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Command Economy

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Title: Command Economy


1
Command Economy
  • Why study command?
  • The command system creates initial conditions for
    transition
  • Legacies from command critical for transition
  • Path dependence
  • Two types of legacies
  • Structural
  • The result of past investments and other
    decisions
  • Enterprises, locational choices
  • Institutional
  • Behavioral patterns
  • How to reverse past decisions
  • Start with the analysis of command system

2
Command Economy
  • Attempt to replace markets
  • The command principle strives to fully and
    effectively replace the operation of market
    forces in the key industrial and developmental
    sectors of the economy, and render the remaining
    (peripheral) markets manipulable and subordinate
    to political direction.
  • Two Basic Imperatives
  • Growth
  • Control

3
3 Key Purposes
  • maximum resource mobilization towards urgent and
    over-riding national objectives, e.g. rapid
    industrialization or the prosecution of war
  • Used by many countries in wartime
  • radical transformation of the socio-economic
    system in a collectivist direction based on
    ideological tenets and power-political
    imperatives and
  • not the least, as an answer to the
    disorganization of a market economy through price
    control, possibly occasioned by inflationary
    pressure arising from (1) and/or (2).

4
Basic Features of the STE
  • state-ownership of the means of production
  • centralized control by means of an administered
    system of planning in physical terms.
  • The system replaces the market with a set of
    directives from the center to the production
    units throughout the economy.
  • These directives are commands, not suggestions.
    They are directives that have the force of law,
    and subordinates are responsible for fulfilling
    them, even if the plans are not feasible.
  • The absence of markets implies loss of
    information about opportunity cost
  • absence of private property, except for
    households

5
STE
  • STE created by Stalin in 1928
  • Exported to Eastern Europe after WW2
  • Imported by China after 1949
  • Yugoslavia mutates in mid-50s
  • Self-management
  • North Korea, Vietnam, Cuba are underdeveloped
    examples of command economies

6
Basic Feature Continued, Implications
  • soft-budget constraints
  • chronic sellers market
  • emphasis on heavy industry
  • gigantomania
  • dynamic incentives problems
  • state control of investment
  • restrictions on entry, no exit

7
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8
Distribution of Employment by Size
9
Structural Differences
10
Ownership
  • Not just commanding heights
  • In the Soviet Union, for example,
  • the state and collective sectors accounted for
    some 88 of the value added in agriculture
    controlled 98 of retail trade, and owned 75 of
    urban housing space
  • The industrial sector was exclusively state
    owned.
  • In 1985, for example, 91 of employment was in
    state enterprises, and another 6 was in
    kolkhozy.
  • The extensive control of retail trade means that
    the smallest shops were state owned.
  • But key factor is hierarchical control

11
Sample Hierarchy
12
Old Gosplan (currently Duma)
13
Hierarchy
  • Only vertical information flows
  • But there are informal horizontal flows
  • Only at the top of the hierarchy can opportunity
    cost be assessed
  • Lower level agents cannot assess tradeoffs
  • Implies subordinate control crucial
  • Bureaucracy must exercise full control and
    discretion
  • But subordinates have their own interests, which
    implies
  • Incentive problems
  • Need for monitoring systems (police, party,
    banks)
  • Corruption
  • Fundamental issue how to get agents to reveal
    information and follow orders

14
Soviet Growth Model
  • Mechanism for extensive growth
  • Paradoxical attitude towards time
  • planners have a very low discount rate -- they
    are willing to sacrifice lots of current
    consumption for future consumption
  • On the other hand, haste implies that they want
    to industrialize fast. So they cut corners, and
    ignore side effects and other costs.
  • Diabetes example
  • Key point
  • Haste sowed the seeds of the barriers to
    longer-term performance.
  • In that sense, the rapid growth in output of the
    first couple of five year plans represent
    borrowing from future performance.
  • Balloon payment
  • Key defect of the SGM is that output growth is
    pursued without regard for the opportunity cost
    of that growth
  • E.g., environmental mess

