The Lure of Socialism
I am convinced there is only one way to eliminate [the] grave ills [of capitalism], namely through the establishment of a socialist economy.… A planned economy, which adjusts production to the needs of the community, would distribute the work … and guarantee a livelihood to every man, woman and child.
ALBERT EINSTEIN, Why Socialism?
Communism is socialism plus electrification.
V. I. LENIN
You don’t understand something until you can build it.
Paraphrase of J. CRAIG VENTER’s variation on RICHARD FEYNMAN
THE ECONOMIC INSTITUTIONS AND THE SOCIAL NORMS, or economic culture, on which the world’s first modern economies operated were not chosen by the people—by their democratic assemblies or judicial bodies. Legislatures and courts occasionally had to decide for or against this or that piece of the system, but there was never a public choice between one system and another.
Britain and America were the nearest to exceptions. By 1800, so many people had left the traditional economy for a commercial and cosmopolitan life and so many of them were engaged and rewarded in what they were doing that both capitalist institutions and norms—its private property and profit seeking—and the modern economy—its freedom, inquisitive and adventurous spirit, and indeterminacy—had wide support. In America’s Constitution and Britain’s judicial rulings, capitalism and modernity were implicit. There was hardly an alternative. Few wanted a return to feudalism.
But in the high period of the modern economy, from the mid-19th century well into the 20th, people participating in a quite modern economy were having a highly varied experience with it—much more varied than the experience with the mercantile economy. Even if there were few who did less well than they would have done in mercantile times, it was how well they were doing relative to what they supposed would be possible that mattered to them. One who had good luck or advantages could disregard whatever inefficiencies or biases in the system had made the outcome less brilliant than it might have been. But one with bad luck or a disadvantage could be right to blame some of the outcome on the system, pointing to this or that supposed “flaw” while leaving it to scholars to decide whether it was a real flaw and, if so, whether it caused real net harm. The discontent must have been far worse among Russian serfs and eastern European peasants, who worked in conditions untouched by the modern economy. Workers’ discontent about inequalities of income and wealth, about unemployment and economic instability, were at the origins of the socialism that emerged in Europe in this period.
Modern Discontents
The evidence does not support popular beliefs of the time that modernization drove down the wages (relative to the median wage in the economy) of the working class—Marx’s proletariat—effectively shearing them from the mainstream of society. Neither is there evidence that middle-income earners dwindled as many were pushed into the “proletariat.” In fact, from the dawning of the modern economies to the eve of World War I in 1913, the working class shrank and the bourgeoisie grew. Nor did wage inequality appear to increase within the set of working class jobs. The term had not been coined yet. Nor is there evidence that labor’s share had contracted. (These points were made in Chapter 2.) Yet the modern economy did have a revolutionary effect on the pattern of incomes and wealth levels.
Modern economies opened up opportunities for individuals to make large-stake bets—betting their whole minds and bodies over months, even years—for highly uncertain prospects of reward: from a very large gain to the loss of the whole bet. As a result, enormous differences in economic results could occur—and there is no law that present winnings will sooner or later be offset by future losses. One person might suffer lengthy unemployment, while another not obviously different person might be working overtime. A person might have been led to an industry in decline, while another was led to an industry that was booming. A person’s pay might double in a few decades, while another’s might quadruple. It is not surprising that those left in the dust by others should take a jaundiced view of the system. Observations by contemporaries and piecemeal historical records all give evidence of an enormous rise in the inequality of income and wealth, though there are not the comprehensive records needed to construct the statistical data we take for granted now. Appreciable numbers of moguls and magnates in the business sector and speculators in the financial markets acquired staggering wealth, some displayed garishly, some tastefully, some hidden from view—especially in the gilded age. Capturing a share of the income from this wealth, if not the wealth itself, through taxation was to become an item high on many socialist agendas. But it was not at the top of the discontents with the modern economy. Great riches were nothing new. It was the democratization of opportunities to get rich that was new. People could take the presence of old wealth among a handful of aristocrats, the origins of which had become shrouded in the mists of time. They could not swallow so easily the “new rich” sprouting up in unexpected places.
Uppermost among the discontents with the modern economy was the precariousness of jobs and wages—the ever-present possibility of the loss of one’s job or a major decline of wages in one’s line of work. Episodes of high unemployment in the economy as a whole (aggregate unemployment) and sometimes in particular industries were endemic to the modern economy in this period. There had been sharp speculative bubbles and crashes in the era of mercantile capitalism, of course: the bursting of the Dutch tulip mania in 1637 and the bursting in 1720 of both the South Sea bubble in Britain and the Mississippi bubble in France, though these events were not broad enough to drive total employment either high or low. The wars of the period caused booms, often followed by recessions. In 1815, at the cusp of the modern, the end of the Napoleonic Wars sent many countries (but not France) into recession and Britain into a long slump. Though the 19th century was generally peaceful, downswings came with greater frequency and amplitude with the rise of the modern economies: there were the financial panics of 1792 (Wall Street’s first crisis), 1796–1797 in Britain and America, 1819 in America, 1825 in Europe except France, 1837 in America, 1846 in all of Europe and, in America, 1857, 1873, and 1893—in addition to minor recessions. Since business was far more tightly tied to the financial sector in the modern economies, employment was far more affected by these financial panics than by earlier ones. Evidence of the time indicates that jobs were on the whole a great deal more precarious than they were in the previous century. (Some of the precariousness in the first half of the century was the result of the financial fragility of companies, especially small firms, and this lessened by degrees over later decades.)1
Yet as finance loomed ever larger in the modern economy, the macroeconomic fallout of speculative excess and reckless financing grew capable of producing important slumps. In the mid-1840s railroad overbuilding led all Europe into a slump, which triggered the 1848 revolutions that swept over the Continent. Deeper slumps followed—the renamed Long Depression of 1873–1879 (first called the “Great Depression”), when U.S. unemployment exceeded 10 percent for years, and the more severe Depression of 1893–1898, when U.S. unemployment exceeded 12 percent for four straight years. Observers at the time must have wondered why, if these breakdowns were part of the “performance characteristics” of the modern economy, countries should want to continue with such a system. And countries with a less-than-modern economy must have wondered why they should aspire to one.
