01.12.2003
Endless Redistribution
№4 2003 October/December

Konstantin Sonin, a professor with the Russian School of
Economics and a leading economist of the Center of Economic and
Financial Research and Development.


Many countries with transition economies have to address the
same problems of development. On the one hand, economic development
is impossible without democracy, since major economic agents must
have an influence on the economic institutions in order to boost
their own efficiency. On the other hand, wealth inequality under
democracy creates public demand for the redistribution of property,
a process that diverts the financial and human resources from the
production activities.

In Russia, the problem of property redistribution has now come
to the forefront of public debate. Opinion polls held in August
2003 showed that two-thirds of Russia’s population support the idea
that the results of the mid-1990s property privatization plan
should be revised. It should not seem unusual that a considerable
part of the population favors reclaiming property from the rich and
handing it over to the poor – such sentiments are customary in the
developed countries as well. Yet, while wealth inequality has
become a legacy in the historic development of many developing
countries, the particular type of inequality that has evolved in
Russia appears to be of a different economic nature. The
concentration of the largest and most profitable manufacturing
enterprises in the hands of a relatively small group of people in
this country resulted not through some erroneous privatization
policy; rather, it was a natural reaction of the economic system to
the weakness of its economic institutions, above all those that
should protect property rights. As shown by cross-country analyses,
the concentration of property is adversely proportionate to the
protection of property rights, especially the rights of small
proprietors.

Therefore, should Russia carry out the redistribution of
property (for example, with the help of the Prosecutor General’s
Office) and subsequent “fair” privatization, such a measure would
narrow the wealth gap, but only temporarily. As long as the country
has a reliable judiciary system and a corrupted bureaucracy, and as
long as the rights of economic agents to make profits on their
business efforts are poorly protected, property will continue to be
concentrated in the hands of a select group of people.

Oligarchs and the protection

of property rights

In an ideal world, it is the wealthy who strive to have their
property rights fully protected, since they are bound to lose more
than others should a redistribution of property occur – be it
through increased taxation or primitive highway robbery. Anders
?slund wrote in 1995 that the major goal should be to make
enterprises independent from each other and from the government,
and allow them to focus on sustaining profits. This will create an
environment where the owners will naturally seek to consolidate
their ownership rights.

This is precisely how the Russian reformers of the early 1990s
planned to create a program of property rights protection. They
believed that property should first go into the hands of private
owners (with little consideration as to whom or how – it should be
a quick process) in the belief that those owners would become
natural proponents for a system of property rights protection. In
Russia, the simple model (owners – demand – property rights) has
proven to be a failure, at least at this stage of the game.

Since the rich already have obvious advantages (the very scale
of their influence gives them privileges in setting up private
security agencies, for example, as well as securing strong ties
with the bureaucracy), they do not have the incentives for lobbying
the creation of well-working state institutions. In other words,
the rich do not need independent courts or efficient bureaucrats.
Instead, they seek to increase their political influence and modify
the existing state institutions so that the resources (wealth)
continue to be redistributed in their favor.

Similar situations were characteristic of the more developed
countries throughout different periods of history. For example,
Andrei Shleifer believes that the period of U.S. history following
the industrial revolution provides a perfect instance of state
institutions, above all the courts, serving the interests of a
relatively small group of super rich entrepreneurs.

But efficient economic institutions – primarily those which
protect property rights – are essential for a country’s steady
economic growth. These are courts enforcing the execution of
contracts, regulatory mechanisms facilitating the development of
small business, and so on. 

Today, the main dramatis personae in the possible redistribution
of property in Russia are the oligarchs, or the business tycoons
who have political influence and control over a large part of
Russia’s biggest production facilities.

Oligarchs are not an exclusively Russian phenomenon. This term
has often been used with reference to the past ruling elite of
imperialist Japan, and to the families now enjoying great economic
influence in Latin American and East Asian countries. In Indonesia
and the Philippines, the ten wealthiest families control more than
one half of corporate assets (57.7 percent and 52.5 percent
respectively). Wealthy families have also accumulated impressive
assets in Thailand (46.2 percent) and Hong Kong (32.1 percent), as
well as in Korea, Malaysia, and Singapore (25 percent). According
to experts, the concentration of corporate power in the hands of a
few selected families creates strong incentives for lobbying
government organizations and public associations through trade
barriers, non-market financing mechanisms, lucrative public
contracts, etc. This concentration also shackles the development of
legal institutions (Claessens, et al, 2000).

