September 19, 2004
Farm to Factory, the final years
And now we come to that period in history Allen calls "the Soviet climacteric". As you may have noticed, Allen consistently stakes out the contrarian point of view against the standard account of the Soviet Union's economic rise and fall, so it's no surprise that he does it again here. (As someone pointed out to me, it's an excellent career move.) But in the final chapter of Farm to Factory, he does it twice. Here's the play by play.
In the standard view, central planning by its very nature caused persistent inefficiencies in the Soviet economy, due to its lack of price signals and incentives, leading to poor economic productivity and stagnation. This line of thought goes back to Mises's economic calculation argument of the 1920s, and appears to show up in the data, as a drop in total factor productivity growth, starting in the 1960s.
But wait, said Weitzman, Easterly, and Fischer. It may be that the structural problems caused by central planning do not result in poor productivity per se at all, but simply make it harder to substitute capital for labor as well as a market-based society. Taking that structural difficulty into account, Soviet productivity growth is reasonable, though not stellar.
Ah, but what contrarian position can Allen take? "I argue," says Allen, "the value of .4 is an illusion. The low measured value of elasticity reflects massive errors in Soviet investment strategy rather than a real difference in technology. It was not purely happenstance that these errors occurred in the 1970s and 1980s, for the end of the surplus labor economy posed new management problems, and the party leadership bungled them."
In other words, even under central planning, had the party leadership planned better, the Soviet economy could have still managed to become more productive.
To anyone familiar with the history of late Soviet (or eastern European) Communism, this is rather difficult to argue with, contrary position or not. I mean, the sheer waste is legendary.
Anyhow, Allen discusses three types of "massive errors" in Soviet planning: in industrial reconstruction, in developing the Soviet Union's natural resources, and in Soviet research and development. These are rather standard takes on the subject, so I will go through them quickly.
The first massive error, in Soviet industrial reconstruction, is easy enough to describe. For political reasons, the Soviet state preferred to refurbish old industrial plants over constructing new ones, in order to prevent local unemployment, but also to prevent social dislocation, since Soviet factory towns were like the old 'company towns' of the US, but even more so. In addition, Soviet planners also believed that renovating pre-existing plant would be more cost-effective than building from scratch.
This turned out not to be the case. Allen refers to Gosplan figures which show that retrofitting old plant for greater capacity cost 50% more than constructing new ones. Meanwhile, production remained low. At the same time, the Soviet Union's newer plants could match higher, Western levels of output. These new plants appear to be responsible for productivity gains in selected industries, such as Soviet steel in the 1960s and 1970s.
Thus, Allen believes that had the Soviets committed to a program of building new plants and closing older ones, Soviet industrial productivity could have continued to increase.
The explanation behind the second massive error, the failure of the Soviet Union to develop its natural resources efficiently, goes back nearly two centuries to David Ricardo. The Soviet Union suffered major declines in productivity in their coal, oil, and ferrous metals sectors. Why?
Just as a farmer in a newly-settled country will pick the best land first, the second-best land next, and leave the worst choice for last, so too with the Soviets and their mines. The Soviets had already worked their most productive sites, many of which were playing out. And mines in ore-rich but remote regions took much more capital to develop than previous ones. As a result, output per capital -- productivity -- dropped markedly. In effect, the Soviet Union was having a "resource crisis", but one masked by its lack of price signals.
And now we come to the third massive error, in Soviet research and development. There is a story, common in certain circles, that US military buildup caused the Soviets to move investment, especially in research and development, from civilian to military use. Allen agrees. But the common version of the story has this happening in the 1980s, leading to the Soviet Union's abrupt collapse. Allen would date the beginning of the trend to the 1960s, when total factor productivity growth began to drop, causing the slow stagnation of the Soviet economy. After all, as Adam Smith commented, there is much ruin in a nation.
Allen notes that even near the end of its life, the Soviet Union was still able to plan and create an entire new and extremely productive industry from scratch (and pipe imports), the natural gas industry. This, for him, is evidence that the late Soviet system was still capable of feats of prodigious growth.
