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Transformation of the Soviet economy: economic reforms and structural crisis.

This article analyses the current problems of the Soviet economy's reform process. The process of transition to a market economy in the Soviet Union, where an extreme degree of monopoly prevails, has been characterised by declining production and accelerating inflation. The rapid growth of the market sector in the situation of highly distorted and heavily regulated prices, dominance of state enterprises, and unclear property rights, leads to the concentration of entrepreneurial activity mainly in speculative operations involving the redistribution of state property, to the deterioration of the macroeconomic situation and to the deepening of the structural crisis in the economy. In fact, the growth of the market sector is based mainly on hidden subsidies from the state enterprises.

The failure of four years of economic reforms is due to inappropriate economic policy based on mythical ideas about the market economy. Rapid, radical reforms, including large-scale privatisation on the basis of development of financial intermediates, are of crucial importance in overcoming the further deterioration of the economic situation and in preventing the collapse of the Soviet economy. The most characteristic feature of structural change in the Soviet economy is its spontaneous, unmanageable character. None of the officially-adopted programmes of economic reform have been implemented. This is a result of the unrealistic character of the programmes as well as of the government's inability to implement them.

For five years Soviet economic reform has been implemented without clear goals and understanding of the real character of the crisis. The government's behaviour was driven by the short-term tasks of economic stabilisation and by mythological ideas concerning marketisation of the economy. Unrealistic plans were implemented by forces not interested in their realisation. It is not surprising that the history of the Soviet economic reform looks like a chain of mistakes and failures.

The present situation is characterised by accelerating inflation, a drastic fall in production (which has reached 10 per cent by the first quarter of this year in comparison with the first quarter of the previous year), and rupture of supply relations between enterprises and regions. The rapid deterioration of the economic situation and of living standards leads to widespread dissatisfaction with economic reform. instead of the promised prosperity people suffer from the deterioration of living standards and increasing economic chaos.

It is worthy of note that Perestroika, which pushed the centrally-planned economy into systemic changes, began from the attempts to accelerate economic growth and to overcome the increasing technological gap between the Soviet and market economies. According to our measurements the average technological gap in major industries increased from 10-15 years in the mid-1950s to 20-30 years in the mid-1980s. Since the mid-1970s it increased significantly, especially in the high-tech sector (Glaziev, 1990). Commercialisation of state enterprises and the growth of the commercial sector in a situation of unrealistic prices and hyper-monopolisation led to the further deterioration of the economic situation and a deepening of structural crises. Disparities in technological structure Will undoubtedly become one of the major obstacles to the further marketisation of the Soviet economy.

Structural crisis in the Soviet economy

The present structure of the Soviet economy is characterised by a range of technological vintages', that is, clusters of interrelated industries linked by their inputs and outputs, with a more or less homogeneous technical level. Large differences in technical level form a barrier to resource flows between industries belonging to different vintages.

In contrast to market economies, in a centrally-planned economy obsolete technological vintages are not replaced by modern ones, but continue in production. At present in the Soviet economy one can see simultaneous production by three technological vintages created in the 1930s, the 1950-60s and in the 1970-80s. These problems are increased by the overproduction of obsolete products; investments follow unchanged technological trajectories, resources are wasted in useless production and over concentrated in obsolete technological chains, and exports are concentrated in low value-added industries (Glaziev, 1991).

The simultaneous existence of a range of technological vintages is one of the major obstacles to the marketisation of the Soviet economy. Privatisation of technologically backward sectors simultaneously with price liberalisation and opening of the economy could lead to the bankruptcy of thousands of enterprises and mass unemployment. Concentration of obsolete industrial production in certain areas determines corresponding regional problems of marketisation.

These technological problems go hand-in-hand with other difficulties: over concentration of high-tech production in the military-industrial complex with a background of technological backwardness in civilian production and the uncompetitiveness of most Soviet products in the world market. Up to the present time, state enterprises are integrated into production-administrative systems (PAS), and subordinated to corresponding ministries. There is no competition between enterprises in the centrally planned economy because of administrative barriers so that economically they look like divisions of large corporations rather than independent firms. Their incentives to innovate have been limited by the necessity to fulfill tasks required of them by ministries. In its turn the ministry, being a monopoly itself, determines demand for its products through central planning procedures. It is interested neither in profit maximisation, nor in satisfying the markets where the PAS are the only suppliers. The introduction of innovations and diffusion of new technologies within the stable environment of a centrally-planned economy happens only occasionally and is not a part of management routine (see also Rassokhin, 1988).

The only exception to this is in the military industry, which faces real competition. (In fact, the top political authorities, interested in the country's prestige in the world, sporadically promote diffusion of radical innovations.) The priority given to defence tasks and the necessity to compete to fulfill them are the reasons R&D resources are concentrated in the military-industrial complex (MIC). Ministries and enterprises of MIC, in contrast to civil branches of industry, are interested in the introduction of innovations and technical growth needed to satisfy the demands of the Ministry of Defence, and are responsible for maintaining the military balance. Inside the MIC there is real competition between enterprises for getting orders and, consequently, for survival in conditions of strict administrative control. This competition stimulates research and the introduction of innovation. It is natural that the best specialists and most highly-skilled workers are concentrated in the MIC--only there can they work fruitfully.

