USSR: SHARPLY HIGHER BUDGET DEFICITS THREATEN PERESTROYKA

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• Publication Date: September 1, 1988
• Content Type: REPORT

STAT
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USSR: Sharply Higher
Budget Deficits Threaten
Perestroyka
A Research Paper
0048553
S0V*10043U4:88
SOVA*11962)8E
1499-1499
SPECIAL ASST FOR DISSEMINATION ANALYSIS
CPAS/CSG/ISS (A-1:
ROOM 7G50
HQS
SOV 88-10043U
September 1988
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iiirecturatv ut
Intelligence
Reverse Blank
USSR: Sharply Higher
Budget Deficits Threaten
Peres troyka
A Research Paper
SOV 88-10043U
September 1988
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Summary
Information available
as of 2 September 1988
was used in this report.
USSR: Sharply Higher
Budget Deficits Threaten
Perestroyka
The Soviet state budget deficit has increased dramatically during the last
three years. We estimate that 1987's deficit, six times the level recorded in
1984, was equivalent to some 7 percent of Soviet GNP. (For comparison,
the highest US Government budget deficit represented 3.5 percent of US
GNP in fiscal year 1986.)
Moscow is essentially financing its deficits by printing money, and the
resulting inflationary pressures are clearly visible. Growth of wages almost
doubled in the first half of 1988, while annual increases in savings deposits
have doubled since 1985 and have continued to surge in 1988. There has
been a marked increase in the prices of consumer goods sold in collective
farm markets, along with higher prices and increased shortages of
consumer goods in state stores. Excess purchasing power also has probably
led to an expansion of the underground economy, which results in resource
diversions from the state sector. Increased inflation probably has under-
mined current attempts to spur state worker productivity by higher wages
and salaries.
General Secretary Gorbachev's policies are partly responsible for the
deficit rise:
? State spending has risen substantially as a result of large boosts in state
investment and the rise in total state subsidies on food and livestock
products.
? Receipts from stiff sales taxes on alcoholic beverages are down substan-
tially as a result of the regime's antialcohol program.
? Revenues from the large markups imposed on the retail prices of
imported food and consumer goods have fallen sharply as a result of the
cutback in such imports.
? Proceeds from enterprise profit taxes grew slowly last year because of
production problems due to retooling, reforms, and quality control
measures.
Moscow has taken a number of steps over the last year to absorb excess
purchasing power or to manage the resulting shortages of goods and
services, including rationing and issuance of a new series of savings bonds.
These policies, however, do not address the budget deficit itself and thus ig-
nore the source of the purchasing power problem.
111
SOV 88-10043U
September 1988
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Leadership concern over the issue seems to be mounting. The General
Secretary first noted stresses in the state budget in a June 1987 speech to
the party leadership in which he criticized the Brezhnev regime for relying
on alcohol sales and oil exports as revenue sources. More recently,
Gorbachev acknowledged in his opening speech to the 19th Party Confer-
ence in June 1988 that the state budget has been in deficit for many years
and that its current level reflects in part "our mistakes."
Gorbachev has a wide range of policy options available for bringing the
deficit under control, but they basically involve either cutting spending or
increasing state revenues:
? Substantial price increases for consumer goods and key industrial
materials, such as fuel and raw materials, would reduce government
subsidies. Indeed, doing away with food subsidies alone would bring the
budget back into balance. But the specter of Polish unrest weighs heavily
on the leadership, with good reason.
? Several high-ranking political and military spokesmen have stated
publicly that the Soviet Union plans to reduce spending on defense. But
the level of cuts needed to make a major impact on the budget deficit is
unlikely. Similarly, state investment outlays could be trimmed, a remedy
suggested by Gorbachev in his July 1988 speech to the party leadership.
Although investment requirements remain high in energy and other
critical sectors, potentially large savings are available through halting
low-priority projects and eliminating waste.
? Higher tax rates are a possibility, particularly in the context of increased
wage differentiation and the expansion of private-sector activities. But
the increases would have to be large to make a dent in the deficit, and
they would have their own disincentive effects. Moscow is considering
relaxing the antialcohol campaign because increased state sales of
alcohol would reap large tax revenues. Finally, much greater consumer-
good imports sold at high prices domestically would raise substantial tax
revenue and soak up purchasing power. Such imports could be easily
financed through foreign borrowing, but Moscow traditionally has
preferred to finance imports of machinery and equipment that expand
domestic production capacity rather than imports for current
consumption.
iv
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? A currency revaluation (for example, 1 new ruble for 10 old rubles) could
effectively wipe out much of the savings overhang and devalue cash
hoards. Although not without precedent, this would appear to be an
especially heavyhanded and politically risky approach. Moreover, unless
accompanied by price revisions, increased taxes, or reduced state spend-
ing, currency reform would not solve the budget imbalance.
Only large-scale imports of consumer goods or relaxing the antialcohol
campaign offer Moscow opportunities to address the budget deficit without
gouging an important interest group. Each option, however, has other
undesirable consequences. The leadership is concerned that five or 10 years
hence the Soviet Union would have to service a much larger foreign debt
with little to show for it. And Moscow is reluctant to ease the antialcohol
campaign because it could undermine efforts to improve health and worker
discipline.
In any event Gorbachev must act quickly. Because the inflationary impact
of the budget deficit exacerbates current consumer problems, the leader-
ship is fighting an uphill battle in trying to improve the quality of life for
average citizens. If the budget deficit is not brought down, it could lead to
inflation much worse than the Soviets have experienced in the postwar era.
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Contents
Page
Summary
iii
Scope Note
ix
Budget Deficit Balloons Under Gorbachev
1
State Spending Surges
1
Revenue Shortfalls
2
1988 Budget Plan: No Relief in Sight
3
Money Creation Finances the Deficit
3
Impact on Prices, Shortages, and Savings
4
Prices Increase
4
Shortages Intensify
5
Forced Savings Increase
7
Increased Soviet Recognition of the Problem
7
Leadership Concern
7
Economists' Statements
8
Official Acknowledgement
9
Limited Policy Measures So Far
9
Rationing
9
Savings Bonds
9
Insurance
9
Charity Funds
9
Increased Role for Collective Farm Markets
10
Cooperative Housing
10
Encouraging Private Business
10
Costs of Continued Inaction
10
Resource Diversions From the State Sector
10
Labor
10
Consumer Goods
11
Producer Goods
11
Weakened Workers' Incentives
11
Price Reform Constrained
11
Gorbachev's Options
12
Removal of Subsidies
12
Increased Sales of Consumer Goods
13
vii
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Page
Spending Cuts on Defense and Investment
13
Currency Reform
13
Outlook: Perestroyka Threatened
14
Appendixes
A. Key Tables
15
B. State Revenue From Foreign Trade
21
C. The Official Balance as an Indicator of the Estimated Deficit
23
viii
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Scope Note
Largely using Soviet official data and statements of Soviet officials and
economists, this paper documents the existence of sharply higher state
budget deficits in the Soviet Union that are being financed to a large extent
by money creation. We are confident that the deficit has increased greatly
in the last two to three years, but are less sure about its exact size for sever-
al reasons:
? Moscow traditionally has treated many elements of government finance
as state secrets. For the purpose of estimating the budget deficit, the most
important information gaps are on the revenue side. Moscow does not
provide a full breakdown of revenues, and, although we have tracked
down and used as much information as the Soviets publish, conceivably
we could be missing an important tax source altogether.
? Most Western analysts agree that one major source of state revenue
missing in the official breakdown is revenue from foreign trade. We have
made estimates of such revenue based on the best available Western
information. Nevertheless, we could be underestimating it by perhaps 10
percent, or about 8 billion rubles. Our estimates of the deficit would thus
be too high by the same ruble amount.
? Moscow publishes virtually no information on the money supply, which
could be used as an independent check on our estimates of the deficit.
Because of rising Soviet concern over the deficit, we may soon see an
improvement in the availability of official financial statistics. Meanwhile, a
September 1988 Soviet newspaper article gave the first hints of Soviet
estimates of the deficit, implying a range of 65 to 75 billion rubles. This
range encompasses our estimate for 1988 and suggests we are close to the
mark.
Western analysis of Soviet budgets and their financial implications has a
long history. Some of the more recent treatments of this area of the Soviet
economy include: Igor Birman, Secret Incomes of the Soviet State Budget
(1981); Raymond Hutchings, The Soviet Budget (1983); James R. Millar
"Financing the Soviet Effort in World War II," Soviet Studies (January
1980); and Mark Harrison, "The USSR State Budget Deficit Under Late
Stalinism," Economics of Planning, Vol. 20, No. 3 (1986).
ix
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Figure 1
USSR: Estimated State Budget Deficit, 1981-88
Billion rubles
80
Percent of GNP
10
1981 1982 1983 1984 1985 1986 1987 1988 1981 1982 1983 1984 1985 1986 1987 1988
317634 6.88
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USSR: Sharply Higher
Budget Deficits Threaten
Perestroyka
. all of our radical reforms are doomed to failure if
Estimating the Budget Deficit
we are unable to realize success in our financial
policies.
