Section 3: Perestroika (1985-1991), A “Restructuring” of the Soviet Economy

SECTION 3 Perestroika (1985-1991): A “Restructuring” of the Soviet Economy Introduction to Perestroika ● When Mikhail Gorbachev became General Secretary of the Communist Party of the Soviet Union, he had inherited an economic and political system that had long been stagnant and corrupt ● Despite the corrupt and stagnant nature of the Soviet political and economic system, it had proved to be a remarkably stable system from its inception until Gorbachev’s succession ● When Gorbachev rose to power, the Soviet economy characterized the following economic and political issues: ○ Reported economic growth rates in the Soviet Union had experienced a prolonged period of decline from the mid-1960s ○ An imminent massive turnover in the Soviet bureaucracy, which had been in power since Stalin’s rule What was Perestroika ? ● Perestroika refers to the period in which Gorbachev introduced a series of economic reforms that were intended to revitalize ● Perestroika represented Gorbachev’s exploitation of a political opportunity for the redistribution of rent flows that came with such political appointments ● Gorbachev seized the opportunity to re-appropriate positions of power from the former holder, and reallocated them as patronage awards to his supporters ● Any real attempt to radically change the institutional framework of the Soviet economy would run contrary to the logic of political decision-making, which is to concentrate benefits on well-organized special interest groups, and disperse the costs of such policies on the masses of the population Attempted Reforms under Perestroika ● Perestroika had been advertised as a policy liberalization, but had established no credible commitment to such reforms ● From 1985-1991, Gorbachev introduced at least ten major policy packages for reform under the name of perestroika, yet not a single one was implemented fully ● An example of such half-measured attempts at reform were two key legal components of perestroika which included: ○ The law on Individual Enterprise of 1986 ○ The law on State Enterprises of 1987 Other Credible Commitment Problems ● In a market economy, institutionally structured by private property rights under the rule of law, firm owners possess full residual claimancy, meaning firm owners bear both the profits and losses of their decision-making ● Given the Soviet system’s commitment to full employment, Gorbachev could not credibly commit to any market reforms that would remove existing inefficiencies and assign residual claimancy ● The contradictory nature of Perestroika led to increasingly large budget deficits and the monetization of government debt The Failure of Perestroika and the Collapse of the Soviet Union (1991) ● The inability for Gorbachev to convey any kind of commitment to reform sealed not only the fate of perestroika, but also the fate of his own political career ● The reforms simply could not get the economy going, and the situation in the Soviet economy continued to deteriorate ● The political instability of failed reforms, alongside deflated expectations on the part of the population, produced a highly troublesome situation for Gorbachev, not only costing him his credibility with his more liberal allies in the Communist Party, but also with the hardline conservatives ● The collapse of the Soviet Union was an unintended by-product of Gorbachev’s policy of perestroika Lessons in Economic Transition from the Soviet and post-Soviet Experience: Summary ● What has emerged in Russia since the collapse of the Soviet Union has not been a move towards the market, but a new variation of the older Soviet-type economy, which had been based on rent-seeking ● The difficulties experienced in Russia in transitioning from socialism to capitalism have led to the following criticisms regarding economic transition: ○ The uncritical adoption of economic models of development, which is claimed to represent neither the only model of development, nor one particularly applicable to Russia ○ Going too fast, where a more gradual strategy of transformation would have been more successful. The Chinese model of transition is often invoked as the counterweight to arguments for rapid transformation in former socialist economies ● Both of these arguments are incomplete for two reasons: ● First, economic reformers and the models of reform implemented in Russia had not absorbed Mises’s fundamental point about the problem of economic calculation ○ The call for “price liberalization” and “privatization” cannot occur with the fundamental institutional precondition of private property under the rule of law ○ ● ● Economic reform without a credible commitment to rules will only incentivize rentseeking by special interest groups to preserve the status quo Second, the comparison with China misses the crucial point that while the Chinese have had very little de jure reforms of their political system, the de facto changes have been enormous since 1978, but particularly after 1985 In Russia, there has been much de jure reform, but the de facto changes have been quite small SECTION 4 The Chinese Experiment with Socialism and Transitional Political Economy in China The Puzzle of Economic Development in China ● Consider the following observations about China since the late 1970s: ○ Economic reform appears to be successfully pursued without political reform ○ The central government seems to retain considerable political discretion, including the ability to reverse suddenly the reform process or to