Price formation

The economy of the U.S.S.R is a money economy. Prices are expressed in rubles, and payments by producers and consumers are made in money, although there are exceptions to this rule. As in capitalist countries, some services are provided free of charge; in the U.S.S.R., however, these services represent a larger share of consumers’ real income than in any capitalist country.

Except on “kolkhoz markets,”¹ price formation is not automatic. There are price lists for all goods and for services which are not given free of charge, and transactions concluded at other than the fixed official prices are illegal.

The technique of cost calculation in individual enterprises may be similar in the U.S.S.R. to that used in capitalist countries, but the economic mechanism behind the calculation is different. There are no prices for the factors of production which may be summarized under the general term “nature,” and prices for capital are largely absent. Inequalities in average costs of production caused by differences in natural conditions, or in the skill of management, are not allowed to become a source of quasi-rent. An industrial enterprise in the U.S.S.R. consists generally of several plants, whose managers perform only technological functions. The management of the enterprise credits each plant for its output at its planned average costs (based mostly on actual past performance) plus a certain mark-up for profits, which at the most amounts to 10 per cent. The enterprise delivers the output of its plants to a central selling organization for the region at prices which result from averaging the costs and profits of the individual plants. The central selling organization, in turn, sells at prices equal to the average of costs plus profit mark-up for all enterprises in the region. Variations in these quasi-arbitrary uniform selling prices, which may be described as “delivery prices,” are usually allowed only between regions.

Demand and supply of any producers’ good in short supply are not adjusted by increasing its price above average production costs plus a mark-up for profits, but through an arbitrary reduction by the planning authorities of the quantities requested by individual enterprises (in their original “microscopic” plans). Occasionally, the central economic authorities increase the profit mark-up for individual enterprises or groups of enterprises to enable them to undertake rationalizing investments or to extend their productive capacity if they are considered to be working under specially favorable conditions and to have a skilled management. However, this is not done with the aim of adjusting effective demand to existing supply conditions.

This method of pricing is similar to that used by capitalist countries in wartime.² It carefully avoids the marginal approach; indeed, the marginal principle is regarded in the U.S.S.R. as heretical, and Soviet economists are careful not to propose anything which appears to be influenced by it. Nevertheless, even in the Soviet economy there is some evidence of the application of the marginal principle. Each manager of a Soviet enterprise in making technological decisions is likely to act in a way that implies adherence to the marginal principle, just like an entrepreneur in a capitalist country. The factors of production of which the supply is determined for the Soviet “entrepreneur” are, however, much more numerous than for his counterpart in a capitalist country. Nor can he regulate the output of his plant in the same way as a capitalist entrepreneur. As a result of the generally narrower scope for the application of the marginal principle than in developed capitalist countries, the allocation of productive resources may be presumed to be objectively less economic in the U.S.S.R. than in such capitalist countries.

The prices of producers’ goods also include turnover taxes. But the tax rates for producers’ goods are very low, and the rates on producers’ goods which are used in the production of other producers’ goods are lower than on those which are next to the stage of consumers’ goods. The rates for a single commodity are also believed to be different, according as the commodity is to be used in the production of producers’ or consumers’ goods.

Turnover, or rather sales, tax rates on consumers’ goods, on the other hand, are very high,³ sometimes constituting as much as 90 per cent of the selling price. Even on goods which in British terminology would be called “utility goods,” they are frequently as high as 75 per cent. In 1940, the turnover tax constituted about 61 per cent of the total value of consumers’ goods sold to the public; for 1941, a percentage of 73 was planned.⁴

Turnover taxes are used to influence consumer demand so that it exerts little influence on the structure of production of producers’ goods. If the scales of preference of those who control economic planning differ from consumers’ preferences, the turnover tax may be used to adjust the demand for any good to an arbitrarily regulated supply. Even for goods in which the planners take no interest, but permit production in proportions regulated by consumers’ choices, producers’ interpretation of consumers’ wishes may be obscured by tax rate manipulations. Since, moreover, consumers are unable by their individual actions to determine either the rate or the volume of savings, “consumers’ sovereignty” is for the most part absent in the Soviet economy.

This method of pricing, largely independent of the marginal principle, gives the Soviet Government power to introduce, almost overnight, changes in the level of prices or in the price structure. Such over-all changes in price lists have occurred several times in Soviet history. In some instances, price adjustments had become necessary as a result of conditions created by inflation or other forms of economic mismanagement; in others, they seem to have been the inevitable outcome of the normal working of the Soviet economic organization.

Prices and economic development

The Soviet economy may be said to be in equilibrium at a given national income level and a given price level of consumers’ goods if the prices of all elements in the cost calculation have been established so as to assure equality between the value of the current production of consumers’ goods and total consumers’ outlays, which in the U.S.S.R. are almost identical with total wage earnings minus loans to the state and insignificant voluntary private savings. If—with given preference scales of consumers and of those who ultimately decide about economic planning,⁵ given techniques of production, and given conditions of economic and social structure—production and government expenditure expand at the same rate as population, the prices of the elements in the cost calculation and of consumers’ goods may remain unchanged. As soon, however, as either the technique of production, the economic and social structure, preference scales, or per capita production of consumers’ goods changes, cost elements and/or prices of consumers’ goods must also change.

