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Gorbachev's Economic Agenda:Promises, Potentials,and Pitfalls

An Intelligence Assessment

Gorbachev's Economic Agenda:Promises, Piitials,and Pitfalls

Key Judgments Since coming to power, Mikhail Gorbachev has set in motion the mostaggressive economic agenda since the Khrushchcv era. The key elementsare:• A reallocation of investment resources aimed at accelerating S&T and

modernizing the country's stock of plant and equipment.• A revitalization of management and planning to rid the Soviet bureau-

cracy of incompetence and petty tutelage and put more operationalcontrol of enterprises in the hands of managers on the scene.

• A renewal of Andropov's anticorruption and discipline campaigns,coupled with a new temperance campaign, to increase and perhapsimprove worker effort.

All of Gorbachev's initiatives are aimed at raising productivity andefficiency throughout the economy by matching more and better equip-ment with a motivated work force and an enlightened managerial cadre.He has put his finger on the very tasks that the economy has never donewell and has become progressively less able to do as it has grown in size andcomplexity.

Although Soviet economic performance has improved in recent years fromthe low levels of 1979-82, Gorbachev still faces an economy that cannot si-multaneously maintain rapid growth in defense spending, satisfy demandfor greater quantit y and variety of consumer goods and services, invest theamounts required for economic modernization and expansion, and continueto support client-state economies. Gorbachev, in our view, has a clearunderstanding of these limitations; he is obviously extremely impatient thatthey be addressed now.

Soviet officialdom probably was caught offguard by Gorbachev's sweepingcondemnation of past economic policies, particularly considering the recenteconomic rebound, and was surprised that he apparently was ready to takeaction so early in his tenure. Despite the urgency of his rhetoric, he seemsaware that implementing his programs too rapidly carries substantialeconomic and political risks:• He has prepared the party and bureaucracy for substantial change by

bluntly laying out the need for management reorganization and renewal,but has yet to provide specific details on controversial issues that wouldprovide a basis for organized resistance.

• He has moved agg ressively to replace old-line economic managers buthas yet to replace Council of Ministers Chairman Tikhonov, regarded bymost Soviets as a major political obstacle to economic change.

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eptetn r 1915

Itiformatioa availableal of 6 September 1985was used in this report.

• He has talked about the potential need for "profound" changes in thearea of economic reform, while strongly supporting the need to maintain

central control.

Program specifics will be announced by next February along, we judge,with Tikhonov's replacement. It is unlikely that they will contain anyradical departures from what Gorbachev has alread y announced. At

present his game plan seems to be a realistic assessment of what can bedone in the short run while planning and developing a consensus for more

radical change over the long haul if.he deems that it is needed

Success with the initial stages of Gorbachev's program could provide arelatively immediate growth dividend that could be used to bolster workermorale and underwrite future growth. flow much economic improvementwill occur and how long it can be sustained, however, is very much an openquestion. Modernization is slow by nature in any economic system and inthe Soviet case will run into the perennial conflict between meeting outputgoals and reequipping enterprises with new equipment and technology.Streamlining the bureaucracy will be resisted by countless officials whosejobs and perquisites are threatened, and a new set of incentives must be in-stituted to motivate a new type of Soviet mana ger. Discipline campaigns

can go only so far in energizing a cynical work force.

Gorbachev will be hard pressed to find the resources necessary tounderwrite his modernization goals. The economic dividend from manage-ment reforms and the discipline campaign will not substantially relieve thebasic scarcity of resources nor obviate the need for fundamental systemicchange:

• Improving worker morale and management effectiveness will require an

effective incentive system and a greater availabilit y of high-quality

consumer goods at a time when the investment sector will be oriented to-ward producer goods and new defense programs will be coming on line.In fact, Gorbachev's investment program implies a potential decline ofsome 60 percent in the investment increment going to consumer-orientedsectors.

• The regime's plan to hold energy's share of investment constant comes at

a time when demand for energy will grow and the cost of offsettingdeclining oil production will be rapidl y rising. If the requisite investment

is not forthcoming, the current decline in oil production could becomeprecipitous.

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• The increased managerial independence necessary to spur effective

technological development and utilization is inconsistent with a centrallyplanned pricing and allocation system, leading to the likelihood ofmanagement disillusionment and subsequent reversion to the verymethods that have led to waste, fraud, and mismanagement for years.

Gorbachev could employ various options to address these issues, but allcontain serious pitfalls. East European countries could be ordered toshoulder a larger part of the economic burden, including increased exportsof equipment to the USSR, but their own deep economic problems increasethe likelihood of confrontation between Moscow and its allies. A drive toincrease imports of Western technolog y would come at a time when theprospects for expanding hard currenc y exports, particularly oil, look dim. Ashift of resources from defence tc, civilian uses could hare considerablennsitive impact over the lon g run, but even the suggestion of such a shiftmig ht denim Gorbachev's relations with the military and risk deepdivisions within the Politburo. Finally, major economic reforms to promotemanagerial effectiveness would encounter strong resistance on political andideological grounds, particularl y since they threaten the institutionalprerogatives and thus the privileged position of the Soviet elite.

Indications that Gorbachev has decided on and gained consensus for moreradical changes could include:

• New, dramatic initiatives to reach an accord at Geneva and concreteproposals for reduced tensions at the November meeting between the USPresident and the General Secretary, which might signal a willingnessand desire to reduce the Soviet resource commitment tn defense andcreate an atmosphere for expanded commerce with the West.

• Select legalization of private-sector activity, particularly in regard toconsumer services, which would indicate a willingness to confront pasteconomic orthodoxy in order to improve consumer welfare and therebyeconomic performance.

• Breaking the monopoly of the foreign trade apparatus, which wouldsignal an increased reliance on managerial independence at some cost tocentralized control.

Continued reliance on marginal tinkering despite clear indications that theplan for economic revitalization is faltering would indicate that Gorbachev,like Brezhnev before him, has succumbed to a politically expedient buteconomically ineffective approach.

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Gorbachev's Economic Heritage The Gorbachev Agenda

Accelerating S&T ProgressRestructuring Investment

Reorganizin g Management and PlanningTightening economic Discipline

An Integrated Approach Favorable Short-Term Outlook

Contents

Key Judgments

Long-Term UncertaintyProblems Facing Industrial ModernizationRevitalizing Management Dealing With Finite Resources

A Rocky Road Ahead

Gorbacliev's Economic Agenda:Promises, Potentials,and Pitfalls!.

Gorbachev's Economic Heritage

In March 1985 Mikhail Gorbachev inherited a tech-nologicall y backward economy that had experienced adecade of slowing growth punctuated by harvestfailures, industrial bottlenecks, labor and energyshortages, low productivity, and declining efficiencyof investment (see figure I). The simple growth formu-la that had propelled the USSR to a major worldpower in the postwar era —ever-increasing inputs oflabor and capital resources—by the mid- 1970s was nolonger effective.IIIII

During the 1950s, this growth formula resulted inrapid gains in output because of the very low level ofGNP in the earl y Postwar period and the relativelyhigh efficiency of new fixed investment in reconstruc-tion and repair of war damage. As the USSR movedout of the reconstruction phase in the 1960s, however,highly effective investment projects became moredifficult to identify, and centralized planning andmanagement of a burgeoning economy became morecumbersome and inefficient. Unable to improve theirability to deal with an increasingly complex economy,Soviet leaders had little choice but to sustain the largecommitment of resources to investment if economicgrowth was to continue apace. In addition to main-taining larger annual flows of investment, Sovietplanners have swelled the expansion of plant andequipment by:• Holding retirement of equipment to a minimum.• Prolonging the service lives of technologically obso-

lete capital through repeated extensive repairs.• Continually expanding new construction projects,

thus channeling the bulk of investment into build-ings and structures rather than into new equi2mcnl,the principal carrier of new technology.

