Arnold Kling  

The Soviet Experiment, Continued

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More on the Austerity of 1945-... Market-Failure Theory vs. Sovi...

I found the discussion in the comments on my earlier post interesting. I have a lot of follow-up, so I will put this below the fold.

Responding to my tongue-in-cheek remark "Replace Lenin and Stalin with Krugman and DeLong, and you would be fine," one person wrote,


I don't think that Krugman and DeLong, with their fancy charts and equations, would have had what it took to pull off a revolution in Russia in 1917 and seize power

Let me push back a bit. Lenin was a theorist. On p.2 of her book, Nell points out that Lenin's collected works come to 45 volumes. Back then, theorists did not use charts and equations so much, but he was (and still is) taken quite seriously. There was no Nobel Prize in economics in Lenin's day. But his theory that imperialism is the last stage of capitalism has more widely cited than many theories that have gone on to earn Nobel Prizes for their authors.

As Nell points out, the Soviet theory was that capitalist competition produced waste, such as duplication and advertising. It struck me as very similar to the views of Marcia Angell on drug companies, and I can recall at least one column by Krugman where he cited Angell approvingly.

The Soviets believed that by eliminating these market failures (admittedly, they would not have used that expression), they would achieve a superior standard of living. What Nell and I are saying is that we should take their experiment seriously.

I think all of us, left and right, can agree that we do not like the totalitarian methods that Lenin and Stalin used to carry out their experiment. That still leaves at least two questions.

1. Are totalitarian methods separable from socialist policies? Friedman and Hayek argued that they are not. One can counter that contemporary America, western Europe, and especially Scandinavia disprove The Road to Serfdom and Capitalism and Freedom.

2. Leaving aside the issue of methods, does it work? By "it" we can mean government attempts to fix market failures in particular or socialism more generally.

As I see it, the central claim of Nell's book, Rediscovering Fire, is that the Soviet Union offers legitimate evidence about this second question, and the evidence is strongly negative. I think this is a point that is very much worthy of consideration.

In hindsight, it is easy for someone to say that Lenin and Stalin had some flaws in their models of the economy. But were those flaws only in their models, or is there something flawed about modeling per se? On the latter point, I quote the latest wisdom from Robin Hanson.


Since our minds are smaller than the world, the world tends to be more complicated than our mental models of it. Yes, sometimes we think things are more complex than they really are, but far more often reality is more complex than we appreciate. All else equal, since far mode makes us neglect detail, it tends to make us think things are even simpler, thus increasing our error. So far mode is a major source of human overconfidence

On a related note, I came across a law review paper by M. Todd Henderson, who writes,

It is a debate about experts versus markets. In one camp, we find those who believe that optimal social policy is something that can be discovered by experts based on an analysis of data and argument. The problem with schools or health care or crime policy, they say, is that the right people aren't in charge, or we don't have enough money to implement the right solutions, or we just need more research on the questions to determine the correct approach. The right answers, the socially optimal answers, are there for the getting. Those holding this vision--what Sowell calls the "unconstrained vision"--believe there are solutions to policy problems that are discernable from the reason and logic of smart people. They believe in experts. Sowell describes the "unconstrained vision" as follows: "the conviction that foolish or immoral choices explain the evils of the world - and that wiser or more moral and humane social policies are the solution."

...In the other camp, we find those who believe that social problems are not comprehendible by the human mind and that no amount of conferences, policy papers, or deep thinking will find solutions for them.

This paper was mentioned by Stephen Bainbridge in a post recommended to me by John Samples.

The Masonomics view is, "Markets fail. Use markets."

To me, the theme of faith in experts wielding models vs. skepticism of experts and respect for decentralized markets keeps showing up. Again, I ask, did the Soviet experiment fail just because they used the wrong experts? Or does it reflect a deeper problem, that centralized expertise is not the answer? And if the latter is the case, does the Soviet experiment not tell us something about less drastic attempts to correct market failure?


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COMMENTS (40 to date)
Philo writes:

(From Robin Hanson:) ". . . the world tends to be more complicated than our mental models of it." This should be more strongly stated: the world as a whole *is necessarily* more complicated than our mental model of it.

". . . does the Soviet experiment not tell us something about less drastic attempts to correct market failure?" You will get the reply: "The dose makes the poison. Massive overriding of the market, Soviet style, will make things worse; but a little bit of tinkering with the market will make things better."

