Abstract
This paper examines the Sachs-Woo hypothesis that the gradual approach to reform, though successful in China, was not possible in the USSR because of structural differences between these two economies. To examine this hypothesis, this paper abstracts from the issue of structural differences by focusing on the industrial sector only and compares the state-owned enterprise (SOE) reforms in China under Deng and in the USSR under Gorbachev. Apart from concerning the same sector, these reforms were roughly contemporaneous, and hence their comparison provides a suitable test of the Sachs-Woo hypothesis. The test shows that the hypothesis does not live up to it.
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Notes
For earlier comparison of the Russian Big Trough with the US Great Depression, see Campos and Coricelli (2002, pp. 793–794), who acknowledge that the Russian output fall was unexpected, and quotes from both Blanchard (1997) and Kornai (2000) to support this view.
Some authors, such as Shleifer and Treisman (2003), try to discount the impact of the Deep Trough on Russia, claiming that Russia has now become a ‘normal country’. Many observers however do not agree with this view, made all the more suspect, in their view, because of Shleifer's personal involvement in administering shock therapy to Russia. See, for discussion, Popov (2009b), Rosefielde (2005) and Zhuravskaya (2007).
First, the recent Russian GDP recovery has been to a great extent due to high oil prices, and hence may not be very robust. Second, the way privatization was carried out in 1993 and 1995 has left Russia with a capitalist class that still lacks social legitimacy, so that Russian capital and capitalists tend to flee to Western countries. On the other hand, those parts of the Russian economy that remain under the state ownership lack many pre-conditions necessary for efficient market functioning. See, for example, Goldman (2003) for discussion of these issues.
Indeed, commenting on the Sachs and Woo (1994a) article, Stanley Fischer (1994, p. 146) note that ‘We should not forget that these are very early days to judge gradualist versus big bang reforms in EEFSU’.
It may be noted here that Sachs suffers from some vacillation and contradiction with regard to characterization of China's approach to reform. On the one hand, he cannot deny that China followed the gradual approach. On the other hand, in order to discount the gradual approach and buttress his claim of superiority of the big bang approach, he sometimes attributes even China's success to the big bang approach. See Islam (2008a) for discussion of Sachs’ vacillation and the reasons behind it.
See, for example, Goldman (1992, 1994) and Popov (1991).
See, for example, Goldman (2003).
They add that ‘industrial reform might have posed a more difficult task in China due to the presence of many small scale facilities in addition to the usual large ones that were common in all centrally planned economies’ (Nolan and Ash, 1995, p. 994).
As Naughton (1995, p. 7) notes, despite the large agricultural sector, ‘industry is the main character in the (Chinese) reform drama’. Similarly, Jefferson and Rawski (1994, p. 47) note that ‘industry stands at the core of China's reform problem’.
See Nolan and Ash (1995) for discussion of similarities and differences of the industry sector in the former USSR and China. In general, as Naughton (1995, p. 26) notes, ‘Command economies share certain fundamental characteristics, and thus the problem of transition from a command to a market economy poses similar challenges, whether carried out in Eastern Europe or China’.
As Nolan and Ash (1995, p. 996) note, ‘a comparative analysis of China and the former USSR indicates that the two countries shared important similarities at the start of their reform programmes’.
The discussion of the Chinese SOE reform in this and the remaining sections reform draws upon the excellent works of Naughton (1994, 1995), who provides probably the most insightful analysis (in English) of the Chinese SOE reform. See also Byrd (1987), Field (1984, 1992), Jackson (1986), Lau et al. (1997, 2000).
As Naughton (1995) informs, although the step was taken without any fanfare, it was very significant since differentials between plan and market prices were generally quite large.
See Naughton (1995) for details.
See Byrd (1987) for more detailed discussion of this issue. Byrd actually thought that with the introduction of the dual track, the reform of plan prices had become a redundant issue. As he put it ‘At a fundamental level, the issues of market allocation and to a lesser extent price reform have become a passé, and they no longer need to be the prime concern for reformers’ (p. 307).
For discussions about Gorbachev's initial steps in the economic sphere and their inadequacies, see, for example, Battle (1988), Gagnon (1987), Popov (1991), Shmelev (1988), and Shmelev and Popov (1989).
