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Estimating the Size of the Soviet Economy: Summary of a Meeting (1991)

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Meeting Workshops WORKSHOP I: THE SIZE OF THE MILITARY-INDUSTRIAL SECTOR Richard Judy defined the major issues before the participants at this workshop as the determination of the areas of disagreement among the experts and the sensitivity of the results to these disagreements. Additionally he called on the participants to determine the data re- quirements that would be necessary in order to improve the existing estimates. Despite the workshop title, this session focused on estimates of the size of the military sector with only peripheral attention paid to questions concerning nonmilitary industrial production. Frank Holzman initiated the discussion with a series of criticisms of the way in which the CIA produces its estimates of the military sector of the Soviet economy. At the most general level of criticism he suggested that the CIA made a major methodological error in preparing its estimates on the basis of dollar rather than ruble prices. He contended that the CIA should have followed its 1983 downward revision of the rate of growth of military expenditures with a corresponding revision of its military burden estimates. He also maintained that the upward revision of the Soviet military burden that was performed in the wake of the 1982 price reform was not warranted. In fact, Holzman argued that this price reform should have reduced the military burden, relative to the burden calculated in 1970 prices, since the prices of high-tech military output should have declined relative to prices of civilian goods as a result of the reform. The military burden, estimated at 12-14 percent by the CIA in 1980, should have declined to about 10 percent in 1982 prices, but the CIA increased its estimate to the 15-17 percent range. Holzman also pointed out that the arbitrary nature of the upward shift in the CIA's estimate was evidenced by the CIA's admission, in a November 1987 pamphlet, that no informa- tion was available on how the 1982 reform affected the prices of weapons. Jim Noren responded that the CIA had made its revision only after a careful study of hundreds of weapons' prices, and that on the basis of that study they had concluded that the 1982 reform had not resulted in sig- nificant changes in the prices of military hardware. He also noted that after 1982 the rate of inflation in military procurement appeared to have remained about the same as it was prior to the reform. He said that the agency had conducted a statistical inquiry into the relation between prices and changes in weapons characteristics at the time and had followed up 13

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14 THE SOVIET ECONOMY with a further study using actual prices on a small sample of goods, and that both had confirmed the validity of their numbers. William Lee advanced the opposite critique, arguing that the CIA underestimated military expenditures in the Soviet economy by imputing too much inflation to military output prices. Most of the price increases, according to Lee, represented genuine improvements in the quality of Soviet weaponry. Lee stated that eliminating this bias would result in an estimate of the military burden on the Soviet economy of 15-19 percent for the 1985-1988 period, or an effective rate of 22-25 percent once one factored in the cost of underground shelters and a number of other mili- tary expenditures not included in the CIA's estimates. Noren asserted that the major difference between Lee's approach and that of the CIA was that Lee derives his estimates from an analysis of official Soviet statistics. Lee's ~residual" methodology derives the size of the military component of the economy from an analysis of Soviet statistics on the Soviet machine-building sector, whereas the CIA uses a Building blocks approach to estimate military output. Lee countered the criticism that he utilizes Soviet Comparable prices as the basis for his calculations with the argument that these prices had been adequately adjusted for in- flation. Noren replied that the CIA had found the residual approach to be completely unreliable and the use of ~comparable" prices to be unwar- ranted. He further noted that comparable prices include significant amounts of inflation and that the precise methodology used to calculate them remains unknown to Western researchers. A different criticism of the CIA's methodology was advanced by Dmitri Steinberg. He estimated Soviet military expenditures as a component of GNP on the basis of Soviet established prices. One of the advantages of this approach is that it estimates the military burden in the same way that it would be calculated in Soviet national accounts, thus permitting insights into Soviet policy making. Another advantage of this approach is that it provides an alternative assessment of the military burden that is inde- pendent from the building block approach. On the other hand, Steinberg's estimates can only be calculated in established prices, and additional work would be required in order to deflate them. Steinberg criticized the CIA estimates of the military sector as incomplete. He stated that part (approximately 16 billion rubles) of what the CIA counts as household consumption was actually purchased by the military. He also asserted that the CIA fails to effectively account for hidden material costs, the purchase of a variety of services, and the artificially low level of revenues compared to the size and quality of labor and capital resources in the military sector. A larger problem is that the CIA makes no attempt to link its GNP and military expenditures estimates. Steinberg insisted that realistic estimates could only be developed by

