THE ECONOMIC NATURE OF EAST - WEST TRADE Thesis for the Degree of Ph. D. MICHIGAN STATE UNIVERSITY JOSEPH ARTHUR MCKINNEY 1970 rhesus LIER : {Y Michigan State University This is to certify that the thesis entitled The Economic Nature of East-West Trade presented by Joseph A. McKinney has been accepted towards fulfillment of the requirements for Ph.D. degree in Economics /v7m{zz%u' Mew» Major prefessor Date 1/4””. ‘72? /€70 d 0-169 ABSTRACT THE ECONOMIC NATURE OF EAST-WEST TRADE By Joseph Arthur McKinney This thesis is a study of the conomic nature of Soviet bloc trade with the industrial West. In the first chapter the development of the Soviet type foreign trade system is traced from its beginnings in Russia through its extension to the other nations of the Soviet block after World War II. The second and third chapters of the thesis are devoted to a discussion of the institutions aspects of the Soviet bloc economics which may affect the economic nature of their foreign trade. Chapter II describes the formulation of the foreign trade plan within the frame- work of the total economic plan, and explains how this plan is implemented by the various agencies of the foreign trade organization. Chapter III deals with the fundamental problem of price formation in the Soviet bloc countries and its implications for their foreign trade. In Chapter IV a Leontief—type input—output study of East-West trade in manufactured goods.is conducted to Joseph Arthur McKinney determine if this trade conforms to the postulates of the Heckscher-Ohlin theory of comparative advantage. The calculations are performed for trade of the entire Soviet bloc with the entire industrial West, and then repeated for various regional disaggregations of both East and West. In every case it is found that Soviet bloc exports to the West are capital intensive relative to their imports from the West, the opposite of what the Heckscher-Ohlin model predicts. A variant of the Heckscher-Ohlin model, which takes into consideration human capital as well as physical capital, is also used. The previous calculations are repeated with human capital incorporated into the analysis, and again it is found that in every case Soviet bloc exports to the West are capital intensive relative to their imports from the West, although not as capital intensive as before. An appendix to Chapter IV reports the results of rank correlation tests of the commodity composition of East-West trade which support the results obtained from the Leontief—type calculations, several possible explorations are offered for the unorthodox results. THE ECONOMIC NATURE OF EAST-WEST TRADE By Joseph Arthur McKinney A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Economics 1970 662274 7—/~7o ACKNOWLEDGMENTS I am indebted to a large number of people who have directly or indirectly helped to make this dissertation possible. I should like first of all to thank the members of my dissertation committee for assistance above and beyond the call of duty. Professor M. E. Kreinin helped me choose a topic, prodded me into applying for a dissertation grant, and provided encouragement and help without which the dissertation would not have been completed before I left Michigan State. I should also like to thank the other members of my committee, Professors Warren and Samuels and James Ramsey for their consideration, suggestion for improvement, and willingness to help in any way. What- ever merit this work may possess is largely attributable to the members of my committee: however, the usual disclainer of responsibility for errors is especially applicable in their case in view of the deadlines they worked so rapidly to help me meet. I am also grateful to Professor W. Paul Strassmann who served on my committee in the earliest stages of the dissertation, and to Professors Abram Bergson and Joseph Berliner of the Russian Research Center of Harvard University for helpful discussions about the general economic nature of East-West trade. 11 I am indebted to Berea College for a tuition-free undergraduate education, to the Woodrow Wilson Foundation and the department of economics at Michigan State University for generous financial support which a graduate student, and to the Institute for International Business and Economic Department Studies for a dissertation grant. My deepest gratitude is reserved for my parents and my wife, Nancy, whose love and devotion have made this effort worthwhile. iii TABLE OF CONTENTS ACKNOWLEDGMENTS . . . . . . . . . . LIST OF TABLES. . . . . . . . . . . . Chapter THE CENTRALLY PLANNED ECONOMY AND INTER- I. II. III. NATIONAL TRADE . . . . . . . . . The Emergence of the Centrally Planned ' Economy . . . . . . Formation of the Soviet Bloc. . . . The Problem and Objectives . . . . Definitions and Method. . . . . . THE ORGANIZATION AND PLANNING OF FOREIGN TRADE IN CENTRALLY PLANNED ECONOMIES. . The Use of State Trading by Soviet Bloc Countries . . The State Foreign Trade OrganizatiOn . The Ministry of Foreign Trade . . . The State Foreign Trade Enterprises . Foreign Trade as an Element of the Total Economic Plan . . . . . Planning by Material Balances . . Construction of the Foreign Trade Plan Effects of Planning upon Foreign Trade Emphasis on Plan (Volume) Fulfillment. Risk Aversion by Planners. . . . Taut Planning. . . . . . Problems of Communication. . . Summary and Conclusions . . . THE PRICE SYSTEM OF SOVIET BLOC NATIONS AND ITS IMPLICATIONS FOR THEIR FOREIGN TRADE O C O O O O O O O O I 0 Types of Prices . . . . . . Lack of Foreign Trade Theory. . . . Foreign Trade Efficiency Indexes . . Inconvertibility. . . . . . . . Bilateralism . . . . . Attempts at Multilateral Trade . . iv Page ii vi 114 15 20 Chapter Page Attempts at Multilateral Trade . . . . 61 Summary. . . . . . . . . . . . . 64 IV. AN ANALYSIS OF THE COMMODITY COMPOSITION OF EAST—WEST TRADE. . . . . . . . . 68 The Concept of Comparative Advantage . . 68 The Heckscher—Ohlin Model. . . . 69 Empirical Tests of the Heckscher-Ohlin Theory . . . . . 79 The Economic Nature of East-West Trade . 86 Assumptions and Definitions . . . . . 88 Data Sources and Method . . . . . 90 An Examination of the Empirical Data . . 96 Incorporation of Human Capital into the Analysis. . . 103 Results with Human Capital Included in the Analysis . . . . . . . 106 Possible Reasons for the Results . . . 112 APPENDIX TO CHAPTER IV . . . . . . . . . . 118 BIBLIOGRAPHY. . . . . . . . . . . . . . 138 Table LIST OF TABLES Capital and labor requirements per million dollars of exports and imports of manufactured commodities--Soviet Bloc. Capital and labor requirements per million dollars of exports and imports of manufactured commodities-—Soviet Bloc excluding East Germany and Czechoslovakia Capital and labor requirements per million dollars of exports and imports of manufactured commodities--U.S.S.R.. . . Capital and labor requirements per million dollars of exports and imports of manufactured commodities--Albania, Bulgaria, Hungary, Poland and Rumania . . . . . Capital and labor requirements per million dollars of exports and imports of manufactured commodities--East Central Europe (Soviet bloc excluding USSR) . . Capital (including human capital) and labor requirements per million dollars of exports and imports of manufactured commodities-- Soviet Bloc . . . .* . . . . . . Capital (including human capital) and labor requirements per million dollars of exports and imports of manufactured commodities-- Soviet Bloc excluding East Germany and Czechoslovakia . . . . . . . . . Capital (including human capital) and labor requirements per million dollars of exports and imports of manufactured commodities-- UOSOSOR. O O O O O O O O O O 0 Capital (including human capital) and labor requirements of exports and imports of manufactured commodities--Albania, Bulgaria, Hungary, Poland and Rumania . . . . . vi Page 98 99 100 101 102 107 108 109 110 Table 10. Capital (including human capital) and labor requirements per million dollars of exports and imports of manufactured commodities-- East Central Europe. . . . . . . . . Results of rank correlation tests. . . . . Trade of Soviet Bloc with the EEC, EFTA (excluding Portugal) and the U.S., 196A— 1966 (millions of current dollars; imports, f.o.b., exports, c.i.f.) . . . . . . . Regional disaggregation of Soviet Bloc Trade with the EEC, l96A-1966 (millions of current dollars; imports; f.o.b., exports, c.i.f.) . Regional disaggregation of Soviet Bloc Trade with EFTA (excluding Portugal), 196A-1966 (millions of current dollars; imports, f.o.b., exports, c.i.f.) . . . . . . Direct and indirect factor input coefficients for 18 manufacturing industries. . . . Capital/output coefficients for both physical capital stock and physical plus human capital stock. . . . . . . . . . .Human capital stock assuming 12.7% rate of return . . . . . . . . . . . . . Human capital stock assuming 9% rate of return . . . . . . . . . . . . . vii Page 111 122 123 12A 125 126 127 128 129 CHAPTER I THE CENTRALLY PLANNED ECONOMY AND INTERNATIONAL TRADE A study of East-West trade is a study of trade between two groups of countries having distinctly different economic systems. The countries of the industrial West are generally categorized as free market economies, although none of them conforms completely to the theoreti- cal construct of a perfectly competitive economy. All of them have government sectors of substantial size, and many of them have engaged in a certain amount of economic planning. Nevertheless, they all depend primarily upon the market mechanism to effect the allocation of scarce resources. This, however, is not the case in Soviet-type economies, where the means of production are both owned and allocated by the state. The basic economic decisions of what commodities shall be produced and in what quantities, how the commodities shall be produced, and for whom they shall be produced, are made by planners. Prices have been utilized largely as a tool in income distribution, and have often borne little or no relation to either costs of production or demand for the product.1 1 The domestic economy has been insulated from outside forces by state monopoly over foreign trade and the strictest exchange control. The Emergence of the Centrally Planned Economy The centrally planned economy has its roots in the Bolshevik Revolution in Russia in 1917. Other countries had previously engaged in large scale economic planning, but only in times of war. Lenin was reportedly impressed by the planning practices used in the United States and Imperial Germany during World War I, and looked to their experience for ideas to apply to the Soviet economy.2 As. the techniques of the war economy have been retained in Soviet-type economies, they have come to be identified with the communist system, although Marx had very little to say about central planning.3 The new Soviet regime in Russia apparently did not hope to achieve a socialist economy immediately after gaining power. The main concern seems to have been in keeping the economy functioning during this tumultuous period. However, circumstances at the time forced a movement toward almost total nationalization of the economy. Banking was made a state monopoly because private bankers refused to cooperate with the new regime.“ The spontaneous confiscation of land by the peasants seems to have proceeded independently of those decrees abolishing land ownership and nationalizing all land.5 In industry, at first only the largest and most important firms, as well as some in which there was danger of sabotage by the owners, were nationalized. However, the syndicalist tendencies of workers so disrupted production, through the taking over of factories by workers who tried to run them as they saw fit, that by the end of 1920 all industries were nationalized.6 Foreign trade was nationalized in April, 1918, but not until 1920 was there established an agency whose duty it was to plan and control foreign trade.7 So during the first few years of the Soviet regime, a period usually referred to as the era of War Communism and lasting from 1917 to 1921, the state assumed direction and control of the entire nonagricultural economy. During this period production decreased drastically and inflation was rampant. The market mechanism virtually ceased to function. Food was requisitioned from the peasants to support those in the cities and the Red Army.8 This taking of food from the peasants without payment, a lack of food in the cities, and a general lack of consumer goods eventually led to the danger of revolt by former 9 supporters of the Soviet government. ‘ Realizing the gravity of the situation, Lenin initiated the New Economic Policy in 1921 with the hope of improving economic conditions in the country. Under this new policy the peasants were required to supply a certain quota of food to the government, but were allowed to keep any in excess of this quota. This change in policy soon led to large increases in food production. In other parts of the economy private trading was again made legal, so that there was in general a return to a market economy. Lenin referred to the economic system which emerged as "State Capitalism," and believed it to be a necessary transitional phase from the system of capitalism to that of socialism.10 Although there was a return to the market economy characteristic of capitalism, the govern- ment retained firm control over the "commanding heights" of the economy, such as foreign trade, banking, transport, and the most important industries.11 The reforms of the New Economic Policy were very successful in restoring the operation of the economy. As prewar equipment and trained workers were used to rebuild the prewar industries, there were very rapid increases in industrial production while incremental capital-output ratios remained very low. Even though the share of heavy industries in total output was increasing somewhat during this period, the very rapid increase in total production made possible an increased supply of consumer goods which ameliorated relations of the regime with the populace.-12 These unusual circumstances were, however, destined to come to an end as prewar levels of production were once again attained. After this point there was no reserve of idle machinery and equipment upon which to draw. Consequently, much larger investment funds were required for new capital equipment in order to maintain the same rate of increase in production. It was not politically feasible at this particular time for the Soviet regime to raise these funds through higher taxes. Therefore, the effect of the slowdown in the rate of industrial growth was soon manifest in strong inflationary pressures in the economy.13 As the price of industrial consumer goods rose, it became less profitable for the peasants to exchange what they had produced on the market. There was a tendency for the peasants to produce those products which would make them self-sufficient, rather than producing for the market. Therefore, ". . . the inevitable adjustment to a lower rate of industrial growth seemed to turn into the threat of a negative rate of growth, of deurbanization and agrarianization of the country."lu Faced with this economic and political crisis, Stalin, who had assumed control upon the death of Lenin, embarked upon the First Five Year Plan. It was viewed, according to Gerschenkron, as a short-run measure which, even though initially requiring more investment, would soon enable greater production of consumer goods, thereby eliminating the imbalance in the economy. Stalin was willing to gamble that peasant unrest could be kept under control until the results of this plan were realized.15 The first steps toward economic planning had been taken by Lenin when he established the GOELRO (State Commission for Electrification) in 1920. This group was to draw up a plan for the electrification of the country.' Almost a year later Gosplan (State Planning Commission) was formed and instructed to develop a unified economic plan for the economy as a whole. For several years it was content to issue occasional reports on particular aspects of the economy, but was meanwhile accumulating the information and resources necessary for the construc- tion of a comprehensive plan.16 In 1927 specific instruc- tions were given for the development of a five year plan for the Soviet economy, and by the time it was completed in 1928, Stalin was ready to seek its implementation. At this same time, Stalin, fearing that the actions of the peasants would soon result in a food crisis, ordered the collectivization of agriculture. This action was strongly resented and was actively resisted. The result was a drastic reduction in the output of agri- cultural goods as both livestock and crops were destroyed in order to avoid turning them over to the collective farms. Nevertheless, by the end of the First Five Year Plan, 60% of all agricultural holding had been collecti- vized.17 This collectivization of agriculture relieved the pressure for the production of consumer goods which had earlier had such grave political implications. It was now possible for the government to force delivery of agricultural goods from the collective farms without having to be concerned with offering consumer goods in return. This fact enabled the government to adopt a different pattern of industrialization than would other- wise have been possible. Investment that would have been required for consumer goods industries could now be poured into heavy industry. Instead of a temporary measure, the First Five Year Plan turned out to be the beginning of a continuous process of industrialization,18 different from any that had preceded it in that the character of the industrialization was planned in great detail, and carried out in accordance with the preferences of the planners. Formation of the Soviet Bloc Thus the Soviet Union embarked upon a period of successive Five Year Plans, the third of which was interrupted by the Second World War. The end of the war saw Russia emerge with a greatly enhanced stature on the international political scene, and as the dominant influence in both political and economic matters in the whole of Eastern Europe. After the Second World War, the communist form of government was extended to Albania, Bulgaria, Czechoslovakia, East Germany, Hungary, Rumania, and Yugoslavia. Except for Albania and Yugoslavia, these countries were spared