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THE MARKET MECHANISM IN A SOCIALIST ECONOMY
 

By Oldrich Kyn

Read to a Seminar at St. Antony's College

St. Antony's Papers, No. 19, Oxford 1965

 

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THE NEW system of economic planning and management which is now being put into effect in Czechoslovakia is of particularly wide interest because it is based on a renewal of the role of the market mechanism in a socialist economy.

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This interest is well deserved, since, until quite recently and with the sole exception of Yugoslavia, the socialist countries denied the positive role, or even the possibility, of its widespread use. Indeed, for many years Marxist as well as non-Marxist economists seem to have held the over-simplified belief that socialism should be as thoroughly equated to centralized planning as is capitalism to a free market. This equation, together with variant methods of distributing the national income and different class and political relationships, were considered to be the decisive characteristics distinguishing socialism from capitalism.

Both viewpoints are evidently founded on similarly arbitrary attributions of a positive or negative role to the market mechanism and to central planning. Thus Marxists considered only the defects of the market, and their opponents looked for those of centralized planning.

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The change of view is recent. 

 

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Since the Second World War, but especially in the late 'fifties and early 'sixties, Western interest in planning has grown - and not only among theoretical economists: a number of countries have in fact begun practical planning, and among Western economists the number of resolute opponents has steadily declined.At the same time, Marxist antipathy to the market mechanism on both practical and theoretical grounds has weakened.

This counter-movement in economic theory may at first seem a paradox. Not long ago Marxist economists who stressed the need for reviving the market mechanism in a socialist economy were criticized for advocating a case already obsolete in the West. But this ignored the evolution in economic thinking during recent years towards the compatibility of planning and the operation of a market mechanism. Instead of a paradox one can discern a common goal a planned market-economy - approached from opposite directions. To say this is not to imply that any and all differences between socialism and capitalism are disappearing. But, it seems to me, the main distinction between Western and Eastern economies will eventually lie not so much in the mechanism of the functioning of the economy, as in metaeconomic factors - in different social goals, values, and political structures.

 

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The traditional conflict between planning and the market mechanism arose from mistaken premises: both sides identified planning with the administrative methods of a highly centralized system of management.

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In other words, the term "planning" was used to designate a situation in which virtually all economic decision-making was concentrated in some central agency - in the sense of Barone's Ministry of Production - leaving individual enterprises merely to fulfill its orders. This view is well enough known from von Mises and subsequent discussion, and was until recently the majority view in the socialist countries. Today, however, it is possible to distinguish between a system of highly- centralized day-to day management of the economy and long-term planning. To plan means primarily to anticipate the probable and preferable evolution of the economy in the future and, within the potential defined by objective characteristics, to choose the optimal path to that development. Planning, so conceived, may be associated with a system of centralized administrative day-to-day management of the economy which aims at an exact fulfillment of the plan, but it may also be connected with an economic system where economic decision-making is largely devolved to the individual enterprise, and coordination of the whole is achieved by the market mechanism, not by decree. Correspondingly, a centralized system of administrative management does not necessarily have to be linked with planning, if the orders given by the central agency to enterprises are not based on reliable projections of the long-term development of the economy. In fact the Czechoslovak economy was for a time managed only under annual plans, of which the period covered was so short that it could hardly be said to have been planned. In other words, while highly- centralized administrative management negates the operation of the market mechanism, it does not necessarily coincide with planned development. The alternative to the market mechanism is administrative centralized day-to-day management of the economy - not planning.

 

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Hence four types of economies may be distinguished:

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  • first, an economic system based only on the market mechanism, without planning;

  • second, an economic system based only on administrative centralized day-to-day management, without planning;

  • third, a planned economy with administrative centralized day-to-day management; and

  • fourth, a planned economy with a market mechanism.

Concrete historical instances of each type can readily be cited; they have their drawbacks and their advantages, but very many economists will today agree that the fewest shortcomings and the most benefits occur in a synthesis between planning and the functioning of the market.

