Transcript Command Economy - Pennsylvania State University

Command Economy
• Why study command?
– The command system creates initial conditions for transition
– Legacies from command critical for transition
• Path dependence
• Two types of legacies
– Structural
• The result of past investments and other decisions
• Enterprises, locational choices
– Institutional
• Behavioral patterns
• How to reverse past decisions
• Start with the analysis of command system
Command Economy
• Attempt to replace markets
– The command principle strives to fully and effectively replace
the operation of market forces in the key industrial and
developmental sectors of the economy, and render the
remaining (peripheral) markets manipulable and subordinate
to political direction.
• Two Basic Imperatives
– Growth
– Control
3 Key Purposes
1. maximum resource mobilization towards urgent and
over-riding national objectives, e.g. rapid
industrialization or the prosecution of war;
•
Used by many countries in wartime
2. radical transformation of the socio-economic system
in a collectivist direction based on ideological tenets
and power-political imperatives; and
3. not the least, as an answer to the disorganization of a
market economy through price control, possibly
occasioned by inflationary pressure arising from (1)
and/or (2).
Basic Features of the STE
• state-ownership of the means of production
• centralized control by means of an administered system
of planning in physical terms.
– The system replaces the market with a set of directives from
the center to the production units throughout the economy.
– These directives are commands, not suggestions. They are
directives that have the force of law, and subordinates are
responsible for fulfilling them, even if the plans are not
feasible.
• The absence of markets implies loss of information
about opportunity cost
• absence of private property, except for households
STE
•
•
•
•
STE created by Stalin in 1928
Exported to Eastern Europe after WW2
Imported by China after 1949
Yugoslavia mutates in mid-50’s
– Self-management
• North Korea, Vietnam, Cuba are
underdeveloped examples of command
economies
Basic Feature Continued, Implications
•
•
•
•
•
•
•
soft-budget constraints
chronic sellers market
emphasis on heavy industry
gigantomania
dynamic incentives problems
state control of investment
restrictions on entry, no exit
So c ialist
Capitalist
Co u n tries
To tal Man u fac tu rin g
Average employ ment per firm
a
Co u n tries
b
197
80
66
32
355
81
75
17
2,542
350
95
79
Average employ ment per firm
Percentage of those employ ed
in firms w ith more than 500 w orkers
253
82
61
28
Average employ ment per firm
Percentage of those employ ed
in firms w ith more than 500 w orkers
Fo o d Pro c essin g
Average employ ment per firm
325
104
79
35
103
65
39
16
Percentage of those employ ed
in firms w ith more than 500 w orkers
Textile In d u stry
Average employ ment per firm
Percentage of those employ ed
in firms w ith more than 500 w orkers
Ferro u s Metals
Average employ ment per firm
Percentage of those employ ed
in firms w ith more than 500 w orkers
Mac hin ery
Chem ic als
Percentage of those employ ed
in firms w ith more than 500 w orkers
So u rc e: Ehrlich (1985)
a
Sample, including C zechoslovakia, GDR, Hungary , and Poland.
b
Sample, including Austria, Belgium, France, Italy , Japan, and Sw eden
Distribution of Employment by Size
West Germany
France
Italy
0-100
14.1
22.5
32.3
100-500
23.9
24.9
27.3
500 and more
62
52.6
40.4
GDR
Czechoslovakia
Hungary
Poland
1
0.1
4.5
1.4
11.1
3.4
16.3
18.2
87.9
96.5
79.3
80.4
source: OECD data for West Germany, France and Italy are for 1987,
and for the other countries are for 1989.
Structural Differences
Agriculture Industry
Services
OECD (1991)
8 richest countries
8 middle countries
8 poorest countries
5.5
5.8
17.9
29.8
30.4
29.5
64.7
63.9
52.6
Centrally Planned
Economies (1998)
GDR
Czechoslovakia
Hungary
Poland
10
11.6
17.5
27.2
44.1
46.8
36.1
36.3
45.9
41.6
46.4
36.4
Ownership
• Not just commanding heights
• In the Soviet Union, for example,
– the state and collective sectors accounted for some 88% of
the value added in agriculture; controlled 98% of retail trade,
and owned 75% of urban housing space
– The industrial sector was exclusively state owned.