Nobel Prize winner in economics, Joseph Stiglitz, believes that
the Russian oligarchs do not generate a demand for equal rules for
all; they turn to legislation only when they feel that their ties
with the Kremlin are getting loose. Since they have extraordinary
wealth and influence, the oligarchs have never supported, and have
often blocked, attempts to protect ownership rights. Even now, when
the pressure on big business in Russia is becoming intense, the
businessmen are in no hurry to advocate the protection of property
rights for all citizens.

Wealth inequality is always accompanied by heavy costs on the
economy, primarily because it produces wide disproportions in the
opportunities available to the people. Furthermore, production
capital often falls into the wrong hands and, as a result, does not
create the profits it could have.

The example of oligarchs highlights another negative effect of
inequality – it undermines the demand for those state institutions
that were originally established to protect property rights. This
effect is especially strong if economic inequality is accompanied
by political inequality, which arises when political clout is
irrepressible.

This is exactly what is happening in Russia now. Political
parties and their financial structures inspire no desire among the
population to make even small donations, while party functionaries
have no incentives for encouraging these donations or collect them.
To compare: during the 1999-2000 election campaigns in the U.S.,
donations from private individuals made up 80 percent of the funds
raised by candidates and party committees, including the federal
election funds. An average donation was approximately $115.

Natural resource rent:

Pros and cons

Apart from property redistribution, there are other measures in
economic policies that seemingly narrow the inequality gap – the
collection of natural resource rent is one of them.

From a purely economic viewpoint, there is nothing particularly
bad in levying the natural resource rent by raising the export fees
on crude oil, for example. Supporters of such an idea would offer
many counter-arguments in favor of shifting the tax burden onto the
resource sector.  But the extra money that oil producers
receive due to an increase in world crude prices may be a natural
choice for redistribution; it is believed that its subtraction
should not affect the producers’ incentives. In other words,
increasing the taxes imposed on oil companies should not affect
their decisions on production volumes, pricing policies, or
reduction of costs  – of course, only to a point when
increasing alternative costs make the operation of the companies on
the world market senseless. This kind of taxation is called
non-distorting taxation.

Also, a transfer of the tax burden to the resource sector could
be a good remedy for what is known as ‘Dutch sickness.’ This is a
situation where the oil sector is yielding more revenues than the
other sectors and therefore attracts a lion’s share of investment.
Moreover, it would make the production of tradable commodities
unnecessary as they could be imported. The only segment of the
economy, besides the resource sector, that would remain on the list
of development priorities is the services sector.

Taken at face value, this scheme looks harmless and not fraught
with the risk of becoming inefficient. There is nothing bad about a
country losing the incentives to produce tradable commodities –
they can be purchased abroad for the money received from oil
exports. Inefficiency appears when the production of tradable
goods, i.e. those products that have to compete with their foreign
analogs on the international market, generates the demand for high
technologies and knowledge. Since economic growth today hinges on
innovations, but investment is limited to resource and non-trading
sectors, the growth rates in these sectors are slower compared to
those ensured by investment in the high-tech production of tradable
commodities. The best cure for this sort of economic sickness is
through corrective tax measures: lower taxes in the non-resource
sectors will stimulate investment there.

Whatever the arguments in favor of collecting natural resource
rent, there are grounds to believe that this type of
redistribution, similar to the re-division of property, has
discouraging effects. According to the data by the International
Bank for Reconstruction and Development (IBRD), those countries
where a considerable part of the GDP came from oil revenues, or
resulted from natural resource rent collection, experienced
stagnation – even during the periods of high world prices. Between
1965 and 1998, the per capita GDP declined in Ecuador, Mexico,
Venezuela, Nigeria, Libya, Iran, Iraq, and Kuwait – all of the
major oil-producing nations. The results of extensive systemic
studies of the efficiency of a wide range of national economies in
the second half of the 20th century confirm the common belief that
“wealth is doomed to perdition.” In the past 30 years, the OPEC
member-states have seen a decline of their per capita GDP at an
average rate of 1.3 percent a year.

The above does not mean that a substantial natural resource rent
will always give way to a slowdown in growth rates. Take, for
example, the South African Republic and Botswana – Africa’s two
fastest-developing economies boasting huge natural resources.

