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USSR: Sharply Higher Budget Deficits Threaten Perestroyka


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USSR: Sharply Higher Budget Deficits Threaten Perestroyka

USSR: Sharply Higher Budget Deficits Threaten Perestroyka

Information oioilaHe atsed in thii repoii

Soviet state budget deficit has increased dramatically durine the last three years. We estimates deficit, six limes the level recordedas equivalent toercent of Soviet GNP. (For comparison, the highest US Government budget deficitercent of US GNP in fiscal)

is essentially financing its deficits by printing money, and the resulting inflationary pressures are clearly visible. Growth of wages almost doubled in the first halfhile annual increases in savings deposits have doubled5 and have continued to surgehere hasarked 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 hascurrent attempts to spur state worker productivity by higher wages and salaries.

General Secretary Gorbachev's policies are partly responsible for the deficit rise:

spending has risen substantiallyesult of large boasts in state investment and the rise in total state subsidies on food and livestock products.

Receipts from stiff sales taxes on alcoholic beverages areesult of the regime's antialcohol program.

Revenues from the large markups imposed on the retail prices of imported food and consumer goods have fallen sharplyesult of the cutback in such imports.

from enterprise profit taxes grew slowly last year because of production problems due to retooling, reforms, and quality control measures.

Moscow hasumber of steps over the last year lo absorb excess purchasing power or to manage the resulting shortages of goods and services, including rationing and issuanceew series of savings bonds. These policies, however, do not address the budget deficit itself and thus ie-nore the source of the purchasing power problem.


Leadership concern over the issue seems to be mounting. The General Secretary first noted stresses in the state budeet7 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 toh Partyin8 that the stale budget has been in deficit for many years and that its current level reflects in part "our mistakes."

Gorbachevide range of policy options available for bringing the deficit under control, but they basically involve either cutting spending or increasing state revenues:

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 toajor impact on the budget deficit is unlikely. Similarly, state investment outlays could beemedy suggested by Gorbachev in his8 speech to the party leadership. Although investment requirements remain high in energy and other critical sectors, potentially large savings are available through hailing low-priorily projects and eliminating waste.

tax ratesossibility, particularly in the context of increased wage differentiation and the expansion of private-sector activities. But the increases would have to be large toent in the deficit, and they would have their own disincentive effects. Moscow is considering relaxing the aniialcohol campaign because increased slate 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.


A currency revaluation (forew ruble forld 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 slatecurrency reform would not solve the budget imbalance.

Only large-scale imports of consumer goods or relaxing the aniialcohol 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 orears hence the Soviel Union would have touch larger foreign debt with little to show for it. And Moscow is reluctant to ease the aniialcohol 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, theis 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.


ft. If.


Deficit Balloons Under Gorbachev

Spending Surges


Budget Plan: No Relief in Sight

Creation Finances the Deficit

on Prices. Shortages, and Savings



Savings Increase

Soviel Recognition or the Problem




Policy Measures So Far



Role for Collective Farm Markets


Private Business

of Continued Inaction

Diversions From the Srale Sector



Workers* Incentives

Reform Constrained


s upiions

Removal of Subsidies

Sales of Consumer Goods

Scopeusing Soviel otficial dala and slalemenls of Soviel officials and

economists, this paper documents the existence of sharply higher slate budget deficits in the Soviet Union thai are being financedarge extent by money creation, Wc arc confident lhat the deficit has increased greatly in the last two to three years, but are less sure about its exact size forreasons:

Moscow traditionally has treated many elements of government finance as slate secrets. For the purpose of estimating the budget deficit, the mosi important information gaps are on the revenue side. Moscow docs notull breakdown of revenues, and, allhough 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 analysis agree that one major source of state revenue missing in ihe official breakdown is revenue from foreign trade. We have made estimales of such revenue based on the best available Western information. Nevertheless, wc could be underestimating ii by perhapsercent, orillion rubles. Our eslimates 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 scon see an improvement in lhe availability of official financial statistics.8 Soviet newspaper article gave the first hints of Soviet estimates of the deficit,ange ofoillion rubles. This range encompasses our estimate8 and suggests we are close to lhe mark.

Western analysis of Soviel budgets and their financial implicationsong history. Some of the more recent treatments of this area of the Soviet economy include: Igor Birman. Secret Incomes of the Soviet Slate Budgetaymond Hutchings, The Sovietames R. Millar "Financing the Soviet Effort in Worldoviet Studies; and Mark Harrison. "The USSR State Budget Deficit Under Lateconomics of Planning,


USSR: Sharply Highcr lludjtct Ikli. lis Threaten Perestroyka

.all of our radical reforms are doomed to failure if we are unable to realise success in our financial policies.

