. ., . 6A HC 336.26 .878 1991 V.2 C:4 International Monetary Fund. A Study of the Soviet Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized A Study of the Soviet Economy

Volume 2

INTERNATIONAL MONETARY FUND

THE WORLD BANK

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT

EUROPEAN BANK FOR RECONi;QW{MJ)IltWFund AND DEVELOPMENT Joint library

fEB 7 1996

lntflrnat\onal Bank for Reconstruction and Developmef'l1 Washington, D_C 20431 February 1991 This study has been prepared by the staffs of the International Monetary Fund, the World Bank, and the Organisation for Economic Co-operation and Development, and by consultants to the designated President of the European Bank for Reconstruction and Development. The findings, conclusions, and interpretations expressed in this study are those of the staffs concerned and should not be attributed to the International Monetary Fund, the World Bank, the Organisation for Economic Co-operation and Development, or the European Bank for Reconstruction and Development, to the executive boards or council of these organisations, or to their member governments.

©Joint copyright, Paris 1991, by the International Monetary Fund, Washington, DC; International Bank for Reconstruction and Developmentffhe World Bank, Washington, DC; Organisation for Economic Co-operation and Development, Paris; European Bank for Reconstruction and Development London. All rights reserved.

Applications for permission to reproduce or translate all oi' part of this publication should be made to: Head of Publications Service, OECD 2, rue Andre-Pascal, 75775 PARIS CEDEX 16, France

11 Table of Contents Volume 2

PART IV.- Systemic Policies

Chapter IV.l- Price Reform 0 00 0 o 0 0 0 00 0 00 0 00 0 0 0 0 00 0 0 0 0 0 0 00 0 0 0 0 00 0 I lo Introduction 0 0 0 0 0 0 0 0 00 0 00 00 0 0 00 0 0 o0 0 0 0 o0 0 0 00 0 0 0 0 0 00 0 0 0 0 00 0 0 0 1 20 The present system 0 0 0 0 0o 0 0 00 0 0 0 o0 0 0 00 0 0 00 0 0 0 0 00 0 0 0 0 00 0 0 0 00 0 00 2 30 The options for price reform 0 0 0 0 0 00 0 0 00 0 0 00 0 0 00 0 00 0 0 0 00 0 0 0 00 0 0 0 5 Tables to Chapter IVol 0 0 00 0 0 0 0 00 0 0 0 00 0 00 0 0 0 00 0 0 0 0 00 0 0 0 00 0 0 0 00 0 0 0 14 Chapter IV.2- Enterprise Reform 00 0 0 0 0 00 0 0 00 0 0 00 0 0 0 0 0 00 0 0 00 0 0 0 0 00 15 lo Introduction 0 0 0 0 0 0 0o 0 0 o0 0 o 0o 0 0 o 0 0o 0 0 00 0 00 00 0 0 0 0 0 00 0 0 00 0 0 0 0 00 15 20 Current status and trends 00 0 0 0 0 00 0 0 0 00 0 00 0 0 0 0 00 0 0 0 0 00 0 0 0 0 00 0 0 0 0 15 30 The commercialization and privatization of enterprises 0 00 00 0 0 0 00 0 0 0 0 18 40 Industrial restructuring and demonopolization 0 0 0 00 0 0 0 0 0 00 0 0 0 00 0 0 0 0 28 50 The management of state-owned enterprises 0 00 0 00 0 0 0 0 0 0 0 00 0 0 00 0 0 0 0 31 60 The training of enterprise managers o 0 0 0 00 0 0 00 0 00 00 0 0 0 0 00 0 0 0 0 00 0 0 0 33 Tables to Chapter IV02 0 0 0 00 0 00 0 0 0 0 0 00 0 00 0 0 00 0 0 0 00 0 0 0 0 0 00 0 0 0 00 0 0 0 36 Chapter IV.3- External Trade Reform o 00 0 0 00 0 0 00 0 0 0 0 00 0 0 0 0 00 0 0 0 00 0 0 41 lo Introduction 0 0 0 00 0 0 0 0 00 0 00 0 0 0 0 00 0 0 00 0 0 00 0 0 0 0 00 0 0 0 0 00 00 00 0 0 0 0 41 20 Features of the trade regime and recent reforms 0 0 0 0 00 0 0 0 0 0 00 0 0 00 0 0 0 42 30 Reform issues 0 o 0 0 00 o 0 0 o0 0 0 00 0 0 0 , 00 0 0 00 0 00 0 0 0 0 0 00 0 0 0 00 0 0 0 00 0 0 51 40 Summary and conclusions 0 0 0 0 00 0 0 0 00 0 0 00 0 0 00 0 0 0 0 0 00 0 0 0 00 0 0 00 0 0 64 Tables to Chapter IV03 0 0 o 00 0 0 o 0 0o 0 0 0 0o 0 0 00 0 0 00 0 0 0 00 0 00 0 00 0 0 0 00 0 0 69 Chapter IV.4- Foreign Direct Investment 00 0 0 0 00 0 0 00 0 0 0 0 00 0 0 0 00 0 0 00 0 75 1. Introduction 00 o 0 0 o 0 o 00 o 0 00 0 0 00 0 0 0 00 0 0 00 0 0 00 0 0 0 0 0 00 0 0 0 0 00 0 0 0 0 75 20 The experience with joint ventures 0 0 0 0 00 0 0 0 00 0 00 0 0 0 0 0 00 0 0 0 00 0 0 0 0 76 30 The regulatory setting 00 0 0 00 0 0 0 0 00 0 0 0 0 00 0 o 00 0 0 00 0 0 0 0 0 00 0 0 0 00 0 0 0 84 40 Summary and recommendations 0 00 0 0 0 0 00 0 0 00 0 0 0 00 0 0 0 0 00 0 0 0 0 0 00 0 93 Tables to Chapter IV.4 0 00 00 0 0 00 0 0 0 00 0 0 0 00 00 0 00 0 0 0 00 0 0 0 0 0 0 00 0 0 0 00 102 Chapter IV.S- Financial Sector Reform 0 00 0 0 0 00 0 0 0 00 0 0 0 0 0 00 0 0 0 00 0 00 107 I 0 The banking system 0 0 0 0 0 0 0 0 0 00 0 0 0 00 0 0 0 0 00 0 0 00 0 0 0 00 0 0 0 0 00 0 00 0 0 I 07 20 The development of securities markets and contractual savings institutions 0 0 0 00 0 0 0 0 00 0 0 00 0 0 00 0 00 0 0 0 00 0 0 0 0 127 Tables to Chapter IV05 0 0 0 0 0o 0 0 0 00 0 o 0 0 o 00 0 0 00 0 0 00 0 0 0 0 0 00 0 0 0 0 00 0 0 0 136

Ill Chapter IV.6- Labor Market, Social Safety Net, Education and Training ...... 137 1. Introduction ...... 137 2. The labor market ...... 138 3. Incomes and living standards ...... 149 4. Policies to facilitate the transition process ...... 159 Tables to Chapter IV.6 ...... 196 Charts to Chapter IV.6 ...... 215 Appendix IV.6-1- Experience with Incomes Policies in Selected Countries ...... 219 Chapter IV.7- Legal Reform ...... 225 1. Introduction ...... 225 2. State authority and the legal regulation of the economy ...... 225 3. Legal foundations for market exchanges ...... 240 4. Regulation of the business sector ...... 260 5. Selected sectoral and specific issues ...... 285 6. Summary ...... 294

List of Tables Chapter IV.l IV. I. I. Relative Prices of Goods on Domestic and World Markets, 1988 14 IV.l.2. Subsidization of Selected Food Products, 1986 ...... 14 Chapter IV .2 IV.2.1. Number of Industrial Enterprises by Sector, 1970-87 ...... 36 IV .2.2. Average Size of Industrial Enterprises, 1970-87 ...... 36 IV.2.3. Size Distribution of Industrial Enterprises as of January 1, 1988 . . . 37 IV .2.4. Size Distribution of Employment in Industrial Enterprises, Selected Sectors, 1987 ...... 37 IV .2.5. Distribution of Industrial Enterprises: Selected Sectors, 1987 . . . . . 38 IV.2.6. Distribution of Industrial Product Groups by Output Share of Largest Producer, 1988 ...... 39 IV.2.7. Concentration of Deliveries to State Supply Agency by Product Group, 1988 ...... 39 IV.2.8. Share of Largest Producers in Output of Selected Products, 1988 40

Chapter IV .3 IV.3.1. Basic Indicators for Soviet Foreign Trade, 1985-89 ...... 69 IV.3.2. Commodity Structure of Exports, 1980-89 ...... 70 IV.3.3. Commodity Structure of Imports, 1980-89 ...... 71 IV.3.4. Proportion of Production Exported by Selected Sectors, 1985 and 1989 ...... 72 IV.3.5. Import Share of Soviet Domestic Consumption of Selected Products, 1985 and 1989 ...... 73

iv List of Tables (Continued)

Chapter IV.4 IV.4.1. Joint Ventures and Initial Capital, 1987-90 ...... 102 IV.4.2. Distribution of Operating Joint Ventures by Size, 1990 ...... 102 IV.4.3. Distribution of Joint Ventures by Size of Initial Capital, 1990 . . . . 102 IV.4.4. Distribution of Operating Joint Ventures by Area of Economic Activity, 1990 ...... 103 IV.4.5. Distribution of Registered Joint Ventures by Area of Economic Activity, 1990 ...... 103 IV.4.6. Distribution of Registered Joint Ventures by Country of Foreign Partner, 1990 ...... 104 IV.4.7. Distribution of Registered Joint Ventures by Location, 1990 ...... 104 IV.4.8. Wage Rates for Employees in Joint Ventures, 1990 ...... 105 Chapter IV.S IV.5.1. Overview of Banking System ...... 136 IV.5.2. Aggregate Balance Sheet of Commercial and Cooperative Banks, End-June 1990 ...... 136 Chapter IV.6 IV.6.1. Labor Force Growth in International Perspective, 1980-89 196 IV .6.2. Employment by Sector in International Perspective, 1988 ...... 196 IV.6.3. Growth in Total and Working-Age Population by Republic, 1979-89 ...... 197 IV.6.4. Employment Shares by Republic, 1989 ...... 198 IV.6.5. Job Separations According to Cause, 1988-89 ...... 199 IV.6.6. Estimates of Job Displacement and Unemployment in the Transition to a Market Economy, 1991 ...... 199 IV.6.7. Unemployment Scenarios ...... 200 IV.6.8. Relation Between Earnings of Salaried Workers and Wage Earners, 1955-88 ...... 200 IV.6.9. Monthly Wages by Industry, First Half 1990 ...... 201 IV.6.10. Monthly Wages by Republic and Branch, 1987 ...... 201 IV.6.11. Cooperatives- Employment and Average Wages, January-June 1990 ...... 202 IV.6.12. Expenditures from Social Consumption Fund and Direct Subsidies, 1988-89 ...... 202 IV.6.13. Measures of Income Inequality, China and USSR ...... 203 IV.6.14. Republican Income Distribution and Poverty Levels, 1989 ...... 203 IV.6.15. Distribution of Annual Per Capita Consumption of Major Food Items Ranked by Households According to Monthly Per Capita Income, by Republic, 1989 ...... 204 IV.6.16. Regional and Household Specific Price Variations ...... 207 IV.6.17. Life Expectancy and Infant Mortality in the USSR and Selected Countries, 1982-86 ...... 210 IV.6.18. Total Pension Expenditures ...... 211

v List of Tables (Continued)

IVo6ol90 Average Pensions 0 0 0 0 00 0 0 0 00 0 0 00 0 0 0 0 00 0 0 0 0 00 0 0 00 0 0 00 0 0 0 0 211 IVo6o20o Distribution of Pensions, 1987 0 0 0 0 0o 0 0 0 0 00 0 0 0 00 0 0 00 0 0 0o 0 0 0 o 211 IVo6o21. Persons Above Retirement Age in the 1979 and 1989 Censuses 0 0 212 lVo6o220 Estimates of Wage Funds, Employment and Persons in Need of Help by Republic, 1991 00 0 0 0 0 0 0 00 0 00 0 0 00 0 0 0 0 0 0 212 IVo6o23o Official Projections for the Employment Fund, 1991 00 0 0 00 0 0 0 0 0 213 lVo6o24o Persons with Secondary and Higher Education, 1970-89 0 00 0 0 0 0 0 213 IVo6o25o Transition from "Incomplete Secondary Education", 1970-89 0 0 0 0 214 IV060260 Transition from "Complete Secondary Education", 1970-89 214 List of Charts Chapter IV .6 lo Trends in Working Age Population and Working Force, 1959-89 215 20 Standardized Labor Force Participation Rates, 1988 00 0 0 00 0 0 0 00 0 0 0 0 0 0 216 3 0 Separation Rate in Manufacturing 00 0 0 0o 0 0 0 0 00 0 0 o 0 00 0 00 0 0 0 00 0 0 0 0 0 217 40 Number of Students Involved in Education, Training and Retraining 00 0 0 218

Vl Part IV

Systemic Policies

Chapter IV.l

Price Reform

1. INTRODUCTION

Under central planning and the central allocation of real resources, prices have generally been viewed as playing largely an accounting role with little effect on consumption, investment, or production decisions. Prices remained fixed for long periods of time at levels unrelated to the pattern of underlying scarcities, and resource allocation generally depended instead on administrative decisions. Even with the focus on physical balances, however, it is likely that the low prices maintained on such basic industrial inputs as energy and steel both reflected and helped to perpetuate the low priority given by planners to economizing on those resources. 1 Inadequate investment in housing and poor maintenance of the exist­ ing housing stock may also be attributable, in part, to the low level of financial flows to the responsible government agencies which resulted from subsidized rents. At the same time, household consumption patterns have been influenced by the heavy subsidization of particular foodstuffs.

Whatever the influence of prices under central planning, they become crucial as allocation decisions are decentralized and enterprises are placed increasingly on a self-financing basis. The need for massive price adjustments has been widely recognized in the USSR and was a centra( element of all the major economic reform proposals put forward in 1990. General agreement does not exist, however, on either (1) the timing and speed of price correction, or (2) the extent of future price control. In the discussions of price liberalization, even among those who advocate radical reform, emphasis is frequently put on the need to wait to free prices until scarcities are eliminated, supplies are stabilized, and monopolies are broken up. The role of prices in influencing demand and as a signal to producers for resource allocation, which itself would help to remove shortages, is often given less weight. In the eyes of many Soviet observers there are also significant economic concerns that argue against rapid price liberalization, including widespread monopoly, and fears of an explosive wage-price spiral, of large-scale bankruptcy of enterprises and displacement of workers, and of severe declines in real incomes. Many of these same dangers exist, however, even in a scenario involving slower administered adjustment of prices. The question is which option offers the most acceptable trade-off between likely short-term costs and prospects for stability and growth in the medium term.

2. THE PRESENT SYSTEM a. Price administration

Like most aspects of the Soviet economy today, prices and the manner of their determination are in a state of flux and confusion. Superimposed on a formal system of price controls, the administration of which is divided among several agencies at each level of government, are "contract" prices, negotiated by enterprises within administratively set limits and later converted to "list" prices by Goskomtsen, the state price control agency; and rapidly growing legal and semi-legal (i.e., tolerated) parallel markets where cooperatives and other nonstate forms of enterprise pay more for their inputs and enjoy greater freedom to set their own prices, and where both state and nonstate enterprises acquire needed inputs or scarce consumer goods for their workers. 2 For these reasons, available price information and price indices, which generally refer to official prices, may present a misleading picture of both price levels and trends. The analysis of prices is further complicated by the wedge between retail and wholesale prices repre­ sented by turnover taxes and subsidies at implicit rates that vary widely from one industrial branch and product to another. The prices of most goods and materials exchanged among industrial enterprises are, in theory, set by the all-union and republican-level offices of Goskomtsen. Producer prices in a particular industrial branch, at the time they are set, are generally based on the branch's average costs of production, plus a nor­ mative markup, building in some incentive for individual enterprises to hold down costs. Demand is generally not taken into account in the pricing decision. Moreover, infrequent revisions weaken cost-price relationships over time. 3 Al­ though the official prices of specific items remain fixed for long periods of time, old products disappear from production, and new products are continually being introduced, to which new prices must be assigned. The branch ministry usually assigns a provisional price on the basis of cost data submitted by the producing enterprise. This price must later-often several years later-be given final ap­ proval by Goskomtsen, which may conduct a thorough review of costing at each

2 stage of the production process as well as a comparison with the costs of similar goods at other enterprises. In reality, it is impossible for Goskomtsen to review more than a fraction of the price proposals brought to it each year or to evaluate more than a handful of them rigorously.4 Consequently, most prices between the major revisions are, in fact, set by the enterprises and branch ministries in accordance with rules set down by Goskomtsen. ·The result is probably considerable exploitation of the oppor­ tunity to introduce minor innovations as new products, but nevertheless keeping price increases within tactical limits to avoid provoking a later Goskomtsen audit. Ministries may also attempt to push prices above the average costs plus the nor­ mative markup in order to avoid losses in the less efficient enterprises. b. Industrial input prices As noted above, official wholesale prices have been comprehensively ad­ justed only infrequently. Prices for such basic inputs as electric power, fuels, and metals have changed little during the interim periods. Whatever may have been the relationship to external prices initially, the present internal structure of prices bears little relation to relative prices in international markets.5 Table IV.l.l il­ lustrates the wide variation in the ratios of the domestic to world market prices across products. The domestic price of oil relative to electricity, for example, is less than one third the comparable ratio in the world market; the relative price of scrap steel is about one seventh the world market ratio; while the relative price of ammonia is almost twice the world market ratio. With input and output prices bearing little relation to supply and demand, enterprises as a matter of necessity have found ways of introducing some flexibility into the otherwise rigid price system. One common vehicle for price adjustment, as alluded to above, is the introduction of a "new" product, which may in fact vary little in cost, quality, or productive value from the old product, but which is put forward for revaluation by Goskomtsen. Goskomtsen is not equipped to evaluate all such proposed increases closely, and the branch ministries have no incentive to do so. Prospective customers for a "new" intermediate good, who may not themselves be subject to a hard budget constraint, find little difficulty in acceding to its higher price. The result may be further distortion of relative prices, insofar as prices in multiproduct and nonstandard product industries (e.g., machine tools) are inherently less easy to control than are the prices of single, mass produced standard products (e.g., electric power, metals, bulk raw materials).6 State orders were still intended to cover about 75 percent of production in 1990 and to fall rapidly thereafter. However, the greater freedom enjoyed by many enterprises to make their own production decisions (see Chapter IV.2) has come at a cost in terms of the loss of guarantees of input deliveries from the state supply

3 system. At the same time, new formal supply channels (wholesale markets) have been slow to form. 7 In addition, production problems and the diversion of raw materials and intermediate goods from the official system into the "shadow economy" has resulted in uncertain supplies even for deliveries still tied into official supply channels. According to Goskomstat, 24 percent of state industrial enterprises failed to comply with their contractual obligations for the supply of products during the first eight months of 1990. Enterprises reported spending substantial time and energy searching for needed inputs in barter markets and lining up stocks of goods to trade on that basis. 8 Some producers apparently export goods below world market price in order to acquire imported goods (e.g., VCRs) that can be traded internally on barter markets for production inputs, food and other consumer goods for workers, or construction materials for worker hous­ ing, thereby also evading the closer monitoring and controls placed on money wages. Nevertheless, the extent of actual shortages of industrial inputs is unclear. Total production has not fallen drastically thus far, and given that the production of most raw materials and intermediate goods is highly concentrated in a few enterprises, even in barter markets the buyers must be acquiring the bulk of their production inputs from traditional suppliers. Most barter trade would therefore appear to represent a mechanism for sur­ reptitiously accommodating changing price relationships. Input costs are clearly rising. With the price controls most effective at the end of the production chain­ i.e., final consumer goods-the profits of consumer goods producers must be getting squeezed, except to the extent that they, in tum, are able to divert produc­ tion themselves to the parallel markets or, by leasing or reorganizing as a coopera­ tive or other business form, to avoid retail price controls. The costs to the economy of supply uncertainties and diversions of resources and managerial time, as well as related transport costs, are undoubtedly high and becoming more serious. There are limits to the level of activity that can be sup­ ported by these means in an economy as complex as that of the USSR, and falling industrial output may be a sign that the system is operating very close to those limits. c. Consumer goods prices Reflecting a longstanding official commitment to retail price stability, the official prices of consumer goods at the retail level have been even more stable than producer prices; some have not been changed for 30 years or more. The official consumer price index rose by an annual average of slightly more than 1 percent per year in the 1980s, and most of this inflation was explained by sharp increases in the prices of alcoholic beverages. Not reflected in the official price index, however, has been the "hidden inflation" associated with the introduction of supposedly new products, and the costs to consumers and to society as a whole of goods being rationed by store-by-store searches and long queues, favoritism,

4 and corruption. Frequently, particularly in the smaller towns and rural areas, many goods were not available at all at the official prices. The impact of these shortages on work incentives is revealed in the common worker saying that "we pretend to work for the money they pretend to pay." Also not captured by the official data is the rapidly growing proportion of consumer goods and services accounted for by nonstate enterprises at significantly higher prices, and apparently growing diversion of goods from official to nonofficial channels. Table IV .1.2 shows the extent of budgetary subsidization of selected food products. In 1986, the average retail price of butter, for example, covered only 40 percent of the cost to the state of its purchase, transportation, processing, and sale. If related budgetary support and credit forgiveness to state farms and collectives are added in, the total cost to the state was almost three times the retail price. Direct price subsidies for agricultural products, mostly foodstuffs, grew from rub 72 billion in 1986 to a planned rub 100 billion in 1990.9 Over this same period, price subsidies to industry (excluding food processing) remained roughly con­ stant.10

3. THE OPTIONS FOR PRICE REFORM As noted above, there is no fundamental disagreement on the need for price reform in the USSR. All of the major reform proposals have included comprehen­ sive price reform as a key element, but none has advocated complete price liberalization at the outset. In particular, all the proposals would extend controls on the retail prices of basic food goods, rents, and key industrial raw materials (particularly energy) for at least two years. The risks of rapid price liberalization have been alluded to above. There are risks on both sides, however, and apparently not as well recognized by the Soviet authorities are the risks of not freeing prices quickly and early in the reform process. a. The risks of rapid price liberalization Perhaps the greatest danger of a rapid abandonment of state price controls is the possibility of setting off hyperinflation. It must be acknowledged at the outset that economic reforms will inevitably involve a substantial increase in the average level of prices and money wages in the USSR, even if monetary and fiscal dis­ cipline are maintained. Many prices would have to be raised several-fold to ap­ proach international price levels, and, given the downward "stickiness" of prices, the upward adjustments are unlikely to be fully offset by price declines in those goods currently overpriced in relative terms. The needed price increases will, in tum, have a serious impact on both production costs and real incomes, creating pressures for subsequent rounds of price and wage adjustments that could easily ratchet out of control. Moreover, while tight monetary and fiscal discipline could

5 undoubtedly bring inflation to a halt, the process may not be smooth, and sub­ stantial short-term unemployment could be created. That said, tight monetary and fiscal discipline are a sine qua non for suc­ cessful economic reform. The government budget in 1990 was expected to be in deficit on the order of 8 percent of GDP, mostly financed by monetary emission (see Chapter 11.2). It is apparent that a sharp reduction and continuing control of the deficit must be taken as a precondition to price liberalization in the reform program. 11 The price subsidies in the state budget currently exceed the total deficit and will grow rapidly in 1991, in the face of administered wholesale price in­ creases, unless drastic action is taken to adjust retail prices. 12 Failure to take such action would make extremely difficult, if not impossible, the achievement of the Government's announced fiscal targets and the control of inflation. A principal concern of the Soviet authorities, of course, is the impact of consumer prices on the living standards of the population. The heavy subsidization of basic consumer goods has, in effect, substituted for money wages throughout the economy, and the expectation of continued subsidization has influenced the savings decisions of the large number of households dependent on pensions and other transfers. The several-fold increases in prices necessary to eliminate sub­ sidies in basic foodstuffs and housing rents could, unless compensated, have a devastating effect on the real incomes of many, if not most, Soviet citizens and would be politically intolerable. Although full compensation is not feasible, be­ cause it would all but preclude the necessary reduction in the state budget and containment of monetary expansion, some way must be found to provide at least partial amelioration of the impact on family living standards. Another risk of rapid price liberalization is the possibility of major disruption of the industrial sector. The technologies in use and the financial viability of many Soviet enterprises are based on heavily subsidized prices of energy and other inputs. A rapid increase in those prices could thus jeopardize the solvency of enterprises unable to adjust their production processes and input mixes quickly to the changed terms, and unable to raise output prices in the face of domestic or external competition. Also at risk would be the solvency of the state banks whose loans to such enterprises comprise an important part of their assets. Subsidies to such enterprises through a transition period would, of course, impact negatively on the budget and complicate macroeconomic stabilization efforts. There is also concern that the freeing of prices would allow the numerous monopolies that characterize the Soviet economy to exploit their market power at the expense of their consumers and to the detriment of efficient resource alloca­ tion; and that prices and incomes would be further distorted by the actions of unrestrained "speculators" and market manipulators. These concerns partially derive from the lack of a full appreciation of market processes (although not, perhaps, of the motivations of those engaging in market activities). Indeed, as discussed below, price liberalization is essential for breaking down the market

6 power of monopolists in the system, while "speculation," as currently defined in Soviet law and concept, contributes positively to the efficiency of the market system. 13 b. The risks of gradual price liberalization The subsidy burden on the union budget of food subsidies is, as noted above, considerable. The authorities have correctly perceived the need to raise agricul­ tural prices for producers in order to provide incentives for increased output. Much of these cost increases have been absorbed in the budget, however, rather than passed on to consumers. 14 The greater decentralization of fiscal responsibilities that might take place under a new union treaty would only serve to shift this deficit into the budgets of the republics. Whereas the risk of social and political disruption from removing subsidies is real and well recognized, the risk of macroeconomic instability generated by the food subsidies also must be taken into account. Failure to allow full price correction early in the reform process also implies that resources would continue to be used inefficiently throughout the system, as producers and consumers both continue to respond to distorted signals. Under present proposals, energy, whose use per unit of output in the USSR is almost double the average of the Western industrial countries, would continue to be wasted, along with other underpriced inputs; the housing stock would continue to depreciate more rapidly than technically necessary or economically justified; and the distorted profit patterns among industries would attract investment and credit to many inefficient uses, while other more efficient activities would be unable to attract the necessary resources. In the short run, the costs to the economy would be manifested in continued shortages and the diversion of resources to possibly unintended uses and beneficiaries. The distortion of new investment flows would have a longer-term impact and significantly raise the later costs of adjustment, when prices were finally corrected. At that time, both the enterprises that were created or expanded in response to the distorted prices, and their lenders and investors, would be put at risk. The underpricing of key inputs and basic consumer goods almost inevitably implies their continued central allocation and invites as well corruption and favoritism in their distribution. It also means large illicit profits to those able to acquire these goods at low controlled prices and to resell them in the black market. These undesirable consequences of price controls are already well evident in the USSR and may serve to discredit the economic reforms generally in the eyes of many. As regards the impact of price increases on consumers, governments around the world have instituted various price controls with the intention of protecting the purchasing power of the poorest members of society. These efforts have been exceedingly costly, however, and have seldom succeeded. In the first place, in-

7 come support through price subsidization is highly inefficient, inasmuch as all purchasers of the subsidized goods benefit whether or not they need such assis­ tance. Where feasible, a targeted program directing income to those in need can meet the same social objectives, while placing a far smaller burden on the state budget. Moreover, the goods themselves often end up being acquired in the black markets by those who can afford to pay higher prices, while the benefits of the subsidy accrue largely to the black marketeers and those officials who may help them to acquire the scarce supplies of goods at the subsidized prices. Indeed, at least some part of the feared inflation and reduction in real incomes has already occurred in the USSR, as a result of the disruption of supplies and diversion of products from the state stores to cooperatives and to the black market. To that extent, the freeing of prices would simply recognize and validate the inflation that has occurred and would permit the concentration of any compensating income subsidies on the intended beneficiaries. At the same time, the very high rents captured by those taking advantage of the present system would be eliminated. 15 Failure to free prices can also serve to help perpetuate the highly concentrated market power found in most Soviet industries. Given the vast market of the USSR and its rich and diversified resource base, all but a few of these monopoly situa­ tions depend on administrative barriers to competition rather than on technical and other advantages. Indeed, many of the huge enterprises are too large to be cost efficient and would be forced by free market pressures to reduce their scale of operation. These competitive pressures operate through the price system, as both new enterprises (as well as existing enterprises from other sectors) are attracted to enter markets precisely by the high profits accruing initially to the monopolists. As the new enterprises enter into competition, prices are bid down, and the mo­ nopolist is forced to restructure and modernize its own operations in order to survive the competitive onslaught. 16 The proposition that supplies of goods must be stabilized before their prices can be freed would also seem to reflect a misreading of market processes. The argument is that current shortages will lead to an excessive increase in prices. To a considerable extent, however, the shortages themselves are the result of prices fixed at levels that provide inadequate incentives to produce and exaggerated incentives to consume, indeed to waste. In other words, distorted prices breed shortages, not the reverse. With the system of state orders no longer able to compel production and deliveries, it is mainly through increased prices that the shortages can be eliminated. So-called speculators (i.e., people who buy goods at one price in order to sell them at a higher price) serve an indispensable market function, assuring that goods in scarce supply are distributed to their most valuable uses. Most producers engaged in mass production in a market economy find it uneconomic to establish the full base of information, personal contacts, and communications and transport facilities necessary to reach widely dispersed potential users. Most buyers, too,

8 would find it difficult to deal directly with all their potential suppliers. Specialized intermediaries thus form the heart of the wholesale marketing activity, establishing the flow of intermediate goods between producers and of final goods from producers to retail shops. The differential between the buying and selling prices of traders is necessary to cover their costs in setting up the necessary information networks and to provide the profit needed to attract them to engage in this useful activity. The main difference between such traders and the official supply agencies that currently fulfill this function in the USSR is that the former are forced by competition to minimize their costs and to provide reliable and satisfactory service to their customers on both the buying and selling sides. 17 This is not to say that markets cannot be manipulated, and that there are not persons in every society who will take advantage of opportunities to seek illicit gain. A proper legal and regulatory framework can serve to minimize these dangers, however, and to punish offenders, without distorting the markets themselves and leading to the inefficiencies that have become evident everywhere that administrative decisions have been substituted for the market. Corruption and opportunism will still occur: they cannot be eliminated entirely. It may be less a problem in market systems, however, where unusual profit margins invite competition, which in turn serves to reduce excesses. Until and unless price distortions are eliminated, it probably will not be possible to impose the hard budget constraint necessary to induce enterprises to respond to market forces. If enterprises are forced to be financially self-sustaining in the face of distorted prices, efficient firms could fail, because their prices are held arbitrarily low; while inefficient firms could remain profitable, because they benefit from prices that are too high. Finally, without prior price reform, there is no way of accurately valuing assets for the purpose of selling or otherwise distributing enterprise shares in the course of privatization and restructuring (see Chapter IV.2). Whether shares are distributed in accordance with equity concerns and/or on the basis of individual choice, their relative values will depend on the profitability and prospects of the respective enterprises in the marketplace. Continuing the controls over prices maintains the distortions and uncertainties that must affect the evaluation of enterprise performance and place a potential responsibility on the government for later losses when the remaining price controls are removed.

c. Recommendations For the reasons given above, the desired transition to a market economy in the USSR would be best served by an earlier, more rapid, and more comprehen­ sive liberalization of prices than is contemplated in the presidential guidelines. This view is influenced in part by the degree to which the administered supply system has already broken down, resulting in shortages of both industrial inputs and consumer goods, hidden inflation, and an apparently massive shift to barter

9 activity to keep production going. Despite the Government's admonitions to enterprises to respect traditional supply relations and to honor state orders, it is doubtful whether the administered system can be reconstituted in such a way as to function at its previous level of effectiveness. In addition to encouraging greater efficiency, rapid price decontrol may now be the fastest, if not the only, road to re-establishing a stable flow of goods. At the same time, however, measures need to be taken to mitigate the impact of price increases on household incomes. It is recommended that the prices of virtually all goods in the economy be freed early on, with only a few items excepted. Even for most of the exceptions, however, there is a need for substantial price increases at the beginning of the reform process. The first exception would be public utilities, including public transport, which are likely to remain state monopolies as in many other countries. A second exception would be made for housing, where present distortions are enormous, but the basic legal and financial infrastructures will require time to develop (see Chapters IV.5 and 7). Third, exceptional treatment might be accorded a handful of key industrial inputs-e.g., energy-for which (1) the supply and demand responses to increased prices are likely to be slow; (2) the potential disruption of industrial production, without a reasonable period allowed for ad­ justment, would be large; (3) the products concerned are important inputs, for which a reasonable degree of predictability of prices is important for users' production plans; and (4) the state supply system is still capable of assuring reli­ able supplies at or near the present levels. For these goods, a time-bound, prean­ nounced schedule of adjustment to world prices over, say, 3 years might be appropriate, giving the affected industries forewarning of the need to adjust their technologies, product and input mixes accordingly. A large initial adjustment should be required (say, to 50 percent of world market prices), achieving full convergence to world market prices by the end of the transition period. A border tax, rather than direct price controls and supply allocations, could be used to create the desired wedge between domestic and world prices. 18 The presidential guidelines call for the prices of energy and other basic materials to be set by agreement among the republics. If this procedure is used, it should be agreed from the start that the purpose is to ease the transition to international prices within an established time frame, as outlined above. The ad­ justment of industry generally could also be eased somewhat by an initially high uniform external tariff (replacing the present myriad quantitative restrictions), that was reduced over time in accordance with a preannounced schedule (see Chapter IV.3). Although retail food prices should be freed, it is recommended that, in the initial stage of reform, the Government seek to use imports to stabilize supplies of the most sensitive basic consumer goods-bread, milk, butter, meat-to prevent hoarding and price overshooting, while at the same time, assuring that market prices fully cover freed producer prices and the costs of transportation and dis-

lO tribution. As the wholesale and retail marketing networks were privatized, govern­ ment intervention through managed imports could be eliminated. The stabilization of inflationary expectations in the wake of this adjustment would depend heavily on the success of the monetary and fiscal program and on guaranteed supplies of imports of the indicated goods. Bilateral assistance might be provided during the first stage to assure import supplies. The composition, volume and resale prices of specific commodity aid, however, would have to be carefully managed to avoid harming domestic producer incentives. For workers, the removal of price subsidies would represent a sharp reduction of what has, in effect, constituted wages in kind. It may be appropriate for both economic and equity reasons that the reduced subsidies be partially compensated by permitted increases in money wages. 19 This increased cost to the enterprises would be partially offset by the transfer of certain social expenditures from the enterprises to the government (see Chapter IV.6) and would constitute a first step toward the market-oriented reform of labor remuneration policies also alluded to in the presidential guidelines. Increased labor costs, along with other input costs and higher interest rates, would now be reflected in the prices of goods in the market.

Pensions and other transfers to individuals not active in the labor force would also have to be adjusted. One approach that has been used elsewhere is a flat per capita transfer for all individuals. Although administratively more difficult, a tar­ geted approach, based on maintaining acceptable real minimum family income levels, would achieve the same social objectives at a lower cost to the budget. Overall, the extent of compensation to consumers for the loss of subsidies would depend on their fiscal impact and on the requirements of macroeconomic stabiliza­ tion. Short-term reductions in the real incomes-although not necessarily con­ sumption--of some members of the population are probably an unavoidable cost of the reforms. The challenge to the Government is to ensure, through the design of the reform program, that this short-term cost is (and is perceived to be) a sound investment in the future.

If, as some observers have cautioned, it might prove infeasible to initiate means-tested income support in the near term, an alternative could be to give each person ration coupons carrying the right to purchase a fixed quantity of certain essential goods at a specified price. Individuals or households wanting more of such goods would have to purchase them at the unsubsidized market price. A variant of this approach would be to provide each person with a given amount of food stamps, which could be used as money in buying eligible foods at free market prices. Since the stamps would have a fixed monetary value, the price an in­ dividual had to pay (or the amount he would be able to buy) would vary with the market price of the goods concerned, but the budgetary cost of the subsidy would be fixed. 20

II NOTES 1. In 1986, the USSR consumed US$7.71 worth of oil equivalent (at international prices) per US$10,000 of GOP, compared to an unweighted average for the five major industrial countries (United States, Japan, Germany, France and the United Kingdom) of US$4.28. Moreover, while the industrial countries were reducing their energy use per dollar of GOP by 25 percent between 1973 and 1986, the ratio in the USSR rose by 15 percent. See Maddison (1989). 2. Included among these parallel markets are longstanding, highly segmented barter markets for industrial inputs and consumer goods, whose principal actors are state enterprises; farmers' markets providing an outlet for production from private plots; and retail consumer goods markets for cooperatives and other producers outside the state supply system. 3. Major wholesale price revisions were carried out in 1949, 1967, 1973 and 1982. 4. It has been estimated that in 1985, Goskomtsen was reviewing some 200,000 price proposals a year, or about 42 percent of the total submitted to it. Only a small fraction of these were reviewed in detail (Hewett (1988)). 5. For details see Chapter IV.3. 6. Another implication of this practice is a significant underestimation of the official rate of inflation. See Appendix 11-2. 7. According to Goskomstat, 17 percent of the sales of producer and technical goods (i.e., ex­ cluding consumer goods, electricity, and heating) took place through the wholesale trading system in 1989. The development of wholesale markets has been inhibited, in part, by the continuing existence of criminal sanctions against "speculation" (see Chapter IV.7). 8. Another reaction to insecure input supplies, of course, is to accumulate large inventories of inputs, an activity also encouraged by low interest rates on enterprise deposits and loans as well as expectations of future price rises. 9. Total fiscal subsidies, including transport and marketing costs, production, support etc., were, of course, much higher. 10. A 1986 market survey carried out in Moscow and four U.S. and European cities gives an indication of the distortions in internal relative prices in the USSR (Radio Free Europe). For example, with one kilogram of wheat flour as the numeraire, the relative price of a kilogram of rye bread ranged from 1.3 to 4.0 in Washington, London, Paris, and Munich, respectively compared to only 0.4 in Moscow. The relative prices for a kilogram of beef in the four Western cities ranged from 10.7 to 38.0, as compared to only 4.4 in Moscow. A month's rent on a representative subsidized apartment ranged from the equivalent of 195-420 kilograms of wheat flour in the Western markets compared to 25 in Moscow. At the other extreme, the same ratios for a cotton t-shirt ranged from 5.7-9.0 in the West but was 33.2 in Moscow; while a 59 centimeter color television in Moscow cost 1,400 times a kilogram for wheat flour as compared to 400 to 840 times in the other four cities. All taxes were included. All such comparisons, of course, are complicated by inevitable quality differences among the goods found in the different markets. 11. It would be important in this respect to estimate the impact that price liberalization itself would have on the deficit. On the one hand, price subsidies on basic consumer goods would be eliminated by rapid price liberalization. On the other hand, the expenditures of the government in continuing public programs would, on balance, rise. Tax revenues would benefit from the increased profits of enterprises whose relative prices rise but would fall with respect to those enterprises whose profits suffer. The budget would have to bear whatever compensation is

12 paid out to government employees in wages and pensions and whatever compensation is offered as a "safety net" to society at large. Interest rate adjustments would also raise the cost of servicing the public debt and reduce the profits and tax payments of borrowing enterprises (but raise tax collections from banks and households). Obviously, the net result of these various impacts will have to be closely monitored, and the Government must be prepared to take whatever actions are required to keep the deficit and monetary expansion under control. 12. To the extent that price controls remain at the retail level, consumer demand will be higher than otherwise, and freed prices at the wholesale level will rise more than they would were prices to be liberalized at both levels. Subsidies will therefore increase still further under these conditions. 13. Both of these propositions depend, however, on an adequate legal and regulatory framework as discussed at greater length in Chapter IV. 7. 14. Some Soviet analysts view the increased prices to the producer as the source of the budgetary problem and as having been a policy mistake. Under most circumstances, however, markets function most efficiently when consumers of a product bear its full costs of production. 15. Money wages have increased significantly more rapidly than output in recent years, leading to a growing "monetary overhang" of involuntary savings (see Chapter III.3). In this context, a distinction might be made between real income and "real" real income, the latter denoting purchasing power that can be actually converted into goods. Whereas corrective inflation will reduce real incomes, it might, for at least some consumers, raise "real" real income. 16. Pressures for vertical integration lead many of these same enterprises into the production of their own inputs, often at sub-optimal levels of production. Competition would also force enterprises to drop these uneconomic activities and to acquire many of their inputs instead from more specialized and efficient producers. 17. Needed reforms in the distribution sector are discussed in more detail in Chapter V .2. 18. Under competitive market conditions, the difference between world and domestic prices would be defined by the tax itself. Under the monopolistic conditions prevailing in the USSR, the domestic price would likely be higher than the border price, at least under conditions of price differentiating profit maximization. Under these conditions, the price could be kept down to the desired level by adjusting the rate of tax. 19. The comparison of newly liberalized prices with the previous official prices would tend to overstate the impact on household incomes, however, because of the unrecorded inflation that has already occurred through the shift of some goods to unofficial supply channels and free prices. Therefore, full compensation would not be required even if the objective were to main­ tain fully the purchasing power of consumers. 20. For a more extensive discussion of these issues, see Chapter IV.6.

13 Table IV.l.l. USSR: Relative Prices of Goods on Domestic and World Markets, 19881

Price 2

USSR World Domestic Market

Oil ...... 1.6 5.0 Copper ...... · ...... 66.0 127.0 Scrap steel ...... 3.1 20.0 Ammonia ...... 5.7 3.0 Meat (per kg.) ...... 0.3 2.0 Wheat ...... ·······.····· 7.1 3.0 Color television (per unit) ...... 75.0 25.0 Personal computer (per unit) ...... 8,125.0 125.0 Screw-cutting lathe (per unit) ...... 311.0 232.0 Videocassette recorder (per unit) ...... 61.0 18.0

Source: The Economist, October 20, 1990, based on published Soviet sources. I. Numeraire is 1,000 Kwh of electricity. 2. Per ton unless otherwise indicated.

Table IV.1.2. USSR: Subsidization of Selected Food Products, 1986 (Rubles per kilogram)

Rye Whole Bread Beef Mutton Pork Poultry Milk Butter

Cost to the state for purchase, transportation processing

and sale •• 0 •••• 0 ••••••••• 0.20 5.37 4.79 3.42 3.02 0.45 8.41 Budget expenditures on the development of production ' 0.05 1.07 0.95 0.68 0.60 0.09 1.68 Total cost to the state ...... 0.25 6.44 5.74 4.10 3.62 0.54 10.09 Average retail price ...... 0.18 1.77 1.50 1.85 2.63 0.25 3.38 Excess of total cost to the state over average retail price O.D7 4.67 4.24 2.25 0.99 0.29 6.71 In percent of the average retail price ...... 38.6 265.1 282.6 121.6 37.6 116.0 198.5

Source: Bomstein (1990), pp. 130-144. I. Including capital investment, write-off of state farm bank loans, "planned expenses" of low-profit collective farms, insurance payments of low-profit state farms, capital repairs of budget-supported organizations, "operational expenditures," losses on housing and municipal services, price subsidies on machinery and mineral fertilizers and "other" outlays.

14 Chapter IV.2

Enterprise Reform

1. INTRODUCTION Reform of the structure, ownership, organization, and management of the USSR's industrial enterprise sector is a fundamental aspect of the transition to a market system. The transfer of responsibility for production and marketing decisions from the central planning bureaucracy to the individual enterprise managers is expected to make better use of the latter's technical expertise and initiative and lead to greater efficiency in resource use, faster technological progress, more rapid output growth, and improved product quality. To achieve these objectives, however, the simple devolution of authority over enterprise ac­ tivities must be accompanied by major changes in manager and worker incentives; the legal and regulatory framework in which enterprises function; the manner in which enterprises interrelate with one another and the communications and transport networks that bring them together as buyers and sellers of products; the sources, terms, and mechanisms of enterprise finance; the structure of enterprise ownership, internal control, and administration; the skills which managers bring to their complex tasks; and the manner in which the society at large manages and finances housing, social insurance, and other social expenditures currently as­ sumed by state enterprises. After a brief overview of the industrial structure and pattern of ownership in the USSR, this chapter focuses on several interrelated aspects of industrial enterprise reform: the commercialization and privatization of enterprises, the demonopolization of industry, enforcement of a hard budget constraint, and the management of enterprises destined to remain, at least for the foreseeable future, under state ownership.

2. CURRENT STATUS AND TRENDS The total number of industrial enterprises in the USSR has changed little since 1970, actually falling slightly from just over 49,000 to under 47,000 through

15 1987 (Table IV.2.1). The average size of enterprises, as measured by the number of employees, has grown in virtually all sectors, however (Tables IV.2.2-IV.2.5), and is significantly larger than found in Western industrial countries. Moreover, the share of the largest industrial enterprises in value-added has been growing over the past couple of decades; in contrast, for example, to the United States, where smaller enterprises have been increasing their share in recent years. a. The state enterprise sector State ownership remains the dominant form of enterprise ownership in the USSR, currently accounting for about 84 percent of the work force, 87 percent of national income, and 89 percent of fixed productive capital. Within the state industrial sector, as a result of the transfer of ownership rights in light industry and agroindustry, the share of republican and locally owned enterprises has grown in recent years, accounting for about 35 percent of sector output in the first half of 1990. Industrial production in most sectors tends to be highly concentrated in one or a few enterprises. For example, in almost two-thirds of the 38 product groups included under sledge-press machines, the largest enterprise accounted for 75 per­ cent or more of total production in 1988, and the same was true for 60 percent of the 38 product lines included in the tractor and agricultural machinery industry (Table IV.2.6). These data actually understate the degree of concentration; when broken down to greater levels of product specificity, there is commonly only one producer in the entire country. For 87 percent of the 5,885 products included in the machine-building sector, a single producer accounts for all deliveries to the State Supply Commission (Gossnab) (Table IV.2.7). A similar picture emerges from disaggregated Goskomstat data, which indicate that some 30-40 percent of Soviet industrial output is composed of goods produced on single sites. For ex­ ample, single factories produce 100 percent of sewing machines, 97 percent of trolley buses, 100 percent of coking equipment, and so on (Table IV.2.8). Even where more than one enterprise exists, the national aggregates hide a high degree of regional monopoly power that is protected by generally poor com­ munications and transportation and by administered marketing channels which, in turn, are insulated from one another by ministerial lines of responsibility. Moreover, the industrial branch ministries tend to view the enterprises under their control as merely cogs of the same wheel, thereby assuring that their activities are coordinated rather than competitive, and allocating and transferring resources among them in complex cross-subsidization. Factories under the same ministry produce all of the USSR's hydraulic turbines, electrolytic tin plate, freezers, and so on. The tendency toward huge scale and extreme concentration reflects, in large part, the preferences of central planners, whose abilities to process information

16 and enforce directives depends on keeping the number of entities they deal with as small as possible. While such monopoly power may not be of great concern in a system of central allocation and administrative pricing, the dangers inherent in this degree of market concentration for the transition to a market system are evident. Moreover, it is likely that in many sectors the current sizes of enterprises significantly exceed optimum scales in terms of costs of operation. At the same time that bureaucratic imperatives have led to extreme con­ centration of production at above-optimum scales, other forces have led, within the huge enterprises, to uneconomic vertical integration of production, in which enterprises strive to meet their own input needs at suboptimal scales of production. Principal factors contributing to this phenomenon are the unreliability of input supply, resulting from the increasingly inefficient centrally administered supply system, the lack of an efficient wholesale market, and breakdowns in the transport system; and the vertical organization and jealously guarded self-interests of the branch ministries responsible for the enterprises.' With the coming into force of the Law on Enterprises in 1988, state enterprise managers were given somewhat greater autonomy in production decisions, with a system of state orders--covering less than total output capacity-replacing the old mandatory production and delivery targets. State orders still accounted for about 75 percent of total production in 1990, however, and 90 percent or more for some industrial branches. More significant has been the enterprises' greater control over financial resources, created by a sharp decline in the profits remitted to the state budget and increased fungibility allowed for retained earnings. The resulting increase in enterprise liquidity more than offset the contraction of bank credit (Chapter 11.2) and permitted, among other things, a rapid increase in wages and social expenditures.2 b. Nonstate forms of enterprise Since 1988, the Soviet economy has seen the accelerating proliferation of new enterprise forms, including cooperatives, leasing arrangements, and newly defined small enterprises. Though not exactly private (see section 3), these enterprises operate with substantial independence from the state planning and allocation system, and managers have enjoyed greater freedom in production, pricing, wages, and employment decisions. By October 1990, there were ap­ proximately 215,000 cooperative enterprises, employing an estimated 5.2 million people, and accounting for some 5-10 percent of GDP, and for just under 2 per­ cent of fixed productive capital.3 Some 39 percent of cooperative enterprises in 1990 were in the manufacturing and construction sectors and accounted for about 49 percent of total cooperative output. The most rapidly growing sector of cooperative activity in the course of 1990 was construction. In contrast, the num­ ber of cooperatives in trade, restaurants, and other consumer services declined

17 significantly, possibly reflecting a deterioration in public attitudes and growing governmental restrictions (see below). Many cooperatives have been formed out of whole plants or work units in existing state enterprises. They often operate on the basis of leasing arrangements within the parent state enterprise. Goskomstat reported that some 170,000 cooperatives were operating in this fashion (in all sectors) during the first half of 1990. Some 1,900 free-standing industrial enterprises were reportedly operating under leasing arrangements during the same period (a more than 10-fold increase since 1988), enjoying a growth of output of more than 4 percent over the previous year, compared to a decline of 0.6 percent for the industry as a whole. 4 The Government's attitude to the growth of the cooperative sector has been ambivalent. As noted, the cooperatives have enjoyed greater freedom than state enterprises and, at first, also benefitted from a lower rate of taxation. Some restric­ tions were placed on their fields of activity, however, beginning in late 1988,5 and taxes and the prices at which they could obtain inputs were sharply raised. Cooperatives are also more dependent than state enterprises on the "gray" markets for their inputs, and find access to sites and public services more difficult. Under the tax reform set to take effect on January 1, 1991, cooperatives were to be given equal tax treatment with state enterprises. Popular attitudes toward cooperatives (particularly those engaged in retail operations) are frequently negative. They are widely characterized as criminal, or at best antisocial, diverting supplies from the official marketing channels and taking advantage of scarcities to charge exorbitant prices and make large profits. Finally, about 1.2 percent of the nation's fixed productive assets are in the hands of private individuals. Individual ownership is still highly concentrated, however, in peasant agriculture. In the industrial sector, it is limited to small-scale artisan activities that require no employed labor. Although the decree on small businesses issued by the Supreme Soviet in mid-1990 appears to permit enterprise ownership by individuals, it is too early to know how it will be interpreted in practice.

3. THE COMMERCIALIZATION AND PRIVATIZATION OF ENTERPRISES a. Background In a system of free markets and private ownership, neither the state nor anyone else bears a responsibility for protecting owners against losses resulting from their enterprise activities. To a considerable degree, therefore, the owners' present and future welfare depend on the success of the enterprise. They thus have a direct personal interest in assuring that enterprise capital is used efficiently and is properly maintained, and that new capital acquisitions will similarly be directed

18 to profitable uses. And they are further impelled by competitive pressures to stay up to date technologically, replacing machinery and restructuring plant and opera­ tions as needed to improve product quality and minimize production costs. Ownership of the means of production in the USSR is formally vested in the people as a whole. In the name of the people, the state, through its various agencies and ministries at different governmental levels, has exercised the basic rights of enterprise ownership, making production and pricing decisions and determining how the capital stock would be used, maintained, and augmented. Nevertheless, fundamental aspects of ownership have been missing for those who have exercised these rights: especially, the ability to buy and sell enterprise assets and a related personal stake in the long-term value of those assets. Soviet planners have placed the principal emphasis on maximizing immediate physical production, with little concern for the waste of capital and other inputs this might entail. Competition has not been present to encourage innovation; indeed, the time needed to install new equipment and teach the new worker skills required by changing technology may often have been considered by managers to be too costly in terms of short­ term production losses. b. Government plans for privatization The Soviet authorities have clearly identified the ownership problem as lying at the heart of the unsatisfactory performance of Soviet enterprises in terms of productive efficiency, product quality, and general technological backwardness. As a consequence, the presidential guidelines for economic reform call for the "denationalization and demonopolization of the economy and the development of enterprise and competition." As commonly used, "denationalization" (sometimes translated as "destatization" or "commercialization") means establishing an enterprise as a financially and managerially autonomous entity. As stated in the guidelines, "Not only are they autonomous in their activity, but they are also economically responsible for the results of this activity-in terms of both current income and their own property." For a large enterprise, as described in the guidelines, commercialization would typically be carried out first through converting the enterprise to a joint stock company while still under public ownership. As proposed, ownership would initially pass to state property funds, which would act as holding companies. Privatization through the sale of shares is seen as a subsequent step for most medium and large commercialized enterprises, but the need for commercialization would apply equally to those enterprises that are expected to remain in the public sector. Smaller enterprises, on the other hand, could be quickly privatized without going through the intermediate stage. While details of commercialization programs are to be worked out by the union and republican governments in their respective areas of ownership--a dis-

19 cussion complicated by intergovernmental disputes over enterprise ownership­ the guidelines propose that outright privatization begin immediately in such ac­ tivities as trade, restaurants, consumer services, repair shops, construction, and small enterprises generally. The commercialization of large and medium-sized enterprises is also to begin right away. Eventually, it is expected that most of the production and service sectors of the economy will have been transferred to private ownership.

c. The process of spontaneous privatization While plans and measures to implement these guidelines are being debated at all levels of government, the process of privatization has already effectively begun with the rapid proliferation described above of cooperative enterprises, leasing arrangements, and other devices by which ownership rights are being devolved to managers and workers of state enterprises. Although the legal basis for property rights in these new enterprise forms remains unclear (see Chapter IV.7), the trend seems unlikely to be reversed, and the challenge will be for those working to reform the legal/regulatory framework to catch up and normalize the process now in train. Many enterprises have already been hived off from existing state enterprises precisely in order to gain the greater degree of managerial freedom that these new organizational forms make possible. There is some evidence, albeit anecdotal, that greater managerial freedom and responsibility has resulted i!l marked increases in the physical efficiency and quality of production in these enterprises.6 These positive observations must be tempered, however, in two important respects. First, so long as the price signals to which these enterprises are respond­ ing remain severely distorted, resources, even though being used more efficiently in physical terms, still may be guided to the wrong uses from the point of view of overall economic efficiency. Private entrepreneurs responding to wrong price signals do not necessarily ensure better results than central planners. Moreover, the dual price system now established for state and nonstate enterprises has led predictably to the diversion of inputs and retail merchandise from the state enterprises and stores to the cooperatives and other nonstate modes of operation, where they are sold at the higher uncontrolled prices. 7 The apparent profitability of the new enterprises may thus derive, in part, from their ability to take advantage of administered price distortions rather than from superior economic performance. Second, while many of the rights of ownership have been effectively con­ ferred on the new enterprise managers, neither they nor those who employ them are able to derive any benefit, through sale, from the growth of enterprise value. Moreover, they still do not bear the risks of losses that would also attach to full private ownership. With the important exception of those cooperative enterprises that have been started with members' own resources, many enterprises under the

20 new modes of organization are starting with state-owned capital, for which they have paid little or nothing out of their own pockets, and which they have no right to sell. As a consequence, the managers of many of these enterprises appear focused on short-term gain, with relatively little attention being given to safeguarding and enhancing the long-term viability of the enterprise and the value of its assets. Indeed, their incentive may be to appropriate and decapitalize those assets. The appropriation of enterprise assets is taking place already, in essentially two ways. The first is the outright transfer of assets from the state to one of the new modes noted above. 8 The other occurs in cooperative units that remain within a larger state enterprise. Such cooperatives use state-owned equipment in their operations, for which the host enterprise typically charges a rent. Formally, the host enterprise provides inputs only for the output that it buys from the coopera­ tive. In fact, however, the cooperative may be using the capital stock (and some­ times variable inputs, too) free of charge to produce for sale or barter in the market. The proceeds of these extra sales are then paid out to the managers and workers in higher wages and salaries.9 Even enterprises that are still formally state-owned are subject to this process. In some cases, for example, several state enterprises have been converted to joint stock ownership, and then they have jointly established a bank which has pur­ chased the shares. Although the state remains the owner of all the enterprises in theory, it is unclear in practice who should or does supervise them. The practical result appears to be that power has been concentrated in the enterprise managers, who, at no cost to themselves, are able to use the enterprise assets to pursue their own economic goals, but who also have little or no incentive to protect and enhance the value of those assets. In short, the spontaneous de facto privatization of enterprises has already begun, but no personal interest is being created in the maintenance and enhance­ ment of enterprise assets. Moreover, the risks of ownership remain with the state. It is consequently urgent that a clear law of private property be put in place, providing owners with the right to buy and sell productive assets and guaranteeing them against arbitrary and uncompensated expropriation of their property rights and assets, while setting out in companion laws on contracts and bankruptcy the responsibilities and material risks that ownership in a market system also confers. Only in this way, along with thoroughg()ing price reform, can successful transition to the market be completed and individual decisions disciplined to correspond to the broader public interest in efficient market-responsive decisions at the enterprise level. There is also a political concern in the present process. In addition to the public's general perception of cooperative activity as profiteering, many resent what they see as the privileged access of certain individuals to the ownership rights being conferred on the managers of the new enterprise forms. It is widely

21 believed in the USSR that many of those acquiring economic power in the new enterprises, and in the process taking ownership of state assets, are members of the traditional Communist Party elite, the nomenklatura, who are exploiting their rank and insider information. Another line of popular belief is that many of the new entrepreneurs are essentially criminals, emerging from the underworld of black marketeers and speculators. This negative public image could generate a serious backlash and impede the transition to free markets. The process of privatization clearly needs to be normalized and made more transparent, with access open to all willing to risk their own resources in the process. d. The pros and cons of rapid privatization 10

The presidential guidelines advocate divestiture of the state's ownership rights over the nation's enterprises. They do not, however, set out a clear program or time frame for transforming enterprise ownership, and questions of speed and sequencing continue to be a matter of debate.

Early privatization, in particular, raises several problems. In the first place, it is difficult to estimate the value of enterprises, when relative prices are still unsettled, and their future prospects remain unclear. In any event, the value of the state's productive assets far exceeds the savings available in the private sector to pay for them. Even in the case of small enterprises, provision will be needed for buyers to pay in installments. Commercialization and privatization in the industrial sector is complicated further by the large and frequently indivisible nature of the assets involved, the high degrees of market concentration, oversizing of plants, and uneconomic vertical integration of production. Two possible consequences of rapid privatization, therefore, are that assets would be acquired at far below their actual values, providing a windfall to buyers, and/or that asset ownership might become concentrated in the hands of the few individuals who have the money or political connections to acquire it.

While receipts from the sale of state assets could help to reduce the monetary overhang and provide important revenues to the government during a period when fiscal consolidation is crucial, rapid privatization of larger enterprises might re­ quire some giveaway of the assets concerned. The resulting widely scattered ownership of individual enterprises, moreover, would be unlikely to result in effective monitoring and control of enterprise managers. It is further argued that persons or entities receiving ownership rights over productive assets at low cost to themselves might feel less of a stake in assuring the efficient use of those assets. Finally, the privatization of enterprises prior to their internal restructuring and the restructuring of the industries in which they operate would confer undesirable monopoly power and profits on some parties, while running the danger of saddling others with hopeless loss-makers.

22 On the other hand, while rapid privatization of shares in the larger enterprises might reduce cash proceeds to the state, it would also permit a wider distribution of assets seen as belonging to all the people. The problem of enterprise control could be reduced by first transferring the ownership of enterprises to property funds or holding companies, whose shares would then be distributed to the public. This is not very different from what is suggested for commercialized, but non­ privatized enterprises. The holding company, either directly or through a board of directors, would exercise ownership control over its enterprises. Moreover, the stake which most new asset owners would see in the future income streams and sales value of the assets could be more important than the purchase price of the assets in providing appropriate incentives. At the same time, the greater the share of the savings that new owners transferred to the government in exchange for the assets, the less they would have available to make the needed investments in enterprise restructuring and modernization, something they are likely to do more efficiently than the government.

The case for more gradual commercialization assumes that the performance of the state enterprises can be improved, or even maintained at their present levels, during the course of a slower transition. Given that poor enterprise performance has, to a considerable extent, been the result of undefined ownership, it is doubtful that such an assumption would hold. Until and unless interest in the efficient use and value of capital becomes imbedded in enterprise decision-making, the nation's capital stock will continue to be wasted and dissipated. By the same token, clear ownership and property rights must accompany rational prices to achieve the desired demonopolization and efficient restructuring of industry. It is argued below that enterprise managers, acting in response to market signals, can do a major part of the job of demonopolization more efficiently than would be done by officials in ministries. However, enterprise ownership must already have passed to persons or organizations that have stakes in the use of its assets. The rapid "spontaneous privatization" process that is already under way also points up the need for a quick regularization and completion of ownership reform.

The proposed middle stage of commercialization of state enterprises under the aegis of state property funds should offer a distinct improvement over the present ministerial control of enterprises. Efforts in other countries to place state enterprises under a hard budget constraint and to subject them to market discipline, however, have not always worked out well in practice. It has been found to be very difficult to insulate state enterprise management from political pressures and the noneconomic objectives of governments. Thus, it is recommended that the authorities consider an even more rapid privatization process than the various reform programs and the presidential guidelines have proposed.

23 e. The manner and terms of privatization

A mixed approach to privatization is recommended, which may vary by type of activity and size of enterprise, as well as according to the preferences of the different republics. Specifically, it is suggested that small enterprises be privatized rapidly through outright sale to individuals, cooperatives, or other bodies willing and able to acquire them and to accept the risks of entrepreneurial activity. The privatization of larger enterprises will necessarily take longer and could proceed along essentially two paths: (i) the direct sale or leasing of divisible product lines, stages of production, or service activities to individuals, cooperatives, etc.; and (ii) conversion into joint stock companies under the initial ownership of state property funds created for the purpose, with privatization proceeding through the market sale of shares to individuals, nonbank financial institutions, and other enterprises and organizations, either directly or through mutual funds. The sale of shares to banks should not, however, be encouraged both because equity invest­ ments, except in strictly limited amounts, represent greater risk than banks ought normally to take on, and because of the inherent conflict of interest that could lead banks to lend excessively to enterprises in which they hold an ownership interest.

(I) Direct sale

In the service sectors, the Government's proposal to sell assets through open and well publicized auctions is commendable and should proceed as quickly as possible. The idea that buyers should be allowed to make payment in installments to permit both rapid sale and a wide and equitable distribution of the assets is equally sensible. Particularly important will be the privatization of transportation, storage, and distribution services, where assets--e.g., trucks, warehouses, retail shops-are easily sold off one by one, and where the existing commercial mo­ nopolies can therefore be rapidly broken up. Sales proceeds would go to the Government and could be used to pay off any debts of the enterprises whose assets were sold, and to recapitalize the banks.

With respect to larger enterprises having multiple product lines, or whose production processes are divisible, the process of sale or leasing of discrete parts of enterprises that is already taking place should be further encouraged. The sellers or lessors could be either the newly formed joint stock companies or, in advance of the completion of conversion, existing state enterprises. Sale would be by open and well publicized auctions and would require a significant equity downpayment by the new owners, equivalent, say, to 15 percent or more of the purchase price, allowing them to finance the remainder with interest at normal terms.

24 (2) Leasing Monthly lease payments could also be established by auction or, alternative­ ly, made equal to an estimated straight-line depreciation of the value of the assets, plus a negotiated return to the lessor, and the life of a lease would be based on the expected life of the covered assets. While leases were in effect, the original assets would be held as collateral by the lessor. No new state or lessor investment would be made in the leased enterprise; any replacement or new investment would be the responsibility of, and would be owned by, the lessees, who would also be responsible for arranging its financing without state subsidy or guarantee. Lessees would be free to organize their enterprise as they see fit-joint stock company, cooperative, individual proprietorship, etc.-and to alter their product lines and methods of production. It should also be possible for lessees to sell lease contracts to other individuals or organizations, subject to antimonopoly laws and regulations. Otherwise, lease holders would lose their interest in protecting the value of the leased assets. At the end of a lease contract, if structured as suggested above, the value of the original assets would have been entirely depreciated, and any new assets would be fully owned by the lessee. Enterprises that became unprofitable, either during or after the life of the lease, whether because of mis­ management or changing market conditions, would be allowed to fail. To ensure against arbitrary and opportunistic behavior in the valuation of assets, it might be desirable to establish a review procedure for sales and leasing contracts, vested in an independent government agency answerable to the union or republican parliaments. To avoid undue delays in the privatization process, as has occurred in other countries undergoing similar reforms, the review should be limited to questionable cases. These could be brought to light by a requirement that all such arrangements be publicized in the newspapers, identifying the sellers and buyers, or lessors and lessees, the assets covered by the contracts, and the terms of the sale or lease.

(3) Commercialization Large enterprises with indivisible production processes, or otherwise not amenable to leasing, would operate as joint stock companies. Shares might be distributed and held in two ways. A large (but less than controlling) proportion of enterprise shares could be distributed free of charge (or at very low cost) to all Soviet citizens (or citizens within the jurisdictions of the governmental levels determined to hold ownership rights over the respective enterprises). 11 To assure equity, given the great uncertainty about share values at the beginning of the reform process, the distribution could take place either as shares in an asset pool­ in effect, a mutual fund-or as vouchers entitling the holder to later purchase of shares in the stock market. Such a distribution could serve to widen both the sense of individual participation in the reform and the ownership interest in improved enterprise performance.

25 A controlling interest in these shares of the large state enterprises would need to be held initially by state holding companies (state property funds) that were independent of the line agencies or regulatory authorities of government and charged with supervising the entities under their control as commercial, market­ oriented enterprises, and with husbanding the long -term value of their assets. Prior to the development of an active equities market, such concentration of control would continue to be necessary to ensure that managers respond to owners' in­ terests. Enterprises should be accorded no preferential treatment from the state by virtue of their public ownership. Moreover, to encourage competition, enterprises producing the same goods or close substitutes should not be owned by the same holding company. Dividends on shares held by the holding companies would flow to the state budget. To avoid owner/agent conflict of interest prior to the privatiza­ tion of share ownership and the creation of an efficient equities market, dividend payments could be specified in advance as a fixed percentage of after-tax profits. Over time, as financial savings and markets grow, state property funds would sell their shares to individual and institutional investors, including mutual funds, pension funds and insurance companies. Some shares could be transferred to national or republican pension funds to provide them with an initial capital base. Alternatively, or in addition to selling off holdings one by one, holding companies could, in effect, convert themselves into mutual funds, selling shares in their respective portfolios. An intention to do this should be written into their charters, including a statement of intentions regarding the period over which the assets would be sold or the holding company itself would be privatized. Another option, attractive for its absorption of part of the monetary overhang, might be the advance purchase of shares in the form of indexed government bonds, the proceeds of which could be used after 2-3 years to buy the shares of enterprises and/or mutual funds (Chapter 11.3).

(4) Other issues The presidential guidelines propose that priority in the buying of property and shares be given to labor collectives, and that their members be accorded various forms of financial assistance to help them become owners. The experience of labor-managed enterprises in other countries, however, has been disappointing. Workers in control of enterprises have tended to concentrate on the maximization of their own incomes with a relatively short-term time horizon, limiting the employment of new workers and decapitalizing the assets of the enterprise over time. It is recommended, therefore, that substantially less than a controlling ownership be distributed on a preferential basis to an enterprise's own workers, and that the shares be distributed to workers on an individual, rather than collec­ tive, basis. Workers would thus enjoy the same ownership rights as other

26 shareholders, including the right to sell their shares (as well as to acquire new shares) in the market. Another issue concerns the treatment of the debts of existing enterprises. Should these be assumed by the new owners? As a general principle, debts in excess of a firm's assets should be written down and not passed on as a burden to the new owners. 12 In the case of leased assets, the debt liability would remain (along with asset ownership) with the lessor, but the related debt service would be included in the lease payment. f. Imposing a hard budget constraint Enterprises, whatever their ownership, only respond to market signals and to the pressures of competition if the owners and managers are truly held responsible for the financial results of their decisions. Market discipline is obviously undercut when there is a "soft budget constraint", i.e., when losses are covered by transfers from other enterprises, the state budget, or automatic credits from the financial system. The imposition of a "hard budget constraint" means making enterprises financially independent of these sources of assured financing. Financial autonomy needs, of course, to be accompanied by managerial autonomy that permits enterprises to adjust to changing constraints and opportunities, i.e., to adjust prices, outputs, employment and other inputs in response to the signals given by the market. The importance of a hard budget constraint, in tum, highlights the urgency of rapidly eliminating existing price distortions. Otherwise, it could have the un­ desirable result of making many relatively efficient enterprises financially invi­ able, while encouraging the expansion of enterprises made profitable only by virtue of the distorted prices. The Government's intention, as outlined in the presidential guidelines and agreed in all the major reform proposals-to put a halt to budget subsidies to enterprises, to force the restructuring of enterprises that can thereby be made financially viable, and to liquidate chronic loss-makers-is commendable. Con­ sistent with this objective and equally worthy of support is the intended reform of the financial system, which is also to be put on a self-sustaining, commercial basis (see Chapter IV.5). Of concern in this regard, however, is the current ten­ dency of branch ministries and groups of enterprises to establish commercial and cooperative banks. If these are used as vehicles for relaxing the hard budget constraint on loss-making enterprises, it will jeopardize both enterprise reform and the soundness of the banking system. The guidelines correctly state that time will be required by many enterprises to adjust to the new economic conditions, and it is proposed to create union and republican stabilization funds, with independent administrations, to provide finan­ cial support of different kinds to properly evaluated and justified restructuring efforts. Such assistance can help avoid unnecessary declines in employment and

27 output, but there is also a risk that such special financing arrangements could channel resources to noneconomic and nonviable uses and become a substitute for, rather than a complement to, the needed restructuring. Consequently, these funds should be allocated according to rigorous economic criteria. Moreover, as the stabilization funds are to be financed from budgetary resources, macro­ economic stabilization objectives will limit the resources available for restructur­ ing programs. As 'indicated in the guidelines, foreign investors can play an important role in the restructuring of Soviet enterprises. They would only be willing to do so, however, under a regime of clear ownership rights, and would do so efficiently only in a context of rational prices. This is yet an additional reason why substantial price reform and commercialization should be among the first steps of the reform process. Finally, it is important that the imposition of hard budget constraints on enterprises be accompanied by the elimination of existing differentials in the tax treatment of enterprises in accordance with their size, branch, mode of organiza­ tion, or other factors. Competition in a market system should take place on as level a "playing field" as possible. The existing system of enterprise accounting will need to be revised to meet the requirements of a market economy. The publication of financial accounts, incorporating a proper valuation of assets and liabilities, should begin at an early stage in the transition. These should be audited (externally as well as internally) and should aim to present a full and fair view of the financial position of an enterprise or bank, for the information of shareholders, creditors and those entrusted with supervisory authority. Such accounts would also provide some of the information necessary to allow managers to evaluate performance and take key decisions, for instance on investment. The necessary changes to the present accounting regulations would be relatively straightforward. Western technical as­ sistance could, however, be of use here as well as in the training of accountants and auditors to implement the new system.

4. INDUSTRIAL RESTRUCTURING AND DEMONOPOLIZATION As noted earlier, production in most branches of Soviet industry is highly concentrated, with a large number of important products being produced by a single factory, and the production of other goods produced under cartel arrange­ ments centered in the industrial branch ministries. While convenient for central planning purposes, this tendency to huge scale and extreme concentration is in­ tolerable in a market economy. Thus, the emphasis given by the guidelines and other reform plans to the demonopolization of Soviet industry, as a prerequisite to efficient market operations, is fully warranted. To ensure that enterprise owners and managers are motivated to reduce costs, raise quality, and satisfy the needs of their customers, their freedom in a market

28 economy to make production decisions must be matched by buyers' freedom to choose among competing products and producers. The possibility of enterprise failure, if customers are not satisfied, places a firmer discipline on enterprise performance than the administrative commands of planners. Currently, however, the development of competition in the USSR is hampered by a myriad of laws and regulations that prevent the entry of new enterprises into the market, branch ministries that act to cartelize the enterprises under their authority, credit and input allocation systems that favor existing state enterprises, and by poor communica­ tions and transportation as well as by administrative trade barriers being set up between regions. If the transition to a market economy is to succeed, these barriers to competition must be dismantled, and the Government must act vigorously to encourage trade rather than to thwart it. a. Introduction and maintenance of competitive markets Governments in market economies have an important responsibility for promoting and protecting competitive market conditions, and the Soviet authorities should act quickly to introduce an effective framework of antimonopo­ ly laws and regulations along with the institutions to enforce them. Given the high degree of concentration and vertical integration of Soviet industry, the behavior of dominant enterprises must be strictly regulated to prevent them from impeding the emergence and growth of competing firms. Effective powers must be provided to the anti-monopoly agency to restructure the dominant firms where feasible. The agency's powers in this regard must apply to both private and state enterprises. Where competition already exists, the legal and regulatory framework should ensure the freedom of new enterprises to enter an industry, prevent collusion among enterprises, and discourage predatory behavior that might lead to the mo­ nopolization of an industry (see Chapter IV.7). Artificial barriers to entry, such as so-called profile restrictions, should be abolished to permit existing firms to seek out new opportunities wherever they may exist. The control of ministries over enterprise activity should be eliminated. In this regard, the current tendency, encouraged by some branch ministries and local governments, for enterprises to join in large associations and conglomerate "concerns," is a step in the wrong direction. There is a very delicate balance to be maintained between the legitimate freedom of association to formulate and defend group interests and the carteliza­ tion and exertion of economic power to the detriment of competition and the public. Interregional trade barriers, such as have recently been imposed by some republican and local governments, must also be avoided; and the various enterprise forms should be put on an equal footing in all aspects of government regulation, taxation, and access to public services. The investigative and enforcement powers of the antimonopoly agency, as expressed in the existing draft legislation, need to be substantially strengthened. To this end, the possibility of substantial fines and criminal penalties should be

29 added for both failure to cooperate with investigations and substantive violations. Given the complex economic analysis required to identify many practices as an­ ticompetitive, it is advisable that a specialized competition tribunal be established to hear private actions or appeals from agency decisions, rather than the normal court or arbitrazh systems (see Chapter IV.7). One major barrier to the entry of new industrial enterprises is the highly monopolized state supply system. As indicated above, the breakup and privatiza­ tion of wholesale trade should be among the first priorities of economic reform. The establishment of a market for lease rights, permitting their ready purchase and sale between private parties, would also greatly facilitate freedom of entry and exit. The continuing desire of many local governments to maintain control over property leases runs counter to this requirement. 13 Finally, a bankruptcy law is needed to provide for orderly restructuring or liquidation of failing enterprises in a way that provides transparent and reliable protection of the interests of owners and creditors.

b. Industrial restructuring

Some Soviet industries-such as steel and petrochemicals-appear sig­ nificantly oversized, and the demand for their output at appropriate relative prices is likely to be far below present capacities (perhaps by as much as 50 percent). Such situations, on top of inefficient organization and backward and highly capi­ tal-intensive technologies, present special problems for privatization. In these cases, a more managed approach may be required, in which plans.are formulated for the overall restructuring and modernization of the industry-including the elimination of excess capacity, phasing of import liberalization, writing-off of assets and the retraining of workers-prior to the commercialization and privatiza­ tion of the surviving assets.

In the course of reform efforts over the past several years, the Soviet authorities have expressed growing concern about the composition of industrial output, noting particularly the historical emphasis on heavy industry at the expense of consumer goods, and adopting the more recent objective of converting defense industries to non-military uses. Enterprises in the defense complex have been increasingly pushed through administrative measures into the production of con­ sumer goods, usually alongside their normal operations, even though the two manufacturing processes may bear little ·relation to one another and offer no economies in the use of plant and equipment. It is virtually impossible to judge, however, what underlying comparative advantages the Soviet economy might enjoy in the industrial sector until domestic prices have been freed and a beginning is made to integrate it into the world economy.

30 c. Market forces for demonopolization and restructuring Various state interventions notwithstanding, most industrial restructuring and demonopolization could occur in large measure as an outcome of the market process itself, rather than as an administered prerequisite to the introduction of market forces or the reform of ownership. Enterprise owners disciplined by market forces are generally in the best position to determine which lines of activity to shed and which to expand. The market itself can thus provide the pressures to eliminate inefficient vertical integration of production. It can also guide the ex­ pansion of consumer goods production, including, where efficient, the conversion of defense-related enterprises. The removal of quantitative restrictions on imports, coupled with reasonable tariff levels, would put an effective ceiling on the ability of domestic enterprises, even where there is only one, to raise prices on tradable goods. This ceiling would be lowered as tariffs were reduced over time (see Chapter IV.3). Nevertheless, enterprises enjoying monopoly power could, as prices are freed, and to the limits set by import competition, be expected to exploit that power by raising their prices. Moreover, the pricing of nontradeable goods would not, by definition, be limited by competition from abroad. There would thus be a period in which monopolistic enterprises succeeded in garnering abnormally high profits. But it is precisely those higher profits which, in a market economy, would attract new entrants and provide the desired competition. Thus, in activities where new entry becomes relatively easy, demonopolization could be expected to take place over time as a result of market forces. In contrast, price controls and taxation of "excess profits" would discourage market entry. Consequently, by seeking to limit the benefits to the monopolist, such an approach might serve to perpetuate the monopoly. 14 On the other hand, it must be acknowledged that, with the predominance of monopoly or oligopoly on both sides of most Soviet markets, and the absence of a commercial tradition, the lag in market response to opening opportunities might be considerably slower than in established market economies. Foreign investment could help in this respect.

5. THE MANAGEMENT OF STATE-OWNED ENTERPRISES

The establishment of financial discipline through imposition of a hard budget constraint is an essential first step in improving the management of state enterprises. At the same time, a central factor in the poor performance of Soviet state enterprises has been the absence of any stake, on the part of those making the fundamental decisions regarding the enterprises' activities and policies, in the efficient use and future value of their capital assets. Once enterprises are converted into joint stock companies, the authorities will still have to face the question of how the need to represent the interests of owners in the assets of the enterprise is

31 to be instilled into the public holders of enterprise shares and the enterprise managers that they employ. The state property funds set up to hold and manage state shares in the enterprises not yet fully privatized must be charged with representing owner in­ terests. The Government should clearly declare in this regard that the basic ob­ jective of these holding companies is to promote the current and long-term profitability of the enterprises under their control, subject to the discipline of competitive markets. The holding companies should not be able to cross-subsidize some enterprises with the profits of others or otherwise relax the hard budget constraints on any enterprises. Nor should they have the ability to prevent the entry or exit of enterprises, or to tilt public policies and the enforcement of regula­ tions to give their enterprises a competitive advantage over others. While the management of the holding companies would make clear that the primary objec­ tives of their enterprises were to maximize productive efficiency and profitability, consistent with protecting the value of enterprise assets, and would monitor and assess enterprise performance in this regard, they should not interfere in their daily management. 15 In the interest of limiting owner losses, the holding companies would also see to the restructuring of enterprises, where this was desirable, the liquidation of chronic loss-makers in their portfolios and to the auctioning of remaining assets.

Given the complexity of supervising the act1v1t1es of large numbers of enterprises in different sectors, it would be expected that the holding companies would exert their ownership rights through boards of directors. Board members would be appointed and held responsible for their performance by the holding companies. The composition of the boards should include technical experts in the fields of the enterprise's activity as well as legal and financial experts. The boards would be directly responsible for setting enterprise policies, monitoring perfor­ mance, and hiring, evaluating, rewarding, and, as necessary, dismissing enterprise managers. Enterprise managers, operating under the policies set by their respective boards of directors, would have full responsibility for the management of the enterprise, including the power to determine the organization of production; to set the offer price, quantity, and composition of output; to hire, reward, and dismiss workers; and to manage the enterprise's finances.

Implicit in this reorganization of enterprise ownership, control, and manage­ ment is a dramatic change in the roles and responsibilities of the existing branch ministries. Indeed, it is expected that most of these ministries would disappear, as some already have. One possibility would be to consolidate them into a single Ministry of Industry, whose functions would include the formulation and monitor­ ing of the government's overall industrial policies and study of sectoral policy issues. It would not become involved, however, in the control or management of enterprises.

