The Traditional Economic Mechanism

INTRODUCTION

The socialist system of management of the economy or the economic mechanism¹ was introduced in the USSR in the 1930s. Its foundation was designed before the start of the first five-year plan, but its building blocks were finally determined on the basis of the experience gained in the process of fulfilling the plan.

The final shape of the management system was determined by several factors. The adopted strategy of economic development, namely the decision quickly to industrialise the economy with stress on heavy industry, played a paramount role. The objectives of such a strategy could not have been achieved by market forces: these would have pushed the economy in a different direction. This strategy was greatly influenced by the security considerations of the country. O. Lange (1973, Works 2, pp. 384-5) likened the Soviet system to a war economy.

The dictatorial system introduced by Stalin also had an influence on the shape of the management system. To make the centralisation of the political power effective it seemed to be advantageous to combine it with economic centralisation.

Finally, Marxist ideology, which predicted that the communist economy would be a markctless economy, backed up the process of centralisation. This is not to say that the Soviets always followed Marxist ideology; they were quite selective.

The Soviet management system is known under different names. In the West, mainly in the 1950s and 1960s, it was known as a command economy.

Some also call the unreformed system classical or traditional. These names are intended to distinguish between the system created in the 1930s and the system which emerged as a result of major economic reforms. I will use most of the names when talking about the unreformed economic mechanism. Both the traditional and the reformed economic mechanisms are regarded as a part of the socialist economic system.

I do not intend to discuss the traditional economic mechanism in any great detail. It has been discussed in many publications,² so here I will only give a short survey of its structure and focus more on its shortcomings.

THE MAIN PRINCIPLES OF THE TRADITIONAL SYSTEM

In the traditional system market forces played a very limited role. Planning was the coordinating mechanism: planners, with the help of annual plans, coordinated the economic activities of enterprises, took care of the distribution of producer goods and consumer goods and concerned themselves with macro- and microequilibrium. The annual plans were to ensure price stability, full employment and proper wage differentials. All this was done by imposing compulsory plan targets and limits on enterprises. The annual plan, which was supposed to be a proper part of the five-year plan, was disaggregated through the channels of the hierarchic management to enterprises.

In order to determine microeconomic targets, the planners had first, of course, to determine macroeconomic targets for the distribution of national income between consumption and accumulation, for the distribution of consumption between personal consumption and the collective consumption fund, and for the distribution of investment between the material and non-material sphere. As a result of these targets, the rate of growth of the economy and of individual sectors was determined to a great degree.

To make sure that enterprises were able to fulfil the plan targets, the planners allocated inputs, producer goods and labour to them in terms of quantity and quality. Thus there was no market for producer goods, but there was a limited labour market in the sense that workers had the right of choice of jobs,³ and wage differentials played a role in the distribution of labour.

To make enterprises interested in the fulfilment and overfulfilment of plan targets, which were assigned to them as compulsory tasks, money and non-money incentives were used. Money incentives were made contingent on the fulfilment of these targets. The money incentives were expressed in terms of growth of the wage bill and the size of the bonus fund. If the assigned plan targets were fulfilled the actual wage bill was equal to the planned. If they were overfulfilled, the actual wage bill was higher, depending on the adjustment coefficient.

It is only natural that in such an arrangement enterprises would try to get soft plan targets (low output targets and maximum inputs including labour) because this enabled them easily to fulfil the plan. Knowing enterprise strategy and not having reliable information about enterprise capacity, the central planners used a simple method: they increased the plan targets each year by a certain percentage. In the literature this method is known as the ratchet principle.

The planned wage bill itself was a product of the planned number of employed, taking into consideration its required structure (white- and blue-collar workers) and skill mix, and the planned average wage. Planning of both factors meant taking into account all the changes over the previous year, including, of course, changes in the size of planned targets. The authorities encouraged enterprises to overfulfil the output plan, whereas in the case of employment they did the opposite. For enterprises the easiest way to overfulfil the plan was to employ more workers. But this was contrary to the interests of the economy because it might have negatively affected productivity.

The central planners controlled not only the wage bill but also the wage rates. These were set from above and were binding on enterprises. They changed only after long intervals. By controlling the wage rates, the planners wanted to have a second defence line against the possible drift of wages and a good control over wage differentials.

