(SANITIZED)UNCLASSIFIED PAPER ON POLISH ECONOMIC INCENTIVE SYSTEMS AND OPERATIONAL PRICE SYSTEMS BY JANUSZ G. ZIELINSKI(SANITIZED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP80T00246A016800350001-7
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 25
• Document Creation Date: December 22, 2016
• Document Release Date: January 3, 2012
• Sequence Number: 1
• Publication Date: June 13, 1962
• Content Type: REPORT

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Mt OR1CtAt USE ONLY
INCENTIVE SYSTEMS AND OPERATIONAL PRICE SYSTEMS
by
Aleksy Wakar and Janusz 0. Zieli$steio
STAT
Depending on their relation to pricoo, we can distinguish two
groups of incentive systems:
a) Incentives which concern the physical product end which are
therefforeindependent of prices. E.g? piece wage systems belong to
this first group.
b) Incentives which concern the value product cad which are thero-
fore partially dependent on prices. Bonuses for. fulfilling the gross
or net production plan and.profitmboamoes belong to this second group.
Our analysis will be confined to the second group of incentives.
1. Ohs roduction incentivea ad $iceso
Until very recently, the most widely used incentive for managers
of enterpriser in socialist countries was a bonus for fulfilling the
grow: production plan in value terms. An appraisal in value terms re-
quires that output be a;gregated according to specified rulers. in
pralctice, ' ally+.:.,,ates are calculated in monetary term, and prices are
,
as a rule, equal to the average total cost of the brraneN of industry
plus a given percentage of profit,
The experience of Socialist countries has shown boyond any doubt
that bonuoes for fulfilling (and overfulfilling) the gross production
plan had decidodly negative\effects on socialist production, the more
so because of existing pricing practices. The current method of pricing
(average total cost of branch of industry plus five per cent profit)
tends to approximate the value relations between different products.
Product A which requires twice as many resources as product B, is also
twice as expensive. By pricing in this manner, the Central Planning
Board attempts to limit the demand for product A in production and con-
aumption and tries to encourage the demand for product B. It its easy to
coo, however, that so long as gross production bonuses are paid and
? The authors are Professor and Associate Professor of Economics
respectively, in the Central School of Planning and ?? The Suthoro are indebted to Prof. Oskar WtarsawsUniverr. ,
City, for valuable comments on Sections 1 and 2. Dr. Peter Schranfrom
Yale University pointed out a serious mistake which the authors overlooked
in the original draft of Sectioz. 1. We want also to express our gratitude
to Messrs. W. Baer, S. Berki and P. 3chran, all from Yale University,
their help in improving the English of this for
paper. o, the
authors can be held responsible for any defic
may have remained.
ienciesOofcthespaperlwhich
FOR OMCML USE ONLY
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current pricing practices are adhered to, managers will not follow the
intentions of the Central Plan.ing Board because it is to their advan-
tage to substitute product A for product Be We may label this a case of
"Gresham's Law a rebours". Therefore, a bonus system for fulfilling the
gross production plan and a system of average cost-plus pricing are con-
tradictory. When they re used together, they disorganize socialist
production. In order to remedy this contradiction, either the price
system has to be adjusted to the incentive system which is being used,
or the incentive system must be made compatible with average cost-plus
pricing.
If for the sake of the argument we disregard practical difficulties
and the prevailin,,, way of thinking in regard to price ratios, we rmy
consider changes in the price system as theoretically feasible. We want
to stress at the outset, however, that in the end we shall not propose
to "improve" the gross production bonus system by adjusting the system
of pricing in an appropriate manner. We merely want to point out those
changes in the price system which must be made if gross production bo-
nuses are to be used effectively as an incentive device for plan fulfilment.
First, let us determine the prices which would induce bu era to meet
the objectives of the Central Planning Board (buyer pricr~s),2
demonstrated that so ion g We have
g gross production incentives exist, there
will be a tendency to prefer expensive inputs. If we want to prevent
enterprises from overfulfilling the plan for, say 100% woolen cloth
at the expense of 40% woolen cloth, it would be advisable to equalize
the prices of 100% woolen yarn and of 40% woolen yarn. The smaller the
price difference between various grades of yarn, the less the danger that
enterprises will violate their assortment plan. The conclusion that in
order to prevent enterprises from taking the easy way out input must be similar or identical applies especially to raw materials, prices
since
their value is transferred into the product during one 9
g production cycle
(process). But it also applies to machinery and equipment. The higher
the depreciation rates and the share of depreciation allowances in total
cost, the more pressing is the need for price equalization,
Second, let us look at the prices which would lead sellers to meet
the objectives of the Central Planning Board (seller prices). In order
to render gross production incentives effective, only the prices of inputs
FU
3C1A rem ,L"' a
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have to be oqualizede Different types of output (e.g., regular watches
and waterproof plus shock resistant watches, dacron suits and woolen suits,
etc.) usually require different production processes and different produc-
tion expenditures. If enterprises are to be induced to fulfil their
production plans under these conditions, prices for different kinds of out-
put have to take these facts into account. If we were to apply the policy
of equal prices to seller prices, we would put a premium on assortments
with a small share of value added because they can be produced more easily,
the bonus for plan fulfilment being the same. However, if we were to dif-
ferentiate seller prices proportionately to average total cost, input prices
being the same, we would put a similarly undesirable premium on assortments
with a large share of value added because they would yield larger gross
production bonuses. Price differentiation according to value added would
make this premium even larger. To avoid both of these consequences, we
have to find a price ratio that would repress concentrating on assortments
which are easy to produce as well as on assortments which yield larger gross
production bonuses. We may expect that such a seller price ratio would range
between a ratio of equal prices and a ratio of prices which is proportionate
to the ratio of average total costa
For purposes of numerical illustration, we may use our example of reg-
ular wristwatches and waterproof plus shock resistant wristwatches. The
temptation to utilize expensive inputs has been eliminated by equalizing
input prices, and it is assumed that the material input is the same in
quantitative terms. Thus production costs differ only because of dif-
ference in valued added:
Cost
Waterproof
Regular shock resistant
watch watch
Average transferred value 10 10
Aye value added 10 20
Average total cost 20 30
If we were to price according to value added, our price ratio would have
to be 1 : 2. If we were to price according to average total cost, our
price ratio would have to be 2 : 3. In order to avoid favoring either
the production of regular watches or the production of waterproof, chock
resistant watches, our price ratio would have to fall between 2 : 3 and
3 : 3 (i.e., 1 : 1). As an example, we may assume the ratio of 2.5 : 3,
with seller prices of 30 for regular watches and of 36 for waterproof
and shock resistant watches. However, this is only one of many possible
examples which fall within this range, and the question remains: which
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`~ y~Y1 ''I~I~-~~ arn' ~,~ ~ ~'.?_- rya era a
ratio of seller prices, precisely, induces fulfilment of the assortment
plans for regular watches and waterproof, shock resistant watches?