impose onerous exaction on successful enterprises ○ There have been few formal attempts to provide the central feature of private markets, a system of secure private-property rights under the rule of law ● Although China has not fully democratized (i.e. voting, free speech and press, etc.), democratization does not encompass all aspects of political reform ● The critical institutional precondition for both economic freedom and political freedom is the rule of law ● The key factor in defining any economic system is the de facto structure of property rights, comprising all the limitations and constraints or rules subject to which people in society compete and interact What has changed in China since the late 1970s? ● What has changed in China is the following : ○ Political decentralization has enhanced the powers of local government, but has altered central-local governmental relations in such a way that (for now) have not been reversed ○ A major shift in ideology underpins the reforms, with the CCP moving from the emphasis on the Maoist version of Marxism-Leninism to be a dramatic, marketorientated approach to development ○ China (post-1978) under the communists opened its economy to trade, foreign direct investment, and provided greater security of private property rights A Theory of Market-Preserving Federalism in China What is Federalism? ● ● Federalism has two distinct meanings that are interrelated 1st Meaning: ○ ● ● Derived from the Latin term foedus, meaning to covenant or enter into an agreement ○ The governing basis of such a relationship is adherence to a set of principles specifying the terms and conditions between two parties entering into agreement, such as a constitution, which may be written or unwritten ○ In this sense, governance implies subjection to rules, not to other individuals ○ Such an understanding is in stark contrast to a hierarchical form of governance, where authority is derived from one party domineering and exercising discretion over the rest of society by setting the terms and conditions of governance 2nd Meaning: ○ Federalism refers to the creation of two or more units of government to exercise concurrent but limited authority to govern the same land and people ○ According to such an understanding, the authority of states and national governments is derived from their citizenry entering into agreement, or covenant if you will, to uphold the terms and conditions of governance as outlined according to constitution rules ○ The presumption is that no single government has the knowledge to govern across an entire geographic are Chinese-Style Federalism ○ Viewed from the perspective of the political relationships among the different levels of government, China’s political decentralization during its transition shares much in common with Western federalism ■ The modern Chinese system includes a division of authority between central and local governments ■ The latter have primary control over economic matters within their jurisdictions, with political durability built into the system The Political Foundations of Market-Preserving Federalism ● A federal system is market-preserving if it has five characteristics: ○ A national and sub-national level of government, each with a delineated scope of authority so that each level of government is autonomous in its own, well-defined sphere of political authority ○ The autonomy of each government is institutionalized in a manner that federalism’s restrictions is self-enforcing ○ Subnational governments have primary regulatory responsibility over the economy ○ A common market across political jurisdictions ○ Sub-national governments face a hard budget constraint The Economic Effects of Market-Preserving Federalism ● The most important implication of market-preserving federalism, in the induced competition among jurisdictions, have the following effects: ○ First, no government has a monopoly of regulatory authority over the entire economy ○ Second, market competition among jurisdictions extends to factors of production, such as capital and labor ○ Third, the hard budget constraint implies that local governments can go bankrupt ○ Fourth, market-preserving federalism provides the political foundations for markets, meaning that it reinforces market competition and, therefore, diminishes the prevalence of rent-seeking and patronage systems Predictions of Market-Preserving Federalism ● Following the imposition of a system of federalism, we should observe diversity of policy choices and experiments ○ (ex. The rise of women’s property rights in the US during the 19th century as result of inter-jurisdictional competition) ● Competition among jurisdictions provides incentives to replace poorly chosen strategies with variants of strategies that appear to succeed elsewhere ● We should not expect the appearance of uniformity among jurisdictions for several reasons (sorting of individuals according to their preferences and willingness to pay for different types of goods) Durability of Government Policies ● Government policy which creates privileges, benefits initial recipients ● However, the value of the rents are capitalized into the value of the property ● Even though there are no longer any extra-normal returns, the privileges persist because removing them would harm the current property owners China Prior to Economic Reform (Pre-1978 and CCP): Background and Context ● China Under Mao Zedong ○ The Great Leap Forward ■ Agricultural collectivization ■ Steel production in “backyard furnaces” ● Exporting grain at this time as well, labor was