Why socialism does not work

It is entirely fallacious when it is sometimes argued that the great power exercised by a central planning board would be “no greater than the power collectively exercised by private boards of directors”. There is, in a competitive society, nobody who can exercise even a fraction of the power which a socialist planning board would possess, and if nobody can consciously use the power, it is just an abuse of words to assert that it rests with all the capitalists put together. It is merely a play upon words to speak of the “power collectively exercised by private boards of directors” so long as they do not combine to concerted action — which would, of course, mean the end of competition and the creation of a planned economy. To split or decentralize power is necessarily to reduce the absolute amount of power, and the competitive system is the only system designed to minimize by decentralization the power exercised by man over man.

–  Friedrich A. Hayek  1944

The failure of Communism

Communism was tried on a big scale in the Soviet Union beginning in 1917. It was extended to Eastern Europe in 1946.  At one time – from about 1950 to 1985 – it was thought that it might take over the world. Then, all at once, in 1989, the whole system collapsed. First Eastern Europe, then the nations of the USSR abandoned communism, and, in the process, revealed their economies to be hollow shells with substandard housing, medical systems, products, services, and incomes. They had sacrificed and struggled, given up their freedom, lived under an iron dictatorship in the interest of progress and a future good life. The good life, however, was provided only to a limited few in the inner circle of the Party. The other 95% lived at a standard lower than the poverty level in western advanced countries.

Communism still lives on in North Korea, Cuba, China and Vietnam. But even in China, capitalism seems to be gaining on it.  Real communism has proved to be a failure everywhere.

How Socialism is different from Communism

What about socialism? Those who favor socialism say that the idea of central planning is still a good one. The problem with Russia and China was that they went about it the wrong way. To set up communism, in these countries there was a revolution, or a revolutionary takeover by an outside army. In the revolution, almost all property owners had their property confiscated by the state. In many cases it was necessary to kill or imprison a great many people because they objected to giving up their property, or to following the orders of the state. The government then undertook to run everything: stores, factories farms, housing, transportation, social services, repair services and spare parts. Money, profits, interest, and rent were abolished.

Decisions were made by central planners in the interest of all, rather than by local or particular industries or individuals who might be thinking of themselves or their own interests.   Unemployment was abolished. Prices were rigidly controlled. Free education and medical care was provided to all. Competition was abolished. Designs of goods were standardized. Production quotas were established for all industries, with materials “allocated” by central planners, rather than traded on the open market. Workers required permission to leave their jobs or travel to different areas, so that the system could count on a competent workforce wherever needed.

Socialists maintain that much of what was done in Russia and China was unnecessary.  Instead, what they should have done was to introduce peaceful central planning.

 The goal of peaceful socialism

The basic idea behind socialism is a simple one: You look at all the industries competing with one another to produce goods and services for the public. Instead of competing with one another, wouldn’t it be much more efficient if they all worked together in one or several large organizations? You could produce output at far less cost.

Socialism can be introduced in a peaceful and democratic way. No one needs to be killed or put in jail. Instead, socialists today favor non-comprehensive planning which retains the market, but directs it in socially desirable directions.

Ever since the world began, people have wanted to change it. For many, it is not enough to change their own lives by imagination, hard work, saving, and good living. They want to change everyone else’s lives too. They want to get control of the power of government, and use that power to make the world better for everyone. Not all of the objectives are the same, but many of them are familiar. Here are some samples:

  • Provide a decent income, free medical care, education, food, housing, day care, job training, and transportation for everyone, regardless of his race, creed, color, luck, or effort.
  • Equalize incomes by taking from the rich and giving to the poor.
  • Enforce a moral code on everyone: no drugs, abortions, gambling, pornography, or unnatural sexual practices.
  • Abolish the business cycle of booms followed by recessions; assure that no farmer ever loses his farm, no homeowner ever loses his home, and no industry ever closes its doors or lays off its workers. Provide meaningful and interesting jobs for all.
  • Keep the water, air, and environment clean; slow the growth of industry, enforce use of mass transit, fuel efficient cars, solar powered homes, keep the public lands free from industry, development, roads, grazing animals, loggers, and tourists.
  • Protect all endangered species; ban the use of the fur or flesh of animals, and ban the use of animals in experiments and tests.
  • Eliminate greed, excessive profits, high prices, foreign imports, export of jobs.
  • Ban nuclear weapons and nuclear power plants, coal plants and any type of industry that pollutes the atmosphere with sulfur or carbon di-oxide.
  • Provide generously for the relief of famine and sickness throughout the world.

