Economic development, central planning and allocative efficiency

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UNITED NATIONS

flJPRICAN INSTITUTE FOR ECONOMie DEVELOPMENT AND PLANNING

DAKAR

ECONOMIC DEVELOPMENT, CENTRAL PLANNING

AND · ALLOCATIVE .·EFFICIENCY

by

Charles K, WILBER

4080

@)

l~~RODUCTION/31-82

Extrect fromt "The Politicnl Economy of Developmant end UBdtrdevelopment

•'

Ed. Charles K. Wilber

Distributed for: 9-Month Programme

COURSE: COMPARATIVE PLANNING SYSTm 1S

Professor: Fawzy MANSOWl

NOVID4BER 1282

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ECONQ1j1~? .nq~QJ?!@!T:r ~J.'N?;RAL

PL4NNING .

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INTRODUCTION

•',·;

REPRODUCT!ON/31-82

Page. :t·

"l·.

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·'· .· This pap~_r. is eonce.rned with. the. question of central planning

-i ~

^·. and alloe.atiove· eff-içiency'

i~

·the eonte:z_t

"~f

e. backward_.

ep.O~omy

^trying

.. , ·. -t.o

acbie~e-

^t.he _.

on-~ :,~~:e~riding g~al of

_{. .} ; .

r'~'dp~omiê

"

· deve·bt~m~n~.

^{:.,No pretense}

is .l:ll'de ·of,construeting a complete the~ry of a centr~lly pl~tnned economy •

·_,. Rather_, the

- ~im

is m1:1eh

m~~e

^limited.: This study Î$' conèerned only with

. . • ~- . i . ! . • . 1 • • ~ ~ •

:.the. d.evelopl!lent pro.~es.s and within this proeess •nly w_i:th. the problem of

. . ^-~ .. : -~ .

•._... . .

This paper will first present' a critique of the usefulness of _{1 ' • ;:·;}

statie equilibrium analyais in evaluating allocative efficiency under.

· • •• ! eon~~ t~on~ of ra~id. economie development • .. Second., the paper will eons-.

·• truet .a modél of dynamic · aii~eative_ ~;tffcieney derived maiJ.?J.y from the

..•.. ^~ . ,.

. .

·•·

..

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his-torie~~ ;,-

development

e~pel:"i~nce ~f

the Soviet Union, moclified where

,· :

· .... appropria te by

tb:e

^{-lat~r -}experience

6f

·the other Saeielist eountries •

.· '·

.· •;'

. CRITIQUE OF STATIC EQUILIBRJ;JJM AN.ALYSIS _{; ...} · ...

.A persistell~ critieism le~ied against Soviet-typ_e central planning by We~te~n ~c~momi,sts i~ that it leeds· to.:a misalloeation of :.: re-sources.·

It is

.a~gued that sil1ee thère is ·no Diâ.rket for intermediate

goods, no interest eha~g~ , on. eapi ta~-~ and . subsidies and· taxes are ueed

· to arrive at: final, pr~ces t prï~es d-o not refleet relative scarci ti es arîd thus distort 'r.es~Uree alloca,tion~

. i.-.··

It is true tbat there' are many examples of mi'sealeulation and 'mi'!iallocation in central:iy _planned èconomies • However;. similar exam.ples

of misallocation ean be found in every eeonomy including market economies • No economy does a perfect .j~~ of allocating resout-ces~ Rather, ille im•

portant question :is~ in w~at:type of economy do the feweat misallocations

*

Reprinted. from ahrbuch des Wir±sc·haft pp. 221-2~3, by permie'8ioÏLof Gttn

as~ Band 2,

1970,

ag.

·,· · · ;·iiru>IioirtrcTioN/31-a2 Page 2

''·

•

r

oceur • While this· wri ter.--·~eels ,an advance-d market ,eeonomy (not, how-

. -·~-.;_ ...... ..,...~.~~-• ....-, ... ~:1": ... ~.--~-~:-~-~.r..~·:-,~·-;:.;..;,~...;.~· .... ~-.. -~ ~·;~.' -. ~~:

ever, an underdeveloped -~~e) ,proba_b:.ïr·. a))pcates resources better than a

. ... ~ .. ~~-:··· •• ·~···· ··- -··~ : .• :::"''·""'·:· -?.~ ...• : . . .

centrally planned economy, there is insuffieient empirical evidence to give a conclusive answer.

Since empirical proof is not available, Western economiste hav:e turned to static-equilibrium.analysis .to p;rove the inefficieney of

Soviet-type central planni~g. Wi t~ .the· recent adva·n~es -in linear pro- gramming1 input-output-analysis, and similar mathematical tools, equi- .libri'wl1 ·analysis bas beconie an inv:a,luable method. for solving the problem

of constrained maximizat~on. of an objective function· for sub-uni ts wi thin an· e'cenomy • . ··.De spi te the probleiD of _,quantifying. costs and bene- fits, General î1otors and the

u.s.

Defen~e.Department can \lB~ equilibrium analysis to increase the efficiency of resource allocation within their .respective units.

