Download Economic Transformation in Eastern Europe and the former Soviet

TRADITIONAL CENTRALLY
PLANNED ECONOMIES
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The Economic Transformation of the
Soviet Union, 1913-1945
edited by Robert William Davies, Mark Harrison,
S. G. Wheatcroft
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Objectives of Typical CPEs
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Rapid growth
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Industrialization
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planners typically target very rapid growth,
much higher than capitalist countries
not all sectors promoted equally
emphasis on heavy industry (political issues)
Centralization of decision making and
control
Full employment
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Main features of the soviet model
of centrally planned economy:
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The dominant position of the state
sector in the whole economy.
Non market allocation of economic
resources.
Independence from the World markets
(sometimes autarky)
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Key Elements
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Social (state) ownership
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seen as a primary means to
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achieve rapid growth
maintain centralized control
CPEs are command economies
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centralized, bureaucratic management of
economy
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non market allocation of economic resources
detailed physical planning
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Planning – Information flows
CPO
Ministry 1
Enterprise 1
Enterprise 2
Ministry 2
Enterprise N1
Enterprise 1
Ministry M
Enterprise 1
Enterprise NM
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CPEs are pressure economies
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high rate of forced saving
taut planning of
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outputs
inputs
inventories
CPEs are priority economies
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planning based on priorities reflecting
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political criteria
socialist ideology
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CPEs rely on extensive development
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growth and industrialization through massive
increases in resources
the alternative is intensive development -- growth
through productivity increasing innovation
CPEs are closed economies
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foreign trade suppressed
used only as a safety valve to complete domestic
plans
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CPEs are shortage economies
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shortages are chronic
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shortages are general
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applying in all spheres of the economy
shortages are intensive
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not just occurring temporarily
severely affecting economic actors and decision
making in general
does not preclude surpluses
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Planning – Incentives; Long-term
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In the long-term, what matters is innovation by existing
firms, the exit of very bad firms, and the formation of lots of
new ones.
But why should firms innovate when they face no effective
competition and have a guaranteed market for their output?
Hence firms came to have an innovation plan, with targets for
innovations.
The result was that often, quite small changes would be
presented to look like an ‘innovation’, and serious innovation
was still quite sluggish.
Poor links between research institutes and enterprises also
didn’t help the situation. Research institutes had incentives
to invent things, but why should enterprise then use the
results?
Overall, system good at copying, poor at real innovation.
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Material Balance Planning
• physical planning
– balancing of equations in physical units
• sequential
– successive approximation rather than
simultaneous solution of equations
• requires vertical channels of information
and control
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Central planning – some theory
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Running the economy through a massive administrative
structure, and much vertical flow of information – up and down
the planning hierarchy. This already implies an economy that is
predominantly state owned, since except under war-time
conditions, private firms would not want to be involved in this
process.
These vertical flows replace the typical horizontal flows of price
and quantity information in a decentralised, market-type
economy.
Hence need Central Planning Office (CPO) at the top, then
sectoral and/or regional structures, then down to the individual
production units – firms and farms (also organisations like
schools, research centres, etc.).
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Operating a central planning system
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To make a central planning system work there are some key
choices to be made:
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For what period should we construct the plan?
How much of the economy should it cover? (scope of plan)
In how much detail should we construct it?
What scope, if any, should remain for market-type mechanisms?
What information flows are needed to formulate and implement a
plan?
What incentives/rewards/penalties are needed at different levels to
make the system function? (incl. defining the plan targets)
What are the implications of our planning model for other features
of the economic structure?
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Planning
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Period – usually one year (for an operational production
plan), or five years (for a medium-term investment
plan).
Scope – in former socialist countries, almost the entire
economy; in war-time UK, focus on aircraft production.
Detail – could be a few key commodities and a limited
number of major firms (as in China), or hundreds (or
even thousands) of economic balances, as in former
Soviet Union.
Market mechanism – need to use to some extent for
labour market and the markets for consumer goods (see
later), also in foreign trade with western countries (see
later)
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Planning – Information flows
CPO
Ministry 1
Enterprise 1
Enterprise 2
Ministry 2
Enterprise N1
Enterprise 1
Ministry M
Enterprise 1
Enterprise NM
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Planning – Information flows (2)
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Figure on previous slide shows simplest organisation chart for a
centrally planned economy, with three levels – usually there would
be more than this.