Vladimir Il'ich Lenin
18 May 1918
Budget Deficit Balloons Under Gorbachev
General Secretary Gorbachev's policy of greatly in-
creased state spending on investment, coupled with
the tax losses from his antialcohol campaign, has
intensified other negative fiscal trends and produced
large budget deficits. Indeed, we estimate that the
Soviet state budget deficit increased from 11 billion
rubles in 1984 (1.4 percent of Soviet GNP) to 64
billion rubles in 1987 (7.4 percent of GNP) (figure 1
and inset).' In contrast, the peak US Government
deficit in fiscal year 1986 of $148 billion represented
3.5 percent of US GNP. Relative to GNP, the Soviet
deficit is roughly two times the size of the peak US
deficit in 1986.2
State Spending Surges
General Secretary Gorbachev assumed power in
March 1985 in time to push for faster investment
growth in the 12th Five-Year Plan (FYP), then being
drafted. He did not have an easy time convincing the
planners to accept his program, suggesting that they
believed his investment objectives would push the
economy beyond its capabilities. Nonetheless, he won
out. According to the FYP, budgetary outlays on
' Throughout this paper we define the budget deficit as the amount
of total government spending per year not met through ordinary
revenues (tax revenues and service fees) and which therefore must
be financed through government borrowing. The percentage shares
of GNP are rough estimates derived by adjusting CIA estimates of
Soviet GNP in constant 1982 established prices, using an assumed
average annual rate of inflation equal to 2 percent.
'The Soviet state budget is a consolidated budget that takes into
account incomes and spending of the central government, the
republics, and local governments. A comparable figure for the
United States thus includes not only the federal deficit ($205 billion
in 1986) but also the surplus run by the 50 states ($57 billion in
1986).
1
Soviet official budgets almost invariably show a
surplus because, by Soviet convention, short-term
loans from the State Bank (which are the equivalent
of printing money) are counted as a revenue. Conse-
quently, the officially reported surpluses have little
economic or financial meaning and are extremely
misleading concerning the extent of money creation.
A Soviet economist acknowledged this in a December
1987 interview in Izvestiya, stating: "In my opinion,
the formation of a significant share of budget reve-
nues using short-term loans from the State Bank was
intended to ensure the deficit-free functioning of the
state budget. As a result, the budget no longer
reflected the true state of affairs in the national
economy."
Our estimates of Soviet state budget deficits are
based on a complete accounting of ordinary budget
revenues (nonloans) (see appendix A). Essentially:
? We assumed Soviet official data on total state
spending are accurate.
? We calculated total Soviet ordinary revenues using
official data on tax revenues and estimates of state
revenue from foreign trade (see appendix B).
? We calculated the deficit as the difference between
total spending and total ordinary revenues.
The key uncertainty in the calculations is the esti-
mates of revenue from foreign trade. We believe,
however, that they are accurate enough to reflect
substantial changes. Moreover, comparing the esti-
mates of such revenue for 1985 and 1987 shows a
decline of 11 billion rubles, which is roughly consis-
tent with Gorbachev's statement in February 1988
that such revenue fell by 9 billion rubles.
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investment were to increase a huge 10 percent in
1986, although followed by much smaller average
annual increases during the period 1987-90 (1.2 per-
cent per year).
Soviet planners were probably concerned about the
budget-busting implications of Gorbachev's invest-
ment push, since other budget commitments were not
relaxed:
? Under Brezhnev's Food Program, procurement
prices paid to farms were raised on 1 January 1983.
Since retail prices for the most part were not raised,
unit subsidies increased. But higher unit subsidies,
Figure 2
USSR: Annual Changes in State
Spending and Revenues, 1984-88
Billion rubles
35
coupled with increased meat and food production, Spending
have greatly increased the burden of this expendi-
ture on the state budget. State appropriations for Revenues
the subsidy of food prices increased from 24 billion
rubles in 1980 (8 percent of state expenditures) to 58
billion rubles in 1986 (14 percent of state expendi-
tures), according to a Soviet agricultural official.
? We estimate defense expenditures also have been
increasing since 1985. Perhaps reflecting the un-
evenness in weapons procurement cycles, defense
spending has been driven by procurement of such
major strategic systems as the new Blackjack bomb-
er and the Typhoon and Delta IV nuclear-powered
ballistic missile submarines.
? Budget spending on social-cultural measures (edu-
cation, health services, pensions) increased an aver-
age 7.5 billion rubles per year during 1986 and
1987.
? While certainly unanticipated, the Chernobyl' disas-
ter cost the state budget 4 billion rubles, according
to a January 1988 Politburo announcement.
Consequently, given the leadership's decision to push
investment spending at all costs, total government
spending rose by a record 30 billion rubles in 1986
and by another 18 billion rubles in 1987 (figure 2).
-5
1984
1985
1986
1987
1988
317635 6.88
Revenue Shortfalls
Meanwhile, Soviet state revenues have had to absorb
a number of major impacts that have held growth of
revenues during 1986 and 1987 to less than 5 billion
rubles:
? Until 1985 the Soviets increasingly counted on a
hefty indirect tax on retail alcohol sales to generate
substantial budget revenues, but a major impact of
the antialcohol campaign has been to cut this inflow
by roughly one-fourth.
? Planning mistakes, retooling, implementation of re-
forms, and establishment of a new quality control
system disrupted industrial performance in 1987,
slowing growth of revenue from enterprise profit
taxes. In the context of discussing strains on the
state budget in 1987, Finance Minister Gostev
remarked in his speech on the 1988 budget (October
1987) that the machine-building, petrochemicals,
and light-industry sectors all had failed to meet
their profit targets in 1987.
2
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? The collapse in world oil prices in early 1986 led to
a sharp fall in state revenue from foreign trade as
hard currency oil exports fell from an average of
$15 billion during the period 1982-84 to just
$7 billion in 1986 (see appendix B). Moreover,
Moscow's decision to reduce consumer goods im-
ports by 10 percent that year contributed substan-
tially to the overall fall in state revenue from foreign
trade.
1988 Budget Plan: No Relief in Sight
According to the current budget plan, total state
spending is to rise 8 billion rubles in 1988. However,
in line with Gorbachev's new emphasis on the con-
sumer, spending on "social-cultural measures" (edu-
cation, science, and health care) is to rise 9.2 per-
cent?an increase of 13 billion rubles.' Apparently
finally recognizing its tight revenue constraint, Mos-
cow plans to cut spending for "financing the national
economy" (capital investment, capital repair, in-
creased circulating capital, and subsidies) by 6 billion
rubles. This would be the first time in over 25 years
that this spending category actually declined.
On the revenue side, Finance Minister Gostev said in
October 1987 that the 1988 budget contemplated a
reduction in foreign trade revenue. Turnover tax
receipts also are scheduled to fall (compared with the
1987 plan); Gostev stated, "Income is built on a
healthier footing?revenue from the sale of alcoholic
beverages is reduced by 11.5 billion rubles." The
Finance Minister did not make clear how these
shortfalls, which?along with the planned spending
level?imply a 1988 budget deficit of some 70 billion
rubles, would be made up. His vagueness is under-
standable, however, since we believe the revenue
shortfall will be made up by money creation.
Money Creation Finances the Deficit
By necessity, the large deficits since 1986 have had to
be met by government borrowing from the State Bank
(see table 1). In the past, Moscow also relied on large-
scale sales of long-term bonds to the population as a
The average annual increase was 4.9 percent during 1981-85 and
6.4 percent in 1986. The state science budget, however, is believed
to finance a large portion of military and civilian research. Thus,
some of the increase in spending on social-cultural measures may be
for defense and investment purposes.
3
Table 1
USSR: Sources of Finance of the
State Budget Deficit
Billion rubles
1984
1985
1986
1987
1988 a
Budget deficit
11.0
17.0
49.8
64.4
68.4
Known sources of finance
Long-term borrowing
(bond sales)
1.0
1.4
1.9
2.2
2.5
Short-term borrowing
from the State Bank
(savings receipts)
15.2
18.7
22.0
24.0
26.0
Residual
Implied other short-term
borrowing from the State
Bank
?5.2
?3.1
25.9
38.2
39.9
a Estimated.
Source: Appendix A, table 5.
means of finance. But sales of mass subscription
bonds were stopped in 1958 because of the leader-
ship's concern about rising debt service charges.
