Commentary : PERSPECTIVE ON RUSSIA : West Shares Blame for Scandal : By trying to impose our ideas on Moscow, we helped create a climate ripe for corruption.

Western criticism of Russian corruption and criminality has reached new heights. The real scandal, however, is that the corruption, much of which has been “legal,” is the logical consequence of the policy the West imposed on Russia as a condition of its aid, a policy that reflected a consensus across the political spectrum.

We need to rethink our basic understanding of economic reform as it applies to Russia and other countries, and not use the corruption to scapegoat the Russians for the failure of our own bad advice.

The problem in Russia is not its old ways of thinking or its lack of a capitalist culture. The founders of classic economics, such as Adam Smith, developed their models in the earliest stages of capitalism in Europe. They understood that, precisely because old feudal institutions were destroyed, businessmen of the time were left with little more than self-interest. Karl Marx called it “naked self-interest.”

Russia today is the same. Rational business people are led to the behavior we see by the incentives established by the reform.

In October 1991, Russian President Boris N. Yeltsin announced a “mixed economy” policy of privatizing a limited number of large enterprises, such as textile and food plants, with existing managers being given the dominant role. We in the West denounced this, but it was an intelligent policy that could have worked well. Most of the insider-owners were production engineers with great managerial experience; they were ideal candidates to reconstruct their plants to make them more efficient.

As Russian plants became more efficient, they would have gained in value. The insiders would have sold stock to the public through initial public offerings. Property would have flowed to the more efficient owners, which would have benefited them but also would have ensured a healthy private enterprise for everyone.

But insider-owners needed access to capital. Reconstruction in East Germany, for example, has required hundreds of billions of dollars, and Russia has eight times its population. The few tens of billions of dollars that the West convinced Yeltsin were enough to do the job and that persuaded him to change policy never could have made much of an impact.

Although the West supported property rights in principle, its program called for a postponement of investment until the insider-owners were removed through state action, a process certain to take at least three years. Capital investment and repair fell 80% from 1990 to 1995 and has remained at that level. The owners, knowing that the government was bankrupting them and would remove them, had every interest in taking an extremely short-term view of profit maximization, even to the point of stripping their companies’ assets. Obviously no real investment could take place in such an environment.

Even worse, the West insisted that Russia privatize the raw material industries that generated hard currency. Anyone who acquired these firms was destined to become incredibly wealthy without the slightest effort, and hence all officials and entrepreneurs concentrated on trying to acquire them to make a quick buck.

There was another catch: No politician would give away such incredible wealth to independent people who then would have the funds to control the political process or even the politician himself. Therefore, Yeltsin naturally ensured that loyal political insiders gained control of the hard-currency earners. Even then, he kept them under tight control, and he forced them to provide their products free to the big cities that were his political base. This happened to such an extent that the oil and natural gas companies had no money to pay taxes. They and the banks that funneled the subsidies were state enterprises in all but name.

The major corruption was legal. The politically connected owners, bankers and reformers earned “dividends” on their “shares” in their quasi-state firms. They earned commissions with their trading firms or underwriting fees on the fake “government bonds” on which the International Monetary Fund insisted.

Government officials did not have to take bribes if they were able to buy shares with loans from the very banks that were under their control. Insiders profited most of all by selling their stocks and bonds to Westerners. Western officials, in turn, misled investors in the desperate hope that foreign investment would bail out an approach that was failing.

In fact, corruption is not the key issue, but capital flight. The U.S. in the 19th century was filled with corruption, as have been the Pacific Rim countries of the past 50 years. But, in both cases, these were periods of great growth because corrupt officials and businessmen naturally invested in their own emerging markets. The close and corrupt relationships between government and business made investment at home more profitable than collecting interest from Swiss bank accounts. By contrast, the incentives against investing at home made it more rational for the corrupt and non-corrupt alike in Russia to send their money to foreign banks.

It will accomplish nothing if the West piously damns the corruption in Russia while throwing a few billion dollars its way to ease its conscience. We must abandon our commitment to abstract economic models and look at the real history of early capitalist development.

We must stop insisting on a policy that discourages investment at home by both the corrupt and non-corrupt, and we must focus on growth, even if it must be promoted by government action.