G. R. Steele, Understanding the failure of socialist economics

State socialism – even in guise of an economic role for wise statesmanship – is a failed creed. The division of Europe in 1945 into market and centrally planned economies was the zenith of the Bolshevik revolution. Its last vestige was covered in 1989 by the debris of the Berlin Wall. In between times, the comparative economic performance of East and West quietened the intellectual socialists, whose aspirations had been sharpened by the Marxist phalanx in the calculation debate of the 1930s. Although socialism was shown to have failed, credit was slow to accrue to the opposing Austrian phalanx. The intellectual case that the Austrian School makes against socialism had been forgotten during the era of a ‘mixed economy’, ‘social democracy’ and the Keynesian–Beveridge–Butskellite middle-of-the-road welfare state. Thereafter, monetarism and the ascendancy of the New Right followed in the wake of a general dissatisfaction with macroeconomic performance. Weighed down by the burdens of high taxes and bureaucracy, and weary of trade union lawlessness and oxymoronic state ‘enterprise’ initiatives, the electorate was ready for change. In the West, aspirations for the free market and trade liberalisation gained an ascendancy.

The final collapse of central planning in the 1990s presented new food for thought. Many were surprised when laissez-faire did not follow laissez-aller: the emergence of free market entrepreneurial capitalism was not automatic. With hindsight, it was always likely that those who had been taught to equate private property with theft would be troubled by the notion of property rights. Although thriving black markets in the former eastern bloc had replicated some aspects of the market economy, they drew no support from the rule of law, nor could they provide any basis for taxation. So, apart from the currency printing-presses, newly independent Eastern states had few public revenue sources to draw upon after the sell-off of state-owned firms.

Although the need for positive action is now apparent, little thought has been given to the kind of institutional infrastructure that is necessary to support a market economy. Stated differently, the long-neglected arguments of the Austrian School are increasingly seen to be relevant. Until recently, the most common retrospect of the calculation debate of the 1930s was that the thesis of central planning had been matched by the antithesis of complete laissez-faire to give a synthesis of market socialism. This is wrong.

Karl Marx had envisaged the self-destruction of capitalism: specialisation would force individuals into an ever greater division of labour and mutual interdependence, the intricacies of which no single individual would be able to grasp; nor would there be any control over its effects; but this was not expected to last. Rather, a growing concentration of industrial might would lead ultimately to central direction that would replace the market system and restore the bond between workers and their product. This was Marx’s prediction.

The counter from Ludwig von Mises had been that local planning is vital. This takes place under the impartial direction of the market process, which no level of sophistication in the instrumentation of a central plan could possibly emulate. Mises emphasises the necessity for market-determined exchange values in respect of capitalistic production, because ‘[t]he human mind cannot orientate itself properly among the bewildering mass of intermediate products and potentialities of production without such aid’ (Mises 1920: 103). Since every entrepreneurial decision affects the whole configuration of prices, such coordination is achieved only through a constant feed-back of new prices and the consequential readjustments to individuals’ plans. With the further point that a centrally directed construction of an economic plan cannot draw upon knowledge of the particular circumstances of time and place, Hayek had shown that intellectual aspirations for socialist planning are an epistemological impossibility. Indeed, the socialist calculation debate drew from Hayek three important arguments against socialism: ‘in the real world goods are not easily specified . . . costs were not objectively given . . . [and] …. knowledge is uncentralizable’ (Streissler 1992: 65–6).

Yet socio-economic coordination is a problem that has received scant attention. In ignoring the issue of knowledge acquisition and coordination, Walrasian general equilibrium economic theory misrepresents the ease with which optimal resources allocation might be achieved. This allows scope for a case to be made for socialism: given the same information set as is assumed to exist under theoretical general equilibrium, Oscar Lange demonstrates that an actual central planning board can replicate the competitive outcome (see Lange 1936). With that sleight of hand, it is made to appear that the mechanism of competitive market prices adjustment can be replaced by the precise mathematical calculation of a planning board. Yet, until the exchanges are made, the data do not exist; and after the exchanges are made, many of the data are no longer relevant. (So spare a tear for the econometrician!) By the failure to acknowledge the methodological gulf that exists between Austrian (disequilibrium) economics and neoclassical (equilibrium) economics, much of the socialist calculation debate was conducted at crosspurposes.

Whereas the Austrian School perceives the economy as a mêlée of competing and contradictory plans, and conducts its analysis against the (dynamic) criterion of multi-plan coordination, neoclassical economic analysis centres upon the (static) criterion of Pareto efficiency (whereby noone can be made better off without at least someone becoming worse off). To Austrians, incentives – that are implicit in the margins that exist when trade is undertaken at disequilibrium prices – are an integral part of the equilibrating process by which markets become mutually readjusted. Here, the entrepreneurial function (that is assumed by neoclassical economics to have already taken place) is vital since, by that activity ‘the price in one particular market is brought closer to equilibrium, and other people are better-informed about the opportunities available’ (Loasby 1989: 160).

The fundamental lesson to be drawn from the socialist calculation debate – the lesson that is lost to advocates of the socialist or even the mixed economy – is that economically efficient methods of production and distribution become evident only as some producers succeed while others fail. Bankruptcies are an important aspect of discovery in which efficiency and ingenuity are tested in open competition. To eliminate the possibility of failure is to eliminate initiative. Equally important is Hayek’s message that economics is an integral part of an evolving social order in which cultural history and mores are vital to the processes of knowledge acquisition and dispersion.

The importance of the cultural infrastructure to free market processes is central to comments made by the Chairman of the US Federal Reserve Bank: [t]he dismantling of the central planning function in an economy does not, as some had supposed, automatically establish a free market entrepreneurial system. There is a vast amount of capitalist culture and infrastructure underpinning market economies that has evolved over generations: laws, conventions, behaviors, and a wide variety of business professions and practices that has no important functions in a centrally planned economy. (Greenspan 1997). Among other requirements identified by Alan Greenspan are a free press, an impartial judiciary and a bill of rights to preclude arbitrary action by government.

The cultural infrastructure provides the cohesion to support the requirement for continuous readjustments that are necessary to accommodate changing patterns of demand. It is in the nature of diverse and dynamic economies that some industrial sectors (or regions) will prosper as others decline. New technologies and new consumer tastes insist that this is so. It is a classical economic proposition that factors of production (the supply side) should adjust continuously to accommodate changes in demand. The objective is the efficient conversion of effort (employment) into benefits (final goods and services). However, that fundamental truth – that supply patterns are adjusted to meet changing patterns of demand – was overridden by Keynes’s notion of deficient aggregate demand. In an era of macroeconomic demand management, the requirement is reversed: it is demand that must be adjusted in order to accommodate the need to supply.

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