Incentives in the form of bonuses went through many changes. Initially, bonuses were given to managers for the fulfilment of the plan. Workers used to get bonuses for saving material, energy, etc. In Hungary in 1957, perhaps for the first time in a socialist country, a profit-sharing scheme was introduced: workers were given year-end rewards. The size of the fund depended first on the achieved level of profitability compared to the target, and later on the amount of profit produced. In Poland in 1957 profit became the success indicator and the source of the incentive fund (for more see Adam, 1984, pp. 127-8).

The fulfilment of plan targets was measured by so-called success indicators. When the traditional system was introduced in the USSR, many indicators were physical, i. c. metres, gallons, tons etc. The planners soon observed that they had committed a blunder, as the physical indicators worked against economic efficiency. Soon the indicators in natura were kept only where they made economic sense; otherwise value indicators were introduced, primarily gross value of output.⁴

To make sure that the demand for inputs resulting from the set targets (including exports) was in equilibrium with the supply available (including imports), the planners used a great number of material balances for important products as a significant method for working out the plan. The material balances meant balancing demand for products with the possible supply.

This was a very laborious and time-consuming method of formulat­ing the plan, particularly at a time when computer technology was not yet available or was only available to a limited degree. If an important material balance (say for coal or steel) on which other balances depended, turned out be in disequilibrium (say because the expected production at home fell short of the target, and the shortfall could not be replaced by imports) it was necessary to rework many other balances. The cumbersomeness of the working out of material balances was the main reason for enterprises getting their plan targets late, after the planning year had already started.

The more comprehensive the regulation of the economy, the greater the number of balances. For example in the mid-1980s the Soviet planners compiled 1800 product balances for the annual plan and 405 for the five-year plan. In 1988 the number of balances declined to 950 (Spulber, 1991, p. 67). The material balances showed what it was possible to produce, but did not show what it was optimal to produce.

Besides material balances the central planners also compiled manpower balances and financial balances. The former were aimed at making sure that the demand for labour, including the needed skill mix, resulting from the output plans would be in line with the possible supply. The aim of the latter was to ensure a link-up between the production, distribution and circulation of goods on the one hand, and the formation and use of incomes in all spheres of the economy on the other hand.

One of the important features of socialism was the pivotal role played by physical planning in the total planning system. Material balancing was an important component of physical planning, but not the only one. The assignment of targets in physical units, the determination of norms of labour intensity of products and technical coefficients from the centre were also a part of physical planning.

It has already been mentioned that the market mechanism was of negligible importance in the traditional system. However, market categories, such as prices and interest rates existed (wages have already been discussed) but only in a passive capacity. Prices of products were mostly planned and thus were not the result of market forces. The price system was marked by some additional socialist specialities. Prices were inflexible and individual price circuits (price subsystems) were mutually separated.

Consumer (retail) prices were planned with the intention of regulating consumption in accordance with consumer demand and planners’ priorities. When they were set, their level was planned with the objective of clearing the market. Once they were set, they remained stable for a long time: changes were made only when great disparities appeared. This approach to consumer prices was dictated by the desire not to allow inflation. The planners were willing to accept shortages and line-ups at stores rather than to accept in∩ation.

Industrial (wholesale) prices neither allocated resources nor influ­enced enterprises very much in their decisions about choice of technology and inputs. Resources were allocated by the plan. Whole­sale prices performed more of an accounting function; the fulfilment of the plan was measured in terms of wholesale prices. These were rigid too; they changed only after long intervals.

Agricultural procurement prices (at which collective farmers sold their products to procurement agencies) were also set by the central planners. Unlike the wholesale prices, which had no bearing on incomes, procurement prices were one of the factors which determined the incomes of collective farmers. In state enterprises the wages (without bonuses) of workers were not dependent on the performance of enterprises, but on workers’ individual performance, wage rates and skill grades, whereas the incomes of collective farmers depended to a great degree on the performance of the collective farm of which they were members. Collective farms were treated as genuine cooperatives when it came to incomes and investment. Otherwise they were more or less subordinated to the planning system like the rest of the economy.

The changes in one price circuit were not necessarily reflected in another, since there was a separation of price circuits. What was especially striking was that even big changes in wholesale prices did not show up in consumer prices.⁵ Instead they were reflected in changes in the turnover tax or subsidies or a combination of both. Increases in agricultural procurement prices were mostly also taken care of by subsidies.