Yancey Ward writes:

What was most disappointing in the previous comment section was that no one could/wouldn't define what is meant by "market failure" in his/her own mind. It seemed that the commenters just argued past one another because of this.

I haven't read Nell's book, but I got the impression from Kling's description that "market failure" is a subjective idea, whereas some think of it as an objective idea. I agree with the former and disagree with the latter.

Daniel Kuehn writes:

Yancey -
I may be wrong, but if an economist says "market failure" it usually has a very specific, objective meaning. There are a variety of types of "market failures", but the meaning is pretty clear.

Now - was the discussion hampered by a lack of conclusive definition? Sure - I'd agree with you on that. And the same could be said of the initial post, which is arguably where the definition should have been in the first place.

Lee Kelly writes:

The concept of market failure, as understood by modern economists, arises within a context of a modern economic theory. Since socialists like Lenin would, I think, reject most of modern economic theory, any notion of "market failure" they had would be quite different. Perhaps there would be some superficial similarity, but I doubt it would go far beyond that. Attempting to criticise modern notions of market failure vicariously through the ideas of people like Lenin borders on disingenuity.

I say this while agreeing with the sentiment of Arnold's post: markets fail, use markets.

liberty writes:

I think everyone is getting a little hung up on the term "market failure." Is Lenin describing a perceived market failure when he accuses markets of the wastes of advertising and duplication? If this isn't a "market failure" as economists define the term, isn't it still the kind of thing that some economists would argue government could intervene to address? In fact, as Kling told us, they do:

"As Nell points out, the Soviet theory was that capitalist competition produced waste, such as duplication and advertising. It struck me as very similar to the views of Marcia Angell on drug companies, and I can recall at least one column by Krugman where he cited Angell approvingly.

The Soviets believed that by eliminating these market failures (admittedly, they would not have used that expression), they would achieve a superior standard of living. What Nell and I are saying is that we should take their experiment seriously."

In the book I first explore the theories put forth by Marxists and other socialists, then I recount the experience in the Soviet Union, including quotes from the leaders and planners about the problems they faced, and the reforms they tried when their policies failed, and then I take the core lesson and consider policies in market economies that are based on a similar theory, trying to address a similar problem, or probably subject to the same issues that faced the Soviets. In other words, I take the lessons the Soviets learned and see whether they offer insight for market economies.

Now, these may only be one half of the story (outweighed by other considerations), or they may be less applicable in some industries. But this too can be informed by the Soviet experience: for example, I discuss the benefits of profit and loss at length, but I also point out that in industries in which there is little profit potential (e.g., public goods), some of these benefits won't exist. This is standard economics, but the full range of benefits of the profit and loss system is not standard subject matter - and it could help to inform the "public goods" discussion.

fundamentalist writes:

Philo:

The dose makes the poison. Massive overriding of the market, Soviet style, will make things worse; but a little bit of tinkering with the market will make things vetter.

That's the typical "third way" response. And the reason Mises spent more time on intervention in his later years than on pure socialism. On it's face, it just seems so obvious that only a fool would deny that the state can improve on the free market in some way, even if just a tiny way.

First, let's make clear that all free marketeers, until Rothbard anyway, assumed that the state would protect life, liberty and property because the market needs that environment in order to thrive. As Mises always wrote, true liberty is not the absence of rules, but the application of general principles to all people equally. A lot of market failure arguments today start with the assumption of no government and dares the market to protect life, liberty and property. Most free marketeers acknowledge it can't and never thought it could. So when people say the market can't handle the pollution problem, the answer is no one ever thought it could or should. Pollution is a life/property issue which is the domain of the state, not the market. Pollution problems result from a lack of clearly defined property rights. That's a legal/political issue, not a moral one.

With the above assumption about domains of responsibility, the issue becomes what is the role of the market? That depends on who you ask. Some say to produce the maximum utility for the most; some say to produce the most goods at the least cost as a pure competition market would. Everyone has a different idea of what the market should be doing and that determines what you consider market failure to be.

The Austrian view is that the market is a process of price discovery, nothing more. If you accept that, then it's hard to see how the market can fail.

But I would like to add that a free market is nothing more or less than the instantiation of property rights. Property means the power to use and dispose of what you own as you see fit. Property rights exist only in a free market. The more the state intervenes, the more it takes power of disposal away from property owners and the more it reduces property rights.

