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Saturday, March 28, 2009

ECONOMICS: Government macroeconomic policy objectives and indicators of national economic performance

Government macroeconomic policy objectives and indicators of national economic performance

Government policy objectives

The main government macroeconomic policy objectives are:

  1. low unemployment
  2. low and stable inflation
  3. a satisfactory balance of payments position
  4. avoidance of excessive exchange rate fluctuations
  5. steady economic growth

Key indicators

To asses how successful a government is in achieving these objectives, economists examine a number of key indicators, which include:

  1. level of output
  2. economic growth
  3. inflation rate
  4. rate of unemployment
  5. balance of payments position

1. The level of output and economic growth

One of the main indicators of a nation’s economic performance it its level of output. Output can be measured in terms of Gross Domestic Product and Gross National Product. Therefore, GDP is a measure of the total output produced by factors of production based in the country. Three ways of calculating GDP are through the output, income and expenditure methods, which should all be equal according to the circular flow of income.

The output method: It measures the value of output produced by the industries. Important not to repeat, therefore the value added by each firm is counted.

The income method, etc

The expenditure method: Total expenditure plus addition to stocks are measured.

Nominal and real GDP

Nominal GDP is GDP measured in terms of the prices operating in the year in which the output is produced, not affected by inflation variations. Economists find this measure to be misleading in evaluating a country’s progress and therefore use the Real GDP: they do this by measuring GDP at constant prices, at the price operating in the selected base year. By doing this they remove the distorting effect of inflation on GDP.

Economic growth

The most common definition of economic growth is an increase in real GDP, which should allow citizens to enjoy a higher living standard.

Actual and potential growth

Increases in output can be referred to as the actual growth whereas increases in the productive capacity of a country can be called potential growth. A shift outwards in the PPC means that a country is capable of producing more goods (potential growth), while a movement outwards of the production point means that the economy is actually producing more output.

Measurement problems

The measurement problems are all used in an attempt to gain an accurate measure of national output and its changes. However, a number of difficulties arise in achieving a completely accurate figure. The key difficulties are:

  1. The existence of a hidden economy, as some goods and services are deliberately not declared for two reasons –to avoid taxes, and because the activity itself is not legal. However, some idea of the hidden or informal economy can be gained by measuring any gap between expenditure and income methods.
  2. Non-marketed goods and services: Services which are produced and which are either not traded or which are exchanged without money changing hands go unrecorded.
  3. Government spending: In the Expenditure method, government spending on final goods is included, and therefore, as some of it goes onto public goods such as defence or fire services, which are not sold, a rather distorted view of what was happening is given to output.

Inflation

A low and steady inflation provides a number of benefits for a country, in particular that of enabling businesses to forward with confidence in business. Country with a rapidly rising inflation rate in excess of that of its main trading partners will be likely to experience a number of problems, including difficulty in selling its goods at home and abroad.

One of the measures of inflation is the Retail Price Index, which is a measure of changes in the prices of consumer goods bought in the UK.

Measurement problem

There are various problems which should be noted when considering the accuracy of methods of measuring inflation. These problems include:

  • Changes in quality: The price changes that are measured do not take quality into account
  • Special offers, prices of second-hand goods, retail sales and car boot sales.
  • Changes in the pattern of expenditure: Measure of RPI may lag behind the new and more modern products that consumers are now purchasing.

Causes of inflation

Demand-pull inflation: This type of inflation tends to be associated with a situation of boom in an economy, with a positive output gap. Demand for goods and services is rising faster than can be supplied from within, as a consequence, firms raise prices, with the security that they will sell everything they produce.

Cost-push inflation: This type of inflation tends to occur when the costs of production are increasing. When the cost of a raw good increases, this leads firms to raise their prices due to increased costs. This in turn triggers off wage demands as real income have fallen. Consequently, a wage-price spiral can come about, fuelling further increases in the RPI unless theses wage increases are matched by gains in productivity.