This separation had two goals. One was to separate domestic production, non-agricultural as well as agricultural, from consumption and from the influences of world markets. The idea behind this separation was that if enterprises did not have to consider consumer demand and developments in foreign trade, they would be able to concentrate fully on output targets. It was assumed that planners had assigned targets in a way that reflected consumer demand, modified by planners’ priorities and foreign trade needs. The second goal was to shield the economy from inflation which might be generated domestically or imported.

Interest rates were planned too. Their level was determined primarily by the need to have a source of funding for the operations of the central bank and its branches. For this reason they were quite low and stable. Thus the interest rate was not viewed as a price for the use of credit, and it had a negligible influence on the size of the credit extended, not to say on investment decisions. The global size of credit was determined by the central planners.

Investments were not allocated on the basis of profit expectations, but on the basis of the plan. Enterprises were obliged to surrender all the profit (minus what was left to them for bonuses) and the amortisation fund (minus sums for maintenance and minor investments) to the state budget. The planners redistributed the funds according to the plan objectives without any consideration for the performance of enterprises. This meant that enterprises which made a lot of profit might not get funds for investments whereas enterprises which suffered losses might. In practice it often happened that light industry made huge profits which, however, were used for the expansion of heavy industry. What is also important to remember is that the distribution of investment funds was very much governed by political considerations, a topic which will be discussed in Chapter 3 in greater detail.

In banking the field was absolutely dominated by a huge state (national) bank with many branches scattered all over the country. The state bank fulfilled the function of a central bank and of a credit­rationing institution. Even the bank for external financial relations, if such existed in the country, was subordinated to the state bank. Economists, who labelled the Soviet banking system as a monobanking system, were correct.

The state bank also fulfilled a very important function in the man­agement of the economy. It was entrusted with the task of supervising the performance of enterprises. To this end enterprises were obliged to conduct all their financial operations through the bank branch in their location. In addition, they were not allowed to extend loans to each other. The bank was allowed to apply sanctions v⅛-d-v⅛ enterprises which did not fulfil the plan and which overdrew wage funds.

The state bank extended short-term credit to state enterprises for certain purposes only. It was, however, not allowed to extend long­term credit to enterprises for investment purposes since enterprises had to content themselves with investment funds allocated to them as grants. Collective farms, which had to finance investments from their own resources, could get long-term loans.

Foreign trade was also planned. In planning, imports were the point of departure. In considering imports the idea of self-sufficiency had a great impact, therefore import substitution was often practised. Imported commodities were primarily those which could not be produced at home for lack of know-how or for other reasons, or could be produced only at very high cost and were needed for the fulfilment of the plan. Of course, imported goods were also goods which could not be produced at home for geographical reasons. For more about foreign trade see Chapter 5.

Economic efficiency was to be achieved by the planning system itself, by employing all resources, including human, and by making the plan targets assigned to enterprises as taut as possible. In addition, the khozraschet (accountability) principle alone - which made enterprises financially quasi autonomous units in that they were expected to arrange their activities in a way to cover costs and make a profit - was also supposed to push enterprises to promote economic efficiency. The stress in socialist countries was on macroeconomic efficiency. The planners, as in many other cases, considered the economy as a huge enterprise belonging more or less to the state, and therefore the total result was primarily of importance to them. This is not to say that microeconomic efficiency was entirely neglected. It was to be achieved by the planning of technical coefficients, norms of labour intensity of products and performance norms for piece workers, and bonuses.

Market equilibrium was to be achieved by balancing the plans for the total purchasing power (minus expected savings) with the value of the supply of consumer goods plus services. For this purpose, the global wage bill as well as total non-wage incomes were planned for each year. In order not to exceed the global wage bill, wage bills in enterprises and organisations, as well as the size of the work force, were planned. The efforts to achieve market equilibrium combined with price rigidity and separation of price circuits were the main instruments in fighting inflation.

THE EVALUATION OF THE TRADITIONAL SYSTEM

I have briefly discussed the main principles of the traditional system. To understand the working of the socialist economic system and its impact on the economy it is also important to discuss the political and social system and the economic and social policies applied during the traditional system. All this will be covered in the next chapters. In this subchapter I would like to discuss the advantages and disadvantages of the traditional economic mechanism. Since the advantages of the system can be summarised in a short paragraph, I will start with them.