The government's large levels of borrowing from the
State Bank since 1986 are equivalent to injecting like
amounts of money into the economy and therefore are
inflationary (see inset).4 The money creation takes
place when the government uses these loans to pay for
pensions, teachers' salaries, military pay and allow-
ances, and other purposes.' While taxes and sales of
long-term government bonds result in reductions of
consumers' purchasing power, government loans from
the State Bank effectively result in many more rubles
chasing roughly the same amount of consumer goods
and services.
? The inflationary impact of these money supply increases partly
depends on how fast money is turned over (the velocity of money).
The Ministry of Finance has some control over the rate of spending
of enterprises and thus could reduce money velocity.
For example, spending on weapons procurement or state housing
or new factories all result in incomes for workers and managers
responsible for producing these goods and services.
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Monetary Expansion in the USSR
The Soviet State Bank (Gosbank) maintains and
monitors the accounts of the government (Treasury),
state enterprises and farms, and the population. The
bank takes in cash from state retail stores and issues
cash to state enterprises for payments of wages. The
bank debits and credits the accounts of state enter-
prises and the Treasury to reflect the millions of
noncash monetary transactions that take place
throughout the economy. The bank attempts to keep
cash balances segregated from noncash balances but
is not always successful.
Like any bank, Gosbank has assets and liabilities
that must be in balance. Its assets largely consist of
short-term loans to enterprises and also to the Trea-
sury. Its liabilities largely consist of the deposits of
the Treasury, enterprises, and the population.
The Treasury takes in taxes and other revenues and
deposits them in its account at Gosbank. Similarly,
as the government makes expenditures, Gosbank
debits the government's account and credits the ac-
counts of the payees or, as in the case of pensions,
pays out cash.
When state revenues are less than expenditures,
Gosbank makes short-term loans to the government
that are then credited to the government's account.
The government can then pay its bills for procure-
ment of weapons, pensions, education expenditures,
and investment just as if the money came from tax
revenues. Gosbank's balance sheet is undisturbed by
the transactions: the increase in its short-term loans
to the government (an asset) is exactly duplicated by
an increase in liabilities (some combination of in-
creased cash in circulation and deposits of enterprises
and the population). Money has been created from
thin air.
A portion of the short-term loans used by the govern-
ment to cover its deficit is balanced by additions to
the population's savings accounts. The population's
willingness to increase its savings deposits reflects a
mix of factors: interest rates of 2 to 3 percent per
year, absence of consumer credit and hence the need
to save for big-ticket items such as cars, and lack of
desirable consumer goods. In the short run, the
population's willingness to set aside funds in savings
accounts, rather than attempt to spend them, relieves
some of the inflationary pressures of government
deficit financing on the consumer sector. On the other
hand, the population's accumulated savings accounts
represent an enormous purchasing power overhang
over the longer term, since savings are subject to
immediate withdrawal by their owners.
Impact on Prices, Shortages, and Savings
The impact of rapid monetary expansion on consu-
mers' purchasing power is confirmed by recent trends
in prices, shortages, and savings, which indicate rising
inflationary pressures.
Prices Increase
Evidence on Soviet retail prices show a marked
acceleration since 1985 (see table 2). Although Soviet
official price indexes have long been criticized by both
Soviet and Western economists as understating actual
price changes, recent data suggest the official retail
price index grew 1.7 percent per year during 1986 and
1987, almost double the average 0.9 percent per year
reported for 1981-85. Moreover, CIA's estimates of
inflation in retail prices also show an acceleration in
1986 to 3.4 percent compared with 2.1 percent per
year during 1981-85.
Similar trends are evident in collective farm market
(CFM) prices. Official Soviet data on prices in CFMs
in 264 cities suggest prices rose by 9 percent in 1987
contrasted with an annual average of 2.2 percent
4
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Table 2
USSR: Selected Measures of
Retail Price Changes
Average annual
growth, percent
1981-84
1985
1986
1987
1988
State retail prices
Official
1.0
0.7
1.8
1.6'
NA
CIA estimate
2.2
1.7
3.4
NA
NA
Collective farm
market prices
Official e
2.6 d
NA
?0.1 e
9.3 1
8s
Derived h
2.2
4.3
?3.1 e
NA
NA
Narodnoye khozyaystvo SSSR (hereafter referred to as Narkhoz)
for various years.
h Estimated by comparing Soviet data on retail sales through
October in nominal terms with corresponding data in constant
terms.
Narkhoz za 70 let (1987), p. 485.
d 1981-85.
e The decline in collective farm market prices in 1986 may reflect
large supply increases in a year of good growing conditions, as well
as a likely timelag between the increase in the budget deficit that
year and the resulting expansion of money demand.
I Based on collective farm market prices for 12 commodities in 264
cities, weighted with Moscow collective farm market shares of those
commodities sold. Vestnik statistiki, No. 3 (1988), p. 61.
g January-March 1988 as compared with January-March 1987,
Pravda (26 April 1988).
h CIA estimates using Narkhoz data.
during 1981-86. The official plan fulfillment report
for January-June 1987 contained a rare reference to
higher prices in CFMs:
As a result of shortages of potatoes, fruit and
vegetables, meat, and butter in the trade net-
work, high prices were established and are
being maintained in the kolkhoz markets at
levels 2.5 to 4 times higher than state retail
prices.
Despite improvements in meat supplies in 1986 and
1987, prices of meat in Moscow's collective farm
markets were 18 percent higher in September 1987
than in September 1985 (see figure 3). Moreover, the
plan fulfillment report for January-March 1988 again
made reference to rising prices in collective farm
markets, indicating they were 8 percent higher than in
the same period in 1987.
5
The absence of free markets for industrial goods and
services as well as lack of information concerning the
extent of shortages make it very hard to determine
whether inflationary pressures have risen in the large-
ly noncash producer goods and services sector of the
Soviet economy. We expect, however, eventually to
see evidence such as the bidding up of workers' wages,
increased prices of machinery and other goods, in-
creased hoarding of industrial materials, and declines
in product quality.6 Already, according to official
statistics, average monthly wages increased 5.7 per-
cent during January-June 1988. In contrast, in the
first half of 1987, the increase was only 3.2 percent.
Shortages Intensify
Although the Soviet press almost invariably blames
shortages in state stores on supply problems, current
shortages probably reflect increases in effective de-
mand as the money supply has grown quickly.' In the
first instance, consumers' purchases of state goods
increased. Even more important, store employees and
others with access probably have increased their
claims on state goods (whether through theft or
purchase at low official prices) for resale in the black
market.
'Results from a CIA contractor's research on inflation in official
Soviet investment statistics strongly suggest the presence of signifi-
cant inflationary tendencies in the investment sector of the econo-
my. Producers are able to meet production targets through price
increases and customers with plentiful funds are willing to pay
premiums to obtain producer durable goods that are in short supply.
The system is particularly vulnerable to this inflationary process
when prices are set for new and custom-made machines which,
according to one Western authority, represent "a large proportion"
of investment equipment. The contractor's study reports Soviet
estimates of the annual rate of inflation in investment ranged up to
2 percent in the 1960s, 2 to 3 percent during 1971-75, and 2 to 4
percent during 1976-85.
'Two other factors also have contributed to the current shortages.
First, Moscow cut back consumer goods imports by about 1 billion
rubles (foreign trade prices) in 1986. Second, the antialcohol
campaign probably has caused drinkers to shift some of their
purchasing power from vodka to other goods. However, this is not
likely to have been a major shift since vodka consumers are
probably much more inclined to turn to purchases of homebrew
rather than purchases of more food and clothes.
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Figure 3
Moscow: Collective Farm Market Prices
of Selected Goods a
Rubles per kilogram Note scale changes
Beef
State store price
10
Pork
10
Apples
4
1970 75 80 85 86 87
1970 75 80 85 86 87
a Data are for purchases made in Moscow in August or
September of each year.
1970 75 80 85 86 87
Anecdotal evidence suggests that consumer com-
plaints of shortages of a variety of goods have in-
creased markedly since 1986, when money expansion
increased dramatically:
? A study conducted by the Ministry of Trade's
research institute and described in the Soviet paper
Trud noted that shortages of toothpaste, women's
panty hose, lotions, eau de toilette, sugar, cassettes,
and batteries "broke records for being in short
supply" last year.
? Food shortages in particular appear to have wors-
ened in 1987. In his March 1988 speech to the
Collective Farm Congress, Gorbachev said that the
Central Committee "is flooded with letters com-
plaining about shortages of livestock products in
many of the country's regions."
? Letters in the central press complaining of wide-
spread shortages of fruits and vegetables were also
more frequent in 1987.
