Chapter 16: the Command Economy

PART

five

Socialist Economies

Chapter 16: The Command Economy

Why Study Planned Economies?

A Brief Overview of Russian Economic History

Chapter 17: The Operation of the Soviet Planned Economy

The Institutions of the SovietState

The Mechanism of Planning

The Determination of Prices

Labor Markets

Market Clearing

Monitoring Plan Fulﬁllment

Incentives in Soviet-Type Systems

Conclusion

Chapter 18: The People’s Republic of China

Introduction

Central Planning, 1952–1959

The Great Leap Forward, 1958–1961

The Cultural Revolution, 1966–1970

The First Phase of Reform, 1978–1993

Reforming State-Owned Enterprise

Creating a Modern Enterprise Sector

Reforming the Tax Finance System

The Financial System

International Trade

Special Economic Zones

The Importance of a “Kindred Model”

The Character of Chinese Reform

Have Reforms Accelerated Growth?

Can Growth Be Sustained?

China and the World Trade Organization (WTO)

Chapter 19: The Participatory Economy: The Case of Yugoslavia

The Participatory Economy

Development of the YugoslavState

Yugoslav Market Socialism

Problems of the Yugoslav Economy

Conclusion

Chapter 20: The Possibilities of a Third Way

Market Socialism and Social Markets

Market Socialism

The Social Market Economy

Conclusion

16 The Command Economy

WHY STUDY PLANNED ECONOMIES?

At this juncture of history it is tempting to view both the theory and the experienceof central planning as an irrelevant footnote. Both popular and academic opinion now consider command planning as a dead end, a mistake into which many nations were dragged for a few decades and from which they have now largely emerged. Today about 30 of the world’s nations,1 with an aggregate population of about 1.6 billion people, who were previously committed to some form of central planning are now regarded as economies in transition—converting from a socialist system to a capitalist one. However, it would be premature merely to salute “the triumph of capitalism” and turn away from any consideration of the achievements and the shortcomings of socialism and central planning, since there is a lot to learn from the careful examination of their history.

Central Planning Is Not Extinct as a System

Mark Twain once observed that “reports of my death have been greatly exaggerated,” and the same may be the case for central planning. Despite current appearances and political trends, it is conceivable that some form of centralized planning will be reestablished, possibly emerging once more within the group of former socialist nations. Indeed, several of the largest nations are by no means so well advanced in the transition process that the situation is irreversible. China, for example, still retains the strong political control required to revert back to centralized planning if the social problems of greater liberalization continue to grow. Vietnam, despite some liberalization and a lot of incoming foreign investment, is committed only to an experiment in what its leadership calls market Leninism. Even within the nations of Central and Eastern Europe, former Communists have made strong showings at the polls, and though nominally committed to maintaining a path toward a full market economy, they still have an ideological bias toward central control. In Western Europe a recent tilt in electoral sentiment has put left-wing parties back into power. Finally, the chaos in Asian markets during 1998 leaves some to wonder whether market capitalism is the most efﬁcient system of economic organization.

Comprehension of the Planned Past Is the Key
to a Successful Transition to a Market Future

An effective transition to a market economy depends on a full understanding of the constraints imposed by the legacy of the prior system. Although many economists advising the nations in transition seem to conceive of the task as building a system “from the ground up,” in reality the culture, mores, institutions, and much of the distribution of power of the old system are very much alive. The direction of transition is contingent on the legacy of the socialist period in most countries and change requires the acquiescence of the more privileged elite established by the prior order.

Most Economies Make Use of Some Form of Planning

As we have noted, none of the world’s economic systems is purely private. All nations pursue some mixture of both private and public systems. Studying the consequences of generalized planning in command economies can help inform our discussion of mixed systems, point to the limitations of government, highlight the need for incentives, and indicate when planning can be the best approach for meeting social needs.

There Are Lessons to Be Learned
from Examining Failure

Finally, we should have a clear idea of why centrally planned systems failed. That those who fail to understand history are doomed to repeat it is an over-used expression, but in terms of choosing an economic system, this perspective may well be valid. Central planning was attractive because it offered a rational alternative to the repeated recessions and skewed income distribution that characterized capitalism. When, in the 1950s, Nikita Khrushchev declared that “we will bury you,” he was talking in terms of systems, and at that time many in the capitalist world feared that he might be right. However, having watched the stagnation and relative decline of the socialist nations, we now know that socialism’s apparent advantages are bought at a high cost.

A BRIEF OVERVIEW OF RUSSIAN ECONOMIC HISTORY2

For our example of central planning, we turn to the experience of the Soviet Union. This was the earliest example of comprehensive planning, and efforts in other countries, notably in Eastern Europe after World War II and in China, drew their expertise and inspiration from the Soviet model.