The traditional system had the advantage of being able to mobilise resources for priority projects quickly, as happened in the case of industrialisation, the space programme, etc. Who knows whether the USSR would have achieved as much progress in the industrialisation effort in such a short time without its centralised system? The traditional system was arranged in such a way that open inflation could be easily held within defined limits, provided the authorities were willing to accept the costs involved. Since the traditional system was a supply-constrained system, it largely contributed to full employment.

Planning in the Traditional System

The traditional economic mechanism had its logic and was to a great extent internally consistent; nevertheless it was inefficient because it was based on unrealistic assumptions. One such an assumption was that planners know best what the possibility and the needs of the economy and consumer preferences are, and that they are able to compile a plan which reflects all this and also ensures increasing economic efficiency. It can be shown theoretically, and experience confirms it, that this is impossible. The working out of such a plan presupposes a rational price system and a very quick, permanent flow of truthful information about the production capacity of enterprises and about demand. The price system, which was the work of the planners and was used for various purposes - among others, for the solution of certain social tasks - could only be and really was a distorted gauge of social cost and scarcity. One could argue that modern computer technology can master the information problem. The argument might be valid if computers could also force enterprises to provide truthful information. It is obvious that computers cannot fulfil such a role and enterprises were very often not interested in revealing their capacities for reasons which will be mentioned. From the foregoing it is clear that the assumption about planning was unrealistic.

There were also other problems which made microeconomic planning ineffective. Their common denominator was the enormous number of products with which the planners had to grapple in compiling the annual plan. The numbers were overwhelming even though the plan targets were formulated in groups of products in most cases. The planners had not only to see to it that all the products or groups of products in demand were produced, but also that the inputs needed for their production were on hand. Once it was decided that enterprises should be assigned output targets, allocation of inputs was a necessary consequence under conditions of shortages. The coordina­tion of production and allocation of inputs turned out to be a job which could not be performed to the satisfaction of producers and consumers. The desire to plan everything was one of the sources of shortages (for more see Nove, 1991, pp. 78-91).

Macroeconomic planning was not effective cither. The planners were not able to formulate an optimal long-term plan which would contain structural changes corresponding to the expected changes in technol­ogy and demand. On the one hand, the theory of planning was not sufficiently developed and on the other, the formulation of macro­economic plans was much influenced by political pressures. Commen­cing with the 1960s, the planners increasingly relied on trends in the development of advanced capitalist countries when compiling long­term plans. On the one hand, this was a smart approach since the advanced capitalist countries were ahead in the development of technology; on the other hand, it shed an unfavourable light on planning. The planners’ approach could be interpreted as the inability of the planned economy to get ahead of market forces when it came to

predicting future priorities. Needless to say, this was a good argument even against reformers who believed that long-term planning had its justification and that it was superior to spontaneous development in capitalist countries.

Insufficient Incentives

Another reason for the failure of the system was the lack of strong incentives to hard and efficient work. In the traditional system the bonuses of managers (and to a lesser extent those of employees) were dependent, as has already been mentioned, on the fulfilment of plan targets. And therefore managers were interested in receiving soft targets and maximum inputs. This was also the reason why they were often not interested in providing truthful information. The linking of the fulfilment of plan targets to bonuses had another effect besides the one mentioned: it encouraged managers to produce not what was demanded in the market, but what was important for the fulfilment of the plan. And because plan targets and market demand - as is clear from the foregoing - often did not coincide, this contributed to shortages. In addition, the mentioned linkage was also one of the main reasons for the shabby quality of goods, lack of interest in innovations and, of course, inefficiencies.

The lack of strong incentives had also to do with the ruling ideology about the more equal distribution of income which the economic policy translated into narrow wage differentials for skill. To make the economy more efficient required allowing relatively wide wage differentials but, of course, nothing like those in capitalist countries. (For more see Chapter 3.)

It has been said that the fulfilment of plan targets was measured by success indicators, usually quantitative indicators, the most important being the gross value of output. This indicator was used though there were objections to it because it lent itself easily to misuse, simply by using more expensive inputs or more inputs, but also because it included semi-finished products and subcontracting services. It is known that enterprises gladly performed services for other enterprises because they could include not only the price of the services rendered, but also a part of the material costs in the gross value of output. And in the course of time cooperation developed between enterprises which, from a macroeconomic point of view, was of little value or maybe even harmful, but it enabled enterprises easily to fulfil the plan targets by performing subcontracting services for one another. It took the

authorities a long time to reduce the role of gross value of output since it had the advantage of allowing an easy aggregation of output.

