Economics 101 Revisited

Those who are wondering why this country has managed to come up with so much bad economic policy for so long would do well to read Prof. Anatoly Halchynsky’s analysis of Ukraine’s “heavily deformed virtual economy,” which he advocates fixing by enhancing the regulatory role of the state and its cooperation with private capital “in the spirit of Keynesian economics.” This would sound fine if it were not for three things: 1) it is the state that is responsible for the virtual economy, 2) little good is likely to come of “enhancing the regulatory role of the state” when there is already gross over-regulation enforced by grossly corrupt regulators, and 3) Keynesian economics is absolutely irrelevant to the situation in Ukraine.

First, the virtual economy concept, developed a couple of years ago at the Brookings Institution, explains that an average inefficient Soviet era enterprise consumes, say a hundred units worth of labor resources, a hundred units worth of energy and other inputs, and uses this to produce a product worth a hundred units. Since it has actually destroyed 100 units of value in the process of pretending to add value, it can only pay a part of its debts, thereby running up huge arrears and resorting to barter at virtual prices (virtual in the sense that nobody pays them in money). In a market economy such an enterprise would go bankrupt, precisely the “constructive function” of the business cycle to which Prof. Halchynsky refers: it frees up less efficiently utilized resources for more efficient use. And why do traditional enterprises get away with this in Ukraine? Because their managers were not businessmen but political appointees who through their political connection with the state are able to survive, usually quite well.

Second, this newspaper has covered enough instances of businessmen’s nightmares in dealing with state over-regulation. According to one material (Oleksandr Fandeyev, “Dark Side of Civil Service,” The Day, No. 5, February 15, 2000) the average Ukrainian businessman gets visited by fire inspectors eleven times a year with each call costing a little over 150 hryvnias. And there are also a host of other “instances” to be paid off. Do we really want to enhance their regulatory role? Do we really think this will do anything to enable private business to pull this country out of the hole economically by producing profitable goods and services? Or will it just line the pockets of the regulators?

Third, John Maynard Keynes wrote about market economies that were far less regulated than they are today, and, yes, when you have a market economy you can prime the pump to spur demand by feeding money into the economy or cool down inflation by cutting spending and raising interest rates. Such amelioration of the business cycle is at the heart of economic policy in most market economies. In Ukraine, however, this will not work, because what holds business back is not so much deficient consumer demand (although it surely exists) but the very demands placed on business by the state (taxes, regulations, bribes, and the fact that oligarchs can suck out billions thanks to state privileges shrinking the tax base and increasing the state’s hunger for money from those less favored, etc.) are strangling the only sector of the economy that can pull this country out of its economic crisis.

Finally, as an old Sovietologist I long ago learned to read the press not only for content but for what the appearance of something at a given time and place signaled. And this signal is very disturbing. When an influential member of the President’s inner circle contrasts the Presidential Message with the Government Plan, this means that the President is being urged, not to help Premier Yushchenko get the reform legislation he needs through Verkhovna Rada, but to throw him to the dogs. Western readers please note, the President might well be reminded why it is also in his (not to mention the country’s) interests that real reforms capable of promoting economic recovery in the real world be carried out and not the sort of mush being advocated by Shcherbytsky-holdover Prof. Halchynsky.