Economics 508 Discussion

1. Economics 508 Discussion This document will be updated from time to time. Go down to next pages to see the latest day’s discussion questions. Subject to daily change.

2. 10-Jan-06 • Today’s Readings • Hayek • Lavigne Ch 10-11 • G&S Ch 1-4

3. Hayek • What is the basic economic problem? • The textbook answer is to find the “solution” to the best use of society’s resources in terms of maximizing an indicator of economic well-being • However, the problem that “society faces” (as opposed to the economist) is to extract and utilize the information or knowedge needed to arrive at the economist’s solution to the economic problem. • How is the solution to this problem achieved? • Not by central planning, but by individual planning. • Why? because no individual has the requisite command of all the knowledge. • Can you think of problems where individual knowledge may be insufficient? • Coordination of arrivals and departures at airports? Is this an inherent problem or is it only a problem under current institutional arrangements? • Is the solution simply an engineering or data problem? • It’s not a matter of acquiring “scientific knowledge” (what is that?) but situation-specific knowledge of “time and place.” • What is an arbitrageur?

4. Hayek (continued) • How do markets help in utilizing knowledge? • The the goal of increasing profits (firms) and satisfaction (consumers) forces sellers and buyers to reveal their information and to look for profit opportunities (discover information—knowledge). • Can planners achieve economic optimization? • They need two things: (1) knowledge and (2) the incentive to use it for society’s benefit. • Under market socialism or democratic socialism managers where to be given “orders” to use market prices to minimize costs and produce the “correct” amounts of goods and services, but there would be no reward for risk-taking, which is necessary when the “data” (information) is changing. • What is the role of “change” in Hayek’s thinking? • There is no need for a market when there is no change. • Can economic knowledge in Hayek’s sense be conveyed to central authorities (planners) in statistical form? • No. We don’t have the resources to do that.

5. Hayek (cont) • How much knowledge does an indvidual need to act successfully in a market economy? • Only knowledge of his/her own affairs, because the market summarizes everything else. • Economic efficiency requires equlality of opportunity costs across uses, but buyers and sellers don’t need to know this. • Prices are equalized through markets. • Is the emergence of markets inevitable? • Who where Leon Trotsky, Oscar Lange, Abba Lerner, von Mises?

6. Lavigne Ch 10 • What does Lavigne mean by the “three transitions?” • from central planning to free markets • from underdevelopment to development • from totalitarism to democracy • Is it necessary for the three transitions to occur at the same time? • clearly not. China is still totalitarian and still has some planning. • Russia is barely a democracy. • China is far less developed than, say, Poland. • Is one of them necessary for another? • This is subject to much debate. More later. • What is the fundamental goal of a firm in soviet-style planning? • To meet output targets dictated by the Plan. • What is market socialism? • Enterprise managers are instructed to minimize costs and to set output so that p = mc. But they do not claim residual revenue over cost (profit), so their incentives are not compatible with their official duties.

7. Gregory and Stuart 1-4 • What is meant by the “three property rights?” • Disposition (alienation) • Utilization • Use of production • What incentives are relevant to different forms of ownership? • private • public • collective (cooperative)

8. Gregory and Stuart 1-4 • How can we evaluate the “success” of an economic system? • What are the “performance criteria” listed by G&S? What do they mean? • Economic Growth • Efficiency • Income Distribution • Stability • Viability

9. Economics 508Discussion 19-Jan-06Lavigne Ch 2-6G&S Ch 1119-Jan-06 • Lavigne • What was the relationship between Marxian ideals and the Soviet socialist system? What was “really existing socialism? • What was NEP? Why did it end? • Est 1921 in USSR, permitted trade of any kind, eliminated compulsory delivery of food products; denationalized small-scale industry. • Ended in 1927-1929 as Stalin seized full power—a political move.

10. Lavigne (cont) • What was the Soviet industriazation debate? • It was about how to finance industrialization. • What was the purpose of mass collectivization of agriculture? • In 1927 about 80% of the Soviet workforce was in agriculture. This was the target resource for acquiring “surplus,” i.e. forced saving. By 1950 this had declined to about 25% • Forced collectivization led to mass sabatoge, decline in incentives and reduced productivity in agriculture from which it never recovered. • Jan 26 2006 • Compare to GLF in China? • After Stalin, did Soviet and E. European leaders recognize problems with planning? • They noticed declining rates of growth that had been occurring almost continuously after the middle 1950s. Increasing difficulty in meeting consumption needs, etc. • What were obstacles to reform? • Vested interests of the Nomenklatura (party managers—”cadres” in China). • Vested interests of the Party—wanted to maintain control. • Payoffs came from meeting plans, not reducing costs or innovating.

11. What kind of over- and under-reporting makes it difficult to measured economic growth in planned economies? • Why did this mis-reporting occur? • Did mis-reporting contribute to economic stagnation? • How did economic planners obtain accurate information about economic performance?