15
Extensive vs Intensive Growth
  • Suppose that output is given by
  • Then the growth rate of output is given by
  • Thus growth occurs either thru growth of inputs
    (more K and/or more L) or technological change
    (growth in A)
  • Extensive growth is the former, intensive growth
    is the latter
  • Growth thru greater efficiency in use of inputs
  • Extensive growth is growth thru accumulation of
    inputs

16
Extensive Growth
17
Intensive Growth
18
Consumption Paths
  • Whose utility is being maximized?
  • Households versus planners objectives
  • Planners willing to defer present consumption
    versus future consumption
  • Planners combine haste with patience
  • Their haste for fast growth with publics
    patience for deferred consumption
  • High rate of time preference on part of owners,
    cost paid for by public

19
Consumption Paths
20
Consumption Path with Balloon Payment
21
Feschbach on Environment
  • In the last decade of the 20th century, there are
    no leading industrial cities in the Soviet Union
    where air pollution is not shortening the life
    expectancy of adults and undermining the health
    of their children. The growth that made the USSR
    a superpower has been so ill-managed, so greedy
    in its exploitation of natural resources and so
    indifferent to the health of its people, that
    ecocide is inevitable.
  • Collapse of the system prevented ecocide?
  • Why does Russia like Kyoto?

22
Aral Sea
23
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24
Soviet Growth Model (cont.)
  • Growth implies maximize investment
  • How? Via control of consumption
  • State is sole employer gt monopsony
  • Let be the subsistence level of consumption
  • Then is aggregate consumption.
  • Let be aggregate
    consumption
  • Then investment is maximized, for given level of
    K, by choosing L so that
  • What if ?

25
Maximizing the Investment Rate
26
Industrialization Strategy
  • Heavy industry
  • Maximize investment
  • Collectivization
  • Surplus labor argument
  • Transfer from rural to urban
  • State control over resources
  • But peasant response
  • Output growth versus welfare

27
USSR, Inc.
  • Soviet economy as a single corporation
  • The corporation owns a large stock of natural
    resources,
  • has no outside shareholders
  • (so that all "profits" can be retained for
    investment)
  • hires labor
  • Moreover, as a monopsonist in the labor market,
    USSR Inc. can minimize the expenditure on labor.
  • Transactions between enterprises are merely
    transfer prices between "divisions."
  • The exceptions are purchase of labor and
    engagement in foreign trade.

28
Exceptions
  • Labor is allocated partly by choice
  • State determines demand, but labor is supplied
  • Though vagrancy is a crime full employment
  • Foreign Trade controlled by FTM
  • FTM trades with ROW
  • Intermediary between producers and ROW
  • Insulates domestic prices from world prices
  • Purchases (sells) goods at state prices and sells
    (buys) at world prices

29
Transfer Prices
  • Prices used in transactions between parts of USSR
    Inc. are not terms of trade
  • gt no need to equal opportunity costs.
  • Transfer prices record activity, they do not
    motivate
  • Agents are executants of orders from above
  • Transfer prices could be randomly assigned
    without changing behavior
  • But arbitrage opportunities could arise

30
Monopsonist Labor Market
31
Haste
  • Command system is good at mobilizing
  • achieving specific objectives
  • Extensive growth
  • Growth through accumulation of inputs
  • It is bad at assessing costs and tradeoffs
  • May be important for intensive growth
  • Growth via greater efficiency
  • Crucial Role of Resource Abundance
  • Delay in reaching BoP constraint

32
Growth Problems
  • Over time growth rates decline in all STEs
  • Despite continued growth in capital-worker
  • Why?
  • Failure to transition to intensive growth
  • Extensive growth trap
  • Inability to substitute capital for labor
  • Innovation Problems
  • The system worked best when the fruit was
    low-hanging
  • mobilization

33
Growth Rates of Output by Eras
34
Soviet Growth Rates Decline
35
Growth in Capital-Worker
36
Intensive vs Extensive Growth
  • Start with
  • Then the growth rate of output can be written as
  • Intensive growth means high
  • Extensive growth means accumulation
  • But notice that as capital accumulates,
    increases
  • What happens to rate of return?

