Enron of the Eggheads?

by Daniel on August 1, 2004

I had rather taken my eye off the ball, but was informed by a pal this week that a charge of civil fraud has been confirmed in a US Court against Andrei Shleifer and one of his assistants for investing in Russian companies while they were running the Harvard Institute for International Development’s project in Russia, contrary to their agreement with USAID not to do so. To be honest, it all looks pretty sleazy stuff, and not at all good for the international reputation of the American economics profession (Shleifer was a recent John Bates Clark medal winner).

On the other hand, I find it quite difficult to get wrapped up in moral outrage over this particular charge; the actual charge on which Shleifer and Hay were found to have committed civil fraud was that they acted in concert with Hay’s girlfriend to set up a mutual fund company and try to become the Fidelity of Russia. Which strikes me as a pretty silly idea at the time, but hardly on a par with Pol Pot.

On the other hand, it appears that nobody at the HIID is going to jail (or even being seriously criticised) for the genuine crime that was committed by that institute during the 1980s; their partisanship of Anatoly Chubais and the disastrous privatisation program associated with that government (here’s a potted summary by FAIR of why you should care, and my own analysis of why it was such a bad idea). This, in my opinion (which I hope to flesh out a bit next week) was a crime which does bear serious comparison with some of the middle-ranking atrocities of the last century. And of course, nobody cares, because such is the nature of things. JK Galbraith has a book out this week called “The Economics of Innocent Fraud”, in which he suggests that innocent frauds perpetrated by people acting in good faith are in general far more damaging than culpable frauds perpetrated by people who know what they are doing. It looks like l’affaire Shleifer is proving once more that even at 96 years of age, he’s got more marbles than most of the rest of us put together.



rd 08.01.04 at 10:07 pm

One problem I’ve always had with the “Harvard economists wrecked Russia” argument is that parts of the former Soviet Union that *didn’t* follow the rapid privatization path, the Ukraine, etc., also suffered huge declines in output and living conditions. It seems like the end of the Communist monopoly on power in virtually all areas of the Soviet Union led to massive self-interested scrambles on the part of the resident apparatchiks, regardless of what policy was chosen for economic reform (or non-reform). Effective state authority collapsed and the economy was cannibalized virtually everywhere, regardless of whether Harvard economists were feted or spurned. Stephen Kotkin’s book on the Communist collapse and his New Republic article “Trashcanistan” are both good on this dynamic. The scary thing is that Russia is the relatively *more* successful part of the former USSR.


WeSaferThemHealthier 08.01.04 at 10:47 pm


“which he suggests that innocent frauds perpetrated by people acting in good faith are in general far more damaging than culpable frauds perpetrated by people who know what they are doing.”

I’m really curious as to why that is, could you give us the gist of the argument?


WillieStyle 08.01.04 at 11:08 pm

any suggestions on policies to remedy the flight of capital through corrupt oligarchs?

The situation is also prevalent in Sub-Saharan kleptocracies like Nigeria. What can be done, within and without, to solve the problem?


Matt 08.01.04 at 11:29 pm

Do you mean “1990’s” above? I don’t think (though I may be wrong) that there was that much “advising” going on by the Harvard boys (certainly not to Chubais) in the 80’s.

RD- You’re right that the Harvard boys can’t really be given the main blame for what happened in Russia- but they were at least complicit w/ gross criminality, and didn’t try to stop it at all, and didn’t support people who might have (i.e.- Yavlinski). So, while it’s stupid to give them too much blame, they surely deserve some. (The Nation had a nice article on this several years ago (in the fall of ’99) that might interest some people. I don’t know if it’s avalible on line or not.)


rd 08.02.04 at 12:45 am

I certainly wouldn’t want to absolve the Harvard crew of all blame. They were at the least massively naive. But I’m just not sure how much they mattered. We tend to talk about things like whether it was right to privatize, or to privatize in a certain way, when in fact all these debates and solemn policy dicussions were pointless. Throughout the former USSR, whether enterprizes were privatized or left under state ownership, they were relentlessly cannibalized and sucked dry by the former apparatchiks. The results were pretty much the same everywhere. The Ukraine which didn’t really even start privatization until 1995, and not much then, still suffered a catastrophic fall in output after 1991. (Somewhat exaggerated in the figures by the growth of the grey economy, but still catastrophic.)The Communist party gave the USSR state whatever coherence and discipline it had. Once it was broken up into national units and stripped of its monopoly on power, the remnants turned on fed upon the state structure that was left. Western debates about “privatization” and “shock therapy” are almost relevant in such circumstances, since they assume a state apparatus that can implement decisions effectively.


rd 08.02.04 at 12:47 am

Whoops Last sentence should read “almost irrelevant.”