Finally, in regard to the low capital-labor substitution hypothesis, it appears to me that Allen is providing the micromotives that produced the Soviet Union's poor macrobehavior, to modify a phrase of Thomas Schelling's. Each of the failures of investment Allen describes can be considered as individual examples of feckless capital intensification. But taken as a whole, the failures appear to add up to the picture drawn by Weitzman, Easterly, and Fischer. Or so it looks to me.
But I should let Allen have the last word here, since after all, it's his book.
A new strategy was needed. The Soviet leaders responded to these changes by squandering vast sums on retooling old factories and by throwing additional fortunes into Siberian development. It was as if the United States had decided to maintain the steel and auto industries of the Midwest by retooling the old plants and supplying them with ore and fuel from northern Canada instead of shutting down the Rust Belt and importing cars and steel from brand-new, state-of-the-art plants in Japan supplied with cheap materials from the Third World. What the country needed was a policy to close down old factories and shift their employees to new, high-productivity jobs, reductions in the use of energy and industrial materials, and increased involvement in world trade.Posted by coyu at September 19, 2004 04:24 AMThe interpretation of the Soviet decline offered here is the reverse of the analyses that emphasize incentive problems and the resulting failure of managers to act in accord with the plans. On the contrary, the plans were implemented; the problem was they did not make sense. The strength of Soviet socialism was that great changes could be wrought by directives from the top. [...] By the 1970s, the ratio of good decisions to bad was falling. President Gorbachev was as bold and imaginative as any Soviet leader was likely to be, but his economic reforms did not aim in the right direction. Perhaps the greatest virtue of the market system is that no single individual is in charge of the economy so no one has to contrive solutions to the challenges that continually arise. The early strength of the Soviet system became its great weakness as the economy stopped growing because of the failure of imagination at the top.
I don't have time to go into it in depth just now (we're heading off to pick apples), but I'm wondering if what he's claiming is really all that contrarian. I recall, for example, a Krugman essay discussing the Soviet and "Asian Tiger" miracles as being a simple matter of adding loads of capital to capital starved systems.
And the idea that Gosplan just had to do a better job of things seems, to me, to miss the point. It couldn't, almost by definition. I'm actually trying to write a serious essay to post at Tacitus titled "How I Learned To Quit Worrying And Love The Bubble", which I think ties in nicely.
Good post, more later.
Bernard
Posted by: Bernard Guerrero at September 19, 2004 06:37 PMBernard, that's why the central questions revolve around productivity, not capital investment. For example, Alwyn Young famously concluded that Singapore, with all its amazing postwar economic success, once you factored out the capital and labor inputs, had very little total factor productivity growth. (This kind of says to me that Singapore's TFP was already high, but be that as it may.)
I should note that South Korea's continuing growth (including significant TFP growth, pace Krugman) was built on a succession of Five Year Plans. Yes, that was the terminology they used, and frankly, some of its methods too. It's a First World nation now, for all intents and purposes.
If the historical record is any guide, planning, dirigisme, et cetera can accomplish a lot; the problem is that it's very hard to do with any continuing success. Dan Drezner had a recent post about this.
So, sure Gosplan could have done a better job. But it's a magic bean strategy. What do you call a strategy that relies on always finding the guy with the magic bean?
As for the bubble, Tic, and not worrying, well, I worry that too much red meat is giving that boy mental indigestion.
C.
PS sour cream apple pie. Trust me.
Posted by: Carlos at September 20, 2004 01:03 AM"If the historical record is any guide, planning, dirigisme, et cetera can accomplish a lot; the problem is that it's very hard to do with any continuing success."
Doubtless. The factories cranking out Soviet tanks in 1943 hadn't been there 25 years prior. But as you say, the rub is that nobody gets it right continuously for long periods of time. Magic beans are only in fairy-tales (and some of Monsanto's latest seed catalogs, I think, but I digress.)
Hence my reference to the Bubble. We did a case study on Western Union and the early AT&T last year. The upshot was, the prof got to laugh at WU's management for being so short-sighted. But I'm wondering if their decision didn't make sense on a risk-adjusted basis given the task at hand. The fact is, most "innovations" stink. I recall conversations with you where I claimed that the recession was a direct result of malinvestment (all the while laughing at those guys who malinvested and took a bath.) You have replied, rightly, that figuring out what's a bad investment a priori is not a straightforward matter, or perhaps even possible. AG agrees.