32 6. THE TRAINING OF ENTERPRISE MANAGERS The shortage of trained and experienced managers is likely to be one of the most serious bottlenecks to rapid improvement in enterprise performance. Many higher-level enterprise personnel are production engineers and technicians, who tend to be more familiar with production processes and design than with their enterprise's finances or the needs of its customers. Financial directors of state enterprises typically know the details of enterprise balance sheets but little of the performance analysis and cash and risk management techniques required of managers of market-based enterprises. Individual managers vary widely in their willingness to take initiative in the uncertain and rapidly evolving Soviet environ­ ment, partly, it seems, depending on the signals being received from their respec­ tive ministries. A large number of training programs of varying quality have sprung up in recent years in the USSR, ranging from short courses on how to attract joint venture partners to full management curricula, including marketing, advertising, cost control, quality control, and other elements of management long removed from the principal concerns of Soviet enterprise managers. Some of these programs are being carried out in collaboration with foreign educational institu­ tions. Such contacts should be encouraged and expanded. Thus far, however, these programs appear to be aimed primarily at top managers-chief executive officers and their closest deputies. Enormous needs at the middle and lower managerial ranks remain largely untreated. Most of this training will have to be provided, as in Western enterprises, within the enterprise itself. Training and orientation to their new roles will also be needed by the many individuals who will be expected to sit on enterprise boards of directors. Management training obviously offers one useful focus of external assis­ tance. Programs now under way in several East European countries might offer useful examples of how to attract and achieve maximum benefits from such as­ sistance. The authorities might also consider, on a pilot basis, the use of fixed-term management contracts, under which experienced foreign managers (perhaps retired from Western firms) could be brought in to reorient the operations of selected enterprises and to train their successors.

NOTES

I. As discussed in Chapters II.2 and IV.!, enterprises also deal with the insecurity of supply through widespread barter transactions and by hoarding of inventories. 2. Thus, wages and salaries rose an estimated 12 percent in 1990, despite falling industrial output. 3. This compares to under 14,000 cooperative enterprises, employing 156,000 workers in 1987. Of the 5.2 million persons employed by cooperatives in 1990, approximately 65 percent were· cooperative members, and the remaining 35 percent were hired employees.

33 4. It is not clear whether this difference is real or simply a statistical result of the reclassification of economic entities. Other sources report that some 12,500 leasing arrangements have thus far been officially registered. 5. For example, cooperatives were prohibited from wholesale trade, natural resource exploitation, and the sale of medical supplies and works of art. 6. One example, a manufacturer of gears and reducers, was converted to operation under a leasing arrangement in order to avoid closure because of the poor quality of its output. The firm was also making substantial financial losses at the time of its conversion. Under the new arrange­ ment, the labor force continued at the same level, but the number of managers was cut by 25 percent. The firm achieved a 50 percent improvement in productivity (in physical terms) during the first year. While output prices remained the same, the enterprise succeeded in negotiating lower prices from suppliers. Now profitable, the enterprise has sold off some of its older equipment, raised wages, and is investing in new equipment. According to present plans, by the end of the lease period (12 years), the firm will have re-equipped its entire plant. The managers intend eventually to convert the firm into a joint stock enterprise and to privatize it formally. 7. Under present regulations, cooperatives and other enterprises outside the state supply system are supposed to pay market prices for their inputs too, but it is widely reported that illegal diversion frequently takes place. With prices in the market often several multiples of state­ controlled prices, such diversions are inevitable. 8. In one case, an enterprise was allowed to lease the assets of the enterprise and, through equity investments and technical assistance, build an association of enterprises, many of which resulted from other leasing arrangements or employee buyouts of state enterprises and their conversion to cooperative form. The central holding company derives a substantial income flow from these enterprises. As of August 1990, the association encompassed numerous enterprises of various forms in activities as diverse as banking, construction machinery, transport, tourism, and publishing. The terms on which the associated enterprises had acquired their assets from the state were unclear; they apparently brought no outstanding debt with them. Also unclear was the legal status of the original mother enterprise and the residual claim, if any, of the state on its assets. 9. One enterprise, formerly producing consumer goods as a small unit in a larger state enterprise, was converted into a cooperative, using space and equipment leased from the parent company. Based on its success, the entire plant is now being divided up into a family of cooperatives and small enterprises with only an association at headquarters continuing to function formally as a state enterprise. In this way, the individual production units are able to escape from wage controls and other bureaucratic interventions, while the association as a whole retains its access to the state supply system and to long-term credit. 10. The present chapter examines the privatization of industrial enterprises. Questions related to the privatization of housing and agriculture are discussed in Chapters V.9 and V.5, respectively. II. Free distribution is consistent with the proposition that state enterprise assets are owned by all the people, on behalf of which the government acts as agent. A small proportion of each enterprise's shares could be distributed preferentially to workers in the enterprise. 12. Implications of this debt write down for the financial sector are discussed in Chapter IV.5. As suggested above, part of the proceeds of the sale of government assets could be used to recapitalize the banking system. To stretch out the impact on the state budget, the government

34 could take over the service of part of the enterprise debt (at the new, higher level of interest rates) rather than writing it off. 13. Governments do have a responsibility to regulate the location and nature of industrial activities for a variety of public purposes, such as preservation of the environment and avoidance of public health hazards. Thus, all market economies impose zoning restrictions, health regula­ tions, etc. Where possible, however, these are best done through general laws and regulations with penalties on offenders, rather than through the detailed ex ante review of all proposals, giving arbitrary authority to government agencies to delay and stop property transfers. 14. High profitability may also be the initial result of and reward for introducing a new product or method of production. The proposed tax on monopoly profits, if it wrongly identifies the sources of unusual profits, could thus weaken the incentive for innovation. 15. As indicated in the presidential guidelines, the social responsibilities of enterprises would be progressively shifted to the Government at its various levels. To the extent th~t state enterprises continue to be charged with the execution of social programs, these should be paid for from the government budget rather than the after-tax profits of the enterprises.

35 Table IV.2.1. USSR: Number of Industrial Enterprises by Sector, 1970-87

1970 1980 1985 1987

Electric power ...... 1,569 1,431 1,434 1,424 Fuel industry ...... 1,453 1,135 1,186 1,179 Metallurgy ...... 619 674 705 711 Machine building ...... 8,046 8,906 9,346 9,238 Chemistry & petrochemistry ...... 1,107 1,043 1,079 1,072 Timber, woodworking, pulp and paper industries .. 6,568 5,330 5,457 5,547 Construction materials industry ...... 4,755 3,905 3,940 4,336 Light industry ...... 8,727 7,972 7,889 7,960 Food industry ...... 10,649 8,186 8,790 9,554 All industry ...... 49,383 44,172 45,691 46,840

Source: Goskomstat.

Table IV .2.2. USSR: Average Size of Industrial Enterprises, 1970-87 (Number of employees)

Branches 1970 1980 1987

Electric power ...... 408 531 604 Fuel industry ...... 1,047 1,427 1,476 Metallurgy ...... 3,231 3,264 3,094 Machine building ...... 1,491 1,752 1,796 Chemistry & petrochemistry ...... 1,418 1,850 1,856 Timber, woodworking, pulp and paper industries ...... 429 563 489 Construction materials industry ...... 421 563 530 Light industry ...... 573 652 641 Food industry ...... 263 366 314 All industry ...... 640 835 813

Source: Capelik (1990).

36 Table IV.2.3. USSR: Size Distribution oflndustrial Enterprises as of January I, 1988

Size Brackets Number of Share of Share of (Number of Number of Employees Enterprises Employees employees) Enterprises (Thousands) (Percent) (Percent)

Total 43,320 34,319 100.0 100.0 Up to 100 ...... 11,821 607 27.3 1.8 101-200 ...... 8,331 1,216 19.2 3.5 201-500 ...... 10,300 3,325 23.8 9.7 501-1,000 ...... 5,690 4,011 13.1 11.7 Over 1,000 ...... 7,178 25,160 16.6 73.3 Of which: 1,001-5,000 ...... 5,991 12,410 13.8 36.2 5,001-10,000 ...... 771 5,350 1.8 15.6 10,001-20,000 ...... 309 3,933 0.7 11.4 Over 20,000 ...... 107 3,468 0.2 10.1

Source: Goskomstat.

Table IV.2.4. USSR: Size Distribution of Employment in Industrial Enterprises, Selected Sectors, 1987

Up to 100 101-500 501-1,000 1,001-10,000 Over 10,000 Industries Employees Employees Employees Employees Employees Total

(Thousands of employees) Ferrous metallurgy ...... 0.8 35.5 29.3 543.9 839.5 1,448.9 Nonferrous metallurgy ...... 0.5 15.9 27.0 525.1 176.2 744.7 Chemical ...... 2.5 62.8 83.2 1,056.0 192.9 1,397.4 Petrochemical ...... 1.3 18.7 25.3 310.7 92.3 448.4 Motorcar and bearing ...... 0.4 18.4 32.4 504.3 739.0 1,294.4 Cement ...... 1.9 19.2 83.8 I 104.9

(Percentage) Ferrous metallurgy ...... 2.4 2.0 37.4 58.2 100.0 Nonferrous metallurgy ...... 0.1 2.1 3.6 70.6 23.6 100.0 Chemical ...... 0.2 4.5 5.9 75.6 13.8 100.0 Petrochemical ...... 0.3 4.2 5.7 69.2 20.6 100.0 Motorcar and bearing ...... 1.5 2.5 39.0 57.0 100.0 Cement ...... 1.8 18.3 79.9 I 100.0

Source: Goskomstat. I. Enterprises up to 5,000 employees.

37 Table IV.2.5. USSR: Distribution of Industrial Enterprises: Selected Sectors, 1987

Up to 100 101-500 501-1,000 1,001-10,000 Over 10,000 Industries Employees Employees Employees Employees Employees Total

(Number of enterprises) Ferrous metallurgy ...... 11 131 43 lSI 42 378 Nonferrous metallurgy ...... 8 59 36 162 11 276 Chemical ...... 38 247 115 288 IS 703 Petrochemical ...... 16 71 35 89 7 218 Motorcar and bearing ...... 7 59 44 136 22 268 Cement ...... 8 25 49 1 82

(Percentage) Ferrous metallurgy ...... 2.9 34.6 11.4 40.0 11.1 100.0 Nonferrous metallurgy ...... 2.9 21.4 13.0 58.7 4.0 100.0 Chemical ...... 5.5 34.9 16.4 41.1 2.1 100.0 Petrochemical ...... 7.4 32.5 16.0 40.9 3.2 100.0 Motorcar and bearing ...... 2.6 22.0 16.4 50.8 8.2 100.0 Cement ...... 9.8 30.5 59.7 I 100.0

Source: Goskomstat. 1. Enterprises up to 5,000 employees.

38 Table IV-2.6. USSR: Distribution of Industrial Product Groups by Output Share of Largest Producer, 1988

Share of Product Groups included in Bracket Number of Product Groups Branches 100-75% 75-50% 50-0% in Branch

Power machines ...... 64.7 14.7 20.6 34 Railroad machines ...... 23.0 46.2 30.8 13 Lifting-transport machines ...... 18.1 18.2 63.7 22 Oil & chemical machines ...... 12.4 18.8 68.8 16 Construction & roadbuilding machines ...... 16.7 58.3 25.0 12 Metallurgical equipment ...... 23.5 35.3 41.2 17 Sledge-press machines ...... 65.8 23.7 10.5 38 Motor cars & bearings ...... 22.7 22.7 54.6 22 Tractors & agricultural machines ...... 60.5 15.8 23.7 38 Machines for livestock farming and fodder crops ...... 63.3 16.7 20.0 30 Electrotechnology ...... 30.3 51.5 18.2 21 Ferrous metallurgy ...... 30.3 51.5 18.2 21 Chemistry and timber industry ...... 6.5 6.5 87.0 31 Consumer goods ...... 23.5 29.4 47.1 17 In all branches ...... 36.6 24.1 39.2 344

Source: Calculations from Capelik ( 1990), based on Goskomstat data.

Table IV -2. 7. USSR: Concentration of Deliveries to State Supply Agency by Product Group, 1988

Production of Products in Bracket (in percent of total) Bracket (No. of Machine Chemical & For social producers) building Metallurgy wood Construction sphere

I ••••••• 0 ••••••••••••••••••••• 87.0 27.9 46.7 30.0 44.9 2-3 ...... 7.8 28.4 27.6 28.9 20.7 4-6 ...... 2.7 20.7 13.1 12.2 12.9 7-10 ...... 1.0 9.6 5.1 17.8 9.0 11-20 ...... 0.7 7.2 4.3 5.6 8.6 21- ...... 0.8 6.2 3.2 5.5 3.9 Total ...... 100.0 100.0 100.0 100.0 100.0

Sources: Calculations from Capelik ( 1990), based on Gossnab data.

39 Table IV -2.8. USSR: Share of Largest Producers in Output of Selected Products, 1988

Percent of Total Product Producer Production

Consumer goods Sewing machines Shveinaia Association Podolsk 100 Automatic washing machines Electrobytpribor Factory, Kirov 90 Transport Trolley buses Uritsky Factory, Engels 97 Forklift trucks Autopogruzhchik Association, Kharkov 87 Diesel locomotives Industrial Association, Voroshilovgrad 95 Electric locomotives and trains Electric Locomotive Plant, Novocherkassk 70 Tram rails Integrated Steel Works, Kuznetsk 100 Metals Reinforced steel Krivoi-Rog-stal, Krivoi Rog 55 Construction equipment Concrete mixers Integrated Mill, Tuva Works 93 Road-building cranes Sverdlovsk Plant, Sverdlovsk 75 Locomotive cranes Engineering Plant, Kirov 100 Oil, chemicals and chemical engineering Polypropylene Neftkhimichesky Combine, Perm 73 Deep-oil-well sucker rods Ochesk Engineering Plant, Ochesk 87 Sucker-rod pumps Dzherzhinsky Engineering Plant, Baku 100 Hosts for coal mines City Coal Machinery Plant, Donetsk 100 Coking equipment Kopeisk Engineering Plant, Chelyabinsk 100 Power engineering Hydraulic turbines Metallurgical Works, Leningrad; Turbines Plant, Kharkov; Pipe Building Factory, Syzran 100 Steam turbines Metallurgical Works, Leningrad; Turbines Plant, Kharkov; Turbo-Motor Plant, Sverdlovsk 95 Metals Electrolytic tin plate Magnitogorsk & Karaganda 100 Rolled stainless-steel Pipe factors, Nikopol and Pervouralsk 96 Consumer goods Color-photography paper Positive Film, Leningrad and Positive Film, Pereslavl 100 Freezers Freezers Association and Plants, Kishinev and Krasnoyarsk 100

Source: The Economist, August II, 1990, p. 67.

40 Chapter IV.3

External Trade Reform

1. INTRODUCTION

The establishment of a well-functioning market economy entails the opening up of the economy to international trade and investment and its integration into the world trading system. Indeed, since 1986 efforts have been made in the USSR to introduce elements of flexibility into what had been a rigidly administered foreign trade system. Earlier it had been dominated by planning traditions that identified "essential imports" as those needed to balance shortfalls of domestic production relative to planned demand, and viewed exports as what can be spared from domestic needs in order to pay for imports. More weight is now given to the potential benefits to be reaped from encouraging trade per se, particularly as regards the potential efficiency gains to Soviet enterprises from closer contact with world markets. In part as a result of initial liberalizing moves, but also and perhaps more profoundly because of the general breakdown of the central planning mechanisms, a critical point has been reached in the process of trade liberalization. It is no longer practicable to go back to a system of centralized management of foreign trade, but the institutions and arrangements that are necessary to underpin a market-based evolution of trade are not yet in place. This "halfway house" is unsatisfactory, and indeed recent trade performance has been poor. Against this background, current Soviet intentions with regard to further trade reform appear to be relatively cautious: the presidential guidelines adopted in October 1990 foresee that foreign trade will continue to be managed to a considerable extent (at least in what are perceived as "essential sectors") during the transition. The purpose of this chapter is to evaluate the pros and cons of this somewhat conservative approach, and to consider what further or additional steps in the trade field might usefully be taken in the coming year or two to enhance the contribution that foreign trade might make to overall Soviet economic performance. Section 2 describes and evaluates the present Soviet trade regime, trade performance and

41 reform efforts to date. Section 3 analyses a number of key issues relevant to further reform. Finally, Section 4 summarizes the principal recommendations.

2. FEATURES OF THE TRADE REGIME AND RECENT REFORMS In 1986, the USSR initiated the process of reforming the administrative and regulatory framework governing foreign economic relations. Although the initial reforms pre-dated the economy wide reforms introduced in 1987-88, they were motivated by similar concerns: the deterioration in economic performance-partly stemming from the "unfavorable" structure of foreign trade-and the lack of responsiveness and accountability on the part of state enterprises. Subsequently, measures were taken to decentralize trading rights, increase the autonomy and accountability of enterprises, and introduce export incentives. These were impor­ tant first steps, but their implementation was incomplete, and their effectiveness was undermined to some extent by the continuing dominant role of the state and pervasive domestic price controls. As a consequence, the trade regime continues to suffer from the rigidities imposed by the administered economy. a. Institutional framework and the structure of foreign trade 1 (1) Historical background Before 1986, foreign transactions of the USSR were tightly controlled through the central plan and the foreign currency budget. The principal institutions involved in foreign economic activity were the Ministry of Foreign Trade and its foreign trade organizations (FTOs), the State Committee on Economic Coopera­ tion, the Ministry of Sea Transport, the Ministry of Passenger Aviation, and the Vneshekonombank (VEB). Inputs to the draft trade plan were prepared by the Ministry of Foreign Trade on the basis of a consolidation of the foreign currency budgets of ministries and departments (analogous to the balance of payments). Domestic resources were mobilized to achieve the planned levels of output in each sector, and shortfalls in production relative to projected domestic consumption were covered by imports. Exports were principally regarded as just the means of financing imports, although other considerations, including political objectives, were of course also present at times. Foreign exchange earnings were surrendered to the VEB and allocated for imports according to the established foreign currency budget. In case of deviation from the plan, the overall balance of payments was controlled through administrative means. Thus, for example, a decline in export receipts would be offset by cutting back on imports, to the extent it was necessary to remain within target levels for external debt. The Ministry of Foreign Trade maintained a monopoly on foreign trade. Actual transactions were conducted by some 30 foreign trade organizations (FTOs), organized rigidly along product lines, which were mainly under its direct

42 control. Planned imports and exports were channelled through these organizations: goods to meet export targets were delivered to them by enterprises on the basis of the plan; and enterprises with import needs allowed for in the plan obtained these imports through the relevant FfOs. Domestic producers thus had no direct contact with foreign enterprises either as suppliers or customers. Transactions between domestic enterprises and FfOs were based on domestic prices. The finan­ cial consequences of differences between domestic prices and prices expressed in valuta rubles (foreign currency prices converted at the official exchange rate) on external transactions were reflected on the books of the FfOs and absorbed by the state budget through a system of taxes and subsidies (so-called price equaliza­ tion). The effect of these institutional arrangements was to isolate the domestic economy from the foreign sector and to neutralize the effects of differences be­ tween domestic and foreign prices on decisions of economic agents regarding investment, production, and consumption. While the USSR has been among the top ten trading countries of the world for the past decade, external trade has played a subsidiary role in economic development. The growth strategy stressed rapid capital deepening achieved by constraining consumption and striving for increasing rates of investment. Trade was inward oriented with the emphasis on obtaining the imports required to fill domestic supply gaps. The bias toward capital accumulation and self sufficiency led to the rapid exploitation of abundant natural resources as a means of obtaining the foreign exchange to finance imports of capital and intermediate goods. This tendency was reinforced by the isolation of Soviet industry from external com­ petition and technological advances abroad, which perpetuated domestic price distortions. As a consequence of these policies, forces of comparative advantage had only a limited role in shaping the structure of production. Rather, a high degree of self-sufficiency was achieved at the cost of lower efficiency of resource use and reduced technological progress.

(2) Trade arrangements In recent years, approximately 70 percent of trade has been conducted on the basis of clearing arrangements, covering governmental agreements with countries belonging to the Council for Mutual Economic Assistance (CMEA), but also with Finland, Yugoslavia, and some developing countries, in particular India. Barter arrangements and other forms of nonconvertible trade account for an ad­ ditional 5 percent or so of total trade. The remaining part of Soviet trade­ primarily trade with developed countries (about 20 percent), but also a portion of trade with developing countries-is conducted in convertible currencies and based on multilateral settlement. Despite some increases in recent years in direct trading by enterprises, state orders continue to be dominant in the conduct of Soviet trade with all regions. Gosplan and Gossnab establish requirements for state orders on the basis of in-

43 tergovemmental contracts and other obligations, and these are placed with firms on terms that are generally attractive to them, including guaranteed inputs, and guaranteed output prices. Historically, trade with the CMEA countries has accounted for over half of Soviet exports and imports measured on the basis of the official exchange rate. The importance of trade with the CMEA region developed after World War II, when the CMEA was established in part as a Soviet response to the Marshall Plan. In theory, the CMEA was designed to encourage regional specialization and the division of labor in order to achieve economies of scale. In practice, an artificial interdependence was developed under state direction and there was often duplica­ tion of production structures in many branches, rather than specialization. Regional interdependence was further intensified as a result of the Cold War, various restraints imposed by the West on trade and the transfer of technology, and the lack of currency convertibility. Central planning was the guiding principle underlying trading relationships between the USSR and other CMEA countries. Trade between CMEA countries was organized within the framework of five-year plans, the last of which covered the period 1986-1990. To deal with intervening changes in prices and other fac­ tors, detailed annual trade protocols were prepared with each trading partner to ensure that trade continued to be balanced bilaterally. These protocols served as the basis for concluding contracts between FfOs, individual enterprises, and firms, which were responsible for fulfilling the terms of contractual obligations. After the mid-1980s, the medium-term plans rapidly lost relevance and were of­ ficially abandoned in 1989, while the annual protocols continued. Another crucial feature of the CMEA trading arrangements has been the bilateral negotiation of trade prices. In principle, prices are set annually based on price developments in world markets in the five-year period preceding the year of delivery (the Moscow formula). In practice, this rule generates unambiguous prices for only a few homogeneous raw materials and intermediate goods for which prices in world markets are well established; for all other goods the rule can at best define starting positions for bargaining. Because of the lack of infor­ mation on world market prices for manufactured products comparable to those produced by CMEA countries, there is substantial scope for negotiation. This process has led to a systematic overvaluation of manufactured goods relative to raw materials and standard intermediate products. With the USSR a net exporter of the latter goods, and a net importer of the former, it has in effect been sub­ sidizing its CMEA partners through this channel. There are methodological dif­ ficulties in quantifying the extent of this subsidy: estimates have ranged from about US$6 billion to US$14 billion based on 1989 trade flows and world prices. 2 CMEA trade transactions are denominated in a common accounting curren­ cy, the transferable ruble (TR), with accounts kept at the International Bank for Economic Cooperation (IBEC). Surpluses remaining in accounts vis-a-vis one

44 trading partner cannot be used to settle deficits vis-a-vis other partners, so that CMEA trade is essentially nonconvertible and bilateral in character. Since un­ planned surpluses cannot be readily used in the absence of convertibility, export quotas are an essential tool, managed so as to avoid as much as possible "involun­ tary trade credits" which amount to a waste of the exporting country's resources. In January 1990 at a meeting of the CMEA Council members, it was agreed that beginning January 1, 1991, CMEA trade would be conducted on the basis of world IJlarket prices with settlement in convertible currencies. Formally, the pre­ vious rules and the existing bilateral agreements were still in force for 1990; however, with the acute balance of payments problems faced by most member countries and the absence of an effective enforcement mechanism, contracts were frequently not fulfilled as agreed. Trade with non-CMEA countries governed by bilateral trade agreements ac­ counted for 12 percent of total Soviet trade (exports plus imports) in 1989. These government-to-government agreements are negotiated individually and contain some country specific features: in general, the protocols define the quantity and quality of goods exchanged between each pair of countries and their prices. In most respects, trade is conducted in a manner similar to CMEA trade; differences arise mainly in the provisions for settling imbalances. The phase-out of these agreements is likely to differ from country to country. Bilateral arrangements with India, and possibly a few others, are expected to continue, while those with China, Yugoslavia, and Finland are expected to move to a convertible currency basis in 1991. About one quarter of trade is with the convertible currency area, comprising mainly trade with developed countries. On the export side, this trade is heavily concentrated, on the export side, in fuels, minerals and some other raw materials. On the import side, the pattern is more diversified, though typically with a high share of agricultural imports. Overall targets for trade with the convertible cur­ rency area are established in the plan. For raw materials, food, and energy products, trade is normally carried out on a cash basis with settlement in 30 days. For machinery and equipment imports, bank credits and supplier credits have been extensively used, though a specific license is required to take up such credits. b. Restructuring foreign trade relations: 1986-1990 In 1986, the Soviet authorities took steps to break up the Ministry of Foreign Trade's monopoly on Soviet trade and to introduce incentives for export growth and diversification. The stated aims of the reforms were to encourage greater contact of branch ministries and enterprises with their counterparts in other countries, to promote the exports of manufactures, and to improve the quality and sophistication of Soviet exports. Another important objective was to pave the way for the eventual integration of the Soviet economy into the multilateral trading

45 system. Results thus far have been generally disappointing, perhaps indicating that partial reforms are of only limited value if they do not substantially alter the basic incentive structure.

(1) Institutional reforms The reforms initiated in 1986 involved a reorganization of the administrative structure and a decentralization of trading rights. The State Foreign Economic Commission (GVK), a permanent body of the Council of Ministers, was estab­ lished to oversee all activities related to the foreign sector. It was given the respon­ sibility for strategic foreign economic planning and for overseeing the activities of the Ministry of Foreign Trade (MFT) and other ministries and organizations engaged in foreign economic activities. With the decentralization of trading rights (see below), part of the trading activities of the MFT were divested and its opera­ tions were consolidated. In 1988, the functions of the MFT and many of those of the GVK were combined under the newly created Ministry of Foreign Economic Relations (MVES). Under this reorganization, the MVES retained jurisdiction over 25 FfOs which traded in raw materials, foodstuffs, individual types of machinery and equipment, and other commodities. These FTOs presently account for about 70 percent of Soviet exports and roughly half of total imports. Most machinery imports and about one third of machinery exports continue to be handled by FfOs under the jurisdiction of the MVES. The decentralization of trading rights initiated in 1986 principally affected the civilian manufacturing sector. At that time, a significant part of the trade in manufactures handled by the MFT was placed under the jurisdiction of the spe­ cialized branch ministries, and trading rights were extended to about 20 economic ministries and some 70 associations and enterprises. The aim was to shift from a system of centralized control to one of indirect control based on the economic autonomy of enterprises and their associations; the principles of cost accounting, self-support, and self-financing were stressed. In early 1989, trading rights were further liberalized to permit any firm or enterprise to engage in foreign trade once it has registered with the MVES, which has branch offices throughout the USSR for this purpose. By 1990, more that 20,000 organizations had registered. Enterprises have the right to export their own products or to import for their own needs; however, they are not generally permitted to purchase imports or domestic products for resale. These restrictions are judged necessary because con­ trolled domestic prices create significant opportunities for arbitrage. While enterprises can engage in trade directly, in practice most enterprises work through trade organizations. These organizations are allowed to intermediate trade by vir­ tue of their charters, and they operate on a commission basis. Enterprises are free to choose the trading organizations they deal with, or to form their own trading

46 associations; however, competition is limited in practice because there is normally just one, or a few trading organizations that handle specific product lines.

(2) The incentive structure An important aspect of the reform effort was to introduce incentives for exports. The previous system, whereby trade was effectively transacted at fixed domestic wholesale prices and the exchange rate served only an accounting role, was changed in 1987, and a foreign exchange retention scheme was introduced in the same year. With the decentralization of trading rights and the ability of enterprises to deal directly with foreign trade partners, it was no longer practical to conduct trade based on fixed domestic wholesale prices. A system of differen­ tiated foreign currency coefficients (DVKs) to provide a more flexible linkage between world prices and domestic prices for traded goods was established in 1987. On the export side, the system covered 100 percent of machinery and varying proportions of other manufactures; raw materials (about 70 percent of exports) were excluded. Only a few import products were covered by the DVK system, mainly intermediate and capital goods provided for in the plan; for other imports, domestic and world prices were aligned by means of import taxes. The coefficients were intended to permit domestic wholesale prices for traded goods to fluctuate with foreign currency prices or the official exchange rate. In practice, however, the use of price equalization taxes and subsidies continued on a wide scale to limit the impact of foreign price changes on domestic prices. The DVKs were frequently set so as to stimulate specific exports. The coefficients were differentiated by export/import region and by commodity, and in effect created a different exchange rate for each separate transaction. Initially, the coef­ ficients were set to reflect the incentive structure embodied in the previously existing system of budgetary taxes and subsidies, so there was no material shift in incentives. Over time the number of coefficients expanded as enterprises demanded more favorable coefficients for their products. Reportedly, the number of coefficients had increased from 1,600 in early 1987 to 10,000 by 1988, and ranged initially from 0.1 to 15.9. Subsequently their number was reduced sharply and their range narrowed. The system was abolished effective November 1, 1990 when a more depreciated commercial exchange rate for the ruble was established. The more important export incentive was the introduction of a foreign ex­ change retention scheme; prior to this, all foreign exchange earnings were sur­ rendered to the state. Under the new scheme, enterprises are allowed to retain a percentage of their foreign currency earnings (retention quotas) in retention ac­ counts that may not be appropriated by the state. Exports of manufactures are encouraged by permitting a higher retention quota the higher the degree of processing. Retention quotas are set by enterprise and presently range from zero to 100 percent, with most quotas in the range of 30 to 40 percent. Joint ventures and cooperatives can retain 100 percent of their foreign exchange earnings. The

47 average retention rate, however, has been small thus far-less than 10 percent­ reflecting the low retention quotas for raw materials and energy, and the fact that convertible currency exports are a small part of the total. Retained foreign exchange can be used by enterprises to meet their require­ ments for intermediate and capital goods; up to 30 percent can be used to pur­ chase consumer goods for their employees. Surplus foreign exchange can also be sold for rubles at the currency auctions that have been held monthly since 1989, though few transactions have taken place despite the attractive rates that have been offered at these auctions. With the introduction of retention quotas and self-financed imports, there has been a corresponding reduction in centralized imports through the plan. In this respect, enterprises requiring imported inputs but not themselves in a position to earn foreign exchange by exporting are at a disadvantage, though the foreign currency budget continues to provide foreign exchange for favored projects. In addition, importers can seek foreign currency loans from the VEB (subject to availability of foreign exchange) and purchase foreign exchange at currency auc­ tions.

(3) Trade regulations The decentralization of trade since 1986 has entailed some loss of control by the authorities over both the composition of trade and its overall balance. As a result, there has been an intensification of the use of trade instruments to limit the resulting strains and dislocations. Trade restrictions are geared primarily toward ensuring adequate domestic supplies of certain commodities, rather than toward protection. Presently about 70 percent of exports are licensed, covering mainly raw materials, energy-related products, and consumer goods. Only about 6 percent of imports are licensed, because the allocation of imports is effectively controlled through the foreign exchange budget. Frequently, quotas are used in conjunction with licenses. A particular instance is the use of quotas to limit the export of consumer goods to the amount provided for in the plan. Licenses are given only to manufacturers that have quotas. It is possible to export more than planned if the manufacturer has fulfilled all domestic contracts and state orders. However, if a product is in short supply domestically, a firm could have fulfilled its domestic obligations but still be prohibited from exporting. Trade with CMEA countries and some developing countries is also regulated by country for balance of payments reasons, i.e., in order to achieve balanced trade. This pertains mainly to countries with which the USSR maintains bilateral trade agreements. If there is a trade deficit, imports are regulated by simply ceas­ ing to issue the relevant licenses. This instrument has become of considerable importance in the past two years as economic disruption has led to non-fulfillment of trade protocols and resulting imbalances. Imports from Finland, Yugoslavia,

48 Egypt, and Hungary have recently been constrained, as have exports to the People's Democratic Republic of Korea. Finally, it should be noted that the emergence of substantial price differences for certain commodities within different regions of the country has entailed the rapid growth of interrepublican trade quotas, generally applied in an ad hoc man­ ner, to assure that local deliveries are not disrupted by diversion of goods to higher priced areas. With the recent phase-out of the DVK system and the introduction of a commercial exchange rate, explicit import and export taxes have been adjusted accordingly. Because most domestic wholesale prices are expected to remain fixed, however, the system of price equalization taxes and subsidies will have to continue, although probably at reduced levels. The customs tariff that has been in effect since 1984 covers only 319 items and has not been enforced. The State Customs Control Authority has recently been reconstituted to develop a new customs tariff and statistical system that would conform to the principles and nomenclature established by the GATT. A new customs law has been prepared to take effect on January 1, 1991. The customs tariff is based on the harmonized system and covers 5,019 items. It includes preferential rates for developing countries and higher rates for commodities im­ ported from countries that do not give most-favored-nation treatment to the USSR. The draft customs law initially sets rather low tariffs--except for luxury goods. While the intention is that tariffs should replace other means of protecting domestic producers from import competition, it is unclear whether other forms of protection will in practice be discontinued. As domestic prices are deregulated and various forms of equalization taxes are phased out, tariffs will be adjusted, or coupled with new border taxes in some fashion, to assure a continuing adequate level of protection. c. Assessment of the trade regime and reform efforts The traditional framework governing the international transactions of the USSR, and the restrictions through which it operated, served to limit the interac­ tion between the domestic and the world economy and to isolate domestic enterprises from world markets. In this environment, the industrial structure of the USSR did not keep pace with the developed economies or realize its growth potential. In an environment in which most goods were administratively allocated, domestic prices did not reflect relative scarcities or comparative advantage and, consequently, did not play the role of channeling resources to their most efficient uses. The reform efforts of recent years have been directed to modifying some of the features of the traditional system by encouraging more direct involvement of enterprises in international trade, and by allowing price incentives some role in

49 influencing resource allocation. But this has resulted in a very complex and non­ transparent regime whose allocative and incentive structure it is almost impossible to assess comprehensively. The following features stand out: First, while reforms have greatly extended and decentralized trading rights, enterprises have been constrained in a variety of ways in responding to the new opportunities. Indeed, few enterprises have exercised these rights, because of in­ adequate incentives. Most continue to depend on trade organizations under the control of branch ministries. The continued primacy placed on meeting domestic demand in the face of fluctuations in production resulting from domestic supply problems has also limited the ability of enterprises to supply export markets on a reliable basis. As a result, directives and state orders continue to be the principal instruments guiding foreign trade, with the FTOs continuing to play a dominant role. Second, the complex system of DVKs neither produced a stable incentive structure for trade that would be responsive to underlying comparative advantage, nor provided a coherent bridge between domestic and world prices. Third, export incentives resulting from currency retention quotas are an important innovation. But the size of these retentions remains small, and the high degree of differentia­ tion by degree of processing could in fact hinder the workings of comparative advantage in allocating resources. For example, low or zero retention quotas for energy products and raw materials would tend to restrict imports by enterprises in these sectors, even though the efficient exploitation of these resources will require the large-scale importation of sophisticated capital equipment. Finally, the composition of imports continues to be primarily determined by administrative decisions on foreign exchange allocation rather than by the price mechanism. The only exceptions to central allocation are the currency retentions, the (minuscule) foreign exchange auctions, and of course the illegal or grey markets of undeter­ mined size. More generally, the regulatory framework lacks transparency and stability and is overly complex because of the need to neutralize distortions arising from domestic price controls and the lack of currency or commodity convertibility. Thus the free flow of resources in response to relative prices is impeded even within the USSR. Restrictions on foreign trade are arbitrarily imposed in response to domestic shortages or for balance of payments reasons. The constraints imposed by bilateral trade arrangements add to the in­ flexibility of the system and the distortions in resource allocation. In particular, the CMEA's potential as a customs union was never realized because of features that inhibited both trade and specialization: contracts arranged by government level agencies rather than by enterprises; the inconvertibility of the transferable ruble both inside and outside the CMEA; relative foreign trade prices that bore little relationship to either the relative domestic prices enterprises faced or relative world market prices; inadequate incentives to share technological knowledge; and uneconomic transactions resulting from the need to balance trade.

50 3. REFORM ISSUES a. Objectives The Soviet authorities recognize the unsatisfactory character of the "half-way house" where the trade system is presently lodged. Intentions as stated in the presidential guidelines are to move towards a system of trade based largely on market mechanisms and a convertible ruble. Nevertheless, the guidelines take a cautious approach to trade liberalization within the overall reform effort. Such caution is perhaps understandable in view of the small share of trade in overall economic activity; and it is no doubt correct that in the short- and medium-term the trade "tail" may be too small to wag the domestic economy "dog." Primary emphasis on domestic economic reform is thus warranted. Nevertheless, the Soviet authorities may underestimate the potential importance of trade liberaliza­ tion to improve economic performance even during the early stages of transfor­ mation to a market economy. At least three specific considerations underlie this judgement. First, an opening up of the economy can contribute to generating the com­ petitive pressures that will be needed to limit the exploitation of market power by highly monopolized domestic industries. While import competition cannot be ex­ pected-for an economy the size of the USSR-to be an adequate substitute for domestic competition even in tradeable goods sectors, its impact in diluting domestic market-power is greater than what would appear from a consideration of import shares alone. Enterprise pricing behavior depends as much on potential as actual competition; and to that extent Soviet concerns that giving freedom to enterprises has to be handled very cautiously to avoid monopoly exploitation may be overdrawn if trade reform is carried out in parallel. Likewise, on the export side, the liberalization of export possibilities would provide incentives to firms to maintain their production even in cases in which domestic market-power would lead them to restrict supplies to the domestic market. This would serve to maintain employment in these firms at higher levels than otherwise, and the resulting in­ crease in foreign exchange earnings would in turn expand the capacity of the economy to import, and thus further weaken monopoly market power. Second, as economic restructuring proceeds, specific bottlenecks and un­ availability of needed inputs are likely to become more frequent and severe, be­ cause changed ways of organizing production are likely to require specific inputs different from those currently produced domestically. For example, agricultural reform may entail urgent needs for smaller tractors, rather than the large models in which Soviet production has specialized. The crucial role of imports in breaking such bottlenecks is evident. Since it is unlikely that critical areas where such "holes" in domestic production emerge could be identified in advance, a framework that allows such "unplanned" import needs to be met in a decentralized way is essential.

51 Third, the general experience of countries "opening-up" to foreign trade has been that such trade expansion generates economic benefits not only through better resource allocation in a static sense, but also significant gains related to the transfer of marketing know-how, to improved information on product lines, and to innovation more generally. There is every reason to suppose that such gains from trade would emerge in the case of the Soviet economy also. For the above reasons, the analysis of trade reform issues presented below is based on the premise that such reform is important not only as a longer-term goal of putting in place a structure for trade relations that would be consistent with a well-functioning market economy, but also in the near term as part of the economic transition. Indeed, the focus of this section is on the relatively short­ term, recognizing that in this period important domestic disequilibria will persist and that the institutions of a market economy will be only partially in place. b. Assumptions and preconditions What is feasible or reasonable in the area of trade reform is heavily dependent on the overall design and implementation of domestic economic reforms. There are enormous uncertainties here, two of which in particular are of decisive impor­ tance: the future of union-republic economic relations, and the pace and extent of domestic price liberalization.

(1) Union-republic relations The presidential guidelines are clear in affirming the importance of preserv­ ing an integrated market for goods and services within the USSR. It remains uncertain, however, if this objective will be realized. Initiatives and laws being discussed in a number of republics would entail fragmentation of the internal market even if such is not their intended purpose. In addition, pressures arising from prices differing across republics and regions are already giving rise to ad hoc measures to restrict interregional flows of certain commodities. In the absence of an agreed common framework, such pressures could be expected to intensify as reforms proceed and gather pace in the different republics. If a generalized fragmentation of the internal market were indeed to take place, issues of external trade reform at the level of the union would become enmeshed with the need to define at the same time a framework for interregional trade relations to limit as much as possible the enormous transition costs resulting from this course of events. It is assumed here that things will not come to such a pass; and that compromises will be found to preserve the essential integrity of the union market. There is no unique model of union-republic relations that is required to assure the integrity of the union market. A range of federal structures, more or less decentralized, have in other countries proved viable. In this regard, for example,

52 the topical question of whether the rights to the natural resources found in a particular republic are vested in the union or in the republic governments is of secondary importance: the coexistence of state owned and federally owned lands and resources (as for example in the United States) is quite workable. What does appear essential is the early adoption of a general prohibition against any republic's taking actions that interfere with the movement of goods or services across its borders with other republics.3 Such a prohibition is explicit in the presidential guidelines though only with respect to "an agreed list of com­ modities." It remains to be seen whether this point of the guidelines will gain general acceptance by the republics. It is assumed here that a common economic space is maintained.

(2) Domestic price liberalization It is unclear what, if anything, can really be accomplished by trade reform as long as domestic prices do not clear markets, hard budget constraints do not force enterprises to focus on marginal costs in managing their operations, and profit seeking behavior is not encouraged so as to induce firms to respond to price incentives. Of course any set of trade regulations will give rise to certain incen­ tives even if domestic markets do not clear, but there is no way to assess whether such incentives, if acted on, promote or reduce national welfare. And as a practical matter, the authorities would normally find administrative control over trade to be essential as a means of preventing arbitrage through international markets from undermining the availability of goods at controlled prices on domestic markets. The presidential guidelines are relatively cautious with regard to price liberaliza­ tion but, for the reasons discussed in Chapter IV.l, it is unlikely that this can in fact be sustained. It is therefore assumed that, in line with the recommendations made in other chapters, price liberalization will proceed rapidly across a very broad range of goods. c. Enhancing the role of market mechanisms There are three essential, interrelated elements in shifting from a system of largely administered trade to one in which determination of exports and imports can be left primarily to the decentralized operation of market mechanisms. First, trading rights have to be broadly distributed in the operative sense that firms and enterprises are able to choose without undue administrative hindrance what goods to buy or sell and on what markets. These choices, however, must be made in an environment in which enterprises compete with each other to exploit trading op­ portunities. Second, a means must exist whereby firms can bid on an equal footing with other firms for the foreign exchange they need to carry out their transactions. Third, appropriate and stable price incentives need to be allowed to operate in guiding firms' decisions with respect to their trading choices.

53 (1) The distribution of trading rights Trading rights have been substantially decentralized in the past few years in the sense that large numbers of enterprises and organizations have been allowed to register their rights to engage in trade. Indeed, this is the area where trade reform has gone furthest: in principle there are no restrictions on enterprises to engage in trade. Trading rights are limited, however, by the widespread imposition of licensing and quota arrangements, with the result that effective capacity to engage in foreign trade remains highly concentrated. The rationale for such ad­ ministrative controls over trade can be expected to diminish as indirect mechanisms for controlling trade are put in place. As this happens, the licensing of specific trade operations would increasingly become superfluous and should thus be abolished. A key administrative reform issue is how to introduce competition into the management of trade operations, so as to bring domestic producers into effective direct contact with producers elsewhere on both the domestic and world markets, while not sacrificing the expertise that particular trading institutions have acquired with respect to the commodities they handle. Clearly, it would be inefficient for every domestic producer to be required to forge its own trading links (though each should have the right to do so). Trading companies and associations have an important role. What is essential is that these companies and associations be in a competitive, rather than a monopoly situation. Trading rights need to be defined broadly and not in terms of specific commodities; this is already allowed for under current legislation but needs to be accelerated by severing the links between trad­ ing organizations and the branch ministries that sponsor them. Indeed, this could be achieved most directly by abolishing the branch ministries. For similar reasons, the FTOs under the control of the MVES should be reconstituted as independent trading companies. Finally, the present prohibitions on arbitrage operations needs to be abolished: their rationale in any event disappears with domestic price liberalization. To establish competition, enterprises need to be able to sell not just what they produce, and not just to buy what they need, but to exploit opportunities for profitable trade wherever they find them. There is no obvious need to restrict the activities of trading companies and associations to executing orders for clients.

(2) Access to foreign exchange The presidential guidelines call for the progressive establishment of "internal convertibility" as rapidly as possible. The precise meaning of this concept is open to debate. One element is that money should be freely convertible into goods on the domestic market, implying inter alia an end to rationing by scarcity at con­ trolled prices. As regards international transactions, the essence of internal con­ vertibility, at least with respect to a well defined set of Soviet enterprises and other residents (including joint ventures) and a broad range of external transactions, is a well defined market in which rubles can be bought and sold for foreign exchange

54 at a rate (fixed or variable) established within a foreign exchange market. With either a fixed or a variable rate, the monetary authorities might intervene to supply or withdraw funds from the market (and indeed under a fixed rate would be bound to do so); but direct controls on foreign exchange (nonprice rationing) would be excluded. It is clear that there can be a greater or lesser degree of "internal convert­ ibility" depending on the restrictions affecting who can enter this market, and for what purposes. A benchmark that is often used is that of current account convert­ ibility, which allows access to the foreign exchange market for both enterprises and households for current transactions. A somewhat more restrictive system would be to limit access to the market to enterprises, and to continue to ration foreign exchange to individuals with respect to their needs for tourism or other purposes. So long as there are restrictions on participation or on the types of transac­ tions that can be funded in the foreign exchange market, there is the likelihood that other exchange rates will exist on parallel markets to accommodate excluded participants. In addition, other nonmarket clearing rates can be maintained by the government to govern particular transactions, entailing legal requirements on the relevant transactors to buy or sell foreign exchange at that rate. From this point of view, a way of assessing progress in achieving internal convertibility might be to focus not only on restrictions in force, but on the dis­ persion of both the administratively maintained rates and those prevailing in paral­ lel markets relative to that established on the officially sanctioned foreign exchange market: an "adequate degree" of internal convertibility might be judged to be one where such rate dispersion was less than some modest threshold, so that the penalty from not being able to transact at the market exchange rate was a relatively small one. A first step, already envisaged for 1991, is the establishment of a foreign exchange market to be fed from retention quotas of exporting firms and central resources organized as an auction market. In the absence of a functioning system of interbank foreign exchange operations, the monetary authorities will have to play a major role, using their reserves (or special funds) to smooth exchange rate fluctuations. It would seem quite unrealistic initially to attempt to fix the exchange rate in this market for periods longer than a day or a week. In the short run, the information needed to define an "equilibrium" rate for this market is not available. Indeed, unless access to the market were tightly limited by administrative means (which would tend to defeat the longer run purpose of making this market the principal vehicle for allocating foreign exchange), it seems likely that current conditions of excess domestic liquidity would spill over into this market and drive the ruble to very depreciated levels. Partly for this reason and more generally to provide a stable framework, current plans call for retaining administered exchange rates, different from the

55 free market rate, to regulate a broad range of transactions. To this end, a new commercial rate of initially 1.66 rubles to the dollar, effective November 1, 1990, has been introduced-a major depreciation compared with the official rate of 0.55 rubles per dollar.4 At present, it is this commercial rate that matters for most transactions. Enterprises earning foreign exchange are obliged to surrender most of these earnings to the authorities at this rate. In turn, enterprises that require foreign exchange to purchase imports receive foreign exchange from the authorities at this same rate if the corresponding imports are authorized in the annual currency budget established on the basis of the plan. Prospectively, with the establishment of a foreign exchange market, and the abolition of a (com­ prehensive) currency budget, importers will to a large extent have to obtain their foreign exchange at the market rate. A surrender requirement will, however, remain in effect for exporters. 5 The foreign exchange obtained by the authorities from exporters is to be used for their own purposes, most importantly for the servicing of foreign debt but also perhaps for priority projects. Such a multiple rate system is in essence an implicit tax on the tradeables' sector of the Soviet economy, whose yield is equal to the gap between the official and market rates of exchange multiplied by the amount of foreign exchange sur­ rendered at the official rate. In the first instance it is the exporter who "pays" the tax (the difference between the rubles it actually receives for the foreign exchange it surrenders and what it would have received at the market rate). But since the market rate is more depreciated than it would otherwise be as a result of a reduced supply of foreign exchange to this market, the incidence of the tax is shifted in part to (some) importers.

Elimination of this multiple rate system would seem desirable. Implicit taxes of this sort on the tradeables' goods sector are unlikely to reflect accurately policy intentions: explicit taxes or tariffs on trade transactions have the virtue of transparency. It may, however, be difficult to move to a single rate in one step because the institutions and experience that are required for the efficient function­ ing of a foreign exchange market will take time to develop. Furthermore, foreign currency reserves appears to be inadequate to provide a sufficient cushion for exchange rate fluctuations. A transition period during which the multiple rate system continues to operate may thus be necessary.

What is important is that foreign exchange surrendered to the authorities be used for debt service or the constitution of reserves (with any surplus funds beyond these being cha.·meled back to the foreign exchange market) and not for priority projects which may appear attractive when casted out at the commercial rate, but would cease to be so if they had to be funded in the market. The likelihood of such restraints being observed is, however, reduced by current problems of union-republic relations. All levels of government expect to "share" in the implicit tax revenues generated by the multiple exchange system.

56 A feasible transition strategy for reaching internal convertibility might focus, in operational terms, on progressively reducing the gap between the commercial and the free market exchange rates to zero. The initial gap will almost certainly be huge. Even the most optimistic projections by the Soviet authorities in late 1990 suggested an initial rate of 6 rubles per dollar in the free foreign exchange market.6 Recent auction rates (perhaps not fully indicative of underlying market conditions because of the very imperfect and restricted character of these auctions) had been in the order of 20-25 rubles per dollar. Starting from these huge gaps, progressive convergence could be achieved by tightening monetary policy, while progressively depreciating the commercial rate. As noted earlier, the authorities have in recent years built a small margin of flexibility into the system of foreign exchange allocation by permitting exporting firms to retain some portion of their foreign exchange earnings for their own use rather than being required to surrender all of it to the authorities at the official rate. In the absence of a foreign exchange market, such retentions would seem on the face of it to provide strong incentives to Soviet enterprises to develop their exports, since other means of obtaining foreign exchange are very restricted. (Likewise, the 100 percent currency retentions accorded joint ventures would seem to provide a strong incentive for Soviet enterprises to enter into such ven­ tures.) Export results thus far have not strongly confirmed this expectation, presumably because of other impediments in the present system. As part of economic reform, it is envisaged to increase retention quotas, and reduce their dispersion. Nonetheless, it is intended to preserve a considerable amount of differentiation between unprocessed and more highly processed goods. The logic for this approach is open to question. While ostensibly geared to creating differentiated export incentives in favor of processed goods, the instrument is perhaps not well suited to this because the strength of the incentive is uncertain, fluctuating over time as the gap between official and market rates changes, and in any event due to disappear as internal currency convertibility is approached. The important thing is that retentions should be substantial, since these will con­ stitute the principal source of funds for the foreign exchange market. A uniform retention rate might be both more effective and easier to implement politically than the intensive negotiations that are implied by the setting-up of a system of differentiated retention quotas. Specific incentives for exporting certain com­ modities are better provided by explicit trade policy measures than by the implicit, though uncertain, tax reliefs provided by differentiated currency retention. Finally, it should be noted that as internal convertibility is achieved, the value of retention quotas falls to zero. At that point the logic for retaining them disappears altogether.

(3) Price incentives for engaging in trade At present there are enormous differences in the structure of relative prices between the USSR and world markets; in the absence of trade liberalization, many

57 of these differences would persist even if domestic prices in the USSR were largely liberalized, because the structure of market clearing prices within the USSR will reflect specific capacities and shortages resulting from the present production structure. Opening up to trade in these circumstances would tend to eliminate differences between relative price structures domestically and on the world market (at least as regards tradeable goods), through the arbitrage operations that would ensue.7 In the past, the Soviet authorities have aimed at neutralizing the pressures arising from differences between domestic and world prices by various means: border levies, the DVK system, and-where these have been insufficient to equal­ ize prices-direct administrative prohibitions on arbitrage operations that would exploit these differences. But a policy of systematically neutralizing price dif­ ferences in this way is not tenable in the context of economic reform. It is precisely such price differences that signal the directions in which resources need to flow, and that provide the incentives for a more efficient resource allocation. In the short run, however, the move to world prices risks being disruptive. It will take time for enterprises to readjust their production to cope with interna­ tional competition although the scarcity of foreign exchange and likely weakness of the ruble on the foreign exchange market will provide considerable protection to domestic enterprises. In some cases, activities revealed to be uneconomic at world prices will have to be scrapped. The sharp increases in input costs, par­ ticularly for energy if its price rose immediately to world levels, might also entail serious adjustment problems for Soviet enterprises. Some ways of cushioning the shock may thus be appropriate. Up to now, trade policy has primarily focussed on the need to prevent diver­ sion of scarce goods from the domestic markets to exports, and extensive quan­ titative restrictions on exports have been imposed to prevent this. This concern would largely cease to be relevant for goods whose prices are liberalized domes­ tically. Indeed, if anything, the problem is more likely to be one of insufficient incentives to export in a situation in which firms are required to surrender a significant portion of the foreign exchange they earn at a commercial rate that is well below market clearing levels. So long as oil prices and perhaps some other input prices were maintained domestically at administered levels below world prices, border measures would of course remain necessary to sustain these prices through quantitative restrictions (or indeed taxes, but such taxes would have to be adjusted continuously as world market prices changed). However, if the objective were to cushion domestic ener­ gy users for a time from the full effect of a move to world prices, this could be done-while eliminating administered prices domestically-by setting export taxes on energy at a predetermined level and with a planned phase-out, say over three years. So long as domestic production of these inputs exceeds domestic demand at the prevailing domestic price, such a system of taxes would assure a

58 gap between domestic and world prices equal to the tax. Fluctuations in world energy prices would then be reflected in domestic prices, assuring, inter alia, that the gap between domestic and world prices converged downward as the export tax was lowered. There would also be considerable gain from this approach in that it would eliminate the need for maintenance of a cumbersome bureaucratic structure to handle administered pricing and would foster independent decision making by energy producing units. At present, customs tariffs play no real role in resource allocation since, at the current exchange rate, it is the availability of foreign exchange rather than the price of imports that is the binding constraint. But once a functioning foreign exchange market becomes the principle vehicle for allocating foreign exchange, relative prices as influenced by customs tariffs will become much more important in influencing trade patterns. It is important, in considering the design of tariff policy, to recognize that customs tariffs will interact with the level of the market exchange rate in ways that will influence both imports and exports. In particular, while high average tariffs might seem to provide greater protection to domestic enterprises than low ones, this cannot be taken for granted. High tariffs might rather result in a more appreciated exchange rate for the ruble in the foreign exchange market than other­ wise, thus offsetting the direct import discouraging effects of the tariffs, and also discouraging exports since the incentive value of currency retentions would there­ by be weakened. Similarly, low tariffs could lead to a more depreciated ruble, thus rationing imports and encouraging exports. In effect, it is not the average level of tariffs, but rather their dispersion that can predictably be counted on to provide protection to those sectors having the highest tariffs. Interactions between tariff levels and the exchange rate such as described above are more likely to be relevant for the USSR than for the industrial economies, since for the latter ex­ change rates are driven to a large extent by capital flows rather than the balance on commercial transactions. In view of the above, there are a variety of considerations pushing in different directions with regard to the desirable features of a tariff policy for the USSR. First, a strongly skewed tariff structure-with relatively high tariffs on those goods where the gap between domestic and world prices is greatest__:_would tend to provide the strongest protection to those enterprises facing the largest adjust­ ment tasks, and so perhaps reduce adjustment costs for a time; but at the expense of weakening the links between domestic and world relative price structures. A more uniform tariff structure with less dispersion would, by contrast, be desirable to speed the adjustment of domestic to world prices and so accelerate economic integration. Second, whatever degree of dispersion adopted, low average tariff rates would promote a more rapid expansion of trade than high ones. High tariffs act as a deterrent to trade not so much because they restrict imports, but because they

59 inhibit the development of exports both directly (by raising the cost of imported inputs into export production) and indirectly through their effects on the exchange rate. On the other hand, high average tariff, may be seen as attractive for two reasons. First, such tariffs generate budget revenues. Given limited administrative capacity to introduce and manage new tax systems and the pressing need to reduce budget deficits, this may be an important consideration. Second, balance of pay­ ments considerations may also argue for a relatively high average tariff.

Finally, equity considerations could argue for relatively high tariffs on luxury consumer goods, although to this end it would be preferable to use excise taxes that fall equally on imported and domestically produced luxuries. Certainly high, and even very high tariffs on luxury goods are to be preferred to quotas or prohibi­ tions. There will surely be "windfall winners" from the economic reform process, and high tariffs on the goods that such winners will demand may constitute the most effective way of taxing these winnings.

Some compromises among such objectives are perhaps unavoidable. A general framework that embodies such compromises would be the following: a set of moderate tariffs with an average rate of around 30 percent and a minimal degree of dispersion could be announced and implemented as an anchor for longer-term relative price expectations. Supplementary import taxes on a small number of goods might be introduced as an adjustment measure in cases where firms were judged to be in a position to compete against imports after a restruc­ turing, but could not survive the shock of an immediate move to world prices. Such import taxes would need to be subject to a preannounced schedule for their reduction and elimination to ensure that they did indeed serve a buffer function, and not as a permanent protection for activities that are not viable at world prices.

There is no good reason for the USSR to impose import quotas, even as a transition measure. To a first approximation, the protective effect of quotas can be achieved equally well by tariffs. In addition, under the highly monopolized conditions of Soviet industry, quotas risk perpetuating market power in a way that tariffs-even high ones--do not. Furthermore, it is extremely difficult in practice to administer quotas in such a way that the "quota rents" are fully captured by the government, or indeed by the domestic economy in general. Most often quota rents are largely appropriated by foreign suppliers. Tariffs, by contrast, do generate a predictable income to the government. The spread of quantitative im­ port restriction in developed countries is less an indication of the superiority of such measures for protective purposes than a result of the fact that tariff measures are largely unavailable on a unilateral basis because tariff levels are "bound" in the GATT. The USSR at present faces no such constraints.

60 d. Other trade issues In addition to the reform issues examined above as central to any move towards a market-based trading system, two further issues are very much "on the table" in assessing the role of trade in the transition process. The first is the nature of Soviet international comparative advantage in coming years and in the longer run, and the trade strategy, if any, that should be adopted. The second is the question of transitional arrangements for CMEA trade, recognizing that the tradi­ tional system is being terminated and that the intention is to shift to decentralized trading relations at world prices and convertible currency settlement.

(1) Comparative advantage Soviet exports are heavily concentrated on energy products and raw materials-and this concentration is even more marked if only convertible cur­ rency trade is considered-with energy products, ores and metals, and wood and paper accounting for over 75 percent of Soviet exports to the developed market economies in 1989. Imports are less specialized: machinery and equipment im­ ports are important, and many types of equipment account for well over half of domestic consumption. This pattern is partly a reflection of an intentional division of labor among the CMEA countries, though machinery imports from the con­ vertible currency area are also significant. The share of food imports in the total, at close to 20 percent, is very high by international comparison, and can be judged to be the result of the serious organizational and incentive problems of the Soviet agricultural sector rather than a reflection of innate lack of comparative advantage in food production. In the long run, it is clear that the dependence on energy and raw material exports will decline in relative importance. An economy as large as the USSR, no matter how well endowed with natural resources, cannot plausibly maintain such a specialization. As the structure of Soviet production develops along market lines, it would be natural to assume that a more diversified trading structure would emerge, with trade in manufactured goods (the most dynamic component of world trade for the past forty years) holding an increasingly large share of the total. Eventual growth of intra-industry trade based on dynamic comparative advantage would seem to be appropriate for the USSR as it has been for most countries reaching higher levels of development along market lines. But in the short run, there is a difficult question of priorities: developing the capacity to compete ef­ fectively in world markets for manufactured goods will take time, and actions to accelerate this would require, inter alia, a very depreciated ruble (or large sub­ sidies to manufacturers) to offset the weaknesses of present Soviet production in terms of product quality. In view of urgent needs to raise foreign exchange earn­ ings in order to ease balance of payments constraints on imports, it may be more effective to concentrate efforts on increasing exports of energy and raw materials, where faster results could plausibly be obtained.

61 The extent to which energy exports might be increased in coming years remains very uncertain with both optimistic and pessimistic evaluations possible. As regards oil, the pessimistic assessment would be that production has already peaked, that marginal production costs are rising strongly, that domestic conser­ vation efforts will bear fruit only slowly, and that therefore the quantities available for export will continue the decline that has been observed in the past two years. But even a superficial analysis of current energy practices in the USSR makes it clear that the scope for increased efficiency in both production and use of oil is enormous. Accordingly, a more optimistic assessment is also possible. This would argue that reform in the oil sector, by creating proper price incentives and by bringing in foreign investment to overcome technological and managerial problems, would make it possible for much of this scope to be realized within a few years. Which of these views is relevant may depend primarily on the degree of ambition and skill in implementation of reform of the petroleum sector. Prospects for natural gas are generally agreed to be somewhat brighter, as even without thoroughgoing reform, production is likely to expand in the years to come. The expansion of gas exports, however, may be dependent on major in­ frastructure developments in new pipelines and liquefaction plants, as well as the development of new markets given that the present structure of the Western European market for natural gas is relatively tightly controlled. Whatever the uncertainties, a sensible strategy would be to assign a high priority in the short term to reform of the domestic energy sector, along the lines developed in Chap­ ter V.6, as the most promising near-term means of increasing foreign exchange earnings. Similar considerations would also place a high priority on agricultural reform. Whether, in the longer term, the USSR would become a major exporter of agricultural commodities is uncertain. The enormous availability of arable land suggests that it could; but this is an area where, more than in any other, trade policies have been decisive in accounting for actual production and trade patterns internationally. While it is to be hoped that progress will be made in reducing barriers to agricultural trade-and the USSR would appear to have a long-term interest in promoting such a process in any way it can-prospects for agricultural trade cannot at this point be assessed very optimistically. What is clear is that Soviet dependence on net imports of basic food stuffs could be substantially reduced in coming years through an energetic program of domestic agricultural reform.

(2) Transitional arrangements for CMEA8

The intended shift of CMEA trade to convertible currency settlement at market prices promises to yield the USSR a very substantial gain in the terms of trade. At the same time, however, intra-CMEA trade volumes are likely to contract

62 sharply and the risk is that this could be quite disruptive both to the USSR and its CMEA trading partners. There are a number of factors accounting for this trade contraction. First, Soviet oil deliveries to CMEA countries are falling, and will likely fall further both because declining Soviet production leaves less for exports and because the priority given to convertible currency earnings will probably result in diversion of a rising share of oil exports to non-CMEA countries, given the severe foreign exchange constraints of many of the Eastern European economies. Second, declin­ ing investment activity in the USSR is likely to affect in particular the demand for machinery and equipment, which constitute a major component of Soviet imports from CMEA. Third, Soviet demands for machinery and equipment may be diverted to Western suppliers and away from the CMEA. One reason that has been cited for this is the perceived superior quality of Western goods, though in principle one would expect this to be compensated by shifts in relative prices. More important may be the expectation that trade credits for financing machinery imports will be more readily available in the west than in CMEA countries, reflect­ ing the lack of a developed trade credit infrastructure within the CMEA. Fourth, some trade may be lost simply because of a breakdown in the mechanism for conducting it. The spreading economic dislocations within the country, and un­ certainty about union-republic relations, are clearly impeding the drawing up of trade contracts among enterprises. Finally, it is probable that some portion of CMEA trade was simply uneconomic, and could be expected to disappear under world pricing and convertible currency settlement. Faced with this situation, the USSR is negotiating bilaterally with her CMEA partners on transition arrangements for the coming year. The outcome of these negotiations is not yet clear. The Eastern European countries are in difficult situa­ tions and would want to maintain certain clearing arrangements so as to continue to be able to obtain some portion of the energy and other imports they require in exchange for goods rather than scarce convertible currency. The USSR would seem to have more to gain from discontinuing such clearing arrangements and is thus in a position to strike a hard bargain. It seems likely that in the end some special arrangements in the form of negotiated lists of products to be exchanged will be put i.n place for some portion of CMEA trade for the coming year. From a longer-term perspective, the maintenance of bilateral clearing arran­ gements of this sort, with the attendant requirement of cumbersome bureaucratic involvement and continuing negotiations, is inconsistent with the thrust of trade reform which is to put it on a market basis. Other approaches to establishing intra-CMEA trade on market foundations will thus be necessary. Proposals to create a payments union involving the USSR and some of the Eastern European countries do not seem realistic, or indeed desirable: a perhaps insurmountable problem is that the USSR could expect to be a structural creditor within such a union and would, to that extent, not find it in its economic self-interest. More

63 generally, such arrangements run counter to the objective-shared by the USSR and a number of the East European countries-to move rapidly towards currency convertibility. Creation of a free-trade zone or customs union within the former CMEA area is another possibility. But this would become relevant only after trading relations and trade regimes in the relevant countries had all been put on a market basis. Once that has been done, the pros and cons of favoring intra-CMEA trade relative to trade with third countries through such arrangements could be assessed. At present, interest in this approach among the countries concerned is not evident. Perhaps the most promising approach is simply to proceed as rapidly as possible with overall trade reform, along the lines discussed above, so as to create an environment in which enterprises have both the incentive and the means to enter into trade contracts with suppliers or purchasers in other CMEA countries. One area where action could be important to strengthen trade is in the crea­ tion of trade credit facilities both within the USSR and its CMEA partners. While of course such facilities are relevant for all trade, they are particularly important to provide an underpinning for CMEA trade since the absence of such facilities would tend to lead to diversions of trade to western countries better placed to provide such credits, even when the continuation of such trade among CMEA countries would generate significant mutual benefits.

4. SUMMARY AND CONCLUSIONS

The presidential guidelines for economic reform indicate a generally liberalizing direction for reform of the trade system, though the drafting of the guidelines is ambiguous on a number of critical points, and indeed contains some suggestions that are on the face of it not consistent with the general thrust of reform. Overall, they suggest a cautious approach in terms of the pace at which reforms are to be introduced, though specific timetables are not set out. The relevant indications from these guidelines on trade reform might be summarized as follows: (l) Further expansion of trading rights, including the diversification or breaking up of foreign trade organizations or their reconstitution as joint stock companies. (2) Maintenance of a system of foreign exchange retentions for exporters, pursuant to rules which "foster the industrialization of exports". A sub­ stantial share of exporters' foreign exchange receipts would, however, continue to be surrendered to the authorities at the commercial rate, to fund government debt service and perhaps other expenditures at both the union and republican levels. (3) Early establishment of an auction market for foreign exchange, open to all resident enterprises, where the value of the ruble is set by supply

64 from retention quotas and demand; and an objective of eventually achieving internal convertibility of the ruble, in stages. (4) Abolition of the DVK system, a reduction of centrally administered ex­ port licenses to a minimum, a strengthening of incentives to export, and reliance on customs duties and taxes, together with the exchange rate, as the principal control mechanisms for trade. (5) Implementation of a package of emergency measures to prevent a decline in oil production and to maintain production of other export goods. (6) Conversion of CMEA trade to convertible currency settlement at world market prices as of January 1, 1991. Areas of trade policy where the generally liberalizing thrust of the guidelines is less in evidence include the indication that state orders for basic Soviet exports will remain in effect for 1991 and 1992; and that a list of goods including oil, gas, gold, diamonds, precious stones, special technology and perhaps a few others would be deemed all union resources to be transacted separately. The overall thrust of the guidelines is not inconsistent with the views that have been developed here, though in general a shift to market based trade that is more rapid than what appears in the guidelines is favored. There are also three specific points of divergence that should be noted. First, a time schedule that foresees the maintenance of state orders for a significant share of exports for at least two more years would seem to imply an overall pace of liberalization that will prove to be inconsistent with the pressing needs to move out of the present, untenable halfway house of economic reform. Second, the emphasis on "emer­ gency measures" to sustain petroleum production, rather than more fundamental economic reform of this sector, is unlikely to yield the hoped for results, validating a pessimistic assessment of Soviet petroleum prospects. Third, the adherence in the guidelines to a system of differentiated retention quotas favoring manufactured exports perpetuates needless complexity and distortions. More fundamentally, the guidelines are generally unclear about the im­ plementation of reform. There is a serious risk that the objectives set out will in fact not be achieved in the absence of a well-defined strategy for implementing the reforms that would maintain coherence among the successive decrees that are being promulgated. The most serious risk in this regard is with respect to achiev­ ing real progress towards convertibility. The key element here is that the foreign exchange market that is to be established needs to be more than a marginal ap­ pendage, and to serve a real resource allocation function. This implies the need for a number of actions: First, substantial retention quotas so that exporting enterprises will indeed find themselves in situations of holding more foreign exchange than they imme­ diately need, so that they would be in a position to provide funds to this market.

65 A requirement that enterprises tender these retentions to the market within a reasonably short time, rather than hold them in retention accounts, would also help to build up the market. Second, sufficient liquidity in the foreign exchange market, and confidence that this will be preserved, so as to make enterprises willing to provide foreign exchange in the expectation that they will also be able to obtain it when the need arises. Otherwise holders of foreign exchange would be tempted to spend it on less essential imports rather than lose control over it. Third, a policy of steadily increasing the range of transactions channelled through this market. Foreign borrowings by banks on behalf of clients, for ex­ ample, could be channelled through this market rather than through the commer­ cial rate from an early date; and government imports should likewise be increasingly financed through this market. The risk is that high surrender requirements resulting from the imposition of union, republican and even local demands for foreign exchange will leave the market so under funded as to be nonviable. Against this general background, the specific recommendations arrived at in this chapter, which constitute a sort of "middle road" to trade reform-neither a "big bang" nor a slow crawl"-can be summarized succinctly: (a) rapid progress is necessary toward creating a genuine competitive en­ vironment in the trade sector. Trading rights, already widely distributed, need to be made effective by phasing out licensing restrictions, by sever­ ing links between trade organizations and ministries (and indeed by abolishing the branch ministries altogether), and by eliminating prohibi­ tions against middleman activities; (b) concerted and sustained progress towards internal convertibility of the ruble should be facilitated, by progressively shifting a wider range of transactions from the commercial rate to the market rate while also rapidly reducing the large initial gap between these two rates; (c) foreign exchange surrender requirements on exporting firms should be limited to a minimum, and they should be steadily reduced over time. The governments' own needs for foreign exchange to service debt could and should increasingly be met by purchases at the market rate. Likewise, the government's needs for foreign exchange for other pur­ poses should be met fully out of funds purchased at the market rate; (d) establishment of a tariff structure with only minimal dispersion of rates is needed, with an average level not higher than 30 percent. Specific temporary border taxes (or subsidies) might be established in special cases, and perhaps most notably energy, subject to a preannounced schedule for phasing these out;

66 (e) priority attention should be given to reform of the energy sector and of agriculture as the most effective means of increasing the availability of foreign exchange over the next few years for the imports needed to accelerate domestic adjustment; (f) the efforts of Soviet enterprises to enter into trade contracts on commer­ cial terms with enterprises in other CMEA countries should be facilitated, so as to limit the short-term dislocation costs of CMEA reform.

NOTES I. See also Chapters 11.2, 11.3 and III.4. 2. According to one approach that quantifies the tenus of trade effect by using highly disag­ gregated comparisons of the prices of goods sold in CMEA countries and on representative Western markets, the Soviet subsidy to the six Eastern European countries may have totaled US$8 billion in 1989. 3. A relevant model for such a prohibition is the Interstate Commerce Clause of the U.S. Con­ stitution. Over the years, this instrument has assured the integrity of the U.S. internal market even while leaving individual states substantial control over economic developments within their borders in other domains. 4. A new rate initially at 1.66 rubles per dollar was set as the commercial rate. The value of the rate will change according to the value of the basket of currencies to which it is pegged. The official rate of about 0.55 rubles per dollar will continue to exist as a measure of the value of certain external claims of the USSR. But for most purposes, the commercial rate is in fact the (depreciated) replacement of the previous official rate. See Chapter III.4 for details on the exchange rate system. 5. A decree issued in October 1990 indicates that exporters will be expected to surrender 40 percent of their foreign exchange receipts to the union government in order to fund the union's debt service obligations. The remainder will be subject to differentiated retention quotas (see Table III.4.12). 6. Such estimates depend, of course, on the size of the monetary overhang and the financial policies pursued at a given point in time. 7. The notion of price equalization through trade should not be taken literally even for market economies. There is abundant evidence that, even in the absence of trade restrictions, prices for most traded goods do not equalize even in the relatively long run: quality differences, imperfect infonnation, and other less tangible factors appear to play a powerful role in allowing similar goods to be sold on different markets at significantly different prices. 8. Developments in CMEA trade and payments are covered in detail in Appendix 11-3.

67 NOTES TOTABLES

Main features of Soviet trade structure and performance The following tables summarize some features of Soviet trade. A cautionary statistical point is in order. Soviet trade statistics are liable to be misleading to some extent because of biases created in converting trade transactions with dif­ ferent partners into a common ruble basis (see Appendix 11-2). Further difficulties arise in international comparisons, because of the difficulty of knowing the ap­ propriate rate at which to convert ruble values into dollars. Ruble foreign trade values with CMEA countries and convertible currency trade with other countries may not be directly comparable due to the very different relative price structures for the two sets of trade. Despite such statistical biases, the general picture con­ veyed in the tables, if not all the details, is probably realistic. The main features are as follows. The USSR is a relatively closed economy as measured by the share of trade in GDP (Table IV.3.1), although it is not a straightforward matter to measure the relative openness of an economy with disputed prices and a distorted exchange rate. While the share of exports in GOP is less than half the OECD average, this is to be expected for a country as large as the USSR. It is to be noted, however, that whereas most countries have continued to become more open during the 1980s as world trade growth has continued to outpace production, the USSR's trade share has stagnated. Because of a heavy concentration of Soviet trade with the CMEA, the USSR is much less important as a trading partner for OECD countries than its overall trade share would suggest. Soviet exports are narrowly based, dominated by fuels and raw materials (especially as regards convertible currency trade) (Table IV.3.2). A significant part of "other exports" are accounted for by arms shipments-primarily to socialist and developing countries. The import structure is more diversified, with machinery and equipment, industrial consumer goods and food together account­ ing for about 60 percent of total imports in 1989 (Table IV.3.3). Import specialization is more marked than export specialization, in the sense that there are no export categories of goods for which exports account for as much as 35 percent of production, whereas the dependence on imports in such areas as machine tools often exceeds 60 percent of domestic consumption (Tables IV.3.4 and IV.3.5). Even on the export side, however, specialization is surprisingly high-at least at the level of aggregation indicated-apparently even higher than for the United States where the overall export share is roughly comparable to that of the USSR. This perhaps reflects the "international division of labor" that was implemented within the CMEA over the past 40 years.

68 Table IV.3.1. USSR: Basic Indicators for Soviet Foreign Trade, 1985-89

Indicator USSR International Comparison

Total exports of goods as percent of GDP ( 1988) 1 6.8 14.4 (OECD average) Position of the USSR in world merchandise trade ( 1988) Exports Share (in percent) ...... 3.9 4.0 (Canada) Rank ...... 8 7 (C~ada) Imports Share (in percent) ...... 3.6 3.8 (Canada) R~k ...... 8 7 (Canada) Trends in Soviet trade (U.S. dollar values; percentage change) Annual average 1988/1978 Imports ...... 7.8 8.1 (world average) Exports ...... 7.8 8.1 (world average) Annual average 1989/1988 Imports ...... 6.8 7.3 (world average) Exports ...... -1.2 6.6 (world average) Share of the USSR in total OECD imports (in percent) 1985 ...... 1.6 1.4 (Korea, Rep.) 1989 ...... 1.2 2.0 (Korea, Rep.) Share of the USSR in total OECD exports (in percent) 1985 ...... 1.7 1.4 (Korea, Rep.) 1989 ...... 1.3 1.9 (Korea, Rep.) Share of the USSR in total OECD imports of manufactures (in percent) 1985 ...... 0.3 2.0 (Korea, Rep.) 1988 ...... 0.2 3.0 (Korea, Rep.) Share of the USSR in total OECD exports of manufactures (in percent) 1985 ...... 1.2 1.3 (Korea, Rep.) 1988 ...... 0.9 1.8 (Korea, Rep.)

Sources: OECD Economic Outlook, GAIT International Trade 1988-89, United Nations Statistics, OECD Statistics, Series A, and OECD Statistics, Series C, various issues. I. Exports are valued in valuta prices.

69 Table IV.3.2. USSR: Commodity Structure of Exports, 1980-89 (In percent of total)

Machinery, Ores, Equipment Concentrates, Food and Production and Metals and Chemicals, Textile, Raw Industrial Services Transport Fuels and Metal Fertilizers, Wood and Raw Materials Consumer and Total Equipment Electricity Products Rubher Paper Materials for Food Goods Arms

198(! total ...... 100 15.8 46.9 8.8 3.3 4.1 1.9 1.9 2.5 14.8 Socialist countries ...... 100 22.8 39.7 13.1 3.5 3.0 2.4 2.4 2.6 10.5 Nonsocialist developed countries ...... 100 1.9 72.1 4.9 3.2 6.4 1.5 1.2 3.2 5.6

1985 total ...... 100 13.9 52.7 7.5 3.9 3.0 1.3 1.5 2.0 14.2 Socialist countries ...... 100 16.9 49.8 10.1 3.9 3.0 1.9 1.6 2.2 10.6 Nonsocialist developed countries ...... 100 1.9 77.0 4.6 4.4 3.6 0.4 1.3 2.2 4.6

1989 total ...... 100 16.0 40.2 10.5 4.1 3.5 1.6 1.6 2.6 19.9 Socialist countries ...... 100 20.7 41.1 10.4 4.2 2.5 2.0 1.4 2.8 1.9 Nonsocialist developed countries ...... 100 3.2 55.1 15.3 4.7 7.0 1.4 2.0 2.8 8.5 -...l 0 Source.· SSSR v tsifrakh 1989 (1990). Table IV.3.3. USSR: Commodity Structure of Imports, 1980-89 (In percent of total)

Machinery, Ores. Equipment Concenlfates, Food and Production and Metals and Chemicals. Textile, Raw Industrial Services Transport Fuels and Metal Fertilizers, Wood and Raw Materials Consumer and Total Equipment Electricity Products Rubber Paper Materials for Food Goods Arms

1980 total ...... 100 33.9 3.0 10.8 5.3 2.0 2.2 24.2 12.1 5.9 Socialist countries ...... 100 43.8 1.7 6.1 3.5 0.6 0.5 18.6 17.7 7.5 Nonsocialist developed countries ...... 100 29.6 1.1 19.4 8.2 4.5 3.8 23.8 5.2 4.4 1985 total ...... 100 37.1 5.3 8.3 5.0 1.3 1.7 21.1 12.6 7.6 Socialist countries ...... 100 47.4 1.8 4.9 3.0 0.4 0.3 17.9 15.5 8.8 Nonsocialist developed countries ...... 100 28.2 1.7 17.7 10.3 3.5 3.3 22.9 7.7 4.7 1989 total ...... 100 38.5 3.0 7.3 5.1 1.2 1.6 16.6 14.4 12.3 Socialist countries ...... 100 45.4 1.9 5.0 2.7 0.3 0.3 14.5 16.2 8.7 Nonsocialist developed countries ...... 100 34.3 0.9 12.4 10.7 3.5 3.6 18.5 7.8 8.3 -..1 - Source: SSSR v tsifrakh 1989 (1990). Table IV.3.4. USSR: Proportion of Production Exported by Selected Sectors, 1 1985 and 1989 (In percent, in relation to production measured in physical units)

Nonsocialist Socialist Developed Total Countries Countries Commodity or Product 1985 1989 1985 1989 1985 1989

Machinery and equipment Passenger cars ...... 20.0 30.1 11.2 16.5 7.5 11.3 Equipment for forestry, cellulose & paper ...... ·.... · .. 28.6 23.1 27.6 21.6 1.0 1.5 Blast-furnace and steel-smelting equipment ...... 2.3 21.1 1.2 9.5 0.7 3.1 Equipment for textile industry ...... 12.2 19.3 11.2 18.0 0.2 0.1 Metal-rolling equipment ...... 16.2 10.8 10.2 5.7 0.2 0.3 Fuels Crude oil ...... : : . . . 19.7 21.0 13.1 13.6 5.6 6.3 Diesel fuel ...... 18.6 18.6 4.6 4.9 12.3 11.2 Heavy heating oil (mazut) ...... 8.8 13.8 2.1 1.8 6.5 11.8 Natural gas ...... 10.7 12.7 5.7 6.5 5.0 5.8 Nonfood raw material Fine leather for processing ...... 21.0 30.4 4.9 14.2 6.1 6.2 Cotton ...... 23.9 29.7 21.7 22.0 1.7 6.6 Potassium fertilizers ...... 30.7 28.8 21.6 14.9 6.9 7.0 Chromium ore ...... 13.9 19.7 11.9 11.8 2.0 7.8 Nitrogen fertilizers ...... 14.2 19.0 8.9 16.2 2.1 0.6 Industrial consumer goods Cameras ...... 39.4 27.9 30.1 24.7 9.2 3.0 Household refrigerators ...... 20.1 26.6 16.1 16.8 3.7 9.4 Household clocks ...... 28.2 19.4 12.9 9.7 13.6 5.7

Source: PlanEcon Report. No. 20-21/1990, based on Vneshnie ekonomicheskie sviazi /989 (1990). I. Shares are arranged in descending order according to the level observed in 1989 for total trade; the residual of the total share of a given category not recorded in the table corresponds to shares of developing countries.

