Today’s Ukraine is where Peru was in 1979

Erik S. Reinert, one of the world’s best economists who had a hand in the success stories of Malaysia and Peru, worked with governments of 80 countries and has recently been appointed as an adviser to the prime minister of Georgia, says that free market policies will turn Ukraine into a major agrarian economy and a source of emigrants. The professor explained how to avoid this fate in his previous interview with The Day past year (“Ukraine today is like Germany after World War Two,” The Day, No. 61, October 27, 2015). This time, we talked about who, how, and why prevented Ukrainians from becoming rich, and how should we confront this.

To be able to refuse to implement the recommendations of the IMF, we need to stop taking money from the Fund. How are we to do it, if, say, industrialization requires considerable financial investments? Can you recommend any organization to which the Ukrainian government should shift its attention?

“Well, the money you are seeking is financial money to cover your debt. And I think one should look at the Ukrainian debt and see is it payable at all.

“This summer the IMF has actually admitted that in Greece they made some big mistakes. So, one should look at what they actually admitted this summer and say to the IMF: ‘What mistake you have admitted in Greece, perhaps you are making the same mistake in Ukraine?’

“The financial sector is very important as a scaffolding, as a structure supporting production. But now, Ukraine is in a situation where the financial sector becomes like a parasite. The financial sector is actually killing the real economy. And you have to put the focus back on production, and have the political will to stop listening too much to the IMF.

“At the Kyiv International Economic Forum, to which I was invited, we had the EU commissioner for neighbor relations and extensions. I think this gentleman was extremely arrogant, he was putting all the blame on the Ukrainian corruption and saying that if you can get rid of corruption, things will go well, and we will pay you more money. Not so long ago I was in Mozambique, and guess what? The EU ambassador to Mozambique was saying that the only problem in Mozambique was corruption.

“So, you have to be aware that they don’t really understand poverty, so they blame the victims of poverty for their own poverty. This is not to defend corruption. It’s very bad. But history shows that the best way to get rid of corruption is to build a healthy protective economy. So, there is still too much focus on this and too little focus on the real economy. And that creates the wrong mentality in Ukraine, this idea that the Ukrainians have themselves to blame for this. ‘Just behave and we’ll give you more tender, more debt.’

“What’s happening now in Ukraine with the de-industrialization is similar to what happened in many Latin American countries in the 1980s. I worked a lot in Latin America. I mean, I recognize this focus that ‘if we could only get some more loans from abroad we would be safe.’ This was the Latin American attitude also, and it was equally wrong. This is so typically IMF and the World Bank.

“In 1979, we lived in Peru, and the Peruvian economy was collapsing. The only solution of the IMF was to triple the price of gasoline. And Peru is a country which is very transportation-intensive, because it’s a big country, and a lot of terrain is jungle, and the coast, and the highlands, and the infrastructure was bad. So, what happened when they raised the price of gasoline – and with the free trade – was that all the milk that was produced in the Andes was poured into the rivers, because it was almost cheaper to buy powdered milk from Holland. So, the mixture of free trade and increasing the price of gasoline was absolutely crazy. We had these pictures of the farmers pouting the milk in the river, and milk in Lima got very bad because it was made from Dutch powdered milk. And I thought this was a one-time craziness of the system. This is the system, this is 1979 till now, they still get away with murder.”

My understanding is that Ukraine has no other way to get the money into the economy but to attract investors. What can we now offer to businesses apart from war or corruption, well-covered by every global media?!

“The biggest trait of Ukraine is that you have a big market. More than 40 million people, that’s enough to create business, a healthy manufacturing sector.

“And if we look how the Americans financed their economic development, how they got rich – 70 percent, in the late 1900s, of the federal income, the income to the federal government, was from tariffs on foreign manufactured goods. So, the tariffs played a very important double role. One was protecting the industries so that they could grow until we get free trade 30 years later. But on the other hand, it was the tariffs that financed the government. I do not think it is possible now, but I think it is useful to say: ‘Look, that’s how it was done earlier! This is how important rich countries got rich.’

“So, that’s why it is important to understand that the free trade era is coming to an end, and historically, free trade eras have been short-lived. The English protected their industry for 350 years, then they had 80 years of free trade, and then, around 1900, let’s say in 1903, what happens now in the United States, happened in England: the English understood that free trade was no longer in their interest. So, they started to protect it, they started to create a free trade Commonwealth, with free trade between England and its colonies, but not with the rest of the world.

“What is important is that as long as you have ‘symmetrical free trade,’ the free trade among countries of roughly the same level of development, that’s very good. But asymmetrical trade – if you sell raw materials and import manufactured goods, like Ukraine does – is very much in the disfavor of the raw materials-producing country.

“An important thing here that we should understand: people’s perception of reality changes. I was past month in Georgia, and I was seeing how the neo-liberals in Georgia are going towards the center. Even the most neo-liberals, after seeing the interview with me on TV, said: ‘In main things we agree. We need to develop manufacturing industry.’ And the prime minister, who is now understanding this, was re-elected.

