Economic Efficiency of New Technology under the Conditions of Economic Reform

Yu. S. Prokofiev

(Presented by the scientific seminar of the Department of Industrial Economics)

The economic reform being carried out in the country has required the introduction of appropriate corrections into the existing methods for evaluating the economic efficiency of production and of capital investments in new technology. In the Standard Methodology for Determining the Economic Efficiency of Capital Investments, published at the end of 1969, the necessity of a dual approach to the evaluation of economic and organizational-technical decisions is officially recognized: a national-economic approach and a local, self-accounting approach from the standpoint of an individual enterprise.

The first of these applies to measures for improving production that are financed from centralized sources, and the second to measures carried out at the expense of the production-development fund. Under the national-economic approach, the choice of the rational variant is proposed to be made according to the well-known indicator of “reduced costs”:

\[ C_p = C + E_n K . \]

As for the local (self-accounting) approach to evaluating the economic efficiency of capital investments, the Standard Methodology gives only the most general provisions on this point, which may be interpreted in different ways.

Thus, in particular, the Methodology states: “The comparative economic efficiency of variants of capital investments at operating enterprises, at the expense of the production-development fund and bank credits for carrying out measures to introduce new technology ... is determined by calculations based on the increase in profit in comparison with capital investments, so that the profit obtained as a result of carrying out the measure ensures the payment of the corresponding charge for funds, payment of bank credits and other obligatory payments, as well as the creation of enterprise funds.”

Quantitatively, the provision quoted above may be represented in the form of the following formula:

\[ E_{rkh}=\frac{\Delta P}{\Delta K} =\frac{(C^I+\Phi^I+B^I+P^I)-(C^{II}+\Phi^{II}+B^{II}+P^{II})}{K^{II}-K^I}, \tag{1} \]

where

\[ E_{rkh} \]
is the indicator of the local (self-accounting) efficiency of additional capital investments;

\(\Delta P\)—increase in profit;

\(\Delta K\)—additional capital investments;

\(C^{I}\) and \(C^{II}\)—production cost (current expenditures) for the compared variants of capital investments;

\(\Phi^{I}\) and \(\Phi^{II}\)—payment for production assets for the compared variants;

\(B^{I}\) and \(B^{II}\)—payment for bank credit for the compared variants;

\(R^{I}\) and \(R^{II}\)—fixed rent payments for the compared variants;

\(K^{I}\) and \(K^{II}\)—capital investments for the compared variants.

The indicator of economic efficiency calculated by formula (1) acquires meaning only if it can be compared with its normative value. However, no explanations on this point are given in the “Standard Methodology.” This circumstance makes it difficult to use the given indicator for calculating the economic efficiency of capital investments, since most economists have no common opinion regarding the nature of the content of the normative efficiency indicator. Some economists believe that the national-economic efficiency norm, established at the level of \(0.12\ \dfrac{\text{rub.}}{\text{rub. year}}\), may be adopted as the local (cost-accounting) norm of comparative economic efficiency.

Others propose using the enterprise’s planned profitability as the norm of economic efficiency. Both of these proposals are untenable.

In the first case, by adopting the national-economic efficiency norm as the local norm, we completely fail to connect it with the enterprise’s capabilities, with the size of its production development fund.

An enterprise may not have at its disposal a production development fund that would allow it to undertake measures with an efficiency of not less than \(0.12\ \dfrac{\text{rub. year}}{\text{rub.}}\), as is currently required under the national-economic approach. Moreover, it may not have the funds to undertake measures with an efficiency even of several rubles for each ruble of additional capital investment. Thus the requirement (placed on the enterprise) to accept for implementation measures with an efficiency not less than that for the national economy may simply prove infeasible.

The untenability of the second proposal will be considered below.

In order for formula (1) to be used for practical calculations, in our view, each enterprise must have its own norm of economic efficiency for additional capital investments, one that would be fully linked to the enterprise’s capabilities and to its production development fund. At present, plants do not yet have such norms. However, for individual enterprises they can be calculated.

Let us consider the method for determining the efficiency norm with the following example. The production development fund at a plant is 290 thousand rubles. Suppose that the enterprise must manufacture 5 types of products: \(A, B, C, D, E\). Each type of the indicated products can be manufactured in several ways. The economic indicators determined by the production of the indicated products by variants are presented in Table 1.

As can be seen from the table, the most economical method of manufacturing the products is the second variant. Implementation of this variant would allow the enterprise to obtain savings of 80 thousand rubles per year. However, for this the enterprise must undertake capital investments whose total amount is 480 thousand rubles. Comparing this amount of investment with the enterprise development fund, we become convinced that

Table 1

the latter proves insufficient for manufacturing all 5 types of products according to the more economical second variant. Consequently, the savings of 80 thousand rubles/year cannot be fully realized, because it is impossible to manufacture all products according to the second variant. Thus, the problem consists in distributing the production development fund in such a way as to obtain the maximum savings in the enterprise’s total costs, or, what is the same thing, the maximum aggregate profit for the enterprise as a whole:

\[ \Pi=\sum_{j=1}^{m}\Pi_j \to \max, \]

where \(m\) is the number of types of products manufactured at the enterprise; \(\Pi_j\) is the profit obtained as a result of carrying out organizational and technical measures in manufacturing the \(j\)-th type of product.

