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Why economic reforms fail in the Soviet system - a property rights-based approach.


Why do economic reforms fail in Soviet-type systems despite the obvious interest of ruling groups in improving the performance of their ailing economies? The author applies a property rights-based analysis stressing modes of rent-maximization by ruling groups as a crucial explanatory variable. Party apparatchiks and economic bureaucrats particularly benefit from persistent interference in the economic sphere and consequently are most interested in maintaining the status quo. The author surveys the impact of these motivations on the content of economic reforms, outlines the strategies of counterreformers and predicts the future of reforms in Soviet-type economies.


In analyzing the disequilibrium characteristics of contemporary Western economies, Mancur Olson [1982; 1984a; 1984b] agrees with the neoclassical macroeconomists in finding that, given the tendencies of markets to clear and given the rational expectations of economic agents, any disequilibrium indicates that all mutually advantageous transactions have not been consummated. Having made this point, however, he asks what can make agents ignore the potential gains from unconsummated transactions and turns his attention toward the structure of incentives, and thus of institutions and policies. Olson insists, and rightly so, that a satisfactory static and dynamic macroeconomic theory has to explain who, among key actors, has the incentive to generate economic growth and equilibrate the economy and who does not. Furthermore, no government, even an authoritarian one, has an incentive to generate serious recessions or disequilibria. Olson [1984a, 637] writes that even in dictatorial systems, the dictator has an incentive to make the economy of the country he controls work better, since this will generate more tax receipts he can use as he pleases and usually also reduce dissent."

Olson's arguments about incentives, institutions, and disequilibria offer an ideal basis for an inquiry into why reforms fail in Soviet-type economies (STEs). In Olson's theories of incentives, the old Roman principle of criminal law cui prodest (who gained) is applied to modem economies, and the results suggest that, contrary to widespread opinion, it is not necessarily the "small but powerful group of high and highest leaders" that stands to gain most in terms of power and privilege from "the preservation of the existing order." A powerful political elite could satisfy its desires for both power and privilege through an alternative undemocratic system, one which involves authoritarian "don'ts" rather than totalitarian "do's." In that perspective, the inefficient system of economic control typical in STEs, involving centrally planned production goals and input rationing, would not be a condition sine qua non of an authoritarian solution. Since totalitarian command and control systems persist, however, one must seek groups other than the powerful and privileged few which have incentives to resist reforms and keep the economy inefficient.

The following sections identify the membership and motives of groups having strong incentives to keep the STEs inefficient and prevent successful (i.e., market-oriented) reforms. We show how those groups operate, and analyze their effects on the economic performance of their countries. First the incentives for these groups to prevent decentralized management in the state sector are spelled out. Then, their incentives to prevent the expansion of the more efficient private sector are outlined. Third, having identified who benefits from the status quo and why, the paper discusses when and how market-oriented reforms are aborted, limited or reversed by those who stand to gain from the reforms' failure. The last two sections consider the prospects of current attempts at economic reform in three specific countries: Poland, the USSR, and China and the prospects for economic reform in STEs more generally.


Disincentives to Decentralized Management in the State Sector

Most analyses of Soviet-style systems focus excessively upon the distribution of power and neglect the distribution of wealth across the ruling stratum. By contrast, in an incentives-oriented analysis the distribution of wealth becomes the focus of attention. Power and privilege are viewed as means to acquiring wealth, and the desire to acquire wealth motivates the actions of the ruling stratum.

This shift of analytical emphasis does not mean that power and its distribution do not matter. On the contrary, the rulers of an STE may regard control over the working population as satisfying their need for power, either as an end in itself or as a means to attaining some long-run goal, such as the creation of "true communism." It is important, however, to realize that the means by which wealth is distributed is crucially important in determining the attitudes of elements in the ruling stratum toward decentralizing, market-oriented reforms. Without considering this issue, it is difficult to explain why economic reforms-badly needed by the rulers themselves to correct flagging economic performance-did not materialize or, if they did, why they failed or at best brought about very little improvement in economic circumstances.

At this point, Douglass North's explanatory framework for the structure and enforcement of property rights, as well as their changes over time, should be brought into the picture. Applying what North [1979] calls a predatory theory of the state to the Soviet-type state, two, sometimes conflicting, objectives of such a state are identified:

(1) to provide a set of public goods and services designed to lower transaction costs and increase the efficiency upon which the growth of wealth is predicated. (In non-STEs economic growth is synonymous with the growth of wealth, but in the STEs the two are distinct. For this argument see Winiecki [1986a]); and

(2) to specify the fundamental rules of the property rights structure, i.e., the ownership structure in factor and product markets, in a way that maximizes the rent flowing to the ruler and the ruling stratum. The fact that this structure is extremely muddled in STEs is irrelevant, since such muddle, i.e., the dominance of non-exclusively owned resources in the state sector, actually facilitates the expropriation of rent.

At this stage, two of North's [1979] reservations about predatory states must be addressed. First, he saw complications arising for such states from the advent of representative government. Soviet-type states, however, despite their coexistence with states having representative government, clearly have pre-representative governments and, accordingly, can be easily analyzed within the basic predatory state framework. Second, North [1971] also pointed out that his model, predicated upon profit-maximization, does not hold if social reformers change institutions so as to benefit groups other than the rulers and profit-makers. However, contemporary Soviet-type states lack profit-maximizing institutions, and the existence or non-existence of social reformers at the beginning of such states is irrelevant. Indeed, any impulse for social reform in the founders of the Soviet-type states quickly degenerated, and the ruling stratum established property rights that maximized their rent. The process has been criticized by insiders such as Trotsky [1937] and Djilas [1956].

The following hypotheses now arise from these considerations:

(i) In STEs the fundamental conflict described by North [1979], i.e., the conflict between efficient property rights designed to lower transaction costs and increase wealth and inefficient property rights designed to maximize rent to the ruling stratum, is strongly in evidence; and

(ii) in such states the nominal ruler will avoid offending powerful groups in the ruling stratum, i.e., the apparatchiks and economic bureaucrats, who benefit most from the institutional and economic status quo.

