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Economics 110
Notes for March 14th Class
The Basic Socialist Model
1. The Big Push
a. Famous Stalin quote – need to industrialize quickly
b. High proportion of GDP to go to investment (define); low proportion to go to
consumption and housing
c. Very large, capital intensive projects are preferred – called Gigantomania – in
heavy industry and military production
2. The Organization of the Communist Party
a. Highly centralized --- orders from above are binding on those below
b. the Nomenklatura to decide all appointments, promotions, etc.
c. No elected leaders. No independent courts.
3. The State Owned Enterprise
a. Personal Characteristics of Managers of Enterprises
1. Well educated, usually in sciences or engineering
2. likely to be a Party member --- appointed under the nomenklatura
3. rose up through the company, from the production departments
b. Powers of Managers of Enterprises
1. cannot introduce new products or new technologies, can't control investment,
and can't fire workers. His main powers involved the ability to bargain with
superiors
c. Goal #1 --- Meet the plan targets (focus on incentives!) Planning is the next topic
1. There were many targets --- but output was the main one
2. problem of the unit of measurement --- the nail cartoon story!
3. Need to overcome shortages of supplies
a. hoard materials --- report as lost in transit or used
b. vertical integration --- produce everything for himself
c. bargain for lower production targets
d. use of expediters
4. Do not overfill the plan target!!
1. ratchet effect
2. storming
5. Resistant to change and innovation
a. If successful, the quota will be raised. If not, the quota will not be met.
d. Profits were not a main goal of the enterprise manager. Most profits went to the
government as its main source of revenue. Explain the soft-budget constraint
(little incentive to be efficient).
1. The soft- budget constraint
a. If a state-owned firm's spending exceeds its budget, it receives external
assistance in four forms:
1. Soft Subsidy: a direct subsidy based on bargaining between the firm and
the Ministry
2. Soft Taxation: Taxes are often assessed on a case-by-case basis
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3. Soft Credit: the bank does not insist on full adherence to the credit
contract
4. Soft Administrative Pricing: while prices are set administratively, they can
be raised
2. In the former Soviet Union, about 20% of the profits were under the discretion
of the enterprise manager --- for small investments in the plant and for bonuses,
housing, and recreation.
3. The manager's bonus came mainly from meeting the production quota. It could
add 25% to 30% to income. There were also non-monetary rewards, such as
living quarters, an automobile, perhaps with a driver, adulation in the press,
vacations to desired areas, and the possibility of future promotions.
4. Failure to meet the production quota meant the loss of the bonus, reduced
promotion prospects, and possibly the loss of the job.
e. Goal #2: Expansion
1. The people at the top saw the ability to catch up with the West and to be
militarily strong as a sign of the superiority of socialism.
2. Power and prestige grow with the size of the unit headed!
3. Define investment hunger. Leads to an investment cycle.
a. Leaders at all levels of the bureaucracy consider that their power and
prestige grow with the expansion of the unit they lead. The difficulties of
obtaining inputs also forces enterprise directors to move into production of
many different products (vertical integration). Any production resulting
from expansion can be sold in a sellers' market. And there is a soft-budget
constraint if investments are bad. At the top levels, there is a belief that
more investment means more rapid growth. The motives of the bureaucracy
and the policies of the central authority coincide!
b. All details of investment projects are centrally determined. Lower units
always demand more investment funds than they really want. They
frequently underestimate the investment project's costs and completion time
so as to increase the chance of approval. The excess demand for investment
goods was called investment tension.
c. The approved investment projects required more inputs than were physically
available. No project was halted, as each has a constituency in the
bureaucracy. All were slowed simultaneously --- leading to lengthening
of approval times and increases in costs.
d. A high priority was assigned to heavy industry, especially machinery and
steelmaking, and most especially to the arms industry. Big units got priority
over smaller ones --- gigantomania --- due to expectations of economies of
scale and ease of control over fewer units. The development of transportation
and telecommunications infrastructure was badly neglected --- trains and
roads were overcrowded while there are too few telephone lines.
e. Creation of new factories gets priority over maintaining older ones for
political reasons – they were seen as more spectacular.
f. Enterprises were very large and very few. Soviet enterprises averaged over 550
employees compared to an average of less than 50 employees for American
companies.
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4. Agriculture
a. Functions of Agriculture in Economic Development
1. To provide food plus raw materials
2. To provide a labor force for industry
3. To provide savings to finance investment
4. to provide export products to earn foreign exchange to buy needed inputs
b. The Collectivization drive of the 1930s in the Soviet Union
c. State Farms
1. budget financed, with workers receiving wages
2. 1983: 23,313 (53% of sown area) with an average size of 41,002 acres
d. Collective Farms (technically “owned” by the members)
1. about 25,000 (42.75% of sown area) averaging 16,055 acres in 1983 and
averaging 500 to 600 workers --- organized into brigades and then into teams
2. Chair was generally chosen by the Party
3. respond to the Plan --- compulsory delivery at low prices; the rest is sold to the
State at higher prices, sold on collective farm markets, or distributed to the
members in kind. The State would buy at low prices and sell at high prices – a
way to extract savings from agriculture
4. Workers paid a wage plus a bonus based on performance of the collective.
Incomes were low as a way to force workers to leave for jobs in heavy industry.
e. Private Plots
1. 3% of sown area in 1983. 3/4 acre for a collective farm member, 1/2 acre for a
state farm member, 0.15 acre for a city dweller
2. spade, hoe, sickle technology
3. workers are often women or retirees
4. produced 60% of potatoes, more than 40% of fruits, berries, and nuts, 30% of
meat, milk, and vegetables, and 25% of total output.
f. Movement of the population was tightly controlled.
g. The State would not make improvements in agriculture – use to extract resources
5. Central Planning
a. There were two main plans. The five-year plan set major goals and priorities, such
as the growth of production, investment spending, etc. It was a statement of intent!