We are afraid that there is no general, theoretical answer to this
question. A solution has to be found by sears of trial and error. We
aay expect, however, that such a solution depends in large moaaure on
the ratio of value added,
To summarize, we found certain rules for price setting within the
framework of gross production incentives, Buyer prices, rule,
ere to be equalized. Thus we eliminate the incentive to useaemeans of production as an easy method of fulfilling rose expensive
gross production
plan. Equalized buyer prices, however, do not solve the assortment prob-
lem. For its satisfactory resolution, seller prices have tobQ set so
that they cover (industrial) average total cost plus "Society?a share"
(accruing to the state in the form of turnover tan, e.g,) and so that
seller price ratios range between unit value and the value of the ratio
of.average total cost, to be found by means of trial and error,
Within the framework of gross production incentives, these methods
of pricing can be used effectively by the Central Planning Board as in-
struments of economic policy in affecting methods as well as directions
of production, since they enable the Central Planning Board to strengthen
administrative orders with material incentives, So far as methods of
production are concerned, the Central Planning Board can induce any branch
of industry to used desired inputs by ergasin the prices of these in-
puts. In the case of machinery and equipment, demand, in addition,
depends on depreciation rates and on rates of interest for fixed capital.
By raising these rates, the Central Planning Board can stimulate demand
for machinery and equipment further. So far as directions of production
are concerned, the Central Planning Board can induce enterprises to exert
special efforts in producing certain products or kinds of products by
fining the ratio of seller prices appropriately in their favor. Generally
speaking, equal buyer prices are "neutral"
indifference between inputs, and certain price they induce
by trial and error, are "neutral" in the sense that they induce oinbe foun
differ-
ence between outputs. In the case of "neutral price ratios", the Central
Planning Board has to rely on administrative orders only. Any deviation
from these "neutral price ratios", however, provides already an incentive
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'~'.dJ 1,.,~i 'i'ce ~~ ',1., ?,
4
in a particular direction, and price differentiation can thus be used
by the Central Planning Board as a tool of economic policy,
So far, we have been trying to chow that, in theory, a method of
pricing canba devised which will enable the Central Planning Board to
eliminate contradictions between prices and incentives with respect to
plan fulfilment. Our contention has been that we can discover prices
which "neutralize" or "balance" the negative influence of gross production
bonuses on the fulfilment of assortment plane for inputs as well as for
outputs. Next, we shall state several serious objections to the implemen-
tation of such a system of prices And gross production incentives:
First, the required price structure violates so-called "common Dense".
The prices of goods which "everywhere and always" were and are expensive
(e.g., 100916 woolen yarn) would h ve to be equal to the prices of rela-
tively cheap goods (e.g., ko% woolen yarn). The prices of goods bought
and sold within the state sector would have to be fixed at ratios which
would deviate far from those which we are accustomed to view as proper,
etc. The habit of thinking that price ratios have to, or ought to; cor-
respond to the "value" ratios cannot be overcome easily. Moreover,
adherence to this habit is not astonishing in view of the several thousand
years of experience which formed it (Friedrich Engels in Das Ka 'tZ? ?
Volume 3, Appendix I). Indeed, one may even wonder whether this habit
can be overcome at ally For this reason, it may be better to look for
an incentive system which would be compatible with the more "traditional"
price system.
Second, within the framework of gross production incentives, we
cannot induce the effective use of resources, even if prices are manipu-
lated as discussed previously, because the system as such does not provide
incentives for "economizing" in the sense of minimizing the use of "alive"
labor and of "embodied labor". This deficiency is attributable to the
fact that the enterprises are held to maximize gross production. By fixing
prices appropriately as described previously, we may be able to eliminate
many of the negative allocative effects of the gross production incentive
system, but we do not create incentives for improving the technical pro-
duction coefficients. within the framework of gross production cannot expect "initiative from below" on the part of enterprises and/or,
branches of industry with respect to economizing the use of means of /or
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production. When prices are given economizing has to be induced from
above, for instance in the form of plan targets for cost reductions,
input norms, etc.V
Third, within the framework of gross production incentives, we
cannot avoid using two different price systems within the socialist
sector, viz. a buyer price system and a seller price system. This
requirement, however, holds true for other incentive systems as well,
as we shall'show in Sections 2 and 3.