-'However, _!ÇC~nt advances in w~.lfare economie~; and particu~

làrly the-theory-of· second best,. show that static equilibri)lJD. analysis,.

b'rèaks · l:iown when i t comes to evaluating the -~fficiency· t>f ,.res ource allo-

. cation -for .an economy as a. whole ,and partic~larly for· an economy in the:.

process of rapid economie development. Static equilibrium analysis indicates that maximum efficiency is .attained when available resources are allocated in such a way as to maximize the particular output mix d~~ermined _. . by c 0nsumers^{. .} . ¹ prefer~nce~ ^. . (in a market economy) or planners' .

pre;f_erences {in a ~entrallf planned economy) •. To achieve this alloca..;

ti on the first-ord.er welfare conditions, which fo.r sim:J?l~ci ty ean be s.~arized as priee eq11als marginal .co S'te, must be. fulfilled in all

' ' '

ma:rket.s. The se first-order or marginal conditions are derived from the

. . . . . ^{~.· \}

rules of the calculs regarding maximization of.functiQns. They consti- tute a set of nec essai-y "condi

ti~'ns - f~~

the attainment of maximum effici- . ,_,~ney, but are .not sufficient conditio!ls• They do not guarantee that

i t .is maximum. efficiency being a_ttained; i t might be minimum efficiency.

- In: addi tiQn, · i

-t

is necessary to have second-order·, convexi tj"

.

^•,

.

^.

conditions ~f all .cost and u~ility functions. Even with this, however, one cannot be sure a maximum maximorum bas been reach~d • . There is nothing · i.n: the .fi·:rst-orde:r and s~cond-order conditions to~:differentiate

the toi}

c>·~ --~: ~ ~~·I:h~r~~,r~~h~t:- oi- :~~ ~:~~i~i.n: .

•

, .. ·· ·". . ^{,. ·' .•}

- .· ··: ;l

( ..

~E~RODUCTIÇN/31-82

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Page 3 .

For ef:ficiency to be. at a ma~}xnum,,~ the ".tp~~~ conditions",

. as .J .R. Hidts, càlls '·thetli, rii~·rt also be satis:f~.~~· . They ~tate that if

efficiency is to be maximized, i t must'. also

~ be

impossible to increase efficiency by introducing a new produc-t .

or

by wi thdre.'\'Jing an old product,

·~ ^•• -.~ -~ ^{:_:: :.. : ::: ,1.. •• • ,.. ... • • ' '}

-:..~ ..

. ··' .·

• • -, . • .,t._

If . the mar~füial ,' seçon~_;o,rder., a~d _. ,totàl, .condJ:t;Joris are all

~ ,.\,.. . ^' . . ' .·

, ' .::: :~ . ·' . ... . ^{. ·~ • ..}

.

satiSi~ed,

stàtic·

éf'ficien~:y

'will be a

11l~~imum,

..

~o~·le:v .er,

i t is not a upique~ maxililitm;

it

is merely o_f}e of an i:r;tfinite numb~r. :of Pareto optima bepause i t .pre:~lUppbsô' ·.a giv~n· di.s~ributi.~n of ii.l . .con:w th~t ·

is

^{not itself}

· ..

de:t~rmined

by th'e c·o:hàiiions of

m·e~imum

effic.ienc!-•

C !?-~-~ ~·?s i.~

the

distribution of income will cause variations in the most eff~cient out- .· p.uts of the various products and allocations of .~the various inputs ^o

. ! 1': , .. ·: .

~ ~-::

"' 't

... A. :Pit:ëe'to·:· ·optimum as· a. posi.tion of maximum efiiciency los es _{~) •. .} i ts

·' . ·' .. . :. validity when

·~e.~terne.l

effects -ct.'e',·, externel

~ .conqmiep:

^{and disecono-}

• . . • ' " ' '' .:.. .. , ' ;o , · · '

mies, interdependence. of· pr.eference functions) in consumption end pro- duction and public goods are taken into account,

Since there are institutional or technical obstacles that precl~de the ' satisfaction of at f êast' s'6~e ~of the condi tiens of maximum

'!.'· .

.ef:f:i<?.ieJ:lÇy . .in all

· ~con~inies, ' ' stati'c

·

e qtiilïbri~1n ~:haly.sis

breaks down as

. . . ' ·.. . :·' ' . - ·:· . : . . . ' ' '. ' 1: : . ' · ... ' '.

an ev.al11~t~ .tool, .. The re i s' ·:no- l,ogieal wri.y of déterminin .. g wh ether an

. - ^{~. :;} . ^: . ' '';.

economy wi

t:P

^on;I:y ·O~e: s~~tor:· falling tri· atta.ih the prie,e-equnls ... r:w.rginal-

•.·1' . cost eondi

~ion

is more eff.jcierit

in r~so~rce· a.llocatio~

:than an economy

wi th no sector. fulfilling _. th·è 'first~order· ·conditions. _{.. .} That is, if any one priee d.o.es not reflectrelative ~bri.riities

(i.e.,

^{priee e}quals mar-

' gi~al . cost) ~ there

is

n~ w~y

of

theo~~tic~iiy sayin~ ~~ ~ t

one set of

.. , ~

pri~es is more rat~o1;1al · th2n anothero ^< Thé' concl.Üsion f~~~ this is that probably ^{11 •·• .} i t is impossible to demonstr.â.t~ the· irrationali ty - or

. . . ^. . . ... ~

ratio.nali ty - of .cen.trally planrled econ~l!Ùes on

the'

basisr:J'f standard

. \ .. 1

welfare economies~" ··

.

^{' .}

CENTRAL PLft_NNU.TG . .P.N;f) DYNP.1'1IC. EFFICIENCY ^,,.·

.. ,_ ·:,·.( ... , . ~.:

1:.11 of the ab ove is coneerned wi th a statie vJelfare analysis of resouree allocation. If the problem of resour ce allocation is placed in the context of economie development, then an entirely different

approaeh to evaluation is required. In a developmentel setting, the

REPRODUCTION/31~82 I?age !.!:

questions of external economies and changing resource scàrcities become

·of prime importance •

. .

