SOVIET ECONOMIC PROBLEMS AND PROSPECTS (ER 77-1043U)

Created: 7/1/1977

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CIA HISTORICAL REVIEW PROGRAM RELEASE IN9

Soviet Economic Problems and Prospects

7

Soviet Economic Problems and Prospects

Ciuiml tntelhg/nc Ajvnr* Ot'triiuair of luirlh^emr

7

Summary

The Soviel economy faces serious strains in ihc decade ahead The simple growih formula upon which lhe economy has relied for moteeneration' maximum inputs of labor and capital -will no longer yield the sizeable annual growih which has provided resources needed for competing claims.

In the past, rapid growth enabled Moscow simultaneously to pursue three key objectives.

catching up with the US militarily;

steadily expanding Ihc industrial base; and

meeting at least minimal consumer expectations for improved living conditions and welfare.

Reduced growth, as is foreshadowed over thedecade, will make pursuit of these objectives much more difficult, and povr hard choices for the leadership, which canajor impact on Soviet relations wilh Eastern Europe and the West

Thrs study examines the causes of then growth, usthe policy choices open to the Soviel leadership, and their possiblen defense, the consumer, foreign Hade, .iml US icUitiom Causns of tho Slowdown

ending to slow down the rate of growth ti-rve been apparent (or >omc lime

The drying up of rural sources of urban labor force growth;

A slowdown in the growth of capital productivity;

An inefficient and undepcndable agriculture which may be hit hardalurn of the harshcr-but probably more normal-climatic patterns lhat prevailed in;

A limited capacity to earn hard currency to pay for needed lechnology imports and intermiltent massive grain purchases.

These problems are not new. The Soviet leadership has tried to offset their effect by improvisation and palliatives, without impairing the priority development of defense produclion. They did not succeed, however, inteady fall-off in economic growth from lis earlier high rate.

Looking toward the next five to ten years, these long-standing problems arc likely to intensify, and wUI be joined by two new constraints which will greaily aggravate the resourceharp decline in the growth of the working age population and an energy constraint.

Labor force. Inhe rale of growth of the labor force is expected to drop sharply (to lesserceni beginningecause of the depressed birth rates of. Moreover, additions lo the labor force will come mostly from ethnic minorities in Central Asia who do not readily move lo Ihc northern industrial areas.

In anticipation of this labor force constraint, the Soviel government is planning for an accelerated growth in the productivity or both labor and capital in lheear. But for years productivity gains have been slowing, and this trend is likely to continue given the sharply rising resource costs facing the economy. The more readily accessible fuel and mineral reserves west of the Urals are being rapidly depleted, while the abundant bul more remote resources of Siberia .mil Central Asia require enormous investment outlays.

hncgy. The most serious problemooming oil shortage Soviet exploration and extraction policy lias long favored increasing cunenl output over developing sources of future output. Asesult, new oil deposits have not been discovered rapidly enough to offset inevitable declines in older

.1

fields. Consequently, production will begin to fall off in ther. The current level of oil production is close to the estimated maximum potential ofillion lo.5 oil output is likely to fall toillion and.

-rvmay or may notemporary phenomenon. Ihc USSR is counting on large new supplies of oil and alternative energy sources-coal, natural gas, and hydroelectric power-coming onstream beyond the. But most of these energy sources lie east of the Urals far from major industrial and population centers: their development would take years and require massive capital investment.

In the near-term, however, even if the development of alternative energy sources is pushed to the maximum, overall energy output will growharply declining rate.lausible set of assumptions, it would declineercento slightlyercentI-8S. Since Soviet energy consumption increases in close parallel with the growth of theharp slowdown in energy production would seriously consirain economic growth unless Moscow finds ways of conserving large amounts of energy or covers its shortfall byet oil imporler. The Soviet government appears to be aware that il lias an energy problem but has not yet made ihc difficult choices which will be needed to deal wilh it Tlie longer the delay in adoptionop-priority energy program, the greater will bc tlie economic impact in

Policy Choices

Measures for grappling with these varied pioblcms must meet two tests: ust, they must be designed to remedy particular elements of the prob-tern-the labor force, productivity, and energy constraints; second, they must be shaped wdh the recognition mat ihc problems are interrelated, and that measures aimed at easing one problem may aggravate another.

r-ven on (he firsl level, it will not bc easyind solutions lhat will do more than alleviate the component probk-ms. Powerful remedies are either not readily available or not politically feasible.

The labor force co.islra.nt could be ca.^rd somewhat by such measuresr in tl" labor force, shortening secondaryndmanpower by ending the lerm of service. But such measures would havene-linn- impact.

Iii

Moscow's options for raising Ihc rate of growth and productivity of plant and equipment are even more constrained.

They could convert industrial capacity from defense to the production of investment goods. Ihey would be reluctant,to impair their defense production capability. Moreover, specialized defense resources are not easily transferred on short notice.

They could stretchrograms and production schedules and slow the rale of expansion of defense-oriented industrial capacity, but this would have limited effect in the short run.

They could institute incentive-enhancing reforms of economic management. Such reforms, however, will be resisted by powerful vested political and bureaucratic interests.

ombination of these measures-sucheveling off of defense production, coupled with measures to obtain additional manpower-would probably raise economic growth only slightly.

Options for dealing with Ihe energy problem are similarly constrained. Opportunities for conservation are less obvious in the USSR than in Ihc West for example, there are few automobiles and most are for commercial or industrial use. Consequently, conservation measures alone are unlikely to yield large oil savings- The leadership thus will probably have to rely on some combination of the following measures:

importing substantial amounts of oil from non-Communist countries:

cutting oil exports IOrone; and

severely rationing oil lodorncslic users.

Moving fromposition or major oil exporter to thatet importer would br particularly painful. Last year Soviel oil exportsS billion accounted for almost one-half of its hard currency earnings. If current trends are projected with no change tn present politics. Soviel oil5 couldillion at today's prices. Even wilh high priority measures to boost other exports, including gold sales, oil imports at

IV

lhal level would absorb most of the Soviet hard currency earnings in, and largely foreclose Ihc import of other goods from the West, including badly needed Western technology.

Cutting oa exports to Kasiern Europe would ease this problem by forcing Eastern Europe to share tho burden of Ihe oil shortage. Anycul in the Soviet oil supply commilmcnt to Eastern Europe, however, would worsen that area's already difficult economic situation.

Placing the burden of the oil shortage on the domestic economy would mean curtailing oil rations to producing enterprises. Such cuts would almost certainly impede production, though the impact would bc less severe if reductions were more gradual as partong-term energy-saving program.

Implementing the foregoing solutions is complicated by the fact lhat lhe problems arc interrelated and the solutions impinge upon each other. For example, pressure on enterprises to save labor will be much less effective if they must also save energy. If the energy shortage is eased by allocating foreign exchange to import oil, Ihc resulting decline of imports of foreign machinery and technology would adversely affect productivity andgrowthew years. Failure to import large amounts of energy equipment and technology from the Wcsi would substantially worsen the USSR's prospects for raising oil and gas produciion in lhe longer-term.

Wc concludearked reducllon in the rate of economic growth inceim almosl inevitable. At best, Soviel GNP may bc able lo continue growingate ofeareclining toercent in the early and. These rates, however, assume prompt, strong action in energy policy, without which the rate of growth could decline toercent in the near-term andercent in.

These are average figures, in some years performance could bc belter, but in others, worse, with zero growth or twtgt declines tnossibility if oil shortagesad crop year coincide.

Potenlial Impact on Defense The slowdown in economic growthintense debate in Moscow over lhe future levels and patternexpenditures. Military programs enjoy greal momentum andl uWn:-

linue to increase in the next few years ,il sornelhiiig like recent annual rales

ercent because of programs in train. As the economy slows, however, ways to reduce the growth of defense expenditures could become increasingly pressing for some elements of the Soviet leadership.

On Consumers The reduced growth potential means that the Sovietwill fare poorly during the next five toears compared to recent gains. Under the projected growth rates, per capita consumption could grow no mereear in contrast toercent.esult, there will be no progress in closing Ihe gap in living standards with the West or, for that matter, with most of Eastern Europe. Moreover, rises in wages over the next ten years combinedlower growth in the availability of consumer goods would result in higher prices, moreshortages, and increasing consume: frustration.

On Relations with the US Moscow's economic problems inill affect its relations with tho West, especially the United Slates. Since the USSR's ability to pay for imports from the industrial West in the early andill be strained, Moscow may seek long-term5specially to develop oil and gas resources. Much of the needed energy technology would have to come from the US.