• In 1985, for example, 91% of employment was in state enterprises,
and another 6% was in kolkhozy.
– The extensive control of retail trade means that the smallest
shops were state owned.
• But key factor is hierarchical control
Sample Hierarchy
Central
Planning
Board
Ferrous
Metals
Steel Trust
Steel Plant
#1
Steel Plant
#2
Rolling Mills
Chemicals
Coke Trust
Coke Plant
#1
Coke Plant
#2
Chemical
Plant
#1
Chemical
Plant
#2
Defense
Chemical
Plant #3
Consumer
Goods
Old Gosplan (currently Duma)
Hierarchy
• Only vertical information flows
– But there are informal horizontal flows
• Only at the top of the hierarchy can opportunity cost be
assessed
– Lower level agents cannot assess tradeoffs
– Implies subordinate control crucial
• Bureaucracy must exercise full control and discretion
– But subordinates have their own interests, which implies:
• Incentive problems
• Need for monitoring systems (police, party, banks)
• Corruption
• Fundamental issue: how to get agents to reveal information and
follow orders
Soviet Growth Model
• Mechanism for extensive growth
• Paradoxical attitude towards time
– planners have a very low discount rate -- they are willing to sacrifice lots
of current consumption for future consumption
– On the other hand, haste implies that they want to industrialize fast. So
they cut corners, and ignore side effects and other costs.
• Diabetes example
• Key point
– Haste sowed the seeds of the barriers to longer-term performance.
– In that sense, the rapid growth in output of the first couple of five year
plans represent borrowing from future performance.
• Balloon payment
• Key defect of the SGM is that output growth is pursued without
regard for the opportunity cost of that growth
– E.g., environmental mess
Extensive vs Intensive Growth
• Suppose that output is given by
• Then the growth rate of output is given by
– Thus growth occurs either thru growth of inputs (more K
and/or more L) or technological change (growth in A)
– Extensive growth is the former, intensive growth is the latter
• Growth thru greater efficiency in use of inputs
• Extensive growth is growth thru accumulation of inputs
Consumption Paths
• Whose utility is being maximized?
– Households versus planners’ objectives
– Planners willing to defer present consumption versus
future consumption
– Planners combine haste with patience
• Their haste for fast growth with public’s patience for
deferred consumption
– High rate of time preference on part of owners, cost
paid for by public
Aral Sea
Soviet Growth Model (cont.)
• Growth implies maximize investment
– How? Via control of consumption
• State is sole employer => monopsony
Let cˆ be the subsistence level of consumption
Then cˆL is aggregate consumption.
Let Y  F ( K , L ) be aggregate consumption
Then investment is maximized, for given level of K,
by choosing L so that FL  cˆ
– What if L*  L ?
–
–
–
–
Industrialization Strategy
• Heavy industry
• Maximize investment
• Collectivization
– Surplus labor argument
• Transfer from rural to urban
• State control over resources
– But peasant response
• Output growth versus welfare
USSR, Inc.
• Soviet economy as a single corporation
• The corporation owns a large stock of natural
resources,
– has no outside shareholders
– (so that all "profits" can be retained for investment)
– hires labor
– Moreover, as a monopsonist in the labor market, USSR Inc.
can minimize the expenditure on labor.
• Transactions between enterprises are merely transfer
prices between "divisions."
• The exceptions are purchase of labor and engagement
in foreign trade.
Exceptions
• Labor is allocated partly by choice
– State determines demand, but labor is supplied
• Though vagrancy is a crime – full employment
• Foreign Trade controlled by FTM
– FTM trades with ROW
• Intermediary between producers and ROW
– Insulates domestic prices from world prices
– Purchases (sells) goods at state prices and sells (buys)
at world prices
Haste
• Command system is good at mobilizing
– achieving specific objectives
– Extensive growth
• Growth through accumulation of inputs
• It is bad at assessing costs and tradeoffs
– May be important for intensive growth
• Growth via greater efficiency
• Crucial Role of Resource Abundance
– Delay in reaching BoP constraint
Growth Problems
• Over time growth rates decline in all STE’s
– Despite continued growth in capital-worker
• Why?
