Motivating the Market

No discussion of the capitalism/socialism debate can ignore the dramatic changes that have taken place in the nations of the East in the late 1980s and beyond. Though much of this change has been in their respective political systems, there have been substantial changes in the economic systems as well.

Why this has happened when it did is something of a mystery. Every eco­nomic system has its problems, and in the abstract, there seems to be no way to know how high a standard of living an economic system ought to be able to deliver. However, it may be that growing and glaring comparative defi­ciencies have finally undermined faith in central planning, even and espe­cially among the elites. Over the past twenty years or so, market economies have initiated, assimilated, and exploited dramatic new technologies so effec­tively that the gap between the standard of living in the socialist East and the capitalist West (which now includes a number of countries in the Western Pacific) has once again begun to grow. Furthermore, this fact has become increasingly well known as the East has become more accessible to Western travelers and journalists and as many people in the East have learned more about the standard of living in the West.

Paralleling these changes in public attitudes have been changes in the intellectual climate. Up until about the middle 1980s, it was possible to find respectable thinkers, including some economists, who had some praise for and were optimistic about centrally planned economies. For example, Robert Heilbroner and Lester Thurow have said, “Can economic command [i.e., central planning] significantly compress and accelerate the growth process? The remarkable performance of the Soviet Union suggests that it can. In 1920 Russia was but a minor figure in the economic councils of the world. Today it is a country whose economic achievements bear comparison with those of the United States” (1984, 629). Now Heilbroner and Thurow do not say what kind of comparison these achievements bear, but the tone is clearly one of restrained admiration. Up until the end of the 1980s, a significant seg­ment of mainstream opinion had it that just as Western capitalist economies had their problems, so, too, did centrally planned socialist economies. The problems were different, and the general standard of living in the East was lower for a variety of (mostly historical) reasons, but the basic difficulties were not categorically different in their extent or severity, though they might be in their etiology.¹

This view is no longer intellectually respectable. This is not a simple con­sequence of the repudiation of central planning in Eastern Europe and the former Soviet Union. Sometime in the middle-to-late 1980s, something approaching a limited consensus began to emerge among the intelligentsia in the West.² This consensus holds that the inefficiencies endemic to any cen­trally planned economy are serious to the point of being catastrophic and that the only reforms that have any chance of success are those which are part of a process of fundamental change that replaces central planning with the mar­ket.

In retrospect, the publication in 1983 of Alec Nove’s The Economics of Fea­sible Socialism may have been a turning point, at least among socialists in the anglophone community. Most of the book is really about the economics of infeasible socialism, that is, central planning. Nove offers a systematic struc­tural critique of centrally planned economies. Only in the last chapter does he get around to talking about feasible socialism, and it involves a substantial reliance on the market. Perhaps because Nove is himself a socialist (and a spe­cialist on the Soviet economy), this book was not dismissed out of hand by those on the Left and was in fact well received.³ The basic message seemed to be that these systems do not work very well—for deep structural reasons— and that recognition of this fact does not require giving up on socialism.

To say that a view is no longer intellectually respectable is not to say that no one holds it anymore. Nor does saying so have much probative value: truth is not discovered by a show of hands. However, this consensus is, in fact, well founded; it is not surprising that the best arguments in support of it come from the Right. This is not because those on the Right have a monopoly on high-level critical skills. It is just that the opponents of a position are most likely to see clearly its most serious weaknesses. By contrast, it would be sur­prising if a position’s most fervent supporters were to discover its main draw­back. It is a testament to the intellectual integrity of many Eastern European socialists that they have come to see (often at the end of a protracted and painful period of soul-searching) that central planning has been at the root of the problems facing their economic systems and that nonradical reforms have no chance of success.⁴

Let us turn from the history of ideas to the arguments.

