Economics of States in Transition: Lecture Notes, Section 1

Syllabus Materials ● Quiz materials drawn from topics/themes that are both in the reading texts and lecture content (quizzes at the start of lecture on Wednesday) ● Grading breakdown: ○ 5 quizzes, 25% total (based on readings/lecture of the last week) ■ Short answers, true/false ○ Midterm, 30% (first half) ■ Multiple choice, short answers, essay questions ○ Final, 40% (cumulative) ■ Multiple choice, short answers, essay questions ● Office Hours: all by appointment (easier virtually) Lecture 1 - Introduction to Course Contents and Theoretical Framework ● Introduction in to Comparative Institutional Analysis: ○ In comparison and relation with the economical way of thinking ○ How social phenomenal emerge from the actions of human beings who are trying to realize their separates and often conflicting goals in a manner that establishes social order ○ How is it that cooperation can ever be realized without command? ● What is Economics? ○ The study of economics entails the study of human action under alternative sets of institutions ■ This human devised constraints structure the payoffs for human action ■ “The rules of the game” for social interaction, they define the structure of the expected costs and benefits of human decision-making ○ The economical way of thinking applies to all humans at all times ■ Applies to all humans at all times, across different societies, we take it that people are always trying to do the best they can given the constraints they are operating in ■ The way to understand the interaction is to study the institutions and the rules of the game in which people are interacting ● “If you a move a soccer player into a football game, the actions will be different not because of a person but because of expected playoffs and how the institutions structure playing the game” ■ The rules are not only to provide incentives to individuals in terms of expected costs and benefits of actions, but it also provides knowledge about how to play the game in the first place ○ Example of Property Rights: ■ They refer to a series of social arrangement that charge and change how interactions take place ● Which are guided by “how they play the game” ● I - Economics is an Analytical Social Science: ○ ○ ○ ○ ● Distinct form pure descriptions ■ Theory composed and researched ■ The study of economic events, though based on human interaction, are not from social human design Seeks to understand the casual parings underpinning social phenomena Invisible Hand Theorizing: ■ Emphasizes that social phenomena up, or composted, from the economic actions of individuals actors under a particular institutional context ■ In order to understand social order (or disorder) we cannot infer from those outcomes that the intentions of individuals, we have to understand how such outcomes come from human action and not human design ■ Essential to understand how institutions have emerged from human actions that dictate human social order ● ex.) Time zones, they structure our understanding of time, but they were not deliberately designed by a central planner or world government ● If prices guide human interaction and consumption, the prices come from the demand and the production alongside consumption Understanding the unintended consequences of different transitional economies (i.e. communism) of exacting a different political economy ■ “Not to infer intentions from outcomes.” ■ “An indirect relationship between human interaction and social phenomenon.” II - The Assumptions of Economics: ○ 1: Methodological individualism ■ The individual is the unit of analysis ● These patterns of outcomes need to be traced back to the decisions of individuals who are considering their costs and benefits ○ Primary unit of analysis ■ Economics emphasizes that all social phenomena emerge from individual actions and interactions ■ What about groups? ● Study methodological individualism to understand how these notions are formed ○ 2: Purposive Action ■ Individuals act purposefully to fulfill their goals and secure needs/wants ■ Rational self-interest and rational choice ● People act rationally to ensure their own needs ■ This does not mean… ● People only care about money ● There are no “Mother Teresas” ● ● ● ● ● People want to take advantage of others ○ 3: Individuals Economize by Considering Costs and Benefits ■ Individuals seek their desired outcomes in the least cost way from their perspective ■ This does not mean… ● People never make mistakes ● People have no self-determination ● People are incredibly intelligent III - The Structures of Theory ○ Two distinct, but not, separate components: ■ The Logic of Choice “Pure Theory” ● Universal and abstract natural choices and action ■ Institutional Analysis ● Logic of choice applied to understand concrete social interaction of a particular time and place ○ Contingent on institutions ○ The analogy of the rules of the game and the players in the game ■ The logic of choice explains the behavior of individuals ■ The rules determine the payoffs of how they can do their best The Logic of Choice ○ The logic of choice states that all individuals choose in response to expected costs and expected benefits of their action ○ Scarcity is the fundamental basis of the logic of choice (and economics as a whole) ■ “Scarce” means that our wants and desires exceed the resources available to satisfy them (i.e. means infinite ends) ■ When means are not scarce, there is no economic problem ■ Is air a “scarce good”? Digression on Scarcity ○ Scarcity v. Poverty ■ Scarcity and poverty are not the same thing ● Absence of poverty implies some basic level of need has been met ● An absence of scarcity would imply that all of our desires for goods are fully satisfied ■ We may someday eliminate