Potemkin America - illusionary prosperity a la the USSR

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Niccolo and Donkey
Potemkin America

The American Conservative

Paul Craig Roberts

February 2, 2011

In 1961 I was a member of the student exchange program to the Soviet Union. It was the second year of the exchange and part of a diplomatic effort to achieve some thaw in the Cold War.

There were three groups of us totaling approximately 35 American students. The Soviet authorities were not comfortable with us hanging out with Russian students, so we were kept constantly on the move. Consequently, we saw a lot of the communist country and its empire.

My group went in through Yugoslavia and Romania, spent time in Moscow, Leningrad, Kiev, Tashkent, Samarkand, and a Soviet sports camp on the Black Sea in Georgia, and came out via Poland and East Germany during the construction of the Berlin Wall. We were in the Caucasus mountains when Yuri Gagarin made the first spaceflight, a propaganda success for the Soviet Union.

What was most striking about the Soviet Union was that, except for the sparkling clean Moscow subway with its gleaming marble floors and walls and some beautiful old buildings built by the czars, there was nothing there. There was no traffic on Moscow’s boulevards. The small food stores were empty. The department store, GUM, had nothing to sell us for our fistfuls of rubles we had been paid for our Levi jeans, button-down shirts, and penny loafers, clothes literally bought off our backs on the streets.

I remember being on a bus in Tashkent when a meat delivery truck appeared. The carcass was hanging on a rail in the open air. The few vehicles on the street were following the delivery truck. The bus driver deviated from his route to follow the delivery.

Bus passengers came alive with anti-cipation. People began coming out from shops and office buildings. By the time the truck arrived at the small butcher’s shop, a long line had formed.

In the Soviet Union people kept a sharp eye out for deliveries of any kind. People would line up to purchase whatever was available as it could be bartered to obtain other goods. As goods of all kinds were scarce, money was not an effective medium of exchange.

My time with the Soviets made me immune to the exaggerated claims made for Soviet economic performance. During my years in graduate school, it was taken for granted that central economic planning enabled the Soviet economy to continuously generate growth rates that were very high compared to those of market economies. In 1962, G. Warren Nutter’s study, Growth of Industrial Production in the Soviet Union , was published by Princeton University Press for the National Bureau of Economic Research. Nutter concluded that the official index of Soviet industrial output exaggerated Soviet growth, and that Soviet growth was not remarkable compared to that of the United States in similar stages of development. Nutter’s conclusions provoked much controversy, and he had few defenders at the time.

Even as late as the 1980s, the view still prevailed in the CIA that the Soviet Union could triumph in an arms race because central control over investment meant that the Soviets could cause their economy to grow at whatever rate it took to counter an American arms buildup. When the Soviet economy collapsed, the CIA arranged for me to explain to the agency’s analysts why they had been mistaken about their enemy’s capabilities.

The Soviet economy failed because it used more valuable inputs to produce less valuable outputs. The outputs would be measured as statistical product, but the values of the outputs were less than the values of the inputs. In other words, instead of producing value, the Soviet system was destroying value.

This was the result of ideological aversion to using prices and profits to allocate resources and investments. Instead of profit serving as a manager’s success indicator, managers were judged according to whether they fulfilled a plan measured in gross physical output, such as weight, number, square meters.

For example, the success indicator for the construction industry was the number of projects under construction. Consequently, Moscow was littered with unfinished projects because all activity was concentrated in starting new ones. The plan produced a housing shortage because the incentive was to start new constructions not to complete ones already underway.

If a shoe factory’s gross output indicator was a specified number of pairs of shoes, there would be plenty of baby shoes, but none for large feet, because the same amount of material could be used to produce one large pair or several small pairs.

If nails were specified in number, there would be small nails but no large ones. If specified in terms of weight, there would be assortments weighted heavily with large sizes. A famous Soviet cartoon shows the manager of a nail factory being awarded Hero of the Soviet Union for over-fulfilling his quota. In the factory yard are two giant cranes holding one giant nail.

If light fixtures were specified in number, they would be small. If in weight, they would be heavy. Nikita Khrushchev complained of chandeliers so heavy that “they pull the ceilings down on our heads.”

An abundance of natural resources with low extraction costs and the minimal allocation of resources to consumer needs permitted the Soviet economy to continue despite its enormous waste of resources in terms of consumer satisfaction and economic efficiency. But it couldn’t go on forever.

In contrast, the U.S. economy during the 1960s was efficient. Prices and profits were the signals that allocated resources and investments. As the goods and services produced by American firms for American consumers were made by American labor, the profits made by corporations were indications that the economy was serving consumer welfare. American real wages and living standards were rising with the productivity of the economy.