In STEs the rulers agree to maintain a property rights structure favorable to those groups, regardless of the effect upon efficiency. In fact, modes of wealth distribution resulting from the STE structure of property rights differ so much from those in other pre-representative government states (i.e., traditional and "modem" autocracies), that institutional change leading to lower transaction costs and increased wealth is much more difficult to achieve. No STE, for example, has replicated the successful, efficiency-enhancing institutional changes of "authoritarian" South Korea or Taiwan.

In "old" autocracies the ruling stratum consists of either the traditional hierarchies or elites based on the military and the police. These appropriate to themselves a larger share of created wealth than they would obtain under a representative government. They get higher salaries and more "perks", while their status symbols (articles of conspicuous consumption or modem professional equipment) have a priority claim upon the state budget. According to Winiecki [1986] however, the rulers of an STE preside over a ruling stratum consisting of these four pillars of the system: communist party apparatchiks, economic bureaucrats, the police, and the military. All may (and do) receive a larger share of the created wealth than is true in representative states. Their salaries may be relatively higher and their "perks" relatively more important in the STE shortage economy. So far, the mode of wealth distribution appears to be the same as in "ordinary" autocracies.

In the STE, however, another mode of wealth distribution exists that maximizes the rent of two particular segments of the ruling stratum: party apparatchiks and members of the economic bureaucracy. This mode, unknown in other systems, enables these groups to benefit from their protracted interference in the process of wealth creation itself. There are two interconnected ways in which this is done.

The first is through the principle of nomenklatura, i.e., the right of the communist party apparatus, from the central party committee down to the enterprise committee, to "recommend" and "approve" appointments for all managerial positions in the economic (and public) administration and all managerial positions in enterprises. These appointments are made primarily on the basis of loyalty rather than managerial competence, and apparatchiks usually appoint themselves and their friends in the party to those well-paid jobs. Nomenklatura has adverse effects for at least two reasons:

(i) it signifies a severe limitation on the pool of talent from which managers are drawn; and,

(ii) given the well-known negative selection process under totalitarianism, the pool of nomenklatura-included talents is not only smaller but also of lower competence relative to any other pool in the society with similar occupational, age, sex, and other characteristics.

Since loyalty is the foremost concern, managers, once appointed, are evaluated on the basis of their loyalty as measured by their compliance with commands (e.g., achieving planned targets or meeting ad hoc commands) rather than their efficiency (e.g., producing desired outputs at least cost). Of course, loyalty to one's own superiors is not necessarily perceived by subordinates as involving an obligation to fulfill commands to the letter. Winiecki [1988a] reports that falsified reports on economic performance are the rule rather than the exception in STEs. Falsification continues, perestroika or no perestroika.

Does the preference for loyalty to one's superiors over real performance signify the dominance of power or ideology over wealth considerations? Since the power of the party and the ruling stratum has rarely been threatened, while a relative neglect of real performance vis-a-vis loyalty has been a constant in STEs, the answer appears to be in the negative. Bureaucrats and apparatchiks learned long ago that their wealth does not depend primarily upon ideology or upon creating social wealth but upon the rents they extract through their control of the wealth creation process. Thus, loyalty to superiors is important in struggles between various coteries within the ruling stratum who position themselves to extract more benefits from the inefficient economic system (Hillman and Schnytzer, [1986]). Power or ideology considerations alone, i.e., the attempts of any one group to set an ideologically different course for the party, rarely dominate.

A major mode of rent extraction involves the system of side payments or kickbacks from managers of (primarily industrial) enterprises. In a shortage economy these kickbacks are mostly of a non-pecuniary nature. Enterprise managers offer to those who appointed them, and to other superiors and colleagues who may advance their careers a variety of goods and services, and have the opportunity to benefit in the same way. More often than not these side payments involve goods in short supply which have a high black market price. These goods are, however, sold to favored people at list prices or even at reduced prices because of allegedly "lower" quality. (Actual lower quality goods do, indeed, reach the market en masse, but kickback-related goods are carefully selected for high quality!) These offers may include delegating workers from auxiliary factory divisions to build country houses at sharply reduced prices, to build one-of-a-kind furniture for the apartment of a superior on the same basis, etc. The relative unimportance of efficiency allows managers to absorb, without being held accountable, the costs of these kickback activities. Leakage of wealth thus takes place not only through the losses incurred and gains foregone by incompetent managers but also because of the time and effort spent on rent seeking activities.

Both types of rent extraction exist because of the muddled structure of STE property rights. Since the means of production are in theory, but not in fact, socialized, since workers are "the hegemonic class" in a socialist society and the communist party is "the leading force of the working class", any appointment through the nomenklatura, or any other decision process for that matter, can be justified. It does not matter whether or not STE property rights were originally devised to achieve a socialist purpose or to maximize rents for the ruling stratum. What matters is that muddled property rights allowing protracted interference in wealth creation serve the latter purpose very well.

Under the nomenklatura system personnel shifts from the ranks of apparatchiks to those of the economic bureaucracy are by far the most frequent. The reverse flow also occurs, however, since young economic bureaucrats perceive that their professional career is advanced by a spell in the party apparatus. On the other hand, such interaction with the party and the nomenklatura is much less common for the police and the military.

The different methods of rent maximization used by groups in the ruling stratum are of primary importance for the prospects of reform in the Soviet system. All segments of the ruling stratum prefer the status quo to the alternative of representative government. But two segments only-party apparatchiks and economic bureaucrats-have, in addition, a strong incentive to maintain the undemocratic, centralized institutional status quo in the economic sphere. To see why this is so, consider that decentralization assumes, as a first step, the substitution of parameters for commands. Since parameters (in contrast to plan targets), such as the interest rate, need not be input- or output-specific, intermediate levels of economic bureaucracy become superfluous. Clearly that the liquidation of the intermediate levels of economic bureaucracy (the dashed-line rectangular area) makes redundant not only the bureaucrats employed in industrial ministries and unions, but also reduces the pool of well-paid jobs to which apparatchiks may be appointed through the nomenklatura. It is only to be expected that such changes will be strongly resisted by the powerful groups most strongly affected.

