Does the Russian mafia deserve the Nobel prize for economics?

Edward Luttwak

It is now conventional wisdom that mafyia extortion and official corruption of every sort are inflicting much damage on the Russian economy. In a widely cited estimate, crooked officials and plain gangsters are said to have sent as much as $100 billion into their foreign bank accounts since 1990, depriving the Russian economy of much more hard currency than the sum total of post-1990 Western aid. Countless newspaper articles have profiled the unappealing beneficiaries of the new economic order, from violent thugs with platinum-blonde molls and BMWs who do their showing off in restaurants, to sleek ex-officials in Armani suits with Vienna bank accounts, Manhattan apartments and good friends in the Kremlin, who show off in New York Times interviews.

Far more numerous are the less obviously criminal and much less glamorous ‘bizness-men’ – thousands of them – who traffick in state-owned raw materials diverted for entirely private export, who help thieving state managers transfer public property to personal ownership, who collaborate with foreign adventurers to smuggle consumer goods in and weapons out, or who simply buy and sell without bothering to pay taxes. Most visitors to Russia have encountered specimens of the type in the hotel lobbies that are their favourite places of business; some earn just enough to get by from day to day while waiting for their big hit, but quite a few have become seriously rich very quickly.

There is no doubt that the pervasive criminalisation of the Russian economy imposes real costs. The purchasing power of an impoverished population is further reduced, because mafia ‘protection’ fees increase prices. Efficient private-enterprise firms suffer from the unfair competition of less efficient rivals backed by corrupt officials. And, as anywhere else, tax evasion must ultimately be offset by inflationary money-printing, or higher taxes inimical to growth. Moreover, the intense popular resentment of both gangsters and tycoons certainly threatens Russia’s economic liberalisation very directly: at the next opportunity, a majority of the electorate may decide to vote for go-slow Communists, or even hardline Stalinists – though even they could only stop further privatisations, not reverse the process.

The political threat is real enough, but in purely economic terms the conventional wisdom is all wrong. To begin with, it overlooks the natural evolution of the capitalist animal. The fat cows that populate advanced economies – stable, highly capitalised firms which offer good employment, pay their taxes in full, invest in new plant, develop new technology and contribute to charities and culture – were not born as such. It was as lean and hungry wolves that they originally accumulated capital, by seizing profitable market opportunities – often by killing off competitors in ways that today’s anti-monopoly commissions would not tolerate – and by cutting costs in every way possible, not excluding all the tax avoidance they could get away with. But when countries and their economies undergo truly drastic transformations, as Germany, Italy and Japan did because of the destructions of World War Two, and as Russia is now doing, conditions are too harsh even for wolves. Only ruthless hyenas can survive and prosper in the chaos: by trafficking in whatever can be profitably sold, legally or otherwise; by buying up valuable real estate for pennies from desperate owners or corrupt officials; by the improvised manufacture of sub-standard products for deprived consumers; or by the simple theft of abandoned, semi-abandoned, or just poorly guarded property.

Many of the dynamic industrial firms that now fill the landscape of Emilia-Romagna, most Japanese real-estate fortunes that long ago diversified into industry and finance, and not a few of the businesses that propelled West Germany’s rise to prosperity, had their start in the immediate post-1945 years – and it was by black-marketeering, predatory buying, sub-standard manufacture and efficient stealing (the polite expression was ‘organising’) that the hyena-entrepreneurs of those days accumulated the capital that enabled them to become honest wolves, and eventually productive cows. Legend has it that many of Emilia’s metalworking firms were first equipped with tools and machinery looted from a Wehrmacht ordnance-repair train abandoned in April 1945 near Piacenza; in Japan, old people still vividly recall some of today’s tycoons in their original incarnations as dance-hall operators, gambling masters or purveyors of GI luxuries diverted from PX shops; while in Germany, the persistence of the GI market after 1945 made the ownership of nightclubs and outright brothels as well as black-marketeering the prelude to many a business career. Had the respective police forces been effective enough to round up all the hyenas and lock them away, the economic recovery of West Germany, Italy and Japan would have been much slower, and many of the successful entrepreneurs of the Fifties and Sixties would never have been able to get their start.

