Chapter II.2 Economic Developments And Reform Since 1985

International Monetary Fund
Published Date:
December 1991
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Numerous steps had been taken by the authorities in the early 1980s to raise productivity, including measures to strengthen labor discipline, tighten surveillance of output quality, improve enterprise rewards for plan fulfillment, give firms incentives for reducing the material and energy intensity of output, and redirect investment toward renovation. These partial reforms foundered, however, on a fundamental contradiction. If efficiency were to be encouraged, bonuses could no longer depend so heavily on the fulfillment of gross output targets. Yet, the coherence and effectiveness of the existing planning and administrative system depended on the ability to generate, at least approximately, a consistent set of inputs and outputs in gross terms. These reform measures were therefore not generally successful, and were seldom pursued beyond an initial experimental phase. Bolder initiatives awaited the arrival of a new leadership in 1985.

1. 1985-87 “CAMPAIGNS”

Soon after assuming the post of General Secretary in March 1985, Mr. Gorbachev began to promote a policy of economic “acceleration” (uskorenie) designed to revive economic growth and to tackle three main defects of the economy: inefficiency, poor quality, and lagging technological development. Although the problems to be addressed were mainly systemic in nature, the strategy generally followed the model of earlier partial reforms in that it attempted to improve the functioning of the existing system, rather than changing its fundamental characteristics. The chosen path to uskorenie was incorporated into the 12th Five-Year Plan (FYP), which was formulated in 1985 for the period 1986-90, and a series of laws and decrees issued between 1985 and 1987. This strategy had several elements.

First, a major retooling of Soviet industry was planned. During 1986-90, gross fixed investment was set to grow at an annual average rate of 4.9 percent, up from the 3.5 percent achieved during the previous FYP.1 Within the total, the proportion of investment devoted to modernization and retooling, as opposed to capacity expansion, was to rise from about 38.5 percent in 1985 to 50.5 percent in 1990. The corresponding need for additional machinery was supposed to be met through an enormous increase in investment in the civilian machine-building sector over the FYP period, which was expected to increase its output by 43 percent. Retooling was assumed to require an approximate doubling of the annual retirement rate of machinery and equipment, to over 6 percent (and to almost 10 percent in the machine-building industry). The idea behind this “campaign” was that large-scale re-equipping of industry would quickly raise the average level of technology employed and therefore increase both the efficiency and the quality of production. Consequently, although it involved a higher investment share in output, it was presented as a strategy for “intensive” rather than extensive growth. Among the secondary objectives of the strategy was a shift away from the traditional reliance on imported manufactures paid for by exports of fuel and raw materials, which was viewed as being inappropriate for a modern industrial nation. The success of the strategy was also to be a key ingredient in providing the basis for the very ambitious targets for the growth of consumer goods output by the year 2000.

A second campaign emphasized the strengthening of quality control. In the past, Gosstandart had set technical requirements for products which were supposed to be enforced by enterprises’ own quality-control departments. But these departments were under the direction of enterprise managers (except, significantly, in the defense industry). Consequently, when plan fulfillment was threatened or the product was in severe excess demand, managers could override their quality controllers and substandard output would be released. In May 1986, a decree (implemented in the autumn) created a new agency, Gospriemka, which would act as an independent enforcer of state standards in the production of machines and consumer goods. Its inspectors were to be highly paid, with bonuses related to the decline in the number of customer complaints, and were accountable only to Gospriemka (which in turn was subordinate to Gosstandart). The stated aim was to bring 95 percent of Soviet machines up to the “highest world standards” by 1991-93.

Third, a series of measures were taken with the intention of stimulating the “human factor.” These included high-level personnel changes, both in the government and in the Party, and the policy of glasnost, which was aimed partly at increasing the accountability of bureaucrats and enterprise managers by exposing them to open criticism. It was also recognized that work incentives were being significantly impaired by the gradual compression of wage differentials and the loss of a clear relationship between bonuses and performance. A decree issued in September 1986 therefore proposed the “increased perfection of the wage system,” abolishing some of the more arbitrary bonuses equal to about 20 percent of the total wage; increasing base wages by 20 percent for blue-collar workers and 30 percent for specialists;2 and giving greater freedom, indeed incentives, for managers to shed surplus labor and permit the existing wage fund to be shared amongst the remaining staff.

A fourth policy, with perhaps the greatest short-term (albeit largely unintended) impact, was the anti-alcohol campaign. The relevant measures, beginning in May 1985, included a cut in alcohol production and an increase in prices (by 50 percent between 1984 and 1987); a reduction in the number of shops, cafes and restaurants allowed to sell alcohol and a time restriction on their sales; an increase in the minimum drinking age; and fines for drunkenness.

Finally, believing that some forms of private enterprise were beginning to encroach on the efficiency of the state sector, the leadership instituted measures to “clarify” the role of private activity in the economy. On the one hand, the campaign against unearned incomes, instituted in the summer of 1986, was supposed to stamp out speculation,3 embezzlement, bribery and the widespread practice of using state facilities for private purposes. On the other hand, the Law on Individual Labor Activity (effective May 1987) was designed to specify more clearly than before the rules under which legitimate private enterprise could operate, by requiring participants to obtain licenses and making it explicit that private activity was to be part-time only and would not be considered as a substitute for a proper job in the state sector.


During its first year, the program to retool Soviet enterprises appeared to be broadly on track. Gross investment in the machinery branch increased by 12.4 percent in 1986 (1985: 4.5 percent—Appendix Table C.2), and production in the machine-building sector rose by 7.1 percent (Appendix Table B.1), although at a rate essentially unchanged from 1985. There was a marked increase in the share of investment in production accounted for by project design as well as by the reconstruction and technical refitting of enterprises (Appendix Table C.4).4

By 1987, however, severe bottlenecks were emerging in machine-building. Gross investment in this branch grew by less than 1 percent, and its output growth slowed to 5.6 percent—somewhat below the average of 1981-85—and continued to fall in subsequent years. By the end of 1989, with only one year of the 12th Five-Year Plan period remaining, the cumulative increase in output from the machine-building industry was only half that originally planned for 1986-90.

This campaign appears to have run into a series of problems, the first being one of sequencing. Machines are themselves important inputs into the machine-building process, and capacity at the outset was insufficient both to raise capacity further in the machine-building industry and satisfy the burgeoning demand for machinery from other sectors at the same time. A related difficulty was that the surge in economy-wide investment in 1986 (Appendix Table C.1)—including a rise of almost 10 percent in housing investment—had put strains on the supply of other resources needed for project implementation, notably manpower and materials from the construction sector. These strains may be reflected in the sharp reduction in stockbuilding in 1987 (Appendix Table C.7). Finally, the campaign had failed to ease the traditional trade-off between quality and output. This time, unusually, it appeared to be quality-control which dominated, initially at least. Gospriemka began in the autumn of 1986 to pursue its mandate with zeal. Some 15-18 percent of output examined was rejected on first inspection and rub 6 billion worth of output was reportedly rejected altogether in 1987. The impact was greatest in the machine-building sector, where 60 percent of production was subject to Gospriemka’s scrutiny, compared with an average of 20 percent for industry as a whole. The resulting disruption was widely and publicly blamed for a stall in output in early 1987, and political pressure intensified as production targets were missed and wage bonuses fell. From about March 1987, quality controls were eased and, although their coverage was subsequently extended, Gospriemka’s effective impact was significantly curtailed.

On its own terms, the anti-alcohol campaign also began well. By 1987, the volume of alcohol sales was less than half what it had been in 1980, and the numbers of alcohol-related crimes, diseases and accidents were reported to have fallen significantly in just two years. However, illegal brewing and distilling rapidly began to fill the gap left by cuts in official production. The prevalence of drunkenness in the work place, one of the prime targets of the campaign, appears to have diminished only briefly, if at all; in 1987, the number of reported cases more than doubled by comparison with the previous year. In 1984, alcohol had accounted for about 16 percent of retail sales; consequently, the cutbacks were a major factor in the slowdown of total retail trade, which rose in current prices by only 2.5 percent and 2.8 percent in 1986 and 1987, respectively, compared with average annual growth of 4 percent in 1980-84.5 As noted earlier, the budget suffered significantly from the decline in turnover taxes on alcohol. Moreover, it appears that the hoped-for improvements in productivity failed to materialize—perhaps partly because the campaign reduced further the range of goods available in the stores, with adverse effects on work incentives, and partly because of its limited impact on overall alcohol consumption due to the induced growth in non-state distilling.

Despite the measures intended to clarify the role of private activity, private enterprise may have been more hindered than helped by the political environment during the early years of the Gorbachev administration. Local authorities proved generally uncooperative in issuing new licenses, which in any case were limited to five years’ validity and therefore did not provide entrepreneurs with the degree of security they required. The framework for price-setting remained unclear in law, while in practice prices continued to be partly regulated. The lack of legal access to transport facilities, material inputs,6 and suitable work premises (which local authorities were often unwilling or unable to provide) were all serious impediments to private sector activity. The campaign against unearned incomes had a negative impact on the collective farm markets, which were affected by the catch-all prohibition against speculation.

In sum, the effects of Gorbachev’s early campaigns were, at best, mixed, and the strategy of “acceleration” faltered at a disappointingly early stage. Under the impetus of the machine-building program, value added in the industrial and construction sectors rose by 5½ percent and 12 percent, respectively, in 1986.7 In the following year, however, as the program ran into capacity constraints, industrial growth slowed to about 4½ percent, and the rate of output growth in construction fell by more than half. The slowdown also spilled over into the transportation and distribution sectors (Appendix Table A.4). Agricultural performance appeared to improve markedly in 1986, with net output rising by over 7 percent, but this too turned out to be transitory, and was probably little more than a reflection of poor harvests in the preceding two years. In 1987, following a particularly severe winter, value added in agriculture fell by almost 1½ percent. Growth in aggregate NMP, having picked up slightly to 2.3 percent in 1986, fell back to only 1.6 percent in 1987 (Table II.2.1). Given hidden inflation, NMP may well have stagnated in 1986-87.

Table II.2.1.USSR: Output and Expenditure, 1976-90(Annual average growth in percent, comparable prices)


NMP produced
by sector of origin:
(excluding turnover taxes)(5.1)(3.9)(4.2)(5.5)(4.6)(6.3)(0.4)(…)
Transportation & communications3.
NMP utilized3.
of which:
of which:
net fixed investment(2.6)(-1.7)(-1.1)(4.9)(5.7)(-7.4)(-6.7)(…)
stockbuilding 2(…)(…)(…)(0.1)(-1.9)(2.5)(0.6)(…)
Foreign trade balance 32.00.6-0.6-0.7-1.4
Source: Tables A.4 and A.6 of Appendix II-1.

As noted in the text, and as discussed in Appendix II-1, many unofficial Soviet and non-Soviet sources suggest that throughout this period official NMP growth rates have been overstated.

Implied contribution to NMP growth. For 1986-89, estimates were calculated using official growth rates for accumulation and net fixed investment and the previous year’s weight of net fixed investment—in current prices—in accumulation. For 1986 and 1988-89 these estimates differ substantially from those derived from official current price data on stockbuilding.

Contribution to NMP growth; merchandise trade only, excluding exports of gold.

Source: Tables A.4 and A.6 of Appendix II-1.

As noted in the text, and as discussed in Appendix II-1, many unofficial Soviet and non-Soviet sources suggest that throughout this period official NMP growth rates have been overstated.

