Dysfunctions of Soviet economic ministries

In my book A New Social Ontology of Government (2020) I tried to provide an analytical inventory of the sources of “dysfunctions” in large organizations and government agencies. Why do agencies like FEMA or the NRC so often do such a poor job in carrying out their missions? The book proposed that we can better understand the failures of agencies and corporations based on a “social ontology” of actors and networks of actors within large organizations. The book discusses principal-agent problems, failures of communication across an organization, inconsistent priorities and agendas in sub-agencies within an organization, corruption, and “capture” of the organization’s decision-making process by powerful outsiders (industry groups, interest groups, advocacy organizations).

It is very interesting to see a similar analysis by Paul Gregory and Andrei Markevich of the sources of dysfunction and organizational failure in the classic Soviet economic agencies in the 1930s-1950s. Their article “Creating Soviet Industry: The House That Stalin Built” (link) provides a good indication of the limitations of “command” even within a totalitarian dictatorship, and many of the conclusions converge with ideas presented in A New Social Ontology. Stalin’s economic agencies and central planning apparatus showed many of the failures identified in other large organizations in the democratic capitalist West.

First, a little background. In the 1930s and 1940s there was an idealized conception of economic organization current in socialist thought (both communist and non-communist) according to which a socialist economy could be rationally and scientifically organized, without the “chaos” of a disorganized capitalist economy. The socialist economy would be vertically organized, with a “chief executive” (boss of bosses) presiding over ministries representing major sectors of the economy and giving commands concerning basic economic factors. The chief executive would set the targets for final outputs of capital goods and consumer goods to be produced. Each ministry would be responsible for production, investment, and labor use for the industries and firms in its sector. The input needs of the overall economy and all sectors and enterprises would be represented in the form of vast input-output tables that capture the interdependency of industries throughout the economy. The professional staff of the chief executive would set final needs for each commodity — refrigerators, tanks, miles of railway tracks, … Each industry has “input” requirements for primary goods (steel, coal, labor, metals, machines, …), and an equilibrium economy requires that the right quantity of final goods and production goods should be calculated and produced to satisfy the needs of each industry as well as final demand. Wassily Leontief proposed a computational solution for this problem in the form of a large multi-sector input-output table — an NxN model for representing the input-output relationships among N industries. Suppose there are 100 basic industries, and each industry requires some quantity of the inputs provided by every other industry. We can now compute the quantity of iron ore, coal, electricity, and labor needed to produce the desired end products in one time period. The results of the I-O model permit the development of plans and quotas for each industry: how much product they need to produce, and how much raw material and other inputs they will need to consume to complete their quota. Now there is the apparently simple problem of organization and management: bosses, managers, and supervisors are recruited for each industry to implement the sub-plan for the various industries and enterprises, and to ensure that the production process is efficiently organized, waste is minimized, and quotas are reached. Production by each enterprise is managed by plans originating with the central economic ministry. Orders and quotas begin with the central ministry; master plans are broken out into sub-plans for each industry; and each industry is monitored to ensure that it succeeds in assembling its resources into the specified quota of output. And the I-O methodology eliminates waste: it is possible to plan for the amount of steel needed for all producers and the number of refrigerators needed for all consumers, so there is no surplus (or deficit) of steel or refrigerators.

This is a vertical conception of economic organization based on a command theory of organization. It is dependent on determination of final output targets at the top and implementation at the bottom. And it is coordinated by the modeling permitted by Leontief tables or something similar. Resource constraints are incorporated into the system by inspection of the final output targets and the associated levels of raw material inputs: if the total plan including capital goods and consumer goods results in a need for ten times the amount of iron ore or coal available to the nation, then output targets must be reduced, new sources of iron ore and coal (mining) need to be developed, or international trade must make up the deficit. International trade presents a new problem, however: it requires that a surplus of goods be available (consumer goods, capital goods, or raw materials) that can generate currency reserves capable of funding purchases from other countries. This in turn requires readjustment of the overall system of plans.