– Failure to transition to intensive growth
• Extensive growth trap
– Inability to substitute capital for labor
– Innovation Problems
• The system worked best when the fruit was lowhanging
– mobilization
Soviet Growth Rates Decline
Intensive vs Extensive Growth
• Start with
• Then the growth rate of output can be written as:
• Intensive growth means high
• Extensive growth means accumulation
– But notice that as capital accumulates, K increases
L
– What happens to rate of return?
Two Explanations of Slowdown
• TFP growth declines due to increased complexity of the
economy
– Difficulty with diffusing innovation
• Low elasticity of substitution
– K/L increase due to high savings rate and limits to growth in labor force
– If substitution is difficult output growth is reduced
• Note that this is organizational, not technological
– No entry, limited exit
– Input-output conservatism in planning
• Extensive growth and natural resources
– Energy was underpriced and over-utilized
– when prices are liberalized many industries are producing negative value
added
Price System
• Prices unrelated to social costs
– Socially necessary costs
•
•
•
•
Average not marginal
Non-existent charges for rent and capital
Raw materials underpriced
Costs of production were thus calculated based on an incomplete
enumeration of costs.
• Prices biased based on user
• Circus mirror effect
• Does it matter?
– USSR, Inc., => transfer pricing
– But illusion about sources of value
• Implications for transition
Price System (cont.,)
• Why have prices in a planned economy?
– an accounting device
– Monitoring of plan performance
– Related question, why have money?
• Active and passive money
• Soft-budget constraint (Kornai)
– If budget constraints are not binding a resource constraint
must eventually be reached
• Implies that shortage is an equilibrium phenomenon in STE’s
• Leads to sellers’ markets
SBC
• Dynamic Commitment problem
– Subsidy available ex post not ex ante
– Effort costly for manager, bonus for fulfillment is B
– Effort is sufficiently costly so
• If effort is low, Y = 0 with no bailout, Y – R with bailout
– If low effort manager must be bailed out because low output
is bad for planner
– Manager knows this so he supplies low effort
SBC
Chronic Sellers’ Market
• Primary cause => the emphasis on growth at all
costs
• Taut plans => uncover hidden reserves
• Soft-budget constraints
– Plan fulfillment imperative
– Excess demand for labor
• Shortage and priority
– Personality dominates
• Lack of quality
Dynamic Incentives Problems
• Planning from the achieved level
Yˆt  (1   )Yt 1
• Enterprise exploits hidden information
– Agents must be induced to reveal information
• Simple 2-person game
– Enterprise director can tell the truth or lie
– Planner can issue a feasible or a taut plan
Preferences
• Director’s preferences:
• Planners’ preferences:
• Illustrative payoff matrix
• Equilibrium: both lie
Bonus Function
• To get director to reveal information planner
implements a bonus function
• But why pay to overfulfill?
– Need for extra resources to meet shortages
– Increase effort
Canonical Bonus Function
B
q
More on the Bonus Function
• Solves static problem
• Assume that effort is required to produce more
output
– Moral hazard
• But that this differs depending on productivity
– Hidden information (adverse selection)
– Then preferences depend on the nature of the
enterprise
Canonical Bonus Function
B
UL
UH
B(q )
B0  B
B0
q
q1
q
Canonical Bonus Function
• Generates separation
• If no bonus for overfulfillment, then pooling
• Sets up the dynamic incentives problem
– Fulfillment today risks fulfillment tomorrow
• Consequences
– Need for a safety factor
– Ratchet effect
– Taxing high performance
Dynamic Problem
– Let
be utility for fulfilling the plan for the
high productivity enterprise
– Current gain from overfulfilling is:
– Loss from revealing information is
– Then director must compare
Dynamic Problem
• LHS is the current gain from revealing (CG)
• RHS is the present value of future losses (DFL)
– Depends on the time horizon of the agent
• Whenever DFL > CG the director will conceal
true capacity
– Ratchet effect => fear of a higher future target
lowers current performance
– Predictability, Shchekino
Shchekino Experiment
• Planning experiment
– Planners commit not to change targets for 5 years
– Enterprise can keep costs savings
– Labor productivity rose so fast, 52% in first year,
planners reneged
• Changed plan targets 7 times in 10 years
• Another plant 17 times in 5 years
• Inability of planners to commit
Ratchet Effect
• More severe the greater is
– Time horizon
– Utility loss
• And the smaller is
– The discount rate
• Leads to reduced incentives to perform and
innovate
– Alexeev and weightlifting records
– Slow diffusion of innovations
Result
• Who said this?