In fact, in the U.S.S.R. national income, techniques of production, and economic structure change rather rapidly. Since the Soviet Government also aims at distributing increments in the national income so that per capita production of consumers’ goods may increase, frequent adjustments in wage earnings and other cost elements and/or in prices of consumers’ goods are therefore to be expected.

If the supply of consumers’ goods increases, equality between supply of and demand for these goods—one of the conditions of general equilibrium—may be maintained by means of a piece-work system of pay, efficiency premiums, and increases in basic wage rates. If total earnings increase in a certain period more or less than the supply of consumers’ goods, the prices of these goods should be changed. Before the war, the Soviet economy was subjected to continuous (although receding) inflationary pressures caused by imperfections in economic management, and there were frequent upward adjustments in the prices of consumers’ goods. Since the war, however, as a result of reconstruction, large imports of machinery, increasing supplies of raw materials, and improvements in the skill and organization of labor, the per capita supply of consumers’ goods has increased rapidly. At the same time, actual average costs of production have been continuously and significantly decreasing, and the cost elements, adapted to the previously existing conditions, have become more and more fictitious. In a highly centralized planning system there is, naturally, strong resistance to frequent changes in the cost elements and in the prices of consumers’ goods. It is a great convenience in planning to operate with stable “values.” In contrast to the actual tempo of economic development, the Soviet system of economic management may therefore in this respect be regarded as rigid.

Under dynamic conditions, planning which operates on values fixed in the past gradually becomes ineffective, and after a certain time, during which only sporadic and uncoordinated adjustments are made beneath the unchanged surface of fixed prices, over-all changes become necessary. Planned costs must be revised so as to reinstate economic incentives in enterprises, and wages and/or prices of consumers’ goods must be changed so as to restore equilibrium between the production of consumers’ goods and the demand for them, in conformity with whatever policy determines the share of consumption in the national income.

Since the monetary and price reform of December 1947, there have been three such major adjustments, each involving an over-all reduction in prices. The method of adjustment by increasing wages and salaries has not been used because it seemed less convenient for planning purposes. Changes in wages would seriously distort all the established elements of cost calculation.

Technique of price reduction

A description of the techniques used in the price reduction of March 1950 and of its financial implications cannot be found in the Soviet publications which are available. They may be deduced, however, from the principles of the Soviet price and financial system.

A reduction in the prices of consumers’ goods in the U.S.S.R. can be accomplished either by decreasing production costs, by lowering the turnover tax, or by a combination of the two, and either with or without a reduction in earnings.

Actual costs of production decrease gradually. As long as planned delivery prices remain unchanged, a reduction in costs results only in increased extra profits, i.e., profits above the established mark-up. An adjustment of planned costs to the actual level of costs is permitted only when the planning authorities so decide. Then if turnover taxes remain unchanged, the retail prices of consumers’ goods must be reduced in accordance with the reduction in costs of production.

The reduction of prices in the U.S.S.R. on March 1, 1950 involved an estimated average fall of 15 to 20 per cent. Under the assumption that, on the average, the turnover tax accounts for 60 per cent of retail prices, such a reduction in prices would require a reduction in total costs of production (including a mark-up for profit) by 37.5 to 50 per cent, if the yield of the turnover tax were to remain unchanged. The actual reduction in production costs is unlikely to have been of this magnitude, since there had been a reduction in prices of consumers’ goods and in costs as recently as March 1, 1949. Neither can it be assumed that the price reduction was effected solely by reducing turnover tax rates at unchanged costs of production. With unchanged costs, prices—of which 60 per cent was accounted for by turnover tax—could have been reduced by this means by 15 to 20 per cent only if it were possible to reduce turnover tax rates by 25 to 33 per cent. Such a reduction would have been either too burdensome for the state budget, or would have had to be associated with some new revenue-increasing measures, which would mean a major change in the financial system of the U.S.S.R., about which nothing has been heard. A change of this kind might be deduced if costs of production were to fall while “delivery prices” remain unchanged, the price reductions then being effected by cuts in the turnover tax rates. This would mean the legalization of extra profits in the form of increased profit mark-ups. The Soviet economic authorities, however, aim at the maintenance of rather low profit margins, to prevent managers of enterprises from relaxing their efforts to economize on expenses. (Actual costs in excess of delivery prices may cause an investigation into the work of the manager, followed by sanctions.) Since part of profits may also be used for investment in the enterprises where the profits originate, increases in profits would mean an expansion of decentralized investments with the eventual possibility of far-reaching changes in the planning system.

