Crisis of Socialism and Effects of Capitalist Restoration

The main criticism leveled at the socialist economies was that a planned economy was inherently less efficient than a market one, due to the sheer scale of the bureaucratic task involved with planning a major economy. If there are hundreds of thousands, or perhaps millions, of distinct products, no central planning authority could hope to keep track of them all. Instead they were forced to set gross targets for the outputs of different industries. For some industries like gas or electric power, this was not a problem. Electricity and gas are undifferentiated, a kilowatt is a kilowatt—no argument. But even for another bulk industry like steel, there was a wide variety of different rolled plates and bars, different grades of steel with different tensile strength, etc. If the planners could not keep track of all these different varieties and just set rolling mills targets in tons, the mills would maximize their tonnage of whatever variety was easiest to produce.

The steel example is a little forced, since this degree of differentiation was still fairly readily handled by conventional administrative means. Tonnage targets could still be set in terms of distinct types of steel. But when you turn to consumer goods—clothes, crockery, etc.—the range of products was too big and targets were set in terms of monetary output.

The plan would specify a growth in the value of output of clothing, furniture, etc. What this translated to then depended on the price structure. In order to prevent other forms of gaming the plan by enterprises, it was important that the prices were economically realistic. If the price for chairs is set too high compared to tables, it becomes rational for factories to concentrate on chair production.

By resorting to monetary targets, the socialist economies were already conceding part of Ludwig von Mises’s argument. They were resorting to the monetary calculation that he had declared to be vital to any economic rationality. Liberal economists argue that it was impossible for planners to come up with a rational set of prices, as only the competitive market could do so. Planning required aggregation. Aggregation implied monetary targets. Monetary targets required rational prices. Rational prices required the market. But if you had the market you could dispense with planning. Planning dialectically implied the supersession of planning.

It is worth noting that this is a largely theoretical argument. It was, in late Soviet days, backed up with lots of anecdotal evidence, but empirical evidence for the greater macroeconomic efficiency of markets even when compared to classical Soviet planning is on much thinner ground. As Robert C. Allen shows, the only capitalist economy whose long-term growth rate exceeded that of the USSR was Japan, whose own model was distant from unplanned capitalism. Compared to other countries starting out at the same economic level in the 1920s, the USSR grew considerably faster. One could argue that this was due to macroeconomic advantages of planning, that is, by removing uncertainty about future market demand it encouraged a higher level of investment. It is possible that this macroeconomic advantage outweighed any microeconomic inefficiency associated with plans.

The strongest evidence that markets may perform better than plans would come from China, and that certainly is the orthodox Chinese view. Their claim is that a socialist market economy avoids the macroeconomic instability of capitalism while harnessing the microeconomic efficiency of the market. As evidence, they cite a higher rate of growth after Deng Xiaoping’s restructuring. But China since Deng has followed a mercantilist road. It has the effect of beggaring the workers of China whose products are exported to the United States in return for U.S. paper. The latter is of no benefit for the Chinese workers, though it does enable private Chinese companies to buy up assets in the United States. From the standpoint of the Chinese state, it is a more nuanced issue. Chinese state companies can buy up overseas firms, but whether this is a long-term advantage is a moot point since real goods that could have been used to improve the Chinese economy and living standards have been sacrificed.

Historically, the process of having an export-led economy allowed China to avoid the technology bans that the West imposed on the USSR, allowing rapid catch-up in manufacturing techniques. Now that China is overtaking the United States in some areas of mass production, that advantage is less clear, and a shift toward higher domestic consumption and higher wages makes sense, and is indeed being followed in China, unlike Germany. It could be that the growth advantage that China experienced post-Deng owed a lot to a new ability to import the latest productive techniques instead of microeconomic efficiency. But what is abundantly clear is that the pro-market restructuring had the effect of drastically widening economic inequalities and giving rise to a new domestic billionaire class. This, in turn, produces political pressure to extend private ownership and undermine the still-dominant position of state industry.

So the question arises, could a planning system work in a modern economy with a highly diversified product range, and how would it overcome the socialist calculation argument of Mises? I and others have since the late 1980s been arguing that the answer is yes.

The Mises critique of socialism focused on the need to compare the costs of alternative ways of making things. Unless you can do that you cannot choose the most efficient. Our response has been not only that labor time in principle is an alternative, which Mises conceded, but that with modern computer technology it is perfectly possible to maintain up-to-date figures for the labor cost of each input to the production process. Using these, workplaces will have data that are as good as prices for choosing between techniques.

