epidemic during the Brezhnev era. Compounding this was the cold war,
whose pressure was greatly increased by America's huge arms buildup under
President Reagan. Not only was the Soviet Union's grip on its satellites
slipping, but also it was having trouble feeding its population: only by importing
millions of tons of grain from the West was it able to keep bread
on the shelves. Inflation, Abalkin's immediate concern, was indeed out of
control—I'd seen with my own eyes long lines outside jewelry stores, where
customers desperate to convert rubles into goods with lasting value reportedly
were being restricted to one purchase per visit.
Gorbachev, of course, was moving as rapidly as he could to liberalize
the system and reverse the decay. The general secretary of the Communist
Party of the Soviet Union struck me as an extraordinarily intelligent and
open man, but he was of two minds. Intelligence and openness were his
problems, in a way. They made it impossible for him to ignore the contradictions
and lies the system presented him with day in and day out. Though
he'd grown up under Stalin and Khrushchev, he could see that his country
was stagnating and why, which unraveled his indoctrination.
The big mystery to me was why Yuri Andropov, the hard-liner who preceded
Gorbachev, had brought him forward. Gorbachev didn't bring down
the Soviet Union purposely, yet he did not raise his hand to prevent its dissolution.
Unlike his predecessors, he did not send troops into East Germany
or Poland when they moved toward democracy. And Gorbachev was calling
for his country to become a major player in world trade; without question
he understood this was implicitly procapitalist, even if he didn't understand
the mechanics of stock markets or other Western economic systems.
My visit dovetailed with Washington's growing effort to encourage
reform-minded Soviets under Gorbachev's openness policy, glasnost. As soon
as the KGB allowed people to attend evening gatherings, for instance, the
U.S. embassy instituted a series of seminars at which historians, economists,
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and scientists could attend lectures by their Western counterparts on previously
forbidden subjects such as black markets, ecological problems in the
southern republics, and the history of the Stalin era.
A large part of my itinerary consisted of meetings with high officials.
Each surprised me in some way. While I'd studied free-market economics
for much of my life, encountering the alternative and seeing it in crisis
forced me to think more deeply than I ever had before about the fundamentals
of capitalism and how it differed from a centrally planned system.
My first inkling of this difference had come during the drive into Moscow
from the airport. In a field beside the roadway, I'd spotted a 1920s steam
tractor, a clattering, unwieldy machine with great metal wheels. "Why do
you suppose they still use that?" I asked the security man who was with me
in the car. "I don't know," he said. "Because it still works?" Like the 1957
Chevrolets on the streets of Havana, it embodied a key difference between
a centrally planned society and a capitalist one: here there was no creative
destruction, no impetus to build better tools.
No wonder centrally planned economic systems have great difficulty in
raising standards of living and creating wealth. Production and distribution
are determined by specific instructions from the planning agencies to the
factories, indicating from whom and in what quantities they should receive
raw materials and services, what they should produce, and to whom they
should distribute their output. The workforce is assumed to be fully employed,
and wages are predetermined. Missing is the ultimate consumer,
who in a centrally planned economy is assumed to passively accept the
goods planning agencies order produced. Even in the USSR, consumers
didn't behave that way. Without an effective market to coordinate supply
with consumer demand, the consequences are typically huge surpluses of
goods that no one wants, and huge shortages of products that people do
want but that are not produced in adequate quantities. The shortages lead
to rationing, or to its famous Moscow equivalent—the endless waiting in
line at stores. (Soviet reformer Yegor Gaidar, reflecting on the power of being
a dispenser of scarce goods, later said, "To be a seller in a department
store was the same as being a millionaire in Silicon Valley. It was status, it
was influence, it was respect.")
The Soviets had staked their entire nation on the premise that central
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THE AGE OF TURBULENCE
planning, rather than open competition and free markets, is the way to
achieve the common good. Contemplating this made me eager to meet
Stepan Sitaryan, the right-hand man of the chief of Gosplan, the state planning
committee. The Soviet Union had a bureaucracy for everything, and
the key ones had names beginning with gos, or state. Gosnab allocated raw
materials and supplies to industry, Gostrud set wages and work rules, Goskomtsen
set prices. At the pinnacle sat Gosplan—which, as one analyst
memorably put it, dictated "the type, quantity, and price of every commodity
produced at every single factory and plant across 11 time zones." Gosplan's
vast empire included military factories, which had access to the best
labor and the best materials and were universally regarded as the USSR's
finest.* In total, Western analysts estimated, the agency controlled between
60 percent and 80 percent of the nation's GDP. And Sitaryan and his boss,
Yuri Maslyukov, were the officials at the controls.
A diminutive man with a white pompadour and a good command of
English, Sitaryan turned me over to a senior Gosplan aide who trotted out
elaborate input-output matrices, the mathematics of which would have
dazzled even Wassily Leontief, the Russian-born Harvard economist who
pioneered them. Leontief's notion was that you could precisely characterize
any economy by mapping the flow of materials and labor through it.
Done thoroughly, your model would be the ideal instrument panel. Theoretically
it would let you anticipate every impact on every segment of the
economy from the change of one output, such as the production of
tractors—or, more to the point in the Reagan era, a major increase in military
production to respond to the U.S. arms buildup for the "Star Wars"
missile defense. But Western economists generally considered input-output
matrices to be of limited use because they failed to capture the dynamism
of an economy—in the real world, the relationships between inputs and
outputs almost invariably shift faster than they can be estimated.
Gosplan's input-output model had been elaborated to Ptolemaic perfection.