Actually, it seems probable that in the changes of March 1950 both techniques for reducing prices were used. Planned delivery prices were reduced and turnover tax rates cut. The application of these techniques means either an actual decrease in government revenue or an increase at a declining rate. According to the Soviet official statement, the recent cut in prices will reduce the 1950 expenditures of the population by 110 billion rubles; 80 billion will be saved through lower prices in state stores and 30 billion through price reductions on kolkhoz markets⁶ and in cooperative stores. This statement probably means that, if prices had remained unchanged (i.e., equal to those of 1949), the population of the U.S.S.R. would have spent in 1950 from their money incomes, increased according to plan, 110 billion rubles more than at the reduced price level. The 80 billion rubles “lost” by state stores would represent 18 per cent of the total revenue planned in the 1949 budget. Even on the assumption that the increase in the national income (at 1949 prices) for 1950 were 20 per cent, and that—if prices had remained at the 1949 level—the percentage increase for state revenue were the same as for the national income, the reduction in anticipated revenue that would be necessary if the price reduction had been only at the expense of current government proceeds would be so large as to be very unlikely. Any increase in the national income is usually divided between consumption and investment (the latter is financed mostly by the state budget) in such a way as to ensure a significant increase in investment, greater than the increase in consumption. The increase in the national income of 1950 would have to be very large if government revenues and, consequently, also investment were to increase significantly, in spite of a cut in the rate of increase in government revenues so severe that, if it had been applied in 1949, actual revenues would have fallen by almost one fifth.

This seems to suggest that the reduction in prices may have been made possible in part by a revision in workers’ efficiency rates, basic wage rates probably remaining unchanged. Sporadic revisions of this kind are possible in view of changes in methods of production (e.g., increases in capital equipment) which increase the efficiency of labor.

However, insofar as the reduction in retail prices was achieved through a cut in turnover tax, it was probably carried out at the expense not only of current budgetary revenues, but also of the revenues of the previous year (1949). Inventories were probably gradually accumulated before prices were reduced (which implies a relative reduction in government revenues during the period of accumulation and also a volume of production in excess of current sales to the public). The expansion in consumers’ demand in response to reduced prices may be satisfied by a gradual depletion of inventories until current production increases sufficiently. In view of these considerations, it seems possible that the reduction of prices may have been achieved without any significant reduction in the earnings of the population.

The relative importance, in practice, of these techniques for reducing prices cannot be evaluated. However, it may be assumed that the combined effect of increased national income and reduced prices will be an increase both in real per capita consumption (although probably not to the full extent of the price reduction) and in government revenue and investment.

The reduction of prices of consumers’ goods by various percentages (necessarily arbitrarily selected, although an analysis of the market certainly preceded this action) will cause shifts in demand. Further price adjustments, covering a wide range of goods, are therefore to be expected. The reduced prices, however, may have been set at such a level that the aggregate value of consumers’ goods available (after previously accumulated extra inventories have been sold) will for some time be smaller than the amount of money which consumers would be willing to spend on consumption goods during the same period. This would have effects similar to those of an inflation. In such a case, the necessity of adjusting prices to consumers’ preference scales (while the general price level remained unchanged) would be less strongly felt, since under inflationary conditions almost any combination of goods can be sold easily, even though relative prices are not correctly fixed.⁷

Price spread

As pointed out above, costs of production under the Soviet pricing system do not include rent or interest, and in industries producing capital goods they include only small profits (compared with those which would be considered as normal in capitalist countries). What is not included by state enterprises in the costs of production is collected by the state in the form of high turnover taxes on consumers’ goods. Turnover taxes are also a means by which the quantity of consumers’ goods which is demanded is made equal to the quantity supplied. The volume of output of consumers’ goods is set by the central planning authorities, and may be safely assumed to be smaller than would be produced if a fair degree of consumers’ sovereignty existed in the Soviet Union. Turnover taxes are therefore a means of collecting a significant part of state corporate savings, which correspond to investments decided by the planning authorities.

The result of this pricing system is a larger discrepancy than is usual in capitalist countries between the delivery prices of all goods—which roughly correspond to wholesale prices charged by producers in capitalist countries—and the retail prices of consumers’ goods. For example, for bread this discrepancy amounted before the war to about 75 per cent of the retail price, which is probably more than the difference between the producers’ price and the retail price in any capitalist country. In comparison with the situation in capitalist countries, there are, therefore, in the U.S.S.R. one group of goods which are relatively “cheap” and another which are relatively “expensive.” To the relatively “cheap” category belong all producers’ goods and consumers’ goods at delivery prices, while to the relatively “expensive” group belong all consumers’ goods at the retail stage of distribution. The difference between the price levels of these two groups of goods may be called the relative price spread or, more briefly, the price spread.

