Policy, Research,and ExternalAffairs WORKING PAPERS Public Economics CountryEconomics Department The WorldBank March1991 Public Disclosure Authorized WPS 615 Socialist Economic Growth Public Disclosure Authorized and Political InvestmentCycles Public Disclosure Authorized Heng-fuZou Investment rates in China have often been highest under leftist (hardline) political regimes, not rightist (softline) political re- Public Disclosure Authorized gimens. I he iP s .R,<ea%I-. a I:m:enr.aI a!rs (COMpIC 'IL,' C' 1I' A irk:ng 'apers to diserninatc the findings of work in proogresand ::r*. --c -i-1. .-- .'te 1 I :: pds;cs rscartrXhese the names of ::::::.-.... .: v . ii *... .".. .<..'' > -.*~. 1: k :~. x :crp:retat. )r. and cornlhr onq are the ,:AI . : * .. :: . ti' .mi, .:.:.rdi% i,r ii nic.rnNr (siltr:so Policy,Research, and ExternalAffairs PublicEconomics WPS 615 This paper - a product of the Public Economics Division, Country Economics Department - is part of a largereffort in PRE tostudy theentrallyplanned economics in transition. Copies are available irre from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Ann Bhalla, room N 10-059, extension 37699 (24 pages). Socialist economic growth in China and Eastem * Why investment hunger is an inevitable Europe has long been characterized by invest- consequence of social planners' rational chioices. ment hunger, drives toward expansion, and cyclical fluctuation of investment rates. * When a drive toward expansion can cause a permanent shortage of consumption goods. For decades, relatively high groA rates - often accompanied by a shortage of consumption Through numerical examples and empirical goods - have typically been achieved at the tests, Zou provides a framework w:thin which to consumers' expense. analyze political investment cycles in a socialist economy. In China, Zou linds that high invest- Treating social planners as self-interested ment rates have often been linked to leftist (or bureaucrats, Zou ofi'rs a positive model to help hardline) political regimes and low or moderate understand the norms of socialist economic investment rates with "rightist" (or so[tline) growth. This model demonstrates: political regimes. Hflow rapid capital accumulation tends to serve the social planners' own interests. The lPREWorking PaperSeries disseminates the findingsof work underway in the lmnksPolicy, Research.and Extemal AffairsComplex.An objectiveofthe scricsis to gettlce findingsout ruickly, evenif preseniationsare less thaln fully polisled. The findings,interpretations, andl conclusions in thesc (donot nTOCCssdrilrcprsent oflficial firink policN. ProduLed h! the PRED)sscnnmaion aun eCntcr Socialist Economic Growth and ?o)'tical Investment Cycles By Heng-fu Zou Table of Contents I. Introduction 1 II. The Model and Its Justification 4 III. The Dynamics of the Model and the Properties of the Equilibrium 7 IV. A Numerical Example and an Iliustration of Political Investment Cycle 11 V. Historical Evidence 16 VI. Summary 22 References 23 Sociallst Economic Growth and Political InvestmentCycles I. introduction In tradltlonaloptimal growth models for a centrallyplanned economy, e. g. Cass (1965) and Koopmans (1965), social planners maximize an lntertemporal soclal welfare function defined on per capita consumption,subject to the dynamic constraint of capital accumulation.The results from these models have become the folklore of modern economics: there exists a unique optimum path converging asymptoticallyto the unique equilibrium;the optimum capital stock in long-run Is determined by the famous modified golden rule, I.e., marginal productivityof capital is equal to the natural growth rate of populationplus the time discount rate of social planners. In these models, social planners all act In the Interestof the society. They do not have any objective function other than the welfare of the people, and their personal Images are only reflected In the time discount rate. Cass (1965) provides a typical picture of the central planners: "The central planning authority'sconcept of social welfare is related to the ability of the economy to provide consumption goods over time. In particular,welfare at any point of time Is measured by a I am grateful to Bela Balassa, Richard Caves, Janos Kornai, Andrew Newman, Dwight Perkins, Yingyi Qlan, Jeffrey Sachs and Xinsheng Zeng for very helpful discussion and comments.The first version of this paper was presented In Janos Kornai's workshop at Harvard, I thank the seminar participantsfor their suggestions. 