The Struggle to Save the Soviet Economy, part 3
An extreme example of what it looks like when a bureaucracy goes off on its own, independent of the leadership and the public
In considering all of the strategies for governance that might make people happier, we should always consider having less government, less committees, less hierarchy, less money, less specialization, less taxes, less police, less enforcement, less rules, less layers, and less responsibility. In both business and politics, there are times when simply having less is a good answer.
But being able to implement radical simplifications is often impossibly difficult in the short term, so we are left with the question, okay, we have this big empire, how do we make it serve the public?
In short, we should ask, can we have no empire at all? If not, can we at least have a well run empire?
The answer is yes, if we can build a system where most of the needs of the public are well studied and there are experts in place who can execute a plan to give the public more of what the public needs (which will be different in every decade). But then there needs to be some kind of public pressure such that those at the top will feel the need to respond to that pressure by following the advice of the experts and so mobilize the resources needed to give the public what the public needs. And finally, there needs to be some system of control such that the bureaucracy we are depending on to implement the plan actually has an incentive to follow our orders. Because if that bureaucracy feels like it doesn't have to listen to the leadership above, nor does it have to listen to the public outside, then that bureaucracy is going to do immense harm while it works to satisfy its own needs.
This is happening in the USA right now, at a small scale, and we can see it clearly in regards to the police forces, which often feel free to ignore the leadership of the cities where they exist, and to ignore substantial public pressure for reform, even as the budget for the police forces continues to expand.
But for an extreme example of what it looks like when a bureaucracy goes off on its own, independent of the leadership and the public, we should study the final days of the Soviet Union.
The Struggle to Save the Soviet Economy:
Mikhail Gorvachev and the Collapse of the USSR
By Chris Miller
©2016
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Page 62-63
Paying for Perestroika: Budget in the Red
Even as Gorbachev launched his efforts to revitalize the Soviet economy, the Kremlin faced a new problem: a growing budget deficit. Even as interest groups began jockeying for higher spending, taking advantage of the young general secretary, the government faced a sharp fall in revenues. Where did this deficit come from? Many scholars, as well as politicians such as former Prime Minister Yegor Gaidar, have argued that the budget deficit was caused by falling oil prices. Oil prices spiked during the 1970s, providing a much needed revenue boost to countries, like the Soviet Union, that exported energy. Yet just as quickly as energy prices rose in the 1970s, they fell in the 1980s. By 1986 the oil price was half its peak. The oil-price fall, though important, explains little by itself. Oil was just one of several factors in the Soviet Union’s budget crisis; on its own, the fall in the price of oil would have led to a serious but manageable recession, not the dissolution of the Soviet state. As Chart 4 shows, between 1985 and 1990, the decrease in earnings from trade (above all, oil) was less than half the level of the increase of the Soviet Union’s budget deficit. This means the decrease in oil export revenues can at most explain about half of the deterioration in the USSR’s fiscal position. Other factors were no less important.
Notes from Politburo meetings show that Soviet officials, including those at the very top, knew that the falling oil price was only one piece of a larger deficit puzzle. To be sure, the Politburo followed oil prices closely. In a meeting on June 11, 1986, for example, Nikolai Ryzhkov, the chairman of the Council of Ministers, underlined the significance of energy prices to the USSR’s budgetary position. The oil price fell from 172 rubles in 1985 to 52 in June 1986, reducing export earnings by 9 billion rubles, Ryzhkov told the Politburo. That required a 4-billion-dollar increase in the country’s debt. In a meeting on October 30 of that same year, Gorbachev sketched out a similar threat to the USSR’s budget, noting that “in 1985 we lost 13 billion rubles from the fall in export prices,” leaving an annual deficit of 5 to 6 billion. “Never before has this happened in the country’s history,” he lamented.
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Page 65-69
...For example, Ruslan Khasbulatov, a member of the Congress of Peoples’ Deputies, argued that “if there is more money, there will be more production” was an iron law of economics. It is true that few Politburo leaders were educated in anything beyond Marxist-Leninist approaches to economics, but records of Politburo meetings and documents from the Council of Ministers show that many Soviet officials understood that there was a link between money supply and inflationary pressure.