The relative price spread in the U.S.S.R., in comparison with, say, the United States, indicates the extent to which the difference in the Soviet Union between the wholesale (delivery price in the U.S.S.R. and wholesale factory price in the U. S.) and retail prices of representative baskets of goods and services is greater than in the United States. If prices of baskets of “cheap” goods in the United States and the U.S.S.R. are denominated “Aa” and “Ar,” respectively, and prices of “expensive” goods “Ba” and “Br,” the following formula may be used for measuring the relative price spread in percentage terms:

It is, however, always possible to assume a hypothetical exchange rate for the Soviet currency which will make Aa equal to Ar. The formula for the relative price spread then becomes

A comparison of the price situations in capitalist countries may also reveal the existence of relative price spreads there. Differences in taxation, in social insurance systems, and in customs duties, may create price spreads for various groups of goods and services, and restrictions on the mobility of factors of production and monopolies help to maintain these spreads.⁸ These spreads, together with the effects of differences in natural resources, may make one country “cheap” or “expensive,” depending on the groups of goods used for comparison, and thus affect the commodity composition of exports and imports. However, such price spreads as exist between capitalist countries are not nearly so extensive as in the U.S.S.R.

The formula suggested above cannot in practice be used to calculate the actual price spread in the U.S.S.R.—e.g., in comparison with the United States—since information on prices in the U.S.S.R. for the “A” group of goods is lacking, and on prices of the “B” group of goods is very limited. The price spread may, however, be estimated indirectly. The turnover tax content in the retail prices of consumers’ goods is known to have been 61 per cent in 1940 and to have been planned at 63 per cent for 1949. It may be assumed to amount to 60 per cent at present. The remaining 40 per cent represents delivery prices plus costs of distribution. If costs of distribution in the U.S.S.R. represent the same percentage of delivery or wholesale factory prices as in the United States, the price spread in the U.S.S.R. relative to the United States would correspond to the turnover tax content in the aggregate value of consumers’ goods. In fact, although the bureaucratic distribution apparatus of the U.S.S.R. works clumsily, the distribution costs in the Soviet Union may be relatively lower than in the United States, because profits of trading organizations are set very low. There are, moreover, in the United States, some price-increasing taxes which correspond to part of the 60 per cent turnover tax content in the Soviet prices of consumers’ goods. The relative price spread may therefore be assumed to be somewhat less than 60 per cent.

Under the conditions of a market economy, an estimate such as that made above would be fairly representative of the price spread for all goods of category “A.” But in the U.S.S.R. the price mechanism does not fulfill its traditional function; the allocation of factors of production between the industries producing capital goods and those producing consumers’ goods is not motivated by relative profitableness. It is, therefore, possible for the price spread for capital goods to differ significantly from that for consumers’ goods, and there seems to be convincing evidence that this is actually the case. Profits in industries producing capital goods are set at a much lower level than profits in industries producing consumers’ goods, the labor assigned to the former group of industries is generally better trained, and the machinery used there is more extensive and modern. Consequently, the price spread between capital goods and raw materials at the “delivery” stage and consumers’ goods at the retail stage may be larger than that between consumers’ goods at the “delivery” and the retail stages.

Exchange rate and the price spread

In order to interpret the real meaning of the ruble exchange rate in its relation to the Soviet price system, let the assumption first be made that the Soviet authorities make decisions concerning international transactions on the basis of existing domestic and foreign prices, as is done in free competitive economies.

In free competitive economies, the difference between wholesale and retail prices does not vary very much from country to country; in other words, any relative price spread that may exist cannot be of great significance. If an exchange rate is allowed to have its full effect upon foreign trade transactions (i.e., without direct or indirect premiums or surcharges), this in itself tends to limit the size of any price spreads. And, in turn, if price spreads are small, this facilitates the use of single exchange rates in economic relations with other countries. The relative price spread for the U.S.S.R., however, is large, and this has a direct bearing on the foreign value of the Soviet currency.

Soviet merchandise exports and imports are composed of goods of “A” price category. Even consumers’ goods are sold to export organizations at delivery prices. Therefore, if prices are to be used as a guide in the decisions of the Soviet foreign trade organizations, the exchange rate used in foreign trade transactions would have to conform to the “A” price level. A similar assumption applied to consumers’ goods and services sold to foreigners inside the U.S.S.R. would mean that the exchange rate applied to foreign travellers, businessmen, and diplomats should conform to the “B” price level. Because of the price spread discussed in the preceding section, these two exchange rates cannot be identical. As long as the present system of pricing is maintained in the U.S.S.R., and on the assumption that exchange rates should conform to domestic and foreign prices, there should therefore be two exchange rates for the ruble.

The realization that no single exchange rate can fully indicate the relationship between the values of the Soviet and other currencies is of great significance for many comparisons between Soviet and capitalist economic magnitudes. Economists sometimes use prices of consumers’ goods for estimating the proper exchange rates of various countries. Because there are no significant relative price spreads among those capitalist countries which do not have extensive economic controls, the exchange rate thus estimated may approximately represent the price relations of all goods in such countries. Such an exchange rate, however, would not be proper for an estimate of, for example, the dollar value of the budgetary investment appropriations in the Soviet Union. Estimates and analyses of the national income of the U.S.S.R. may also lead to erroneous conclusions if the peculiarity of the Soviet economic system discussed above is not taken into account.

