Criticism of socialism

Friedrich Hayek, one of the most prominent critics of socialism.

The dismal science
Economics

Economic systems

$  Free market
€  Social democracy
☭ Socialist economy

Major concepts

* George Mason University
* Sustainability
* Insurance in the U.S.
* Foreclosure mill
* Modern Monetary Theory

The worldly philosophers

* Paul Krugman
* Friedrich Hayek
* Thomas Sowell
* Max Weber

v \- t \- e

“”Socialism—defined as a centrally planned economy in which the government controls all means of production—was the tragic failure of the twentieth century. Born of a commitment to remedy the economic and moral defects of capitalism, it has far surpassed capitalism in both economic malfunction and moral cruelty. Yet the idea and the ideal of socialism linger on. Whether socialism in some form will eventually return as a major organizing force in human affairs is unknown, but no one can accurately appraise its prospects who has not taken into account the dramatic story of its rise and fall.

—Socialist economist Robert Heilbroner acknowledging the failure of his beloved system.[1]

Criticism of socialism is as old as socialism itself: arguments against socialism used in 1850 are still in vogue.[2] There are two main kinds of critiques of socialism: arguments based on the economic theories of socialism, claiming that it’s a very inefficient system when compared to capitalism, and more abstract, political arguments, that claim that even if socialism is feasible, it’s still immoral.

Due to the distressful lack of democratic socialist countries, most empirical analysis of socialism comes from dictatorships, a fact that some adherents use as a scapegoat to criticism, claiming that this time it will be different. That doesn’t mean, however that the criticism is not valid to other forms of socialist. Some critics, such as the philosopher Karl Popper, also see socialism as inherently authoritarian and incompatible with human rights. As a result, according to them, dictatorships are just a natural result of socialism.[3] Others, such as Keynesian economist and Nobel Memorial Prize Laureate Joseph Stiglitz argued that the repressive political system provided a substitute to the lack of incentives that socialism tends to produce, and a democratic socialist community would perform even more poorly than the Communist bloc did.[4]

## Contents

* 1 Prices and information
* 2 Incentives
* 3 Prices, information and incentives
* 4 Private property matters
* 5 Economic freedom fosters economic growth
* 6 The trade-off between efficiency and equity
* 7 Government consumption, government failures and state-owned enterprises
* 8 "But how did the Soviet Union grow so much then?"
* 8.1 "And how about China?"
* 8.2 So, what?
* 9 The black market
* 10 Could market socialism work?
* 11 Socialism results in totalitarianism
* 12 Markets and freedom
* 13 Notes
* 14 References

## Prices and information[edit]

“”Surprisingly, the unplanned 'chaos' of a market economy turns out to be far more orderly than the 'planning' of a command economy

—Paul Krugman[5]:2

Why, and how are things produced in capitalism? As the Nobel Memorial Prize laureates Paul Samuelson and William Nordhaus explain:[6]:59-60

> By determining the equilibrium prices and quantities, the market allocates or rations out the scarce goods of the society among the possible uses. Who does the rationing? A planning board? Congress? The president? No. The marketplace, through the interaction of supply and demand, does the rationing. This is rationing by the purse.

> What goods are produced? This is answered by the signals of market prices. High corn prices stimulate corn production, whereas falling computer prices stimulate a growing demand for computation. Those who have the most dollar votes have the greatest influence on what goods are produced.

> For whom are goods produced? The power of the purse dictates the distribution of income and consumption. Those with higher incomes end up with larger houses, fancier cars, and longer vacations. When backed up by cash, the most urgently felt needs get fulfilled through the demand curve.

> Even the how question is decided by supply and demand. When corn prices are high, farmers buy expensive tractors and more fertilizer and invest in irrigation systems. When oil prices are high, oil companies drill in deep offshore waters and employ novel seismic techniques to find oil.

In socialist economies, however, things are different. While analyzing the failure of communism, Harvard professor Greg Mankiw wrote:[7]:7

> Communist countries operated on the premise that government officials were in the best position to allocate the economy’s scarce resources. These central planners decided what goods and services were produced, how much was produced, and who produced and consumed these goods and services. The theory behind central planning was that only the government could organize economic activity in a way that promoted well-being for the country as a whole.

> Most countries that once had centrally planned economies have abandoned the system and instead have adopted market economies. In a market economy, the decisions of a central planner are replaced by the decisions of millions of firms and households. Firms decide whom to hire and what to make. Households decide which firms to work for and what to buy with their incomes. These firms and households interact in the marketplace, where prices and self-interest guide their decisions.

> At first glance, the success of market economies is puzzling. In a market economy, no one is looking out for the well-being of society as a whole. Free markets contain many buyers and sellers of numerous goods and services, and all of them are interested primarily in their own well-being. Yet despite decentralized decision making and self-interested decision makers, market economies have proven remarkably successful in organizing economic activity to promote overall prosperity.

Changes in equilibrium price and quantity

What went wrong? Can other forms of socialism circumvent the limitations faced by the communist bloc? One of the most famous arguments against socialism was advanced by the Austrian economist Ludwig von Mises. According to Mises on his article Economic Calculation in the Socialist Commonwealth, socialism is theoretically impossible because, in any economy, prices are a signal: if they are higher, the producers will produce more. If they are lower, the producers will produce less, adjusting the market accordingly. In socialism, however, prices are not defined by the market. As a result, no one knows how to produce.

The most famous attempt to refute Mises’ argument came from the Polish economist Oskar Lange[note 1], who developed a market socialism theory. According to Lange (in what latter became the Lange-Lerner Theorem, or the Lange-Lerner-Taylor Theorem) planners would be able to use the information available on a central planning board to set prices, raising them to get rid of shortages and lowering them to get rid of surpluses. The problem, therefore, would be a matter of administration, not socialism or capitalism.[9][10]

Anarcho-capitalist economist Bryan Caplan (so, even more radical than on his defense of the market economy than his Austrian fellow) also criticized Mises argument claiming that while economics calculation under socialism might be impossible, that doesn’t mean that socialism is, also stating that Mises’s idea is incompatible with his own epistemology. According to Caplan, incentives, which we’ll see next, are the main reason why socialist countries have performed so poorly.[11]

However, a far more compelling criticism would soon appear by another Austrian economist.

