Command Economy

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Command Economy

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Title: Command Economy

1
Command Economy

Why study command?
The command system creates initial conditions for
transition
Legacies from command critical for transition
Path dependence
Two types of legacies
Structural
The result of past investments and other
decisions
Enterprises, locational choices
Institutional
Behavioral patterns
How to reverse past decisions
Start with the analysis of command system

2
Command Economy

Attempt to replace markets
The command principle strives to fully and
effectively replace the operation of market
forces in the key industrial and developmental
sectors of the economy, and render the remaining
(peripheral) markets manipulable and subordinate
to political direction.
Two Basic Imperatives
Growth
Control

3
3 Key Purposes

maximum resource mobilization towards urgent and
over-riding national objectives, e.g. rapid
industrialization or the prosecution of war
Used by many countries in wartime
radical transformation of the socio-economic
system in a collectivist direction based on
ideological tenets and power-political
imperatives and
not the least, as an answer to the
disorganization of a market economy through price
control, possibly occasioned by inflationary
pressure arising from (1) and/or (2).

4
Basic Features of the STE

state-ownership of the means of production
centralized control by means of an administered
system of planning in physical terms.
The system replaces the market with a set of
directives from the center to the production
units throughout the economy.
These directives are commands, not suggestions.
They are directives that have the force of law,
and subordinates are responsible for fulfilling
them, even if the plans are not feasible.
The absence of markets implies loss of
information about opportunity cost
absence of private property, except for
households

5
STE

STE created by Stalin in 1928
Exported to Eastern Europe after WW2
Imported by China after 1949
Yugoslavia mutates in mid-50s
Self-management
North Korea, Vietnam, Cuba are underdeveloped
examples of command economies

6
Basic Feature Continued, Implications

soft-budget constraints
chronic sellers market
emphasis on heavy industry
gigantomania
dynamic incentives problems
state control of investment
restrictions on entry, no exit

7
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8
Distribution of Employment by Size
9
Structural Differences
10
Ownership

Not just commanding heights
In the Soviet Union, for example,
the state and collective sectors accounted for
some 88 of the value added in agriculture
controlled 98 of retail trade, and owned 75 of
urban housing space
The industrial sector was exclusively state
owned.
In 1985, for example, 91 of employment was in
state enterprises, and another 6 was in
kolkhozy.
The extensive control of retail trade means that
the smallest shops were state owned.
But key factor is hierarchical control

11
Sample Hierarchy
12
Old Gosplan (currently Duma)
13
Hierarchy

Only vertical information flows
But there are informal horizontal flows
Only at the top of the hierarchy can opportunity
cost be assessed
Lower level agents cannot assess tradeoffs
Implies subordinate control crucial
Bureaucracy must exercise full control and
discretion
But subordinates have their own interests, which
implies
Incentive problems
Need for monitoring systems (police, party,
banks)
Corruption
Fundamental issue how to get agents to reveal
information and follow orders

14
Soviet Growth Model

Mechanism for extensive growth
Paradoxical attitude towards time
planners have a very low discount rate -- they
are willing to sacrifice lots of current
consumption for future consumption
On the other hand, haste implies that they want
to industrialize fast. So they cut corners, and
ignore side effects and other costs.
Diabetes example
Key point
Haste sowed the seeds of the barriers to
longer-term performance.
In that sense, the rapid growth in output of the
first couple of five year plans represent
borrowing from future performance.
Balloon payment
Key defect of the SGM is that output growth is
pursued without regard for the opportunity cost
of that growth
E.g., environmental mess

15
Extensive vs Intensive Growth

Suppose that output is given by
Then the growth rate of output is given by
Thus growth occurs either thru growth of inputs
(more K and/or more L) or technological change
(growth in A)
Extensive growth is the former, intensive growth
is the latter
Growth thru greater efficiency in use of inputs
Extensive growth is growth thru accumulation of
inputs