On the assumption that the decisions of Soviet authorities concerning international transactions are based on existing domestic and foreign prices, and that there are generally favorable conditions for the development both of exports and of tourism, the existence of a single ruble exchange rate would result in smaller foreign exchange proceeds than if there were two exchange rates (or three, if the relative price spread between prices of capital goods and delivery prices of consumers’ goods is significant).

In fact, after July 1, 1950 there was to be only one exchange rate for the Soviet currency, 4 rubles to 1 U. S. dollar. Until June 30,1950, there were two exchange rates: one official, 4 rubles per U. S. dollar, which followed from a declared gold content of the ruble, and the other preferential, 6 rubles per U. S. dollar, which was called the “diplomatic” exchange rate. The existence of two exchange rates, however, did not necessarily mean that there was conformity between exchange rates and prices in the U.S.S.R. and abroad; nor did it prove that decisions concerning individual international transactions were based on prices in the U.S.S.R. and abroad. Even an approximate conformity between exchange rates and price levels in the U.S.S.R. and abroad could merely suggest, but not prove, that exchange rates were actually applied to Soviet individual international transactions. There was, in fact, no such conformity; and there is no conformity between the present single exchange rate of the ruble and the price levels of either “A” or “B” groups of goods. This will be shown in the last section of this paper. In the present section, only the problem of the conformity between exchange rates and prices in individual transactions will be discussed.

The relevance of the exchange rate

Foreign trade in the U.S.S.R. is a state monopoly. Its purpose, apart from the achievement of the highest possible prices for exports and the lowest possible prices for imports,⁹ is, as has been explicitly stated by those responsible for Soviet economic policy, to shield the domestic economy from external influences.

Foreign trade organizations buy in the domestic market goods destined (by the economic plan) for export, and sell imported commodities to Soviet enterprises at domestic delivery prices. (The prices of imported goods may be set more arbitrarily by import organizations, since in many cases they are very imperfect substitutes for goods produced domestically.) Export goods are sold and import goods bought by the trade organization at the prices prevailing in foreign markets. Prices in trade with other member countries of the Council of Mutual Economic Assistance¹⁰ deviate from world market prices because of adjustments for differences in transportation costs, etc. They are probably also influenced by the comparative bargaining powers of the parties to a trade agreement.

The ruble exchange rate is of no interest to Soviet domestic producers (i.e., those who sell goods destined for export to exporting organizations), to final purchasers of imported goods, or to foreign exporters and importers. Transactions between foreign exporters and importers and Soviet specialized foreign trade organizations are settled in foreign currencies (or in some abstract unit of value), and transactions between Soviet foreign trade organizations and Soviet suppliers or purchasers of exported or imported goods in rubles. No explicit exchange rate is used.

In view of the method of price formation in the U.S.S.R. and of the fact that domestic prices are “shielded” from outside influences, any resemblance between the price patterns in the U.S.S.R. and in other countries could be nothing more than a sheer coincidence. Therefore, if a uniform exchange rate were applied to foreign trade transactions, carried out according to a plan constructed independently of domestic prices, some exporting and importing enterprises would make extra profits while others would suffer losses. The exchange rates actually involved are, therefore, only implicit and necessarily multiple, and, in the management of the Soviet economy, are of no significance. The exchange rate is, in fact, irrelevant in foreign trade transactions. It in no way serves as a guide in making foreign trade decisions. If it were to be used for this purpose, it would have to be a price, which the ruble exchange rate is not.

The only use of the official exchange rate in the U.S.S.R. is to convert foreign exchange reserves into rubles in order to make them an item formally comparable with other items in the balance sheet of the State Bank. But since the official exchange rate does not represent an average value of the ruble (as will be shown in the next section), the ruble values of foreign exchange obtained in this way cannot serve any planning purpose. It is doubtful whether even an exchange rate which conformed to the “A” price level could serve a planning purpose, because the distortion of prices would mean that any shift in the commodity composition of exports or imports would cause changes in the value of the ruble.

A comparison of foreign trade balances expressed in terms of a foreign currency and in rubles may provide a limited substitute for the guidance functions of the exchange rate. U.S.S.R. foreign trade may be balanced in terms of rubles and at the same time unbalanced in terms of foreign exchange, or vice versa. A comparison of these balances might reveal fiscal ruble losses or profits. Where accounts are unbalanced in terms both of foreign exchange and of rubles, a formula may be devised for calculating the fiscal results of foreign trade transactions.