Most proponents of socialism begin with the assertion that modern society has become too complex and interrelated for the old fashioned market system. Only sophisticated technicians with complete data and power can bring the economy under control, and get things coordinated according to a sound and sensible plan.

                                                        Three Basic Problems

There are three basic reasons why comprehensive planning does not work. They are:

  • The Knowledge Problem
  • The Obsolescence Problem
  • The Incentive Problem

To understand the problem of comprehensive planning, we must first contrast it with the market system that it replaced. Under a well running market system, there is intense competition. If prices are too high, or too low, entrepreneurs will rush in to sell at the high prices, or buy at the low prices. Their selling and buying will force prices down or up, until they reach a temporary equilibrium. In the process, consumers get what they want, and producers make a profit. The process as a whole seems chaotic, since no one is in charge. Inside each separate business, however, things are generally run very efficiently and economically — because if they weren’t, some more efficient or economical competitor would come along who would soon put them out of business.

Outsiders looking at the market say, “Baseball players make too much.” “There are too many cars on the road with a single driver”. “Competitors are always being forced out of business, throwing loyal employees out of work, and wasting the capital of the enterprise.” “There are too many gas stations and physicians clustered around a single main center, and not enough out in the countryside where they are needed.”

The solution to all of this is to put power into the hands of a central planning board that would decide everything: what will be produced, who will do it, what methods will be used, what quantities, etc. It sounds good, but in practice the system does not work well. Here is why:

The Knowledge Problem

The knowledge problem is that no one person, or group of people, can ever accumulate and use the knowledge necessary to run a tremendously complex modern society. They can accumulate data, and store it in computers. But data is not knowledge.

A technician will tell you there are many ways of providing electricity: coal, oil, nuclear, hydro-power, gas, geo-thermal, solar, wind or purchase from an existing network. Which is the best way in a particular place, with a particular load factor? The answer requires a lot of knowledge about that particular situation which planners hundreds of miles away cannot possibly accumulate or bring to bear. One would have to know, among other things, the price of each of the fuels, and the power plant construction costs for each fuel, plus the nature of the demand in the area. If the economy is planned centrally, and there are no markets — coal, oil, gas, cement, steel, and other materials are not bought and sold in any market — the planners have no idea of which solution is the most cost effective. They will have to make their decision on grounds other than cost efficiency.

That is what happened in Russia for seventy years. Decisions were made on political grounds: “We have a river nearby. Let’s build a dam.” or, “We want to show our technical skill, let’s build a nuclear plant.” The results were, often, terribly expensive mistakes or ecological disasters.

The knowledge problem is deeper than just a problem of collecting and using masses of data. Most of the knowledge about how a modern economy works does not exist in written form anywhere.  When a new employee shows up for work in any office or factory, it is several days, weeks, or months before he can learn his job well and be able to do it properly. Some of what he needs to know is written in manuals. Most of it is not, and cannot be.

  • Your biggest customer says that he has been offered a product by one of your competitors which is the same price as yours but works 20% faster. What should you respond?
  • Your main source of a vital raw material for your product just went out of business. You cannot operate without this material. What should you do?

Knowledge needed for the decisions in an economy exists, mainly, in the minds of thousands of competing decision makers, not on paper. In fact, it is impossible in principle to accumulate centrally the sort of knowledge that is necessary for rational planning. The market — made up of thousands of independent minds all figuring out what to do in their daily situation — can make effective use of personal economic knowledge in a way that a single comprehensive national planning office cannot.

The Price System

The biggest loss in comprehensive planning is the absence of information about prices that the market provides. Price information extends human understanding of the economy in a very dynamic way.

