Freedom and the Prospect for Soviet Economic Reform; D. R. Lee

Correct though this advice is, it is easier to give than to take. No matter how much Soviet citizens and their leaders have become interested in eco nomic reform, the move to a market economy will be difficult. The fundamental problem facingSoviet reform ers is the connection between market institutions and tolerance for economic freedom. Without market institutions, the Soviets will be hard pressed to allow economic freedom. Without tol erating economic freedom, they won't be able to develop market institutions. SomeSuperficialProblems Most difficulties seen as hampering the transi tion to a Soviet market economy are overstated. One perceived problem is the "ruble over hang." Soviet consumers have amassed large Dwight R. Lee is an adjunct fellow at the Center for the Study of American Business at Washington University. He is also the Ramsey Professor of Economics at the University of Georgia. He is co-author, with Richard McKenzie, of Quicksilver Capital, reviewed on page 85.

holdings of unspent rubles because there are so few consumer goods. Although some rubles were confiscated recently in what was described as a currency reform, the fear remains that if Soviet consumers are allowed to spend all their money in free markets, explosive price rises will follow. There is also the concern that the Soviet people have never lived in a market economy, and there fore won't be able to respond correctly to the incentives of prices and profits. Workers aren't accustomed to the disruptions of unemployment and job changes caused by shifting preferences and improving opportunities in market economies. After decades of depending on the state for subsidized housing, medical care, food, and almost everything else, Soviet consumers are supposedly unprepared to face the full-costpricing and complex choices of the marketplace. Further more, Sovietcitizensare seen as almost completely lacking in entrepreneurial spirit.

These concerns, though potentially trouble some in the very short run, are overstated as seri ous problems. Privatizing housing and other state owned assets could soak up excess rubles, in addition to increasing the care givento what is now public property. Of course, temporary price increases are inevitable in a move from state sub sidies to private markets, but market incentives would soon lead to dramatic reductions in the real costs of products to Soviet consumers by motivat ing significantincreases in the quantity and quality of those products. Also, there can be no doubt that people learn quickly to respond to the incentives, choices, and opportunities of the marketplace. South Koreans, Taiwanese, and Japanese, assumed by many to lack a market mentality, have demonstrated how quickly such a mentality can arise when given the opportunity. When workers find that they are rewarded for greater effort, they become more diligent. When consumers are faced with market prices and abundant alternatives, they quickly learn to make appropriate comparisons and sensi ble choices. And there is nothing like the potential for profit to stimulate entrepreneurial zea1.1 The Fearof Freedom Underlying all the problems associated with a transition from socialism to capitalism is a more fundamental issue that has been almost complete ly ignored. This concerns the interaction between market institutions and the tolerance for freedom that those institutions make possible.

Most Soviet citizens are eager for the economic improvements now recognized to depend on a market economy. Yet they continue to fear eco nomic freedom, since in the absence of well developed market institutions, such freedom can harm many innocent victims. For example, one of Mikhail Gorbachev's more important attempts at economic reform has been to allow cooperatives: private businesses largely limited to the service sector and permitted to set their own prices in response to market forces. Pre dictably,cooperatives have met with much popular resistance, as they have been seen as acting with out full accountability to the concerns of others. While cooperatives sell their products at market prices, they obtain many supplies at lower, con trolled prices. This has led to resentment, public protests, and the destruction of cooperative prop erty.2The Kremlin has responded by increasing its controls on cooperatives.

In an economy dominated by state control, con sumers grow accustomed to mandated allocations of goods to local shops. The idea of suppliers having the freedom to desert traditional con sumers to make more profitable sales elsewhere is considered intolerable. Not surprisingly, a num69 ber of Soviet republics have outlawed the ship ment of goods beyond their borders by local enterprises. 3 While unemployment may never be welcome, in a market economy the freedom of firms to lay off employees is tolerated because workers can relocate to where their skillshave the greatest val ue. Unemployment is far more frightening in the Soviet Union because Soviet citizens cannot read ilymove-government directives rather than mar ket wages play the most important role in allocat ing labor. But even though it has recently become easier for Soviet citizens to receive political permission to relocate, their ability to do so is still extremely limited by a chronic housing shortage. The typical Soviet family considers itself lucky to have an apartment of 500 square feet, and it isn't uncom mon for two families to share such an apartment.

With long queues and political favoritism making it almost impossible for a family to obtain housing in another city, being laid off would be a genuine disaster for most Soviet workers. So in the absence of a free market in housing, there is little sympathy for the freedom of firms to layoff work ers in response to changing market conditions. Yet such freedom is an essential feature of a market economy. The Dilemmain Making the Transitionto the Market In the absence of a well-developed market economy, the fear the Soviets have of freedom is understandable. But this fear, and the reason for it, creates an agonizing dilemma for the Soviets as they attempt to make the transition from a socialist to a market economy. That dilemma can be stated simply: Tolerating freedom is difficult without market institutions, but developing mar ket institutions is impossible without freedom. The Soviet Union does not have the basic insti tutions required for the operation-and free dom-of a market economy. It lacks the type of banking system, legal structure, and commercial codes needed for the transactions and investment that are the lifeblood of the market. Neither does it have a stock market, which is essential for the rational allocation of capital formation that drives economic progress. These ~conomic institutions, along with the political institutions of limited and 70 THE FREEMAN • FEBRUARY 1992 Mikhail Gorbachev and Boris Yeltsin.