poverty, but scarcity will always be with us Economic Problem v. Technological Problem (Apollo 11 example w/ Buzz Aldrin) ○ Allocating scarce resources among alternative useless is an economic problem ○ Allocating scarce resources towards a single end is a technological problem ○ Technological problems require scientific knowledge that is objective in nature ○ Economic problems require contextual knowledge based on value judgments that are subjective in nature ● ● ● ● ● ● ● ● ○ What is the “best” way to build a railroad Logic of choice ○ Scarcity implies choice, and therefore making trade offs ○ Making trade offs implies opportunity costs ○ Cost and choices are assessed on the margin Choice Implies Tradeoffs ○ If everything involves a cost, and this cost is the next best alternative foregone, this implies that we have to make choices about how to allocate time, resources, etc. ■ Examples: ● Building one more school means building one less police station ● One more hour of sleep means one less hour studying and so on ○ So how do we decided which things to do in which amounts? Tradeoffs Imply opportunity Costs ○ Opportunity cost refers to the expected value of the best alternative foregone opportunity, or that which is being given up ○ Opportunity costs are the reciprocal of choice: ■ Costs are always tied to future action, not to objects or things ■ Costs are not objective; they are subjective valuations placed on foregone opportunities Value is Subjective ○ The value of a good is subjective and varies with individuals preferences ○ Economics does not judge one person’s preferences to be “better” or “worse” than another’s Additional Implication of Opportunity Cost ○ The postulate of self-interest does not imply pure selfishness ○ Self-interest implies nothing more than the fact that when individuals choose, the individual weighs costs and benefits as the chooser perceives them ○ Individuals prefer more of what they want rather than less ○ Was Mother Teresa self-interested? The Seen & Unseen ○ Economics involves looking not just at the observable consequences of choices, but also the unseen consequences ■ Always ask: “And then what…?” ○ Question: What is the expected effect of mandating airbags on the incidence of reckless driving? Cost and Choice are Assessed on the Margin ○ The term “marginal” in economics refers to an additional unit Economists use the marginal concept to talk about benefits and costs ○ Marginal benefits: the additional benefit from one more unit of an activity ○ Marginal costs: the additional cost of one more unit of an activity ● ● ● ● ● Why Marginal Analysis? (you’re not going to buy all the milk or none, you buy a gallon) ○ Economics focuses on marginal costs and benefits, and thus marginal decisionmaking, because this is what nearly all of our actual choices involve ■ We don’t confront “either-or” or “all or nothing” decisions ■ e.g. reckless driving example Implications of Marginal Analysis ○ Individuals engage in an activity when the expected marginal benefit exceeds the expected marginal cost ○ Individuals refrain from an activity when the expected marginal cost exceeds the expected marginal benefit The Ubiquity of Competition ○ Competition is a process of resolving conflicting ends ○ All economic interaction implies a multiplicity of diverse and even incompatible individual’s goals or objectives ○ Scarcity implies that striving to achieve one’s goals or improve one's situation will be competitive, by definition ○ The fact that we have to choose gives rise to competition among potential alternatives ■ Even in a world without greet where everyone cared only about others, there would still be competition because there would still be scarcity ■ Changing the rationing method used will change the form of competition, but it will not eliminate competitive tactics Forms of Competition ○ Every society, by definition, will require competition to allocate resources ○ Resources and goods can be rationed in various ways: ■ First-come, first served (queuing) ■ Violence ■ Exchange Why do they matter? ○ Institutions are formal and informal rules and their enforcement ○ Institutions create payoffs (i.e. incentives) for various courses of action, for better or worse Lecture 2 - From Poverty to Wealth For next week’s quiz, we will cover this week’s content and Chapter 3 by Holcomb ● Institutions and Entrepreneurship ○ Different sets of rules will spur different types of economic individuals ○ Human are rationally striving to do their best everywhere, which will imply tradeoffs ○ ○ ● Tradeoffs imply competition Competition is inherently an entrepreneurial act, individuals trying to meet the best ends, but how individuals seek that end out drastically differ What is Economic Development? ○ Development entails people using scarce resources in ways that generate wealth ■ Wealth is defined broadly to include broader material and non-material things that people value ○ Development implies an expansion of the feasible choice set of individuals ■ Development is not necessarily synonymous with industrialization ● Trade is an alternative of production ○ ● ● ● ● Poverty is the default state of the world ■ Everyone was once poor and had low societal/economic conditions ■ About the ability of individuals to be prepared for an uncertain world ○ Economics can shed light on the conditions that alleviate poverty The Great Fact of Modern History ○ According to the World Bank, as of 2015, for the first time in human history, the percentage of individuals living on less than two dollars power day has fallen to less than 10% of the world’s population ■ Pre-1990, more than ⅔ of world economies were centrally planned ■ From 1990 to 2015, 37.1% → 9.6% or around 2 million to 702,000 ● A transfer of countries acting internally and