When the first organisms in evolution developed the ability to see, they greatly extended their capacity to function, which previously had been limited to things that they could touch.  The knowledge provided by prices extends human understanding of the world in the same way as the ability to see helped primitive organisms. Prices tell market participants what is scarce, what is plentiful, what is hard to get, easy to get, what is becoming obsolete, etc. The decisions to substitute materials, to manufacture in-house, or to change processes, are dictated by relative prices. To deprive decision makers of this type of information is like asking them to do business with their eyes closed.

But is a free market necessary to determine prices? Could not economists at various government ministries use their computers to trade materials back and forth, computing relative prices in the process?

Playing at a market is not having a market. In the real market, real people who own resources are trading them trying to make a profit. Each one is vitally concerned that his enterprise be a success — or he is out of a job or loses his capital. Tens of thousands of people are trading every day. The prices that are arrived at daily provide information to all of the participants about what is happening to supply, demand, technology, productivity. This is vital information necessary to operate an efficient enterprise. Government employees, with no personal stake in the outcome of any trade, cannot possibly produce prices that provide the information that the market provides.

The Obsolescence Problem

The obsolescence problem comes about because in a market system, products and processes have continually to be scrapped long before their usefulness is exhausted because something better has emerged as a result of free competition.  Without competition, planned economies do not know about, or cannot properly evaluate these new products and processes.  They are reluctant to abandon billions of dollars of capital sunk in the manufacture of older products and processes just because some new thing has emerged. The basic conservatism of the planning process forces planners to keep making obsolete products in old fashioned ways.

In the market system, old products and processes are constantly being scrapped before their time. Look at the history of the Personal Computer:

Personal Computers began with the Apple — the brainchild of two young computer experimenters. Within five years, Apple had sales of $139 million, and a host of competitors. When the industry grew large enough, IBM entered with its PC which immediately became the standard of the industry. Every new computer had to be “IBM compatible” or they soon died. Scores of early computer companies went out of business — Atari, Osborne, Commodore. Because IBM offered an “open architecture” which invited other companies to make plug-compatible printers, modems, disk drives, monitors, memory, and multi-function boards, a huge industry sprang up making computer equipment, and “clones” — copies of IBM PCs. Some companies became huge overnight: Compaq, and Dell. Japanese companies became important competitors: Toshiba and NEC. Thousands of software manufacturers began to turn out increasingly complex programs.

The competition of hundreds of independent companies resulted in constant innovation. Within a couple of years, the original IBM PCs were obsolete. A computer that sold for $2,500 in 1986 was worth less than $200 three years later because much faster and more sophisticated machines came out very rapidly. Machines built around an 8088 chip were replaced by a 286 chip. At about eighteen month intervals these were replaced by the 386, 486 and the 586. A major price shakeout in 1992 forced scores of companies into bankruptcy, while scores of other local firms continued to spring up to offer still cheaper clones made of hastily assembled parts from all over the world.

What was the result of this activity? Tremendously advanced computer power for the user. Jobs were created using highly sophisticated software for engineering design, word processing, graphics, accounting, financial planning, and desktop publishing.

The cost of this growth was high: thousands of individual firms went bankrupt in the process, discharging hundreds of thousands of employees, and forcing the scrapping of billions of dollars of capital equipment. At the same time, however, within the space of 15 years, the industry created more than a million jobs manufacturing or writing software, and at least two million jobs for users doing word processing and financial analysis.

The countries which created this revolution included the United States, Japan, Korea, Taiwan, Hong Kong, Singapore, plus some contributions from European countries. None of this revolution took place in any of the planned economies throughout the world. Why not?

Mainly because a planned economy cannot cope with obsolescence. Government enterprises throughout the world have great difficulty with the idea of abandoning a plant when its product becomes obsolete and throwing government employees out on the street. Politically, it cannot be done.  If a government plant had been set up in Russia, or Cuba (for example) to make IBM 8088 PCs in 1986 it would still be producing 8088 PCs in 1993 five years after their production ended throughout the rest of the world. Virtually all of the products being actively produced in Russian factories by 1991 when Communism came to an end were obsolete by world standards. The same is true of the factories of Eastern Europe. It is not a fault of poor leadership as much as it is an inherent defect of the idea of central planning.