37
Innovation Problems Recognized
  • Malenkov (1941)
  • ...highly valuable inventions and product
    improvements often lie around for years in the
    scientific research institutes, laboratories and
    enterprises, and are not introduced into
    products.
  • Gorbachev (1987),
  • ...many scientific discoveries and important
    inventions lie around for years, and sometimes
    decades, without being introduced into practical
    applications.
  • Why?
  • Dynamic incentives problems

38
Two Explanations of Slowdown
  • TFP growth declines due to increased complexity
    of the economy
  • Difficulty with diffusing innovation
  • Low elasticity of substitution
  • K/L increase due to high savings rate and limits
    to growth in labor force
  • If substitution is difficult output growth is
    reduced
  • Note that this is organizational, not
    technological
  • No entry, limited exit
  • Input-output conservatism in planning
  • Extensive growth and natural resources
  • Energy was underpriced and over-utilized
  • when prices are liberalized many industries are
    producing negative value added

39
Labor Force Participation Rates for Women
40
Role of Elasticity of Substitution
41
Price System
  • Prices unrelated to social costs
  • Socially necessary costs
  • Average not marginal
  • Non-existent charges for rent and capital
  • Raw materials underpriced
  • Costs of production were thus calculated based on
    an incomplete enumeration of costs.
  • Prices biased based on user
  • Circus mirror effect
  • Does it matter?
  • USSR, Inc., gt transfer pricing
  • But illusion about sources of value
  • Implications for transition

42
Price System (cont.,)
  • Why have prices in a planned economy?
  • an accounting device
  • Monitoring of plan performance
  • Related question, why have money?
  • Active and passive money
  • Soft-budget constraint (Kornai)
  • If budget constraints are not binding a resource
    constraint must eventually be reached
  • Implies that shortage is an equilibrium
    phenomenon in STEs
  • Leads to sellers markets

43
SBC
  • Dynamic Commitment problem
  • Subsidy available ex post not ex ante
  • Effort costly for manager, bonus for fulfillment
    is B
  • Effort is sufficiently costly so
  • If effort is low, Y 0 with no bailout, Y R
    with bailout
  • If low effort manager must be bailed out because
    low output is bad for planner
  • Manager knows this so he supplies low effort

44
SBC
45
Chronic Sellers Market
  • Primary cause gt the emphasis on growth at all
    costs
  • Taut plans gt uncover hidden reserves
  • Soft-budget constraints
  • Plan fulfillment imperative
  • Excess demand for labor
  • Shortage and priority
  • Personality dominates
  • Lack of quality

46
Dynamic Incentives Problems
  • Planning from the achieved level
  • Enterprise exploits hidden information
  • Agents must be induced to reveal information
  • Simple 2-person game
  • Enterprise director can tell the truth or lie
  • Planner can issue a feasible or a taut plan

47
Preferences
  • Directors preferences
  • Planners preferences
  • Illustrative payoff matrix
  • Equilibrium both lie

48
Bonus Function
  • To get director to reveal information planner
    implements a bonus function
  • But why pay to overfulfill?
  • Need for extra resources to meet shortages
  • Increase effort

49
Canonical Bonus Function
50
More on the Bonus Function
  • Solves static problem
  • Assume that effort is required to produce more
    output
  • Moral hazard
  • But that this differs depending on productivity
  • Hidden information (adverse selection)
  • Then preferences depend on the nature of the
    enterprise

51
Canonical Bonus Function
52
Canonical Bonus Function
  • Generates separation
  • If no bonus for overfulfillment, then pooling
  • Sets up the dynamic incentives problem
  • Fulfillment today risks fulfillment tomorrow
  • Consequences
  • Need for a safety factor
  • Ratchet effect
  • Taxing high performance