The Soviet Uniontë apprfJaeh to the specifie resource alloca ...

tion problems

of

invèstment fete (choiee betwee~ present and future),

· investment

~lloeation

and choice of ·production techniques (including faetor proportions) will b~ analyzed in th~ pe~t section. For now it is en-eugh to say that their approach eentered on the capture of· external economies and eeonomizi:iigthe obviously soaree factors"'" capital and skilled labor.

In addition, ·reeognition of eonst~ntly changing resource sear- eities led to the use of:

a

pricing system ·that deviit.ted markedly from current re source s'carei ti es. ·· It is wortbwhile to analyze the Soviet priee system in some detail at this timê,

The Pricing System.

To repeat,. almost every Western specialist on centrally

planned economies has .ergued .that the Soviet pricing system is irretio.- nel• that ~s, it does not reflect the relative ·scarcities of resources derived from the structure of planners¹ preferences. Two importent points are mede~ First, i~ is argued that Sovie{ priees do not include an interest .rate on capital. While an appropriate interest rate is theoretically determineble,, p~acti~ally i t is very di ffi cult~ The So- viet use of the "coefficient of relative 'effectiveness" bas been a

. 2 . .

rough, i f inadequate, s\lbstitute. Second, it is argued that Soviet subsidization of some capital goods and taxation of consumer goods diatorte present rel~tive scarcities, and, more importently, the low

priee of capital relative to the priee of labor does so also. However, as seen above, these arguments cannot be logically derived from static equilibrium theory. Furthe~ore, in the context of economie development this pricing system might even be. rational.

·: ...

"

''REPRQDUCTlON/31!".&2 Page

5 ., .

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:-: ':.r . . . . ; ;_<: ·A

'~entÏ·Ai:iy'· pta~uîèd '':~é~noniy '

at·t·empts to secure a coordinated

L •

· · · ··

~~t ·~t r:hve·~ttriè~t d~éiè':ion~'

· ex:

'/dite,

'tna:-t

is:, in·: advance ·of:' ally commit-

• ment

~f · re·so~r(à~s~

• . 'tn

a ' · mark~~t-_.

·econ&iiiy the al1:o;cation o:C investment is

• the r~sùit

()• f':.'tJ:ié

·'estimates ariâ 'expectalions .of Hùlèpendent entrepre- ' neti.rs ,'

ré~i' sed i~i

the long..:run' by<ex

po~t :

in:ovements.. o:f market priees·.

The <Ùfference:t/

bet~ijèrl:

^{the' plamied1 and' ui:arket}

approac.h · :a~e importent~

. . . ·. . . . . . ' _: . .. · .... ·. ^:· ·. . . : · ... -~-'

Current investirierit 'êha'iiges both pro'ductive ;capa'city and ~employment an~

thus exercises an important influence upon .market pri;.oes by · èhanging relative scarcities. -Accordingly, the present structure of market priees cannot be used as a sure measure: of ;:the< future structure of p:r:ices, or, therefore, of what will be the return on any particular

!

iti:V:~~tm~rii::' p~oj'ect.

^·

P~ofe~~-or

Kenneth Bouldirtg ergU.es that "there is

_·_ ;.. . .. . ^,· . ^.-···· ... -: .. ·-... . · ^..

. not" the sliglitest reason.;" •• to sûppose ·thât.; the, equilibriuin' priee set,

'in the -sense. of c.iassicaî~ dF neo'cbùisi·cal'¹e~quilibrium the.o:Fy•, · is the pricë set whic.b.' ·w:lll' go

~~·îth

the m'a:ximum rat·e of economie'

· d'€veiopment~ ~,3,

·-.... ^{·· -.'} ..

~. ·_ The :ap·propriat·ë p<ric~ structure-·wiil 'depend· on ·a number of .. · conside·r~ti6ns • . Where'· ~hel"'e is;. ;a ,..d'i:.vergencé' ~between the ·:pri vâte and

so'c''ial r~tu:tns

on'

1-:nves:tmènt ·ih.

a:·

pâl'ticular aren due to •exte:inal eco-

· noinies:

. .

^~-.

··. !· ,·-··· _{• !_ •.}

·:·, ' ,. · ^.. , .

• • • ---th'è:te i's a· 'strorlg argwnent for di:sto·rting the priee structure awey froa what would be a market ,es_uilibt~um by deliberately lowering the relative priees arld hene'e ldiscou- reging investgent in those industries vhere the external eco- nomies .or -.t.-he,. nonfinanc,ial ~e;tu:rns are. small, end rising priees end .encoufâging · investment in tliose industries where __ tlie extërnal eco:il'omies or 'the :n-ônfinanciel :returns are large •

••• (or) the general principle of the taxation of vice and the subsidization. of. virt~-r __ çan b~ e:x:tended to include the

. •.taxation of ~bose COIIl!JlOdi:ties .. t~e produc-t;ion of which lv-e wish

to discourag~ :h~om·; the .point of . .-v~ew of ~conomic development and the subsidization of: those' the production of which we wièh.to encourage.~ . - ^{A . .}

! !

. The Soviêt accomplish~d thi's end by subsidizing strategie

' . f: . ··..,-f' . ·,· . .

