Soviets' Hard Road to the Markets

HIS travels over, Mikhail Gorbachev has returned to the greatest challenge the Soviet Union faces: reforming its failing economy. The Soviet system is not only failing to produce prosperity, let alone clean air and clean water - it is failing to put food on the table. Soviet economists and politicians know that they need a market economy. But one reform proposal after another is scrapped, or proves ineffective, or is wildly unpopular. The latest proposal is no exception: In its first phase, which will last up to three years, it's a package of price increases and benefit increases. Because the price increases go primarily to the government and not to producers, they are actually tax increases - an attempt to deal with the Soviets' budget deficit. The government will keep 30 percent of the increased revenue; 70 percent will be returned to the people in the form of higher wages, pensions, or benefits.

Most prices will still be set by the government, and the government will continue to allocate raw materials and producer goods by state order, deciding in minute detail who gets what. In this environment higher prices will not serve as an incentive to increased production.

The most successful Soviet effort to introduce market forces into the economy - the 1987 Law on Cooperatives - has created over 100,000 small businesses, but they have no source for supplies and raw materials except diversion from the central plan, and thus their efforts do not serve as an incentive for increased production either.

So far the Soviets have not figured out how to transform a socialist, centrally planned economy into a market economy. No wonder, since the process of transition is uncharted water. Observers are beginning to conclude, however, that economies are dominated either by central planning or by the market. The truly mixed economy - with central control of investment, which the Soviets seem to want to keep - is beginning to look like a contradiction in terms.

A market economy means not just voluntary exchange of goods and services, but private markets for both debt and equity capital. The ultimate market is the capital market, not the bread market, because it is here that crucial decisions - on investment, expansion, and innovation - are made.

The challenge is to create markets and private enterprise at the same time, because one does not work without the other. State enterprises are unresponsive to market prices; they're responsive to state orders and bonuses for reaching quantity goals. Markets require decisionmakers - private enterprises - who care about prices. Private enterprises can't function without markets in which to acquire resources.

There are two possible approaches (and infinite combinations). One approach is to start small, as the Soviets did with cooperative and individual enterprises, and encourage them by making sure they have access to resources. With enough commitment, this has a chance of working - but only if the basic rules give these enterprises both the opportunities and the discipline of markets. The market sector the Soviets have thus far allowed to develop employs only a few hundred thousand people, the enterprises can't be sold, supplies are hard to get, and they have no commercial banks from which to borrow.

Building on the small market sector would require not only the political will to persuade the public that these enterprises are the economy of the future, but also a program to convert existing state enterprises to market enterprises. The chances of such an approach getting blocked by bureaucrats are considerable; it will surely fail if they don't get the basic rules for the market right at the beginning, and they don't have them right yet.

The incremental, gradual approach is a more likely Soviet choice than the all-at-once approach. The all-at-once approach involves selecting a future date on which price controls will be abolished, the state orders of the planned economy and all its other rules and regulations will be null and void, subsidies will end, and all state enterprises, profitable and unprofitable, will be transferred to private ownership through the free distribution of limited liability shares, with the government keeping some of the stock to sell at a later date to recover its capital investment.

This second approach provides simultaneously for markets and for private ownership. To prepare for it, the government would have to create the foundations for private lending institutions, establish the mechanism for transferring shares, decide how to deal with monopolies, and most important, explain it to the public.

Sooner or later the Soviet Union will have to choose one approach or the other. Meanwhile, more taxing and more spending will only make the current economy worse and the future more difficult.

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