1 utility Index of current consumption per capita .... The central planning authorityrecognizes that consumptiontomorrow is not the same thing as :onsumptiontoday. For thls reason, It takes the politicallypragmatic view that its planning obligation is stronger to present and near future generationsthan to far removed future generations.This view is implemented .n practice by discountingfuture welfare at a positive rate". This approach to socialist growth suffers .rom serious limitationswhen compared to socialist reality. First of all, traditionaloptimal growth models are based on an insufficientunderstanding or InH ed, a misunderstandingof the nature of the social planners.This point has been emphasized by Janos Kornal In his various studles ( Kornal, 1982, 1986, 1988). With both political power and economic resources in their control, social planners are not constrainedor directed to choose the optimum feasible growth path with respect to the only criterion,which Is to maximize social welfare. "Such an unworldlybureaucracy never existed in the past and will never exist In the future. Political bureaucracieshave Inner conflicts reflecting the divisions of society and the diverse pressuresof varlous social groups. They pursue their own Individualand group Interests,Including the Interestsof the particular specializedagency to which they belong. Power creates an irresistabletemptation to make use of it. A bureaucratmust be interventionistbecause that Is his role in the society; It Is dictated by his situation" (Kornai 1986, pp. 1726-27). In practice,social planners are often investmentgrowth rate maximizers (Grosfeld,1987), and their personal interestsare more connected to the persistentexpansion of their organizationsthan to the Increase In people's consumption.In their investment trategies, "the highest priority is placed on Industry,and within industryon heavy industry,and within heavy Industryon the part related to 2 the military. ... Anztongthe neglected,non-priority sectors, one typically finds agriculture,and even more so all the branches of the tertiary or service sector, such as transport and telecommunication,housing, other communal services,domestic trade, and health. This diversion of resources from consumptionto Investmenttakes place not provisionallyfor two or three years, but for decades, for twenty, thirty, or forty years". (Kornal, 1988, p.244). In this paper, we intend to offer a simple alternativemodel to capture certain essential aspects of socialisteconomic growth. The most imnortant ieature of the model Is In defining the social planners'objective function in both per capita consumptionand per capita capital stock. The model Is Justifiedand set up ln Section II. In Its abstract form, thls modelling was presentedby Mordecal Kurz In 1968. That paper has long been neglected in the economicsprofession partly because, we guess, Kurz has not offered any Justificationfor the so-called wealth effects model. In this paper, we are able to find a realisticsetting for the Kurz model In socialisteconomic growth. In Section III, we demonstrate that this simple model provides good framework for the understandingof "Investmenthunger" and "expansion-drive"studied by Kornal (1980).Section IV derives a theory of polltical Investmentcycle frcm our basic model. It Is shown that the investment rates (or accumulationrates In the terminologyof socialisteconomics) are related to different political regimes In socialist countries. In Section V, we will look at the empirical data on lnvestmentrates from 1952 to 1985 In China. The variations on Investmentrates throughout those years can be substantiallyexplained by the change of political power at the top level of government,evidence supporting 3 the theory of the political investmentcyc:'e. II. The Model and Its Justification We define the Instantaneousutility function of social planners at a given time t as the summation of two parts: u(ct) + iv(kt). ct Is consumptionper capita and kt Is capital stock per capita at time t. Social planners derive positive utility from both consumptionenjoyed by che people and capital stock owned by the state, so the first order derivativesof functionsu(.) and v(.) are positive. The Greek letter x Is a positive constant that measures the importanceof capital accumulationfrom the point of view of the social planners. In later sections,we will allow x to take different values, and its effects on capital accumulation,the Investmentrate and const..Iptionwill be studied. Furthermore,for technicalreason, we assume that the second order derivativesof u(.) and v(.) are negative,and that: lim u'Cc ) =X ct -->0 which guarantee the sufficiency of the first order condltions for optimization,and exclude the corner solutionof zero consumption. In modelling the social planners'preference, we maintain that social planners do care about people's consumption,and the improvementin the living standard of the people seems to Justify their manipulationof political power and economic