The Soviet Command Economy
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I. History
1.
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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:
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War communism (1917-1921)
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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
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small enterprises were reprivatized,
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reintroduction of the mkt for resource allocation
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some were restituted to former owners,
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
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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).
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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.
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After Khrushchev, Brezhnev, Andropov, Chernenko, Gorbachov
3. 1985-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 4the
reform effort.
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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III. The Soviet Economy:
1. 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.
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• The Legislature
– 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.
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2. Decision-making hierarchy —vertical structure
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The Soviet state operated through gov’t ministries and Communist party
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3. Mechanism for providing information
a) 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
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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
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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
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and goods)
– 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
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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
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– eliciting worker discipline, etc.
• 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
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– Resources allocated often turned out to be unavailable
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
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• 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
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• Resulted in huge, unspecialized enterprises using outdated technology
• 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)
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• 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.
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• 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
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4. Property rights
a) State Sector
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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:
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retail trade (70%)
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agriculture (50%)
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housing (75% urban, 25% rural)
b) Collective Sector
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Collective farms and consumer cooperatives, operated in rural areas
Formal ownership by members, but actual control by state
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a farm’s output planned by state
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output required to be sent to state
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prices set by state
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inputs set by state
workers’ wages set state
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Only to cover cost. Thus, each peasant’s share of net farm income would be
small, allowing for few purchases of consumer goods.
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
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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
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materials purchased from state
labor provided by household
friends
moonlighting construction workers
– Moonlighting permitted for
• Doctors; artists and craftsmen; construction workers
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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?
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a)
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
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b)
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
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workers paid money wages
money bonuses
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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
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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
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reflect political/ideological concerns
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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:
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Shortages, long lines, black-market activities, encouraging corruption and
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dilution of work incentives
Budgetary problem when many wholesale prices exceeded retail prices.
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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
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Gosplan and political leadership decide
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investment’s share of national product
distribution of total investment by industry and region
design of investment projects based on cost minimization
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true economic costs not minimized because prices do not reflect scarcity
7. Finance
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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
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Hard for enterprises to hide transactions
8. Foreign Trade —was a state monopoly
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Planning by Gosplan
Actual import and export operations carried out by more than 60 foreign
trade organizations (FTO) under the Ministry of Foreign Trade.
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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.
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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
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9. Labor market
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All able-bodied adults expected to work full time unless they were
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full-time students
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in prison
Free to find own jobs unless
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drafted in military
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on assignment in return for advanced training opportunities
Planners had variety of ways to channel workers into planned jobs
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system of differential wages
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control of occupational training
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By profession—higher educational institutions were directed by state
control; number of students and majors were determined by the state
placement services
residence permits
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Was used to influence the distribution of labor by region, season,
profession
It is an attempt to induce appropriate supplies to meet planned demands
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
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Labor market was subject to some frictional unemployment
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unemployment as workers look for jobs
There was evidence of some structural unemployment
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mismatch between skills and employment opportunities
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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
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A change in unemployment levels linked to cyclical econ. change
The price for labor was the wage, the demand for labor was primarily plandetermined. The households were free to supply labor.
Wage Structure
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Wages determined by several factors
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Occupation, e.g., engineer’s wages were double that of retail clerks, on average
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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
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Non Wage Income
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Interest from savings account
Second economy income (private plot, moonlighting)
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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.
Transfers
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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
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paid maternity leaves
survivor benefits upon death of spouse
sick leaves
child allowances
income supplements for the poor
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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.
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IV. Centrally-Planned Economy (CPE)
1. The objectives of a Centrally-Planned Economy (CPE)
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To built socialism as quickly as possible:
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Rapid growth in the econ.
Industrialization
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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
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State ownership—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
CPEs are pressure economies
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high rate of forced saving (no consumer goods)
planning of
• outputs
• inputs
• inventories
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•
CPEs are priority economies
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planning based on priorities reflecting
• political criteria and 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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Resources were channeled away from consumer into investments in
order to achieve a high investment rate
foreign trade suppressed
CPEs are shortage economies
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