MODELING SOVIET MODERIZATION PROSPECTS FOR ECONOMIC GROWTH

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP93T00643R000301820001-4
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 66
• Document Creation Date: December 22, 2016
• Document Release Date: December 15, 2011
• Sequence Number: 1
• Publication Date: October 1, 1987
• Content Type: REPORT

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o-X gql-5cr V
Directorate of S (V
Intelligence 25X1
Prospects for
Economic Growth
Modeling Soviet Modernization:
Secrete
SOV 87-10058
October 1987
Copy 337
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Directorate of Secret
Intelligence
Prospects for
Economic Growth
Modeling Soviet Modernization:
This paper was prepared by
Office of Soviet AnalysisF-
Comments and queries
are welcome and may be directed to the Chief,
Economic Performance Division, SOVAF--]
Secret
SOV 87-10058
October 1987
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Modeling Soviet Modernization:
Prospects for
Economic Growth
Scope Note This paper uses a macroeconomic model of the USSR to evaluate prospects
Information available for Soviet economic growth to the year 2000. Because of the considerable
as of 8 September 1987 uncertainty regarding the ultimate success of General Secretary Gorba-
was used in this report.
chev's modernization and reform program, and because of the long time
frame of the projection, a single "most likely" forecast cannot be made. In-
stead, three scenarios were constructed to reflect different degrees of
success for Gorbachev's initiatives. The results of these simulations provide
insights into what is possible and illustrate the dynamics involved when an
economy administered by central planners for nearly 70 years attempts to
change its method of operation.
This is a technical paper that presents the results of the simulations,
provides a description of the model used to obtain those results, and
documents the underlying assumptions. The traditional version of CIA's
model of the Soviet economy-SOVSIM-was originally designed to
project GNP growth during periods of relative stability in the relationship
between inputs (capital and labor) and output. Because Gorbachev's
program attempts to sharply change this production relationship, it was
necessary to substantially revise SOVSIM before the analysis. The paper
discusses the major revisions and the rationale for them.
Secret
SOV 87-10058
October 1987
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Modeling Soviet Modernization:
Prospects for
Economic Growth
Summary General Secretary Gorbachev's program to modernize the Soviet economy
is intended to sharply change longstanding relationships between inputs
(capital and labor) and output that will alter the growth path of the
economy during the rest of this century. His modernization and reform
program represents the most intense and comprehensive effort to address
Soviet economic problems in decades. Its aggressive implementation, in
fact, is causing serious disruptions and turbulence in the economy and is
expected to cause more as the bureaucratic factions attempt to adjust to
the many changes being imposed from above:
? Gorbachev's quality control program is disrupting production and the
supply network as poor-quality goods are rejected.
? New initiatives in organization and management are creating confusion
and apprehension in some quarters, and bureaucratic foot-dragging and
outright resistance in others.
? The rapid pace of the reform program imposes a staggering set of tasks
on the central bureaucracies and on the producing units, while simulta-
neously demanding fulfillment of the 12th Five-Year Plan (1986-90).
? The sharp reallocation of limited investment resources will undoubtedly
lead to imbalances in production and new capacity.
Capturing Policy Changes
To capture the effects of Gorbachev's policy changes, CIA's macroeconom-
ic model of the Soviet economy (SOVSIM) was upgraded to take specific
account of the modernization program. It was used to simulate Soviet
economic growth prospects to the year 2000 under alternative assumptions
about the success of individual elements of the program. We modified the
model's production functions to:
? Distinguish between the productivity of new and old capital equipment
emanating from the sharp change in investment policy, which was
designed to foster the development and production of high-technology
equipment (embodied technological change).
? Accommodate changes in labor's contribution to economic growth,
originating from policies intended to improve skills and increase
productivity.
? Account for economic disruptions that might result from the myriad
changes to entrenched economic mechanisms and practices.
The revised model enables us to take specific account of Gorbachev's
initiatives in assessing the economy's potential growth path, but it does not
enable us to see into the future any more clearly than did the traditional
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model. By using the revised model, however, we are able to isolate the
effects on growth of alternative judgments about the success or failure of
Gorbachev's main policies
The Impact on Growth
The results of our simulations indicate that the Soviet growth goals of 4 to
5 percent per year-measured in real terms-are well beyond reach.
Nevertheless, under the right circumstances, economic performance may
be good enough for Gorbachev to declare his program a success.