Similar resistance appears at the enterprise level. For example, strengthening enterprises' budget constraints by holding them financially accountable for the effects of management decisions will be resisted, since the costs of kickback-related activities would begin to affect the enterprises' balance sheets as well as rewards and penalties for managers and workers. The effects would also be felt by every actual and potential receiver of kickbacks who would spread resistance even wider. Financial accountability could, in fact, affect the whole system of dependence based on loyalty. Conflict resulting from a divergence between the requirements of loyalty and those of financially sound performance is an everyday occurrence in modified STEs like Poland and Hungary, where financial indicators matter to some extent. That conflict's outcome, however, is predetermined in favor of loyalty because of the operation of the nomenklatura. Simply put, managers caught between whether to follow the "suggestions" of their superiors or pursue other, more financially appropriate goals for their firm choose the former and ask for subsidies afterwards. Otherwise they might lose their jobs. That is why even in Hungary, the most reformed STE, the budget constraint continues to be "soft," to use Janos Komai's [1979; 1980] well-known phrase.

Predictably, apparatchiks and economic bureaucrats would most strongly resist attempts to replace nomenklatura by selections based on merit. As a result, nomenklatura has never been abolished for managerial posts in the economic sphere, the sphere where efficiency gains are most important for the rulers. While it is true that apparatchik and bureaucratic resistance is found throughout the STE, its intensity differs among sectors of the economy. Since the best paying managerial jobs under the nomenklatura (i.e., those enjoying best opportunities for kickbacks) are in industry, it is in industry that reform faces the strongest resistance and, correspondingly, the highest probability of failure. The economic history of STEs shows some partly successful reforms of state agriculture, a sector in which opportunities for rent extraction are less frequent and the benefits smaller. To date, no reforms of state industry, based on general parameters, accountability, or merit, have been successful.

The wealth-maximizing interests of apparatchiks and bureaucrats in maintaining the inefficient economic status quo is in sharp contrast with that of the current ruling groups in the Soviet-type states. On the other hand, while a "small but powerful group at the top", to employ Thalheim's phrase, does not necessarily need central planning in its system of rule and wealth-maximization, those upon whom it depends for maintaining that rule-those who control the STE-draw considerable benefits from the existing economic arrangements.

Before proceeding with the argument, the term "control of economic activity" by the economic bureaucracy and party apparatus requires some further definition. In an STE, this function has little in common with guidance toward efficient achievement of desired economic outcomes, at least those desired by the public or even by the ruler. Rather, the goal most often is to maximize rent for the ruling stratum. Control is process-oriented, rather than outcome-oriented, and is based on detailed prescriptions of how, when, and with what means to produce what outputs. The obedience of subordinates is all-important, since this gives superiors a sense of control and of an ability to protect their rents. Ironically, control of the process does not confer control of the outcome because the consequences of following such detailed prescriptions are far from the expected ones: part of output exists only on paper; products are shoddy and obsolescent; deliveries are late; efficiency indicators miss plan targets and the managers are obviously unable to do anything to correct the situation (see, Winiecki [1986a]). Another irony is that this style of control may impede realization of the ruler's own objectives, yet the ruler is also powerless because the apparatchiks and economic bureaucrats are essential for his (their) political control of the whole system. Controlling economic activity means simply that the apparatchiks and economic bureaucrats are able to issue commands ("suggestions" at the very least) affecting process or product. These commands are superficially in form, but not in substance, obeyed by enterprises.

The amount of effort expended on control by the economic bureaucracy and party apparatchiks will be lower with a simpler control procedure. For example, commands are preferred to suggestions, since the latter require bargaining. Commands may be, and are, often changed, but changes later need less arguing, since the disparity between targets and reality becomes more visible over time. The fact that making changes later is also more costly does not bother bureaucrats and apparatchiks in the least. Thus, even if systemic modifications or reforms do not actually threaten maximum rent extraction, such changes may increase the effort needed to maintain (superficial) control of economic activity. Therefore, the apparatchiks and bureaucrats have incentives to resist change, however modest it may be.

The ruler-ruling stratum relationship clearly is crucial to understanding reform failure in the Soviet system. The juxtaposition of these two groups in this article should not be confused, however, with the oft-encountered good czar, bad officials" approach to Russian politics. The rulers (or "ruling group") is actually representative of all the ruling stratum and reflects all the moral, intellectual and professional consequences of decades of system-specific negative selection. Thus, the czar is not any better than his officials. Nonetheless a great difference exists between the rulers and other groups in the ruling stratum. The ruler, alone within the ruling stratum, is interested not only in seeing reports that commands are fulfilled, but also, and more importantly, in seeing that the commands were actually fulfilled! No other group bears that ultimate responsibility. He will be blamed for any failure of the system by competing groups within the ruling stratum, and his interest in real performance makes the ruler more sensitive to falling efficiency and consequently more ready to reform the economy than is the average representative of the ruling stratum.

As a result, if rulers try to change the economic system significantly, they may face a revolt by functionaries who have the strongest incentives to maintain the status quo, placing their political dominance in jeopardy. Thus, rulers face both the rent-maximizing and the transaction cost constraints stressed by North [1979]. In periods of declining performance, the ruler feels the transaction cost constraint. Inefficient property rights do not generate the increased wealth needed, for example, to sustain the superpower status of the Soviet Union, or to avert consumer dissatisfaction in all Soviet-type states. On the other hand, if the ruler attempts a significant revision of the existing property rights structure, he risks loss of support from important members of the ruling stratum who will turn to competitors for political power. It is, moreover, a special feature of STEs that even if competitive constraints on the ruler diminish and reforms begin, their implementation is in the hands of party apparatchiks and economic bureaucrats. Reforms, if not aborted or weakened from the start, may then be sabotaged, distorted or finally reversed.

Clearly and unequivocally it is the apparatchiks and bureaucrats of STEs who gain most from maintaining the institutional status quo, and they are the groups which resist change most strongly. Given the key positions of these groups in the STE system, we may predict a very high probability of failure of decentralizing, market-oriented, efficiency-increasing reforms.