Can the state produce better results than a free market in any area at all? That depends on the results you want. Will the state produce a more equal distribution of wealth than the market? Of course it will, but not without costs. The real question is what is the cost/benefit analysis of state intervention. It can be shown that the costs of state intervention always outweigh the benefits if the total effect in the long run is allowed to be considered and not just the immediate effect on a few, which is the usual comparison.

Lee Kelly writes:

Since Lenin was, I think, an advocate of the labour theory of value, he might as well have been living on another planet when denouncing the failures of capitalism. Modern theorists have a radically different conceptual understanding of what market failure means and entails, even if they sometimes arrive at similar positions.

blighter writes:

"As Nell points out, the Soviet theory was that capitalist competition produced waste, such as duplication and advertising."

Or, as a preternaturally eloquent & infinitely intelligent speaker once pithiliy put it when discussing the immense benefits to be derived by having the government directly compete with those vile, venal villains in the private market: "by avoiding some of the overhead that gets eaten up at private companies by profits, excessive administrative costs and executive salaries, it could provide a good deal for consumers."

Now is the time when the promised glories of the progressive revolution can be realized! This is the moment when the tide of economic history turns and a bounty is freed from the greedy hands of the capitalists to rain upon the deserving people! Yes we can!

Daniel Kuehn writes:

liberty -

"I think everyone is getting a little hung up on the term "market failure."

Because that is what Arnold is hanging so much on.

I don't think anyone is disputing your primary insight (at least how you've stated it here). I haven't seen a comment that dispure that yet.

The problem (and the reason for the focus on terminology), is that Arnold's loosey-goosey use of the terminology misapplies your insight and overextends it.

8 writes:

In the previous thread, Dain wrote:
Nell's book discusses how the rationale for market failures that derived from classical liberal notions of perfect competition informed the Marxist conception of how to improve upon capitalism or "bourgeois economics."

I haven't read the book, but I get the sense that the fixation on the Soviets (by the critics) is incorrect. It sounds like the larger point is that the mistake came before communism. By examining communists, who we view as so different, we can see how they are in fact quite similar in some of their fundamental beliefs. Rather than viewing the implementation as incorrect, perhaps some of our fundamental assumptions are wrong.

Daniel Kuehn writes:

*- "that disputes that yet"


Ed Dolan writes:

"Again, I ask, did the Soviet experiment fail just because they used the wrong experts? Or does it reflect a deeper problem, that centralized expertise is not the answer?"

Yes, a deeper problem, but not quite the one about centralized expertise. It is important not to exaggerate the extent to which the Soviet economy was really centralized. In fact, as Paul Craig Roberts and I, among others, were arguing way back in the 1960s, the Soviet economy was highly polycentric, run by individual farm and factory directors each acting independently to maximize their own gain given the signals from their environment. The difference between the Soviet economy and a market economy was not so much its extent of decentralization, but the nature of the signals and incentives.

First, scarcity was not indicated by real prices, but instead, by a complex procurement game that followed dysfunctional bureaucratic rules that made somethings "cheap" and others "costly" in a way that produced famous paradoxes, like hauling coal 2000 miles (because transportation looked "cheap"), thereby using more energy to move it than was in the coal.

Second, gain for the local manager tended to be not a share of profit (which in a market economy at least approximately measures value produced, absent truly massive market failures) but instead a share of gross output. That feature encouraged production of huge quantities of "stuff," so that the Soviet economy produced 60 times more tractors than the US economy but no more wheat, and so on.

I'm glad someone is digging up this issue of lessons of the Soviet experiment. It was a very, very interesting one and there is a lot to learn.

My suggestion for the next thread is "what can we learn from Gorbachev's failed experiment to reform the Soviet System."

fundamentalist writes:

Daniel, I don't think Kling was being lose with the term "market failure." Socialists like Lenin considered everything about the market to be a failure because it didn't produce prosperity with absolute equality. That's how I took his use of the term.

Thomas DeMeo writes:

I think it is a big mistake to think that the world will continue to work the same way it did in the 20th century. Wouldn't the dynamics change considerably as societies get wealthier and more advanced technologically?

