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The Soviet Command Economy

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1 The Soviet Command Economy

2 I. History The Bolshevik revolution 1917.
The Bolshevik revolution in 1917 brought the end of the preceding czarist era. In October 1917 Lenin led the Bolshevik to power. Initially the Bolshevik control was largely limited to the capital (St Petersburg) w/ most of the country in dispute. Reunification of the country took 3 years of civil war. Russian econ development in 1917 was at a relatively low level (per capita GDP). 2 econ experiments were conducted in the decade following the revolution: War communism ( ) to promote recovery from the Russian civil war , implemented by Lenin introduction of state ownership thru massive nationalization, an attempt to eliminate mkt relationships in industry and trade, and the force requisitioning of agri products from the peasants; the econ consequences were a disaster, the economy was in ruin To instill econ recovery Lenin introduced the New Econ Policy (NEP) in 1921 to return to private ownership small enterprises were reprivatized, some were restituted to former owners, reintroduction of the mkt for resource allocation control of food production was returned to the peasant & mkt relations were reinstituted to regulate the flow of food to the cities, the implementation of tax on agri instead of requision. By 1927, the Soviet economy was recovered from the losses of civil war and war communism. In effect NEP was a form of mkt socialism, w/ combination of state ownership of industry and mkt allocation. NEP was not a planned economy

3 2. At the end of 1920’s Stalin system of central planning based on compulsory state & party directives were established (industrial prod. away from consumer goods toward prod goods). Rapid industrialization depend on the availability of agri surpluses to the industrial sector to provide investments agriculture were collectivized (a collective farms-kolkhoz were created) Results increase the sate control & to eliminate the rich peasants, kulaks. Individual land holdings were confiscated & the peasants forced into communities. The kulaks were dispossessed, but rather than becoming a part of communes they were internally deported, usually to Siberia. Many kulaks not just lost their livelihoods but also their lives (deaths were in millions) totalitarian system of political governance (Communist party) The ES that Stalin put in place in the early 1930’s was radically different from any prior system. Stalin increased his power over the planning process & extended control into every aspect of economy, centralized price determination, emphasis on heavy industrial growth. During the WWII, the SU lost b/w 20-15% of its population to military action, starvation or exile to the gulag (Soviet corrective labor camps—political prisoners and criminal were sent, 1936—5 million prisoners). Despite the heavy losses, postwar recovery was rapid, the prod exceeded their 1940 levels. Agri was the most difficult area due to the low priority assigned in the planning process, but also b/c of the lack of incentives on the collective farms. Lack of attention & investments led to generally depressed conditions in rural sector. Industry on the other hand enjoyed a high priority in the investment continued a strong performance. (Stalin died in 1953).

4 3. 1985-Gorbachev became secretary general of CPSU.
After Stalin, Nikita Khrushchev became the leader. He attempted fundamental change in political and econ life: he drew attention to Stalinist abuse of human rights, put more emphasis on incentives—management was allowed to retain a large slice of difference b/w value of sales and the cost of material (profit) to use to provide material incentives for themselves and their workers; in agri—he put more investments. After a trip to Iowa in 1956 he became a huge enthusiast of corn and decided to introduce it to his country, most of which has an unsuitable climate. After Khrushchev, Brezhnev, Andropov, Chernenko, Gorbachov Gorbachev became secretary general of CPSU. Many citizens of SU had big hopes Gorbachev wanted to carry out many political and social reforms. Two Russian words were used in the international linguistic usage: glasnost and perestroika, It was divided up into 3 main points: Uskorenie: acceleration Glasnost: openness Demoktatizatsiia- democracy Gorbachev wanted to create a more open society. There should be the right of freedom of the press and everyone was allowed to have an own opinion. The people should have the chance to make a few political decisions and they should understand the economy much better. Gorbachev didn’t want to do away the communist system but he wanted to renew it or save it from a breakdown. First he started with reform of the central planning, gave more freedom and incentives to enterprise managers, the law on state enterprises which tried to put firms on a corporatized and accountable basis. Firms to have self-management and self –finance. Despite the reforms the productivity fell, econ crisis became more intense, shortage of basic consumer goods contributed to the popular discontent with the reform effort.