the bitter civil war through which the communists had gained control in Russia because, ". . . the Soviet Army, advancing through their territory, had not only defeated the German army but had shattered the old political structure, and disarmed the old ruling 19 classes, of Eastern Europe." In Albania and Yugoslavia, the old political structure had been destroyed by the Axis invaders, so the communists fought both a national war to expel the invaders and also a civil war to assure that they gained control of the government.20 In 19MB, Yugoslavia, while remaining communist, left the Soviet bloc. In all of the other countries of the bloc, Soviet personnel were in authority. In Yugoslavia, Tito refused to permit this, although he was a dedicated communist with an ideological loyalty to the Soviet Union. It was mistakenly assumed that a denunciation from Moscow would cause his deposition by Yugoslav communists. However, the party members were loyal to him personally, so he was able to remain in power, and Yugoslavia left the Soviet orbit.21 The reaction to the successful defiance of Stalin by Yugoslavia was an intensification of Soviet hegemony over the rest of Eastern Europe. Not only the Soviet political system, but also the Soviet economic model was extended to these countries. Features which had previously been characteristic only of the Soviet economy, such as the complete nationalization of industry, the collectivi- zation of agriculture, and a centrally planned economy, were extended to the economies of the other Soviet bloc countries. Most of these countries had suffered severe damage to their economies during the Second World War, and in some cases, in the aftermath of the war. All of the countries except Bulgaria had been fought over by German and Soviet troops. All of them had been economically exploited to some degree by the Germans during the war,22 and by the Soviet Union after the war.23 Due to the widespread economic damage that these countries had suffered, it was some time before even prewar levels of production could be again attained. So the first economic plans in these countries were short- term recovery plans introduced in four of the countries in 1947.2“ In most of the countries prewar levels of production were reached by 19A9, and, as the recovery plans were completed, longer term plans were introduced. Five Year Plans were set in motion in Czechoslovakia and Bulgaria in 19A9, in Hungary in 1950, in Rumania and East Germany in 1951, and a Six Year Plan was begun in Poland in 1950.25 The implementation of these plans was eventually to lead to important changes in the economic structure of all 10 of these countries. The emphasis of all of these plans was the same as that of the plans implemented earlier in the Soviet Union, i.e., the rapid development of heavy industry such as machine building and metallurgical industries. Before the war, some of the countries of Eastern Europe had developed little industry, and those which were industrialized had develOped primarily light industries and consumer goods industries. Thus the postwar pattern of development in these countries was radically different from that of the prewar years. The development of these heavy industries required huge investments, resources for which had to be squeezed out of the economies involved. As a result, agriculture, which was at this time involved in the process of col- lectivization, received virtually no investment funds, and was in fact a source of the income with which industry was developed. Resources were diverted from consumption by the depression of wage levels so that, between l9u8 and 1953, the standard of living in this group of countries is estimated to have been reduced by 20 per cent.26 Concurrent with, and partly as a result of, the changes taking place in the economic structure of the Eastern European countries, there was a reorientation of the trade pattern of these countries in the postwar years. There were very significant changes in both the direction ll of trade and its commodity composition. Before the war, the Eastern European countries had served as a market for the heavy industrial products produced in Western Europe, and had in turn supplied the West with raw materials and foodstuffs. For example, in 1938, 60% of the exports from Western Europe to Eastern Europe were the products of heavy industry, while 80% of the exports of Eastern Europe to Western Europe fit into the categories of raw materials, foodstuffs, and the products of light industry.27 After the war, there was an attenuation of Eastern European trade with Western Europe, and a redirection of this trade toward the Soviet Union. In 19A8, exports from Eastern to Western European countries stood at 34% of their level in 1938, and imports of Eastern European countries from Western Europe amounted to 42% of their 1938 level.28 In contrast, exports from Eastern Europe to the Soviet Union had increased by 19A8 to 91A% of their level in 1938.29 Much of this change in the direction of Eastern EurOpean trade was the result of Stalin's policy of autarky for the Soviet bloc. This policy was motivated by the desire to keep the satellite countries linked economically with the Soviet Union for political purposes, and also by the idea that depriving the capitalist countries of the West access to markets accounting for 12 35% of the world population would worsen the crisis of the capitalist system and hasten the advent of world communism.3O However, there were economic reasons as well for this reorientation of trade flows. The economies of Eastern Europe were rebuilt after the war according to the Soviet model with its strong emphasis upon heavy industry. Therefore, many of the products which these countries were now producing were those which tradition- ally they had imported from the West. It was much easier to sell such products in the Soviet Union than in the West, since import demand was greater for them there. Furthermore, neglect of the farm sector in the Eastern European countries had caused a sharp decline in their production of foodstuffs and raw materials, so that these products, which had been so important in the exports of Eastern Europe to the West before the war, were no longer available in large quantities for export.31 As the chilling of political relations between East and West occurred in the late l9HO's, this inevitably was paralleled by a worsening of economic relations. The United States, fearing Soviet expansionism in Europe, instituted in 19A8 a system of export licenses on all goods being exported from it to the East. In 1949, other countries of the West Joined in the institution of a strategic goods embargo, the stated purpose of which was 13 to deny products to the Soviet bloc which could be important to the development of its military power. With the Soviet bloc following a policy of limited trade with the West, and with the West restricting many of the products which the East could have been expected to purchase from the West, the flow of East-West trade declined steadily toward the end of the Stalin era. In 1952 and 1953, free world trade with the Sino-Soviet bloc amounted to only about 2% of total free world trade, the lowest level since the formation of the Soviet bloc.32 After the death of Stalin in 1953, and also the end of the Korean War in that same year, there was a considerable relaxation of political tensions. The Soviet bloc countries began showing a renewed interest in trade with the West, and businessmen in the West were anxious to take advantage of profitable trade opportunities wherever new markets were opened in the East. With pressure from the business community, and with the political situation being somewhat ameliorated, the process of dismantling the export controls in the West was soon started. A Since 1953, East-West trade has been one of the fastest growing segments of world trade. Yet, consider- ing the abyss into which this trade was plunged by war and the political developments afterwards, and from which its recovery has had to proceed, it is imporbable that the it: limits of economically profitable trade between East and West have even been approached. The economic ties which were so easily severed are requiring much time and effort to reconstruct. The fact that there appears to be a potential for a sizable increase in the level of this trade is suf- ficient to make it a subject of interest to the economist. In addition, there is the common belief, or at least hope, that an expansion of economic relations between communist and capitalist nations will in turn lead to more peaceful political relations, which makes such trade a matter of almost universal concern. Finally, foreign trade is an important tOpic in the study of comparative economic systems which must be investigated if economic processes under different types of economic organization are to be fully understood. The Problem and Objectives The foreign trade of centrally planned economies is different in many ways from that of competitive economies. In the free market economy, foreign trade is conducted by private traders who are guided by price and cost con- siderations in determining which commodities can be profitably traded, and in what quantities. In the centrally planned economy, both the commodity composition and the level of foreign trade may be, and generally have been, determined by central planners as part of the total 15 economic plan for the economy. After the amount and commodity composition of foreign trade are decided upon, export and import activity are conducted by state trading organizations. Unrealistic prices, costs, and exchange rates, where recognized and identified as such, pose difficult problems for planners in determining the desirability of trade. The objective of this thesis is to investigate the economic nature of Soviet bloc trade with the West by asking if it is conducted in accordance with the trade pattern postulated by the Heckscher-Ohlin theory of comparative advantage. It is demonstrated in Chapter IV that countries of the Soviet bloc are labor abundant relative to countries of the industrial West. Therefore, the normal trade pattern according to the Heckscher- Ohlin theory would be for the countries of Eastern Europe to import relatively capital intensive commodities from the West and export relatively labor intensive commodities to the West. Definitions and Method Chapters II and III discuss institutional aspects of the Soviet bloc economies which have bearing upon the economic nature of their foreign trade. Chapter II describes the formulation of the foreign trade plan within the framework of the total economic plan, and explains how this plan is implemented by the various 16 agencies of the foreign trade organization. In Chapter III the fundamental problem of price formation in the Soviet bloc economies, and its implications for their foreign trade, is discussed. In Chapter IV a Leontief—type input-output study is used to analyze the commodity composition of East- West trade. Since the two-factor Heckscher—Ohlin model of comparative advantage is used, the analysis is limited to trade in manufactured foods so as to eliminate those commodities which enter into trade primarily because of the natural resource endowment of the country concerned. Through the use of an input-output study, both direct and indirect factor inputs into each commodity are determined. This information, in com- bination with data on the commodity composition of trade, is used to measure the factor intensity of exports relative to imports, and therefore to test the conformity of East-West trade with Heckscher-Ohlin hypothesis. Also in Chapter IV, a variant of the Heckscher- Ohlin model, which takes into consideration human capital as well as physical capital, is used. In recognition of the fact that much of a nation's capital is invested in its labor force, estimates of human capital stock are derived for each industry and added to the industry's physical capital stock to form new capital/output coefficients. With human capital thus incorporated into 17 the analysis, the previous tests are repeated and the results compared with those obtained considering physical capital stock alone. In the remainder of this study, the terms "West" and "industrial West" refer to the United States and those countries of Western Europe which belong to either the European Economic Community or the European Free Trade Association, with the exception of Portugal. The terms "East" and "Eastern Europe" refer to the Soviet bloc countries of Albania, Bulgaria, Czechoslovakia, East Germany, Hungary, Poland, Rumania, and the Union of Soviet Socialist Republics. The terms "Soviet-type economy" and "centrally planned economy" are used to refer only to the economies of the Eastern European countries, although there are other economies of this type. 18 FOOTNOTES lJ. Wilczynski, "The Theory of Comparative Costs and Centrally Planned Economies," Economic Journal, LXXV (March, 1965), p. 6“. 2Harry Schwartz, An Introduction to the Soviet Economy (Columbus, Ohio. Charles E.*MerrI11, 1968), 3John M. Montias, Central Planning in Poland (New Haven: Yale University Press, 1962), p. vii. “Harry Schwartz, Russia's Soviet Economy (2d ed.; Englewood Cliffs, N.J.: Prentice Hall, 1954), p. 10“. 5Marshall I. Goldman, The Soviet Economy: Myth and Reality (Englewood Cliffs, N.J.: Prentice-Ha11,)I968), p. 20. . 6Schwartz, Russia's Soviet Economy, p. 105. 7Alexander Baykov, Soviet Foreign Trade (Princeton, N.J.: Princeton University Press, 1936), pp. 8-9. 8Schwartz, Russia's Soviet Economy, p. 106. 9 lOMaurice Dobb, Soviet Economic Development Since 1917 Goldman, p. 21. (6th ed.; London: Routledge and Kegan Paul, 1966), p. 133. llSchwartz, Russia's Soviet Economy, p. 107. 12Alexander Gerschenkron, Economic Backwardness in Historical Perspective (New York: Frederick A. Praeger, 1962), p. 193. l3Ibid., pp. 1u3-1uu. lulbid., p. luu. lsIbid., p. 1u5. l6Schwartz, Russia's Soviet Economy, p. 118. 17Georg von Rauch, A History of Soviet Russia (5th ed.; New York: Frederick A. Praeger, 1967), p. 182. l9 18Gerschenkron, p. 146. 19Hugh Seton—Watson, The East European Revolution (New York: Frederick A. Praeger, 1956), pp. 168-169. ZOIbid. 21 Donald W. Treadgold, Twentieth Century Russia (2d ed.; Chicago: Rand McNally, 1959), pp. 422-423. 22Seton-Watson, p. 230. 23J. F. Brown, The New Eastern Europe (New York: Frederick A. Praeger, 1966), p. 76. 2“Seton-Watson, p. 240. 251bid., p. 246. 26Brown, p. 78. 27U.S. Congress, Senate, Committee on Foreign Relations, A Background Study on East-West Trade, 89th Cong., lst Sess., 1965, p. 2. 28United Nations, Economic Commission for EurOpe, Economic Bulletin for Europe, Vol. I., 1949, p. 27. 290.8. Congress, A Background Study of East-West Trade, p. 3. 3OIbid. 3lIbid., p. 5. 32It was not considered necessary to include Canada in the analysis since her trade with the Soviet bloc in manufactured goods is relatively insignificant. While Japan's trade with the Soviet bloc in manufactures is of more significant proportions, Japan could probably not be considered capital abundant relative to the Soviet bloc countries. CHAPTER II THE ORGANIZATION AND PLANNING OF FOREIGN TRADE IN CENTRALLY PLANNED ECONOMIES There are several respects in which the foreign trade of the Soviet bloc economies differs from that of market-type economies. In this chapter the foreign trade organization of Soviet-type economies is described, and the relationship of the foreign trade plan to the total economic plan is discussed. Also, some of the more important effects of economic planning upon foreign trade are discussed. The Use of State Trading by Soviet Bloc Countries Although state trading has a history reaching back at least as far as the Middle Ages when it was used by the city-states of Italy,1 it has in recent years become an important part of total world trade, primarily through its use by Soviet-bloc economies. The mobilization of resources for World War I required government participa— tion in many hitherto private aspects of the economies involved. As mentioned in Chapter I, Lenin was much 20 21 impressed with the ability of governments to mobilize the resources of an economy for the war effort, and con— cluded that the same methods could be utilized to mobilize resources for industrial development. Thus with the coming to power of the Bolshevik regime in Russia the planned economy became a permanent type of economic system. Lenin considered the state monopoly of foreign trade to be absolutely essential to the development of the Soviet economy. He was afraid that a cartel of capitalist producers would dominate the Soviet market, overcoming any conceivable tariff protection so as to thwart the development of state industries and thereby undermine the new Soviet government.2 Therefore, one of the primary purposes of state trading was to protect the Soviet infant industries from foreign competition, and in so doing to protect the interests of the Soviet state. Foreign trade was nationalized in Russia within six months after the new Soviet regime was established. The new foreign trade organization was not established until two years later, but in the interim none was needed since chaotic internal economic conditions and the almost universal ostracism of the Soviet government from abroad had reduced Russia's foreign trade to miniscule prOpor- tions.3 22 As one of what Lenin called the "commanding heights" of the economy, foreign trade remained a government monopoly during the period of the New Economic Policy, even though some enterprises were given the right by the government to sell abroad the products that they them- selves produced and to buy from abroad products needed for their own production. Stalin also was convinced of the absolute necessity of state trading, and under his direction a system of foreign trade was established in the Soviet Union which placed responsibility for not only the control but also for the conduct of foreign trade totally upon the government. The powers of state trading to facilitate rapid industrialization were fully exploited, as raw materials and agricultural products were sold abroad even during the Great Depression at whatever price they would bring in order to obtain foreign exchange to finance machinery imports. The same set of methods and institutions which had been developed in the Soviet Union was extended after World War 11, along with the other aspects of the Soviet economic model, to the countries of Eastern Europe. By 1948 foreign trade had been nationalized in all of the satellite countries,"I and during the next few years the other components of the SoViet foreign trade system were applied in these countries also. The same basic system 23 is used today, and, along with the planning of foreign trade, is discussed in the remainder of this chapter. It should perhaps be mentioned at this point that there are a number of reforms being experimented with in the Soviet bloc countries, some of them indicating a movement toward more liberal trade policy. No attempt to discuss these various experiments will be made here, since their implementation has come too late to have affected the trade analyzed in this study. In any case, close control over foreign trade and foreign exchange is likely to be maintained unless there is a large scale revision of the economic system of these countries, for without this control it would not be possible to retain a high degree of control over internal trade, production, land the money supply.5 The State Foreign Trade Organization The following definition of the state foreign trade monOpoly was recently given by a Soviet economist: "The state monopoly of foreign trade comprises the exclusive right of the state to define all the principal directions and aspects of foreign trade activity, including the procedure for distribution of the results of savings of social labor from foreign trade."6 There are a number of different institutions involved in the control, planning, and conduct of the foreign trade of a Soviet—type economy. The more important of these are discussed below. 