The mechanism described above leads to stratification of the economy into two sectors with different technical levels (see also Kuznetsov and Shirakov, 1989). The priority sector, connected with the Defence Ministry and with prestige projects, exists at the expense of the other part of the national economy. The flow back of resources and modern technologies from the priority sector to the rest of the national economy is insignificant, because civil PAS are not interested in innovations, while MIC branches are not interested in spin-offs or any profitable use of technologies. This stratification prevents the technical development of the national economy and involves an inevitable decrease of its economic efficiency.

The orientation of modern high-tech industries to military needs makes the constituent enterprises uncompetitive in the world market. Production for military procurements is determined by specific technological requirements. To satisfy them, enterprises are provided with the necessary resources and subsidies, information and technologies. In fact under the central planning system they operated in a rather favourable environment. Transition to a market system raises the problems of production costs, consumer demand, intellectual property rights, and so on, which are unfamiliar to operating managers. Adaptation to this new environment will not be easy and probably not even possible for many high-tech enterprises.

Apart from military needs, another incentive for innovation is the change in priorities following the top authorities' recognition of a technological gap as significant. These innovations usually imitate corresponding technological changes in the West and are supported by import of the necessary equipment.

The imitation of the technological trajectories already passed by advanced countries is followed by the import of obsolete equipment, which leads to backwardness and poor competitiveness of national producers in the world market. By now disparities in the technological structure of the national economy have reached the critical point. To be successful economic reforms must provide the solution to the above-mentioned structural problems, including conversion of the MIC and its opening to world market competition, reconstruction of obsolete industries and regions, overcoming the uncompetitiveness of Soviet producers and fostering high value-added exports. Unfortunately the spontaneous changes of the last few years failed to solve these problems and the situation became even worse.

Trends in Soviet economic reform

In spite of the spontaneous character of Soviet economic reform, its main lines have already been formed. These include the growing independence and commercialisation of state enterprises and local authorities, the growth of the commercial non-state sector, and the weakening of state regulation. We shall now consider these features in different sectors and from different points of view. Changes in the state sector. the road to self-management

The state sector covers the vast majority of national economic production. According to legislation already adopted, the guideline for change in the state sector is the weakening or abolition of subordination to Ministries and local party authorities of the state enterprises (SEs). The responsibility for their administration by Ministries has been partly replaced by responsibility to employees' collectives, which have the right to take strategic decisions and to control administration. These moves towards self-management lead to a decline in economic efficiency in the state sector, in accordance with economic theory and worldwide experience.

Firstly, workers' motivation is determined by the short-run interests of wage maximisation. Not surprisingly wages have grown very fast since workers' collectives have had access to profit distribution. in 1989-90 wages increased four times faster than labour productivity. In 1990 labour productivity decreased by 3 per cent while wages increased by 13.5 per cent (Goskomstat, 1990a and b).

Secondly, the concentration of power in employees' collectives has led to a politicising of relations between SEs and state authorities. SEs, together with their workers' collectives, force local and central state authorities to grant them privileges. In a situation of growing social tension they usually succeed; it would hardly be possible to introduce the institution of bankruptcy in an environment of SE self-management.

Thirdly, the transfer of the right to make decisions to workers' collectives decreases innovative activity. The economic behaviour of workers has a dual character. They are interested both in wage increases and in the decrease of labour intensity. The introduction of innovation is usually connected with redistribution of personnel and increases in labour intensity. This causes worker resistance to innovation. In a self-management situation, the management of SEs does not have enough power to overcome this resistance so long as the SE is still receiving enough revenue to maintain wages at a satisfactory level. This is not difficult in the highly monopolistic state of the Soviet economy. According to some estimates, more than 80 per cent of machinery is produced by one or two enterprises (Yasin and Tsapelik, 1988). in a monopoly situation, commercialisation of state enterprises leads to price increases together with a decline in production. In general, independence of SEs in the present institutional structure of the Soviet economy stimulates inflation and increases chaos in the national economy. Because of state regulation, soft-budget constraints, difficulties with material supply, a distorted price structure which does not reflect relative scarcity of goods, shortage of goods produced, monopoly position and other business conditions the SEs, managed by workers, are pushed into decisions which from the point of view of the long-term development of the national economy are inefficient.

The first steps towards privatisation

Currently, nearly 12 per cent of Soviet GNP is produced in the private sector (Goskomstat, 1990a). in spite of its low share in GNP the private sector plays an important role in structural change and is growing very fast.

The private sector of the Soviet economy now includes four types of firm: individual and collective proprietorships, state enterprises leased by employees, and various self-management organisations with mixed property. According to the formal distribution of property rights, the last three forms can be considered to be variations of collective property. In reality, of course, a lot of cooperatives are latent private firms.

In the situation of shortage of all material resources the basic attraction of entrepreneurship in the private sector is free profits distribution. However, this advantage by itself does not stimulate the growth of production. Under the present political and economic instability, employees and managers in the private sector are oriented towards maximisation of their personal consumption. Investment in the private sector is even lower than in the state sector. in many cooperatives up to 80 per cent of revenues are distributed directly to wages without accumulation of the necessary reserves (Ekonomica e Zhizn, no. 38, 1990). Thus, redistribution of resources from the state sector to the private one in the present situation leads to a decline in investment activity including R&D expenditures. Perhaps this is a short-term effect, explained by the enormously high profitability of speculation and general political and economic instability. But even a temporary fall in investment and R&D activity could undermine further economic growth.