Gorbachev publicly argued that increasing the supply of money without equivalent increases in production caused nothing but inflation and, in the context of price controls, shortages. In a prominent speech in September 1988, he explained, “Comrades, we could print rubles - whatever quantity we need, we could print. That does not require as much paper as the newspapers; we could find it. But what does that mean, if we look at the crux of this issue seriously? It means that money was issued that was not tied to the end product.” Increasing the supply of money - and the supply of credit to industries - did not make the Soviet Union better off, Gorbachev asserted, it simply shifted resources between different social groups, while the inflation it produced degraded the country’s economic institutions. Politburo records show that Soviet leaders fully understood their options in dealing with the deficit in 1986 and 1987. They could close the deficit through tax hikes or spending cuts. Alternatively, they could continue printing money to fund the difference between revenue and expenditures, and thereby pass on the costs to the population via higher prices and more shortages. No one thought that inflation was an optimal outcome. But political gridlock meant that Gorbachev was unable to push through either tax hikes or spending cuts. The only remaining option was to print rubles.
The Debate over Price Increases
Soviet leaders saw that inflationary pressure was building. In April 1987, Finance Minister Gostev bluntly informed the Politburo that “the financial system is reaching a point of crisis. Inflationary processes have begun.” Soviet leaders did not want inflation to continue, but they were even less willing to take the steps needed to fight it. Gorbachev explained the dilemma at a Politburo meeting in 1986. “Finance is in a critical condition,” he told his colleagues, because “wages came into conflict with productivity. There is more money than there are goods. And now the situation has us by the throat.” The budget needed to be balanced, but Soviet leaders could not agree who should pay the price.
Because imposing cuts on the country’s farms, industries, and military proved politically impossible, attention turned toward Soviet consumers. Subsidies in the form of low prices on consumer goods, Finance Minister Gostev pointed out, cost the government far more than the decline in revenue from oil exports or alcohol taxes. Soviet leaders knew that government programs to subsidize food and other consumer prices constituted a multi-billion-ruble annual spending program, eating up 10 percent of the USSR’s GDP. Food subsidies were by far the largest component of the Soviet welfare state, dwarfing spending on pensions or education, for example. Through subsidized prices, the government paid nearly one-third of the cost of every loaf of bread that was purchased, over half the cost of every gallon of milk, two-thirds of the cost of butter, and a whopping 72 percent of every kilogram of beef. The main beneficiaries of this spending were not the poor, but the wealthy.
Slashing consumer subsidies would have resolved the Soviet budget crisis. It would have reduced, Finance Gostev noted, expenditure levels by 100 billion rubles per year by the end of the 1980s. But Gorbachev believed, probably correctly, that raising prices was politically impossible. “Some people are demanding price increases,” he said. “We won’t do that. The people have not yet received anything from perestroika. They haven’t felt it materially. And if we raised prices, you can imagine the political results: we would discredit perestroika.” Discrediting perestroika meant discrediting himself. It also meant empowering those among the Soviet leadership who opposed any economic reform. Gorbachev was unwilling to take that risk. Soviet leaders remembered the riots in the southern city of Novocherkassk after the price increases of 1962. Gorbachev knew that a similar revolt could easily cause his opponents to oust him.
Setting food prices at exceptionally low levels not only exacerbated the Soviet Union’s budget deficit, it also led to painful shortages. As the government printed more rubles to fill the budget deficit, the value of the rubles on the free market - black markets, in this case - fell. In a market economy, that would have translated into higher prices, because there were more rubles chasing the same number of goods. Indeed, on the Soviet Union’s black markets and at farmers markets where prices freely responded to supply and demand, prices increased dramatically. Yet most prices in the Soviet Union couldn’t rise, because they were fixed by law. Because prices remained low - and declined in real terms, along with the fall in the value of the ruble - it became far less worthwhile for individuals and enterprises to sell things. Even if a baker made the same number of rubles per each loaf of bread as before, the rubles he received now bought far less on the black markets. Shortages meant that those same rubles could barely buy anything in state stores. So why bother baking?