## Incentives[edit]

“”Try pouring water into a tank where there's a pipe at the bottom draining it out faster than you pour it, and each bucket you bring breaks that pipe an inch wider, and the harder you work the more is demanded of you, and you stand slinging buckets forty hours a week, then forty-eight, then fifty-six-for your neighbor's supper - for his wife's operation-for his child's measles-for his mother's wheel chair - for his uncle's shirt - for his nephew's schooling-for the baby next door - for the baby to be born - for anyone anywhere around you it's theirs to receive, from diapers to dentures - and yours to work, from sunup to sundown, month after month, year after year, with nothing to show for it but your sweat, with nothing in sight for you but their pleasure, for the whole of your life, without rest, without hope, without end.... From each according to his ability, to each according to his need...

—Libertarian novelist Ayn Rand, showing her  amazing writing skills.[12]

Another, more intuitive, albeit still relevant criticism, is the idea that the abolition of private property and the "From each according to his ability, to each according to his need" ideal may create bad incentives. Put in a very simple manner, most people don’t like to have their stuff taken – and won’t put much effort on their work if you give them too much free stuff.

In 1848, the British classical political economist and philosopher John Stuart Mill wrote on his book The Principles of Political Economy:[13]

> It is the common error of Socialists to overlook the natural indolence of mankind; their tendency to be passive, to be the slaves of habit, to persist indefinitely in a course once chosen. Let them once attain any state of existence which they consider tolerable, and the danger to be apprehended is that they will thenceforth stagnate; will not exert themselves to improve, and by letting their faculties rust, will lose even the energy required to preserve them from deterioration. Competition may not be the best conceivable stimulus, but it is at present a necessary one, and no one can foresee the time when it will not be indispensable to progress.

This criticism is so intuitive that Karl Marx and Friedrich Engels themselves tried to refute it on their Communist Manifesto,[14] released on the very same year as Mill published his Principles of Political Economy.

> It has been objected that upon the abolition of private property, all work will cease, and universal laziness will overtake us. According to this, bourgeois society ought long ago to have gone to the dogs through sheer idleness; for those of its members who work, acquire nothing, and those who acquire anything do not work. The whole of this objection is but another expression of the tautology: that there can no longer be any wage-labour when there is no longer any capital.

Evidence hasn't been kind to Mill's argument: according to Nobel Memorial prizer Abhijit V. Banerjee on a World Bank study, there is no systematic evidence that cash transfer programs tend to discourage work.[15] However, socialist countries have so far faced some serious problems at creating incentives, so much that they haven't managed to create a substitute to the market. In sectors where the party leadership really wants results, such as military, incentives are used. As the Pulitzer-winner journalist Hedrick Smith puts:[16]:312-13

> Not only do defense and space efforts get top national priority and funding, but also they operate on a different system from the rest of the economy. Samuel Pisar, an American lawyer, writer, and consultant on East-West trade, made the shrewd observation to me that the military sector is ‘the only sector of the Soviet economy which operates like a market economy, in the sense that the customers pull out of the economic mechanism the kinds of weaponry that they want. Generally speaking, the Soviets have a push economy—products are pushed out to consumers on orders from above, essentially repeating past production, without tapping the inventions and new technology of Soviet scientists in laboratories and Institutes. But the military, like customers in the West, has a pull effect. It can say, 'No, no, no, that isn't what we want.'’

The collectivization of agriculture in the Soviet Union also shows how inefficient an economy without incentives can be: by taking the lands from the ‘’kulaks’’ and sending the food from the camp to the cities, millions died. The incentives that dictator Josef Stalin and his crew offered to their people? The right to not be shot if you worked. However, using the whip as an "incentive" can lower productivity. Why should you stuck your neck by trying new ideas when your gain would be minimal anyway and when failure could be met (if you're very lucky) with severe punishment? The lack of incentives also leads to wastes: since the community, and not the individual firms will pay for the resources, people tend to be less careful while managing them.

The Holodomor in the Soviet Union.

Eventually, the collectivization had to be halted and some private property and incentives were established. According to the economic historian Alec Nove, "How did the peasants survive the confusion and hardship of the revolution from above'? They could not have survived without the toleration, in and after 1930, of some private food-growing, and, after the initial excesses of super-collectivization, they were allowed some domestic animals."[17]:184 By 1934, private livestock holdings were again permitted, and in 1938 over threequarters of all cows, over two- thirds of all pigs, nearly two-thirds of all sheep in the Soviet Union were again in private hands.[18] This wasn't the first time that the Soviet Union had to give up on socialism in order to survive: Under Vladimir Lenin, the so called "War Communism" had to be replaced by the New Economic Policy, that abolished parts of the central planning and allowed for some private economy, especially on the agriculture.[17]:81

Indeed, as early as 1931 Stalin gave up on the idea of creating “socialist men and women” who would work without monetary incentives. Thereafter, not only did different jobs get paid different wages but also a bonus system was introduced. Such bonuses however, created disincentives to technological change. First because innovation would take resources away from current production, risking the output targets. Second, because output targets were usually based on previous production levels. This created a huge incentive never to expand output, since these incentives only meant having to produce more in the future, as future targets would be “ratcheted up.” Underachievement was, therefore, the best way to meet targets and get bonuses. The fact that such bonuses were paid monthly also kept planners focused on the present, while innovation is about making sacrifices in order to have a better future.[19]:129-30

We don’t need such an extreme example as the Soviet Union under Stalin to show how the economy can be distorted by policies that hinder incentives. In fact, even the most capitalistic countries, like the US, can have inefficiency problems caused by these policies. According to Harvard professor Greg Mankiw:[7]:413

> Welfare, Medicaid, SNAP, and the EITC are all programs aimed at helping the poor, and they are all tied to family income. As a family’s income rises, the family becomes ineligible for these programs. When all these programs are taken together, families can face effective marginal tax rates that are very high. Sometimes the effective marginal tax rates even exceed 100 percent so that poor families are worse off when they earn more. By trying to help the poor, the government discourages those families from working. According to critics of antipoverty programs, these programs alter work attitudes and create a “culture of poverty.”