Vladimir It'teh Unin Il1

Budget Deficit Balloon* Under Gorbacho

General Secretary Gorbachevs policy of greatlyslate spending on invesimeni. coupled wilh the tax losses from his antialcohol campaign, has intensified other negative fiscal tiends and produced large budget deficits. Indeed, we estimate that the Soviet state budget deficit increased fromillion rubles4 percent of Soviet GNP) loillion rubies4 perceni of GNP)ndn contrast, lhe peak US Government ckbcil in fiscal68 billionercent of US GNP Relative to GNP. the Sovietoughly two limes ihe size of the peak US deficit1

Stale Spending Some*

General Secretary Gorbachev assumed power ir5 in time to push for faster invesimeni growth inh rive-Year Plan (FYPk then being drafted He did no: have an easy time convincingBanners to accept hit piogtam, suggestingey believed his investment objectives would push ihc economy beyond in capabilities Nonclhclcss. lie wun out. Accordiiin toI', budgetary outlays on

ill* iMftt'ew iV Iwtiei delicti as lhe amouM revenue.service <tec| asditiereloiebe nnawed lh-otiBi ,o.xnthe percent ice

ofC.Nl' arc roughder.vey rdfumni CIA eM. mates ot

Seel ONf in Minin wreeui(equaleneni 'TVSovm PBMitconwbiUicd bvSft BkM mwncwn adi*cibe <c- [fibe*wd localA iim.MnSkcd Siaieiaewde>oM. iN led*.ji dewta nJV) tal aho ibe twaMs nm bv Ibe JOOSWIM

Estimating the Budget Deficit

Soviet official budgets almost Invariablyurplus because, by Soviet convention, short-term loans from the Slate Bank (which are the equivalent of printing money) are countedevenue.the officially reported surpluses have Utile economic or financial meaning and are extremely misleading concerning the extent of moneyoviet economist acknowledged this7 interview in Izveatiya, stating: "In my opinion, the formationgndicant share of budgetusint short-term loans from Ihe Stale Bank was intended to ensure lhe deficit free functioning of the state budget.esult, the budget no longer reflected ike true slate of affairs in the national economy."

Our estimates of Soviet state budget deficits are basedomplete aeeommimg of ordinary budget revenues 'noedoani) (seessemlally

We assumed Sonet official dala on lotal slate spending are accurate

We calculated total Soviet ordinary revenues using official data on mx revenues and estimates of stoic revenue from foreign trade 'jee appendix B)

We saltultitcd the deficit asjhe difference between total spending -ind lotal ordinary revenues

The Act uncertainly in ihe calculations is lheOfforeign trade. We believe,

however, thai thci are accurate enough to reflect titbsianiial ehauget. Moreover, comparing theof such revenue)7ecline Id II billion rubles, which it roughly const' lent kii'i CofwavAaVj imftwifH thai Such revenue fellillion rubley

invesimeni were tougeercenillhough followed by much smaller average annual jncrcascs during theet^eff).

Sovict planners were probably concerned aboul ihc budget-busting implications of Gorbachev'spush, since other budgci commitments were not relaxed:

Under Brezhnev's Food Program, procurement prices paid to farms were raisedince retail prices for the most part were not raised, unit subsidies increased. But higher unit subsidies, coupled with increased meat and food production, have greatly increased the burden of thison the state budget. State appropriations for the subsidy of food prices increased fromillion rubles8 percent of state expenditures) toillion rublesercent of stateaccordingoviet agricultural official.

We estimate defense expenditures also have been increasingerhaps reflecting the un-cvenness in weapons procurement cycles, defense spending has been driven by procurement of such major slrategic systems as the new Blackjackand the Typhoon and Delta IV nuclear-powered ballistic missile submarines.

Budget spending on social-cultural measureshealth services, pensions! increasedillion rubles per year6 and


certainly unanticipated, thecost the stateillion rubles, according8 Politburo announcement.

Consequently, given the leadership's decision to push investment spending at all costs, total government spending roseecordillion rubles6 and by anotherillion rubles7

mi ivta '

Revenue Shortfall*

Meanwhile. Soviet stale revenues have had toumber of major impacts that have held growth of revenues67 to lessillion rubles:

5 the Soviets increatingly countedefty indirect tax on retail alcohol tales to generate substantial budget revenues,a/or impact of tbe amulet*hd campaign has beca to cut this inflow by roughly one-fourth.

Planning mistakes, retooling, implementation ofand establishmentew quality control system disrupted industrial performancelowing growih of revenue from enterprise profit taxes. In lhe context of discussing strains on the siatc budgciinance Minister Gosiev remarked in his speech on8 budgethat the machine-building, petrochemicals, and light-industry sector* all had failed to meet their profit targetst7.

Tbe collapse in world oil prices in6 ledharp fall in slate revenue from foreign trade as hard currency oil exports fell from an average ofillion during theo justillion6 (seeoreover, Moscow's decision to reduce consumer goodsbyercent that year contributedto the overall fall in state revenue from foreign trade,

udget Plan: No Relief in Sight

According to the current budget plan, total state spending is toillion rublesowever, in line with Gorbachev's new emphasis on thespending on "social-cultural measures"science, and health care) is toincrease ofillionpparently finally recognizing its tight revenue constraint,plans to cut spending for "financing the national economy" (capital investment, capital repair,circulating capital, and subsidies)illion rubles. This would be the first time in overears that this spending category actually declined.

On the revenue side. Finance Minister Gostev said in7 that8 budgeteduction in foreign trade revenue. Turnover tax receipts also are scheduled to fall (compared with7ostev stated, "Income is builteallhierfrom the sale of alcoholic beverages is reduced5 billionhe Finance Minister did not make clear ho* ihese Shortfalls,wilh the planned8 budget deficit of someillion rubles, would be made up. His vagueness ishowever, since wc believe the revenue Shortfall will be made up by money creation.


USSR: Sources of Finance of tbe State Budget Deficit




socicm of finance

bono-mi (bond



borrowing from ihe Suit Bant (saving* receipt*)


other sbori-term borrowing ftom the.