• Yuri Andropov, General Secretary, CPUSSR
– Top officials know the problem, can’t solve it
Lack of Observability
• Inflated reports – simulation – is commonplace
• Difficulty of monitoring
• Occasional audits show this:
Enron, Global Crossing, Stock options
• Similar problems occur in corporations
• Directors and managers engage in simulation
– simulation of performance to achieve bonuses
– Simulate earnings to benefit from options
– Incomplete information necessary but not sufficient
• it is also necessary that rewards be skewed toward the present,
– especially if those costs can be shifted on to others in the future.
• Much harder to keep simulations hidden in markets
– Need to hide losses, but Soviet pricing does not reveal losses
Vasily Alexeev
Date of First Adoption versus Diffusion
(proportion of output produced in 1982)
Structure of Command Economy
• Imperative is microbalance
• Planning by material balances
– Feasibility, not optimality
– Iterative process of vertical information flows
• Basic idea
– Sources = uses, good by good
– For good j we have:
– Where does Xˆ
j
come from?
• The input requests from other enterprises
• Where does this come from?
Material Balances, cont.
• Planners start with a target for sector j: X 0j
• Enterprise calculates its input needs assuming fixed
coefficients:
• So multiply to get needs:
• Now planner adds. E.g. for sector 1 (such an equation
for each sector of course):
Schematic
CPB
X 0j
Steel Plant j
Steel
Steel Plant #2
Chemicals
Steel Plant #3
Chemical Plant #1
Chemical Plant #2
Chemical Plant #3
Material Balances, cont.
• Put the sum back into the material balance:
– No reason to assume it equals zero.
– So adjust output targets:
– Now we have a new set of input needs for each enterprise.
For j we have:
– And we just repeat the whole process, again, and again…
Material Balances, cont.
• Process continues till all the Dj’s are zero
• Notice how simple are the operations
• If the process goes on long enough a feasible plan result
– But the number of iterations could be very large
– In practice only one or two iterations
• So plan as implemented is infeasible
– Some plans taut, others slack
• Note emphasis on intermediate goods
– But optimal plans look at final goods
• Central control and subordinate responsibility
– Micro-balance is the imperative
• Process assumes truthful revelation
Incentives versus Complexity
• Mises, Hayek thought central planning problem
was too complex to solve
• Lange and Lerner suggested market solutions
–
–
–
–
Set Q such that MC = P
But this ignores incentives problems
Why would managers follow the rules?
Private information (about actions or conditions) is
valuable
• Agents must be induced to reveal this
Command Problems
• Detailed planning and the corresponding directives are
often late, are insufficiently detailed, may lack the
requisite information, hence often cannot be effectively
coordinated
– Owing to their rigidity they are peculiarly vulnerable to
uncertainty
• Planning in a command economy must be largely in
physical terms due to the crucial importance of
balance.
– The bottom line of the planning process must be available
physical units of required inputs, in appropriate assortment,
quantity and timing, necessitating physical targets for
production and input utilization.
• Success indicator problem
Success Indicator Problem
• Bonuses are non-synthetic
• One linear price schedule produces imbalances
– No secondary market
– Planners cannot know tradeoffs at each enterprise
• Pollution permits
• Emphasize priority
– Quality problems shifted to users
– Because micro-balance is priority
– Teaching versus research?
• Bonus for retention
Command
• Command is good for well-defined measurable
tasks
– Build the Atom Bomb
• Don’t worry about cost = $25.7 billion at current prices
• Command is bad at assessing tradeoffs
– No prices to measure opportunity cost
– Physical indicators lead to success indicator bias
– Teaching is harder to measure than research
Shortage
• SBC, fixed prices, output fixation => shortage
– In production, to avoid wasted resources; full
utilization to achieve growth
– In consumption, because planners do not want to
divert output
– Of course, flexible prices could eliminate shortage,
but command means dominance over market
• Market allocation weakens central control
• Implication: Generalized shortage
Shortage
P
S
P*
Pˆ
Excess Demand
D
Qˆ
Q
The Big Nail
Problems with Linear Pricing
quality
SW
enterprise
2
enterprise
1
B
A
P
P
quantity
Mormon Comparison
• Many similarities
– Sense of encirclement
– Holistic vision of utopia
• Virtuous haste
–
–
–
–
Totalitarian leadership (without terror)
Primacy of collective over individual
Hostility to speculation, private initiative
Insulation and isolation
• Need for autarky to conserve foreign exchange
• Like the Soviet economy, economy was collectivist,
mobilizational, centrally planned, largely command-managed,
and often redistributional in regard to factors, products, and the
economic surplus.