· ... mate rial and: indust-~iés s~ç,h ,,~s s.t~el, ; engineering, . chemical s, and

el~ctrical_: equipm6nt-; .-and :ta~ing: low priori ty products such as textiles

· · ·

a~d

m9st consilmer

- ~oods~

⁵- . ··

• • •. ! . ,.., • ~ f

REPRODUCTION/31-~2 Page

6

- . : .. ·~ :·., '\!: I;n the co.n~ext of, economie devel'opmen.'t·, "persona! consumption

.és1tould have a low cl~i~ on re sources~ ; an~

the

st4tic "'elfare criterion

~f

:equating priee :·to.

m~rgin~l ~~-st

must

reced~

:i:n the bàckground,"6

This .the· Soviets have.

dQ~~

.by imposing, high turnover taxes on mo'st con- ,:. sumer ~oods • _3ome. con~un:ter go~ds whicii hâve significa:nce, fqr, , develop-

;

. <.-men.t ,-~ 13:uch ~s pape:r which p~ays ari. important. :t'Ole in the spread of li-

·._.teracy,-are favoredt., Soviet pricirig p.olicies,.:thus, _have e rational ina .development context •.

' ...

. J.

Central Planni~g, t•'.

,. ' '.

The process ~i industrialization and economio.'development was

· facili tated in the . Soviet Union by the 'c!e·D.tralized dispôsal of' economie

,resources ,, . All of

th~

^{countryi:s ,.}

res~~~ces

^were. concentrated on. certain

·' . . .

.objectives and their dissipati6n on otber objectiv~s which w·.ere not

cqnduoive to rapid industrialization was avoided,_ The lack and wea.k-.

ness of indus trial cadr.es mad~·

i

t desirabik :Co conceri:trate the available .talent on high priority o'-bj:ectives •. Thtïs in the S'oviet Union,. planning in the early stages of

dev~iopment

was · 'cha;racterlzed

;D Y; 'll.d~:i,nistrative

management and administrative allocation of resources on the basis of priorities centrally established,

of

the -development process: can be

ec~~omy-,"7

The Soviet mode! in the early stages best describe.il_{... -,._} -os o. "sui generis war

A major advantage ·of · public ownership' and central planning is its ability to overcome Nurkse's -fam.ous "vicions circle of poverty."

On the supply side ,·' the re .is the small .c.apaci ty to save, .. resulting from th:ë low:'level· of real income. The low level · of real income is ·a reflection: of lO\i product bri ty, which in its turn ïs due largely to thé l~ck of capital. The lack of capital is a result of the small capacity to save, and 00 the ci_rcle is complete,

On the ·demand si de, ·the· itiducement to. invest may be low becausê o'f the small buying power of the people, which is due

· to their · sJpall ·.real incomé, which again is due to low produc-

tivity. The low level of p:[;oductivity, however, is a result of the small amount of capi t~l used in _ _.producti<m, which in its turn may be

8caused, at lèast pa'rtly, · by the sinell induce- ~

ment to inveet.

--· ' ..

.l. •. \. :EŒP~ODUCTION/31-82 Page 7

The Soviet Union was· able to .. bre~~ the,.~j.rcle on :the supply :'

~lde - -: (i~e:r, rais '~

^{the. sayings:}

rn·t~) b :~~~us ·~ , ~f ~~~ -,

^ab:i,li

ty,~ ~~

^eollect

.·

th~ > e~~ri~mt~

_{. . -}

·

_·.

,s~rpl~s- ' tro~ : : tÏ.e a~ri~ul~ural

^..

;~ct~~ ~nq .

^{i ts,.}

~E)ntrol

^over

. . . , .... ^' ·-... . _·_.:·.. . . . ' ^{.\ '}

th~ ";. divis.ion \ietw~e~ ···cons~pti~~

^and

ipve~tment ~I,l

^the

induE~iïrial

^sec-..

'·· .

tor~

^9·

~1di~ o~ershi~-. ~ ~ll~wed th~ _ · fo~~~ i~~ury _ co~&wnption

^{.. from}

pro~

' "' ".' pè~i-y

inc6me to be

·c~nvërt~d

^{into _savings· f();r}

inv~s.tmen-1< .

^purpoa1e• The

:.:·

a~·ility -~of ce~tral _;i'~n~lhg

^t.o_

' c 0 n~ent,rate

^.. on the one

· ~o~l

^{of. develop-}

ment permi tted the Soviet :Un'i'6n to :chan~el s~vings end :thtis .. ;r~sources

.. ^~.. .

_

^{... .}

...

^{.. : ·-.}

.. : -~- . .. . . . . . . . . .· . .

into the most productive purposes and to reduce the proportion of

.s.àvings. go.ing into (f~om th_e pci~p;t of .vi,ew .q,f. rapid growth) unproduct ive

· ·· : :inv~;stme_ ~t'.·

· · ·

.. J:

. . · . .. - · · ·. · .;. '- ..

. •:j

; .··

; .....

The d{miand side ·of the pr:oblem did not e~ist .in tlle Soviet Union-~ Long~z'ange de~el'opm~rit~~ not short~run profits, l-r.as the goal .• The

p ~ oblem

^of

findin~

_.

~ huyers

_{.-·, .·.•} ^for· what was produce.d did no.t

exi~t-~

^{:: The}

siàte, through. centrtÜ plannfng:; i: created the 'noecesaa)l'y demand QY i ts ,. decision to

·'p~od~ce-~

iO In making_ decisions about the allocation of re-

• ~4 ^{• ' .: ... • .-(·: • ' • • • •• • · ' . • •• • ·' • • .: • \.. ... ••}

. ··• sourcéS bet\'/een the production

of

^cap~tal · goods and COIHnunér • goods, the

.. : . stnte made ipso.facto

: a_

savings decision. In ·real terms ·~oth investment

'e'nd savings must

r~fer '

^{to ·the}

diff~.renç_e bet~eén to~al

pro<tUction and

. .. . ' . e'6i:isumer goods produc.tion.· .. Thus ~ therl is. an identi ty of s_avings deci-

..