Sustaining a high level of increase in total capitalassets by these methods enabled the Soviets to achievehigh rates of growth and to support an enormousdefense establishment, but also impeded technologicalprogress and productivity gains. Efforts to increasethe quality and quantity of output and make better

use of available resources in the economy continued tobe frustrated by a backward technological base, in-flexible production processes, and, perhaps most im-portant, a cumbersome and inefficient system ofplanning and management.

These problems were well understood by Gorbachev'spredecessors. Rhetorically at least, Brezhnev recog-nized that in the future the economic system wouldhave to operate differentl y if it was to meet the needsof the Soviet polity and society. Various CentralCommittee and Council of Ministers' decrees werepromulgated to address these problems, but Hrezhnev

in his wanin g years lacked the energ y and politicalwill to follow through on his diagnosis. As a result ofthis administrative lethargy and the endemic natureof many of the problems facing the Soviet economy,Brezhnev's successors were saddled with:

• A technolog icall y antiquated industrial base and aburdensome defense sector that has systematicallysiphoned oil' high-quality resources needed for eco-nomic revitalization.

• An energy sector beset by stagnation and decline inproduction of its major fuel—oil—and a 30-yearpattern of energ y use that inhibits the rapid transi-tion from oil to other fuels.

• A level of technology that generally lags that of theWest. Even in military applications, the Sovietshave encountered technological problems in recentyears that are sharply driving up costs and delayingnew sophisticated weapon systems, thus creating afurther drain on available resources.

• An inefficient farm sector that despite large invest-ments still employs one-fifth of the Soviet laborforce, is bereft of an adequate storage and transpor-tation system, and is unable to produce grain andmeat in sufficient quantities to meet rising domesticdemand.

Combleell Pruducolvily ofLoad. Labor. owl Coplial

Caplis ComNimp1461

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1066•70 71-73 WV 11-14 u 116640 71-71 76-10 11-14

Pew t

GNP

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INdintrldl Prudwalun

10

Figure 1USSR: Key Economic Indicators,Average Annual Growth Raies

• A hidebound bureaucracy whose rigidities contrib-ute to irrational investment decisions, retard scion-aft-technical innovation, and eiii ge high Costs

and massive waste of resources.

Moreover, by the end of the Brezhnev era, a growingmalaise had spread through much of the work force,not only because gains in living standards had slowed,but also because workers believed that the system wasincapable of bringing sny meaningful improvement.This attitude—reflected in the rise of alcoholism andrelated health problems—exacerbated the corruptionand ineMciency that had permeated the Soviet eco-nomic bureaucracy from farmhand to factory workerto the ministerial superstructure. Workers and man-agers alike /spent increasin g amounts of time andeffort trying to insulate themselves—often throughillegal means—from the effects of shortages in boththe home and factory. This reduced productivity onthe job and promoted greater shortages of goods andservices throughout the economy, especially for indi-viduals aiirprises with little or no "specialaccess."

While Andropov's ascension to power gave a glimmerof hope for change, his tenure Was too short and hehad too little personal energy to reverse the decades ofabuse and mismanagement tolerated by his predeces-sors. Anticorruption and discipline campaigns stimu-lated some improvement in economic growth butmade only minor ripples across the surface of thedeeply entrenched system of planning and manage-ment. Chernenko, for his part little more thanlipservice to these initiatives.

The Gorbachev Agenda

When Gorbachev came to power, many Soviet offi-cials—except those of the old guard, who felt threat-ened—had high expectations for a vigorous revival ofAndropov's anticorruption and discipline programs, aswell as a stepped-up pace of personnel change. But,with economic growth having recently acceleratedfrom the unusually slow rates of 1979-82, manyprobably felt that he would avoid sharp changes inresource allocations.

Gorbachev 's Hit List

Gorbachev has made it clear he intends to overcomeentrenched resistance to his domestic programs bycleaning house:• He has named eight new economic ministers since

coming to power, including those In charge of oiland steel production.

• He has replaced three Central Committee depart-ment chiefs who oversee the machine-buildin con-struction, and trade and services sectors.

In addition, he has supervised an extensive turnoveramong regional party first secretaries—who play acritical role in implementing economic policies, arespokesmen for local economic interests, and act asfacilitators in overcoming economic bottlenecks. Al-ready over 20 such officials have been appointed,nearly one,p week since Gorbachev came to power,and more changes are likely during the party elec-tions that will precede next February's party con-gress.

Gorbachev probably also has other high-level changesIn mind:

• Reports persist that he intends to retire PremierTikhonov at the congress or perhaps even sooner.Some Soviet officials claim that Gorbachev might

take the job himself, while others indicate that hewill give it to a close ally like . RSFSR PremierVorotnikov or party secretary Ryzhkov.

• Several Soviets have strongly implied that StatePlanning Committee Chairman Baybakov is on thehit list, and Gorbachev indirectly criticized him inJune for undermining an economic experimem be-ing implemented in major industrial sectors.

• Gorbachev may also want to go after the remainingdozen or so top economic officials who have been

• around since the beginning of the Breshnev era.

He has already shown his intention to reassert partycontrol over the vast economic bureaucracy, whichhad grown accustomed to Breshnev's benign neglect.The firings solar have probably sent an unmistak-able message to economic officials that they must toe

iithe airk or face disgrace and forced retirement.

Gorbachev, however, has taken little solace in recenteconomic improvement; by all indications he realizesthat long-term gains will require solving endemicproblems that for the last decade have prevented theeconomy from simultaneously sustaining:• Continued rapid growth in defense spending that

had proceeded unabated since the mid-190s.• Greater quantity and variety of consumer goods and

services demanded by an increasingly discriminat-ing population.

• Rapid growth in investment goods for economicmodernization and expansion.

• Increased support for client states whose own econo-mies are coming under increasing strain..

In little More than five months, Gorbachev has dem-onstrated that he is the most aggressive and activistSoviet leader since Khrushchev. He is taking power by

virtue of his strong, assertive personality and byaggressively inserting his own cadre into key positions.Moving forcefull y to place his personal stamp oneconomic policy , Gorbachev has repeatedly told man-agers that they must change the way they do businessor "get out of the way":

• He has assailed managers by name for lack ofinnovation, laziness, and poor management and hasstrongly implied that they will be removed. He hasattacked the complacent attitude toward corruptionwithin the part y bureaucracy and called for promo-tion of younger and more competent officials at alllevels. While such rhetoric is not new in itself, hehas already underscored his intention to back up histough rhetoric with dismissals (see inset "Gorba-chev's Hit List").

• lie has returned for revision the centerpiece of theplanning system's raison d'etre, the draft five-yearplan, demanding specific changes—so far unspeci-fied—in the planncd pattern of resource allocationsfor 1986-90.

