Prof. Vladimir Treml Comparative Economic Systems Ec 140/240 February 1997 SOVIET FOREIGN TRADE The main objective of the Soviet foreign trade system in the post-war period has been to generate needed imports without exposing the economy to the outside world, uncertainties of foreign markets, and to protect it from the perceived hostility of Western democracies. Stalin's forceful preference for autarky was gradually replaced by Khrushchev's willingness to expand foreign trade, particularly with other socialist countries and the Third World, but "trade aversion" continued to be the norm. Western theoretical arguments stressing the benefits of trade based on comparative advantage have never been accepted by Marxist-Leninist- Stalinist ideology SOVIET FOREIGN TRADE FLOWS AND ACCOUNTS |=================================| | World markets | |=================================| /\ \/ |----------| |----------| | Payments | | Revenues | | for | | from | | Imports | | Exports | | in $$ | | in $$ | |----------| |----------| /\ \/ |=============================| |-----------------| | STATE MONOPOLY | |Surplus in rubles| | Ministry of Foreign Trade | | turned over to | < | and its agencies (FTO's) | | the state budget| | (Keeps separate accounts in | |-----------------| | rubles and in foreign | | exchange in foreign banks) | |=============================| /\ /\ \/ \/ |------------------------| |------------------------| | Payments from domestic | | Payments to domestic | | buyers of imports | | producers of exports | | made in rubles & based | | made in rubles & based | | on domestic prices | | on domestic prices | |------------------------| |------------------------| /\ /\ \/ \/ |-----------------------------------------------| | Domestic markets, enterprises, and households | | dealing only in rubles | |-----------------------------------------------| Most of the features described here have been common to all socialist "command economies." In some countries, such as China, foreign trade reforms (mainly decentralization) were introduced as early as 1970s. Gorbachev relaxed the state foreign trade monopoly in the late 1980s and allowed a small number of state industrial enterprises to deal directly with the outside world but with mixed results. In overall terms the system remained unchanged until the 1989 political reforms in East European socialist countries and the dissolution of the Soviet Union in 1991. Main Features 1. Rubles were not convertible into foreign currencies nor traded in foreign exchange markets. Soviet enterprises and citizens were prohibited from holding foreign exchange and gold. Foreigners entering the country had to exchange their currency for rubles at the State bank at the state-fixed rate. 2. The state established nominal exchange rates for foreign currencies, e.g., in 1978 one US dollar was set to be equal to 0.68 rubles. At the state-fixed rates the ruble was, as a rule, grossly overvalued (for example, in the late 1970s the black market rate was 4 rubles per dollar). The exchange rate unilaterally fixed by Soviet authorities, however, did not really matter because these rates were used only for accounting purposes within state organizations and for tourists and diplomates visiting the USSR. Merchandise trade was based on world market prices and was denominated in foreign currencies. This applied both to trade with market (capitalist) economies and centrally-planned socialist countries. Thus, for example, the socialist Poland would buy Soviet fertilizer at average world market dollar prices and the Soviet Union would buy Hungarian buses at world dollar prices. 3. The Ministry of Foreign Trade in conjunction with Gosplan would determine the list of goods to be imported and then placed orders with domestic producers of export goods to balance the trade in foreign currencies. The trade was thus essentially driven by country's needs for imports and not by the desire to maximize exports. Domestic producers of goods for export delivered these goods to the Ministry of Foreign Trade and were paid in rubles in prices which bear little or no relation to world market prices. The Ministry then sold these goods in world markets at world market prices. The Ministry would purchase imports at world market prices in foreign currencies and sell them to domestic Soviet buyers in rubles at prices set by state price authorities without regard for world market prices. Thus, the country was completely isolated from the world and changes in world market prices were not transmitted to the domestic economy. 4. The Ministry tried to balance expenditures on imports in foreign currencies with foreign currency revenues from exports on a bilateral basis. Thus, as a rule, foreign trade in foreign currencies was annually balanced on a country by country basis. In years when the dollar value of imports exceeded the export earnings the difference would be covered by sales of Soviet gold. The Soviet Union used international credit markets to borrow foreign exchange and extended trade credit and grants to political allies such as Cuba or countries of Socialist Eastern Europe. No direct foreign investment in the domestic economy was allowed until late 1980s. The Ministry's balance sheet in rubles (ruble revenues from selling imports to domestic buyers less ruble payments to domestic producers of exports) was not, however, balanced. The commodity structure of exports and imports and ruble prices received by export producers and paid by buyers of imports are such that the Ministry earns huge net profits. In late 1970s, for example, for every ruble the Ministry spent in purchasing export goods from domestic factories it would earn 1.55 rubles by selling imports to domestic buyers. In the early 1980s the so-called profits from foreign trade provided the state budget with 20 percent of all revenues compared with 8 percent generated by personal income taxes. 5. The quality of goods manufactured in the Soviet Union was lower than the general quality of goods traded in world markets and many Soviet goods could not be sold outside of the Soviet Union or had to be sold at large discounts. The Soviet Union was therefore forced to concentrate on exporting raw materials, particularly crude oil and natural gas. Soviet military hardware which was of high quality was an exception and the Soviet Union became a major exporter of arms to the Third World. Consequences: -- Because of traditional preference for bilateral arrangements foreign trade was understated. -- Because of the isolation from world markets the country did not enjoy full benefits of international division of labor. -- The domestic economy and domestic prices were isolated from the rest of the world and the "official" exchange rate between rubles and foreign currencies was set unilaterally by Soviet authorities and was meaningless. Domestic prices set by government fiat without regard to demand did not reflect relative scarcities. As the result world market prices could not be compared with domestic prices to determine which goods could be exported profitably and which should be imported. An equality perplexing question would arise concerning the desirability of specializing in production of goods for export or in developing import substitutes. Soviet planning and foreign trade specialists had to develop elaborate models to ascertain "efficiency" of exports and imports but in most cases these proved to be useless. Trade was therefore suboptimal. -- The so-called "trade dependency ratio" (sum of exports and imports divided by National Income) measured in dollars was about 5 percent in 1960 and rose to 7-8 percent in 1980. This low ratio supported the notion held by many Western academic economists and government specialists that the Soviet Union was highly self- sufficient and protected from the outside world. Measuring both foreign trade and national income in rubles, however, produced estimated trade dependency ratios of about 12 percent in 1960, 15 percent in 1970, and 27 percent in 1980. This suggested a growing dependency of the Soviet economy on foreign trade and raised a controversial issue of increasing Soviet vulnerability to outside political or economic pressures. Read pp. 291-292 and pp. 378-384 in Gregory and Stuart Fore more background information scan through [for-trad.294] in /treml/home