Source Acocndi* A, table S.

means of finance. Bul sales of mass subscription bonds were stopped8 because of theconcern about rising debt service charges.

The government's large levels of borrowing from lhe State Bank6 are equivalent to injecting like amounts of money into the economy and therefore arc inflationary (seche money creation takes place when the government uses these loans to pay for pensions, teachers' salaries, military pay andand otherhile taxes and sales of long-term government bonds result in reductions of consumers* purchasing power, government loans from lhe State Bank effectively result in many more rubles chasing roughly the same amount of consumer goods and services.

Creation Finances the Deficit

By necessity, (he large deficits6 have had to be met by government borrowing from the Stale Bank (seen the past, Moscow also relied on large-scale sales of long-term bonds to ihc populaiion as a

'The inftilions') impact ufthese money supply increisei panly depend* co ho- fji!urned oier (ihe veloeit) of money) The Mmistiy of Finance hM wmeCOnUOlthe rale of tpeMlisig u( enlerptisej aid (Km could reduce moneyor example, spending onrocurement or tuier new taciorietncome; foiand manager*lc tot producingoodi and services.

annual increasepcrcenlSSercenthe state science budget, hnweier. it believed toarge portion of military and Civilian icscaicli Ihm. mmc of ihcrending on (CCitil-cultural measu-es may be ford mvctifiKM

Monetary Expansion in the USSR

Soviet State Bank IGosbankf maintains and monitors the accounts of the governmenttate enteifasRand farms, and the population. The bank takes in cosh from state retail stores and issues cash to state enterprises for payments of wages- The bank debits and credits the accounts of staleand 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 theIts liabilities largely consist of the deposits of the Treasury, enterprises, and the population.

The Treasury lakes 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 theof ihe payees or, as in the case of pensions, pays out cash.

When stale revenues are less than expenditures. Gosbank makes short-term loans lo the government lhat are then credited to the government's account.

The government can then pay its bills forof weapons, pensions, education expenditures, and invesimeni fust as If lhe money came from lax revenues. Gosbank's balance sheet Is undisturbed by the transactions: the increase in its short-term loans to lhe government (an asset) Is exactly duplicated by an increase in liabilities (some combination ofcash in circulation and deposits af enterprises and theoney has been created from thin air.

A portion of the short-term loans used by theto cover its deficit is balanced by additions to the population's savings accounts. The populations willingness to increase Us savings depositsix of factors: interest ratesercent 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 lhe inflationary pressures of government deficit financing on the consumer sector. On the Other hand, the population's accumulated savings accounts represem an enormous purchasing power overhang ovtr the longer term, since savings are subject io immediate withdrawal by iheir owners.

oo Prices, Shortages, and Saiings

The impact of rapid monetary expansion Onpurchasing power is confirmed by recent trends in prices, shortages, and savings, which indicate rising inflationary pressures.

Prices Increase

Evidence on Soviet retail pricesarked acceleration5 (seellhough Soviet official price indexes have long been criticiwd by both Soviet and Wesiern economists as understating actual price changes, recent data suggest the official retail price indexercent per year6 and

lmost double theercent per year reported. Moreover. CIA's estimates of inflation in retail prices aho show an acceleration6ercent comparedercent per year.

Similar trends arc evident in collective farm market (CFM> prices. Official Soviet data on prices in CFMsities suggest prices roseercent7 contrasted with an annual averageercent


USSR: Selected Measures*wW


it retail prices




farm itiPitxet prices




yMH>SSSIt (tirirmtXtr referred loet A'siranori (oryein

br comparing Sarin data oa retaJ talc*erars nil tBTenKrwhfoauaat ttraaa.

' The decline in collective (aim mirVcl prices6 may reflect large supply ineieaies in aot good iioaing condilieni, ai wellit ely lime lag between the increaseudge) driicn thai year aid the mulling cipaiuion uf moneyated on coIIccDtc bran marlei pnen lorcigiunl *i'rserkrt thamef tboec

iuMk laauiritf.ISttL g> 61

) aa cosstpartd

estimates using toafthoi da In

. Tbe official plan fulfillroeni report for7are reference to higher prices in CFMs

esult of shortages of potatoes, fruit and wgrtables. meal, and butler in the tradeigh prices fere established and are bring maintained in lhe kolkhoz markets atimes higher than state retail prices

Despite improvements in meat supplies6rices of meat in Moscow's collective farm markets werecrcenl higher in7 than in5 (see figure ii- Moreover, lhe plan fulfillment report for8 again made reference to rising prices in collective farm markets, indicating theyercent higher than in the same period

The absence of free markets for industrial goods and servicei as well as lack of information concerning tbe client of shortages make it very hard to determine whether inflationary pressures have risen in thenoncash producer goods and services sector of the Soviet economy. Wc expect, however, eventually to see evidence such as lhe bidding up of workers'ncreased prices of machinery and other goods,hoarding of industrial materials, and declines in producllready, according to official statistics, average monthly wagesduringn contrast, in the first halfhe increase wasercent.

Shortagts Intensity

Although the Soviet press almost invariably blames shortages in state stores on supply problems, current shortages probably reflect increases in effectiveas the money supply has grownn Ihc first instance, consumers' purchases of state goods increased. Even more important, store employee! and others wilh access probably hHve increased their claims on state goods (whether through theft or purchase at low official prices) for resale in the black market.