5 Territory-8.6 mil square miles; Population-290mil; SU-15 republics;
II. The Setting Territory-8.6 mil square miles; Population-290mil; SU-15 republics; Different natural environment rich resource base, major producer of fish and forest products, minerals; was the world’s largest producer of petroleum, coal and iron ore.

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7 III. The Soviet Economy: Political and Economic Institutions
Organization of the Communist Party General Secretary is the most powerful person in society Politburo is the most powerful political group of the Communist Party, controlling domestic and foreign policy and appointments to top positions; drafted government policy. Secretariat was responsible for the central administration of the party; directed work of Central Committee departments, which controlled appointments to other high-level positions. Central Committee —about 300 members from national and regional agencies. Conducted the day-to-day business of the Party and the government. Elected Politburo and Secretariat, controlled press organizations, provided forum for communication and debate. Party Congress —supposed supreme body of the Party, provided media event to "elect" new Central Committee and announce policies.

8 The Legislature The Administration
Supreme Soviet was "rubber stamp" legislature until 1989 The highest legislative body of the SU (elected) Presidium of the Supreme Soviet (smaller and more powerful) Chairman of the Presidium, or President, was ceremonial head of state. The Administration Premier (chairman of the Council of Ministers) had direct responsibility for management of the economy The most important decisions were passed jointly with the Politburo. Some Soviet leaders held Premier and General Secretary positions. Council of Ministers —supreme administrative body. State Planning Committee (Gosplan)—coordinated creation and execution of plans. Ministries and state committees —administered all aspects of the economy, including production, distribution, prices, and wages. Farms and enterprises —handled actual production.

9 2. Decision-making hierarchy —vertical structure
The Soviet state operated through gov’t ministries and Communist party

10 3. Mechanism for providing information Highly centralized ES
national economic plan b) Administrative –command economy mechanism for resource allocation. Council of Ministers and Communist Party leadership set broad objectives and approves final plan Actual tasks of planning conducted by several specialized planning agencies State Planning Committee (Gosplan) in charge of overall coordination and planning of outputs and investment State Bank in charge of planning and monitoring financial flows c) Planning in Theory the material balance system were developed to equate supply and demand of key industrial commodities, labor inputs. Consistent plan—only minimal balance in money and prices for resourse allocation

11 d) Planning in Reality Annual Planning Timetable Spring—Directives
Council of Ministers and Communist Party set aggregate growth targets Targets reflect goals of current five-year plan Gosplan’s assessment of feasibility Directives (tentative plan assignments at highly aggregated level) sent to each ministry Summer—Input claims and bargaining each ministry makes up separate tentative output assignments for each of its departments each department makes tentative output assignment for each of its enterprises each enterprise then requests inputs from its department each department aggregates input claims and requests total from ministry each ministry makes its requests from Gosplan intense bargaining at each step as lower level attempts to bargain with higher level for easier output and input assignments Fall—Balancing Gosplan and other planning agencies balance revised aggregate assignments into a consistent national plan (achieves balance b/w sources and uses of all resources and goods)

12 November and December—Approval
Plan submitted to Council of Ministers in November and ratified by Supreme Soviet in December December—Disaggregation Gosplan sends each ministry its plan each ministry sends each department its plan each department sends each enterprise its plan After plan approval, State Committee for Material and Technical Supply (Gossnab) matches up supplying and customer enterprises The deviation of actual from planed performance was so great, the resources were actually allocated by resource managers in the party and state after the plan was completed. All plans were preliminary and subject to change at any time by virtually any resource manager in the state or party; informal resource allocation; high level of unplanned exchange system among ministries. Material Balances Major objective to achieve consistency between planned supplies and planned uses of each commodity Thousands of material balances constructed each expressed in physical units Balance identifies planned sources and uses during the period

13 The Soviet Manager: The Principal-Agent Problem Enterprise Management
The combination of different objectives and different access to info created classical principal-agent conflict b/w enterprise managers and their superiors The Soviet Manager: The Principal-Agent Problem Enterprise Management Formal organization Director In theory the enterprise manager simply followed centrally-determined plans, in practice he has control over info. Appointed by the CP, has to be a member of the CP, nomenclature appt executives in charge of material supply, labor, production, accounting, etc. superintendents of production units Chief engineer (responsible for coordinating of prod) foremen Communist Party head of Communist Party group in enterprise plays an important decision making role Trade union head of unit shares management responsibilities eliciting worker discipline, etc.