Tim Worstall writes:

Reading Anne Applebaum's Gulag what really struck me (I'd read Solzhenistin, even if I can't spell it so I already knew the horror of the camps) was Stalin's real belief that all labour was just that, labour.

Absolutely no idea at all about specialisation. He really did think that if you took an urban book keeper and stuck him in a forest with a saw then he'd produce as much wood as a trained forester. All you had to do was incentivise him with the right food rations. (Work quotas were actually set this way.)

So I think there was something more to the failure of Soviet economics than just the way in which attempting to solve all market failures is doomed to, erm, failure.

Yancey Ward writes:

Daniel,

Then, what is a market failure?

Kurbla writes:

"Are totalitarian methods separable from socialist policies? "

Social processes aren't something that happen to people, independently of their will. If 90% of people want non-totalitarian socialist country, yes, they can build it. What can prevent them? Foreign occupation only.

"Again, I ask, did the Soviet experiment fail just because they used the wrong experts? "

Mostly because they had no genuine support of the majority of population. We know that 1917, 25% of people supported Bolsheviks, and on first presidential elections 1991, it was 17%. You cannot explain efficiency or inefficiency of some system without asking "how many people really supported that system. "

ThomasL writes:

@Kurbla

"If 90% of people want non-totalitarian socialist country, yes, they can build it."

You're only describing a case where the totalitarianism would not chafe most of the time. It is still there. The level of cooperation is incidental to whether or not totalitarianism exists. That is a question of who decides for whom (Kgo? Kogo?), not the percentage of people that agree with the decision.

floccina writes:

I had a professor who used to say "you can either a market system or a command system". If you socialize enough you will start to need to command people to work in the taxed economy. I have been thinking about this in terms of health care. Health care in the USA is now up to 17% of the economy. If you socialize it completely (it is already 1/2 way there) you will need to raise taxes and health care will be freely available.
So how many women will stop working in the taxed economy and instead produce untaxed goods and services for in family consumption, which BTW is a tax dodge?
If you continue to raise taxes and make more goods and services freely available to all at some point you will have to eliminate the option of not working in the taxed economy. You are then in a command economy.

In a market system you just say, if you want X you have to work for it. One has the option to do without. One does not have the the option to consume and not pay.

liberty writes:

Ed Dolan,

Interesting comment. I would argue though that the issues you mention in the Soviet economy did come from "centralized expertise" -- for example, it was centralized expertise that set the prices, which, in addition to other factors which were also due to the plan (such as a shortage of inputs of a certain type), determined whether transportation "looked cheap" etc. Centrally set prices also meant that you could not use profit to reward managers--they tried, but profit was relatively meaningless and often led to worse distortions than rewarding by plan fulfillment.

An article in Pravda explained, “As a result of [the profit target] the output plan of wool dresses was greatly overfulfilled despite the absence of a large demand for them, while the output of children’s items lagged behind the plan, although there was a large demand for these goods.”

If profit is based on prices that don't reflect supply and demand, output targets and assortment targets may actually work better than profit targets!

Now, you say it was not really so centralized--and I have read Roberts and a few others who make this argument, but I am not impressed. The articles and books I have read this make this case seem not to cite any of the major Sovietologists or original source material, and they seem to be contradicted by both, from my reading.

You say: "Paul Craig Roberts and I, among others, were arguing way back in the 1960s, the Soviet economy was highly polycentric, run by individual farm and factory directors each acting independently to maximize their own gain given the signals from their environment."

How does this square with the fact that these managers had tightly controlled funds for wages, investment, procurement, regular bonuses, special types of bonuses, and a dozen other specific payment-types and could be (and were) prosecuted for misusing the money from these funds? Or that wages were centrally set, as well as prices on every input item and on the final product? Or that failing to meet targets was generally harshly punished while plan fulfillment was well rewarded? It seems to me that this was a highly centralized system--and most major Sovietologists seem to agree. It tends to be those on the periphery, like Austrian economists, who argue otherwise.

fundamentalist writes:

kurbla:

If 90% of people want non-totalitarian socialist country, yes, they can build it.

No, they can't. At least, they can't build a socialist society as imagined by Marx. They can build a partial socialist society, or a mixed economy, but pure socialism is impossible without totalitarianism. That was Hayek's point. To avoid totalitarianism they have to compromise with the market at some point.

Mostly because they had no genuine support of the majority of population.