Disincentives to Expanding the Private Sector

Expanding the role of the private sector in an STE usually has the same objectives as decentralizing, market-oriented, efficiency-enhancing reforms in the state sector. Theoretically, private sector expansion could serve as a substitute for state sector reforms, and could provide the means to circumvent strong resistance to market-oriented change in the state sector. In actuality, attempts to reform the state sector have complemented simultaneous private sector expansion. Changes in policy toward the private sector have been numerous, however, since often the private sector has had to contend with various forced concentration drives in the state sector. In the course of these drives, large state enterprises often gobbled up small state and private enterprises alike.

Analysts invariably cite ideology as the cause for the limited role of the private sector (except in agriculture) in Soviet type economies. The same ideological argument comes to the fore in two other circumstances: (i) when Western experts and journalists seek the sources of vilification campaigns and other obstacles to change that follow each official policy shift favoring the private sector, and (ii) when rulers must explain the unsatisfactory results Of pro-private sector policy changes. In the latter case, the rulers usually produce some type of circular memorandum aimed at the economic bureaucracy or party committees and lecturing them on the need to overcome the "old style", "dogmatic" approach with respect to the role of the private sector under socialism. These memoranda are usually ineffectual.

An ideological explanation for the failure to harness private enterprise to improve performance in a persistently disequilibrated and structurally distorted STE fails for two reasons. First, ideological fervor has generally subsided, although admittedly to differing degrees, since the imposition of the STE system. This subsidence has occurred in all spheres of the society and suggests that ideology is not a good explanation for unabated hostility towards the private sector. Second, and more important, any ideological reservations have had to be overcome first and foremost at the top. When a policy to promote the private sector is announced, it is actually the ruler who has to "eat the toad", i.e., to confess directly or indirectly, that the state sector cannot do what the private sector is expected to do. Even policy changes announcing the most limited expansion of the private sector amounts to precisely such a confession. It would seem, then, that few lower level bureaucrats or party apparatchiks, whose position depends not on performance but on loyalty, will dare to sabotage the latest twist of the party line and remain ideologically hostile to privatization.

On the other hand, the ancient principle of cui prodest suggests that there must be strong disincentives for certain groups to follow the rulers' privatization lines. The two avenues of rent distribution, i.e., nomenklatura and kickbacks, operate simultaneously in a STE. However, in interactions between segments of the ruling stratum and the private sector, both are conspicuously absent, or extremely rare. There are no well-paid posts to be filled by nomenklatura appointment in small private enterprises, nor is there a soft" budget constraint, so permissive to a variety of rent-maximizing kickbacks even under reform. A shift of activity from the state to the private sector reduces, therefore, the possibilities for party apparatchiks and economic bureaucrats to extract rent. Hostility towards the private sector is, therefore, based not on ideology or even actual rent losses, but on gains foregone when expansion of the state sector is curbed in favor of the private sector.

The story does not end here. A bureaucrat, or even an apparatchik who can indirectly influence each decision, may extract rent by taking a bribe for a concession to set up a private industrial firm, or to open a restaurant or a repair shop. But this way of extracting benefits violates private sector property rights, where resources are clearly exclusive, and is consequently much more dangerous. In plain words, taking bribes is a criminal act. By contrast, in an STE rent extraction from the state sector is either fully legitimized, i.e., through the nomenklatura and the rationing of goods at the center's order, or, as with system-specific kickbacks, belongs to the "grey area" between the improper and the criminal. Therefore, since negative selection assures that moral scruples are rare among ruling stratum rent-takers in an STE, something akin to a political earthquake, like the "Solidarity" period in Poland, is needed to threaten all who predatorially extract rent from an STE system. Otherwise, only a few luckless individuals whose punishment was decided upon by higher-ups will be the show pieces in trumpeted, but deceptive, anti-corruption campaigns.

It should be stressed that only so-called "secondary" corruption-that not legitimized within the ruling stratum-is the type usually punished in an unreformed STE. Such secondary corruption arises from conflicts between the utility function of the ruler and that of his agents. This is readily understandable in light of North's [1979] property rights approach. The inability of the ruler to constrain his agents perfectly would result in the diffusion of some of the ruler's monopoly rent and would, therefore, call down sanctions on the head of the offenders. Barzel [1974] and Cheung [1974] note the ruler's problem is rendered more difficult, and the rent diffusion is greater, when the measurement of output is more difficult and more costly. Since in STEs this measurement is most difficult in industry, one would expect diffusion is greatest precisely in that sector; Winiecki [1982; 1986a] has confirmed this. Diffusion is so great in fact that it trickles down to some of the ruled as well, through widespread falsification of performance reports by enterprises. Nomenklatura-covered managers and, to a smaller extent, but in larger numbers, all employees of affected enterprises may all benefit from these falsifications.


Because decentralizing market-type reforms of the state sector and expansions of the private sector adversely affect rent extraction possibilities, the apparatchiks and bureaucrats who benefit from the existing STE arrangements embrace what may be termed a multifaceted "counterreformation" course. To understand how reforms may thus be reversed or aborted one must consider again the relations between the rulers (or ruling group) and key elements in the ruling stratum, especially the apparatchiks and economic bureaucrats.

In analyzing those relationships and the counteffeformation," however, it is necessary to consider the ability of the members of large groups to act in concert. Olson [1965; 1982] stresses that large groups are not always able to act as if guided by their collective interest, yet for STEs this generally valid point does not apply so fully to actions by the apparatchiks and economic bureaucrats. A large difference exists between, on the one hand, a large, perhaps opposition, group struggling to bring organized pressure on a government or a ruling party to effect certain outcomes and, on the other hand, a large group that consists for all practical purposes of the government and/or its ruling political party. "Counterreformers" in STES, indeed, usually are in the party and often coalesce around members of the ruling group itself. There are always one or few top party figures who think that cracking the whip, tightening discipline and increasing control are enough to solve the problem of falling efficiency. The hostile group's capability to act collectively is much greater in such situations for the simple reason that theirs is a very unusual, often majority, interest faction with access to mechanisms of political and economic control. If such a group sets itself to thwarting reforms outlined by the rulers and their advisers, the organizational and descriptive capacity of the "counterreformers" may turn out to be markedly greater than that of politically powerful elements who are outside the mainstream of economic control.

