THE SOVIET ECONOMY IN 1988: GORBACHEV CHANGES COURSE (DDB-1900-155)

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OA HISTORICAL REVIEW

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The Soviet Economyorbachev Changes Course

The Soviet Economyorbachev Changes Course

Information Cutoff Date:9

A paper presented by the Central Intelligence Agency and the Delense Intelligence Agency to the National Security Fxonomies Subcommittee of the Joint Economic Committee, Congress of tlie United Slates.

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9

The Soviet Economyorbachev Changes Course

SUMMARY

rompted by another year of slow economic growth, continuing disappointment in bis efforts to modernize and reform the economy, and rising consumer dissatisfaction. General Secretary Mikhail Gorbachev reassessed and revised bis economic policies. Gorbachev remains committed to his original visionevitalized economy. He has, however, apparcnUy concluded that he cannot realize this vision as rapidiy as he once thought possible, or proceed directly along the path he initially planned to follow. According to our estimates, the Soviet economy grew by onlyercenthe second straight poor yearly showing. Meanwhile, Soviet media indicated that the campaigns to modernize Industrial plant and equipment and reform the economic system, and even the once much-vaunted antialcohol campaign, were not only failing to meet the leadership's expectations but were occasioning major disruptions:

Onlyercent of the states priority projects scheduled for commissioning last year were actually completed and tlie growing backlog of unfinished construction testified to widespread waste of Investment resources.

Although economic perestroyktJ has yet to Include such radical moves as the eJirmnation of price subsidies, the economic reforms that have been Introduced reportedly have been confusing to planners and managers accustomed to Brezhnev-era ways of conducting their business.

Reduced state revenues combined with increased state spending for investment, defense, and subsidizing unprofitable factories and farms substantially boosted the budget deficit and, in mm, inflationary pressures.

Consumers grew more dissatisfied and more willing to voice theira development driven home to Gorbachevuch-publicized trip to Siberia where he faced crowds of angry consumers.

Recognizingontinuation of these problems would threaten both the USSR's economic well-being and his own political standing, Gorbachevumber of major policy changes designed to increase substantially the production of consumer goods and services, reduce the budget deficit, and postpone reforms thai would require sacrifices on consumers' part. These shifts were reflected im

approval9 plan that greatly Increased the priority of consumption

Tl"

A subsequent decision to cut state centralized investmentillion rubles9 (rom what was originally planned.

The promisepcrccm cut in overall defense expenditures over ihcears.

The leadership's move to put retail price reform on hold indefinitely.

The adoption of this package of measures docs not signal the abandonment of modernization or economic reform, llie cutbacks in investment are to come primarily from large, expensive projects such as land reclamation. At the same time, the leadership has reaffirmed its commitment io retooling Soviet plants with modem equipment. Similarly, Gorbachev is proceeding with reforms such as land leasing and the encouragement of private-sector initiatives. StilL he has clearly modified his program in an effort to increase popular support for pereslmyka and reduce its disruptive impact.

In our view, the shifts that Gorbachev has implementedIf sustainedhave the potential to boost consumer welfare andense of order to theuccessful diversion of resources from defense to consumption, in particular, could do much to increase worker incentives and rase inflationary pressures, thereby paving the way for the eventual Implementation of key economic reforms Effectingiversion, however, will be no easy task given the inefficiencies that plague the Soviet economy.

Gorbachev, moreover, is likely to face political as well as economic obstacles io proceeding wilh his program. He increasingly will he held personally responsible for any of its futureTliis situation obviously increases the pressure on Gorbachev to produce results. Moreover, his decision to alter ihc pace of economic restructuring has made him vulnerable io second guessingopponents 3nd bureaucrats could sec Gorbachev's temporizingign ofand become even more recalcitrant Although the regime has portrayed the defeatizable number of party officialsseveral at high levelsin the March 1QH9 electionsarning to Uiosc who arc resisting Gorbachev's reforms, lhe unexpected repudiation of so many parry officials almost certainly has strengthened pressure on Gorbachev from more conservative leaders who view his political reformshreat to party authority. On the other band, the electionloc of radical reformers beyond Gorbachevs controlsuch as former Moscow leader Boris Yel'tsingives those who have entlclzcd ihc slow pace of economicew forum In which to press their demands.

IV

TABLE OF COVTENTS

Page

conomic IVrformancc: Few Bright

Slow Progress on Perestroyla

"Human Factor"

Modernization

Economic

Growing Popular

Rethinking

Trading Guns For

Selectively Seeking Outside

ew Investment

Backing Off From

appi:ndixi.s

8 Economic Performance by

H. Tables on Soviet Economic

V

The Soviet Economyorbachev Changes Course

Joint CIA DIA report is the fourtheries examining General Secretary Mikhailefforts to revitalize the Soviet economy and the implications for defense. In particular, it assesses the major policy shifts8 to get his program on track. 'lite first pan of the paper details the economy's per-lormancc8 and the status of the modern-izaiton and reform programs. Tlie paper thenGorbachev's backtracking on economic reform and his move to shift resources togoods production. Finally, it considers whether ihcse changes arc likely io he successful.

conomic Perfonnance; Few Bright Spots

According to our estimates,purt6 ihc Soviet economy grew byercent in7H.

rate reminiscent of the pre-Gorhachevyears" (seelthough the regime could take some comfort from the acceleration in the growth of labor productivity last yearas enterprises disgorged surplus labor and used ihc savings to raise wages and salariestheof most sectors of the economy was extremely discouraging to Soviet leaders (secAciailcd discussion andor selectedisappointing harvest did much to slow the economy's growthfarmfell by ancrcenl- Record highs in the production of mcai, milk, and eggs were more than offsetrain harvest thataccording to Soviet statisticswas aboul 8less thanotato crop thai was the worstnd stagnating vegetable and fruii produciion.

Not all of ihc blame for slow growth, however, can he attributed to agricullure. Our estimates

Intelligence Community Estimates vs. Official Soviet Claims

Although Soviet media commentary and leadership statements on last year's economic results have been highly negative, the officially reported growth of Soviet GNP5 percentIsabove the Intelligence Community's estimate, as well as high by historical Soviet standards. As in the past, Moscow's official statistics exaggerate actual growth both because of their failure to correct completely for inflation and their understatement of agriculture's influence on overall economic performance1 Soviet leaders have become increasingly critical of the official growth statistics, and our estimate of the growth of Soviet GNP lastercentismore in line with leadership statements of the economy's performance than the growth figures reported by the state statistical authorities.

Imcaigrncc Agency. Ktvisiiing SovielUnder Clainisl: Implication* tor CIA tftlmatei. SOV.8

csliiiuti*8 Jtr ptclimtnirv. and.wllli prcvuiw cMifiiaiii. will pccibalii I* reined Uighdy .it more (omplcic MMtmnWin nr, rhc fatj yi-ir't cciiimxiiu: performance become* jvjiUhkv

l

Average Annual Growth 6

-

85

SSR: Growth of.

that industrial produciion increased byercent last yearnot muchthan the sluggish rates registered throughout most of this decade. This continued low growth might have been acceptable to the leadership if it had been caused mainly by enterprises halt-big produciion in order to retoolathat might promise more and betterIn the future. Unfortunately for the Soviets, such was not die case Instead, supply disrupiions. failure to bring new capacity on line, andgenerated by reform measures such as wage reform and self-financing constrained outpui in roosi branches of industry. The crucialsector continued to lag as even high-priority state orders for many types of machinery were not fulfilled. Although energy production grew byercent according to our estimatesa respectable rate in light of the continuingof oil and coal extractionihe much ballyhoocd Soviet campaign to conserve energy showed few positive results.