317636 6-88
The 1987 Plan Fulfillment report (published in late
January 1988) also details a litany of woes implying
shortages may have increased:
6
. . . But the population's incomes increased fast-
er than trade turnover and the consumption
fund, and there was consequently an increase in
unsatisfied demand.
An unsatisfactory situation developed in the
supply of potatoes, fruits and vegetables for the
population, and their range and quality often
fail to satisfy the population's demands.
At the same time, the population's demand for
many types of clothing and knitwear was not
fully satisfied, while the shortage of footwear in
the trade network remained acute. The situa-
tion is aggravated by the imbalance between
demand and supply in terms of range and
quality.
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In 1987, various organizations concerned with
the allocation of housing had registered and
had on their lists 13 million families and
individuals waiting for better housing.
Forced Savings Increase
Some Soviet and Western economists believe that a
substantial share of Soviet savings are "forced" in the
sense that consumers save because desired goods and
services are not available. They view the large stock of
savings as an indication of repressed inflation. Ac-
cording to one Soviet economist, the research arm of
the Ministry of Trade estimates that such deferred
demand amounts to 60-65 billion rubles, about one-
quarter of total savings deposits.
Soviet savers added record amounts to their savings
deposits during 1985-87. The average addition to
savings per year during 1981-84 was 11.4 billion
rubles. In contrast, additions were 19, 22, and 24
billion rubles in 1985, 1986, and 1987, respectively.
Through the first half of 1988, savings increased 13
billion rubles, implying an annual rate of 26 billion
rubles. Some of the increased pent-up demand of
Soviet consumers resulting from inflationary pres-
sures probably is being absorbed through increases in
forced saving.
Soviet citizens also maintain a portion of their finan-
cial assets in the form of cash hoards. Both Western
and Soviet analysts have pointed to the phenomenon
of large holdings of cash "under the mattress" as an
indication of repressed inflation.' Our estimates of
rapid money expansion since 1985 suggest that cash
hoards probably have increased substantially over the
last two years.
Increased Soviet Recognition of the Problem
Leadership Concern
The General Secretary has severely criticized eco-
nomic policy and performance under Brezhnev, re-
peatedly referring to the late seventies and the early
eighties as a period of stagnation, a precrisis situation,
or a period of growing contradictions. In his speech to
In a recent interview, economist Aganbegyan was asked whether
vast amounts of money are lying unused?"260 billion rubles in the
banks, plus a further 240 billion under mattresses?" He replied, "It
is true, more or less."
7
the party leadership in June 1987, the General Secre-
tary broadened his critique to include the state
budget:
Take the state budget. Everything looked favor-
able on the surface. Expenditures were covered
by revenues, but how was this achieved? Not
through a growth in the efficiency of the nation-
al economy, but by other ways which had no
economic or social justification.
Gorbachev particularly takes the Brezhnev regime to
task for relying too heavily on generating state reve-
nues through high taxes on alcoholic beverages and
enterprise profits, as well as sales of oil and other fuels
on the world market.
Gorbachev returned to this theme in his speech to the
party leadership in February 1988, suggesting that
without the effect of rising world oil prices and
increased alcohol sales economic growth would have
been much lower (see inset). In this same speech, he
concluded that "the country's economy has come up
against a very serious financial problem," that is, a
much larger state budget deficit. For example, he
stated:
As a result of reducing the sale of alcohol, in
the last three years the state has suffered a
revenue shortfall of more than 37 billion rubles.
In addition to this, in comparison with 1985,
revenue in 1987 from domestic sales of import-
ed goods, the purchase of which we have been
forced to limit due to a shortage of hard
currency, fell by 9 billion rubles.
Prime Minister Ryzhkov in his May 1988 speech to
the Supreme Soviet indicated that "growing cash-
backed demand of the population" remains an acute
problem, adding:
The disparity between the income of the work-
ing people and their opportunities to use this
income to buy goods is increasing. Unsatisfied
demand is growing and that engenders the
occurrence of inflationary processes in money
circulation.
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Gorbachev 's Statement on National Income:
Justifying Slow Growth in 1987
Gorbachev estimated in his February plenum speech
that the average annual increment in Soviet national
income would have declined in the early 1980s if the
influence of higher world oil prices and accelerated
domestic retail sales of alcohol were disregarded. In
doing so, he ratcheted up the contrast between eco-
nomic performance in the Brezhnev "stagnation"
period and performance under his tenure. He is
saying in effect that the Soviet economy was on the
way to decline in the early 1980s but for the influence
of luck (higher world oil prices) and wrong-headed
policy (accelerated retail sales of alcohol).
This formulation appears to be an attempt to put
some of the negative consequences of Gorbachev's
own policies in a better light. His antialcohol cam-
paign and other policy initiatives have increased the
gap between purchasing power and availability of
consumer goods and services. Last year, the new
quality control program and implementation of new
reforms contributed to the lowest growth in Soviet
national income since 1979. By telling the Party
leaders at the February plenum that the average
annual increment in national income would have
declined in the early 1980s but for higher oil prices
and greater alcohol sales, we believe Gorbachev was
attempting "to level the playing field." He alleged
that one must compare the results of his policies with
Brezhnev's economic performance only after netting
out the impact of increased alcohol sales and wind-
fall profits from oil exports. As Gorbachev states at
the end of this part of his speech, "This is the real
picture, comrades. Only now is the economy begin-
ning to grow on a healthy basis."
In an offhanded way, he tied the purchasing power
growth problem to budget stresses, remarking that a
"neglected financial situation" existed at the start of
the 12th Five-Year Plan period (1986-90) and that "It
is not in a favorable state even now." Specifically, he
blamed state subsidies to loss-making enterprises and
the decline in world oil prices for the current financial
situation.
Economists' Statements
The leadership's willingness to address the state bud-
get issue is paralleled by increased openness on the
part of Soviet economists. For example, in an article
published last September, Oleg Bogomolov (head of
the Institute of the Economics of the World Socialist
System) hinted at the existence of a budget deficit
when he blamed "the deficit in the state bank cash
balance" as a major cause of inflation.
Nikolay Shmelev, perhaps the most provocative Sovi-
et economist, provides the most graphic discussion so
far of the budget deficit and its causes and effects in
the April 1988 issue of Novyy mir. He writes:
Having handed over income from alcohol to the
home distiller, the state has in the last two
years seen a drastic exacerbation of the imbal-
ance in the budget, in which the deficit is today
covered by that supremely dangerous, un-
healthy means?the mint.
Shmelev returns to the problem of the budget deficit a
number of times in this important article:
? Perestroyka requires increased government spend-
ing but traditional state revenues are not even
sufficient to cover "today's gap in the budget."
? The financial system is "fundamentally based on
largely inflationary methods of finance."
? State borrowing is being extended in an "unhealthy,
covert way."
? Nontraditional means of raising state revenues
should be considered such as bond sales and foreign
borrowing.
? State expenditures on investment should be reduced
with enterprises investing more from their own
incomes. Subsidies of loss-making enterprises should
be stopped. But the option of reducing defense
spending "is a separate question."
Beyond suggesting that the budget deficit has grown
subtantially, Shmelev does not provide numerical
estimates of its current size or increases over time.
8
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Official Acknowledgement
In late May, Pravda published the proposals to be
considered at the June party conference. Included in
the proposals was the following sentence:
The commodity-money imbalance and state
budget deficit are having an adverse effect on
current production and the course of the reform
itself
This is one of the few times in the post-war period
that Moscow has officially acknowledged the exis-
tence of a budget deficit and indicates the seriousness
of the problem. In early June, the Soviet press
reported a roundtable discussion on the proposals that
noted the past practice of masking the actual budget
position:
Our readers have learned a very important
thing from the theses for the first time: our state
budget has a deficit. However, each year the
Supreme Soviet approves a report on budget
implementation in which income exceeds expen-
diture. This recurs every year. Of course, spe-
cialists know that the real situation is different.
But who is fooling whom?
Then, in late June, General Secretary Gorbachev
reported at the party conference that the state budget
has been in deficit for many years.
Now that the deficit has been acknowledged official-
ly, in effect calling into question official budget
statistics, we may see some substantial revisions in
such data in the near future.
Limited Policy Measures So Far
Moscow has taken a number of steps over the last
couple of years to soak up excess purchasing power or
to otherwise manage the resulting shortages of goods
and services. These policies, however, do not address
the budget deficit itself, and thus ignore the source of
the purchasing power problem.