Gorbachev is determined to deal with the economy'sunderlying problems. He has thrown down the gaunt-let on issues as controversial as the allocation ofinvestment, broad-gauge management reform, and acomplete purging of incompetent and corrupt officialsfrom the system. While the details of his economicgame plan probably will await the new draft of the12th Five-Year Plan (1986-90) to be announced at the27th Party Congress in February 1986, the broadfeatures of his program are already emerging. All areaimed at raising productivity and efficiency through-out the economy—something the system has neverdone very well and has become prog ressively less ableto do as it has grown in size and com plexity. He hascalled for annual growth in national income of at least4 percent. If this plan were achieved, growth in realGNP as measured in the West would also amount toan increase of about 4 percent per year—a healthyincrease above the good performance of 1983-84 (seeinset "Measuring Soviet Economic Growth"). Heplans to achieve this goal by pursuing an ambitiousstrategy for modernizing the economy's stock of plantand equipment and by raising the level of effort andsense of personal es nsibility of managers andiiiioworkers alike.

Gorbachev personally has provided a pointed exampleof how critical a substantial improvement in produc-tivity and efficiency is to his entire program. In hisJune speech to a special science and technolog y (S&T)conference, the General Secretary indicated that anadditional 8-10 million people in the labor force andan average annual growth in investment of 5.5 to 7percent during every five-year period would be re-quired to achieve his goal of 4-percent annual growthin national income in the absence of a substantialIncrease in the combined productivity of land, labor,and capital. Both he and his audience probably wereaware that less than 4 million people will be added tothe labor force in 1986-90 and a 5.5- to 7-percentIncrease in the rate of growth of investment would put

Measuring Soviet Economic Growth

The principal conceptual difference between GNP andSoviet reported national income is the latter's exclu-sion of (I) most personal services as well as servicesprovided by the government (for example, health,education, housing, personal transportation and com-munications, recreation and personal care, govern-ment administration, credit and insurance, researchand development, and military personnel costs) and(2) depreciation on fixed capital. However, officialSoviet statistics on growth of national Income over-state real growth, because they do not allow properlyfor inflation. The CIA index of GNP, which attemptsto correct for these differences, has shown real growthto be about I percentage point lower than reportedstatistics on national laconic. Moreover, Soviet plandata, such as Gorbachev's 4-percent-growth target,unlike officially reported achieved rates, are notdistorted by inflation.

severe strains on the other resource claimants—de-fense and consumption. They also probably recog-nized that productivit y increases will not be easy—growth in combined productivity of land, labor, andcapital hasp consistentl y negative for the lastdecade.

To help address these issues, Gorbachev has appointedseveral economic advisers who have long advocated amajor overhaul of the economic system: substantialincreases in investment in machine building, changesin the incentive structure, a greater role for privateactivity, and more devolution of authority and person-al responsibility to enterprise managers (see inset"Reform-Minded Economist Advising Gorbachev").The ascent of such reform-minded economic advisersto policy-level positions is a signal of Gorbachev'scommitment to finding ways to make the system workbetter. At present these include accelerating S&Tprogress, restructuring investment, implementingmanagement reforms, and tightening discipline. (c NF)

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Reform-Minded Economist Advising Gorbachev

The prominent and controversial economist AbelAganbegyan has become an influential informal ad-viser to General Secretary Gorbachev. The longtimedirector of an economic institute in Novosibirsk, herecently moved to Moscow to head a committee of theAcademy of Sciences. Aganbegyan has a history ofinvolvement in controversy with conservatives overhis criticism of the workings of the economic system.Several changes he has proposed, which includeaccelerating the modernization of industry throughretooling and a streamlining of the Moscow-basedbureaucracy, have become major themes in Gorba-chev's recent speeches on the economy.

Aganbegyan's new status is another indication OfGorbachev': intention to shake up the economicestablishment. Al 32, Aganbegyan's ties with Gorba-chev date back to Moscow University days in the19505. As an adviser to Gorbachev, he is likely toreinforce the party chiefs determination to look foriiiinew a ro hes to economic planning and manage-

ment.

There have also been indications that Tatyana Zas-lavskaya, a well-known sociologist and close col-league of Aganbegyan, may now have a stronger voiceIn the academic community, if not an advisory role inthe government. In a recent interview In lzvesti ya, shereiterated arguments originally made about the inap-propriateness and ineffectiveness qf the centralizedeconomic system In a confidential document that wasleaked to the Western press in April 1983.

Accelerating S&T ProgressGorbachev views a modern, efficient industrial baseas crucial to the success of his economic program. Aspecial conference was held in June to develop acomprehensive strategy for accelerating technologicalprogress. In addressing the conference, Gorbachevfocused on the need for the rapid introduction of newproduction technology, insisting that the Soviet Unionmust launch a revolutionary program to reequip itsfactories and farms with the most up-to-date machin-ery. He recognizes that acceleration of SALT progress

depends critically on the success of other elements ofhis strategy . As he pointed out at the conference:

• In carrying out the SdT revolution, the command-ing key role belongs to machine building. . . . Firstand foremost, machine building itself must bereconstructed. . . . In the years 1986-90, capitalinvestment for the civilian machine-building minis-tries should be increased by 80 to 100 percent.

• The acceleration ofSd 7' progress insistently de-mands a profound reorganization a the system ofplanning and management. ... Without this, every-thing we are ta k 'ng about today may remain but afond hope.

Restructuring InvestmentGorbachev recognizes that his call for acceleratedtechnological progress is only possible with a majoralteration in investment priorities. Currently, 30 to 40percent of all Soviet equipment has been in operationfor more than 15 to 20 years. By 1990, Gorbachevdeclared, one-third of the fixed capital stock—includ-ing one-half of all machinery—must be "new." Heurged that special priority be given to the "develop-ment and introduction of fundamentally new systemsof machines and technologies" and called for a 50-percent increase in expenditures for retooling existingenterprises finance in part, by a cutback in newconstruction.

In his June address, Gorbachev accused the StatePlanning Committee (Gosplan) of paying "verbaltribute" to the role of civilian machine building whilecontinuing to starve it of resources and suggested thathis call for nearl y doubling investments for this sectorin the 1986-90 period could be achieved by the partialredistribution of capital investments from the indus-tries that use the machines. This "suggestion" waspresaged in a particularly forceful statement in aspeech to an ideological conference last December,where Gorbachev insisted that the longstanding prac-tice of allocating economic branches the same proporslions of new investment from one plan to another mustbe "changed decisively."

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In this context, Gorbachev hinted that the need tosupply additional resources to machine building mightaffect the priority status of two of the biggest claim-ants on investment resources, energy and the ugro-industrial complex:• He suggested that the share of investment in energy

could be "stabilized" by giving greater attention toconservation.

• He indicated that the present level of investment inthc agro-industrial complex is adequate and that itis the return on this investment that continues to beunsatisfactory.

He has not addressed how other major claiman s oninvestment—such as defense—will fare.

Reorganizing Management and PlanningGorbachev has been particularly critical of intermedi-ate management bodies that choke off initiative andhas hinted that they should be streamlined or elimi-nated. His aim is to rid the system of some of themassive bureaucratic apparatus whose petty tutelagein implementing Central Committee decisions defeatsthe purpose of the decisions.

The level of specificity in his June speech in Dnepro-petrovsk suggested that plans for such a reorganiza-tion have now reached an advanced stage and willinclude the creation of superministerial bodies, start-ing with agro-industrial and machine-building sectors.His speeches also suggest that these superministrieswill be restricted to "strategic" planning and leaveoperational control of enterprises in the hands of themanagers on the scene.