Monetary economists would disagree with the above theory. They argue that inflation is simply a monetary problem, caused by a change in the money supply in an economy, particularly where governments act irresponsibly in the way they print money.

Employment and unemployment

Countries measure both the numbers in employment and the numbers of those unemployed. If there is unemployment, output will be below its potential level, tax revenue will be lower and more state benefits will have to be paid out. Unemployment also leads to increases in the crime levels. The level of unemployment is different from the rate of unemployment. The level refers to the number of people who are unemployed whereas the rate of unemployment is the number of people in the labour force.


Exchange rates

The exchange rate is the price of one currency in terms of another. It is the external value of a currency (the internal is the purchasing power of that currency within the country).

  • In a floating exchange rate system, this price is determined by market forces of supply and demand.
  • In a fixed system, the government intervenes to maintain the external value of the currency.

Changes in the exchange rate

In a floating system, an increase in the exchange rate is an appreciation, while a fall is a depreciation.

In a fixed system, if the rate at which the currency is fixed is increased this is a revaluation, if a lower rate is fixed, this is a devaluation.

At any moment in time there are many exchange rates. The value of one currency might go up against some and down against others.

Trade weighted index: measures the value of a currency against a basket of currencies which are weighted according to their importance in UK trade.

Effective exchange rate: takes into account how much trade the country does with other countries (and weights movements accordingly). It also considers the extent to which the country competes with these other countries internationally.

Real exchange rate: takes inflation into account

The demand for a currency (pounds, for e.g.)

This refers to the desire to change foreign currencies into a country’s currency (pounds) in order to:

  • spend on UK goods and services
  • save in Uk banks and other financial institutions
  • speculate on the currency in the hope that pound will become more valuable in the future

The demand for pounds will increase if:

  • UK goods and services are demanded more (quality improves, more tourism, foreign income increases, etc)
  • UK interest rates increases, because there will be a greater desire to save in the UK to ear higher rates of return
  • People think its value will increase in the future so they buy it now

The elasticity of demand for pounds.

If the pound falls, the price of UK goods and services in foreign currency also falls- thus demand for UK goods will increase. The extent of this increase and therefore of the increase of quantity of goods demanded of pounds, depends on the price elasticity of demand for UK goods. The more elastic the demand for UK goods and services, the more elastic the demand for pounds.

The supply of pounds

This refers to the desire to change pounds into other currencies in order to:

  • buy overseas goods and services and travel abroad
  • save in overseas financial institutions
  • speculate on a foreign currency in the hope that it will increase in value

The slope of the supply of pounds

If the UK exchange rate falls, the price of imports in UK currency increases- this will reduce the amount of imports which are bought. If demand for imports is inelastic, the total amount spent on imports will increase and the supply of pounds is downwards sloping.

If the demand for imports is elastic, then when their price rises in pounds, the total amount spent on them falls. This means the supply of pounds is upward sloping.

The supply of pounds will increase if:

  • overseas interest rates increase so saving abroad becomes more attractive
  • overseas goods are demanded more
  • people think the pound will fall in the future so they sell now

Floating exchange rate system

The exchange rate is determined by demand and supply of the currency in the foreign exchange market. There is no government intervention.

Advantages of a floating exchange rate system

· The exchange rate automatically adjusts so that supply equals demand- this automatically eliminates balance of payments deficits or surpluses. If imports rise, for e.g. the supply of pounds increases, leading to a fall in their price. As the pound falls, exports become more competitive and imports become less competitive which should eliminate the deficit.

· There is no need for the central bank to keep foreign reserves.

· The government can pursue its own domestic policies, such as adjusting interest rates more easily.

· It prevents imported inflation- if one country has higher inflation, then under a fixed exchange rate system, another country will import those via higher import prices

· It may reduce speculation as it represents a risk

Disadvantages of a floating exchange system

· It causes instability which deters investment and trade (although business can avoid exchange rate movements by buying or selling currency at some date in the future in the forward currency markets to reduce the risk)

· It can lead to inflation- if a country has inflation which makes its goods uncompetitive, this will lead to a fall in demand for its currency and a fall in the exchange rate. This makes its goods competitive again but makes imports more expensive, which in the long run will lead to more inflation (cost-push)

· Speculation on future movements can lead to major changes in the rate.