centrally planned to the opening of modernization and trade ● Dramatic reduction of poverty in South East Asia ■ Institutions mark strong divisions between poverty and wealth What explains the transition from poverty to wealth? ○ Economic transition as institutional transition ■ Economic transition (as well as political and legal transition) is fundamentally a change in institutions governing purposive human action ■ Dual level of analysis ● The ‘rules of the game’ ● Social interaction within a set of rules Property Rights (the fundamental cornerstone of institutional analysis) ○ Broadly speaking, property rights are a set of institutional arrangements, which define our expected ability to exercise choices over goods ■ The basis of property is the existence of scarcity ■ Property rights refer to rights to an action, not a right to an object ○ (and the assignment of consequences to one’s actions) ● So long as we have scarcity, there is going to be a pattern of interaction that is determined by the property rights that exist in a particular society Components of Property Rights ○ The ability to exclude ■ ● The ability, or right, to exclude non-users as well as non-beneficiaries of a good ● Owners are excluded from private as well as public predation ■ The implication is to concentrate both costs and benefits over the use of a resource or good ■ Owners have a strong incentive to care for and manage what they own: ● Why? Internalize benefits of care and costs of neglect/abuse ■ They incentivize social and environmental responsibility ○ The ability to use ■ Owners have a strong incentive to care for and manage what they own: ● Why? Internalize benefits of care and costs of neglect/abuse ■ They incentivize social and environmental responsibility ■ The ability, or right, to use or derive benefits from the consumption of a good or service: ● For present consumption ● For future consumption (savings and investment) ○ The ability to exchange ■ The ability, or right, to transfer ownership, or title, to a good or service (indirect consumption) ● The distinguishing attribute of private property rights ● The distinguishing attribute of a market economy from other economic systems ● Private property is a social liability, not a private privilege ○ Concentrates the economic ruin of a potential loss ○ Note: distinct, though, not completely separate components of property rights Implications of Property Rights ○ ○ Private property provides the conditions for peaceful competition, which is positive sum ■ Private property encourages productive specialization and productive entrepreneurship ■ Private property creates the conditions for economic calculation ● To access the relative scarcity of goods through prices “Non-economic” implication or private property ■ Private property disperses both political and economic power and shields us from the coercion of others Week 3: ● Digression of Production ○ Property rights are entrepreneurial filters (both productive and unproductive) ○ What is production?: ■ Fundamentally, production refers to the creation of utility through the transformation of the physical shape, location, or availability of commodities into goods for final consumption ■ Among the inputs in production, economists usually include: ● Land ● Labor ● Capital ● Entrepreneurship ■ Note: theoretically distinct, though empirically entangled together in the real world Trade/exchange is an indirect way of production ● ● ● ● ○ Land: ○ Land refers to the permanent and inexhaustible powers of the soil ○ The payment to owners of land is referred to as rent: ■ An economic rent is a payment above opportunity cost ■ An economic rent is the portion of the price that does not influence the amount of that good in current existence. It does not affect the present amount of a good. Labor: ○ Labor refers to human effort ○ The payment to owners of labor is referred to as a wage Capital: ○ Capital refers to the produced means of production, such as human-made tools and machinery ○ The payment to owners of capital is referred to as interest: ■ Interest ins a payment for deferring present consumption (i.e. savings for capital formation) ■ Interest follows from rational action, since individuals prefer more rather than less, this implies that they also prefer greater consumption now rather than in the future ○ Tangible and intangible Entrepreneurship: ○ Refers to the human propensity to discover previously unrecognized profit opportunities ■ These profit opportunities are the result of sheer ignorance ○ The payments to entrepreneurs are known as profit and loss ■ It is in this sense that we refer to the entrepreneur as a residual claimant ■ After all of the contractual payments are made by the entrepreneur to the other factors of production, what is left over is the residual (which is either a profit or a loss) ○ In a market economy, it is the entrepreneurial decision-maker in production that owns the residual ○ The entrepreneurial decision-maker of a firm is not defined by ownership over other factors of production per se ■ They may hire, or lease, other factors of production ■ What fundamentally defines the entrepreneurs is that they are the owner of the profit and loss ● Alternative Approaches to Understanding Development: ○ Ricardian Approach to Development ■ Increases in output are a function of land, labor, and capital ● Fundamentally, economic growth is caused by increases in land, labor, and particularly capital ■ Shortcomings of this approach ● Diminishing returns ● Development viewed as a technological problem ● Development and increases in output are not necessarily synonymous ■ The difference between increased outputs and value-added out-puts (i.e. development) Smithian Approach: - Increases in value-added output are fundamentally caused by