The Soviet leadership has expressed increasing alarm over the lack of economic progressNikolay Ryxhkovear-end review of the economy painted an especially gloomy picture. Although some of the economy's problems were due to circumstances beyond Moscow's controlthe Armenian earthquake (secorGorbachev placed much of the blame on the failure of his own policies to take root.peech to scientists and cultural figurese said that progress ui ihcprogram was being made only "very slowly" and lhat economic reform iset the leadership currently seems most womcd about the growingpressures caused by large state budget deficits and the consequent consumer discontent. Inanuary speech. Gorbachev labeled this "the keyhile onremier Ryzhkov said that the USSR's 'most importantts| to satisfy the Soviel people's steadilyneeds."

n .iim. Impact of the Armciilan Earthquake

The Armenian earthquakeecemberevere economic blowepublichobbled by months of ethnic unrest and economic dislocation. Before the earthquake. Armenia's economy was suffering from work stoppages and disruptions resulting from ethnic clashes between Armenians and Vir.s

The earthquake kfllcd an0 people andomeless.damage to the region's industry. rail lines, road system, and power lines. Ecooocruc recovery will cost bdliom of rubles and take several years

Moscow plans to constructillion square meters of housing over lheears, at an estimated cost ofillion rubles,ercent of annual investment in national housing construction.

The length of time needed io rebuild damaged factories suggests that Armenian industrial capacity will not be fully restored for atears.

Armenian agncuhurc will falter until destroyed irrigation systems arc rebuilt

Allhough the damage to the small Armenian economy will havearginal effect on national economic performance, it will still strain Gorbachev's economic program:

The costs associated with reconstruction will Increase Uie Soviet budget deficit and probably exceedillion-ruWe cost of the CJicrnobyl' cleanup

The diversion of food and consumer gotxls io die stricken region will threaten already limited supplies of some of these commodities in other republics.

Moscow's intervention in the economy to relieve ihc effects of ihe earthquake will further retard an already delayed program to increase cnierpnsc independence and move toward economic decentralization

Progress on Perestroyka

To Judge from media commentary and leader' ship speeches, the Soviels were counting onpositive results from their "human factor" campaign to achieve higher overall growih and clleci some tangible Improvements in Using Man ilardshey also expected their pro grim to retool civilian industry to begin to bear iruit. Finally, they hoped that new economicwould get the economy on the path to ceo nomlc vitality. In each of these areas, however, they were disappointed

"Human Faaor" Campaign To givetn the economy Gorbaihcv lirst relied on his "human factor* campaign, whichcnes ofo increase personal account ability, improve worker altitudes, and weed outi.The most visWe of these measure* were his campaigns for discipline and against cor-

ruption and akobobsm During his first year in of fice. foe example.conomic ministers and state commlnce chairmen were replaced as Gorbachev made clear his intention to hold government and party officials more responsible for theirTlse Soviet press5ndicated thatesult of the antukoliol campaign, there badarked decrease in absenteeism, fewer Industrial accidents, awl In creased productivity overall.

Gorbachev continued io press pans of Imlacior" campaign8 Willi ihc trial of former General Secretary Brezhnev'saw Yuri* (hurtunov last summer. Gorbachev again put officials on notice that corruption would no longer he tolerated Similarly lhe kadcrship con tinurd to pay hp service to (be issues of dm iplme and lhe need fororts byow ever, in at least one critical areatbeorbachev appears to have retreated

I

8 'ITic apparent reason tor this retreat was his recognition that the campaign had been less effective than originally claimed and had led to unforeseen problems. In contrast to earlier official claims that per capita alcohol consumptionbyercent during theears of the campaign to reduce drunkenness, recentby Soviet officials indicate thai the drop was less than half that amountesulturge in illegal production. Home distilling ofalso contributed to widely publicized sugar shortages, and Ihe loss of revenue (rom taxes on official alcohol sales added to the budget dcacit. perhaps by as much asillion rubles per year For these reasons, Gorbachev has allowed state production of alcohol to increase over the past year.

Moderrtization Pnigram. Soviet media reports also indicate thatull years. Gorbachev's program to rccquip Soviet industry with more

modern machinery has failed to live up toOn the positive side, ihc proportion ofusedetool and reconstruct existing enterprises continued to increaselso, newly introduced machinery models were saki toercent of machine building out put. comparedlanned leveler-cent These successes, however, have not been accompanied by comparable increases in cornmis-sionings. production capacity, or across-the-board improvements in product quality or in theembodied In new products. In (act, onlyercent of the state's priority projects scheduled for commissioning last year were actuallywith short/alls in all sectors of the(seconsequently, the total value of uncompleted construction projects increasedercentn addition, according to Izvestiya commentator Yuriy Kyiov,and supply miscalculations resulted in overillion rubles worth of equipment simply waiting to he installed at the end of the year.

Parcont it

B

5?

2 USSR: Raportcd Growth in Commissioning ol New Capital Assets

Confusion accompanying implementation of decisions to reorganize theegional base, to shift constructiontoward housing and other social cultural purposes, and to switch constructionto self-financing undoubtedly contributed to the growth In unfinished construction Inlocal officials and enterprises took advantage of increased autonomy to restart petprotects Moscow had halted6n effect dissipating scarceresources. The pace of factorysufferedcommissionings of computerized processing centers and robotized line* actuallyshortfalls appeared in the plannedof heavy electrical machines, turbinechemical machinery, metal-working machine tools, and hall bearings

To make matters worse, much of theproduced8 failed to meet Moscow's expectations for higher quality. Prime Minis-

ter Ryzhkov again complained that machine tool builders made too many manually operatedtoofe and too few numerically controlled ones According to the Soviet press,uarter of newly produced machines purporting lo meet world technological standards failed to do so. This trend must be particularly worrisome to Soviet leaden, as they struggle to overcome largeand in many areas growinglags behind ihe West (see

hxtmomtc Reftmn. Meanwhile. Gorbacliev's economic reform packagewhich faced iu first real testid little io help matters Ai-nwst without exception, implementation of the reforms (sec table I) proved to he disruptive

Among the reforms introduced or extended last year wete measures designed to

Slash the number of centrally mandated ouipul targe'snow known as "state orders"and give the enterprises

Approximate length of US lead (in years)

Microcircults

1

Computers

I

.' :.

Equipment

Machine Tools

S

Manufacturing Systems

L

..

i i

i

10

Years

'us M on >M

lia UmaSuiai

Figurestimated Soviet Lag Behind the United States in Key Technologies.

Table 1

Soviet Economictatus Report

Purpose

tntetpfse Enterprises win bear lull economic sell.financing responsibility tw the .mn.lt* ol theii activity. Investment villi be financed throughr.ts.pW* own resources

Regional se"- Republics and local governmoiMsa greater role U> forming their own

midgets and will be expectedreater Share ol iheir eiponditures.

will pioducoortion

of lhair ouipul in compfcance wilh mandatory state order* and will beaicretermining Ihe rest.

"scarce" producer poods and

supplies lor state orders will be rationed by the state Olher supplies will be distributedholesale trade system to allow free purchase anc sate toiwaen supplier* and buyers.

wage and salary structure in lhe

production secioi is to be overhauled Increases will depend on an enterprise's abilily to finance them and be lied to increase* in productivity.

Faeino Iff/to Allows selected mirKtuics and

enterprises tofd uni) oniot into |Oini >

Results

Enterprises producingercent o) output in the economy reponecBy operated on self-financing.

Noi vet introduced.

State cders made upercent ot industrial production

ercent ol industrial output was distributed through wholesale nade

Contraryhe reform, wages roseercent while officially reported labor productivity rose byercent.

ercentxs*ts andercent e' import)conducted directly bv emerprses

Goals

Reform is io be extendederceni ol industry and agnculiure: planners -hope" lo complete changeover ol nonproducuon sphere to same punches.

Reforms to bem Estonia. Latvia. Lithuania. Moscow Cly. Tatar ASSR. and SwioSowk Oblast

Staie orders ara toupercent of industrial produclion

Aboulercent oi total mduswai production under wholesaleercent of sales Uvough State Supply networks operated on wholesale Irade.

