SIMULATIONS OF SOVIET GROWTH OPTIONS TO 1985 (ER 79-10131)

Created: 3/1/1979

OCR scan of the original document, errors are possible

National Foreign Asset imc nt

Simulations of Soviet Growth Options5

A Research Paper

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Contents

Baseline Projection of Soviet Growth

Key

Patterns of Production and Final

Patterns of Fuels Use and

Hard Currency Trade and

Alternative Scenarios Depicting Soviet Policy

I lie: Oil

Conservation Required To Avoid Energy

Other Domestic Policy

Foreign Trade

Sensitivity of Model Results lo External

Model Simulationsix of Options and

Some General

Appendix

A Summary of the Econometric Model of the Soviet

Tables

Projected Fuel Balances for Baseline Scenario

Projected Nci Fuel ifoi Baseline Scenario

Projections Under Possible Domestic Policy Options

Assumed Paltem foi Reallocation of New Fixed Investment

Assumed Pattern (or Reallocation ofploymcnt

Moil- V.. ic Options

Model Projections Under Major Contingencies

Alternaiive VlCws nf Growth ProspectsS

inures

Scenario: Trends in Oil Production and

2.

Scenario: Projections of Net Soviet Hard Currency Exports of fuels

Scenario: Projections of Net Soviet Fxporls or Fuelshc World

Scenario- Projections of Net Soviet Exports or Fuels by Region

Scenario: Trends in Hard Currency Fxportsand Imports

Scenario: Trends in lhe Debt-to-Export Ratio and Debt Service Ratio

M-iiito V. lien Urbi Service Trigger Is Applied

:

Oil Case: Net Exports of Oil to Hard Currency Countries

Ceiling Case: New Credit Drawings

Ceiling Case: Debt Service Ratio

Comparative Projections5

Oil Use: Comparative Projections5

Hard Currency Oil Exports: Comparative Projections lliMngji

Currency Dtbi Service Ratio: Comparative ProjectionsS

Mow Diagram of the Soviet Economic Model

Model Structure

Simulations of Soviet Growth Options5

Foreword

In Soviet Economic Problems and Prospect*e argued thai lhe USSReriod oi unusuil economic strain over the nestsing costs of rawmpcrxitng energy shortages, slowing labor force growih, and sluggish productivity stuns pointedommunis slowdown in Soviet growth in.

That assessment still stands, in our view.7 paper, however,ery aggregative analytical framework and dealtelatively smalt rant of policy options that might be adopted by trie Soviet leadership in an effort tolowdown or cushion its effect* In this paper wcarge-scale macrocconamic model of the Soviet economy -put together over theider selection of the tradeoffs and contingencies that Soviet policymakers face. Analysis using the modelore integrated view of the Soviel economy than wa, possible in our earlier study aad allows ui lo cuminc explicitly issues such as ihe effects ol eacrgy dkori-falls and foreign tradethai could not be fully considered before.

1 he model is still at an early stage ol development and some of llie scenarios introduced rest on thinlytump!herefore, the present findings should not be takenevision or modification of our earlier estimate Instead, we put this paper forward to elicit discasMon and criticism both of the scenarios examined and ihc um fulnessodel based ap preach this kind of analysis

'Soil**URI6U, Ar-ill IW.fjiKliadflad

Simulations of Soviel Growth Options5

Recently CIA's macroeconomic model of Ihe Soviet economy was described at some length in anreport' Thai reporleriod ofas the next step in the development of the modelool of economic analysis. An csscniial part of learning the uses and limits of the model is Ihc application of lhe model in scenarioprocess of examining the possible effects of different policy choices and alternative external economic events on Soviet economic development. The present paper reportscries of experiments conducted to test risein theto improve the realism of Ihc scenarios run through it. Because Ihe model was specifically designed to deal with Ihe effects of energy shortfalls and foreign trade constraints, many of the scenarios Have to do with attempts to provide enough energy to the economy while keeping the foreign trade sector in reasonable shape.

Since it is convenient to analyze the implications of various scenariosommon reference point, we firstaseline case for the. The baseline projection clearlyoinl of departure, not an estimate, because it assumes that policyexample, in the allocation of manpower and investment are frozen in ihe pattern revealedn olher words, historical trends are not continued, nor do policymakers change Iheir minds when bad news accumulates.

With the baseline backdrop in hand, the paper thenumber of policy options openoviet leadership determined to prop up rales of economic growth whileiable position in trade with bard currency countries. First, we estimate Soviet growth potential if energy supplies were sufficient io meet projected demand. Then wccries of alternative domestic policies keyed to higher labor force participation rates and reallocation of manpower

a Model al ihe Swift Zto*omy. EJt ra.inooi.

and investment resources. In the foreign arena, we assess ihe impact of cutting oil exports to Eastern Europe, diverting gas exports for hard currency to domestic use in place ofoil, belt-lightening with respect to imports other than oil or grain, and the observanceeiling on the Soviet debt-service ratio. Finally, the model's response to changes in Ihc overall economic environment is tested by consideringtrends in domestic oil produciion, world oil prices, growth of Western markets for Soviet exports, and Western lending policies toward the USSR lhat arc beyond lhe control of Soviel policymakers.

The main purpose of Ihis paper is to exercise the model and gain experience in scenario analysis. Therefore, wc made no attempt to putncfii likely set of Soviel policies or external contingencies, since such an assessment goes beyond the limiicd scope of the present study. In addition, the simulations are carried out onlyaper intendedew cuti male of Soviet economic prospects would have io dealonger span of years because ihc manpower crunch becomes most severe in thend because many of the policies affecting domestic investment in ihcave most of their consequences in the second half of tbe decade

Nonetheless, ihc implications of some of the scenarios go right to Ihe heart of lhe problems confronting the Soviet leadership. The "what if analysis seems to say thai the Politburo cannot staveeduction in rates of economic growth by simply exercising lhepolicy levers under its control.

As wc argued in .Soviet Economic Problems and Prospects, curreni growth prospects reflect an unusual coincidence of faciors that sharply restrict Soviel growth potential. Demographic trends will prevent much growth in the labor force during most ofhe likely peaking of domestic oil production

1

will brineramatic shift in Ihc Soviet energy balancc. Difficulties caused by traditionalin the investment process are already being accentuated by Ihe rising capital costs of developing new sources of raw materials. The results of this analytical study of Soviet growth options simply serveeinforce our earlier assessment that the USSR is inrolonged period of shrinking growth prospects.

A Baseline Projection of Soviet Growth

The central purpose of our analysis is to suebcsi how policy shifts and uncertain events could change the picture of Soviel economic growth projected by our macrocconomelric mode! of the Soviet economy. Thiseference against which to judge the impacts of these changes. We have chosenrojection of Soviet growth5 that reflects presentsuch areas as manpower,foreign trade, energy, anda stable domestic and internationalater we will examine the impacts that changes in both policies and the economic environment would have on growth prospects.

Key Assumption*

This baseline outlook is based upon several key assumptions. They are described here in some length so that later scenarios, which often involve modifications of these assumptions, can be more easily understood.

Investment. New fixed investment is distributed among producing, sectors as it was

Fuels Production Oil production peaksillion metric tons0 and fallsillion ions' The output of gas grows at an annual rate of aboui r>ittle more than twice the rate for coal.

