Econ Lecture Notes. Adam Galambos 1136 Heller Hall Department of Economics University of Minnesota

Transcription

1 Econ Lecture Notes Adam Galambos 1136 Heller Hall Department of Economics University of Minnesota Summer 2002 These lecture notes will serve as a useful study aid only if you regularly attend the lectures and participate in class discussions. You are given these notes so that you spend more time participating in class rather than taking notes. Together with the assigned readings and class participation, these notes will help you study and understand the material.

2 2 Lecture 1 - Introduction Econ Lecture 1 Introduction to the theory of economic systems I. What is an economy? Although we use the word often and we know it when we see one, it is actually not easy to define what we mean by the economy. We will use the following definition: Definition An economy consists of 1. a group of individuals, the economic agents (such as the inhabitants of a country), 2. a set of rules, customs governing the activities of agents (such as the legal framework), 3. the environment in which economic activity takes place (such as the qualities of land, geography, climate). A. What isn t comparative economics? Comparative economics is not directly concerned with 1. and 3. above. Economic anthropology, economic psychology and other fields study the nature and evolution of the behavior of economic agents. Economic geography studies the relationship between a country s geography and economy. Economic history describes the evolution of the economy through time. Comparative economics relies on all these fields, but it is directly concerned with studying 2. above, which we call the economic system. If we are interested in the rules of the economy, first we must define exactly what these rules pertain to: B. The economic process We picture the economic process as consisting of two phases. In the first phase, the economic agents (producers, consumers, resource holders, government agencies) exchange messages (proposals, bids, plans, information about technology or preferences). In the second phase, these messages are translated into plans of action (production, exchange) for the various units and ultimately into decisions to be actually implemented. [Hurwicz] p. 81. We may summarize the economic process as Communication = Action = Outcome. Definition An economic system is a set of rules, customs, traditions which form a framework for the economic process. They govern the way communication and action can take place, how communication leads to action, and what outcome certain actions lead to. Now we can define our subject:

3 Econ Lecture 1 - Introduction 3 II. Comparative economics Definition Comparative economics studies (compares and contrasts) economic systems that exist or have existed. Though it is not commonly included in the subject, it would be perfectly reasonable to study economic systems that have never existed, of course based exclusively on theoretical knowledge. In fact, the history of the subject started with the notion of designing economic systems that had never existed: Interest in alternative economic structures can be traced to antiquity: Plato s Republic illustrates the possibilities of state planning, while Aristotle points out the disadvantages of collective ownership. Over centuries, humanity has resorted to a variety of institutional settings serving as background for the economic process. These settings, sometimes idealized into economic systems, have been a subject of systematic comparative study, until recently primarily descriptive in nature. Philosophers and scholars, however, have not had the field all to themselves. Those dissatisfied with their economic environment have often felt that the system itself is to be blamed and that it should be replaced by a different structure. Such views were implicit in the various Utopias, of which Plato s Republic is a forerunner. In addition to More s imaginary island community which is responsible for the term, these included Bacon s New Atlantis and Campanella s Civitas Solis. But it is only in the early nineteenth century that the idea of replacing the existing economic system by a new one comes into full view in the writings, as well as actual experimentation, of the early socialists (Owen, Saint-Simon, Fourier). While some, at least, of the socialist schemes called for a measure of centralized control of the economic activities, an alternative direction of structural change-away from governmental power and toward voluntary association of independent units-was envisaged. by Proudhon and his anarchist successors. In a less radical form, the debate concerning the role of the government in relation to the economic process has been among the most striking features of the development of economic thought. This discussion occurred, for instance, during the transition from mercantilism in the direction of laissezfaire during the eighteenth century, with Adam Smith as one of the famous protagonists, and again, over a century and a half later, in the context of controlling, or at least moderating, the fluctuations in employment and prices. [Hurwicz] p. 79

4 4 Lecture 1 - Introduction Econ Readings for next lecture Rosser: chapter 1

5 Econ Lecture 2 - Economic Mechanisms 5 Lecture 2 Economic mechanisms I. Mechanism design is a fairly recent branch of economic theory, and it originates with the seminal work of Professor Leonid Hurwicz. While earlier economic theory often took the rules of the game as a given, and examined how the economy operates under those rules, in mechanism design the rules are the unknown of the problem; the rules are the subject of inquiry, and are not treated as given. For example, much attention is devoted in economic theory to examining the properties of perfectly competitive markets. But how do the rules of perfect competition compare with some other rules? Could one invent better rules? Such questions can be asked using a mechanism theoretic approach. II. The basic ingredients of the formal description of a mechanism are the following: A. a set of agents, who participate in the economy, denoted by natural numbers (say 1 through N) B. a strategy set for each player i, denoted S i - a listing of all the courses of action agent i can take C. an outcome function f : S 1 S 2... S N O, where O is the set of possible outcomes; this function assigns to each strategy profile (s 1,..., s N ) a feasible outcome. Note that the word mechanism is used in a very precise sense here. III. Mechanism theory can be used to examine the possibility of implementing certain desirable outcomes. IV. If you know some game theory, you can see that this is very similar to the description of a game, except here no preferences (utility functions or payoffs) are given. This is why a mechanism is also called a game form. Readings for next lecture Rosser: chapter 1 see for example The Design of Mechanisms for Resource Allocation, American Economic Review v63, n2 (May 1973): 1-30.

