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Política y economía en Venezuela

January 12, 2009

Los dos procesos más poderosos que afectarán este año a Venezuela llegarán simultáneamente a principios de 2009: el referendo constitucional para permitir que el presidente Chávez se postule para un nuevo período presidencial y los efectos de la crisis económica que golpeará a todos los países de América Latina.

Los dos están enlazados en forma inextricable. La orientación socialista de Venezuela ofrece al país la posibilidad de defender el nivel de vida del pueblo venezolano y la economía nacional contra las tendencias extremadamente negativas de la crisis financiera internacional. La victoria de la “oposición” y el fin de la orientación socialista del país lo expondrían al impacto total de la crisis financiera internacional, lo que implicaría una severa caída del nivel de vida del pueblo venezolano y un grave daño a la economía nacional.

Las razones para esta cruda y simple selección son fáciles de entender. La economía de Venezuela, igual que la de todos los países de América Latina, sufrirá el impacto de la crisis financiera internacional. Cada uno de los países más importantes del mundo se está viendo obligado a enfrentar esta crisis, y lo está haciendo, a través de aumento del papel del estado en la economía; por lo tanto, la orientación socialista de Venezuela ofrece la mejor oportunidad para confrontar la crisis económica actual.

En contraste, la “oposición”, debilitando o desmontando el papel del estado en la economía venezolana, provocaría, en primer lugar, enormes penurias para el pueblo, pues la crisis económica sería resuelta a sus expensas; en segundo lugar, dejaría la economía nacional de Venezuela debilitada e inerme ante la mayor crisis financiera de los últimos 80 años.

Por lo tanto, la victoria del presidente Chávez en el referendo es vital no solo por razones morales, políticas y sociales, sino por motivos directamente económicos. Por consiguiente, explicar la relación entre el referendo y la opción de Venezuela para enfrentar la crisis económica internacional también es crucial.

A continuación abordaremos en detalle las implicaciones de decidir entre defender los niveles de vida y la economía nacional de Venezuela, a través de la orientación socialista de la economía, o dejar que la población y la economía venezolanas sean golpeadas por la crisis financiera internacional, debido a las políticas de la oposición.

La razón por la que la orientación socialista de Venezuela es una ventaja decisiva frente a la crisis económica internacional se puede entender fácilmente. El núcleo de cualquier recesión, en particular una tan grave como la actual, es la caída de la inversión privada. En una economía privada, las compañías reducirán la inversión, lo que hará que la economía entre en una fuerte espiral descendente. Sin embargo, una economía socialista, como la de China o Cuba, no tienen que permitir que caiga la inversión. Por ende, la decisión entre seguir una orientación socialista en Venezuela, que significa intervenir en forma decisiva en el proceso de inversión para impedir su caída, o tomar otro camino diferente al socialismo y permitir que las compañías privadas arrastren la economía con ellas en su caída debido a la falta de inversión determinará el destino de Venezuela durante la crisis económica actual.

Las consecuencias de una recesión internacional en una economía dominada por la propiedad privada se muestran en las Figuras 1 y 2.

La Figura 1 muestra el desarrollo de los diferentes componentes del PIB interno de Estados Unidos en la crisis económica más clásica de todos los tiempos, la Gran Depresión en Estados Unidos después de 1929.

Figura 1


La Figura 2 muestra los componentes internos del PIB estadounidense al entrar en la recesión económica actual; la similitud entre los dos gráficos es evidente. La magnitud de la caída económica después de 1929, hasta ahora, es, sin duda, mucho mayor que la actual, pero el patrón de la recesión actual es totalmente clásico.

Figura 2



Analizando estas tendencias con mayor detalle se observa que durante la Gran Depresión, la caída del PIB (Producto Interno Bruto) de Estados Unidos fue de 29,7 por ciento. El gasto público en consumo aumentó durante la recesión. La caída del gasto en consumo personal después de 1929 fue muy fuerte, pero menor que la caída general del PIB. La fuerza motriz de la recesión fue el colapso extremo de la inversión en Estados Unidos, la cual se desplomó 73,9 por ciento con respecto a su nivel de 1929. Sin duda, éste fue el elemento más grave de la depresión, el cual, por efectos económicos multiplicadores, propagó sus consecuencias al resto de la economía.

La Figura 2 muestra el mismo patrón en la caída actual de la economía en Estados Unidos. El PIB estadounidense y el gasto del consumo de ese país siguieron aumentando hasta el segundo trimestre de 2008, mientras que el gasto en consumo final del gobierno estadounidense todavía sigue creciendo. Sin embargo, la inversión fija de Estados Unidos empezó a bajar después del primer trimestre de 2006 y para el tercer trimestre de 2008, había caído casi seis por ciento; una baja que se aceleró en forma significativa en el cuarto trimestre de 2008.

La razón por la que el descenso de la inversión impulsa el bajón de la economía es que los diferentes componentes de la “demanda” en la economía están controlados por mecanismos económicos muy diferentes. La inversión es el elemento estratégicamente más vulnerable, debido a la propiedad privada de los medios de producción.

· El nivel del gasto público en consumo está controlado por el estado y, por ende, se pueden tomar decisiones directas para impedir cualquier descenso. En este sector, la orientación socialista de Venezuela ofrece una oportunidad particularmente buena para mantener el nivel de la demanda durante la recesión internacional. En contraste, el deseo de la “oposición” de reducir los programas de protección social provocaría una fuerte caída de la demanda del sector del gasto gubernamental, lo que conduciría a una reducción del nivel de vida de la población y profundizaría de manera significativa las tendencias a la recesión de la economía venezolana.

· El consumo personal está determinado por el objetivo de la masa de la población de tener el mejor nivel de vida posible; el problema más fuerte que afecta el consumo personal es el nivel de ingreso y empleo, no el deseo de consumir. El compromiso del gobierno bolivariano de mantener los niveles de vida de la población venezolana y el uso de la política de estado para alcanzar esta meta, por ende, representan la mejor oportunidad de mantener la demanda de los consumidores. La política de la “oposición”, al no utilizar el estado para mantener el nivel de vida de la población, al crear condiciones en las que el desempleo aumentaría severamente y permitir la exportación de capitales, conduciría a un empeoramiento de las condiciones de vida de la población, lo que no solo es una situación no deseada, sino que provoca un descenso de la demanda de los consumidores, con la consiguiente intensificación de las tendencias a la recesión.

· No obstante, las decisiones sobre la inversión privada no están controladas por el consumo sino por las ganancias. Por consiguiente, la inversión no está controlada por los mismos mecanismos que controlan el consumo personal y público y puede caer prácticamente a cualquier nivel. Tal como ya se indicó, este descenso de la inversión es lo que conduce a la baja de la economía en una recesión. Un gobierno comprometido con la economía privada no puede intervenir directamente para detener el descenso de la inversión ya que los medios de producción están en manos privadas. Pero si el gobierno toma decisiones en el tema de la inversión fuera del control de los propietarios privados de los medios de producción, logra limitar o descartar el hecho de que los medios de producción sean privados. Por consiguiente, en circunstancias de crisis económicas profundas como la actual, si un gobierno acepta un marco en el que la propiedad privada domina los medios de producción decisivos en un país, no será capaz de detener el desplome de la inversión. Al contrario, si el gobierno está determinado a impedir que caiga la inversión, deberá contar con instrumentos suficientemente fuertes, en cuanto al peso del sector estatal de la economía, a fin de detener esta caída.

En consecuencia, si al enfrentar la grave crisis financiera internacional, los sectores decisivos de la economía venezolana están controlados por entes privados, y se sigue una orientación que no sea la socialista, no será posible detener la caída de la inversión ni la crisis económica; la economía venezolana entraría en una fuerte recesión. Por el contrario, el hecho de que en Venezuela importantes sectores de la economía estén bajo el control del estado y su orientación sea socialista significa que el gobierno puede intervenir directamente para mantener los niveles de inversión. Es por esta razón que la posición de Venezuela para resistir la crisis financiera internacional es mucho más favorable de la que tendría si su gobierno no fuese socialista.

Asimismo, estos mecanismos demuestran cómo un país con una economía de mercado socialista, como la China, puede intervenir para evitar, o limitar en gran medida, la caída económica, porque puede intervenir directamente en el proceso de inversión a fin de mantener planes de inversión importantes.

Las herramientas disponibles en este tipo de economías para evitar este tipo de crisis de la inversión son muchas y no se cuenta con ellas en una economía dominada por la propiedad privada. En particular:

· Las compañías estatales pueden recibir instrucciones directas de mantener o aumentar sus programas de inversión.

· Los bancos estatales pueden recibir instrucciones de mantener sus programas de crédito.

· Estos pasos ayudan indirectamente a las pequeñas y medianas empresas, que no deberían ser parte del sector estatal; es decir, la actividad del sector público también favorece al sector privado.

En una economía subordinada a la propiedad privada no se cuenta con este tipo de instrumentos. Por ende, las economías que actualmente están dominadas por la propiedad privada, como las de Estados Unidos y el Reino Unido, están pasando en estos momentos por los siguientes procesos negativos:

· Debido a la crisis financiera, las empresas privadas están reduciendo considerablemente sus programas de inversión, lo que profundiza la recesión.

· Los bancos privados anteponen los intereses de sus accionistas a los de la economía en general y, por lo tanto, reducen el crédito, lo que también conduce a una mayor recesión.

· Debido a esta incapacidad del sector estatal para impedir que caiga la inversión o que se mantengan los niveles de crédito de los bancos, la pequeña y mediana empresa cae en crisis.

La conclusión consiguiente es que para resistir la crisis financiera internacional, Venezuela debe contar con un sector estatal suficientemente grande para poder controlar el proceso de inversión en el país; es decir, debe tener una orientación socialista, lo que sería una parte decisiva de la acción en las tres áreas de la “demanda” en la economía. En este caso se requerirían acciones en estas tres áreas:

· Para evitar una caída general de la demanda, se deben mantener altos niveles de consumo personal.

· Se debe mantener el gasto social del gobierno y podría ser necesario aumentarlo a fin de complementar el alto nivel de demanda de los consumidores.

· Lo más importante, el estado debe tomar fuertes medidas para mantener y aumentar el nivel de inversión con el propósito de compensar la caída de la inversión privada provocada por el efecto de la recesión económica internacional. El objetivo de esta inversión, además de su efecto inmediato en el mantenimiento de la demanda en la economía, debe ser aumentar la eficiencia a largo plazo de la economía y mejorar la calidad de vida de la población. En la mayoría de los países, uno de los medios más eficaces para alcanzar esta meta es un marcado aumento del gasto en inversión en infraestructura (transporte, vivienda, comunicaciones, etc.).

En resumen, la política y la economía serán decisivas para Venezuela a comienzos de 2009. La victoria del presidente Chávez en el referendo, manteniendo la orientación socialista de la economía, permitirá a Venezuela enfrentar la crisis financiera internacional. Una victoria para la “oposición”, que permitiría que Venezuela recibiera en pleno rostro el golpe de la crisis financiera internacional, significaría una caída abrupta de los niveles de vida del pueblo venezolano y un grave daño para la economía nacional de Venezuela.

Politics and economics in Venezuela

January 12, 2009

The two most powerful processes that will affect Venezuela this year will come together at the beginning of 2009 – the constitutional referendum to allow President Chavez to run for a new term and the effects of international economic crisis which will strike every country in Latin America.

The two are inextricably intertwined. The socialist orientation of Venezuela gives to the country the possibility to defend the living standards of the Venezuelan people and the national economy from the extremely negative trends of the international financial crisis. The victory of the ‘opposition’, and the ending of Venezuela’s socialist orientation, would expose Venezuela to the full force of the international financial crisis with consequent severe fall in the living standards of the Venezuelan people and great damage to the national economy.