53
Dynamic Problem
  • Let be utility for fulfilling the
    plan for the high productivity enterprise
  • Current gain from overfulfilling is
  • Loss from revealing information is
  • Then director must compare

54
Dynamic Problem
  • LHS is the current gain from revealing (CG)
  • RHS is the present value of future losses (DFL)
  • Depends on the time horizon of the agent
  • Whenever DFL gt CG the director will conceal true
    capacity
  • Ratchet effect gt fear of a higher future target
    lowers current performance
  • Predictability, Shchekino

55
Shchekino Experiment
  • Planning experiment
  • Planners commit not to change targets for 5 years
  • Enterprise can keep costs savings
  • Labor productivity rose so fast, 52 in first
    year, planners reneged
  • Changed plan targets 7 times in 10 years
  • Another plant 17 times in 5 years
  • Inability of planners to commit

56
Ratchet Effect
  • More severe the greater is
  • Time horizon
  • Utility loss
  • And the smaller is
  • The discount rate
  • Leads to reduced incentives to perform and
    innovate
  • Alexeev and weightlifting records
  • Slow diffusion of innovations

57
Result
  • Who said this?
  • Yuri Andropov, General Secretary, CPUSSR
  • Top officials know the problem, cant solve it

58
Lack of Observability
  • Inflated reports simulation is commonplace
  • Difficulty of monitoring
  • Occasional audits show this

59
Enron, Global Crossing, Stock options
  • Similar problems occur in corporations
  • Directors and managers engage in simulation
  • simulation of performance to achieve bonuses
  • Simulate earnings to benefit from options
  • Incomplete information necessary but not
    sufficient
  • it is also necessary that rewards be skewed
    toward the present,
  • especially if those costs can be shifted on to
    others in the future.
  • Much harder to keep simulations hidden in markets
  • Need to hide losses, but Soviet pricing does not
    reveal losses

60
Vasily Alexeev
61
Date of First Adoption versus Diffusion
(proportion of output produced in 1982)
62
Structure of Command Economy
  • Imperative is microbalance
  • Planning by material balances
  • Feasibility, not optimality
  • Iterative process of vertical information flows
  • Basic idea
  • Sources uses, good by good
  • For good j we have
  • Where does come from?
  • The input requests from other enterprises
  • Where does this come from?

63
Material Balances, cont.
  • Planners start with a target for sector j
  • Enterprise calculates its input needs assuming
    fixed coefficients
  • So multiply to get needs
  • Now planner adds. E.g. for sector 1 (such an
    equation for each sector of course)

64
Schematic
65
Material Balances, cont.
  • Put the sum back into the material balance
  • No reason to assume it equals zero.
  • So adjust output targets
  • Now we have a new set of input needs for each
    enterprise. For j we have
  • And we just repeat the whole process, again, and
    again

66
Material Balances, cont.
  • Process continues till all the Djs are zero
  • Notice how simple are the operations
  • If the process goes on long enough a feasible
    plan result
  • But the number of iterations could be very large
  • In practice only one or two iterations
  • So plan as implemented is infeasible
  • Some plans taut, others slack
  • Note emphasis on intermediate goods
  • But optimal plans look at final goods
  • Central control and subordinate responsibility
  • Micro-balance is the imperative
  • Process assumes truthful revelation

67
Incentives versus Complexity
  • Mises, Hayek thought central planning problem was
    too complex to solve
  • Lange and Lerner suggested market solutions
  • Set Q such that MC P
  • But this ignores incentives problems
  • Why would managers follow the rules?
  • Private information (about actions or conditions)
    is valuable
  • Agents must be induced to reveal this

68
Command Problems
  • Detailed planning and the corresponding
    directives are often late, are insufficiently
    detailed, may lack the requisite information,
    hence often cannot be effectively coordinated
  • Owing to their rigidity they are peculiarly
    vulnerable to uncertainty
  • Planning in a command economy must be largely in
    physical terms due to the crucial importance of
    balance.
  • The bottom line of the planning process must be
    available physical units of required inputs, in
    appropriate assortment, quantity and timing,
    necessitating physical targets for production and
    input utilization.
  • Success indicator problem