16
Extensive Growth
17
Intensive Growth
18
Consumption Paths

Whose utility is being maximized?
Households versus planners objectives
Planners willing to defer present consumption
versus future consumption
Planners combine haste with patience
Their haste for fast growth with publics
patience for deferred consumption
High rate of time preference on part of owners,
cost paid for by public

19
Consumption Paths
20
Consumption Path with Balloon Payment
21
Feschbach on Environment

In the last decade of the 20th century, there are
no leading industrial cities in the Soviet Union
where air pollution is not shortening the life
expectancy of adults and undermining the health
of their children. The growth that made the USSR
a superpower has been so ill-managed, so greedy
in its exploitation of natural resources and so
indifferent to the health of its people, that
ecocide is inevitable.
Collapse of the system prevented ecocide?
Why does Russia like Kyoto?

22
Aral Sea
23
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24
Soviet Growth Model (cont.)

Growth implies maximize investment
How? Via control of consumption
State is sole employer gt monopsony
Let be the subsistence level of consumption
Then is aggregate consumption.
Let be aggregate
consumption
Then investment is maximized, for given level of
K, by choosing L so that
What if ?

25
Maximizing the Investment Rate
26
Industrialization Strategy

Heavy industry
Maximize investment
Collectivization
Surplus labor argument
Transfer from rural to urban
State control over resources
But peasant response
Output growth versus welfare

27
USSR, Inc.

Soviet economy as a single corporation
The corporation owns a large stock of natural
resources,
has no outside shareholders
(so that all "profits" can be retained for
investment)
hires labor
Moreover, as a monopsonist in the labor market,
USSR Inc. can minimize the expenditure on labor.
Transactions between enterprises are merely
transfer prices between "divisions."
The exceptions are purchase of labor and
engagement in foreign trade.

28
Exceptions

Labor is allocated partly by choice
State determines demand, but labor is supplied
Though vagrancy is a crime full employment
Foreign Trade controlled by FTM
FTM trades with ROW
Intermediary between producers and ROW
Insulates domestic prices from world prices
Purchases (sells) goods at state prices and sells
(buys) at world prices

29
Transfer Prices

Prices used in transactions between parts of USSR
Inc. are not terms of trade
gt no need to equal opportunity costs.
Transfer prices record activity, they do not
motivate
Agents are executants of orders from above
Transfer prices could be randomly assigned
without changing behavior
But arbitrage opportunities could arise

30
Monopsonist Labor Market
31
Haste

Command system is good at mobilizing
achieving specific objectives
Extensive growth
Growth through accumulation of inputs
It is bad at assessing costs and tradeoffs
May be important for intensive growth
Growth via greater efficiency
Crucial Role of Resource Abundance
Delay in reaching BoP constraint

32
Growth Problems

Over time growth rates decline in all STEs
Despite continued growth in capital-worker
Why?
Failure to transition to intensive growth
Extensive growth trap
Inability to substitute capital for labor
Innovation Problems
The system worked best when the fruit was
low-hanging
mobilization

33
Growth Rates of Output by Eras
34
Soviet Growth Rates Decline
35
Growth in Capital-Worker
36
Intensive vs Extensive Growth

Start with
Then the growth rate of output can be written as
Intensive growth means high
Extensive growth means accumulation
But notice that as capital accumulates,
increases
What happens to rate of return?

37
Innovation Problems Recognized

Malenkov (1941)
...highly valuable inventions and product
improvements often lie around for years in the
scientific research institutes, laboratories and
enterprises, and are not introduced into
products.
Gorbachev (1987),
...many scientific discoveries and important
inventions lie around for years, and sometimes
decades, without being introduced into practical
applications.
Why?
Dynamic incentives problems

38
Two Explanations of Slowdown

TFP growth declines due to increased complexity
of the economy
Difficulty with diffusing innovation
Low elasticity of substitution
K/L increase due to high savings rate and limits
to growth in labor force
If substitution is difficult output growth is
reduced
Note that this is organizational, not
technological
No entry, limited exit
Input-output conservatism in planning
Extensive growth and natural resources
Energy was underpriced and over-utilized
when prices are liberalized many industries are
producing negative value added