There are limitations to labor values as there are to any scalar measure like price, since the constraints on production are multifactorial. Not only labor power, but also natural resources and ecological considerations constrain what we can make. No single scalar measure can handle this. But the problem of how to deal with multiple constraints like this was already solved by socialist economics way back in the 1930s. L. V. Kantorovich came up with a completely general technique for how to meet a socialist plan subject to constraints additional to labor time.¹ His method is a form of in-kind calculation, that is, non-monetary. It was not practical to use it at the level of the whole Soviet economy during his lifetime, as the computing resources were too poor, but by the 1990s computers were up to the job.²

So the basic problem of socialist economic calculation without money had been solved since Mises wrote. It was impractical in the USSR for two reasons: (1) the computer technology was not there; (2) it would have involved replacing money calculation and payment with nontransferable labor accounts. This would have been a radical step toward greater social equality.

The collapse of the Soviet and later the Russian economy under Mikhail Gorbachev and then Boris Yeltsin was an economic disaster that was otherwise unprecedented during times of peace. The world’s second superpower was reduced to the status of a minor bankrupt economy with a huge decline in industrial production and in living standards. Nothing brings out the scale of the catastrophe better than the demographic data pointing to the huge rise in the mortality rate, associated with the increased poverty, hunger, homelessness, and alcoholism resulting from the catastrophe itself (Table 1).

In determining what caused this, one has to look at long-term, medium-term, and short-term factors that led to relative stagnation, crisis, and then collapse. The long-term factors were structural problems in the Soviet economy and required reforms to address them. The actual policies introduced by the Gorbachev and Yeltsin governments, far from dealing with these problems, actually made the situation catastrophically worse.

Long Term

During the period from 1930 to 1970, and excluding the war years, the USSR experienced rapid economic growth. There is considerable dispute about just how fast the economy grew, but it is generally agreed to have grown significantly faster than the United Kingdom between 1928 and 1975, with the growth rate slowing down to the UK level after that. This growth took the USSR from a peasant country, whose level of development had been comparable to Brazil in 1922, to becoming the world’s second industrial, technological, and military power by the mid–1960s.

A number of reasons contributed to this relative slowdown in growth in the latter period. It is easier for an economy to grow rapidly during the initial phase of industrialization when labor is being switched from agriculture to industry. Afterward, growth has to rely on improvements in labor productivity in an already industrialized economy, which are typically less than the difference in productivity between agriculture and industry.

A relatively large portion of Soviet industrial output was devoted to defense, particularly in the latter stages of the Cold War, when they were in competition with Ronald Reagan’s “Star Wars” programs. The skilled labor used up for defense restricted the number of scientists and engineers who could be allocated to inventing new and more productive industrial equipment.

The United States and other capitalist countries imposed embargoes on the supply of advanced technological equipment to the USSR. This meant that the USSR had to rely to an unusually high degree on domestic designs of equipment. In the West, there were no comparable barriers to the export of technology so the industrial development of the Western capitalist countries was synergistic.

Although Soviet industrial growth in the 1980s slowed down to U.S. levels, this by itself was not a disaster; after all, the United States had experienced this sort of growth rate (2.5 percent a year) for decades without crisis. Indeed, while working-class incomes in the United States actually stagnated over the 1980s, in the USSR they continued to rise. The difference was in the position of the intelligentsia and the managerial strata in the two countries. In the United States, income differentials became progressively greater, so the rise in national income nearly all went to the top 10 percent of the population. The bulk of the working class in the United States has seen its income stagnate for half a century. In the USSR, income differentials were relatively narrow, and while all groups continued to experience a rise in incomes, this was much smaller than had been the case in the 1950s and ’60s. This 2.5 percent growth was experienced by some of the Soviet intelligentsia as intolerable stagnation—perhaps because they compared themselves with managers and professionals in the United States and Germany. A perception thus took root among this class that the socialist system was failing when compared to the United States.

Again, this would not have been critical to the future survival of the system were it not for the fact that these strata were disproportionately influential within the USSR. Although the ruling Communist Party was notionally a workers’ party, a disproportionately high proportion of its members were drawn from the most skilled technical and professional employees, and manual workers were proportionally underrepresented.

