11 - On the optimal compensation of a socialist manager

Summary

The problem

The idea for this essay was suggested, unwittingly to be sure, by the Soviet Premier Alexei Kosygin in his famous speech of September 27, 1965, inaugurating the Soviet Economic Reforms. Of the several changes in directives to enterprises, which he announced, two are relevant here: (1) the greater emphasis to be placed on profits, and (2) the replacement of the output target by sales.

Taking advantage of the theorist's inherent right of simplification, I would say that the enterprise manager (or director, as he is usually called) was instructed to maximize an unspecified function of profits and sales, subject to certain planning directives and several constraints that, though important in themselves, need not be considered here. I will argue in Section II that the maximization of a weighted sum of profits and sales makes excellent sense when the enterprise is allowed to set the prices of its outputs. It is not needed, however, if prices are set by the State, as indeed they are in the Soviet Union. Under these conditions, why was the Manager not given freedom of decision and instructed to maximize profits only, in accordance with good old economic theory, and without the additional directives and constraints?

I suspect that Mr. Kosygin's solution was not based on fine theoretical considerations. Even if he sympathized with them (for which there is little, if any, evidence), he would certainly be reluctant to abolish the planning mechanism and give complete freedom to Soviet enterprise managers.