When Putin Turned His Back on Reaganomics

Unarguably, the war in Ukraine is the result of the machinations of Vladimir Putin, who has been the clear leader of Russia for nearly 23 years. Yet, as one who had a rather unique (for an American) association with Putin at the beginning of his presidency, I would argue that the Putin of today is behaving quite differently than the way he did at the start of his rule. There is a Putin I and a Putin II.

That said, I think the Russian leader’s zeitgeist has not fundamentally changed. Both Putin I and Putin II have been typical Russian leaders: fierce Russian patriots who, like virtually every predecessor dating back to at least Ivan the Terrible (1533–1584), have believed that Russia needs to expand its role on the European (if not the world) stage and overcome the derision that allegedly more civilized Europeans have showed toward it, thus gaining new respect and becoming a world power. As now–Israeli Prime Minister Benjamin Netanyahu concluded (based on a 2001 meeting with the Russian president), “Putin was smart and shrewd and totally committed to restoring Russia’s standing as a great power.” Indeed, I find it richly ironic that, before Napoleon and Hitler, arguably the last foreign government to seriously threaten Russia was that of Sweden. Russia’s defeat of Sweden in 1709 at the Battle of Poltava—in central Ukraine—more than any other event heralded Russia’s rise to great-power status. Might Ukraine be playing a role now in Russia losing that status?

When this century began on Jan. 1, 2000, Russia was in pretty bad shape. Literally the day before, Dec. 31, 1999, Vladimir Putin became the acting president of the Russian Federation, replacing Boris Yeltsin. Estimates of output change are notoriously unreliable for nations like Russia, which moved from a centrally planned to a more market-oriented regime, so some estimates of about a one-third decline in output in the first eight years after the demise of the old Soviet Union at the end of 1991 are probably exaggerated, but clearly the transition from communism had gone poorly under Yeltsin. A new breed of politically well-connected oligarchs in the 1990s seized control of previously state-owned assets, culminating in a horrendous financial crisis in 1998 in which Russia defaulted on its debt and was forced to devalue its currency, the ruble.

Yet times changed dramatically in the first two terms of Putin’s presidency, or Putin I, from early 2000 to 2008. The World Bank tells us that the country’s gross domestic product rose 74 percent, a compounded annual growth rate of 7.2 percent per year. Russia, no longer burdened by the inefficiencies of communism, belatedly began to show significant convergence with Western Europe and the U.S. as it increasingly embraced the advantages of free-market capitalism.

But the “Russian economic miracle” that seemed so promising in Putin’s early years has dramatically stalled. The era of Putin II probably formally started with Putin’s third term in office, which began in 2012. (From 2008 to 2012, Putin was constitutionally demoted to prime minister, although even in that period, he was the country’s most powerful leader.) Economic performance during Putin II looks altogether different. Looking at the last six pre–COVID pandemic years of 2014 to 2019, for example, the World Bank estimates that Russia’s gross domestic product rose an anemic 1 percent per year—far less than it did in booming neighbors and former Soviet satellites such as Poland (4.2 percent) or Estonia (3.7 percent), not to mention such Western rivals as the U.S. (2.5 percent), Germany (1.8 percent), or France (1.5 percent), or booming Asian nations like China and India.

Putin was formally elected president of Russia on March 26, 2000. A few days later, I received a phone call asking if I would like to join a small group of other economists in advising the Russian government on how to reform and revitalize its economy. I was an economic historian with a public policy orientation and interested in the process of economic change generally and specifically in Russia, which I had visited on multiple occasions dating back to 1970 and about whose economic history I taught students at Ohio University. A bit over two weeks later, I was in Moscow, joined by four others: a former president of the American Economic Association and prominent University of California Los Angeles and University of Chicago economist, Arnold “Al” Harberger; Florida State University economics professor James Gwartney; Jim Carter, a young staff person who had worked at the U.S. Congress Joint Economic Committee (JEC), and Peruvian economist and former finance minister, the late Carlos Boloña.

It was not unusual for Russian leaders to seek foreign advice. Peter the Great (1682–1725) had done so in his attempts to modernize Russia at the beginning of the 18th century. Similarly, Yeltsin’s government had invited the prominent Keynesian economist Jeffrey Sachs of Harvard (later Columbia) University and other international advisers from organizations such as the International Monetary Fund (IMF) and the World Bank to offer technical assistance.