The Czarist Economy

No system develops independently of historical inﬂuence, and the emergence of the planned Soviet state was no exception. The development of modern Russia, including the Soviet period, owes much to Peter the Great. He was the ﬁrst great modernizer, aggressively importing Western technology and science, while simultaneously resisting the liberalizing inﬂuence of Western political thought. He began the process of Russian industrialization, founding a variety of state industries. He revolutionized public ﬁnance and increased the income of the treasury ﬁve-fold. However, he did little to reform serfdom, which was the basic institution of the labor market, and relied heavily on forced labor for his projects, the most enduring of which was the construction of his “European” capital, St. Petersburg. Consequently, the dualism of Russian society increased: a more afﬂuent and westward-looking aristocracy contrasted increasingly with a backward and exploited peasantry.

The repressions of an absolutist monarchy, an elitist aristocracy, and a highly conservative Orthodox Church were formidable barriers to economic change, and Russia, despite its great potential, remained relatively poor. Failure to defeat a rather small Anglo-French force in the Crimean war of 1853–1856 underlined Russian backwardness and in 1861 led Czar Alexander II to take the immense step of liberating the serfs, who then represented about three-quarters of the population. Emancipation was accompanied by land reform and after their manumission the peasants held, through communal organizations, about half of the country’s agricultural land. Predictably the aristocracy retained ownership of the best land,3 and the poorer acreage transferred to the serfs was not given but sold on mortgage, so from the start of their liberty the peasantry was encumbered by heavy debts.

The government set about modernizing the Russian infrastructure, with special emphasis on the transportation needs of the vast empire. More than 20,000 miles of railway track were built between 1861 and 1894, opening up the interior for export-oriented agriculture. The supply of grain for export was stimulated by the need of the peasants to sell much of their output for cash to meet their heavy debt obligations and taxes. By the 1890s Russia had emerged as the world’s largest grain exporter, and the hard-currency revenues were used to ﬁnance the import of capital goods required for the aggressive industrialization scheme of the ﬁnance minister, Sergius von Witte. Industrial output tripled between 1880 and 1900 and after a brief dip due to the global recession in the ﬁrst years of the 20th century, industrial growth accelerated again, making Russia the world’s ﬁfth largest industrial power in 1913.

Living conditions remained grim for both agrarian and industrial workers. The peasants, “held in a vise of ruinous aggregate taxation,”4 were forced to sell the bulk of their output to raise cash for taxes and debt service payments. The conditions of industrial workers were little better, and labor discontent led to political organization. Support grew among the industrial workers for the Russian Social Democratic Party, which held its ﬁrst convention in 1903, but the party was from the ﬁrst divided into two factions. The more moderate Menshevik wing consisted of social reformers, committed to piecemeal liberalization along the lines of Western Europe. The other wing, Lenin’s followers—somewhat inaccurately termed the Bolsheviks,or majority—favored radical revolutionary change. The two factions of the party became increasingly alienated and formally split in 1912.

The Russo-Japanese war of 1904–1905 proved another rude shock to the czarist system. Russia was rapidly defeated by an Asian nation that had, only 35 years previously, been isolated in a state of feudalism. The losing war effort led to privation at home, accompanied by rioting and strikes. A peaceful protest in front of the WinterPalace in St. Petersburg was ﬁred on by the military, and sympathy for the regime fell, forcing the czar into a series of political reforms, among them the formation of a permanent parliament, the Duma. On the economic front, the Stolypin reforms (named for the ﬁnance minister) accelerated the rate of industrial growth, freed the peasants from the communes, and alleviated their crushing debt burden.

It is possible that in the aftermath of the Stolypin reforms Russian economic development might have followed the path of peaceful evolution taken in Western Europe, where feudalism had given way to industrial capitalism in a relatively leisurely and peaceful fashion. However, a look at the sources of Russian industrial growth provides a reason to doubt a thesis of a gradually evolving market capitalism. Although expansion had been rapid, and as a result Russia had emerged as one of the world’s major industrial powers, the growth of output owed most to the increase of the industrial labor force and sustained growth in the volume of capital employed. Expansion was therefore highly extensive in character, the result of an increased use of factors of production, not of rising factor productivity. Total factor productivity growth (the residual increase in output, after allowing for the increase in labor and capital employed) was negligible. Industrial expansion could not in these conditions be accompanied by rising wages or living standards, and one likely scenario is that prolonged capitalism in Russia would have seen only the continued increase of a badly paid, and consequently angry, workforce, which might have provided revolutionary material at any time.