During the 1970s, worsening trade-offs developed between inflation and employment, raising the specter of stagflation. However, this proved to be a problem with economic policy, not a problem inherent in the capitalist economy. Keynesian macroeconomic policy had stimulated demand with easy money but restricted the response of output with high tax rates. Supply-side economists corrected this problem by reversing the policy mix: tighter monetary policy and lower tax rates. Consequently, the U.S. economy resumed economic growth without having to pay for it with rising inflation.

Ironically, when the Soviet Union collapsed in 1991, the consequence was to initiate ruin within the U.S. economy. “The end of history” caused Chinese communists and Indian socialists to join the winning side and to open their economies to First World capital. For the first time, American corporations had access to massive supplies of unemployed low-wage labor. The huge excess supply of labor in India and China meant that workers could be hired at wages far below their productivity, and the difference would flow in profits to executives, shareholders, and Wall Street.

The offshoring of American manufacturing separated Americans’ incomes from the production of the goods and services that they consumed. The advent of the high speed Internet made it possible to offshore professional service jobs, such as software engineering, which drove down the returns to a college education and the employment prospects of graduates. In an offshored economy, the profits of corporations are not a measure of the economic welfare of the population.

As American incomes stagnated—except for the rich, there has been no real increase in 20 years—the economy was kept going by the growth of consumer debt to take the place of the missing growth in take-home pay. Federal Reserve Chairman Alan Greenspan’s low-interest-rate policy fueled a real estate boom and drove home prices to new highs, permitting Americans to refinance their mortgages and to spend the equity. Anyone could obtain credit cards, and many Americans maxed out several.

By the 21st century, the U.S. economy was a Potemkin economy just as the Soviet economy had been. Rising consumer indebtedness had taken the place of income growth and had reached unsustainable levels just as the greed of the unregulated financial sector leveraged debt to irresponsible levels and caused a financial crisis that still threatens the Western world.

Traditional economic policy—low interest rates and large budget deficits—cannot put Americans back to work when the jobs have been sent overseas. The low interest rates deprive retirees and those living on their savings of interest income, thus further suppressing consumer demand. The massive deficits drive down the dollar’s value and threaten its role as world reserve currency. As the U.S. is an import-dependent country, a weaker dollar further suppresses consumer purchasing power.

In addition, the bailouts of the banks and the monetization of the federal deficit by the Federal Reserve, known as quantitative easing, suppress consumer incomes while threatening consumers with inflation and reductions in benefits, such as Social Security and Medicare, and cuts in income-support programs.

The Potemkin American economy pretends that it can afford trillion-dollar wars, trillion-dollar military budgets, and trillion-dollar bailouts despite having sent much of its tax base offshore and undermining the dollar and creditworthiness of the U.S. Treasury.

Amidst high and intractable unemployment, President Obama’s Deficit Commission finds the solution in squeezing the American people harder so that the rich are not deterred by taxes from monopolizing every dollar of wealth growth. Social Security recipients have been selected to pay for the wars and the bailouts by having the retirement age raised and benefits reduced. To spread the misery, commissioner Alice Rivlin wants a 6.5 percent national sales tax, which, if enacted, would further reduce consumer spending during the worst downturn since the Great Depression.

In the USSR, a defunct ideology prevented the Soviets from saving themselves by using price and profit signals, instead of gross output indicators, to organize their economy. In the United States, politically powerful interest groups, such as Wall Street and the military-industrial complex that President Eisenhower warned us about, prevent the measures that would rejuvenate the consumer economy by bringing the offshored jobs home and reduce the deficit by ending the counter-productive wars.

The advantage to corporations and the financial sector of cheap foreign labor can be offset by taxing corporations according to where value is added to their product: a low tax rate if value is added with American labor and a high tax rate if value is added with foreign labor. This simple change would bring jobs back to Americans, rebuild the ladders of upward mobility that made the U.S. an opportunity society, restore the tax bases of cities, states, and the federal government, and reduce the trade deficit by the amount of the goods and services that are produced offshore by U.S. firms for U.S. markets.

Yet just as the Soviet communist bosses held on to power to the point of their self-destruction, the American oligarchies will squeeze the U.S. economy to its death. Is President Obama’s failure to bring any change yet another indication that change in America will only follow catastrophe?
In other words, they didn't have a profit/loss system, so it was never clear whether a process destroyed market value or created market value.

Bearing in mind that point about profit, I wonder which firms in America today are posting high profits. It wouldn't be all that bad news if it is companies that export or companies that build physical, productive capital.

President Camacho
Great article. This part is key:
All that "offshoring" or "outsourcing" does is eliminate the middle class, the backbone of the economy, increasing unemployment and making the wealth pyramid steeper.
Of course the GDP numbers as usual do not tell the full story of how destructive this practice is.