Implied contribution to NMP growth. For 1986-89, estimates were calculated using official growth rates for accumulation and net fixed investment and the previous year’s weight of net fixed investment—in current prices—in accumulation. For 1986 and 1988-89 these estimates differ substantially from those derived from official current price data on stockbuilding.

Contribution to NMP growth; merchandise trade only, excluding exports of gold.

Despite the continued decline in the growth rate of value added in this period, growth in the average nominal wage accelerated slightly—reaching 3.7 percent in 1987—perhaps reflecting the changes in wage regulations noted earlier. Real private consumption, while increasing more rapidly than NMP in these years, still rose on average by only 2.3 percent, less than the average annual rate of growth achieved in 1981-85. As a result, the measured household saving rate rose from 6.3 percent in 1985 to 7.6 percent in 1987 (Table II.2.2), and household broad money increased at an average annual rate of just less than 10 percent (Table II.2.5).

Table II.2.2.USSR: Incomes and Prices, 1986-90(Annual growth in percent)


Household money incomes3.
Household expenditures
Saving rate (percent of disposable income)
Average monthly wage2.
Retail price index2.
Enterprise profits:
pre-tax 215.43.816.311.5-1.8
Source: Derived from tables in Appendix II-1.

On goods and services only.

Profits before payments to the budget, as in Table D.5, Appendix II-1.

Defined in Table D.5, Appendix II-1.

Source: Derived from tables in Appendix II-1.

On goods and services only.

Profits before payments to the budget, as in Table D.5, Appendix II-1.

Defined in Table D.5, Appendix II-1.

Table II.2.3.USSR: Fiscal Developments, 1985-90


(In billions of rubles)
State budget revenue367.7366.0360.1365.1384.9410.1
Tax revenue and transfers 1337.1335.6342.9340.0361.6387.8
Income taxes and transfers148.4159.7158.8154.3157.3168.0
of which:
From state enterprises115.9125.9123.4115.6111.4120.4
Social security contributions25.426.528.
Turnover tax97.791.594.4101.0111.1121.9
Foreign activity65.657.961.654.659.051.8
Nontax revenue30.630.417.225.123.322.3
State budget expenditure386.0415.6429.3445.9465.1485.6
of which:
Social and cultural111.9119.3127.6134.3139.3160.5
Foreign activity2.24.911.915.615.414.9
Interest payments44.55.36.3
Overall balance-18.3-49.6-69.2-80.8-80.2-75.5
Extrabudgetary agricultural price support3.615.49.34.4
Adjusted balance-18.3-49.6-72.8-96.2-89.5-79.9
Financing (net)18.349.672.896.289.579.9
(In percent of GDP)
State budget revenue47.345.843.641.741.042.8
State enterprises14.915.815.013.211.912.6
Turnover tax12.611.511.411.511.812.7
Foreign activity8.
State budget expenditure49.752.
Investment in economy8.
Overall balance-2.4-6.2-8.4-9.2-8.5-7.9
Adjusted balance-2.4-6.2-8.8-11.0-9.5-8.3
Memorandum items:
State budget total investment9.39.49.910.08.4
Extrabudgetary centralized funds
Government domestic liabilities19.721.629.139.246.761.1
Sources: Ministry of Finance; Goskomstat; and estimates.

Includes also revenue derived from sources other than fixed-rate taxes.

Subsidy payments include the subsidies proper, expenditure on price differentials, and expenditure for increases in procurement prices.

Prior to 1988 only a fraction of actual defense outlays is shown; 1989 is the first year for which global defense data are available. Therefore, the institutional breakdown of budget expenditure is not fully comparable before or after 1988.

On domestic liabilities only.

Actual amount is unknown and assumed to be zero.

Excess of credit plan allocation over required financing.

Sources: Ministry of Finance; Goskomstat; and estimates.

Includes also revenue derived from sources other than fixed-rate taxes.

Subsidy payments include the subsidies proper, expenditure on price differentials, and expenditure for increases in procurement prices.

Prior to 1988 only a fraction of actual defense outlays is shown; 1989 is the first year for which global defense data are available. Therefore, the institutional breakdown of budget expenditure is not fully comparable before or after 1988.

On domestic liabilities only.

Actual amount is unknown and assumed to be zero.

Excess of credit plan allocation over required financing.

Table II.2.4.USSR: State Budgetary Operations, 1989-90(In billions of rubles)
First halfFull yearFirst halfFull year
Total revenue182.1188.8372.7384.9208.6210.8410.1423.2
Tax revenue and transfers 1171.7177.7346.3361.6196.3196.8387.8390.8
Income taxes and transfers77.980.3156.7157.384.483.5168.0169.9
Individual income taxes18.220.536.341.721.723.643.546.5
Profit taxes and transfers59.759.8120.4115.662.759.9124.5123.4
Cooperatives and social organizations1.
Social security contributions15.815.931.433.122.120.944.844.7
Turnover tax52.054.4104.8111.158.860.2121.9122.5
Foreign activity26. 2
Other tax revenue1.
Nontax revenue10.411.126.423.312.314.022.332.4
Total expenditure236.5217.6480.8465.1241.8229.7485.6497.6
Economy 3105.191.2203.2200.197.388.9188.2196.0
Justice and internal security3.
Social and cultural73.470.8143.8139.381.177.6160.5163.8
Foreign activity7.65.718.515.
Overall balance-54.4-28.9-108.1-80.2-33.2-18.9-75.574.4
(In percent of GDP)(…)(…)(-11.5)(-8.5)(…)(…)(-7.9)(-7.8)
Source: Ministry of Finance.

Includes also revenue derived from sources other than fixed-rate taxes.

Foreign financing is estimated as a residual, given the estimated deficit.

Includes production-related investment and subsidies.

Totals may differ slightly from those in annual tables, as it was not possible to carry out all adjustments for financing elements in debt service.

Source: Ministry of Finance.

Includes also revenue derived from sources other than fixed-rate taxes.

Foreign financing is estimated as a residual, given the estimated deficit.

Includes production-related investment and subsidies.

Totals may differ slightly from those in annual tables, as it was not possible to carry out all adjustments for financing elements in debt service.

Table II.2.5.USSR: Monetary and Credit Developments, 1981-90(Period averages, in percent)

(Annual growth rates)
Total bank credit18.
Credit to the government18.630.439.416.6
Credit to the economy 18.7-2.3-4.74.3
Of which: short term10.3-2.6-7.45.9
Money (M2)7.511.514.415.3
Of which: households7.29.613.113.5
(Interest rates)

Demand deposits2.
Time deposits3.
Average on bank loans2.
Demand deposits0.90.30.7-1.6
Time deposits2.
Average bank loans1.40.61.2-0.9
Source: Data provided by the Soviet authorities; projections for 1990.

Adjusted for changes in accounting procedures and for debt write-offs (see Table K.1 in Appendix II-1).

Nominal interest rates deflated by the official retail price index. The latter is widely considered to understate the actual rate of open inflation in retail sales by the socialized sector which, in turn, at least in recent years, is considered to have understated the underlying rate of inflation.

Source: Data provided by the Soviet authorities; projections for 1990.

Adjusted for changes in accounting procedures and for debt write-offs (see Table K.1 in Appendix II-1).

Nominal interest rates deflated by the official retail price index. The latter is widely considered to understate the actual rate of open inflation in retail sales by the socialized sector which, in turn, at least in recent years, is considered to have understated the underlying rate of inflation.

The problems of economic management were compounded by the drop in world oil prices. Although the effects were mitigated somewhat by a contemporaneous fall in prices of imported grain, and by the five-year moving average mechanism used in setting intra-CMEA trade prices, the terms of trade declined by a cumulative 12 percent during 1986-87, and by 16 percent vis-à-vis the non-socialist area (Appendix Tables G.4-G.5). In addition, exports of processed goods to the convertible area were adversely affected by the lack of adaptation of the Soviet system to an increasingly competitive world market. Furthermore, exports to developing countries (primarily arms and raw materials) could only be sustained through a further extension of sizable export credits averaging US$10.5 billion per annum during 1986-87 (Appendix Table 1.1), many of which were not serviced on a timely basis because of these countries’ own payments difficulties.

The authorities responded in several ways. First, exports to the convertible area, particularly of fuels and raw materials, were substantially boosted; overall, export volume to the nonsocialist area increased by 22 percent during 1986-87. Second, over the same period, the volume of imports from the nonsocialist area was slashed by 17 percent (Appendix Table G.5). As a result, the trade surplus vis-à-vis the nonsocialist area rose by rub 4 billion between 1985 and 1987. Third, gold exports were reportedly raised substantially, implying sales both from current production and official reserves.

The external adjustment was mirrored in the balance of payments on both a settlements (cash) basis and a transactions basis.8 A comparison between the two presentations shows that the decline in exports and imports in convertible currencies between 1985 and 1987 was much sharper on a cash basis than on a transactions basis, which suggests that both exports and imports were increasingly supported by trade credits. The deficit on the services balance in convertible currencies declined slightly as increasing net interest payments (reflecting payments difficulties of debtor countries and the growing convertible debt) were more than compensated by rising net receipts on transport and insurance and on other services. The capital account with the convertible area, which had recorded a surplus of US$2.0 billion in 1985, swung into a deficit of US$4.4 billion in 1987, partly because the USSR encountered increasing difficulties in obtaining syndicated credits in the international capital market, amortization payments rose, and also because there was a sharp reduction in actual repayments of loans extended by the USSR to developing countries. While an overall balance of payments deficit in convertible currencies of about US$1.7 billion was recorded during 1986-87, this was not reflected in gross foreign exchange reserves as measured in U.S. dollar terms (Table II.2.7). This was partly related to valuation changes, as the U.S. dollar declined sharply against major European currencies,9 and partly to the fact that gold reserves probably declined during this period.

Table II.2.6.USSR: Balance of Payments on a Transactions Basis, 1985-90

I. Balance of Payments in Nonconvertible Currencies
(In billions of rubles)
Current account (excluding gold)
Trade balance2.23.22.2-0.8-3.3-6.7
Services balance-0.2-0.2-0.6-0.8-0.7-0.6
Capital account-2.6-2.4-1.90.9-0.27.3
Overall balance-1.00.5-0.3-0.6-4.2
II. Balance of Payments in Convertible Currencies
(In billions of rubles)
Current account (excluding gold)-
Trade balance1.
Services balance-1.5-1.3-1.1-2.0-2.4-2.9
Gold exports1.
Capital account-2.3-3.6-7.9-3.7-2.2-4.2
Overall balance-1.30.4-1.5-0.4-2.4-8.3
(In billions of U.S. dollars)1
Current account (excluding gold)-
Trade balance1.
Services balance-1.8-1.8-1.7-3.3-3.8-5.0
Gold exports1.
Capital account-2.8-5.2-12.4-6.1-3.5-7.2
Overall balance-1.50.6-2.3-0.7-3.7-14.3
Memorandum items:
Crude oil price 2
(U.S. dollars per barrel)27.314.518.315.018.223.7
Current account in convertible
currencies as percent of GDP0.20.50.1-0.3-0.6
Sources: Ministry of Finance, Vneshekonombank, Goskomstat, and estimates.

Converted at the average official exchange rate for each year.

U.K. Brent.

Sources: Ministry of Finance, Vneshekonombank, Goskomstat, and estimates.

Converted at the average official exchange rate for each year.

U.K. Brent.