As IMF et al. (1991, p. 23) note, Gorbachev's attempts to revive the economy ‘faltered at a disappointingly early stage’. See also Fischer (1993).
The Law uses the Russian word ‘yarmark’ which is different from ‘rinok’, the more straightforward Russian counterpart of the English word ‘market’. This particular usage also reflects the reluctance on the part of the drafters of the Law to accept the option of market.
Other components of the proposed reform package included payment of fees to the budget for fixed capital and to banks for working capital and gradual transformation of budgetary investment grants into repayable interest bearing loans. But these were largely ignored.
As a result of the cost-plus method, the world of plan prices was like a hall of mirrors, with each price reflected on prices of others, and any change in one of them having cascading effects on prices of all others.
See Naughton (1995, p. 239) for details. The arbitrary price and profit structure also acquired certain regional dimensions, because, for example, the coal producing western provinces had more enterprises earning low profits while eastern, coastal provinces had more enterprises producing consumer goods and hence enjoying higher profit rates.
See Naughton (1995, pp. 99–103) for details.
See Naughton (1995, pp. 122–123).
Interestingly, the origin of the ‘tax-for-profit’ system can actually be traced to the initial reform of 1979–1980, when, in trying to go beyond the ‘profit retention’ system, the ‘tax for profit’ system was introduced to a very limited number of SOEs in January 1980. Under this system, SOEs paid ‘four taxes and two fees’, among which were capital charges, resource taxes, sales taxes, and income tax. However, the experiment could not go further due to the reversal of reform as a whole in 1981.
It is important to note that though the taxes and fees were supposed to whittle away rent components of the accounting profit, the ‘tax-for-profit’ scheme was supposed to be preceded by a comprehensive reform of plan prices so as to create a level playing field for the enterprises (leading to equalization of profit rates). Thus the ‘tax-for-profit’ scheme per se was not an alternative to the goal of comprehensive price reform. See Naughton (1995) for details.
In a sense, the idea of ‘Manager Responsibility System (MRS)’ goes back to early 1960s when Deng, as General Secretary of CPC-CC, found himself in charge of reviving the economy following the disaster of the Maoist Great Leap Forward. Confronted with the task, Deng presided over formulation in 1961 of the ‘70 articles on State Industrial Enterprise Work’ that emphasized clear delineation of personal responsibility, authority, and incentives. Deng returned to this theme when in 1973 he was once more put in charge of rehabilitating the economy following the disaster of the Cultural Revolution and supervised drafting of the State Planning Commission document, ‘On Several Questions of Accelerating Industrial Development’. See Naughton (1995) for details. See also Lee (1986) and Walder (1989, 1995).
See Mises (1935), Lange (1936, 1937), and Hayek et al. (1935) for this debate.
They noted that managers still lacked the incentives to become ‘true profit maximizers’, and hence saw much benefit in dual-track, because it allowed managers to become accustomed to operating in actual market environment and pick up the necessary managerial skills.
First round contracts signed during 1986 and 1987 were mostly with individual managers, though in some cases contracts were signed with management groups or the work force as a whole too. See Naughton (1995, pp. 217–218) for details.
In practice, many different concrete forms of the auction and bidding process arose, and the government tried to ensure that the auctions were genuine and not stage-managed. Some evidence of government's success can be seen in the survey in Hebei province showing that about half of the enterprises had their managers changed as a result of the auction. By 1988 most SOEs were operating under long-term contracts signed in 1987 or earlier. See Naughton (1995, pp. 216–218) for details.
As Naughton (1995, p. 214) notes, in such a system, the state, instead of earning revenues from its assets as collector of capital fees and taxes, earns a quasi-market return on assets in its role as the owner of those assets. The return is determined by competition for the right to manage – instead of accruing as fixed interest payments as would be the case if capital fees were charged.
The idea was advanced mainly by the IGPAN (Institute of State and Rights) of AN-USSR (Academy of Sciences of the USSR) through its journal SGiP (Soviet State and Rights), edited by Kurashvili, and also the Novosibirsk Division of the USSR Academy of Sciences (led by Aganbegyan and Zaslavskaya) through its journal Eko. However, there were differences of opinion among advocates of workers’ council regarding its exact jurisdiction. While these intellectuals advocated the right to the selection of the manager, others had a more limited view of the jurisdiction. According to some Soviet scholars, setting up of workers’ councils was to be complemented by creation of independent labor courts. See, for example, Moses (1987) for further details.