Carlos 08.02.04 at 1:09 am

I’m curious what DD thinks the alternate scenario would look like. Without the capital flight, Russian production would have not have dropped? Would have dropped some? Would have dropped quite a bit, just not as much as it did with the capital flight?

(Also, excess death methodology can be spun like a drunk executive at an office party. Did you know the US Supreme Court is responsible for one million excess deaths a year? Fortunately the US sugar tariff is lowering that. To pick two examples.)


dsquared 08.02.04 at 1:12 am

Matt: yes, 1990s.

RD: Although Ukraine didn’t start privatising until the Kuchma government, unless I remember very wrongly, they liberalised the capital account at about the same time as the Russians did, and if you read my own essay linked above, my suspicion is that it was capital account convertibility rather than privatisation per se which did the real damage.


dsquared 08.02.04 at 1:21 am

Carlos: I would have guessed that given the political conditions, there would have been fairly minimal new investment in Russian capital anyway, so I would have set a benchmark of three years’ depreciation on the Russian capital stock; maybe a 3-5% fall in GDP.


Carlos 08.02.04 at 2:15 am

Okay. My own intuitions have been shaped by Blanchard’s toy disorganization model, which suggests a deeper and longer drop in output the greater the degree of central planning beforehand. It does explain the faster patterns of recovery for the peripheral economies in the Soviet sphere compared to the Soviet core pretty well. And I like it a hell of a lot more than the pseudo-cultural reasons that are often trotted out by Kaplan-Huntington types to explain economic differences in the region.

But your idea intrigues me, though I don’t think it can explain all the drops in the transition economies.


bull 08.02.04 at 2:37 am

“my suspicion is that it was capital account convertibility rather than privatisation per se which did the real damage”

Having lived and worked in Ukraine for many years, I can assure you that it didn’t matter one iota what the law said about capital account convertibility (whatever the hell that means) or capital outflows, or anything else for that matter: if the people with money wanted to send their money elsewhere, they could. Ukraine was (and still is, from what I can gather) the ultimate lawless society. In analyzing Ukraine, don’t focus too terribly hard on what the law states, or else you’ll miss what’s actually happening.

I suspect, without any actual experience, that the same is true in Russia.


Zizka 08.02.04 at 5:12 am

Two Nobel prize felonies came out of the Long Term Capital Management collapse, Myron Scholes and Robert Merton.


Merton’s father of the same name wrote a very amusing book called “On the Shoulders of Giants”, which I wholeheartedly recommend. The leder Merton did a considerable amount of work on the sociology of crime, which makes googling the son trickier.


rd 08.02.04 at 5:34 am

I’d have to read up on the extent of capital account liberalization, but whatever the case, bull’s post reinforces what I think is the real story for both Ukraine, Russia, and almost all the post-Soviet republics: the hollowing out of state authority and the cannibalization of economic enterprises by local bureaucracies whose members, freed of any central discipline, turned en masse to personal enrichment. That’s what makes all talk of bad policy choices almost beside the point. There was no state anymore ready or willing to carry out any coherent policy, be it liberalization or continued state managment. If you’ve got a New Republic subscription, I highly
recommend historian Stephen Kotkin’s “Trashcanistan”:



Matt 08.02.04 at 6:37 am

For anyone interested in these topics I can’t recommend Matthew Maly’s writings too strongly, espeically _Understanding Russia_ and _How to Make Russia a Normal Country_. He’d second Bull’s point about law essentially not exisiting, I’d think. Maly’s books are avaliable at his web page:


Matt 08.02.04 at 6:41 am

Damned inability to put in a link! Maly’s web page is:


Giles 08.02.04 at 10:25 am

Actually I think the outrage ahs to be reserved for Scheleifer – he in effect got the US government to subsidse his setting up of a business to sell shares while advising the Russian government of terms under which they issued them. So in one transaction he attempted to rip off both the US taxpayer and the Russian peasant. That he didn’t make a lot of money out of what looks like a slam dunk is not a mitigating factor but simply proof of the old adage that you there are economists and millionaires but no billionaire economists. This story shows why.


alkali 08.02.04 at 3:52 pm

The opinion, for those who care to read it, is available at this link.


