The Collapse of the Soviet Union

It wasn’t as bad as you think

The harm from the collapse of the USSR has been much exaggerated. So too have the harms from privatization, exaggerated in the West by those reflexively opposed to markets. The effects were positive, and the collapse in Russia was not so much an actual collapse in living standards, but a case of measurements finally catching up to reality.

Let’s start with theory. The superiority of a price system at discovering information is obvious and well-acknowledged. Different uses of resources trade off against each other. We need some methods of getting people to reveal their true preferences – if you simply asked people, they would tend to opportunistically over-report their desires. The socialist response to the economic calculation debate, as typified by Lange and Lerner, was to acknowledge the justice of von Mises’ argument with regard to consumer goods, but to have the capital market be controlled by a central planning board which would vary prices and quantities supplied in response to deficits and surpluses. The aim is to equate marginal cost to marginal benefit, such that there are no people who could be served at a competitive price but aren’t. If we grant constant marginal costs for ease of exposition, in any case where there is a fixed cost to establishing the business equating marginal cost and benefit necessitates the business selling at a loss. Hence, government subsidy is justified.

Why would we want to have private ownership, rather than public ownership? It is not enough to say that what went on behind the Iron Curtain was not what Lange and Lerner intended. Even in theory, private ownership prevails in most circumstances. A fundamental difficulty with the government is that there is no owner of the residual. There is no one who directly benefits from delivering a product cheaply, or from making a new or higher quality product. Government ownership can be useful only when we want things to be less efficient. Hart, Shleifer, and Vishny (1997) discuss the case where there are multiple dimensions on which the product is to be judged, and only some of them are measurable. Something might have a price, which everyone can observe, and quality, which is hard to observe. Energetic ownership might drive down the price at the cost of cutting quality, leaving people worse off. A privately owned prison might cut down on the cost by making conditions really bad for the prisoners, for example. If quality can be observed, or there are great productive advances which could be made in the production of the good, then government ownership would not be justified. There are very few goods which fit these criteria.

After the fall of the Iron Curtain, and the liberalization of the Eastern European economies, economic output substantially improved in the Warsaw Pact nations, but not in the former USSR. A large part of this, however, was due to the statistics in the USSR being overstated. Measuring the quality of goods, unlike output, is difficult, especially when there is no market and no genuine consumer choice. Shleifer and Treisman (2005) argue in “A Normal Country” that the goods in the USSR were shoddy. Where direct comparisons are possible, such as in motor cars, they are far below those of the West. People also have a taste for variety in goods, and there were far fewer available in Russia. (Who could forget Yeltsin beholding the freezer full of Popsicles and Jello?). Much of what was counted in GDP was also totally useless to the consumer. 25% of soviet GDP was spent on the military. (For comparison, the United States was spending 6% by the late 1980s.) One does not have much practical use for the endless BTRs which Russia is present brushing the dust off of and sending into Ukraine!

Last on the theme of mismeasurement, the incentives of managers shifted from over-reporting to under-reporting with the fall of communism. Before, you would be rewarded for squeezing out Stakhanovite productivity, or simply claiming that you did. After, you’d be taxed. Since there is and was considerable tax evasion in Russia, production figures were biased toward a fall in living standards. Looking at other consumption indicators tells a different story. Electricity consumption (a weak indicator anyway, as there was little incentive to economize on electricity) fell by considerably less than GDP fell. Household consumption measures – like ownership of automobiles and other consumer durables, or living space, increased after the fall.

And what about elsewhere? In the former Warsaw pact nations, privatization has been unambiguously good. Communism caused immense misallocation of resources between firms. It is better for society for more efficient firms to be larger than inefficient firms, and in free countries, like the United States, it is. We use what is called an “Olley-Pakes” decomposition to measure this, which breaks down the weighted average of industry level productivity into an unweighted firm average, and a covariance term of size and productivity. Bartelsman, Haltiwanger, and Scarpetta (2009) show there was no correlation between firm size and productivity under communism, but that the situation rapidly improved throughout the 1990s.

In other empirical estimates, Brown, Earle, and Telegdy (2006) estimate substantial gains in productivity in Romania and Hungary between 1985 and 2002, with much more muted gains in the far more corrupt Ukraine and Russia. (Privatization is not the only thing – favored firms may still receive substantial under-the-table favors, replicating much of what was bad about state-owned firms in the beginning). They are essentially doing difference-in-difference analysis on similar firms and controlling for differences in trend before privatization. Obviously this isn’t lights out evidence, but the cleanness of identification is allowed to vary negatively with respect to the importance of a question. Claessens and Djankov (2002) do event studies on a panel of 6000 privatized and state-owned firms, and show that privatized firms substantially outperform comparable public firms.

I cannot pretend to cover in an exhaustive manner privatization outside of Eastern Europe; I can, nevertheless, provide some supporting evidence. In China, private firms substantially outperform state-owned enterprises, especially when the state-owned enterprises are failing. This is in spite of a naive regression being biased toward a negative effect, with the Chinese government pursuing the policy of “grasping the large, letting go of the small”. Unproductive, money-losing enterprises were more likely to be privatized. Chen et al (2021) estimate that privatized firms would go on to be three times more productive per worker than state-owned enterprises. To estimate the causal effect of privatization, they estimate a production function for each firm during the year before it was privatized but after the decision was made.

Market economies are pretty great, and communism pretty bad. We oughtn’t be misled by sensationalism.