Stresses upon the Leadership

These serious problems aheadmost likely to prompt Soviet leaders to consider policies rejected in the past as too contentious or lacking in urgency. Some leaders might be pcrvuaded that basic organization and management reforms in industry areut that will raise the spectre that such reform would threaten political control. Consideration of olher options-such as accelerating investment at the expense of defense oror reducing the armed forces to enhance the civilian laboralso result in strong leadership disagreements, "soviet responses to these problems could be further complicated by the fact that leadership changes will almost surelv lake place during the coming period.onfident new leadership woukl have difficulties in coming lo grips with the problems ahead

VI

CONTENTS

Background 1

Soviet Development

Hecont 2

The Problem of

Changes in the Economic

Slowing of Labor Force Growth 3

Possibility of Lass Favorable Weather

for

Rising Costs of Fuel and Raw Materials

Energy

Prospects for the

Leadership Intentions and

Plans Still Overly Optimistic

Possibility of Material

What the Leadership is Counting

Some Options tor ihe

Material Supply

Manpower

Possible Investment

Economic Reform

Outlook for Economic

Some Policy-Conditioned

Base-Line

Business as-Usual

Best Case

General

Implications lor Foreign Trado

Potential tor Increasing

v..

Soviet Hard-Currency Import

CONTENTS (continued)

Pyje

Political Implications

The Burden ol Eastern

Communist Oil Policy in the Middle

USSR: Indicators of Economic 2

Table 2: Policy-Conditioned Forecasts of Soviet

Figure ncremental Output-Capital Ratios

car moving

FigureSSR: Population of Working

(annual increment in million persons) 5

Figure SSR Primary Energy Produciion.

6

FigureSSR: Annual Growth Rates of Inputs

lo the Economy-the Base

FigureSSR: Annual Rate of Growth of Inputs lo the Economy. Under Different

Investment

Figure SSR: Annual Rate of Growth of Inputs

lo the Economy Under Different Investment

.ind Manpower

Figure SSR: Capacitymport Hard Currency

Goods and Services Other than Oil and

Appendix

ii i

Soviet Economic Problems and Prospects

With ihr second Largest economy in the world, the USSR has great crude economicwealth of naturalabor force half again as large as that of the United States,ough, unchallenged leadership dedicated to continuous growth in economic and military power. During much of itsthe Soviet economy has grown at rates comparable to those of Western Europe but considerably faster than the United States.onsequence, Soviet gross national product (GNP) has risenS from about one-third to roughly one-half that of the United States.

Soviet Development Strategy

Soviet growlli strategy has been based largely

on the enforced mobilization ol capital and labor. By restricting the growth ofthe USSR has been able toigh and riving share of annual output Io investment;nvestment comprised nearlyercent nf GNP, compared wilhcicent in the United States. In recentmall but growing portion of new plant and equipment has been imported from (lie West. Gtowlh of the labor force has been unusually rapid, and participation rales are the highest of any industrialized country. Moreover, targe numbers of workers have been shifted from agriculture lo industry and services, andinvestment has beenrcd into ed-

ucation and training programs Finally, rapid explottation of relatively cheap and abundant natural resomces, especially oil and gas, hasey role in Soviet development.

An overriding objective of Soviet policy the acquisitiontrong militarys dictated the pattern of industrial growth The tradition of using national resources first for military goals is deeply rooted in Russian as well as Soviet history. Today there ispopular as wdl as official pride in the achievement uf rough military parity with the United Slates. Indeed, military powth is wliat the Soviet economy docs best and the arena In which it competes most effectively with the United States.

Precisely how the Soviet leaders view their specific needs for additional military power is not clear. Il is obvious, however, thai they recognize the possibility of general war and believe thaiapability to wageonflictecessary condition for averting one. Defense expenditures have been risingercent annually in recent yean and haveteadyoercent of GNP over the pastefense impacts heavily in high-lechnology areas, where itriority claim on manpower and output. ForIt iL.ii' ol ONT It bitrd on lhe cvncvpl of oV'cni*

ii Ji'nt'-l it US bu4tn.fi ount!. UnoCi broadei

atttMlion-ni II- SWMacrawM for (kxu

in electronics, defense requirements account for most of the ouipul of iniegratcd circuits.ensc alsoarticularly large share of the products of major invesimeni goods industries such as machine building (aboutetallurgy (abouthemicalsnd energy (about one-sixth)

The emphasis on industrializationof early Soviet history has been relaxed under Stalin's successors in favor of morelo agriculture and consumer goods.decades of neglect, thr Sonet people have experienced marked pins, with per capita consumption more than doubling in the past quarter century Consumer gains havein recent years, howcvci. with thein overall economic growth. Moreover,asic needs for food, clothingew durables have been mcl, consumers want better Quality and more variety in the products they buy us wellost of services. Bul the economic system is Ix'ltcr suited toasic assortment of goods and services than to responding to the shifts In consumer demand induced by higher incomes Unsatisfied demand has (omul expression in lengthening queues for quality goods andesort to black or gray markets.

ajor industrial power, llie USSR is still far behind in terms of technologicalExcept in military production.manufactured products arc generally poor in quality and often lecl'.nolofjcallv inferior. Because of the poor quality of manufactures and an inability toeliable flow of spare pans and services. Soviet exports to thr West consist almost entirely of raw jud semi processedrade pattern that is ur.iquc .imoiig industrialized countries Mear while. Ihe USSR has turned increasingly Io the West lor grata lo offset harvesi shot (falls ind lor machinery tn modernize the economy.

Recent Performance

Sincehe effectiveness of thedevelopment formula has been steadilyA slowdown in growih. whichnearly all sectors of lhe economy,throughnd inloven industry, which has always been favored in investment allocations, has not escaped.6 the growth of GNP wasercent-the same as the average annual gain duringa record grain crop. Industrial growth was the slowest since World War II. Although the poor6 largely reflects the aftermath of the5 crop, the falloff wassharp and has continued wellevere problems were encountered in bringing new capacity into operation. In lhe consumer sector, widespread food shortages occurred throughout lhe year and continuedueuing and expressions of popular discontent remain al unusually high levels.

The marked year-to-year fluctuations in GNP growth-usually because of wide swings in faun

ToblK i

USSR: Indicate* ol Economic GrowiH

nnus) Rues olerceni I

secto-i

. 'i.r.

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end

j toiioo

Pit

-1

fixed

6

production am an added headache for0 annual GNP growth rates have been as high) and as low asxpensive program*to expand crop production in more weal her-reliable areas hare made little headway thus far. Moreover, the instability in agricultural oulput has occurredong period of unusually favorable weather;24 approximately half of the increase in grain production can be attributed Io belter weather. Even under these iclatively favorablehowever, (he USSR has had lo import substantial amounts of farm products.

The Problem ol Productivity

To some exlcnt, the general economicreflects lhe exhaustion of the factors that

lapid development, especially Ihc abundant supplies of labor and cheap, widely availabled oilier naturalore importantly, itecular decline in the growth of overall productivity. Growth inpci man hour slowed by nearly one-half betweennd the firs! half of the

. The productivity of addihons to ihe stock of plant and equipment also slumped.esult, overall resource productivity (outpui per unit of combined inputs of labor, capital, and lamh actually declined.

The reliance on mobilization of additional resources for ihc major share of economic growth has distinguished Soviet development from thai of other modem industrial nations. The level of factorell below thai ol (he US, Japan and most of Western Europe, in agriculture, which still employs one nul of every few Soviet workers, labor produc-(nnly is about one-tenth that of the United Stalesonsiderable extent, productivity levels mirror differences in levels of technology Slow giowlli ol productivity reflects slowin closing thi' technological pap wilh (lie West.

Over the past decade the Soviels have taken two important steps to try to boostgrowth First, they embarked on aspree in Western markets for machinery and equipment imports of these goods rosefrom JSIO million5 to roughly S5 billionecond, the Soviets maintained high rates of growth of domestic investment andarge share of it into agriculture and high technology indusiries, despite de-dining rales of return.

Falling returns on new fixed investment have led lo recurrent campaigns to reduce the amount of unfinished construction and upgrade technology. Nonetheless, the amount of output produced per ruble of fixed capital has declined steadily, estiecially in agriculture (see figure 11

Changes in the Economic Environment

Future Soviet attempts to hall adverse trends in output and productivity must overcomeproblems quite different from anything experienced since World War II. In addition to (he continuation of chronic difficulties related to low efficiency, several new problems will beset the rrpmc The rate of growth of lhe labor supply will be close to recent experience in the rest ofut will decrease sharply in the. At thu same time, the cost of obtaining raw materials will rise sharply. And in the case of crude oil. past improvidence will bringeriousThe USSR's economic problems will be further exacerbated if weather patient* rclurr. lo the harsher but more normal conditions lhat prevailed before tlie

Slowing ol Lnbur force Growth

fhe decline in birth rates in, already icflrctedall in lhe number of new entrain- lo the labor force, will become much more aculc iu Ihc early and, ihc ijrowlliopulation then will be less Hum one-hall percent annually compared

of Lew Favor.iblr> Weather lor Crops

It is highly probable that normal weather condition* will return after moreecade of moslly above average prctipitalion in thi* Soviet farm belt. About half of the increase in

i i '.