They had the support of the population. As Mises wrote, not even a dictator can rule against the will of the majority for very long. Even China today fears public unrest from unpopular decisions. Socialism failed because no expert, no matter how intelligent, or group of experts can assemble the required amount and type of knowledge necessary to make all of the decisions. As Hayek wrote, intelligence is highly overrated, especially by intellectuals.

James A. Donald writes:

liberty writes:

"It seems to me that this was a highly centralized system"

It was and it was not. It tried very hard to be a highly centralized system, and failed catastrophically to be so. Thus, for example, potatoes tended to be allocated more by soldiers bushwacking trucks of potatoes, than by the plan.

It emitted a vast strangling tangle of red tape that made any movement impossible, and then commanded movement on pain of terrible penalties, forcing people to act in violation of red tape, doing what they were forbidden to do in order to accomplish what they were commanded to accomplish.

The Soviet Union was highly centralized in the fashion that Dilbert's office is highly decentralized, and highly decentralized in the fashion that Dilbert's office is highly decentralized.

In this, it closely resembled our health care system and financial system, only even more so. The financial reform bill is 2500 pages of unreadable gibberish, quite comparable soviet regulation, and just as unworkable.

Douglas Bennett writes:

Yancey-

A market failure, in the view of most economists, is when the market fails to produce and distribute the optimal amount of a good or service (the optimal amount being that the good is produced by those who can produce it at the lowest cost and consumed by those who most value it right up to the quantity where those who value it most value it at exactly what it cost those who could produce it for the least to make it).

Examples of market failures include monopolies (not enough is produced), externalities (negative externalities are where the costs of your actions do not accrue to you and positive externalities are where the benefits of your actions do not accrue to you; leading you to do too much or too little of that activity, respectively), and asymmetric information (this is what goes wrong in insurance markets- I know how risky my behavior is, but my insurance company does not, lading it to make mistakes when estimating the cost of insuring me because I am likely to lie in the first place (adverse selection) or to become more reckless once I'm insured (moral hazard)).

To determine if there is a market failure, ask: Could one more unit of this good be produced at a lower cost to society than it would be worth to society? If the answer is yes, there is a market failure. If no, ask: If one fewer unit of this good were produced, would the resulting reductin in cost to society be greater than the reduction in benefit to society? If yes, there is a market failure. If no, there is no market failure.

Since the costs and benefits to society of most goods and services are simply the costs and benefits to the parties immediately involved, these questions aren't nearly as difficult as they sound, and markets get them right in the absence of situations like those described above.

The last question is: Once we find a market failure, would the outcome be better if the government "fixed" it? This step is, almost without exception, always left out by politicians and those favoring larger government. To make matters worse, the same parties who omit that question are often the first to clai that there is a market failure, but without actually demonstrating what that failure is, or if it is even a market failure in the economic sense of the word.

Granted, if you thought the driving purpose of life was for everyone to have 42 rabbits, you would view any free market that did not result in this outcome as a total failure. However, that would not make it a market failure in the objective sense of the word- it would simply mean that your ideals of what everyone should prefer differ from what everyone actually prefers. It would take extreme narcissism to call that a market failure. Replace "42 rabbits" with "the same amount and type of stuff" and you have what Lenin would likely have called a market failure.

Daniel Kuehn writes:

Yancy: Then, what is a market failure?

Douglas - the discussion of a monopoly as a market failure is interesting - I had never heard that before. I imagine this is more tied in with questions of path dependence and entry barriers, rather than monopolies per se. The rest of the list looks good, obviously.

[Url changed to full form from tinyurl. Please use full urls so our readers can see where they are going before they click the links. Thanks! --Econlib Ed.]

Snorri Godhi writes:
Are totalitarian methods separable from socialist policies? Friedman and Hayek argued that they are not.

It is important to remember that Hayek did not have the Soviet Union in mind; he had in mind fascist Italy and especially nazi Germany. In those countries, socialism led to dictatorship; in the Soviet Union, it was the other way around: dictatorship made socialism possible.

Also, remember that, in fascist Italy, political repression was quite mild for a dictatorship (before the split between Mussolini and the King led to German occupation in the North); but most people would not want to live in a dictatorship even if they are at no risk of ending up in a gulag.

One can counter that contemporary America, western Europe, and especially Scandinavia disprove The Road to Serfdom and Capitalism and Freedom.