Gorbachev's first move to give greater operationalindependence to enterprise managers was to expandthe economic experiment, begun in January 1984,giving enterprises greater control over investment andwage funds and making fulfillment of contractualsales obligations the prime indicator for evaluatingenterprise performance (see inset "Managerial Initia-tives"). He has also implemented a far-reaching ex-periment at the Tol'yatti Automotive Plant that in-creases the plant's authority for its own managementand for making purchase and sales a greements withforeign firms, without the direct participation of theministries or foreign trade associations.

Gorbachev has also endorsed Brezhnev's 1982 FoodProgram, which, as party secretary responsible foragriculture, he helped formulate. In this connection,he has supported increasing the authorit y of theregional agricultural production associations(RAP0s)—an innovative form of administration thatcuts across ministerial lines and concentrates author-ity at the local level for coordinating the activities offarms, agricultural service agencies and processingenterprises in a given district.

Tightening Economic DisciplineGorbachev is banking on improved worker effort toimmediately bolster economic growth. Because heneeds the support of both managers and workers, hehas appealed directly to them to buy into his program.He has pledged to increase both the material rewardsfor good performance it4 the, penalties for violationsof economic discipline.

Much of Ciorbachev's campaign for improved workereffort, however, will rest on the more vigorous imple-mentation of programs initiated before his tenure.These include:

6 Improving labor productivity by reviving the disci-pline campaign, which Andropov initiated but whichflagged somewhat under Chernenko. Gorbachev hasalready initiated a vigorous antialcoholism cam-paign that is serving as a daily reminder of the newleadership's seriousness and intensity in attackingproblems of both a social and economic nature.

• Tying workers' earnings more closely to their out-put, through greater differentiation of wages andexpanded use of contract brigades—small groups ofworkers whose earnings depend on fulfillment ofcontractual obligations to management".

An Integrated Approach

On balance, Gorbachev's game plan reflects an appre-ciation of what we and many Soviets believe to bemany of the economy's fundamental problems. More-over, he recognizes that all elements of his program

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7

Managerial Initiatives

The Soviets have announced a major expansion of theexperiment in industrial management that began on 1January 1984 in five all-union and republic-levelministries and was extended this year to 20 addition-al ministries. The experiment will extend to allmachine-building ministries and many consumer-related industries in 1986 and to all qf industry in1987.

The experiment's aim Is to improve the centralplanning and management system by reducing thenumber of success indicators used to evaluate enter-prise performance and by slightly increasing theenterprise's limited control over wage and Investmentfunds. The decree to expand the experiment presentsmeasures to improve prodnct quality and furtherincrease enterprise control over plant operations:

• Enterprises of the machine-building sector produc-ing products judged to be cif highest quality will beable to increase their earnings by raising prices upto 30 percent. Enterprises producing lower qualitygoods will have to cut prices by up to 30 percent andthen reimburse the state for lost revenue withmoney takenfron: their worker and manager bonusfunds.

cannot be implemented immediatel y and simulta-neously across the economy. The centerpiece of hismodernization strategy, replacing the economy's stockof machinery and eq uipment and improving manage-ment techniques, will require years of effort. Never-theleu, Gorbachev probably feels that, unless hestarts now in earnest and maintains constant pressureon his economic managers, the future will continue tobe hostage to indecision and inaction..

Gorbachev, in essence, is proposing an Integratedapproach for the resurgence of economic growth (see

fi gure 2). Anticorruption and discipline campaigns are

• Enterprises will have increased authority to spendlimited amounts of investment funds at their owndiscretion for industrial renovation and for con-struction a housing or other consumer-related un-dertakings. The state planning and supply organshave been instructed to give such projects priority,

• Penalties for delays, nondelivery, or delivery qfinferior goods will be increased, and rewards fortimely provision atisfactory products will beImplemented.

Moscow has also announced a managerial reorgani-•Won program—described as a model for the rest ofthe economy—for the Ministry of Instrument Manu-facturing (Minpribor). The program includes:• Eliminating the management level that lies between

the enterprise and the ministry.• Creating additional scientific production associa-

tions to spur RdD and prototype production.

aimed at reducing worker apathy, which, togetherwith the attendant massive waste and theft of re-sources, have held down growth in productivitythroughout the economy. Some success here, alongwith some redirection of investment resources, fewerlayers of bureaucratic tutelage, and a more equitablesystem of rewarding productive workers and manag-ers, is geared to provide a growth dividend that can beused both to bolster worker morale (via more andbetter consumer goods and services) and to underwrite

Jr

Strengthen defenie

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Production dividendMore output of SOUdiand tamesMore machineryReiter machinery

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Reward productive workersand menage/1Higher consumption

Rime investment growth

—10 Increase morale endpride in work

activity

Improve quality Modernise capital stockStimulate innovation

adorn'Conserve resources

prier4,purm

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Figure 2Gorbachev's Growth Strategy

— Announced initiatives or intentions- - Potential future initiatives

Anihoiluploon.tempetsme. andJonspline

Raised productivity:More hours, greater effort,and less theft

Streamline Reform wage Clf111:1111C tic Ku () olawnsmanagement structure and investment closer tolrnsluctionand planning towers indlcatio, Improve ftA()

8

further growth. Gorbachev appears to be countingheavily on a synergistic effect among the several partsof his program to provide even greater dividends inthe years ahead, returning the economy to an upwardgrowth path and, perhaps, providing him with justifi-cation for future fundamental changes in the central-ized control of the economy, if needed.

Gorbachev's strategy is not without substantial eco-nomic and political risk, particularly as he is seekingto change an economy that has recently been on theupswing. In public statements, Gorbachev has so farfocused on the general themes of his economic pro-gram rather than on specific measures that couldgalvanize opposition. lie may well have decided torefrain from translating vague expressions of supportfor controversial measures into specific proposals untilhe has more fully formulated his plans—in part byencouraging public dialogue and selectively testingsome options—and consolidated his political strength.lie has not openly challenged the legitimacy of cen-tralized economic control, including such fundamen-tal obstacles to the success of his program as thearbitrary nature of Soviet prices that prevents plan-ners from making economically rational decisions, orthe lack of sufficient consumer input into roduc odecisions

or •c ev s current approach ne ofrst adopting noncontroversial economic measures

while simultaneously working on a long-range andmore far-reaching program. Gorbachev may be re-fraining from more radical measures because he hopesthat the steps he has already proposed will be suffi-cient to remedy the economy's Ills,

Whether he will be able to achieve his economic goalsin the absence of additional, bolder changes—movestoward market socialism, for example—is problemati-cal. There have been hints in Gorbachev's past andrecent speeches and in the Statements of some knowl-edgeable Soviet officials that he MAY eventuall y bewilling to make such changes. In his Lenin Dayaddress in April 1983, for example, Gorbachevstressed the importance of g reater reliance on pricesas an economic lever. He returned to this theme in hisJune 1985 address to the SttT conference, calling forA more dec isive shift from administrative to economicmethods of regulating the econom y. In the sameaddress, he also called for an end tisie dominationof the consumer by the producer."