Not only was industrial life treating people very differently, the people in the cities also represented an ever-increasing variety of backgrounds. Large numbers of Chinese, then Irish, and later Jews from eastern Europe and Italians from the Mezzogiorno came streaming into London, New York, and San Francisco. Although the evidence is not quantifiable, it appears that, compared to the yeoman farmers and tradesmen and business owners in 1800 or even 1850, the new populations were more accustomed to communitarian ways—to habits of sharing, equalitarian notions of fairness, and an alienation from capitalist owners, who may have been indistinguishable to the newcomers from the inherited and entrenched owners of property and businesses found in the old country. Many or most of the older populations would have rejected the idea of belonging to a trade union, or crafts union, while many or most in the new populations would have thought it was wrong not to belong.
Talk of socialism arose in these times. The burgeoning diversity of experience and background that gave a boost to commercial innovation—discussed in Chapter 1—must have been an impetus to thinking up new elements in the institutions and norms of society. Henri de Saint-Simon was an early socialist.2 He criticized the economic system that had arisen around him as unscientific and irrational, thus wasteful of resources, and was the first to say that the system was not advantageous to the working poor. The Communist Mani festo by Marx and Engels, first published in January 1848 on the eve of the uprisings, was a strong condemnation of the waves of unemployment and its seemingly upward trend in Europe.
The uprisings of 1848 brought expressions of discontent with wages, employment, and working conditions to a new peak, though many of those rebellions were no more than a democratic opposition to the aristocracies, such as the February Revolution in Paris overthrowing the constitutional monarchy of Louis-Philippe and the March Revolution in Berlin and some German states demanding German national unity and a national parliament. Marx was to complain that the workers had no clear objectives or program, so it was not surprising that the workers gained nothing. It was only in the next decades that an extensive socialist agenda was proposed and debated.
The Idea of Socialism
The very idea of socialism was fraught with difficulties. Defining the set of ends that socialism would serve was never completely resolved. Some purposes of socialism in the minds of one might run counter to some purposes in the mind of another.
Socialism’s appeal, when it had one, was to say, at one and the same time, that its mission was to transcend capitalism while improving it; that everyone was equal but that the proletariat was the leading class; that money was the root of all evil but the workers needed more of it; that capitalism was doomed but the capitalists’ profits were as high as ever; that religion was the opium of the people but that Jesus was the first socialist; that the family was a bourgeois conspiracy but it needed defending from untrammeled industrialization; that individualism was to be deplored but that capitalist alienation reduced people to undifferentiated atoms; that there was more to politics than voting every few years while demanding universal suffrage; that consumerism beguiles the workers but they should all have a color television, a car and go on holidays abroad.3
Thus “socialism” was a fuzzy concept, and a variety of conceptions were advocated—Christian socialism, Marxian socialism (called communism), state socialism, market socialism, guild socialism, and Fabian (or evolutionary) socialism.
Declared socialists on the Continent began efforts around 1860 to reach agreement on a core set of values or rights—mostly in meetings of worker associations, intellectual periodicals, and conferences of Germany’s Social Democratic Party. Socialist countries were to be guided by a socialist ethic that was an alternative to the spirit of modernity and the capitalist ethic that motivated individuals working in a modern capitalist economy.
In this ethic, access to employment was a right, not only because a job was a worker’s livelihood—even in socialism nonparticipants judged of sound mind and body could not claim the wage paid to participants—but also because of its necessity for a person’s sense of self-respect. Joblessness was to be combated.
Another part of this ethic had to do with the conditions and opportunities provided to the worker in society’s enterprises, private (if any) and public. The right to a job meant the right to a job offering dignity. The abuse of power by the employer was not acceptable, so that dismissal without a hearing or without compensation was not to be permitted. To his credit, Marx brought up the normal need of human beings for a mental life, about which he felt deeply:
[Adam] Smith has no inkling whatever that this overcoming of obstacles [in work] is in itself a liberating activity … hence as self-realization, objectification of the subject, hence real freedom, whose action is, precisely, labor.4
Similar expressions were to be heard from a range of social thinkers, not all of whom thought of themselves as socialist.
Another socialist value was that wealth and power must not be so disparate in society that some participants are denied the ability to realize their potential. Under socialism, large accumulations of wealth would not be allowed and, upon instituting equal opportunity, “to each according to his contribution” would rule in wage setting.5 If all auto workers are necessary and interchangeable in producing a car, their wages would be equal; and a farmer would be construed as contributing as much as an auto worker. (Under communism, as The Communist Manifesto conceived it, “the free development of each is the condition for the free development of all.”)
The socialist ethic saw private business as unattractive—as “money grubbing”—whether it made a profit or a loss. In the capitalist ethic, personal growth is, in part at any rate, a climb up the greasy pole to obtain better terms for oneself in one’s career—better pay, higher fees. In the socialist ethic, personal growth comes from the love of one’s work and mastering one’s craft or profession.