If Gorbachev's program continues to be implemented vigorously the cost of
adjusting to the new conditions will be a disruption that over the next few
years could depress economic growth considerably below 2 percent per
year. If, during this adjustment period, the leadership relaxes the pressure
for quantitative gains in output in favor of stimulating higher quality, more
efficient use of newer technology, and real decentralized decisionmaking,
Gorbachev's policies could begin to take hold. This would bring higher
returns to new capital equipment, an increase in the effectiveness and
productivity of the labor force, and a progressive reduction in the economic
disruptions of the adjustment period as the system adapts to the new
conditions. Under this scenario-which we call "Gorbachev wins"-
growth would accelerate in the 1990s. Although the 5-percent-per-year
average that Gorbachev originally called for will not be reached, rates that
would yield an average for the decade of about 3 percent per year are possi-
ble. More important, the mix of output would consist of higher quality and
higher technology products. Although we believe Moscow would not be
able to close the technological gap with the West under this scenario, it
might narrow the gap in some key areas.
On the other hand, the period of economic disruption and slow growth
could continue indefinitely if, for example, the system fails to adjust to the
demands of Gorbachev's initiatives because of continued bureaucratic
resistance, political conflict among the leadership, and frequent changes in
objectives and directives. Under this scenario-which we call "Gorbachev
loses"-growth would probably remain depressed throughout the 1990s,
and the technological gap between the USSR and the West would widen
appreciably. Under these conditions, Gorbachev might well suffer the same
fate that befell Nikita Khrushchev in 1964.
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Figure 1
Projections of Soviet GNP
Gorbachev wins
Gorbachev loses
Gorbachev doesn 't matter
Finally, if Gorbachev's program is not vigorously implemented-piecemeal
reforms continue to be watered down by political compromise and central
control over prices, resources, and production plans remains supreme-
there probably would be very little change in the way the system operates
or in its growth pattern. Under this scenario-which we call "Gorbachev
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doesn't matter"-the disruptions of an adjustment period would be
avoided, and growth would be somewhat higher during the next few years
than we would expect under either of the other scenarios. But there would
be virtually no chance of acceleration in the 1990s, the mix and quality of
goods produced would remain obsolete by Western standards and Soviet
expectations, and the technology gap would undoubtedly widen in most
areas
There are, of course, possibilities for Soviet economic growth other than
those presented above. Gains from the modernization drive may be more or
less than those simulated in the scenarios; the costs of adjustment
associated with those gains may vary; and factors outside Moscow's control
can affect economic growth. The outcome will depend not only on the
specific nature of the reforms but also on how the reforms are imple-
mented. It is not clear whether the regime will have the will-or ability-
to sustain the modernization drive when faced with inevitable near-term
reductions in growth that will result from Gorbachev's efforts to change
the way the economy operates.
Fighting To Win
Although we cannot predict with confidence the extent to which Gorba-
chev will "win" or "lose," we believe he will not let his program be viewed
as a failure without a major struggle. He fought long and hard to get his
new reform program ratified at the Central Committee plenum in June,
and he will
fight equally hard for implementation. These reforms could bring increased
competition among state enterprises and a major decentralization of the
price and supply systems that allows suppliers to deal directly with
customers at prices determined through negotiations. Implementing such
changes, however-even without political and bureaucratic resistance-
will be difficult. Market mechanisms cannot be easily mixed with the
command elements of a socialist system. Even the gradual introduction of
markets would upset the delicate balance of the flow of goods and
materials required by the command allocation of resources.
Nevertheless, because the long-run impact of his policies has considerable
potential for improving Soviet economic performance in the 1990s, Gorba-
chev is likely to stay the course. Most of the leadership is likely to support
him and probably will be willing to wait for results; they will be less
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concerned with near-term growth rates and more concerned with produc-
ing higher quality products, stimulating more efficient use of new technol-
ogy, and promoting some real decentralized decisionmaking. Although
Gorbachev's success could be undone by external events, he is working
hard to ensure that the external environment will be favorable to his
programs:
? Reduced tensions in international relations. Gorbachev is working hard
at forging new relationships with the West, reviving ties to China, and
maintaining the loyalty of client states in the Third World. Success in
this effort would provide the breathing space necessary for redistributing
resources to the civilian economy and acquiring the necessary equipment
and technology, as well as for promoting a positive climate at home for
his reform program.
? Forward movement in arms control. Arms control probably will not yield
significant economic dividends in the near term, but it might prevent an
expanding arms competition that could be increasingly costly. A success-
ful arms control program probably would allow continued restraint in the
growth of defense programs, providing additional resources for industrial
modernization.
