The Shleifer Russia fiasco fascinates me. It seems to reveal more than a simple case of weak willed people succumbing to temptation. Rather it suggests that some of the world’s most powerful people and institutions consider use of political privilege for personal financial gain as their guiding ideal, the centre piece of the system they are endeavouring to bring about. Now Shleifer’s key mentor and protector, Larry Summers, is front runner to head the Fed.

This sorry saga started in the early 1990s after the Soviet Union collapsed. The end of the soviet era left Russia lacking the institutional arrangements needed for a modern capitalist nation. Russia did have tremendous potential; it had an extremely well educated population, abundant natural resources and extensive capital equipment and infrastructure. In principle Russia could have been expected to spring into becoming a global font of technological innovation. Russia was bounded on either side by the prosperous nations of Finland and Japan. However, instead of realizing that potential, the Russian economy collapsed; leaving a husk limited to extracting and exporting raw mineral resources whilst squandering the talents of the Russian people.

The Russian experience stands in stark contrast to what happened to Japan and Germany after WWII. In the late 1940s, the USA took on the task of setting up institutional frameworks to ensure that West Germany and Japan were able to prosper for the benefit of all their people. In both cases it was a herculean task. The USA conducted that responsibility admirably and those countries became beacons of progress and widespread prosperity. That transformation entailed dramatic redistributions of wealth and power amongst the Japanese and German people. In Japan, farmers were able to buy their farmland at an affordable price after the traditional large-scale land-owners were ordered to sell up. In Germany, the Nazi era debts were voided leaving a clean sheet.

The USA clearly had a very noble history of turning around the fortunes of former enemy states –creating affluent allies in the process, with everyone benefiting. As such, the USA was the natural place for Russia to seek advice on the massive challenge it faced. However what Russia received was very different from the earlier treatment of Germany and Japan. The USA deployed academic economists from Harvard University to guide Russia’s reconfiguration as a capitalist state. Those advisers are the people who now are looked to by western leaders when considering the future direction of western nations. Does Russia reflect what they wish for all of us?

Post WWII reconfiguring of Germany and Japan was orchestrated by US military Generals* who took a pragmatic approach. They were guided by experience of the war-time US economy and the presumption that widespread prosperity was a prerequisite for creating a nation that would serve the USA as a valuable ally rather than fester as a source of future conflict. The spectre of communism helped to focus attention on ensuring that a version of capitalism was installed that would trounce communism at every level for every sector of society. By contrast, after the Soviet Union collapsed, communism no longer posed any form of competition and so there was no longer that concern. What was set in place in Russia may reflect an unfettered political ideal of the most powerful western policy makers.

The post-war US military authorities took the common sense view that the economy needed to be crafted into a framework that aligned financial interests with what benefited the wider population. It was fully recognised that an economy might instead fall down a malign path where financial interests led instead to waste and conflict. By contrast, the Harvard team in Russia had such unqualified faith in the constructive properties of avarice that they seemed to be guided by the principle that their role was merely to sweep aside any impediments that hindered money from doing what it wilt. The Harvard ideology boiled down to the belief that personal wealth gathering would always generate benefits for the wider economy. It was deemed inappropriate meddling to be concerned about wealth distribution. Having ownership concentrated to a tiny segment of the population was not viewed as a problem because their ideology was that owners would always maximise the utility of everything they owned.

There is a certain irony to all of this. The soviet system clearly failed to make optimal use of the resources it had. The classic explanation is that, without the profit motive, resources were misallocated and disaffected workers let things slip. To my mind much of the problem with a soviet style of economy is simply that economic power is overly concentrated. A few central planners are tasked with sensing what everyone else is capable of contributing and wants to consume and co-ordinating all of that. By contrast a capitalist system with widely distributed economic power, channels the combined parallel decisions of everyone. That capability breaks down once economic power becomes overly concentrated. An oligarch is faced with just the same impossible task as a soviet central planner. They have no way of knowing what all the “little people” are up to contributing or want. So oligarchs flunk at the challenge of mobilizing human resources and an oligarchic economy atrophies down to leave just the natural resource extracting industries. Haiti provides a classic example of where oligarchy leads.

The Harvard role in the Russian privatizations took its most bizarre twist when the academic economists themselves started joining in with the asset grabs to carve out fortunes for themselves. They became entirely pre-occupied with grubbing around to gather personal fortunes and neglected (and were conflicted with) the epoch making challenge of setting up the institutional framework to enable a constructive form of capitalism for Russia. That astonishing behaviour has to be viewed in the context of their wider ideological view point as to the economic role of wealth and wealth distribution. They seem to believe that the optimal solution is for ownership to accrue to whoever is cunning enough to grab it; if that happens to be themselves, then so be it. Deploying political privilege as part of that cunning is all fair game. Following this logic, if the ultimate endgame is to deploy political power to configure the economy into a form that hands over financial power to those with political power, then those winners are the rightful victors.  Under such an ideology there is a particular imperative for believers to gather a vast personal fortune. The old adage, “if you’re smart, then why aren’t you rich?” takes on a reality in which not being immensely rich becomes a mark of failure. By contrast, my guess is that General McArthur would never have contemplated using his position for personal financial gain. Prestige came from doing the job well as evidenced by the future course of the Japanese nation. Personal enrichment from exploiting political power would have been seen as shameful and little minded.

What strikes me most about the Shleifer Russia affair is how Summers’ Harvard stood up for the protaganists and nurtured their careers whilst paying tens of millions of dollars in damages and legal fees brought on by fraud charges from the US government over the affair. Clearly Summers’ view is that the Russia privatization team did not act disgracefully and bring shame on Harvard as an institution. Schleifer has never acknowledged any wrong doing and has been backed to the hilt by Harvard.

Political power now seems to be shifting towards the kleptocratic viewpoint. The 2008 bank bail-outs were an awesome display of the political system being commandeered to appropriate immense financial power and Larry Summers was in the thick of it. If Larry Summers does get appointed as Fed chairman then that will be a crowning of the conquest.

*It is obviously important to also credit German and Japanese participants. Ludwig Erhard deserves much of the credit for the Wirtschaftswunder but ultimately it was the US who chose to put such admirable people in the driving seat in the crucial period before the first elections.

Related stuff on the web:

How Harvard lost Russia -David McClintick

‘Tawdry Schleifer Affair’ Stokes Faculty Anger Towards Summers – The Harvard Crimson

Did an Expose Help Sink Harvard’s President -NYT

Theft of the Century Privatization and the Looting of Russia – Paul Klebnikov

Who Lost Russia – George Soros

Russian Ripoff -Michael Hudson

Why Wall Street Wants Larry Summers (and Why the Rest of Us Should Not) -Kotlikoff and Sachs

Larry Summers will destroy the economy (again)– Salon

Anyone But Larry Summers – Barry Ritholtz

Larry Summers’ Take on Efficient Markets and Regulators – William K Black

Why Janet Yellen, not Larry Summers, should lead the Fed – Stiglitz (link added 14Sep2013)

Max Keiser and Greg Palast on Larry Summers and the Financial Crisis – Jesse cafe Americain (link added 18Sep2013)

Larry Summers: Goldman Sacked – Greg Palast (link added 18Sep2013)