69
Success Indicator Problem
  • Bonuses are non-synthetic
  • One linear price schedule produces imbalances
  • No secondary market
  • Planners cannot know tradeoffs at each enterprise
  • Pollution permits
  • Emphasize priority
  • Quality problems shifted to users
  • Because micro-balance is priority
  • Teaching versus research?
  • Bonus for retention

70
Command
  • Command is good for well-defined measurable tasks
  • Build the Atom Bomb
  • Dont worry about cost 25.7 billion at current
    prices
  • Command is bad at assessing tradeoffs
  • No prices to measure opportunity cost
  • Physical indicators lead to success indicator
    bias
  • Teaching is harder to measure than research

71
Shortage
  • SBC, fixed prices, output fixation gt shortage
  • In production, to avoid wasted resources full
    utilization to achieve growth
  • In consumption, because planners do not want to
    divert output
  • Of course, flexible prices could eliminate
    shortage, but command means dominance over market
  • Market allocation weakens central control
  • Implication Generalized shortage

72
Shortage
73
The Big Nail
74
Problems with Linear Pricing
75
Mormon Comparison
  • Many similarities
  • Sense of encirclement
  • Holistic vision of utopia
  • Virtuous haste
  • Totalitarian leadership (without terror)
  • Primacy of collective over individual
  • Hostility to speculation, private initiative
  • Insulation and isolation
  • Need for autarky to conserve foreign exchange
  • Like the Soviet economy, economy was
    collectivist, mobilizational, centrally planned,
    largely command-managed, and often
    redistributional in regard to factors, products,
    and the economic surplus.

76
Mormon comparison, cont.
  • More similarities
  • Property owned by church
  • Capital formation
  • Via tithes, mostly in kind
  • Prices as accounting devices, economy demonetized
  • Frequent reforms
  • Cooperative forms of organization
  • Key differences
  • Voluntary, not coercion
  • Building on virgin soil

77
Seeds of Transformation
  • End of isolation
  • Immigration of gentile tradesman
  • Like the second economy of USSR
  • Railroads lower transportation costs
  • Raises cost of autarky
  • Hostile US legislation
  • Trade leads to corruption and sub-rosa
    privatization

78
Second Economy
  • Informal economy arises to meet challenges of
    command
  • Precisely because command economy cannot achieve
    balance, and as terror dissipates
  • 2nd economy defined as all production and
    exchange activity that meets at least one of two
    criteria
  • being directly for private gain
  • being in some significant respect in knowing
    contravention of existing law. See Grossman,
    1977, p. 25.
  • These market-mediated activities are at times
    supportive, helping to achieve tolerable
    micro-balance in the increasingly complex
    economy,
  • but they often are in violation of planned
    implementation and regime values.

79
Second Economy
  • Brezhnev on second economy
  • You don't know life. No one lives on wages alone.
    I remember in my youth we earned money by
    unloading railroad freight cars. So, what did we
    do? Three crates or bags unloaded and one for
    ourselves. That is how everybody lives in our
    country.
  • Blat markets
  • 2nd economy activity necessarily introduces
    discretion
  • Potential for diversion

80
Second Economy
  • Virtually every area of economic life is touched
    upon, and often entangled with, second economy
    activities
  • legal private activity naturally opens a loophole
    for illegal trading and entrepreneurship,
    generally below the purview of the authorities.
  • Dual contradictory roles of 2nd economy
  • First, it addresses a number of the problems of
    coordination and balance endemic to the command
    mechanism
  • But, second, it mocks the pretense of social
    direction and control, subverts its egalitarian
    impulse, accentuating differences in access and
    income, and gives lie to the pretense of a new
    ideologically correct (Soviet) man

