Chapter 15: Why Socialism Doesn't Work

WE COME NOW TO THE MOST WIDESPREAD OF ALL FALSE REMEDIES FOR poverty -- outright socialism. Now the word "socialism" is loosely used to refer to at least two distinct proposals, usually but not necessarily tied together in the minds of the proposers. One of these is the redistribution of wealth or income -- if not to make incomes equal, at least to make them much more nearly equal than they are in a market economy. But the majority of those who propose this objective today think that it can be achieved by retaining the mechanism of private enterprise and then seizing part of the bigger incomes to supplement the smaller ones. This proposal has been separately considered in Chapter 11.

By "outright socialism" I refer to the Marxist proposal for "the public ownership and control of the means of production."

One of the most striking differences between the 1970s and the 1950s, or even the 1920s, is the rise in the political popularity of Socialism Two -- the redistribution of income and the decline in the political popularity of Socialism One government ownership and management. The reason is that the latter, in the last half-century, has been so widely tried. Particularly in Europe there is now a long history of government ownership and management of such "public utilities" as the railroads, the electric light and power industries, and the telegraph and telephone. And everywhere the history has been much the same -- deficits practically always, and in the main poor service compared with what private enterprise supplied. The mail service, a government monopoly nearly everywhere, is also nearly everywhere notorious for its deficits, inefficiency, and inertia. (The contrast with the performance of "private" industry is often blurred, however, in the United States, for example, by the slow strangulation of the railroads, telephone, and power companies by government regulation and harassment.)

As a result of this history, most of the socialist parties in Europe find that they can no longer attract votes by promising to nationalize even more industries. But what is still not recognized by the socialists, by the public, or even by more than a small minority of economists, is that present government ownership and management of industries, not only in "capitalist" Europe but even in Soviet Russia, works only as well as it does because it is parasitic for accounting on the world market prices established by private enterprise.

We are so accustomed to the miracle of private enterprise that we habitually take it for granted. But how does private industry solve the incredibly complex problem of turning out tens of thousands of different goods and services in the proportions in which they are wanted by the public? How does it decide how many loaves of bread to produce and how many overcoats, how many hammers and how many houses, how many pins and how many Pontiacs, how many teaspoons and how many telephones? And how does it decide the no less difficult problem of which are the most economical and efficient methods of producing these goods?

It solves these problems through the institutions of private property, competition, the free market, and the existence of money -- through the interrelations of supply and demand, costs and prices, profits and losses.

When shoes are in deficient supply compared with demand and the marginal cost of producing them, their price, and therefore the margin of profit in producing them, will increase in relation to the price and margin of profit in producing other things. Therefore the existing producers will turn out more shoes, and perhaps new producers will order machinery to make them. When the new supply catches up with existing demand, the price of shoes, and the profit in making them, will fall; the supply will no longer be increased. When hats go out of fashion and fewer are worn, the price will decline, and some may remain unsalable. Fewer hats will be made. Some producers will go out of business, and the previous labor and salvageable capital devoted to producing hats will be forced into other lines. Thus there will be a constant tendency toward equalization of profit margins (comparative risks considered) in all lines. These yearly, seasonal, or daily changes in supply and demand, cost and price, and comparative profit margins will tend to maintain a delicate but constantly changing balance in the production of the tens of thousands of different services and commodities in the proportions in which consumers demand them.

The same guide of comparative money prices and profits will also decide the kinds and proportions of capital goods that are turned out, as well as which one of hundreds of different possible methods of production is adopted in each case.

In addition, within each industry as well as between industries, competition will be taking place. Each producer will not only be trying to turn out a better product than his competitors, a product more likely to appeal to buyers, but he will be trying to reduce his cost of production as low as he possibly can in order to increase his margin of profit -- or perhaps even, if his costs are already higher than average, to meet his competition and stay in business. This means that competition always tends to bring about the least-cost method of production -- in other words, the most economical and efficient method of production. Those who are most successful in this competition will acquire more capital to increase their production still further; those who are least successful will be forced out of the field. So capitalist production tends constantly to be drawn into the hands of the most efficient.

If Capitalism Did Not Exist

But how can this appallingly complex problem of supplying goods in the proportions in which consumers want them, and with the most economical production methods, be solved if the institutions of capitalism -- private ownership, competition, free markets, money, prices, profits and losses -- do not exist?