If there are to be neither gains nor losses, the following condition must be fulfilled: $\frac{\mathit{Ir}}{\mathit{Id}}=\frac{\mathit{Er}}{\mathit{Ed}}$; where “Ir,” “Er” are the ruble values of imports and exports, and “Id” and “Ed” the dollar values of imports and exports, respectively. This condition means that the average implicit exchange rate for imports is equal to that for exports. If it is not fulfilled, the difference between the actual ruble value of imports and the hypothetical dollar value which would give a zero fiscal profit, $\mathit{Ir}-\frac{\mathit{IdEr}}{\mathit{Ed}}$, or a similar difference computed for exports, $\frac{\mathit{IrEd}}{\mathit{Id}}-\mathit{Er}$, shows the range in terms of rubles of the fiscal profits or losses. If exports and imports in terms of dollars are equal, both formulae reduce to Ir—Er.

Such calculations may be applied for the purpose of choosing the goods to be exported or imported. In order to eliminate or diminish fiscal losses, or to obtain fiscal profits, the commodity composition of exports and imports should be set so as to maximize the implicit exchange rate of the ruble. In fact, however, shifts in the commodity composition of Soviet foreign trade are determined by the requirements of Soviet economic plans for production and consumption, and appear not to be influenced by any consideration of this kind.

While the official exchange rate of the ruble is irrelevant in foreign trade transactions, it is relevant in transactions with foreigners who purchase consumers’ goods and services inside the U.S.S.R. at retail prices and pay in rubles. The scope of transactions in which the exchange rate is relevant might be widened or narrowed. For example, it might be made relevant in payments for transit charges, if these had to be made in rubles according to domestic tariffs, or its relevance might be limited by organizing special stores for diplomats, where payments were required in foreign exchange. It is, however, difficult to imagine any practical policy which would completely eliminate the relevancy of the exchange rate.

Since the official ruble exchange rate is irrelevant for foreign trade purposes, i.e., in transactions in goods of “A” price category, but is relevant in transactions in goods of “B” price category, it should be expected to conform to the “B” price level.

Revaluation of the ruble

On February 28, the Council of Ministers of the U.S.S.R. announced the revaluation of the Soviet ruble and, as indicated above, a reduction of retail prices of important consumers’ goods, effective March 1, 1950. The value of the ruble used in accounts for foreign trade transactions was fixed at 0.222168 grams of fine gold, which corresponds to a price for fine gold of 4.5011 rubles per gram. The exchange rate of the ruble was accordingly changed from 5.30 to 4 rubles to the U.S. dollar, a revaluation of 32.5 per cent.¹¹ The preferential diplomatic exchange rate was changed from 8 to 6 rubles to the U.S. dollar, a revaluation of one third. As of July 1, 1950, the preferential diplomatic rate was abolished.

By tying the ruble to gold, the Soviet Government discontinued the practice established in 1937 of calculating exchange rates in terms of other currencies on a dollar basis: “In the event of further changes in the gold content of foreign currencies or in their exchange rates, the State Bank of the U.S.S.R. shall alter the foreign exchange rate of the ruble correspondingly.”¹²

The revaluation of the ruble was justified, according to the official statement, by three reductions of prices of consumers’ goods in the U.S.S.R. since the monetary reform of 1947, and by the increase of prices in Western countries.¹³ This “resulted in … strengthening of the ruble, increasing its purchasing power, so that it is now ¹⁴ higher than its official exchange rate.”¹⁵

“Internationalization” of the ruble

Since under the present price and foreign trade system of the U.S.S.R. the exchange rate of the ruble has been irrelevant for foreign trade transaction purposes, the opinion of the Soviet Government that the rate should conform to relative price levels, and its decision to change the rate, may suggest that the Soviet Government intends to give the ruble some new important functions in its foreign trade.

The Soviet Union has ceased, since 1949, to observe strictly the long-established rule of expressing foreign trade agreements in terms of foreign exchange, mostly in U.S. dollars. The values of goods to be exchanged were expressed in rubles in a few of the agreements concluded in 1949 with Eastern European countries. Also, after the ruble revaluation of February 28, 1950, Poland published her 1949 foreign trade statistics in terms of the new ruble, instead of in U.S. dollars, as had previously been customary. This development may seem to indicate that the U.S.S.R. intends, in its trade transactions, to replace the U.S. dollar with the ruble, and to create a ruble bloc in Eastern Europe, possibly with a multilateral system of settlement.

If the ruble were to replace the U.S. dollar in Eastern European trade, it would have to fulfill the same functions that are now performed by the dollar. (This would be a necessary but not a sufficient condition for the ruble to become an international currency.) At present the U.S. dollar is used by member countries of the Council of Mutual Economic Assistance in quoting prices and values in international trade and for reserve purposes. In fulfilling the first function, however, it expresses approximately world market prices, and not the prices actually prevailing in the U.S.S.R. and in other Eastern European countries. The importance of the dollar as an element in monetary reserves is very limited: trade under bilateral agreements is usually balanced, and temporary export surpluses represent an accumulation of “clearing dollars,” which can be converted into goods only within specified commodity lists at negotiated prices. The dollar performs a reserve function in the full sense only for the final export surpluses which, according to some agreements, must be paid in U.S. dollars. But even in this case, this function is performed only because dollars are convertible into goods in countries outside Eastern Europe and are therefore acceptable by any Eastern European country.

