Variants of Transition among Former Socialist Economies

1. Variants of Transition among Former Socialist Economies Chapter X The Former Soviet Union: The Myth and Reality of the Command Economy and Russia’s Economic Transition

2. 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

3. 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

4. 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

5. 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

6. 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)

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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

30. 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

31. 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

32. 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

33. 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)

34. 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

35. 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

36. 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

37. 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

38. 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?

39. 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

40. 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

41. 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

42. 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

43. 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

44. 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

45. 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

46. 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

47. The Reform Cycle:First Attempts at Economic Reforms Economic 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

48. 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)

49. 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

50. 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