The Economics Of Illusion

This portrait of political economy decision-making at successive stages of the planning hierarchy over output targets and input requirements did not engender the rational allocation of scarce resources in either theory or practice. In fact, the system generated economic irrationalities throughout the entire process. Plan failure among economic agents was a staple part of Soviet economic life for managers of enterprises as well as consumers. Obviously, the Soviet planning system possessed a certain rationality, but it was not economic rationality.

The ideological illusion of a rationally planned economy had to co-exist with the reality of systemic economic failure.9 Without the ideological illusion, the Party's economic monopoly could not be justified. As a result, the Soviet people had to live a lie. This was not a normal lie, however, in that it was the peculiar Soviet false reality that had to be protected to legitimate the revolution and the Party. Soviet citizens spoke in one language that conformed to the pseudo-reality of Soviet socialism, while they lived within an entirely different reality. There was one lie, but two realities.10

The problem with the planning system was not limited to the vast amount of information that was supposed to be processed by the center, and the sheer complexity of that task. Rather, the quality of the information available to economic planners in the absence of free market prices would prevent any mind or group of minds from assessing the economic allocation of scarce resources among alternative uses even if the most advanced computational technology was available to them. This fundamental problem with central planning of the economy has often been overlooked because analysts and planners confuse technical and economic efficiency. It is one thing to determine that platinum, steel or cement, could be used to build a bridge, it is quite another to discover which material would be economically employed in that use. The technical problem concerns achieving one end and allocating means to obtain that end given certain physical and engineering constraints. The economic problem, on the other hand, is one where scarce means must be allocated among competing ends, and the knowledge required to accomplish this allocational task economically is dispersed throughout the economy in scattered bits and pieces. In other words, the economic problem of a complex industrial economy is one of mobilizing the private information that is embedded within the various, and often conflicting, plans of economic actors in a way which translates that information into effective knowledge for others so as to promote the coordination of economic plans between actors.

The functional significance of economic calculation in the market economy is that, despite its imperfections, it allows the social system to select out from among the numerous array of technologically feasible projects those which are economic. In economic calculation, the market system possesses a weapon to combat the general knowledge problem that all social systems confront in attempting to mobilize the dispersed and incomplete information that exists throughout the economy and is not available to anyone in its entirety.11 Through a process of error detection and the corresponding opportunity for economic profit, the market system motivates learning among economic agents so they may discover how better to allocate scarce resources to satisfy consumer demand. The hierarchical planning system does not possess similar weapons.

Not only does the planning hierarchy lack the requisite information rationally to plan the economy, but it also does not possess the disciplinary devices that a market system does to overcome strategic incentive problems.12 Consider, for example, the principal/agent problem that exists whenever a principal relies on an agent to carry out her goals. In such situations, the agent because of informational asymmetries may find it in his interest to act in a manner inconsistent with the goals that the principal has set. Unless the principal can effectively monitor the activity of the agent, her goals will not be achieved.

A large corporation potentially faces this problem because of the separation of ownership from control. The owners (shareholders) may desire that management only act in a manner as to increase the profitability of the firm. Management, however, may wish to pursue an alternative course of action that maximizes their perquisites independent of the goal of profit maximization. Without effective monitoring, management can act in a manner that diverges significantly from the goals of the owners. But the market system provides a disciplinary force through the capital market that compels management to act in line with the goals of the shareholders.

A decline in the stock price of a corporation signals to economic actors that the expected future profitability of the firm has declined. If individuals believe they can increase the profitability of the enterprise, then they will buy up shares, take over the enterprise and restructure management. Takeovers and mergers discipline managers to act in accordance with the interests of owners through the market for corporate control. Market competition from new groups of would-be managers in addition to competition within the firm by those who want to climb the corporate ladder present challenges to existing management whenever they behave contrary to the interest of the principal.

Well-established and freely functioning labor and capital markets, however, are a prerequisite for this disciplinary device to exert the corrective monitoring of agent behavior necessary to overcome the problem of strategic incentives. Without these markets, or similar devices, agents will strategically act in a manner that diverges from the interest of the principal.

In a democracy, for example, politicians are supposedly the representatives of the electorate. Elected officials, in other words, are the agents while the citizenry are the principals. The vote mechanism supplies the monitoring device to discipline the behavior of politicians. The problem that exists within democratic procedures, however, is that the phenomena of rational abstention and rational ignorance among voters seriously questions the ability of the voting system to convey accurately information about voter preferences. Moreover, there does not exist in the political process the kind of error detection and learning mechanism that do exist within the market process to motivate a quick adjustment of behavior among political actors so as to conform to the expectations of the electorate.

This potential problem of agency is compounded within government decision-making when it is recognized that there are also deeper layers of the principal/agent problem throughout the system. Most functional tasks of governance are not carried out by vote-seeking politicians who must face re-election, but by a non-vote-seeking bureaucracy. Beyond the principal/agent problem that exists between voter and politician, there is another principal/agent problem between the politician and the bureaucracy and another between the head of the bureau and her subordinates.13 Political actors must devise monitoring mechanisms to make sure that the bureaucracy acts in line with their goals. But there are definite limits to the supervisory capacity of officials (or the electorate). And, these limits vary inversely with the degree of coordination required to accomplish the task assigned. In a large organization, the higher the degree of coordination required the lower the limit of supervisory capacity.

Whereas the price system can achieve a high degree of coordination of economic plans in the complex task of advanced industrial production by summarizing the terms of exchange (and, thus, economizing on the amount of information actors must process), politics does not have recourse to any analogous procedure. A free market provides the incentives and information for the mutual adjustment of behavior among participants even though no single mind or group of minds consciously directs the flow of resources for the system as a whole. Bureaucratic organization of the economy, however, would require the superior consciously to coordinate the activities of all subordinates.

Under Soviet rule, even the potential check of the electorate was absent from political economy decision-making.14 The Party, and the Party alone, was the principal and the planning bureaucracy was the agent. Most Soviet economic practices, in fact, can be explained as attempts by the Party to monitor effectively the behavior of bureaucratic agents. Soviet practices, from the periodic purges within the Party and the elaborate nomenklatura system of patronage to the five-year plans and gross output success indicators, can be explained as the rational outcome of attempts to reduce the agency costs associated with centralized economic administration of the economy.15

The sole purpose of the Soviet economic administration was to maintain monopoly control over resources.16 In this way, the Party could treat all economic problems as technological ones. The Party leadership would decide priorities and dictate that resources flow in a direction that would achieve those priorities. Such a wartime approach to the allocation of scarce resources cannot persist indefinitely since it tends to disregard the economic cost of resource use.17 Throughout their history, Soviet economic planners possessed neither the information nor the incentive to appraise the alternative use of scarce resources in production. Without any method to assess the opportunity cost of resource use, waste and mis-allocation inevitably result. In other words, the Soviet system was in a state of perpetual economic crisis.18

This crisis, however, could not be revealed otherwise the leading role of the Party would be questioned. The underlying ideology of the Soviet system promised a more moral and efficient society. Unfortunately for the peoples of the Soviet Union it produced neither. But, that could not be openly admitted or the system would lose legitimacy.19 The major function of the economic bureaucracy was transformed into the production and maintenance of the illusion of rational economic planning that achieved tremendous economic growth.

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