24 The Ministry of Foreign Trade The agency which is in charge of the administration of trade operations in the Soviet bloc economies is the Ministry of Foreign Trade of each of the countries. This ministry maintains supervision and control over the foreign trade enterprises which engage in the actual conduct of foreign trade, and acts as a link between these enterprises and the State Planning Commission which draws up the overall economic plan for the economy, of which the foreign trade plan is a part.7 In order to supervise the activities of the foreign trade enterprises domestically, the Ministry of Foreign Trade has personnel located in the primary trading centers of the country, and in areas where a lot of exports are produced.8 In other countries the Ministry maintains trade delegations, whose principal officer and his deputies are considered part of the Soviet diplomatic corps.9 These representatives of the Ministry supervise the activities of the foreign trade enter- prises in the country in which they are located, and often act as the representative of these enterprises in trade activities. These trade delegations also study the markets and general economic conditions of the country in which they are located, and promote commercial relations between it and the country which they represent.10 25 In addition to supervising the activities of the foreign trade enterprises, the Ministry of Foreign Trade works closely with the State Planning Commission to draft the foreign trade plans, which will be discussed later in this chapter. Other responsibilities include the drafting of trade agreements, development of tariff policy, the issue of permits for export, import and transshipment of goods, inspection of the quality of export goods, and a general monitoring of foreign trade activity.11 The State Foreign Trade Enterprises The state foreign trade enterprises are given responsibility for the actual conduct of the foreign trade of Soviet bloc countries. These enterprises are relatively few in number, as few as twelve in Bulgaria and not over fifty in any of the countries. Each of them is assigned a specific group of commodities in which it is to deal abroad. As a rule, each enterprise engages in both the import and export of its assigned commodities although there are exceptions to this rule. Each enterprise has monopoly rights in the group of commodities which it is assigned, so that none of the others can deal in these commodities anywhere in the world. The agents of the foreign trade enterprise usually function as a part of their country's trade delegation in the country 26 with which they are dealing, and their activities are supervised by the trade delegation. The foreign trade enterprises act as intermediaries between domestic and foreign firms. They purchase those commodities abroad which have been planned for import, and sell them to the domestic firms which have been designated to use the product. Those commodities which have been planned for export are purchased by the foreign trade enterprises from domestic producers and then sold abroad. The producers of exports are paid in domestic currency by the foreign trade enterprise with funds received as bank loans from the State Bank with the export commodities as collateral. These loans are in turn paid off with the foreign exchange received from the sale of the goods. Therefore, foreign exchange is accumulated in the State Bank, which is later distributed to the foreign trade corporations for the purchase of imports in accord- ance with the import plan.12 Domestic prices remain insulated from world prices since exports are purchased from domestic producers by the foreign trade enterprise at domestic prices, and imports are also sold to domestic users at domestic prices. Deficits or surpluses in the accounts of the foreign trade enterprises arising from the difference in domestic prices and world prices, and/or unrealistic exchange rates, are absorbed by the State Bank.13 27 Although the foreign trade enterprises are owned by the state, legally they are entities unto themselves. They can own prOperty abroad, enter into contracts, and sue and be sued as any private business organization. They alone are liable for any obligations they may incur. So while they are organs of the state, in order both to promote commercial relations with other countries and limit the liability of the state, they enter into the adjudica- tion of trade disputes with the same rights and obliga- tions as a private firm. Ostensibly the foreign trade enterprises are financially independent and are expected to earn as much profit as possible. However, the goal of profitable trade becomes somewhat obscure when trade operations are conducted in the realm of artificial exchange rates and unrealistic domestic prices. Given these prices which are not accurate reflections of economic considerations, an attempt to maximize profits would indubitably lead to an economically inefficient pattern of foreign trade. In fact, the foreign trade pattern is for the most part determined from above by the planners.) The bonuses which the foreign trade enterprises can earn for making profits, in addition to those awarded for plan fulfillment, are intended to motivate the foreign trade enterprises to maximize foreign exchange earnings while Operating within the confines of the foreign trade plan. It is this con- sideration which gives some limited significance to the 28 tariff structure of the Soviet bloc countries. Most of these countries have a two-column tariff with the higher tariff schedule applying to certain of the Western nations which have refused to extend most favored nations treatment to the Soviet bloc nations. If all other factors are equal, it will be to the advantage of the foreign trade enterprise to import from the country upon which the lower duty is levied. Of course, tariffs are not needed in the Soviet bloc countries for the protection of inefficient domestic industries, since the state can exercise the most effective form of protection by merely instructing the foreign trade enterprises not to import certain commodities. Apparently they are kept primarily as a tool to be used in bargaining tariff reductions with other countries. Inasmuch as the pattern of foreign trade in the centrally planned economies of the Soviet bloc is primarily determined by planners, a study of the economic nature of East—West trade must look beyond the foreign trade organization to the planning of foreign trade. In the following sections of this chapter the relationship of trade to the total economic plan is investigated, then the planning of foreign trade described, and finally the effects of planning upon foreign trade discussed. 29 Foreign Trade as an Element of the Total Economic Plan The foreign trade plan is an integral part of the total economic plan of each of the Soviet bloc countries. There are economic plans of various lengths, ranging from perspective plans of up to 20 years in length which indicate the intended course of the economy in the absence of major policy changes or unforeseen circumstances, to medium-term plans of 5-7 years in length, down to yearly and even quarterly plans. In concord with the emphasis upon supply planning in the Soviet bloc economies, imports are considered to be the primary component of the foreign trade plan with exports serving to earn foreign exchange to finance the necessary imports. In the perspective and medium—term plans the import plan is a function of the investment and production plans. It is drawn up in a fairly determinate form for the machinery and raw materials expected to be required for the planned development of the economy, and in a much less determinate form for consumer goods. The export plan is established so as to earn the foreign exchange necessary to finance planned imports by exporting commodities obtained from existing productive capacity. Additions to productive capacity solely for the purpose of providing goods for export are planned as a rule only within the framework of 30 medium—term trade agreements, and then primarily with other Soviet bloc countries.15 While the more operational annual plans are based upon these longer term plans, there are certain short run factors which affect the composition, level, and direction of imports and exports, as will be discussed below. Planning by Material Balances The principal method for planning the production and distribution of goods in the Soviet bloc economies is a system of material balances. A material balance is in effect a balance sheet showing the sources (or supply) of a given product on one side, and the uses (or demand) on the other. Imports are included as one of the sources of the commodity and exports as one of the uses, these preliminary trade figures being based upon past experience, existing trade agreements, and anticipated changes in the level and composition of trade. The number of these material balances ranges from 100 in Albania to around 14,000 in the Soviet Union.16 Balance is attained in these material balances through a procedure which is somewhat analagous to the inversion of an input-output matrix by iteration. For example, when the proposed uses of a commodity are greater than the sources, and it is decided to increase production of the commodity to remedy this imbalance, this will require increases in the planned outputs of all the 31 inputs into this product. As the input industries increase production to remedy their imbalances, there must be planned increases in the output of the industries supplying their inputs, etc., which means that other industries in the economy must be deprived of resources. The additional inputs required to increase production in a given industry are determined through th; use of technical coefficients (input norms) which are similar to the direct input coefficients of the typical input- output table except that they are expressed in physical terms rather than in terms of value.17 Since an increase in the planned output of a com- modity to achieve balance in its materials balance will generally have repercussions affecting many other commodities, alternative methods of achieving balance are often preferred. One obvious way to try to achieve the balance while avoiding second—round effects is to reduce the technical coefficients of heavy users, forcing them to use the product more economically. However, due to the "taut" nature of planning in the Soviet bloc countries these coefficients are already strained as a rule, so the possibilities for reducing the inputs into an industry while maintaining the same output are probably fairly limited.18 Another possible way of avoiding second-round repercussions to some extent is to shift resources from the consumer goods industries to those of higher priority. 32 However, the position of consumer goods on the planners' scale of priorities has evidently been rising in recent years, so this alternative may be less feasible than it once was. Finally, there is the possibility of correcting the imbalance by increasing the source of the commodity through additional imports. This alternative is certainly an attractive one if there is foreign exchange or gold available with which to purchase the increased imports, or if there are unplanned surpluses of goods which may be exported to obtain such foreign exchange. Foreign trade is used in this way as a safety valve, which undoubtedly affects the commodity composition of both exports and imports. More is said about this phenomenon in a later section of this chapter. The achievement of balance in this way is limited by the fact that when it becomes necessary to increase export production in order to finance additional imports, this will also have secondary effects upon various material 19 Recent information balances throughout the economy. indicates that even for the Soviet Union gold production is not a feasible solution to the problem of scarce foreign exchange reserves.20 Achievement of overall balance through the method of iteration is very complex and time-consuming. Pre- liminary balances are drawn up 6 to 8 months before the beginning of the plan year, and it is usually not until 33 after the plan year has begun (sometimes 2-3 months after) that the final draft of the plan is complete.21 Since the iterative approach is so complex and time- consuming not many iterations are actually performed, and substantial reliance is placed upon the alternatives previously discussed which avoid secondary effects.22 Planning by material balances may be inaccurate because knowledge of production functions is imperfect or is lost in the collection and transmission of data, and also because errors may occur during fulfillment of the plan.23 Furthermore, since the balances are not drawn up for all commodities there will be gaps in information for this reason. Abstracting from all these difficulties, it can be shown mathematically that a system of material balances is capable of leading to an internally consistent solution in which all resources are employed if enough iterations are performed and if the technical coefficients are accurate. Even so, there would be no reason to expect that the necessary marginal conditions would be fulfilled so as to reach an economically efficient solution.2u Construction of the Foreign Trade Plan Due to the time required to achieve internal con- sistency in a system of material balances, preliminary material balances for the annual plan are drawn up by the 34 State Planning Commission several months before the beginning of the plan year. On the basis of these pre- liminary balances, preliminary estimates of planned output (control figures) are sent to the production ministries where they are checked and forwarded to domestic producers. Preliminary estimates of imports and exports are sent to the Ministry of Foreign Trade, from which they are forwarded to the individual foreign trade enterprises. The domestic producers determine their need for inputs on the basis of the preliminary production esti- mates, using the input norms which have been established for them. These input requirements are then sent back to the production ministries where they are aggregated and sent on to the State Planning Commission. Concurrently, the foreign trade enterprises, using the preliminary import and export targets, draw up detailed plans for their trade according to product, country, and currency area. These are sent to the Ministry of Foreign Trade to be checked, revised and consolidated into a draft foreign trade plan. On the basis of this additional information the State Planning Commission draws up new material balances and works with the Ministry of Foreign Trade and the production ministries to eliminate inconsistencies. From these new balances a different combination of target 35 outputs is derived. These new figures are sent back down the planning hierarchy where the producers revise their estimates of necessary inputs to conform to the new planned output figures, and necessary adjustments are made in the foreign trade plan. These revisions are then sent back up the planning hierarchy where once again target outputs are revised as the new estimates are worked into the material balances and a consistent solu- tion sought.25 Through this process of planning and counter-planning the national economic plan eventually takes shape, and the transition is made from the macro- economic magnitudes with which the planners have to deal for practical reasons to the microeconomic level at which the plan is finally implemented. After the last revision of the plan by the State Planning Commission it travels back down the planning hierarchy, being disaggregated along the way so that each production enterprise and foreign trade enterprise is assigned a detailed Operational plan fOr the year. The foreign trade plan is in fact composed of a number of separate plans, including an import plan, an export plan, a currency plan and a transportation plan.26 These plans become the basis for the trade assignments made by the Ministry of Foreign Trade to the individual foreign trade enterprises. 