Despite all the efforts by the government, people under socialism are still self-interested. As a result, they try to find incentives whenever is possible. Economists Andrei Shleifer and Robert W. Vishny also claim that, under socialism not only industries have no interest to be efficient and innovative since they get no profit from but, but also that shortages were made by planners on purpose: because planners cannot keep the profits the firms earn in socialist economists, they intentionally create shortages in order to bribe costumers. In contrast, capitalism tends to create supplies, as producers want to sell more. Again, this sort of inefficiency and corruption also happen in capitalistic countries with a large public sector, such as France.[20]

## Prices, information and incentives[edit]

Finally, we can merge the two sections above into a different argument. Using classical political economists such as Adam Smith, David Hume and Bernard de Mandeville and focusing more on entrepreneurship rather than the price theory like Mises, Nobel Memorial Prize laureate Friedrich Hayek argued on his 1945 article The Use of Knowledge in Society that knowledge is disperse in society: information only exists in tiny bits of incomplete and often contradictory knowledge. Businessmen know the best way to run their business, while workers know the best way of making products and consumers know what’s the best for them. How does market resolve this issue? Giving us the example of the tin market, Hayek writes:[21]

> Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all the things made of tin, and their substitutes, and so on; and all this without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes. The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all.

In other words, let's suppose there's a disruption of the tin market. This information (although not necessarily the cause of such disruption) will spread through markets, and consumers will economize on tin and seek out substitutes. On the other hand, as the price of tin goes up, tin producers have an incentive to produce more. As economists Tyler Cowen and Alex Tabarrok wrote, “a price is a signal wrapped in an incentive”. All you need are producers trying to profit and consumers trying to save money.[22]:118

Another example was given by Cowen and Tabarrok[22]:115

> How does the price of oil affect the price of candy bars? One way is obvious: Higher energy costs increase the cost of producing most products, including candy bars. But the market also links oil and candy bars in more subtle ways. For instance, ethanol is the active ingredient in alcoholic beverages, but it’s also a good fuel that can be made from a variety of crops like corn or sugar cane. Brazil is the largest producer and consumer of fuel ethanol in the world, so much so that it has managed to reduce its gasoline consumption by 40% by adopting flexible fuel vehicles that can run on ethanol, gasoline, or any combination of the two. Brazil is also the largest producer of sugar in the world. Can you see the connection between the price of oil and the price of candy bars now? As the price of oil has increased, the Brazilians have shifted sugar cane from sugar production to ethanol production, thereby holding down fuel costs but increasing the price of sugar.

Despite its robust start, the Soviet economy lagged behind. At the same time, China abandoned most of its central planning, lifting millions from poverty.

If you don’t feel like reading the whole thing above, all you need to know is that, by eating candy bars, you’re making oil more expensive.

In socialism, however, it is impossible, according to Hayek, to assimilate so much information. Let’s keep our oil example. Oil is used to produce steel, but also to produce food. Which one is more important? A central planner has no way to decide this, and we’re only talking about two uses for oil (oil has many, many other uses, from a fuel to asphalt production). Moreover, even if we could compute all the information available. What would be the incentive to send the actual information to the central planners? Every user of would just claim that their use is the most important. One just need to study the history of the Nixon shock, when the American government tried to allocate the oil in the economy, to understand why it cannot work, and how a market economy managed to eliminated (through a painful way, it’s true) the shortage of oil. Now, if this failed at one sector, imagine the same thing happening with the whole economy? As once again, Cowen and Tabarrok put:[22]:126

> After a hurricane, the prices of ice, generators, and chainsaws often skyrocket. Consumers complain of price gouging, and politicians call for price controls. That’s understandable, because it can seem doubly harsh to be hit by a hurricane and high prices. But the price system is just doing its job. A sky rocketing price is like a flare being shot into the night sky that shouts—bring ice here! A price control eliminates the signal to bring ice into the devastated area as quickly as possible. The high price of ice in a hurricane-devastated area signals a profit opportunity for ice suppliers. Buy ice where the price is low and ship it to where the price is high. As the supply of ice in the hurricane-devastated area increases, the price will fall. More generally, price signals and the accompanying profits and losses tell entrepreneurs what areas of the economy consumers want expanded and what areas they want contracted. If consumers want more computers, prices and profits in the computer industry will increase and the industry will expand.

In other words, higher prices incentivize producers to produce more and compete with better products which will… lower the prices to consumers.

Furthermore, it is essentially impossible for all the relevant information to be communicated to a central planner. There is really no alternative other than some form of decentralization and a far more fundamental form of decentralization than envisaged by the market socialism model.[4]:152 Reformers who begin groping toward market socialism along Lange's lines regularly learn by bitter experience in their own countries that the hope Lange held out was illusory.[23]:476

The Use of Knowledge in Society is widely regarded as one of the most important articles in the history of the economic thought,[24] being considered one of the top 20 articles published in the American Economic Review during its first 100 years[25] and Hayek is thought to have won the debate.[23]:476[4]:198[26]

According to socialist economist Robert Heilbroner:[1]

> Here is the part hard to swallow. It has been the Friedmans, Hayeks, von Miseses, e tutti quanti who have maintained that capitalism would flourish and that socialism would develop incurable ailments. Mises called socialism “impossible” because it has no means of establishing a rational pricing system; Hayek added additional reasons of a sociological kind (“the worst rise on top”). All three have regarded capitalism as the “natural” system of free men; all have maintained that left to its own devices capitalism would achieve material growth more successfully than any other system.

According to the former president of Harvard University and former United States Secretary of the Treasury Larry Summers, not only Hayek won the debate, but his teachings on how the market organizes the economy is perhaps the single most important insight of the economic thought:[27]:476

> What's the single most important thing to learn from an economics course today? What I tried to leave my students with is the view that the invisible hand is more powerful than the hidden hand. Things will happen in well-organized efforts without direction, controls, plans. That's the consensus among economists. That's the Hayek legacy.