· Governments are not forced to control their economies, e.g. they do not have to ensure that domestic inflation is in line with other countries to ensure their firms are competitive (because the country’s currency can float downwards)

The Government and the exchange rate

The government can influence the exchange rate by:

  • buying and selling currency
  • changing interest rates to influence capital inflows and outflows from the economy

To increase demand for the currency the Government can:

  • buy the currency
  • raise interest rates to attract investors

Fixed exchange rate

The government intervenes to maintain the exchange rate. If the price is about to fall, the Gov. increases demand by buying its own currency (using foreign currency reserves) or increasing interest rates. If the price is about to increase the Government sells its own currency (compra dolares como ARG) or lowers interest rates.

Advantages of fixed exchange rates

· Provides stability for firms and households- this encourages investment and trade.

· They act as a constraint on domestic inflation- if a country has a higher inflation than its trading partners, it will become uncompetitive (the currency will not depreciate to offset the inflation). Firms have to control costs to compete.

· In theory they prevent speculation, as there is no point because the value is fixed.

Disadvantages of fixed exchange rates

· A government must have sufficient reserves to intervene to maintain the price of it currency

· A country’s firms may be uncompetitive if the exchange rate is at too high a rate

· The Government must make intervention a priority. This may mean it undertakes policies which damage the domestic economy(e.g. to keep demand for pounds up, the Gov. might increase interest rates, which causes less demand within the country)

Exchange Rate Mechanism (ERM): Each country agrees to stabilize its currency against a central rate. The central bank must intervene to keep currency within this band.

Fiscal and monetary policy and exchange rate systems

Under a fixed exchange system, monetary policy becomes more difficult- any change in the interest rate will lead to inflows or outflows of currency and put pressure on the currency e.g. the Government tries to control the money supply, leading to higher interest rates which encourage inflows on the capital account. These inflows increase the money supply again.

Fiscal policy is effective, e.g. the Government tries to deflate the economy through higher taxes and less spending. This reduced aggregate demand and spending on imports. Lower demand will also reduce demand for money and interest rates. Lower interests rates lead to capital outflow which reinforces the contradictory fiscal policy.

In a floating system monetary policy is more powerful

For example, an expansion of the money supply will reduce interest rates, which will boost spending within the economy. It will also lead o outflows of currency of the capital account. This will lead to a fall in the value of the currency which will boost exports leading to a further increase in aggregate demand.

Alternatively, a tight (contractionary) monetary policy increases interest rates and reduces aggregate demand. Higher interest rates lead to capital inflows and an appreciation of the currency. This further reduces aggregate demand

Fiscal policy is less effective, e.g. contractionary fiscal policy reduces income and demand for money. This reduces interest rate and leads to an outflow on the capital account. This in turn leads to a depreciation of the exchange rate which raises aggregate demand.
The balance of payments

The balance of payments is a record of a country’s economic activities with other countries. It provides information of the country’s current and future international competiveness and net movements of income and assets. The first part of the balance of payments is divided into 2 main sections: the current account, the capital account. These are a record of all money entering and leaving the country over the period of a year.

The current account

This in turn has four main headings:

  1. Balance of payments (trade in goods and services): this covers the exports and imports of goods and services. It is the visible trade account.
  2. net factor income (such as interest, profits and dividends flowing in and out of the country)
  3. transfer payments (such as foreign aid and contribution to E.Union).

The capital account

The capital account records investments and financial flows. Movements in money capital by firms, households, and the Government, e.g. to invest in factories or in shares.

If, at a given exchange rate, there is excess demand for currency i.e. there is a greater demand for pounds than supply, the Government will have to sell pounds to keep the value constant. (“This is entered as a negative number under official financing in the balance of payments.”)