For any particular good (or, more usually, product group – such as
TVs or household furniture), the planners need to construct a
material balance.
They do so by collecting information on sources of supply – from
domestic producers (and possibly imports); and expected demand
from domestic firms (intermediate demand) and final users
(government, households, investment, exports).
Note that the information flows to construct this material balance
are mostly vertical, and mostly to do with physical volumes of
outputs and inputs – little to do with costs and prices.
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Planning – Information flows (3)
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If a given material balance doesn’t balance at some point in the
process of formulating their plan, the planners have three ways to
deal with it:
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They can ignore it, and in effect rely on firms to manage (using
reserves, stocks, or whatever);
They can instruct producers to produce more with the given inputs; or
require some users to use less of the product per unit of their own
output (firms); or ration supplies to households; or
They can undertake a comprehensive recalculation of the whole set of
material balances – but this is very complicated and time consuming, so
no time to do this many times. Thus a significant change in the steel
balance will upset the coal balance, a change in output of vodka will
upset the sugar balance, etc.
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Planning – Incentives
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Eventually, the method of material balances yields
an operational plan for the coming year.
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Firms (and farms) know what output they should be producing,
and to whom they should deliver it;
Firms also know what inputs will be delivered to them, and how
many workers they can employ;
Retail outlets (shops) know what products will be supplied to
them for sale in the coming year.
The whole plan is generally based on fixed, statedetermined prices, typically set for quite long periods
(supposedly based on some measure of costs).
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Planning – Incentives (2)
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So how does this planning system work, what
incentives does it offer the various agents in the
system to cooperate in supplying information, and then
to strive to fulfil the resulting plan?
Related to this, we also need to consider some serious
informational problems with the model.
We review these issues in stages:
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Static, short-run operation of the system;
Medium-term operation – investment;
Long-run operation – innovation and change
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Planning – Incentives (3); Short-run
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Firms were usually rewarded for plan fulfilment, generally
with reference to their output target, xp.
Thus a firm’s bonus might take the simple form:
B = α + β.(x – xp)
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In this case, the firm loses out if it under-fulfils the plan, but
receives more and more bonus the more it produces.
An alternative would set B = 0 if x < xp, which implies a big
penalty for under-fulfilment, while over-fulfilment is
rewarded.
Sometimes, both over-fulfilment and under-fulfilment might
be penalised, with the highest reward for exact achievement
of the plan.
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Planning – Incentives (4); Short-run
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Clearly, firms can do better if their initial plan is not too
demanding, i.e. if xp is low. Thus firms have an incentive to
try to get low plan targets.
But if they then over-fulfil by a lot, the central planners will
know that the firm was underestimating its capacity – and
next year’s plan will probably be a lot higher.
Hence it makes sense for firms to set modest targets that
they over-fulfil by a little.
To counter this sort of behaviour, the central planners
commonly adopt a simple rule of thumb, planning from the
achieved level – this simply means that next year’s plan
target is some percentage above this year’s actual output.
This is sometimes called the ratchet principle of planning.
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Planning – Incentives (5); Short-run
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What does the output target, xp, actually mean? Note that in
practice, xp will normally include several different products,
measured in value terms, or in physical units. E.g. 10mn
roubles worth of machinery; 155,000 tons of furniture.
The firm might find it easier to produce some products rather
than others, hence it has an incentive to choose the product
mix that meets the plan target most easily.
With a target expressed as a value, the firm will prefer to
produce the items that give the highest revenue per unit of
‘effort’ – this may not be equivalent to the most profitable
mix unless the firm is rewarded for making profits.
With a plan target expressed as tons of furniture, might be
easier to go for a small number of heavy items (as was the
case in Soviet Union).
Firm needn’t care whether specific goods demanded or not.
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Planning – Incentives; Medium-term
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Turning to investment, note that all firms will be keen to
invest, in this system – because expansion is good for annual
bonuses (mostly paid to managers), and penalties for a bad
project are low or zero (soft budget constraints).
Hence task for planners is to keep investment down, make
sure not too many projects get started in a given period.
The five-year plans were basically massive lists of investment
projects, often only quite loosely co-ordinated.
Most investment financed from tax revenues, mostly coming
from above-plan profits of enterprises – especially in FSU,
above-plan profits were often taxed at 100%, not a great
way to give firms incentives to improve efficiency.