No announced8 goalercent ofCe.

pril, all enterprises have right to engage in direct ffuetijn uMe Subteei io *omn constraints not yet disclosed

pnecs Will be made more flexible and will Not scheduledreflect supply andimplemented

probably resulting in higher prices 'or foods, housing, and consumer snrvicev

To begin only alter lull public discussion.

authority to make their own production decisions.

Reduce the central rationing of supplies and gradually replace itystem of "wholesale iradr" that allows enterprises to freely purchase their supplies from other enterprises, manufacturers' oudcts. or territorial supply organs.

ystem of economichat allows the enterprises toarger percentage of their profits in return for footing more of their own expenscs-

Encourage the formation of independent businesses (cooperatives) to improve

the quality and availability of consumer goods and servicesExpjuid long-term leasing arrangements in agriculture to encourage greater individual initiative and responsibility

Given the euoniwus bureaucratic Inertia that plagues the Soviet economy, even wcll-confeivcil and well implemented reforms would inevitably have beene disruptions occasioned by these reforms, however, also reflected aof problems in both their design and theirThe most serious of these were caused by the decision toackage ofinterdependent measures gradually and

6

sequentially, leaving full implementation of two of diessential reformsthose in prtc ing and wholesale tradeuntil last.eries of "disconnects" that reduced the effectiveness of the packagehole roc example, the attempt to imptcment self financing before reforming the price structure meant that profitability could not be used as an accurate measure of enterprise efficiency. It was partly to compcnsaie for these pricing inequities lhat the ministries continued to prop up unprofitable enterprises and rely extensively on state orders, nndcnniiilng the intent of the reform.

Implementation of lhe reform* was also made mote difficult by their introduction in the midstive-year plan that had been adopted before Ihe reforms were worked outesult, en icrprne managers were asked to undertake ma (or reforms while a* the same lime meeting high outpui targets Holding the ministries response hlc lor meeting those targets virtually guaranteed their continued interference in enterprise dec! sionmaking

These design iwoblcms were eompoumled by execution of the reforms In ways that distorted iheir original intent- Tor examplc--

foot dragging on the conversionholesale trade forced an even greater dependence on

the cemral supply system than was envisaged by8 plan

Some pcrvate businesses set their prices at exorbitantly hagh levelsa row that discredited the cooperative moven the eyes of many consumers.

Vnwn centrally set state orders were reduced, ministries stepped in to estabbsh their own state orders that often accounted for muchIf not allof an enterprise's capacity, iherehy circumventing attempts to decentralize production planning

leasing arrangements were interpreted by many larrn managers in ways thai gave the individual farmer no more iiHcniivencrease his production than he had under tbe okl system

Growing Popular

While the leaderships efforts to restructure the ecooocay were floundering, the regimegrowing popular discontent over its failure lo improve living standards In laying outh Free-Year, Gorbachev had originally told consumers ihey would have toin the short run until economic reform and Ihc industrial modernization program began to yield results. The regime stuck to this poLcy through most6ut speeches by Gorbachev and other senior officials7 signaled the realization that Soviet workers ex-pec ied more goods and services up front To counter growing skepticism among iheas to the benefits of pernSruyka andbuiki support for the regime, the Sovsrihad promised to improve the availability of goods and servicesespecially foodand the quality of lift8 Indeed, in laying out the planhen Gosplan Chairman Niko lay Talyzm said that consumer goods produciion was to be "considerably in excess" ofh Five-Year Plan targets for that year

Consumers, however, had Utile causeer capita consumption grew, according io our estimates, by onlyercent and would have been stagnant hadof stale-produced alcohol continued lo fill Reduced farm outpui. processing, marketing, and distribution problems, and the Inadequacy ol storage facilities resulted in ftxxl shortage* and widespread consumer complaints According to the Soviet press, "intemiptions in the supply of beer affectedercent of the majorThe availability of nonfood consumer gimd* improved only slrghtly as well, and industry continued to be criticized by Soviet leaders fiw the poor quality of iis goods. According to Premier Ryzhkov. ihe Soviets estimate that the unsatisfied demand for consumer goods last year amountedilliony our estimates aboutercent of lotal consumer purchases of goods ami services

The goods that were available, moreover, were often priced higher than in pre**his years. In deed, since Gorbachev became General Sccrc-

laryrices in collective farmarge share of meat, fruit, and vegetables is purchasedhave risen almostercent, due to poor supply of these goods in state stores and rising consumer demand. Similarly, average prices for manufactured goods have risen sharply,because many enterprises either anificlally tabclcd some of their products as "new,'* allowing them to increase prices, or stoppedcheaper varietiesiven item.

The difficulties wilh mounting inflationary pressures last year were due primarily, however, to the emergence of large-scale budget deficits, resultingise in state spending for food subsidies, defense, investment, and the support of unprofitable enterprises, and near stagnation in the growth Of government revenues. Wc estimate that8 the deficit rose toercent of Soviet GNP (secoreover, as part of ihc wage reform package introducednterprises were given much more control over wages Hiis allowed enterprises to raise wages

far in excess of productivity Increases, rhercby contributingncreased demand fur consumer goods that were already in short supply (sec

All of ihcsc factors led8 to adisparity between consumer expectations and actual results (seehe most strikingof popular dissatisfaction came duringmuch-publicized trip to Krasnoyarsk inhere he was besieged byresidents complaining of poor housing, food, schools, and hospitals. Indeed, commentary in the Soviet press and widespread worker expressions of unliappincss suggest thai Soviet citizens saw themselves worse off8 than previously.

Kcthiiiking Strategy

The lack of progress on economic perestroyka and the surge in consumer discontent last year highlighted for the Soviet leadership the serious-

Percent of

6 -

4 -

7 -

figureSSR: Estimated State Budgetl 88

SSR: Comparison of Reported Growth In Average Monthlyith estimated Growth in Real Per-Capita Consumption.1

of ihc problems ihc USSR faces, as well as the extent of the economic and socialto be expected during the transitioneformed" economy. Indeed, we believe that the growing recognition that his campaign tothe economy was simply not working has led Gorbachev to alter his basic approach to solving the country's economic problems. In the clearest manifestation of this shift in course, Gorbachev has aclaicrwicdgcd that consumer welfare must be substantially Improved soon if the regime is to develop broad-based popular support for per-estroyka. He put9 plan that gives consumerigher priority than didplans: production of consumer goods is slated to growercent, rather tlian the original targetercent. Minister of lightVladimir Ktyiiyev has also stated lhat during

uipul of consumer goods willillion rubles higher than the plan target. To raise the output of consumer goods, Gorbachev hasto tlie traditional strategy of bringingproduciion resources to bear, as opposed to relying on increased efficiency. What setsapart from his predecessors is that these resources are to come primarily from defense.

The Soviel leadership has also realized lhat it must restore financial order io the economy,by tackling the budget deficit, before it can bring inflationary pressures under control. To thisigh-level government commission chaired by Ryzhkovrogram in9 for reducing the deficit. Expenditures arc to be slashed by cutting defense spending and by re-

9

ummary of Selected Indicators of Consumer Welfare

M oaiu to*1 Perceptions^

Indira tors'1

Con-

loc-Js

goods

care

repair

care

*

0 changa

n crt

ircwnmi

rM BtAlChX H

BmM v> raw HOgnwo oliUMtM

M

wb.m m

ducing state centralized investmentillion rubles from what was originally' planned.

Gorbachev has also apparendy decided to slow substantially the pace of those economic reforms, such as the elimination of price subsidies, that would require sacrifices on the pan of the con-sumcr. Leonid AbaJkut. the director of theof Economics of the Academy of Scienceseading advocate of reform. rccenUythat the failure to meet consumer demand, combined with the higher budget deficit, hadetfiinking of priorities that would stow the reform effort, with the first real results of reform noi to be felt

Trading Guns for Butter. Over the past yearalf, Gorbachev has increasingly called on the defense industries to step up their support to Uie civilian sector. Ine gave

them responsibillry for reequipprng most oflantsisbanded civilian ministry that manufactured equipment for food and consumer goods production.