Even if they do not act collectively but only individually, the "counterreformers" "unusual position in the party and the bureaucracy will help them throw sand into the machinery of reforms. Although they may not be members of a strong trade union or an influential professional association, they effectively govern and control the STE. Individual decisions of a minister, a regional party secretary, or a city administrator, all nomenklatura-linked functionaries, have serious consequences. For example, they can twist and distort decentralizing reforms pertaining to all state enterprises in a given industry or region, or they may forbid establishment of private enterprises in a given industry or region. These actions symbolize an Olsonian "free rider" situation in reverse: everyone outside the informally organized group of "counterreformers" brings his valuable individual contribution to the common cause of resisting reform.

The preceding considerations suggest that (1) aborting reforms costs less effort by the interested parties than reversing reforms later, and (2) reversing less consistent reforms (with inconsistency deliberately built into the systemic modifications) costs less effort than reversing more consistent reforms.

Although the counterreformers are very effective in adjusting their obstructive actions to different circumstances, they probably cannot always implement their first-best (i.e., completely reform-suppressing) solutions and may try to abort reforms, at least in part,

Aborting reforms neither means that no changes whatsoever are introduced nor that all changes are repudiated. It means, rather, that the reforms actually introduced do not threaten the property rights structure in the state sector through which apparatchiks and economic bureaucrats maximize their rent. Abortive reforms also do not alter either the institutions or the procedures of central planning. Examples of such abortive or sham reforms abounded in the 1980s in such STEs as Bulgaria, Czechoslovakia, and the German Democratic Republic. The 1980s Soviet reforms likewise belong to the category of abortive reforms.

The second-best solution for the apparatchiks/bureaucrats is to introduce internally inconsistent quasi-reforms, which modify the system so inconsistently that they are doomed to fail. To the category of quasi-reforms belong the Polish reforms of 1956-1958 and 1973, and most of the East European reforms of the 1960s (excluding the Hungarian reforms to be discussed later). Quasi-reforms may increase the effort apparatchiks and economic bureaucrats must expend in controlling economic activity, but that increase is only temporary, since reversal of the quasi-reforms is assured because of problems created by the inevitable reform and system contradictions. In any case, the structure of property rights remains intact.

With inconsistencies often obvious from the start, beneficiaries of the traditional STE model need only to wait until the first problems appear to begin their campaign for reform reversal. Usually they do not need to wait for long, since STEs always enter reform periods in a state of larger or smaller disequilibrium, and reforms can thus be blamed for the persistence of disequilibrium even if no other reform-related adverse consequences have appeared. Actually, major adverse consequences will, in any event, Likely arise because of quasi-reform and system inconsistencies. To be sure, small efficiency gains may be registered, but they are temporary and disappear over time under the impact of the process of reform reversals.

To the dismay of the ruling stratum, some crises are so severe, however, that neither no reform nor abortive or quasi-reforms are possible. For example, in Poland in 1981-82 popular pressure combined with economic disaster prevented the abortion of reforms and forced the ruling group to appear to permit fundamental economic reforms, largely in order to deflect pressure for political reforms. A genuine attempt to improve Polish economic conditions was needed, since the rulers realized that the people understood that not all of the problems were the outcome of Gierek's mistakes or of Solidarity-organized strikes (despite attempts to convince the general public otherwise). The pressure for political reform did not abate, however, and martial law was introduced to stave off fundamental political system changes. Ironically, as Winiecki [1986c] has explained real economic reforms are impossible in the Soviet-type systems without political reforms, at the very least without the shift from totalitarian to "ordinary" dictatorship. Real economic reforms radically alter the structure of property rights and eliminate the role of the nomenklatura, thus sharply reducing the possibilities for maximizing rent. Combined economic and political reforms also reduce the value of many privileges. For example, the rent to be extracted from access to rationed, underpriced consumer goods would fall to near zero if the national economy operated at equilibrium prices and more of those goods were produced.

The Polish economic "reforms" of 1982 under martial law provide a classic example of how a ruling stratum can turn back even strongly-grounded reforms. The 1982 programs yielded an emasculated version of the measures envisaged in 1981, and threats to the apparatchiks' ability to extract rent were either eliminated or reduced. Even so, the remaining reforms demanded increased efforts to control economic activity, and the functionaries soon regarded them as unbearable. Taking advantage of the various built-in inconsistencies of the 1982 reforms, the apparatchiks/bureaucrats busily rolled back the remnants of the reform under the guise of "further perfectioning".

The Hungarian reforms of 1968, as well as their later modifications, belong to a special category, not because they attempted more far reaching reforms than did other STEs but again for basic political reasons. In fact, the economic reforms were not very great, nor were the adverse consequences of inconsistent reforms significantly smaller than in other STES. Also, the degree of control over economic activity by party apparatchiks and the economic bureaucracy did not change, even if their control efforts had to expand substantially. Rather, in Hungary it was the presence of certain visible concessions to the population that were a hallmark of what became known in the West as "goulash communism." These concessions extended beyond the economic sphere to include a certain depoliticization of everyday life and less obnoxious propaganda. Economic concessions included, among other things, the inclusion of non-party members in the pool of candidates for managerial positions. Additionally, the more sensitive attitudes of the ruling stratum made them more receptive to other reform measures disadvantageous to themselves. For example, despite the nomenklatura's survival intact, certain well-paid jobs disappeared during the reforms' second phase in 1980, when the industrial ministries were amalgamated into one and certain large enterprises were broken up into smaller units. Moreover, with Hungarian prices being much nearer to equilibrium levels than elsewhere in East European STEs, the value of perks such as rationed cars decreased.

The explanation for these outcomes is as follows. The Hungarian communists were the only ones in Eastern Europe who, after having taken power, found themselves, albeit briefly, in 1956, at the receiving end of repression. Consequently they learned one thing, namely, that in case of another popular uprising the Soviets might come quickly enough to save the system but not necessarily quickly enough to save each of them personally. It is this collective memory of the ruling stratum that results in Hungarian policies that often moderate, rather than aggravate, the adverse characteristics of the system. In substance the system itself has, however, changed surprisingly little.

The examples of Poland and Hungary suggest that economic reforms in the STEs, even those with strong popular backing, do not bring about systemic modifications seriously limiting the ability of the party apparatchiks and economic bureaucrats to extract rent. Reforms at most reduce the number of well-paid jobs in intermediate levels of the bureaucratic hierarchy and increase the effort required to control economic activity. Both "defects", however, largely disappear in the inevitable process of reform reversal.