Outward investment will later generate income an will be shown as such in the current account, whilst inward investment is likely to result in certain income streams leaving the UK as debit items in the current account.

Balance of payments and floating exchange rates

In a free floating exchange rate system the balance of payments will automatically balance. The exchange rate automatically changes automatically until the supply of pounds equals the demand for pounds i.e. the number of pounds leaving the country equals the number entering. This does not mean each element of the BoP balances, current account can have deficit and capital account surplus, or viceversa.

Balance of payments and fixed exchange rates

If the exchange rate is fixed above the equilibrium rate (price) there will be excess supply of currency i.e. more money wants to leave the country than come into it. There is a balance of payments deficit.

If the price is fixed below the equilibrium rate (price) there will be excess demand for the currency à more money wants to come into the country than leave it. This means there is a balance of payments surplus.


Policies to reduce the balance of payments surplus

  • reflate to boost demand and so increase imports
  • remove import controls
  • revalue the currency

Problems of a balance of payments surplus

  • as one country’s surplus is another’s deficit, the country with the deficit may introduce protectionist measure
  • a large and sudden surplus in the balance of payments of a country may lead to an increase in the exchange rate, which can make the country firms uncompetitive
  • if the exchange rate is fixed, a balance of payments surplus will increase the domestic money supply (a surplus means there is excess demand for the currency so the Gov. must sell it). This increase in the money supply may lead o inflation

Current account deficit

Occurs when a country spends more on foreign goods and services than is being spent on that country’s goods and services. Money is leaving the country.

Problems

In the long run this could indicate problems with the competitiveness of a country’s industries. Usually more of a problem in a fixed exchange rate system, compared to a floating rate. In a floating system the external value of currency falls, making exports competitive again. In a fixed system the deficit may be offset by inflows on the capital account or the Government will have to intervene to buy up excess currency (this cannot continue indefinitely as the country will run out of foreign currency reserves).

Policies to reduce a balance of payments deficit

  1. Expenditure switching policies: These are attempts to make imports relatively expensive compared to exports by introducing:
    1. import controls such as tariffs
    2. bringing about a reduction in the exchange rate such as a devaluation
  2. Expenditure Reducing policies: The Government attempts to reduce spending throughout the economy (deflate the economy) This is likely to reduce the amount spent on imports. To reduce spending, the Government could increase taxation rates, cut its own spending or increase interest rates.

Monday, March 9, 2009

Fall of USSR (Part 2) - The collapse of the USSR and the end of communist rule

When Gorbachev resigned as president of the USSR on December 1991, the Soviet Union had ceased to exist and the Cold War was over. This turning point in history occurred with little bloodshed. No one had predicted this rapid collapse of the superpower. The USA and British intelligence services were surprised, as the East Germans, with the fall of the Wall. However, even before the Berlin Wall fell in 1989, relations between the Soviet Union and the USA had changed dramatically.

What was the impact of Mikhail Gorbachev?

Stalin’s legacy meant that the USSR remained an authoritarian, one party state and that economically it was focused on producing military hardware rather than consumer goods. On his succession as General Secretary, Gorbachev is reported to have said that the USSR could not go on like that. Not only was he the youngest leader since Stalin, but also the first university educated leader since him.

Gorbachev introduced two key reforming ideas- perestroika (aimed at the restructuring of the economy) and glasnost (“openness”- was the principle that every are of the regime should be open to public scrutiny). This represented a radical change in politics , with a greater democratization and more people involved in the Communist party and political debate.

Through these strategies, Gorbachev intended to make the USSR more productive and responsive, and he realized that part of this process also had to involve a reduction in military spending. If his reforms were going to work, the USSR could not challenge Regan’s SDI system; he thus abandoned the arms race and attempted a negotiated reduction in arms with the USA. Besides the economic reasons, Gorbachev hoped for a reduction in arms expenditure as he knew there could be “no winners” in a nuclear war and vowed to maintain peace. The Chernobyl disaster only heightened Gorbachev’s awareness of the dangers of nuclear power.