Hedrick Smith’s misadventures on Soviet Russia illustrate well the failure of the central planning to allocate resources, and how shortages, surpluses and lines were a staple on the most powerful socialist country the world has ever seen:[16]:77-8

> In spite of the various tinkering reforms, the Soviet economy still operates by Plan from above rather than in response to consumer demand from below and this produces a lopsided assortment of goods. Goods are produced to fill the Plan, not to sell. Sometimes the anomalies are baffling. Leningrad can be overstocked with cross-country skis and yet go several months without soap for washing dishes. In the Armenian capital of Yerevan, I found an ample supply of accordions but local people complained they had gone for weeks without ordinary kitchen spoons or tea samovars. I knew a Moscow family that spent a frantic month hunting for a child's potty while radios were a glut on the market. In Rostov, on a sweltering mid-90s day in June, the ice-cream stands were all closed by 2 p.m. and a tourist guide told me that it was because the whole area had run out of ice cream, a daily occurrence. (…) The list of scarce items is practically endless. They are not permanently out of stock, but their appearance is unpredictable—toothpaste, towels, axes, locks, vacuum cleaners, kitchen china, hand irons, rugs, spare parts for any gadget from a toaster or a camera to a car, stylish clothes or decent footwear, to mention a few listed in the Soviet press.

Since the demise of Soviet-style socialism, another proposal to solve this issue is the use of technology. Socialist computer scientist Paul Cockshott claimed in his 1993 book Towards a New Socialism that a network of computers can plan the economy.[28] Practical and empirical evidence of this proposal is still meagre, with journalists (read, not academics) Leigh Phillips and Michal Rozworski contributing to the debate, arguing that, if companies like Amazon and Walmart can plan their immense economies, so can countries.[29] Another contemporary Austrian school economist, Peter Boettke, claimed that Hayek's point still stands because artificial intelligence can only find associations, not meaningful causal relationships, being therefore unable to overcome fundamental information-incentive problems that the market can solve. According to Boettke, it's not simply the knowledge that is difficult to compute; but also the knowledge tied up with questions of incompleteness and undecidability. "The subjective judgements of the exchange value of goods and services", he writes, "are translated into publicly information embodied in market prices only in the context of exchangeable private property rights, from which exchange ratios (i.e. market prices) emerge, and emerges only within that context (...)".[30]

## Private property matters[edit]

Poverty started to drop as property rights became more secure

A famous motto by socialists is that property is theft. However, the evidence available shows that private property and property rights are vital to economic development. MIT economist Daron Acemoglu found that property rights, that is, institutions and rules and regulations protecting citizens against the power of the government and elites, like those protecting (or failing to protect) investors against government expropriation, have a first-order effect on long-run economic growth, investment, and financial development.[31] Indeed, apparently one of the reasons why the world was so poor until not so long ago was because property rights weren't well protected, and one of reasons why places such as Africa are still so poor is the fact that the state cannot protect property rights.[32]:1124According to Acemoglu:[19]:75

> The contrast of South and North Korea, and of the United States and Latin America, illustrates a general principle. Inclusive economic institutions foster economic activity, productivity growth, and economic prosperity. Secure private property rights are central, since only those with such rights will be willing to invest and increase productivity. A businessman who expects his output to be stolen, expropriated, or entirely taxed away will have little incentive to work, let alone any incentive to undertake investments and innovations. But such rights must exist for the majority of people in society.

Contrary to popular belief, property rights can also prevent environmental degradation. Some environmental problems can be seen as problems of incomplete, inconsistent, or unenforced property rights regimes.[33] One of the most famous market failures, the tragedy of the commons is maximized under socialism: when the entire community owns a certain asset, no one actually owns it – and no one takes care of it. UCLA microeconomist Armen Alchian gives us a good explanation of this, that also explains why socialist experiments have been so disastrous while taking care of the environment:[34]

> The problems posed by communal rights are abundantly clear when we analyze the causes of pollution. Since the state has invited its citizens to treat lakes and waterways as if they are free goods, that is, since the state generally has failed to exclude persons from exercising communal rights in the use of these resources, many of these resources have been overutilized to the point where pollution poses a severe threat to the productivity of the resource.

The Korean Peninsula at night.

One important kind of property rights that socialists often oppose are intellectual property rights. Intellectual property rights are the key to creative destruction, the processes which new firms replace inefficient incumbents by innovations.[32]:550 As a result, technical progress that takes place under socialist countries consists almost exclusively of copying of innovations introduced in developed capitalist countries.[23]:294 Intellectual property rights also boost economic growth (especially long-term, healthy economic growth) by making more investment activities possible, particularly research and development activities. The investments in tangible and intangible capital in turn stimulate long-term growth.[35] Studying 80 countries in a 30 years panel, David M. Gould, William C. Gruben from the Federal Bank of Dallas found out that that, by influencing the incentives to innovate, stronger intellectual property rights protection corresponds to considerably higher economic growth.[36]

It's not hard to understand why property rights matter so much. When property rights are insecure, laws are poorly enforced and there are too many barriers to start a business, the profit-maximizing firms will probably tend to have short time horizons and little fixed capital, and will often tend to be small scale. The most profitable businesses in these cases might even be the black market.[37]:67

Property rights are also, according to Harvard historian Richard Pipes, fundamental to democracy and freedom. Contrasting England and Russia, Pipes argued that one became democratic and the other didn’t because of their culture and institutions regarding property rights. The importance of private property in England resulted, according to Pipes, into the development of individual liberty and democracy. The strength of the English Parliament, especially the House of Commons, grew as response to the king’s greed and need for money. In other words, the institution of private property in England forced the monarchs to respect property rights through their elected representatives in Parliament. On the other hand, in Russia with its historically weak tradition of private property, authoritarianism reigned.[38]

## Economic freedom fosters economic growth[edit]

Economic growth in East and West Germany.