The Incentive Problem

Why did the personal computer revolution happen? What made all of those thousands of individual companies come into existence — most of which failed in a few years? It was freedom and the hope for profits. Each entrepreneur thought to himself, “If I can just make this new product in a creative way, thousands of people will buy it, and I will become rich.”  In a market system there is plenty of incentive. It is this incentive that makes the whole system work.

A planned economy does not, and cannot have this type of incentive. Once a government factory is set up to build computers, they cannot allow individuals to set up rival companies to compete with it — particularly if they begin to make some product that is more innovative and popular than the planner’s model.  Such rival plants will destroy the planner’s system. It is easy for the planners to prevent competition. They just deny rival companies access to raw materials or labor.

Of course, well run government factories have to have some sort of incentive system. Employees are encouraged to come up with good ideas. They may receive promotions or bonuses. But employees cannot be allowed to take their ideas outside and set up rival factories. Such inside bonus systems seldom result in significant innovations because change disrupts a planned economy. Changing a model will result in putting skilled craftsmen out of a job, in scrapping expensive government-owned machinery and factories.  In a planned economy, this type of change is not supposed to happen, and it doesn’t.

The incentive problem comes about because planned economies cannot provide the same incentive to its entrepreneurs that the market economy does: the possibility of becoming rich through market activities. Without this incentive, planned economies get only a portion of the creative, innovative talent which is available to market economies. Without this talent, they fall further and further behind.

As a result, comprehensive planning fails in theory, and has failed in practice every time it has been tried. Centralization of the planning process in a modern economy is a backward, inefficient, ponderous, wasteful system, rejected today by those who have studied it, and those who have lived through it.

Non-comprehensive Planning

“True”, say the advocates of non-comprehensive planning. “It was a mistake for the governments of all of those countries to take over everything and abolish the market. We will keep the market, so we can know the prices of things. We will permit obsolescence and provide incentive for the entrepreneurs. Then we will intervene in the market, and steer it in the correct direction to achieve socially desirable outcomes.”

Non-comprehensive planners announce that they will abandon control over the details. “The people in the market know far more about how to build automobiles than we do.  We will let them make the cars. We will just tell them broad goals: what kind of cars to make, how many to make, and where to make them.”  For example, the planners will dictate the miles per gallon requirements, the source of the parts (Ford may buy from small business, but must not join forces with GM or Chrysler), the working conditions in the plant, the maximum number of hours per week, the minimum wage that may be paid, who may be hired (must meet quotas for various minorities), the affiliation of the workers (must, by law, belong to the United Auto Workers Union). The planners may require that the company provide day care for their employees’ children, and grant leave for workers for several weeks whenever there is a family problem. They will probably also issue directives on emission controls, the type of fuel, crash resistance. They will forbid automobile companies from joining with other companies to sell their products abroad or at home (due to anti-trust fears), and limit the percentage of imported parts permitted in cars made here.  The planners will also limit the profits that the car companies can make, and control the salaries of chief executives and directors. Finally, if a plant is in trouble, the planners may forbid management from shutting it down, or combining it with rival factories.

What is the effect of such non-comprehensive planning?  It reduces efficiency, productivity, and national income.  How can such a dogmatic statement be justified? Won’t some regulations provide a necessary corrective for “market excesses”?

If you think about it, you can see that no regulation can make the market work better. Look at personal computers. Suppose the government intervened to standardize the design of computers in 1988 to prevent wasteful competition, and avoid layoffs. The effect would have been to prevent the emergence of more advanced computers, and advanced software. At any given time, the free market is the least cost, highest innovation solution to any production problem. There is no way that a restriction on the market can produce lower costs or more innovative solutions.Many non-comprehensive planners make use of economic models for their plans. One of the most famous of the models was constructed by Wassily Leontief, Nobel Prize winner, whose model is called the input-output method. It is a giant table with the horizontal rows showing how output of each sector is distributed to other sectors, and the vertical columns show how each sector gets its inputs from others. Instead of broad aggregates like capital, labor, and raw materials, the chart contains groupings like steel, copper, plastic, glass, electrical machinery. Such a table, he explains, “is essential for a concrete understanding of the structure of the world economy, as well as for a systematic mapping of the alternative paths along which it could move in the future.”

