How do the systems compare?

Legitimacy of Communist Party

• Rested on the following claims: 1. It was capable of ensuring internal /external security:

– based on record during WWII– government’s investment in military hardware and personnel

2. It was capable of “catching up and overtaking” the advanced industrial powers economically:– reported superior rates of economic growth– appearance of new industrial products and services

3. It ensured a greater degree of social justice than was possible under capitalism– availability of a range of welfare services– absence of unemployment or large disparities in wealth– assertion that socialism and central planning were a superior form

of economic organization to the market economy

• Military security of USSR questionable– Defeat in Afghanistan, 1979-88– inability of Soviet defence industry to match American production of

sophisticated weapons – growth of crime, decline of moral standards in public life

• Economic performance was inadequate– inability to match western production of new products or

fashionable consumer goods– reduction of economic welfare

• persistent and increasing shortages of food, housing, etc

• Greater social justice of socialist system was false– More info about welfare provisions in western Europe

• improved opportunities for travel, and tourism • spread of television

– Citizens learned more about privileges enjoyed by political elite – “Dissidents” challenged some of the myths of Soviet communism– Democratic changes in Eastern Europe

• Economic superiority of socialism was called into question, so was the Party’s right to rule

Soviet Crisis of 1980s

Cold War video link

1985 “Perestroika” – Restructuring

• No intention to dismantle the communist system, tried to make it work• Glasnost (Openness)

– freedom of speech, press less controlled– political prisoners and dissidents released – media exposed corruption within Communist Party – improvement in information access – public dissatisfaction more overt– democratization of daily life

• Acceleration of economic growth – investment burden even heavier, structural

disproportions intensified• Anti-alcohol reform

– Higher prices on vodka, wine and beer, sales restricted

– Lower revenues for state, larger black market – Supply side instead of demand side reform

• Campaign against “unearned income”

Gorbachev (1985-91)

Perestroika, 1985-91• Law on State Enterprises–Gosplan's responsibilities - general guidelines, not plans–Firms free to determine output levels based on consumer demand –Permitted to sell output after fulfilling state orders–Self-financing: cover expenses with revenues–Control over enterprise operations shifted to elected workers' collectives –Contractual relationships between enterprises

• Law on Private Economic Activity – Individuals allowed to work as private taxi drivers, own restaurants or repair

shops - private ownership of businesses –State employees permitted to form cooperatives to produce consumer goods

• Managers set up cooperatives• Cooperatives permitted to sell goods/services to SOEs for cash• SOEs have access to state funds – soft budget constraint• Repressed INFLATION!

• Joint Venture Law– Individual state enterprises permitted to conduct foreign trade–Allowed foreigners to invest in USSR

• Soviet partner supplied labor, infrastructure, large domestic market• Foreign partner supplied capital, technology, entrepreneurial expertise

Last chance for reform: why it did not work

• Not comprehensive enough– Firms were to respond to prices– Most prices remained controlled and

irrational– Firms could select inputs– Inputs were still allocated by

planners – No reforms in agriculture

• Complementarity of reforms– Firms were to contract with each

other– No legal system to enforce contracts

• Bureaucratic resistance– Officials still responsible for

enterprise achievements• Uncertainty

– No previous experience with private ownership, market prices

USSR 1991 : Neither central

planning nor market • Decentralization (elimination of central control over production decisions), discretion • Increased wages increased excess demand for retails goods• Budget deficit increased (G-T) to 30% of GDP– Tax revenues declined • Production of SOEs decreased• Harder to collect revenue, more opportunities to hide income

– Government spending increased• Consumer price subsidies continued• Increasing number of unprofitable enterprises needed state support • Gosbank issued more credits repressed inflation! more excess demand

an shortages• Balance of payments in deficit– Falling prices of exports (decreasing world oil prices) – Rising prices of imports (manufactured goods, imported food)

• High and rising foreign debt • Government lost control over economic conditions– Gorbachev—General Secretary of the CPSU - resigned from party

• Soviet Union broke up in December 1991

• US: fewer people live in cold climate area in 2005 than in 1950• Population of Siberia increased in 1960-80s – overpopulation

– World’s largest aluminum plant, huge dams and power plants, world’s longest railway line, military bases

– Some cities (Norislk, pop. 200,000) can only be reached by air• Costly: Cold and large distances

– snow removal on roads, railways and runways, heating and fuel; food; building and construction problems caused by the cold; emergency planning and weather services; health impacts

Mises and Hayek Economic growth in administratively planned

economy would be insufficient to improve well-being and sustain the system over time.