But the delegation of economists first advising Putin on his ascension to power had a quite different perspective: They were all strong believers in the power and efficiency of markets, with strong conservative or libertarian political orientation. Why? Putin in early 2000 had selected as his top economic adviser a young economist (age 38), Andrei Illarionov, who admired such classical liberal economists as Friedrich Hayek, Milton Friedman, and Ludwig von Mises. He had also read the distinct supply-side writings done for the JEC by Jim Gwartney and by me that cast grave doubts on the alleged economic advantages of large activist governments. Our evidence, which was independently published, suggested that existing Western governments tended to far exceed the size that would maximize incomes. Big government financed by high levels of taxation tended to inhibit economic growth, a key message of the American supply-side revolution of the 1970s and 1980s. In time, however, Illarionov became disillusioned with Putin and ended up at the Cato Institute, a libertarian think tank in Washington, D.C.—probably the most remarkable career change of an economist that I have ever seen.

Our group garnered a good deal of press attention. A story in the leading business newspaper Kommersant by Constantine Levin had the headline “Putin Will Be Trained in Jesuit Methods of Managing the Economy.” In it, Al Harberger was called the “father of the Chicago boys,” and I was termed “the ideologue of Reaganomics.” Excerpts of one lecture I gave to university students showed up on Russian national TV.

Our little delegation of economic experts spent four days meeting key officials such as Russian Prime Minister Mikhail Kasyanov, IMF and World Bank officials, Russian central bank executives, and others. All of us independently gave lectures at prominent local universities and elsewhere. For me, a highlight was a lecture that I gave to a large number of apparatchiks and leaders of the Russian nomenklatura who were mandated by the Kremlin to attend my presentation. Drawing on Russian economic history, I asserted that Russia’s economy had advanced the most when Russia improved private-property rights and the rule of law, such as in the 1890s and early 1900s, and that economic decentralization, low taxes, and minimal regulation, which support a booming private economy, were the keys to Russia’s future prosperity. It was a gloriously ironic moment, as my lecture was delivered to a largely indifferent or hostile audience from what until recently had been the Communist Party headquarters.

The culmination of our weeklong Moscow visit came on April 21, when the five of us met for about an hour and a half with Putin, Illarionov, and an interpreter. Putin, who was clearly very smart, actually seemed to understand English far better than he let on. We had a lovely opulent Russian lunch, which came complete with four basic alcoholic food groups: vodka, white wine, Russian imitation champagne, and cognac, in addition to such Russian delicacies as beluga caviar. Each of us made different points. Harberger, for example, was particularly concerned about the exchange rate between the ruble and other currencies. Gwartney and I were more focused on the fact that, considering social insurance and other levies, the marginal income tax rate for some Russians far exceeded 80 percent, creating a massive underground economy. The American ambassador (James F. Collins) had already warned us before the Putin meeting that “no one in Russia is paying all those taxes.”

The American experience throughout modern history—the Mellon (Harding-Coolidge) tax cuts of the 1920s, the Kennedy tax reductions of the 1960s, and the Reagan tax cuts of the 1980s—showed that income tax reductions served to reallocate resources from a highly inefficient public sector to a more efficient and innovative private one, accelerating economic growth. The private sector was disciplined by markets and incentivized to minimize resource use, adopt new innovations to satisfy consumers, and reduce costs. So, I stressed the need to reduce marginal tax rates, which would stimulate an increased supply of both labor and capital resources. Others appropriately talked about other Russian economic weaknesses, such as the failure to fully follow standard international accounting standards or the lack of a fully independent impartial judiciary enforcing the rule of law. We also argued that America’s federal system had positive dimensions for promoting economic growth, such as by encouraging tax competition among the 50 states.

Less than four months after the American delegation left, Russia adopted a flat-rate income tax with a 13 percent rate, which took effect at the beginning of 2001. While I always embraced Winston Churchill’s admonition that “democracy is the worst form of Government except for all those other forms,” Putin’s quick action suggests that while a relatively authoritarian government may not serve the public welfare, it can act decisively and quickly. When speaking to groups of American politicians, I sometimes say, only half-jokingly, that “the only politician who has ever acted on my advice is Vladimir Putin.”

In what may be the best example ever of the Laffer Curve, the dramatic reduction in income tax rates (the corporate rate was also reduced considerably), led total tax revenues to rise—sharply. Within two years of the introduction of the new tax code, tax revenues had risen by 50 percent, even after adjusting for inflation. The underground economy shrunk dramatically, a triumph of the rule of law—people felt they could now afford to obey the tax statutes.