stable government, are crucial to the social infra structure that must be in place if improvements in the physicalinfrastructure are to be developed and utilized effectively. If it were possible to impose market institutions by government fiat, then the Soviet government would be able to create an economy in which its citizens could begin benefiting immediately from a full measure of economic freedom. Unfortu nately, market institutions cannot simply be decreed by political authorities. 4 Market institu tions have to emerge through a process of trial and error that requires time and freedom. 5 The cre ation and operation of a market economy is a spontaneous and evolving process that can emerge only from freedom; it cannot be replicated by central direction. Furthermore, ~hile no economy can prosper without a well-developed system of market institu tions, there is no one model of a market economy appropriate for every country. Markets are cul tural artifacts, and the specific forms of market institutions suitable to one market economy are not suitable to other market economies. So while the Soviet Union can benefit from the general example of the prosperous market economies, even if Soviet authorities could choose a set of market institutions as they now exist in another country and impose them from above, the results would be disappointing.

The unavoidable conclusion is that the transi tion from a socialist to a market economy is g~ing to be painful for the Soviet Union. The freedom that is necessary if markets are to develop is dis ruptive until that development is considerably advanced. While this conclusioncan hardly appeal to those most optimistic about Soviet economic reform, it should not be taken as a counsel of despair. Free dom is alwaysdisruptive, even when disciplinedby a well-developed market. And even in the absence of market institutions, freedom is productive over the long run because market institutions emerge from the exercise of freedom. Economic progress alwaystakes time. No econ omy has gone from poverty to prosperity overnight. All market economies progressed only over significant periods of time, and all did so through a process that was neither smooth nor painless. But they did progress. Market economies FREEDOM AND THE PROSPECT FOR SOVIET ECONOMIC REFORM 71 have progressed far beyond that which can ever be possible under socialism.

After almost 75 years of rigid socialist control, it is now clear to all but the most ideologicallyblind ed that prosperity in the Soviet Unionor in the independent republics that once formed the Soviet Union--ean only be achieved by economic free dom and the market economies that will emerge from that freedom. The enormous talent and cre ativity of the Soviet people leave no doubt that, given freedom, they will quickly begin making the economic progress that has been denied them for far too long. SomeImportantLessons The first lesson to be drawn is that the major industrialized countries should not attempt to assist the Soviet Union with financial aid.6 Indeed, foreign aid would more likely hinder rather than help the Soviet Union move to a free market. The benefits from making the transition far exceed the costs, but the benefits are a generation or more away while the costs are immediate and, for rea sons already discussed, significant.

Mikhail Gorbachev and Boris Yeltsin,as with all politicians, are far more sensitive to immediate costs than to delayed benefits. By artificiallyprop ping up the flawed Soviet economy a little longer, such aid would let Soviet leaders continue to post pone granting the economic freedom required for genuine reform. Gorbachev has shown over six years of reluctance to start the painful process of moving to a market economy. He, or his succes sors, will start that process in earnest only when economic conditions deteriorate to the point where the temporary pain of freedom and reform is less than the permanent pain of the socialist status quo. A second lesson is that, at a fundamental level, economic reform cannot be approached incre mentally. The basic ingredient in reform is eco nomic freedom, and the sooner the Soviet people are granted a full measure of that freedom the bet ter. True, if a benevolently motivated government knew in advance exactly how particular freedoms would be used, then it might be possible for it grad ually to permit more economic freedom in ways that allow for the benefits of freedom while mini mizing the disruptions. But governments are sel dom motivated by benevolence and never guided by omniscience.? So freedom has to be granted quickly and completely.

This is not to deny that economic change willbe gradual. No matter how immediately or complete ly economic freedom is granted, the evolution of market institutions and the expansion of economic prosperity willtake considerable time.8 But to rec ognize that the progress of reform will be piece meal is not to argue for gradualism on the part of government. The more clear and decisive the pol icy of economic freedom, the more difficult it will be for the apparatchiks, who continue to infest the huge Soviet bureaucracies and have a vested inter est in the socialist status quo, to derail movement toward a market economy. Another lesson is that the move to a market economy in the Soviet Union, or any other social ist country, is not primarily a task for government. There is little government can do to directly facil itate a transition from a socialistic to a market economy. Markets will arise as a result of the freedom that requires little more from govern ment than getting out of the way of people attempting to better their conditions through productive activity. So even if the Soviet govern ment could be depended upon to use foreign financial aid efficiently to promote the transition to a market-based economy, little, if any,financial aid would be required. The only financial infu sions that can be depended upon to promote prosperity in the Soviet Union are private invest ments that will be forthcoming in significant amounts only when the Soviet government's eco nomic role is greatly reduced and, as a conse quence, market institutions and arrangements have been allowed to develop.

