Chapter

Chapter IV.3 External Trade Reform

Author(s):
International Monetary Fund
Published Date:
December 1991
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1. INTRODUCTION

The establishment of a well-functioning market economy entails the opening up of the economy to international trade and investment and its integration into the world trading system. Indeed, since 1986 efforts have been made in the USSR to introduce elements of flexibility into what had been a rigidly administered foreign trade system. Earlier it had been dominated by planning traditions that identified “essential imports” as those needed to balance shortfalls of domestic production relative to planned demand, and viewed exports as what can be spared from domestic needs in order to pay for imports. More weight is now given to the potential benefits to be reaped from encouraging trade per se, particularly as regards the potential efficiency gains to Soviet enterprises from closer contact with world markets.

In part as a result of initial liberalizing moves, but also and perhaps more profoundly because of the general breakdown of the central planning mechanisms, a critical point has been reached in the process of trade liberalization. It is no longer practicable to go back to a system of centralized management of foreign trade, but the institutions and arrangements that are necessary to underpin a market-based evolution of trade are not yet in place. This “halfway house” is unsatisfactory, and indeed recent trade performance has been poor. Against this background, current Soviet intentions with regard to further trade reform appear to be relatively cautious: the presidential guidelines adopted in October 1990 foresee that foreign trade will continue to be managed to a considerable extent (at least in what are perceived as “essential sectors”) during the transition.

The purpose of this chapter is to evaluate the pros and cons of this somewhat conservative approach, and to consider what further or additional steps in the trade field might usefully be taken in the coming year or two to enhance the contribution that foreign trade might make to overall Soviet economic performance. Section 2 describes and evaluates the present Soviet trade regime, trade performance and reform efforts to date. Section 3 analyses a number of key issues relevant to further reform. Finally, Section 4 summarizes the principal recommendations.

2. FEATURES OF THE TRADE REGIME AND RECENT REFORMS

In 1986, the USSR initiated the process of reforming the administrative and regulatory framework governing foreign economic relations. Although the initial reforms pre-dated the economy wide reforms introduced in 1987-88, they were motivated by similar concerns: the deterioration in economic performance—partly stemming from the “unfavorable” structure of foreign trade—and the lack of responsiveness and accountability on the part of state enterprises. Subsequently, measures were taken to decentralize trading rights, increase the autonomy and accountability of enterprises, and introduce export incentives. These were important first steps, but their implementation was incomplete, and their effectiveness was undermined to some extent by the continuing dominant role of the state and pervasive domestic price controls. As a consequence, the trade regime continues to suffer from the rigidities imposed by the administered economy.

a. Institutional framework and the structure of foreign trade1

(1) Historical background

Before 1986, foreign transactions of the USSR were tightly controlled through the central plan and the foreign currency budget. The principal institutions involved in foreign economic activity were the Ministry of Foreign Trade and its foreign trade organizations (FTOs), the State Committee on Economic Cooperation, the Ministry of Sea Transport, the Ministry of Passenger Aviation, and the Vneshekonombank (VEB). Inputs to the draft trade plan were prepared by the Ministry of Foreign Trade on the basis of a consolidation of the foreign currency budgets of ministries and departments (analogous to the balance of payments). Domestic resources were mobilized to achieve the planned levels of output in each sector, and shortfalls in production relative to projected domestic consumption were covered by imports. Exports were principally regarded as just the means of financing imports, although other considerations, including political objectives, were of course also present at times. Foreign exchange earnings were surrendered to the VEB and allocated for imports according to the established foreign currency budget. In case of deviation from the plan, the overall balance of payments was controlled through administrative means. Thus, for example, a decline in export receipts would be offset by cutting back on imports, to the extent it was necessary to remain within target levels for external debt.

The Ministry of Foreign Trade maintained a monopoly on foreign trade. Actual transactions were conducted by some 30 foreign trade organizations (FTOs), organized rigidly along product lines, which were mainly under its direct control. Planned imports and exports were channelled through these organizations: goods to meet export targets were delivered to them by enterprises on the basis of the plan; and enterprises with import needs allowed for in the plan obtained these imports through the relevant FTOs. Domestic producers thus had no direct contact with foreign enterprises either as suppliers or customers. Transactions between domestic enterprises and FTOs were based on domestic prices. The financial consequences of differences between domestic prices and prices expressed in valuta rubles (foreign currency prices converted at the official exchange rate) on external transactions were reflected on the books of the FTOs and absorbed by the state budget through a system of taxes and subsidies (so-called price equalization). The effect of these institutional arrangements was to isolate the domestic economy from the foreign sector and to neutralize the effects of differences between domestic and foreign prices on decisions of economic agents regarding investment, production, and consumption.

While the USSR has been among the top ten trading countries of the world for the past decade, external trade has played a subsidiary role in economic development. The growth strategy stressed rapid capital deepening achieved by constraining consumption and striving for increasing rates of investment. Trade was inward oriented with the emphasis on obtaining the imports required to fill domestic supply gaps. The bias toward capital accumulation and self sufficiency led to the rapid exploitation of abundant natural resources as a means of obtaining the foreign exchange to finance imports of capital and intermediate goods. This tendency was reinforced by the isolation of Soviet industry from external competition and technological advances abroad, which perpetuated domestic price distortions. As a consequence of these policies, forces of comparative advantage had only a limited role in shaping the structure of production. Rather, a high degree of self-sufficiency was achieved at the cost of lower efficiency of resource use and reduced technological progress.

(2) Trade arrangements

In recent years, approximately 70 percent of trade has been conducted on the basis of clearing arrangements, covering governmental agreements with countries belonging to the Council for Mutual Economic Assistance (CMEA), but also with Finland, Yugoslavia, and some developing countries, in particular India. Barter arrangements and other forms of nonconvertible trade account for an additional 5 percent or so of total trade. The remaining part of Soviet trade—primarily trade with developed countries (about 20 percent), but also a portion of trade with developing countries—is conducted in convertible currencies and based on multilateral settlement.

Despite some increases in recent years in direct trading by enterprises, state orders continue to be dominant in the conduct of Soviet trade with all regions. Gosplan and Gossnab establish requirements for state orders on the basis of intergovernmental contracts and other obligations, and these are placed with firms on terms that are generally attractive to them, including guaranteed inputs, and guaranteed output prices.

Historically, trade with the CMEA countries has accounted for over half of Soviet exports and imports measured on the basis of the official exchange rate. The importance of trade with the CMEA region developed after World War II, when the CMEA was established in part as a Soviet response to the Marshall Plan. In theory, the CMEA was designed to encourage regional specialization and the division of labor in order to achieve economies of scale. In practice, an artificial interdependence was developed under state direction and there was often duplication of production structures in many branches, rather than specialization. Regional interdependence was further intensified as a result of the Cold War, various restraints imposed by the West on trade and the transfer of technology, and the lack of currency convertibility.

Central planning was the guiding principle underlying trading relationships between the USSR and other CMEA countries. Trade between CMEA countries was organized within the framework of five-year plans, the last of which covered the period 1986-1990. To deal with intervening changes in prices and other factors, detailed annual trade protocols were prepared with each trading partner to ensure that trade continued to be balanced bilaterally. These protocols served as the basis for concluding contracts between FTOs, individual enterprises, and firms, which were responsible for fulfilling the terms of contractual obligations. After the mid-1980s, the medium-term plans rapidly lost relevance and were officially abandoned in 1989, while the annual protocols continued.

Another crucial feature of the CMEA trading arrangements has been the bilateral negotiation of trade prices. In principle, prices are set annually based on price developments in world markets in the five-year period preceding the year of delivery (the Moscow formula). In practice, this rule generates unambiguous prices for only a few homogeneous raw materials and intermediate goods for which prices in world markets are well established; for all other goods the rule can at best define starting positions for bargaining. Because of the lack of information on world market prices for manufactured products comparable to those produced by CMEA countries, there is substantial scope for negotiation. This process has led to a systematic overvaluation of manufactured goods relative to raw materials and standard intermediate products. With the USSR a net exporter of the latter goods, and a net importer of the former, it has in effect been subsidizing its CMEA partners through this channel. There are methodological difficulties in quantifying the extent of this subsidy: estimates have ranged from about US$6 billion to US$14 billion based on 1989 trade flows and world prices.2

CMEA trade transactions are denominated in a common accounting currency, the transferable ruble (TR), with accounts kept at the International Bank for Economic Cooperation (IBEC). Surpluses remaining in accounts vis-à-vis one trading partner cannot be used to settle deficits vis-à-vis other partners, so that CMEA trade is essentially nonconvertible and bilateral in character. Since unplanned surpluses cannot be readily used in the absence of convertibility, export quotas are an essential tool, managed so as to avoid as much as possible “involuntary trade credits” which amount to a waste of the exporting country’s resources.

