Living Economics

The dismal transition of the Soviet centrally planned economy into a market economy invites the questions of what kind of a super power the Soviet Union was and why capitalism has not spontaneously developed.

In retrospect, the "success" of the Soviet economy was based on its tremendous power to increase investment at the expense of consumption. Though much of the investment was misdirected, the high rate of investment did result in conspicuous success in military weaponry.

Prior to the collapse of the Soviet empire, however, the ability of the state to extract output surplus for investment had been seriously compromised. Planners of the economy were increasingly divorced from the reality of the economy as enterprise managers had successfully colluded to keep an increasingly larger share of the national output by feeding the planners false information. Since legitimate markets were ruthlessly suppressed, there were no independent sources of market information to check the collusion of enterprise managers. When the communist government collapsed, it was replaced by a relatively fractionalized democracy, so the encompassing interest¹ of the center virtually disappeared, and the capacity to extract output from the state-owned economy vanished with it.

The large state enterprises, on the other hand, continue to be organized and politically powerful. Indeed, under democracy they can lobby more openly than before and their workers can strike as well. As part of the government, the managements and workers of the state enterprises are still on the inside, and they claim entitlements to public funds akin to those claimed by civil servants and pensioners. So there is virtually no force to impose coherent plans upon or extract output from the state sectors of the societies in transition. Thus performance in the state sector is even worse than it was in the last years of communism. In addition, with the onset of democratization, an even larger number of narrow special interests has come to have influence.

The partial emergence of private markets has facilitated some transactions that were outlawed before. But most of these transactions would have existed underground in the Soviet days because of their irresistibly large benefits. To realize the potential gains from a full array of new markets, there has to be a stable legal system and political order that enforces contracts, protects property rights, carries out mortgage agreements, provides for limited liability corporations, and facilitates a lasting and widely used capital market that makes the investments and loans more liquid than they would otherwise be. Without these rights and institutions, permissive markets alone cannot generate nearly as much new income as they should - and not enough to offset the decline or collapse of production in state enterprises.

And without institutions that define and protect private rights, the gains from privatization are also uncertain. The conventional preoccupation with privatization assumes that the state enterprises and the huge amounts of capital that were invested in them are necessarily commercially valuable. In fact, many enterprises might have to be liquidated to salvage whatever is still valuable. But since the tradition of using the enterprise as the provider of much of the social insurance has hopelessly jumbled the rights to enterprise, the process of privatization cannot be efficiently carried out.