specialization and exchange due to increases in the scope of the market. - Increases in land, labor, and capital are proximate causes of growth in the Smithian approach. - Accumulations of capital, technology, and other factors of production are a by- product of institutions that extend the scope of the market. - What does this imply about the effects of globalization on poorer countries? - Poorer countries were precluded from globalization - Focuses less on quantities of factors of production and more on entrepreneurial processes that combine land, labor, and capital into valuable outputs. - The nature of such entrepreneurial processes are a function of the rules of the game that incentivize different types of entrepreneurial behavior. - The potential for economic growth derives from land, labor, and capital through entrepreneurial behavior. Value is being created (and is more than its inputs). Schumpeterian Entrepreneurship: - Schumpeterian entrepreneurship emphasizes the seizure of profit opportunities through technological innovation. - Schumpeterian entrepreneur is an innovator that has a equilibrating or disruptive effect on the market process - “Creative destruction” - Ex: horse and carriages were the equilibrium at the time until someone invented motors/car, “disrupting the market” Kirznerian Entrepreneurship: - Kirznerian entrepreneurship seizes previously unnoticed profit opportunities by correcting a misapplication of resources - Kirzernerian entrepreneur is an arbitrageur that has an equilibrating, or coordinating, effect on the market process. Both types of entrepreneurs are no different from each other The Entrepreneurial Market Process: - Process of coordination and social harmony - Knowledge is generated, discovered, and acted upon - Interconnection of economic activities and production guided by economic calculation - Note that entrepreneurship can only be introduced into analysis when competition is viewed as dynamic and the future is uncertain. - Open-ended environment where relevant opportunities are not known at the outset. Feedback: - Entrepreneurial alertness entails recognizing that inputs can be acquired and combined to produce a good that can be sold. - Entrepreneurial alertness can lead to profit and loss: - Entrepreneurship is drive, ex ante, by the potential for monetary (as well as nonmonetary) profit Entrepreneurship is rewarded/sanctioned, ex post, by the profit/loss as a result of the activity. Institutions as Entrepreneurial Filters Produce vs Unproductive Entrepreneurship: Profit-Seeking (Productive) vs Rent-Seeking (Unproductive): - Both are forms of entrepreneurship and seeking profit above opportunity cost. Its the outcome (of positive-sum vs negative-sum) that determines productive vs unproductive entrepreneurship. - “Rent is part of the payment to the owner of resources over and above that which those resources could command in any alternative use. Rent is receipt in excess of opportunity cost” - “So long as owners of resources prefer more to less, they are likely to be engaged in rent seeking, which is simply another word for profit seeking.” Rent-Seeking: The entrepreneurial effort to acquire existing wealth or prevent transfers of existing wealth. The outcome will be negative-sum. Intentional - monopolizes a good or service - “The term rent seeking is designed to describe behavior in institutional settings where individual efforts to maximize value generate social waste rather than social surplus.” - In markets, entrepreneurs seeking new opportunities to earn rents generate benefits. - A first-moving innovator who brings their product to market will earn economic rents - Over time, and absent artificial barriers to entry, these rents will attract new entrants and be competed away. - Ex: surge pricing (i.e. uber prices increase spontaneously) -> example of profitseeking, not rent-seeking - Rent seeking politics is different than in markets. - Economic actors seek favors, barriers to entry, etc through the political process. - Resources are expanded to secure transfers of existing wealth which is different from the creation of wealth in markets. - Resources are expended to establish barriers to entry (government licenses, quotas, permits, authorization, etc.) to prevent the competitive process from operating meaning rents are not competed away. - Scarcity and opportunity costs lost Rent-Seeking: Welfare Loss - Gordon Tullock - “The welfare costs of tariffs, monopolies, and theft” - Main point: where there is profit to be gained through politics, people will invest resources to secure that profit - Implication: most studies of tariffs, monopolies, etc. focus on the associated deadweight loss and neglect the rent-seeking that takes place to secure those privileges ● Institutions as Entrepreneurial Filters: Implications ○ Entrepreneurship is ubiquitous across time and place, but the manner in which entrepreneurship manifests itself at a particular time and palace is institutionally contingent ○ The difference in economic performance between societies is not explained by a lack of entrepreneurship, but institutions that incentivize unproductive entrepreneurship rather than productive entrepreneurship ■ War is rent-seeking ● Predatory pricing → (i.e. Rockefeller, Carnegie) starting with the lowest prices and then after the competition is gone when a monopoly exists to raise the prices ● Horizontal integration is when a business grows by acquiring a similar company in their industry at the same point of the supply chain. Vertical integration is when a business expands by acquiring another company that operates before or after them in the supply chain. Entrepreneurship, the Paradox of Governance, and the Economic Foundations of Political Freedom (democracy under the rule of law) ● The