Getting to Market

March 1, 1991 Topic: Economics Tags: PostmodernismSociology

Getting to Market

Mini Teaser: Over the past century, economists and other intellectuals have produced an enormous amount of literature on how to convert capitalist market economies into socialist centrally planned ones.

by Author(s): Charles Wolf, Jr.

China's economic restructuring efforts probably rank somewhere between Poland and the Soviet Union--perhaps warranting a grade of C, probably higher for its rural reform in the early 1980s, but lower for its meager reform efforts in the urban sector before and after the Tiananmen tragedy of June 1989.  While there has been extensive price deregulation, wages remain largely fixed.  Limited progress has been made in the direction of privatization, especially through joint ventures with foreign investors.  State enterprises remain largely responsible for social security, thereby burdening them with high-cost obligations and impeding any prospective progress toward the breaking up and privatization of these enterprises.  Although there has been no explicit move toward convertibility, the establishment of fairly effective monetary and fiscal discipline has helped to create a situation in which the black market value of the yuan is only about 30 percent below the official rate.

Transitional Costs of Transformation

It is widely assumed that the transitional costs of transforming command economies into market ones will be extremely high, as well as protracted.  But this assessment is flawed by a fundamental measurement error.  In fact, the costs and pain of the transition are likely to be less than is usually presumed if the process is pursued along the inclusive and expeditious lines described earlier.

The critical error arises from comparing real levels of output, employment, and prices in the post-transformation market environment with the spurious recorded levels of the prior command environment.  For example, it has been said that Poland's GNP has declined by 16 percent, unemployment has risen to more than one million, and inflation has increased by 35 percent more than wages since Poland's "crash" economic reform program was initiated in January 1990.  Similar or greater disruptions have been predicted by Gorbachev and others for the Soviet Union if "radical" restructuring were to proceed there.  All these figures are wide of the mark.

In non-market systems, recorded output is typically and substantially overestimated due to several factors: first, underestimation of "hidden" inflation that takes the form of maintaining constant prices for products of decreasing quality, or establishing higher prices for products that are reclassified to reflect apparent, but not actual, increases in quality (in the Soviet Union, it has been estimated that the annual rate of inflation in recent years has probably been two or three times the previously acknowledged rate of about 2 percent); second, inclusion of physical, but valueless, output--for example, shoes that consumers won't buy and bulldozers that are too hazardous to use and too costly to fix; third, fraudulent reporting--the padding of reported data (pripiski in Russian) to meet or exceed established production norms; and fourth, data manipulation for internal or external propaganda purposes.

Such factors probably account for overestimates of at least 25 percent of recorded GNP in the Soviet Union and other non-market systems.  It is significant that estimates of the size of the Soviet GNP relative to that of the United States by the CIA (as well as by the Soviet State Committee on Statistics), have placed the figure at about 50 percent, whereas estimates by other economists--Soviet, American, and European--have placed the figure between 14 and 30 percent.(1)  It is also significant that East Germany's per capita GNP in 1987 was estimated by both the CIA and the World Bank at about 88 percent of West Germany's, while more accurate estimates since unification suggest a figure of less than 50 percent.

Similarly, comparisons between post- and pre-transformation unemployment are misleading because they are based on unemployment that is visible in the market economy, but do not allow for the make-work, featherbedding, and pay-without-product unemployment that is hidden in the non-market system.  The employment realities are suggested by the familiar Soviet joke: "We pretend to work, and they pretend to pay us."

Finally, it is misleading to compare post-transformation "inflation" with pre-transformation's apparent price stability.  Transformation to a market system converts inflation that has typically been "hidden" in the non-market system (but reflected in long and uncertain queues and declining product quality) into visible price increases in the market system.

When properly measured, the economic costs of the transition--in the accurate sense of opportunity costs--should be much less than suggested by most comments and estimates.

Why Is Transformation Faltering?

If transformation to a market system is more tractable and the attendant costs are likely to be lower than is commonly assumed, why has progress been lacking (as in the Soviet Union), or very limited (as in China), or at best only modest (as in Poland)?

The question relates more to the politics than to the economics of transformation, more to the motivation and capacity of potential leadership and organizations than to understanding the policies necessary for moving forward.  Part of the answer lies in the fact that there are deep underlying divergences among many of those who intone free market rhetoric and slogans, but are themselves decidedly ambivalent about the desirability of real system transformation.  Hence, they seek reasons or excuses for delaying and temporizing, even while solemnly acknowledging the necessity for eventual systemic change.  To profess a belief in free markets, together with an intention of maintaining the political dominance of the Communist Party, as does the leadership of both the Soviet Union and China, is oxymoronic.

Transforming command economies into market economies inevitably means winners and losers, although in the aggregate the economy will gain much more than it loses.  In the Soviet Union, the issue is further complicated by the likelihood that the economy that gains will be that of the republics, while the loser will be that of the union.  The practical problem created by impending transformation is that the reigning leadership in the ostensibly transforming economies--especially in the Soviet Union, China, Romania, Bulgaria--is very likely to be among the losers in terms of their power, privilege, and prestige.  Hence, while they may use the rhetoric of markets and competition, their interests induce, if not compel, them to temporize, to delay, and perhaps to incapacitate the transformation process.

Charles Wolf, Jr., is dean of the RAND Corporation's graduate school in Santa Monica, California and director of RAND's research program in international economics.

1.  See my testimony before the Senate Foreign Relations Committee, "Estimating the Size and Growth of the Soviet Economy," July 16, 1990.  See also Henry S. Rowen and Charles Wolf, Jr. (eds.), The Impoverished Superpower: Perestroika and the Soviet Military Burden (San Francisco: ICS Press, 1990); especially Chapter 1 by Anders Aslund, "How Small is Soviet National Income?".

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