Table II.2.7.USSR: External Liabilities and Assets, and Debt Service Obligations in Convertible Currencies, 1985-90

(In billions of U.S. dollars)
External debt28.931.439.
Of which:
Medium-and long-term22.024.030.631.836.342.21
Foreign exchange reserves 212.914.714.115.314.75.1
Net debt316.016.725.127.739.347.1
Other external assets 418.522.925.228.6
External debt service7.
Of which:
Medium and long term7.
Memorandum item:
(In percent of exports of goods and services)
External debt101.8111.1117.3120.5139.4129.1
External debt service27.726.523.124.233.0
Sources: Data provided by the Soviet authorities; Bank for International Settlements (BIS); and projections.

June 1990.

BIS data, except end-1990 which is a projection.

External debt minus foreign exchange reserves.

Claims in convertible currencies on developing countries. In addition, the USSR has claims in nonconvertible currencies.

Sources: Data provided by the Soviet authorities; Bank for International Settlements (BIS); and projections.

June 1990.

BIS data, except end-1990 which is a projection.

External debt minus foreign exchange reserves.

Claims in convertible currencies on developing countries. In addition, the USSR has claims in nonconvertible currencies.

The effects on the state budget of the oil price decline and the costs associated with the “campaigns” were contained much less effectively. The budget deficit rose from about 2½ percent of GDP in 1985 to over 6 percent in 1986 and almost 8½ percent in 1987 (Table II.2.3). In 1986, besides the loss in revenues from foreign trade—due to a narrowing of the gap between domestic and world prices for oil—and from the turnover tax in the wake of the anti-alcohol campaign,10 there were increased investment expenditures connected with the machine-building program and higher outlays associated with the full-year costs of pension increases implemented in the previous year as well as with the Chernobyl accident. Meanwhile, higher wholesale prices (with unchanged retail prices) increased subsidies and further reduced turnover tax receipts; the latter decline, however, was almost fully offset by increased profit transfers from enterprises to the budget.

The position changed somewhat in 1987, when aggregate budgetary expenditure was kept largely stable as a proportion of GDP, and the increase in the budget deficit, by over 2 percent of GDP, was due partly to a fall in enterprise profit remittances.11 In an attempt to improve incentives facing enterprises, the authorities had sought to replace a large part of the requisition by the budget of residual profits with fixed-rate taxes—albeit with differing implicit rates across branches. In practice, this led to a reduction in the share of profits remitted to the budget from nearly 60 percent in 1986 to around 56 percent in 1987 (Appendix Table D.6). The decline in revenues from profits was to become a serious problem for the state budget in subsequent years, even though the revenue loss would increasingly be compensated for by cuts in investment expenditures. Some of the reduction in enterprise transfers to the budget seems to have been replaced, however, by a significant increase in financial flows among enterprises through extrabudgetary centralized funds under the control of branch ministries.

In the monetary sector, the 1986-87 period marked the beginning of a series of attempts to compensate for the increased borrowing requirement of the Government by curtailing credit to enterprises. In 1986, bank credit to the state rose by almost 20 percent, while growth in enterprise credit was close to zero;12 in the following year, credit to enterprises was reduced by 4.8 percent and lending to the state rose by 42.7 percent (Appendix Table K.2). Despite the squeeze on their borrowing, enterprises’ bank deposits rose by 37 percent in 1987 alone (Appendix Table K.6), reflecting an increase in pre-tax profits and the fall in the effective profit tax rate (Appendix Table D.5). The increase in enterprise deposits, in combination with the rise in household savings, led to an acceleration of the growth rate of broad money from 8½ percent in 1986 to more than 14½ percent in 1987. With administrative control over enterprise deposits still more or less intact, however, the impact of the monetary expansion was for a time largely suppressed.13


Together with the industrial modernization and discipline campaigns, the Government subsequently introduced a third scheme of “radical reform,” which was explicitly endorsed at the 27th Party Congress in February 1986. Reform and industrial modernization were intended to be complementary, but they were bound to conflict initially if the reform were truly radical, as it would involve at least short-run disruption of traditional links between suppliers and customers and modernization based on an evolving restructured base rather than the traditional industrial structure. The reform measures announced over the next 18 months aimed, however, for a hybrid “market socialism,” with increased economic autonomy for enterprises and individuals, but still within a framework of predominantly state ownership. Key prices and investment decisions would continue to be controlled by the state, with factor markets narrowly circumscribed. In parallel to the diminishing role of central planning and greater enterprise autonomy, the conduct of fiscal and monetary policy was to become, at least in principle, increasingly independent of the plan.14

a. Reforms in planning, management, and distribution15

The cornerstone of the reforms was intended to be the Law on State Enterprises, promulgated on July 1, 1987 in time to be reflected in the 1988 Plan. Abolishing the traditional mandatory output targets, it allowed enterprises to contract directly with their suppliers and customers, and gave them greater freedom in decisions concerning investment and the deployment of profits.16 Central planners and branch ministries would concentrate on formulating long-term investment objectives and putting out procurement contracts (“state orders”) for direct government needs.17 Enterprises were now given centrally-determined profit norms and remained subject to rules governing the setting of prices, but would otherwise be free to produce and trade as they wished. Their profits would be taxed at rates which would be reasonably stable and homogeneous. The residual would be available for allocation across various funds, from which investment would be financed and bonuses and other nonwage remuneration paid.18 In addition, workers were given an expanded role in the selection of enterprise managers.

In practice, however, state orders accounted for over 90 percent of all industrial production in 1988, and the degree of enterprise autonomy in respect to inputs and outputs was less than had been envisaged. This was partly a result of planners and branch ministries wanting to ensure supplies of low-profit or loss-making items. But it also reflected pressure from enterprises themselves who, in an economy prone to chronic shortages and distribution failures, wanted the assurance of a guaranteed source of inputs to meet their own state orders.

State orders were, however, less tightly specified than the previous production targets. Thus, enterprises, when producing under these new contracts, were able to switch the composition of their deliveries toward higher-priced products. This may have contributed to the very rapid increase in total enterprise pre-tax profits in 1988 (up 16 percent from the previous year (Table II.2.2)), as the gross operating surplus of enterprises (i.e., profits before payment of turnover taxes and receipt of subsidies) increased by 2 percentage points of GDP (Appendix Table D.6).19 Having generated larger profits, however, enterprises were not in fact subject to a markedly more stable or less differentiated profit tax system than before. Ex post tax rates continued to vary from zero to 90 percent, and ministries continued to confiscate profits arbitrarily in order to cross-subsidize loss-making enterprises. Nevertheless, total profit remittances to the budget actually fell in nominal terms in 1988, and after-tax profits in relation to GDP rose by over 4 percentage points. In the face of low or negative real interest rates,20 and to guard against possible confiscation of funds by branch ministries or the budget, enterprises used much of their increased liquidity to accumulate excess inventories and hoard investment goods. One approach was to launch new investment projects, in the expectation but with no guarantee of being able to procure the additional resources necessary to ensure completion. Following two years in which changes in total “material circulating means and reserves” (i.e., stockbuilding broadly defined) made little or possibly even a negative contribution to NMP growth, the build-up in these resources unambiguously made a significant contribution to NMP in 1988 (Appendix Tables A.6 and C.7).21 At the same time, the change in unfinished construction almost tripled as a proportion of gross fixed investment (to 9.8 percent) and of GDP—to 2.2 percent (Appendix Table C.5).22

The pervasiveness of state orders began to diminish in 1989, leaving an increased proportion of output to be traded on inter-enterprise wholesale markets. This was in the spirit of the provisions of the Law on State Enterprises but under the circumstances it proved to be highly disruptive. The first problem was that a comprehensive network of market contacts between enterprises did not exist. While it should have begun to develop as soon as the new law came into operation, the domination of state orders in 1988 had almost certainly stunted its growth. A significant number of enterprises had so-called “stable links” with their main suppliers and customers, but these would not have provided enterprises with much flexibility in the event of shifts or disruptions in demand and supply conditions of the kind that prevailed in 1989.23

The lack of well-functioning markets interacted with the continued growth of enterprise liquidity (Appendix Table K.7) to induce an apparent further increase in 1989 in stockbuilding—although at a slower rate than in 1988—and in unfinished construction.24 As the role of the state wholesale distributor (Gossnab) declined, uncertainty regarding the availability of inputs and possibly rising inflationary expectations probably encouraged enterprises to accumulate excess inventories. This behavior was, of course, mutually-reinforcing, since hoarding could itself aggravate or even generate shortages, in turn creating the disruption in supply which enterprises had feared. It was also associated with an increasing prevalence of inter-enterprise barter and of a growing tendency toward enterprise self-reliance, whereby firms took on ancillary functions—such as producing their own machine-tools, or consumer goods for their workers—which they might normally have contracted out.

The distribution system for agricultural produce was also adversely affected by the weakening of central control. Farmers were increasingly reluctant to sell their output to the state procurement agencies at what they regarded as inadequate prices and given the growing shortages of various consumer goods available to them. Despite a 16 million ton rise in grain production in 1989, the share going to the state’s All-Union Fund was the lowest in 30 years, and a full 30 percent short of the plan. While it had been deliberate policy to reduce reliance on the All-Union Fund, the aim was to spur local production, not simply redirect output onto local markets. The result was an increasingly uneven distribution of food between the cities—which relied heavily on state food stores—and the countryside, as well as across regions.

b. Wage reforms25

The Law on State Enterprises also substantively affected the growth of wages. Previously, firms were narrowly constrained in making individual wage and bonus payments, and the annual growth in the wage fund was governed by a so-called growth normative, which limited its rate of increase to a fraction (typically in the range of 30 percent) of the rate of growth of output. Under the principle of “full self-financing” advocated by the Law, enterprises could not only more flexibly adjust their production to increase profits, but were now permitted to retain a higher share of internally generated funds (i.e., including depreciation),26 and to allocate these more freely among wages and the various “funds” to which after-tax profits had traditionally been allocated.27 This expanded control over internally-generated funds was accompanied by a relaxation of various restrictions on the payment of premia and bonuses.

These changes, coupled with the increased prevalence of worker-elected managers now permitted under the Law, led wages to soar in 1988, with payments from the wage and material incentive funds rising by nearly 7.5 percent, “other remuneration” increasing by over 13 percent (Appendix Table D.3), and the average monthly wage in the material sector rising by close to 9 percent (Appendix Table E.2). In 1989, the growth of wages and other payments from state enterprises accelerated, with wages increasing by 8 percent (the average wage in the material sphere increased by almost 10 percent) and “other remuneration” rising by close to 14 percent.

Faced with the upsurge in wages, the authorities tried various expedients to restrain wage growth, all unsuccessful. In 1989, they attempted to enforce a “normative” guideline that would hold the growth of the wage fund to the growth rate of productivity. In the first three quarters of 1989, wages grew so much faster than productivity that enterprises would have had to institute wage cuts in order to comply with the norm for the year as a whole. The authorities therefore overrode the guideline and instituted in the last quarter of 1989 a highly progressive tax on “excessive” wage increases irrespective of productivity growth. Wage fund increases in excess of 3 percent but less than 5 percent were taxed at a 100 percent marginal rate, increases of 5 percent to 7 percent were taxed at a 200 percent marginal rate, and further increases were taxed at a 300 percent marginal rate. The authorities exempted various high priority branches of production from this tax, and with time the exemptions became so pervasive as to render the scheme ineffective. Indeed, despite an apparent further acceleration of wage growth, tax collections on excess wages actually declined in the first quarter of 1990 from the fourth quarter of 1989. A new scheme was introduced in February 1990, which exempted or partially exempted various branches of production from regulation and redefined thresholds for excess wage taxation in terms of output growth. The successive mechanisms for indirectly controlling wages, and their general ineffectiveness, were reminiscent of similar approaches taken in Poland in the 1970s and 1980s.

c. Price reform28

Effective January 1, 1988, enterprises were permitted to negotiate “contract” (dogovornye) prices for so-called new goods. These prices were still subject to limits, however, and the limits varied across branches and over time. In heavy industry, contract prices applied for two years, after which the price was converted into an official list price compiled according to the standard pricing formulas developed by the State Committee on Prices (Goskomtsen). According to these rules, contract prices could not be higher than the base price of the closest comparable item plus 70 percent of the so-called marginal value of the new good, as documented by the supplier. Contract prices covered about 15 percent of machine-building output in 1989, but in heavy industry outside of machine-building, innovation was less frequent and contract prices were rare.