72 Table IV.3.5. USSR: Import Share of Soviet Domestic Consumption of Selected Products, 1 1985 and 1989 (In percent, in relation to consumption measured in physical units)

Nonsocialist Socialist Developed Total Countries Countries Commodity or Product 1985 1989 1985 1989 1985 1989

Machinery and equipment Equipment for leather/shoe industry 73.0 82.1 40.0 17.9 33.0 64.3 Equipment for apparel industry ...... 42.2 78.9 33.4 13.4 8.8 65.1 Knitting equipment ...... 52.2 68.4 46.4 20.9 5.8 47.5 Equipment for dyeing/finishing industry ...... 49.3 68.2 34.7 23.4 14.6 41.6 Equipment for chemical industry ...... 55.5 61.4 31.6 20.4 23.6 40.5 Equipment for printing industry ...... 56.3 58.7 41.1 28.5 13.7 28.7 Equipment for textile industry ...... 52.9 57.8 47.6 37.2 5.2 19.1 Equipment for food processing industry ...... 52.1 39.4 39.3 24.2 12.0 15.1 Nonfood raw materials Wool (washed equivalent) ...... 24.2 27.4 1.6 1.1 18.0 23.7 Pesticides and herbicides ...... 32.6 26.7 12.8 14.8 18.7 9.7 Steel pipes ...... 21.4 14.7 2.8 2.7 18.6 10.9 of which: pipes for oil industry .... . 17.6 17.8 3.2 3.1 14.3 11.7 Soda ash ...... 9.7 10.4 9.7 10.1 Food and raw materials for food Fresh frozen vegetables ...... 87.8 76.9 87.8 76.9 Tea ...... 31.0 35.0 4.1 8.1 Grains, excluding coarse grain ...... 20.3 15.5 1.9 1.1 14.9 13.9 of which: corn ...... 56.8 40.4 7.1 2.8 42.8 37.2 Edible oils of vegetable origin ...... 25.3 25.6 0.8 0.5 4.3 3.4 Raw sugar ...... 26.2 25.4 22.6 15.6 2.6 Industrial consumer goods Soap ...... 0.8 18.5 0.8 1.5 5.9 of which: toilet soap ...... 2.6 34.0 2.6 1.7 8.6 Pharmaceuticals ...... 31.4 28.2 28.3 22.9 1.2 2.5 Detergents and cleaing agents ...... 3.7 22.7 3.4 4.3 6.8 Apparel ...... 24.3 21.6 16.3 16.6 7.0 3.0 Furniture ...... 12.8 10.7 12.6 10.5 0.2 0.1

Source: PlanE con Report, No. 20-21/1990, based on Vneshnie ekonomicheskie sviazi 1989 ( 1990). I. Shares are arranged in descending order according to the level observed in 1989 for total trade; the residual of the total share of a given category not recorded in the table corresponds to share of imports of developing countries.

73

Chapter IV.4

Foreign Direct Investment

1. INTRODUCTION Few, if any, countries offer as potentially attractive opportunities for large­ scale foreign direct investment as the USSR: a vast internal market; a critical need for an efficient and expanded consumer goods industry; enormous natural resour­ ces whose efficient exploitation would yield large benefits both to the USSR and to foreign investors; new, untapped business opportunities resulting from the con­ version of the defense industries; a woefully underdeveloped services sector-in­ cluding the basic distribution system and business-related services-where foreign know-how would be extremely valuable; and a general need to import foreign technology, managerial skills, and experience in operating in a market environ­ ment. This potential notwithstanding, foreign direct investment in the USSR has been minimal to date in terms of foreign capital actually invested, and is unlikely to expand significantly in the absence of a dramatic improvement in the country's political, economic and regulatory environment. One, but not the principal, reason for this disappointing performance is the inadequacy of the regulatory framework for foreign investment. More fundamental from a foreign investor's viewpoint are overall political and legal uncertainty, economic risk, and the lack of functioning input markets and basic infrastructure in such areas as finance and telecommunica­ tions. Against this background, it is clear that there are great potential benefits to the USSR from increased participation of foreign investors in the development of the USSR and its integration into the world economy. Indeed, by providing favorable feedbacks to the process of economic reform, success in attracting sub­ stantial flows of foreign investment could be crucial in the transition to a market economy. It is also evident that the difficulties to be overcome in achieving this are considerable. This chapter reviews the available statistical evidence on the activity of joint ventures established in the USSR, assesses the present climate for foreign invest-

75 ment, and evaluates the regulatory parameters applying to ventures with foreign participation, including proposals for reform currently under consideration. The chapter concludes by considering a number of specific recommendations with respect to foreign direct investment.

2. THE EXPERIENCE WITH JOINT VENTURES The equity joint venture has been to date the principal form of foreign direct investment in the USSR. 1 This form is characterized by an equity ownership in a separate legal entity by the foreign partner(s) of up to 99 percent, reflecting a commensurate investment of capital. As a general rule, joint ventures are subject to the same laws and practices as other Soviet business entities, but there are a variety of important exceptions in areas such as supply and distribution, taxation, wages and management rights. a. Statistical background 2 The enabling legislation for joint ventures was passed in January 1987 and by mid-1990 there were 1,754 registered joint ventures with a total registered initial capital of around rub 4 billion. This figure is, however, a poor indicator of the volume of convertible currency funds that has actually been invested in joint ventures. Although convertible data are not available in this respect, it can be reasonably estimated that the stock of foreign investors' convertible currency con­ tribution is unlikely to exceed the equivalent of rub 500 million, and may indeed be substantially less. 3 The initial stage of joint venture development was marked by steady growth-as would be expected as the first wave of negotiations bore fruit. How­ ever, with the initial enthusiasm becoming tempered by the realization of the problems posed by economic disorganization and bureaucratic resistance, growth has slowed down noticeably since late 1989 in terms of both numbers of new ventures and, especially, initial capital investment (Table IV.4.1 ). Furthermore, of the 1,754 joint ventures registered at end-June 1990, only 541 are actually operating and producing goods or services; an additional 162 (mainly in the ser­ vices sectors) are reportedly paying their workers but have not yet entered the production phase. All in all, the number of ventures that can be said to be opera­ tional is 703, or some 40 percent of the total registered. The average size of joint ventures tends to be small by both international and Soviet standards. More than half of the operating ventures employ fifty or fewer persons (Table IV.4.2) and only eight ventures have in excess of a thousand employees. These eight ventures accounted, however, for some 15 per­ cent of the overall volume of production recorded in the first half of 1990, while the 470 joint ventures with a workforce of up to 200 employees contributed just over half of the total production. The limited size of joint venture operations is

76 even more evident when measured in terms of capitalization.4 Indeed, from the outset, Soviet officials have noted with disappointment that joint ventures have tended to be, from their perspective, seriously undercapitalized. The statistics (Table IV.4.3) bear out this impression. More importantly, the trend has been to reduced levels of investment. Thus, the average capital investment of Soviet and foreign partners dropped from rub 4.3 million at end-1988 to rub 2.6 million at the end of the first quarter of 1990. Over that period, the proportion of ventures with initial contributions of less than rub 1 million increased from 48 percent to 62 percent5 while the percentage of operations with an initial capital in excess of rub 10 million fell from 14.5 per­ cent to only 6.2 percent. An important factor behind the statistical decline in average capitalization has been the growth of joint ventures arranged by Soviet cooperatives, which tend to be small in size and involve modest foreign participa­ tion. More generally, it would appear thatin view of the present economic uncer­ tainties, partners tend to inject as little capital as possible in new ventures and put greater reliance on debt as a source of finance.

An assessment of the distribution of joint ventures according to economic sector or sphere of activity is particularly difficult because there is no official classification scheme for such activities and also because many ventures designate in their founding documents a very wide variety of potential activities. Although available information does not permit definitive conclusions to be drawn on joint venture involvement in the various branches of activity, there is ample evidence that the services sector plays a predominant role for the time being. Indeed, Soviet officials have expressed concern that the sectoral distribution of joint ventures had not conformed to Soviet expectations, particularly with regard to the limited size of manufacturing start-ups (especially in heavy industries) relative to investment in business and distribution services and in computer-related activities (Tables IV.4.4 and IV.4.5). 6

The vast majority of joint ventures (1 ,256 at end-March 1990) has been set up with partners based in OECD countries, but the participation of firms from other regions is not negligible: 186 ventures have been established with CMEA countries and 116 with developing countries. Firms from Germany, Finland and the United States are the leading investors in absolute numbers (these three countries are the only ones with participation in over 100 joint ventures) while the ranking with respect to total initial capital investment places Germany and Italy in the top two positions followed by France, Finland and the United States (Table IV.4.6). It is worth noting, however, that the ranking changes significantly when only the contribution of the foreign partner is considered. In this latter case, foreign partners from the United States appear to have made the largest contribu­ tion (some rub 173 million) followed by Germany (rub 170 million), Italy (rub 167 million) and France (rub 146 million).

77 The RSFSR has attracted the greatest share of foreign investment into the USSR, accounting for some 70 percent of both registrations and foreign capital invested. Moscow is by far the most popular location for joint ventures (Table IV.4.7), on account of its being the most important political and economic center and having better financial and telecommunications infrastructure than other zones in the USSR. Additional but smaller concentrations are to be found in Leningrad and in the Baltic republics. Virtually all the joint ventures employ predominantly Soviet workers. Indeed, out of a total work force of 66,600 employees accounted for at end-June 1990, approximately 65,500 (or 98.4 percent) were Soviet citizens. Wage rates for Soviet joint venture workers were substantially above the national monthly average (rub 257); indeed, up to three times as high (Table IV.4.8). As to foreign trade, 166 out of the 541 joint ventures operating as of the end of June 1990 had exported goods and services abroad for an aggregate value of 88.5 million valuta rubles (80 percent in convertible currency). A larger number of joint ventures (247) had imported goods from abroad worth rub 400 million, with payments in convertible currency accounting for 48.6 percent. The vast majority (86 percent) of imports was made up of machinery and equipment, and computer technology in particular. The net convertible currency expenditure of these export-import operations amounted to rub 123.6 million. b. The current investment climate A fully comprehensive assessment of the climate for foreign investment would require a whole range of very detailed information on the operational dif­ ficulties actually encountered by foreign investors-information that is not readily available at present. On the other hand, anecdotal evidence and ad hoc research7 make it possible to single out some typical problem areas that have emerged since joint ventures began operating, and that have effectively constrained the scope of their business and limited their contribution to the development and restructuring of the Soviet economy. To shed light on the current investment climate, it may be worth considering the principal motivations underlying the decision of foreign and Soviet partners to establish joint ventures in the USSR before turning to assess the importance of the main negotiating and operational obstacles that it has been possible to identify.

(1) Motivations offoreign partners As of early 1990, the most common motivations for engaging in joint ven­ tures in the USSR appear to be: (1) the perceived opportunity for sales and profits in the Soviet market; (2) the desire to use the joint venture as a conduit for importing products made by the foreign parent company; and (3) the desire to establish an early foothold in the Soviet market, which could serve as a defense

78 against future competition from other foreign companies. It is also important to note that the desire to take advantage of Soviet capabilities in basic research and applied technology, the skills of Soviet workers, and the low wage level were among the motivations least commonly mentioned in early 1990. These perceptions seem to have undergone significant changes in the most recent period. It is probably true that the first wave of joint venture negotiations was primarily motivated on the foreign side by the perceived opportunity to operate in a new market and the desire to position oneself against future competi­ tion on that market. But the difficulties encountered in negotiating and operating joint ventures in the USSR, together with poor and deteriorating domestic economic and political conditions, have cautioned foreign investors. In particular, fewer foreign firms now expect to find in the Soviet market a short-term source of profit, and the high risks of investing in the USSR tend to offset concern about being out-positioned by the competition. At the same time, however, some of the motivations that were regarded as low-ranking during the early stages of the joint venture experience appear to be gaining in importance. Thus, the low level of Soviet labor costs has been increasingly viewed as an important incentive for foreign partners. The experience of many joint ventures operators has been that Soviet labor can be motivated--e.g. by higher wages, access to Western goods and travel, and career opportunities-to work diligently and to produce quality work. Moreover, for those firms that have taken the time to sift through the claims about Soviet strength in scientific research and engineering prowess, bright spots have appeared where Western partners now see potential for developing important new products or for producing at lower costs products that are marketable in the industrialized countries. 8

One motivation that appears constant and strong is to use joint ventures as vehicles for importing goods and services from foreign partners. The joint venture would use the imports to manufacture a product that is sold for convertible cur­ rency, usually domestically, and these earnings would be used in tum to pay for the imports. The joint venture may or may not earn any significant additional profit out of these transactions, but that may not be of primary concern to the partners. The essence of the arrangement is that it will enable the Soviet partner to limit the degree of interference by government authorities and provide both partners with leverage under the laws ~xtending certain benefits to joint ventures.

In some cases, joint ventures appear to have been set up primarily, if not exclusively, because they provide a relatively inexpensive and quick way to es­ tablish a physical presence in the USSR. This factor seems to be most important for smaller foreign companies, which often find it easier to identify a Soviet partner willing to establish foreign ties than to traverse the many bureaucratic obstacles to setting up a legal representation in the USSR. The positive economic impact of this "illusory" form of direct investment is likely to be marginal,

79 measured only in terms of that amount of additional business that is made possible by circumventing government interference. Given the present state of the Soviet economic system, it is not surprising that there should be cases in which the contribution of a joint venture to the Soviet economy may be perceived by some as negative. This situation occurs in particular whenever the purpose of the arrangement is simply to exploit an artificially high ruble price for certain products as compared to the world price, which is a direct result of the inconvertibility of the ruble and the distortions in the economic structure in the USSR. The proliferation of this particular type of joint venture may contribute to the image of foreign investors "profiteering" from regulatory arbitrage rather than contributing to the economic development of the country. Another consequence is that the Soviet authorities tend to overreact to the instan­ ces of such exploitation by joint ventures and promote overly broad restrictions­ such as those inhibiting "intermediary" functions of joint ventures-which, m tum, reduce the scope for economically-sound operations.

(2) Motivations of Soviet partners

From a broad policy viewpoint, joint ventures are an especially attractive form of commercial cooperation from the Soviet perspective for a large number of reasons including, in particular, the consideration that: (a) initial and ongoing capital contributions by the foreign partner provide badly-needed infusions of convertible currency and goods; (b) convertible currency earnings by the joint venture may be retained in the USSR through taxation and distribution of profits (or payments for goods and services) to Soviet entities; (c) foreign investment provides a vehicle for technology transfer; (d) the cooperation between the Soviet and foreign managers of the joint venture maximizes the opportunities for the transfer of management know-how, as well as employee training; and (e) the need for most joint ventures to export a portion of their production to Western markets as a means for earning convertible currency ensures that high quality will be observed, thereby providing a source of salutary competition for domestic producers and a source of quality goods for domestic consumers. Soviet negotiating partners are apparently not unambiguously supportive of the concept of entering into a joint venture. This results largely from the different perspectives and interest of ministry personnel-who often assume much of the negotiating responsibility-as compared to those of the subordinate enterprise, which would actually enter into the operational phase of the joint venture. It is well known that, in several instances, the enterprise concerned was not even aware that it was being positioned to take on the joint venture responsibility until serious bargaining had already begun, and it was quite common for the enterprise to be excluded-or cast in only a minor role-from the process of negotiation and preparation of supporting studies and documents.

80 Thus, until recently, the controlling motivations, at least at the initial stages of finding partners and beginning negotiations, were often those of the ministry or other superior bodies rather than the eventual operating partner in the venture. The situation in this regard could be expected to change noticeably due to the process of decentralization which gained momentum through 1990. In particular, if the ministries and other central bodies were to continue to lose control over the decisions of large enterprises nominally under their jurisdiction, the balance of influence in the negotiating process could shift towards the enterprises. In spite of these changes, foreign negotiators may still face a range of interests, rather than a unified position, on the Soviet side as long as many enterprises retain their monopoly position. This may appear paradoxical to the extent that it is usually assumed that monopoly power brings with it the capacity for a uniform position. However, monopolistic Soviet enterprises are also characterized by a very strong vertical organization: they may be in a commanding position with respect to producing goods for a consumer market that cannot reveal its demand through price signals, but they do not have the research or marketing base to change direction and work flexibly in a consumer-driven market economy. Consequently, to supply the necessary horizontal flexibility, a Soviet production enterprise may need to bring into the joint venture other entities, such as research institutes and foreign trade organizations for marketing and distribution. Hence, it is relatively common for a joint venture to have a number of Soviet partners and only one foreign partner. Moreover, experience suggests that several Soviet partners may not have much of a history of such cooperation. As a result, the foreign partner may face in negotiations-as well as in operations-a variety of Soviet institutions and motivations. Notwithstanding this potential for diversity, an enduring motivation shared by Soviet partners-particularly those at the enterprise or cooperative level-is the desire to gain political leverage and legal protection for the purpose of thwart­ ing bureaucratic interference as well as, in particular, to benefit from the tax and other advantages afforded to joint ventures (for details, see section 3). This being said, there are also more positive aspirations. A comparison of assessments by Soviet and foreign partners and experts indicates that the Soviet side is usually more optimistic about the intrinsic value of joint ventures than their foreign counterparts, and more sanguine about the future course of joint venture develop­ ment in the USSR. In part, this appears to be due to the fact that the Soviet media increasingly features stories about the successes of joint ventures and the favorable prospects for new cooperative arrangements with foreign companies. This media bias is probably not the result of a systematic plan to distort reality. Rather, it is the product of the initial enthusiasm for a dramatic new turn in East-West economic cooperation and, above all, a general lack of sophistication about the difficulties of developing commercial relations under present circumstances. Widespread cynicism about the potential of the Soviet economy to pull itself up by its own bootstraps has stimulated a trend towards a more positive and

81 hopeful assessment of the potential role of Western economic assistance and cooperation. Thus, although there is some popular discontent over the privileged position of Soviet joint venture employees and growing concern about the sup­ posed environmental costs of foreign exploitation of national resources, joint ven­ tures and their potential contribution to the economy continue to enjoy periodic resurgences of interest in the context of new economic programs. Within this generally positive assessment of the potential of foreign invest­ ment, the principal explicit motivation cited by Soviet partners is the desire to develop exports to the West. At the same time, they do not seem to place much importance on gaining a stable foothold in the world market. This apparent con­ tradiction stems from the fact that Soviet manufacturers do not generally believe that their goods would be appealing enough to capture Western markets, even if produced in the joint venture context. They do aspire, however, to make discrete sales for convertible currency where opportunities arise. From the Soviet perspective, personal motivations are at least as important as institutional ones. Employment in a joint venture is seen by many Soviet managers and workers (especially scientists and other experts) as a close second best to employment in the West. The perceived benefits are relatively obvious, ranging from higher salaries and perquisites, such as travel to the West or access to Western goods, to the chance for career development and an outlet for pre­ viously suppressed creativity.

(3) Obstacles to negotiation When asked to rate potential negotiating issues-i.e., issues that were con­ sidered to be important during the negotiation stage and which proved to be difficult to deal with in the drafting of the founding documents-according to their relative importance, the predominant concern of foreign partners was the non-con­ vertibility of the ruble. Other issues frequently cited as both important and difficult to resolve include obtaining office and work space, product quality control, management control and decision-making, and financing from foreign sources. 9 Contrary to popular belief, the identification of a proper partner does not seem to rank high in the list of Western companies' concerns. Many Western firms appear to be ready to sign on with the first reasonable candidate that shows up--particularly in the case of joint ventures set up on the basis of "foot-in-the­ door" or "rule-circumventing" strategies. This tendency is reinforced by the. fact I that often a ministry or other central agency has been the initial contact for the foreign side and this central authority has then decided which Soviet entity to tap as the operational partner. However, as central authority diminishes and enterprise independence grows, this directing function from the center will decline. As al­ ternatives to state enterprises-such as cooperatives, other joint ventures, and joint stock companies etc.-develop as potential partners for foreign firms, the question of finding the right partner may loom larger in the initial calculus on the foreign

82 side. An improvement in the availability of information on investment conditions and opportunities may be expected to occur in the future as a result of greater advertising efforts on the initiative of business advisory organizations, such as chambers of commerce or business federations, and of the Soviet companies them­ selves.

(4) Obstacles to operation Important operational problem areas cited by foreign partners include the hiring of Soviet workers, the sale of products in the USSR, quality control, financ­ ing from foreign sources, political risk insurance, customs duties and tariffs, and relations with local government authorities. This latter concern is generally ex­ pressed in complaints about the lack of a clear legal framework governing rela­ tions between the joint venture and government at local, republic and all-union levels. The Soviet authorities are well aware of the deficiencies in this regard, but relief has been very slow in coming and the proliferation of new reform plans has further delayed their resolution. In this connection, the absence of a key element of Western jurisprudence-administrative procedure law-is most acutely felt. Foreign partners need a regulatory framework incorporating opportunities to pro­ vide input to government administrators before they make decisions, to examine a record of the decision-making process leading to a ruling, to request administra­ tive reviews of decisions, and to seek judicial review of administrative actions deemed contrary to law. The most acute operational problem appears to concern, however, the dif­ ficulty of developing a reliable means of securing supplies. Given the seriousness of the overall situation in this respect, a more refined perspective can be obtained by considering several factors of direct relevance to this issue. First, supply is a major, and growing, problem for all enterprises in the USSR and many joint ventures are not in a particularly disadvantaged position in this regard-but this consideration is, of course, of little comfort to foreign investors. Even though they are formally outside the central planning and allocation systems, the negative effects of this exclusion are sometimes attenuated because, in the case of priority sectors, the Soviet partner or its superior ministry may provide the joint venture with supplies from their own allocations. As the central system breaks down, it is gradually being replaced at the margin by negotiations between suppliers and manufacturers, usually involving the same parties as under the central system. 10 Other considerations pertinent to the supply problem, however, include the fact that some joint ventures (especially in the services sector) have relatively few material supply requirements and that many of them may rely on imports. Be that as it may, the vast majority of joint ventures face severe local procurement constraints that seriously affect the scope for operating in an efficient manner. Under these circumstances, several ventures have attempted to address the supply problem by producing in-house some of the essential inputs (but this

83 of course entails a diversion of managerial and financial resources from the venture's core activities) and by developing horizontal linkages to strengthen interfirm cooperation. In most cases, however, these practical approaches to the supply problem are not sufficient to overcome the difficulties resulting from the narrowness of the network of suitable domestic trading partners. Management is another problem area identified by many ventures as of equal importance with that of supply. In general, the focus of complaint about "opera­ tional management" centers on the lack of experience of Soviet managers and key employees in operating in a market environment. In particular, severe problems appear to exist in such areas as the understanding of profit as a motivating force, the need to keep looking ahead to the next product or the next marketing tool, the importance of compressing costs, and maintaining sensitivity to possible competi­ tion. Predictably, a host of problems associated with poor economic infrastructure are targeted as critical roadblocks. No doubt, one of the most serious is confusion about Soviet accounting methods: issues concerning depreciation and allocation of pretax profits to certain funds are in the forefront in this regard. 11 It is worth noting that work is underway to address some of the problems connected with existing accounting practices. Poor infrastructure, including domestic and interna­ tional communications, hotel and office facilities, banking and related financial services, and housing and amenities, also are major practical barriers to foreign investment. Finally, timely payment in convertible currency by Soviet purchasers was not a problem until late 1989, but delays have subsequently arisen in the trade area. There is as yet no clear indication that this problem has become important to the operation of those joint ventures that sell their products for convertible currency in the Soviet market, but there is some evidence that foreign partners may be becoming more circumspect in this regard.

3. THE REGULATORY SETTING In recent years, the regulatory framework pertaining to foreign direct invest­ ment has undergone a profound transformation. Until 1987, foreign investors' involvement in the USSR was confined to a limited range of contractual forms­ such as payback, license or turnkey agreements-that did not involve the estab­ lishment of a legal entity. The first legal instrument dealing explicitly with foreign direct investment was a 1987 government decree which established the legal con­ ditions for the setting up of joint ventures. 12 The decree was subsequently modified in 1988 13 in response to foreign business criticism and with a view to improving the scope for inflows of foreign capital, which had not materialized to the extent anticipated by the authorities. New laws were under active consideration in 1990 at the all-union level as well as in individual republics. 14

84 a. The present situation

(1) Authorization procedures There are two general approaches that a country can take in determining what sectoral and/or geographical areas are open to foreign investors. On the one hand, an approach based on a "positive list" can be adopted, which would single out the sectors and areas where foreign investment is allowed. Alternatively, a "negative list" principle may be used, which specifies where such investment is not per­ mitted. While logically these two approaches can lead to the same specification of areas open to foreign direct investment, it has generally been the case that a positive list approach turns out to be more restrictive. There is also an important philosophical distinction between the two systems in that the negative list ap­ proach conforms to the basic principle that a foreign investor should be permitted all forms of business that are not specifically prohibited by law or regulations. The USSR has adopted a "modified" positive list approach to foreign invest­ ment by specifying the characteristics of foreign direct investment it wants. Thus, in order to be approved under the current system, a foreign investment should have several of the following characteristics: (i) it should supply goods needed on the domestic market (consumer goods in particular); (ii) it should supply needed inputs (e.g., capital, equipment, technology, management expertise); and (iii) it should contribute to increasing exports or reducing imports. These specifications are relatively broad, and for that reason may not be too restrictive in and of themselves. It is when these requirements are taken in conjunction with other characteristics of the system that they become more constraining. The screening process to ensure that an investment meets these tests is rather complicated in practice. 15 Consent is required by the "supervisory agency" (usual­ ly the sectoral ministry) that is responsible for the Soviet partner in the venture and, in addition, the joint venture has to be registered by the Ministry of Finance. These registration procedures involve a substantive review to ensure that the proposed venture meets the tests set out above as well as an analysis of the feasibility of the project and its economic and financial aspects. In the screening process, the legal form of the venture 16 and the share of foreign ownership do not seem to be at issue. Foreign investors are now allowed to own 100 percent of the share capital and the foreign partner is otherwise subject to very few limita­ tions on its shareholding in the venture. Indeed, it is up to the partners to agree on the contents and valuation of the respective contributions as well as to the respective shares in the statutory capital ("authorized fund"). It is, of course, possible that ownership restrictions are more restrictive in practice than it would appear from the regulations. In the process of securing approval from either the branch ministry or the Ministry of Finance, an implicit restriction on ownership shares may be imposed as a condition for approv~l. This is a situation which arises often in those countries where approval criteria are not

85 transparent and spelled out in detail. Indeed, lack of transparency--coupled with the absence of a requirement that the licensing authorities should make a deter­ mination on an application within a specified time limit-would appear to be a major drawback in the present Soviet authorization system.

(2) Labor and management Foreign investors are always concerned about their ability to manage the joint ventures in which they invest. These concerns include the legal right to make decisions without interference from the government, to have management authority commensurate with ownership, to be in a position to obtain sufficient ownership resulting in management control if that is deemed appropriate in the circumstances, and to bring in their own people to be managers if that is desirable. With regard to these matters, the USSR seems to offer a relatively favorable environment for foreign firms to participate in the management of joint ventures. Virtually any ownership structure is permitted, and representation on the Board is to be decided by mutual agreement among the partners and can be proportional to ownership. A foreign national can serve as chairman of the Board and managing director; other management positions are also open to foreigners. These provisions are liberal relative to those prevailing in many countries, where Board repre­ sentation is often biased in favor of the local partner and the number of foreign nationals is made subject to specific limitations. True, some "fundamental" issues have to be resolved by unanimous agreement of all Board members regardless of Board composition, but the definition of what constitutes a fundamental issue is left up to the partners. Ordinary Soviet laws on employment and conditions of work do not apply fully to joint ventures. Recruitment and dismissal procedures as well as wages and other material incentives can be freely determined by the partners. Foreign nationals can be employed without limit or any special permission on the basis of individual contracts, which would stipulate wages, currency of payments, leave, pension rights, etc. Salaries to Soviet citizens are not subject to any ceiling, though payments must be made in rubles. As is the case for state enterprises, joint ven­ tures can allocate 25 percent of convertible currency profits to a fund for social development, which can be used for importing goods for employees. A joint venture is required to conclude a collective bargaining agreement with a trade union organized within the enterprise. The venture is also required to contribute to the state social security and pension systems on the same basis as for Soviet enterprises. Taken overall, the regulatory system applying to employees and workers of joint ventures provides for a vastly superior treatment in comparison with that of Soviet enterprises. Workers can be, and indeed are, substantially better paid in terms of both basic salary and additional incentives while retaining a broad range

86 of social protection, including representation in trade unions and a system of collective bargaining.

(3) Operational framework

According to present laws, joint ventures are free to develop their own strategic and operational plans, to purchase and sell through the local wholesale or branch supply system, and to carry on transactions on foreign markets on their own account. Payments for local inputs and sales can be made in rubles or in convertible currency on the basis of agreements with the counterpart. Another special characteristic of joint ventures is that they operate outside the state plan­ ning system. This is a clear advantage in terms of operational flexibility but it also implies that there is no government guarantee for any supply of raw materials, components or other needed inputs. The critical importance of this element has been noted previously but it is important to stress here that the present state of affairs in this regard goes a long way to explain the reticence with which potential investors consider the possibility of setting up industrial firms. In addition to the issue of local procurement, two regulatory constraints are at the forefront of foreign partners' concerns for the commercial viability of joint ventures. The first relates to the existing limitations on the "intermediary" func­ tions17 in which joint ventures may engage. The second, and certainly more fundamental, concern is connected with the functioning of the present system of foreign exchange allocation. The ability to obtain foreign exchange in order to import equipment, spare parts, and raw materials as well as to repatriate profits and capital is one of the most important elements in the investment environment for both actual and poten­ tial investors. Moreover, the need to repatriate profits is a crucial consideration in 1990 that distinguishes foreign from domestic investment. There is almost nothing in an investment environment, except perhaps a threat of expropriation, that dis­ courages foreign direct investment more than uncertainty in this area. The system currently in place for providing foreign exchange to foreign investors involves considerable uncertainty of supply. Basically, joint ventures have to generate all the foreign exchange they need. To do so, they are allowed to retain all the foreign exchange they earn through exports of their own products and sales against convertible currency -on the domestic market. Admittedly, there is also a vague provision for the government to supply foreign exchange if local sales substitute for imports, or if the project otherwise has a high national priority; how, and to what extent, this is actually done, however, is unclear. By and large, although joint ventures are treated better under this system than Soviet enterprises, foreign investors regard this type of foreign exchange allocation system as being highly unsatisfactory and hindering the development of locally-oriented manufac­ turing and services activities.

87 In addition to the very real operational difficulties to which it gives rise, the foreign exchange allocation system provides scope for a number of structural distortions. On the one hand, the differential treatment between domestic enterprises and those with foreign participation makes it attractive for Soviet productive entities to bring in foreign investors solely to enjoy the possibility of 100 percent retention rights-and, indeed, such bias has reportedly resulted in the establishment of a large number of joint ventures with "sham" foreign participa­ tion. At the same time, foreign investors for their part are discouraged from in­ vesting in the USSR unless they plan to operate in sectors which can generate substantial foreign exchange income. Thus, the system is biased towards invest­ ment in industries where the USSR has a comparative advantage in exporting. As long as the present system remains in place, supplying the domestic market will be less interesting and will not generate much of a response from foreign investors, even though the size of the Soviet market might potentially be one of the main attractions for them.

(4) Financing Joint ventures are required to operate on a cost-accounting and self-financing basis: they are not, therefore, entitled to state subsidies. On the other hand, financ­ ing of start-up and operating costs can be structured to include convertible cur­ rency borrowing, 18 from foreign sources as well as from the Vneshekonombank (VEB), and ruble funding from Soviet banks. The VEB is entitled to extend credit to joint ventures outside its overall annual ceiling for convertible currency opera­ tions, to extend guarantees on the basis of a commercial assessment, and to grant licenses for borrowing operations on the international market. Such a license would be granted only after an examination of the terms of the transaction and related guarantees to ensure that they do not deviate significantly from market conditions. On the whole, financial regulations do not seem to discriminate against enterprises with foreign participation, which in fact enjoy better than national treatment in several respects. Rather, the problems joint ventures have en­ countered result mainly from the blatant inadequacies of the financial infrastruc­ ture, especially with regard to the practical difficulties of executing foreign currency transactions in a highly centralized system, the lack of even relatively unsophisticated financial instruments and services, and operating constraints resulting from the archaic payments and settlements system currently in place.

(5) Tax and other incentives The USSR provides several incentives to foreign investors. The tax rate on profits is lower for joint ventures than for domestic enterprises and the former enjoy a two-year tax holiday from the accounting year when a taxable profit is attained for the first time, which can be extended for priority projects. 19 In

88 addition, the import of equipment or other property that constitute a foreign partner's contribution to the initial capital of the joint venture is exempt from import duties, and the venture's imports of production inputs are subject to the lowest or zero duty. As already noted, joint ventures enjoy other advantages rela­ tive to Soviet firms (particularly with regard to currency retention and flexibility in hiring, wages and pricing)-although the overall level of specific incentives for joint ventures does not seem higher in the USSR than that offered in other countries where, for example, ten-year tax holidays are not unusual, cash grants are given, and imports of equipment are duty-free, regardless of their financing. This being said, two important considerations would seem to apply to Soviet policy in the area of fiscal incentives to foreign investment. First, there would seem to be no reason for a further extension of fiscal incentives. As a rule, fiscal incentives are thought to be ineffective in influencing investment decisions, except possibly in the case of industries aimed almost exclusively at the export market. More generally, tax and other incentives are no substitute for an appropriate mac­ roeconomic and political environment to promote foreign direct investment. In the case of the USSR, if the foreign exchange allocation system can be adjusted to provide opportunities for foreign investments aimed at supplying the domestic market, then fiscal incentives could be deemphasized. In that event, a sensible tax system based on relatively low rates and other pro-investment features such as loss carry-forward, could fruitfully replace the types of fiscal incentives now in place. Second, existing tax incentives are a particularly strong force motivating the formation of joint ventures, irrespective of the extent to which they would actually satisfy an economic need and regardless of the real contributing of the foreign investor. This is because the benefit of the special tax treatment accrues to the venture as a whole, rather than only to the new investment. While most countries that give tax holidays relate them to the additional profits generated by the new investment, tax benefits in the USSR extend to the entire venture in which the foreign investment is taking place. This implies that, for example, a venture set up by a Soviet enterprise contributing existing assets for 70 percent of the capital (and with the remaining 30 percent being accounted for by foreign partners) can benefit from at least a two-year tax holiday and a comparatively low tax rate thereafter. As a result, the profits generated by the assets contributed by the local enterprise are taxed at a privileged rate (if at all) solely because they are in a joint venture. Such a system is clearly biased towards the establishment of "artificial" ventures, rather than encouraging productive investments.

(6) Profit remittance and repatriation of capital The remittance of profits and repatriation of capital are not subject, in prin­ ciple, to limitations or restrictions. A foreign partner has the right to transfer its share of foreign currency profit2° in any currency, and on the basis of the official

89 exchange rate (the new commercial rate as from November 1990), without any special approval or authorization. The same applies to the repatriation of assets resulting from the sale of shares to a third party or the liquidation of the venture. Transfers of profits are subject to a 15 percent withholding tax (to be paid in the currency of transfer), but exemptions or abatements are available in cases where a double taxation agreement applies or for ventures located in developing areas or operating in priority sectors. On the face of it, the regulations governing dividend transfers do not seem particularly restrictive, even considering that the application of the withholding tax results in a double taxation of realized profits. Foreign investors are, however, severely penalized in an indirect manner on at least two counts. First, the pos­ sibility of transfer is conditioned by the availability of sufficient convertible cur­ rency within the venture, on account of the self-financing principle. When the joint venture fails to generate sufficient convertible currency, the absence of con­ vertibility of the ruble is likely to give rise to "artificial" transactions to improve the self-financing position in convertible currency. Second, "ruble profits" cannot be transferred abroad or, indeed, used for alternative investment within the USSR-thereby reducing the potential profitability of local market based ac­ tivities.

(7) Investment protection and dispute settlement Private property has only recently been recognized in the USSR with the approval in March 1990 by the Supreme Soviet of a law establishing the right of private ownership, although the specifics still remain to be determined by the individual republics. Moreover, joint venture decrees prohibit expropriation of joint venture property or confiscation by administrative order. This evident progress notwithstanding, it remains true that domestic legal mechanisms to protect private property have not been fully developed as yet and there continue to exist major uncertainties about the application of the law in a number of im­ portant areas. Disputes between joint ventures and Soviet organizations, among joint ven­ tures, or among partners to a joint venture may be resolved in Soviet courts under Soviet law or by arbitration within the USSR. However, it is also possible for partners in a joint venture to take disputes among themselves to arbitration outside the USSR if agreed by both parties. External arbitration awards are enforceable in the USSR, which is a party to the 1958 New York Convention on the Recog­ nition and Enforcement of Foreign Arbitral Awards. As far as bilateral investment agreements are concerned, the USSR has negotiated 17 treaties with home countries of potential foreign investors, but none of these has been ratified to date by either the USSR or the other countries in­ volved. In general, these agreements are based on MFN principles and provide guarantees for profit repatriation, full compensation to investors, settlement of

90 disputes and subrogation rights. Consideration is being given to including provisions on improved market access, business facilitation measures, and intel­ lectual property right protection. The USSR is in the process of establishing the legal and administrative basis for adequately protecting the property of foreign investors and providing for dis­ pute settlement mechanisms. These emerging mechanisms draw credibility from the reputation the USSR has built over the years as a reliable commercial partner in dealings with foreign firms. On the basis of this reputation, there may be a presumption of general intent to protect fully the interests of foreign direct inves­ tors. Whether this presumption works out in specific instances will depend on the future development of an adequate legal infrastructure. b. Reform measures and proposals

A new foreign investment law has long been under consideration in the USSR Supreme Soviet. Moreover, laws dealing with foreign investment issues are also being drafted in individual republics, with the RSFSR being on the verge of adopting a comprehensive legal framework on foreign investment. Of course the fact that several laws are being considered at the same time at both union and republic levels raises the issue of potential legal conflicts. At a minimum there is a clear need to coordinate the provisions of these laws and, more fundamentally, decisions need to be made concerning the allocation of powers in this area among the union, the various republics and the local authorities concerned. As a matter of principle, a decision to replace earlier decrees with laws would represent a positive development. The legislative process provides an opportunity to make improvements in the rules governing foreign direct investment as well as to build political support for the adoption of a liberal attitude towards foreign investment and for setting conditions in place which could contribute to a more favorable investment climate. Finally, a law provides more stability for the inves­ tor than a decree which, as experience shows, can be more easily changed. Notwithstanding a desire to regulate foreign investment through a com­ prehensive law, the recently announced reform measures in the foreign investment area have once more taken the form of decrees. 21 This being said, they represent a significant step towards reducing barriers to foreign investment and improving the specific legal setting within which foreign investors will operate. The new presidential decree on "Foreign Investment in the USSR" centers on the basic principle of applying national treatment to foreign investors, with exceptions being confined to a limited number of cases to be specified in the law. This implies, inter alia, that foreign investors will be allowed to be established in all legal forms existing in the USSR, viz. not only as joint ventures but also as joint stock com­ panies, partnerships, cooperatives and associations. Moreover, the possibility of

91 making such investment will be open not only to legal entities but to private individuals and international organizations as well. Under the new decree, wholly-owned subsidiaries of foreign companies will be permitted, as will inward portfolio investment and the acquisition of sharehold­ ings in Soviet enterprises and of financial assets and real property. 22 The pos­ sibility of operating wholly-owned subsidiaries is of considerable importance for foreign investors in that it provides them with freedom to choose the investment modalities best suited to their particular needs. True, full ownership is by no means an essential condition for all foreign investors, but it can be crucial in certain areas, such as the protection of intellectual property rights in high-tech­ nology investments or where the management philosophy of the company (regard­ less of its activity) requires full control and ownership. Consideration is being given to establishing a set of "principles" at the union level which would provide the basis for foreign investment legislation to be enacted at republic and local levels. The registration procedures would in principle be the same as those applying to domestic companies. Thus, approval by the branch ministry of a joint venture partner would no longer be required. The specific modalities of the approval process would depend on the size ·of the company's initial capital (rub 100 million being the threshold) and on whether the foreign investor has 100 percent ownership. Large wholly-owned subsidiaries would probably need approval by the USSR Council of Ministers, while authoriza­ tion for smaller ones would be granted by the individual republics. The registration of joint ventures would be delegated to the republics, with small ventures required to register only with local authorities and large ones with the republican ministry of finance. To limit the scope for the establishment of "artificial" joint ventures­ i.e., ventures whose primary purposes are to circumvent the existing requirements for setting up a legal representation in the USSR and to obtain tax benefits-new companies with foreign participation would be required to pay in at least 50 per­ cent of the initial capital within one year. No doubt, the new registration process would provide foreign investors with more flexibility and greater scope for choosing the legal structure of the company, but there would still remain a number of unresolved issues limiting the transparen­ cy and predictability of the system being set in place. The most important would seem to be the degree of compatibility and coordination among the various legal provisions and the requirements of republics and territorial entities. 23 Another is the absence of a well-defined decision-making process applying to the bodies in charge of granting authorizations and, especially, the lack of an appeal mechanism. Management and labor provisions have been left largely unchanged in the new decree, which has restated the principles that top management positions are open to foreign citizens and that a company with foreign participation is required to set in place a collective agreement with labor. Similarly, no significant changes

92 have been introduced in the area of incentives but the matter is under review in individual republics. 24 On the other hand, the new decree provides explicitly for the right to repatriate dividends and profits, though it makes this right contingent on the specific provisions of Soviet laws-which have not yet been finalized. The possibility of applying third-country law and arbitration to dispute set­ tlement among joint venture partners, or even with other state organizations if agreed by both parties, has been made more explicit in the various draft laws which, however, do not always incorporate terminology recognized in internation­ al law. And the extent to which compensation would be granted in the case of expropriation does not seem to meet fully international adequacy standards. 25

4. SUMMARY AND RECOMMENDATIONS Joint venture activity in the USSR has so far been characterized by two major paradoxes: first, a rapid formation of new joint enterprises has not been reflected in a commensurate volume of foreign investment and, second, the progressive liberalization of policies and legal requirements has not generated any significant­ ly greater interest in doing business in the USSR. The structure and contents of the specific legal regime governing joint ventures are not the primary disincentive to foreign investors. Rather, the main problems stem from the risks and practical difficulties of conducting business under the Soviet system, especially the uncer­ tainties and operational vulnerabilities resulting from the coexistence of what remains of the centralized planning and allocation mechanisms with more market­ oriented arrangements for the joint venture sector. Under these circumstances, joint ventures have not been integrated into the Soviet economy and operate to a large extent in quasi-enclaves, specializing in operations where high returns are possible with low levels of capital commitment by exploiting gaps and distortions in the existing system. The relevance of these considerations is clearly borne out by an analysis of the motivations behind the decision to operate joint ventures. Soviet interest has been driven mainly by regulatory considerations, especially tax and foreign ex­ change availability, which are strongly favorable to this particular form of cor­ porate establishment. Foreign interest is largely driven by possibilities of exploiting price distortions for (more or less disguised) arbitrage opportunities or foreign investment incentives currently in place. Despite these distortions, it is probable that joint ventures are making an important economic contribution by transferring ideas and skills relevant to "doing business" and diffusing initiatives and expertise. But there is also ample evidence that their contributions to develop­ ing the internal market and to exposing local enterprises to competitive conditions are dramatically underrealized. Notwithstanding the lackluster performance to date, the positive contribution that foreign direct investment can make to the revival and modernization of the

93 Soviet economy should not be underestimated. Its promotion should be seen as part of any program aimed at significantly improving economic conditions. Foreign investors' involvement in the economy will be critical not only for upgrading productive capacity in terms of capital, technology and managerial skills but, more fundamentally, as a catalyst for instilling a "culture of the market" and for developing the premises for an efficient functioning of the market place by exposing domestic enterprises to competitive influences. Looking ahead, the prospects for market-driven foreign investment to in­ crease significantly depend crucially on the elimination, or at least sharp attenua­ tion, of the prevailing price and administrative distortions that pervade the Soviet economy. Another indispensable requirement is the establishment of a confidence­ promoting legal framework for business activities. Finally, the adoption and im­ plementation of sound, transparent and forward-looking policies are a necessary basis for stimulating investors' long-term commitments of capital and human resources. In other words, reform in the foreign direct investment area should be seen as an integral element of a broad program aimed at widening the scope for doing business in the USSR. This should include, inter alia, the development of competitive market structures, the introduction of modem commercial law, includ­ ing the basic elements of contract law, improvements in the provision of in­ frastructure and financial and business services, and sustained progress towards the convertibility of the ruble-all essential prerequisites that go well beyond the framing of an appropriate foreign investment law. A global overhaul of the Soviet economic and regulatory system might be based on a three-pronged approach encompassing: (i) the broad constitutional and legal features of the Soviet system; (ii) the economic setting within which foreign investors operate; and (iii) the specific regulatory framework pertaining to foreign investment. The following recommendations are not ranked according to a specific order of priority and many of them should be seen as complementary to, and interacting with, more fundamental reforms aimed at instilling economic rationality in the Soviet system. Although the precise sequencing of these measures depends on the pace of the more basic reforms, both the seriousness of the economic situation and the magnitude of the benefits that would accrue from substantial foreign involvement suggest that action in the foreign investment area should be undertaken on a broad front and without delay. On the constitutional front, there is a vital need for an unambiguous deter­ mination of the status of private sector activity within the emerging legal framework, with a clear allocation of responsibilities to the different levels of government. This involves, inter alia, a resolution of the issue of the primacy of law between the union, the republics and other local authorities in the area of foreign direct investment and a determination of the extent to which an integrated internal market will be maintained in the country. To the extent that foreign direct investment will be regulated under laws emanating from different levels of

94 government, it is imperative to ensure full compatibility among the various rules and regulations. The experience of the recent past shows clearly that legal uncer­ tainties can be highly detrimental to the promotion of investors' interest in entering the Soviet market. Regulatory compatibility and predictability are to be seen as essential elements for reducing such uncertainties and for confirming the authorities' resolve to pursue liberalization in the foreign investment field. A broadly-based and coherent recasting of the legal structure for private sector activities is critical for attracting foreign investors. This involves the estab­ lishment of a legal framework adapted to the realities of a market-based economy in areas covering private property, contract law enforcement, competition, bankruptcy, desirable labor relations, and accounting. An issue which calls for particular attention in this regard relates to the introduction of adequate legal provisions enabling foreign investors to mortgage assets and transfer leases as a means for facilitating local and foreign debt financing. Effective steps should be taken to facilitate the creation of commercial com­ panies and enterprises that could become viable partners in joint ventures with foreign investors and to develop procedures for restructuring ventures when local partners disappear, particularly if this is the result of government reorganizations. The clarification of responsibilities and relations between government bodies and private companies and the establishment of specific legal mechanisms to support and protect private enterprises are to be seen as preconditions for dealing with some of the most important disincentives to foreign investors' involvement in the Soviet economy. Foreign investors must be in a position to rely on a more assured source of foreign exchange. To this end, progress towards currency convertibility and a reduction in the existing large distortions between domestic and world prices should be pursued vigorously and as a matter of urgency. In this context, the recent decisions to set in place an auction market for convertible currency open to foreign enterprises, to introduce a more realistic exchange rate for the ruble, and to broaden the scope for profit repatriation are all important steps in the right direc­ tion. Further action will, however, be needed to ensure that the auction market is sufficiently liquid to be effectively usable by foreign investors. Local procurement constraints constitute a major operating obstacle for foreign enterprises and this issue should be tackled as a matter of priority. The rapid development of domestic wholesale markets, the improvement and enhan­ cement of local financial markets, and the liberalization of the foreign trade regime are all indispensable conditions for addressing this issue. While recognizing that liberalization in the trade area would be of major relevance for the proper functioning of the economy as a whole, such action may prove vital in supporting the development of enterprises with foreign participation-whose difficulties in procuring needed inputs on local markets are exacerbated by their lack of access to the state allocation system.

95 Urgent consideration should be given to liberalizing, streamlining and making more transparent the authorization rules and procedures applying to private foreign investment. If screening is considered necessary during the tran­ sition, it should be limited to a "negative list" of sectors where remaining domestic distortions are such that the risk of counter-productive foreign investment is par­ ticularly severe. Screening procedures should be based on transparent, clearly­ specified and unobtrusive criteria. The sectoral coverage and operational modalities of the screening system should be reviewed periodically with the aim of phasing it out as economic reform proceeds. Soviet preferences for foreign investment in "productive" rather than services sectors do not conform to the requirements of a modern economy. The social return to investment in services is likely to be high in a large number of areas. Enterprises with foreign participation can play a major role in the promotion of efficient services markets and their contribution should be encouraged through the removal of implicit and explicit impediments to investment in service industries. In this connection, and subject to the screening procedures noted earlier, early consideration should be given to lifting the existing general restrictions on inter­ mediary activities of joint ventures. A significant improvement in the climate for foreign investment would be achieved through a strengthening and acceleration of the process establishing the legal and administrative basis to provide full investment protection (including protection of intellectual property rights and against expropriation), to guarantee the repatriation of investment income and liquidation proceeds, and to set in place appropriate arbitration and dispute settlement procedures. The process of con­ fidence-building would no doubt be enhanced if such mechanisms and procedures were to conform closely to internationally-agreed principles and understandings and if the USSR were to proceed with ratification of bilateral investment protec­ tion treaties and to become a full participant in international organizations provid­ ing political risk insurance and dispute resolution. As a general principle, policies towards foreign direct investment should aim at promoting a level playing field through reliance on the principle of national treatment, whereby foreign investors would not benefit from special incentives relative to domestic investors. Although it is recognized that investment incentives cannot substitute for an appropriate economic and political environment to attract foreign capital, the maintenance of some positive discrimination in favor of foreign investors may be justified under present circumstances as a means of partially offsetting the existing distortions and structural inadequacies of the Soviet system. It is also clear that if, as a transitory device, special incentives in favor of foreign investors are to be maintained, they should be strictly limited in terms of their budgetary implications and time frame. During the transition to a more rewarding investment environment, there may be considerable scope for mobilizing large-scale foreign investment through the

96 structuring of self-contained direct investment arrangements, such as capital-in­ tensive projects in energy and natural resource exploitation and possibly also in certain segments of the reconverted defense industries. Such arrangements-in which the precise parameters governing the project are fully negotiated in ad­ vance-are less dependent than other types of direct investment on the overall reform of the Soviet economy. The potential payoffs to such projects are suffi­ ciently large to both the USSR and foreign participants that means could be found to overcome specific difficulties arising from the lack of appropriate infrastructure and other weaknesses of the present economic system. This being said, it will still be necessary to create an adequate framework for such deals, e.g., by establishing the broad terms for exploration and development in line with general practices. Furthermore, the pursuit of these opportunities should not be seen as an alternative to the fundamental reforms needed to attract foreign direct investment across a wide range of economic sectors.

NOTES

I. A new form of investment that may be expected to play an increasing role is the purchase of shares by foreigners in existing or new Soviet enterprises or cooperatives. Contract joint ven­ tures--consisting in essence of a joint project between foreign and Soviet partners without ownership interests and obligations in a new entity-may also become more common. And wholly-owned foreign enterprises are permitted by the presidential decree of October 26, 1990. 2. The analysis in this section draws on two primary sources: the registration records of the Ministry of Finance and data based on reports submitted under law to Goskomstat by joint ventures. At present, joint ventures are required to submit on a regular basis two types of documents: (i) a quarterly accounting form providing details of output (volume of manufac­ tured items and services rendered), labor (number of persons on the payroll and expenditures for wages), exports, imports, and sales on the Soviet market against payments in rubles or foreign exchange; and (ii) an annual report which should include the balance sheet of the joint venture, a profit and loss report, and an appendix covering. inter alia, data on the movement of capital stock, the composition of fixed assets, details on production costs, and selected financial flows. There are a number of deficiencies in both of these primary sources. With regard to the data compiled by the Ministry of Finance, available information is incomplete (records were not available for about 4 percent of registered ventures), some of the key in­ dicators (especially those relating to capital investment) are presented in a potentially mislead­ ing form, and the description of sectors of economic activity does not follow a recognized scheme such as the International Standard Industrial Classification (!SIC). No information is currently collected on such items as the actual contribution to the capital stock made by each of the partners, the costing of technology contributed by the foreign partners, the volume of foreign credit granted to the joint venture and related interest payments, and the value of a joint venture's direct investment in affiliated branches and subsidiaries in the USSR or abroad. Moreover, since the Goskomstat data collection system has been in operation only for a short time, it encompasses information only for the first half of 1990. 3. Valued at the official exchange rate, the estimate of rub 500 million can be arrived at by considering that the share of foreign investors in the initial capital of joint ventures stood

97 below 50 percent in mid-1990 and that the convertible currency portion of such contributions is unlikely to have exceeded 25 percent. The actual inflow of convertible currency funds into the USSR may have been noticeably lower than the above estimate to the extent that not all "initial" capital has been paid in to date. 4. Data on "capital contribution" should be treated with caution. First, no distinction is made between a joint venture's "statutory fund" and actual paid-in capital. According to Soviet officials, in many joint ventures the amount actually paid in is only a small fraction of the initial capital contribution provided for in the "statutory fund." Second, the valuation of the various components of the "capital contribution" is somewhat arbitrary. Thus, the contribution of the Soviet partner often includes land and building, neither of which have established market prices and, in the case of land, may be highly inflated in view of the fact that the Soviet partner does not have ownership rights to the land. The contribution of the foreign partner may include trademarks, know-how, patents, marketing rights, market access and other intan­ gibles that may be valued at prices intended to allow the parties to reach agreement on per­ centage ownership rather than through a calculation of intrinsic values. Indeed, according to market estimates, the actual convertible currency contribution is usually of the order of only 20-25 percent of the total foreign contribution. Finally, all contributions of the foreign partner are converted into rubles at the official exchange rate, a valuation which may significantly understate the foreign contribution in terms of rubles. 5. It should be noted; however, that several large-scale joint ventures in capital-intensive industries are under active negotiations which, if completed, could change significantly the present statis­ tical picture. 6. These tables are based respectively on ad hoc sectoral classifications used by the Ministry of Finance and Goskomstat. 7. The assessments in this section are based, inter alia, on replies to a questionnaire addressed to a sample of joint ventures in April 1990, supplemented by interviews conducted sub­ sequently. 8. These impressions are based on interviews with Western firms that were recently negotiating joint venture or other cooperative agreements in the areas of computer technology and aerospace technology, including composite materials. 9. Other negotiating issues viewed as important, but not particularly difficult to resolve, include the agreement on business objectives, valuation of contributions, partnership share, protection of intellectual property, financing from Soviet sources, and figuring input and output prices. 10. Consideration has also been given to using the new law on joint stock companies and the anticipated privatization of Soviet enterprises to create new distribution mechanisms, e.g., whereby a user would buy an ownership share in its suppliers in order to ensure reliable deliveries. II. Calculation and distribution of profit is often referred to as a major issue in the context of joint venture accounting. This relates, inter alia, to methodologies concerning recognition of earnings and expenses, depreciation rules, formation of provisions, and the creation of special purpose funds, the use of which is confined to the legally defined purposes and whose dis­ tribution to shareholders is prohibited. 12. The initial legislative basis for the setting up of joint ventures was a decree adopted by the Presidium of the Supreme Soviet of the USSR on January 13, 1987 on "Questions Concerning

98 the Establishment in the Territory of the USSR and Operation of Joint Ventures. International Associations and Organisations with the Participation of Foreign Organisations, Firms and Management Bodies," supplemented by Decree 49 (January 13, 1987) of the USSR Council of Ministers on "The Order of the Establishment in the Territory of the USSR and Operation of Joint Ventures with the Participation of Soviet Organisations and Firms from Capitalist and Developing Countries." The decree specified, inter alia, that Soviet partners should retain the majority in the joint venture, that the Chairman of the Board and the general managers had to be Soviet citizens, and that each joint venture would require special authorization by the Council of Ministers. This latter condition was modified by an amendment of September 1987, which delegated the granting of authorization to the relevant sectoral ministries. 13. In December 1988, a Resolution of the USSR Council of Ministers provided for the abolition of the (49 percent) maximum limit on foreign participation, the opening up of top management positions to foreigners, and the acceptance of the principle that wages could be freely negotiated between management and workers. 14. In addition to the decrees specifically aimed at them, joint venture activities are affected by the rules and provisions embodied in other legal acts governing economic activity including, in particular, the Law on Property (March 1990), the Law on Enterprises (April 1990), the income tax law (April 1990), the indirect tax law (June 1990), the Local Authorities Act (April 1990) and the decree on joint stock companies (June 1990). 15. The procedure for the establishment of a joint venture centers on the mandatory registration with the Ministry of Finance. The documentation to be examined by the Ministry includes, inter alia, copies of the agreement and charter of the venture, a statement of consent by the "supervisory agency" (e.g. the branch ministries responsible for the Soviet organizations to be partners in the venture or, in the case of joint ventures set up with the participation by Soviet cooperatives, a specified state government or local authority), the incorporation record of the foreign partner, and a statement by a foreign bank on the financial situation of, and guarantees extended to, the foreign partner. The assessment of the feasibility study, which should cover both the production/sales aspects of the venture and its financial/profit targets, is carried out by the supervisory agency but the study is also subject to examination by the Foreign Investment Division of the Ministry of Finance. In principle, no economic sector is precluded to foreign investors, other than those related to public order and security. Through the registration with the Ministry, which has the power to refuse it if the documentation does not appear to be in compliance with Soviet laws, the joint venture acquires the rights of a legal entity. An additional registration with the Ministry of Foreign Economic Relations is required to acquire the right to carry on an economic activity in the USSR. This latter registra­ tion is also a prerequisite for obtaining a blanket approval to make import/export transactions within the scope of the activities listed in the venture agreement and charter. 16. Only legal foreign and Soviet entities (i.e:, state and cooperative enterprises, organizations and associations) are entitled to participate in a joint venture, which may be formed as a limited liability company or as a partnership such as associations, consortia and similar legal entities admitted by Soviet law. At present, no requirement exists for the initial capital of the venture or for a minimum value of foreign investment. 17. Concerned with the development of practices which tended to exploit the very large distortions between domestic and world prices, the Soviet authorities introduced in 1989 a decree (no. 203) that prohibits the creation of joint ventures for carrying on "intermediary" trade

99 operations and makes all such operations subject to prior authorization by the Ministry of Foreign Economic Relations. 18. The overall convertible currency debt of joint ventures stood at around rub 1.2 billion at mid-1990. 19. For the assessment of taxes on profits, joint ventures are divided into two categories. Those with foreign participation of less than 30 percent are subject to the same tax treatment as domestic enterprises (a basic tax rate of 45 percent). Other joint ventures are taxed on the basis of a 30 percent rate, which can be substantially reduced for ventures located in the less developed regions. Thus, joint ventures established in the Far Eastern Economic Region of the USSR are subject to a 10 percent tax rate on profits, with a three-year tax holiday. Currently there are no provisions for tax relief for losses, but the possibility of loss carry forward is contemplated in the new tax law and the Ministry of Finance has the right to grant tax reduc­ tions (or a tax-exempt status) to joint ventures operating in certain priority sectors (e.g., agricul­ ture, medical equipment, high-technology products) or for companies set up in the context of special deals. Reportedly, no such exemption has been granted so far. According to the tax law adopted on June 14, 1990. joint ventures registered January I, 1991 will be entitled to a tax holiday only if they engage in production and provided that the foreign partner's participa­ tion is at least 30 percent. The tax holiday would not apply to ventures engaged in oil or other mineral extraction. 20. Taxable profits are assessed on the basis of the surplus of earnings over production costs after deduction for imputations to the reserve and development funds. Profit allocations to the reserve fund must be made until it reaches 25 percent of statutory capital, the annual amount of the allocation being stipulated in the charter of the joint venture. The after-tax profits are allocated to the Soviet and foreign partners according to their respective shares in the venture's capital. 21. Two Presidential decrees were issued on October 26, 1990 which have direct relevance for foreign investment in the USSR. The first concerns the conditions for the establishment of foreign enterprises in the USSR and the scope for investment in the country by nonresidents. The second sets a new commercial rate for the ruble (which can also be used for the valuation of new foreign investment) and provi~es for the establishment of a new auction system for trading foreign currencies, which will be open to participation by Soviet and foreign enterprises. 22. Nonresidents will not be allowed to purchase land but they will be entitled to acquire long-term leases. 23. Thus, the draft law of the RSFSR stipulates that companies with foreign participation of 50 per­ cent or more should register with the republic's ministry of finance in accordance with the law on joint stock companies, while the registration of other companies should take place with the relevant local authority. Decisions on an application for registration must be made within 90 days and if approval is not granted, the reason for rejection must be given. 24. The draft law of the RSFSR contains provisions for special tax breaks linked to the share of foreign ownership. Thus, if foreign investment exceeds US$0.5 million or 20 percent of the equity capital, 20 percent of the tax base is exempt for 20 years; if foreign investment exceeds US$1 million or 30 percent of the equity capital, 20 percent of the tax base is exempt for the first five years and 40 percent for the following five years; in the case of investment in sectors specified in the law, there is a tax holiday for the first five years and 60 percent of the tax base is exempt for the following five years.

100 25. In a number of areas, the draft Russian law contains specific provisions. Companies with foreign participation may use the accounting standards of the RSFSR or those of the home country of the foreign investor. Protection of the rights of foreign investors with regard to intellectual property is explicitly recognized and made subject to detailed provisions. The pos­ sibility of nationalization or expropriation is retained but investors are guaranteed compensation on the basis of the damages that may result from such measures. Compensation should be paid within two months, in the currency of the original investment.

101 Table IV.4.1. USSR: Joint Ventures and Initial Capital, 1987-90

Total Initial Total Number Capital Increment of Joint End-period Ventures Increment (In millions of rubles)

December 1987 ...... 23 23 159.37 159.37 December 1988 ...... 193 170 826.85 667.48 June 1989 ...... 689 496 2,122.73 1,295.88 December 1989 ...... 1,269 580 3,521.99 1,399.26 June 1990 ...... 1,754 485 4,000.00 I 478.00 I

Sources: Data provided by Soviet authorities. I. Approximate figure.

Table IV .4.2. USSR: Distribution of Operating Joint Ventures by Size, 1990 1

Volume of Production Size by Number Number of Number of Workers of Employees Joint Ventures in Each Category 2 (In millions of rubles)

0-50 ...... 284 6,416 286.6 51-200 ...... 186 18,641 442.6 201-600 ...... 50 16,012 298.6 601-1,000 ...... 13 9,830 187.5 Over I ,000 ...... 8 11,633 209.9 Total ...... 541 62,532 1,425.2

Sources: Data provided by Soviet authorities. I. First half of 1990. 2. The largest joint venture in terms of employment had a work force of 2,218. The second and third largest had I ,491 and I ,458 employees, respectively.

Table IV.4.3 USSR: Distribution of Joint Ventures by Size of Initial Capital, 1990 1

Range of Initial Number of Joint Ventures Initial Capital Capital Investment in Each Category in Each Category

(In millions of rubles) Number Percent (In millions of rubles)

0-0.5 ...... 695 47.02 129.29 0.5-1.0 ...... 225 15.22 144.55 1n~n ...... 381 25.78 771.23 5.0-10.0 ...... 86 5.82 556.80 Over 10.0 91 6.16 2,174.87 Total ...... 1,478 100.00 3,776.74

Sources: Data provided by the Soviet authorities. I. Situation as of end-March 1990. Data missing with respect to 64 registered joint ventures.

102 Table IV.4.4. USSR: Distribution of Operating Joint Ventures by Area of Economic Activity, 1990 1

Employees Value of Production Number of Joint Ventures (In thousands) (In millions of rubles)

Industry ...... 285 35.7 741.0 Trade and public catering ...... 64 4.0 72.0 Scientific research and project construction .. . 56 5.5 159.7 Construction ...... 36 2.1 36.8 Other branches of the national economy ...... 235 15.8 387.0 Cooperatives ...... 27 3.5 28.7 Total ...... 703 66.6 I ,425.2

Sources: Data provided by the Soviet authorities. I. Data through June 1990. The total figure for employees includes about 4, I 00 employees who are being paid but are not involved as yet in the production of goods or services.

Table IV.4.5. USSR: Distribution of Registered Joint Ventures by Area of Economic Activity, 1990 1

Joint Ventures Initial Capital

Millions of Number Percent rubles Percent

Fuel/energy ...... 16 1.11 89.74 2.46 Metallurgy ...... 21 1.45 167.50 4.58 Chemicals/timber ...... 97 6.70 450.61 12.33 Heavy machinery ...... 91 6.29 307.92 8.43 Personal computer production and programming 208 14.37 276.21 7.56 Construction and building materials ...... 117 8.09 461.60 12.63 Transportation and communications ...... 27 1.87 33.97 0.93 Food and agricultural products processing ... . 91 6.29 375.60 10.28 Retail trade and public dining ...... 71 4.91 100.55 2.75 Tourist hotels and passenger transport services 87 6.01 227.19 6.22 Health and medical care ...... 56 3.87 174.62 4.78 Public education ...... 2 0.14 2.35 0.06 Light industry ...... 53 3.66 117.45 3.21 Other consumer goods ...... 123 8.50 331.04 9.06 Film and video ...... 34 2.35 35.19 0.96 Concerts ...... 22 1.52 13.47 0.37 Publishing ...... 43 2.97 56.94 1.56 Research and development ...... 71 4.91 43.89 1.20 Engineering ...... 58 4.01 75.92 2.08 Consulting and intermediary services ...... 149 10.30 304.84 8.34 Personnel training ...... 10 0.69 7.23 0.20 Total ...... 1,447 100.00 3,653.83 100.00

Sources: Data provided by Soviet authorities. I. Situation at end-March 1990. Data missing for 95 out of the I ,542 registered joint ventures.

103 Table IV.4.6. USSR: Distribution of Registered Joint Ventures by Country of Foreign Partner, 1990 1

Initial Capital

Number of Joint Millions of Rank by Total Country Ventures rubles Percent Initial Capital

Federal Republic of Germany ...... 214 548.22 12.48 West Berlin ...... 30 32.17 0.73 Finland ...... 175 367.40 8.36 4

United States •••••••••••••••••• 0 ••••• 172 359.47 8.18 5 Austria ...... 99 272.38 6.20 6 United Kingdom ...... 96 190.94 4.35 9 Italy ...... 95 510.74 11.63 2 Switzerland ...... 69 107.09 2.44 12 Sweden ...... 58 194.74 4.43 8 France ...... 54 370.23 8.43 3

Poland 0 ••••••••••••••••••••••••• 0 •• 54 124.56 2.84 II

Sources: Data provided by the Soviet authorities. I. Situation at end-March 1990. In terms of total initial capital contribution, Bulgaria ranked seventh (rub 204.82 million), and Australia ranked tenth (rub 151.67 million).

Table IV.4.7. USSR: Distribution of Registered Joint Ventures by Location, 1990 1

Number of Republic Joint Ventures

RSFSR 1,072 Of which: Moscow ...... (717) Leningrad ...... (113) Other locations ...... (242) Ukraine ...... 99 Belorussia ...... 27 Estonia ...... 104 Latvia ...... 39 Lithuania ...... 18 Moldavia ...... 14 Georgia ...... 41 Armenia ...... 10 Azerbaidzhan ...... 10 Kazakhstan ...... 10 Turkmenistan ...... I Uzbekistan ...... : ...... II Tadzhikistan ...... I Kirgizia ...... 2 Unspecified ...... 83

Sources: Data provided by the Soviet authorities. I. End-March 1990.

104 Table IV .4.8. USSR: Wage Rates for Employees in Joint Ventures, 1990 1

Average Monthly Wage for Joint Venture Relation to Employees National Average (rubles) (= 100)

Industry ...... 535 208 Construction ...... 678 264 Trade and public catering ...... 789 307 Scientific research and project construction ...... 644 251 Other branches of the national economy ...... 705 274 Cooperatives ...... 742 289

Sources: Data provided by the Soviet authorities. l. Situation at end-June 1990.

105

Chapter IV.5

Financial Sector Reform

1. THE BANKING SYSTEM a. Banking prior to the 1987-88 reforms The Soviet banking system under central planning was viewed as an integral part of the central allocation system. Most financial transactions of enterprises were separated from those of households both physically and functionally. Trans­ actions within the enterprise sector and between enterprises and the state were carried out via transfers of deposits held at Gosbank. Enterprise deposit accounts paid minimal interest, 1 were earmarked for specific end-uses in accordance with the plan and their amounts and uses were closely monitored and controlled by Gosbank. Indeed, deposit accounts were often held "jointly" with the state and were frequently reallocated through the budget or the branch ministries. Enterprises used cash almost exclusively for wage payments; holdings of cash for other purposes were virtually prohibited. Consequently, the resources of the enterprise sector provided little liquidity. To the extent they were free to choose, enterprises sought to minimize money holdings in favor of inventories, which provided both a better store of value and some insurance against chronic shortages of materials. The financial flows of enterprises were regulated through the credit plan. The latter was simply the counterpart of the quantitative production plan, aggregating the planned demand for credit for each enterprise, as derived from its assigned production targets. The credit extended to the enterprises by Gosbank was mainly short-term working capital. Virtually all enterprise investment was financed by budgetary transfers, while most profits were remitted to the budget. 2 Certain deviations from the plan-such as shortfalls from planned profits-were automat-

107 ically accommodated by credit from Gosbank, which thus provided indirect financing to the budget. Gosbank was also frequently forced to provide credit beyond planned amounts to key enterprises which claimed they would otherwise be unable to meet planned output targets. On the other hand, the shifting of enterprise incomes and depreciation funds to the budget left them highly depend­ ent on credit and gave Gosbank some influence over their activities. Finally, Gosbank functioned as fiscal agent for the government, collecting, allocating, and disbursing government revenues. Households received their money incomes in, and made practically all pur­ chases with, cash. Savings accounts at the state Savings Bank provided households with an alternative financial asset but not a means of payment. At the same time, the savings deposits were implicitly treated as direct resources of the state budget. 3 As discussed in Chapter III.2, monetary policy played an essentially passive role under central planning. In addition to Gosbank and the Savings Bank (Sberbank), two specialized banks were in operation prior to the 1987-88 reforms. The Construction Bank (Stroibank) was created to provide long-term investment credits to enterprises, gradually replacing budgetary grants. All foreign exchange operations were con­ ducted on behalf of the state by the Bank for Foreign Trade (Vneshtorgbank), which also managed international reserves and extended credit to enterprises responsible for foreign trade. 4 While the banking system described above was an effective counterpart of the central materials allocation system, it also shared the latter's increasingly evident defects. To the extent that central allocation led to inefficient use of real resources, financial allocations were similarly distorted. The incentives given to enterprises to invest liquid funds in inventories, for example, resulted in chroni­ cally excessive stock building and a waste of resources. The monopolistic position of the banks gave them no incentive to reduce their operating costs and allowed them to interfere arbitrarily in the operations of their client enterprises. At the same time, the lack of a hard budget constraint on either the enterprises or the banks, and the high expectation that loans would, in any event, be written off or automatically rolled over, left both borrower and lender with little concern about the inefficiency with which the resources were used. The reforms introduced in 1987-88 followed a series of generally minor initiatives to improve the functioning of the system. b. The 1987-88 reforms

The financial sector reforms introduced in 1987 and 1988 had three principal objectives: (1) establishment of a two-tiered banking system, in which all com­ mercial banking operations were detached from the Gosbank; (2) greater inde-

108 pendence for the specialized banks in their lending decisions; and (3) development of new instruments of monetary control. In pursuit of the first objective, three new state-owned specialized banks were established: the Agriculture Bank (Agroprombank), the Industry and Construction Bank (Promstroibank), and the Social Investment Bank (Zhilsotsbank), to channel credit to enterprises in their assigned sectors.' These banks were to take over all the former commercial banking activities of Gosbank, including both credit and deposit operations, and to act as fiscal agents for the government. The assets and liabilities of the new banks depended on the deposits and loan portfolios assigned to them, and their sectoral specialization was underlined by their subordination to corresponding line ministries, which appointed their chairmen. The other two already existing banks, the Savings Bank and the Bank for Foreign Trade­ renamed the Bank for Foreign Economic Affairs (Vneshekonombank)-basically continued their former operations. For the first time since its establishment in 1922, the Savings Bank briefly became institutionally independent, before being reincorporated into Gosbank in 1990. With the reform, Vneshekonombank main­ tained its monopoly over foreign exchange operations. Its functions were ex­ tended, however, to include the granting of foreign currency credits to domestic enterprises engaged in foreign trade, wtih the repayments to be made from export receipts. The creation of the new specialized banks, carried out from mid-1987 to mid-1988, failed to increase competition in the banking sector. Competition was, in fact, precluded by the strict sectoral specialization of each institution's activities and the assignment of enterprises to the services of one bank. With the banks dependent on branch ministries, credit allocation remained essentially administra­ tive, with little concern for either the profitability of loans or the creditworthiness of borrowers. Soft credit policies were reinforced by the continued lack of hard budget constraints on either lenders or borrowers. Bank profits flowed to the state budget, and losses were covered by it. Moreover, the delay of price reforms in the real sector militated against the reliance on financial criteria in lending decisions. As discussed below, the specialized banks are now being divided up, largely along the lines of their existing republican and local branches, and con­ verted into joint stock companies. According to the presidential guidelines, they are to be transformed into commercially oriented, universal banking institutions. New impetus was given to financial sector reform by the 1988 Law on Cooperatives, which authorized the establishment of cooperative banks to serve the needs of cooperative enterprises that were expected to be ignored by the state-owned specialized banks. Soon after, state enterprises were also granted the right to establish their own financial institutions. The number of commercial and cooperative banks (CCBs) grew rapidly reaching more than 400 by September 1990. The CCBs differ from the specialized banks in a number of important respects. First, their activities are relatively unlimited; they are licensed to provide

109 both long and short-term credit and to accept deposits. At least one has been licensed to engage in foreign exchange operations. Second, their customers are not assigned. They can compete freely for both household and enterprise clients, and households and enterprises are also free to choose among banks. Third, the monetary controls applied to the CCBs are largely indirect. These developments in the financial system were paralleled by significant changes in the enterprise sector. As described in Chapter IV .2, the 1987 Law on State Enterprises gave managers greater freedom to allocate enterprise after-tax incomes. Enterprise financial resources were thus given greater liquidity and fun­ gibility and, in this sense, greater "moneyness". This, combined with the greater options to depositors and borrowers that accompanied the appearance of the CCBs, created the need for a more active monetary policy (see Chapter III.2). Credit ceilings were apportioned to the specialized banks in accordance with the sectoral demands for credit projected by Gosplan. Within these ceilings, the spe­ cialized banks were free (under the continuing guidance of the branch ministries) to allocate credit among enterprises.6 By contrast, lending by the CCBs was controlled via a mandatory reserve requirement, which was raised in August 1990 from 5 percent to 10 percent. Their lending was also constrained by several prudential regulations (see section d). In summary, enterprises and households have acquired increased flexibility over the past few years in their holdings of financial resources, which complicates the task of the monetary authorities in ensuring macroeconomic stability. At the same time, the banking system has been evolving on two tracks: the division and commercialization of the state specialized banks, and the rapid proliferation of small commercial and cooperative banks. Both tendencies, which could eventually merge into one unsegmented banking system, are consistent with the development of an efficient, competitive financial sector and are supported in the presidential guidelines. As in the enterprise sector, however, both of these developments suffer from gaps in the legal and regulatory framework and from uncertainties regarding ownership rights. c. Structure of the banking system

In terms of loans outstanding to the economy (households and enterprises), the Agroprombank remains the largest of the lending institutions, even after the substantial writedown of its assets in 1990 (Table IV.5.1). The three major credit institutions-Agroprombank, Promstroibank and Zhilsotsbank-mobilize only a fraction of the monies they lend, the remainder of their funding being provided largely by Gosbank. In contrast, the Savings Bank is the principal mobilizer of financial resources in the system. It is the largest of the banks in terms of numbers of sites and employees, but it does very little direct lending of its own. In the two years following their authorization, the number of activities of commercial and

110 cooperative banks (CCBs) have expanded rapidly. By September 1990, they ac­ counted in the aggregate for just over 5 percent of total credit to the economy.

(1) The specialized banks The specialized state banks account for the balance of the outstanding bank credit. Their evolution and financial soundness are, consequently, fundamental to the efficiency of the financial sector and to the stability of the monetary system. The Government has announced its intention to transform these institutions into independent joint stock, commercial, universal banking institutions. The details of this transformation have not yet been spelled out, but it is intended that they operate strictly within the limits of their own resources and the funds they succeed in mobilizing, and that they be completely responsible for their own profits and losses. The presidential guidelines enter a caveat, however, that it may be neces­ sary to retain one state bank with budgetary support to channel concessional resources to activities "in the state interest," and that the Savings Bank would also remain a state bank. 7 As a step toward their commercialization, the process of transforming the specialized banks into joint stock companies has already begun. Shareholders are initially expected to consist largely of state organizations, including the union and republic ministries of finance, other ministries at both the union and republican levels, municipal governments, and state enterprises. The future development of the specialized banks is complicated by conflicting ownership claims by the dif­ ferent levels of government, and it now appears that they will be broken up along geographical lines. A major concern with regard to the commercialization and privatization of the specialized banks is the unknown quality of their loan portfolios. While the banks now have greater freedom to allocate credit than they had under the strict control of the credit plan, their loans have, by and large, continued to go to traditional borrowers, responding both to personal relationships and to the still important role of state orders in the resource allocation system. Supervision by Gosbank, once intensive in ensuring adherence to the credit plan, is now largely limited to the quarterly receipt of balance sheet information and annual reports. The Agroprombank provides credit, deposit facilities and payments services to the farm and agro-industrial sectors of the economy. In addition to its normal credit activities, it performs quasi-fiscal functions, including provision of subsidies to farm organizations and food processors to cover gaps between wholesale and retail prices. Its initial portfolio included a large share of nonperforming loans, rub 73 billion of which were written off in 1990, continuing a long tradition of agricultural credit forgiveness in the USSR.8 Additional write-offs are reportedly anticipated. Agricultural credit has been, in any event, highly concessional. On November 1, 1990, interest rates were raised from 0. 7 percent to 9-12 percent on long-term loans. Short-term interest rates were raised to 6 percent on short-

111 term loans, compared to former rates of 1 percent to collective farms, 2 percent to state farms, and 3 percent to processing enterprises. A penalty rate of 3-5 per­ cent per annum is charged on rescheduled credits. The Agroprombank was transformed at the all-union level into a joint stock company in September 1990, with similar conversions being carried out at some republican, and possibly municipal, levels. 9 The solvency of the institution and its individual branches is highly doubtful, however, in spite of the write-offs noted above and its large outstanding debt to Gosbank. The new share capital of Agroprombank totals rub 8 billion (rub 5.5 billion paid in as of October 1990), of which just under one third is held by the USSR Ministry of Finance. 10 There are almost 4,000 other shareholders, consisting mostly of state and collective farms (whose own solvency may be in doubt) and food-processing enterprises­ i.e., Agroprombank's principal borrowers. Promstroibank is responsible for serving the credit and deposit needs and providing payments services to much of the industrial sector, including construc­ tion, transport, and communications. By Resolution of the Supreme Soviet of December 11, 1990, it is to be converted into a joint stock commercial bank before December 31, 1991. With its substantial enterprise deposits, Promstroibank is less dependent on Gosbank than are the other specialized banks. Although undoubtedly stronger financially than the Agroprombank, the quality of Promstroibank's portfolio is nevertheless largely unknown and will inevitably be affected by economic reforms in the real sector and the significant impact they are likely to have on the profitability of different enterprises. Zhilsotsbank provides banking services to certain branches of light industry, state retail trade, housing construction, individual professional activities, and com­ munal, social and cultural services. It also serves as the collection agent for much of the government's revenue. The fragmentation of the Zhilsotsbank network is the most advanced among the specialized banks, perhaps because of its close involvement in the financing of local government activities. At the same time that plans were under way at the union level to convert the bank into a joint stock company, republican branches were already being restructured as independent institutions and, in Moscow and Leningrad, branches of Zhilsotsbank were effec­ tively being liquidated and their premises and equipment were to be passed, as of January 1, 1991, to new 1y established commercial banks in which the respective city councils would have a substantial_ share ownership.'' The Savings Bank remains essentially a deposit-taking institution for redeposit in Gosbank. It also acts as agent for the sale of government debt to the household sector and its servicing. Although its lending to households has grown rapidly, the total remains small. The appearance, beginning in 1988, of commer­ cial and cooperative banks forced the Savings Bank to raise its deposit interest rates and to offer certificates of deposit at still higher rates. 12 To compensate for the higher interest costs, the Savings Bank was authorized to lend, within strict

112 limits, to the commercial and cooperative banks at interest rates of 5-6 percent. 13 Consideration has been given by its management to future conversion into a joint stock company and expanding its commercial lending activities. One model under consideration for a national savings bank system, based on the German system, calls for a three-tiered arrangement, consisting of the all-union Savings Bank at the top, the republican branches in the middle, and the major retail operations carried out at the local branch level. Nevertheless, the Savings Bank will undoub­ tedly be the last of the specialized banks to be commercialized, given the con­ tinued short-term dependence of the entire financial system on its mobilization of savings and its relative lack of lending experience. Some spontaneous denationalization has already begun in the Vneshekonom­ bank network, as its republican branch in Uzbekistan has declared itself an inde­ pendent joint stock company, with over 100 large enterprises having pledged the initial share capital. Its declared objective is to attract foreign investment into the republic and foster the development of high-technology industry. The approach in other areas to independent entry into foreign currency operations (e.g., in the cities of Moscow and Leningrad) has been to seek the necessary authority for local commercial banks. In any event, as plans for the decentralization of foreign currency holdings of enterprises and other organizations are implemented, it will be difficult for Vneshekonombank to prevent significant shrinkage of its balance sheet, unless it diversifies its activities by developing local currency business. A serious handicap in this regard is Vneshekonombank's current lack of a broad branch network. For all the specialized banks, the uncertainties of the present situation make it a particularly difficult time to launch into commercial banking. The difficulties are magnified by the almost total lack of experience of these banks in the types of decisions faced by commercial bankers in assessing and managing the multiple risks involved in financial intermediation. With the exception of the Savings Bank, the specialized banks have substantial familiarity with their sectors and their bor­ rowers. Soft budget constraints have reduced the importance of credit risk analysis, however, while interest rate risk has simply not existed and foreign currency risk has been of concern only to Vneshekonombank. With the bulk of funds coming to them from the Gosbank and from mandatory enterprise deposits, the lending banks have not had to concern themselves with deposit mobilization and liability management. The Savings Bank, on the other hand, has operated as virtually a pure deposit bank, offering insured savings accounts to households which have few alternatives for safeguarding and earning interest on their savings. Although it has recently begun a small amount of consumer lending, the Savings Bank passes almost all of its deposits to Gosbank. In this way, household savings have been the major source of financing for the budgetary deficit and for the credit lines of Gosbank to the other specialized banks. The commercialization of the Savings Bank may

113 therefore be inhibited in the short term by the lack of alternative significant mechanisms for financing the fiscal deficit, as well as by the lack of necessary staff skills and experience.