Fourth, and last but by no means least, the practical difficulties
of devising and operating a price system which is compatible with groarse
production incentives are evidently enormous. In view of our other ob-
jections to such a price system, it does not seem worth the effort
necessary to implement it.
As we noted in the beginning, the aim of our analysis was not to
defend the system of gross production incentives, but to derive re-
quirements for an effective price system corresponding to it. As a
"by-product" of this discussion, the relativity of the "law of supply and
demand" became conspicuously apparento Such obvious relationships as
that between price and demand (the higher the price, the smaller the de-
mand) holds true, in fact, only under the condition of specific institution-
al arrangements. Changes in the system of st.mulating producers (e.g.,
a change to gross production incentives) affect the above relation between
price and demand (e.g., in the case of gross production incentives, an
increase in the price of an input will increase the demand for that input).
However obvious the fact as such mby be, it is worthwhile to emphasize
that a given relation depends upon a given institutional setting, because
of the tremendous power of habit which is connected with that relation,
This power of habit is probably the only factor which explains why the
Central Planning Board made use and continues to make some use of gross
production incentives in combination with more or less "normal" price
ratios and why it practiced a price policy which assumed more or less
"traditional" price-demand relations.
2. Profit Incentives and Prices.
At the present time only a very few economists would defend an in-
centive system based on gross production. Rather, the profit sharing
system for workers, and bonuses based on profit for management are advocated.
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The incentive system based on profit consists also of two parts:
1) bonuses based on profit achieved (or planned) and 2) a system of
prices for means of production and final goods to determine the
profitability of individual enterprise? and branches of production,
Can there be contradictions between profit incentives and the
existing price system? Very likely yes. Only one (or few) price
systems can stimulate enterprisseG to behave in accordance with planned
tasks both regarding "what" and "how" to produce, and , as will be
shown below, the existing system of operational prices doeG not moot
the necessary requirements.
Within the framework of profit incentives, the operational price
structure and policy bear some resemblance to prices under "market
socialism", except for these fundamental differences:
1) In the theoretical model of "market socialism" prices constitute
an internally consistent system which, on the one hand, enables tho CPB
to find the optimal allocation of resources, and on the other, in con-
junction with bonuses based on profit, stimulates enterprises to plan
fulfilment, ,
In existing socialist countries (DEC)./, the prices together with
profit incentives have to_stimulate tho enterprises to plan fulfilment.
However, as we had argued elsewhere, they cannot and are not used for
economic verification of technical coefficients, but can and have to
be used to enforce the universal application of methods of production
that the CPB deems appropriate.
Both in the theoretical "market socialism" model and in DEC, opera-
tional prices coupled with a given incentive system have an empirical
character. They have to be adjusted according to the supply.demand
situation and must not be based on any a riori rule of price determination
(e.g. average total costs of branch of industry plus 5% profit),
2) In theoretical "market socialism" there is only one price facing
both. buyers and sellers. This is one of the basic requirements of this
model. The "one price" principle is essential for achieving the technical
efficiency of production. Different prices for a
exist only in the sphere of-consumption. given good can and do
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DPI 6 u p~' u'~ iL%1 I, a
is not one of its cornerstones. It seems to us that the principle of
"double prices"--different for buyers and ssellera- aunt be adhered to,
if prices are to be used effectively as part of the incentive systomo
Let us begin with the prices of moans pro oboe. The necessity
of two different systems of operational prices, one for buyers and one
for sellers, is the result of the external character of production
methods in DEC," Because of the eazternal character of methods of pro-
duction there is little reason to o pact that one price can properly
stimulate both sellers and buyers to follow the methods of production
prescribed for them in the national plane Those planned methods of
production are not internally consistent in the national economy as a
whole and are not fully coordinated with the price structures The letter
evolves historically; among its many parents were the efforts to use
prices to stimulate increased production in bottleneck areas,
In such a situation one should not be astonished by rather general
contradictions between the methods of production proscribed by the CPS
and the methods of production implied (and stimulated) by relative pricess.
To resolve these contradictions one needs a "double-price" system which
differentiates between producers and users, or a turnover tan calculated
to achieve the same results
The contradiction of the interests of sellers and buyers can apply
to the general price level as well as to the individual prices of means
of productions
In the sphere of consumere? goods there is also a need for different
prices for sellers and buyers (the latter of which are now individual
consumers). Two main reasons for this need can be noted here:
1) The CPB iso as a rule, active in the sphere of individual cone
oumption. It has definite preferences regarding the desired structures
of consumption because of social, welfare and other considerations. To
effectuate this policy, within the framework of free consumers' choice,
the level and the structure of consumer goods' prices play an important
role. As long as.the total volume of consumer goods does not call for
an amount of resources in excess of that allocated to Division XI, in
a planned economy there are no serious reasons for the CP3 m-irrreopective
of the type of economic calculation actually applied--to be constrained
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In DEC, the situation is quite differ?nta Tho "one price principle
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in its consumer goods price policy by the level and structure of tho
costs of production of individual commodities. There are no per-
suasive reasons for "cost fetishism"--.in any type of economic calculation-
because the costs of production are more or less incidental, as incidental
as the level and pace of technical progress in different branches of
production, factor endowment in a given country, otc,/
2) If it is true that there are no valid reasons for "cost
fetishism" under any method of economic calculation, it is especially true
under DEC, As we argued elsewhere, in DEC prices are mainly means of
aggregation, and their ratios as a rule do not reflect marginal rates
of transformation. Costa based on these prices, then, obviously must
also deviate from marginal rates of transformation. In such a situa-
tion it would be a serious mistake to allow the cost structure (via
retail prices) to influence the structure of consumption. Elements which
have to be considered to determine the level and structure of retail
prices are discussed elsewhere,2"
We have said above that within the framewors of DEC two systems of
operational prices are needed for the effective use of prices as a part
of a profit-incentive system, Let us discuss them in more detail and
also introduce the concept of "margin of tolerance" which, in many cases,
may render different prices for buyers and sellers unnecessary,
The margin of tolerance can be defined as an area around the ex-
isting price within which price changes for buyers and/or sellers do
not induce the enterprises to change the existing methods of production
and product smix. As long as the margins of tolerance of buyers prices
(Pb) and sellers prices (Ps) are tangent or overlapping, the need for a
system of two distinct operational prices does not exist.