In January 1990 at a meeting of the CMEA Council members, it was agreed that beginning January 1, 1991, CMEA trade would be conducted on the basis of world market prices with settlement in convertible currencies. Formally, the previous rules and the existing bilateral agreements were still in force for 1990; however, with the acute balance of payments problems faced by most member countries and the absence of an effective enforcement mechanism, contracts were frequently not fulfilled as agreed.

Trade with non-CMEA countries governed by bilateral trade agreements accounted for 12 percent of total Soviet trade (exports plus imports) in 1989. These government-to-government agreements are negotiated individually and contain some country specific features: in general, the protocols define the quantity and quality of goods exchanged between each pair of countries and their prices. In most respects, trade is conducted in a manner similar to CMEA trade; differences arise mainly in the provisions for settling imbalances. The phase-out of these agreements is likely to differ from country to country. Bilateral arrangements with India, and possibly a few others, are expected to continue, while those with China, Yugoslavia, and Finland are expected to move to a convertible currency basis in 1991.

About one quarter of trade is with the convertible currency area, comprising mainly trade with developed countries. On the export side, this trade is heavily concentrated, on the export side, in fuels, minerals and some other raw materials. On the import side, the pattern is more diversified, though typically with a high share of agricultural imports. Overall targets for trade with the convertible currency area are established in the plan. For raw materials, food, and energy products, trade is normally carried out on a cash basis with settlement in 30 days. For machinery and equipment imports, bank credits and supplier credits have been extensively used, though a specific license is required to take up such credits.

b. Restructuring foreign trade relations: 1986-1990

In 1986, the Soviet authorities took steps to break up the Ministry of Foreign Trade’s monopoly on Soviet trade and to introduce incentives for export growth and diversification. The stated aims of the reforms were to encourage greater contact of branch ministries and enterprises with their counterparts in other countries, to promote the exports of manufactures, and to improve the quality and sophistication of Soviet exports. Another important objective was to pave the way for the eventual integration of the Soviet economy into the multilateral trading system. Results thus far have been generally disappointing, perhaps indicating that partial reforms are of only limited value if they do not substantially alter the basic incentive structure.

(1) Institutional reforms

The reforms initiated in 1986 involved a reorganization of the administrative structure and a decentralization of trading rights. The State Foreign Economic Commission (GVK), a permanent body of the Council of Ministers, was established to oversee all activities related to the foreign sector. It was given the responsibility for strategic foreign economic planning and for overseeing the activities of the Ministry of Foreign Trade (MFT) and other ministries and organizations engaged in foreign economic activities. With the decentralization of trading rights (see below), part of the trading activities of the MFT were divested and its operations were consolidated.

In 1988, the functions of the MFT and many of those of the GVK were combined under the newly created Ministry of Foreign Economic Relations (MVES). Under this reorganization, the MVES retained jurisdiction over 25 FTOs which traded in raw materials, foodstuffs, individual types of machinery and equipment, and other commodities. These FTOs presently account for about 70 percent of Soviet exports and roughly half of total imports. Most machinery imports and about one third of machinery exports continue to be handled by FTOs under the jurisdiction of the MVES.

The decentralization of trading rights initiated in 1986 principally affected the civilian manufacturing sector. At that time, a significant part of the trade in manufactures handled by the MFT was placed under the jurisdiction of the specialized branch ministries, and trading rights were extended to about 20 economic ministries and some 70 associations and enterprises. The aim was to shift from a system of centralized control to one of indirect control based on the economic autonomy of enterprises and their associations; the principles of cost accounting, self-support, and self-financing were stressed. In early 1989, trading rights were further liberalized to permit any firm or enterprise to engage in foreign trade once it has registered with the MVES, which has branch offices throughout the USSR for this purpose. By 1990, more that 20,000 organizations had registered.

Enterprises have the right to export their own products or to import for their own needs; however, they are not generally permitted to purchase imports or domestic products for resale. These restrictions are judged necessary because controlled domestic prices create significant opportunities for arbitrage. While enterprises can engage in trade directly, in practice most enterprises work through trade organizations. These organizations are allowed to intermediate trade by virtue of their charters, and they operate on a commission basis. Enterprises are free to choose the trading organizations they deal with, or to form their own trading associations; however, competition is limited in practice because there is normally just one, or a few trading organizations that handle specific product lines.

(2) The incentive structure

An important aspect of the reform effort was to introduce incentives for exports. The previous system, whereby trade was effectively transacted at fixed domestic wholesale prices and the exchange rate served only an accounting role, was changed in 1987, and a foreign exchange retention scheme was introduced in the same year. With the decentralization of trading rights and the ability of enterprises to deal directly with foreign trade partners, it was no longer practical to conduct trade based on fixed domestic wholesale prices. A system of differentiated foreign currency coefficients (DVKs) to provide a more flexible linkage between world prices and domestic prices for traded goods was established in 1987. On the export side, the system covered 100 percent of machinery and varying proportions of other manufactures; raw materials (about 70 percent of exports) were excluded. Only a few import products were covered by the DVK system, mainly intermediate and capital goods provided for in the plan; for other imports, domestic and world prices were aligned by means of import taxes.

The coefficients were intended to permit domestic wholesale prices for traded goods to fluctuate with foreign currency prices or the official exchange rate. In practice, however, the use of price equalization taxes and subsidies continued on a wide scale to limit the impact of foreign price changes on domestic prices. The DVKs were frequently set so as to stimulate specific exports. The coefficients were differentiated by export/import region and by commodity, and in effect created a different exchange rate for each separate transaction. Initially, the coefficients were set to reflect the incentive structure embodied in the previously existing system of budgetary taxes and subsidies, so there was no material shift in incentives. Over time the number of coefficients expanded as enterprises demanded more favorable coefficients for their products. Reportedly, the number of coefficients had increased from 1,600 in early 1987 to 10,000 by 1988, and ranged initially from 0.1 to 15.9. Subsequently their number was reduced sharply and their range narrowed. The system was abolished effective November 1, 1990 when a more depreciated commercial exchange rate for the ruble was established.

The more important export incentive was the introduction of a foreign exchange retention scheme; prior to this, all foreign exchange earnings were surrendered to the state. Under the new scheme, enterprises are allowed to retain a percentage of their foreign currency earnings (retention quotas) in retention accounts that may not be appropriated by the state. Exports of manufactures are encouraged by permitting a higher retention quota the higher the degree of processing. Retention quotas are set by enterprise and presently range from zero to 100 percent, with most quotas in the range of 30 to 40 percent. Joint ventures and cooperatives can retain 100 percent of their foreign exchange earnings. The average retention rate, however, has been small thus far—less than 10 percent—reflecting the low retention quotas for raw materials and energy, and the fact that convertible currency exports are a small part of the total.

Retained foreign exchange can be used by enterprises to meet their requirements for intermediate and capital goods; up to 30 percent can be used to purchase consumer goods for their employees. Surplus foreign exchange can also be sold for rubles at the currency auctions that have been held monthly since 1989, though few transactions have taken place despite the attractive rates that have been offered at these auctions.

With the introduction of retention quotas and self-financed imports, there has been a corresponding reduction in centralized imports through the plan. In this respect, enterprises requiring imported inputs but not themselves in a position to earn foreign exchange by exporting are at a disadvantage, though the foreign currency budget continues to provide foreign exchange for favored projects. In addition, importers can seek foreign currency loans from the VEB (subject to availability of foreign exchange) and purchase foreign exchange at currency auctions.

(3) Trade regulations

The decentralization of trade since 1986 has entailed some loss of control by the authorities over both the composition of trade and its overall balance. As a result, there has been an intensification of the use of trade instruments to limit the resulting strains and dislocations. Trade restrictions are geared primarily toward ensuring adequate domestic supplies of certain commodities, rather than toward protection. Presently about 70 percent of exports are licensed, covering mainly raw materials, energy-related products, and consumer goods. Only about 6 percent of imports are licensed, because the allocation of imports is effectively controlled through the foreign exchange budget. Frequently, quotas are used in conjunction with licenses. A particular instance is the use of quotas to limit the export of consumer goods to the amount provided for in the plan. Licenses are given only to manufacturers that have quotas. It is possible to export more than planned if the manufacturer has fulfilled all domestic contracts and state orders. However, if a product is in short supply domestically, a firm could have fulfilled its domestic obligations but still be prohibited from exporting.