14 The Enterprise Plan Soviets referred to an enterprise as being “economically accountable” legal entity with own fixed capital and funds provided by budget grants own account at State Bank and right to borrow additional funds from the Bank expected to enter into contracts with suppliers and customers in accordance with plan expected to earn a profit, most of which was handed over to Ministry of Finance State Enterprises were responsible for fulfilling plan targets and Enterprise received detailed plan specifying quantities of outputs by type and the corresponding value of sales at the centrally determined wholesale prices (e.g. the assortment) amounts of materials, components, fuels, allocated for which it pays at the industrial wholesale prices authorized number of workers, distributed by major categories, total wage fund, and productivity (output per worker) profit amount of capital investment in construction and equipment These plans were very demanding It was often impossible to achieve production and investment assignments with the resources allocated Resources allocated often turned out to be unavailable

15 Managerial Incentives
Soviet enterprises were responsible for fulfilling plan targets, and managers were motivated within an incentive framework Managerial Incentives Material high salary prospect of large bonus prospect of promotion for good performance higher salary and bonuses prospect of demotion for poor performance lower salary and bonuses Non-material power status recognition

16 Manager’s Response to Incentives
Full rewards depended on plan fulfillment. If plans were over fulfilled, bonuses increased slight­ly.  Managers avoided over fulfilling targets (to avoid higher targets in future) The manager was required to fulfill the plan-produce output target and assortment. Only the manager new the true productive capacity of the enterprise and its true needs for materials. The manager’s superiors in the ministry could only guess. This info asymmetry enabled the manager to engage in opportunistic behavior. The manager’s opportunism in the following areas: Managers bargained with superiors during the plan formation stage for easy targets (low output with ample inputs and investment) Bonus system caused managers to misrepresent input needs and production capacity, understated enterprise potential (complained of breakdowns and long repair times) Had to bribe allocators to gain access to supplies. Tried to stash concealed inventories of outputs and inputs They stockpile materials that are in short supply Resisted specialization, especially at later stages of production the more specialized, the more dependant on suppliers who are likely not to be able to deliver Resisted technological innovation, which was poorly rewarded innovation introduced uncertainty loss of production during installation and training required new sources of materials more specialized labor which was often hard to get Resulted in huge, unspecialized enterprises using outdated technology

17 a form of horizontal communication
Used expeditors greatest problem was material supply supply expeditors (tolkachy) were workers who had connections at other enterprises and could barter for needed supplies; arrange unplanned transactions. black market a form of horizontal communication illegal but usually tolerated as long as it wasn’t too obvious Engaged in forms of simulation substitution of inputs when unable to get certain inputs (e.g., using a thinner grade of sheet metal than that specified in plan) substitution of outputs when unable to get adequate supplies of inputs (e.g., shirt factory producing more small sizes and fewer large sizes to save on cloth) false reporting (claiming better results than were achieved) monitoring by State Bank made it hard to get away with simulation tends to make subsequent plans harder Approaching deadlines caused Storming (last minute spurt of activity as period nears end) Lethargy (when obvious that targets won’t be met)

18 All finance transactions are monitored by the bank Ruble control
Soviet enterprises operated on soft budget constraint, means that enterprises that failed to cover their costs could count on automatic subsidies from their ministry, which redistributed profits from profitable to unprofitable enterprises, or from the state budget. Unanticipated profits were confiscated by industrial authorities. What kind of strategic behavior would a manager adopt in the face of these constraints. The firm had little incentive to overfill plans/targets or to reveal its true capacity (since next year will have larger output target). It had little incentive to reduce costs since the profits would be grabbed by the ministry. Thus, the behavior of the socialist from was likely to be perverse compared to its private twin in a market economy. While a competitive mkt would reward good and penalize bad performance, the socialist ministry penalized efficiency and subsidized poor performance. Monitoring of Agents-the communist party and the state had their own control commission to punish illegal managerial behavior All finance transactions are monitored by the bank Ruble control surveillance of enterprises by the State Bank to monitor and enforce plan fulfillment.

