Foreign Trade in the Centrally Planned Economy

T. Wolf

• Publisher: Taylor & Francis
• Year: 2013
• ISBN:
  9781136471988
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Analyses the main institutional and policy determinants of the foreign trade behaviour of a centrally planned economy and studies factors that affect the level and pattern of foreign trade.

Foreign Trade in the Centrally Planned Economy

THOMAS A. WOLF

International Monetary Fund, Washington DC, USA

1.  INTRODUCTION

The centrally planned economy (CPE) considered in this monograph is a stylized version of the planned economies actually existing in the Soviet Union and, beginning in the late 1940s and early 1950s, in most of Eastern Europe. This essay is therefore neither an examination of foreign trade in a hypothetical CPE,¹ an exposition of the Marxian theory of foreign trade, nor a study of the implicit role that foreign trade might play in the so-called Lange- Lerner model or other models of market socialism. Rather, the objective of this essay is to explore the ways in which the main features of this stylized real-world CPE influence, along with the internal and external environment, its foreign trade behavior and the level and pattern of its trade.

Because the CPE examined in this study is a stylized representation of real-world economies, it is not always easy to distinguish between the systemic and policy determinants of its foreign trade behavior and outcomes.² Whenever possible such distinctions are made here, but because in most instances foreign trade behavior is in fact co-determined by both factors, and they are both very difficult to quantify, it is usually impossible to separate out their different effects. By necessity, therefore, the CPE portrayed in this study is a centrally planned economy with a specific set of fundamental policies, a set which has been heavily influenced by the historical environment in which the CPE was established and developed. A CPE could be imagined, of course, in which policymakers operated with a very different policy configuration, which in general would result in very different foreign trade behavior and outcomes; as noted, however, such a “hypothetical” CPE is not discussed in this essay.

The second section briefly describes the organization of foreign trade activities in the CPE, and discusses the main institutional and policy determinants of CPE foreign trade behavior. The actual impact that these factors have on foreign trade decisionmaking is examined in more detail in Section 3. The role of foreign trade in the macroeconomy and in macroeconomic stabilization in the CPE is the focus of the fourth section. Because there are continuing efforts in a number of real-world CPEs to improve economic performance through economic reforms, Section 5 examines in some detail the pressures for reform that emerge in foreign trade as well as the impact that reform may have on foreign trade decisionmaking and macroeconomic adjustment in the “modified” CPE.

¹ Foreign trade behavior of a hypothetical CPE that follows Pareto-optimal rules is examined in Batra [7]. A critique, which emphasizes the differences between this hypothetical CPE and those existing in the real world, is provided by Wolf [122].

² The theoretical framework that distinguishes among an economy's environment, system, goals, policies and outcomes is developed in Koopmans and Montias [61] and Montias [84]. An application of this framework to CPE foreign trade is provided by Hewett [42].

2. INSTITUTIONAL AND POLICY CONTEXT

The economic system of the real-world CPE has the following characteristics that are directly relevant to the conduct of foreign trade: state ownership of the bulk of the means of production; information flows and hierarchical bargaining over enterprise plans and access to resources, which occur in a bureaucratic rather than a market environment; the elaboration of detailed central plans for enterprise inputs and outputs; rigid prices set by the central authorities, which are intended to facilitate the planning process and the evaluation of enterprise performance; plan fulfillment, rather than profits, as the main criterion for evaluation; a relatively free labor market, but wages that are subject to close regulation from the center; and a monolithic state banking system that passively supplies the credit necessary to physical plan fulfillment and that maintains a fairly strict dichotomy between the money supplies held by enterprises and households, respectively.

The authorities in real-world CPEs have typically adopted the following fundamental policy objectives: rapid industrialization, based on a high rate of capital accumulation and a rapid growth rate of the industrial labor force; retail price stability; downward rigidity in money wages; full employment and indeed individual job security; and strict limits on wage and salary differentials (on the prototype CPE system, see Campbell [27] and Nove [90]).

In this CPE, foreign trade is largely carried out by a number of state-owned foreign trade organizations (FTOs) that are mainly subordinate to the Ministry of Foreign Trade (MFT).³ The MFT is subordinate, in turn, to the governmental Council of Ministers. Generally the FTOs only engage in foreign trade, and do not have manufacturing operations or distribute goods domestically at the wholesale or retail level. Although in some cases the industrial branch ministries, also subordinate to the Council of Ministers, may have some direct influence on the activities of the FTOs, for the most part these ministries and the domestic trading and/or producing enterprises under their authority have little direct relationship with foreign enterprises. The FTOs generally are non-competing with one another, and therefore each FTO may be considered to have a foreign trade monopoly for a particular range of products. Likewise, the FTOs together, and by the same token their principal superior organ, the MFT, constitute an institutional state monopoly of foreign trade.