The magnitude of the "margin of tolerance" in different product
groups and in the same product group, in different enterprises of buyers
and sellers, may vary. The very existence and actual magnitude of the
margin of tolerance is a result of several factors:
1) Differentiated pressure of administrative orb, In DEC one
of the main reasons for the existence of the margin of tolerance is
the system of administrative orders--quantitative ("what to produce")
influencing Ps and qualitative ("how to produce")
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influencing Pb? Under the system of administrative orders any devia-
tions from planned tasks not resulting from n e ga or, represents
illegal act. This undoubtedly inhibits deviations from the plan that
may arise from the desire for material gaino. The size of the margin
of tolerance attributable to administrative orders depends on throe
elements: 1) the actual pressure of administrative orders, 2) the
achieved level of social integration and 3) the absolute and relative
magnitude of financial 3ainc realizable by plan deviation (e.g. frog
assortment plan)o Here wo are concerned only with the first. As we
know from otperionco, the actual preseuro of administrative orders
usually differs by branches of industry and by product groups. 't is
especially great in branches or products of so called "high priority".
As a result, the margin of tolerance attributable to the use of admin-
istrative orders differs accordingly.
2) Ach eve l_ovel of eoc al tat ion also has an influence on
the magnitude of the margin of-tolerance. Under coterie ar bus as-
sumptions, the magnitude of the margin of tolerance is proportional
to the achieved level of social integration. A high level of social
integration means that the producers identify the planned goals with
those of their own and therefore do their bast to achieve them even if
the actual price structure makes certain deviations profitable.
3) As already menti.onei,the absolute and relativeanjtuda of
financial ,wine realizable by plan deviation obviously constitutes an
important parameter determining the magnitude of the margin of toleranco.
The payoffs of plan deviation depend on many variables; among others,
on the relative share of bonuses in the total income of management per-
eonell. In the situation, not unknown in Poland a few years ago, when
bonuses run as high as 50-60% of total income and were de acto indis-
pensable for maintaining a "normal" standard of living, the natural
tendency on the part of management to obtain bonuses (almost "regardleoa
of consequences") substantially diminishes the actual margin of toler
ance. Under other circumstances, with different incentive intensities,
the margin of tolerance would be substantially greater.
b) The existence of the "insensitivity I. They magnitude of
the margin of tolerance depends also on several factors which we can
denominate as the "insensitivity margin". (a) First of all there is
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the relative share of a given input in total costs. If the share of-
a given input in total costs is in the range of one or a few percent,
the "sensitivity" of the enterprise (or the branch of industry) to its
price change is, as a rule, small. If a certain input comprises, say
1% of total costs, even a 20% increase of its price will lead to only a
O,2% increase in total cost. It is very probable that a total cost
increase of this magnitude will not cause any realignments in enterprise
demand, and so the given price increase lies within the margin of tol-
erance, If; on the other hand, the very aamo input comprises 20% of
total costa, the same price increase can initiate the process of
substitution. We can conclude therefore, that the margin of tolerance
for any commodity is differentiated according to individual enterprises,
buyers or sellers. That is, the 'Affective mar in of toler ance11 is a
magnitude of price change which does not cause deviation from plan tasks'
in aM_enterpr?ise. It is determined by the smallest margin of tolerance,
i.e. the margin of tolerance in the branch or enterprise with the nar-
rowest "insensitivity margin". This obviously complicates the task'of
constructing a system of uniform prices for buyers and sellers, but,
nevertheless, it enables the CPB to construct a system of "double-
prices" (P b and Ps) instead of individual accounting prices for every
enterprise.
(b) The further element which accounts for the existence of the
"insensitivity margin" and, via this margin influences the magnitude of
the margin of tolerance, is routine. Because of routine, price changes
within certain limits do not have any effect on the demand or supply
schedules of enterprises. This "unwillingness to change" has its sub-
jective aspect--any change means, as a rule, effort and trouble for
enterprise management, and its objective aspect--usually every change
costs money (the cost of changing technology, input norms, machine
operations, etc). In short, routine is also one of-the elements de-
termining the existence and level of the margin of tolerances
5) Lack of subati s (party because of rationin . Another
factor which affects the existence and magnitude of the margin of tol-
erance is the substitutability of the mean of production. The more
specialized the means of production, the less sensitive the enterprise
to a change in its price and the greater the margin of tolerance around
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it. Roaever, the eeso of substituting input.A varies with different
enterprise. Input A may be easy to subatituto in producing X9 and
very difficult in producing Z. Here again we meet the effective margin
of tolerance described above.