Non-comprehensive planners intend to use such information to make national decisions on the future of each industry: which should get government funding, contracts, subsidies, tariff protection, anti-trust exemption, and higher or lower taxes, and which should not.

Economic Democracy

Many such non-comprehensive planners favor a process they call Economic Democracy. The idea is to “transfer economic decision making from the few to the many.”  Advocates of this type of government control are upset at the power of the large corporations which cater only to the demands of the consumers, rather than producing the products of “small, appropriate, technologies.” They want a powerful central planning office that will coordinate the decisions of thousands of management-worker councils at the grass roots level in arriving at national plans for the development of each industry.

The problem with this idea, of course, is that it will make the whole production process intensely political. Just as each community fights today to get a defense contract in its area, each locality under Economic Democracy will put intense lobbying pressure on the planning agency to bring the production of goods and services of all kinds to their area. The planners will have to determine the quotas for hiring, the tax advantages, the government contracts, the tariff protection, for virtually every industry in the country.

One technique advocated by Economic Democracy supporters would be to set price controls over certain industries essential to “the poor”, such as rent, heat, telephone service, electricity, transportation, gasoline, medical care and food. If, and when, these controlled industries fail to expand (because of the controls) then they would suggest that the industries be nationalized in the public interest.

Reindustrialization

Other non-comprehensive planners seek to bring back manufacturing to their country, which has supposedly gone overseas. They refer to some golden years (usually the 1950′s) when most products were made locally, and contrast that age with today when our economy has unraveled.

Robert Reich, for example, declared in 1983 that “It has been apparent for some time that our economy was out of control.” He said “The U. S. economy is grinding to a slow painful halt.”  We need an institution for “orchestrating adjustment”, and “more strategic policies to shift citizens to higher-valued production.”

The main argument of some of these planners is that certain industries are basic to our economy, like steel and automobiles. These industries should be supported at the expense of other industries such as food, paper and services. Other industrial planners favor support for “high tech” industries such as computer chips and electronics, at the expense of “sunset industries” like metals and mining.

The problem with this approach is that there is no way for the planners to know if they are right in their assumptions. The market allocates resources to the areas of greatest opportunity. When this allocation is distorted by a planner who has fixed in his mind that steel is more important than computers, or computers are more important than soybeans, the market process is distorted. Politically favored projects get the resources, rather than the most profitable ones. An economy that continues to choose less profitable methods will soon be a nation in decline, like Russia and Eastern Europe from 1950 to 1990.

The only way we can be sure which are the most profitable lines of production are by observing the outcome of market rivalry.  By channeling money directly to selected participants, we push the market in a pre-determined direction and deprive ourselves of the benefit of a market solution, which must be the most profitable one for the nation.

How government would direct the market

Spokesmen for industrial policy often look to the Japanese MITI (Ministry of International Trade and Industry) as an example of the way their planning would be carried out. In the past, Japan had spectacular growth in their industrial output. Their GNP grew from 21 trillion yen in 1951 to 404 trillion yen in 1990 — a growth rate of 3.3%. Many people think that much of the credit for this growth is due to the activities of MITI in picking and fostering sunrise industries.

They did have some success, but they had many failures as well. In the 1950′s MITI technicians were so unimpressed with the transistor that the tried to prevent Sony from buying manufacturing rights from Western Electric.  They tried to dissuade Japan’s automobile manufacturers from getting into the export market.

The real reason for Japanese success has been their high rate of saving. In 1980, saving was 19% of personal income, and government takes a much smaller share of GNP (25%) than does the U.S. governmental structure (40%). The result is that the private capital funding available to Japanese firms is much greater than that available to U.S. firms.

In fact, the case against non-comprehensive planning comes up against the knowledge problem again: how could a government planning agency know the correct answer to the question of which industries to support and which not to support? The answer is that they could not know. In the process of guessing, they would invite intense political infighting focused on the central government, with hundreds of billions of dollars spent, possibly, backing the wrong horse.

