Roger McKinney | On July 29, 2020

Democratic Socialists march in Occupy Wall Street, 2011.

Before the collapse of the USSR, Russian workers would say, “We pretend to work and the government pretends to pay us.” Today, people who favor free markets often say that socialism would work if humans were angels, pointing to the incentive problem.

Hayek argued that socialism is necessary for small groups, such as families. In fact, applying capitalist principles to families would destroy them. Hayek believed socialism could work in small groups, like communes and churches, where everyone knows everyone else. Many theologians think the early church in Jerusalem practiced communism, although the context and Greek indicate they didn’t.

However, all communes from the Pilgrims to the kibbutzim have failed because of the incentive problem. Kibbutzim have continued to exist in Israel but have changed radically from the original design. It’s human nature to quit working when the diligent see the lazy getting the same rewards.

All socialist intellectuals understood the incentive problem but insisted that the widespread adoption of socialist principles would transform human nature, returning it to a state of innocence and eliminating the incentive problem. When that didn’t happen in the U.S.S.R. and China under Mao, socialist leaders turned to punishment, then execution for those who refused to emerge from their capitalist cocoons as redeemed socialist butterflies. North Korea, Cuba, and Venezuela carry on that venerable tradition.

Not only have socialists failed to solve the incentive problem, socialism still won’t work if people were angels without a sinful nature. By that I mean that socialism can’t reduce poverty and make everyone wealthy; people will grow poorer. Ludwig von Mises explained it as a calculation problem in his 1920 book, Socialism and Hayek explained the problem as one of information in his “The Use of Knowledge in Society.”

Here’s the problem: for a nation to maintain its wealth, let alone grow wealth and reduce poverty, it has to produce more than it wastes and consumes. The world remained mired in starvation poverty for most of human history because no nation could accomplish that. The hockey stick growth in per capita GDP, that is, growth in standards of living or reduction in poverty, began only in the 17^th century in the Dutch Republic because that nation solved the problem.

How do you produce more than you waste or consume? You need accurate prices. High prices tell producers to make more cars; low prices incentivize them to crank out fewer. Prices do the opposite for consumers: high prices discourage them from buying cars and lower prices persuade them to buy more. Only accurate prices can coordinate production and consumption so that little is wasted. So how do we get the right prices?

Accurate prices, those that reflect the scarcity of supply and the demands of consumers, can appear only in free markets, that is, those markets unhindered by regulations from the state except the ones prohibiting theft, fraud and violence. Theologians associated with the University of Salamanca, Spain, determined that the only just prices were those arrived at through negotiations in free markets. Mises showed that producers can’t calculate how much of a product to produce or of what quality without prices established in free markets, because without accurate prices, much of what they produce is wasted.

Socialist intellectuals disagreed and tried to prove for decades that deploying econometrics and computers the state could approximate accurate prices. Hayek disagreed and demonstrated that the most important information for producers lies in the tacit knowledge of those with experience. The state cannot acquire that information because it is widely dispersed and mostly unpublished. Socialists declared victory in the debate and most mainstream economists went along with them. Then the U.S.S.R. collapsed because it couldn’t feed its people.

I realize that most Republicans think President Reagan brought down the evil empire by outspending it on military hardware, and there is some truth to it. But Yegor Gaidar, the economic adviser to Boris Yelstin, disagreed in his book, Collapse of an Empire. Gaidar shows that the Soviet Union had to import most of its food from outside the Soviet block and paid for it with oil sales. The collapse of oil prices in 1986 forced the Soviets to borrow money to import food, but every nation refused to loan money to them for obvious reasons. So, the Soviets begged the U.S. to guarantee the loans, which it did.

Then Poland rejected socialism. In the past, the Soviets had sent in the troops and tanks and showered people with enough lead to put out the rebellion. This time, it asked the U.S. ambassador how his country would respond to such measures. The ambassador said the U.S. could not guarantee any more loans for food if the Soviets responded to the Polish uprising with violence. Mikhail Gorbachev, the head of the Soviet Union, had to sit back and hope for the best, which didn’t happen. In a short time, socialism collapsed across all Eastern Europe and the Soviet Union.

Guinevere Liberty Nell makes a similar point to Hayek’s in her Rediscovering Fire: Basic Economic Lessons from the Soviet Experiment. Socialist attempts at planning created enormous waste. She offered glass production as one among hundreds of examples. If the state set quotas for glass in tons, producers cranked out glass thick as bricks and no one could use it. If it set quotes in meters, they shoved out glass so thin that a breeze would shatter it. Those of us old enough can remember news stories from the Soviet Union before its collapse showing cavernous department stores with little in them to sell. Russians had plenty of money, so much in fact that they used it to paper the walls inside their apartments and to insulate against the cold because there was little gas or coal to burn for heat.

If humans were angels, the calculation and information problems wouldn’t go away because angels are not omniscient as God is. They would face the same problems that humans must muddle through. Even angels couldn’t make socialism work.

Originally published on Townhall Finance.

Roger McKinney