Mormon comparison, cont.
• More similarities
– Property owned by church
– Capital formation
• Via tithes, mostly in kind
– Prices as accounting devices, economy demonetized
– Frequent reforms
– Cooperative forms of organization
• Key differences
– Voluntary, not coercion
– Building on virgin soil
Seeds of Transformation
• End of isolation
– Immigration of gentile tradesman
• Like the second economy of USSR
– Railroads lower transportation costs
• Raises cost of autarky
• Hostile US legislation
• Trade leads to corruption and sub-rosa
privatization
Second Economy
•
Informal economy arises to meet challenges of command
–
Precisely because command economy cannot achieve balance, and as
terror dissipates
2nd economy defined as “all production and exchange activity
that meets at least one of two criteria:
•
1.
2.
•
being directly for private gain;
being in some significant respect in knowing contravention of
existing law.” See Grossman, 1977, p. 25.
These market-mediated activities are at times supportive,
helping to achieve tolerable micro-balance in the increasingly
complex economy,
–
but they often are in violation of planned implementation and regime
values.
Second Economy
• Brezhnev on second economy
– You don't know life. No one lives on wages alone. I remember
in my youth we earned money by unloading railroad freight
cars. So, what did we do? Three crates or bags unloaded and
one for ourselves. That is how everybody lives in [our] country.
– Blat markets
• 2nd economy activity necessarily introduces
discretion
– Potential for diversion
Second Economy
• Virtually every area of economic life is touched upon,
and often entangled with, ‘second economy’ activities
– legal private activity naturally opens a loophole for illegal
trading and entrepreneurship, generally below the purview of
the authorities.
• Dual contradictory roles of 2nd economy:
– First, it addresses a number of the problems of coordination
and balance endemic to the command mechanism
– But, second, it mocks the pretense of social direction and
control, subverts its egalitarian impulse, accentuating
differences in access and income, and gives lie to the pretense
of a ‘new’ ideologically correct (‘Soviet’) man
Evaluation and Size
• 2nd economy completes the cancerous development of agent
autonomy
– Generates undesirable (system perspective) redistribution of
incomes,
• although recipients, including many high placed officials, find it very
desirable.
• Size
– Estimates based on the surveys of Soviet emigrants relate to the second
half of 1970’s and range approximately between 10% and 30% of
incomes of urban households.
– An alternative set of estimates based on the Soviet-era official family
budget survey data puts the second economy at around 23% of
household income (Kim, 2003).
– Could be as large as 12% of GDP in 1979
• But double counting
Legacies
• Two types
– Structural legacies
– Institutional legacies
• Financial underdevelopment
• Absence of rule of law
– Khruschev: ”Who’s the Boss: we or the law? We are masters over
the law, not the law over us — so we have to change the law; we
have to see to it that it is possible to execute these speculators.”
• FTM
Structural legacies
• Industrial structure
– Industry bias
• Industry intentional, agriculture unintentional
• Under-provision of services
• Hypermilitarization
• Industrial concentration
– Gigantomania
– Absence of small enterprises
Distribution of Capital Stocks
Structure by Labor Force
Indicators of Raw Materials and Energy Consumption, 1988
Enterprise Size in US and Russia
35
30
25
Percent
20
15
10
5
0
50 to 99
100 to 249
250 to 999
Russia
US
1000 to 9999
GT 10,000
Hypermilitarization and Climate
• Size estimates difficult
– Pricing distorts measurement
– Cost shifting
• Defense burden unsustainable
– Locational burden
– Interaction with climate problems
• Soviet Union got colder in 20th century!