In September, in an effort to increase theirto do more for the consumer, the Council of Ministersecree that allows theindustries to retain profits from above-plan production of consumer goods9reviously they had to remit most profits to the state. At the same time, defensewere publicly criticized for not doing more. Ryzhkov warned that anyone who failed tothe consumer goods program wasig mistake."

In tbe past, attempts to prompt the defense industry to support the consumer goods and the modernization programs base been relativelybecause the leadership did not apply substantial pressure and was unwilling to pare back military demands. Last year was noWc estimate that Soviet defense spending, as measured in2 rubles, grew byercentIn line with ihc growth rates of the past several years. Procurement of weapon systems wasajor contributor to growth. Expenditures on ship procurement rose sharply, caused primarily by an Increase in spending on both strategic and general purpose submarines Missile procurementparticularly for intercontinental ballistic missiles (ICBMs) and strategic surface-to-air missilesalso displayed strong growth.

Last year, however, Gorbachev took several actions that evidently were intended to by the groundwork for future military cuts Ath Party Conference inhe leadership characterized the threat from the West aswhile charging that the expenditures Of "huge sums" on weapons and the neglect ofmeans had weakened both the economy and national security. Numerous commentators, for example, criticized the deployment of theissileaste of badly needed resourcesove that intensified political strains between the Soviet Union and the West. The Confer-encc's response to such complaints was tothat future improvements in military capabil-

10

iiy be based (in qualiiadvc rather than quantitative factors, and that political considerations be given greater weight before new weapon systems are developed and deployed. Soviet spokesmen began imprying ihai this would result in lower defense expenditures, while other officials Mated that the increased civilian demands on defense Industries could reduce military production.

ecember at tbe United Nations, Cor-hacbev moved from hints and suggestions about fus pbns for defense to roorc specific promises by announcing major unilateral cuts In Soviel military manpower and equipment to be carried0 (seeeeting with the Trilateral Commission inorbachev' expanded upon this pledge, promising that the defense budget will he cut byer-cent and the produclion of weapons and military equipmentercent durtng die same pe ciod. Soviet commentators subsequently said (hat the promised cum In defense spending will be ap-

Table 3

Promised Soviet Force Reductions in Eastern Europe, USSR, and Mongolia

6 rank Division* From Eastern Europe.

a liom GDI*

1 horn Cmvif-uovrt,1

1 fan Hungary

Tank;

rom (astern Europe

o Dathers convened lo "actors and training vehielee

0 total

fthcnfl

BOO total

Pan* ot pUnts to be used as spar's

Ground support equipmente "redistributed"

Personnel

rom (urooeen pen ol0 Irom southern pari o*ompan erf USSR

Mongolia

3roundnAir forces to be eliminated

plied io "toul defense expenditures'* rather than to the small portion of ihis total published in the annual state Isudgei (sec insei on

For all the Soviets' show of openness on their defense spending plans, some crucial points about Gorbachev's pledge remain unclear Moscow has not. for example, indicated whether theercent cut applies8 spendingor to llie expenditures planned9imilarly. It has not indicated whether the defense iHidgct rs to be reduced In real or only nominal termswhether the cuts will be made after or before the budget Is corrected for Inflation Miircovcr. die Soviet* have yet toal any figures on the level of their localspending. This continuing silence makes It difficult to assess the sue of the promised de fense spending cuts. Given the lUstortions thai historically have characterized Soviel economic and financial statistics, this difficulty almostwill persist even if the Soviets make good on their pledge lo release thrlr "total defense expenditures"

In view of ihc problems inherent in measuring Soviet defense expenditures, moreover, confirm ing lhe implementation of the promised spending cuts will require substantial evidence ol rcduc tions in Soviet forces and the flow of weapons and equipment to them In many cases, Moscow will provide sulistaiitUI publicityboth lor domes tic and foreign audienceson specific culs. In some areas, national technical means will provide ihc Wrst vsnh indersrodcni confirmation In Other areas, such as research and dcvxiopnsrni. cuts in spending will be far more difficult to monitor.

If the promised cut is to be appliedefense budget as large as wr estimate Moscow's in beabouioerceni of Soviet GNPihen ihc resource savings involved will lie substantial Indeed, our estimates indicate lhat in reduce their local defense budgeterceni. Use Soviets would have to go beyond theilitary' programs that ihey have specmcaMy promised to make

By our estimates, onlyhirdalf ofercent reduction can be accounted for by savings avsotiaicd with withdrawing from

11

t.UsiuM on the Soviet Military

In ihc pan. the Soviet* have releasedingle hgurc for the "defenseneputy Foreign Minister Vladimir Pcirosskiy publicly announced lhat this figure represented only Ministry of Defense expenditures for nsamtaming military personnel, military' pensions,military construction, andumber of othere also pledged that corrrprehensive defense spending data would be releasedrice reform which would "allow coropara-bdity with the West" Other spokesmen quickly claimed that this would happen inears"

There haveumber of statements recently in the Soviet pressincluding those from government officials such as Foreign Minister Shevardnadzecalling for early release of the Soviet defease budget. Pro-reform elements, who want io use the data to strengthen their case forresources from production of defense to civilian goods, arc apparently growing impatient with what they perceive as stalling by opponents ofi. They have said that they would like to sec the new Supreme Sovietreater role in determining allocations to defense.

Tlie Soviets may release defense spending data this year because ol mounting pressure. Even then, however, it will take lime and strong political supportorbachev for the Supreme Soviet to shape Soviet defense spending policies in the face of entrenched military Intcrcsis.

Meanwhile, claims by the Soviets that they are unable to release their delense budget because they themselves do noi know whai they arc spending are increasingly less credible, now lhat Moscow hascryercentpromiseeduction in total military expenditures Indeed, continued Soviet delays intrue" defense budget will lease ihc USSR open to the charge that it is using the time tolausible but still deceptive or uninformaiivc set of figures

complying with the Intcimediatc-Rangc Nuclear Forces (INF) Treaty, and carrying oui the reductions promised at the UN. Although some ad<litlonal savings will come from reduced demand for weaponslhat is.esult of the force restructuringpromised during his UN speech, wcthe Soviets will have in do much more than what Uiey have publicly disclosed to achieveamounting loercent

Actions ihc Soviets might take to meet their promiseefense spending cut includein military research, development, testing, and evaluationelense Minister Dummy Ya/ov. Deputy Defense Minis ter for Armaments vitaliy Shabanov. and Deputy Foreign Minister Alcksandr Bessnvcnnykh all erai cued ihe USSR's militaryaken together, these criticisms suggest lhat future Soviet RDT&E

may be concentratedmaller number of protects, but lhat those projects funded may be more technologically ambitious than was typical in the past Projects thai would result in only minor improvements might be rejected asnot being worth the elfort. At the same time, technologically ambitious projects designed to counter very distant or only hypothetical threats mtghi also be refected. As noted above, however, cutbacks In military RD'IAE would be especially difficult to confirm.

The Soviets prnlxibly also hope that some of the promised spending cuts can be implemented under or in anticipation of future East-West arms reduction agrccmcnu. although they rccogmzc lhat agreements vsdl be difficult to concludetheir1 deadline for impicmeni ing the reductions. Conclusiontrategic Arms Reduction Talks (START) treaty, for exam-

12

pic. could save ihc Soviets several billionear. Mrrfcover, the Soviets probably abo hopeTART agreementparaciuarty when combined wilh their unilateral reductions Inforceswill lead to negotiatedin the conventional area or.inimum, weaken NATO's resolve for conventional andnuclear weapons modernization. Anywith NATO that would allow them io forgo or reduce expeodiuires on modemiz-ing conventional forces could result in substantial savings.

According to Bcssmcrtnykh, the Soviets also expect their foreign policy to conirlbuie to the country's economic goals not only direcdy by achieving arms control agreements, but indirectly byore benign internallonalthat will allow them to redirectfrom defense to the civilian economy without damaging the USSR's security. Easingwith the People's Republic of China, for example, might allow the Soviets to reduce ihc size of their armed forces in the eastern Soviet Unionreater extent lhan they already have promiscd.