'IA contractor! maarchon nSalion <it onVUI Soviet imcitmeni statistics strongly auggesr tbe presence nfinflationary tendencies in the investment sector ot theProducers are able tu meel prediction urged throughincreases and cuttcencrt aim plentiful funds are Billing io pay pirmmmi to obtain producer durable (code thai areihcelanicoUrtyso this InRaUnu') imxupem are set hi new and iinters trade itiachiae* vtHch.e carn ana*large

.1 itS, -m

f ihe annul rale e* inflation In MrteiMwM ranged up toercent inercent.ercent.

'Two other factors, also have contributed to the currenl ihorlign rim. Mmoow cut back consumer tcods import* byillion iuMciecond, the aniialeolvt

hai Cauwd di ill Iso abaft some ol

peaer fraas vodka is other goods Hoacacr.or hairy ae havenajar saWi tine* soda* eoataaieri areinch -rati incUvd tossicniacs of hnrncbnra rather than piirduics of more land and clothes.

Figure 3

Moscow: Colleclive Farm Market Prices of Selected Goods '

pei kilogram



arc lor purchases made In Muttonugusi oi Sepiembeeeh year.

evidence suggests thai consumerof shortagesariety of goods havemarkedlyhen money expansion increased dramatically:

A study conducted by the Ministry of Trade's research instiiutc and described in the Sovietd naicd ihai sbortaecs of tooihpastc. women's rjanty liose. lotions, cau dc loilc-lc, sugar, cassettes, and batteries "broke records for being in short supply" last year.

Food shortages in particular appear toV. In his8 speech to the Collective latin Congress, Gorbachev said that the Central Committee "is flooded with lettersabout shortages of livestock products in many of the country's regions."

Letters in the central press complaining ofshortages of fruits and vegetables were also more frequent

7 Plan Fulfillment report (published in latelsoitany of woes implying shortages may have increased:

ui the population's Incomes increasedthan trade turnover and the consumption fund, and there was coiuequemly ah increase in unsatisfied demand.

An unsatisfactory ittuation developed in the >upply of potatoes, fruits and vegetables for the population, and ihetr range and quality often fail to Satisfy the population's demands

At the tame time, ihe 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. Theis aggravated hy the imbalance between demand and supply in terms of range and quality


arious organisations concerned wilh Ihr allocation of housing had registered and had on Iheir lisisillion families and individuals walling for belter housing

forced Satifttt Increase

Some Soviet and Western economists believeubstantial share of Soviet savings arc "forced" in the seme that consumers save because desired good* and services arc not available. They view the large stock of savings as an indication of repressed one Soviet economist, the research arm of the Ministry of Trade estimales that such deferred demand amountsillionbout one-quarter of total savings deposits

Soviet savers added record amounts to their savings deposits. The averageavings per year4 billion rubles In contrast, additionsndillion rublesespectively Through the first halfavings increased IJ billion rubles, implying an annual raw ofillion rubles. Some of the increased pent-up demand of Soviet consumers resulting from inflationarypiobably is being absorbed through increases in forced saving

Soviet dliKfis alsoortion of theirassets in the form of cash boards. Both Western and Soviet analysts have pointed to the pnenomenor of large holding* of cash "under the mattress" as an indication of repressed inflation* Our estimates of rapid money expansion5 suggest ihal caifi hoards probably have increased substantially over (hi last two yean.

Increased Soviet Recognition of the Problem leadership Concern

The General Secretaryseverely ertbeuedpolicy and performance undoo ihe Uie seventies and lhe early eightieseriod ofroctitis situation,eriod of growing contradict urns In his speech to

men) ml; . - . i AfinSriyinM "HnTiei

fiits of money nreilinn lubleti* the fctinkvliontttciici" He rep ied. "tioe, more ur Im "

the party leadership inhe Generalbroadened his critique to Include the state budget:

Take lhe state budget. Everything lookedon the surface Expenditures were covered by revenues, but how was this achieved? Sotrowth in the efficiency of theeconomy, 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 statethrough high taxes on alcoholic beverages und 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 inuggesting that without Ihc effect of rising world oil prices and increased alcohol sales economic growth would have been much lower (seen this same speech, he concluded that "tbe country's economy has come upery terms financialhaiuch larger stale budget deficit. For example, he suied.

esult of reducing the sale of alcohol, in the last three years the state hasevenue shortfall of more thanillion rubles In addition lo ihts. in comparisonevenue7 from domestic sales of import ed goods, the purchase .ofwhich we have been forced to limit duehortage of hard currency, fellillion rubles

Prime Minister Ryzhkov in his8 speech to the Siprcmc Soviet indicated thai "growing cash-backed demand of the population" remains an acute problem, adding:

The disparity between the Income of the workpeople and their opportunities lo use this income to buy goods f| Increasing. Unsatisfied demand is growing and lhat engenders the occurrenc? of inflationary processes In money circulation.