: "it- !i ii. .

ended with lhe severe drought5 II the climate in lhe principal grain areas returnsore nonn.il pattern, average annualwhile above the averageill be well below both official targets and actual requirements. This would furl her com-

forcing llie Soviets lo increase grain purchaseseriod of increasing hard-currency stringency.

fihtng Cma ofand Raw Materials

Fuels and raw malcrials will become more expensive for the USSR in the years lo come. Ores, fuels, electric power, and timber arc all being produced al increasing costs-largelyof the depletion of reserves west of the Urals and the costly effort to develop lesources in Siberia and Central Asia for the use ofindustrial areas.

Ore extraction is becoming more difficult andteady decline in tbe quality of Soviet iion ore has forced the steel industry torowing share of its invest ment funds to new ore mining capacity, facilities lo upgrade the ore. and sintering and pcllclizing facilities to improve the quality of the iron charge for the blast furnace.

In lhe case of oil, the Soviets face both rising costs and declining ouipul in the near future. Because the drop in crude oil output will haverofound effect on the entire economy, the outlook lor Soviel energy is discussed in more detail in the following section.

Energy

Allliouv.li the USSR has vast energy Ihc supply of oil will bc its mostresource problem. New deposits of oil are not being found and developed rapidly enough to offscl declines in older Fields.esult, produciion will begin to fall in therroduction of other major energy sources is being pushed about as hard as Soviet industrial capabilities permit, even wilh Ihe help of imported Western equipment. Thus, eveni -vp upnvestment allocations to the fuel producing sectors, growth of'..un will tv

Oil production has growner ycaiul will soon peak, perhaps as early8 and certainly noi later than theesult of this rapid growth,6 oil accounted for Ihc major

share of total energyercent of lhe total, compared withecade earlier (seeast year's production*. however, was close to the estimated maximum potentiale expect oil output to fall toon addition to the failure to Find enough new deposits to offset depletion, production techniques now in use-such as excessive waterfluoding focus on short-lerm gains al the expense of maximum life-ume recovery.

All growlh in oil output0 is to come from West Siberia, where Die inhospitable climate, difficult terrain, and vast distances greatly complicate operations.ne-fifth of national production came from tlie giant Saor field on the Middle Ob' River This field will reach peak production in lhe next year or so and will hold peak levels for no more than four years. Because of extensive watcrfloodmg. il is already experiencing rapid water incursionater share of aboutcrcenl) and increasing quantities of fluid (water plus oil) musl be lilted loiven quantity of oil. New fields arc being discovered in Wesl Siberia, bul no giant ones comparable

have been found.

The Urals-Volga region, currently the leading

in the USSR, probably willby West Siberia this year. In theUrals-Volga accounted forf total nil output. Afterearsmany of these deposit! areexhaustion and output hasoff and will soon fall. Sizableincreases were expected from lhethe Mangyshlak Peninsula in westernbuf because of improperand complex drilling problemshas noi risen nearly as fast as anticipated.

The downturn in oil production seemsprobably will bc sharp but its timing rs noi as predictable Although lhe discovery of new fields may arrest or slow ihe decline, such re-ipiles are likely lo bc temporary becauseol existing fields is now very rapid and exploration and development of frontier areas is

Percent

Nuclear

BOW and cosily process. To stave off or slow the expected fall in production, the Soviets will need high capacity lifting equipment involving US technology-gas lift and electric submersible pumps. Without Ihem, oil production will fall sooner ilian would otherwise be inc case.'

'l-TT tht USSH hitmattBboi ^1 oil full ul|inicnl and nil 4od jul pipeline

euuipmenl, ind anI billion lorpipe.am that SSSt) nip', ot itttt* 1

oe dewahatal Om HM(Iffl M) annuallpnml will(mreair timepipeline conmuelloei will Increio, and oiluipmenr orden will die ihaiply. Cai III' pmiecd lot .Sinndo4 PJelda-Mw itaakeSe-aalo*Mwa0 bdHna.

0*pn6irt( "inn Ik* abcr ol itm and hnlKpcrwd

reqaiieneii BV

We expect natural gas output to expand lo anf oil equivalentS-roughly double productionprobably exceeding crude oil output in caloric terms. The key lo growth will be the pipeline capacity needed lo carry large volumes of ga* from huge new West Siberian fields to IhcUSSR and Europe. Tlie main bottleneck will be high-capacity compressors; most of these arc imported from the West and have long lend times for negotiation, manufacture, and

Gai consumption will continue to increase substanlially in industrial sectors that arelarge gas consumers, particularlyWhile the possibilities for substituting gjs for coal have been all but exhausted, gas could be substituted for oil in some industrial uses, notably as fuel for industrial boilers. Household use of gas will also increase bul will not involve gas-for-oil substitution, since oil has notbeen used directly for heating or other purposes.

Coal production will grow slowly piobably at an average annual rateercent during the nextoears. The actual rale will depend Ijijylv on the speed with which the

Soviets develop lhe eastern coal basins This coal, though inexpensive to mine, is expensive to transport over long distances lo the main consuming centers and much of it is of poor quality. An increasing share of output probably will be allocated lo electric power produclion. in part lo offsetecline in fuel oil supplies

Beyond th, the USSR is un-doitblertly counting on laigc new supplies of oil and lhe development of alicrnativc energy sources-coal, natural gas. and hydroelectric power. Even ilources air ilc-velopcd. most ol these lie east of the Utah, far front major industrial and population centers, and their development will take years, require massive capital invest men ts. and incurhigh transportation costs Nuclear powci will consiiiuii- onlyercent nf national energy pioducltonS.

Even undet optimistic assumptionsfuture growih in ouiput of nonotl fuels, and assuming lhe middle case of the projected range of oil output, annual growth of energy output would declineercent5ercent.ercent. The demand for energy will grow much faster lhan this. The relationship between giowih in Soviel domestic energyEU> and CNP has been historically very dose. Assuming CNP growthercentercent. historical relationships yield a total energy consumption7.il consumption would be1* assuming currentpolicies for fuel substitution: that is, there will be no unusual efforts lu substitute other fuels for oilall lo building new oil-fueled thcimal power plants and theof coat for oil in some existing oil-fueled power pljnts.

The USSR cannot accept the consequencesustncss-as-usual program. If Moscowits present energy policy, oil output would dropillion to5 while consumption would rise lomore lhanis shoitfnll for hard-currency earnings and Soviet ability to supply oil to Eastern Europe are disastious. The implications for lhe economy If the shortfall were taken out ol' domeslit consumption rather lhan by shifting from not export! toimports aie serious. Energy conservallon is an obvious goal, but exceedingly difficult to achieve. Help may be soughl from lhe Weal.

Prospects for the Fconomy

LeaiUmhip Intentions and Plans

SorMl plans and apparent intentions foi the balance o! lhe scvenlics reflect an intent to

^Cfiiirihumoilit iim o' "i.

i*ii

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ew growth strategy and hones that major breakthroughs in productivity can be achieved. The leadership may believe thatprograms to improve efficiency willthe effect on growth of smallerto the labor force. We do not know what the Soviet leaden really expeel in the way of economic giowthong-term plan, promised for some time, has yet to appear, lite harsh realities of tlie resource situation inay explain lhe delay in part.

ubstantial departure from previous plans, theive-Year Planelatively low rate of growlh-bystandards-for industry (ft percent per year)arked slowdown in Ihc growth of new fixed investmentercent per year comparedercent per year) The current ptwi sharply curtails Ihc growth of new construction starts in favor of! (a) investing in advanced machinery and equipment,nd ireqiiipiolduicker and cheaper process than building on grccnficld sites, and (c) mechanizing activities such as materials handling, slill done manually in large part In this way lhe leadership Intends toconcentration and modernization at tbe expense of traditional patterns of expansive growth.