Another attraction of the private sector is the absence of central control over transactions of all kinds in comparison to the state sector. In particular, firms in the private sector have much more opportunities for price setting and conversion of money from bank accounts to cash. On this basis a mutually beneficial symbiosis of state enterprises and private firms emerges. Private firms receive access to cheap resources through state enterprises; state enterprise managers, in their turn, receive opportunities to redistribute income to salaries through private firms. A large number of cooperatives and joint ventures are organised on the basis of state enterprise and use their resources, equipment and workers for the fulfillment of the orders which they receive from the same enterprises. Usually these private firms are founded by corresponding SE's managers or by their friends and relatives. In fact such cooperatives and joint ventures constitute a part of the state enterprise sector which is used for privatisation of its income. Expenditures remain state, while profit becomes private.

One of the most vivid examples of this process is the privatisation of intellectual property. In the present situation state enterprises cannot prohibit the imitation of their inventions by domestic firms. In such a situation private firms use industrial espionage to use and sell inventions and know-how developed by state organisations. One widespread form of industrial espionage is the direct sale of information by specialists in state enterprises. This mechanism of new technology transfer stimulates not R&D itself, but only its transfer: not the researchers, but the entrepreneurs selling stolen intellectual products. Of course, free access to new technologies stimulates their diffusion. However, it is not clear how the necessary finance for R&D will be provided in this new situation.

Another important trend is the commercialisation of state enterprises which has developed rapidly since the adoption of legislation on joint stock companies. Typically, this takes the form of transforming a state enterprise into a joint-stock company with the shares held by other state enterprises and institutions (ministries, local authorities, banks, workers' collectives). Usually enterprises and ministries together found a commercial bank in the form of a joint-stock company and use it later as a shareholder of the transformed SE. This cross-ownership structure is typical of a form of spontaneous privatisation taking place in the Soviet economy. By the transformation of state enterprises into joint stock companies their managers get rid of state control. Shares in their enterprises are owned by other state enterprises managed by their friends. In turn, the latter also transfer their enterprises into joint stock companies and distribute their shares in the same manner. Under this scheme, managers of state enterprises receive all the rights of private entrepreneurs without any of their responsibilities. Controlling, through this crossownership structure, a large amount of state capital, they have a good opportunity for privatising the SE's profits.

Control over the market behaviour of state enterprises and banks united through cross-ownership structure is very difficult. Lack of accountability induces managers to undertake high-risk operations using cheap credits which they receive from their' banks. The latter operate with insufficient reserves using deposits of 'their' enterprises. The instability of this system gives managers incentives for short-term profit-seeking behaviour on the verge of bankruptcy. Frequently managers of state enterprises divert resources which they receive from the state supply system on a low, fixed price basis to their own private firms. This subsidisation of private firms is possible because of the lack of accountability of managers in the state sector.

In such ways the state sector subsidises the development of the private sector. This spontaneous privatisation takes place in a very unstable environment and is characterised by the short-term orientation of the new owners, corruption and large-scale stealing of state property. Under these circumstances managers of state enterprises have no incentives to increase efficiency. The instability of the present property rights structure and the worsening economic situation encourage managers into latent privatisation of the SEs' profits and their transfer to their own personal accounts in foreign banks. At the same time, on the basis of the cross-owned self-managed enterprises, strong pressure groups emerge applying to the local and central governments for cheap credits and subsidies. Their basic argument is that the state must protect them from bankruptcy, because it would lead to large distortions in the national economy and increase unemployment.

In general the spontaneous privatisation described above leads to a decline in accumulation and production in the national economy. Resources and capital drain abroad, inflation increases and the structural crisis deepens further. At the same time the interests of the most powerful groups already controlling the national economy are satisfied. The reform of this process requires radical transformation of the property rights system and will be very difficult.

Collapse of the monetary system

The present situation is characterised by accelerating inflation and simultaneously increasing shortage of resources and consumer goods. In the last few years inflation increased from 4.8 per cent in 1985 (Goskomstat, 1990a and b) to 19 per cent in 1990 and jumped to 170 per cent in April 1991 due to the price reform (Kommersant, 30th May 1991). The latter was implemented in the administrative way and did not remove shortages. Prices of basic commodities and vital consumer goods remain fixed; few prices were actually liberalised. At the same time almost nothing is happening in trade, which is still monopolised by the local and central state departments.

State monopoly of retail trade is a serious barrier between consumers and producers. Under the state monopoly retail traders have an interest in shortages, which give opportunities for very profitable illegal distribution of goods. Shortages are also a basis of their social status and prestige; therefore, under state monopoly, retail traders do not satisfy consumers' demands. Producers in this situation have no adequate information about the real demand for their products, thus inflation is complemented by shortages. This combination induces enterprises to avoid the use of the rouble. More and more transactions take the form of barter exchange. The increasing instability of the monetary system ruins production activity and stimulates speculative operations. it becomes more and more difficult to get access to fixed price resources distributed through the state supply system. In a growing number of cases neither entrepreneurs in the commercial sector, nor managers of state enterprises, know at what prices they will receive the necessary inputs in future or whether they will receive them at all. in this situation SEs are not able to fulfill their obligations to deliver products according to plan and to contracts, which leads to a crisis of under-production. Many enterprises now have to stop operating because they do not have enough raw materials to continue production and this has caused a wave of decreased production in the Soviet economy.