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THE SOVIET ECONOl,IY 15 integrating the two, that everything the military does occurs within the economy, and that if it appears there is insufficient room for the military sector within the overall GNP estimates, that this insufficiency is an important indicator that something is wrong with the aggregate estimates. Steinberg's estimate for total Soviet military expenditures in 1988 in established prices was 120-125 billion rubles or 14-15 percent of GNP, but he noted that this figure does not represent the effective resource cost of the military to the Soviet economy. The Soviet military generally pays the same prices for goods and services as civilian users, but receives higher quality for its money. Also, military personnel enjoy various Perks in addition to their monetary wages. Factoring in these hidden resource costs would add 25-30 percent to his established prices estimate, bringing the total military expenditures for 1988 to approximately 160 billion rubles or 18 percent of GNP (this compares with a CIAJDIA estimate of approx- imately 150 billion rubles or 15-17 percent). Several points concerning Steinberg's approach were noted at the ses- sion. First, U.S. military contractors operate under cost-plus pricing and they are also able to inflate the prices of some of their major inputs. For the sake of comparability, estimates of the military burden on the U.S. economy should therefore be adjusted as well. Second, Soviet military industry produces a significant quantity of civilian output, of which the GNP share changes over time. This factor complicates the calculations of real resource costs. It was also noted that although the underlying metho- dologies are quite different, numerically, Steinberg's estimates do not differ greatly from those produced by the CIA. The difference in approach may be more important, however, in calculating the rates of growth of Soviet military expenditures. WORKSHOP II: CONSUMPTION AND SERVICES The most important debate at this workshop revolved around U.S./ Soviet comparisons of per capita consumption. Comparisons have been made in both ruble and dollar prices, and one of the key issues in the debate concerned the best way to calculate the dollar/ruble ratio. Another major issue was how to account for factors that are not normally included in conventional international comparisons of consumption and GNP. The workshop discussion particularly focused on the debate concerning the CIA estimate of the U.S./Soviet per capita consumption ratio for 1976. Igor Birman contended that the CIA's figure (34 percent) was far too high, and he argued that even his own estimate (22 percent) probably erred on the high side. After prolonged debate between Gertrude Schroeder, Gur

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16 THE SOVIET ECONOMY Ofer, and Igor Birman the group reached a consensus on the following factors as being the principal factors responsible for the difference between the two sets of calculations. Nonquantifiable factors, such as the lack of variety in consumer goods and services and time wasted in queues, were considered to account for approximately one-third, or five percentage points of the difference, but these are factors that are neither included in conventional international comparisons of consumption nor in GNP. Another five percentage points of the difference was ascribed to different ways of accounting for retail trade services. In this area the CIA follows the International Comparisons Project (ICP) methodology that does not include these services in GNP calculations for any country. It was indicated that the CIA was well aware of the importance of this omission for its U.S./U.S.S.R. comparisons, but had decided to follow the ICP convention for the sake of international comparability. The remaining difference appeared to be the result of differences in calculating the dollar/ruble ratio and of different ways of accounting for the contribution of services. The workshop discussion also centered on the methodological prob- lems posed by the measurement of the service sector. The standard practice for measuring such services as health and education is to derive output from the total value of the inputs used to provide the service. This approach assumes, however, that the skill of a doctor or teacher does not vary from country to country. This assumption may be entirely unwar- ranted when the countries being compared are at substantially different levels of development. The ICP dealt with this problem in its most recent comparisons by assigning a weight of 50 percent to labor inputs in this sector for Hungary, Yugoslavia, and Poland. This introduction of non- unitary weights into the ICP comparisons was considered highly contro- versial by the participants. They were unanimous, however, in rejecting its application only to formerly centrally planned economies and not to LDCs. Some participants suggested that the CIA should investigate the possibility of assigning a less than unitary weight to Soviet labor inputs in the production of services. The discussion also included an examination of issues concerning housing in the Soviet economy. Once again, the CIA's use of physical data does not make any adjustments for changes in the quality of output. Many researchers have argued that the quality of Soviet housing has improved over time, particularly in view of the increasing availability of various household amenities. If this is the case then the CIA underestimates real growth in consumption, and, therefore, the level of consumption as well. In contrast, Steinberg argued in the paper he prepared for the meeting that the quality of many Soviet services had actually declined over time. He reached this conclusion on the basis of an analysis of a mix of inputs,