' Tbe auiimpiionf undcilyini Ibr baseline projectionutter of convenience Tbe? cenaintyda not reflect Ibe mow likely lei ot politic* thai So-art planneri might advocate over the neat decade

' The production figure ofill inn tnnie high end of the range Imtet nil viodoclioii in 1annulled inmOil /WutwM ER .'. Uncla.iiticd. Productioni could b; aa lawillion lorn

Defense. Personnel expenditures growear, nonpcrsonncl expenditures byslighily moreerceni. and military manpower is stable.

Total Factor Productivity. Total factor productivity (average output per unit of labor and capitalin nonagricultural producing sectors is flat overeriod, and in agriculture it rises slowly. Both assumptions are consistent with Ihe general historical record. The productivities of capital and labor taken separately vary over time based on estimated production function relationships.

Energy Allocation Policy. Hncrgy-producing sectors and public and private consumpiion are given priority when oil deliveries are insufficient to mcci ihc full demands of all users. Under all circumstances, they areercent of their nominal requirements.

Fueh Traile Net exports of oil, coal, and gas for hard currency arc the residual left from domestic produclion after domestic deliveries and net exports to Communist and other countries have beenunless import floors are reached first. Soviet exports of oil to Communist countries are assumed to increase toillion ion*0 and lo hold ai this levelhe real export/import price ofSoviet oil remain* constanthen risesear.

Currency Trade. Soviel exports tu IheWest of commodities Other than fuelsercent annually in real terms. Wcalsoassumc that grain imports arc given priority in Western trade and thai ihcre isa minimum level of other hard currency imports acccpiablc to policymakers. Wc take half7 ratio of Western imports of manufaciured goods and nongrain foodstuffs to gross national product (GNP)loor below which such imports arc nm allowed to fall in any single year. As for trade fniiinci'ig. new medium- and long-term credit drawings arc assumed to increaseercent per year in nominal termsercent in real terms).

Populationploymem. Thcablc-bodiedgrowsercent annuallyilh the rate declining to essentially zero5 as the demographic cfTccis ofan aging population take hold. Participation rates arc almost flat through iheenlirc period. Agriculture's share of the total labor force falls from aboutercent80 percentale of decline consistent with trends of the lastears. The distribution of the nonagricultural labor force among producing sectors is based7 sector shares.

Weather. Normal weather conditions basedon the last several decades are assumed for all years throughouteriod.'

Pattern* of Production and Final Demand

In the baselineontinuation of present Soviet policies, eventable economic environment, leads to serious economic difficulties in the. These problems are reflected in annual average projected growth rates of all major economicas follows:

admiral Outpui

il-I'lil-

million

Filed In'tMmriH

<.ii.iion

projections are sensitive to analyticalin two key areas: the linkage between energy deliveries and capital utilization, and lhe linkage between capital utilization and the utilization of labor services The baseline rcllccts midrange assumptions regarding the elasticity of capital utilization in the face

1ot io My lhal Ibcie cooditioca sic necessarily ciocficriaiiiedits for arguing thai Soviet "caiher ruUcriu "ill rei urn bySOs inrevailed* Impori of Ketem Climate C'faMgfla Produulor..n iisumpCioaor normalneither unusually Rood nor unusually bid by reeonireasonable reference fnr th it

1 The baseline protections of agricultural col put sic bunt on uOrmil weather conrliiions and measure agricultural oalput in term* ol value nfklcrl Od-lti rate* for net siy (Cultural output areraRCM-rtcn;aee nuini hichcr.

of energy shortfalls (the percentage change in active use ofa given siock of capital divided by Ihe percentage change in energy supplied loimilar analyses with alternative assumptionsange of GNP growth rates ofercentage point, with lhe midrange elasticity assumptions giving results generally in the middlee range. However, the trends remain unchanged.

The baseline also assumes that capital and labor inputs are independent, so lhat the level of labor services is maintained in Ihe face of any incremental losses in capita! uiilisation. This is an optimistic assumption lhat leads to the highest output whenever growth is constrained by energy supplies. The opposite,assumption of fixed proportions between capital and labor inputs would impose an equal penalty on both capital and labor use whenever energy is in short supply. This assumption would reduce the baseline average growth of GNPy as muchercentage point, if all other conditions were kept consiani

The annual projections suggest noteneral fall in growth rates over the entire period butharp acceleration of this trend toward the later years. This acceleration is caused in the simulation by oilinteracting with problems in financing hard currency trade. During the early part oferiod, the simulation indicates that the Soviets would bc able to afford all of their basic hard currency importalinimum level of manufactured goods, and even oil when it becomes necessary to import it from Ihe West. But, because of falling domestic oil production, rising domesticand assumed maintenance of oil exports to Eastern Europe, this situation no longer holds true in Ihe last ihrec years.

Autiiniiuon* of baseline capital ela.il icily vary amoat sectors to reflect ihe espiUl Hoe* used in each lector. Inec ion "heremec share of IQtalcaOiUl. CSpiul animationassumed io bc very sensitive lu enemy vappbet Inr uc where tiruciure* dominue tbe capital slock, wc assume lhat capial

n-.; i; li-: Mi,

1

hoke has Io be made since import needs in all ihrce areas cannol be fully mei. We assume thai hard currency oil imports will be cul back when necessary to allow full imports ofo keep imported manufactured goods at least at their assumed minimum level, and to maintain oil exports to Eastern Europe. This means that domestic oil deliveries fallercent of nominal domestic demand:

L'O

of government expenditures would rise byercent88 percent of GNP inthe assumed annual growth in defense spending ofercent is substantially above the average GNP growth of lessercenthis forces Ihc share of GNPdevotcd to private consumption to fallercent0

On the production side, industry's share in GNP rises1 percent6 percent85 at (he expense of an almost equivalent fall inhare. The underlying causes of this shift arc best seen by looking al projected patterns of average annual growih rates for labor and capital inpuls:

consequence of this forced reduction in domestic oil allocations is sharply reduced growth rates3 and beyond in all aggregates projected by thehe projected average annual rale of growih (AARGl Of CNPs thenercent, moreercentage point below the comparable figure. increases in per capita consumption could be Sustained at little moreerceni per year, only half the rate projected for the earlier period.

The baseline scenario also leads to shifts in the structure of both production and final demand. The

' Hard currency grain imports nrCvcClol by tbe model are in Ihc rinse otillion torn per yearS. which is continent with our asseSHnenl. in USSR. low Term Outlook for Grain Impels. ER,nclassified.

e rate at whichNP fall* in response solelyecrease in domedic energy deliveries is ectivaleniure enerttv elanperecnlage change in GNP which resultsirtn percentage chance in energy supply, all olher fittersnder the orximislD: auumrtiKui. of ihe baseline. This imphe* miik substitution of labor lot capital in Ihc face of energy (hoitfalls and assumes that capital uiilnatioo is cut back first in Ihc trail efficient capital .uxl in each scclur. The figure could rise teas high as0 fl under aitcrrulc assumreioea, which would simply make the deceleration in growth much sharper once the energy constraint lakes head. In naniculir. the Eiigci elasticity is (Ontisieiil with the periodic shutdown of (oil plant operations fur al' plants regardless of their relative energy efXiciencirs. W'e ilio assume throng hoiit thai ihc USSR has xiffWwol Ouihilny n> tuhvtitutehe margin. To Ihc client thai thr, is not Ihc GNP would be reduced si ill (iiriheriven drop inergy deliveries and the elasticity could approach I.

imire

Capital

We haveallercent per year in agricultural employment. Superimposed on Otherand labor forcegrowth in the able-bodied population, stable participationstill leadsarked deceleration in the growth of nonagricullural employment. Capital useimilar trend. Because capital utilization rates depend on the level of energy deliveries to each sector, (he growth in active capital the gross capital stock adiustcd by the utilizationsharply with reduced oil allocation. The effect on agriculture is particularly acute because iteavy oil consumer.