.,, . . . ^~. . . . .. . : .. - . ·. . . . 11

· · sicuü{ and 1nvestment décisions. ·

.A closely· related problen:t is that of external economies:12 If

an· économy is fer from e(rui~ibz:ium, cu,rre~:t market priees, and-.profit

maxi.mizntion are poor signals for

in~estment de.~ision:s:

·· In neo.-classi- ctll · terms, equilibri\m · occur~ . whe:n firms~ (aild the industry).

a. :re

at the . bottom of their long-ruri cost curves, that' is,. where th.ere· are constant

t" • • ~. . • • •

o~rdec~easing rettirns to ~cal~. In addition~. ex ante· coordination of

invêstm~nt

^{decisions· is}

excluded~

^However;, in underdevelQped· countries such

~s

the Soviet

U~ion

ⁱⁿ

th~ ·.19~0

^{1 s}

~irms :

(and industrie$) are likely

. . : .

to ''be on an inereasing return seê'tion of the cost curve. And :Since they

; • •• ' · -· ~ 1. • • • • ' • • •

are far from th~ technological fr.~ntier,' the co.st. curves 'l.t'ill -shi ft downwnrd over t:line. The prèsence_of potentiel: externe! economies makes pre-plnnned coordinati(m amoll:g devè~opme._nt proj ects highly desirable.

,; ..

\REPIJ,ODUCTION/31-82

·~ : 1 • • • • • • • •

,

Page 8 _..

~ .

Mor.eover,-.. i~ ,.many d~velopm~nt schemes tl;!!'!re. ex}sts a high degree of phy-

. . ' . . ' .. \ . ', .. · . .

·· .. · .sical i~terdepend~no~ a~JJong· d.i,ffer~n,t. proje.ots s:u,ch that

. . .

,t~e producti-

. · . vi ty of anyone ca,nnot _b .. ~ ma-xi.mized in isolat.ion;, Ml,J:li.i,p~rpose river

. ' .,; . ', . . .

basin planning, ~yqroel.ectrici ty. ~enel'ation, _o.r_ganizatio~ . of an iron and

.• .. .. steel. indusi;ry• .anO, ;the· deyel9pmer;t o~- che~icals are -'~'mmples ,,of this

~ ~ ·. . •' . ^. . . . . . . . . ^. ·: . .

... .

^{·; .}

nature. Th~ indiv~dual _.px;oJ:ect with~n SU:~.h a scheme,, c~n seldom be exa-

. . .. ' . . . ^{. .} . . ^~ •,

mined by i tself and in ~st~~atin~L,its op,eration,el e:ffi'cie~cy ,i t bas to

. • - .· ·, .J .

· be jointly cons.idere4 withits related ·WlJts •.

:_ 1

'! , In,ùnder4ev~l9peq countries, private marginal pro.~uctivity of

~-; .· . ;

.. i:

capital frequently falls short of i ts social margine~

. .

pr()_quc~i ^. vi ty. In developed economies, external economies of various industries support . each other_~nd thus hein t9bridge ~he gap between private and social

,prodùctivi 1:;y. .HQwev,:J;", lack of b13,:sic ~~d~strial structure.s . and of so-

c:tal overhead _.

· ~api ~ai

^... d.oes not p;'rmit

,. th~_ ·.· c~pt~~~ ~~ ·; ot~ri.:Çia!

^.external

. -^{. .} . . . ^{: .} . . ^{~ '} . ' ..

eco11omiesond co~ple)4entcri t i es in underdevelQped countries •. J'he net pro~ .

.. :-_ : . :_. . ^' . . ~ . ^: ·' ^; . ;. . . ^{: ~} .. ^'

. ductivity of capital, therefore~ does not attain a sufficiently high ie-

: • . • .• . 'i • • •. •. ~- • . • 1• - . . ·.: ··:.

vel to sl;imulate pro.d~c.~ive private in_vestment. 'J,'l,lus, . since .. ~ modern in-•

• • . • } ,; . . • :1 : '.. . •

dustrial struc~ure is J;lighly interdependent,, .~ny particuler investment

. . - . .· .,. •• . . -·l

. proj ect, l;>y, i tself, freguently appears uneconomic, _{. .} unless. viewed in the

. .

per,speçtive .of interrelated growth of ot~er firms and ~ndustries. Since

"the lifetime of equipment is loJ?-g~·· .the investor¹s fo_{. .} r.esight is l ikely

-

.

^.

to be more imperfect than thet of the buyer and seller or of the producer.

The individ~al investor's risk may be higher then that confronting an overall

in~~stment

program."l3 The

vol~e

and cost of_production have _,

•. _ .

.. to be computed on the ba~is of the anticipated futu~e, and since each project has to be so vie~ed, the plans for any one pr?ject cannot be fi- nisbed until the plans for all the .. o~hers are kno"rn• The priee system fails in these computations because th~ externe! econ,omies of individuel projects get interrel~ted .and the sl:lpply priees depend upon the levels .of outputs, which in turn are

·-

related to the overall input requirements

of the entire development scheme. It is important to remember thet when the economy is f~r fro~ ~quilibri~, pres~~t prie ès are poor indicators

of future pri_ces, and there is no g~arantee l;het the nequcmce of invest-

. - - ^:...· ·. . ^.

.

^{. . . .}

. ~,ment di,ctated by the markc::t will maximize

the

rate. o; growth. t,owerd

. -· . . ·-.. · ^{.( . . .. . .·} . . ·- -

.

equilibrium. To promote coordinated industriel expansion, therefore, the perspective of growth must be known well in advance. This is what the state, through central planning, provided in the Soviet Union.

., .

• • ',•. •l • •

. . . I1.EPRODUC. TÎÔN731-82

Page 9 ··· .