Gorbachev's Statement oa National Income: Justifying Slow Growth7

GoJ^otfev estimated in his February plenum speech that the average annual increment in Soviet national income would have declined in thef the influence of higher world oil prices and accelerated domestic retail sales of alcohol were disregarded. In doing so, he ratcheted up the contrast betweenperformance in the Brezhnev "stagnation" period and performance under his tenure. He Is saying in effect lhat lhe Soviet economy was on the way to decline in Iheut 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 Gorbachevs own policiesetter light. His amialcoholand olher 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 incomey telling the Party leaders at the February' plenum that the average annual increment in national income would have declined in theut 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 Brezhnevs economic performance only after netting out the impact of Increased alcohol sales and wind-falLaroSfS from oil exports. As Gorbachev states ai the endof this part of his speech. "This Is the real picture, comrades. Only now is the economyto growealthy basis."

In an offhanded way, he lied ihe purchasing dowct growth problem lo budget stresses, remarkingneglected financial situation" existed at the start ofh Five-Year Plannd that "It is notavorable state evenpecifically, he blamed state subsidies to loss-making enterprises and the decline in world oil prices for the current financial

I- cononml Statement*

The leadership's willingness to address the stateissue is paralleled by increased openness on the part of Sovietor example, in an article published last September, Oleg Bogomolov (head of the Institute of the Economics of the World Socialist System) hinted at the existenceudgci deficit when he blamed "the deficit in the state bank cash balance"ajor cause of inflation.

Nikolay Shmelev. perhaps the most provocativeeconomist, provides the most graphic discussion so far of the budget deficit and its causes and effects in the8 issue of A'ovyy mir. He writes:

Having handed mer income from alcohol to the home distiller, the stale has nt the last two yearsrastic exacerbation of thein the budget, in which the deficit is today covered by that supremely dangerous,mint.

Shmelev returns to (he problem of the budgetumber of times in this important article:

requires increased governmentbut traditional state revenues arc not even sufficient to cover "today's gap In Ihe budget."

financial system is "fundamentally based on largely inflationary methods of finance."

borrowing is being extended in an "unhealthy, covert

Nontraditional means of raising slate revenues should be considered such as bond sales and foreign borrowing.

State expenditure* on investment should be reduced wiih enterprises, investing more from their own incomes. Subsidies of loss-making enterprises should be stopped. But Ihc option of reducing defense spendingeparate question."

Beyond suggesting that the budget deficit has grown subtantially, Shmelev does not provide numerical estimates of its current sire or increases over time.


Official Acknowledgement

In laic May, Pravda published lhe proposals io be considered at ihc June pany conference Included in ibe proposals was the following sentence:

The com modi ly- money Imbalance and stale bud gel deficit art having on advent effect on current produciion and the course of the reform itself.

This is one of the few times in the post-war period that Moscow has officially acknowledgedudget deficit and indicates the seriousness of the problem In early June, Ihc Soviet pressoundiable discussion on the proposals that noted the past practice of masking Ihc actual budget position:

Our readers haveery important thing from ihr theses for lhe first lime: our slate budgeieficit. However, each year the Supreme Sovieleport on budgei implementation in which income exceedsThis recursyear. Of course,iti* thai ihr real situation is different. But who is fooling whom'

Then, in late June. Genera! Secretary Gorbachev repcetcd at the party conference that the state budget has been in ckacil for many

Now that lhe delicti has been acknowledged ofticial-ly. in effect calling into question official budget statistics, we may sec some substantial revisions in such data in the near future

Limited Policy Measures So Far

Moscow hasumber of mem over the last couple of yearsook up cuccss purchasing power or to otherwise manage the resulting shortages of goods and services. These policies, however, do not address the budgei deficit luclf, and thus ignore the source of tbe purchasing power problem.


ather quiet manner, Moscow has grantedgovernments greater authority to implementAs reportedatvian radio program inhe USSR Council of Ministers granted the IS republics io7 the right tofix norms for rationed goods. There were numerous reports of rationingariety of foodsarly inravda noted that rationing has been introduced in eight republics. In the RSFSR, for example, rationing is being used inblasls. krays, and autonomous republics for the sale of meat, inor the sate of butter, and in S3 for the sale of sugar.

Savings Bonds

Asoviet citizen* canew scries of savings bonds redeemable aficrears, paying an interest rateercent. However, Ihe Soviel press indicaies that the public has shown little interest in purchasing them io date and few have been sold.


Asoviet citizens mayew form of insurance to supplement state old-age pensions. This appears to be another measure meant to absorb extra rubles in the hands of ibe populace. The State Insurance Agency ifiossirakh) has also been pushing overall insurance sales (life, accident,ccording to ihc latest official data, the population's payments of premiums grew byercent

Charity Funds

oviet citizens have increasingly been pressured io contribute to newly formed "socialist" charitydevelopmenl of culture, for the victims of Chernobyl', for the care of orphans, and for improving health care.

Increased Role for Collective tana6 decree on management of the igro-iodutirial sector allows farms to sell up toercent of theiregetables lo collective farm markets ana*the Tsentrosoyur.predominantly rural retail trade network, where prices are higher lhan in slate stores. By selling less instate stores and more through the other channels where prices arc higher, (he government *ould raise the average price of food and thereby absorb cicess purchasing power. This measure has had little success so far. however: farms continue to marketinor share of their produce through the CFMs or the rural retail trade network.


Moscow is hoping that increased construction of cooperative housing will absorb some of the excess rubles in the hands of the populace. An8 decree calls for formation of more housingassociations composed of Soviet citizens who pool their money for the const ruction andof apartment buildings. An increased role for cooperative bousing obstruction will require (he backing of state housing construction organizations, which previously have given tittle priority lo coopera-lives.