The argument for the necessity of market prices starts from the fact that production in the modern world is enormously complicated. A wide range of producer goods and different kinds of labor go into the production of even the simplest consumer good. Think of what is involved in getting a pencil from unimproved raw materials to the consumer. For production to proceed efficiently, there must be coordination between and among suppliers of raw materials and labor, producer goods Hrms, and consumer goods firms. Oth­erwise, shortages and surpluses will develop and inappropriate goods (e.g., parts that don’t fit, shoddy products) will be produced. To effect coordina­tion in a centrally planned economy, planners assign firms production tar­gets, expressed in physical terms, such as so many tons of nails or so many automobiles.

Because so much depends on the particulars of both what is supplied and what is demanded, the planning system must assimilate and process enor­mous amounts of information if the plan itself is to be well informed and ulti­mately successful. For example, if there is a need to transport tomatoes from Tbilisi to Minsk, it is not enough to know that there are trucks available in Tbilisi. One must also know that these trucks are not used to haul manure, that they are actually running, that there is adequate fuel along the way, and so on. Highly specific or particular information is required for effective plan­ning, yet the only manageable way to gather and process the huge quantities of information needed to plan a large economy is to put that information in statistical form. The problem with using statistical information for planning was clearly recognized by Hayek.

The statistics which such a central authority would have to use would have to be arrived at precisely by abstracting from minor differences between things, by lumping together as resources of one kind, items which differ as regards location, quality, and other particulars, in a way which may be very significant for the specific decision. It follows from this that central plan­ning based on statistical information by its very nature cannot take direct account of these circumstances of time and place. (1945, 524)

The central planners, then, are faced with an intractable informational problem in that the information they have access to is not very helpful, and the information they need is largely unavailable.⁶ What enormously compli­cates this basic problem is that the relevant information is constantly chang­ing. Mises called attention to five broad categories of change: (1) change in the physical world, (2) demographic change, (3) changes in the means of pro­duction (e.g., tools and machinery wear out), (4) technological change, and (5) changes in consumer preferences (1951, 196-208).

In addition to these informational difficulties, there are several serious motivational problems involved in formulating the plan and getting it exe­cuted. It is not just that people will not work very hard in a centrally planned economy (although that has been a genuine and chronic problem). An equally serious difficulty is that key individuals have a strong incentive to pre­vent the efficient utilization of resources. For example, since managers are evaluated by the success of their units at meeting production targets, they have an incentive to underestimate plant capacity, to hoard means of pro­duction and labor, and to overstate actual production. All of these activities impede the timely convocation of producer goods and labor services required for efficient production. A third motivational problem is that there is little incentive to produce high-quality goods or goods that are actually needed. This is in part an echo of the problems involved in knowing what is actually needed and what trade-offs between quality and cost are acceptable in both producer goods and consumer goods. But it is also in part a motivational problem stemming from the fact that what actually drives production are the planning directives from the center and not the needs of downstream pro­ducers and consumers. Finally, the attempt to plan comprehensively all pro­duction discourages innovation in both production techniques and final products. Because innovation upsets existing ways of doing things, there is no place in the system for new ideas.

The true significance of these motivational and informational problems is evident only by a comparison with an alternative way of organizing produc­tion, namely, the market. In a market system, both consumers and firms transmit their needs and wants to supplier firms by their acts of buying and abstentions from buying. The retailer, the wholesaler, the manufacturer, the supplier of capital goods, and the owners of original factors of production (natural resources and labor) all get information from the market by way of prices for their outputs and costs for inputs and outputs. Hayek’s (1945) cen­tral insight is that market prices are fraught with epistemological significance. The prices at which goods and services exchange tend to reflect and amal­gamate both the plans of market participants and their beliefs about the alter­natives open to them.

Moreover, changes in prices reflect changes in those plans or changed beliefs about alternatives. For example, suppose that the Florida citrus crop is repeatedly decimated by frost. When the frost hits, the price of citrus will be raised by those with product to sell. This serves as a signal to others on both the supply and the demand side that less of this crop will be available than was previously thought, and people adjust their plans accordingly. Other suppliers who are not affected (e.g., the Brazilians) may move to increase production; buyers will turn to substitutes, which will drive up those prices, which, in turn, will lead to an increase the production of substitutes for substitutes, and so on.