Thus far we have been discussing substitutability 92gsu str cto
i.e. determined by technical causes, and have comp to the concluo
sion
that the smaller the substitutability the greater the margin of t
olorm
ance and vice vet (of course under ceteris P_ar bua aseumptions)e
Substitutability can also be limited (the aargin of tolerance increased)
administratively, by rationing. The rationing of means of production,
which means that the enterprise cannot buy, say, bricks and lunber in
other proportions than prescribed by plan9 or cannot buy more of any
of these inputs than the planned allotment, has the same effect me
technical ineubaetitutability and diminishes the enterprioes? sensitivity
to price changes, i.e. increases the margin of tolerance.
The ggesibility.of substitution acts counter to the margin of
tolerance, because it creates the objective basis for deviation from
quantitative and qualitative planned tasks. The mon, however, for
taking advantage of substitution possibilities is financial gain (in
the form of profit bonuses) which can be achieved as the result of un-
authorized changes in plan fulfilment. If the ssibility is the result of technological and institutional(rationing)$factoretution
the profitability of substitution, with the above given, depends ones
the price ratios. The margin of tolerance around the price of input A
depends then, among others, on the profitability of its S substitution
by or for input B, i.e. on the price ratio of substitutes. It sosns that
the margin of tolerance around a given price depends on the price system.
The price eysteLn, however, does not determine the magnitude of
the margin of tolerance, but only its distribution around a given price,
Lot us assume, for example, that the price ratio of lignit and coal io
1 : 2 and that with their prices fixed at 10 : 20 the margin of tolerance
is identical for both prices, aymetric and at the 10% level, that is, in
this case the margin of tolerance
= price _? 103. The change in the price
ratio to 9 : 22 will make the margin of tolerance asymmetric for both
prices, and moreover, the margin of tolerance will exist now only in the
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- 13 -
case of a price increaGG for lignit (?20) and for a price dscroaago for
eomj (-20%). In constructing the system of operational prices tie have
to take this into account.
x
The existence of the margin of tolerance creates the objoctive
basic for fixing one price for both buyers and oellere, in spite of the
external character of methods of production, without the danger of
active, negative influenco of prices on plan fulfil?ent. Such
poseilbil-
ty of one price exists when the effective iargino of tolerance around
pb and Ps are n?errlapping nrr taIIgen ._ Tt
below: In illu?trated by the table
For Enterprises
(buyers prices as a percentage of
sellers prices with sellers prices
equal 100)
Table 1
Pri ee
For' Egf of TolerMcp
The Limits
of feasible uniform
prices for buyers and
sellers (as a percen-
tage of existing
ellers? price).
105-1o8
80-85
40 60 80
100 120 140
Margin of Tolerance around sellers prices
Margin of Tolerance around buyers prices
As demonstrated in Table 1, there can be one price for goods A, B
and D for both buyers and sellers because the effective margins of tol-
erance around the prices of these products are overlapping.
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The effective margin of tolerance can be IKLgaded or contract
as a result of the CPB'o economic policy. One reason why the CPB aay
be interested in extending the margin of tolerance is the desire to have
one price for both buyers and sellers in the greatest possible number of
caaeeo
In changing the margin of tolerance the CPB can rely on: 1) the
varying intensity of administrative orders, 2) differentiating the share
of bonuses (based on profit) in absolute terms and in relation to basic
salaries and 3) rationing policy. With (a) strong administrative orders
and (b) limited bonuses it is possible, in a great number of cases, to- z
fix one rice both for buyers and sellerao
In the practice of socialist countries both of these conditions
(a) and (b) are generally fulfilb d. In Poland, for example, the yearly
profit bonus cannot exceed one month's wage or salary. This policy of
limited bonuses is explained in terms of needs for market equilibrium
for consumers' goods.
This policy of limited bonuses can be defended also by a different
set of arguments along the lines mentioned above. The policy of limited
bonuses is in accord with the character of our economy based on Direct
Economic Calculation. It constitutes a valuable incentive for improving
enterprise performance and yet not strong enough to endanger the discipline
necessary for strict plan fulfilment.
At the same time we have. to realize that increasing the aargin of
tolerance b the CFB has also its negative aspect because, in its ultimate
effects, it means diminishing the force of incentives. Direct diminishing
-=
when we consciously linit the possible "absolute and relative magnitude
of financial gains" which can be obtained by management; indirect4mUhon
we rely on administrative orders and rationing of the means of production.
Diminishing the force of material incentives, at a given level of social
integration, means the actual "deterioration" of average performance.
x
The margin of tolerance is a feature of prices not unique to
socialist economies. It also exists in capitalist economies, however,
as far as we know, it is usually not taken into account in texts on
price theory. The existence of the margin of tolerance in capitalist
economies is not strange, because most of its causes are not specific
characteristics of socialist economies and with few exceptions (adainistrativ
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15
orders and rationing) are present in market economies as well. We are
also inclined to think--it is however only a guess which still needs
substantial research for its verification--that the margin of tolerance
is present especially in enterprises. It seems to us that in bin
enterprises the causes for the existence of the margin of tolerance
(specifically the "insensitivity margin") are especially strong. (In
a big enterprise the cost and time involved in adapting to price changes
are particularly great and hence the profitability of reacting to every
price change,,however small, is apt to be lose than in smaller business
unit.)
x
At this stage of our analysis we can formulate several conclusions:
1) There are "equilibrium" price systems for a given plan,
2) Because of the margin of tolerance the CPB can in many cases
fix 9price for both sellers and buyers, in spite of the external
character of the methods of production in Direct Economic Calculation.
