Ramon Moreno

English

Research Papers in Economics

FRBSF WEEKLY LETTER
March 3, 1989
Why Perestroika?
The Soviet experiment with socialism has had
uneven results. On the one hand, the Soviet
Union has fulfilled certain basic objectives set
out early in this century: it is a major world
power and some basic social needs are being
met. On the other hand, lagging Soviet eco-
nomic performance presents major difficulties.
Shortages are endemic. Available products are of
poor quality and design, creating large invento-
ries of unwanted goods. The lack of amenities
and restrictions on free speech have created a
passive and increasingly unproductive work force
that is little motivated by wages that can pur-
chase only a limited quantity and selection of
goods.
In response to these developments, the Soviet
Union has launched a wide-ranging program of
economic restructuring, known as perestroika.
The bulk of the program was adopted in June
1987, and is to be completed by January 1, 1991,
in time for the implementation of the Thirteenth
Five-Year Plan. This Letter reviews some of the
causes of poor Soviet economic performance and
the thrust of the reforms.
The economy
Following comparatively robust growth in the
second half of the 1960s, Soviet economic per-
formance began deteriorating sharply in the
1970s, with economic growth consistently falling
below target. From 1981 to 1985, estimated an-
nual GNP growth of two percent was less than
half the peak of five percent in the period from
1966 to 1970. Indicators of lagging performance
have extended across the major economic sec-
tors. Growth of industrial output fell even more
sharply than did GNP growth, and chronic diffi-
cuIties beset agricuItural production.
Underlying the slowdown in growth has been a
decline in productivity growth. The annual
growth in labor productivity fell from 6.2 percent
in the period from 1966 to 1978 to three percent
in the 1981 to 1984 period. Capital productivity
appears to have declined "at a 2.8 percent annual
rate during this latter period. As a result, total
factor productivity growth fell from a peak an-
nual rate of 3.2 percel\lt in the earlier period to
1.1 percent in the later period.
Shortages of labor and intermediate products
have impaired production. In addition, the tend-
ency for enterprises and ministries to undertake
large new projects has exacerbated existing ca-
pacity constraints. The hundreds of thousands of
construction projects now in. place have report-
edly lengthened the average time required to
bring new productive facilities on line to 20 .
years in several sectors. In the 1960s, in contrast,
the gestation period for investment projects was
seven to eight years from design to full capacity
operation, still about twice the average for other
industrial countries.
Sluggish economic performance has contributed
to government budget deficits (financed by loans
from the State Bank) over the past ten years. So-
viet authorities recently estimated that the gov-
ernment deficit will reach $56 billion in 1989, or
about four percent of GNP. In the West, estimates
of the Soviet budget deficit actually run as high
as $90 billion. Bailouts of loss-ridden public
enterprises are largely to blame for these deficits,
although the falling price of oil on world markets
and the cost of cleaning up after the Chernobyl
nuclear plant disaster also have had a major
impact on government finances since 1985.
Economic structure
Two structural factors account for the Soviet
Union's poor economic performance since the
late 1960s. The first is the overwhelming burden
of centrally managing a complex economy. It is
estimated,(that the State Planning Committee and
the State Committee for Material Supply must
plan the supply and distribution of 25,000 prod-
ucts. At the same time, the State Price Committee
considers approximately 200,000 price proposals
per year, and 500,000 other price proposals are
handled by ministries or other authorities.
The second factor is the perverse incentives the
system creates. Prices and subsidies designed toFRBSF
provide absolute job security and prevent bank-
ruptcies ratify economic inefficiency. Perform-
ance targets are based on currently achieved
levels, creating incentives to hide true produc-
tion capabilities. Moreover, since enterprises are
required to focus primarily on output targets, .
profitability, productivity, and quality frequently
suffer. The focus on output also discourages inno-
vation, as retraining workers and retooling lower
output in·theshortrun. Although the government
has introduced additional targets for profits, total
wage bills, productivity, quality, and R&D expen-
diture, these targets generalIy cannot be fuIfilied
simultaneously. Inthe final analysis, successful
managers cannot concentrate on developing
good products, but instead must spend their
energies developing good ties to ministerial
bureaucracies to minimize penalties for targets
they fail to fulfill.
Efficiency is further impaired by the direct inter-
ference of ministerial bureaucracies in the opera-
tions of enterprises and by the periodic demands
of local authorities for labor or capital resources
from. enterprises operating in their jurisdictions.
EconomiC reforms
In an effort to address these structural problems,
an economic reform program was adopted in
1987. The program involves enterprise reform,
price reform, bureaucracy reform, the legalization
of privateenterprise, and a number of related
fTIeasures designed to improve economic per-
formance.
Enterprise reform is designed to increase both
the autonomy and the financial self-sufficiency of
enterprises. Enterprises may now select their
customers and suppliers and decide the output
and input mix, the structure of wages and bo-
nuses, andthe magnitude of capital investments.
Top management of enterprises is to be elected
for five years by aworkers'conference in multi-
candidate elections confirmed by higher organs.
To increase efficiency, enterprises will have to
earn the funds to cover labor, material costs, and
supplies and still have an investable surplus (to
besupplemented by loans in the case of large
projects). Provisions for identifyinginsolvent