Reagan was also interested in disarmament and had previously put forward an arms control proposal known as Zero Option, which would eliminate all intermediate-rang missiles form Europe. Gorbachev was the first Soviet leader ready to discuss this option . Thus, the leaders met in four summits.

  • Geneva summit, November 1985. No substantial progress was made but the two leaders did agree that nuclear war should be avoided.
  • Reykjavik summit, October 1986. Talks ended without agreement, mainly because Reagan’s refusal to make any concessions over the SDI. However, the talks also covered a sweeping arms control proposal, which was considered as an breakthrough in relations between the two superpowers.
  • Washington summit, December 1987. The INF treaty was signed which agreed to abolish land-based missiles of intermediate and shorter range. This was an important first step in reducing the nuclear warheads and the inspection of their destruction.
  • Moscow summit, May 1988. Again there was disagreement over the SDI, but arms reduction negotiation continued. Reagan claimed no longer to believe in the “evil” empire.

Also, foreign policy initiatives by Gorbachev like the 1988 withdrawal from Afghanistan and the aid withdrawal from its “allies” in the Third World reassured the West. The “thawing” of the Cold War continued under the new U.S president, George H.W. Bush.

What was the role of Ronald Reagan?

While Gorbachev role is key to explaining the breakdown of the Cold War, many historians also give Reagan credit for this and argue that it was his approach to the Soviet Union in the early 1980s that was crucial for pushing the USSR into arms negotiations. Ideological and military pressures, -especially the Star Wars initiative- gave the soviets little choice but to abandon expansionism abroad and repression at home. The “Reagan victory school” is therefore critical of the “détente” approach to relations with the Soviet Union which was followed under the Carter administration, arguing that if it had been continued, then the life of the Soviet Union would have been prolonged.

Other historians also claim that Reagan played an important role, nut mainly due to his views on anti-nuclearism, which helped to convince Gorbachev at the different summits the possibilities of halting the nuclear arms race.

LONG TERM FACTORS IN THE ENDING OF THE COLD WAR

What was the role of the Soviet economy?

Although the actions of Gorbachev and Reagan were important in explaining the turnout of events, it is also important to look at the long-term forces that were at work in pushing the Soviet Union into ending the Cold War. By 1982, Brezhnev’s death, the political and economic policies of the USSR were in crisis.

During Brezhnev’s period the Soviets spent even more resourcese on forign policy. During this period, the USSR reached parity with the USA in the nuclear field, but with a high price. This era is remembered as a period of stagnation and decline for the Union, due to a lack of spending not only on consumer goods, but on the domestic economy as a whole. Brezhnev left his successors an economy that was based on Stalin’s command economy, which fell behind in modern technology and had a declining industrial output. Agricultural production was terrible, grain was imported from North America, workers had little incentive to work harder or produce better goods, labor morale was low, with high absenteeism and chronic alcoholism.

When Gorbachev took over, he inherited an economy in serious trouble. It could thus be argued that Gorbachev was forced to take the actions that he did in both internal reform and negotiations with the West. Therefore, many historians claim that keeping the Cold War through containment and détente played a role in bringing about the end of the Cold War rather than prolonging it.

WHAT WAS THE ROLE OF NATIONALISM AND PEOPLE POWER IN ENDING THE COLD WAR?

In the late 1980s, a resurgence in nationalist movements began to develop in most of the satellite states due to the combination of the deterioration of the living standards, the fact that the USSR was becoming less involved in the internal affairs of these countries and the implications of Gorbachev’s reforms. The new leader had made it clear that he was unwilling to use force to maintain control over the satellite states.

In December 1988, Gorbachev announced that the USSR would be cutting by half a million men its commitment of troops to the Warsaw pact, and claimed that he refused to use force as an instrument of foreign policy. This was a clear signal for the peoples and governments of Easter Europe – the Brezhnev Doctrine would not be applied. 1989 saw an amazing series of revolutions in the satellite states, resulting in the fall of the Soviet system.