Investment went to sectors where the planners expected or
wanted to see growth – and it was too bad for the lagging
sectors when they got it wrong.
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Planning – Incentives; Medium-term
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For much of the Soviet period, planners had a
theory of growth that led them to give priority to
heavy industry (production of means of production
– not a bad idea in early stages of development,
not so sensible later on).
They also gave high priority to production of
military equipment, etc.
Most consumer good sectors had rather low
priority, hence were technologically underdeveloped, often experienced shortage conditions.
Not surprisingly, best managers and best rewards
were to be found in heavy industry and defence.
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Planning – Incentives; Long-term
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Entry and exit of firms
Innovation and change in existing firms
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Cost-reducing innovation
Product innovation
Seeking new markets, designing new
products
Improving product quality – problems of
supply chains and sales networks
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Planning – Information
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Already discussed in connection with material balances, and
where we saw that plan targets were often expressed in
terms of aggregated information.
The aggregation problem is even more serious, as much plan
information is aggregated and then disaggregated as it
passes up and down the planning hierarchy – essential to
make plans understandable, but also a source of errors.
If we tried to plan using fully detailed information, there
would simply be too many balances to manage, probably
several million.
So how does the market system work? It is fully
decentralised, based on horizontal information flows. Each
agent only needs to know about the prices that affect its own
business, not about the entire economy. No one has the full
picture, no one needs to.
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Trade and foreign investment under
central planning
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Outline:
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Trade with socialist partners, Comecon;
Trade with western partners;
Restrictions on trade – conventional trade
barriers, controls on high-technology trade;
Foreign investment and technology transfer;
Exchange rates, deficits and indebtedness
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Trade with socialist partners, Comecon
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Trade mostly determined as part of the
regular planning process, normally annual
bilateral deals between each pair of countries.
Trade conducted in the ‘transferable rouble’.
Prices based on western world market prices,
though lagged and smoothed to remove
fluctuations.
Not much attention to comparative
advantage, so trade probably not very
efficient either in volume, direction or
commodity mix.
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Comecon
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Comecon was the usual name given to the CMEA – Council for
Mutual Economic Assistance, based in Moscow.
Essentially an Eastern version of the EEC (now the EU), but
included countries not in Europe like Mongolia and Cuba.
Trade among socialist countries was planned through Comecon,
and the Comecon bank handled payment and financing aspects
of this trade.
Comecon also tried to promote production specialisation among
the socialist countries.
Mostly not very efficient, nor very flexible.
Probably also, too much influenced by the biggest country, the
Soviet Union.
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Trade with western partners
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This part of the socialist countries’ trade could not be
planned like the Comecon trade.
For exports, the countries usually had to take the world
market prices as given, and could only export what the
market demanded at these prices.
For imports, the socialist countries could choose the
quantities (volumes), but they had to pay whatever
prices the market conditions imposed.
Hence western trade for the socialist bloc was an
aspect of their economic life subject to substantial
risks. It was not something they could control.
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Restrictions on trade
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There were some tariffs on trade among the socialist countries, but
mostly the trade was determined through the plan – with the
implication that any trade not in the plan was not allowed.
Trade flows not much influenced by price-type signals or by cost
factors. So how did anyone know what trade was profitable, what
wasn’t? (mostly they didn’t, though some countries did start to
produce measures of export efficiency).
With western trade, a mix of tariffs and quotas, also most countries
used multiple exchange rates.
Some trade preferences for developing countries, usually
implemented through annual trade deals that could be included in
the planning process (e.g. trade between Soviet Union and India)
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Restrictions on trade (2)
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There were some controls over exports of advanced technology
from western countries to the socialist bloc.
Controls administered by a NATO sub-committee, CoCom – the
Coordinating Committee for Multilateral Export Controls (some
controls lasted until 1994).
Basic aim: to stop the socialist bloc acquiring advanced military
technology, electronic equipment (incl. computers), etc.
Such embargoes can simply stimulate domestic production of the
banned exports, or encourage theft of technology.
However, there is no doubt that these controls did slow down the
development of certain key technologies in the socialist bloc.
Indirectly, they made the arms race relatively more expensive for
the Soviet bloc, possibly advancing the time when the system
collapsed, especially as the system was bad at internal innovation.
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Foreign investment and technology
transfer
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Before 1989, very little FDI in the socialist countries, mostly due
to the highly restrictive conditions under which it was allowed.
