TITLE : THE SECOND ECONOMY IN CONSUMER GOOD S AND SERVICES IN THE USSR AUTHOR : Dennis O'Hearn CONTRACTOR : The University of California, Berkele y PRINCIPAL INVESTIGATOR : Gregory Grossman COUNCIL CONTRACT NUMBER 620-5 DNA DATE : October, 198 6 The work leading to this report was supported by funds provided by the National Council for Soviet and East European Research ; It is one of several papers originally prepared for a Conferenc e on the Soviet Second Economy held in January 1980 at the Kenna n Institute for Advanced Russian Studies, in Washington, D . C . Dennis O'Hear n The Second Economy in Consumer Goods and Service s Summary Beginning with the premise that the Soviet system of centralized plan - ning is the basic cause of the second economy, this paper proceeds to exa - mine the second economy in consumer goods and services with a view toward s shedding light on its relationship with the first economy . The paper firs t sets forth an official Soviet legal taxonomy of the various forms of secon d economy activity, the most important of which are private enterprise, com - mercial mediation and speculation . A key distinction is made in this clas - sification system between private activity that takes place at the state o r collective enterprise and that which occurs elsewhere . Thus, in the contex t of Soviet law, 'private enterprise' must be carried out under the guise o f a state, cooperative, or other socialist enterprise ; otherwise, it is simply classified as employment in a handicraft without certification or engagin g in a prohibited trade . Based on this distinction, the paper compares secon d economy private enterprise and capitalist production with respect to facto r costs, prices and profitability . Because Soviet private enterprise has fre e use of state-owned fixed capital, it is argued that second economy produc - tion enjoys a cost advantage over capitalist production, which in turn im - plies a tendency for second economy profits to rise relative to profits unde r capitalism . In the second-economy labor market, labor costs may have a ten - dency to rise due to the workers' flexibility in allocating their labor ser - vices between the first and second economies and the need for compensation fo r the risk of being caught ; this tendency may be offset, however, by the fac t that some of the second economy labor costs are usually paid by the stat e enterprise . Finally, prices in the second economy are likely to be rela - tively high due to the combined effect of the low availability of consume r goods and services in the state sector and low state retail prices . Thi s again implies a tendency for profit margins to be relatively wide . To the extent that private enterprise takes place within the state en - terprise, rather than outside it, the impact of the second consumer econom y on the first economy is detrimental in several respects . The use of stat e machinery and materials lower capital formation since the private enter - prise pays neither a direct charge for depreciation nor taxes toward expande d reproduction . Moreover, the diversion of materials to the second econom y often involves some form of skimping on product quality in the state sector . The diversion of labor into the second economy may exacerbate the proble m of labor shortage and low labor productivity in the state sector . Finally , the second economy further distorts the balance of production set forth in the plan . In analyzing the systemic nature of the second economy, the author stresse s the fact that the enterprise worker does not have adequate incentive to protec t a plan which is passed down from above . However, because the Soviet authori- ties cannot admit the systemic nature of the second economy, he conclude s that prospects for effective deterrence of illicit private enterprises ar e fairly bleak . (Summary prepared not by the author .) Dennis O'Hearn THE SECOND ECONOMY IN CONSUMER GOODS AND SERVICE S 1 I . Introductio n "The objective of Soviet law in the case of economi c crimes is to preserve the rights and procedures of socialis t forms of organization ." Most Soviet criminologists an d economists begin from this premise . Yet for the bulk of th e second economy precisely those "socialist forms of organization " have been preserved and used for the purpose of privat e profit . A franker Soviet expert may say the "object" of th e second economy "is to undermine social relations whil e retaining the form ." 