6 6 Lecture 3 - Describing an economic system Econ Lecture 3 Describing an economic system Real-world economic systems are incomprehensibly complicated, and describing them precisely seems almost impossible. Thus we idealize economies that are similar in some respects and group them into pure economic systems. It is important to remember that our idealized, pure systems are not found anywhere in the world, they are theoretical constructs that help us understand real economies. Comm. I. Communication We may describe the information flow in an economy by specifying what signals are used and who sends them to whom. A. Perhaps the most important distinction is that between informationally centralized and non-centralized systems: Intuitively, an adjustment process is informationally centralized if, at some stage of the process, at least one of the participants comes into possession of all relevant information concerning everyone s environment and everyone s prospective actions. A process is informationally noncentralized if such concentration of information in one agent s hands cannot occur. [Hurwicz] p. 96. At one extreme, we have the case of central planning, where all information is communicated to the central planners. At the other extreme there is informational decentralization, where only a minimal amount of information is communicated. The example usually cited for the latter is pure competition, where agents only communicate by proposing bids and offer prices. Communication may be forbidden, as in the case of anti-collusion laws, or mandated, as in the case of income tax returns. 1. We will see that the issue of informational centralization plays a very important role when we discuss the socialist debate. Friedrich A. Hayek argued in 1940 that it would be extremely difficult to gather all the information and communicate it to a Central Planning Authority in a socialist system, and that the price mechanism is the most efficient way to transmit information (see II.A.3 on the Course Outline). II. One important aspect of the way communication leads to action is the degree of enforcement. This lecture relies heavily on [Rosser]ch.1. Think of an adjustment process as the economic system for now. Socialist Calculation: The Competitive Solution, Economica (May 1940) pp

7 Econ Lecture 3 - Describing an economic system 7 A. When enforcement is loose, communications of intention (promises) cannot be taken seriously, and thus transactions that rely on promises cannot materialize. For example, if you have the invention of the century (which nobody else recognizes) and all you need to start making it is $ 500,000, with liberal bankruptcy laws you might never be able to get your business started. B. When there is complete ( full ) enforcement, such transactions might be possible, and this might improve the efficiency of the economic system. This area is the subject of today s frontier research. III. Action Allowing and prescribing different actions is perhaps the most definitive aspect of an economic system. Action A. Level of decision making One of the most important actions of economic agents is economic decision making. 1. In a traditional economy economic decisions are made according to rules inherited from earlier generations. Agents are prescribed certain actions by tradition. 2. In a market economy economic decisions are made by the participants in the market. 3. In a command economy economic decisions are made by the central authorities who prescribe actions to the economic agents. B. Forms of ownership Another important characteristic of economies is their ownership structure. Ownership may be understood in several ways. One definition is: Ownership of an asset entails one or more of the following rights: (1) the right to control the asset (in an organization, the right to determine what positions exist in the firm, what are their functions and who fills them, etc.); (2) The right to appropriate the payoff (surplus, returns, usufruct) generated by the asset after contractual payments; and (3) the right to delegate, sell or otherwise dispose of the previous rights, in part or in entirety. [MBN] p In a system based on private property, individuals are allowed to acquire, control and sell property. In a system based on state property, the state has these rights, but usually certain individuals do control property. 2. Economic systems are often defined by their ownership structure. Thus capitalism is sometimes considered equivalent to private property, and socialism to state ownership. These definitions are, however, very fragile : search the Journal of Political Economy or the Quarterly Journal of Economics in EconLit for enforcement or commitment to see some recent examples.

8 8 Lecture 3 - Describing an economic system Econ i Example Consider an apparatchik in socialist Hungary who has the authority to delegate the right to rent from the state the permission to operate a small shop to his own profit. Although the shop is formally entirely state-owned, the apparatchik owns it in the sense of the above definition. This informal ownership lead to the fact that such delegations of rights were done for rather significant bribes. C. If the above types of actions chosen seem arbitrary to you, this example may convince you that they are quite fundamental: 1. Example Suppose you would like to take the following economic action: produce and sell picture nails. First of all, you must know whether you are allowed to take this action. If you are in a traditional economy, you can do it if your father, grandfather, etc. have done the same. In a market economy, you can do it if you have the means of production and you can sell it at the market, while in a command economy you can do it only if directed to by the authorities. The whole question of whether you can at all own the means of production and sell the product depends on the ownership structure. Outcome IV. Outcome The rules assigning economic outcomes to economic actions determine for example the types of incentives used in the economy. The most common incentives are material, but some societies rely also on moral incentives. The degree and mode of redistribution is also determined by the outcome rules. A. The distribution of income is an important issue in all real-world economic systems. Choice of a certain method and degree of redistribution is usually a political decision based on ethical, philosophical and political considerations. Advocates of free market capitalism often prefer minimal government intervention in this area as well. On the other extreme, the philospher John Rawls suggests that society should maximize the welfare of its worst-off indivdual (Rawlsian utilitarianism). Many Western European states are in between: for example, the situation of families with many children in Sweden is made easier by numerous welfare benefits. Readings for next lecture Rosser chapter 1 pp see [Rosser] p. 188