Annual and five-year plans for foreign trade are developed as the result of a bargaining process involving the provision by the FTOs of information on foreign market developments, the aggregation of the draft plans of individual FTOs by the MFT, and the development of both disaggregated and aggregated plans by the governmental Central Planning Commission, in close coordination with the supreme political authorities and the individual branch ministries responsible for domestic production and domestic trade. The foreign trade plan that emerges from a process of several iterations is an integral part of the overall national economic plan. It specifies, in varying degrees of detail, the volume, commodity composition and geographical pattern of foreign trade that is to be undertaken in the next period. The aggregate plan for imports essentially reflects the pattern of the central planners’ excess demands, after taking into account domestic production objectives, for those goods that are central to plan fulfillment in priority sectors. Exports, on the other hand, are planned for the most part in light of the foreign exchange needs implied by the import plan and a balance of payments constraint. Most imports and exports are reflected in the so-called material balances worked out by the planners, which may cover hundreds or even several thousands of material inputs that are deemed critical for overall plan fulfillment.⁴

Institutional determinants of foreign trade behavior

The foregoing institutional set-up has several distinctive implications for foreign trade behavior and outcomes in the CPE. First, the state monopoly of foreign trade institutionally separates, and indeed insulates, domestic producers and consumers from foreign markets. As a result, domestic producers of both exportables and importables tend to be insulated from competitive forces on world markets, and their standards for quality and innovation in production and for reliability in delivery are largely determined by those of the domestic market. This insulation from the world market is manifested most clearly in the difficulty that CPEs have in exporting finished and, in many cases, even semi-finished manufactures to market economies (MEs).

Second, the predominance of bureaucratic, or vertical relationships over horizontal relationships with other enterprises, and the tendency for firms to concentrate their dealings with other enterprises belonging to the same ministry, has the effect of limiting the degree of specialization, particularly in final products. This, in turn, restricts the degree to which FTOs have been able to base their export strategies on specialization within the realm of manufactures, and their ability to attain and maintain strong positions on the highly competitive export markets for manufactured products in MEs (Winiecki (121]).

Third, the de facto predominant role played by quantity targets in the plans of both domestic enterprises and the FTOs, together with managerial remuneration schemes tied mainly to plan fulfillment, result in an extraordinary emphasis being placed by the CPE on the quantity of production rather than its quality. This emphasis spills over into foreign trade, as well, and is a further cause of the relative difficulty that CPEs have in exporting to MEs those manufactures that are subject to significant product differentation on the basis of quality (Holzman [47]).

A fourth crucial determinant of CPE foreign trade behavior is the domestic price system taken together with the incentive system and the very limited degree of autonomy enjoyed by the FTOs. Domestic prices at the producers’ and wholesale level are administratively fixed, by the State Price Office, and typically held constant for long periods. Although fixed prices may reflect important policy objectives, in this case they can also be viewed as the logical outcome of central planning. The fixing of prices facilitates the planners’ tasks of aggregation across thousands or millions of commodities, and it also simplifies the evaluation of enterprise performance in the sense that with fixed prices, enterprise revenues and costs can easily be given a physical as well as a value interpretation. Moreover, it removes from the State Price Office the burden of attempting to simulate market outcomes for the thousands or millions of individual products.

For accounting purposes the foreign currency values of traded goods are converted at a so-called valuta or external exchange rate into a “foreign exchange” equivalent of the local currency (e.g., foreign exchange rubles, or valuta rubles). This accounting unit will typically not be directly convertible by FTOs into domestic currency (Pryor [96]). Unlike domestic prices, foreign currency prices will generally be subject to frequent change. Even if the valuta exchange rate is fixed, the valuta value of the trade of a FTO, and of the aggregate value of the CPE's exports and imports, will fluctuate along with changes in foreign currency prices as well as with changes in trade volumes. Abstracting from FTO commissions and overhead costs, the FTOs as a group earn a profit (T) from foreign trade equal to:

T = Q_m(P_m – P^*_me ′) + Q_x(P^*_xe ′ – P_x), (1)

where Q_m and Q_x represent the volumes of a composite import and export, respectively, P_m is the weighted average price at which FTOs resell imports to domestic trading organizations, P_x is the weighted average price at which FTOs purchase exports from domestic producers, P^*_m and P^*_x are the weighted average foreign currency prices of imports and exports, respectively, and e ′ is the valuta exchange rate, expressed in units of the nominal valuta currency per unit of foreign exchange. The valuta value of imports and exports will be equal to P ′_mQ_m and P ′_xQ_x, respectively, where P ′_m = P^*_me ′ and P ′_x = P^*_xe ′. The foreign trade profit of the FTOs is only nominal from their standpoint, because it is exactly offset (ignoring commissions) by a system of so-called price equalization taxes (if T_i > 0) and subsidies (if T_i < 0), where T_i refers to the net profit on price discrepancies earned by the ith FTO (Pryor [96], Wiles [120] and Wolf [124]).