The leadership also plans to retrench in Ihe consumption sphere. The current five-year plan recognizes lliat Brezhnev's program to laisc per capita meal consumption to Western levels will

uiciKy oi ine Mivtci livestock iniluslry. Tins program has cost llie USSR dearly in grain, which must be imported at the nuipi The new plan cdl* lor4 percentotal meat ouiput. compared witherceni. Thus, even if Ihc plan is met. ih'i mixta meat consumption wouldittlehan

Wink- jjoah Io* defense are not announced. Ihe prcwil upward momentum ot Soviet de-

fense programs is likely lo continue. First of all. future Soviet military budgets will continue to be strongly influenced by programs already in motion. To maintain forces now jn being will require large and unavoidable expensesdeployment programs now under way in both Ihc strategic and theater forces and new weapons systems well advanced in theircycles presage additionalcommitments. When deployed, the new systems will contribute to higher operating and maintenance costs Although new programsold programs, new weapons are more complex and, hence, more cosily lhan those Ihey replace. This systeinalic increase in unit costs means that maintenance andof existing force levels leads lo ever-increasine expenditure levels. Moreover, cost escalation appears lo be much more rapid in the USSR than in lhe United Slates.

Institutional factors also support continued giowth of Soviel defense programs. The Soviets consider expansion of defenseajor national goal. The natural alliance between defense Industrialists andIcadeis makes il difficult in the short run to make major cutbacks of investments inindustries in favor of nondefense goals

Ii sum, the scale and pace of Soviet weapons programs show no signs of abating at Ihis time, noi an* Ihere indications of intenl to slow the gfOWlll ol military iniluslry or to reorderpriorities so as to lessen the rale of growth ot defense in favor of investment or consumer gcodi- Wc therefore expeel aol ilk*ercent annualefense spending during the nexl few years

PUns Still Overly Optimistic

less ambitious thanns in regard to productivity,lanircalisticaboulgrowth. The problem can be seen in lhe jccoiii|.jiiymg tabulation.

Annual Rats of Growth of GNP. Inouli. ind Productivity

rVWaaaaa Incraaw Ino Murium GhP Growthar cant

'0

.rf

5

1

implied productivity growthannually to meet planned growth in outputs twice the rate realized in;. productivity actuallylargelyonsequence of the bad harvests2

At the same time, dependence onpins is increasing because input growth is slowing down.otal inputs to the economy grewercent (seche annual growth in combined inputs dins5 percent, and5 toarried outhe calculation shows lhe yearly percentage increment oflo labor, capital, and land falling to little morebe converse of the falling rate of growth in the supply offactors to Ihe economy is the acceleration in productivity gains necessary to sustain growth of Soviel GNP. By way ofcrcrni growth in GNP requires productivity

tkaUitt-ilI-S4imMMr-ramlm ict un* Tlpit nor Jiaeui.

'ton-wl.aMw.

labor tad opaK tn dum. Math of IW

abaaa pUa crowth an labor n bSc pact

to nse by the percentage amounts0 shown in the tabulation. Nothing in pas! Soviet economic history suggests that an acceleration of this magnitude can bc achieved.

Some decline in GNP growth inrobably appears both inevitable and acceptable lo planners and high party officials alike.the Soviet leadership probably believes it canrowth of GNP of atercent per year iny pushingto raise efficiency. Even with somein goals for economic growth, however, the implied productivity targets are extremely demanding. This is especially so in view of threatened shortages of energy and otherraw matcriab-

Postib/lity of Material Shortages

Since Ihe, potential shortages of industrial raw materials could generally be ignored in assessments of Soviel growthThis is no longer the case. In al least two key sectors-steel and fuels-unexpectedin produciion could wreak havoc onoutput. Because Soviel planning istaut, the effects of shortages of widely used materials would reverberate quickly through the economy.

An immediate problem for Soviet planners is steel. Growth in output of crude steel, whichdlion metric tons annually since

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III

, droppedillion tons inand imports from Western suppliers ruse rapidly. In firs!roduction was actually below the tint6 level The lost production will not be easy to make up. Construction of new steel-making capacity has lagged badly.. less than 2Ions ot new uip.ieily were brought on

stream each year only half the amount Plannedesult, retirements of older,facilities have been deferred and operating leveb raised so high that routine maintenance

suffers.

As noted above, fuel supplies may wellthe pace of economic growth. If the plan

ncis do nol -dap! quickly lo the expected abrupt decline in oil liftings, severe shortages will be hard lo avoidecession could result

WImi llie Leadership is Counting On Wilh less reliance on investment and greater stress on efficiency,lan requires the Soviel economic system lo produce results quile different from any achieved in the paslears.reat deal seems to depend on better management, the measures proposed lo improve economic management have little

The leadership is on firmer ground, however, in expecting lhat labor will be used moreal the level of lhe individual factory and faim. Because of ihe wasteful use of laboi in the Soviel economy, some efficiency gains can be achieved under concerted pressure. The tightening labor market could be the catalystn labor productivity.

Indeed, lhe experience in industrya slowdown in growth oferceni per year comparederceni) suggests that Ihe process of forcing out redundant labor has had some success The average annual rate of growth ol output per industrial worker has increased as employment growth declined.ndustry is expected lo add fewerill.on newecade ago. Sovielwas adding more workers than this every year.

IVjno. JflIhr |

inln Uip aitu, MI ioni. Gaini hi flTMIi-iiti

ii.im Kitheen! llml (ai.SB)Nft>j am the

bflum. Mill ih.ii. lh.

CIIHI Ii.

Impnt'.Mny ind acornfchnolouiii>iHiH> IH mmiing plum.ma Im raK.nf Hit quality or pr.Kli.Ot '"I

lv.1tht Ihr

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Output o" Woikw

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6.7

6.7

One concrete approach lo raising labor pro dtictivity is the program to mechanize and automate labor-intensive auxiliary processes, such as loading and unloading operations. More than half of all industrial workers in Ihc USSR perform manual work, and this share Im been decliningnail's pace-about one-half apoint each year. Success in mechanizing Ihese processes depends on Ihe ability of Ihe domestic economy to turn out large quantum of labor-saving equipment, which often must be tailored to specific uses. Complaints are already being heard that many types of small-scale mechanization are not included in the plan and thai resources for their production are not being provided. Thus, wc believe that theof mechanization to productivity will (all short of plan.

lhe USSR also hopes to raise Ihe products ily of new investment. The plan calls for

shift in llie structure of invest men! in favor of equipment rather that buildings and

st rue lures

.'ediMion in Ihc backlog oft rest me nl in new plant and equipment

"ifi'i. ij|*rI assimilation and diffusion of imported and domestically generated

The ftivi two objectives, recurrent featuresher Soviet plans, are even less likely to bOOst productivity than in the past. The dunging sources of energy and raw materials and the uneven geographic distribution of labor force growih biggest chat fixed investment should not be focused at existing sites.oncs'ii-

tration on project completions could lead to imbalances in produciion capacity.7

The impact of imports of Western technology over the nextears cannot he determined. The Soviets look to the West primarily for advanced technology and equipment to help in Iheir niodcriii/.ation drive,ertain vitalsuch as chemicals and oil and gasWeslern equipment will continue to play an important role. The level of total machinery imports will riseime hut may drop precipitously if crude oil exports are cut hack.

The most difficult question concerns thcin-djrect effect or imporled equipment andImports from lhe Wesl have accounted forercent of total Soviet investment in machinery and equipment over the lail five years, and. once assimilated, directlyelalively small portion of the USSR's stock of fixed capital The payoff would be much laiger if the importsemonstration effeel that spread quickly beyond the immediate point of application through research, engineering, and produciion. Slow assimilation and diffusion ol technology have been widely noted tn lhe USSK,eries of decrees have endeavored to improve ihc performance of. and educational institutions in this area In view of Ihc slow progress registered thus far, it seems unreasonable lo count on aow tlie next several years

hc efficiency gains that Ihc Soviets may achieve in the management of labor,ami Ril) resources some importanttiends must he considered. Theosts ol o'jiai.nnj; raw materials already have

<vtout irj.nnati, Oaaavaau

IU*W

hi Ji-l. In 'til Iii mii Hut iho 'ir-iIM pUn din* nili<li' ImInt Hailing ami irt

v wj uSSHM

iiiwi) naflWbSl imvi-iKillmn lu imiilv <iil(ipf llm inipiilnlvaI.'x

been noted Transportation costs are rising, and in some cases like coal and ore. the rawmust be upgraded al great expense. When the capital cost of supplying intermediaterises the productivity of resources infinal goods and services tends lo decline. Moreover, the shift in investment needed to move the energy balance away from oil will increase capital requirementsroad range ot the economy, further depressing

ll, wc do not believe thai the Sovirt leadership can conlinue on its present coursearked slowdown in growth is to be avoided. The resource situation and the ineffectiveness of the measures designed to raise productivity will force the leadership to develop new policies.

Same Options far tlte Leadership Searching for ways to overcome the currents retarding Soviet economic growth, the planners willange of options. Tliey will haw io do something about material supply and could adopt some fairly stringent measures wilh respect to manpower and investment. Serious economic icform, while certain to be on Ihe agenda for discussion, is much less likely lo he includedolicy package.