The socialist ethic also condemned amassing and holding great wealth. The aim was to cultivate a “new person” (Neuer Mensch) who will be guided by instincts to serve others rather than by the shallow values of an “acquisitive society.” In his 1860s cycle of four operas telling the story of the cursed ring of the Niebelungs, Wagner, a passionate socialist, dramatizes movingly the moral that when we choose wealth and power over love, we condemn ourselves to our own destruction. Audiences, especially if they know that Wagner was a dedicated socialist, reasonably interpret the Ring cycle as contrasting the greed of capitalism with the idyll of socialism. (Yet entrepreneurs and investors touched by Wagner’s music drama apparently go right back to taking satisfaction from their lives as entrepreneurs and investors.)
Still another socialist value was attached to allocating resources by the principle of where they are most needed rather than by the profit motives of capitalism. Centralized coordination was deemed superior to decentralized competition and individual initiative. “Production for use rather than profit” is shorthand for this principle.
But a functioning economy has to have means to its ends, means in the form of economic institutions and economic culture. These are the norms, rules, institutions, and laws by which it enlists participants; opens them to know-how and experience; inspires them to exercise creativity; and, as neoclassical economics says, allocates land, labor, and capital over enterprises and industries and sets rules for the distribution of income or goods. How, in these terms, did a socialist economy work?
The socialists, though far from united in their ends, instinctively came together on what the means would be—figuring that they could thrash out later the main ends to which the means would be put. A key instrument, both at the communal level and at the national level, would be some mechanism for centralized control over the main directions of investment activity. There would be neither capitalists nor private entrepreneurs to veto investment projects. Another instrument would be the wage paid to workers—miners, nurses, musicians, and so forth. The state would supplement this wage with a “social dividend”—what would be profits under capitalism. The production method and the assignments of workers to jobs in an enterprise would be decided cooperatively with an eye to the workers’ satisfactions as well as their productivity; a worker would be motivated by how stimulating the job was, not how long the worker would expect to be in the unemployment pool in the event he or she were fired in favor of a better worker. Finally, the allocation of labor and capital across enterprises and industries would be decided politically, by the workers’ representatives, rather than by seeking the lowest cost, highest price, and greatest valuation—the market mechanism.
The various factions within socialism differed in matters of scope. The thoroughgoing, classical socialists, including Marxian socialists, sought centralized control of the capital available and the prices chargeable in all enterprises, large and small, and all industries, from farming to film making. More moderate socialists sought state control only over the “commanding heights” of the economy, including heavy industry. Proponents of market socialism wanted state-owned companies, as well as those under private ownership, free to buy and sell their products and intermediate goods in open markets (though prohibitive company taxation was always an option). Britain’s Fabian socialists advocated starting small and feeling their way to the right scope over the economy. They wanted some “reforms” of capitalism; for communists, capitalism could not be reformed, only overthrown.
Could a Viable Socialism Be Built?
The classic debates of the 1920s and 1930s, the interwar years, were not about what anyone today would suppose they were about, namely the desirability of the socialist values. These new debates were on the feasibility of designing economies that would have the properties sought by socialists. Could the socialists succeed on their own terms? For a pragmatist, the question may have looked entirely empirical: let’s wait to see how the socialist experiments turn out. But in the 1920s there was only the experiment starting in Russia and the chance that another one or two might start in Germany or France. So evidence was going to have less weight—and theory, such as it was, more weight—than it would have in an agronomy experiment conducted on several different plots of land. If the socialist economy on Russian soil succeeded in all respects or failed in all respects year after year, that would be no guarantee that the same results would follow experiments in other countries, or even that Russia’s results would continue.
Enter Ludwig von Mises, a Viennese economic theorist of fiery temperament who founded the Austrian school of economics with his former student, Friedrich Hayek. Mises, so near to the revolution in Russia and socialist measures in Germany, could be said to have been an eyewitness of the creation of socialism. He immersed himself in the debate from 1920 to the early 1930s.6 As Mises saw it, trying out socialism was an experiment without a theory. “[I]n the cloud-cuckoo land of their fancy,” he wrote, “roast pigeons will in some way fly into the mouths of the comrades, but they omit to show how this miracle is to take place.” He went on to argue that a socialist economy is not viable—not just uninnovative but ultimately impossible (unmöglich).
Mises’s objections to socialism were based on the idea that in the modern economies around him the actors were restlessly trying out departures from normal practice in hope of obtaining higher prices for what they sell or lower prices for what they buy; in that way, new methods were tested and economic gains discovered. While socialists, including Marx, supposed that industrial workers, peasants, and craftsmen would somehow engage in the experiments necessary to achieve high efficiency, Mises argued that a socialist economy, in which nobody really owns anything—even one’s own labor—would not present the incentives and the information needed for the deviations, or experiments, by individuals that ultimately make market prices and wages reflect the costs of products and the value of labor in each use:
[I]n a socialist state … rational conduct might still be possible, but in general it would be impossible to speak of rational [i.e., efficient] production any more. There would be no means of determining what is rational, … hence … production could never be directed by economic considerations. For a time the remembrance of the experiences gained in a competitive economy … may provide a check to the complete collapse of the art of economy … [though] … the older methods … would meanwhile have become irrational, as no longer comporting with the new conditions.… [I]n place of the “anarchic” economy, recourse will be had to the senseless output of an absurd apparatus. The wheels will turn, but to no effect.… The administration [in a socialist state] may know exactly what goods are urgently needed. But in so doing it has only found what is, in fact, but one of the two necessary prerequisites for economic calculation.… It must dispense with the other—the valuation of the means of production.… Thus in the socialist commonwealth, every economic change becomes an undertaking whose success can be neither appraised in advance nor retrospectively.