39
Labor Force Participation Rates for Women
40
Role of Elasticity of Substitution
41
Price System

Prices unrelated to social costs
Socially necessary costs
Average not marginal
Non-existent charges for rent and capital
Raw materials underpriced
Costs of production were thus calculated based on
an incomplete enumeration of costs.
Prices biased based on user
Circus mirror effect
Does it matter?
USSR, Inc., gt transfer pricing
But illusion about sources of value
Implications for transition

42
Price System (cont.,)

Why have prices in a planned economy?
an accounting device
Monitoring of plan performance
Related question, why have money?
Active and passive money
Soft-budget constraint (Kornai)
If budget constraints are not binding a resource
constraint must eventually be reached
Implies that shortage is an equilibrium
phenomenon in STEs
Leads to sellers markets

43
SBC

Dynamic Commitment problem
Subsidy available ex post not ex ante
Effort costly for manager, bonus for fulfillment
is B
Effort is sufficiently costly so
If effort is low, Y 0 with no bailout, Y R
with bailout
If low effort manager must be bailed out because
low output is bad for planner
Manager knows this so he supplies low effort

44
SBC
45
Chronic Sellers Market

Primary cause gt the emphasis on growth at all
costs
Taut plans gt uncover hidden reserves
Soft-budget constraints
Plan fulfillment imperative
Excess demand for labor
Shortage and priority
Personality dominates
Lack of quality

46
Dynamic Incentives Problems

Planning from the achieved level
Enterprise exploits hidden information
Agents must be induced to reveal information
Simple 2-person game
Enterprise director can tell the truth or lie
Planner can issue a feasible or a taut plan

47
Preferences

Directors preferences
Planners preferences
Illustrative payoff matrix
Equilibrium both lie

48
Bonus Function

To get director to reveal information planner
implements a bonus function
But why pay to overfulfill?
Need for extra resources to meet shortages
Increase effort

49
Canonical Bonus Function
50
More on the Bonus Function

Solves static problem
Assume that effort is required to produce more
output
Moral hazard
But that this differs depending on productivity
Hidden information (adverse selection)
Then preferences depend on the nature of the
enterprise

51
Canonical Bonus Function
52
Canonical Bonus Function

Generates separation
If no bonus for overfulfillment, then pooling
Sets up the dynamic incentives problem
Fulfillment today risks fulfillment tomorrow
Consequences
Need for a safety factor
Ratchet effect
Taxing high performance

53
Dynamic Problem

Let be utility for fulfilling the
plan for the high productivity enterprise
Current gain from overfulfilling is
Loss from revealing information is
Then director must compare

54
Dynamic Problem

LHS is the current gain from revealing (CG)
RHS is the present value of future losses (DFL)
Depends on the time horizon of the agent
Whenever DFL gt CG the director will conceal true
capacity
Ratchet effect gt fear of a higher future target
lowers current performance
Predictability, Shchekino

55
Shchekino Experiment

Planning experiment
Planners commit not to change targets for 5 years
Enterprise can keep costs savings
Labor productivity rose so fast, 52 in first
year, planners reneged
Changed plan targets 7 times in 10 years
Another plant 17 times in 5 years
Inability of planners to commit

56
Ratchet Effect

More severe the greater is
Time horizon
Utility loss
And the smaller is
The discount rate
Leads to reduced incentives to perform and
innovate
Alexeev and weightlifting records
Slow diffusion of innovations

57
Result

Who said this?
Yuri Andropov, General Secretary, CPUSSR
Top officials know the problem, cant solve it

58
Lack of Observability

Inflated reports simulation is commonplace
Difficulty of monitoring
Occasional audits show this

