The European centrally planned economies (CPEs) have sustained chronic hard currency deficits since East-West trade began to expand in earnest about fifteen years ago. While their outstanding hard currency debts almost doubled over 1975-76 as a result of an inability to adjust quickly to the Western recession-a previously unsuspected vulnerability-other systemic factors rooted in Stalinist central as practiced in the CPEs, have been responsible for the more secular balance-of-payments problems.' I refer to the wide use of direct controls to allocate intermediate products, the prevalence of or over full-employment planning, and irrational domestic pricing. These have several implications for economic performance which are relevant to the CPEs hard currency balances of payments. First, the CPEs tend to produce relatively low quality manufactured products and have a marked inability to sell their products in Western markets. Inability to compete successfully is not due to price, but, to quote a Hungarian economist, Imre Vajda, to deficiencies in performance, reliability, appearance, packing, delivery and credit terms, assembling facilities, after-sale services, advertising, selling itself , primarily factors other than price . (p. 53). This ineptness results largely from lack of competition-the fact that domestic products are distributed by the plan rather than sold and that quantitative goals take precedence over qualitative goals. Further, taut planning results in sellers' markets, additionally weakening managerial incentives to improve quality. Nor does play a significant role in intrabloc foreign trade. This trade is characterized by large state trading agreements, protected markets, and little or no direct contact between the producing enterprise in one nation and consuming enterprise in the other. Second (and related) is the well-known relative weakness of socialist nations in innovation and technological change. This is due to the absence of competition just noted, to rewards for innovation which are inadequate to offset the risks or overcome inertia, and to the dysfunctional organization of R&D establishments and their relations to operating enterprises. Third, the CPEs trade with each other and with the West at roughly world prices, even though these prices usually have no organic or consistent relationship to domestic prices. Their exchange rates serve as units of account but not as real prices. Their currencies are not only totally inconvertible into each other, they are also largely inconvertible into goodsso-called commodity inconvertibility (see the author, 1978). That is to say, foreign importers (exporters) are not allowed to compete freely with local enterprises for products (markets) because this would disrupt the plan. This significantly reduces short-run ad hoc exports-most exports have to be planned long in advance. These factors lead to at least three causes of persistent hard currency shortages: 1) the *Professor of economics, Tufts University and associate, Harvard Russian Research Center. Some of the ideas in this paper appeared earlier in my 1973 article. A much longer current version is available on request. I am indebted to Abram Bergson for incisive criticisms of two earlier drafts. 'Other than systemic factors may also be responsible. For example, the current availability of Western investments and credits on reasonable terms and the present willingness of the CPEs to entertain such relations with the West is one such factor. It should also be noted that the LDCs and some advanced industrial nations also have chronic balance of payments problems. However, I argue that the factors to be mentioned below are unique to the CPEs.

The U.S. policies toward the USSR in the postwar period have been less friendly than those of our NATO allies. These policies have been, however, a largely understandable reaction to the miliary posture and undemocratic domestic policies of the USSR and to the nature of its economic system. But the situation is changing rapidly. The Gorbachev Reform is already a minor social, political, and economic revolution, and may well turn into a major one. These circumstances require a reassessment of our policies toward the Soviet Union. Some reassessment has already taken place as indicated by our signing the INF Treaty. Nevertheless, the overall tone of our administration is dominated by attitudes of skepticism and show me when hardly a week goes by that the Soviets do not show by saying or doing something that two or three years ago was unthinkable. I think it is important for us to adopt a more positive approach toward the Soviet reform. Our major foreign policy goal over the past forty years has been containment of the Soviet Union. This goal has been enormously expensive to implement, and pursuing it bears much of the responsibility for the difficult economic problems this nation faces today. The relentless pursuit of this goal has been based on the assumption that, while uneasy truces between the two camps might be worked out from time to time, the differences between us are irreconcilable over the long run. Now, for the first time in Soviet history, this assumption may no longer be valid. There is little doubt that Gorbachev genuinely wants to eliminate many of those aspects of the Soviet system that we consider objectionable and to end the cold war. His task will be difficult and good relations with the West would simplify it. Gorbachev's policies are in our interest. The opportunity should not be missed-it may not come again for decades.