The Soviet Experiment, Continued

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.

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.

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.

“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!

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.

“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.”

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?

Daniel,

Then, what is a market failure?

@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.

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.

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.

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.]

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.”

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.

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.

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.

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.

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.

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: 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.