Material Supply

Turning lo lhe problems raised by theof critical industrial material shortages, the iic.ii-term options open lo the leadeiship uar-rciv< down to conservation, increased imports.jllov.itions towardommodity like slcel, conservation has litlle slicrlrun potential. Steel import tonnage lias doubledainly in lhe categories in short suppb in tbe USSR law-di.imdci "inn

sto obtain steel in ihc West ins. Al ihe same (line, there is some room

foi saving 'iused in the production of tlie big ticket consumer durables that have been produced in increasing quantities in recent years.e less, over the longer termof steel or other raw materials need not last if investments arc directed wisely Although costing more, materials such as lion ore. timber, and nonferrous metals can be made available.

Ensuring an adequate fuel supply will be much more difficult. The USSR can offset some effects of the anticipated decline in oilby launching high priority programs to conserve energy and substitute oilier energy sources for oil Such programs would be costly and take time. Success is, moreover, far from certain. Central control over fuel allocations is as strict as in any country in the world, but large sources of oil saving arc more difficult to identify in the USSR than in the West. For example, the bulk of automotive transport in the USSR is for commercial and industrial use, whereas in Ihc West much is for private use, and onlyercent of total oil is used directly by households in the USSR comparedhe US. Asa result, opportunities for oil conservationould nol hinderare more limited in the USSR lhan in Westernigorous conservation pro-giam, however, would enable Ihc USSR to avoid widespread domestic oil shortages -al least in (he period before Soviet oil production slump* badly.

The greatest opportunity for oil wrings lies in Uic substitution of natural gas and coaleneration of electricity. At prewnl, about two-llurils ol Ihe residual fuel oil produced in lhe USSH is used in thermal powci plants. Cur-rciil plans provide that no new thermal power plants prodiKing only electricity-as opposed lo1 both electricity and steamlo use oiluel, and that low quality coal will be the primary fuel source At the _Sih Party Congress. Kosygin slatedumber of laige power plants in Ihe Urals andegions would be converted to burn coal instead ol oil. While lonvetsior to gas is 14

technically feasible, conversion lo coal isunless the plant was originally built to use both oil andubstiiution of natural gas will be limited by the level of gaiand demands of competing users Natural ps might be used in place of oil in some chemical processes. The USSR also has plans to begin lo use gaseous fuels, or liquefied gas, as fuel for motor vehicles, and some savings in use of gasoline and diesel fuel can be affected by substituting lighter plastics and aluminum for steel in motor vehicles

Wc judge that the USSR probably could saveercenl of the energy use projected on lhe basis of the historical relationship between GNP and energy demand. Thisighly subjective estimate, based on general knowledge in llie absence of specificSuch savings, if al) focused on oilwould enable the USSR lo cut oil consumption to by ompared1usi-ncswvrsualf produclion5 turns out to be in the upper portion of our projected rangeillion toi. domestic requirements could be covered. Even then, however, the USSR would lose lis exports of oil lor hard currency and would have to eta back oil shipments to its client states in Pastern Kuiopv. On the other hand, if production lallsuccessfuland substitution measures lhat reduced dcnivslL demandould no: prevent Ihe USSR from having toreat deal of oil or. its own accountcavurci

Iii the past, failure lo reach plan production goals has usually led the USSR to Mrs) li> to ,rul mots labor into industryivzn plan

f*>l oa Mslf

-r4 mm ibibcI* BM auaV>fa<oalia.

a IMSi -n IllriiovIS of 'Nl'ilial (V

ndlittle mmteat in So Ihr

specified. The above-plan cadres usually have been skimmed from lhe farm labor poof Since agriculture cannot spare many of the more mobile young people that it now has. (he authorities are now likely to turn to the service sector. By restraining the growth of services, where labor productivity ts relatively low. the manpower authorities can reallocate laboray lhat will raise avenge productivity in the economyhole.olicy, however, soon would conflict with Ihe influential body of opinion that argues for greater worker inccnlives to raise productivity Provision of more servicesajor part of Ihe program Io enhance ihc quality of life in Ihe Soviet Union.

As Uie manpower situation worsens, the authorities will have time to review and perhaps adopt policies to boost the rate of growth of manhours Older workers could be rclaincd by raising pension ages and lifting penalties for working after rcliremenl.10 More young workers would be brought into the labor force In ihj: education policies to restnet lhe numberll-tune studentseduction in lhe site of the armed forces would also make workeis available. Inasmuch as Ihe Soviels view milit.iiy consen pi ion as serving political, kJeo-lagicjl. .ind educational purposes as well as mililary needs,utback would probably take the formhortening of tho term ofhcrowering of the r ation talcs All of thesekencould postpone Ihe impending drop-olT in Ihe rale ol growth of the Soviet laboi force Still, nothing that lhe planners can do willonp and pronounced dceln'c in Ihc annual additions lo ihc Inhuilide Hut would not Ixttloni out until ihcQs (lll'i'U .'. on i S>

miiUitK. ., icr

eiii|ilutminl jiiinnrluili-ul-i'ird ptuleniiicul ind

WO norm i/.

n;Hii*iHrlriml pntnaBCt m

of i.itIk wMa oldo ind mmr rkpwwnwil

iKi'uiiii'l iBiHini miRh mtm.

While reviewing ways of increasing ihc size of Ihe labor force, the authorities will press efforts lo use labor more efficiently. They should have some success in ibis area. The majorfactors to "over-full employment" in the Soviet economy have beenovernment policy ensuring jobs for all who want them,endency on Ihe pari of managers lo hoard workers, and lc) an aversion on the part of policymakers lo the social and politicalof technological unemployment.ight labor market, hoarding of labor will he-come increasingly difficult and technological unemployment lessoncern.

Ponlbtii Investment Strategy

Responding to productivity shortfalls by pushing up Ihc rale of growth of fixed capital will not be easy in the short run. Oneapproach would be lo abandon the scheduled use in the rale al which old planl and equipment is retired.lanncrease in annual retirement rates from an averageercenter-ceni. Holding retiremcnl rates atevel would raise the rale of growth of fixed capit.iltile lessercentage point, although the penalties on productivity in terms of increased obsolescence would offset some of lhe positive effect of having more capital

Alternatively, capital slock growth could be stepped up by increasing imports of machinery. Wc believe, however, that Ihc USSR will hive trouble reaching the goals for foreign purchase* implied in (lie plan large ts for growth in the votiune of loreign trade, and therefore in ihc eMstsng invest ment plan. In any event, because of lhe Ions lead lime required bclwccr. Ihe placing of orders and thr delivery andof new foreign machinery, ihr growth of Ibe stock of plant and equipmeni by stepping up machinery purchases isiable near-term alternative.

A harder policy decision would be lo reorient domestic capacity Tot producing machinery. As production of consumer durablesmall though increasing share of total machinerya large cut in production of passenger cars, refrigerators, electrical appliances, and the like would br icq uired to have much Impact on the production of machinery for investment. It rs highly unlikely that such large-and politicallyuts in tbe ouiput of consumer durables woukf he made.

Aof defense industrial capacity toof investment goods also would beto the leadership and difficult to effectime spanew yean The

Soviets consider defense industrial capacity at least as important as military forces in the field-indeed, more important in the long term. And they know that the Soviet economy is less effective than that of the US in marshalling technological resources in an emergency.because of their specialized nalure, such resources could not be transferred easily to civilian purposes on short notice. For these reasons, wc believe it unlikely that the Sovieis would divert weapons development resources or defense production capacity or abandonor deployment programs currently under way. They may. however, be willing to stretchcsrch and development proyani. and production schedule* and slow tlie >ale of expansion ol defense-oriented industrialthus releasing some materialnd oil ui rcxiu'ccs thai can be used for iivjlun prtKliK-liiMi. Passing into. Ihc pins-peeloir; period of resource constraint could incline the fcradciship to lakebantn look ai defense. Arms limitation agrvciiKnls that saw more than marginal amounts ol iv sourw lutein iIkii he ;ivcn greater wci|,'ht in Soviet policy than they appear lo have al presentuch agreements were icached. savingsinto investment could riseiibsiaoii.tl level by IV'O. (The coiifvqufiu.es

I.,

of an agreement leading lo fairly deep cuts are explored further in Ihls paper.)

