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Variants of Transition among Former

Socialist EconomiesChapter X

The Former Soviet Union:

The Myth and Reality of the Command Economy and Russia’s Economic Transition

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Transformation of Russian economy in 1990s Centrally planned economy was replaced by

an economy operating on the basis of market forces and private property

Some of the former communist states of Central Europe began their process of economic transition earlier

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Historical Background of The Soviet Economy: Until December 25, 1991 USSR was the largest country in the world

Occupied 1/6th of the earth’s inhabited land

293 million population (third largest in the world)

128 ethnic groups

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Historical Background of The Soviet Economy: Until December 25, 1991

Ethnic Groups in USSR Eastern Slavs (70 percent)

Russians Belorussians Ukranians

Turkic Baltic Finno-Ugric Caucasian Persian Armenian

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Historical Background of The Soviet Economy: Russian Empire before 1917 Intermediate case compared to underdeveloped

Asia and to industrially developed Western and Central Europe

Duality between traditional agriculture and military-driven industrial development

This duality produced undecided attitudes toward change and reforms: Change is seen as industrialization at the expense of agriculture

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Historical Background of The Soviet Economy: Russian Empire before 1917

Peasant Emancipation Act of 1861 Abolished serfdom Granted personal freedom to the peasants

However, the freedom given by Peasant Emancipation Act was constrained by collective decision-making in rural communes (mir)

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Historical Background of The Soviet Economy: Russian Empire before 1917

Rural Communes (Mir) Rural communes started in 1400s and survived into the 19th

century

Collective land ownership

Held back private farming in most of European part of Russia

Communal Agrarian Practice feeding the uniqueness of the Russian economic tradition

Allowed Russia to avoid industrial capitalism

Given the Russian peasants egalitarian (democratic) and collectivists instincts → Forced Russia into agrarian communism

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Historical Background of The Soviet Economy: Russian Empire before 1917

Industrialization Industry was considered as alien to Russian culture

Initial foundation of heavy industry in late 1600s under Tsar Peter the Great was associated with his pro-western policy of modernizing Russia

Peter’s industrialization continued in the aftermath of Russian army’s defeat in the Crimean War with the Ottoman Empire, Britain and France in 1854 Industrialization’s belated implementation driven by

militarization

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Historical Background of The Soviet Economy: 1917 Revolution In 1917, in the middle of the First World War,

after the elimination of the Russian autocracy system and Tsar Nicholas, Union of Soviet Socialist Republics (USSR) under the control of the Bolshevik party and Lenin was established

The socialist economy in Soviet Russia did not start until the First-Five Year Plan in 1928

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Historical Background of The Soviet Economy: New Economic Policy (NEP) 1921 Repair the conflict between the workers and the

peasantry

Allowed limited restoration of markets

Partial reprivatization of previously nationalized

industries

Banks taking responsibility for maintaining critical state control over strategic key industries controlled by the state

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Historical Background of The Soviet Economy: New Economic Policy (NEP) 1921 Result of NEP reforms, the recovery of

agriculture surpassed that of industry and was perceived as a possible political threat to the goals of the proletarian revolution → thus aborted

The Soviet economy rejected the use of market forces and turned to command central planning

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Command Economy:Launching the Model Several economic subsystems coexist that ranged

from Self sufficient communes with mostly barter exchange

Individual small-scale proprietorships

Medium-sized businesses that produced for markets with the use of hired labor

Also publicly owned large-scale enterprises (mostly in heavy industries) that by nature were socialist prototypes using direct administrative allocation of resources and assigned labor

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Command Economy:Launching the Model This economic pluralism produced political break in

the ruling Communist Party

Leon Trotsky, founder of the Red Army in the Soviet Union, was Stalin’s chief rival for power

Advocated super-industrialization in the Soviet Union that would lead to a worldwide permanent communist revolution

Call for liberalization of domestic and international markets

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Command Economy:Launching the Model

Divisions between Trotsky and Stalin Trotsky and Stalin agreed about the need for

rapid industrialization, but they disagreed whether this should be done in isolation or in an international context

Trotsky supported the idea of an international permanent revolution, believing that true socialism could not be achieved in the Soviet Union without an international revolution