9
Rationing
In a rather quiet manner, Moscow has granted repub-
lic governments greater authority to implement ra-
tioning. As reported by a Latvian radio program in
July 1987, the USSR Council of Ministers granted
the 15 republics in early 1987 the right to indepen-
dently fix norms for rationed goods. There were
numerous reports of rationing on a variety of foods in
1987. Early in September 1988, Pravda noted that
rationing has been introduced in eight republics. In
the RSFSR, for example, rationing is being used in 26
oblasts, krays, and autonomous republics for the sale
of meat, in 32 for the sale of butter, and in 53 for the
sale of sugar.
Savings Bonds
As of 1 March 1988, Soviet citizens can purchase a
new series of savings bonds redeemable after 10 years,
paying an interest rate of 4 percent. However, the
Soviet press indicates that the public has shown little
interest in purchasing them to date and few have been
sold.
Insurance
As of 1 January 1988, Soviet citizens may purchase a
new form of insurance to supplement state old-age
pensions. This appears to be another measure meant
to absorb extra rubles in the hands of the populace.
The State Insurance Agency (Gosstrakh) has also
been pushing overall insurance sales (life, accident,
property). According to the latest official data, the
population's payments of premiums grew by over 7
percent in 1986.
Charity Funds
Since 1986, Soviet citizens have increasingly been
pressured to contribute to newly formed "socialist"
charity funds?for development of culture, for the
victims of Chernobyl', for the care of orphans, and for
improving health care.
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Increased Role for Collective Farm Markets
A March 1986 decree on management of the agro-
industrial sector allows farms to sell up to 30 percent
of their fruits and vegetables to collective farm
markets and the Tsentrosoyuz?the predominantly
rural retail trade network, where prices are higher
than in state stores. By selling less in state stores and
more through the other channels where prices are
higher, the government would raise the average price
of food and thereby absorb excess purchasing power.
This measure has had little success so far, however:
farms continue to market only a minor share of their
produce through the CFMs or the rural retail trade
network.
Cooperative Housing
Moscow is hoping that increased construction of
cooperative housing will absorb some of the excess
rubles in the hands of the populace. An April 1988
decree calls for formation of more housing coopera-
tives: associations composed of Soviet citizens who
pool their money for the construction and mainte-
nance of apartment buildings. An increased role for
cooperative housing construction will require the
backing of state housing construction organizations,
which previously have given little priority to coopera-
tives.
Encouraging Private Business
The Gorbachev regime has launched a program en-
couraging the development of legal private businesses
operated by individuals and small groups in an effort
to satisfy consumer demand without large invest-
ments. New legislation has affirmed the legality of
individual labor activity and fostered the establish-
ment of member-run cooperatives. While the develop-
ment of legal private business is proceeding more
slowly than the leadership had hoped, Gorbachev
continues to emphasize this program.
Costs of Continued Inaction
Moscow probably cannot stay the present course.
Continued large deficits financed through monetary
expansion will lead to an expansion of the second
economy, a substantial redistribution of income from
state workers to second-economy participants, greater
resource diversions, and in general a growing loss of
state control of the economy. Moreover, rising prices
in the second economy coupled with more empty
shelves in state stores will cut into the living standards
of citizens on fixed incomes, including pensioners,
bureaucrats, and many state workers. Worker incen-
tives will weaken further and efforts to increase
support for perestroyka could be thwarted.
Resource Diversions From the State Sector
Increased purchasing power of Soviet consumers does
not affect production activity in the state sector of the
economy, at least directly. In the state sector, enter-
prises producing consumer goods and services take
their marching orders from ministries and other ad-
ministrative authorities?not consumers. Prices are
administered from the center and largely fulfill an
accounting function rather than serve as a guide to
production.
The Soviet "second economy," however, is based on
private initiative responding to market demand.' In-
creases in consumer purchasing power will result in
some combination of higher prices and greater supply
of goods and services in this sector, often at a cost to
the state of rising theft and corruption.
Labor. Higher prices translate into higher incomes of
second-economy participants, which in turn will draw
in more participants. For example, pensioners, work-
ing mothers, and students?some of whom might be
employed in the state sector?will have greater incen-
tive to take up work in the second economy. More
full-time state workers also could be increasingly
tempted to work in the second economy, even if just
As defined here the Soviet "second economy" includes the whole
of the private economy (legal and illegal) as well as illegal state
activities (theft, cheating of state store customers, resale of state
goods at black-market prices). Estimates of the size of the second
economy vary, but there is little doubt that it is substantial. Soviet
economists V. Rutgayzer and V. Kostakov of the Gosplan Econom-
ics Research Institute recently estimated that by the mid-1980s,
17-18 million people participated each year in the underground
service sector at least part-time, providing some 5-6 billion rubles of
everyday services?from car repairs to tailoring?annually. This
amounts to almost a third of all such purchases by Soviet
consumers.
10
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on a part-time basis. For example, the potential to
earn large incomes producing and selling moonshine
has clearly drawn in much more labor into this
activity. One measure of this shift is the number of
arrests for moonshining. Interior Minister Vlasov
announced in November 1987 that there had been
390,000 arrests so far that year, as compared with less
than 70,000 in 1985. This suggests a roughly fourfold
increase in labor supply, although some of the in-
crease in arrests may reflect tighter enforcement.
Consumer Goods. Higher prices in the second econo-
my will tend to result in a greater supply of goods and
services as producers respond to greater profit poten-
tial. Some of the supply increase will come exclusively
through increased application of labor. Some of it,
however, will come through increased diversions from
the state sector. Theft of consumer goods at the
factory and throughout distribution channels, whether
for own consumption or resale in the second economy,
is a frequent occurrence. Recently the Ukrainian
procurator's office reported that over 54,000 workers
were caught pilfering in the meat, dairy, and food
industries of that republic in 1987. In light industry,
where the differential between state and second-
economy prices is much lower, 6,000 workers were
caught pilfering.
Producer Goods. Higher second-economy prices will
also draw in more raw materials and other producer
goods from the state sector, primarily through theft.
Diversions of such goods as gasoline, textiles, tools,
and other products will increase as profit opportuni-
ties expand in the second economy. For example, a
recent Soviet radio report said that 242,000 kilograms
(242 metric tons) of sugar was stolen in 1987 partly as
a result of the spread of "home distilling." A recent
Soviet article on the second economy observed that
the main advantage of a "private operator" is usually
his access to shortage goods?"spare parts for cars,
components for household equipment, Finnish wallpa-
per and toilet bowls, construction materials, and so
forth."
Weakened Workers' Incentives
State workers' incentives and productivity are likely
to suffer when purchasing power is rising but supplies
of goods and services are not. At state stores, longer
queues and greater shortages will result in more
absenteeism from work, as working wives and mothers
11
especially struggle to ensure that food is on the table.
Recently the official Literaturnaya gazeta reported
that 65 billion hours are spent each year in shop-
ping?about 32 million man-years representing 25
percent of total annual employment.? Moreover,
while rubles can always be spent in the second
economy on food, services, and handicraft items,
longer waiting lists for such big-ticket items as cars,
appliances, housing, and furniture could result in a
greater sense of futility. This will be especially true if
such goods come to be recognized as being rationed
through nonmoney means such as political
connections.
Excess purchasing power will also undermine Gorba-
chev's wage reform, which is predicated on Soviet
workers' wanting to earn more rubles. Under this
reform, workers' wages and salaries are to increase
about 30 percent, but at the same time pay is to
correspond much more closely to productivity. But if
desired goods are not readily available, rubles are
worth less and the incentive effects of the wage
reform will be blunted.
Price Reform Constrained
Most Western analysts and many Soviet economists
agree that reform of the price-setting mechanism is
essential for the success of Gorbachev's effort to
revitalize the economy. The decree on the price
reform published in July 1987 makes clear that one of
its major objectives is to reduce the role of state
authorities in establishing prices and give greater
freedom to enterprises to set prices through negotia-
tions. Given strong inflationary pressures, however,
any relaxation of state controls will lead to large price
increases across the board. Reform advocates, aware
that price reform rather than excess money creation
would be blamed for this inflation, have called for
resolving the financial problem before relaxing state
controls on prices. Gorbachev said in his party confer-
ence speech that resolving the deficit was a precondi-
tion for price reform.
1? Much of this time does not represent absenteeism because it
includes shopping by retirees and housewives, as well as shopping
after work hours. Nonetheless, since most state stores are not open
in the evenings or on weekends, a large proportion of these hours
must involve absences from work.
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Price reform in China has run into just such difficul-
ties. On several occasions, price controls have been
relaxed only to be tightened again when rapid price
increases occurred, even though rapid money supply
growth was a key factor behind the increases.
Gorbachev's Options
Gorbachev indicated in his February 1988 speech that
"extraordinary efforts"?"radical" reform and great-
ly increased production of consumer goods and ser-
vices?were needed to bring the "financial problem"
under control. In his July speech at the Central
Committee plenum, the General Secretary was much
more explicit, stating that the 1989 budget and
economic plan should incorporate measures, possibly
even a reduction in investment, to reduce the deficit.