roger 08.02.04 at 4:35 pm

The search for one cause for the collapse of the Russian economy in the 90s is probably a vain quest. The real quest, I think, should be for a series of causes (the decay of the industrial infrastructure under Brezhnev, the rise of a criminal underground that intersected with the bureaucracy of the state, etc) that amplified the bad effects of the radical free market ideology that motivated Yeltsin’s advisors in the nineties. There are obvious symptoms of this — for instance, the way the selling off of state owned industries was handled (which has had effects that are still destabilizing — see Peter Maas’s fascinating article in the NYT Mag this Sunday about Vagit Alekperov) — which fed back into the corruption of the system — viz, the essentially coup like manner in which Yeltsin allied himself to the mafia to win the 96 elections.
The injection of the Americans produced the typical best and brightest side show: American advisors in such situations (think of the privatizations urged on Argentina and Mexico) come with a pre-determined theory about the way the system should work, paying more attention to the metric they know (with its self-validating definition of efficiency) than the metrics they don’t know (the matrix of production relations that operate to keep villages going, for instance) and consequently pay no attention as their grand plan amplifies problems until they reach catastrophic proportions. This is a story of an organizational mindset as much as one about macro-economic policy. On another level, this is exactly what happened in Iraq last year. Bremer was a poster boy for the arrogant American advisor mindset, who was unfortunately given uncurbed decision-making power.


Tracy 08.02.04 at 8:34 pm

If we start jailing policy advisors for policy that turns out to be bad there is going to be a massive shortage of policy advisors. Given the inability to carry out controlled experiments in order to test what actually causes economic growth (or any other policy objective you’re aiming at), actual policy advice is always going to be heavily buggy. Especially since the people the policy is being carried out on are generally at least as smart as the policy advisors, and thus are going to respond in ways that the policy advisors don’t expect.

Then there is all the fun of figuring out what the counter-factual would be, and how much blame should be attributed to who (e.g. the forthcoming pensions crisis – are the people who were opposed to population growth to blame, or the people who put in place a pension scheme that’s basically a giant Ponzi scheme? Is there a way of putting in a pension scheme that wouldn’t face the coming crunch?) It would be a very brave court system that would tackle those issues. And the courts can do a pretty bad job of policy-making themselves. To take an example well removed from privitisation in Russia, an Australian court judge ruled that people who had sold a business were not then liable for its taxes, an innocous decision itself, thus setting up a big hole in the tax system by which people sold businesses to criminals, who then didn’t pay any taxes and sterotypically sunk the books in Sydney Harbour.

And if you describing people as having “committed a serious crime” does not count as serious criticism, I am interested in what you think does. Is anything less than hordes of people chanting outside your bedroom window mild disapproval?

I am all for seriously, or sarcastically, or satirically critising people who give policy advice that turns out to be bad. However, if you’re going to suggest that people be jailed, are you willing to take up a role advising poor countries on how to create economic growth? How have you tested your theories on what Russia should have done after the collapse of communism?


Kimmitt 08.02.04 at 9:46 pm

If we start jailing policy advisors for policy that turns out to be bad there is going to be a massive shortage of policy advisors.

You say this like it’s a bad thing.


christopher ball 08.02.04 at 10:39 pm

This does put his “Does Competition Destroy Ethical Behavior?” American Economic Review Papers and Proceedings, May, 2004. in a whole new light.


dsquared 08.02.04 at 10:52 pm

That’s what the New York Times thought, in a rather sad little correction to the article they wrote about it …


Matt 08.03.04 at 12:27 am


The charges against the Harvard boys were not the result of “giving bad advice” but rather for massive fraud. This is beyond the rather gross use of USAID (i.e.- tax) money to finance high-flying lifestyles for themselves in Mosow. (On this, see Maly.) Now, it’s true that more people were hurt by their “bad advice”, but it’s only the criminal behavior they are being tried for.


Tracy 08.04.04 at 1:08 pm

Matt, the FAIR summary does not give me sufficient detail to be sure that the Harvard group should and could definitely be tried for fraud and therefore it is disgraceful that they are not (finding proof is always a problem under our justice system). It looks like at least one person is under investigation for criminal acts, so possibly criminal charges may be laid.

And it still sounds to me like Daniel was arguing that HIID should be jailed for their policy advice rather than fraudulently stealing aid money, e.g.

that innocent frauds perpetrated by people acting in good faith are in general far more damaging than culpable frauds perpetrated by people who know what they are doing

I agree that bad policy advice can cause heaps of damage, but I don’t think the courts can or should deal with it.

Comments on this entry are closed.