Russia/China: Robber Barons or Robber Bureaucrats?

(more at http://money-sage.com)

The BRIC countries (Brazil, Russia, India, China) have become a great
investment favorite in recent years. These are major countries with
great potential for economic growth. In each case, there has been a
partial dismantling of the prior statist economic systems. In the case
of the former Communist countries -- Russia and China -- economic
stagnation was directly attributable to a COMMAND ECONOMY, whose
hallmarks were centralization of economic decision-making, prohibition
of private profit, refusal to countenance entrepreneurial behavior,
refusal to accommodate foreign investment, the lack of a reliable
statutory regime to protect private and foreign investment, and, above
all, TOTAL HOSTILITY TO MARKET PRICING in favor of pricing and
resource allocation decisions being placed in the hands of a central
state, but party-dominated bureaucracy.

In short, these systems were close to perfect ECONOMIC IRRATIONALITY.
The complete failure of this anti-market system was inevitable.

The question is: has what has replaced these Command Economies laid a
solid foundation for the durable economic growth which the current
level of stock prices in these countries reflects?

Wall Street's near-unbridled enthusiasm for these two economies, and
for both real and portfolio investment, seriously downplays certain
disconcerting realities. Supporters of the Wall Street hypothesis
airily reiterate that a true market economy will inevitably evolve.
Along with this market economy will come political democracy. These
iterations do not go beyond the level of mere assertion, however.

The initial stage of capitalism in the major western countries has as
its hallmark the unbridled search for and accumulation of wealth by
clever, hardhearted individuals who possessed the foresight to
anticipate and exploit the future economic potential of new
technologies. These individuals, who knew no ethical, moral, or
religious bounds succeeded in accumulating great wealth. These
agglomerations of wealth were then employed in part to finance more
emerging technologies, and to create the means to harness them to new,
profit-making enterprises. This in turn produced the next wave of
wealth, innovation, capitalization upon that innovation, and the
accumulation of even larger concentrations of capital.

A crucial ENABLING FACTOR in this process was the weakness or
corruption of government. The losers in this economic process were
politically incapacitated; thus they suffered without finding relief
from government. This then was the Golden Age of the Robber Barons,
who took everything within their grasp -- and then some.

This "immature" capitalism produced crises, which in turn created a
powerful popular backlash. In the "democratic" western countries where
capitalism developed most rapidly, these backlashes produced reforms
which were essential to saving the market economy and its wealth
creation machine--as well as the grossly unequal distribution of
wealth and power. The motivation for reform -- to placate the
demographic majority, make structural improvements in the system, and
expand the developing mass consumption base of capitalism -- produced
the modern MODIFIED WELFARE STATE and facilitated the emergence of a
highly sophisticated, productive, and somewhat "kinder, gentler"
market economy. The Robber Barons gave way to a new type of
capitalist. This system has been generally satisfactory, especially in
light of its obvious superiority to ALL OTHER ECONOMIC/POLITICAL
systems ever attempted by humankind.

The question is: are China and Russia traveling along essentially the
same path? Is their "immature" capitalism slated to mature? Will a
modified welfare state, a regime of law and order, and a DURABLY
PRODUCTIVE MARKET ECONOMY TRULY EMERGE? Or, alternatively, are these
countries headed somewhere else?

There is a huge YELLOW LIGHT flashing, we believe. This cautionary
signal derives from a FUNDAMENTAL DIFFERENCE between China/Russia
today and America, Britain, France, and Germany in the 19th century.
In the western countries there was extant a well-developed and long-
established tradition of LAW. Private property and the sanctity of
contracts were not only deeply entrenched, but were enforced by courts
of law and governments which, though to some extent corrupt, were able
to operate effectively to uphold those principles and practices
essential to a strong market economy. It is a truism to say that
dependability and regularity are necessary preconditions for business
agreements and the effective functioning of a market economy, but it
is a very important truism. The question is: do China and Russia
measure up? And if not, can we reasonably infer that their evolution
toward the desirable state is underway?

Our answer to both questions is NO. Political power in both countries
is centralized in the hands of a very small number of individuals.
These individuals exploit their political power to accumulate wealth
for themselves, their families, and their hangers-on. This crony
"capitalism" bears no relation to the real thing, in our view. While
power was also concentrated in a small number of hands in the United
States and other western countries during the "immature" phase of
capitalism, it was acquired VIA SUCCESSFUL ENTREPRENEURIAL ACTIVITY.
The capitalist risked his capital on the basis of his ability to make
smart business decisions. In Russia/China today, there are no real
entrepreneurs, except at lower levels of the system. Fortunes are
acquired through obedience to the political center, rather than vice-
versa. Fortunes are also lost -- ostensibly confiscated by the state,
but basically stolen by the power-holders -- when the rich individual
does not conform to the wishes of the power-holders.

Beyond this there is also the question of the identity of the power
holders, and the skill set which enables them to acquire and retain
power. These individuals are, in the case of Russia, primarily former
senior officers of the secret police. Ascent through the KGB
bureaucracy required the typical skills of the courtier: fawning
subservience to the next higher echelon, mindless obedience, lack of
any scruples, contempt for weak players, and a penchant for brutality.
The Soviet system evolved from one dominated by the paranoia and
brutality of a single psychopath (J.V. Stalin) to a government of self-
seeking bureaucrats and secret police officers. This constitutes the
governing class of Russia, and the source of wealth. We see here a
situation which resembles that of many backward African dictatorships,
where a corrupt elite siphons off the wealth of their country while
the populace lives in squalor. There is NO EVOLUTION HERE toward
political democracy or even toward a real market system. It is not
price and productivity which allocate resources and wealth, but a
corrupt elite.

In China, the situation is similar, with the difference that the power-
holders are party bureaucrats, rather than ex-secret police officers.
(There is, it should in all fairness be noted, more genuine
entrepreneurial activity in China than in Russia).

Rather than evolving toward a functional market system these countries
are headed in the direction of perpetuating dysfunctionalities in
their economies. Foreign investment is NOT SECURE -- certainly not in
Russia. The vast disparity in wealth and lifestyle between the favored
few and the many is not narrowing, insofar as we can see. Nor is
either state developing a modified welfare state apparatus to insure
minimal income levels and to provide the safety net for the mass of
potential consumers.

We do not believe that the Russian and Chinese equity markets are
pricing in the great degree of risk which actually exists. This
mispricing of risk is amplified by the extreme overvaluation of stock
prices in these countries as measured by the normal yardsticks of
stock valuation.

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