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Command Economy:Launching the Model Stalin supported an autarkic model of socialism in

one country

Exterminated his opponents (Trotsky) in the party

Established his own cult

Reasserted economic traditionalism in the guise of revolutionary socialism

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Command Economy:Launching the Model Implementing socialism in one country

required speedy industrialization For self-sufficiency

Military Buildup

Social transformation from a relatively backward agro-industrial economy into an urban industrial one ordered by the political center

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Command Economy:Launching the Model Disallowed market allocation of resources

State monopolized foreign relations

Closed the economy through restrictions on foreign trade, currency inconvertibility, and limited trade specialization

Accelerated industrialization, which favored producer and military goods at the expense of agriculture, assumed unbalanced economic growth

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Command Economy:Launching the Model Pressure for super-industrialization reinforced by

hostility toward Communism by Britain, Japan, Poland and Chinese Nationalists

The possibility of foreign military invasion → a push for rapid change instead of gradualism

The debate on industrialization between the genetics and the teleologists Focused on the feasibility of economic engineering

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Command Economy:Launching the Model The genetics argued that planning could give the

market as with indicative planning Argued for objectivity of economic laws and viewed

planning as a navigating tool Movement toward general market equilibrium

The teleologists leaned toward social engineering, with resource allocation determined by planners A biased economy with an imposed equilibrium reflecting

the preferences of the ruling elite Sought to eliminate markets that bred capitalism

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Command Economy:Launching the Model Super-industrialization favored the

teleologists that asserted the need for long-run plans and opposed market forces

First Five-Year Plan in 1928 Central comprehensive planning Ensured political control over the diverse republics Grouping them into economic regions to meet

nation-wide production needs

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Command Economy:Launching the Model Prioritize industry over agriculture for sociopolitical

reasons

Emphasize on regional specialization

Deemphasize republic-level diversification

Establish state monopolies in key industries

Eliminate the entrepreneurial subsystems alien to socialism

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Command Economy:Launching the Model Agricultural collectivization

Forced collective ownership on peasants as a stepping stone to comprehensive public ownership

Success of industrialization program turned out to be a disaster for agriculture

An over-industrialized and over-urbanized economy with an inadequate and no longer self-sufficient agricultural sector

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Command Economy:Soviet Central Planning: The Beginning Central administrative planning eliminating waste of

market forces, thus pushing structural and social reorganization of the economy

Central planners steered individual sectors to assigned targets and instructed every enterprise, industry and region

State control over virtually all means of production and over investment, production, and consumption decisions

throughout the economy

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Command Economy:Soviet Central Planning: The Beginning Proportionate allocation of resources that are

established a priori by central planning

The initial industry-biased growth to be compensated for in the long-run by future production increases in the reprioritized sectors of consumer and agricultural goods

The economic strategy consisted of plans relying on mass enthusiasm with little use of material incentives

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Command Economy:Soviet Central Planning: The Beginning Economic policies designed by Five-Year Plans and Annual

Plans

A dual role → allocating resources and setting targets for economic growth

According to those economic policies, the State Planning Committee (Gosplan) formulated countrywide output targets for certain planning periods

Responsible for plan feasibility studies and for research on the methodology of balancing nationwide proportions

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Command Economy:Soviet Central Planning: The Beginning The goal of First Five-Year Plan was to catch up

with capitalist industrial countries

Success of the initial industrialization push attributed to central planning accomplished at cost of forced collectivization and a major decline in living standards The share of private consumption declined

Concentrated investment in growth-supporting sectors based on domestic savings

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Command Economy:Soviet Central Planning: The Beginning Industrialization produced an extensive bureaucracy

in planning and executive institutions interested in increasing their own power → rent-seeking

Merger between the party, planners, and the ministerial and local government bureaucracies resulting in the formation of a new class nomenklatura Consisted of party members appointed to particular

government jobs

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Soviet Central Planning:Implementation Planning versus market

Planning is concerned with expanded reproduction and particular investment, with consumption deemphasized Soviet planning → Prioritized investment to catch

up with the West industrially and militarily Ignored static efficiency in favor of high rates of economic

growth

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Soviet Central Planning:Implementation A system of annual, medium-term and perspective plans

Increase in the building of overly large production facilities that would employ up to 10000 people, gigantomania, that led to industrial and regional monopolization