Trade with CMEA countries and some developing countries is also regulated by country for balance of payments reasons, i.e., in order to achieve balanced trade. This pertains mainly to countries with which the USSR maintains bilateral trade agreements. If there is a trade deficit, imports are regulated by simply ceasing to issue the relevant licenses. This instrument has become of considerable importance in the past two years as economic disruption has led to non-fulfillment of trade protocols and resulting imbalances. Imports from Finland, Yugoslavia, Egypt, and Hungary have recently been constrained, as have exports to the People’s Democratic Republic of Korea.

Finally, it should be noted that the emergence of substantial price differences for certain commodities within different regions of the country has entailed the rapid growth of interrepublican trade quotas, generally applied in an ad hoc manner, to assure that local deliveries are not disrupted by diversion of goods to higher priced areas.

With the recent phase-out of the DVK system and the introduction of a commercial exchange rate, explicit import and export taxes have been adjusted accordingly. Because most domestic wholesale prices are expected to remain fixed, however, the system of price equalization taxes and subsidies will have to continue, although probably at reduced levels.

The customs tariff that has been in effect since 1984 covers only 319 items and has not been enforced. The State Customs Control Authority has recently been reconstituted to develop a new customs tariff and statistical system that would conform to the principles and nomenclature established by the GATT. A new customs law has been prepared to take effect on January 1, 1991. The customs tariff is based on the harmonized system and covers 5,019 items. It includes preferential rates for developing countries and higher rates for commodities imported from countries that do not give most-favored-nation treatment to the USSR.

The draft customs law initially sets rather low tariffs—except for luxury goods. While the intention is that tariffs should replace other means of protecting domestic producers from import competition, it is unclear whether other forms of protection will in practice be discontinued. As domestic prices are deregulated and various forms of equalization taxes are phased out, tariffs will be adjusted, or coupled with new border taxes in some fashion, to assure a continuing adequate level of protection.

c. Assessment of the trade regime and reform efforts

The traditional framework governing the international transactions of the USSR, and the restrictions through which it operated, served to limit the interaction between the domestic and the world economy and to isolate domestic enterprises from world markets. In this environment, the industrial structure of the USSR did not keep pace with the developed economies or realize its growth potential. In an environment in which most goods were administratively allocated, domestic prices did not reflect relative scarcities or comparative advantage and, consequently, did not play the role of channeling resources to their most efficient uses.

The reform efforts of recent years have been directed to modifying some of the features of the traditional system by encouraging more direct involvement of enterprises in international trade, and by allowing price incentives some role in influencing resource allocation. But this has resulted in a very complex and non-transparent regime whose allocative and incentive structure it is almost impossible to assess comprehensively. The following features stand out:

First, while reforms have greatly extended and decentralized trading rights, enterprises have been constrained in a variety of ways in responding to the new opportunities. Indeed, few enterprises have exercised these rights, because of inadequate incentives. Most continue to depend on trade organizations under the control of branch ministries. The continued primacy placed on meeting domestic demand in the face of fluctuations in production resulting from domestic supply problems has also limited the ability of enterprises to supply export markets on a reliable basis. As a result, directives and state orders continue to be the principal instruments guiding foreign trade, with the FTOs continuing to play a dominant role. Second, the complex system of DVKs neither produced a stable incentive structure for trade that would be responsive to underlying comparative advantage, nor provided a coherent bridge between domestic and world prices. Third, export incentives resulting from currency retention quotas are an important innovation. But the size of these retentions remains small, and the high degree of differentiation by degree of processing could in fact hinder the workings of comparative advantage in allocating resources. For example, low or zero retention quotas for energy products and raw materials would tend to restrict imports by enterprises in these sectors, even though the efficient exploitation of these resources will require the large-scale importation of sophisticated capital equipment. Finally, the composition of imports continues to be primarily determined by administrative decisions on foreign exchange allocation rather than by the price mechanism. The only exceptions to central allocation are the currency retentions, the (minuscule) foreign exchange auctions, and of course the illegal or grey markets of undetermined size.

More generally, the regulatory framework lacks transparency and stability and is overly complex because of the need to neutralize distortions arising from domestic price controls and the lack of currency or commodity convertibility. Thus the free flow of resources in response to relative prices is impeded even within the USSR. Restrictions on foreign trade are arbitrarily imposed in response to domestic shortages or for balance of payments reasons.

The constraints imposed by bilateral trade arrangements add to the inflexibility of the system and the distortions in resource allocation. In particular, the CMEA’s potential as a customs union was never realized because of features that inhibited both trade and specialization: contracts arranged by government level agencies rather than by enterprises; the inconvertibility of the transferable ruble both inside and outside the CMEA; relative foreign trade prices that bore little relationship to either the relative domestic prices enterprises faced or relative world market prices; inadequate incentives to share technological knowledge; and uneconomic transactions resulting from the need to balance trade.

3. REFORM ISSUES

a. Objectives

The Soviet authorities recognize the unsatisfactory character of the “half-way house” where the trade system is presently lodged. Intentions as stated in the presidential guidelines are to move towards a system of trade based largely on market mechanisms and a convertible ruble. Nevertheless, the guidelines take a cautious approach to trade liberalization within the overall reform effort. Such caution is perhaps understandable in view of the small share of trade in overall economic activity; and it is no doubt correct that in the short- and medium-term the trade “tail” may be too small to wag the domestic economy “dog.” Primary emphasis on domestic economic reform is thus warranted. Nevertheless, the Soviet authorities may underestimate the potential importance of trade liberalization to improve economic performance even during the early stages of transformation to a market economy. At least three specific considerations underlie this judgement.

First, an opening up of the economy can contribute to generating the competitive pressures that will be needed to limit the exploitation of market power by highly monopolized domestic industries. While import competition cannot be expected—for an economy the size of the USSR—to be an adequate substitute for domestic competition even in tradeable goods sectors, its impact in diluting domestic market-power is greater than what would appear from a consideration of import shares alone. Enterprise pricing behavior depends as much on potential as actual competition; and to that extent Soviet concerns that giving freedom to enterprises has to be handled very cautiously to avoid monopoly exploitation may be overdrawn if trade reform is carried out in parallel. Likewise, on the export side, the liberalization of export possibilities would provide incentives to firms to maintain their production even in cases in which domestic market-power would lead them to restrict supplies to the domestic market. This would serve to maintain employment in these firms at higher levels than otherwise, and the resulting increase in foreign exchange earnings would in turn expand the capacity of the economy to import, and thus further weaken monopoly market power.

Second, as economic restructuring proceeds, specific bottlenecks and unavailability of needed inputs are likely to become more frequent and severe, because changed ways of organizing production are likely to require specific inputs different from those currently produced domestically. For example, agricultural reform may entail urgent needs for smaller tractors, rather than the large models in which Soviet production has specialized. The crucial role of imports in breaking such bottlenecks is evident. Since it is unlikely that critical areas where such “holes” in domestic production emerge could be identified in advance, a framework that allows such “unplanned” import needs to be met in a decentralized way is essential.

Third, the general experience of countries “opening-up” to foreign trade has been that such trade expansion generates economic benefits not only through better resource allocation in a static sense, but also significant gains related to the transfer of marketing know-how, to improved information on product lines, and to innovation more generally. There is every reason to suppose that such gains from trade would emerge in the case of the Soviet economy also.

For the above reasons, the analysis of trade reform issues presented below is based on the premise that such reform is important not only as a longer-term goal of putting in place a structure for trade relations that would be consistent with a well-functioning market economy, but also in the near term as part of the economic transition. Indeed, the focus of this section is on the relatively short-term, recognizing that in this period important domestic disequilibria will persist and that the institutions of a market economy will be only partially in place.

b. Assumptions and preconditions

What is feasible or reasonable in the area of trade reform is heavily dependent on the overall design and implementation of domestic economic reforms. There are enormous uncertainties here, two of which in particular are of decisive importance: the future of union-republic economic relations, and the pace and extent of domestic price liberalization.

(1) Union-republic relations

The presidential guidelines are clear in affirming the importance of preserving an integrated market for goods and services within the USSR. It remains uncertain, however, if this objective will be realized. Initiatives and laws being discussed in a number of republics would entail fragmentation of the internal market even if such is not their intended purpose. In addition, pressures arising from prices differing across republics and regions are already giving rise to ad hoc measures to restrict interregional flows of certain commodities. In the absence of an agreed common framework, such pressures could be expected to intensify as reforms proceed and gather pace in the different republics.

If a generalized fragmentation of the internal market were indeed to take place, issues of external trade reform at the level of the union would become enmeshed with the need to define at the same time a framework for interregional trade relations to limit as much as possible the enormous transition costs resulting from this course of events. It is assumed here that things will not come to such a pass; and that compromises will be found to preserve the essential integrity of the union market.

