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
1
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
2
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
3
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
4
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
5
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)
6
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
7
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
8
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
9
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
10
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
11
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
12
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
13
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
14
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
15
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
16
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
17
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
18
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
19
Command Economy:
Launching the Model

Super-industrialization favored the
teleologists that asserted the need for longrun 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
20
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
21
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
22
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
23
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
24
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
25
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
26
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
27
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
28
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 lastminute attempts to meet production quotas
29
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
30
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
31
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
32
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)
33
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
34
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
35
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
36
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
37
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?
38
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
39
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
40
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
41
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
42
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
43
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
44
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
45
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
46
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
47
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)
48
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
49
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
50
The Reform Cycle:
Gorbachev’s Revolution


Secessionist Movements
Decentralization of economic decision
making stimulated the nationalist sentiment of
individual republics and sped up secessionist
movements
The disintegration of the Soviet Union in 1991
and the rise of economic nationalism
fragmented the reform movement by diverting
it into the individual political realms
51
Legacies of Soviet Economy

State-planning for state-owned industries and demand structuring by
the state budget

State-determined monetary policy with a one-tier banking system

State-run monopolistic firms, producing a narrow range of goods at
state-administered prices and facing monopolistic suppliers

Risk-aversion by managers who were reluctant to innovate

Full-employment guarantee and as a consequence, the systemic
impossibility of firms going bankrupt- a soft-budget constraint policy

State monopoly in foreign trade, administered prices and exchange
rates reflecting the inconvertibility of the domestic currency

Fiscal revenues generated by turnover taxes and mandatory transfers
of profits used to subsidize firms
52
Problems with Legacies of Soviet
Economy

Monopolistic producers and risk-averse managers
lacked the motive to innovate

Full-employment guarantees hidden unemployment
and favor labor-intensive production processes

Domestic production is not exposed to international
trade and therefore, becomes non-competitive

State provision caused the creation of poor quality
of public goods
53
Slowdowns and Stagnations

Slowdown in growth rates from the mid 1970s

Economic stagnation in 1980s

Central planners’ inability to deal with a complex, overindustrialized economy’s need for constant adjustment

A succession of reforms failed to improve central
planning, was unsuccessful in questioning state
ownership

Late 1980s → legal recognition of private enterprise
ranging from introduction of cooperatives to individual
proprietorships
54
Collapse of the USSR
Establishment of Russian Federation

After the collapse of the USSR in December
1991, the Russian Federation faced the
demanding need for moving away from
Centrally Planned Economy

Boris Yeltsin, the first democratically elected
president of Russia, launched the sixth
reform to undo the legacies of Soviet model
55
Transition in Post-Soviet Russia:
Boris Yeltsin (1991-1999)

Destroyed of Communist Party’s monopoly politically
and economically

Failed to build a new pluralist society

Finished off the remnants of command economy
system

Yeltsin took great steps toward developing a market
economy:




Price liberalization
Mass privatization of state enterprises
Foreign trade liberalization
Introduction of full convertibility of ruble
56
Transition in Post-Soviet Russia:
Problems with Yeltsin’s Reforms

Price and foreign trade liberalization created high inflation and
decline in domestic production

Mass privatization was accompanied by political rhetoric,
contrary to the West’s economic emphasis on the fundamental
importance of private property for the institution of a market
economy

Voucher privatization forced negotiations in the regional
implementation of privatization

Several local elites succeeded in seizing formerly state-owned
enterprises

Local established elites continued to exercise their power
57
Transition in Post-Soviet Russia:
Problems with Mass Privatization

By the end of 1995, Russia had completed the privatization of
over 120,000 enterprises

55 percent of the large and medium-sized enterprises sold could
be classified as non-competitive worker-management buyouts

Labeled as destatization officially and grabitization informally

This mass privatization failed to improve economic efficiency and
induce normal market behavior

Instead generated effects of persistent arrears (non-payment of
outstanding liabilities) and sliding into a barter (non-money)
economy
58
Transition in Post-Soviet Russia:
Problems with Barter Economy and Persistent Arrears

The emergence of arrears due to the enterprises’ failure to keep
pace with collapse of demand in the short-run and to continue to
produce

The underdevelopment of banking system played an additional
role

Emergence of risk-free tax arrears and reliance on state
subsidies

Resurfacing of barter economy
 1960-mid 1980s → inefficient planned distribution
 Late 1980s-early 1990s → general shortages
 1992-1994 → enterprises’ financial deficits
 Starting in 1997 → institutionally built into system and accounted
for 90 percent of industrial output
59
Transition in Post-Soviet Russia:
Problems with Barter Economy and Persistent Arrears

Barter economy and persistent arrears (amount overdue)
locked regions into local transactions, hindered
competition and corrupted the effectiveness of property
rights

Privatization and price liberalization created income
inequality

State revenues, which consisted mostly of profits from
state-owned enterprises during the Soviet era dropped
as a result of the recession and mass privatization

Issuance of short-term state bonds that offered high
interest rates crowded out private investment
60
Transition in Post-Soviet Russia:
Deep Recession

Russian industrial production fell by 55 %

Consequently, tax rates were raised creating a shadow
economy

Budget debt increased

The rate of export dropped

The fall in oil prices magnified the current account deficit,
causing a financial crisis that resulted in the devaluation
of ruble in 1998

Severe economic instability and hyperinflation
61
Conclusion:
The Soviet Model of a Command Economy

Created by a combination of internal economic
underdevelopment and international political discontinuity in
the aftermath of WW I, when workers’ revolutions threatened
many nations

Designed to produce a transition from a relatively backward
nation to a modern industrial society

Central planning that is a superior tool for balancing economic
proportions and maximizing the use of resources, produced
disproportionate and inflexible economic outcomes

Producing many problems, agriculture being a prominent
example
62