:" .: . ,:: . :'.!! ·.·

The. most.

imJ;>p-:z:tazi~

q:uestj.on is

~h~re;

a·re most o·f :tbe external

eQonomies .and comp';:I~ni'é'Jt~!i.ties to be foun·d,•~. In the present co~;t.ext, they can be class'ified into two types - horizo~tat exte~nal ec'o:noJilies and complementari ti es of demand and vertical externQ.lities O:hd ''coinple- mentarities -of. forward .. and backward linkage. These tuo types lie at

. ~. ' .. : ~ '! . .. ; • . : . ~ ' .:;. '

tQ.e-· hear~ of both .the debate over balanced · growth versus unbalanced

·.··

growth .and· the qu~stipn, of ~nv~~~ment .' cri teri a.

·As

such théy. will be considered ~n de:tail .i:n t~r· next s~ction of this pap-er ,.,he~ the stra- tègy: of·

res

ource .allocation in. the :·s~viét•:Union. is · dis6~s~~d. For now i t ·ÎS ·erio~gh tp say th,at:.~·e_çaus~ . OÎ :·interdepend~~Ce OÎ deniand and of

in.du.~t~ ies,

^{a system}

9f ~entral planni~g

^{.. m.}ore eaaily maxiih:tzes the po-

tentja~

external

e~()noii(l.~s JI.!. Individu~if· inve~tors

willi be ·tess motiva- ted to do so bec~use the. _.. benefi ts of exte:_{. . ·~·} rnal econpmien _. ab~ rue to socie-

. ^{'; :}

ty as a whole, or at least to somemembers of' it, without 'bringing a direct return to the investor that can be anticipated. l:5y using profit maximization and current pricE:s as criteria.

'

...

^'

DEVÈLOPivlENT _. 'i'. ; "

STRATEGY~·

^{AND· RES OuRCE} ALLOCATION

.. ' · r

J ..

In discussing resource allocati~n within the context of eco- n$>m·:j.c development, . three major -p:roblems arise. First is the problem of

.... ^-

a.llocationbetween 'the.preserit and future, that is, the choice of an

\ l .

opt.imum rate .of invea,t~5~_1.lt•

imon~ sector~ and.projects .•

tion technique.

Second is the allocation of invèstment The third problem is the choice of produc-

The Rate of Investme:r:tt..

., ^-

. :: ·.

W)lat is.the optimum :rate of investment for &:poor co1mtry be- / ginning_;_ a develoJ>m.ent: p:t;'ogr~l,ll? : There is· no uni~uely: dete~inate econo- mie. )s&l,\l_tion to. this question. Inc~easing the rate of l.nvestment today

•• f 1 -~.Jj {) :.. . .i.: . ') .. .

m.eans lowerin·g the s.bare of cons:umption in gross national product

{tho,ugh not

n~ces~arily

the absolute amount}' in .tb.'e··

p: r'E h/ehi :

¹

1n

^{1 exchange}

for a l,arger incomé anq . co~sumption in th~ future • . L lm·rer r~'te of

RFJ!llllq~UCTION/31-82 .:rage 10

in.vest~ent. ,.,ill yi~ld g__. reater consumption in the _{,. r . . . .} present, but lower amounts in the future, tha)l w.ould. higher rates of investment • . The key

. .. . . . .. • ~ . ' . t . . . . . . . . . .

' . '

.. i':-.

to t~e s.olution, t.herefore, . is the . trade-off bet\'leen present and future consumption.

.•·. i .·

. ·.··'

.. ^{. -~ .}

In en ideal market economy ;individuels' time preferences would

• • • : : ...... ~ .. .'' ; 1 :. ·:; • • •

determine the rel.ative values of present and future consumption. _{. .} A

. '. . •. . . . . .

.. . . '

market rate of interest or discount of future income streams would emerge

. . , . . . . ·r . . .. . .

from the

.

^{. . .} · particul.ar^{.. : ~.} . co~:figura:tion ^{. ~ . .· .} of time preferences. ^{.··, . .} The market deter- mined rate .of investment .would be the rate at which the margi_nal produc-

th:i ty of -inv~st~ent ^{.... : ;·} equ,al s :the mark_^{,. . .} .

.

^{. .... ·....} et rate of ^{... .} d~scount that emerges from the interplay cd uni la t'aral decisions of savers and investors • _.

' . . . . . '· .. : '

.

^. . ; · , . . .

Ec<?no~ists are fa:irly well agre_ed thet this market determined rate is not necessar~ly an. optimum rate from ei ther a l'!'elÏare or a gro\<Jth

·;; 1 :

vi.ewpoint • .

. •· ·:0\ . ·. ·. .. ,. . . ·.·· . .

••• we reject the twin notions (1) thet the rate of inte- rest determined in an atomistic competitive market need have any normative, significance in the planning of collective in- vestment, and (2) that the ma~ket-determined rate of invest- ment, and bence the market-determined rote of economie growth, need be optimal .in any welfare sense.15

.. ,.. . .. . . ç· :.-: .··.

:···. ·,· '

Th~ market ra~~ o:f interest as a deviee for discounting the . wo_rth of f'Q.ture income streams, howev_er i t may be justified for an in-

div:i,dual, .is inappropriate for the community as e l>Thole, at least within the context of

econo~fc

development • .

~y

determining the rate of saving and inv~stment, time preferences of individuels-, \vould decide not only their own. future income and consumption but that of future generations

•

.· .

as well. There seems to be an inevitable short-sightedness in the in~­

vidual' s choice, owing to the limited perspective in time from which the individual t .~-~ isolated individuel, necessarily views the range of

available alternatives. This limitation in. regard to time bas often

- .

béen:referred to as the Q.~ficiency of the "telescopic facultyll of tbe llldividuàl with re~ard to ~he future, and the fact thet i t gives rise to a "psychologicel discount" of his future income does not appear to

·- . - . .. . . .•. . · . . -16

be relevant to planning economie development. In fact, even " ••• the

..