36 Effects of Planning gpon Foreign Trade One would expect the fact that investment, pro- duction and trade are functions primarily of planners' preferences in the Soviet bloc economies to have important effects upon their foreign trade. While a determination of the exact nature of these effects would require extensive testing of hypotheses for which data are scarce, some general observations can be made from what is known about these economies. Emphasis on Plan (Volume) Fulfillment One way in which foreign trade is affected by the planning process of Soviet-bloc economies is through the emphasis upon plan fulfillment. The primary goal of the domestic firm is to produce the quantity of the commodity which has been assigned to it by the planners. If it becomes necessary for the producer to change the specifi- cation of a product or lower its quality in order to fulfill his output quota, it is to his advantage to do so. In other words, since the foreign trade enterprise is solely responsible for the marketing of exports while the domestic producer has fulfilled his obligation as soon as the commodities are manufactured, whether they are sold or not, commodities of the correct quality and specifications necessary to compete in the world market are often not obtained.27 37 The emphasis upon plan fulfillment also affects the foreign trade enterprises. Their task with regard to imports is to acquire those commodities designated by the plan in such quantities as specified by the plan, almost without regard to cost, since failure to obtain them could have widespread consequences for the other parts of the plan. Also, they are probably not as concerned about the quality or detailed specifications of imports as the domestic user would be if he were purchasing them himself. In selling exports the task of the foreign trade enterprises is to maximize foreign exchange earnings, which may be accomplished by selling products below cost if demand is elastic enough. Risk Aversion by Planners A factor working against Soviet bloc participation in foreign trade is the element of uncertainty which it adds to the planning process. In these countries the ultimate responsibility for failure of plan fulfillment is borne by a small number of administrators who, in their own self interest, have a tendency to minimize the role of the foreing trade sector since developments therein are in a relatively large measure beyond their control.28 Over the course of the plan year foreign trade prices tend to fluctuate more than the technical coefficients used in planning domestic production, which makes it very difficult to predetermine the amount of 38 exports that will be necessary to finance a given bundle 29 of imports. Adjustments arising from unexpected develOpments in the foreign trade sector must be made by the planners.30 Not only does a desire to avoid these tedious adjustments foster a reluctance to depend upon foreign trade, but that also makes it less likely that these economies will respond to profitable trade oppor- 31 tunities which may arise during the plan year. Taut Plannigg Although risk aversion on the part of central planners is likely to inhibit international trade to a certain degree, there are other aspects of the Soviet- type planning process which have a tendency to make additional foreign trade necessary and alter its commodity composition. As mentioned earlier, the iterative pro- -cedure of planning by material balances which is used in the Soviet bloc countries can theoretically lead to a consistent solution, but there is nothing to ensure that it will be an economically efficient solution. In attempting to achieve a more efficient use of resources, the planners of the Soviet bloc economies construct "taut" plans. Taut planning involves the setting of overopti- mistic targets for production, while reducing both input 32 coefficients and inventories to a minimum. 39 While the practice of taut planning is intended to motivate producers to use resources more efficiently, it has implications for the foreign trade of these countries. With low levels of inventories and little slack in the economy, ". . . even a minor shortage of an important material often becomes a major bottleneck."33 Foreign trade is an important method of relieving these bottle— necks. Foreign trade plans are also taut, however, so it is unlikely that there will be much excess foreign exchange available for the purchase of unplanned imports. Therefore, to finance unplanned imports it is necessary to increase export production wherever this can be done without serious secondary effects, and to export unplanned surpluses from domestic production. Imports of a lower priority may also be eliminated.3L| Intuitively, one would expect the use of trade as a safety valve to be of greater significance in the trade of the Soviet bloc countries with the West than in intra- bloc trade. There has been a tendency, more pronounced in the Soviet Union than in other countries of the bloc, to obtain from the West only those goods which it is neither practical to produce nor to obtain from one of the other Soviet bloc countries.35 While this attempt to avoid dependence upon capitalistic countries inhibits to some extent the development of normal trade relations with the West, it probably does not discourage trading with 40 the West for the purpose of relieving bottlenecks or disposing of surpluses. Although there has been a large increase in the level of East-West trade in recent years, the trade of the Soviet bloc with the West can still be considered primarily a residual of intrabloc trade. The percentage of intrabloc trade in the total trade of these countries was 59.2% of exports and 65.0% of imports in 1955, as compared to 64.7% of exports and 65.8% of imports in 1965.36 So the level of intrabloc trade has actually increased slightly in a decade in which trade with the West increased from 8.8% to 20.6% of total exports and 16.3% to 21.5% of total imports.37 This would seem to indicate that, when these countries find it necessary to trade outside the bloc, they have turned increasingly to the West as the attitude toward East-West trade has been liberalized in both East and West. However, the evidence does not indicate an increasing willingness to trade outside the bloc. The present economic structure of the Soviet bloc countries and their geographical contiguity would naturally give rise to a relatively large amount of intrabloc trade. However, the existing high level of this trade can be explained only with reference to political and ideological considerations. The Soviet Union, which alone accounts for about 40% of Soviet bloc 41 trade with the West, attempts for political reasons to maintain strong economic ties within the bloc, and exerts pressure on the other countries to follow suit. Also, there remains a fear among these countries of economic fluctuations originating in capitalist countries. Keeping trade within the bloc is supposed to provide pro- tection against ". . . the evils of competition, anarchy of production, and economic exploitation holding uncontrolled sway over the capitalist markets."38 One may wonder why, in a market as large as that of the Soviet bloc, these countries should look to the West for as much as one-fifth of their trade if there is an effort to trade primarily within the bloc. One important reason is that the products desired by these countries may not be available from the other Soviet bloc countries when they need them because they have not been planned 39 for export. More is said about the phenomenon of "commodity inconvertibility" in Chapter III. In the industrial West there is a wide choice of goods con- tinually available for purchase. This consideration takes on added significance when these countries must import under emergency conditions in order to relieve bottlenecks that have developed in the economy. Another reason why the Soviet bloc countries may look to the West for certain products is the fact that Western products are often of a higher quality than those available in the Soviet bloc.“0 The emphasis on quantity 42 fulfillment of quotas has often caused the quality of products produced in the Soviet bloc to be poor. For products which play a crucial role in production, quality considerations may provide enough incentive to shift trade from within the bloc to the West. A third reason for Soviet bloc trade with the West is to gain the benefits of Western technology.“1 An important weakness of the command economy is that it does not adequately provide the incentives apparently required for technological innovation. By their relative economic isolation from the rest of the world, the Soviet bloc countries have in large measure been deprived of the free exchange of technology which takes place in the West. It has come to be recognized that trade with the West is the easiest way to share in the benefits of the rapid technological change occurring there. While these considerations provide economic incentive for the Soviet bloc countries to import from the West, the incentive to export to the West is the necessity of earning foreign exchange to finance imports. As mentioned earlier in this chapter the Soviet bloc countries ordinarily invest in export industries only in response to medium or long term trade agreements with the nations of the Soviet bloc. The fact that there are few export industries producing goods specifically for the Western market means that exports to the West and which 43 are available in quantities greater than needed by the domestic economy have commonly been exported to the West. One would expect the residual nature of Soviet bloc trade with the West to give it a different commodity com- position from that which would otherwise result. When the commodities imported and exported are to a large extent determined by errors in the planning of supply and demand, a relatively unstable commodity composition and volume of trade would be expected. However, whether the resulting commodity composition would on the average be more labor intensive or capital intensive is impossible to say. Problems of Communication One other problem resulting from the organization of foreign trade in the Soviet bloc countries is the lack of contact between the domestic producer and his foreign purchaser or supplier. Smooth trade relations are much more difficult when communications and transactions must pass through a third organization rather than being direct. Also, complaints are heard that the foreign trade enter- “2 This prises are inflexible and slow in their actions. may be partly due to what Brown has called "crisisphilia" on their part. He indicates that it is sometimes in the interest of the foreign trade enterprise to delay its purchase of imports until a crisis develops in the 44 domestic economy. Under such conditions it is often able to get its allocation of foreign exchange increased, which makes it easier for it to fulfill its quotas and show a profit.L43 Summary and Conclusions The effects of planning and of the organization of foreign trade in the Soviet bloc economies upon their foreign trade are numerous and of great significance. Some of those touched upon in this chapter include the emphasis upon plan fulfillment which often results in products of poor quality, the lack of a community of interests and problems of communication between domestic producers and foreign trade enterprises, lack of contact between domestic and foreign firms, the tendency of planners to minimize the role of foreign trade so as to reduce uncertainty and avoid adjustments in the plan, and pressure planning which tends to make foreign trade a mechanism for relieving shortages and disposing of surpluses. Although these are deep-rooted problems that are not likely to disappear overnight, some progress is being made in dealing with them. The degree of pressure planning has been lessened, and the emphasis upon quota fulfillment reduced somewhat. As the tautness of the economies is reduced and inventories accumulated, the need to use trade as a safety valve is decreased. Also, some domestic firms ’45 are being allowed to negotiate directly with their foreign customers or suppliers. To the extent that these trends continue, these economies will be able to attain a higher degree of economic rationality in their foreign trade. Yet there are other aspects of the Soviet economy which must be altered before economically efficient trade can be realized. These are discussed in Chapter III. FOOTNOTES lMelvin G. Shimm, "Foreword to State Trading: Part 1," Law and Contemporary Problems, XXIV (Spring, 1959), p. 24I. 2John N. Hazard, "State Trading in History and Theory," Law and Contemporary Problems, XXIV (Spring, 1959), p' 2&5- 3Alexander Baykov, Soviet Foreign Trade (Princeton, N.J.: Princeton University Press, 1946), p. 9. “Nicholas Spulber, The Economics of Communist East EurOpe (New York: John Wiley and Sons, 1957), p. 163. 5Raymond F. Mikesell, Foreign Exchange in the Postwar World (New York: Twentieth Century Fund, 1954), p. 367. 6V. S. Pozdniakov, "The State Monopoly of Foreign Trade in the USSR," The Soviet Review, IX (Summer, 1968) p. “70 7Frederic L. Pryor, The Communist Foreign Trade System (Cambridge, Mass.: The MIT Press, 1963), p. 53. 8Herbert S. Levine, "The Effects of Foreign Trade on Soviet Planning Practices," International Trade and Central Planning, ed. Alan A. Brown and Egon Neuberger (Bergeley: University of California Press, 1968), p. 2 0. 9Leon M. Herman, "Soviet Foreign Trade," The Soviet Econom , ed. Morris Bornstein and Daniel R. Fusfeld (rev. ed.; Homewood, 111.: Richard D. Irwin, 1966), p. 246. loIbid., p. 247. llPozdniakov, p. 45. lzlbid., p. 46. 46 47 l3Alec Nove and Desmond Donnely, Trade with Communist Countries (New York: Macmillan Co., 1960), p. 24. 1“United Nations, "Trade Problems Between Countries Having Different Economic and Social Systems," Economic Bulletin for Europe, Vol. 16, No. 2, 1964, p. 41. 15United Nations, Economic Survey of Europe in 1962, Part 2, Chapter IV, Geneva, 1965, p. 22. 16 Ibid., p. 24. 17J. M. Montias, "Planning with Material Balances in Soviet—Type Economies," American Economic Review, XLIX (December, 1959), p. 967. 18 Ibid., p. 976. 19Levine, "The Effects of Foreign Trade on Soviet Planning Practices," p. 271 20Keith Bush, "Soviet Gold Production and Reserves Reconsidered," Soviet Studies, XVII (April, 1966), p. 493. 21 Montias, p. 964. 22Herbert S. Levine, "Input—Output Analysis and Soviet Planning," American Economic Review, LII (May, 1962), p. 131. 23Montias, p. 978. 2”Heinz KOhler, Welfare and Planning: An Analysis of Capitalism versus Socialism (New York: John Wiley and Sons, 1966), p. 102. 25Levine, "The Effects of Foreign Trade on Soviet Planning Practices," p. 268. 26 Ibid., p. 262. 27Bela A. Balassa, The Hungarian Experience in Economic Planning (New Haven: Yale University Press, 1959), p. 272. 28Franklyn D. Holzman, "Soviet Central Planning and ts Impact on Foreign Trade Behavior and Adjustment Mechanisms," in Brown and Neuberger, eds., p. 284. 48 29Levine, "The Effects of Foreign Trade on Soviet Planning Practices," p. 272. 30 31Alan A. Brown, "Towards a Theory of Centrally Planned Foreign Trade," in Brown and Neuberger, eds., p. 67. 32 33Herbert S. Levine, "Pressure and Planning in the Soviet Economy," in Industrialization in Two Systems, ed. Henry Rosovsky (New York: John Wiley and Sons, 1966), p. 279. Holzman, p. 283. Ibid., p. 68. 3“See Oleg Hoeffding, "Recent Structural Changes and Balance-of—Payments Adjustments," in Brown and Neuberger, eds., pp. 312- 336 for a detailed study of the manipulation of merchandise trade in the Soviet Union so as to finance unusually large imports. 35Alfred Oxenfeldt and Vsevelod Holubnychy, Economic Systems in Action (3rd ed.; New York: Holt, Rinehart and Winston, 1965), p. 109, in reference only to Soviet Union. 36Karel Holbik, "An Economic Profile of Eastern Europe," in American—East European Trade, ed. by P. D. Grub and K. Holbik (Washington: The National Press, 1969), p. 146. 37Ibid. 38Leon Herman, "The Promise of Economic Self- Sufficiency under Soviet Socialism," in The Soviet Economy, ed. by M. Bornstein and D. Fusfield (Homewood, 111.: Richard D. Irwin, 1970), p. 278. 39 uoIbid., p. 179. ”lipid. 