As shown above, the timing of the "counterreformation" depends on circumstances such as the degree of deterioration of economic performance, the existence of popular pressure for reforms, and the strength of that pressure. Consequently, the most effective time to act cannot be selected a priori by the interested parties, since the timing depends on the dynamics of a given reform process. "Counterreformers" enjoy greater latitude, however, in the choice of measures that will allow them to retain control over economic activity and to ensure that reforms will not succeed. With each failed attempt at economic reform, the apparatchiks and bureaucrats become more effective in applying their reactive measures, largely because of learning curve effects. Some of the most successful strategies to thwart reform are analyzed below.

1) Pseudo-reorganization. This classically Parkinsonian measure makes it possible to maintain the institutional structure basically intact by shedding a few middle levels of the multilevel hierarchy. At the same time, it is preferable to add some functional institutions in order to keep the pool of well-paid nomenklatura-covered jobs as large as possible. Pseudo-reorganization was a typical maneuver of "counterreformers" in the Czechoslovak reforms of 1967, the Hungarian reforms of 1968, all Polish reforms of 1956-1958, 1973 and 1982, and the Soviet reforms of the 1980s.

(2) Limiting the number of obligatory plan indicators for enterprises. This typical substitute for the abolition of commands has been widely used in most economic reforms under the rubric of simplifying enterprise management. However, with the STE's institutional structure intact and with government campaigns aimed at assuring the implementation of successive partial targets, many obligatory plan indicators are sooner or later reestablished while new ones were added in the process. An example of this in the Polish engineering industries from 1946-1981. The number of obligatory indicators has risen, fallen, and then risen again in a recurrent pattern.

An additional "counteffeformer" device is to shift obligatory plan indicators to other categories instead of simply reducing their numbers. For example, in Czechoslovakia the number of obligatory plan indicators in industry was reduced from 1120 in 1965, to 66 in 1966, but at the same time 510 other items were added in two new classes of "orientating" and "auxiliary" indicators. The same happened in the Soviet reforms of the 1980s. A large number of indicators were shifted to a new category of controlling figures," broken down to the enterprise level and then passed on the enterprises to guide" them in their activities.

(3) Abolishing commands but retaining the rationing of inputs. Even if most production targets are formally abolished (which rarely occurs), allocation of scarce inputs by superiors in the multilevel economic bureaucracy constrains the pursuit of more profitable output mixes by enterprise managers. 17 Managers understand that any output mix other than that "suggested" by their superiors will reduce their prospects for obtaining scarce materials, since those materials will be shifted to other enterprises producing priority" outputs, i.e., those desired by the economic bureaucracy or party apparatchiks. This pattern was typical of the Polish reforms of 1982, where the share of rationed material inputs increased to 90 percent." The same was also true in the Soviet Union, even with the USSR's smaller, less ambitious program of command abolition. The modest room for maneuver secured by Soviet industrial enterprises has in the 1980s been reduced to virtually zero due to continuing rationing of almost all inputs.

(4) Abolishing commands and rationing but retaining the right to appoint and dismiss enterprise managers. This "revolutionary" change-one at least hailed as such-has happened to date only in Hungary. However, as was pointed out above, the Hungarian command/rationing system of central planning was not transformed into a decentralized, market-type economy, since the property rights structure in the state sector did not change. Even without production targets and input rationing, enterprise managers continued to be dependent on their superiors for periodic evaluations based on loyalty first and foremost. In such an environment the strength of their superiors' "suggestions" was not much weaker than that of commands. With their position, salary, and bonuses dependent upon the economic bureaucracy above them, managers in STE enterprises analyze performance in terms of efficiency and in terms of the specific suggestions of their superiors. When these conflict, suggestions prevail.

Furthermore, in Hungary the market did not really substitute for central planning; therefore, the control void was filled by "suggested" auxiliary or orientating indicators covering the whole range of enterprise activities and by bargaining between managers and the economic bureaucracy for changes in the value of these indicators. These were accompanied by informal rationing and bargaining for inputs, by the participation of the economic bureaucracy and party apparatchiks in the preparation of enterprises' "autonomous" output plans, and by an amalgam of disguised or undisguised, formal or informal, persistent or ad hoc, interferences in enterprise activities. Enterprises, although formally unconstrained in the pursuit of better performance, were, in fact, bound in a maze of mutually inconsistent constraints on their actions, which severely limited gains in efficiency. Consequently, according to Bauer [1984], patterns of economic development and foreign trade did not significantly differ from those in STEs not formally following the Hungarian reform model.

Counterreform measures designed to maintain an unchanged degree of control over economic activities can be supplemented or reinforced by other measures. These may include expressions of various policy preferences or ad hoc regulations that contravene the thrust of reforms and, if implemented, reduce the ability of enterprises to react to profitable opportunities. These measures also raise costs, reduce quality, increase obsolescence of outputs, and otherwise make firms less efficient. Ironically, counterreformers use the adverse results arising from their interference as evidence of the failure of the reforms themselves during the next campaign for reversal,

Propaganda against reforms supplements these other measures. It often includes two types of arguments: "reforms increase inflation," although reforms usually only bring hidden inflation into the open; and "reforms increase inequality," although reforms usually, at least at the beginning, reward more efficient smaller enterprises and reduce existing, unjustified wage and salary differentials favoring employees of large enterprises. Also, isolated critical anecdotes by individuals or by employees in large enterprises are often overblown in the press and mass media, strengthening the campaign against reforms by conferring upon it a quasi-legitimacy.


This analysis based on property rights, with special emphasis on the structure of incentives facing the ruling stratum in the Soviet system, not only explains the repeated failures of economic reforms in the STEs but also, given the argument's theoretical underpinnings, enables analysts to predict outcomes of ongoing reforms. This analysis has been applied to three industrial reform programs: the Soviet, Polish, and Chinese.