already taken from agricultural gains and then exported, starvation, Zedong then moved away from the USSR style planning-board ○ The Cultural Revolution ■ Central objective was to eliminate bureaucracy ■ Delegate administration of the economy at the subnational level ● Mao Zedong’s Legacy ○ The effects of the Great Leap Forward and the Cultural Revolution had important ramifications for China’s economic reform after 1978 ■ ■ ■ Unlike Stalin in the Soviet Union, Mao did not leave his successors a rigid, centralized bureaucracy Management of the Chinese economy, including state-owned enterprises, transferred from ministries and bureaucracies of the central government to local authority Decentralization under Mao did not imply market-preserving federalism Decentralization in China (1980s) ● The idea of decentralization in China was not new in 1978 ● China experienced two previous waves of administrative “decentralization” during the Great Leap Forward and the Cultural Revolution ● Decentralization in the 1980s differed, however, in that it is combined with financial incentives, reliance on market mechanisms, increased control for lower governments over their economies, and a new openness to international markets ○ These features would parallel (to a great degree than before) the conditions of market-preserving federalism China’s Economic Transformation (Post-1978) ● 5 Key aspects of Institutional Transition in China: 1.) Fiscal contracting system 2.) The household responsibility system 3.) Township and village enterprises (TVEs) 4.) The managerial responsibility system 5.) Special economic zones (SEZs) Digression on Economic Transition ● Remember, the key to understanding economic transition is to understand institutional transition ● The fundamental factor defining economic transition is the change in the structure of de facto property rights ● Property rights are fundamentally social relationships defining individual responsibility 1.) The Fiscal Contracting System ● Starting in 1980, China implemented a fiscal revenue-sharing system between any two adjacent levels of government ● Two-step process to the fiscal contracting system between the central and provincial governments ○ In the first step, revenue income in each province is divided between “Central fixed revenue” all of which is remitted to the center, and “local revenue”, which is subject to sharing ○ In the second step, a particular formula of sharing is determined ● ● The importance of these new fiscal arrangements is that they induce a strong positive relationship by tying local revenue to local economic prosperity for all provinces and cities, thus providing local officials with an incentive to foster that prosperity Differences between the fiscal contracting system and that of the former communist system, including the former Soviet Union and Eastern Europe ○ In the Soviet Union, the central authorities retained the discretionary authority to the profits “earned” by producers, typically using this authority both to take resources from those firms with positive earnings (profits) and to bail out those with negative earnings (losses) ○ This discretionary redistribution was described in the Soviet Union by the Russian word uravnilovka, which translates to “equalization” or “leveling off” 2.) The Household Responsibility System [de facto private property rights, let farmers pick what they could build, started with a fix due and then they could keep their own outputs] ● The main feature of agricultural reform is the de facto change in the nature of ownership in land ○ The “responsibility contract” is equivalent to granting of de facto private property rights through a state lease of land ○ By 1983, such contracts allowed peasants to have an exclusive plot of land by contract with government, for which plot holders paid a fixed due (a fixed portion of the value of the crop yield), and allowed plot holders to keep the rest of their output ○ By the end of 1983, peasants were allowed to decide what crops to grow, and dues were paid to the government in cash ■ Transition from a tax in kind, to a tax in cash ● What followed from the freedom to specialize and produce was the de facto recognition of market prices in agricultural goods ○ Though the state remains retain de jure ownership, paying a fixed due for such responsibility contracts in analogous to paying a property tax to the government under a formal private property system 3.) Township and Village Enterprises (TVEs) ● Another result of China’s reform is the spectacular growth of the market in the flourishing sector of TVEs, owned de jure by township and village communities, but de facto operated under the conditions of private property, market prices, and profits and losses ● By the mid 1990s, TVE’s produced almost thirty percent of industrial output in China ● Although both TVEs and state owned enterprises are “owned” by governments de jure, their incentives and hence their behavior are far different de facto ○ The organizational structure of TVEs granted residual claimancy (in essence, the rights to profits and losses) this means that TVEs have both control rights and cash-flow rights ○ Not only may they go bankrupt, but unlike state owned enterprises, could not be endlessly bailed out 4.) The Managerial Responsibility System (Dual track system) ● Economic reforms, initially, did much less to directly improve the productivity of SEOs (state-owned-enterprises) ● In SEOs, a “dual-track system” emerged ○ Beginning in 1983, SEOs began to pay taxes instead of turning over all profits to