The process of the collapse of the Soviet Union began in May 1989 when the Hungarian government dismantled the wire fence in the border with Austria. Thousands of Hungarians and East Germans then crossed over to Austria in order to cross into West Germany.

Events in Poland

Although the union movement “Solidarity” had been suppressed in 1981, there continued to be popular support for it due to the combination of economic stagnation that the government failed to resolve, and also the support of the Pope and Church. Due to Gorbachev’s reforms, Solidarity was legalized in 1988 and it won the first free elections in 1989. The Communist Party had been defeated by a huge popular vote, and the government was the first in the Eastern bloc since the 1940s not to be controlled by Communists. After Gorbachev’s refusal to support the old Communist regime, and in the absence of support, the Polish Communist party collapsed.

Events in East Germany

Honecker, a hard-line Communist, had been the leader of East Germany since 1971. Although considered the most successful country in the Eastern bloc, living standards there were well below the West; there was no sense of Eastern German nationalism and people look forward for reunification. Honecker’s repressive regime was unpopular and its leader was particularly hated.

By mid-1980, there was pressure to remove him as leader; people criticized the repressive sysyem and openly demanded reforms. Thousandes of East German holidaymakers in Hungary crossed to Austria across the new open border. Moreover, groups like the “New Forum” decided to stay and resist. Although Honecker proposed the used of force to regain control, Gorbachev made it clear that he would not intervene if there was a revolt. Honecker was replaced by the politburo and the new government announced on November 9, 1989 an easing of travel and emigration restrictions. The lack of clarity of the official statement meant that thousand of citizens descended to the border: the East German guards were taken by surprise and, lacking direction from above, opened the barriers that night. Within 24 hours the wall had ceased to be the symbol of the Cold War and its destruction became the symbol of its ending. Elections were held in 1990, when parties in favour of unification won; East and West Germany were unified on 3 October 1990.

Events in Hungary

Reform in Hungary came from the Communist Party itself. Reformers sacked the hard-line leader Kadar and dominated the government. On October 1989 a new Hungarian Republic was declared and elections took place the following year.

Events in Czechoslovakia

The changes in Czechoslovakia were known as the “Velvet Revolution” as there was very little violence and people power was the clear driving force here. The government was force to respond to the mass demonstrations calling for reform. In 1989 a dissident playwright Havel, was elected president and the Warsaw Pact nations, including the USSR, issued an official statement condemning the 1968 invasion as illegal and promising never to interfere in each other affairs again.

Events in Romania

Events in Romania were far more violent. Its leader President Ceausescu and his regime was one of the most repressive in the East. In 1989 inspired by events in Hungary and the killing of demonstrators by the army there was an uprising against the leader. When he appeared in public they met a hostile reception. The army refused to act against the demonstrators and Ceausescu was arrested and executed.

THE END OF THE USSR

Gorbachev’s policies brought admiration and in 1990 he was awarded the Nobel Peace prize. However, at home, his failure to bring about an improvement in the country’s economic situation meant that he became increasingly unpopular. Events in Eastern Europe brought about calls for independence from the republics of the Soviet Union. Thus during 1991, the empire disintegrated. The republics that had been part of the USSR claimed their independence. This break-up intensified hostility towards Gorbachev and in 1991 there was an attempted coup by hard-line Communits. This was defeated by Boris Yeltsin, and although Gorbachev was restored, he had lost local authority. On 25 December 1991, Gorbachev resigned and the Soviet Union formally ceased to exist.

WHAT WAS THE IMPACT OF THE FALL OF THE USSR AND THE END OF THE COLD WAR?

The collapse of the USSR had a huge impact on international politics as well as the economic situation of the countries that had been dependant on the Soviet Union for aid.

For many in the USA, it seemed that they had won and that they were the only country in international politics capable of having a military alliance around the world. Capitalism seemed to have triumphed. Even in China and Vietnam, changes in economic controls allowed free market forces to have an impact.