For many reasons, socialists, in general, oppose to economic freedom, that is, the institutions that protect the liberty of individuals to pursue their own economic interests and undertake economic activities of their own choice. Evidence clearly suggests, however, that economic freedom is a determinant on economic growth since they promote greater opportunities for innovation and progress.[39][40][41][42] In addition, economic freedom has an indirect positive effect on economic growth through its positive impact on physical capital formation.[43] The reason for this is because economic freedom results in more competition and innovation. On its crusade against economic freedom, socialism ends up prohibiting the independent planning of self-interested individuals. Under a capitalist economy, when a person sees a profitable opportunity, they can act on their own initiative and are motivated to do so by the prospect of profit. As a result, new ideas can be implemented.

Some may argue that this economic freedom is only good for the rich. However, according to economists Andreas Bergh and Christian Bjørnskov, there is evidence that economic freedom affects all parts of the income distribution equally, and some indications that the growth effects are largest for the poorest and richest quintiles.[44]

Reviewing over 400 studies, economist Robert A. Lawson discovered that, on average, people living in countries with higher economic freedom enjoy much greater levels of income. Many other measures, like poverty rates, political rights, civil rights, gender inequality, live expectancy at birth, infant mortality rates, and life satisfaction surveys, are also better in the countries with more economic freedom. When it comes to income inequality, he argues that economic freedom is not the likely cause of excessive inequality: the share of total income going to the poorest tenth of the population is about the same in countries with high economic freedom as it is in countries with low economic freedom.[45]

## The trade-off between efficiency and equity[edit]

“”“The inherent vice of capitalism is the unequal sharing of blessings. The inherent virtue of socialism is the equal sharing of miseries.

—Winston Churchill

“”The uneven distribution of wealth in the world is due to the uneven distribution of capitalism.

—Jonah Norberg

On his seminal book Equality and Efficiency: The Big Trade-off, economist Arthur Okun gives us the following thought experiment:[46]:89

> First, consider the American families who make up the bottom 20 percent of the income distribution. Their after-tax incomes in 1974 were less than $7,000, averaging about $5,000. Now consider the top 5 percent of families in the income pyramid; they had after-tax incomes ranging upward from about $28,000, and averaging about $45,000. A proposal is made to levy an added tax averaging $4,000 (about 9 percent) on the income of the affluent families in an effort to aid the low-income families.

> Since the low-income group I selected has four times as many families as the affluent group, that should, in principle, finance a $1,000 grant for the average low-income family. However, the program has an unsolved technological problem: the money must be carried from the rich to the poor in a leaky bucket. Some of it will simply disappear in transit, so the poor will not receive all the money that is taken from the rich. The average poor family will get less than $1,000, while the average rich family gives up $4,000.

When it enacts policies in order make the distribution of income more equal, the government also distorts incentives, alters behavior, and makes the allocation of resources less efficient.[7]:398 Socialists are often willing to pay in reduced efficiency for greater equity, but while taking steps to redistribute income from the rich to the poor, governments ends up harming economic efficiency and reduce the amount of wealth available to distribute. In other words, if we value equality, we would approve when a dollar is taken in a bucket from the very rich and given to the very poor. But, as Okun puts, this bucket of redistribution has a leak in it. Only a fraction of each dollar paid by the rich in taxes actually reaches the poor. Then redistribution in the name of equity has been at the expense of economic efficiency. In terms of Okun's experiment, we might find that for every $100 of taxation on the rich, the income of the poor increased by only $50, with the rest dissipated because of reduced effort or administrative costs, although the exact size of the -actual leak is still subject to much debate.

In the American case, generous social programs, especially social security and Medicare, reduce the need for people to save for old age and health contingencies. However, countries with larger redistributive policies than US have found declining labor-force participation, growing unemployment, and rising budget deficits. These countries have taken steps to reduce the burden of the welfare state.[6]:333 One good example of this is Sweden, where in the 90s the Swedish Social Democratic Party was forced to liberalize the economy, severely cut spending (including cuts in the social security and pensions), and consolidate a harsh fiscal policy in order to make the country’s welfare state sustainable.[47]

The trade-off is also perceived on taxation systems: equality and efficiency will often conflict on taxes. Heavy income and property taxes might discourage people from working as hard as they otherwise would, discourage them from saving and may also lead capital flight, such as happened on France under François Hollande, of the French Socialist Party.[48] Meanwhile, luxury taxes may also create distortions such as Deadweight losses as they often have a very elastic demand. One good example happened in the US under George H. W. Bush administration: Bush tried to reduce the deficit budget by taxing luxury goods such as yachts. However, this resulted in a collapse of the yacht industry. The government expected a revenue of around US$30 million, but ended up with only half of it, spending more on unemployment benefits from those that were fired due to the new tax than it collected with it.[49] When it comes to wealth taxes, even proponents of this policy, such as the French economist Gabriel Zucman, acknowledge that they have failed so far, arguing that they would, however, work in the US.[50][note 2]

Additionally, macroeconomist Robert J. Barro argued that high levels of inequality reduce growth in relatively poor countries but encourage growth in richer countries.[53] As economic growth is probably the best thing for raising the quality of life of the poor,[54] socialists, on their quest for equality might in fact deteriorate the quality of life of millions.

That doesn't mean, however, that inequality is efficient. Nobel Memorial Prize laureates Abhijit V. Banerjee and Esther Duflo showed that the growth rate is an inverted U-shaped function of net changes in inequality: Changes in inequality (in any direction) are associated with reduced growth in the next period, although their data has little to say on whether inequality is bad for growth.[55] On his The Price of Inequality, Nobel Memorial Prize George Stiglitz shows (with mostly anecdotal evidences, it's true) how inequality can also harm the economy, with the wealth using their power to shape monopolies, incur favorable treatment by the government, and pay low taxes.[56] According to a 2011 IMF study, in the long term, the trade-off might not in fact exist, and too much inequality may also bring political instability, which can discourage investment and growth.[57] Finally, there are, of course, policies that can promote both equality and efficiency when well-designed, such as good public education.