The growth of active capital in nonagricultural sectors holds up much hctler because (I) these sectors rely relatively more on gas and coal, which arc not projected to be in short supply,nergy and fuel producing sectors in industry arcercent allocations of energy and fuel*riority basis.

Unclaimed

i ofist and Trade Dc-xtoprnenls in ihc energy sector shape much of ibe story summarized in lhe economic aggregates. These simulations assume that oil production peaks0illion tons and then falls backillion tonshe baseline projections based on thb oat pat profileteadily iisinc domestic use until the hard currency constraint is hit3n older to meet export obligations to Eastern Europe, net hard currency oil trade would have to shifttrong net capo" position0arge net import positionil imports based oa assumed foreign-exchange priorities arc insufficient to meet domestic needss the hard currency constraint5harply reduced growth in hard currency oil importser causes domestic use to fall slowly2 under the combined impact of reduced domestic production andimports. Overall Soviet net oil exports fall sharply

Table 1

USSR: Projected Fuel Balances for Baseline Scenario

Produciioe

ConvumtHioi

(nutlion marie torn)

(million metric ton*)

Ox (Mlllnr -M

m j

(million tnclnclorit) Coal (million metric land

iMcins. WHOm.

J60

>00

ut remain positiven the strength of heavy exports to Eastern Europe and the restraint imposed on hard currency imports by foreign exchange considerations.

The projected fuel balances05 under tbe baseline assumptions art shown in detail inhe model projects net oil exports lo fall fromercent of domestic produclionoercentnd toercentbe rapid rise in coal and gas exports partially offsets tbe slump in oil exports (tableet hard currency exports of oil fall substantiallyut net earnings on total trade in fuels are much more stable becauseombination cfci mo increased quantities of coal and gas exports.hough, even these factors (ail to keep net hard currency exports of fuels from fallingarge deficit position.

Over theeriod, the net value of hard currency fuel exports in the baseline case follows the general trend of net Oil exportsecause of rising fuel prices and increases in the net volume of gas and coal exports, the net value of Soviel fuel exports chances littlefter which it plummets quicklyersistent deficit level However, the influence of. growing gas and coal exports boMs tbe net hard currency trade deficit in fuels loillion

TaMa 2

USSR: Projected Net Fuel Exports for Baseline Scenario

Currrar

F

Toul

tnrussi

Ot (aaWkm satinc mm)

J4

ft

1

in

(wMmleeo,)

l*.i>

mrussi

(million flicirtciiw)

(million metric too)

"'i

II

picture lor overall Soviet fuels trade is much different in the baseline simulation (figurehe value of mi oil exports falls dramaticallynd so does Ihe value of net fuel exports. The nel volume of oil iradc5 is considerably above zero (sececause exports to Eastern Europe arc maintainedubstantia! level Nevertheless, lhe nel value of oil trade is tn deficit5 because volume traded in Ibe higher priced hard currency oil market shifts sharplyet import positron while that in the lower ririced CEMA (lhe Council or Mutual Economic Assistance) market holds steadyel export ofillionnlike oi) exports, though, net exports of total fuels level off2 in value terms because the prices and volumes of nel gas and coal exports rise strongly over lime for all regions.

' We bix jBiiowd (tut CEMA oE prices intiam brio world msrbc! lewis iMouth. reacft tnrU leek b, iben. (hi.

protectedvened

Scenario:

Projections of Net Soviet

Hard Currency Exports of Fuels

milieu ion us s

Baselinea

Projections of Net Soviet Exports of Fuels to the World

IBTT USS

90

The regional patterns of fuels trade shown inighlight the projected turnabout in hard currency trade that would result from pursuing current and announced policies for. The net value of fuel exports to Eastern Europe just aboul doubles between

hile net exports to the West fall from5 billion surplus4 billion deficit. After

et exports to Communist countries arc greater than net exports lo Ihe world, which means that nel Soviet fuels trade with non-Communist countries is in deficit

Hard Currency Trade and Finance The projected shift in nel oil trade with the West in the baseline simulationajor restructuring of hard currency trade over the next decadehe slow fall in net oil exports0 servesreak the growth in hard currency exports and.consequently, in affordable imports. Once the USSR is forced to

move fromet oil exporter toet oil importer in the hard currency arena, growth in total exports and therefore total imports reflect the underlying trends in nonoil bard currency earnings and net crcdil availability.il imports from the West would compete directly with nonoil. nongrain imports for scarce foreign exchange. The only way to maintain ihcse imports al the level assumed io be the acceptable minimum is to restrict oil imports, as Ihe break in the nel oil exports profile indicates.

lso illustrates very clearly the projected conflict in Iheetween oil and nonoil imports paid for in hard currency.he Soviels could not afford to meet oil, grain, and nonoil, nongrain import requirements simultaneously.would have to bc made, and our analysis assumes one way of making them. The trends inuggest

4

Projections of Net Soviet Exports of Fuels by Region

us s

Baselinei

Trends in Hard Currency Exports and Imports

7 US 3

M

I97B 70 SO 61 02 S3 04 nclassified

7

Ihc volume of Soviel trade wilh hard currency coun-irics is likely to grow little through lhe. The longer term prc^pecis for imports other lhan oil and grain look particularly dismal under lhe conditions of the simulation, since oil imports would displace aboul half of the current level of nongrain importsithout our assumed floor on these other imports, the situation would be even worse.

The baseline case in turnlowly rising Soviet trade imbalance with the West.hc hard currency trade deficit holds steady al about the current level. Total exports would bc essentially unchanged because the fall in nel oil exports of almost S2 billion would just aboul offset Ihe rise in nonoil exports allowed for by extrapolating recent trends. Imports would also bc ilai because flat export earnings mean little growth in import capacity. The siiuaiion would shifl during; export growth05 would then stem solely from sales of commodiiies other than oil. Although imports would fallsubsequent import growth would reflect not only growth in nonoil export earningsrowing share of credits in financing total Western imports

The fall in oil exports leadsharp rise in the debt-service and debt-to-export ratios (figurehe rise in these ratios is unavoidable with total exports stable or rising slowly and Western debt projectedccumulateteady rale. The debt-service ratio would exceedercent by ihes oil exports lo the West fall. It falls back somewhat aficr thai, bul debt service would still represent more than one-third of commodity export earningsperccntage-poinl rise above present levels. The debi-tocxportratio of medium- and long-term debt to commodity exports to theimilar paltern withharp rise in thends debt rises even in the