For Cuba, the drying up of Soviet aid, along with the USA trade embargo, brought about an economic crisis. Also, other regimes in Africa formerly supported by the USSR suffered economically. In other parts of the world, which had been focus of superpower conflict and fighting, such as Afghanistan, conflict continued, with little attention from the rest of the World. These were dubbed “failed states”.

Fall of USSR (Part 1) - Gorbachev and the end of communist rule

Gorbachev and the end of communist rule

Gorbachev, who came to power in March 1985, was the most gifted and dynamic leader Russia had seen in many years: he was determined to revitalize the country following the years of stagnation after Khrushchev's fall. He intended to achieve this by modernizing and making more efficient the communist party with the policies of glasnost and perestroika (economic and social reform).

Gorbachev claimed that the system was centralized, leaving no room for local individual initiative and that it was based almost completely on state ownership and control, and weighted strongly towards defense and heavy industry, leaving consumer goods for ordinary people in short supply.

Gorbachev did not want to end communism; he wanted to replace the existing system, which was still basically Stalinist, with a socialist system which was humane and democratic. However, he did not have the same success at home as abroad, as his policies failed to provide results quickly enough, and led to the collapse of communism and the breakup of the USSR.

Gorbachev’s new policies

1 Glasnost

It was seen in areas such as human rights and cultural affairs. Dissidents were released, leaders like Bukharin were claimed innocent, and Pravda was allowed to publish an article critical of Brezhnev. Political events such as the 19th Party Conference and the first sessions of the Congress of Deputies were televised.

In cultural matters and the media generally there were some developments. For example, long banned anti-Stalin films and novels were now shown and published. Also there was a new freedom for the press. The Chernobyl incident, for example, was discussed with unprecedented frankness.

The aims of this new approach were to:

  • use the media to publicize the inefficiency and corruption which the government was so anxious to stamp out
  • educate public opinion
  • mobilize support for the new policies

2 Economic affairs

In November 1986 Gorbachev announced that announced that new methods of economic management would be applied. Small scale private enterprise in the manufacture of goods and services was to be allowed, as well as workers cooperatives of no more than 50 members. The objective behind this was to provide competition for the slow and inefficient services provided by the state, in the hope of stimulating a rapid improvement. Another reason was the need to provide alternative employment as patterns of employment changed over the decade, and automation and computers left many people with no job.

Also, the responsibility for quality control throughout industry as a whole was to be taken over by independent state bodies rather than factory management.

The most important of the reforms was the Law on State Enterprises of 1987, which removed the central planner’s total control over raw materials, production quotas and trade and made factories work to orders from customers.

3 Political changes

These changes began in 1987 when Gorbachev made a move towards democracy within the communist party by announcing that members of the soviet would now be elected by the people rather than appointed. Also top party positions and factory managers would be elected.

During 1988, the old Supreme Soviet would be replaced by a much smaller one, elected through a Congress of People’s Deputies. This Supreme Soviet would be a proper parliament, active throughout the year. Reserved seats for the communist party were cancelled. Gorbachev was elected President of the Soviet Union in 1990. These new institutions completely sidelined the old system, and meant that the communist party was on the verge of losing its privileged position.

What went wrong with Gorbachev’s policies?

1 Opposition from radicals and conservatives

Gorbachev found opposition from two sides. Some party members such as Boris Yeltsin, the Moscow part leader, were more radical than Gorbachev and felt that the reforms were not drastic enough. They wanted to change to a market system as soon as possible. On the other hand, the conservative communists such as Ligachev felt that changes were too drastic and the party was losing control. This caused a dangerous split within the party and brought trouble to Gorbachev.

When elections were held and the conservatives won a majority in the Congress, massive protests broke out in Moscow ere Yeltsin was popular. Now, due to Glasnost, the new freedoms of the people were beginning to turn against the communist party.