Mises gives as an example the question of whether a new railroad should be built. A market economy, he says, enables an estimate of what the savings in transport costs would be. Mises concedes that the socialist state might have a decent estimate. But if the values of labor, energy, iron, and so forth required for the project’s construction are not available in a common unit—in money—it is impossible to calculate whether the savings would cover the cost of the railroad. (In the jargon of economics, a socialist economy does not reveal to the “administration” each input’s opportunity cost, or shadow price, which is equal to the value of its use in production elsewhere; in contrast, a market economy presents to entrepreneurs observable prices, which Mises views as adequate approximations of opportunity costs.)
Mises could have supplied a simpler example. Under a socialist economy in which equality of wages is regimented, no worker would ever try to see whether being more diligent or industrious than the others would be rewarded. Said worker would not receive an increased wage in return, since all wages are equal. And the worker would not save his or her job that way, since their jobs are very secure anyway. No worker has an incentive to exercise greater care and put greater energy into his or her work no matter how valuable to society. The system never allows the market to “discover” the correct general level of effort—and the correct general level of wages that corresponds to it—even when everyone is alike and has the same preferences, since no market process of trial moves takes place.7 The conclusion is that private ownership of the fruits of one’s own labor permits and encourages experimentation, without which the pattern of wages and prices in the economy could continue without a tendency toward correction.
The analysis by Mises may have been abstract to most of his readers. History, however, would provide graphic illustrations of Mises’s points. The failure of Soviet personnel policy to reward workers taking greater care and to promote workers showing greater talent must have led to a sense of futility, and this helplessness must have been behind the massive alcoholism that plagued Soviet life in its last decades. This was a waste of the natural inclination of people to pitch in, to do a good job, and to try to make something of themselves. An appalling decline in the work ethic resulted, with severe effects on efficiency. There is a story of a foreigner living in Moscow in the 1980s who decided to gather field data by following a large truck as it left a brick-making factory. According to the observer, as the truck bumped along the streets and highways, about as many bricks fell out of the truck as it unloaded on its stops. If workers had had individual earning power and the freedom to make investments that would increase that power, their efforts and wages and self-respect would all have ended up being at far higher levels. For these insights, Mises is regarded as the originator of property rights theory.
A second argument by Mises turned on the “profit motive.” He hammered away, primarily in Socialism, at the theme that enterprises operating as arms of a bureaucracy would not even attempt to operate with efficiency, in contrast to enterprises driven by the profit motive:
The motive force of the whole process which gives rise to market prices for the factors of production is the ceaseless search on the part of capitalists and entrepreneurs to maximize their profits.… Without these private owners the market loses the mainspring that sets it in motion and keeps it in operation. (pp. 137–138)
Socialist managers would be lacking in this motive. They would have relatively little incentive to seize opportunities for increased profit regardless of inconvenience or political cost: If the profit increased, the central government would not know to what to attribute this increase, so the manager might not get the credit, and if the profit decreased, it might raise suspicions that the manager was less competent than others. A manager or worker who knows there is no way to protect his or her idea from being claimed by others is not apt to think of a new idea. When nevertheless an enterprise does have a new idea, there is apt to be no good way by which that enterprise can signal its belief in the benefit of the idea. Furthermore, the incentives of socialist managers would be mostly undesirable. They would always do the bureaucratic thing of “following the rules” and attending to appearances. They could compete for promotion up the ladder, but that incentive would lead them to avoid any risk of failure. For these insights, Mises could be seen as the originator of public choice theory—the decisionmaking of self-dealing individuals in a bureaucracy, such as a state agency.
Mises’s warning led to one of the most famous exchanges in the annals of economics. Oskar Lange, a brilliant theorist rising into prominence in the West in the 1930s before returning to his homeland, communist Poland, challenged Mises’s contention that a thoroughly socialist economy must ultimately lead to collapse.8 Lange argued that a nation wanting a socialist economy without the failings warned of by Mises had open to it a way to put the right prices on labor, iron, railroad track, and all the fruits of production. It could use the same markets made use of by capitalist economies. Enterprises would, in general, be state-owned, as before. These socialist enterprises would supply each of their products to the market, where other socialist enterprises and households might convey their demands. Some of these markets might be auction markets, as in capitalism, while others would not be, just as in capitalism. Thus, the market would determine prices. Wages could be determined similarly, as enterprises communicated terms and individuals offered their services. Competition would ensure equal pay for indistinguishable labor working the standard workweek. (When some enterprises offered a high wage for greater effort, the other enterprises would have to offer the same. There could be two or more tiers of workers, differentiated according to their category of effort.) Confident of his triumph, Lange joked that every socialist town in Europe will put up an ironic monument to Mises for having provoked insights showing that socialism was not “impossible” after all. In fact, market socialism was tried in Poland and Hungary in the 1980s.
But most of those studying Lange’s argument tended to conclude that market socialism would not really work either. It might be an improvement over the more regimented system adopted by the Soviet Union but not an escape from the limits that a thoroughgoing socialism would impose. Mises’s profit-motive argument suggests that socialist enterprises will not be driven to supply the socially desirable amount of output in response to any given market price; so where that undersupply is relatively acute, prices will be driven to relatively high levels. Mises scored again in noting that it is one thing to expect the government to motivate socialist managers to “play” at being profit-maximizing producers—some might do a fair job of it. It is another thing to expect the government to delegate to the managers the responsibility for investment decisions. No managers would declare it was their duty to let their enterprises shrink in the interest of the economy’s “efficiency.” The socialists themselves, far from being grateful for the idea of competitive socialism, were all against it—because they wanted to take over the power heretofore residing in the marketplace and/or because for them the whole point of socialism was to direct the reshaping of the economy—to plan.