The same was the case with the Soviet 1977 Constitution, Article 8 of which enjoined that ‘Work collectives promote socialist emulation, the spread of progressive methods of work, and the strengthening of production discipline, educate their members in the spirit of communist morality, and strive to enhance their political consciousness and raise their cultural level and skills and qualifications’.
For example, soon after Gorbachev became the General Secretary, the CPSU Central Committee adopted a resolution on 28 June 1985 expressing support for the idea, criticizing several Belorussian enterprises for failing to implement the intent of the 1983 Law on Labor Collectives. See Moses (1987, p. 220) for further discussion.
Apart from brigade leaders, members of party, trade union, komsomol organizations, and members of the administration could also be elected to the Soviet, though their number was not to exceed one-fourth of the total number of members of the Soviet. Also at least one-third of Soviet members were to be new in each election cycle.
Meetings of the Soviet were to be held as necessary, but at least once every quarter. The members of the Soviet were to serve on a voluntary, social work basis.
The Law further stipulated that this principle of election will apply to leadership at all levels, down to that of the brigade leaders.
Although Article 6 of LSE mentions edinonachaleye, it is now the edinonachaleye of a director, who in turn depends on the labor collective and its soviet to be elected and remain in the post.
Naughton (1995, p. 504) notes that Deng was ‘constantly exhorting the Party’ and relying on party mobilization to carry out economic policies. For Deng, CCP was the ‘major actor’.
Naughton (1995, p. 511), for example, notices that, as a result of the continued party leadership, ‘the chain of command within the state sector has been maintained intact’.
This thesis absolutized political reform, reducing economic reform itself to political reform. At a conference held in 1987, Leonid Abalkin, a Gorbachev's economic adviser, concluded that ‘deep transformations in the management of the economy cannot be realized without corresponding changes in the political system’.
For discussion of Gorbachev's steps toward introducing democracy in the USSR, see, for example, Gooding (1990), Popov (2000, 2007), Shlapentokh (1988), and White (1990).
The existing Supreme Soviet consisted of two chambers, one based on popular representation and the other based on representation of nationalities. In its place, Gorbachev suggested a single chamber Congress of People's Deputies, comprised of three parts, with the first based on popular representation, the second based on national representation, and a third based on representation from CPSU and mass organizations. This 2,250-member body was however to elect a 542-member smaller body of permanent standing, called (again!) Supreme Soviet. Thus the new State body would effectively have two chambers too.
At this time he also got himself elected as Chairman of the Presidium of the Supreme Soviet, thus combining the positions of the head of the state and the chief of the Party. The existing Supreme Soviet dissolved itself after approving these constitutional and electoral rule changes.
Nevertheless, 87% of the newly elected CPD were CPSU members, including party stalwarts. Even Boris Yeltsin could find a berth on the Supreme Soviet when another member relinquished his position in favor of Yeltsin. Gorbachev got elected unopposed as Chairman of the Supreme Soviet. However, as a commentator observed, ‘The first CPD was the last moment of real control for Gorbachev over the political life in the Soviet Union’.
It ran for two weeks and was televised in its entirety. As one commentator noted, ‘Deputies from all around the country railed against every scandal and shortcoming of the Soviet system that could be identified without sparing Gorbachev, KGB, or even the military’.
How Boris Yeltsin metamorphosed from a CPSU leader into the leader of the Opposition is of itself a fascinating and crucially important story, which is however beyond the scope of this paper.
Apparently he did this to insulate himself from removal from power by CPSU conservatives. This was the third time in 18 months that Gorbachev assumed the office of the head of the state of the USSR. Anatoly Lukyanov became the Supreme Soviet Chairman, a post which was no longer (for the first time in Soviet history) equivalent to that of the head of the state, and now became closer to that of the Speaker of the parliament.
As Popov (1991, p. 323) notes, ‘By the time of the 28th CPSU Congress in July 1990, the CPSU was regarded by liberals and nationalists of the constituent republics as anachronistic and unable to lead the country. The CPSU branches in many of the fifteen republics began to split into large pro-sovereignty and pro-union factions, further weakening central party control’.