The authorities tried to cope with the misuse of success indicators by enlarging their number and by thus plugging the loopholes. As a result the following logic of success indicators developed: the system could start with a few indicators and at certain periods their number could even be reduced, and after a long while their number could grow again for reasons already mentioned.⁶

Irrational Prices

From what has been said before it is clear that price relativities within individual price circuits (price subsystems) as well as among individual circuits were distorted. Without the possibility of reliable economic calculation, the planning agencies were deprived of a fundamental tool for making rational decisions about alternative uses of resources. Distorted prices hampered the making of rational choices among the alternative investment projects and the use of alternative technology, the making of decisions about what it was advantageous to produce at home and what should be imported, as well as what kind of changes to make in the structure of the economy. The distorted prices also made it difficult to use profit as an objective indicator of performance.

To overcome these difficulties Soviet mathematical economists urged the use of shadow prices, an idea which spread to East European countries. There were attempts to apply them in planning, but because of data problems not much progress was made. (For more sec Nove 1980, pp. 182-4; Gregory and Stuart 1989, pp. 137-8. )

Price rigidity contributed to the rise of shortages of producer goods as well as of consumer goods. Shortages of producer goods were the most important reason for their rationing. Consumer goods were not rationed; the authorities preferred to accept queues at the stores, which were quite costly for the economy.⁷ (For more, see Chapter 3.)

The separation of individual price subsystems had also contributed to shortages, in that enterprises were able to disregard demand with impunity.

Soft Budget Constraint

The khozraschet principle, which was intended to make enterprises self­financed, could not work for several reasons. Enterprises were not economically autonomous units which could freely make decisions about the scope of their activities and the methods of their implementation. The superior authorities determined their activities, in many cases in great detail. They had to obey the orders of the superior authorities with regard to output even if this meant losses. ⁸ It is clear that such conditions do not create a proper environment for self-financing.

In addition, the authorities did not usually apply sanctions against enterprises which did not perform well. Bankruptcy, which in capitalist countries is the usual fate of enterprises with persistently higher outlays than revenues, did not exist on the books of the socialist countries. The authorities usually bailed out such enterprises by giving them subsidies, making concessions with regard to taxation, allowing new credit, etc. Enterprises worked under conditions which J. Kornai (1992, pp. 142-3) calls a ‘soft budget constraint’. Liquidation of non-efficicnt enterprises was quite rare, primarily for political reasons: the political leaders tried to avoid potential social tension.

The fact that the authorities were willing to bail out enterprises, if they found themselves in a financial bind, undermined various financial incentives and disincentives which were supposed to encourage enterprises to behave rationally.

Investment Decisions

The fact that allocation of investment funds to industrial branches and enterprises did not depend on the amount of profit produced but on the objectives of the plan meant that economic efficiency was often sacrificed in order to achieve objectives which were frequently dictated by non-economic considerations - political and state security reasons, to mention some.

The arrangement that state enterprises were not obliged to repay the allocated funds for investment purposes encouraged enterprises to seek the maximum funds possible for investment. Many high Party functionaries behaved likewise: they used their influence to obtain funds to establish new plants in their constituencies. This was one of the reasons for overinvestment. However, the economic policy of maximum economic growth was the main reason for overinvestment. The approved investment projects usually exceeded the construction capacity, and as a result they could not be finished as planned, though the lead time (the time between the planning of the project and completion) was much longer than in the West. The phenomenon of a growing number of unfinished projects was one of the ills of the traditional system, which the socialist countries did not manage, though they tried, to cure. The high number of unfinished projects had negative consequences for the economy. It caused investment cost overruns which in turn were reflected in inflationary pressures which were compounded by the frequent fact that investment funds spent on wages were not matched by supply increases in consumer goods. Due to the long lead time many projects became obsolete before they could be finished.

Technological Lag

When the communists seized power, the countries under review were much behind Western countries in technology. The same was true of the USSR. From the 1950s to the 1970s they managed to close the gap somewhat. In the 1980s the gap started to grow again. Western countries managed to respond to the challenge of big oil price increases by developing new technologies which were less energy intensive and by conservation. Neither the East European countries nor the Soviet Union managed to achieve as much success as the West. What was worse was that even the reforms of the 1980s in Poland and Hungary could not reverse the negative impact of the traditional economic mechanism on the development of technology. It seems that this was so partly because the reforms were not pervasive enough and partly because not enough time had elapsed since they were introduced.