## Government consumption, government failures and state-owned enterprises[edit]

A chief tenet between socialists, such as Bernie Sanders and Alexandria Ocasio-Cortez in the US is the increase of the government spending, especially in the welfare state. While there are many arguments in favor of this, many other variables should be considered, especially considering the scale of the projects proposed, as a higher level of government spending means not only is a higher share of income taken in taxes but also that there are higher transfer payments that reduce incentives to work. Americans are not only richer than Europeans, but are also getting richer, and one of the reasons for this is the smaller size of the government.[58]

A myriad of studies explain why a larger government slumps economic growth. Studying about 100 countries in the post-war world, Harvard professor, Robert Barro, concludes that “the cross-country data indicate that government consumption is inversely related to growth, whereas public investment has little relation with growth". According to Swedish economist Stefan Fölster “that an increase of the expenditure ratio by 10 percentage points is associated with a decrease in the growth rate on the order of 0.7–0.8 percentage points”.[59] A bigger government also harms the employment rates.[60] A study conducted by another Harvard professor, Alberto Alesina, states that a reduction by one percent of government spending leads to an increase in investment by 0.16.[61]

Unsurprisingly, a larger, more active government, also leads to more government failures. Many socialists also detract the Market economy because of market failures, believing that the government activity may solve them. However, as Public Choice scholars argue, government activity often makes the outcome even worse. The reason is the same as we saw before in the third section: the incentives and information to act are not available to bureaucrats and politicians. Such failures arises when government has created inefficiencies because it should not have intervened in the first place or when it could have solved a given problem or set of problems more efficiently, that is, by generating greater net benefits. Using thirty years of empirical evidence on the efficacy of market failure policies initiated primarily by the federal government, but also by the states, economist Clifford Winston argues that the welfare cost of government failure may be considerably greater than that of market failure. Some policies have forced the U.S. economy to incur costs in situations where no serious market failure exists.[62] Such failures often happen because politicians are also people. They have their goals, and be elected and re-elected are goals number one and two. They aren’t always looking out for the well-being of society as a whole, and are willing to sacrifice the national interest to solidify their base of voters. A bigger government also leads to more corruption, probably the most detested of all government failures.[63]

As China grew, most jobs fled to private companies

Some socialists also favor state-owned enterprises (SOEs) instead of private ones. But many many studies across many countries and economic sectors found out that SOEs are less efficient than mixed or private sector enterprises in every measurement imaginable.[64][65][66][67][68] This is especially true to manufacturing sectors, as SOEs have to face competition of private companies.[69] A study conducted by the World Bank concluded that SOEs often:[70]

* Are less efficient than private companies
* Do much worse to control pollution
* Can undermine fiscal stability and fuel inflation as they are often unable to generate the resources to finance their operation, and have to rely on public money.
* Have a negative effect on economic growth
* Crowd out expenditure on health and education
* Capture a disproportionate share of credit, squeezing out private sector borrowing

Additionally, Harvard economist Martin Feldstein argues that, one of the reasons why the American economy grows faster than the European economy despite the fact that Americans are already richer than Europeans, is the fact that are virtually no state-owned enterprises in the US.[58]

The very few SOEs in the US also face similar problems. Another reason why some socialists like SOEs so much is because of their allegedly ability to fix market failures. However, according to Nobel Memorial Prize Paul Krugman, perhaps the most well-known left-wing economist in the US, SOEs don't work well even when it comes to remedy market failures such as natural monopolies:[5]:391

> Experience suggests, (…) that public ownership as a solution to the problem of natural monopoly often works badly in practice. One reason is that publicly owned firms are often less eager than private companies to keep costs down or offer high-quality products. Another is that publicly owned companies all too often end up serving political interests—providing contracts or jobs to people with the right connections. For example, Amtrak has notoriously provided train service at a loss to destinations that attract few passengers—but that are located in the districts of influential members of Congress.

Why are SOEs often so inefficient? For the same reasons we saw before. In a market economy, companies that fail to motivate workers, produce goods of reasonable quality, or meet their production targets are ultimately driven out of the market. However, state-owned enterprises often don't even have to worry about competition or about being driven out of the market, and it is the government that set prices and foot the bill if these enterprises lost money.[71]

## "But how did the Soviet Union grow so much then?"[edit]

Stalin apologetics often claim that their favorite dictator put one of the poorest countries in Europe in the space era. The Soviet economy was, however, far less impressive than what these people think, and the Imperial Russia, far more remarkable, being one of the fastest growing countries in the world in the early XXth century.[72]:195 If the New Economic Policy wasn't repealed, the Soviet Union might have been a much wealthier nation by 1940. In the worst case scenario, a Tsarist economy would have achieved a rather similar structure of the economy and levels of production as Stalin’s economy by 1940. The short-run (1928-1940) costs of Stalin’s policies for industrialization are very significant for an economy in a peaceful period. Japan, for instance, achieved a far more prosperous economy without any mass starvations in the same period.[73]

The Soviet government was just an apparatus of repression, and could use force to move resources from agriculture, where they were very inefficiently used, into industry, what resulted into high growth rate.[19]:92 Such growth, however, couldn't last forever, since it didn't came from technological advance outside the military and aerospace field.[note 3] Even during Stalin's rule, waste and inefficiency were the rule. Stalin himself spent his time making seemingly trivial decisions, like setting the price of metro tickets, and corruption and rent-seeking were the rule. In the 1970s, the country's economic growth had all but stopped. The Soviet economy came to rely more and more on oil and gas, and when the prices started to drop, the country fell apart.[72]:196

### "And how about China?"[edit]

Mao's Great Leap Forward was so disastrous it crashed the entire global life expectancy.