Removal of Subsidies
Under the forthcoming price reform announced last
year, retail prices are to be revised although major
changes are to be preceded by a public debate.
Removal of subsidies on food products could result in
large savings of government expenditures. Food prod-
ucts alone cost the government 60 billion rubles?
roughly the size of the current deficit. Moreover, the
effective price increases would devalue much of the
accumulated purchasing power in savings accounts
and cash hoards.
Although the administrative price revision as a whole
is supposed to be completed before the beginning of
the next five-year plan in 1991, the pricing decree
does not set a specific target date for the politically
sensitive task of revising retail prices (reducing subsi-
dies), as it does for wholesale and procurement prices.
Even the reformers have become more aware, howev-
er, of the political costs of increasing food prices.
The timing of the introduction of higher food prices is
an especially difficult problem. Removing the subsi-
dies gradually seems to make the most political sense.
But from an economic perspective, this would greatly
dilute the effectiveness of the policy. Not only would
deficit reduction take longer, but also announcement
of a policy of gradual reductions in subsidies would set
in motion a number of responses by the populace.
Hoarding would increase. Savers would start drawing
out their deposits to turn them into material goods.
Owners of cash hoards would do the same. The result
would be rampant price increases in the second
economy, including collective farm markets, and
mostly empty shelves in state stores.
On the other hand, an overnight removal of subsidies
maximizes its economic benefits (since consumers and
savers have no chance to adjust) but carries higher
political risks. As reform economist Nikolay Shmelev
recently wrote: "We must not forget the lamentable
experience of Poland, where, in 1976, they tried to
change prices overnight, and were then forced to
retreat." The recent unrest in Poland tied to a 45-
percent increase in prices since the first of the year is
a pointed reminder, if one was needed.
Lower subsidies of industrial goods also would reduce
government spending. According to the price reform
decree, subsidies for industrial output sold to the
agricultural sector are to be eliminated. For example,
agricultural enterprises are to pay the same rates as
industry for electricity, heat, and natural gas.
Price increases, however, would help the budget only
if they do not result in compensating expenditures.
For example, some Soviet economists have argued
that consumers will need to be compensated for the
expected retail price increases through such measures
as reducing income taxes or providing supplements to
wages and pensions. The relief to the budget from
reduced subsidies would be diluted by any increases in
expenditures for pensions or reductions in tax
collections.
Gorbachev's reforms also intend to reduce the bud-
get's role in financing investment by increasing the
role of enterprises. Spending on investment represents
about a third of the budget. But it is not clear that this
measure will reduce the budget deficit, since the share
of state deductions from enterprise profits is to fall
also so that firms are able to invest more.
12
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Increased Sales of Consumer Goods
Increased sales of certain consumer goods could raise
substantial tax revenues." Such manufactured con-
sumer goods as appliances, automobiles, clothing, and
shoes carry high tax rates, and thus increased produc-
tion and sales of them would contribute to increased
budget receipts. Gorbachev's push for the expansion
of cooperatives that produce consumer goods and
services could also contribute to state revenues to the
extent they earn high incomes and meet their tax
obligations.
The quickest step Moscow could take to raise reve-
nues through increased consumer goods production
would be to back off the antialcohol campaign and
permit legal sales of alcoholic beverages to increase. A
6 May Izvestiya article called for a reassessment of
the antialcohol campaign, stating that the grumbling
it caused was more dangerous than drunkenness.
Moscow could use its high credit rating in the West to
finance consumer good imports. Because of the large
price markups on domestic sales of imported goods,
such a policy could earn the state large revenues?
amounts equal to 3 to 4 times the values of the loans
used to finance the imports. Economist Shmelev
estimated in his April 1988 Novyy mir article that the
import of consumer goods valued at $1.5-2 billion
would cover the loss in state revenues from the
reduction in vodka sales.
Spending Cuts on Defense and Investment
Since the June 1987 plenum, several high-ranking
political and military spokesmen have stated publicly
that the Soviet Union plans to reduce spending on
defense. For example, in an August 1987 interview
with a Spanish reporter, Gen. Yuriy Lebedev said
that, although the Soviets must be careful not to
ignore the armed forces' needs, "nevertheless, our
plans include a reduction of military spending in order
" A number of Soviet officials and economists have proposed
increased production of consumer goods and services also as the
solution to the purchasing power overhang. Given the low state
prices of many consumer goods and services, the supply increases
needed to equate supply and demand would be extraordinary and
essentially impractical. This proposal illustrates the Soviet predilic-
tion to focus on the supply side of market imbalances rather than
demand and the role of prices.
13
to allocate the money to other areas." While this
statement and similar ones could reflect a propaganda
motive, they might also reflect the budget situation.
Reduced outlays on investment would also trim the
budget deficit, but it is not clear which areas could
afford to be cut back:
? Growth of energy production requires continued
large investments.
? As a key element of the modernization program, the
machine-building industry is scheduled to receive
large amounts of investment through the rest of the
five-year plan period (1986-90).
? The rest of heavy industry and transportation all are
in need of large investments for modernization, new
projects, and upkeep of existing plant and
equipment.
? Gorbachev's new emphasis on the consumer implies
large investment flows to both housing and indus-
tries producing consumer goods and services.
The most likely short-term target for reductions
would be nonpriority sectors in industry and possibly
agriculture. A January 1988 Kommunist article hints
strongly that Moscow is considering substantial cut-
backs of investment in agricultural machinery and
land reclamation. Neglect of industrial sectors for
more than a couple of years might produce bottle-
necks. Moreover, the economy is structured to pro-
duce large amounts of investment goods. Any sub-
stantial reduction in investment spending would imply
shutting down some of heavy industry.
Currency Reform
Gorbachev may need to undertake a currency reform
to take care of the problem of excess purchasing
power, although by itself such a reform would not
help the deficit. As in the case of removing consumer
subsidies, a currency reform would have to be imple-
mented overnight so that consumers and savers could
not take evasive actions that would result in large
increases in demand for goods.
Currency reform is not unprecedented in the Soviet
Union. The inflation in World War II greatly in-
creased collective farm market prices, resulting in
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large cash accumulations by peasants. Concern about
the resulting pent-up demand caused Moscow to
decree a currency reform on 14 December 1947 (with
no advance notice). The reform consisted of the
following elements:
? New currency was issued at a rate of one new ruble
to 10 old ones which had the effect of devaluing
cash holdings by a factor of 10 (or to one-tenth their
previous value).
? State bonds were converted at an exchange rate of
1-to-3 and thus lost two-thirds of their value.
? Savings accounts less than 3,000 rubles were con-
verted at an exchange rate of one-to-one. Thus
savings of urban workers, who were much more
likely to use banks than peasants, were treated
favorably.
? Wages and prices were not changed. Thus the
primary effect of the currency reform was a sub-
stantial confiscation of the wealth of peasants.
According to Shmelev, currency reform is a "hot topic
of discussion" among Soviet economists today. In his
most recent Novyy rnir article, moreover, he points
out that "Strong rumors are circulating about a
possible monetary reform and the consequent confis-
cation of a proportion of investments in savings
banks." To avoid a bank run and other adverse
reactions, the authorities will probably be quick to
deny these rumors.
Outlook: Perestroyka Threatened
General Secretary Gorbachev, other Soviet leaders,
Soviet economists, and others have in the last several
years frequently pointed out the serious nature of
Soviet economic and financial problems, even at times
suggesting that a crisis situation existed. Politically
this probably is a useful tactic for justifying the many
policy shifts, reforms, and other changes Gorbachev
has initiated. However, there is also a tone of real
concern in many of the comments, which is reflected
in the hurried and heedless nature of many of Gorba-
chev's initiatives.
However, the rush to put new policies in place has if
anything exacerbated the economy's problems. Such
key initiatives as sharply increased investment and the
antialcohol campaign not only have failed to accom-
plish key objectives, but also have contributed to the
drastic increases in the state budget deficit and money
creation. The cost of living is higher, shortages have
intensified, modernization is proceeding at a snail's
pace, and the economy's fastest growing industry is
moonshining.
The General Secretary needs to come to grips with the
budget deficit. Most of the options open to him,
however, impinge on the welfare of the population or
key interest groups, such as the military, just at a time
when he needs as much political support as he can
garner. Indeed, the leadership apparently has made a
decision to do more for the consumer quickly as a
means of obtaining the population's backing for peres-
troyka. This decision in turn probably means that
consumer subsidies will not be reduced soon, despite
the large potential this offers for reducing the deficit,
nor?for the same reason?are taxes likely to be
raised.