Economic Reform

A thoroughgoing reform of the economic system could boost appreciably the efficiency and quality of productioneriod of years But lhe Politburo correctly perceives that reform threatens its political control The most radical reform conceivably acceptable would be some kind of market socialism, which might alsoarger role for private enterprise in agriculture and services The obstacles to refonns of this kind are thorny. Introduction of markets and expansion of private activity would entail compromises with ideology, and markets, if effective, would replace bureaucrats and hence incur resistance. Economic reforms would threaten the entrenched positions ol" both slate and party bureaucracies and weaken the Party's grip on Ihe economy. Moreover, the transition to markets could cause unemploy-menl and severe disruption in Ihe short run. Therefore,erious breakdown in the economy occurs, changes in planning andare unlikely toactor in stimulating economic development through

Outlook lot EconomicSouk Policy Conditfoned Projections

Shkc the development of the Sovietwill depend increasingly on how Die leadership responds lo lhe emerging energy anil manpower problems, single-value foictasts willdo Therefore, we will present threeiftiiu ol the growth of CNP-each tnJ to jacl of economic policies lhateislnp mighthe first isim- raw. It assumes thai lhe USSItvoiding economic dislocations altnbulahk to^ ii fuel and othermain ahrv* nuiliirrz to accelerate the rale ol giowth ol

k'c jiii* "Ji* cwili'llun u' ill* miili(iilnlii|ii nni in

(nnwtltK

investmenl or to increase participation in the civilian labor force. The second casesusual case in which Ihe leadership fails to act decisively enough to prevent fueland other supply bottlenecks fromproduction and docs not adopt measures to spur investment or Io offset the effects of demographic trends on Ihe labor force,hird. besMase scenario we assumeimely reponsc to energy and raw material problems a'ld energetic policies toresources from consumption and defense to Investment and pull more workers into the labor force.11

Bitr Lint Caw

Should Ihe USSR manage to prevent fuel and raw inalcnjl shortages from interfering with production-while holding to present invest-

IbtMJ'i poi ut taunt tOniiU th* range ol noulblc polio- cooiDinMumi. Wc wou'd uncut. howc**i, thaibvii-rcuMi.ntuil .ndcaws itpiotm >boul ihf worn and Ixsi

[till Ihr Sovitik cniihl j0 In jnfluclKing ttoniHnK giuwiji

merit policies and accepting the impendingin the rate of increase of the labor force-GNP growthnevitably trend downward, following tbe resource curve inroduc-tivily gams probably would bcper year, resultingale of growth of GNP ofercent per yearercent per yeariableigher rate of growth of GNP than the range shown inouldebound in productivity growth lhat scans highly unlikely, given recent experience and Ihc assumption of no fundamental change inpolicies. On Ihc other hand, if supply bottlenecks do not appear, productivity should at least increase, even though slowly.

The base-line caseey aspect of the USSR's economic future. Growth will almosl certainly Uper off even if the leadershipolution to the predicted decline in oil produciion. The rate of growth of GNPercent2 pcicent projecteds unprecedented in postwar Soviet history, und

r i

Pol icy-Condi lotted FiHtoam o* So-lm Growth

Avn^g- Annual Pccunuea Rate* ol Growth

hi,.

fttr

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BnwiHt

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and Invniraunt politico

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continuing fall in Hie rale of increase of Inputs to trie economy suggests that normal GNP growth could be lessercent per year in the later part of.

Bulls-Usual Cue

If the USSR fails to limit the damageownturn in oil production. GNP growth could fall off abruptlyhe projection puts tho transition ineriodoil production may drop in the next few years. In the busmess-as-usual projection, the effects of fuel shortages (perhaps reinforced by shortages of other raw materials)ecline in the level of theof factor inputs. Kaclor productivity has decreased in certain years because of bad crops, but the pervasive and continuing effects of shortfalls in fuel supplies could easily shut down some of the USSR's productive capacity, lndresl, over the courseear or two. before adjustments can bc made, the effeel onmight well be larger than wc have1 *

Realistically, business-as-usual could not last beyond ihc first lucl crises. The urgentreallocation, and substitution measures thai would surely be enforced would ultimately bring relief. Nonetheless, if die first dislocations were felt in tin- middle oferiod, GNP growth probably would noi riseercent per year during the4 The recovery in productivity would partly offset lhe steadyhe laic ol increase of inputs to the economy

"luJ*

rBtixu It iw "mwl'iiH ml fitiwla mlir! Hifrni pn it*i.-iof lotali nuilr

VIHIIJ IliHB III ' in - t VSM

Iii InI' iiiiioo ill i. viii fv vh|f -I'i (il.

la tba pteardaua

wl theot CTt. ia Ik* iSsatstSSSI

A-iitaal umaiih tlie Intra codiogr nl

ouipul,

Fldl Case

Because Soviet growth potenlial falls steadily from now through the, the leader ship will come under increasing pressure lonew policy initiatives. Tlie leadership's choice of policies and the success of these policies can only bc guessed. We bebeve.that assuring an adequate supply of energy is by far ihe most desirable palh lhat the USSR can follow. As in the base case, we assume lhal energy isonstraint. Next, the USSR will my likely search hard for more investment and labor resources if its hopes for productivity are disappointed. To test the possibilities in (his direction, we have specified two combinations of policies that Ihe Politburo mighl adopt in (he nexi few years, to take erTeci in.

(a) The first set of measures focuses onBy freezing the level of military(acquisition of hardware and newat Ihc0 level, sums rangingillion rubles1 loillion rubles0 could be added lo new fixed investment. At the same time, thewould probably iry to lake something from the consumers as well. Consumer durablefor example, could be cut back from piesenl levels by amounts increasingillion rubles0illion rubles. The effect of these policies on inputs to the economy is shown in figurehc growth of capital stock and lotal input* rises onlyen0 the increase in combined inputss nil ol ihe higher investment isercentage points hiflwr thin in ihc base case.

ihlecond option, we assume ih.ilsupplements the investmentabovetrenuous attemptthe labor force. ihe armed forces arc paredillion men0 lo ihu I 'h-

Isc Civilian participation in'1 SSR .outii

ear-olds into the economy by reducing

or. w

higher schools.5 lhe impliedrate f'oi this age cohort rises (o somrwh. i

in thend

lo jr.duce higher employment in the oldei acethe leadership would have lo raise ike it-tireiucni ajte or induce retirees to return to work. The result of this doubleis an average boost lo the

of input growth of aboul one-half of one percentage point. Nonetheless,illion more people would be workingS under this option than in the base case.5 the employment growth rate drops back to about the same level as the base case.

Fmuloymcnt. however, continuesubstantially higher level than in the base case

The economy's response lo such measures (tableighl seem paltry to the planners. The two options combined boost (iNP growth bv

ercent per yearwilh the basehe investment and manpower policies have not lakcn hold, so the projected growth is the same Si in Ihe base case. After thehe effect of the manpower policies on growth has been spent, while the impact of raisingallocations is too small to make much difference to ihc growth of inputs. The trend in productivity therefore determines Ihc course of the economy in lhe, leading to GNP growth of2ercent per year -again, as in ihc base case. Projections, by no means precise, depend on assumptions regarding productivity. We believe the Soviets will be lucky to achieve productivity gains averaging one-half of one percent per year and thaiIn younger, untrained workers and reliiecs would lower the rate of increase of productivity, compared with the base case.

Good'til Aitesimw.1

These illustrative projections of Sovietgrowth do not exhibil muchange, aside from the case in which the leadership fails to react quickly enough lo forestall serious shortages of energy and basic materials. For example, as indicated above, such shortages could occur, from the demand side, if Ihere is Utile or no energy conservation or. from lhe supply side, if the outpui of energy falls to the lower end of ine expected production range. Undci these conditions growth in GNP might be limited lo as link*ercent per year.

Somewhalomparison ol ihc .ilicfn.it iw policy packages suggests thai the leadership cannot have much influence on the rale of growth of consumption either. Con-Sumption is lhe residual claimant in the dislii

mibv*na Dr mm pttt$ui mmoiiMroilon profiimi rkSSsU tupi-on

pii<vin In OMPtSl 1 per iii- ind ul M

hi btuH4IUIU.

button of GNP in the different scenarios and by far the largest claimant. Since none of the three choices-leaving investment and defenseboosting investment, or increasingand the labor force-alters GNP growth much, lhe growth of consumption varies between the base 3nd best cases by not moreercent per year throughout. Thus, il is doubtful thai thewould be interested In this sort of defense-in vestment-man power trade off.

On ihe other hand, the slower growth of GNP associated with persistent shortages of energy, and possibly other basic materials, wouldrowth in per capitaof onlyercent per yearnd an absolute decline for Ihc balance of, compared with an increase in per capita consumption ofearcrcenl there-aflcruccessful energy policy

Under these conditions, the inevitable rise hi wages over the nextears combined with the slower growth in the availability of conMimei goods will result in inflationary pressure and increasing fruslralion for the consumer. Tbe Soviet consumer is relatively content as long as some improvements arc made. However, if he is forced to experience an extended standstill u. living levels, this could affect subslanlull) in-erntives and productivity and cause public unrest.esult, it is clear that to maintain an economy healthy enough to preserve domestic stability, the leadership mustaw materials crunch.

