Why socialist economies fail

By James Pethokoukis

Consider: Without competition and threat of failure, companies won’t engage in game-changing innovation and the adoption of new technology. In his book The Innovation Decision in Soviet Industry, economist Joseph Berliner termed this market mechanism the “invisible foot” — a complement to Adam Smith’s invisible hand — and argued that its absence helps explain the lack of innovation in the Soviet Union. Berliner writes that “from the point of view of innovation, the evil of monopoly is that it enables producers to enjoy high rates of profit without having to undertake the exacting and risky activities associated with technological change.”

Chinese President Xi Jinping makes a speech during an event at Tiananmen Square in Beijing on July 1, 2021, to mark the 100th anniversary of the founding of the Communist Party.
Via REUTERS

The word “risky” is key here because the innovation may turn out to be a bad one. And even if a new technology eventually boosts production, there may be an adjustment period where production is lower than otherwise as the technology is integrated. Science historian Loren Graham provides an example of this dynamic in his 2013 book, Lonely Ideas: Can Russia Compete? (and gives Berliner a shout-out):

As the economist Joseph Berliner observed, the fatal flaw of the Soviet economic system was its inability to promote creativity and innovation. The frustrations of Soviet engineers who were so frequently unable to introduce their innovations into practice were perhaps most graphically illustrated in a famous 1956 novel by Vladimir Dudintsev titled Not by Bread Alone. In this novel an engineer who has developed a superior method of making metal pipes vainly tries to gain the attention of his employer or anybody else in the Soviet bureaucracy who might want to improve Soviet production methods. He finds out that Soviet administrators are primarily interested in production output, not improvements, because the administrators are rewarded for achieving increases in gross output. They oppose any innovation that would mean temporarily stopping the production line while new equipment is installed. Dudintsev’s novel struck such a responsive chord among Soviet engineers (by that time the largest group of educated people in the Soviet Union) that it became a best-seller until repressed by Soviet authorities.

But the lack of an “invisible foot” and its impact on the Soviet economy is just part of the Graham thesis about why a country capable of great scientific discovery and invention was not capable of economically deploying those advances across its economy in a way that would boost productivity. Again, Graham:

The person who develops an idea with commercial potential needs a variety of sustaining societal factors if he or she is to be successful. These factors are attitudinal, economic, legal, organizational, and political. Society needs to value inventiveness and practicality; the economic system needs to provide investment opportunities; the legal system must protect intellectual property and reward inventors; and the political system must not fear technological innovations or successful businesspeople but promote them. Stifling bureaucracies and corruption need to be restrained. Many people in Western societies and, increasingly, Asian ones take these requirements for granted. Just how difficult sometimes they are to fulfill is illustrated by Russian history and by Russia today.

In other words, Russia had a bad case of socialism, which intensified lots of pre-existing problems. But what about China? Graham concedes its fast-growing economy is “the greatest challenge to the basic thesis of this book, that technology is most creative and successful in a democratic, law-governed society. Much will depend on the future, but China so far has been much more successful in achieving economic growth than it has in creating its own novel high technologies.” Indeed, being a fast follower isn’t the same as pushing forward the innovation frontier, a reality recognized by Beijing in its industrial policy plans to make itself the world leader across of a range of advanced technologies.

But is brute-force, top-down planning, even with tremendous funding, enough without the sort of innovation ecology that Graham describes? Cai Xia suggests we should be skeptical. Cai was a professor of political theory at the Central Party School of the Chinese Communist Party in Beijing from 1998 to 2012 and has lived in exile in America since 2018. This is from her new essay in The Economist:

Then there is innovation, the basis of future growth. An essential precondition for creativity is respect for human dignity, protection of basic human rights, and upholding freedom of thought and speech. For China’s economic development to continue, the country needs to follow the general trend of freedom and democracy in the world. However, the one-party system is fundamentally opposed to freedom and democracy. It is not only a huge obstacle to China’s development, but a catastrophe in terms of civil liberties. The pillars of China’s one-party dictatorship are violence and terror, lies and deceit, coupled with strict surveillance.

I have previously written about China’s productivity problem, one which — if Graham, Cai, and I are correct — will not be fixed under the authoritarian, state-capitalist model being pushed by Xi Jinping. Of course, the failure of socialist economies should also provide a few lessons for America about the importance of democratic capitalism, even with all its disruption, to create a flourishing society that helps its citizens to maximize their human potential.

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Source: aei.org

Why socialist economies fail