" llv dcbl-service and debt-too port ratios imolved Ihe uie of data lor Soviet eiport earning* in hard currency trade. In this paper, we have uted only carninet in Comirtodily irsde. which exclude* coldard Currencyd transfers Ocilning the ratios boxd on Ihc more inclusive earning! concept would lead tovalues for bothear Foi trample,he debinr.nr ratioctcem. while bawd on allliaid currency earnings, il ercent For the ilcbl ratio, comparable figures wereercent andercent

Baseline

Trends in the Debt-to-Export Ratio and Debt Service Ratio

Tlfy

79 80 81 82 03 84 nclassified

wa

face of steady export earnings, andartial recovery to more reasonable levels5 as the expert earnings situation improves somewhat.the level of hard currency debi would representtO perccnl of annual merchandise exports byullercent above recent historicalbutercent below the peak in the.

cenarios Depicting Soiiet Policy Options

The baseline simulation projects Soviet growthtatic set of policiestatic economicSince Soviet policymakers arc likely to consider policy shifts in Ihe face of the economic difficulties wc foresee, wc can use the model to estimate the improvements that mighl result. Below we explore lite

8

impact*election of domestic andrade policy options might have on the basic Soviet crowth trends we protect

The GNP Costs of OH Shortages Growth under the baseline scenario leads to major dislocations) as the Soviet economy runs upombined oilhard currency constraint. As the baseline simulation suggests, falling oil production0 would eventually force tho Soviet need for Western oil to unaffordablc levelsmports of manufactured goods from the developed West would be at minimum acceptable levels, with domestic cat deliveries still below nominal requirements. Wc can use our econometric model to estimate the economic costs of these constraints in terms of lost production.

The cost of this constraint can bc viewed as the difference between Ihc level GNP would have reached if nominal domestic oil requirements were fully met and the level projected under the constraint. Our calculations indicate that the assumed oil produawn profile casts the Soviets about lit billion rubiesercent of GNP5 when compared withGNP under full oil allocations. The average annual rate of growthouldercentage poini higher if the required allocations were achieved

Catenation Required To Avoid Energy Shortfalls

One way to interpret Ihis analysis is by hypothesizing lhe energy conservation required lo eliminate lhe energy bottleneck. The description of energ> demand in the model already reflects trends in improved efficiency that are embodied in historical data on produciion and consumption in. Simulalions Of extraordinary conservation indicate lhat ibe USSR would have lo improve energy efficiency shgitly moreercent per yearallow full oil allocations and thus avoid hitting the hard currency and oil constraints.

The impects of ihis extraordinary conservation esse on kc> economic variables aie given ineduces nominal domestic demand for all fuels. In so doing, il releases more coal and gas for export to hard currency countries and makes it possible to import more oil from tbe West to compensate for shortfalls in domestic production

Greater conservation would of course raise potential GNP and growth even further bul additionalwould be small Conservation up to (he point that prevent* shortagesig marginal impact.ould bc "high powered" conservation because il raises capital utilization rates; ihc growth incapital stock increases by an average ofercent per yearnder theconservation scenario. Conservation over and above the "high powered" conservationercent per annum would bc "low powered" conservation because it would simply free more fuels for export, lo the extent these new exports helped finance capital imports they would lead to additional increments in production. Bul this process of capital forrrution through trade occursag and is also subject to leakage of import capacity into noncapital goods. Consequently, marginal impacts on output of eonser-vationercent per year would be small

Ihis analysis also supports the position that the deceleration in Sonet growth we foresee for ihc nest decade is much moreellcction of difficulties with energy production. Removing lhe energy and subsequent hard currency constraints still leaves the projected average growth of GNPercent per year, halfercentage point below ihe comparable figurehe underlying causes of the growth slowdowneduction in the labor force growth rate, diminishing returns toa more slowly growing capital stock, and our projections of little growth in factor productivity. Energy problems simply serve lo aggravate the underlying difficulties, by reducing ihc rales of capital utilisation and accclcrai-ing downward trends already projected for

0/Aer Domestic Policy Options The Soviet leadership could certainly react to slower growth by changing ongoingthose focusing on the oVxneslic eexmceny and those centered in the foreignby instituting new one* The key Question ui whether these options wouldignificant impact on growth when compared wilh the baseline simulation.

9

lank 3

USSR: Projections Unxkr Possible Domestic Policy Options

VsriaiKmi Dmsio KotoOpt ions'

Variables

level

Conservation

Rcalkxatw,

0 (perceeii)

A H'!

1 ll.IV PilKI**!

ssa

A

ii

DruDici)50 rubles)

627

18

6

4

III* Capital Stork

AI0 (percent)

S<nercent)

I

SQ (percent)

perceni)

Oil Use

(million metric tons)

:n

< million metric turn)

Hard Currency Imports

(in'll'on mettle tons)

^

(nullion metric toos)

Net Oil FiiMirtt

>9

1)

(million metric loos)

(million metric tons)

Currene. Imports Eicluefins Kneb ind Grain

S S)

i.

7 USS)

'.

Katie

V fe^irr-aiFTtt

1

1

IJ

The difference between the value oflhe variable under Ihe fl-en policy coiion awl ill value in the baseline cue

10

To gauge lhe possible impacts of policy initiatives on growth possibilitiesc rcsimulated Soviet growth under alternative policy conditions. We have chosen to examine the effects of three domestic policy options that would piobably be open to the Soviets during this period:

Manpower. Participation rates rise by onepoint for the able-bodied population5 andercentage points for pensioners.

Defense. Military manpower is reducedalf million menonpcrsonnel defense expenditures grow alercent per ycai, half their baseline rate

Resource Reallocation. The shares of new fixed investment and employment going to the energy sectors (oil. coal, gas, and electrichemicals, machinery, transportation and communication,and industrial materials are increased gradually at the expense of investment in trade and services, consumer goods, housing, and employment in consumer goods.

We resimulated Soviet growth5 with each option separately modifying the baseline conditions. By comparing the results of these simulations with the baseline case itself wc can judge Ihe potential change in key economic variables due solely to lhe particular Option considered

Manpower policies have ihc virtue of directlya major growth bottleneck. Increments lo the able-bodied population arc established by longstanding demographic factors and respond Only very slowly to policy changes. The participation rate can be more directly manipulated through incentives andsetting retirement ages. However, Sovietrates have been among the very highest in the world and leave little room for further increases The gains assumed in the Manpower Casesuspectrequire substantial changes in incentives and regulations. Yet, ashows, the economic gains probably would be modest. Soviet GNPandwould beercent highernd growth rates would remain essentially unchanged from those achieved without the policy change*

The Defense Case reflects morepcrcent reduction in military manpower and anercent increase in Ihe civilian labor forcel alsoalving of tbe growth in Soviel nonpcrsonnel defense spending. Al the aggregate level, this defense slmdown has little perceptible impact on tbe Soviet economy The extra increment In invcsiOKnt made possible by slower growth in military claims on the ouipul of capital goods industries is very small, especially when compared with the total Soviet stock of productive capital. Therefore Iii tie extra production is available5

Of course, important sectors of the economy could still benefn from reduced competition with defense for key resources, and this could have greater potential for improving growth5 Slower defense growth does have an immediate impact on the side of final demandortion of GNP is freed to meet cn-dun needs. Protections show that an increase inof moreercent would be possible5 through the assumed reductions in the personnel and operating and maintenance ponton* of defenseand the subsequent redirection of resources.