59
Enron, Global Crossing, Stock options

Similar problems occur in corporations
Directors and managers engage in simulation
simulation of performance to achieve bonuses
Simulate earnings to benefit from options
Incomplete information necessary but not
sufficient
it is also necessary that rewards be skewed
toward the present,
especially if those costs can be shifted on to
others in the future.
Much harder to keep simulations hidden in markets
Need to hide losses, but Soviet pricing does not
reveal losses

60
Vasily Alexeev
61
Date of First Adoption versus Diffusion
(proportion of output produced in 1982)
62
Structure of Command Economy

Imperative is microbalance
Planning by material balances
Feasibility, not optimality
Iterative process of vertical information flows
Basic idea
Sources uses, good by good
For good j we have
Where does come from?
The input requests from other enterprises
Where does this come from?

63
Material Balances, cont.

Planners start with a target for sector j
Enterprise calculates its input needs assuming
fixed coefficients
So multiply to get needs
Now planner adds. E.g. for sector 1 (such an
equation for each sector of course)

64
Schematic
65
Material Balances, cont.

Put the sum back into the material balance
No reason to assume it equals zero.
So adjust output targets
Now we have a new set of input needs for each
enterprise. For j we have
And we just repeat the whole process, again, and
again

66
Material Balances, cont.

Process continues till all the Djs are zero
Notice how simple are the operations
If the process goes on long enough a feasible
plan result
But the number of iterations could be very large
In practice only one or two iterations
So plan as implemented is infeasible
Some plans taut, others slack
Note emphasis on intermediate goods
But optimal plans look at final goods
Central control and subordinate responsibility
Micro-balance is the imperative
Process assumes truthful revelation

67
Incentives versus Complexity

Mises, Hayek thought central planning problem was
too complex to solve
Lange and Lerner suggested market solutions
Set Q such that MC P
But this ignores incentives problems
Why would managers follow the rules?
Private information (about actions or conditions)
is valuable
Agents must be induced to reveal this

68
Command Problems

Detailed planning and the corresponding
directives are often late, are insufficiently
detailed, may lack the requisite information,
hence often cannot be effectively coordinated
Owing to their rigidity they are peculiarly
vulnerable to uncertainty
Planning in a command economy must be largely in
physical terms due to the crucial importance of
balance.
The bottom line of the planning process must be
available physical units of required inputs, in
appropriate assortment, quantity and timing,
necessitating physical targets for production and
input utilization.
Success indicator problem

69
Success Indicator Problem

Bonuses are non-synthetic
One linear price schedule produces imbalances
No secondary market
Planners cannot know tradeoffs at each enterprise
Pollution permits
Emphasize priority
Quality problems shifted to users
Because micro-balance is priority
Teaching versus research?
Bonus for retention

70
Command

Command is good for well-defined measurable tasks
Build the Atom Bomb
Dont worry about cost 25.7 billion at current
prices
Command is bad at assessing tradeoffs
No prices to measure opportunity cost
Physical indicators lead to success indicator
bias
Teaching is harder to measure than research

71
Shortage

SBC, fixed prices, output fixation gt shortage
In production, to avoid wasted resources full
utilization to achieve growth
In consumption, because planners do not want to
divert output
Of course, flexible prices could eliminate
shortage, but command means dominance over market
Market allocation weakens central control
Implication Generalized shortage

72
Shortage
73
The Big Nail
74
Problems with Linear Pricing
75
Mormon Comparison

Many similarities
Sense of encirclement
Holistic vision of utopia
Virtuous haste
Totalitarian leadership (without terror)
Primacy of collective over individual
Hostility to speculation, private initiative
Insulation and isolation
Need for autarky to conserve foreign exchange
Like the Soviet economy, economy was
collectivist, mobilizational, centrally planned,
largely command-managed, and often
redistributional in regard to factors, products,
and the economic surplus.