The traditional economic mechanism did not encourage innovations for several reasons. In a system where enterprise incentives were based on the fulfilment and overfulfilment of plan targets, inventions were regarded almost as a nuisance. Before inventions could be introduced into production, they had to be tested for their suitability for the purpose assumed, and workers had to be trained for their proper use. Usually new inventions did not work flawlessly and therefore time and costs were lost. In addition, new inventions often disrupted the production process to the extent that the fulfilment of the plan targets was endangered and with it the receipt of bonuses. Very often the risk involved in the introduction of innovations was not properly rewarded. On the other hand, failing to introduce innovations was less risky. Enterprises did not have to fear that, if they remained behind in technological progress, they would be unable to sell their products.

In addition, the pricing of new products was not addressed for some time. In the beginning of a new product’s life cycle its production costs are much higher than when its production mode is stabilised on the basis of experience gained. Therefore the price must be adjusted to the life cycle, or enterprises must get subsidies for the preparation of the production of new products.

For a long time most research and development institutes were centralised, subordinated to the ministries and separated from enterprises. The departure point for this arrangement was the belief that in a socialist system there was no place for commercial secrecy, and therefore measures should be taken which would stave off duplication. However, this arrangement did not work as expected. If institutes came up with a design of a new machine or a consumer gadget, it was a long time before a prototype of the product was tested, let alone produced for consumption. Had the institutes always known in advance which enterprise would be entrusted with the production of the new products, they could have adjusted the design to the needs of the enterprise, thus avoiding long delays, which made many products obsolete before their completion. The idea of centralising the institutes was also wrong, because the impetus for many innovations emerges in enterprises when they are grappling with production problems. This is not to say that once the research institutes became decentralised everything worked well.⁹

Innovators were held in public esteem; their achievements were publicised. But the pecuniary rewards were modest, and therefore innovation was not as attractive as one would expect. In addition, according to Lavigne (1991, p. 223), at least 50 per cent of the inventions ‘never resulted in actual production or building of prototypes’.

The lag in technological progress was primarily in civil production, which had a much lower priority than military production. One of the reasons for this was that in the East, unlike the West where a large spin-off exists from defence innovations into civilian production, the spin-off was small because of a separation between the civilian and the military sectors (cf. Lavigne, 1991, p. 196).

According to Kornai (1992, p. 294) technical progress achieved under traditional socialism was almost exclusively the result of copying innovations carried out in developed capitalist countries. I am not sure whether Kornai’s statement is entirely accurate, but there is no doubt that in the 1970s and 1980s there was a widespread notion among East Europeans that all the inventions which brought about new working conditions, life style and entertainment were the work of capitalist countries, a notion which did not endear the socialist system to the public. However, a glance at Kornai’s list of technical advancements (pp. 298-300) shows that the credit he gives to the developed capitalist countries belongs in reality to the USA. Very few technical advance­ments listed were made by other developed capitalist countries, and these were countries which were on a much higher level of technology than the socialist countries.

What also worked against the socialist system was the fact that new inventions were not instantly available in the East and, when they appeared in the market, they were very expensive and in short supply. In as far as these were domestic substitutes, they were also often of poor quality. (For more see Chapter 8.)

Some believe that the growing gap in technology was the most important, and some believe that it was one of the most important reasons, for the collapse. Chase-Dunn for example, belongs to the first group: in his article (1992) he takes the position that the collapse was because ‘party cadres no longer believed that catching up with the West in high technology sectors was possible’. The view of a leading member of the CP politburo of one of the countries under review belongs to the second group. He insisted, in a consultation I had with him, that the collapse of socialism was due to three factors: huge military expenses, the gap in technology, and excessive support of developing countries. I am inclined to agree with the second view in the sense that the gap in technology was only one of the most important factors, since I believe that political factors were more important or at least as important as economic.

Foreign Trade

The fact that production enterprises were not allowed to enter into trade relations with foreign firms and that this activity was left to special state enterprises, foreign trade corporations, and that domestic prices were separated from world market prices, had negative effects on the economy. All this will be discussed in Chapter 5.

Monopolisation

Production enterprises in their capacity as suppliers had a strong monopolistic position which negatively affected the working of the economy. There were several factors which brought about mono­polisation and most of them were of a systemic nature.