In short, production will have been recoordinated to be brought better into line with the new economic realities. No one person or committee had to make all of these decisions about production. Prices transmit the necessary information from those who have the knowledge to those who need to know. Entrepreneurial profit or pure profit (as it is sometimes called) comes from being among the first to notice, either through luck or foresight, that peo­ple’s plans are not as well adjusted as they might be relative to the changing underlying economic realities. The constant changes in the five broad cate­gories listed means that there will always be profit opportunities “out there” for firms and individuals with foresight or luck or both. The hope of making positive profits and the fear of suffering negative profits (i.e., losses) comprise the main incentives for firms and individuals to act in ways that improve the coordination of production.

Ofcourse, these processes do not always operate without impediments— some thrown up by entrepreneurs themselves and some by their friends in the state. This story abstracts from monopolies, externalities, artificial barri­ers to entry, public goods problems, and so forth. The system is not perfect. However, these are complications or wrinkles on a more fundamental story about how a market economy works. According to that story, resource allo­cation, and thus the coordination of production, is fundamentally achieved by entrepreneurial decisions based on prices and motivated by the desire for profits. The contrast with how production is coordinated in a centrally planned economy could hardly be more stark and dramatic.

The preceding is a fairly compressed statement of the Mises-Hayek argument for the superior efficiency of a market system relative to central planning. The notes to this chapter direct the reader to more elaborate discussions of these points. The main ideas, however, should be clear enough. This argu­ment and the surrounding discussions over the years constitute a clear instance of progress in the capitalism/socialism debate. Mises and Hayek have offered a comprehensive critique (see chapter 1) of a significant (sub-)type of socialist economic systems, namely, those with a centrally planned economy. Nearly all existing socialist systems have had this type of economic system; until recently, many people believed that central planning is, in many respects, comparable to a market system.⁷ However, Mises and Hayek argued that the economic system of the good society could not be a centrally planned economy because, by its very nature, such a system is grossly inefficient rel­ative to what a market system can achieve. The main problem with these economies was not capitalist encirclement, political despotism, a poor natural resource base, or any of the other excuses that have been trotted out over the decades. Instead, it is—and always has been—central planning itself.

Notice that this critique of central planning includes a limited defense of a free enterprise system. Mises and Hayek explain not only the informational and motivational deformities of central planning but also the corresponding excellences of a free enterprise system. This is as it should be, since they con­ceived of themselves as giving reasons against a certain kind of social change that was high on the socialist agenda in the early part of this century: the abo­lition of the market.

This argument also spurred socialist theoreticians to think about how a socialist economic system might employ markets. Mises’s first and most important opponent in the calculation debate, Oskar Lange, even suggested that a statue of Mises be erected in at the Ministry of Socialization in every socialist country in recognition of Mises’s contribution to socialist thought (1938, 57-58).⁸ On Lange’s view, Mises had called attention to a heretofore unrecognized problem that socialists needed to solve. As a result, the capi­talism/socialism debate has narrowed to the point that the dispute can now fairly be characterized as between different types of market systems.

ft is beyond the scope of this book to give a history of attempts to com­bine markets and socialism beyond noting the origins of the idea in the cal­culation debate. There are, however, two related terminological points that warrant brief mention. Sometimes in discussions of attempts to reform or change existing socialist economies, the term ‘market reform’ is used to refer to any change which tries to take scarcity values into account in a more sys­tematic way than central planning does. This seems to be what many jour­nalists (East and West) and government spokesmen in Eastern Europe and the former Soviet Union have meant when they talked about market reforms, at least before the events of 1989-91. For example, it has been reported that in the former Soviet Union, a plane ticket for a five-hundred-mile trip cost less than a blank video cassette and that until Poland dismantled its centrally planned economy, subsidies on bread made it economical to feed it to hogs. Market reforms, as the term was used, involved repricing these goods and services to diminish these apparent irrationalities.