The reasons for this stark and simple choice may be clearly understood. Venezuela’s economy, as with all countries in Latin America, will be attacked by the international financial crisis. Every major country in the world is being forced to, and is, meeting this crisis by increasing the role of the state in the economy – Venezuela’s socialist orientation therefore gives the best opportunity to confront this economic crisis.

In contrast ‘the opposition’, by weakening or dismantling the role of the state in Venezuela’s economy, would, first , lead to enormous hardship for Venezuela’s people as the economic crisis would then be resolved at their expense and, second, it would leave Venezuela’s national economy weakened and defenceless confronted with the greatest financial crisis for eighty years.

The victory of President Chavez in the referendum is, therefore, vital not only for social, political and moral reasons but for directly economic ones. To explain the relation between the referendum and the choice for Venezuela in facing the international economic crisis is therefore also crucial.

The detailed working out of the implications of this choice between defending the living standards and national economy of Venezuela, though the socialist orientation of the economy, or of leaving Venezuela’s population and national economy to be struck by the international financial crisis due to the policies of the opposition, will now be considered.

The reason that the socialist orientation of Venezuela is a decisive advantage confronted with the international economic crisis is easily understood. The core of any recession, in particular a very serious recession such as the present one, is the decline in private investment. In a privately owned economy companies will cut investment – causing the economy to enter a deep decline. A socialist economy, such as China or Cuba, however, does not have to let investment decline. Whether Venezuela follows a socialist orientation, which means decisively intervening in the investment process to prevent it falling, or whether it fails to follow a socialist orientation, and allows private companies to drag the economy down through their lack of investment, will therefore determine Venezuela’s fate during the current economic downturn.

What happens in an international recession in an economy dominated by private ownership is shown in Figures 1 and 2.

Figure 1 shows the development of the different components of US domestic GDP in the most classic of all economic downturns – the Great Depression in the US following 1929.

Figure 1



Figure 2 similarly shows the domestic components of US GDP as it enters the current economic recession – the similarity between the two graphs is evident. The dimensions of the economic decline after 1929, so far, are of course far greater than in the current downturn, but the pattern of the current recession is entirely classical in its character.

Figure 2


Stating these trends in more detail during the Great Depression the fall in US GNP (Gross National Product) was 29.7 per cent. Government consumption spending increased throughout the recession. The decline in personal consumption expenditure after 1929 was severe but less than the overall decline in GNP. The driving force of the recession was the extreme collapse of US investment, which declined by 73.9 per cent from its 1929 level. This was by far and away the most severe element of the depression – which, by economic multiplier effects, spread its consequences through the rest of the economy.

Figure 2 shows the same pattern in the current economic downturn in the US. US GDP and US consumer expenditure continued to rise until the second quarter of 2008, while US final government consumption expenditure is still rising. However US fixed investment already started falling following the first quarter of 2006 and by the third quarter of 2008 US fixed investment had fallen by almost six per cent – a decline that will accelerate significantly in the fourth quarter of 2008.

The reason the decline in investment drives the economic downturn is that the different components of ‘demand’ in the economy are controlled by quite different economic mechanisms. It is investment which is the strategically vulnerable element due to the private ownership of the means of production.

· The level of government consumption spending is controlled by the state – and therefore direct decisions can be taken to prevent any decline. In this sector Venezuela’s socialist orientation gives a particularly good opportunity to maintain demand during the international recession. The desire to cut programmes of social protection by the ‘opposition’ would, in contrast, create a severe fall in demand in the sector of government spending – leading to a decline in the living standard of the population and significantly deepening the tendencies to recession in the Venezuelan economy.

· Personal consumption is determined by the aim of the mass of the population to have as good a living standard as possible – the most powerful issue affecting personal consumption is the level of income and employment, not the desire to consume. The commitment of the Bolivarian government to maintain the living standards of the Venezuelan population, and the use of state policy to achieve this, therefore gives the best opportunity to maintain consumer demand. The policy of the ‘opposition‘, by failing to use the state to maintain the living standards of the population, by creating conditions in which unemployment would sharply increase, and by allowing export of capital abroad, would lead to a worsening of the living conditions of the population – not only undesirable in itself but producing a decline in consumer demand that would also deepen the tendencies to recession.

· Private investment decisions, however, are not controlled by consumption but by profit. Therefore investment is not controlled by the same mechanisms as personal and government consumption and can fall to almost any level. As already shown it is this decline in investment which drives the economy downwards in a recession . A government committed to a privately owned economy cannot intervene directly to stop the decline in investment because of private property in the means of production. However if the government takes decisions on investment out of the hands of private owners of the means of production it, in fact, limits or abolishes that private ownership of the means of production. Therefore, in circumstances of deep economic crisis such as the present, if a government accept a framework of dominance by the private ownership of the decisive means of production in a country it will be unable to halt the investment decline. In contrast if the government is determined to halt the decline in investment it must have sufficiently strong instruments, in terms of the weight of the state owned sector of the economy, in order to prevent investment declining.

Consequently, if confronted with the severe international financial crisis, the decisive sectors of Venezuela´s economy are privately owned and controlled, and a non-socialist orientation is followed, it will not be possible to halt the investment decline and economic downturn – Venezuela´s economy would go into severe recession. The fact that in Venezuela important sectors of the economy are state owned, and it has a socialist economic orientation, on the contrary means that the government can directly intervene to keep up investment levels. This is why Venezuela is in a much better position to resist the international financial crisis than if did not have a socialist government.

These mechanisms also show the way in which a country with a socialist market economy, such as China, can intervene to prevent, or greatly limit, the economic downturn – because it can directly intervene in the investment process to maintain high investment programmes.

The weapons available in such an economy to prevent such a downturn in investment are multiple, and not possessed in an economy dominated by private ownership. In particular:

· State owned companies can be directly instructed to maintain or increase their investment programmes.

· State owned banks can be instructed to maintain their lending programmes companies.

· These steps indirectly aid small and medium enterprises, which should not be part of the state sector – that is the activity by the state sector also aids the private sector.

Such instruments are not available in an economy subordinated to private ownership. Therefore at present in economies dominated by private ownership, such as the US and UK, the following extremely negative processes are instead occurring.

· Due to the financial crisis privately owned companies are severely cutting their investment programmes, deepening the recession.

· Privately owned banks put the interests of their shareholders before those of the economy as a whole and thereby cut lending – again further deepening the recession.

· Because of this inability of the state sector to either prevent the investment decline or to maintain bank lending small and medium private enterprises are thrown into crisis.

The conclusion is therefore that to withstand the international financial crisis Venezuela must have a sufficiently large state sector to be able to control the investment process in the country – that is it must have a socialist orientation. This must be a decisive part of action in all three areas of ‘demand’ in the economy. This involves action in three areas:

· In order to avoid an overall decline in demand personal consumption must be maintained at a high level.

· Government social spending must be maintained, and increases may be necessary, in order to complement the high level of consumer demand.

· Most important, strong state measures must be taken to maintain and increase the level of investment in order to compensate for the decline in private investment due to the effect of the international economic recession. The aim of such investment, in addition to its immediate effect in maintaining demand in the economy, must be both to increase the long term efficiency of the economy and to improve the quality of life of the population. In most countries, some of the most effective means to achieve this is a sharp increase in spending on infrastructural investment (transport, housing, communications etc).

In short at the beginning of 2009 politics and economics comes together decisively in Venezuela. The victory of President Chavez in the referendum campaign, by maintaining the socialist orientation of the economy, will permit Venezuela to confront the international financial crisis. A victory for the ‘opposition’, by opening Venezuela to be struck by full force of the international financial crisis, would mean a sharp fall in the living standards of the Venezuelan people and severe damage to Venezuela’s national economy.

Es necesario aumentar la inversión para combatir la inflación

January 12, 2009

Las presiones inflacionarias en Venezuela son sin duda el resultado de una serie de factores específicos y complejos. Ahora bien, existe un parámetro macroeconómico esencial que, por sí solo, genera presiones inflacionarias significativas: el insuficiente nivel de inversiones en la economía nacional.

La experiencia histórica nos enseña que existe una relación estrecha y predecible entre la tasa de desarrollo sustentable de la economía y su tasa de inversión.

La inversión no puede financiarse sino mediante el ahorro. En los últimos cuatro años, la tasa promedio de ahorro en Venezuela ha sido alta, más de 35% del PIB. Esto equivale a la tasa de ahorro de una economía asiática de rápido crecimiento como Vietnam, Corea del Sur o China. Si todo este ahorro se utilizara en inversión interna se alcanzaría, según lo demuestra la experiencia histórica e internacional, una tasa de crecimiento de 8-9 por ciento anual.

No obstante, en Venezuela la brecha entre la tasa de ahorro y la tasa de inversión es enorme. En los últimos cuatro años, el nivel promedio de formación bruta de capital fijo ha sido apenas de 21 por ciento del PIB. En el 2007, la última fecha para la cual se dispone de cifras, se logró un 24 por ciento.

Figura 1

La experiencia histórica e internacional muestra que un nivel de inversión de 20-25 por ciento del PIB, como mucho, permite soportar de manera sustentable un crecimiento de alrededor de 4-5 por ciento. Sin embargo, la tasa promedio de crecimiento de Venezuela en los últimos cuatro años ha sido mucho mayor alcanzando 12 por ciento. Esta cifra sin duda que se ha aumentado de manera un tanto artificial durante la recuperación de los efectos de la huelga petrolera. Sin embargo, en los últimos tres años de los cuales se dispone de cifras, es decir hasta el 2007, el crecimiento económico anual ha sido de 10 por ciento.

Resulta evidentemente indeseable poseer una gran cantidad de ahorro ocioso que no se invierta internamente. Ahora bien, esto se vincula directamente con la política antiinflacionaria.

Sin duda que la disparidad entre una tasa de inversión que sólo contribuye a una tasa de crecimiento anual de 4-5 por ciento y un crecimiento mayor produciría presiones inflacionarias. Por ende, una manera eficaz de reducir las presiones inflacionarias, en el mediano y largo plazo, es aumentar la tasa de inversión.

Es muy posible, como lo demuestra el ejemplo de otros países (Vietnam, Corea del Sur, China, Singapur, Tailandia, etc.), mantener una tasa de crecimiento de 8-10 por ciento anual, pero esto exige que el nivel de inversión en la economía nacional se incremente a 30 por ciento o más del PIB, lo cual es perfectamente financiable con la actual tasa de ahorro de Venezuela.

Cuando se consideran los mecanismos que garantizan que los ahorros se empleen en la inversión interna, no existe evidencia que esto pueda hacerse de preferencia a través del sector privado. Por el contrario, todo indica que si fuera por este sector los ahorros del país se esfumarían con la fuga de capitales. El hecho de que, a pesar del alto nivel de ahorros de los últimos cuatro años, éstos no se hayan invertido confirma que no se puede confiar en el sector privado para garantizar que los ahorros se traduzcan adecuadamente en inversión nacional.

Así pues, el sector público venezolano debe emprender un vasto programa de inversiones que garantice que estos ingentes ahorros se traduzcan en una inversión mucho mayor en la economía nacional. Esta es una medida de estímulo anticíclico necesaria para incrementar la eficiencia de la economía y mejorar sustancialmente las condiciones de vida de la población. Al incentivar la demanda, este programa de inversión resultará asimismo crucial como medida antiinflacionaria en el mediano y largo plazo.