Unless an FTO has market power in foreign markets, the foreign currency prices it faces, as well as the administratively set domestic prices, are beyond its control. Its import plan will typically be fixed in volume terms, for these goods will mainly be high priority goods critical to fulfillment of the national economic plan. If FTO commissions, and in turn the remuneration of its employees, are a function of its nominal profit or the extent to which this profit exceeds planned profit, the enterprise may have an incentive to search for the lowest cost sources of foreign supply of the specified imports. Because the volume constraint is binding, however, the FTO's effective negotiating room, in the event it has external market power, will be limited.

On the export side, the autonomy of the FTO vis-à-vis the higher authorities may be somewhat greater. This is because the FTO itself is in a position to identify and analyze changing export prospects, and unlike in the case of imports it will not face a centrally imposed minimum constraint on its export volumes. If it could obtain a higher price by cutting back its export offer, and still earn the valuta revenue called for in the plan, it might be evaluated just that much more highly, as this action would free additional quantities of the exportable for domestic consumption. If the FTO were instead evaluated mainly with respect to its nominal profit, T, then it would seek to equate its marginal revenue from exporting with the marginal cost of this activity. If it also had external market power, this would imply setting its export price above the fixed domestic price it pays for the exportable. If instead it were a price taker abroad, the profit maximizing FTO would attempt to maximize its export volume, given the fixed domestic price of the exportable. If revenue maximization were the objective of the FTO, it would try to maximize export volume if it were a price taker, but would attempt to set its export price to correspond with the unit elastic point on its foreign demand curve if it enjoyed external market power.

Although greater autonomy may exist on the export side, it is usually considered that FTOs in practice have only limited autonomy in the CPE. To give FTOs a significant degree of autonomy would, after all, work against the fundamental objective of central planning, which is to exert the maximum possible central control over all areas of resource allocation. As a result, the overall “offer curve” of the CPE is likely to be decided at the level of the central authorities, and to be determined by aggregate economic considerations rather than by the parochial concerns of individual FTOs (see Section 3).⁵

A fifth consideration is that this circumscribed autonomy of the FTOs and the insulation of domestic enterprises from foreign markets will logically be reinforced by a policy of de jure resident inconvertibility with respect to the purchase and sale of foreign exchange. Importing FTOs must apply to the Ministry of Finance or the state-owned Foreign Trade Bank for the foreign exchange needed to meet their plans. Only in rare circumstances would domestic persons or enterprises be allowed to purchase foreign exchange (for example, in the case of authorized trips abroad, and so forth). Exporting FTOs typically will not earn foreign exchange; rather, their revenues denominated in foreign currencies will be paid directly to the above-mentioned financial authorites, which will offset these revenues with valuta earnings credited to the FTOs’ bank accounts.

Sixth, the centralized formulation and implementation of foreign trade plans has a subtle but powerful impact on the de facto convertibility of a CPe′s currency. Because all intermediate and final investment products are centrally allocated, and since all trade by the FTOs is in principle stipulated in their plans, by volume and assortment, there is very little unplanned trade. Now consider a foreign firm that exports to the CPE. It could take payment in some convertible currency; or, if it is based in a member country of the regional grouping of the CPEs, the Council for Mutual Economic Assistance (CMEA), it could accept a claim in its domestic currency or valuta at its own national bank, which in turn would increase its own claim on the importing CPE in terms of the common intra-CMEA clearing unit, the transferable ruble (TR).⁶ Alternatively, at least in theory, the foreign exporter could accept in payment a direct claim on the banking system of the CPE. Because the importing CPe′s exports in the present and possibly even in foreseeable plan periods have already been largely determined, however, the foreign holder of its currency would be severely limited in terms of the domestic purchasing power of this currency. For this reason, and independent of whatever legal restrictions might be applied to the exchange of the CPe′s currency for others (including, as noted above, resident inconvertibility), its currency may be said to lack “commodity convertibility,” and therefore will be de facto inconvertible for nonresidents, a...

Table of contents

• Front Cover
• Half Title
• Title Page
• Copyright
• Title Page
• Copyright
• Contents
• Introduction to the Series
• Abbreviations
• 1. Introduction
• 2. Institutional and Policy Context
• 3. Foreign Trade Decisionmaking
• 4. Foreign Trade and the Macroeconomy
• 5. Economic Reform and Foreign Trade
• 6. Summary
• Acknowledgement
• References
• Index