THE EFFECT OF PRICE INFLATION ON 1968 SOVIET EXPENDITURES FOR DEFENSE AND SPACE

Created: 10/1/1968

OCR scan of the original document, errors are possible

Intelligence Memorandum

The Effect of Price Inflation

8 Soviet Expenditures for Defenseace

Secret^ _

ER5 SR8

CENTRAL INTELLIGENCE AGENCY Directorate of Intelligence8

INTELLIGENCE MEMORANDUM

The Effect of Price Inflation on aB Soviet Expenditures for Defense and Space

Summary

Tho major price revisions established by the USSR7 probably account for aportion of the large increases announced in8 defense budget, as well as the science budget, which includes funds fornd all space programs.

If the price changes are applied to CIA estimates of8 expenditures for defense and space that are in terms of previously established fixed prices, they indicate an inflationary effect ofillionillion rubles, orercent of total expenditures. Price changes probably have8 expenditures for militaryand basic materials byillion rubles and outlays for military equipment byillion rubles.

Note: This memorandum was produced solely by CIA. It vas prepared jointly by the Officee of Economicand Strategic Research.

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Introduction

In7 the USSRefense budget87 billionronounced increase over5 billion rubles announced At the same time, it was announced that the science budget, most of which is used to finance military andrograms, would increase byillion rubles Although the announced budgetary data have limited utility for measuring the Soviet military and space effortof their incompleteness and lack of detail, the reasons for major changes in announcedsuch as8 increase are importantin assessing actual trends in Soviet military and space programs.

In addition to funding genuine increases in military programs, the rise in the budget couldthe transfer of defense-related expenditures from other budget categories to the explicit defense budget. No evidence of such transfers8 has been uncovered thus far, ise in the defense budget could also be explained by price increases. In7 the USSR carriedeneral revision of prices that appears to have significantly affected the prices paid by the defense establishment for materials, construction, and equipment,

memorandum considers theon the nature of thericeits likely impact on the prices of militaryservices and estimates the effect on theof Soviet expenditures for defense and space

General Features ofrice Revision

evision of enterprisein the USSR was concentrated in the branches

of heavy industry. As announced, the general features of this revision were: (a) sharp increases inprices for the products of branches producing raw materials, particularly the previously unprofitable iron ore and coal branches; (b) smaller but still sizable increases in prices for the products of heavy machinery branches where raw materials and

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other materialsarge share of total costs; (c) still smaller price increases for products that require relatively few inputs of raw materials; (d) unchanged prices for machinery productshole; and (e) some reduction in prices for theof such machinery branches as instrumentradio equipment, and electronics where raw material costsarticularly small part of total costs.

specific price changes announced bysuggest that the cost to the militaryof purchases of basic materials (such asmaterials and tires) increased and that thefood and clothing did not change significantly as

a result of price changes. With respect to military hardware, the announced changes suggest that the cost of heavy equipment rose and that of highly sophisticated military equipment such as electronics and radarprobably decreased. In addition to the judgments that can be made from announced price changes, analysis of data on the profits of ministries producingindicates that prices of military hardware probably rose significantly on the average, thereby boosting overall expenditures for equipment purchases.

increase in Expenditures for Materials and

estimated net increasepace expenditures resulting from price changesmaterials and construction isillion rubles. This estimate isdistributing the CIA estimates of Sovieton such categories8 (in constantproducing sectors and then multiplying theby the announced price changes forcategories. The results are shown in Table.1.

-SECRET "

Table 1

USSR: Estimated changes8 Defense Expenditures for Selected Commodities and Construction Resulting fromrice" Revisions a/

Average

in

(Million Rubles)

Construction wood, and

paper products

Rubber products

Nonferrous metals

Construction materials

Ferrous metals

Processed foods

Other

bj

The categories included accountillion rubles of the total military-apaoe expenditures of aboutillion rublea estimated. Baeed on unrounded data.

Increase in Expenditures for Military Equipment

The net increase8 defense and space expenditures resulting from the changes in prices of equipment is estimated to beillionillion rubles, uncertainty about much of the data used to calculate the price changesrecise estimate, but it appears likely that the actual increase in expenditures would be closer to the high side of the rangeprobablyillion rubles.

The most important inputs into the estimate of price changes are calculations of the profits before and after the price reformof ministries responsible for producing hardware. These profit calculations are derived from published Soviet data giving the profits earned by individual industrial

SECRET

ministries during varying periods. The published data list by name all of the civilian ministries producing basic materials, food, and clothing as well as all of the ministries producing primarily civilian-type machinery and give total ruble profits for each ministry. Eight defense-related ministries plus several others are omitted, but the profits earned by them can be obtained by subtracting the profits of listed ministries from total industrial profits.

9. The comparison of profit data for the first five months7 and the first five months8 (before and after the price reform) inhows; (a) increases in profits in ministries producing basic materials, food, and clothing consistent with what is known about theevision ofprices; (b) ercent decrease in profits of the listed (civilian-oriented) machinery ministries; and (c) anercent rise in profits of the residual category, which includes the ministries responsible for producing military hardwareDefense Industry, Aviation, General Machine Building, Medium Machine Building, ship Building, Radio Industry, Electronics Industry, and Machine Building. Compared withperiods6he divergentof profits in the civilian-oriented machinery sector and the residual sector following the price reform is striking.

10. If production costs and gross output increased in both the identified group of ministries and the residual group of ministries to the same extent, then the divergent profit behavior for the two groups would reflect divergent changes in the average prices of their products.* The increase in total production costs for the products of the machine building and metalworking sectorhole can be estimated by applying what is known about price increases for fuel, power, and materials and trends in labor productivity and wages to the input structure of9 Soviet input-output table.

* It is not likely that other factors, whichcould aaaount for some of the divergentbehavior, would have moreegligible impact.

11. Toaso estimate of the average price increase for the residual group (military-spacet was assumed that: (a) costs in the residual sector rose the same as estimated for machine building and raetalworkingholeercent); (b) the profit margin in the residual group before the price reform was the same as that for machine building and mctalworkinghole5nd (c) gross output in the residual sector increased at the same rate aa machine building and roetalworkingn this basis the average price increase for the residual group necessary to achieve the reported increase ofercent in profits is calculated toercent. This price increase, whon applied to the current estimate8 military-space hardware purchases from machine building and1 billionesults in additional outlays ofillion rubles. Experiments with plausible alternatives to the underlying assumptions on production costs, profit margins, and output,suggest that the calculated rise in prices of military-space equipment. ercent) is more reliably estimatedange ofoercent. The resulting increaso in expenditures for purchasing military-space hardware then falls in the range ofillionillion rubles.

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