76
Mormon comparison, cont.

More similarities
Property owned by church
Capital formation
Via tithes, mostly in kind
Prices as accounting devices, economy demonetized
Frequent reforms
Cooperative forms of organization
Key differences
Voluntary, not coercion
Building on virgin soil

77
Seeds of Transformation

End of isolation
Immigration of gentile tradesman
Like the second economy of USSR
Railroads lower transportation costs
Raises cost of autarky
Hostile US legislation
Trade leads to corruption and sub-rosa
privatization

78
Second Economy

Informal economy arises to meet challenges of
command
Precisely because command economy cannot achieve
balance, and as terror dissipates
2nd economy defined as all production and
exchange activity that meets at least one of two
criteria
being directly for private gain
being in some significant respect in knowing
contravention of existing law. See Grossman,
1977, p. 25.
These market-mediated activities are at times
supportive, helping to achieve tolerable
micro-balance in the increasingly complex
economy,
but they often are in violation of planned
implementation and regime values.

79
Second Economy

Brezhnev on second economy
You don't know life. No one lives on wages alone.
I remember in my youth we earned money by
unloading railroad freight cars. So, what did we
do? Three crates or bags unloaded and one for
ourselves. That is how everybody lives in our
country.
Blat markets
2nd economy activity necessarily introduces
discretion
Potential for diversion

80
Second Economy

Virtually every area of economic life is touched
upon, and often entangled with, second economy
activities
legal private activity naturally opens a loophole
for illegal trading and entrepreneurship,
generally below the purview of the authorities.
Dual contradictory roles of 2nd economy
First, it addresses a number of the problems of
coordination and balance endemic to the command
mechanism
But, second, it mocks the pretense of social
direction and control, subverts its egalitarian
impulse, accentuating differences in access and
income, and gives lie to the pretense of a new
ideologically correct (Soviet) man

81
Evaluation and Size

2nd economy completes the cancerous development
of agent autonomy
Generates undesirable (system perspective)
redistribution of incomes,
although recipients, including many high placed
officials, find it very desirable.
Size
Estimates based on the surveys of Soviet
emigrants relate to the second half of 1970s and
range approximately between 10 and 30 of
incomes of urban households.
An alternative set of estimates based on the
Soviet-era official family budget survey data
puts the second economy at around 23 of
household income (Kim, 2003).
Could be as large as 12 of GDP in 1979
But double counting

82
Legacies

Two types
Structural legacies
Institutional legacies
Financial underdevelopment
Absence of rule of law
Khruschev Whos the Boss we or the law? We are
masters over the law, not the law over us so we
have to change the law we have to see to it that
it is possible to execute these speculators.
FTM

83
Structural legacies

Industrial structure
Industry bias
Industry intentional, agriculture unintentional
Under-provision of services
Hypermilitarization
Industrial concentration
Gigantomania
Absence of small enterprises

84
Distribution of Capital Stocks
85
Structure by Labor Force
86
Indicators of Raw Materials and Energy
Consumption, 1988
87
Enterprise Size in US and Russia
88
Hypermilitarization and Climate

Size estimates difficult
Pricing distorts measurement
Cost shifting
Defense burden unsustainable
Locational burden
Interaction with climate problems
Soviet Union got colder in 20th century!
Too many people in the wrong places
Big problem for market economy

89
Location in RussiaPopulation of Siberia and Far
East in 1989 37 mln (25 of RF total)
Manufacturing employment 1.8 mln (16 of RF
total)
90
Location in CanadaPopulation 85 000. (0.34 of
Canadian total) Manufacturing employment
295people (0.017 of Canadian total)
91
TPC in Canada, USA, and Russia
92
Duluth, population 86,000
93
Omsk, population 1.2 million
94
Perm, population 1.008 million
95
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96
Internal vs External Inefficiency

Internal inefficiency
Lack of high-powered incentives
Input combinations and X-inefficiency
External inefficiency
Lack of market pricing
allocative
Dynamic inefficiency
Lack of innovation