There is no unique model of union-republic relations that is required to assure the integrity of the union market. A range of federal structures, more or less decentralized, have in other countries proved viable. In this regard, for example, the topical question of whether the rights to the natural resources found in a particular republic are vested in the union or in the republic governments is of secondary importance: the coexistence of state owned and federally owned lands and resources (as for example in the United States) is quite workable. What does appear essential is the early adoption of a general prohibition against any republic’s taking actions that interfere with the movement of goods or services across its borders with other republics.3 Such a prohibition is explicit in the presidential guidelines though only with respect to “an agreed list of commodities.” It remains to be seen whether this point of the guidelines will gain general acceptance by the republics. It is assumed here that a common economic space is maintained.

(2) Domestic price liberalization

It is unclear what, if anything, can really be accomplished by trade reform as long as domestic prices do not clear markets, hard budget constraints do not force enterprises to focus on marginal costs in managing their operations, and profit seeking behavior is not encouraged so as to induce firms to respond to price incentives. Of course any set of trade regulations will give rise to certain incentives even if domestic markets do not clear, but there is no way to assess whether such incentives, if acted on, promote or reduce national welfare. And as a practical matter, the authorities would normally find administrative control over trade to be essential as a means of preventing arbitrage through international markets from undermining the availability of goods at controlled prices on domestic markets. The presidential guidelines are relatively cautious with regard to price liberalization but, for the reasons discussed in Chapter IV.1, it is unlikely that this can in fact be sustained. It is therefore assumed that, in line with the recommendations made in other chapters, price liberalization will proceed rapidly across a very broad range of goods.

c. Enhancing the role of market mechanisms

There are three essential, interrelated elements in shifting from a system of largely administered trade to one in which determination of exports and imports can be left primarily to the decentralized operation of market mechanisms. First, trading rights have to be broadly distributed in the operative sense that firms and enterprises are able to choose without undue administrative hindrance what goods to buy or sell and on what markets. These choices, however, must be made in an environment in which enterprises compete with each other to exploit trading opportunities. Second, a means must exist whereby firms can bid on an equal footing with other firms for the foreign exchange they need to carry out their transactions. Third, appropriate and stable price incentives need to be allowed to operate in guiding firms’ decisions with respect to their trading choices.

(1) The distribution of trading rights

Trading rights have been substantially decentralized in the past few years in the sense that large numbers of enterprises and organizations have been allowed to register their rights to engage in trade. Indeed, this is the area where trade reform has gone furthest: in principle there are no restrictions on enterprises to engage in trade. Trading rights are limited, however, by the widespread imposition of licensing and quota arrangements, with the result that effective capacity to engage in foreign trade remains highly concentrated. The rationale for such administrative controls over trade can be expected to diminish as indirect mechanisms for controlling trade are put in place. As this happens, the licensing of specific trade operations would increasingly become superfluous and should thus be abolished.

A key administrative reform issue is how to introduce competition into the management of trade operations, so as to bring domestic producers into effective direct contact with producers elsewhere on both the domestic and world markets, while not sacrificing the expertise that particular trading institutions have acquired with respect to the commodities they handle. Clearly, it would be inefficient for every domestic producer to be required to forge its own trading links (though each should have the right to do so). Trading companies and associations have an important role. What is essential is that these companies and associations be in a competitive, rather than a monopoly situation. Trading rights need to be defined broadly and not in terms of specific commodities; this is already allowed for under current legislation but needs to be accelerated by severing the links between trading organizations and the branch ministries that sponsor them. Indeed, this could be achieved most directly by abolishing the branch ministries. For similar reasons, the FTOs under the control of the MVES should be reconstituted as independent trading companies. Finally, the present prohibitions on arbitrage operations needs to be abolished: their rationale in any event disappears with domestic price liberalization. To establish competition, enterprises need to be able to sell not just what they produce, and not just to buy what they need, but to exploit opportunities for profitable trade wherever they find them. There is no obvious need to restrict the activities of trading companies and associations to executing orders for clients.

(2) Access to foreign exchange

The presidential guidelines call for the progressive establishment of “internal convertibility” as rapidly as possible. The precise meaning of this concept is open to debate. One element is that money should be freely convertible into goods on the domestic market, implying inter alia an end to rationing by scarcity at controlled prices. As regards international transactions, the essence of internal convertibility, at least with respect to a well defined set of Soviet enterprises and other residents (including joint ventures) and a broad range of external transactions, is a well defined market in which rubles can be bought and sold for foreign exchange at a rate (fixed or variable) established within a foreign exchange market. With either a fixed or a variable rate, the monetary authorities might intervene to supply or withdraw funds from the market (and indeed under a fixed rate would be bound to do so); but direct controls on foreign exchange (nonprice rationing) would be excluded.

It is clear that there can be a greater or lesser degree of “internal convertibility” depending on the restrictions affecting who can enter this market, and for what purposes. A benchmark that is often used is that of current account convertibility, which allows access to the foreign exchange market for both enterprises and households for current transactions. A somewhat more restrictive system would be to limit access to the market to enterprises, and to continue to ration foreign exchange to individuals with respect to their needs for tourism or other purposes.

So long as there are restrictions on participation or on the types of transactions that can be funded in the foreign exchange market, there is the likelihood that other exchange rates will exist on parallel markets to accommodate excluded participants. In addition, other nonmarket clearing rates can be maintained by the government to govern particular transactions, entailing legal requirements on the relevant transactors to buy or sell foreign exchange at that rate.

From this point of view, a way of assessing progress in achieving internal convertibility might be to focus not only on restrictions in force, but on the dispersion of both the administratively maintained rates and those prevailing in parallel markets relative to that established on the officially sanctioned foreign exchange market: an “adequate degree” of internal convertibility might be judged to be one where such rate dispersion was less than some modest threshold, so that the penalty from not being able to transact at the market exchange rate was a relatively small one.

A first step, already envisaged for 1991, is the establishment of a foreign exchange market to be fed from retention quotas of exporting firms and central resources organized as an auction market. In the absence of a functioning system of interbank foreign exchange operations, the monetary authorities will have to play a major role, using their reserves (or special funds) to smooth exchange rate fluctuations. It would seem quite unrealistic initially to attempt to fix the exchange rate in this market for periods longer than a day or a week. In the short run, the information needed to define an “equilibrium” rate for this market is not available. Indeed, unless access to the market were tightly limited by administrative means (which would tend to defeat the longer run purpose of making this market the principal vehicle for allocating foreign exchange), it seems likely that current conditions of excess domestic liquidity would spill over into this market and drive the ruble to very depreciated levels.

Partly for this reason and more generally to provide a stable framework, current plans call for retaining administered exchange rates, different from the free market rate, to regulate a broad range of transactions. To this end, a new commercial rate of initially 1.66 rubles to the dollar, effective November 1, 1990, has been introduced—a major depreciation compared with the official rate of 0.55 rubles per dollar.4 At present, it is this commercial rate that matters for most transactions. Enterprises earning foreign exchange are obliged to surrender most of these earnings to the authorities at this rate. In turn, enterprises that require foreign exchange to purchase imports receive foreign exchange from the authorities at this same rate if the corresponding imports are authorized in the annual currency budget established on the basis of the plan. Prospectively, with the establishment of a foreign exchange market, and the abolition of a (comprehensive) currency budget, importers will to a large extent have to obtain their foreign exchange at the market rate. A surrender requirement will, however, remain in effect for exporters.5 The foreign exchange obtained by the authorities from exporters is to be used for their own purposes, most importantly for the servicing of foreign debt but also perhaps for priority projects.

Such a multiple rate system is in essence an implicit tax on the tradeables’ sector of the Soviet economy, whose yield is equal to the gap between the official and market rates of exchange multiplied by the amount of foreign exchange surrendered at the official rate. In the first instance it is the exporter who “pays” the tax (the difference between the rubles it actually receives for the foreign exchange it surrenders and what it would have received at the market rate). But since the market rate is more depreciated than it would otherwise be as a result of a reduced supply of foreign exchange to this market, the incidence of the tax is shifted in part to (some) importers.

Elimination of this multiple rate system would seem desirable. Implicit taxes of this sort on the tradeables’ goods sector are unlikely to reflect accurately policy intentions: explicit taxes or tariffs on trade transactions have the virtue of transparency. It may, however, be difficult to move to a single rate in one step because the institutions and experience that are required for the efficient functioning of a foreign exchange market will take time to develop. Furthermore, foreign currency reserves appears to be inadequate to provide a sufficient cushion for exchange rate fluctuations. A transition period during which the multiple rate system continues to operate may thus be necessary.