In a similar vein, the term ‘market socialism’ has been used to refer to any centrally planned socialist system that tries to take scarcity value into account in a more systematic way than they have previously done, with, however, no commitment to decentralized market pricing, that is, to letting firms charge whatever they think the traffic will bear. These ways of using the term ‘mar­ket’ may be appropriate for discussions of gradual reforms in centrally planned economies, but the ‘market’ part of market socialism must be defined more narrowly for the purposes of this book.

A market socialist system must, by definition, be one in which the market pricing mechanism, as it was just described prevails. The reason for this is simple: the preceding discussion indicates that the efficiency of the market is to be found in the process by which market pricing coordinates production. If a market socialist system is to be about as efficient as a free enterprise sys­tem, it must employ a market pricing mechanism. Accordingly, let us say that an economic system is a market economy if and only if most production is coordinated through market pricing. This implies that firms in a market socialist economy are free to raise and lower the prices of both producer and consumer goods as they see fit. This definition allows for exceptions to, and restrictions on, the basic market process along the lines discussed in Chapter 1, provided that they do not individually or collectively overwhelm the mar­ket pricing mechanism.

The primary motivation for wanting a socialist economic system to be a market economy in the sense just defined is not far to seek: it permits the economy to approximate the efficiency of a free enterprise system. An appre­ciation of the efficiency of market pricing is now widespread among social­ists (Nove 1983, 180-82; Miller 1989b, 30-32; Schweickart 1980, 67-68; Horvat 1982, 501; Estrin and Winter 1989, 106-7). The term ‘approximate’ is carefully chosen, but it has some misleading connotations.

First, the misleading connotations. Socialist respect for the market is hedged, qualified, and highly conditional; in short, it is grudging. In light of this, it is a little misleading to suggest an attitude of emulation toward free enterprise systems among those who favor market socialism. No such sug­gestion is intended here. Moreover, this way of talking suggests a compari­son with free enterprise systems (or aspects thereof) as they exist “on the ground.” For socialists who think in pictures, this conjures up images of Wall Street, the Chicago Board of Trade, and even Las Vegas. Nothing like these institutions finds its way into the socialist vision of the good society. However, as the terms of the debate have been defined in chapter 1, the objects of com­parison are never economic systems as they exist “on the ground” but are, instead, types of economic systems, which are abstractly specified by their type-defining features. When comparing types of economic systems, one abstracts from all other properties of existing economic systems except those that are relevant for the purposes at hand. Whatever market socialists find objectionable about existing free enterprise systems, it is not their basic pric­ing mechanism; it is primarily this feature (and perhaps only this feature) that market socialists find admirable and worthy of emulation, however reluctant they are to put it in those terms.

The misleading connotations neutralized, or at least noted, it does seem to fair to say that market socialists believe that the efficiency of a market socialist economic system is at least in vicinity of what one finds in a free enterprise system. Certainly, they do not believe it would be significantly less efficient. And because the basic method of coordinating production is the same, it is doubtful that they believe such a system would be dramatically and categorically more efficient. It is difficult to be more precise than this, in part because it is difficult to find clear pronouncements on this question in the writings of contemporary market socialists. The usual view seems to be that a favored type of market socialist system would be about as efficient as a free enterprise system. In support of this, some authors simply point to the effi­ciency advantages of the market in such a way that there is no apparent pre­supposition of private ownership of the means of production. The implica­tion is that social ownership would be equally efficient. (See Selucky 1979, 208-9; Horvat 1982, 205-8; Miller 1989a, 9; Miller 1989b, 31.)