Reallocation of labor and investment resourcesolicy option the Soviets certainly would consider. Reallocations of various kinds have been mentioned in the Soviet press, but no hard information exists on the changes, if any, thai might be in the offing The specific reallocations wc simulated are therefore purely speculative, allhough ihey do reflect ourof what might be feasible given the lime frame considered and the broad range of existing and emerging problem areasnd 5)

For the reallocations wc looked at. GNP growthncreases byercentage poiai5 is leuercent higher GNP is lower, however,0 because the value of the output lost from the sectors rosing resources is slightly more than the saluc gained from the sectors receiving extraiseflection of two factors in lhe calculations the estimated marginal products of capital and labor, and the value weights given ouiput indexes for each sector.

ll

wWti

Assumed Pattern for

Rea llocalioa of New Fixed Iniestment

Seeioi

ii'.mcd

Chinas -

)

line Change

0S-

and caramon ication

and services

35

initial ra* it rig Is

>i

good*

'S

an

no

;o

"W

n

5:

ij

28

j ai rt i

>:

41

4i

V-

Man Yean

USSR: Assumed Paltern for Reallocation Of Nona mi cultural Employment

Secior

Gunge -

in potation and communication

and service*

minimal maieiuli

goods

ie 6

USSR: Model Projections

Under Possible Foreign Trade Options

VariitKHti Due to Policy Ovi-mi '

Variable

Le.el

luporl*

Impart*

Service

ercent)

perceni)

3

0 ,ubl<i)

0 rnWe*)

Capital Stock

perceni)

ercent)

1

(million metric tons)

(million metric tnni)

12

Hard Currency Oil fcaporl*

(million metric ions)

ni.iciori*)

Oil Export*

(million metric tors)

(million meirlc tons)

Currencychidrt* TtKb andGiain

0 USS)

0 US S)

Ratio

(percent)

iffcrcoee between tbe value of the variable under tbe gntn policy coKon and ill value in ihe baseline cue

marginal impacts of extra capital and labor in the energy sectors, especially oil, are low until the oil shortages occur late in the period, but are much higher afterwards. Domestic oil deliveries are up5 in this case but arc still not enough Io meet nominal domesiic requirements. The increased oil deliveries reflect bolh extra domestic production and additional hard currency imports financed by extra gas and coal exports Because of increased fuel production, the debt-service ratio Tails substantially as exports io the Wcsi of surplus coal and gas increase while debt is fixed by assumption ai baseline levels.

Foreign Trade Options

The economic strains we project forumber of strong linkages to lhe foreign sector, especially lo bard currency trade. We therefore analyzed the possible impacts of four policy optiease foreign trade area io sec what additional flexibility these might provide the Soviets

Oil Exports Oil cxporii to Pastern fcuropc fall fromillion tans0 toillion tons

Substitution. Half of the hard currency gas exports projected under baseline conditions arc redirected to domestic use in place of oil, and domestic oilarc reduced accordinEly.

Western Imports. The floor on hard currencyother than grain and oil is cut in half toercent of the current import-GNP ratio.

Debtrigger point ofercent is assumed for the debt-service ratio, which leads in restrictions on borrowing by the Soviets. In each year that the ratio exceedsercent, actual new credit drawings arc only one-half the corresponding levels in the baseline case.

Lower oil exports to Eastern Europe couldtrong impact on the Soviet economy because capital utilization rates would be immediately raised when oil is in short supply. This would add moreercent to GNP and consumption5 comparedaseline projection and would postpone the emergence of domestic oil shortagesouple of years. By assumption, all oil diverted from export to Eastern Europe is consumed domestically, not exported to the West, unless the nominal domestic demand for oil is fully met. Therefore, this policy's impact on hard currency trade is negligible.

Substitution ofgas for oil holds SOrne attraction fur the USSR since it is expected toajor gas producerarge domestic surplus over the next decade. With the export valuetandard fuel unit of gas projected to be less than thatof oil" there is an advantage in substituting gas for oil in domestic use. Diversion of half the hard currency gas exports of the baseline case to domestic use would reduce domestic oil requirements by an equivalent amount in energy terms. Since the oil saved would be worth more in trade than the gas lost lo export, thereet gain to the economy through this substitution Bui, the boost to GNPillion rubles is quite modest, especially considering that the analysis docs

" This ii consistent with recent win -alne rial* It llie relative pike between gas and ml al llie point ora proportional to encrey content, ilicn tbe relative price in lerms. prices mm! shifts. became it is more eipensiveransport thin oil. The observed irendsm uni( value data. -Inch arc baocdoni.ay reflect this relationship

C

not account for the Cost of convening from oil to gas in specific industries. Moreover, the debt-service ratio would rise substantially as export earnings fell with increased domestic use of gas.

Cutting hard currency imports other than grain and oil wouldonus for the Soviet economy, adding as muchillion rubles to GNPhis gain comes from the additional oil imports-illion tons inthat can be obtained by diverting scarce hard currency import capacity away from other commodities. As long as oil is in short supply, this substitutionarge immediate impact on production. At issue here is Ihc trade-off between more ouiput now and more output in the future. The drop of almost S3 billion in imports from Ihe West5 wouldevere blow to longer term growth prospects in crucial sectors like Oil, chemicals, and machinery -where imported capital goodsignificant share of new, high technology invesimeni. Theconomic consequences of sacrificing imports of Western capital goods in favor of more oil and therefore more domestic productionould be substantia) indeed, bul are noi accounted for in our analysis.

Moscow's attitude toward the Soviet debt-service ratio reflects its desire to borrow on favorable terms and to convey an image of economic strength to the rest of tbe world. High debt-service ratios arc generally viewed by potential lenders as indicators of high risk and therefore lead to higher costs of borrowing funds lo finance Western imports. Our simulationpercent trigger rule sliows lhat it would have little impact on Soviet GNP. It would, however,ignificant impact on the Soviet hard currency trade picture. In part, because of the fall in oil exports, the dcbi-service ratio soars aboveercentriggering two successive years of credit restrainthis is more than sufficient to send the debt-service ratio belowpercent trigger point3 and to keep it in the vicinity ofercent below the baseline level

Debt Service Case: Debt Service We decided to examine the effects of sixDebt Service Trigger isinvolving the domestic economy and

P(i concerned with foreignby rcsimulaiing

growth tinder changed underlying conditions.'*

Debt-SiNvice Case

JO

79 BO 81 8? 63 84 nclassified

The cost of this debt-service control is the hard currency imports forgone duringeriod. Since this amounts to onlyercent of the projected hard currency imports for those live years, the Soviets would beosition to control potential debt servicing problems whitelow of most crucial imports from the West. Nonetheless, the decision to cut back on Western credits would not be an easy one under the multitude of economic pressures that arc likely to coexist in the, and the impact on the consumer or certain investmentcould be considerable.

Semi ti.ity of Model Results to External Contingencies

Our baseline caseather stable economic environment in the formtraightforwardof recent trends. Shifts in the assumed economic environment would of course change our projections of Soviet growih. From the standpoint of this study, however, the interesting issue is how sensitive our baseline projections arc to possible changes in the conditions that wc have assumed.