All this is true of the Russian economy – only more so, because in its case even simple theft could be highly productive. The still intact Soviet Union produced more electricity per capita than Italy (5986 kWh v. 3650), more steel per capita than the United States (557 kg v. 382), much more mineral fertiliser than Japan (119 kg v. 12), more tractors per 1000 people than West Germany (1.9 v. 1.3), more cement per capita than France (488 kg v. 469) and 70 kg of meat per capita as compared to 32 for Japan, 63 for Italy, 96 for West Germany and 120 for the United States. At the same time, the Soviet standard of living was almost incomparably lower than those of France, Italy, Japan, West Germany or the United States. Statisticians quarrelled over the numbers in trying to come up with numerical comparisons which in truth were entirely meaningless: what did an X or Y income per capita mean when much patience or ingenuity were needed to get 100 grams of butter, and it took special connections to be able to buy a decent pair of shoes?

The too-obvious explanation of this gap was the huge cost of Soviet military ambitions, by then in the final stage of baroque excess. Much steel did go into the making of tanks and warships, and cement, too, was consumed in great amounts to build gigantic underground command centres, as well as more mundane air-fields, missile silos and more. But what about the agricultural tractors and fertiliser, in both of which the Soviet Union out-produced not only West Germany and Japan but also the United States, France and Italy? Neither was claimed by the military for their own use in any significant quantities, yet all those tractors and all that fertiliser did not finally produce enough grain for home consumption, let alone the sort of export surpluses that France and the United States must dump on world markets. By the highest estimates, the military used up some 30 per cent of the Soviet Union’s GNP, but the gap between basic inputs and outputs actually useful to the Soviet population was much greater.

As everyone knows, the real explanation for the gap is that by 1989 the Soviet economic system was no longer just inefficient: in many ways, it was positively destructive. Perfectly good Uzbek cotton which had real value – it could be sold on the world market – was made into shirts so poorly cut and of such ugly colours that not even Soviet consumers would buy them. Hence all the spinning, weaving, dyeing, cutting and sewing actually removed value from the raw material, turning virgin cotton into the equivalent of scrap rag for paper-making. The same was true of leather, wool and synthetics (which imported Western plants produced in vast quantities by 1989), of wood and structural plastics, and of all sorts of other inputs that went into Soviet light industry. Likewise, the steel and cement not reserved for military use that ended up in Soviet building projects was, in effect, lost for several years because the pace of construction was so slow (five to seven years even for standard housing) – and quite a lot was lost for ever, as unsheltered cement bags solidified and steel rods rusted away.

Above all, by the Eighties Soviet agriculture had become a more costly luxury than the armed forces. While the Soviet Army at least kept its tanks in service for twenty years or so, Soviet state and collective farms ruined many tractors, reapers and combine harvesters of near-Western quality in less than one year, because of the lack of maintenance, or simply because they were left out to rust in the open all winter long. Likewise, truckloads of fertiliser dumped on fields actually reduced the output of crops.

Given such a counter-productive system, simple theft can be highly productive – it definitely increased the overall standard of living of the Soviet Union. Cotton – as well as other light-industry raw materials diverted from official channels – could be made into useful products by domestic or illegal craft work. Construction materials stolen from the interminable official projects provided the means to build many apartment blocks and dachas with illegal or do-it-yourself labour. Petrol, removed from state trucks that often drove about uselessly, could provide much needed fuel for private car-owners. And it was with stolen fertiliser and farm tools that the tiny private plots produced so much of the Soviet Union’s food supply.