^.

i1EPROD:UCTI ON/31•82

Page 11

accuracy of its basi~ âssttmptioil that :an'apticipated 'satisf&ction is always lesa attràctivethe:mor~ distaiit the future date to which the aètU:al satisfaction is assigllëd appears io be questiëmàble, as anticio..

pétion can also: be

erij oyable '~nl7

This lest point is val id ·both for an individuel at d:Üferent points ciuring his · iifetime and ' even, beyond bis lifetime, in the case where satis:faèi~ioh is received' from ·passing on weal

th

to heirs·.

~ . ! ;.

Prof essor Hoizman' points out' s-everal problems1.8

of .time pref-

er~nèe. Th·e present .. eval~ation

of

the present versus the future will

diff.'~r fro~ the future · eveiuetion .:ôf the pre.sent vers-us the· future·. The

·. :}l'_t:: . . ·.. ' '

hindsight of the future wiii overèome the :nw.eekness of iniagin~tion"

and "defeétive teiescopic facti.l ty" ·ô'f the pre.sent·~ Thus, he argues, the rate of fl1vestment undertaken ·in the present l'/Ould be higher if i t could be chosen by thé populatio~ from the vantage point of :the future insiead of the present~ · in additi~rt t~ére i~.a particular time prefe-

.. . .

renee configuration for every possiblèinéome- distribtition~

If

the ineo~e distribution changes betwèen;the présént. ~nd_ the: 'future, then ceter.is paribus, the investnent rate will also change. He argues thet . :the .optimum rate i~ , indetermine te between a lower limi .... t set by the pre-

sent evaluation and an upper limi t se:t by the. future. evaluation.

Professor Sen introduces the con~ept of the "isolation pare-

dox"19 in e.rguing

the

limitations of time_ preference in choosing an

. ^' . . .

investment rete~ An individuel ~ay bé '·ünwflling to give up one unit of consumption _t_oday so thet a future 'genéràtion' s consunption can be in- creased by· three uni ts. However;-Ts·-:a·omë'6ile el se agrees to give up one unit of consumption now if .he; :does likewise then he IJ.ight very well

change his decision. To "t'he firs't indi vi dual, the ·loss of one unit to- day will be compensated · by a .,gein of six units for the future.. Tbere- fore, while he is not preplfx"ed to make the sa:·crific.e al one, he is rea.dy to do so if others join in.

A central plannl.ng··board cânnot simply imi tF.tj'"'-~~é-~ _ _!.ate of inve'stment that would emerge from individuel time,prefërerices. The social perspective of the future and the time horizon of a community

REPRODUCTION/31-82 Page f-2

differ significantly from those of an individuel. The community cannot and do es not discount ·i ts future in the· same manner ·and at the same rate

· ' d' 'd 1-20 _{1' 1}h t t f · t t d th 1 · b d as an 1n 1v1 ua. • " a ra e ·

o

1nves men oes, e p ann1.ng oar choose? As zioted above, Professor Holzman ~ays it is indeterminate

· between the lower limi t set by the .:present· evaluat~on of the future and the ùpper limit

set

by the future evaluation ofthe future• Professor Sen argues thët the rate is indeterminate.between a lover limit set by the rate necessary to utilize existing productiv~ capacity and to main- tain a constant consumption level•for a growing population and an upper

' limft

set by the·· rate 'tJf ii:lvestment whi.ch: maintains the present leve!

of consu.nlption: ·and· do es not ·yïeld. neg:ative · marg,inal retur?-s.₁₁ 21

, The in-

·determinanèy in praé-ti·ee ia not so great as the se limi ts might. imply.

· The rate of invèstment is not· determined in isolation. The pest allo-

cation bet\'ieen. 'cons\Imption and investmerit ·production >dll. physically limit the présent alternatives. The rate of inveatment chosen .in the

nn

present will, in tur:n, limit the al t~rnatives in the future • ..-.~ 14ore importantly, the choice ·of investment .rat.e cannot be determined inde- pendentfy· oÎ ·the choice of ifnvestment projects and technique.·

•. J

., · Once :the specifici ty of ·.productive capa city is re co gnized -to have an important bearing on the question, the problem of

the allocation of investinent between different sectors becomes the pr:esent-day equivalent. of choosine; future . rates . of saving.

If, for exemple, we assume that investment goods are of two types, viz., those that make consumer goods and those that produce 'investment-goods, the present-day allocation of pro-

ducti_ve capital .between the se two sectors comes to vety much the same thing as the determination

of

^{the future} division of national output betweeil consumption and investment. .·The allo- cation of inves.tment between the two becomes th.ê means of in- fluenci :ng the :rates of ''investment in the future.

If one assumes·further specificity, so that investment goods to.makè.investmefit goods to. make consuraer goods nre dif- ferent from investm~nt goods to. make investment goods to make investment goods, the decis;ion bas to be taken one further step backwards ;· and so on. 2)

Thus, the decision on inve.13tmen't rate is dependent on the allocation of investment and vice-versa. In a centre:.lly planned economy particularly, the decision on nllocation.greatly affects the final deter-

·:;• ..

- -

. ^{~-.. .}

· .. '

(.