The slowdown in Soviet growth was in large measure the inevitable result of economic maturity, a movement toward the rate of growth typical of mature industrial countries. A modest program of measures to improve the efficiency of economic management would probably have produced some recovery in the growth rate, but it would have been unrealistic to expect the rapid growth of the 1950s and ’60s to return. What the USSR got, however, was not a modest program of reform, but a radical demolition job on its basic economic structures. This demolition job was motivated by neoliberal ideology. Neoliberal economists, both within the USSR and visiting from the United States, promised that once the planning system was removed and once enterprises were left free to compete in the market, then economic efficiency would be radically improved.

Medium Term

The medium-term causes of Soviet economic collapse lay in the policies on which the Gorbachev government embarked in its attempts to improve the economy. The combined effect of these policies was to bankrupt the state and debauch the currency.

One has to realize that the financial basis of the Soviet state lay mainly in the taxes that it levied on turnover by enterprises and on sales taxes.

In an effort to stamp out the heavy drinking that led to absenteeism from work and to poor health, the Gorbachev government banned alcohol. This and the general tightening up of work discipline led, in the first couple of years of his government, to some improvement in economic growth. It had, however, unforeseen side effects. Since sales of vodka could no longer take place in government shops, a black market of illegally distilled vodka sprang up, controlled by the criminal underworld. The criminal class that gained money and strength from this later turned out to be a most dangerous enemy.

While money from the illegal drinks trade went into the hands of criminals, the state lost a significant source of tax revenue, which, because it was not made up by other taxes, touched off an inflationary process.

Were the loss of the taxes on drinks the only problem for state finance, it could have been solved by raising the prices of some other commodities to compensate. But the situation was made worse when, influenced by the arguments of neoliberal economists, Gorbachev allowed enterprises to keep a large part of the turnover tax revenue that they owed the state. The neoliberals argued that if managers were allowed to keep this revenue, they would make more efficient use of it than the government.

What actually ensued was a catastrophic revenue crisis for the state, which was forced to rely on the issue of credit by the central bank to finance their current expenditure. The expansion of the money stock led to rapid inflation and the erosion of public confidence in the economy. Meanwhile, the additional unaudited funds in the hands of enterprise managers opened up huge opportunities for corruption. The Gorbachev government had recently legalized worker cooperatives, allowing them to trade independently. This legal form was then used by a new stratum of corrupt officials, gangsters, and petty businessmen to launder corruptly obtained funds.

Results

Liberal theory held that once enterprises were free from the state, the “magic of the market” would ensure that they would interact productively and efficiently for the public good. But this vision of the economy greatly overstated the role of markets. Even in so-called market economies, markets of the sort described in economics textbooks are the exception restricted to specialist areas like the world oil and currency markets. The main industrial structure of an economy depends on a complex interlinked system of regular producer-consumer relationships in which the same suppliers make regular deliveries to the same customers week in, week out.

In the USSR, this interlinked system stretched across two continents and drew into its network other economies: Eastern Europe, Cuba, North Vietnam. Enterprises depended on regular state orders, the contents of which might be dispatched to other enterprises thousands of miles away. Whole towns and communities across the wilds of Siberia relied on these regular orders for their economic survival. Once the state was too bankrupt to continue making these orders, once it could no longer afford to pay wages, and once the planning network that had coordinated these orders was removed, what occurred was not the spontaneous self-organization of the economy promised by liberal theory, but a domino process of collapse.

Without any orders, factories engaged in primary industries closed down. Without deliveries of components and supplies, secondary industries could no longer continue production, so they too closed. In a rapid and destructive cascade, industry after industry closed down. The process was made far worse by the way the USSR split into a dozen different countries each with their own separate economy. The industrial system had been designed to work as an integrated whole; split up by national barriers it lay in ruins.

The figures in Table 2 show how far the economy had regressed in 2003. These figures show how little recovery there had been, even after thirteen years of operation of the free market. If the economy had continued to grow even at the modest rate of the later Leonid Brezhnev years, say 2.5 percent, then industrial production would, on this scale, have stood at 140 percent of 1990 levels. The net effect of thirteen years of capitalism was to leave Russia with half the industrial capacity that could have been expected even from the poorest performing years of the socialist economy.

Notes

1. ↩ The original paper was L. V. Kantorovich, “Mathematical Methods of Organizing and Planning Production,” Management Science 6, no. 4 (1960): 366–422. I explain for a modern readership how his technique worked in “Von Mises, Kantorovich and In-Natura Calculation,” European Journal of Economics and Economic Policies: Intervention 7, no. 1 (2006): 167–99.
2. ↩ For a good lay person’s introduction to the use of computers in Soviet planning, see the novel: Francis Spufford, Red Plenty (London: Faber and Faber, 2010).