the state ● An unintended consequence of economic reform was the emergence of the “managerial responsibility system” ○ Analogous to the household responsibility system in agriculture 5.) Special Economic Zones ● Decentralization of authority is particularly associated with the establishment of special economic zones, coastal open cities, and development zones ● In 1979, China established four SEZs in Shenzhen, Zhuhai, Shantou (adjacent to Hong Kong in the Guangdong Provinence), and Xiamen, in Fujian Province across the Taiwan Strait ● SEZs attract foreign capital, technology, and managerial talent China’s Transition: Future Prospects ● Several issues still remain that will affect China’s path towards a market economy based on the rule of law: ○ Privatization of the state sector of the economy ○ Economic calculation and reported growth rates ○ Economic liberalization is a necessary condition, though not a sufficient condition, for political freedom in China SECTION 5.1 Market Reform in India Political Economy of India: Background ● 1947: Independence from the British Empire ● Between 1947 and 1991, India implemented central planning and as well as other government interventions: ○ Creation of state monopolies, particularly in utilities ○ Protectionist policies in the form of tariffs and quotes ○ Strict regulation of industry under the Permit Raj ■ System of licensing for nearly everything in the economy ■ Redirected entrepreneurship from productive to unproductive services 1991: Foreign Exchange Crisis ● Under the leadership of Finance Minister Manmohan Singh, India began a set of marketorientated reforms ○ Trade liberalization and elimination of quotas ○ Privatization and the rise of capital-intensive industries in utilities and transport ○ The emergence of new industries outside the scope of government control, such as information technology ■ Human capital, the ability for individuals in India to pursue IT or remote work because they are not limited by their rules of the game and can use that human capital to work outside of India Why had India Lagged Relative to China in Terms of Growth? ● The regressive nature of licensing through the Permit Raj on labor-intensive industries ● Unlike in China, agriculture had been the sector of the economy that remains largely unreformed ● Therefore, a great deal of entrepreneurial talent and human capital of the rural poor still remains largely untapped Lessons for Economic Transition ● Sustained economic development cannot occur without the poorest and least advantaged in society being able to productively specialize and exchange through social cooperation under the division of labor SECTION 5.2 The African Development Conundrum Economic Growth in Perspective ● Sub-Saharan Africa accounts for two-thirds of the extremely poor global population (living on less than $2 per day) ● Between 1990 and 2018, the percentage of individuals living on less than $2 per day in sub-Saharan Africa has fallen from 56% to 42% ● During that same time, unlike China or India, the number of individuals has increased from 284 million to 433 million in sub-Saharan Africa ● What can explain this relative stagnation in poverty reduction? The Eternalist Argument in Perspective ● There is no doubt that Western imperialism and colonialism had had a negative impact on economic development in Africa. ● However, this explanation raises several questions: ○ ○ ○ If Ethiopia was never colonized by Western powers, why does it remain poor? If Switzerland was never a colonial power, how did it become wealthy? How can the theory or rent-seeking help us evaluate the effects of Western imperialism and colonialism in Africa? Policy Implications of the Eternalist Argument ● The eternalists, influenced by Marx and Lenin, argued for the substitution of socialism for capitalism in order to divest Africa of its colonial legacy and spur economic growth ○ According to Lenin, colonialism and imperialism is capitalism in transition to socialism ○ The increase in monopolization of capital predicted by Marx generates violence conflict as capitalists fight over economic territory The Internalist Argument in Perspective ● Socialism and state-led development planning has created a transitional gains trap ● Once a political privilege is created, to eliminate it creates a dispersed benefit throughout society ● To abolish this privilege is also a concentrated cost to political elites, who will expend resources and effort to prevent the limitation of state control or intervention into the economy Policy Implications of the Internalist Argument ● To the extent that Africa’s development problems can be explained by its institutional context, foreign aid has two effects: ○ It disincentives political leaders from seeking political support from the local population ○ It decreases the cost of engaging in rent-seeking activities ● This is different from foreign investment, which is a voluntary exchange of private property rights over material resources What Can Aid Do? ● Not unlike central planning, the best case scenario of aid is that it can solve a technological problem ○ Aid can increase a pre-determined output X by devoting given resources to X’s production ○ If planners pick a specific outcome, such as more immunizations, aid can provide additional resources to produce immunizations ● This is not a complete indictment of aid in any form, but a clarification that foreign aid, by definition, cannot solve economic problems. It can solve, at best and under ideal conditions, technological problems. READ FOR VENEZUELA