“On the other hand, this takes time, because mentalities have to change, and unfortunately, in order for people to understand, things have to get worse. As long as things do not get worse, people do not see how destructive it [neo-liberalism] is.

“But you have had a slide of 25 years of de-industrialization and increasing poverty. Now is the time to ask ‘What we have been doing for 25 years? This neo-liberal dream was wrong.’ Fortunately, now also the Americans are saying it, see it as wrong. So, if this model does not even work in the United States, as the center of capitalism, how can we expect this model to work in Ukraine? This is an argument. That’s why Trump is so useful.”

We shall return to Trump later. Professor, the government of Ukraine has announced it will open Ukraine investment offices at our embassies all over the world. Which continents and which countries should we focus our effort on?

“I’m not an expert on Ukraine. But I think that what you need in Ukraine is a development bank, and a development bank supports production and trade. And strangely enough, the most successful development bank in the world is Brazilian. So, I think, one thing to do – is to send the mission to Brazil or ask the Brazilian embassy: “Could you please, tell us what you do, what you have done to achieve such a success?” I think, for a while your focus should be on the internal production, but you still need exports in order to pay for your imports, of course. Ukraine sells wheat on the international market and buys back spaghetti. And the price of the spaghetti, which is essentially wheat, is probably one hundred times that of the wheat.

“In the 16th century there was a famous memorandum to the king of Spain, saying ‘we’re making a big mistake here by selling our raw materials and then buying the finished products back.’ This was the basis of industrialization in Europe in the 1960s and 1970s, when these things got rediscovered.

“I think, in order to improve balance of payment, you must try to support your domestic manufacturing industry. And one way of doing that is such that I spoke of. But then you have to control that your process is just, and you need competition. You need not one spaghetti factory, but two or three or four. With 40 million people that’s not a problem.”

The main difference between corruption in poor and rich countries is that bribe takers from poor countries remove money from their own economies and spend it in rich countries, buying real estate, luxury cars, yachts, or spending holidays there. To close these “holes,” you advise us to industrialize the country. But how can it succeed when this same corruption creates obstacles in the form of lobbying for monopolies, the financial sector, etc.?

“Well, the recipe would be the restriction on transfer of currency which we already have to some extent. And also make it profitable for people to invest here.

“I agree with you. This is a vicious circle – political instability, no manufacturing industry, money gets exported – how do you stop that circle? You can try to control it but it can only be stopped by creating profitable economic development at home.

“And there are different kinds of corruption. In Italy they have names for it. The bustavella is the kind of corruption when an official gets a percentage of the work, like he was an agent. Say you build a bridge and the commission is one percent. That’s one type of corruption. And then you have the pizzo – the money that mafia ‘extracts’ from people.

“In Africa, Zimbabwe is corrupt because Mr. Mugabe tries to run the whole country like a clan, like his family. And if you help your cousin, it’s not corruption there – but in the West it is seen as corruption.

“And perhaps an explanation is actually to look at the roots – it’s not an excuse but as an attempt to explain why it is so.

“Corruption in Ukraine to me has its roots also in the trading of favors which took place under the planned economy. If you are managing a state company, and the plan is to deliver you the material, you need it – you will get together with another guy, who runs a different plant, and you trade in favors. And if you go to the doctor, you bring a little gift. This was at all levels, it only got the system to work if you are exchanging favors. So it was an escape clause for the inefficiency of the system. And in my way, because of that many people think that corruption is legitimate.”

The fourth technological revolution will make the economy more reliant on technology and less on human resources. What industries and sectors should a country like Ukraine develop in order to provide jobs for 40 million people, if we do not want depopulation of the country continuing?

“If we talk about the Fourth Industrial Revolution, the key thing is that the new technology should be created in a way that it links to the real economy. You should use the new knowledge, the new technology also in the marmalade factories. It’s something not very complicated, but it’s as big as elsewhere. The technology can be moved easily. But if you just concentrate on high-tech, you will make the same mistake as the Russians are making in their high-tech city, Skolkovo.

“The risk of Skolkovo is that the technology created there does not link well enough to the Russian economy.

“And we see that in Estonia, which is a successful post-Soviet state, even during the Soviet times there was Tallinn Institute of Cybernetics, which was very high-tech. And a lot of those skills were kept. But it is also linked to the entrepreneurship in the country. But we also see there is the risk that Estonian research, paid for by the Estonian state, is used for production in other countries. And I think there is a risk that if you try to build only very high-tech companies, these people will be lured into Poland, where the wages are higher.

“I learned that in certain areas of Ukraine, Romanians are giving away passports. So high-skilled Ukrainians are given Romanian passports in order to lure them into Romania. Poland is attracting and paying for a lot of Ukrainian students. I think you have some predators out there, you have some predators that are trying to steal your skills.

“So, by all means, don’t neglect that, but the key thing should be to create employment. The food processing sector is very important industry which employs a lot of people. And it can employ a lot of people all over the country. And that was just one example. And there the wheat-to-spaghetti thing enters the picture.