? Continued Western commercial interest in East-West trade. Eventual
access to the vast Soviet market is the bait that continues to attract
Western businessmen to the USSR. Recent reforms in the foreign trade
apparatus, the ability of some Soviet enterprises to negotiate directly
with foreign firms, the expansion of joint ventures, and increased interest
in participating in international organizations-such as the General
Agreement on Tariffs and Trade-increase the attractiveness of the
USSR as a trading partner. This may provide Moscow with valuable
access to Western products, particularly machinery and technology.
Outlook
On balance, we expect some real progress to occur, particularly if
meaningful economic reforms can be implemented and sustained without
an accompanying political upheaval. But, because movement in the
direction of reform will be painful and risky for many in the leadership and
the bureaucracy, the progress will be slow and incremental. Even if
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everything goes right and Gorbachev "wins," the gains from developing (or
acquiring) and using new technology as well as from creating a more
productive labor force are not likely to come quickly enough or in large
enough doses to significantly narrow the technology gap with the West
during the remainder of this century. Substantial gains could occur in
selected areas, especially those related to defense, but it will take years,
perhaps even decades, of application and experience with new industrial
processes, management techniques, and incentive structures before the
Soviets would be able to match the rate of advance in industrial technol-
ogies that is becoming commonplace in the West.
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25X1
Gorbachev's Modernization Strategy
Capital Modernization Program
1
Labor Force Strategy
2
Discipline and Antialcohol Campaigns
2
Modeling Embodied Technological Progress
5
Production Functions for Agriculture and Housing
8
Modeling Adjustment Costs
9
Measuring the Return to Capital
12
A Graphical Approach
12
Application of the Approach to Each Sector of the Economy
14
Industry
14
Construction
15
Domestic Trade and Other Sectors, Services, and
Housing
15
Agriculture
16
Statistical Estimates of Production Function
Parameters
16
Simulating Future Economic Performance
17
Returns to Capital and Human Factors in the Context of the
1986-90 Five-Year Plan
17
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Simulating Performance to the Year 2000 20
B. Assumptions Underlying the Modeling Results
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Modeling Soviet Modernization:
Prospects for
Economic Growth
Since becoming General Secretary in 1985,
Gorbachev has gradually put forward the most com-
prehensive program for economic modernization since
Khrushchev.' The program is a combination of man-
agement reform, investment strategy, and human
factors. Although parts of the program have already
been put into place, the bulk of Gorbachev's "new
economic mechanism" will not be fully implemented
until after the start of the 13th Five-Year Plan in
1991.'
Plans to increase the productivity of labor and capital
are at the core of the program. Because the labor
supply is determined largely by demographic factors
that are not under Moscow's direct control, the
leadership has initiated education reforms, wage re-
form, an antialcohol campaign, and a discipline cam-
paign-all designed to increase the quality and pro-
ductivity of labor. Similarly, Gorbachev's capital
modernization initiatives include programs to increase
the quality of new capital, as well as the technology of
production embodied in the machinery and equipment
that comprise the new capital. But Moscow faces a
very difficult challenge, because centrally planned
economies are not well suited to change. There are no
"automatic" mechanisms to bring supply into balance
with demand when the methods of production and the
composition of output change. Moreover, there is a
high risk that planning mistakes during adjustment
periods will result in decreases in economic efficiency
that could create disruptions in producer-supplier
Capital Modernization Program
An important feature of Gorbachev's game plan for
revitalizing the economy is his program for moderniz-
ing the industrial capital stock. His plan calls for
substantially increased investment growth targeted
principally at the machine-building sector-the
carrier of new technology. The intent of this new
strategy is to renew the capital stock by a combination
of high rates of investment and increased rates of
retirement of old plant and equipment.' Because the
existing stock of fixed capital is so large, however, its
renewal cannot be accomplished within a single five-
year plan period.
Higher rates of growth of investment represent the
quantitative dimension of Gorbachev's program, but
the qualitative dimension is more important. The
returns to new investment depend heavily on the
technological level of the new plant and equipment
being installed and the efficiency with which it is
used. Specific aspects of the program to increase the
technology level include:
Creating interbranch scientific and technical com-
plexes to expedite development and assimilation of
new technologies into the machine-building produc-
tion base.
Increasing expenditures for science-a rough indi-
cator of the resources committed to research and
development (R&D)-by 35 percent during the cur-
rent five-year plan, as compared with the 11th Five-
Year Plan period.
relations and, in turn, retard economic growth.
