Socialist Resource Allocation in Practice

Any ongoing economy must allocate its resources. The Austrian economists' argument was that, in practice, a socialist economy would find it impossible to determine a set of prices that would efficiently allocate resources. It is helpful to consider the path that Russia followed in setting prices to see, first, the difficulties with socialist pricing, and, second, under what circumstances a planned economy might efficiently allocate resources.

After the revolution in Russia, pragmatism overwhelmed theoretical consid­erations. Five-year plans were developed, and much attention was paid to physical output and meeting physical output quotas. There was little concern for prices or issues of efficiency. These plans were brought into balance through trial and error by material balances, in which the desired products were placed on one side of the ledger and the resources available to produce those products were placed on the other side. Predictable problems were encountered. For example, when farmers were not given high enough prices, they refused to turn their output over to the government so that the government could supply food and materials to the urban sector. In response the Russian government decided to collectivize the farms and thus "assure" the supply of agricultural products. Collectivization further exacerbated the incentive and efficiency problems. The plan's focus on investment goods over consumer goods meant that the shelves of many retail firms were empty, leaving workers with little incentive to work. The goods that were in shops were seldom the goods that people wanted; industries met their quotas by producing goods, not by satisfying needs. More­over, there were few incentives for technological change, and as a result Russian manufacturing techniques fell further and further behind Western techniques.

Some Soviet economists recognized the inefficiencies in the Soviet system of material-balances planning. They are the intellectual fathers of the movement toward perestroika and glasnost. To understand their contributions to modern economic thought, it is necessary to see why Marxian theory had inhibited economic planning.

The labor theory and planning. We have seen the difficulty in using the labor theory of value to arrive at market prices. At first, planners tried to keep their plans consistent with the labor theory of value. That changed over time. The assault on the labor theory of value came about not as a broadly conceived thrust but as a byproduct of attempts to solve everyday problems in planning. The strength of ideology and the authoritarian nature of the Soviet system are evidenced by the time lag between the publication of papers in 1939 by L. V Kantorovich, who later was awarded a Nobel Prize, and V V Novozhilov, and the fuller discussion of these issues that began with Khrushchev's sanction in the early 1960s. These men were the first to implicitly question the labor theory of value.

Shadow prices. Kantorovich, a mathematician by training, was asked to help solve a scheduling problem in the plywood industry. Soviet mathematicians long before had developed certain techniques that could be applied in industry. Because the particular problem presented to Kantorovich was not adaptable to existing techniques, however, he developed a new method for its solution. Kantorovich thus became the originator of linear programming, a technique independently discovered in the United States in 1947.

In the solution of a linear programming problem, certain so-called multipliers are derived. Although Kantorovich did not immediately perceive their impor­tance and implications, his further investigations into the application and eco­nomic significance of linear programming made apparent their usefulness in economic planning. These multipliers are what economists refer to as shadow prices, and they reflect the scarcity value of commodities.

It soon became clear to many Soviet economists that planners employing shadow prices as indicators of value would achieve a much more efficient allocation of resources than planners using prices set by a planning board and derived from some mixture of ideology and expediency. Others were equally quick to see that the shadow prices generated by linear programming implied that relative prices are not just a function of labor time but also depend upon the scarcity value of capital and land. Use of shadow prices was therefore an obvious and fundamental attack on the labor theory of value.

Opportunity costs. The other pincer in the movement against Marxian ortho­doxy also started as an attempt to solve limited practical problems of planning. Suppose that a planning board must choose among several investment alterna­tives. Should it allocate funds (capital) to build a hydroelectric plant, a steel mill, or a machine tool plant? A labor theory of value that excludes interest from consideration does not help to solve this everyday problem even in an economy organized like that of the Soviet Union. This is one example of a series of problems that can be solved only by admitting the productivity and scarcity value of capital.

Problems such as these engaged the attention of the economist Novozhilov in the late 193 Os and led him to write a series of papers. His solution to the problems of rational calculation is complicated in its details but clear in its outline and main thrust. He proposed to measure value, or price, by what economists term opportunity costs and thereby allow not only for labor costs but also for capital and land costs. By expressing his concept of opportunity costs in units of labor, he gave the impression of remaining within the tent of Marxian orthodoxy.

In the post-Stalinist period there was a relatively free and open discussion of Kantorovich's and Novozhilov's proposals, and the pot started to boil.17 These early discussions of resource allocation were studied by others and led in the 1960s to a critical reexamination of economic planning in the Soviet Union. An economist, Evsei Gregorevich Liberman (1897-1983), suggested giving the state firm greater latitude in making decisions and reducing the number of production targets assigned to the firm by the state planners; this was a strong suggestion for greater decentralization. Liberman also advocated the discontinuation of paying bonuses to firms based on output because more production of unwanted or inferior goods was wasteful. Instead, he recommended that bonuses be based on the profitability of firms.

Slowly the tide began to turn; witness the post-Stalinist period, the era of Khrushchev, and the collapse of the Soviet Union under Gorbachev. With these events came profound changes in many countries of Eastern Europe.

Planning and Economic Theory: An Assessment

With the fall of many of the socialist economies in the 1990s and their attempts to introduce markets into their economies, it is helpful to go back and consider the debate on socialist economic planning from this historical perspective. It seems that, in practice, mainstream economists were wrong, and Mises and Hayek were right. Planning in socialist countries did not lead to anything like efficient allocation of resources. It did not lead to what most people would call increases in personal freedom or to distributional equality. Most people in the socialist countries felt that the Communist party was simply an oppressor.
What is not clear is whether that failure is endemic to socialism or occurred for other reasons. Making a judgment based on history is difficult. We will, however, offer the opinion that the disequilibrium adjustment process, which involves knowledge acquisition, freedom, and entrepreneurs, is an important part of the understanding of an economy and that the events in the formerly socialist countries should reinforce the need for the mainstream to consider that disequilibrium process more carefully.