In light industry, contract prices were permitted on around 15 percent of goods on the grounds of improved quality. From January 1, 1989, these prices were limited to a maximum of 30 percent above list prices but, as opposed to heavy industry, were not subject to a time limit. A further 25 percent of light industry products were allowed a surcharge of up to 30 percent for two years for supposedly attaining world quality standards.

Outside these sectors, all but a few prices continued to be set by the authorities either at the central, republic or local level. The extent of price liberalization was therefore considerably less than had been pursued in, say, Hungary from 1968 or Poland beginning in 1982. The overall impact of the introduction of contract pricing on the wholesale price index cannot be evaluated, since the latter has been compiled only since 1988 after a 10-year hiatus. In 1989, however, the rise in the index was a seemingly modest 1.7 percent.

d. Private/cooperative activities

The authorities began to take a decidedly more liberal approach toward private activity in 1988. The Draft Law on Cooperatives, which appeared in March 1988, placed cooperative ownership—defined sufficiently broadly to include both large collective farms and three-person family cooperatives—on a legal par with state ownership. Cooperatives were allowed to engage in a broad range of activities, to lease property, to subcontract to other cooperatives or individuals, to hire outside labor, and to raise capital through issue of shares. Cooperative protection was further strengthened in the final version of the Law promulgated in May 1988 for implementation effective July 1, 1988. The revisions permitted additional activities, including recycling of waste materials, fishing, road construction, and sport and fitness services. They also simplified the procedures for registration, strengthened legal protections against the withholding or withdrawal of registration, and affirmed the rights of cooperatives to refuse state orders. Nevertheless, some administrative barriers to registration remained (in particular, some local authorities refused to register cooperatives lacking an independent business address, which they knew was difficult to obtain given the shortage of office space and the restrictions on resale and subletting of apartments). Moreover, cooperatives had difficulty in gaining access to scarce supplies.

The initial supply increment from cooperatives was small and competition limited. However, the same price controls that made supplies scarce also provided substantial opportunities for quick profit for those cooperatives able to establish good connections. Public opinion began to associate cooperatives with high prices, speculative profits, and corruption, although quite often cooperatives were themselves reportedly the victims of corruption. The authorities’ response, encouraged by state enterprises that were threatened by cooperative competition, was to tighten restrictions. In December 1988, the Council of Ministers forbade cooperative engagement in some activities, while for other activities (in direct violation of the Law on Cooperatives) it allowed cooperatives to engage only under contract with state enterprises and organizations “for which these activities are basic.” In October 1989, the Supreme Soviet passed a resolution allowing local Soviets to set maximum prices for cooperative products and forbidding cooperatives from buying state goods for resale or selling imports for more than state stores charged for comparable goods. While attempts to impose surtaxes on cooperative incomes have been rebuffed, special charges are frequently levied on cooperative purchases of inputs.

By the spring of 1990, the official attitude toward cooperatives had become more relaxed, and open discussion of outright private enterprise became generally acceptable. Cooperatives were given the right to charge either state or negotiated prices for their output. Those that chose to charge negotiated prices, however, were required to pay three to five times the official prices for raw materials, according to list prices posted by Goskomtsen, with compliance monitored by inspectors of Goskomtsen and the Ministry of Finance. Fines equal to twice illegally-earned profits could be imposed. State enterprises were barred from supplying raw materials to nonregistered cooperatives or private parties.

According to data supplied by the Union of Cooperatives, the turnover of cooperatives increased from only rub 33 million in 1987 to rub 40 billion in 1989 and rub 32 billion in the first half of 1990 alone. By October 1990, there were some 215,000 cooperatives employing 5.2 million people, or more than 3.5 percent of total employment.29 Wages earned by cooperative employees in 1989 were officially estimated as accounting for almost 3½ percent of total money incomes received from the socialized sector,30 up from only about ½ percent in 1988 (Appendix Table D.4).31

e. Reforms in the banking system32

The authorities began in 1988 to restructure the Soviet banking system. The intention was to create a two-tier system, in which commercial banking functions would be performed by several state-owned banks, specialized by sector, with Gosbank retaining the role of a conventional central bank. It was envisaged that the new banks, though they would be expected to continue to accommodate enterprise demand for credit under the annual plan, would be free to extend additional loans on their own initiative, on the basis of assessment of risk, profitability and creditworthiness. There would be some degree of competition between the banks, subject only to centrally-imposed ceilings on total credit advanced by each bank. In the event, however, the system of specialized banks did little to advance the cause of decentralization and competition. The branch ministries dominated the banks’ lending decisions, and the strict sectoral demarcation effectively precluded competition for loans.

Towards the end of 1988, a more radical liberalization began, as the newly legalized cooperatives and some (now more autonomous) enterprises found they had only restricted access to the state-owned banks. The cooperatives and those enterprises with surplus liquidity were permitted to establish their own (“commercial”) banks. These were initially almost entirely unregulated, and substantially beyond the influence even of the central bank. They were free to attract deposits from households and extend credit to enterprises in any sector of the economy, and were not subject to the credit controls under which the specialized banks operated. In some respects, they formalized a system of inter-enterprise credit, easing the problem of unevenly distributed liquidity within the enterprise sector. Subsequently, a 5 percent reserve requirement was introduced,33 along with a range of prudential ratios. Later still, as the state-owned Savings Bank began to lose household deposits—which are a primary indirect source of financing of the budget—a ceiling, equal to the guaranteed rate paid by the Savings Bank, was placed on the deposit rates of these commercial banks. This substantially curtailed their operations in the market for household deposits. Although they increased rapidly in number to more than 400 by September 1990, the commercial banks still accounted for only about 5 percent of all outstanding credit.

In macroeconomic terms, the most significant monetary reform in 1988 was the lifting of administrative control over enterprise deposits. With the extension of self-financing under the Law on State Enterprises, deposits which had previously been strictly earmarked, and often owned “jointly” with a branch ministry, became fungible and at the sole disposal of the enterprise. As a result, the “money-ness” of these deposits (and consequently their potential effect on aggregate demand) was increased dramatically.

f. External reforms34

Although external sector reforms had been initiated in 1986 with the tentative decentralization of trading rights and the reorganization of government bodies overseeing foreign economic relations, the effects of these measures on foreign trade flows and domestic economic activity remained minimal. Trade continued to be conducted mainly through foreign trade organizations (FTOs). More extensive reform was put off until April 1, 1989 when all state enterprises, joint ventures, production cooperatives and other entities judged by the Ministry of Foreign Economic Relations (MVES) to be competent to trade internationally were given the right to do so.35 By the second half of 1990, some 20,000 firms were registered to participate directly in foreign trade (although the actual number of participants probably was closer to one third of this total), and their combined share of total transactions had risen significantly at the expense of the traditional FTOs. This dismantling of the state foreign trade monopoly and the licensing of imports under the principle of self-financing were to aggravate balance of payments difficulties in 1989-90 (see section 4.d. and 5.c).

Until 1987, the exchange rate served mainly as an accounting unit, with trade taxes and subsidies making up the difference between foreign and domestic prices. The introduction of differentiated foreign exchange coefficients (DVKs)36 for most exports and imports from the start of 1987 was intended to give the exchange rate more of an economic function by making enterprises sensitive to changes in foreign currency prices. Trade flows were little affected, however, as most continued to be determined on the basis of plan targets. The dispersion and number of DVKs were subsequently reduced to cover mainly exports and imports of machinery.37

Of generally greater importance was the introduction in 1987 and subsequent enhancement of foreign exchange retention quotas, which represented the first breach of the state foreign exchange monopoly. Depending on the degree of processing of their output, enterprises were allowed to retain a portion of their foreign exchange earnings. The conditions under which these retained balances could be used were successively relaxed. Of some significance were the permission to use part of the retained amounts for imports of consumer goods for the benefit of workers, and the introduction of foreign exchange auctions in late 1989 at which excess holdings of foreign exchange could be sold at market exchange rates.38 The foreign exchange retention scheme failed to promote rapid export expansion, however, due to quantitative restrictions on exports, the largely unchanged price system, and continued central allocation of most material inputs.

Attempts to attract foreign capital through joint-venture legislation failed to elicit a significant response. The initial legislation was passed in 1987 and liberalized in December 1988 to permit majority foreign ownership and enhanced tax benefits.39 However, the number of joint ventures that actually commenced operation remained small and foreign exchange inflows limited. The reasons for this disappointing response seem to lie in the unstable legal framework, the great uncertainties about economic conditions in the USSR and the continued difficulties encountered by the private sector in securing inputs in the economy.


a. Financial policies

Government finances continued to worsen in 1988, as revenues fell by a further 2 percent of GDP (Table II.2.3). A renewed deterioration in the terms of trade, and the associated restraint on imports, reduced budget receipts from foreign trade by over 11 percent. This was roughly offset, however, by the beginning of a recovery in turnover taxes, as the anti-alcohol campaign was gradually abandoned and official alcohol production resumed. The dominant factor reducing revenues was the enterprise reform. Self-financing led to a further reduction in transfers of profits to the state budget, equivalent to 1¾ percent of GDP between 1987 and 1988. The counterpart was supposed to be significantly less financing of enterprise investment directly from the budget. But, given the inertia inherent in the planning system and the legacy of investment decisions made in previous years, the anticipated savings did not materialize. In fact, state investment expenditure increased by 6½ percent in 1988, with capital transfers to enterprises and collective farms rising by 8 percent. While the budget’s intervention in the use of enterprise earnings declined, financial flows through the so-called centralized funds showed a marked increase of about 70 percent—measured in terms of either inflows or outflows.40

In addition to the continued rise in capital spending, significant expenditure pressures came from increases in agricultural procurement prices, averaging 13 percent in 1988 (Appendix Table E.1), and hikes in coal prices at the wholesale level. As a result, consumer subsidies rose sharply and subsidy payments from all sources, including extrabudgetary agricultural price support (financed directly by Gosbank), reached 15 percent of GDP by 1988, one third of which consisted of subsidies on meat and dairy products.41 Additional demands came from social security transfers, reflecting a 25 percent rise in the minimum pension, and payments to the victims of the Armenian earthquake. Notwithstanding these expenditure increases, it would appear that aggregate budget outlays fell in relation to GDP in part due to a substantial effort to rationalize public sector employment,42 but a major reclassification of expenditures—notably, a shift of some expenditures from enterprises to defense43—means that no firm conclusions can be drawn regarding changes in budgetary outlays in 1988. Given the fall in revenues, the state budget deficit peaked at 9¼ percent of GDP, or 11 percent of GDP including extrabudgetary price support.

The year 1989 marked a turning point for budgetary policy, as the authorities sought actively to contain the deficit. Faced with the emergence of inflationary and external pressures, they revised the deficit target down sharply from the initial limit—equivalent to 11½ percent of GDP—approved by the Supreme Soviet. In the event, the state budget deficit remained unchanged in nominal terms from that of the previous year, and fell to 8½ percent of GDP 9½ percent including extrabudgetary price support). This improvement was achieved entirely through expenditure cuts.