In particular, Jefferson and Singh (ed). (1999) provide detailed analysis of productivity improvement of Chinese SOEs under reform. See also Jefferson and Rawski (1994), Jefferson et al. (1996), Jefferson and Xu (1991), and Lau et al. (1997, 2000). For a critical view, see Woo et al. (1994).
See Naughton (1995, pp. 236–239) for further details. This also explains the apparent puzzle of productivity improvement of Chinese SOEs while at the same time their profit rates declined.
See, for example, IMF et al. (1991) and Popov (1991, 2000, 2007) for discussion of consequences of Gorbachev's economic reforms.
In a sense, SOEs were reaping the rent opportunities created by distorted Plan prices.
NMP stands for Net Material Product, which was the measure of economy's output used by the former USSR and many other socialist countries. The main difference between NMP and the conventional GDP is that the former generally excluded services.
The average monthly wage increased by about 9% in the material sector as a whole.
For further details, see IMF et al. (1991, pp. 27–28).
Domestic debt was 20.5% in 1987 and 30.3% of GDP in 1988. In absolute terms, the state deficit grew from 0 to 109 billion rubles between 1985 and 1989. As Gorbachev himself acknowledged in October 1990, ‘we lost control over the financial situation in the country. That was our most serious mistake in the three years of perestroika’ (The New York Times, 20 October 1990, quoted in Marshall Goldman (1991a, 1991b)).
As Popov (1991, p. 307) notes, different ways to reduce budget deficit were discussed, but the so called ‘radical’ economists preferred the easy way out, namely printing money and external borrowing.
According to Hewett (1990/1991, p. 147), the ‘hot money’ amounted to about 165 billion rubles (equal to about a half-year's consumption expenditures). See also Pipes (1990/1991).
Since the Soviet SOEs never had to find customers and suppliers on their own, many of them found it difficult to cope with the new responsibility under LSE of procuring dogovors. See IMF et al. (1991, pp. 26–27).
Lithuania declared independence on 11 March 1990; Estonia followed suit on 30 March 1990. Latvia also followed the same path on 4 May 1990.
Among these are the Land Act, approved by the Supreme Soviet in February 1990, effective from 15 March, allowing farmers to lease land with lifetime tenure (thus going farther than the Chinese Household Responsibility System, which allowed 15-year tenure), though not ownership, and the possibility of inheritance. The Act however, prohibited sale and purchase of plots of land and use of them as collateral. The Law of Property of March 1990, effective from 1 July, allowed private ownership of small enterprises for family members and ‘other persons, jointly operating labor based business’. In July 1990, however, the government issued a decree allowing small private businesses, with up to 200 employees. In June 1990, a government decree allowed the transformation of state enterprises into shareholding companies with possible buyout of part of the shares by individuals and other companies. See Popov (1991, p. 313) for details.
Yeltsin received 57% of the vote, defeating Gorbachev's candidate Ryzhkov, who received only 16% of the vote.
RSFSR stands for Russian Soviet Federated Socialist Republic, the formal name that current Russia had within the USSR.
For discussion of the Russian privatization and its aftereffects, see, for example, Black et al. (2000), Blasi et al. (1997), Brainerd (1998), Friedman et al. (2003), Frydman et al. (1996), Hoff and Stiglitz (2004), Hoffman (2002), Klebnikov (2000), and Prakash and Mauro (2001).
‘If our analysis is correct, the main source of the contrasting outcome under system reform in China and Russia must be difference in policy choice’ (Nolan and Ash, 1995, p. 997). See also Buck et al. (2000).
See Islam (2008b) for a general discussion of the role of surplus labor in China's industrialization.
As Naughton noted, the rent-opportunities associated with the distorted Plan prices created a ‘hot house’ for the development of NSEs. See Islam (2008a), Naughton (1995), Sachs and Woo (2000) for a discussion of the various factors that led to the development of TVEs in China.
In 1987, cities and their subordinated areas comprised 58% of the population, 91% of state industrial production, 87% of non-state industrial output, and 77% of rural industrial output (meaning output of village collectives and below-village cooperatives and private businesses). Thus even rural industry was concentrated in peripheries of cities and not in the remote hinterland. Rural industries were also concentrated in coastal areas. Thus Jiangsu, Zhejian, and Shandong (which had only 17% of China's population) accounted for 43% of rural industry. See Naughton (1995, p. 147) for further details.
