. I remember making two main points to our Bank representative in 1995. One, I predicted that Russia under Yeltsin would see tragedies unseen (but not equal) since Stalin. Our Bank friend laughed and assured me all would be fine, hinting that Yeltsin took orders from 'us,' so all would go well, with the usual bumps in the road.

Second, I predicted that Latvia would not see steady growth for many years, chiefly because of its overvalued currency. This comment was also dismissed by our omniscient expert, the kind Joseph Stiglitz, the recently departed chief economist of The World Bank, had few kind words for in his now infamous April, 2000 New Republic article.

Unfortunately, I proved right on both scores. After Yeltsin killed democracy in his 1993 assault on parliament (often to kudos in the US, but often criticized by the more informed West European media), that left some 200-1000 people dead in the streets, things in Russia got worse. Just to correct a misperception, this parliament was not the 1989 SSR Soviet one, but the even more democratic elected in 1990 elected. During the Yelstin years some 4 million people died prematurely of ailments caused by the destruction of their health infrastructure and economy. While declines in health indices were recorded during the 1980s, they plummeted during the 1990s under Yeltsin, making this an almost purely post-Soviet phenomenon. Moreover, Yelstin would go on to invade Chechnya, a conflict which has since left that province decimated along with many more dead. Indeed, it has been recently reported that Russia now intends to use the FSB (the successor to the KGB) to hunt down the remaining Chechen resistance in the same fashion they used against the Balts and Western Ukrainians in the late 1940s and early 1950s.

Interestingly, our World Bank acquaintance left Latvia in 1996 to go and help Yeltsin rescue his economy. More gas to the flame as things only worsened until the collapse of the Russian ruble inadvertently saved Russia from the macro-economic policies advocated by the IMF and World Bank. Indeed, when I returned to Latvia in late June of 1998 I predicted the Russian ruble would collapse by the end of the year. When I shared this opinion with another visiting US expert in Latvia working on economic policy to CIS nations, I was met with hostility for my lack of confidence in the ability of Russia's pyramid scheme economy to maintain its overvalued currency. The hostility arose from my lack of faith in the authority of this policy making community, which by 1998 was already beginning to buckle under the criticism of East Europe's neoliberal failures.

It was only with their currency's collapse that Russia's economy returned to growth after 1998, which was facilitated by the reduced value of the ruble. This in turn made Russian products both cheaper at home and for export, thus creating for the first time since the Soviet period renewed investment in production. Indeed, one Western tire dealer at the time complained to me that his tire sales were off in Russia because it now made economic sense for them to buy their own, and they did! Moreover, Yvegeny Primakov, that old Soviet boss, was brought in by Yelstin to stop the hemorrhaging of the Russian economy in part created by Western advisors, who served Russia's oligarchs--knowingly or not--and the US equity markets, which received hundreds of billions of dollars in Russian money. He stopped the bleeding, but rather than cure the patient he only had enough time to apply a tourniquet--hardly a long-term solution. Once Primakov's triage measures succeeded, Yeltsin fired him to prevent further rise of Primakov's soaring popularity. After that a renewed assault on Chechnya distracted attention further from Yeltsin, and the oligarchs were able to put their man Putin in power. Buoyed by a gutter locker room talk of how he was going to 'wet the Chechens' and 'stick their heads in the toilet,' he was able to use this rhetoric, plus rising oil prices, to maintain some popularity and also maintain the Russian economy growing built on the momentum of events in 1998. Now, in Putin, Russia has a dictator--who built on the near dictatorial powers of Yeltsin established in the wake of events in 1993. An opportunity was presented to Russia in 1998 for its economy to rebound in the wake of neoliberal policy failures, but it appears Putin lacks the vision to capitalize on it. Indeed, the growth we have seen there since 1999 may soon fade. We may not like any of this, but the facts are clear.

Second, Latvia's currency was too strong. I told our World Bank 'specialist' that if this strong currency was kept it would create a speculators' economy, which would smother and destroy what little industry Latvia had left by making its products too expensive both at home and abroad, along with inflicting damage on its farmers. This too was dismissed in 1995, and I was assured all would be fine soon in Latvia, as things would in Russia.

Returning to the Central European Business Review article which brought these memories to the surface. On Latvia, unfortunately, the Review reports the two biggest problems are: 1) its overvalued currency, which it states has made Latvian products too expensive for export, and has resulted in its farmers taking a hit as Latvia imports twice as much food from Estonia as it exports to it. This was all quite predictable in 1995. 2) Latvia's corruption, it claims, has 'made Latvia one of the sleaziest nations in which to do business in Central Europe.' Those are strong words, but they are the Central European Business Review's, not mine.

Now, I want to suggest that the second issue, corruption, is linked to the first issue, Latvia's overvalued currency. By slowing Latvian growth and making it easier to make money in finance, real estate, speculative deals, etc., instead of production, Latvia's overvalued currency has created a climate rife for corruption. There are other many negative implications of this policy, but for now I will leave us with this.

