SECOND ECONOMY

The second economy of the USSR included economic activities that supplemented the command, or first, economy. As defined by Gregory Grossman, the second economy consisted of all production and exchange undertaken directly for private gain, knowingly illegal in some substantial way, or both. This definition encompassed both legal and illegal activities, but most studies focus on the illegal part, also referred to as underground, unofficial, or shadow economy, or the black market.

The legal second economy was made up mainly of private agriculture, small-scale construction services, extraction of precious metals, hunting of valuable wild animals, and certain professional services, such as those provided by physicians, dentists, and tutors.

The illegal economy was significantly larger than the legal part of the second economy. Legal private activities often served as fronts for illegal ones. The most common illegal economic activity in the USSR was theft of state property. Presumably the second-most widespread illegal activity was the corruption that reached into the highest echelons of power; one purpose of corruption was to protect the functioning of the rest of the illegal economy. Another major illegal activity was speculation, defined as resale of goods by individuals for profit. Unlike theft from the state sector and corruption, which would be illegal anywhere, speculation was a crime only in socialist economies.

Illegal production by individuals or by teams was also significant. Much of the illegal production for private purposes took place at state enterprises. Output was usually sold privately, but sometimes it was distributed through the official retail trade network. Private manufacturing without an official facade also existed.

None of the major conditions giving rise to the existence of a large underground economy were unique to the USSR, but the way they came together in Soviet society was unusual and created a highly favorable environment for an illegal economy. These conditions included price controls on virtually all consumer goods, the prohibition of many private economic activities and high taxes on others, the ubiquity and poor protection of public property, the immense discretionary power of poorly paid bureaucrats, and social attitudes that tolerated theft of state property, corruption, and many other economic illegalities.

While the Soviet second economy was large, its magnitude, especially in the illegal sphere, is difficult to ascertain. One widely used way to estimate the extent of the second economy was based on interviewing emigrants from the USSR about their lives prior to emigration. Three major surveys were performed in Israel and the United States in the 1970s and 1980s. The Berkeley-Duke household budget survey, the only one focused explicitly on the second economy, implied that about 27 percent of urban household income in Russia in the late 1970s was derived from the second economy. The corresponding estimates from the other two surveys were about half that amount.

Evaluating second economy dynamics is even more difficult. One methodology infers the growth of the second economy from comparisons of electricity consumption with the official Gross Domestic Product. This approach indicates that Russia's second economy grew by more than 80 percent between 1979 and 1989.

The rise of the second economy amounted to an implicit market reform within the Soviet system, but it also facilitated or even compelled the partial reforms of perestroika, which expanded the scope of the legal second economy. Nonetheless, the illegal and quasi-legal economy also mushroomed, undermining central planning and leading to the economic transition to markets starting in 1992. During the transition, the notion of a second economy was restricted to illegal activities, the growth of which continued throughout the 1990s. The reasons for this growth included persistent excessive regulation of the economy, high statutory tax rates, weakening of official institutions and their inability to protect property rights protection and enforce contracts, lack of credibility of government reform policies, and continued corruption. The illegal second economy may have benefited from the emergence of the mafia, which taxes underground firms but also provides property rights protection for its victim/clients.

The existence of a large second economy, and particularly its illegal part, had important implications for Russia's economy both before and after the collapse of the USSR. First, underground activity hinders an accurate understanding of the economy and impedes policy-making by distorting various statistics, including GDP data, household incomes and their distribution, and employment. Additionally, the illegal economy weakens the feedback to policy-makers on government decisions and actions, undermines official institutions, and promotes corruption. From an efficiency point of view, the illegal economy suffers from the black market's need for secrecy, which results in poor flows of information, greater operational uncertainty, and suboptimally small-scale production. Economic distortions also appear because some activities are easier to hide than others. At the same time, the second economy often benefits a centrally planned economy by improving incentives and resource allocation. During the post-Soviet transition, the existence of the second economy restricted the government's ability to tax and regulate excessively. On the margin, the net balance between the second economy's costs and benefits to society depends on its size and other factors, and is a difficult empirical question.

See also: black market; command administrative economy

bibliography

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Grossman, Gregory. (1979). "Notes on the Illegal Private Economy and Corruption." In Soviet Economy in a Time of Change, Vol. 1, Washington, DC: U.S. Government Printing Office.

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Treml, Vladimir, and Alexeev, Michael. (1994). "The Growth of the Second Economy in the Soviet Union and Its Impact." In Issues in the Transformation of Centrally Planned Economies, ed. Robert Campbell. Boulder, CO: Westview Press.

Michael Alexeev