As inflation made it less worthwhile to sell goods, enterprises brough fewer products to market and placed fewer items on store shelves. Long lines and disastrous shortages were the result. Shortages were a persistent problem in the USSR, but during perestroika the situation got far worse. The top leadership knew it was a problem. “When there were shortages on specific products, we could lie through it,” Gorbachev told the Politburo, “but when there are lines for everything it’s unbearable.” By the end of the 1980s, one Soviet economist calculated, the value of the time that Soviet citizens wasted while standing in lines at stores was equivalent to 75 percent of average incomes.
Gorbachev and his economic advisers knew that the only way to eliminate shortages was to increase prices, allowing enterprises to make more money, and thereby increasing their incentive to bring products to market. As Gorbachev told the Politburo in May 1987, “the question about prices is principle, fundamental. If it’s not solved, there won’t be self-accounting for enterprises, nor self-financing, and perestroika will not work. But you know how hard it is to start a new policy [perestroika] with price increases! Something, however, has to be done. But how, in what stage, and what to concretely propose? While everything around us is in a fog. We need to start a discussion and simultaneously work on the problem of prices.”
Yet nothing happened. There were no significant price increases until 1990. Even as inflation raced out of control, shortages spread, and lines lengthened, the Politburo declined to loosen consumer price regulations. The politics were too tough. The Politburo and Council of Ministers regularly discussed price increases during 1987 and 1988. Yet Gorbachev was deathly afraid of the political consequences. Vadim Medvedev, a top Gorbachev adviser, cited the influence of a “massive campaign against the revision of consumer prices in the print media” that was “impossible to counteract.” Gorbachev understood that public opinion was strongly against higher prices. “In general we should make it a rule now: such questions [prices] will never from now on be decided without a detailed discussion with the nation, without consulting with people….Announce about prices….and confusion will erupt. And the people will say: ‘Why do we need all this?’”
Many Politburo members remained skeptical of price increases. Politburo member Nikolai Slyunkov, for example, suggested postponing the question for half a year, or at least for three months - anything to get such a controversial topic off the agenda. The politics were toxic, as Gorbachev himself admitted. “We’ll soon be throwing punches,” he predicted, because “this Politburo is already on the verge of a serious split.” Gorbachev advocated price revisions in principle, but never proposed a concrete policy. “On the subject of price controls. If we don’t come to an agreement, it means that we’re afraid,” he argued. But he was afraid, and sensibly so. Gorbachev realized, as he explained to the Politburo, that if prices do not “correspond with reality, we won’t have any mechanism of economic governance. But most importantly: changes in prices shouldn’t undermine the standards of living of the population, or economic development at the present time.”
This was the basic dilemma: raising prices to approximate free-market levels would help resolve the country’s growing economic problems, but price hikes were opposed by many in the Politburo. Even if Gorbachev had been able to push through price increases over his opponents’ objections, the public backlash against higher prices would give Gorbachev’s rivals a propaganda coup and let them derail perestroika. The issue came up repeatedly at the highest levels of government, but it was never resolved. In April 1988, the Politburo debated yet another plan to increase prices. Valentin Pavlov, head of the State Price Committee, called for 8 billion rubles of price increases, three-quarters of which were designed to eliminate subsidies and shortages on children’s products. Yet Gorbachev hesitated, insisting that this discussion was just “the first reading of this difficult problem.” His concern was living standards. “We need to keep in mind,” he admonished his colleagues, “in terms of meat and milk, a large portion of the population buys these on the market. Increasing prices will be felt immediately,” he argued, especially by “56 million pensioners and 92 million youths below the age of 17.”
...Gorbachev was left with a terrible dilemma. The budget could not be balanced. Raising consumer prices would have been politically fatal, resulting in Gorbachev’s political marginalization, if not complete removal from power. That would have frozen efforts to liberalize industry and agriculture. At the same time, Gorbachev lacked the political influence to reduce spending on the parts of Soviet society most able to absorb cuts - the USSR’s massive military-industrial complex, its bloated industrial ministries, or its perennially inefficient agriculture sector. Reducing these groups’ subsidies was so politically untenable that it was not seriously discussed.