For example, in the province level municipalities of Beijing, Shanghai, and Tianjin, about 60 to 80% of rural industrial output was produced by NSEs under sub-contract with SOEs. This share was higher in the neighboring provinces of Jiangsu and Zhejiang, for which links with Shanghai SOEs played a decisive role. In the southern Jiangsu town of Wangshi, each of the 93 TVEs in 1985 had some form of sub-contracting or joint venture relationship with SOEs of Shanghai area. Similarly, in the Changsu district under Suzhou city, of the 3,400 TVEs, over 1,500 had horizontal links with Shanghai, and in Wuxi municipal district, 2,055 NSEs were linked with urban SOEs. See Naughton (1993, p. 155) for further details.
The phenomena of labor hoarding in centrally planned economies and the reasons behind it have been analyzed earlier by scholars, including Kornai (1992), who has provided a particularly detailed treatment of the issue.
See Nolan and Ash (1995) for useful discussion about the presence and potential use of surplus labor in the USSR for reform.
The LoC was very detailed, as was the case generally with other Soviet Laws, having 54 Articles and running through 22 pages of small print, specifying in detail different aspects of functioning of cooperatives. Earlier in 1986, the Soviets also introduced the ‘Law on Individual Labor’ to bring some order to the area of work by individuals outside their formal jobs.
According to Article 19, Section 2, cooperatives could set their prices either in agreement with consumers or on their own. This right was however laced with many restrictions. For example, it also stipulated that the Soviets of People's Deputies may set limits to prices (and rates) of basic consumer goods produced and sold by cooperatives. Similarly, cooperatives were required to follow state prices in carrying out state orders, in producing output using state supplied inputs, and in retailing out products procured from the state, etc (see Article 19, Sections 3 and 4). Overall, despite many confusing statements, cooperatives were allowed to set their prices, as long as they were not producing under state orders, not using raw materials supplied at state prices, and are not distributing products procured at state prices from state and other marketing agencies. Thus, compared with SOEs, cooperatives had more independence over price setting.
Article 25, Section 2 announced that cooperatives could determine on their own the form and system of wage payments.
Having stipulated that tax rates for cooperatives will remain fixed for at least five years, LoC (Article 21, Section 2) authorized local Soviets to provide cooperatives tax concessions (in order to encourage production of items enjoying popular demand and in accordance to the Laws of the USSR).
See IMF et al. (1991, p. 30), Narodneye Khozyatsvo SSSR 1991, and Economika and Zhiz’n, 1991 No. 20.
Recall that in China there were no such restrictions, and sub-contracting by SOEs played an important role in spawning NSEs.
As Blasi et al. (1997, p. 175) concludes, ‘We believe that Gorbachev lost an important opportunity to use agricultural reform and a rapidly growing small business sector to stimulate the Soviet economy’. See, for example, Islam (2008a) and McKinnon (1994) for discussion of the role of agricultural surplus for the overall reform process in China.
See Pospielovsky (1970) and Hedlund and Lundahl (1982) for discussion of the history and experience of Zvenos in Soviet agriculture.
This situation in the USSR may be contrasted with that of China where it was the Commune members themselves who, practically in defiance of higher authorities, took the initiative to switch from communal farming to family farming.
Naughton (1995, pp. 201–202) for example notes that ‘There was no programmatic document that can serve as a guide to reforms in this period. In a sense, then, reform continued to develop in an evolutionary manner, without a single blueprint. Reformers continued to “cross the river by groping for stepping stones” and the different measures added up to a distinctive Chinese approach to economic reform’.
The receipt of the Nobel Prize by the Soviet economist, Leonid V. Kantorovich for his work on linear programming was an evidence of the Soviet interest in this line of search for optimal prices.
By contrast, planning in China was never really as comprehensive and tight, so that parts of the economy always operated outside the Plan, making it easier for the Chinese to accept formally the market track and market prices. See Naughton (1995) for details.
An interesting question that arises in this connection is how the Soviets dealt with profit retention for their khozrashchet funds in face of differential profit rates caused by arbitrary Plan prices. As noticed, it was this problem that propelled much of the Chinese SOE reform. See Kushnirsky (1989) and Shmelev and Popov (1989) for discussions of this issue.
