Economics 294 Professor Vladimir G Treml March 1995 SECOND ECONOMY IN THE SOVIET UNION IN THE 1970S AND 1980S Summary of findings of the Berkeley-Duke-George Mason research project derived from the study of urban areas. -- The second economy has comprised an important segment of the overall Soviet economy as can be seen from the fact that in the late 1970s private incomes comprised between 30 and 33 percent of total money incomes (i.e., combined first and second economy incomes) of the urban population, and labor inputs into the second economy accounted for between 10 and 12 percent of total employment in full year equivalents (results differ somewhat depending on weights used in standardization). Conservatively estimated earnings per person operating in the second economy were on the average five to six times higher than in state employment. -- Some illegal private activities always existed under the Soviet system as they exist in all countries. But they and labor participation in these activities began to grow rapidly in the more liberal atmosphere of the early 1960s and rates of growth far exceeded rates of growth of the official economy. -- Second economy activities were made possible by a number of features of the Soviet economic system such as high and differentiated excise taxes on some consumer goods (e.g., tax comprised about 90 percent of the retail price of vodka), perennial excess demand for many consumer goods, and multiple prices for some goods. Relatively low wages of state officials who has some control over scarce resources made rent seeking attractive. -- Second economy activities were important in both private production of goods and services and in redistribution of national income through theft, bribes, etc. The largest (in terms of the overall ruble volume of transactions) second economy markets were found to be in the illegal distillation of moonshine, consumer services (repair of soft goods, appliances and durables, medical services, services such as tutoring, barbers etc), consumer state trade and public dining, sales and repair of privately owned automobiles, resale of gasoline and automobile spare parts, residential housing (rent, construction, and repair of both privately and state owned housing), resale of scarce consumer goods procured in state trade, and production and distribution of narcotics. While small in terms of the overall value of transactions, private incomes were particularly high in funeral services, smuggling of foreign-made consumer goods, prostitution, foreign currency markets, and in the production, processing and distribution of foods such as meat. Illegal production of scarce goods, ex-market distribution of goods and services, private "arrangements," "side payments," graft and bribes permeated the entire Soviet economy and affected incomes and expenditures of a dominant share of the Soviet people. -- Soviet economists and statistical and planning agencies and research institutes were late in recognizing that the second economy was a unique component of the national economy and not just a mere aggregate of economic crimes. First official but poorly documented reports on the magnitude of the second economy appeared in 1989; after a number of upward revisions Goskomstat USSR (the official statistical agency) reported that the second economy reached 99.8 billion rubles in 1991. Under the Soviet law virtually all private production (except for agricultural outputs on private plots) and resale of goods for profit was illegal. The law enforcement agencies had remarkably little success in eradicating or slowing down the growth of illegal second economy activities. This is explained both by the fact that the second economy has corrupted a large part of the law enforcement and managerial cadres who accepted bribes to look elsewhere, by the amazing ingenuity and skills of private entrepreneurs acquired over decades of onerous state controls, and by the small scale, informal and unorganized character of private operations. -- Our studies found distinctly different regional patterns of second economy activities and transactions -- they were the highest in the South (Armenia, Georgia, Azerbaidzhan, and Central Asia), lower in the West and the North (Russia, Ukraine, Belorussia, and Moldavia), and lowest in the Baltics. The South was also as the breeding ground for Soviet "mafias," organized crime groups encompassing criminals, second economy entrepreneurs, and high communist party and state officials. -- Most private economy entrepreneurs worked singly or with few (often family) partners and would only occasionally hire outsiders. It is, however, possible that the emigre sample from which we derived most of our estimates did not "capture" large operators or relatively large private enterprises. A dominant share of private operators (except for the elderly) had state jobs, often just as a cover, and pursued their illegal activities on a part time basis. -- Inputs for illegal production were procured in a variety of ways, such as wide-spread theft of materials and finished goods from state enterprises by employees, home production (e.g., agricultural produce from private plots, narcotics), legal purchases in state consumer trade (e.g., sugar for illegal home distillation of moonshine), and by smuggling. -- Second economy activities appear to be more labor than capital intensive compared with the first economy. We cannot, however, on the basis of presently available information fully quantify the utilization of capital goods -- in many instances second economy entrepreneurs had access to state equipment, tools, and working space or employed dual-use privately owned capital goods (e.g., automobiles, tools and implements, or residential space). -- As a rule, men spent more time in remunerative private economic activities and earned higher second economy incomes than women. Otherwise, no picture or "socio-economic profile" of a second economy entrepreneur that would be different from the parent population emerged from our studies. Thus, state wages and transfer payments, age, education, and family status of people active in the second economy did not differ from urban USSR averages. The ubiquitous nature of the second economy and the high rate of population participation in private economic activities is probably the most likely explanation of this phenomenon. -- The second economy has to a large extent (but not completely) obviated the Soviet system of administrative rationing of many important consumer goods, such as housing, automobiles, and medical services. -- The symbiosis of the first and second economies is very complex and its patterns have been continuously changing over time. It would, therefore, be very difficult to ascertain whether the overall impact of the second economy was harmful or beneficial for the first or the official economy and how the second economy affected the efficiency and resource allocation in the first. The second economy provided the stimulus for corrupting the society, thereby significantly reshaping the character of the polity and administration and, with time, led to the present situation of a largely corrupt officialdom, mafias, and organized crime. The second economy's largest adverse impact on the first economy was effected in wide-spread theft from the state (including employee theft of materials from places of employment), large-scale theft of time from state employers, and income and sales tax evasion (i.e., nonpayment of income taxes on private incomes and private illegal production and sale of goods subject to high sales taxes.) Ubiquitous opportunities to engage in profitable illegal activities have also adversely affected labor productivity in state enterprises. State directed allocation of resources was thus significantly distorted by the second economy. On the other hand, the second economy facilitated and lubricated operations of the first economy by compensating for and correcting at least some inefficiencies and errors in state planning, administration and management. Thus, wrong goods delivered by the state to wrong localities at wrong times would be reshipped by private middlemen increasing the welfare of the people. Most Western and Soviet specialists believe that in overall terms the growing second economy had a detrimental effect on the effectiveness of the official economy.