Where planning leads to

Non-comprehensive planning inevitably leads to greater and greater control over the economy and freedom, and, ultimately, comprehensive planning. Why should this be? There are several reasons.

  • Permanent regulations.  Government restraints on the market, once imposed, are seldom, if ever removed. The deregulation of the airlines in 1978 is the unusual exception to this general rule. The granddaddy of them all — the Sherman Anti-Trust Act, designed to prevent competition in the 1890′s, is still on the books, being applied to situations 100 years later which are totally unrelated to those before 1900.
  • Entrenched bureaucracy and constituents.  Once an industry receives favored treatment from a government planning process, it builds up a bureaucracy inside and a constituency outside the government, which collude to keep the benefits flowing forever. One has to look no further than the massive benefits given to American farmers to see an example of this force at work.
  • Unintended Consequences.  Intervention in the market usually has unintended consequences which require more intervention to correct. Case in point: deposit insurance in savings and loan and the banking industry. The insurance led many bank managements to take on unsound loans and illegal practices, on the assumption that their depositors would be bailed out. The result of the disaster that ensued is that more bank regulations are now required to overcome the problems caused by the original intervention.
  • Destruction of the regulated industry. Intervention in the market operates under the assumption that the market is self-sufficient and self-correcting. It will adjust to whatever taxes or regulations are imposed on it. If the intervention is too severe, however, the basic industry being directed loses its ability to function independently. It becomes a creature of the government. Government is then responsible for its welfare. Comprehensive planning has set in. Examples: defense contractors, many farmers, small business dependent on “set asides”, electric utilities, the railroad system.
  • Power gains in wartime.  The greatest gains in planning have occurred during our major wars, particularly World War I and World War II. During both of these wars, government took over major industries such as railroads, military construction, and basic metals. They instituted price and wage controls, rationing, and allocation of industrial materials. Tremendous power was congregated in the hands of a few planners brought to Washington to run the country. When the wars were over, most of the controls and regulations were abolished: but not all of them. After each conflict, the country was left with a longer and longer list of government powers that have moved the country closer to comprehensive planning.  Walter Lippman said on this subject in 1936:

though the planned economy is proposed as a form of social organization which will provide peace and plenty, thus far in all its concrete manifestations it has been associated with scarcity and war…In all the nations which are still democratic and capitalistic, plans are drawn for their rapid transformation into totalitarian states…That, I believe, is where all planned economies have originated and must in the very nature of things originate. For it can be demonstrated, I am confident, that there is only one purpose to which a whole society can be directed by a deliberate plan. That purpose is war, and there is no other.[1]

At the present time, there is a steady growth, year by year, in the planning powers of the government. The US government has taken effective control of the US Automobile industry – regulating everything including the MPG of cars, seat belts, emissions.

“I am absolutely committed to working with Congress and the auto companies to meet one goal: The United States of America will lead the world in building the next generation of clean cars,” Obama said in his first extended remarks on the industry since taking office nearly 10 weeks ago. And yet, he added, “our auto industry is not moving in the right direction fast enough to succeed.” 

 Obama, flanked by several administration officials at the White House, announced a short-term infusion of cash for the firms, and said it could be the last for one or both. 

 Chrysler, judged by the administration as too small to survive, got 30 days’ worth of funds to complete a partnership with Fiat SpA, the Italian manufacturer, or some other automaker. 

 GM got assurances of 60 days’ worth of federal financing to try and revise its turnaround plan under new management with heavy government participation. That would involve concessions from its union workers and bondholders. The administration engineered the ouster of longtime CEO Rick Wagoner over the weekend, an indication of its deep involvement in an industry that once stood as a symbol of American capitalism. 

 Obama’s announcement underscored the extent to which automakers have been added to the list of large corporations now operating under a level of government control that seemed unthinkable less than a year ago. Since last fall, the Bush and Obama administrations, often acting in concert with the Federal Reserve, have engineered the takeover of housing titans Fannie Mae and Freddie Mac, seized a large stake in several banks and installed a new CEO at bailed-out insurance giant American International Group.