• Too many people in the wrong places
– Big problem for market economy
Location in Russia
Population of Siberia and Far East in 1989: 37 mln (25% of RF total)
Manufacturing employment: 1.8 mln (16% of RF total)
Location in Canada
Population: 85 000. (0.34% of Canadian total) Manufacturing employment:
295…people (0.017% of Canadian total)
TPC in Canada, USA, and Russia
Duluth, population = 86,000
Duluth January Daily Temperatures, 1994-2002
25
Mean:
-11.7
Coldest decile: <-22.1
20
15
10
5
-38
-34
-30
-26
-22
-18
-14
-10
-6
-2
2
0
Omsk, population = 1.2 million
Omsk January Daily Temperatures, 1994-2002
25
Mean:
-16.8
Coldest decile: <-27.2
20
15
10
5
0
2
-2
-6
-10
-14
-18
-22
-26
-30
-34
-38
Perm, population = 1.008 million
Perm January Daily Temperatures, 1994-2002
25
-12.5
Mean:
Coldest decile: <-22.7
20
15
10
5
-38
-34
-30
-26
-22
-18
-14
-10
-6
-2
2
0
How Cold is Cold?
Cold Thresholds
in Siberia
Finally,
use the
T em p.
(°C )
-6
-10
-15
Effects on Stan dard Soviet M achin er y
Internal com bustion engines require pre-start engine heaters
D estruc tion of som e standard m etal dredge com ponents
H igh -carb on steels b reak; c ar batteries m ust be heated; first critical
thres hold for s tandard equipm ent
-30
Standard c ompress ors w ith internal c om bus tion engines cease to operate;
standard ex cavator hiltbeam s break; destruction of som e tow er c rane
com ponents, dredging buc kets, and bulldoz er blades
U nallo yed steels b reak ; car-engine space, fuel tank s, and oil tank s m ust be
ins ulated; frost-resis tant rubber required; non-frost resistant convey or belts
and standard pneum atic hos es break ; som e cranes fail
M inim um tem per atu re fo r use o f an y stan dard equ ipm en t
-30 to –35
T restle cranes fail; s om e tractor shoes break
-35 to –40
A lloyed steel com po nen ts (ball b earing s, etc.) shatter ; s aw fram es and
circ ular s aws stop work; all com pres sors stop w ork ; stan dard steels and
structures ru ptur e on mass scale
-20
-25 to –30
Source: Dogay ev , cited in Mote.
10
Internal vs External Inefficiency
• Internal inefficiency
– Lack of high-powered incentives
– Input combinations and X-inefficiency
• External inefficiency
– Lack of market pricing
• allocative
• Dynamic inefficiency
– Lack of innovation
Legacy of Never-ending Reform
• Waves of reform
• Why a treadmill?
– Rejection of alien organisms
• Pitfalls of partial reform
– Cooperatives
– Supply diversion
• Timber and boxcars
Example
• Efficient rationing of timber
• Plan price = P, excess demand in housing
– Cooperatives bid for timber
• x units of timber diverted to housing from boxcars
Supply Diversion
• Notice that P* is the shadow price of timber
– With freedom to sell, timber sector sells qm to the housing
(cooperative) sector, cutting back deliveries to the boxcar
sector
– Shadow value of timber is now much higher in boxcars
• Consumer surplus falls by A in boxcars and rises by C in housing;
note A >> C
• Producer surplus in boxcars falls by B = 2C
• Notice that the problem arises because the boxcar
industry cannot compete for timber, and the capital in
that sector cannot flow to housing.
– The moral of this story is that as the state loses control over
the state sector, diversions make things worse.
– But China will be different!
Achievements
• Full employment
– By law => no unemployment insurance
– Soft budget constraint
• Free health care
– Good at infections, bad at modern diseases
• Low income inequality
– Gini Coefficient
• Ratio of the area between the Lorenz curve and OB, and the whole
area OAB.