3) This uniform price for buyers and sellers usually also has a cer-
tain margin of tolerance to the extent that margins of tolerance were
previously overlapping. It is, however, much smaller than when we have
two different price systems, for buyers and for sellers.
4) The existence of the margin of tolerance facilitates the stabs i-
of operational prices without negative effects on plan fulfilment.
As long as changes in economic conditions (e.g. in planned tasks) call
for a change in prices within their margins of tolerance, keeping prices
unchanged does not cause by definition any reaction by enterprises and
does not weaken incentives to any substantial degree. Keeping prices
stable, therefore, has no adverse effects on plan fulfilment.
When we discussed the price system required for an incentive system
based on gross production, we felt a little bit like "Alico in Wonderland".
It was the economic world as we know it 6 rebours: products "everywhere
and always" expensive were priced the same as cheap goods, price increasso
had the effect of increasing effective demand, etc. Within the framework
of profit incentives such an "extraordinary" price system is not necessary
for effective plan fulfilment. Because the goal of the enterprise is
now profit rather than gross production, it is possible to use prices
based on the notion of production costs, to have a more or less "traditional"
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price structure. Scarce goods, which have to be edonomiaed, can again
command the high price and vice versa. Of course, we are only saying
here that now prices can be related to production costs, not that there
is any one rigid formula by which they should be determined. If
profit bonuses are to be used as an effective incentive for fulfilling
planned tasks, the prices must have an empirical character, to be fixed
and changed according to varying economic conditions and plan objectives,
This empirical approach to prices is in direct contradiction to the
general and deeply rooted tendency of "price fetishism". The experience
of capitalist economies accustomed us to think that prices must be based
on value, price of production or costs. This is the root of the belief
that prices have to be'"proper", that is to say, they must have an ob-
jective basis in costs, however calculated. It would be in direct
contradiction to t is belief to fix a high price for low cost goods or
vice versa. The empirical approach is limited by fetishism.
We want to stress that in Direct Economic Calculation there is no
per as optimal price system. The price system depends to a great extent
on the incentive system used, on the goals posited for enterprises. To
every incentive system there corresponds a specific price system such
that changes in one necessitate compensating changes in the other. This
is requisite if we want to avoid inherently contradictory stimuli of
prices and incentives on plan fulfilment. The tasks of economists--as
we see it--is not to look for price or incentive systems optimal per U,
but to find the optimal set of their possible combinations: those com-
binations which best serve the task of plan fulfilment and will prevent
prices or incentives to influence production in any directions contrary
to plan.
3. Net product incentives and prices.
The incentive system based on gross production stimulated enterprises
to use expensive instead of cheap methods of production and to produce
material-intensive rather than labor-intensive goods.
The change from the incentive system based on gross production to
one based on net production eliminates, to a great extent, the negative
influence of "normal" prices (i.e. prices based on average cost of pro-
duction + 5% profit) upon plan fulfilment. At the same time, however,
it creates certain new problems_?dange:poue:.for the effective functioning
of the national
economy,
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Sf
d . ; d Ill'-':I . .'?:J ~..
By net product is Meant the difference between gross production and
the value of all material means of production, interest, rent and tanoa.
This definition of net product is used for the purpose of economic policy
and differs from the definition of net product sensu stricto as used in
Marxian economic theory. In the latter sense the net product is equal
to v + s (variable capital plus surplus value) and, obviously, also
includes interest, rent, taxes and similar forms of redistribution of
value added.
Within the framework of the incentive system, based on not product
as defined above, the enterprises will use means of production according
to their price ratios fixed by the CPH. Because the values of inputs /
do not influence directly the net product, there is no reason for the
enterprises to prefer expensive inputs in choosing production methods.
There is also no reason for them to try to overfulfil the plan of gross
production by eliminating the cheap goods from their assortment plan.
How will enterprises behave under the incentive system based on
net product?
Ao Methods Production. With given
prices the enterprises will try
to minimize the "transferred value" (i.e. value of constant capital) and
other items which are subtracted from gross production, because this, '
ex definitione, will maximize their net product, The CPB can stimulate
the enterprises to economise any given input by a relative rise of its
price or vice versa.
Whether, the enterprises will economise the capital stock depends on
the type of cost calculation used. Under the cost calculation which does
not include interest charges and rent, there will be a tendency on the
part of enterprises to have as big a capital stock as possible. The latter
does not cost them anything and facilitates the maximization of net
product. This, however, can be avoided by charging a proper interest
rate and rent, and by a sound depreciation policy. Under this type of
cost calculation it will be profitable for enterprises, trying to maximize
net product, to use the capital stock and natural resources only to a cer-
tain level. The CPB can raise or lower this level by appriopriate changes,'
in interest and rent charges.
Using an incentive system based on net product, we can expect the
initiative for economizing the material means of production to come from 1
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A m
within the enterprise. Whether this initiative will also include an
attempt to economize capital stock and natural resources will depend on
the type of cost calculation used.
This rosy picture of incentives based on net product also has its
negative side: the impact on labor force utilization--also influencing
the utilization of material means of production.
Within the framework of incentives based on net product the labor
force has a ?ero o2r tven e~ative r;ce from the point of view of its.
influence on the level of net product,
Let us assume that the production plan of the enterprise is 10
units of X at 10 zlotys per unit in operational prices and planned costs
are:
material and others
wages and salaries (net product)
total
80
20
100
with 10% bonus for achieving the planned volume of net product.
