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Where there is no law, but every man does what is right in his own eyes, there is the least of real liberty
Henry M. Robert

Grzegorz W. Kolodko On the Virtual Economy

6 March, 1999 - 00:00

Post-Communist Depression And Negative Value Added Output

The biggest failure of the transition process in Russia and a number of
other post-Soviet states has been the dearth of strong, positive supply
responses and thus meager if any economic growth so far. Contrary to the
early expectations and promises, the fundamental systemic and political
changes have not delivered expansion and improvement of living standards.
Hence, as the depression continues, there are several attempts to explain
the causes of output collapse by non-standard factors. Among them time
and again the concept of negative value added output is brought to the
fore, and recently so-called virtual economy has been discussed.

Not surprisingly, these attempts try to minimize the actual range of
dire consequences of wrong economics and wrong policies, which have led
to such severe contraction as over the last seven lean years in Russia.
The perplexity and confusion of different processes, like the shortage
removal effect, liquidation of negative value added output, and unregistered
economic activities, lead sometime to indeed weird opinions. They try to
exploit the complexity of the changes by arguing that contraction was better
than growth, decline of real salaries was better than increase, higher
prices were more suitable for consumption than lower ones, etc. Some advisers
still claim that there is a market economy in Russia, only the people do
not understand it. Yet as long as they do so, there is no market economy,
since a market system presumes that there are private property and liberalization,
but also organizations and the rules as well as proper understanding of
these rules and market culture. Jeffrey Sachs - instead of taking his part
of blame and making at last a sound effort to understand and explain what
has not worked in the Russian economy and why - tries to say that they
didn't listened to his advice. The problem is that some Russian policy-makers,
unfortunately, have followed his ill-advised recipe - as in Poland at the
early 1990s, which caused deep contraction and vast crisis at the time
- and he should claim now due credit for his role in such mismanagement.

There are more examples. For instance Jan Winiecki repeats his early
false assertions about the improvement of living standards and the general
economic situation despite the great slump, while suggesting in ridiculous
way: "An Estonian who bought a packet of western-made (and therefore reliable)
condoms for $1 in 1991 was spending 3% of his monthly income. Now (after
the contraction of one-third of GDP! - GWK) he is spending less than 0.5%,
so the relative price to him of these high-quality foreign goods has fallen
steeply - a rise in his living standard that most measures would ignore."
(Quoted in "Now You See It, Now You Don't," The Economist, November
22, 1997). Of course, now one pays relatively less, if the income and prices
are expressed in dollars, but if they are denominated in the local currency,
that happens to be always in circulation as the legal tender, one pays
much more in real terms. After all, if still only the Western products
would be reliable in a country aspiring to join the European Union after
a decade of transition, why would it have begun this transition at all?

There are abundant good reasons to be a real fan of the transition and
one indeed must not try to support it by false declarations or trivial
and vague arguments. Thus it is worthwhile to continue the debate about
the phenomenon of so-called virtual economy. But Russia is not such. Though
it is true that a part of production was of poor quality and in extreme
cases the value added during manufacturing process happened to indeed be
negative, that type of output was neither that big, nor it was replaced
by any other production soon after it ceased to flow. The same is true
vis-И-vis other transition economies including the former GDR. Whatever
was the genuine quality of that famous Eastern German "piece of art" of
automotive industry, the Trabant the automobile, its past possession, even
if it was manufactured at negative value added, could not be substituted
for by the current lack of the brand new BMW! This is not virtual reality,
but the real problem of lost output and wealth due to the transitional
contraction, of which a great part in turn is due to wrong policies based
upon wrong economics.

It could be objected that cutting negative value added activities should
raise rather than reduce GDP. But it was only after price liberalization
that the negative nature of many productive activities was revealed. Cutting
negative value added activities raises GDP with respect to what it would
have been without such cuts, but it still causes GDP to fall with respect
to earlier levels achieved when domestic prices diverged from the opportunity
costs and international prices. Over the transitional contraction a great
deal of output was wiped out in a radical way, without instant replacement
by other production. At most, falling output was made up for by growing
imports. Some companies were crowded out from the market by a credit crunch,
especially by prohibitively high real interest rates imposed not only on
new loans (which was justified, considering the need of financial squeeze
for the sake of successful stabilization policy), but on old debt as well.

 

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