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THE SOVIET ECONOMY 17 including labor, capital, and materials. For example, he considered that a decline in the capital/labor ratio in the production of a service was likely to have resulted in a reduction in labor productivity and thereby counted this as a deterioration in the quality of output. On the basis of this methodology, Steinberg concluded that the CL4-'s disregard of trends in the input mix may have led to an overestimation of consumption in the service sector. Although there was no firm consensus, the balance of opinion in- dicated that the participants considered that the CIA estimates of the U.S./U.S.S.R. consumption ratio probably suffered from an upward bias. The discussion was also instrumental in clarifying existing disagreements and identifying areas for further study. WORKSHOP III: THE SECOND ECONOMY The first issue examined at this session was the most appropriate definition of what constitutes the second economy. Several approaches have proven useful in the context of the Soviet economy. According to Gregory Grossman's definition, the second economy consists of any eco- nomic activities that satisfy at least one of two tests: (1) the activity is directly for private gain, or (2) the activity is knowingly illegal. An alternative approach that some participants considered useful for the purposes of the present discussion was the statistical approach. This approach considers the second economy to include all economic activities that are not directly reflected in official economic statistics. While the first definition provides a wider scope for research and does not place a re- searcher at the mercy of the statistical authorities, the second definition may be more useful for GNP adjustments. Traditionally, illegal economic activities have been excluded from official statistical accounting, but a number of countries have recently begun to make adjustments in order to incorporate their second economies into their GNP accounts. For example, Italy increased its official GNP figure for 1984 by 11 percent. It was noted, however, that when such adjustments are made, they are usually phased in, and this is done in such a way that they do not affect the growth rates of the economy. All the participants agreed that the second economy in the U.S.S.R. is sufficiently large to warrant its inclusion in the Soviet GNP accounts. According to the calculations made by Grossman within the framework of the Berkeley-Duke project on the second economy, approximately one- third of urban household income in the U.S.S.R. is generated within the second economy. The salience of the second economy is enhanced by the

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18 - THE SOVIET ECONOMY fact that it appears to be the only sector of the Soviet economy that is experiencing rapid growth. In a recent Soviet newspaper interview, Soviet economist Tatiana Koriagina estimated that the second economy has been growing at an average rate of about 10 percent per year since 1960. Not only does the second economy affect many of the magnitudes used in the weighting procedures for calculating GNP growth rates, but official prices often have a tendency to follow those of the black market. The CIA does attempt to incorporate part of the legal second economy in its GNP accounts. For example, the output of private plots and some private construction are explicitly included and some adjustments are made in its estimates of the weighting of food and services. Several participants argued, however, that the CIA is not doing enough in this respect. Vladimir Treml suggested that the inclusion of elements of the second economy that are missing from the CIA adjustments would add another 15-18 percent (in nominal terms) to Soviet GNP. Some types of income are not taken into account by the CIA in its analyses of the Soviet economy, but are included in conventional estimates of U.S. GNP, for example, the income of churches. This results in further imbalances in comparisons. Many difficult issues arise once the attempt to incorporate the second economy into the GNP accounts is made. To begin with, one cannot simply add the turnover in the second economy to the GNP estimate, since a large part of the second economy consists of transfer payments. Also, an indeterminate amount of the inputs used in second economy production have already been counted in the official statistical data. Another problem is that of pricing, since prices for the same goods are frequently higher in the second economy than they are in the first. The international convention is to use average realized prices, but it is difficult to calculate the quantity of goods sold at official and at second economy prices in the Soviet context. The emergence of entirely new institutions in the U.S.S.R. in the most recent period, particularly the creation of the crypto-private cooperatives, has complicated the situation even further. Koriagina has estimated that 1.75 rubles worth of illegal activities are generated with every ruble of officially recorded cooperative sales. Despite these difficulties, many adjustments can be readily made to the CIA GNP accounts. The main economic activities that should be included are the production of moonshine, various kinds of repairs (appliances, cars), and the crypto-private production of clothing. The reclassification of certain components of GNP will also be necessary. For example, a certain portion of bread and sugar production that has traditionally been counted as consumption, but that are actually being used as inputs in the second economy (both in the production of livestock and moonshine), will have to be reclassified. It was pointed out by a number of participants

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THE SOVIET ECONOMY 19 that a proper accounting for second economy activities will raise the U.S./U.S.S.R. GNP ratio by a far from trivial amount, and that it might also help to reduce the "cognitive dissonances discussed in Session III.

Representative terms from entire chapter:

military expenditures