enterprisesand beginning bankruptcy proceed-
ings have now been established.
Price reform dictates that by 1991, prices largely
will be negotiated between buyers and sellers,
following rules established by the State Price
Committee. The latter will set the prices of a few
key products (raw materials, fuels, and scarce
"nationally important" products). In the mean-
time, a price index is being developed.
Under bureaucracy reform, detailed planning is
to be abandoned, and interference from govern-
ment ministries is forbidden. As a result, the staff
of government ministries is likely to be pared
down, and ministries may be merged into "com-
plexes" covering machine building, transporta-
tion, construction, fuel and energy, metallurgy,
chemicals and timber, foreign economic rela-
tions, consumer goods, and agro-industry.
However, central government control will not
be eliminated altogether. Non-binding guidance
plans, reflecting desired productive activity and
efficiency criteria, will be sent to enterprises as
part of each five-year planning cycle. In addition,
the State Planning Committee, ministries, and re-
public authorities can issue orders for the fulfill-
ment of the st\).te's highest priority needs (defense,
for example) and for central government invest-
ment projects. Procurement will in some cases be
issued competitively, with guarantees for the
supply of key inputs.
Private enterprise was legalized in May 1987, to
encourage the production of consumer goods.
Enterprises may be formed by individuals or
cooperatives and are licensed bythe state and
subject to tax or license fees. Workers employed
in state industry can only engage in private ac-
tivity in their off-hours, but their immediate
family members over 16 years of age, as well as
students, housewives, and pensioners can work
full-time in such businesses. Some state assis-
tance is offered in finding facilities for private
operations.
Other measures
A key element of the effort to improve economic
performance is a major investment program de-
signed to modernize Soviet industry to levels
comparable to the West. A plan to freeze up to
40 percent of the ongoing construction projects
may free some resources for this machine build-
ing and metalworking investment program.Financing for the program may also be obtained
by borrowing from abroad. The Soviet Union's
net external indebtedness totalled an estimated
$23 billion in 1986. Late in 1988, Western banks
approved an additional $6 billion in long-term
lines of credit to the Soviet Union. Recent steps
to allow joint ventures involving minority parti-
cipation by foreign investors may also provide
capital and improve technology and manage-
ment.
Perhaps the best-known measure associated with
perestroika is the glasnost ("openness") cam-
paign, which encourages citizens to criticize all
but the top leadership through the press, televi-
sion call-in shows, and town hall meetings. A
democratization program is also in place, and
elections have been introduced at the local level.
Both measures are designed to encourage civic
consciousness, as well as to highlight inefficiency
or corruption.
Prospects
Perestroika represents a major breakthrough,
because Soviet leaders now appear to recognize
the limitations of highly-centralized economic
planning. Four previous efforts at reform since
Stalin's time have failed, in large measure be-
cause accountability for production targets
remained highly centralized, encouraging inter-
ference in enterprise operations by higher author-
ities. In contrast to previous episodes, the present
reform abandons detailed planning and transfers
accountability and a great deal of authority to
enterprises.
Nevertheless, the risk of repeating previous fail-
ures remains. One problem is that it is not clear
how much authority really will be transferred to
enterprises. The new arrangements for "guidance
planning" may provide an avenue for renewed
high-level interference in enterprise activities.
The government may also preempt the new free-
dom of enterprises to determine output if it
places large orders with enterprises to meet
"priority" needs.
Social pressures may also limit the extent of the
reform or its effectiveness. For example, efforts to
increase productivity through financial incen-
tives and the legalization of private enterprises
may lead to inequalities in income distribution
that are likely to be resisted by hardliners.
Another crucial problem is that price reform is
currently the last, rather than the first, compo-
nent of the reform program. One reason for the
delay is the fear that, as in China, price reform
may lead to accelerating inflation due to pentup
excess demand. Inflation in the Soviet Union is
unofficially estimated to be at six to eight percent
and rising. Also, Soviet policy makers may not
fully recognize the importance of a functioning
price mechanism. Consequently, prices will not
serve as signals for correcting imbalances in sup-
ply and demand or for motivating newly autono-
mous enterprises to operate more efficiently until
1990. Even after 1990, enterprises may remain
sheltered from domestic and foreign competition
to some extent. Unless the present system of
allocating resources by fiat is replaced by a
functioning price system, perestroika may not
succeed in fulfilling any of its economic objec-
tives.
Many observers, in fact, doubt the feasibility of
the wide-ranging reforms encompassed by per-
estroika, as they require the bureaucracy to sur-
render power and changes to be made in values
and attitudes fostered for over half a century.
However, a significant number of Soviet leaders
appear to recognize that the economic problems
of the Soviet Union will not be solved without
fundamental changes. Perhaps the broad scope
of perestroika, and the magnitude of the stakes
involved, are the best guarantee that it will
achieve some success.
Ramon Moreno
Economist
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be adllressed to the editor (Barbara Bennett) or to the author.... Free copies of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
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Why perestroika?

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