Location in Russia, 1989 Population of Siberia and Far East: 37 mln (25% of Russia’s total)

Manufacturing employment: 1.8 mln (16% of Russia’s total)

Population • 1917: 10 mil• 2005: 40 milJanuary -60F• 80% of oil, gas, diamonds

precious metals

Location in CanadaPopulation: 85 000 (0.34% of Canadian total)

Manufacturing employment: 295 (0.017% of Canadian total)

Institutions ofCentrally Planned

Economy

Presidium

Council of Ministers

Ministries

Enterprises

State Agencies

Planning (Gosplan), Material Supply (Gossnab)Construction (Gostroy), State Security (KGB), State Statistics (Gosstat)State Bank, etc. State Pricing Agency

50 national ministriesMinistry of financeMinistry of transportationMinistry of heavy industryMinistry of educationMinistry of foreign trade, etc Responsible for executing plan Supervise enterprises in their domain Redistribute inventories, profits, production tasks, supplies between enterprises

All levels of governmentshadowed by the Communist Party

41,000 industrial enterprises27,000 construction22,000 state farmsState chooses managers to fulfill plans

Material Balance Planning: Theory

Plans for enterprises: output quantity targets, input allocations, suppliers, deliveries, financial flows, wage bills

Leonief’s input-output analysis (linear algebra problem)Linear relationship between quantities of outputs, material

inputs, and resources for each commodity: Aggregate supply (Production + Inventory + Imports) = Aggregate demand (Intermediate demand + Final demand + Export)

For example, for 3 goods: steel X1 + V1 + M1 = a11 X1 + a12 X2 + a13 X3 + Y1 + E1

cars X2 + V2 + M2 = a21 X1 + a22 X2 + a23 X3 + Y2 + E2pots X3 + V3 + M3 = a31 X1 + a32 X2 + a33 X3 + Y3 + E3

– Input coefficients aij = how much of input i is needed to produce one unit of output j

• PRICES are IRRELEVANT for PLANNING !• Imagine economy without prices

Functions of PricesIn market economy prices reflect:• Relative scarcities of goods/services

– scarce = expensive, abundant = cheap– signal from consumers to producers: what should

be produced In centrally planned economy:• Centrally set by Ministries for accounting

– To calculate of revenues, input costs, national product

• To obviate the need for rationing goods• Changed infrequently

– massive informational need complicates planning• Did not reflect relative scarcities

• housing in short supply, rents for apts low – equity– Misallocation of resources– cheap oil, natural gas, coal for industries– bread cheaper than wheat and animal feed

Prices• Industrial Wholesale

– Paid by state to enterprises for output– Cost of production + small mark-up

• average cost across all enterprises• included raw materials, depreciation, labor • did not include rent, interest, transportation• profits did not reflect enterprise efficiency – could be due to different location• Military sector charged lower prices for inputs– appeared more profitable than civilian sector

• Agricultural Procurement Prices– Paid by the state to farmers – “average cost + extra”

• if there are industrial consumer goods available for farmers– “average cost - extra”

• if farmers hold large idle money balances• Retail Prices

– Industrial (agricultural) wholesale prices + turnover tax• Tax set with some account for consumer demand, to clear market • Scarcity in the retail market is not communicated to producers!

Ideal plan would have to be… • Consistent

– balance between sources and uses of all resources and commodities

• Feasible– possible- resources and technologies actually

exist• Efficient

– planners cannot reallocate resources so as to increase one output without having to reduce others

– infinite number of efficient plans– Technical efficiency

• Plans maximize profits and minimize costs of production

– Allocative efficiency • Planned combination of goods and services best

satisfies the need of all consumers • Optimal

– one efficient plan most desirable from planners’ perspective

– solution to optimization problem

Planning in Practice1. Party establishes output targets for priority sectors2. Gosplan sets output targets for 200 major product groups, estimates input requirements

– may set percentage growth rates for strategic sectors 3. Enterprise managers report plant capacities to Gosplan thru ministries 4. Ministries and Gosplan bargain over quantity targets and input requirements5. Ministry disseminates control figures / input requirements to enterprises6. Enterprises bargain for input requirements with ministries7. Consistency of final target inputs and outputs is checked by Gosplan

If total demand exceeds supply, demand is cut or supply increased8. Final version of the plan is approved, numbers sent down to enterprises9. ratchet principle: Plan in year t = plan in t-1 + upward adjustment

Plan in constant state of revisionCommand, not planned economy!

Managerial Incentives• Rewards depend on plan fulfillment

– bonus 50% of salary for plan fulfillment– more for each % of over-fulfillment– Quality of output does not matter

• Non-material rewards– Promotion/demotion– Access to summer houses, car, better health care, shops for elite – Power, status, recognition, red banner

• Managerial incentives: • Understate enterprise capacity• Exaggerate breakdowns and repair time• Hoard inventories of outputs, inputs• Over-order inputs, labor, capital equipment • Minimize innovation to avoid delays• Use expeditors to overcome input shortages - bartered for supplies• Substitute inputs if unable to get inputs - use thinner sheet metal• Substitute outputs when unable to get inputs

– producing more small size shirts– include no spare parts

Principal-Agent ProblemManagers (Agents) know more about firms than a Ministry (Principal) • Asymmetric information

• Ministry: maximize social benefit– output quantity and quality

• Managers: maximize own rewards – Get a bonus

• Move managers between plants – to prevent misreporting– reduced “learning by doing” – encouraged short enterprise-level planning horizons (discouraged

investment in long-term projects)

• No incentive to innovate• no reward • output target will be raised• will receive lower price for output