paradox of governance ○ The combination of empowering a governing authority to secure and define property rights also generates strong incentives to abuse such power, and therefore undermine the enforcement of property rights ○ ● ● Theoretically speaking, the use of force can be a productive activity if it used as a means to define and enforce property rights ○ Or, it can be unproductive if violence is used to engage in wealth transfers in the form of public predation or private predation ○ From this perspective, the fundamental basis for securing and defining property rights, and hence economic development, is the minimization of the returns to using force in the first place ○ The question then becomes one of how the relative payoffs become established regarding the utilization of trade or violence to allocate resources The “entrepreneurial” foundations of the economic freedom, the rule of law, and democracy: ○ Bamoul (1990): ■ Why Europe, not Asia, first to achieve sustained economic development? ■ “In China, as in many kingdoms of Europe before the guarantees of the Magna Carta and the revival of town sand their acquisition of privileges, the monarch commonly claimed possession of all property in his territories (p.87) ■ “As a result, in China, when the sovereign was in financial straits, confiscation of the property of wealthy subjects was entirely in order.” (p.87) ■ “Before the rise of the cities and before monarchs were able to subdue the bellicose activities of the nobility, wealth, and power were pursued primary through military activity.” (Baumol, p.87) Approach to economic and political development ○ How could it ever be in the self-interest of an autocratic ruler to cede political authority and unintended sow the seeds for economic freedom and democracy? ○ The critical link is the evolution of the rule of law ○ Political trade off: security vs. wealth SECTION 3: The Socialist Calculation Debate, the Soviet Experiment with Socialism, and Transitional Political Economy in Post-Soviet Russia Highlights of the Socialist Calculation Debate ● Formal Timeline: 1920-1945 ● “Rounds of the Debate ○ Marxists economists vs. Austrian economists ○ Market socialist economists vs. Austrian economists ■ The notion that value is determined on the margin or subjectively determined by the value by consumers ● ● Marxists regarded the source of value being determined by the labor being put into a product Key Articles and Books: ○ Ludwig von Mises (1920) “Economic Calculation in the Socialist Commonwealth” ○ Oskar Lange (1936) “The Economic Theory of Socialism” Key Points of the Socialist Calculation Debate ● The socialist calculation debate, the debate over the possibility of economic calculation under socialism, is best understand as a methodological battle over economic theory itself, not as an ideological battle ○ The debate centered around different meanings (and misunderstandings) of the word “competition” ○ The debate included advocates of free markets, who agreed with socialist economists that economic calculation under socialism was theoretically possible (e.g. Frank Knight and Joseph Schumpeter) ● ALL of the contributions to the debate were meant to answer or defend the og. article Marx’s Economic Critique of Capitalism and Economic Theory of Socialism ● Marx’s concept of socialist central planning has an importance that transcends its role in the calculation debate ● In its broad outlines, Marx’s idea of bringing social production under “conscious control,” rather than leaving it to the whims of the “anarchic” forces of capitalism, is still the primary economic reason of socialism ● Marx was a systemic and radical theorist ○ Marx understand well the institutional underpinnings that fundamentally distinguished capitalism from socialism ● Within Marx’s explicit critique of capitalism, there was also an implicit theory of socialism ○ For Marx, studying capitalism and developing a positive theory of socialism are how aspects of the same endeavor ○ ● ● ● ● Marx said little directly about the nature of socialism, but in Das Kapital he described its fundamental attributes by clarifying its antithesis - capitalism If we understand what socialism is, we understand what capitalism is not Marx’s criticism of capitalism is not that it is based on human action, but that it is not of human design Marx would like to eliminate the wastes and exploitation of capitalism through perfect plan coordination under a single, deliberate, and unified plan Marx expected socialism to emerge from the progression of capitalism ○ Hence, it could not be achieved until the workers were numerous and united enough to take control of the means of production, or before the centralization of capital has proceeded far enough to make these means of production accessible to such centralized control ● ● ● In Marx’s vision of the production process, he distinguishes between production time and circulation time ○ Production time refers to actual time spend producing the commodity that the capitalist intends to make with the inputs purchased ○ Circulation time refers to the time spent transforming money into commodities and commodities into money It is precisely this aspect of the production process (circulation time) that is claimed to be unnecessary under Marxist socialism Resources expended in circulation time are wastes of the capitalist mode of production (or commodity production) and deductions of the capitalist’s surplus value, which is expropriated from workers What is Socialism? ● For Marx, socialism means first and foremost the abolition of private property in the means of production, and therefore an abolition of all market exchange in the means of production, for the purpose of delivering advanced material production ○ Production for direct use