The Soviet Union was largely a rural preindustrial economy when the Communists took over in a bloody civil war and revolution around 1920. Over the next 50 years, this large but undeveloped nation would be transformed into a modern industrial state, a world leader in aerospace and military technology, and an economy second only to the United States. How did this happen? What is remarkable is that more so than any country before or after, the growth of the Soviet Union was driven by capital accumulation.
What is Capital Accumulation
Capital can be understood as capital goods, one of the factors of production or inputs used to produce finished goods or services. The idea is that increased inputs — including increased capital — would lead to increased output and economic growth. This idea is seen as “extensive growth”. This differs from “intensive growth”, which is the more efficient use of existing inputs such as by increasing productivity. Capital accumulation can also be understood as investment in productive capital stock such as factories, public infrastructure, and machinery. It is basically an investment in assets which produce other goods and with the expectation of future economic returns.
Obtaining funds to invest in capital goods requires either accumulated domestic savings or a reliance on foreign investment. Thus, there is a close link between the level of savings and the increase in capital accumulation. This factor has been included in the Solow-Swan growth model and the Harrod-Domar model to link the savings rate with economic growth.
Growth through Capital Accumulation
The Soviet Union’s initial nationalisation of industry and agriculture resulted in a decline in output and the famine of 1921. The “New Economic Policy” reform partially allowed for private industry, but large industry remained state owned. This reform led to economic growth, with agricultural and industrial output in 1928 above the pre-war levels. However, the first five-year industrialization plan in 1928 in the “great break” nationalised whatever private sector was left. Agricultural output declined, resulting in another famine in 1933. While revenue to the state from the agricultural sector rose significantly, signalling much higher taxes. Despite being the largest country in the world in terms of land area and having vast amounts of arable land, the Soviet Union was a net food importer for most of its history.
Increased tax revenue from agriculture was then invested in heavy industry and public infrastructure such as dams, railways and canals. This resulted in an increase in the level of capital accumulated and led to economic growth. In their book “Why Nations Fail”, Acemoglu and Robinson explain how capital accumulation in the Soviet Union led to economic growth:
“Between 1928 and 1960, national income grew at 6% per year, probably the quickest rate ever at the time. This was driven by reallocating labour and by capital accumulation through the creation of new tools and factories” (Why Nations Fail p.127)
“The productivity of heavy industry was so much higher that all attempts to put people into it led to economic growth when compared to agricultural productivity” (Why Nations Fail p.126)
This growth and its causes are evident in the table below by Gur Ofer:
Gur Ofer describes the causes of early Soviet industrialisation:
“One of the Soviet strategy's outstanding characteristics is its commitment to extensive growth, which involves a policy of very high investment rates, leading to a rapid growth rate of capital stock. Until 1975 the growth rate of capital remained between 8 and 9.5 percent, doubling its size every 8-9 years.”
This rate of capital accumulation was the highest ever for any country for a sustained period, maybe only China recently comes close. However, with low productivity growth and labour growth slowing due to declining population growth, capital accumulation became the primary driver of economic growth.
Another factor driving economic growth other than capital accumulation is the rise in the labour force participation rate. The Soviet Union was really good at getting people to work, unemployment being illegal and forced labour camps probably helped. High labour force participation was also driven by a high female employment rate in the Soviet Union, which was one of the highest in the world for most of its history. Female labour force participation rate was 87% in 1980 compared to 59,7% in the United States in 1982.
In the Soviet System, consumption stayed relatively low — consumption growth was constantly equal or below GDP growth. While consumption in terms of GDP declined, its nominal value increased and resulted in a clear increase in the average standard of living. This rapid growth guided by the state led many to believe in the economic power of the Soviet System — Paul Samuelson famously predicted that the Soviet Union would overtake the US as the largest economy in the world. This new type of economy prompted the journalist Lincoln Steffens to declare:
“I’ve seen the future, and it works.”
Economic slowdown after 1960
The Soviet growth strategy ended. The focus on capital accumulation in industry had diminishing returns and productivity not only stalled but started to fall after the 1970s. Thus, there are clear limits to economic growth when relying solely on capital accumulation. There were also other flaws in the Soviet economic model. These include the very high military spending that was a drag on the overall economy. It amounted to about 15 to 17% of GDP the 1980s, about three times higher than that of the United States.
Another issue is that central planning struggled with the increasingly more complicated modern economy and with the low quality of the industrial products being produced— the Soviet Union exported very little of what its factories produced with the exception of military equipment. The exports of the Soviet Union were mostly related to oil, gas and precious metals — natural resources that are easy to extract. Thus, while the Soviet Union invested a lot to accumulate capital, the quality of these investments probably wasn’t great. There are multiple arguments why the Soviet Union was unable to escape the middle-income trap. Acemoglu and Robinson argue that the lack of growth was due to extractive institutions which limited creative destruction, competition, and innovation.
Gur Ofer has this explanation for the decline of the Soviet Union economy:
“The main Soviet industralization drive took place when the dominant technological advance was concentrated in heavy industry and machinery, energy, and raw materials. In a way, this suited the goals and structure of the Soviet system. But the technological frontier has shifted to electronics, computers, and communications-toward an "information-intensive economy."”
Ofer’s argument is that the Soviet system struggled in the less capital-intensive information economy that describes advanced economies. This is Stanley Fischer’s explanation for the decline of the Soviet Economy, which focuses on the diminishing returns to capital accumulation:
“The simplest explanation for the Soviet growth slowdown is that the Soviet extensive growth model had reached its natural limits by the end of the 1960s. Soviet growth was based on the rapid accumulation of capital, the increasing use of labor, and increasing exploitation of natural resources. Capital accumulation at the rate of 7-9 percent per annum meant a steady deepening of capital that must have reduced the return to further capital accumulation.”
The Soviet Union also had a relatively high level of human capital, similar to Italy. However, this did not lead to increasing productivity. Fischer also argues that “Soviet-style economies” had reached a level of development in which the service sector usually expands, but the Soviet Union did not have the technology or market structure to expand the service sector. Overall, the rise and decline of the Soviet Union shows the vital role that capital accumulation has on economic growth. However it is not the whole story, there are other factors that also play a role.