Encouraging Pmaiehe Gorbachev regime hasrogramthe development of legal private businesses operated by individuals and small groups in in effort lo satisfy consumer demand without largeNew legislation lias affirmed the legality of individuifljffrt activity and fostered theof member-run cooperatives While theof legal private business is proceeding more slowly lhan the leadership had hoped. Gorbachev continues io emphasize this program

f Continued Inaction

Moscow probably cannot stay the present course. Continued large deficits financed through monetary expansion will lead to an expansion ot Ihe secondubstantial redistribution of income from state workers to second-economy participants, greater

resource diversions, and inrowing loss of slate control of the economy. Moreover, rising prices in the second economy coupled with more empty shelves tn state stores will cut inlo tbe Irving standards of citizens on fixed incomes, including pensioners, bureaucrats, and many state workers. Workerwill weaken further and efforts to increase support for prrrtirovka could be thwarted.

Resource Diversions From tbe State Sector

Increased purchasing power of Soviet consumers does not affect produclion activity in the state sector of the economy, at least directly, in the state sector,producing consumer goods and services take iheir marching orders from ministries and otherconsumers. Prices are administered from the center and largely fulfill an accounting function rather than serveuide to production

The Soviet "secondowever, is based on private initiative responding to market demand.*in consumer purchasing power will result in some combination of higher prices and greater supply of goods and services io this sector, oftenost to the state of rising theft aod corruption

Labor. Higher prices translate into higher incomes of second-economy participants, which in turn will draw in more participants. For example, pensioners,mothers, andof whom might be employed in lhe statehave greaterio take op work in the second economy. More full-time state worker* also could be increasingly tempted to work in the second economy, even if just

' Ki Odincd heir Soviet inohrludet (heibe prime cconumi Octal ind illentl atit illegalflhcfi. ihaiioi ofitnic time cutton* it. leulc ofa: bliekn.ilei pncoi EtiinMici ol ihe i* ol Ihcvery,itrbiiiniulV St j'v

In Reuartn Imimwmta-mmrO thai bv it*Mribe*Mwn'^nbmiit*vctai ai luu |uti-nentiif to-*Mlm Irinn u< -epu-it idThn

io tlrnutiihiid af si; ivc> purchitrt hy Sonet


* time basis. Pot example, the potential to earn large incomes producing and telling moonshine has clearly drawn in much more labor into this activity One measure of thishe number offor moonshirurK Interior Minister Vlasov announced in7 that there hadrrests to far that year, as compared with less0hisoughly fourfold increase in labor supply, although some of thein arrests may reflect tighter enforcement.

Coniumer Goods. Higher prices in the secondwill tend to resultreater supply of goods and services as producers respond to greater profitSome of the supply increase will come exclusively through increased application of labor. Some of it. however, will come through increased diversions from tbe slate sector. Theft of consumer goods at the factory and throughout distribution channels, whether for own consumption or resale in the second economy,requent occurrence. Recently the Ukrainian procurator's orficc reported that0 workers were caught pilfering in tbe meat, dairy, and food industries of that republicn light industry, where the differential between stateuchorkers 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 profitexpand in the second economy. For example, aSoviet radio repot: said7 metric torn) of sugar was stolen7 partlyesult of lhe spread of "borne distillingA recent Soviet article on the second economy observed thai the main advantageprivate operator" is usually his access to shortageparts for cars, components for household equipment, Finnishand toilet bowls, construction materials, and so forth "

Weakened Workers' Incentives

Sute workers" incentives and productivity are likely to suffer when purchasing power it rising but supplies of goods and services are not. At stale siorcs, longer queues and greater shortages will result in more ^absenteeism from work, as working wives and mothers

especially struggle to ensure that food is on the table. Recently the official Literalurnaya gaieia reported lhatillion hours are spent each yearillion man-years representingercent of total annualoreover, while rubles can always be spent In the second economy on food, services, and handicraft items, longer waiting lists for such big-ticket ilems as cars, appliances, housing, and furniture could resultreater sense of futility. This will be especially iruc if such goods come lo be recognized as being rationed through non money means such as political connections

Excess purchasing power will abo underminewage reform, which is predicated on Soviet workers' wanting to earn more rubles. Under this reform, workers' wages and salaries are to increase aboutercent, but at the same time nay is to correspond much more closely to produclivily. Bul 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 analysis and many Soviet economists agree that reform of tbe price-selling mechanism is essential for the success of Gorbachev's effort to revitalize the economy. The decree on the price reform published in7 makes clear lhat one of its maior objectives is to reduce the role of state authorities in establishing prices and give greater freedom lo enterprises lo set prices throughGiven strong inflationaryowever, any relaxation of slate controls will lead lo large price increase* across the board. Reform advocates, aware that price reform rather than excess money creation would be blamed for this inflation, have culled for resolving the financial problem before relaxing state controls on prices. Gorbachev said in his partyspeech lhal resolving the deficit was afor price reform.

* Matcha tana aata not rccecscci: ibtcaieriia* aatantc il include* ikteini If tttwuei andril ai thccipuag after aorh hoars Neaethekii, una meat itate Korea are not ope* in lhe crrninii or onarge proportion nf Ihesc hcari tnuit invnhc utw>ce> Irom uorh.

