T C AD-A235 657 A RAND NOTE The Changing Soviet Priority Economy: Modeling the Conflict Between Gold and the Sword Gregory G. Hildebrandt, Peter B. Staugaard RAND The research described in this report was sponsored by the Director of Net Assessment, Office of the Secretary of Defense, under RAND's National Defense Research Institute, a federally funded research and development center supported by the Office of the Secretary of Defense and the Joint Chiefs of Staff, Contract No. MDA903-90-C-0004. The RAND Publication Series: The Report is the principal publication doc- umenting end transmitting RAND's major research findings and final research results. The RAND Note reports other outputs of sponsored research for general distribution. Publications of RAND do not necessarily reflect the opin- ions or policies of the sponsors of RAND research, Published 1991 by RAND 1700 Main Street, P.O. Box 2138, Santa Monica, CA 90407-2138 A RAND NOTE N-2840-NA The Changing Soviet Priority Economy: Modeling the Conflict Between Gold and the Sword Gregory G. Hildebrandt, Peter B. Staugaard Prepared for the Director of Net Assessment, Office of the Secretary of Defense I,' A17 IAPPROVED RAN D FOR PUBLIC RELEASE; DISTRIBUTION UNLIMITED iii - - PREFACE This Note is part of a larger study whose purpose is the development of new methods and models for analyzing the Soviet economy that are linked more closely than are existing models to certain key characteristics of the Soviet system. The analysis investigates Soviet decisionmaking during plan implementation using a prototype input-output model. It characterizes the conflict between the exogenous priority system that is specified by the leadership and the endogenous priority system that emerges from the structure of an interdependent economy. The analysis continues to be relevant as civilian activities are moved inside the Soviet defense industry, which is currently managed using a priority system. This research was sponsored by the Director, Net Assessment, Department of Defense, and carried out within RAND's National Defense Research Institute, a federally funded research and development center sponsored by the Office of the Secretary of Defense and the Joint Chiefs of Staff. It was conducted as part of the project, "Alternative Views of the Soviet Economy and the Role of the Military-Industrial Complex," in RAND's International Economic Policy Program. SUMMARY The Soviet economy operates under a system of conflicting priorities. On the one hand, the leadership goals, which are embodied in the economic institutions and formulated plans, as well as in the rules associated with plan implenentation, direct the activities of the first (or command) economy. On tie other hand, individual economic agents operating in the monetized eavironment of the second economy, where decisions are based on individual values and opportunities, pursue their own goals, which may not be consistent with those of the leadership. Therein lies Pushkin's tension between "gold and the sword," emphasized by Gregory Grossman over twenty years ago and relevant today as the Soviets employ a system of "state orders" that is used in conjunction with decentralized decisionmaking. It is unclear whether perestroika will eliminate this type of duality in the Soviet economy. Indeed, the new institutions may formalize the historical characteristic. For example, civilian production activities have been moved inside the defense industry, and a new priority ordering has been implemented in which top priority is given to certain classes of consumer-related products. In this study, we develop a model of the Soviet conflicting priority system. One type of priority system is specified by the leadership and is exogenous to individual decisionmakers; this is the domain of exogenous priorities. The second type, based on the conditions of production of an interdependent economy, is endogenous to the economic system; this is the domain of endogenous priorities. Before introducing our formal model, however, we first address in Sec. II some features of disequilibrium and priority in the Soviet economy. We believe that the link between priority, both exogenous and endogenous, nnd disequilibrium is implicit in the analysis of Rush Greenslade, who emphasized multiple opportunity c rts P- being a centrS. feature of the Soviet economy. His result can be explained by both - vi - changing leadership priorities and the clash between the two priority systems. Our prototype priority model provides an empirical starting point for understanding and predicting the Soviet economy. In Sec. III, we develop this model by contrasting a situation in which defense, heavy industry, and consumption targets are achieved seriatim during plan implementation. The high status given defense is consistent with our understanding of historical Soviet military-economic doctrine and the supporting institutions; the low status given to the consumer is consistent with Mikhail Gorbachev's discussion of the "residual principal" being a major dimension of recent Soviet history. We first contrast an (exogenous) priority model with both a GNP maximizing marginalist model and a proportionalist model. An illustrative shock to the infrastructure sector of these models leads to a more than proportional decrease in consumption and GNP in the priority model as the low priority sector provides the buffer to ensure that high priority output is achieved. As expprted, the proportionalist model reduces all outputs and final outputs proportionally. Under the marginalist model, there is a less than proportional reduction in