Economics 110 Notes for March 28

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Economics 110 Notes for March 28

Pass out Examination #2. Update on Paper.

Performance of the Former USSR

1. Review the Goals from Class #1

2. Economic Growth --- data from handout

a. Extensive, not Intensive (define)

Annual Percentage Change 1971-75 1976-80 1981-83 1984-87

GDP 3.7% 2.7% 2.3% 1.6%

Industrial Production 5.9 3.4 1.5 2.1

Agricultural Production 22.3 0.3 4.2 0.8

Investment 5.4 4.3 4.2 3.0

3. Efficiency --- Static and Dynamic

a. Data from the handout--- Low growth of productivity

b. Investment rates were high but very low productivity of capital (high ICOR)

c. One estimate for the USSR: if resources were allocated efficiently, industrial output would have risen 10% in 1975.

4. Full-employment and Macroeconomic Stability

a. Full-employment but Over-manning (pretend to work, pretend to pay)

b. Repressed inflation --- shortages

5. Standards of Living --- data from handout

a. GNP per capita

b. Consumption per capita plus its growth over time

c. Severe housing shortages (low rents but poor maintenance)

d. Food

e. Poverty -- Article

f. Graft and Corruption + Rudeness as Part of the Sellers' Market

g. Shopping Time (Kornai, 242)

6. Distribution of Income --- not very equal – see article

7. Social Welfare --- Handout

a. Education

b. Health Care -- Data for USSR of falling life expectancy

c. Public Welfare --

d. Environmental Disruption -- In the USSR, in 102 cities (with 50 million

people) pollution is 10+ times permissible norms!

8. Economic Freedom

9. Population Growth

a. Abortion in the USSR b. Divorce Rates

Reform: 1987 to 1991

1. Causes of Perestroika (Define)

a. High economic growth rates in the West and in Asia

b. SDI --- shift the competition to technology based where the old system was

inappropriate

c. Afghanistan

d. The communist system was not near collapse!!

e. Central planning became inappropriate in the new technological world that required flexible production, innovation, and complex relationships between companies

2. Beginning (Mention Gorbachev)

a. Restore discipline

1. anti-alcohol campaign --- loss of revenue for the government and illegal production (sugar shortage)

b. Glasnost

1. a change of leadership

2. end of Marxist-Leninist ideology as the official ideology of the state --- this led to the revival of nationalism which ultimately led to the demise of the USSR

c. Outward orientation --- observer status in GATT (became a member in 1990)

1. disband COMECON

2. desired Western capital

d. Large increase in state investment, merging of Ministries, attempts to improve quality (all attempts to improve the traditional system)

3. 1987 Law on State Enterprise

a. decentralization of decision making to the enterprises and local authorities

b. end of detailed annual plans

c. much fewer centrally allocated products – 618 instead of 13,000

d. Ministries were to have only indirect means to influence enterprises

e. enterprises to be financially self-sufficient + bankruptcy laws

f. enterprises could export and import on their own

1. However, Foreign Trade Organizations still controlled most of the trade and

foreign exchange was mostly still under state control

g foreign exchange auctions were begun (beginning of making the ruble convertible)

h. enterprise workers to elect the director

i expand the cooperative sector + legal certain private activity (1990 data). Private

economic activity was legalized, but only on off hours

j. revision of prices by 1991. In 1991, consumer goods prices rose 60% to 70% on

average

k. an attempt to keep the traditional system while moving more to markets and while

decentralizing decision making

4. Evaluation

a. Prices were distorted (free for some but still fixed for other products) --- hard for enterprises to obtain resources --- production fell

1. oil example

2. directors steal and then resell at higher prices

b. rapidly rising incomes in wages (data p4), agricultural incomes, and cooperative incomes

c. rapid growth of investment (data p4) --- another investment cycle with shortages, unfinished construction, etc. Finally have to retrench in 1989 and 1990 (data p4)

d. large number of project starts due to the decentralization--- expansion drive (no one to restrain)

e. regional inequality (ultimately led to disintegration in 1991)

f. investment went to producer goods (esp. machine tools) at the expense of consumer goods and railroads (Railroad disrepair and accidents) – goods could not be shipped. Food shortages in the cities!

g. problems in food production despite the 2% growth + need for agricultural subsidies (as the state raised procurement prices but not consumer prices)

h. regional decentralization --- republican and city autarky in a world of severe shortages

i. inability to end the soft-budget constraint --- subsidies

1. virtually no bankruptcies occurred

2. deficits were financed mainly by money creation (11% of GDP by 1990)

3. ruble overhang (sat in bank accounts or currency hoards)

j. Conclusion--- scrap the old system without creating a new one to replace it!