12. Can foreign-currency exchange rates be used to convert local measures to U.S. measures of GDP and GDP growth? • What is purchasing-power-parity? • What obstacles existed to increase productivity in state industry through “intensive growth”? • labor-hoarding • conservatism • lack of technology transfer from western economies

13. Lavigne (cont) • Was reform possible under Communist leadership? • What was reformed? • Planning? • There was some movement toward sub-unit contracts with planners. Targets were still in force. • Agriculture? • No evidence of that in USSR • Large or small enterprises? • Only large enterprises. There was a dearth of small enterprises. • Where there emerging “private” or “nonstate” enterprises? What was “hidden privatization?” • There was growth of a parallel economy. But private sector remained marginal until the end of the system. • Was the price system allowed to operate in the state sector? • No • What light does all this shed on the shock-therary/gradualism debate?

14. Points to note Lavigne Ch 4 • E. Europe and USSR growth fell after mid 1950s • 1970s oil “crisis” was bad for C.E. Europe, but USSR had lots of oil • Collapse of oil prices in 1980s hurt USSR and their aid to other communist countries

15. More on Lavigne Ch 4 • Was there “unemployment”? • What was “hidden inflation” (actual price rises not reflected in official data). • What was “repressed inflation”? • Why did economic reform lead to open inflation?

16. Lavigne Ch 5 • What is “bloc autarky”? • How was foreign trade treated as part of a planning process? • What was the importance of currency convertability? How convertible were currencies in the planned economies? • Why, according to Lavigne, can the U.S. maintain a continuous trade deficit? • What is the role of the PPP concept in understanding international trade? • Is there evidence of international specialization in trade within the Soviet bloc and between E. Europe, Russia, and the West? • What was China doing?

17. G&S Ch 11 • What is the principal-agent conflict in planning? • How does this relate to Hayek’s view of the role of knowledge in the economy? • What is information asymmetry? • What is opportunistic behavior? • What is the soft budget constraint?

18. G&S Ch 11 (cont) • What is the turnover tax? • Did this tax act a signal between consumers and producers? • What is meant by “money illusion” • What was its role in planned economies? • What was repressed inflation? • What were the machine-tractor stations? • (What happened to them? Could these have been a stepping stone to TVE’s as in China?)

19. Lavigne Ch 6-7-8 • What was “really existing socialism”? • Explain the significance of the “systemic inability to substitute capital for labor.” • What happened to Russian-CE trade after 1990 and conversion to convertible currencies? • Russian oil exports • European machinery exports • How did Russia adjust to the collapse in trade with CE?

20. Macroeconomic Reforms • What happened to the USSR monetary system after the breakup of USSR? • What delayed privatization among the CIS countries? • What is the parallel between “shock therapy” in C Europe and Bolivia? • Macro stablization • Supply response • How was shock therapy adopted in E E and Russia compared to CE? What was the outcome? • Shock therapy without reform in EE and Russia • Worse outcome in EE and Russia.

21. What were the elements of shock therapy? • price liberalization • government budget balance • taxes • spending • monetary policy • incomes policy • foreign trade liberalization • current account internal convertability • devaluation of domestic currency

22. What structural measures were supposed to complement shock therapy? • privatization • banking, financial, and tax reform • social safety net • industrial policy • Was there an optimal sequence of transition steps? • What was monetary overhang and how was it eliminated? • What was the importance of political credibility and how did it impact the timing and sequencing of transition steps? • Was adoption of “big bang” vs “gradualism” based mainly political or economic grounds? • Did all the CE countries adopt “big bang” in theory? in fact?

24. What do gradualists (evolutionists?) argue against shock therapy with respect to • structural reform (market creation)? • alternative therapies that cost less? • What made it difficult to achieve balanced budgets? • taxation problems • tax evasion • How were deficits financed? • public debt? • borrowing from central bank? • What were the three intellectual reactions to output decline? • incredulity (the figures lie) • complacency (it was inevitable) • gradualism was a practical alternative

25. Variable definitions in “Indexes” file

26. Structural Reforms • Four areas of reform • privatization • financial sector • taxation • agriculture

27. Important Issues in International Trade • Initial collapse of trade among the CE and EE economies and among CIS economies. • Contrasts with steady growth of trade between China and r.o.w. • C, EE/former USSR trade links have not been restored. Why? What “glue” held the trading block together before 1990? • What is important about international integration? • comparative advantage • substitute for factor flows—factor-price equalization • FDI, technogogy transfer, and transparency • competition and x-efficiency

28. International (cont.) • Monetary systems • floating exchange rates • fixed peg • currency board • Capital inflows • Foreign assistance (conditional transformation policies) • FDI (conditional on profitability) • Foreign portfolio investment (conditional on legal system, transparency, profitability, convertability) • Risk of capital flight and financial crisis. • Is full capital-account convertability a good idea?