There is also growing evidence that Gorbachev favorsan expanded role for private initiative as a way ofalleviating consumer problems without much addi-tional investment or change in the way the socializedsector is organized and managed. In the past, Gorba-chev has been a staunch suppotter of expandingproduction on private agricultural plots, and, in hisspeech to the Central Committee plenum in April, hetwice referred to the contribution that the privatefarming sector can make to improving the quality oflife. In MaY he returned to this subject in a speech inLeningrad and expressed disagreement with the Polit-buro's recent handling of the issue. lie contrasted thePolitburo decision to earmark land for an additional1 million private market gardens with Soviet citizens'

„requests for some 15 million new plots. "Mathemati-cally," he noted with evident sarcasm, "our approachto this problem is fundamentally weak."

Gorbachev's remarks in Leningrad also lend credibil-ity to earlier reports that he favors the more contro-versial policy of allowing a greater role for privateinitiative in the service sector. He called for a "morerealistic evaluation" of the major role "moonlighters"currently pla y in providing such services as homerepairs and seemed to suggest that the state shouldnot just tolerate such activity but should activelysupport it. Materials used, he said, are generallystolen and "come from the state anyway." In thiscontext, hvesriya acknowledged in August that illegalprivate services are too widespread to stamp out andcalled for their le lization under contract to stateenterprises.

Favorable Short-Term Outlook

Gorbachev needs some near-term success to sustainhis early momentum for change, particularly since heis seeking major changes in an economy whose perfor-mance has improved in recent years. To this end, hemade it clear at a recent Central Committee meetingthat the 1986-90 Five-Year Plan must get off to a fast

start. lie should be able to capitalize on the aura ofchange and rejuvenation he has created in the earlymonths of his regime to elicit some genuine increasein effort by at least part of the work force. Moreover,

9

Potential Gains From Increased Discipline

According to Abel Aganbegyan, writing in the Sovietlabor newspaper Trud in 1981, one-half of the declinein growth of labor productivity that occurred in /976-80 compared with 1971-75 was due to "people'sattitudes toward their work." Andropov recoveredsome of the earlier momentum with the initiation oftough discipline campaign in 1982; labor productivityrose by 3.2 percent in industry in 1983 as slackerswere forced to actually be on the job during the ninethey were counted as being there. Gorbachev ma.v beable to recoup even more cif the momentum with hisrevival of the discipline campaign and his strongstand on temperance. Indeed, the reduction in absen-teeism due so drunkenness may have a potential forachieving a greaser Increase in actual hours workedthan was achieved under Andropov. Moreover, Gor-bachey 's direct appeal to workers, together with hisother initiatives, may elicit a more responsible ef-fort—at least in the short run—from many whomight otherwise merely put in their time.

the discipline campaign, which was evidently an im-portant factor in the economic upswing during Andra-pov's tenure, could again have a favorable impact oneconomic performance (see inset "Potential GainsFrom Increased Discipline"). This, together with anew set of Gorbachev appointees—who probabl y havethe energy and determination to use the carrots andsticks available to them with greater consistency thantheir predecessors—could promote at least someshort-run gains in economic performance. AlthoughGorbachev is gambling heavily on the impact of hisearly initiatives—a risky Approach given that previousattempts to implement similar changes have beenfrustrated by entrenched bureaucratic interests—hisprospects for near-term success should not be underes-timated.

iii

Gorbachev's program also may get a short-run boostfrom the upsurge in machinery production that oc-curred in 1983-84 and a particularly favorable harvestthis year. Growth in production of machinery pickedup sharply in 1983-84, registering annual increasesbetter than 5 percent, after averaging about 3.5percent per year in 1981-82. The added machinery

could help raise growth in investment enough to getGorbachcv's modernization program moving. More-over, the outlook is for a substantial increase in cropproduction and livestock products this year after adismal performance by the farm sector in 1984 (seefigure 3). A better harvest this year would help holddown queues for food, provide workers fewer excusesto be away from their jobs during working hours,improve consumer morale, and reduce hard currencyoutlays for grain.'

Long-Term Uncertainty

How much economic improvement will occur and howlong it can be sustained, however, is very much anopen question. Short-run gains alone will not ensuresuccess. For longer term aspects of the program tosucceed, many things must go right for Gorbachev—some he can control, others he cannot. Moreover, thes y nergism he appears to count on ma y not develop,especially in the short run. For example, he hopes topair improved worker initiative with a modernizedindustrial base. But this will require redirecting in-vestment resources, which, in turn, could lead tobottlenecks in industries whose investment allocationsare squeezed. Any campai g n-sty le modernization pro-gram could create imbalances in new capacit y andencounter lengthy delays in achieving results:MB

Moreover, if plants are forced to shut down produc-tion lines to permit renovation, short-run performanceindicators will be adversely affected. This, in turn,might provide ammunition for Gorbachev's oppo-nents, who could contrast 1983-84 industrial produc-tion gains with a poor output record of newly renovat-ed enterprises as evidence of harebrained ormisguided programs. In the long run, each of Gorba-chev's initiatives faces particularly challenging prob-lems that will take more th n st ong rhetoric andwilling hands to overcome.

' Moscow also should enjoy the benefits of a buyers market thisyear in the international grain trade. World supplies are expected tocontinue to be abundant, largely Pacause of a bumper cro n theUnited Stales And reduced Soviet demand for grain.

10

Figure 3USSR: Agricultural Parformance

1912

64

15*

• P10114041

Problems Facing Industrial ModernizationRenovation. Renovating existing enterprises ratherthan building new ones is a key element of Gorba-chev's modernization strategy. He is likely to find,however, that this approach is fraught with difficulty.Plans to concentrate inveatment on renovation havebeen touted by Soviet leaders for more than 15 yearsbut have never been effectively implemented. Thestrategy has been resisted by enterprise managersbecause the downtime required to replace old machin-ery, as well as the uncertainty inherent in new

production processes, threatens their ability to achieveshort-term performance goals. Maintenance and sup-port for new processes—particularly highly automat-ed processes—Are essential, but problematical in theSoviet economy. It has always been safer from amanager's perspective to build a new production plantor add to an ezistinLplant than to renovate anoperating facility.

Moreover, the renovation approach is not effective forlarge areas of the country. According to Soviet litera-ture, many of the existing industrial facilities are so

decrepit that renovation—if possible at all—will beextremel y costly and time consuming. Modern eq uip-ment requir es facilities that have a broad assortmentof heating and ventilation features. Most old buildingsin the USSR cannot be easily converted to accommo-date such equipment. This is especially relevant to thethickly populated regions of the European USSR, theUrals, and the Donets and Dnepr Basins—the oldindustrial core of the Russian Empire, which accountsfor about 75 percent of total Soviet industrial produc-

tional"'

In addition, the emphasis on renovation could exacer-bate the ever-present tension in resource supplythroughout the economy. For example, as productionlines are shut down for renovation, the lost productionwill have to be made up by other plants if supplybottlenecks are to be avoided. Too much simultaneousrenovation could lead to shortages of key industrialmaterials. Indeed, many of these materials are al-ready stretched so thinl y that even small shortfalls aremagnified as their impact ripples throughout thesystem.

Machinery Production. Gorbachev plans to under-write industrial renovation by a rapid expansion inoutput of high-qualit y equipment. To achieve hisannounced goal of 50 percent "new machinery" by1990, he must manage an acceleration in the annualoutput of producer durables to rates unmatched since

the early 1970s. Additionally, the machines must betailored to meet the unique needs of the wide varietyof plants being remodeled—a difficult task for anindustry accustomed to manufacturing large lots of asmall variet y of equipment for use in plants beingconstructed under highly standardized designs. In-deed, the increased pressure on Soviet machine build-ers to boost output probably will reinforce the tenden-cy to reproduce the same pattern of output that hasprevailed for years, only faster and—unless major

illgains are made in u i y control—perhaps in a moreslipshod manner.