A year following these actions, President Obama signed the Patient Protection and Affordable Care Act (which soon became known as Obamacare) in which the US government assumed control and ownership of one sixth of the US private economy.  The stated goal of many of those supporting the new law was to establish a “single payer” healthcare system in which the government pays all doctors, hospitals, laboratories and pharmaceutical companies. This healthcare system was the most significant step ever made towards socialism of the US economy.  The law is being challenged in the courts as being unconstitutional. If it survives these challenges, it will then become the established health care system for America. It will exhibit all the problems of socialism listed in this article.

For example, in the past fifty years, the US has become the world leader in advanced healthcare solutions. Whenever a political leader of wealthy person anywhere in the world has a major health problem, they are very often sent to the US for treatment. Why?  Because in the US there is intense competition in the healthcare industry that results in development of the latest medicines and techniques. Once the government controls all healthcare competition will be abolished. Competition is the reason that new products and techniques are created.

Is Change Impossible?

From what we have said here, comprehensive planning is unworkable, and non-comprehensive planning tends to so weaken and destroy the market that it leads to comprehensive planning. Does that mean that no change is possible?

Not at all. Changes are needed in our society and economy. There are many social problems that need correction: the decay of the family, crime, drugs, pollution, poverty, decaying cities, a degenerating educational system, slow growth, inability to save, low productivity, periodic serious recessions, high levels of unemployment, and a growing dependence of more and more citizens on government handouts as a way of life.  These things should be corrected.

The solution to these problems does not lie in vesting greater power in the hands of powerful planners in Washington. The knowledge problem shows that the freely competitive market makes more effective use of the information that lies dispersed throughout society than can any of its participants.

Change must come about through freedom of the individual to work, save, invest, grow, succeed, fail and learn. We cannot be our brother’s keeper, because we don’t know how to. It is better to free our brother to be his own keeper. The answer to our problems is to dismantle the constraints and barriers to freedom which have been erected over the years, and to allow free competition to flourish on the farms, in the factories and offices, and in the marketplace. Once people are truly free, there is no limit to what our people, our economy and our country can accomplish.

Summary

1.  Most people who look at the world see much that needs improvement. There are poor people, unfair laws, backward institutions. Modern society is huge and complex. Changes are difficult to make.

2. The market permits daily adjustment of the world to changing circumstances. But many people want more, they want radical changes. There are two key routes which are advocated: comprehensive planning, and non-comprehensive planning.

3. Comprehensive Planning, or Revolutionary Socialism: Plan and run everything from a central national planning office with power to enforce its decisions. Eliminate the market, and substitute ownership of the means of production by the people.

4. Noncomprehensive Planning or Evolutionary Socialism: (advocated by people who think that comprehensive planning will not work) Maintain a market economy, but intervene to control the market and direct it along socially desirable lines.

5. Comprehensive planning — socialism — has been tried over more than 50 years in scores of countries involving billions of people.  In these countries the government runs everything: stores, factories farms, housing, transportation, social services, repair services and spare parts. Money, profits, interest, rent is abolished.

Decisions are made by central planners. Unemployment is abolished. Prices and competition are controlled. Free education and medical care provided to all. Designs of goods are standardized. Production quotas are set for all industries, with materials “allocated” by central planners, rather than traded on the open market. Workers require permission to leave their jobs or travel to different areas.

6. Using central planning USSR and China became superpowers. Scores of countries tried to copy their seeming success.

7. In 1989, the whole system collapsed. All but a couple of nations have abandoned communism, and revealed their economies to be hollow shells with substandard housing, medical systems, products, services, incomes. They now want a market system as soon as possible.

8. There are three reasons why comprehensive planning does not work: a) The Knowledge Problem  b) The Obsolescence Problem  c) The Incentive Problem.

9. The knowledge problem is that no one person, or group of people, can ever accumulate and use the knowledge necessary to run a tremendously complex modern society. They can accumulate data, and store it in computers. But data is not knowledge.

Most knowledge about how the market works is not written down. It is in people’s heads.  The market — made up of thousands of independent minds all figuring out what to do in their daily situation — can make effective use of personal economic knowledge in a way that a single comprehensive national planning office cannot.