Most foreign investment took the form of so called joint
ventures (a foreign firm and a local firm usually formed a new
company, a subsidiary of both, to manage an agreed project).
During the 1980s, the more liberal socialist countries (e.g.
Poland and Hungary) tried to encourage more FDI, but their
efforts were mostly not a big success.
A few western hotels and fast-food outlets were established,
and there was some early cooperation in car production.
There was very little investment by firms in socialist countries
outside their home country – mostly this was not allowed.
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FDI and TT (2)
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As for technology transfer, this occurred through licensing
agreements, the import of western capital equipment, and to an
extent through technology theft.
But in areas that had top-level priority, the socialist system could
achieve big successes, e.g. Soviet space programme.
Limited movement of people and skills (an important vehicle for
technology transfer among western countries).
Few people from the socialist countries worked in western
universities and research institutes, and the countries have been
slow to modernise their own universities and research facilities.
Spending on new technology and R&D in the former socialist
countries still very low – they still rely heavily on imports of
technology rather than developing it locally.
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Exchange rates, deficits and indebtedness
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Normally, we think of countries as having a single exchange
rate and a single balance of trade/balance of payments.
For the socialist countries this was not the case, as they
effectively operated with two separate accounts – one for hard
(or convertible) currencies (usually expressed in US dollars), one
for socialist trade (in transferable roubles).
Hence each country had two key exchange rates – that with the
US dollar, and that with the transferable rouble.
But in practice, the countries also operated so called multiple
exchange rates, i.e. different exchange rates for different
product groups.
The result was an extremely inefficient, non-transparent foreign
trading system (cf. Uzbekistan, even today in 2006).
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Deficits and indebtedness
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Until the 1970s, the socialist countries mostly maintained both
their hard currency accounts, and their transferable rouble
accounts, roughly in balance.
World oil price rises in 1973 (Yom Kippur War) and 1979 (Iranian
Revolution), led by a strengthened OPEC.
Soviet Union continued to supply its allies with cheap oil, and
most socialist countries acted as if oil prices rises would be
‘temporary’.
Western banking systems suddenly awash with cash to invest, so
willing to lend to lots of countries where not much lending in the
past, including the socialist countries.
Result – some socialist countries started to accumulate hard
currency debt (e.g. Hungary), some remained more cautious
(e.g. CSFR).
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Deficits and indebtedness (2)
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Some countries accumulated debt as a result of internal political
conflict + poor economic management (e.g. Poland).
Countries that continued to treat energy as very ‘cheap’
developed economic structures that made their energy use very
inefficient – most of the former Soviet Union still uses 2 – 3
times as much energy per unit of GDP as in the UK! This later
became a source of problems for the transition.
By the late 1980s, Poland was already in default, other
countries like Hungary had worryingly high levels of external
debt. Not a good ‘initial condition’ for transition.
Romania, in contrast, had had high external debt, but the ruling
group half starved the population and severely restricted most
imports in order to pay off most debt by the late 1980s.
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Deficits and indebtedness (3)
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By the time that the Soviet Union disintegrated
in 1991, it had accumulated external debts of
the order of $80 billion (exact amount is still
debated).
Russia then inherited all the external debts and
assets of the former Soviet Union.
Low oil price in early 1990s + poor export
performance of Russia left the country
struggling to service the debt.
Hence need for some rescheduling, partial debt
relief, and external assistance.
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Central planning – its successes
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Mobilised resources and achieved high rates of
investment (a necessary, but not sufficient condition
for growth).
Generated fast growth, largely by replicating known
technology – so called extensive growth.
Shifted resources from low productivity agriculture
into higher productivity industry.
Lack of open unemployment.
Low but equal level of wealth (equal sharing of poverty).
Socialistic welfare state.
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Central planning – where it went wrong
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Rapid growth rates in early years turned out not to be sustainable.
System good at replication, poor at serious innovation.
Generated widespread micro-imbalances, inefficient shortages and
surpluses.
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The centrally planned economy was a supply-constrained economy;
Non elastic character of the economy.
Non innovative character of the economy.
Lack of the financial discipline.
Irrational allocation of resources.
Encouraged inefficient micro-level behaviour:
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Politicized economic decisions.
Informal network of contacts.
Almost no entry and exit of firms
Too many plan targets for each firm, so managers not sure which
should have priority.
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http://prawo.uni.wroc.pl/pracownicy/651
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