42 Pryor, p. 178. Balassa, p. 273- l‘3Brown, pp. 79-80. CHAPTER III THE PRICE SYSTEM OF SOVIET BLOC NATIONS AND ITS IMPLICATIONS FOR THEIR FOREIGN TRADE Of all the characteristics of the Soviet bloc economies which have implications for their foreign trade, one of the most important is the price system of these countries. In contrast to free market economies where prices serve to determine automatically resource allocation, production, and consumption, in the Soviet— type economy prices are a tool of the planners which can be used in various ways to help the planners achieve their set of objectives for the economy.1 In the free market economy which is characterized by consumers' sovereignty, it may be said that prices bring about an adjustment of supply to demand. In the Soviet-type economy in which planners sovereignty is the rule, prices are used to adjust demand to planned supply.2 In the Soviet bloc economies a substantial portion of national income has been appropriated for investment, leaving a relatively limited amount of resources engaged in the production of consumer goods. For example, in the decade from 1950 to 1960, gross domestic capital formation 49 50 accounted for 27.5% of gross national product in the Soviet Union, as compared with 18.0% in the United States and 18.8% in France.3 The planners have not been willing to let free market prices ration this limited amount of consumer goods. Neither have they found direct rationing, considering its costs and the black markets it tends to foster, desirable. Instead, they have used a system of differential sales taxes, called turnover taxes,” in part to allocate this limited quantity of goods. The quantity of goods to be supplied is determined by direct command, then the differential tax added so as to equate quantity demanded with quantity supplied. As one would expect, the size of tax required for this purpose is not always correctly estimated, with the result that goods with too high a tax accumulate unsold in the stores whereas those with too low a tax disappear rapidly. This problem is aggravated by the fact that prices are not changed for long periods of time during which there may be sub- stantial changes in conditions of demand and/or productivity. The turnover tax on consumer goods in the Soviet Union, computed as a percentage of retail price less trade charges, has ranged from 28% to 90% in recent 5 years. While planners have found unequal money incomes necessary in order to maintain incentives, turnover taxes 51 are used to try to achieve what the planners consider to be a more equitable distribution of real income. Low turnover taxes are levied on basic consumer goods, while much higher taxes are levied on goods which are not considered necessities.6 Furthermore, in addition to helping ration scarce consumer goods, turnover taxes are a very important source of revenue for the government. In the Soviet Union, for example, they account for about 40% of total budget revenue.7 Types of Prices There are at least four different types of prices which can be distinguished within the price system of the Soviet bloc economies.8 First, there are the state retail prices at which goods are sold to consumers. These prices are based upon costs of production as cal— culated in these countries, any turnover tax which may be applicable, and a profit markup for both the wholesaler and retailer which covers his cost of handling the product plus a profit which is an additional source of revenue for the state. Secondly, there are collective farm market prices, which are actually retail prices also, but are unique in that they are the only free market prices in the Soviet bloc countries. These prices are formed in markets for agricultural goods which have been left over from the production of collective farms after the state has made 52 its procurements. Although these prices fluctuate freely, even they are influenced by the state since the supply on these markets depends to some extent upon what the state procures from the collective farms, and also demand on these markets is a residual of expenditures in the state retail trade sector which is directly con- trolled by the state.9 Thirdly, there are agricultural procurement prices. These are the prices paid by the state procurement agency to the state and collective farms for agricultural goods. The workers on state farms are paid wages in the same manner as industrial workers, but the prices paid to collective farms largely determine the distribution of income between the industrial and agricultural sectors of the economy.10 Finally, and most important as far as foreign trade is concerned, there are industrial wholesale prices. As a rule they are based upon planned branch average cost of production plus a markup for profit.11 It should be emphasized that the profits referred to here are not the same as profits in a competitive economy. They are planned and the amount determined before they are realized, and are not intended to play a role in resource allocation, but only to provide an element of control and a source of revenue for the state.12 Neither do the average costs have an exact counterpart in the West. They include both direct and indirect labor costs, 53 material costs, depreciation allowances andoverhead.l3 They do not include economic rent, and until very recently have not included capital cost. They are further affected by the fact that some producer goods industries receive large subsidies from the state. Furthermore, they are based upon planned rather than actual costs, which are in turn often based upon over- optimistic estimates of productivity increase.lu It is evident that these prices diverge in many ways from scarcity prices which would be required for an economically efficient allocation of resources. They do not accurately reflect conditions of demand, and are ". . . based upon a fallacious definition and computa- tion of costs."15 Even if they did provide some indica- tion of average costs, it is marginal costs which are needed as a guide to efficient foreign trade. Lack of Foreign Trade Theory The Soviet bloc economies have had no consistent criterion for determining an economically efficient pattern of foreign trade. Neither Marx, Lenin, nor Engels attempted any rigorous analysis of the economics of international trade.16 They concentrated instead on the political aspects of foreign trade, specifically its role in the alleged scheme of capitalist imperialism. The emphasis upon international trade as a tool for exploita- tion is so much a part of Marxism that, according to 54 Wiles, ". . . no Marxist thinker can imagine an inter- national exchange without origin in, or effect on, the 17 international power structure." Consequently, Soviet bloc economists have generally rejected the theory of international trade developed in the West, regarding it as ". . . a convenient theoretical justification of Western economic domination of the rest of the world."18 It has often been argued that trade according to Western trade principles would have kept the communist countries backward by preventing their industrialization. The same argument has in recent years been invoked by the less developed countries of the Soviet bloc in opposition to plans for international division of labor within the Council of Mutual Economic Assistance (COMECON), the Soviet bloc organization for promoting regional economic integration. As Bergson has observed, when Marxist principles are not applicable, but Western theory is rejected, often the result is no theory at all, so that arbitrariness becomeslunavoidable.19 This seems to have been the case for Soviet bloc trade during much of the postwar period. Having no foreign trade theory of their own, but for ideological reasons rejecting Western theory, foreign trade has largely served the purpose of a vent for surplus and a convenient method for relieving production bottle- necks. 55 Foreign Trade Efficiency Indexes In the Soviet Union with its extensive resource base and large domestic market, foreign trade is of marginal importance so there has been little incentive for developing a theory of foreign trade. The other Eastern European countries had traditionally been much more dependent upon foreign trade, but after the establishment of communist governments in these countries trade with the West was largely cut off, and autarky had a certain appeal to them since it implied industrializa- tion.2O Beginning about the mid-1950's, there was a renewed interest in economics in the Soviet bloc countries as ideological constraints were eased somewhat. Out of this new economic discussion emerged a search for foreign trade criteria, especially in the more trade- dependent countries. It was discovered that the foreign exchange earnings of some exports did not finance the materials which were being imported to produce these goods. Consequently, attempts were made to construct indexes of foreign trade efficiency (to be shown below) which would give at least some indication of whether or not trade in a particular commodity were profitable. Most of the effort toward development of foreign trade efficiency indexes has been aimed at an assessment of the efficiency of exports. Some countries have 56 experimented with indexes which would indicate import efficiency, but imports are recognized as being primarily determined by what commodities are necessary to balance the material balances.21 All the Soviet bloc countries except Albania have used indexes of export efficiency since 1958.22 An example of one of the export efficiency indexes, as presented by Wilczynski,23 is shown below: Rf - iMf nfE = c - iMd + mC nfE = net foreign exchange efficiency of export Rf = average export receipts in foreign currency iMf = value of imported component materials used in foreign currency at world prices C = average cost of production without profit markup iMd = value of imported component materials used in domestic prices mC = domestic portion of marketing costs The purpose of this index is to provide a ranking of exports according to the foreign exchange they will earn, relative to their cost of production, after imported materials are taken into account. There are many variants of such indexes, some of which carry the analysis back through several stages of the production process. Although these export efficiency indexes have helped to prevent some grossly uneconomic exports, they can hardly have been successful in providing a guide for 57 economically efficient trade. One reason is that they must make use of the deficient framework of domestic prices in the Soviet bloc countries.2u This problem is complicated by the fact that in these calculations foreign currencies are valued through the official exchange rate25 which has no real economic significance. This is evidenced by the fact that very substantial changes in the value of the exchange rate have had no discernible effect upon the level or composition of foreign trade.26 Furthermore, foreign trade efficiency must be evaluated in the context of total trade; consideration of exports alone is not sufficient.27 There are also practical considerations which tend to limit the success of foreign trade efficiency indexes. They have not been calculated for all products in any of the countries because of the time and effort that is required for their calculation.28 Also, there are a variety of indexes, none of which is indisputably recognized as best, and different indexes may yield contradictory orders of priority.29 Even when the indexes agree that the foreign trade structure should be changed, this does not mean that it will be. In addition to the usual noncommercial considera- tions of Soviet bloc trade, it has been noted that when the indexes indicate that the export of a given commodity is uneconomic, those interested in exporting it bring in 58 30 other considerations to prove its merit. Also, the practice of bilaterally planned trade limits the extent to which these efficiency calculations can be utilized. The problems of inconvertibility and bilateralism are discussed below. Inconvertibility None of currencies of the Soviet bloc countries is convertible. This means that claims expressed in any one of these currencies cannot be used in payments to a third country or converted into gold or currencies that are convertible. Given the uneconomic nature of prices and exchange rates in these countries, the necessary conditions for currency convertibility are not met. Since domestic prices are unsatisfactory, world market prices are used as the basis for foreign trade transactions. There still remains a large element of uncertainty concerning theSe prices due to the fact that there are few homogeneous commodities, especially with regard to quality, and there is no single world price for a commodity. Therefore, an element of arbitrariness inevitably enters into the choice of a world price, and the price at which trade is actually conducted is not known until negotiations are completed. The problem of uncertainty is compounded by the existence of what has been termed "commodity inconvert- ibility."31 This term refers to the fact that even if 59 other countries held the currencies of Soviet bloc countries, which they are not generally permitted to do, the opportunities for converting these currencies into commodities would be restricted. Since production proceeds according to the dictates of the economic plan in these countries, the foreigner may not be permitted to compete with domestic enterprises and consumers for a commodity which has not been planned specifically for export.32 Complete commodity convertibility, i.e., free trade, would seem to be inconsistent with the goals of planners in the Soviet bloc nations. The international division of labor which would result from free trade would require a different pattern of resource allocation from that chosen by the planners. In other words, the Soviet bloc countries apparently wish to choose a particular point on their production possibilities curve at which to produce. If they engaged in free trade, they would not be able to do this. Bilateralism An important consequence of inconvertibility of Soviet bloc currencies is a high degree of bilaterally conducted trade. A bilateral trade agreement is one in which one country agrees to supply another country with certain specified goods or a certain value of goods, and to accept in payment certain goods or a 60 certain value of goods from the other country.33 A study by Michaely of multilateralism in international trade revealed that for the five Soviet bloc countries included in the study, only 9.6% of their trade in 1958 was multilateral, as compared to 23.8% for the same countries in 1938. None of the 60 non—Soviet countries included in the study had as high a degree of bilateralism as any one of the Soviet bloc countries}!4 Other countries are not, as a rule, allowed to hold the currencies of the Soviet bloc nations, and, considering the existing currency and commodity inconvertibility, would be reluctant to do so in any case. Therefore, payments must be balanced unless the Soviet bloc economy can finance a deficit through sales of gold or an export surplus with countries having convertible currencies. The possibilities for either of these alternatives appear to be quite limited. While the high degree of bilateralism in East-West trade is attributable primarily to inconvertibility and a lack of foreign exchange reserves, there are other reasons why the Soviet bloc countries may be attracted to bilateralism. The goal of achieving balance in material balances may be carried over into the planning 35 of foreign trade. Also, because a bottleneck in one part of the plan can require widespread adjustments, there is a desire on the part of planners to avoid uncertainty. 61 Bilateral trade agreements are relied upon to provide a more certain and steady supply of required imports. Whether or not these trade agreements, which do not specify prices and are open to revision annually, do actually provide a more stable flow of imports than could be purchased on the world market is debatable. Even if it is granted that bilateral trade does provide a more certain supply of imports, it works against another of the goals of the planners——use of trade as a safety valve. By making trade more predetermined through trade agreements, the planners partially deprive them— selves of the effectiveness of foreign trade as an adjustment mechanism for domestic production.36 Considering the re-export of goods which usually results, it is not clear whether or not bilateralism actually reduces the level of foreign trade of these countries. It does seem clear, however, that the profit- ability of trade is reduced if a country is forced to accept goods of a type or quality that it would not other- wise buy in order to complete the bilateral balance. Attempts at Multilateral Trade The countries of the Soviet bloc have recognized the advantages of multilateral trade, and some attempts have been made to achieve multilateral clearings. The first scheme was an agreement among the members of Comecon which was signed in 1957 in the same month that a 62 system established by the United Nations Economic Com- mission for Europe (ECE) went into effect.37 The ECE scheme included all of Europe, and has since 1963 included underdeveloped countries also. Its procedure is to build voluntary closed chains of countries with unsettled balances, each country compensating the next 38 It has facilitated East-West trade by the same amount. to some degree, but has evidently not been of benefit to intrabloc trade. The system set up within Comecon provided that, with the consent of both countries, a bilateral balance might be transferred to a central pool where settlements were made wherever possible. Those balances which were not offset could be settled by goods as agreed upon by representatives of the ministries of foreign trade. This scheme reportedly met with very little success.39 In 1963 a new agreement among the Comecon countries provided for the establishment of the International Bank for Economic Cooperation (IBEC), which was put into Operation on January 1, 1964. Under this new system each country has only one clearing account with the IBEC which is expressed in "convertible gold rubles." Trade negotiations are still bilateral in character, but are channeled through the IBEC and expressed in terms of the "convertible" ruble. This means that a surplus with one country can be used to pay off a deficit with another 63 country. The resources of the IBEC for extending short-term credits are very limited, and the countries' surpluses or deficits with the bank at the end of the calendar year are settled in a round of multilateral negotiations by further exchanges of commodities.“0 It appears that the IBEC will provide a facility through which unplanned imbalances in trade may in many cases be cancelled. Presumably, however, foreign trade is still to be planned so as to achieve bilateral balance, with only unplanned surpluses and deficits being cleared through the IBEC. Although this clearing of unplanned imbalances will in itself be very helpful, it would be much better if provision were made for planned multi- lateral trade.“1 The currency of the IBEC is called the "convertible gold ruble," but could more appropriately be called the transferable ruble as it is merely a unit of account for the transferring of balances. It is not freely convertible into gold, truly convertible currencies, or any commodity in any of the Soviet bloc countries. Until prices reflect relative scarcities and are permitted to perform the function of resource allocation, there will not be commodity convertibility which is a prerequisite for currency convertibility and truly multilateral trade. 64 Summary The price system of the Soviet bloc countries is a most serious obstacle to the attainment of efficient foreign trade by these countries. It is difficult to see how they can take full advantage of the economic gains from trade until domestic prices come to reflect economic considerations more accurately. Recently there have been price reforms throughout the Soviet bloc which have improved the structure of prices somewhat. However, none of the countries has a price mechanism which will cause prices to automatically change in response to economic stimuli. It seems apparent that until there is such a price mechanism, domestic prices in these countries will be in some degree deficient for the purpose of evaluating the economic efficiency of their foreign trade. Since in these countries domestic prices diverge from scarcity prices, and exchange rates are unrealistic, economic considerations which would affect trade in free market economies do not find explicit expression. There- fore, one would expect the commodity composition of the trade of these countries to diverge to some degree from that which would result if these were market economies. In the next chapter an emperical investigation is made of the commodity composition of their trade in order to determine whether the trade pattern which results from their trading system is "rational" when judged according to the standards of Western trade theory. I FOOTNOTES lJere L. Felker, Soviet Economic Controversies (Cambridge, Mass.: The MIT Press, 1966), p. 271. 