The Soviet Union

In the Soviet case the structure of STE property rights remains intact, retaining both modes of wealth distribution among the ruling stratum-the nomenklatura and kickbacks-despite exemplary punishments for "secondary corruption" handed out to a few improperly constrained agents of the ruler. As to the reforms themselves, Soviet responses display almost all the devices to ensure that reforms fail right from the start.

In the USSR, pseudo-reorganization and illusory limitations on obligatory plan indicators are the most common "counterreforms" in the measures promulgated so far. Changes at the top, ranging from traditional industrial ministries to committees playing the role of superministries, belong to the category of pseudo-reorganization, aimed nominally at decreasing uncertainty and shortages by integrating certain suppliers and purchasers under the same bureaucratic umbrella. However, this type of reform has never worked anywhere; the only thing it can do is redistribute shortages across enterprises. A given committee's "own" purchasers are relatively better supplied, while the plight of those under the aegis of another committee is ignored or worsened.

A shift of emphasis within the multilevel hierarchy from ministries to unions of enterprises (a measure that has failed many times elsewhere in STEs) is a similar non-performer. Ministries and unions are not interested in increasing efficiency but in showing improved average results from one year to another. Many analysts have shown that these bodies redistribute scarce resources for both current production and capacity expansion with the main intention of improving these average results. Therefore they shift resources from relatively more efficient to relatively less efficient enterprises. Soviet architects of reform in the 1970s and 80s showed an understanding of this point by early 1988.

In the case of exports, emphasis has shifted from the Soviet Foreign Trade Ministry to industrial ministries, associations, and, in a very limited number of cases, to enterprises. Again, this measure has not succeeded because it is mainly redistributive, not corrective, and it cannot succeed in the future in an unchanged economic environment. Overall, in an STE shortage economy having strong disincentives to innovate and operating with low quality requirements, the costs incurred to turn out manufactures saleable on the world market far outweigh any possible trade benefits accruing to manufacturers.

The STE experiment with limiting obligatory plan targets also has a long history of failure. The Polish reforms of 1956-1973, the Czech reform of 1967, and pseudo-reforms in other Soviet-type economies, support this proposition. The much touted Soviet brigade system, which seeks to reduce inefficiencies by making contracts with small teams ready to implement specific tasks for specified remuneration, may improve the performance of some Soviet enterprises but only to a limited extent and not for long. The extent of improvement cannot be large because enterprises in the STEs are constrained, first of all, by system-specific excess demand, shortages and uncertainty, i.e., by the external environment of the enterprise; worker negligence and inefficiency is only a secondary source of enterprise inefficiency. Therefore, even if brigade workers were to exert themselves somewhat more, their efforts at the team level may not translate into effects at the enterprise level. This failure will raise costs without generating any compensating benefits and will bring conflict with higher levels of the economic bureaucracy. Workers will also have to be paid for their readiness to fulfill the contract even when, as frequently occurs, inputs fail to arrive, which again will increase costs. These problems lead to reservations being written into contracts or ad hoc interventions to reduce specified remuneration, actions which subvert incentives for workers to exert themselves. The whole brigade approach, then becomes another useless institutional fixture under which gains will first decrease and later disappear altogether. Ultimately, even cracking the whip over brigades through tightening labor discipline and more thoroughly checking plan implementation reports will cease to yield even paper gains.

Finally, otherwise laudable Soviet attempts to reestablish some incentives for non-manual workers as means of eliminating plan targets, will have as little, or less, effect on the enterprises' performance as will the brigade system. Both implemented and planned increases in wage differentials between white and blue collar workers in favor of the former are going to disappear rather fast. Winiecki [1988b] shows that STEs tend not only to generate excess demand for labor but also much stronger excess demand for manual labor. Such excess demand combines with a common industrial economy pattern of relatively reduced manual labor supply to decrease wage differentials between non-manual and manual workers. Actually, in some countries these differentials were already reversed in favor of the latter. Even ad hoc Polish and Czech interventions similar to those in the Soviet Union did not reverse wage convergence; they only delayed further narrowing of differentials by some two to three years.


The Polish reforms of 1982, despite attempts at counterreform under martial law, cannot be dismissed as completely sham. Although the structure of STE property rights did not change, the abolition of most commands, some limitation of rationing, and some reduction of price controls did occur. Even if the subsequent reform reversal process deprived enterprises of large parts of their freedom of action existing in 1982, the extent of decentralization was higher in the 1980s than it was in the 1970s. Also, the elected self-management bodies in enterprises still retained certain rights although those rights were strongly circumscribed from the start of the 1982 reforms. However, even with these positive aspects, the 1982 reforms in toto, to say nothing of their remnants, could not ensure efficient enterprise performance. Consequently, the failure of the reforms was assured. Nonetheless, the reforms increased considerably the effort expended by party apparatchiks and the economic bureaucracy in controlling economic activity.

By 1987 the failure of the latest round of Polish reforms was glaringly visible even to the rulers. The propaganda apparatus, therefore, started a campaign for the "second stage" of the economic reforms; and the bureaucracy prepared a blueprint of expected changes. However, the blueprint had all the marks of a "counterreformation" move. It was quite radical in its verbal encouragement to entrepreneurship, innovation, autonomy in enterprise activities, and the role of prices in the economy, but fundamentally unchanged institutional structures and proposed interventionist policy instruments kept the "second stage" much like the first, having a similar probability of failure.

Because of the distinctive political situation surrounding the introduction of economic reforms in 1982, the Polish case is even more instructive about the probability of successful reform in an STE. The rulers apparently tried to "buy" the acquiescence of the ruling stratum (especially the most affected segments, the apparatchiks and economic bureaucrats) to the economic reforms it regarded as necessary to relieve the economic crisis. Therefore, the share of consumer goods diverted outside the regular trade channels increased sharply. The proportion of cars, the most coveted durable good, rationed through the system of centrally allocated coupons is said to have doubled from 20 percent in the late 1970s to 40 percent in the early 1980s. Regional data for household consumer durables likewise showed a 45 percent share going to privileged access sales. The official figure for 1983 was 38 percent of all nonfood manufactured goods, including cars. Even if one considers that the rulers were also trying to "buy" members for the new government-sponsored trade unions by distributing various goods through trade union organizations during this period, these shares for the ruling stratum are shockingly high. (It is noteworthy that cars were not among the goods distributed by union organizations.)