would replace production for exchange ● Socialism, by definition, therefore included an abolition of money prices, which are a result of the exchange of private property in the means of production Mises’s Critique of Economic Calculation under Socialism ● Mises’s argued that economic calculation under socialism is impossible ○ Positive critique of the coherence between means and ends of socialism ○ NOT a normative critique of socialism ● Mises’s critique was NOT a normative critique of the goals of socialism, ONLY the means by which to achieve it What is Economic Calculation? ● A competitive process of allocating scarce capital goods among competing consumer ends ● Mechanism for sorting among technologically feasible production projects those that are economically viable from those that are not ● Fundamentally, a competitive process that communicates contextual knowledge The Basis of Mises’s Critique of Socialism ● For the sake of argument, Mises granted central planners the following assumptions: ○ A free market in consumer goods ○ Perfect motivation (benevolence) ○ Complete access to current technological knowledge Mises’s Syllogism 1. Without private property in the means of production, there will be no market for the means of production 2. Without a market for means of production, there will be no monetary prices established for the means of production 3. Without monetary prices, reflecting the relative scarcity of capital goods, economic decision-makers will be unable to rationally calculate the alternative use of capital goods The Nature and Implications of Mises’s Critique of Socialism ● Mises argued that the nature of the knowledge generated through market rivalry and embodied in money prices is contextual ● F.A. Hayek would render explicit the knowledge argument that had already been implicit in Mises’s critique against Marxist socialism ● Mises’s critique extends also to non-comprehensive planning Lange-Lerner Model of Market Socialism: The Response to Mises ● Central planning board would instruct the managers of state-owned enterprises to follow a set of profit maximizing rules consistent with perfect competition: ○ Price according to marginal cost ○ Produce at a level of output that minimizes AC ● By doing so, such managers would grope towards the conditions of equilibrium through trial and error, or what Leon Walras referred to as a series of tatonnements, a process which Langue and Lerner regarded as analogous to that which takes place under capitalism Hayek’s Response to Market Socialism ● According to Hayek, relative prices serve two roles in the market process: ○ An ex-ante role of guiding production in their capacity as relative prices ○ An ex-post role of assessing previous economic decisions in their capacity as inputs through profit and loss accounting ● Market prices are never equilibrium prices, and therefore not sufficient for economic calculator ● The information required to achieve profit-maximization and market equilibrium that are assumed to be given by market socialists, are by-products of the rivalrous market process ● Market socialism assumes away the very economic problem it claims to solve, namely how the information becomes generated and embodied in prices in the first place ● Outside the context of market competition through the exchange of private property over the means of production, this information does not exist, and therefore is not accessible to central planners Concluding Remarks ● Fundamentally, the socialist calculation debate was a controversy over the nature and role of competition in the market process ○ ○ ○ ● The Marxists condemned competition for wastefulness The Austrians (Mises and Hayek) asserted its information necessity The market socialists thought assumed it easy or failed to recognize the consequences of its introduction into their models without the institutional prerequisite of private property Whereas the Marxists and Austrians understood competition as a verb (a process of equilibrium), the Market Socialists understood competition as a noun (an equilibrium state of affairs) Policy Implications for Economies in Transition ● Until the collapse of communism in Eastern and Central Europe, Lange and Lerner were regarded as having “won” the debate ● In the aftermath of the collapse of central planning, what many mainstream economists had to “rediscover” were the institutional prerequisites that made a transition to a market process possible in the first place ● Policy recommendations such “privatization” or “price liberalization” without privet property under the rule of law puts the cart before the horse The Soviet Experiment with Socialism The Period of “War Communism” (1918-1921) ● Bolsheviks and Mensheviks ● The Political economy of Soviet Socialism ○ Our previous discussion on the problem of economic calculation was to establish theoretically how it would be impossible to rationally calculate under socialism The Debate over War Communism ● The chronology of economic events and economic polices that were pursued during the Russian civil war between are known today as “War Communism” (1918-1921) ● The debate over the period of “War Communism” is not a dispute over the facts of economic history, but a dispute over the interpretation of such facts, which included: ○ The abolition or private property ○ The elimination of currency and money prices ○ Forced collectivization of land and labor to centrally manage production Historical Background of the “War Communism” Period: 1918-1921 ● During the spring of 1917 leading up to the October Revolution in which power was seized from Czar Nicolas II of Russia, there existed four major political factions under a provisional government in Russia: ○ 1. Conservatives to the right of Constitutional Democrats ○ ○ ○ 2. The