The problems of implementation: Informal bargaining by enterprise to lower their quotas plagued

the implementation of plans The ratchet effect that is an increase in the planned assignment

if the previous plan’s target was achieved Storming arose from holding off production followed by last-

minute attempts to meet production quotas

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Soviet Central Planning:Implementation Prices were used by planners to ensure compliance with

plans and continuous control over plan implementation

Domestic prices were distorted because they reflected planners’ priorities in distribution and production rather than relative scarcities

Pricing disabled rational decision making by producers

The planners used wholesale prices to balance inter-sectoral outputs and to provide for comparison of alternative production mixes based on different technologies

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Soviet Central Planning:Implementation In agriculture, government procurement prices

designated quotas promoted specific crops, individual regions and financially controlled collective farms

Retail prices produced inequality in income distribution

Two policies to solve: Free provision of public goods (health care and education) Low prices for mass consumption goods (food, housing,

transportation) while raising prices for luxury goods

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Soviet Central Planning:Implementation The gap between sticky prices and scarcity values

increased over time and lowered the effectiveness of planning

The planned creation of a socialist market where efficiency of production rose with diminishing inequality in income distribution failed Success in creating a second economy where market

forces partially corrected artificial shortages

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Soviet Central Planning:Agriculture: The Peculiarity of Soviet Model Surviving agricultural producers:

State Collective Private farm

Stalin’s industrialization was dependent on the mass collectivization of peasants and the elimination of the well-off peasants (kulaks)

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Soviet Central Planning:Agriculture: The Peculiarity of Soviet Model The collective farm (kolkhoz)

A pseudo-cooperative, with elected management ensuring a supply of agricultural goods to the state at minimum cost

The income of peasants at subsistence level maintained by household plots and individually owned livestock

Exploited by paying low procurement prices and by overcharging for state-owned tractors and machinery

Not have guaranteed wages and were paid in labor days Payments were arbitrary and variable depending on

regions, seasons and specific farms Consumer goods sold to kolkhozes at high prices

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Soviet Central Planning:Agriculture: The Peculiarity of Soviet Model The state farm (sovkhoz)

Factories in the fields and were run under more favorable policies

If underpaid, compensated by subsidies State employees and got a guaranteed wage Have access to better inputs at wholesale prices

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Soviet Central Planning:Agriculture: The Peculiarity of Soviet Model The individual farmer

Found in private sector Land in auxiliary household plots not privately

owned and cultivated only by peasants and state employees

Livestock was privately owned but usually pastured on collective or state land

Individuals worked on these plots for themselves and owned their produce but also worked for collective or state enterprises

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Soviet Central Planning:Agriculture: The Peculiarity of Soviet Model The collective farm (kolkhoz) versus the

state farm (sovkhoz) Their coexistence served the sociopolitical goal of

crowding out entrepreneurship A decline in productivity and in absolute

production On collective farms because of price discrimination and

compulsory deliveries On state farms because of subsidization

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Soviet Central Planning:Agriculture: The Peculiarity of Soviet Model Agriculture deprioritized resulting in

dependence on grain imports

The increasing role of imports of agricultural products and other goods inspired reforms in export sector and the overall economy

Raising questions about maintaining itself as a closed economy?

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Soviet Central Planning:Closed Economy: Command Trade Isolationism Its ideological underpinning is an autarkic

socialist country encircled by hostile imperialist countries

The anarchy of world markets could undermine the effectiveness of central planning

Domestic firms were protected from foreign competition and world prices

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Soviet Central Planning:Closed Economy: Command Trade Isolationism State authority over foreign trade and foreign currency

transactions through state monopolies

Planners determined imports and exports by balancing domestic inputs with projected outputs and making up for potential discrepancies

Export production derived from the need to pay for imports

Producers of exportable goods did not have direct relationships with foreign buyers but dealt with foreign trade bureaucracies organized at the industrial level

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Soviet Central Planning:Closed Economy: Command Trade Isolationism Foreign trade relations bilateral and highly politicized

The use of trade for greater integration with the socialist satellites through Council of Mutual Economic Assistance (CMEA or Comecon) founded in 1949

As a multilateral body to persuade these countries to adopt a uniform strategy of communist industrialization with the USSR

CMEA membership → USSR, Czechoslovakia, Hungary, Poland, East Germany, Romania, Bulgaria, Albania (withdrew in 1961), Mongolia, Cuba and Vietnam joined later, Yugoslavia as an associate member

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Soviet Central Planning:Closed Economy: Command Trade Isolationism Two principles:

Extensive development that prioritized capital goods at the expense of consumer goods

An autarkic focus on import substitution and minimal dependence on western markets

CMEA countries dependent on soviet energy resources and raw materials

The idea of socialist international division of labor suggested intra-industrial rather than inter-industrial specialization

A collective isolationism from world markets and a tendency to create a socialist alternative to international capitalist trade

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Soviet Central Planning:Closed Economy: Command Trade Isolationism Intra-CMEA specialization acknowledged the benefits of trade

for economic development

The international socialist division of labor was shaped by concentrated planning rather than markets

The problems of inefficiency and non-competitiveness of individual national industries increased in the mid-1960s, leading to declining intra-bloc trade

Liberalization of trade with the West brought about by technological backwardness in the course of the arms race

Decade of trade promotion ended in 1979 with the Soviet invasion of Afghanistan

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The Reform Cycle:Reluctant Reform Thinking Soviet economy characterize pervasive protectionism

Enterprises were shielded against bankruptcy through centralized subsidies

No financial discipline and managers’ performance assessed on basis of compliance with the government's plans

People were protected against economic fluctuations and the possibility of unemployment

The state monopoly of foreign trade protected domestic firms from external shocks and from competition with foreign goods

The network of commodity flows with preset prices and quotas created a sense of certainty in domestic trade

THIS ECONOMIC STABILITY LACKED ANY IMPETUS TO CHANGE

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The Reform Cycle:Reluctant Reform Thinking Reform and reformism unacceptable and interpreted as

dangerous Western imports

The strengths of Stalin’s economic model → Mobilization of resources for industrial catch-up Development of a military-industrial complex The postwar recovery through extensive growth

The weaknesses of Stalin’s economic model → Undervaluation of the opportunity cost of planned priorities

absent appropriate criteria to assess economic performance Protectionism downplaying economic incentives Vertical institutional structure producing shortsighted

bureaucracies and compartmentalism

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The Reform Cycle:First Attempts at Economic Reforms Khrushchev’s Period Nikita Khrushchev, Communist Party General

Secretary during 1953-1964, initiated destalinization in domestic politics and economics

In foreign policy Khrushchev embraced the idea of peaceful coexistence and competition between socialism and capitalism

Higher standards of well-being and consumption without cutting back on military control over the Soviet block

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The Reform Cycle:First Attempts at Economic ReformsEconomic Reforms during Khrushchev’s period

Agriculture (reduced taxes and canceled old debts)

Administrative Decentralization (through delegating authority of decision-making to regions and away from ministries)

Aggressive use of foreign trade and military and industrial assistance to aid regimes sympathetic to USSR

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The Reform Cycle:Gorbachev’s Revolution Reducing soviet economic performance and a

widening technological gap with the West

The initial strategy to form greater political and economic unity with Warsaw Pact countries and proceed with concerted reforms

Raised the issue of real socialism

Opened debate over the divergence between existing practices and theoretical socialism in his policy of openness (glasnot)

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The Reform Cycle:Gorbachev’s Revolution

Perestroika (Economic Restructuring) Opened the economy into international competition

hoping that it would provide incentives to change

Eliminated the state monopoly on foreign trade to end Soviet enterprises’ insulation from international competition

Wanted to duplicate the success of China’s gradual opening to foreign trade that had spurred its economic growth

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The Reform Cycle:Gorbachev’s Revolution

Radical reform started in 1990 Open debate over transition to a market economy

by dismantling central planning introducing different kinds of property relations to promote

individual entrepreneurship

Replacement of the vertical planning hierarchy by horizontal market linkages and direct interaction between demand and supply → introducing economic decentralization

Removal of the central authority → distancing of the Communist Party from economic matters

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The Reform Cycle:Gorbachev’s Revolution

Secessionist Movements Decentralization of economic decision

making stimulated the nationalist sentiment of individual republics and sped up secessionist movements

The disintegration of the Soviet Union in 1991 and the rise of economic nationalism fragmented the reform movement by diverting it into the individual political realms

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Legacies of Soviet Economy

State-planning for state-owned industries and demand structuring by the state budget

State-determined monetary policy with a one-tier banking system

State-run monopolistic firms, producing a narrow range of goods at state-administered prices and facing monopolistic suppliers