Flat Oil. Soviet oil production peaksillion tonsnd holds flat at this level

High Oil. Soviet oil production peaksillion ionsut falls to the baseline levelillion tons

Low Oil. Soviet oil production peaksillion tons0 bul fallsillion tons

Lower Western Growth. Soviet nonfucl exports to the West giov. at only one-balf ihc baseline rale, reflecting slower growth in Ihe developed West and. hence, lower levels of Western demand for Soviet exports.

Higher Oil Prices. World oil prices inise at an annualercent faster than under the baseline conditions,ighter world oil market during this period.

Credit Celling. Baseline credits are taken whenever they falleiling consisting ofercent of Soviet imports of hard currency capital goodsmaller amount of general purpose credits. Ceiling credits are taken whenever baseline credits arc higher.

The results of these six simulations are compared with Ihe baseline simulation in tabic 7.

"Soviet, aeiieuiiorc ii an additional source of nw)or uncertainty in 0u- anatysii All nf ihe projections Intudy ire based on normal -Miner conditions and therefore normalgriCul-lure. Simulations of older performance patterns in agriculturehreeyear cycle composed of good. bad. and normaluccessmn of bad yea rs in theuccession of loud yearshe had lutlc perceptible effect ontrendsive -naWr economic aes-rcBatcs. While the potential impacts on carmnas in hard currency trade and finance were lubsianlial in cerl)in years, the overall hard Currency trade situution appeared lo be manageable

ruble 7

USSR: Model Projections Under Major Contingencies

DimaaBtk

Due lo

: Cominienciei '

Doe to Foreign Trade Ccclingi

Ituel

Oil

Oil

Oil

Western

Giowih

Oil Hoots

Ceiling

peicenO

1

0 rubles)

0 ruble)

Cageta! Slock

I9SI-SS (percent)

i

Imillioa metric loni)

(million mtlric tow)

Hard Cnnicy Oil Exportt

(million metric torn)

(million metric torn)

Oil

metric toos)

(million metric ion.)

Currener Import. Other Than Fuel* nnd Grain

7 US I)

7 US J)

Ratio

(percent)

(percent)

The difference between lhe value ol lhe variable under lhe given contingencyalue in ihc baseline cue.

16

Alternative

a

Production Profiles

Malic To*i|

Oil Case: Net Exports.

Oil to Hard Currency Countries

too

High 0'i

H<'in

Ol

19 80 81 83 B3 *4 15

is

The plausible range of Soviet oil production over lhe nest decade is wide and ihis uncertainty naturally has an important impact on the range or possible Soviet economic performancehows four alternative production profiles: high oil from7 study of Soviet oi)hc baseline assumption reflectingost likely situation under picscnl conditions, flat oil as an extreme possibility on Ihe high side, and low oil as an extreme on ihe low side."

UncUttitRM

full penod, and the growth rate for the active capital slock would rise an averageercentage points. Hard currency imports would nudge the acceptable floorul would be kept above the assumed minimum level in all other years. Nonetheless. lint oil production itself would in no way reverse thein growth prospects in general and hard currency trade in particular thai our simulations clearly ind kale.

oil production05 is.we believe, not in the cards. However, If it were to occur and all the extra od went to meet domestic needs, our

tons indicate lhat energy would notonstraint on Soviet growth during the period Doth the rate of GNP growthercent and5 GNPof moreillion ruble* arc both consistent wiih the potenlial performance weearlier in the absence of an energy constraint, livenerceni of domestic energy demand can bc mei. This means thai capital uliliralion rates could be held at or closecrcenl during therfifttit/or Sarin Oil /Wwivioa.

Ihc produeilon figureillion inm) Ii ihe low end) of Ih* iince cilimaled in7 oudy

The effects of the high oil scenario would bc primarily to delay lhe inevitable and to provide an additional year or two for adjustment. But the impacts on the aggregate economy5 would be minimal. High oilould allow substantial hard currency oil eiporu1 and would delay the need to import oil from the West3 (figurebis means several estra years of high imports of Western capital goods and full domestic oil allocations. With oil production assumed to drop eventually to theion ton level as in lhe baseline case, ihough. ihc effects on GNP5 would be very small.

The low oil case, like the flat oil case, is not likely lo occur. However, ir recovery rates continue to fall and peak production of Samotlor is noi held for more thin

a couple ycurit, Soviet oil production could indeed approach Ihe level* of the low oil case. Simulation results show that the impacts on the Soviet economy would be severe. Average growthould fall more thanercentage point, with even more serious reductions on an annual basis in the later years. With oil production down, little additional import capacity available, and export commitments to Eastern Europe fully met, domestic oil use would have to fall by more thanercent. The Soviets would certainly take steps to avotd such dire consequences if oil production as lowillion tons5eale mia of reactions resource reallocations, export reduction, greater conservation, larger imports can be only conjectural now.

Slower Western growih means lhat the Soviet hard currency import capacity would grow more slowly. Oil imports duringould have to be reduced accordingly and this would have an adverse effect on capital utilization. Oil imports from the West5 fall fromillion ions toillion tons in the faceore binding hard currency shortage. During yearshen energy isonstraint on trade, reduced exports to tbe West would leadubstantial fall in affordable nongrain imports from lhe West. Lower hard currency exports also mean higher debt-serviceeak figure of more thanercent is reached in theven with reduced capital imports and lower domestic oil use in the later years, slower Western growth hasmall effect on realizable levels aad rates of growth of GNP.

The effect of higher oil prices (in real terms) on Soviet growth would shift as the Soviets moved fromet exporter torojected net importerard currency basis,hen the USSR iiajor net oil exporter to all regions, higher oil prices increase foreign exchange earnings and ultimately hard currency imports.he Soviets are projected to be substantialestern oilesult, higher prices for imported oil exacerbate the protected hard currency problems and leadmaller import volume in the faceloor on other hard currency imports Again, the aggregate irend effects on such broad aggregates as GNP and consumption would be small

The possibilityredit ceiling exists because most Western lending is correlated with Soviet imports of Western capital goods The model shows thai the Soviel capacity to import Western capital goods is likely lo fall in tbes domestic energy needs restrain the growth in export earnings We assume,oincident fall in the availability of Western credits at terms acceptable to tbe USSR."

Simulation ofredit ceiling leadsrojection of new credit drawings that is very different from the baseline case.redit levels assumed available in the baseline case are consistent with ihe credit ceiling.hey areabove the level thai would correspond to the projected volume of hard currency capital imports, and actual drawings are constrained to the lower ceiling figure. These lower drawings mean lower deb* and debt service during the last few years of the raeriod. The debt-service ratio falls belowercentertcniagc-point imptove-mcnt over the baseline case. The credit ceding would reduce potential GNP5 onlyresult of somewhat lower affordable oil imports and therefore lower capital utilization rules ineriod.

Model Simulationsia Of Option* and Contingencies

Il is easier lo understand the possible effect* of policy shifts and contingent events by examining them individually as wc have done above. However, isolated changes are not realmic. Soviet growih rvrjspccts areomplex reflectionix of policies and contingent events operating simultaneously The final step in our analysis is to examine Soviet growih possibilitiesix of options and contingencies. The econometric model is particularly useful in this kind of analysis, for it provides an integrated analytical framework for looking at the interactions of many simultaneous events, whose effects would otherwise be considered separately.