What I'm wondering is, are booms and crashes _necessary_? I have, to date, interpreted Schumpeterian "creative destruction" as going on continuously on a micro basis, a sort of day-to-day the-lion-catches-the-slowest-wildebeest thing. But, to mix in one more metaphor, a rising tide lifts all boats. Including the ones that are sinking.
Maybe the key, the spot where actual discovery is taking place, is something like what Gould postulated vis-à-vis evolution, some kind of punctuated equilibrium? This might explain why dirigisme seems to work in early stages after its implementation, but then fades. The knowledge of what can be accomplished with, say, Russia in 1918, has already been collected and has failed to be implemented only because of various roadblocks. A potential productivity "overhang" exists which is available for implementation via authoritarian means. But afterwards...
"well, I worry that too much red meat is giving that boy mental indigestion."
Har! Well, for myself, I can't blame the ketones. I'm damned good at compartmentalization, though. Almost Zelig-like. :^)
Will do on the pie.
Bernard "Embert" Guerrero
Posted by: Bernard Guerrero at September 20, 2004 01:29 PMHi Bernard,
Several things going on here. You're talking about sectoral booms and busts, which aren't necessarily related to the business cycle, which in turn is not necessarily related to Schumpeter's concept of creative destruction. (The most technologically innovative decade in the US during the twentieth century was... the 1930s. But I digress.)
The other thing, yeah, there's a stock of pre-existing knowledge that a developing economy can rely on. I don't know how applicable that is to the Soviet Union, though. Both Tsarist Russia and the Soviet Union were capable of cutting edge research and development, as the US found out to its shock in 1957.
C.
Posted by: Carlos at September 20, 2004 04:47 PM"yeah, there's a stock of pre-existing knowledge that a developing economy can rely on. I don't know how applicable that is to the Soviet Union, though."
Oh, certainly, it's not like the Tsar had A-bomb plans lying around in the basement of the Kremlin for the Bolsheviks to pick up. What I'm getting at is more mundane. Clearly, the Soviets found Russia in a state such that the mere application of boatloads of capital over the first couple of decades did wonders. The resulting surplus could then be applied towards creating really cutting-edge stuff like nukes and ZiL limos. The problem seems to arise thereafter.
Analogously, the Bubble was the commercial expression of a productivity overhang that had been building up for some time. The main improvement seems to be that we don't need to shoot large numbers of "wreckers" in order to get T1 lines and Pentiums.
As to exclusively sectoral booms, are they possible? Looking at it from a simple PoV, the funds flowing towards the new industries gets spent on _something_, and it isn't exclusively the product of said industries. Geeks cannot live by flat-screens alone.
Posted by: Bernard Guerrero at September 20, 2004 05:33 PMAs a Russian-themed aside:
From Bankingrisk.com
"In Russia, the week opened with a report from the Moody's Interfax rating agency that domestic banks had lost around 5 billion rubles ($170m) trading securities during the second quarter of the year - problems that were compounded by an interbank liquidity crisis (see this BankingRisk.com analysis).
The industry's trading losses were primarily the result of a tumbling Russian stock market which (according to a report from Standard & Poor's last week) hit an all-time high of 781 points on April 12 and has since dropped by 40% - in part because of the problems faced by Yukos Oil.
Now, fears of systemic vulnerability in the banking industry (dubbed one of the world's riskiest by S&P), coupled with the remaining uncertainty at Yukos, are expected to result in high levels of capital leaving Russia this year. The director of macroeconomic forecasting at the Russian Economy Ministry said this week that outflows could reach $12bn. In March, he had projected total annual outflows of $3-4bn. On Tuesday, a senior IMF official also warned that, until the Yukos situation is resolved and the financial sector is reformed, investors will view Russia with caution."
Impacts on the rest of eastern Europe?
Posted by: Bernard Guerrero at September 20, 2004 06:01 PMBernard, unless the sector is large with respect to the size of the economy, it's usually not going to have significant effects. The past stock bubble, when looked at dispassionately, was based on overvalued catalog sale and office equipment stocks. In the grand scheme of things, not so much.
Remember, a recession happens when people stop spending, who knows why. Making bad investments is not a sign of people stopping. And most bad investments usually go right back on the block again.
C.
Posted by: Carlos at September 21, 2004 04:44 AM