If the enterprise achieves the production target, using a labor
input 10% higher than planned (e.g. due to overtime work) the level of
net product will not be influenced. Bonuses will therefore not be
diminished. In this situation, from the point of view of Qe enterprise,y
the cost of labor is zero.
If the enterprise achieves the production target, using a labor
input 1094 higher than planned (e.g. due to overtime work), but at the
same time cutting non-labor'inputs by 5 units, it will overfulfil the net
product plan. In this case, the labor force has a negative price from /-
the point of view of bonus maximization. The same will hold, only not so
strongly, if using more labor input than planned, results from additional.
employment (and not overtime) since then the bonuses will have to be
shared by a greater number of employees. This will also be true, even
more strongly, under a system of progressive bonuses based on net product.
The result of the above is that within the framework of incentives
based on net product there will be a tendency on the part of enterprises,
to substitute labor for material means of production. There will also
be a lack of financial incentives to economise labor.
Two serious dangers are connected with this:
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19
1)'the danger of spending more for the national wage fund than
planned, resulting in a disequilibriure in the consumers' goods market,
leading to infl
ti
a
onary pressure;
2) the danger of deviation from planned methods of production di
turbing the planned real balance equilibrium.
Can these dangers be prevented by appropriate ric
~ o a
Obviously not. In the situation where the price of the labor from the
enterprise's point of view is zero or negative, there is no possible
change in the price ratios of material means of production to labor Which
can remedy the two dangers mentioned above.
The remedy lies in administrative means. Price policy er is in_
effective. But used in conjuntion with administrative means it can
again become an effective tool in stimulating producers to fulfil planned
tasks. To achieve this, we have to eliminate the zero or negative price
of the labor at the enterprise level. It can be done by strict cow
and rationing of the wa fund.
Under strict rationing of the wage fund, when the enterprise cannot
increase its net product by increasing labor inputs, labor ceases to have,,
a zero or negative price in enterprise calculation. When this is true,
price policy for the material means of production is again an effective
tool for stimulating producers to achieve the planned methods of pro-
duction and product misr. The enterprises treat labor inputs as given
(a function of the planned wage fund) and react to changes in price
ratios the same as under profit incentives, i.e. they try to equalize
the value marginal productivity of each factor with its price. The CPB
can again use th ,rices of factors of production as a part of an incen-
tive system.
We have to realise, however, that net product incentives create a
certain conflict of inter between enterprises and the Central Planning
Boardo At the stage of bull1kZ, when the wage fund is not yet
fixed, labor from the enterprise calculation point of view has a zero
or negative price. As a result, enterprises will try to get as high a
wage fund as possible in order to create hidden reserves. These can be
used to overfulfil the planned net product by cutting material costs., This
pressure from the enterprises, due to the incentive system used, will,
undoubtedly, be reflected in methods of production approved by the planners.
N
OFFICIAL UIS~ 'UNLV
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51
SE ONLY.
Then, at the stage of fulfilment, the actual performance will tend
to deviate from planned tasks because enterprises will try to take ad-
vantage of existing reserves in approved methods of production. They
will try to maximize the net product by substituting labor for material
means of production within the limits of the approved wage fund. The
consequences of this conflict of interests cannot be resolved oatis-
factorily within the framework of an incentive system based on net
product.
B. ghat to rod ce. Lot us now discuss the consequences of net product
incentives on "what to produce".
The magnitude of net product for 100 zlotys of
gross production
differs in various branches of production (e.g. it is relatively great
in mining and relatively small in the electric power industry) and--
what is especially important-sit differs also for various products within
a given branch of industry or enterprises. For example, the relative
share of net product in gross production is greater in tho case of hand
painted porcelain than plain or regular porcelain. This fact creates
certain problems for economic policy.
1) The different share of net product for 100 zloty, of gross
production in various branches of industry makes it necessary to apply
bonuses differentiated by ranches or, in the case of equal bonuses,
the use of a properly differentiated turnover tax. Those are necessary
if we want to avoid unjustified differences in the level of bonuses
received by different branches of industry.
2) The different share of net product in various goods makes
necessary the use of a turnover tax differentiated bZ 2roducta. Otherwise
there will be a tendency to deviate from the planned product mix.
Summing up: the properly differentiated turnover tax makes possible
the use of price policy as an effective tool for stimulating enterprises
to produce in accordance with the tasks prescribed for them in the
national plan.
x
Incentives based on net product do not invalidate the argument
put forward in the previous Section that in Direct Economic Calculation
there is a need for a system of two operational prices--one for buyers
and one for sellers-due to the external character of the methods of
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~Ctt'6~ him,",
production. Since our discussion of the margin of tolerance existing
around every operational price also ap:lies to the incentive system
based on net product, we do not have to repeat our previous arguments
here.
x
We can formulate the main conclusions of our analysis in the
following ways:
1) The operational price and incentive systems always have to be
analysed together and not in isolation. The latter, however, is the
prevailing practice. For every incentive system there is an appr.opriato
price system, and changes in one will always have to be accompanied by
compensating changes in the other. Otherwise, there will ba a contradic-
tion between prices and incentives used, a contradiction from the point
of view of their influence on plan fulfilment.
2) In Direct Economic Calculation there is no price or incentive system
.per se optimal. de can find, however, an optimal combination: that
combination which serves best plan fulfilment and which precludes price
or incentive stimuli not in harmony with planned tasks.