Advanced Technology. In addition to rapidly ex pand-ing machine-building capacity, Gorbachev must turnaround a system characterized by its relative failureto create and use technically advanced equipment.

II

mentsrecent assess-

con- Reforms To Spur Innovation Backfireclude that the qual ty o oviet machinery is wellbelow world standards.' The geographic and bureau-cratic separation of research organizations from pro-duction enterprises impedes introduction of new tech-nolog y into the production process. Insufficientfunding of research—most noticeably in the machinetool industries and in the ministries responsible forproducing agricultural machiner y—contributes topoor performance. Finally, the Soviet system ofbonuses—with its inherent bias toward volume ofproduction and apparent rather than real qualitychange—is a de facto barrier to the production ofbetter capital equipment. According to one high-ranking Soviet official, only IS percent of wage andperformance bonuses are ke yedihintroduction ofnew technology and equipment.

Many Soviet officials probably view Gorbachev'smodernization strategy with pessimism. A "BusinessClub" roundtable discussion that Pravda held recent-ly, for instance, pointed to major difficulties in imple-menting the ongoing renovation program in theUkrainian Republic (home for about 20 percent ofSoviet industry). The program—developed along thesame lines as Oorbachev's strateg y—is failing, it wasconcluded, because of:• Perverse incentives that discourage construction

ministries from undertaking reconstruction.• Inadequate funding for installing equipment.• Lack of qualified workers.• The inability of the machinery industry to keep pace

with the increased demand for more efficient, s -cialized equipment needed for renovation.

While Gorbachev may ultimately be able to overcomesome managerial biases by changing success criteria(which he has not yet done) and a ppointing newmanagers, he cannot overcome the economic realitiesof outdated plants and limited investment resources.In the final analysis, no matter how hard Gorbachevpushes, modernization will occur onl y slowly and must' Evidence also suggests that average leadtimas for using nowtechnology are much longer in the USSR than in the West. Datashow that about 30 want of US and WINI German inventions ereImplemented la about one year compared with three years forSoviet Inventions. At the end of two years, the US Implementsabout 66 cant; West Germany, 64 percent; and the USSR, 23percent.

Central authorities are attempting to stimulate high-quality production by assigning higher prices. Enter-prises producing a new product or one judged of the"highest quality " are able to increase earnings byraising the price by up to 30 percent. This is leadingto actions that planners did not anticipate, andinnovation Is the loser.

For example, the Norirsk Metallurgical Combineresponded to the leadership's call to innovate bymanufacturing an improved copper cathode. Onceproduced, it had to be inspected by central authoritiesto be certified as being a the highest quality. TheState Price Committee then had to review a formalpetition for a price adjustment. When the higher pricewas approved, central planners readjusted the com-bine's sales targets to take into account the increasedrevenues the superior product should generate. Pro-duction plans were formulated and sales targetsfinalized before industry 's demand for an improvedcopper cathode was tested.11111

When finally put on sale, the high-quality cathodewas rejected by most domestic customers in favor ofthe cheaper, less advanced version that has been usedfor years. If the price were reduced by having thecopper cathode recertified at a lower quality level, thecombine would not be able to achieve its sales outputtarget, which was set on the basis of the higher price.Thus, for all Its trouble to produce a technologicallyadvanced product, the combine now finds itself in ano-win situation—unable to sell the more expensivehigher quality copper cathode but also unable to cutits price and still achieve performance targets. Thus,the Inflexible and formalistic procedures characteris-tic of centrally controlled prices and output targetscontinue to undermine even seemingly sensible mea-sures to encourage innovation.

12

Figure 4. USSR: bureaucracyrun amok (u)

come from new construction as well as renovation.Substantial results cannot be expected for severalyears. Even now, signs are emerging that some aspectsof Gorbachev's early initiatives are backfiring andinhibiting rather than stimulating high-quality pro-duction (see inset "Reform* To Spur Innovation Back-fire"). Part of the problem is the intricate layering ofthe managerial bureaucracy, which Gorbachev is stilla long way from purging. Decades of bureaucraticdevelopment have created a labyrinth of buck-passingand indifference that will probably take years andthousands of key personnel changes to rectify.

Revitalizing ManagementStreamlining the bureaucracy, refurbishing iii rankswith his allies, and developing better managementskills Are critical to the success of Gorbachev's plan tostimulate higher productivity. The General Secretaryhas already managed to firm up his base of support inthe Politburo, anhe in ends to replace m n sterisi officials an

members of the Central Committee with hisown aides between now and the party congress nextFebruary. Nevertheless, his plans to streamline the

industrial ministries, remove unnecessary bureaucrat-

ic linkages between enterprises and ministries, andincrease the Autonomy of enterprises will not be

welcomed by many officials whose jobs, and perqui-sites, will be threatened. In the meantime, Gorbachevruns the risk of having his directives ignored, misin-terpreted, or even reversed (see figure 4)1MM

In addition to cleansing the bureaucracy of redundan-cy, indifference, and gross incompetence, Gorbachevmust also come to grips with an incentive system thatstifles initiative and fosters corruption. Reducing themyriad of success indicators and tying wages closer toproductivity, as Gorbachev has called for, will help.But the real trick will be to develop a set of success in,dicators that are beneficial both to the individual andto the econom y. This, however, can only happen as aresult of a major change in the Soviet economicsystem that will induce producers to respond toconsumers and allow prices and wages to reflect

13

consumer prefcrenccs.t As long as a set of detailednational preferences (reflected in five-year and annualplans) is imposed on producers, and prices and wagesare set and changed at the discretion of centralplanners, the managerial initiative Gorbachev seeks todevelop—despite some likely early success—will even-tually succumb to the waste and inefficiency engen-dered by conflicting interests of enterprise managersand central planners.

Tying workers' wages more closely to productivity willhave some beneficial effect in the short run. Wageincentives, however, will only be effective in the longterm if there is a substantial increase in high-qualityconsumer goods available for purchase. Indeed, Gor-bachev has personally identified himself with anexpanded commitment to consumer-goods production.A 7-billion-ruble program to modernize and increaseshoe production has already been announced. Accord-ing to one Soviet official, action to bolster output ofhousehold durables and materials for housing con-struction soon will follow. But much more investmentis necessary to substantially improve the provision ofconsumer goods, and, given the strain already beingput on investment resources, it seems unlikely thatconsumer-goods sectors will benefit from much addi-tional investment during the next few years. In fact, ahigh-ranking Soviet official recently acknowledgedthat problems will continue in the consumer sector,and few additional resources will be made available toovercome them.111111

Dealing With Finite Resources

Gorbachev will be hard pressed to find the resourcesnecessary to underwrite his goal of developing amodernized industrial base. The economic dividendfrom management reforms and the discipline cam-paign, while potentially substantial, will not come

Consumer means any purchaser of goods or services—individualor enterprise. (u)'Enterprise managers with increased autonom y , for example, willplace new and perhaps excessive demands on local suppliers for rawmaterials and semifinished goods. Suppliers, on the other hand, willstill be functioning under the direct control of central authoritiesand may be unable to reconcile the demands of their customerswith the directives and resource allocations of their masters. As aresult, both producers and suppliers ma y become disillusioned andmay once again resort to the very methods that have led to wave,fraud, and mismanagement for years.IIIIII

close to meeting these resource needs. Increaseddiscipline, less corruption, greater temperance, andnew management will help to raise labor productivitybut will do little to offset the declining trend in capitalproductivity. Given enough time and investment re-sources, the modernization program could eventuallypay off. While five years may be enough time to makea substantial dent in the stock of plant and equipmentthat needs to be modernized, there is simply notenough investment to go around.