La forma más efectiva de mejorar la eficiencia de la economía nacional es la inversión en infraestructura, en especial transporte, comunicación y vivienda. Por lo tanto, una parte esencial de la estrategia antiinflacionaria debe ser aumentar el nivel de inversión interna en un 30 por ciento del PIB mediante un vasto programa de obras públicas en infraestructura.

Claro está que pasar de 24 a 30 por ciento del PIB el nivel de inversión, que a su vez posibilitaría un crecimiento del 8 por ciento, no puede hacerse en un solo año puesto que no se dispone aún de las estructuras necesarias que generen programas de inversión pública de esa envergadura. Un estudio concreto permitiría establecer cuán rápidamente podría alcanzarse este aumento decisivo de la inversión. La experiencia internacional indica que un aumento de 1 o 2 por ciento anual en la proporción del PIB que se dedica a la inversión sería razonable. En el caso venezolano, esto implicaría una aceleración en el nivel de inversión de 24 a 30 por ciento del PIB en un período de 3 a 5 años.

Un aumento de esta magnitud de la tasa de inversión no sólo es totalmente financiable sobre la base de los ahorros actuales, sino que resulta determinante para alcanzar numerosos objetivos económicos y sociales, entre ellos uno de los más importantes es el combate de la inflación en el mediano y largo plazo.

The need to raise the level of investment to combat inflation

January 12, 2009

There are evidently a number of specific and complex factors in inflationary pressures in Venezuela. Nevertheless one key macro-economic parameter undoubtedly would, by itself, produce significant inflationary pressures – this is the insufficient level of investment in Venezuela’s economy.

Historical experience shows that there is a close and predictable relation between the sustainable rate of growth of economy and its investment rate.

Investment can only be financed by savings. Venezuela, in the last four years, has had a high savings rate averaging over 35 per cent of GDP. This is equivalent to the savings rate of a very rapidly growing Asian economy such as Vietnam, South Korea or China. If all such a savings were used in investment in Venezuela’s domestic economy then, based on historical and international experience, a growth rate of 8-9 per cent a year can be sustained.

However there is a very large gap between Venezuela’s savings rate and its investment rate. The average level of gross fixed capital formation in the last four years has only been 21 per cent of GDP. In 2007, the last year for which figures are available, it reached 24 per cent of GDP.

Figure 1

Historical and international experience shows that such an investment level of 20-25 per cent of GDP is, at maximum, able to support sustainably an economic growth rate of around 4-5 per cent. However Venezuela’s average growth rate in the last four years has been far higher than this – averaging 12 per cent a year. This latter figure is undoubtedly somewhat artificially raised through recovery from the effects of the oil strike. Nevertheless in the last three years for which figures are available, that is up to 2007, the annual economic growth rate has been 10 per cent.

It is evidently undesirable itself to have a large amount of unused savings that are not being used for domestic investment. However it is also directly related to anti-inflationary policy.

A disparity between an investment rate that will only support a 4-5 per cent a year growth rate and far more rapid economic growth would necessarily by itself produce inflationary pressures. A decisive means to reduce inflationary pressures over the medium and long term is therefore to raise Venezuela’s investment rate.

It is entirely possible, as shown by the example of other countries (Vietnam, South Korea, China, Singapore, Thailand etc) to maintain a rate of growth of 8-10 per cent a year but this requires that the level of investment in Venezuela’s economy be raised to 30 per or more of GDP – an investment rate that is entirely financeable on the basis of Venezuela’s savings rate.

Considering mechanisms to ensure that Venezuela’s savings will be used in domestic investment there is no evidence that this will primarily be carried out by the private sector. On the contrary, the evidence is that, purely on the basis of the private sector ,Venezuela’s savings will be squandered in capital flight abroad. The fact that, despite the very high level of savings in the last four years, this has not been invested confirms that the private sector cannot be relied upon to ensure that savings are more adequately transformed into domestic investment.

The conclusion that flows from this is that Venezuela’s state sector must undertake a relatively large scale programme of investment that will ensure that the high savings level is translated into a much higher level of investment in the national economy. This is required as an anti-cyclical stimulus measure, to increase the efficiency of the national economy, and to substantially improve the conditions of living of the population. But, by boosting the supply side of the economy, such an investment programme is also a crucial anti-inflationary measure in the medium and long term.

The most effective means of improving the efficiency of the national economy is investment in infrastructure – in particular transport, communication, and housing. Therefore a decisive part of anti-inflationary strategy must be to raise the level of investment in Venezuela’s domestic economy to around 30 per cent of GDP through a major programme of state infrastructure investment.

Evidently such an increase in the investment level from the current 24 per cent of GDP to 30 per cent, which would then make an eight per cent growth rate sustainable, cannot be carried out in a single year as the necessary structures to deliver such a large scale of public investment programmes are not yet in place. It is a matter of concrete study how rapidly such a decisive increase in the investment rate can be achieved – based on international experience an increase in the proportion of GDP devoted to investment of one to two per cent of GDP per year would be reasonable. This would imply acceleration in Venezuela’s investment level from around 24 per cent of GDP to 30 per cent of GDP over a three to five year period.

Such an increase in the investment rate is not only full financeable on the basis of current savings levels but is crucial for very many economic and social objectives – among these is that it is one of the most important medium and long term anti-inflationary steps that are required.

Venezuela and China to create a high technology park close Caracas

January 12, 2009

The Bolivarian Republic of Venezuela endorsed an agreement with China’s Lanchao Group on the support and cooperation to put into operation a Technological Industrial Park, located in Miranda state.

The Ministry of People’s Power for Science and Technology, through the Corporation for Scientific and Technological Development (Codecyt), agreed on the creation of a bi-national working group to conceptualize, carry out and strengthen the foundation of research, development and innovation of high-technologies.

With this agreement, the Technological Industrial Park will promote training and technological transfer to meet the social and economic needs of Venezuela.

The Technological Park will be a specially equipped territory for high technology companies with innovating vocation.

Likewise, it will support the development of training, research and technology in the country.

Langchao Group’s representative Wang Miao said that “this technological park’s goal is to install a number of Chinese factories in Venezuela to achieve this country’s technological development.”

“In Venezuela and China, we are building socialism. Under this structure, and thanks to President Hugo Chávez, we are strengthening the technological and productive development,” added Miao.

In addition, Venezuela’s Deputy Minister of Science and Technology Luis Marano indicated that Venezuela and China have strengthened their cooperation relations, and a proof is the launching and operation of the first Venezuelan satellite.

“The People’s Republic of China is a good ally in the field of high technologies such as the Simón Bolívar satellite,” and the computer factory called Venezolana de Industria Tecnológica (VIT), stressed Marcano

“Langchao Group represents the Shandong province in China, a very important industrial province,” said Maracano.

Bolivarian News Agency (ABN) / January 12, 2009

The decline in US asset prices and the perspectives for the global economy

January 3, 2009

The fundamental assessment presented on this blog, for underlying macro and structural economic reasons, has been that the financial events of 2008 portend a deep world recession but not an economic depression of the type witnessed in the 1930s. This deep recession will be accompanied by a major strengthening of their positions in the world economy by China and India, and to a lesser extent Russia. [1]

To gauge the degree of seriousness of the economic crisis it is evidently merely necessary to consider the depth of the fall in financial markets. The decline in asset prices in 2008, as discussed in detail below, was fully comparable to 1929 – and greatly exceeds any fall seen in the period since. However whatever the similarities in financial markets the world macro-economic situation differs significantly to 1929.

In 1929 the US was not only the world’s largest but also the world’s most dynamic economy with the highest rates of savings and investment. When the US financial system entered deep crisis in 1929, therefore, there was no external economic force that could pick up either it or the world economy – no economic backstop. The financial implosion in the US in 1929, therefore, necessarily dragged the world economy down into the abyss of prolonged depression.

In 2008 the configuration of world economic forces differs significantly. China and India are today the world’s most dynamic large economies. with the world’s highest savings and investment rates and the most rapid economic growth. Furthermore China has sufficient economic weight, in terms of world savings, not to prevent international recession but to be a significant counterbalance to the situation in the US.

China’s savings and investment rates are not only far higher than the US as a proportion of GDP but are also now approximately equal to those of the US in absolute terms. India’s internal savings and investment rates, now at over 30 per cent of GDP, are also far higher than those of the US – enabling it to maintain significant economic growth in what is, in real terms, now the world’s fourth largest economy.

For the relative trends in US, Chinese and Indian investment rates see Figure 1.

Figure 1

The world has already been saved once from the consequences of US financial crisis in the last economic period. Following the 1987 US stock market crash the export of financial resources from Japan, carried out via an ultra-expansionary monetary policy, played a crucial role in stabilising both US and world financial markets. Whether Japan was wise to purse these policies in the particular form it did, in light of the consequent Japanese ‘bubble economy’ and financial crash which commenced in 1990, is another issue, but it showed that there was now an ‘economic backstop’ for the US in the world economy in a way that one had not existed in 1929.

This economic strength of China, and to a lesser extent India, therefore significantly alters the situation of the world economy compared to 1929 – despite any apparent parallels on financial markets. Provided there are not disastrous economic policy miscalculations by the US, which of course are possible, international macro-economic fundamentals mean there need be no 1930s style depression. However there will be, instead, a deep recession of the global economy out of which China and India will emerge significantly strengthened in their relative weight in the world economy. This is therefore the conclusion which flows from consideration of international economic fundamentals.

Nevertheless, first it is possible that the US government will make disastrous economic miscalculations. The reason for this is that a rational economic course by the US administration requires it accepting its reduced role in the world economy – one in which the US is the world’s largest economy but no longer an unchallengeable economic superpower. It is possible therefore that there may be future, George W Bush type, US administration attempts to escape a rational economic outcome which may fundamentally destabilise the international economic situation – posing the risk of turning a recession into an economic depression.

Second, it is constantly necessary to check economic fundamentals against facts – the weight of individual elements may be misjudged or factors that were not taken into account may be operating. Macro-economic data that would verify, or disprove, an assessment of ‘deep recession but not economic depression’ is not yet available for the period following the decisive financial events of September 2008. However trends for financial markets are available. The end of 2008, therefore, represents a convenient opportunity to sum up the qualitative situation revealed by financial markets and to compare it to the assessment of economic fundamentals.

Considering first the area in which the financial crisis originally manifested itself, that is in US house prices and sub-prime mortgages, the decline of US house prices is now more rapid than at the time of the Great Depression following 1929. US house prices in October 2008 were 18 per cent lower than a year previously – the fall being 2.2 per cent in October alone. The rate of decline is still accelerating. The annual fall in individual US cities such as Phoenix, Las Vegas and San Francisco was greater than 30 per cent. The decline in the price of US housing assets at the end of 2008 totaled around $7.1 trillion.

Turning to shares, the fall in the Dow Jones Industrial Average in 2008 was 33.8 per cent – the worst annual fall since 1931 in which year the decline was 52.7 per cent. Share prices in the US financial sector declined by 57 per cent in 2008.

The most relevant, because most long term and fundamental, comparison continues to be that of the current decline in US share prices with the fall in US shares after 1929. Figure 2 confirms that the fall in US share prices, since their peak in October 2007, continues to far exceed the other major declines of the 20th century – either that following the beginning of the international recession in 1973 or the collapse of the dot com bubble in 2000. Only the fall in US share prices following 1929 is comparable to, or exceeds, those which have occurred over the last year. There is, therefore, no element of exaggeration to say this is the worst fall in financial assets since 1929 nor are comparisons to that date, in the financial field, unjustifiable exaggerated.