(2) The commercial and cooperative banks (CCBs) As noted earlier, the formation of new commercial banks under cooperative and joint stock forms of ownership began with promulgation of the Law on Cooperatives in 1988. By the end of 1988, 77 CCBs were operating with assets of over rub 2 billion. Twelve months later, their number had almost tripled and, by September 1990, they numbered more than 400, with loans outstanding of rub 20 billion and total assets of rub 32 billion. Most of CCB lending has been short-term credits to industrial and commer­ cial enterprises, often to the banks' own shareholders and depositors (Table IV.5.2). They have also engaged in a considerable amount of interbank lending, bringing some capital mobility to the system. Most resources come from enterprise deposits, from their own capital and reserves, and from deposits placed with them by the specialized banks. The CCBs are, by international standards, comfortably capitalized. Their own capital, which in many cases has been increased since initial registration, is equivalent on average to 16 percent of total assets, far exceeding the standards set by Gosbank (5 percent of liabilities for commercial banks and 8 percent for cooperative banks). This apparent conservatism, however, may be indicative of the new banks' difficulty in expanding their deposit resource base. The CCBs as a group appear to be profitable; before-tax profits totaled some rub 220 million in the first half of 1990, equivalent to 5. 7 percent of capital at the end of the period. Interest rate margins are high, averaging around 13-16 percent, with lend­ ing rates of the order of 20-25 percent and deposit rates of 7-9 percent. Loan losses appear to have been small, around 2 percent of outstanding loans, but the trend is reportedly rising. As of October 1990, there had only been two cases in which a CCB 's registration had been canceled. This action resulted from violation of prudential regulations or from engaging in prohibited activity, rather than from insolvency, and depositors reportedly did not suffer any losses as a consequence. About one third of CCBs are set up as cooperatives to provide credits and other financial and nonfinancial services to the cooperative enterprise sector. In addition to lending, many are engaged in leasing and factoring, as well as in organizing barter transactions among enterprises. 14 Roughly half of the CCBs have been organized by industrial state enterprises, by groups of enterprises in the same industrial sector (e.g., automobiles, gold mining, power generating equip­ ment), and/or by regional organizations, including municipal governments. The remainder of the CCBs consist of so-called "innovation banks," set up to sponsor the development of high-technology products, and of institutions owned by various associations and organizations (labor groups, cultural organizations) and

114 by governmental bodies. Republican and municipal governments, branch mini­ stries, and the state-owned specialized banks have played a significant role in promoting the formation of CCBs. Promstroibank, for example, is reportedly a shareholder in some 50 CCBs. The CCBs provide a vehicle for lending outside the restrictions of the monetary authorities' Credit Plan and for reaching borrowers who normally lack access to the specialized banks. The CCBs have enjoyed considerably greater freedom than do the specialized state banks in their lending decisions, the interest rates they are allowed to pay for enterprise deposits and to charge on loans, and the salaries they can pay to employees. On the other hand, unlike the Savings Bank, their deposits are not guaranteed, acceptance of household deposits cannot exceed their capital, interest rates on such deposits cannot exceed those offered by the Savings Bank, 15 and the lack of a real estate market has made it difficult for most of them to acquire well-located premises of adequate size and expansion potential. As of November I, 1990, interest rate controls were extended to apply equally across the banking sector. Although still very small in comparison to the specialized banks, the CCBs have constituted a source of competition in the financial system. Nevertheless, some aspects of their development could create serious problems for their future soundness and for competition. As noted, a large proportion of the CCBs have been established by a particular industry or group of enterprises with the explicit purpose, set down in their charters and by-laws, of serving the credit needs of those enterprises. As a result, loan portfolios tend to be concentrated on particular borrowers or in particular branches of industry. Shareholders also commonly in­ clude the specialized banks, other cooperative banks, branch ministries and other agencies of the union, republican, and local municipal governments. There is some concern that the newly organized commercial banks could, if they provided loans to their owners on anything other than regular commercial conditions, become vehicles for enterprises to get around the "hard budget constraint". The concept of conflict of interest does not appear to be well developed in the USSR, and there are currently no regulations to avoid it. The close relationships being formed between banks and enterprises also poses a threat to competition in the real sector, insofar as it gives preferred access to credit to enterprises that are affiliated with banks. In addition, competition among banks is being threatened by the formation of associations of CCBs that are promoting interlocking ownership among them. Both of these tendencies should be subjected to antimonopoly laws and regulations. 16 d. Banking regulation and supervision Banks provide the basic payments mechanism in virtually all modem economies, and are the principal source of credit to enterprises and households.

115 At the same time, however, given the high liquidity of their liabilities, banks are extremely vulnerable financially to anything that may affect the confidence of depositors, such as the fear of war, a failed harvest, a sudden change of govern­ ment policies, or simply rumors that a bank is about to fail. Moreover, given the strong interrelationships among the elements of a financial system in a market economy, a sudden drain of deposits from one large bank can easily spread and become a generalized financial panic. Societies thus have a vital interest in assur­ ing the soundness of the banking system, and governments in the major market economies thus tend to regulate and supervise banks much more closely than they do the real sector. Banking regulations typically have two main objectives: to ensure that banks adequately manage their risks and that a bank's capital is sufficient to withstand reasonable loan losses without jeopardizing its solvency. Banks are also subject to strict rules requiring disclosure of information about their financial situation. In order to guard against fraudulent behavior, particular rules are applied to trans­ actions involving a bank's own managers and employees. Finally, in order to protect depositor confidence, many countries have introduced deposit insurance or guarantee programs. In the past, with neither lenders nor borrowers in the USSR facing a hard budget constraint, and with banks effectively acting as budgetary agents, there was little reason for concern for the financial soundness of the banking system or of its individual institutions. Supervision of the specialized banks or of its own branches by the Gosbank consisted of assuring that resources were being allocated in accordance with the Credit Plan. Even as the specialized banks have acquired some discretion in their credit activities, and as they have begun to move into less traditional banking areas (e.g., leasing and factoring), both bank managers and government authorities have only gradually become aware of the financial risks in their portfolios. There is a general lack of familiarity with basic accounting principles and an almost total absence of rigorous internal auditing procedures as well as external supervisory control. Credit risk analysis is also impeded by the lack of proper accounts in the borrowing enterprises.

(1) Current status of bank regulation in the USSR Initiatives have been taken by Gosbank in recent years to introduce prudential regulation and bank supervision. These have focused almost exclusively, however, on the CCBs, which account for only a small share of credit. Up to now, Gosbank has not been in a position to exercise effective supervision of the specialized banks. In January 1989, six months after the establishment of the first CCB, Gosbank established a special Commercial Bank Department for the auditing, prudential regulation and supervision of these banks. Detailed prudential standards have since been issued by Gosbank, which has also assumed the authority to seek corrective measures in cases of noncompliance. The quality of supervision, how-

116 ever, needs improvement, given important shortcomings in current accounting standards and the shortage of qualified examiners and other staff, particularly at the republican and local branches of Gosbank. It also appears that exceptions to the prudential regulations are granted by the local branches. 17

(a) Licensing standards In 1988, when the first CCBs were established, an ad hoc registration pro­ cedure was put in place and managed by the Promstroibank, which was itself an important sponsor and shareholder of many of the new institutions. Later in that year, responsibility for the registration process was passed to Gosbank, and the banks initially registered by Promstroibank were required to re-register. 18 The re-registration process appears to have been a formality, however. In January 1989, Gosbank and the Ministry of Finance jointly issued provisional regulations (pending passage of the central banking law) setting the minimum requirements for obtaining a commercial or cooperative banking license. The regulations are fairly detailed and reflect an effort by Gosbank to adopt international practices. Among the requirements: a. The founding shareholders must prepare a document, giving basic infor­ mation about the bank-e.g., name, location, etc.-and setting out, in a kind of organizational statute (ustav), its intended purpose; b. An application is to be filed with Gosbank containing the bank's ustav, a financial plan, a list of the founding shareholders and their respective capital contributions, and the bank's pro forma balance sheet and income statement in accordance with a specified format; c. Commercial banks must have a minimum capital of rub 5 million, and cooperative banks a minimum capital of rub 0.5 million. Registration applications are reviewed initially at the regional (oblast) office of Gosbank, the judgment of which is subject to subsequent review at a higher level. The file is then sent to the head office of Gosbank, which evaluates the application in cooperation with the Department of Money and Credit Operations of the Ministry of Finance. Supplementary to the original regulations, Gosbank also set conditions on the qualifications of the bank's top manager, specifying that he or she should have a degree in economics, at least 5 years' experience in banking, and a clean legal record. Despite Gosbank's efforts, it appears that the licensing process thus far has involved little more than formal registration, and that eligibility criteria have not been strictly and uniformly applied. The minimum capital requirement, for ex­ ample, has frequently been circumvented by allowing that only a portion be paid in at the commencement of activities. In response to public pressures, Gosbank was forced to drop eligibility requirements for bank managers and generally to expedite the registration process. The issue of bank licensing has been further

117 complicated by political decentralization, although the recently enacted Law on Banks and Banking Activities may clarify responsibilities. Under that law, licenses are to be issued by the central banks of the republic within whose territory the respective banks will be located. Gosbank will license all-union banks.

(b) Prudential regulation Two sets of prudential regulations were put into effect by Gosbank in April and May 1989. Inspired by the Cooke Committee's recommendations on capital adequacy, as well as other rules in effect in the Western industrial countries, these regulations cover liquidity and capital ratios, a limit on individual loans, auditing requirements and the process for securing collateral. Capital-liability ratios of 1:20 and 1:12 are specified for commercial banks and cooperative banks, respectively; household deposits cannot exceed 100 percent of capital; credit to a single bor­ rower cannot exceed 100 percent of capital for commercial banks, or 50 percent for cooperative banks; the ratio of liquid assets to short-term liabilities must ex­ ceed 30 percent for banks providing cashier services, or 15 percent for banks that do not; and the ratio of long-term assets to capital plus long-term liabilities should not exceed 100 percent. Gosbank's authority to establish capital and liquidity standards, as well as other prudential regulations, is confirmed in the new central banking law. It would also be empowered, jointly with the republican central banks, to take action in the event of a bank's noncompliance with the standards, including raising the bank's mandatory reserve requirement and arranging for the bank's reorganization or delicensing and liquidation. The present regulations do not require provisioning against bad or doubtful loans, but the new law does empower Gosbank to develop a policy on loan-loss reserves. Gosbank has asked each commercial bank applicant to specify in its ustav the particular provisioning method it proposes to adopt. As a general guideline, it has suggested that 20 percent of profits be placed in a reserve ac­ count, until reserves accumulate to 25 percent of the bank's own capital. In its recent conversion to a joint stock company, Agroprombank committed itself (in its ustav) to a more ambitious eventual target of reserves equivalent to 100 per­ cent of equity, to be reached through annual contributions of at least 5 percent of profits. Moreover, the reserve is to be replenished whenever loans are written off, although the conditions that would trigger a write-off are not specified. 19

(c) Supervision Although an informal supervisory process has been instituted by Gosbank, supervisory practices are not yet fully developed. The regional offices of Gosbank are responsible for monitoring the operations of the CCBs, which are required to open correspondent accounts in Gosbank or in a specialized bank. The CCBs provide monthly financial information, consisting of a balance sheet and the re-

118 quired prudential ratios. A formal balance sheet must be published annually. Al­ though the format for an income statement is set out in the regulations, these statements are not typically collected or evaluated by Gosbank. Indeed, while financial flow data are routinely gathered on the basis of daily transactions recorded in a bank's books, little use is made of this information and the indica­ tions it can provide of a bank's operating performance and financial position. In the event of minor noncompliance with regulations, Gosbank may simply send a letter to the bank requesting that the problem be corrected and credit policies strengthened. Where a problem is considered more serious, Gosbank can block (and has reportedly done so) the bank's correspondent accounts. In an ex­ treme case, registration can be annulled, and the bank liquidated. As of October 1990, as noted earlier, two CCBs had in fact been closed. Nevertheless, the en­ forcement of existing regulations appears to have been weak. Bank supervision does not appear to have received high priority from the Gosbank branches respon­ sible for it, and CCBs do not appear to have a strong incentive to allocate sig­ nificant resources to internal auditing and data collection to satisfy banking regulations. Effective risk management by the banks and related supervision also suffers from scarce and outdated equipment. The computer center of Gosbank is equipped with calculating machines and computers that are, on average, 20 years old. Equip­ ment in the regional branches is even more primitive. More importantly, monitor­ ing and enforcement will be hampered in the medium term by the lack of qualified personnel in the regional and local offices of Gosbank. A strong nucleus of future bank auditors and supervisors does exist in Gosbank's Auditing Department at the union, republican, and regional levels. However, their past focus has been on the auditing of the branch offices of Gosbank itself, verifying whether cash is safeguarded, bookkeeping accurate, and rules for extending credit followed. More recently, with attention shifting to the CCBs, the auditing process has consisted of checking a sample of loans, including the largest credits, on an annual basis. Loan maturity, profitability, repayment, collateral, and use of funds are all verified. ·The positions taken by republican representatives toward banking regulation have in some cases complicated the effort to strengthen supervision. Unless a significant educational effort is mounted to change attitudes, the combination of free-wheeling bankers and political interference in banking decisions will repre­ sent a severe threat to the stability of the developing banking sector, and the USSR could be obliged to repeat the painful experiences of the Western market economies in this area.

(2) Deposit protection Deposits at the Savings Bank are fully guaranteed by the government while deposits in the CCBs are not protected at all. This, along with interest rate ceilings,

119 puts the CCBs at a competitive disadvantage vis-a-vis the Savings Bank. 20 While some form of deposit insurance or guarantee covering all banks is probably ad­ visable in order to give confidence and stability to the system, the governments of many market economies that have heretofore supported full protection of deposits (usually up to some maximum absolute amount per account) are now rethinking whether 100 percent coverage is a good idea. With full insurance coverage of deposits, depositors need not concern themselves with the quality of bank management, and the managers may feel free to take on excessive risk in their lending activities. Many experts now believe, therefore, that an insurance or guarantee scheme that protects only a proportion of each individual's deposits, say 50 percent, is preferable to full protection. In this way, depositors will more carefully monitor bank performance, and bank owners and managers will be forced to behave more prudently for fear of losing their depositors.

(3) Interest rates Until recently, different interest rate regimes applied to the specialized banks and the CCBs. The former were not allowed to pay, on average, above 0.5 percent on enterprise deposits and 2-4 percent on household deposits (depending on maturity). Interest rates on loans from the specialized banks could vary according to the financial position of the borrowers but remained, in practice, near or below the refinancing rate charged by Gosbank, which itself varied across sectors. 21 The CCBs, meanwhile, were allowed to freely set both deposit and lending rates; their interest rates on household deposits averaged about 6 percent, well above the rate offered by the Savings Bank, while lending rates averaged about 9 percent, but with a very wide dispersion. Interest rates as high as 60 percent have been reported on very short-term loans. As noted earlier, since February 1990 interest rates on household deposits in the CCBs have been limited to the deposit rates offered by the Savings Bank. These, along with other rates, were administratively raised in November 1990 to 5 percent for 1-3 year maturities; 7 percent for 3-5 years; and 9 percent for maturities over 5 years. Lending rates were permitted as high as 15 percent. 22 e. Recommendations (1) Regulatory framework Macroeconomic stability, public confidence, and the strength of the banking system are closely interrelated, especially in a market economy. For this reason, the Government should proceed as a matter of urgent priority to clarify and strengthen the legal, regulatory and supervisory framework for the banking sys­ tem. Toward this end, under the new Law on Banks and Banking Activities, a strong supervisory authority should be established, empowered to license banks,

120 both specialized and CCBs, and to ensure their soundness and their safety as depositories. Soundness should be explicitly stated in terms of solvency, liquidity, profitability, and quality of management, with the detailed criteria for licensing and regulation to be defined by the supervisory agency. The latter should also have clear powers to enforce the rules and to impose sanctions for noncompliance, including the authority to close the offending bank and to force it into restructuring or liquidation. The existing prudential framework and arrangements for enforcement should be improved. Capital adequacy standards for the formation of new banks and governing banks already in operation should be strengthened. Banks should be required to observe adequate standards of risk management, with regard, in par­ ticular, to liquidity risks and to solvency risks that may arise from undue loan concentration. Arrangements for containing other risks, such as those related to exchange and interest rates, should be considered at an early stage, even though most banks are not yet involved in activities where these risks arise. Arrangements are also needed to closely monitor and limit the scope for "self dealing"; i.e., operations between banks and their shareholders and between banks and their own staff and managers, with a view to avoiding abuses and conflicts of interest.

(a) Licensing The current approach to the registration of commercial banks should be trans­ formed into a genuine licensing procedure, involving the application of strict eligibility criteria. Managerial competence and accountability should be assessed, along with regulatory standards and other criteria judged appropriate by the su­ pervisory authority in light of legislated public policy objectives. Immediate measures are needed to counter the present tendency of enterprises and govern­ ment agencies to organize new banks, which they control. It is recommended that bank applicants, whose ustav sets out the objective of lending to their own share­ holders or their affiliates, or whose purpose in applying appears aimed at assuring their access to bank credit, not be registered or given licenses. This restrictiveness could be relaxed, once enforceable limits on loan concentration and insider lend­ ing are in place.

(b) Capital adequacy The existing regulations of Gosbank and the recent banking legislation both emphasize the importance of capital adequacy standards. It should be noted, how­ ever, that it is not feasible to set capital requirements so high as to withstand substantial losses in a bank's asset portfolio. Such requirements provide protec­ tion, therefore, only insofar as the other basic prudential rules, such as asset diversification and asset classification and provisioning, have been successfully applied. Given the high concentration found in both CCB and specialized bank portfolios in the USSR, a high initial capital-asset ratio would appear to be ap-

121 propriate. Present Gosbank regulations require only a 5 percent capital-liability ratio for commercial banks, as compared to the 8 percent capital-assets ratio recommended by the Basel Committee for commercial banks in the Western in­ dustrial countries. Under the present start-up circumstances in the USSR, a ratio of 10-15 percent would seem more appropriate; on average, as noted earlier, this ratio appears to be met. 23 Dividend payments could be suspended until proper ratios are achieved.

(c) Asset diversification Extreme concentration of loans in particular sectors and, often, particular borrowers is a characteristic of both the specialized banks and the CCBs. In­ dividual loan amounts also tend to be large relative to bank capital. In the case of many CCBs, a significant proportion of loans has been extended to the banks' own shareholders. For the specialized banks, concentration problems may be ex­ acerbated by their likely division along geographical lines. The existing limit on loans to a single borrower, or to borrowers joined in a legal association, has recently been lowered by Gosbank from 100 percent of capital to 50 percent. It nevertheless remains too high and leaves banks excessively vulnerable to a single borrower failure. Moreover, it is not clear whether the present limit is being effectively enforced. A uniform limit on loans to a single borrower or associated group of borrowers of no more than 15 percent of a bank's capital, with secondary limits set on the total outstanding to the three or four largest borrowers, is strongly recommended. The authorities need to be particularly wary of the danger to the banking system of allowing enterprises and affiliated ministries to control commercial banks. 24 Such conflicts of interest not only threaten the soundness of the particular bank, but also impede competition in both the financial and real sectors and can distort the allocation of credit away from higher-return investment possibilities. Regulations should limit the amount of credit extended to shareholders or officers of the bank and to parties related to them to a small fraction of capital and subject them to an absolute ceiling. It should also be required that any such loans be made on the same terms and conditions as applied to other borrowers.

(d) Asset classification The classification of assets in accordance with their likely collectibility is essential to ensuring that a bank's financial statements accurately present its finan­ cial condition.25 An assessment of asset quality also provides important evidence of the capabilities and competence of managers, and of the adequacy of the institution's lending policies and procedures. The supervisory authority should thus be empowered and required to review and, as necessary, to correct the clas­ sification of each bank's assets on the basis of an impartial assessment of asset quality based on objective criteria.

122 Regulations should require that banks classify their loans according to dif­ ferent risk categories. The criteria for defining nonperforming loans should be specified; for example, loans 60-90 days past due, depending on the type of col­ lateral, should be classified as nonperforming. There should also be a precise rule for suspending the accrual of interest and for reversing previously accrued, but uncollected, interest on nonperforming loans. Guidelines should be provided for the formal renegotiation and rescheduling of loan repayments, and the current practice of automatically rolling over bad loans should be explicitly prohibited. The classification of a loan as bad should be reflected in appropriate adjustments to loan-loss reserves. Finally, bank regulation and related supervision should also deal with con­ tingent liabilities of the banks and other off-balance sheet activities. These are reported to be significant in the USSR, in both the specialized banks and the CCBs.

(e) Disclosure of information Laws and regulations should ensure that investors and depositors in banks have adequate and reliable information about the bank's activities and financial condition. Banks should be required to disclose financial information-including audited financial statements-through a publicly available registry at the office of the bank supervisory agency, and to publish such information. Such a requirement gives confidence and protection to the depositors and investors and, in tum, puts additional pressure on the bank's owners and managers to assure efficient and prudent operation.

(2) Bank supervision Bank supervision, including on-site inspection, needs to be intensified. The staffs of Gosbank's Auditing and Commercial Banking Departments, with their wide network and professional experience, would provide a nucleus upon which to build an operational system of banking supervision. Their analysis, however, needs to be refocused, new concepts of financial analysis and risk management must be learned, on-the-job experience gained, and new equipment introduced. The process will necessarily be time consuming. Whether the supervisory function is assigned to Gosbank or to a new agency, the supervisors must be insulated from external interference and political pressure, particularly in light of the substantial interests that ministries and other government agencies currently have in the banks and in their borrowers.

(a) Accounting and auditing It is urgent that accounting standards be upgraded, with particular regard to the treatment of late and doubtful loans and requirements for loan provisioning.

123 Bank supervisors and auditors should work together with the accountants to im­ prove definitions and practices, with the common objective of better assessing bank performance and financial condition. An intensive training program should be mounted for accountants and supervisory personnel, including auditors and examiners.

(b) Supervisory methodology Once a basic accounting framework is effectively in place, and an adequate core of auditors and examiners has been trained, an intensive effort should be undertaken to assess the quality of individual bank portfolios and to assure their adequate provisioning and, as necessary, recapitalization. On-site examinations should be introduced as soon as the size of supervisory staff permits. Contacts of the supervisors with bank accountants and managers can hasten and reinforce the learning process for both. Examinations can also expedite compliance, as the results are communicated and a response is required. In preparation for the even­ tual liberalization of interest rates and increasing foreign exchange activity, special attention should be given to assuring that the attendant risks are properly managed. Competence in off-site monitoring should also be gradually developed. A data collection format and system should be designed to enable both a mechanical test of compliance with regulations and to develop simple means for spotting possible problems. A bank's balance sheet and income statement would be evaluated in the light of its portfolio, with particular attention to such factors as delinquencies and problem assets, foreign exchange position, and off-balance sheet liabilities. A program specifying the frequency of data submission should be worked out in accordance with the supervisory staff's ability to respond. Any noted weaknesses should trigger an immediate follow-up in the form of a com­ munication to the bank's management or, as needed, a supplementary on-site inspection.

(c) Staffing Staffing is perhaps the most immediate bottleneck to effective supervision, and efforts should begin urgently to expand staff size and upgrade skills. A career path should be developed for bank supervisors. Training and recruitment could be pursued in conjunction with the banks' own training and recruitment efforts, given their broad overlap. The upgrading of equipment--computers, etc.-should also be introduced as rapidly as feasible to streamline operations and to limit the demand for relatively unskilled staff.

(3) Modernizing the payments system Well-functioning financial systems require an efficient payments system, providing fast clearing and settlement at both the central and regional levels. This

124 is a matter of utmost urgency in the USSR. At present, money transfers between banks in different republics may take weeks or even months to clear, involving huge implicit interest costs, greatly complicating liquidity management of banks, and weakening overall control of the money supply. Gosbank is presently seeking to modernize its technological and institutional infrastructure for interbank pay­ ments settlement, including the introduction of correspondent accounts not only for the CCBs but also for the specialized banks and their successor institutions and for public sector organizations whose budgets are administered by Gosbank. The new system is expected to become operational in 1991. Reforms in this area are also vital to the development of securities markets, whose operations depend on efficient clearing and settlement systems. It is advisable that the new payments system be based on the most modem technology, allowing effective linkages with international money transfer systems.

(4) The transition to a market-based banking system

In the context of a strengthened regulatory and supervisory framework, the growth of CCBs and the commercialization of the specialized banks should be encouraged. The reinforcement of licensing and regulatory standards might result in a slowing of new bank formation and in the merger or disappearance of some existing CCBs, but the result should be the emergence of a stronger and more stable banking sector. In the meantime, ownership rights and the legal status of different forms of organization should also have been clarified, for banks as well as other enterprises, putting the CCBs on a level competitive playing field with the specialized banks. Similarly, a law on pledge should be enacted, clarifying the conditions for the use of property as collateral, introducing registration require­ ments for encumbered property, and establishing the procedures for foreclosure (see Chapter IV.7). At the same time, the denationalization of the specialized lending banks would proceed in much the same way as for state enterprises (see Chapter IV.2): viz., they would be transformed into joint stock companies, the shares to be held in separate state property funds-or holding companies-independent of the min­ istries and regulatory agencies (including Gosbank). However, the likely reclas­ sification of the assets of the specialized banks could force a reassessment of their overall financial solvency, or that of some of their branches, and cause a slowing of their full commercialization and privatization. New lending operations should be conducted on a fully commercial basis. Before being passed on to new owners, however, bad and doubtful assets should be written down and/or shifted to a special state agency for their collection or liquidation. The government should, in effect, take responsibility for the inherited bad debts. The magnitude of the prob­ lem cannot be known until these specialized banks have been subjected to com­ prehensive portfolio audits, and the economy has adjusted to reforms in the real sector.

125 During this period of clarifying and rectifying the financial status of the banks, their ownership would remain with the respective property funds. These holding companies, acting through boards of directors, would ensure that managers were held to the new performance criteria of commercial lending on all new credit decisions, and, very importantly, that appropriate training was being provided to managers and staff. The banks' operations should no longer be sub­ jected to sectoral limits, and both depositors and borrowers should enjoy freedom in their choice of banks. The specialized banks would thus be in increasing com­ petition with each other and with the CCBs. Only as they are placed on a sound financial footing and are adequately staffed for their new functions, however, should they be fully commercialized and the process of privatization begin. During an initial period, the Savings Bank could, as suggested by the presidential guidelines, remain under state control. With its extensive branch net­ work, it would probably remain, for a time, the principal mobilizer of household savings to the other banks and to the Government. As the Government's financing needs were reduced and increasingly satisfied through a growing securities market, and as the specialized banks were progressively commercialized, the Savings Bank could expand its own lending activities through the interbank market and, increasingly, directly to private sector customers. It, too, would be put on a commercial, self-sustaining basis, the foundation of managerial and staff skills having been laid during the transition period. A corollary of this evolution would be the withdrawal of Gosbank from its credit intermediation role; in the meantime, it will have developed its indirect tools of monetary controJ.26 Competition in retail banking could be further enhanced by allowing the post office system to engage in banking operations, such as cash and payments ser­ vices, retail foreign exchange transactions in tourist areas, the management of savings accounts, and the sale of government securities to small savers. This approach has the advantage that a wide network for the provision of such services is already in place in the postal system. Many countries have exploited this ad­ vantage, and, in some cases, the financial services departments of the postal sys­ tem have eventually been converted into independent, full-fledged commercial banks. In the course of this transition to a competitive market-oriented financial sector, the banks will have to prepare themselves to meet the vast financial service needs of enterprises, households, and local governments and other public bodies, as the entire economy operates increasingly on market principles. The increasing commercialization and privatization of existing enterprises and the creation of new enterprises of all sizes will place a heavy demand on the nation's financial resour­ ces. An expanding branch network will be required to reach and serve the needs of households and, especially, of small and medium-sized enterprises. A wide range of advisory and other merchant banking services will be needed to assist in the process of industrial restructuring and to support newly-formed enterprises.

126 Banks can also help their clients to establish commercial and investment linkages with foreign enterprises. The ability of banks to assist in the process of privatiza­ tion will require massive training of staff in the analysis of enterprise finances and market prospects, and the development of new financial instruments, institu­ tions, and markets through which savings are mobilized and channeled. As the reforms progress, the entry of foreign banks, on their own or in joint ventures with domestic institutions, can strengthen competition, create effective links with foreign financial centers, introduce needed management skills, and accelerate the process of financial modernization and innovation in the USSR. Foreign banks will remain reluctant to enter or to expand their operations in the Soviet market, however, until the legal basis for their activities and for credit operations generally is firmly established. Finally, the Government should reconsider its plans to retain one of the specialized banks under state ownership as a vehicle for channeling preferential credit to state-designated activities. Although such institutions are commonly found in other countries, the experience with them has not been good. While originally conceived as development-promoting institutions, their ability to dis­ pense credit on subsidized terms has frequently turned them into vehicles for political favoritism and bad loans. Instead of mobilizing additional resources for development, their lending practices have resulted in a heavy drain on state resour­ ces. This same advice applies also to the republican and local governments, which may be tempted to take over one or more specialized bank branches as their own state banks. As a general principle, it is recommended that a clear distinction be main­ tained at all levels of government between activities to be determined by the state and financed through the budget, and activities best left to market determination and to the financial system. Overlapping the two tends to subvert both decision­ making processes. This suggests that, where there is a public interest in promoting activities that are unable to service credit on full market terms, any subsidies be provided from the state budget, where they can be reviewed in the normal budgetary process, rather than financed from the earnings of banks.

2. THE DEVELOPMENT OF SECURITIES MARKETS AND CONTRACTUAL SAVINGS INSTITUTIONS The presidential guidelines indicate the Government's intention in the near future to support the creation of stock and commodities markets and related brokerage companies, as well as insurance companies and other institutions char­ acteristic of developed financial systems. Although of lesser urgency than the strengthening of the banking system, the establishment of such institutions is important, among other things, for the development of long-term instruments of investment finance, risk-sharing and the transfer of ownership rights, and improv-

127 ing the tools of monetary policy. The development of securities markets greatly contributes to the mobilization of resources for investment, by providing the long­ term instruments required by investors while at the same time helping to meet the liquidity needs of savers. a. Securities exchanges Steps have already been taken toward the establishment of securities exchan­ ges in Moscow and Leningrad,27 and Gosbank is drafting related rules and regula­ tions based on Western models. The only securitized claims currently in the system are a relatively small volume of government debt instruments, some bank certificates of deposit, and a limited number of shares issued by joint stock com­ panies, the most prominent of which is the Agroprombank, discussed earlier. The nature of ownership rights conferred by shares and their negotiability remain unclear.

(1) Existing securities No private debt securities have been issued to date. However, some govern­ ment securities have been issued, in addition to the certificates of deposit of the Savings Bank. Three types of government securities were being actively sold in 1990. Zero-coupon lottery bonds, due in 2002, were first issued in 1982 and continue to be issued on an ad hoc basis. As of September 1990, some rub 20 billion of such bonds were outstanding. With the Savings Bank serving as agent, the bonds are sold and can be redeemed at par at any time. The bonds are in bearer form and are available in denominations of rub 25, 50, and 100. 28 Lottery draw­ ings are held 8 times per year, and winning amounts range from rub 100 to rub 10,000. Large winnings (rub 5,000 and rub 10,000) can be applied against the price of Zhiguli or Volga automobiles and put the winner at the head of the queue for these cars. In late 1989, the Government issued rub 75 billion of 16-year, 5 percent Treasury bonds (dated January 1, 1990) to be sold through the Savings Bank. When these bonds failed to sell, the Government agreed to pay two coupons on each interest payment date, effectively halving the maturity and doubling the interest rate to 10 percent, and to reduce the amount available for sale to rub 15 billion. As of September 1990, only about rub 300 million had been sold. The bonds are available in denominations of rub 250, 500, and 1,000, and the Savings Bank is the sole paying agent. Commodity bonds are a securitized form of advance payment by "investors" seeking to secure access to 16 specific commodities, mostly consumer durables, identified by the Council of Ministers.29 The stated intention is to channel resour­ ces to expand production capacity for the specified goods, but it is not clear whether this is, in fact, happening. According to the 1990 Budget Plan, some

128 rub 5 billion of such bonds were to be issued. The bonds are obligations of the Ministry of Finance, with the Savings Bank once again serving as agent. The greatest demand was reportedly for bonds for automobiles and refrigerators. The Savings Bank has been issuing certificates of deposit since 1988, in denominations of rub 250, 500, and 1,000. These COs carry a nominal maturity of 10 years, with the interest rate graduated up to 4 percent, depending on the actual holding period. Information was not available on the amount of such paper outstanding, and it is not clear whether the certificates are traded.

(2) Legal and regulatory framework Important gaps in the legal and regulatory framework affecting securities markets need to be filled before substantial and stable development of these markets is possible. First and foremost, legislation is required to establish the legitimacy of financial claims and the rules and mechanisms of their enforcement. The salability of financial claims, including equity shares, must also be clearly established if savers are to be induced to share the risks of enterprises, and if secondary markets are to play their role in providing the liquidity demanded by most potential buyers of long-term debt or equities. To provide efficient intermediation of resources, and to enjoy the confidence of both savers and issuers of securities, securities markets must operate under clear rules and regulations. Potential buyers of securities need reliable information, on the basis of which to judge the financial strength and prospects of the enterprises and other entities whose obligations they have the option to buy. Legislation is needed, therefore, requiring accurate disclosure of information on the part of those wishing to issue securities, with strong penalties for misinformation or fraud. Disclosure standards may initially fall short of those applied in more advanced Western financial systems, given the present state of development of accounting practices. The quality of both will need to be raised over time, however, to inter­ national levels, if Soviet financial markets are to be made attractive to foreign investors. Securities investors must be able to rely with confidence on the inter­ mediaries--e.g., brokers-involved in market transactions. A system is needed for the registration and licensing of broker-dealers, with appropriate eligibility requirements concerning the experience, background, and capital base of the ap­ plicants. Following registration, intermediaries must be held to high standards of professional conduct. Market intermediaries should be required to disclose any financial interest they may have in the securities they are intermediating. Savers and investors should be protected against the potential monopolistic, collusive, or manipulative behavior of brokers and large market players. Rules against insider trading are of particular importance. Antimonopoly legislation should prohibit the fixing or manipulation of securities prices and broker spreads and commissions. Competition should also be protected by appropriate restrictions on interlocking

129 ownership and directorships among financial institutions and enterprises. The in­ tegrity of the exchange itself must also be assured, with strict qualifications set for the exchange's own personnel and standards set out for member conduct. For all these purposes, it is necessary that the law provide for the estab­ lishment of a strong regulatory agency with jurisdiction over the securities markets and with the authority to issue regulations applying to all the market participants­ issuers, intermediaries, investors, the exchanges, and organizations providing the clearing services for exchange transactions. It is important that the regulatory authority have the power to impose sanctions and that it be an independent agency, insulated from political pressures in its activities. This is particularly important in a situation in which the owners of many issuers of securities may continue to include government agencies. It will probably take two years or more before formal, well regulated securities markets for the trading of enterprise debt and shares would be in place in the USSR. Establishment of the necessary legal and regulatory framework will take time, as will the training of regulatory staff and creation of the required technological infrastructure. Investor confidence will also be slow to develop in the uncertainty of the reform process and restructuring of the economy. The is­ suance and trading of government debt instruments could, in principle, begin much earlier, however, given their relatively low risk to buyers. 30 Since most concerns about investor protection should not arise with respect to government securities, secondary market trading could be permitted and encouraged. The Government should shift its focus from the long-term end of the market and work to develop the market for shorter-term instruments. These would presumably be of greater immediate appeal to savers, given past experience with government bonds and the inevitable uncertainties of the Soviet economy in the next few years. Short-term government securities are likely to be viewed by savers as a close substitute for government-guaranteed savings deposits, particularly if their liquidity can be assured. Development of the market for such securities offers the additional advantage of serving the interests of monetary policy, allowing the authorities to affect base money through market means. Later in the process, consideration might be given to the conversion of existing government debt, which amounted to about rub 400 billion at the beginning of 1990, into negotiable in­ struments. A formal market for enterprise debt should await an adequate regulatory framework, particularly as regards investor protection. No market for long-term securities is likely to develop amid the uncertainties of the transition process. A possible exception could be mortgage lending by banks, which could be made an acceptable risk by the availability of secure collateral. For a mortgage market to develop, however, clear laws on property ownership and debt recovery would have to be in place. Short-term corporate debt, consisting of commercial bills and paper, could be encouraged to promote corporate liability management. Seasonal

130 fluctuations in the cash flow of agro-industrial enterprises, for example, could be partially smoothed through the issuance of short-term commercial paper during low-flow periods and investments in short-term paper during periods when reser­ ves build up. A market for short-term corporate paper might develop initially with banks acting as dealers. The volume and types of equity issued will depend largely on the plans adopted for the privatization of state enterprises (see Chapter IV.2). If most medium- and large-sized enterprises will be converted into joint stock companies early in the reform process, the shares could be held initially by state property funds. Subsequently, shares in the individual enterprises, in mutual funds formed of a diversified package of enterprise shares, or in the property funds themselves, would be sold to other state bodies, enterprises, and individuals. Although it is advisable to start now to develop the rules and regulations, including improved accounting practices and disclosure of financial information, it is not essential that the issuance and trading of the new equity shares commence on the basis of rigorous standards. Meanwhile, as the formal framework for share trading is being developed, the informal issuance and trading of securities is likely to grow. The Government should not try to stifle this activity, which can play a valuable role in mobilizing risk capital and giving liquidity to the new ownership claims. Without a satisfactory regulatory framework in place, however, the Government should not officially endorse or sponsor this activity, and should publicize the risks involved to its participants. b. Insurance The only nonbank institutional investors in the USSR currently are insurance companies. The State Insurance Company (Gosstrakh) dominates the system, with a network of 6,000 branches and 240,000 employees. Like other state agencies, Gosstrakh is organized in hierarchical layers in accordance with the several levels of government. Every republic has its own board of directors, as does every oblast. In addition, inspection sites are located in each municipality and rayon. Gosstrakh offers households and enterprises about 30 different types of insurance, covering 3 life, health, work disability, and property. ' Since 1988, however, a number of new companies have been organized as cooperatives or other forms. Some of these have, in fact, been promoted by Gosstrakh, along with municipal governments and industrial enterprises. It has also entered into a joint venture with a foreign insurance company. Gosstrakh's reserve funds, representing future obligations under insurance contracts, total some rub 34 billion; it is unclear, however, how this amount compares to its estimated actuarial liabilities. Some 41 percent of Gosstrakh's annual gross income (premiums less insurance payout) is transferred to the state budget. This amounted to about rub 1 billion in 1989. In the past, Gosstrakh's reserves were deposited in Zhilsotsbank at a fixed 3 percent rate of interest.

131 Recently, however, it has shifted a small amount of its reserves (about rub 4 billion) to higher-yielding CCB accounts. These accounts are not guaranteed, however, and tend to increase the riskiness of Gosstrakh's portfolio. Insurance companies in the Western industrial countries provide large and stable sources of long-term finance, including housing finance, and Gosstrakh and its present and future competitors should be viewed by the authorities as poten­ tially important elements of the Soviet financial system. Gostrakh's immediate evolution depends on how the economic relationships between the union and the republics are resolved. Some republican branches have been more profitable than others, and some have been loss-makers. A break-up of Gosstrakh would increase the riskiness of at least some of the republic operations and could weaken the insurance industry's competitive position vis-a-vis the banks. c. Pension funds Pensions in the USSR have historically been funded from a payroll tax on enterprises supplemented by payments from the state budget. The Savings Bank has served as the paying agent, and a Social Insurance Committee in each district is responsible for pension administration. Under the State Pension Law enacted in May 1990, a new, self-financing pension system was to be put in place as of January l, 1991. A new independent institution is to manage all pensions in the country as well as specific social welfare payments. Collection will be the respon­ sibility of the republican branches of the new institution. In addition, transfers from republican budgets are to cover military and other pensions. The head office of the pension fund is to manage surplus funds with a view toward maximizing their return; its profits would be exempt from taxation. 32

NOTES

1. For the three decades prior to the reforms of 1987-88, the interest rate on enterprise deposits was fixed at 0.5 percent. 2. Indeed until the mid-1960s, long-term credit was non-existent. Even after that, the distinction between credit and budgetary grants remained blurred, given the soft terms of the former and the frequency with which arrears were forgiven. 3. The Savings Bank monopolized the collection of household savings, which it redeposited with Gosbank. Prior to 1963, the Savings Bank was subordinated to the Ministry of Finance. Since then, except during 1988-89, it has functioned as a department of Gosbank. 4. Foreign trade was also serviced by Soviet-owned banks operating abroad. 5. Promstroibank took over the operations of the old Stroibank to provide both working capital and fixed investment financing. 6. If banks mobilize greater deposits than planned, they can exceed their credit ceilings by the same amount, while those with deposit shortfalls can still lend at their assigned ceilings. For the macroeconomic implications, see Chapter 111.2.

132 7. Article 6 of the Law on Banks and Banking Activities, enacted on December II, 1990, em­ powers the union and republican Supreme Soviets to create special commercial banks to finance all-union, republican, regional or other programs. Article 38 of the same law confirms the special emphasis on the Savings Bank as a mobilizer of individual savings, while a resolution of the USSR Supreme Soviet (also dated December II, 1990), reiterates that the Savings Bank is to remain the property of the USSR. Under that resolution, transfer of a Savings Bank branch to the possession of a republic can be made if the republic accepts a portion of the government debt financed by the savings accounts of its population. 8. The loans were taken over by the Government. In effect, the assets of Agroprombank were written down by rub 73 billion (equal to about a third of its outstanding loans at the time), and its liabilities to Gosbank were written down by a like amount. At the same time, Gosbank's loans to Agroprombank were replaced on its balance sheet by an equal amount of state bonds. 9. The republican branches of Agroprombank in the Ukraine and Belorussia have already become independent joint stock banks. 10. The pricing of the shares was done administratively. Total assets were estimated to be worth about rub 160 billion after write-offs. Applying the capital-liabilities ratio required of CCBs (see section d) implied a minimum capital requirement of rub 8 billion. The authorized capital was divided into 72,000 ordinary shares, priced at rub I 00,000 each, and 800,000 preferred shares priced at rub 12,000 each. The latter shares pay a 15 percent dividend but carry no voting rights. II. The disposition of existing assets and liabilities of the converted branches remains unclear. 12. The maturity of the CDs is nominally 10 years, but they can be cashed in early at any office of the Savings Bank. Interest rates range from 3 percent to 6 percent, increasing with the time held. 13. As of October 1990, Gosbank paid only 2.77 percent for the monies deposited with it by the Savings Bank. 14. Financial institutions are apparently exempted from Soviet criminal prohibitions against "speculation" and middle-man activities (see Chapter IV.7), and have served as convenient agents for barter and other trading activities on behalf of enterprises. These possibilities, how­ ever, may now have been eliminated. Article 2 of the new Law on Banks and Banking Ac­ tivities forbids banks from engaging in trade in material goods. 15. Until 1990, the CCBs were free to negotiate interest rates on household deposits. The present limits were evidently imposed to protect the deposits of the Savings Bank. Like bankers in other countries, however, innovative CCBs have found ways to circumvent these limits through offering premia of various kinds. 16. Article 9 of the new Law on Banks and Banking Activities permits commercial banks to create unions, associations and other combinations for the purpose of coordinating their activities and protecting their interests. Article 29, however, expressly prohibits the use of such unions, associations or other groupings to fix interest rates, commissions or otherwise restrict com­ petition in banking. 17. Under Articles 30-36 of the new central banking law enacted in December 1990 (see Chapter 111.2), Gosbank is to establish prudential norms for all commercial banks, including the spe­ cialized banks. According to the Resolution of the Supreme Soviet that accompanied the law, however, individual norms are to be established for Vneshekonombank, Promstroibank, and

133 the Savings Bank during some unspecified transition period. The responsibility for monitoring and enforcement is shared by Gosbank and the republican central banks. 18. In accordance with a decree issued in April 1989, banks wishing to engage in foreign exchange operations must obtain a license from Vneshekonombank; some 20 such licenses had been issued by September 1990. Under the central banking law enacted in December 1990, that authority was shifted to Gosbank and the central banks of the republics. At least one com­ mercial bank has already received such a license from Gosbank. 19. It has been common banking practice in the USSR to roll over unpaid principal automatically, while continuing to report accrued interest as income. 20. Under Article 38 of the new Law on Banking and Banking Activities, depositors at the Savings Bank will continue to enjoy a state guarantee of their deposits. Other commercial banks are in­ structed (Article 37) to establish interbank funds to insure the deposits of individuals in accordance with the procedures and conditions to be defined by the central banks of the republics. 21. In 1989, the average lending rate of Promstroibank was 3.78 percent compared to the 4 percent it paid on refinancing from Gosbank. The comparable paired rates for the other specialized banks were: Zhilsotsbank - 2.89 percent and 4 percent; Agroprombank - 1.77 percent and 1.5 percent. It should be noted that some bank branches also held interest-free government deposits. 22. Articles 27 and 36 of the new Law on Banks and Banking Activities free commercial banks to set their own interest rates and commissions, subject to the stipulations of Article 17 of the central banking law (Law on the USSR State Bank), which give Gosbank the authority to control interest rates when deemed necessary for monetary control. 23. Since the specialized banks at present fall far short of these and the other prudential standards recommended below, however, a transition period will be necessary, as discussed in section (2). 24. Article 8 of the Law on Banks and Banking Activities declares banks independent of the executive and administrative bodies of the state authorities in their decision-making and forbids state agency and administrative personnel to be administrators of the banks. 25. A general problem affecting the financial system is the present inadequate legal basis in the USSR for the recovery of debt. Severe restrictions exist on the use of state property or of leaseholds and use-rights to secure debt. Private property can apparently be foreclosed, but represents a tiny share of total assets, and there is no mortgage law. (Chapter IV.7 provides a more detailed discussion of the relevant legal framework.) 26. The bulk of outstanding state debt in the USSR is held on the books of Gosbank, its counterpart being money in circulation and Gosbank's liabilities to the Savings Bank. Breaking of the credit relationship between Gosbank and the Savings Bank, therefore, must be accompanied by a corresponding reduction in Gosbank's holdings of government debt, if intolerable monetary expansion is to be avoided. The only practicable approach would appear to be a substantial "securitization" of government debt. In other words, the creation of a large pool of marketable government debt would be a precondition for cutting the institutional linkage between the Savings Bank and Gosbank. 27. A commodities exchange of sorts is already functioning in Moscow, with the active support of the Moscow City Council. At present, it is essentially a trading room where participants can meet to enter into barter deals; the exchange itself plays no role in executing deliveries. 28. While they are fully negotiable, it is not clear whether a secondary market for these bonds exists. 29. These are also referred to as warrants for consumer goods. See Chapter 11.2.

134 30. Government debt in the USSR has not, in fact, carried a low risk historically. Payments have frequently been suspended, and interest rates lowered unilaterally. As a consequence, Govern­ ment debt issues are viewed negatively by many. 31. A separate company, lngosstrakh, insures external activities such as trade, Soviet tourists abroad, and transportation. 32. For details on the pension system and its financing, see Chapters 111.1 and Appendix III.l-3, and Chapter IV.6.

135 Table IV.S.l. USSR: Overview of Banking System (As of September I, I990)

Loans Outstanding to Households and Enterprises Number Number Shan­ Long­ of of Institution term term Total Capital Branches Employees (In billions of rubles) (Thousands)

Specialized banks ...... 261.0 82.4 343.4 17.7 63,395 I 435.8 ------Promstroibank ...... 99.3 23.6 122.9 2.4 1,466 68.6 Agroprombank ...... 109.4 43.1 152.5 3.7 3,374 91.4 Zhilsotsbank ...... 33.9 7.7 41.6 0.8 716 40.6 Sberbank ...... 0.3 8.0 8.3 1.0 56,637 I 231.2 Vneshekonombank ...... 18.1 18.1 3.1 33 4.0 Commercial and cooperative banks ...... 15.9 4.2 20.1 4.9 400 2 Gosbank ...... 1.8 169 10.6

Source: Gosbank. 1. Includes 52,347 agencies, i.e., offices that provide only savings deposit and withdrawal services. 2. Number of banks.

Table IV.5.2. USSR: Aggregate Balance Sheet of Commercial and Cooperative Banks,' End-June 1990

End-June 1990 Millions of rubles Percent

I. Assets Cash ...... 134 Reserve accounts ...... 542 2 Correspondent accounts ...... 2,029 9 Interbank claims ...... 2,855 12 Credits to enterprises ...... 16,359 69 2 Securities •••••••••••••••••..•.•••••••••••••••••••••.•• 367 I Factoring claims ...... 646 3 Fixed assets ...... 157 I Other assets ...... 657 3 Total ...... 23,746 100 II. Liabilities Statutory capital ...... 3,845 16 Loan loss reserves ...... 295 I Interbank deposits ...... 6,367 27 Other deposits ...... 11,646 49 Other liabilities ...... 1,451 6 Profits ...... 142 Total ...... 23,746 100

Sources: Gosbank, and Business in the USSR, No.3, July-August 1990. 1. 330 institutions; data are not consolidated. 2. Including panicipations.

136 Chapter IV.6.

Labor Market, Social Safety Net, Education and Training

1. INTRODUCTION The transition to a market economy in the USSR will involve significant adjustments and social costs, and will require putting in place effective labor market and social policies to both support the transition process and sustain the political consensus in favor of reform. In the past, the key instrument in the USSR for providing social protection was a formal job guarantee written into the Constitution. Although such a guaran­ tee is not possible in a market economy, through a set of appropriate policies it should be possible to minimize the costs of unemployment and to guarantee min­ imum incomes and standards of living. Not surprisingly, recent reform proposals leading towards a market economy have included eliminating the employment guarantee and introducing various forms of income compensation. Open unemployment will be a completely new phenomenon in the USSR and there is considerable concern about its social and economic consequences. The starting point for the analysis, therefore, must be the labor market situation. Past and possible future labor market developments are discussed in section 2. The principal conclusion is that labor shedding could become significant if and when enterprises are confronted with a hard budget constraint. Section 3 deals with incomes and living standards. The main finding is that the traditional system of administered wages and prices and the available social transfers have been inadequate to prevent poverty or to ensure access to the basic goods and services desired by the population. The final section reviews a range of policies involving labor markets, educa­ tion and training, wage formation and social protection which could help support the reform process. It is suggested that in many cases new institutions or in­ frastructure to deliver such policies will need to be established. This will neces­ sarily take time and will impinge on scarce budgetary resources. However, postponing action now would further delay the normal functioning of a market economy. The key requirement for the pursuit of effective labor market policies

137 will be the build-up of a nation-wide public employment service. In the vocational education and training area, a reasonably well-developed infrastructure is avail­ able but needs reform to respond to the emerging skill requirements of a market economy. The system of industrial relations has to be completely overhauled and requires new institutions and "rules of the game"; there is a particular urgency to develop collective bargaining structures. But this will not occur overnight. In the meantime, an effective incomes policy is needed to contain wage cost pressures and to support macroeconomic stabilization. The social protection of weak and vulnerable groups, including the un­ employed, is of particular relevance for cushioning the immediate adverse effects of the transition process. A number of options for social safety nets are also discussed in section 4. Liberalizing the prices of basic food items would result in a severe drop of living standards for those on low and fixed incomes. Measures to protect these groups could include cash transfers, the provision of specified quantities of certain essential goods at given prices, or food-stamps. The method of delivery may be in-kind, universal or targeted. The effectiveness of the cover provided and the consequent budgetary implications of these options are ex­ amined.

2. THE LABOR MARKET a. Labor force and employment

(1) Labor supply trends The dominant trend in the Soviet labor market over the last decade has been a sharp slowdown in the growth of the labor force (Chart 1 and Table AI, Ap­ pendix II -I); the average annual rate of growth in the second half of the 1980s was about one third that of the second half of the 1970s. While the growth rate of the Soviet labor force in the 1980s was roughly in line with that of Eastern Europe, it was less than one half the average rate achieved in the OECD countries (Table IV .6.1 ). Up to the late 1960s, buoyant labor force growth had been main­ tained by a combination of moderate population growth and rapidly rising par­ ticipation rates. But participation rates stagnated after the early 1970s and labor force growth since then has been determined mainly by the growth of the work­ ing-age population. While the working-age population grew rapidly, at almost 2 percent per annum in the 1970s, a contraction in fertility rates and an increase in death rates caused a major slowdown in the 1980s. Labor force participation rates in the USSR have traditionally been higher than in most Western countries. Measured as the total labor force divided by the total population aged 16-64, the standardized labor force participation rate in 1988 was higher in the USSR than in any of the G-7 countries (Chart 2). 1 However,

138 participation rates in several small Western countries, notably the Nordic countries, were significantly higher than in the USSR. High female participation rates have tended to push up the overall participation rate in the USSR, while a low-by Western standards-pension age (men: 60 and women: 55) has tended to depress it. Indeed, in contrast to most Western countries, the participation rate for working-age women in the USSR is only marginally less than for able-bodied men. The gap between female participation rates in the USSR and in the West has narrowed over the last two decades, as rising rates in the latter have begun to catch up on a stable Soviet rate. However, the number of working hours supplied by Soviet women on average is much higher than in the West. This reflects the fact that part-time work is almost non-existent while it has expanded rapidly in most Western countries in recent years. Part-time work is concentrated among female workers in the OECD countries, while about 99 percent of Soviet working women work full-time. 2 The 1980s witnessed an increasing tendency for old-age pensioners in the USSR to remain in the labor market beyond retirement age. According to the 1989 census, 17 percent of all old-age pensioners continued to work after reaching pension age, 5 percentage points higher than in 1979. This increase seems to be linked to the low value of retirement pensions, lack of indexation and the strong demand for labor. During the 1980s, the value of retirement pensions fell relative to average wages and the prices of goods and services (see section 3). This, in tum, has forced many old-age pensioners to supplement their pensions with earned income.

(2) Special features of the Soviet employment structure

In line with the experience of most Western countries, there has been a large fall in the share of agriculture in total employment in USSR and the share of services has increased. Within the service sector, social and community services have recorded the largest gains. In contrast to the pattern observed in most Western countries, however, the manufacturing industry's share in total employ­ ment has remained constant over the last two decades. There have also been relatively small changes in the importance of sub-sectors within manufacturing, with the share of heavy industry remaining very high at the expense of consumer goods industries. International comparisons show that the employment structure in the USSR differs significantly from the structure in Western countries (Table IV.6.2). The most striking differences are the very high shares of agriculture in the USSR, 3 the virtual absence of a financial sector and a very small retail and wholesale trade sector. Apart from these three sectors, the Soviet employment structure is well within the range observed in the OECD countries, notably for the two major sectors, manufacturing and community services.

139 The easing of restrictions on private employment in the latter part of the 1980s has resulted in a small, but rapidly growing, private sector outside agricul­ ture. Until the mid-1980s, the only authorized "private" sector activities were in so-called private subsidiary farming which, traditionally, was an important source of agricultural output. Three percent of total employment is estimated to have been engaged in such activities in 1989. Genuine private activity outside agricul­ ture was legalized in 1987 after the adoption of the Law on Individual Labor Activity, allowing individuals to be self-employed. In 1989, it was estimated that 300,000 persons were legally self-employed, about 0.2 percent of total employ­ ment. Legislation permitting the leasing of land has opened up the possibility of private farming, and about 100,000 persons were engaged in such activity in the first three quarters of 1990. The Law on Cooperatives, adopted in 1988, allows a group of people to engage in any legal activity and also to employ people. This form of enterprise spreads quickly and is common in consumer services, retail distribution, and con­ struction. By October 1990, there were some 215,000 cooperatives, employing 5.2 million persons (more than 3.5 percent of total employment), of which some­ what fewer, however, were considered to have their main job in such activities. Soviet enterprises tend to be much larger than enterprises in OECD countries, reflecting the central planners' obsession with economies of scale. There are only 46,000 enterprises in industry, implying that the average enterprise employs around 830 employees. Twenty thousand of these enterprises employ less than 200 workers. This. in tum, implies that the average enterprise with more than 200 workers employs more than 1,250 employees. Although large enterprises are also the norm in Eastern European countries,4 the size distribution of Soviet enterprises is very different from the typical profile found in Western countries. For example, establishments in France, Germany and Japan with a work force of up to 100 employees account for 50-60 percent of all private sector employment. 5 In these countries, establishments with more than 1,000 employees provide jobs to only 20-33 percent of the industrial work force.

(3) Regional variation in labor supply and demand Aggregate figures on Soviet labor supply and employment conceal important regional differences. The labor market can be split into two broad regional areas according to demographic trends and employment structure: the more developed regions (Russian Republic, Baltic republics, the Ukraine, and Belorussia) and the less-developed regions (Central Asian republics, Kazakhstan, Transcaucasian republics, and Moldavia). The developed regions are characterized by sluggish population growth and stagnating or falling employment levels (Table IV.6.3). In the 1980s, the annual average population growth rate in these regions ranged from 0.4 percent (Ukraine) to 0.8 percent (Lithuania). The ageing of the population resulted in much slower growth in the working-age group than in the overall

140 population. The Ukrainian working-age population even fell in the 10-year period ending in 1989. The dominant feature of demographic developments in the less developed regions is rapid growth of both the overall population and the work­ ing-age population. The highest annual average population growth rates in the 1980s were recorded in the Central Asian republics (ranging from l. 9 percent annual growth in Kirgizia to 3 percent growth in Tadzhikistan). Population growth was more modest in the other developing regions, especially in Moldavia, Georgia, and Armenia. In the developed areas, manufacturing accounts for around 30 percent of all employment, while in the less developed regions its share is generally less than 20 percent (except in Armenia) (Table IV.6.4). By the same token, the developed areas have relatively fewer workers in agriculture, ranging from 14 percent in the Russian Republic to 22 percent in the Ukraine. In the less developed regions, the employment share of agriculture exceeds 25 percent, and is especially high in the Central Asian republics, partly due to the importance of private subsidiary farming in these regions. A surprising feature of the employment structure across the USSR is that service sectors have relatively high shares in the less developed regions. For example, community, social and personal services account for a higher percentage of total employment in the Central Asian republics than in the developed regions. b. Labor market: pressures and imbalances The crucial difference between the Soviet labor market and those in the West relates to the demand for labor. While every able-bodied Soviet citizen has a constitutional obligation to work, there is in fact considerable freedom to choose where to work. The choice is the result of economic incentives, such as wages, fringe benefits and working conditions, as well as administrative regulations governing residence permits (propiski) and the availability of housing. But on the demand side Soviet managers, unlike their Western counterparts, have not been subject to strict financial discipline in determining labor requirements; instead they have been faced with a soft budget constraint and the imperative of fulfilling the production targets laid down by the central planners. Since wages have been largely determined by a very complex and cumbersome system of centrally-deter­ mined wage tariffs, wages have played little role in allocating labor to its most productive uses.

(1) Overmanning in enterprises There is general agreement that Soviet enterprises tend to employ more workers than are needed. 6 Soviet estimates of overmanning in the first half of the 1980s, based on surveys of managers, suggested that many enterprises retained between 15 to 20 percent more labor than was necessary to fulfill their production

141 plans, and that for some branches the figure was as high as 25 percent. Soviet figures may even underestimate the extent of overmanning in industry, since decades of excess demand for labor may have fundamentally affected the percep­ tions of what are necessary labor requirements. Thus, comparisons of manning levels in Western-built plants in the USSR with matched plants in the West indi­ cate that the Soviet plants employed 50 to 150 percent more workers. While a soft budget constraint has favored labor hoarding, overmanning has also been a rational response by Soviet managers given the constraints imposed on them by the central planning system. Their overriding objective is to fulfill the plan's targets for outputs but, at the same time, they are continually faced with potential disruption to production schedules. Overmanning has also probably been stimulated by an overheated labor market. Lack of labor discipline ("shirking") is a prevalent feature of the organization of labor resources in the USSR. Many official campaigns have been launched to improve the situation, but to little avail. Workers spend much of their working time arranging their personal affairs, moon­ lighting, and queueing for scarce goods. There is some evidence that managers have competed for workers in the tight labor market by offering less-intensive working schedules. Given that their ability to offer higher wages has been to some extent circumscribed by central guidelines, this paid "leisure" was a natural alter­ native way of attracting workers. Labor market pressures do not seem to have eased in the 1980s, and large numbers of vacant job places continued to be recorded at the end of the decade. However, increased freedom for enterprises to set wages in recent years has meant that demand pressures may be increasingly reflected in higher wage increases rather than in less labor discipline. The authorities have made several attempts to encourage enterprises to release excess workers over the last 20 years, but only since the mid-1980s have they enjoyed some success. A common aim of these reforms was to give enterprises and their work forces an incentive to reduce overmanning: allocating fixed wage funds to enterprises, or to a given task, so that average wages would rise with a smaller work force; or attempting to relate bonus payments to planned labor productivity growth. The failure of these reforms was due to planners revis­ ing the wage norms as soon as productivity increases occurred, thus pre-empting any rewards workers may have gained from greater work effort. The 1986 wage reform led to an increase in tariff wages, i.e., in the basic wage scales for state employees in individual occupations and at various skill levels, but required that these higher wages be financed by enterprises out of their own resources. The 1987 Law on State Enterprises also encouraged the linking of productivity and wage levels. These measures, notably the 1986 wage reform, are thought to have reduced overmanning to some extent. By January 1990, when the wage reform had been implemented for more than 80 percent of the 72 mil­ lion potentially affected workers, about 3.3 million workers (5 percent) had been displaced. Around a third of the displaced workers found a new job within the

142 same enterprise; the remaining workers were laid-off and 30 percent of those went into retirement. This degree of labor shedding was minor, however, com­ pared with the scale of labor hoarding in the economy.

(2) High labor turnover Official labor turnover rates in the USSR are not markedly out of line with those recorded in many Western countries (Chart 3). In industry, 6.5 million workers left their jobs in 1989 out of a total industrial work force of 37 million; in construction, there were 4 million job-leavers out of a total work force of 12.5 million. Measured as the total separation rate per 100 employees in industry, Soviet turnover rates in the 1980s exceeded those of Japan, France, Italy, and Sweden. They fell well short of those in the United States, however, and were slightly lower than separation rates in the United Kingdom. There are reasons to believe, however, that official turnover data under­ record actual turnover in the USSR. Official statistics are based on surveys of large enterprises, i.e., enterprises which have independent accounting systems. In 1989, employment in these enterprises accounted for two thirds of total employ­ ment in the state sector. Experience in the West shows that labor turnover tends to be inversely related to the size of the enterprise, and scattered evidence from the USSR suggests a similar pattern. As a result, official turnover statistics probab­ ly have a downward bias of unknown magnitude. Voluntary quits are the single most important reason for leaving jobs in both industry and construction, accounting for between 30-45 percent of all separations in recent years (Table IV.6.5). In industry, the second most important motive for job separation is to leave the labor market, e.g., for retirement, military service, return to education, or maternity leave. This is followed by termination of work assignments, disciplinary dismissals, and transfer to other enterprises. In construc­ tion, termination of work assignments, transfer to other enterprises, and exit from the labor force each account for about a fifth of all separations. The most important reason for voluntary quits--cited by a quarter of all respondents in 1987 in a Goskomstat sample survey-was the need to change geographic location. Unsatisfactory living conditions, such as bad housing and insufficient child care, dissatisfaction with working conditions, and low wages, were also cited as major factors behind the decision to quit. The trend of recorded voluntary quits-and presumably total separations­ was marked by a sharp decline in the period from 1970 to 1985, after which quit rates started to edge upwards again. Three factors seem to have been instrumental in bringing about this secular decline in quit rates. First, the ageing of the Soviet population should have reduced quit rates. In the USSR, as in the West, young workers have much higher quit rates than older workers. Second, repeated pres­ sure from Gosplan and the branch ministries on enterprise managers to reduce unplanned turnover may have prompted them to transfer some activities to sub-

143 sidiaries. Third, several administrative measures were taken in the 1980s to curtail voluntary quits. These included lengthening the period of advance notification for quits, strengthening the links between length of job tenure and entitlements to social security benefits and holidays, and temporary restrictions on the right to quit. Given the incentive structure in the Soviet labor remuneration system, job changes have frequently not contributed to improved allocation of labor resources. One reason is the movement of skilled personnel from jobs where their skills were required to jobs which required no particular skills. Viewed from the perspective of the individual worker, such behavior may be perfectly rational; it could be a natural response to the sharp compression of wage differentials between skilled and unskilled workers (section 3). Another unwanted side-effect on labor alloca­ tion was the movement of workers from areas with tight labor markets to areas where there was no shortage of labor. Such migration flows were common up to the 1970s. Thus, labor-shortage areas, such as Siberia, had difficulties in attracting workers, whereas labor-surplus areas, such as the Central Asian republics, ex­ perienced net inflows. This could have been linked to inadequate regional varia­ tion in wages and salaries.

(3) Low unemployment despite high turnover Official estimates of unemployment in the USSR put the number of jobless persons in 1990 at around 2 million. 7 The incidence of unemployment differs markedly across republics, with the bulk of unemployment being concentrated in Kazakhstan, Central Asia, and the Transcaucasian republics. There is little information on how either the official or unofficial unemploy­ ment estimates are derived, which makes it difficult to evaluate their reliability. One possible reason for the wide range of estimates relates to the category of "discouraged workers", i.e., people who want a job but are not actively looking for one because they believe such search would be futile. (These individuals would be excluded from the ILO definition which requires not only that a job seeker be available for work but that he/she has also taken active steps to find work within a recent period.) This is a particularly important category for Kazakhstan and the Central Asian republics. Once an unemployment insurance system is put in place in the USSR-which is under active discussion-many of these discouraged workers are likely to register as unemployed at job placement agencies and claim benefits. There are grounds for believing that the lower official estimate of 2 million unemployed understates the true unemployment total as it would be measured on the ILO definition. As mentioned earlier, significant labor turnover takes place in the USSR, implying that there is some search (or frictional) unemployment as part of the process of job changing. Western analysts have attempted to estimate the magnitude of search unemployment in the USSR using data on turnover together

144 with very sketchy information on the average duration of unemployment spells. These estimates suggest an unemployment rate in the range of 1 to 3 percent for the state sector (i.e., excluding collective farms) in the mid-1980s, or between 1 '14 and 3 'lz million persons unemployed. 8 Total unemployment on the ILO definition should be higher than these estimates for two reasons. First, the es­ timated rates of frictional unemployment themselves are probably biased downwards because of the bias in labor turnover discussed above. Second, the estimates do not include first-time job-seekers. Some Soviet evidence suggests that this group has much longer unemployment spells than the average. Assuming that the data on labor turnover are reasonably reliable, an un­ employment stock between, say, 2 and 6 million would imply that the average duration of unemployment spells is somewhere between 1 and 3 months. Com­ pared with the experience of most Western countries, an average spell length of not more than a quarter is relatively short. Most European OECD countries, for example, have experienced average durations of unemployment spells well in excess of 9 months. c. Transition to a market economy: estimates of job displacement and unemployment

( 1) Sources of displacement The transition to a market economy will inevitably involve large-scale dis­ placement of the Soviet work force. The size of this displacement will partly depend on the evolution of the macroeconomic situation but will also be deter­ mined by the following structural developments: Reduced overmanning. As discussed above, current levels of overmanning could be around 20 percent or more; hence large-scale lay-offs should occur if and when enterprises are confronted with hard budget constraints. The extent to which they occur will depend on the cost of making workers redundant and on who bears this cost. The propensity to lay-off excess labor will also be influenced by the introduction of an unemployment insurance system: employers will be less reluctant to fire people once this system is in place. Closure of uncompetitive firms. Moving towards a market economy will re­ quire sharp cuts in budgetary support to ailing enterprises, and increases in interest rates. Goskomtrud estimated that in 1990, 3 million workers were employed in loss-making enterprises: 2 million in 1,825 industrial firms, 0.3 million in 1,253 construction enterprises, and 0.7 million on 1,738 farms. Unless price reforms significantly improve the relative price structure faced by these enterprises, cutting off subsidies will inevitably result in plant closures and large job losses. Structural changes. A market-determined structure is likely to create job losses in the capital goods industries. It is now government policy to transfer

145 resources to industries producing consumer goods, and capital-intensive projects are also prime candidates for reducing the budget deficit. With capital goods industries accounting for about a fifth of total employment, abrupt reduction in capital spending would result in huge displacement. Demilitarization. Implementation of recent disarmament agreements would imply that the Soviet armed forces would likely release manpower in the near future. The Soviet army currently consists of 4 million conscripts and professional soldiers. Moreover, the Ministry of Defence employs large numbers in unspecified activities within the USSR. De-bureaucratization. With the central government administration and espe­ cially the branch ministries losing much of their functions, job losses are to be expected in the state bureaucracy as welP

(2) Destinations of displaced workers Displaced workers will face four alternatives: Re-employment. There are several sectors in which there is a large potential to expand employment. Consumer goods industries, wholesale and retail trade, and the financial sector account for a very small proportion of total employment. Although private employment has expanded rapidly in these areas in the past two years, it would require massive growth in new small enterprises to absorb a sig­ nificant share of the large-scale lay-offs from the state sector. Creating the right climate for entrepreneurs and ensuring that they have adequate access to finance and business advice will be crucial factors in this regard (see Chapters IV.2 and IV.5). Exit from the labor force. Some displaced workers will leave the labor market. This option is likely to be availed of by older workers who are close to retirement. The degree to which this is a viable option for them will depend on the generosity of retirement pensions and severance payments, and perhaps also on the extent to which part-time work becomes more widespread as the service sector expands. Emigration. Once a new emigration law has gone into effect giving Soviet citizens the right to leave the USSR, there could be a sharp rise in emigration, especially of highly-skilled workers. The Government has indicated that several million Soviet citizens would like to emigrate to the West in the coming years. The extent to which large-scale emigration materializes will partly depend on the response of Western governments to increased immigration pressures. Unemployment. The degree to which job displacement gets translated into higher unemployment is likely to depend importantly on the personal charac­ teristics of the redundant workers, as well as the state of the labor market and employment policies. Experience from the industrialized countries shows that while prime-age men are most likely to be made redundant, they will generally

146 have short unemployment spells. Older workers, women, and unskilled workers tend to have much longer unemployment spells if they lose their job. The propor­ tion of these groups in overall lay-offs can have a decisive influence on the stock of unemployed workers. Soviet officials expect that these groups will be strongly affected by redundancies. The destination of displaced workers will also depend importantly on the evolution of wages. If wages rise relative to producer prices or other input prices, employers will be more reluctant to expand production or they will use other inputs more intensively. In principle, growing unemployment in a market economy should prevent real wages from deviating too far from their full-employ­ ment equilibrium value. However, experience from many market economies shows that real wages tend to respond only gradually to high unemployment. 10

(3) Soviet estimates of displacement and unemployment Goskomtrud has projected the labor market implications of a move towards a market economy under two different scenarios: (1) a transition period of 8-10 years; and (2) a transition period of 2 years (Table IV.6.6). The Shatalin plan also gave an estimate of the unemployment consequences in 1991 of the "500 days" transition program. According to Goskomtrud's "gradual" scenario, unemployment would in­ crease only moderately despite a sizable increase in the number of redundancies. It was projected that employment in the state sector would be reduced by a third (40 million) over the period of 8-10 years, with a fall of 9.5 million expected in 1991. About two-thirds of the contraction in 1991 was projected to come about through workers leaving the state sector on their own accord. Around 500,000 workers were expected to be made redundant due to ownership changes, presumably due to reduced overmanning. The state sector was also assumed to lay off 3 million workers: 1 Y2 million as a result of loss-making enterprises clos­ ing down, and 1 Y2 million due to structural changes in industry. As well as 3 million lay-offs, Goskomtrud assumed that voluntary quits would remain at their 1990 level. This latter assumption seems most unrealistic as evidence from market economies suggests that quits should decline significant­ ly in an environment of slack labor markets and rising unemployment. A salient feature of these projections is that total employment in the Soviet economy is expected to remain at its 1990 level. This in tum implies that the number of unemployed persons would increase solely in line with the projected increase in the labor force of some 700,000 persons. Indeed, the gradual increase in un­ employment in the first half of the 1990s under these projections, up to 4 Y2 million (an unemployment rate of 3 Y4 percent) in 1994, is entirely accounted for by the projected increase in the labor force. In the "shock" scenario, Goskomtrud estimated that layoffs would be 6 mil­ lion in 1991. Compared with the gradual scenario, the increase in redundancies

147 would arise from more rapid structural changes in the state sector and faster privatization. The unemployment consequences of these developments were not explicitly stated by Goskomtrud, but if the job creation capacity of the economy were not impaired by the shock, the number of unemployed persons could still rise by 3lf4 million in the first year of the program. If this is added to the current official estimates of unemployment (2-2.5 million), it would imply an unemploy­ ment rate of around 4 percent in 1991. The Shatalin program had expected unemployment to rise by 5 million in the first year of a rapid transition to a market economy. This increase was to have resulted from 25 million workers changing jobs, an estimated increase over the previous year of about 50 percent, of which almost 20 million were expected to find new jobs. The labor force (the employed plus the unemployed) was expected to increase by only 0.5 percent. The near doubling of unemployment to 11.6 mil­ lion (an unemployment rate of over 8 percent) would be associated with a dou­ bling of the average duration of an unemployment spell, from one to two months.

(4) An assessment of the Soviet estimates The Goskomtrud estimates of displacement and unemployment look modest compared with the experience of Eastern European countries which have em­ barked on a rapid transition to a market economy. Since the start of the Polish program in January 1990, recorded unemployment had risen by end-1990 to about 6 percent of the total labor force. The unemployment rate in the former GDR had increased to over 7 percent during the same period. In both cases, firms reacted swiftly to tighter financial discipline and greater competition by laying off workers, and job creation in the rest of the economy failed to keep pace. Sizable numbers of unfilled vacancies prior to the transition all but disappeared in the new environment. In the first quarter of 1990, vacancies in Poland were only 7 percent of what they had been one year earlier; and unfilled vacancies in the GDR fell by 7 5 percent in the first five months of 1990. Possible reasons for relatively low unemployment in the Goskomtrud projec­ tions are that they did not fully take account of overmanning in enterprises, or that even under the "shock" scenario that it was assumed that enterprises would not immediately be subjected to hard budget constraints and competition. Another reason for low unemployment in the Goskomtrud projections was that virtually no increase was assumed in the average duration of unemployment spells during the period of restructuring. Keeping the average duration of unemployment con­ stant at a time when there is a steep increase in redundancies would appear to be highly unrealistic. The Soviet unemployment rate could easily exceed 5 percent during the transition to a market economy on relatively modest assumptions about the current degree of overmanning and the average duration of unemployment spells. This can be illustrated by two hypothetical scenarios for 1991-92 (Table IV .6. 7). In

148 both scenarios, enterprises are assumed to eliminate overmanning in two years and the initial stock of unemployment is set at 2 Yz million as of the end of 1990. Lay-offs are assumed to be relatively evenly spread across quarters in the "gradual" scenario. In the "radical" scenario, they are assumed to follow an in­ verted U-shape path, beginning with a slow start, a peak, and dwindling towards the end of the period. Enterprises currently operating at a loss are assumed to go out of business in one year, the layoffs being evenly spread over the year. In addition to redundant workers, inflows into unemployment will include new entrants to the labor market and voluntary quits. Voluntary quits are assumed to be inversely related to lay-offs, but the growth in the labor force is the same in both scenarios. The duration of unemployment spells increases gradually in the course of the two years. With these assumptions, an unemployment trajectory can be computed for different starting values for overmanning and different lengths of the average duration of unemployment spells. If current overmanning is assumed to be around 12Yz percent and the average duration of unemployment is assumed to increase to 7Yz months (i.e., the gradual scenario), the unemployment rate could climb to around 9 percent before descending to its steady-state value of around 7Vz per­ cent.11 If overmanning is assumed to be around 25 percent and the average duration of unemployment increases to 10 months (i.e., the radical scenario), the unemployment rate would rise to around 12 percent in the first year of the tran­ sition period. The steady-state value would be around 10 percent. Judging from the experience of many West European countries, an average duration of un­ employment of 10 months would still be relatively low. While care should be taken not to read too much into such mechanical calculations, they do show that the unemployment consequences of a transition to a market economy could be much sharper than recent Goskomtrud projections.

3. INCOMES AND LIVING STANDARDS Living standards in the USSR have, in principle, been determined by an employment guarantee, in conjunction with administratively set wage rates and transfers. Wages and transfers, such as pensions, have been set at levels reflecting the system of controlled prices for consumer goods. In practice, however, the ability to mould living standards has been severely limited in recent years. The reforms of the late 1980s conferred a degree of decentralized decision making to enterprises in the setting of wages, bonuses, and in-kind transfers to employees. At the same time, the state procurement and distribution system has been under increasing pressure and has not been able to cope with increased demand. This has resulted in shortages and queues, as well as higher parallel market prices for some goods in particular areas. High cash wages have therefore not been adequate to ensure significantly increased access over goods and services. Moreover, groups depending on fixed transfers, such as pensions, have experienced declining

149 standards relative to both wages and prices. It is not surprising, therefore, that there have been widening differentials in both living standards and poverty across various regions of the USSR. a. Wages and incomes A system of tariff wages has been in operation on a national scale in the USSR since the reforms of wage policy and administration in the mid-1950s. In addition to tariff wages, most employees earn bonuses, which are determined and allocated at the enterprise level. The social consumption fund, financed by con­ tributions from enterprises as well as the union budget, provides for additional cash and in-kind payments to employees. While its distribution is less well docu­ mented,12 the system of in-kind payments is particularly important, and may vary considerably within as well as across enterprises. Even more limited is the infor­ mation base regarding incomes from private activities.