Plans for the 12th Five-Year Plan (1986-90) call for an 80-percent
In his plenum report of 26 June 1987, Gorbachev said: "The
radical reform of the system of economic management is not a
single act but a process for whose completion a certain amount of
time will be needed.... We must enter the 13th Five-Year Plan
with a new economic mechanism, although its development will
increase in investment in the 11 civilian machine-building minis-
tries, compared with the 11th Five-Year Plan (1981-85). The
retirement rate of productive fixed capital is slated to rise from 1.8
percent in 1985 to 3.1 percent in 1990, while the retirement rate for
the machinery component of productive fixed capital is to climb
from 3.2 percent to 6.2 percent. (In Marxist parlance, productive
capital is used directly in the production process. Nonproductive
capital includes capital in the housing and municipal services sector
and in organizations and institutions of public health, education,
science, culture, art, credit institutions, and administrative organs.)
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? Introducing a new system of quality control-
known as state acceptance-to put teeth into
Gorbachev's plan to improve product quality.'
? Increasing dramatically the supply of more techno-
logically advanced equipment. For example:
Production of robots in the current five-year
plan is to increase by 120 percent, numerically
controlled machine tools by 90 percent, and
machining centers by 330 percent, compared
with production in the 11th Five-Year Plan
period.
Production of personal computers is to reach 1.1
million per year by 1990, compared with almost
none through the mid-1980s.
But to stimulate the introduction of new technology
and the production of better products requires the
enthusiastic efforts of enterprises and research and
development institutes. In shaping the organization
and administration of the economy, Gorbachev is
searching for a combination of organizational changes
and economic levers that will encourage this kind of
initiative at lower levels, while permitting control to
be maintained from the center. Former Soviet leaders,
including Khrushchev and Brezhnev, had similar
goals but could not find the formula, or rejected it
after seeing its implications of a diminished role for
the party. It is clear from the results of the USSR's
Central Committee plenum in June 1987 that Gorba-
chev intends to go well beyond the tinkering that
characterized the Brezhnev economic reform decree
in 1979 and the experiment in industry introduced
under Andropov and Chernenko.6
Gorbachev's major achievement at the plenum was the approval of
a landmark program for comprehensive economic reform that
would-if fully implemented-reduce central control over eco-
nomic activity and provide a wider scope for market forces. Also
approved were 11 draft decrees detailing changes in major sections
of the economy, and a new law on enterprises designed to expand
their decisionmaking powers and to force them to be financially
responsible for their activities.
Labor Force Strategy
The success of Gorbachev's program will largely
depend on the performance of the work force. A
combination of measures is being implemented to
strengthen discipline, improve labor utilization, en-
hance worker incentives, and provide more skilled
labor. These measures represent the human factors in
Gorbachev's program.
Discipline and Antialcohol Campaigns. The cam-
paign for labor discipline, which was initiated by
Andropov and foundered somewhat under Chernenko,
has been revived in a new form. Workers at all levels
are being told they could lose their jobs if they don't
perform. The antialcohol campaign scored initial suc-
cesses, sharply cutting alcohol consumption and there-
by reducing drunkenness and absenteeism. Soviets
credit these campaigns with helping to improve labor
productivity in 1986.8
Efforts To Improve Labor Utilization. Moscow has
long tried to improve labor utilization. Gorbachev has
intensified this effort through a number of initiatives,
including:
? Work position certification. Under this program,
begun in 1985, all enterprises are tasked with a
systematic inventory and evaluation of their labor
and equipment-with the aim of eliminating low-
productivity jobs and obsolete machinery. The in-
ventory is also to provide planners with the informa-
tion necessary to draw up regional balances in
supply and demand for labor, and to more critically
evaluate ministries' requests for labor.
? Shchekino-type schemes. Under these programs-
variations on the experiment begun in 1967 in the
Shchekino Chemical Combine-enterprises are as-
sured a fixed wage fund and encouraged to release
8 In his plenum report of 26 June 1987, however, Gorbachev
admitted that the campaigns are now flagging, saying "in many
places the momentum has been lost. . . . The incidence of drunken-
ness has increased again and idlers, parasites, and pilferers ...
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their least productive workers and use the resulting
savings in wages to reward their most productive
personnel. The Shchekino system is the basis for the
wage reform (see the section "Wage Reform"), the
new pay system recently introduced in scientific
research institutes, and the staff-cutting scheme
recently mandated for all Soviet railways. The
Soviets expect these schemes to induce overmanned
enterprises to release by 1990 up to 3.5 million
workers for other jobs in the economy.
background, emphasizing independent study rather
than rote learning, and practical training in
enterprise-sponsored facilities.