This description is incomplete in several important aspects. First, this account focuses on quantity rather than quality by setting quotas in terms of total output rather than output at a given level of quality. This means that directors and managers have the option of producing more low-quality steel or bread rather than a smaller quantity of high-quality product. Much as a commercial bakery on Main Street in Fargo can reach market goals by adulterating the bread it produces, so the railway wagon enterprise in Chelyabinsk can substitute inferior inputs in order to achieve output quotas. (Here is a critical assessment of product quality in the late Soviet economy and the last-ditch efforts made by Mikhail Gorbachev to address the issue of quality control; link.) But the problem is systemic: managing to quota does not reward high standards of quality control, and there is no way for consumers to “punish” producers for low-quality products in the system described here because price and demand play no role in the process.

A second shortcoming of this concept of a planned economy is that it leaves out entirely the possibility of technological change and process improvement; implicitly this conception of production and investment assumes a static process of production. Technology change can be reflected in the planning process described here, because technology change shifts the quantities of inputs required for production of a unit of output, so technology change would be reflected in the I-O table for the industries that it affects. But the model itself does not have a mechanism for encouraging technology innovation.

However, there is a more fundamental problem with the vertical description provided here: it makes assumptions about the capacity to implement a command system in a vast network of organizations that is completely impossible to achieve. It is simply not the case that Stalin could decree “10 million toasters needed in 1935”; his ministry of “Small Electrical Appliances” could take this decree and convert it into sub-plans and commands for regional authorities; and plant bosses could convert their directives into working orders, smoothly implemented, by their 1,000 toaster assemblers. Instead, at each juncture we can expect to find conflicting interests, priorities, problems, and accommodations that diverge from the idealized sub-plan delivered by telegram from the Ministry of Small Electrical Appliances. We may find then that firms and sub-ministry offices fail to meet their quotas of toasters; or they lie about production figures; or they build one-slice toasters at lower cost; or they may deliver the correct number of completely useless and non-functional toasters; or they may deliver the toasters commanded, but at the cost of shifting production away from the electric borscht cookers and leave great numbers of Soviet consumers short of their favorite soup. And in fact, these sorts of opportunistic adjustments are exactly what Gregory and Markevich find in their analysis of Soviet archives. So let’s turn now to the very interesting analysis these researchers provide of the organizational dysfunctions that can now be detected in Soviet archives.

Here is the approach taken by Gregory and Markevich:

The textbook stereotype has focused on the powerful State Planning Commission (Gosplan) as the allocator of resources, but most actual planning and resource management was carried out by the commissariats and more specifically by their branch administrations (glavk). This study considers the internal workings of the commissariats, rather their dealings with such organizations as Gosplan and the Commissariat of Finance. (789)

So, to start, Gregory and Markevich propose to disaggregate the Soviet organizational decision-making process, from the high-level planning agency to the commissariats and branch administrations — the more proximate levels of economic organization. In other words, they implicitly adopt the perspective taken by current organizational theorists in western organizational studies: the idea that large organizations consist of networks of more or less loosely connected centers of decision-making (linklinklinklink).

In the three-tiered Soviet system, the industrial commissariats occupied the intermediate level between the “dictator” (assisted by functional agencies such as Gosplan or the Commissariat of Finance) at the top, and enterprises subordinated to the industrial commissariat (at the bottom). The “dictator” was an interlocking directorate of officials from the Politburo and the Council of People’s Commissars (Sovnarkom). Notably, the most important industrial commissars, such as Ordzhonikidze and later Kaganovich, were also members of the interlocking directorate, allowing them to plead their cases both within the dictatorship and as part of the system’s vertical hierarchy. (790)

The idealized view of the command economy emphasizes “vertical” relations of authority; whereas Gregory and Markevich pay much more attention to “horizontal” relations among managers, firms, and other economic actors. Horizontal agreements among managers within firms and across firms may act contrary to vertical commands; and because of the lack of accurate information, it may be impossible for higher-level bosses to punish those horizontal actors.