There are lessons here from America that arise from our federal system of different rates of taxation for each state. For example, take the nine states (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming) with no general state income tax (the ultimate flat tax) and compare the number of jobs created there from November 2021 to November 2022 with that created in the five jurisdictions (California, D.C., Hawaii, New York, and New Jersey) with a top marginal state income tax rate in the double digits—at least 10 percent. The population of the two areas is nearly identical—slightly higher in the high-tax areas. Yet 198,000 more jobs were created in the states where workers got to keep more of their earnings. It’s no wonder that the flat-tax movement is spreading in America, with states such as Arizona, Georgia, Iowa, and Mississippi now transitioning from a graduated to a flat-rate income tax. In Iowa, for example, a highly progressive tax with a top rate of 8.53 percent will become a 3.9 percent flat tax by 2026, and even sooner Arizona will have a 2.5 percent rate.

An even better indicator of human welfare probably is net migration—are people moving into or out of a jurisdiction? People move into places usually expecting to have a better life and leave places because they think other areas will provide them with a more satisfying living environment. In the latest census estimates, for mid-2020 to mid-2021, 494,430 persons on net moved into the nine jurisdictions without state income taxes—an average of almost precisely one person each minute of every day and night over that period. By contrast, about 1,000 per day on net moved away from each of two very-high-tax jurisdictions, California and New York.

We spent a fair amount of time with Putin and other advisers talking about standardizing accounting procedures, protecting shareholder rights, ensuring that there is a level playing field for all participants in economic activity, and promoting the sanctity of intellectual property (patents, etc.). We mentioned something the Western world as a whole and the U.S. in particular often ignores these days: balancing budgets, stabilizing currency values, and promoting price stability. We promoted the idea of intergovernmental competition, which the American federal system of government has encouraged and which we thought probably had potential in Russia, a country with scores of regional governments reaching 11 time zones. We stayed away from discussing world politics and Russia’s perpetual yearning for power and international respectability. Although not our intent, it undoubtedly was a big part of Putin’s thinking that achieving greater output through tax and other reforms would enable Russia to strengthen its military prowess and great-power status. And clearly a sizable portion of increased resources from vibrant Russian growth under Putin I went to enhancing military prowess.

What happened to Russia during Putin II, the last decade or so? I think Mark Whitehouse summarized it well in a 2018 Bloomberg article: “Oppressive governance and an aging population have left the economy with little capacity to grow…. Putin says he wants a breakthrough, yet the crucial conditions—the sanctity of private property and personal freedom—are precisely what he can’t deliver: The Kremlin elite derive their wealth and position from violating them.”

With the passage of time and the consolidation of power, Putin jailed, poisoned, or otherwise neutralized businessmen and others who disagreed with his increasingly dictatorial rule. In a nation that for centuries had rightly prided itself on its brilliant intelligentsia, some of the best and brightest of its “human capital” fled or were jailed, perhaps personified best by the former world chess champion (1984–2005) Garry Kasparov, but also including bright, rising political leaders such as Alexei Navalny. Brilliant, innovative, and entrepreneurial Russians such as Google co-founder Sergey Brin had already moved to Silicon Valley pre–Putin I, part of a sizable outmigration of Russian Jews. Even Putin-favored oligarchs moved vast amounts of assets to places like London or the Bahamas, as Russia belatedly abandoned the popular low flat-rate income tax that the American libertarians persuaded Putin to adopt over two decades ago.

Another politician’s leadership very roughly coincides with Putin’s: that of Netanyahu, Israel’s prime minister from 1996 to 1999, finance minister in the early 2000s, and prime minister again most of the time since 2009. Unlike Putin, he chafed at the socialist nature of Israeli society and embarked on a campaign to lower taxes, kill stifling regulations, open financial markets, privatize property ownership, build needed transportation infrastructure, and so on. I was speaking at a conference on tax issues in Vienna around 2005 with then–Finance Minister Netanyahu, and as I listened to him both in private conversation and in speaking to a broader audience, I thought that he was a bigger proponent of Reaganomics than Reagan himself. During Putin I, when the Russian economy opened up considerably to capitalism but Netanyahu’s leadership within Israel was severely diminished, Russia outgrew Israel. Yet in the last decade (2012– 2021), World Bank data show that Netanyahu’s Israel had an impressive 3.65 percent annual growth in total output, nearly three times that of Putin’s Russia’s 1.32 percent.

And these indicators of economic weakness may ultimately bring the era of Putin to an end. A relatively economically weak Russia simply cannot afford to be a great power. Russia’s abundant natural resources are not enough to overcome the hubris and what Hayek called the “fatal conceit” arising from believing that the iron fist of government can outwit and outproduce the invisible hand of markets.