(1) Tariff wages and bonuses A major issue in relation to the administrative determination of the structure of wages has been the tension between the desire to control the distribution of income and the need to provide appropriate work incentives. As a result, an elaborate system of tariff wages has been devised for workers in the state-owned productive sector. There are (I) basic rates, specifying wages for the least skilled for each branch of the economy; (2) skill scales reflecting differentials relative to the least skilled; (3) additional coefficients for arduous work; and (4) regional coefficients to attract workers to inhospitable parts of the country. Wages in the so called non-productive sector (e.g., services, health care and administration) are determined in relation to similar jobs in the productive sector. While collective farmers are not covered by the tariff system, they are nonetheless guaranteed minimum wages. D Bonuses have become a significant element of the monthly average wage. The importance of bonuses varies considerably, however, and they also have tended to vary by skill levels. Despite the elaborate paraphernalia of the tariff wage structure, there was a compression of wage relativities over the 1956-66 period, although a widening of differentials since 1986. At the beginning of the wage reform of 1956, the ratio of earnings in the ninth decile relative to those of the first decile was reported to be 4.4. 14 This ratio declined, however, to 2.8 in 1968, as a result of a cap on maximum wages, as well as the 50 percent increase in the minimum wage to rub 60 with effect from January 1968. 15 The ratio stabilized between 3.0 and 3.3 until wage reforms began in 1986; by 1989 the ratio between the ninth and first deciles had risen to around 4.

150 A consequence of the earlier compression of differentials was the reduction in the salaries of professionals and technical staff relative to workers' wages, although this may also have been due to an excess supply of technical and profes­ sional graduates. Salaries relative to wages in the construction sector, for example, fell below parity during the 1980s-they had been twice as high in 1955 (Table IV.6.8). Despite differential access to superior and scarce goods and services, particularly for managerial staff and administrators, by the mid-1980s it was thought that better pay was attracting technical staff into blue collar occupations. The 1986 wage reform was partly designed to rectify this structural problem, and there have been larger increases in salaries than wages subsequently.

(2) Sectoral and regional variations The sectoral pattern of wages has remained fairly stable despite the reforms to date, with a few exceptions. Earnings in industry and transport have remained above average, and those in agriculture, housing, health, education, culture and art have been well below average throughout the 1980s (Table IV.6.9). Despite above-average growth in agricultural wages in the first half of the decade, they were no higher, relative to the overall average wage, at the end of the decade than in 1980. The improvement in salary levels relative to wages has had an effect in changing sectoral rankings only in financial services and administration, and that only in 1990. In other sectors, while the position of technicians and administrators relative to wage earners may have improved, overall sectoral rankings appear to have been unaffected. Within the industrial sector, there were declines in wage levels relative to the national average in the fuel, metallurgy, chemical and petrochemical industries, but increases in light and food industries, and in timber and wood processing. 16 This reflects the recent shift of emphasis from heavy to consumer goods industries. Wage differences remain marked across republics. To some extent this is due to the location of industries, with the high wage sectors generally absent from the poorer regions. Agricultural activities normally attract lower wages. There is, moreover, variation across republics for the same sectors. Comparisons for a rela­ tively less developed republic (Uzbekistan) with one of the more developed republics (the RSFSR) suggest that in 1987 average wages were lower in each sector in the poorer republic (Table IV.6.10}. The main form of private activity until now has been that in cooperatives. Average earnings in cooperatives were around rub 367 per month in the first half of 1990 (Table IV.6.11 ), compared to rub 256 in the national economy (Table IV.6.9). The variation in earnings of cooperative workers across sectors tends to reflect the relative earnings potential in state-owned enterprises, with the highest wages in reprocessing and construction. It has been argued that cooperative mem­ bers do not report their full income, and that these earnings reportedly range up to rub 900 per month. 17

151 (3) Wage adequacy and other benefits Wage levels have apparently been designed such that a family with children would require two wage earners to satisfy basic needs, given current prices. Gos­ komtrud estimates suggest that, with the appearance of a child, 30 percent of single earner families fall below a poverty threshold of rub 75 per capita per month, and with more than one child more than 50 percent of single earner households fall below the poverty line. This puts pressure on the spouse to return to full time work in order to make ends meet. It also highlights the difficulties faced by single mothers with children. In addition, women tend to work in services and light industry, which traditionally have been low-paying; in general, they also appear not to advance as far as men. 18 In addition to the payments out of the wage fund, benefits provided from the social consumption fund (SCF), often in kind, are an important element in deter­ mining the real living standards of recipients. The SCF includes both the totality of social benefits paid directly by the enterprise, and those provided by the Government, including (1) free benefits in kind: mainly educational and health services; (2) money payments and allowances-for vacations, stipends, sick leave, pensions, maternity leave, and income supplements; and (3) subsidized services, including rental housing, children's activities, and vacation homes. Direct sub­ sidies on food items, while an essential ingredient in the determination of the standard of living, are not included in the SCF. Out of the total SCF of rub 175 billion in 1988, just under rub 75 billion was spent on pensions and allowances, and around rub 100 billion accrued in the form of benefits in kind and other cash transfers. In addition, there were overt budgetary outlays of over rub 85 billion on account of subsidies to consumers for food items (Table IV.6.12). In 1988, various in-kind benefits and price subsidies together probably were equal to almost one-third of the size of the total money incomes (including transfers) of the population received from the socialized sector (Table IV.6.12 and Table D.2, Appendix 11-1). The SCF may indeed have heen a policy instrument in the equalization of the income distribution. 19 However, while a significant number of families with low or no earnings may be lifted above the poverty threshold through SCF pay­ ments, low pensions and allowances led to many retired, one-parent, and large families remaining below the poverty line. A significant proportion of retired people only manage to stay above the line by continuing to work. As for free education, it has been argued that low-income families received larger benefits because they have more children and there is universal education. The situation with respect to the health care services seems to favor the better-off, who appear to have easier access than the poorer groups. In any event, living standards appear not to be dependent either on an individual's productivity or level of remuneration. Moreover, since various fringe benefits-such as places in pre-school, the better hospitals, dachas or dining

152 rooms-are in short supply, privileges in this respect tend to confer greater access to such benefits than wage earnings per se. 20

(4) Food subsidies Highly subsidized meat and dairy products are more important in the budgets of households living in relatively high income republics, whereas very limited quantities are either available or consumed in the poorer Central Asian republics. Moreover, high income families tend to benefit more than low income families from food subsidies, given their higher per capita consumption of these products. Consequently, the commodity pattern of subsidies favors both richer households and regions. It should also be emphasized that many commodities, including grain and bread, bear implicit subsidies and are at well below world prices. Reforms aimed at ensuring appropriate prices to farmers will transform these implicit sub­ sidies into explicit subsidies unless measures are taken to adjust consumer prices. 21 b. Inequality, poverty and need The foregoing discussion suggests that both the setting of the wage mechanism and the system of transfers through the social consumption funds has, at least until recently, been directed by considerations of equality. But while the need to prevent wide income differentials appears to have been a political objec­ tive, the existence of poverty has not been a matter of particular concern, since it was assumed that the administratively determined system of wages and transfers would be adequate to meet minimum living standards. An official poverty line was not established until 1989. It is more appropriate, however, to define poverty in a broader sense, to encompass not only the lack of monetary means to ensure a minimum command over material resources, but to reflect unsatisfactory social conditions, including health, sanitation and access to services.

(1) The distribution of income The distribution of income in the USSR is not very concentrated by interna­ tional standards. The contrast with China is particularly instructive. In China, reforms in rural areas were instituted in 1978 leading to a dismantling of com­ munes and a move towards a market oriented system. While this rapidly increased average incomes, there was also an increase in inequality: both because the new income generating activities led to relatively high incomes, and because the social support system which depended on the communes to protect the vulnerable was not replaced. In urban areas, the pace of reform has been much more limited. A comparison of rural and urban areas shows a much lower incidence of inequality in the latter in 1987, using different inequality measures to reflect the different types of inequality.22 It is interesting that the pattern of inequality in the USSR in 1989 roughly corresponds to that obtained in urban China in 1987 (Table IV.6.13).

153 Given that rural China has undergone the transformation to a market-based system (and urban areas have not), this sector provides an interesting contrast and sug­ gests likely directions of change for the USSR. At present Soviet income is much more equally distributed than in rural China, with both relatively fewer well off and relatively fewer poor individuals. While there is likely to be some increase in inequality in the transition period, it is more important from a policy perspective to be concerned about minimum living standards of the poor rather than inequality per se.

(2) Poverty The relatively egalitarian distribution of income in the USSR, however, does not mean that poverty does not exist. Indeed, the minimum wage, which is cur­ rently rub 70 per month, has not been adjusted since the 1970s. In order to con­ struct minimum incomes, a representative consumption basket assessed at administered prices was chosen by Goskomtrud. The method did not allow for the non-availability of goods at administered prices, or that parallel market pur­ chases might be at prices considerably higher than the administered levels. The disutility and time loss involved in extensive queueing was not accounted for either. Goskomtrud estimated that in 1988, the minimum income level should have been rub 100 per capita per month, and that at such a threshold 80 million persons (or over a quarter of the population) would have been classified as poor. However, the official poverty line chosen was rub 75 per capita per month, and according to this threshold there were 43 million persons, or around 15 percent of the popula­ tion, living in poverty. While the numbers falling below a constant nominal pover­ ty line have decreased since 1988 (to around 30 million in 1989-see Table IV.6.14), higher parallel market prices in conjunction with greater shortages should have led to a revision of the poverty line. Estimates by Gos­ komtrud and its affiliated research institutes suggest that both the numbers of the poor and the proportion of the population in poverty has increased. Given the large proportion of households concentrated between rub 75 and rub 150 per capita (45 percent of the total population in 1989-see Table IV .6.14 ), small adjust­ ments to the definition of the poverty line would lead to large changes in the numbers classified as poor. It is difficult to compare poverty in other countries with that in the USSR, given the absence of purchasing power parity estimates for the latter. However, the 1990 World Development Report, using a cut-off point on a purchasing power parity (PPP) basis of US$370 per capita per year, found 33 percent of the popula­ tion in developing countries to be poor, ranging from 47 percent in Sub-Saharan Africa, to 51 percent in South Asia, to 20 percent in East Asia, and 8 percent in Poland. (In terms of local standards, however, about 20 percent of the population in Poland was considered to live below the poverty line in the late 1980s.) At the commercial exchange rate of the USSR, the US$370 poverty line would translate

154 into about rub 50 per capita per month, although at the noncommercial rate the poverty line should have been about rub 180. On this basis, a poverty line be­ tween rub 100 and rub 150 might be considered comparable to international standards. The regional distribution of incomes for 1989 indicates high concentrations of poverty in particular republics. Thus in Tadzhikistan and Uzbekistan, 51 per­ cent and 43 percent, respectively, of the population fell below the poverty threshold in 1989, compared to less than 2 percent in Estonia, and 5 percent in the Russian Republic. The substantial difference in poverty levels between the RSFSR and Uzbekistan is explained not so much by variations in salary levels (although these do exist, as noted above), but by differences in family composition and size. 23 Uzbekistan, for example, has quite a different demographic profile from the RSFSR with a younger population and a high under-15 dependency ratio. On the other hand, the RSFSR tends to have a smaller average family size, but with an ageing population structure. Higher income levels in the RSFSR are, however, no guarantee of an equivalently higher standard of living, given the regional variation in shortages of basic goods and services. Azerbaidzhan, for example, with relatively low wage levels, does not suffer one of the lowest living standards in the union, because of relatively abundant supplies of essentials at relatively low prices. In some cases, however, such as Uzbekistan, the relative abundance of cheap fruits and vegetables is not adequate to completely counter­ balance low money income levels.

Actual consumption patterns are therefore a much more accurate indicator of living standards than wage levels. For the main items currently carrying a budgetary subsidy, there are significant differences in consumption patterns across republics (Table IV.6.15).24 For example, per capita consumption of meat and products, milk and eggs in Uzbekistan is roughly half that in the RSFSR, and consumption of potatoes a third. However, the consumption of vegetables and fruits in Uzbekistan is somewhat higher. This pattern is also reflected in the consumption of durables, with the per capita sale of television sets and refrigerators in Uzbekistan (6.3 and 16 units per 1,000 inhabitants respectively in 1984) less than half or around half that in the RSFSR (16.3 and 31.4 per 1,000 inhabitants ).25

There are clearly price variations too, both across income categories and across regions (Table IV.6.16). In the RSFSR, a kilogram of meat costs rub 2.58, somewhat below the national average of rub 2.68, but in Uzbekistan the price is rub 3.49 per kilogram. And in Uzbekistan, as in other Central Asian republics, the poorest income group pays a higher price for meat per kilogram than the richer households. This might suggest that the poorer segments of the population are forced to buy in parallel, higher priced markets for some commodities in short supply, as they may have less access to supplies at lower, controlled prices. This

155 pattern is not borne out, however, for some of the other highly subsidized products, and therefore it is difficult to generalize.

(3) Social indicators Living standards involve not only access over goods, described above, but also the quality of services and provision and quality of public goods such as preventive health care. Two fairly general indicators are life expectancy at birth and infant mortality rates. They capture a variety of factors reflecting social con­ ditions and standards of living. With life expectancy at birth for men and women estimated at 64.2 and 73.3 years respectively in 1987, the USSR trailed behind all Eastern European countries and industrial countries except Turkey (Table IV.6.l7). The infant mortality rate in the USSR was also higher than in all other countries surveyed except Romania. As with other indicators, both life expectancy at birth and infant mortality rates vary across republics in the USSR. The standards in the RSFSR are fairly similar to those in Eastern Europe. However, both measures indicate somewhat lower living standards in Central Asia and the Caucasus. Infant mortality in Uz­ bekistan, Turkmenistan and Tadzhikistan in 1988 was 43.3, 48.9 and 53.3 per thousand respectively, 26 roughly twice the overall average for the USSR and reported to be increasing rapidly. In some regions of Uzbekistan, every tenth child reportedly dies at birth. 27 To some extent this reflects the lower availability of doctors, hospital beds, and quality of care. c. Pensions and family allowances There are two broad categories of households that are particularly disad­ vantaged under present circumstances in the USSR: the elderly relying on pen­ sions, and families with large numbers of children. Both groups have a combination of low per capita incomes and a greater need for health care facilities and services.

(1) Pensions The provisions of the current old age pension system in the USSR date from 1956. At present there are around 60 million pensioners who received an estimated rub 65 billion in pensions in 1990 (Table 4, Appendix 111.1-3; also see Table IV.6.18). The average pension in 1990 was about rub 100 per month (for data through 1988, see Table IV.6.19). The pension legislation was supplemented in 1964 to extend coverage to collective farm workers (kolkhoznikz), although the terms were less generous than for workers on state farms, who were treated on a par with other state employees. It was envisaged that the differences would be gradually reduced, and while this may have happened to some degree, they have not been entirely eliminated. The retirement age is relatively low in the USSR

156 (well below the OECD average), and large groups qualify for pensions at an earlier age because of the nature of their job (workers in hazardous jobs). There is a precipitous drop in living standards on retirement, which forces elderly workers to remain employed if possible. In 1987, over 50 percent of state pensions and 90 percent of collective farmers' pensions were below rub 80 per month (Table IV.6.20), thus fairly close to or below the official poverty line. Minimum pensions have been rub 70 per month since 1981, when they were set equal to the minimum wage. Maximum state pensions were fixed at rub 120 in 1956, at a time when the average wage was rub 73 per month. The average wage exceeded rub 250 per month in 1990 (Table IV.6.9), and the replacement rate for a retiring worker receiving the average wage has dropped from around 100 percent in 1956 to under 50 percent. Fixing pensions in absolute terms has clearly resulted in eroding standards of living for old-age pensioners. The increase in the number of pensioners has been quite dramatic, and is set to continue. Between 1960 and 1981, while the total number of pensioners in­ creased by 143 percent, there was a 650 percent increase in old age pensioners, predominantly from the state sector. Over the period 1979-89, persons of retire­ ment age increased from just under 27 percent of the working population to almost 31 percent (Table IV .6.21). A similar increase is projected during the 1990s, and by the year 2000 the ratio of persons of pensionable age to the working population is expected to reach 34 percent. Significant regional differences in demographic characteristics are reflected in regional patterns of expenditures on pensions. While in the Ukraine the old age dependency ratio in 1979 was already higher than the current national average, and approached 38 percent in 1989, the ratio in Uzbekistan actually declined from 18 percent to just over 16 percent over the same period. These differences impose a severe constraint on the degree of pooling that is feasible on account of pensions. A national pool would redistribute resources from regions with low old-age de­ pendency ratios to the regions with concentrations of retirees, which under Soviet circumstances would imply redistribution from poorer to richer republics. This highlights a fundamental dilemma in the formulation of a union-wide pension policy: the extent of the ageing of the population dictates as wide a pooling of risks across generations as possible, but the inter-regional redistribution that is involved may not be acceptable. The all-union pension legislation of 1956, which provided considerable ex­ tensions in the coverage of the system and a substantial increase in benefit levels, 28 was designed to be financed through a payroll tax ranging between 4.4 and 9 percent, with minimal contributions from the national budget. At present, old-age pensions are funded on a pay-as-you-go basis, through payroll taxes on enterprises and contributions from general budget revenues. Enterprises in 1990 paid 12 per­ cent on average of their wage fund (tariff wages and bonuses) to the social security budget, which finances old-age pensions and other social expenditure, but about

157 40 percent of the expenditures were covered by general budget revenues. The two major factors responsible for the increase in the payroll tax were the extension of coverage to include workers on collective farms-approaching universality without a commensurate increase in resources-and the substantial increase in the number of pensioners due to the ageing of the population. There are significant difficulties with administering the pension system. Ac­ cording to Goskomtrud, the present archaic system of accounting on the basis of the wage fund of enterprises cannot be changed easily. Unlike in many Western countries, there is no system of social security numbers and individual contribu­ tions cannot be identified. The authorities are attempting to computerize the sys­ tem, but this is difficult without citizen codes. An important measure to be introduced under the new pension reform is a contribution to be paid by in­ dividuals, for the first time, on their monthly earnings at a rate of 1 percent. This would introduce individual accounting procedures and would also be an important signal for persuading individuals to contribute to their retirement, as the market determination of wages develops. 29 Another difficulty in administering the system lies in the fact that the place of work and of retirement often differs. Many workers temporarily migrate to Eastern Siberia for high wages with high pension entitle­ ments and early retirement but seldom live there in their old age. Administering benefits to such individuals poses particular difficulties.

(2) Allowances There are a number of allowances for particular contingencies, some of which are means-tested. Meager child allowances have long been payable to low income households. Maternity benefits and birth grants, as well as temporary disability allowances, also exist. Nonetheless, the expenditures on these items (apart from the temporary disability allowances, which were almost rub 9 billion in 1989), have been fairly limited, and only the maternity grant (rub 2.37 billion in 1989), and care allowances for children under the age of one (rub 1.51 billion in 1989), have been of any consequence. New benefits, or adjustments to the levels necessary to make an impact on the poverty of particular groups, are likely to have major budgetary or financing consequences. Moreover, the ability to pay and the need for social assistance does not often coincide within the same area (e.g. in Central Asia), and continuation of such transfers is likely to be contingent upon resources from the union and the higher income republics. Means-testing is frequently advocated to limit budgetary outlays. The payment of means-tested child allowances is currently one of the provisions of the social security system. Unlike in industrial countries, such as the United States or the United Kingdom, means-tested benefits in the USSR in the past have had relatively high take-up rates, as adequate income levels have been perceived as a right (although not always fulfilled). In Uzbekistan, as noted earlier,

158 43 percent of households qualified for assistance. However, the means-test did not include income from garden plots and home grown produce, thus indicating potential difficulties. The experience of means-testing in developing countries is quite poor,30 and that of developed countries has not been particularly successful either. Administra­ tion is a major issue, as is the determination of the appropriate cut-off point for the means-test. It is not easy to determine either sources of income or whether households or individuals are likely to fall below a particular poverty line. This issue is particularly severe in respect of services, the informal sector, and in agriculture. Nonetheless, the administration has to be local if there is to be any chance of accurately identifying those below the cut-off point. However, with local and regional administration of funds from higher levels of government, there is usually little local incentive to limit expenditures. Potentially the most serious issue with means-testing involves disincentive effects. This issue will become more important as benefit levels rise as proposed by the authorities (see section 4.e). As the allowances are based on per capita income, benefits for a four-child family could be substantial enough to discourage a shift into productive work. There is thus a need to design social assistance programs in such a way that disincentive effects are minimized. The difficulty with means-testing is that high marginal tax rates are generated at the point at which the benefit is withdrawn, leading to what is called a "poverty trap". How­ ever, targeting by household, rather than on a per capita basis, may avoid this distortion to the overall tax-benefit structure.

4. POLICIES TO FACILITATE THE TRANSITION PROCESS a. Labor market policies This section deals primarily with the role of labor market policies during the transition period. It also addresses some issues of improving economic perfor­ mance through labor market policy when the period of large-scale labor displace­ ment is over.

(I) Labor market information and matching High turnover in the Soviet labor market suggests that many workers are accustomed to market-like behavior in regard to job search; two thirds of all hiring reportedly takes place at the enterprise gate and about 20 percent is the result of placement efforts by the labor offices. Eighty percent of these latter placements concern unskilled jobs, as enterprises are apparently not keen to notify skilled vacancies to the labor offices. The numerous imbalances persisting in the labor market, however, suggest that the relatively high turnover has not contributed to

159 a better matching of supply and demand and that a more developed system of labor market information, job search assistance and placement is required. The transition to a market economy will lead to a large number of workers searching for new jobs and of enterprises looking for personnel. This will further increase the need for the collection, analysis and publication of information on vacancies and job seekers. The availability of such information could help avoid high search costs, labor shortages, unsatisfactory working conditions or lengthy periods of unemployment. The advertising of job vacancies in the mass media is one approach to rapid dissemination of information; it is widely used in all Western countries and is considered to be an efficient method of recruitment. But for many job seekers, more developed services such as vocational counselling, retraining and the provision of work experience are needed; many enterprises will also require assistance in personnel planning and advice on recruitment and train­ ing.31 Such services have not hitherto generally been provided in the USSR. The existing network of some 2,000 labor offices concentrates on locating personnel for state enterprises. Vocational counselling takes place in the education system. According to Goskomtrud and to officials interviewed in employment offices, students hardly ever meet with their vocational counsellor. There is on average only one counsellor available for 50,000 persons. Since 1988, some 500 employment centers have been established which are to coordinate the col­ lection of employment information by local offices in their area and to support enterprises in their training activities. It is generally accepted, however, that the existing labor offices are understaffed and that their resources are insufficient to provide a satisfactory flow of labor market information. Goskomtrud plans a large increase in the number of placement officers and vocational counsellors. It is important to recognize, however, that the labor offices in a reform setting must not only provide a more complete range of labor market information and place­ ment services but must also cope with the new phenomenon of unemployment. It will be difficult to concentrate on both functions at the same time and priority will have to be given to assisting the unemployed. An expanded and reformed employ­ ment service should aim, however, at collecting and disseminating information on as many vacancies as possible as this is a precondition for effective help to the unemployed. This is presumably the reason why compulsory notification of vacan­ cies is contained in the Employment Law approved on first reading by the Supreme Soviet in October 1990. The experience of industrialized countries sug­ gests, however, that enacting legislation requiring notification has not been par­ ticularly helpful in encouraging enterprises to cooperate with the employment offices.

(2) Effective assistance to the unemployed Assistance to the unemployed has two elements: (l) income support and (2) assistance to get back to gainful work. Eligibility for income support raises the

160 question of the definition of unemployment. The new law defines a person as "unemployed" if he is "capable of working but who for reasons beyond his or her control has no earnings or other legal source of income, who is registered with the state employment service as being available for work, who is actually seeking work, who is prepared to undergo training and for whom the service has not yet made a recruitment offer". The law adds that details of this definition should be regulated at the republican level according to particular circumstances. While this definition is fairly restrictive, it is most likely that the very acceptance of the notion of unemployment will by itself increase the number of registered un­ employed. Enterprises will be less reluctant to lay off workers if they have access to some income support and/or policies to assist them to find a new job. Second, individuals who are only marginally attached to the labor force may register with the employment service in order to become eligible for income support. Under this legislation, laid-off workers are to receive up to three months wages from their previous employers. In this period they are expected to search for new employment and they have to register with the employment service if they want to safeguard eligibility for future benefits. New entrants and re-entrants have a right to benefits as well. There is a waiting period of 10 days before benefits are paid. Benefits are paid for a maximum of six months within any 12-month period. During the following six months income support is only possible through participation in public works or training programs. Thereafter, eligibility for unemployment benefits is re-established for an additional period of six months. Benefits correspond to 50 percent of the tariff wage earned in the previous job but no less than the minimum wage. The use of the tariff wage as the base implies that bonuses and other cash or in-kind benefits are not taken into consideration although they can represent a significant portion of actual earnings. The minimum benefit, which applies to first-time job seekers and others with no recent employ­ ment history, is fixed at 75 percent of the minimum wage. Benefits for the un­ employed with family responsibilities are increased by 10 percent. Replacement ratios will be normally less than 50 percent depending inter alia on the difference between actual earnings and the tariff wage (on average 20 percent) and on family responsibilities. During the first six months of receipt of unemployment benefits, beneficiaries are obliged to accept jobs considered to be "suitable" for them, with suitability judged not only in terms of age or health record but also in accordance with professional competence and skills. The latter criteria are not taken into considera­ tion for those entering or re-entering the labor market or for those receiving un­ employment benefits during a second period. Training assistance for the unemployed with family responsibilities amounts to 75 percent of previous tariff wages (50 percent if without family). For new entrants and re-entrants the support is based on 100 percent of the minimum wage. Participation in public works is paid at the going wage for the activity involved but at not less than the minimum wage.

161 In principle, this benefit system appears to be carefully formulated. It provides incentives for the unemployed to take on a new job or training without depriving them of benefits. It also puts pressure on public authorities to focus on the reintegration of the unemployed and to avoid prolonged dependency on in­ come support. However, the system will require close interaction between the administration of benefits and the placement service as well as the institutions responsible for designing and providing training and public works programs. Western experience suggests that this coordination is often difficult to establish. Such a policy would also require an elaborate infrastructure, the establishment of which may be constrained for budgetary reasons. Some unemployment scenarios suggest that inflows of job seekers may be­ come so large that they could easily overwhelm the administrative capacity of the employment service. If the providers of training and public works or the employ­ ment services are no longer able to cope, it may become necessary to set priorities in favor of certain groups in need of intensive help. Even then, long-term un­ employment on a considerable scale could emerge, in which case the limitation of the payment of unemployment benefit to six months within any 12-month period could become a serious problem. The Employment Law does not relieve enterprises completely from their responsibilities towards their workers. It requires them to give early warning to the workers' representatives and the employment service in the case of major redundancies. The main obligation, however, concerns the three months severance payment. The severance payment is not only a source of income for the workers laid off but may act as a disincentive for enterprises to shift short-term adjustment costs outside the firm. The Employment Law suggests that employment offices should have the possibility to delay lay-offs for up to six months by subsidizing the enterprises from an employment fund. Experience with similar schemes in Western countries does not suggest that this would be a worthwhile investment of public funds. As soon as such a provision is established, it may become impossible not to use it in response to political pressures at the local level. If financial support for firms in temporary difficulties or in a period of restructuring has to be provided, it should be done within the framework of industrial or regional policies. Resources for averting redundancy could be used in a more forward-looking way. One option might be to establish regionally-based institutions which would provide employ­ ment measures for the workers concerned-retraining, self-employment assistance or subsidizing re-employment in expanding enterprises.

(3) Financing, resources and implementation The key provision of the authorities' plan for reorganizing the employment service is the decentralization of management and policy planning to the local or regional level. It is up to the republics to decide on the number and location of

162 new offices and regional centers, as well as their links to other public authorities at the local and regional level. At the union level, general guidelines and minimum requirements are fixed. Given the size of the USSR and the economic and social differences between the regions and republics, such an approach seems ap­ propriate. It leaves the necessary flexibility for developing regional and republican programs and policies, while making sure that policies in the whole country are based on the same principles and that certain minimum standards are provided. There is another reason for ensuring that the central government has some say in the operation of labor market policies at the lower levels. The resources to be made available for employment policies will be raised by a one percent levy on payroll. However, the number of persons in need of help (essentially the un­ employed) and the tax-base are distributed unequally over the country (Table IV.6.22). If some minimum standards are to be provided throughout the union, regional and inter-republican redistribution is needed. To finance a minimum provision of unemployment assistance, including income support, would require at officially projected levels of unemployment-according to calculations of Gos­ komtrud-a contribution rate on the wage fund in Uzbekistan of about 4 percent compared with less than 0.5 percent for the Western republics. The mechanism suggested by the union government would have all enterprises pay a contribution of 1 percent of their wage fund into the republican employment funds. Twenty five percent of this revenue would be transferred to the union fund which would be essentially used for redistribution. The envisaged transfer of surpluses to the union fund, however, would be insufficient for the required redistribution in 1991 (Table IV.6.23). Furthermore, the assumptions underlying this mechanism probably reflect existing patterns of need and un­ employment more than likely projections of structural adjustment. It is likely that the adjustment would be more severe in the heavily industrialized areas of the country, and that this might generate a different regional pattern of expenditures than these official estimates suggest. Payroll tax revenues would also be used to finance the expansion of the employment service. There are currently about 11,000 staff members working in the labor offices. If on average there were five million unemployed in 1991-92, one employee in the employment service would have to take care of 500 un­ employed persons, which compares with about 100 in Portugal and Greece and about 50 in most other OECD countries. The authorities are well aware of the need to expand the employment service and plan to reach a figure of about 40,000 officers in 1992-93. The plans for expansion include an increase in salaries of placement officers to the average levels of state employees. Staff training and the provision of equipment for the employment service would be a promising area for technical assistance from the West. In most Western countries about 10 percent or less of total expenditure re­ lated to unemployment is needed for the operation of the employment service.

163 The driving factor behind costs is unemployment. According to projections of Goskomtrud, a one percent contribution rate would be sufficient to finance programs for about 3 million unemployed (i.e., just over 2 percent of the labor force), assuming full redistribution of revenues between the republics. If additional expenditure for training (apart from allowances) is taken into account, a 1 percent contribution rate would allow full measures for about 2IJ4 million unemployed. However, the limitation of full redistribution of resources projected by Gos­ komtrud (above) would reduce the potential coverage by about 20 percent. Taking all these factors into account, it would appear that an increase in the unemploy­ ment rate by 2 percentage points would require an increase in the contribution rate by about another one percentage point. 32 This possible shortfall in financing for employment programs has already been underlined by many observers, including the official trade unions, and some republican governments were apparently planning to use their budgets to finance additional employment-related activities. To rely so heavily on the general budget does not necessarily provide a solid base either for raising the required resources for programs to cope with large-scale unemployment, or for a long-term strategy to build up the employment service. The policy objectives regarding the budget are clearly more restrictive and there will be stiff competition among government departments for scarce resources. Likewise, the increases in payroll taxes repre­ sent increases in wage costs and could be expected to reduce the demand for labor and reinforce labor shedding. An alternative to raising the tax on the wage fund may be to introduce separate contributions for employees and employers. This would be a sensible step for several reasons. First, it would introduce an element of solidarity between employed and unemployed workers, which would certainly be desirable to ameliorate the social tensions associated with rising unemploy­ ment. Second, although it may be correct that in the long-run the effects of taxes on employment are independent of whether they are paid by the employer or by the employee, it would likely make a difference in the short term. 33 Third, there is a case for sharing the costs of displacement and unemployment among all employers.

( 4) Employment programs

Exceptional programs might be required during the transition process. Shortages of goods, particularly food and other consumer goods as well as ser­ vices, are endemic throughout the USSR. If programs could be designed to focus on these needs by providing temporary jobs, large numbers of the unemployed could find productive employment and a source of income. Two approaches are worth considering: (1) public works programs organized by local authorities; and (2) encouragement of self-employment on a large scale. Local and regional coun­ cils should be able to set up programs of this nature. The republican employment

164 funds could offer subsidies taking into account expenditures for benefits which would otherwise have to be paid in the form of unemployment compensation. Goskomtrud has made proposals to the Council of Ministers for a public works program. The main areas of economic activity would be agricultural production, food processing, infrastructure renewal, social, cultural and health services, and child-care services. It is envisaged to leave the organization to local authorities who would also have to contribute to the financing. Not only full-time jobs but also part-time or seasonal jobs are envisaged. The Employment Law provides for two-month contracts with the possibility of a further two months for participation in public works. Short periods of employment of this nature have the advantage that temporary economic activity and seasonal production can be sup­ ported effectively. Such special measures for the unemployed, if needed, should be concentrated on economically meaningful activities and pursued with the objectives of rein­ tegrating displaced workers as quickly as possible into gainful work and prevent­ ing long-term unemployment. Goskomtrud intends to minimize the substitution of public works for regular employment by requiring that funded projects be separated from regular activities of local authorities. More recently, the authorities have considered one- to two-year contracts for public works programs in order to provide longer-term professional orientation. The provision of work experience is an appropriate way to achieve professional re-orientation for older workers or those who have less capacity for retraining. Longer participation may also be necessary in order to achieve reintegration of those who have been unemployed for long periods or who belong to particularly disadvantaged groups. The direct costs of such programs would be considerably higher, although the net results would depend on the savings of unemployment benefits and on induced labor supply effects in the longer-term. It might be more difficult to avoid substitution effects in the case of long-term programs. However, these programs would have a strong social and redistributional objective and aim at improving the employability of severely disadvantaged groups such as older unemployed workers with obsolete skills. Active encouragement of self-employment initiatives is a second promising route to pursue. Presently, self-employment is still inhibited by legal restrictions and by a generally unfavorable climate for entrepreneurial activities. Many people are engaged in such activities which, however, are not generally legalized and are often used as a second job. The first step to encourage self-employment would be to legalize all types of entrepreneurial activities, notably in the areas in which shortages exist. The second step would be to give some support to people who are interested in developing these activities further: access to premises, supplies of raw materials and other inputs, as well as some financial help and social security.

165 As a result of active encouragement of small-scale enterprise and self­ employment activities, black market activities would tend to be moved into the regular economy. Moreover, many individuals have a legal job but also an un­ declared business at the same time. If their second activity were to be legalized and given public support, they might decide to drop the first jobs and concentrate on expanding their businesses, which could lead to the creation of additional jobs. At the same time, this would contribute to relieving the overmanning problem in the state sector. The latter consideration also suggests that it might be in the interests of state enterprises to assist their workers who want to set up their own businesses by providing them with financial support or supplies of necessary inputs. It is difficult to estimate the additional opportunities in the area of self­ employment. As noted in section 2.a.(2), self employment in the USSR accounts for only 0.2 percent of the labor force as compared with about 10 percent on average in OECD countries. This suggests that considerable job opportunities may arise in this area once the transition process has gained momentum.

b. Education and training Rapid industrialization in the USSR required a massive expansion in the supply of skills and technical knowledge, which was provided by an extensive network of educational and training institutions. The number of students involved in education, training, and retraining has multiplied several times since 1940 (Chart 4). The result has been a steady rise in the average level of education of the labor force, with no significant gender differences in this respect. About 12 percent of the population aged 20 and over is estimated to have completed higher education. International comparisons of educational attainment are difficult to make because of immense differences in the structure of educational systems in general, and especially in the role of non-university post-secondary training; nonetheless, 12 percent is at or above the level of several countries of Western Europe, and much higher than the countries of Southern Europe. In 1984, the legislated entrance age into Soviet primary schools was lowered from seven to six years. As a result, most children should eventually receive eleven years of schooling. The last two years are not compulsory, and 16 percent of the labor force is described as having only "incomplete secondary school" (Table III.6.24). Nevertheless, very few join the labor force with less than ten years of schooling. Some 60 percent of students complete secondary school on an academic track.

(1) Vocational, technical secondary and higher education Two types of vocational and technical schools provide alternatives to the last two years of regular secondary school: "professional-technical schools" (PTUs) and "specialized secondary schools" (SSUZs). There are now about 8,000 PTUs,

166 90 percent of which provide regular day-time classes, to which about 20 percent of those completing eight (possibly nine) years of general education attend (Table IV.6.25). The PTUs have traditionally trained skilled manual workers and were particularly important in rural areas. Some years ago, to improve their stand­ ing, the PTUs began to include academic training and increased their course length to three years so their graduates are now also recorded as completing secondary education. In addition, students who have completed general secondary school may take one-year courses in PTUs-in 1989, these amounted to 18 percent of such graduates (Table IV.6.26). At any one time there are about 4 million students in these schools (including some 10 percent studying at night) and about 2.4 million graduate annually. Each PTU is associated with at least one base enterprise, and all enterprises with over 2,000 employees are supposed to be associated with a PTU. All training of the PTUs is carried out within the context of contracts con­ cluded with a particular enterprise, and although individual students are not direct­ ly contracting parties, they are expected to take a job in the designated enterprise on graduation. Contracting enterprises provide some practical training on their premises (though schools also have their own workshops), and in cases in which this produces saleable output, the enterprises will pay an appropriate allowance usually similar to the wage of an entry level worker. Other educational costs, including meals, clothing, and boarding where necessary, are paid by the state. This close association with local enterprises reduces the danger that training will be dissociated from enterprise needs; indeed, the practice of contracting with enterprises arose because many of the graduates of vocational schools were having difficulty in getting appropriate employment. This has not, however, prevented criticism that training is poorly organized and fails to respond to new needs. 34 There are also complaints that many of the PTUs are old, their own equipment is obsolete, they are short of qualified teachers, and they are not competitive in the market for scarce skills. A further 10 percent of students with eight or nine years of regular school attend 4,500 specialized secondary schools (the SSUZ-also known as tekhnikomy.) These provide four-year courses to train for careers in elementary education, or for such occupations as paramedics or laboratory technicians. In­ creasingly, the SSUZs have also taken in complete secondary graduates. In 1988, some 63 percent of the 1.5 million admissions to the SSUZs had completed general secondary school. A high proportion are nighttime and correspondence students. Graduates of both SSUZs and PTUs are eligible to compete for places at higher educational institutions (VUZs), but in 1986, only 4 percent from SSUZs and 2 percent from PTU s, in contrast to 15 percent from general secondary schools, successfully applied. The VUZs include both universities and specialized institutes and typically offer five-year courses. Those who take at least half of

167 such a course but do not complete it are classified for statistical purposes as having "incomplete higher education." In the past, graduates of both VUZs and SSUZs were subject to administrative assignment for their first three years, though this has not always been followed and now has been dropped, at least as a formal requirement.35 About five million students are enrolled in some 900 institutions of higher education, of which 69, with nearly 600,000 students, are classified as universities. The majority are directed towards technical careers--Qver 40 percent of graduates are classified as engineers. Many institutions teach at night or by correspondence; these account for nearly 40 percent of students.

(2) Relationships between training and occupation

A survey conducted in January 1988 suggests that only half of all industrial specialists had jobs requiring their particular qualifications. Four million out of 37 million (11 percent) "specialists with higher and secondary education" in in­ dustry were in jobs which required less education than they had received. While complaints of mismatches are so widespread that there is no reason to doubt their validity, it might be noted that the same problem could probably be found in most countries. Moreover, these numbers are very difficult to interpret. Soviet training systems prepare students in a very large number of separate specializations, which presumably implies a very large extent of overlapping content among "adjacent" specializations. PTUs currently train individuals for more than 1,500 occupations, with about 80 percent of the training for 300 occupations. In contrast, the voca­ tional training system in the Federal Republic of Germany trained for 440 occupa­ tional categories in 1985, with 60 percent of boys being trained in the 20 most popular categories; a comparable figure for girls was 80 percent. 36 The number of occupations for which vocational training takes place in Western Europe con­ tinues to fall.

The fact that many individuals are in positions that normally require much less education or training than they have received is a potentially more serious problem. To some degree it is likely to reflect supply factors. First, there is the common tendency for the output of the upper levels of the educational system to grow faster than the demand for its specialized skills; the proportion of those completing secondary education rose from less than one-half in the early 1960s to around 80 percent by the late 1970s. 37 Yet, in the 1970s, 40-50 percent of industrial jobs were still manual rather than mechanized. Second, there are the inevitable imperfections of a rigid and excessively ambitious system of central planning. In particular, the need for workers in service industries is neglected compared with training for the so-called productive sectors. The problem of over­ qualification reflects excessively egalitarian wage policies in the past which have resulted in pay structures which tend to provide higher incomes for many skilled manual workers than for those with engineering or technical training.

168 Regarding overqualification as a supply-side phenomenon, some analysts have seen it as a cause of poor worker motivation; successive cohorts are disap­ pointed to find their qualifications mean somewhat less than those of their predecessors and so are discouraged from trying to work hard. 38 Far larger propor­ tions of younger cohorts have technical qualifications than do older cohorts which, combined with the rigidity of the labor market, means that there may be many underqualified people in senior technical positions, blocking the promotion of overqualified people at lower levels. This distortion has potentially adverse effects on efficiency and worker motivation as well as being a waste of educational investment. Given the egalitarian wage structure, the economic return on the expansion of upper levels of secondary education has probably been very low. However, as noted earlier, the link between wages and salaries and productivity is very unclear, and conclusions in this regard must be very tentative. While perverse pay differen­ tials between technical and some manual workers suggest that the private financial rate of return from education will be low, the generous system of free education and student grants, which has lowered the opportunity cost of education, offset this effect to some extent. The 1986 wage reform had some success in improving the relative pay of salaried workers. This suggests that at least part of the compression of differentials that had taken place over the previous thirty years was induced by institutional factors rather than by the market. On the other hand, in many branches of industry, wage earners continue to earn more than professional personnel, suggesting that to some degree such perverse differentials also represent excessive training. Even if part of the problem may have been poor information, and may suggest to some degree waste of training, it has not resulted in emerging general shortages of technically qualified workers. Moreover, even if there has been a drop in the relative social status of certain occupations requiring higher level training, there is no evidence that this has yet led to reluctance of qualified students to undertake such training. Although of considerable concern to the authorities, the stock of trained manpower appears large enough to prevent any large-scale emigration-following removal of legal constraints in this respect-from seriously weakening the economy as a whole. Given linguistic and other obstacles abroad to the acceptance of such emigrants, future emigration of highly skilled manpower may not be significant; this does not necessarily apply to individual republics, however, if local conflicts were to lead to substantial internal migration.

(3) Further training and retraining As in any other industrial economy, there has been a steady process of retraining and upgrading of the labor force, not only at the workplace and in enterprise training centers but in evening and correspondence courses and study-

169 leave programs as well.39 In 1988, some 6 million workers received enough further training, or retraining, to have their occupations reclassified. A further 37.7 million people (nearly 30 percent of whom were managers and specialists) had further training to improve their skills. PTUs retrain about half a million workers a year. There is also an extensive network of state institutes devoted to the upgrad­ ing and advanced training of government officials, enterprise managers and other specialists such as medical personnel and teachers. There are more than 600 departments in higher educational institutions devoted to this, some focusing on technical courses, others on managerial training. At their apex is the Academy of the National Economy, which runs courses for very senior officials from across the ministerial and enterprise spectrum, as well as providing training for the staff of the other upgrading institutions.

(4) Effects of recent reforms

The principle of self-financing has spread to educational institutions, and this, together with the increased profit-orientation of enterprises, should encourage even greater closeness between enterprises and vocational schools. There is the risk, however, that the schools may attempt to carry out too much practical training on their own premises in order to enhance the employability of their students. This could raise costs substantially, since equipment in vocational schools is typically used much less intensively than that in factories, and it could also isolate the schools from the needs of the enterprises.

Concern has been expressed that the harder budget constraints and greater profit orientation associated with economic reform might make enterprises reluc­ tant to contribute as much to the cost of training workers, especially if the mobility of workers increases (although as noted earlier, turnover is already fairly high). The 1987 Law on State Enterprises appears to have reduced the demand for newly-trained workers-as evidenced by the difficulty that some training institu­ tions have had in placing their graduates-but not yet to an alarming degree. This situation does, however, require monitoring.

Five hundred of the larger job placement centers have been designated as Centers for Professional Orientation, Employment and Retraining. These have some responsibility for obtaining retraining for the unemployed, if work is not available in the previous occupation, using existing centers such as the PTUs. The process is only just beginning, and the small amount of involuntary unemployment until now has meant that the requirements for retraining have not been very large. In contrast to normal vocational training, state funds have not been available to support workers undergoing retraining, and this has therefore taken place only when enterprises have been prepared to provide the necessary finance. The proposed Employment Fund should take care of this particular problem.

170 (5) Prospective needs for training and retraining The institutional basis for future technical and vocational training is well established. A balance has to be struck between an emphasis on general education, which provides a base for the future acquisition of specific skills, and direct vocational and technical training. It is clear that there is no unique solution. There are great differences among successful industrial countries; for example, the role of formal pre-employment vocational training, in contrast to higher levels of general education, is much greater in Germany than Japan. It is important that the USSR preserve at least the existing emphasis on general education, which means a continuation of state financing for part of the program of training institutions. It is also important that enterprises continue, and indeed increase, their involve­ ment in the training process. The content of training programs and courses will need to change to reflect the needs of a market-oriented economy. This is true both for pre-employment training and for the retraining that will be needed as part of the transition. The amount of such retraining is expected to be large, since a significant proportion of existing activities are expected to prove internationally uncompetitive, and be­ cause the structure of the economy will change, in particular with a shift out of heavy industry towards consumer goods and services. The very slow growth of the labor force, especially in the European part of the RSFSR, means that this change in structure cannot be met simply by shifting the training of new entrants to the labor market-it will be necessary to retrain an increased number of adult workers. Estimates run as high as 30-35 million workers changing their jobs in the years to come. At first glance, the numbers of those expected to be displaced as part of the transition to a market economy seem very large compared to formal training capacity. It is estimated that the PTUs could be used to train some 1.5-2 million additional workers each year, if they were used more intensively in the afternoons. Other facilities could also be used, and also specially created, but they could serve only a fraction of the workers who would be displaced under most projections. However, all the redundancies will not occur at once. It may take time to restruc­ ture the stock of physical capital, and it is not essential to restructure the entire stock of human capital in advance. Most worker retraining can be accomplished relatively quickly as new investment is taking place.40 What is desirable is for the two processes to take place at the same time. Special efforts may be needed in particular fields in which Soviet technology has lagged well behind the state of the art elsewhere. A very considerable effort, for instance, will be needed to broaden and deepen all levels of knowledge involving computers-whether programming, electronics maintenance, or computer-aided design. But individuals who have the necessary background for this work may not be those who have difficulty in finding other employment-in these fields, the availability of facilities for part-time upgrading may be more important than retraining the unemployed.

171 Training in the areas of finance and management is perhaps the most impor­ tant of all. Only about 5-7 percent of state enterprise directors have any training in economics. Moreover, such training would in any case have little relevance to managerial decision-making in a market economy. Such areas as modem methods of accounting, as an aid to managerial decisions rather than simple bookkeeping; banking and finance; investment choice; the assessment of risks; marketing decisions; and the interpretations of price movements and trends in the world economy are completely unknown questions for most Soviet enterprise directors. A number of courses have been started, both within established institutions and in new cooperative schools, some in conjunction with foreign institutions. But the needs are massive; to provide a very limited training to a handful of people in each of the 46,000 state enterprises could easily involve more than a million man-months of training. There has been substantial experience in industrial countries with the use of distance learning techniques, predominantly using video cassettes, in the training of corporate managers and of the staff of financial institutions. This approach has a great deal more flexibility than the use of television. While home-ownership of VCRs is not yet wide enough to focus these on home use, they could be used at special local training centers, which may often be within individual corporations themselves. The material should be based on Soviet examples. An early priority must be the training of the teachers themselves. c. Industrial relations

(I) The role of the official trade unions Throughout its existence, the USSR has retained institutions for regulating labor relations which, at least in name, resemble those found in industrialized market economies. In particular, trade unions always have had the nominal role of protecting workers from managerial excesses. In fact, however, they were ful­ filling quite different functions and this has so compromised them in the eyes of many workers that it is an open question what role the official union movement will play in a truly competitive market economy. The origins of this ambiguous role lie in Lenin's dictum that under Com­ munist Party rule the trade unions were to be the "transmission belt" between the "vanguard" party and the mass of the people. This meant that while the unions did have the nominal function of "transmitting" grievances from below, they also had the role of "transmitting" decisions from above. Trade unions exercised quite conventional functions during the New Economic Policy (NEP) period of the 1920s: they organized workers in the still extensive private sector, and strikes also occurred even in the state sector, which was subject to market competition. From 1930 to 1953, the industrialization drive eliminated unemployment and a general scarcity of labor became the norm. During this period, the union movement lost

172 most of its role of protecting workers' rights, and came to be almost solely an instrument of the state assisting in the drive for greater production, and in par­ ticular in enforcing labor discipline. This extreme distortion of the unions' role was eliminated shortly after Stalin's death, and since the mid-1950s the unions have been allowed a distinct role within the Soviet system, though until 1989 it was exercised under the explicit control of the Communist Party. This role essentially has been to administer to the welfare needs of workers. It has included taking responsibility for the ad­ ministration of both state and enterprise funded welfare benefits and acting as the formal mechanism for employee representation within the enterprise.41 As a result, the funds controlled by the All Union Central Council of Trade Unions (AUCCTU) fell into two major categories. One category comprised the union dues transmitted to the center. This totaled rub 14 billion for the three years 1987-1989. The other was the welfare fund collected from a payroll levy and supplemented by a budget subsidy-this totaled rub 175 billion over the same period.42 This fund, controlled by the trade unions, represented a significant part of the total social consumption fund (SCF) discussed in section 3.

(2) Reform of trade union government The AUCCTU is seeking to escape from the legacy of poor representation of workers' interests by changing the constitution and the name of the organiza­ tion. At a Congress held in October 1990, it was decided that the organization would change from the present highly centralized structure to a General Con­ federation of Trade Unions (GCTU), in which the branch and/or republican level organizations would be autonomous. The ownership of the assets accumulated over the years by the AUCCTU remains a controversial issue. Since many entitlements (such as full sick pay) were in the past only available to union members, membership and payment of 1 per­ cent of wages as union dues was de facto compulsory. The assets accumulated from these dues (8 percent of which were transmitted to the center) mean that even though entitlements are not now conditional on membership, loss of access to union owned facilities is so costly that workers do not effectively have "free choice of representatives."43 The official unions remain responsible for the dis­ tribution of discretionary funds, and in particular for deciding who will have access to the sanitaria and rest homes. There are several possible ways to deal with this issue. One would be to take into account that the AUCCTU was essentially a part of the state since the dues were de facto compulsory and its leadership appointed by the state. On this argu­ ment, union assets are state property and should be disposed of as part of the general privatization process. In the interim, such property would presumably be leased by the state to potential users including, possibly, trade union bodies.

173 An alternative process, for possible consideration at a republican level, might be the one pursued in the Czech and Slovak Federal Republic. In that country, in preparation for its movement to individual unions, the property of the former Revolutionary Trade Union Movement was vested in a "property union". If there is opposition to the dismantlement of the property,44 another option would be to vest it in a "foundation of labor" to which all workers would belong, no matter to which (if any) union they belonged.45 The case for establishing a "foundation for labor" becomes much stronger if it is decided to continue the operation of a separate welfare fund, paid for out of payroll taxes. If such a separately identified fund is to continue, it will be ab­ solutely necessary to insulate the operations of the fund and its management from the representation of workers. Here, the European examples of authorities operat­ ing under tripartite management and using the state's taxation authority, such as the French Caisse Nationale d'Assurance Maladie, could offer some models. However, for some time it will not be possible to establish true tripartite manage­ ment, as no clearly identifiable employer groupings will be available. Hence a foundation could well be a more appropriate framework. The GCTU, as successor to the AUCCTU, is pressing for the welfare fund to continue to be under its administration. However, if the successor bodies to the AUCCTU unions continue to receive and to control such funds, and to maintain discretion over use of existing union facilities, this would compromise the free choice of workers in choosing their representatives.

(3) Collective bargaining structures The move to a market economy involves the dismantling of the old proce­ dures for determining wages and conditions of employment. In fact some key decisions have already been taken. According to the new Law on Enterprises, enacted in June 1990 and effective January 1, 1991, enterprises other than those totally dependent on the state budget are to be free to determine their wages, constrained only by an "incomes policy" which taxes excessive wage increases and by a floor which will be provided by the existing tariff wage structure. As of December 1990, there were two alternative legislative frameworks under consideration for collective bargaining on wages and conditions. One was a draft decree of the Council of Ministers, which had been proposed by Gos­ komtrud. The other was a draft law proposed by the AUCCTU to the Supreme Soviet. The Goskomtrud draft differed from the AUCCTU draft in two crucial respects. First, it extended the right to choose the body to represent workers in collective bargaining which was conferred on the work collective by the 1987 Law on State Enterprises. The draft envisaged that a general assembly (con­ ference) of the work force shall decide: whether it is necessary to conclude a collective agreement; and whether the trade union committee or any other body so empowered shall: (1) engage in collective bargaining on behalf of the work

174 force; (2) be a party to the collective agreement; and (3) ratify an agreement on behalf of the work force. Both drafts specified that any agreement shall apply to all wage earners, specialists and salary earners, irrespective of whether they are members of the trade union. The draft decree also modified the law passed in 1989 legalizing strikes by specifying that "the parties may also decide that workers shall refrain from striking on matters that fall within the obligations set out in the collective agreement as long as the agreement remains in effect". The provision in the 1987 Law on State Enterprises which empowers the work collective to choose collective bargaining representatives, and which has occasionally resulted in the Workers' Council (STK) or rival "strike committees" being chosen to represent workers, is considered as discriminatory by the AUCCTU, which views this provision as contradicting its reason for existence. It maintains that workers always have the right to elect new union leaders if they are not satisfied with their present ones. The draft legislation presented to the Supreme Soviet by the AUCCTU reflected this view. It specified the trade union committee as the party to collective bargains at the enterprise, specified that the trade unions, through their corresponding elected bodies, "have the right" to con­ duct collective bargaining on behalf of workers, and conceded only that trade unions "organize the collection of workers and work collectives' proposals for inclusion in collective agreements". However, the draft did specify that the draft agreement is to be approved by the general assembly (or conference) of the work collective before being finalized. The other issue on which there is disagreement is that the official trade unions want legislative recognition of their right to conclude "conventions" with union, republican and regional government bodies. These conventions would cover at the all-union level both basic guidelines for wage formation and social security protec­ tion including, for example, a specification of the minimum wage, indexation procedures for other wages, and tax concessions for enterprises which engage in socially constructive activities. The breadth of these proposals seems to have been inspired by the phenomenon of "strike committees" making demands on regional governments as well as on enterprises; it appears that the union confederation is seeking to have itself recognized as the spokesman for workers in such negotia­ tions. The proposals of Goskomtrud, for these reasons, seem to provide a much better basis for the establishment of a collective bargaining system than do those of the trade union federation. They provide an institutional context for bargaining on the terms and conditions of employment in enterprises that will be changing their orientation from fulfilling central plan directives and filling· state orders, to serving the uncoordinated needs of consumer, producer goods and export markets. This bargaining process will require the abandonment of the doctrine that managers and workers have the same interests as joint beneficiaries of the

175 development of state property, and the recognition of the creative tension between the role of the enterprise in serving the markets to which it sells and the desire of workers for improved living standards and job security. This tension is the reason that collective bargaining in a market economy involves a clear divide between the management side and that representing the workers, although the way such tensions are addressed varies widely between, and within, Western market economies. Nonetheless, such bargaining cannot take place in each enterprise in isola­ tion. Workers' demands will inevitably be affected by general price rises and shortages and by changes in collective provisions of basic facilities such as hous­ ing. There will thus be a commonality in issues arising across enterprises and unless some common approach is reached a "wage-wage" spiral between enterprises could easily be generated. Such commonalities of approach could be discussed through regional or branch negotiations between organizations of employers and federations of workers' representatives, which would result in guidelines for workplace negotiators. 46 However, formally binding centralized negotiation, common to some Western European countries, should be approached with caution. For the time being, only the existing state-sponsored unions would be in a position to participate in such negotiations. Moreover, the size and diversity of a country like the USSR would make centralized bargaining impractical.

The new Enterprise Law clearly distinguishes between "owners" and "workers", and provides for the establishment of an enterprise board with equal representation from each side. However, these boards could easily be dominated by the management side if the employees are disunited and disorganized. The reason the latter is likely is that workers' experience with official unionism over the last half century may make them skeptical and apathetic about any attempt to "organize" the workers' side. Furthermore, the stringency of the economic climate and the threat of unemployment will make them very reluctant to defy managerial authority, particularly if the enterprise has been privatized and that authority is therefore not under challenge as being a continuation of traditional state control.

In summary, the structure of collective bargaining must be adapted to a wide range of conditions. Decentralized collective bargaining at the individual enterprise level, although a flexible instrument, can lead to leap-frogging wage settlements in situations in which enterprises compete among themselves in ac­ commodating labor demands. Centralization of bargaining may therefore be beneficial in limiting wage price spirals but may not be practical in a country as large and diverse as the USSR. To provide market signals and incentives, wages must reflect productivity performance and regional differentials in cost of living. More appropriate, therefore, would be regional or economic branch negotiations between employers' organizations and federations of workers' representatives to establish guidelines for plant-based negotiations.

176 (4) Wage bargaining Some features of the current Soviet wage system have clearly influenced the development of enterprise labor relations, and will now need to change. In particular, the failure to properly account for capital usage, and also for environ­ mental and personal health degradation, resulted in a tendency to emphasize material output increases alone-both in the setting of production targets, and in the construction of bonuses within the enterprise to encourage the attainment and surpassing of such targets. In this context, local union officials came to identify their joint functions of defending workers and maximizing production through cooperation in the design and implementation of bonus systems that were intended to maximize output and earnings. The local union officials were not particularly successful in this respect. First, failure to account for other input costs meant that capital goods and other inputs were used inefficiently. Second, any success in raising output above the norm carried the risk that the norm would be revised upwards through the process of "planning to the achieved level". Third, the provision of many goods and services (in particular housing) outside the price system meant that cash wages were often not particularly important for achieving a better life. 47 Finally, recent reforms have resulted in a growth of aggregate wages at a time when output has stagnated, leading to a general shortage in goods on the market which has further discredited cash wages as a means of motivating workers. In a market economy, bargaining between workers' representatives and management occurs in a context in which enterprises are required to pay the full cost of capital, and to implement adequate environmental and health and safety standards. Western experience suggests that efficiency and productivity will be enhanced if there is a move away from payment systems based on individual and even group bonuses (particularly if they are based on material production targets), towards a system of time-rate payments which are adjustable on the basis of the overall factor productivity of the enterprise.48 However, in the transitional period, such a bargaining system will have to evolve within the context of overall wage controls, i.e., the pursuit of an incomes policy (see section d).

(5) Occupational health and safety The consequences of placing a priority on material production over both the health and safety of workers and the environment in general is now evident throughout the USSR. Western experience has shown that health and safety regulation at the workplace generally requires worker involvement if it is to be effective. It also means giving local authorities the responsibility required to en­ force national standards, and relying on workplace health and safety committees as a "front line" inspectorate. In the light of Soviet history on this issue, there must now be a new, relatively uncompromising outlook. It needs to be accepted that work sites which are unsafe must be brought up to standard, and that if this

177 cannot be done at a cost that is consistent with the financial viability of the workplace, it will have to be closed down. In order to bring about even this very basic representational function, a fun­ damental change in existing attitudes to worker compensation will be needed. The current paradigm for representing workers' interests is to associate them with the production process by basing a large part of earnings on production levels. Given the low level of real wages, and their possible further reduction as a result of structural dislocation in the move to a market-oriented economy, such a wage system encourages and almost requires workers to ignore health, safety and en­ vironmental standards in order to exceed production targets and thereby earn large bonuses. It will be necessary to re-orient production processes away from this system to one in which managers will attempt to maximize total factor produc­ tivity. If defined with proper breadth, this will also involve taking account of the true cost of imperiling workers' health and safety, and of the cost of environmental degradation. This probably requires that enterprises be required themselves to meet the full cost of compensation for industrial safety and accidents, and to pay stiff levies for breach of environmental standards (see Chapter V.l). A workers' compensation fund may be necessary, but it should only be drawn on to compen­ sate workers who come from enterprises that have gone out of business. Western experience is that workers' compensation insurance which is not performance rated encourages employers and workers to ignore long-term health and safety risks, relying on the general insurance pool for compensation. 49

(6) Industrial democracy The confusing nature of social changes in the USSR, and the absence of a clearly defined and legitimate focus of authority, has led in many instances to workers' movements taking on both a political and an industrial nature. One by-product of this has been a tendency to include the demand for workers' control of their enterprises in more general calls for democratization. In this, the Soviet workers' movement has followed in the steps of some workers' movements in other East European countries, most notably Solidarity in Poland. In principle, the 1987 Law on State Enterprises did in fact confer on workers, through their enterprise council (STK), considerable authority over their enterprises, including the right to vet the appointment of the Managing Director. In practice, these rights have been very largely formal, with the existing apparatus controlling the elections in most instances. However, this has not been the case everywhere, and there is already a perception-within the official union move­ ment at least-that some of the decisions of the workers' councils were not in the interests of the enterprises. These reservations have now been accepted in the new Enterprise Law, which will cover both state and private sector enterprises. It provides for the establishment of enterprise boards, whose composition will be 50 percent from the owners and 50 percent from the work collective (including

178 managers). These enterprise boards will have some functions similar to those of the supervisory boards in the German system. The crucial issue is who will constitute the "owners" side, both on the enterprise boards and in any collective bargaining which takes place. This goes to the heart of the privatization debate. Some proposals for privatization envisage part or all of the ownership rights to enterprises being given or sold (presumably under credit terms) to the workers in those enterprises. Such proposals are par­ ticularly seductive when the scale of the privatization task is considered. They raise serious equity issues. Under the existing system, workers in successful enterprises have already been relatively privileged compared with those in the service sector or in enterprises with less favored positions. Moreover, the distinc­ tion between the workers' side and management disappears-both on the enterprise board and in a collective bargaining context-if the owners who appoint the bargaining agents are the workers themselves. This is particularly the case if ownership rights are not transferable, and are vested purely in workers as long as they are employed by the enterprise. A system of labor management is prone to overconsumption and underinvestment at the enterprise level. For this reason, it is very important that any attempt to involve workers in the privatization process should clearly distinguish their role as owners from their role as employees. This would require that any share allocation to workers be made on an individual rather than on a collective basis. d. Wage determination and incomes policy

(1) Incentive structure and wage reforms In the past, the centrally determined tariff wage structure had little or no relation to market forces, productivity differences or availability of skills. Instead, it appears to have been based on an egalitarian notion of fairness, together with a rather ideological hierarchy of sectors and skills, but with little weight attached to the incentive function of wages. As noted in section 3, past trends in money wage differentials may be broadly characterized by a relative stability of sectoral differentials-in particular, within a given skill category-and by a gradual nar­ rowing of skill differentials until 1986. The lack of a proper incentive structure has long been a concern of the central authorities and has inspired many reform attempts since the mid-1960s. In par­ ticular, labor requirements in certain sectors, occupations or regions have been accorded a corresponding raise in pay, i.e. so-called "compensating differentials" to offset the disutility of working and living conditions in these sectors or regions. In addition, poor productivity performance and the need to enhance workers' motivation have led to a proliferation of so-called material incentives-bonuses, piece rates, benefits-that alter the structure of wages from that given by the tariffs. Material incentives have been tied to quantitative indicators of productivity

179 and to the fulfillment of plan targets in physical terms. The focus on volumes has frequently given rise to perverse incentives, notably in terms of product quality. It has also influenced the evolution of the industrial relations system, with local union officials viewing their function as one of defending workers through cooperation in the design and implementation of systems that maximize earnings. But the criteria for receiving bonus awards were often so easy to attain that material incentive payments became a fixed addition to basic pay, without requir­ ing much effort on the part of the work force. The lack of real incentives in the traditional system for workers to enhance efficiency and for managers to economize on labor has prompted several attempts to reform the wage remuneration system. The Shechekino experiment, which began in the late 1960s and had been applied to half the industrial labor force by the mid-1980s, assigned the enterprise a fixed wage fund, instead of having the wage fund depend on the number of employees. This meant that the enterprise was entitled to reallocate part of its saving on wage costs to the bonus fund, making salary increases dependent on productivity increases. The brigade system, which was encouraged in the first half of the 1980s, was an attempt to apply the Shechekino method to small groups within enterprises. While the incentives em­ bedded in these remuneration systems could in principle stimulate workers to increase productivity, in practice they had limited effects. Efficiency bonuses were subject to official regulation, which restricted supplementary payments to 30 per­ cent of the base wage, thus blurring the incentives for marginal productivity in­ creases. A more fundamental reason for the ineffectiveness of these schemes was the tendency of the central planners to raise the output norm in line with the efficiency increases actually obtained, thereby all but eliminating the incentives for workers to be more productive. The 1986 wage reform attempted to strengthen the link between the perfor­ mance of an enterprise and the basic wages of its work force. The reform called for a general increase in tariff wages of 20-25 percent, with qualified workers and engineers receiving higher pay raises. The changing structure of tariff wages was intended to reverse the previously mentioned compression of the skilled-unskilled wage differential, which the authorities had judged to have had adverse effects on labor allocation. In contrast to previous tariff wage revisions, enterprises were only allowed to raise tariff wages if they could pay the increasing costs out of their own funds. This meant that the tariff wage increase had to be financed by reducing the bonus fund. But if this did not suffice, the tariff wage could only be raised by increasing labor productivity or by saving on other inputs. The wage reform had been tried out on an experimental basis on the Belorussian railway system during 1985-1986, with large gains in labor productivity, partly due to labor displacement, and steep gains in average wages. As discussed earlier, the 1986 wage reform is credited as one of the factors behind the reduction of employ­ ment in state industrial enterprises since the beginning of 1987. However, the impact of the reform in stimulating labor productivity was weakened by the fact

180 that it was implemented in an environment set by the 1987 Law on State Enterprises. The 1987 law established profit-related pay with the aim of forging closer ties between salaries and economic results. The crucial element was that all state enterprises should be self-financed, i.e., cover their costs (including the user cost of capital and cost of product development) from their revenues. With respect to wage determination, the law offered enterprises a choice between two alternatives, depending on the share of salaries which was related to profits. One possibility was to relate total salaries to profits, and the other was to continue with tariff wages but to supplement them with a profit-related bonus component. The over­ whelming majority of enterprises opted for the second alternative. With profit-re­ lated pay, increased labor productivity showed up in higher salaries for the work force. Other provisions in the 1987 law, as well as its administration, nevertheless weakened the incentives for enterprises and the work force to economize on labor use. The law gave enterprises some freedom to set their own prices (see Chapters 11.2 and IV .1 ). With lack of competition in the product markets, this opened the way for enterprises to finance wage increases by increasing their prices rather than using labor more efficiently. The pressure on management to raise wages without shedding labor was also increased by the law giving the work collective a greater say in management decisions. As noted earlier, the work collective was given the right to vet the appointment of the manager of the enterprise, and the manager was made answerable to the general meeting of the work collective for his ac­ tivities. A serious weakness in the implementation of the law was that branch ministries did not allow the share of the profit-related pay component to become a significant element in workers' salaries. As a result, salaries responded only modestly to increases in profits, weakening incentives for the work force to be­ come more efficient. To some extent, the law also met with political and social resistance due to a low tolerance for large income differentials. More fundamen­ tally, however, it failed to produce real improvements in incentives because in a shortage economy pay raises do not necessarily entail greater command over consumer goods and services.

(2) The current situation and policy tasks The twin objectives of the 1986 wage reform were to restore skill differen­ tials by granting higher pay raises to skilled workers-especially managers and engineers-and to favor some top-priority sectors. As noted earlier, this policy has resulted in a partial reversal of past trends. But the gap between average wages in the "productive" sectors and some of the more labor intensive "non-productive" ones-education, health, culture-is still very large. More generally, in the process of adjusting the relative wage structure and trying to improve incentives, the authorities have lost control of the wage determination process. Recent wage

181 inflation may be partly attributed to continuing labor shortages in some branches of the economy, as well as to social unrest. In addition, competition for the best workers stemming from newly created private activities (cooperatives, self­ employment and black market activities) has increased the pressure on wages in the state sector. More fundamentally, however, increases in money wages that have outpaced both price inflation and real productivity growth have reflected growing enterprise liquidity and weakened central control over enterprise wage payments (see Chapter 11.2). From a policy point of view the current situation, therefore, is particularly complex and difficult. The transition to a market economy would require, in prin­ ciple, the withdrawal of the government from the wage determination process, thus giving room to decentralized wage setting, a widening of wage differentials and the inclusion of non-tariff elements in the actual market wage. However, the urgency of the macroeconomic stabilization goal and the need to cushion social hardship during the transition period require the government to regain some con­ trol over wage determination. At least in the short term, there is a need to set a ceiling for wage increases in order to prevent a wage-price spiral and to maintain minimum wage floors in order to protect the economically weak against inflation. Is there nevertheless some room for decentralization and wage flexibility? The Employment Law and the presidential guidelines foresee the maintenance of the current tariff wages as minima which cannot be undercut. Otherwise enterprises would be free to set wages. This amounts to turning the current basic wage structure into a complex structure of minimum wages. Actual earnings, however, might decrease if bonuses and/or benefits are cut. Since this provision does not protect real wages, some form of partial indexation has been envisaged by the authorities as well. This approach would permit a degree of wage flexibility, however, only within the lower bound given by the indexed minima and the upper bound imposed by an incomes policy involving a cap on maximum wage increases (see below). Under the circumstances, this policy could be viewed as a reasonable solution. Retaining the current tariff wage structure as a floor for future wage settlements would also have the advantage of enforcing some stability in the transition process by providing basic guidelines for wage setting-pending the development of a proper collective bargaining structure as discussed in section c.

(3) Incomes policies The need to halt inflationary pressures and prevent a wage-price spiral in a situation of pent-up demand and price liberalization lies at the heart of the stabilization problem. This raises the question of the role, if any, an incomes policy might play as part of the macroeconomic stabilization discussed elsewhere in this study. The experience from some other countries is reviewed in Appendix IV.6-l.

182 In the USSR, a tax-based incomes policy has been pursued since 1989. The initial formula of the so-called Abalkin tax was that enterprises would become subject to a tax penalty if their total wage bill-money and in-kind wages-in­ creased in excess of 3 percent. The tax failed to limit the steep rise of wages for two reasons. First, it was not effectively enforced. Since it was an across-the-board formula, which would have entailed a considerable degree of rigidity, several exemptions had to be granted. Once this process had started, it was impossible to refuse a proliferation of exemptions. Second, the arrangement did not stop enterprises from granting taxable pay increases since they did not operate in com­ petitive markets or under hard budget constraints. They could in some cases avoid losses by increasing prices; in other cases, losses were covered by state subsidies or credits from the banking system. The "consumption fund tax"-adopted under the Act of June 14, 1990 to become effective January 1, 1991-is also intended to curb excessive increases in the total wage bill of enterprises. Under this scheme, an increase in the wage bill will be liable to tax unless it is accompanied by a reduction in the share of labor remuneration in value added (excluding profit taxes) by a certain margin. The authorities can vary this margin across sectors, but the legislation contains central guidelines on determining the wedge. The tax rate schedule has 4 brackets, with very steep increases in marginal rates for wage increases which exceed norms by up to 3 percent, the top rate being 200 percent for increases in excess of 3 percent (for details see Appendix 111.1-1). At first sight, this formula looks like an improvement compared to the pre­ vious attempt in that it does not freeze inter-firm differentials. But while this may be an advantage in the very short term, it could make the policy more vulnerable over time. The higher remuneration of workers in well-performing enterprises is likely to induce workers in other enterprises with the same or similar skills to seek wage increases in order to catch-up with their fellow workers. These forces will be stronger, the more developed the sense of equity and solidarity in the work force. Other shortcomings may arise as well. First, the policy may not be easily enforceable, and collection lags are likely to dampen its efficacy. Second, even if the policy is enforced toughly and widely, and supposing that subsidies and non­ commercial bank credits will no longer be available, firms may seek to pass on wage increases into higher prices for their products, and may be successful within limits at doing so, especially given the degree of monopolization in the economy. In other words, the current formula provides a mechanism for almost fully index­ ing the enterprise wage bill on own-product prices. Finally, a potential problem with an incomes policy based on the total wage bill is that it may introduce an incentive for "insiders" (workers with a strong position within the enterprise) to increase their own wages by reducing the number of workers with whom they have to share, or to retard the hiring of new workers in enterprises that should be

183 expanding. In other words, this formula may encourage labor shedding and dis­ courage hiring which is unrelated to productivity developments. The alternative would be to base the wage norm on average wages. This would be more ad­ vantageous in terms of protecting employment, but would create an incentive for enterprises to hold on to lower skilled workers and thus retard the upgrading of the human capital stock. Whatever the precise formula chosen, it would be desirable to detach the wage norm from the enterprise's own results. Another essential element is that the policy must be enforced rigorously and consistently. Since it will come at the expense of flexibility, it should be regarded as a purely transitional device. Finally, the experience of Eastern European countries suggests that even in the short term it will only work if it is accompanied by macroeconomic stabilization, the imposi­ tion of hard budget constraints and a decisive move towards competition in product and factor markets. e. Social protection Relative price adjustments affect the real living standards of all, including those not in the labor market. This results from administered wages and transfers being determined in the context of a fixed set of prices. As discussed in section 3, there is a fairly equal distribution of incomes at a relatively low mean in the USSR, given the extensive free, subsidized and in-kind provisions. While this has not been adequate in preventing poverty, it is clear that major price adjustments without regard to wages would lead to further dramatic increases in poverty. Issues of social protection also arise in respect of existing programs, particularly for pensions and allowances to cover various contingencies. These programs had deteriorated in terms of adequacy of cover well before the formulation of the present reform proposals, and the transition to a market economy will put them under additional pressure. Moreover, provisions will be needed for new contin­ gencies, particularly the unemployed.

( 1) I nco me protection during the period of price liberalization It is expected that a market oriented price system in the USSR would lead to an increase in the prices of most agricultural goods and raw materials, but also a decrease in the prices of some manufactures. This report concentrates on food prices, which are crucial in establishing standards of living, although the discus­ sion could be extended to other items of essential consumption such as housing.

(a) Reform proposals The Abalkin reform program had suggested an administered adjustment in producer and consumer prices, with subsidies on meat and milk products being phased out. However, a full "lump-sum" compensation was proposed for con-

184 sumers. The Shatalin plan was more cognizant of the market mechanism, arguing for the free interplay of demand and supply, although during the initial transition period prices of 20-30 percent of commodities were to be frozen to limit the possibility of a potentially inflationary wage compensation-price spiral. While the presidential guidelines echo many of the Shatalin proposals on price reform, they recognize that freezing producer prices for essential goods could have adverse supply responses and argue for fundamental changes in the "method of paying out subsidies," with considerable leeway for adjustments for producers and ration­ ing at the local and republican levels. The presidential guidelines advocate the full indexation of pensions and transfer payments. There would be partial indexation for those on low and fixed incomes. While the precise formulae to be used for the latter were not disclosed, the guidelines suggest that the range of indexation, for example for those in the so-called nonproductive public sector such as teachers, would be between 50-70 percent with the degree of indexation declining as income levels rise. The extent of indexation would depend on the choice of commodities to be included. The basket of goods to index would include a heavy weighting of essential items provided at administered prices. This would limit the budgetary outlays on account of minimum wages and transfers such as pensions, allowances and unemployment compensation. It had been determined by the Government, in agreement with trade unions, that if the prices in the chosen basket increased by more than 2 percent, there would be automatic compensation, but not otherwise. The different proposals concerning the initial level of minimum wage to which indexation would apply range between rub 70-100. If no adjustment is made to the minimum wage, then indexation would apply to the current figure of rub 70 per capita per month.

(b) Measures for the transition

There are number of different methods of ensuring social protection in the transition period. They are not mutually exclusive, nor is any given solution likely to be suitable for all regions of the USSR, as consumption patterns and administra­ tive capabilities vary. For a given adjustment in prices, attempts to compensate households fully would likely exacerbate inflationary trends; moreover, less than full compensation could be attractive on distributional grounds. The options in­ clude: (1) undifferentiated benefits which (e.g., through a system of coupons) could serve to ensure the provision of a limited quantity of goods at predetermined prices, or the cash equivalent, to all in a particular region; (2) food stamps, which could be either means-tested, or targeted by individual characteristics, such as age or disability; and (3) means-tested cash compensation. Amongst these alternatives, there are two basic questions: whether the benefits should be universal or restricted in some fashion; and the method of administering the chosen option.

185 (c) Universal provision An important method of protecting consumers is to continue to provide cer­ tain quantities at subsidized prices. Market clearing prices would obtain for producers and for quantities demanded in excess of the ration. Limiting subsidized quantities consumed to the average consumption level of, say, the poorest 10-15 percent of the population, would restrict the budgetary outlays. In providing fixed supplies at given prices, undifferentiated benefits would also ensure that the prices of essentials are not bid up beyond the reach of the poor. A similar system adopted during World War II in the United Kingdom ensured that nutritional standards actually improved with the assurance of an adequate provision of a balanced diet of proteins and carbohydrates, despite the disruptions of supply. High market prices of milk and meat would otherwise have forced a substitution of consumption by the poor towards less nutritious starches and potatoes. Rationed benefits in kind would lead to considerable reductions in budgetary outlays, compared to a general subsidy, as only limited quantities of a few goods would be involved. Targeting would reduce costs further. However, in the Soviet case, universal rations would minimize additional costs that arise through the indexation procedure. This is because the prices of rationed com­ modities would be included in the weighting of a basket of goods used to deter­ mine changes in the index. While cash transfers are recommended on grounds of simplicity and ad­ ministrative ease, resalable in-kind benefits are equivalent in principle. If there are sharp price movements and the eventual price level is uncertain, then in-kind provision may have the advantage of shielding consumers from the uncertainty involved. Cash transfers may be inadequate in ensuring guaranteed consumption minima, but have the advantage that budgetary outlays are likely to be known in advance. However, if there are additional cash payments to compensate for un­ foreseen (or unplanned) price rises, then this advantage would be lost. Moreover, outlays with respect to in-kind transfers would be limited by the international price of importables.

(d) Targeted options If it were relatively costless to identify the poor and vulnerable, then the preferred approach would be targeted transfers to persons below or around the poverty line. Universal provision could actually become more targeted in practice through the public supply of relatively low quality types of meat or grains as part of an in-kind transfer. The method of delivery would, however, vary according to administrative capabilities at the local or republican levels. Rising prices for agricultural products, to the extent that these were not offset by input price chan­ ges, should lead to rising incomes for farmers; in this case it would not be neces­ sary to compensate such groups for the price changes. Moreover, provision of rations in rural areas may pose administrative difficulties.

186 Given the regional differences in consumption across the union, it makes little sense to determine all-union norms for in-kind transfers. To limit the annual public provision of meat or dairy products to the levels consumed by the poor (defined as those with less than rub 75 per capita) in Uzbekistan, or 18 kilograms per capita of meat and 145 kilograms of dairy products, would lead to considerable hardship in the RSFSR, since the poor in the latter consume more of these items than the average for all households in Uzbekistan (Table IV.6.15). Conversely, a provision determined by the minimum quantities of such items consumed by the poor in the RSFSR (38 kilograms of meat and 305 kilograms of dairy products) would be overly generous in Uzbekistan, and would be tantamount to a general subsidy in some regions. One approach to targeting would be to issue food stamps to the needy. If, say, 30 percent of the population in the USSR is below the current poverty line, limiting the transfers to these households could, in principle, reduce the expendi­ tures on universal provision correspondingly. However, as discussed in section 3, there is a concentration of individuals at or just above the current poverty line. Therefore, the necessary adjustments of the poverty line in consonance with price increases would spread the net much wider, reducing the budgetary savings rela­ tive to uniform provisions. Administrative costs and feasibility are also important, as is the need to generate wider, political support. Another difficulty with means­ testing, as noted earlier, is the high marginal tax rate that is involved at the point of withdrawal of the benefit, which could result in a "poverty-trap". Food stamps or targeted benefits provided on the basis of household charac­ teristics, such as to the elderly, families with a large number of children (defined in the Soviet context as exceeding two), or the disabled, might be easier to ad­ minister than the means test, and would tend to avoid the poverty-trap disincen­ tives. Such individuals could be easily identified on the basis of current benefit programs. Another category of persons in need is likely to be the unemployed and those in retraining, or those employed under the safety net of last resort-public works. Such persons also could be provided with the food stamps along with other benefits. The lower direct cost of the targeted options could be offset (as the example below suggests), however, by additional expenditures on account of the full in­ dexation of pensions and benefits, as well as the adjustment of wages of those in the nonproductive sector such as teachers, the military, doctors and nurses and so on. Compensation cannot be made only to those on the poverty threshold, as this would lead to a further compression of relativities (see section d). Thus, adjust­ ments might entail fairly major additional expenditures on (non-enterprise) public sector wages. Where the majority of the population in a region is at a relatively low income level, and is in danger of poverty after the price changes, or if incomes cannot be

187 easily verified, then universal provision (perhaps targeted by quality differentials) may be the most cost-effective option.