Other authors recognize that their favored system may be subject to some inefficiencies that do not face free enterprise systems (e.g., Vanek 1970; Schweickart 1980, 73; Cohen and Rogers 1983, 164; Bonin and Putterman 1987; Estrin 1989, 175-76). On the other hand, they believe that a market socialist system would not have some of the inefficiencies facing free enter­prise systems. The reasons given are various, but a common (if not univer­sal) thread is the enhanced role of the state in the economy. On their view, the state in a market socialist system is better able to handle externalities and public goods problems; through its control of new investment, it can dampen or eliminate the inefficiencies associated with the business cycle.⁹

However the finer points of this issue are decided, a free enterprise sys­tem can and should serve as at least an implicit standard of comparison for market socialist economic systems for at least two reasons. First, to the extent that socialists’ acceptance of the market is motivated by a rejection of central planning, that rejection is based on a comparative judgment between cen­trally planned economies and free enterprise systems. Although the Mises- Hayek argument is cast in terms of private ownership of the means of pro­duction, market socialists are clearly committed to the view that their favored type of system would compare about as favorably with central planning as free enterprise systems do.

Second, for reasons that need not detain us here, noncomparative effi­ciency assessments of economic systems of any sort seem to be deeply prob- Iematic.¹⁰ In consequence, it may be that only comparative judgments of the efficiency of economic systems are possible. If that is true, market socialists are faced with saying that their favored type of system is much less efficient, about as efficient, or much more efficient than free enterprise systems. The first alternative is plainly unacceptable, and there is no justification for the third option. Only the middle alternative is one that both has some prima facie plausibility and supports the market socialist view that the economic evils associated with central planning are not endemic to socialism.

But why does efficiency (comparative or otherwise) matter at all? It is not simply a question of keeping up with the Joneses, that is, the capitalist West. Rather, this efficiency is important because, at the very least, it makes it pos­sible for everyone’s basic material needs to be satisfactorily met. Material needs are those that can be met through the economic system (e.g., needs for food, clothing, and health care). In other words, they are needs that can be met by exchangeable goods and services. ‘Satisfactorily’ and ‘basic’ prob­ably must be understood historically and relatively. Every society that per­sists for any period of time meets most people’s basic material needs at some level. Clearly, however, not every existing society (today or in the past) is a good society when it comes to meeting people’s basic material needs. When most of a society’s population regularly waits in line for food and other basics, when that food (including staples) is of poor quality and often unavailable, when a duplex for two families is two adjoining rooms instead of two adjoining houses, when medical care for all but an elite falls far below what widely available technology and a little skilled application can offer, then people’s basic needs are simply not being satisfactorily met. By contrast, most people in the West do not face these problems. To be sure, the West has its homeless and hungry, but these comprise a tiny fraction of the total population. The vast majority do have their basic needs satisfactorily met, something that simply cannot be said of those who have lived under a regime of central planning.

It seems to be the case (though it is hard to document directly) that mar­ket socialists believe that people’s basic material needs would be satisfactorily met by whatever version of a market socialist economic system they favor and however ‘basic’ and ‘satisfactorily’ are understood. Its proponents believe that their favored type of system would at least do what centrally planned economies in the East have been unable to do and what existing free enter­prise systems in the West have been able to do for most of their citizens, namely, satisfactorily meet those basic material needs. The standard of living that market socialists believe is achievable by their favored type of system might be higher, say, at the level of the middle class in advanced Western countries. It would probably have to be at least that high if market socialism is to garner democratic support in the West in the absence of a total economic collapse. To the question, Why this standard of living? or, more cautiously, Why must an economic system satisfactorily meet people’s basic material needs?, the most obvious answer is that it is a necessary condition for any soci­ety—now or in the foreseeable future—to be a good society.

Though economic efficiency is perhaps the primary reason for market socialists to favor the market, it is not the only one. Another desideratum that the market can achieve (and that is part of most socialists’ conception of the good society) is freedom of occupational choice (Miller 1989b, 33). There may be others. However, in light of the catastrophic failure of cen­tral planning—the main form that actually existing socialist economic sys­tems have taken in the twentieth century—the most important motivation for the ‘market’ part of market socialism is that it can approximate the effi­ciency of a free enterprise system. That level of efficiency is itself necessary for satisfactorily meeting people’s basic material needs, which, in turn, is a necessary condition for a society to be a good society. Market socialists may well believe that their favored type of system would do much better, but they at least are committed to satisfactorily meeting people’s basic material needs. They believe, quite plausibly, that a market economy is adequate to that task.¹¹