Figure 2

Considering the comparison with 1929, 31 December 2008 was 313 trading days after the peak of share prices during the current cycle on 9 October 2007. The Dow was 38.0 per cent below that peak. On the equivalent trading day following 1929 the Dow was 52.0 per cent below its peak in that cycle.

The wider based S&P 500 fell by 41 per cent in 2008, the worst decline since a parallel measure would have dropped by 47.1 per cent in 1931.

The slightly lesser decline of the Dow and S & P 500 in the current cycle, compared to 1929, is however primarily due to the relative stabilisation of US share prices since large scale state financial intervention commenced from late September 2008.

This relative stabilisation of US share prices ran in parallel with the improved conditions in interbank lending similarly created by huge state intervention – see Figure 3.

US Federal Reserve loans rose from $900 billion in September 2008 to $2.2 trillion by December 2008. Already projected Federal Reserve exposures range up to $5 trillion.

Figure 3

However, as may be seen from Figure 2, the most important difference between the present decline in share prices and that after 1929 is the duration of the fall. Following 1929 US share prices continued to fall for three years, with the worst decline being in the second full year of the drop in 1931. So far the decline in US share prices in this cycle has progressed for only just over a year before being halted, at least temporarily, by massive transfers of resources by the state.

Taking non-US stock exchanges in 2008, the UK FTSE 100 declined by 30.9 per cent and the FTSE All Share index fell 32.8 per cent – its worst annual fall since losing 55.3 per cent in 1974. The Germany Xetra Dax fell 40.3 per cent, the Paris CAC 40 fell by 42.1 per cent and the FTSE Eurofirst 300 suffered an annual decline of 44.7 per cent.

The Nikkei 225 index in Tokyo ended by recording a 42.1 per cent fall in 2008, worse than its previous biggest annual loss of 38.7 per cent in 1990. Korea’s Kospi index ended the year with a decline of 40.7 per cent.

The conclusion from these trends so far, therefore, is that massive state intervention succeeded in both reducing interbank interest rates and stabilising share prices during the final two months of 2008. But what is its capacity to fundamentally reverse the decline in asset prices that created the crisis in the first place – for, as noted elsewhere, it is the fall in asset prices which is creating the pressures to a liquidity crisis, and not a liquidity crisis that caused the fundamental decline in asset prices?

It is here that the other valid scale of comparison is that with Japan following the bursting of its national asset price bubble in 1990. As may be seen from Figure 4, the decline of the Japanese Nikkei share index after 1990 remains, in terms of duration, considerable worse than that of US shares following 1929. Japanese property prices, equally, remain deeply depressed 18 years after the bursting of the asset bubble.

Such experience indicates that there must, therefore, be no automatic presumption that there will be any V shaped recovery of share prices or asset values – i.e. that the fall in asset prices will be merely short lived followed by recovery. Contemporary, as well as historical, experience indicates that the depression of asset prices below their levels of 2007 may be of long duration.

Figure 4

Such economic processes create a new configuration between the state and the financial system.

Given the magnitude of the financial shifts it is evident that the international financial system is in intensive care with its artificial respiration system being currently powered by state finance. Nor, given the scale of the resources involved, is this situation likely to be reversed in the short term – any perspective that the state will be able to sell back, without huge losses for the taxpayer, the assets it has acquired in any short time frame are illusory. The economic rise of China and India is, therefore, being accompanied by a massive increase in the role of the state in the US and Western Europe.

The scale and pattern of the decline in asset prices means that a world economic depression can, as noted at the beginning of this article, be avoided. But a fundamental change in the configuration of the world economy cannot.

Notes

[1] In Latin America the outcome is not yet determined and will depend on the policies adopted.

The international financial crisis’s impact on commodity prices and Latin American financial markets

January 1, 2009

John Authers of the Financial Times has an excellent video analysis, in English, on the impact of the international financial crisis on financial markets in emerging markets in general and on Latin America in particular. It should be seen by anyone who doubts how serious the impact of the international financial crisis will be for Latin America – the relevant section starts one minute into the two minute twenty second video. The core of its analysis is on the relation between commodity prices and financial markets in Latin America and their extremely close correlation.

The different outcome of the economic reforms in China and Russia as seen in advance – by John Ross

January 1, 2009

China and Russia have recently become relatively fashionable subjects of economic analysis – notably as two key components of BRIC (Brazil, Russia, India, China). Their importance is, however, far greater than that.

China and Russia are two of the largest economies in the world. They have combined populations of almost one and a half billion people. Together they occupy a large part of the world’s landspace.

Both China and Russia emerged from centrally administratively planned economies but then they underwent the most diametrically counterposed economic developments in history. China experienced, in the last thirty years, the most rapid economic growth ever witnessed in human history. Russia underwent the greatest decline in GDP ever seen in any country in peacetime.

Events of such economic magnitude evidently merit the closest study. The lives of several billion people are directly and indirectly affected by both the practical outcomes and the theoretical policy conclusions drawn from such a scale of events. An economics that is incapable of explaining such events, which are among the greatest scale of economic shifts ever witnessed, is clearly not an economics adequate to explaining the real world.

The article republished below is, therefore, reproduced to show that it was perfectly possible, with the right analytical tools, to foresee in advance the counterposed outcomes in China and Russia of their respective ‘economic reforms’. The article’s date of writing, spring 1992, drawing on articles written in 1991, shows that it was not a retrospective rationalisation of events but a prediction of what was to come as the 1990s unfolded in China and Russia. Its original title, ‘Why the Economic Reform Succeeded in China and will fail in Russia and Eastern Europe’, is self-explanatory.

It is worth putting this article in its historical context. In January 1992 Russia embarked on the economic reform policy known as ‘shock therapy’ – full price liberalisation accompanied by the most rapid possible, and free, privatisation of state companies and assets. The alternative course adopted by China, when it launched its economic reforms a decade and a half earlier, was carried out without immediate full price liberalisation and without privatisation of existing large scale state owned companies, and is described below.

The ‘shock therapy’ course was implemented by the then Russian government headed by Yegor Gaidar, supported by the IMF, and was advocated by journals such as The Economist and Financial Times. These also held that China would lose as a result of carrying out a ‘half’ reform compared to Russia.

The actual results, as noted, were the exact opposite – Russia suffered the greatest peacetime fall of production ever suffered by any country. while China enjoyed sixteen years of the greatest economic growth ever seen in human history.

It might be thought that such an outcome would have led to an abandonment of the theories which had led to predictions that were refuted by events. After all in physics, or any other branch of science, if a theory leads to predictions which are falsified by facts then the theory is abandoned – and a theory which does predict the facts is put in its place. Therefore, it might be imagined that those economists and commentators who had been in error would now be studying and advocating what China had done right, analysing why the policies pursued and advocated in Russia had produced such catastrophic economic decline, and noting which wrong theories had led to this mistaken policy and why China, in contrast, had pursued far more correct policies.

But in the real world, unfortunately, some branches of economics are more akin to dogmatic theology than science: if a theory does not fit the real world then it is the real world which is abandoned, not the theory. Such ‘ostrich economics’ might be mildly amusing if wrong economic decisions affecting real people were not taken, and large sums of money lost, based on such views. For these were not academic economic debates with no practical consequences.

For it was, as shown below, entirely possible to predict in advance what would be the consequences of the different ‘economic reform’ policies embarked on by China and Russia. The views of those who advocated that the policies of ‘shock therapy’ would lead to success, and China would suffer in comparison, were simply falsified by facts. Those who argued, as in this article, that China would enjoy success and Russia would suffer economic collapse, as a result of the policies adopted were vindicated by events. Sixteen years later there is no longer any ambiguity as to the outcome.

But economic theory is about more than history. It analyses, or at least correctly carried out it should analyse, material forces which in many cases continue to operate today.

It is evident that the economic tools deployed in the article below are not in themselves unusual. They analyse well known, but different, types of market – monopolistic, oligopolistic, and ‘perfectly’ competitive. They however do not assume that a homogeneous market, corresponding to something approaching perfect competition, either exists or can be created – a central fallacy of the theories which underlay ‘shock therapy’ and which continue to misunderstand the Chinese, and indeed most modern, economies. The stress in the article is how markets interact in a real economy.

Put another way, the article pivots around a single point: that an economic theory must analyse the real world, the real world does not have to conform to an economic theory. The attempt to apply a theoretical structure to an economy whose reality had little in common with it, as in Russia at the time of the introduction of its new economic policies in 1992, led to an economic catastrophe. The decision by China to ignore such advice, and to proceed with an economic reform which corresponded to a real structure of its economy, produced the greatest economic success seen in world history. The resulting differences were not purely theoretical but have transformed the situation of the world economy.

A number of the key theoretical analyses used in this article, and related ones written at the same time, therefore continue to be relevant to analysing the course of the world economy and those of individual countries – and guide analysis in this blog. These include that:

  • a market is not an abstract entity – something to be mystically mythologised as ‘the market’ in a way that obscures its actual material features. Any actual market must be analysed as a real structure – in which, for example, the different degrees of competition operating in different parts of it, or in different interacting markets, would produce different effects if essentially similar policies were applied to them.
  • that in the long term the proportion of GDP devoted to fixed investment plays a decisive role in economic growth rates. Indeed, provided that an international orientation is adopted by the economy, historical experience shows that the overall level of fixed investment is far more powerful in determining economic growth rates than pre-occupation with attempting to achieve the highest possible marginal efficiencies of capital via maximum market deregulation – for a detailed analysis of this read here.
  • that manipulation of relative prices, internationally via devaluation and similar measures, or internally in China in the early period of economic reform via controlling relative prices between the state and non-state, monopoly/oligopolised and non-monopoly, economic sectors is a powerful tool of economic management. That is, China showed that economic management can be carried out through market mechanisms as well as by administrative controls – a lesson, in different forms, China continues to demonstrate today.

One or two immediate policy proposals made in an article written sixteen years ago have naturally been bypassed by changes in the intervening decade and a half. The economic collapse of Russia post-1992 means that an incorrect distribution of investment, which at that time failed to provide adequate consumption resources for the population, thereby removing the material incentive to work and sharply reducing the productivity of capital due to the perverse industrial structure which it created, and which therefore required a short term transfer of resources into consumption, no longer exists. On the contrary, due to the economic collapse in 1992-98, a key problem in Russia today is the inadequate investment level. As the article notes: ‘In China, where the economy was stable, investment was initially reduced to create resources for extra consumption. However in Russia a precipitate investment collapse is underway – the share of investment in the economy has almost certainly already declined too much. The problem is therefore to stabilise and increase investment.’

China’s short term transfer of resources into consumption, via a short term reduction in investment and a substantial cut in military expenditure, at the launching of its economic reform – which was used to provide the initial demand for the development of its consumer industries – has long since been bypassed. As the article notes: ‘Over the 10 years 1978-88 reduction of the share of military expenditure in GNP was the chief means by which the increase in the share of personal consumption in GNP was financed… The increase in the share of personal consumption was initially financed by a reduction in the proportion of fixed investment in GNP… After 1981, however, the benefits of reduced military spending began to be felt, and the enormous increase in the share of personal consumption necessary to bring about the initial change in economic structure could be reduced. .. By 1984 the percentage of fixed investment in GNP had regained its 1978 level. The dynamic of the change on the demand side over the decade is therefore clear. Initially the proportion of consumption was raised by reducing fixed investment. Then, as military spending fell, the resources released were shifted into investment.’ The proportion of China’s GDP devoted to fixed investment has continued to rise since, until it has now become the highest experienced in world history – while simultaneously this has been accompanied by continuously rising living standards.

This article below is considerably longer and more technical than those which normally appear on this blog. The justification that is offered for this is the importance of the issues dealt with.