consumption aiid GNP. Appendix A summarizes our analysis of a number of alternative cases, and additional information associated with the models is contained in Apps. B and C. In general, we find that a shock in any sector causes unemployed resources in the nonpriority sector of the priority model. Also, final output in this model is always less than or equal to that obtained in the marginalist model. Recognizing that the marginalist model reflects a situation in which the tolkachil (facilitator) of the state enterprises bid for bottleneck resources in the second economy based on the endogenous priorities, we describe a situation of conflicting priorities. If the system exhibits a mixed response that enforces both exogenous and 'The tolkach has no close counterpart in a market economy. His task is to facilitate plan fulfillment by obtaining inputs in short supply often through bemi-legal or illegal means. - vii - endogenous priorities, there may be shortages and surpluses of inputs simultaneously, and the priority objectives of the leadership may not be met. Such an outcome will motivate the leadership to design institutions that support its priority interests. Within the Soviet defense macninery industricz, prcduction has been "vertically integrated from basic industry to end product," and we can see in this phenomenon the leadership's response to the conflicting priority systems. Insulating the defense sector from the economy in this fashion may have supported the defense interests in the short run, but it is also likely to have adversely affected the economic-technological base from which a modern military establishment must draw. The rigid priority system may, therefore, have been ultimately self-defeating. Soviet economic priorities have clearly changed under Gorbachev. These changes have been marked by a significant erosion of the status of the military-economic institutions that have traditionally supported defense priority. These developments, however, need not greatly diminish the priority model's relevance. To this point the history of Gorbachev's reforms can be captured largely as shifts in Soviet economic priorities away from defense, first toward investment and more recently toward consumption. The priority system, however, has remained very much in place, albeit in a somewhat diluted and altered state. The persistence of traditional methods of central planning, the transfer of high-priority civil production to the defense industry, and the continued use of state orders all suggest that the priority system has been revised rather than replaced. These revisions can perhaps best be captured through priority models of the type developed here. Should the Soviet leaders follow through on their plans to make the transition to a market economy, priority models may prove useful in several ways. During the transition phase a model of conflicting priorities may help shed light on the difficulties likely to be encountered. And following a successful conversion to a market economy, the priority model developed in this study will remain useful both for - viii - the light it sheds on historical Soviet military economics and as a benchmark for assessing future changes. - ix- CONTENTS PREFACE............................................................ iii SUMMARY............................................................. v FIGURES............................................................. xi TABLES............................................................. xiii Section I. INTRODUCTION................................................. 1 II. DISEQUILIBRIUM AND PRIORITY IN THE SOVIET ECONOMY ..... 8 Greenslade Disequilibrium....................................8 Administrative Priorities................................. 10 III. THE PROTOTYPE PRIORITY MODEL..................................19 IV. APPLICATIONS AND EXTENSIONS OF THE MODEL......................39 Applications of Priority-Driven Models......................39 Extending the SL-ope nf the Prototype Priority Model ... 40 Developing Microfoundations.................................41 V. CONCLUSIONS................................................. 43 Appendix A. EFFECTS OF SHOCKS IN OTHER SECTORS............................47 B. RUBLE COSTS OF INPUT SHORTAGES................................58 C. THE TOLKACH INTERPRETATION OF THE MARGINALIST MODEL...........63 BIBLIOGRAPHY........................................................ 65 - xi - FIGURES 1. Prototype Input-Output Problems ........................... 25 2. Alternative Resource Allocation Rules and Shock in Infrastructure ... ........................................... 26 3. Effect of Infrastructure Capacity on Defense .............. 27 4. Effect of Infrastructure Capacity on Consumer Goods ....... 28 5. Effect of Infrastructure Capacity on Investment Goods ..... 29 6. Effect of Infrastructure Capacity on Final Demand .......... 29 7. Effect of Infrastructure Capacity on Unemployment ......... 30 8. Marginal Costs of Infrastructure Shortage ................. 31 9. Effect of a Mixed Shock on Final Demand ..................... 33 10. Value of Unused Infrastructure Inputs Under Conflicting Priorities .... .............................................. 34 11. Effect of a Mixed Shock on Defense ........................ 35 A.l. Alternative Resource Allocation Rules Under Overtaut Planning ... ................................................. 48 A.2. Alternative Allocation Rules and Shock in Light Industry .. 50 A.3. Alternative Allocation Rules and Shock in Defense ......... 51 A.4. Alternative Allocation Rules and Shock in Heavy Industry 53