Implications for Foreign Trade

The USSR's growing economic problems will hil Importi from the West especially hard. Al though such imports are small in relation to Soviel6 percent. Ihey have been increasing rapidly. Imports of machinery und steel have been especially important to the Soviet economy, and. with increased stress on

raising productivity tile need for Western goods will become even greater. The problem is that the USSR will not have the foreign exchange to meet these increased demands. The expected fall in cmde oil production threatens to squeeze severely Moscow's capacity to import Western manufactured goods.

Under any but optimistic scenarios for oil production, and in the absenceighcampaign to save oil domestically, the USSR will shift from earning to spending hard currency in its oil trade. The difference belwcenasndthe projection5 that assumes no unusual conservation efforts)illion7 prices, more than the USSR's6 hard-currencyubstantial rise in real oilhich is likely to occur al the very time when the USSR iset oil importer, would further increase the

'*CompriiMts IS mill.ur PtMfjtMuropt

in bM 'ui Jomialli loiiaymplion (Ih*1 nd pio

jKlcd productionn eafllri CIA itwly. -Ih* IniCfTikiloml lit tin SiCoirlon; Outlook- lopril etilmaic* combined Sovlai andiinipe ail impomSillion bM rimooiiilenlth the base line InW* mad* In thain Ui* aau-mpiion trial th*Union naliM notalafroM lo on oil.

diffecvnce itariwi ealloialelRoanaOia aod Varnlnii wbM IfeoB* in A*mt Miim Ibex(uwalfMa. iiaU

'. aii no! uatalcHt clNart fo*pwrai^Ati

D, Ibe USSR ooaNO UK ap IJKif firf

tic'vin rttit nai* *Uvaoaa*m'oareiiu abotii nlh* USSKi cancel oat If KnnuaUa aodKlndtal. ibr

(uiichI haw line limw m ole Hi ihc

nf lh* nit- in Ihc raj'ller paper.

t.'nhli the tifiic'' RfMM MBtHaBpouibte Impact o'nciy> np du<ew Suviet pnlMin. With additional rnciii urinalcn-rni.all

inil. lb* USSH willop.I

it'lni. orvlndinx Hnnuiila mid Yufoalaxa.

"ihai the pi.c- or nil ilwi dative to pit miorta and

other ir>poi(i

hard-currency drain. To offsethift, non-oil Soviet exports would have to more than quadruple in real terms in eight ycan-antask.

Thus, Moscow will take steps, if necessary, drastic ones, to protect its ability to continue importing high quality manufactures and high priority foods from the West. Such steps would include all-out attempts to push nonoil exports, and reductions of oil exports to Eastern Europe.

Potential for Increasing Exports

The USSR will probably lind it impossible to offset the hard-currency shift in oil trade by expanding hard-currency earnings from other sources. If exports behave as they have in the past, Soviet nonoil exports should increase al an average annual teal growth rate of about 5Exports of wood and wood products Ithe second largest hard-currency earner,0 millionre expected tooercent annually in real terms. Soviet limber harvesting problems will inhibit larger increases. Diamond exports, valuedhould maintain their strongtrend. Coal and cokerobably will not growuntilhen new Siberian mines are opened. Exports of platinum-group metals, which have fluctuated annually by as much0 million, were valued at0 millionhey should increase over the long term in part because of Iheir use in poSulton control devices. Prospects for manufactured goods, valued al0 millionrt beansli: the Soviets themselveshat export prospects are pool.

iri inunction* refer only tononciliidf><

(liiM ind aim ace trclled'low. TheiK.ru an

towd on lal tieiiicttal lelailoninipi between Saviet oivint jiiC

'AtM.cn iiiduiliial production anil tW likely liendtlCktem Inoi.

2

New export earnings from compensation agreements already signed will boost annualgiowth by several more percentage points from present levels. Natural gas exports to Western Europe will rise0 millionS lo more than S2rices)xports of chemicals-especiallyand wood products, coal, and me lab will add another billion dollars to Soviet exportsnother new source of hard currency is uranium enrichment services, which should0 million0 million annually lo hard-currency earnings beginning in tho.

In light of the above, an average annua) giowth rateercent seems appropriate for nonoil exports paid for in hard currency. An aii-out Soviet effort to expand such exports (again excluding gold andombined wilh more favorable economic conditions in the West, could boost annual export growih lo roughlyercent

Earnings from gold sales should increase steadily, bul rapid expansion will probably be limited by market conditions in the West.decisions alieady made indicate aSoviet commitment to increase goldwhich is expected to rise fromons6onsven if the USSR should market most of its gold production, wc estimate that annual earnings in real terms would increase onlyercent.oviet gold sales were approximately4 billion. The USSR also could boost production and/or sellortion of itson gold reserve in an effort to boost earnings Soviet willingness to markedly expand sales will be tempered,by the adverse effect heavy Soviet sales would have on the market price for gold.

Hatd-currency earnings from aims sales arc substantial (an estimatedillion,

and have potential for growth. With aof Ihc recent trend towards higher prices for moic sophisticated equipmentising share of sales for cash, real earnings mightas much asercent annually.

Although Moscow will wish to continueajor share of machinery andimports through medium- and long-term credits, it will find it increasingly difficult to do soevertheless, existingand (datively easy credithe West suggest that the USSR should be able to increase drawings on export credils by upercent (in ical terms) annually.

0 at the latest, ihc expected decline in Soviet oil exports will cause increasedin the West about Moscow's ability to increase ils foreign exchange earnings and manage ils debt. Substantial new credits are likely to depend upon Soviet willingness to undertake laige compensation deals,in the energy sectors, that provideof future export capacity. In any case, growing debt service will virtually eliminate any (jvorable impact that more credits could have on import0 repayments on past debt will exceed new drawings.

Soviet oil consumption policies willar greater impact than the availability of new credits on Soviet import capacity in. An oil conservation program lhat5 resultsercent reduction in overall energy use and some substitution of other fuels

rftard aa

asm o* tasfflatsMaimm*orh* Weil liin hart lull

(Liai on hard curnair tor mpurU. aapiadtrif 01

harxitt lopagBfltH ptnpofU Br* UHUl U>

M-crn Si ii J.SIntlior. annually.

for oil seems plausible. Together such programs would result in the savingsf oiloughly S3 billion7 prices.

More importanl will be Soviet policyregarding exports of oil thai do not earn haid currency.6 such foreign sales came. two-thirds of which went to Eastern Europe. Declining oil production will probably cause Moscow to terminate oil exports to such customers outside of Eastern Europe. More importantly, it will force Moscow to weigh carefully the tradeoffs betweeneconomic support to Eastern Europe and trade wilh the West. Soviet oil exports to Eastern Europe are scheduled to riseiversion of overillion? prices) from hard currency oil markets

We expect that Eastern Europe will be forced to share the burden of the Soviet oil shortfall. If ihc Soviets cut deliverieso lhat5 deliveries were only one-half0 level, the East Europeans would have lo turn lo the Wesl to make up the shortfall. The bast Europeans alieadysrom hard-currency countries valued at0 million annuallyercent of total hard-currencyssuming lhal the Kjs( European countries take no additional conservation measures, their hard-currency oil imports could risehat would COM lhe East Europeans7 prices, and more if Ihe price of oil increases- as we expect. An oil import hill of this iiMj'iiliide (about one-fourth o' estimated hard-currency imporls) would eul into Eastern Europe's ability tn obtain critically needed materials and equipmentloomy prospect in view of Eastern Europe'son such imnoits to sustain growth

The East Europeans will lake steps to ease the oil crunch but these will have limitedoost in exports to the West and massive conservation programs would help but. in lurn, would require more imports from then the final analysis, the East Europeans would be forced to cut economicecline in growth from ourateercentercent would reduce oil demandnd lhe oil import bill byS2 billion. The reduction in economic growth would force the Fast Europeans, and ultimately Soviet, leaderships to engageelicate balancing act between maintaininglevels and satisfying consumer

Soviet Hard-Currency Import Capacity

Die range of uncertainly regarding future oil production and consumption and lhe extreme sensitivity of import capacity lo alternativemake il difficult lo pinpoint I'uluiccapacity. The interrelated nature of the assumptions, however, narrows Ihc range- of forecasts. For example, if Soviet oil production falls quickly and early and if the woild oil prices rise rapidly, Moscow would probably stress conservation efforts and be underlo make substantial cuts in exports to Eastern Europe.lower decline in ol production coupledlower rise ir. world oil trices would reduce lhe need I'mh mcdsuies.