The annual plan was the operational tool for running the economy. See the dates
handout for the annual plan in the former USSR.
b. First, indicators on the total volume of production nationally as well as the
distribution of this among main sectors, such as industry, agriculture, and
transportation.
c. Second, the distribution of materials and finished products to various uses is
determined. Each use receives a quota for various inputs. This quota is an upper
limit.
d. To allocate priority products, material balances were prepared. On one side were
the sources (production, imports, reduction of stocks) and on the other the uses
(production use, exports, consumption, or increase in stocks). In the USSR, this
was done for about 4,000 products. It is seen as a sign of success if the plan
balances. No attempt to find the optimal uses is made.
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e. Information basically flowed down the hierarchy. The lower level received a
command from the higher level. But the lower level also made proposals and
comments on initial drafts. There was bargaining at all levels and repeated
negotiations between planners and users. The head of the firm wanted as easy a
production quota as possible and as plentiful a supply of materials and labor with
which to carry it out. He would thus distort information to report a smaller
capacity and larger input requirement than he needs. The superior level knows of
this and therefore initially requires a 10% to 20% tighter plan than they consider
realistic. The superior level has to consider its own superior. Each wants more and
more output with less and less input. In the former USSR, the top leadership
wanted taut plans designed to force a rapid growth in production. The actual
outcome depended on the power relations between the two.
f. Because of the complexity involved, planning was commonly done "on the
margin". It was easier to conduct such a planning process because there were
relatively few companies and because there was no foreign sector to consider.
g. Third, manpower quotas and wage funds are distributed among the areas.
h. Fourth, the aggregate investment quota is broken down. Investment projects
were financed through a separate plan.
i. Fifth, there was a plan for foreign trade. Import quotas were used to balance with
the exports.
j. There is also a financial plan. All financial transactions went through the State
Bank. This Bank must receive evidence that the transaction was according to the
plan. All company funds were kept in the State Bank. Individuals dealt with each
other using only currency. There was a plan for the household sector to balance
money demand for consumer goods with the supply at established prices. In fact,
there was little price inflation but were always shortages. In such a sellers' market,
companies had no concern about quality.
k. Implementation of the plan was compulsory. The chief executive's bonus
depended on implementation of the plan. The superior levels of the bureaucracy
intervened daily in every detail of the firm's activities.
6. Calculation of the Prices of Products --- see Handout
a. Prices are based on Average Costs
b. No charge for land rent nor for interest on capital --- incentives to overuse these
c. Rarely changed
d. Relative prices were arbitrary and irrational (explain as to why some goods are
expensive and some are cheap in the United States). The desires of consumers
had no influence on producers!
e. Prices of some consumer goods are kept low through government subsidies --paid for by the printing of money --- with health and education basically free
(shortages)
f. The function of prices was to create a weighting system and a common
denominator for arriving at the aggregate volume indicators.
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7. Labor Markets
a. Labor was allocated to the firm based on the overall plan. Labor demand was
based on input norms.
b. Labor mobility --- reasonably high in Eastern Europe, non-existent in China.
1. internal passports + must have permission to re-locate
2. main constraint was the shortage of housing; therefore, companies often
Provided housing for the workers.
c. Very high labor force participation --- mandated
1. low real wages forced two in a family to work
2. laws against paracitism
d. Wages --- based on Marx
1. Wage was for the lowest grade. The others are multiples of this.
2. Used to attract workers --- differentiate by region, by job difficulty, etc.
3. Worker bonuses could add up to 1/3 of income
3. A low wage, full-employment economy!
e. Hard to fire! Workers were very inefficient! Pretend to work, pretend to pay!
1. Low unemployment rates meant that unemployment benefits were low or nonexistent.
2. Companies try to hoard labor to be able to meet quotas.
f. Working Conditions in the former Soviet Union
1. 5 day workweek --- 40.6 hours
2. 15 days + in paid vacations
3. retire at age 60 for men, 55 for women
4. state provides free health care
g. distribution of income (no income from land or capital)
h. women in the labor force
1. very high participation
2. certain industries dominate
3. wage disparities
4. still shouldered most of the housework
5. results in a low birth rate!
i. Unions
1. an instrument of the Party --- no collective bargaining
2. enforce discipline
3. protect against arbitrary dismissals
4. run the social insurance fund
5. do have strikes --- some famous ones (coal in 1989)
6. compare to Solidarity in Poland.
7. Trade Autarky
a. exports were used only to pay for necessary imports
b. see foreign countries as the enemy
c. a trade central plan with trade done by specialized government agencies
So producers had no direct connection with foreign companies and there was no
relation between the domestic price and the foreign price
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d. Currencies were not convertible and foreign exchange was strictly controlled
e. Tuzak stores!
9. The Shortage Economy
a. Shortages were general, frequent, intensive, and chronic
b. Average waiting time for housing in the former Soviet Union was 10 - 15 years;
also long waits for telephone service and for cars (3 to as long as 17 years,
depending on the model and the country). Also health services, places in
educational institutions, and vacations in publicly owned vacation centers were
rationed
c. Led to Forced Savings --- a Monetary Overhang ---can appear on the market for
goods as demand at any time!
d. Yet some products are of such low quality that they cannot be sold, even in the
extreme shortage economy! A sellers' market!
e. Standard of living --- Handout
10. The Second Economy (Black Market)
A. Added about 25% to the value of goods and services sold
B. Examples --- Jeans, Construction, Handyman