: i

Price reform in China has run inlo just suchOn several occasions, price controls have been relaxed only to be tightened again when rapid price incjsusft occurred, even though rapid money supply growihey factor behind the increases.

Gorbachevs Options

Gorbachev indicated in his8 speech that "extraordinaryreform andincreased production of consumer goods andneeded to bring the "firuocial problem" under control In his July speech at theommittee plenum, the General Secretary was much more explicit, stating that9 budget and economic plan should incorporate measures, possiblyeduction 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 arc to be precededublic debate Removal of subsidies on food products could result in large savings of government expenditures. Foodalone cost the governmentillionroughly thef the current deficit Moreover, the effective price increases would devalue much of the accumulated purchasing power in savings accounts and cash hoards.

Allhough the administrative price revisionhole is supposed to be completed before ibe beginning of five-year planhe pricing decreepecific target date for the politically sensitive task of revising retail prices (reducingas it does for wholesale and procurementen the reformers have become more aware,of the political costs of increasing food prices.

The timing of the introduction of higher food prices is an especially difficult problem Removing thegradually Kerns 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 announcementolicy of gradual reductions in subsidies would set

inumber of responses by tbe populace. Hoarding would increase. Savers would start drawing out their deposits to turn them into material goods. Owners of cash boards would do the same. The result would be rampant price increases in tbe second economy, including collective farm markets, and mostly empty shelves in slate stores.

On the other hand, an overnight removal of subsidies maximizes its economic benefits (since consumers and savers have no chance to adjust) bui carries higher political risks. As reform economist Nlkolay Shmelev recently wrote: "We must not forget the lamentable experience of Poland, where,hey tried to change prices overnight, and were then forced tohe recent unrest in Poland tiedpercent increase in prices since ihe first of ihc yearointed reminder, if one was needed

Lower subsidies of industrial goods also would reduce government spending. According to ihe price reform decree, subsidies for industrial output sold to the agricultural sector are to be eliminated. I'or example, agricultural enterprises are to nay the same roles as industry for electricity, heat, und natural gas

Price increases, however, would help lhe budgci only if ihey do not result ia 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 aa 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 therole in financing investment by increasing the role of enterprises. Spending on investment representshird of lhe budget. Bul il is not clear that this measure will reduce the budget deficit, since Ihc share of state deductions from enterprise profits is lo fall also so lhat firms are able to invest more.

Increased Salesinsumer Good*

Increased sales of certain consumer goods could raise substantia! taxuch manufacturedgoods as appliances, auiomobdes, clothing, and atrhoes carry high tax rates, and thus increasedand 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 tbe extent they earn high incomes and meet their tax obligations.

The quickest step Moscow could take to raisethrough increased consumer goods production would be to back ofT the aniialcohol campaign and permit legal sales of alcoholic beverages toay Ixvesiiya article calledeassessment of the aniialcohol campaign, stating lhat the grumbling it caused was more dangerous than drunkenness

Moscow could use its high credit raling in the West to finance consumer good imports. Because of lhe large price markups on domestic sales of imported goods,olicy could cam the state large revenue*amounts equalimes the values of the loans used to finance the imports. Economist Shmclcv esiimatcd in his8 Novyy mir article that the import of consumer goods valued2 billion would cover the loss in state revenues from the reduction in vodka sales

Spending Cuts on Defease and Imminent

Since the7 plenum, several high-ranking political and military spokesmen have statedhe Soviet Union plans to reduce spending on cnie. For example, in an7 interviewpanish reporter. Gen. Yuriy Lebedcv said Thai, although lhe Soviets must be careful noi to ignore the armed forces' needs, "ocrenrtciess. our planseduction of military spending in order

umber of Soviet uUVwIs andhue proposed increased prndaciion of couturier goods lad unices abohehe parclwiaag power overhang GMca Ihc km Male prices ol wary aeaaii good* sad Mmou. theincrease*quate iunpt>demand "mild be citraordrniry ind essentially impractical Tin- proposal Hluiiriiei lhe Soviel predilic-lionhi on Ihe iunity -iJc of mortal imbalance* rathct than demand and Ihe ivtt of prices

to allocate the money to otherhile this statement and similar ones couldropaganda motive, ihey might also reflect the budget situation.

Reduced outlays on investment would also trim the budget deficit, but it is not clear which areas couldto be cut back:

of energy production requires continued large invesiments-

ey element of the modernization program, Ibe machine-building industry is scheduled to receive large amounts of investment through the rest of the five-year plan.

The rest of heavy industry and transportation all areeed of large investments for moderrtiiation. new projects, and upkeep of existing planl and equipment.

Gorbachev's new emphasis on the consumer implies large investment flows to both housing andproducing consumer goods and services.

The most likely short-term target for reductions would be nonpriorily sectors in industry and possibly8 Kommunlsi article hinls strongly that Moscow is considering substantialof irivesimeni in agricultural machinery and land reclamation Neglect of industrial sectors for moreouple of years mighl produceMoreover, the economy is structured lolarge amounts of investmenl goods. Anyreduction in investment spending would imply shelling down some of heavy industry

Currency Reform

Gorbachev may need tourrency reform to take care of the problem of excess purchasing power, although by itselfeform would noi help the achat As in the case of removing consumerurrency reform would have to beovernight so. that consumers and savers could not take evasive actions that would fesull in large increases in demand for goods.