Although the Soviets have not formally revealed theirinvestment plans for the 12th Five-Yea

nvestment will increase byabout 4 percent annuall y .' At the same time, Gorba-chev has indicated that investment in civilian machinebuilding will nearly double, while agriculture andrelated industrial support will maintain a large share.This will leave little room for increases in othersectors. The consumer ma y be especially hard hit inthe nonfood areas. Gorbachev also will have to dealwith pressures to expand investment in other areas as:

• Oil and natural gas exploitation moves farthernorthward into the offshore areas of the Arctic anddeeper into the Pricaspian Depression.

• Demand for roads, railwa ys, and other infrastruc-ture development—projects with heavy up-frontcosts and long leadtimes—increases in more costlyand inhospitable regions.

' Analysis performed with the aid of our macroeconomic model ofthe Soviet economy (SOVSIM) indicates that, to meet an invest-ment growth rate of 4 percent per year in 1996-90, Soviet industrywill have to increase the output of metals at the rate of about Spercent per year and machinery at about 6 percent per year ifdefense procurement is allowed to grow at roughl y 2 percent peryear and per capita consumption Is to increase moderately. Evenallowing tor a boost in productiv it y , our model forecasts a 2- to 2.5-percentage-point shortfall in the growth of metals production underthese conditions of Investment, procurement, and per capita con-sumption growth. Unless this shortfall is made up b y increasedImport, of metals and/or equipment or by gains in efficiency ofmetals use, the implied target alai-percent growth in GNPwill probably not be achievable.

14

• Expensive new conventional and strategic weapons 's.that have completed or are about to com lete testing

implications al Stabilizing Energy

enter series roduction on a lar ge scale.Share of Investment

Gorbachev's announcement that energy's share ofinvestment should be stabilized during 1986-90carries special risks. Oil production has already begunto fall, and, without substantial increases in invest-ment, the production decline could become precipitous(see inset "Implications of Stabilizing Energy's Shareof Investment"). Electric power, too, will need largeincreases in investment resources to meet the in-creased power requirements that will accompany themodernization effort. Coal production—the USSR'sbest long-term source of energy—has been slighted ininvestment allocations for years and will need a majorincrease to adequately exploit the large Siberian andKazakh basins. Thus, if the energy sector has to makedo with the same share of investment it received in1981-85, likely production shortfalls could knockGorbachev's modernization program into a cockedhate.

The leadership seems to be counting heavily on itsabilit y to increase energy efficiency enough to offsetany production shortages that might arise. Retoolingand installing more energy-efficient equipment prom-ises substantial savings, but only in the long run andafter considerable expense. The share of energy con-sumed by Soviet residential, commercial, and trans-portation sectors, which present relatively greateropportunities for immediate cutbacks, is comparative-ly small. Apartments and stares consume over one-half of the fuel used residentially, and most of Themburn low-grade coal or firewood. Trains rather thantrucks provide the dominant mode of Soviet commer-cial transport and are already the most energy effi-cient in the industrial world. Private automobile usewill remain far below levels in the developed Westthrough 1990.

Industry and electric power generation are the princi-pal energy consumers in the USSR. The Soviets areworld leaders in cogeneration—the production ofsteam for space heat at thermal electric power

We 'Mutate that, to keep oil production from fallingbelow about 11 million barrels per day (b/d) by 1990.investment in she oil sector alone during 1986-90would have to increase by about 45 billion rublesfront the 1981-85 level. We estimate that this is morethan twice the investment increment that would beallocated to the entire energy sector in 1986-90 ifGorbachev stabilizes energy's share ai total invest-ment. lithe needed investment in oil is not forthcom-ing, production could fall to less than 10 million b/dby 1990. Such a drop in production would be greaterthan total hard currency exports af oil in 1984.

plants—which has raised considerably the total effi-ciency of those power facilities in comparison withpower plants in the West. Some Soviet basic steel-making processes are also relatively energy efficient.Additional major energy savings in industry thereforemust come through massive capital investment for theproduction and/or importation of more energy-efficient equipment.

However, the production of more efficient equipmentis a difficult and time-consuming task. Machinebuilders—having had little incentive to produceenergy-efficient machinery in the past, will have tostart virtually from scratch. Payback is uncertain, anddelayed until new equipment can be designed, pro-duced, and put into operation—often a process of atleast six to eight years. As a consequence, givenGorbachev's announced growth goals, the mix ofSoviet output over the next five years is likely tobecome more, rather than less, energy intensive."'"

A Rocky Road Ahead

Gorbachev probabl y believes that, if he can kick-startthe ponderous economic machinery hard enough andsustain the momentum long enough, the early gainshe achieves are likely to stimulate lasting improve-ment. Indeed, because of the strong interdependence

15

among his plans for energy savings, industrial mod-ernization, managerial renewal, higher productivity,and an improved work ethic, a large dose of curlysuccess in some areas could promote success in others.The longer he can sustain the earl y gains, the betterthe chances for long-term progress. This same inter-dependence, however, increases the risk of failure;because so many things that have gone wrong for solong must now go right, the likelihood is high thatsome will continue to go wrong and thereb y impedeprogress.

Reducing waste, fraud, and mismanagement and di-recting available resources to their most productiveuses will contribute substantially to the modernizationprogram. But the economic dividend from manage-ment reforms and the discipline campaign will notcome close to meeting the econom y 's resource needs.The key to success will be Gorbachev's ability to copewith some fundamental paradoxes, and he will have todo so sooner rather than later:

• Improving management efficiency and workermorale will require an effective incentive systemand increased availability of high-quality consumergoods at a time when the investment sector will beoriented toward producer goods and new defenseprograms will be coming on line. On the basis ofGorbachev's program for redirecting investment, weproject that the increment in consumer-orientedinvestment during 1986-90 could be some 60 per-cent less than that for 1981-85.

• Energy's share of investment is to be held constantat a time when demand for energy will grow and thecost of offsetting declining oil production will berapidly rising. The implications of redirection ofinvestment away from other sectors, particularlyconsumer-oriented sectors, may be equall y ominous.

• The increased managerial independence necessaryto spur effective technological development andutilization is inconsistent with a centrall y plannedpricing and allocation system, leading to the likeli-hood of management disillusionment and subse-quent reversion to the very methods that have led towaste, fraud, and mismanagement for years.

Gorbachev's approach in resolving these issues couldhave strong political and strategic implications; fail-ure to reso v them will stymie his modernizationeffort.

He could, and probabl y will, seek some relief from theeconomic dilemma by demanding that East Europeancountries, which have benefited from Soviet economiclargess in the past, shoulder a greater part of theburden. Imports of equipment from Eastern Europeaccounted for one-fourth of total Soviet machineryand equipment investment in 1983, and Gorbachevwill probably push for an even higher flow in thefuture while reducing Soviet deliveries of costly rawmaterials.. East European leaders, beset with theirown deep economic problems and popular expecta-tions, arc likel y to strongl y resist such suggestions,paving the wa y for growing confrontation betweenMoscow and its allied states.