“And this is an old type of development economics that worked in Latin America in the 1950s and 1960s. The Chilean government, which was really rightist, under Mr. Pinochet, prohibited the export of Chilean wine in bulk. They were sending tank boats, tankers with wine. And Mr. Pinochet forced the Chilean wine producers to only export wine in bottles. Because then we get a value added on the bottle, on the bottling, on the cork, on the label and all that – and suddenly, the export value of Chilean wine goes up to the factor of three or four.

“This is the kind of thinking. And this was a fascist who did that. This is something which happens in the communism, but it also happens in the fascism – everyone did this until the fall of the Berlin Wall, when we entered this age of neo-ignorance, as I call it.

“What will come after this, is, I think, a reinventing of what was so successful about the 1950s and 1960s and the early 1970s. And then there was an international trade agreement, which was called Havana charter. In Havana charter all UN members agreed unanimously, in 1946 or 47 I think, to allow non-industrialized countries to support, to protect an industry if they had unemployment or if they had an industrial plan.”

You have said that neoliberalism is dying out. What is replacing it? What is this new theory called?

“Well, first of all, this new theory will be based much more on facts and on history. It’s not based on abstract models, but it’s based on actual historical experience. And what got Europe and the world out of the crisis in the 1930s was the theory of John Maynard Keynes.

“Keynes said, to put it briefly: demand is everything. In order to solve the problem we need to create demand. And then the ideology shifted, and we got a different theory of Mr. Hayek, and people before and after, and they are saying: the quantity of money is everything.

“So we left the demand theory and we go for the quantity theory of money. That’s why we are printing so much money. But Mr. Hayek was living in a period where the relationship between the financial sector and the real economy was very stable, and the financial sector didn’t have a lot of money. So you can kind of excuse Mr. Hayek for not seeing that the financial sector could become the parasite.

“But if you told Mr. Hayek that ‘look, you also have to look at how this money is distributed – in this quantity theory of money – who gets the money? If the money goes to people who don’t consume – your theory doesn’t work, because it doesn’t consider the marginal propensity to consume.’ So, perhaps the quantity theory of money worked 50 years ago, but it doesn’t work now.

“So, the deadly combination of what is happening now is that we have austerity, meaning shrinking demand, and the quantity theory of money. Printing money on the one hand and restricting consumption on the other – that’s crazy. And this is what is gradually happening. The British government said on this austerity – you know, we can’t continue with that. They are leaving the combination of printing money and restricting demand.

“So, we are slowly moving back to the Keynesian world, where demand is everything, or almost everything, and where there is a real or potential problem of underconsumption in capitalism.

“And for the people who are economists, Hayek and others – they believed in something called Say’s law (Jean-Baptiste Say was a French economist). His law says that production creates its own demand. So you can never have an underconsumption crisis. And that’s totally awful. But this is the way in their minds that they can have this crazy theory. Because they assume that if you produce something there will be a demand for it.”

So, it turns out that we are entering an era of the neo-Keynesian theory’s domination?

“Yes, we are coming closer to Neo-Keynesianism.”

In your opinion, what geopolitical transformations of the world can be caused by the crisis of neoliberalism? Could the US lose economic leadership?

“Well, I think it has already lost it, because it goes to China. The West started believing in its own propaganda – they only get free trade and everybody will get richer. And if you start believing in your own propaganda, that’s very dangerous. And unfortunately I think the idea of the perfect market, the idea of the invisible hand solving things meant that if you only got rid of evil people, the market will solve all the problems. So if you only killed Saddam Hussein and Muammar Gaddafi, you’d have spontaneous order. This is idea of economy as harmony-making machinery. And this bombing for democracy is very dangerous.

“I read many American newspapers, every day I get a lot of mails, and I see that people are worried about Hillary Clinton being too fond of war. And they are afraid that she will be a warrior. And perhaps also because she is a woman. And if she is not strong and macho – they will criticize her. That’s very sad, I don’t want to go too much into that, but this is a worry that all war machinery of the United States, all these people who started it – Cheney and Wolfowitz – who started the Iraq war, will get power again.”

Is it possible that the world will come back to bipolarity, as desired by the Kremlin?

“I don’t think that will succeed, but when I go back and think about what the Cold War was about, I grew up, all my life has been Cold War. And Norway had a border with Russia. That was a border with the Soviet Union. That was very scary. And I was so happy when communism collapsed. It’s an awful system. But now I start to miss communism. And I miss it because it was a credible threat to the capitalists. The capitalists understood that if they didn’t treat their workers well, they didn’t share the income, there was an alternative. And now that credible threat is gone, and we are getting middle feudalism back. What’s coming after industrialism or perhaps what came before industrialism was feudalism.

“Inside the EU we are now creating new feudalism. And I have a colleague in Bucharest who heads an institute of geography at the University of Bucharest and he tells me that what’s happening there (and I also have this confirmed by a Romanian student in Italy) that wealthy people buy up houses for the homeless and they put the homeless in these houses and they say: you can live here for free, but when I need your labor, you’ll work for me for free. That’s feudalism.

“In a sense, the mere existence of communism shaped capitalism to be a more humane system. So the question is: can we create another credible threat?”