Currency reform is not unprecedented in the Soviel Union. The inflation in World War II greatlycollective farm markel prices, resulting in

lame cash accumulations by peasants. Concern about the resulting pent-up demand caused Moscow tourrency reform on7 (with nohe reform consisted of the following elements:

New currency was issuedate of one new ruble told ones which had the effect of devaluing cash holdingsactor ofor to one-tenth their previous value).

State bonds were converted at an exchange ratend thus lost two-thirds of their value.

Savings accounts lessubles wereat 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 aconfiscation of the wealth of peasants.

According to Shmelev. currency reformhot topic of discussion" amone Soviet economists today. In his most recent Novyy nttr article, moreover, he points out lhat "Strong rumors arc circulatingossible monetary reform and theroportion of investments in savingsoank 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 sevetal years frequently pointed out ihc serious nature of Soviet economic and financial problems, even at times suggestingrisis situation existed. Politically this probablyseful lactic for justifying the many policy shifts, reforms, and other changes Gorbachev has initiated. However, there isone of real concern in many of the comments, which is reflected in the hurried and heedless nature of many ofs initiatives.

However, the rush to put new policies in place has if anything exacerbated the economy's problems. Such key initiatives as sharply increased uitolment and tbe aniialcohol campaign not only have failed tokey objectives, bul also have contributed to the drastic increases in ihc state budget deficit and money creation. The cost of living is higher, shortages have intensified,roceedingnail'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, justime when he needs as much political support as he can garner. Indeed, the leadership apparently hasecision to do more for the consumer quicklyeans of obtaining the population's backing forThis decision in turn probably means that consumer subsidies will not be reduced soon, despite the large potential this offers for reducing lhe deficit,the sametaxes likely to be raised.

Large-scale imports of consumer goods and relaxing lhe antialcohol campaign offer Moscow opportunities to address the budget deficit without gouging an important interest group. Both steps are underin 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, imparts of invesimeni goods do not help resolve the immediate problem of the budget deficit and Soviet conservatism on borrowing for currentmay 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, il could lead to in flat ion much worse than the Soviets havein the postwar era.

Appendix A

Key Tables

tftur info*nuikm coma from published anddata from the Center for International(formerly the Foreign Demographic Analysis Division) of the United States Depattment ofvarious issues of the annual Soviet economic and foreign trade handbooks [Narodnoyt kko-lyaystvo SSSR and Vneshnyayahefive year statistical budgethe taws on the stale budget, and the annual budgei speeches of Ihc Soviet Minister of Finance to the Supreme Soviet The analytical framework behind the tables follows the methodology developed by Mark Harrison in his article, "Tbe USSR Slate Budgeiteapital Formation, Govcrnmcniand Monetary Growth" in Seonomws of Planning,J*)-



-1 *


> B

Sill 2

- jj ^




, Iii



Appendix B

Revenue From Foreign Trade

Slate revenue from foreignot completely understood by Westernimplifyingthe mechanitm teems to work in tbe fcrfiovirtg way:

Soviet trade authorities try to keep exports and imports roughly in balance in termi of foreign currencies (or. what amounts to the tame thing, in terms of "foreign trade" rubles).

Moscow prices Imports much higher domestically on average than what it pays for Ihem In foreign markets. Accordingly, the value of imports inrubles is now about twice what it is in foreign trade rubles.

On the other hand, domestic prices for capons on average are set lower than foreign trade prices. Exports in foreign trade rubles are now aboutoercent higher than in domestic rubles.

" For more details,rentotMitty. FXinriilr Value oll'imrnt of Commerce.ii. UK 30

The surplus obtained by selling imports to Soviel consumers and enterprises at high domestic prices, and selling exports at high world prices, constilutes the revenue from foreign trade. The Center for International ResearchS Bureau of the Census, estimates that total revenue from foreign trade7 billion rublesrercent of estimated current budget revenues for that year. Consumer goods imports stand outource of ihis surplus because their domestic prices arehigher than foreign trade prices. For example, according to CIR estimates, textile and apparel imports were pricedimes their foreign trade prices

Appendix C

Official Balance as an Indicator of the Estimated Deficit

rSoviel official budget data almost invariablymall budget surplus every year. While this surplus clearly is misleading concerning the true relationship between current government revenues andat the same time it does vary somewhat from year lo year. Harrison, in his study of trends in the state budge!. carriedtatistical analysis lhat showed that his estimates of the budget deficit were strongly related to the officialn particular, he found that increases in lhe official surplut were slrongly indicative of reductions in the actual deficit.

Wc carriedimilar analysis for Ihcsing our estimates of the budge! deficit and Soviel data on the official budget surplus. The regression results) and the scatter diagram (figurerc consistent with Harrison's findingignificant statistical relationship between the deficit and the official surplus.

" Murk Harrison. "The USSR Suit Hudeelsi) Mor, etarrEcoicmio ol Planniw.M

Figure 4

USSR: FAtimated Deficit Versus

Official Surplus (Percent or stare expenditure*}

Euimated bvd/il deficit



Rcgieuon line


Off.lie! trudge! ru/plui

egression Resulls

Key to Symbols

estimated budget Otltcil as pcrcenl of line eipeno lyiv

(finci ia)

X *> Soviet olhcitl bvdgcf *uipltrt as pcrcciii afwjn cipcrrfi

lurct (deit-xd from data in thejnou. tv:ii*v|



Sample6 Number7


Original document.

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