The young Hayek, turning his attention to the controversy over socialism, cast a new light on the debate over “socialist calculation.”9 The arguments of Hayek are knowledge-based, while those of Mises were incentive-based. Hayek starts with his idea that the know-how in any complex economy—complex either because it is very modern or highly diversified—is necessarily dispersed over the participants in the business sector. Yet, as he says, any individual or agency desiring to “plan”—from scratch—such an economy’s allocation of resources over industries would need all this know-how to set up the most suitable methods of production. Diverting everyone with know-how to advise in planning would be prohibitively costly. Even if all the possessors of know-how could be put in one stadium, the mass of detail would swamp any attempt by the planner to use it all. The planner would not be able to put it all together. Therefore, central planning cannot work satisfactorily.
Hayek was fond of a shorter route to the same conclusion. A modern economy, with its institutions and culture and with its production methods and the capital goods it uses, could not have been built by one individual or one company or any one body of any kind—the thing is too complex. So a government could not have built one either. Nor build it now.
A socialist state might succeed well enough at first by copying some similar economy abroad, making what socialist changes it could. But inefficiency in resource allocation would grow as the economy took its own path—as product demands rose here and fell there and as older people retired and younger ones entered the workforce. In Hayek’s view of the modern capitalist economy, increases in relative prices and wages in some industries or lines of work indicate to participants elsewhere that they might do well to gather know-how in those industries or lines of work. In the socialist economy, people have little incentive to choose an industry or occupation on that basis, and they may be faced with bureaucratic obstacles to moving to the industry or occupation of their choice. An industry in a socialist economy might finally lose the key to how to produce because of its failure to provide individuals with motives to maintain or acquire the needed know-how.
Another Hayekian argument is that a good business decision may often require the input of practitioners whose know-how, born of long experience, offers them insights with which to appraise the difficulty of carrying out some investment project or the difficulty of developing a product that the enterprise had not produced before. This problem appears in a free-enterprise economy as well. How to produce a new thing and how costly it will be are questions to which the answers are not known beforehand. If the state were to decide whether to take an initiative in some industry, the full opportunity costs of the project to all other industries in the economy could not really be known to anyone in the government. Even the experts on the ground would have to make educated guesses. From this Hayekian viewpoint, the private entrepreneur deciding whether to build a new rail line (in consultation with engineers, financiers, and so forth) will usually come to a far better sense of the costs of acquiring the new line, having been in the business for years, than would the administration of a socialist economy, no matter how transparent the prices of things. Here is Hayek in his classic 1935 paper on socialist calculation:
In a centrally planned society the selection of the most appropriate among the known technical methods will be possible only if all that knowledge can be used in the calculations of the central authority.… It is hardly necessary to emphasize that this is an absurd idea even in so far as that knowledge is concerned which can properly be said to “exist” at any moment of time. But much of the knowledge that is actually utilized is by no means “in existence” in this ready-made form. Most of it consists in a technique of thought which enables the individual engineer to find new solutions rapidly as soon as he is confronted with new constellations of circumstances.10
Over the years, more and more in the general public came to be persuaded by the arguments of Mises and Hayek against the socialist economy—though some needed to see the malfunctions and mounting stagnation of the Soviet economy in the 1980s to feel sure. But what persuaded them was not so much the argument that limitations in a socialist economy would saddle it with growing inefficiencies—an economist’s argument. It was the idea, which people read between the lines or simply supposed was a part of the broad critique, that if a relatively well-functioning modern economy went socialist, it would become less innovative. It would be saddled with increasingly obsolete products and production methods. People cared more about economic growth, it seems, than they did about dry-as-dust efficiency.
In fact, the socialist economies were fatally lacking in dynamism. The innovatorship of the former state managers was tested when massive privatization began in eastern Europe after the collapse of the Soviet Union. These managers, fearing they would lose their post to a rival or see their enterprise close if they did not succeed in innovating, made frenzied efforts to create and market new products. Yet they met with almost total failure. They were willing entrepreneurs, when their backs were to the wall at any rate, but they were not able at entrepreneurship. The Darwinian process in the communist economies had not selected managers for that talent, so those managers who had that trait were few and far between.11
Mises seemed set to make the innovation argument. He implied that those in control of a socialist enterprise, doubting they would win much of the credit for an innovation and fearing they would have much to lose from failure, will be far less willing to attempt an innovation than private owners of such an enterprise would, since the latter can expect to pocket any winning and, thanks to limited liability, escape much of the loss. Mises also understood that the “ceaseless search” for profit has also the function of tending to weed out the wrong people from various jobs and to put in new people to be tested. Lacking the profit motive, a well-functioning socialist economy—far more than a well-functioning modern economy would—would let into managerial positions people whose talents did not lie in either the conception or the development of ideas for novel commercial products. But Mises did not make the point explicit.
Hayek’s conception of the modern economy may have seemed to lead to the innovation argument. In his bottom-up, grassroots theory, the modern market economy, in the process of creating new products, whether goods or methods, draws on the freedom of individuals in that system to exercise their originality and thrives on the individuality of their situation and their know-how. Hayek opened the door to a model of indigenous innovation—innovation indigenous to a country’s economy—based on the new and diverse ideas that strike individuals in the economy. In contrast, the socialist economy does not confer on individuals any right to apply for financial support for an innovative project. At best, an individual would be free to suggest an innovative idea to the manager of the socialist enterprise, and a manager would be free to apply to the national bank for a loan to develop such an innovative idea into a new product. From Hayek’s perspective, a socialist economy could not realize its potential for innovation, since diverse entrepreneurs are not free to compete with one another for market share through new products and methods, diverse financiers are not free to bet on their private judgments in deciding which new ideas to back, and diverse creative types are not free to compete with one another for an entrepreneur to help develop their new ideas.