9 Econ Lecture 3 - Describing an economic system 9 Balassa, B.A.: Success criteria for economic systems, pp. 2-11, in Comparative economic systems: models and cases, 5th ed., ed. M. Bornstein, Irwin, Bornstein, M.: The Comparison of Economic Systems: An Integration, in Comparative economic systems: models and cases, 6th ed., ed. M. Bornstein, Irwin, Look at the UNDP Human Development Report 2001, especially the tables on Human Development Indicators and the Human Development Index (see link on class webpage).

10 10 Lecture 4 - Evaluating economic systems Econ Lecture 4 Evaluating economic systems Comparing economic systems Economists and others often wish to compare or evaluate economic systems. This is usually rather problematic and controversial, and laden with value judgments and ideology. Thus one must be especially cautious and critical in this area. Problems include: I. The implicit motivation to evaluate and compare economic systems is sometimes to promote one over the other, to advocate the adoption of one rather than another. This immediately brings up the philosophical debate about historical laws, about the extent of the ability of humans to shape the world. II. To evaluate economic systems, one must have criteria to judge by. Not only is it very difficult to find such criteria, but it is at least as difficult to measure them. III. The same criteria are used for countries with radically different cultures, i.e. different ideals of success, of happiness, of good life, etc. Moreover, these criteria often reflect the notions concerning these ideals of the analyst. Despite the above difficulties, there are indicators of the performance of economic systems which seem reasonable. In any case, attempts have been made to come up with performance criteria. I. The following nine criteria are given by Morris Bornstein in [Born]. Balassa in [Bala] cites some of these in a more logical order and explaining a bit about how these developed in economics. A. Static efficiency Economists have always recognized the inherent difficulties of evaluating economies, and have traditionally relied only on non-normative indicators. The earliest of these was proposed by Vilfredo Pareto (thus its name: Pareto efficiency). The idea is very simple: Definition An allocation in an economy is Pareto efficient if there is no way to reallocate resources to make someone better off without making anybody worse off. Note that Pareto efficiency has nothing to do with income distri- Important! bution. 1. With respect to Pareto efficiency, the so called Fundamental Welfare Theorems tell us that the allocation which the market mechanism, or pure competition are Pareto efficient. However, the theorem does not hold under market failures, e.g. if A summary of these can be found in [Rosser] p. 15.

11 Econ Lecture 4 - Evaluating economic systems 11 there are increasing returns to scale, which give rise to monopolies. there are externalities. there are public goods such as education, defense, etc. B. Dynamic efficiency Economists have recognized that Pareto efficiency applies only to a given point in time. In constrast, the economy happens over time, and we must be interested in how efficient it is in intertemporal resource allocation. Definition [informal] An intertemporal allocation in an economy is dynamically efficient if there is no way to reallocate resources over time to ensure a higher sustainable growth rate. The distinction between static and dynamic efficiency: A system - any system, economic or other - that at every point of time fully utilizes its possibilities to the best advantage may yet in the long run be inferior to a system that does so at no given point of time, because the latter s failure to do so may be a condition for the level or speed of long-run performance. [Schu] p. 83., quoted in [Bala] p.7 There has been much discussion about the dynamic efficiency of market vs. command systems. Some points to think about ([Bala] p. 98): 1. Technical progress In a market system the profit motive and the need to survive give e strong motivation to invest in technical progress. On the other hand, firms in pure competition may be too small to support R&D. This would imply that there is a social benefit to monopolies, namely that they are big enough to support R&D (think of AT&T and Bell Laboratories). This argument is due to Joseph A. Schumpeter. In a command economy based on state ownership, salaried employees might not be motivated to think about technical progress. On the other hand, when innovations are made, they can be made in a coherent coordinated manner in the whole economy. 2. A lot of infrastructure involves externalities, which make it unprofitable for private firms to provide it. In developing countries the resulting lack of infrastructure can impede economic development, which can usually be overcome only through government intervention. C. The level of real per capita output This is probably the most accepted indicator and shows material well-being the best. It is a very simple and crude measure. this intuitively means that it is cheaper, or pays off better to produce more Direct interaction between producers [...] and consumers which is unaccounted for in market valuations. [Bala] p. 6 i.e. non-excludable and/or non-rival