 

The first of the types listed above - an economy based on the market mechanism, without centralized management or planning - closely resembles European capitalism of the last century. Its theoretical analysis is to be found in Adam Smith, Marx, Walras, and Marshall, to name only a few. Economists writing at the turn of the century (particularly Marshall and Walras) emphasized the positive role of the market, rightly stressing that its mechanism can spontaneously coordinate the decisions of millions of producers and consumers - or, in more modern terminology, that it is automatically self-regulating. These positive aspects of the functioning of the market mechanism are today very highly thought of among Czechoslovak economists. On the other hand, one cannot idealize the market mechanism. The market as an automatic regulator is never perfect, so that an economy based only on its functioning is usually unstable. The principal negative aspects of the market mechanism have been analyzed within Western economic theory, especially in the context of imperfect and monopolistic competition and of time lags which inhibit equilibrium (the "Cobweb Theorem"). Keynes's interpretation of business cycles led, moreover, to entirely different conclusions from those of Walras and Marshall, and initiated recognition of the need for a system of state intervention, central control, and planning as accessories to the market.

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It is relevant to note that Marx had long before referred to this negative aspect of the functioning of the market, concluding that rational central control would eventually replace "blind" market forces.

 

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Marx himself was, however, no utopian and never concerned himself with describing or advocating any operational technique of management and planning in a socialist economy. It is nevertheless true that in socialist economic writings the opinion long prevailed that the market would disappear in the transition from capitalism to socialism, and that socialism, being incompatible with the market mechanism, would replace it by a rational centralized system of management of the whole economy. The sources of such theories are indeed the utopian socialists - such as John Gray; it was the ideal society of Campanella which was organized on virtually military principles. Marx himself never implied a hierarchical arrangement of socialist society: he assumed the creative self-assertion of man under socialism to be achieved uniquely by eliminating all economic and social exploitation. He explicitly stated many times that in this sense socialism and communism were identical with humanism.

This point needs emphasis because the equation of the market mechanism with capitalism, and of socialism with centralized administrative management, which was typical of some Marxists, has no Marxian foundation. One may even venture to say that such a system of management under a socialist economy would contradict Marx, for whom the essence of a socialist or communist society was not mere efficiency, but democracy and humanism.

 

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There is much to be said for the belief that the administrative centralization of management under socialism evolved more from specific economic and political circumstances than from any theory.

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To this view may be added the fact that under extraordinary conditions - such as wars or natural disasters - even capitalist countries to some degree limit the free functioning of the market and introduce direct methods of economic regulation (price control, rationing, etc.). It is further true that the new economic system of the socialist countries came into existence in an environment which appeared to preclude successful functioning of the market mechanism. To accord full freedom for market forces under such conditions would have made it virtually impossible to reconstruct the national economy and to restore its normal activity. The very limited resources of the country could not be monopolized and exploited by private interests, but had to be controlled for use on a scale of priorities which took full account of the needs of the economy as a whole. Such a form of economic management was a necessary instrument for solving certain specific situations, but Marxist economists for a while erroneously considered it as the only adequate means of managing a socialist economy and, hence, as superior to the market mechanism.

 

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Experience has now shown that abolishing (or radically limiting) market relations, and replacing them by a system of central decrees, cannot of itself ensure long-term market equilibrium.

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With the aim of achieving this, long-term planning is added to the administrative, centralized system of day-to-day management, but such planning inevitably tends towards conformity with the system of management. The plans were thus based on extensive systems of mutually interconnected financial and material balances, whence the production programs for individual enterprises took the form of detailed directives concerning the composition of output, which were binding on the producers. Plans were thus conceived deterministically as a list of tasks, allowing no room for maneuver when unforeseen difficulties or technical improvements appeared. The economy was hence inflexible and averse to innovation. In such a system the desired rate of growth is achieved by maximal mobilization of the sources of accumulation, and economic management is reduced to a set of instruments for plan fulfillment. Material incentives are used not for ensuring proper relations between producer and consumer, or for encouraging innovation, but only as a technique of plan implementation.

 

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According to the theory, such a system of management should have nullified the negative aspects of the market mechanism and ensured fast and smooth growth.