21bid., p. 110. 3A. Bergson and S. Kuznets, eds., Economic Trends in the Soviet Union (Cambridge, Mass.: Harvard University Press, 1963), p. 360. ”The turnover tax is very complex with various rules for payment. It is levied primarily upon the producing enterprise at each stage of production, but may also be levied upon the wholesale organization, or, in the case of farm products, on the state procurement agency. It may be levied as a percentage of the retail price, as a percentage of the wholesale price, as a lump sum tax, or in other ways. 5 6Morris Bornstein, U.S. Congress, Joint Economic Committee, New Directions in the Soviet Economy (Washington, D.C.: U.S. Government Printing Office, 1966), p. 67. 7 8Mikhail Bor, Aims and Methods of Soviet Planning (New York: International Publishers, 1967), p. 172. Felker, p. 109. Bornstein, p. 88. 9Bornstein, p. 89. lOIbid., p. 77. ll Felker, p. 105. 12 Bornstein, pp. 67-68. l3Ibid., p. 67. 1“George R. Feiwel, "The Dual Price System: The Polish Experience," New Currents in Soviet-Type Economies: A Reader, ed. by George R. Feiwel (Scranton, Pa.: International Textbook Company, 1967), p. 202. 65 66 r 1)George R. Feiwel, "Pricing of Producer Goods: Factory Prices in Poland," in Feiwel (ed.), p. 209. l6Frederic L. Pryor, "Foreign Trade Theory in the Communist Bloc," Soviet Studies, XIV (July, 1962), p. 41. 17P. J. D. Wiles, Communist International Economics (Oxford: Basil Blackwell, 1968), p. 9. 18J. Wilczynski, "The Theory of Comparative Costs and Centrally Planned Economies," Economic Journal, LXXV (March, 1965), p. 66. 19Abram Bergson, The Economics of Soviet Planning (New Haven: Yale University Press, 1964), p. 331. 20 Wilczynski, p. 67. 21Alfred Zauberman, "The Criterion of Efficiency of Foreign Trade in Soviet-Type Economies," Economica, N.S., XXXI (February, 1964), p. 8. 22 Pryor, p. 43. 23Wilczynski, p. 71. 2“Zauberman, p. 7. 25Wilczynski, p. 78. 26F. D. Holzman, "The Ruble Exchange Rate and Soviet Foreign Trade Pricing Policies, 1929-1961," American Economic Review, LVIII (September, 1968), pp. 812-818. 27Wilczynski, p. 76. 28Wiles, p. 79. 29United Nations, Economic Commission for Europe, Economic Surveyiof Eurppe in 1962, Part 2, Chapter IV, p. 44. 3OWilczynski, p. 79. 31Oscar L. Altman, "Russian Gold and the Ruble," Staff Pppers, VII (April, 1960), pp. 430-435. 32Franklyn D. Holzman, "Foreign Trade Behavior of Centrally Planned Economies," Industrialization of Market Economies, ed. by Henry Rosovsky (New York: John Wiley and Sons, 1966), p. 243. 67 33Marcin R. Wyczalkowski, "Communist Economics and Currency Convertibility," Staff Papers, XIII (July, 1966), p. 155. 3“Michael Michaely, "Multilateral Balancing in International Trade," American Economic Review, LII (September, 1962), pp. 685-702. 35Holzman, "Foreign Trade Behavior of Centrally Planned Economies," p. 250. 36Alan A. Brown, "Towards a Theory of Centrally Planned Foreign Trade," International Trade and Central Plannin , ed. by Alan A. Brown and Egon Neuberger , (Berkeley: University of California Press, 1968), p. 81. 37Wiles, p. 277. 381bid. 39Ibid., p. 278. uoHolzman, "Foreign Trade Behavior of Centrally Planned Economies." ulWiles, p. 280. CHAPTER IV AN ANALYSIS OF THE COMMODITY COMPOSITION OF EAST-WEST TRADE In Chapter II of this study the organization and planning of foreign trade in Soviet bloc economies was discussed. In turn, Chapter III was devoted to an in- vestigation of the price system of these economies and its implications for their international trade. In both cases it was concluded that Soviet-type central planning is likely to lead to a pattern of trade different from that which would result if these were market economies. In this chapter the commodity composition of Soviet bloc trade with the West is studied in an attempt to determine whether, in spite of these institutional differences, their trade with the West conforms to the pattern of trade postulated by the Heckscher-Ohlin theory of com- parative advantage. The Concept of Comparative Advantage Comparative advantage was first discussed by Torrens (1815) and Ricardo (1817). Basically it states that a country will export those commodities which it can pro- duce at a relatively lower cost. It is emphasized 68 69 that every country can profitably export some commodities since it is comparative advantage rather than absolute advantage which provides the basis for international trade. The Ricardian theory of international trade was concerned primarily with demonstrating the gains from trade, and did not attempt to explain why a country should have a comparative advantage in a given commodity. In subsequent interpretations of the theory, comparative cost differences have been viewed as arising from the assumption that the production function of a given commodity varies from one country to another, and that the extent of this variation is not the same for all commodities.1 This theory has been extensively elaborated upon, and has been expressed in terms of opportunity cost and marginal analysis, rather than the labor theory of value used by Ricardo. The Heckscher-Ohlin Model Approximately one hundred years after the original statement of the classical comparative cost theory, an alternative theory of international trade was formulated. This theory, which was originally expressed by E. Heckscher (1919) and subsequently qualified and refined by B. Ohlin, has come to be known as the Heckscher-Ohlin model. While admitting that comparative cost differences are the reason for the profitability of international trade, this 70 theory seeks to explain how these comparative cost dif- ferences arise and what determines the commodity compo— sition of trade. The Heckscher-Ohlin theory contends that different endowments of productive factors are at the root of comparative cost differences. An explanation of the commodity composition of trade is found in the fact that as different countries have different relative scarcities of productive factors, commodities are produced with different factor proportions--the latter difference assumed to be uniquely determined regardless of factor prices. A country can be expected to produce relatively more cheaply, and therefore to export, those commodities whose production requires relatively large amounts of its relatively abundant factor of production. The Heckscher-Ohlin theory is based upon a number of very restrictive assumptions. The major assumptions of the simplified version of the model are as follows: 1. Perfect competition exists in both product and factor markets. 2. Production functions are homogeneous of first degree, and are the same in all countries for the same product, but are different for different products. 3. Factors of production are of identical quality from country to country, are fully employed, and are perfectly mobile within a country but perfectly immobile internationally. 4. There are no transportation costs. 7. 71 Technology is constant and factor supplies are fixed. There is no reversibility of factor propor- tions. This means that the ranking of com- modities by their capital/labor ratios is the same in the trading countries. This condition is automatically satisfied as long as the elasticity of substitution is the same for all commodities (isoquants intersect only once). Demand conditions are similar from one country to another. For a simple demonstration that the "commodity composition" results follow from these assumptions,2 consider two countries, Country I capital abundant relative to Country 11, i.e., where QCI > QCII QLI QLII QCI = quantity of capital in Country I. QLI = quantity of labor in Country I. QCII = quantity of capital in Country II. QLII quantity of labor in Country 11. Because of the assumptions of perfect competition and similar demand conditions in both countries, the inequality above implies PLI > PLII PCI PCII 72 where PLI = price of labor in Country I. PLI = price of capital in Country I. PLII = price of labor in Country II. PCII = price of capital in Country 11. Next consider two products, 9 and p, e being labor intensive relative to p. Due to the assumption of homogeneous first degree production functions, the entire isoquant map for each of the commodities may be represented by a single isoquant. The assumption of no reversibility of factor intensities insures that the isoquants intersect only once, and permits the unequivocal statement that commodity e is labor intensive relative to p at any factor price ratio. If the factor price line in Country I is QP, then in this country commodity e is produced with the factor ratio determined by the ray OM i.e., %%° The production of commodity p uses the factor ratio determined by the Labor 73 0.2 ’ Ot' into capital according to the prevailing factor price ray ON, i.e. When the cost of labor is converted line, it is found that the cost in terms of capital of producing each of the products in Country I is OP. In Country 11 where labor is relatively abundant, and therefore cheaper, this fact is reflected in a flatter lepe of the factor price line. In this country the factor use ratio in the production of commodity e is that denoted by ray OT, i.e., %%° The factor use ratio in the production of commodity p is that determined by the ray OU, i.e., ggu It should be pointed out that the isoquants represent the same level of output of commodity a in both countries, and the same level of output of p in both countries. 74 When labor is converted to capital according to the prevailing price line, it is found that the cost of commodity e in terms of capital in Country II is OD, whereas the cost of commodity p in terms of capital is 0G. In Country I the cost ratio of g to p was %%'= 1. In Country 11 the ratio is gg < 1. Therefore Country II, which is relatively labor abundant, can produce relatively more cheaply, and will therefore export, commodity e, the labor intensive commodity. And Country I which is the relatively capital abundant country can produce the capital intensive commodity relatively more cheaply, and will therefore export commodity p to Country II. The same results can be derived using directly the relative quantities of factors with which the countries are endowed, rather than their prices. The same seven assumptions hold in the following alternative demonstration. Assume two countries as before, Country I capital abundant relative to Country 11, 5231.39.12. Q I QLII Also, assume two commodities, commodity e labor intensive relative to commodity p. This situation can be-demon- strated by the use of Edgeworth-Bowley box diagrams as shown below. The horizontal and vertical sides of each box represent the given supplies of labor and capital, 75 respectively, of each of the two countries. The two boxes are superimposed so that the e isoquants for Country I have Q as their origin, while the p isoquants for Country II have 0' as their origin. The isoquants have been omitted to avoid cluttering the diagram. Any point within the box of either country repre- sents some distribution of that country's factors of pro- duction between the production of commodity e_and the production of commodity p. However, only points of tangency of the e and p isoquants will be production equilibrium points under perfect competition, for only at such points is the ratio Of the marginal products of the two factors in the production of e_and p equalized. The locus of these points determines the contract curve of each country, OMQ for Country I and ONQ' for Country II. 76 In order to show that M and N are possible post— trade production equilibrium points, it is necessary to show that relative commodity prices are equalized at these points, since the level of trade will change until they are equal. Let L‘a equal the marginal physical product of labor in the production of commodity e, and C'a equal the marginal physical product of capital in the production of commodity e. Consider the ray OMN. From the assumption of constant returns to scale we know that L' I" II C'al at point M is equal to C'a at point N. But since on pl 311 the contract curve the isoquants of e and p are tangent, t I t t L L L L bII implying (3,91 = 5731 and 5731—1— = 57-— , this further a_l pl 311 p11 1" I L'bII implies that ETgh-at point M is equal to Er-—— at point N. bI bII Therefore, the ray OM is parallel to the ray Q'N. It can now be demonstrated that relative commodity prices are equal at points M and N, the necessary and sufficient condition for free trade equilibrium. In Country I, because of the assumption of perfect competition, payments to a factor will be the same in both industries. If we denote product prices by Pa and P then b, 77 L' P or L'aI = PbI (l) bl 31 For the same reasons in Country 11, L' P L'aII = Pen (2) p11 a_II Because of the assumption of constant returns to scale, along the ray OMN, t = v I = I L aI L all and L b1 L pII’ which implies that {iii - E1213 (3) L' ' Lt pl 911 Therefore, we have Phi L' I P__'= ETQ— from equation (1), _1 p1 L' L' E72; = L'aII from equation (3), pl p11 L' II P611 and ET§__.= P from equation (2). 78 Combining these equations we get, P L' L' P p1 _ a1 = 91 _ bII P ‘ L' L‘ “F"‘ a1 p1 p11 n11 Since relative commodity price ratios are equal in the two countries, points M and N are trade equilibrium points. The amount of commodity 3 produced by Country I is denoted by the ray OM, while that of Country II is denoted by the ray ON. The ratio of the 3 output of Country I to the e output of Country 11 is 8% < 1. The ratio of the 3 output of Country I to the 2 output of Country 11 is g¥fi > 1. Therefore, Country I, which is the capital abundant country will produce relatively more of commodity p which is the capital intensive commodity. The same is true for all other "pairable" trade equilibrium points. Exactly which pair of equilibrium points will result is determined by demand conditions. The Heckscher—Ohlin theory, while providing a neat and simple explanation of the commodity structure of international trade, has been criticized because of the very restrictive nature of its assumptions. Furthermore, emperical tests of the theory have yeilded mixed results which have not completely settled the question of the theory's power for prediction. Results of the more important of these tests are reported below. 79 Empirical Tests of the Heckscher- Ohlin Theory The first empirical test of the Heckscher-Ohlin hypothesis was conducted by MacDougall3 as an extension of his tests of the classical comparative cost doctrine. Taking horsepower used as an indication of relative capital intensity, he attempted to see if the U.S. had a larger relative share of the world market in capital intensive goods than did Great Britain. He did not find this to be the case, and therefore rejected the Heckscher-Ohlin hypothesis. A similar failure has been reported by Kravis.“ The most significant tests of the Heckscher-Ohlin theory began with a study by Leontief published in 1953.5 In this study Leontief used the input-output tables for the U.S. economy in 1947 to compute both the direct and indirect capital and labor requirements of exports and import substitutes. He found that the exports of the U.S. required relatively more labor and less capital than would have been required to produce U.S. competitive import replacements. Since the U.S. undoubtedly has more capital per unit of labor than any country with which it trades, these results were inconsistent with those postulated by the Heckscher-Ohlin theory, and have come to be known as the "Leontief scarce-factor prardox." 