Large-scale imports of consumer goods and relaxing
the antialcohol campaign offer Moscow opportunities
to address the budget deficit without gouging an
important interest group. Both steps are under discus-
sion in Moscow. The leadership may follow through
by allowing increased alcohol sales. Increased imports
of consumer goods could be easily financed through
foreign borrowing, but Moscow so far prefers to
reserve foreign loans for investment uses that expand
domestic production capacity rather than for current
consumption. While in general this restriction makes
sense, imports of investment goods do not help resolve
the immediate problem of the budget deficit and
Soviet conservatism on borrowing for current con-
sumption may eventually be relaxed.
Gorbachev must act quickly. Because the inflationary
impact of the budget deficit exacerbates current
consumer problems, the leadership is fighting an
uphill battle in trying to improve the quality of life for
average citizens and gain support for perestroyka. If
the budget deficit is not brought down, it could lead to
inflation much worse than the Soviets have experi-
enced in the postwar era.
14
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Appendix A
Key Tables
Our information comes from published and unpub-
lished data from the Center for International Re-
search (formerly the Foreign Demographic Analysis
Division) of the United States Department of Com-
merce, various issues of the annual Soviet economic
and foreign trade handbooks (Narodnoye kho-
zyaystvo SSSR and Vneshnyaya torgovlya), the Sovi-
et five-year statistical budget handbooks, the laws on
the state budget, and the annual budget speeches of
the Soviet Minister of Finance to the Supreme Soviet.
The analytical framework behind the tables follows
the methodology developed by Mark Harrison in his
article, "The USSR State Budget under Late Stalin-
ism (1945-55): Capital Formation, Government Bor-
rowing and Monetary Growth" in Economics of
Planning, Vol. 20, No. 3 (1986).
15
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Table A-1
USSR: Estimated State Revenues From Foreign Trade
Billion current rubles
1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988
Foreign trade prices
1. Exports
2. Imports
3. Net exports
Conversion ratios
11.5 12.4
10.6 11.2
12.7 15.8 20.7 24.0 28.0 33.3 35.7 42.4 49.6 57.1
13.3 15.5 18.8 26.7 28.7 30.1 34.6 37.9 44.5 52.6
1.0 1.2 -0.6 0.3 1.9 -2.6 -0.7 3.2 1.1 4.5 5.2 4.5
63.2 67.9 74.4 72.7 68.3 68.1 68.0
56.4 59.6 65.4 69.4 62.6 60.7 61.0
6.8 8.3 9.0 3.2 5.7 7.4 7.0
4. Exports
5. Imports
Domestic prices
1.59 1.50 1.40 1.28 1.12 1.04 1.00 0.98 0.96 0.83 0.74 0.66 0.77 0.74 0.70 0.69 0.69 0.69 0.69
2.36 2.36 2.36 2.44 2.21 2.04 2.08 2.06 2.06 1.97 1.86 1.74 1.90 1.95 1.90 1.93 1.93 1.93 1.93
6. Exports
7. Imports
8. Net imports
18.3
24.9
6.6
9. Net exports in foreign trade prices 1.5
converted to domestic prices
18.6
26.5
7.9
1.8
17.8 20.2
31.4 37.9
13.6 17.7
-0.8 0.3
23.2 25.0 28.0 32.6 34.2 35.2 36.7 37.7 48.6 50.2 52.1 50.1 47.1 47.0 46.9
41.6 54.4 59.8 62.0 71.2 74.6 82.7 91.6 107.2 116.2 124.2 134.0 120.8 117.2 117.7
18.4 29.4 31.7 29.4 36.9 39.4 46.0 53.9 58.5 66.0 72.1 83.9 73.7 70.2 70.8
2.1 -2.7 -0.7 3.1 1.1 3.8 3.8 3.0 5.2 6.1 6.3 2.2 3.9 5.1 4.8
10. Estimated foreign trade revenues 8.1
9.7 12.8 18.0 20.5 26.7 31.0 32.5 38.0 43.2 49.8 56.8 63.7 72.1 78.4 86.1 77.6 75.3 75.6
Notes:
1. Lines 1 and 2, 1970-86: Soviet foreign trade handbooks,
Vneshnyaya Torgovlya, various years; 1987: Soviet foreign trade
journal, Vneshnyaya Torgovlya, No. 3 (March 1988); 1988:
estimated.
2. Line 3 = line 1 - line 2.
3. Conversion ratios, 1970-85: Center for International Research,
US Department of Commerce printout; 1986-88: same values as
1985 assumed.
4. Line 6 = line 1 X line 4.
5. Line 7 = line 2 X line 5.
6. Line 8 = line 7 - line 6.
7. Line 9 = line 3 X line 4.
8. Line 10 = line 8 + line 9. See Foreign Economic Report, No.
20, Domestic Value of Soviet Foreign Trade: Exports and Imports
in the 1972 Input-Output Table, (US Department of Commerce,
October 1982), for discussion of methodology used to estimate
special earnings from foreign trade.
9. Components may not add to totals shown because of rounding.
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Table A-2
USSR: Miscellaneous State Budget Revenues
Billion current rubles
1. Local taxes and collections
2. Forest income
3. Rent income
4. Other incomes
5. Total miscellaneous revenues
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
0.8
0.9
0.9
0.9
1.0
1.0
1.0
1.0
1.0
1.1
1.1
1.1
1.2
1.2
1.3
1.3
1.2
1.2
1.2
0.5
0.5
0.5
0.5
0.5
0.5
0.5
0.5
0.5
0.5
0.5
0.5
0.8
0.8
0.8
0.8
0.7
0.7
0.7
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
3.0
2.8
2.4
4.8
5.9
6.0
6.6
5.7
5.1
5.6
6.3
4.8
6.2
7.8
5.5
6.1
6.1
6.1
6.1
4.4
4.2
3.9
6.3
7.5
7.6
8.2
7.3
6.7
7.2
7.9
6.5
8.2
9.8
7.6
8.3
8.1
8.1
8.1
Notes: 2. Line 5 = sum of lines 1 through 4.
1. Lines 1 through 4, 1970-85: the five-year statistical handbooks 3. Components may not add to totals shown because of rounding.
on the USSR state budget published by the Ministry of Finance:
Gosudarstvennyy Byudzhet SSSR: various years; 1986-88: estimat-
ed as annual average of 1981-85.
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Table A-3
USSR: Ordinary State Budget Revenues
Billion current rubles
1. Turnover tax
2. Payments from profits
3. Taxes on individuals
4. Social insurance taxes
5. Income taxes paid by cooperatives
and public enterprises
6. Miscellaneous revenues
7. Total revenues from domestic
sources
8. Estimated foreign trade revenues
9. Total
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
49.4
54.5
55.6
59.1
63.5
66.6
70.7
74.6
84.1
88.3
94.1
100.4
100.6
102.9
102.7
97.7
91.5
90.0
89.0
54.2
55.6
60.0
60.0
64.4
69.7
70.6
78.4
78.6
84.2
89.8
92.4
102.4
106.6
115.6
119.5
129.8
135.0
137.5
12.7
13.7
14.8
15.8
17.1
18.4
19.6
20.8
22.1
23.2
24.5
25.5
26.6
27.6
28.8
30.0
31.2
32.4
33.6
8.3
8.8
9.3
9.9
10.6
11.3
12.2
12.4
13.1
13.9
14.2
15.0
22.3
23.1
24.5
25.4
26.5
27.5
28.5
1.2
1.4
1.3
1.5
1.5
1.5
1.5
1.6
1.6
1.6
1.7
1.9
1.9
2.2
2.6
2.5
2.6
2.8
2.9
4.4
4.2
3.9
6.3
7.5
7.6
8.2
7.3
6.7
7.2
7.9
6.5
8.2
9.8
7.6
8.3
8.1
8.1
8.1
130.2
138.2
144.9
152.6
164.6
175.1
182.8
195.1
206.2
218.4
232.2
241.7
262.0
272.2
281.8
283.4
289.7
295.8
299.6
8.1
9.7
12.8
18.0
20.5
26.7
31.0
32.5
38.0
43.2
49.8
56.8
63.7
72.1
78.4
86.1
77.6
75.3
75.6
138.3
147.9
157.7
170.6
185.1
201.8
213.8
227.6
244.2
261.6
282.0
298.6
325.8
344.3
360.2
369.5
367.3
371.1
375.2
Notes:
1. Ordinary domestic revenues, also called current revenues, are
mainly forms of taxation. They accrue to the government without
creating corresponding liabilities that require servicing or redeem-
ing in the future.