The problem is solved as follows. First, using formula (1), we calculate the indicator of comparative economic efficiency of additional capital investments (Table 1). Then we construct the following table, in which production of the individual types of products is arranged in decreasing order of investment efficiency (Table 2).

Table 2

It follows from Table 2 that, within the limits of the given production-development fund, equal to 290 thousand rubles, it is expedient to manufacture products \(A\), \(B\), and \(D\) according to the second variant. The total saving in the enterprise’s costs in this case will amount to 55 thousand rubles/year \((20+15+20)\). To obtain the indicated sum, capital investments of 290 thousand rubles \((100+80+110)\) are needed. This amount precisely corresponds to the enterprise’s capabilities, its production-development fund. Such a distribution of the production-development fund is the best. Any other distribution reduces the total saving in costs.

It follows from Table 2 that the marginal product, for the production of which under the second variant the production-development fund is exhausted, is product \(D\). All the remaining products that fall below the line have to be manufactured according to the first (old) variant. The calculated efficiency indicator in the production of product \(D\) is

\[ 0.18 \frac{\text{rubles}\cdot\text{year}}{\text{ruble}}. \]

This indicator, obviously, can subsequently serve as a guide in determining the economic expediency of carrying out organizational and technical measures.

In other words, the calculated efficiency indicator for the marginal product can be adopted as the norm of local (cost-accounting) efficiency \(E_n\). Equating to the efficiency norm will make it possible to accept for implementation such organizational and technical decisions as correspond to obtaining the maximum aggregate profit for the enterprise as a whole. At the same time, it should be borne in mind that the achievement of maximum savings in the production of an individual product by no means always increases the total profit of the enterprise. Equating to the efficiency norm makes it possible to link the solution of partial, separate tasks of improving equipment, technology, and the organization of production with the general interests of the plant.

The efficiency norm is a dynamic magnitude. It depends on a number of conditions and, first of all, on the size of the production-development fund.

Suppose that, in our example, the production-development fund increased to 350 thousand rubles. In that case, under the second variant it would be possible to manufacture one more product—product \(E\). The calculated efficiency indicator for this product would be

\[ 0.17 \frac{\text{rubles}\cdot\text{year}}{\text{ruble}}. \]

Consequently, with an increase in the production-development fund, the efficiency norm decreases.

If the production-development fund were reduced (for example, to 180 thousand rubles), one could see that the efficiency norm rose to

\[ 0.19 \frac{\text{rubles}\cdot\text{year}}{\text{ruble}}. \]

Thus, the better the enterprise operates, the greater its opportunities for increasing the production-development fund, and the lower the efficiency norm.

The reasoning given above proves the untenability of the proposals of those economists who propose, as the local (cost-accounting) norm of comparative economic efficiency, the indicator of the planned profitability of production.

The norm of comparative cost-accounting efficiency, linked with the capabilities of the enterprise, its production-development fund, and the indicator of planned profitability of production, are entirely different indicators both in their economic essence and in their purpose. This is proved at least by the example that, when improving the eco-

…in the economic activity of the enterprise, one of these indicators (the efficiency norm) decreases, while the other (profitability of production) increases at the same time.

Nor can one agree with those economists who propose evaluating the comparative local (cost-accounting) efficiency of variants of technology by the profitability indicator \((p)\)

\[ p=\frac{\Ц-(C+\Phi+Б+P)100}{K_{\phi}},\ \%, \tag{2} \]

where \(\Ц\) is the price of the product;
\(K_{\phi}\) is the value of production funds (capital investments).

They believe that the increase in profit from the sale of a particular product, calculated per ruble of the funds required for it, allegedly indicates profitability for the enterprise as a whole. Under certain conditions such an assessment may indeed result, but by no means in all cases. This can be verified in our example. Suppose that products \(A, B, C, Д\), and \(E\), at wholesale prices, amount respectively to 200, 180, 230, 250, and 160 thousand rubles. Calculating the profitability indicator by formula (2), we find that under the second variant it is expedient to manufacture products \(A, C, B\), and \(E\), and under the first (old) variant—product \(Д\).

Within the limits of a given production-development fund equal to 290 thousand rubles, it would be necessary to manufacture, under the second variant, products \(A, C\), and part of \(B\). The total saving in the enterprise’s costs in this case would amount to less than 50 thousand rubles, whereas in the first case this saving amounted to 55 thousand rubles. Thus, orientation toward the profitability-of-production indicator when choosing the most rational variants of technology may fail to correspond to the attainment of the maximum total profit for the enterprise as a whole.

Consequently, the most economical variant of technology should be considered not the variant that requires the least expenditures in the production of a particular product, but the one that corresponds to the attainment of the minimum costs for the production of all the enterprise’s output.

The solution of the indicated problem can be successful only if, in choosing rational variants of technology, we are guided by an indicator quantitatively expressed by formula (1), or by the derivative of this indicator, which has received the name of the enterprise’s reduced costs \(C_{\п}\).

\[ C_{\п}=C+\Phi+Б+P+E_{\н}\cdot K, \tag{3} \]

\(E_{\н}\) is the norm of local (cost-accounting) efficiency of additional capital investments;
\(K\) is the capital investments made from the production-development fund.

By the minimum of this indicator are determined the variants of technology whose implementation will contribute to the attainment of the maximum aggregate profit of the enterprise as a whole.