Thc Soviets have indicated lhat ihcreduction in the defense budget wUI he carried outut transferring the freed-up resources io civilian usesand fullyeconomic benefits from themis likely to take more time (seche Sovietshave admitted thai In many cases ihey arc just beginning feasibility studies onfinal assembly plants from military to civilian uses. They have indicated that they iniend tuexisting plants from defensehilianrather than transferring manpower and equipment from defense plants to civilianUnless, however, the converted defense plants arc given the same priority Ui resourcethat ihey have enfoyed historically, thclr ability to satisfy ihc requirements of their new civilian customers may not be as great as il was for the military.

In our view. Gorbachev will have strongto keep defense spending down, at least through the period ofh Five-YearS) This would be consistent with theannounced plans for the defenseto aid the consumer sector during the same period. Council of Ministers Deputy Chairman

Transferability of Resources

Ultimately, the degree io which resources arc transferable from one use to anotheruestion of time II is relatively easy to plan for shifts in resources that will occur several years into the future. If it is known now. for example,iven weapon is not going to be bulk In, then lhe plant and machinery needed to produce ihai weapon do not have to be built and the materials and intermediate goods intended for that purpose can be readily divertedifferent plant or purpose. Shifting the existing stock of resources, or those planned for defense withui the next few years, in contrast, can be more difficult, depending upon the resource lnvoh*cd:

Most materials used In weapons productionspecialty steels, construction materials, and engineering fibers, for exampleare both readily transferable and in great demand in the civilian sector.

Intermediaie goodssuch as bearings, composites, and, most Iraportani,are also relatively easy to transfer and important for civilian production.

The Soviets would bcncfii from lhe transfer of large numbers of defense-Industrial workers and.esser degree, from reduced conscription demands resulting from personnel reductions.

Transfers of defense-related industrial plant and equipment would prove more difficult, but .ihc USSR would derive clear benefits from the reallocation of high-quality production machinery to Chilian production

Igor' Bclousov has said, for example, lhal5 (he defense industrial ministries arc to5 billion ruWcs of machinery (outotal ofillion rubles) for ibe food processing sectoralmost as much as the total value ofInstalled In food processing07 (seehey are also toillion rubles worth of goods for light industry, as well as increase output of construction materials, medical equipment, and plumbing supplies.this greater emphasis, Ryzhkov has Stated that the share of civilian goods produced by the defense industries would increaseurrently toercent1 and to someercentn the surface, this suggests further efforts to reduce die defenseh Five-Year Plan.

Selectively Seeking Outside Support. Although the Soviet leadership appears firmly committed to seeking indigenous solutions to economicit is not ignoring potential gains from trade and other foreign relations. Indeed, debate within the leadership over the role foreign resources can play in economic restructuring has intensified over Ihc pastumber of Sovlci economists

Table 4

Ministry

Aviation

Contributions of Soviet Defense-Industrial Ministries to Food Processing Modernization

Food Processing Equipment

Fruit and vegetable processing Starch and syrup production Pasta production Canning industry Packaging o> dry goods

Incustry

Dan

General Machine Building

Livestock and poultry processing lea ceam production Canning industry

Medium Machine Building

Radio Industry

Shipbuilding

Bakariea end sugar refineries Confection industry Processing ol tats and oils

Dairy industry

Rnlrigoralfni equipmeni Bskerv ovens

have, in particular, called for steppedup imports of consumer goods toestiveand, hopefully, provide sufficient Incentives to giveoost

The leadership has not, to be sure, abandoned ihc conservative approach toward increasingthat it has pursued in recent years. For the most pan. the current leaderslike those before themremain sensitive to tbe nationalimplications of becoming financiallyThey arc panicularty reluctant to boost imports substantially without greater confidence ui iheir ability io pay for the goods as well as to effectively absorband ultimately diffuseimported technology. Moscow's debt runup in the, the subsequent application of Western economic sanctions against the USSR, and Eastern Europe's own financial plight earlier in ihis decade arc still cited frequently in Soviet discussions of foreign economic policy.

The recent pattern of Soviet trade and financial activities nevertheless is sending mixed signals on Moscow's immediate plans. Soviet orders ofand equipment from the West climbed in the third and fourth quarters of lastoost ui these imports over theears (figureonversely, the Council of Ministers has recently proposed that imports of consumer goods he increased, with lhe increase apparently io be financed by reducedof capital goods. And while nci newrose several billion in ihc first halfie trend appeared to have tailed oSduring the (alter half of the year. Moreover, the program iosizable Western credit lines for the import of machinery for consumer goods production has quieted considerably. Sizable lines were finalized only with consortiums of West German andbanks, and these arc being drawn down very slowly Most important, despite growingunrest, the Soviets have yei io arrangeubstantial infusion of Western consumer goods.

To the extent Moscow is seeking Westernit isoncerted effort io ensure thai ii will neither waste whai it obtains nor pay more than is necessary, (or example. Moscow-Is continuing its aggressive pursuit of joint ven-

i i

In

150

2 tr

-

2 3 4

3 f

lr-> r.'wi ftttiim "ir

US.IVfKwMI, .cco-o. in, SO*,

FigureSSR: Orders of Western Machinery and Equipment from Top Seven

wiUi Western firms to Improve its chances of more effectively absorbing Western equipment and know-how (sec inset on. Moscow is also seeking tics to international organizations Such as the General Agreement on Tariffs and Tradepparendy hoping thatwill increase its knowledge of world markets and lead to increased exports.

ew Investment Course. During the past year, Soviet commentators havemisgivings about the long-term efficiency of their investment strategy that emphasized rapid growth of investment and targeted heavyfor top priority. The Soviet press wascritical of the waste and inefficiency involved in large-scale investment projects such as dams, canals for water diversion, and hugeInstallations Even the completion and main-

tenance of the Kaykal-Amur railway (thehowpiece investment projectwasThe move toward more efficient use of investment resources resulted in proposals last year toumber of maior projectsthe Dnepr-Bug hydraulic complex, ihc planned world's largest hydroelectric power complex on the Yenlsey River In Northern Siberia, and the Volga-Chogray canal projectand culminated in March with an announcement that investment spending financed by the state butlgct would be cutillion rubles9 from whai was originally planned. These cuts are to come from halts in regional development programs and land reclamation projects.0 on. moreover, state expenditures for investment arc io berestricted hy giving enterprises moreto finance investment through their own funds and interest-bearing bank loans

15

Recent Trends In Soviet Joint Ventures

The USSR's continued "hard sell" of )oint ventures, as well as its willingness to grant concessions during project negotiations, resultedubstantial increase in contract signings last year. As of

oscow reportedolni ventures had been registered with foreign firms.

f them Involving Western participants. Onlyoint ventures had been registered by the endest Germany, the US, Italy, France, Great Britain, and Finland were the leading partners In terms of the number of agreements actually signed.

Despite the impressive growih in the number of deals concluded, the Soviet leadership is far from satisfied with the progress of its (obit-venture program, foreign firms have committed to make relatively small investmentsm the aggregate only about one-third of the estimated total Si.3investment. Well over one-half of the projects with Western firms Involve capital contributions of less0 million Service and consumer-related projectsrather than deals that will enable Moscow to acquire advanced technologiescontinue to dominate the list of complete contracts The Sovieis have, however, completed several small deals to assemble personal computers andsoftware, and some ventures ln the machine-tool area arc also under way. The transfer of human capitalthe technical skills, expertise, and know-how of Western labor and managementhas also been far less than the Soviet leadership anticipated.

'Ihe Sovieis have expressed Interest during the past year in establishing "free economic zones" in the Soviet Far East and the Baltic states, largelyeans to attract additional Joint-venture investment. Joint enterprises operating in these zones would be granted concessions on taxes and customs payments. Research on this topic is In an early stage.ew zones may be established as carry ast will lake several yearsand probably better terms and conditions than are likely to be offered initiallybefore ihey attract subsianiial foreign investment.

