PERFORMANCE   

Industrial Inefficiencies in Poland's Command Economy

by Greg Bigelow

An examination of Polish industries today reveals that they are in need of serious improvements. This is a fact that this paper will not attempt to argue. What is in question is how the Polish industries arrived at the current state. And what effect Poland's former command economy had on producing this result.

The Organization for Economic Co-operation and Development (OECD) sums up nicely the problems facing Polish Industry in their "Industry in Poland" manuscript (pg 51). First, resources need to be reallocated among enterprises, sectors, and locations. This should be done according to sound economic principles rather than by politicized investment decisions formerly made at the national and Council of Mutual Economic Assistance (CMEA) levels. Second, there are major technological and productivity gaps in most enterprises and sectors that must be covered. This is compared to the world market and is related to the necessity of across the board quality improvements.

So what aspects of the former Polish command economy brought about this situation? Consider first the soft budget constraint (a concept originated by Kornai). The soft budget constraint could be considered benevolent, but certainly not efficient, because it prevents firms from "going out of business" as they do in the market economy. Closure of a firm can have adverse effects on the economy, and certainly the individuals that will be out of their jobs. But, by operating under a soft budget constraint, firms lose a majority of the incentives that their market economy counterparts have for minimizing costs (OECD, pg 54) and maximizing profits. Basically, enterprises lose their desire to be efficient. Of course, firms that are earning profits are looked upon more favorably by the government, but this is not as great an incentive as staying in business.

Perhaps the birth of the planning process demonstrates best the inefficiencies of the command economy. In 1945 Poland needed to recover from the devastation of World War II. The Council of Ministers (CM) began drawing up plans for production figures in all branches of the newly acquired state industries. During this process, "reactivation of industrial production was given decisive priority over implementation of rational wage and price systems" (Feiwel, pg 3). Expediency was given priority over (market) efficiency.

The inefficiency of the "plan" is inherent in its design. A central planner that determines production volumes for each enterprise is necessarily detached from the actual production process. Therefore, production is rigid, it can not respond quickly to changes in needs. "The central planner's production decisions do not result from an interplay of prices and costs but from dissident views of Party officials and technicians, without the possibility of verifying the correctness of the decision made" (Feiwel, pg12). Therefore, firms are not producing at the optimal level that a profit maximizing firm would. Whether they are under- or over-producing, there is an associated cost. Under-production results in needs not being met in other parts of the economy and poor utilization of labor. Over-production costs in the form of inventory stockpiles, decaying quality, and waste.

Central planning greatly reduces incentives to improve by introducing "technological norms". As Feiwel illustrates, "production requirements are estimated on the basis of constant technological coefficients prepared by the central planner" (pg 12). There are two causes of inefficiency here. First, the technological norms are constant. This implies that technology is not improving, and therefore gives firms no incentive to improve, minimize costs, etc. Second, as mentioned above, the detached central planner who is determining coefficients has insufficient information to complete this task efficiently. If the norm is estimated too low, firms will be struggling to meet the plan. If it is too high, firms will be under-utilizing their resources.

How did the price structure in Poland's command economy influence its efficiency? "With collectivist ownership of the means of production there can be no market valuation and no rational prices and costs" (Feiwel, pg 45). Why is market valuation necessary for economic efficiency? Market prices valuations are used by firms to decide how much to produce. Because prices in the command economy are determined by the government, and are part of plans that change only once every five years, they are not effective signals to the enterprises on how much to produce. The production volume is also determined by the rather rigid five year plan.

Therefore, it is difficult for changes in peoples' preferences to be seen by the enterprises. Because people's preferences change, it is quite likely that at any given time firms are either under--or over--producing. Meaning an inefficient quantity is being made available. Therefore, a Pareto superior move could be made if the firm could increase (decrease) its production to meet the higher (lower) needs of the economy. A five year rate of change suggests that, for a large portion of this time, the economy will be inefficiently allocating goods.

I would also like to examine the effect of set prices on quality of goods manufactured. In a market economy, firms have strong incentives to improve quality: they can charge a higher price, gain more market share, and reduce wasted of resources (i.e., for fixing quality problems). With set prices determined by the planning authority the first incentive disappears. If improved quality does not result in a higher price then why bother with it? And with production volumes determined also by the plan the second incentive disappears (at least in the short run, in the long run the planning authority may recognize the higher quality of a certain plant and allocate more of its goods). So we are left with waste reduction as an incentive. But, really the soft budget constraint voids this. So, the effect of set prices is to stagnate and depreciate the quality of goods produced.

As a final example of inefficiencies in the former Polish command economy, I would like to focus on the classic negative externality of pollution. Marlow defines a negative externality as, "when private markets fail to allocate resources on the basis of full social costs" (pg 640). Though the definition applies to private markets, I believe we can regard certain actions of the socialist government as producing negative externalities. Pollution has a certain cost to society that in market economies is generally accounted for by legislation, regulation, or sale of pollution rights (Marlow, pg 100). Pollution does not appear on the balance sheet of the central planner, and when technological norms are calculated, pollution is not a consideration.

What is the result of this negative externality? Poland has excessively high levels of pollution. Sulfur dioxide, a byproduct of burning brown coal, is a particularly nasty air pollutant. As measured in kilograms produced (of sulfur dioxide) per capita, in 1988 Poland had one of the highest levels in the world at 114kg (OECD, pg 160). In 1989 there were 1,612 factories in Poland with very high levels of air pollution (OECD, pg 160). These inefficient outcomes produce a strain on the economy in many ways.

Baruch Fischhoff (see references) has seen these effects during a recent trip to Poland as part of a documentary. The situation as he describes it: "the life expectancy is falling; the infant mortality rate is up; many babies are born premature; the rate of leukemia is up; by age 10, most children are under routine medical treatment?". At a steel factory he visited, Nowa Huta steel works, "80% of their workers retire for disability reasons".

Why such problems? The answer is that pollution was never part of the calculations conducted to run the command economy. It was a side effect that was generally ignored. Baruch Fischhoff mentions the difficulty of finding any data on pollution in the country except for recent years. A societal inefficiency has resulted from the workings of the command economy.

In conclusion, the command economy in Poland was characterized by certain striking inefficiencies. Foremost, the lack of incentive that results from central planning. This resulted in production level, quality, and also pollution problems.

References:

  • "The economics of a Socialist Enterprise", by George R. Feiwel, Frederick A. Praeger Publishers: 1966

  • "Industry in Poland: Structural Adjustment Issues and Policy Options", by OECD Centre for Co-operation with the European Economies in Transition: 1992

  • "Some Risks in Poland and West Germany", by Baruch Fischhoff, Internet URL "http://alpha.solutions.net/rec-travel/europe/Poland/trip.fischhoff.html"

  • "Public Finance Theory and Practice", by Michael L. Marlow, The Dryden Press: 1995

  • "The Socialist System", by Janos Kornai, HX73.K6715 1992

 

 

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