2 The economic reforms did not produce results quickly enough

The rate of economic growth stayed put through 1988 and 1989 and fell after 1990, almost by 15%

A major reason for this crisis was the failure of the Law on State Enterprises. The problem was that wages were dependant on output, but since it was measured by its value in roubles, factories did not increase overall output, but instead concentrated on expensive goods. This led to higher wages, forcing the government to print more money, which caused soaring inflation. Also, basic goods were in short supply, and some common good were totally scarce.

Disillusion with Gorbachev rapidly set in, and people became outraged at the shortages. Half a million miners went on strike in 1989, the first one since 1917. The disciplined and well organized miners put forward detailed demands. The government soon granted many of the demands, promising complete reorganization of the industry and full local control.

By the end of July the strike was over, but the general economic situation did not improve. Gorbachev was fast losing control of the reform movement which he had started.

3 Nationalist pressures

The nationalist pressures also led to the breakup of the USSR. The Soviet republics, each with its won parliament, had been kept under tight control throughout Stalin’s time, but glasnost and perestroika encouraged them to hope for more independence. Gorbachev seemed sympathetic to this provided the Communist party remained in overall control.

  • Nagorno-Karabakh conflict
  • Baltic States declare their independence but Moscow refuses to recognize it.
  • Boris Yeltsin, excluded from the Supreme Soviet was elected president of the Russian federation in 1990.

4 Gorbachev and Yeltsin were rivals

They disagreed over fundamental issues:

  • Yeltsin believed that union should be voluntary, with independent republics with joint responsibilities but with the power to opt out of the Union. Gorbachev believed this would lead to disintegration
  • Yeltsin was completely disillusioned with the communist party and thought it no longer deserved it privileged position. Gorbachev was still a convinced communist and hoped for a humane and democratic communism.
  • Yeltsin believed that the answer for the economic problem was a rapid changeover to a market system, despite the initial hardships it would cause. Gorbachev was more cautious, and knew that those plans would cause higher unemployment and inflation, which would result in his overthrowing.

The coup of August 1991

As the crisis deepened Gorbachev and Yeltsin worked together, Due to attack of the conservatives, Yeltsin left the communist party. Gorbachev was loosing control, as many of the republics demanded independence. In May 1991 Gorbachev held a conference with the leaders of the republics and persuaded them to forma a new voluntary union largely independent from Moscow.

At this point, hardline communists launched a coup to overthrow Gorbachev and reverse his reforms. He was arrested and told to hand power to his vicepresident. When he refused, he was kept under house arrest while the coup went ahead in Moscow. The public was told Gorbachev was ill and a committee took power, declaring state of emergency, banning demonstrations. They brought in tanks and troops to surrounded public buildings in Moscow that they intended to seize.

However, the coup was poorly organized and the leaders failed to have Yeltsin arrested. He called on the people to rally in support. The troops did not know whom to support, but they did not take action against the popular Yeltsin. Some sections of the army were sympathetic with the reformers. People went to the streets, and the army hesitated to cause heavy casualties. On August 1991, leaders admitted defeat and were eventually arrested. Yeltsin had triumphed and Gorbachev returned to Moscow. However, the coup had important consequences:

  • The communist party was discredited due to the actions of the hardliners. Gorbachev resigned as party general secretary and the party was soon banned in Russia.
  • Yeltsin was seen as the hero and Gorbachev was increasingly sidelined. Yeltsin ruled Russia as a separate republic, introducing a drastic programme to move o a free-market economy. The Ukraine voted to become independent in 1991 December and the USSR was clearly finished.
  • Yeltsin was already negotiating for a new union of republics
  • Gorbachev’s role as president of the USSR had ceased to exist, and he resigned on Christmas Day 1991.

Verdict on Gorbachev

Despite his failures, Gorbachev as one of the outstanding leaders of the 20th century. His achievement especially in foreign affairs was enormous. His policies of perestroika and glasnost restored freedom to the people of the USSR. His policies of reducing military expenditure, détente, and withdrawal from Afghanistan and Eastern Europe, made a vital contribution to the ending of the Cold War.