Listener 14 June 2003.

Keywords: Growth & Innovation;

Americans take great pride in their role in the rehabilitation of Japan and Germany after the Second World War. Each went through great trauma – famine in Japan, inflation in Germany – but today they are generally respected members of the world community in contrast to their dreadful records before their reconstruction, and are the second and third to largest economies in the world.

There are echoes of this achievement in the US promises to reconstruct Iraq, but the subsequent record is not so compelling. Setting aside Afghanistan – recall the promises of reconstruction there? – the saddest story is what has happened to Russia after the end of the Cold War. This did not involve a military occupation, so the parallel is not exact, and some of the problems may be attributed to international agencies such as the IMF (which, however, may be seen as part of the US fiefdom). Moreover, some of the dreadful exploitation of Russia was carried out by Europeans businesses too, so this is not an anti-American column. Even so, the likelihood is that what will happen to Iraq is more a parallel with Russia than Japan.

The sad fact is that a decade after the collapse of the Russian Empire, the Russian output (GDP) is 30 percent lower, while the population in poverty has increased from 2 percent to over 40 percent. These figures are not without their problems. To what extent does the GDP allow for the changes in quality and choice, which is so valuable if one has income? And the material poverty might be moderated by a reduction in the repression of the state, although some of the corporate gangsters may be little better. Even so, it is hard to argue that Russia is a happier place than it was under communism, despite the promises that were made that capitalism would suit them better.

A major factor in the Russian economic disaster was the overvalued exchange rate, which crumpled the tradeable sector, the engine of growth in an economy even as large as Russia. The same thing happened to New Zealand from 1985, although the economy only stagnated, rather than collapsed.

But even had not there been no exchange rate cock-up, the Russian economy would have had enormous difficulties adapting to the decentralisation of the market. The most unbridled capitalist market economy needs a government to provide a framework of property rights in order to minimise transaction and information costs. Effective laws, courts and other procedures to enforce rights and laws are vital as, too, are the tacit understandings of those involved in the system. Sadly, Russia did not have these to any great depth, since its centralist state dispensed with them. So Russia’s breakout into capitalism lacked the commercial infrastructure that reconstruction required.

The lack of the underpinning infrastructure created opportunities for deals for those with inside information and in other positions of privilege. Greedy capitalists invaded the country, connived with Russian bureaucrats and party apparatchiks who abandoned any notion of the public service their past careers had played lip service to. Some made fortunes from poorly organised privatisation schemes or by exploiting unrestrained monopolies. They prospered, but neither the economy nor the majority of the public did.

What was forgotten was that the extent to which greed works most effectively in a market economy when there is a governance framework which harnesses it and restrains it excesses. Russia did not have that framework, while Germany and Japan (and some of the European countries which fled the Russian empire) did to some degree. I hazard that Iraq does not have that framework either.

Ideally its reconstruction would involve the establishment of a functioning commercial infrastructure. I fear however that, as in the case of Russia, the greedy will ignore such priorities as they seek personal gain. It is a situation reinforced by the US shaky economy. There will be not be the generosity of a Marshall Plan for the reconstruction as there was after the Second World War. (Perhaps Islam does not present the same threat to US hegemony today as communism did then.) Instead the priority will be to exploit Iraq’s under-utilised oil fields to fund the reconstruction, creating major opportunities for greed.

But an irony has to be recorded. The US military conquest of Iraq was not a triumph of capitalism. Rather, a highly bureaucratic, strictly centralised organisation performed impressively (although not perfectly), bolstered, admittedly, by a careful coordination of the market. Now it is the turn of decentralised capitalism to lead, almost certainly with insufficient attention to the role of the centralised elements of economic regulation. Given Iraq’s mosaic of regional, religious and ethnic differences we have the script for a Greek tragedy. I hope, for the Iraqis’ sake, that I am wrong.