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In fact, such measures as the general determination and long-term stabilization of prices succeed solely in eliminating external signs of economic instability and disequilibrium (i.e., inflation or fluctuation), while being incompatible with the complex inter-relationship of a contemporary economy. Thus overt movement of prices might disappear but internal tension remained. Disequilibrium manifested itself in other, and sometimes worse, forms. Chronic shortages of some raw materials and consumers' goods occurred while at the same time goods were being produced for which no consumer existed. Any unexpected change external to economy, such as in foreign relations or simply bad weather, aggravated the situation. Methods for drawing up the plan according to extensive systems of balances have, furthermore, proved themselves inadequate: they require voluminous paper work, are very slow, and barely permit the elaboration of a single variant of the plan. The problem of discovering the optimum variant among many has not even arisen. Some economists have deluded themselves that mathematical methods, such as input-output or linear programming, combined with computers, would make it possible to eliminate all those negative aspects of planning just described and to achieve scientific planning and management through a further centralization of decision-making. As soon as such methods were tried, it became clear that their use within the frame-work of an administrative centralized system of planning and management was difficult, if not impossible. It is not without interest that in Czechoslovakia mathematical economists were among the first to call for decentralization and a renewal of the function of the market mechanism.

 

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Economists not concerned with mathematical methods came to a similar conclusion. Deficiencies in the economic situation in Czechoslovakia became a strong incentive to radical measures.

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At the end of the 'fifties and the beginning of the 'sixties economic difficulties began to accumulate, in turn generating disequilibrium, slowing the rate of growth, and leading to tension in the balance of payments and to the belated introduction of technical innovations. A thorough analysis of the whole economy brought the conclusion that the source of these difficulties was the inadequate and obsolete system of planned management. Before a proposal for a new system of planned management of the economy could be worked out, however, it was necessary first to reexamine without prejudice all the theoretical postulates. One prejudice to be disposed of was the theory of the incompatibility of the market mechanism with planned development. In this connection it was shown that highly centralized management methods are simply transitory, and are not permanent attributes of a socialist economy. Some concepts on the form and role of the plan also required revision. The theory for a new system of planned management was gradually worked out, and is now being put into practice in Czechoslovakia in accordance with laws approved by the National Assembly in November 1968.

 

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Renewal of the function of the market can bring many favourable results for a socialist economy.

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First, it will set off a process of automatic regulation of production and consumption, which should eliminate much of the work of central agencies of economic management which were created to deal with the day-today coordination. Administrative staff could then be reduced, giving greater flexibility to the whole system, and the central agencies will be free to concentrate on more important problems - notably, long-term planning, and the question of the social aims of the economy. The renewal of market forces is also important to the consumer and to the enterprise. The consumer would regain relative sovereignty (everywhere a fiction in absolute terms), in that his preferences need not be dictated by the producer.

From the point of view of a socialist enterprise, the most important aspect of a renewal of the market mechanism is its association with a revival of entrepreneurial activity. Schumpeter's concept of the entrepreneur - one who carries out innovations - is by no means appropriate only to capitalist ownership. I am convinced that the entrepreneurial phenomenon is possible under socialism - and that "socialist entrepreneurship" is one of the most important aspects of the new system. To experiment, to take decisions involving uncertainty or risk, to seek truly new combinations of productive factors - these are all essential if the economy is to absorb sufficiently the flow of innovations.

 

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The concept of a socialist enterprise as an exactly defined technological unit fulfilling orders received from a central body seems to have been displaced.

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Concepts and methods of central management are also changing. Renewal of the market mechanism and decentralization of economic decision-making do not entirely obliviate centralized choice. The central authority should simply retain such decisions as it can usefully make, viz., those which the spontaneous market mechanism cannot successfully resolve. Nevertheless, intervention from the centre must as far as possible be implemented through economic incentives, while decrees should be limited to a minimum. In this connection the most important function of an economic centre is to draw up "the rules of the game" to which producers, consumers and other economic units must conform. Suitable "rules" should facilitate the manipulation of otherwise completely spontaneous economic processes.

One of the most important instruments of the new system is still, of course, the plan. It must primarily serve as a source of information for the enterprise, on the basis of which decisions may be taken; it must not constitute a list of orders to be fulfilled at any cost, yet this should not exclude the use of a limited number of directives. The plan must essentially be a long-term forecast of the development of the economy, and not, as formerly, lay the stress on annual production programmes. This does not, however, imply that the plan cannot shape future development, for objectively-existing material relationships can be used for many different paths. It is the role of the plan to influence social preferences.

In putting all these concepts into effect, aims must still be modest. The social-welfare function is complex and the methods and data required for optimal planning are still incomplete; work in this direction is however, under way and the results are beginning to be perceived.

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