But judging by the top aide's remarks, I couldn't see that any of the
*Indeed, the USSR's supposedly passive consumers flocked whenever possible to acquire the
superior household goods produced by military factories. These consumers were as sophisticated
as any in the West.
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TH E FALL OF TH E WALL
limitations had been solved. So I asked how the model took into account
dynamic change. He just shrugged and changed the subject. Our meeting
obliged him to keep up the pretext that planners can set production schedules
and manage a vast economy more efficiently than free markets can do.
I suspected that the aide didn't actually believe that, but I couldn't tell
whether what he really felt was cynicism or doubt.
One might think that smart planning authorities should have been able
to adjust to their models' shortcomings. People like Sitaryan are smart, and
they tried. But they took too much on themselves. Without the immediate
signals of price changes that make capitalist markets work, how was anyone
to know how much of each product to manufacture? Without the help of
a market pricing mechanism, Soviet economic planning had no effective
feedback to guide it. Just as important, the planners did not have the signals
of finance to adjust the allocation of savings to real productive investments
that accommodated the population's shifting needs and tastes.
Years before becoming Fed chairman, I'd actually tried picturing myself
in the central planner's job. From 1983 to 1985,1 served under Reagan
on the President's Foreign Intelligence Advisory Board (PFIAB), where I
was asked to review U.S. assessments of the Soviet ability to absorb the
strain of accelerated armament. The stakes were enormous: The president's
Star Wars strategy rested on the assumption that the Soviet economy was
no match for ours. Ramp up the arms race, the thinking went, and the Soviets
would collapse trying to keep up, or they'd ask to negotiate; in either
case, we'd hold out our hands and the cold war would end.
The assignment was clearly too important to turn down, but it daunted
me. It would be a Herculean task to learn the ins and outs of a production
and distribution system so different from ours. Once I dug into the project,
though, it took me only a week to conclude that it was impossible: there
was no reliable way to assess their economy. Gosplan's data were rotten—
Soviet managers up and down the line had every incentive to exaggerate
their factories' output and pad their payrolls. Worse, there were large internal
inconsistencies in their data that I couldn't reconcile and I suspected
neither could Gosplan. I reported to the PFIAB and the president that
I couldn't forecast whether the challenge from Star Wars would overload
the Soviet economy—and I was fairly certain the Soviets couldn't either.
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THE AGE OF TURBULENCE
As it turned out, of course, the Soviets didn't try to match Star Wars—
Gorbachev came to power and launched his reforms instead.
I mentioned none of this to the Gosplan officials. But I was glad I
wasn't in Sitaryan's shoes—the Fed's job was challenging, but Gosplan's
was surreal.
Meeting with the head of the Soviet central bank, Viktor Gerashchenko,
was much less fraught. Officially he was my counterpart, but in a planned
economy, in which the state decides who gets funds and who does not,
banking plays a much smaller role than in the West: Gosbank was little
more than a paymaster and record keeper. If a borrower fell behind in payments
on a loan or went into default, so what? Loans were essentially transfers
among entities all owned by the state. Bankers did not need to worry
about credit standards, or interest rate risks, or market value changes—the
financial signals that determine who gets credit, and who does not, and
hence who produces what, and sells to whom, in a market economy. All the
topics I'd talked about the previous evening were simply not part of Gosbank's
world.
Gerashchenko was forthcoming and friendly—he insisted we call each
other Viktor and Alan. He spoke excellent English, having spent several
years running a Soviet-owned bank in London, and he understood what
Western banking was about. Like many people, he made believe that the
Soviet Union was not that far behind the United States. He sought me out,
and sought out other bankers in the West, because he wanted to be part of
the prestigious central banking establishment. To me he seemed totally benign,
and we had a pleasant talk.
J
J
ust four weeks later, on November 9, 1989, the Berlin Wall came down.
I was in Texas on Fed business, but like everybody else that night I was
glued to the TV. The event itself was remarkable, but even more amazing
to me in the following days was the economic ruin the fall of the wall exposed.
One of the most fateful debates of the twentieth century had been
the question of how much government control is best for the common
good. After World War II, the European democracies all moved toward so
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TH E FALL OF TH E WALL
cialism, and the balance was tilted toward central government control even
in America—the entire war effort by American industry had been effectively
centrally planned.
That was the economic backdrop of the cold war. In essence, it turned
out to be a contest not just between ideologies but between two great
theories of economic organization: free-market economies versus centrally
planned ones. And for the past forty years, they'd seemed almost evenly
matched. There was a general belief that even though the Soviet Union and
its allies were laggards economically they were catching up to the wasteful
market economies of the West.
Controlled experiments almost never happen in economics. But you
could not have created a better one than East and West Germany, even if
you'd done it in a lab. Both countries started with the same culture, the
same language, the same history, and the same value systems. Then for forty
years they competed on opposite sides of a line, with very little commerce
between them. The major difference subject to test was their political and
economic systems: market capitalism versus central planning.
Many thought it was a close race. West Germany, of course, was the
scene of the postwar economic miracle, rising from war's ashes to become
Europe's most prosperous democracy. East Germany, meanwhile, became
the powerhouse of the Eastern bloc; it was not only the Soviet Union's biggest
trading partner but also a country whose standard of living was seen to
be only modestly short of West Germany's.
I'd compared the East and West German economies as part of my work
for the PFIAB. Experts had estimated that East German GDP per capita
was 75 percent to 85 percent of West Germany's. I thought this couldn't be
right—all you had to do was look at the crumbling apartment buildings on
the other side of the Berlin Wall to conclude that productivity levels and