For the ruble to fulfill the functions at present performed by the U.S. dollar, it must be made acceptable in payments for final trade surpluses, and indeed if trade within the Eastern European countries is to be multilateralized, it must be made acceptable for that purpose to a larger extent than is the U.S. dollar at present in that area. This requirement might be satisfied in two ways.

First, the prices used for foreign trade purposes might still be world market prices, while Eastern European countries would be supplied with the amounts of rubles convertible into U.S. dollars (or any other Western currency) needed to cover their import surpluses in trade with the West, which for all practical purposes would be equivalent to the convertibility of rubles into gold. This solution, although it probably would contribute to the multilateralization of trade, would not in fact replace the U.S. dollar with the Soviet currency. The ruble supplied to Eastern European countries by the U.S.S.R. would not be the ruble circulating in the Soviet Union. As long as the valuation of goods exchanged was based on world market prices, it would in fact be only the U.S. dollar or some other currency, to which the name of ruble would be given while it was being used in Eastern Europe. Such a solution may be called a nominal substitution of the ruble for the U.S. dollar.

Alternatively—and this is the only way by which the Soviet currency could actually be made a substitute for the U.S. dollar in its economic functions—the ruble might be made directly convertible (within the conditions of the trade agreements) into goods at the delivery prices prevailing in the U.S.S.R. and in other member countries of the Council of Mutual Economic Assistance. This would mean that the ruble exchange rate would become relevant in foreign trade transactions, and would perform the function of guidance normal to an exchange rate. If this condition were fulfilled, the ruble would cease to be a purely domestic currency and, under favorable technical conditions, might come to be used in international transactions, not only inside the U.S.S.R. but also by other countries.

The new exchange rate and the price level

The March 1950 revaluation of the Soviet currency could be regarded as a preliminary step toward internationalization of the ruble, only if the exchange rate of 4 rubles to the U.S. dollar then established were to correspond approximately to the “A” price level in the U.S.S.R. Such an exchange rate would facilitate the changes in price patterns which are necessary if the exchange rate of the ruble is to perform guidance functions and become a relevant factor in international trade.

The lack of data on wholesale prices in the U.S.S.R. does not permit any precise estimate of the ruble exchange rate which would conform to the “A” price level in the U.S.S.R. and to general price levels in Western countries. On the basis of limited data on the prices of consumers’ goods, the exchange rate which corresponds to the purchasing power of the ruble, measured in terms of prices of “B” goods, may, however, be roughly estimated at about 25 rubles to the U.S. dollar. The value of the ruble measured by reference to the cost of living is greater because of the importance in the U.S.S.R. of relatively inexpensive services, e.g., rents, and may be estimated at about 20 rubles to the U.S. dollar. If the relative price spread in the U.S.S.R. amounts to 60 per cent, the average exchange rate based on “A” prices, calculated on the basis of the simplified formula, would be around 10 rubles to the U.S. dollar, with the rate appropriate for capital goods perhaps somewhat higher. On this hypothesis, the ruble seems, at the present exchange rate of 4 to the dollar, to be overvalued by about 150 per cent. If the price spread in the U.S.S.R. is assumed to have been estimated with sufficient accuracy, the present exchange rate is thus too high to represent even approximately the relation between average domestic Soviet prices of “A” goods and wholesale prices in Western countries.

It might be argued that the present ruble exchange rate has been established because it corresponds to the prices and exchange rates of the members of the Council of Mutual Economic Assistance, which account for about two thirds of the total “commercial” foreign trade¹⁶ of the U.S.S.R. If this were so, the currencies of the Eastern European countries, in relation to Western currencies, would also be overvalued by about as much as the ruble.

The exchange rates of at least three countries, Czechoslovakia, Hungary, and Poland, which account for the greater part of Eastern European trade with the U.S.S.R., probably correspond approximately to their “B” price levels, and in any case are not overvalued by 150 per cent. To ascertain how far the present ruble exchange rate corresponds to Eastern European prices and exchange rates, however, rates corresponding to “A” price levels should be compared. Since such exchange rates do not exist in these countries, the Soviet Government cannot have been motivated in its decision to revalue the ruble by a desire to adjust it to Eastern European exchange rates.

It may be concluded that, at the present exchange rate, the ruble is seriously overvalued in comparison with any currency of importance to the U.S.S.R., and that it does not represent even approximately the “A” price level purchasing power parity.