While proposition for family farms embodied an extreme form of material incentive, Stakhanov movement basically meant repudiation of material incentive.
See, for example, Naughton (1993), Pye (1993), Shambaugh (1993), and Yang (1993) for discussion on Deng's role in the Chinese reform process.
Mention may be made of Hu Yaobang, the Party Secretary during 1981–1987, who took initiatives with regard to liberalization of thinking and expression of views. See Merle Goldman (1991) for a discussion on Hu Yaobang's role in the reform process.
See, for example, Li Jingjie (1994), Li Linda Chelan (1997), Liu (1992), and Parris (1993) for discussion of examples and importance of experimentation at regional level for the Chinese SOE reform process.
See for example, Palei and Radzivanovich (1990).
Interestingly, Gorbachev visited China in 1989, coincidentally in the midst of the Tiananmen unrest. It is a matter of conjecture whether the Tiananmen unrest had any impact on the Soviet leaders with regard to their willingness to study and learn from the Chinese experience.
See Slider (1987) for discussions about the brigade system of labor that was introduced in Soviet SOEs as a way to improve their performance.
The very fact that people like Gorbachev and Yeltsin could rise to the top leadership of CPSU and the ease with which Gorbachev removed and sidelined many leaders in September 1988 Plenum also shows that whatever resistance to reform there was in the CPSU was not insurmountable.
The opposition was so strident and the retreat of Deng was so clear that when his collected works were published in 1983, the passage advocating MRS was expunged from his speech that was included in the volume.
Popov (2007) notes that one of the main reasons for institutional collapse in the USSR was that ‘competitive elections were introduced before the rule of law was established’. Perhaps removal from power and dissolution of the CPSU were unanticipated outcomes of introduction of multi-candidate election, but that only shows the potency and the strategic nature of the move.
It may therefore be said that Gorbachev's shallowness in economics found its match in his recklessness in politics. Unfortunately, adventure feels good only as long as it lasts, but it cannot last too long, as Gorbachev himself found out very soon. According to many observers, the subsequent descent of Gorbachev into advertizing for Pizza Hut, Louis Vuitton, etc, shows that he was probably too lightweight to be the CPSU General Secretary and to shoulder the great responsibility of transforming the Soviet economy and society.
See, for example, Pye (1986) for a discussion on Chinese pragmatism in the 1980s. Also, see Goldstein (1995).
It is well known that Deng suffered many personal losses due to Cultural Revolution and previous adventurist steps of Mao.
By contrast, the half-century long political stability probably led to some boredom and ennui, making it easier for Soviet citizenry to accept the adventurist steps of Gorbachev.
This explains Deng's dictum that ‘It does not matter whether the cat is black or white. What is important is whether it can catch mice!’ It also explains why Deng reportedly recommended postponement of discussion of ideology for 100 years, so that all attention can be focused on achievement of economic progress. Whether such postponement is possible or not is another matter. See Islam (2009, p. 44) for a discussion of the latter issue.
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Acknowledgements
The author would like to thank three anonymous referees and the editor, Josef Brada, for their comments that helped to improve the paper. Earlier versions of the paper were presented at the annual conference of Western Economic Association International (WEAI) held in Hawaii in July 2008, and at the 9th Pacific Rim conference of the WEAI held at Ryokoku University, Kyoto, Japan, in March 2009. The author is thankful to the participants of these conferences who commented on the paper. The author is particularly grateful to Vladimir Popov, whose considerable previous research on the subject provided a useful point of departure for the current paper. In addition, he helped the author through helpful discussions, providing data and information, and assisting in preparing several graphs. The author is also grateful to Andrei Klepach, Margarita Prokofiev, Dimitry Prokofiev, and Andrei Yakovlev for helpful discussions and support. The author alone is responsible for remaining errors and shortcomings. The views expressed in this paper are author's own and may not be ascribed to organizations with which he is associated.
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Islam, N. Was the Gradual Approach Not Possible in the USSR? A Critique of the Sachs-Woo ‘Impossibility Hypothesis’. Comp Econ Stud 53, 83–147 (2011). https://doi.org/10.1057/ces.2010.30
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DOI: https://doi.org/10.1057/ces.2010.30