Thayer Watkins
Silicon Valley
& Tornado Alley

Conflicts of Ideology and Decision-making
in the Soviet Union

Robert W. Campbell gives an excellent illustration of the way ideology can interfer with rational decision-making in economic matters. Electrical power can be generated in a number of different ways. Some ways such as by means of water power from dams use no fuel but require a huge initial capital investment. Other ways such as from steam power require less of an initial capital investment but need a constant stream of fuel. The rational way to choose among the various generating methods is to compare overall costs. The relative costs of hydroelectric power versus steam power generating plants will depend upon the relative costs of fuel and capital. The cost of capital investment include depreciation costs and the interest costs, which represent the opportunity costs of having capital committed to use versus the alternative uses. The interest cost depends upon the market interest rates. All of this seems so obvious that there would be not seem to be any problem in making a rational choice about how to generate power.

In the Soviet Union interest was considered an artifact of capitalism and therefore should not enter into decisions in a socialist state. If no interest could be charged as a cost then the hydroelectric dams were always considered to be less costly than steam power plants. Therefore in the 1930's and 1940's the Soviet Union only built hydroelectric power dams and this used up a major share of the available capital. But the Soviet Union had many needs requiring capital and thus capital was scarce and had great opportunity costs.

By the 1950's Soviet planners recognized that they could have created their power generation capacity with a far lower investment in steam generating plants. At that point they modified their investment rule to the criterion of a payback period. Thereafter investment projects would only be undertaken if they paid back their investment within a specified period. This indirectly took into account the time-value of capital. For example, if investment projects had to return their investment within ten years it was roughly the same as requiring a project to have a rate of return of ten percent and thus equivalent to charging an interest cost of ten percent. But in their calculation the planners did not have to calculate an interest cost when using the payback period criterion so this method was ideologically acceptable.

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