So far, only part of the Polish story has been told. During these years the number of posts covered by nomenklatura rose from about 100,000 in the 1970s to 250,000 in the 1980s. Thus, the ruling stratum's access to well-paid positions improved considerably. In fact, in comparison with Voslenski's 1984 estimates for the Soviet Union (750,000 posts), the relative extent of formal control by the communist party over managerial posts seemed in the 1980s to be distinctly higher in Poland than in the USSR.

If the Polish and Soviet ruling strata behaviors analyzed above are the norm in acute crises, STEs could not often extricate themselves from dire economic troubles. In the first place, the ruling stratum aggravates the crisis when it compensates itself for an absolute fall in the nation's wealth by appropriating to itself a much larger share of the remainder. This action reduces the wealth that can be distributed according to merit, thus reducing incentives for good performance (even assuming that possible reforms could restore performance incentives). Second, the extension of the nomenklatura over the national economy reduces ex ante the capacity of enterprises to perform, especially given the effect of negative selection to managerial posts on enterprise performance (assuming that managers could choose among various production options). Consequently, even in the case of true decentralizing market-type reforms-which the Polish reforms of 1982 definitely were not-parasitic nomenklatura behavior would preclude a positive outcome.

In comparative terms, acute economic crises can be handled more easily in market economies with a representative government than in Soviet-type economies with pre-representative governments. If one uses Schumpeter's term, "creative destruction," to characterize positive innovative behavior stimulated by crisis in representative market economies, one should, in parallel, use the term "destructive destruction" to identify crisis-induced behavior in STEs.


Ongoing reforms in China sparked the most excitement in the West until the beginning of similar Soviet developments. It appears, however, that the optimism of both Western observers and Chinese reformers reflects wishful thinking more than anything else. Deng Xiaoping, the prime mover of Chinese reforms, may have hoped that "if the reforms in the countryside worked out very well in three years ... it will take five years for the reforms in the city," but as shown in sections II and III above, the assumption of a causal relation between rural-agricultural and urban-industrial reforms has no foundations whatever. The amount and variety of benefits extractable by the ruling stratum through protracted interference in production are infinitely greater in industry than in agriculture; hence the prospects for successful reform in industry are much dimmer.

The partial success of agricultural reforms in China hence has no bearing on the possibilities for the success of industrial reforms. Hungary is a case in point. The success of Hungarian agriculture (relative to that in other STEs) was not followed by successful reforms in industry. Over two decades have passed since 1968, and Hungarian industry remains by and large unreformed. Whatever marginally greater efficiency it has enjoyed resulted not from a shift to a decentralized market-type economy but from a more cautious policy that alleviates some of the worst effects of the traditional Soviet system.

Reasons why the Hungarian ruling stratum has behaved as it has are clear. By contrast, there was no popular revolution and Soviet intervention in communist China and hence no ruling stratum victims to exert a moderating influence on the conflict between reforms and reactions. On the other hand, the domestic Maoist convulsions may have had a similar effect on party apparatchiks and the economic bureaucracy. Mao Zedong was a social reformer who, in his quest for a coercive utopia, also subjected many apparatchiks and economic bureaucrats (but not the military or the police) to often cruel and humiliating persecutions. Consequently, these functionaries, mindful of the not too distant past of the "Cultural Revolution," may have preferred a period of stability. They may have settled for gains in their own wealth proportional to those in the country as a whole, even if they experience a fall in relative position compared to, say, the new entrepreneurs.

Attitudes may change, however, as memories of the "Cultural Revolution" fade. The maintenance of reforms requires further limitations on ruling stratum benefits, including ultimately the abolition of nomenklatura in industry. In any case, the situation in a predatory STE state such as China, in which important segments of the ruling stratum are deprived of the power to extract rent through the structure of existing property rights, is inherently unstable. The transformation or liquidation of the totalitarian political party and of the Soviet-type economic bureaucracy is one possible outcome of such instability. Reform reversal is another one. Unfortunately the former is less likely than the latter.

In a previous paper, Winiecki [1987] predicted marked political changes resulting from China's instability in the early 1980s. That assertion proved prophetic in that the general secretary of the Chinese communist party was soon thereafter removed. Although his removal was associated with his support for greater political freedom rather than for economic liberalization, the counterattack of dissatisfied apparatchiks and bureaucrats reflected, and affected, economic reforms as well. Certain crucial pieces of legislation were withdrawn from parliamentary consideration (e.g., the law on enterprise activities and the bankruptcy law), and economic policy decisions supported old-style solutions to problems of disequilibrium and inflation. In spite of a measured critique of the "faulty views" of the antagonists of economic reforms by the general secretary, Zhao Ziyang, in the late 1980s, there was little forward movement. Reforms appear stalled for the foreseeable future.


Despite the pessimistic analyses offered in this article, one should not conclude that economic reforms in STEs will inevitably fail. Reforms, it is true, are much more difficult to achieve there than in other predatory states, largely because of the unique interface between the political and economic spheres in STEs. However, under certain conditions of long-term economic decline, such as apparently affected all East European STEs in the 1980s, political changes may positively affect the chances for the success of economic changes (See Bauer [1984] and Winiecki [1984a; 1986b]).

Winiecki [1986c] suggests two scenarios which could lead to real economic reform. The first involves the breakdown of consensus within the ruling stratum and the defeat of those interested not only in maintaining political power but also in maintaining the existing structure of property rights in the economic sphere, i.e., the party apparatchiks and economic bureaucracy. The other scenario assumes a gradual self-limitation by the communist party as the economic decline drags on and as the costs of maintaining the existing system increase as a result of falling absolute wealth and the augmented efforts needed to control economic and non-economic activities. Since the decline of STEs is multifaceted, combining falling living standards, rapidly increasing pollution, and increasing mortality, many hard questions will be asked within the ruling groups and the ruling strata. Accordingly, the probability of the occurrence of one of these scenarios may increase. Either scenario would enhance the prospects of successful economic and political reform in STEs as they approach the last decade of the 20th century,


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Title Annotation:Soviet-type economies
Author:Winiecki, Jan
Publication:Economic Inquiry
Date:Apr 1, 1990
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