What is important is that foreign exchange surrendered to the authorities be used for debt service or the constitution of reserves (with any surplus funds beyond these being channeled back to the foreign exchange market) and not for priority projects which may appear attractive when costed out at the commercial rate, but would cease to be so if they had to be funded in the market. The likelihood of such restraints being observed is, however, reduced by current problems of union-republic relations. All levels of government expect to “share” in the implicit tax revenues generated by the multiple exchange system.

A feasible transition strategy for reaching internal convertibility might focus, in operational terms, on progressively reducing the gap between the commercial and the free market exchange rates to zero. The initial gap will almost certainly be huge. Even the most optimistic projections by the Soviet authorities in late 1990 suggested an initial rate of 6 rubles per dollar in the free foreign exchange market.6 Recent auction rates (perhaps not fully indicative of underlying market conditions because of the very imperfect and restricted character of these auctions) had been in the order of 20-25 rubles per dollar. Starting from these huge gaps, progressive convergence could be achieved by tightening monetary policy, while progressively depreciating the commercial rate.

As noted earlier, the authorities have in recent years built a small margin of flexibility into the system of foreign exchange allocation by permitting exporting firms to retain some portion of their foreign exchange earnings for their own use rather than being required to surrender all of it to the authorities at the official rate. In the absence of a foreign exchange market, such retentions would seem on the face of it to provide strong incentives to Soviet enterprises to develop their exports, since other means of obtaining foreign exchange are very restricted. (Likewise, the 100 percent currency retentions accorded joint ventures would seem to provide a strong incentive for Soviet enterprises to enter into such ventures.) Export results thus far have not strongly confirmed this expectation, presumably because of other impediments in the present system.

As part of economic reform, it is envisaged to increase retention quotas, and reduce their dispersion. Nonetheless, it is intended to preserve a considerable amount of differentiation between unprocessed and more highly processed goods. The logic for this approach is open to question. While ostensibly geared to creating differentiated export incentives in favor of processed goods, the instrument is perhaps not well suited to this because the strength of the incentive is uncertain, fluctuating over time as the gap between official and market rates changes, and in any event due to disappear as internal currency convertibility is approached. The important thing is that retentions should be substantial, since these will constitute the principal source of funds for the foreign exchange market. A uniform retention rate might be both more effective and easier to implement politically than the intensive negotiations that are implied by the setting-up of a system of differentiated retention quotas. Specific incentives for exporting certain commodities are better provided by explicit trade policy measures than by the implicit, though uncertain, tax reliefs provided by differentiated currency retention. Finally, it should be noted that as internal convertibility is achieved, the value of retention quotas falls to zero. At that point the logic for retaining them disappears altogether.

(3) Price incentives for engaging in trade

At present there are enormous differences in the structure of relative prices between the USSR and world markets; in the absence of trade liberalization, many of these differences would persist even if domestic prices in the USSR were largely liberalized, because the structure of market clearing prices within the USSR will reflect specific capacities and shortages resulting from the present production structure. Opening up to trade in these circumstances would tend to eliminate differences between relative price structures domestically and on the world market (at least as regards tradeable goods), through the arbitrage operations that would ensue.7

In the past, the Soviet authorities have aimed at neutralizing the pressures arising from differences between domestic and world prices by various means: border levies, the DVK system, and—where these have been insufficient to equalize prices—direct administrative prohibitions on arbitrage operations that would exploit these differences. But a policy of systematically neutralizing price differences in this way is not tenable in the context of economic reform. It is precisely such price differences that signal the directions in which resources need to flow, and that provide the incentives for a more efficient resource allocation.

In the short run, however, the move to world prices risks being disruptive. It will take time for enterprises to readjust their production to cope with international competition although the scarcity of foreign exchange and likely weakness of the ruble on the foreign exchange market will provide considerable protection to domestic enterprises. In some cases, activities revealed to be uneconomic at world prices will have to be scrapped. The sharp increases in input costs, particularly for energy if its price rose immediately to world levels, might also entail serious adjustment problems for Soviet enterprises. Some ways of cushioning the shock may thus be appropriate.

Up to now, trade policy has primarily focussed on the need to prevent diversion of scarce goods from the domestic markets to exports, and extensive quantitative restrictions on exports have been imposed to prevent this. This concern would largely cease to be relevant for goods whose prices are liberalized domestically. Indeed, if anything, the problem is more likely to be one of insufficient incentives to export in a situation in which firms are required to surrender a significant portion of the foreign exchange they earn at a commercial rate that is well below market clearing levels.

So long as oil prices and perhaps some other input prices were maintained domestically at administered levels below world prices, border measures would of course remain necessary to sustain these prices through quantitative restrictions (or indeed taxes, but such taxes would have to be adjusted continuously as world market prices changed). However, if the objective were to cushion domestic energy users for a time from the full effect of a move to world prices, this could be done—while eliminating administered prices domestically—by setting export taxes on energy at a predetermined level and with a planned phase-out, say over three years. So long as domestic production of these inputs exceeds domestic demand at the prevailing domestic price, such a system of taxes would assure a gap between domestic and world prices equal to the tax. Fluctuations in world energy prices would then be reflected in domestic prices, assuring, inter alia, that the gap between domestic and world prices converged downward as the export tax was lowered. There would also be considerable gain from this approach in that it would eliminate the need for maintenance of a cumbersome bureaucratic structure to handle administered pricing and would foster independent decision making by energy producing units.

At present, customs tariffs play no real role in resource allocation since, at the current exchange rate, it is the availability of foreign exchange rather than the price of imports that is the binding constraint. But once a functioning foreign exchange market becomes the principle vehicle for allocating foreign exchange, relative prices as influenced by customs tariffs will become much more important in influencing trade patterns.

It is important, in considering the design of tariff policy, to recognize that customs tariffs will interact with the level of the market exchange rate in ways that will influence both imports and exports. In particular, while high average tariffs might seem to provide greater protection to domestic enterprises than low ones, this cannot be taken for granted. High tariffs might rather result in a more appreciated exchange rate for the ruble in the foreign exchange market than otherwise, thus offsetting the direct import discouraging effects of the tariffs, and also discouraging exports since the incentive value of currency retentions would thereby be weakened. Similarly, low tariffs could lead to a more depreciated ruble, thus rationing imports and encouraging exports. In effect, it is not the average level of tariffs, but rather their dispersion that can predictably be counted on to provide protection to those sectors having the highest tariffs. Interactions between tariff levels and the exchange rate such as described above are more likely to be relevant for the USSR than for the industrial economies, since for the latter exchange rates are driven to a large extent by capital flows rather than the balance on commercial transactions.

In view of the above, there are a variety of considerations pushing in different directions with regard to the desirable features of a tariff policy for the USSR. First, a strongly skewed tariff structure—with relatively high tariffs on those goods where the gap between domestic and world prices is greatest—would tend to provide the strongest protection to those enterprises facing the largest adjustment tasks, and so perhaps reduce adjustment costs for a time; but at the expense of weakening the links between domestic and world relative price structures. A more uniform tariff structure with less dispersion would, by contrast, be desirable to speed the adjustment of domestic to world prices and so accelerate economic integration.

Second, whatever degree of dispersion adopted, low average tariff rates would promote a more rapid expansion of trade than high ones. High tariffs act as a deterrent to trade not so much because they restrict imports, but because they inhibit the development of exports both directly (by raising the cost of imported inputs into export production) and indirectly through their effects on the exchange rate.

On the other hand, high average tariff, may be seen as attractive for two reasons. First, such tariffs generate budget revenues. Given limited administrative capacity to introduce and manage new tax systems and the pressing need to reduce budget deficits, this may be an important consideration. Second, balance of payments considerations may also argue for a relatively high average tariff.

Finally, equity considerations could argue for relatively high tariffs on luxury consumer goods, although to this end it would be preferable to use excise taxes that fall equally on imported and domestically produced luxuries. Certainly high, and even very high tariffs on luxury goods are to be preferred to quotas or prohibitions. There will surely be “windfall winners” from the economic reform process, and high tariffs on the goods that such winners will demand may constitute the most effective way of taxing these winnings.

Some compromises among such objectives are perhaps unavoidable. A general framework that embodies such compromises would be the following: a set of moderate tariffs with an average rate of around 30 percent and a minimal degree of dispersion could be announced and implemented as an anchor for longer-term relative price expectations. Supplementary import taxes on a small number of goods might be introduced as an adjustment measure in cases where firms were judged to be in a position to compete against imports after a restructuring, but could not survive the shock of an immediate move to world prices. Such import taxes would need to be subject to a preannounced schedule for their reduction and elimination to ensure that they did indeed serve a buffer function, and not as a permanent protection for activities that are not viable at world prices.

