Perestroika: Can It Work?

by Manuel F. Ayau and Julio Cole

It is all very well to hail perestroika -- the current moves toward liberalization of Soviet bloc economies, the establishment of "profits" as incentives for Soviet managers, and steps to organize Soviet production in a more businesslike manner. But all these changes soon will bring disappointment, for technical reasons.

It isn't enough to imitate the marketplace. The essential ingredient of a market economy is the private ownership of scarce resources and the means of production. And even with perestroika this ingredient is missing.

The technical reasons have to do with a problem which continues to be ignored by most people, and indeed, by most economists. In the 1930s, when it was debated in small intellectual circles in Europe, it was called the Problem of Economic Calculation.

Simply stated, we live in a world of scarcity, and no matter how a society is organized, we always will need some means of deciding how resources can be put to the best use.

In a capitalist society, free market prices provide the answer. Competition among buyers and sellers in a free market establishes relative prices which eliminate the least economic (profitable) uses of each particular unit of a resource, inducing the use of substitutes which in turn must be withdrawn from other uses by the same market process. All this happens only because resources and the means of production are privately owned -- they can be bought and sold and consequently have market prices. How this happens is amply explained in economics texts, although seldom are students reminded that it happens only in economies with private ownership.

What has yet to be explained is how a true socialist society (one that doesn't copy capitalist prices) could carry out this necessary task of efficient allocation. Ration cards, queues, and income controls today are used in so-called socialist countries, along with arbitrarily determined shadow prices, to ration consumer goods.

But how would the planning czar determine how best to use, say, a pound of silver when confronted with such competing uses as more Xray film, industrial film, microfilm for banks, tourist film, jewelry, electronic contacts, tooth fillings, and wart removals? Remember that he also would have to decide on the price relationships of all the inputs used to produce the pound of silver, as well as the prices of all the things of which it becomes a part. And we must bear in mind that he cannot simply sum up the costs, since costs themselves are prices.

The nature of the problem of economic calculation is that of assigning relative prices to millions upon millions of items, each of whose price is a function of all other prices, with the ultimate deciding factor for each price being the ever-changing subjective valuations of millions of consumers. Even assuming that the "Central Authority" could paternalistically decide upon the proportions of final consumer goods to be produced, the main problem is how to produce the desired outputs -- determining which of the myriad of technically feasible input "mixtures" is most efficient.

The fact that the leading Soviet planning theorist, L. Kantorovich, stumbled across the problem in 1939 is one of the most curious incidents in the history of modern economics. He found that the correct solution of a production problem, given several inputs and several possible input combinations, required the introduction of certain auxiliary variables which he called "allocation coefficients." As it turned out, when western economists read his paper after the war, they realized that these "allocation coefficients" were simply the prices of the different inputs.

Because we live in a world where things have prices, we take them for granted. But market theory teaches us that prices are not established by "someone" or by some "authority." They arise from private transactions in the marketplace.

What this boils down to is that no one has ever explained how socialism is supposed to work. Just because some totalitarian countries call themselves "socialist" does not mean that they actually operate in a socialist manner.

If you are wondering how "socialist" countries go about setting their prices, it is simple: they copy them from capitalist countries, from Sears' catalogues, and from newspapers, adjusting them to their current plans. And whereas profit incentives are important motivationally, they are useless if decision makers lack the information to be able to economize resources and achieve efficiency.

Myths die hard, and the myth of the feasibility of central planning is no exception. Failures will be blamed on people, on sabotage, and on the weather. Revolutionary new corrective measures again will be announced. Stay tuned: the new perestroika is coming.