Gorbachev may also increase imports of Westerntechnology to secure state-of-the-art equipment in keyareas. A marked rise in imports, however, wouldrequire a substantial increase in hard currency expen-ditures at a time when the USSR is facing a decline inthe production of oil, its major hard currency earner.While Moscow has the capabilit y to expand importsby markedly increasing its hard currency borrowing,such an expansion would create a potential vulnerabil-ity to Western exporters, lenders, and their parentgovernme ts that past Soviet regimes have sought toavoid.

Gorbachev could attempt to reallocate resources awayfrom defense to provide some relief to the civilianeconomy, but he probably would encounter stiff oppo-sition if he attempted major adjustments in defenseallocations. Currently, about 30 percent of all ma-chinery output probabl y goes to support defense pro-duction. Moreover, this share generally represents thehighest qualit y products and newest technologicalprocesses in Soviet machine building. The militarysector also receives the most capable managers. Somelabor, materials, and components could be readilyshifted to civilian uses, but most defense industrial

16

17

The Khrushchev Analogy

Nikita Khrushchev, during his 11 years at the top(1953-64), launched his own "revolution" In Sovietpolitics. Crude, boisterous, and aggressive by nature,he bullied and cajoled his colleagues and the bureau-cracy to adopt his vision of the Communist future. Hemade catching up with the United States a majorgoal and enshrined it in the utopian party program of1961. He eliminated terror as an instrument a1everyday politics, brought Stalin's police apparatusunder effective political control, and publicized someof the crimes and abuses of power af his formermentor. (These revelation; were a tremendous shockto the Soviet people and to Communist sympathizersaround the world.) He made dramatic changes ineconomic policy and management—abolishing thesame central ministries that now so trouble Gorba-chev, reorganizing the parry apparatus that overseesthem, and changing economic priorities almost byfiat. He dramatically increased Soviet involvement Inthe Third World and vigorously stepped up Sovietcompetition with the United States for power andinfluence around the world. His risky political courseboth at home and abroad—along with his nonconsen-sus style—ultimately led to his ouster by the verypeople he brought into power..

The most striking similarity between Gorbachev andKhrushchev is their informal, populist style of leader-ship. Like Khrushchev, Gorbachev has made an eonto show that he is accessible and interested in theviews 41 normal citizens. He has made forays into thestreets and visits to factories to engage in unre-hearsed, well-publicized exchanges with the assem-bled crowds. The informal style af both leaders isalso evident In their willingness to make extempara-

plants would require extensive, time-consuming re-tooling before they could productively turn out muchcivilian production. Nevertheless, in the long runmany defense resources could be applied productivelyin the civilian economill.

Although military leaders recognize that the long-term strength of the Soviet militar y depends largelyon the country's economic health, the Soviets are

11■MM.

neous remarks during their prepared speeches as wellas in the public role for their wives and families. Thesimilarities between both leaders are particularlypronounced when compared to the cautious, stiff, andhighly formalized style Brezhnev that was thenorm for the past 20 years.111

Al the sonic time, Gorbachev—more polished andeducated than Khrushchev—appears to have learnedfrom Khrushchev's mistakes and is using very differ-ent tactics in pressing his agenda for change. WhenKhrushchev was removed, his successors accused him

.iiinong other things of "harebrained scheming, imma-ture conclusions, and hasty decisions and actionsdivorced from reality, bragging, and phrasemonger-int." These accusations stemmed from his efforts tohastily push through major reforms that were notwell thought out and his highly personalized style ofleadership that was based more on confrontation thanconsensus"'

While Gorbachev appears equally determined to over-haul the system, he has gone about the task muchmore deliberately and cautiously than Khrushchev.His signals to the bureaucracy are clearer and makeIt easier for lower level officials to calculate what isexpected front them and to respond accordingly.Instead of presenting specific proposals for reform, asdid Khrushchev, Gorbachev has defined the generaldirections of ihe changes he would like to accomplishand encouraged further discussion of the optimalways to achieve them. At the same time, he issystematically building political support for his agen,do by installing loyal afficials in key positions andremoving those who might thwart his plans.

committed to programs for modernizing their offen-sive and defensive strategic forces, as well as theirconventional weapon programs. In addition, the USdefense modernization and the long-term implicationsof the Strategic Defense Initiative (SDI) probably arebeing cited b y Soviet military leaders as justification

for higher growth rates for defense spending. The rateof growth of defense spending since the mid-1970s hasbeen a relatively modest 2 percent, and militaryleaders probably already feel that defense has accept-ed slow growth in resources for as long as it can, giventhe extensive requirements for upgrading weaponsystems.

The institution of major economic reforms such asprivate enterprise and market-determined prices andallocations could, over time, markedly improve eco-nomic efficiency, consumer welfare, and technologicaladaptation. They would encounter strong resistanceon political and ideological grounds, but Gorbachevhas already shown that he will aggressively tackle theproblems he has inherited and, like Khrushchev morethan two decades ago, use his considerable power toforce the pace of change (see inset "The KruslichevAnalogy").

Premier Tikhonov almost certainly will be replaced ator before the congress in February by Gorbachevhimself or an ally. The leadtime to the congress willalso give Gorbachev the opportunity to more thor-oughly clean out the deadwood from the party andgovernmental bureaucracies and bring in a manage-ment team more sympathetic to his policies and betterequipped to carry them out. Over the next year,indications that he is moving ahead with his economicagenda could include:

• A clear delineation of winners and losers in the1986-90 plan for investment allocations. Besidesmachine building, sectors such as ferrous metalsand chemicals must receive a greater share of theinvestment pie for the modernization program tohave any chance for success.

• The creation of superministries (for example, bycombining ministries in the agricultural area) with aconcomitant reduction in ministerial control of en-terprise operations.

• Specific changes in managerial incentives (for ex-ample, tying bonuses to the share of new equipmentinstalled) to promote modernization of plant andequipment.

• The replacement of Gosplan Chairman Baybakovwith an outsider (possibl y even Nikolay Ryzhkov)who would enhance the political stature of Gosplanand signal increased emphasis on long-term strate-gic planning rather than detailed annual planning.

• A reduction in reported resistance to the ongoingindustrial management experiment coupled with.measured gains in productivity.

Moreover, with his own people in place, Gorbachevshould be able to build a consensus behind the morefar-reaching proposals that he has only hinted at todate. Indications that he has decided on and gainedconsensus for more radical changes could include:

• New dramatic initiatives to reach accord at Genevaand concrete proposals for reduced tensions at theNovember meeting between the US President andthe General Secretary, which might signal a willing-ness and desire to reduce the Soviet resource com-mitment to defense and create an atmosphere forexpanded commerce with the West.

• Select legalization of private-sector activity, partic-ularly in regard to consumer services, which wouldindicate willingness to confront past economic or-thodoxy in order to improve consumer welfare andthereby economic performance.

• Breaking the monopoly of the Foreign Trade appa-ratus, which would signal an increased reliance onmanagerial independence at some cost to central-ized control.

Continued reliance on marginal tinkering, despiteclear indications that the plan for economic revitaliza-tion is faltering, would indicate that Gorbachev, likeBrezhnev before him, has succumbed to a politically

i

crieni but economicall y ineffective approach.

IN