War Communism

Because of the turn of world events, we will never know whether the mold of extensive growth would have been broken or whether increasing labor demand would have ultimately resulted in burgeoning labor productivity and rising wages. In 1914 Russia became involved in a dispute with Austria and its ally Germany over the Balkans, and in August1914 Russia was propelled into war along with its own allies, France and Britain. World War I was immensely costly to Russia as its massive but badly equipped and poorly led army absorbed enormous casualties—two million dead in less than three years. At home even the barest essentials of life became unavailable for both the peasants and the urban poor, leading to food riots. In May1917 the czar abdicated, and power passed to the Mensheviks, led by Alexander Kerensky. Menshevik policy was to continue the unpopular war, despite persistent failure on the battleﬁeld and growing deprivation at home. Germany contrived to return the exiled Lenin from Switzerland to St. Petersburg where he led the Bolsheviks to power in the revolution of October1917. Initially Bolshevik control was largely limited to the capital, with most of the countryside in dispute, and reuniﬁcation of the country took three years of civil war.

The ﬁrst decisive act of the new Bolshevik government was to end the war with Germany by the treaty of Brest-Litovsk signed in 1918 on terms close to capitulation. It consigned a large part of the czarist empire to German control, including much of Poland and the Ukraine, the industrial heart and breadbasket of the Empire. France, Britain, and the United States intervened in an attempt to restore the czar and bring Russia back into the war with Germany. However, their somewhat half-hearted efforts were fruitless and the Red Army slowly won control of Russia and ultimately of most of the former czarist territory.

The system of economic organization instituted by the Bolshevik administration during this period is known as war communism. Economic management was almost totally by command; food was “requisitioned” in the countryside by police and party ofﬁcials and distributed in the cities. Thirty-seven thousand enterprises were taken into state hands, including every ﬁrm that employed more than 10 workers (5 in establishments where artiﬁcial power was used). The coordination of economic activity was ostensibly the preserve of the Supreme Council of National Economy (VSNKh) but effective action was fatally hampered by an almost total lack of meaningful information. Workers were conscripted and organized by military methods, and economic incentives for the industrial and agricultural labor forces alike were replaced by dictum and force.

Market economic relations were replaced by what the political leaders termed “natural” ones; housing, electricity, food, postal services ,and transportation were all supplied to the public without charge. Inter-enterprise relations between the state-owned production units were of bookkeeping signiﬁcance only. Obviously the system of war communism had many shortcomings, as without doubt efﬁciency suffered and corruption was rife. However, a dispassionate evaluation of this period as an economic system is not very meaningful. The country was in a state of civil war, struggling to recover from a disastrous defeat in war with Germany, the food and material shortage was acute, and desperate needs justiﬁed the desperate measures adopted. Moreover, from the Bolshevik viewpoint the near-term objective was merely survival and the economic system of war communism enabled them to gather enough resources to defeat both White Russians and foreign interventionists.

The New Economic Policy

By 1920 the civil war was more or less over and the Bolsheviks had established their rule not only within Russia itself but also on almost all of the former czarist empire, including areas that had been conceded to Germany in the treaty of Brest-Litovsk. The economy fashioned by von Witte and Stolypin was reunited, and the Bolshevik leadership had an opportunity to develop a new economic system in relative peace.

The blueprint for development was the New Economic Policy (NEP) articulated by Lenin in 1921, which attracted recent attention because it has common features with the Soviet (and subsequently) Russian reforms of the late-1980s and early 1990s. It is important to understand that the early leaders of the Bolshevik state were working in a vacuum. To legitimize their revolution they had to create an alternative to capitalism that was not only superior in its theoretical rationale but also in its concrete results, at least in terms of the distribution of income and the avoidance of mass unemployment. Moreover, this system had to be in some sense Marxian, although Marx’s writings gave the Bolshevik leadership little guidance. An astute observer of capitalist societies and economies, Marx had little to say on the socialist future. Moreover, he had predicted that the ﬁrst socialist revolutions would occur in the most advanced capitalist societies (Britain and Germany were the most likely candidates), and so revolution in Russia was somewhat anathematic to his theories. Lenin was careful to establish the orthodoxy of his revolution by a subtle reinterpretation of Marx, whose thought, he asserted, was really that revolution would occur in “the weakest link in the capitalist chain,” rather than necessarily in the most advanced capitalist economy. Despite his care in establishing the Marxian pedigree of the Bolshevik Revolution, Lenin was surprisingly liberal in his design of the economic institutions embodied in the NEP. Although he allowed considerable economic freedom, he regarded the NEP as a pragmatic step backward to establish stability before the creation of socialism could proceed.

During its brief life, the NEP was a form of market socialism. The “natural” economic relations of war communism were terminated in favor of price mechanisms. Control of food production was returned to the peasantry, and market relations were reinstituted to regulate the ﬂow of food to the cities. Small enterprises (deﬁned as those employing fewer than 20 persons) were reprivatized, some were restituted to their former owners and others leased to new entrepreneurs. Most of large-scale industry remained in state hands. Sectors seen as strategically essential—the commanding heights of the economy, including fuels, metals, banking, transportation, and foreign trade—became an integral part of the state, dependent on budget allocations and controlled in all important dimensions by the government. The rest of industry was granted substantial subsidies by the state but had no production quotas to meet and was otherwise encouraged to act in a proﬁt-maximizing fashion.