(e) Budgetary implications Despite difficulties in determining regional variations in consumption pat­ terns, and the local solutions that are likely to emerge, it is important to establish overall budgetary implications for the social programs. Under present rules, social protection expenditures on pensions and allowances would be limited to 26 per­ cent of the wage fund of enterprises (plus one percent for unemployment in­ surance) and the one percent on individual wage receipts (see below). Increased expenditures arising from indexation would have to be accommodated through a reduction in contingencies covered or benefit levels, or if this were not possible, would emerge as a charge on the budget. In the following, the magnitude of the likely direct subsidies are estimated. Producer price increases from January 1991, in the absence of adjustments in consumer prices, were estimated to increase food subsidies from approximately rub 100 billion, or around 10 percent of GDP, to rub 160-180 billion (with some estimates as high as rub 200 billion). Methods of reducing this subsidy, without excessive burdens on the poor, are discussed below. On average, the consumption of key food items in quantity terms by those under the official poverty line is about 43 percent of average per capita consump­ tion (Table IV.6.15). Guaranteeing the maintenance of the existing consumer bas­ ket for the poorest in the USSR at existing prices, and no more than this to richer households, would entail a fairly limited subsidy. A system of universal benefits in kind could reduce the direct subsidy to around 43 percent of projected outlays, or to around rub 70 billion. A system of food stamps or targeted cash transfers, based on a poverty line with around 30 percent of the population classified as poor, would reduce direct budgetary outlays to about one third of the universal benefit, or to around rub 24 billion. However, with the full price rise, it is likely that the number of persons classified as poor would increase, reducing the savings through the targeting. The full price changes may also trigger adjustments in (non-enterprise) public sector wages that would have to be met through the budget, as discussed above. Even if concentrated initially on low income wage earners, the indirect adjustment of wages could be expensive if relativities were maintained. With a wage bill in the non-productive sector of around rub 180 billion, a 60 percent increase in the price level would involve an additional expenditure of rub 108 billion. Adjust­ ments on account of pensions and transfers would also be more than in the rations case, with lower aggregate price effects. The choice of an appropriate mechanism to protect the vulnerable is more likely to tum on administrative feasibility rather than overall cost, and for this

188 reason should be decided at a republican or local level. Food stamps may be easier to administer in Estonia, for example, than in Uzbekistan. It is apparent, however, that there is significant scope for reductions in the subsidy bill, regardless of the option adopted, without adversely affecting the living standards of the poor in the USSR.

(2) Reform of pensions and other transfers There are a number of policy issues relating to the system of social protection for existing contingencies, including the elderly and households in need of assis­ tance. Some of those relating to living standards were discussed in section 3. In this section the provisions for established coverage of life-cycle contingencies are examined: old age, disability, maternity and child birth and the special needs of childr~n and particular types of households. 5°

(a) Pensions New pension provisions designed to protect old-age pensioners from declin­ ing standards of living were to come into effect on January l, 1991. Minimum pensions, aligned to minimum wages, are to be determined on an all-union basis, while the pension law gives individual republics a free hand in increasing old-age pensions beyond the centrally guaranteed level. Changes in minimum pensions would be reflected at all pension levels, thus maintaining relativities. Minimum pensions are to be indexed to prices as well as to minimum wages, so that price rises would be reflected in the minimum pension even if there were no change in minimum wages. Finally, the new law provides coverage to all individuals ir­ respective of source of incomes, provided contributions will have been made to the Pension Fund. A guiding rationale for the reform of the Soviet social security system is the need to separate pensiqns, which should be organized on social insurance principles, from other allowances for households. To this end, two separate funds are to be established, the Pension Fund and the Social Security Fund. The intention is to make these funds viable without calls on general revenues, taking social expenditures off-budget. Given the demographic profiles of various republics, a Pension Fund would redistribute resources from poor (but relatively "young") Central Asian republics to richer (and demographically mqre "mature") regions such as the Baltic republics. The initial proposal was, therefore, for the Pension Fund to include not only items that are normally covered under social insurance, such as old age pensions, disability and loss of breadwinner pensions, but also two groups of child allowances, one universal and the other apparently means-tested. The inclusion of these allowances would change the direction of resource flows towards poorer regions. Thus, the Ukraine, with potential collections of rub 20 billion, for ex­ ample, and expenditures including allowances of rub 15 billion, would contribute rub 5 billion in principle to the all-union fund. The inclusion of allowances in

189 Uzbekistan, however, would more than offset the surplus on pension account, resulting in a deficit of around rub 2 billion to be met out of the central fund. In principle, this appears to be a sensible and well thought out scheme. However there are difficulties which may preclude the effective establishment of an all-union fund and vitiate the objective of moving these expenditures off­ budget. The major difficulty is partly administrative and partly political. As noted earlier, the USSR does not have a system of individual social security identifica­ tion numbers, and Goskomtrud thus far has no administrative powers in this area. Collections, verification of work records, and disbursement of benefits are in the republican domain. Even the proposed Pension Fund would in fact be composed of 15 republican funds, with surpluses transferred to and deficits met from the all-union fund. However, it is not clear whether republics with surpluses would be willing to part with them. Elimination of aggregate surpluses with a reduction of the contribution rate, so that the overall system remains essentially pay-as-you­ go, does not remove the problem as interregional transfers would still be involved. The difficulty is that different republics may have varying objectives, with the Ukraine, for example, probably keen to build up reserves to cater for increasing numbers of the aged, but with Uzbekistan likely to be more anxious to use surpluses on pension account to provide benefits to poor children. The current legislation setting up an all-union fund would be the preferred option on economic grounds, during the transition and subsequently. However, if this were politically infeasible, then the second-best option would be only to legislate minimum benefit levels on an all-union basis. Republics would then be free to add to these (as at present), but would determine funding options and contribution rates. Effectively there would be 15 republican funds for pensions, but without the possibility of inter-fund transfers. Allowances could then be separated from the pension account and be treated analogously, although recourse to republican or union revenues might be needed in particular cases. To the current payroll tax for pensions and social security, it would be neces­ sary to add the taxes for employment measures and unemployment compensation (see section a), and eventually health care. 51 As noted earlier, there are doubts about whether the level of payroll tax initially proposed was in line with the realities of a changing labor market situation, with considerable pressure on enterprises and the likelihood of substantial short-run austerity and unemploy­ ment. Given hardening budget constraints, the tax would eventually have to be borne by adjustment within enterprises, possibly accelerating the labor shedding process. High contribution rates may also be difficult to implement, particularly with an expanding private sector, and may have the effect of reducing the con­ tribution base as has happened in several Latin American countries. There are also some doubts as to the ability of the currently underdeveloped capital market to maintain the value of surpluses. Thus expenditures for future retirees may still require additional increases in contribution rates or subsidies from the budget. In

190 October 1990, the Government announced that the proposed enterprise contribu­ tion rate had been reduced from 37 percent to 26 percent of the wage fund. 52 This drastically reduces planned reserves, and returns the overall system towards pay-as-you-go funding, but without Government contributions. The ageing of the population will increase outlays fairly rapidly, however, necessitating rising con­ tribution rates. An alternative, akin to the French repartition system, would be to fix the contribution rates for a period of time and to adjust benefit levels, eligibility and scope of allowances.

(b) Allowances Under the reform provisions, most social allowances are to be paid from the Social Security Fund, although two major allowances would continue to be paid out of the Pension Fund. The first is a universal child allowance for all children from birth to 18 months, with benefits at 100 percent of the minimum wage paid to working mothers, or 50 percent for non-working women. The second is a means-tested child benefit which would be paid from 18 months to age 6, at 50 percent of the minimum wage, irrespective of whether the mother works outside the household or not. The means test is to be based on family per capita income less than twice the minimum wage (or rub 140, currently), to be determined and administered at the local level. Other means-tested benefits would be contracted with republics and local authorities with support from the central fund. However benefits and minimum criteria would be allowed to vary, given the differences in demographic charac­ teristics. There are major incentive problems in administering a means test at the local level with union or republican funding, as there is no sanction against a proliferation of expenditures (see section 3). The other allowances proposed to be paid out of the Social Security Fund include (percentage of minimum wages in brackets): (l) maternity leave, 18 weeks before birth (100 percent); (2) lump-sum benefits after birth, equal to 3 months minimum wages; (3) unmarried mothers' allowance (50 percent) for a child until 16, or 18 if the child pursues studies at a higher education estab­ lishment; (but until the child is 6 years old the mother receives full allowance (100 percent)); (4) wives of military personnel (100 percent); (5) widows with children and persons taking care of orphans (100 percent) to age 16, or to 18 if studying; ( 6) guardians of children (l 00 percent) to age 16 or 18; and (7) an allowance for looking after a sick child under the age of 14, for not more than 14 consecutive days, depending on the salaries of the person taking leave. These allowances consolidate the myriad of ad hoc provisions which cur­ rently prevail, and offer cover for most life-cycle contingencies. However, these are seen as enabling provisions to prevent poverty. A solution to the basic problem of existing poverty depends primarily on growth prospects to generate the resour­ ces which would be required for the social protection provisions to operate effec-

191 tively. The tradeoffs may be seen in the reduction in the proposed payroll tax to 26 percent. This would reduce the resources for the allowances from around rub 25 billion to rub 16 billion in 1991. The response has been a proposal to move the grant for the birth of a child (allowance 2) to the Pension Fund, and the allowances for unmarried mothers, military wives and guardians (allowances 3, 4, and 6) to republican budgets. The guardians' allowance would be reallocated to the educational budget of the republics. Clearly, birth grants are viewed as essential, and the other benefits to be reallocated to republican budgets are per­ ceived as "dispensable", since they cannot be forced on the republics. The effects of minimum guarantees on the expenditures to be incurred on pensions and allowances are not easy to quantify, not least because of the uncer­ tainty concerning the establishment of the minima. The actuarial balances between potential costs and likely resources are hazardous to determine in a situation in which the indexation procedures are still to be finalized, and possible changes in the base could occur as a result of the overall reform program. The danger to be avoided is to construct an elaborate and expensive social security edifice that provides benefits to a privileged subset of the target population, in the presence of poverty and need. If the state can actually ensure minimum standards of living for the entire population, it will have achieved a major objective of any social security system. To this purpose, it will be necessary to evaluate the needs of various groups of the population, including those such as the unemployed that become vulnerable as the system changes.

NOTES I. The labor force in Western statistics is conventionally defined as the sum of employment plus unemployment. However, since the concept of unemployment does not exist yet in official Soviet labor force statistics, Soviet participation rates are essentially equivalent to employment/ population ratios. The international comparisons in Chart 2 are based on a "standardized" labor force participation rate which relates the labor force to the size of the age group 15-64, not to the number of adults below retirement age. This accounts for the lower standardized rate for the USSR in Chart 2 than is usually recorded, since the Soviet retirement age is relatively low. 2. According to a recent Goskomstat survey, the main reason women cite for working full-time is that they need the income to support their families. This suggests that continued high par­ ticipation rates among women may be related to relatively low wages of the main breadwinner. Given the choice, the majority of women stated their preference for part-time work. But many respondents also added that they could not find part-time jobs because their employers were unwilling to create such positions. 3. It is worth noting that the current Soviet share of around 20 percent of total employment in agriculture is similar to the OECD average in 1950; the average share of agriculture in the OECD countries has since declined to around 7 percent. See Maddison (1989). 4. The average employment in Hungarian industrial enterprises is 2,500 (Hare (1990)). 5. OECD (1989), p. 190.

192 6. See Oxenstiema (1990), pp. 31-34, for a review of this issue. 7. Goskomstat estimated that, according to ILO definitions, there were 2 million unemployed persons in 1990. Goskomtrud had cited a figure of 2.5 million for the end of 1990. Non-official Soviet sources have quoted estimates ranging from 4 to 6 million. 8. See Oxenstiema (1990), pp. 222-28, for a review of this literature. 9. The estimates supplied by the Soviet authorities for the scale of such employment cut-backs are, however, quite small. Available data show that the central administration employs around 2 million persons, or less than 1.5 percent of total employment. Compared with Western countries this proportion is very small, suggesting that not all employment in branch ministries is allocated to the central administration in the statistics. 10. A recent review of cross-country econometric estimates of the unemployment elasticity of real wages concluded that it is small, of the order of -0.1. See Blanchflower and Oswald ( 1990). 11. Assuming that inflows into unemployment revert back to their late-1980s value. 12. See, however, the discussion in Ofer and Vinokur (1990), based on a sample of Soviet migrants to Israel in the 1970s. 13. If the collective farm is unable to pay the minimum wages, the state lends it money for this purpose. Such loans have rarely been repaid. See Oxenstiema ( 1990), p. 126. 14. Chapman (1990). 15. An effective minimum wage was reintroduced only in 1957, the first since 1937. This was initially rub 27-35 a month, then rub 40. It has been held at rub 70 a month since 1977. 16. See Oxenstierna (1990), pp. 144-145. 17. Glushetsky (1990). 18. For a discussion of the issues, see Chapman (1990), pp. 16-21. 19. For evidence in this regard, based on surveys of Soviet emigrants to Israel, see Ofer and Vinokur (1990). 20. Shcherbakov ( 1990). 21. See Chapter III. I for a detailed discussion of the budgetary implications of food subsidies. 22. Commonly used inequality indices are sensitive to transfers in particular segments of the in­ come distribution. The coefficient of variation, for instance, is particularly sensitive to changes amongst higher income groups, reflecting inequality due to the presence of rich individuals. The Gini coefficient is more sensitive to changes in the middle ranges of the size distribution. The Atkinson index permits explicit weighting of a social welfare function, ranging from equal treatment of transfers to all households (zero inequality aversion), cases where relatively greater weight is placed on transfers to the poor than to others (inequality aversion parameters in the range 1-2), toward Rawlsian preferences,when only the welfare of the poorest is considered (inequality aversion parameters of 5 or more). Thus, the Atkinson index with an inequality aversion parameter of 2 will represent inequality due to large numbers of the poor relative to the mean, whereas that implied by an inequality aversion parameter of 5 will concentrate on the poorest households relative to the mean. 23. To some extent, the per capita size distributions overstate the extent of poverty in the Central Asian republics, relative to the Baltic republics for example, as children and adults are treated the same. However, this procedure is quite commonly adopted. See, for example, World Bank (1990). Equivalence scales and household observations were not available.

193 24. This probably reflects limitations of access to supplies for the poorer income groups rather than taste factors, since the upper income households tend to have more similar consumption patterns across republics. The data are based on household consumption surveys conducted by Goskomstat. 25. See Rumer (1989), p. 137. 26. Goskomstat, Social Statistics ( 1990), p. 40. 27. Carey (1989), pp. 1-38. 28. Old age pensions doubled on average and for the lowest paid they increased three-fold. The minimum pension was set at 50 percent above the previous maximum, and the minimum disability pension was raised by 600 percent. See Madison ( 1990), p. 166. 29. For a more detailed description of the various social security benefits and their present and prospective financing, see Appendix III.l-3. 30. See, for example, Atkinson ( 1990). 31. For a discussion of the role of employment services in raising labor market efficiency, see OECD ( 1990b ). 32. See also the discussion in Chapter III. I. 33. See OECD ( 1990a), pp. 153-171, for a full discussion of this issue. 34. See Bermant and Feonova ( 1990). 35. See Granick ( 1987). 36. See Schwartz ( 1986). 37. See Yanowitch (1984-85). 38. See Yanowitch (1981) and Mamie (1986). 39. Kostakov ( 1990) estimates that a Soviet worker spends 15 percent of his time in training, although the estimate of this may include pre-employment education and training of students of working age. 40. See World Bank (1990). 41. For further information about the functioning of trade unions in the centrally planned Soviet economy see Low it ( 1971) and Ruble ( 1981 ). 42. These figures were contained in the report of the Control Commission to the inaugural Congress of the successor body to the AUCCTU, the General Confederation of Trade Unions (GCTU), which was held in Moscow on October 23-25, 1990. 43. For example, in April 1990, the ICFTU reported that since the (then) AUCCTU was determined to keep its major assets such as recreation centers and health centers, "Many workers are therefore reluctant to resign from the established unions and at least some of the independent groups accept that their members or supporters will stay in these unions at least for the time being." 44. The issue of the disposition of the property of the AUCCTU generated considerable discussion at the Congress held in October 1990. The final decision was that the assets should not be dismantled, which ensured that it would remain under the central control of the successor body to the AUCCTU, the GCTU. 45. The Austrian Chamber of Labor provides one example of such an arrangement.

194 46. The National Council for Coordination of Interests, established in Hungary in 1989-and in which all union groups are represented-is one example of such a nonbinding coordinating body. The Hungarian Government now plans to establish such councils at the regional level. 47. For a particularly stringent critique of these distortions in the wage system, see the paper delivered to the Joint ILO/USSR Conference, October 1-4, 1990, in Moscow, by the Chairman of Goskomtrud (Shcherbakov (1990)). 48. Such adjustments are frequently achieved through so-called thirteenth or fourteenth month bonuses which are related to overall enterprise performance. 49. For a discussion of these issues in health and safety regulation, see OECD ( 1989). 50. Also see Appendix III.l-3 for a detailed discussion of social security reform and its budgetary implications. 51. The authorities confirmed that medical insurance and health care spending were not covered under the proposed social security funds. There were proposals to form a special health in­ surance fund, which would be independent of the state budget. This fund would be financed by a special insurance premium, and if it were to cover current health care spending of around rub 19 billion, the rate would have to be set around 2-3 percent of income. Within the present framework of state health guarantees to all, it might prove difficult to switch over to an insurance-based system. 52. See Appendix III.J-3 for a more detailed discussion.

195 Table IV.6.1. USSR: Labor Force Growth in International Perspective, 1980-89 (Annual average growth rate, in percent)

USSR ...... 0.5

Czechoslovakia ...... 0.8 GDR ...... 0.4 Hungary ...... -0.4 Poland ...... -0.1 Romania ...... 0.4

United States ...... 1.6 Japan ...... 1.1 Germany ...... 0.8 France ...... 0.5 United Kingdom ...... 0.8 Italy ...... 1.0 Canada ...... 1.9 OECD Europe ...... 1.0 Total OECD ...... 1.3

Sources: Goskomtrud: OECD; United Nations, Economic Commission for Europe, Economic Survey of Europe in 1989-90 ( 1990).

Table IV.6.2. USSR: Employment by Sector in International Perspective, 1988 (Shares in percent)

United United USSR' States Japan Germany' France Italy Kingdom Canada

I. Agriculture ...... 20.2 2.9 7.9 5.3 6.8 9.8 2.3 4.5 2. Mining and quarrying ...... 1.7 0.7 0.1 1.3 0.4 1.5 0.7 1.5 3. Manufacturing ...... 23.6 18.5 24.2 32.2 21.6 23.3 21.4 17.2 4. Electricity ...... 0.6 1.1 0.5 0.9 1.0 0.9 0.9 5. Construction ...... 9.3 6.6 9.3 6.6 7.3 12.7 6.4 5.9 6. Wholesale and retail trade .... 6.1 22.1 23.1 15.1 17.1 21.0 19.8 23.6 7. Transportation and communication ...... 8.0 5.4 5.9 6.0 6.5 7.3 5.7 6.3 8. Financing and insurance ..... 0.5 11.3 7.5 6.7 9.2 3.7 10.9 11.0 9. Community services ...... 25.9 31.4 21.0 25.9 30.1 20.7 30.3 29.0 0. Not defined ...... 4.0 1.4 I. Primary ...... 20.2 2.9 7.9 5.3 6.8 9.8 2.3 4.5 2.-5. Secondary ...... 35.2 26.9 34.1 41.0 30.3 37.5 29.6 25.5 6.-D. Tertiary ...... 44.6 70.2 58.0 53.7 62.9 52.7 68.1 70.0

Sources: lLO for the USSR. For other countries, OECD, Labour Force Statistics, 1968-88 ( 1990c). I. Adjusted by the ILO for the purposes of international comparisons. Because of this, the employment structure for the USSR does not correspond to that shown in Table F.2 of Appendix 11-1. 2. 1986.

196 Table IV.6.3. USSR: Growth in Total and Working-Age Population by Republic, 1979-89 (Average annual growth rate, in percent)

Working Total Age Population Population

Total ...... 0.9 0.4 Developed regions Russian Republic ...... 0.7 0.1 Ukraine ...... ·...... 0.4 -0.1 Lithuania ...... 0.8 0.7 Latvia ...... 0.6 0.3 Estonia ...... 0.7 0.4 Belorussia ...... 0.6 0.2 Less developed regions Moldavia ...... 0.9 0.5 Annenia ...... 0.8 0.5 Georgia ...... 0.8 0.6 Azerbaidzhan ...... 1.5 1.8 Kazakhstan ...... 1.2 1.2 Uzbekistan ...... 2.6 2.7 Kirgizia ...... 1.9 1.8 Tadzhikistan ...... 3.0 3.0 Turkmenistan ...... 2.5 2.7

Source: Census data from Goskomtrud.

197 Table IV .6.4. USSR: Employment Shares by Republic, 1989

Private Transport, Comm- Central Other Security, Self- Agri- Collective State Con- Communi- unity Govern- State Political Cooper- Employ culture Farms Farms Industry struction cations Trade Finance Services Housing ment Activity Admin.' atives 2 ment Total

RSFSR ...... 1.2 5.5 7.4 29.4 10.1 8.2 7.6 0.5 17.7 4.0 1.6 1.6 2.9 2.3 0.1 100 Ukraine ...... 2.0 13.8 5.5 29.0 7.9 7.6 7.2 0.5 16.1 3.5 1.5 1.5 2.0 1.6 0.4 100 2 Belorussia ••••••••••••••••••••••• ... 12.7 9.6 29.3 7.9 6.9 6.6 0.5 16.0 2.5 1.8 2.1 1.9 2.2 ... 100 Estonia ...... 0.5 9.2 6.4 27.3 8.3 8.6 8.4 0.5 15.5 4.1 1.5 2.5 3.3 3.2 0.7 100 Latvia' ...... 0.9 10.3 7.4 27.5 7.3 8.2 8.0 0.6 15.8 4.5 1.9 1.9 3.0 2.7 ... 100 Lithuania ...... 1.1 10.1 7.9 27.5 9.0 7.1 7.4 0.5 16.2 3.5 1.6 1.6 2.1 2.3 2.1 100 Moldavia ...... 7.0 16.0 15.0 19.4 6.2 6.3 6.8 0.4 14.2 2.1 1.6 1.1 1.3 2.2 0.4 100 Georgia ...... 6.3 8.9 11.0 17.9 8.9 8.2 6.3 0.4 18.5 3.9 1.7 2.7 2.4 2.6 0.2 100 Armenia ...... 5.7 3.4 9.7 28.3 8.2 5.8 6.1 0.4 19.6 3.8 1.6 1.8 - 5.1 0.6 100 Azerbaidzhan ...... 8.7 10.8 11.6 16.2 7.9 7.7 6.2 0.4 19.8 3.4 1.7 1.5 2.5 1.5 0.1 100 Kazakhstan 3 ...... 3.6 17.6 19.3 9.2 11.2 7.3 0.6 18.3 3.2 1.8 0.9 4.0 3.0 ... 100 Turkmenistan ...... 14.1 22.3 3.7 9.0 9.6 7.7 6.1 0.3 16.5 2.5 1.8 1.2 3.9 1.2 0.1 100 3 Uzbekistan ••••••••••••••••••••••• 13.4 13.4 11.4 13.8 7.7 5.6 6.1 0.4 18.0 2.5 1.5 1.0 2.7 2.7 ... 100 -\0 00 Tadzhikistan ...... 18.2 13.4 8.6 11.9 7.2 6.2 5.4 0.4 17.2 2.2 1.6 1.1 4.5 2.0 0.2 100 3 Kirgizia ...... 10.9 10.6 10.9 16.6 6.7 6.5 6.3 0.5 18.1 2.2 1.6 2.0 5.5 1.6 ... 100

Sources: For all sectors except collective fanns, Ministry of Defence, private subsidiary farms, cooperatives and self-employment: Heleniak ( !990a). For all other sectors: Heleniak (1990b). I. Employment in the Ministry of Defence, Ministry of Internal Affairs, Central Committee of the Communist Party, and administration of Komsomol. 2. The figure for cooperatives includes self-employment and private agriculture. 3. The figure for cooperatives includes self-employment. Table IV.6.5. USSR: Job Separations According to Cause, 1988-89 (In percent of total)

Manufacturing Construction 1988 1989 1988 1989 Transfer to other enterprise ...... 6.4 7.5 19.5 20.3 Termination of work ...... 13.2 12.5 23.3 19.9 Leaving the labor force ...... 29.8 27.6 20.0 18.6 Voluntary quits ...... 43.1 44.7 32.0 35.5 Disciplinary dismissals ...... 7.5 7.7 5.2 5.7 Total ...... 100.0 100.0 100.0 100.0

Source: Goskomtrud.

Table IV.6.6. USSR: Estimates of Job Displacement and Unemployment in the Transition to a Market Economy, 1991

Goskomtrud Gradual "Shock" Shatalin scenario scenario group

Inflows into unemployment ...... 21.2 25.0 Of which: Lay-offs ...... 3.5 6.0 Quits ...... 17.0 New entrants ...... 0.7 0.7 Outflows ...... 20.5 19.7 Increase in unemployment ...... 0.7 5.3 Memorandum item: Unemployment, end-1990 (millions) 2.5 2.5 6.3

Source: Goskomtrud.

199 Table IV.6.7. USSR: Unemployment Scenarios' (In thousands)

Entrants Closure Inflow Outflow Stock to the of Loss- Reduced into from of Unemploy- Voluntary Labor Making Over- Unemploy- Unemploy- Unemploy- ment Quits Market Enterprises manning ment ment ment Rate Gradual Scenario 1990 IV ...... 4,250 175 4,425 4,425 2,500 1.8 1991 I ...... 3,995 175 725 1,546 6,441 4,167 4,774 3.4 II ...... 3,740 175 725 1,769 6,409 5,968 5,215 3.7 III ...... 3,570 175 725 1,915 6,385 5,395 6,205 4.4 IV ...... 3,570 175 725 2,315 6,785 4,654 8,336 6.0 1992 I ...... 3,570 150 2,515 6,235 5,558 9,014 6.4 II ...... 3,570 150 2,415 6,135 4,917 10,232 7.3 III ...... 3,740 150 2,315 6,205 4,725 11,715 8.3 IV ...... 3,740 150 2,315 6,205 4,686 13,234 9.4

Radical Scenario

1990 IV ••• 0 ••••• 4,250 175 4,425 4,425 2,500 1.8 1991 I ...... 3,995 175 725 3,654 8,549 3,750 7,299 5.2 II ...... 3,825 175 725 5,307 10,033 8,110 9,221 6.6 III ...... 3,570 175 725 6,614 11,084 7,280 13,025 9.3 IV ...... 3,230 175 725 7,614 11,744 7,815 16,954 12.1 1992 I ...... 2,975 150 4,414 7,239 8,073 16,120 11.5 II ...... 2,975 150 2,389 5,514 6,448 15,186 10.8 III ...... 2,975 150 1,654 4,779 5,237 14,728 10.5 IV ...... 2,975 150 1,654 4,779 4,419 15,089 10.8

1. It is assumed that the overall quit rate in the Soviet economy is 12.5 percent in the steady state. The increases in the labor force of 700,000 in 1991 and 600,000 in 1992 are estimates supplied by Goskomtrud. The estimate for employment in enterprises currently operating at a loss was also supplied by Goskomtrud. Overrnanning rates of 12.5 percent and 25 percent in the gradual and radical scenarios, respectively, refer to the state sector plus collective farms. The quarterly outflow from unemployment is calculated as the reciprocal of the estimated average unemployment spell measured in months multiplied by three, which in tum is multiplied by the stock of unemployment in the previous quarter. This method is based on the assumption that those who are unemployed experience only one spell of unemployment during a single quarter. It also assumes that the labor market is in a steady state, in which eventually inflows into and outflows from unemployment cancel each other out.

Table IV.6.8. USSR: Relation Between Earnings of Salaried Workers and Wage Earners, 1955-88 (Earnings of wage earners= 100)

Year Industry Construction

1955 146 190 1960 133 143 1970 126 126 1980 109 97 1985 106 93 1988 114 109

Sources: Trud v SSSR (1988), pp. 189, 209; Narkhoz 1988 (1989), p. 77, and Chapman (1990).

200 Table IV.6.9. USSR: Monthly Wages by Industry, First Half 1990 (USSR average wage= 1.00)

1980 1989 1990

Industry ...... 1.10 1.11 1.11 Agriculture ...... 0.88 0.86 0.86 Construction ...... 1.20 1.31 1.26 Transport ...... 1.18 1.17 1.17 Communications ...... 0.86 0.91 0.90 Trade ...... 0.82 0.77 0.85 Information services ...... 0.76 0.92 0.96 Housing & services ...... 0.79 0.78 0.78 Health & social services ...... 0.75 0.69 0.69 Education ...... 0.80 0.78 0.75 Culture ...... 0.66 0.60 0.61 Art ...... 0.80 0.69 0.71 Science ...... 1.06 1.27 1.25 Financial services ...... 0.96 0.94 1.22 Administration ...... 0.94 0.93 1.19 Memorandum item: Average wage in the national economy (rubles per month) ...... 168.9 235.8 256.0

Source: Calculated from data provided by Goskomtrud.

Table IV.6.10. USSR: Monthly Wages by Republic and Branch, 1987 (USSR average wage= 1.00)

Russian Republic Uzbekistan

Republican economy ...... 1.07 0.84 Industry ...... 1.14 0.90 Agriculture ...... 1.08 0.78 Construction ...... 1.34 1.10 Transport ...... 1.29 0.96 Communications ...... 0.92 0.75 fu~ ...... 0.82 0.66 Information services ...... 0.87 0.72 Housing & services ...... 0.80 0.62 Health & social services ...... 0.75 0.67 Education ...... 0.84 0.82 Culture ...... 0.63 0.53 Art ...... 0.79 0.60 Science ...... 1.11 0.97 Financial services ...... 1.05 0.83 Administration ...... 0.99 0.81 Memorandum item: Average monthly wage (rubles) ...... 216.1 169.7

Source: Trud v SSSR ( 1988).

201 Table IV.6.11. USSR: Cooperatives- Employment and Average Wages, January-June 1990

Employees Average Monthly Wage (thousands) (rubles)

Total ...... 5,219.5 367.15 Consumer services ...... 383.4 261.74 Consumer goods ...... 877.1 345.36 Catering ...... 40.1 173.73 Trading ...... 14.1 264.78 Purchasing ...... 41.8 267.15 Supply ...... 3.3 393.94 Reprocessing ...... 85.1 429.30 Construction ...... 2,070.8 416.52 Design ...... 120.3 393.18 Research ...... 298.1 364.42 Agriculture ...... 98.4 206.81 Marketing ...... 311.4 378.56 Transport ...... 51.9 223.51 Medical care ...... 54.3 306.02 Care of sick/elderly ...... 2.4 145.83 Sports ...... 24.2 219.70 Art ...... 61.0 338.80 Leisure ...... 23.4 240.74 Hotels ...... 4.2 261.90 Other ...... 654.2 359.83

Source: Goskomstat.

Table IV.6.12. USSR: Expenditures from Social Consumption Fund and Direct Subsidies, 1988-89 (In billions of rubles)

1988 1989

Total social consumption fund ...... 175.4 Education ...... 44.4 Health care ...... 25.4 Pensions/allowances ...... 73.6 Of which: Pensions 54.9 Housing 11.4 Direct subsidies ...... 86.3 97.6 Meat and meat products ...... 21.7 22.7 Milk and milk products ...... 15.8 17.5

Source: Sot sial" noe razvitie SSSR (1990).

202 Table IV.6.13. USSR: Measures of Income Inequality, China and USSR 1

China ( 1987) USSR (1989) Urban Peasants

Coefficient of variation ...... 0.535 0.614 1.010 Gini coefficient ...... 0.267 0.258 0.285 Atkinson index Parameter = 2.0 0.232 0.216 0.284 Parameter= 5.0 0.554 0.565 0.849

Sources: Estimates for the USSR are based on Goskomstat data. Estimates for China are from Ahmad and Wang, in press. I. Both sets of estimates are based on grouped data on the assumption of linear interpolation of the withingroup distributions. The parameters for the Atkinson index refer to the level of inequality aversion.

Table IV.6.14. USSR: Republican Income Distribution and Poverty Levels, 1989

Households by Per Capita Income Groups Less Greater than rub rub rub than Population rub75 75-100 100-150 150-200 rub 200 (Millions) (Percent of total population)

USSR ...... 286.7 11.1 13.7 31.3 22.1 21.8 RSFSR ...... 147.3 5.0 11.0 31.1 25.1 27.8

Ukraine 0 ••••••• •••••••••••••••••••• 51.5 6.0 14.2 37.2 24.5 18.1 Belorussia ...... 10.2 3.3 10.3 34.1 27.5 24.8 Estonia ...... 1.6 1.9 6.0 24.3 26.4 41.4 Latvia ...... 2.7 2.4 7.4 27.6 27.4 35.2 Lithuania ...... 3.7 2.3 7.1 27.1 27.1 36.4 Moldavia ...... 4.3 11.8 17.9 35.5 20.2 14.6 Georgia ...... 5.4 13.0 16.4 32.1 19.9 18.6 Armenia ...... 3.3 14.7 19.2 35.0 18.7 12.8 Azerbaidzhan ...... 7.1 33.5 20.3 25.8 11.6 8.8

Kazakhstan 0 •••••••••••••••••••••••• 16.5 15.5 17.8 32.0 18.6 16.1 Turkmenistan ...... 3.6 35.0 22.6 26.2 10.1 6.1 Uzbekistan ...... 20.0 43.6 22.7 22.5 7.4 3.8 Tadzhikistan ...... 5.2 51.1 21.8 18.9 5.4 2.8 Kirgizia ...... 4.3 32.8 23.0 27.7 10.6 5.9

Source: Goskomstat.

203 Table IV.6.15. USSR: Distribution of Annual Per Capita Consumption of Major Food Items Ranked by Households According to Monthly Per Capita Income, by Republic, 1989 1

Less than rub rub rub rub rub Average rub 75 75-100 100-125 125-150 150-175 175-200 Meat and Meat Products (kilograms per capita)

USSR 0 •••••••••••••••••••• 65 27 47 58 67 74 82 RSFSR ...... 72 38 53 62 69 76 84 Ukraine ...... 68 43 49 57 64 71 77 Belorussia ...... 86 67 62 74 77 87 90 Estonia ...... 80 56 69 61 74 82 76

Latvia 0 0 ••••••••••••••••• 83 67 58 68 74 73 82 Lithuania ...... 89 63 69 76 79 87 88

Moldavia •• 0 • •••••••••••• 64 38 49 56 65 70 75 Georgia ...... 41 26 34 38 42 49 50 Armenia ...... 43 28 38 43 49 61 63 Azerbaidzhan ...... 36 20 32 37 48 56 58 Kazakhstan ...... 64 33 46 63 68 78 82 Turkmenistan ...... 41 26 35 46 61 71 71 Uzbekistan ...... 32 18 33 43 54 66 71 Tadzhikistan ...... 35 19 31 47 66 72 87 Kirgizia ...... 44 22 40 54 59 75 72

Milk/Dairy Products (kilograms per capita) USSR ...... 367 216 316 352 372 392 417

RSFSR ••• 0 ••••••• 0 •• 0 ••• 389 305 351 358 376 390 419 Ukraine ...... 382 304 314 352 368 393 405 Belorussia ...... 436 352 355 403 396 429 437 Estonia ...... 465 323 433 427 449 433 449

Latvia •••••• 0 •••• •••••••• 492 539 451 462 438 460 478 Lithuania ...... 481 416 431 445 453 440 464 Moldavia ...... 307 185 267 281 298 345 333 Georgia ...... 332 223 280 298 323 356 385 Armenia ...... 460 345 405 477 510 572 603 Azerbaidzhan ...... 404 303 402 446 493 550 550 Kazakhstan ...... 340 221 289 345 344 361 373 Turkmenistan ...... 216 159 197 255 284 325 305

Uzbekistan ••••••••• 0. 0 ••• 206 145 222 263 309 331 403 Tadzhikistan ...... 186 124 195 256 294 319 354 Kirgizia ...... 245 166 243 280 281 342 354

204 Table IV.6.15 (Continued). USSR: Distribution of Annual Per Capita Consumption of Major Food Items Ranked by Households According to Monthly Per Capita Income, by Republic, 1989 1

Less than rub rub rub rub rub Average rub75 75-100 100-125 125-150 150-175 175-200 Eggs (number per capita)

USSR ••••• 0 •••••• 0 •••••••• 221 109 185 216 230 241 249 RSFSR ...... 235 178 218 224 226 232 241 Ukraine ...... 272 196 228 250 262 283 291 Belorussia ...... 250 248 217 234 239 239 263 Estonia ...... 228 157 217 202 211 229 219 Latvia ...... 242 250 211 221 210 219 237 Lithuania ...... 224 205 181 192 209 216 228 Moldavia ...... 243 145 188 212 268 263 264 Georgia ...... 144 101 160 135 138 167 185 Armenia ...... 169 124 143 176 186 198 219 Azerbiaidzhan ...... 184 134 173 206 222 247 272 Kazakhstan ...... 208 92 141 188 202 235 215 Turkmenistan ...... 86 so 70 103 138 152 167 Uzbekistan ...... 97 58 90 128 205 189 212 Tadzhikistan ...... 116 82 lOS ISO 181 201 238 Kirgizia ...... 166 87 138 171 230 292 221

Vegetables (kilograms per capita) USSR ...... 95 72 85 90 93 97 103 RSFSR ...... 90 62 75 82 86 90 97 Ukraine ...... 116 92 98 104 109 117 122 Belorussia ...... 79 58 66 66 71 78 86 Estonia ...... 62 34 58 51 59 61 58 Latvia ...... 76 67 61 63 69 71 70 Lithuania ...... 79 64 69 65 70 72 78 Moldavia ...... 134 89 Ill 117 140 148 lSI Georgia ...... 82 52 71 78 89 98 106 Armenia ...... 116 77 104 117 130 138 141 Azerbaidzhan ...... 76 49 75 83 96 113 124 Kazakhstan ...... 83 44 61 80 83 95 99 Turkmenistan ...... Ill 88 113 135 131 130 140 Uzbekistan ...... 107 80 118 136 133 157 160 Tadzhikistan ...... 104 88 117 117 132 134 !56 Kirgizia ...... 91 61 86 103 116 148 124

205 Table IV.6.15 (Concluded). USSR: Distribution of Annual Per Capita Consumption of Major Food Items Ranked by Households According to Monthly Per Capita Income, by Republic, 1989 1

Less than rub rub rub rub rub Average rub75 75-100 100-125 125-150 150-175 175-200 Potatoes (kilograms per capita)

USSR ••••••••••••••• 0 •••• 0 86 43 77 86 91 94 97

RSFSR •••••• 0 • •••••••••• 93 80 91 91 90 91 95 Ukraine ...... 115 93 Ill Ill 113 115 114 Belorussia ...... 116 108 114 107 104 Ill 120 Estonia ...... 94 72 85 89 93 109 93 Latvia ...... 91 91 83 91 82 91 87 Lithuania ...... 108 96 93 98 105 99 107

Moldavia ••••••••••• 0 •••• 69 55 65 60 69 72 71 Georgia ...... 35 25 32 33 35 39 47

Armenia •••••••••••• 0 •••• 49 33 44 57 55 55 52 Azerbaidzhan ...... 34 24 33 36 40 43 46 Kazakhstan ...... 73 38 54 70 73 84 85 Turkmenistan ...... 32 25 29 35 41 46 45

Uzbekistan ••• 0 ••• 0 ••••••• 33 22 35 42 48 51 55 Tadzhikistan ...... 33 25 32 41 45 52 57

Kirgizia •••• 0 • ••••••••••• 60 39 56 66 72 86 78

Source: Goskomstat. I. For each republic and type of commodity, the average consumption in quantity terms and the mean consumption of those below the poverty line (rub 75 per capita per month) and other income groups.

206 Table IV.6.16. USSR: Regional and Household Specific Price Variations (Rubles per kilogram)

Households with Per Capita Income Less Greater All than than Households rub 75 rub 200 Meat and Meat Products USSR 2.68 3.19 2.66 RSFSR ...... 2.58 2.61 2.62 Ukraine ...... 2.71 2.49 2.91 Belorussia ...... 2.43 2.43 2.71 Estonia ...... 2.44 2.40 2.59 Latvia ...... 2.65 1.98 2.94 Lithuania ...... 2.61 2.25 2.75 Moldavia ...... 2.35 2.18 2.51 Georgia ...... 3.32 3.24 3.68 Armenia ...... 3.13 3.45 2.70 Azerbaidzhan ...... 3.30 3.88 3.55 Kazakhstan ...... 2.49 2.73 2.53 Turkmenistan ...... 3.29 3.59 2.96 Uzbekistan ...... 3.49 4.41 3.15 Tadzhikistan ...... 2.65 3.16 2.76 Kirgizia 2.84 3.42 2.86

Milk/Dairy Products USSR ...... 0.22 0.22 0.23 RSFSR ...... 0.22 0.23 0.23 Ukraine ...... 0.21 0.21 0.23 Belorussia ...... 0.22 0.21 0.23 Estonia ...... 0.23 0.23 0.24 Latvia ...... 0.22 0.20 0.24 Lithuania ...... 0.22 0.21 0.22 Moldavia ...... 0.21 0.21 0.22 Georgia ...... 0.28 0.29 0.34 Armenia ...... 0.22 0.19 0.21 Azerbaidzhan ...... 0.24 0.24 0.26 Kazakhstan ...... 0.20 0.22 0.21 Turkmenistan ...... 0.22 0.21 0.22 Uzbekistan ...... 0.20 0.21 0.23 Tadzhikistan ...... 0.22 0.23 0.26 Kirgizia ...... 0.21 0.21 0.24

207 Table IV.6.16 (Continued). USSR: Regional and Household Specific Price Variations (Rubles per kilogram)

Households with Per Capita Income Less Greater All than than Households rub 75 rub 200 Eggs USSR 0.10 0.10 0.11 RSFSR ...... 0.10 0.10 0.11 Ukraine ...... 0.10 0.10 0.11 Belorussia ...... 0.11 0.11 0.11 Estonia ...... 0.11 0.11 0.11 Latvia ...... 0.11 0.10 0.12 Lithuania ...... 0.11 0.10 0.11 Moldavia ...... 0.10 0.10 0.11 GeJrgia ...... 0.12 0.12 0.13 Armenia ...... 0.13 0.12 0.12 Azerbaidzhan ...... 0.12 0.11 0.13 Kazakhstan ...... 0.09 0.10 0.10 Turkmenistan ...... 0.11 0.11 0.11 Uzbekistan ...... 0.10 0.11 0.11 Tadzhikistan ...... 0.11 0.11 0.14 Kirgizia 0.10 0.11 0.12

Vegetables USSR ...... 0.59 0.47 0.66 RSFSR ...... 0.63 0.53 0.69 Ukraine ...... 0.52 0.42 0.56 Belorussia ...... 0.60 0.45 0.67 Estonia ...... 0.72 0.78 0.72 Luv~ ...... 0.75 0.57 0.83 Lithuania ...... 0.63 0.55 0.67 Moldavia ...... 0.43 0.38 0.46 Georgia ...... 1.05 1.02 1.03 Armenia ...... 0.82 0.78 0.80 Azerbaidzhan ...... 0.81 0.77 0.97 Kazakhstan ...... 0.47 0.42 0.54 Turkmenistan ...... 0.45 0.39 0.59 Uzbekistan ...... 0.43 0.44 0.63 Tadzhikistan ...... 0.44 0.38 0.58 Kirgizia ...... 0.46 0.45 0.51

208 Table IV.6.16 (Concluded). USSR: Regional and Household Specific Price Variations (Rubles per kilogram)

Households with Per Capita Income Less Greater All than than Households rub 75 rub 200 Potatoes USSR 0.25 0.36 0.24 RSFSR ...... 0.22 0.26 0.24 Ukraine ...... 0.23 0.24 0.25 Belorussia ...... 0.17 0.18 0.19 Estonia ...... 0.21 0.18 0.21 Latvia ...... 0.21 0.22 0.23 Lithuania ...... 0.18 0.16 0.19 Moldavia ...... 0.24 0.23 0.26 Georgia ...... 0.68 0.71 0.67 Armenia ...... 0.46 0.49 0.53 Azerbaidzhan ...... 0.83 0.85 1.01 Kazakhstan ...... 0.23 0.29 0.23 Turkmenistan ...... 0.51 0.58 0.56 Uzbekistan ...... 0.48 0.55 0.52 Tadzhikistan ...... 0.47 0.45 0.55 Kirgizia ...... 0.27 0.31 0.28

Source: Goskomstat.

209 Table IV.6.17. USSR: Life Expectancy and Infant Mortality in the USSR and Selected Countries, 1982-86 1

Life Expectancy at Birth Infant Mortality Male Female (Deaths per (in years) thousand live births) OECD average ...... 71.6 78.0 8.42 Australia ...... 72.8 79.1 8.8 Austria ...... 71.5 78.1 9.8 Belgium ...... 70.0 76.8 9.7 Canada ...... 73.0 79.3 7.9 Denmark ...... 71.8 77.6 8.4 Finland ...... 70.5 78.7 5.3 France ...... 72.0 80.3 7.6 Germany, Fed. Rep...... 71.2 77.8 8.3 Greece ...... 73.6 78.3 11.7 Iceland ...... 75.0 80.1 5.4 Ireland ...... 70.1 75.6 7.4 Italy ...... 71.5 78.2 9.6 Japan ...... 75.2 81.4 5.2 Luxembourg ...... 68.9 76.0 9.3 Netherlands ...... 73.1 79.6 6.4 New Zealand ...... 71.2 77.7 9.8 Norway ...... 72.8 79.6 8.4 Portugal ...... 69.7 76.7 14.2 Spain ...... 74.0 80.0 8.7 Sweden ...... 74.2 80.2 6.1 Switzerland ...... 73.6 80.3 6.8 Turkey ...... 60.8 65.5 United Kingdom ...... 71.5 77.4 9.1 United States ...... 71.5 78.3 10.0 East European average ...... 67.2 74.4 17.6 Bulgaria ...... 68.6 74.8 14.7 Czechoslovakia ...... 67.3 74.9 13.4 GDR ...... 69.5 75.4 9.2 Poland ...... 66.7 75.1 17.5 Romania ...... 67.1 72.7 25.6 USSR' ...... 64.2 73.3 25.1

Sources: U.S. Department ofHea1th and Human Services (1989, 1990). I. Life expectancy data for most OECD countries and all data for East European countries are for a selected year between 1982 and 1986. 2. Excludes Turkey. 3. 1987.

210 Table IV.6.18. USSR: Total Pension Expenditures (In thousands of rubles)

1975 1980 1985 1986 1988

State pensions ...... 45,323 50,198 55,728 56,780 58,585 Of which: Old age ...... 29,395 34,007 39,333 40,501 43,164 Disability ...... 6,460 6,349 6,363 6,422 6,495

Loss of breadwinner •• 0 •• 0 ••• 0 •••••••••••• 6,989 7,224 7,169 6,436 5,723

Collective farms ••••••••••••••••••••••• 0 ••••• 11,858 11,135 10,073 9,982 10,432 Of which:

Old age •••••••••••••••••••••••••• 0 ••••• 10,339 9.769 8,926 8,873 9,383

Disability •••••••••••••• 0 • ••••••••••••••• 820 736 645 639 630

Loss of breadwinner 0 • •••••••••••••••••••• 697 630 502 470 419

Source: Sotsial' noe razvitie SSSR (1990).

Table IV.6.19. USSR: Average Pensions (In rubles per month)

State Sector Collective Farms 1975 1980 1985 1987 1988 1975 1980 1985 1987 1988

Average ...... 55.0 63.8 78.7 83.7 86.3 25.1 35.2 47.0 53.1 54.3 Old age ...... 62.7 71.6 87.2 91.7 93.9 25.1 35.2 47.2 53.4 54.5 Workman's disability ...... 49.7 52.7 57.6 59.7 60.8 27.8 34.6 40.6 45.3 46.8 General disability ...... 45.2 53.4 64.4 68.2 70.2 25.2 36.6 48.5 56.3 57.4 Loss of breadwinner ...... 35.9 39.1 46.3 48.0 48.8 25.1 31.3 38.7 41.1 41.9

Source: Sotsial' noe razvitie SSSR (1990).

Table IV .6.20. USSR: Distribution of Pensions, 1987 (In percent)

State Pensions Collective Farms Total Old age Total Old age

Total ...... 100.0 100.0 100.0 100.0 Less than rub 80 ...... 50.4 41.5 92.9 92.8 rub 80-100 ...... 14.9 17.0 3.6 3.6 rub 100-120 ...... 11.3 13.1 1.8 1.8 More than rub 120 ...... 23.4 28.4 1.7 1.8

Source: Sot sial' noe razvitie (1990), p. I 07.

211 Table IV.6.2l. USSR: Persons Above Retirement Age in the 1979 and 1989 Censuses '

1979 1989 Age Age Retirees Working dependency Retirees Working dependency (thousands) (thousands) ratio (thousands) (thousands) ratio

USSR ...... 40,510 151,883 0.267 48,818 158,911 0.307 RSFSR ...... 22,436 82,959 0.270 27,195 83,746 0.325 Ukraine ...... 9,333 28,805 0.324 10,895 28,721 0.379 Belorussia ...... 1,603 5,546 0.289 1,984 5,685 0.349 Uzbekistan ...... 1,308 7,345 0.178 1,583 9,719 0.163 Estonia ...... 282 846 0.333 315 879 0.359

Source: Goskomstat. I. "Retirees" refer to persons above retirement age, which is 55 years for women and 60 years for men. The "working" population refers to the population of legal working age. The dependency ratio does not account for the fact that some "retirees" may be working, and that some persons of legal working age may not be in the labor market.

Table IV.6.22. USSR: Estimates of Wage Funds, Employment and Persons in Need of Help by Republic, 1991 (In percent of USSR total)

Persons in Republic Wage Fund Employment Need of Help

USSR ...... 100.0 100.0 100.0 RSFSR ...... 59.7 54.0 32.4 Ukraine ...... 16.3 18.3 11.4 Belorussia ...... 4.6 3.7 2.2 Estonia ...... 0.7 0.6 0.2 Latvia ...... 1.1 1.0 0.4 Lithuania ...... 1.4 1.4 0.6 Moldavia ...... 1.2 1.5 2.5 Georgia ...... 1.4 1.9 1.9 Armenia ...... 1.1 1.1 2.7 Azerbaidzhan ...... 1.3 2.0 7.3 Kazakhstan ...... 5.1 5.4 8.6 Turkmenistan ...... 0.8 1.1 3.3 Uzbekistan ...... 3.6 5.5 18.1 Tadzhikistan ...... 0.9 1.3 5.5 Kirgizia ...... 0.9 1.2 2.9

Source: Goskomtrud.

212 Table IV.6.23. USSR: Official Projections for the Employment Fund, 1991 (In millions of rubles)

Transfers Redistribution to the of Employment Expenditures Outtum by Central Central Republic Fund 1991 in 1991 Republic Fund Funds (- =shortfall)

USSR ...... 4,734.6 3,839.9 990.0 J,J97 I

RSFSR ...... 2,823.0 1,255.2 1,567.7 705.0 Ukraine ...... 774.0 474.6 299.4 193.0 Belorussia ...... 216.0 92.0 122.7 54.0 Estonia ...... 32.0 12.3 19.7 8.0 Latvia ...... 54.0 16.9 37.1 13.0 Lithuania ...... 68.0 24.3 43.7 17.0 Moldavia ...... 57.8 95.5 -37.7 37.7 Georgia ...... 67.5 76.2 -8.7 8.7 Armenia ...... 50.5 100.8 -50.3 50.3 Azerbaidzhan ...... 60.8 269.1 -209.3 208.3 Kazakhstan ...... 242.0 319.1 -77.1 77.1 Turkmenistan ...... 36.5 121.0 -84.5 84.5 Uzbekistan ...... 171.0 671.3 -500.3 500.3 Tadzhikistan ...... 40.3 201.4 -161.1 161.1 Kirgizia ...... 41.2 110.2 -69.0 69.0

Source: Goskomtrud. I. Shortfall made up from union budget.

Table IV .6.24. USSR: Persons with Secondary and Higher Education, 1970-89 (Share of employed labor force)

Completed Completed Completed Incomplete Secondary Secondary Incomplete Higher Higher General Vocational Secondary Total Education Education Education Education Education

1970 ...... 65.3 6.5 58.8 1979 ...... 80.5 10.0 1.1 27.6 15.6 26.2 1989 ...... 92.1 14.3 1.3 37.1 23.3 16.1

Source: Goskomstat, based on census data.

213 Table IV.6.25. USSR: Transition from "Incomplete Secondary Education," 1970-89 (In millions of persons)

1970 1980 1989

"Incomplete secondary" output ...... 4.3 4.1 4.2 Proceeded to: General secondary ...... 2.6 2.6 2.5 Daytime PTUs ...... 0.1 0.8 0.8 Daytime SSUZs ...... 0.5 0.4 0.5 Labor force ...... 1.1 0.3 0.5

Source: Goskomstat.

Table 6.26. USSR: Transition from "Complete Secondary Education," 1970-89 (In millions of persons)

1970 1980 1989

"Complete secondary" output ...... 2.0 2.7 2.2 Proceeded to: Higher education ...... 0.3 0.4 0.4 Daytime PTUs ...... 0.2 0.6 0.4 Daytime SSUZs ...... 0.3 0.4 0.4 Labor force ...... 1.3 1.3 1.1

Source: Goskomstat.

214 Chart 1. USSR :TRENDS IN WORKING AGE POPULATION1 AND LABOR FORCE (Average annual growth rate)

% % 2.0 Ill 1959·70 2.0 1.8 D 1970·79 1.8 1.6 D 1979·89 1.6 1.4 1.4 1.2 1.2 1.0 1.0 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 1...... 1----1-.l.~.....J.----J 0.0 Working-age population Total labor force

Source: Data from the 1959, 1970 and 1979 Censuses are from M. Feshbach (1983). Data from the 1989 Census were supplied by Goskomtrud.

1. Men: 16-59; Women: 16-54.

215 Chart 2. STANDARDISED LABOR FORCE PARTICIPATION RATES1 1988

Total 80

60

40

20

0 USSR2 us Japan Germany France Italy U.K. Canada

100 Men

80

60

40

20

0 2 USSR us Japan Germany France Italy U.K. Canada

80

60

40

20

0 USSR 2 us Japan Germany France Italy U.K. Canada

Source: Goskomtrud; OECD (1990a).

1. Total labor force divided by the population aged 15 to 64. 2. 1989.

216 Chart 3. SEPARATION RATE IN MANUFACTURING1

50

45

40

35

30

25

20

15

10

5

0 USSR us Japan France Italy U.K. Sweden Netherlands (1989) (1981) (1984) (1984) (1982) (1984) (1984) (1985)

Source: Goskomtrud; OECD (1986); J.C. van Ouvs (1990). 1. Number of separations per 100 employees.

217 Chart 4. USSR: NUMBER OF STUDENTS INVOLVED IN EDUCATION, TRAINING AND RETRAINING (in millions)

50 Daytime General Education ------+-- Upgrading and Retraining ...... General (night and correspondence) 45 Secondary Vocational (PTU)

-e-- Specialized Technical Secondary (SSUZ)

40

30

25

20

15

5 •••••••••••••• .:.. _.•..a..r;-- ·····:...... ------·· .. ~~~~-~-----J~~ ----- .. . 0 1940 1950 1960 1970 1980 1990

Source: Education and Culture in the USSR: Statistical Compendium (1989).

218 Appendix IV.6-l

Experience With Incomes Policies In Other Selected Countries

1. LESSONS FROM INCOMES POLICIES IN OECD COUNTRIES Incomes policies were very prominent in many OECD countries in the late 1960s and early 1970s. They were viewed as a means to contain wage pressures in an environment of creeping inflation, stop-go cycles in demand management and a rising tide of worker militancy. It was also a period of full employment and a rapid spread of generous welfare provisions. With the onset of the world reces­ sion following the first oil price shock, the concern of governments shifted from inflation to unemployment. Incomes policies were now predominantly viewed as a possible means to reduce high wage costs, which were regarded as discouraging job creation. During the 1980s, the policy emphasis shifted to structural reforms of labor markets, their deregulation and improved flexibility. These micro­ economic reforms came to be viewed as a more effective approach to ensuring that labor markets, including the wage formation process, contributed to non-in­ flationary and job-creating economic growth. The most extreme and interventionist form of an incomes policy is a statutory one. In this case the government or the legislator fixes a certain wage target, such as a total wage freeze, over a specified period of time. Wage settlements above this target are unlawful. It is generally felt that statutory incomes policies are not compatible with industrialized market economies because they run counter to the principle of free collective bargaining between organized labor and management. Only under exceptional circumstances, such as war conditions or abrupt changes in the economic environment, can statutory incomes policies on a temporary basis be justified in free societies. They were nevertheless tried occasionally, with the result that typically stabilization gains achieved during the freeze were reversed by efforts to catch up once the period of restraint had ended-unless there had been a marked weakening of labor market pressures during the freeze. "Voluntary" incomes policy has been tested more widely as governments have sought ways to influence collective bargaining outcomes indirectly and with

219 the consent of the parties involved. One such option was simply to announce "wage guidelines" and to use "moral suasion" to convince negotiators to stick to them. However, workers and. their representatives who accepted the guidelines became quickly frustrated when others behaved less responsibly or when they discovered that non-wage incomes, such as profits or transfer incomes, had in­ creased more rapidly than wages. One important lesson learned from early experiences with wage guidelines was that it is essential to ensure that the burden of a stabilization program is shared in a just and equitable way between the various groups of income earners. How­ ever, "equality of sacrifice" means different things to different people. Should low and high wage earners forego the same amount of income? If so, should it be measured in absolute terms or in percentage terms? The general view-strongly pushed by the trade union movement-was that low-wage earners should be less severely affected by wage restraint. Most stabilization policies therefore contained a significant redistributional element. Another significant development was the attempt to link wage outcomes explicitly with fiscal measures. One variant was a wage/tax bargain where a decrease in tax rates was partially substituted for an increase in wages. Another similar version was a wage/expenditure bargain which substituted an increase in "social income" arising from government expenditure for wage income. Also widely discussed, but never implemented in a single OECD country, were so­ called tax-based incomes policies (TIP). The general idea behind TIP was to impose tax penalties on employers who exceeded wage guidelines and, in some versions, to grant tax rewards or rebates for those who undercut them. The proponents of TIP suggested that if the policy were designed to relate not to individual but to total wage bills, employers could still have scope to vary dif­ ferentials within a prescribed increase in overall wages. This would permit some wage flexibility which is usually not possible under other forms of incomes policy. A crucial question became how to implement a consensus-based incomes policy. Since the idea was to preserve free collective bargaining, a subtle policy machinery was needed. Since industrial relations systems vary among OECD countries, it is not possible to point to a standard approach. The common feature, however, was the need to base the policy, not on enforcement, but on consensus between governments and the social partners. Typical approaches attempted in various OECD countries consisted of social contracts, concerted action, tripartite bargaining, and similar devices. In this context it is often difficult to draw a borderline between "corporatist" arrangements and institutional links between governments and the social partners, on the one hand, and the pursuit of an in­ comes policy on the other. A typical example of a "corporatist" approach is Austria, which will be discussed below. These consensus-based attempts worked somewhat better than statutory in­ comes policies and voluntary wage guidelines. But in general, and judging

220 retrospectively, it can be said that they mostly worked in countries which had a good industrial relations climate, centralized bargaining structures and strong union and business leadership. A general problem which all forms of incomes policies seem to encounter is that, with the passage of time, powerful forces start to work against them. These include conflicts and competition between trade unions, and within trade unions between leadership and membership; efforts of some groups to re-establish wage differentials; and decentralized bargaining struc­ tures resulting in leads and lags of wage settlements and subsequent attempts to "catch up" on previous settlements. Most importantly, it is clear that any effective incomes policy cannot impose outcomes unduly at variance with market condi­ tions and therefore has to be pursued in conjunction with appropriate demand management policies.

2. INDIVIDUAL COUNTRY EXPERIENCE A tax-based incomes policy has been pursued in Poland since the early 1980s, and it formed one of the cornerstones of the stabilization program put in place at the beginning of 1990. Attempts to limit "excessive" wage increases in the 1980s, through making enterprises liable to a progressive tax on wage growth in excess of govern­ ment established norms, were not successful, mainly because of widespread exemp­ tions from the tax. Indeed, this experience clearly shows the difficulties in implementing a tax-based wage policy in an environment in which enterprises are lacking a hard budget constraint. The incomes policy pursued after January 1, 1990 generally avoided exemption for specific sectors or enterprises. Increases in average wages or the wage bill beyond a certain norm were subject to progressive taxes, the top marginal tax being 500 percent on wage increases in excess of 3 percent over the norm. The norm was determined every month as a percentage of the increase in consumer prices, and unused permissible wage increases could be carried forward. The norms applied in 1990 implied a sharp fall in real wages, as well as a marked slowdown of the rate of increase in nominal wages. Developments in the first half of 1990 were consistent with these objectives, but this does not necessarily reflect the effectiveness of the incomes policy measures: an abrupt easing of the labor market with the unemployment rate rising from virtually zero to over 8 percent should have generated disinflation on its own. Indeed, in the first half of 1990 wage increases were below the norms established by the Government, suggesting that demand defla­ tion had rendered the incomes policy measures superfluous. However, in spite of the unused scope for wage increases gained in the ftrst half-year, wage increases ex­ ceeded the norm in the second half-year. During the early 1980s, the growth of enterprise wage funds in Hungary was linked to indicators of economic performance. Apart from encouraging produc­ tivity gains, this policy was aimed at containing inflationary wage pressures. The economic performance of firms was assessed relative to output targets, that of workers in terms of time standards. Experience with these wage regulations was

221 rather disappointing, partly because of flaws in the indicators and partly due to firms using bonus funds to evade restraints on the growth of their wage bills. In conjunction with the abolition of direct controls on wage funds in the mid-l980s, the authorities introduced a tax-based incomes policy to contain the rise in nominal wages. Taxes were levied on profits if the growth of the wage bill exceeded a productivity related ceiling. In 1989, wages were further liberalized, but taxes on "excessive" wage increases were strengthened. Under the new regime, the dif­ ference between the rate of growth of wages and value-added became subject to a 50 percent profits tax (adjusted in 1990 to 35-40 percent, depending on the size of enterprises). So far, the policy has not been very successful as enterprises have resorted increasingly to non-cash forms of remuneration of employees. Government intervention in wage determination in Yugoslavia was frequent in the 1980s, but it failed to moderate wage trends or inflation. Successive stabilization packages over the decade generally included a mixture of price and wage controls, with wage controls assuming a greater role over time. Common to all the wage regulation measures was that an abolition of controls was followed by a step increase in wages to restore real incomes, and such increases were accommodated by the banking system. The 1990 stabilization program differed from its predecessors in that most prices were exempt from controls, while no nominal wage increases were allowed for the first six months of the year unless the Government departed from its commitment to keep the dinar/deutsche mark exchange rate fixed. Real wages fell sharply in the first half of the year, but the abolition of wage controls was accompanied by a step increase in wages which, however, was less than on similar occasions in the past. This can be attributed mainly to policy-induced demand compression in the economy which worsened the labor market situation and moderated price increases, as well as a continued commitment of the authorities to maintain a fixed exchange rate between the dinar and the deutsche mark. The relative failure of the incomes policy was due to the fact that a new framework to set wage increases had not been established. A key condition for the success of incomes policy would seem to be the reform of the self-management system. Incomes policy has traditionally played an important role in economic management in Norway. The authorities have sought to facilitate discussion among the social partners by creating permanent institutions, where the social partners could come to an agreed view on the state of the economy and its likely evolution. This institutional setting would seem to have contributed both to keep­ ing the equilibrium rate of unemployment low as compared with other countries, and to enhancing the responsiveness of wages to changes in unemployment. In the 1970s, the authorities repeatedly offered a broad range of measures; such as increased public spending and tax benefits, in exchange for moderate wage set­ tlements. This form of tripartite bargaining was abandoned as it yielded disap­ pointing results, generally adding fiscal stimulus to an already overheated economy. Faced with acute imbalances in the economy and the need to prevent a

222 wage-wage spiral, the authorities put statutory limitations on wage increases in 1988 and 1989, effectively imposing on all labor market participants the moderate wage agreements between the main social partners. The period of statutory wage limitations was accompanied by a sharp easing of wage increases. However, as unemployment was growing very fast at the same time, it is uncertain what inde­ pendent role incomes policy played in the disinflation. It is likely that the policy brought about the disinflation more rapidly than otherwise. Incomes policy is widely regarded as having played a crucial role in Spain in its transition to a modern market economy. Against the background of a disor­ derly labor market in the mid-1970s, in which real wages and unemployment rose in tandem, the authorities issued wage guidelines to stabilize the purchasing power of wages in the context of slower wage increases. The guidelines were only in­ dicative for the private sector, but were backed-up by threats of more restrictive policies if they were not adhered to. This intervention paved the way for a national agreement between the social partners and facilitated the development of a modern industrial relations system. In conjunction with measures to deregulate the labor market, the Government continued to issue wage guidelines in the 1980s to en­ courage wage disinflation. It also entered into direct negotiations with the social partners, offering commitments to substantial job creation and comprehensive changes in labor and social policy in exchange for wage moderation. The incomes policy in the first half of the 1980s is judged to have assisted the deceleration of price increases during this period. However, wage guidelines have not succeeded in moderating wage increases more recently. This is partly because the Govern­ ment has failed in its aim to create a permanent institutional framework for the pursuit of incomes policy, but it also reflects the difficulty of moderating wage increases in a booming economy. The Austrian system of "social partnership" grew out of a long history of strong unionism and in response to controversial relationships between trade unions, employers and the Government during the inter-War period. Since the early 1950s, trade unions and employers' organizations have been involved in virtually all aspects of economic policy. The Government consults regularly the leaders of these organizations, many decisions on economic policies are made in tripartite bodies, and the social partners are represented and play a leading role on the board of the central bank. There are regular gatherings on economic re­ search and forecasting issues with the view to developing a common perspective on the state of the Austrian economy and its likely evolution. Collective bargain­ ing is carried out by individual trade unions, not by the Confederation of Austrian Unions. However, even without issuing official wage guidelines, the Confedera­ tion has a considerable influence through discussions with negotiators which take place prior to the start of the negotiations. Formally, negotiations cannot take place without the consent of a Social Partnership Commission ("Paritatische Kommis­ sion"). This strengthens the position of the Confederation vis-a-vis the individual unions. Since the late 1970s, Austria has followed a hard currency policy by

223 pegging the schilling to the deutsche mark. This has kept the rate of inflation down due to the imposition of a severe budget constraint on export and import compet­ ing firms. This policy is strongly supported by the union movement. To satisfy the external constraint imposed by this policy without impinging on domestic employment, wage moderation is required-an argument widely used by the union leadership and accepted by the membership. This internalization by labor of the discipline involved in the maintenance of a hard currency has been a key factor in shaping the wage setting environment in Austria during the 1980s. The Italian Government regularly intervened in wage determination during the 1980s with a view to dampening wage increases. Indicative wage guidelines in 1981, which were accepted by the social partners, were accompanied by a deceleration in wage growth. These were followed by a tripartite agreement in 1983, with the Government promising, inter alia, changes in tax 'policy in ex­ change for wage restraints, both in the form of moderate increases in negotiated wages and changes in the wage indexation mechanism. With continuing erosion of international competitiveness, the authorities requested further limitations in the coverage of indexation and imposed this by decree when the main union federa­ tions failed to agree among themselves on the issue. The decree was later sup­ ported in a national referendum in 1985, and the automaticity of the wage indexation mechanism was further weakened subsequently. While not changing the indexation process fundamentally, these modifications are generally con­ sidered to have assisted disinflation. However, the main factors behind the disin­ flation in Italy have been the stance of macroeconomic policy and, in particular, the commitment to a stable exchange rate within the EMS. Australia has a comprehensive and complex system of minimum wages dif­ ferentiated by occupation and industry, in some ways similar to the Soviet system of tariff wages. Since 1983 an accord between the (sole) central union federation and the Government has drawn on the centralized arbitration procedures which govern this system to implement an anti-inflationary incomes policy. The access of individual unions to centrally determined wage increases has been made de­ pendent on their commitment to making "no extra claims" at a sectoral level. The central agreements were initially based on indexation for price increases, but since 1985 have increasingly used reductions in direct taxation as a complementary means of compensation for increases in prices. These policies have resulted in reductions in real wage costs of the order of one percent per annum, and this has contributed to Australia having enjoyed one of the highest rates of employment growth in the OECD area. However, the contraction in real wages has taken place in an environment of high nominal wage growth, spurred, inter alia, by exchange rate movements and buoyant aggregate demand. Recently, the central decisions have sought to improve labor market functioning by requiring the amalgamation of previously segregated skill classifications, the removal of age limits on training access, and the elimination of inhibitions on labor market flexibility, such as constraints on part-time employment.

224 Chapter IV.7

Legal Reform

1. INTRODUCTION The speed and depth of the legal changes in the USSR have increased dras­ tically in the past year. The changes now occurring involve the fundamental prin­ ciples on which Soviet legal regulation is based. In many areas of the law, change is at its earliest stages, having proceeded no further than the issuance of a new set of basic legal principles on which further legislation and regulations are to be based. Continuing debate over political issues and the proper overall direction of reform has sidetracked the process of elaboration of subordinate legislation and regulations, and there is often little or no enforcement history or authoritative interpretation of new laws. Thus, the current state of the law in many areas is extremely uncertain. This chapter briefly discusses a number of the areas of Soviet law which are basic to the reform process. Section 2 covers issues of authority to legislate and regulate, including issues of federal structure, separation of powers, and local capacity. Section 3 discusses those elements of the legal structure which form the basic framework of a market economy: property rights, the ability to transfer those rights, and the enforcement of the law. Section 4 discusses basic regulation of the business sector: business forms, privatization issues, and antitrust legislation. Sec­ tion 5 contains comments on a number of sectoral or specific matters including banking and finance problems encountered by new businesses, foreign invest­ ments, agricultural land use, regulation of the housing market, taxation, environ­ mental regulation, and institutional capacities to implement reforms. A summary is presented in section 6.

2. STATE AUTHORITY AND THE LEGAL REGULATION OF THE ECONOMY a. Introduction The most serious legal problem currently facing the Soviet economic reform effort does not concern any particular piece or pieces of legislation but rather the

225 lack of clarity and uniformity with respect to the substantive law governing economic matters and the standards and means for its implementation. At the time of this writing, the problem of lack of clarity and uniformity exists at all levels of government and involves uncertainty concerning the location of authority to legislate and to implement the laws, the nature and extent of the legislative and executive powers, and the appropriate means and methods for enforcement. The presidential guidelines identify lack of respect for the law as a primary cause of the current economic crisis, but under existing conditions, even those who strongly desire to follow faithfully the applicable law may be unable to ascertain what law is applicable and what must be done (or may be demanded by implementing authorities) in order to fulfill its requirements. Because the current uncertainty with respect to the structures of state power is comprehensive, extending not only to legislative, administrative, and executive structures, but to judicial powers as well, no stable resolution of such uncertainties is available from judicial bodies. Unless a significant amount of this uncertainty with respect to state authority is resolved and some clarity is achieved concerning which national, state and local bodies have the authority to define, administer, and enforce economic rights and obligations, no reform program, regardless of its content or emphasis, is likely to be successful. The extreme levels of uncertainty with respect to the applicable law and its implementation which currently exist in the USSR result from a combination of problems. The primary and most publicized source of uncertainty is the current conflict between the union government and various subordinate territorial govern­ ments concerning the proper relationship between and among the constituent parts of the union. This is a fundamental conflict concerning the most basic questions of political and economic relations among nationality groups and territorial units and some resolution of the conflict, even if temporary or subject to gradual evolu­ tion, is clearly required before anything in the nature of economic reform programs can be devised and implemented. The problem of uncertainty concerning state authority is not, however, simp­ ly a problem of uncertain political relationships. The traditional Soviet legal theory envisions a unified state power-organic in nature and indivisible-and the struc­ tures of Soviet state authority formed according to this theory are indeed very integrated and overlapping. While most legislators and legal scholars now accept the idea of a need for a "separation of powers," only the first steps toward defining and implementing such separation have been made and the continuing lack of clear boundaries between the powers of various bodies may give rise to substantial uncertainties even in the absence of serious political turmoil. In addition to problems of distribution of power and of legal competence, technical and organizational problems also contribute to legal uncertainty and particularly to lack of uniformity in implementation. The traditional modes of economic regulation in the USSR did not place large amounts of economic respon-

226 sibility in the hands of local bodies of state power. As political power and respon­ sibility for economic regulation are decentralized (whether this occurs as a result of political breakdown of the union or by way of a planned political and economic reform), increasing amounts of responsibility for economic regulation and enfor­ cement will fall into the province of local bodies that do not have institutional structures designed to fulfill these functions and may not have the training, per­ sonnel, or experience to adequately interpret, refine and enforce economic law. Under these conditions, laws and regulations that must be interpreted, or simply implemented and enforced, at the local level are likely to be interpreted, imple­ mented, and enforced in an inconsistent fashion. b. Soviet federalism and issues of territorial power

(1) Soviet state structure The structure of Soviet territorial-administrative divisions is quite complex and somewhat reminiscent of a matryoshka-a traditional Russian nesting doll which contains within itself many smaller dolls. The territory of the USSR is divided among fifteen Soviet Socialist Republics (sometimes referred to as SSRs or "union republics"). Union republics have long been referred to as "sovereign" and have had a constitutional right to secede since the first union constitution in 1924. 1 Union republican bodies are immediately below the all-union level bodies in the Soviet state authority structure and there are a variety of legislative and regulatory tasks which are solely the province of the union republics. A union republic may contain one or more autonomous republics. Autonomous republics (ASSRs) are territorial units based, like union republics, on a fairly populous nationality group. Autonomous republics were not created as union republics either because they are located in the center of the country (making secession a problem) or were based on a somewhat smaller population group existing within the territory of a larger one, or both. Although the autonomous republic is subordinate to the union republic, its structure of govern­ ment may be nearly identical to the union republic level structure and it maintains its own constitution and a significant amount of independence. The autonomous republic is created at the all-union level and, once created, its territory may not be altered without its consent. A union republic may determine its own division into lower level units of territorial administration, with the exception of the creation and alteration of autonomous republics. These generally include one or more oblasts (regions)-a purely geographical unit of territorial administration without basis in nationality characteristics of the population. They may also include a territorial division called a kray (territory)-usually a large territory which is not itself based on nationality, but which contains within its area a lesser unit of territorial administration based on a nationality group. Beneath the level of the kray, autonomous oblasts or

227 autonomous okrugs (districts) (sometimes referred to as national okrugs) may be formed-both of which divisions are based upon particular nationality groups. Autonomous okrugs may also be formed within an oblast.2 Large cities are often separated out from the larger territorial unit in which they are located and form their own territorial administrative unit. At the lowest level of administration is the rayon (town), which is a small, geographically based division of a city (some­ what like a ward or borough) or of a suburban or rural area (somewhat like a county or township). Territorial divisions which are based on nationality group have representation in the USSR Soviet of Nationalities, one of the houses of the bicameral national legislature, and are therefore accorded constitutional recognition at both the union and union republican levels, although the functions and powers of formations below the level of autonomous republic are not constitutionally defined.3 Ter­ ritorial units which are not based on nationality group do not have specific rep­ resentation in the national legislature or constitutional status but may nonetheless have substantial significance in administrative and state affairs. Lower level territorial units are subordinated to the relevant state bodies at higher levels, but the precise nature of the division of competencies between levels is poorly defined. Local bodies of power have, according to traditional Soviet legal theory, the power to resolve all questions of local significance and to do so inde­ pendently. However, they can do so only to the extent that the relevant power is not exclusively granted to another body and to the extent that the lower bodies follow the guidelines and decisions of those above them. Traditionally, most im­ portant decisions concerning economic policy, infrastructure investment, and even industrial plan operations have been made at fairly high levels of the state structure or through the centralized planning system, leaving the localities with a very limited sphere of independent action with respect to economic matters.

(2) Deterioration of the federal structure In the past year, many of the union republics as well as some autonomous republics, regions, cities, and even urban districts have become increasingly in­ sistent on being granted more effective control over local matters than they have had in the past. A significant number of the larger formations have issued decla­ rations on political and/or economic sovereignty which proclaim that laws and regulations issued by higher bodies shall be effective on the territory of the declar­ ing lower level formation only after the supreme state bodies of that formation confirm them. The validity of this formulation of local sovereignty has been rejected repeatedly by the union government. These rejections have, in general, not caused the republics and localities to rescind their declarations, although many have avoided taking actions that would cause an immediate confrontation. New legislation on the issue was recently passed by the Supreme Soviet of the USSR, once again declaring union law to be supreme in all areas of union jurisdiction

228 and purporting to invalidate republican acts which contradict union law in those areas. The ability of the union to enforce this legislation over republican objection is in doubt, however, and a declaration on RSFSR sovereignty was passed almost concurrently, giving the RSFSR Council of Ministers and RSFSR Supreme Soviet the right to suspend union enactments which are believed to violate the sovereignty of the RSFSR, as well as other powers.

(3) The future shape andform of the union There appears to be a broad general agreement that a new definition of the relationship between the union government and various constituent parts of the union, especially the republics, is needed. The need to reconsider the relationship is not only a result of the current strife, but also a natural outgrowth of the process of political and legal change that has occurred over the past several years and the resulting need to prepare a new Constitution of the USSR. While there is also broad general agreement that the new arrangement should include greater effective sovereignty at local levels, especially with respect to economic and environmental matters, there remains fundamental disagreement about the proper form of any agreement between and among the republics and the central government, and the proper division of powers between the union and its constituent parts. One proposal for a means of redefinition of federal relationships involves the creation of a new "union treaty." Such a treaty would be concluded among the various union republics and would redefine the relationships among them and the nature of the federal power within the union. The treaty would then be included as a fundamental part of the new Constitution of the USSR. 4 A substantial amount of effort is being directed toward the resolution of the problem by this means, and a variety of committees at the union and republican levels have produced numerous draft texts of the treaty. 5 However, while the discussion of the redefini­ tion of Soviet federalism goes on in the context of widespread expectation that some form of a "union treaty" will, in fact, be concluded, there appear to be significant numbers of dissenters who feel that another form of resolution is preferable. Opinions on the matter vary across a broad spectrum, ranging from those who seek complete sovereignty and political independence for the republics and dissolution of the union government, to those who feel that the matter can be resolved by fairly simple constitutional amendment. Prior to the issuance of the presidential guidelines, the Ministry of Justice of the USSR indicated its desire to see a union government with supremacy in a variety of specifically defined areas of law and regulation. The areas chosen were those in which the Ministry believes some substantial degree of consistency and uniformity are required for the creation and maintenance of an all-union market economy. In the Ministry's view, these include laws on: currency and the monetary system, basic federal banking regulation, issuance of and trade in various kinds of securities, an antimonopolies system, general principles of civil

229 law (i.e. contract, property rights, etc), definition of union rights and obligations with respect to infrastructure and emergency services, basic union-level rights for consumers, regulation of foreign economic relations, basic labor regulation, the means by which state requirements are to be met (i.e., a state contracting system), and the means by which prices are to be formed and price controls gradually eliminated. Although the Ministry itself saw this "wish list" as eminently restrained and reasonable, Ministry representatives made it clear that they were uncertain which, if any, of these powers would actually be retained by the central government. Ministry representatives favored a union treaty as a means of resolving the issue of federal power and union relationships and providing the union with the powers it needs to maintain the all-union market, but expressed concern about the current willingness of some republics to enter into such a treaty. The type of union desired was described as similar to the European Community, but somewhat more tightly knit. This would suggest a union which could also conceivably be formed by means of an economic agreement that would not require a federal government, as such, or a union-level constitution. The Ministry proposal generally avoided discussion of the fate of existing union-level political bodies, concentrating instead on the need for legal uniformity on particular economic issues. Discussions with Ministry representatives on the subject of judicial bodies, however, suggested that the Ministry's model assumed a federal apparatus with considerable power. The presidential guidelines appear to advocate the maintenance of a relatively strong union, with a substantial amount of power remaining in the hands of central bodies. The precise nature and concept of the union, however, is somewhat dif­ ficult to determine. The guidelines themselves do not discuss the powers of the union and union republics in terms of division of legislative authority, but refer instead to a variety of specific areas in which an all-union administrative body should be created because the activity requires uniform management at the union­ wide level. If it is assumed that a call for an all-union administration in a particular area indicates an intention to create union-level supremacy on the named issues, the guidelines appear to agree in large part with the list of desirable union powers discussed by the USSR Ministry of Justice. Basic monetary, banking and foreign exchange regulation, foreign economic relations, external customs, emergency response system, union-level infrastructure (i.e., transportation, communications, fuel and energy, etc.), antimonopoly policy, consumer protection, and certain kinds of price regulation are all to be placed in the hands of union-level bodies according to the guidelines. There are also, however, some notable differences between the apparent dic­ tates of the guidelines and the Ministry's list. In one important example, the guidelines state that the republics shall regulate, through legislation, the posses­ sion, use, and disposition of all of the national wealth located on their territories. This may indicate an intent to create not only republican freedom to control the

230 use of republican resources, but also republican freedom to define ownership and contract rights within the republic's territory. Should this be the case, the defini­ tion of ownership and the standards for establishing and maintaining it might well differ across republican borders, creating confusion and difficulty in cross­ republic transactions and hindering the functioning of a union-wide market. No other mention is made of the level at which basic civil law matters (e.g., contract) will be controlled, and the guidelines also omit mention of the locus of control for securities regulation and definition of business forms-matters the Ministry would have placed under all-union regulation. In the guidelines, union involvement in price setting appears to involve more direct union regulation of the price of particular products, rather than the regula­ tion of the process for price formation and the process of price de-control, as envisioned by the Ministry. However, the guidelines suggest that the products for which the union may set prices are to be determined by agreement among the republics, giving the republics a power to control union-level involvement that did not appear to be envisioned by the Ministry and perhaps effectively denying the union the ability to set any prices at all.6 The guidelines do envision a union­ wide minimum wage scale which would be obligatory for the republics.