Conditions for relevance of the exchange rate

Even if the present ruble exchange rate corresponded approximately to the relation between “A” price levels in the U.S.S.R. and in Eastern European countries and wholesale price levels in Western countries, this would not be a sufficient condition for the internationalization of the ruble. A further condition would also have to be fulfilled: national exchange rates would have to be made relevant in international trade transactions. Only then, under favorable technical circumstances and arrangements, might the ruble become an international currency. This condition has not so far been fulfilled in the U.S.S.R. or in the Eastern European countries which are members of the Council of Mutual Economic Assistance.

If internationalization of the ruble is to be achieved on a world scale, Soviet domestic prices in foreign trade transactions would have to be adjusted to Western price patterns, in order to make them relevant for foreign trade transactions. Western price patterns could be influenced only insignificantly by the U.S.S.R., through changes in the volume or the commodity composition of its trade. The changes which would be necessary in Soviet domestic price patterns, and possibly also in its taxation system¹⁷ would, however, be far-reaching. That this would be the aim of the Soviet Government is improbable. It would involve radical changes in economic planning, and for that matter in the whole economic system of the U.S.S.R., and is in any event impossible on ideological grounds. The Soviet economic system and its technical methods of economic management are considered by the Soviet authorities to be superior to any other, and the conviction that the acceptance of external influences would impair the purity of socialist principles, as interpreted by the Communist Party, is deeply rooted in Soviet minds.

It might be argued, however, that internationalization of the ruble may be feasible if limited to the U.S.S.R. and other members of the Council of Mutual Economic Assistance (possibly including Eastern Germany and China). This, it might be maintained, is possible, since Eastern European prices could be adjusted to Soviet patterns by governmental administrative action. An Eastern European clearing union could then be created and a certain degree of multilateralization achieved.

Such a unification, however, would require the members of the Eastern European Clearing Union to have two different standards of value for foreign trade: one for partners in the Union and the other for the outside world. The first would be based on Union price patterns, the latter on the U.S. dollar and other Western currencies. It is doubtful whether such a system would represent any simplification, compared with the present one.

In any event, such unification would not be consistent with the present economic doctrine and management of the U.S.S.R. The system of pricing (as distinct from the price pattern which results from the pricing system) applied in the U.S.S.R. is regarded there as the ultimate perfection of economic calculus and is gradually being accepted by other Eastern European countries. Because of differences in basic economic facts, the price patterns which will emerge in Eastern European countries after the Soviet pricing methods have been introduced could, however, be similar to those in the U.S.S.R. only by accident. There are significant differences in the patterns of prices of labor. Therefore, if goods moving in intra-Eastern European trade were to be priced according to the Soviet price pattern, this could not be done by a thoroughgoing application of the Soviet pricing methods in other Eastern European countries. Either the Soviet price pattern or the Soviet pricing methods may be accepted by Eastern European countries. Both cannot be maintained at the same time. The fact that the Eastern European members of the Council of Mutual Economic Assistance are introducing the Soviet pricing methods seems to rule out the possibility, at least for the time being, of a unification of prices.

Therefore, of all the characteristics of an international currency, only the purely technical condition that the ruble shall be related to national currencies through exchange rates can be and is fulfilled. This in itself, without fulfillment of the condition that exchange rates shall be relevant, gives the ruble only the appearance of an international standard of value, and may satisfy only the requirements of prestige. Prices in trade agreements may be expressed in rubles, but these prices will either be agreed arbitrarily or will represent only translations from the prices of Western capitalist countries.

Since it can hardly be expected that the Soviet pricing methods will be changed in the foreseeable future, any spectacular moves of the U.S.S.R. affecting foreign trade and exchange, similar to the latest revaluation of the ruble, would at most mean only an approach to the nominal substitution of the ruble for the U.S. dollar. There is no doubt that the Soviet Union is gradually consolidating the economies of Eastern European members of the Council of Mutual Economic Assistance, and that foreign trade is one of the main instruments of this policy. But it seems evident that this will involve only a consolidation of planning, the pooling of commodities and specialization of production, and that currency considerations will play no active part in it.

Diplomatic exchange rate

Since under the present price patterns in the U.S.S.R. the exchange rate of the ruble must continue to be irrelevant, an improvement in the terms of trade of the U.S.S.R. in relation to Eastern European countries could not have been the aim of the revaluation of the ruble. The terms of trade were, however, improved in relation to all countries by the revaluation of the diplomatic exchange rate. The Soviet Government does not intend to increase its foreign exchange proceeds from tourists, diplomats, etc., and, therefore, could afford to revalue the diplomatic ruble, although it was already greatly overvalued. It is possible, however, that the demand for rubles at the diplomatic exchange rate is already so inelastic that this revaluation will in fact slightly increase total foreign exchange proceeds. At the same time, the revaluation of the ruble may decrease the expenditures of Soviet representatives in Eastern European countries and in Eastern Germany, and reduce the costs of all services bought by them in these countries, which are not covered by clearing trade agreements.

June 1950