New regulations attempt to address some Western concerns by allowing foreign partners to exercise greater management conuol over joint-venture projects and reduce their hard currency oudays. Western bsjsinessrnen are reportedly disappointed, however, that Moscow failed tosolutions io the problem of profit repatriationthe main barrier to foreignroup of six US companies known as the American Trade Consortium has recently signed aagreement that will allow the members to overcome this problem by pooling their hard currency revenues,S oil company shouldering most of the burden by exerting productsoicntial petroleum joint venture. Even if the profit rcpatriadon angle can be surmounted, additional problems confront joint ventures once ihey are established, including high lax rales, unreliable material supplies, unexpected hard currency costs,f working and living at commixlations.

line wlih ihe increased emphasis on the consumer, invesimeni for the development of ihc consumer goods sector is being increasedwhile heavy industry will receive lessInvesimeni In ihc food Industry is to rise byercent and in the meal and dairybyerceni. When imported machin-

ery is included, equipment for light industryis io increaseerceni In addition, inove to preventfrom being squandered, the SovietsIhai henceforth only those machinery designs thai supported one of theriorityof technological development would be

16

centrally funded (see rablel least hall <ifirections arc dearly im coded to benefit the consumer

Meanwhile, Moscow hi* laken major steps to focus lu modernization effort. The primary em-phasis remains on the machine-building sector and the need to modernize the technology' of en tcrprrscs Inhe Pobtburoihe machine building sector's priority role as the technological basis of economic modem izatton and gave the Machine Budding Bureau, the ministries, andonths to plan "radical measures"mprove machine building's(see inset below)

If Ihis trend holds, the planned averagerate of investment growth Inh Five Year Plan will probably he lower thancreeni rate ofh. Investment growth is more likely to be in theercent range, as resource constraints put pressure on state spending across the board- Investment al location* will probably favor consumer onenled

sectors and rural infrastructureespecially roads. Nonetheless, compciition for Investment resources will remain heated. For example,the Soviets are successful in shiftingproduciion away from oil and towardgas, investment in this area will have to increase rapidly to avoid energy shortfalls that would cause economic stagnation (sec Inset,ransportation rs another sector that will probably need more resources, especially if the Soviets intend to improve the rural infra structure and help Ihe cntical railroads Consc-queniry, heavy industry and Soviet farms maysmaller Increases than In the past

Rtuking Off Fnm Kefhrm. To avoidconsumer problems, the regime has also decided io hack off from some of iis plannedSpccifirally, retail price reform, which was to be implemented1 along wilh wholesale price reform, appears to have been pushed into the indehnite future While recognizing lis cnti-cality to other reforms, even reform economists arc expressing skepticism about its wisdom be

'Hieon Technology

The "radical measures" the Politburo has called for to improve machine building's performance are likely to reflect the leadership's preference for "highnd require the introduction of advanced production tctnnotoglesassive scale. Currently,9 plan calls for the Ministry of Instrument Making. Automation equipment, and Control Systems to Increase itshfcch is vital to the rccqutpping of the RSD lest basebyercent. Ihe overall produciion of the crucial components of factory automationmachinery, equipment, and Instruments tacorporaiing microprocessorsis to Increase byercent, and almost every product newly entering into production will coniain microprocessors. To meet ihis surge In demand for microprocessors, last year lour civil machine-building ministries joined the Ministry of the Electronics Industry as producers of electronic equipment

Moscow also hasew strategy to move these technologies onto the factory floor. Previous ellorts often led to lhe piecemeal introduction of flexible manufacturing cells or other automated producdon technologies into existing factories and resulted In inefficient "Islands ofhe Sos'icts hope thai by concentrating deliveries of advanced equipmeni io their most obsolete factories, they can skip over the islands of automation stage and convert their worst factories Into showcases of computer-integrated mx-iufacturing Western experience suggests lhat ihis isisguided approachlumping directly lo full automation often results Inexisting inefficiencies. The preferred course in the West is io first simplify the production process, then begin io automate where economically justified, and only Uien to integrate the islands of automation.

Table 5

Focusing Industrial Modernization:riority Areas

of Areas

Social

Food

Construction

Fuel and energy

Metallurgical

Machine-building

Chemical and

Emphasis

Consumer goods

Medical equipment

Publishing and printing equipment (one nol reported)

Automated processing complains

Scaled-down equipment lor brigades end private (arms

Advanced technologies (five nol reported)

Subway trams

Local Trains

Improved buses

Compact cars (eight not reported)

General construction equipment

Road laying equipment

Road repair equipment [throo noi reported)

(none reported) (none reported)

(none reported)

inonerspOftfO]

Assessed Needs

CWor TVs. VCRs. <efrigeiaiors. and freezers

Diagnostic equipment

Finishing, tanning and lootsvear equipment lor light industry

Knitting equipmeni

Processing equipment tor dairy industry, fruits and vegetables

Slainless steel equipment

Packaging equipment

Measuring equipment

Beverage equipmeni

Refrigerated storage

Locomotives wan improves braking end electronic systems

Freight cars, especially refrigerated end special-purpose rolling siock

Train commo and control equipment

Boars, including icebreakers

Mcchaniied loading/ unloading eoucment

Motors, engines, and valves

Geophysical equipmeni

High-quality noncO"OHve pipes

Sciap sieel processors

Electric arc furnaces

Rolling mills Machine tools

Com outers

Eiectronics/eieciiica) equipment

Processing equipment with automated controls

Nonconosrve tanks

Engineering plastics

Stainless steel, titanium pipes, and valves

Energy;Imrsmncnt Wild Card

In responserowing domestic demand, ihc USSR his become ihc world's largest energybut ihc associated costs are skyrocketing New deposits of oil, coab. and gas are increasingly distant from populated areas and more ddbcult and costly to exploit Soviet energy users. however, fuse nor yet been forced to adjust to this new reality. Vase heretofore easily apkatahie reservo lure firmly emrxdded in the minds of ihe Soviel popuUnoo the impression of cheap, pkntrful energy. Waste remains pervasive In factories and household*

Soviet plans caB for energy production lo increase byercent by the0 and od output to remain stable. Goab this ambitious toukl push energy's share of imestracni from about IS perceniearlyerceni of the total, usurping resources essential to nwdembx industry and improve consumer welfare Curbing growth in energy Investment, however, would risk almost certain energy shortfall and economic stagnation Unless ihere are major improvements in energy efficiency, the USSR will be hard pressed to sustain morecrccnt average rate of economic growth over the next decade Addressing the shortfall by reducing oil exports would undermine Soviet trade with Eastern Europe ami severely Crimp Moscow's ability to import from lhe West.

of anticipated public outcry against price increases (sec inset,

Other reforms have been pui on hold as well

Despite the leadership's prontbes to reduce state orders substantialy9tate orders wil continue to dominate the consumer sector because of the need to ensure the production of inexpensive goods

To correci what Council of Ministers Chairman Ryzhkov calledreatecisions on wage mcrcascs. which were lo be the preserve of the enterprise, are now io be monitored by the hanks to keep wages from exceeding productivity gains and adding to inflationary pressures

In another step to restrain inflation, prices of consumer goods will abo be stabilized through stricter governmental controls.