There is no good reason for the USSR to impose import quotas, even as a transition measure. To a first approximation, the protective effect of quotas can be achieved equally well by tariffs. In addition, under the highly monopolized conditions of Soviet industry, quotas risk perpetuating market power in a way that tariffs—even high ones—do not. Furthermore, it is extremely difficult in practice to administer quotas in such a way that the “quota rents” are fully captured by the government, or indeed by the domestic economy in general. Most often quota rents are largely appropriated by foreign suppliers. Tariffs, by contrast, do generate a predictable income to the government. The spread of quantitative import restriction in developed countries is less an indication of the superiority of such measures for protective purposes than a result of the fact that tariff measures are largely unavailable on a unilateral basis because tariff levels are “bound” in the GATT. The USSR at present faces no such constraints.

d. Other trade issues

In addition to the reform issues examined above as central to any move towards a market-based trading system, two further issues are very much “on the table” in assessing the role of trade in the transition process. The first is the nature of Soviet international comparative advantage in coming years and in the longer run, and the trade strategy, if any, that should be adopted. The second is the question of transitional arrangements for CMEA trade, recognizing that the traditional system is being terminated and that the intention is to shift to decentralized trading relations at world prices and convertible currency settlement.

(1) Comparative advantage

Soviet exports are heavily concentrated on energy products and raw materials—and this concentration is even more marked if only convertible currency trade is considered—with energy products, ores and metals, and wood and paper accounting for over 75 percent of Soviet exports to the developed market economies in 1989. Imports are less specialized: machinery and equipment imports are important, and many types of equipment account for well over half of domestic consumption. This pattern is partly a reflection of an intentional division of labor among the CMEA countries, though machinery imports from the convertible currency area are also significant. The share of food imports in the total, at close to 20 percent, is very high by international comparison, and can be judged to be the result of the serious organizational and incentive problems of the Soviet agricultural sector rather than a reflection of innate lack of comparative advantage in food production.

In the long run, it is clear that the dependence on energy and raw material exports will decline in relative importance. An economy as large as the USSR, no matter how well endowed with natural resources, cannot plausibly maintain such a specialization. As the structure of Soviet production develops along market lines, it would be natural to assume that a more diversified trading structure would emerge, with trade in manufactured goods (the most dynamic component of world trade for the past forty years) holding an increasingly large share of the total. Eventual growth of intra-industry trade based on dynamic comparative advantage would seem to be appropriate for the USSR as it has been for most countries reaching higher levels of development along market lines. But in the short run, there is a difficult question of priorities: developing the capacity to compete effectively in world markets for manufactured goods will take time, and actions to accelerate this would require, inter alia, a very depreciated ruble (or large subsidies to manufacturers) to offset the weaknesses of present Soviet production in terms of product quality. In view of urgent needs to raise foreign exchange earnings in order to ease balance of payments constraints on imports, it may be more effective to concentrate efforts on increasing exports of energy and raw materials, where faster results could plausibly be obtained.

The extent to which energy exports might be increased in coming years remains very uncertain with both optimistic and pessimistic evaluations possible. As regards oil, the pessimistic assessment would be that production has already peaked, that marginal production costs are rising strongly, that domestic conservation efforts will bear fruit only slowly, and that therefore the quantities available for export will continue the decline that has been observed in the past two years. But even a superficial analysis of current energy practices in the USSR makes it clear that the scope for increased efficiency in both production and use of oil is enormous. Accordingly, a more optimistic assessment is also possible. This would argue that reform in the oil sector, by creating proper price incentives and by bringing in foreign investment to overcome technological and managerial problems, would make it possible for much of this scope to be realized within a few years. Which of these views is relevant may depend primarily on the degree of ambition and skill in implementation of reform of the petroleum sector.

Prospects for natural gas are generally agreed to be somewhat brighter, as even without thoroughgoing reform, production is likely to expand in the years to come. The expansion of gas exports, however, may be dependent on major infrastructure developments in new pipelines and liquefaction plants, as well as the development of new markets given that the present structure of the Western European market for natural gas is relatively tightly controlled. Whatever the uncertainties, a sensible strategy would be to assign a high priority in the short term to reform of the domestic energy sector, along the lines developed in Chapter V.6, as the most promising near-term means of increasing foreign exchange earnings.

Similar considerations would also place a high priority on agricultural reform. Whether, in the longer term, the USSR would become a major exporter of agricultural commodities is uncertain. The enormous availability of arable land suggests that it could; but this is an area where, more than in any other, trade policies have been decisive in accounting for actual production and trade patterns internationally. While it is to be hoped that progress will be made in reducing barriers to agricultural trade—and the USSR would appear to have a long-term interest in promoting such a process in any way it can—prospects for agricultural trade cannot at this point be assessed very optimistically. What is clear is that Soviet dependence on net imports of basic food stuffs could be substantially reduced in coming years through an energetic program of domestic agricultural reform.

(2) Transitional arrangements for CMEA8

The intended shift of CMEA trade to convertible currency settlement at market prices promises to yield the USSR a very substantial gain in the terms of trade. At the same time, however, intra-CMEA trade volumes are likely to contract sharply and the risk is that this could be quite disruptive both to the USSR and its CMEA trading partners.

There are a number of factors accounting for this trade contraction. First, Soviet oil deliveries to CMEA countries are falling, and will likely fall further both because declining Soviet production leaves less for exports and because the priority given to convertible currency earnings will probably result in diversion of a rising share of oil exports to non-CMEA countries, given the severe foreign exchange constraints of many of the Eastern European economies. Second, declining investment activity in the USSR is likely to affect in particular the demand for machinery and equipment, which constitute a major component of Soviet imports from CMEA. Third, Soviet demands for machinery and equipment may be diverted to Western suppliers and away from the CMEA. One reason that has been cited for this is the perceived superior quality of Western goods, though in principle one would expect this to be compensated by shifts in relative prices. More important may be the expectation that trade credits for financing machinery imports will be more readily available in the west than in CMEA countries, reflecting the lack of a developed trade credit infrastructure within the CMEA. Fourth, some trade may be lost simply because of a breakdown in the mechanism for conducting it. The spreading economic dislocations within the country, and uncertainty about union-republic relations, are clearly impeding the drawing up of trade contracts among enterprises. Finally, it is probable that some portion of CMEA trade was simply uneconomic, and could be expected to disappear under world pricing and convertible currency settlement.

Faced with this situation, the USSR is negotiating bilaterally with her CMEA partners on transition arrangements for the coming year. The outcome of these negotiations is not yet clear. The Eastern European countries are in difficult situations and would want to maintain certain clearing arrangements so as to continue to be able to obtain some portion of the energy and other imports they require in exchange for goods rather than scarce convertible currency. The USSR would seem to have more to gain from discontinuing such clearing arrangements and is thus in a position to strike a hard bargain. It seems likely that in the end some special arrangements in the form of negotiated lists of products to be exchanged will be put in place for some portion of CMEA trade for the coming year.

From a longer-term perspective, the maintenance of bilateral clearing arrangements of this sort, with the attendant requirement of cumbersome bureaucratic involvement and continuing negotiations, is inconsistent with the thrust of trade reform which is to put it on a market basis. Other approaches to establishing intra-CMEA trade on market foundations will thus be necessary. Proposals to create a payments union involving the USSR and some of the Eastern European countries do not seem realistic, or indeed desirable: a perhaps insurmountable problem is that the USSR could expect to be a structural creditor within such a union and would, to that extent, not find it in its economic self-interest. More generally, such arrangements run counter to the objective—shared by the USSR and a number of the East European countries—to move rapidly towards currency convertibility. Creation of a free-trade zone or customs union within the former CMEA area is another possibility. But this would become relevant only after trading relations and trade regimes in the relevant countries had all been put on a market basis. Once that has been done, the pros and cons of favoring intra-CMEA trade relative to trade with third countries through such arrangements could be assessed. At present, interest in this approach among the countries concerned is not evident. Perhaps the most promising approach is simply to proceed as rapidly as possible with overall trade reform, along the lines discussed above, so as to create an environment in which enterprises have both the incentive and the means to enter into trade contracts with suppliers or purchasers in other CMEA countries.

One area where action could be important to strengthen trade is in the creation of trade credit facilities both within the USSR and its CMEA partners. While of course such facilities are relevant for all trade, they are particularly important to provide an underpinning for CMEA trade since the absence of such facilities would tend to lead to diversions of trade to western countries better placed to provide such credits, even when the continuation of such trade among CMEA countries would generate significant mutual benefits.