The production decrease is accompanied by acceleration of money supply growth. In spite of all the promises of the central government to limit the emission it continues to grow very quickly. New money creation increased from 4.7 billion roubles to 18 billion in 1989 and to 27 billion in 1990 (Goskomstat, 1990a and b). The level of 1990 was reached already in the first quarter of 1991, for the whole year it would amount to about 40 billion roubles. Together with credit emission this would amount to 130-140 billion roubles.

The State bank has to cover government expenditures, which are growing much faster than the state budget revenues. The latter in the first quarter of this year were 70 per cent less than planned, for two main reasons. First, most of the republics refused to pay their contributions to the all-union budget. In spite of continuing debate about all-union treaty, they have already spent a large part of this money on social programmes of their own. Second, the tax revenues were much less than planned because of the extraordinary fall in production. At the same time the central government cannot limit its expenditures to the amount of revenues without danger for the major all-union institutions: the army, military-industrial complex, police, educational and medical services, Academy of Science, and so on. Thus, the state budget deficit in just the first quarter of 1991 reached the amount (27 billion roubles) which was planned for the whole year.

The all-union state budget deficit is complemented by republican and local budget deficits. Their expenditures grew during the last year because of the increase in subsidies to retail trade to keep prices down when wholesale prices were rising. With price reform this burden becomes easier. But at the same time republican governments and local authorities, in search of popularity, have adopted many expensive social programmes including compensation for price increases. Social programmes have now become an important argument in the political struggle between the centre and the republics. This competition in social welfare between bankrupt governments is financed through credits from the all-union and republican banks.

The budget deficit is an important, but not perhaps the most important, source of excess money supply growth. The chaos in the banking system has led to a sharp increase in credit emission. Commercialisation and decentralisation of the banking system in 1990 was not accompanied by the introduction of adequate regulation. in spite of the adoption of the banking law there are still no mechanisms to prevent excess credit emission.

Access to financial markets continues to be easy. There are some 2000 commercial banks now in the country and their number continues to grow very quickly. However the majority of them are cross-owned by SE and government industrial bodies. Privately owned shares in banks (belonging to cooperatives and joint ventures) amount to 10 per cent of the total. As explained below, the state cross-ownership structure has not provided enough control over managers' actions. The latter operate with the capital of state enterprises which also have no responsible owner. This lack of responsibility is complemented by the confidence of financial managers that large banks are too important to be allowed to fail'. They seek to grant as much credit as possible in order to become more important'. At the same time the republican central banks act in accordance with these expectations, giving guarantees to the deposits in commercial banks. in turn, the State bank provides commercial banks with liquidity in the amount they need. It is not surprising that in this situation many commercial banks are operating almost without reserves, relying on assistance from the state in the case of difficulties.

The Soviet monetary system has now reached a point where hyper-inflation is inevitable. it seems that the central and republican governments have given up and make no attempt to prevent monetary and credit emission. The state and republican banks satisfy all commercial banks' requirements. These requirements are supported by republican and local authorities fearful of the crisis which may be caused by the local banks' collapse. in supporting the commercial banks, the authorities are trying to prevent the situation in which the collapse of a bank can lead to the loss of state enterprises' deposits accumulated for the payment of salaries. At the same time these banks are used by enterprises (their owners) and local authorities as the source of cheap credit. in this situation the Central government turns out to be too weak to protect the State bank from the pressure of republican banks and local governments. it prefers to force the State bank to satisfy commercial banks' requirements for credit, together with its own demand for credits to cover the budget deficit. In this vicious circle both central and republican authorities as well as managers of state enterprises have an interest in excess credit emission, while seeking to benefit from inflation.

Changes in foreign trade

One of the first steps of economic reform was to abolish the state monopoly of foreign trade. In 1988 all enterprises formally received the right to export and import. To use this right an enterprise has to register itself as a member of foreign economic relations oust a formal procedure) and to receive a licence either from the ministry responsible for the export of a particular product, or from the Ministry of Foreign Economic Affairs. Licences are needed for some import operations also.

Another important innovation in this sphere was the increasing access of enterprises to hard currency. The latter may be purchased at the auctions held by the Foreign Economic Bank (Vnesheconombank) and several other commercial banks, or may be received from exporters in exchange for supplying them with intermediate products. in reality both of these sources were used quite rarely. Most imports are purchased by exporters using their export revenues and by the Ministry of Foreign Economic Affairs according to the decisions of central government.

The circulation of hard currency is still heavily regulated by Vnesheconombank. Up till this year it had a monopoly of all financial operations requiring hard currency. It was the only bank where Soviet enterprises could keep foreign currency. At the same time Vnesheconombank managed the government's foreign obligations. Being the state monopoly, Vnesheconombank had no responsibility for its operations-usually it takes a long time for enterprises to receive their foreign currency deposits. This monopoly was abolished this year by the All-Union Parliament Act on currency regulation, which implements the procedures of providing the banks with the licences to conduct foreign currency operations.

At the same time the new order for foreign economic transactions was implemented. it abolished numerous rouble exchange rates and introduced a tax for export and import operations as well as new customs tariffs. The main purpose of this tax is to prevent speculation on the price difference between internal and external markets. It varies between 20 and 1300 per cent.