Inevitably, thieves and final consumers could only be brought together by a functioning illegal market, which in turn could only be operated by criminals who were sufficiently organised to do the job, i.e. organised crime, i.e. the Soviet mafia. Because bureaucrats and policemen had to be paid off at every stage of acquisition, transportation and distribution, it followed that the mafia had to collect ‘protection’, i.e. its own unofficial taxes. It was that crypto-capitalist system which emerged in view fully ready to function in sector after sector, in place after place, as the official liberalisation progressed. Many if not most of the Russians who bitterly complain about the mafia had greatly relied on its indispensable services during Soviet times. True, by now almost half of the economy has been privatised. But that leaves the other half in state ownership – and much of it remains so counter-productive that theft can still increase Russian living standards. Moreover, many state firms have only been privatised very nominally – they are still run by their old managers, in the old inefficient ways.

It is also true that mafia extortion practised against private shops and stalls adds no value, but instead redistributes income from many, mostly very poor consumers to fewer, richer gangsters. But in one crucial respect organised crime remains a very beneficial force: it is the only counterweight to the great number of firms backed by corrupt officials which now engage in ruthless monopolistic practices. At the local level, ex-Soviet officials who now own shops, restaurants, hotels and workshops do not hesitate to use their old Party connections to drive competitors out of business – by arranging the imposition of huge taxes and fines, by hygiene inspections followed by shut-down orders, by arbitrary administrative rules. In such cases, there is almost no possibility of obtaining redress from the overburdened Russian courts, which have barely started to deal with commercial and fiscal matters. Only the local criminal mafia may be able and willing to resist the ex-Party mafia, if the two are not one and the same, and at a price.

On a larger scale, genuinely private industrial firms – usually joint ventures with foreign partners – are now often confronted by the extortionate pricing of officially-backed suppliers, especially for natural gas, oil, coal and electricity. For the liberalisation has created many natural monopolies, but there is still no functioning anti-monopoly system, nor any mechanism to regulate utility prices. Again, the only possible counterweight is organised crime. In one case, an important industrial firm in a rather remote location was confronted by a sudden 500 per cent increase in gas prices (‘that is how it is under capitalism – it’s supply and demand, and we control the supply’). With immediate closure as the only possible alternative, the enterprising foreign manager on site, who had once worked in Sicily, turned for help to the local mafia, which threatened the gas company officials with serious bodily harm, eventually persuading them to accept a tolerable compromise – including a cut for themselves, of course. And finally, there is the truly extreme case: it is widely believed that the war in Chechnya originally started in a struggle over pipeline fees between the Grozny mafia and a large Russian oil company with strong Kremlin connections.

Local mafias act in many places and many ways to resist the excessive concentrations of economic power brought about by government corruption, or rather by the prevalence of under-the-table joint ventures between Russian government officials and the new private firms run by ex-officials – including the very highest officials and the very largest firms. They are, in effect, competitors which use physical force, or more often just the threat of force, usefully to offset monopolistic market power in a still lawless economy.

Nor is Russia unique in deriving a broad economic benefit from organised crime. Colombia, Peru and Bolivia all receive much hard currency from the drug trade, but because the accompanying lawlessness inhibits economic growth, Colombia and Peru if not Bolivia, the poorest of the three, might be better off without the drug trade. By contrast, its Yakuza gangsters have certainly been of great economic benefit to Japan. So highly organised that at least one gang has more than 20,000 registered members, and most have overt street-level offices, the Yakuza collect protection money from bars, gambling dens, massage parlours and brothels. But it is their role in the construction industry that is vital for Japan’s economy. Because of the extreme fragmentation of land ownership into a huge number of tiny house plots, developers usually find it impossible legally to buy up sites big enough for apartment blocks or office buildings of economic size. Only with the help of hired gangs and their colourful repertoire of threats and vandalism (bodily violence is rare) can house-owners be persuaded to sell, even at very, very high prices. Many of the modern buildings one sees in Japanese cities could never have been built without Yakuza help, which is just as essential for the Japanese construction industry as ferro-concrete.

One day, Russia will acquire a functioning system of commercial law, administrative and fiscal courts that can actually protect citizens from the exactions of arbitrary, corrupt government officials, and even anti-monopoly safeguards. Only then will it be safe to unleash the police against the mafia, to stop the social and political damage it is inflicting. In the meantime, it is the only force interposed between the new economic boyars and the defenceless consumers and entrepreneurs of Russia.