On the expenditure side, a further adjustment of agricultural procurement prices raised domestic subsidy payments from the state budget by the equivalent of half a percent of GDP, and the utilization of contingency reserves was relatively large in the aftermath of the Armenian earthquake. At the same time, however, there was a sharp cutback in budget-supported financing of capital formation—for the first time in recent history—amounting to 1½ percent of GDP. The picture is clouded by a further reclassification of defense outlays—which explains the bulk of the measured jump in military expenditures—but capital transfers to enterprises do appear to have declined in line with the policy of increased enterprise self-financing. The apparent increase in cross-subsidization through centralized funds was, however, inconsistent with that policy. Revenue continued to decline, by nearly one percentage point, to 41 percent of GDP, reflecting, in particular, the drop in enterprise income tax revenue. Part of this fall, however, was offset by increased revenue from income taxes on individuals and social insurance contributions.

As the budget deficit rose, enterprise credit was tightened further in an attempt to prevent serious monetary overruns. Credit to the nongovernment sector (mainly enterprises) as a share of total bank credit fell to around 50 percent by the end of 1989, from 82 percent in 1985. While the squeeze on enterprises was insufficient to offset the acceleration in government borrowing, and the growth rate of total credit more than doubled relative to the 1986-87 period (Appendix Table K.2), there were some corrective effects from the point of view of the banking system. The granting of bank credit to cover losses was reduced and the amount of overdue debt declined from rub 17 billion in 1985 to rub 4 billion in 1989. An exception was the agricultural sector, where the volume of bad loans continued to increase rapidly, leading to a substantial debt write-off (amounting to more than rub 70 billion) in the course of 1990.44

b. Organizational and structural problems

(1) Problems with industrial restructuring45

With the machine-building campaign having run out of steam and mounting pressures for increased output and quality of consumer goods, the leadership decided in 1988 to begin large-scale conversion of defense-related manufacturing facilities to the production of consumer products. The defense industries had always produced a significant proportion of the total output of consumer durables.46 But now it was envisaged that some plants would be completely retooled, and it was hoped that, with better equipment and the defense sector’s traditionally higher technical standards, the quality as well as the quantity of consumer goods could be raised.

The growth rate of production of consumer goods—excluding alcoholic beverages—did accelerate somewhat in 1989 (to 5.9 percent), but this was still not much higher than in 1986-88 (average growth rate: 5.0 percent).47 The conversion process apparently proved more difficult and costly than had been anticipated. The planners were accused of failing to allocate the resources necessary for retooling, and of making no allowance for the lags involved in switching production. It also seemed that some of the enterprise managers involved were less than enthusiastic, arguing that it would have been better to step up military exports to pay for imported consumer goods, so making use of the USSR’s existing comparative advantage.

(2) Bottlenecks in transportation48

Almost a half of all freight in the USSR is distributed by rail (Table V.3.5). As with infrastructure in general, investment in expansion and renovation of the railroads had traditionally been accorded lower priority than the accumulation of “productive” plant and machinery. In the latter half of the 1980s, the share of total gross fixed investment allocated to the railroad system, having been on a rising trend, declined slightly (Appendix Table C.3). The rail network was perennially stretched to its capacity limits, and functioned relatively efficiently only because freight shipments and the deployment of rolling stock were tightly controlled and coordinated from the center. In 1989, this system was pushed seriously off-balance by the growing decentralization of distribution, increasing shortages of vital spare parts and fuel, and by the lack of labor and warehouse space at city terminals and ports, which frequently resulted in long delays in the unloading of freight. Added to this, a blockade imposed by Azerbaidzhan, during a territorial dispute over the Nagorno-Karabakh region, left a significant number of freight cars stranded in Armenia. The disruption caused by trains arriving late, or not at all, spread quickly from region to region. Bottlenecks intensified in the second half of 1989, as normal harvest-time demands were supplemented by a surge in imports of consumer goods. For the year as a whole, almost half of the nation’s railroads failed to meet freight shipment targets.

(3) Problems in the energy sector49

As world market prices for oil fell in the mid-1980s, and oil output declined, the authorities attempted to sustain export revenues by rushing new wells into production. The share of total gross fixed investment directed to the oil and gas branches rose from about 8 percent in the 1981-85 period to 10.5 percent by 1989 (Appendix Table C.3). In 1986-89, gross investment in the oil and gas branches increased at average rates, in comparable prices, of around 8 percent and almost 19 percent, respectively, while investment in the coal industry grew by an average of almost 7 percent (Appendix Table C.2). The energy sector as a whole accounted for over 15 percent of gross fixed investment by 1989.

The new oil wells, however, were sited in smaller and more remote fields that were less productive, and extraction techniques were often inefficient. Average unit extraction costs reportedly increased by over 60 percent between 1985 and 1989. By the end of the decade, reflecting the shift of priorities toward the production of consumer goods, the rate of investment growth in petroleum was cut back sharply; in 1988-89, it averaged only one-third the rate of 1986-87. The budget for repairs and maintenance was also apparently cut along with that for new capacity, so that stoppages and breakdowns of oil rigs proliferated. Ethnic unrest in Azerbaidzhan, the site of much of the Soviet oil-servicing industry, cut the supplies of valves and pipes to the Siberian fields. And the pipeline system, which had been in poor condition for some time and was largely neglected in the rush to raise extraction rates, continued to deteriorate. Reflecting these developments, oil output fell by 2.7 percent in 1989 (Appendix Table B.3).

In the coal industry, as production from underground mines in the European USSR fell, increasing reliance was placed on Siberian open-pit mining. This coal was relatively cheap to extract but, being difficult to burn, was frequently rejected by consumers. Relatively mild winters in the USSR in the last three years also tended to weaken demand. Coal output fell for the first time in 1989—by 4 percent (including the effects of major strikes in July)—and was down a further 5 percent for the first three quarters of 1990.

The growth in output of natural gas has also suffered in recent years from a maturing of the more accessible sources: all proven European reserves are now in production, while output from fields in Kazakhstan and Central Asia has already peaked. The main cause, however, of the sharp slowdown in 1989 (to 3.3 percent growth, from almost 6 percent in both 1987 and 1988) appears to be the increasing distribution problems. The Soviet gas pipeline system is enormous (215,000 kilometers in total) and, despite some increase in investment, it has not been possible to devote adequate resources to its upkeep. The pipeline leakage rate is high, and the need for reconstruction is said to be twice the actual rate. Added to this, in June 1989, a devastating explosion destroyed part of the Bashkiri pipeline, a major carrier of natural gas liquids (including 80 percent of all Soviet LPG, used by households for cooking and heating).

The energy sector also appears to be one of the main casualties from a rising wave of popular concern over the USSR’s serious environmental problems. Responding to public pressure, the authorities (mostly at a local level) began in 1989 to force the closure of the worst-offending facilities, and to postpone or cancel the construction of others. The nuclear electricity industry suffered a particular backlash from the Chernobyl disaster. Plans for the construction or expansion of a number of nuclear plants were shelved, and the commissioning of others delayed. Local pressure has also postponed the development of natural gas fields on the Yamal peninsula in north-western Siberia. Elsewhere in industry, the most affected sectors were pulp and paper plants (forced to shut down or change their product mix) and some chemical and pharmaceutical industries.

The effects of fuel and raw material shortages, transport and distribution breakdowns, strikes, environmental shutdowns and ethnic disturbances were aggravated by the high concentration of production in Soviet industry.50 Those industries which relied to a significant extent on imported inputs from the convertible currency area also began to suffer from the shortage of foreign exchange. This affected particularly industries producing intermediate and capital goods, as priority was given to reallocating the dwindling hard currency to industries producing consumer goods or machinery for their production.

c. Frictions in interrepublican trade51

As the power of the central authorities declined, the regional distribution of reserves, specialization in production and the structure of interrepublican trade began to have increasingly important implications for the Soviet economy.

Roughly 60 percent of NMP, including in industry, is reportedly generated in the RSFSR alone, with another 20 percent originating in Belorussia and the Ukraine. Only about half of agricultural value added is produced in the RSFSR, however, while 23 percent originates in Belorussia and the Ukraine and another 16 percent in the four Central Asian republics and Kazakhstan (Appendix II-4, Table 13). The Baltic republics emphasize the production of meat, milk and light consumer goods. Russia, the Ukraine and Kazakhstan are the major fuel and metals producers. Moldavia and the Caucasus specialize in fruit and vegetable production. The Ukraine is a major grain producer, while cotton comes from Central Asia, particularly Uzbekistan. Machine-building is concentrated in the European regions of the USSR and the Caucasus.

In terms of the proportion of NMP exported to other republics, the Baltic and Caucasian republics, Moldavia, and Belorussia exported the highest proportions of their value added (in most cases, over 60 percent in 1988) while the Central Asian republics (40-50 percent), the Ukraine (39 percent), Kazakhstan (31 percent) and the RSFSR (18 percent) followed. The RSFSR, by contrast, exported abroad the highest share of its NMP (measured in domestic prices)—almost 9 percent—while the Central Asian and southern republics exported abroad less than 5 percent of their NMP. The higher RSFSR share was due largely to the concentration of energy exports in that republic (Appendix II-4, Table 26).

If trade is valued in domestic prices, the RSFSR, Belorussia, the Ukraine and some of the southern republics have tended in recent years to run trade surpluses with the rest of the union, while every republic has incurred deficits in its trade with the outside world. At the same time, only the RSFSR has been running more than negligible surpluses with the outside world in valuta rubles, i.e., at border prices. Official Soviet re-estimations of interrepublican trade at valuta prices52 suggest an enormous RSFSR surplus with the other republics (presumably, largely due to its net exports of energy)—equal to more than twice its valuta surplus with the rest of the world in 1987—while virtually all the other republics would be in deficit (Appendix II-4, Table 28).53

As shortages of food, consumer goods, and fuels spread in 1989, many of the individual republics—which under glasnost’ were asserting increasing autonomy in any event—became more wary of exporting to other regions without greater assurance that their own supply needs would be met in turn. Increasingly, the notion of an all-union, integrated market—albeit the result of central planning rather than market forces—was being challenged. Barter transactions grew in importance, and the attitude of the republics became increasingly autarkic.

d. Economic outturn: growing internal and external imbalances

The sharp rise in the recorded growth of aggregate NMP in 1988—to 4.4 percent—is somewhat puzzling. In industry and agriculture, gross output rose by only 3.9 percent and 1.7 percent, respectively (Appendix Tables B.1 and B.4). But official statistics indicate growth in net output of 6.1 percent and 2.5 percent for the two sectors (Appendix Table A.4). Where the implied improvement in efficiency was concentrated, and what could have caused it, is not immediately apparent. Moreover, renewed deterioration in the overall terms of trade and the associated fall in value added generated in foreign trade are estimated to have contributed more than half a percentage point decline in NMP (Appendix Tables G.5, A.3, and A.6).54 From the domestic expenditure side, the rapid growth in NMP is also difficult to explain. Aggregate consumption grew by 4.2 percent—or less than the rate of growth of NMP—while accumulation reportedly rose by over 5½ percent in real terms. Yet, net fixed investment declined by 7.4 percent, implying that the increase in real stockbuilding and other “material circulating means” must have been equal to some 2.5 percent of 1987 NMP (Appendix Table A.6). As noted earlier (section 3.a), there are reasons to believe that stockbuilding (including increases in unfinished construction) was significant in 1988, but official statistics would appear to imply that the deflator for stockbuilding was essentially unchanged in 1988 (Appendix Tables A.6 and C.7).