4. SUMMARY AND CONCLUSIONS

The presidential guidelines for economic reform indicate a generally liberalizing direction for reform of the trade system, though the drafting of the guidelines is ambiguous on a number of critical points, and indeed contains some suggestions that are on the face of it not consistent with the general thrust of reform. Overall, they suggest a cautious approach in terms of the pace at which reforms are to be introduced, though specific timetables are not set out. The relevant indications from these guidelines on trade reform might be summarized as follows:

  • (1) Further expansion of trading rights, including the diversification or breaking up of foreign trade organizations or their reconstitution as joint stock companies.
  • (2) Maintenance of a system of foreign exchange retentions for exporters, pursuant to rules which “foster the industrialization of exports”. A substantial share of exporters’ foreign exchange receipts would, however, continue to be surrendered to the authorities at the commercial rate, to fund government debt service and perhaps other expenditures at both the union and republican levels.
  • (3) Early establishment of an auction market for foreign exchange, open to all resident enterprises, where the value of the ruble is set by supply from retention quotas and demand; and an objective of eventually achieving internal convertibility of the ruble, in stages.
  • (4) Abolition of the DVK system, a reduction of centrally administered export licenses to a minimum, a strengthening of incentives to export, and reliance on customs duties and taxes, together with the exchange rate, as the principal control mechanisms for trade.
  • (5) Implementation of a package of emergency measures to prevent a decline in oil production and to maintain production of other export goods.
  • (6) Conversion of CMEA trade to convertible currency settlement at world market prices as of January 1, 1991.

Areas of trade policy where the generally liberalizing thrust of the guidelines is less in evidence include the indication that state orders for basic Soviet exports will remain in effect for 1991 and 1992; and that a list of goods including oil, gas, gold, diamonds, precious stones, special technology and perhaps a few others would be deemed all union resources to be transacted separately.

The overall thrust of the guidelines is not inconsistent with the views that have been developed here, though in general a shift to market based trade that is more rapid than what appears in the guidelines is favored. There are also three specific points of divergence that should be noted. First, a time schedule that foresees the maintenance of state orders for a significant share of exports for at least two more years would seem to imply an overall pace of liberalization that will prove to be inconsistent with the pressing needs to move out of the present, untenable halfway house of economic reform. Second, the emphasis on “emergency measures” to sustain petroleum production, rather than more fundamental economic reform of this sector, is unlikely to yield the hoped for results, validating a pessimistic assessment of Soviet petroleum prospects. Third, the adherence in the guidelines to a system of differentiated retention quotas favoring manufactured exports perpetuates needless complexity and distortions.

More fundamentally, the guidelines are generally unclear about the implementation of reform. There is a serious risk that the objectives set out will in fact not be achieved in the absence of a well-defined strategy for implementing the reforms that would maintain coherence among the successive decrees that are being promulgated. The most serious risk in this regard is with respect to achieving real progress towards convertibility. The key element here is that the foreign exchange market that is to be established needs to be more than a marginal appendage, and to serve a real resource allocation function. This implies the need for a number of actions:

First, substantial retention quotas so that exporting enterprises will indeed find themselves in situations of holding more foreign exchange than they immediately need, so that they would be in a position to provide funds to this market. A requirement that enterprises tender these retentions to the market within a reasonably short time, rather than hold them in retention accounts, would also help to build up the market.

Second, sufficient liquidity in the foreign exchange market, and confidence that this will be preserved, so as to make enterprises willing to provide foreign exchange in the expectation that they will also be able to obtain it when the need arises. Otherwise holders of foreign exchange would be tempted to spend it on less essential imports rather than lose control over it.

Third, a policy of steadily increasing the range of transactions channelled through this market. Foreign borrowings by banks on behalf of clients, for example, could be channelled through this market rather than through the commercial rate from an early date; and government imports should likewise be increasingly financed through this market.

The risk is that high surrender requirements resulting from the imposition of union, republican and even local demands for foreign exchange will leave the market so under funded as to be nonviable.

Against this general background, the specific recommendations arrived at in this chapter, which constitute a sort of “middle road” to trade reform—neither a “big bang” nor a slow crawl”—can be summarized succinctly:

  • (a) rapid progress is necessary toward creating a genuine competitive environment in the trade sector. Trading rights, already widely distributed, need to be made effective by phasing out licensing restrictions, by severing links between trade organizations and ministries (and indeed by abolishing the branch ministries altogether), and by eliminating prohibitions against middleman activities;
  • (b) concerted and sustained progress towards internal convertibility of the ruble should be facilitated, by progressively shifting a wider range of transactions from the commercial rate to the market rate while also rapidly reducing the large initial gap between these two rates;
  • (c) foreign exchange surrender requirements on exporting firms should be limited to a minimum, and they should be steadily reduced over time. The governments’ own needs for foreign exchange to service debt could and should increasingly be met by purchases at the market rate. Likewise, the government’s needs for foreign exchange for other purposes should be met fully out of funds purchased at the market rate;
  • (d) establishment of a tariff structure with only minimal dispersion of rates is needed, with an average level not higher than 30 percent. Specific temporary border taxes (or subsidies) might be established in special cases, and perhaps most notably energy, subject to a preannounced schedule for phasing these out;
  • (e) priority attention should be given to reform of the energy sector and of agriculture as the most effective means of increasing the availability of foreign exchange over the next few years for the imports needed to accelerate domestic adjustment;
  • (f) the efforts of Soviet enterprises to enter into trade contracts on commercial terms with enterprises in other CMEA countries should be facilitated, so as to limit the short-term dislocation costs of CMEA reform.

NOTES TO TABLES

Main features of Soviet trade structure and performance

The following tables summarize some features of Soviet trade. A cautionary statistical point is in order. Soviet trade statistics are liable to be misleading to some extent because of biases created in converting trade transactions with different partners into a common ruble basis (see Appendix II-2). Further difficulties arise in international comparisons, because of the difficulty of knowing the appropriate rate at which to convert ruble values into dollars. Ruble foreign trade values with CMEA countries and convertible currency trade with other countries may not be directly comparable due to the very different relative price structures for the two sets of trade. Despite such statistical biases, the general picture conveyed in the tables, if not all the details, is probably realistic. The main features are as follows.

The USSR is a relatively closed economy as measured by the share of trade in GDP (Table IV.3.1), although it is not a straightforward matter to measure the relative openness of an economy with disputed prices and a distorted exchange rate. While the share of exports in GDP is less than half the OECD average, this is to be expected for a country as large as the USSR. It is to be noted, however, that whereas most countries have continued to become more open during the 1980s as world trade growth has continued to outpace production, the USSR’s trade share has stagnated. Because of a heavy concentration of Soviet trade with the CMEA, the USSR is much less important as a trading partner for OECD countries than its overall trade share would suggest.

Table IV.3.1.USSR: Basic Indicators for Soviet Foreign Trade, 1985-89
IndicatorUSSRInternational Comparison
Total exports of goods as percent of GDP (1988)16.814.4 (OECD average)
Position of the USSR in world merchandise trade (1988)
Exports
Share (in percent)3.94.0 (Canada)
Rank87 (Canada)
Imports
Share (in percent)3.63.8 (Canada)
Rank87 (Canada)
Trends in Soviet trade
(U.S. dollar values; percentage change)
Annual average 1988/1978
Imports7.88.1 (world average)
Exports7.88.1 (world average)
Annual average 1989/1988
Imports6.87.3 (world average)
Exports-1.26.6 (world average)
Share of the USSR in total OECD imports
(in percent)
19851.61.4 (Korea, Rep.)
19891.22.0 (Korea, Rep.)
Share of the USSR in total OECD exports
(in percent)
19851.71.4 (Korea, Rep.)
19891.31.9 (Korea, Rep.)
Share of the USSR in total OECD imports
of manufactures (in percent)
19850.32.0 (Korea, Rep.)
19880.23.0 (Korea, Rep.)
Share of the USSR in total OECD exports
of manufactures (in percent)
19851.21.3 (Korea, Rep.)
19880.91.8 (Korea, Rep.)
Sources: OECD Economic Outlook, GATT International Trade 1988-89, United Nations Statistics, OECD Statistics, Series A, and OECD Statistics, Series C. various issues.

Exports are valued in valuta prices.

Sources: OECD Economic Outlook, GATT International Trade 1988-89, United Nations Statistics, OECD Statistics, Series A, and OECD Statistics, Series C. various issues.

Exports are valued in valuta prices.