"redit eotarrsjai mid <aaat oa ihc tvffdy saec because ol iha partaralar auweiarc of impels aaajaaaatl lorsrrsulivriy. :r< Sosien couldalumhcmsclvcohw may already be reflected inoviet bctianot Ihi>iml rami ua lhe demand Mac wouldir same analytical Implications ai an equivalent oonsirainl on lhe supply side, and Ihudiiliisuiom Dccantesonicsvlial arbitrary

Credit Ceiling Clio: New Credit Drawing*

S s

Ceiling,,

Debl Service Ratio

PaiLnnt

51)

ell no

Credit Coding

79 80 81 83 83 84 89

mmr

Wc have looked ai Soviel growth prospects under ihree separate sets of conditions:

Composite Options. This case begins wilh Ihc baseline economic environment but assumes lhe So* victs exercise (a) the manpower option because il is the most direct attack on lhe labor supply problem, (bl the oil exports option because cutting oil exports to Eastern Europe is ihc most feasible way of realizing short-term gain* in oil mppties, (el thcJeof-irrvtcc option because of the Soviet historyonservative approach to trade finance, and (d) the resource reallocation option because tl has beneficial effects on energy and investment in both the short and long term The other options were taken to be less attractive or less feasibleariety of reasons. Lower defense growth gave little aggregate gain5 and would face strong political opposilion: Ihe floor on Wesicrn imports in the baseline case already implies severe restrictions on even high priority imporu; gas substitu tion would email corisiderable conversion costs, and there is litUe technological or organizational basis for expecting extraordinary conservation

Composite Contingencies. This case incorporates the base case assumptions except thai it assumes that the three foreign tradeWestern growth, higher oil prices, and lower hard currencyoccur. High oil was considered the most

79 80 81 II 83 84 nclassified

P^m

likely of ihe alternative oil production profiles and was also included.

Composite Projection This ease combines the four policy options and the four contingenciesomposite view of Soviet growth prospects that can bc compared with the baseline simulation.

The results of these three composite simulations arc compared with :he bateline case innd figuresoo indicate the senuliviiy of lhe models forecast of Sovietfonnar*ce to some fairly complieaied mixes of assumptions.

The combined options would addercent to both GNP and consumption5 and aroundercentage point to ihc average rale of growth in the first half of. As wc showed earlier, much of Ihis gain comes from reduced oil esports to Eastern Europe In fact, this case indicates lhat the Soviels would be net importers of od5 with increased domestic use and lower ciporu lo Eastern Europe This simulation implies moreovset reluctance to dip aggressively into Western crcdil markets, leading naturallyubstantial decrease -toetIhe debt-service ratio5

7

Table 8

USSR: AKernativc Views or Crowlh Prospects

Vtmilxnu.1

VarttKes

Level

Option*

Coatinniicics

0 (percent)

5 (percem)

VKO0 runlet)

I9SS0 rubles)

Capital Stock

fwceno

:

!

S

pcrcenll

IMI-ftS(paccni)

Use

(million metric tons)

(million metric toot)

Hud Currency Oil Export,

(million men ic tons)

(million metric inns)

Oil FaporU

(million metric tons)

(million metric torn)

Currency Importsitan Fueh end Grain

7 LSI)

6

SI)

4

Ratio

1 QJtl)/iwrrnr 1

(petcenl)

'

r

-7

-6

J

difference betn-cea lhe valce of toe variable under ihe jirai policy option or contingenci and iu value in tbe outline case.

20

GNP:n

Projections5

0 Pi^lel

Options

913 84

On ihc oihcr hand, lhe combined contingenciesuch smaller negative effeel on growth, except in the hard currency trade area where slower growth of exports to the Westredit ceilingubstantial fall in affordable importsecreaseercent in the debt-service ratio. The contingencies would alsoharp increase in net oil exports because of lower affordable imports of Western oil.

T he combined effects or the policy options and assumedby the Compositesiill sirongly positive. They suggest thai Ihc Soviets could maintain growth aiercent per yearndNP ofillion rublesnder lhe conditions of our analysis. Ihis would also imply some improvement over the baseline case in lhe international financial position of the Soviet Union, as the lower debt-service ratio indicates. Under this composite view. Soviet oil trade

would be in Overall balanceilh exports to Communist countries essentially offset by imports from the Wcsi.

These observations are amplified in the following charts showing the projected lime paths for important variables:

. The projections are sensitive to the assumed conditions only ioward the end oferiod when the oil and trade constraints come inlo play. The effects of the policy options stronglythose Of iheconlingencies and resultange for cxpccicd Soviet GNP5 ofillion rubles.

Domestic Oil Use. There isaycarortwo swing in the expecied break in lhe trend of domestic oil use, depending on assumptions. Eventually, though, oil allocations must be held below nominal requirements under all conditions we examined. The range of possible domestic oil use5illion tons or almostercent of the baselinethe shifting analyticalhave strong impacts on net oil exports. However, the difference between the baseline case and the Composite Projection is only aboutercent.

tfel Hard Currency Oil Exports. Tbe liming of lhe Soviet shiftet oil exportet oil import position wilh the West is somewhat sensitive to the particular conditions analyzed. The option of lower exports io Eastern Europe and the contingency of high oil both stretch oul the period of potential oil surplus and together delay lite need to import Western oil3 or later. But this shift seems inevitable by

iven the Soviet oil production profile underlying lhe analysis.

Currency Debt-Service Ratio (figurehe debt-service ratio seems destined lo rise in the late

nd, primarily due to the expected slowdown in growth of Soviet export earnings in the West. The peak figure could exceedcrcenl. especially if the drop-off in oil exports from one year lo the next is particularly severe as il is in lhe Composite Projection3 The simulations olhcr than the baseline scenario allorm of credit-either voluntary or involuntary. Restraint of

Domestic Oil

Comparative Projections5

Million Metric

Net Hard Currency Oil

Comparalive Projections5

Wittmr Momc Ton* 'U'l

Options and

Options

63 84 S3

kind simulated effectively corrects any debt-servicing problems implied by the debt-service ratio and, under all three conditions, brings the figure back intopercent ranee

Some General Observations

Any analysis of the prospects for Soviet economic growth is very speculative. This uncertainty iseflection of the many unknown events and reactions-some under the control of Soviel policymakers and somearc likely torofound influence on growih over the next decade. The analysis in this paper, especially in the preceding section,ay of looking at some of these uncertaintiesonsistent and integrated manner. While the likelihood of the sets of events and policy decisions we have analyzed cannot be established precisely, measures of their potential quantitative impaction the Soviet economy can be calculated. From this analytical process emerges, then,ingle forecast of Soviet economic growth,ange of possible performance depending on specific conditions. This range iseasure of the degree of uncertainty inherent in Ihc analysis, and servesreferred guided forthe development of Soviet economic potential into the next decade.

The econometric modelentral tool in assessing the uncertainties in Soviet growth possibilities and sizing the possible effects of policy options and contingent events into. In particular, the modelsuggest that:

Falling oil production could lead to anercent loss in GNP5 compared to potenlial GNP withoui an oil constraint.

Resource reallocations on the scale of the recent past arc not likely solutions toic problems underlying future Soviet growih.

