Thayer Watkins
Silicon Valley
& Tornado Alley

An Example of the Misallocation of Capital
in the Soviet Union

Under Josef Stalin's system the Soviet Union carried out innumerable programs which involved brutal treatment of human beings. There were two major projects carried out in the 1930's that were carried out in the Soviet Union, which viewed together, illustrate a tragic misallocation of capital. Both were offshoots of Stalin's collectivization of agriculture.

In the early 1930's Stalin forced the collectivization of farming. The rhetoric spoke of improved efficiencies and economies of scale but there never was any evidence of improved efficiency of collective farming compared to private farming. The impetous for collectivization was to achieve central control of agriculture. Stalin did not want a repetition of what had occurred in 1921. Under the czars Russian farmers were required to sell their grain crop to the state at fixed ruble prices. Since the market price was higher than the price paid by the government this was a form of disguised taxation. When the Bolsheviks (communists) gained control of the government in their coup d'etat of October 1917 they had little in the way of funds to run the government. They resorted to printing up money and some talked of the printing press as functioning like a machine gun that would destroy capitalism. The inflation of the money supply led to the inflation of prices. An economy can function without much difficulty under inflation if all prices are increased proportionally. The problems of inflation come when there are some prices which are fixed, such as pensions or, in the case of Russia in 1917-1921, the prices set for the purchase of grain from the farmers. Under the Bolshevik-created inflation the prices the farmers were to receive for their grain fell in value to virtually zero. In effect, the Russian farmers were being required to give their grain to the state. Had the Bolsheviks adjusted the purchase price for inflation there would not have been such an extreme problem, but they did not. Understandably the Russian farmers were reluctant to give up their hard-won production and get nothing in return. The flow of grain from the countryside to the cities diminished. What the authorities did to increase the flow of grain to the cities was to send squads of soldiers to the farms to confiscate the the harvest of grains. Stalin was at that time a strong advocate of the use of terror to make the farmers comply with the wishes of the government; he, at that time, had not gained the control he achieved in the middle 1920's. The soldiers were told to leave the farmers enough grain for the farm family's consumption and enough to plant for the next season. After a couple years of this policy many farmers were not growing any more grain than what they needed for their own consumption. As a result of the diminished grain production a famine developed in 1920-1921.

Although some of the Bolsheviks like Stalin thought the solution to the problem was more control of the farmers, Vladimir Lenin was more realistic. He looked at the incidents of rebellion against the government and recognized that Bolshevik control would not survive unless the food supply was increased. He then announced his New Economic Program (NEP), which was none other than a return to capitalism in agriculture and small industry. Lenin kept control of the large scale industries and the transport system, what he called the Commanding Heights of the economy. The NEP did work. Within a few years private agriculture was producing at record levels. But Stalin never forgot that the drive to socialism was sent on a detour because of the unwillingness of the Russian peasants to comply with the Bolsheviks wishes. When Lenin died in 1924 Stalin wrested power away from Leon Trotsky and emerged in 1928 as the unchallengeable ruler of the Soviet Union.

The general public has the notion that the economic structure of the Soviet Union somehow derived from Karl Marx, but Marx wrote virtually nothing about how socialism would work. He devoted his attention to the historical development of feudalism and capitalism, two words which he invented. Lenin dictated the political structure but it was Stalin who created the economic model for the Soviet Union. The concept of economic development through five-year plans was the heart of the Stalin system. When the system of five-year plans was initiated in the late 1920's Stalin was concerned with the danger that the Russian farmers would derail the program as they had in 1921.

Stalin ordered that the peasants be induced to pool their land, livestock and tools into collective farms. The creation of a collective was supposed to have the semblance of a voluntary decision, but the pressures were so extreme that it took incredible resolve for a farmer not to join. Those that did cave into the pressures still showed their dissatisfaction with the collectivization by butchering their livestock and eating them rather than turning them over to the collective farm. Through out Russia this mass slaughter took place in the days before the collectivization was to become effective. And it was not just the livestock that were destined for market that was slaughtered; the draft animals were slaughtered as well. Consequently the collective farms came into existence with a serious shortage of horses to pull the plows, cultivators and wagons needed to plant and harvest grain.

Their were some farmers who did manage to resist the collectivization. They were usually the more productive farmers and they often were the farmers who made loans to other farmers. They were called kulaks from the Russian word for fist. The term had the connotation of tight fisted. The farmers who resisted collectivization were simply arrested and designated as enemies of the state. Their families were left destitute and the other farm families were afraid if they helped them, they too would be branded as enemies of the state. The kulaks were collected into prison camps pending decisions on the part of the central authorities about what to do with them.

In Moscow the central authorities made two decisions. The shortage of horse-power on the collective farms would be remedied by manufacturing tractors. The second decision was that the kulaks would not be executed outright but would instead be executed by working them to death in state projects where it was hard to get workers to go voluntarily.

One of the state projects was to build a canal connecting the Baltic Sea with the White Sea on the Arctic Ocean. Most of that canal would utilize natural channels of rivers and lakes, but some sections required clearing forested areas and digging a canal. So about a hundred thousand kulak prisoners were shipped to northwestern Russia to build the Baltic-White Sea Canal. This work force had practically nothing in the way of tools to work with, but they had to start clearing the canal route of trees. They did not have axes and saws.

How can trees be taken down without axes and saws to cut them? The method used initially was to position hordes of prisoners around a tree and, through pushing and pulling with ropes, rock the tree enough to break it loose and topple it over. This was obviously inefficient and dangerous. A little bit of capital in the way of axes and saws would have been highly productive.

Back in Moscow the authorities were wrestling with the problem of how to build a tractor factory. In Michigan, Henry Ford had just built a state-of-the-art tractor factory with his signature assembly line methods of production. In the U.s. such capital-intensive methods of production made economic sense because in the U.S. labor was relatively expensive and capital relatively cheap. In the Soviet Union the situation was reversed; labor was relatively cheap and capital relatively expensive.

Ignoring the economic differences between the U.S. and the Soviet Union the authorities in Moscow decided that they wanted the same state-of-the-art tractor factory that Henry Ford had built. Stalin sent representives to Michigan to offer Ford a huge amount of gold to build a tractor factory for the Soviet Union. Ford accepted the offer. It should be noted that at the time the outside world was not aware of the evils that Stalin was perpetrating in the Soviet Union. Even Time magazine gave a guardedly favorable treatment of Stalin and his five-year plans acknowledging that such programs might be the wave of the future for all countries.

Henry Ford wisely chose not to try to build the factory from scratch on-site in Russia with its problems of shortages of materials and skills. Instead he built an exact duplicate of his Michigan plant at another site in Michigan. Once that factory was built and operational he had it disassembled and shipped to south Russia where is was re-assembled. So Stalin got his tractor factory but at great cost in terms of the capital that the Soviet Union had to work with. It was a capital-intensive plant in a country that was desparately short of capital. One project that was desparately short of capital in the form of simple tools was the project building the Baltic-White Sea Canal. The allocation of capital between the tractor factory and canal-building project was a tragic misallocation of capital.

About three hundred thousand prisoners died building the canal. Years after its construction Alexandr Solzhenitsin viewed its operation. While he was viewing it two ships were in view. One ship was traveling south with the same type of cargo as the ship that was traveling north. Solzhenitsin noted that two ships were canceling out the effects of each other. A more rational system would have avoided the wasteful cross hauling and distributed their cargoes untransported.

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