19 Agricultural Organization
The Rural Economy Agricultural Organization Kolkhoz—Collective farm, supposedly owned and managed by members, but members had few ownership rights. (Impoverished before 1958 by low prices of compulsory deliveries) Sovkhoz—State farm, organized and operated like an industrial enterprise; huge acreage (12,000). Management was appointed by the government and state workers were paid by a wage and bonus system. Private Plots—Gardens assigned to agricultural or industrial workers.  Output could be sold at market prices at farmers mkts. Denounced by Stalin, but supported by Gorbachev (controlled 3 % of the land, but produced 29% of output; stronger incentives). Suffered from all the problems of industry Lack of incentives Shortages, supply problems, low fixed prices

20 4. Property rights a) State Sector b) Collective Sector
The state owned all natural resources—land, timber, minerals. The state controlled virtually all major non-agricultural production—industry, construction, transportation, communication, health, education. The state share was smaller but still large in: retail trade (70%) agriculture (50%) housing (75% urban, 25% rural) b) Collective Sector Collective farms and consumer cooperatives, operated in rural areas Formal ownership by members, but actual control by state a farm’s output planned by state output required to be sent to state prices set by state Only to cover cost. Thus, each peasant’s share of net farm income would be small, allowing for few purchases of consumer goods. inputs set by state workers’ wages set state In the supply constraint Soviet economy, consumer goods were in short supply, one way to alleviate shortage was by cutting the purchasing power of the peasants Management formally elected by worker-members but, in fact, determined by Communist Party and government officials

21 About a fifth of new housing construction private
c) Private Sector Individual could own consumer goods; a house; livestock; tools and small farm equipment; a car; savings account at the State Bank; government lottery bonds; currency/money One area of free mkt activity was provided by granting workers in farms and other enterprises, plots on which to raise their own crops, which could be sold at uncontrolled prices at farmers mkts. Primary productive activity was the private plot 1/2 to 3 acres produced outputs that could be produced with household labor and little capital 1980’s: 1/3 of milk and meat consumed in Soviet Union 2/3 of potatoes 40% of fruit and vegetables part consumed by household rest sold to state at prices set by state or at farmer’s markets at higher prices About a fifth of new housing construction private materials purchased from state labor provided by household friends moonlighting construction workers Moonlighting permitted for Doctors; artists and craftsmen; construction workers

22 5. The Role of Prices and Money
Employment of a person by another prohibited Any purchase with intent to resell at profit prohibited Lending at interest prohibited Renting apartment from another individual prohibited Renting a car from another individual prohibited 5. The Role of Prices and Money What is the Prices role in mkt economies? Relative Prices guide resource-allocation Money affects price level, level of real output and employment The founders of the administrative-command economy hoped money and prices play only a small role in economy. The Soviet prices are set by administration authorities. Prices were cost based and the demand side had little or no influence Measure of value To translate physical units into monetary values, prices would be needed as accounting units aggregation and comparison of outputs calculation of revenues input costs national product Played role in distribution of income workers paid money wages money bonuses

23 c) Households spend their incomes on available goods and services
d) Prices affect allocation in private sector (production of fruits& vegetables) e) Prices affect enterprise behavior enterprises supposed to minimize money costs and maximize revenue within constraints of plan. e) Prices within state and cooperative sectors set by State Price Committee reflect political/ideological concerns Price policies (subsidies to books, housing, medical care, transportation—low prices; automobiles, vodka—high prices) do not reflect supply and demand (very distorted) wholesale price is equal to the average (not marginal) industry-wide unit cost plus small profit markup enterprises with above-average costs immediately ran losses, requiring state subsidies Provided little incentive for enterprises to respond to consumer demand Retail prices—initially set to equate quantity demanded with quantity supplied (as controlled by planners) with some adjustments. f) Problems: Shortages, long lines, black-market activities, encouraging corruption and dilution of work incentives Budgetary problem when many wholesale prices exceeded retail prices.