I would encourage people to see if the claims made for policy match the reality of policy outcomes. In economics and finance policy making, 'success' is often measured by how well people articulate the consensus of special interests. Intellectual production in those areas affecting the powerful are often shaped by considerations related to their pocketbooks rather than academic or intellectual merit. That is how policy production gets funded, or just as importantly, does not get funded. The observation is hardly new. With economics it goes back to the iconoclastic founder of the Stockholm School of Economics who wrote as much in the early 20th century with this book THE POLITICAL ELEMENT IN THE DEVELOPMENT OF ECONOMIC THEORY. Others include that scion of America's great family of historians, Brooks Adams, who a century back stated to Oliver Wendell Holmes, that the 'philosophers were hired by the comfortable classes [meaning those in power] to prove everything is all right.' Or, if one prefers to go even further to the political right in selecting a commentator on the business of intellectual production, one can always count on Henry Kissinger for a revealing quote when he candidly asserted, 'the expert has his constituency--those who have a vested interest in commonly held opinions; [and] elaborating and defining [that] consensus.' The point is that 'experts,' just as they did during the Soviet period, have a strong interest, both personal and psychological, to provide interpretations for policy which defend their legitimacy as experts, even when those policies fail, and indeed, especially when they fail. Moreover, they often have an incentive to protect their benefactors who ultimately pay the bills. To be clear, it is not always both. Many intellectuals become inflamed with anger when they hear they may merely be tools of other interests, rather than recognizing that anyone can be a tool of an interest. One need not be aware of it to be used.

In sum, I would encourage people to examine the record and think through for themselves whether policy has produced results its architects have claimed for it, and if not, whether their explanations for why not are satisfactory. Latvia's achievements in creating productive enterprises have been made in spite of Latvian policy, not as a result of it. Pound for pound I would match most Latvian business people with their American counter-parts, and operating under equal conditions, I would bet on the success of the Latvian every time. Latvian business has to deal with high real interest rates, propped up artificially by macroeconomic policy. Latvian business is punished again by its overvalued currency, by making its products too expensive at both home and abroad. It then has to run a gauntlet of corruption--which many claim to be second only Russia's--before they can turn a profit. The first two hurdles are linked to macroeconomic policy, that is simply fact, and a good case can be made for the third being a byproduct as well.

One final note. I am told people want answers not analysis. I am afraid the answers will not come without a serious examination and overview of what has happened to date. For example, the reason I explore the above events is not to demonstrate how clever and prescient I was over the past 6 years. I am no genius, and neither are those who have made policy for Latvia and CIS nations generally. What I am striving to achieve is a historical understanding of the present and how by using different theoretical formulations than the neoliberal model now dominant since the 1980s, one could easily have predicted the economic problems which have surfaced. The test of a 'theory' is how well it predicts outcomes to see if the theory indeed has predictive value. We must apply this test to extant economic theory. This is not the place, however, for long pedantic digressions on economic theory. Yet, rejecting neoliberal assumptions of how an economy works, and instead using a structural Keynesian one, anyone could have predicted the current problems Latvia's economy is experiencing, and more importantly, why.

More practically, given the evidence, it seems clear that there is no longer even maneuver for arguing whether Latvia's currency should be devalued, the question now is by how much and how fast. The latter is certainly grounds for discussion, and hopefully productive exchange both free of acrimony and substantively centered. To further clarify, the amount will surely be minor, with prudence and caution guiding this downward movement. Moreover, these slight downward shifts will be nothing like the radical devaluations of currency taken twice following independence, whose purpose was to wipe-out Soviet era savings in order to launch a new round of accumulation to facilitate the creation of a class of new rich entrepreneurs. The result of that process, instead, was the impoverishment of the middle-aged and elderly, while a mostly speculative, rather than productive, wealthy class was created. That is terrain for another debate, but it is important to know what I am, and am not, advocating with currency devaluation.

More precisely, reducing the value of the currency will provide only moderate immediate-term benefit for the average person, through making local foods cheaper, for example. It will make life slightly more expensive for the middle-class that buys more imports, and will hit those at the very top of the economic scale hardest, as they spend almost all their money on imports. It will drive the cost of domestic products down, and imports up. It might, however, serve as an incentive for further economic development. While Latvia's economy is small, domestic demand can be a precursor to export promotion. Indeed, the classic model of this has always been grounded in domestic demand. Now, some such as, Gundars King, have argued Latvia is too small to generate domestic demand. To a certain extent he is right, however, in the press I recently saw reference to a report (whose veracity I have not yet checked) suggesting that Estonia's mini-export boom was created on the platform of domestic demand. Given it is even smaller than Latvia, it might be worth investigating how this process unfolded in Estonia, and which industries can build on Latvia's small domestic demand and which can not. To then implement such a plan would require a devaluation of currency to foster that internal demand and encourage export.


Jeffrey Sommers