12 12 Lecture 4 - Evaluating economic systems Econ D. The growth rate of output This is related to dynamic efficiency. It has been argued that under a command system a higher growth rate could be forced, leading to higher welfare. The link in that argument between growth rate and welfare is not clear, and there are counter-arguments that in a market system people have the incentive to save just as much as they should. To increase welfare, it is not enough that there is more - it is also important that there is more of what : E. The composition of output This refers to the allocation of goods between the private and public sectors, between military and civialian consumption, between consumption and investment, etc. There are some normative and ethical issues involved in these decisions. In a market economy the doctrine of consumer sovereignty ensures that consumers make the decision of what to produce for the most part. But consumer sovereignty may be questioned, as for example by Samuelson: Individual tastes and wants are socially conditioned by advertising and custom so that they can hardly be said to belong to him in any ultimate sense. See [Bala] p. 14. for more on this issue. P.A. Samuelson, quoted in [Bala] p.15 F. Macroeconomic stability By this we mean the lack of large oscillations of output, employment or the overall price level. ([Rosser] p. 16) This seems intuitively desirable. Command economies have (naturally) greater success in this. G. Economic security of the individual There might be many ways of measuring this, e.g. in terms of income, employment, health care, etc. H. Equity of income and wealth distributions One tool for measuring this is the Lorenz curve. Economies based on state ownership usually have greater income equality, but often only on the surface. In these economies most of the individuals income is often given in goods and services rather than money. I. The degree of freedom of the individual in terms of work, consumption, property, etc. The UNDP Human Development Index (HDI) tries to take such variables into account. J. We can add some other variables measuring the general welfare of people, such as the literacy rate, gender equality, etc., which the UNDP HDI uses. II. An alternative criterion for evaluating the success of economic systems could be based on the degree of attainment of the goals of economic decision makers. In a command economy, this would mean that the system would be considered successful if the planners attain their goals. In a market economy, the system would be successful

13 Econ Lecture 4 - Evaluating economic systems 13 if the individual participants in the market attain their goals. In the latter case, however, it is very difficult to say when individuals attain their goals. Readings for next lecture Rosser pp Dalton For more on this issue, see the literature on the aggregation of individual preferences, in particular the work of Kenneth Arrow.

14 14 Lecture 5 - Utopian socialism Econ The main points of this lecture: Lecture 5 Utopian socialism The origins of socialism and the main writers Utopian socialism is very different from Soviet-type socialism I. The origins of socialism and the main writers A. The origins of the ideas of utopian socialism can be found in a recurring theme of literature and social thought: to create a society where people are equal and which is free of the evils observed in the world. Visions of such societies are called utopias, after Thomas More s book with that title. B. After the French Revolution, disenchantment with the social results of the revolution brought a new enthusiasm for socialism. The two most important French utopian socialist authors were Henri de Saint-Simon and Charles Fourier. C. Saint-Simon had an engineering background and was also known for some crazy experiments in the physical sciences. He believed that science and knowledge should be put to service for the benefit of society by social engineering. He proposed that a central plan should be worked out and implemented for the greatest welfare of society. Thus he is the father of the modern notion of central planning, and the French indicative planning also stems from the school of thought he created. D. Fourier advocated the establishment of small communities called phalansteries. In these people would own everything in common and would share everything and live in harmony. The only effort to actually develop one was made by the New England transcendentalists. E. The third main writer was Robert Owen, a succesful capitalist who implemented his ideas of socialism in his factory community. The term socialist was actually first used to refer to him and his followers. His community in New Lanark, Scotland, contained the seeds of the modern welfare state. He also established New Harmony in Indiana. These communities managed to overcome the ills of industrialization and yet preserve the factory system. Thus Owen anticipated that an industrial community cannot prosper without social regulation. Though his attempts to pass such regulation on a national level in the British Parliament failed in his time, later they caught on, as we saw in our discussions of modern capitalism. This lecture relies on ch. 3 of [Rosser].

15 Econ Lecture 5 - Utopian socialism 15 F. The ideas of both Fourier and Owen came in response to the ills of industrialization, so vividly depicted by Engels, among others. II. Relation of utopian socialism to Soviet-type socialism A. Different forms of utopian socialism had their effect on real-world economies in time, but mostly on the capitalist economies. They were one force behind social regulation, indicative planning, some aspects of labor-management relations, etc. B. The main ideology of the Soviet-type system was Marxism-Leninism. This is based on the works of Marx and Engels, and later Lenin, which are quite different from utopian socialism. In fact, Marx and Engels coined the term utopian socialism to separate themselves from the works of earlier socialists. C. Formally, Soviet economies featured common ownership of the means of production. However, this common ownership was administered by an extensive and powerful bureaucracy - an idea very much foreign to utopian socialism. Readings for next time Dalton pp Rosser and Rosser pp see Lecture 5 notes