81
Evaluation and Size
  • 2nd economy completes the cancerous development
    of agent autonomy
  • Generates undesirable (system perspective)
    redistribution of incomes,
  • although recipients, including many high placed
    officials, find it very desirable.
  • Size
  • Estimates based on the surveys of Soviet
    emigrants relate to the second half of 1970s and
    range approximately between 10 and 30 of
    incomes of urban households.
  • An alternative set of estimates based on the
    Soviet-era official family budget survey data
    puts the second economy at around 23 of
    household income (Kim, 2003).
  • Could be as large as 12 of GDP in 1979
  • But double counting

82
Legacies
  • Two types
  • Structural legacies
  • Institutional legacies
  • Financial underdevelopment
  • Absence of rule of law
  • Khruschev Whos the Boss we or the law? We are
    masters over the law, not the law over us so we
    have to change the law we have to see to it that
    it is possible to execute these speculators.
  • FTM

83
Structural legacies
  • Industrial structure
  • Industry bias
  • Industry intentional, agriculture unintentional
  • Under-provision of services
  • Hypermilitarization
  • Industrial concentration
  • Gigantomania
  • Absence of small enterprises

84
Distribution of Capital Stocks
85
Structure by Labor Force
86
Indicators of Raw Materials and Energy
Consumption, 1988
87
Enterprise Size in US and Russia
88
Hypermilitarization and Climate
  • Size estimates difficult
  • Pricing distorts measurement
  • Cost shifting
  • Defense burden unsustainable
  • Locational burden
  • Interaction with climate problems
  • Soviet Union got colder in 20th century!
  • Too many people in the wrong places
  • Big problem for market economy

89
Location in RussiaPopulation of Siberia and Far
East in 1989 37 mln (25 of RF total)
Manufacturing employment 1.8 mln (16 of RF
total)
90
Location in CanadaPopulation 85 000. (0.34 of
Canadian total) Manufacturing employment
295people (0.017 of Canadian total)
91
TPC in Canada, USA, and Russia
92
Duluth, population 86,000
93
Omsk, population 1.2 million
94
Perm, population 1.008 million
95
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96
Internal vs External Inefficiency
  • Internal inefficiency
  • Lack of high-powered incentives
  • Input combinations and X-inefficiency
  • External inefficiency
  • Lack of market pricing
  • allocative
  • Dynamic inefficiency
  • Lack of innovation

97
Legacy of Never-ending Reform
  • Waves of reform
  • Why a treadmill?
  • Rejection of alien organisms
  • Pitfalls of partial reform
  • Cooperatives
  • Supply diversion
  • Timber and boxcars

98
Example
  • Efficient rationing of timber
  • Plan price P, excess demand in housing
  • Cooperatives bid for timber
  • x units of timber diverted to housing from
    boxcars

99
Supply Diversion
  • Notice that P is the shadow price of timber
  • With freedom to sell, timber sector sells qm to
    the housing (cooperative) sector, cutting back
    deliveries to the boxcar sector
  • Shadow value of timber is now much higher in
    boxcars
  • Consumer surplus falls by A in boxcars and rises
    by C in housing note A gtgt C
  • Producer surplus in boxcars falls by B 2C
  • Notice that the problem arises because the boxcar
    industry cannot compete for timber, and the
    capital in that sector cannot flow to housing.
  • The moral of this story is that as the state
    loses control over the state sector, diversions
    make things worse.
  • But China will be different!

100
Achievements
  • Full employment
  • By law gt no unemployment insurance
  • Soft budget constraint
  • Free health care
  • Good at infections, bad at modern diseases
  • Low income inequality
  • Gini Coefficient
  • Ratio of the area between the Lorenz curve and
    OB, and the whole area OAB.
  • Wealth v income, and access to goods

101
Lorenz Curve
102
Earnings Distribution, Full-time workers
103
US Income of Top Decile
104
Social Uncertainty
  • Command economy minimizes income shocks
  • Full employment, socialized medicine
  • Social insurance is high
  • Underemployment vs unemployment
  • Risk taking is low
  • Institutions to cope with uncertainty in modern
    economy are absent