An even less inspiring argument, advanced for instance by the Stalinist philosopher Domenico Losurdo,[74] is that the Chinese economic miracle shows the efficiency of socialism. The problem is, China only started to grow after the many reforms, after the dictator Mao Zedong died, when China abandoned much of its socialist institutions. The first reforms dismantled many of the aspects of the command economy that China has struggled under Mao. Agriculture, for instance, was an economic sector that had been gravely damaged by collectivization and the misguided attempt to industrialize rural areas. In the late 1970s, these, however, these policies failed began to be reversed. Among the first reforms was the revival of household farming. As a result, the grain output rose by nearly one-third between 1978 and 1984. Additionally, these increases in agricultural productivity freed up hundreds of millions of workers to move into industrial labor.[72]:217

On the other hand, in 1995 and after, reforms involved widespread privatization. The state's share of industrial output declined from around 50% in 1995 to 24% in 2008. China also saw an expansion in the legal protection for private enterprise. There was no rule of law in China before these reforms. However, as a market economy was introduced, a corresponding legal system had to be developed. A major development was the adoption of elements of the German civil law such as the right for private citizens to sue the government. Despite the opposition to private property rights by the communists reforms were able to create and protect property rights. At the same time, the country re-joined the global economy.[72] This leads to further investments and growth. And why do people in China save so much? Because the social safety net in "socialist" China is abyssal, and people have to save their much of their money in order to retire.[75]

Since the rise of Xi Jinping, China has gradually move away from the market. As a result, its economy has slowed-down too, although other factors, such as the catch-up effect and an ageing population also explain this slower growth. A 2023 study found out that that, while remarkable, China's growth pattern is very similar to that of several other East Asia economies that initially grew very quickly. The study also suggested that China's growth will substantially slow even further, so much so that the US growth rate will likely be higher than China's by 2043. The authors also argued that China's income per capita will level off at roughly 44%of the US level around 2100.[76]

### So, what?[edit]

It is no absurd to claim that China and Soviet Union grew more because of capitalism than because of socialism. But still, supposing China is a socialist nation and that the Soviet Union grew because of socialism, that still isn't a good argument for socialism. 80 per cent of all famine victims in the twentieth century died in the Soviet Union and China.[77] Does the all these famines, authoritarianism and violations against human rights in these two countries worth the economic growth? Especially considering how many countries also saw a tremendous economic growth under democratic institutions?

## The black market[edit]

“”What's the longest and most painful road to capitalism? Socialism.

—Hungarian joke

As we saw, the centralised planned economy that stymies private initiative, the endless regulations, as well as poor quality production, ensure that consumer goods are in chronic short supply under socialism. The lack of incentives and the limitations of the planned economy resulted in what is often called the second economy of the Soviet Union, that is, the black market and the informal sector in the economy. The existence of the second economy can be traced to the earliest years of Soviet power and its size is unknown, but was indeed huge, and its existence was everywhere.[78]:368-370 Not only the productive activities of the second economy have clearly increased the standard of living in the Soviet Union but its efficient production also made it possible for the government to continue with a policy that gives priority to heavy industry, the space industry, and the military sector.[79]:x While part of this black market was composed of drugs and alcohol, the largest black market is that of ordinary consumer goods, since, as we saw, the most powerful socialist nation in history was always facing short supplies.[80]:11

That doesn't mean, however, that this black market only brought benefits to those living under socialism. The effects of the second economy were so widespread that they affected the demography of the country: beneficiaries of the second economy rarely moved to urban areas with strong industrial economies where less potential of unofficial earnings exists.[80]:11 A considerable part of the today's mighty Russian Mafia was created due to such markets.[78]:370

The Soviet Union wasn't the only country plagued by a huge, parallel market. Countries with very different socialist systems, such as Yugoslavia, China, Angola and Cuba faced the same problems.[80]:vii While more of an anarchist experiment than a socialist one, the short-lived Revolutionary Calatonia also had to deal with black markets.[81] In the Yugoslavia, a country that adopted a market socialist model, perhaps more than 25% of the GDP in 1981 was composed by the Black Market.[80]:86 The socialized sector of the economy was very affected, with enterprise managers, politicians, and administrators resorting to unofficial economic methods to enable an overadministrated, overregulated and inefficient economy to function.[80]:93

Perhaps the most important lesson that the second economy of the socialist countries can give us is that humanity tends to adapt and seek out the market. Even under the repressive Soviet system prices that evade central control will inevitably appear[23]:518 and not even the Soviet machine of repression could enforce well regulations against prices sought by sellers and accepted by buyers, that is, based on agreement. In other words, society can stand the socialist repression, but it can't get away of markets.[23]:156

The history of black markets in socialist countries also raises doubts on the viability of "democratic" socialism. If even the socialists dictatorships of the 20th century were unable to suppress the market-oriented profit motive, then how to do this within a democracy? Indeed, as economic historian and Nobel Memorial Prize laurate Douglass North puts, the Marxist theory of socialism is deficient because it needs what he called a "fundamental change in human behavior to achieve its results, and we have no evidence of such a change (even after seventy years of socialist society)."[37]:132

## Could market socialism work?[edit]

A market socialist economy is an economy in which firms are owned and controlled by the government but then sell their products to consumers in competitive markets.[82] The closest thing that the world ever had to a market socialist economy, Yugoslavia, suggests that no. Just like other socialist countries, Yugoslavia under Tito had a strong start (exactly what one would expect due to the Catch-up Effect), but in the long term, the country showed the same problems that other socialists faced, like stagnation, international debt, enterprise inefficiency, inflation,[83] and, of course, an authoritarian government. Labour-managed firms distorted labour incentives to innovate and with increasing domestic unemployment, a large fraction of Yugoslavs responded by emigrating, draining the domestic supply of labour.[84] The relationship between the public and the private sector on market socialism is less-than-stellar too. The two sectors should cooperate while concurrently engaging in market competition with each other, but that's not what really happen. As economist János Kornai put:[23]:506

> Publicly owned firms are particularly disturbed by the fact that the private sector siphons off some of the labor force, often the best white-collar and manual labor. It is able to do so because numerous bureaucratic constraints prevent a publicly owned firm from deciding its own wages, and the private sector can. pay much higher wages. That is just one manifestation of a more general phenomenon: the firm's managers, hampered by hundreds of different regulations, envy the private sector its autonomy.

> Meanwhile, private entrepreneurs see the many privileges of publicly owned firms, particularly large state-owned firms, as unfair: their advantages in credit, imported materials, and foreign-exchange rationing, and the state subsidies and tax concessions for their investments. A publicly owned firm can rely on the support of the party and mass organizations and use the connections it has in every branch and at every level in the bureaucracy. Moreover, those employed full time in the private sector envy the privileges and job security of state-sector employees in many respects.