The loss of innovation would be particularly clear and pronounced in the case of a knowledge economy. Government takeover of enterprises in which the talents and services of most participants are idiosyncratic, such as architectural firms, soccer teams, comedy clubs, oil drillers, gourmet restaurants, ballet companies, and wine growers, would be unworkable for the Hayekian reasons that the government would have little or no knowledge of the business and of which ones to invest in. Moreover, worker management would typically vote no to moving, to newcomers, and to innovation. Those who had dreamed up new ideas would lack the clear channels they had used before. (In modern economies there are companies called ESOPs in which employees are the shareowners, but they are seldom as successful as their owner-managed competitors.) A socialist state with a knowledge economy would thus be particularly hard-pressed to acquire dynamism.
Why, then, did Mises and Hayek not make these innovation arguments? For one thing, Mises and even Hayek, writing as late as the mid-1930s, were still Schumpeterian in their thinking about innovation. Had they warned of a dearth of indigenous innovation in a nation choosing a socialist economy, acute readers would have commented that a socialist economy is as free as a modern capitalist economy to import the magnificent new technological advances wrought by scientists and inventors around the world. The concept of the modern economy—creative and successful at indigenous innovation—had not surfaced in their 1920s and 1930s papers or even in Hayek’s famous 1944 tract.12 For another thing, to argue that the nations like czarist Russia that had gone socialist could realize high dynamism if they just returned to private ownership would have been seen as absurd. (It was nations like America, Germany, Hungary, and France that would lose their dynamism if they switched to socialism—as those that tried soon found out.)
Over the decades most economists, including many on the left, came to declare the Austrian team the winner of the debate. The Austrian school persuaded the economics profession that a socialist economy would cause a decisive deterioration of efficiency. The Austrian side did not have to claim that the modern capitalist economy was free of its own inefficiencies—the misdirections and the waste brought by financial panics hardly needed to be acknowledged. They had only to argue that such an economy, once socialized, would suffer a sickening slide into greater and greater inefficiency.
The Austrians lost another battle, though. They seemed to believe that every country that threw out its capitalist economy in favor of a socialist economy would soon be worse off owing to growing inefficiencies. But it was one thing to argue that there would be, generally speaking, a decisive loss of efficiency from socializing in its entirety an economy of great complexity and sophistication, which had required a long evolution of institutions and culture to achieve—a modern economy or merely a knowledge economy. It was quite another thing to suggest that every economy, no matter how ineffective, would be still worse off by going socialist. And it was yet another to argue that any amount of socialism, no matter how moderate and how aimed, would spell worse inefficiency than would otherwise have been experienced. The socialist movement could live! And it did.
Socialism managed to take power in economies that were not advanced and were not rapidly becoming advanced through modernization. It was no use to tell the Russians that their socialism would not be as efficient as well-functioning capitalist economies were, since the Russians had no experience with such an economy. And it would not have been persuasive to tell them that their socialism would not be as innovative as an economy of high dynamism, since they had no experience with that either. In fact, Soviet Russia had an extraordinary run of Schumpeterian innovation from the 1920s to the 1960s as electrification and other advances were quickly introduced. No one yearned for the return of the czar.
Socialism also managed to take over limited sectors in some economies—the less-advanced economies, to be sure, but also in some economies that were relatively advanced. The notion grew that socialist ownership and control would work well in the “commanding heights” of the economy—energy, telecommunications, railways, ports, and any heavy industry. The unexpected revival of this thinking in China was confirmed in an address by Prime Minister Wen Jiabao in Beijing in March 2010. “The socialist system’s advantages enable us to make decisions efficiently, organize effectively and concentrate resources to accomplish large undertakings.”13
The socialist discussion, especially in the more advanced economies, shifted from the workability of a socialist economy to the workability of state ownership and control in one or more sectors. It also shifted toward the regulation and taxation of the private sector. The Austrians’ perspectives were applicable to this discussion, of course. The power of Hayek’s perspective can hardly be overestimated. There was a Hayekian moment in the past decade when Western governments took measures to encourage the use of biofuels instead of the conventional fossil fuels, coal and oil, by inducing farmers to switch land from raising the usual crops to producing soybeans, which could be used for making soy biodiesel. The reallocation of land caused a catastrophic rise in the price of various staple foods and thus led to hundreds of thousands of deaths by starvation. It was also a cause of the further deforestation of the Amazon basin. On top of all that, the soy biodiesel produced was later found to have virtually no advantage over conventional fuels in terms of overall greenhouse gas emissions.14 There was great irony in the failure of “planning,” since the socialists in particular and government planners in general were always asserting that socialism, by virtue of being rational, would look to the long term in contrast to the short-termism of capitalism. But it was precisely capitalism, with its huge step forward in introducing share owning, that solved the problem that the principal owner would not be expecting to live forever. It was the single proprietorship and, earlier, the feudal barony that were apt to suffer the problem of no heirs.
In particular, even an incremental move toward social ownership raises the question of why the government should nationalize to undertake projects that veterans of private industry presumably rejected. Mises’s point that a socialist government does not face the right prices does not apply if the part of the economy under social ownership and control is too small to change the configuration of prices in the economy. But in the Hayekian perspective, the lack of the needed know-how in the socialist government may cause it to proceed in the wrong direction or to fail when it is moving in the right direction.
Yet the Austrians overgeneralized, supposing that their theory applies in every case and must always trump other considerations. It can happen that business people, not having worked much in government, do not know everything known by the state. Possibly the state has knowledge about some industries that would make state ownership and control better on balance than private ownership. On the issue of nationalization of any particular kind of production, then, the Hayekian bias in favor of private ownership may be outweighed. However, Hayek was certainly correct to see the dangers of totalitarian control of the economy—by the state or by anyone. He was not the extremist he was taken to be. He never proposed a zero-level of state activity in production. In his famous wartime tract, The Road to Serfdom, he proposed a range of roles for the state, including research to increase longevity.15 Hayek was not an ideologue.