constitutional Democrats 3. The Social Democrats and the Socialist Revolutionaries (including Mensheviks) 4. The Bolsheviks Two Interpretations of the History of “War Communism” ● Interpretation #1: The policies implemented during the Russian Civil War between the Mensheviks and the Bolsheviks between 1919 and 1922 were a matter of military expediency ● If so, then Mises’s original critique regarding the impossibility of economic calculation under social is not historically applicable to “War Communism” Interpretation #1: War Communism as a Function of the Russian Civil War ● Maurice Dobb and E.H. Carr argued that this was necessary for the Bolsheviks to fight the civil war ○ Inflation was a forced tax on the moneyed bourgeois class, not on the proletariat in keeping with socialist principles ○ Once money became worthless, it became necessary to abolish private poverty by confiscating resources by force for the war effort Two Interpretations of the History of War Communism ● Interpretation #2: The period of “War Communism” represents an intended attempt to immediately implement a new social order in strict accordance with Marxist theory ● If so, it therefore demonstrates that Mises’s critique regarding the impossibility of economic calculation under socialism is correct Interpretation #2: “War Communism” was intended prior to the Russian Civil War ● According to Lenin and the Bolsheviks, World War I had ripened the conditions for a Marxist revolution given that war planning (emulating the German move to a command economy under the Hindenburg Program of 1916) had increasingly concentrated capital and brought production under increasingly conscious control ● World War I had intensified the exploitation of the proletariat ● Therefore, Lenin believed that the workers could and should take state power immediately and implement socialism according to Marxist doctrine The New Economic Policy (1921-1928), Introduction: ● After the failed attempt to construct a socialist order along Marxist lines during the period of “War Communism” (1918-1921) never thereafter did the Soviet Union attempt to implement socialism in its purest form ● In order to maintain power, Vladimir Lenin and the Bolsheviks were forced to retreat from their experiment with pure socialism ● This retreat was characterized by a series of economic policies that partially reintroduced market exchange and production, beginning in the spring of 1921, known as the “New Economic Policy” (NEP) Credible Commitment and Economic Reform ● Economic reform cannot achieve its desired objections without a credible commitment to institutional change, one that recommits political officials to rules, and therefore changes the payoff structure of both political agents as well as economic agents ● Distinction between de jure reforms and de facto reforms ○ De jure reform implies an official, or formal, change institutions or public policy ○ De facto reform implies an actual change in institutions or public policy, even though it may not be an official policy ○ De jure changes do not necessarily result in de facto changes, particular if there is no credible commitment to such change ● The argument for discretion is based on the premise that policies accepted for one period may prove to be inappropriate for another and, therefore, policymakers must have flexibility to adjust as circumstances change ○ The fundamental problem with the exercise of discretion in public policy is that, without binding commitment to the policy, unexpected changes in policy, which may appear optimal to a particular situation of time and place, can provoke unintended consequences that run counter to the objectives of policy ○ The problem is that economic actors who realize such unexpected changes will anticipate the policy change and act in a counterproductive manner from the perspective of the policy-maker ○ Focusing on the credibility and commitment problem allows us to highlight why recurring rounds of reform efforts that occurred in the Soviet Union failed to achieve its objectives The Economic Transition to NEP ● NEP represented a policy of economic liberalization that was intended to restore partial economic freedom to the peasants, appease political unrest, and spur agricultural production ○ Relative freedom of exchange and production produced a drastic recovery from the catastrophe of war communism, particularly through the entrepreneurial activity of middlemen, known as “Nepman” ● The fundamental basis of NEP was the substitution of the tax in kind for the grain requisitioning of “War Communism” ● May 1921: The Sovnarkom (Council of People’s Commissars) permitted not only the sale of surplus food by peasants in farmer markets as well as trade by others of goods produced by small scale private manufacturers Problems with Reform Efforts of NEP ● ● ● ● The fundamental problem with the NEP is that it did not dismantle the existing institutional infrastructure within which production took place ○ Through some private property exchange was allowed, sustained economic growth and recovery could not occur without the rule of law ○ Without a credible commitment that established binding constraints on the discretion of the Bolsheviks, NEP was not able to achieve its objectives The NEP that was implemented with incentive incompatibilities, failing both economically and politically Political Problems underling the goals of NEP ○ Ideological commitments of the Communist Party ○ At the same time that Lenin re-introduced market mechanisms, he outlawed all political factions within Soviet politics, including factions within the Communist Party Economic Problems undermining the goals of NEP ○ Price controls and laws against speculation created legal uncertainty for NEP ○ Without the rule of law, arbitrary