Piketty Zeroes In on Putin’s Pain Point; The West should stop relying on sanctions and instead target Russia’s massive offshore wealth.

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(Bloomberg – bloomberg.com – Leonid Bershidsky – August 14, 2017)

After alerting the Western world to the alarming rise of inequality, Thomas Piketty has turned his attention to Russia. To someone who has lived through Russia’s transition from Communism to crony capitalism, his take on that transition reveals deep flaws in his overall methodology — but some of his conclusions should have important implications for Western policy toward Russia.

In a fresh working paper, Piketty, his Paris School of Economics colleague Filip Novokmet, and Gabriel Zucman of University of California at Berkeley set out to show that official measures vastly underestimate inequality in Russia and the extent to which it has been robbed by its oligarchy. Unfortunately, some of the analysis is based on data so unreliable that the researchers should have minded the old computing principle: Garbage in, garbage out. [http://gabriel-zucman.eu/files/NPZ2017.pdf]

Piketty works with datasets that go back centuries. His Russian one starts with 1905. But the Bolshevik revolution in 1917 made a mockery of official statistics. In a planned economy, apart from serving a propaganda purpose, they were also meant to back up influential groups’ and industries’ funding appetites and cover up inefficiencies. Using these numbers, Piketty and collaborators reach the conclusion that “Russian living standards were about 60-65% of the Western European average in 1989-1990, and reached about 70-75% by the mid-2010s.”

That’s a laughable statement to anyone who actually lived in the Soviet Union in 1989 and 1990 — and to those who remember the grim bread lines that dominated media reports on the country. Everything from toilet paper to running shoes was in short supply. After drawing my salary, I’d go into a store and see nothing but rows of three-liter jars of sweetened birch sap. Sixty percent of the Western European average? That’s the current gap in purchasing power parity-adjusted per capita economic output between Poland and Germany. The Soviet-era gap with Western Europe felt, and was in practice, considerably wider. When I first went to a Western European country, Greece, in 1992, I was struck by how much wealthier the locals were; it looked like a gap that could never be bridged.

Official statistics in the Soviet Union’s final years weren’t even close to describing the economic hardship we experienced or the true inequality level. The late Soviet society was highly unequal, but that was measured in access to a variety of goods and experiences, not in assets or incomes that could be described by economic statistics. In the 1990s, the switch to capitalism converted this inequality to the type that is better understood in the West, but data on Russians’ incomes were worthless, anyway: The government statistical system was undergoing a painful transition with inadequate resources, and, for a decade, barely anyone paid taxes, and the government didn’t have much of an idea of how much people earned. Neither, as a result, do the researchers — which undermines their conclusion that the bottom 50 percent of Russians have seen very small or negative income growth since 1989 and the middle 40 percent saw only modest growth. The leap to the current 70 percent of the West European level — which intuitively feels high but possible, and which is based on much better data — was much steeper than Piketty and collaborators would have it.

Novokmet, Piketty and Zucman acknowledge the limitations of their data and the importance of non-monetary inequality in Soviet times — but they still plow ahead with assessments of how inequality evolved in Russia since 1905. Given the available data, it would have made more sense to scuttle the task as hopeless.

The researchers’ work becomes interesting and valuable when the data sufficiently improves in quality, starting in the early 2000s, with the introduction of, in the researchers’ words, “a 13% flat rate on top incomes which Reagan, Thatcher and Trump combined could not have dreamed of.” That development, no matter how abhorrent from a leftist point of view, made the meaningful study of government data possible because it ended the mass tax evasion.

For the first time in a Western study, the researchers used national income tax data as well as survey data to estimate incomes; that drives up the Gini coefficient, used to measure inequality, and increases the share of income accruing to the top 10 percent. But, perhaps even more interestingly, the researchers concerned themselves with the contrast between Russia’s large trade surpluses and the small net foreign assets Russia managed to accumulate — only 25 percent of national income by 2015.

In part, this discrepancy is explained by foreign investors’ enormous windfall from buying up Russian assets in the mid-1990s, when they were sold at rock-bottom prices. But capital flight is a more relevant explanation. Novokmet, Piketty and Zucman calculate that by 2015, offshore wealth accumulated by wealthy Russians reached 75 percent of national income, or about as much as the entire domestic wealth held by all Russian citizens, and three times Russia’s official net foreign reserves. That’s not a precise calculation — but, unlike the researchers’ income equivalencies for the late 1980s and early 1990s, it’s intuitively plausible given the offshore-based ownership structures of large and even medium-sized Russian companies and the anecdotal evidence of Russian money flowing through Western financial centers.

There’s nothing particularly surprising about the conclusion that as much Russian wealth is held offshore as domestically. Sergei Glazyev, an economic adviser to President Vladimir Putin, has estimated the Russian offshore wealth at $1 trillion, with half never expected to return. $1 trillion is about 78 percent of last year’s economic output, and it’s roughly in line with Novokmet, Piketty and Zucman’s estimate. Glazyev, however, holds views that are so far from the modern economic mainstream that few in the West pay any attention to him. The names of Piketty and his collaborators lend a different level of credibility to the assessment.

The picture Novokmet, Piketty and Zucman paint is of a country plundered by an oligarchy that has achieved an extraordinary wealth concentration. “Extreme inequality seems acceptable in Russia, as long as billionaires and oligarchs appear to be loyal to the Russian state and perceived national interest,” they write.

This raises the question of whether the current Western sanctions against Russia strike at the heart of the Russian system or merely pretend to do so. Since the sanctions were introduced, no Western government has made a meaningful effort to investigate the provenance of hundreds of billions of dollars in Russian offshore assets. No significant asset freezes have taken place. The money is still out there, to be invested inside or outside Russia, in the service of its “perceived national interest” or otherwise (Putin would like to get his hands on some of it, too, but it doesn’t belong to his cronies).

A Western effort to track down that money and make it available to a post-Putin, democratic Russia could potentially be a game-changer. But it would require far more work, and probably a lot of uncomfortable revelations about Western business and politics. The current sanctions regime is simply not intended to open that can of worms.

©2017 Bloomberg L.P. All Rights Reserved. Article also appeared at bloomberg.com/view/articles/2017-08-14/piketty-zeroes-in-on-putin-s-pain-point