Confronted with what is now the overwhelming evidence of the success of China’s economic reform, and the failure of the policies that were counterposed to it, there are only two courses that can be adopted regarding the relation between economic theory and reality.

The first is to deny the real world. To, Canute-like, ignore the incoming waves of events and declare that while China’s economy has not failed ‘yet’ this is in fact just around the corner, This is why the literature ‘predicting’ that China will suffer crippling economic crisis ‘next year’ or in the short term – the prediction normally moving forward a year at a time, would now fill several bookshelves. A typical example, relatively chosen at random, is the The Economist‘s special supplement A Dragon Out of Puff: A Survey of China, dated 15 June 2002. This proclamation that China was ‘out of puff’, had the distinction of being produced just as the country was about to enter the most rapid sustained economic growth seen in human history – as those with an online account with The Economist can read.A large subsequent, and preceding , literature of the same ilk can be produced.

Current predictions of ‘deep crisis’ in China are as invalid as the similar ones made in the intervening 16 years since the events analysed below. China will inevitably encounter various significant frictional problems in dealing with the consequences of the international financial crisis. But China’s economic fundamentals, launched by processes analysed in this article, ensure that not only will it continue to be the world’s most rapidly growing economy but it will succeed in overcoming the current international financial crisis far more comfortably than the US and Western Europe.

The second path is the economics of reality. To understand that China’s economic reform succeeded in producing the world’s greatest ever economic growth for reasons that were entirely comprehensible. And that the different outcomes of the course of deepening ‘economic reform’ pursued in China and in Russia were predictable in advance – because, as will be seen, they were predicted in advance.

The article by the author of this blog originally appeared in Voprosy Economiki, in Russian, in September 1992.

* * *

Why the Economic Reform Succeeded in China and Will Fail in Russia and Eastern Europe

Given that Russia, China, and Eastern Europe all share a common historic economic structure any policy seeking a way out of Russia’s economic crisis must confront a central question. Why has the economic reform in China since 1979 produced the greatest economic success in the world and the economic changes since 1989 in Eastern Europe and January 1992 in Russia produced the greatest economic disaster?

This is not simply an academic question. In the last seven months the Russian government has pursued a policy consistent with those followed in Eastern Europe for the last two and a half years. [1] These policies have produced probably the greatest economic disaster outside war in history. As the UN Economic Survey of Europe in 1991-92 notes regarding Eastern Europe: “The cumulative drop of output registered over the last two to three years in some countries has attained proportions that are unmatched even by the Great Depression of 1929-1933.” Russia has suffered the greatest peacetime economic decline in its history. The contrast between the results after the start of the economic reforms in 1979 in China, and in 1989 in Eastern Europe, as shown in the figures of the OECD, IMF, and World Bank, illustrates the situation graphically.

– in the decade after 1979 Chinese Gross Domestic Product (GDP) grew at an average 8.8 per cent per year. The Chinese economy more than doubled in size – expanding by 135 per cent. In contrast Hungarian GDP fell by 11.7 per cent, Romanian GDP by 18.6 per cent, and Polish GDP by 19.0 per cent. Czech Net Material Product (NMP) fell by 12.8 per cent, the NMP of the former USSR by 16.0 per cent, and Bulgarian NMP by 30.9 per cent.

– Chinese industrial output expanded at an average 11.2 per cent a year. Chinese industrial production nearly tripled in 1979-89 – increasing by 195 per cent. In contrast from the beginning of 1990 to mid-1991 industrial output declined by 25.9 per cent in Czechoslovakia, 27.2 per cent in Hungary, 38.1 per cent in Bulgaria, and 40.1 per cent in Poland.

– Chinese employment increased by 3 per cent a year. Unemployment fell from 5.3 per cent to 2.6 per cent. Labour productivity grew by 5.9 per cent a year. In contrast, between 1989 and the middle of 1991, employment fell by 11.6 per cent in Rumania, 13.8 per cent in Czechoslovakia, 16.9 per cent in Poland, and 20.1 per cent in Bulgaria. As the fall in output in Eastern Europe was even more rapid than the decline in employment productivity sharply declined.

– In China growth of output of the most important goods for the Russian population – high quality food and consumer products – was even more rapid than that of the economy as whole. Total Chinese agricultural production expanded at 4.1 per cent a year. But sugar production increased by 8.5 per cent a year, butter by 8.6 per cent a year, eggs by 10.5 per cent a year, beef and veal by 17.0 per cent a year, oranges by 18.4 per cent a year, grapes by 19.3 per cent a year, and bananas by 21.9 per cent a year. Among consumer goods output of cigarettes grew at 13.0 per cent a year, cloth at 13.8 per cent a year, televisions at 36.7 per cent a year, and refrigerators by 65.0 per cent a year, while average housing space per person in rural China increased from 9.5 to 18.5 square metres. In contrast real wages fell by 20 per cent in Czechoslovakia and by 30 per cent in Poland.

– Even by the criteria the Russian government set itself, the promotion of private enterprise, China has been far more successful. China in a decade created more than 10 million private enterprises which dominate services, retailing, and light industrial production. The Russian government has produced a deep crisis in the private sector.

– In China no collapse in output occurred prior to commencement of rapid growth – as is claimed is necessary in Russia. Economic growth accelerated rapidly with the start of the economic reform and living standards doubled since its commencement. China demonstrably made the type of economic change Russia requires. Consumer production became the leading sector of the economy, the supply of high quality foodstuffs enormously increased, the service sector expanded rapidly, small scale enterprise flourished, output and productivity of labour and investment both soared, and living standards rose rapidly. However whereas the Russian government proclaimed these goals in theory, it completely failed to achieve them in practice. The Chinese economic reform created them in the real world.

This article demonstrates that this contrast is not accidental. Once the specific character of the Russian, East European and Chinese economies is understood then the same laws of economics which determined success in China dictate failure in Russia and Eastern Europe. The mistake of the Russian government is that it fails to understand the specific character of the Russian economy and applies policies designed for a quite different structure – the competitive economies of the West. The economies of Russia, Eastern Europe and China must, instead, be defined as specific “dual economies” constituted by: (i) an almost pure monopoly sector which operates according to the laws of monopoly economy, (ii) a non-monopoly sector which, for theoretical purposes, may be considered as operating according to laws of perfect competition. The specific dynamic of the economy results from the interaction of the two sectors. Once the character of these dual economies is understood then their laws, and the policies necessary within them to achieve success, are clearly defined.

The relative weight of the national and international markets

Before turning to the structure of the Russian economy, however, a preliminary question must be considered – the relative weight of the international and domestic markets for Russia. This is necessary not simply because of the difference between exports and imports and domestic sales, but because the structure of the international and Russian economies are different. The international economy may be considered as competitive – only a small percentage of production can merely be supplied by one country. The Russian domestic market is within a dual economy. If the dominant sector for the Russian economy were its international connections then the laws of competitive economy would dominate. If the domestic market is dominant those of dual economy will operate.

The first error of the Russian government is, therefore, that it fails to draw the necessary conclusions from the fact that the domestic and former Soviet markets are dominant for Russia. This error is rooted in the concept of the IMF that countries should seek “export oriented growth” – as exemplified by South Korea. The specific application is that the IMF suggests that Russia should be inserted into the world economy as a supplier of raw materials.

This orientation is defined in the figures of the IMF’s A Study of the Soviet Economy. The concluding section of this, ‘Assessment of Medium Term Economic Prospects’, projects former Soviet/Russian industrial production declining by a minimum 20 per cent in the first year of IMF policies. Measures to increase exports of energy and agriculture are proposed – notably liberalisation of energy prices which would release oil for export, by reducing Russian demand, while making large parts of Russian industry unviable. Such a combination entails that the Russian economy would be fundamentally shifted in the direction of deindustrialisation and raw material export production.

Such a perspective for Russia is an historic dead end. The most clearly established long term trend in economics is that the price of raw materials fallsrelative to finished products. All countries which have undergone economic development, including in the last two decades, have done so through moving out of primarily raw material production into manufacturing. If Russia were to accept the distortion of its economy in line with the estimates of the IMF it would become an historical backwater doomed to national decline.

More fundamentally the entire model of export oriented growth, of the South Korean type, cannot be applied to Russia for quantitative reasons. A country such as South Korea must necessarily rely on export oriented growth – as the small size of its internal market prevents it achieving the necessary economies of scale or specialisation on a domestic basis. But the size of the Russian economy means different comparisons apply. The best estimates put the size of the former Soviet economy at approximately the size of Japan’s – or approximately half that of the US or European Community (EC). Comparing Russia with these economic units, exports of goods are 7.1 per cent of US GDP, 9.4 per cent of EC GDP (excluding trade among members), and 9.8 per cent of Japanese GDP.

The situation of Russia is equivalent to Western economic units of comparable size. On IMF calculations, Russian trade is 22.3 per cent of GDP. However 12.9 per cent is with the former USSR and only 9.4 per cent “external” trade. Such a figure, slightly under 10 per cent of GDP, is in line with comparable economies and therefore would not be expected to increase greatly. This is reinforced by the fact that the economy of the former USSR was integrated not simply in terms of a market but in terms of production. In short 90 per cent of the market for Russia is either domestic or within the economy of the former USSR. It is the national, not international, market which is decisive.

The Russian dual economy

Turning now to the Russian economy first the dynamic within the monopoly sector of the dual economy will be considered and then the relation between the monopoly and non-monopoly sectors.

The difference between the Russian monopoly structure and the structure of a Western economy is worth repeating. In the former USSR, for example, 87 per cent of the 5,885 products delivered to the State Supply Commission in the machine building industry came from single sites. Some 30-40 per cent of industrial products came from single producers. Enterprises with more than 1,250 employees accounted for 85 per cent of industrial employment. Not only final assembly but components supply is monopolised.
Similar structures exist in Eastern Europe and, historically, in China – in the West enterprises with more than 1,000 workers account for only 20-33 per cent of employment. Even in an extremely concentrated and capital intensive sector, such as Japanese semi-conductors, the top five firms only account for 60 per cent of production. A Japanese automobile plant has 13,000 firms, many small and competing, directly and indirectly supplying it.

The Russian economy in the industrial sphere is closer to a perfect monopoly structure than anything in the West. Furthermore the hopes of the Russian government that either privatisation or international competition can offset the effects of this monopoly structure are illusory as (i) monopolisation is of physical production, not simply ownership, and therefore privatisation will not change the situation (ii) given Russia’s problems with exports, no amount of imports sufficient to create large scale competition on the domestic market can be financed.

The laws of operation of monopoly economy are well known -and have been applied by many Russian economists in pointing out the errors of the government’s policies. In the former economic system monopolies either produced to planning targets and, because of price controls, could in any case only maximise profits by increasing output. With a transition to full price liberalisation a monopoly’s rational profit maximising market strategy is to reduce output and increase price. This occurred in Russia and Eastern Europe and by itself explains a large part of the economic decline.

The dynamic within the credit system

These direct effects of monopolisation on production are reinforced by the dynamic within the monetary system. As this underlies the dispute over credit policy, and shows the incoherence of the government’s strategy even within its own monetarist framework, it will be considered from a fundamental point of view.
The analytical starting point of monetarism is the Quantity Theory of Money. This states that MV=PT (Mass of money x Velocity of its circulation = Price level x Transactions in the economy (equivalent for present purposes to output)). This formula is true by definition and therefore in any economic system. Monetarism, following Friedman, asserts that V is essentially constant – which will be accepted for present purposes.

The dynamic under monopoly economy is then clear. By algebraic rearrangement the quantity theory states that T=MV/P – ie, given that velocity is taken as constant, the change in output depends on the ratio between the change in the money supply and the change in the price level.