16 16 Lecture 6 - Marxian theory Econ Lecture 6 Marxian theory The main points of this lecture: Marx s philosophy of historical and economic change Marx s analysis of the economy Marx s analysis of capitalism I. Marx s view of history A. The main influence on the Marxian view of history was Hegelian dialectic. Dialectic refers to Hegel s philosophy that all phenomena result from the interaction of opposing forces. These are referred to as thesis and antithesis. From their clash a new synthesis is created, which becomes a new thesis, with its own antithesis. B. Hegel s view was, however, idealistic, meaning that he saw ideals and spirituality as the ultimate reality. Marx, on the other hand, followed another German philosopher, Feuerbach, who contended that the ultimate reality is material. Thus his view of history was historical materialism, the idea that changes in the material reality are fundamental and drive history, while changes in the reality of ideas and spirituality just mimick these changes. C. The combination of the above two philosophies is dialectical materialism. It is a philosophy asserting that the ultimate reality is material and is always changing through dialectic. D. The application of this philosophy to history is historical materialism, and this is very important in understanding why Marx believed that capitalism would not last: For dialectical philosophy nothing is final, absolute, sacred. It reveals the transitory character of everything and in everything; nothing can endure before it except the uninterrupted process of becoming and of passing away, of endless ascendancy from the lower to the higher. Fredrick Engels The End of Classical German Philosophy Cited in [marxists.org] under Dialectical Materialism This lectures relies on ch. 3 of [Rosser]. Also, is an excellent source on Marxism. Georg W. F. Hegel, 19th century German philosopher

17 Econ Lecture 6 - Marxian theory 17 E. Thus Marx explained historical change with changes in the material reality, in particular in the productive resources. Thus the economic reality forms the political, religious, etc. realities, which amounts to a theory of economically determined history. II. Analysis of the economy A. In Marx s analysis of the economy, the central idea is that productive resources must be used to survive, and thus the crucial issue is the ownership of these resources. The resources are called forces of production, and the ownership structure is the relations of production. The two together form the mode of production. B. The forces of production are the material reality, and changes in these induce changes in the relations of production, leading to a new mode of production, such as in the change from feudalism to capitalism. C. Another key idea is that all value comes from labor. The value of anything is the socially necessary amount of labor required to reproduce it. While land and capital are inputs in the production process, land really adds no value to the product, and capital is nothing but stored labor. This theory has predecessors: David Ricardo and to some extent Adam Smith also believed that labor is the source of value. III. Analysis of capitalism A. Marx applied his philosophy of dialectical materialism and his labor theory of value to analyze capitalism. The analysis revolves around the equation W = c + v + s, where W denotes value, c denotes fixed capital, v denotes variable capital or labor, and s denotes surplus value. B. The last term, surplus value, refers to what the capitalist gets to keep after paying for capital and labor. According to the theory of surplus value, the capitalist expropriates the value produced beyond what is paid to labor. C. The payments to labor are also determined by the labor theory of value, and thus labor is paid (v in the equation) the socially necessary amount of labor required to reproduce it, or the subsistence wage. This is the subsistence theory of wages. D. This leads to the idea of exploitation: the bourgeoisie, ot the capitalists, exploit the proletariat, or the workers who own nothing but their labor. This is the basis of the class struggle, which is the driving force in history. The capitalist inevitably invests more and more in capital, leading to an increasing reserve army of the unemployed and a deterioration of the condition of the proletariat, and at the same time less profit, since value came from labor.

18 18 Lecture 6 - Marxian theory Econ E. In addition, workers cannot afford to consume the ever-increasing production of capitalists, and this and other factors cause cycles of recessions. These lead to the weaker firms dying out and a greater and greater concentration of capital, with more and more of the proletariat in worsening conditions, finally leading to the revolution of the proletariat. F. Ultimately this leads to the dictatorship of the proletariat, first administered by a state under socialism and then without a state under communism, the end of history. Readings for next time Rosser and Rosser pp. Panning) (The Socialist Debate and Theory of Central Bornstein chapters 6,7

19 Econ Lecture 7 - The socialist debate 19 Lecture 7 The socialist debate and the theory of central planning The main points of this lecture: The socialist debate The theory of central planning I. The socialist debate A. We have seen in earlier lectures that utopian socialist writings about the exact workings of a socialist society were highly unrealistic, and that Marx gave very vague and general hints about how a socialist or communist country should function. The real discussion of the exact functioning of a socialist society started with the socialist debate. B. Enrico Barone, 1908: In his The Ministry of Production in a Collectivist State Barone spells out how the state is supposed to collect all economic information, and to solve for a Walrasian general equilibrium. There would be no money involved in the economy, the state would determine equivalences or relative prices instead. C. Ludwig von Mises, 1922: Critiqued Barone, saying that one cannot calculate prices without money and that the only right incentive scheme is that provided by the profit motive. D. Oskar Lange, 1936: Defended Barone with a modification of his scheme, namely letting consumer prices be set by the market and and the state setting only producer goods prices. Firms would have to behave as if they were in perfect competition. Lange shows that this would solve all market failures. E. Friedrich von Hayek, 1940: Argues that in Lange s scheme firms (managers) still do not have the right incentives to satisfy consumer demand and to minimize cost. The right incentive can only come from capital ownership. Also, he emphasizes that gathering all economic information would be impossible and that nothing can serve better as a communication device than the price system. F. János Kornai later argues that another crucial difficulty is that firms in state ownership operate under a soft budget constraint, leading to inefficierncy. II. The theory of central planning A. Central planning was first introduced in the Soviet Union in the 1920 s, carried out by the state planning agency, the Gosplan. The main tool used throughout the Soviet era was the material balance method. The main idea is that the This lectures relies heavily on ch. 3 of [Rosser].