105
Life Expectancy at Birth, Russia, 195859,
196162,196364, 19652002
106
An Alternative Factor
  • Decline of Oil prices
  • When rents exploded, so did commitments
  • Rents market value of revenues less natural
    costs of extraction
  • Including subsidies to Eastern Europe
  • When rents declined hard to cut commitments
  • Resource abundance is addictive
  • increase in energy investment between 1981 and
    1985 absorbed nearly 90 pct of increment
    allocated to industry
  • Production maintained by borrowing from future
  • Tightened the resource constraint

107
An Alternative Factor
108
Rents and GDP
109
Rents, Addiction
  • Resource rents postponed day of reckoning
  • "In sum, the Soviet economic system became what
    it is in part thanks to the country's rich
    resource base, which permitted the planners
    largely to ignore the day-to-day discipline of
    the balance of payments and therefore also the
    imperatives of the market place and the pains of
    real economic cost. On this basis an elaborate
    and rigid institutional edifice sprang up. This
    economic system thrived for two human generations
    and achieved marked successes by its own
    criteria. But inevitably it hardened and came to
    be supported and protected by powerful vested
    interests Grossman, 1983 202.
  • addiction to rents postponed fundamental reforms,
    made the system more fragile
  • The lesson is that resource abundance,
    misapplied, can be addictive

110
Addiction
  • Addiction leads to short-time horizon
  • This leads to an inability to implement reforms.
  • Three characteristics
  • tolerance - the need for an increasing amount of
    the substance to obtain the same effect
  • withdrawal - severe unpleasant effects when the
    addict ceases to use the substance craving
  • "willingness to sacrifice all (to the point of
    self-destructiveness)" in order to obtain and use
    the substance.
  • In Soviet case tolerance arose because windfall
    was used for many new activities
  • defense, East European subsidies and other
    international adventures
  • interests created that depend on rents, makes
    withdrawal painful
  • where is the methadone for an addicted Soviet
    economy?

111
Defense Addiction
  • Marshal Akhromeev on addiction
  • Why it was necessary to produce so many weapons?
    Akhromeev answered
  • "Because at a great cost of many sacrifices we
    created first-class factories, no worse than the
    American ones. Would you order them to stop work
    and begin producing cooking pots?"
  • Shakhnazarov described the "military-industrial
    mentality" as a "cancerous growth" that had
    metastasized to every sphere of Soviet life
  • This is an example of addiction. The investment
    in factories created interests that were very
    costly to reverse.

112
Aspects of Collapse
  • Macroeconomic
  • Budget crisis, inflationary finance
  • Shortages, stolen hours, more queues
  • Weaker state lower tax collection
  • Microeconomic
  • Misallocation of resources
  • Lack of property rights
  • Pseudo privatization

113
Two Views on Collapse
  • Essentialists
  • Essentialists hold that the Soviet system
    collapsed because it was essentially abnormal
  • The nature of the Soviet system made its eventual
    collapse inevitable and even predictable
  • Of course, few made this prediction before the
    system collapsed. Autopsies are easier on dead
    bodies.
  • Voluntarists
  • Soviet economy was murdered, or its death was
    decisively hastened, by voluntary acts of policy,
    though the consequences may have been unintended.
  • We tend to confer the mantle of inevitability on
    accomplished facts, and arguing that what
    happened did not have to happen is likely to be
    dismissed as inventing excuses for the losing
    side. But the collapse of the Soviet system was
    the unintended result of a small number of
    disastrous decisions by a few individuals

114
Was Demise Inevitable?
  • Productivity growth slowed, but never turned
    negative
  • The odds on overtaking fell
  • Reforms upset performance
  • Reforms made the system more fragile
  • Monitoring costs rose and deterring corruption
    became more costly
  • Erosion of belief in system
  • So small shocks could lead to collapse