Soviet exports are narrowly based, dominated by fuels and raw materials (especially as regards convertible currency trade) (Table IV.3.2). A significant part of “other exports” are accounted for by arms shipments—primarily to socialist and developing countries. The import structure is more diversified, with machinery and equipment, industrial consumer goods and food together accounting for about 60 percent of total imports in 1989 (Table IV.3.3).

Table IV.3.2.USSR: Commodity Structure of Exports, 1980-89(In percent of total)
TotalMachinery,

Equipment

and

Transport

Equipment
Fuels and

Electricity
Ores,

Concentrates,

Metals and

Metal

Products
Chemicals,

Fertilizers,

Rubber
Wood and

Paper
Textile,

Raw

Materials
Food and

Raw

Materials

for Food
Industrial

Consumer

Goods
Production

Services

and

Arms
1980 total10015.846.98.83.34.11.91.92.514.8
Socialist countries10022.839.713.13.53.02.42.42.610.5
Nonsocialist developed countries1001.972.14.93.26.41.51.23.25.6
1985 total10013.952.77.53.93.01.31.52.014.2
Socialist countries10016.949.810.13.93.01.91.62.210.6
Nonsocialist developed countries1001.977.04.64.43.60.41.32.24.6
1989 total10016.040.210.54.13.51.61.62.619.9
Socialist countries10020.741.110.44.22.52.01.42.81.9
Nonsocialist developed countries1003.255.115.34.77.01.42.02.88.5
Table IV.3.3.USSR: Commodity Structure of Imports, 1980-89(In percent of total)
TotalMachinery,

Equipment and

Transport

Equipment
Fuels and

Electricity
Ores,

Concentrates,

Metals and

Metal

Products
Chemicals,

Fertilizers,

Rubber
Wood and

Paper
Textile,

Raw

Materials
Food and

Raw

Materials

for Food
Industrial

Consumer

Goods
Production

Services

and

Arms
1980 total10033.93.010.85.32.02.224.212.15.9
Socialist countries10043.81.76.13.50.60.518.617.77.5
Nonsocialist developed countries10029.61.119.48.24.53.823.85.24.4
1985 total10037.15.38.35.01.31.721.112.67.6
Socialist countries10047.41.84.93.00.40.317.915.58.8
Nonsocialist developed countries10028.21.717.710.33.53.322.97.74.7
1989 total10038.53.07.35.11.21.616.614.412.3
Socialist countries10045.41.95.02.70.30.314.516.28.7
Nonsocialist developed countries10034.30.912.410.73.53.618.57.88.3

Import specialization is more marked than export specialization, in the sense that there are no export categories of goods for which exports account for as much as 35 percent of production, whereas the dependence on imports in such areas as machine tools often exceeds 60 percent of domestic consumption (Tables IV.3.4 and IV.3.5). Even on the export side, however, specialization is surprisingly high—at least at the level of aggregation indicated—apparently even higher than for the United States where the overall export share is roughly comparable to that of the USSR. This perhaps reflects the “international division of labor” that was implemented within the CMEA over the past 40 years.

Table IV.3.4.USSR: Proportion of Production Exported by Selected Sectors,1 1985 and 1989(In percent, in relation to production measured in physical units)
TotalSocialist

Countries
Nonsocialist

Developed

Countries
Commodity or Product198519891985198919851989
Machinery and equipment
Passenger cars20.030.111.216.57.511.3
Equipment for forestry, cellulose
& paper28.623.127.621.61.01.5
Blast-furnace and steel-smelting
equipment2.321.11.29.50.73.1
Equipment for textile industry12.219.311.218.00.20.1
Metal-rolling equipment16.210.810.25.70.20.3
Fuels
Crude oil19.721.013.113.65.66.3
Diesel fuel18.618.64.64.912.311.2
Heavy heating oil (mazut)8.813.82.11.86.511.8
Natural gas10.712.75.76.55.05.8
Nonfood raw material
Fine leather for processing21.030.44.914.26.16.2
Cotton23.929.721.722.01.76.6
Potassium fertilizers30.728.821.614.96.97.0
Chromium ore13.919.711.911.82.07.8
Nitrogen fertilizers14.219.08.916.22.10.6
Industrial consumer goods
Cameras39.427.930.124.79.23.0
Household refrigerators20.126.616.116.83.79.4
Household clocks28.219.412.99.713.65.7
Source: PlanEcon Report, No. 20-21/1990, based on Vneshnie ekonomicheskie sviazi 1989 (1990).

Shares are arranged in descending order according to the level observed in 1989 for total trade: the residual of the total share of a given category not recorded in the table corresponds to shares of developing countries.

Source: PlanEcon Report, No. 20-21/1990, based on Vneshnie ekonomicheskie sviazi 1989 (1990).

Shares are arranged in descending order according to the level observed in 1989 for total trade: the residual of the total share of a given category not recorded in the table corresponds to shares of developing countries.

Table IV.3.5.USSR: Import Share of Soviet Domestic Consumption of Selected Products,1 1985 and 1989(In percent, in relation to consumption measured in physical units)
TotalSocialist

Countries
Nonsocialist

Developed

Countries
Commodity or Product198519891985198919851989
Machinery and equipment
Equipment for leather/shoe industry73.082.140.017.933.064.3
Equipment for apparel industry42.278.933.413.48.865.1
Knitting equipment52.268.446.420.95.847.5
Equipment for dyeing/finishing
industry49.368.234.723.414.641.6
Equipment for chemical industry55.561.431.620.423.640.5
Equipment for printing industry56.358.741.128.513.728.7
Equipment for textile industry52.957.847.637.25.219.1
Equipment for food processing
industry52.139.439.324.212.015.1
Nonfood raw materials
Wool (washed equivalent)24.227.41.61.118.023.7
Pesticides and herbicides32.626.712.814.818.79.7
Steel pipes21.414.72.82.718.610.9
of which: pipes for oil industry17.617.83.23.114.311.7
Soda ash9.710.49.710.1
Food and raw materials for food
Fresh frozen vegetables87.876.987.876.9
Tea31.035.04.18.1
Grains, excluding coarse grain20.315.51.91.114.913.9
of which: corn56.840.47.12.842.837.2
Edible oils of vegetable origin25.325.60.80.54.33.4
Raw sugar26.225.422.615.62.6
Industrial consumer goods
Soap0.818.50.81.55.9
of which: toilet soap2.634.02.61.78.6
Pharmaceuticals31.428.228.322.91.22.5
Detergents and cleaing agents3.722.73.44.36.8
Apparel24.321.616.316.67.03.0
Furniture12.810.712.610.50.20.1
Source: PlanEcon Report, No. 20-21/1990, based on Vneshnie ekonomicheskie sviazi 1989 (1990).

Shares are arranged in descending order according to the level observed in 1989 for total trade; the residual of the total share of a given category not recorded in the table corresponds to share of imports of developing countries.

Source: PlanEcon Report, No. 20-21/1990, based on Vneshnie ekonomicheskie sviazi 1989 (1990).

Shares are arranged in descending order according to the level observed in 1989 for total trade; the residual of the total share of a given category not recorded in the table corresponds to share of imports of developing countries.

NOTES
1.See also Chapters II.2, II.3 and III.4.
2.According to one approach that quantifies the terms of trade effect by using highly disaggregated comparisons of the prices of goods sold in CMEA countries and on representative Western markets, the Soviet subsidy to the six Eastern European countries may have totaled US$8 billion in 1989.
3.A relevant model for such a prohibition is the Interstate Commerce Clause of the U.S. Constitution. Over the years, this instrument has assured the integrity of the U.S. internal market even while leaving individual states substantial control over economic developments within their borders in other domains.
4.A new rate initially at 1.66 rubles per dollar was set as the commercial rate. The value of the rate will change according to the value of the basket of currencies to which it is pegged. The official rate of about 0.55 rubles per dollar will continue to exist as a measure of the value of certain external claims of the USSR. But for most purposes, the commercial rate is in fact the (depreciated) replacement of the previous official rate. See Chapter III.4 for details on the exchange rate system.
5.A decree issued in October 1990 indicates that exporters will be expected to surrender 40 percent of their foreign exchange receipts to the union government in order to fund the union’s debt service obligations. The remainder will be subject to differentiated retention quotas (see Table III.4.12).
6.Such estimates depend, of course, on the size of the monetary overhang and the financial policies pursued at a given point in time.
7.The notion of price equalization through trade should not be taken literally even for market economies. There is abundant evidence that, even in the absence of trade restrictions, prices for most traded goods do not equalize even in the relatively long run: quality differences, imperfect information, and other less tangible factors appear to play a powerful role in allowing similar goods to be sold on different markets at significantly different prices.
8.Developments in CMEA trade and payments are covered in detail in Appendix II-3.

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