– Wealth v income, and access to goods
Lorenz Curve
Earnings Distribution, Full-time workers
US Income of Top Decile
Social Uncertainty
• Command economy minimizes income shocks
– Full employment, socialized medicine
• Social insurance is high
– Underemployment vs unemployment
• Risk taking is low
• Institutions to cope with uncertainty in modern
economy are absent
Life Expectancy at Birth, Russia, 1958–59, 1961–62,
1963–64, 1965–2002
An Alternative Factor
• Decline of Oil prices
– When rents exploded, so did commitments
• Rents = market value of revenues less natural costs of
extraction
• Including subsidies to Eastern Europe
– When rents declined hard to cut commitments
• Resource abundance is addictive
• increase in energy investment between 1981 and 1985
absorbed nearly 90 pct of increment allocated to industry
• Production maintained by borrowing from future
– Tightened the resource constraint
An Alternative Factor
Russian Oil & Gas Rents 1970-2005
Real (2005)
USD blns/yr
$300
$250
$200
OIL
$150
$100
$50
GAS
1970
1975
1980
1985
1990
1995
2000
$0
2005
Rents and GDP
Russian GDP in 1990
PPP (1970=100)
Oil and Gas Rent
(2005 dollars)
160
150
$350
$300
140
130
120
$250
$200
110
100
90
80
70
1970
$150
$100
$50
1975
1980
1985
1990
1995
2000
$0
2005
Rents, Addiction
• Resource rents postponed day of reckoning
– "In sum, the Soviet economic system became what it is in part thanks to
the country's rich resource base, which permitted the planners largely to
ignore the day-to-day discipline of the balance of payments and therefore
also the imperatives of the market place and the pains of real economic
cost. On this basis an elaborate and rigid institutional edifice sprang up.
This economic system thrived for two human generations and achieved
marked successes by its own criteria. But inevitably it hardened and came
to be supported and protected by powerful vested interests [Grossman,
1983: 202].
• addiction to rents postponed fundamental reforms, made the
system more fragile
• The lesson is that resource abundance, misapplied, can be
addictive
Addiction
• Addiction leads to short-time horizon
– This leads to an inability to implement reforms.
• Three characteristics
– tolerance - the need for an increasing amount of the substance to obtain
the same effect
– withdrawal - severe unpleasant effects when the addict ceases to use the
substance craving –
– "willingness to sacrifice all (to the point of self-destructiveness)" in order
to obtain and use the substance.
• In Soviet case tolerance arose because windfall was used for
many new activities
– defense, East European subsidies and other international adventures
– interests created that depend on rents, makes withdrawal painful
– where is the methadone for an addicted Soviet economy?
Defense Addiction
• Marshal Akhromeev on addiction
• Why it was necessary to produce so many weapons?
Akhromeev answered:
– "Because at a great cost of many sacrifices we created firstclass factories, no worse than the American ones. Would you
order them to stop work and begin producing cooking pots?"
– Shakhnazarov described the "military-industrial mentality" as
a "cancerous growth" that had metastasized to every sphere
of Soviet life
• This is an example of addiction. The investment in
factories created interests that were very costly to
reverse.
Aspects of Collapse
• Macroeconomic
– Budget crisis, inflationary finance
• Shortages, stolen hours, more queues
• Weaker state lower tax collection
• Microeconomic
– Misallocation of resources
– Lack of property rights
– Pseudo privatization
Two Views on Collapse
• Essentialists
– Essentialists hold that the Soviet system collapsed because it was essentially
abnormal
– The nature of the Soviet system made its eventual collapse inevitable and
even predictable
• Of course, few made this prediction before the system collapsed. Autopsies
are easier on dead bodies.
• Voluntarists
– Soviet economy was murdered, or its death was decisively hastened, by
voluntary acts of policy, though the consequences may have been
unintended.
• “We tend to confer the mantle of inevitability on accomplished facts, and
arguing that what happened did not have to happen is likely to be dismissed
as inventing excuses for the losing side. But the collapse of the Soviet system
was the unintended result of a small number of disastrous decisions by a few
individuals”
Was Demise Inevitable?