Other reforms, however, particularly those that will benefit the consumer, continue to be pushed by the leadership. Land leasing was endorsed by the recent plenum on agriculture, and Gorbatho laid out bold puns to reduce central controls over lhe farms The reform of agriculturalprices. ongftaOr scheduledas moved up0 Abo, ihe regime continued lo support the expansion of the private sector, at

though measures have beenestrict cooperatives in setting prices because of popular resentment over price gouging

Outlook

We bclsevc that the policy shifts Gorbachev has made have the potential to advance his ef Ions to revitalize the Soviet economy Asseems io recognize, he must pu< his hrun cial house in order and regain the support ofif he is io proceed with the olher pans of his economic agenda. Cuts In Invesimeni and lie-feuse spending should help case the deficitami provide resources for Increasing produc lion of consumer goods. At ihe same time, ihc reduced largcis for produclion of capital goods slsotild allow the Sovieis to tackle the problem of unfinished construction, allowing them to bring additional capacity on Line and thus increase

successful diversion of resources from defense and investment to consumption, however, winifficult task, especially given the irsrftkicneic* that plague the Sos-iet economy Chancing athat for ihe postears hasd heavy industry into one ooenied toward the con sumer will be lime -consuming ami disrupirve

Ilacklng Off Irom Retail Price Reform

We simply cannotwin ibe price [reform| campaign under die present conditions. No matter how carcfulh/ the retail price Increase might be prepared and explained to the people, no matter how much compensation will be paid to the consumer, the ensuing situation would not satisfy the majority.

.nstitute of USA and Canada

A reform fof retail prices) would beiink. under certain conditions. First, there must be adequate stability of the consumer market when the supply of goods and money are in balance Second, there must be suflicicntly large stocks nf goods to prevent potential negative events. Third there must be economic competition among state enterprises, between them and cooperatives! and so forth Do all of these conditions objectively exist today? Not yet

UooJd AhoJkhx Director, Institute ottmtxxnles, USSR Academy of Science*

A yearearalfas writing and insisting on [price reform) Fvenelievetructural reform of prices is necessary. Only before it was both necessary and possWe- now it is necessary andope we will still getoint where it will once again becomebut for now the moment has passed

1 uS Deputy Chief Editor, Kjmimunist

The threat of growing Irulaiion. as the cxpcr>rr>cc of Hungary. FvJand. and thma warns, requirescautious and gradual approach to the implementation erf reformso usemany iflusions about the possibility of putting the consumer market In order by

Oleg Bogomotov, Director, Institute of Economics of the World SochUst System

even once the transfer of resources is achieved, thereubstantial risk thathift in resource allocation will come to be re gardeday of as-oiding radical reform rather thaneans of preparing the populace for it In sum. we believe thai while the policy shifts GCttMChcV has made may buy him lime to pro cecd with the hard parts of his economica key question to be answered in the next few years is whether he will be able to make roVcirvc use of trus time. To do so. Goroachcvchieve at least modest near term irnprove-menu ui totisumcr living standards, reduce the bodgci deficit and the wasteful use of invest mem resources,omprehensive plan for

tbe implementation of difficult measures such as price reform, and prepare the population psycho-logkaUy for the sacrifices these reforms wfll In rvitably entail.

Gorbachev, moreover. Is likely to face political as well as economic obstacles io proceeding with his program He will Increasingly be heldresponsible for any of iu future failures This situation increases the pressure on Gorbachev to pniduee results. Moreover, hit decision to after ihe pace ctf cconornk restniciunng has made him mlnerablc to second guessingopponents and Imreaucrais may see Gorliachev's temporizingign of weakness and become even mure rcealci-

20

tram. Although the regime has portrayedizable number of party officialsseveral at high levelsin the9 electionsarning to those who arc resisting Gorbachev's reforms, the unexpected repudiation of so many party officials almost certainly has strengthened pressure on Gorbachev from more conservative

leaders who view his political reformshreat to pony authority. On the other hand,loc of radical reformers beyondcontrolsuch as former Moscow leader Yeltsingives those who have criticized the Slow pace ofew forum in which to press their demands

8 Economic I'erfonnaixe by Sector

Our preliminary estimates indicateroyka did tilde to improve Sovietoor harvest, supply shortages, widespread failure to meet delivery deadlines, and confusion sparked by reform policies all contributedelativelycrceni growth in GNPa rate similar to the previous year's.

Industry

Industrial production grew by anercent last year. Production was disruptedof transportation bottlenecks, supply interruptions, and difficulties in Implementing economic reform

Machinery. According to our estimates, outpui of civilian machinery showed its slowest growth Since the, finishingercent higher than ihe level' We estimate that ouipui of Consumer durables increased byercent last year. Consumer complaints remained widespread, however, as much of the output apparently continued to be of poor quality and consisted of items not highly sought after. Wc estimate that the growth of producer durables was considerably lower last year thanustercentreflecting continuing problems implementing the industrial modernization program.

Industrial Materials. The rate of growth of produciion of industrial materials (chemicals, metals, construction materials, and wood products)8 was an estimatedercenta repeatdisappointing performance. Continued problems with modernization were compounded by the introduction of economic reforms Mediocre results were registered across the board: growth in two of five subsectors dropped compared

shortfall in output of plasties and resins, intermediate chemicals, and pesticides brought down estimated annual growth in the chemical industryercent7ercent

Output of cementillion tons, helping (he construction materials industry toerccnt gain. However, the production of window glass and precast ferroconcreteboth critical to Gorbachev's plans to modernize constructiondeclined.

Ferrous metals producdon rase anercentutput of crude steel, steel pipe, and rolled steel rose modestly, while iron ore output fell.

Growth of nonferrous metals productionanercent lastrebounded6 levels, due In large part to increased utilization of processing capacity and new Western smelting cquipmcnt.

nixlttncry production ii becoming panlculariv dJPicuTi hecauK Uk Soviet* hire cut back on the release of imbues on vinous machineryhile Uicy have lncteiM.il the nuliblUty ai information on (Oi&umct durable. mifciie* on producer dunMcsa>ai some industrial materials with is clienuc* ind woodincreasingly scarce.thLt reason our estimates of machinery output should he considered very preliminary.

Continued)

Strong performance in furniture productionruCkJhng improvement in paper outpui helpedercent Increase in the output of the wood products Industry. The industry was criticized, however, for shortfall* in producuon of chipboard and cardboard packaging

Fnrrjry Despite unresolved problems in the fuels and energy industries, the Soviet Union re maim the only major industrialized nation that Is energy independent, with the largest proven od reserves outside the Persian Gulf andercent of the world's natural gas reserves. rocrgy production8 grew byercent, although this level of output requiredercent ofovietcrcenl If pipeline systems areo prevent declines in national production. Moscow will need to make another large boost in oiMndustry Investment I'M! productionillion barrels per day (hhl/d)lthough daily ouipul felligh of3 millionn the second quarter tu" millionn the founh quancr Production In the key West Siberian regionwhich accounts for two-thirds of nationalha* iiff while production Irom other regions continues to fallubstantial increase In drilling and new well corrrplciions. West Siberian production will soon begin io decline

Sulurul gas output again led growth in energy producuon.illion cubic meters, with increased production from gasfiekls in northern West Siberia continuing to account for nearly all the growth Maintaining this robust growth over the next several years, however, will become difficult and expensive Further expansion innsumpnon will require accelerated construction of local distribution pipelines as well as successful addition of new customers through conversion of existing equipment to gas and wider use of new gas-fired equipment

Raw civi/ fietxttiction Increased by only In percentnd once again the net gain to Soviet energy ouipul is probably less than ihis due to lhe declining average energy content of Soviet coal. The trend toward small gains in energy from coal is likely to continue since almost all of the growth In raw coal production continues io come from open-pit mines in ihc lastcm USSR thai prOdUCC some of the lowest-quality coal in the Soviet Union Coal production willnunuc to grow slowly because Moscow is facing technical challenges in exploiting lastcrn soal and developing new industrial consumer* very slowly.