Our projections of future import capacity were derived by combining scveial assumptions.

Moscow pushes oil conservation hey ond

"Hulk ihr

hrtuli nn tedtern fur nUird n art mO

Im lonHmiid fMfiy.

current plans,ercenl savings in overall energy use

Nonoil exports, excluding gold and arms, increaseercent andercent annually.

Gold and arms sales will grow in real term*ercent andercent per year,

Oil produciion falls lo

The real price of oil remains at current levelsnd rises by up toear.

Soviet oil exports lo Eastern Furopeither remain at the0 levelr are progressively reduced lo one-half0 level.

Under ihesc assumptions, Soviet importin real terms will peak0 al billionillion and will fall by

o between S3 bdlion and Sll bdlion (see

The fall in import capacity will force the Soviet leadership lo make hard decisionstiailc wilh the West. Wc judge lhat:

- Imports related lo energy conservation and production will take precedence, as failure to obtain such equipment and technology would only exacerbate Soviet oil problems and increase Soviet hard-currencylor oil over the longer tun. "Under1 'i aiiinitptKtciiraipMI in oil ptudiK*

Unit ji-rl minurni'i.<pii airxl puwth.landfattm.Mhardii. in Oh ISICH willan (iti

ib MUUin mIn Sib Nil ion inl

Tkni bdUv" trm Iban lit* CSSR aaj Km***

e Ian*man a* iMicauiht aral

O.iii.nil unnunlly IxUS.

Imports of consumer goods andfoodstuffs probably will be cut drastically.

Imports of planl and equipment designed to increase future export capacity will have priority second only to energy-relatedand Soviet reliance on compensation deals guaranteeing future export earnings will increase.

In order lo encourage Westernin compensation agreements and tolhat energy resources arc exploitedand rapidly, the USSR may have to acquiesce lo Western demand for profit shat-ing, equity ownership, and onsitecontrol.

Political Implications

Soviet economic problems over lhe nextears ot so will become highly complex and noi susceplible to quick and easy solutions. As Soviet leaderselter perception of lhe resource problems ahead, choices amongpolicy options will become abrasive issues in leadership politics For example, alack of success in coping with Ihe energy problem could leadolicy crisis and pressure tot changes wilhin lhe leadership.

Soviet responses lo economic problems will be severely complicated by ihc fail thatiu lhe political leadership, which has been quite high over lheears since Khrushchev's fall, is almost certain lo weaken duiiiu?period. Hre/hnev's vigoi and stamina areuestion: his senior coBcag^tes are Ml age or older. The controlling group has been limid in its appioach to economic reform, and lis timidity has grown with time,5 reforms were only partially implemented, and

25

An all poet Ol SIZ-StMunelTi uted undw tin hluh tc.ii.ilo white 'ot the. with jn.

new constitution's emphasis uponand parly control testifies to Bre/hneVs consirrvaiism on these matters

Cautious economic policies arc likelyeriod of transition to it post-Bre/lmev leadership.ew leadership has

finally established itself, it is more likely Lhal policy options, which were considered andin the past as too contentious or lucking in urgency, will behance. Foi example, new leaders might bc persuaded lhat basicnn and management reforms inunit an expansion of Ihe private sector ;n

agriculture are necessary. They might alsoother options such as acceleratingat the expense of defense or consumption, or reducing the armed forces to enhance the civilian labor force.

The leadership may be spurred to action by the growing potential for consumer unrest as this sector is squeezed by both defense and investment in the competition for the nation's resources. Consumer expectations for andiet already have been disappointedof the poor harvests2n unfavorable climate change combinedard-currency shortage couldegree of belt-tightening unknown since theyears. Having justecade of relatively rapid growih in levels of hvrng. and expecting continued growth in the next decade. Soviet consumers will be doubly disappointed. They have, of course, learned to bearbefore, and the key unknown factor is whether another round will finally impact adversely on incentives and labor productivity.

Economic pressures lhat mightajor political reassessment will depend nol only on domestic factors but also upon externalespecially Soviet perception of Ihe international "correlation ofestern economic health. North-South and Atlantict ions, OPEC and oil prices arc among the most important factors lhat will enter into the equation.

The West's icccnl economic troubles enabled the Last lohe giowth sweepstakes in Ibeul, becauseower-than-nonn.il demand lor the East's exports, alsolhe Bloc's debt to Ihe West. Despite beiier Bloc export prospects arising fiomrecovery, most of lhe problems relatedurther expansion of economic relations with Ihc West, including Ihc debt accumulated, will

IV .HI1.

In the meantime, the decline in Soviet hard-currency import capacity-coupled with aneed for imports of Western grain, key industrial materials, technology, andlead the USSR lo look to new sources of foreign help. As indicated above Ihe only viable option would be massive Western government-backed, self-liquidating credits for large joint ventures such as those proposed for the Yakutsk and North Star LNG (liquefied natural gas) projects. Wesl Germany, Japan, and olher Western industrial countries can provide substantial amounts of capital, technology and equipment, bul US participation in such projects would almost certainly be required both because of unique technology and to spread financial and political risk.

The Burden of Eastern Europe

In deciding how much of the burden of rising costs and declining oil production Eastern Europe should bear, the USSR will have lo be careful not to push its allies too hard lo gain economic relief for itself. Reducing ils oilto Eastern Europe will forcepend scarce foreign exchange to buy morehe West at the expense ofand industrial materials vital for economic growth.

Moscow would see economic benefits from an expansion of East European trade with the West and lo join potentially helpfulorganizations such as the World Bank and International Monetary Fund. Western direct private invesimeni may have lo be ac-ceptrd to help Eastern Europe deal wilh its hard-currency problems.

Communist Oil Policy in the Middle Fall One maior modification of Soviel policy in thejt which has already begun rs likely to become increasingly important as lime goes on. Tins is the degree of emphasis given by the Soviet leadership to using arms sales,in the Middle Fast,ard-currency

earner, as distinguished from using themoss leader Tor purely political purposes. As Ihc economic function of arms sales becomes more and more vilal to Soviet interests, the Soviets are likely to become proportionately avid in seeking customers possessing hard currency or

its oil equivalent. This new economic interest -superimposcd on the old political interest in using arms sales to supplant Western influence-is likely to reinforce Soviet disinclination to enter into international agreements reslricting such sales.

APPFNDIX

Forecasting Soviet Economic Growth

forecasts of Soviet economic growth relyombination of econometric techniques and analytical judgments based on previous trends and patterns in Soviet economic prrfor-anoe. Central lo the analysis in this rc|>orl is the aggregate production function. Afunctionelation between inputs-usually capital, labor, and land-and theoutput or production. Production functions of one kind or another arc often used forforecasting. In forecasts for the USSR, both (he general form and the preciseof the relationship between output and inputs have been assumed or specified bywith Western practice.

ariety of production functions were Investigated, the aggiegale production function used in this paper was the generally accepted Cobb-Douglas form:

where

in man-hours

slock

factor productivity

The coeilicients b. c, and) represent the distribution of labor costs (wages, otherand social insuranceapital costs (depreciationpercenln fixed capital net otnd an assumed laud rent. The lad that thesesum lo one involves an assumption ol constant returns to scale, thai is, proportional increases in all inputs will yield proportional increases in output. Tlie distribution of these (actor costs in producliM was derived fiom the

NP accounts lor the Soviet Union. The share of labor was computed8 pcrcenl, of capital2 percent, and of land

percent.

The combined factor productivity term. A, is inesidual factor. It includes allor decreases in production which are not explained by increases or decreases in theinputs of capital, labor, and land. This term incorporates primarily new technology, qualitative improvements in management,engineering, health and education of workers, and organization, changes in output mix or material inputs, good luck, and anything else noi accounted for by quantitative changes in the primary inputs

Tbe quantitative changes in primary inputs used in the production functions computed for the study are graphically portrayed innd 6.

For Ihc. periodhe GNPutilizes planned increments to inputs and the assumption that factor productivily willpasl (iciuls quite closely, The forecast growth ralecrcenl pers consistent wilh an aggregation of individus' forecasts lor lhe various sectors of the economy (for example, indnslry anderivedariety of econometric and analytical techniques.

For ihche forecast is based onaboul the growth of inputs and combined factor productivity since no plan is available for these years. Labor growth is based on analysis of projected demographic trends. Growth ol capital stock is more difficult lo predict because of changing Soviel strategy for capital formation. The growth rates oi

capital portrayed inssume that investment continues to grow al lhe relatively low rate plannednd thai some success is achieved in reducing ihc growth of

unfinished construction. The growth rate of land is held at the rate plannednd reflects the effect of Soviet land reclamation programs.

Original document.

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