Industry is called on to shoulder some of the burden of
financing the educational improvements. Ministries
and enterprises are to provide schools with use of staff
and equipment and to provide funds to partially
defray the training cost. These funds are to go for
equipment to expand the computer education program
and make badly needed improvements in educational
? Mechanization. Moscow hopes that the mechaniza-
tion of labor intensive processes can free 20 million
workers from manual labor by the year 2000. Five
million manual workers are to be released during
the current five-year plan period, as compared with
a reported reduction of less than half that figure
during the 11th Five-Year Plan period. This goal is
to be realized largely through increased production
of modern equipment
Wage Reform. The implementation of a new wage
system in Soviet industry began on 1 January 1987.
The new system is designed to improve a worker's
incentive to perform well and acquire advanced skills
by reversing the longstanding trend toward wage
leveling. Under the new system, sharply higher wage
increases would go to those with skills vital to the
modernization program-engineers, designers, and
skilled labor in machine building. Wage increases are
to be funded by the enterprises themselves through
increases in productivity and savings in the wage fund
created by releasing excess labor.
Education Reform. On 25 March 1987, Moscow
adopted a program to overhaul the Soviet specialist
training system, hoping to make it more responsive to
the needs engendered by technological change and
industrial modernization. The program calls for fewer
but better trained graduates in engineering, in part
through closer cooperation between industry and
higher education. It includes tougher admissions stan-
dards, a more rigorous system of evaluating student
performance, and special training for the best stu-
dents. New curricula, texts, and teaching methods are
to be developed by 1989. Schools are to reduce the
number of specialties and provide a general scientific
facilities.
To capture the impact of Gorbachev's modernization
program on our forecasts of economic growth, we
modified CIA's macroeconomic model of the Soviet
economy (SOVSIM)' to:
? Distinguish between the productivity of new and old
capital equipment emanating from a sharp change
in investment policy designed to foster the develop-
ment and production of high-technology equipment
(embodied technological change).
? Accommodate changes in labor's contribution to
economic growth originating from policies intended
to improve skills and increase the work effort.
? Account for economic disruptions that may result
from a myriad of changes to entrenched economic
mechanisms and practices.
The revised model enables us to take specific account
of Gorbachev's initiatives in assessing the economy's
potential growth path, but it does not enable us to see
into the future any more clearly than did the tradi-
tional model. By using the revised model, however, we
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Figure 2
Macroeconomic Model of the Soviet Union
Production
functions
are able to isolate the effects on growth of alternative
judgments about the success or failure of Gorbachev's
main policies.
Overview of the Model
The primary purpose of SOVSIM is to project the
real growth of Soviet GNP (value-added measure in
constant, factor-cost prices)." The model projects
10 The principal conceptual difference between GNP and Soviet
reported national income is the latter's exclusion of (1) most services
(for example, health, education, housing, personal transportation
and communications, recreation and personal care, government
administration, credit and insurance, research and development,
and military personnel costs); and (2) depreciation on fixed capital.
For a discussion of the methodology for constructing national
economic accounts for the Soviet Union along Western lines, see
Joint Economic Committee, US Congress, USSR: Measures of
Economic Growth and Development, 1950-80, December 8, 1982.
GNP by estimating net output according to the
historical relationship between capital and labor in-
puts and output (see figure 2). Separate estimates of
net output are made for each of 12 sectors of the
economy." Total GNP is estimated by summing the
net output projections for the 12 sectors." It is thus a
" The traditional model was simplified by reducing the number of
sectors from the original 18-including three exogenous energy
sectors-to 12, including two endogenous energy sectors. The 12
sectors include transportation and communications, construction,
services (less housing), housing, agriculture, domestic trade and
other sectors, and six industrial branches-machine building,
chemicals, fuels, electric power, consumer goods (including light
industry and food processing), and industrial materials (including
ferrous and nonferrous metals, forest products, construction materi-
als, and other branches of industry).
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supply-side model. On the demand side, GNP is
allocated among four primary end uses-investment,
consumption, military spending, and government
administration.
The Production Functions
At the heart of the model are 12 production functions
used to forecast net output by sector of the economy.
The traditional version of SOVSIM forecasts net
output using the Cobb-Douglas production function:
Q = e? Kp Ll-p,
such that
0