Yet, the government’s active interference, albeit aimed at
ridding the country of its dependence on resource exports,
predictably produces structural flaws. Theoretically, government
involvement can have a positive effect if there is a major market
flaw, i.e. when free economic agents are unable to foresee the
outward effects of their activity. In this case, the government may
play a positive role of redirecting investment flows. However, the
record of the developing world has proven the inefficiency of
state-managed investment in countries rich in natural resources.
For instance, in Nigeria physical capital grew at a rate of over 6
percent a year between 1965 and 1998, while per capita GDP
increased by around one percent. The physical capital swelled
mostly due to government investment.

Economists know pretty well what rent seeking is. It always
involves two or more private companies that pool their efforts in
order to receive a certain “reward,” like lobbying of import
duties. Rent seeking has a low level of economic efficiency because
it is redistribution in essence, not a productive activity. Every
single Russian ruble invested in rent seeking prompts other
participants to invest more than their opponents, since the
dividends from that investment keep growing as long as the
competitors’ costs increase. At the same time, the size of the
“reward” remains unchanged. Inefficiency is unavoidable if rent
seeking involves politicians: these are likely to promote both
their own interests and the interests of the population as a
whole.

To sum up, natural resource rent reveals two basic problems. In
the first place, even if natural resource rent is collected without
serious losses, the very fact that the budget receives this extra
money may pose a problem. Secondly, collection of  extra
natural resource rent, however simple it may seem in the oil
industry, is pretty costly for the economy – it prompts the people
who control the rent at the moment to invest heavily in its
protection and divert money from production.

An implausible contract

One major reason behind the endless redistribution of property
is the implausibility of contracts between the state and individual
citizens. 

Relationships between the oligarchs and politicians have one
distinctive feature: agreements in the redistribution games are
implausible. Many wealthy Russians who thrived on privatization and
redistribution in the past decade would probably agree to pay a
considerable part of their wealth for the guarantee that nobody
would ever come to take the rest of it away from them.
Unfortunately, getting such guarantees is a highly improbable
thing: there are no courts that could ensure the execution of a
contract between a businessman and a politician, let alone a
contract between the business and the state. The parliament may
endorse a law one day, for example, stating that an oligarch will
never be approached with questions concerning the privatized
property if he turns over, say, three billion U.S. dollars.
However, it is highly probable that the following day the state may
endorse yet another law demanding that he pay more. The oligarch’s
standing will have deteriorated by then, since he would have lost
three billion U.S. dollars (and, consequently, some of his lawyers,
bodyguards, contacts from among the media and the bureaucrats). If
this really happens, no law on limitation periods will have an
effect, since the parliament can always revise those limitations.
The Demidov and Mamontov families – the Russian industrialists and
philanthropists – were swept away by the Bolshevik revolution of
1917; the fact that their ancestors had acquired wealth on an
absolutely legitimate basis did nothing to help them.

Nor is it possible for the businessmen to conclude more
specified contracts with politicians, like “Bridle corruption and
drop excessive checks on us and we’ll pay you all the taxes in
return.” Maintenance of such contracts is impossible: the
politicians can reduce the taxes today, but they cannot guarantee
they will not raise them again tomorrow. Hence, the reluctance of
the businessmen to get out of the shadows; even if the politicians
swear to keep the taxes unchanged there is no court that can punish
them if they go back on their oaths.

The theory of conflicts knows numerous instances when wars –
whether they be between countries or between businessmen and
politicians – broke out much earlier than the opposing sides ran
out opportunities of a peace settlement through the transfer of
some of its controversial resources from the weak side to the
strong one. The modern theory of conflict offers the following
explanation: the weak side, a potential victim of aggression, can
open up hostilities instead of meeting the demands of its stronger
opponent. The reason given for this being that the weaker opponent
understands that it will grow weaker as its opponent grows
stronger, and that it will have to face much tougher conditions the
next time.

In this sense, an optimal solution would be to attain a
sustainable distribution of wealth that would rule out the
opportunity for either the businessmen or the politicians taking
away anything from either side, or to alter the balance of forces.
The observance of political contracts is an acute problem even in
the most developed democracies, while the mechanisms for ensuring a
balance of forces are meager. Some of these can be identified,
however. The governments are usually more reluctant to expropriate
investments made by foreign investors than by their own native
people; therefore, the sale of stakes to outside partners is one of
the possible mechanisms. Another mechanism for achieving a
sustainable situation is through the strategic renunciation by the
government of some of its powers.

Mutual mistrust between the negotiating sides is a common
problem. Its importance goes beyond the real fulfillment of mere
promises and stems from the fact that the ability of both sides to
enact their threats strengthens their negotiating positions. One
party of the negotiations will not have the incentive for
satisfying the demands of the opposing side unless the latter
proves that its threats are genuine.