requisitioning was perceived as a viable policy option The End of NEP ● What followed the end of NEP in 1928 were the increasingly authorization measures of Joseph Stalin, including collectivization of agriculture ● The failure of NEP was caused neither by market institutions nor due to the particular motivations of political officials (Lenin and later Stalin) ● NEP failed due to the internal contraindications of its policy, which would required increasing political control over the economy The Tragedy of the Failure of NEP ● The failure of the experiment with pure socialism, the subsequent failure of the NEP, and the rise of totalitarian rule under Stalin, cannot be explained by having malevolent individuals in charge of planning the economy ● As Mises argued above, the institutional conditions of socialism precluded central planners from achieving their objectives even under the best of intentions ● The rise of totalitarianism under Stalin is an unintended consequence of socialism, not a historical accident. How? F.A. Hayek “Why the Worst Get on Top” ● An application of Adam Smith’s notion that specialization under the division of labor is limited by the extent of the market, but applied to politics ○ Distinction: markets are based on voluntary exchange, whereas government refers to a monopoly of legitimatized force (Max Weber) ○ ● As the extent of central planning increases, the incentive structure within this political context, by logical implication, will select leaders with a comparative advantage to specialize in the use of force ○ The complexity of centrally planning an economic system implies that the planners must be granted almost unlimited discretion in order to respond to its unintended consequences Totalitarianism is neither a consequence of “corruption” nor “historical accident”, but rather a logical consequence of the institutional incentives of the attempt to transition to a centrally planned economy A Rent-Seeking Model of Soviet Economy: The Soviet Economic in Theory and Practice ● Questions: ○ Given the impossibility of economic calculation under a socialism, how can we explain the duration and existence of the Soviet Union? ○ If central planning did not operate under the guidelines of Marx or according to the model of market socialism, how did it actually operate? ○ Why were there pervasive shortages in the Soviet economy, as well as other centrally planned economics in Eastern and Central Europe. ● Soviet-style socialism in reality was best understood as a mercantilist economy Characteristics of Mercantilism ● The government is headed by an autocrat ● This autocratic state extensively intervenes in the economy and sponsors a large variety of monopolies and cartel arrangements ● Positions of monopoly status as well as various other restrictions on competitive entry are sold by the autocrat as a means of raising revenue; ● The autocrat employs a specialized bureaucracy whose is to monitor the various monopolist-franchisees to ensure that they do not behave “competitively” in relation to one another, and also to enforce barriers designed to deter outside entrants Why is the Mercantilist Model to Understand the Soviet Economy? ● First, given the Soviet economy’s inefficiency in terms of delivering economic prosperity to the masses of the population, it explains the political logic by which the Soviet system was able to last so long ○ This logic was to concentrate benefits on those in power and disperse the costs of inefficiency on the masses of impoverished Soviet citizens ○ As a result, the Soviet system incentivized the creation of a loyal bureaucracy, who benefited directly from maintaining the existing system ● Second, this model is uniquely well-suited to analyzing resource allocation in non-market settings, such as in politics ○ ○ ○ Mercantilism is a rent-seeking economy Rent-seeking is simply the non-market manifestation of competition for income, derived from political control rights over resources Rather than abolishing private property and rivalrous competition of the marketplace, in reality property rights and competition were simply transferred to the political marketplace of patronage, known as the nomenklatura system Digression: The Nomenklatura System ● The nomenklatura refers to a vast political cartel of interlocked state monopolies, which worked to provide and protect perquisites to those in appointed positions of power, namely by controlling entry and competition to these positions ○ ● ● In effect, the nomenklatura refers to a vast collusion among the separate stateowned firms and ministries so that the Soviet system operated as an effective political and economic monopoly ○ Illicit entry and competition by one monopolist into the privileged market domain of another state-sanctioned monopolist was controlled so as not to chisel the value of the latter’s monopoly privilege, which came in the form of bribes and perquisites received from de facto control of state resources Third, it also provides the rationale behind the persistence of a shortage economy and the bias in centrally planned prices throughout the history of the USSR Contrary to the model of market socialism, why were the Soviet central planners incentivized to hold down prices over scarce goods and services, and therefore perpetuate shortages, rather than set market-clearning prices? Summary ● De jure, centralization of the Soviet economy was centralized into one big factory along the guidelines of Marxism, where private property in the means of production, market prices, and profit and losses were abolished. ● De facto, informal property rights continued to operate, both externally in the form of black markets, and internally through control over state-produced resources, which were monetized via exchange on the black market.