Inherent weaknesses:1.Requires massive amount of information –

the world is continuously changing2. Lacks information on what is

cheap/expensive - rational economic calculation impossible– No technical efficiency • Planners do not maximize profits and minimize costs

of production– No allocative efficiency • Prices do not convey information about scarcity,

opportunity costs, consumer preferences

Oscar Langer (1904-1965) Trial and Error Model

• State-run economy could be as efficient as a free market economy if : – maintain state control over production– use markets to find relevant prices and valuations – managers instructed to minimize costs– planning board adjusts producers' prices to eliminate

disequilibria in the markets for final goods – state ensures equitable distribution of incomes through

allocation of surplus (profit) from efficient production and investment in socially desirable planned development

• Other scientists: Danger of socialism is outside economics – Bureaucratization, police state – Free markets and absolute planning are both extremes– Need a proper mix of the two

Yes for Central Planning• Mobilization of labor• recruitment of unproductive agricultural labor,

unemployed urban labor into industrial workforce• labor training

• Capital formation• high rate of forced saving and investment to achieve

rapid growth and industrialization• Directed development

• ability to focus on high priority sectors• rapid growth of GDP

• Equal income distribution• Formation of new elite• Faster technological progress• innovation motivated w/o inducement of patent

protection• central control allows rapid diffusion of innovations

• Alleviation of market imperfections– externalities

• free market fails to produce socially optimal amount of education, air pollution, etc

• planning takes a social perspective– monopoly power• inefficiency of monopoly due to decision makers

placing firm’s interest over society’s• Economic stability

– price-wage stabilization• no wage-price spirals

– avoids capitalist volatility of investment spending– insulation from international business cycles– avoids stop-go fiscal and monetary policy

Yes for Central Planning

Adult literacy rate, 2005 Rank Country Literacy

1 Czech Republic 99.91 Georgia 99.91 Germany 99.91 United States 99.922 Estonia 99.823 Latvia 99.723 Poland 99.723 Slovenia 99.727 Belarus 99.627 Lithuania 99.627 Slovakia 99.630 Kazakhstan 99.530 Tajikistan 99.532 Armenia 99.432 Russian Federation 99.432 Ukraine 99.435 Hungary 99.335 Uzbekistan 99.338 Azerbaijan 98.838 Turkmenistan 98.8

Rank Country Literacy40 Albania 98.740 Kyrgyzstan 98.745 Bulgaria 98.246 Croatia 98.147 South Korea 97.952 Romania 97.353 Argentina 97.255 Cuba 96.955 Israel 96.959 Moldova 96.260 Republic of Macedonia 96.165 Bosnia and Herzegovina 94.681 China (mainland only) 90.9146 India 61.0

0-100 100-500 500 and moreWest Germany 14.1 23.9 62France 22.5 24.9 52.6Italy 32.3 27.3 40.4

GDR 1 11.1 87.9Czechoslovakia 0.1 3.4 96.5Hungary 4.5 16.3 79.3Poland 1.4 18.2 80.4

source: OECD data for West Germany, France and Italy are for 1987, and for the other countries are for 1989.

Focus on heavy industryGigantomania

Distribution of Employment by Enterprise Size

D

Pric

e

Quantity0

PfFIXED LOW PRICE

CEILING BYGOVERNMENT SHORTAGE

S (Communism)S’ (Market)

CENTRALLY PLANNED ECONOMIES: How can Capitalism reduce prices?

Pa

Pe

Black market raises prices

to Pa

Market

prices at Pe

Classical Socialist Economy (J.Kornai)1) Political power

– Monopoly by Marxist-Leninist Communist Party• unquestioned, coherent, self-legitimizing ideology, promise to help poor

economy develop faster while meeting basic needs and full employment– Party controls economy / society, intolerance for independent org’s

2) State ownership of the means of production – Conversion of capitalist firms (“commanding heights”) into SOEs– Collectivization of farmers, small producers

3) Bureaucratic coordination and management– Central planning, Vertical linkages of information flows, Poorly

defined objectives, SOE provides housing, education, food, etc to workers, Manager enforces state policy

4) Peculiar Incentives for firms, workers, consumers– Soft budget constraint , Plan bargaining, Poorly -defined, often irrational

targets, Weak price response, Ratchet effect, Seller’s markets, Investment hunger, Labor hoarding, Import hunger and export aversion, Misallocation of labor , Low morale, Shortage psychology, Risk aversion

5) Observable and characteristic phenomena– Shortage Economy, Capital-intensive large -scale projects, Poor quality,

Relative equality of nominal incomes, not access to desirable goods, Separation of science and product innovation, Erosion of human capital , Obsolete physical capital, Environmental ecocide (tragedy of the commons)