Drastic reductions in oil exports Io Eastern Europe may be the only effective way to contain the potential domestic damages of energy shortages likely to emerge

USSR willet importer of Western oilnless prospects for domestic oil production move sharply upward over the next few years ot exports to Eastern Europe drop substantially

Hard Currency Debt Service Ratio: 'f. Comparative Projections5

Paioani

SO

Options and Contingencies

Since the problems we foresee become acute only5s unlikely thai these trends "ill be reversed by the. Prospects5 depend on such issues as ihe strength and timing of improvement! in demographic factors affecting the supply of laboi, the institution of effective policies to improve the use of investment resources, and the discovery and development of new oil icserves. Even if developments in these areas in the neat few years prove favorable, their full impacts will not be felt until thend. Tbe basic shape of Soviet economic growth over the neat decade seems already set by events currently being played out both wilhin and outside lhe USSR.

8 79 BO 81 82 83 IM nclassified

Soviet hard currency imports other than grain and eventually oil arc likely lo fall in real terms5 as hard currency export earnings and credits become increasingly unable to meet all trade financing requirements.

Considering both Soviet policy options and contingent events lhat arc likely to influence Soviet growth, lhe range of our projections suggests lhal Ihe Soviets have surprisingly little economic maneuverability. The model simulations indicate that they will bc hard pressed lo maintain growth at an average of3ear in lhe first half of ihc next decade: growth could fall nearer loercent range if the necessary policy adjustments are not taken. The assumptions we made in several key areas labor productivity holding ap in Ike face of energy shortages affecting the use of capital, full lubmtuiibiliiy of fuels at Ihe margin, smooth adjustment to policy shifts, tbe absence of shori-icrmvery optimistic from the Soviet standpoint, Therefore, actual growth is more likely to bc even below, rather than above, these protections.

23

Appendix

Summary of ihr Econometric Model Of IheEconomy

Our model of ihe Soviel economy reflects thenatureentrally rjUnoed economyPE is supply oriented tnxtc*nic activity and economic institutions The supply or labor and stock of productive capital are more or less fully employedange of productive activities determined by labor und invesimeni allocation policies. Output is divided among competing uses according to both availabilihci and relative priorities, wilh private consumptiontaken as tbe residual claimant

The general structure of the Sovielhown inhe model can be used to project five groups of economic variables- the model's endogenous

variables^

Produclion. In this group are the output* of each producing sectorin terms of value added. It also includes private consumption as the residual claimant on output once deductions are made for public consumption, investment and foreign trade

Capital Formation The model computes investment in each producing sector plus housing, and projects the capital stock in each sector from knowledge of pas; investment levels.

Employment This involves projeclions of the labor force and ultimately the level of employment in each producing sector

Energy The model calculates an energy balance between domestic production, producing sectorfinal demand and net exports II abo estimates effective or active capital slock.

Foreign Trade In this group arc variables describing Soviet trade tvith communist countries and wilh the West. Il also includes measures of hard currency debi and debi service

The mmm a-odel

All projections from the model are conditioned by assumptions regarding six groups of external or exogenous variables:

Energy. These variables include projected outputs of the energy sectors, the energy allocation policy, and the capital flexibilities for each producing sector.

Population andhe pattern ofgrowth, participation rates and the structure of labor allocations are inputs to the model.

Weather. Indexes of temperature and rainfall are used to calculate agricultural production

Foreign Trade. Nonfuel exports to the West depend primarily on external economic conditions and ate an input to the model Energy exports to Eastern Europe arcunction of both political andfactors and are therefore set outside the model Gold sales also fall in this category

Invettment. The allocation of available investment resources among competing uses is set by policy

decision.

Spending This group includes the leveh of personnel and nonpcrsonnel expenditures forand the shares of administration and research and dcvclopmcni in GNP

Two hundred and seven equationsike number of endogenous variables wilh.ubles Thirty-five of lhe equations involve coonestimales of parameters. Theitaer use nonsiatisucal procedures to estimate structural parameters or are accounting identities.

Ihe functional relationships among model variables shown in condensed form in the figure A2 define the variables and parameters appearing in these equations

Fhesc linkages en be described as follows

There arcconsiant-rclurns'to-scalc. Cobb- Dim glasnci ions for each non-energy producing sector* Value added in

energycaled from grossied is oogenous for these sectors GNP is obtained by summing value added inroducing sectors

Government expenditures (equationnclude exogenous defense spending and an endog. enous component scaled from ihc level of GNP Private consumption (equations calculated as the

residual claimant of GNP

Investment. The supply of capital goods available for domeu ie investment is the residual of deliveries of machinery and construction output to final demand, after deductions are made for deliveries io defense, exports, consumption, and capital repair (equation M.istributes new fixed investment to each producing sector and housing with shares set outside the

Capital Formation. Net additions to tbe productive capital stock are estimated from past investnd assumed depreciation ratesdentit) equations then link capital stock to tbe previous year's capital stock and net capital formation

The labor force is estimated from the able-bodied population and participation rates (equa lionotal employmentepends on the labor force and employment rates, and sectorymeni levelsollow from lhe toial employment and labor allocation shares

1 SUMiitil ciiiinniun withconventionnl llBcb>newtral inoufioi-itmiof disembodieda nee proved unuKcmliiluiti lO-Mate aiinmplion, nude in order lo obtain ttatiuultp acceptable teaolta, (acta up tome of the leeftnoloi^al change elfot hreaweactaal raamvvmk are precabb bclo* mmm,ami Melon The ila>nimbaivan the wooraw*hdnciopaaeM. wtwk hi.ore byicaan* rather thu tMemneon of ikMoUc* Tan weald brm ibe teneril nu of ite til*-1 ach teaor. not fiaiati tread nln lold factor productivity.

uationstimates nominal demands for oil. gas. coal, and electric power in each consuming sector from the capital stock and energy.usetied lo the capital slock of the given sector Actual deliveriesrc determinedombination of nominal requirements and assumed allocation policy. Equationalculates domestic energy residuals by subtracting domestic deliveries from gross domestic output Depending on in sign, the residual indicatesapacity for next exportseed for nel imports. Equation IS calculates lhe fraction of sector energy requirements, in terms of standard fuel units, actually met by deliveries.with an elasticity of active capital with respect to energyhis fraction determines tbe rale of capital utilization and thus Ihc active capital slock in each sectorny shortfall in meeting nominal domestic requirements for energy lendseduction in capital utilization Tbe degreeiven shortfall varies by sector depending on the value of lhe capital elasticity and tbe relative contribution of lhe type of energy in short supply to lhe particular sector's energy consumption.

Foreign Trade Nel exports of fuels to hard currency countriesre the difference between tbe domestic energy residuals and oogenous net exports lo Communist and other countries. Net exports of fuels to hard currency countries, alung with other variables thai represent sources of hard currency, feedalculation of tbe hard currency import capacity. which in turn drives imports from hard currency countriesf these import* fa',pecified floor, domestic energy use is reduced by reducingand energy exports are increased (or energy imports are reduced) until sufficient import capacity ex-sis to meet the import minimum

1 Tba elit* wdlhe pceewUfiutcatpnal aiiluawa thai lollox.nrieri.eiici fail one pncenl below nominal lector

26

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