Risk-aversion by managers who were reluctant to innovate

Full-employment guarantee and as a consequence, the systemic impossibility of firms going bankrupt- a soft-budget constraint policy

State monopoly in foreign trade, administered prices and exchange rates reflecting the inconvertibility of the domestic currency

Fiscal revenues generated by turnover taxes and mandatory transfers of profits used to subsidize firms

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Problems with Legacies of Soviet Economy Monopolistic producers and risk-averse managers

lacked the motive to innovate

Full-employment guarantees hidden unemployment and favor labor-intensive production processes

Domestic production is not exposed to international trade and therefore, becomes non-competitive

State provision caused the creation of poor quality of public goods

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Slowdowns and Stagnations

Slowdown in growth rates from the mid 1970s

Economic stagnation in 1980s

Central planners’ inability to deal with a complex, over-industrialized economy’s need for constant adjustment

A succession of reforms failed to improve central planning, was unsuccessful in questioning state ownership

Late 1980s → legal recognition of private enterprise ranging from introduction of cooperatives to individual proprietorships

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Collapse of the USSREstablishment of Russian Federation After the collapse of the USSR in December

1991, the Russian Federation faced the demanding need for moving away from Centrally Planned Economy

Boris Yeltsin, the first democratically elected president of Russia, launched the sixth reform to undo the legacies of Soviet model

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Transition in Post-Soviet Russia:Boris Yeltsin (1991-1999) Destroyed of Communist Party’s monopoly

politically and economically

Failed to build a new pluralist society

Finished off the remnants of command economy system

Yeltsin took great steps toward developing a market economy: Price liberalization Mass privatization of state enterprises Foreign trade liberalization Introduction of full convertibility of ruble

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Transition in Post-Soviet Russia:Problems with Yeltsin’s Reforms Price and foreign trade liberalization created high inflation and

decline in domestic production

Mass privatization was accompanied by political rhetoric, contrary to the West’s economic emphasis on the fundamental importance of private property for the institution of a market economy

Voucher privatization forced negotiations in the regional implementation of privatization

Several local elites succeeded in seizing formerly state-owned enterprises

Local established elites continued to exercise their power

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Transition in Post-Soviet Russia:Problems with Mass Privatization By the end of 1995, Russia had completed the privatization of

over 120,000 enterprises

55 percent of the large and medium-sized enterprises sold could be classified as non-competitive worker-management buyouts

Labeled as destatization officially and grabitization informally

This mass privatization failed to improve economic efficiency and induce normal market behavior

Instead generated effects of persistent arrears (non-payment of outstanding liabilities) and sliding into a barter (non-money) economy

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Transition in Post-Soviet Russia:Problems with Barter Economy and Persistent Arrears The emergence of arrears due to the enterprises’ failure to keep

pace with collapse of demand in the short-run and to continue to produce

The underdevelopment of banking system played an additional role

Emergence of risk-free tax arrears and reliance on state subsidies

Resurfacing of barter economy 1960-mid 1980s → inefficient planned distribution Late 1980s-early 1990s → general shortages 1992-1994 → enterprises’ financial deficits Starting in 1997 → institutionally built into system and accounted

for 90 percent of industrial output

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Transition in Post-Soviet Russia:Problems with Barter Economy and Persistent Arrears Barter economy and persistent arrears (amount overdue)

locked regions into local transactions, hindered competition and corrupted the effectiveness of property rights

Privatization and price liberalization created income inequality

State revenues, which consisted mostly of profits from state-owned enterprises during the Soviet era dropped as a result of the recession and mass privatization

Issuance of short-term state bonds that offered high interest rates crowded out private investment

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Transition in Post-Soviet Russia:Deep Recession Russian industrial production fell by 55 %

Consequently, tax rates were raised creating a shadow economy

Budget debt increased

The rate of export dropped

The fall in oil prices magnified the current account deficit, causing a financial crisis that resulted in the devaluation of ruble in 1998

Severe economic instability and hyperinflation

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Conclusion: The Soviet Model of a Command Economy Created by a combination of internal economic

underdevelopment and international political discontinuity in the aftermath of WW I, when workers’ revolutions threatened many nations

Designed to produce a transition from a relatively backward nation to a modern industrial society

Central planning that is a superior tool for balancing economic proportions and maximizing the use of resources, produced disproportionate and inflexible economic outcomes

Producing many problems, agriculture being a prominent example