There is also another problem with market socialism. Market socialists such as the American economist John Roemer often obfuscate the importance of politician's intentions by imagining complex corporate governance structures and believe that a market socialism can work under a democratic system. However, Corruption and mismanagement are almost inevitable under the market socialist system as politicians tend to influence more and more the firms. These problems will probably arise even supposing that socialism can be democratic, as SOEs around the democratic world suggest. In these countries, governments failed at biding the political influence on them, and there's no reason to believe that this wouldn't happen in a system where the free enterprise is even less prominent.[82]

In the end, even a mitigated form of socialism such as market socialism fails for the same reason as other socialist systems. The authorities don't have the information to run the economy. The incentives are misdirected. There isn't enough competition. The economy fails to adapt and innovate.[4]:198-205

## Socialism results in totalitarianism[edit]

“”[S]ocialism can be put into practice only by methods which most socialists disapprove

—Friedrich Hayek[85]:159

On his most famous work, The Road to Serfdom, Friedrich Hayek also argued that socialism would almost inexorably lead to a totalitarian government.[note 4] Why may socialism lead to this “road to serfdom”? This is because, according to Hayek, economics ends are not separate from the other ends of life.[85]:125 As he writes:

> Economic control is not merely control of a sector of human life which can be separated from the rest; it is the control of the means for all our ends. And whoever has sole control of the means must also determine which ends are to be served, which values are to be rated higher and which lower—in short, what men should believe and strive for. Central planning means that the economic problem is to be solved by the community instead of by the individual; but this involves that it must also be the community, or rather its representatives, who must decide the relative importance of the different needs.

A state socialist government needs power to plan the collective economic activity and constraint the individual choices, and one intervention inevitably leads to another. Bureaucrats would make most of the decisions. As planning becomes more and more embracing, it also becomes, according to Hayek more necessary to qualify legal provisions increasingly by reference to what is “fair” or “reasonable”. In practice, this means that it becomes necessary to leave decisions of concrete cases more and more to the freehand of the judge or authority in question, which completely undermine the concept of the rule of law, based on abstract rules.[85]:116 While some may argue that Hayek arguments is a slippery slope, it's hard to argue that this is precisely what happened in most, if not all countries that tried to plan their economies.

Economist Daron Acemoglu argued that Hayek's argument is incapable of explaining the Nordic Model of social democracy,[86]:465-67 but Hayek was clear on his book that he wasn't talking about the welfare state on his criticism towards planning and socialism.[85]:29

## Markets and freedom[edit]

“”Democracy and socialism have but one thing in common—equality. But note well the difference. Democracy aims at equality in liberty. Socialism desires equality in constraint and in servitude.

—Alexis de Tocqueville[87]

Indian Nobel Memorial Prize laureate Amartya Sen claimed that economic efficiency is not the only reason why the market economy is superior to socialism. According to him, a denial of opportunities of transaction, through arbitrary controls, like socialism proposes, is also a source of unfreedom. In other words, people are prevented from doing what can be taken to be—in the absence of compelling reasons to the contrary—something that is within their right to do in socialism. This point, according to him, does not depend on the efficiency of capitalism nor on any analysis of the consequences of having or not a market system; it is based only on the importance of freedom of exchange and transaction without let or hindrance. [88]:25 This is not an argument for laissez-faire, as there are many areas where regulations are required, but there is, according to Sen, some social loss involved in denying people the right to interact economically with each other. Sen continues his argument with the following though experiment:[88]:27

> Take for example the well-known argument in economics that a competitive market mechanism can achieve a type of efficiency that a centralized system cannot plausibly achieve both because of the economy of information (each person acting in the market does not have to know very much) and the compatibility of incentives (each person’s canny actions can merge nicely with those of others). Consider now, contrary to what is generally assumed, a case in which the same economic result is brought about by a fully centralized system with all the decisions of everyone regarding production and allocation being made by a dictator. Would that have been just as good an achievement?

> It is not hard to argue that something would be missing in such a scenario, to wit, the freedom of people to act as they like in deciding on where to work, what to produce, what to consume and so on. Even if in both the scenarios (involving, respectively, free choice and compliance to dictatorial order) a person produces the same commodities in the same way and ends up with the same income and buys the same goods, she may still have very good reason to prefer the scenario of free choice over that of submission to order. There is a distinction between “culmination outcomes” (that is, only final outcomes without taking any note of the process of getting there, including the exercise of freedom) and “comprehensive outcomes” (taking note of the processes through which the culmination outcomes come about)(…) The merit of the market system does not lie only in its capacity to generate more efficient culmination outcomes.

A similar argument was made by Harvard philosopher Robert Nozick, who claimed that a socialist society would have to forbid capitalist acts between adults, even when they are totally consensual. According to Nozick, individuals have a right to private property and that compulsory redistribution would be a form of unjustified coercion.[89]

## Notes[edit]

1. ↑ Ironically, Lange believed that Mises’s insight may have saved socialism from an early demise. According to him: "Socialists have certainly good reason to be grateful to Professor Mises, the great advocatus diaboli of their cause. For it was his powerful challenge that forced the socialists to recognize the importance of an adequate system of economic accounting to guide the allocation of resources in a socialist economy. Even more, it was chiefly due to Professor Mises' challenge that many socialists became aware of the very existence of such a problem."[8]
2. ↑ The fact that America has perhaps the most progressive taxation systems in the world makes this claim far more questionable though.[51][52]
3. ↑ One of the reasons why poor countries like Cuba often have remarkable results in the Olympics is the fact that the dictatorships can choose where to allocate the resources. As such resources are scarce, the results in sports come in expense of the people's wealth.
4. ↑ Contrary to popular belief, Hayek's insight wasn't deterministic: he was mostly talking about the risks that socialism and planning represents. According to Hayek himself he wasn’t “arguing that these developments are inevitable. If they were, there would be no point in writing this”[85]:25

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