Corruption doesn’t pay: Why capitalism worked in the Baltic states

Published Sunday, Oct. 21 2012, 7:00 PM EDT

My Oct. 8 column described a recent expedition that took my wife and me to Russia and Estonia, Latvia and Lithuania, a tour that left us with puzzling questions. Chief among them: Why has moving from socialism to capitalism proven so disappointing for Russians, and so rewarding for those in the former Soviet-controlled Baltic states?

The answer lies in the two fundamental requirements for the transformation from socialist repression to a free-market capitalist economy. First, a thoughtful, transparent and unbiased privatization process is required to make the move from state-controlled socialism. Second, the rule of law must be enforced against corruption.

Russia’s transition from socialism to capitalism failed on both counts. In an ill-considered privatization process, vouchers exchangeable for shares in huge oil, mining, and other industrial companies were distributed to citizens who had no concept of private ownership. Chaos reigned as some people even traded vouchers for shots of vodka in bars; many vouchers were bought for a pittance by men who instantly became fabulously wealthy. Several Russians told us that these so-called oligarchs gained their private jets, yachts and international palaces “over the backs of the Russian people,” thus becoming symbols of capitalism’s failure.

But even if the privatization debacle had been avoided, the country would have been doomed by entrenched government corruption. Transparency International ranks 183 countries for public-sector corruption. In its most recent ranking, the 10 best are New Zealand, Denmark, Finland, Sweden, Singapore, Norway, the Netherlands, Australia, Switzerland and Canada. (The United States ranks 24th.) Near the bottom is Russia, at No. 143, in the same league as Sierra Leone, Nigeria and Uganda.

To get almost anything done in Russia, the palms of crooked government officials must be greased. No wonder Russians are cynical: They hoped capitalism would bring prosperity, only to find themselves pawns of the same corrupt elite that ruled in the past.

The privatization process in the Baltic republics was more carefully thought out. The first priority was home ownership, for example, but people couldn’t afford to buy their apartments from the government. Estonia’s solution was a transfer of home titles based on how long people had lived and worked in the country. Where pre-Soviet ownership of houses and farms could be traced, title was transferred back to the original owners or their descendants.

While the privatization of other assets and businesses in Estonia utilized a voucher system similar to that in Russia, a stepped process yielded better value for the public treasury while generally avoiding the unfair enrichment of individuals.

Lithuania’s transition to capitalism followed a similarly successful process. Latvia’s privatization also followed the same basic template, although many Latvians believe the sale of the country’s larger base of industrial assets involved corruption that unfairly enriched insiders.

It’s not surprising that the post-privatization success of the three Baltic republics and that of Russia mirror their Transparency International rankings. Estonia ranks almost the same as the United States at No. 29, Lithuania ranks 50th and Latvia sits at No. 61 – all vastly better than Russia’s dismal showing.

The people of the Baltic states revel in their hard-won personal and economic freedoms. Gaining membership in the European Union was a huge milestone, symbolizing their final step in “rejoining” Europe after decades of Russian repression. Those long years of enforced socialism taught them that hope and prosperity does not lie in government programs, but rather in their own creativity, determination and work ethic.

Comparing her country with its Scandinavian neighbours, one Estonian told me: “We lost four decades, but will catch up.” I have no doubt they will.