20 20 Lecture 7 - The socialist debate Econ total amount of inputs should be just what is required to produce the total amount of outputs. B. The mathematical formalization of this is the input-output analysis of Wassily Leontief. A generalization of that is linear programming developed by Leonid Kantorovich, a very important figure in mathematical economics, who won the Nobel Prize. C. In practice, central planning meant that each year a slightly modified version of the previous year s plan was used. Readings for next time Rosser

21 Econ Lecture 8 - USSR - history and culture 21 Lecture 8 The Union of Soviet Socialist Republics - history and culture The main points of this lecture: Historical overview Political heritage Cultural heritage Important! Although Russia is emphasized below, remember that the U.S.S.R. and Russia have always been very diverse countries with almost half of the population non-russian. I. Historical overview A. Before the eleventh century what in the area of today s Russia there were small countries ruled by dukes. B. One of these became prominent in the seventeenth century and gained power over the others, leading to a Russian kingdom under the rule of the tsars, from the seventeenth century on given by the Romanov dynasty. The last of the Romanov s were murdered in the 1917 revolution. C. In the nineteenth century some industrialisation began, partly in the form of foreign investment, mostly from Germany. D. The Great October Revolution of 1917 marked the beginning of the Soviet era. Lenin s party, the Bolsheviks, seized power in the chaos that prevailed between the March and the October phase of the revolution, and established themselves quickly as an organized and disciplined government. E. Socialization was one of their first actions, as well as closing the economy from foreign trade, abolishing prices and forcing peasants to give their produce to feed the city workers. The civil war between the White and the Red Army as well as the above measures led to a great famine and a general breakdown of the economy. F. As an emergency measure, the New Economic Policy (NEP) was instituted, letting markets work again and letting peasants sell their products. The economy started to grow quickly, production reached pre-war levels. G. With Lenin s death and Stalin s ascension to power, the NEP was ended in 1928, and strict command planning was put in place. A policy of forced industrialisation was begun, concentrating on heavy industry and leading to rising GDP without rising consumption or living standards. This lectures relies on ch. 10 of [Rosser].

22 22 Lecture 8 - USSR - history and culture Econ H. By WWII, the U.S.S.R. was a major military and industrial power. Under Stalin, it was victorious in the fight against Nazi Germany, and as a result, extended its sphere of influence to Eastern Europe. I. After the death of Stalin in 1953 a series of reforms were tried, culminating in Gorbachev s Perestroika and Glasnost, but without much success. Khrushchev tried to improve the long-neglected situation of agriculture, but very incompetently. Brezhnev reasserted the Soviet control of Eastern Europe, and an era of stagnation was characteristic of his years in power. The system broke down altogether in about 1990, leading to a disintegration of the U.S.S.R. II. Political heritage A. Autocratic rule was characteristics of the tsars, and is definitely an important aspect of Russian political heritage. It was characteristic of Soviet times as well, continuing the tsarist traditions. B. Paternilism was another important aspect of tsarist power that was carried over to Soviet times. The expression our father the tsar summarizes the attitude of the masses towards the ruler. The cult of Stalin was very similar to the earlier loving attitude towards the tsars. C. Centralization is related to autocratic rule, but it had a special role in Russia: the territory of the country was so big that people not around Moscow or St. Petersburg could physically not get close to power. Central power over the whole territory was highest under Stalin, and the loss of this power was a major factor in the disintegration of the country. D. Exile to labor camps was already common in tsarist times, and was the tool used to murder millions later under Stalin. III. Cultural heritage A. The mir, meaning community, was the form of organization of agricultural production in pre-revolutionary Russia. Land was owned collectively, and was cultivated collectively, as a team effort. B. Thus Russians had a different attitude towards private property from that of Western Europeans, and respect for private property did not develop much. C. From the times of Peter the Great, a philosophical-political-cultural debate between Westernizers and Slavophiles has been the underlying theme of policy questions. The first group advocates the adaptation of Western technology and customs to develop Russia, while the second group believes that Russia is fundamentally different from any other country and thus must find its unique way of development, keeping its purity from Western influences.