5. Performance

a. slowdown in real GDP per capita followed by recession (depression?) – data p6

b. severe inflation (10% in 1988; 12-14% in 1989; 19% in 1990; 100% in 1991) – greater than the rise in incomes so that real incomes fell

c. less working time + more time spent in lines (25% of the waking time of every adult)

d. domestic value of the ruble declined --- farmers respond by reducing production and selling only 30% of production to the state (cf 40% in the past)

e. Social effects worsen --- health, crime (data p7), pollution (data p7)

f. balance of payments crisis (large trade deficits) + international debt

1. imports of grain especially and also consumer goods

2. lower world oil prices

3. financed by sales of gold + borrowing from Western governments

6. three groups: conservatives, moderates (Gorbachev), and radicals (Yeltsin) --- explain each

a. Gorbachev shifted toward the radicals due to the worsening crisis --- Shatalin Working Group Proposals for shift to a market economy in 500 days

b. vascillation of Gorbachev

c. coup attempt of August 1991

Reform Since 1991 (to be concluded next week)

1. Transition – replace one economic system with another

a. Political structure

b. Privatization

c. Liberalization (starting next time)

d. Stabilization

e. End of Autarky

f. Institutions

g. Safety Net

2. Shock Therapy vs. Evolution Debate -

3. Political Situation

a. Failure of attempted coup – disintegration of the USSR (see map)

b. New Constitution (1993) – bicameral Duma, very strong President, independent central bank, federalism (much power devolved to regional and local authorities)

4. Privatization

a. Taken as the 1st step in transition

b. had to be market efficient, politically acceptable, and irreversible!

1. to be mollified: the Ministers who had had complete control in the communist days; the workers and their unions; managers; local government officials; people at large – all had power and could prevent the full realization of the reforms

2. to expropriate the special interest or to co-opt it? Both!

c. Initial privatization involved 15,000 companies

d. Small businesses sold to the ones who had been running them for cash. The money went to local government officials, who became supporters.

e. Companies in railroad transport, education, health, space, defense remained government owned. The Ministers retained some control but had to relinquish the rest of their power.

f. All companies to be privatized became corporations with a Board. This also reduced the power of the Ministries, who became expropriated.

g. Option 2: workers and managers could buy 51% of the stock at a price that was 1.7 times the book value of the company. Pay for the shares in cash or vouchers. Shares were owned individually and could be sold. This option co-opted the workers and the managers into support. How the remaining shares were to be sold was determined by the management of the company, not the Ministry.

1. The managers had great independence as there were no large outside shareholders.

h. Vouchers: all citizens could pay 10 cents to receive a voucher worth $40. The voucher could be sold. Or the person could put the voucher in a private investment fund (over 600 were formed). Or the person could exchange the vouchers for shares of stock (affected about 29& of shares)

1. Some accumulated large amounts of vouchers and became significant shareholders

2. All bidders got at least some shares. And the price was the same for all shares --- a bidder could not bid up the price as in the USA.

i. More than 100,000 enterprises privatized in this way by 1994 with about 2/3 of the shares owned by workers and managers. Outside owners owned about 20% of shares (half owned by people with at least 5% of a company). The government owned the other 15%.

j. By 1995, 65% of total capital and half of all workers were private! Almost half of all income came from ownership of capital.

1. The distribution of income became much more unequal.

k. later, another 20,000 companies were privatized with shares sold at auction. This was resisted by managers and local government officials.

l. 1995: the government borrowed from banks, pledging its shares in 12 energy companies as collateral. When the government did not repay the loans, the banks sold the shares for a profit. These shares were sold to favored people, known as the oligarchs! The energy companies were bought for much less than they were worth. Each used the gains to expand into other industries and become a conglomerate. Each contributed greatly to the funds needed for the election campaign of Yeltsin in 1996.

m. Based on these sales, Russian companies had a low valuation! See example on Pg 6.

n. The privatized companies did better than the government at replacing their top management and firing workers and at raising productivity.