Socialism’s Strange Side
It is clear now, from the distance of time, that something was very odd about the socialism debate of the interwar decades. The Austrians made the strange assumption that the goal of the socialists was economic efficiency. But the socialists were not plotting revolutionary changes in the structure of the Western economies for the sake of bringing economic waste under better control. Output per head in Western Europe had quadrupled between 1820 and 1920. So even the most earnest socialists could have afforded to let go whatever loss of output resulted from the occasional panic and the unemployment that accompanied the modern economy.
Most socialists, in fact, held aloft their goals of stability, equality, dignity, and contentment. They had no wish to smash the individual. But to the extent the individual is encouraged to excel in the social sphere, it is through his alignment with the state. The values expressed in this set of goals represented a fundamental shift from the core values of the Western world—some from as far back as ancient Greece. Absent from the socialist terms was the vocabulary of the humanist tradition—terms like exploration, creation, and exhilaration.
The socialist goals were pursued with fanatical zeal. The socialist experiments, dating from Lenin’s to Castro’s, made a fetish of enforcing rigid equalities, controlling population in the name of “full employment,” and forbidding virtually all individual initiatives in the economy. These economies became faceless, suffocating, boring—not just grossly inefficient.
So it was odd that, at first, Mises and Hayek did not criticize these goals. They gave the impression that efficiency was decisive in the choice of an economic system. It seemed they would have been willing to accept socialism—the limitation on wealth, bars against opening a business, workers voting on the conduct of businesses, and so forth—if they could be persuaded that no loss of total output, or economic efficiency, would result. Economists effectively voted to award victory in the debate to the Austrians on the narrow grounds on which the Austrians made their arguments. Had there been, following the debate, a consensus that, all things considered, the socialist economy’s avoidance of unemployment and swings in employment would increase output more than new inefficiencies would decrease it, Mises and Hayek would have lost their debate.
Later, in The Road to Serfdom, Hayek conveyed his sense of tragedy over the loss of freedom suffered in Italy and Germany since the 1930s with the rise of authoritarianism. There could be no longer any doubt about his feeling for humanity. If Sen’s reading is right, freedom in Hayek’s thinking is a means to other goals. Yet The Road to Serfdom did not indicate what goals would be infringed on by a loss of economic freedom at the hands of the authoritarians other than efficiency—except to warn that output, or efficiency, would be diminished if the freedom of businesses is crimped by the authoritarian leaders. (Most of the book is concerned with the importance of political freedom.)
With hindsight we can see that missing in the discussion of socialism was a debate between socialist values and Western humanist values. It has come to be clear that neither the proponents of the modern economy nor its opponents—the advocates of socialism and those of corporatism—could formulate a justification of the system they favored until they could show that it served compelling social values.
The Fear of Socialism
For many of those who feared the coming of socialism, the problem was not that socialism might fail but that it could succeed well enough by its own lights to go on and on. One could not be sure that a robust majority would always be there to stop socialism in one’s own country—in Italy, say, where the capitalist economy paled next to those in America, Britain, and Germany. By 1919, little more than a year after the Bolshevik revolution, several countries—Italy, Germany, and America too—were in the grip of the Red Scare.
In Germany and France, an incremental socialism was making some headway. Germany’s Social Democratic Party (known as the SPD), which sought a socialist economy, headed the coalition that gained control of the parliament in 1919. The socialists won the establishment of factory councils (Betriebsrat) in which workers would have a say in various company matters. An arbitration mechanism was set up for labor disputes. Private capital retained ownership but lost some control. The work day was shortened not to 10 or 9 hours but to 8 hours. Social reforms that ought to have been discussed in the society at large and, if chosen, paid for by taxpayers because they wanted the reforms, were squeezed out of the business sector. The West was started in the direction of regulations, mandates, and fees that were to take a toll on investment and innovation.
As the 1920s dawned on the West, there was a great sense of foreboding about the economic future. A revolution had started, and no one could know whether it was going to spread.
1. Job security in America looks to have improved with the Galbraithian era—the early 1950s to the early 1970s—when Americans were safely employed in big entrenched companies enjoying stable growth and Europeans were steadily engaged in the process of “catching up.” It is a question, though, whether jobs were also more secure in the 30-year era from the mid-1970s to the mid-2000s—though that span includes the 20-year Great Moderation dating from the mid-1980s. This era saw the U.S. slump of 1973–1983, the continental European slump of 1978–1988, the global 1987 stock market crash, the 1990 U.S. savings-and-loan crisis, the slump Japan entered in 1990, the East Asian economic crisis in 1997, the collapse of Long Term Capital Management, and the correction of the U.S. tech stocks in 2000–2001. The “Great Moderation” was an egregious misnomer.
2. An early statement of his criticisms is his Lettres d’un habitant de Genève à ses contemporains (1803). The “anarchy” of the modern economies was a major theme of Friedrich Engels in Germany and Thomas Carlyle in England. Saint-Simon went on to propose that business people and scientists direct the state and society’s use of resources. His last book, Nouveau Christianisme (1825), states that the resources ought to be directed for the purpose of improving the conditions of the poorest class. He is believed to have coined the term socialisme, first used by Pierre Leroux in an 1834 essay “De l’individualisme et du socialism,” that is, “On Individualism and Socialism.” (Leroux, an economist and philosopher, was skeptical of both.)