23 Econ Lecture 8 - USSR - history and culture 23 Readings for next time Rosser

24 24 Lecture 9 - USSR - economic structure Econ Lecture 9 The Union of Soviet Socialist Republics - economic structure The main points of this lecture: Transition from NEP to forced industrialization The decision-making apparatus Collectivized agriculture I. Transition from NEP A. While the New Economic Policy (NEP) alleviated the economic crisis of and brought production back to pre-war levels, it also led to underinvestment in industry and a class of relatively well-off peasants. It became clear that the U.S.S.R. needed to speed up industrialization. B. The industrialization debate was a very important turning point in Soviet economic policy. One side, represented by Preobrazhensky, argued for a fast and all-out industrialization, supported by peasant savings. This would imply unbalanced growth, since investment would be directed towards industry alone. The other side, represented by Bukharin, preferred balanced growth, arguing that the economy can only develop if all sectors develop at the same time. C. Stalin first sided with Bukharin, and used this opportunity to purge the other side from power. However, setbacks in economic performance and in voluntary grain marketings of the peasants convinced Stalin that superindustrialization is necessary, and he signed the First Five-year Plan in D. The goal of this plan was to catch up with capitalist countries and to double the capital stock. It emphasized heavy industry, and called for drastic savings on the part of the peasants. This was to be enforced by collectivizing agriculture. E. The process of collectivization was brutal, and resulted in millions of peasants dead or deported to forced labor camps (the gulag). The main ideological fight was against the well-off peasant, or the kulak, who was supposedly hoarding produce and keeping it from the workers, thus an enemy of socialism. F. Through this terror Stalin instituted a system of collectivized agriculture that was held under close control and that was forced to supply the savings necessary to carry out the industrialization program. II. The state and the party beaurocracy This lectures relies on ch. 10 of [Rosser] and on ch. 5-8 of [Gregory].

25 Econ Lecture 9 - USSR - economic structure 25 A. Under the new central command planning system, the economy was informationally centralized, the planning agency (Gosplan) collecting economic data from enterprises and sending back to them the plan. At the time of the industrialization debate alternative views concerning planning were proposed, and two schools of thought were formed: the geneticists favored planning that was similar to indicative planning and was to set the direction while bringing about a general equilibrium; and the teleologists believed that planning must override the market equilibrium and the planners must enforce the equilibrium they prefer. The superindustrialization program of course called for the teleological stule of planning, and thus command planning was chosen. B. A large state beaurocracy was in place to create the plans, which were done for three time-horizons: the 1-year horizon, which was the most precise, the 5-year horizon, which emphasized structural change and there were 15-year perspective plans. C. On the enterprise level, managers were responsible for fulfilling the plan. They had some input in forming the plan through the reports they gave of the resources and capacities of the enterprise, and they were then handed down the plan indicating the required annual output. D. This led to a very important shortcoming of the command planning system: it was not incentive compatible. This means that the enterprise managers did not have an incentive to achieve the goals the planners set - in fact they had an incentive not to achieve them. The main reason was that although managers got bonuses if they achieved or overachieved the plan, they were careful not to overachieve it by much and to understate the resources of the enterprise because next year s plan was adjusted upward if the previous year s was successfully fulfilled. E. Along with the state beaurocracy, a party beaurocracy oversaw the operations of all enterprises and institutions, and even the state beaurocracy itself. The main purpose of this was to make sure that all decisions are in concordance with the official policy of the Communist Party. All organizations, such as factories, schools, research laboratories, orchestras, had a representative of the Party, and this was a very powerful position within the organization. This system also served to put reliable people in decision-making positions. The people who filled these positions were part of the nomenklatura: a class of people who made up the elite of Soviet society, who were insiders, who recommended each other and each others children to powerful positions to perpetuate their elite standing. III. Collectivized agriculture A. Collectivization made the functioning of agricultural enterprises different from industrial ones. There were three main forms of agricultural enterprise:

26 26 Lecture 9 - USSR - economic structure Econ The kolkhoz, or the collective farm, was the least effective. It was a way to extract agricultural output while paying subsistence wages to the farmer. The members did not receive wages, but in essence received whatever was left over after making the compulsory payments from the produce. 2. The sovkhoz, or state farm, was run like a factory in that workers received wages and the enterprise received subsidies. 3. The third important source of agricultural production was the private plot. Larger plots were assigned to kolkhoz and sovkhoz members, but city dwellers also often got smaller plots. On these plots people could produce and sell their produce to the state or in collective farm markets, or they could consume it. Occupying only 4% of arable land in 1970, these plots gave 40% of fruits, berries and eggs, over 60% of potatoes, and 30% of milk, meats and vegetables. It is clear that the incentive system was distorted, leading to great inefficiency in state-run agricultural enterprises as compared with private plots. Readings for next time Rosser Goldman: USSR in Crisis, p. 83, quoted in [Rosser] p. 247.