97
Legacy of Never-ending Reform

Waves of reform
Why a treadmill?
Rejection of alien organisms
Pitfalls of partial reform
Cooperatives
Supply diversion
Timber and boxcars

98
Example

Efficient rationing of timber
Plan price P, excess demand in housing
Cooperatives bid for timber
x units of timber diverted to housing from
boxcars

99
Supply Diversion

Notice that P is the shadow price of timber
With freedom to sell, timber sector sells qm to
the housing (cooperative) sector, cutting back
deliveries to the boxcar sector
Shadow value of timber is now much higher in
boxcars
Consumer surplus falls by A in boxcars and rises
by C in housing note A gtgt C
Producer surplus in boxcars falls by B 2C
Notice that the problem arises because the boxcar
industry cannot compete for timber, and the
capital in that sector cannot flow to housing.
The moral of this story is that as the state
loses control over the state sector, diversions
make things worse.
But China will be different!

100
Achievements

Full employment
By law gt no unemployment insurance
Soft budget constraint
Free health care
Good at infections, bad at modern diseases
Low income inequality
Gini Coefficient
Ratio of the area between the Lorenz curve and
OB, and the whole area OAB.
Wealth v income, and access to goods

101
Lorenz Curve
102
Earnings Distribution, Full-time workers
103
US Income of Top Decile
104
Social Uncertainty

Command economy minimizes income shocks
Full employment, socialized medicine
Social insurance is high
Underemployment vs unemployment
Risk taking is low
Institutions to cope with uncertainty in modern
economy are absent

105
Life Expectancy at Birth, Russia, 195859,
196162,196364, 19652002
106
An Alternative Factor

Decline of Oil prices
When rents exploded, so did commitments
Rents market value of revenues less natural
costs of extraction
Including subsidies to Eastern Europe
When rents declined hard to cut commitments
Resource abundance is addictive
increase in energy investment between 1981 and
1985 absorbed nearly 90 pct of increment
allocated to industry
Production maintained by borrowing from future
Tightened the resource constraint

107
An Alternative Factor
108
Rents and GDP
109
Rents, Addiction

Resource rents postponed day of reckoning
"In sum, the Soviet economic system became what
it is in part thanks to the country's rich
resource base, which permitted the planners
largely to ignore the day-to-day discipline of
the balance of payments and therefore also the
imperatives of the market place and the pains of
real economic cost. On this basis an elaborate
and rigid institutional edifice sprang up. This
economic system thrived for two human generations
and achieved marked successes by its own
criteria. But inevitably it hardened and came to
be supported and protected by powerful vested
interests Grossman, 1983 202.
addiction to rents postponed fundamental reforms,
made the system more fragile
The lesson is that resource abundance,
misapplied, can be addictive

110
Addiction

Addiction leads to short-time horizon
This leads to an inability to implement reforms.
Three characteristics
tolerance - the need for an increasing amount of
the substance to obtain the same effect
withdrawal - severe unpleasant effects when the
addict ceases to use the substance craving
"willingness to sacrifice all (to the point of
self-destructiveness)" in order to obtain and use
the substance.
In Soviet case tolerance arose because windfall
was used for many new activities
defense, East European subsidies and other
international adventures
interests created that depend on rents, makes
withdrawal painful
where is the methadone for an addicted Soviet
economy?

111
Defense Addiction

Marshal Akhromeev on addiction
Why it was necessary to produce so many weapons?
Akhromeev answered
"Because at a great cost of many sacrifices we
created first-class factories, no worse than the
American ones. Would you order them to stop work
and begin producing cooking pots?"
Shakhnazarov described the "military-industrial
mentality" as a "cancerous growth" that had
metastasized to every sphere of Soviet life
This is an example of addiction. The investment
in factories created interests that were very
costly to reverse.