3. Sassoon, “All Shout Together.”
4. Marx, translated from Grundrisse der Kritik der politischen Ökonomie (1858, p. 611). Some would say that Smith was better than that. He deplored repetitive tasks, by which he meant unchallenging tasks. (Flying jet planes on the milk routes is repetitive but sometimes severely challenging. “It’s hours of sheer boredom,” as someone said, but “punctuated by moments of sheer terror.”) It could be that Marx’s hostility sprang from his anxiety that Smith had thought of the point and others before he did. It could also be that Marx felt impelled to diminish Smith by portraying him as a rightwing zealot.
5. See Marx’s 1875 Critique of the Gotha Program. The Gotha Program was a draft statement of socialist goals prepared for the founding conference in May 1875 of Germany’s new Socialist Democratic Party in the town of Gotha. In a letter to friends, Marx vented his anger at the program’s conception of a socialist state as merely subsidizing “producers associations,” and he stated his ideas on the rewards to work in a socialist economy. Marx’s Manifesto, Grundrisse, and Gotha letter are his basic short works.
6. Mises’s first publication (in German) was the 1920 landmark, “Die Wirtschaftsrechnung im sozialistischen Gemeinwesen,” translated in Mises, “Economic Calculation in the Socialist Commonwealth,” where the quote that follows above can be found on page 88 and the next extract on 110. His big work, published two years later, was Die Gemeinwirtschaft, translated in Mises, Socialism (1936).
7. The socialist theoreticians could reply that there remains in the socialist system a healthy incentive to perform well: failing to perform up to prevailing standards would likely cost a worker his or her promotion to jobs with greater scope for taking on responsibility. Thus there has to be some inequality, though not wage inequality. But the force of that counterargument would depend on how much more rewarding the jobs higher on the ladder were. Mises could have retorted that if the socialist plan envisioned an essentially stationary economy, in which only the occasional natural disaster interrupted the general tranquility, it is not obvious that there would be any nonpecuniary rewards from moving up the ladder that would be enough to motivate the workforce. And an economy that does not revolve around innovation would not need deep ranks of managerial personnel to begin with.
8. The original article appeared in Lange, “On the Economic Theory of Socialism,” Review of Economic Studies, October 1936 and February 1937. It is reproduced in Lange, “On the Economic Theory of Socialism” (1938).
9. Hayek, “Socialist Calculation” (1935, pp. 201–243), reprinted in Hayek, Individualism and Economic Order (1948).
10. Hayek, “Socialist Calculation” (p. 210). The italics have been added.
11. The construction of the survey of managers and the statistical findings are described in Frydman et al., “When Does Privatization Work?” (Mises could have said in defense that his argument about prices being increasingly wrong in a socialist economy clearly implied that innovative effort in that economy would go increasingly awry.)
12. In his The Road to Serfdom (1944) the terms innovation, creativity, originality, invention, growth, advance, and progress do not appear in the index. Hayek scholars might agree that the first flicker of recognition that—as was virtually pointed to in his own work!—indigenous creativity could occur within a nation’s economy, not just its scientific establishment, may have come when Hayek was sent a lecture by Oskar Morgenstern in 1937. Hayek had supposed in influential work in 1927 that the economy has a tendency to home in on some equilibrium path, though errors could cause disequilibrium for some time. Morgenstern’s lecture argued that to suppose that was to assume that the actors in the economy possessed perfect foresight, which they could not do in a world of endogenous innovation (nor, for that matter, in scientific research outside economies). Certainly Hayek saw the problem. His recognition of the uncertainty within an economy caused by innovators (and more generally the pluralism of views among participants) became explicit in the 1960s. Hayek’s 1961 paper “The Non-Sequitur of the ‘Dependence Effect’%” teased J. K. Galbraith for supposing that would-be innovators bringing out new products know they would succeed or know the probability of any given level of sales.
13. As reported on the International Herald Tribune’s website, www.iht.com, March 5, 2010.
14. Ammous and Phelps, “Climate Change, the Knowledge Problem and the Good Life” (2009). See also Volpi, “Soya Is Not the Solution to Climate Change” (2006).
15. In a 1933 paper, “The Trend of Economic Thinking,” Hayek wrote that laissez-faire is not “the ultimate and only conclusion.” (p. 134). In The Road to Serfdom he speculated that “nothing has done so much harm to the liberal cause as the wooden insistence of some [libertarians] on certain rules of thumb, above all the principle of laissez-faire” (p. 13). That tract brought a range of reactions. A mild one was from Keynes, who in a letter expressed great admiration for the book, then said he differed with it at only one point. He favored a radically different list of activities for the state to do—an agenda as odd from present-day perspectives as from Hayek’s. The fury of some of the reactions is incomprehensible to scholars in the present age. On its sixtieth anniversary in 1994, The Road to Serfdom won high praise from Amartya Sen, writing in the Financial Times. It remains true that Hayek was alarmed as few others were by the loss of individual freedom he expected to result from British economist William Beveridge’s plan for a massive system of social insurance and other interventions.
Incidentally, many imagine that Road was a broadside against Soviet socialism based on Hayek’s previous theoretical work. In fact, it was Hayek’s answer to those in Britain who claimed there was no reason to fight a war with Nazi Germany. It was a warning against the state-sponsored corporatism in Germany more than against communism in the Soviet Union, though Hayek often alluded to the latter. Maybe Hayek saw corporatism in Beveridge’s extreme welfare state. During the war, Hitler’s economists got hold of a draft of the Beveridge blueprints after it was air-dropped over Nazi-occupied Europe. The Nazis apparently exclaimed, “This is what we need here in Germany!” See “Commission on Social Justice: Beveridge’s Appeal for an Attack on Five Giant Evils” in The UK Independent, October 25, 1994.