The comparatively modest growth rate for NMP in 1989 (2.5 percent) is more plausible, although it too may be exaggerated to the extent that accelerated hidden inflation was induced by the growing scope for negotiated “contract” prices discussed earlier. The recorded slowdown in growth affected virtually all major sectors, except distribution and foreign trade (Appendix Table A.4). Domestic expenditure was more buoyant than output in 1989, and the trade balance made an estimated negative contribution to NMP growth of about 0.7 percentage points. Within domestic expenditure, the new priority attached to consumption was reflected in a fall in net fixed investment of 6.7 percent and a rise in real consumption of around 5 percent in 1989. Household incomes, however, were up by 13 percent in nominal terms, as growth in both wages and pensions accelerated. Consequently, the measured household saving rate rose by a further 2.8 percentage points in 1989, to a level almost twice that prevailing in 1985 (Table II.2.2).

Higher saving pushed the growth rate of households’ financial assets from an average 9.3 percent in 1986-87 to 11.3 percent in 1988 and 14.6 percent in 1989 (Appendix Table K.6). Given that the real yield on households’ deposits—if deflated by the underlying inflation rate—was negative in 1989, and with few alternative assets available to households, much of the additional saving is thought to have been involuntary. At the same time, there was a marked shortening in the maturity structure of household assets. The stock of demand deposits and, especially, currency grew more rapidly than the less liquid components (savings deposits, bonds, and insurance policies), reversing the trend of the previous two decades. The relatively rapid build-up in the most liquid assets may have been a symptom of increasing uncertainty—regarding the availability of goods, for example—or of rising fears of possible administrative measures (such as a temporary freeze) against bank deposits. But it is estimated that, by the end of 1989, the stock of currency and bank deposits in the hands of households exceeded their desired level by approximately rub 130 billion (around 30 percent of households’ financial assets). Liquidity was also rising strongly during the 1988-89 period in the enterprise sector, where excess money holdings were estimated at close to rub 50 billion in 1989.55 The inflationary risks this posed were heightened by the freeing of enterprise money from the control of branch ministries. By 1989, the growth rates of M1 and M2 had been in the range of 14-15 percent for three years running, compared to annual average growth of 6-8 percent in the 1981-85 period.

The external current account deteriorated progressively during 1988-89. A renewed drop of world market oil prices, a surge in grain import prices, and the lagged impact on export prices vis-à-vis CMEA countries of previous declines in world market oil and gas prices resulted in a further sharp decline in the terms of trade in 1988. Another factor behind the deterioration in the trade balance was a sharp increase in the volume of imports, particularly from the convertible currency area (Appendix Table H.8). This reflected in part some release of pent-up excess demand, following the decentralization of trade and financing, as well as imports to provide disaster relief after the Armenian earthquake in late 1988. Despite further growth in oil exports, which reached an all-time peak in 1988, and continuing expansion of natural gas exports (Table V.6.6), the trade balance with the convertible currency area deteriorated by more than US$8 billion (on a transactions basis) between 1987 and 1989. Meanwhile, the trade balance with socialist countries also deteriorated by nearly rub 5 billion (Appendix Table H.4), largely due to the lagged deterioration in the terms of trade (Appendix Table G.5).

The worsening in the trade balance was accompanied by growing deficits in the services balance, particularly in convertible currencies, as receipts on transport and insurance dwindled and net interest payments rose sharply. As a result, the current account balance in convertible currencies (on a transactions basis and excluding gold exports) swung from a surplus of almost US$7 billion in 1987 to a deficit of US$4 billion in 1989. Over the same period, the current account with socialist trade partners deteriorated by rub 5 billion to reach a deficit of rub 3 billion in 1989.

The current account deficits in convertible currencies were financed through continued borrowing in the international capital markets, including syndicated credits and bond placements abroad. However, as the possibilities for medium-and long-term financial loans were limited, the USSR stepped up its short-term borrowing in the form of deposits and credit lines with foreign banks. The stock of short-term debt doubled from US$9 billion at end-1987 to almost US$18 billion by end-1989 (Table II.2.7). No significant change took place in the stock of foreign exchange reserves, which appear to have amounted to five months of convertible currency imports by end-1989.


The functioning of the economy continued to deteriorate in 1990, and at an accelerating rate. It became clear that the piecemeal reforms of the previous years had failed to stabilize the economy, let alone produce higher rates of growth. The combination of substantial monetary, fiscal and external imbalances with a disintegrating system of internal trade and distribution brought shortages in some cases to a crisis point. The authorities were faced with severe day-to-day problems of economic management and had, at the same time, to respond to growing pressures to formulate new and more radical reform plans.

a. Financial policies56

The authorities intensified their efforts in 1990 to bring monetary growth under control. Attention was focused primarily on fiscal measures—in particular, on recouping some of the drop in revenues (relative to GDP) which had occurred during the late 1980s. But there was also an unsuccessful attempt to move away from automatic money-financing of the deficit, by promoting debt sales outside the banking system.

The 1990 budget sought a cut in the deficit of more than half a percentage point, to below 8 percent of GDP; the adjusted budget deficit was projected to decline by 1¼ percentage points (Table II.2.3). On the expenditure side, investment was to be cut by nearly 3 percentage points of GDP, and defense by half a point. Subsidies were planned to increase by around 1 percent of GDP, and there was to be a 2 percentage point across-the-board increase in social outlays. Social security payments, in particular, were to rise by more than 16 percent in nominal terms. These increased payments, however, were less than half the projected increase in social insurance contributions, which were expected to rise by 35 percent compared with 1989, reflecting an increase in the average effective contribution rates—from around 9 percent to 12 percent—together with sharp increases in wages.

Total revenue was planned to recover by 1¾ percent of GDP. Besides the higher social security contributions, an increase of 1½ percent of GDP was projected for revenue from enterprise taxes and the turnover tax. Foreign trade tax receipts, however, were expected to decline, given the disarray in the oil and gas industry and the foreign exchange constraint on consumer imports.

Preliminary results for the first half of 1990 showed a deficit of rub 19 billion as against a target of rub 33 billion (Table II.2.4). Revenues were slightly above target, with individual income tax collections particularly buoyant as wages continued to rise, and turnover tax receipts marginally exceeding the planned level. However, the slump in production, in combination with a further decline in the effective rate of profit taxation, led to a decline in receipts from enterprises, which fell by 6 percent compared to the budget estimate. Total expenditures were 5 percent below the planned level, mainly because of investment cuts, while in defense and administration spending was precisely as planned.

It seems likely that these favorable outcomes masked upward pressures on the deficit in the second half of the year. The most vulnerable of the budget estimates were those for subsidies, the government wage bill, and revenue from enterprise taxation. Subsidies may have risen particularly as a result of procurement price increases for grain announced in May, and higher government purchase prices for meat effective in October, neither of which were followed by a comparable adjustment in retail prices. Also uncertain was the outlook regarding revenue from foreign transactions, 57 despite a possible windfall from the rise in the world price of oil in the last quarter.58

In August, the authorities issued a decree cutting expenditures by around rub 4 billion for the remainder of 1990. This decree, which was supposed to correct for possible slippages, annulled unspent appropriations remaining after the first semester; authorized the Ministry of Finance to prepare a list of nonessential expenditures to be cut in the rest of the year; disallowed funding of construction (except for special projects, particularly housing) not yet begun; and cut foreign grants by rub 0.6 billion. However, its budgetary effect was more than offset by a rub 7 billion spending package which provides rub 4.2 billion to cover the cost of higher prices for cereals, rub 1.5 billion to finance supplementary pensions for World War II veterans, and rub 1.2 billion for the Chernobyl cleanup.

As late as November, revised official projections suggested that the budget deficit may have remained on track for the year as a whole. There could, however, be a significant shift in its composition between the union and the republics. The union budget was expected to have a deficit of rub 67 billion instead of rub 49 billion as planned, while the consolidated republic budgets were expected to show a rub 8 billion surplus rather than the planned rub 11 billion deficit.59 Shortfalls in tax revenues totaling more than rub 10 billion, mostly from enterprise tax revenue and to a lesser extent from oil exports, were expected to affect primarily the union budget, whereas a considerable portion of the rub 7 billion in revenue windfall from the turnover tax and from income taxes on individuals and cooperatives was to accrue to the republics—which presently retain a substantial share of this revenue. Similarly, on the expenditure side, the republics appeared to be shouldering a smaller portion of the overruns, especially as regards subsidies and possible budgetary assistance of enterprises, than the union.

The authorities had initially hoped to finance the deficit increasingly through the issuance of government bonds to the nonbank public. Bonds were to be placed on a voluntary basis with state enterprises, cooperatives and individuals, and warrants were to be sold to individuals, giving the right to purchase certain consumer durables at a fixed price on a specified maturity date. Most of these issues were unsuccessful. A rub 19 billion tranche of 10-year bonds remained unsold, and had to be taken up by Gosbank.60 An issue of 5 percent fixed-coupon bonds to be sold to households was a total failure—even after the interest yield was doubled to 10 percent and the maturity halved to 8 years—and sales of the traditional “lottery bonds” were extremely slow. Only the warrants for consumer goods met with a reasonably positive response, although the total amount involved (rub 3 billion) was modest.

In sum, the growth in bank credit to the government is thought to have slowed in 1990 to around 16-17 percent, compared with over 30 percent in 1989—more on account of the reduction in the deficit than of changes in the sources of financing. At the same time, however, credit to enterprises—perhaps reflecting the expected 2 percent decline in pre-tax profits, and a growing unevenness in the distribution of liquidity across enterprises—began to rise again in 1990, and was estimated to be 4 percent higher than at the end of 1989 after four years of continuous decline.61 As a result, total credit growth—which was originally planned to fall from a rate of 11 percent in 1989 to around 7½ percent in 1990—was expected to have slowed only marginally (Table II.2.5).

b. Economic developments

The energy sector continued to be hit by distribution problems,62 strikes, interregional conflicts, shortages of spare parts, and a cutback in drilling activity. In the first nine months of 1990, oil and coal output both fell by 5 percent (compared with January-September 1989), while growth in gas production slowed further to 3 percent. In July, the authorities announced that oil exports would be curtailed in order to supply domestic needs, and in August the USSR became a net importer of gasoline for the first time in post-war history. The official estimate of the likely decline in oil output during 1990 as a whole was around 5 percent, implying a level well short of the authorities’ original target. As a result, oil exports may have declined by as much as 19 percent in volume terms.

While in 1989 a shortage of foreign exchange had already begun to constrain some producers who relied on imported inputs, by the fall of 1990 this was being cited as one of the main causes of industry’s problems. The automobile industry was short of cold-rolled steel sheets, the tire industry of critical additives, the furniture industry of imported dyes and lacquers, and the food processing industry of vital packaging materials.

The primary cause of the foreign currency shortage was the fall in energy exports, but the consequences may have been aggravated by a serious misallocation of the available hard currency. Prior contracts had led to continued high imports of grain being imported despite the record harvest. And enterprises had large quantities of imported machinery sitting idle, as the resources needed to complete the planned investment projects were unobtainable. Enterprises had to be asked to export part of their huge stocks of capital equipment and intermediate products in order to reallocate funds to more productive uses.