It is worth mentioning that the price structure in the internal market differs greatly from the price structure in the world market. The purchasing power rouble-dollar rate varies from 0.03 for computers to 6 for steel scrap and even more for other raw materials and military equipment (Lvov, et al, 1989). Due to this difference commercial non-state foreign trade is concentrated in purely speculative transactions. For example, the export of steel scrap in exchange for import of computer equipment gives a profit rate of several thousands per cent, which is completely impossible to achieve in manufacturing. Under price control these speculative operations do not lead to changes in the relative prices of goods, which are kept at levels which offer artificially high profitability. The growth of raw material and energy exports in exchange for high value-added goods is stimulated, which leads to the further deepening of structural crisis in the economy. The heavy administrative regulation, including several thousand exchange rates, worked as a counter balance to the incentives offered by disparities in prices.

As was mentioned above, with the introduction of the new order for foreign economic transactions the multitude of exchange rates was replaced by the export/import tax, which increased the profitability of foreign transactions.

At the moment, foreign exchange transactions between enterprises and the state are effected at the fixed commercial exchange rate which is still artificially low. At the same time in transactions between enterprises and between persons the free market exchange rate is used. With further price liberalisation a gradual relaxation of state regulation of foreign trade will take place.

At the start of the reform high expectations were attached to foreign capital investment. Huge privileges were granted to joint ventures in 1988-9. Now direct foreign investment also benefits from the privilege scheme. However, the results turned out to be disappointing. Total foreign investment in the Soviet economy does not exceed 2 billion dollars. Among nearly 3000 registered joint ventures less then 1260 were actually operating at the beginning of May (Goskomstat, 1991). The majority of joint ventures were organised by Soviet bodies in order to receive privileges and opportunities for the export of capital. Political instability and shortages continue to be serious obstacles to business in the USSR.

Regional separatism

The USSR is a multi-national state, uniting populations with large differences in culture, mentality, and economic behaviour. For decades cross-national and cross-cultural differences and contradictions as well as national movements were suppressed by the communist regime with its ideology of proletarian internationalism. But this suppression did not destroy the cultural roots of different nations, and immediately after the weakening of the core institutions of the empire one could observe the fast growth of national movements. Some of them have the character of national consolidation, delayed by communist suppression, others are movements of cultural rebirth of already existing nations. Both of these movements include a strong political trend for national sovereignty and independence. All the republics have already declared their sovereignty, and six of them refused to sign the all-union treaty, considering themselves to be independent states. National separatist movements are accelerating in other republics, including the Russian federation. The deterioration of the economic situation induces republics to limit their exports to other regions and to introduce rationing of consumption. Some of them, including Russia, started the organisation of their own customs services. The trend towards autarchy of the republican economies is becoming one of the most important factors in the collapse of the all-union market.

The diversity of the Soviet economy's spatial organisation is so substantial that it makes preservation of the Union as a federation during the transition to a market economy hardly possible. Citizens of each region consider the different market behaviour in the other regions as a threat to their economic and political independence. For instance, aggressive expansion of family corporations from the SouthAsian islamic regions in the Russian market can lead to the establishment of illegal monopolistic control over certain sectors of it which would increase social tension and stimulate national separatist movements. Thus the collapse of the USSR is the natural result of democratisation of the Soviet political order and marketisation of its economy. Diversity of the Soviet socio-economic order has become a clear barrier to marketisation and further economic development.

However, not all republics have an interest in the collapse of the Union. The Islamic republics of the second region can hardly avoid the pauperisation of their population and a social explosion in the event that the Union collapses. Without huge investments from the Centre they could not avoid also environmental catastrophe due to drying up of the Aral Sea and a critical shortage of drinking water. Currently, these republics are bastions in the All-union authorities' struggle with republican separatism. However the Slavic republics have no interest in keeping this link and probably will try to throw off the Central Asia burden. The Baltic states and three other republics have already declared their willingness to leave the Union and are now seeking to integrate their economies into the world market.

Separatism emerges not only on a national base. Destabilisation of the monetary system, destruction of existing business relations and the collapse of the state supply system induce regions to introduce trade barriers and control over production on their territory. Local authorities introduce rationing of consumption by the population and by enterprises. The collapse of the monetary economy induces enterprises and local authorities to found trade associations for barter exchange. To do this, they have to organise a local planning system with administrative control over the enterprises' production. The further deterioration of the economic situation and the growth of social tensions lead to the splitting of the country into many regions with their own local planning systems.

According to the legislation on local self-management and economy, local authorities receive several important rights for the regulation of business activity, including the registration of firms, the introduction of local taxes and granting tax privileges. To use these rights efficiently, authorities must be able to conduct an independent economic policy, which is almost impossible in the politicised state of business relations which has followed on from the self-management trend in SEs. Workers' collectives of self-managed SEs form strong pressure groups inducing local authorities to grant them various privileges and to arrange cheap credit. Strong pressure comes also from local entrepreneurs who seek protection from the central regulation of production, income distribution, foreign trade, and so on. In a situation of growing corruption at all levels of the state hierarchy, these pressure groups are very successful. A symbiosis of local bureaucracy, entrepreneurs, workers' collectives and political leaders emerges and leads to the establishment of a semi-planned, highly corrupt and inefficient economic order in autarchic regions.

Summary: 'Yugoslavisation' of the Soviet Economy As was described above, the real effects of economic reform are far from those expected. Transformation of SEs on the basis of self-management, increasing rights of local authorities and weakening of conventional state institutions have led to progressive destruction of the central planning system. In the absence of regulatory authorities appropriate to a market economy this leads to hyper-inflation, a shift in resources, income distribution towards consumption and away from investment, growing social inequality, falling output and the collapse of the national economy into autarchic regions. By now one can see the disorganisation of the consumer market and introduction of various forms of consumption rationing, rapid growth of money and credit emission, a reversion to barter, increase in social tension, and national and regional separatist movements. These trends have emerged spontaneously as unintended consequences of the implementation of economic reform.