112
Aspects of Collapse

Macroeconomic
Budget crisis, inflationary finance
Shortages, stolen hours, more queues
Weaker state lower tax collection
Microeconomic
Misallocation of resources
Lack of property rights
Pseudo privatization

113
Two Views on Collapse

Essentialists
Essentialists hold that the Soviet system
collapsed because it was essentially abnormal
The nature of the Soviet system made its eventual
collapse inevitable and even predictable
Of course, few made this prediction before the
system collapsed. Autopsies are easier on dead
bodies.
Voluntarists
Soviet economy was murdered, or its death was
decisively hastened, by voluntary acts of policy,
though the consequences may have been unintended.
We tend to confer the mantle of inevitability on
accomplished facts, and arguing that what
happened did not have to happen is likely to be
dismissed as inventing excuses for the losing
side. But the collapse of the Soviet system was
the unintended result of a small number of
disastrous decisions by a few individuals

114
Was Demise Inevitable?

Productivity growth slowed, but never turned
negative
The odds on overtaking fell
Reforms upset performance
Reforms made the system more fragile
Monitoring costs rose and deterring corruption
became more costly
Erosion of belief in system
So small shocks could lead to collapse

115
Weakening of Central Control

Critical difficulty for central planning
Brezhnev Communism Stalinism without terror
Raises the prices of information and action
Loss or resources at center
Agents have two options
Fulfill the plan, F
Dont fulfill the plan, NF
Payoffs depend on whether observed or not
Let be the probability of being observed

116
Stalinist Incentives

Let be the payoff to NF if unobserved
Suppose that
and
Then the expected payoffs are
Planners want
Two instruments, detection and punishment
We can plot this

117
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118
Stalin v Brezhnev

Stalinist system set punishment - infinity
Lowers cost of detection
Brezhnev system
Cheating is optimal for larger range of
Problem is more severe with greater complexity
Glasnost makes it even worse
Explosion of Second Economy
Loss of central revenue

119
Multiple Equilibria

The same system can have two equilibria
High output
Low output
Consider the producers decision to supply effort
Depends on gains and penalties
And whether this is observed

120
Producers Choice of Effort
Producer works hard, if
Gain from working hard gt cost of working hard
If work is hard and monitoring is strict, then
If work is hard and monitoring is lax, then
Work hard if reward gained penalty avoided gt
cost of effort
Dont work hard
No rewards gained, low effort supplied
Gain reward for working hard, avoid penalty for
not working hard, spend effort working hard
121
Dictators Choice

Dictator wants to deter stealing
Two key parameters
Cost of incentives provided
Costs of monitoring
Over time these parameters shift
Complexity raises monitoring costs
Weakening center (decline in oil revenue) raises
costs of providing incentives
High output is no longer an equilibrium

122
Dictators Decision
Dictator Monitors if
Effort is high, and if
Effort is low and if
Cost of monitoring lt value of output stolen
future output lost
Else, dont monitor
Costs of monitoring lt output stolen future
output loss
Else, dont monitor
123
Parameter Shift

Evolution of the system led to parameter shift
Complexity raises monitoring costs
Information flow weakens central authority
Value of incentives decreases as their cost rises
Second economy grows
High output is no longer the equilibrium
Reforms weaken the structure
Do not lower monitoring costs
Reforms make defection easier
Cooperatives
Law on state enterprise

124
Bank Run

Why the sudden collapse?
As center weakens officials defect
Race to cash in on assets
Solnick on the collapse
Key to bank run
Illiquidity
Sudden loss of trust

125
Solnick

...the image of a "disintegrating"
state...is...seriously incomplete. Soviet
institutions did not simply atrophy or dissolve
but were actively pulled apart by officials at
all levels seeking to extract assets that were in
any way fungible. Where organizational assets
were more specific to their particular use by the
state, as in the case of draft boards, for
example, hierarchical structures proved more
resilient. Where organizational assets were
chiefly cash and buildings, hierarchical
breakdown was almost total. At both ends of the
spectrum, the catalysts of state collapse were
the agents of the state itself. Once the bank run
was on, these officials were not merely stealing
resources from the state, they were stealing the
state itself."