2 But it is perhaps more accurate t o assert that only the "form" of socialism exists in the Sovie t Union, that the prematurity of the attempt at socialism an d the subsequent route of "socialism in one country" hav e restricted the system to something other than socialism . Moreover, the "social relations" of the Soviet system ar e precisely the cause of the second economy, rather than bein g undermined by it . In other words, Soviet-style centralize d planning is neither socialist planning nor even effectiv e planning . Since it is not socialist, or democratic planning , the preferences of society (much less of individuals) are no t met . Under these conditions incentives for workers to con- tinually check and defend the plan are lacking . As a result, -2 - the plan is not effective--it is violated at all stages o f the economy . Violations take either the passive form of low productivity of labor and shoddy work, or the active form o f the second economy . It is the purpose of this essay to examine this "secon d economy" in the sphere of consumer goods and services (Marx' s Department II) . Throughout, the objective is to analyze ou r subject in such a way that the analysis will shed light o n the relationship between the second economy and the first . Further, we will discuss the comparability of the secon d economy to capitalist commodity production in terms of facto r supply, ownership and pricing . II . Structural activitie s Soviet analysts do not treat the subject of the secon d economy explicitly, but the legal literature does discus s individually its components . This is a source that has hardl y been tapped in the West . Yet viewed as a whole, lega l articles and books provide a way of finding out which activi- ties the experts feel are important, and how important eac h is relative to the others . Much of the present paper focuse s on the Soviet perception of the second economy as reveale d in the legal literature . Among questions which stand out th e most is the distinction between private activity that take s place at the state or collective enterprise, and that whic h does not . By way of introduction, a systematic review of the - 3 - components of the consumer second economy is possible, usin g the legal classifications set forth in the criminal codes o f the Soviet republics . In approximate order of importance, the activitie s undertaken in the consumer second economy are : private enterprise (chastnopredprinimatel'skaia deiatel'nost') , commercial mediation (kommercheskoe posrednichestvo), causin g property damage through deception or abuse of trust (pri- chinenie imushechestvennogo ushcherba putem obmana il i zloupotrebleniia doveriem), speculation (spekuliatsiia) , engaging in a handicraft without certification (zaniati e kustarnym promyslom bez registratsionnogo udostovereniia) , and engaging in a prohibited trade (zaniatie zapreshchenny m promyslom) . Another crime which is intrinsically tied to the second economy but which in itself does not constitute a secon d economy activity is misappropriation (khishchenie) of stat e or social property . The relationship of misappropriation to the second economy will become clear in the subsequent text . Review of the Soviet literature and discussions wit h Soviet citizens and emigres point to "private enterprise" a s the most widespread form of large-scale second economy activity . As in the West, the objective of these activitie s is the receipt of profits or labor income--in Soviet terms , unearned income . But in the context of Soviet law, to be classified as "private enterprise" an activity must also be - 4 - carried out "under the mask" of a state, cooperative, o r other socialist enterprise . 3 Otherwise, it is simply classe d as employment in a handicraft without certification o r engaging in a prohibited trade . The usual forms of private enterprise are organization s (factories, artels, design bureaus) ; structural subdivision s in existing enterprises (shops, branches, workshops, sections) ; or producing partly within the plan and partly outside of it . 4 The first form is generally known as a "pseudo-socialis t enterprise," an enterprise which outwardly appears to b e socialist . It will, for example, keep an account with the state bank, keep books, pay some taxes, etc . But its rea l function is to create private profits . The widesprea d creation of pseudo-socialist enterprises has been called "on e of the most socially dangerous types of private enterpris e activities ." 5 A private subdivision within the state enterprise i s more common, usually in the form of a subsidiary shop . The subsidiary will use the signboard of the parent enterprise , as well as its documents, letterheads, and capital . Often this takes place at collective or state farms . For example , a group of entrepreneurs, by agreement with a series o f collective farms, set up a large number of subsidiary depart- ments for production of various industrial goods . The organ- izers of the shops themselves hired workers, using kolkho z documents, obtained the materials, and sold the products . - 5 - All financial operations were carried out through the ban k accounts of the kolkhozes, who were paid 25-35 percent o f the sales revenues .