Conclusion The most precious thing provided by a market economy is not an abundance of material wealth, but freedom. Those of us with the good fortune to spend our lives in market-based economies have difficulty appreciating our freedom because it is always difficult to appreciate advantages one has never had to do without. Few people who benefit from markets and freedom recognize how precious their freedom is, and fewer still are aware of how crucially their freedom depends upon the institutions of the marketplace. For this reason, it is difficult for people in market 72 THE FREEMAN • FEBRUARY 1992 economies to understand the ambivalence toward freedom felt by those in socialist coun tries, such as the Soviet Union, and the severity of the problems faced in their attempt to move to a market economy. There can be no doubt that the citizens of the Soviet Union desperately desire the freedoms that so many of us take for granted, as do the citizens of all repressive socialist regimes. Many Soviets have taken tremendous risks and made enormous sacrifices to escape the tyranny of their mother land and reach the freedom and opportunity of countries with established market economies.

Yet, at the same time, there is widespread reluc tance by the Soviet people to accept significant increases in economic freedom within their own country. This cannot be understood unless one rec ognizes that the freedom so many of us take for granted is a freedom that is difficult to tolerate in the absence of market institutions. Lacking the institutions of the marketplace, it is impossible for the Soviets to immediately begin realizing the ben efits from freedom available to those who live in market economies. Unfortunately, acquiring the market institutions needed to disciplinethe exercise of freedom, there by making it easy to tolerate, requires the exercise of freedom. The Soviets are understandably reluc tant to allow freedom without workable markets, but the institutions required for workable markets can emerge only when freedom is allowed. Overcoming this dilemma is not impossible, but neither is it easy.Making the transition to a market economy is going to be a disruptive and painful process for the Soviet Union. And there is little that can be done by other governments to facilitate the transition. Only when the Soviet government allows freedom, and the economic disruption that will initially go with it, can the process of moving toward a market economy begin in earnest in the Soviet Union. D 1. It should be acknowledged, however, that attitudes formed during several generations of socialism can be a barrier to a transition to a market economy. For example, James Buchanan argues, for reasons consistent with the thesis developed here, that the attitudes of Soviet citizens are such that they have a difficult time accepting much behavior that is standard in market economies. See James M. Buchanan, "Tacit Presuppositions of Political Economy: Implications for Societies in Transition," working paper. (Fairfax, Va.: Center for the Study of Public Choice, George Mason Universi ty,1991).

2. Padma Desai, Perestroika in Perspective:The Design and Dilemmasof Soviet Reform (Princeton, N.J.: Princeton University Press, 1990),p. 156. 3. Ibid.,p. 170. 4. Even if it were possible for Soviet political authorities to impose workable market institutions, it would be naive to expect them to do so. Those with the greatest authority are those who have succeeded under the existingpolitical and economic institutions. The changes occurring in the Soviet Union are not the result of an enlightened leadership dedicated to doing what is in the best long run interest of Soviet citizens. Rather the changes are being forced on a leadership interested primarily in maintaining its power and perks by international economic forces that are relegating centrally planned economies to the ghettos of the global economy. See chapter 7 of Richard B. McKenzie and Dwight R. Lee, QuicksilverCapital: How the Rapid Movementof Wealth Has Changedthe World (New York: Free Press, 1991). Also see, Gary M. Anderson and Peter J.

Boettke, "Perestroika and Public Choice: The Economics of Auto cratic Succession in a Rent-Seeking Society," working paper (Northridge, Calif.:Department of Economics, California State Uni versity,1990). 5. For a useful discussion of the evolutionary process by which social institutions, such as those of the market, are created and reformed, see Karen I. Vaughn, "Can Democratic Society Reform Itself: The Limits of Constructive Change," in For a Free Societyin the ComingDecade:The N. GottoEssayPrizeCompetitionWinning Essays, Mont Pelerin Society, 1982 General Meeting, Berlin. Although Vaughn's concern is with democracies, her discussion highlights important aspects of reform that apply to non-democratic societies. 6. In July 1991,at the G-7 conference in London, the seven major industrialized nations decided against givingthe Soviet Union direct financial assistance. But the door was left open for consideration of future Soviet requests for financial aid. In the aftermath of the attempted coup, the pressure in the industrialized countries to give government aid to the Soviet Union has intensified.

7. And as Nobel prize winning economist Friedrich Hayek has informed us, "If we knew how freedom would be used, the case for it would largely disappear. We shall never get the benefits of free dom, never obtain those unforeseeable new developments for which it provides the opportunity, if it is not also granted where the uses made of it by some do not seem desirable.... It is because we do not know how.individuals will use their freedom that it is so important." See F. A. Hayek, The Constitutionof Liberty(Chicago: The Univer sity of Chicago Press, 1960),p. 31. 8. In arguing against a "big bang" approach to Soviet economic reform, Padma Desai points out that "Even a 'big bang' policy of simultaneous and instant policy announcements will necessarily encounter reality, and the rate of effective implementationon differ ent components of the package will diverge, yielding piecemeal reform." (emphasis in original) See Desai, op. cit.,p. 182.