Scandinavia does not count because it is composed of small, homogeneous countries: see chapter 15 of The Road to Serfdom. The rest of Europe has arguably never been as centrally-planned as fascist Italy. Perhaps Britain came closest under the post-war consensus, and where did that lead? to the Winter of Discontent, which could easily have ended in dictatorship, at least in a country with a weaker democratic tradition.

As for the USA, you have not been socialist long enough to feel the need for a strong leader.

See also this empirical study.

Kurbla:

If 90% of people want non-totalitarian socialist country, yes, they can build it.

If 90% of people in a democracy want socialism = central planning, they can vote for it; but they cannot possibly agree on a concrete plan, and when they realize that, they will have to choose between democracy and central planning. The British gave up on planning (at least temporarily); other countries gave up on democracy.

Two Things writes:

I believe (A) "that social problems" ARE "comprehendible by the human mind" AND AT THE SAME TIME (B) "that no amount of conferences, policy papers, or deep thinking will find solutions for them."

The Second Law of Thermodynamics is "comprehendible" but (effectively) cannot be repealed.

Many social "problems" stem from human nature which we cannot (or shouldn't try to) alter. That doesn't mean we can't recognize, understand, and explain human nature and the "problems" which result therefrom.

(E.g., problem: racial "gaps" in average academic performance. Comprehendible basis: racially-grouped genetic differences in IQ. Available solutions: short-term, none; long term, none except perhaps an extensive forced cross-breeding program more coercive than anything Stalin ever tried.)

A side note: of course socialism in Scandinavia is totalitarian. See, e.g., Roland Huntford's study "The New Totalitarians."

Yancey Ward writes:
To determine if there is a market failure, ask: Could one more unit of this good be produced at a lower cost to society than it would be worth to society? If the answer is yes, there is a market failure. If no, ask: If one fewer unit of this good were produced, would the resulting reductin in cost to society be greater than the reduction in benefit to society? If yes, there is a market failure. If no, there is no market failure.

Sorry, but this is just proving my point that a market failure is a subjective evaluation, not objective. People see market failures where they want to see them, and don't see them where they don't want to.

fundamentalist writes:

Douglas provided a good textbook definition of market failure. However, most free market economists would completely disagree with the purpose assigned to the market by most textbooks. The textbook definition comes from the obsession with perfect competition, which, as Hayek noted, is not competition at all. Perfect competition excludes all of the factors on which companies normally compete, such as quality, and allows competition on price only.

When I teach perfect competition, I explain why the commodity market is the closest thing to perfect competition, then I ask students to try to imagine how the state might force the auto industry into the perfect competition model. They are appalled when they realize that all cars would have to have the exact same design and engine and color. There would be no choice.

Ed Dolan writes:

Liberty writes “As a result of [the profit target] the output plan of wool dresses was greatly overfulfilled despite the absence of a large demand for them, while the output of children’s items lagged behind the plan, although there was a large demand for these goods.” I wonder when that quote was. It sounds to me like what was happening during the perestroika period, when Gorbachev found, to his misfortune, that the profit motive did not really work in a system without private ownership, market-based finance, and so on. Earlier, the time PCR and I were writing about, profit incentives weren't of much importance, incentives were geared more to gross output.

I think James A. Donald is is right smack on the mark when he writes "It tried very hard to be a highly centralized system, and failed catastrophically to be so." His further comment "forcing people to act in violation of red tape, doing what they were forbidden to do in order to accomplish what they were commanded to accomplish" exactly captures the essence of the polycentric view of the Soviet economy.

The key to understanding "How this squares with the fact that these managers had tightly controlled funds . . . failing to meet targets was generally harshly punished while plan fulfillment was well rewarded . .." and so on is the fact that the planners just couldn't cope. They did not have the expertise to put together consistent plans that could physically be fulfilled, and anyhow, they were constantly under political pressure to promise more (in their plan documents) than what they knew could be delivered.

The chronic infeasibility of the plans is exactly what gave local managers their freedom to maneuver. They swapped inputs, found off-the-books workers, manipulated output data, and traded off targets they knew to be more important against those that were also mandatory on paper, but known to be less important.