3) The "price consequences' of any incentive system or of contem-
plated changes in it (i.e. changes in rules and/or intensity of incentives)
always have to be carefully analysed to avoid their possible negative
effect on plan fulfilment. And vice versa' any price changes have to be
analysed from the point of view of their impact on the functioning of
the given incentive systems
4)The choice of any given incentive system determines the system
of operational prices which can be effectively used in conjunction with
it and vice versa. Thus, as we have shown in Section 1, the effects
of average cost-plus pricing operate in contradiction to the stimuli of
gross product incentives. This mutual interdepend6nce of the incentive
and operat:~_onal price systems limits the CPB's freedom of action in
making both price and incentive pilicy.
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1?~~ u' ,~Il' L9lrfriilU ~ZL L, Vi:.v u,
FOOTNOTES
/ The buyers are hare, of course, the state enterprises and not the
individual consumers, We are concerned in this paper with the co called
"operational prices" only, which are used within the socialist sector
for stimulating producers?sellero and buyers- to plan fulfilment. In
the socialist economy there are also so called "programming prices" used
for plant construction and so called "consumers' drices", which have to
equalise sup,-,ly and demand, and at the same time, to influence consumption
patterns in the direction socially desirable (as aeon by the Central
Planning Board).
VIn practice, gross production incentives are usually suplemented by
incentives to economise inputs per unit of output, e.g. in the fora of
bonuses for diminishing unit cost. In this paper, however, we do not
analise the "mixed" incentive systems with bonuses for many indices, as
e.g. level of gross production, diminishing the unit costs, raising
quality of products, introducing technical progress, etc.
/The method of economic calculation applied in existing socialist
countries we call Direct Economic Calculation (DEC) because in this type
of calculation one computes and co-ordinates direct the physical
magnitudes. E.g. the supply of steel which is a function of existing
capacities and other material and technical conditions, with demand for
steel, which is also the result of certain technical calculation (inputs
norms multiplied by volume of ,)roduction) when desired final products
are defined. Three basic elements are co-ordinated directly in this
type of calculation: 1) existing material and human resources, 2) desired
final products which represent preferences of the CPB and 3) technical
coefficients of )roduction. This type of calculation is known and
described as material balances and/or input-output analysis,
In DEC we have prices, wages, etc. but they do not ,)lay an active,
balancing role: in DEC the supply and demand of steel is not--ceteris
paribus--a result of the price of steel; demand for labor is not the
function of the wage level, and prices and wages do not fulfill the
equilibrium conditions, In DEC there is--as a rule--a direct comordinatter
du
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footnotes cont.
(balancing) of physical quantities without active use i.e, determining
supply and demand, of value categories such as pricese wages, rate of
interest.
This is obvious enough and generally recognized. Unfortunately the
ame cannot be said about conclusions generating from it as well
as of
developing the model of economic process where the magnitudeo expressed
in monetary terms are not used as the basis for economic choice but
rather as the way of representing the inputs and out,)uts when the aim
and methods of production are given.
See A. Wakar, J.G. Zielifiski, The Direct Economic Calculation,
("Ekonomista", Hr. 1, 1961)9 and J.G. Zielifiski, Economic Calculation
in a Socialist Economy, Panstwowe Wydawnictwo Naukowe, Warsaw 1619 pp.225.
V One of the most fundamental feature of DEC is the external character
of methods of production. Within the framework of DEC there is no
mechanism f economic verification of technical coefficients (methods
of production). The "fundamental assumption" of input-output analysis
(and the same, of course, applies to material balances) is that required
input per unit of output is technologically determined and can be consider(
as a structural constant. When we treat the technical input coefficients
as independently given parameters, we assume that they are independent
of factor prices and eliminate from this model of general equilibrium
the substitution principle of marginal productivity theory, This can
be considered its fundamental weakness (Loontief).
It means th._;t the methods of production used in DEC are external to
the system. They are not verified within the system, so that the beet
methods of producing a given output cannot be chosen, but are taken from
outside the system and constitute unverified data. They are so called
"traditional" methods of production, i.e. methods of production used in
the past, or so called "advanced" methods of ;-)roduction, usually taken
from the practice of more advanced countries and used as data for plan
building by the country under consideration.
V Of course, the consumers' "sovereignty" is abolished here. But lot
us assume for the moment that differences in price ratios between, say,
Poland and the U.S. as shown in the table below, are the result of real
differences in marginal cost ratios. Would it not be risky to say that
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one or the other structure of consumption, resulting, ce? aribus,
frcm the givcn price stru':,:re, is better than the cthcr? If there are
no objective criteria to determine what strcuture of consumption is
better than the other, the CPB has no reason to be much worried that
because of random elements in the consumer price structure it is doing
any harm. Moreover, in many cases it has definite opinions about the
desired structure (and volume) of consumption, and price policy allows
it to achieve them without limiting the freedom of consumers' choice.
Retail price ratios (1961)
U.S.A.
Wand
50 :
1
60
: 1
2 :
1
40
: 1
0.5 :
1
10
: 1
1 :
1
18
: l
1 :
1
4
: 1
2/ See A
.
Wak
e
r,
J
.
B
eksiak, The Consumers' Goods Prices ("Studies in
the Theory of Socialist Economy" [A. Waker, ed.] Vol. II9 Central School
of Planning and Statistics, Warsaw, 1962), and J.G. Zielinski, oR. Sit.
Chapters IV) The Place of the Consumer is A Planned Economy) and V
(Remarks on Market and Planning). Both works are Polish.
ready-made suit -~ one lb. of ham
can of sardines -- one telephone call
cup of coffee -- tram ticket
drip-dry shirt -- scientific book
"helanca" socks -- cinema ticket
oil
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