The current economic debate: looking for away out

One of the main positive results of failure in the economic reform process was the discrediting of several myths which had a great influence on Soviet decision-makers as well as on public opinion. First of all, there was the myth about private property, according to which the employment of labour by a private entrepreneur was considered to be exploitation (which means according to Marxist interpretation the appropriation by capitalists, of the unpaid labour of employees). Communist ideology regards any kind of production based on private property as socially unjust. Only two forms of production organisation are considered acceptable - those based on either state or collective property. it is not surprising that structural changes in the Soviet economy tended towards self-management-the latter was in accordance with communist ideology. After the bankruptcy of an economic order based on state property, the only ideologically acceptable reform was on the basis of collective property.

Thus, Soviet economic reform was determined not by economic studies and theory, but by ideological doctrine. it was only after a number of 'socialist market' construction failures that a rational approach to economic reform was adopted. The turning point was the adoption of the '500-days' programme by the Russian Parliament in September, 1990, and The basic guidelines' by the all-union Parliament a few weeks later. This was the first officially adopted programme, which was free of ideological 'blinkers' and included obvious measures for the transition to a market economy, such as restructuring of the financial system, privatisation, price liberalisation, opening of the economy.

The new phase of economic reform, opened by the '500-days' programme, can be described as the market romanticism period. Official government documents declared a quick transition to a market economy as a main goal of economic reform. Many programmes for marketisation of different sectors of the Soviet economy appeared. Most of them consist of new legislative proposals and advocacy of the establishment of new institutions. The latter was not difficult to put into practice and now the Russian government has several market' bodies (like the Antimonopoly Committee or the State Property Fund) responsible for the organisation of corresponding activities. The only problem is that very few things happen in reality-high activity in the formation of new organisations and new legislation is not followed by business activity and economic growth. Structural changes continue to go on spontaneously in spite of economic programmes. The present market propaganda is similar to the former communist propaganda. The leaders of the economic reform are sure that they can build a new market society on the basis of a good programme. Each new economic reform leader promises to achieve economic prosperity in not less than 1 1/2-2 years. Unfortunately, not many economists and political leaders understand the scale of social changes necessary for the transition to a market economy. At the same time public opinion polls demonstrate that the majority of the country's population is not yet ready to take on board the reality of the market economy. Many regard it as a kind of automaton producing consumer goods in abundance and not as a system of more or less harsh competition. People do not understand well the tie between market incentives for production activity and price liberalisation, between economic growth and competition, between market and property rights.

The key institutions of a developed market economy-entrepreneurship and competition-are based on the corresponding mode of economic behaviour, cultural stereotypes, and business ethics. Market legislation and formal institutions can work only in an appropriate social environment. in contrast to the market economy, the basis of operation of the central planning economic system is status relationships. People's status in society is determined not by their personal qualities or the utility of their activity but by their place within the social hierarchy where upward movement to a large degree depends upon factors such as family connections and friendships, personal preferences of bosses. A competitive market system can hardly arise in such a social environment except after many years.

A market system where competition is not sufficiently developed does not lead to economic prosperity. Such an economy is characterised by a high rate of inflation, corruption, low efficiency of production, sharp differentiation in the living standards of the population, and social tension. So we should not be surprised that the growth of market forces under the extreme degree of monopoly, characteristic of the Soviet economy does not lead to increased efficiency of production and greater supply of goods but to price increases, falls in output, and shortages.

The biggest paradox of the current economic reform is that up to the present moment practically no attention has been paid to the development of competition. Simultaneously with the abolition of some ministries, corresponding PAS have born again in the form of cross-owned associations and amalgamations of enterprises controlling whole industries and managed by the same people.

Development of competition is the key problem of the economic reform which can hardly be solved within a short time. It would not be sufficient to adopt laws limiting monopolisation and promoting competition. Legislative activity should be supplemented by active measures on the part of the executive authorities aimed at breaking up the existing monopolies, creating favourable conditions for new competitive firms to enter the market, and so on. Direct subsidies from the state would be necessary for reconstruction and modernisation of hopelessly obsolete and uncompetitive enterprises in order to avoid the growth of social tension and the transformation of some cities and regions of the country into areas of social disaster.

In this situation state intervention as a substitute for the absent mechanisms of market self-organisation becomes inevitable. During the transition period such state intervention would be necessary in order to compensate for the undeveloped state of competition, to break up monopolies and to set up competitive business structures. Obviously, the activities of the state bodies would not be able to compensate fully for the lack of institutions of market self-regulation. For a long time the national economy would operate on the principles of state capitalism. Such an economic order is typical for developing countries and its efficiency depends to a decisive degree upon historic traditions, competence and honesty of state officials, and responsibility of those in charge of mixed state-private capital.

Coming back to the current economic debate, it should be noted that it is concentrated on two main subjects-stabilisation and privatisation of the economy. As for stabilisation, the majority of scholars as well as politicians responsible for the reform have the same view on the requisite methods: reduction of budget expenditures, transformation of the banking system, price liberalisation. It is not clear, however, how to put these methods into practice. As for privatisation, one can see quite opposite views in current economic and political discussion. The rest of the article is devoted to this subject.