The consequence of the vast upward movement in prices under a price liberalised monopoly economy is then evident. Unless the money supply rises by at least at an equivalent rate to the price level (a 350 per cent increase in January alone) output must decline. The attempt to constrain the money supply under monopoly pricing necessarily produces a fall in output. In Eastern Europe this mechanism operated violently. The quarterly rate of expansion of the Polish broad money supply fell from 190 per cent in the third quarter of 1989 to under 10 per cent in the second quarter of 1990 in the context of a 400 per cent increase in domestic prices. Real money supply, the ratio of money to the total price of output, fell by 44 per cent. As the money supply did not accommodate the increase in prices output collapsed.

The joint demand by Russian industrialists and trade unions this summer to expand credit, to avert a catastrophe, was therefore justified not merely from a contingent but from a fundamental theoretical point of view – as are measures such as indexation of capital assets.

The problem, however, is that while expansion of the money supply is necessary under monopoly to prevent the collapse in output – and its social and output effects can be ameliorated by measures such as indexation of wages, pensions, and amortisation – it cannot halt the price increases. This problem will be returned to below.

The relations between the monopoly and non monopoly sector

If the dynamic created within the monopoly sector is for output to decline and prices to increase then the relation of the monopoly to the non-monopoly sector is equally clear. Under full price liberalisation monopoly output declines but simultaneously its prices rise relative to the non-monopoly sector. These two basic laws: (i) Within the monopoly sector decline in output and increase in prices; (ii) the rise of monopoly prices relative to non-monopoly prices, together define the basic dynamic of the dual economy.

The ‘scissors crisis’ between agricultural and industrial prices, the fact that throughout Eastern Europe the agricultural crisis is even deeper than the industrial crisis, is one manifestation of this. Although food prices rise rapidly the price of industrial inputs into agriculture, from the monopoly sector, increase even more quickly – a process described by agriculture minister Khlystun. Crushed between a decline of demand on one side, due to impoverishment of the population, and a rise in input prices on the other, the agricultural sector is thrown into profound crisis.

However the same process, with specific modifications, operates in relation to other non-monopoly sectors. It is for these reasons that full price liberalisation in Russia has produced a deep crisis within the small private business sector – Professor Yasin has pointed out that 50 per cent of cooperatives in Russia have gone bankrupt. This dynamic is strategically decisive not only in itself but, in particular, because the relation between the monopoly and non-monopoly sectors is inseparably connected to the single most important historical distortion of the domestic Russian economy – its underdevelopment of individual consumption. As this issue is at the core of the contrast between economic success in China, and disaster in Eastern Europe, it will be considered in detail.

The underdevelopment of consumption in Russia

The historical underdevelopment of individual consumption in Russia is clear. Only 55 per cent of former Soviet GDP was devoted to personal consumption – compared to 60-65 per cent of GDP in most Western economies and 67 per cent in the United States. This underdevelopment of consumption was disastrous from the point of view of production – destroying the incentive to work. However it also profoundly distorted the structure of the supply side of the economy.

– The most rapidly growing sectors of the post-war world economy, in addition to computers and related industries, were increasingly concentrated among consumer durables and services. However, due to the low share of individual consumption in the former Soviet economy, these sectors had a very restricted market and were inhibited in their development. The sectors in which the former USSR concentrated – metal production and machine building – were, in contrast, among the most slowly growing sectors of world production.[3]

– The low percentage of consumption concentrated production in sectors requiring very high investment per unit of output (heavy industry, energy) and underdeveloped sectors with much higher ratios of output to investment (light industry, services). This by itself dictated a low productivity of capital.[4]

– Investment to meet the needs of the population was extremely low. In the main Western economies one sector, housing, accounts for approximately 23-33 per cent of total investment. In Russia, in 1971-89, the average share of housing in investment was only 15.4 per cent. [5]

– Services, the most rapidly growing sector of a modern economy, were underdeveloped. Employment in services in 1990 was 57 per cent of civilian employment in Germany, 59 per cent of civilian employment in Japan, and 71 per cent in the US but only 45 per cent in the USSR.[6] While these are not the only factors explaining the low productivity of capital in the USSR expansion of Russian production into consumer durables and services would, by itself, raise the productivity of investment. [7]

The structure of employment and industry

The relation between heavy and consumer industries and services is, however, inseparably connected to that between the monopoly and non-monopoly sectors of the economy. Light industry and services are characterised by much smaller units of production than heavy industry and by a quite different structure of employment. For example in Germany, a country with a very large industrial sector, 11 per cent of the workforce are self-employed/ employers. However in retailing and wholesaling 18 per cent are self-employed/ employers, in the private service sector 20 per cent, and in restaurants and hotels 36 per cent – in agriculture the figure is 79 per cent. Within German manufacturing only 3.9 per cent are self-employed or employers. But in textiles and clothing 8.5 per cent are self-employed/employers, in food processing 9.4 per cent, and in miscellaneous (chiefly light) manufacturing 12.3 per cent. In construction 10 per cent are self-employed/ employers.[8]

In contrast, in 1989, it was estimated that only 0.2 per cent of the workforce were legally self-employed in the former Soviet Union. A further 3.5 per cent were employed in the cooperative sector, giving a total of 3.7 per cent – equivalent to less than 3 million persons in Russia. However production for the consumer sector cannot be developed without creating a very large number of small enterprises – ie a huge development of the non-monopoly sector. Taking international comparisons, between 8 and 19 million self-employed/ small employers must be created in Russia – the higher figure being necessary if the decision were taken to de-collectivise agriculture. However in Russia, under the economic policies of the government, the shift in relative prices in favour of the monopoly sector crushes the non-monopoly sector – making it, among other things, impossible to meet consumer demand.

The basic dynamic of the dual economy under price liberalisation

The basic mechanism of the dual economy under conditions of full price and economic liberalisation, that is the East European and Russian economic reform, may now be seen: (i) output in the monopoly sector declines while its prices rise (ii) the rise in monopoly prices relative to non-monopoly prices crushes the non-monopoly sector – creating a mechanism sucking resources out of the non-monopoly sector. What is instead required is the exact opposite mechanism. One which (i) maintains output in the monopoly sector (ii) pours resources into development of the non-monopoly/consumer sector. The Chinese economic reform precisely created such a mechanism. In examining this first the monopoly sector will be considered and then, most important, its relations with the non-monopoly sector.

The Chinese economic reform

No significant part of the Chinese monopoly industrial structure was privatised . There were several waves of ‘small privatisation’, in particular in retailing, but these did not affect large scale industry. Output in the monopoly sector was expanded by three complementary mechanisms.

– the entire economy was expanded extremely fast under the impact of policies discussed below. Demand for goods from state industry was therefore high.

– slightly under half investment in the state sector was subject to a central plan – such investment declined only from 8.7 per cent of GNP in 1978 to 7.5 per cent in 1988. Large supplies of credit were given to enterprises under a “credit plan” – such credits increased from 9.3 per cent of GNP in 1978 to 29.9 per cent of GNP in 1988. However, because price controls in the monopoly sector existed, enterprises could only maximise profits by increasing output.

This combination of high demand and cheap investment credits led to extremely rapid increases in state output. Gross output by state industry in 1981-86 rose by 56 per cent – an annual growth rate of 8.9 per cent. The change in industrial structure in China, therefore, came not because the state sector was curtailed or privatised, as in Russia, but because the non-state sector grew even more rapidly – gross industrial output in the non-state collective sector, a concept discussed below, increased at 19.3 per cent a year in 1981-86.

Similarly Chinese investment rose not because the share of state investment fell – despite a reduction in 1979-81 it was 19.5 per cent of GNP in 1988 compared to 19.2 per cent of GNP in 1978 – but because non-state investment rose from 7.6 per cent of GNP in 1978 to 10.2 per cent of GNP in 1989.

China therefore grew not by destroying its state sector but by altering the relations between the monopoly and non-monopoly sectors – rapidly expanding the latter. This mechanism is the key to the Chinese economic reform. First the demand and then the supply sides of the process will be considered.

The demand side of the Chinese economic reform

On the demand side the foundation of the Chinese economic reform was a radical increase in the share of personal consumption in the economy . In only three years, 1978- 81, the share of private consumption in GNP was raised from 52.6 per cent to 58.5 per cent – an increase of almost 6 per cent. In real terms individual consumption rose by 20 per cent. All other priorities were subordinated to achieving this initial leap in consumption [9] – government final consumption was reduced from 14.2 to 11.5 per cent of GNP and fixed investment was temporarily reduced from 26.8 to 20.1 per cent of GNP (although fixed investment recovered rapidly once the initial transition to a new pattern of demand had been achieved).

This huge, six per cent of GNP, upward shift in the share of personal consumption was the precondition for the transformation of the supply side. New industries – high quality foods, consumer durables, and services – could only develop if a market was created for them. The rapid upward shift in consumption was the mechanism to achieve this. The time sequence of the shift is clear. There was no voluntaristic attempt, as in Russia, , to lower military spending with reckless speed.

Over the 10 years 1978-88 reduction of the share of military expenditure in GNP was the chief means by which the increase in the share of personal consumption in GNP was financed. Military expenditure as a percentage of GNP was reduced by slightly over half in constant price terms over a decade – the 3.1 per cent of GNP fall in the share of military spending, in current price terms, almost exactly matched the 3.8 per cent of GNP rise of the share of personal consumption. But the reduction of the share of military expenditure was gradual, 0.3 per cent of GNP a year in current prices terms. In 1979, with transitional expenditures, the percentage actually increased marginally.[10]

The increase in the share of personal consumption was initially financed by a reduction in the proportion of fixed investment in GNP – a 6.7 per cent fall in the percentage of fixed investment in GNP in 1978-81 financed a 5.9 per cent of GNP increase in the share of personal consumption. After 1981, however, the benefits of reduced military spending began to be felt, and the enormous increase in the share of personal consumption necessary to bring about the initial change in economic structure could be reduced. By 1984 the percentage of fixed investment in GNP had regained its 1978 level. The dynamic of the change on the demand side over the decade is therefore clear. Initially the proportion of consumption was raised by reducing fixed investment. Then, as military spending fell, the resources released were shifted into investment. [12]

The supply side

This huge shift in the structure of demand was connected to the supply side of the economy by being used to produce a large shift in relative prices in favour of the non-monopoly sector. This mechanism was the key to the economic reform.

The sequence of the price shifts is clear. In 1978-81, with the start of the rural reform, the procurement price of agricultural goods was raised by 38 per cent more than industrial goods and the price of consumer goods rose 11 per cent faster than those in the economy as a whole. In 1984-86, with the start of the urban reform, consumer prices rose by a further 11 per cent compared to average prices. The population was protected against the rise in prices because the resources saved through reducing investment were transferred into consumer subsidies and increasing wages. [13] Therefore, unlike Russia, as the population did not suffer from the change in relative prices, and benefitted greatly from the increase in supply, there was popular support for the changes, not opposition.

Over the decade as a whole consumer prices rose by 24.8 per cent relative to average prices and agricultural prices 77 per cent relative to industrial prices. [14]

The shift in favour of non-monopoly sectors

As the boundary between consumer and investment goods also largely corresponds to that between the monopoly and non-monopoly sectors of the economy, what fundamentally took place in China was clear. A gigantic shift was produced in favour of prices in the non-monopoly sector – i.e. the exact opposite to that in Eastern Europe.