The grain harvest was officially estimated at around 220 million metric tons in 1990, up almost 12 percent over 1989. The increase in yields was ascribed mostly to very good weather, which is plausible since other factors were almost entirely adverse. Shortages of fuel, batteries and spare parts had, by July, reportedly put 120,000 combine harvesters and 40,000 tractors out of action. In addition, the usual exodus of students and factory workers to the countryside, upon which farms rely for harvest labor, was significantly smaller than in previous years—the instructions of the central government being in many cases simply ignored. Consequently, one in five of the combines that could be used had no driver.

Although the harvest appeared to be good despite these handicaps, serious distribution problems led to substantial losses of grain (around 30 million tons, on official estimates), and generated severe shortages of supply to the state bakeries during the summer. Among the causes of high losses were a lack of trains and functioning trucks, and a shortage of storage facilities (some of which were full of imported grain).63 Meanwhile, possibly to an even greater extent than in 1989, farmers were withholding grain from the state partly to feed their livestock, given shortages of other animal feedstuffs,64 and partly in anticipation of being able to sell on the private markets.65 Aside from grain, the output of most agricultural products in 1990 was expected to be at, or slightly below, the levels of 1989. Aggregate gross output in agriculture was thought to have remained unchanged.

The authorities expected aggregate NMP to decline in 1990 by around 4 percent, in comparable prices; GDP was to fall by somewhat less, possibly around 2 percent, because of continued growth in the service sector. On the expenditure side, total consumption was expected to rise by 3 percent in real terms, and total fixed investment and stockbuilding were both expected to drop by around 20 percent.

The fall in gross industrial output in the first nine months was put at 0.9 percent, and was expected to exceed 1 percent by year-end. Profits in industry were officially estimated to fall by even more than the approximate 2 percent decline foreseen for enterprises as a whole. Production was hit by serious industrial unrest, leading to an estimated loss of 10 million workdays in the six months to July from strikes and absenteeism. Many of the strikes were related to ethnic and regional conflicts, affecting Armenia and Azerbaidzhan in particular (where industrial production fell 7½ percent and 13 percent, respectively, in the first half). The output of the defense sector fell, higher production of consumer goods failing to offset the fall in military output. Plants continued to be shut down for environmental reasons—in the cement industry, for example—although the authorities attempted to reverse some earlier closures where it was apparent that the impact on supply had been catastrophic (e.g., in the production of raw materials for medicines). With the transport and energy sectors continuing to deteriorate, shortages of fuel and other inputs intensified.

Output levels in the construction and transport sectors were also expected to decline in 1990. The former suffered primarily from a shortage of inputs; production of wood, cement, window-glass, asbestos, concrete-piping and other vital materials were all reported to have fallen in the first half of the year. The total volume of freight carried in the first nine months declined by close to 5 percent, with fuel shortages causing particular problems for road haulage (down 6 percent).

Total employment was estimated to have fallen by 0.8 percent in the first nine months of 1990. If the trend were to continue for the year as a whole, as the authorities expected, employment would have declined for the first time in the post-war history of the USSR. The shift in employment from state to cooperative sectors continued in 1990. During the first nine months, average employment in the state sector dropped by 1.5 percent (1.8 million workers), while the number working in nonagricultural cooperatives rose by 1.2 million, or 46 percent. There are no official statistics for unemployment; but since the labor force remained essentially unchanged in 1990, unemployment is likely to have risen, albeit remaining very low by the standards of most market economies. The official estimate was about 2 million unemployed on average in 1990, about 1.4 percent of the labor force.66 At the same time, the continued existence of (localized) labor shortages was suggested by reported vacancies of around 3 million.

Household incomes were officially projected to rise by more than 14½ percent in 1990, after an increase of 13 percent in 1989. The growth in money expenditures was expected to reach 13.7 percent, sustained partly by additional imports of consumer goods and partly by increased production from the military conversion program. With overall consumption on a national accounts basis officially estimated to increase in 1990 by around 3 percent, however, the much higher projected increase in nominal consumers expenditure suggested that the official inflation estimate—at just under 5 percent—might have substantially underestimated the actual rate of open inflation in 1990.

The growing dissatisfaction of consumers, despite official statistics that indicate an increase in real consumption spending, suggests that the official estimates may be overly optimistic. Even if consumption spending had grown, however, the availability of goods was extremely uneven in 1990, with individual items appearing in abundance and then rapidly disappearing altogether. This was often, initially, a supply problem which, because of the uncertainty that the shortages generated, led to panic-buying, hoarding and further shortage. In fact, the large increase in retail sales in the first six months of 1990 is thought to have been partly due to a major episode of panic-buying in May, following an abortive proposal by the Government for large price increases on a range of consumer goods and services (including a tripling of bread and a doubling of meat and milk prices). Intermittent supply required people to stand even longer in queues for whatever product was available on the day, so reducing productivity (queuing often had to be done during work hours) as well as welfare. The worsening shortages also led to an increasing proportion of goods being distributed directly at the workplace, through “invitation only” sales, and on private markets—and therefore to a partial collapse of the traditional system of open sale through state outlets. Moreover, the growth in aggregate consumption may have encompassed forced switches from some products in short supply to others in relative abundance, the resulting “basket” yielding a less-than-normal level of utility. One reason given for the shortages of bread in late summer, for example, was that consumers were substituting bread for meat and other, more desirable but less available, foodstuffs. Indeed, by the summer, almost every major city had outright rationing of some products.

The continued rise in consumers expenditure in 1990, however, did begin to reduce the rate of growth in households financial assets—to an estimated 13.8 percent, from 14.6 percent in 1989 (Appendix Table K.6). At the same time, the growth rate of enterprise broad money rose from 14½ percent in 1989 to an estimated 20 percent in 1990 (Appendix Table K.7), partly reflecting enterprises’ increased access to bank credit, and, possibly, a significant cutback in stockbuilding to the extent that this was reflected in a rundown of stocks of consumer goods. There was, however, some maturity lengthening, with time deposits growing substantially faster than holdings of M1. Broad money growth in 1990 was expected to be slightly above the 14.8 percent outturn for 1989 which, at a time when the economy was contracting in real terms, suggested that if anything overall monetary policy was being loosened rather than tightened. Indeed, it is estimated that the monetary overhang increased further in 1990, to rub 170 billion for households and rub 85 billion for enterprises (representing 32 percent and 43 percent of sectoral M2 holdings, respectively).67

Retail price inflation, as noted, was officially expected to move up close to 5 percent in 1990, compared with 2 percent in 1989. This reflected the growing prevalence of contract pricing and substantial price rises on the collective farm markets (24 percent in the first nine months of 1990). Measured inflation, however, has become an increasingly misleading indicator of excess demand (official estimates of repressed inflation reached almost 7 percent in 1990)68 and of cost-of-living increases—particularly in the rural areas, where collective farm market prices have a much higher weight than is implied by the retail price index.69

c. External developments

There was a further sharp deterioration in the external accounts in 1990. The decline in exports of oil and oil products, in the wake of a further reduction in domestic oil output, is estimated at 19 percent in volume terms (and 31 percent vis-à-vis CMEA countries). At the same time, imports continued to rise, reflecting both planned state imports, which were not cut in parallel with the decline in exports, and direct enterprise imports of consumer durables and food products, as growing domestic demand coincided with disruptions in domestic supplies. In the first half of 1990, the trade deficit against developed countries was US$6 billion (transactions basis), while trade with the socialist countries was in deficit by rub 5 billion.70 Reflecting seasonal factors and the sharp rise of oil prices from August 1990, however, it was expected that the overall trade deficit might be limited to rub 10 billion for the year as a whole, of which over rub 3 billion (US$6 billion) would be with the convertible area, rub 6 billion with the CMEA countries and the remainder with other countries with which the USSR has bilateral payments agreements (Table II.2.6).71

Increasing debt service payments in convertible currencies also strained the external situation. Debt service (excluding net repayments on short-term debt) which had remained almost stable at US$8-9 billion during 1986-89, rose to US$13 billion (33 percent of exports of goods and services in convertible currencies) in 1990, as both principal repayments and interest payments increased (Table II.2.7).72 These obligations were, according to Soviet officials, serviced on a timely basis. Furthermore, as arrears began to emerge on suppliers’ credits in late 1989 and continued growing during 1990, the USSR’s credit rating plummeted. Consequently, it became increasingly difficult to renew short-term credit lines and deposits, and the stock of such debt fell substantially (by a projected US$13 billion in 1990 as a whole). In addition, access to syndicated credits and bond issues dried up. Borrowing became possible only with the guarantee of creditor country governments. Such guarantees for financial borrowing were issued by the German Government in the second half of 1990, and other governments made commitments for future loans. In addition, the USSR borrowed US$1 billion against future exports of diamonds73 and reportedly made extensive use of gold swaps to boost official foreign exchange reserves. Nevertheless, official reserves declined by a projected US$9 billion during the year to US$5 billion by the end of 1990, and arrears accumulated during the year reached an estimated US$5 billion.74

In relation to CMEA countries, the USSR accumulated liabilities vis-à-vis all Eastern European countries, except Romania, with particularly large liabilities against the former GDR, Poland, the Czech and Slovak Federal Republic, and Hungary (see Appendix II-3). Total gross external debt, although smaller than for most Eastern European CMEA countries in relation to export earnings, has increased rapidly in recent years and, given the deficits in the current account, the maturities have shortened.75 External debt contracted or guaranteed by the Vneshekonombank was US$52 billion in mid-1990, including 20 percent at short term.76 In trade with developing countries, sizable claims were accumulated—more than US$130 billion by end-1989, including about US$29 billion in convertible currencies—though it is questionable how much of this debt will be repaid, at least for several years.

Although no exact information is available from Soviet sources on the share of debt which was extended or guaranteed by foreign governments, it is believed that virtually all of long-term bank loans, but only a small part of other debt, was extended or guaranteed by governments or official export agencies abroad. Based on this information, it appeared that about 33 percent of debt service obligations in 1990 were either official or officially-guaranteed, while 47 percent represented nonguaranteed debt service to banks and the remaining 20 percent nonguaranteed debt to foreign suppliers.


The bonus and wage measures were to be phased in between 1987 and 1990.


The definition of speculation was never made clear but in practice it meant any activity which generated earnings deemed by the authorities to be excessive, including, typically, simple arbitrage transactions.


Indeed, one goal of the retooling strategy that may have been essentially fulfilled is the shift in the composition of investment toward reconstruction and refitting. In 1989, this type of investment accounted for 49.6 percent of the total, compared to the planned share of 50.5 percent mentioned earlier (Appendix Table C.4).


Imputed from Torgovlia SSSR (1989), pp. 127-28 and Narkhoz 1984 (1985), p. 483.


Private firms were outside the Gossnab (state) distribution network.


The growth figure for industry is reported exclusive of turnover taxes so as to exclude the significant effect that the decline in output of highly-taxed alcohol had on overall growth.


The balance of payments on a settlements basis, as compiled by the Soviet authorities (Appendix Tables H.1, H.3, H.5 and H.7), records only cash transactions, i.e., trade data exclude trade on a barter basis, and trade on a credit basis is recorded only when settlement takes place. Imports financed from gold exports are also excluded. Similarly, the extension or receipt of trade credits is not recorded in the capital account. The balance of payments on a transactions basis (Appendix Tables H.2, H.4, H.6 and H.8) has been estimated which, in principle, records all trade transactions, including gold, in the year when they take place, as well as trade credits.


According to the Soviet authorities, at the end of 1987, 60 percent of bank deposits abroad were denominated in U.S. dollars and the remainder primarily in European currencies and the ECU. The U.S. dollar declined by 32 percent against the ECU between end-1985 and end-1987.


Taxes on alcohol are thought to have financed over 12 percent of total state expenditure in the 1981-84 period. By 1987, this share was down to around 8 percent.