• Productivity growth slowed, but never turned
negative
– The odds on overtaking fell
– Reforms upset performance
• Reforms made the system more fragile
– Monitoring costs rose and deterring corruption
became more costly
• Erosion of belief in system
– So small shocks could lead to collapse
Weakening of Central Control
• Critical difficulty for central planning
– Brezhnev Communism = Stalinism without terror
– Raises the prices of information and action
• Loss or resources at center
• Agents have two options
–
–
–
–
Fulfill the plan, F
Don’t fulfill the plan, NF
Payoffs depend on whether observed or not
Let  be the probability of being observed
Stalinist Incentives
• Let
be the payoff to NF if unobserved
• Suppose that
and
• Then the expected payoffs are
• Planners want
– Two instruments, detection and punishment
– We can plot this
Stalin v Brezhnev
• Stalinist system set punishment = - infinity
– Lowers cost of detection
• Brezhnev system
– Cheating is optimal for larger range of

• Problem is more severe with greater complexity
– Glasnost makes it even worse
– Explosion of Second Economy
– Loss of central revenue
Multiple Equilibria
• The same system can have two equilibria
– High output
– Low output
• Consider the producer’s decision to supply
effort
– Depends on gains and penalties
– And whether this is observed
Producer’s Choice of Effort
Producer works hard, if
Gain from working hard > cost
of working hard
If work is hard and
monitoring is strict, then
Work hard if reward gained + penalty
avoided > cost of effort
Gain reward for working hard, avoid
penalty for not working hard, spend
effort working hard
If work is hard and
monitoring is lax, then
Don’t work hard
No rewards gained, low effort
supplied
Dictator’s Choice
• Dictator wants to deter stealing
– Two key parameters:
• Cost of incentives provided
• Costs of monitoring
• Over time these parameters shift
– Complexity raises monitoring costs
– Weakening center (decline in oil revenue) raises costs
of providing incentives
• High output is no longer an equilibrium
Dictator’s Decision
Dictator Monitors if
Effort is high, and if
Cost of monitoring <
value of output stolen +
future output lost
Else, don’t monitor
Effort is low and if
Costs of monitoring
< output stolen +
future output loss
Else, don’t monitor
Parameter Shift
• Evolution of the system led to parameter shift
–
–
–
–
Complexity raises monitoring costs
Information flow weakens central authority
Value of incentives decreases as their cost rises
Second economy grows
• High output is no longer the equilibrium
• Reforms weaken the structure
– Do not lower monitoring costs
– Reforms make defection easier
• Cooperatives
• Law on state enterprise
Bank Run
•
•
•
•
•
Why the sudden collapse?
As center weakens officials defect
Race to cash in on assets
Solnick on the collapse
Key to bank run
– Illiquidity
– Sudden loss of trust
Solnick
• “...the image of a "disintegrating" state...is...seriously incomplete.
Soviet institutions did not simply atrophy or dissolve but were
actively pulled apart by officials at all levels seeking to extract
assets that were in any way fungible. Where organizational assets
were more specific to their particular use by the state, as in the
case of draft boards, for example, hierarchical structures proved
more resilient. Where organizational assets were chiefly cash and
buildings, hierarchical breakdown was almost total. At both ends
of the spectrum, the catalysts of state collapse were the agents
of the state itself. Once the bank run was on, these officials were
not merely stealing resources from the state, they were stealing
the state itself."
Shock to Loyalty
• Income of an official is
• Probability of detection
– Strength in numbers
• Expected value of defection
• Critical value of loyalty
Critical Loyalty Value
K
y   Kn 2
(1   )w
w
n*
1
n
Add Theft
• Race to cash in
– Each defecting agent steals 
• Not enough to steal, illiquidity
• Official income is now
• Output falls faster
– Critical value reached sooner
– Agents know nothing will be left if
The Bank Run Case
K
(1   )w   
w 
y  Kn 2
y  K 1  ( 1  n ) n 2
w
(1   )w
n*
n'
1
n
Conclusion
• Was the collapse a disaster?
• Implications for transition
– Political and economic collapse
• Is this more difficult than just economic reform?
– Macroeconomic imbalance
– Window of opportunity
– Agenda for reform?
• No blueprints
Midterm One Results
14
Mean
79.58462
Standard Error
1.471695
Median
82
Mode
89
Standard Deviation 12.40072
Variance
153.7779
Kurtosis
1.166432
Skew ness
-1.13572
Range
57
Minimum
40
Maximum
97
Sum
5173
Count
65
Confidence Level(0.950000)
3.01466
12
10
8
6
4
2
0
40
43
46
49
52
55
58
61
64
67
70
73
76
79
82
85
88
91
94
97
100