The contrast, in the crucial sector of agriculture, is shown in Figures 3 and 4 [The original draft article graphed the figures given below- JR]. Figure 3 illustrates the upward shift in consumer prices and agricultural prices in China. Figure 4 shows the movement of relative agricultural prices in Czechoslovakia following price liberalisation – similar figures exist for all East European countries.[15] In three months following Czech price liberalisation agricultural prices rose more rapidly than the general price level – due to pent up demand for food . However, in the following nine months, relative agricultural prices then fell rapidly, until by a year after price liberalisation they were 8 per cent lower than before it.

The contrast to China is evident. In China relative prices were moved sharply in favour of the non-monopoly/ agricultural economy. As all barriers were removed to production for consumer and agricultural markets, and as small scale production can develop rapidly in response to demand, consumer and agricultural production boomed. By the price shift the Chinese government produced not merely a legal but real economic possibilities to develop consumer/small scale production – whereas in Eastern Europe a legal right to establish enterprises is created but they are crippled in practice by the decline in consumer demand and the effect of monopoly pricing.

If, in a dual economy full liberalisation of prices becomes a mechanism whereby the monopoly sector sucks resources out of the nonmonopoly sector, China created a mechanism whereby huge resources were pumped into the non-monopoly sector to meet consumer demand. Once the shift in prices, and relative demand, was coupled with liberalisation in supply the other processes flowed logically.

In China three sectors were developed:

– state, ‘collective’ (frequently groups leasing premises from municipalities, but also cooperatives with their own facilities etc), and private.[16] The industrial private sector remained small – in 1989 56 per cent of industrial production was by the state sector, 36 per cent by the collective sector, and 5 per cent by the private sector . However the collective sector grew more rapidly than the state sector – increasing its share of industrial output from 20.7 per cent in 1980 to 35.8 per cent in 1989. [17]

In the service sector, by 1988, only 39 per cent of retailing turnover was in the state sector, compared to 33 per cent in the collective sector, and 19 per cent in the private sector. In catering 22 per cent of turnover was state sector, 25 per cent collective, and 50 per cent private.

Service employment exploded. In 1978-88 China’s total workforce increased by 35 per cent [18] but catering employment increased by 327 per cent, retailing by 380 per cent, and other services by 750 per cent.[19] Total employment in these three sectors increased from 6 million to 30 million.

In agriculture decollectivisation was undertaken – land remaining nationalised but responsibility for production passing to family farms. From the production point of view a system of essentially perfect competition was created.

Onto this a system of incentives was grafted by the state paying a fixed price for a quota, and above that guaranteeing to buy all agricultural production at a higher price. [20] To produce incentives agricultural procurement prices were progressively raised. [21]

The increase in agricultural output followed the predictions of economic theory. Between 1980 and 1984 food output in China increased by 6.9 per cent a year – cereals by 7.4 per cent a year. By 1984 the fundamental problem of food supply was solved, the relative increase in procurement prices was halted, and attention was switched to increasing output of high quality food (beef, pork, oranges, bananas, sugar) and industrial crops.

The interaction between rural and urban sectors created a huge demand for consumer goods. Total industrial output in 1979-84 rose by 8.6 per cent a year but production of televisions by 47 per cent a year and refrigerators by 98 per cent a year. After 1984, with a halt to the rise of procurement prices, agricultural growth slowed to 5.0 per cent a year but the annual increase in industrial output rose to 14.5 per cent a year. [22] Production of consumer durables was now large in absolute terms – in 1988 China produced 7.6 million refrigerators and 25 million television sets. A housing boom took place.[23]

By this mechanism China made the type of structural transformation required by Russia. With monopoly output increasing due to state control, and resources pouring into the non-monopoly sector due to the shift in relative prices, consumer production of all sorts soared.

This mechanism in China was, literally, the exact reverse of that in Eastern Europe and Russia. In Eastern Europe, state domination of the monopoly sector was abandoned, monopoly output collapsed while the monopoly sector simultaneously sucked resources out of the non-monopoly sector through the rise in relative prices. In China state domination of the monopoly sector meant: (i) its output was raised, (ii) the price boundary between the monopoly and non-monopoly sector could be manipulated to pump resources into the non-monopoly sector. Success in China flowed just as inevitably from application of the economic laws of the dual economy as did disaster in Eastern Europe.

The Chinese economic reform, therefore, was not simply about the relations between industry and agriculture. It concerned the general relations between the monopoly and non-monopoly economy – of which the agricultural-industrial relation is only one, extremely important, aspect. While in a predominantly rural country, such as China, agricultural prices were raised even more rapidly than those for all consumer goods such shifts in relative pricing can, in principle, be used equally in favour of other non-monopoly sectors.

From a fundamental economic point of view, indeed, there is a rather interesting parallel between the Stalin system and the system of East European reform. Stalin produced a huge shift in relative prices against agriculture and reduced consumption. So, by a different mechanism, does the East European reform. In its most fundamental feature the Chinese economic reform is the exact opposite to both. Furthermore it is clear from the laws of the dual economy that only the fundamental principles of an economic reform of the Chinese type can succeed in Russia. No matter how long an ‘East European’ reform is applied it can, for reasons the outlined, only lead to disaster.

Equally a reform simply of the Ryzhkov [former Soviet prime minister – JR] type cannot create the necessary huge network of non-monopoly enterprises necessary to meet consumer demand and achieve flexibility in production – no administrative mechanism, centred for example on conversion of defence industries, can create this. Instead, in China, a system was created whereby state investment led the economy through market mechanisms not administrative decisions – the only possible way with decentralised consumer production.

What are the implications for the Russian economy? Russian suffers from the great disadvantage that, unlike China it does not start from a stable, if stagnant, base but from a catastrophic decline in output created by an East European economic reform. Therefore, an intermediate term programme for structural transformation must be integrated with an immediate anti-crisis package. However the broad principles are clear.

(i) The precondition for success is to end the destruction of the state industrial sector. Without this (a) output in the monopoly sector cannot be stabilised (b) price relations with the non-monopoly sector cannot be controlled.

(ii) It is imperative to restore the national market. Everything possible must be done to re-strengthen links between the republics – it is this market, not the external one, which is decisive. As a supplement any recreation of trade links with Eastern Europe will be mutually beneficial.

(iii) Domestically, in the short term, everything must be subordinated to halting the decline in living standards and consumption. This is not merely necessary for human reasons but to provide the basis of structural transformation of the economy. Given that consumer output has fallen less rapidly than total output the share of consumption in GDP has already increased (unfortunately in a declining, not expanding, economy). Both an immediate stabilisation programme, and structural transformation, require the introduction of wage indexation. Immediately wages must be indexed to prices, to halt the decline in consumption and the domestic market.

Later they should be indexed to ensure a share of individual consumption in GDP of approximately 60 per cent (5 per cent higher than the historic level ).

(iv) To halt inflation, and create conditions for the necessary rise in relative prices of consumer goods and agricultural items, price controls must be reintroduced in the monopoly sector. In some non-monopoly sectors in which competition has been developed this may not be necessary. In competitive consumer sectors prices may be allowed to rise, within limits, relative to monopoly prices (the population will be protected against the effects of this through wage indexation).

(v) To create supply to respond to demand shifts an extremely rapid programme of elimination of state control and/or ownership in areas where competition can be created quickly should be undertaken – “small privatisation” must be as rapid as possible.

(vi) Output in the state sector must be maintained through a system of state orders, state contracts etc. Large credits for enterprises must be given and their assets must be indexed.

(vii) In China, where the economy was stable, investment was initially reduced to create resources for extra consumption. However in Russia a precipitate investment collapse is underway – the share of investment in the economy has almost certainly already declined too much. The problem is therefore to stabilise and increase investment. This must be done through: (i) state decisions on investment in priority sectors, (ii) strong incentives for investment such as indexation of amortisation and tax incentives. Given the current depth of the crisis strong administrative decisions are almost certainly necessary on investment – transition to credit as the primary instrument for maintaining investment can only function when inflation has been curtailed.

(viii) While in the intermediate term the resources to increase the share of individual consumption in the economy must come from reduction in the share of military expenditure this cannot be cut precipitately – closure of armaments factories would, in any case, reduce overall demand in the economy. Use of the resources of the military complex in exports would, however, be economically rational.

Three groups clearly have an interest in such an economic reform: (i) Industrialists and managers who wish to stop the destruction of industry and prepare conditions for economic modernisation; (ii) Representatives of the mass of the working population who are interested in halting the decline in consumption and production, maintaining employment and preparing for a rapid expansion of consumer production, (iii) Small business, which would gain an economic climate in which it would thrive – rather than one in which it is given a legal right to exist but is crushed by economic processes.

The three interests coincide in the restoration of the domestic Russian economy – that is such a solution is truly “national” in character. The forms in which these three groups would work out their interests is, of course, a question of politics and domestic Russian affairs which it is not within the competence of this article to discuss.

Naturally Russian economists will be able to develop much more detailed and adequate programmes than these – which relate only to the most fundamental issues. However the economic laws of dual economy, which dictated success in China and failure in Eastern Europe, are not specific but universal in character. They therefore apply to Russia. The specific application of these laws in defining an adequate programme for Russia can, of course, only be achieved in Russia, by Russians.

Notes

[1] Set out in the Memorandum to the IMF and ‘The Programme of Deepening of the Economic Reform’.

[2] Both in terms of domestic production and international competitiveness.

[3] This trend was already clear in 1960 to 1973. In this period world output of, for example, iron and steel rose only by 5.8 per cent a year, non-ferrous metallurgy by 5.6 per cent a year, and metal piping by 4.4 per cent a year – compared to annual rates of increase of 13.4 per cent for computers, 11.6 per cent for photographic equipment, 9.6 per cent for watches and clocks, 9.0 per cent for pharmaceuticals, 8.4 per cent for consumer electronics, and 8.2 per cent for household goods (refrigerators, washing machines etc).

But after 1973 the development became even more extreme. After 1973 18 of the 25 most rapidly growing branches of industrial output were in only 3 groups: electronic and computer equipment (computers, electrical components, telecommunications, and electrical equipment), high quality consumer products (pharmaceuticals, toiletries, consumer electronics, photographic and optical equipment, watches and clocks, household goods, books and printing, and paper), and food products (animal fodder, edible fats, meat and fish, meat preserves, cereal based products, and beverages). The world market in sectors in which the USSR specialised – such as iron and steel, piping, machine tools, and non-ferrous metallurgy – actually shrank ie the USSR was producing into declining sectors. By 1987 the USSR produced more than twice as much steel as the United States, twice as much cement and almost three times as much iron ore but was totally underrepresented not only in computers and electronics but in the most dynamic sectors of consumer durable and high quality food production.

[4] To take international comparisons, in Germany, from 1980 to 1988, the ratio of annual value added in manufacturing to gross fixed capital formation in manufacturing was 850 per cent. However it was only 650 per cent in basic metals, 690 per cent in non-metallic minerals, 840 per cent in fabricated metal and machine production. In light, primarily consumer, manufacturing the output to investment ratios are far higher – in Germany 980 per cent in food processing, 1210 per cent in furniture production, and 1230 per cent in clothing. In the service sector ratios are similar to light industry – 930 per cent for restaurants and hotels, 1030 per cent for wholesaling and retailing, and 1390 per cent in financial services. In energy, in which the USSR specialised, the ratio of output to investment is even lower. A comparison cannot be made with Germany, where production is insignificant, but for the US and UK, Western economies with large energy sectors, the ratios in the 1980s were 350 per cent for the United States and 540 per cent (including coal production) for Britain.

[5] The share of housing in the reproducible assets of the USSR is less than 18 per cent compared to 30 per cent in the US, 33 per cent in west Germany, and 45 per cent in France.