The guidelines also mention several additional areas for all-union administra­ tion not discussed by the Ministry. Defense programs and the conduct of major scientific and technological development programs are mentioned, as well as space systems and research, the development of single accounting standards, col­ lection and organization of statistics, and the maintenance of patent, weights and measures and meteorological forecasting systems. The guidelines also mention the setting of union standards and the adoption of international standards as activities to be undertaken by the union-level bodies, although they fail to provide detail concerning the types and purposes of such standards.

With respect to the means by which the union is to be formed and maintained, the guidelines are not entirely clear. The guidelines state that the sovereign republics shall enter the union voluntarily and on the basis of their mutual interest, and further specify that powers delegated to the union may not be changed without the consent of the republics and that republics shall be economically liable for violations of their accepted obligations. The guidelines do not, however, specify the means by which the republics will enter into the arrangement or the legal form of the union, nor do they give any indication of the means by which the republics must agree to change the delegation of powers to the union, the ability of republics to withdraw from the union, or the means by which a republic is to be held economically accountable for failing to fulfill its obligations to the union. There is no specific mention of a union treaty, and while the union described could be formed by that means, the language could also be taken to simply refer to the terms which should be included in the new version of the constitution.

231 Both the Ministry's presentation of its conclusions concerning union power and the treatment of the same issues in the guidelines are excellent illustrations of the current tenor of the debate. The Ministry's list included no powers which were not directly related to the economy, and no discussion of the means by which the relevant union powers were to be enforced. The absence of such matters is even more stark in the guidelines. In discussing the union, the guidelines state that the republics will voluntarily enter the union for the purpose of forming a single economic territory, carrying out mutually beneficial economic relations and coor­ dinated economic policies, and defending the market. There is a nearly complete absence in the document of discussion of the mechanisms by which union-level law and regulation should be generated or enforced and the political, administra­ tive and other structures that would be required. Discussions with the Ministry would indicate an assumption that union-level bodies of power would remain essentially the same, with some redefinition of powers and jurisdiction. Similarly, the guidelines mention that an Inter-Republic Economic Committee will be established under the USSR Council of the Federa­ tion, indicating that existing political/legislative structures are to continue to remain in place. The exclusive focus on economic needs and stark omission of related political and institutional issues which is occurring in union-level discus­ sions of federal structure and legislative power is an indication of the climate in which these issues must be resolved. The center appears at present to be forced to conduct its argument for continued union largely in terms of economic neces­ sity, as there appears to be little or no public support at this time for the argument that political or social unity is in and of itself a desirable goal. This complicates discussion of economic matters, as the center and republics argue in terms of the economic necessity of particular arrangements, but fail to address directly the assumptions that may be made concerning associated institutional and political structures, thus making economic efficiency arguments the proxy for other politi­ cal issues. Republican views on the preferable future shape of the union vary consider­ ably, ranging from the Lithuanian declaration of complete political and economic independence to the views of conservative members of the Russian Republic parliament that the union must be maintained in roughly its present fomt. Other views tend to recognize the need for substantial economic integration and the desirability of burden sharing via common defense arrangements and infrastruc­ ture. Many also accept as desirable or unavoidable the existence of a union-level administrative structure of some kind which would administer policy and programs which are coordinated at the union level. The terms on which such a union would be entered, the powers to be given to the union-level structure, and the means by which the union structure would be funded and maintain its powers, however, are matters of substantial disagreement among republics, and among groups within republics.

232 Recently, the idea has arisen within some groups that not even a union treaty is required: instead, some argue for the adoption of some form of cooperation agreement, to be concluded between republics that are considered to be sovereign states on the international level. One concept that is apparently being discussed is a union based on the voluntary and freely revocable gift of powers to the center by various union republics. Under this model the union republics would be free to transfer to the center whatever powers each thought appropriate, but there would be no necessary correspondence or relationship between the powers given to the union by one republic and those given to it by any other. The union would be given only enough funds by the various republics to perform those functions appointed to it and would serve as a variety of hired agent for the republics, performing military, diplomatic and other services on a fee-paid basis.

With respect to the intentions of other territorial units, a substantial number of the union and autonomous republics have made clear statements that they intend to achieve some form of sovereignty and delineation of their powers from those of the USSR.7 It is not at all clear that such republics would be unwilling to take part in an economic union arrangement similar to that described in the guidelines, so long as such participation was based on an initial recognition of the republics as sovereign states and the maintenance of options for free exit from the union. As an example, the Ukrainian Republic recently passed a comprehensive declaration of sovereignty and an additional declaration on economic sovereignty, declaring its intent to establish complete political and economic independence with the establishment of customs borders and, if necessary, the creation of a separate currency. Yet, Ukrainian officials also expressed an ardent desire for a strong economic union with at least some of the other republics.

(4) Conclusions and recommendations

The resolution of these issues of territorial and national sovereignty is fun­ damentally a political matter that must be resolved among the parties involved. Some resolution, however, even if subject to evolution, must be achieved before there can be a successful economic reform which preserves an all-union market. Even in those areas in which basic policy actually remains relatively stable, it is to be expected that political and legal uncertainty will severely retard risk taking and the development of new forms of business activities. Only those activities that will produce immediate profit, or those which would appear to be both acceptable and profitable under most likely future scenarios, will be undertaken in this climate. Further, because many such activities are those requiring limited invest­ ment and/or are designed to take advantage of current market deficits in consumer goods and services, continuing failure to establish clear lines of authority and a stable regulatory regime may produce results which give credence to charges that those engaging in new types of activity are privateers not interested in seriously

233 investing in the economic growth of their communities and may thus contribute to pressure for reversal of economic liberalization. If a permanent solution cannot be achieved immediately, a clear commitment to an acceptable temporary or partial arrangement might be preferable to no resolution at all. Such an agreement might specify which laws were to govern particular economic spheres or even specific economic activities during a period of years, with an assurance that, should the governing law change after that period, individuals would not find themselves severely penalized for having taken part in particular economic activities during the interim period. It is possible that such temporary measures might be of assistance in areas in which there is substantial agreement among most competing groups about the proper conditions for economic activity. In the alternative, more permanent measures might be taken to clarify control over particular parts of the economy where there is general agree­ ment on the appropriate territorial or political level of control. 8 Unfortunately, the complications inherent in any attempt to come to such an agreement, the time required to draft and agree upon the relevant legislation and the pressure of more basic political issues suggest that even temporary or partial arrangements are unlikely at this time and that they would be perceived as unstable even if passed. The maintenance of such solutions would require a level of politi­ cal stability and basic policy agreement that is simply absent from the current environment. Temporary agreements, even if such agreements could be reached, would by definition be temporary and would thus fail to resolve the fundamental uncertainty problems. Similarly, partial agreements would by definition clarify the source of legal control for only a small segment of the economy, leaving the determination of the broader conditions in which that segment operates subject to the extreme uncertainty described above. c. Competencies and capacities of state bodies (1) Introduction There are a number of bodies in the USSR that are empowered to issue laws, or decrees and regulations with the force of law. The relationships among the various bodies and the acts which issue from them, however, are not always clear. In some cases, this is the result of a legal tradition which defined state authority as a single unified system with undifferentiated powers, while in others it is a result of the as yet incomplete definition of the boundaries of the authority of newly created bodies. The lack of a clear separation of powers is a separate legal issue that is capable of causing difficulties even in the absence of federal strife.

(2) The Soviet theory of state structure Until quite recently, the concept of separation of powers was strongly rejected by the greater part of the Soviet legal and political community as a

234 characteristic of bourgeois states, where the various state bodies did not represent the interests of the whole people. According to this traditional Soviet theory, state power is an indivisible organic whole and all of the state organs represent all of the people. While some division of functions might be appropriate for the sake of efficiency, no separation of powers-in the sense of checks and balances-is required, as all bodies are expected to work together in pursuit of the same public interests. Rather than defining the power of government bodies narrowly as the power to act in only those ways and with respect to only those subjects which are specifically delegated to the body by the USSR Constitution or other relevant document, the Soviet tradition defined the powers of various state bodies by the assignment of broad responsibility and the grant of generalized tools (e.g., the issuance of laws, or of binding decrees). Accordingly, the competencies of various government bodies were defined primarily by the grant of certain exclusive powers and topics of regulation to particular higher organs, while those below retained all other powers necessary to their tasks (very broadly defined), but could nearly always be overruled by the organ above them.

(3) Changing theories and the problems of the transition period As a part of the overall process of perestroika and democratizatsia (democratization), the generally accepted Soviet theory of state power has changed markedly. The reformation of the union and highest union-republican level organs of state power has included some elements reflecting this change in theory and the legislative (supreme soviets, congresses of people's deputies) and executive (presidents and councils of ministers) bodies have been defined or redefined so that their functions and powers vis-a-vis one another are a bit more clearly delineated. Although the power to review legislation has not been vested in the court system, the courts and state arbitrazh have been empowered to hear cases concerning illegal or ultra vires actions of state officials that violate the rights of individual citizens or organizations, and a committee has been created under the Supreme Soviet of the USSR that is responsible for supervising and reviewing the constitutionality of legislation and regulation. The process of delineation of the powers of particular bodies, however, is only at its earliest stages and the over-broad definition of powers still contributes to confusion and incon­ sistency in elaboration and implementation of laws and normative acts. Even the small steps toward delineation of competencies mentioned above have been made only at the highest levels of state power, while the lower levels have been much less affected by the process. District, regional and local soviets of people's deputies remain largely in the same form that they have had for many years. The soviets themselves elect their executive committees and presidiums, which are considered to be the executive arms of local government and which may carry out many of the daily functions of government in some localities. The distinction at these levels between legislative and executive functions is limited

235 at best and there is far less institutional check on the actions of either the soviets or the executive committees. The recent reforms have made one important change in the local structure-i.e., the elections of people's deputies are now open and contested, thus producing a congress or supreme soviet that is more representative of and responsive to the population. While this reform may produce local govern­ ment that is more responsive, however, it does not address the separation of powers problems. In addition to the primary bodies of state power, there exist numerous min­ istries and committees. These bodies, although considered to be a part of the executive rather than the legislative apparatus, are generally authorized to issue binding resolutions and regulations within their areas of responsibility and within their territorial jurisdictions. Indeed, at the union level, the Council of Ministers has often been made responsible for issuing the detailed instructions and regula­ tions that implement very general all-union laws, and similar tasks have tradition­ ally fallen to other ministries or institutions with respect to dictating the means by which broad legislative pronouncements will be implemented. These mini­ stries, committees and departments have in the past issued enormous masses of regulations and instructions which in theory implement the laws and decisions issued by higher bodies, but which in fact may limit or significantly alter those laws and decisions. The degree to which such limitations and alterations are per­ missible is very poorly defined. The result of this failure to clearly define the competencies of state bodies is a substantial amount of uncertainty and a lack of uniformity with respect to the interpretation and implementation of legislative acts. Local bodies may impose differing requirements on new business entities for registration, place restrictions on the activities of such entities, or otherwise regulate activities under new laws. At the same time, ministries and other institutions empowered to insure binding regulations, rules, or orders may effectively restrict enterprises or others to whom such acts may be addressed in ways that are inconsistent with the intent of new economic legislation. Although direct contradiction of a new legislative act in a decision taken with respect to a particular person or matter may be appealed, restrictions can occur without direct contradiction of the broadly worded new legislation, and the appeal of restrictions issued as generally binding rules rather than with respect to a single individual or entity (for example, registration require­ ments, blanket prohibitions) is substantially more difficult. Thus, there may be significant differences in the implementation of legislation at lower levels and participants in the economy may face the possibility of arbitrary restrictions and unpredictable changes in the rules of behavior. During the current period of transition, when there is substantial disagree­ ment over economic law and policy, the problem caused by a lack of clear limita­ tions on competencies is increased by several orders of magnitude. Various territorial units deliberately circumvent the requirements of new laws, and the lack

236 of clear standards causes regulation of this kind of behavior to be extremely difficult. In addition, these same separation of power issues cause difficulties for legislators attempting to create new state bodies capable of enforcing new laws and regulations broadly-against state and quasi-state participants in the market as well as private parties.

(4) Conclusions and recommendations

Resolution of these problems will require a better definition of the boundaries of authority between legislative, executive, and administrative bodies at various levels. The best means for addressing this problem in the short term are not entirely clear. A significant amount of legislation redefining particular bodies and their powers may be required to achieve enforceable standards, and even this may be insufficient without constitutional amendments at the union and/or republican levels. Some attempt has been made in recent legislation to address this problem by clear legislative statements concerning the powers of lower-level state bodies under the law. For example, the all-union law states that a local body may not refuse to register a cooperative except for the reason that its proposed activities, or its documents presented for registration, do not conform to legal requirements. This is one excellent means to circumvent the problem in the interim period and it would be useful for legislators to continue to use such provisions in legislative acts in order to define precisely the permissible exercise of discretion on the part of lower bodies. In addition to limiting the exercise of discretion by lower bodies and clearly defining the considerations which may influence discretionary decisions, legis­ lators could reduce confusion and increase uniformity of application by limiting possibilities for delay and for the exercise of arbitrary, inappropriate or corrupt influences. Managers, entrepreneurs, and legal counsel at the local levels complain repeatedly of the use of implementation procedures (e.g., registrations, applica­ tions for licenses and permits, etc.) as the occasion for the relevant authorities to use their powers to assist or hinder particular economic actors on the basis of prevailing ideologies, personal predilections, or outright corruption. The estab­ lishment of specific implementation procedures in the law-including clear state­ ments concerning the grounds on which registrations, permissions, etc. are to be granted or refused, relatively strict time limitations on the consideration of ap­ plications, and the creation (in appropriate cases) of default presumptions in favor of the applicant9 -would all contribute to an increase in uniformity of application of the law and a reduction in corruption and inappropriate exercise of discretion. Although the use of such systems does impose costs, both in terms of higher-level legislative time and effort in devising them for each relevant law and in loss of flexibility, the gains in certainty and faith in the operative effect of the laws among

237 the public and the business community may be worth the costs, particularly during the transition period. The provision of effective recourse when illegal or ultra vires actions are taken is also required. The clear definition of the bounds of discretion and specification of procedures will go a great distance in making the existing right to appeal actions taken in individual cases meaningful-both by providing clearer standards by which individuals, officials, and courts or arbitrazh bodies may evaluate the actions of state bodies and by reducing the need for lower-level bodies to implement the laws through issuance of normative acts and general regulations. Nonetheless, given the emphasis on increasing effective control at local levels and the strong support for local sovereignty campaigns, it is likely that there will be a need for an expeditious means of resolving questions related to normative acts as well, particularly during the coming transition period. The creation of a general power of judicial review may be thought to be undesirable, either as a general matter or at least until the completion of reforms of the judiciary and the dispute resolution system as a whole. If this is so, consideration might be given to the creation of another means of review of legislation and regulations­ perhaps through an arm of the relevant legislative body. In order to provide ex­ peditious review of matters of inconsistent implementing legislation or procedures, it might be advisable to separate the body responsible for review of legislative inconsistency questions from that responsible for more difficult and cumbersome constitutional questions. d. Localization of power and local capacities

(1) Introduction The guidelines call for the role of autonomous republics and other national formations (i.e. autonomous oblasts and autonomous okrugs) to increase consid­ erably, although they do not define the specific ways in which the role of such formations should be augmented. The role of local bodies in general (i.e., rayon and city soviets as well as okrug and higher-level bodies) will increase substan­ tially as the guidelines call for such bodies to take decisions on temporary price limitations, market controls, and other matters affecting local economic behavior and conditions. In fact, this process has already been occurring with respect to some areas and some functions, as new legislation places increasing amounts of responsibility on local bodies and the reduction of the powers of central bodies results in more localized distribution of control and implementation activities. While some reallocation of regulatory and implementation powers is clearly in order, a localization process that fails to take account of the pressures on local bodies to act irresponsibly with respect to the larger market, and their technical incapacity to meet many of the demands placed on them, is likely to produce undesirable results.

238 (2) Responsibility of local bodies to the larger community

As local bodies have begun to exercise new powers, many of them have shown tendencies to attempt to meet local interests without regard to the needs of the larger community. Orders have been issued restricting the movement of goods or attempting to interfere in interregional competition in order to protect the in­ terests of local consumers or enterprises. As a new model of state structure begins to be elaborated, with respect both to questions of federalism and questions of separation of powers, local bodies may begin to have a clearer picture of their place in the social structure.

(3) Technical capacities of local bodies

Under the previous planning and budgetary system, local bodies of state tJower had only limited amounts of responsibility for economic planning, budgetary control, and the funding and provision of local services. Thus, local bodies have not had occasion to develop substantial skills or experience in per­ forming such tasks as budget formation, evaluation of tax bases, management and control of local utilities, property registration, etc. Most bodies at the lowest levels lack the knowledge, staff, and technological means to fulfill many of the basic tasks of local government which have been or will be assigned to them. If these local bodies are not able to obtain substantial amounts of assistance in meeting their new responsibilities, even an otherwise well-planned reform effort may fail to show satisfactory results at the local levels.

(4) Conclusions and recommendations

Although there is substantial pressure for increasing democratization and control at local levels, localization of control should proceed with caution during the transition period and increased localization of control should not be permitted to substitute for the resolution of difficult privatization issues or questions of local sovereignty.

The ability of the reform program to show results at the local level will be heavily dependent on the ability of local bodies to meet their responsibilities and to use their new powers to promote market activities, provide better local services and infrastructure, and work creatively to assist in local development. Local bodies should seek, and capable organizations should provide, technical and financial assistance in developing techniques of planning, organization and control that are effective during the difficult transition period and that are capable of developing into viable local government structures and practices.

239 3. LEGAL FOUNDATIONS FOR MARKET EXCHANGES a. Introduction The effective functioning of a market-based system is dependent upon the existence of clearly defined and reasonably broad property rights, the ability of market participants to freely exchange property rights through a system of legally enforceable agreements, and the existence of a system which provides reasonably secure and predictable enforcement of such agreements. While there now seems to be greater recognition of the fundamental nature of these matters, the need to establish stable basic principles in these areas has until recently been somewhat obscured by a tendency to focus on particular pieces of legislation authorizing and defining specific forms of business activity. Although several new pieces of legis­ lation have appeared in the last year that touch on these matters, they are generally "framework" laws which do not yet provide the clarity or detail required in these areas. The presidential guidelines focus heavily on defining specific institutions and instruments, while devoting little detailed attention to the need to alter basic civil law concepts. In their present forms, neither the substantive civil law nor systems for dis­ pute resolution and law enforcement are adequate to support and facilitate the growth of a market economy. Substantive law in the areas of property and contract still contains many aspects more suited to central planning than to decentralized market exchange. Although there are some underlying civil law principles which might serve as the basis for the growth of the law in new directions, these aspects of the law are simplistic and will need development before they are adequate to support complex commercial relationships. The systems for civil dispute resolution and enforcement of economic obliga­ tions are currently being reorganized and are as yet in a state of some disorganiza­ tion. It is clear that they are not yet prepared to handle the burdens that market transition will place upon them. With respect to the enforcement of criminal laws relating to economic activity and the general supervision of legality, the concern is not one of readiness to address new problems but rather one of excessive armament of supervisory agencies with intrusive powers and continuing existence of legal sanctions inappropriate to a market system. b. Property rights (1) Introduction The guidelines call repeatedly for the expansion of property ownership and property rights in a variety of fashions. They explicitly call for the recognition of the right to private property, a substantial program of privatization of state proper­ ty, and a program of land reform as major components of the stabilization of the

240 economy. In addition, the guidelines implicitly call for the redefinition of rights to own and use property (especially productive property) in discussing the expan­ sion of business activities of all kinds and the need for a law on freedom of entrepreneurial activity. These proposals are substantially more far reaching than any of the previous union level suggestions related to ownership and neither the current union nor most republican level legislation is consistent with the aims described. Implementation of the guidelines will require a significant legislative effort, including the immediate issuance of a number of pieces of new legislation and amendment or repeal of several other pieces, and, in the longer term, the redrafting of entire civil codes and a massive amount of conforming amendment of related legislation.

(2) Traditional Soviet doctrine Until recently, ownership law in the USSR was strictly divided between socialist ownership and personal ownership. Socialist ownership included the general ownership of the state and state enterprises, ownership of rural coopera­ tives, ownership of collective farms, ownership of trade unions and also of social organizations. Personal ownership, a separate but related category, included the personal and household belongings of individuals and other objects needed by the individual for conducting subsidiary farming operations on a plot of land, or for engaging in a permitted handicraft or individual labor activity. Personal ownership was to be derived principally from the labor savings of individuals and was not to serve as the basis for the extraction of illegal or "unearned" incomes. 10 The state was regarded as the sole owner of all state property, which could be held in "operative management" by enterprises and other bodies to which the state gave property for use. Operative management of property means, in effect, that the property can be possessed and used, but use is restricted. Property held in operative management by an enterprise must be used at all times consistently with the charter of the enterprise and the purpose of the property. Disposition can be made only in accordance with the law, often requiring an order or permission of the superior state body (ministry, department or committee) to which the enterprise or organization desiring to dispose of such property is subordinate. While personal property could be the subject of a pledge or lien and can be disposed of far more freely than state property, both the objects of personal owner­ ship and the permitted forms of individual economic activity were, until recently, quite limited, rendering personal property essentially irrelevant as a source of market activity. 11 Under the applicable civil code provisions, state property could not (in general) be alienated to individuals and could rarely be used as security or levied against. 12 As an illustration of the relative importance of the two forms of proper­ ty, the criminal codes generally provided penalties for stealing, converting or even negligently wasting state property which were very substantial and notably harsher

241 than those corresponding to similar actions involving the personal property of individuals. These code provisions have not, in general, yet been repealed al­ though newly issued legislation suggests that they may no longer be enforced, and there is a clear intention to equalize the position of both types of property in the future.

(3) Fundamentals of legislation on ownership In March 1990, the new Fundamental Principles of Legislation13 on Owner­ ship were passed and the USSR Constitution amended 14 in an attempt to bring ownership law in general into a state consistent with the new developments in economic regulation. Although the new Fundamentals do authorize ownership by a variety of new economic entities, thus overcoming the limitation of property ownership forms to the "socialist" and "personal" forms enumerated in the 1977 USSR Constitution and corresponding laws, they are otherwise extremely general. The law also states that all forms of property will be equally protected-a sub­ stantial step in terms of the history of Soviet jurisprudence-and provides general­ ly for the right of both owner and legitimate users to protection of their property or use rights. The law does not, however, mention any requirement of, or means for, registration of property ownership. The new Fundamentals mention a number of different types of property ownership which are permissible, many of which-such as the property of a labor partnership, the property of an economic partnership, or the property of religious organizations-have not previously been specifically addressed by the Soviet law of ownership. The Fundamentals themselves, however, do not provide definitions of the particular rights and duties associated with the new types of ownership. Some of these "new" types of ownership are classified according to categories which already existed in the law; for example, the ownership of a labor partnership is identified as shared common ownership. This form of ownership is, in turn, defined in a general fashion in republican civil codes, e.g. chapter 12 of the Civil Code of the RSFSR. In this fashion, the general rights and duties of the owners vis-a-vis one another are already defined. The ownership of most business entities, however, is classified as "collective ownership"-a category of ownership defined neither in existing civil codes nor in the Fundamentals. A number of the types of ownership placed in this new category are the ownership rights of new kinds of business entities, which entities are, in turn, defined by relatively comprehensive all-union laws. In some of these cases, the laws themselves define the rights of both the business entity as owner and (where relevant) the individuals who may be part owners of the business entity. In other cases however, the law is still silent as to the entity's definition or the rights of its owners and of the entity itself as an owner. While the lack of a general civil law definition of collective property does not prevent the use of owned property by the relevant business entities, it does

242 cause substantial uncertainty concerning the precise boundaries of their ownership rights and the rights of individuals and organizations who are, in tum, the owners of the business entities and the managers of their property. This uncertainty is particularly acute with respect to those types of business entity which have not been defined in other laws. If the definition of those types of ownership as "col­ lective" stands, it is to be expected that this new term will be defined on the adoption of Fundamentals into the republics' civil codes and their further elabora­ tion therein. Under current conditions, however, the redrafting of republican civil codes is not likely to occur with any rapidity, and short-term development of the law in this area is likely to occur by means of laws defining additional business forms. There are many remaining questions which are not answered by the new Fundamentals, concerning, for example, the extent of restrictions on the disposi­ tion of productive property. The Fundamentals themselves state that an owner may possess, use, and dispose of the property belonging to him in any way not prohibited by law. There is, however, little law as yet concerning permissible disposition of property. The exception to this is the Fundamental Principles of Legislation on Land, which provide for very substantial control of land use by the state and withdrawal of use rights as a penalty for inefficient use. This is an ominous precedent which suggests that the owner of production facilities may not be free to dispose of those facilities in ways which might appear wasteful or negative to society in general. The right simply not to use owned property, or to destroy it if one so desires, may be problematic--especially in industries where there are supply and/or monopoly problems. Attempts to control disposition in general, however, may lead to restrictions on alienation that hamper the free movement of property and reduce efficiency.

(4) Additional legislation affecting property rights Several additional pieces of legislation have recently been passed which have had effects on the Soviet property regime. In November 1989, the Fundamental Principles of Legislation on Leasing were passed, which provide a means for all kinds of economic actors, including individuals, cooperatives and also state enterprises, to work on the basis of leased property. The leased property may be excess capacity rented out by an enterprise to a cooperative or individual or may be state property rented by an enterprise, cooperative or other organization directly from a ministry or other body. By using the lease-purchase option provided for in the new law, enterprises and other economic organizations can purchase and own productive assets that once belonged to the state. Shortly after the Fundamentals on Leasing, another set of Fundamental Prin­ ciples of Legislation was passed concerning land. Although the new law does appear to allow more flexibility in land use and codifies the possibility for land users to be given a life tenure in land, it does not envision unrestricted purchase

243 and sale of land and appears to presume continued substantial control over land use. According to the new Fundamentals, land can now be given to agricultural and other users, for use in their private businesses or affairs. Such land may be inheritable by the descendants of the holder of a plot of land and there is no limit on the number of times it can be passed down, although rights to bequeath outside familial or business succession lines are not clear. 15

(5) Use ofproperty as security The new Fundamentals do generally authorize the use of liens on property for securing obligations. This is an encouraging development that suggests that restrictions previously placed on productive assets owned by the state will not "follow" those assets into private hands. Productive property that has been privatized (through lease-purchase or other means) may thus begin to serve, along with personal property, as the basis for project finance. At the time of this writing, liens on property-or pledges-are regulated by basic republican civil code provisions. 16 Such provisions generally allow pledge only of property that is owned outright or is in the operative management of the party making the pledge. They require that contracts of pledge be in written form and define the general conditions for maintenance, insurance, and recovery of pledged items. A draft Law on Pledge, however, is currently being considered, which redefines the con­ ditions of an enforceable lien or pledge, the types of property rights that may be the subject of a pledge, and the procedures for effecting a foreclosure, and also introduces registration requirements for encumbered property. 17 In order for property to be used effectively as security, there will need to be attention to the technical means by which legal requirements can be met and rights substantiated. Particular difficulty will be caused by the absence of a coherent system for registration of property ownership and of liens and encumbrances on property. While it appears possible to obtain documents from the local authorities which attest to the ownership of property, and this may be helpful in proving ownership during the process of obtaining a loan and/or making a pledge, it will not provide the kind of systematic registration and tracking that will allow a normal market to function.

(6) Property rights of individuals With respect to the property of individuals, the new Fundamental Principles of Legislation on Ownership have been criticized by some on the grounds that the sections relating to individuals preserve the system by which the permissible ob­ jects of individual ownership are enumerated by an exclusive list, continuing the previous tradition in which individual or personal ownership was discouraged and restricted relative to other forms. The language of the Fundamentals is, in fact, less than clear on this matter and would support both a broad and a narrow construction.

244 Article 7 discusses in some detail the objects of citizens' rights of ownership, separating such ownership from the provisions of Article 3, concerning objects of the right of ownership in general. Both articles contain permissive language­ "citizens may own," "ownership may be exercised over"-suggesting that items not included in the list provided are not permissible objects of either rights of ownership in general, or citizens' rights of ownership in particular. The list provided in Article 3 of objects of rights of ownership in general is very broad and contains the catchall category "other property." In contrast, the list of objects of citizens' rights of ownership contained in Article 7 is substantially more specific and limited and its catchall category is "other property for purposes of production and consumption." Part 3 of Article 7 permits additional limitations to be placed on the ownership of citizens by union, union republic, or autonomous republic laws, while neither Article 3 nor any other article contains such a clause concerning other types of ownership. All of these differences suggest that individual ownership continues to be a matter of some sensitivity and is subject to special restriction. A narrow inter­ pretation of the Fundamentals could place restrictions on individual ownership of property for investment purposes (as opposed to consumption or production), and might tolerate very substantial restriction on individual ownership by the republics. Even if the provisions of Article 7 are interpreted more broadly, the separate treatment of individual ownership creates confusion and invites restric­ tion of individual business and investment activities.

(7) Conclusions and recommendations The presidential guidelines call for the creation of a varied economy based upon multiple forms of ownership. In order for the property law regime to support such an economy, a number of changes in the property laws will be required. It must be recalled, however, that the guidelines also call for the republics to have complete sovereignty over the national wealth located in their territories and to be able to define the conditions on its use and ownership. Thus, changes in the legal regulation of property rights may have to be made at the level of individual union and autonomous republics. While the guidelines themselves do not call for any particular means to ensure uniformity in this respect, it is clear that substantial differences between union republics with respect to the nature and means of protection of property rights will cause difficulties in the development of an all­ union market. If property laws are to be issued by individual republics, some means of coordination needs to be found so that differences in republican laws do not inhibit interrepublican trade. One important way in which the property regime could be improved would be the amendment of fundamental principles on ownership, at either the union or republican level, to establish a general right of natural and juridical persons (in­ cluding state entities) to own all types of property, with the exception of those

245 specifically forbidden by law and the elimination of the use of permissive lists of the objects of ownership rights. This formulation of ownership rights would re­ quire both a concurrent replacement or amendment of significant portions of the existing civil law and subordinate legislation and regulations-since the older provisions would in fact impose substantial restrictions-and a concurrent enact­ ment of legislation limiting ownership rights with respect to various types of property, such as those that are inherently dangerous. While this would be a significant legislative task, establishment of this formulation of the objects of legal ownership would avoid problems caused by gaps in permissive lists and problems of interpretation with respect to new forms of property and would eliminate un­ certainties caused by the differences in provisions applying to individuals and other types of entities. A similar formulation of disposition rights of property owners would be of assistance in ensuring the freest possible movement of property. A general reformulation of ownership rights as described above might eliminate the need to create an identified special category of ownership--such as "collective ownership"-to differentiate such ownership from individual and state forms. A business entity, as a juridical person, would be considered the owner of its property in simple terms. Ownership relationships between and among the owners of the business entity would be regulated by the laws governing the crea­ tion of such entities, as well as by general provisions concerning such forms as common and joint ownership. If, however, the creation of a special category of ownership is desired for purposes of providing general principles, identifying common characteristics, and allowing ease of reference in other legislation, the characteristics of this category of ownership should be defined in the law before particular ownership relations are so characterized. If the current characterization of various types of business ownership as "collective ownership" is to be retained, content will need to be given to the category immediately so that the property rights of those entities are clear. A more open formulation of general ownership rights need not entail the loss of ability to control undesirable uses of property or to moderate extreme differen­ ces in individual income or wealth accumulation. Problems of unproductive be­ havior with respect to productive property (e.g., failure to use the property, its neglect or destruction) will, in general, be regulated by market incentives and by pressure on business owners and managers to use and dispose of property effi­ ciently. In situations in which there is an absence of competition or severe shortage conditions, antimonopoly legislation or laws governing emergency situations should be adequate to provide the necessary control without preventing the effi­ cient movement of property to other uses (including the scrapping or destruction of obsolete capital) or unduly restricting the use of productive property for invest­ ment. If concern over destructive behavior is great, requirements concerning public offering of property for sale under appropriate circumstances might be considered. Similarly, taxation laws or specific restrictions on the accumulation

246 by individuals of particular types of property could be used to control extreme wealth differentiation or restrict particular types of accumulation deemed to be inappropriate either during the transition period or for social reasons. Principles discussed in the paragraphs above may also be applied to the legal regulation of the ownership and use of particular types of property, such as land. Land use rights must be relatively freely transferable in order for efficient land use patterns to develop, and the extremes of state control over land use dictated by the Fundamental Principles of Legislation on Land will need to be eliminated so that agricultural producers will not be enslaved to production minimums and prevented from developing efficient land use schemes. c. Contract law

(1) Introduction In contrast to the direct recognition of the need for reform in the legal regula­ tion of property rights, contract law as such is not a direct focus of the guidelines and was not featured in previous reform plans. Attention has been paid to the need to eliminate particular restrictions on contractual freedom that stem from the plan­ ning system (e.g., price controls or the assignment of contractual partners), but little attention has been focused on the underlying system of contract law as such. The removal of limitations on freedom of contract is, indeed, a matter of first importance. In addition, however, attention will need to be paid to the develop­ ment of the complex forms of contract required to support modern market trans­ actions.

(2) Current state of the law The basic principles of Soviet contract law can be found in the civil codes of the various union republics. The outlines of these principles were drawn from pre-Soviet European Civil Codes, and many of the principles are not inconsistent with a market economy. However, the broad general principles have never applied directly to contracts between enterprises involved in the planning process. Those enterprises are subject to special code provisions, as well as other regulations, which bind them to the dictates of the state economic plan, supplemented by general and procedural provisions of the Statute on the Supply of Consumer Goods, the Statute on Material and Technical Supply, and similar legislation that sets out the terms and conditions of contractual relations in the given sphere, and/or by the terms of a mandatory contract. These statutes, and also the form contracts and planning orders, have served as a means of specific prescription of contract forms and terms for most enterprises, essentially eliminating the need for the development of a more generalized contract law and practice that would guide the free formation of complex commercial relationships. In addition, the lack of

247 a need to draft efficient, legally enforceable contracts has contributed to a problem of "contract illiteracy" on the part of many enterprises, business participants, and even jurists. There has been a call by a number of well known jurists, including the Minister of Justice of the USSR, for work to begin on the conceptualization and drafting of new civil codes-with at least some principles to be determined at an all-union level-which would be up-to-date, would encourage participation of enterprises and other business entities in various forms of production, and would be uniform and binding all over the union. Included in such a code would be a new set of contract principles which might advance the state of contract law. However, given the pressure for greater republican economic independence, at­ tempts to create a complete all-union code in a field in which previous codes were republican is not likely to be widely supported and even an attempt to draft a new set of all-union fundamental principles of legislation concerning such topics is likely to be seen by many as an attempt to undercut the republics' abilities to devise their own systems. Further, even if successful, the creation of a new set of fundamental principles might not solve the problem of a lack of complexity and concrete provisions, as the fundamentals could prescribe only general principles to be incorporated into more specific republican codes.

(3) Conclusions and recommendations Some fairly immediate development of contract law will be needed in order to regulate normal market relations among a wide variety of economic actors. As the wholesale recreation of the civil codes will clearly require a substantial amount of time, the immediate steps may need to be taken through other means. Some steps in this direction are being taken within the confines of new laws on specific topics, such as the draft Law on Pledge or the decree on joint stock societies, where specific requirements are set out for inclusion in particular types of contract. It seems likely that elaboration of general standards for types of commercial contract not currently included in the civil codes, or included only in very basic form, will have to proceed by this means for some time. Interim amendments to the civil codes pose substantial difficulties as uniformity would require changes in many separate codes among republics that may have significant differences concerning appropriate content. With respect to contract law, as with ownership rights, the issue of uniformity among republics will need to be addressed. The guidelines do not mention contract provisions specifically, and there is no indication that these principles are intended to be more unified within the union than those regarding property use and owner­ ship. Indeed, such differentiation would be difficult as many provisions of contract law are dependent upon underlying regulation of property ownership. Even if property ownership regulation is relatively uniform, however, substantial differen­ ces in contract law will retard efficient business practices within the union and

248 lead to localization of contractual relationships, particularly if they result in failure to enforce interrepublican contracts. In addition to improvements in the codified law of contract, some attention could fruitfully be paid to issues of education. "Contract illiteracy" could be com­ batted by increasing the availability of information on the law and on the require­ ments of the enforcement systems, or by the provision of some efficient means for parties concluding contracts to check that the contract meets minimum require­ ments before concluding it. Unfortunately, the dearth of practicing attorneys in the USSR and the lack of contract experience on the part of those who exist suggests that such services would have to be provided by some other source. State arbitrazh is currently responsible for providing educational support to enterprises and the public concerning contract and economic discipline, but it is not clear that it will continue to have such responsibilities in the future nor that it would be capable of fulfilling them with respect to the general public under new conditions. The provision of model contracts might also be of use in educating new business participants about the necessary form and content of an enforceable con­ tract, as well as in informing existing enterprises about changes in the law and about options in drafting contracts under new conditions. Some of these models might be based on adaptations of the previously mandatory standard contract forms. Many of the standard contracts, however, were drafted by ministries or other bodies with a substantial interest in ensuring that contractual provisions and standards favored particular interests or groups. If these contracts are used as models, it will be important that they be revised by an independent group or body without interest in the content, except as it is consistent with law.

d. The dispute resolution and law enforcement systems

(1) Introduction A great deal could be written in pursuit of an adequate description and criti­ que of the Soviet systems for law enforcement and dispute resolution. There are a number of features of the systems, such as the division of civil cases between the courts and state arbitrazh or the supervision role of the procuracy, which are not common to Western systems. The following discussion provides only the most basic descriptions of the relevant institutions and concentrates discussion and criti­ que on aspects of those systems which are of most concern in the regulation and support of a market-based economy.

(2) Civil dispute resolution The civil dispute resolution system has, as yet, received limited attention as a key component of basic market functions. The guidelines decry the lack of respect for the law as one of the chief causes of the current economic crisis, but

249 fail to address the institutions called upon to enforce the law and their adequacy to perform that task. While this may in part reflect a correct recognition that the questions of state authority to legislate and to enforce the law must be resolved before the nature of dispute resolution and enforcement bodies can be addressed, the resolution of those issues alone will be insufficient to ensure implementation of the law. If the available institutions for civil dispute resolution are not capable of adequately enforcing the property and contract rights of market participants, the redefinition of such rights will not have the desired effects and the expansion of market activities will be limited by the tendency of market participants to do business with only those partners whom they already know and trust. At present, neither the civil courts nor state arbitrazh are prepared to address adequately the number and types of civil cases that will arise as a corollary to market develop­ ment, and attention must be given to redefining the functions of these bodies and preparing them for new case loads. Although there are both union level and republic courts, the Soviet court system is not a federal system on the U.S. model. All lower-level courts are republican courts, with the only union-level courts being the Supreme Court of the USSR and the military tribunals. Although superior courts may in some cir­ cumstances hear cases in the first instance, the large majority of cases are heard in the first instance in the local "people's court." The republican level courts are arranged according to administrative unit, with a court level for each level of territorial administration. Thus, the number of intermediate instances which stand between the people's court, or court of first instance, and the Supreme Court of the USSR depends heavily upon the territorial formation in which the court is located. The district or city "people's court" is a court of general jurisdiction, which hears both civil and criminal cases, although the case load within the court may be divided among divisions which specialize in cases of particular types. Each court also has a presidium, which consists of the court's chairman and deputy chairmen, and a number of other members, and which exercises supervisory func­ tions and considers protests brought against judgments of the relevant court. Such protests can, in law, be brought by a number of officials, but are in practice generally almost always brought by the procurator. As the theory of separation of powers was not traditionally accepted in Soviet legal theory, there was no attempt to create in the courts a "third branch" of government with the accompanying power and independence. The Soviet courts have been traditionally subordinate to the higher organs of the state (i.e., to the Supreme Soviet and to Council of Ministers through the Ministry of Justice) and have had no ability to review or reverse legislative or regulatory acts of govern­ ment bodies. Judges were, until recently, appointed by state functionaries (the local soviet or its executive committee) at the same territorial level as the relevant court and were dependent upon these local bodies for the provision of their

250 material needs. Given this system, it is not surprising that reports of interference with judicial process have been common. In comparison with many Western models, Soviet court rulings are relatively impermanent, in the sense that they are open to challenge and to consequent revision or reversal from quite a number of sources. Challenges can be brought not only by the parties to the case, but also from outside the case by the procurator at the local or higher level, by the presidium of the relevant court, by courts at a higher level, and also by other persons and officials. Such challenges or protests may be brought at any time after a judgment has been rendered. If the case is found, by the higher court, to have been wrongly decided, the decision and its effects may be overturned despite the lapse of time since the judgment was rendered and the degree of reliance placed on the judgment by the parties in­ volved. A program of court reform has recently begun and the first steps have been taken in order to remedy some of the problems here discussed. A new set of Fundamental Principles of Legislation on the judicial system was passed in November of 1989, and also a new Law on the Status of Judges and a Law on Liability for Disrespect of the Court. These new laws provide that judges shall be independent and subordinate only to the law. In an attempt to break the depend­ ence of judges on local officials, the new laws provide that judges shall, in most instances, now be appointed by the state body at the next higher level of com­ petence rather than that equivalent to the court and that the material needs of the court shall be provided for primarily by the Ministry of Justice. The independence of judges and judicial decision-making is protected by the imposition of fines, or in some cases prison terms, for attempts to influence particular decisions or for failure to carry out legitimate orders of the court. However, while these new initiatives are clearly steps in the right direction, they do not provide a basis for the courts to fulfill the kinds of demands that will be placed on them under new economic conditions. The court's jurisdiction with respect to commercial matters has traditionally been rather limited. The civil court has had jurisdiction over economic matters involving individuals, those involving kolkhozy (collective farms), and cases in­ volving very small sums of money. The large bulk of commercial cases-disputes between enterprises, organizations and other juridical persons involving a planned or compulsory element-have been under the compulsory jurisdiction of state arbitrazh rather than the courts. Thus, the civil courts have a very limited ex­ perience of commercial disputes, and almost no experience with the resolution of complex business matters. However, as the number of business entities not bound by planning acts or state orders increases and the number of transactions contain­ ing mandatory elements decreases, a substantially greater number of commercial disputes will fall within this category. It is possible that many such disputes will, if formal resolution is necessary, be taken to civil courts rather than to state

251 arbitrazh-as many attorneys and business managers associate state arbitrazh with the imposition of centrally dictated tasks rather than the neutral resolution of disputes. In addition to serving as a forum for the resolution of commercial disputes, the courts are increasingly being called upon to provide a forum for complaint about inappropriate acts of authorities. For example, the 1988 Law on Coopera­ tives in the USSR provides that unjustified failure by local authorities to register a cooperative can be appealed to a court. Even in the absence of specific provisions, a general law allows the appeal of any action of Soviet officials which infringes the rights of an individual natural or juridical person to be appealed to the court and held void if illegal or beyond the competence of the body in question. Given these provisions, it seems inevitable that commercial and commercially related disputes in the civil courts will quickly increase in both number and com­ plexity. While the steps taken thus far with respect to the court system may be of some assistance to the courts in remaining independent and neutral when address­ ing new civil matters, there have been few steps taken that will provide the courts with the clear and final authority necessary to meaningfully resolve commercial cases or that will help to prepare courts to deal knowledgeably and efficiently with the new types of cases they will be encountering. Without such steps, court resolutions of commercial matters may lack the authority, uniformity, and finality required for them to serve as real resolutions. Parties may find it necessary to seek other means for resolution of legal disputes, and may in some cases be unable to enforce their contracts or vindicate other legal rights. The Soviet system of state arbitrazh has, since the early 1930s, functioned as a separate dispute-resolution and general oversight system with exclusive juris­ diction over most economic disputes between most enterprises, organizations and institutions. 18 The role of the arbiter in the state arbitrazh system is one that combines functions of mediator, judge, investigator-prosecutor, state ad­ ministrator, and legislator. Arbiters are expected to assist the parties to a dispute to find an acceptable resolution of the problem by themselves, but failing that are responsible for determining a solution to the problem based on the applicable law (which usually includes the legal requirement of adherence to mandatory planned relationships). Disputes which must be resolved by arbitrazh have included those between enterprises which are unable to agree on the terms of a contract which they are legally required to enter into; thus the arbiter may be called upon to serve as the state administrator who elaborates planned or legally required economic relationships at the individual level. Arbiters are required to be aware of and to remedy legal violations which may be occurring in enterprises with which they have contact, regardless of whether those violations are related to the subject of the dispute, and arbitrazh proceedings may be instituted by arbitrazh authorities sua sponte if an arbiter

252 believes that violations of law are occurring. This investigative-prosecutorial side of the arbiter's role involves substantial power to issue notifications to enterprises or to state enforcement authorities concerning violations of the law. These notifications must be returned within a stated period of time with a description of remedial measures taken. Arbiters also have the power to issue specific binding instructions to economic actors concerning the elimination of violations of law. Finally, arbitrazh organs are expected to draft normative acts which elaborate on the procedures that enterprises are required to follow in economic activities which have a mandatory nature, 19 and to issue interpretations of economic law to min­ istries and departments. The role to be played by state arbitrazh in the new market economy is not at all clear. Some pieces of economic legislation have referred disputes arising under the legislation to courts or state arbitrazh, without providing guidance as to the relevant jurisdiction of either, or the relationship of one to the other in resolving the disputes.20 As mentioned above, general civil code provisions give jurisdiction over disputes not involving mandatory elements to either/both ar­ bitrazh and the courts. Yet, the traditions and procedures of these bodies are quite different and the treatment of a single dispute is likely to vary substantially be­ tween the two bodies. Arbitrazh bodies have traditionally examined disputes in which the actions of the parties are heavily determined by legal requirements, with a primary goal being the enforcement of those requirements. It is not clear that this body can be quickly or easily transformed into an "economic court" which will serve simply to examine and resolve disputes presented to it by essentially free economic actors. On the other hand, arbitrazh bodies are the only bodies that have any experience at all with large commercial disputes and any knowledge about the types of conditions and the traditional contractual and economic relation­ ships that have existed in Soviet industry. First versions of new draft legislation on arbitrazh are due to be presented to the union-level Supreme Soviet and also to some republican-level supreme soviets late in this year. Early drafts of the union-level laws (produced by the union-level arbiters) appear to envision the new arbitrazh as more of a mediation and conciliation body than it has been previously, and (in some versions) perhaps also as the home of other nonjudicial dispute resolution options including both binding and nonbinding arbitration in the Western style. Jurisdiction provisions of the draft were very broad and exclusive-placing nearly all economic disputes except those involving individuals into mandatory arbitrazhjurisdiction-without reference to the planned or voluntary nature of their economic relationship. In addition, the drafts retained in relatively intact form the institution's traditional roles as law enforcer, administrator, and elaborator of economic law and regula­ tion. Clearly, one of the matters of first importance relative to the definition and support of the civil dispute-resolution authorities under new conditions will be the

253 resolution of the questions of definition of union, republican and local authority. Until the issue of legislative and regulatory authority is resolved, it will remain unclear which law is to be applied to any given case and which court or arbitrazh body has final jurisdiction. Thus, decisions of courts and arbitrazh will remain an unstable basis for action by parties. In addition, as the union is reshaped, it will be necessary for not only the law, but the direct relationships between and among the courts and arbitrazh bodies themselves to be clearly redefined in terms of rights of appeal, and proper jurisdiction for multirepublic issues. Officials of the Ministry of Justice of the USSR stated that they find the U.S. model of a federal judicial system attractive and hope to model the newly revamped Soviet judicial system along similar lines, perhaps including some of the more restrictive features of U.S. practice with respect to the appealability and permanence of judgments. No steps have yet been taken in this direction, however. Fundamental redefinition of the court system will be extremely time-consum­ ing and is dependent upon the resolution and redefinition of the complex political relationships that form the Soviet state. The process cannot be completed in the near term. There may, however, be some steps which would contribute to the ability of courts and arbitrazh bodies to resolve disputes in the near term while the more fundamental changes are being made.

One important step is the clarification, even if on an interim basis, of the relationship between state arbitrazh and the civil courts. The precise nature of the relationship, however, is less important than that the system provide certainty­ with respect to jurisdiction to decide a particular dispute, the legal standards under which a body will decide, the point at which a resolution has reached finality, and enforceability of the resulting resolution. As long as these conditions are met, the provision of several different fora for resolving disputes need not necessarily be objectionable. Indeed, the legal systems of most developed market economies provide a number of means for the resolution of economic disputes and experience seems to suggest that this facilitates dispute resolution.

There may, however, need to be additional attention paid in the Soviet con­ text to the effect that a multiplicity of resolution fora has on the development of commercial law and practice. Most developed market economies have built these alternative structures on the basis of a fairly well-developed body of commercial law, so that there is little concern about confusion in the development of basic legal principles. In the Soviet context, as basic principles of market-based com­ mercial law are developing, it will be important that there also be certainty with respect to the meaning and effect of particular laws and a reasonable possibility for the experience of each type of dispute-resolution fora to be considered and incorporated in the development of commercial law principles. For these reasons, and particularly if the jurisdictions of the bodies are going to overlap, there may need to be some provision for elaboration of a single interpretation of law and a

254 single standard of enforcement in relation to cases over which both bodies may preside. The relationship of the dispute-resolution role of arbitrazh to its functions of general law enforcement needs to be reconsidered, and the law enforcement func­ tions may need to be separated from dispute resolution or even placed entirely with other bodies. It is plain that there will be little resort to arbitrazh for dispute resolution or contract enforcement if it is expected that the institution will use the opportunity to conduct a general fishing expedition for legal violations and will institute enforcement proceedings. In addition, if arbitrazh is to fulfill dispute­ resolution functions for economic actors who possess substantial freedom to dis­ pose of property and to contract as they see fit, the portions of its activities which are concerned with the general functioning of the economic system and the system of contracting may have to be removed to a separate agency so that there is no concern with respect to the application of a new law to disputes other than current law. These functions could be confined in a separate department of arbitrazh which could be given the task of assisting with the elaboration of Soviet contract and economic law by means of the generation of models and suggestion of regula­ tions to a competent legislative authority. In addition to the need for clarification of systemic relationships, there will be a very serious need for additional personnel, facilities and training that has not yet been addressed. To date, no substantial steps have been undertaken that will provide training to judges on the handling of complex commercial cases and there have been no plans announced for the hiring and training of the large number of new judges and other personnel that will be needed as the burden on the civil dispute-resolution system expands. This may be a very fruitful area in which technical assistance and cooperation could be begun. Such technical assistance, however, will be most useful if it is available not only on the issues of complex commercial cases of particular types, but also on basic questions of court organiza­ tion and docket control, basic civil process matters, and the organization and availability of nonjudicial as well as judicial means of dispute resolution.

(3) Procuracy supervision of business activity The Soviet Procuracy is an institution charged with responsibility for "super­ vision" of all branches of Soviet society to ensure that legality is observed. Current legislation divides this supervisory responsibility into four specific types: super­ vision over agencies conducting investigations, supervision over the legality of court process and decisions, supervision of places of confinement, and general supervision over the execution of laws by ministries, lower level bodies of state power,21 institutions, organizations, and citizens. The Procuracy may undertake a review of the actions of organizations, enterprises, or other bodies on its own initiative or may conduct a review or investigation on the basis of a complaint or a procurator's observation that dif-

255 ficulties are being experienced. In addition, the Procuracy has in previous years conducted a variety of "campaigns" against certain categories of violation, often in response to Party resolutions urging that greater attention be paid to .the elimina­ tion of the particular type of violation. In recent years, campaigns against environ­ mental offenses and violations of economic legislation have been frequent, engendering substantial Procuracy involvement in reviewing the activities of economic actors. In connection with the procurator's review, documents from various bodies and individuals may be requested, including copies of subordinate legislation and regulations, information concerning measures taken to ensure compliance with the law, and other information-including business documents and records-needed to verify information concerning alleged violations and ascertain the state of legality. Expert investigations may be ordered and individuals may be required to give oral or written explanations concerning possible violations of the law. Procurator's demands in these respects are mandatory and must be fulfilled by the relevant organizations and individuals. There is no requirement that the procurator show grounds for investigation or bring charges before making demands for information.

If violations of the law are found, the procurator may take several kinds of action. Illegal or ultra vires normative acts may be protested against, which in some cases entails the suspension of the act until the protest is considered. 22 The procurator may also issue a recommendation regarding the elimination of a viola­ tion and has the right to take part in sessions of collegial organs where such recommendations are to be considered.23 If the violation of law is clear and threatens immediate harm, the procurator may issue a written instruction to the relevant individuals or bodies, or to their superiors, requiring the immediate elimination of the violation. Fulfillment of such instructions is mandatory and must be undertaken immediately. 24 Finally, the procurator may issue a decree concerning the initiation of criminal or civil investigation or administrative or disciplinary enforcement proceedings. Procurators are not limited to consideration of serious violations and they can and do take enterprises and their managers to task for such matters as lack of labor discipline, managerial incompetence or errors, and waste or lack of efficiency. 25

The degree to which the Procuracy will exercise supervision over the ac­ tivities of private business entities is not entirely clear. Although its previous supervision of enterprise activity was, by definition, supervision of the activities of state agents, the Procuracy's powers are not limited by the governmental or quasi-governmental nature of the objects of supervision. By the terms of its statute, the Procuracy has the power to supervise the activities of private busi­ nesses and citizens as well as those of other entities. Thus, the Procuracy has nearly unlimited rights to review business records, employee and customer

256 knowledge and other information concerning the operations of businesses and individuals, and to conduct fishing expeditions for legal violations. It is not clear to what extent procurators have been exercising their powers to investigate the activities of newly formed private businesses. The most effective means for limitation of the Procuracy's role in private business affairs would be to amend the statute governing its activity to eliminate any power of general supervision over private activities, whether individual or by business entities. Another option would be to require that some minimum grounds (evidentiary standard) for investigation be met before procurators may have access to infor­ mation concerning such activities. A more comprehensive version of this option is favored by some members of the Procuracy itself, who feel that the respon­ sibilities of general supervision unduly detract from the Procuracy's functions as public prosecutor. These members of the Procuracy favor the complete elimination of the general supervision functions. While this would certainly solve the problem, it is unlikely to occur immediately, particularly given the current tendencies of lower bodies to ignore or even flout superior directives and the probable desire of superior officials to employ general supervision powers as one tool to control local insubordination. An amendment of the Procuracy's general supervision powers to eliminate its power over private businesses and individuals, however, would address the possibility for interference in business affairs without prevent­ ing the Procuracy from addressing unacceptable official behavior. If retained, the Procuracy's power of general supervision over official bodies could be put to positive use in restricting the tendency of ministries and other bodies to interfere with new economic activities. Procurators could be instrumen­ tal in prevention of attempts by ministries to protect specific enterprises or in­ dustries from competition and might also be helpful in preventing individuals or groups in positions of power from using the economic transformation process to unfairly enrich themselves. In order for the Procuracy to fulfill this function, however, the necessary laws preventing inappropriate official conduct must be in place and the relevant rights of new economic actors well defined.

(4) Criminal and administrative sanctions The Soviet state has traditionally controlled "undesirable" economic behavior by providing criminal or administrative sanctions for behavior which violates accepted norms and/or undermines the economic system. Although the severity of these sanctions has diminished somewhat over the years, there are still a number of articles of the criminal and administrative codes of most republics that give serious cause for concern. Some of these articles criminalize behavior that may be rational and economically beneficial, while others appear to define "legitimate­ ly" criminal behavior but could be of concern if interpreted too broadly. It appears likely that many of these articles of the codes will be eliminated in the next major revision of the criminal codes. This process has already begun

257 in the traditional way, with the issuance of draft Fundamental Principles of Criminal Law of the USSR and union republics. These new Fundamentals were issued in draft form for public discussion in January of 1989, and appear to envision substantial changes in the criminal law including the elimination of the differentiation between property crimes relating to state property and other proper­ ty crimes, the elimination of many economic crimes, and the recognition of reasonable risk as necessary to business and personal activities. Since the issuance of the draft version, however, it does not appear that any substantial further action has been taken on the matter and the objectionable portions of the existing criminal codes continue to stand and to hamper the economic reform effort. Prosecution under most of these articles continues, with thousands of convictions per year. Taking the RSFSR Criminal Code as an example (most republican criminal codes are very similar), there are two sections of the code which are a particular cause for concern. The first is Chapter II, which deals with crimes against socialist ownership. Although many of the crimes discussed in this section are legitimate­ e.g. theft or intentional destruction of state property-the penalties provided for such actions with respect to state property are currently vastly disproportionate to those provided for similar actions with respect to any other type of property. This perpetuates the notion that state property is of more importance than other types of property and may tend to skew the deterrent effects of the criminal law. In addition, there are a number of "crimes" in this section of the code which would seem not to merit criminal punishment and which may be subject to inappropriate interpretations. Of particular concern here is Article 100, which proscribes an "unconscientious attitude toward state property" which results in damage, destruc­ tion or theft. Such provisions provide a tempting means for criminal liability to be inferred whenever there is some kind of damage to state property. It would be of some use to eliminate the most egregious differences by means of amending the sanctions in the state property crimes sections to conform more closely to those in the general property crimes sections of the code and by repealing one or two of the most draconian articles. The second section of the RSFSR Criminal Code which gives cause for concern is Chapter VI-Economic Crimes. This chapter contains a number of articles criminalizing rational economic behavior which, because of irrationalities in the economic system, may have undesirable economic consequences. Article 153 provides for criminal punishment for commercial middleman activity, while Article 154 criminalizes "speculation"-the buying up and reselling of goods for the purpose of extracting a profit. Article 154-1 addresses the problem of irrational grain and bread pricing by criminalizing the purchase of bread and other grain products (meant for human consumption) for use as animal feed. Clearly, these articles address behavior that is, in some cases, not only not criminal but even desirable in the context of market activity. Articles 153 (com­ mercial middleman activity) and 154 define activities which are necessary to keep

258 markets functioning smoothly and to adjust the distribution of goods. While Ar­ ticle 154-1 (feeding bread to animals) deals with a rather specific subsidy situa­ tion, the desirable means to deal with the problem is a pricing adjustment rather than the criminalization of rational behavior. Other articles in the section on economic crimes deal with actions which might well remain crimes in some circumstances under market conditions, but whose scope and definition needs to be altered. For example, Article 156 criminal­ izes the deception of purchasers and customers by means of false weights and measures, false accounting, and also by the marking up of retail prices on goods or services. While the use of false weights and measures clearly constitutes criminal fraud, the matter of price markup needs to be removed from the code or redefined to limit application to the commission of fraud by retail employees. As with many of the articles in the "socialist property" section of the codes, it is clear that the new code versions, if based on the draft Fundamentals, will remove or adjust many of the articles in the "economic crimes" sections. Some of these articles, however, are very serious impediments to normal economic activity and need to be dealt with immediately by means of amendment, particular­ ly Articles 153 (middleman activity) and 154 (speculation). These particular ar­ ticles are, however, least likely to be wholly repealed immediately, because of the fear that such an action would give license to wholesale redistribution, runaway inflation, and the arrogation of state subsidies on basic goods to private persons. There exists a common belief in the need to control speculation in order to prevent inflation and to provide for a fair distribution of scarce goods. Even if it is not feasible to remove the offending articles from the code immediately, steps need to be taken to limit the chilling effect of these provisions on those who wish to engage in new forms of business using legitimate sources of supply and channels of distribution. Limitation of the articles to the organized resale of basic goods purchased at state controlled prices would be of some help in clearing the way for entrepreneurs and small businesses to engage in business activity using contract prices without fear of prosecution. In addition, the creation of a clear exception for those who provide distribution services (i.e., purchase goods and transport them to areas where they are needed) might allow better goods distribution and competition by firms located far from promising markets. There are a number of other articles in the criminal codes which may be of some concern. Article 69 of the RSFSR Criminal Code defines "wrecking"-a crime against the state which involves an act or omission directed toward the subversion of any part of the Soviet economy or state, committed for the purpose of weakening the Soviet state, by the use of a state institution or organization or by obstruction of its work. This was a common charge during the years of the terror of the 1930s and it has not been seen much in the courts since that time. Nonetheless, it is clearly subject to dangerously broad interpretation, particularly

259 in times of economic upheaval and distress, and there is no need for anything more in the code than the existing article on sabotage. Article 88 is also of some concern. Article 88 criminalizes violations of the rules for transactions involving currency. Currency violations are classified as crimes against the state (the most serious classification) and the penalties for such violations are draconian, including death for speculation in currency on a large scale or as a form of business. Given the growing "dollarization" of the Soviet economy and the recent relaxation of the rules for use of convertible currency by Soviet citizens, this article would appear to be out of date and in need of imme­ diate amendment or repeal.

The larger part of the discussion above applies not only to the various republican codes of criminal law, but also to codes of administrative violations. Administrative offenses are generally less serious versions of offenses which ap­ pear in the criminal codes, or are offenses not meriting criminalization. Most republican codes of administrative violations include articles describing conduct analogous to that which is discussed above under articles of the criminal code. For example, Article 151 of the RSFSR Code of Administrative Violations prohibits petty speculation, while Article 153 prohibits unauthorized operations with foreign currency and Articles 150 to 150-2 deal with unauthorized trade in goods. Each of the relevant articles of the administrative code will need amend­ ment or repeal in the same fashion and for the same reasons that such is required for the criminal code.

4. REGULATION OF THE BUSINESS SECTOR a. Introduction

The guidelines establish, as one of their primary goals, the creation of equal opportunities for all citizens and organizations to engage in business activities in a variety of forms, in an environment in which market forces are able to operate. According to the guidelines, this goal is to be achieved through the passage of legislation ensuring freedom of economic activity and prevention of state inter­ ference in the management of businesses and through a series of measures designed to create competition, including the rapid privatization of large portions of state property, the freeing of prices, and measures to demonopolize the economy. Achievement of these broad goals will require significant changes in legislation, for while some steps have been taken to create new legal forms of business activity, very little progress has been made in the legal area in respect of privatization, decontrol of prices, or antimonopoly measures.

260 b. Legal forms of business organization

(1) Introduction One of the primary means for reform of legal regulation of the economy used to date has been the passage of relatively comprehensive laws intended to authorize and define a new form of business activity. There has been a steady stream of such legislation, beginning with the Law on Individual Labor Activity in 1986, and continuing with the Decree on Joint Enterprises and the Law on State Enterprises in 1987, the controversial Law on Cooperatives in the USSR in 1988, and in 1990 a new Law on Enterprises, a decree on joint stock companies and companies with limited liability, and a decree creating special conditions for small enterprises. This method of legislative reform has allowed the Soviet government to create substantial new business opportunities relatively quickly and to exercise some control over the pace and direction of the development of private activity. Inevitably, however, reform of this type has produced gaps and anomalies in legal regulation which will need to be addressed if the goal of equal business oppor­ tunity expressed in the presidential guidelines is to be met.

(2) Regulation of enterprises Improvement in the functioning of enterprises has been a primary goal of Soviet economic reform efforts for nearly the entire history of the planned economy and is clearly one of the keys to the success of the reform effort as a whole. In 1987, the Law on State Enterprises was designed to begin a gradual liberalization of the rules and planning that had hindered enterprise initiative by gradually releasing planners' claims on the products of enterprises and allowing them to sell the released products at freely contracted prices to whatever purchaser they chose. The concept was one of a learning process in which the state enterprises could gain experience with market-like situations without committing all of their resources or risking the possibility of serious losses. Unfortunately, the implementation of the law did not provide the kinds of results that had been hoped for. Complaints abounded concerning the failure to release a sufficient amount of production from central control, with some concern also being expressed over the substantial rights that the 1987 law had given to the enterprise labor collectives. Subsequent amendments to the 1987 law sought to further limit central and ministerial controls over enterprise decision-making and to limit the powers of the labor collective, but results in terms of increased produc­ tion and market-based activity of enterprises continued to be unimpressive. A wide variety of factors were believed to have contributed to the poor performance, ranging from continuing interference by ministries and state organs, to supply problems, distribution difficulties, and the inhibitions of enterprise managers produced by uncertain political and economic conditions. In addition, although the law envisioned a reduction in the amount of production to be delivered to the

261 state, fear of disruption of supply chains resulted in the passage of a requirement that enterprises maintain supply relationships that had been in existence for more than a minimum term. In June of 1990, a new Law on Enterprises was enacted to supercede the amended 1987 law. By its terms, the current version applies to all enterprises, not only those that are state-owned; but in practice specific legislation concerning the formation and activities of particular types of enterprises (e.g., joint stock com­ panies) will govern the activities of other types of enterprises. As most of the "privatized" forms of business enterprise will need to be organized under one or another of the specific laws, it would appear that the newer version of the enterprise law will, like its predecessors, apply primarily to state enterprises. The new law is quite broad and general in many of its provisions and refers many of the most important questions of ownership and management to other legislation. It provides for complete freedom for the enterprise to plan its activities and production, but also states that enterprises shall provide work or services to the state according to a procedure determined by union and republic laws. At present, the law governing state orders makes such orders mandatory for enterprises, obviating the general provision in the enterprise law. Similarly, the enterprise law states that enterprises may sell their product at rates to be deter­ mined individually or by contract, but also requires that, in cases determined by union or republican law, output be sold at state prices. It further provides for confiscation of monies received above state prices and fines for failure to abide by price discipline. Thus, the enterprise law itself provides a framework for rela­ tively unobstructed decisions on production and pricing, but this freedom may be curtailed by other legislation. In attempting to pass a generalized enterprise law, the drafters of the newest version of the law may have actually hampered the movement of state-owned enterprises toward more independent and efficient behavior. The current version of the enterprise law appears to be something of a hybrid: taking great pains in some areas to protect the prerogatives of the enterprise owner, but also making reference in various articles to the independence of the enterprise itself; restricting the rights of the owner to interfere in the management of the enterprise; and defining in some detail the structure of the enterprise and its management rather than leaving such matters to the owner or board. A law directed specifically to the requirements for efficient operation of state enterprises might be preferable to the current version, as it would be able to deal more directly with the need to see that state enterprises are well organized and to prevent undue interference with enterprise operation by the central planning agencies and branch ministries. Without the need for concern that restrictive provisions might violate the rights of private enterprise owners, the law could be drafted to cover in detail the rights of public employees engaged in production work and the precise nature of ap­ propriate-and inappropriate-relationships between the management of such

262 enterprises, the owner (the state), and the owner's agents (ministries, departments, etc.). Given the fact that under current conditions the basic enterprise law appears not to be intended to apply to the vast majority of private enterprises in any case, the apparent general applicability of the law serves only to confuse matters and provides little benefit to offset the costs of failure to draft the law in a more tailored fashion.

(3) Cooperatives Without question the most active, and the most controversial, new form of business activity is the cooperative, authorized and defined by the 1988 Law on Cooperatives in the USSR. Under the law, cooperatives may be formed by groups of three or more persons and may hire labor, lease or purchase business premises and equipment, and operate on as large a scale as may be desired. Cooperatives are permitted under the law to charge freely negotiated prices for goods and services, although products or services under state contracts, using inputs provided by the state or for resale of goods purchased in the state supply network (whether wholesale or retail), are subject to centrally dictated price levels and/or permissible markups. Not long after the boom in cooperative formation, a public outcry began over the prices charged by cooperatives for goods and services and the practice of some higher quality cooperatives (especially restaurants and service coopera­ tives) of reserving part or all of their production or services to be sold to foreign citizens for hard currency. Pressure for control of cooperative activities and prices grew and in 1989 a set of amendments was made to the cooperative law, reem­ phasizing the restrictions on activities involving state-source supplies, allowing republican authorities to impose price ceilings on basic commodities regardless of the source of the supply, and placing price restrictions on imported goods sold by cooperatives. In addition, the list of activities in which cooperative businesses are not permitted to engage continued to expand, with cooperatives being banned from any business involving precious metals or stones, v;;~.rious kinds of trade in works of art, books and films, and a variety of others. Responding in part to public pressure, local and higher authorities often refused registration to cooperatives, attempted to close them or interfered in their activities in other ways. Some pressure for control of arbitrary behavior by offi­ cials began to be felt, although public and much official opinion continued to be anti-cooperative. In June of 1990, another substantial set of amendments was passed which (among other things) both reemphasized price control measures and provided various new protections for cooperatives from interference with their activities or finances, including expedited means for cooperatives to seek review of official actions. At present, cooperatives remain subject to a variety of restrictions concerning the types of activities they may engage in and the prices they may charge, many of which restrictions have not yet been placed on other new forms of enterprise.

263 If this inequality in restriction continues, business activities may move away from cooperative forms and into the forms of joint stock companies, small enterprises and others. While this may not prevent new businesses from forming, it will limit experimentation with the flexible, worker-oriented cooperative form and prepetuate unequal conditions of competition between existing cooperatives and other forms of business in which both ownership and profit distribution are more controlled and more diffused.

(4) Joint stock companies and companies with limited liability Joint stock companies and companies with limited liability may be formed according to the provisions of a decree of the USSR Council of Ministers issued in June, 1990. The decree is considered to be an interim measure, taken to permit activity related to the formation of such companies to begin, while more per­ manent legislation is elaborated. Joint stock companies and companies with limited liability may be formed by two or more individuals or entities, While the formation of such companies is thus theoretically open to most business par­ ticipants, substantial minimum capital requirements ensure that these forms will not, for the present, be used by smaller business enterprises. Joint stock companies can be created as new business enterprises, or can be formed by the transformation of an existing enterprise into joint stock company form. The companies are created through the conclusion of an agreement between the founders and the elaboration of a charter for the company and the registration of the agreement and the charter. Registration of companies must be completed within 30 days of submission of satisfactory documents and may not be refused except on the grounds of a violation of the law or failure of the submitted docu­ ments to conform to legal standards. Authorities may require the submission of additional information from persons or entities attempting to register companies in order to verify the information submitted and the 30 day time limit will be calculated from the time at which all required documents have been submitted. Failure to register the company within the required period may be appealed to a court or state arbitrazh. The decree specifies in some detail the structure of the bodies which will have authority to govern the companies (including a general meeting of shareholders, auditing commission, executive body, and optional shareholders council) and the means by which decisions shall be taken by such bodies. Quorum rates, minimum frequency of meetings, and percentage votes required for passage of various types of decision are specified, with very limited provision for alteration by the company charter. Of particular interest is the formation of joint stock companies on the basis of companies which are partly or entirely state-owned. Until the creation of the State Property Fund, this process required the permission of the relevant ministry to which the state enterprise was subordinated and the agreement of the

264 enterprise's labor collective. Since the creation of the State Property Fund, which has responsibility for the administration of state property, that body presumably has the authority to authorize the creation of joint stock companies from state­ owned enterprises. There is no restriction on the ability of ministries themselves to form joint stock companies or to retain some share of stock, and it is permissible for state bodies other than the controlling ministry to take shares in the new company and for other enterprises and organizations to be stockholders.26 While experience with the creation of joint stock companies on the basis of existing state enterprises is as yet extremely limited, it may be expected that such conversions will result frequently in the creation of companies that remain state-controlled through majority shareholders which are state bodies. 27 If there is no requirement that the ministries and state committees divest themselves of controlling interests in most such companies, control through stock ownership may be allowed to replace the more direct control that ministries pre­ viously exercised. Concerns have already been voiced concerning the possibilities for ministries to use the joint stock company form to avoid restrictions that may be placed on state enterprises that are directly owned and controlled. For example, creation of a joint stock company may allow ministries (as well as other potential owners) to avoid the requirements of the enterprise law concerning the powers of the labor collective and to dilute the power of the collective within the joint stock company by promoting worker investment on an individual basis. Of even greater interest to some ministries and state bodies will be the possibility to engage in profit-taking through dividends that would not otherwise be permissible to them. The guidelines state an intention to use the joint stock company form as a step in the process of privatizing medium- to large-sized enterprises and organiza­ tions and creating competition in the market. Enterprises are to be turned into joint stock companies, whose stocks will in tum be sold off in order to privatize them. While the sale of stocks or shares of some kind may well be the only viable means of privatizing large enterprises, there could be a number of possible pitfalls under current legislation that could be reduced or avoided. It is extremely important that privatization programs depending upon the creation and sale of joint stock com­ panies include carefully drafted restrictions on the retention and/or use of shares by ministries and state bodies. Such restrictions should prevent state bodies from retaining controlling interests in joint stock companies and using those interests to perpetuate their control over Soviet industry. The definition of controlling in­ terest will need to be quite precise, as even fairly small percentages of stock ownership may provide a state body with effective control if the remaining stock ownership is very diffused. An alternative means to prevent the maintenance of state control over joint stock companies would be to prevent the relevant state bodies from retaining any interest at all in such companies. This option would require that holding com­ panies or agencies be created to take ownership of stocks that could not be sold

265 on the market. In a similar vein, state bodies might be permitted to hold some stock in the companies, but forbidden to exercise voting powers or other shareholder rights related to the control and management of the company. Systems that do not take the ownership of the stocks, and the consequent receipt of benefits in the form of dividends, out of the hands of the state bodies entirely, however, may foster situations in which state bodies are tempted to use their authority to create advantageous conditions for companies in which they hold investments­ creating anticompetitive conditions in particular markets. Another step that would be of assistance in reducing the potential for abuse by state owners of interests in joint stock companies would be the passage of a strictly drafted state enterprise law that would define with specificity the permis­ sible relationships between the state as owner, its agents, and any type of business or enterprise in which the state has an interest, and also the structures and proce­ dures by which the commercial operation of such enterprises is to be ensured and state interference (whether to the advantage or disadvantage of the enterprise) prevented. Strict application of such a law to the relationships between joint stock companies and state bodies which own stocks could substantially reduce the problems of detrimental state controls and anticompetitive behavior by state owners during the privatization process in which the state is likely to retain sub­ stantial ownership.

(5) Small enterprises Special conditions for the creation and regulation of small enterprises or small businesses were created by a decree of the USSR Council of Ministers of August 8, 1990. The decree emphasizes the importance of small businesses in the expansion of economic activity and creation of a market and, with the purpose of stimulating small business formation, offers a number oftax and other benefits to businesses that fall within its guidelines. The recognition of the importance of small business activity is encouraging and there are some provisions of the decree that will have a positive effect. The intended scope of the decree, however, appears to be more limited than would at first appear, and may allow more state involve­ ment in small enterprise operation than would be desirable. The provisions of the small enterprise decree permit the formation of small businesses in all sectors of the economy and on the basis of all forms of owner­ ship, including state ownership and mixed ownership. In addition, any existing businesses that meet the size definitions contained in the decree are to be qualified as small businesses. The primary criterion for defining which businesses fall within the dictates of the decree is size of the work force. This criterion varies according to the sector of the economy: businesses in industry and construction qualify with a work force of up to 200 persons, in science and scientific services with up to 100 persons, in other production sectors of the economy with up to 50 persons, in nonproduction businesses with up to 25 persons, and in retail trade

266 businesses with up to 15 persons. Union and autonomous republics are permitted to establish lesser maxima for the qualifying size of the work force and may also define equivalent criteria based on economic turnover. Although the decree is not specific on the point, it is to be assumed that lower maximum limits established by republican authorities would apply to qualification of small businesses for republican level programs and would not replace the union standard with respect to businesses in that republic. Small businesses may be created by individuals, and by nearly any kind of group or entity, alone or in combination with others. State-owned enterprises and associations may create small businesses, and government bodies authorized to administer state property may create small enterprises directly. Small businesses may also be created by means of separation of a subdivision or structural unit from an enterprise or association on the initiative of the workers in that sub­ division. When this occurs, provision must be made for the subdivision to meet its contractual commitments, steps must be taken to avoid reduction in budget revenues, and the enterprise or association, rather than the workers group, will be considered to be the founder of the business. In effect, a small business is created by creating any business entity that conforms to the size limitations, since coopera­ tives, joint enterprises, joint stock companies, and other business entities which are defined by separate legislation may also be considered to be small businesses for purposes of receipt of the benefits of the small business legislation. The decree also authorizes the creation of small enterprises which do not fall within other categories of business. Such enterprises may be established by registration of a charter with the local authorities. 28 The registration process itself is subject to a two week time limit from the date of submission of registration materials and the grounds for refusal to register a small business would appear to be limited to violation of the formation procedure or failure to comply with re­ quirements for valid registration documents. A founder who has not received his documents back by the two week deadline, or who has received an unjustified refusal, may appeal to the courts or state arbitrazh. 29 Small businesses which are created as joint stock companies, or in other separately defined forms of legal organization, must adhere to the legal require­ ments of those forms as defined in the relevant law. With respect to small busi­ nesses which are not regulated by other legislation, internal operations and .relationships are not defined with the specificity found in the laws defining most of the other forms. The decree states no requirements with respect to the manage­ ment structure or ownership distribution within the small business and stipulates that the relationship of the small business to its founder shall be determined by its charter. With respect to conduct of its economic activities, the decree states that a small business is independent with respect to disposal of its products and its profits, but later states that the products and work of small businesses must be realized at the prices and rates determined by legislation. It would thus appear

267 that the small business form will allow freedom with respect to use of proceeds, but not allow businesses to operate outside state price controls for any product to which they apply and will not serve as a vehicle for developing market relations on a more realistic price basis until prices are generally decontrolled. The decree creates a number of special privileges for small businesses designed to encourage their creation and growth. These include an exemption from payments into the budget from income (i.e., a tax exemption), with the exceptions of cooperatives which are required to pay the taxes normally levied on them, and those small businesses which already exist, which must continue to pay in the same fashion and at the same rate as previously. Accelerated depreciation is per­ mitted for small businesses and the decree authorizes the creation of special funds for assistance to small businesses, on either a private or state basis. Such funds may offer advantageous loans and other forms of financial support. In addition to the funds, the decree requires or authorizes the creation of various state organiza­ tions which will assist small businesses with training, construction of facilities, foreign trade, and other matters.

The special privileges granted to small businesses and the lack of specific regulation of their internal structures and activities has reportedly encouraged entrepreneurs to favor the creation of new business endeavors as registered small businesses, rather than in cooperative or other form. The degree to which this decree has been or will be successful in stimulating new business activities, how­ ever, is not clear.