A perfectly informed dictator could impose vertical discipline, but the agent will always possess superior information (asymmetric information), and thus be left with the choice to obey or to engage in opportunistic behavior. Opportunism is promoted by the fact that the superior must hold the agent responsible, in this case, for production and delivery, and must mete out punishment for plan failure. The agent has an incentive to use its information advantage to obtain easy production and delivery plans and to provide inaccurate information in the case of plan failure. (792)

This feature of a command economy derives from “information asymmetry”. Another situational feature involves the fact that “plans” in the Soviet economic system were rarely exact or specific, which meant that managers could evade their responsibilities (perhaps excepting the quotas imposed on their units). Further, central planning ministries and offices were generally very poorly staffed, and therefore had little capacity to genuinely oversee and manage the enterprises within their formal scope. Further, the strategy of using increasing levels of punishment and threat against managers who failed to reach quotas and targets had perverse consequences for the “vertical” command structure; punishment tactics had the effect of incentivizing local managers to make separate horizontal deals with other actors and to withhold the truth about production to their superiors (799). (It is worth recalling that China’s Great Leap Forward Famine largely resulted from the fact that collective farm directors and regional economic authorities withheld information from Beijing about the terrible economic consequences of agricultural collectivization.)

As described earlier, in the nested Soviet dictatorship, the superior issues vertical orders to subordinates, which the subordinate either obeys or disobeys. In extreme cases, the subordinate might disobey the order outright; or the subordinate might disobey the order by engaging in a horizontal transaction while concealing this fact from the superior. In addition, the subordinate could lobby to influence the superior’s vertical orders, to shape them to be more suitable. The archives provide a wealth of information on all these dealings between superiors and subordinates. (801)

Gregory and Markevich’s analysis often turns on pervasive principal-agent problems within and across agencies and firms: “A persistent principal/agent conflict characterized the relationship between dictator and commissariat that followed from the commissariat’s requirement to “fulfill the plan” and from the commissariat’s information advantage” (813). But numerous other sources of “loose-connectedness” among agencies and firms appear in their analysis as well. And it is striking that there is a great deal in common across the organizational problems posed in running the Environmental Protection Agency (US), the GOSPLAN (USSR), and the General Motors Corporation.

Were reforms possible in the Communist economic systems?

In historical context, it is interesting to speculate whether some of the ideas associated with “market socialism” could have been incorporated into the Soviet economy in a way that enhanced quality, resource allocation, and technological and process innovation. Could the system of state-owned enterprises be reconciled with a system of market-determined prices? Could a state-owned economy become less centralized and more guided by “consumer preferences” and market conditions? Reforms along these lines would address some of the sources of systemic weakness in the Soviet economy — imbalanced investment decisions, poor quality of both consumer and capital goods, and slow technological and process innovation. But this kind of reform would have a fatal flaw from the point of view of the Soviet dictatorship: it would substantially reduce the power of the party and the dictator over the economy, over the use of labor, and over the questions of what is produced and in what quantities.

During 1989-1991 I had the special opportunity to have several lengthy conversations with Hungarian socialist economist Janos Kornai at Harvard’s Center for International Affairs, at the time of the collapse of communism in Hungary and the pending collapse of the USSR. It was highly interesting to hear this astute observer’s observations about the economic failures of the command economy in the USSR and its satellites. From notes I took at the time, Kornai had in mind a package of reforms of socialism that might be referred to as “radical reform market socialism”. (1) Price reforms should be undertaken in order to establish a system of market-clearing prices, reflecting relative scarcities and real opportunity costs. (2) Enterprises should be regulated by the principle of profit-maximization, and they should be subject to a hard budget constraint; unprofitable enterprises should be allowed to go bankrupt. (3) Barriers to competition should be eliminated in commodity markets, labor markets, and capital markets. (4) The skewed size distribution of enterprises in socialist economies should be redressed, with a larger proportion of middle- and small-scale enterprises. (5) International trade should be encouraged and exchange rates should be realistic. (6) The state should enact strong and credible legal protections of the new economic institutions: land-use arrangements should be formalized, private businesses should be protected, and the right to accumulate property should be assured. Kornai was also aware of the negative economic and political consequences that reforms like these could have for countries like Hungary, Poland, or the USSR. A hard budget constraint on enterprises would be likely to lead to waves of bankruptcies among inefficient enterprises, producing large numbers of unemployed workers. Price reforms would be likely to significantly alter the pattern of income distribution across sectors and regions, including a rebalancing of urban-rural incomes. And substantial price reform might lead to high rates of inflation in the medium term, again leading to unpredictable political consequences. These are consequences that might be politically unacceptable for socialist states. I don’t recall that Kornai was favorable towards even deeper structural reforms of the socialist economies, including a transition to worker-owned cooperatives in place of state-owned enterprises.

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