Suppose that all property -- at least in the means of production -- is taken over by the State, and that banks and money and credit are abolished as vicious capitalist institutions. How is the government to solve the problem of what goods and services to produce, of what qualities, in what proportions, in what localities, and by what technological methods?

There cannot, let us keep in mind, be a hundred or a thousand different decisions by as many different bureaucrats, with each allowed to decide independently how much of one given product must be made. The available amount of land, capital, and labor is always limited. The factors of production needed to make a given quantity of A are therefore not available for B or C; and so on. So there must be a single unified overall decision, with the relative amounts and proportions to be made of each commodity all planned in advance in relation to all the others, and with the factors of production all allocated in the corresponding proportions.

So there must be only one Master Production Plan. This could conceivably be adopted by a series of majority votes in a parliament, but in practice, to stop interminable debate and to get anything done, the broad decisions would be made by a small handful of men, and the detailed execution would probably be turned over to one Master Director who had the final word.

How would he go about solving his problem?

We must keep in mind that without free competitive markets, money, and money prices, he would be helpless. He would know, of course (if the seizure of the means of production has only recently occurred) that people under a capitalist system lived in a certain number of houses of various qualities, wore a certain amount of clothes consisting of such and such items and qualities, ate a certain amount of food consisting of such and such meats, dairy products, grains, vegetables, nuts, fruits, and beverages. The Director could simply try to continue this pre-existing mix indefinitely. But then his decisions would be completely parasitic on the previous capitalism, and he would produce and perpetuate a completely stationary or stagnant economy. If such an imitative socialism had been put into effect in, say, the France of 1870, or even of 1770, or 1670, and France had been cut off from foreign contacts, the economy of France would still be producing the same type and per capita quantity of goods and services, and by the same antiquated methods, as those that had existed in 1870, or even in 1770 or 1670, or whatever the year of socialization.

It is altogether probable that even if such a slavishly imitative production schedule were deliberately adopted, it would overlook thousands of miscellaneous small items, many of them essential, because some bureaucrat had neglected to put them into the schedule. This has happened time and again in Soviet Russia.

But let us assume that all these problems are somehow solved. How would the socialist Planners go about trying to improve on capitalist production? Suppose they decided to increase the quantity and quality of family housing. As total production is necessarily limited by existing technological knowledge and capital equipment, they could transfer land, capital, and labor to the production of more such housing only at the cost of producing less food, or less clothing, or fewer hospitals, or schools, or cars, or roads, or less of something else. How could they decide what was to be sacrificed? How would they fix the new commodity proportions?

But putting aside even this formidable problem, how would the Planners decide what machines to design, what capital goods to make, what technological methods to use, and at what localities, to produce the consumers' goods they wanted and in the proportions they wanted them?

This is not primarily a technological question, but an economic one. The purpose of economic life, the purpose of producing anything, is to increase human satisfaction, to increase human well-being. In a capitalist system, if people are not willing to pay at least as much for the consumer goods that have been produced as was paid for the labor, land, capital equipment, and raw materials that were used to produce them, it is a sign that production has been misdirected and that at least some of these productive factors have been wasted. There has been a net decrease in economic well-being instead of an increase.

There are many feasible methods -- rucible, Bessemer, open-hearth, electric furnace, basic oxygen process -- of making steel from iron. In fact, there are today a thousand technically feasible ways of making almost anything out of almost everything. In a private enterprise system, what decides which method will be used at a given place and time is a comparison of prospective costs.

And this necessarily means costs in terms of money. In order to compare the economic efficiency of one productive method with another, the methods must be reduced to some common denominator. Otherwise numerical comparison and calculation are impossible. In a market system this common denominator is achieved by comparisons in terms of money and of prices stated in money. It is only by this means that society can determine whether a given commodity is being produced at a profit or a loss, or at what comparative profits or losses any number of different commodities are being produced.

"Playing" Free Market

In recent years even the most doctrinaire Communist countries have become aware of this. They are going to be guided hereafter, they say, by profit and loss. An industry must be profitable to justify itself. So they fix money prices for every thing and measure profit and loss in monetary terms.

But this is merely "playing" free markets. This is "playing" capitalism. This imitation is the unintended flattery that the Communists now pay to the system they still ostensibly reject and denounce.