REPRODUCTION/31-82

Page 13 ·

mination of the rate of savi~g~., ~n,d investment. This problem of allo-

\ 1 •

ca~ici~ b~t~een sectors and project~ is the next aspbct of resource allo- c~ti~n ~o ·~e c~~s~d~red~

_The Allocation of !lnvestment. "

. E:xponents of "~mbalaJM:ed growth", such as Hiroschman, have stressed that is .a . count;ry _deci~es to industriel ize,

tb: e

?orrect deve..;

lo~ment ·strategy i&-Q.ot to seek an optimal allobatio~ 'o:f resources at any given _-time nol\ :t.o di~~.ipate. scarce rèsource's by :tittenil?_ti.ng to

~dvance

on:

-~11

fronts siiJiul ta:raeou.slj, but

rà.the~ tb.

;.concentrate on a few

. . . ··'

IJiejor objectives most conducive -:to .transforming the economy to a higher

• • . - • • ,•, ' ~r. _1 "' ' j ·' ' ' ' '' •

stage. Efficiency.is attained in the dynamic sen:se of finding the most

t ,, ' - .• .. ·•

, .. e.ffectïvé sequences for cpnverting a stagnent, backward_ economy into

• '!, ' . . .. -

one_.which is _d,yn~~ic and m-odern. In other words, to be breathlessly ciiobing e p~ek in a. mountain rang-É! is ·. constdered more· imp~:rtant then

.. · ... ' . :_ . . • ,.. :..1

standing poio~d on the crest Df a·ridgé· iri the f6ottiills~

. ~ ;';. ;1, .. . •

' •l '

.Thez;e is nqt ·an infinite numbér of :àlternative .investment al-

..

location patterns. Because of. é:01~plemeritaries and inc!ivisibiii ti es each individuel investment project cannot be evaluateà in isolat~on.

The cons,truction ·of ~ steel in:dustry :r~quires increased coal mining and investment

in,

!'ltee~-using industries~<): The capture of . ~xtèrne:I econo- mies requires thet the entir·e ·range of· 'investment ~ proj ects be evaluated

. . ^{' ~} . . . .

as a vhole. ,

• •·• problems of economie planning seem. to a.cquire a re- semblanee to the p:roblems. of mil;i ta·ey strategjr, '\'rher·e in prao- .tice ·the choice lies batwe.~n a relatively_ small n~J:>.~r of plans, which have in 1-he:-m&in to be treated and chosen be-

. tl'reen as orgenic whol~s,. and vhith for a. variety of reas ons

do not eesily périni t ·of intemediate combine ti ons. The si tu- _ a ti on will demand ~ concentration of forces round a few main

objectives, and not. a di_s,persion of resourcec over a very wide range. 2,4

:

.

^.

' • _;

REPRODUCTION/31-..82 Page :tA

Investment allocation in the Soviet U:qion gives us an.histo- rical exemple of this strategy. They pur-sued _~

.

^{. -}~ .".shock" strategy of ^{. . . '} bottleneckE successively created and resohre.d. Thus, Soviet plamiing

concentreted on certain key branches in each plan to overcome particu-

- • • ; ',._ • • • 0 - ·

lar bottlenecks. Scarce ~e.pi tal and managerial talent tlere then con-

··., centrated on these .. key tar.gets. This gave Soviet planning i ts pecùliar

. .. ~ ~ .. .. ^{: -.~,~ ' ~--}

nature.· .of .. planning. l>Y "c~mpaigning".

. . .. ^,. . :. . ,· .. During the first Five Year Plan the main targ.et :~t.es i hee:rr. industry wi th parti culer emphesis . on·· ttiachine building •_. . · During t.he sec.ond end third .Five_{.• . . . ; .} .' Year PlaJ;J.s the target wes _.

. ~ . · ....

agaip•heavy industrY:with metallurgy, machine building, fuel, eriergetics,

. . . ;, i . . :. ;

and chemicals singled, out f_pr .. emphasis. This emp.hasis on key brÈmches yielQ.ed ·high growth .:r;a-tes. The. ay·era(l;e

~~u~. { rat~ ~ : :~f ·

growth in Soviet . :beavy industry.b.etween.192~/29 and 1937 '•ere 18.9 percent ·:rormfichinery,

18.5 percent for; iron and steel, · H: .6

perce~t

for coal, .

1 ;{.7 pe~cent

for petroleum products, 22.8 perce~t ... for electric p~wer, and 17~8 percent for ell. heavy industr;. 25 Sec

tor·~-

which did not contribute directly to furtber. growth ( consûmption) were neglected while sectors .which enhon- ced growth (capital goo~s) were emphnsized. Growtb tempos auch as . these· caused acuteshorteges end strains. The bottlenecks which eppea-

~ . ^~ ..

red

then becnme the new te:rgets.

Much of the .balanced growtb ve:.:sus imbela:nced growthdebete

' . '

boils down to the question of where external economies are the greetest.

' '

One of the key questions in choosing investment criteria~ in turn, hinges on how best to teke advnntege of externa.l ecoiiomies end avoid external,diseconomies • . Economi~ theorists usuolly argue that investment should be allocated in:such a way thet its soci~l marginal product

( SMP)

is. equel in ell uses. N'hile this is .• true as a formàl statement i t bas

little meaning Uilless • the ¹¹empty box" enti tled Sî-'IP can be fil led wi th sorne ,content • . To date. no one bas done so~ One advantage of the imbe- lanced gro,·ith strategy is that i t provides a practical signal for real- locating investment. When bottlenecks appear the planner can be sure that the SHP of investment is not equal in all uses. The industries that are the bottlenecks will have a high SMP and thus should receive large investoent allocations in the next period. In t his sense the SiviP will be equated in all uses through time, that is, in a dynamic sense.

•