27 Econ Lecture 10 - USSR - reforms 27 Lecture 10 The Union of Soviet Socialist Republics - economic reforms The main points of this lecture: Reforms under Khrushchev Reforms under Brezhnev Reforms under Gorbachev I. The Khrushchev era ( ) A. Khrushchev tried to improve the long-abandoned situation of agriculture by encouraging marketization of agricultural products. Also, he tried to increase agricultural production by planting crops in areas that had not been cultivated, but this was not successful. B. A major organizational reform in this period was the replacement of most central ministries with sovnarkhozy, or regional economic councils. These gave the regions more autonomy, but led to a lot of ambiguity, because power relations were not clear to the beaurocrats at different levels. Central planning was emphasized while regional power was to be increased, two incompatible processes. C. The sovnarkhozy were abolished under Brezhnev, and Khrushchev was labeled a hare-brained schemer. D. A set of reform proposals were put forth in an article in the Pravda in 1962 by little-known economist Evsei Liberman, which received a lot of attention because it flirted with the idea of using the profit motive as an incentive. While supporting central planning, he promoted a system of basing manager rewards - once the plan is fulfilled - on enterprise profits. He also proposed giving enterprises a greater role in planning. While there was some experimentation with these ideas in light industry, they were never adopted in their original form on a wide scale. II. Brezhnev s reforms ( ) A. This period is often described as stagnation. Earlier reforms were revoked and central power was emphasized again. B. Politically, the Brezhnev doctrine made it clear that the U.S.S.R. was going to fight to keep its satellite states. (To Hungarians this became quite clear a decade earlier.) This lectures relies on ch. 10 of [Rosser] and on ch. 11 of [Gregory].

28 28 Lecture 10 - USSR - reforms Econ C. The most important set of economic reforms is associated with the prime minister Alexei Kosygin. His reforms were to give enterpriss more freedom in providing incentives by having some control over profits and investment decisions. In the area of planning, the number of planning targets were to be reduced and the mechanics were to be improved by the use of computers and new mathematical methods. The financial sector was to be reformed as well. D. In reality, these reforms were supposed to be implemented over a period of 5-10 years, and as implementation progressed, all important aspects were slowly revoked. For example, the number of planning targets was actually increased. III. Gorbachev s reforms This set of reforms came under three slogans: Perestroika, Glasnost and Democratization. A. Perestroika 1. The word means restructuring, and it refers to the set of reforms between These reforms were a major departure from the traditional strict command planning model. 2. In , central beaurocracies were coordinated and in some cases reduced. These organizational changes were supposed to revitalize the economy of stagnation and improve investment and modernization. 3. Improving worker morale was another goal, and thus measures like restrictions on alcohol consumption were introduced, with no success, but with some serious drawbacks such as reduced state revenue (lack of alcohol taxes). 4. A landmark economic reform was the 1987 Law on State Enterprises. This gave enterprises freedom to trade and make their own decisions, under a profit norm and some rules on price determination. The central beaurocracy was to influence the economy by making long-term plans and controlling enterprises only through some rules, laws and norms, and not by direct control. 5. In 1988, private enterprise through family cooperatives was introduced. 6. Perestroika failed for a number of reasons. First, the people and the economy were not ready to handle so many reforms at once. Second, the beaurocracy was against reforms, wanting to preserve their privileges under the status quo. B. Glasnost and Democratization were to support economic and political reform through the involvement of the masses in the reform process and general improvements in the relation of the masses to the government. Some link this trend to the Chernobyl disaster in 1986, which the government initially tried to keep secret. A crucial aspect of this was demanding honesty on the part of the government and thus revealing mistakes and shortcomings of the system.

29 Econ Lecture 10 - USSR - reforms 29 Gorbachev admitted that the exisiting socialism is different from ideal socialism. Open discussion of past failures and present problems was allowed, and censorship of domestic and foreign literature was weakened. Readings for next time We ll talk about Kornai s book.

30 30 Lecture 11 - Contradictions and Dilemmas Econ Lecture 11 Analysis of socialism in János Kornai: Contradictions and Dilemmas The main points of this lecture: Shortages Psychology of a socialist economy Efficiency and socialist ethics I. Shortages were characteristic of socialist economies. A general remark is that shortages go hand in hand with redundancy, because a shortage in an input means that with the given technology only less of other inputs can be used. Kornai explains shortages with the following arguments. A. There are three kinds of constraints on production for any firm wanting to increase production: resource constraints, demand constraints and budget constraints. In a capitalist economy, the demand constraint is binding, but in a socialist economy, the resource constraint is binding. The reason is that in capitalism the firm faces a hard budget constraint, while in socialism it faces a soft budget constraint, and so it does not have to worry about sales or costs, only producing more. B. Thus the demand for inputs of the firm is almost unbounded. On the other hand, once shortages occur, firms will expect them and try to hoard inputs, leading to even greater demand. C. The soft budget constraint causes the firm to be irresponsive to prices, and so the firms suck away demand from the consumers. Also, they are not responsive to consumer demand. D. The constant strive to increase production came not only from central plans but also from the expansion drive. This means that managers identified themselves with their production units and often felt that expansion was a personal issue and a matter of high societal importance. II. Psychology A. In an economy of shortage there is a seller s market. The buyer was clearly subordinate to the seller, she was at the seller s mercy. This led to a lot of frustration in the consumer and a lot of conflict. Cambridge, Mass. : MIT Press, 1986, c1983.