Yeah, Liberty, you're right, this view of matters never caught on among "mainstream" Sovietologists, but I still they they were the ones that were wrong. In the last years of perestroika and the rest of the 90s, I lived, worked, and taught economics in Moscow, and I discussed these points with a lot of people who had lived through the Soviet years. Russian economists I talked to tended to agree with the notion that the system was not as centralized as it was made to look. They were quite clearly at home with the notion that corruption, personal relations ('blat'), and so on, not The Plan, were what determined what was made.

Gosh, it is fun to revisit this stuff. I haven't thought about it for years.


Bill N writes:

There are a couple funny things about experts.

First, an expert is, by definition someone with advanced understanding and/or capability in his or her field. That expertness, however, doesn't carry over into other fields. They often have insights gained by carrying over their favorite models and tools from their expert field, but outside of a very narrowly defined space, they are no longer expert.

Second, the world is a very complex interconnected place. It takes a lot of experts to keep any system running. I think Boudreaux, or maybe it's Williams is fond of the pencil analogy. The experts needed to manufacture a computer or automobile or run our airline travel industry challenges the imagination. You need experts not only in various disciplines of engineering, programming and manufacturing, but in management and coordination to make it all happen. It's no wonder that regulators are often captured by the regulated. Where else to you get the necessary expertise.

Putting together the narrowness of expertise and the almost unimaginable number of areas of expertise, it would be quite a wonder that any large system managed by a few experts wouldn't eventually stagnate or run into some sort of catastrophe.

Chris Koresko writes:

Two Things:

I believe (A) "that social problems" ARE "comprehendible by the human mind" AND AT THE SAME TIME (B) "that no amount of conferences, policy papers, or deep thinking will find solutions for them."

That strikes me as plausible, in a lot of cases at least. Understanding the mechanism that produces a problem doesn't necessarily give you a practical way to solve it.

E.g., problem: racial "gaps" in average academic performance. Comprehendible basis: racially-grouped genetic differences in IQ.

Hold on there. My impression is that some or all of the variation among racial groups in most or all socially relevant metrics can be completely accounted for by differences in the out-of-wedlock birth rate. Is that not so?

ThomasL writes:

I would define a market failure as a situation where there is no way to align incentives so that an actor is adequately rewarded for providing a useful service, or adequately punished for causing harm.

Pietro Poggi-Corradini writes:

1. I thought 'market failure' happens when there are benefits accruing for all parties of an economic transaction, but not for society as a whole. The typical example being pollution.

2. My head is spinning a little bit about 'decentralization'. This has happened to me before where a word I was familiar with, all of a sudden ends up meaning the opposite of what I thought originally. For instance, 'regulation' often entrenches current monopolies that can then do whatever they want and thus gives rise to 'deregulation', etc...

Likewise, it seems that the elimination of the price system in Soviet Union actually disconnected each individual plant manager from the rest, and gave rise to a highly 'decentralized', fractured, system.

So I'm starting to think that 'decentralized' is not really a good word to describe what we actually want. Just like 'deregulation' does not convey the 'market discipline' that we think would emerge, likewise 'decentralization' does not capture the high connectivity that price signals would provide.

liberty writes:

Ed Dolan & James Donald -

I don't think our views are very far apart. The fact that the plan was unworkable meant that the consequences of trying to enforce an unworkable plan drove the economy, which is a bit different than the idea that the economy was perfectly centralized under a plan.

However, it is wrong to take this too far and describe the economy as just a rent-seeking economy, or a corrupt system no different than some South American corrupt country.

There were black, grey, pink and brown markets in the Soviet Union, yes. However, firm managers *could* be prosecuted for misusing funds, and sometimes were. Yes, if they needed to, in order to fulfill the plan, they sometimes did misuse them; just as they often broke the law by acquiring inputs from suppliers other than the ones delegated, e.g., through tolkachi middlemen with additional bribes, blat, etc.

Still, the vats majority of what they did was (a) in order to fulfill their targets, which were set centrally, (b) using funds for the purposes intended by planners, (c) with prices and wages set centrally. Even the markets that did exist (black, pink, grey and brown) were generally used in order to fulfill the plan (except as end-consumers, when they were used to fill the needs unfilled by planned output) and prices were either set by the plan or emerged due to the supply (and often demand) generated by the plan.

So, as convoluted and distorted as the plan implementation was, the economy was guided by it.