2. Lines 1 through 5, 1970-86: Narkhoz, various years.
3. Line 1, 1987 and 1988: estimated. Revenues from turnover taxes
began to fall sharply in 1985 as a result of the launching of
Gorbachev's antialcohol campaign. Further revenue losses due to
the antidrinking campaign occurred in 1986 when tax revenues
were more than 10 billion rubles below plan. The 1987 plan called
for 96.4 billion rubles, but Finance Minister Gostev said in October
1987, "The turnover tax will produce less than planned" in 1987.
Gostev also said the plan figure for 1988 was 89 billion rubles, with
planned revenues from the sale of alcoholic beverages reduced by
11.5 billion rubles, indicating a possibly more realistic assessment
of the effect of the antialcohol campaign on tax revenues.
4. Line 2, 1987 and 1988: estimated as 31 percent of total planned
revenues (435.7 and 443.6 billion rubles, respectively, during 1987
and 1988), the average share during 1984-86.
5. Line 3, 1987 and 1988: estimated by increasing previous year's
value by 1.2 billion rubles, the average annual increment during
1985-86.
6. Line 4, 1987 and 1988: estimated by increasing previous year's
value by 1 billion rubles, the average annual increment during
1985-86.
7. Line 5, 1987 and 1988:- estimated as 0.65 percent of total planned
revenues, the average share during 1984-86.
8. Line 6 = table A-2, line 5.
9. Line 7 = sum of lines 1 through 6.
10. Line 8 = table A-1, line 10.
11. Line 9 = line 7 + line 8.
12. Components may not add to totals shown because of rounding.
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Table A-4
USSR: Estimated State Budget Deficit
Billion current rubles
(except where noted)
1. Revenues from domestic sources
2. Estimated foreign trade revenues
3. Sum of ordinary revenues
4. Expenditures
5. Budget deficit
6. Budget deficit (as a percent of
expenditures)
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
130.2
138.2
144.9
152.6
164.6
175.1
182.8
195.1
206.2
218.4
232.2
241.7
262.0
272.2
281.8
283.4
289.7
295.8
299.6
8.1
9.7
12.8
18.0
20.5
26.7
31.0
32.5
38.0
43.2
49.8
56.8
63.7
72.1
78.4
86.1
77.6
75.3
75.6
138.3
147.9
157.7
170.6
185.1
201.8
213.8
227.6
244.2
261.6
282.0
298.6
325.8
344.3
360.2
369.5
367.3
371.1
375.2
154.6
164.2
173.2
184.0
197.4
214.5
226.7
242.8
260.2
276.4
294.6
309.8
343.1
354.3
371.2
386.5
417.1
435.5
443.6
16.3
16.3
15.5
13.4
12.3
12.7
12.9
15.2
16.0
14.8
12.6
11.2
17.3
10.0
11.0
17.0
49.8
64.4
68.4
10.5
9.9
8.9
7.3
6.2
5.9
5.7
6.3
6.1
5.3
4.3
3.6
5.1
2.8
3.0
4.4
11.9
14.8
15.4
Notes:
1. Line 1 = table A-3, line 7.
2. Line 2 = table A-3, line 8.
3. Line 3 = table A-3, line 9.
4. Line 4, 1970-86: Narkhoz, various years; 1987 and 1988: USSR
state budget laws for 1987 and 1988, respectively. Almost always,
actual expenditures turn out to be somewhat greater than expendi-
tures given in the budget plan. Only twice in the past 20 years have
actual expenditures been lower than the plan. The expenditure
figures shown here for 1987 and 1988, therefore, are likely to
represent conservative estimates of expenditures for those years. To
the extent that expenditures are understated, given the estimate of
current revenues, the estimate of the budget deficit will also be
understated.
5. Line 5 = line 4 - line 3.
6. Line 6 = line 5/line 4 X 100.
7. Components may not add to totals shown because of rounding.
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Table A-5
USSR: Sources of Finance of the State Budget Deficit
Billion current rubles
1970
I. Budget deficit 16.3
Known sources of finance
2. Long-term borrowing (bond sales) 0.5
3. Short-term borrowing from the 8.2
State Bank (savings receipts)
Residual
4. Implied other short-term borrowing 7.6
from the State Bank
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
16.3
15.5
13.4
12.3
12.7
12.9
15.2
16.0
14.8
12.6
11.2
17.3
10.0
11.0
17.0
49.8
64.4
68.4
0.3
0.3
0.4
0.4
0.6
0.6
0.6
0.6
0.7
0.6
0.4
1.0
1.0
1.0
1.4
1.9
2.2
2.5
6.6
7.5
7.9
10.3
12.1
12.0
13.7
14.5
15.1
10.3
9.2
8.6
12.6
15.2
18.7
22.0
24.0
26.0
9.4
7.7
5.0
1.6
0.1
0.2
1.0
0.9
-1.0
1.7
1.6
7.7
-3.7
-5.2
-3.1
25.9
38.2
39.9
Notes: crease in savings deposits reported for first half of 1988.
I. Line 1 = table A-4, line 5. 4. Line 4: calculated as the difference between the budget deficit
2. Line 2, 1970-86: Narkhoz, various years; 1987-88: estimated. and long-term and short-term borrowing.
3. Line 3, 1970-86: Narkhoz, various years; 1987: 1987 plan 5. Components may not add to totals shown because of rounding.
fulfillment report; 1988: estimated, based on 13-billion-ruble in-
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Appendix B
State Revenue From
Foreign Trade
State revenue from foreign trade is not completely
understood by Western analysts.' Simplifying great-
ly, the mechanism seems to work in the following way:
? Soviet trade authorities try to keep exports and
imports roughly in balance in terms of foreign
currencies (or, what amounts to the same thing, in
terms of "foreign trade" rubles).
? Moscow prices imports much higher domestically on
average than what it pays for them in foreign
markets. Accordingly, the value of imports in do-
mestic rubles is now about twice what it is in foreign
trade rubles.
? On the other hand, domestic prices for exports on
average are set lower than foreign trade prices.
Exports in foreign trade rubles are now about 40 to
50 percent higher than in domestic rubles.
'2 For more details, see V. Treml and B. Kostinsky, Domestic
Value of Soviet Foreign Trade (US Department of Commerce,
October 1982), FER 20.
Reverse Blank 21
The surplus obtained by selling imports to Soviet
consumers and enterprises at high domestic prices,
and selling exports at high world prices, constitutes
the revenue from foreign trade. The Center for
International Research (CIR), US Bureau of the
Census, estimates that total revenue from foreign
trade was 63.7 billion rubles in 1982, or 20 percent
of estimated current budget revenues for that year.
Consumer goods imports stand out as a source of
this surplus because their domestic prices are espe-
cially higher than foreign trade prices. For example,
according to CIR estimates, textile and apparel
imports were priced at 4.3 times their foreign trade
prices in 1982.
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Appendix C
The Official Balance as an
Indicator of the Estimated Deficit
Soviet official budget data almost invariably report a
small budget surplus every year. While this surplus
clearly is misleading concerning the true relationship
between current government revenues and expendi-
tures, at the same tithe it does vary somewhat from
year to year. Harrison, in his study of trends in the
state budget during 1945-55, carried out a statistical
analysis that showed that his estimates of the budget
deficit were strongly related to the official surplus.?
In particular, he found that increases in the official
surplus were strongly indicative of reductions in the
actual deficit.
We carried out a similar analysis for the period 1970-
86 using our estimates of the budget deficit and Soviet
data on the official budget surplus. The regression
results (table C-1) and the scatter diagram (figure 4)
are consistent with Harrison's finding of a significant
statistical relationship between the deficit and the
official surplus.
' Mark Harrison, "The USSR State Budget under Late Stalinism
(1945-1955): Capital Formation, Government Borrowing and Mon-
etary Growth," Economics of Planning, Vol. 20, No. 3 (1986),
p. 204.
Table C-1
Regression Results
Key to Symbols
Y = estimated budget deficit as percent of state expenditures
(from table A-4)
X = Soviet official budget surplus as percent of state expendi-
tures (derived from data in the Narkhoz, various years)
Estimated Equation
Y = 9.42? 1.68X 122 = 0.24
(0.77)
Sample years: 1970 - 86
Number of observations = 17
Reverse Blank
23
Figure 4
USSR: Estimated Deficit Versus
Official Surplus (Percent of state expenditures)
Estimated budget deficit
14
A 1986
1970
12
1971
A
10
A
A
1972
'973A
1977
8
Regression line
1978
1974 AA
1976
6
A1982
1985
1979A \
A
1983 ?
1975
A
?
1980
1981
4
1984
2
0
0
1
2
3
4
Official budget surplus
317637 6-88
Declassified in Part - Sanitized Copy Approved for Release 2013/01/18: CIA-RDP91500056R000400110002-6