Ftectric pnttcr output ficw byercent last yearthe smallest gainI Nearly all of this increase was produced at nuclear and hydro plants instead of at fossd fueled plants as tn previous years The suspension or cancellation ofucleareactorsmeans that maintaining thecrcrnt annual rate of growth in electricity will become Increasingly difficult unless efforts to increase powcrplant capacity receive priority attention

Consumer Grinds Industries. Overall output in ligltt tiulttstrygsCvi by anercentith most productsexcept textiles andshowing higher growth rates than7 light industry was sharply* criticized, however, for the high price of its goods and was accused .if using price supplements and contract pricing io boost the price of its goods without making real style improvements. The food processing industry alsoespectable performance, wuh increased output of meat, dairy, and fish products offsetharp drop in sugar productionht tal announcement of the easing of ihe antiakohol campaign is also reflected in produciion statistics, with output of roost alcoholic beverages showing strong growth. Ihis industry also time in fur heavy cntiersm lax year, with complaints of shortages and declining quality

21

Coiitinued)

Agriculture

We estimate that Soviet farm production dropped byercentn the heelsercent dropecord highs in production of meat, milk, and eggs ledcrccnt Increase in the livestock sector. Still, this was not enough to offset the negative effects ol die smallest potato crop inhirdentury,ercent drop in grainillion tons7illion tonsnd unchanging vegetable and fruit production. The only bright spotercent increase in cotton production. Moscow's efforts to eliminate corruption in the cotton-growing Central Asian republics and io reestablish proper crop rotationcrucial for obtaining higher yieldsare evidently taking hold.

Future food consumption may also be undercut by changes in inventories of livestock. The number of hogs held steady last year, but the stocks of cattle, sheep, and goats continued their slide and arc now down3 levels. According to some Soviet researchers, the declines in herd size may jeopardize ambitious long-term plans for meat production. In pan because of this inventory reduction, per capita meat availability was up by moreercent. Supplies were Spotty, however, as marketing and distribution problems resulted in numerous shortages

Transport

Freight shipments by all canters increasedercenthe second yearow of slow growth. Transport plans overall were fulfilled, mainly because the slow growth of Industrial output dampened demand for transport services. Shipments were up on the river fleet and pipelines, and virtually unchanged on common carrier trucking. The volume of freight shipments carried hy railroadsthe main barometer of freight transportationgrew hyittle moreercent

Moscow is trying to support future growth in shipments by unproving efficiency.tabor productivity continues to soar because of the implementation of the Behirus-sian railroad experiment that pared down the size of the workrogram to shift highway freight from departmental carriers to the centralized fleet is maldng slow progress but promises to Improve the notorious Inefficiency of overall trucking withto labor, capital, and fuel usage. Sovici transportespecially the railroadsnevertheless will require substanUal Investment to modernize antiquated equipment and expand capacity. For example, severe railear shortages and slow progress in automating traffic control arc constraining growth of rail shipments.

Trade

The USSR's hard currency trade balanceurn for the worse8trong showing the previous year. On the basis of preliminary data, wc estimate that the trade surplus fell5 billion to aboutillion because cxpon growih could not keep pace with surging imports The dollar value of Soviet hard currency exports increasedercent last year duencreased arms salesagain on creditto the less developed countries (LDCs) and growth in nonmiliiary, non-energy exports, with the composition of these sales spreadumber of commodity categories.

25

Continued)

Imports were up nearlyercentoor harvestubstantial burst in grain purchases. The higher quantity of grain Importscoupled with rising world pricesadded at leastillion to Moscow's import bill. Sizable growth In Imports from countries such as West Germany, Austria, and Japan suggests that machinery and equipment imports abo increased last yearsome increase was anticipatedickup In orders from those countriesurchases of consumer goods reportedly rose, albeit not enough toisible impact on store shelves. Moscow also boosted imports of oil from the Middle fastlargely in payment for arms salesfor resale elsewhere.

The shrinking Soviet trade surplus prompted both higher borrowing and increased gold sales. Net new borrowing increased by several billion dollars, much of it taking place early in die year when the leadership probably decided to finance some imports and build up reserves in the face of uncertain export earnings because of weakening oil prices. In looking to foreign credits, the USSR sought to diversify lis sources of money by issuing its first state bonds in the Swiss and West German capital markets. The Soviets also began to negotiate large credit linesumber of Western banks during lhe latter half of the year. Theyeal with West German banks, but so far they have made liitte use of thb credit line Estimated Soviet gold sales amounted to approximatelyillions for the third straight year Moscow turned heavily to the gold market in order to earn hard currency.

The Soviet Union's trade with its Communist partners also sufferedoscow registered large trade deficits with most of the countries of Eastern Europe as falling Council for Mutual Economic Assistance (CMEA) energy prices continued to erode Soviet terms of trade with the region. "Hie value of Soviet exports to Eastern Europe declined byerceni, prompting Moscow to limit the growth of Imports from the region to avoid even larger deficits. Trade wiih Yugoslaviaanother large customer for Soviel oildeclined slightly because the Soviets have been unable to boost non-energy exports to offset the falling value of oil exports. Moscow's trade with China rebounded sharply8owniurn the previous year, buttill below planned targets.

26

ables on Soviet Fconondc Perfbrnuuxc

AM

USSR; Estimated QNP by Sector of Origin at Factor

USSR; Fstlmatcd Value Added In Industry al Factor

USSR: tslimaurd Average Annual Growth of Per Capita Consumption

USSR: Estimated Growth of GNP, Industry, and labor

USSR: Gross Fixed Capital

USSR: Total Trade,

USSR: Estimated lUrd Currency Balance of

imated Ilard Cuirency- Debt lo the

ISSR' Selected Indicator* of Agricultural Output

Continued)

USSR: Estimated GNP by Sector of Origin at Factor Cost2 rubles)

llnclud-

6

1

8

7

'" sonntl)

id ikiiOmmm ol-svinJ-'O rialml ixiUimm t'U"

USSR: Estimated Value Added in Industry at Factor Cost2 rubles)

2

fenous

Nonferrous Fuel

Electric power

ChemiCaH Wood. oulp.

Construction Lu)tl "wkistry Food industry Othor Industry

6

1

0

4

4

8

0

2

4

5

1

5

2

5

1

4

1

i

Contain" mir i* i

2B

Appendix II (Continued)

USSR: Estimated Average Annual Growth ol Per Capita Consumption1 (percent change)

65

-75

con-

I

1

0

goods

8

fl

2

'

7

1

I

a

'

and

care

2

1

3

iseimi.

USSR: Estimated Growth of GNP, Industry, and Labor Productivity1 (average annual percent change)

Gioss national product3

Labor productivity

tndutiry Labor

productivity

5.0

H

3.2

i a

2.2

14

24

1.0

19

1,2

4

4.0

3 7

3

1 3

US

29

3.2

25

Out

tO nuiD

Continued)

SSR: Gross Fixed Capital Investment4 rubles')

iKVMbT#M

2

9

6

4

2

9

0

fermi

t

I

6

7

apart-

Sector

0

1

0

eomrnu

0

9

., 1

6

0

ww>cmmi..iii

M

6

Total'

current US dollars)

Average

88

Eaporh by region

7

7

5

7

4

2

9

0

counir

4

ountries

2

Import* tiy region

2

8

5

5

5

0

6

pMM

5

4

1

2

CO

i

HI

Continued)

USSR: Estimated Hard Currency Balance of Payments (million current. US dollars)

Correnl account balance

Meicl-aeO'* trade balanca.

Nci intcnl

Other inwsibloi and transfers

Capital account balance

Clianness deM -

Official wbi Ccnmccjl atobi

Net chanw in ainctseMetn bandit J

estimatedrate offect

Nel credis lo LOCs

ales

net erroii and omissions 1

975

760

5

0

0

7

B70- 0

0

0

0

nuMnm

iv

SI

Continued)

USSR: Estimated Hard Currency Debt to tbe West (billion current US dollars)

debi

0

7

dub!

8

6

end government-

backed debt1

1

in Western banks

3

4

debt

nemmuw.

'cftiiiMicui awnin avm

USSR: Selected Indicators of Agricultural Output

Value ol output" (billion rubles)

4

pioduetion (million metric tons)

Gram*

8

2

8

6

6

5

7

beets

3

8

tend

3

5

9

(billion)

7

/ i

5

7

6

SH ol Iral Mill I. illWMl'l 'ulcrUKHnf

Original document.

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