ECON Lecture 6.3: Global Economic Implications and the Inefficiency of Central Planning

Introduction to Lecture 6.3: The Inefficiency of Central Planning

• This lecture concludes Chapter 6 on the organizing principles of socialism, specifically focusing on why the centrally-planned socialist system of the Soviet Union ultimately failed due to massive economic inefficiencies.

• Review of the Central Planning Mechanism:

  • Central planning operates through a "material balance mechanism."

  • Planners must determine the "nuts and bolts" of production, such as quantifying every 2x4, amount of concrete, amount of steel, and number of workers required.

  • Example: To build a specific number of dormitories, planners must calculate the necessary resources and compare them against available resources, making adjustments until the desired output equals the available resources to achieve a "consistent plan."

• Primary Thesis: While material balance can create a consistent plan, it cannot create an efficient one. The Soviet system's collapse was directly linked to the cumulative weight of these inefficiencies.

Comparative Analysis: Capitalist Market Mechanisms vs. Socialist Bureaucracy

• Market Dynamics (Chapter 4 Review):

  • Individual Bargaining Range: Individuals have a maximum price they are willing to pay, while sellers have a minimum price they are willing to accept. If the difference is positive, a bargain is possible.

  • Price Convergence: In a market with many participants, prices converge to a "market price." An example provided is regular gasoline, which typically sells within a few pennies' difference across competing stations because everyone bargains toward the market price.

  • Entrepreneurial Roles: Entrepreneurs must start businesses based on consumer desire, organize effectively, motivate workers, and respond to material needs on time.

• Socialist Dynamics:

  • Centralized Decision-Making: Decisions are made by a central planning apparatus (e.g., "a bunch of people in Washington" or Moscow) rather than individual consumers.

  • The problem of Bureaucracy: The planning apparatus is a bureaucracy, compared to institutions like the Department of Motor Vehicles (DMV), KSU's registration process, or the admissions office.

  • Bureaucratic Disconnection: Bureaucrats often do not care about individual outcomes because they do not personally profit from the user. Their pay is not linked to the quality or success of the final product, leading to inherent inefficiency.

Lack of Consumer Demand Revelation

• Function of Consumer Demand: Demand reveals to a firm how much customers truly value a product.

• Market Example (Apple vs. Kodak):

  • If a consumer is willing to pay $\$700$ for an iPhone but only $\$20$ for a Kodak camera, it provides clear signals.

  • Apple receives the message to produce more iPhones.

  • Kodak receives the message that it needs to pivot or exit the business because people no longer want film-based cameras.

• Socialist Failure in Demand: In socialist systems, there is no mechanism to reveal what consumers truly desire or the intensity of that desire, removing the guidance needed for efficient production.

The Absence of Profit Motive and Incentives

• Legal Prohibitions: In socialist systems, profits are not legally allowed, and businesses are not privately owned.

• Bureaucratic Labor: Construction companies and other firms are staffed by government employees on fixed salaries.

• Lack of Consequences and Rewards:

  • If a government official or worker makes a major mistake ("fucks up"), no money is taken away from them.

  • If a worker is brilliant and performs exceptionally well, they do not receive extra pay.

• Resulting Quality Issues: Because no individual feels it is their specific duty to ensure the process works properly, firms in the Soviet Union produced goods of incredibly poor quality that people did not want.

Prohibition of Creative Destruction

• Definition: Creative destruction is the process where new innovations replace and destroy older, less efficient industries.

• Market Discipline: In capitalism, firms like Smith Corona (typewriters), Kodak (film), and Blackberry (mobile phones) failed because they did not adapt to technological changes (e.g., electronic cameras and new smartphone paradigms). New entrepreneurs took over their factories to build better products.

• Socialist Stagnation:

  • Human Failing: Government officials are psychologically resistant to admitting mistakes.

  • Policy Failure: Instead of shutting down failing industries, socialist governments continue to produce outdated goods (e.g., film-based cameras) and tell citizens to "suck it up" because they have no other options.

  • Example: The DMV is cited as a government agency that never changes its hours ($9:00\,am$ to $5:00\,pm$) or methods because it faces no threat of going out of business.

  • Economic Drag: In the Soviet Union, this lack of creative destruction applied to all industries—steel, concrete, lumber, and housing—causing the entire country to fall behind market-based systems.

Historical Economic Performance of the USSR

• Initial Success (1950–1960):

  • GDP Growth Rate: $7.2\%$ per year.

  • Comparison: This is comparable to the rapid growth of modern China as it transitioned from a peasant society to an industrial superpower.

• The Period of Decline:

  • 1960–1970: Growth fell to $4.2\%$.

  • 1970–1975: Growth fell to $3.2\%$.

• The Period of Stagnation:

  • 1975–1980: Growth was approximately $1\%$.

  • 1980–1985: Growth was just above $0.5\%$.

  • 1987: A slight bounce to $2\%$.

• Collapse and Implosion:

  • By the late 1980s, the economy ground to a halt due to planning errors and the accumulation of uncorrected mistakes.

  • 1989: The Berlin Wall falls.

  • 1991: The Soviet Union collapses as officials and citizens lose faith in the central planning model's ability to keep pace with modern innovation.

Empirical Comparison: Real GDP Per Capita

• Measurement Definitions:

  • GDP: Measurement of the size of the economy.

  • Real: Numbers adjusted to remove the impact of inflation.

  • Per Capita: Total GDP divided by the population to get "dollars per person" (essential for fair comparison between large countries like China and small countries like Australia).

• The USSR Performance Graph:

  • 1917 to 1989: Real GDP per capita grew from under $\$1,000$ to approximately $\$7,000$. While this looks like significant growth (over 7x increase), it is lackluster when compared to capitalist peers.

• The Gap with Western Europe (Capitalist Welfare States):

  • Western Europe Definition: Primarily capitalist business processes with private ownership, profit motives, and creative destruction, despite having welfare states.

  • 1947 (Post-WWII): The gap between the average Russian ($\$2,000$) and the average Western European ($\$4,000$) was approximately $\$2,000$.

  • 1989: The average Russian was at roughly $\$7,000$, while the average Western European reached roughly $\$17,000$.

  • Result: The income gap widened from $\$2,000$ in 1947 to $\$9,000$ in the late 1980s. The size of the gap ($\$9,000$) became larger than the total income of the average Soviet citizen ($\$7,000$).

Global Trends and Alternative Socialist Outcomes

• The failure of the Soviet Union is echoed in every country that adopted significant socialist principles:

  • China: Experienced low growth under command planning; rapid growth only began in the 1980s when government control was removed.

  • Cuba vs. Puerto Rico: In the 1950s, they were peers. Today, Cuba’s wealth per person is less than one-third of Puerto Rico's.

  • North Korea vs. South Korea: South Korea is highly successful under capitalism, while North Korea faces mass starvation and cannot provide consistent electricity ("keep the lights on at night").

• Global Shift: Most of the world is moving away from full central planning. Russia has abandoned it; China is abandoning it; Cuba is moving slightly away (with expectations of further shifts after the death of the Castros).