These remittances fell by a little less than 1 percent of GDP. A sharp drop in unidentified nontax revenue accounts for the remainder of the increase in the deficit.


In October 1986, in order to free banks from the burden of monitoring the progress of construction work and in recognition of the fact that a large share of delayed construction projects would never be completed, bank loans of about rub 70 billion to the construction sector were removed from the banks’ balance sheets, together with the corresponding contracting enterprises’ escrow accounts. (These had represented advance payments by the banks on account of construction projects in progress.) At the same time, it was decided that payment for new construction works would be made directly to the building firms. The 1986 growth rate of bank loans reported in the text has been adjusted for the amount of this operation, which did not imply an actual decrease in credit extended to firms.


As will be seen in Chapter II.3, this control was substantially weakened by the Law on State Enterprises, which became effective on January 1, 1988.


The shift in primary responsibility over the budgetary process from Gosplan to the Ministry of Finance did not, however, materialize until very recently. From July 1987 onward, Gosplan no longer issued directives, but instead provided “estimates” and “suggestions” to budgetary institutions. Yet, until 1989, spending ministries continued to be rewarded upon fulfillment of these suggestions. In July 1989, Gosplan was assigned an advisory role in the budgetary process. See Chapter III.1.


See also Chapters IV.2 and V.2.


The abolition of mandatory obligatory targets had in principle taken place in Hungary as early as 1968 and to some extent in Poland in 1982, but in practice, as long as the planning and ministerial apparatus remained fundamentally unreformed, a great number of enterprise output targets continued to be heavily influenced by the central authorities in these countries.


This system of state orders was similar in many respects to that used in Poland during 1983-89, although by the end of that period state orders in that country were estimated to have accounted for less than 5 percent of gross output.


Being an allocation of profits, these funds are distinct from the “wage fund,” which is deducted from revenues in the calculation of profit.


The figures quoted here for growth in profits are derived from the aggregated financial accounts of enterprises. These, however, involve large unexplained differences between total sources and uses of enterprise funds and cannot easily be related to national accounts concepts. Any discussion of changes in profits is therefore subject to wide margins of error.


The positive real rates of interest in this period suggested by Table II.2.5 must be interpreted in light of the probable understatement of the open inflation rate—and almost certainly of underlying inflationary pressures—by the official deflator.


As suggested by the estimates for the contribution of stockbuilding to NMP growth reported in Appendix Table A.6, however, the quantification of “stockbuilding” (broadly defined) may be subject to wide margins of error.


Ironically, the hoarding of investment materials and the long gestation periods for construction projects were two of the phenomena which enterprise self-financing under the Law on State Enterprises was supposed to discourage.


These “stable links” were to remain in force until 1993. A stable link was defined as a supplier-customer relationship that had been in effect for at least two years prior to the coming into effect of the Law on State Enterprises. It could not be broken without the consent of the customer.


The increase in unfinished construction projects may also have been related to the diversion of construction resources to Armenia, following the earthquake there in December 1988. The pattern of stockbuilding is somewhat different in the derived financial accounts of enterprises (Appendix Table D.5), which show a fairly moderate increase in stocks in 1988 (about 1 percent of GDP) but an enormous increase in 1989 (about 4.5 percent of GDP).


See Chapter IV.6 for a detailed discussion of this issue.


The shares of internally generated funds that had to be paid to the branch ministries and the budget were reduced.


The main funds are the fund for development of production, science and technology, the fund for social-cultural measures and housing, and the material incentive fund (from which various premia and bonuses are paid). Under the Law on State Enterprises, enterprises were also allowed to amalgamate the material incentive and wage funds into a single labor payment fund, with corresponding adjustments in tax obligations.


See Chapter IV.1 for further details.


Goskomstat reported average cooperative employment of only 3.8 million for the first nine months of 1990.


Cooperatives have been classified as part of the socialized sector by the Ministry of Finance for purposes of compiling the statement on money incomes and expenditures of the population (vis-à-vis the socialized sector).


The very rapid growth of this type of private activity compares favorably in magnitude with the experiences of Hungary after 1968 and Poland after 1981.


See Chapter IV.5 for further details.


This was raised to 10 percent in August 1990.


See also Appendix III.4 and Chapter IV.3 for details.


Exceptions were retained for certain strategic products (mostly fuels and raw materials).


DVKs are coefficients that are multiplied by the official (or valuta) exchange rate to yield the value of domestic rubles to be paid by importers or received by exporters. For further discussion, see Chapters III.2 and III.4.


The DVKs were withdrawn with the introduction of the commercial exchange rate on November 1, 1990.


The amounts offered in these auctions have remained small. Rates in these auctions have varied, during the first ten months of 1990, between rub 10 and rub 24 per U.S. dollar, compared to an average official exchange rate of rub 0.58 per U.S. dollar.


For details, see Chapter IV.4.


Even after enactment of the Law on State Enterprises, firms were required to make certain allocations of after-tax profits to their respective branch ministries, which redistributed these funds among enterprises by means of so-called centralized funds that mirrored the types of enterprise “funds” discussed in section 3.b.


See the discussion of consumer price subsidies in Chapter III.1. Subsidy rates, calculated in reference to retail price, stood at 233 percent for meat, 247 percent for butter and 171 percent for milk in 1988.


As part of this effort, the number of all-union ministries was reduced from 64 to 55 in March 1988. Between 1986 and 1988, the number of workers in state administration (at all levels of government) fell by 523,000, or more than 25 percent.


The significance of this write-off will depend on the extent to which it sets a precedent, relieving the recently-imposed pressure on banks to assess the creditworthiness of their borrowers. In itself, it simply involved a shift of nonperforming loans from the state-owned agricultural bank to Gosbank, leaving the state’s total assets and liabilities effectively unchanged.


For details, see Chapter V.8.


In the early 1980s, for example, all television and radio receivers and cameras, around 30 percent of bicycles and vacuum cleaners, and 10 percent of passenger cars had come from industries that mainly produced for the military.


SSSR v tsifrakh 1989 (1990), p. 7. It is unclear whether these data are in current or comparable prices.


Problems in the transport sector are discussed in detail in Chapter V.3.


See Chapter V.6 for further details.


The output of diesel locomotives, for example, fell in 1989 because of a shortfall in deliveries by the only manufacturer of vital electrical components; and the blockade of Armenia left a tractor factory near Moscow without tires—there was no other source in the USSR. One consequence of the highly concentrated industrial structure, together with the sheer size of the country, was that production tended to be relatively transport-intensive. The effects of failures in the transportation system on the overall functioning of the economy were therefore particularly severe.


For further detail on republican issues, see Appendix II-4.


It is unclear whether valuta prices in this case were meant to reflect world market prices, rather than some average of these and intra-CMEA trading prices.


The interpretation of these re-estimations of interrepublican trade is quite controversial, with some republics noting that such quantification overlooks other costs of their association with the union. In any event, a strong national element has been added to the already sensitive issues of property rights, while conversely, disputes over property rights have tended to exacerbate ethnic and interrepublican tensions. Uncertainty over the future political and economic relations within and among the republics has complicated the issue of reform as well as economic relations with the outside world.


A possible explanation of the puzzle would be that with the extension and formalization of “contract” pricing in 1988, the rate of hidden inflation may have increased significantly. The official retail price deflator actually registered a lower rate of inflation in 1988 than in 1987 (Appendix Table E.1).


See Chapter III.3 for a comprehensive discussion of the “monetary overhang” and a description of the methodology underlying these estimates.


See Chapter III.1 for further details on the fiscal system.


For instance, a failure to pass through the November 1 depreciation into higher domestic prices of imports could result in an unanticipated import tax shortfall.


The projected increase in bank credit to the government for agriculture, which should be seen as a quasi-fiscal operation of Gosbank, should also be mentioned.


After allowing for the proceeds of rub 20 billion—which did not materialize, as discussed below—from fixed coupon bonds and consumer durable warrants.


Gosbank also had to redeem rub 5.4 billion of government bonds issued in 1957.


The figure of 4 percent refers to the growth rate adjusted for the increase in credit extended to the construction sector as a counterpart of “escrow deposits” created by the contracting enterprises. This increase is due to the revival of the system by which building firms are not paid directly by the contracting entities but receive the funds required for the construction through the banking system as “loans” (see section 2).


Despite the obvious problems with the pipeline system, the 1990 budget allocated only rub 1 billion to the oil and gas construction ministry for work on pipelines, compared to rub 3.3 billion in 1989 and rub 5.1 billion in 1988.


It is not clear why this grain was not being used to supply the state bakeries.


Production of hay silage and other roughage crops (60 percent of all animal feed) had fallen in 1989.


In the Baltic republics, farmers were able to get prices as much as 5 times higher than the state would pay.


See Chapter IV.6 for a more detailed discussion of the issue of unemployment in the USSR.


Repressed inflation is defined by Goskomstat as the rate at which prices would have had to rise to maintain the ratio of retail trade turnover to the stock of household money unchanged for the year as a whole. It should be emphasized that this does not measure the rise in prices that would occur in any one year if administrative controls were suddenly lifted. The latter would depend on the stock of excess money outstanding, not the flow addition to the overhang for the year in question. Nor does the methodology allow for changes in the velocity of the demand for money.


Measurement of the living standards of the rural population is complicated by the likelihood that income in the form of home-grown food is underrecorded. In terms of a cost-of-living index, however, prices on the collective farm market would still be the relevant base, since these represent the opportunity cost to households of consuming their own food production.


Trade data for the first half of 1990 were not available on a country-by-country basis to permit calculation of the trade balance in convertible and nonconvertible currencies.


Soviet trade statistics for the period 1984-89 reveal a pronounced seasonality of exports and imports, which imply a considerable improvement in the second half trade performance relative to the first half. In all years, exports peaked in the fourth quarter and slumped in the first quarter of the following year, because enterprises stepped up their efforts to comply with export targets, including those under international agreements. By contrast, the seasonal peak of imports is in the second quarter. Two factors are likely to account for this phenomenon. As domestic grain stocks are being depleted, deliveries of imported grain pick up in the second quarter. And, in the absence of interest rate penalties, enterprises rush to use the full annual allocation under the import plan early in the year.


These debt service figures relate to debt contracted or guaranteed by the Vneshekonombank (VEB). There is no official data on debt which is not guaranteed by the VEB. However, all such borrowing required licensing from the VEB. By October 1990, total licenses issued amounted to rub 1.7 billion (about US$3.6 billion). The actual use of the licenses, however, was not known.


Exports of diamonds are not specified in the published trade statistics. But according to the Soviet authorities, exports of diamonds, other precious stones and jewelry amounted to 905 million valuta rubles (US$1.6 billion) during the first nine months of 1990—15 percent lower than in the corresponding period of the previous year.


Arrears identified by the VEB amounted to US$5 billion in October 1990. In addition, there may have been other arrears outstanding.


At end-1989, external debt in convertible currencies amounted to 139 percent of exports of goods and services in the USSR, against 227 percent in Bulgaria, 104 percent in the Czech and Slovak Federal Republic, 319 percent in Hungary, 486 percent in Poland, and 2 percent in Romania.


It could be expected that the debt figures reported by the Soviet authorities would be slightly higher than those reported by the BIS, because they would be more comprehensive. This is indeed the case for end-1989. However, for the preceding years, the international banking statistics reported somewhat higher claims on the USSR than reported by the authorities. One possible explanation is that the BIS statistics include claims on the two CMEA institutions located in Moscow (the IBEC and IIB) which should be excluded from Soviet debt.

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