Several improvements and clarifications could be made in the decree, or incorporated into a law on small business if such were envisioned. First, the relationship of the decree to state bodies and state-owned or state-controlled enterprises and organizations should be better defined and may need to be altered. The unstructured nature of the relationship between the founder of a small busi­ ness and the business itself invites abuse by state bodies wishing to avoid the noninterference restrictions that are contained in some other legal provisions. The provisions concerning the creation of funds to assist small businesses open the possibility that state-created and state-owned small enterprises will be assisted by means of these funds, allowing portions of enterprises (or whole small enterprises) to avoid a hard budget constraint and/or to compete on advantageous terms with other private enterprises. It is not clear that there is any substantial benefit to be gained by fostering the creation of new enterprises-of whatever size-that will be under the control of the old state administrators, and it may be appropriate to limit the creation of small enterprises to those involving private individuals and entities, or perhaps mixed entities. A less drastic means to address this problem would be the application of a strict law on state enterprieses--ensuring the inde­ pendence of state-owned enterprises from state bodies-to any small business owned or controlled by the state or another state-owned entity. 30

268 Although the version of the decree available at the time of writing permits the establishment of small businesses in any sector of the economy, it assigns priority to the fostering of businesses concerned with production of consumer goods and provision of consumer services, production of construction materials, accelerated development of new equipment and technologies, and the solution of ecological problems. While the development of small businesses in these areas would certainly be beneficial, small business should also be encouraged to form in the areas of business and industrial services/' transportation, and wholesale trade, as well as in service sectors that could contract with government bodies to perform some of their functions. Privatization and demonopolization in these areas must occur quickly in order for the independent business community in general to be able to function and for markets to develop. The encouragement of small businesses which would serve these needs should be given at least equal priority with those mentioned in the decree. There is no clear reason for cooperatives to be denied the tax benefits accru­ ing to new small businesses and to be thus disadvantaged with respect to their competitors. If a tax holiday is desired only with respect to newly formed busi­ nesses, this could be provided for in the legislation, but the general provisions of the legislation should apply equally to all forms of businesses. Finally, it is important to note that the general conditions under which small businesses created under the provisions of the decree will operate are quite similar in a number of respects to those under which cooperatives have operated for the past two years. There are no restrictions on the distribution of profits within the businesses, and they are being encouraged to operate in many of the same sectors in which cooperatives have operated. Like cooperatives, it is to be expected that many small businesses will form, at least in the short term, in sectors of the economy in which limited investment is required and in which supply conditions and pricing requirements allow business owners to take substantial rents and to quickly recoup their investments. It is thus quite possible that the same kind of regulatory frustration concerning lack of visible investments and infrastructure improvements and public frustration with high prices and high incomes for employees that has been directed at cooperatives will arise with respect to private small businesses as well. In order to allow these businesses to make contributions to the economy and to assist in the formation of a market, state bodies must resist pressures to restrict their activities or to regulate their profits and incomes through high taxation.

(6) Individual business activities The Law on Individual Labor Activity, passed in November 1986, was in­ tended particularly to expand the involvement of individuals in the production of handicrafts and consumer goods and the provision of services. It contains lists of specifically authorized and specifically prohibited production, service and cultural

269 activities, as well as a general statement that all activities in the relevant spheres which are not specifically prohibited are to be considered legal. The scale on which such activities could be conducted, however, was clearly intended to be strictly limited. No activity, according to the terms of the law, could involve the use of hired labor or the extraction of "unearned income" or other detriment to social interests. The law required that citizens obtain permission from local authorities to engage in such activities and gives substantial leeway to local offi­ cials to set conditions and fees for licensing and registration, although a refusal to issue a registration could be appealed to administrative bodies superior to that which issued the refusal. Until August 1990, the rights of individuals to engage in business activities continued to be rather restrictively defined by the 1986 law, although groups of three or more individuals were authorized by the Law on Cooperatives in 1988 to establish substantial business operations and to hire a labor force. This main­ tenance of stringent restrictions on individuals was echoed by the continuation of restrictions on individual property ownership, individual use of banking and finance facilities, and other similar restrictions. This anomaly with respect to business activities now appears to have been at least partially addressed by the August 1990 Council of Ministers decree on small enterprises, discussed above, which envisions the creation and chartering of small enterprises by "citizens, family members, and other persons jointly engaged in labor activity." Taking the provisions of the decree on small enterprises at face value, the inclusion of individuals in the decree would appear to render the restrictions on individual labor activity contained in the 1986 law essentially moot. The decree states that "individual...and other types of small business-the procedure of whose creation, activity, and liquidation is not regulated by special legislation-are guided by this ordinance and their own charter." Such language would appear to indicate that the provisions and restrictions of the Law on Individual Labor Ac­ tivity are not intended to apply to small businesses chartered and run by in­ dividuals. While this would bring restrictions on individual activity more into line with those applying to business activity pursued by groups, it would seem to produce a different type of anomaly, in that the restrictions on types of activity that previously applied to both cooperatives and those pursuing individual labor activities would effectively apply only to cooperatives.

(7) Dissolution, reorganization and insolvency of business entitities Some of the laws discussed above contain provisions which permit both the founders or owners of a business entity, and also agencies of the state under certain conditions, to order the dissolution of a business. The provisions applying to most currently existing business entities are contained in Article 37 of the 1990 Law on Enterprises, which provides generally for the liquidation and reorganization of enterprises. The Article provides for an enterprise to be liquidated or reorganized

270 on the basis of a decision made by the owner of the property of the enterprise, the state organ authorized to create the enterprise, or by decision of a court or state arbitrazh, but does not stipulate the grounds on which such a decision may by made, or any conditions under which it must be made. The Article goes on to state that if the reorganization or dissolution of the enterprise could cause conse­ quences (ecological, social, demographic, or other) affecting the interests of the population of the territory on which it is located, the reorganization or dissolution must be coordinated with the corresponding local council of people's deputies. Unfortunately, no guidance is provided concerning the "coordinating" role of the local soviet in reorganization or dissolution. The Article goes on to specify other cases in which an enterprise may be liquidated, including when it is declared bankrupt, when it fails to meet conditions established by legislation or fails to make necessary changes to conform to the law within an allowed time period, when its charter documents are declared in­ valid by the court, or for other reasons provided for in legislation of the USSR and union or autonomous republics. Although these instances would appear to be grounds for a court- or arbitrazh-ordered liquidation of an enterprise, the provision is separate from that allowing dissolution or reorganization by order of the court or arbitrazh and the relationship of the two provisions is not clear. No definition of bankruptcy is provided by the law and no information on the procedures by which an enterprise may be declared bankrupt or the persons and institutions which may institute and/or participate in that process. No guidance is provided concerning the types of additional conditions for reorganization or dissolution that may be required by further legislation at the union or republican levels. The Law on Cooperatives in the USSR, as amended to date, provides far more specific provisions on insolvency and reorganization. Article 23 now provides that a bank which has issued a loan to a cooperative may recall its loan as a whole if the cooperative violates its payment schedule, although the coopera­ tive is provided with a right of appeal. A cooperative which has not met its commitments may be declared insolvent by the bank in which it holds its running account, and after six months of insolvency the bank is permitted to raise the question of liquidation of the cooperative to the local soviet which registered it. While these provisions would appear to give substantially greater certainty to questions of procedure with respect to insolvent cooperatives, they would also appear to be substantially harsher than the provisions related to other types of business entity, which do not grant banks similar leverage or provide for specific periods within which decisions to liquidate may be proposed to local authorities. Even these provisions, however, do not contain standards by which banks or local authorities are to exercise their discretion in such matters or make decisions con­ cerning liquidation or reorganization. The decree on joint stock companies and companies with limited liability provides for winding up of the company in cases in which its foundation docu-

271 ments specify a limited life for the company, its stated objectives have all been achieved, a decision is taken by the highest body of the company, or when a court or state arbitrazh decides that the company is insolvent. The decree provides that decisions of the court or state arbitrazh are to be made upon representation of the appropriate financial or banking authorities, but does not provide guidance as to the nature of insolvency which would justify winding up the company, the stand­ ards for permitting or requiring reorganization rather than closure of business activities, or other relevant matters. The decree does make specific provision for the creation of a liquidation commission and deal with the priority of some creditors. Comparison of the relevant provisions in different laws and legislative acts suggests that there is a need for bankruptcy legislation defining the procedures under which businesses may or must declare bankruptcy, or may be declared bankrupt by others, and the procedures for examining the affairs of an insolvent or threatened business and determining what actions should be taken. In some cases, particularly during the transition period, it may be appropriate for the authorities to provide temporary protection of business entities from creditors in order to allow them to adjust to new conditions and/or to restructure their ac­ tivities. In others, particularly where the business entity in question is a state enterprise, it may be necessary for bankruptcy legislation to enforce standards requiring either dissolution or reorganization of insolvent enterprises within desig­ nated time periods in order to prevent indefinite subsidization of enterprises through state budgets and the resulting inefficient use of resources and anticom­ petitive effects in the relevant market. In all cases, bankruptcy legislation should provide uniform standards requiring and/or allowing declarations of bankruptcy, presentation and approval of reorganization plans, and payment of creditors, as well as uniform procedures for conducting bankruptcy proceedings and a means for such proceedings to be publicly registered as notice to existing and potential creditors of the business.

(8) Conclusions and recommendations

There are a number of ~onditions commonly thought to be necessary for businesses, of whatever legal form, to operate in an efficient manner within a market. These conditions include the maintenance of relatively equal conditions for competition among businesses and relative freedom for businesses to choose the prices at which they are willing to buy and sell goods, and the existence of suitable institutional frameworks and supports for businesses to be created and defined. The guidelines recognize the importance of each of these factors and express strong intent to create the necessary conditions. The elimination of price control can be accomplished through a combination of the removal of products from price control lists, the redefinition of the powers

272 of price-setting agencies, and the movement of business activities into forms not subject to price controls. The creation of relatively even conditions for competition between busi­ nesses is also a complicated matter, and one that receives top priority in the guidelines. The guidelines suggest that a presidential decree on the freedom to engage in business or entrepreneurial activities will be issued in the near future which will protect the right of all individuals and entities to engage in business activities. While this might be helpful in clarifying the situation of those groups whose rights to engage in business are not clear, and particularly in clarifying the rights of individuals with respect to business activity, the creation of equal con­ ditions for such business activity is at least as important as the simple estab­ lishment of the right to engage in such activity in general. Perhaps the most important step that could be taken in regard to the equaliza­ tion of conditions for business activity would be the passage of a clear and detailed law concerning the relationship between the state and its employees and agencies and any business, enterprise, or commercial organization in which the state has an ownership interest. Such a law could clearly define the permissible and imper­ missible relationships between state-owned entities and state bodies, providing a defined management structure with specific safeguards against interference (whether helpful or harmful) in the financial or business affairs of the enterprise. Properly drafted and enforced provisions of this type could be of great assistance in eliminating some of the most troubling inequities in the current conditions for market activity, including subsidization and the absence of a hard budget con­ straint for many state enterprises and anticompetitive behavior by state bodies designed to advantage particular enterprises. While the application of such a law could not be instituted across all sectors immediately, and certain exceptions might have to be made/2 it would be a very substantial step forward in the creation and protection of market competition. A number of inequalities are caused by differences between and among the laws applying to particular business forms. While some of these differences relate to legitimate differences in the ways in which such forms should function, a number are not necessary and should be eliminated. Examples of these types of differences include the substantial restrictions on activities of cooperatives and their exclusion from the tax benefits provided by the decree on small businesses, and the apparent restriction of individual entrepreneurs to the small business form and thus to the size limitations on small businesses. The history of the cooperatives is an excellent illustration of another source of inequalities in business conditions. The problems experienced by the coopera­ tives in relation to interference by local authorities indicate the importance of providing protection to new businesses against inappropriate attempts at regulation or intimidation. In addition, the history of regulation of cooperatives shows a disturbing tendency on the part of legislators to respond to difficulties and to

273 public dissatisfaction with broad restrictions removing problematic activities from the purview of independent businesses. Such a response has allowed legislators to avoid the necessity of specifically identifying the causes of the problem and designing means to address it. If conditions for business activity are to be equal­ ized across all types of business form, however, and if independence of business activity is to be increased for all types of business organization, this response to regulatory problems will no longer be acceptable. Legislators will need to develop more tailored means of regulating undesirable business behavior, such as reporting requirements or licensing and inspection systems, which can be applied equally to all businesses.

Finally, the technical and institutional structures for effective regulation must be in place. One of the most important of these, particularly during the transition period, is a reliable mechanism for reviewing laws and regulation to identify inconsistencies and anomalies and to see that they are addressed. Reliable means for obtaining information concerning new laws and regulations must be available to participants in market activity so that they can regulate their conduct accord­ ingly. This would require an effort to ensure that all the legislation, regulation, and normative acts relevant to the conduct of business are contained in publica­ tions with a suitably large circulation and availability. Systems for efficient registry of businesses and the property they possess are absolutely necessary and do not yet appear to exist. In each of these areas, technical assistance in the form of training in information control and analysis, computerization of data bases, means for maintaining a permanent and useful record of business registrations, and other matters will be required.

c. Legal framework for privatization

(1) Introduction

Although the need for a substantial privatization of state property has been acknowledged by both the union and some republican governments, no specific policy or program, and no legislation, has yet been announced with respect to the means, conditions, and pace of privatization. While some of the laws concerning business forms do provide a means for privatizing particular state assets or enterprises, these laws are not supported by any special conditions intended to assist in their use as privatization vehicles and there is no requirement that state property be made available for privatization through these means. The guidelines place considerable emphasis on a privatization program in creating a market, but they provide little in the way of a coherent program.

274 (2) Privatization through leasing The primary means of privatization of state property under current law are the use of lease-purchase arrangements, the outright purchase of state property, and the creation of joint stock companies. While there does not appear to be any official record of the amount of property "privatized" through each means, the lease-purchase method may have accounted for a large portion of the movement of state property into private hands. According to figures provided by the newly established Union of Leaseholders, seventy percent of leasing agreements include a right to purchase the asset leased at the end of the term at a price which is fixed at the beginning of the leasing arrangement. Although many leasing arrangements are small businesses or involve the lease of facilities by restaurants or providers of services, such arrangements are said to include leases on some very large enterprises and firms.

(3) Privatization through joint stock companies It is possible under the terms of the decree on the creation of joint stock companies for this vehicle as well to serve as a means of privatization of enterprises. As the decree itself was issued only a few months ago, little activity has yet taken place under its terms and it is somewhat early to evaluate its use as a privatization tool. Joint stock company creation under current conditions, how­ ever, appears likely to lead to the creation of mixed-ownership companies, often with continuing effective state control. Indeed, complaints have already appeared that the joint stock companies in particular, as well as other new forms of business organization, serve simply as a ministerial dodge in that they allow ministries to shift enterprises into a "quasi-private" legal form and thus entitle themselves to dividends and returns as owners without losing control over the enterprise. Should the ministry be willing and able to sell its shares of the stock, the joint stock company could become a completely private entity, but the likelihood that this will occur frequently is small and the ministry's ability to sell off its stock may now be subject to approval from the State Property Fund discussed below. Some larger enterprises have expressed an intention to avoid these issues by first moving their operations to a leasing basis-removing the state or ministry as a participant in their business activities except in the role of lessor-and thereafter creating a joint stock company without state or ministry participation. Whether or not these plans are ultimately successful, they in fact rely not on the creation of the joint stock company but on the leasing arrangement itself to remove state ownership and/or control of the property involved.

(4) The state property funds Legislation at the union level has recently created the USSR State Property Fund-an organization with broad responsibility for the care and management of

275 state property. The legislation simply creates the Fund itself, without providing any information on the procedures by which it will operate or the limits, if any, on its discretion. The Fund has the capacity to value and to dispose of state property, but the terms and procedures by which such valuation and disposal are to proceed have not yet been defined. As it is likely that the union-level State Property Fund will have jurisdiction only over property owned or controlled by the union government, it would appear necessary for coordinate institutions to be formed at all other territorial levels at which independent property ownership exists before comprehensive privatization can take place. This would certainly include the union republics, and would likely include the autonomous republics as well. 33 It might also be necessary to create such bodies within larger cities. The issue of the level at which state property is owned must be resolved before the organs of the state can begin to transfer the relevant ownership rights. Under current Soviet conditions, this promises to be a difficult and divisive process that is likely to consume a substantial amount of time and energy. In order for any privatization to proceed in the short term, it may be necessary for lesser agreements to be reached among the relevant state bodies, allowing the various territorial authorities to dispose of particular properties where the territorial owner­ ship can be agreed upon.

(5) Further plans for privatization The guidelines recognize the importance of private (i.e., non-state) owners in the economic structure and their role in protecting not only the operating revenue of businesses, but also their net worth. They place heavy stress on a program of commercialization and privatization as a key component in estab­ lishing a real market economy. Although they do not provide any significant amount of detail about the process to be used for privatization, there are a few indications concerning the way in which it might proceed. According to the guidelines, privatization would take place first in some priority industries in which it is most desirable to create non-state businesses. These industries include commerce, restaurants, consumer services, repair and construction, and small businesses. However, although privatization of these small enterprises is stated as a priority, no particular means for conducting such privatization is specified in the guidelines. No specific mention is made of any priority on the privatization of transportation or other services related to business activity. For medium- and larger-sized enterprises, the guidelines envision a privatization process that will begin with the transfer of those enterprises into joint stock company forms. The guidelines are silent, however, concerning any limita­ tion on the amount of stock that may be held by the state or by a state-owned business entity and any need thereafter to sell off the stocks in such companies. Special concern is expressed about the need to avoid "legalization of wealth obtained illegally" and the guidelines state that there must be strict monitoring of

276 the process to prevent this from occurring. No further information is provided about the possible monitoring process, but the statement raises the ominous spectre of state use of the privatization process to identify and confiscate profits from illegal (or previously illegal) activities through some kind of a "source test" for funds used to buy property. Any attempt to use the process in this way is certain to have a substantial chilling effect on public willingness to invest. Further, it might well be argued that the illegally obtained wealth would be more produc­ tive and better controlled if allowed to enter the normal business sector, where its activities could be regulated and its profits taxed, instead of being forced to remain in illegal channels. In connection with this issue, the guidelines state that priority for purchase of property and stocks is to be given to worker groups and their members. It is not clear whether this indicates an intention to create a preference for purchases by workers in a given enterprise of stock in that enterprise, or whether a broader preference is envisioned. While the point is not explained, the reference suggests that individual investment in state property, even if not subject to a source test regarding the money used for purchase, may be discouraged or disadvantaged. The guidelines state that workers groups and their members will be given assis­ tance for property and stock purchases in the form of discounts, loans, installment sales, and the use of enterprise funds. With respect to authority to conduct the privatization program, the guidelines state that the programs themselves-that is, the determination of the goals, prin­ ciples and direction of the privatization-will be issued by decrees of the President at the union level, and by the supreme governmental authorities of the union republics. All concrete procedures connected with the process at the union level will be handled by the USSR State Property Fund, and the guidelines call for the creation of similar agencies in the republics. There is no mention of the need for decrees to be issued or agencies established at any levels lower than the union republic and no hint of the procedure by which the level at which particular pieces of property are owned is to be determined. As the guidelines call for complete republican sovereignty over property and the specific identification of union property as a part of the process of conclusion of a new union treaty, it may be assumed in their discussion of the privatization process that this division will already be complete. 34

(6) Conclusions and recommendations In order for the goal of substantial privatization contained in the guidelines to be met, a number of legal steps must be accomplished and several pitfalls avoided. Of first importance in the privatization process is the determination of owner­ ship for state property. Little property can be privatized on a stable basis if the threat of confiscation of the property by a competing state body exists. Whether

277 this process takes place through the conclusion of a new union treaty or through some other means, it must occur before the privatization process can begin in earnest. In the interim, before the matter as a whole is resolved, some privatization could take place with respect to property for which the locus of ownership is clear. In order to facilitate these processes, it might be helpful for an interim process to be established by which a prospective purchaser could obtain the explicit agree­ ment of union and republican offices that a piece of property could legitimately be transferred by a particular state property fund. It might be possible for the funds themselves to be given the power to come to agreement on these matters, at least with respect to a limited group of properties.

Once ownership of property is established, the relevant owners should im­ mediately develop specific plans for privatization, together with the financial and other means to support them. While it may be considered desirable to ensure that workers within a particular enterprise have ample opportunity to invest, privatiza­ tion plans which provide assistance and installment-purchase options only to workers' groups may not produce the kind of response necessary to privatize large sections of the economy. Such plans may also cause inappropriate valuations of properties (by disfavoring or excluding some bidders) and may lead to their inef­ ficient use. The guidelines' stated commitment to equal conditions for all in con­ ducting business operations will be much less meaningful if the conditions of privatization are strongly skewed toward particular forms of ownership and con­ trol. Individuals and other groups must have adequate opportunities to purchase state property. In connection with this, the privatization process should not be used as a means to identify and confiscate illegally earned income.

If privatization is conducted in the absence of antimonopoly measures, valua­ tion of enterprises currently holding monopolies will be difficult and monopoly behavior by newly privatized enterprises may lead to irresistible pressure for state controls or limitations on privatization. The elaboration of privatization legislation must be closely coordinated with the creation of antimonopoly legislation, and the practices, procedures and powers of the State Property Fund connected in part with those of the antimonopoly enforcement agency.

Priority in privatization should be given not only to small shops and enterprises in the retail, restaurant and consumer services industries, but also to industrial and business services, wholesale trade, and trucking and other industrial transport. Even small endeavors in these sectors may make substantial inroads into state monopolies, and the availability of these business services is vital to the survival of other privatized companies. Priority should also be given to the estab­ lishment of competitive bidding systems for the supply of state orders and the use of competitively awarded service contracts to meet state needs.

278 d. Antimonopoly law and policy

(1) Introduction Antimonopoly and/or fair competition law, although not an initial focus of reform efforts, has been receiving an increasing amount of attention by legislators and policy-makers in recent months. While drafts of antimonopoly laws have been produced at both the union and some republican levels, there is still substantial confusion over the proper direction of policy and the precise nature of the func­ tions to be fulfilled by the antimonopoly enforcement body. In the interim, a decree of the Council of Ministers of the USSR provides for some general an­ timonopoly powers for union and local authorities.

(2) Barriers to entry In order for deconcentration of Soviet industry to occur, a variety of existing barriers to new entry must be removed or reduced. These barriers include price controls, foreign trade and foreign exchange restrictions, lack of infrastructure, and cartel activities by existing enterprises. In terms of services, the current poor state of Soviet transportation, telecom­ munications and postal communications stands out as an impressive barrier to the creation of new enterprises, as does the lack of development of financial and other supporting sectors. The ability for firms easily to communicate and transport goods is necessary for all business to function efficiently and is particularly neces­ sary to new entrants who will initially work without established supply and transportation networks and firm business connections. State monopolies in these sectors will need to be dismantled quickly. Transportation is particularly important for its ability to permit entry by existing firms into new geographical markets and create competition almost immediately. In sectors such as road freight transpor­ tation, privatization and demonopolization should therefore move as quickly as possible. In order to support the emergence of private road haulage companies, needed infrastructure including terminal and warehouse facilities will have to be constructed. New entry may also be stymied by the anticompetitive conduct of existing firms. Associations of enterprises, permitted under the 1990 Law on Enterprises, have reportedly already begun to coordinate their conduct to limit entry. For example, it has been alleged that an association of approximately 25 large state enterprises in Leningrad, involved in many industrial sectors, was able to block new entry by denying inputs to new firms. 35 In addition to such broadly based exclusionary conduct, associations composed of horizontal competitors pose ob­ vious dangers of cartel conduct, and appear to be permitted or even fostered by the existing law. Article 3(1) of the Law on Enterprises provides that enterprises may join together into associations "for purposes of coordinating their activities" and that "[by] a coordinated decision of the enterprises the association may be

279 made responsible for centralized performance of certain production, economic and other functions." While this article also requires that the associations abide by the terms of antimonopoly legislation, there seems to be the risk of at least confusion as to the extent of horizontal cooperation permitted. Because horizontal coopera­ tion poses the gravest risks of anticompetitive effects, an effort needs to be made to clarify and limit the types of conduct permitted through associations. Legally mandated product standards may also serve as an entry barrier. Man­ datory quality standards already exist for many industrial and consumer goods and it has been suggested that higher standards would soon be set, at least for con­ sumer goods. Although the level required by currently existing standards appears to be quite low, the effects of such standards should be examined and caution should be used in setting new standards in order to avoid unintended anticompeti­ tive effects. Mandatory standards (apart from standards affecting health or safety) may well pose a barrier to entry by new firms capable of producing products acceptable to some consumers but not of meeting the standards. Voluntary stand­ ards, on the other hand, can be useful and can help competition and new entry in appropriate circumstances, especially in a market such as the USSR where the brand names of the numerous new entrants will convey little information to con­ sumers about product quality.36 A number of provisions of existing criminal codes criminalizing private enterprise are extremely serious barriers to entry, as to any private business ac­ tivity, and must be amended or repealed. In particular, articles which prohibit private entrepreneurial activity, activity as a commercial middleman, and specula­ tion, need to be addressed in order for potential entrants to come forward.

(3) Draft antimonopoly legislation A draft set of Fundamental Principles of Antimonopoly Legislation was due to be submitted to the USSR Supreme Soviet before the end of 1990. In the interim, the Decree of the Council of Ministers of the USSR Concerning Measures for the Demonopolization of the National Economy, promulgated on August 16, 1990, provides the basis for the creation of an antimonopoly agency and the beginnings of its activities. Both the Decree and the draft.Fundamentals draw on the main lines of com­ petition legislation in Western countries. The abuse of dominant position, cartel agreements, unfair competition, discrimination, and anticompetitive mergers are all prohibited under their provisions. In addition, provisions not typically seen in the West are included in the Fundamentals, particularly the power of the An­ timonopoly Committee (AMC) to break up dominant firms without regard to specific conduct. Articles 7-11 of the draft Fundamentals and Article 4 of the Decree spell out the purposes, powers, and functions of the AMC. Neither the Decree nor the

280 Fundamentals, however, include provisions specifying the details of the AMC's form and staffing, and the status of the AMC thus remains vague. Dominant position is defined in Article 2 of the draft Fundamentals as "an exclusive position of a market participant granting him an opportunity to exert a decisive influence on the level of competition in a certain market or to limit the freedom of economic activity by other participants in the market." It is unclear whether the firm must have both an exclusive position and usable market power or whether the two are equated. The provisions of the Decree suggest that a threshold share of the market will be considered sufficient to constitute a dominant position, while firms below that share may be considered to have a dominant position only if they have both a minimum market share and usable market power. The Decree provides that firms with a market share exceeding 70 percent are dominant and those with a share of from 35 to 70 percent may be considered dominant "depending upon their opportunities to exercise decisive influence in each concrete case .... " Article 3 of the draft Fundamentals prohibits a firm from abusing its dominant position by suppressing competition through production limitations, refusals to deal, price increases, tie-ins and other means. It is not clear whether the suppression of competition itself must be proved or whether it is presumed once it is shown that the dominant firm has engaged in prohibited conduct. For at least some of the violations enumerated above, (e.g., tie-in sales) an anticom­ petitive effect need not arise in the market for the second good even though the firm has, by definition, a dominant position in the market for the first good. For other conduct, (e.g. withholding goods to create a shortage), an anticompetitive effect (the creation and capture of rents) should follow from the conduct, given the existence of a dominant position. Cartel agreements (agreements between market participants) are prohibited by Article 4 of the draft Fundamentals and Article 2(b) of the Decree. Such agreements are prohibited and void if they are aimed at anticompetitive market division, creating barriers to entry, fixing uncontrolled prices to gain either high profits or the elimination of a competitor, or bid-rigging. The draft Fundamentals would permit such agreements to be approved by the AMC where they increase efficiency or output or promote exports. Unfair competition, including false label­ ing, false statements about a firm or its products, false or deceptive claims about a product, incorrect comparative advertisements, unauthorized use of a trademark, and unauthorized use or disclosure of confidential information, are also prohibited by both the Decree and the draft Fundamentals. The draft Fundamentals prohibit state bodies from applying discriminatory or exclusive conditions to firms, if those conditions restrict competition, or from directing firms to give priority to particular customers. Such bodies are also prohibited from attempting to limit the independence of firms in selling their output or concluding among themselves agreements which limit competition. An-

281 tidiscrimination is treated more simply in the Decree, which states that competi­ tion-limiting discriminatory or prejudicial circumstances must not be established against "participants in a given market." With respect to the conduct of state bodies, the Decree states that "central economic organs, ministries and depart­ ments" of the union are immediately relieved of the task of "direct guidance of the fulfillment of ongoing economic tasks" and of the administration of enterprises and organizations. This article is placed in abeyance, however, pending stabiliza­ tion of the economy and a legislative sorting out of union-level administration. Article 19 of the Fundamentals gives the AMC control over the creation, reorganization or liquidation of large-scale market participants ("large" being un­ defined), with the right to prohibit such moves if they may lead to a dominant position or other restraint on competition and to make exceptions where there are countervailing efficiency, output, or export gains. Where a dominant firm already exists, the AMC is empowered to break up the firms, apparently without regard to conduct. Under the terms of the Decree, a firm with a greater than 20 percent market share may not hold shares in a competitor, while legal persons holding a controlling interest in a firm with a greater than 20 percent market share may not hold a controlling interest in the shares of a competitor of that firm. The Decree permits ministries and departments of the USSR and of republican and autonomous region governments and even the executive councils of local govern­ ments to break up highly monopolized enterprises and organizations, if allowed by productive and technological circumstances and where "the economic ex­ pediency of the reorganization is apparent." In addition to powers of reorganization and merger control, the draft Fun­ damentals provide the AMC with the power to issue orders directed to the cessa­ tion of a violation, to the restoration of the status quo, to the restructuring or breakup of a firm, to the disgorgement of "illegally gained profits," and to impose fines for slow compliance or noncompliance with orders. Forty percent of fines and disgorged profits are to go into a fund for the promotion of competition. Consumers or firms may also enforce the provisions of the Fundamentals by bringing private actions for damages against firms or bodies which act in violation of the antimonopoly legislation. These actions may be brought either in court or state arbitrazh.

(4) Conclusions and recommendations Several issues are highly important in the development of competitive markets in the Soviet industrial sector. First, anti-cartel provisions must be clearly and vigorously applied. It is crucial that enterprises not fall into comfortable patterns of behavior guided by their association, rather than engage in vigorous competition. Horizontal associations, in particular, pose threats in both upstream and downstream markets as the firms can combine into either sellers' or buyers' cartels.37 Moreover, if such associations are in fact buyers' or sellers' cartels, that

282 fact will surely push their counterparts to organize similarly, further decreasing efficiency by creating a chain of monopolies. The risk of cartelization through the association structure is sufficiently great that clearer provision regarding permis­ sible association may need to be provided in both the antimonopoly and the enterprise laws, and the new antimonopoly authority should consider restructuring existing associations into competing groups. An issue that is not well treated in the existing Decree or draft laws is the distinction between vertical and horizontal restraints. There is the strong pos­ sibility that competition-promoting vertical restraints, in particular by small firms or new entrants, will be prohibited under the Soviet law given that decision­ makers will not be well equipped to make the necessary distinctions between intra­ and inter-brand competition. From this point of view, it would be useful for the fundamentals to be more explicit as to the types of agreements which are prohibited and the types permitted, and to distinguish explicitly between vertical and horizontal agreements. The use of some non-exclusive examples would not make for elegant drafting but might serve to educate courts and enterprises quickly and directly as to what standard of conduct is expected. Another area for close attention is certain abuses of dominant position, par­ ticularly in the area of refusal to deal. Given the highly vertically integrated nature of Soviet industry, entry at any level of a monopoly sector may be difficult or impossible if the monopoly firm controls needed inputs or is the sole or major market for output. If the monopoly firm refuses to deal with the new entrant, that entrant will be forced to enter at all levels of the vertical structure, raising the costs and risks of entry substantially. Given the already great risks of doing busi­ ness in the USSR and the undeveloped nature of the financial markets which would have to finance that entry, such a strategy of refusing to deal with new entrants could well be successful. Related to the refusal to deal issue is the question of the terms imposed by a dominant firm in transactions with entrants at some level of the vertical structure. While the imposition of price controls on even monopoly firms may distort price signals, attention should be paid to prices aimed at impeding entry of new com­ petitors. The application of restructuring powers may need to be limited to certain well-defined situations. It is easy to see how restructuring should be applied where the issue is the breakup of an association, or where there are a number of inde­ pendent producers or unrelated products grouped into one firm. It is not at all evident, however, how a monopoly based on a single assembly line could be constructively broken up. In such cases, the focus should be on encouraging new entry. Merger control is not a focus of the Fundamentals, perhaps out of a belief that the immediate issue is breakup of firms rather than merger. As soon as breakup occurs, however, firms will seek to merge, arguing that they are not

283 efficient or viable as divided. This claim will be correct in some cases. The AMC needs to anticipate this and develop procedures for reviewing the mergers that will arise. In particular, criteria need to be developed, to define the mergers which will need to be cleared by the AMC. Such criteria will have a double benefit: firms which do not meet the criteria will be able to register without question and the AMC will not be inundated with more merger proposals that it can handle, paralyzing both the AMC and the registration of the firms. A related merger issue concerns the relative powers of the union-level AMC and republican AMCs. The law must state clearly which body has the responbibility to review particular mergers and what the relationship of the bodies to one another will be with respect to supremacy and preemption. The antimonopoly law will be applied, in part, through proceedings in court or the arbitrazh system. Many of the provisions of the law, however, require decision-makers to perform sophisticated economic analyses with which they are unfamiliar. Judges and arbiters will have had little or no experience with competi­ tion and free market economics and probably will not have access to the extensive antitrust literature which is available in the West. It may be appropriate to create a specialized tribunal for hearing these matters, whether brought by the AMC or by private parties. Creation of such a specialized tribunal would greatly simplify the task of training the decision-makers and supplying them with the background materials which they will need. Penalties for violations of the Fundamentals appear to be weak in several ways. First, penalties for violation of the substantive prohibitions, especially the anti-cartel provisions, may need to include the possibility of imprisonment, given the grave effects of the offense on the economy, and the upper limit on fines raised substantially. Second, the investigative powers of the AMC appear to be lacking in both substance and enforcement powers. Individuals cannot be called to testify under the current draft, yet testimony is often required to understand both what appears in documents and practices which may not be memorialized on paper. Further, criminal penalties, as well as increased fines, may be needed to make investigations work. Without the threat of criminal penalties for impeding an investigation, documents may be destroyed rather than produced and false tes­ timony provided with impunity. Finally, while it is clear that antimonopoly legislation must be in place and enforced for a market economy to function efficiently, no antimonopoly provisions are themselves sufficient to deconcentrate the Soviet economy. Widespread deconcentration can occur only when conditions exist for businesses to be created and market forces to operate. Development and implementation of antimonopoly legislation must be closely coordinated with programs of privatiza­ tion, price decontrol, and the opening' of possibilities for foreign trade. These are elements which must be present to make deconcentration possible rather than items which can be deferred until later.

284 5. SELECTED SECTORAL AND SPECIFIC ISSUES a. Banking and finance The guidelines place emphasis on immediate attention to the banking and finance system/8 with the primary intention of gaining control over inflation and the issuance of currency. The guidelines also envision a transfer of the specialized state banks (which together account for 95 percent of bank deposits and credits) from state-owned and regulation institutions to joint stock company form. This step is intended to stimulate the provision of banking services on economic criteria and commercial terms to the economy. One of the specialized banks (Agroprom­ bank) has already been converted to a joint stock company. There seems to be some value in stimulating the large state banks to provide better banking services and to take more account of commercial factors in their activities (particularly lending policies), by transfering these banks to joint stock company form. While the guidelines focus on revamping the banking system to control the issuance of currency in order to restore public confidence in the ruble, they do not discuss the need to foster public and business confidence in the banks them­ selves and to develop banking legislation and practice that will facilitate the use of the banking system for business purposes. There are a number of very simple measures that could be taken to improve general public confidence in and will­ ingness to use the banking system, and to make the use of banks by smaller businesses easier and more efficient. These measures would, in line with the guidelines' focus on equal conditions for business activity, serve to help equalize conditions for all businesses with regard to banking. Banking and financial regulations are not reliably available to the public and there is substantial evidence that basic regulations applying to the management of accounts and banking activity are not understood by many businesses. Banks may have vastly differing regulations concerning the ability of a customer to use funds deposited with the bank-for example, requirements that funds be drawn via bank documents rather than cash payment or upper limitations on the amount of funds that may be withdrawn during specified periods of time. These limitations are sometimes contained in the bank's charter, but there is no requirement that such charters be published or available to clients or that clients be advised of such restrictions prior to depositing funds with the bank. Similarly unpublished restric­ tions may apply to use of convertible currency funds. Some new businesses, and also individuals, have been surprised by these restrictions and in some cases in­ curred penalties for late payment of obligations. Legislation or regulation needs to be passed requiring some uniformity in this respect, or at least mandating disclosures prior to deposit. Problems in individual and small business use of the banking system have been caused by the lack of a system for bank payment that is available to in­ dividual account holders. Bank clearing systems were designed for use by juridical

285 persons only, with individuals previously having the right to hold only savings deposits in the state banking system. The payments of individuals were generally made by means of cash, or occasionally (i.e., taxes, trade union dues, judicially imposed support or penalties) by means of deductions from salary. Although this restriction is in the process of disappearing, there still exists no meaningful check­ ing or bank draft system by which individuals, or small businesses which run through individual accounts, may make business payments and have verifiable transaction records. Further, because of lack of familiarity with any financial instrument other than cash, or enterprise clearing procedures and uncertainty as to the means to verify validity of payment documents, most businesses will not accept any form of payment other than cash. Such facilities are very necessary for the development of business activities, and appropriate legislation and regula­ tions need to be issued clearly authorizing these transactions, permitting the charg­ ing of reasonable fees for such services (to encourage banks to develop them), and defining the forms required for validity and the nature of obligations to honor drafts and payment documents. In this area as well, there is a particular problem with convertible currency accounts. Since individuals were until recently prevented by law from conducting any operations whatsoever involving convertible currency, there was no provision for individuals to have accounts with Vneshekonombank, the only bank previously authorized to carry out convertible currency operations. While this restriction has also recently been lifted, no provision has been made by Vneshekonombank for opening convertible currency accounts for individuals and this service is only available from a few banks which have recently been authorized to conduct cur­ rency transactions under its supervision. Small businesses and social organizations have complained that those banks that accept foreign currency will only do so for businesses with substantial accounts and that they continue to have no means to maintain accounts or to make foreign currency payments. The absence of such facilities will seriously inhibit the participation of small businesses and enterprises in foreign trade, reducing the competitive benefits to be achieved thereby. Finally, there is a need for legislation concerning access to financial and account information about individuals and businesses. There is a belief among some sections of the population that the building up of large bank deposits, the conduct of very substantial business operations, or the deposit of any amount of convertible currency is likely to give rise to disapproval, increased scrutiny, and possibly some kind of investigation or enforcement action, on the part of bank officials and state authorities. There is also a general failure to understand bank procedures and a fear that bank accounts could be sequestered by state agencies for purposes of enforcing legal requirements not related to financial regulation. There is good historical basis for these beliefs, as the banking system has at various times in the past served as a means for enforcing the law in a variety of respects, including notification of law enforcement authorities where "suspicious" activities were occurring and the requirement, through a complicated documentary

286 payments process,. of proof of compliance with everything from quality standards to social security laws. In addition, much of the public remembers earlier currency reforms. Fears of such difficulties, and the resulting unwillingness to use the banking system, might be somewhat assuaged through the passage of privacy legislation which would strictly limit the use of account information. b. Foreign investment The opening up of foreign investment and trade possibilities is a vital com­ ponent of the Soviet economic reform effort, both because of the importance of imported goods and equipment to the growth of competition in the market and because of the need for substantial amounts of investment funds. The guidelines clearly recognize the importance of and need for foreign investment funds and the availability of foreign exchange for purchases (although the appreciation of the competition issue is not always obvious), and they give a prominent place to the strengthening of foreign economic relations. The reduction of domestic spending and the provision of guarantees, or even special inducements, to foreign investors cannot substitute for the existence of a stable political and economic environment. While the most important and imme­ diate aspect of stability to be resolved is the authority crisis discussed earlier, economic and regulatory stability are also important in attracting foreign invest­ ment. The clarification of property and contract rights, the legal rights of foreign parties, and the measures to be taken to privatize and demonopolize the economy will give foreign investors a greater security and an ability to evaluate the wisdom of various investment projects. With respect to the rights of foreign investors, a presidential decree was issued on October 26, 1990, equalizing the rights of foreign participants in the economy with those of Soviet citizens in a variety of respects. The decree allows foreign investment in all kinds of business enterprises, either in combination with Soviet investment or alone. Foreign firms are to be permitted to establish su"­ sidiaries in the USSR that are 100 percent owned by the foreign parent. Rights of foreign investors are to be protected to a degree not less than those of Soviet citizens. While this decree clearly expands the possibilities for foreign investment, it actually provides none of the requisite certainty with respect to the rights of the foreign investor. Equation of the foreign investors' rights with those of Soviet citizens will only provide certainty when the rights of Soviet citizens are them­ selves relatively stable. Until this is the case, uncertainty will continue to be a major factor in retarding foreign investment. 39 c. Agricultural issues By far the largest legal issue confronting agricultural reform is the question of legal rights to own and use land. Some substantial liberalizing change with

287 respect to land use rights occurred during the preceding year, but until the issuance of the guidelines it appeared clear that the state intended to continue to exercise substantial control over land use and land disposition. The guidelines, however, contain strong statements concerning the need for land reform as an early part of the economic stabilization and reform process, including calls for an end to the monopoly on land ownership and the institution of land mortgages. While the proposed legal regime with respect to land ownership and use is not specified, achievement of the goals stated in the guidelines clearly requires change in the existing law.

Until quite recently, the Constitution of the USSR stated clearly that the land (along with a variety of other natural resources) belonged to the state. While a variety of land-use plans could and did exist, ownership of the land itself was reserved entirely to the Soviet state. However, Article 10 of the USSR Constitu­ tion, which previously provided for state ownership of land, was substantially revised by a portion of the Law on the USSR Presidency, which was passed in April 1990. The relevant portion of Article 10 as it is now constituted reads: "The land, its mineral wealth, the waters and the vegetable and animal world in their natural state shall be the inalienable property of the peoples living on a given territory, they shall be managed by the Soviets of People's Deputies, and they shall be made available for use to citizens, enterprises, institutions and organiza­ tions." In addition, there is the following section of Article 11: "For conducting peasant and personal auxiliary farming operations and for other purposes stipu­ lated by the law, citizens shall have the right to hold plots of land in lifelong possession, with the right of inheritance, as well as to hold such plots in use."

While these sections of the current Constitution appear to make a substantial change in the rules of land ownership, the extent of the practical consequences is not as clear as might first appear. While the Constitution no longer dictates state ownership of the land, the new formulation appears to specify a form of collective ownership--by the "peoples living on a given territory." A formulation giving ownership rights to "the peoples" would not normally be interpreted as authorizing individual ownership of the property involved. In practice, this formulation might well mean that the representatives of the "peoples"-the state bodies at the relevant level of government-would in fact exercise the ownership rights which in theory belonged to the collective population and would be the functional "owners" of the property. Control over land would be exercised by local soviets and their executive committees, or under the control and guidance of higher bodies of power if the words "a given territory" were interpreted to mean a larger portion of territory than that governed by a local soviet. Under this interpretation, decisive control of land use would be likely to move from the hands of all-union authorities into the hands of union republican or perhaps lower-level authorities, but would not move into the hands of individual or corporate private owners.

288 The provisions of the Fundamental Principles of Legislation on Land, passed after the constitutional amendment, would appear to confirm that this interpreta­ tion was intended. Although several portions of the law refer to the possibility for local soviets or other bodies of state power to grant plots of land, such plots are to be granted for use rather than individual ownership. According to Article 5 of the Fundamentals, "land may be granted for lifelong use with the right of be­ queathal, to Soviet citizens for purposes stipulated by Article 20 of these Fun­ damentals of Legislation." Thus, permissible use by individuals is defined as a heritable life tenure rather than as simple ownership with the power to dispose freely of the land. The conditions for land use by corporate bodies would appear to be quite similar with the Fundamentals, providing that "permanent ownership of land shall be granted to collective and state farms, other state-sector, coopera­ tive and public enterprises, associations and organizations, and religious organiza­ tions for the purposes of agriculture and forestry." Discussion of the current state and probable future of land ownership tends to confirm the generally held view that completely free sale and purchase of land is not likely to be instituted soon. The issue of land ownership rights appears to be extremely divisive and the real bone of contention is free disposition and the concentration of land in private hands. It has been reported that draft land legis­ lation for the Russian Republic essentially duplicates the "use for its purpose with bequeathal rights" formulation that appears in the union-level Fundamentals. Unless some acceptable formula is adopted which will allow for flexible disposition of land, land-use patterns may be locked into the distribution which occurs initially as land is granted to those who want individual farming operations. Restrictions on the purchase and sale of land are likely to hamper the development of efficient land use; for example, by preventing concentration of less rich land into larger, potentially profitable farms. 40 While concentration of land ownership in individual hands need not remain unrestricted, means need to be provided for reasonably direct transfer of land between users and facilitation of farming and other operations of different sizes depending upon local conditions. As to use, the existing Fundamentals appear to envision very substantial state supervision and control over all kinds of land use, regardless of the ownership status of the land. Article 9 allows the termination of rights in land on a wide variety of bases, including irrational or improper use of the land (defined in some cases as failure to use the land for its purpose or failure to achieve appropriate harvest yields). Later portions of the Fundamentals which discuss the types of use to which land may be put also include substantial specifications regarding the purposes for which land may be granted to and used by different types of in­ dividuals and groups. The imposition of restrictive use and yield requirements on agricultural land would significantly hamper the ability of individual farmers to innovate and to make efficient choices based on land conditions and on market conditions and signals.

289 While the guidelines call for land reform, including the elimination of the monopoly on land ownership and the institution of land mortgages, it must be noted that they do not explicitly call for individual private ownership of land. It would be possible to interpret the guidelines as advocating the elimination of the union-level monopoly on land ownership, or of referring to the move to ownership by the "peoples" on the territory as the elimination of the land monopoly. Similar­ ly, the draft law on pledge would permit the establishment of a pledge of land-use rights, and "land mortgages" could be established on this basis. Such an inter­ pretation of the terms of the guidelines would indicate an interpretation of the recommended land reform as a substantial redistribution of use rights, for which the basis has already been created in legislation. Such a "land reform" would fail to solve any of the problems identified with respect to existing law. It is also possible to interpret the guidelines as calling for the institution of individual and other private ownership rights to land. This would be consistent with the apparent principal purpose of such an innovation, which would appear to be the creation of vehicles for investment and for the securing of borrowing. The creation of individual and private ownership rights in land would require fundamental changes in the existing law, and perhaps another alteration in the relevant constitutional language as well. If the reform were to encompass the elimination of some of the burdensome use restrictions now existing, as would be consistent with provisions of the guidelines concerning increases in the inde­ pendence of farmers and agricultural producers and in the efficiency of agricul­ tural activities, it might be appropriate to replace the Fundamentals with a new law reflecting more restrained powers of zoning and use-monitoring.41 d. Regulation of the housing market The transfer of housing stocks and the creation of a private housing market is emphasized by the guidelines as a means of soaking up excess household li­ quidity and creating a vehicle for investment and for the securing of loans. Several changes in existing legislation will need to made for this goal to be met. Prior to the passage of the new Fundamental Principles of Legislation on Ownership, Soviet citizens were limited to the possession of one dwelling house or apartment and one dacha (country house). If a citizen acquired an additional house through inheritance or other means, he or she was required to dispose of one of the homes. Provisions of the civil codes of the republics dealing with ownership still contain these restrictions. According to the new Fundamentals, property that may be the object of ownership by individuals includes a dwelling house or apartment, and also a country house. The Fundamentals provide the citizen with the right of purchase of an apartment in the state housing fund which he or she is occupying. The Fundamentals do not specifically state a limit on the number of houses or dwellings that may be owned by an individual, although the language of the article is singular rather than plural. Thus, the status of restrictions

290 on individuals rights to own dwellings is not entirely clear and should be clarified. The provision of rights to own more than one house might well spur the creation of new housing space by individuals hoping to take high rents under conditions of extreme housing shortage. However, given the fact that extremely large num­ bers of Soviet citizens have been on the waiting list for housing for many years and may now lose their rights to a freely granted apartment (when available), a liberalization which allowed some individuals to own more than one dwelling might simply be socially unacceptable at this time. Many individuals will not want to own even a single dwelling if the incen­ tives for ownership are not provided. At present, most people pay very little for their apartments in rent, and they are not responsible for the repair and main­ tenance of the apartment or building. Purchase of an apartment, particularly where there may be no guarantee that neighbors will also purchase and will contribute to improving conditions, will not be attractive unless rents are increased to reflect the real costs of building and maintaining housing stocks and the benefits of ownership--the ability to obtain credit on the basis of ownership and to freely rent or sell the owned property for a price approximating its value-are made available to purchasers along with the burdens.42 e. Environmental regulation Soviet environmental law is still very much in its infancy. The first legal enactments in this area were made in the late 1980s and those tended to be quite general in tone and to have little in the way of meaningful sanctions. Until 1988, when the State Committee for Nature Preservation (Goskompriroda) was created, there was no state agency generally responsible for oversight of natural resource use and elaboration of environmental law and policy. Thus, although pressure for environmental regulation and clean-up has produced quite a lot of attention to this topic among legal scholars in recent years, the legal regulation of use of natural resources is still in its earliest stages. Beginning in the late 1960s, a series of Fundamental Principles of Legislation of the USSR was drafted concerning the use of various types of natural resources. In 1968, the Fundamental Principles of Land Legislation were passed, in 1970 the Fundamental Principles of Water Legislation, in 1975 Fundamentals on Minerals, and in 1977 Fundamentals on Forestry. The union republics duly took these prin­ ciples as the general parts of their codes on the subject and elaborated correspond­ ing codes of law at the union republic level. Even the codes, however, proved to be rather general in tone concerning sanctions for failure to properly use natural resources, providing more detail on the types of use that could legitimately be made of particular resources and the procedures for obtaining use permissions. Although misuse or pollution of the relevant resource is prohibited in each of the codes, the sanctions available are often unclear, or where clear, ineffective. Fines for violations by individuals, administrative discipline for enterprise managers,

291 confiscation of illegally taken resources and of implements used therefore, and other similar sanctions are provided. The sanctions tend to be rather mild by international standards and seem to be designed primarily to prevent theft or misuse of resources. Similar problems are encountered with the USSR Laws on Protection and Use of the Animal World and on Protection of the Atmos­ phere (both passed in 1980 as union-level laws rather than as Fundamental Principles). Effective control of pollution by enterprises has been a difficult issue under conditions of central planning and state ownership. The imposition of fines on state enterprises by state enforcement agencies did not prove to be an effective method of controlling enterprise behavior, and the sanction of enterprise closure, which is available under most of the natural resource laws, has not been an at­ tractive one in conditions of shortage. Attempts were made for a number of years to enforce environmental standards and to control pollution through the planning system, by requiring Gosplan and the ministries to take account of conservation needs and pollution problems, but this approach has not met with great success. Now, as the restructuring of the economy goes forward, new means are being sought to enforce environmental norms both against state enterprises and against new types of economic entities. Under current legislation, the new Goskompriroda has broad powers to prohibit new construction or renovation, to suspend enterprise operation, and to bring suits to force enterprises to clean up pollution and/or pay damages to the state. Under the 1988 legislation, Goskompriroda must, in most cases, approve the building of new plants and facilities. According to Soviet scholars in the area, these powers have been used in the ensuing two years to prevent the construction of a number of plants and/or to require significant changes in design in order to meet environmental standards. The same sources reported that at least one of those plants whose construction was substantially held up by Goskompriroda was to belong to a Soviet-Western joint venture, but there was no indication that environ­ mental restrictions were being differentially enforced with respect to newer types of economic entities.43 In addition to delays in prevention of new construction, there are numerous reports of forced plant closings connected with environmental concerns. The reported number of such closings varied, with reportedly nearly 400 plants having been closed in the RSFSR alone. These closings appear to be occurring mainly on the local administrative level and, in some cases, in response to public demonstrations without any official involvement, rather than at the behest of Goskompriroda. Draft legislation on the protection of the environment has been pending now for more than a year. This legislation would allegedly tighten the environmental regulations and increase the strength of some sanctions, and would also unify some of the natural resources legislation that is now contained in separate laws

292 dealing with particular resources. It is not clear what was preventing the legislation from moving forward, although possibly more pressing matters had taken precedence and that there was now some need to refashion the old draft law to correspond to economic reforms that were broader than expected at the time of drafting.

According to Soviet sources, the most serious problem facing the USSR in effectively enforcing environmental regulations and in dealing with problems that have already been created is not the lack of legislation but the lack of available resources and technology for evaluation and clean-up, a lack of disinterested par­ ticipants in the evaluation and clean-up processes, and insufficient affordable clean technology both for retrofit and for new plants. In theory, enterprises and organizations are already required by law to prevent environmental damage and are liable under the law for the remedy of any pollution damage they cause. Unfortunately, scientists and specialists who are retained to perform evaluations for Goskompriroda and for particular enterprises are not independent and often have institutional interests to protect in issuing their findings. Where findings of damage and enterprise liability are made, enterprises cannot be forced to clean up damage when the enterprise itself does not have the ability to do so and there are no services available that will evaluate the sight and perform remedial work. While these circumstances continue, the details of liability imposed by legislation are essentially irrelevant, and both the enterprises and enforcement authorities will continue to be faced with stark choices between continuing production and en­ vironmental safety. Plainly, it is desirable that legal incentives created at this time not be counterproductive or allow evasion, but refinement of legal incentive struc­ tures designed to affect business behavior cannot proceed until both the general economic and regulatory structure and the conditions on which environmental services are available are better defined.

One legislative change that might be of some assistance in the short term would be the legally mandated devotion of some substantial portion of fines and penalties to the creation of the needed infrastructure. It has also been suggested that provision of favorable legal conditions for the creation of private companies in these areas, as well as favorable conditions for foreign firms to take part in such work, might be considered as ways to begin to remedy the problems faced. While there may be room for some additional assistance, there are already means for the union and republic governments to exempt firms which provide important services from taxes and fees and to expedite their establishment. A number of efforts are under way to establish such firms-primarily as joint enterprises with the participation of a western firm experienced in environmental work-and some subset of these have already been granted special advantages. The key issue for some time to come will be the continuing devotion of sufficient funds and atten­ tion to the problem.44

293 f. Institutional capacity to implement legislation

With regard to all areas of legal reform discussed in this and the previous sections, there are serious questions concerning the ability of existing institu­ tions--economic, social and legal-to implement reform measures. Serious deficiencies in staffing, training, and technological capacity will hinder implemen­ tation of many of the reforms discussed, and may in some cases cause reform measures to be almost completely ineffective. While it is not possible nor is it desirable for the reform process to be delayed for the years that would be required for these problems to be addressed, reform measures and implementation provisions must be drafted with the actual capacities of the existing bodies in mind. Implementation procedures requiring sophisticated information tech­ nologies, for example, will not function well in most areas of the USSR at the present time. Problems may also be caused by attempts to implement legal provisions in the absence of their institutional corollaries. One of the best ex­ amples of this is the complete absence of land and property registration systems and the enormous problems that this is likely to generate concerning proof of ownership and registration of claims and encumbrances on property. Large amounts of technical assistance will be required for these deficiencies to even begin to be overcome and such technical assistance is vital to the success of the reform effort.

6. SUMMARY a. State authority and the legal regulation of the economy

The most serious legal problem currently facing the Soviet economic reform effort does not concern any particular piece or pieces of legislation but rather the lack of clarity and uniformity with respect to the substantive law governing economic matters and the standards and means for its implementation. At the time of this writing, the problem exists at all levels of government and involves uncer­ tainty concerning the location of authority to legislate and to implement the laws, the nature and extent of the legislative and executive powers, and the appropriate means and methods for enforcement. Unless a significant amount of this uncer­ tainty with respect to state authority is resolved and some clarity is achieved concerning the boundaries of national, state and local authority to define, ad­ minister, and enforce economic rights and obligations, any reform program, regardless of its content or emphasis, is likely to be severely constrained. The primary and most publicized source of uncertainty is the current conflict between the central government of the USSR and various subordinate territorial govern­ ments concerning the proper relationship between and among the constituent parts of the union.

294 The problem of uncertainty concerning state authority is not simply a prob­ lem of uncertain political relationships. The traditional Soviet legal theory en­ visions a unified state power-organic in nature and indivisible-and the structures of Soviet state authority formed according to this theory are indeed very integrated and overlapping. While a complete constitutional and/or legislative redefinition of the power of Soviet state bodies will require a substantial amount of time, improvement could be made in the interim by increased use in legislation of clear statements concerning the limits of discretion of executive and lower bodies in implementing and enforcing the law. During the transition period, an expeditious review of normative acts of executive and lower level state agencies for consistency with governing legislation could also be undertaken. The traditional modes of economic regulation in the USSR did not place large amounts of economic responsibility in the hands of local bodies of state power. As political power and responsibility for economic regulation are decentralized, increasing amounts of responsibility for economic regulation and enforcement will fall into the province of local bodies that do not have institutional structures designed to fulfill these functions and may not have the training, personnel, or experience to adequately interpret, refine and enforce economic law. In addition, democratization of local election procedures has produced greater pressure on local bodies to address local needs. Under these conditions, interpretation, im­ plementation and enforcement of laws and regulations at the local level is likely to be inconsistent and local bodies may be tempted to solve local problems and satisfy local constituencies at the expense of national interests. Localization of control should proceed with caution during the transition period and should not be permitted to substitute for resolution of difficult political and economic issues. Large scale programs of technical assistance should be put into place to assist local bodies in developing the systems of planning, registration and control needed to make the reform successful. b. Legal foundations for market exchange

The effective functioning of a market-based system is dependent upon the existence of clearly defined and reasonably broad property rights, the ability of market participants to freely exchange property rights through a system of legally enforceable agreements, and the existence of a system which provides reasonably secure and predictable enforcement of such agreements. While there now seems to be greater recognition of the fundamental nature of these matters, the need to establish stable basic principles in these areas has until recently been somewhat obscured by a tendency to focus on particular pieces of legislation authorizing and defining specific forms of business activity. Although several new pieces of legis­ lation have appeared in the last year that touch on these matters, these are general­ ly "framework" laws which do not yet provide the clarity or detail required.

295 The presidential guidelines call repeatedly for the expansion of property ownership and property rights. The guidelines explicitly call for the recognition of the right to private property, a substantial program of privatization of state property, and a program of land reform as major components of the stabilization of the economy. In addition, the guidelines implicitly call for the redefinition of rights to own and use property in discussing the expansion of business activities of all kinds and the need for a law on freedom of entrepreneurial activity. These proposals are substantially more far-reaching than any of the previous union-level suggestions related to ownership and neither the current union-level nor most republican-level legislation is consistent with the aims described. Implementation of the guidelines will require a significant legislative effort, including the imme­ diate issuance of a number of pieces of new legislation and amendment or repeal of several other pieces, and, in the longer term, the redrafting of entire civil codes and a massive amount of conforming amendment of related legislation. The Fundamental Principles of Legislation on ownership will need to be amended if the ownership rights of natural persons and those of juridical persons are to be equalized. This could be accomplished through a reformulation of basic ownership rights to include a general right of both natural. and juridical persons to own all types of property except those forbidden by law. In order to avoid confusion and uncertainty, the use of permissive lists of the objects of ownership rights and the means by which the property of specific organizations may be formed should be discontinued and content must be given to categories of owner­ ship which are referenced in legal acts. For any type of property in which full ownership rights are not made available, use-rights and the means for their transfer will need to be defined with specificity. An effort should be made to make use­ rights as freely transferable as possible in order to promote efficient use of property. In contrast to the direct recognition of the need for reform in the legal regula­ tion of property rights, contract law as such is not a direct focus of the presidential guidelines and was not featured in previous reform plans. Attention has been paid to the need to eliminate particular restrictions on contractual freedom that stem from the planning system (e.g., price controls or the assignment of contractual partners), but little attention has been focused on the underlying system of contract law as such. The removal of limitations on freedom of contract is, indeed, a matter of first importance. In addition, however, attention will need to be paid to the development of the complex forms of contract required to support modern market transactions. The presidential guidelines decry the lack of respect for the law as one of the chief causes of the current economic crisis, but completely fail to address the institutions called upon to enforce the law and their adequacy to perform that task. While this may in part reflect a correct recognition that the questions of state authority to legislate and to enforce the law must be resolved before the nature of

296 dispute resolution and enforcement bodies can be addressed, the resolution of those issues alone will be insufficient to ensure implementation of the law. In order for the civil courts and state arbitrazh to function effectively in resolving economic disputes, the relationship between the two bodies and their divisions must be clarified, particularly where jurisdictions overlap. If jurisdic­ tional overlap is to be permitted, some appropriate means must be found to ensure a uniform standard of interpretation among bodies, by the provision of a single highest instance for review or by other means. With respect to arbitrazh, dispute­ resolution functions will need to be separated from law enforcement respon­ sibility. Finally, a program of technical assistance focused on the training of judges and arbiters in the handling of complex commercial cases, as well as in docket control and other matters, would be of assistance. The Soviet Procuracy has nearly unlimited rights to review business records, employee and customer knowledge and other information concerning the opera­ tions of businesses and individuals and to conduct fishing expeditions for legal violations. The most effective means for limitation of the Procuracy's role in private business affairs would be to amend the statute governing its activity to eliminate responsibility for general supervision over private activities. Another option would be to require that some minimum evidentiary standard be met con­ cerning the grounds for investigation before procurators may have access to in­ formation concerning such activities, but this may be the functional equivalent of elimination of the general supervision powers without the clarity of doing so explicitly. There are still a number of articles of the criminal and administrative codes of most republics that prohibit behavior that may be rational and economically beneficial. While it appears likely that many of these articles will be eliminated in the next major revision of the criminal codes, steps need to be taken to repeal or strictly limit the reach of the most destructive articles. In particular, laws punishing commercial middleman activities need to be eliminated immediately, and laws concerning speculation must either be eliminated or, at minimum, amended to restrict application to the most destructive cases of abuse of rationing and subsidy systems.

c. Regulation of the business sector Inevitably, however, reform of this type has produced gaps and anomalies in legal regulation which will need to be addressed if the goal of equal business opportunity expressed in the guidelines is to be met. Perhaps the most important step that could be taken in regard to the equaliza­ tion of conditions for business activity would be the passage of a clear and detailed law concerning the relationship between the state and its employees and agencies and any business, enterprise, or commercial organization in which the state has

297 an ownership interest. Such a law could clearly define the permissible and imper­ missible relationships between state-owned entities and state bodies, providing a defined management structure with specific safeguards against interference (whether helpful or harmful) in the financial or business affairs of the enterprise. Properly drafted and enforced provisions of this type could be of great assistance in eliminating some of the most troubling inequities in the current conditions for market activity, including subsidization and the absence of a hard budget con­ straint for many state enterprises and anticompetitive behavior by state bodies designed to advantage particular enterprises. In addition, inequalities caused by differences between and among the laws applying to particular types of business entity, including the substantial restrictions on activities of cooperatives and their exclusion from the tax benefits provided by the decree on small businesses, should be eliminated. Finally, the efficient and effective conduct of business, and the efficient regulation of business by the state, requires the presence of the technical and institutional structures that make effective regulation possible. One of the most important of these, particularly during the transition period, is a reliable mechanism for reviewing laws and regulation to identify inconsistencies and anomalies and see that they are addressed. Reliable sources of information con­ cerning new laws and regulations must be available to participants in market activities so that they can regulate their conduct accordingly. Systems for efficient registry of businesses and for registration of property and encumbrances on property are necessary, and also bankruptcy laws which will provide standards and procedures for the rehabilitation or closure of insolvent enterprises. In each of these areas, technical assistance in the form of training in information control and analysis, computerization of data bases, means for maintaining a permanent and useful record of business registrations, and other matters, will be required. In order for the goal of substantial privatization contained in the guidelines to be met, a number of legal steps must be accomplished. Of first importance in the privatization process is the determination of ownership for state property. Whether this process takes place through the conclusion of a new union treaty or through some other means, it must occur before the privatization process can begin in earnest. In the interim, before the matter as a whole is resolved, some privatiza­ tion could take place with respect to property for which the locus of ownership is clear. In order to facilitate these processes, it might be helpful for an interim procedure to be established by which a prospective purchaser could obtain the explicit agreement of union, republican, and other possible claimants that a piece of property could legitimately be transferred by a particular state property fund. Once ownership of property is established, the relevant owners will need to develop specific plans for privatization taking account of the financial and other means which will be necessary to support them. Privatization plans which provide assistance and installment-purchase options only to workers groups may not

298 produce the kind of response necessary to privatize large sections ofthe economy, may cause inappropriate valuations of properties (due to the elimination of some bidders) and may lead to inefficient use of properties. Individuals and other groups should also have equal opportunities to purchase state property. In connection with this, the privatization process should not be used as a means to identify and confiscate illegally earned income. If privatization is conducted in the absence of antimonopoly measures, valua­ tion of enterprises currently holding monopolies will be difficult and monopoly behavior by newly privatized enterprises may lead to strong pressure for state controls or limitations on privatization. The elaboration of privatization plans and legislation must be closely coordinated with the creation of antimonopoly legis­ lation, and the practices, procedures and powers of the state property funds may need to be coordinated during the main period of privatization with those of the antimonopoly enforcement agency. Antimonopoly and/or fair competition law, although not an initial focus of reform efforts, has been receiving an increasing amount of attention by legislators and policy-makers in recent months. While drafts of antimonopoly laws have been produced at both the union and republican levels, there is still substantial con­ fusion over the proper direction of policy and the precise nature of the functions to be fulfilled by the antimonopoly enforcement body. In the interim, a decree of the Council of Ministers of the USSR provides for some general antimonopoly powers for union and local authorities. Several issues are highly important in the development of competitive markets in the Soviet industrial sector. First, anti-cartel provisions must be clearly and vigorously applied. It is crucial that enterprises not fall into familiar patterns of cooperative behavior rather than engage in vigorous competition. Horizontal associations, in particular, pose threats in both upstream and downstream markets as the firms can combine into either sellers' or buyers' cartels. The risk of car­ telization through the association structure is sufficiently great that clearer provision regarding permissible association may need to be provided in both the antimonopoly and the enterprise laws; and the new antimonopoly authority should consider restructuring existing associations into competing groups where neces­ sary. An issue that is not well treated in the existing decree or draft laws is the distinction between vertical and horizontal restraints. Vertical restraints may reduce competition within the vertical structure but promote competition between vertical structures. There is the strong possibility that competition-promoting ver­ tical restraints, in particular by small firms or new entrants, will be prohibited under the Soviet law given that decision-makers, especially courts, will not be well equipped to make the necessary distinctions between intra- and inter-brand competition. It would be useful for the law to be explicit as to the types of

299 agreements which are prohibited and the types permitted, and to distinguish ex­ plicitly between vertical and horizontal agreements. d. Sectoral and specific issues While the guidelines focus on revamping the banking system to control is­ suance of currency, they do not discuss the need to foster public and business confidence in the banks themselves and to develop banking legislation and prac­ tices that will facilitate the use of the banking system for business purposes. Banking regulations must be required to be publicly available so that customers may inform themselves about the conditions placed on their use of credit and their deposited funds. Legislation and regulations defining and authorizing increased use of bank payment documents (e.g., checks) should be passed to encourage development of these forms of payment. In addition, there is a need for legislation protecting financial information from disclosure, to increase confidence in the privacy of the banking system and reduce use of that information to enforce other laws. The opening up of foreign investment and trade possibilities are a vital com­ ponent of the Soviet economic reform effort, both because of the importance of imported goods and equipment to the growth of competition in the market and because of the need for substantial amounts of investment funds. With respect to the rights of foreign investors, a presidential decree was issued on October 26, 1990, equalizing the rights of foreign participants in the economy with those of Soviet citizens in a variety of respects. While this decree clearly expands the possibility for foreign investment, it actually provides none of the requisite cer­ tainty with respect to the rights of the foreign investor. Equation of the foreign investor's rights with those of Soviet citizens will only provide certainty when the rights of Soviet citizens are themselves relatively stable. Until this is the case, uncertainty will continue to be a major factor in retarding foreign investment. By far the largest legal issue confronting agricultural reform is the question of legal rights to own and use land. Some substantial liberalizing change with respect to land-use rights occurred during 1989, but until the issuance of the guidelines it appeared clear that the state intended to continue to exercise substan­ tial control over land use and land disposition. It is possible, however, to interpret the guidelines as calling for the institution of individual and other private owner­ ship rights in land. The creation of such ownership rights would require fundamen­ tal changes in the existing law, and perhaps another alteration in the relevant constitutional language as well. If the reform were to encompass the elimination of some of the burdensome use restrictions now existing, as would be consistent with provisions of the guidelines concerning increases in the independence of farmers and agricultural producers and in the efficiency of agricultural activities, it might be appropriate to completely replace the currently existing Fundamental

300 Principles of Legislation on Land with a new law reflecting more restrained powers of zoning and use-monitoring. · The transfer of housing stocks and the creation of a private housing market is emphasized by the guidelines as a means of soaking up excess liquidity in the hands of Soviet citizens and creating a vehicle for investment and for the securing of loans. Several changes in existing legislation will need to be made for this goal to be met. The status of restrictions on individuals' rights to own more than one dwelling is not entirely clear and should be clarified. In addition, purchase of an apartment will not be attractive unless rents are increased to reflect the real costs of building and maintaining housing stocks and the benefits of ownership-the ability to obtain credit on the basis of ownership and to freely rent or sell the owned property for its real value-are made available to purchasers along with the burdens. The most serious issue with respect to enforcement of environmental regula­ tion is the lack of facilities for environmental evaluation and clean-up. In the absence of such facilities, legal requirements based on assessments and payment of costs of damages are not realistically enforceable. Legislation might ease this situation by providing means for fines and damages paid in environmental matters to be used to create appropriate facilities or by providing incentives for their creation. A second issue of importance with respect to environmental legislation is the prevention of use of state budget funds or subsidies by state enterprises to pay fines and damages. This possibility eliminates any incentive effect of such penalties. Effective drafting of law on state enterprises could be of assistance here, as could a flat prohibition on such uses of state funds. With regard to all areas of legal reform discussed in this and the previous sections, there are serious questions concerning the ability of existing institu­ tions--economic, social and legal-to implement reform measures. Serious deficiencies in staffing, training and technological capacity will hinder implemen­ tation of many of the discussed reforms, and may in some cases cause reform measures to be almost completely ineffective. One of the best examples of this is the complete absence of land and property registration systems and the enormous problems that this is likely to generate concerning proof of ownership and registra­ tion of claims and encumbrances on property. Large amounts of technical assis­ tance will probably be required for these deficiencies to be overcome.

NOTES I. The first Soviet era constitution was the Constitution of the Russian Soviet Federated Socialist Republic in 1918. As this constitution concerned only a single republic. there was no need to deal with republican rights of secession. It is interesting to note, however, that this first Soviet constitution made no provision for separate or special representation of the many minority groups represented in the territory of the Russian Republic, instead providing for representation strictly according to population count. In 1924, the first constitution of the union was passed,

301 uniting the Russian Republic, the Ukrainian SSR, the Belorussian SSR, and the Transcaucasian Socialist Federated Soviet Republic (a federation including the Georgian SSR, the Armenian SSR, and the Azerbaidzhan SSR), and providing for a right of free secession for any republic. 2. Confusion is sometimes caused by the use of the word oblast to denote a territorial formation that may be either simply geographical, or nationality based. A geographical oblast may contain a nationality-based okrug, but cannot contain a nationality-based oblast. A kray may contain both autonomous oblasts and autonomous okrugs. 3. Article 88 of the USSR Constitution simply states: "A district (okrug) is part of a territory (kray) or autonomous region (oblast). A Law on Autonomous Areas shall be adopted by the Supreme Soviet of the Union Republic." 4. There would be clear historical precedent for this. Part 2 of the 1924 USSR Constitution, which contains all of its substantive provisions, is in the form of a "Treaty on the Formation of the Union of Soviet Socialist Republics." 5. There was even a public contest declared in which citizens were invited to submit drafts of a union treaty. 6. Given the choice, most republican legislatures are likely to choose to set prices themselves rather than to cede that power to union-level bodies. 7. All fifteen union republics have passed some form of declaration of sovereignty, as have a substantial number of the autonomous republics and some lower level territorial units. 8. For example, an agreement might be reached that the. proper territorial level for control of freight trucking is the district level. 9. For example, the creation of a registration system in which failure to return documents with a valid reason for rejection within a limited period would be construed as their acceptance and registration. 10. The definition of "unearned" income has always been somewhat elusive. Illegal income-earning activities for individuals have generally included entrepreneurial activities involving hired labor (income derived from the labor of another is "unearned" by the receiver), illegal sale or lease of property or sale or lease above permitted price levels, any variety of middleman or trading activity, etc. II. In those restricted areas in which personal property was permitted to serve as the basis for market activity, production and exchange were significant. The best case in point is the use of "personal plots" for the growing of foodstuffs and raising of animals. Although extremely small in total area, it has been estimated that the "personal plots" have provided up to a third of the national supply of some fruits and vegetables. From the legal point of view, however, this individualized market activity took place on a fairly simple basis and did not foster any significant development of market-oriented legal structures. 12. While the relevant code provisions still stand at the time of this writing, draft legislation is in preparation which will eliminate many of these restrictions. 13. Fundamental Principles of Legislation are sets of general principles in a given area of the law which are issued at the union level. These principles are then adopted by the republics and become the General Part of the relevant code of law. The republic elaborates the Special Part of the code, which contains more specific provisions on the application of the general principles to particular circumstances. The Fundamental Principles, along with particular all-union laws which may require the inclusion of certain provisions in the Special Part of the codes, serve to provide uniformity across republics on general legal concepts.

302 14. The amendment, which eliminated the constitutional language restricting property forms, was passed not as a separate amendment, but as a part of the series of constitutional amendments that created the office of the presidency. 15. The possibility of free sale and purchase of land is likely to be a fairly contentious issue, especially within some union republic level executive and legislative bodies that are drafting plans for economic transition and reform based on the assumption that they will become substantially independent in the near future. 16. See, e.g. Civil Code of the RSFSR, Articles 192 through 202. 17. The draft law is significant in that it would provide for means of pledging diverse types of property rights (e.g. lease rights, use rights, etc.) in addition to pledges of property held in simple ownership or operative management. The ability to use such rights as security will be very important in allowing immediate economic activity, as the amount of property that is owned outright is quite limited and appears likely to grow slowly through lease-purchase and other gradual means of privatization. The draft law, however, does not deal with questions of ability to transfer restricted use rights or those which require permission of authorities to be granted for a specific use and/or user. This may be particularly problematic with pledges of rights to use of land or natural resources. 18. State arbitrazh has traditionally had two branches: one generally referred to as "state arbitrazh" and the other as "departmental arbitrazh." Departmental arbitrazh takes care of disputes that arise between entities which are both under subordination to the same administrative body, while state arbitrazh covers the remaining disputes under arbitrazh jurisdiction. Although there are two branches, the system is a unitary one, with state arbitrazh carrying responsibility for overseeing the activities of departmental arbitrazh. 19. The most comprehensive of these are the General Conditions applying to all deliveries of goods of particular types. 20. It was suggested by some members of the legal community that the remedies provided in such legislation were exclusive-i.e. that the complainant could proceed in arbitrazh or the court but could not then appeal the decision in the other forum-but this has not been clearly stated in any of the relevant legislation. 21. The Procuracy has no power over higher bodies of state power, i.e., the union and republic level councils of ministers, congresses of peoples' deputies, supreme soviets, and presidiums. 22. Protests concerning such acts must be considered by the relevant officials within ten days and a notification sent to the procurator concerning the results of such consideration. If the protest is rejected by the relevant officials at the level of issuance of the protested act, the procurator may bring a protest to the body superior to the body or individual issuing the act. 23. There is no time limit on the consideration of recommendations. 24. Such instructions may be appealed to a superior procurator within ten days, but appeal of the instruction does not entail suspension of the instruction's force. 25. Because the majority of enterprise activities were, until recently, subject to the legal require­ ments of the planning system, and legislation (either criminal, administrative, or civil) generally prohibits the negligent waste or damage of state property, many matters of wasteful business behavior or failure to meet contractual commitments fell under the general rubric "violations of legality."

303 26. Some restrictions on the ability of enterprises and organizations to hold the stock of other enterprises or companies apply under the terms of the Council of Ministers decree concerning demonopolization. 27. As an example, representatives of the specialized state banks in the Ukraine, which are being converted into joint stock companies, stated that the Ministry of Finance of the Ukraine would hold large percentages of the stock in the company, with additional stock to be held by in­ dustrial ministries, and by state enterprises. 28. The provisions for direct registration of small businesses, combined with the expansive list of persons and entities permitted to form such businesses, would seem to allow individuals to register and operate a business on the same basis as groups and entities-an option that was not open to individual entrepreneurs before the passage of this decree. 29. As discussed above, registration provisions might be more effective if they provided that failure to return the document within the allotted period should be construed as registration. 30. The passage of such a law, generally controlling the relationship of the state to state enterprises, would seem in any case to be desirable. 31. It is interesting that the decree provides for creation by a number of state bodies of enterprises specializing in the lease of equipment to small business. This is precisely the type of activity that a small business itself could provide to the business community. 32. For example, some enterprises or entire industries may remain state-run monopolies for the long run. Different legislation might be required for efficient operation of such companies, although its provisions should also be clearly defined and strictly enforced. 33. If the declarations of local sovereignty promulgated by a variety of territorial formations below the autonomous republic level are accorded any validity, it may also be necessary to create state property funds for those areas. 34. This would also explain the failure to discuss the need for agencies below the level of union republic, as the union would have no authority over such matters once the new treaty is concluded. 35. What is unusual here is that the association would seem to comprise a sort of conglomerate cartel; the members are not horizontal competitors. Some have disputed the effectiveness of this particular association in limiting entry. 36. If a new entrant can certify that its product meets a given standard, that certification may substitute for the reputation of a brand name in informing consumers about the quality of the product. 37. The efficiency rationales of these associations may be weak and need to be examined closely on a case-by-case basis. For example, it is hard to see why all firms buying scrap metal need to be associated into one association in order to overcome problems of supply. It seems likely that the economies of joint buying would be exhausted somewhere below I 00 percent par­ ticipation. 38. For a more in-depth treatment of banking regulation, see Chapter IV.5. 39. For more details on this subject, see Chapter IV.4. 40. The Fundamentals of legislation on Land contain provisions which suggest that the problem of less productive farm land might be dealt with by means of provision of subsidies to those who hold the land. This approach would discourage or prevent both the formation of profitable farms on such land and the transfer of the land to other, more efficient uses.

304 41. On agricultural issues, see Chapter V.5. 42. Also see the section on housing (Chapter V.9). 43. It would be reasonable to expect that the burden of enforcement might at least appear to fall rather disproportionately on the newer entities, because those who are not on the state budget will be more likely to respond to financial sanctions, they form a larger proportion of new constructions or newer process installations, and they may be perceived to have greater resour­ ces and external connections to use in securing clean technology and/or cleaning up polluted sites. Unfortunately, statistics are not available on these matters. 44. Also see the chapter on the environment (Chapter V .I).

305 NOTES

~957 ~1 827 6 . . l At the July 1990 Houstoq Summit, the Heads of State and Government of the seven principal industrial countries and the President of the Commis­ sion of the European Communities requested the International Monetary Fund (IMF), the World Bank (IBRD), the Organisation for Economic Co-operation and Development (OECD), and the designated President of the European Bank for Reconstruction and Development (EBRD), to und~r iake a detailed study of the Soviet economy, make recommendations for its refqrm, and establish the criteria under which Western economic assistance <;uuld effectively support such reforms. The summary and recommendations · ·were submitted in December 1990 to the participants in the Houston Summit and published in January 1991. These' three volumes contain the detailed information, analysis and recommendations underlying the summary report. The transformation of the Soviet. economy is certain to be extraordinarily complex and will take many years to complete. Three closely related areas would require action at the outset of the process: macroeconomic stabilization, price reform and liberali­ zation in an environment of increased domestic and external competition, and ownership reform, including an irrevocable signal of private ownership. In these areas, the study ad'-:ocates a radical approach to reform. Fundamental structural changes would be needed to complement these reforms, an.d mea­ sures taken to cushion the effects on consumers and enterprises of price liberalization, unemployment and the transitional costs of restructuring. Volume 2 describes systemic policies in a number of areas. Broad-based and immediate price liberalization is seen as a prerequisite for the effective­ ness of most other reforms. Similarly, the break up of the traditional central planning system through enterprise reform is essential to a market economy. · To promote competition in the domestic market and a more appropriate pattern of relative prices, trade reform is also necessary. Foreign direct investment could be instrumental in providing capital infusion as well as the much' ·needed transfer of know-how and technology. A market economy would also require the early establishment of a well functioning banking and financial system. The reform efforts should be complemented by the estab­ lishment of a social safety net and new relations in the labor market. Finally, and importantly, in all these areas the legal system should be modified to free economi~ initiative and to facilitate the transition to a market economy and to provide clearly defined legal responsibilities between the various levels of government. Volume I deals with the general economic and reform developments and macroeconomic policies and reform . •. Volume 3 describes sectoral issues, including the environment, distribution, transport, telecommunications, agri­ culture, energy, metals and mining, man·ufacturing and housing. In addition, medium-term economic prospects for the Soviet economy are assessed.

(14 91 02 1} ISBN . 92-64-13468-9 (Three volume set) FF 500