The privatisation of the major part of state property is considered in the economic reform debate as one of the key pre-conditions for the successful marketisation and reconstruction of the Soviet economy (Lewandowsky and Ssomburg 1990; Chubais and Vasiliev, 1990). However, its practical implementation is rather difficult. The task of mass privatisation of state property in a country where the institutions of the capital market do not exist has no precedent in the world experience of privatisation. Standard methods of privatisation could not be applied directly in this case. Several necessary pre-conditions for this are lacking. First, the evaluation of state enterprises' assets is impossible because there is no information about their expected profitability after price liberalisation and abolition of central planning. Second, there are no institutions for buying and selling securities, in particular, no stock exchange. Third, there are no organisations capable of performing the task of stock placement and of servicing the privatisation process. And, finally, the population does not have sufficient funds or inclination for saving especially in the form of securities) to generate demand adequate to balance the supply of public property.

These 'technical' difficulties of privatisation in a country with a command-run, economy are supplemented by considerable social problems. The population is concerned about the issue of maintaining social justice during the privatisation of accumulated state property. In accordance with the official ideology and public opinion, state property is a common heritage of all the people which belongs equally to all members of society. On these grounds numerous suggestions of how to divide it fairly are produced as well as protests against its sale for cash which, in the popular view, is amassed by thieves, speculators and bribe-takers. However, if state property is given away free of charge also, this would not solve the problem of social justice because under any procedure of privatisation a considerable part of the population would be left out due to speculation and spontaneous changes of the market situation.

Two major approaches to wide-scale privatisation of public property in the socialist countries have been identified so far and discussed in the literature (Nuti, 1990). The first of them may be defined as a centralised method or 'privatisation from the top'. This approach envisages establishment of a specialised state body possessing the rights of ownership and disposal over the public property and charged with the task of implementing the privatisation. This body would transform public enterprises into joint-stock companies and subsequently sell their stock directly or through specially-established state investment funds. Stocks would be sold according to a plan approved by a higher legislative or executive authority and within a stipulated time schedule. A simpler procedure by-passing the joint-stock stage may be employed in the case of small and medium enterprises during their sale to private owners or leasing.

This option envisages, sale of state property to individuals and organisations willing to buy it for cash. Here the main danger lies in the high probability of negative social implications. The majority of the inhabitants have very small savings and the aggregate demand of the population for public property in the event of its privatisation would amount, according to various estimates, to no more than 10 per cent of its residual value. Obviously, the overwhelming majority of the population would not be able to participate in this 'auction sale' while an insignificant number of millionaires would have the chance to buy public enterprises ridiculously cheap. In the most advantageous position would be the entrepreneurs who would be able to use for these purposes funds of the state enterprises through banks and holding companies controlled by them. Perhaps this redistribution of wealth would be economically efficient, but it is not socially just from the point of view of the majority of the population. in particular, strong social resistance would emerge towards attempts to sell state property to foreign firms whose position is more favorable due to the low rouble commercial exchange rate. If we employ the black market or present commercial exchange rate of the rouble it is not hard to estimate that the overall aggregate demand of the population for the state enterprises' assets would not exceed several billion dollars. So the purchasing capacity of the total Soviet population equals that of an average foreign investment bank.

This option envisages super-centralisation of the state property's management within a state department responsible for privatisation. Together with investment funds it would become a kind of 'superministry' concentrating the functions connected with the disposal of state property. Such a degree of concentration of executive authority in a single state body is not desirable. The growing corruption of the executive authorities of the state may well lead to a virtual merger of the state departments in charge of privatisation with Mafia-type domestic and foreign entrepreneurial organisations.

The concentration of the former public property in the hands of the 'shadow economy wheeler-dealers' and foreign companies against the background of progressive pauperisation of the majority of the population is rather probable in this case. Such a result of privatisation would obviously be regarded by the majority of the population as socially unjust. A large number of people would not simply be left empty-handed as a result of the distribution of public property but would lose their former rights and status, however formal, as its owner, as well. This would bring forth mass protests which would not be limited to meetings, demonstrations and strikes only but would include forced seizures of privatised enterprises, and destruction and plunder of privatised property as well. Such developments, in their turn, would lead to growing repression on the part of the state and, on the other hand, would increase the popular appeal of left radical parties. The destabilisation of the political situation might result either in a halt to the privatisation process or in establishment of a repressive authoritarian regime. Whatever the orientation of such a regime-whether leftist or rightists-such an outcome to mass privatisation could hardly be regarded as desirable.

The second approach to privatisation may be defined as privatisation from the grass roots'. In accordance with this approach public property is equally distributed among the population with the help of specially-issued vouchers. Each citizen receives an equal number and may exchange them for a share of state property during its privatisation. In this case the latter would take the form of an outright sale of items of public property to the population, either on a whole company basis or in the form of shares during public auctions (bidding in exchange for the vouchers).

From the formal point of view this version satisfies the requirements of social justice by allotting to every citizen of the country an equal share of the public property. However, its implementation is rendered problematic by the ignorance of the majority of the population about the operation of financial markets. Under this approach the sale of state property would assume the form of an unmanageable wave of speculative transactions which would leave the majority of the population duped while the former public property would be concentrated in the hands of a small number of well-organised entrepreneurs. And though this version provides for equal starting conditions for everybody those left empty-handed would feel themselves victims of a wide-scale and malicious fraud. Besides, such an abrupt and spontaneous change of ownership of a part of enterprises functioning within the national economy would inevitably lead to disruption of many business relationships and disorganisation of production and cause a sharp drop in output. The probable outcome of this version of privatisation is similar to that of the previous one.