80 Explanations of the Scarce- Factor Paradox Several attempts have been made to make the Leontief results consistent with the Heckscher-Ohlin theory. Leontief himself proposed that labor should be measured in terms of efficiency units rather than man years. He contended that labor in the U.S., working with the same machinery, is three times as effective as labor in other countries. Possible reasons for this could be superior management, motivation, or education and training. There- fore, to measure labor in efficiency units, one should multiply the actual labor force by a factor of three. If labor were measured in this way, the U.S. would indeed be a labor abundant country. Leontief offered no proof that labor in the U.S. is three times as effective as labor in other countries. Diab6 attempted to test Leontief‘s contention by using a Cobb-Douglas production function to estimate capital/labor ratios for the U.S., Canada, and several countries of Northwest Europe. By assuming capital productivity constant from country to country and measuring labor in terms of efficiency units, he found the U.S. to be labor abundant relative to the other countries. However, this procedure attributes all of the U.S. efficiency advantage solely to labor. To demonstrate that this procedure is arbitrary, Bhagwati performed the same tests assuming labor productivity constant from country to country, and 81 found the U.S. to be overwhelmingly capital intensive.7 An empirical study by Kreinin utilizing questionnaire data found that U.S. labor is at most 1.25 times as effective as foreign labor.8 TherefOre, Leontief's attempt to reconcile his results with the Heckscher- Ohlin theory appears to be unsatisfactory. Another explanation which has been Offered for Leontief's results is the possible existence of factor intensity reversals, so that industries which are labor intensive in one country may be capital intensive in another country. This of course could destroy the theory. Arrow, Chenery, Minhas, and Solow, in their study of constant elasticity of substitution production functions, found instances where factor intensity reversal might occur between the U.S. and Japan within a realistic range of factor prices.9 In a later study, Minhaslo claimed to have found more conclusive evidence of factor-intensity reversal using both parametric and nonparametric tests, but in each case the validity of his results has been questioned.11 So although the theoretical possibility of factor-intensity reversals is commonly conceded, whether or not they are important empirically has yet to be conclusively demonstrated. Both Diab and Vanek have pointed out that the Leontief results may be explained by the fact that the trade structure of the U.S. is heavily influenced by its 82 natural resource endowment. From an input-output study of U.S. trade, Vanek concludes that natural resources are actually the scarce factor in the U.S., and while capital may be the abundant factor relative to both labor and natural resources, ". . . relatively less of its productive services is exported than would be needed for replacing our imports, because resources, which are our scarce factor, can enter productive processes efficiently only in conjunction with large amounts of capital."12 13 and Another explanation emphasized by Travis others, is that the tariff structure of the United States protects heavily the labor intensive industries, keeping out many labor intensive imports. This distorts the structure of trade, making imports more capital intensive than they would have been in the absence of the tariffs. Still another explanation of the Leontief results has been provided by Kenen.lu He contends that when investment in human capital as well as physical capital is brought into consideration, there will be a different ordering of industries according to relative capital intensity. Upon repeating the Leontief test with human capital incorporated into the analysis, he found that U.S. exports were slightly capital intensive relative to its imports, and concluded that in this way the paradox 83 could be resolved. The same method is employed in the present study. After a Leontief-type examination of the factor intensity of East-West trade, estimates of human capital are derived for each industry and incorporated into the analysis to see what effect this has upon the results. The Leontief results have cast considerable doubt upon the validity of the Heckscher-Ohlin theory, and have stimulated much thought and discussion as attempts have been made to resolve the paradox. There have been, in addition, several other tests of the Heckscher—Ohlin hypothesis, most of them using the same basic method as Leontief, but applying it to other countries. We now turn to a consideration of some of these. Tests of the Theory in Other Countries 15 In 1959, Tatemoto and Ichamura used an input- output study of Japan to analyze her trade. They found Japan's total exports to be capital intensive relative to her imports. On the surface this result would seem to be inconsistent with the Heckscher-Ohlin hypothesis. However, when Japan's total trade was disaggregated, it was found that approximately three—fourths of it was with the less developed countries which are presumably even more labor abundant than Japan. While exports to these countries were relatively capital intensive, it was 84 found that Japan's exports to the U.S. were relatively labor intensive. Therefore, the results are consistent with the factor endowment theorem. In 1961, Wahll6 conducted a Leontief-type study of Canada's trade in industrial products. In this study it was found that Canada's exports were relatively capital intensive. Since Canadian trade is primarily with the United States, the Heckscher-Ohlin hypothesis is not verified in this case. Also in 1961, Roskamp and Stolperl7 reported the results of an input-output study of East German trade. They found that East German exports are relatively capital intensive, which was considered to be in support of the Heckscher-Ohlin theory since 75% of East Germany's trade is with the other communist countries which are pre- sumably less well endowed with capital. 4 In 1962, Bharadwaj18 conducted a study of India's trade with the U.S. This study yielded the amazing results that India's exports to the U.S. are capital intensive relative to their imports from the U.S., which is without a doubt contradictory to what the Heckscher- Ohlin theory would predict. Finally, in a forthcoming study of the commodity composition of trade in manufactured goods, Hufbauer19 has found support for the Heckscher-Ohlin theory in a different type of test. In a study of the trade of 24 85 countries, he found a very high correlation between a ranking of the countries according to capital endowment and a ranking according to the capital intensity of their exports. In his study, however, factory intensity of a commodity was determined with reference only to the factor intensity of the final industry, giving no con- sideration to intermediate inputs. It is obvious that all of these tests, with their mixed results, have not settled the question of whether or not the Heckscher-Ohlin model is a valid theory of international trade. It could not be eXpected to explain all trade since in the real world there are such things as transportation costs, product differentiation, dif- ferences in technology, and many social and institutional factors which can influence trade. Furthermore, the model deals only with the supply side of trade, while demand conditions can also play an important role. Yet, the Heckscher-Ohlin model remains the pre- dominant theory of international trade, as no other theory which is as plausible or logically consistent has been developed to replace it. In the absence of a pre- ferable alternative, the Heckscher-Ohlin theory will be adopted in this study as a valid theory of international trade, and will be used to analyze the commodity composi- tion of East—West trade. Also, a variant of the model which takes into consideration human capital as well as physical capital will be used. 86 The Economic Nature of East-West Trade As mentioned above, the assumptions of the Heckscher- Ohlin theory are so strict that they are never met in the real world. Some of them, such as the assumption of per- fect competition in both product and factor markets, are particularly unrealistic with regard to the Soviet bloc- economies. Therefore, East—West trade would not logically be chosen to test the validity of the factor proportions theory. However, we reverse the procedure and use the model to test whether Soviet bloc trade with the West is "rational" in a sense that it conforms to the postulates of comparative advantage as expressed in the factor pro- portions model. That is, if we make the assumption that comparative cost differences do arise from different factor endowments, then we may ask whether or not these cost considerations find sufficient expression in Soviet- type economies to determine the commodity composition of their trade with the West. In an unpublished doctoral dissertation, Wayne W. Sharp20 studied the trade of Comecon with the EurOpean Economic Community (EEC) to see if it conformed to the predictions of the factor endowment theorem. For the purposes of his study, capital and labor were combined into a single composite factor, with natural resources considered the second factor of production. On the basis of Vanek's study of the natural resource content of U.S. 87 trade, he classified those products in Sections 5-8 of the Standard International Trade Classification (SITC) as intensive in capital and labor, and all other com- modities (except SITC 9, commodities and transactions not classified according to kind), as natural resource intensive commodities. After establishing that Comecon is natural resource abundant relative to the EEC, Sharp examined the trade flows between these two groups of countries. It was found that of the total exports of Comecon countries to the EEC in 1962, 73% were natural resource intensive commodities. For East Central EurOpe (Comecon excluding the USSR) and the Soviet Union considered separately, the percentages were 72% and 77%, respectively.21 In contrast, when the imports of Comecon from the EEC were examined, it was found that, in 1962, 86% of these were capital and labor intensive commodities. For East Central Europe and the Soviet Union considered separately, the results were 82% and 91%, respectively.22 From these results it is evident that, at least at this level of aggregation, the exports of Comecon countries are natural resource intensive relative to their imports from the EEC. Since Comecon was shown to be natural resource abundant relative to the EEC, it was concluded that this trade is consistent with the factor endowment theorem. 88 In the present study a different definition of factors of production is adopted, since resource intensive products are not dealt with here, and an attempt is made to disaggregate other (manufactured) products. Also, a different method of analysis used to try to determine if Soviet bloc trade with the West conforms to that postulated by the Heckscher-Ohlin theorem of comparative advantage. Assumptions and Definitions In this chapter a Leontief-type study of Soviet bloc trade with the industrial West is performed. It is assumed that there are two factors of production, capital and labor. Since much of East-West trade is in raw materials, which tend to reflect natural resource endow- ment rather than the relative capital and labor endow- ments of the countries involved, it was decided to limit the analysis to trade in manufactured goods. The definition of manufactured goods adOpted for the purposes of this study is essentially the same as that of the revised SITC, that is, those products in SITC Sections 5, 6, 7, and 8. Although it is characteristic of the Leontief-type studies which have been conducted previously that relative factor endowments are assumed rather than demonstrated, and even though the Soviet bloc countries are commonly referred to in the literature as capital poor relative 89 to the West, it was deemed advisable to provide at least some evidence that this is in fact the case. By way of indirect evidence, one may point to the difference in levels of per capita income, since more capital abundant economies generally have a higher level of per capita income. According to United Nations estimates for 1964, the per capita gross domestic product of the Comecon countries was $1,020, as compared with $1,465 for the EEC countries and $1,583 for the countries of EFTA.23 Another characteristic of capital abundance is a small percentage of the labor force engaged in agricul- ture. As capital becomes more abundant in an economy, capital requirements in the industrial sector are more adequately met so that capital is employed in other sectors of the economy. When capital is applied to the agricultural sector, labor is generally released to be employed in the industrial or service sectors. In the Soviet bloc countries, 40% of the labor force is employed in agriculture as compared to 13% in the EEC.2u Although data necessary for a direct comparison of physical factor endowments are scarce, fairly comparable data have been found for the U.S., France, Great Britain, and the USSR. Because of its economic size the USSR is the most important country in the Soviet bloc, and therefore receives the most weight. The capital labor rates of the USSR in 1960 was approximately $3,240 of 90 gross fixed capital stock per worker, which was in all probability above average for the bloc since the USSR is the most highly developed country of the bloc in terms of per capita national product. Similar ratios for the U.S., France and Great Britain were $10,510, $3,950 and 25 This evidence is consistent $5,740, respectively. with the indirect evidence presented above. Since the available evidence indicates that the Soviet bloc countries are labor abundant relative to the industrial West, the hypothesis tested in this study in order to see if East-West trade conforms to the pattern postulated by the Heckscher—Ohlin theory may be stated as follows: Hypothesis: The Soviet bloc countries' exports of manufactured commodities to the West are labor intensive (i.e. embody a higher L/C ratio) relative to their imports of manufactured commodities from the West. The same hypothesis is tested using a variant of the Heckscher-Ohlin model which incorporates human capital into the analysis. Data Sources and Method In order to determine the relative factor intensity of Soviet bloc exports and imports, use is made of an input-output study of the Soviet economy. For some 91 manufactured goods a relatively small percentage of the total value of the product is added in the final stage of production. Therefore, for an accurate determination of the actual factor intensity of a commodity it is necessary to know the factor intensities of those industries which have contributed inputs either directly or indirectly into the final industry, and the extent of their contribution. Such information may be obtained through inversion of an input-output matrix. The input-output table used here is a reconstruction 6 of the Soviet input-output table for 1959.2 The original 82—sector Soviet table has never been published in its entirety, but a gleaning of information by Professor Vladimir has made in value in terms pondence obtained official Of Treml and associates from numerous Soviet sources possible the reconstruction of a 38-sector table 27 terms. The entries in the table are expressed of purchasers' prices in 1959. A close corres- has been found by Treml between the totals from this reconstructed input-output table and the 28 Soviet national income and product accounts. the 38 industries in the reconstructed Soviet input-output table, 20 fall within the definition of manufactured goods adOpted in this study, i.e., Sections 5-8 of the revised Standard International Trade Classifica- tion. However, because of classification problems one of these, Industry not elsewhere classified, is omitted from 92 the analysis. Two others, General machinery and Machinery not elsewhere classified, are for the same reason treated as a single industry in the collection of trade statistics. In order to obtain the direct and indirect factor input coefficients from an input-output matrix, it is necessary to form a Leontief matrix. Such a matrix is formed by subtracting the matrix of direct technical coefficients A from an identity matrix I, to form the matrix (I—A), which is then inverted to form the matrix (I-A)-l. The columns of this Leontief matrix are then multiplied by the vectors of capital/output coefficients and employment/output coefficients, which are themselves 1 x 38 row vectors, to obtain vectors of direct and indirect capital and labor input coefficients. The inverse matrix was formed and the direct and indirect labor input coefficients calculated by Treml. However, only recently have capital data become available and been reported by Treml,29 so the vector of capital/ output coefficients had to be multiplied by the relevant columns of the matrix of full input coefficients to obtain the direct and indirect capital input coefficients for each of the 18 industries. The labor input coefficients are expressed in terms of man years/thousand rubles of gross output, while capital input coefficients are expressed in terms of rubles/ruble of gross output. 93 After the direct and indirect input coefficients have been calculated, it is necessary to multiply them by the relevant trade figures in order to determine the relative factor intensities of imports and exports. For example, to determine the capital content of Soviet bloc exports to the West, the direct and indirect capital input coefficient for each commodity is multiplied by the export figures for that commodity. A summation of the results of this Operation over all commodities gives the total capital content of Soviet bloc exports to the West. When this sum is divided by total exports expressed in millions of dollars, the direct and indirect capital requirement per million dollars of representative exports is obtained. A similar operation is carried out using import statistics to find the direct and indirect capital requirements of imports. Identical procedures are followed using the direct and indirect labor input coefficients to Obtain the labor requirements per million dollars of imports and exports. A comparison of the capital and labor inputs required in the production of exports with those required in the production of imported products makes it possible to determine whether exports or imports are more labor intensive. Therefore it provides a test of our hypothesis that exports of the Soviet bloc countries to the West are labor intensive relative to their imports from the West. 94 Due to the fact that Soviet bloc international trade statistics are often incomplete, of dubious reliability, and conform to no consistent commodity classification, Western sources of trade statistics have been used throughout. Figures for Soviet bloc trade with the United States are those reported by the Organization for Economic Cooperation and Development. Those for trade with the EEC and EFTA are from a special tabulation of East-West trade statistics prepared by the United Nations International Trade Statistics Center for the Economic Commission for Europe.30 Since previous studies have indicated that East- West trade is subject to larger annual fluctuations than 31 trade statistics for a trade among Western nations, three year period have been used in an attempt to prevent annual fluctuations from unduly influencing the results. These figures are reported in Appendix Tables 1-3 in the appendix to this chapter. Although these trade statistics are for 1964-66, while the capital and labor data are for 1959, it was decided that this disadvantage would be more than outweighed by the fact that the special tabulation of statistics by the United Nations permits tests of the commodity composition of trade at various levels of regional disaggregation, which would not otherwise have been feasible. It should be kept in mind, however, that the ensuing analysis is based upon the assumption that 95 factor use ratios did not change enough in the years between 1959 and 1964-66 to significantly alter the factor input coefficients. Also, because of the assump- tion of similar production functions, these coefficients are assumed to be valid for other countries of the bloc as well. The hypothesis that Soviet bloc exports to the West are labor intensive relative to their imports from the West is tested first for trade of the entire Soviet bloc with the entire industrial West. Then the calculations are repeated with the West disaggregated into the EEC, EFTA, and the U.S. After the investigation is conducted for trade of the entire West and regional disaggregations of the West, it is