[6] In “personal” (consumer) services in particular services employment in the USSR was only 19 per cent of the working population compared to 28 per cent in Germany, 33 per cent in France, 37 per cent in Japan and 39 per cent in the US. The disastrous situation of the Soviet retail system is easily explained by the fact that only 6 per cent of the working population was employed in wholesaling and retailing compared to 15 per cent in Germany, 17 per cent in France, 22 per cent in the US, and 23 per cent in Japan. West Germany, for example, itself a Western country with an unusually large heavy industrial sector, devoted 25.2 per cent of its investment to industry and 24.4 per cent to services, while the USSR devoted 36.4 per cent to industry and only 14.9 per cent to services.

[7] In addition to domestic effects the inappropriate structure of industrial production struck at the international competitiveness of the Soviet economy. This is graphically illustrated by comparison with the most rapidly growing economies in the last two decades apart from China – the Newly Industrialising Economies (NICs) of South Korea, Taiwan, Hong Kong, and Singapore. Starting from far lower levels of development than the USSR these were able to achieve spectacular export success by concentrating on sectors such as consumer electronics. They were aided by technological mastery in consumer goods being much easier to achieve than in the investment sector – UN studies indicate that in washing machines, refrigerators, radios, and televisions South Korea and Taiwan are already at the same technological level as Japan, that is the most advanced in the world. These economies dominate the export of cheap personal computers. However the USSR, which had the advantage of a much more advanced starting point and a much larger domestic market, failed to develop any such industries – in part because its domestic production of consumer items was extremely low compared to the size of its economy.

[8] The proportion of the working population who are self-employed/employers in countries with larger agricultural sectors than Germany is much higher – 15 per cent in France, 21 per cent in Japan, 27 per cent in Spain, and 32 per cent in Italy. Even in the United States, which has the most developed economic structure, the figure is 9 per cent.

[9] Far from allowing consumption to collapse, as in Russia and Eastern Europe, China started its reforms by determined measures to raise the short term living standards of its population.

[10] As the economy more than doubled in size in the decade real military expenditure probably rose slightly at the same time as its share in GNP was halved.

[11] After 1984 the percentage of fixed investment rose above its pre-1979 level, financed by further reductions in military spending and reductions in other government economic expenditure, until by 1989 economic overheating was occurring The percentage of fixed investment in the economy was then reduced to its 1984 level.

[12] Such figures also show clearly that far from the state sector abandoning the process of change to the market it in fact led the transformation through state control of the investment mechanism. First there was marked reduction of the share of state fixed investment in GNP in 1978-81, from 19.2 per cent of GNP to 14.4 per cent, to create the space for increased consumption. Then through the reexpansion of state investment as a percentage of GNP in 1981-86, from 14.4 per cent of GNP to 20.9 per cent of GNP, general investment was expanded. Finally in 1988- 89 state investment was reduced to curb economic overheating (Figure 3). The difference to the previous situation was that state investment increasingly led the economy through the market, not through administrative decisions – which in any case could not have been implemented given the enormous increase in the number of small enterprises discussed below.

[13] In the first phase, from 1978 to 1981, subsides on daily necessities rose from 2.2 per cent of GNP in 1978 to 6.4 per cent of GNP in 1981 – an increase in subsidies of 4.2 per cent of GNP. Later consumer subsides were reduced and instead compensation was given through de facto indexation of increased wages and pensions – a more efficient system but which has exactly the same result.

[14] If relative prices had remained as in 1978 the share of private consumption in GNP in from 1978 to 1988 would actually have contracted from 52,6 per cent to 45.2 per cent – instead of expanding from 52.6 per cent to 56.4 per cent.

[15] In Hungary food prices rose by 10 per cent more rapidly than the general price level in the three months following price liberalisation at the end of 1989. Food prices then fell by 16 per cent relative to the general price level – leaving them six per cent lower, in relation to prices, than before price liberalisation. In Poland the process is not yet finished but the trend is clear. Food prices rose by 30 per cent relative to other prices in 1989-90. They then fell by 20 per cent relative to other prices and are continuing to fall rapidly.

[16] The second category undoubtedly contains a proportion of both quasi-state and quasi-private enterprises as well as genuine collective ones.

[17] This rapid development of the “collective” industrial sector in China explains the extremely rapid development of small industrial enterprises in China – by 1986 there were 500,000 industrial enterprises in China of which 420,000 were small scale (Jiang Yiwei, “Enterprise reform” in The Chinese Economy and its Future ed Peter Nolan and Dong Fureng, Polity Press Cambridge 1990 p159.). This sector primarily developed in light industry, which also helped its extremely efficient use of capital – by 1987 one third of industrial output was produced by small enterprises with only one eighth of investment. This sector also developed significant exports – $5 billion in 1987.

Overall the share of light industry in total industrial output increased from 42.7 per cent in 1978 to 49.3 per cent in 1988. Three directly consumer industries – food processing, textiles and clothing, and publishing and paper making – alone increased their percentage of industrial production from 29.7 per cent in 1978 to 34.3 per cent in 1987 on the basis of only 17.8 per cent of industrial investment – implying an efficiency in investment almost double that of industry as a whole.

[18] Industrial employment increased by 59 per cent. Employment in construction, reflecting
the building boom, increased by 178 per cent.

[19] By 1989 only 17 per cent of employment in retailing was in the state sector, 34 per cent in the collective sector, and 49 per cent in the private sector. In catering 13 per cent worked in the state sector, 25 per cent in the collective sector, and 61 per cent in the private sector. In the other service sectors 19 per cent worked for the state, 31 per cent in the collective sector, and 48 per cent in the private sector. In the retailing, catering, and service sectors alone more than 10 million new firms were created in 1978-88.

[20] This is technically known as a system of “price perversity”. Normally prices remain static, or fall, with increases in output. In this case average price rose as output rose.

[21] Given the conditions of perfect competition monopoly profits could not be made. But the new incentives gave extremely strong possibilities to increase profit by increasing output.

[22] This being too rapid and creating overheating in the economy by 1989 after which the pace of growth was slowed down.

[23]As indicated by the figures for the ratio between light and heavy industry output in heavy industry grew more slowly – although after 1984 coal production still increased at 5.4 per cent a year, steel at 6.4 per cent a year, sulphuric acid production at 7.0 per cent a year, and nitrogenous fertilizers at 12.5 per cent a year

What happens in a recession – why Venezuela´s socialist orientation is crucial confronted with the international financial crisis

December 23, 2008

Venezuela´s socialist economic orientation is usually judged from the point of view of moral criteria – the improvement of the living standards of the majority of the population. But it also has a decisive practical aspect. The socialist orientation of Venezuela´s economy gives it by far the best opportunity to deal with the impact of the international financial crisis. In order to understand this it is vital to understand what occurs in a recession.
In the development of a recession, such as the one the world economy is entering, what is decisive is not consumer or government spending. What, above all, occurs in a recession is that investment declines or, in the most severe cases, collapses.
In order to illustrate this Figure 1 shows the changes in the main domestic components of US GDP in the most classic of all recessions/depressions – that in the US following 1929. [1]

Figure 1

As can be seen the pattern is clear. The economic decline in US was extremely severe – on a far larger scale than anything occurring at present. The fall in US GNP (Gross National Product) was 29.7 per cent between 1929 and 1933.[2] The 1929 US level of GNP was not regained for a decade – until 1939.
Looking at the components of this decline in GDP, however, a clearly differential pattern shows itself.
Government spending increased throughout the recession – not only after Roosevelt became president in 1933 but even under Hoover.
The decline in personal consumption expenditure after 1929 was severe but less than the overall decline in GNP. By 1933 US personal consumption expenditure had fallen by 19.7 per cent compared to the 29.7 per cent drop in GNP. Personal consumption expenditure regained its 1929 level by 1939.
But the collapse in investment was extreme, far exceeding the decline in GNP – explaining the difference between the drop in personal and government consumption expenditure and the drop in overall output
By 1933 US private domestic fixed investment had fallen by 73.9 per cent from its 1929 level. Or, put another way, by 1933, US private domestic fixed investment was only 26.1 per cent of its 1929 level. This was by far and away the most severe element of the depression – which, by multiplier effects, spread its consequences through the rest of the economy. Similar patterns are seen in any recession.
The reason for this differential decline is that while ‘demand’ in the economy may be spoken of in general, in fact the different components of demand are controlled by quite different mechanisms.
Decisions on the level of government spending are taken directly by the state and can therefore be relatively easily controlled – here Venezuela´s socialist orientation gives a good opportunity to maintain demand during the international recession.
Regarding personal consumption, the aim of the mass of the population is to have as good a living standard as possible. The most powerful issue affecting personal consumption is the level of income, not the desire to consume. [3]
However, private investment decisions are not controlled by consumption but by profit. Therefore investment decisions are not controlled by the same mechanisms as personal and government consumption – and can fall to almost any level. It is this decline in investment which is by far the largest in a recession.
Why, therefore, cannot a capitalist government intervene directly to stop the decline in investment? The issue here is private property in the means of production. If the government takes decisions on investment out of the hands of the private owners of the means of production it, in fact, limits or abolishes that private ownership of the means of production. Therefore, in such circumstances, if the government accept the private ownership of the decisive means of production in a country it cannot halt the decline in investment. Whereas if, in such circumstances, the government aims to halt the decline in investment it must have sufficiently strong instruments, in terms of the weight of the state owned sector, in order to prevent investment in the economy declining.
Confronted with the severe international financial crisis, if the decisive sectors of Venezuela´s economy were privately owned it would not be possible to halt the decline in investment. Venezuela´s economy would go into severe recession. The fact that in Venezuela important sectors of the economy are state owned, and it has a socialist economic orientation, means that the government can directly intervene to keep up investment. This means that Venezuela is in a much better position to resist the international financial crisis than if it were not a socialist government.
The practical consequences in terms of economic policy are clear. The core of givernment policy to deal with the international financial crisis must have three components.
Firstly, in order to avoid a decline in demand in the economy personal consumption must be maintained at a high level in the economy.
Second, government spending must be maintained, and increases may be necessary, in order to complement the high level of consumer demand.
Third, and most important, strong state measures must be taken to maintain and increase the level of investment in order to compensate for what will almost certainly be a decline in private investment due to the effect of the international economic recession.
The aim of this investment, in addition to its immediate effect in maintaining demand in the economy, must be both to increase the long term efficiency of the economy and to improve the quality of life of the population. In most countries, both China and the US being examples, the most effective means to achieve this is a sharp increase in spending on infrastructural investment.
Such counter-cyclical programmes will, of course, be even more effective if co-ordinated with Venezuela´s Latin American partners.

Notes
[1] The international source of demand is net exports. There was a drastic contraction of international trade after 1929 which seriously deepened the depression. However this does not affect the argument regarding the components of domestic demand dealt with here. Inventories also declined after 1929, adding to the recessionary effect, however changes in stocks, by their nature, are cyclical and again the concentration here is on the long term elements in economic shift.
[2] Gross National Product (GNP) differs from Gross Domestic Product (GDP) in that is equal to GDP plus net income earned from abroad. Long term US historical economic data is in GNP terms. The size of difference to GDP is, however, small and does not seriously distort comparisons to other countries GDP figures.
[3] In a recession personal consumers may decide to save more – among other reasons to protect themselves from the threat of future economic hardship or unemployment. However there are relatively effective mechanisms to tackle this, and in any case if the extra savings are invested by the government or companies no fall in aggregate demand takes place – the savings by individual are merely spent somewhere else in the economy. The biggest effect is the fall in income due to either declines in real wages or unemployment.