Quality of Output

• Deterioration of quality along the chain of production

– sunglasses too dark for the brightest sun– rain coats that could never be unfolded– pairs of shoes -produce one size– glass planned in tons - make it thick and

heavy– glass in square metres – make it thin and

fragile– nails measured by weight – make heavier

nails

Shortages

When prices set too low, expect lines, black markets, bribes, barter

• No price signals about demand• Fundamental impact of shortages:

– lower labor force participation– lower work effort – higher savings– “monetary overhang” = hidden inflation

• Black market – Prices set in the market– Foreign goods– Domestic goods stolen from workplace

• Shortages – intentional?– Savings reinvested through state bank

into heavy industry

Money• One state bank Gosbank

– Provides of credit to enterprises– Holds all deposits– All financial transactions

• No credit cards• No checking accounts• Savings accounts paid interest• Wages paid in cash• No inter-enterprise lending• Credits from state to enterprises

in non-cash money– State Bank created new money by

authorizing enterprises to pay wages above cash reserves

– Janos Kornai: Enterprises faced “soft budget constraint”

– If enterprise fails to cover its costs, state subsidies prop it up

• No official inflation

Labor Supply1936 Constitution: Work in the USSR is a duty and a matter of honor for every able-bodied citizen, on the principle: He who does not work shall not eat. • Free to find own jobs unless

– full-time students – in prison– drafted in military– university grads: 2 year assignment

• Full employment:• >90% labor force participation among men and

women • Educational system prepared specialists according

to estimated demand, emphasized science and engineering

• Organized recruitment for new construction projects and agricultural harvests

• Unemployment on the job

Wages, Labor Mobility

• Pay scales reflected:– Education, skill– Occupation, priority of industry– Unpleasant or risky conditions

• Siberia, Kazakhstan, Central Asia• Mining, chemical industry

• Managers competed for workers by manipulating pay scales• 1931: Campaign against wage equalization• Limited labor mobility

– Internal passports with address registration – “Closed” enterprises– Labor books - record of employment history– Permission required to change jobs

• Enterprises responsible for social welfare functions– building and maintaining housing for workforce – managing health, recreational, educational, etc facilities

Industrialization

Chelyabinsk Tractor FactoryChelyabinsk Tractor Factory

MagnitogorskMagnitogorsk

• Capital allocation to investment projects decided in Moscow

• How to select best investment projects? • A steel factory or more housing?• A power dam or household

appliances or schools?– Capital is scarce– No markets to price capital, labor,

other inputs• Concentration on high-priority projects and

sectors • Construction of large plants to take advantage

of economies of scale

• 1930-40s: Soviet Union built hydroelectric power dams to generate electricity, no steam power plants

– despite their huge capital intensity of dams and high opportunity cost of capital

– switched to steam in 1950s

Private sector- Legal Activities

• Private plot of land– 1/2 to 3 acres– employ household labor, tools, small equipment– sell produce on collective farmer’s market– animal husbandry

• In 1965 private sector supplied – 40% of all milk and meat consumed – 67% of eggs – 40% of fruit and vegetables (incl. potatoes)

• Individuals could own – savings account at the State Bank– government lottery bonds– domestic currency– a car

• Sale of personal property, flea markets• Housing construction

– 1/5 of new housing construction private– materials purchased from state– labor provided by household and friends– moonlighting construction workers

Private sector- Illegal• Tolerated

– Moonlighting for doctors, artists, craftsmen, construction workers

– Private production on the job, taking advantage of official position

• Prohibited strictly– Use of socialist property for personal gain– Theft from the state, corruption, bribes– Buying and selling for a profit (speculation)– Hiring other than household help– Holding foreign currency– Lending at interest – Renting apartment– No Property mkts– Renting a car from another individual

Mormon Comparison(by Barry Ickes)

– Collectivist– Mobilizational– Centrally planned– Command-managed– Redistributional – Sense of encirclement– Holistic vision of utopia– Totalitarian leadership – Primacy of collective over individual– Hostility to speculation, private initiative– Isolation– Property owned by church/state– Prices as accounting devices– Economy demonetized– Frequent reforms

• Key differences– Voluntary, not coercion– Building on virgin soil

Phenomenon: Homo Sovieticus

Mentality evolved in society where vast majority of people

• did not own anything• all private enterprise forbidden• control of bureaucracy • nearly all commodities scarce• isolation from world culture

Main attitudes of Homo Sovieticus :• Indifference to results of his labor: "They pretend

they are paying us, and we pretend that we are working"

• Lack of initiative, creativity and responsibility• Indifference to common property - petty theft from

workplaces

Problems with Material Balance Planning

• Final demand combinations determined by preferences of planners, not consumers.

• Extremely high information needs– very slow to adapt to technological change, new

circumstances• Data collection• Plan does not allow for substitution between inputs

(or outputs) due to scarcity• Input shortages or unmet targets propagate into

more simultaneous shortages and surpluses.• Efficient allocation and distribution not even

considered as a goal of the system• Little attention paid to managerial, worker

incentives.

USSR, Inc. • Soviet economy as a single corporation• The corporation owns a large stock of natural resources • Enterprise profits are social dividend

– Citizens = shareholders– no outside shareholders so that all "profits" can be retained for

investment• Hires labor

– monopsonist labor market, USSR Inc. can minimize the expenditure on labor

• Transactions between enterprises are merely transfer prices between "divisions." – The exceptions are purchase of labor and engagement in foreign trade.– Transfer Prices =prices used in transactions between parts of USSR Inc.

are not terms of trade– => no need to equal opportunity costs.– Transfer prices record activity, they do not motivate– Agents are executants of orders from above– Transfer prices could be randomly assigned without changing behavior

• But arbitrage opportunities could arise