repeated for various regional disaggregations of the Soviet bloc. Trade with the United States is not included in these calculations because it was not included in the special United Nations tabulation of statistics, and because of the relatively insignificant size of its trade with the Soviet bloc. For the commodities con- sidered here, 8.6% of the exports of the Soviet bloc to the West were to the U.S., and only 1.8% of imports from the West were from the U.S. For the first regional disaggregation of the Soviet bloc, the two most industrially advanced of the Soviet bloc countries, East Germany and Czechoslovakia, are 96 eliminated from the analysis. Both of these countries are industrially developed at a level not much different from that of Western EurOpe, and both have suffered labor shortages. The relative factor endowments of East and West are more divergent when these two countries are excluded. In the next series of calculations the Soviet Union, as well as Czechoslovakia and East Germany, is excluded in order to concentrate on the five most labor abundant and least economically developed of the Soviet bloc countries--Albania, Bulgaria, Hungary, Poland and Rumania. Finally, the calculations are conducted separately for the Soviet Union on the one hand, and the remaining Soviet bloc countries, here referred to as East Central Europe, on the other. The countries of East Central Europe have historically been economically linked more with Western EurOpe than with the Soviet Union, and until they were incorporated into the Soviet bloc their trade was primarily directed toward the West. Also, because of their location they have naturally tended to trade more with Western Europe than has the Soviet Union. An Examination of the Empirical Data Strictly interpreted, the calculations performed here indicate what the capital and labor content of the commodities traded would be if they were produced in the Soviet Union. The analysis has been extended to the trade 97 of the various groups of countries by relying upon the usual assumptions of the Heckscher-Ohlin theory that production functions are identical in every country for the same product, and that there are no reversals of factor intensities. We shall accept our hypothesis if C/L input ratio for exports the C/L input ratio for imports is less than 1, indicating that Soviet bloc exports to the West are labor intensive relative to their imports from the West, and reject our hypothesis if the ratio is greater than 1, indicating that Soviet bloc exports to the West are capital intensive relative to their imports from the West. The results of the various calculations are shown in Tables 1-5. They can be summarized very briefly by the statement that, in every case, the exports of the Soviet bloc countries to the West are found to be more capital intensive than their imports from the West. Therefore, in every instance we must reject the hypothesis that Soviet bloc exports to the West are labor intensive relative to their imports from the West. It is interesting to note that of all the tests, exports of the USSR to the West are found to be the most capital intensive. On the other hand, the exports of East Germany and Czechoslovakia are evidently the least capital intensive since the results indicating the least capital intensity are obtained for East Central Europe, i.e., when East Germany and Czechoslovakia are included 98 .m canes xHecmdd< ca czonm mucmHOHmmmoo paged Hopomm can sum mcaome chccdd< 2H cmuHOQOH mOHpmauwpm comp» Heaven Eonm uxou CH eanpomoc mm cmpmHsoamo "mopeom Hmwzpnom wcfipsaoxmw . mMH.: om:.mmm.H smm.mmm menoneH . . one H Hom.= o:m.mme.H mse.msm menonxm m a . mmm.: mse.msm.H :mm.HHm mpeoneH . =Hm.e mmm.mow.H mmm.Hsm mpeoneH HmH H mmm.: mHm.Hmm.H mes.msm npponxm 0mm . mmm.= mmo.Hmm.H :m:.Hsm mpnoneH . Hmm.e Hem.mmm.H mom.emm mesonsH mmH H mom.= omo.mms.H, mmm.msm mpnonxm pnpz mphOQEH Amcanmv Ampmc» cmzv non OHpnm n anano eoneq oHpem p: eH . 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LM.AH n.m mnnenoee Hwewz .m Hm.nmm o .mmH ew.HmH mm.nn m.nm na.- ne.nnm mm.eeH wawnwe weoeewm .m em.w- om.MMH ms.cn he..m H.ne mm.ew mn.nnfi mm.fln nepwflEwew onwwe new Hwewefiz .H muLOQEH mppoex; uueoezm IlanOexm nuLOdEH nueogxm mpLOdEH wpeogxm n nonnaoxm pmmu 90 wUmL9 .mLmBCS: .m«Lmufi:m .wficnefiq no mnwee r». 0 dqum cu“: oOHD pmw>oo go mUmLB pcmppso ho mcoflHHHEV .A.u.H.o .mpzwuxm ..p.o.u «mueOQEa Mn ewHHon nnmfilanmfl .mfiwneneom weeneaoxwv when epez wnwes ween ewe>on eo eoflnwwwewwwwfie Hweonwmuun: memes xHezmeee APPENDIX 126 TABLE 5.—-Direct and indirect factor input coefficirnts for 18 manufacturing industries. Total Input Coefficients Direct and Indirect Direct and Indirect Direct and Indirect Industry Labor Requirements Physical Capital Human and Physical Requirements Capital Requirements (Nan Years/1,000 (Rubles/Ruble of (Rubles/Ruble of Rubles of Gross Gross Output) Gros: Output) Output) 1. Mineral and basic chemistry .87136 2.85lu29 n.685975 2. Ferrous metals .39837 2.450977 . “.051731 3. Metal products .41522 9.5“9355 H.23U539 A. Nonferrous metals .31829 2.13u136 3.361610 5. Paper .“5713 1.795693 3.U7l755 6. Synthetics, paints .297N1 1.390956 2.533915 7. Transportation M and E .37lb9 1.582608 3.0?9OA2 8. Automobiles .2058 1.231233 2.375892 9. Rubber products .28275 1.028967 2.098506 10. Construction materials .57511 2.290201 H.582129 11. Electrical and power M and E .UIOBI 1,59u313 3.192701 12. Agr1011tural h and E .3'3.) . 97777 Z.iu3-_ 13. General machinery and Machinery, n.e.c. .36977 1.199681 2.587098 1A. Glass .u7u303 1_3ug519 3.1bu376 .0“" an} instrltcnzs ,Jfijiu .“5715, 1'suvg—z 10. Textiles .3937} .553939 I.C‘”‘u4 lT. Metalworking _u3338 1.373133 3_)5::7, 18- Apparel and footwear .25272 .35Q332 1.980765 M and E = machinery and equipment {1.8.0. Source: = not elsewhere classified Labor input coefficients from V. Treml, "The 1959 Soviet Input-Output Table (As Reconstructed)," U.S. Congress, New Directions 11 the SO'iet Econnmy, Joint Economic Committee, 89th Cong., 2nd Sess., 1966. Physical capital coefficients calculated as described in text from capital/output coefficients from V. Treml, "New Soviet lnterindustry Data," U.S. Congress, Soviet Economic Performance: 1966—67, Joint Economic Committee, 90th Cong., 2nd Sess., 1H8, and the inverse matrix in Treml, "The 1959 Soviet Input-Output Table (A3 Reconstructed)." 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Mineral and basic chemistry 512 515 513 521 514 561 2. Ferrous metals 671 674 677 672 675 678 673 676 679 3. Metalgproducts 692 694 698 4. Nonferrous metals 682 685 688 683 686 689 684 687 5. Paper 251 641 642 6. Synthetics and paints 531 571 893 532 581 541 533 599 7. Transportation machinery and equipment 731 733 732 734 8. Automobiles 732 9. Rubber products 621 629 10. 11. 12. 13. l4. 15. l6. l7. 18. 131 Construction materials 661 662 663 Electrical and power machinery and equipment 711 725 722 726 723 729 Agricultural machinery and equipment 712 General machinery and machinery not elsewhere classified 715 719 717 724 718 Glass 664 665 666 Tools and instruments 693 861 864 695 862 891 714 863 Textiles 266 653 656 651 654 657 652 655 Metalworking 691 697 696 812 Apparel and footwear 612 842 831 851 841 132 Commodities in SITC 5-8 Commodities not in SITC 5—8 not included in the 18 but included in the 18 industries industries 551 681 251 553 821 266 554 892 611 894 613 895 631 896 632 897 633 899 667 aExcept for number 13, these industries correspond directly to the classification of manufacturing industries presented by V. Treml, "New Soviet Interindustry Data," U.S. Congress, Soviet Economic Performance: 1966-67, Subcommittee on Foreign Economic Policy of the Joint Economic Committee, 90th Cong., lst Sess., 1968, 155—156. Number 13, general machinery and machinery n.e.c., because of classification problems, is an aggregation of two of the industries classified by Treml. Also because of classification problems, Treml's industry number 32, industry not elsewhere classified, was omitted from the analysis. The concordance between the commodity classifi- cation of Treml and the Standard International Trade Classification was devised on the basis of a description of the 18 industries in Treml, ibid., pp. 155- 156, and the United Nations Statistical Papers, Series M., No. 43, Classification of Commodities by Industrial Origin, New York, 1966. FOOTNOTES 1M. O. Clement, et al., Theoretical Issues in Inter- national Economics (Boston: Houghton Mifflin Co., 19677: p. 4. Also see J. S. Chipman, "A Survey of International Trade: Part I, The Classical Theory," Econometrica, XXXIII (July, 1965), pp. 477-519. 2The following demonstrations of the model are essentially those presented in Subimal Mookerjee, Factor Endowments and International Trade (Bombay: Asia Publishing House, 1958), pp. 27-30. 3G. D. A. MacDougall, "British and American Exports: A Study Suggested by the Theory of Comparative Costs," Economic Journal, LXI; LXII (Part 1: December, 1951; Part II: September, 1952). “I. B. Kravis, "'Availability' and other Influences on the Commodity Composition of Trade," Journal of Political Economy, LXIV (February, 1956), pp. 143-155. 5Wassily W. Leontief, "Domestic Production and Foreign Trade: The American Captial Position Re—examined," Proceedings of the American Philosophipal Society, XCVII (September, 1953), pp. 332-349. Leontief reworked his original calculations to take account of criticisms, and published the work as "Factor Proportions and the Structure of American Trade: Further Theoretical and Emperical Analysis," Review of Economics and Statistics, XXXVIII (November, 1956), pp. 386-407. 6M. A. Diab, The United States Capital Position and the Structure of its Foreign Trade (Amsterdam: North- Holland Publishing Co., 1956). 7J. N. Bhagwati, "Some Recent Trends in the Pure Theory of International Trade," in International Trade Theory in a Developing World, ed. by Roy Harrod and Douglas HagueT(New York: St. Martin's Press, 1963). 8M. E. Kreinin, "Comparative Labor Effectiveness and the Leontief Scarce-Factor Parado," American Economic Review, LV (March, 1965), pp. l3l-140. 133 134 9K. J. Arrow, 22 al., "Capital—Labor Substitution and Economic Efficiency,"_Review of Economics and Statistics, XLIII (August, 1961), pp. 225-250. 10B. S. Minhas, An International Comparison of Factor Costs and Factor Use((Amsterdam: North-Holland Publishing Co., 19637. 11See specifically Wassily Leontief, "International Factor Costs and Factor Use," American Economic Review, LIV (June, 1964), pp. 335-345, and D. S. Ball, "Factor Intensity Reversals in International Comparison of Factor Cost and Factor Use," Journal of Political Economy, LXXIV (February, 1966), pp. 77-80. l2Jaroslav Vanek, The Natural Resource Content of United States Foreign Trade, 1870-1955 (Cambridge, Mass.: The MIT Press, 1963), p. 135. 13w. P. Travis, The Theory of Trade and Protection (Cambridge, Mass.: Harvard University Press, 1964). 1“Peter B. Kenen, "Nature, Capital and Trade," Journal of Political Economy, LXXIII (October, 1965), pp. 437-360. 15Masahiro Tatemoto and Sinichi Ichimura, "Factor Proportions and Foreign Trade: The Case of Japan," Review of Economics and Statistics, XLI (November, 1959), pp. 442-446. 16D. F. Wahl, "Capital and Labor Requirements for Canada's Foreign Trade," Canadian Journal of Economics and Political Science, XXVII (August, 1961), pp. 349-358. 17w. Stolper and K. Roskamp, "An Input-Output Table for East Germany with Applications to Foreign Trade," Bulletin of the Oxford University Institute of Statistics, XXIII (November, 1961), pp. 379-392. 18R. Bharadwaj, "Factor Proportions and the Structure of Indo-U.S. Trade," Indian Economic Journal, X (October, 1962), pp. 105—116. 190. c. Hufbauer, "The Commodity Composition of Trade in Manufactured Goods," (unpublished manuscript). 2OWayne W. Sharp,"Trade Relations Between the EEC and COMECON: Implications for U.S. Agricultural Trade Policy," (unpublished Ph.D. dissertation, Department of Agricultural Economics, Michigan State University). 135 21Ibid., p. 89. 22 Ibid., p. 92. 23Michael Kaser, Comecon: Integration Problems of Planned Economies (London: Oxford University Press, 1965). p. 202. 24 Sharp, p. 76. 25Employment and capital data for U.S. and USSR from Abram Bergson, Planning and Productivity Under Soviet Socialism (New York: Columbia University Press, 1968), p. 89. Employment data for France and Great Britain from Ibid., pp. 88-89. Capital stock data for France and Great Britain from Edward F. Denison, Why Growth Rates Differ (Washington: The Brookings Institution, 1967), pp. 418 and 422, respectively. Data for France in terms of 1956 prices, for Great Britain in 1958 prices, and for the U.S. and the USSR in 1955 prices. 26The reconstructed table and accompanying notes are presented in V. G. Treml, "The 1959 Soviet Input-Output Table (As Reconstructed)," New Directions in the Soviet Economy, U.S. Congress, 2nd Sess., 1966, pp. 259-270. 27Ibid., p. 262. 28Ibid., pp. 265-268. 29V. G. Treml, "New Soviet Interindustry Data," Soviet Economic Performance: 1966-1967, U.S. Congress, Joint Economic Committee, 90th Cong., 2nd Sess., 1968, pp. 145-158. 3OStatistical Appendices to Economic Bulletin for Europe, United Nations, Economic Commission for Europe, Vol. 18, No. l, 1966 and Vol. 19, No. l, 1967. 31See for example, G. J. Staller, "Patterns of Stability in Foreign Trade: OECD and COMECON, 1950- 1963," American Economic Review, LVII (September, 1967), pp. 879:888. 32Irving B. Kravis, "Wages and Foreign Trade," Review of Economics and Statistics, XXXVII (February, 1956), pp. fl-30o 136 33D. B. Keesing, "Labor Skills and Comparative Advantage," American Economic Review, LVI (May, 1966), pp. 249-258, and "Labor Skills and International Trade: Evaluating Many Trade Flows with a Single Measuring Device," Review of Economics and Statistics, XXXXVI (August, 1965), 287-294. 3“Kenen, pp. 458-460. 351bid., p. 459. 36Descriptions of the skill categories as presented by Treml are as follows: I. Administrative--managerial, supervisory, and engineering personnel with completed higher education. II. Other engineering and technical supervisory personnel. III. Workers employed in production or auxiliary services of the highest skill group. IV. Same as III but medium skills. V. Unskilled workers. VI. Other employees including trainees, apprentices, clerical personnel, watchmen, etc. 37Data on wage differentials are taken from A. Aganbegian, "Methods of Analyzing and Calculating the Distribution of Workers and Employees by the Amount of Wages," Problems of Economics, III, No. 6 (October, 1960), p. 32. Wage rates are not formally issued for specific occupational titles, but according to wage grade with persons of higher skills generally being assigned the higher grades on the wage scale. The wage differentials used here are projections of the wage structure to have been achieved during the 1959-1965 Seven Year Plan, and are supposedly a revision of the wage rates to more accurately reflect skill differentials. There were seven wage grades in the scale presented, the second and third of which were combined to arrive at a single average wage rate, this procedure having been suggested by com- paring the projected distribution of labor with the actual distribution according to the six skill categories. Estimates of average annual wage for 1959 are from J. Thornton, "Estimation of Value Added and Average Returns to Capital in Soviet Industry from Cross-Section Data," Journal of Political Economy, LXXIII, No. 6 (December, 1965), p. 624. The estimated annual wage was arbitrarily assigned to the skill category of medium skills, and annual wages for other skill groups calculated according to the dif- ferentials described above. 137 38J. Mincer, "On-the-Job Training: Costs, Return, and Some Implications," Journal of Political Economy, LXX (supp1.) (October, 1962), p. 66: 396. Smirnov, "On Appraising the Economic Effective- ness of the Foreign Trade of the U.S.S.R.," Problems of Economics, VIII (December, 1965). “OBela Balassa, Trade Liberalization Among Industrial Countries (New York: McGraw-Hill, 1967), pp. 203—227. BIBLIOGRAPHY 138 BIBLIOGRAPHY Books Adler-Karlssor, Gunnar. Western Economic Warfare 1947- 1967. Stockholm: Almquist and Wiksell, 1968. Balassa, Bela A. The Hungarian Experience in Economic Planning. 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Leontief, Wassily W. "Domestic Production and Foreign Trade: The American Capital Position Re-examined." Proceedings of the American Philosophical Society, XCVII (September, 1953), 332-349. "Factor PrOportions and the Structure of American Trade: Further Theoretical and Emperical Analysis." Review of Economics and Statistics, XXXVIII (November, 1956), 386-407. "International Factor Costs and Factor Use." Journal of Political Economy, LXXIV (February, 1966), 77—80. 145 Levine, Herbert S. "Imput-Output Analysis and Soviet Planning." American Economic Review, LII (May, 1962), 127-137. MacDougall, G. D. A. "British and American Exports: A Study Suggested by the Theory of Comparative Costs." Economic Journal, LXI, Part I (Decem- ber, 1951); LXII, Part II (September, 1952). Mincer, Jacob. "On-the-Job Training: Costs, Returns, and Some Implications." Journal of Political Economy, LXX, Suppl. (October, 1962), 50-90. Michaely, M. "Multilateral Balancing in International Trade." American Economic Review, LII (September, 1962), 685-702. Montias, J. M. "Planning with Material Balances in Soviet-Type Economies." American Economic Review, XLIX (December, 1959), 963-985. Pozdniakov, V. S. "The State Monopoly of Foreign Trade in the U.S.S.R." The Soviet Review, IX (Summer, 1968), 42-49. Pryor, F. L. "Foreign Trade Theory in the Communist Bloc." Soviet Studies, XIV (July, 1962), 41-61. Smirnov, G. "On Appraising the Economic Effectiveness of the Foreign Trade of the U.S.S.R." Problems of Economics, VIII (December, 1965). Staller, G. J. "Patterns of Stability in Foreign Trade: OECD and COMECON, 1950-1963." American Economic Review, LVII (September, 1967), 879-888. Stolper, W. and K. Koskamp. "An Input-Output Table for East Germany with Applications to Foreign Trade." Bulletin of the Oxford University Institute of Statistics, XXIII (November, 1961 , 379-392. Tatemoto, Masahiro and Sirichi Ichimura. "Factor Proportions and Foreign Trade: The Case of Japan." 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