Monday, August 25, 2008

The Russian mess and the Socialist debacle

Why and how did one of the infamous Socialist experiments, the Russian economy, collapse? Many economists argue that it was due to the US policies (Cold War expenses) and capitalism. However, Richard Lipsey, argues that the destruction was in the making internally because of incoherence in production, prices, demand, and supply of goods and services.

Why did the academic community get the Russian story wrong? Well, because they were too naive and bought the state-cooked statistics at face value.

- They believed that Soviet statistics, although not good, were just subject to honest errors and reliable enough to convey useful information.

- They believed that national income figures were accurate representations of the economy.

- They would not listen to dissenters such as Jasny and Birman and other more recent émigrés who told of the decline in living standards. (Academics often do not see real events because of  concentrating exclusively on value statistics, which can obscure the reality of the physical objects that lie behind them.)

The following list captures what was wrong with the Soviet command economy:

Soviet managers were rewarded for fulfilling quantity targets with little attention to quality. Thus:

  • Administered prices plus allowing firms to retain some part of their profits give an incentive to maximize the quantity of output with little attention to quality.
  • Shoddy consumer goods abounded (a typical later example being black and white TV sets that tended to explode when overheated).
  • Shoddy parts were passed on down the line from one stage in the production process to the next. When a parts producer found that it was producing substandard parts, the incentive was to pass them on anyway and let the firms down the line cope rather than slowing production to fix the quality.
  • Quantity targets were often set on finished goods but not on parts so, for example, farm fields were littered with tractors that could not be repaired because of lack of spare parts while new tractors were available.
  • Prices were typically set with considerations other than market clearing in view. Thus prices did not respond quickly to changes in demand and supply, making the economy poorly adapted to deal with large shocks. Shortages and surpluses abounded.
  • Pricing of capital investments did not reflect opportunity costs. For years, because of the dogma that interest was a capitalist phenomenon, capital investment was not evaluated efficiently so that waste abounded.
  • The communist leaders were all urban persons and thought they could treat agricultural work as if it was a 9-5 factory job. Having no appreciation of the life and work of peasants, they collectivized agriculture, treating it as factory with disastrous results, including a famine in which several millions died in the 1930s and low agriculture productivity from then on. (Later what should have been one of the
    worlds’ great bread baskets came to require imported food in the 1970s and 1980s.)
  • Workers are paid more than the value of their output at controlled prices and so are forced to save because there are no goods available to buy. This is a time bomb as financial savings for which there is no real counterpart accumulate.
  • Services were valued at cost while there was little incentive to produce real value in many service activities. (For a later example, I once waited for an hour for a taxi in Budapest while the drivers played chess. Measured GNP is same if they play chess or take me to where I want to go.

The short paper is really informative about what was wrong with the analysis produced by Russia analysts in the US. This somehow has relevance to the current US involvement in Pakistan and Iraq.

(Thanks to Professor Farrant for the link).