115
Weakening of Central Control
  • Critical difficulty for central planning
  • Brezhnev Communism Stalinism without terror
  • Raises the prices of information and action
  • Loss or resources at center
  • Agents have two options
  • Fulfill the plan, F
  • Dont fulfill the plan, NF
  • Payoffs depend on whether observed or not
  • Let be the probability of being observed

116
Stalinist Incentives
  • Let be the payoff to NF if unobserved
  • Suppose that
    and
  • Then the expected payoffs are
  • Planners want
  • Two instruments, detection and punishment
  • We can plot this

117
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118
Stalin v Brezhnev
  • Stalinist system set punishment - infinity
  • Lowers cost of detection
  • Brezhnev system
  • Cheating is optimal for larger range of
  • Problem is more severe with greater complexity
  • Glasnost makes it even worse
  • Explosion of Second Economy
  • Loss of central revenue

119
Multiple Equilibria
  • The same system can have two equilibria
  • High output
  • Low output
  • Consider the producers decision to supply effort
  • Depends on gains and penalties
  • And whether this is observed

120
Producers Choice of Effort
Producer works hard, if
Gain from working hard gt cost of working hard
If work is hard and monitoring is strict, then
If work is hard and monitoring is lax, then
Work hard if reward gained penalty avoided gt
cost of effort
Dont work hard
No rewards gained, low effort supplied
Gain reward for working hard, avoid penalty for
not working hard, spend effort working hard
121
Dictators Choice
  • Dictator wants to deter stealing
  • Two key parameters
  • Cost of incentives provided
  • Costs of monitoring
  • Over time these parameters shift
  • Complexity raises monitoring costs
  • Weakening center (decline in oil revenue) raises
    costs of providing incentives
  • High output is no longer an equilibrium

122
Dictators Decision
Dictator Monitors if
Effort is high, and if
Effort is low and if
Cost of monitoring lt value of output stolen
future output lost
Else, dont monitor
Costs of monitoring lt output stolen future
output loss
Else, dont monitor
123
Parameter Shift
  • Evolution of the system led to parameter shift
  • Complexity raises monitoring costs
  • Information flow weakens central authority
  • Value of incentives decreases as their cost rises
  • Second economy grows
  • High output is no longer the equilibrium
  • Reforms weaken the structure
  • Do not lower monitoring costs
  • Reforms make defection easier
  • Cooperatives
  • Law on state enterprise

124
Bank Run
  • Why the sudden collapse?
  • As center weakens officials defect
  • Race to cash in on assets
  • Solnick on the collapse
  • Key to bank run
  • Illiquidity
  • Sudden loss of trust

125
Solnick
  • ...the image of a "disintegrating"
    state...is...seriously incomplete. Soviet
    institutions did not simply atrophy or dissolve
    but were actively pulled apart by officials at
    all levels seeking to extract assets that were in
    any way fungible. Where organizational assets
    were more specific to their particular use by the
    state, as in the case of draft boards, for
    example, hierarchical structures proved more
    resilient. Where organizational assets were
    chiefly cash and buildings, hierarchical
    breakdown was almost total. At both ends of the
    spectrum, the catalysts of state collapse were
    the agents of the state itself. Once the bank run
    was on, these officials were not merely stealing
    resources from the state, they were stealing the
    state itself."

126
Shock to Loyalty
  • Income of an official is
  • Probability of detection
  • Strength in numbers
  • Expected value of defection
  • Critical value of loyalty

127
Critical Loyalty Value
128
Add Theft
  • Race to cash in
  • Each defecting agent steals
  • Not enough to steal, illiquidity
  • Official income is now
  • Output falls faster
  • Critical value reached sooner
  • Agents know nothing will be left if

129
The Bank Run Case
130
Conclusion
  • Was the collapse a disaster?
  • Implications for transition
  • Political and economic collapse
  • Is this more difficult than just economic reform?
  • Macroeconomic imbalance
  • Window of opportunity
  • Agenda for reform?
  • No blueprints

131
Midterm One Results
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