Thus both types of privatisation of state property in their pristine form are unrealisable due to social and political reasons. As a way out, a mixed' approach must be found which would be manageable and would depend to a minimum degree upon officials while promoting the increased efficiency of production and satisfying the demands of the population for social justice. The following features of the 'mixed' approach can be enumerated.

1 . The creation of special institutions of privatisation which function independently on a commercial basis and compete with each other. This role can be assumed by investment funds between which the stocks of reorganised public enterprises would be distributed. These funds must be economically independent and responsible. Therefore they should not be subordinated to the executive authorities and, at the same time, should have clearly defined criteria for the evaluation of their activities.

2. The partial utilisation of vouchers in order to increase the population's demand for privatised property and to reduce social tension. Vouchers should be distributed among the population simultaneously with privatisation of the respective parts of the public property. At the same time these vouchers should cover only a part of the value of the state property offered for sale in the form of stock of privatised enterprises. The balance should be paid for in cash by the population and sold in packages to the interested institutional investors, including foreign companies.

3. Timing of the privatisation process: To determine the market value of the privatised enterprises a part of their stock may be left in the state treasury without voting rights as a kind of reserve fund. These stocks would be offered for sale at the final stage of the process when the market value of privatised enterprises is determined.

The All-Union Law on guidelines for the destatisation and privatisation of enterprises permits the use of different approaches. An example of the mixed approach described above is currently being developed in the Russian Federation in the process of implementing the Law on privatisation adopted this summer. According to this Law state enterprises should be transformed into joint-stock companies by the State Committee of State Property Management and their shares should be offered to the public by the State Property Fund which operates on a commercial basis. State property will be sold for roubles and vouchers which will be issued in a sequence of blocks and distributed among the population free. Any citizen or firm including foreign ones according to corresponding legislation, but exchanging state-owned ones (where more than 30 per cent of the shares belong to the state or to state enterprises) can purchase the state property offered for sale.

The choice of privatisation scheme depends not only on economic efficiency criteria--political and social resistance as well as the prevailing mentality of the population should be taken into account as factors of crucial importance. The main difficulties lie in the public's negative image of entrepreneurs. In the popular view, entrepreneurial behaviour is considered dubious. For this reason, a privatisation scheme which favours entrepreneurs would be viewed as massive theft of state property. Privatisation must accord with society's ideas of justice. At the same time it must be economically efficient. To satisfy these requirements a privatisation scheme must satisfy the following criteria. First, forms of privatisation must stimulate long-term investments. Second, privatisation must introduce clear and strict economic accountability of entrepreneurs and managers. Third, privatisation procedures and forms must be capable of being understood by the participants in this process. None of the pure privatisation schemes satisfy these criteria. The vouchers scheme must be complemented by special institutions of capital accumulation. To be efficient, these institutions must be managed privately, but to provide a socially justifiable distribution of public property they must be mutually owned. This contradiction may be eliminated in the following way, which is similar to the pension privatisation scheme implemented in Chile.

Having received vouchers, people put them into mutual investment funds which may be founded by any firm. These investment funds belong to the people who have invested their vouchers in them, and they are managed by private firms. The latter carry full responsibility for the investment fund operations. These firms guarantee a certain level of profitability. if profitability is below this level, the firm managing the investment fund is announced bankrupt and all investors can transfer their funds to another investment fund. As a last resort, the state guarantees the minimum level of profitability of personal investments. At the same time, to limit opportunities for corruption and to avoid high risk investments, some restrictions on the structure of mutual funds' portfolios and a mechanism for their control by the public and government should be introduced.

It is sensible to have mutual funds of different type in the economy and to let citizens choose the best. One type can be pension funds with strong restrictions on portfolio structure and government guarantees. Another one can be investment funds with a reserve system of their own and some government support. The third one can be investment firms operating at their own risk without any guarantees. The special Act should provide opportunities for citizens to transfer their contributions from one fund to another and to allow the market to determine the most efficient distribution of capital. It is sensible to set up a Central Investment Bank, which will keep the reserves of the mutual investment funds and will be managed by them. This bank can issue bank notes which in the event of hyperinflation could play the role of a parallel currency.

If this scheme is implemented mutual investment funds will become one of the main investors in the economy. Private firms would manage them for a commission to the mutual benefit of the population receiving dividends. Competition between management firms for investors' funds would induce them to operate efficiently on the financial market. According to this scheme, citizens' investment funds cannot lose the capital they received under the voucher scheme. Their dividends are guaranteed by the mechanism of investment funds' competition and by the government which controls the operations of investment funds and plays the role of ultimate arbiter.

The key idea of this privatisation scheme is the formation of special financial institutions which could accumulate savings and vouchers for long-term investments in the privatised state enterprises. The mutual investment funds described above will provide an institutional framework for the formation and stabilisation of the capital market. This institutional structure for the capital market will promote long-term investment activity and would provide the basis for successful stabilisation policy if accompanied by reform of banking and the state financial system.


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Author:Glaziev, Sergei
Publication:National Institute Economic Review
Date:Nov 1, 1991
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