Say a corporation is making profits of $10 million one year with 300 American workers employed in a certain sector making an average of $40,000 per year. If all of those workers are fired, and coolies from India hired in their stead for pennies on the dollar, the company might now see profits of $20 million. This is "economic growth" in today's jargon, even though it only improves corporate profits and executive salaries at the expense of everyone else in the economy.

This is also a very good and simple remedy for much of our problems:
In marxist system, the whole idea of value was different. The value of a product was estimated according to the resource input and the amount of labor used, not according to the demand, as it is understood to be norm today since Ricardo, I think.

And it would all be good and well, if only the author actually knew what he was talking about. Since at least Kosygin's reforms under Khruschchev in 1967, the situation in Soviet economics underwent a radical change - from then on, the role of enterprises (collective farms, factories) increased with more autonomy granted, and the main measurement of effectiveness was not only about units/square meters/ etc. - that was true only for several crucial industries, but about profitability, understood as.

Pr - profitability ratio (in percent)
P - annual profits
Mf - average annual cost of main production facilities
PCr - average annual cost of production cycle resources

Yes, it was pretty much the same as in capitalist countries, with main difference being, where the idea of cost was derived from. Since a lot if not most resources and funds in this estimation were home produced andestimated in rubles, and prices for Mf, PCr and the purchasing power of the population also set in rubles, as a result it was not the free flow of capital, but directive orders from top economic planning authorities, that set prices and salaries for all goods/jobs to a certain level to ensure a certain level of convertability of one into the other (so that, say, an average dock worker salary could afford to buy 1 tonne of bread, 2 units of standard clothes, etc. per year).

As for the 'small nails', 'big shoes', nonsense, since Kosygin reforms, factories were given the right to decide upon the amount of type of goods of each type (big shoes, small shoes, average shoes) to produce themselves, without burdening central authorities with microplanning, as long as factories lived up to the required indicators of profitability and profits.

The biggest issue in this line of thought though, as one can see, is that resources don't have any value of their own . Neither land occupied, nor resources have any value of their own outside of production cycles. The prices for coal depended solely on the needs of other industries actually using that coal and the amount and cost of man-hours invested, which is a travesty, impossible in a world, where resources are limited, i.e. our world.

Informative post, Theo. Thanks for that.

That's spot-on.

You might find this interesting:


The USSR wasn't a "pure" socialist system, but you would be able to see from Mises' work that he was at worst, mostly right.

IT Wizard,

I'm a big fan of Mises and of course, familiar with his general argument about economic impossibility of socialism, but thanks all the same. This stuff is always worth rereading.


the problem is, most of these companies would simply abandon US head office and rebase to India/ China etc. They really don't need even to be US companies at this point, they can simply move their business to India or China. What's to be won? Unless you are also planning to set up huge tariffs against anything and everything coming from across the ocean, as well as up and down the borders (and do expect a similar courtesy from all trading partners), I see little to gain by forcing business out of the country.

Right now, you lose working places, but you retain money flow. By resorting to this kind of policy, you'll lose both.
The federal corporate tax rate for earnings within America is 5%. Earnings abroad is 35%.

The mercantilists would argue that the latter number needs to increase to promote more employment within the US. Someone with a half-decent understanding of economics would realize that there is a tradeoff, and the company might do exactly as you suggested.
President Camacho
Take a US company like General Motors, which increasingly employs overseas coolie labor to assemble smaller components and even full vehicles. [Assume that the union is straightened out and incompetent management liquidated, and GM reverts back to a competitive company in the following scenario]

If GM says "fuck America" and moves ALL operations (including R&D & labor) to India or China, the labor-tax would hit them even harder because the percentage of foreign employees would increase (this is assuming the Chinese gov't allows such an intrusion, for example-- they're not free-marketeers either). This would effectively abandon sales in the American auto market, driving them bankrupt.

If GM moves headquarters overseas as a sort of "shell" but retain most of their workforce in the United States-- well, what's wrong with that? Americans would still be employed, and the nation would be producing valuable, tradeable goods. What benefit would there be to moving the managerial elite to China anyway? They'd just be taxed more for that share of executive labor and be more disconnected from operations.

Management are all internationalists anyway; it doesn't matter where headquarters are located. From a national standpoint what matters is economic leverage, which is gained by productive capacity in goods. Services will intrinsically develop a considerable presence in any advanced economy , but glorifying an all-service economy is utopian and insane. It also produces a dangerous situation where the the proletariat no longer have reliable labor opportunities. The "financial services" industry was making a staggering 1/3 of all economic profits in the United States at the height of the bubble in 2005. House of cards.

One note: tariffs/labor-tax policies don't have to be be applied like a bludgeon, imposing uniform conditions on all industries and all trading partners. A competent government can select favorites for political ends, it can discriminate more harshly against perceived enemies, and it can subsidize "winning" industries with the potential for growth and power while ignoring industries of tertiary national concern. State policy should shape the interests of corporations, not the other way around as in democracy.