But the reason why this mock-market system has so far proved so disappointing is that the Communist governments do not know how to fix prices. They have achieved whatever success they have had when they have simply used the quotations they found already existing for international commodities in the speculative markets -- i.e., in the capitalist markets -- in the Western world. But there are a limited number of such grains and raw materials with international markets. In any case, their prices change daily, and are always for specific grades at specific locations.

In trying to fix prices for commodities and for the multitudinous objects not quoted on these international markets the Communist countries are at sea. The Marxist labor theory of value is false and therefore useless to them. We cannot measure the value of anything by the number of hours of "labor time" put into it. There are, for one thing, enormous differences in the skill, quality, and productivity of different people's labor.

Nor can we, as suggested by some Soviet economists, base prices on "actual costs of production." Costs of production are themselves prices -- the prices of raw materials, of factories and machinery, rent, interest, the wages of labor, and so on.

And nowhere, in a free market, are prices for long exactly equal to costs of production. It is precisely the differences between prices and costs of production that are constantly, in a free market economy, redirecting and changing the balance of production as among thousands of different commodities and services. In industries where market prices are well above existing marginal costs of production, there will be a great incentive to increase output, as well as increased means to do it. In industries where prices fall below marginal costs of production, output must shrink. Everywhere supply will keep adjusting itself to demand.

Where prices have been set arbitrarily, real profits and losses cannot be determined. If I am a commissar in charge of an automobile factory, and do not own the money I pay out, and you are a commissar in charge of a steel plant, and do not own the steel you sell or retain for yourself the money you sell it for, and we are each ordered to show a profit, the first thing each of us will do is to appeal to the Central Planning Board to set an advantageous price (to him) for steel and for automobiles. As an automobile commissar, I will want the price of the cars I sell to be set as high as possible, and the price of the steel I buy to be set as low as possible, so that my own "profit" record will look good or my bonus will be fixed high. But as a steel commissar, you will want the selling price of your steel to be fixed as high as possible, and your own cost prices to be fixed low, for the same reason. But when prices are thus fixed blindly, politically, and arbitrarily, who will know what any industry's real profits or losses (as distinguished from its nominal bookkeeping profits or losses) have been?

The problems of centralized direction of an economy are so insuperable that in socialist countries there are periodically experiments in decentralization. But in an economy only half free -- that is, in an economy in which every factory is free to decide how much to produce of what, but in which the basic prices, wages, rents, and interest rates are blindly fixed or guessed at by the sole ultimate owner of the means of production, the State -- a decentralized system could quickly become even more chaotic than a centralized one. If finished products m, n, o, p, and so on are made from raw materials a, b, c, d, and so on, in various combinations and proportions, how can the individual producers of the raw materials know how much of each to produce, and at what rate, unless they know how much the producers of the finished products plan to produce of the latter, how much raw materials the latter are going to need, and just when they are going to need them? And how can the individual producer of raw material a or of finished product m know how much of it to produce unless he knows how much of that raw material or finished product others in his line are planning to produce, as well as relatively how much ultimate consumers are going to want or demand?

An economic system without private property and free-market price guides must be chaotic. In a Communistic system, centralized or decentralized, there will always be unbalanced and unmatched production, shortages of this and unusable surpluses of that, duplications, bottlenecks, time lags, inefficiency, and appalling waste.

In brief, socialism is incapable of solving the incredibly complicated problem of economic calculation. That problem can be solved only by capitalism. ⁽⁶⁾

Notes

6. For a fuller discussion of the problem of economic calculation, see the present writer's novel Time Will Run Back (originally published by Appleton Century-Crofts in 1951 as The Great Idea, and republished under the new title by Arlington House in 1966). And see especially the discussion by the great seminal thinker who has done more than any other to make other economists aware of the existence, nature, and extent of the problem, Ludwig von Mises, in his Socialism: An Analysis, London: Jonathan Cape, 1936,1951,1953, 1969, and in his Human Action (Chicago: Henry Regnery, 3rd. rev. ed., 1963, pp. 200-231 and 698-715. See also Collectivist Economic Planning, edited by F. A. Hayek, London: George Routledge, 1935, and Economic Calculation in the Socialist Society, by T. J. B. Hoff, London: William Hodge, 1949.

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