Go-go gradualism

Jude Wanniski

October 05, 1993|By Jude Wanniski

RUSSIA'S political turmoil comes down to a dispute over public finance.

Neither Boris Yeltsin nor his foes in Parliament have figured out how to finance the conversion of the communist system to a market economy.

Public finances also contributed to the breakup of Yugoslavia, broke two successive governments in Poland and roils all the economies of Eastern Europe. China is the only communist power to come close to solving this problem, which is why it has the world's fastest-growing economy.

The transition from one system to another cannot be paid for simply out of cash flow. It can be financed only by taxing, borrowing or printing money. Throughout history, the economies of most countries at war have been inflationary because the wars were financed by printing money.

China is making the transition because it has struggled to avoid this method, thereby keeping the value of its currency, the yuan, relatively steady for 10 years.

It has also pursued a gradual approach.

A decade ago, China focused on turning the farm communes, which employ 90 percent of the nation, into capitalist cooperatives, which can do what they want, even branch into light industry -- if they pay taxes. This has produced enormous increases in productivity and wealth, steadily easing the relative drag on the economy of the inefficient state enterprises, without an unemployment problem.

Russia and Eastern Europe, by contrast, have opted for shock therapy -- a quick scrapping of central planning and wage and price controls -- on the advice of the World Bank and International Monetary Fund.

This is the heart of the struggle. Mr. Yeltsin has been told %J repeatedly that he will get no financial aid from the West unless he takes this advice. His attempts to carry out this painful method have been resisted by the Parliament and have been wildly inflationary.

The price of bread, for example, went from 13 kopecks (an eighth of a ruble) to 120 rubles a loaf. Last week bread prices were freed and are likely to soar further.

This method involves an austere fiscal policy -- higher taxes and slashing of state spending -- while the government allows the ruble's value to float together with wages and prices.

Three years ago, the World Bank persuaded Mikhail Gorbachev's government to raise the state oil price to 200 rubles per metric ton from 120 in order to bring it closer to the world price level. State enterprises could not afford the higher price without credits from the central bank, which the World Bank argued would be inflationary.

Because the Parliament, not the government, has controlled the central bank, the credits were issued to avoid the large-scale unemployment that would occur.

A ripple effect then pushed up other prices and wages. It sank the What Russia needs is the China syndrome, not shock therapy.

ruble's value against the dollar, removing the oil price further from the world dollar price. This game has gone on ever since, with the Yeltsin government raising the oil price and the bank issuing inflationary credits.

The oil price now stands at 38,000 rubles per metric ton, the equivalent of a gallon of gasoline going from $1 to $316 in three years in America.

There has been no unemployment problem, but people's life savings have been wiped out, with no end in sight to the gridlock.

By dissolving Parliament, Mr. Yeltsin has forced the central bank to report to the government; the bank's chairman, Viktor V. Gerashchenko, has pledged loyalty to him. If the bank withholds credits, state enterprises will shut and enormous unemployment will result. If it extends credits, inflation will continue. Meanwhile, the ruble is disintegrating and the International Monetary Fund wants the oil price raised again.

China's problem is growth. China faces a soaring demand for public funds because tax revenues cannot keep pace with the exploding demands for capital outlays for infrastructure, public utilities and education.

My recommendation in Beijing was that the People's Bank of China guarantee the value of the yuan in gold in a major bond issue in 1994.

This would take pressure off the tax and monetary authorities. It would also increase the efficiency of the private capital market that is emerging because all yuan bonds, private and public, would then sell at very low interest rates.

In Russia the situation is more complex, but if any government is to halt the rampant inflation, it has to start by reducing the oil price, thereby signaling that it intends to increase the purchasing power of the ruble. A gold-backed bond issue, collateralizing the state's vast wealth, would then have credibility. The public finance problem would be resolved.

This may not seem like a free-market solution, but a market must first be built around money that has the people's confidence.

There are few real communists in Russia anymore, but there are plenty of people who prefer China's philosophy of growth to high-voltage therapy.

Jude Wanniski is president of Polyconomics Inc., a political and economic consulting firm.

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