Ed: that quote is from ~1965. The 1965 reforms introduced profit targets on a wider scale, although they had been used even before that on a smaller scale - but the price problem, as the quote reveals, made its use problematic, and that was never resolved. The whole debate around the 1965 reforms was about using profit more widely -- I discuss this at length in the book.

liberty writes:

Pardon me - that quote is from earlier than that, because I found it in Factory and Manager in the USSR - Berliner (1957).

fundamentalist writes:

Ed

They were quite clearly at home with the notion that corruption, personal relations ('blat'), and so on, not The Plan, were what determined what was made.

Your post is very interesting and I'd love to hear more about your experiences in the old USSR. I have read about it, but it's not the same. What did you think of "The New Russians" by Hedrick Smith? Of course, he was a journalist, not an economist, but he spent about 10 years there and married a Russian.

We probably do place too much emphasis on central planning. It has never worked anywhere as it was intended. That's partly because human nature thwarts it and black markets develop. But the main point is that the decision makers did not have accurate prices to guide them and that created enormous waste and guaranteed the failure of the system.

prometheefeu writes:

I think our ability to answer your question is limited by the very problem you bring up. To answer whether a government can run the economy well, we have to model a pure government. But what does that mean? I would argue we are limited in our ability to model a government because of our inability to fundamentally understand how real governments work and in the same way we cannot fully understand the economy. In other words: the real world is larger than our brain. So, any such general model of government would say more about about the biases of the modeler than anything else and would prove worst than useless in answering your question.

Michael Strong writes:

Scandinavia does not disprove "The Road to Serfdom." As I note in "Be the Solution," by the Fraser/Cato Economic Freedom of the World Index, with the exception of "Size of Government," Scandinavia has just as much economic freedom as does the U.S. Scandinavia is a free market welfare state, NOT socialism, insofar as socialism originally referred to government control of the economy. In the 19th century Henry George was a brilliant advocate of free trade (even the Mises Institute thinks so) who yet advocated land taxes and some form of redistribution. The issue of transfer payments, a la Scandinavia and George, is analytically distinct from socialism, i.e. government control of the economy. Neither Scandinavia nor the U.S. is Hong Kong, which itself is not a perfect manifestation of the classical liberal ideal, and yet it is important to differentiate transfer payments from government control of economic activity.

Magnus writes:

The purpose of USSR was to outcompete the capitalist world with military power, not with ice cream or washing machines. If we looking at actual preferences and deeds of Soviet leadership, that is.

And for failure - if a politbyro of libertarian economists were put in charge of illiterate medieval country devastated by war and were tasked with building the strongest possible war machine, are you sure you would have better results? ;-)

Tracy W writes:

Magnus: The purpose of USSR was to outcompete the capitalist world with military power, not with ice cream or washing machines. If we looking at actual preferences and deeds of Soviet leadership, that is.

Nope, this is wrong. The forced collectivisation of farming or Stalin's purges can't be explained as desire to outcompete the capitalist world with military power.

And for failure - if a politbyro of libertarian economists were put in charge of illiterate medieval country devastated by war and were tasked with building the strongest possible war machine, are you sure you would have better results? ;-)

We don't know what result the Communist leaders would have achieved if they were put in charge of an illiterate medieval country. What they put themselves in charge of was an industrialising country devestated by war. It is also not apparent that the Communist leaders tasked themselves with building the strongest possible war machine, Stalin's motivations for example seem to have been to maintain himself in power and if that meant purging the Red Army to do so, then so be it. Consequently it makes answering your question as to whom would be "better" impossible.

However, we do know what post-WWII Western Germany managed to accomplish - Ludwig Erhard, a German free-market economist, managed to introduce free-market reforms such as eliminating price controls and rationing regulations, and this was followed by the German economy recovering far better than, say, Britain, which wasn't as devastated by WWII.
See http://www.econlib.org/library/Enc/GermanEconomicMiracle.html

Now, of course, Erhard only had to worry about the economy and about political power, the Allies were taking care of Germany's military system. Whether he would have been able to win a civil war and avoided the risk of being overthrown by a coup is another question - a leader who is good at one thing is not necessarily good at another. Perhaps libertarian economists lack the necessary bloodthirstiness for winning civil wars and surviving coup attempts. So we can't be *sure* that libertarian economists would have done better with Russia in 1917 than the Communist leaders did.

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