24 6. Investment 7. Finance Gosplan and political leadership decide
The control of savings and investment was a powerful mechanism to promote more rapid capital accumulation, the state directed high investment rate and the state control savings. Since prices and wages were set by the state, the state could determine the savings rate. 6. Investment Gosplan and political leadership decide investment’s share of national product distribution of total investment by industry and region design of investment projects based on cost minimization true economic costs not minimized because prices do not reflect scarcity 7. Finance No checking accounts; no credit cards Currency used between individuals Currency used between enterprises and individuals (wage payments) Credit/debit entries at State Bank used for transactions between enterprises State Bank responsible for planning enough (but not too much) currency for intended transactions State Bank serves as control agency since all deposits must be at State Bank and all transactions between enterprises must be through State Bank accounts Hard for enterprises to hide transactions

25 8. Foreign Trade —was a state monopoly
Planning by Gosplan Actual import and export operations carried out by more than 60 foreign trade organizations (FTO) under the Ministry of Foreign Trade. FTO acts as intermediary; exports are sold to FTOs at domestic prices, and sold overseas at international prices. Price differences cause losses and profits for FTOs, which are canceled by governmental taxes and subsidies. No direct interaction by a Soviet enterprise and a foreign entity The Soviet firms were isolated from world mkts. They did not have the opportunity to profit from foreign trade, not were they exposed to the competition in foreign mkts. In January 1987, the FTO monopoly of foreign trade was broken when 20 ministries and 76 large enterprises were allowed to initiate direct trade and to retain hard currency earnings. Bilateral negotiations-barter

26 9. Labor market All able-bodied adults expected to work full time unless they were full-time students in prison Free to find own jobs unless drafted in military on assignment in return for advanced training opportunities Planners had variety of ways to channel workers into planned jobs system of differential wages Was used to influence the distribution of labor by region, season, profession It is an attempt to induce appropriate supplies to meet planned demands control of occupational training By profession—higher educational institutions were directed by state control; number of students and majors were determined by the state placement services residence permits Have to carry internal passports and have them stamped by the police before changing places to live. To travel abroad need special permit from the state and currency. control of housing availability very short supply much of housing stock assigned to enterprises

27 Labor market was subject to some frictional unemployment
unemployment as workers look for jobs There was evidence of some structural unemployment mismatch between skills and employment opportunities tended to be a greater problem with wives seeking jobs in light industry and service sectors in areas where most jobs were in mining or heavy industry) No cyclical unemployment A change in unemployment levels linked to cyclical econ. change The price for labor was the wage, the demand for labor was primarily plan-determined. The households were free to supply labor. Wage Structure Wages determined by several factors Occupation, e.g., engineer’s wages were double that of retail clerks, on average Skill, e.g. top grade in occupation earns double lowest grade compensating differential for difficult conditions priority of industry, e.g. workers in steel industry earned more than workers in retail trade

28 Non Wage Income Other transfers Interest from savings account
Second economy income (private plot, moonlighting) Doctors have private clients for higher fees Sale person would set aside quality merchandise for high tip Collective farmers would divert supplies to his private lot In mid 1980’s, 20-25% of the transactions were illegal Transfers Publicly provided free goods (education, health care) The Soviet elite received superior medical care in secret facilities closed to the masses. Members of CPSU, senior econ managers enjoyed not only higher salaries but also more comfortable apartments, better recreational opportunities, access to luxury goods and foreign travel. Major transfer was the pension retirement for men at 60 after at least 25 years work retirement for women at 55 after at least 20 years work Other transfers paid maternity leaves survivor benefits upon death of spouse sick leaves child allowances income supplements for the poor

29 10. Income Distribution and Poverty
Inequality persisted, as income rewarded plan fulfillment, skill, and high-priority professions. Inequalities reduced through price subsidies, public goods, and small wage differentials.

30 IV. Centrally-Planned Economy (CPE)
The objectives of a Centrally-Planned Economy (CPE) To built socialism as quickly as possible: Rapid growth in the econ. Industrialization Heavy industry was a priority Activities that do not contribute to material productivity such as services would be limited and within industry, priority had to be granted to heavy industry, which laid the foundations for socialism Centralization of decision making and control 2. Key Elements of the CPE State ownership—seen as a primary means to achieve rapid growth maintain centralized control CPEs are command economies centralized, bureaucratic management of economy CPEs are pressure economies high rate of forced saving (no consumer goods) planning of outputs inputs inventories

31 CPEs are priority economies
planning based on priorities reflecting political criteria and socialist ideology Resources were channeled away from consumer into investments in order to achieve a high investment rate CPEs rely on extensive development growth and industrialization through massive increases in resources the alternative is intensive development—growth through productivity increasing innovation CPEs are closed economies foreign trade suppressed CPEs are shortage economies


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