According to the theory of ‘costly signaling’ (an idea which
made Dr Michael Spence a Nobel Prize winner), neither side at the
negotiating table will possess the “stimuli” for believing certain
signals, that is, promises or threats from the other side, unless
they are made to understand that these signals are backed up by
real costs. The greater the wish of the signaling side that the
other heed its signals, the costlier those signals should be. It is
essential that the costs of the signal are made very clear to the
other side.

Lost profit investment

Unfortunately, examples of the sound redistribution of
joint-stock property as part of government-sponsored reforms are
non-existent. But an analysis of the Latin American experience
could provide us with some insight into the problem.

The redistribution of property in Latin America came mostly in
the form of land reapportioning, while inequality was manifest in
wealth rather than income disparity. In the 20th century, many
Latin American countries found themselves in a vortex of
alternating reforms. The impoverished masses would put political
pressure on the elite, and some form of democratization, or in
other cases, revolution, would ensue. The majority of the people
would get the right to franchise, redistribution reforms would be
launched, and land would be handed over to the poor. Soon
afterwards the rich – the former elite – would organize coups
d’etat with the active involvement of the military, which would not
necessarily have to be bloody. Property would then go back to the
rich, or would simply be restituted to its former owners. Later,
political pressure would force the elites to hold democratic
elections in which some populist-leftist politician would secure
victory. And the spiral would start all over again.

For example, Argentina held its first elections in 1912, with
the entire male population having the right to franchise. This was
followed by a military coup in 1930 and new elections in 1946,
another coup in 1955 and elections again in 1973. Finally, there
was one more coup in 1976, and since 1983 democracy has reigned
there. Let us note in the margins, however, that Argentina, a
country that boasted a per capita GDP standing at 80 percent as
that of the U.S. in 1946, has experienced no growth since that
time.

Military coups in Venezuela in 1948, in Guatemala in 1954, and
in Chile in 1973 helped the rich to gain back a great part of the
lands that had been taken away from them shortly before each of the
coups. The 1954 coup in Guatemala was preceded by an agrarian
reform of 1972, and the overthrow of a democratically elected
president in Brazil in 1964 cancelled the plans for land reforms he
had been promoting.

In Latin America, the redistribution of property – whether from
the rich to the poor as a result of land reforms carried out by a
populist government, or from the poor to the rich as a result of a
military coup – mostly coincided with periods of economic
recession. The current flurry of the Russian government’s activity
is very unusual in that sense, as the Russian economy is growing
quite rapidly. However, faced with the threat of property
redistribution, the rich in Russia will have to spend fortunes in
order to uphold their political power. All of this money is
actually lost profit investment, since neither the government’s
redistribution activities, nor attempts to counter these
redistributions, add to the country’s GDP.

At the same time, economic growth is critical for the oligarchs,
since it shields them from questions from the electorate concerning
the legitimacy of their property. In other words, no one pays much
attention to the guests who have gulped the lion’s share of the
cake until new cakes stop emerging from the stove.

What could the oligarchs do to foster economic growth? In the
first place, they could cut their spending for corrupting judges
and strengthening their rapport with the bureaucracy and
politicians, i.e. for financing the costly redistributing activity
as opposed to any productive efforts.

This brings us back to the problem of coordination. A separate
oligarch may probably consider it more profitable to invest in
enhancing production than in protecting his own property rights,
but his contenders will then have more benefits from any
redistribution of property, which will make production less
profitable.

Today, the former oligarch groups in Russia are making the
structure of their corporate properties more transparent, partly
from the necessity of entering the international markets of money
and commodities. In any case, it testifies to the oligarchs’
willingness to develop more respect for the proprietary rights of
others. Whereas in the 1990s they found it more economically
feasible to gain control of financial flows, today property rights
play an ever greater role for them. It is not at all surprising
that improvements in corporate governance produce a noticeable
growth of capitalization.

To sum it up, an extremely uneven distribution of wealth that
mostly took shape in the past ten years has had a negative effect
on Russia’s economic development, yet a forcible redistribution of
property will be equally ineffective, whatever the reasoning behind
it. Attempts to reduce inequality by revising the results of
privatization of the major industrial enterprises, or by levying
natural resource rent will not reap any benefits. The only
predictable result of these attempts will be an endless chain in
the redistribution of property and its further concentration. Under
such conditions, economic growth in Russia is hardly
imaginable.