10. The obsolescence problem comes about because in a market system, products and processes have continually to be scrapped long before their usefulness is exhausted because something better has emerged as a result of free competition.  Without competition, planned economies do not know about, or cannot properly evaluate these new products and processes.  They are reluctant to abandon billions of dollars of capital sunk in the manufacture of older products and processes just because some new thing has emerged. The basic conservatism of the planning process forces planners to keep making obsolete products in old fashioned ways.

11.  The incentive problem comes about because planned economies cannot provide the same incentive to its entrepreneurs that the market economy can: the possibility of becoming rich through market activities. Without this incentive, planned economies get only a portion of the creative, innovative talent which is available to market economies. Without this talent, they fall further and further behind.

12.   Non-comprehensive planning recognizes that comprehensive planning does not work. It favors retaining the market so that prices will be known, and there can be obsolescence and incentives. This type of planner wants to provide incentives and regulations to steer the market in socially desirable directions.

13. In fact, any intervention in the market makes it less efficient. The free market is the least cost, highest innovation solution to any production problem. Any restriction will make it higher in cost, and less innovative.

14. There are many types of non-comprehensive planners. One type consists of those who favor economic democracy. They want to substitute decision making by the owners of enterprises with decision making by worker’s councils directed by planners in Washington. Economic democracy makes production extremely political.  The planners will have to determine the quotas for hiring, the tax advantages, the government contracts, the tariff protection, for virtually every industry in America.

15. Other planners favor industrial policies to bring back manufacturing to the position it had in society in the 1950′s. They favor government support to basic industries (such as steel and automobiles) or high-tech industries (such as electronics and computers).  They point to the success of MITI in Japan in directing Japanese industry into productive channels.

16. The problem with this approach is that there is no way for the planners to know if they are right in their assumptions. The market allocates resources to the areas of greatest opportunity. When this allocation is distorted by a planner who has fixed in his mind that steel is more important than computers, or computers are more important than soybeans, the market process is distorted. Politically favored projects get the resources, rather than the most profitable ones. An economy that continues to choose less profitable methods will soon be a nation in decline.

17. The real reason for Japanese success was not MITI which often was seriously wrong in their predictions, but in their saving rate, and low government spending. Private capital is much more available in Japan than it is here.

18. Non-comprehensive planning inevitably leads to comprehensive planning for several reasons:

  • Regulations, once imposed, become permanent. There is no going backward. Once planners have rewarded an industry, the bureaucracy and recipients become hooked on the government aid, and will not permit its reduction. All intervention in the market has unintended consequences. New regulations are needed to deal with these consequences.  Regulation of industries is eventually so comprehensive that the industry is no longer viable without government assistance. At that point, planning becomes comprehensive. Planning gets a special boost in wartime. Many wartime controls are retained in peacetime.

19. At the present time, there is a steady growth, year by year, in the planning powers of the government. In the 1990′s the insurance, medical and transportation industries are becoming more and more regulated, controlled and planned.  Although virtually everyone today agrees that a planned economy does not work, America is gradually becoming a planned economy.

20. The fact that comprehensive planning does not work, and that non-comprehensive planning leads to comprehensive planning does not mean that change is impossible. Change must come about through freedom of the individual to work, save, invest, grow, succeed, fail and learn.   The answer to our problems is to dismantle the constraints and barriers to freedom which have been erected over the years, and to allow free competition to flourish on the farms, in the factories and offices, and in the marketplace.

[1][1] Lippmann, Walter 1936 The Good Society New York, Grosset & Dunlap.

About Arthur Middleton Hughes

Arthur is currently Vice President of The Database Marketing Institute based in Fort Lauderdale, FL. Arthur is the author of 11 books, the latest of which is Strategic Database Marketing 4th Edition (McGraw-Hill 2012). A BA graduate of Princeton with an MPA in Economics and Public Affairs, Arthur taught economics at he University of Maryland for 32 years. He is an Austrian Economist.
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One Response to Why socialism does not work

  1. Dudley Foulke says:

    I like this analysis. We do not want to become like the European governments that just accept socialism as if it were a normal means of running a country. Does anyone read Hayek any more?

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