Without Reform of Prices Soviet Economy Can’t Rise

Those who believe that it is in the West’s interests for Soviet economic reforms to succeed have misdirected their attention.

They have proposed Western credits, direct investments, joint ventures, technology transfer, most-favored-nation benefits and Soviet participation in international economic organizations. But prospects for the success of perestroika do not depend on these instruments. Success instead depends on rapid price reform: moving speedily from reliance on administered prices toward market-determined ones. With price reform--and regardless of Western help--Soviet resource allocations will improve and output, productivity and living standards will rise. Without it, external help will be ineffectual.

Administered prices reflect “priorities” and “social needs,” as judged by central authorities--ultimately, the criteria are political. Market prices reflect the choices of users and the costs to producers--ultimately, the criteria are economic and technical. Administered prices frequently provide perverse incentives that lead to surpluses in some fields, shortages in others, waste of resources and deteriorating quality. These are the precise characteristics of the Soviet economy. Few have described them more starkly than Soviet President Mikhail S. Gorbachev himself. Market prices, including the prices of labor and capital, provide positive incentives that generally lead to equalization of supply and demand (rather than shortages and surpluses), improved product quality and more efficient use of resources.

These points about price reform and its effects are familiar and widely accepted by such Soviet economists as Nikolai Shmelyev, Abel Aganbegyian, Vasili Selyunin and others, no less than by most Western economists. The problem, and the disagreement, that arises at this point concerns “how to get there from here.”

Specifically, there is a worry that severe inflation would be unleashed by a recourse to market-determined prices. This worry is based on a misunderstanding about the nature, causes and symptoms of inflation and its relation to price reform. And this misunderstanding, in turn, obscures a readily available remedy for the actual problems that rapid price reform would entail in a command economy like that of the Soviet Union.

Inflation arises when there is an increasing quantity of money seeking to buy a relatively fixed or reduced supply of goods. Inflation comes in two variations: “demand-pull,” in which an increase in money supply creates a gap between monetary demand and the unchanged supply of goods and services, resulting in price increases across-the-board; and “cost-push,” in which nominal labor and other production costs begin to rise without a corresponding increase in productivity (and with an ensuing increase in the money supply to facilitate the initial cost increases). Once again, the result is pervasive and self-reinforcing price increases.

Neither of these conditions accurately describes the circumstances associated with price reform in the Soviet Union. Moving from administered prices toward a market system doesn’t in itself imply or generate an increase in the money supply, a diminished supply of goods or a rise in production costs. Hence, inflation is not the real problem to be feared. In the transition from administered to market prices, the real problem lies elsewhere.

Under the existing Soviet system of administered prices combined with rationing of essential commodities, much of the currently earned income simply cannot be spent because the supply of goods is deficient--both in quantity and quality. Hence, income that isn’t spent accumulates as holdings of ruble cash or savings deposits. As a result, total holdings of cash and savings deposits are three or four times larger, in relation to Soviet gross national product, than the corresponding holdings in the United States.

In some instances, accumulations held by individuals are extremely large, having been amassed over many years. This presents a serious problem for an abrupt shift to market-determined prices, because these holdings could become active sources of monetary demand, boosting prices across the board, as well as resulting in major changes in relative prices among different commodities.

The concern this creates is that, with the ensuing rise in market prices, the existing supply of goods--especially consumer goods--would be commandeered by holders of cash or deposits, resulting in distributional inequities, labor unrest and political stress. To the extent this concern is warranted, an effective remedy is readily at hand--one that a command economy like that of the Soviet Union is singularly well-equipped to apply.

The remedy lies in an immediate reform of the monetary system--exchanging all large holdings (say, above 5,000 rubles) for long-term (say, 10 to 15 years) nontradable ruble bonds, and converting all small holdings of “old” rubles into “new” rubles. Such a monetary reform would enable price reform to succeed by sterilizing the bulk of the monetary overhang, allowing the market mechanism to determine relative commodity prices and providing enterprises with clear signals as to where and when to increase, decrease or terminate production.

Incidentally, this proposal carries no implication concerning the state’s continued production and provision of “socially necessary” output. Such production by and for the state would simply entail costs determined by market forces, would be purchased at market prices and would be financed by taxes or other revenues and endorsed by the Congress of People’s Deputies.

The success of perestroika need not wait for an indefinite future. It is readily at hand if the Soviet leadership makes use of the state’s power to move rapidly toward effective price reform.