Setting horizontal ties from above was one of the most important factors. Enterprises were not free to buy their material inputs from enterprises of their choice. Suppliers were determined from above. Their position was considerably strengthened by the industrial concentration trend which started in the late 1950s in Czechoslovakia and continued in the 1960s in the other two countries under review. This arrangement, combined with shortages, brought about a sellers* market.

Consumers were free to shop for consumer goods wherever they liked. This was not the case for retailers. They were hampered in their choice of suppliers.

Another important factor was the state monopoly of foreign trade. Production enterprises could import inputs only with the approval of the branch ministry and the foreign trade ministry. The branch ministry usually approved imports of inputs only if they could not be produced at home or if they could be produced at home but with very high costs. All the socialist countries pursued a policy of autarky, and to this end they often resorted to import substitution.

Suppliers could not use their monopolistic position in the classical way, by dictating prices. These were determined by the authorities. Even in cases where enterprises were allowed to set prices for new products, they were under the control of the authorities. They could, however, use their monopoly position to impose low-quality goods on enterprises and consumers.¹⁰

Cyclical Development

The socialist ideology promised an even development of the economy without the known business cycles of the capitalist economy. A glance at the statistics of economic development shows that the economies of socialist countries were also exposed to fluctuations in economic growth. This was much less true about the Soviet Union than of the countries under review. The fluctuations in socialist countries did not have the same effect as in capitalist countries, and also the method used to cope with these fluctuations was different. The decline in economic activity did not produce increases in unemployment as is the usual case in capitalist countries. Enterprises were not under pressure to adjust their workforce to the amount of economic activity. In any case, there was overemployment in many enterprises, and some increase in overemployment did not bother managers very much, all the more because it was expected that the reduction in economic activity would be temporary.

This is not to say that fluctuations did not have a negative impact on the economy. Of course they had. At the peak of the cycle, when economic growth was the highest, shortages were the most severe. Since, in such a situation, investment projects for heavy industry, as already mentioned, were given priority over those for light industry and the food industry, inflationary pressures could not be avoided. Furthermore, other negative phenomena resulted from the over­investment, as discussed above (see p. 32 of this chapter).

The reasons for fluctuations in economic growth did not become a research topic until the 1960s. It would exceed the scope of this book to discuss in any detail the theories of fluctuations, and therefore ³ will touch on them only very briefly.¹¹ Perhaps J. Goldmann, a Czechoslovak economist (1964 and 1964a), was the first to come up with a plausible explanation of what he called a quasi-cycle. According to him, the fluctuations were the result of an economic growth rate beyond what was regarded as optimum in the existing conditions. Such a fast economic growth drive brought about a raw material barrier, namely, the production of the extracting and basic material industries lagged behind that of manufacturing industries. The only remedy for such disproportions was a reduction in economic growth. This, combined with newly completed output facilities, stemming from investments in the previous period, mitigated disproportions. Once the government started a new drive for high growth rates in excess of the optimum level, a cycle was in place again. Goldmann used the term quasi-cycle in order to distinguish the fluctuations in Eastern Europe from those in the West. According to him fluctuations in the West are a necessary product of the working of the capitalist system, whereas in socialism they were the result of a lack of knowledge of socialist laws and shortcomings in their application in planning (1964).

If one accepts Goldmann’s explanation, one must draw the conclusion that socialist countries did not internalise the knowledge needed to stave off fluctuations in the economy. One can also argue, and this, in my opinion, is closer to the truth, that the socialist countries stuck to their policies of ambitious economic growth for a long time, disregarding its negative effects, and thus created conditions for fluctuations in economic growth. Needless to say, such policies were the result of the industrialisation drive.

CONCLUDING REMARKS

In sum the traditional system was marked by many shortcomings which turned it into an inefficient system, doomed to fail sooner or later. It was a system which hampered innovations and lacked strong incentives to make workers do hard and quality work, and therefore the goods produced under such a system were on the average of low quality, definitely much lower than in the West, and contributed to shortages. As will be shown in Chapter 8, this system could not ensure a growing standard of living, once the factors of extensive growth had been exhausted. In other words the traditional system, after its political and economic consolidation, worked well, but not well enough to survive long in competition with the West (cf. Berliner, 1992). Needless to say, the traditional system needed an overhaul, if the socialist system was to survive.

Despite the shortcomings of the traditional system, the economies of the countries under review would have been much better off had the system not been combined with an economic policy and with improper labour-management relations which compounded the shortcomings of the system. These are discussed in Chapters 3 and 4.

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